Management's Discussion and Analysis of Financial Condition and Results of Operations reviews the operating results ofPaychex, Inc. and its wholly owned subsidiaries ("Paychex ," the "Company," "we," "our," or "us") for the three months endedAugust 31, 2021 (the "first quarter"), the respective prior year period endedAugust 31, 2020 (the "prior year period"), and our financial condition as ofAugust 31, 2021 . The focus of this review is on the underlying business reasons for material changes and trends affecting our revenue, expenses, net income, and financial condition. This review should be read in conjunction with theAugust 31, 2021 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, 2021 ("fiscal 2021"). Forward-looking statements in this review are qualified by the cautionary statement included under the next sub-heading, "Cautionary Note Regarding Forward-Looking Statements".
Cautionary Note Regarding Forward-Looking Statements
Certain written and oral statements made by us may constitute "forward-looking statements" within the meaning of the safe harbor provisions ofthe United States ("U.S.") Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by such words and phrases as "we expect," "expected to," "estimates," "estimated," "intend," "overview," "outlook," "guidance," "we look forward to," "would equate to," "projects," "projections," "projected," "projected to be," "anticipates," "anticipated," "we believe," "believes," "could be," "targeting," and other similar words or phrases. Examples of forward-looking statements include, among others, statements we make regarding operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to our outlook, revenue growth, earnings, earnings-per-share growth, or similar projections. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict, many of which are outside our control. Our actual results and financial condition 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:
·our ability to keep pace with changes in technology and to provide timely enhancements to our products and services;
·software defects, undetected errors, or development delays for our products;
·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;
·risks related to acquisitions and the integration of the businesses we acquire;
·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;
·our failure to comply with covenants in our debt agreements;
·changes in governmental regulations and policies;
·our ability to comply with
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·our compliance with data privacy laws and regulations;
·our failure to protect our intellectual property rights;
·potential outcomes related to pending or future litigation matters;
·the impact of the COVID-19 pandemic on the
·volatility in the political and economic environment;
·changes in the availability of qualified people; and
·the possible effects of negative publicity on our reputation and the value of our brand.
Any of these factors, as well as other factors discussed in our Form 10-K for fiscal 2021 or in our other periodic filings with theSecurities and Exchange Commission ("SEC"), could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10-Q is based upon the facts and circumstances known as of the date of this report, and any forward-looking statements made by us in this Form 10-Q speak only as of the date on which they are made. Except as required by law, we undertake no obligation to update these forward-looking statements after the date of filing this Form 10-Q with theSEC to reflect events or circumstances after such date, or to reflect the occurrence of unanticipated events. Our investor presentation regarding the financial results for the first quarter is available and accessible on our Paychex Investor Relations portal at https://investor.paychex.com. Information available on our website is not a part of, and is not incorporated into, this Form 10-Q. We intend to make future investor presentations available exclusively on our Paychex Investor Relations portal. Overview We are a leading human resource ("HR") software and services company, offering HR, payroll, benefits, and insurance solutions for small- to medium-sized businesses. Within our human capital management ("HCM") solutions, we offer a comprehensive portfolio of technology solutions and services that allow our clients to meet their diverse HR and payroll needs. Our comprehensive solutions allow our clients to manage their workforces effectively from hire to retire. We provide leading-edge HCM technology solutions, coupled with human expertise, to make complex HR, payroll, and benefits issues simple for our clients. Paychex Flex is our proprietary HCM software-as-a-service "SaaS" platform that unites