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EX-21.1 - EX-21.1 - PAYCHEX INCpayx-20180531xex21_1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_____________________________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended May 31, 2018

Commission file number 0-11330

 ____________________________

Paychex, Inc.

911 Panorama Trail South

Rochester, New York 14625-2396

(585) 385-6666

A Delaware Corporation

IRS Employer Identification Number: 16-1124166



 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, $0.01 Par Value

Name of exchange on which registered:

 

NASDAQ Global Select Market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes     No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes     No 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes     No 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes     No 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10‑K.    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



 

 

 

 

 

 

Large accelerated filer    

 

Accelerated filer    

 

Non-accelerated filer    

 

Smaller reporting company     



 

 

 

(Do not check if a smaller reporting company)

 

Emerging growth company   

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes     No 

As of November 30, 2017, the last business day of the most recently completed second fiscal quarter, shares held by non-affiliates of the registrant had an aggregate market value of $21,553,152,555 based on the closing price reported for such date on the NASDAQ Global Select Market.

As of June 30, 2018, 358,999,129 shares of the registrant’s common stock, $.01 par value, were outstanding.

Documents Incorporated by Reference

Portions of the registrant’s definitive proxy statement to be issued in connection with its Annual Meeting of Stockholders to be held on or about October 11, 2018, to the extent not set forth herein, are incorporated by reference into Part III, Items 10 through 14, inclusive. 



 


 

PAYCHEX, INC.

INDEX TO FORM 10-K

For the fiscal year ended May 31, 2018



 

 

 



 

 

 

Description

Page



PART I

 



Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities 
Litigation Reform Act of 1995

 

Item 1

Business

 

Item 1A

Risk Factors

 

Item 1B

Unresolved Staff Comments

11 

 

Item 2

Properties

11 

 

Item 3

Legal Proceedings

12 

 

Item 4

Mine Safety Disclosures

12 

 



PART II

 

Item 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity 
Securities

12 

 

Item 6

Selected Financial Data

14 

 

Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations

15 

 

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

30 

 

Item 8

Financial Statements and Supplementary Data

32 

 

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

67 

 

Item 9A

Controls and Procedures

67 

 

Item 9B

Other Information

68 

 



PART III

 

Item 10

Directors, Executive Officers and Corporate Governance

68 

 

Item 11

Executive Compensation

69 

 

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

69 

 

Item 13

Certain Relationships and Related Transactions, and Director Independence

70 

 

Item 14

Principal Accounting Fees and Services

70 

 



PART IV

 

Item 15

Exhibits and Financial Statement Schedules

71 

 

Item 16

Form 10-K Summary

73 

 



Signatures

73 

 



 



 

i


 



PART I

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS PURSUANT TO THE UNITED STATES PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain written and oral statements made by management of Paychex, Inc. and its wholly owned subsidiaries (“we,” “our,” “us,” “Paychex,” or the “Company”) may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the United States (“U.S.”) Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by such words and phrases as “we expect,” “expected to,” “estimates,” “estimated,” “overview,” “current outlook,” “we look forward to,” “would equate to,” “projects,” “projections,” “projected to be,” “anticipates,” “anticipated,” “we believe,” “believes,” “could be,” and other similar words or phrases. Examples of forward-looking statements include, among others, statements we make regarding operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to our outlook, revenue growth, earnings, earnings-per-share growth, or similar projections.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict, many of which are outside our control. Our actual results and financial conditions may differ materially from those indicated in the forward-looking statements. Therefore, you should not place undue reliance upon any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:



·

general market and economic conditions including, among others, changes in U.S. employment and wage levels, changes to new hiring trends, legislative changes to stimulate the economy, changes in short- and long-term interest rates, changes in the fair value and the credit rating of securities held by us, and accessibility of financing;



·

changes in demand for our services and products, ability to develop and market new services and products effectively, pricing changes, and the impact of competition;



·

changes in the availability of skilled workers, in particular those supporting our technology and product development;



·

changes in the laws regulating collection and payment of payroll taxes, professional employer organizations (“PEOs”), and employee benefits, including retirement plans, workers’ compensation, health insurance (including health care reform legislation), state unemployment, and section 125 plans;



·

changes in health insurance and workers’ compensation insurance rates and underlying claim trends;



·

changes in technology that adversely affect our products and services and impact our ability to provide timely enhancements to services and products;



·

the possibility of cyberattacks, security breaches, or other security vulnerabilities that could disrupt operations or expose confidential client data, and could also result in reduced revenues, increased costs, liability claims, or harm to our competitive position;



·

the possibility of failure of our operating facilities, or the failure of our computer systems, and communication systems during a catastrophic event;



·

the possibility of third-party service providers failing to perform their functions;



·

the possibility of a failure of internal controls or our inability to implement business process improvements;



·

the possibility that we may be subject to liability for violations of employment or discrimination laws by our clients and acts or omissions of client employees who may be deemed to be our agents, even if we do not participate in any such acts or violations, including possible liability related to our co-employment relationship with our PEO;



·

potential outcomes related to pending or future litigation and legislative matters;



·

the expected impacts of the Tax Cut and Jobs Act of 2017 (the “Tax Act”); and



1


 

·

risks related to the integration of the businesses we acquire.



Any of these factors, as well as such other factors as discussed in Part I, Item 1A, “Risk Factors” and throughout Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10‑K (“Form 10-K”), as well as in our periodic filings with the Securities and Exchange Commission (the “SEC”), could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10‑K is based upon the facts and circumstances known at this time, and any forward-looking statements made by us in this Form 10‑K 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-K with the SEC to reflect events or circumstances after such date, or to reflect the occurrence of unanticipated events.



2


 

Item 1.    Business

Incorporated in Delaware in 1979, we are a leading provider of integrated human capital management (“HCM”) solutions for payroll, human resource (“HR”), retirement, and insurance services for small- to medium-sized businesses. As of May 31, 2018, we served over 650,000 payroll clients. We maintain our corporate headquarters in Rochester, New York, and serve clients throughout the U.S. and Europe. We report our results of operations and financial condition as one business segment. Our fiscal year ends May 31st.

Company Strategy

Our mission is to be the leading provider of HCM solutions for payroll, HR, retirement, and insurance services for small- to medium-sized businesses by being an essential partner with America’s businesses.  We believe that success in this mission will lead to strong, long-term financial performance.  Our business strategy focuses on the following:

·

flexible, convenient service;

·

industry-leading, integrated technology;

·

providing a comprehensive suite of value-added HCM services;

·

solid sales execution;

·

continued service penetration; and

·

engaging in strategic acquisitions, when possible.

Our Clients

The target market for our integrated HCM solutions is in the small- to mid-market space. Within this space, we serve a diverse base of small- to medium-sized clients operating in a broad range of industries located throughout the U.S. and Europe. Our clients have the option to select the HCM modules they need with the ability to easily add services as they grow. They can also opt for our comprehensive HR and payroll outsourcing solutions, Paychex HR Services. This flexibility allows our clients to define the solution that best meets their needs. We utilize service agreements and arrangements with clients that are generally terminable by the client at any time or upon relatively short notice. For the fiscal year ended May 31, 2018 (“fiscal 2018”), client retention was approximately 81% of our beginning client base for the fiscal year, consistent with a year ago.

We support our small-business clients in reducing the complexity and risk of running their own payroll, while ensuring greater accuracy with up-to-date tax rates and regulatory information. We simplify their payroll with a combination of our dynamic products and customer service options for a quick and easy payday. Clients can choose to have our service team handle everything for them, or can process payroll themselves utilizing our robust Paychex Flex® processing platform or SurePayroll®  online applications. Both products are cloud-based software-as-a-service (“SaaS”) solutions that allow users to do payroll when they want, how they want, and on any device (desktop, tablet, and mobile phone).

With an environment of increasing regulations, the need for HR outsourcing services is moving down-market.  Our small-business clients benefit from our time and attendance products, which allow them to accurately and efficiently manage the gathering and recording of employee hours worked.  Our advanced suite of time and attendance products, including web and mobile tools, assist companies with the scheduling, tracking, and reporting of time.

Our mid-market clients have more complex payroll and employee benefit needs. Our mid-market clients are serviced through our Paychex Flex Enterprise solution, which offers an integrated suite of HCM solutions on the Paychex Flex platform, or through our legacy platform.  All new clients are sold on the Paychex Flex platform.  Clients using Paychex Flex Enterprise are offered a SaaS solution that integrates payroll processing with HR management, employee benefits administration, time and labor management, applicant tracking, and onboarding solutions.  Paychex Flex Enterprise allows mid-market clients to choose the services and software they need to meet the complexity of the business and have them integrated through one HCM solution.

3


 

Description of Services

We offer a comprehensive portfolio of HCM services and products that allow our clients to meet their diverse payroll and HR needs. Clients can select services on an á la carte basis or as part of various product bundles. Our offerings often leverage the information gathered in our base payroll processing service, allowing us to provide comprehensive outsourcing services covering the HCM spectrum.

Our portfolio of HCM and employee benefit-related services are comprised of the following:

·

Payroll processing services: Payroll processing services include the calculation, preparation, and delivery of employee payroll checks; production of internal accounting records and management reports; preparation of federal, state, and local payroll tax returns; and collection and remittance of clients’ payroll obligations.

·

Payroll tax administration services: Our payroll tax administration services provide for accurate preparation and timely filing of quarterly and year-end tax returns, as well as the electronic transfer of funds to the applicable tax or regulatory agencies (federal, state, and local). In connection with these services, we electronically collect payroll taxes from clients’ bank accounts, typically on payday, prepare and file the applicable tax returns, and remit taxes to the applicable tax or regulatory agencies on the respective due dates. These taxes are typically paid between one and 30 days after receipt of collections from clients, with some items extending up to 90 days. We handle regulatory correspondence, amendments, and penalty and interest disputes.

