PAYCHEX, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations reviews the operating results ofPaychex, Inc. and its wholly owned subsidiaries ("Paychex ," the "Company," "we," "our," or "us") for the three months endedAugust 31, 2020 (the "first quarter"), the respective prior year period endedAugust 31, 2019 , and our financial condition as ofAugust 31, 2020 . The focus of this review is on the underlying business reasons for material changes and trends affecting our revenue, expenses, net income, and financial condition. This review should be read in conjunction with theAugust 31, 2020 consolidated financial statements and the related Notes to Consolidated Financial Statements (Unaudited) contained in this Quarterly Report on Form 10-Q ("Form 10-Q"). This review should also be read in conjunction with our Annual Report on Form 10-K ("Form 10-K") for the year endedMay 31, 2020 ("fiscal 2020"). Forward-looking statements in this review are qualified by the cautionary statement included under the next sub-heading, "Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995."
Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995
Certain written and oral statements made by us may constitute "forward-looking statements" within the meaning of the safe harbor provisions ofthe United States ("U.S.") Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by such words and phrases as "we expect," "expected to," "estimates," "estimated," "intend," "overview," "outlook," "guidance," "we look forward to," "would equate to," "projects," "projections," "projected," "projected to be," "anticipates," "anticipated," "we believe," "believes," "could be," "targeting," and other similar words or phrases. Examples of forward-looking statements include, among others, statements we make regarding operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to our outlook, revenue growth, earnings, earnings-per-share growth, or similar projections. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict, many of which are outside our control. Our actual results and financial conditions may differ materially from those indicated in the forward-looking statements. Therefore, you should not place undue reliance upon any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
·the impact of the COVID-19 pandemic on the
·changes in governmental regulations and policies;
·our ability to comply with
·our ability to keep pace with changes in technology and to provide timely enhancements to our products and services;
·our compliance with data privacy laws and regulations;
·the possibility of cyberattacks, security vulnerabilities, and Internet disruptions, including breaches of data security and privacy leaks, data loss, and business interruptions;
·the possibility of failure of our operating facilities, computer systems, or communication systems during a catastrophic event, including the COVID-19 pandemic;
·the failure of third-party service providers to perform their functions;
·the possibility that we may be subject to additional risks related to our co-employment relationship with our professional employer organization ("PEO");
·changes in health insurance and workers' compensation insurance rates and underlying claim trends;
·our clients' failure to reimburse us for payments made by us on their behalf;
·the effect of changes in government regulations mandating the amount of tax withheld or the timing of remittances;
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·volatility in the political and economic environment;
·risks related to acquisitions and the integration of the businesses we acquire;
·our failure to comply with covenants in our debt agreements;
·changes in the availability of qualified people, including management, technical, compliance, and sales personnel;
·our failure to protect our intellectual property rights;
·the possible effects of negative publicity on our reputation and the value of our brand; and
·potential outcomes related to pending or future litigation matters.
Any of these factors, as well as such other factors as discussed in our Form 10-K for fiscal 2020 or in our other periodic filings with theSecurities and Exchange Commission ("SEC"), could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10-Q is based upon the facts and circumstances known as of the date of this report, and any forward-looking statements made by us in this Form 10-Q speak only as of the date on which they are made. Except as required by law, we undertake no obligation to update these forward-looking statements after the date of filing this Form 10-Q with theSEC to reflect events or circumstances after such date, or to reflect the occurrence of unanticipated events. Our investor presentation regarding the financial results for the first quarter is available and accessible atPaychex's Investor Relations page at https://investor.paychex.com. Information available on our website is not a part of, and is not incorporated into, this Form 10-Q. We intend to make future investor presentations available exclusively through our Investor Relations page.
Overview
We are a leading provider of integrated human capital management ("HCM")
solutions for human resources ("HR"), payroll, benefits, and insurance services
for small- to medium-sized businesses. The workplace is evolving, and we lead
the way by making complex HR, payroll, and benefits simple for our clients. Our
purpose is to allow our clients the freedom to succeed. Our mission is to be the
leading provider of HR, payroll, benefits, and insurance solutions by being an
essential partner to small- and medium-sized businesses across the U.S. and
parts of Europe , and we believe that success in this mission will lead to
strong, long-term financial performance. Our strategy focuses on providing
industry-leading, integrated technology; increasing client satisfaction;
expanding our leadership in HR; growing our client base; and engaging in
strategic acquisitions.