HR, payroll, time and attendance, and benefits processes to maximize efficiency and savings.Paychex Flex helps clients manage the employee life cycle from recruiting and hiring to retirement, providing an integrated suite of solutions including recruiting, onboarding, HR, time and attendance and employee benefits. It utilizes a single cloud-based platform, with single client and employee records. Clients can select the modules they need and easily add on services as they grow. In addition, we provide comprehensiveHR Outsourcing solutions to help our clients plan, manage, and comply with all aspects of HR. Our portfolio of HCM and employee benefit-related services is disaggregated into two categories, (1) Management Solutions and (2) PEO and Insurance Solutions, as discussed under the heading "Description of Services" in Part 1, Item 1 of our Form 10-K for fiscal 2021. 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 technology solutions and services 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 sales and marketing and innovative technology. We believe these investments are critical to our success. Looking to the future, we believe that investing in our products, people, and technology-enabled service capabilities will position us to capitalize on opportunities for long-term growth. 17
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A recent Company survey of 1,000 small businesses noted that the biggest challenge they currently face is recruiting and retaining employees as the evolution of the workplace resulting from the pandemic has increased the competition for talent. We continue to be a leader in innovative technology solutions. Our most recent round of product releases includes solutions designed to help employers hire and retain top talent in this challenging environment, including: ·Paychex Pre-Check, which notifies employees on the channel of their choice - including smart watches and smart speakers - that their gross-to-net paystub is ready to be securely reviewed. Employees may perform the review in Paychex Flex mobile app and are prompted to confirm the amount's accuracy or report an issue to the employer's administrator, who can address the potential issue before payday;
·Retention Insights, which uses predictive analytics to identify employees who may be more likely to consider leaving the organization;
·Pay Benchmarking, which allows employers to compare compensation details by
position against national data provided by the
·Talent Dashboard, which pulls together Retention Insights, time off balances, and performance management ratings into one place, allowing administrators to compare the performance rating and compensation of each job position; ·Amazon Alexa Integration, which makes it easy for users to interact with the Paychex Flex application from anywhere. With the addition of Amazon Alexa to existing integrations with Google Assistant™ and Siri® Shortcuts, Paychex Flex is the first HCM application to offer integration with three of the major voice assistant platforms; ·Time Off Management, which provides a full, end-to-end solution to ensure clients maintain compliance with ever changing time off regulations. Our solution includes an automated time off request and approval process (via our Flex mobile application) and manages accrual calculations and balance tracking; and
·Paychex Employee Retention Tax Credit Service, which helps businesses retroactively identify tax credits and file amended returns to claim these credits.
First Quarter Business Highlights
Highlights compared to the prior year period are as follows:
For the three months ended August 31, In millions, except per share amounts 2021 2020 Change(2) Total service revenue$ 1,068.4 $ 917.3 16 % Total revenue$ 1,082.9 $ 932.2 16 % Operating income $ 442.9$ 284.0 56 % Net income $ 333.6$ 211.6 58 % Adjusted net income(1) $ 323.2$ 228.0 42 % Diluted earnings per share $ 0.92$ 0.59 56 % Adjusted diluted earnings per share(1) $ 0.89$ 0.63 41 % Dividends paid to stockholders $ 238.1$ 223.2 7 % (1)Adjusted net income and adjusted diluted earnings per share are notU.S. generally accepted accounting principle ("GAAP") measures. Adjusted net income and adjusted diluted earnings per share in both periods included an adjustment for net tax windfall benefits related to employee stock-based compensation payments. In the prior year period, adjusted net income and adjusted diluted earnings per share included an adjustment for one-time non-recurring cost-saving initiatives. Refer to the "Non-GAAP Financial Measures" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to theU.S. GAAP measures of net income and diluted earnings per share.
(2)Percentage changes are calculated based on unrounded numbers.