·

Employee payment services: Our employee payment services provide an employer with the option of paying their employees by direct deposit, payroll debit card, a check drawn on a Paychex account (Readychex®), or a check drawn on the employer’s account and electronically signed by us. For each of the first three methods, we electronically collect net payroll from the clients’ bank accounts, typically one business day before payday, and provide payment to the employees on payday. Same day ACH functionality is also available for clients using direct deposit, allowing employers the flexibility to pay employees via direct deposit on the same day they initiate payroll. Our Readychex service provides a cost-effective solution that offers the benefit of convenient, one-step payroll account reconciliation for employers.

·

Regulatory compliance services: We offer new-hire reporting services, which enable clients to comply with federal and state requirements to report information on newly hired employees. This information aids the government in enforcing child support orders and minimizes fraudulent unemployment and workers’ compensation insurance claims. Our garnishment processing service provides deductions from employees’ pay, forwards payments to third-party agencies, including those that require electronic payments, and tracks the obligations to fulfillment. These services enable employers to comply with legal requirements and reduce the risk of penalties.

·

Paychex HR Services: We offer comprehensive HR outsourcing solutions that provide businesses a full-service approach to the outsourcing of employer and employee administrative needs. Our Paychex HR Services offering is available through Paychex HR Solutions, an administrative services organization (“ASO”), or Paychex PEO. Both options offer businesses a combined package of services that includes payroll, employer compliance, HR and employee benefits administration, risk management outsourcing, and the on-site availability of a professionally trained HR representative. These comprehensive bundles of services are designed to make it easier for businesses to manage their payroll and related benefit costs while providing a benefits package that is competitive with those offered by larger companies. Clients are also assigned a dedicated HR professional called a human resources generalist, or HRG. Available to meet onsite, the HRG helps clients navigate obligations related to federal and state regulations, and supports employers with workforce functions such as hiring, training, and workplace safety. We believe HRGs differentiate us in the marketplace.

Our PEO differs from the ASO in that we serve as a co-employer of our clients’ employees, offer health care coverage to PEO client employees, and assume the risks and rewards of workers’ compensation insurance and certain health insurance offerings. PEO services are sold through our registered and licensed subsidiary, Paychex Business Solutions, LLC and HR Outsourcing Holdings, Inc., which was acquired in August 2017. We are certified under the Small Business Efficiency Act to provide PEO services. We also offer Paychex HR Essentials, which is an ASO product that provides support to our clients over the phone or online to help manage employee-related topics.  As of May 31, 2018, Paychex HR Services was utilized by approximately 41,000 clients with approximately 1,157,000 client worksite employees.

4


 

·

Retirement services administration: Our retirement services product line offers a variety of options to clients, including 401(k) plans, 401(k) SIMPLE plans, SIMPLE IRAs, 401(k) plans with safe harbor provisions, owner-only 401(k) plans, profit sharing plans, and money purchase plans. These services provide plan implementation, ongoing compliance with government regulations, employee and employer reporting, participant and employer online access, electronic funds transfer, and other administrative services. Auto enrollment is an optional plan feature that allows employers to automatically enroll employees in their company’s 401(k) plan and increase overall plan participation. Clients have the ability to choose from a group of pre-defined fund selections or to customize their investment options within their plan. We are the largest 401(k) recordkeeper for small businesses in the U.S. Our large-market retirement services clients include relationships with financial advisors. As of May 31, 2018, retirement services covered approximately 82,000 plans and the asset value of participants' funds externally managed totaled approximately $30.6 billion.

·

Insurance services: Our licensed insurance agency, Paychex Insurance Agency, Inc., provides insurance through a variety of carriers, while allowing employers to expand their employee benefit offerings at an affordable cost. Insurance offerings include property and casualty coverage such as workers’ compensation, business-owner policies, commercial auto, and health and benefits coverage, including health, dental, vision, and life. Our insurance services simplify the insurance process to make it easy to find plans with the features and affordability to meet the client’s needs. With access to numerous top national and regional insurance carriers, our professional insurance agents have access to a wide selection of plans from which they can best match the insurance needs of small businesses. Additionally, clients have the option to integrate their insurance plans with Paychex payroll processing for easy, accurate plan administration.

We also offer comprehensive solutions to help employers and employees with certain mandates under the Affordable Care Act (“ACA”), which sets forth specific coverage and reporting requirements that employers must meet.  Our Paychex Employer Shared Responsibility (“ESR”) Service is aimed at helping clients: 1) determine if the ACA’s ESR provision applies to them; 2) provide ongoing ACA analysis and monitoring, along with automatic alerts, of their employees and hours worked; 3) evaluate if their health care offering meets the minimum coverage requirement; and 4) prepare and file end-of-year reporting.

·

HR administration services: We offer cloud-based HR administration software products for employee benefits management and administration, time and attendance solutions, recruiting, and onboarding. Paychex HR Online offers powerful tools for managing employee benefits, personnel information, and HR compliance and reporting. Our BeneTrac service manages the employee-benefit enrollment process. Our time and attendance products, including our integrated Flex Time software, provides timekeeping, scheduling, and workforce analytics. These services allow the employer to handle multiple payroll scenarios, improving productivity, accuracy, and reliability in the payroll process. In fiscal 2018, we introduced the InVisionTM IRIS Time Clock, a biometric clock that scans the iris, providing fast and accurate time capture. Our expense reporting solution is a web-based solution that provides clients with tools to manage and control the expense reporting process. The applicant tracking suite provides technology that streamlines, simplifies, and drives the applicant workflow and onboarding process for companies of all sizes.

·

Other HR services and products: We offer the outsourcing of plan administration under section 125 of the Internal Revenue Code, allowing employees to use pre-tax dollars to pay for certain health insurance benefits and health and dependent care expenses not covered by insurance. All required implementation, administration, compliance, claims processing and reimbursement, and coverage tests are provided with these services. We offer state unemployment insurance services, which provide clients with prompt processing for all claims, appeals, determinations, change statements, and requests for separation documents. Other products include employee handbooks, management manuals, and personnel and required regulatory forms. These products are designed to simplify clients’ administrative processes all while enhancing their employee benefits programs.

·

Accounting and Financial Services: We offer various accounting and financial services to small- to medium-sized businesses. Our wholly owned subsidiary, Paychex Advance, LLC, provides a portfolio of services to the temporary staffing industry, including payroll funding (via the purchase of accounts receivable) and outsourcing services, which include payroll processing, invoicing, and tax preparation. We recently launched Paychex Promise, a subscription-based service that offers protection against payroll interruptions and solutions to address routine challenges of running a successful business.  The primary offering is payroll protection, which extends the collection of payroll funds from a client’s bank account by seven days without interruption of service or charges for insufficient funds.  In addition, through partnerships with third-party providers, we provide clients opportunities for services such as payment processing services, financial fitness programs, and a small-business loan resource center.

5


 

Technology and Service Platform

Paychex Flex is our proprietary HCM SaaS platform through which we provide an integrated product suite that covers the employee life cycle from recruiting and hiring to retirement. Paychex Flex streamlines workforce management through innovative technology and flexible choice of service. It uses a single cloud-based platform, with single client and employee records and single sign-on, including self-service options and mobility applications. The HCM product suite integrates recruiting and applicant tracking, employee onboarding, payroll, employee benefits and HR administration, time and attendance, and retirement services. In addition, Paychex Flex presents function-focused analytics throughout the platform, assisting HR leaders with making more informed business decisions.  Paychex Flex also provides technology-enabled service, with options that include self-service, a 24/7 dedicated service center, an individual payroll specialist, and integrated service via a multi-product service center.  In addition, mid-market clients can utilize a relationship manager for more personalized service.  This flexible platform services our small- to medium-sized clients, and our PEO business.

The integration of flexible service options and leading-edge technology allows us to meet our clients' diverse needs by providing them with information and products when, where, and how they want it.  Our Paychex mobile applications add greater value and convenience for our clients and their employees by allowing them instant access and increased productivity.  Paychex Flex uses a mobile-first design throughout our HCM suite, which allows full functionality of all application components, regardless of device or screen size.  Enabling our clients and their employees to have full access to our products offers diverse capabilities and flexibility for both the employer and employee.

Sales and Marketing

We market and sell our services primarily through our direct sales force based in the metropolitan markets we serve. Our direct sales force includes sales representatives who have defined geographical territories and specialize within our portfolio of services. Our sales representatives are also supported by marketing, advertising, public relations, trade shows, and telemarketing programs. We utilize a virtual sales force to service geographical areas where we may not have a local presence, cover inbound leads for certain small-business clients, or for products for which we do not have a local sales force.

In addition to our direct selling and marketing efforts, we utilize other indirect sales channels such as our relationships with existing clients, certified public accountants (“CPAs”), and banks for new client referrals. Greater than 50% of our new small-market payroll clients (excluding business acquisitions) come from these referral sources. Our dedicated business development group drives sales through banking, national associations, and franchise channels.  We also utilize digital marketing as a means to market our services.

We have a long-standing partnership with the American Institute of Certified Public Accountants (“AICPA”) as the preferred payroll provider for its AICPA Business SolutionsTM Program. Our current partnership agreement with the AICPA is in place through September 2021.  We also partner with various state CPA society organizations.

