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 each of the three fiscal years endedMay 31, 2020 ("fiscal 2020" or the "fiscal year"),May 31, 2019 ("fiscal 2019"), andMay 31, 2018 ("fiscal 2018"), and our financial condition as ofMay 31, 2020 . This review should be read in conjunction with the accompanying consolidated financial statements and the related Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K ("Form 10-K") and the "Risk Factors" discussed in Item 1A of this Form 10-K. Forward -looking statements in this review are qualified by the cautionary statement under the heading "Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995" contained at the beginning of Part I of this Form 10-K. 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. Within our HCM solutions, we offer a comprehensive portfolio of services and products that allow our clients to meet their diverse HR and payroll needs. We support our small-business clients, reducing the complexity and risk of running their own payroll, while ensuring greater accuracy with up-to-date tax rates and regulatory information. Clients may choose to have our service team handle everything for them, or process payroll themselves utilizing our proprietary, robust, software-as-a-service ("SaaS") Paychex Flex® platform and our SurePayroll® SaaS-based products. Our mid-market clients generally have more complex payroll and employee benefit needs. However, in the current environment of increasing regulations, we believe the needs for HR outsourcing solutions have been moving down-market. Any of our clients using Paychex Flex can opt for the integrated suite of HCM solutions, which allows clients to choose the services and software that will meet the needs of their business. Our portfolio of HCM and employee benefit-related services is disaggregated into two categories, Management Solutions andProfessional Employer Organization ("PEO") and Insurance Solutions, as discussed in Part 1, Item 1 of this Form 10-K. 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 theU.S. and parts ofEurope . 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. 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. 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. EffectiveDecember 20, 2018 , the Company acquiredOasis Outsourcing Group Holdings, L.P. ("Oasis"). Upon closing, Oasis became a wholly owned subsidiary of the Company. Oasis is an industry leader in providing HR outsourcing services. The purchase price was$992.2 million , net of$262.3 million in cash acquired, including$132.1 million of restricted cash. The acquisition was financed through a combination of cash on hand and the issuance of long-term private placement debt totaling$800.0 million .
Fiscal 2020 Financial Highlights
Financial highlights for fiscal 2020, compared to fiscal 2019, are as follows:
·Total revenue increased 7% to
·Operating income increased 7% to
·Net income increased 6% to
·Diluted earnings per share and adjusted diluted earnings per share(1) both
increased 6% to
·Dividends of
(1)Adjusted net income and adjusted diluted earnings per share are notU.S. generally accepted accounting principles ("GAAP") measures. Refer to the "Non-GAAP Financial Measures" section of this Item 7 for a discussion of these non-GAAP measures and a reconciliation to the most comparableU.S. GAAP measures of net income and diluted earnings per share. 19
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For further analysis of our results of operations for fiscal years 2020, 2019, and 2018, and our financial position as ofMay 31, 2020 , refer to the tables and analysis in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 7. InMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19 as a pandemic. The COVID-19 pandemic affected our business, our customers' businesses, and the markets we serve during the three months endedMay 31, 2020 (the "fourth quarter"). See the "COVID-19 Response" section of this Item 7 for further discussion on the impact of COVID-19 on our results of operations along with our response to the pandemic.
Business Outlook
Our payroll and PEO client base, including all acquisitions, was greater than 680,000 and approximately 670,000 clients as ofMay 31, 2020 andMay 31, 2019 , respectively, and greater than 650,000 clients as ofMay 31, 2018 . Client retention was at record levels of over 83% of the beginning client base for fiscal 2020. Client retention was over 82% for fiscal 2019 and approximately 81% of the beginning client base for fiscal 2018. While our HR product offerings provide services to employers and employees beyond payroll, they effectively leverage payroll processing data. These services are included as part of the integrated HCM solution within Paychex Flex or provided through the Prism HR PEO platform. The following table illustrates the growth in selected HR product offerings: $ in billions As of May 31, 2020 Change(1) 2019 Change(1) 2018 Paychex HR Solutions and PEO client worksite employees(2) 1,428,000 (4) % 1,491,000 29 % 1,157,000 Paychex HR Solutions and PEO clients 55,000 7 % 52,000 26 % 41,000 Health and benefits services applicants 182,000 (4) % 189,000 7 % 177,000 Retirement services plans 91,000 4 % 87,000 6 % 82,000 Asset value of retirement services participants' funds$ 32.3 4 % $
31.0 1 %
(1)Percentage changes are calculated based on unrounded numbers.
(2)Oasis is included in the total number of worksite employees and clients for both fiscal 2020 and fiscal 2019.