For further analysis of our results of operations for the first quarter and
prior year period, and our financial position as of
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COVID-19 Update
As the global COVID-19 pandemic has continued to evolve, our priority has been, and continues to be, the health and safety of our employees. A portion of our workforce that initially transitioned to work remotely has voluntarily returned to the office. As vaccination levels continue to increase and masking and social distancing guidelines further relax, we look forward to welcoming more of our employees back to their office locations. We currently anticipate a phased return to the office beginning in Fall 2021, with a greater level of flexibility in response to the feedback our employees have shared with us. As our clients continue to manage through the COVID-19 pandemic, we remain committed to helping them adapt and thrive, not only through the uncertainties of the COVID-19 pandemic, but the transition to the future business environment. Our COVID-19 Help Center remains a source of near real-time information and tools to help businesses navigate this constantly evolving environment, including information surrounding the Biden administration's recent new vaccine requirements. We launched a new Paychex Employee Retention Tax Credit ("ERTC") service to help businesses retroactively identify tax credits, based on wages already paid, and file amended returns to claim the credit. Prior to and including this new service, we have helped clients secure$4.0 billion to date in combined ERTC and paid leave credits. As the global economy continues to evolve, whether due to legislative changes, the pandemic, or other factors, we are committed to supporting our clients to help them navigate these challenges. Our unique blend of technology solutions and expertise provides valuable tools and resources to assist our clients and their employees during this critical time and beyond. Our strong balance sheet and operational flexibility have allowed us to successfully manage through the ongoing impacts of the COVID-19 pandemic to date while protecting our cash flow and liquidity. The fiscal year is off to a strong start as we achieved double-digit growth in both revenue and earnings over the prior year period. These results reflected gradual improvement in the economy, continued momentum in sales, and strong levels of client retention. We believe we are well-positioned with a broad portfolio of innovative technology and products along with our unparalleled expertise to meet the continuing needs of businesses and help them succeed and thrive as they begin to bring employees back to work and adjust to the changes of how, where, and when work gets done. We continue to evaluate the nature and extent of changes to the market and economic conditions related to the COVID-19 pandemic and will assess the potential impact on our business and financial position. Despite improving macroeconomic conditions and the emergence of vaccines, surges in COVID-19 cases, including variants of the strain, such as those recently experienced inEurope and theU.S. , may cause people to self-quarantine or governments to shut down nonessential businesses again. We expect that the pandemic will continue to have an effect on our results, although the magnitude, duration, and full effects of the pandemic on our future results of operations or cash flows are not possible to predict at this time.
For further discussion on the risks posed to our business from the COVID-19 pandemic, refer to Item 1A of our Form 10-K for fiscal 2021.
RESULTS OF OPERATIONS
Summary of Results of Operations:
For the three months ended August 31, In millions, except per share amounts 2021 2020 Change(1) Revenue: Management Solutions $ 805.5$ 687.4 17 % PEO and Insurance Solutions 262.9 229.9 14 % Total service revenue 1,068.4 917.3 16 % Interest on funds held for clients 14.5 14.9 (3) % Total revenue 1,082.9 932.2 16 % Total expenses 640.0 648.2 (1) % Operating income 442.9 284.0 56 % Other income/(expense), net 1.0 (7.9) n/m Income before income taxes 443.9 276.1 61 % Income taxes 110.3 64.5 71 % Effective income tax rate 24.9 % 23.4 % Net income $ 333.6$ 211.6 58 % Diluted earnings per share $ 0.92$ 0.59 56 %
(1) Percentage changes are calculated based on unrounded numbers.
n/m - not meaningful
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The changes in revenue as compared to the prior year period were primarily driven by the following factors:
?Management Solutions revenue:
oIncrease in our client base and penetration of our suite of solutions, primarily HR outsourcing and time and attendance,
oHigher checks per client as our clients' employees return to work, and
oHigher revenue per check reflecting better price realization.
?PEO and Insurance Solutions revenue:
oIncrease in the number of worksite employees and the impact of an increase in average wages per worksite employee,
oHigher revenue on state unemployment insurance, and
oIncrease in PEO health insurance revenue.
?Interest on funds held for clients:
oLower average interest rates, partially offset by
oIncrease in average investment balances; impacted by growth in our overall client base and improving macroeconomic conditions.
We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As ofAugust 31, 2021 , 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 were as follows: For the three months ended August 31, $ in millions 2021 2020 Change(1) Average investment balances: Funds held for clients$ 3,897.5 $ 3,507.2 11 % Corporate cash equivalents and investments 1,197.1 1,022.2 17 % Total$ 5,094.6 $
4,529.4 12 %
Average interest rates earned (exclusive of net realized gains/(losses)): Funds held for clients
1.5 % 1.7 % Corporate cash equivalents and investments 0.1 % 0.2 % Combined funds held for clients and corporate cash equivalents and investments 1.1 % 1.3 % Total net realized gains $ 0.1$ 0.3
(1) Percentage changes are calculated based on unrounded numbers.
