10-K 1 payx-20160531x10k.htm 10-K PAYX-053116-10K_Taxonomy2016

 

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, 2016 

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 10K.    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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)

 

 

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, 2015 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 $17,491,967,248 based on the closing price reported for such date on the NASDAQ Global Select Market.

As of June 30, 2016, 360,532,001 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 12, 2016, 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, 2016 



 

 

 



 

 

 

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

 

Item 2

Properties

10 

 

Item 3

Legal Proceedings

10 

 

Item 4

Mine Safety Disclosures

10 

 



PART II

 

Item 5

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

11 

 

Item 6

Selected Financial Data

13 

 

Item 7

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

16 

 

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

28 

 

Item 8

Financial Statements and Supplementary Data

29 

 

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

58 

 

Item 9A

Controls and Procedures

58 

 

Item 9B

Other Information

59 

 



PART III

 

Item 10

Directors, Executive Officers and Corporate Governance

59 

 

Item 11

Executive Compensation

60 

 

Item 12

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

60 

 

Item 13

Certain Relationships and Related Transactions, and Director Independence

60 

 

Item 14

Principal Accounting Fees and Services

60 

 



PART IV

 

Item 15

Exhibits and Financial Statement Schedules

61 

 



Signatures

63 

 



 



 

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,” “current outlook,” “we look forward to,” “would equate to,” “projects,” “projections,” “projected to be,” “anticipates,” “anticipated,” “we believe,” “believe,” “could be,” and other similar 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, 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 rates and underlying claim trends;

·

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

·

the possibility of a security breach that disrupts operations or exposes client confidential data;

·

the possibility of failure of our operating facilities, 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 processing 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; and

·

potentially unfavorable outcomes related to pending or future (possible) legal matters.

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 10K (“Form 10-K”), as well as in our periodic filings with the Securities and Exchange Commission (“SEC” or “Commission”), could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10K is based upon the facts and circumstances known at this time, and any forward-looking statements made by us in this Form 10K 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.

1


 

Item 1.    Business

Incorporated in Delaware in 1979, we are a leading provider of integrated human capital management (“HCM”) solutions for payroll, human resource, retirement, and insurance services for small- to medium-sized businesses. As of May 31, 2016, we serviced approximately 605,000 payroll clients. We maintain our corporate headquarters in Rochester, New York, and serve clients throughout the U.S. and Germany.  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 payroll, human resource and employee benefit 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 strategy focuses on the following:

·

flexible, convenient service;

·

industry-leading, integrated technology;

·

solid sales execution;

·

comprehensive suite of value-added HCM services;

·

continued service penetration; and

·

strategic acquisitions.

Services and Products

We offer a comprehensive portfolio of HCM services and products that allow our clients to meet their diverse payroll and human resource needs.  Clients can select services on an á la carte basis or as part of various product bundles.  Our payroll-related ancillary services and Human Resource Service (“HRS”) offerings often leverage the information gathered in the base payroll processing service, allowing us to provide comprehensive outsourcing services covering the HCM spectrum. We also offer professional employer organization (“PEO”) services and provide insurance offerings through the Paychex Insurance Agency, Inc. (“PIA”) that allow employers to expand their employee benefit offerings at an affordable cost. We mainly earn our revenue through recurring fees for services performed. Service revenue is primarily driven by the number of clients, checks or transactions per client per pay period, and utilization of ancillary services.

Paychex FlexSM is our proprietary HCM software-as-a-service (“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. The platform 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 human resource administration, time and attendance, and retirement services. Paychex Flex also provides technology-enabled service, with options that include self-service, a 24/7 dedicated service center, individual payroll specialist, and integrated service via the multi-product service center.  In addition, large clients can utilize a relationship manager for more personalized service.  This flexible platform services our small-business clients, mid-market 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 allows for device independence, providing a consistent experience regardless of device. Our mobile apps are available for iOS® and AndroidTM tablets and smartphones, and allow our clients and their employees to have full access to our products, offering diverse capabilities for both the employer and employee.

2


 

Small-Business Clients

For our small-business clients, which we define as typically less than 50 employees, Paychex supports the client 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 for a quick and easy pay day.  Small-business payroll is provided via our core payroll, utilizing our robust Paychex Flex processing platform, or SurePayroll®  products.  Our core payroll clients can opt for our full-service customer service model through our branch operations or use Paychex Online Payroll®, our secure Internet portal. Paychex Online Payroll offers a suite of self-service and interactive services twenty-four hours a day, seven days a week. Both service models offer payroll processing, employee access online, general ledger service to provide payroll information to the client’s general ledger accounting software, and access to our industry-leading, web-based report center and robust report writer. Our SurePayroll SaaS solution offers “do-it-yourself,” self-service and mobile applications for small business.

Our small-business clients also 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, can assist companies with the scheduling, tracking, and reporting of time which can be beneficial to clients in complying with overtime regulations recently enacted by the Department of Labor.  Other Paychex solutions, such as our comprehensive human resource outsourcing solutions are also available for our small-business clients.

Mid-Market Clients

Our mid-market clients are typically defined as more than 50 employees with more complex payroll and employee benefit needs.  These clients are serviced through our Paychex Flex Enterprise solution set, which offers an integrated suite of HCM solutions on the Paychex Flex platform, or through our traditional mid-market platform.  Clients using Paychex Flex Enterprise are offered a SaaS solution that integrates payroll processing with human resource management, employee benefits administration, time and labor management, applicant tracking and onboarding solutions.  Paychex Flex Enterprise allows our 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.

Mid-market clients also have the option to select from a number of á la carte payroll and human resource ancillary services and can opt for our comprehensive human resource and payroll outsourcing solutions, Paychex HR Services. This flexibility allows our clients to define the solution that best meets their particular needs.

Description of Services

Payroll processing:  For both our small-business and mid-market clients, payroll processing is the backbone of our portfolio of HCM services.  Payroll processing services include the calculation, preparation, and delivery of employee payroll checks; production of internal accounting records and management reports; preparation of payroll tax returns; and collection and remittance of clients’ payroll obligations.  Along with payroll processing, clients can also select from the following payroll-related ancillary services:

·

Payroll tax administration services:   Our payroll tax administration services provide 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 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. Our Readychex service provides a cost-effective solution that offers the benefit of convenient, one-step payroll account reconciliation for employers.

3


 

·

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.

Human Resource Services: We offer complementary services for outsourcing of various human resource functions to our payroll clients.  In addition, some of these services can be provided to clients who do not opt for payroll processing.  Our complementary services are categorized as follows:

·

Paychex HR Services:    We offer comprehensive human resource 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, human resource and employee benefits administration, risk management outsourcing, and the on-site availability of a professionally trained human resource 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 equal to that of larger companies. Our PEO differs from the ASO in that we serve as a co-employer of the clients’ employees, provide health care coverage to PEO 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. 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, 2016, Paychex HR Services was utilized by approximately 35,000 clients with approximately 944,000 client worksite employees.