Concentrated effort remains on the continued enhancements of Paychex Flex, our robust, cloud-based HCM software solutions platform, which allows direct client access to HR, payroll, and benefits information in a streamlined and integrated approach to workplace management. In fiscal 2020, we continued to focus on enhancing the value to clients, including new offerings and enhancements to Paychex Flex as follows: ·Paychex Integrations enabling users to connect Paychex Flex with some of the world's leading HR, accounting, point-of-sale, and productivity applications on the market;
·Smartwatch Solution, which enables users to track time worked via their smartwatch;
·Pay-on-Demand, which provides participating customer employees the option to request access to a portion of earned pay before the scheduled pay date;
·Real-Time Payments, which provides employers an efficient way to instantly pay their employees for time worked;
·Help Center, which provides users access to training resources and how-to tutorials in written, video, and tour-like deliverables;
·Enhancements to Flex Assistant, that provides a user with an in-app learning journey that aligns with their preferences as a verbal, visual, or physical learner and offers written how-to documents, tutorial-style video vignettes, or a guided interactive tour from in-app step-by-step messaging; ·Document Management was enhanced to add electronic signature capabilities and the ability for customers to run on-demand reports that show the entire process, from initial log-in through signature event;
·HR Conversations, a new tool that enables managers, employees, and HR staff to collaborate and capture day-to-day interactions; and
·Other enhancements including, grid entry view capabilities and the ability for employees and administrative users to create a custom dashboard.
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We continue to strengthen our position in the industry by serving as a source of education and information to clients, businesses of all sizes, and other interested parties. We provide free webinars, white papers, and other information on our website to aid existing and prospective clients with the impact of regulatory changes.The Paychex Insurance Agency, Inc. website, www.paychex.com/group-health-insurance, helps small-business owners navigate the area of insurance coverage. Both this website and www.paychex.com/worx have sections dedicated to the topic of health care reform.
COVID-19 Response
InMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19 as a pandemic. The COVID-19 pandemic began affecting our operations and employees, our customers' businesses, and the markets we serve in the three months endedMay 31, 2020 (the "fourth quarter"). The health and safety of our employees remains our top priority. 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. Results of operations for the fourth quarter were adversely impacted by the COVID-19 pandemic as businesses suspended operations. Management Solutions revenue was impacted by a decline in check volumes, partially offset by increased penetration of retirement services and time and attendance services. The decline in check volumes was due to a reduction in the number of clients processing payrolls as well as the number of employees paid due to state and regional shutdowns. PEO and Insurance Solutions revenue was impacted by a decline in the number of worksite employees serviced by our existing clients. Insurance Solutions revenue was impacted by a decrease in the number of health and benefit applicants and a decline in workers' compensation premiums. Since the end of April, we have seen sequential improvement in our key business metrics across our lines of business. As our clients continue to manage through the COVID-19 pandemic, our priority remains 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.
We created a COVID-19 Help Center on our website to assist our clients and provide them with the support and resources they need, including:
?Webinars and white papers with information on the Coronavirus Aid, Relief, and Economic Security Act, including the historic PPP, and Families First Coronavirus Response Act;
?Guidance on the
?Interactive PPP loan estimation tool for businesses
?State-by-state resources to help our clients understand specific directives that may impact their business.
The COVID-19 Help Center also provides 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. Our strong balance sheet and operational flexibility allowed us to successfully manage through the initial impact of COVID-19 while protecting our cash flow and liquidity. 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. We expect to take a cautious approach to modifying our office and travel restrictions and will wait until we have a clearer vision on how the pandemic unfolds and utilizing guidance provided by the federal, state, and local governments.
For further information on the risks posed to our business from the COVID-19 pandemic, refer to Item 1A of this Form 10-K.
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Results of Operations
Summary of Results of Operations for Fiscal Years:
In millions, except per share amounts 2020 Change(1) 2019 Change(1) 2018 Revenue: Management Solutions$ 2,963.0 3 %$ 2,877.7 4 %$ 2,758.4 PEO and Insurance Solutions 990.6 22 % 814.2 46 % 555.8 Total service revenue 3,953.6 7 % 3,691.9 11 % 3,314.2 Interest on funds held for clients 86.9 8 % 80.6 27 % 63.5 Total revenue 4,040.5 7 % 3,772.5 12 % 3,377.7 Total expenses 2,580.0 7 % 2,401.2 15 % 2,086.2 Operating income 1,460.5 7 % 1,371.3 6 % 1,291.5 Other (expense)/income, net (23.4) n/m (3.3) n/m 8.6 Income before income taxes 1,437.1 5 % 1,368.0 5 % 1,300.1 Income taxes 339.0 2 % 333.6 9 % 306.0 Effective income tax rate 23.6 % 24.4 % 23.5 % Net income$ 1,098.1 6 %$ 1,034.4 4 %$ 994.1 Diluted earnings per share$ 3.04 6 %$ 2.86 4 %$ 2.75
(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 ofMay 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: Year ended May 31, $ in millions 2020 2019 2018 Average investment balances: Funds held for clients$ 3,931.3 $ 3,969.7 $ 4,040.8 Corporate cash equivalents and investments 870.7 848.4
915.1
Total$ 4,802.0 $ 4,818.1
Average interest rates earned (exclusive of net realized gains): Funds held for clients
1.9 % 2.0 % 1.6 %
Corporate cash equivalents and investments 1.4 % 1.6 % 1.3 %
Combined funds held for clients and corporate
cash equivalents and investments 1.8 % 1.9 % 1.5 %
Total net realized gains $ 11.3 $ - $ 0.1
$ in millions
As of May 31, 2020 2019 2018
Net unrealized gains/(losses) on
available-for-sale securities(1) $ 100.0 $ 19.7 $ (38.3)
Federal Funds rate(2) 0.25 % 2.50 % 1.75 %
Total fair value of available-for-sale
securities $ 2,757.2 $ 3,620.8 $ 3,104.8
Weighted-average duration of
available-for-sale securities in years(3) 2.9 2.9 3.1
Weighted-average yield-to-maturity of available-for-sale securities(3) 2.1 % 2.1 %
1.9 %
(1)The net unrealized gain on our investment portfolios was approximately
(2)The Federal Funds rate was in the range of 0.0% to 0.25% as ofMay 31, 2020 , in the range of 2.25% to 2.50% as ofMay 31, 2019 , and in the range of 1.50% to 1.75% as ofMay 31, 2018 .