Within our HCM solutions we offer a comprehensive portfolio of services and
products that cover the spectrum of the employee life cycle and allow our
clients to meet their diverse HR and payroll needs. Clients can select services
on an á la carte basis or as part of various product bundles. We can customize
our offering to the client's business, whether it is small or large, simple or
complex.
Our portfolio of HCM and employee benefit-related services is disaggregated into
two categories, Management Solutions and PEO and Insurance Solutions, as
discussed in Part 1, Item 1 of our Form 10-K for fiscal 2020. Our solutions
bring together payroll and HCM software with flexible, personalized,
technology-enabled service capabilities. Paychex Flex®, our proprietary HCM
software-as-a-service platform, unites HR, payroll, time and attendance, and
benefits processes to manage the employee life cycle from recruiting and hiring
to retirement. Clients can select the modules they need and easily add on
additional services as they grow. Paychex Flex provides function-focused
analytics throughout to assist HR leaders in making informed business decisions.
Paychex Flex mobility and self-service capabilities allow clients and their
employees access anywhere, at any time, on any device. We also provide
comprehensive HR outsourcing solutions through our administrative services
organization and PEO solutions. Our HCM and HR outsourcing solutions are
supported with our HR and Compliance expertise and our technology-enabled
service capabilities.
We continue to focus on driving growth in the number of clients, revenue per
client, total revenue and profits, while providing industry-leading service and
technology solutions to our clients and their employees. We maintain
industry-leading margins by managing our personnel costs and expenses while
continuing to invest in our business, particularly in leading-edge technology
and go-to-market tools and resources. We believe these investments are critical
to our success. Looking to the future, we believe that investing in our
products, people, and service capabilities will position us to capitalize on
opportunities for long-term growth.
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Concentrated effort remains on the continued enhancements of our Paychex Flex platform. Our current and past investments in our platforms have prepared us well for the demands of this environment, allowing us to adapt while maintaining high levels of service delivery resulting in client satisfaction and retention. The Company's most recent round of product releases includes solutions designed to help organizations stay connected with remote workers and assist clients as workers return to the office, which are as follows:
?HR Connect, which enables employees to digitally submit questions, requests, and incidents directly to HR through an easy-to-use workflow;
?
?New Live Reports, such as Job Costing and Labor Distribution, Workers' Compensation, and Employee Change History reports, which provides improved report search capabilities and helps businesses lead with insights.
First Quarter Financial Highlights
Results of operations for the first quarter were adversely impacted as the COVID-19 pandemic has continued to affect our business, our clients' businesses, and the markets we serve. Refer to the "COVID-19 Update" section of this Item 2 for further discussion on the ongoing impact of COVID-19 along with our response to the pandemic.
Financial highlights for the first quarter compared to the prior year period are as follows:
?Total revenue decreased 6% to
?Operating income decreased 19% to
?Net income decreased 20% to
?Diluted earnings per share decreased 19% to
(1) Adjusted operating income, adjusted net income, and adjusted diluted earnings per share are notU.S. generally accepted accounting principles ("GAAP") measures. Adjusted operating income, adjusted net income, and adjusted diluted earnings per share include adjustments for one-time costs of$31.2 million related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization, and net tax windfall benefits related to employee stock-based compensation payments. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measures of operating income, net income, and diluted earnings per share. For further analysis of our results of operations for the first quarter, and our financial position as ofAugust 31, 2020 , refer to the tables and analysis in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 2. COVID-19 Update As the global COVID-19 pandemic has continued to evolve, our priority has been and continues to be, the health and safety of our employees. We were expedient with the implementation of our business continuity plan, which included moving 95% of our workforce to work remotely and restricting unnecessary travel. While we are well-prepared to continue operating this way, we are in the planning stages of bringing back a small portion of our workforce to the office on a volunteer-only basis. As our clients continue to manage through the COVID-19 pandemic, we remain committed to helping them keep their businesses open and return to more normal operations. Our blend of technology and service provides valuable tools and resources to assist our clients and their employees during this critical time. The technology investments we made to our Paychex Flex payroll and human resources suite of products positioned us to service our clients and support them in managing a remote workforce. In addition, we created a COVID-19 Help Center on our website to assist our clients and provide them with the support and resources they need as well as provide resources to our key business partners, including accountants, financial institutions, financial advisors, and national associations. The COVID-19 Help Center has been translated into Spanish to serve our Spanish-speaking clients. We released several new innovative Paychex Flex features and functions during the first quarter to our clients to address the ongoing business challenges and shifting workplace dynamics as a result of the COVID-19 pandemic which are discussed in the "Overview" section of this Item 2. As the global economy continues to evolve for our clients, whether due to legislative changes, the pandemic, or other factors, we are committed to supporting our clients to help them navigate these challenges. 18
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Financial results for the first quarter showed marked improvement as most of our key business metrics recovered at a faster rate than anticipated. The effects of the COVID-19 pandemic continue to impact our results causing unfavorable year-over-year comparisons, however, client retention has remained strong and sales performance is accelerating with year-over-year growth in the number of clients sold. Our strong balance sheet and operational flexibility allowed us to successfully manage through the ongoing impacts of COVID-19 to date while protecting our cash flow and liquidity. In addition, we implemented cost-saving initiatives, including a long-term strategy to reduce our geographic footprint and headcount optimization. We will continue to evaluate the nature and extent of future changes to market and economic conditions related to COVID-19 and will assess the potential impact to our business and financial position.