Our website, which is available at www.paychex.com, includes online payroll sales presentations and service and product information.  It also serves as a cost-efficient tool that serves as a source of leads and new sales, while complementing the efforts of our direct and virtual sales forces. This online tool allows us to market to clients and prospective clients in other geographical areas where we do not have a direct sales presence. In addition, the insurance services section of our website, which is accessible at www.paychex.com/group-health-insurance, provides information to help small businesses navigate the insurance industry, and generates leads by allowing interested parties to get in contact with one of our professional insurance agents.

Paychex also builds on its reputation as an expert in the HCM industry by providing education and assistance to clients and other interested parties. We provide free webinars, white papers, and other information on our website to aid existing and prospective clients with the impacts of regulatory change. We track current regulatory issues that impact the business community and provide a monthly regulatory update. Our Paychex Accountant Knowledge Center is a free online resource available through our website that brings valuable information and time-saving online tools to accounting professionals. Through the Paychex Flex online platform, AccountantHQ offers access to authorized client payroll and HR data and key account contacts, along with an extensive accountant resource library. AccountantHQ drives efficiency by putting accountants in the best position possible to easily access critical client payroll and HR data and powerful reporting tools. Our Paychex WORX website, available at www.paychex.com/worx, is a digital destination for insightful resources useful for businesses at every stage, from entrepreneur to enterprise. Paychex WORX highlights the breadth of our product line, expertise, and ability to help businesses of all sizes with a wide range of HR and financial information for current clients and prospects alike.

6


 

Markets and Competition

We remain focused on servicing small- to medium-sized businesses based upon the growth potential that we believe exists in the markets we serve. Our internal database source indicates that there are approximately 11 million addressable businesses in the geographic markets that we currently serve within the U.S. Of those businesses, approximately 99% have fewer than 100 employees and comprise our primary customers and target market. We believe that there is opportunity for us in the HCM market as the demand is moving down-market to smaller businesses.

The market for HCM services is highly competitive and fragmented. We have one primary national competitor and we also compete with other national, regional, local, and online service providers. In addition to traditional payroll processing and HR service providers, we compete with in-house payroll and HR systems and departments. Payroll and HR systems and software are sold by many vendors. Human Resource Services (“HRS”) products also compete with a variety of providers of HR services, such as retirement services companies, insurance companies, and HR and benefits consulting firms.

Competition in the payroll processing and HR services industry is primarily based on service responsiveness, product quality and reputation, including ease of use and accessibility of technology, breadth of service and product offerings, and price. We believe we are competitive in each of these areas.  We believe that our excellent customer service, together with our leading-edge technology and mobility applications, distinguishes us from our competitors.

Software Maintenance and Development

The ever-changing mandates of federal, state, and local tax and regulatory agencies require us to regularly update our proprietary software to provide payroll and HR services to our clients. We are continually engaged in developing enhancements to and the maintenance of our various software platforms to meet the changing requirements of our clients and the marketplace. We continue to enhance our SaaS solutions and mobility applications to offer our users an integrated and unified experience.  Continued enhancement of the client and client employee experience is important to our future success.

Employees

We believe our ability to attract and retain qualified employees in all areas of our business is important to our future success and growth. As of May 31, 2018, we employed approximately 14,300 people.  None of our employees were covered by collective bargaining agreements.

Intellectual Property

We own or license and use a number of trademarks, trade names, copyrights, service marks, trade secrets, computer programs and software, and other intellectual property rights. Taken as a whole, our intellectual property rights are material to the conduct of our business. Where it is determined to be appropriate, we take measures to protect our intellectual property rights, including, but not limited to, confidentiality/non-disclosure agreements or policies with employees, vendors, and others; license agreements with licensees and licensors of intellectual property; and registration of certain trademarks. We believe that the “Paychex” name, trademark, and logo are of material importance to us.

Seasonality

There is no significant seasonality to our business. However, during our third fiscal quarter, which ends in February, the number of new payroll clients, new retirement services clients, and new Paychex HR Services worksite employees tends to be higher than during the rest of the fiscal year, primarily because many new clients prefer to start using our services at the beginning of a calendar year. In addition, calendar year-end transaction processing and client funds activity are traditionally higher during our third fiscal quarter due to clients paying year-end bonuses and requesting additional year-end services.

Available Information

We are subject to the informational and reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, we file periodic reports, proxy statements, and other information with the SEC. Such reports may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the Public Reference Room may be obtained by calling the SEC at (800) SEC-0330. The SEC also maintains a website (www.sec.gov) that includes our reports, proxy statements, and other information. The information on our website is not incorporated by reference into our Form 10-K.

7


 

Our corporate website, www.paychex.com, provides materials for investors and information about our services. Our Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other SEC filings, as well as any amendments to such reports and filings, are made available, free of charge, on our website as soon as reasonably practicable after such reports have been filed with or furnished to the SEC. Also, copies of our Annual Report to Stockholders and Proxy Statement, to be issued in connection with our 2018 Annual Meeting of Stockholders, will be made available, free of charge, upon written request submitted to Paychex, Inc., c/o Corporate Secretary, 911 Panorama Trail South, Rochester, New York 14625-2396.

 

Item 1A.    Risk Factors

Our future results of operations are subject to a number of risks and uncertainties. These risks and uncertainties could cause actual results to differ materially from historical and current results, and from our projections. The risk factors described below represent our current view of some of the most important risks facing our business and are important to understanding our business. The risks described below are not the only risks we face. Additional factors not presently known to us or that we currently deem to be immaterial also may adversely affect, possibly to a material extent, our business, cash flows, financial condition, or results of operations in future periods. In addition, you should refer to the description of forward-looking statements at the beginning of Part I of this Form 10-K.

Our services may be adversely impacted by changes in government regulations and policies.    Many of our services, particularly payroll tax administration services and employee benefit plan administration services, are designed according to government regulations that continually change, for example, the ambiguity surrounding the Department of Labor’s fiduciary rule for retirement plan service. Changes in regulations could affect the extent and type of benefits employers are required, or may choose, to provide employees or the amount and type of taxes employers and employees are required to pay. Such changes could reduce or eliminate the need for some of our services and substantially decrease our revenue. Added requirements could also increase our cost of doing business. Failure to educate and assist our clients regarding new or revised legislation that impacts them could have an adverse impact on our reputation. Failure by us to modify our services in a timely fashion in response to regulatory changes could have a material adverse effect on our business and results of operations.

Our business and reputation may be adversely impacted if we fail to comply with U.S. and foreign laws and regulations.  Our services are subject to various laws and regulations, including, but not limited to, the ACA and Anti-Money Laundering rules. The growth of our international operations via acquisition also subjects us to additional risks, such as compliance with the Foreign Corrupt Practices Act and United Kingdom Bribery Act. As of this fiscal year, the financial impact of our international operations to our overall business has been insignificant. However, over time, our international operations may grow and increase their significance to our business. Uncertainty regarding the potential future modifications of existing laws and regulations can also adversely affect our business. There is uncertainty regarding the potential future evolution and modification of the ACA. Failure to update our services to comply with modified or new legislation in the area of health care reform as well as failure to educate and assist our clients regarding this legislation could adversely impact our business reputation and negatively impact our client base. Failure to comply with laws and regulations could result in the imposition of consent orders or civil and criminal penalties, including fines, which could damage our reputation and have an adverse effect on our results of operations or financial condition.  We have policies and procedures to monitor our compliance with U.S. and foreign laws and regulations throughout the business and our acquisitions.

We may not be able to keep pace with changes in technology or provide timely enhancements to our products and services.  The market for our products is characterized by rapid technological advancements, changes in customer requirements, frequent new product introductions, and enhancements and changing industry standards. To maintain our growth strategy, we must adapt and respond to technological advances and technological requirements of our clients. Our future success will depend on our ability to: enhance our current products and introduce new products in order to keep pace with products offered by our competitors; enhance capabilities and increase the performance of our internal systems, particularly our systems that meet our clients’ requirements; and adapt to technological advancements and changing industry standards. We continue to make significant investments related to the development of new technology. If our systems become outdated, we may be at a disadvantage when competing in our industry. There can be no assurance that our efforts to update and integrate systems will be successful. If we do not integrate and update our systems in a timely manner, or if our investments in technology fail to provide the expected results, there could be a material adverse effect to our business and results of operations.

8


 

Our reputation, results of operations, or financial condition may be adversely impacted if we fail to comply with data privacy laws and regulations.  Our services require the storage and transmission of proprietary and confidential information of our clients and their employees, including personal or identifying information, as well as their financial and payroll data.  Our applications are subject to various complex government laws and regulations on the federal, state, and local levels, including those governing personal privacy.  In the U.S., we are subject to rules and regulations promulgated under the authority of the Federal Trade Commission, the Health Insurance Portability and Accountability Act of 1996, the Family Medical Leave Act of 1993, the ACA, federal and state labor and employment laws, and state data breach notification laws. In addition, the European Union’s General Data Privacy Regulation became fully effective in May 2018. Failure to comply with such laws and regulations could result in the imposition of consent orders or civil and criminal penalties, including fines, which could damage our reputation and have an adverse effect on our results of operations or financial condition. The regulatory framework for privacy issues is rapidly evolving and future enactment of more restrictive laws, rules, or regulations and/or future enforcement actions or investigations could have a materially adverse impact on us through increased costs or restrictions on our business and noncompliance could result in regulatory penalties and significant legal liability.

We could be subject to reduced revenues, increased costs, liability claims, or harm to our competitive position as a result of cyberattacks, security vulnerabilities or Internet disruptions.  We rely upon information technology (“IT”) networks, cloud-based platforms, and systems to process, transmit, and store electronic information, and to support a variety of business processes.  Cyberattacks and security threats are a risk to our business and reputation.  A privacy or IT security breach could have a material adverse effect on our business.