·

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, 2016, retirement services covered approximately 74,000 plans and the asset value of participants' funds externally managed totaled approximately $23.6 billion.

·

Insurance services:    Our licensed insurance agency, PIA, provides insurance through a variety of carriers. Insurance offerings include property and casualty coverage such as workers’ compensation, business-owner policies, commercial auto, and health and benefits coverage, including health, dental, vision, and life. 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 new 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 ESR provision applies to them; 2) provide ongoing ESR 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 end-of-year reporting.

PIA has a website, www.paychexinsurance.com, with information and interactive tools to help educate visitors on insurance and aid in making business insurance decisions.   A section on this website is designed to provide answers, information, and solutions that employers can use to prepare for and take action to comply with health care reform.

4


 

·

HR administration services:    We offer cloud-based human resource administration software products for employee benefits management and administration, time and attendance solutions, and recruiting.  Paychex HR Online offers powerful tools for managing employee benefits, personnel information, and human resource compliance and reporting.  Our BeneTrac service manages the employee-benefit enrollment process.  Our time and attendance products, including our Stratustime® software acquired in June 2014, help minimize the time spent compiling time sheet information. These services allow the employer to handle multiple payroll scenarios, improving productivity, accuracy, and reliability in the payroll process.  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 human resource 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 HRS products include employee handbooks, management manuals, and personnel and required regulatory forms. These products are designed to simplify clients’ office processes and enhance their employee benefits programs.

Accounting and Financial Services:  We offer various accounting and financial services to small- to medium-sized businesses.  These services offer additional value-added benefits for small-business owners including: purchasing of accounts receivable as a means of providing funding to clients in the temporary staffing industry; a cloud-based accounting service; payment processing services; payment distribution services; and a small-business loan resource center.

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. Within payroll, we differentiate the markets we serve between small-business and mid-market companies.  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 or for products for which we do not have a local sales force.  We sell HRS products to both new clients and our existing client base.

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.  Approximately 50% of our new core 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 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.  More than half of the CPA firms in the U.S. are enrolled and actively participating in the Paychex Partner Program from AICPA Business Solutions.   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 sales force. 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, our insurance services website, which is available at www.paychexinsurance.com,  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 small 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.  The BuildMyBiz® website, which is available at www.BuildMyBiz.com, provides tools and resources for starting, growing, and managing a business.

5


 

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. The average client size within our existing client base is approximately 16.7 employees.  We believe that there is opportunity for us in the HCM market as the demand is moving down-market to smaller businesses.

We serve a diverse base of small- to medium-sized clients operating in a broad range of industries located throughout the U.S. and in Germany.  Revenue from operations in Germany and long-lived assets in Germany are not material. We also have a joint-venture arrangement to provide payroll and human resource services in Brazil. 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, 2016 (“fiscal 2016”), client retention was in excess of 82% of our beginning of the year client base, consistent with the prior year’s record high. No single client has a material impact on total service revenue or results of operations.

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, all of which we believe have significantly fewer clients than us. In addition to traditional payroll processing and human resource service providers, we compete with in-house payroll and human resource systems and departments. Payroll and human resource systems and software are sold by many vendors. HRS products also compete with a variety of providers of human resource services, such as retirement services companies, insurance companies, and human resources and benefits consulting firms.

Competition in the payroll processing and human resource 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 human resource 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

As of May 31, 2016, we employed approximately 13,500 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. Historically, as a result of these factors, our total revenue has been slightly higher in our third fiscal quarter, with greater sales commission expenses also reported in that quarter.

6


 

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.

Our corporate website, www.paychex.com, provides materials for investors and information about our services.  Our Form 10-Ks, 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 2016 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. 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 clients and our business could be adversely impacted by health care reform:    The ACA was enacted in March 2010 and entails sweeping health care reforms with staggered effective dates from 2010 through 2018.  As a service provider, we have a responsibility to our clients to help them understand their increased obligations under the federal and state regulations facing employers under the ACA. Failure to provide clients with appropriate information or solutions to effectively manage their health care benefits and related costs could have an adverse impact on our reputation and a negative impact on our client base.  There is no guarantee that solutions we have developed to help clients navigate health care legislation will continue to be readily accepted by clients, which could have a material adverse impact on our insurance services business.  Insurance services revenue is at risk for lower commission revenue from underwriters if clients move away from traditional insurance policies utilized in the past or as a result of pressure on commission rates, driven by restrictions on insurers as to use of premiums.  Refer to the discussion later in this section on changes in health insurance and workers' compensation insurance rates and underlying claim trends for a  discussion of health care reform as it impacts our PEO.

We may not be able to keep pace with changes in technology or provide timely enhancements to our products and services:    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 capabilities and increase the performance of our internal systems, particularly our systems that meet our clients’ requirements. 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.

7


 

Cyber-attacks and security vulnerabilities could lead to reduced revenues, increased costs, liability claims, or harm to our competitive position:  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.  Cyber-attacks 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 LeaksWe 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.  As cyber threats continue to evolve, we are focused on ensuring that our operating environments safeguard and protect personal and business information.  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, 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.

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.

8


 

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 claim experience and are a significant portion of our PEO costs. If we experience a sudden or unexpected increase in claim 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 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 financial and economic environment:    During periods of weak economic conditions, employment levels tend to decrease and interest rates may 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. 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.

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.

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.



9


 

Item 2.    Properties

We owned and leased the following properties as of May 31, 2016:







 

 



 

 



 

Square feet

Owned facilities:

 

 

Rochester, New York

 

721,000 

Other U.S. locations

 

65,000 

Total owned facilities

 

786,000 



 

 

Leased facilities:

 

 

Rochester, New York

 

231,000 

Other U.S. locations

 

1,889,000 

International locations

 

35,000 

Total leased facilities

 

2,155,000 



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 regional, branch, and sales offices and data processing centers. These locations are concentrated in metropolitan areas. Our international locations are primarily in Germany and house our German branch and sales locations. We believe that adequate, suitable lease space will continue to be available to meet our needs.



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, 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.

10


 

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, 2016, there were 12,548 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 5,813 participants in the Paychex, Inc. Employee Stock Purchase Plan and 4,841 participants in the Paychex, Inc. Employee Stock Ownership Plan.

The high and low sale prices for our common stock as reported on the NASDAQ Global Select Market and dividends for fiscal 2016 and the fiscal year ended May 31, 2015  (“fiscal 2015”) are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Fiscal 2016

 

Fiscal 2015



 

 

 

 

 

Cash

 

 

 

 

 

Cash



 

 

 

 

 

dividends

 

 

 

 

 

dividends



 

Sales prices

 

declared

 

Sales prices

 

declared



 

High

 

Low

 

per share

 

High

 

Low

 

per share

First quarter

 

$49.79 

 

$41.59 

 

$0.42 

 

$42.66 

 

$40.10 

 

$0.38 

Second quarter

 

$54.54 

 

$43.19 

 

$0.42 

 

$48.20 

 

$41.59 

 

$0.38 

Third quarter

 

$54.78 

 

$45.76 

 

$0.42 

 

$50.19 

 

$44.52 

 

$0.38 

Fourth quarter

 

$54.58 

 

$51.06 

 

$0.42 

 

$51.72 

 

$48.00 

 

$0.38 



The closing price of our common stock as of May 31, 2016, as reported on the NASDAQ Global Select Market, was $54.22 per share.