(3)These items exclude the impact of variable rate demand notes ("VRDNs"), as they are tied to short-term interest rates.
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Management Solutions revenue: Management Solutions revenue was$3.0 billion for fiscal 2020 and$2.9 billion for fiscal 2019, reflecting growth of 3% and 4%, respectively, compared to the prior fiscal year periods. Both fiscal 2020 and fiscal 2019 benefited from 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 HR outsourcing, retirement services, and time and attendance. Retirement services revenue growth for both fiscal 2020 and fiscal 2019 benefited from an increase in the number of retirement services plans, along with an increase in revenue earned on the asset value of participants' 401(k) funds. PEO and Insurance Solutions revenue: PEO and Insurance Solutions revenue was$990.6 million for fiscal 2020 and$814.2 million for fiscal 2019, reflecting growth of 22% and 46%, respectively, compared to the prior fiscal year periods. In addition to the acquisition of Oasis, PEO and Insurance Solutions revenue growth in fiscal 2020 and fiscal 2019 was driven by growth in clients across our PEO business. In addition, for fiscal 2019, PEO and Insurance Solutions revenue growth was driven by growth in client worksite employees across our PEO business. Insurance Solutions revenue for both fiscal 2020 and fiscal 2019 benefited from an increase in the number of health and benefit clients, offset by declining rates in the workers' compensation market. In addition, for fiscal 2019, Insurance Solutions revenue was impacted by an increase in the number of health and benefit applicants. Interest on funds held for clients: Interest on funds held for clients increased 8% for fiscal 2020 and 27% for fiscal 2019 to$86.9 million and$80.6 million , respectively. For fiscal 2020 the increase was due to higher realized gains, offset by lower average investment balances and average interest rates. The realized gains primarily resulted from the strategic repositioning of our client fund portfolio to enhance liquidity in response to the uncertainty caused by COVID-19. For fiscal 2019, the increase was primarily due to higher average interest rates earned. Average investment balances for funds held for clients decreased approximately 1% and 2% for fiscal 2020 and fiscal 2019, respectively. For fiscal 2020, funds held for clients average investment balances were impacted by lower client fund collections due to COVID-19 and changes in client base mix, offset by wage inflation and timing of collections and remittances. For fiscal 2019, the decrease in average investment balances for funds held for clients was primarily driven by the impact of lower client withholdings as a result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"), and changes in client base mix, partially offset by the impact of wage inflation.
Refer to the "Market Risk Factors" section contained in Item 7A of this Form 10-K for more information on changing interest rates.
Total expenses: Total expenses increased 7% and 15% for fiscal 2020 and fiscal 2019, respectively, compared to the prior fiscal year periods. The following table summarizes total combined cost of service revenue and selling, general and administrative expenses for fiscal years: In millions 2020 Change(1) 2019 Change(1) 2018 Compensation-related expenses$ 1,480.8 6 %$ 1,396.8 13 %$ 1,235.2 Depreciation and amortization 209.7 16 % 181.5 32 % 138.0 PEO insurance costs 334.7 17 % 286.7 40 % 205.2 Other expenses 554.8 3 % 536.2 6 % 507.8 Total expenses$ 2,580.0 7 %$ 2,401.2 15 %$ 2,086.2
(1)Percentage changes are calculated based on unrounded numbers.