Data Security and Privacy Leaks:  We collect, use, and retain increasingly large amounts of personal information about our clients, employees of our clients, and our employees, including:  bank account numbers, credit card numbers, social security numbers, tax return information, health care information, retirement account information, payroll information, system and network passwords, and other sensitive personal and business information.  At the same time, the continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security.  Vulnerabilities, threats, and more sophisticated and targeted computer crimes pose a risk to the security of our systems and networks, and the confidentiality, availability, and integrity of our data.

Our service platforms enable our clients to store and process personal data on premise or, increasingly, in a cloud-based environment that we host.  The security of our IT infrastructure is an important consideration in our customers’ purchasing decisions. Because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently, are increasingly more complex and sophisticated and may be difficult to detect for long periods of time, we may be unable or fail to anticipate these techniques or implement adequate or timely preventative or responsive measures.  As cyber threats continue to evolve, we are focused on ensuring that our operating environments safeguard and protect personal and business information. We may be required to invest significant additional resources to comply with evolving cybersecurity regulations and to modify and enhance our information security and controls, and to investigate and remediate any security vulnerabilities. While we have security systems and IT infrastructure in place designed to detect and protect against unauthorized access to such information, if our security measures are breached, our business could be substantially harmed and we could incur significant liabilities. Any such breach or unauthorized access could negatively affect our ability to attract new clients, cause existing clients to terminate their agreements with us, result in reputational damage, and subject us to lawsuits, regulatory fines, or other actions or liabilities which could materially and adversely affect our business and operating results.  Third parties, including vendors that provide services for our operations, could also be a source of security risk to us in the event of a failure of their own security systems and infrastructure.

Data Loss and Business InterruptionIf our systems are disrupted or fail for any reason, including Internet or systems failure, or if our systems are infiltrated by unauthorized persons, both the Company and our clients could experience data loss, financial loss, harm to reputation, or significant business interruption. We may be required to incur significant costs to protect against damage caused by disruptions or security breaches in the future. Such events may expose us to unexpected liability, litigation, regulatory investigation and penalties, loss of clients’ business, unfavorable impact to business reputation, and there could be a material adverse effect on our business and results of operations.

In the event of a catastrophe, our business continuity plan may fail, which could result in the loss of client data and adversely interrupt operations.    Our operations are dependent on our ability to protect our infrastructure against damage from catastrophe or natural disaster, severe weather including events resulting from climate change, unauthorized security breach, power loss, telecommunications failure, terrorist attack, or other events that could have a significant disruptive effect on our operations. We have a business continuity plan in place in the event of system failure due to any of these events. Our business continuity plan has been tested in the past by circumstances of severe weather, including hurricanes, floods, and snowstorms, and has been successful. However, these past successes are not an indicator of success in the future. If the business continuity plan is unsuccessful in a disaster recovery scenario, we could potentially lose client data or experience material adverse interruptions to our operations or delivery of services to our clients.

9


 

We may be adversely impacted by any failure of third-party service providers to perform their functions.    As part of providing services to clients, we rely on a number of third-party service providers. These service providers include, but are not limited to, couriers used to deliver client payroll checks and banks used to electronically transfer funds from clients to their employees. Failure by these service providers, for any reason, to deliver their services in a timely manner could result in material interruptions to our operations, impact client relations, and result in significant penalties or liabilities to us.

We may be exposed to additional risks related to our co-employment relationship within our PEO business.    Many federal and state laws that apply to the employer-employee relationship do not specifically address the obligations and responsibilities of the “co-employment” relationship. As a result, there is a possibility that we may be subject to liability for violations of employment or discrimination laws by our clients and acts or omissions of client employees, who may be deemed to be our agents, even if we do not participate in any such acts or violations. Although our agreements with clients provide that they will indemnify us for any liability attributable to their own or their employees’ conduct, we may not be able to effectively enforce or collect such contractual obligations. In addition, we could be subject to liabilities with respect to our employee benefit plans if it were determined that we are not the “employer” under any applicable state or federal laws.

We may be adversely impacted by changes in health insurance and workers’ compensation rates and underlying claims trends.    Within our PEO business, we maintain health and workers’ compensation insurance covering worksite employees. The insurance costs are impacted by claims experience and are a significant portion of our PEO costs. If we experience a sudden or unexpected increase in claims activity, our costs could increase. In addition, in the event of expiration or cancellation of existing contracts, we may not be able to secure replacement contracts on competitive terms. Also, as a co-employer in the PEO, we assume or share many of the employer-related responsibilities associated with health care reform, which may result in increased costs.  Increases in costs not incorporated into service fees timely or fully could have a material adverse effect on our results of operations. Incorporating cost increases into service fees could also impact our ability to attract and retain clients.

Our clients could have insufficient funds to cover payments we have made on their behalf, resulting in financial loss to us.  As part of the payroll processing service, we are authorized by our clients to transfer money from their accounts to fund amounts owed to their employees and various taxing authorities.  It is possible that we could be held liable for such amounts in the event the client has insufficient funds to cover them.  We have in the past, and may in the future, make payments on our clients’ behalf for which we may not be reimbursed, resulting in loss to us.

Our interest earned on funds held for clients may be impacted by changes in government regulations mandating the amount of tax withheld or timing of remittance.    We receive interest income from investing client funds collected but not yet remitted to applicable tax or regulatory agencies or to client employees. A change in regulations either decreasing the amount of taxes to be withheld or allowing less time to remit taxes to applicable tax or regulatory agencies could adversely impact interest income.

We may be adversely impacted by volatility in the political and economic environment.    Trade, monetary and fiscal policies, and political and economic conditions may substantially change, and credit markets may experience periods of constriction and variability. When there is a slowdown in the economy, employment levels and interest rates may decrease or become more volatile. These conditions may impact our business due to lower transaction volumes or an increase in the number of clients going out of business. Current or potential clients may decide to reduce their spending on payroll and other outsourcing services. In addition, new business formation may be affected by an inability to obtain credit.

We invest our funds held for clients in high quality, investment-grade marketable securities, money markets, and other cash equivalents. However, these funds held for clients are subject to general market, interest rate, credit, and liquidity risks.  These risks may be exacerbated during periods of unusual financial market volatility.  The interest we earn on funds held for clients may decrease as a result of a decline in funds available to invest and lower interest rates. In addition, during periods of volatility in the credit markets, certain types of investments may not be available to us or may become too risky for us to invest in, further reducing the interest we may earn on client funds.

Constriction in the credit markets may impact the availability of financing, even to borrowers with the highest credit ratings. Historically, we have periodically borrowed against available credit arrangements to meet short-term liquidity needs. However, should we require additional short-term liquidity during days of large outflows of client funds, a credit constriction may limit our ability to access those funds or the flexibility to obtain them at interest rates that would be acceptable to us. Growth in services for funding payrolls of our clients in the temporary staffing industry may be constricted if access to financing becomes limited.  If all of these financial and economic circumstances were to remain in effect for an extended period of time, there could be a material adverse effect on our results of operations and financial condition.



10


 

We may not be able to attract and retain qualified people, which could impact the quality of our services and customer satisfaction.  Our success, growth, and financial results depend in part on our continuing ability to attract, retain, and motivate highly qualified people at all levels, including management, technical, compliance, and sales personnel. Competition for these individuals can be intense, and we may not be able to retain our key people, or attract, assimilate, or retain other highly-qualified individuals in the future, which could harm our future success.

Failure to protect our intellectual property rights may harm our competitive position and litigation to protect our intellectual property rights or defend against third party allegations of infringement may be costly.  Despite our efforts to protect our intellectual property and proprietary information, we may be unable to do so effectively in all cases. Our intellectual property could be wrongfully acquired as a result of a cyberattack or other wrongful conduct by employees or third parties.  To the extent that our intellectual property is not protected effectively by trademarks, copyrights, patents, or other means, other parties with knowledge of our intellectual property, including former employees, may seek to exploit our intellectual property for their own and others’ advantage. Competitors may also misappropriate our trademarks, copyrights or other intellectual property rights or duplicate our technology and products. Any significant impairment or misappropriation of our intellectual property or proprietary information could harm our business and our brand, and may adversely affect our ability to compete.

We are involved in litigation from time to time arising from the operation of our business and, as such, we could incur substantial judgments, fines, legal fees or other costs. We are sometimes the subject of complaints or litigation from customers, employees or other third parties for various actions. From time to time, we are involved in litigation involving claims related to, among other things, breach of contract, tortious conduct and employment and labor law matters. The damages sought against us in some of these litigation proceedings could be substantial. Although we maintain liability insurance for some litigation claims, if one or more of the claims were to greatly exceed our insurance coverage limits or if our insurance policies do not cover a claim, this could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Quantitative and qualitative disclosures about market risk:    Refer to Item 7A of this Form 10-K for a discussion on Market Risk Factors, which could have a material adverse effect on our business and results of operations.

 

Item 1B.    Unresolved Staff Comments

None.



Item 2.    Properties

We owned and leased the following properties as of May 31, 2018:







 

 



 

 



 

Square feet

Owned facilities:

 

 

Rochester, New York

 

1,012,000 

Other U.S. locations

 

65,000 

International locations

 

19,000 

Total owned facilities

 

1,096,000 



 

 

Leased facilities:

 

 

Rochester, New York

 

156,000 

Other U.S. locations

 

1,883,000 

International locations

 

55,000 

Total leased facilities

 

2,094,000 



Our facilities in Rochester, New York house various distribution, processing, and technology functions, certain ancillary functions, a telemarketing unit, and other back-office functions. Facilities outside of Rochester, New York are at various locations throughout the U.S. and house our branch and sales offices, regional service centers, multi-product service centers, and data processing centers. These locations are concentrated in metropolitan areas. Our international locations primarily house our European branch and sales locations. We believe that adequate, suitable lease space will continue to be available to meet our needs.