In May 2014, the Board approved a program to repurchase up to $350 million of our common stock with authorization expiring on May 31, 2017.  Shares repurchased under this program during fiscal 2016 and fiscal 2015 were as follows:





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

Fiscal 2016

 

Fiscal 2015

In millions

 

Total
number
of shares
purchased

 

Total dollars

 

Total number of shares purchased

 

Total dollars

First quarter

 

1.3 

 

$

62.9 

 

 

0.9 

 

$

37.5 

Second quarter

 

 

 

 

 

0.3 

 

 

15.1 

Third quarter

 

0.9 

 

 

45.0 

 

 

0.4 

 

 

17.9 

Fourth quarter

 

 

 

 

 

2.3 

 

 

111.9 

Fiscal year

 

2.2 

 

$

107.9 

 

 

3.9 

 

$

182.4 

As of May 31, 2016, the approximate dollar value of shares that may yet be purchased under the program is $59.7 million.  Shares of stock repurchased during fiscal 2016 and fiscal 2015 were purchased pursuant to the program and were retired. 

11


 



The following graph shows a five-year comparison of the total cumulative returns of investing $100 on May 31, 2011, 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 3









 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

May 31,

 

2011

 

2012

 

2013

 

2014

 

2015

 

2016

Paychex

 

$100.00 

 

$96.81 

 

$125.11 

 

$142.92 

 

$177.59 

 

$201.67 

S&P 500

 

$100.00 

 

$99.59 

 

$126.75 

 

$152.67 

 

$170.69 

 

$173.25 

Peer Group

 

$100.00 

 

$94.61 

 

$125.45 

 

$155.83 

 

$200.87 

 

$208.71 



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 will neither make nor endorse any predictions as to future stock performance.

Our Peer Group for fiscal 2016 is comprised of the following companies:





 

 

Automatic Data Processing, Inc. (direct competitor)

 

Broadridge Financial Solutions, Inc.

Fiserv, Inc.

 

Robert Half International Inc.

The Western Union Company

 

Intuit Inc.

Total Systems Services, Inc.

 

Iron Mountain Incorporated

Global Payments Inc.

 

Moody’s Corporation

The Brink’s Company

 

H&R Block, Inc.

DST System, Inc.

 

TD AMERITRADE Holding Corporation

The Dun & Bradstreet Corporation

 

 



 

12


 

Item 6.    Selected Financial Data







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions, except per share amounts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended May 31,

 

2016 (1)

 

2015

 

2014 (2),  (4)

 

2013 (3),  (4)

 

2012 (4)

Service revenue

 

$

2,905.8 

 

 

$

2,697.5 

 

 

$

2,478.2 

 

 

$

2,285.2 

 

 

$

2,186.2 

 

Interest on funds held for clients

 

$

46.1 

 

 

$

42.1 

 

 

$

40.7 

 

 

$

41.0 

 

 

$

43.6 

 

Total revenue

 

$

2,951.9 

 

 

$

2,739.6 

 

 

$

2,518.9 

 

 

$

2,326.2 

 

 

$

2,229.8 

 

Operating income

 

$

1,146.6 

 

 

$

1,053.6 

 

 

$

982.7 

 

 

$

904.8 

 

 

$

853.9 

 

Net income

 

$

756.8 

 

 

$

674.9 

 

 

$

627.5 

 

 

$

569.0 

 

 

$

548.0 

 

Basic earnings per share

 

$

2.10 

 

 

$

1.86 

 

 

$

1.72 

 

 

$

1.56 

 

 

$

1.51 

 

Diluted earnings per share

 

$

2.09 

 

 

$

1.85 

 

 

$

1.71 

 

 

$

1.56 

 

 

$

1.51 

 

Cash dividends per common share

 

$

1.68 

 

 

$

1.52 

 

 

$

1.40 

 

 

$

1.31 

 

 

$

1.27 

 

Purchases of property and equipment

 

$

97.7 

 

 

$

102.8 

 

 

$

84.1 

 

 

$

98.7 

 

 

$

89.6 

 

Cash and total corporate investments

 

$

793.2 

 

 

$

936.4 

 

 

$

936.8 

 

 

$

874.6 

 

 

$

790.0 

 

Total assets

 

$

6,440.8 

 

 

$

6,467.5 

 

 

$

6,321.0 

 

 

$

6,127.3 

 

 

$

6,448.8 

 

Total debt

 

$

 —

 

 

$

 —

 

 

$

 —

 

 

$

 —

 

 

$

 —

 

Stockholders’ equity

 

$

1,911.7 

 

 

$

1,785.5 

 

 

$

1,777.0 

 

 

$

1,773.7 

 

 

$

1,604.5 

 

Return on stockholders’ equity

 

 

40 

%

 

 

36 

%

 

 

35 

%

 

 

34 

%

 

 

34 

%



(1)

In the first quarter of fiscal 2016,  a net tax benefit was recorded for income derived in prior tax years from customer-facing software we produced.  This increased full-year diluted earnings per share by approximately $0.05 per share.



(2)

With the introduction of a new health care offering within the PEO during the fiscal year ended May 31, 2014, the Company began to recognize certain PEO direct costs as operating expenses rather than as a reduction in service revenue.  In the table above, this impacted service revenue and total revenue, but had no impact on operating income.



(3)

In the fourth quarter of the fiscal year ended May 31, 2013, the Company increased its tax provision related to the settlement of a state income tax matter.  This reduced diluted earnings per share by approximately $0.04 per share.



(4)

With the adoption of Financial Accounting Standards Board Accounting Standards Update No. 2015-17 “Income Taxes (Topic 740) - Balance Sheet Classification of Deferred Taxes” during fiscal 2016, the reclassification of prior year deferred tax amounts was made on the Consolidated Balance Sheets to conform to the current period presentation.  In the table above, a similar reclassification was made, which impacted total assets.  Refer to Note A of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further details on this recently adopted accounting pronouncement.



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,” “we,” “our,” or “us”) for each of the three fiscal years ended May 31, 2016 (“fiscal 2016”),  May 31, 2015 (“fiscal 2015”), and May 31, 2014 (“fiscal 2014”), and our financial condition as of May 31, 2016. 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 human resource needs.  Our payroll processing services, the foundation of our service model, include:

·

payroll processing;

·

payroll tax administration services;

·

employee payment services; and

13


 

·

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

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

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

·

comprehensive human resource 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 human resource services and products.

We also offer certain accounting and financial services, which include: the purchase of accounts receivable as a means of providing payroll funding to clients in the temporary staffing industry; a cloud-based accounting service; payment processing services; payment distribution services; and a small-business loan resource center.

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.