August 31 ,May 31 , $ in millions 2021
2021
Net unrealized gains on available for sale ("AFS") securities (1)
$ 78.7 $ 79.3 Federal Funds rate (2) 0.25 % 0.25 % Total fair value of AFS securities$ 3,002.4 $ 3,020.2 Weighted-average duration of AFS securities in years (3) 3.4
3.3
Weighted-average yield-to-maturity of AFS securities (3) 1.8 %
1.9 %
(1) The net unrealized gain on our investment portfolio was approximately
(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of
(3) These items exclude the impact of variable rate demand notes ("VRDNs") as they are tied to short-term interest rates.
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Total expenses: The following table summarizes the total combined cost of service revenue and selling, general and administrative expenses for the periods below: For the three months ended August 31, In millions 2021 2020 Change(1) Compensation-related expenses $ 382.9$ 370.6 3 % PEO insurance costs 96.0 84.5 14 % Depreciation and amortization 45.7 49.6 (8) % Cost-saving initiatives - 31.2 n/m Other expenses 115.4 112.3 3 % Total expenses $ 640.0$ 648.2 (1) %
(1) Percentage changes are calculated based on unrounded numbers.
n/m - not meaningful
Total expenses decreased 1% to$640.0 million for the first quarter compared to the prior year period. Excluding one-time costs of$31.2 million in the prior year period, total expenses increased 4%, impacted by the following:
?Compensation-related expenses:
?PEO insurance costs:
?Depreciation and amortization:$45.7 million for the first quarter, reflecting an 8% decrease, due to lower amortization driven by intangible assets amortized using accelerated methodologies.
?Other expenses:
Operating income: Operating income increased 56% to$442.9 million for the first quarter compared to the prior year period as a result of double-digit revenue growth and slight expense reduction. Adjusted operating income(1), which excluded the impact of one-time costs related to theAugust 2020 geo-optimization plan in the prior year period, increased 41% to$442.9 million for the first quarter compared to the prior year period. Operating margin and adjusted operating margin (1) are as follows: For the three months endedAugust 31, 2021 2020
Operating margin (operating income as a percentage of total revenue)
40.9 % 30.5 % Adjusted operating margin (1) (operating income, adjusted for one-time costs, as a percentage of total revenue) 40.9 %
33.8 %
Fluctuations in these metrics were attributable to the factors previously discussed.
(1) Adjusted operating income, adjusted operating margin, adjusted net income, and adjusted diluted earnings per share are notU.S. GAAP measures. Refer to the "Non-GAAP Financial Measures" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measures of operating income, net income, and diluted earnings per share. Income taxes: Our effective income tax rate was 24.9% for the first quarter, compared to 23.4% for the prior year period. This increase was the result of an increase in state taxes. Both periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments. 21
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Non-GAAP Financial Measures: Adjusted operating income, adjusted net income, adjusted diluted earnings per share, earnings before interest, taxes, depreciation, and amortization ("EBITDA"), and adjusted EBITDA are summarized as follows: For the three months ended August 31, $ in millions 2021 2020 Change(1) Operating income $ 442.9$ 284.0 56 % Non-GAAP adjustments: Cost-saving initiatives(2) - 31.2 Total non-GAAP adjustments - 31.2 Adjusted operating income $ 442.9$ 315.2 41 % Net income $ 333.6$ 211.6 58 % Non-GAAP adjustments: Excess tax benefit related to employee stock-based compensation payments(3) (10.4) (7.0) Cost-saving initiatives(2) - 23.4 Total non-GAAP adjustments (10.4) 16.4 Adjusted net income $ 323.2$ 228.0 42 % Diluted earnings per share(4) $ 0.92$ 0.59 56 % Non-GAAP adjustments: Excess tax benefit related to employee stock-based compensation payments(3) (0.03) (0.02) Cost-saving initiatives(2) - 0.06 Total non-GAAP adjustments (0.03) 0.05 Adjusted diluted earnings per share $ 0.89$ 0.63 41 % Net income $ 333.6$ 211.6 58 % Non-GAAP adjustments: Interest expense, net 9.0 8.4 Income taxes 110.3 64.5 Depreciation and amortization expense 45.7 49.6 Total non-GAAP adjustments 165.0 122.5 EBITDA 498.6 334.1 49 % Cost-saving initiatives(2) - 31.2 Adjusted EBITDA $ 498.6$ 365.3 36 %
(1) Percentage changes are calculated based on unrounded numbers.