Compensation-related expenses increased 6% for fiscal 2020 and 13% for fiscal 2019. For fiscal 2020, the increases in compensation-related expenses were driven by the acquisition of Oasis, increased headcount, and higher wages, offset by a decrease in performance-based pay. For fiscal 2019, the increases in compensation-related expenses were driven by the acquisition of Oasis, increased headcount, higher wages, and an increase in performance-based pay. As ofMay 31, 2020 , we had approximately 15,800 employees compared with 15,600 employees as ofMay 31, 2019 . 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 growth in depreciation and amortization for both fiscal 2020 and fiscal 2019, were primarily driven by the amortization of acquired Oasis intangible assets. 23
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PEO insurance costs include workers' compensation, minimum premium medical insurance plan arrangements, and self-insured dental and vision plans where we retain risk. The acquisition of Oasis, along with the growth in our PEO business, contributed to the increase in PEO insurance costs for both fiscal 2020 and fiscal 2019. In addition, the acquisition ofHR Outsourcing Holdings, Inc. ("HROi") contributed to the increase in PEO insurance costs for fiscal 2019. 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 fiscal 2020 was impacted by the acquisition of Oasis and by continued investment in product development and supporting technology, tempered by the impact of COVID-19 in the fourth quarter which drove decreases in other selling, general and administrative expenses, including travel and entertainment. The increase in other expenses for fiscal 2019 was impacted by the acquisitions of Oasis and HROi and continued investment in product development and supporting technology. Other expenses for fiscal 2018 included a one-time expense of$32.6 million related to the termination of certain license agreements. Operating income: Operating income increased 7% to$1.5 billion for fiscal 2020 and 6% to$1.4 billion for fiscal 2019. Operating margin (operating income, as a percentage of total revenue), was 36.1%, 36.3%, and 38.2% for fiscal years 2020, 2019, and 2018, respectively. Adjusted operating income(1) increased 7% to$1.5 billion for fiscal 2020 and 4% to$1.4 billion for fiscal 2019. Earnings before interest, taxes, depreciation, and amortization ("EBITDA")(1) increased 8% to$1.7 billion for fiscal 2020 and 9% to$1.6 billion for fiscal 2019. EBITDA margin(1) was 41.4%, 41.2%, and 42.3% for fiscal years 2020, 2019, and 2018, respectively.
(1)Adjusted operating income, EBITDA and EBITDA margin are not
Other (expense)/income, net: Other (expense)/income, 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$23.4 million and$3.3 million of other expense, net in fiscal 2020 and fiscal 2019, respectively, which was driven by interest expense related to our long-term borrowings. Other expense, net included$33.3 million and$13.7 million of interest expense related to our long-term borrowings in fiscal 2020 and fiscal 2019, respectively. Income taxes: Our effective income tax rate was 23.6% for fiscal 2020, 24.4% for fiscal 2019, and 23.5% for fiscal 2018. The effective income tax rates in all periods were impacted by recognition of net discrete tax benefits related to employee stock-based compensation payments. In fiscal 2019, the effective income tax rate included discrete tax expense for changes in tax reserves and the revaluation of deferred tax balances for legislative updates. In fiscal 2018, as a result of the Tax Act, we recorded a non-recurring net tax benefit for the revaluation of our net deferred tax liabilities. This amount impacted diluted earnings per share by approximately$0.23 per diluted share for fiscal 2018. Additional discrete tax items recognized during each respective period are insignificant. Refer to Note L of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on income taxes. Net income and diluted earnings per share: Net income increased 6% to$1.1 billion for fiscal 2020 and 4% to$1.0 billion for fiscal 2019. Diluted earnings per share increased 6% to$3.04 per diluted share for fiscal 2020 and 4% to$2.86 per diluted share for fiscal 2019. Adjusted net income increased 5% to$1.1 billion for fiscal 2020 and increased 11% to$1.0 billion for fiscal 2019. Adjusted diluted earnings per share was$3.00 per diluted share for fiscal 2020 and$2.84 per diluted share for fiscal 2019, reflecting increases of 6% and 11%, respectively. Refer to the "Non-GAAP Financial Measures" section that follows for a discussion of these non-GAAP measures. ? 24
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Non-GAAP Financial Measures: Adjusted operating income, adjusted net income, adjusted diluted earnings per share and EBITDA are summarized as follows:
$ in millions
2020 Change 2019 Change 2018
Operating income $ 1,460.5 7 % $ 1,371.3 6 % $ 1,291.5
Non-GAAP adjustments:
Termination of license
agreements(1) - - 32.6
Total non-GAAP adjustments - - 32.6
Adjusted operating income $ 1,460.5 7 % $ 1,371.3 4 % $ 1,324.1
Net income $ 1,098.1 6 % $ 1,034.4 4 % $ 994.1
Non-GAAP adjustments:
Excess tax benefit related to
employee stock-based
?compensation payments(2) (14.9) (8.3) (12.9)
Revaluation of net deferred tax liabilities(3) - 1.7 (83.5) Termination of license agreements(1) - - 24.7 Total non-GAAP adjustments (14.9) (6.6) (71.7) Adjusted net income$ 1,083.2 5 %$ 1,027.8 11 %$ 922.4 Diluted earnings per share$ 3.04 6 %$ 2.86 4 %$ 2.75 Non-GAAP adjustments: Excess tax benefit related to employee stock-based ?compensation payments(2) (0.04) (0.02) (0.04) Revaluation of net deferred tax liabilities(3) - - (0.23) Termination of license agreements(1) - - 0.07 Total non-GAAP adjustments (0.04) (0.02)
(0.20)
Adjusted diluted earnings per share$ 3.00 6 %$ 2.84 11 %$ 2.55 Net income$ 1,098.1 6 %$ 1,034.4 4 %$ 994.1 Non-GAAP adjustments: Interest expense/(income), net 26.5 4.3
(8.0)
Income taxes 339.0 333.6
306.0
Depreciation and amortization expense 209.7 181.5
138.0
Total non-GAAP adjustments 575.2 519.4
436.0
Earnings before interest, taxes,
depreciation and amortization
("EBITDA") $ 1,673.3 8 % $ 1,553.8 9 % $ 1,430.1
(1)Additional expense and corresponding tax benefit recognized as a result of
the termination of certain license agreements. This event is not expected to
recur.