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 are 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.

Our financial results for fiscal 2016 reflected sustained growth in our business.  Payroll service revenue continued to experience steady growth of 4% for fiscal 2016 as compared with fiscal 2015, driven by growth in client base and revenue per check.  Our payroll client base grew 2% in fiscal 2016 to approximately 605,000 clients as of May 31, 2016, resulting from solid sales execution and client retention results in excess of 82% of the beginning of the fiscal year client base, consistent with the prior year’s record high

Our financial results continue to be impacted by the interest rate environment as interest rates available on high-quality financial instruments remain low.  Our combined funds held for clients and corporate investment portfolios earned an average rate of return of 1.1% for fiscal 2016, compared to 1.0% for fiscal years 2015 and 2014.  In December 2015, the United States (“U.S.”) Federal Reserve raised the Federal Funds rate by 25 basis points.  This was the first interest hike in nearly a decade.  The Federal Funds rate was in the range of 0.25% to 0.50% as of May 31, 2016, and was in the range of zero to 0.25% as of May 31, 2015.  

Highlights of our financial results for fiscal 2016, compared to fiscal 2015, are as follows:

·

Total revenue increased 8% to $3.0 billion.

·

Total service revenue increased 8% to $2.9 billion.

o

Payroll service revenue increased 4% to $1.7 billion.

o

HRS revenue increased 13% to $1.2 billion.

·

Interest on funds held for clients increased 9% to $46.1 million.

·

Operating income increased 9% to $1.1 billion.

14


 

·

Net income increased 12% to $756.8 million and diluted earnings per share increased 13% to $2.09 per share.  During the first quarter of fiscal 2016 (the “first quarter”), a net tax benefit was recorded for income derived in prior tax years that increased full-year diluted earnings per share by approximately $0.05.   Excluding this net tax benefit, net income and diluted earnings per share would have increased 9% and 10%, respectively, for fiscal 2016.

·

Dividends of $606.5 million were paid to stockholders, representing 80% of net income.

Business Outlook

Our payroll client base totaled approximately 605,000 clients as of May 31, 2016, compared to approximately 590,000 clients as of May 31, 2015, and approximately 580,000 clients as of May 31, 2014. Our payroll client base increased approximately 2% for each of the fiscal years 2016, 2015 and 2014.

While HRS provides services to employers and employees beyond payroll, they effectively leverage payroll processing data and, therefore, are beneficial to our operating margin.  Our HR administration services are often included as part of the SaaS solutions for mid-market clients.  The following table illustrates the growth in selected HRS service offerings:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

Balance at

 

Growth rates for fiscal year



 

May 31, 2016

 

2016

 

2015

 

2014

Paychex HR Services client worksite employees

 

944,000 

 

10 

%

 

12 

%

 

14 

%

Paychex HR Services clients

 

35,000 

 

10 

%

 

11 

%

 

13 

%

Health and benefits services applicants

 

150,000 

 

%

 

%

 

%

Retirement services plans

 

74,000 

 

%

 

%

 

%



In fiscal 2016, we made significant enhancements to our Paychex Flex platform,  which is our cloud-based HCM solution.  In fiscal 2016, we completed the integration of key HCM modules with the release of Paychex Flex Time, Paychex Flex Benefits Administration, and Paychex Flex Hiring.  We believe this leading-edge technology, along with our flexible service options, positively impacted our performance in the mid-market space, as we experienced especially strong sales results for this division in fiscal 2016.

In December 2015, a wholly owned subsidiary of Paychex acquired substantially all of the net assets of Advance Partners.  Advance Partners is a leading provider of integrated financial, operational, and strategic services to support independent staffing firms.  Advance Partners offers customizable solutions to the temporary staffing industry, including payroll funding and outsourcing services. 

Our full-service Paychex Employer Shared Responsibility (“ESR”) services continued to show strong market acceptance and growth in fiscal 2016. The Affordable Care Act (“ACA”) sets forth specific coverage and reporting requirements that employers must meet.  Paychex ESR services help clients navigate the complexities of those requirements, avoid steep fines and penalties, and reduce ACA-related administrative work.

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.paychexinsurance.com, helps small-business owners navigate the area of insurance coverage.  Both this website and www.paychex.com have sections dedicated to the topic of health care reform.

Financial position and liquidity

Our financial position as of May 31, 2016 remained strong with cash and total corporate investments of $793.2 million and no debt. Our investment strategy continues to focus on protecting principal and optimizing liquidity. Yields on high quality financial instruments remain low, negatively impacting our income earned on funds held for clients and corporate investments. 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 2016, our primary short-term investment vehicles were bank demand deposit accounts, variable rate demand notes (“VRDNs”), high-quality commercial paper, and government agency discount notes.

15


 

A substantial portion of our portfolio is invested in high credit quality securities with ratings of AA or higher, and A-1/P-1 ratings on short-term securities. We limit the amounts that can be invested in any single issuer and invest in short- to intermediate-term instruments whose fair value is less sensitive to interest rate changes. We believe that our investments as of May 31, 2016 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 our ongoing operations. Cash flow from operations exceeded $1.0 billion for the first time for fiscal 2016. 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 2016 allowed us to support our business growth and to pay substantial dividends to our stockholders. In July 2015, we announced an increase in our quarterly dividend of 11%, or $0.04 per share.  In July 2016, we subsequently announced an additional $0.04 per share, or 10%, increase in our quarterly dividend.  Dividends paid to stockholders were 80% of net income in fiscal 2016. It is anticipated that cash and total corporate investments as of May 31, 2016, along with projected operating cash flows, 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 2016,  2015, and 2014, and our financial position as of May 31, 2016, 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.

Outlook

Our outlook for the fiscal year ending May 31, 2017 (“fiscal 2017”) is based upon current market, economic, and interest rate conditions continuing with no significant changes. Our expected full-year fiscal 2017 payroll revenue growth rate is based upon anticipated client base growth and increases in revenue per check.  Our guidance for fiscal 2017 is as follows:

·

Payroll service revenue is anticipated to increase approximately 4%;

·

HRS Revenue is anticipated to increase in the range of 12% to 14%;

·

total service revenue is expected to increase in the range of 7% to 8%;

·

interest on funds held for clients is expected to reflect mid-single-digit growth;

·

net income is expected to increase approximately 8%, excluding the net tax benefit recognized in fiscal 2016 related to income derived in prior tax years;

·

operating income, net of certain items, as a percent of service revenue is expected to approximate 38%; and

·

the effective income tax rate for fiscal 2017 is expected to be in the range of 35.5% to 36%.

The average rate of return on our combined funds held for clients and corporate investment portfolios is expected to be approximately 1.1% for fiscal 2017. As of May 31, 2016, the long-term investment portfolio had an average yield-to-maturity of 1.7% and an average duration of 3.1 years.

Purchases of property and equipment for fiscal 2017 are expected to be in the range of $110 million to $120 million. This includes costs for internally developed software as we continue to invest in our service supporting technology. Fiscal 2017 depreciation expense is projected to be in the range of $100 million to $110 million, and we project amortization of intangible assets for fiscal 2017 to be in the range of $15 million to $20 million.