(2) One-time costs and corresponding tax benefit recognized during fiscal 2021 related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization. These events are not expected to recur.
(3) Net tax windfall benefits related to employee stock-based compensation payments recognized in income taxes. This item is subject to volatility and will vary based on employee decisions on exercising employee stock options and fluctuations in our stock price, neither of which is within the control of management.
(4) 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. In addition to reporting operating income, net income, and diluted earnings per share, which areU.S. GAAP measures, we present adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, which are non-GAAP measures. We believe these additional measures are indicators of our core business operations performance period over period. Adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, are not calculated through the application ofU.S. GAAP and are not required forms of disclosure by theSEC . As such, they should not be considered a substitute for theU.S. GAAP measures of operating income, net income, and diluted earnings per share, and, therefore, they should not be used in isolation, but in conjunction with theU.S. GAAP measures. The use of any non-GAAP measure may produce results that vary from theU.S. GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies. 22
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LIQUIDITY AND CAPITAL RESOURCES
As ofAugust 31, 2021 , our financial position remained strong with cash, restricted cash, and total corporate investments of$1.2 billion . Total short-term and long-term borrowings, net of debt issuance costs, were$804.5 million as ofAugust 31, 2021 . Our primary source of cash is generated by our ongoing operations. Cash flow from operations were$385.6 million for the first quarter. Our positive cash flows have allowed us to support our business and pay dividends. We currently anticipate that cash, restricted cash, and total corporate investments as ofAugust 31, 2021 , along with projected operating cash flows and available short-term financing, will support our business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future. We believe that our investments in an unrealized loss position as ofAugust 31, 2021 were not impaired due to increased credit risk or other valuation concerns, nor has any event occurred subsequent to that date to indicate any change in our assessment. Financing Short-term financing: We maintain committed and unsecured credit facilities and irrevocable letters of credit as part of our normal and recurring business operations. The purpose of these credit facilities is to meet short-term funding requirements, finance working capital needs, and for general corporate purposes. We typically borrow on an overnight or short-term basis on our credit facilities. Refer to Note M of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2021 for further discussion on our credit facilities.
Details of our credit facilities as of
Maximum August 31, 2021 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 - 500.0PNC Bank, National Association ("PNC") February 6, 2023$ 250.0 7.1 242.9 Total Lines of Credit Outstanding and Available $
7.1
Amounts outstanding under the PNC credit facility as of
Subsequent toAugust 31, 2021 , we amended our$500.0 million credit facility with JPM. The amendment increased the credit facility's maximum borrowing capacity to$750.0 million , extended the term throughSeptember 17, 2026 , with the option to extend for two additional one-year periods, and amended interest rate provisions to phase out the use of the London Interbank Offered Rate ("LIBOR"). In addition, we also amended our$1.0 billion credit facility with JPM. The amendments phase out the use of LIBOR and adopt other administrative changes to maintain consistency with our other credit facilities.
Details of borrowings under each credit facility during the first quarter and the respective prior year period were as follows:
For the three months ended August 31, 2021 Credit Facility$1 Billion $500 Million $250 Million $ in millions JPM JPM PNC Number of days borrowed - - 92 Maximum amount borrowed $ - $ -$ 106.5 Weighted-average amount borrowed $ - $ -$ 8.3 Weighted-average interest rate - % - % 1.15 % 23
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Table of Contents For the three months ended August 31, 2020 Credit Facility$1 Billion $500 Million $250 Million $ in millions JPM JPM PNC Number of days borrowed 2 - 92 Maximum amount borrowed$ 135.0 $ -$ 246.1 Weighted-average amount borrowed$ 89.5 $ -$ 14.3 Weighted-average interest rate 3.25 % - % 1.07 %
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 AFS securities allocated to our long-term portfolio.