(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)For fiscal 2019, this line item represents a one-time tax charge that was recognized during the three months endedAugust 31, 2018 as a result of updated guidance on Internal Revenue Code Section 162(m). This event is not expected to recur. For fiscal 2018, this line item represents non-recurring tax benefits recognized as a result of the Tax Act related to the revaluation of net deferred tax liabilities. In addition to reporting operating income, net income, and diluted earnings per share, which areU.S. GAAP measures, we present adjusted operating income, 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 our core business operations' performance period over period. Adjusted operating income, 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 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. 25
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Liquidity and Capital Resources
Our financial position as ofMay 31, 2020 remained strong with cash, restricted cash, and total corporate investments of$1.0 billion . Total short-term and long-term borrowings, net of debt issuance costs were$801.9 million as ofMay 31, 2020 . Our primary source of cash is generated by our ongoing operations. Cash flows from operations were$1.4 billion for fiscal 2020. Our positive cash flows for fiscal 2020 allowed us to support our business and pay substantial dividends. We currently anticipate that cash, restricted cash, and total corporate investments as ofMay 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 of
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 this Form 10-K for further discussion on our credit facilities.
Details of our credit facilities are as follows:
Maximum May 31, 2020
Amount Outstanding Available
$ in millions Expiration 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
("PNC") February 6, 2023 $ 250.0 5.1 244.9
Total Lines of Credit Outstanding
and Available $
5.1
Details of borrowings under each credit facility during the fiscal years ended 2020, 2019, and 2018 were as follows:
Year ended May 31, 2020
Credit Facility
$1 Billion $500 Million $250 Million
$ in millions JPM JPM PNC
Number of days borrowed 17 29 362
Maximum amount borrowed $ 694.0 $ 450.0 $ 246.0
Weighted-average amount borrowed $ 343.2 $ 307.8 $ 54.2
Weighted-average interest rate 5.06 % 3.30 % 2.50 %
Year ended May 31, 2019
Credit Facility
$1 Billion $500 Million $150 Million
$ in millions JPM JPM PNC
Number of days borrowed 95 92 359
Maximum amount borrowed $ 483.0 $ 400.0 $ 58.9
Weighted-average amount borrowed
3.55 % 2.81 %
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Year ended May 31, 2018
Credit Facility
$1 Billion $500 Million $150 Million
$ in millions JPM JPM PNC
Number of days borrowed 22 42 358
Maximum amount borrowed $ 700.0 $ 400.0 $ 59.9
Weighted-average amount borrowed
2.80 % 1.94 %
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 as needed 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 this Form 10-K and otherSEC filings, including any impacts related to COVID-19, 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 ofMay 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 betweenJune 2020 andJanuary 2022 . No amounts were outstanding on these letters of credit during fiscal 2020 or as ofMay 31, 2020 . Subsequent toMay 31, 2020 , letters of credit expiring in June andJuly 2020 were renewed through June andJuly 2021 , respectively. Long-term financing: OnMarch 13, 2019 , we borrowed$800.0 million through the issuance of long-term private placement debt. Certain information related to the Senior Notes are as follows:
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 March 13, 2026 March 13, 2029
Note type Unsecured Unsecured
Refer to Note O of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further discussion on our long-term financing.
Other commitments: The following table summarizes our significant contractual
obligations as of
Payments due by period
Less than More than
In millions Total 1 year 1-3 years 4-5 years 5 years
Operating leases(1) $ 140.9 $ 39.4 $ 55.3 $ 32.4 $ 13.8
Purchase obligations(2) 132.4 74.3 51.0 7.1 -
Workers' compensation
estimated obligations 174.2 72.2 48.4 16.7 36.9
Debt service obligations(3) 1,050.8 33.3 66.6 66.6 884.3
Total $ 1,498.3 $ 219.2 $ 221.3 $ 122.8 $ 935.0 (1)Operating leases are primarily for office space and equipment used in our service, fulfillment, and sales operations.
