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 endedNovember 30, 2019 (the "second quarter"), the six months endedNovember 30, 2019 (the "six months"), the respective prior year periods endedNovember 30, 2018 , and our financial condition as ofNovember 30, 2019 . 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 theNovember 30, 2019 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, 2019 ("fiscal 2019"). 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," "overview," "current 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:
·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;
·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;
·volatility in the political and economic environment;
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·risks related to acquisitions and the integration of the businesses we acquire,
including integrating
·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 2019 or 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. We have made available our investor presentation regarding the financial results for the second quarter. Please visitPaychex's Investor Relations page on our website at https://www.paychex.com/investors to view the presentation. We intend to make future investor presentations available exclusively through our Investor Relations page. Business We are a leading provider of integrated human capital management ("HCM") solutions for human resource ("HR"), payroll, benefits, and insurance services for small- to medium-sized businesses. Our business strategy focuses on personalized, technology-enabled service; industry-leading, integrated technology; providing a comprehensive suite of value-added HCM services; solid sales execution; continued service penetration; and engaging in strategic acquisitions. We believe that success in our mission to be a leading provider of HCM services by being an essential partner with America's businesses will lead to strong, long-term financial performance. We do this through the Power of Simplicity. Our industry-leading technology combines with our personalized, technology-enabled services to make HR administration, payroll, and benefits simple for our clients. We offer a comprehensive portfolio of HCM services and products that 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. Our offerings often leverage the information gathered in our base payroll processing service, allowing us to provide comprehensive outsourcing services covering the HCM spectrum. We support small-business companies through our core payroll, utilizing our proprietary, robust, software-as-a-service ("SaaS") Paychex Flex® platform and our SurePayroll® SaaS-based products. Both products allow users to process payroll when they want, how they want, and on any device (desktop, tablet, and mobile phone). Clients with more complex payroll and employee benefit needs are serviced through our Paychex Flex Enterprise solution, which offers an integrated suite of HCM solutions on the Paychex Flex platform, or through our legacy platform. Clients using Paychex Flex Enterprise are offered a SaaS solution that integrates payroll processing with HR management, employee benefits administration, time and labor management, applicant tracking, and onboarding solutions. Paychex Flex Enterprise allows mid-market clients to choose the services and software they need to meet the complexity of their business, all integrated through one HCM solution. 26
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Our portfolio of HCM and employee benefit-related services are as follows:
Service Description
Management Solutions:
Payroll processing services Includes the calculation, preparation, and
delivery of employee payroll checks; production
of internal accounting records and management
reports; preparation of federal, state, and local
payroll tax returns; and collection and
remittance of clients' payroll obligations.
Payroll tax administration Provides accurate preparation and timely filing
services of quarterly and year-end tax returns, as well as
the electronic transfer of funds to the
applicable federal, state, and local tax or
regulatory agencies.
Employee payment services Provides an employer the option of paying their
employees by direct deposit, payroll debit card,
a check drawn on a Paychex account (Readychex®),
or a check drawn on the employer's account and
electronically signed by us.
Regulatory compliance Includes new-hire reporting and garnishment
services processing, which enable employers to comply with
legal requirements and reduce the risk of
penalties. We also offer comprehensive solutions
to help clients navigate the Affordable Care Act.
HR Solutions (ASO) Offers businesses a combined package that
includes payroll, employer compliance, HR and
employee benefits administration, risk management
outsourcing, and the on-site availability of a
professionally trained HR representative, among
other services. Paychex HR Essentials is an
Administrative Services Organization product that
provides support to our clients over the phone or
online to help manage employee-related topics.
Retirement services Offers a variety of retirement plan options to
administration clients, as well as recordkeeping services, which
include plan implementation, ongoing compliance
with government regulations, employee and
employer reporting, participant and employer
online access, electronic funds transfer, and
other administrative services.
HR administration services Offers cloud-based HR administration software
products for employee benefits management and
administration, time and attendance solutions,
recruiting, and onboarding.