For further discussion on the risks posed to our business from the COVID-19 pandemic, refer to Item 1A of our Form 10-K for fiscal 2020.
RESULTS OF OPERATIONS
Summary of Results of Operations:
For the three months ended
August 31,
In millions, except per share amounts 2020 2019 Change(1)
Revenue:
Management Solutions $ 687.4 $ 724.5 (5) %
PEO and Insurance Solutions 229.9 247.0 (7) %
Total service revenue 917.3 971.5 (6) %
Interest on funds held for clients 14.9 20.5 (28) %
Total revenue 932.2 992.0 (6) %
Total expenses 648.2 642.9 1 %
Operating income 284.0 349.1 (19) %
Other expense, net (7.9) (4.8) n/m
Income before income taxes 276.1 344.3 (20) %
Income taxes 64.5 80.1 (19) %
Effective income tax rate 23.4 % 23.3 %
Net income $ 211.6 $ 264.2 (20) %
Diluted earnings per share $ 0.59 $ 0.73 (19) %
(1) Percentage changes are calculated based on unrounded numbers.
n/m - not meaningful
We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As ofAugust 31, 2020 , we had no exposure to high-risk or non-liquid investments. Details regarding our combined funds held for clients and corporate cash equivalents and investment portfolios are as follows: For the three months ended August 31, $ in millions 2020 2019
Change
Average investment balances: Funds held for clients$ 3,507.2 $ 3,744.6 (6) % Corporate cash equivalents and investments 1,022.2 862.0 19 % Total$ 4,529.4 $ 4,606.6 (2) %
Average interest rates earned (exclusive of net realized gains/(losses)): Funds held for clients
1.7 % 2.1 %
Corporate cash equivalents and
investments 0.2 % 1.8 %
Combined funds held for clients and
corporate cash equivalents and
investments 1.3 % 2.0 %
Total net realized gains $ 0.3 $ 0.9
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August 31, May 31,
$ in millions 2020 2020
Net unrealized gains on available-for-sale securities(1)
$ 100.0 Federal Funds rate(2) 0.25 % 0.25 % Total fair value of available-for-sale securities$ 2,980.1
3.3 2.9
Weighted-average yield-to-maturity of available-for-sale securities(3)
2.0 % 2.1 %
(1) The net unrealized gain on our investment portfolio was approximately
(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of
(3) These items exclude the impact of variable rate demand notes ("VRDNs") as they are tied to short-term interest rates.
Management Solutions revenue: Management Solutions revenue was$687.4 million for the first quarter reflecting a decrease of 5% compared to the prior year period. The decrease was primarily driven by a decline in check volumes, partially offset by increased penetration of retirement services. The decline in check volumes was due to a reduction in the number of clients processing payrolls as well as the number of clients' employees paid. PEO and Insurance Solutions revenue: PEO and Insurance Solutions revenue was$229.9 million for the first quarter reflecting a decrease of 7% compared to the prior year period. The decrease was primarily driven by a decline in the number of our clients' worksite employees. Insurance Solutions revenue declined as a result of lower workers' compensation premiums driven by reduced wages due to fewer worksite employees for certain industries and related premium rates. Interest on funds held for clients: Interest on funds held for clients was$14.9 million for the first quarter reflecting a decrease of 28% compared to the prior year period. The decrease resulted from lower average investment balances, average interest rates, and realized gains. Funds held for clients average investment balances were impacted by lower client fund collections and changes in client base mix, offset by wage inflation and timing of collections and remittances. Total expenses: Total expenses were$648.2 million for the first quarter reflecting an increase of 1% compared to the prior year period. The following table summarizes total combined cost of service revenue and selling, general and administrative expenses: For the three months ended August 31, In millions 2020 2019 Change(1) Compensation-related expenses $ 370.6$ 363.4 2 % Depreciation and amortization 49.6 52.9 (6) % PEO insurance costs 84.5 90.0 (6) % Cost-saving initiatives 31.2 - n/m Other expenses 112.3 136.6 (18) % Total expenses $ 648.2$ 642.9 1 %
(1) Percentage changes are calculated based on unrounded numbers.