(2)Purchase obligations include our estimate of the minimum outstanding commitments under purchase orders to buy goods and services and legally binding contractual arrangements with future payment obligations. Included in the total purchase obligations is$5.0 million of commitments to purchase capital assets. Amounts actually paid under certain of these arrangements may be different due to variable components of these agreements. (3)Includes principal and interest payments on our Senior Notes. Refer to Note O of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for more information. 27
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The liability for uncertain tax positions, including interest and net of federal benefits, was approximately$26.5 million as ofMay 31, 2020 . Refer to Note L of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for more information on income taxes. We are not able to reasonably estimate the timing of future cash flows related to this liability and have excluded it from the table above. We are involved in two limited partnership agreements to contribute a maximum amount of$20.0 million to venture capital funds in the financial technology sector. As ofMay 31, 2020 , we have contributed approximately$8.4 million of the total funding commitment. The timing of future contributions to be made to these venture capital funds cannot be specifically or reasonably determined and thus have been excluded from the table above. 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 are not material as ofMay 31, 2020 . 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 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 ofMay 31, 2020 .
Operating, Investing, and Financing Cash Flow Activities
Year ended May 31,
In millions 2020 2019 2018
Net cash provided by operating activities
1,276.4
Net cash provided by/(used in) investing activities 771.9 (1,628.3)
998.5
Net cash used in financing activities (1,488.2) (1,008.5)
(423.8)
Net change in cash, restricted cash, and equivalents$ 724.6 $ (1,365.3) $
1,851.1
Cash dividends per common share$ 2.48 $ 2.30 $
2.06
Operating Cash Flow Activities
The changes in our operating cash flows for both fiscal 2020 and fiscal 2019 compared to the prior fiscal year periods were due to higher net income, higher non-cash adjustments, and fluctuations in our operating assets and liabilities.
The increase in non-cash adjustments for both fiscal 2020 and fiscal 2019 were primarily driven by larger adjustments for the amortization of intangible assets.
In fiscal 2020, the smaller outflow related to changes in operating assets and
liabilities compared to the prior fiscal year period was due to changes in
accounts receivable and PEO unbilled receivables, which were adversely impacted
by COVID-19. We experienced an increase in the number of non-processing clients
and a reduction in the number of employees and worksite employees paid as
businesses suspended operations due to the pandemic. In addition, accounts
payable and other current liabilities were impacted by a decrease in accrued
compensation related to worksite employees and timing of accruals and cash
settlement. In fiscal 2019, the larger outflow was due to higher accounts
receivable balances related to growth in our payroll funding business for
temporary staffing agency clients.
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Investing Cash Flow Activities
The changes in our investing cash flows for both fiscal 2020 and fiscal 2019 compared to prior year periods were primarily attributable to fluctuations in the net purchases and sales/maturities of available-for-sale securities, changes in net cash outflows related to acquisitions of businesses, and purchases of other assets. 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 fiscal years 2020, 2019, and 2018 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 fiscal 2020 and fiscal 2019 compared to prior year periods were due to changes in investment mix. The changes in net cash outflows related to acquisition of businesses reflect our acquisitions of Oasis inDecember 2018 ,Lessor Group ("Lessor") inFebruary 2018 , and HROi inAugust 2017 . We paid cash for the Oasis and Lessor acquisitions, while we paid a combination of cash and common stock for the HROi acquisition.
The net cash outflow for purchases of other assets during fiscal 2018 was
impacted by the resolution of a contractual dispute with certain licensees and
the acquisition of rights to certain client lists for approximately
Discussion of interest rates and related risks is included in the "Market Risk Factors" section contained in Item 7A of this Form 10-K.
Financing Cash Flow Activities
The changes in our financing cash flows for both fiscal 2020 and fiscal 2019 compared to prior fiscal year periods were impacted by net proceeds from long-term borrowings, the net change in client fund obligations, repurchases of common shares, and dividends paid. In fiscal 2019, we borrowed$800.0 million under our JPM credit facilities to fund the acquisition of Oasis which was replaced by the issuance of long-term private placement debt inMarch 2019 . Refer to Note O of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on our long-term financing. 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.May 31, 2020 fell on a Sunday andMay 31, 2019 fell on a Friday, which is a significant disbursement day for direct pay funds, and as such only created minor timing differences in this liability when comparing fiscal 2020 with fiscal 2019. However,May 31, 2020 balances were impacted by lower client fund collections due to COVID-19. In contrast,May 31, 2018 fell on a Thursday, which is a significant collection day for direct pay funds. These funds were then paid out onFriday June 1, 2018 . The increase in dividend payments for fiscal 2020 and fiscal 2019 compared to the corresponding prior year periods is primarily due to an 11% and 12% increase in our dividend rate beginning inMay 2019 andApril 2018 , respectively. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board. During fiscal 2020, fiscal 2019, and fiscal 2018, we repurchased 2.0 million shares, 0.7 million shares, and 2.5 million shares, respectively. As ofMay 31, 2020 ,$228.1 million remains available under the common stock repurchase program. Refer to Note C of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further discussion on our common stock repurchase program. Other
Recently issued accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for a discussion of recently issued accounting pronouncements.