Other HR services and Includes section 125 plans and state unemployment
products insurance services.
Business services Offers various business services to companies.
Our wholly owned subsidiary, Paychex Advance,
LLC , provides a portfolio of services to the
temporary staffing industry, including payroll
funding (via the purchase of accounts receivable)
and outsourcing services, which include payroll
processing, invoicing, and tax preparation.
?
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PEO and Insurance Services:
PEO services Our licensed subsidiaries, Paychex Business
Solutions, LLC , HR Outsourcing Holdings, Inc.
("HROi"), and Oasis offer businesses a combined
package that includes payroll, employer
compliance, HR and employee benefits
administration, risk management outsourcing, and
the on-site availability of a professionally
trained HR representative, among other services.
We serve as a co-employer of our clients'
employees, offer health care coverage to PEO
client employees, and assume the risks and
rewards of workers' compensation insurance and
certain benefit insurance offerings.
Insurance services Our licensed insurance agency, Paychex Insurance
Agency, Inc. , offers insurance through a variety
of carriers. Insurance offerings include property
and casualty coverage, such as workers'
compensation; business-owner policies; commercial
auto; and health and benefits coverage, including
health, dental, vision, and life.
Overview
Our financial results for the second quarter reflected continued growth across
our major HCM product lines. Total revenue and total service revenue each
increased 15% for the second quarter. Management Solutions revenue and PEO and
Insurance Services revenue increased by 6% and 57%, respectively, for the second
quarter.
Interest on funds held for clients increased 9% for the second quarter. Our
combined funds held for clients and corporate investment portfolios earned an
average rate of return of 2.0% for the second quarter, compared to 1.9% for the
same period last year.
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 are continually
engaged in developing enhancements to and maintaining our software platforms to
meet the changing requirements of our clients and the marketplace. We continue
to invest in Paychex Flex, our robust cloud-based HCM platform, making
significant enhancements designed to simplify the complexity of HR
administration. The latest enhancements to our solutions will streamline payroll
processes and support business owners and HR professionals as they work to
optimize operations, comply with regulations, and drive productivity. For
example, Paychex Flex Assistant, our customer service chatbot, helps drive a
personalized, efficient, and simplified user experience by allowing users who
need help completing a task within Paychex Flex to rely on Flex Assistant, and
the intelligence behind it, to quickly and easily discover the answer.
Highlights of our financial results for the second quarter as compared to the same period last year are as follows:
?Total revenue increased 15% to
?Total service revenue increased 15% to
oManagement Solutions revenue increased 6% to
oPEO and Insurance Services revenue increased 57% to
?Interest on funds held for clients increased 9% to
?Operating income increased 11% to
?Net income increased 10% to
?Diluted earnings per share increased 11% to
?Earnings before interest, taxes, depreciation, and amortization ("EBITDA")(1)
increased 16% to
(1) Adjusted net income, adjusted diluted earnings per share, and EBITDA are notU.S. generally accepted accounting principles ("GAAP") measures. 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 net income and diluted earnings per share. 28
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Financial Position and Liquidity
Our financial position as ofNovember 30, 2019 remained strong with cash, restricted cash, and total corporate investments of$707.8 million . Total short-term and long-term borrowings, net of debt issuance costs were$847.9 million as ofNovember 30, 2019 . Our investment strategy continues to focus on protecting principal and optimizing liquidity. We invest predominately in municipal bonds - including general obligation bonds; pre-refunded bonds, which are secured by aU.S. government escrow; and essential services revenue bonds - along withU.S. government agency and treasury securities, corporate bonds, and asset-backed securities. During the second quarter, our primary short-term investment vehicles were money market securities, bank demand and time deposit accounts, andU.S. government agency and treasury securities. A substantial portion of our portfolio is invested in high credit quality securities with ratings of AA or higher, and A-1/P-1 ratings on