Subsequent to
We expect to have access to the amounts available under our current credit facilities to meet our ongoing financial needs. However, if we experience reductions in our operating cash flows due to any of the risk factors outlined in, but not limited to, Item 1A in our Form 10-K for fiscal 2021 and otherSEC filings, 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. Furthermore, if we determined the need for additional short-term liquidity, there is no assurance that such financing, if pursued and obtained, would be adequate or on terms acceptable to us. Letters of credit: As ofAugust 31, 2021 , we had irrevocable standby letters of credit available totaling$139.6 million , required to secure commitments for certain insurance policies. The letters of credit expire at various dates betweenNovember 17, 2021 andDecember 5, 2022 . No amounts were outstanding on these letters of credit during the first quarter or as ofAugust 31, 2021 . Long-term financing: We have borrowed$800.0 million through the issuance of long-term private placement debt ("Senior Notes"). Certain information related to our Senior Notes are as follows: Senior Notes Senior Notes Series A Series B Stated interest rate 4.07% 4.25% Effective interest rate 4.15% 4.31% Interest rate type Fixed Fixed
Interest payment dates Semi-annual, in arrears Semi-annual, in arrears
Principal payment dates
March 13, 2029 Note type Unsecured Unsecured Refer to Note N of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2021 for further discussion on our long-term financing. Other commitments: We had outstanding commitments under existing workers' compensation insurance agreements and legally binding contractual arrangements, which included immaterial leases that have yet to commence. We also entered into various purchase commitments with vendors in the ordinary course of business and had outstanding commitments to purchase approximately$7.9 million of capital assets as ofAugust 31, 2021 . 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 ofAugust 31, 2021 , we have contributed approximately$12.9 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 claims as they relate to their services provided to us. 24
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We currently self-insure the deductible portion of various insured exposures under certain corporate employee and PEO employee health and medical 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 ofAugust 31, 2021 . We also maintain insurance coverage in addition to our purchased primary insurance policies for gap coverage for employment practices liability, errors and omissions, warranty liability, theft and embezzlement, cyber threats, and acts of terrorism; and capacity for deductibles and self-insured retentions through our captive insurance company.
Operating, Investing, and Financing Cash Flow Activities
For the three months ended August 31, In millions 2021 2020
Change
Net cash provided by operating activities $ 385.6
(22.3) (236.3) 214.0 Net cash used in financing activities (211.7) (382.8) 171.1 Net change in cash, restricted cash, and equivalents $ 151.6 $
(404.1)
Cash dividends per common share $ 0.66 $
0.62
The changes in our cash flows for the first quarter compared to the corresponding prior year period were primarily the result of the following key drivers:
Operating Cash Flow Activities
?Higher net income attributable to the reasons discussed in the "Results of Operations" section of this Item 2.
?Changes in purchased receivables balances due to the timing of collections, offset by growth in our business.
?Timing and magnitude of income tax payments; partially offset by,
?Higher incentive compensation payments than in the prior year period; and,
?Decrease in the net change in operating lease right-of-use assets and liabilities due to the prior year period reduction of our geographic footprint.
Investing Cash Flow Activities
?The decrease in cash used was primarily related to prior year period purchases of AFS securities from funds held for clients that were previously being held as cash or cash equivalents due to uncertainty in the economy. This is partially offset by,
?Greater investment in technology as we continued to introduce new product solutions and enhancements.
Fluctuations in the net purchases and sales/maturities of AFS securities are also due to timing within the client funds portfolio and market conditions. Amounts 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.
Discussion of interest rates and related risks is included in the "Market Risk Factors" section of this Item 2.
Financing Cash Flow Activities
?Increase in net cash inflows from changes in client fund obligations as our clients continued to recover from the impacts of the COVID-19 pandemic.