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Critical Accounting Policies
Note A of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K discusses the significant accounting policies ofPaychex . Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenue, and expenses. On an ongoing basis, we evaluate the accounting policies and estimates used to prepare the consolidated financial statements. We base our estimates on historical experience, future expectations, and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates. Certain accounting policies that are deemed critical to our results of operations or financial position are discussed below. Revenue recognition: Service revenue is recognized in the period services are rendered and earned under service arrangements with clients where service fees are fixed or determinable and collectability is reasonably assured. Our service revenue is largely attributable to processing services where the fee is based on a fixed amount per processing period or a fixed amount per processing period plus a fee per employee or transaction processed. Fees earned for funding of temporary staffing clients' payrolls via purchase of accounts receivable are based on a percentage of funding amounts as specified in the client contract. The revenue earned from delivery service for the distribution of certain client payroll checks and reports is included in service revenue, and the costs for delivery are included in cost of service revenue on the Consolidated Statements of Income and Comprehensive Income. We receive advance payments for set-up fees on some of our service offerings from our clients. Advance payments received for certain of our service offerings are considered a material right. We defer the revenue associated with these advance payments, recognizing the revenue and related expenses over the expected period to which the right exists. PEO Solutions revenue is reported net of certain direct pass-through costs billed and incurred, which include payroll wages, payroll taxes, including federal and state unemployment insurance, and certain health insurance benefit premiums, primarily costs related to our guaranteed cost benefit plans. Direct costs related to workers' compensation and certain benefit plans where we retain risk are recognized as cost of service revenue rather than as a reduction in service revenue. Interest on funds held for clients is earned primarily on funds that are collected from clients before due dates for payroll tax administration services and for employee payment services, and invested until remittance to the applicable tax or regulatory agencies or client employees. These collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days. The interest earned on these funds is included in total revenue on the Consolidated Statements of Income and Comprehensive Income because the collecting, holding, and remitting of these funds are components of providing these services. Assets Recognized from the Costs to Obtain and Fulfill Contracts: We recognize an asset for the incremental costs of obtaining a contract with a client if it is expected that the economic benefit and amortization period will be longer than one year. Incremental costs of obtaining a contract include only those costs that are directly related to the acquisition of new contracts and that would not have been incurred if the contract had not been obtained. We do not incur incremental costs to obtain a contract renewal. The Company determined that certain sales commissions and bonuses, including related fringe benefits, meet the capitalization criteria under Accounting Standards Codification ("ASC") Subtopic 340-40, "Other Assets and Deferred Costs: Contracts with Customers" ("ASC 340-40"). We also recognize an asset for the costs to fulfill a contract with a client if the costs are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. We determined that substantially all costs related to implementation activities are administrative in nature and meet the capitalization criteria under ASC 340-40. These capitalized costs to fulfill a contract principally relate to upfront direct costs that are expected to be recovered and enhance our ability to satisfy future performance obligations. The assets related to both costs to obtain and costs to fulfill contracts with clients are capitalized and amortized using an accelerated method over an eight-year life to closely align with the pattern of client attrition over the estimated life of the client relationship. We regularly review our deferred costs for potential impairment and did not recognize an impairment loss during the fiscal years endedMay 31, 2020 orMay 31, 2019 . 30
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PEO insurance reserves: As part of the PEO solution, we offer workers' compensation insurance and health insurance to clients for the benefit of client employees. Workers' compensation insurance is primarily provided under fully insured high deductible workers' compensation insurance policies. Workers' compensation insurance reserves are established to provide for the estimated costs of paying claims up to per occurrence liability limits. These reserves include estimates of certain expenses associated with processing and settling these claims. In establishing the PEO workers' compensation insurance reserves, we use an independent actuarial estimate of undiscounted future cash payments that would be made to settle claims. The evaluation, review and determination of estimated ultimate losses by our appointed actuary are based on actuarial methods and assumptions. The estimated ultimate losses are primarily based upon estimated loss development factors, and other factors such as the nature of employees' job responsibilities, the historical frequency and severity of workers' compensation claims, and an estimate of future cost trends. Each reporting period, changes in actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers' compensation claims cost estimates. With respect to our PEO health insurance, we offer various health insurance plans that take the form of either fully insured guaranteed cost plans with various national insurance carriers or a fully insured minimum premium insurance arrangement with coverage provided through a single national carrier. In addition, we also provide self-insured dental and vision plans to certain PEO clients. Under the minimum medical premium insurance arrangement and self-insured dental and vision plans, our health benefits insurance reserves are established to provide for the payment of claims in accordance with our service contract with the carrier. The claims liability includes estimates for reported losses, plus amounts for those claims incurred but not reported, and estimates of certain expenses associated with processing and settling the claims. Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss experience and independent actuarial loss projections, and is subject to change due to multiple factors, including economic trends, changes in legal liability law, and damage awards, all of which could materially impact the reserves as reported in the consolidated financial statements. Accordingly, final claim settlements may vary from the present estimates, particularly with workers' compensation insurance where those payments may not occur until well into the future. We regularly review the adequacy of our estimated insurance reserves. Adjustments to previously established reserves are reflected in the results of operations for the period in which the adjustment is identified. Such adjustments could possibly be significant, reflecting any combination of new and adverse or favorable trends. Adjustments to previously established reserves were not material for the fiscal years 2020, 2019, or 2018.Goodwill and other intangible assets:Goodwill is not amortized, but instead is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change in a way to indicate that there has been a potential decline in the fair value of the reporting unit. We perform our annual impairment testing in our fiscal fourth quarter. A qualitative analysis was performed for all reporting units in fiscal years 2020, 2019 and 2018, to determine if it is more-likely-than-not that the fair value of the reporting units had declined below its carrying value. The qualitative assessment considered various financial, macroeconomic, industry, and reporting unit specific qualitative factors. Based on the results of our testing, no impairment loss was recognized in the results of operations for fiscal 2020, 2019, or 2018. Subsequent to the latest review, there have been no events or circumstances that indicate any potential impairment of the Company's goodwill balance. We also test intangible assets with indefinite useful lives for potential impairment on an annual basis and between annual tests if events or changes in circumstances change in a way that indicate that the carrying value may not be recoverable. We have determined that there is no impairment of intangible assets with indefinite useful lives for fiscal 2020, 2019, or 2018. Impairment of Long-Lived Assets: Long-lived assets, including intangible assets with finite lives and operating lease right-of-use assets, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. We have determined that there is no impairment of long-lived assets for fiscal 2020, 2019, or 2018. Stock-based compensation costs: All stock-based awards to employees are recognized as compensation costs in our consolidated financial statements based on their fair values measured as of the date of grant. We estimate the fair value of stock option grants using a Black-Scholes option pricing model. This model requires various assumptions as inputs including expected volatility of thePaychex stock price and expected option life. Volatility is estimated based on a combination of historical volatility using stock prices over a period equal to the expected option life and implied market volatility. Expected option life is estimated based on historical exercise behavior. We periodically reassess our assumptions as well as our choice of valuation model. We will reconsider use of this model if additional information becomes available in the future indicating that another model would provide a more accurate estimate of fair value, or if characteristics of future grants would warrant such a change. 31
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The fair value of stock awards is determined based on the stock price at the
date of grant. For grants that do not accrue dividends or dividend equivalents,
the fair value is the stock price reduced by the present value of estimated
dividends over the vesting period or performance period.
We estimate forfeitures and only record compensation costs for those awards that
are expected to vest. Our assumptions for forfeitures were determined based on
type of award and historical experience. Forfeiture assumptions are adjusted at
the point in time a significant change is identified, with any adjustment
recorded in the period of change, and the final adjustment at the end of the
requisite service period to equal actual forfeitures.
The assumptions of volatility, expected option life, and forfeitures all require
significant judgment and are subject to change in the future due to factors such
as employee exercise behavior, stock price trends, and changes to type or
provisions of stock-based awards. Any material change in one or more of these
assumptions could have a material impact on the estimated fair value of a future
award.
Refer to Note F of the Notes to Consolidated Financial Statements contained in
Item 8 of this Form 10-K for further discussion of our stock-based compensation
plans.
Income taxes: We account for deferred taxes by recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the consolidated financial statements or tax returns.
Under this method, deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the fiscal year in which the
differences are expected to reverse. We record a deferred tax asset related to
the stock-based compensation costs recognized for certain stock-based awards. At
the time of the exercise of non-qualified stock options or vesting of stock
awards, we recognize any excess tax benefit within income taxes in the
Consolidated Statements of Income and Comprehensive Income.
We maintain a reserve for uncertain tax positions. We evaluate tax positions
taken or expected to be taken in a tax return for recognition in our
consolidated financial statements. Prior to recording the related tax benefit in
our consolidated financial statements, we must conclude that tax positions will
be more-likely-than-not to be sustained, assuming those positions will be
examined by taxing authorities with full knowledge of all relevant information.
The benefit recognized in our consolidated financial statements is the amount we
expect to realize after examination by taxing authorities. If a tax position
drops below the more-likely-than-not standard, the benefit can no longer be
recognized. Assumptions, judgment, and the use of estimates are required in
determining if the more-likely-than-not standard has been met when developing
the provision for income taxes and in determining the expected benefit. A change
in the assessment of the more-likely-than-not standard could materially impact
our results of operations or financial position. Refer to Note L of the Notes to
Consolidated Financial Statements contained in Item 8 of this Form 10-K for
further discussion of our reserve for uncertain tax positions.
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