short-term securities. We limit the amounts that can be invested in any single issuer and invest in short- to intermediate-term instruments whose fair values are less sensitive to interest rate changes. We believe our investments as ofNovember 30, 2019 that were in an unrealized loss position were not other-than-temporarily impaired, nor has any event occurred subsequent to that date that would indicate any other-than-temporary impairment. Our primary source of cash is generated from our ongoing operations. Cash flows from operations were$564.6 million for the six months, an increase of 14% from the same period last year. Our positive cash flows have allowed us to support our business and to pay substantial dividends, approximately 80% of our net income, to our stockholders. It is anticipated that cash, restricted cash, and total corporate investments as ofNovember 30, 2019 , along with projected operating cash flows and available short-term financing, will support our normal business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future. For further analysis of our results of operations for the second quarter, and our financial position as ofNovember 30, 2019 , refer to the analysis and discussion in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 2. RESULTS OF OPERATIONS
Summary of Results of Operations:
For the three months ended For the six months ended
November 30, November 30,
In millions, except per
share amounts 2019 2018 Change 2019 2018 Change
Revenue:
Management Solutions $ 726.7 $ 685.4 6 % $ 1,451.2 $ 1,373.1 6 %
PEO and Insurance Services 244.1 155.2 57 % 491.1 313.2 57 %
Total service revenue 970.8 840.6 15 % 1,942.3 1,686.3 15 %
Interest on funds held for
clients 19.9 18.3 9 % 40.4 35.4 14 %
Total revenue 990.7 858.9 15 % 1,982.7 1,721.7 15 %
Combined operating and
SG&A expenses 649.0 551.7 18 % 1,291.9 1,094.2 18 %
Operating income 341.7 307.2 11 % 690.8 627.5 10 %
Other (expense)/income,
net (4.7) 2.1 n/m (9.5) 4.4 n/m
Income before income taxes 337.0 309.3 9 % 681.3 631.9 8 %
Income taxes 78.3 73.5 7 % 158.4 152.5 4 %
Effective income tax rate 23.2 % 23.8 % 23.3 % 24.1 %
Net income $ 258.7 $ 235.8 10 % $ 522.9 $ 479.4 9 %
Diluted earnings per share
1.45 $ 1.33 9 %
n/m - not meaningful
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We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As ofNovember 30, 2019 , 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
For the six months ended
November 30, November 30,
$ in millions 2019 2018 Change 2019 2018 Change
Average investment balances:
Funds held for clients $ 3,726.3 $ 3,656.2 2 % $ 3,735.5 $ 3,675.5 2 %
Corporate cash equivalents
and investments 788.5 878.9 (10) % 825.2 881.6 (6) %
Total $ 4,514.8 $ 4,535.1 - % $ 4,560.7 $ 4,557.1 - %
Average interest rates earned (exclusive of net realized gains/(losses)):
Funds held for clients 2.0 % 2.0 % 2.1 % 1.9 %
Corporate cash equivalents
and investments 1.7 % 1.4 % 1.9 % 1.4 %
Combined funds held for
clients and corporate cash
equivalents and investments 2.0 % 1.9 % 2.0 % 1.8 %
Total net realized
gains/(losses) $ 0.9 $ (0.3) $ 1.8 $ (0.2)
November 30, May 31,
$ in millions 2019 2019
Net unrealized gains on available-for-sale securities(1)
$ 19.7 Federal Funds rate(2) 1.75 % 2.50 % Total fair value of available-for-sale securities$ 2,992.1
3.1 2.9
Weighted-average yield-to-maturity of available-for-sale securities(3)
2.1 % 2.1 %
(1) The net unrealized gain on our investment portfolio was approximately
(2) The Federal Funds rate was in the range of 1.50% to 1.75% 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$726.7 million for the second quarter and$1.5 billion for the six months, reflecting an increase in both periods of 6% compared to the same periods last year. The increase was primarily driven by increases in our client base and growth in revenue per client, which improved as a result of higher price realization and increased penetration of our suite of solutions, particularly time and attendance, retirement services, and HR outsourcing. Retirement services revenue also benefited from an increase in asset fee revenue earned on the asset value of participants' funds. PEO and Insurance Services revenue: PEO and Insurance Services revenue was$244.1 million for the second quarter and$491.1 million for the six months, reflecting an increase in both periods of 57% compared to the same periods last year. In addition to the acquisition of Oasis, this increase was driven by growth in clients and client worksite employees across our PEO business. Insurance Services revenue benefited from an increase in the number of health and benefit clients and applicants, partially offset by the impact of softness in the workers' compensation market as state insurance fund rates declined.