16


 

Results of Operations



Summary of Results of Operations for the Fiscal Years Ended May 31:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions, except per share amounts

 

2016

 

Change

 

2015

 

Change

 

2014

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payroll service revenue

 

$

1,729.9 

 

 

%

 

$

1,656.8 

 

 

%

 

$

1,599.3 

 

HRS revenue

 

 

1,175.9 

 

 

13 

%

 

 

1,040.7 

 

 

18 

%

 

 

878.9 

 

Total service revenue

 

 

2,905.8 

 

 

%

 

 

2,697.5 

 

 

%

 

 

2,478.2 

 

Interest on funds held for clients

 

 

46.1 

 

 

%

 

 

42.1 

 

 

%

 

 

40.7 

 

Total revenue

 

 

2,951.9 

 

 

%

 

 

2,739.6 

 

 

%

 

 

2,518.9 

 

Combined operating and SG&A expenses

 

 

1,805.3 

 

 

%

 

 

1,686.0 

 

 

10 

%

 

 

1,536.2 

 

Operating income

 

 

1,146.6 

 

 

%

 

 

1,053.6 

 

 

%

 

 

982.7 

 

Investment income, net

 

 

4.5 

 

 

(28)

%

 

 

6.4 

 

 

17 

%

 

 

5.4 

 

Income before income taxes

 

 

1,151.1 

 

 

%

 

 

1,060.0 

 

 

%

 

 

988.1 

 

Income taxes

 

 

394.3 

 

 

%

 

 

385.1 

 

 

%

 

 

360.6 

 

Effective income tax rate

 

 

34.3 

%

 

 

 

 

 

36.3 

%

 

 

 

 

 

36.5 

%

Net income

 

$

756.8 

 

 

12 

%

 

$

674.9 

 

 

%

 

$

627.5 

 

Diluted earnings per share

 

$

2.09 

 

 

13 

%

 

$

1.85 

 

 

%

 

$

1.71 

 



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, 2016, 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

 

2016

 

2015

 

2014

Average investment balances:

 

 

 

 

 

 

 

 

 

 

 

 

Funds held for clients

 

$

4,105.5 

 

 

$

4,080.0 

 

 

$

3,968.7 

 

Corporate investments

 

 

922.6 

 

 

 

1,011.5 

 

 

 

973.8 

 

Total

 

$

5,028.1 

 

 

$

5,091.5 

 

 

$

4,942.5 

 



 

 

 

 

 

 

 

 

 

 

 

 

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

Funds held for clients

 

 

1.1 

%

 

 

1.0 

%

 

 

1.0 

%

Corporate investments

 

 

0.9 

%

 

 

0.7 

%

 

 

0.7 

%

Combined funds held for clients and corporate investments

 

 

1.1 

%

 

 

1.0 

%

 

 

1.0 

%



 

 

 

 

 

 

 

 

 

 

 

 

Total net realized gains

 

$

0.1 

 

 

$

0.3 

 

 

$

0.6 

 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

$ in millions

 

 

 

 

 

 

 

 

 

 

 

 

As of May 31,

 

2016

 

2015

 

2014

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

 

$

47.6 

 

 

$

13.6 

 

 

$

34.5 

 

Federal Funds rate(2)

 

 

0.50 

%

 

 

0.25 

%

 

 

0.25 

%

Total fair value of available-for-sale securities

 

$

4,141.9 

 

 

$

3,595.6 

 

 

$

3,391.4 

 

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

 

 

3.1 

 

 

 

3.2 

 

 

 

3.0 

 

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

 

 

1.7 

%

 

 

1.6 

%

 

 

1.6 

%



(1)

The net unrealized gain on our investment portfolios was approximately $63.5 million as of July 15, 2016.

(2)

The Federal Funds rate was in the range of 0.25% to 0.50% as of May 31, 2016, and in the range of zero to 0.25% as of May 31, 2015.

(3)

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

17


 

Payroll service revenue:  Payroll service revenue was $1.7 billion for both fiscal 2016 and fiscal 2015, reflecting growth of 4% for both fiscal 2016 and fiscal 2015 compared to fiscal 2014.  Both fiscal 2016 and fiscal 2015 benefited from increases in client base and revenue per check.   Revenue per check improved as a result of price increases, net of discounts.  Fiscal 2016 also benefited from two additional processing days during the year.

For fiscal 2016 and fiscal 2015, our total payroll client base growth was approximately 2%.  Client retention was in excess of 82% of the beginning of the year client base for fiscal 2016, consistent with fiscal 2015, which reflected a record high.

Human Resource Services revenue:  HRS revenue was $1.2 billion for fiscal 2016 and $1.0 billion for fiscal 2015, reflecting growth of 13%  and 18%, respectively, compared to each of the prior fiscal year periods.

For both fiscal 2016 and fiscal 2015,  HRS revenue growth was primarily driven by increases in client base across all major HCM services, including: comprehensive outsourcing services; retirement services; time and attendance; and HR.  HRS product key statistics are as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ in billions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of May 31,

 

2016

 

Change

 

2015

 

Change

 

2014

Paychex HR Services client worksite employees

 

 

944,000 

 

10 

%

 

 

858,000 

 

12 

%

 

 

766,000 

Paychex HR Services clients

 

 

35,000 

 

10 

%

 

 

31,000 

 

11 

%

 

 

28,000 

Health and benefits services applicants

 

 

150,000 

 

%

 

 

142,000 

 

%

 

 

134,000 

Retirement services plans

 

 

74,000 

 

%

 

 

70,000 

 

%

 

 

66,000 

Asset value of retirement services participants’ funds

 

$

23.6 

 

 —

%

 

$

23.5 

 

%

 

$

21.9 

We continue to experience strong demand for our Paychex HR Services, our largest HRS revenue stream, as evidenced by the continued double-digit growth in client worksite employees.  During both fiscal 2016 and fiscal 2015, the PEO, in particular, experienced strong demand.

Retirement services revenue growth was tempered in fiscal 2016 by a lower average asset value of participants’ funds, offset somewhat by higher basis points earned from external fund managers.  Retirement services revenue for fiscal 2015 compared to fiscal 2014 benefited from pricing and higher average asset value of participants’ funds.

Insurance services revenue growth for both fiscal 2016 and 2015 benefited from growth in our full-service ACA product.  In addition, higher average premiums and clients in our workers’ compensation product positively impacted revenue in both years.

Our HR administration products, including time and attendance and HR management, contributed to growth through strong sales of our SaaS solutions.  Time and attendance solutions benefited from a small business acquisition in fiscal 2015.



Total service revenue:  Total service revenue increased 8% for fiscal 2016 and 9% for fiscal 2015, attributable to the factors previously discussed.