n/m - not meaningful
The increase in total expenses was primarily driven by one-time costs of$31.2 million related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization. Total expenses, excluding these one-time costs, decreased approximately 4% for the first quarter compared to the prior year period. This decrease in total expenses, excluding one-time costs, was driven by lower discretionary spending and a decrease in PEO direct insurance costs, partially offset by an increase in compensation-related expenses. Compensation-related expenses increased 2% for the first quarter compared to the prior year period. The increase in compensation-related expenses was driven by higher wages compared to the prior year period. Depreciation expense is primarily related to buildings, furniture and fixtures, data processing equipment, and both purchased and internally developed software. Amortization of intangible assets is primarily related to client list acquisitions. The decrease in depreciation and amortization for the first quarter was driven by amortization of intangible assets acquired fromOasis Outsourcing Group Holdings, L.P. , which are amortized using an accelerated method.
PEO insurance costs include workers' compensation, minimum premium medical insurance plan arrangements and self-insured dental and vision plans where we retain risk. The decrease in PEO insurance costs was primarily driven by a decline in the number of our clients' worksite employees.
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Other expenses include items such as non-capital equipment, delivery, forms and supplies, communications, travel and entertainment, professional services, and other costs incurred to support our business. The decrease in other expenses was driven by lower spending in all areas, primarily travel and entertainment expenses. Operating income: Operating income was$284.0 million for the first quarter, reflecting a decrease of 19% compared to the prior year period. Operating margin (operating income as a percentage of total revenue) was 30.5% for the first quarter, compared to 35.2% for the prior year period. Adjusted operating income(1), which excludes the impact of one-time costs, decreased 10% to$315.2 million for the first quarter compared to the prior year period. Adjusted operating margin(1) was 33.8% for the first quarter, compared to 35.2% for the prior year period. (1) Adjusted operating income and adjusted operating margin are notU.S. GAAP measures. Adjusted operating margin is calculated as operating margin, adjusted for one-time non-recurring items, as a percentage of total revenue. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measure of operating income. Other expense, net: Other expense, net primarily represents interest expense incurred on our debt instruments, netted against earnings from our corporate cash and cash equivalents and investments in available-for-sale securities. We recognized$7.9 million and$4.8 million of other expense, net for the first quarter and respective prior year period, which was driven by interest expense related to our long-term borrowings. Other expense, net for both periods included$8.3 million of interest expense related to our long-term borrowings.
Income taxes: Our effective income tax rate was 23.4% for the first quarter compared to 23.3% for the prior year period. The effective income tax rates in both periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments.
Net income and diluted earnings per share: Net income was$211.6 million for the first quarter, reflecting a decrease of 20% compared to the prior year period. Diluted earnings per share was$0.59 per share for the first quarter, reflecting a decrease of 19% compared to the prior year period. Adjusted net income and adjusted diluted earnings per share, both non-GAAP measures, each decreased 11% to$228.0 million and$0.63 per share, respectively, for the first quarter. Adjusted net income and adjusted diluted earnings per share include adjustments for one-time costs of$31.2 million related to the acceleration of cost-saving initiatives and net tax windfall benefits related to employee stock-based compensation payments. Refer to the "Non-GAAP Financial Measures" section that follows for a discussion of these non-GAAP measures. 21
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Non-GAAP Financial Measures: Adjusted operating income, adjusted net income,
adjusted diluted earnings per share, earnings before interest, taxes,
depreciation, and amortization ("EBITDA"), and adjusted EBITDA are summarized as
follows:
For the three months ended
August 31,
$ in millions 2020(1) 2019 Change
Operating income $ 284.0 $ 349.1 (19) %
Non-GAAP adjustments:
Cost-saving initiatives(2) 31.2 -
Total non-GAAP adjustments 31.2 -
Adjusted operating income $ 315.2 $ 349.1 (10) %
Net income $ 211.6 $ 264.2 (20) %
Non-GAAP adjustments:
Excess tax benefit related to employee
stock-based compensation payments(3) (7.0) (6.6)
Cost-saving initiatives(2) 23.4 -
Total non-GAAP adjustments 16.4 (6.6)
Adjusted net income $ 228.0 $ 257.6 (11) %
Diluted earnings per share $ 0.59 $ 0.73 (19) %
Non-GAAP adjustments:
Excess tax benefit related to employee
stock-based compensation payments(3) (0.02) (0.02)
Cost-saving initiatives(2) 0.06 -
Total non-GAAP adjustments 0.05 (0.02)
Adjusted diluted earnings per share $ 0.63 $ 0.71 (11) %
Net income $ 211.6 $ 264.2 (20) %
Non-GAAP adjustments:
Interest expense, net 8.4 5.8
Income taxes 64.5 80.1
Depreciation and amortization expense 49.6 52.9
Total non-GAAP adjustments 122.5 138.8
EBITDA 334.1 403.0 (17) %
Cost-saving initiatives(2) 31.2 -
Adjusted EBITDA $ 365.3 $ 403.0 (9) %
(1) The calculation of the impact of non-GAAP adjustments on diluted earnings
per share is performed on each line independently. The table may not add down by
+/- $0.01 due to rounding.