Total service revenue: Total service revenue was
Interest on funds held for clients: Interest on funds held for clients was$19.9 million for the second quarter and$40.4 million for the six months, reflecting increases of 9% and 14%, respectively, compared to the same periods last year. The increase resulted from higher realized gains, average investment balances, and average interest rates. Funds held for clients average investment balances were impacted by wage inflation and increases within our client base, partially offset by changes in client base mix and timing of collections and remittances. 30
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Combined operating and SG&A expenses: Total expenses were$649.0 million for the second quarter and$1.3 billion for the six months, reflecting an increase in both periods of 18% compared to the same periods last year. The following table summarizes total combined operating and SG&A expenses: For the three months ended For the six months ended November 30, November 30, In millions 2019 2018 Change 2019 2018 Change Compensation-related expenses $ 373.0$ 333.0 12 %$ 736.4 $ 660.7 11 % Depreciation and amortization 55.0 36.8 49 % 107.9 72.7 48 % PEO insurance costs 83.7 62.0 35 % 173.7 125.7 38 % Other expenses 137.3 119.9 15 % 273.9 235.1 16 % Total expenses $ 649.0$ 551.7 18 %$ 1,291.9 $ 1,094.2 18 % Compensation-related expenses increased 12% for the second quarter and 11% for the six months, compared to the same periods last year. The increase in compensation-related expenses was primarily driven by the acquisition of Oasis as well as increased headcount due to investment in technology resources and operations to support the growth in the business. Headcount was approximately 15,700 employees, including Oasis, as ofNovember 30, 2019 , compared to approximately 14,600 employees as ofNovember 30, 2018 . 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 increase in depreciation and amortization expense was primarily driven by the intangible assets recorded for the Oasis acquisition, which are amortized using either straight-line or accelerated methods.
PEO insurance costs include workers' compensation and minimum premium insurance plan arrangements for various medical, dental, and vision benefits where we retain risk. The acquisition of Oasis, along with the growth in our PEO business, contributed to the increase in PEO insurance costs.
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. Other expense growth for the second quarter and the six months was primarily impacted by the acquisition of Oasis and by continued investment in product development and supporting technology. Operating income: Operating income was$341.7 million for the second quarter and$690.8 million for the six months, reflecting increases of 11% and 10%, respectively, as compared to the same periods last year. The changes in operating income were attributable to the factors previously discussed. Operating margin was 34.5% for the second quarter and 34.8% for the six months, compared to 35.8% and 36.4% for the respective prior year periods. EBITDA(1) increased 16% to$398.8 million for the second quarter and 14% to$801.8 million for the six months. EBITDA margin(1) was 40% for both the second quarter and the six months, consistent with respective prior year periods. (1) EBITDA and EBITDA margin are notU.S. GAAP measures. 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 net income. Other (expense)/income, net: Other (expense)/income, net primarily represents interest expense incurred on our debt instruments, netted against earnings from our cash and cash equivalents and investments in available-for-sale securities. Investment income does not include interest on funds held for clients, which is included in total revenue. We recognized$4.7 million and$9.5 million of other expense, net, for the second quarter and the six months, respectively, which was driven by interest expense related to our long-term borrowings and a decrease in average corporate investment balances. The interest expense related to our long-term borrowings was$8.3 million and$16.6 million for the second quarter and the six months, respectively. The decrease in average corporate investment balances was due to funds used for stock repurchases over the past twelve months, higher dividend payments, and acquisitions. For the three and six months endedNovember 30, 2018 , we recognized other income, net, of$2.1 million and$4.4 million , respectively. 31