Interest on funds held for clients:  Interest on funds held for clients increased 9% for fiscal 2016 and increased 3% for fiscal 2015.  For fiscal 2016, the increase was primarily due to higher average interest rates and slightly higher average investment balances.  For fiscal 2015, the increase was primarily due to an increase in average investment balances, while average interest rates earned were flat. 

Average investment balances for funds held for clients increased 1% for fiscal 2016  and 3% for fiscal 2015.  The net increase in average investment balances for fiscal 2016 was mainly due to client base growth and wage inflation, partially offset by lower state unemployment insurance rates.  The increase in average investment balances for fiscal 2015 was mainly driven by increases in client base and wage inflation.   

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

18


 

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







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions

 

2016

 

Change

 

2015

 

Change

 

2014

Compensation-related expenses

 

$

1,148.2 

 

%

 

$

1,087.1 

 

%

 

$

1,003.9 

Depreciation and amortization

 

 

115.1 

 

%

 

 

106.6 

 

%

 

 

105.0 

Other expenses

 

 

542.0 

 

10 

%

 

 

492.3 

 

15 

%

 

 

427.3 

Total expenses

 

$

1,805.3 

 

%

 

$

1,686.0 

 

10 

%

 

$

1,536.2 



Total expenses increased 7% for fiscal 2016 and 10% for fiscal 2015. Fiscal 2015 was impacted by costs relating to the new minimum premium plan health insurance offering within our PEO, introduced in January 2014, which contributed three percentage points of the increase in total expenses for fiscal 2015.

The increases in total expenses were driven largely by growth in compensation-related expenses.  For fiscal 2016, compensation-related expenses increased due to higher wages and performance-based compensation costs.  For fiscal 2015, compensation-related expenses increased due to higher sales headcount and variable costs resulting from strong sales execution, along with higher employee-benefit-related costs, primarily medical expenses.  As of May 31, 2016, we had approximately 13,500 employees, compared with 13,000 employees as of May 31, 2015.

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 higher growth rate for depreciation and amortization in fiscal 2016 was primarily driven by higher depreciation related to an increase in internally developed software that was placed in service.

Other expenses include items such as non-capital equipment, delivery, forms and supplies, communications, travel and entertainment, professional services, and other costs incurred to support our business.  Other expenses increased due to growth within the PEO.  In addition, continued investment in product development and supporting technology impacted other expense growth for both fiscal 2016 and fiscal 2015.

Operating income:  Operating income increased 9% for fiscal 2016 and 7% for fiscal 2015. The fluctuations in operating income were attributable to the factors previously discussed.

Operating income, net of certain items, is as follows for fiscal years:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In millions

 

2016

 

Change

 

2015

 

Change

 

2014

Operating income

 

$

1,146.6 

 

%

 

$

1,053.6 

 

%

 

$

982.7 

Excluding:  Interest on funds held for clients

 

 

(46.1)

 

%

 

 

(42.1)

 

%

 

 

(40.7)

Operating income, net of certain items (1)

 

$

1,100.5 

 

%

 

$

1,011.5 

 

%

 

$

942.0 



(1)

Operating income, net of certain items is a non-GAAP measure.  Refer to the “Non-GAAP Financial Measure” discussion that follows.



Operating income, net of certain items, as a percentage of service revenue was approximately 38% for each of the fiscal years 2016, 2015 and 2014

Non-GAAP Financial Measure:  In addition to reporting operating income, a U.S. generally accepted accounting principle (“GAAP”) measure, we present operating income, net of certain items, which is a non-GAAP measure. We believe operating income, net of certain items, is an appropriate additional measure, as it is an indicator of our core business operations performance period over period. It is also the basis of the measure used internally for establishing the following year’s targets and measuring management’s performance in connection with certain performance-based compensation payments and awards. Operating income, net of certain items, excludes interest on funds held for clients. Interest on funds held for clients is an adjustment to operating income due to the volatility of interest rates, which are not within the control of management. Operating income, net of certain items, is not calculated through the application of GAAP and is not the required form of disclosure by the Securities and Exchange Commission (“SEC”). As such, it should not be considered as a substitute for the GAAP measure of operating income and, therefore, should not be used in isolation, but in conjunction with the GAAP measure. 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.

19


 

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, decreased 28% for fiscal 2016 as the result of immaterial losses on equity method investments and a decrease in average investment balances, partially offset by higher average interest rates earned.  The decrease in average investment balances for fiscal 2016 is the result of cash consideration paid for the acquisition of Advance Partners in December 2015 and stock repurchase activity.    Investment income increased 17% for fiscal 2015 due to an increase in average investment balances resulting from investment of cash generated from operations, while interest rates earned remained relatively flat.     

Income taxes:  Our effective income tax rate was 34.3% for fiscal 2016 compared to 36.3% for fiscal 2015 and 36.5% for fiscal 2014. The decrease in the effective income tax rate for fiscal 2016 is related primarily to a net tax benefit that was recorded for income derived in prior tax years from customer-facing software we produced. During the first quarter, we engaged tax specialists to assess the qualification of such software for the Federal “Qualified Production Activities Deduction.”  Based on this assessment, we concluded that certain of our software offerings qualified for this tax deduction in prior tax years and, therefore, we recorded the tax benefits and related tax reserves as a discrete item in the first quarter.  Excluding this net tax benefit, the effective income tax rate would have been approximately 35.8% for fiscal 2016.  Refer to Note J of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on income taxes.

Net income and earnings per share:  Net income increased 12% to $756.8 million for fiscal 2016 and 8% to $674.9 million for fiscal 2015. Diluted earnings per share increased 13% to $2.09 per share for fiscal 2016 and 8% to $1.85 per share for fiscal 2015. These fluctuations were attributable to the factors previously discussed. Excluding the net tax benefit recognized in the first quarter, net income and diluted earnings per share for fiscal 2016 would have increased 9% and 10%, respectively.



Liquidity and Capital Resources

Our financial position as of May 31, 2016 remained strong with cash and total corporate investments of $793.2 million and no debt. We believe that our investments as of May 31, 2016 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date that would indicate any other-than-temporary impairment. We anticipate that cash and total corporate investments as of May 31, 2016, along with projected operating cash flows, will support our normal business operations, capital purchases, business acquisitions, share repurchases, and dividend payments for the foreseeable future.

Commitments and Contractual Obligations

Lines of credit:  As of May 31, 2016, we had unused borrowing capacity available under uncommitted, secured, short-term lines of credit at market rates of interest with financial institutions as follows:







 

 

 

 



 

 

 

 

Financial institution

 

Amount available

 

Expiration date

JP Morgan Chase Bank, N.A.

 

$350 million

 

February 27, 2017

Bank of America, N.A.

 

$250 million

 

February 28, 2017

PNC Bank, National Association

 

$150 million

 

February 27, 2017

Wells Fargo Bank, National Association

 

$150 million

 

February 27, 2017



Our credit facilities are evidenced by promissory notes and are secured by separate pledge security agreements by and between Paychex, Inc. and each of the financial institutions (the “Lenders”), pursuant to which we have granted each of the Lenders a security interest in certain of our investment securities accounts. The collateral is maintained in a pooled custody account pursuant to the terms of a control agreement and is to be administered under an intercreditor agreement among the Lenders. Under certain circumstances, individual Lenders may require that collateral be transferred from the pooled account into segregated accounts for the benefit of such individual Lenders.