(2) One-time costs and corresponding tax benefit recognized during the first
quarter related to the acceleration of cost-saving initiatives, including the
long-term strategy to reduce our geographic footprint and headcount
optimization. These events are not expected to recur.
(3) Net tax windfall benefits related to employee stock-based compensation payments recognized in income taxes. This item is subject to volatility and will vary based on employee decisions on exercising employee stock options and fluctuations in our stock price, neither of which is within the control of management.
In addition to reporting operating income, net income, and diluted earnings per share, which areU.S. GAAP measures, we present adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, which are non-GAAP measures. We believe these additional measures are indicators of our core business operations performance period over period. Adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, are not calculated through the application ofU.S. GAAP and are not required forms of disclosure by theSEC . As such, they should not be considered as a substitute for theU.S. GAAP measures of operating income, net income, and diluted earnings per share, and, therefore, should not be used in isolation, but in conjunction with theU.S. GAAP measures. The use of any non-GAAP measure may produce results that vary from theU.S. GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies. ? 22
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LIQUIDITY AND CAPITAL RESOURCES
Our financial position as ofAugust 31, 2020 remained strong with cash, restricted cash, and total corporate investments of$952.1 million . Total short-term and long-term borrowings, net of debt issuance costs were$803.0 million as ofAugust 31, 2020 . Our primary source of cash is generated by our ongoing operations. Cash flow from operations were$215.0 million for the first quarter. Our positive cash flows have allowed us to support our business and pay substantial dividends. We currently anticipate that cash, restricted cash, and total corporate investments as ofAugust 31, 2020 , along with projected operating cash flows and available short-term financing, will support our business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future. We believe that our investments in an unrealized loss position as ofAugust 31, 2020 were not impaired due to increased credit risk or other valuation concerns, nor has any event occurred subsequent to that date to indicate any change in our assessment. Financing Short-term financing: We maintain committed and unsecured credit facilities and irrevocable letters of credit as part of our normal and recurring business operations. The purpose of these credit facilities is to meet short-term funding requirements, finance working capital needs, and for general corporate purposes. We typically borrow on an overnight or short-term basis on our credit facilities. Refer to Note N of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2020 for further discussion on our credit facilities.
Details of our credit facilities are as follows:
Maximum August 31, 2020
Amount Outstanding Available
Expiration
$ in millions Date Available Amount Amount
Credit facilities:
JP Morgan Chase Bank, N.A. ("JPM") July 31,
2024 $ 1,000.0 $ - $ 1,000.0
JPM August 17,
2022 $ 500.0 - 500.0
PNC Bank, National Association February
("PNC") 6, 2023 $ 250.0 6.1 243.9
Total Lines of Credit Outstanding
and Available $
6.1
Amounts outstanding under the PNC credit facility as of
Details of borrowings under each credit facility during the first quarter and the respective prior year period were as follows:
For the three months ended August 31, 2020
Credit Facility
$1 Billion $500 Million $250 Million
$ in millions JPM JPM PNC
Number of days borrowed 2 - 92
Maximum amount borrowed $ 135.0 $ - $ 246.1
Weighted-average amount borrowed $ 89.5 $ - $ 14.3
Weighted-average interest rate 3.25 % - % 1.07 %
For the three
months ended
Credit Facility
$1 Billion $500 Million $150 Million
$ in millions JPM JPM PNC
Number of days borrowed 6 10 88
Maximum amount borrowed $ 469.0 $ 450.0 $ 56.6
Weighted-average amount borrowed $ 288.3 $ 395.6 $ 54.8
Weighted-average interest rate 5.33 % 3.27 % 3.07 %
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Short-term borrowings are primarily used for the settlement of client fund obligations, rather than liquidating previously-collected client funds that have been invested in available-for-sale securities allocated to our long-term portfolio.