11


 

Item 3.    Legal Proceedings

We are subject to various claims and legal matters that arise in the normal course of our business. These include disputes or potential disputes related to breach of contract, tort, patent, breach of fiduciary duty, employment-related claims, tax claims, and other matters.

Our management currently believes that resolution of outstanding legal matters will not have a material adverse effect on our financial position or results of operations. However, legal matters are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of these matters could have a material adverse impact on the Company’s financial position and the results of operations in the period in which any such effect is recorded.



Item 4.    Mine Safety Disclosures

Not applicable.



PART II



Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock trades on the NASDAQ Global Select Market under the symbol “PAYX”. Dividends have historically been paid on our common stock in August, November, February, and May. The level and continuation of future dividends are dependent on our future earnings and cash flows, and are subject to the discretion of our Board of Directors (the “Board”).

As of June 30, 2018, there were 11,262 holders of record of our common stock, which includes registered holders and participants in the Paychex, Inc. Dividend Reinvestment and Stock Purchase Plan. There were also 4,661 participants in the Paychex, Inc. Employee Stock Purchase Plan and 4,386 participants in the Paychex, Inc. Employee Stock Ownership Plan.

The high and low sales prices for our common stock as reported on the NASDAQ Global Select Market and dividends for fiscal 2018 and the fiscal year ended May 31, 2017 (“fiscal 2017”) are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Fiscal 2018

 

Fiscal 2017



 

 

 

 

 

Cash

 

 

 

 

 

Cash



 

 

 

 

 

dividends

 

 

 

 

 

dividends



 

Sales prices

 

declared

 

Sales prices

 

declared



 

High

 

Low

 

per share

 

High

 

Low

 

per share

First quarter

 

$61.13 

 

$54.24 

 

$0.50 

 

$61.87 

 

$53.57 

 

$0.46 

Second quarter

 

$67.31 

 

$56.71 

 

$0.50 

 

$61.62 

 

$52.78 

 

$0.46 

Third quarter

 

$70.25 

 

$61.86 

 

$0.50 

 

$62.18 

 

$57.07 

 

$0.46 

Fourth quarter

 

$66.72 

 

$59.84 

 

$0.56 

 

$63.03 

 

$56.57 

 

$0.46 



The closing price of our common stock as of May 31, 2018, as reported on the NASDAQ Global Select Market, was $65.58 per share.



During fiscal 2018, we maintained a common stock repurchase program authorized by the Board in July 2016 which expires on May 31, 2019. In addition, during fiscal 2017, we maintained a second common stock repurchase plan authorized by the Board in May 2014 which expired on May 31, 2017. Both programs allow us to repurchase up to $350.0 million of our common stock. Shares repurchased under these programs during fiscal 2018 and fiscal 2017 were as follows:





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

Fiscal 2018

 

 

Fiscal 2017

In millions

 

Total
number
of shares
purchased

 

Total dollars

 

 

Total
number
of shares
purchased

 

Total dollars

First quarter

 

1.6 

 

$

94.1 

 

 

 —

 

$

 —

Second quarter

 

 —

 

 

 —

 

 

2.9 

 

 

166.2 

Third quarter

 

 —

 

 

 —

 

 

 —

 

 

 —

Fourth quarter

 

0.9 

 

 

49.0 

 

 

 —

 

 

 —

Fiscal year

 

2.5 

 

$

143.1 

 

 

2.9 

 

$

166.2 

12


 

As of May 31, 2018, the approximate dollar value of common stock shares available for repurchase under the program authorized in July 2016 is $100.5 million. All amounts authorized under the program in May 2014 were fully repurchased. All shares of stock repurchased during fiscal 2018 and fiscal 2017 were retired.



The following graph shows a five-year comparison of the total cumulative returns of investing $100 on May 31, 2013, in Paychex common stock, the S&P 500 Index, and a Peer Group Index. All comparisons of stock price performance shown assume reinvestment of dividends. We are a participant in the S&P 500 Index, a market group of companies with a larger than average market capitalization. Our Peer Group is a group of companies with comparable revenue and net income, who are in a comparable industry, or who are direct competitors of Paychex (as detailed below).



Picture 1







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

May 31,

 

2013

 

2014

 

2015

 

2016

 

2017

 

2018

Paychex

 

$100.00 

 

$114.24 

 

$141.94 

 

$161.20 

 

$181.73 

 

$206.30 

S&P 500

 

$100.00 

 

$120.45 

 

$134.67 

 

$136.98 

 

$160.91 

 

$184.05 

Peer Group

 

$100.00 

 

$126.92 

 

$163.02 

 

$167.30 

 

$196.63 

 

$253.88 



There can be no assurance that our stock performance will continue into the future with the same or similar trends depicted in the graph above. We neither make nor endorse any predictions as to future stock performance.

Our Peer Group for fiscal 2018 is comprised of the following companies:





 

 

Alliance Data Systems Corporation

 

H&R Block, Inc.

Automatic Data Processing, Inc. (direct competitor)

 

Intuit Inc.

Broadridge Financial Solutions, Inc.

 

Moody’s Corporation

DST System, Inc.

 

Robert Half International Inc.

The Dun & Bradstreet Corporation

 

TD AMERITRADE Holding Corporation

Equifax, Inc.

 

Total Systems Services, Inc.

Fiserv, Inc.

 

The Western Union Company

Global Payments Inc.

 

 





13


 

Item 6.    Selected Financial Data







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions, except per share amounts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended May 31,

 

2018(1),(2),(3)

 

2017(3)

 

2016(4),(5)

 

2015(5)

 

2014(5)

Service revenue

 

$

3,317.4 

 

 

$

3,100.7 

 

 

$

2,905.8 

 

 

$

2,697.5 

 

 

$

2,478.2 

 

Interest on funds held for clients

 

$

63.5 

 

 

$

50.6 

 

 

$

46.1 

 

 

$

42.1 

 

 

$

40.7 

 

Total revenue

 

$

3,380.9 

 

 

$

3,151.3 

 

 

$

2,951.9 

 

 

$

2,739.6 

 

 

$

2,518.9 

 

Operating income

 

$

1,287.5 

 

 

$

1,239.6 

 

 

$

1,146.6 

 

 

$

1,053.6 

 

 

$

982.7 

 

Net income

 

$

933.7 

 

 

$

817.3 

 

 

$

756.8 

 

 

$

674.9 

 

 

$

627.5 

 

Basic earnings per share

 

$

2.60 

 

 

$

2.27 

 

 

$

2.10 

 

 

$

1.86 

 

 

$

1.72 

 

Diluted earnings per share

 

$

2.58 

 

 

$

2.25 

 

 

$

2.09 

 

 

$

1.85 

 

 

$

1.71 

 

Cash dividends per common share

 

$

2.06 

 

 

$

1.84 

 

 

$

1.68 

 

 

$

1.52 

 

 

$

1.40 

 

Purchases of property and equipment

 

$

154.0 

 

 

$

94.3 

 

 

$

97.7 

 

 

$

102.8 

 

 

$

84.1 

 

Cash and total corporate investments

 

$

719.7 

 

 

$

777.4 

 

 

$

793.2 

 

 

$

936.4 

 

 

$

936.8 

 

Total assets

 

$

7,463.7 

 

 

$

6,833.7 

 

 

$

6,440.8 

 

 

$

6,467.5 

 

 

$

6,321.0 

 

Total debt

 

$

 —

 

 

$

 —

 

 

$

 —

 

 

$

 —

 

 

$

 —

 

Stockholders’ equity

 

$

2,024.5 

 

 

$

1,955.3 

 

 

$

1,911.7 

 

 

$

1,785.5 

 

 

$

1,777.0 

 

Return on stockholders’ equity

 

 

46 

%

 

 

42 

%

 

 

40 

%

 

 

36 

%

 

 

35 

%



(1)

In fiscal 2018, the enactment of the Tax Act significantly impacted our net income, basic and diluted earnings per share, and return on stockholders’ equity. Refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for additional discussion of the impact of the Tax Act.



(2)

In fiscal 2018, an additional expense and corresponding tax benefit was recognized as a result of the termination of certain license agreements. Refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for additional discussion of the impact of the termination of certain license agreements.



(3)

In fiscal 2017, we early-adopted new accounting guidance related to employee stock-based compensation payments. As a result, a discrete tax benefit was recognized upon exercise or lapse of stock-based awards. This increased diluted earnings per share by approximately $0.04 per diluted share and $0.05 per diluted share for fiscal 2018 and fiscal 2017, respectively.



(4)

In the fiscal year ended May 31, 2016 (“fiscal 2016”), a net tax benefit was recorded for income derived in prior tax years from customer-facing software we produced. This increased diluted earnings per share by approximately $0.06 per share.



(5)

During fiscal 2016, we adopted new accounting guidance related to the presentation of deferred taxes within the Consolidated Balance Sheets. As a result, a reclassification of prior year deferred tax amounts was made to conform to the May 31, 2016 presentation of deferred taxes within the Consolidated Balance Sheets. In the table above, a similar reclassification was made, which impacted total assets.