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Income taxes: Our effective income tax rate was 23.2% for the second quarter and 23.3% for the six months, compared to 23.8% and 24.1% for the respective prior year periods. The effective income tax rates in these periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments. In addition, the effective income tax rate for the six months endedNovember 30, 2018 included discrete tax expense related to the revaluation of deferred tax balances for legislative updates. Net income and diluted earnings per share: Net income was$258.7 million for the second quarter and$522.9 million for the six months, reflecting increases of 10% and 9%, respectively, compared to the same periods last year. Diluted earnings per share was$0.72 per share for the second quarter and$1.45 per share for the six months, reflecting increases of 11% and 9%, respectively, compared to the same periods last year. These fluctuations were attributable to the factors previously discussed. Adjusted net income, a non-GAAP measure, was$253.8 million for the second quarter and$511.4 million for the six months, reflecting increases of 8% and 7%, respectively, compared to the same periods last year. Adjusted diluted earnings per share, a non-GAAP measure, was$0.70 per share for the second quarter and$1.42 per share for the six months, both reflecting an increase of 8% compared to the same periods last year. Refer to the "Non-GAAP Financial Measures" section that follows for a discussion of these non-GAAP measures.
Non-GAAP Financial Measures: Adjusted net income, adjusted diluted earnings per share, and EBITDA are summarized as follows:
For the three months
ended For the six months ended
November 30, November 30,
$ in millions 2019(1) 2018 Change 2019 2018 Change
Net income $ 258.7 $ 235.8 10 % $ 522.9 $ 479.4 9 %
Non-GAAP adjustments:
Excess tax benefit related to
employee stock-based
compensation payments (2) (4.9) (0.5) (11.5) (3.8)
Revaluation of net deferred tax
liabilities (3) - - - 1.7
Total non-GAAP adjustments (4.9) (0.5) (11.5) (2.1)
Adjusted net income $ 253.8 $ 235.3 8 % $
511.4
Diluted earnings per share
1.45 $ 1.33 9 %
Non-GAAP adjustments:
Excess tax benefit related to
employee stock-based
compensation payments (2) (0.01) - (0.03) (0.01)
Revaluation of net deferred tax
liabilities (3) - - - -
Total non-GAAP adjustments (0.01) - (0.03) (0.01)
Adjusted diluted earnings per
share $ 0.70 $ 0.65 8 % $ 1.42 $ 1.32 8 %
Net income $ 258.7 $ 235.8 10 % $ 522.9 $ 479.4 9 %
Non-GAAP adjustments:
Interest expense/(income), net 6.8 (2.0) 12.6 (4.3)
Income taxes 78.3 73.5 158.4 152.5
Depreciation and amortization
expense 55.0 36.8 107.9 72.7
Total non-GAAP adjustments 140.1 108.3 278.9 220.9
Earnings before interest, taxes,
depreciation and amortization $ 398.8 $ 344.1 16 % $
801.8
(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) 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.
(3) One-time tax charge that was recognized during the three months ended
In addition to reporting net income and diluted earnings per share, which areU.S. GAAP measures, we present adjusted net income, adjusted diluted earnings per share, EBITDA, and EBITDA margin (EBITDA as a percentage of total revenue), which are non-GAAP measures. We believe these additional measures are indicators of the performance of our core business operations period over period. Adjusted net income, adjusted diluted earnings per share, EBITDA, and EBITDA margin 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 net income and diluted earnings per share, and therefore should not be 32
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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.