Subsequent to
We expect to have access to the amounts available under our current credit facilities to meet our ongoing financial needs. However, if we experience reductions in our operating cash flows due to any of the risk factors outlined in, but not limited to, Item 1A in our Form 10-K for fiscal 2020 and otherSEC filings, including any impacts related to the COVID-19 pandemic, we may need to adjust our capital, operating and other discretionary spending to realign our working capital requirements with the capital resources available to us. Additionally, if we determined the need for additional short-term liquidity, there is no assurance that such financing, if pursued and obtained, would be adequate or on terms acceptable to us. Letters of credit: As ofAugust 31, 2020 , we had irrevocable standby letters of credit available totaling$147.9 million , required to secure commitments for certain insurance policies. The letters of credit expire at various dates betweenNovember 30, 2020 andJuly 15, 2022 . No amounts were outstanding on these letters of credit during the first quarter or as ofAugust 31, 2020 . Long-term financing: Certain information related to our Senior Notes are as follows: Senior Notes Senior Notes Series A Series B Stated interest rate 4.07% 4.25% Effective interest rate 4.15% 4.31% Interest rate type Fixed Fixed
Interest payment dates Semi-annual, in arrears Semi-annual, in arrears
Principal payment dates
Unsecured Unsecured
Refer to Note O of the Notes to Consolidated Financial Statements contained in
Item 8 of our Form 10-K for fiscal 2020 for further discussion on our long-term
financing.
Other commitments: We had outstanding commitments under legally binding
contractual arrangements and commitments under existing workers' compensation
insurance agreements. We also enter into various purchase commitments with
vendors in the ordinary course of business and had outstanding commitments to
purchase approximately $4.5 million of capital assets as of August 31, 2020 . In
addition, we are involved in two limited partnership agreements to contribute a
maximum of $20.0 million to venture capital funds in the financial technology
sector. As of August 31, 2020 , we have contributed approximately $8.7 million of
the total funding commitment.
In the normal course of business, we make representations and warranties that
guarantee the performance of services under service arrangements with clients.
Historically, there have been no material losses related to such guarantees. We
have also entered into indemnification agreements with our officers and
directors, which require us to defend and, if necessary, indemnify these
individuals for certain pending or future legal claims as they relate to their
services provided to us.
We currently self-insure the deductible portion of various insured exposures
under certain corporate and PEO employee benefit plans. Our estimated loss
exposure under these insurance arrangements is recorded in other current
liabilities on our Consolidated Balance Sheets. Historically, the amounts
accrued have not been material and were not material as of August 31, 2020 . We
also maintain insurance coverage in addition to our purchased primary insurance
policies for gap coverage for employment practices liability, errors and
omissions, warranty liability, theft and embezzlement, cyber threats, and acts
of terrorism; and capacity for deductibles and self-insured retentions through
our captive insurance company.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions with unconsolidated entities, which would have been established for facilitating off-balance sheet arrangements or other limited purposes. We do maintain investments as a limited partner in both low-income housing projects and venture capital funds focused on the financial technology sector. These are not considered part of our ongoing operations. These investments are accounted for under the equity method of accounting and represented less than one percent of our total assets as ofAugust 31, 2020 . ? 24
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Operating, Investing, and Financing Cash Flow Activities
For the three months ended
August 31,
In millions 2020 2019
Net cash provided by operating activities $ 215.0 $ 294.8
Net cash (used in)/provided by investing activities (236.3)
544.7
Net cash used in financing activities (382.8)
(413.2)
Net change in cash, restricted cash, and equivalents
426.3
Cash dividends per common share $ 0.62 $
0.62
Operating Cash Flow Activities
The changes in our operating cash flows for the first quarter compared to the prior year period were due to lower net income and changes in our operating assets and liabilities. The changes in our operating assets and liabilities were primarily driven by the timing of income tax payments, offset by changes in accrued compensation items.
Investing Cash Flow Activities
The changes in our investing cash flows for the first quarter compared to the prior year period were primarily attributable to fluctuations in the net purchases and sales/maturities of available-for-sale securities.