 

14


 

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations reviews the operating results of Paychex, Inc. and its wholly owned subsidiaries (“Paychex,” the “Company,” “we,” “our,” or “us”) for each of the three fiscal years ended May 31, 2018 (“fiscal 2018” or the “fiscal year”), May 31, 2017 (“fiscal 2017”), and May 31, 2016 (“fiscal 2016”), and our financial condition as of May 31, 2018. 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 payroll, human resource (“HR”), retirement, and insurance services for small- to medium-sized businesses. We offer a comprehensive portfolio of HCM services and products that allow our clients to meet their diverse payroll and HR needs. Our payroll processing services, the foundation of our service model, include:

·

payroll processing;

·

payroll tax administration services;

·

employee payment services; and

·

regulatory compliance services (new-hire reporting and garnishment processing).

We support small-business companies through our core payroll, utilizing our proprietary, robust, software-as-a-service (“SaaS”) Paychex Flex® platform, and our SurePayroll® SaaS-based products. Mid-market companies typically have more sophisticated payroll and benefits needs, and are serviced through our Paychex Flex Enterprise solution set, which offers an integrated suite of HCM solutions through the Paychex Flex platform, or through our legacy platform.  Our SaaS solution through Paychex Flex Enterprise integrates payroll processing with HR management, employee benefits administration, time and labor management, applicant tracking, and onboarding solutions.

We offer a suite of complementary Human Resource Services (“HRS”) products including:

·

comprehensive HR outsourcing through Paychex HR Services, under which we offer Paychex HR Solutions, our administrative services organization (“ASO”), and Paychex PEO, our professional employer organization (“PEO”);

·

retirement services administration;

·

insurance services;

·

HR administration services, including time and attendance, benefit enrollment, recruiting, and onboarding; and

·

other HR services and products.

Our wholly owned subsidiary, Paychex Advance LLC (“Paychex Advance”), provides a portfolio of services to the temporary staffing industry. This includes the purchasing of accounts receivable as a means of providing payroll funding to these clients.

Our mission is to be the leading provider of payroll, HR, and employee benefits services for small and mid-sized companies by being an essential partner with America's businesses.  We believe success in this mission will lead to strong long-term financial performance.  Our strategy focuses on flexible, convenient service; industry-leading, integrated technology; solid sales execution; providing a comprehensive suite of value-added HCM services; continued service penetration; and engaging in strategic acquisitions, when possible.

We continue to focus on driving growth in the number of clients, 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.

15


 

Our financial results for fiscal 2018 reflect another year of steady growth.  HRS revenue continued to experience strong growth of 14% for fiscal 2018 as compared with fiscal 2017. HRS revenue growth was primarily driven by increases in client bases across the following HCM services:  comprehensive HR outsourcing services, including HR Outsourcing Holdings, Inc. (“HROI”) acquired in fiscal 2018; retirement services; time and attendance; and insurance services.  Payroll service revenue increased 2% for fiscal 2018 as compared with fiscal 2017, primarily driven by growth in revenue per check, which improved as a result of our price increases, net of discounts. As of May 31, 2018, including the Lessor Group (“Lessor”) acquisition, we served over 650,000 payroll clients.  As of May 31, 2017, we served approximately 605,000 payroll clients.  Client retention was approximately 81% of our beginning client base for the fiscal year, consistent with a year ago.

Interest rates available on high-quality financial instruments are gradually increasing. Our combined funds held for clients and corporate investment portfolios earned an average rate of return of 1.5% for fiscal 2018, compared to 1.2% for fiscal 2017 and 1.1% for fiscal 2016.  The United States (“U.S.”) Federal Reserve raised the Federal Funds rate by a total of 75 basis points during fiscal 2018 to a range of 1.50% to 1.75% as of May 31, 2018.  In June 2018, the Federal Funds rate was raised an additional 25 basis points to a range of 1.75% to 2.0%.  The Federal Funds rate was in the range of 0.75% to 1.0% as of May 31, 2017.

Highlights of our financial results for fiscal 2018, compared to fiscal 2017, are as follows:

·

Total revenue increased 7% to $3.4 billion.

o

HRS revenue increased 14% to $1.5 billion.

o

Payroll service revenue increased 2% to $1.8 billion.

o

Interest on funds held for clients increased 26% to $63.5 million.

·

Operating income increased 4% to $1.3 billion.  Adjusted operating income(1) increased 6% to $1.3 billion.

·

Net income increased 14% to $933.7 million.  Adjusted net income(1) increased 15% to $920.0 million.

·

Diluted earnings per share increased 15% to $2.58 per share.  Adjusted diluted earnings per share(1) increased 16% to $2.55 per share.

·

Dividends of $739.7 million were paid to stockholders, representing 79% of net income.

(1)

Adjusted operating income, adjusted net income and adjusted diluted earnings per share are not U.S. generally accepted accounting principles (“GAAP”) measures.  Please 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 comparable GAAP measures of operating income, net income, and diluted earnings per share.

Business Outlook

Our payroll client base, including Lessor, exceeded 650,000 clients as of May 31, 2018, and was approximately 605,000 clients as of May 31, 2017 and May 31, 2016.  Excluding Lessor, our payroll client base was relatively flat for fiscal 2018 as compared to fiscal 2017.

While HRS products provide services to employers and employees beyond payroll, they effectively leverage payroll processing data.  Our HR administration services are included as part of the integrated HCM solution within Paychex Flex.  The following table illustrates the growth in selected HRS service offerings:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

Balance as of

 

Growth rates for fiscal year



 

May 31, 2018

 

2018

 

2017

 

2016

Paychex HR Services client worksite employees(1)

 

1,157,000 

 

13 

%

 

%

 

10 

%

Paychex HR Services clients(1)

 

41,000 

 

12 

%

 

%

 

10 

%

Health and benefits services applicants

 

177,000 

 

%

 

%

 

%

Retirement services plans

 

82,000 

 

%

 

%

 

%

(1) The total number of worksite employees and clients for fiscal 2018 include HROI.

16


 

In fiscal 2018, we expanded our commitment to delivering superior technology and service solutions to our Paychex clients.  New offerings introduced in fiscal 2018 included:

·

Accountant HQ, a Paychex Flex platform-based offering, which provides access to authorized client payroll and HR data and key account contacts to assist a client’s accountant in driving greater efficiency;

·

InVisionTM Iris Time Clock, a biometric clock that scans the iris, providing fast and accurate time capture;

·

Netspend’s Tip NetworkTM, which streamlines the process for paying tipped employees;

·

Do-It-Yourself online employee handbook; and

·

Onboarding Essentials, which enables clients to onboard new hires quickly and in a completely paperless fashion.

Concentrated effort remains on the continued enhancements of Paychex Flex, our robust cloud-based HCM platform, which allows direct client access to payroll, HR, and benefits information in a streamlined and integrated approach to workplace management.

We continue to strengthen our position as an expert in our industry by serving as a source of education and information to clients, small businesses, 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.

Financial position and liquidity

Our financial position as of May 31, 2018 remained strong with cash and total corporate investments of $719.7 million and no debt. Our investment strategy continues to focus on protecting principal and optimizing liquidity.  We invest predominately in municipal bonds – including general obligation bonds; pre-refunded bonds, which are secured by a U.S. government escrow; and essential services revenue bonds – along with U.S. government agency securities and corporate bonds. During fiscal 2018, our primary short-term investment vehicles were Variable Rate Demand Notes (“VRDNs”) and bank demand deposit accounts.

A majority of our portfolio is invested in high credit quality securities with ratings of AA or higher, and A-1/P-1 ratings on short-term securities. We limit the amounts that can be invested in any single issuer and invest in short- to intermediate-term instruments whose fair values are less sensitive to interest rate changes. We believe that our investments as of May 31, 2018 that were in an unrealized loss position were not other-than-temporarily impaired, nor has any event occurred subsequent to that date that would indicate any other-than-temporary impairment.

Our primary source of cash is generated by our ongoing operations. Cash flows from operations were $1.3 billion for fiscal 2018.   Historically, we have funded our operations, capital purchases, business acquisitions, share repurchases, and dividend payments from our operating activities.  Our positive operating cash flows for fiscal 2018 allowed us to support our business and to pay substantial dividends to our stockholders. In April 2018 and July 2017, our Board of Directors (the “Board”) increased our quarterly dividend by 12% to $0.56 per share from $0.50 per share, and 9% to $0.50 per share from $0.46 per share, respectively.  Dividends paid to stockholders were 79% of net income for fiscal 2018. It is anticipated that cash and total corporate investments as of May 31, 2018, along with projected operating cash flows and available short-term financing, will support our normal business operations, capital purchases, share repurchases, dividend payments, and business acquisitions, if any, for the foreseeable future.

For further analysis of our results of operations for fiscal years 2018,  2017, and 2016, and our financial position as of May 31, 2018, refer to the tables and analysis in the “Results of Operations” and “Liquidity and Capital Resources” sections of this Item 7 and the discussion in the “Critical Accounting Policies” section of this Item 7.