?Decrease in the repurchase of common shares as we did not repurchase any shares in the first quarter versus 0.4 million shares repurchased in the respective prior year period.$472.4 million remains available under our common stock repurchase programs. Refer to Part II, Item 2 of this Form 10-Q for further discussion on our common stock repurchase programs. ?Dividends paid increased$14.9 million compared to the prior year period due to an increase in our quarterly dividend from$0.62 to$0.66 per share. 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. 25
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The client fund obligations liability will also 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. MARKET RISK FACTORS Changes in interest rates and interest rate risk: Funds held for clients are primarily comprised of short-term funds and AFS securities. Corporate investments are primarily comprised of AFS 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 AFS 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; corporate bonds; andU.S. government agency and treasury 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 AFS securities to a benchmark duration of two and one-half to three and three-quarters years. During the first quarter, our primary short-term investment vehicle was bank demand deposit accounts. We have no exposure to high-risk or non-liquid investments. We have insignificant exposure to European investments. We have not and do not utilize derivative financial instruments to manage our interest rate risk. During the first quarter, the average interest rate earned on our combined funds held for clients and corporate cash equivalents and investment portfolios was 1.1% compared to 1.3% 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 AFS securities. Earnings from AFS securities, which as ofAugust 31, 2021 had an average duration of 3.4 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 AFS securities that had stated maturities
as of
August 31, 2021 Amortized Fair In millions cost value Maturity date: Due in one year or less$ 318.7 $ 322.0
Due after one year through three years 715.0 741.0 Due after three years through five years 1,025.1 1,062.1 Due after five years
864.9 877.3 Total$ 2,923.7 $ 3,002.4 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 ofAugust 31, 2021 , the Federal Funds rate was in the range of 0.00% to 0.25%. There continues to be uncertainty in the changing market and economic conditions, including the possibility of additional measures that could be taken by theFederal Reserve and other government agencies, related to the COVID-19 pandemic. We will continue to monitor the market conditions.
Calculating the future effects of changing interest rates involves many factors. These factors include, but are not limited to:
?governmental action resulting from the COVID-19 pandemic;
?daily interest rate changes;
?seasonal variations in investment balances;
?actual duration of short-term and AFS 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
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? 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$3.5 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$5.5 billion for fiscal 2022. Our anticipated allocation is approximately 40% invested in short-term securities and VRDNs with an average duration of less than 30 days and 60% invested in AFS securities, with an average duration of two and one-half to three and three-quarters years. The combined funds held for clients and corporate AFS securities reflected net unrealized gains of$78.7 million as ofAugust 31, 2021 and$79.3 million as ofMay 31, 2021 . During the first quarter, the net unrealized gain on our investment portfolios ranged from$68.0 million to$89.2 million . These fluctuations were driven by changes in market rates of interest. The net unrealized gain on our investment portfolio was approximately$58.2 million as ofSeptember 28, 2021 . As ofAugust 31, 2021 andMay 31, 2021 , we had$3.0 billion , respectively, invested in AFS securities at fair value. The weighted-average yield-to-maturity was 1.8% as ofAugust 31, 2021 and 1.9% as ofMay 31, 2021 . The weighted-average yield-to-maturity excludes AFS 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 AFS securities as ofAugust 31, 2021 , would be approximately$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 our results of operations unless any declines in fair value are due to credit related concerns and an impairment loss is recognized. Credit risk: We are exposed to credit risk in connection with these investments through the possible inability of the borrowers to meet the terms of their bonds. We regularly review our investment portfolios to determine if any investment is impaired due to increased credit risk or other valuation concerns and we believe that the investments we held as ofAugust 31, 2021 were not impaired as a result of the previously discussed reasons. While$273.9 million of our AFS 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$1.8 million were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. Most of the AFS securities in an unrealized loss position as ofAugust 31, 2021 andMay 31, 2021 held an AA rating or better. We do not intend to sell these investments until the recovery of their amortized cost basis or maturity, and further believe that it is not more-likely-than-not that we will be required to sell these investments prior to that time. Our assessment that an investment is not impaired due to increased credit risk or other valuation concerns could change in the future due to new developments, including changes in our strategies or assumptions related to any particular investment. We have some credit risk exposure relating to the purchase of accounts receivable as a means of providing payroll funding to clients in the temporary staffing industry. There is also credit risk exposure relating to our trade accounts receivable. 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 as ofAugust 31, 2021 . CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for
fiscal 2021, filed with the
?revenue recognition;
?assets recognized from the costs to obtain and fulfill contracts;
?PEO insurance reserves;
?goodwill and other intangible assets;
?impairment of long-lived assets;
?stock-based compensation costs; and
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?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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