LIQUIDITY AND CAPITAL RESOURCES
Our financial position as ofNovember 30, 2019 remained strong with cash, restricted cash, and total corporate investments of$707.8 million . Total short-term and long-term borrowings, net of debt issuance costs were$847.9 million as ofNovember 30, 2019 . We believe that our investments in an unrealized loss position as ofNovember 30, 2019 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date to indicate any other-than-temporary impairment. We anticipate that cash, restricted cash, and total corporate investments as ofNovember 30, 2019 , along with projected operating cash flows and available short-term financing, will support our normal business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future.
Short-Term Financing
We maintain credit facilities and letters of credit as part of our normal and recurring business operations.
Credit Facilities: We maintain three committed, unsecured credit facilities as
follows:
Maximum
Amount
Bank Borrower (1) Date Entered Expiration Date Available Purpose
JP Morgan Paychex of New July 31, 2019 July 31, 2024 $1 To meet
Chase Bank, York, LLC Billion short-term
N.A. ("JPM") ("PoNY") funding
(2) requirements.
JPM (2) PoNY August 17, 2017 August 17, 2022 $500 To meet
Million short-term
funding
requirements. To finance
National Advance, LLC Million working capital
Association needs and
("PNC") general
corporate
purposes.
(1)Borrower is a wholly owned subsidiary of our Company.
(2)JPM acts as the administrative agent for this syndicated credit facility.
OnJuly 31, 2019 , we entered into a credit agreement with a group of lenders led by JPM which established a new$1.0 billion five-year unsecured revolving credit facility ("2019 credit facility"). This revolving credit facility replaced our predecessor$1.0 billion five-year unsecured revolving credit facility that was entered into onAugust 5, 2015 ("2015 predecessor credit facility") and which was terminated onJuly 31, 2019 . Refer to our Current Report on Form 8-K filed with theSEC onAugust 1, 2019 for additional details.
For all credit facilities, obligations under any facility are guaranteed by us and certain of our subsidiaries and will bear interest at competitive rates based on options provided to the borrower. Upon the expiration date, any borrowings outstanding will mature and be payable on such date.
JPM$1 Billion Credit Facility: There were no borrowings under this credit facility as ofNovember 30, 2019 . Details of borrowings under this 2019 credit facility and the 2015 predecessor credit facility during the second quarter and six months, and the respective prior year periods are as follows: For the three months ended For the six months ended November 30, November 30, $ in millions 2019 2018 2019 2018 Number of days borrowed 10 4 16 10 Maximum amount borrowed$ 694.0 $ 483.0 $ 694.0 $ 483.0 Weighted-average amount borrowed$ 398.4 $ 389.8 $ 357.1 $ 285.7 Weighted-average interest rate 4.99 % 5.12 %
5.09 % 5.06 %
We typically borrow on an overnight basis and only borrowed on an overnight basis during the second quarter, six months, and the respective prior year periods.
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JPM$500 Million Credit Facility: There were no borrowings under this credit facility as ofNovember 30, 2019 . Details of borrowings under this credit facility during the second quarter and six months, and the respective prior year periods are as follows: For the three months ended For the six months ended November 30, November 30, $ in millions 2019 2018 2019 2018 Number of days borrowed 14 3 24 7 Maximum amount borrowed$ 400.0 $ 135.5 $ 450.0 $ 223.0 Weighted-average amount borrowed$ 305.0 $ 83.0 $ 342.8 $ 111.8 Weighted-average interest rate 3.15 % 5.25 %
3.21 % 5.07 %
We typically borrow on an overnight basis. In addition to overnight borrowings, during the second quarter and six months we borrowed:
?
?
In addition, during the six months, we borrowed:
?
We only borrowed on an overnight basis during the respective prior year periods.
Subsequent to
PNC$150 Million Credit Facility: As ofNovember 30, 2019 , we had$51.3 million outstanding under this credit facility which remains outstanding as of the date of this report. Details of borrowings under this credit facility during the second quarter and six months, and the respective prior year periods are as follows: For the three months ended For the six months ended November 30, November 30, $ in millions 2019 2018 2019 2018 Number of days borrowed 91 91 179 179 Maximum amount borrowed$ 56.7 $ 57.7 $ 56.7 $ 57.7 Weighted-average amount borrowed$ 54.3 $ 57.3 $ 54.6 $ 56.6 Weighted-average interest rate 2.74 % 2.68 %
2.90 % 2.61 %
All of our credit facilities contain various financial and operational covenants that are usual and customary for such arrangements. We were in compliance with all of these covenants as ofNovember 30, 2019 .