 



17


 

Results of Operations



Summary of Results of Operations for Fiscal Years:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions, except per share amounts

 

2018

 

Change

 

2017

 

Change

 

2016

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payroll service revenue

 

$

1,810.0 

 

 

%

 

$

1,779.3 

 

 

%

 

$

1,729.9 

 

HRS revenue

 

 

1,507.4 

 

 

14 

%

 

 

1,321.4 

 

 

12 

%

 

 

1,175.9 

 

Total service revenue

 

 

3,317.4 

 

 

%

 

 

3,100.7 

 

 

%

 

 

2,905.8 

 

Interest on funds held for clients

 

 

63.5 

 

 

26 

%

 

 

50.6 

 

 

10 

%

 

 

46.1 

 

Total revenue

 

 

3,380.9 

 

 

%

 

 

3,151.3 

 

 

%

 

 

2,951.9 

 

Combined operating and SG&A expenses

 

 

2,093.4 

 

 

10 

%

 

 

1,911.7 

 

 

%

 

 

1,805.3 

 

Operating income

 

 

1,287.5 

 

 

%

 

 

1,239.6 

 

 

%

 

 

1,146.6 

 

Investment income, net

 

 

8.6 

 

 

66 

%

 

 

5.2 

 

 

13 

%

 

 

4.5 

 

Income before income taxes

 

 

1,296.1 

 

 

%

 

 

1,244.8 

 

 

%

 

 

1,151.1 

 

Income taxes

 

 

362.4 

 

 

(15)

%

 

 

427.5 

 

 

%

 

 

394.3 

 

Effective income tax rate

 

 

28.0 

%

 

 

 

 

 

34.3 

%

 

 

 

 

 

34.3 

%

Net income

 

$

933.7 

 

 

14 

%

 

$

817.3 

 

 

%

 

$

756.8 

 

Diluted earnings per share

 

$

2.58 

 

 

15 

%

 

$

2.25 

 

 

%

 

$

2.09 

 



We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As of May 31, 2018, we had no exposure to high-risk or illiquid investments. Details regarding our combined funds held for clients and corporate investment portfolios are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Year ended May 31,

$ in millions

 

2018

 

2017

 

2016

Average investment balances:

 

 

 

 

 

 

 

 

 

 

 

 

Funds held for clients

 

$

4,040.8 

 

 

$

4,066.3 

 

 

$

4,105.5 

 

Corporate investments

 

 

915.1 

 

 

 

906.7 

 

 

 

922.6 

 

Total

 

$

4,955.9 

 

 

$

4,973.0 

 

 

$

5,028.1 

 



 

 

 

 

 

 

 

 

 

 

 

 

Average interest rates earned (exclusive of net realized gains):

Funds held for clients

 

 

1.6 

%

 

 

1.2 

%

 

 

1.1 

%

Corporate investments

 

 

1.3 

%

 

 

1.1 

%

 

 

0.9 

%

Combined funds held for clients and corporate investments

 

 

1.5 

%

 

 

1.2 

%

 

 

1.1 

%



 

 

 

 

 

 

 

 

 

 

 

 

Total net realized gains

 

$

0.1 

 

 

$

0.1 

 

 

$

0.1 

 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

$ in millions

 

 

 

 

 

 

 

 

 

 

 

 

As of May 31,

 

2018

 

2017

 

2016

Net unrealized (losses)/gains on available-for-sale securities(1)

 

$

(38.3)

 

 

$

32.0 

 

 

$

47.6 

 

Federal Funds rate(2)

 

 

1.75 

%

 

 

1.00 

%

 

 

0.50 

%

Total fair value of available-for-sale securities

 

$

3,104.8 

 

 

$

4,613.2 

 

 

$

4,141.9 

 

Weighted-average duration of available-for-sale securities in years(3)

 

 

3.1 

 

 

 

3.2 

 

 

 

3.1 

 

Weighted-average yield-to-maturity of available-for-sale securities(3)

 

 

1.9 

%

 

 

1.7 

%

 

 

1.7 

%



(1)

The net unrealized loss on our investment portfolios was approximately $33.0 million as of July 18, 2018.

(2)

The Federal Funds rate was in the range of 1.50% to 1.75% as of May 31, 2018,  in the range of 0.75% to 1.00% as of May 31, 2017, and in the range of 0.25% to 0.50% as of May 31, 2016.  In June 2018, the Federal Funds rate was raised an additional 25 basis points to a range of 1.75% to 2.0%.

(3)

These items exclude the impact of VRDNs, as they are tied to short-term interest rates.

18


 

Payroll service revenue:  Payroll service revenue was $1.8 billion for fiscal 2018 and $1.8 billion for fiscal 2017, reflecting growth of 2% and 3%, respectively, compared to each of the prior fiscal year periods.  Both fiscal 2018 and fiscal 2017 benefited from increases in revenue per check, which improved as a result of price increases, net of discounts.  The impact of the acquisition of Lessor on payroll service revenue growth for fiscal 2018 was insignificant.  The acquisition of Paychex Advance contributed approximately 1% to payroll service revenue growth for fiscal 2017.

As of May 31, 2018, including the Lessor acquisition, we served over 650,000 payroll clients.  For fiscal 2017, our total payroll client base of 605,000 was comparable to fiscal 2016.  Client retention was approximately 81% of the beginning client base for fiscal 2018, consistent with fiscal 2017.  Client retention was approximately 82% of the beginning of the year client base for fiscal 2016.

Human Resource Services revenue:  HRS revenue was $1.5 billion for fiscal 2018 and $1.3 billion for fiscal 2017, reflecting growth of 14% and 12%, respectively, compared to each of the prior fiscal year periods. HROI contributed approximately 6% to the growth in HRS revenue for fiscal 2018 and Paychex Advance contributed approximately 1% to the growth in HRS revenue for fiscal 2017.

For both fiscal 2018 and fiscal 2017, HRS revenue growth was primarily driven by increases in client bases across all major HCM services, including: comprehensive HR outsourcing services (including HROI), retirement services, time and attendance, and insurance services.  HRS product key statistics are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ in billions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of May 31,

 

2018

Change

 

2017

 

Change

 

2016

Paychex HR Services client worksite employees(1)

 

 

1,157,000 

 

13 

%

 

 

1,021,000 

 

%

 

 

944,000 

Paychex HR Services clients(1)

 

 

41,000 

 

12 

%

 

 

37,000 

 

%

 

 

35,000 

Health and benefits services applicants

 

 

177,000 

 

%

 

 

162,000 

 

%

 

 

150,000 

Retirement services plans

 

 

82,000 

 

%

 

 

78,000 

 

%

 

 

74,000 

Asset value of retirement services participants’ funds

 

$

30.6 

 

12 

%

 

$

27.4 

 

16 

%

 

$

23.6 

(1) The total number of worksite employees and clients for fiscal 2018 include HROI.

We continue to experience strong demand for our Paychex HR Services, our largest HRS revenue stream, as evidenced by the continued strong growth in client worksite employees for both our ASO and PEO. Retirement services revenue growth for fiscal 2018 and fiscal 2017 benefited from an increase in asset fee revenue earned on the asset value of participant funds, along with an increase in the number of plans served. Insurance services revenue growth for both fiscal 2018 and fiscal 2017 benefited from growth in the number of health and benefits applicants.  In addition, for fiscal 2017, revenue was positively impacted by higher average premiums in our workers’ compensation insurance product.



Total service revenue:  Total service revenue increased 7% for both fiscal 2018 and fiscal 2017, attributable to the factors previously discussed.

Interest on funds held for clients:  Interest on funds held for clients increased 26% for fiscal 2018 and 10% for fiscal 2017 to $63.5 million and $50.6 million, respectively.  For both fiscal 2018 and fiscal 2017, the increases were primarily due to higher average interest rates earned.

Average investment balances for funds held for clients decreased approximately 1% for fiscal 2018, primarily due to the impact of the Tax Cut and Jobs Act of 2017 (the “Tax Act”) on employee withholdings and changes in client mix, which offset the impact of wage inflation.  Average investment balances for funds held for clients decreased approximately 1% for fiscal 2017 primarily due to the impacts of timing of certain remittances due to taxing authorities and client mix. 

Refer to the “Market Risk Factors” section contained in Item 7A of this Form 10-K for more information on changing interest rates.

19


 

Combined operating and SG&A expenses:  The following table summarizes total combined operating and SG&A expenses for fiscal years:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions

 

2018

 

Change

 

2017

 

Change

 

2016

Compensation-related expenses

 

$

1,242.4 

 

%

 

$

1,188.5 

 

%

 

$

1,148.2 

Depreciation and amortization

 

 

138.0 

 

%

 

 

126.9 

 

10 

%

 

 

115.1 

PEO insurance costs

 

 

205.2 

 

44 

%

 

 

142.2 

 

17 

%

 

 

122.0 

Other expenses

 

 

507.8 

 

12 

%

 

 

454.1 

 

%

 

 

420.0 

Total expenses

 

$

2,093.4 

 

10 

%

 

$

1,911.7 

 

%

 

$

1,805.3 



Total expenses increased 10% for fiscal 2018 and 6% for fiscal 2017.  For fiscal 2018, compensation-related expenses increased due to higher headcount reflecting accelerated investment in technology, sales teams, and the impact of the acquisitions of Lessor and HROI.  In addition, compensation-related expenses in fiscal 2018 included a one-time bonus paid to non-management employees.  For fiscal 2017, compensation-related expenses increased due to higher headcount in operations, partially offset by lower variable selling costs. As of May 31, 2018, we had approximately 14,300 employees, including Lessor, compared with 13,700 employees as of May 31, 2017.

Depreciation expense is primarily related to buildings, furniture and fixtures, data processing equipment, and software. Amortization of intangible assets is primarily related to client list acquisitions, which are amortized using either straight-line or accelerated methods.  The increase in depreciation and amortization for fiscal 2018 and fiscal 2017 was primarily driven by an increase in internally developed software that was placed in service over the past two years as well as changes to the useful life of certain assets which accelerated depreciation expense recognition.

Expense growth for fiscal 2018 and fiscal 2017 was impacted by continued growth in our PEO. 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.  Continued investment in product development and supporting technology impacted other expense growth for both fiscal 2018 and fiscal 2017.  For fiscal 2018, other expenses also reflect a one-time expense of $32.6 million related to the termination of certain license agreements.  In addition, the combined acquisitions of HROI and Lessor contributed approximately 5% to the total expense growth for fiscal 2018 compared to fiscal 2017.  The acquisition of Paychex Advance contributed approximately 1% to the growth in total expenses for fiscal 2017.