The primary uses of the lines of credit would be to meet short-term funding requirements related to deposit account overdrafts and client fund obligations arising from electronic payment transactions on behalf of our clients in the ordinary course of business, if necessary. No amounts were outstanding against these lines of credit during fiscal 2016 or as of May 31, 2016.

Certain of the financial institutions are also parties to our credit facility and irrevocable standby letters of credit, which are discussed below.

20


 

Credit facilitiesOn August 5, 2015, the Company entered into a committed, unsecured, five-year syndicated credit facility, expiring on August 5, 2020.  Under the credit facility, Paychex of New York LLC (the “Borrower”) may, subject to certain restrictions, borrow up to $1 billion to meet short-term funding requirements.  The obligations under this facility have been guaranteed by the Company and certain of its subsidiaries.  The outstanding obligations under this credit facility will bear interest at competitive rates to be elected by the Borrower.  Upon expiration of the commitment in August 2020, any borrowings outstanding will mature and be payable on such date.  This agreement supersedes the $750 million credit facility agreement set to expire on June 21, 2018, which was terminated as part of the new agreement.

There were no amounts outstanding under this credit facility as of May 31, 2016.  During fiscal 2016,  the Company borrowed against this facility, and its predecessor facility, for one-day periods each, from one to two times a quarter as follows:





 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

 

 

 

 

 

 

$ in millions

 

2016

 

 

2015

Number of days borrowed

 

 

 

 

 

Maximum amount borrowed

 

$

450.0 

 

$

150.0 

 

Average amount borrowed

 

$

305.0 

 

$

125.0 

 

Weighted-average interest rate

 

 

3.39 

%

 

3.25 

%

The Company subsequently borrowed $100 million for one day under this line in June 2016.



The credit facility contains various financial and operational covenants that are usual and customary for such arrangements.  The Borrower was in compliance with these covenants during fiscal 2016. 

Certain lenders under this credit facility, and their respective affiliates, have performed, and may in the future perform for us, various commercial banking, investment banking, underwriting, and other financial advisory services, for which they have received, and will continue to receive in the future, customary fees and expenses.

On March 17, 2016, the Company entered into a committed, unsecured, three-year credit facility with PNC Bank, National Association, expiring on March 17, 2019.   Under the credit facility, Paychex Advance LLC (“Paychex Advance”) may, subject to certain restrictions, borrow up to $150 million to finance working capital needs and for general corporate purposes.  The obligations under this facility have been guaranteed by the Company and certain of its subsidiaries.  The outstanding obligations under this credit facility will bear interest at competitive rates to be elected by Paychex Advance.  Upon expiration of the commitment in March 2019, any borrowings outstanding will mature and be payable on such date.

There were no amounts outstanding under this credit facility as of May 31, 2016Subsequent to May 31, 2016, Paychex Advance borrowed approximately $56 million under this line, which remains outstanding as of the date of this report.

Letters of credit:  As of May 31, 2016, we had irrevocable standby letters of credit outstanding totaling $43.0 million, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between July 2016 and April 2017, and are collateralized by securities held in our investment portfolios. No amounts were outstanding on these letters of credit during fiscal 2016 or as of May 31, 2016. Subsequent to May 31, 2016, the letter of credit expiring in July 2016 was renewed through July 2017.

Other commitments:  We have entered into various operating leases and purchase obligations that, under GAAP, are not reflected on the Consolidated Balance Sheets as of May 31, 2016. The table below summarizes our estimated annual payment obligations under these commitments as of May 31, 2016:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Payments due by period



 

 

 

 

Less than

 

 

 

 

 

 

 

More than

In millions

 

Total

 

1 year

 

1-3 years

 

4-5 years

 

5 years

Operating leases(1)

 

$

106.7 

 

$

35.7 

 

$

48.5 

 

$

20.3 

 

$

2.2 

Purchase obligations(2)

 

 

109.7 

 

 

73.6 

 

 

28.1 

 

 

7.4 

 

 

0.6 

Total

 

$

216.4 

 

$

109.3 

 

$

76.6 

 

$

27.7 

 

$

2.8 



(1)

Operating leases are primarily for office space and equipment used in our branch operations.

(2)

Purchase obligations include our estimate of the minimum outstanding commitments under purchase orders to buy goods and services and legally binding contractual arrangements with future payment obligations. Included in the total purchase obligations is $6.8 million of commitments to purchase capital assets. Amounts actually paid under certain of these arrangements may be different due to variable components of these agreements.

21


 

The liability for uncertain tax positions, including interest and net of federal benefits, was approximately $54.2 million as of May 31, 2016. Refer to Note J of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for more information on income taxes. We are not able to reasonably estimate the timing of future cash flows related to this liability and have excluded it from the table above.

Certain deferred compensation plan obligations and other long-term liabilities reported in our Consolidated Balance Sheets amounting to $68.3 million are excluded from the table above because the timing of actual payments cannot be specifically or reasonably determined due to the variability in assumptions required to project the timing of future payments.

Advantage Payroll Services Inc. (“Advantage”) has license agreements with independently owned associate offices (“Associates”), which are responsible for selling and marketing Advantage Payroll Services® and performing certain operational functions, while Paychex and Advantage provide all centralized back-office payroll processing and payroll tax administration services. Under these arrangements, Advantage pays the Associates commissions based on processing activity for the related clients. When we acquired Advantage, there were fifteen Associates. Over the past few years, arrangements with some Associates have been discontinued, and there are currently fewer than ten Associates. Since the actual amounts of future payments are uncertain, obligations under these arrangements are not included in the table above. Commission expense for the Associates for fiscal years 2016,  2015, and 2014 was $16.1 million, $15.1million, and $14.4 million, respectively.

In the normal course of business, we make representations and warranties that guarantee the performance of services under service arrangements with clients. Historically, there have been no material losses related to such guarantees. In addition, we have entered into indemnification agreements with our officers and directors, which require us to defend and, if necessary, indemnify these individuals for certain pending or future legal claims as they relate to their services provided to us.

We currently self-insure the deductible portion of various insured exposures under certain employee benefit plans. Our estimated loss exposure under these insurance arrangements is recorded in other current liabilities on our Consolidated Balance Sheets. Historically, the amounts accrued have not been material and are not material as of the reporting date. We also maintain insurance coverage in addition to our purchased primary insurance policies for gap coverage for employment practices liability, errors and omissions, warranty liability, theft and embezzlement, cyber threats, and acts of terrorism; and capacity for deductibles and self-insured retentions through our captive insurance company.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions with unconsolidated entities which would have been established for the purpose of facilitating off-balance sheet arrangements or other limited purposes. We do maintain investments as a limited partner in low-income housing projects that are not considered part of our ongoing operations. These investments are accounted for under the equity method of accounting and are less than 1% of our total assets as of May 31, 2016.