Fluctuations in the net change in purchases and sales/maturities of available-for-sale securities are largely due to timing within the client funds portfolio. The amount will vary based upon the timing of collection from clients, and the related remittance to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services. Specific timing impacting cash flows for the first quarter and the respective prior year are discussed further in the financing cash flows discussion of net changes in client fund obligations. In addition to timing fluctuations, the net change in purchases and sales/maturities of available-for-sale securities for both periods were due to changes in investment mix.
Discussion of interest rates and related risks is included in the "Market Risk Factors" section of this Form 10-Q.
Financing Cash Flow Activities
The changes in our financing cash flows for the first quarter compared to the prior year period was primarily impacted by a decrease in the repurchases of common shares, an increase in the net cash outflows from changes in client fund obligations, and a decrease in net proceeds from short-term borrowings. During the first quarter, we repurchased 0.4 million shares for$28.8 million . During the respective prior year period, we repurchased 2.0 million shares for$171.9 million . As ofAugust 31, 2020 ,$199.3 million remains available under common stock repurchase program. Refer to Part II, Item 2 of this Form 10-Q for further discussion on our common stock repurchase program. The client fund obligations liability will vary based on the timing of collecting client funds and the related required remittance of funds to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services. Collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days. The changes in cash flows related to the client fund obligations liability was primarily driven by Taxpay collections timing. For the first quarter, weekly and semi-weekly Taxpay collections received were remitted to regulatory authorities byAugust 31, 2020 . In the respective prior year period, weekly and semi-weekly Taxpay collections received were not remitted untilSeptember 2019 . 25
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MARKET RISK FACTORS
Changes in interest rates and interest rate risk: Funds held for clients are primarily comprised of short-term funds and available-for-sale securities. Corporate investments are primarily comprised of available-for-sale securities. As a result of our investing activities, we are exposed to changes in interest rates that may materially affect our results of operations and financial position. Changes in interest rates will impact the earnings potential of future investments and will cause fluctuations in the fair value of our longer-term available-for-sale securities. We follow an investment strategy of protecting principal and optimizing liquidity. A substantial portion of our portfolios is invested in high credit quality securities with ratings of AA or higher, and A-1/P-1 ratings on short-term securities. We invest predominantly in municipal bonds - including general obligation bonds and revenue bonds;U.S. government agency and treasury securities; corporate bonds; and asset-backed securities. We limit the amounts that can be invested in any single issuer and invest primarily in short- to intermediate-term instruments whose fair value is less sensitive to interest rate changes. We manage the available-for-sale securities to a benchmark duration of two and one-half to three and three-quarters years. During the first quarter, our primary short-term investment vehicles were bank demand deposit accounts and VRDNs. We have no exposure to high-risk or non-liquid investments. We have insignificant exposure to European investments. We have not and do not utilize derivative financial instruments to manage our interest rate risk. During the first quarter, the average interest rate earned on our combined funds held for clients and corporate cash equivalents and investment portfolios was 1.3% compared to 2.0% for the respective prior year period. When interest rates are falling, the full impact of lower interest rates will not immediately be reflected in net income due to the interaction of short- and long-term interest rate changes. During a falling interest rate environment, earnings decrease from our short-term investments, and over time, earnings will decrease from our longer-term available-for-sale securities. Earnings from the available-for-sale-securities, which as ofAugust 31, 2020 had an average duration of 3.3 years, would not reflect decreases in interest rates until the investments are sold or mature and the proceeds are reinvested at lower rates. The amortized cost and fair value of available-for-sale securities that had stated maturities as ofAugust 31, 2020 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, 2020 Amortized Fair In millions cost value Maturity date: Due in one year or less$ 347.8 $ 351.0
Due after one year through three years 680.7 705.1 Due after three years through five years 836.1 881.0 Due after five years
998.6 1,043.0
Total $ 2,863.2 $ 2,980.1
VRDNs are primarily categorized as due after five years in the table above as
the contractual maturities on these securities are typically 20 to 30 years.
Although these securities are issued as long-term securities, they are priced
and traded as short-term instruments because of the liquidity provided through
the tender feature.
As of August 31, 2020 , the Federal Funds rate was in the range of 0.00% to
0.25%. In response to the COVID-19 pandemic, the Federal Reserve reduced the
Federal Funds rate a total of 150 basis points in March 2020 to its current
range of 0.00% to 0.25%. There continues to be uncertainty in the rapidly
changing market and economic conditions, including any residual effects of the
COVID-19 pandemic. We will continue to monitor the market conditions.