Certain lenders under these credit facilities, and their respective affiliates, have performed, and may in the future perform for us, various commercial banking, investment banking, underwriting, and other financial advisory services, for which they have received, and will continue to receive in the future, customary fees and expenses.
Long-term financing: OnMarch 13, 2019 , we borrowed$800.0 million through the issuance of long-term private placement debt to replace short-term borrowings under our JPM credit facilities used to fund the acquisition of Oasis. Long-term debt, at amortized cost, consisted of the following: November 30, In millions 2019 Senior Notes, Series A$ 400.0 Senior Notes, Series B 400.0 Total long-term borrowings 800.0
Less: Debt issuance costs, net of accumulated amortization (3.4) Long-term borrowings, net of debt issuance costs
$ 796.6 34
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Certain information related to the Senior Notes are as follows:
Senior Notes Senior Notes
Series A Series B
Stated interest rate 4.07% 4.25%
Effective interest rate 4.16% 4.32%
Interest rate type Fixed Fixed
Interest payment dates Semi-annual, in arrears Semi-annual, in arrears
Principal payment dates
Unsecured Unsecured
Letters of credit: As of November 30, 2019 , we had irrevocable standby letters
of credit outstanding totaling $147.4 million , required to secure commitments
for certain insurance policies. The letters of credit expire at various dates
between December 31, 2019 and November 30, 2020 . No amounts were outstanding on
these letters of credit during the second quarter or the six months, or as of
November 30, 2019 .
Other commitments: We enter into various purchase commitments with vendors in
the ordinary course of business. We had outstanding commitments to purchase
approximately $8.5 million of capital assets as of November 30, 2019 . 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 November 30, 2019 , we have contributed approximately $7.1 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 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 November 30, 2019 . We also maintain
corporate 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 the purpose of 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 ofNovember 30, 2019 .
Operating Cash Flow Activities
For the six months ended
November 30,
In millions 2019 2018
Net income $ 522.9 $ 479.4
Non-cash adjustments to net income 243.4 225.3
Cash used in operating assets and liabilities (201.7)
(207.5)
Net cash provided by operating activities
The increase in our operating cash flows for the six months, compared to the
same period last year, was the result of higher net income and non-cash
adjustments. The increase in non-cash adjustments was primarily due to higher
amortization expense of intangible assets related to the acquisition of Oasis,
partially offset by a lower provision for deferred income taxes.
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Investing Cash Flow Activities
For the six months ended
November 30,
In millions 2019 2018
Net change in purchases and sales/maturities of
available-for-sale securities $ 629.3 $ 115.5
Purchases of property and equipment (59.9) (60.8)
Purchases of other assets (4.2) (1.0)
Net cash provided by investing activities $
565.2
Purchases and sales/maturities of available-for-sale securities: Available-for-sale securities include funds held for clients and corporate investments. The portfolio of funds held for clients and corporate investments is detailed in Note F of the Notes to Consolidated Financial Statements (Unaudited) contained in Item 1 of this Form 10-Q.
Fluctuations in the net change in purchases and sales/maturities are largely due to timing within the client funds portfolio. The amount of funds held for clients will vary based upon the timing of collection of client funds, and the related remittance of funds 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 six months and respective prior year period are discussed further in the "Financing Cash Flow Activities" section which follows.
Additional discussion of interest rates and related risks is included in the "Market Risk Factors" section of this Form 10-Q.