Operating Cash Flow Activities





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

Year ended May 31,

In millions

 

2016

 

2015

 

2014

Net income

 

$

756.8 

 

$

674.9 

 

$

627.5 

Non-cash adjustments to net income

 

 

234.9 

 

 

211.4 

 

 

198.6 

Cash provided by changes in operating assets and liabilities

 

 

26.5 

 

 

8.9 

 

 

54.8 

Net cash provided by operating activities

 

$

1,018.2 

 

$

895.2 

 

$

880.9 



The increase in our operating cash flows for fiscal 2016 compared to fiscal 2015 is primarily the result of higher net income, adjusted for non-cash items, along with the positive impact from fluctuations in our operating assets and liabilities.  The increase for fiscal 2015 compared to fiscal 2014 is primarily the result of higher net income, adjusted for non-cash items, offset by the decrease in cash provided by changes in our operating assets and liabilities.  Non-cash adjustments to net income increased for both fiscal 2016 and fiscal 2015, compared to the respective prior year periods.  The increase in non-cash adjustments for fiscal 2016 was largely due to higher depreciation expense related to an increase in internally developed software placed in service, and an increase in the deferred tax provision.  The increase in non-cash adjustments for fiscal 2015 was largely due to higher amortization of premiums on available-for-sale securities as the Company has increased its holdings of longer-duration investments, and higher stock-based compensation costs.  The fluctuations in our operating assets and liabilities between all periods were primarily related to the timing of collections from clients and payments for compensation, PEO payroll, income tax, and other liabilities.     

22


 

Investing Cash Flow Activities





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

Year ended May 31,

In millions

 

2016

 

2015

 

2014

Net change in funds held for clients and corporate investment activities

 

$

339.7 

 

$

(151.8)

 

$

(211.4)

Purchases of property and equipment

 

 

(97.7)

 

 

(102.8)

 

 

(84.1)

Acquisition of businesses, net of cash acquired

 

 

(296.1)

 

 

(27.1)

 

 

(9.3)

Purchases of other assets

 

 

(9.0)

 

 

(3.3)

 

 

(11.3)

Net cash used in investing activities

 

$

(63.1)

 

$

(285.0)

 

$

(316.1)



Funds held for clients and corporate investments:  Funds held for clients consist of short-term funds and available-for-sale securities. Corporate investments are primarily comprised of available-for-sale securities. The portfolio of funds held for clients and corporate investments is detailed in Note F of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Fluctuations in the net change in funds held for clients and corporate investment activities are largely due to timing within the client funds portfolio.  For fiscal 2016 compared to fiscal 2015, there was a significant fluctuation due to timing of the day of the week for fiscal year-end.  There were larger cash outflows on Tuesday, May 31, 2016 that required the liquidation of funds held in the funds held for clients portfolio.  This resulted in positive cash flow from investing activities for fiscal 2016.  Our net cash inflow from funds held for clients and corporate investment activities for fiscal 2016 was partially offset by the change in mix of investments with more invested in VRDN securities and less in cash equivalents as of May 31, 2016.  For fiscal 2015 compared to fiscal 2014, there was not a significant fluctuation due to timing of the day of the week for fiscal year-end.  The net cash outflow position for both fiscal 2015 and fiscal 2014 is related to more purchases of short-term and available-for-sale securities resulting from higher average collections from clients.  See further discussion of this timing in the financing cash flows discussion of net change in client fund obligations.

In general, fluctuations in net funds held for clients and corporate investment activities primarily relate to timing of purchases, sales, or maturities of investments. The amount of funds held for clients will vary based upon the timing of collection of client funds, and the related remittance of funds to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services.  Additional discussion of interest rates and related risks is included in the “Market Risk Factors” section contained in Item 7A of this Form 10-K.

Other investing activities:  To support our continued client and ancillary product growth, purchases of property and equipment were made for data processing equipment and software, and for the expansion and upgrade of various operating facilities. During fiscal years 2016,  2015, and 2014, we purchased approximately $4.9 million, $6.9 million, and $4.7 million, respectively, of data processing equipment and software from EMC Corporation. The Chairman, President, and Chief Executive Officer of EMC Corporation is a member of our Board of Directors (the “Board”).

During fiscal 2016, we paid, net of cash acquired,  $296.1 million for the acquisition of Advance Partners.  During fiscal years 2015 and 2014, we paid, net of cash acquired, $27.1 million and $9.3 million, respectively, for immaterial business acquisitions. 

Financing Cash Flow Activities





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

Year ended May 31,

In millions, except per share amounts

 

2016

 

2015

 

2014

Net change in client fund obligations

 

$

(304.8)

 

$

93.0 

 

$

127.4 

Dividends paid

 

 

(606.5)

 

 

(551.8)

 

 

(510.6)

Repurchases of common shares

 

 

(107.9)

 

 

(182.4)

 

 

(249.7)

Equity activity related to stock-based awards

 

 

25.6 

 

 

48.5 

 

 

113.3 

Net cash used in financing activities

 

$

(993.6)

 

$

(592.7)

 

$

(519.6)

Cash dividends per common share

 

$

1.68 

 

$

1.52 

 

$

1.40 



Net change in client fund obligations:  The client fund obligations liability will vary based on the timing of collecting client funds, and the related required remittance of funds to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services. Collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days.

23


 

Fluctuations in net change in client fund obligations for the years presented are primarily the result of timing of collections and remittances and overall trends in client fund balances.   Timing for fiscal 2016 resulted in a net cash outflow position.   May 31, 2016 was a Tuesday, a larger cash outflow day due to clearing of Readychex and tax payments.  As May 31, 2015 was a Sunday, cash on hand would have been higher.  As a result, there was a net cash outflow over the period in fiscal 2016.

May 31, 2015 fell on a Sunday, while May 31, 2014 fell on a Saturday.  Friday is a large cash outflow day for direct deposit funds, partially offset by tax payment funds collected on that day.  This impact was consistent and did not impact the net cash flow position for client funds obligations reflected in fiscal 2015 or fiscal 2014.  The net cash inflow position in those years is the result of growth in average client funds held.  The slight decrease in net cash inflows for fiscal 2015 was the result of lower cash collections for state unemployment insurance with many states lowering their rates early in calendar 2015.

Dividends paid:  In July 2015, the Board increased our quarterly dividend to stockholders by 11% to $0.42 per share from $0.38 per share.  In July 2014, the Board increased our quarterly dividend to stockholders by 9% to $0.38 per share from $0.35 per share. The dividends paid as a percentage of net income totaled 80%, 82%, and 81% for fiscal years 2016,  2015, and 2014, respectively. The payment of future dividends is dependent on our future earnings and cash flow, and is subject to the discretion of our Board.

Repurchases of common shares:  In May 2014, the Board approved a program to repurchase up to $350 million of Paychex common stock, with authorization expiring in May 2017. Under this share repurchase program, we repurchased 2.2 million shares for a total of