Calculating the future effects of changing interest rates involves many factors. These factors include, but are not limited to:
?governmental action resulting from the COVID-19 pandemic;
?daily interest rate changes;
?seasonal variations in investment balances;
?actual duration of short-term and available-for-sale securities;
?the proportion of taxable and tax-exempt investments;
?changes in tax-exempt municipal rates versus taxable investment rates, which are not synchronized or simultaneous; and
?financial market volatility and the resulting effect on benchmark and other indexing interest rates.
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Subject to these factors and under normal financial market conditions, a 25-basis-point change in taxable interest rates generally affects our tax-exempt interest rates by approximately 17 basis points. Under normal financial market conditions, the impact to earnings from a 25-basis-point change in short-term interest rates would be approximately$3.0 million to$4.0 million , after taxes, for a twelve-month period. Such a basis point change may or may not be tied to changes in the Federal Funds rate. Our total investment portfolio (funds held for clients and corporate cash equivalents and investments) is expected to average approximately$4.9 billion for fiscal 2021. Our anticipated allocation is approximately 40% invested in short-term and VRDNs with an average duration of less than 30 days and 60% invested in available-for-sale securities, with an average duration of two and one-half to three and three-quarters years. The combined funds held for clients and corporate available-for-sale securities reflected net unrealized gains of$116.9 million as ofAugust 31, 2020 and$100.0 million as ofMay 31, 2020 . During the first quarter, the net unrealized gain on our investment portfolios ranged from$97.2 million to$121.9 million . These fluctuations were driven by changes in market rates of interest. The net unrealized gain on our investment portfolio was approximately$112.6 million as ofOctober 2, 2020 . As ofAugust 31, 2020 andMay 31, 2020 , we had$3.0 billion and$2.8 billion , respectively, invested in available-for-sale securities at fair value. The weighted-average yield-to-maturity was 2.0% as ofAugust 31, 2020 and 2.1% as ofMay 31, 2020 . The weighted-average yield-to-maturity excludes available-for-sale securities tied to short-term interest rates, such as VRDNs. Assuming a hypothetical increase in longer-term interest rates of 25 basis points, the resulting potential decrease in fair value for our portfolio of available-for-sale securities as ofAugust 31, 2020 , would be in the range of$20.0 million to$25.0 million . Conversely, a corresponding decrease in interest rates would result in a comparable increase in fair value. This hypothetical increase or decrease in the fair value of the portfolio would be recorded as an adjustment to the portfolio's recorded value, with an offsetting amount recorded in stockholders' equity. These fluctuations in fair value would have no related or immediate impact on the results of operations, unless any declines in fair value were considered to be other-than-temporary and an impairment loss recognized. Credit risk: We are exposed to credit risk in connection with these investments through the possible inability of the borrowers to meet the terms of their bonds. We regularly review our investment portfolios to determine if any investment is impaired due to increased credit risk or other valuation concerns and we believe that the investments we held as ofAugust 31, 2020 were not impaired as a result of the previously discussed reasons. While$29.0 million of our available-for-sale securities had fair values that were below amortized cost, we believe that it is probable that the principal and interest will be collected in accordance with the contractual terms, and that the gross unrealized losses of$0.2 million were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. Most of the securities in an unrealized loss position as ofAugust 31, 2020 andMay 31, 2020 held an AA rating or better. We do not intend to sell these investments until the recovery of their amortized cost basis or maturity, and further believe that it is not more-likely-than-not that we will be required to sell these investments prior to that time. Our assessment that an investment is not impaired due to increased credit risk or other valuation concerns could change in the future due to new developments, including changes in our strategies or assumptions related to any particular investment. We have some credit risk exposure relating to the purchase of accounts receivable as a means of providing payroll funding to clients in the temporary staffing industry. This credit risk exposure is diversified amongst multiple client arrangements and all such arrangements are regularly reviewed for potential write-off. No single client is material in respect to total accounts receivable, service revenue, or results of operations.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for
fiscal 2020, filed with the
?revenue recognition;
?assets recognized from the costs to obtain and fulfill contracts;
?PEO insurance reserves;
?goodwill and other intangible assets;
?impairment of long-lived assets;
?stock-based compensation costs; and
?income taxes.
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There have been no material changes in these aforementioned critical accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
Recently adopted accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements (Unaudited) contained in Item 1 of this Form 10-Q for a discussion of recently adopted accounting pronouncements.
Recently issued accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements (Unaudited) contained in Item 1 of this Form 10-Q for a discussion of recently issued accounting pronouncements.
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