Financing Cash Flow Activities
For the six months ended
November 30,
In millions, except per share amounts 2019 2018
Net change in client fund obligations
51.3 57.3
Dividends paid (444.3) (402.7)
Repurchases of common shares (171.9) (32.8)
Activity related to equity-based plans 7.9 12.2
Net cash used in financing activities
Net change in client fund obligations: 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 six months and the respective prior year period both reflected a net cash outflow resulting from the net change in client fund obligations. Client fund obligation balances can be significantly impacted by the timing of the period end and overall trends in client fund balances.November 30, 2019 fell on a Saturday, the day after a significant payment day for direct pay funds, andMay 31, 2019 fell on a Friday. As a result, timing impacts were not as significant as in the prior year whenNovember 30, 2018 was on a Friday butMay 31, 2018 was on a Thursday, a significant collections day. Funds collected onMay 31, 2018 were then paid out onFriday, June 1, 2018 impacting the cash outflows reported in the prior year period. Dividends paid: The increase in dividend payments for the six months compared to the corresponding period last year is primarily due to an 11% increase in our dividend rate beginning inMay 2019 , offset slightly by the impact of repurchases of our common stock. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board of Directors (the "Board"). Repurchases of common stock: InMay 2019 , our Board approved a program to repurchase up to$400.0 million of our common stock, with authorization expiring inMay 2022 . During the six months, we repurchased 2.0 million shares for$171.9 million . During the respective prior year period, we repurchased 0.5 million shares for$32.8 million under a previously authorized program. The purpose of both programs is to manage common stock dilution. All shares of common stock repurchased were retired. As ofNovember 30, 2019 , approximately$228.1 million remains available under theMay 2019 approved common stock repurchase program. 36
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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; pre-refunded bonds, which are secured by aU.S. government escrow; and essential services revenue bonds - along withU.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 six months, our primary short-term investment vehicles were money market securities, bank demand and time deposit accounts, andU.S. government agency and treasury securities. We have no exposure to high-risk or illiquid 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 six months, the average interest rate earned on our combined funds held for clients and corporate investment portfolios was 2.0% compared with 1.8% 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 ofNovember 30, 2019 had an average duration of 3.1 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 of
November 30, 2019
Amortized Fair
In millions cost value
Maturity date:
Due in one year or less $ 336.9 $ 337.8 Due after one year through three years 797.0 806.7 Due after three years through five years 937.0 953.0 Due after five years
882.5 894.6
Total $ 2,953.4 $ 2,992.1
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 November 30, 2019 , the Federal Funds rate was in the range of 1.50% to
1.75%. The Federal Reserve has reduced the Federal Funds rate by 25 basis points
three times in fiscal 2020 after periodically raising the rate from December
2015 through May 2019 .
?
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Calculating the future effects of changing interest rates involves many factors. These factors include, but are not limited to:
?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.
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 2020. 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$38.7 million as ofNovember 30, 2019 and$19.7 million as ofMay 31, 2019 . During the six months, the net unrealized gain on our investment portfolios ranged from$19.8 million to$57.3 million . These fluctuations were driven by changes in market rates of interest. The net unrealized gain on our investment portfolios was approximately$33.4 million as ofDecember 16, 2019 . As ofNovember 30, 2019 andMay 31, 2019 , we had$3.0 billion and$3.6 billion , respectively, invested in available-for-sale securities at fair value. The weighted-average yield-to-maturity was 2.1% as ofNovember 30, 2019 and as ofMay 31, 2019 . 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 ofNovember 30, 2019 , 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 other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. We believe that the investments we held as ofNovember 30, 2019 were not other-than-temporarily impaired. While$421.3 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$1.9 million 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 ofNovember 30, 2019 andMay 31, 2019 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 other-than-temporarily impaired could change in the future due to new developments or changes in our strategies or assumptions related to any particular investment. We have some credit risk exposure in connection with our 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. 38
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CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for
fiscal 2019, filed with the
?revenue recognition;
?PEO insurance reserves;
?goodwill and other intangible assets;
?impairment of long-lived assets;
?stock-based compensation costs; and
?income taxes.
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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