Operating income:  Operating income increased 4% to $1.3 billion for fiscal 2018 and 8% to $1.2 billion for fiscal 2017.   The fluctuations in operating income were attributable to the factors previously discussed.  Operating income, as a percent of total revenue, was 38.1%, 39.3%, and 38.8% for the fiscal years 2018, 2017, and 2016, respectively.  Adjusted operating income increased 6% to $1.3 billion for fiscal 2018 and 8% to $1.2 billion for fiscal 2017.  See the “Non-GAAP Financial Measures” section of this Item 7 for further discussion of this non-GAAP measure.

Investment income, net:  Investment income, net, primarily represents earnings from our cash and cash equivalents and investments in available-for-sale securities. Investment income does not include interest on funds held for clients, which is included in total revenue. Investment income, net, increased 66% for fiscal 2018 primarily due to higher average interest rates earned.  The increase in average investment balances for fiscal 2018 was the result of higher net income partially offset by share repurchases, business acquisitions, and an increase in the rate for quarterly dividend payments.  Investment income, net, increased 13% for fiscal 2017 primarily due to higher average interest rates earned, partially offset by a 2% decrease in average investment balances.

Income taxes:  Our effective income tax rate was 28.0% for fiscal 2018 and was 34.3% for both fiscal 2017 and fiscal 2016.  The effective income tax rate for fiscal 2018 was significantly impacted by the Tax Act.  As a result of the Tax Act, we recorded a non-recurring net tax benefit of $25.5 million for fiscal 2018 for the revaluation of our net deferred tax liabilities. This amount impacted diluted earnings per share by approximately $0.07 per share for fiscal 2018.  In addition, as it relates to the Tax Act, our effective income tax rate for fiscal 2018 benefited from a reduced statutory tax rate applied to our current year taxable income.  The effective income tax rates were impacted by additional discrete tax items recognized during fiscal 2018, fiscal 2017, and fiscal 2016.  Effective June 1, 2016, we early-adopted new accounting guidance related to employee stock-based compensation payments which resulted in discrete tax benefits recognized in income tax expense.  This discrete tax benefit impacted diluted earnings per share by approximately $0.04 per diluted share for fiscal 2018 and $0.05 per diluted share for fiscal 2017.  During fiscal 2018, we recognized a tax benefit as a result of the termination of certain license agreements, which increased diluted earnings per share by approximately $0.02 per diluted share.  During fiscal 2016, we recognized a net tax benefit on income derived in prior tax years related to customer-facing software that we produced which increased diluted earnings per share by approximately $0.06 per diluted share.  Additional discrete tax items recognized during each respective period are insignificant.  Refer to Note K of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on income taxes.

20


 

Net income and diluted earnings per share:  Net income increased 14% to $933.7 million for fiscal 2018 and 8% to $817.3 million for fiscal 2017.  Diluted earnings per share increased 15% to $2.58 per diluted share for fiscal 2018 and 8% to $2.25 per diluted share for fiscal 2017.  These fluctuations were attributable to the factors previously discussed. Adjusted net income increased 15% to $920.0 million for fiscal 2018 and increased 9% to $799.0 million for fiscal 2017.  Adjusted diluted earnings per share was $2.55 per diluted share for fiscal 2018 and $2.20 per diluted share for fiscal 2017, reflecting increases of 16% and 8%, respectively.  Refer to the “Non-GAAP Financial Measures” section that follows for a discussion of these non-GAAP measures.

Non-GAAP Financial Measures: Adjusted operating income, adjusted net income, and adjusted diluted earnings per share are summarized as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ in millions

 

2018(5)

 

Change

 

2017

 

Change

 

2016

Operating income

 

$

1,287.5 

 

%

 

$

1,239.6 

 

%

 

$

1,146.6 

Non-GAAP adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Termination of license agreements(1)

 

 

32.6 

 

 

 

 

 

 —

 

 

 

 

 

 —

Total non-GAAP adjustments

 

 

32.6 

 

 

 

 

 

 —

 

 

 

 

 

 —

Adjusted operating income

 

$

1,320.1 

 

%

 

$

1,239.6 

 

%

 

$

1,146.6 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

933.7 

 

14 

%

 

$

817.3 

 

%

 

$

756.8 

Non-GAAP adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit related to employee stock-based
compensation payments(2)

 

 

(12.9)

 

 

 

 

 

(18.3)

 

 

 

 

 

 —

Net tax benefit on income derived from prior tax years
for customer-facing software(3)

 

 

 —

 

 

 

 

 

 —

 

 

 

 

 

(21.1)

Revaluation of net deferred tax liabilities(4)

 

 

(25.5)

 

 

 

 

 

 —

 

 

 

 

 

 —

Termination of license agreements(1)

 

 

24.7 

 

 

 

 

 

 —

 

 

 

 

 

 —

Total non-GAAP adjustments

 

 

(13.7)

 

 

 

 

 

(18.3)

 

 

 

 

 

(21.1)

Adjusted net income

 

$

920.0 

 

15 

%

 

$

799.0 

 

%

 

$

735.7 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

2.58 

 

15 

%

 

$

2.25 

 

%

 

$

2.09 

Non-GAAP adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit related to employee stock-based
compensation payments(2)

 

 

(0.04)

 

 

 

 

 

(0.05)

 

 

 

 

 

 —

Net tax benefit on income derived from prior tax years
for customer-facing software(3)

 

 

 —

 

 

 

 

 

 —

 

 

 

 

 

(0.06)

Revaluation of net deferred tax liabilities(4)

 

 

(0.07)

 

 

 

 

 

 —

 

 

 

 

 

 —

Termination of license agreements(1)

 

 

0.07 

 

 

 

 

 

 —

 

 

 

 

 

 —

Total non-GAAP adjustments

 

 

(0.04)

 

 

 

 

 

(0.05)

 

 

 

 

 

(0.06)

Adjusted diluted earnings per share

 

$

2.55 

 

16 

%

 

$

2.20 

 

%

 

$

2.03 



(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 or shortfall 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)

Non-recurring net tax benefit recognized on income derived in prior tax years related to customer-facing software that we produced.



(4)

Non-recurring tax benefits recognized as a result of the Tax Act related to the revaluation of net deferred tax liabilities.



(5)

The calculation of the impact of non-GAAP adjustments on diluted earnings per share is performed on each line independently.  The table above may not add down by +/- $0.01 due to rounding.



21


 

In addition to reporting operating income, net income, and diluted earnings per share, which are U.S. GAAP measures, we present adjusted operating income, adjusted net income, and adjusted diluted earnings per share, which are non-GAAP measures.  We believe adjusted operating income, adjusted net income, and adjusted diluted earnings per share are appropriate additional measures, as they are indicators of our core business operations performance period over period.  Adjusted operating income, adjusted net income, and adjusted diluted earnings per share are not calculated through the application of GAAP and are not a required form of disclosure by the Securities and Exchange Commission (“SEC”).  As such, they should not be considered as a substitute for the GAAP measures of operating income, net income, and diluted earnings per share, and therefore should not be used in isolation, but in conjunction with, the GAAP measures.  The use of any non-GAAP measure may produce results that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies.



 

Liquidity and Capital Resources

Our financial position as of May 31, 2018 remained strong with cash and total corporate investments of $719.7 million and no debt. We believe that our investments in an unrealized loss position as of May 31, 2018 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date to indicate any other-than-temporary impairment. We anticipate that cash and total corporate investments as of May 31, 2018, along with projected operating cash flows and available short-term financing, will support our normal business operations, capital purchases, business acquisitions, if any, share repurchases, and dividend payments for the foreseeable future.

Short-Term Financing



We maintain credit facilities, letters of credit, and lines of credit as part of our normal and recurring business operations.



Credit Facilities:  We maintain three committed, unsecured credit facilities as follows:









 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

Bank

 

Borrower (1)

 

Date Entered

 

Expiration Date

 

Maximum Amount Available

 

Purpose

JP Morgan Chase Bank, N.A.(2)

 

Paychex of New York, LLC

 

August 5, 2015

 

August 5, 2020

 

$1 Billion

 

To meet short-term funding requirements.

JP Morgan Chase Bank, N.A.(2)

 

Paychex of New York, LLC

 

August 17, 2017

 

August 17, 2022

 

$500 Million

 

To meet short-term funding requirements.

PNC Bank, National Association (“PNC”)

 

Paychex Advance, LLC

 

March 17, 2016

 

March 17, 2020

 

$150 Million

 

To finance working capital needs and general corporate purposes.



(1)

Borrower is a wholly owned subsidiary of the Company.



(2)

JP Morgan Chase Bank, N.A. (“JPM”) acts as the administrative agent for this syndicated credit facility.



For all credit facilities, obligations under any facility are guaranteed by the Company and certain of its subsidiaries and will

bear interest at competitive rates based on options provided to the borrower.  Upon the expiration date, any borrowings outstanding will mature and be payable on such date.



JPM $1 Billion Credit Facility: There were no borrowings outstanding under this credit facility as of May 31, 2018.  Details of borrowings under this credit facility are as follows:







 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

Year ended May 31,

$ in millions

 

2018

 

2017

Number of days borrowed

 

 

22 

 

 

 

30 

 

Maximum amount borrowed

 

$

700.0 

 

 

$

450.0 

 

Weighted-average amount borrowed

 

$

319.1