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, 2015 (“fiscal 2015”), May 31, 2014 (“fiscal 2014”), and May 31, 2013 (“fiscal 2013”), and our financial condition as of May 31, 2015. 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 payroll, human resource, insurance, and benefits outsourcing solutions for small- to medium-sized businesses. We offer a comprehensive portfolio of human capital management (“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

•	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 tied together by 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;

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

•	other human resource services and products.

Our mission is to be the leading provider of payroll, human resource, 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 drive growth in clients, revenue, and profits. 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 2015 reflected sustained growth in our business. Payroll service revenue continued to experience steady growth of 4% for fiscal 2015 as compared with fiscal 2014, driven by growth in revenue per check and clients. We achieved a milestone of $1 billion of HRS revenue for fiscal 2015, as strong demand for our comprehensive human resource outsourcing solutions drove double-digit growth. Our sales execution was strong as we achieved significant growth in new annualized revenue. For the third year in a row, we achieved record levels of client retention, ending fiscal 2015 in excess of 82% of the beginning of the year client base.

Our financial results continue to be impacted by the interest rate environment as interest rates available on high-quality financial instruments remain low, but steady. The Federal Funds rate has been at a range of zero to 0.25% since December 2008. Our combined funds held for clients and corporate investment portfolios earned an average rate of return of 1.0% for fiscal years 2015, 2014, and 2013.

Highlights of our financial results for fiscal 2015, compared to fiscal 2014, are as follows:

•	Total service revenue increased 9% to $2.7 billion.

◦	Payroll service revenue increased 4% to $1.7 billion.

◦	HRS revenue increased 18% to $1.0 billion.

•	Interest on funds held for clients increased 3% to $42.1 million.

•	Total revenue increased 9% to $2.7 billion.

•	Operating income increased 7% to $1.1 billion.

•	Net income and diluted earnings per share each increased 8% to $674.9 million and $1.85 per share, respectively.

•	Dividends of $551.8 million were paid to stockholders, representing 82% of net income.

Business Outlook

Our client base totaled approximately 590,000 clients as of May 31, 2015, compared to approximately 580,000 clients as of May 31, 2014, and approximately 570,000 clients as of May 31, 2013. Our client base increased approximately 2% for fiscal 2015 and fiscal 2014, up from growth of approximately 1% for fiscal 2013.

For fiscal 2015, payroll services client retention was at a record level in excess of 82% of our beginning of the year client base. Our client satisfaction results remained high, which we believe is a result of our focus on providing innovative technology solutions and outstanding personal service to our clients to maximize client retention.

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 online 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 May 31, 2015			Growth rates for fiscal year
		2015			2014			2013
Paychex HR Services client worksite employees		858,000			12	%		14	%		9	%
Paychex HR Services clients		31,000			11	%		13	%		10	%
Health and benefits services applicants		142,000			6	%		3	%		8	%
Retirement services plans		70,000			6	%		5	%		4	%

We continue to position ourselves to capitalize on the opportunities arising from the shift to SaaS solutions as we increase our investment in product development relating to our SaaS capabilities and mobile applications. In fiscal 2015, we broadened our portfolio of value-added services, offering the following new or upgraded payroll and human resource services:

•

We introduced Paychex Flex, a solution that includes our leading-edge, cloud-based platform and mobility applications, with a multi-tiered service offering, which streamlines workforce management through innovative technology and flexible choice of service. This provides a unique blend of both service and software that we believe differentiates us from our competitors. The comprehensive, cloud-based Paychex Flex platform offers powerful capabilities in a simple user experience that is adaptive to the needs of users across the HCM spectrum – recruiters and recruits, HR and payroll stakeholders, benefits administrators, employees, contractors, financial advisors, and accounting partners. All Paychex services, including payroll, time and attendance, HR, benefits, training, and performance management, are accessible on a single cloud-based platform with Paychex Single Sign-On. The mobile apps within Paychex Flex give employers access to the fullest set of employee data available on-the-go, in addition to plan-level views of retirement, health, and benefit accounts. Likewise, employees receive visibility into a wide set of personal and benefits data and functionality, including the industry’s broadest set of retirement self-service features.

•

We also expanded our mobile applications by introducing mobile applications for our Paychex Accounting Online® services, time and attendance, and our expense management solution. The Paychex Accounting Online mobile application allows users to access their Paychex Accounting Online account from their iPad®, iPhone®, and iPod Touch® in order to keep track of their business finances anywhere and anytime. Paychex Time provides a mobile time punch app that offers the quickest mobile punch possible. The mobile interface for expense management provides clients and their employees with anytime, anywhere accessibility to view, review, and analyze expense reports, upload receipt images, and check on the status of an expense report.

•	We acquired nettime solutions, LLC, a leading cloud-based time and attendance solutions provider. This small- business acquisition pairs Paychex’s exceptional customer service with the SaaS time and attendance technology of a market leader.

•

We released the newest version of our applicant tracking system, myStaffingPro®, which has expanded mobility and new features. These new features are designed to enhance the candidate experience by reducing data entry, improving completion rates, and providing the ability to create candidate differentiators. The improved candidate experience helps our clients increase their applicant pools and they can also utilize enhanced tools to screen applicants.

•	Our full-service Paychex Employer Shared Responsibility (“ESR”) services are experiencing strong market acceptance. 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, 2015 remained strong with cash and total corporate investments of $936.4 million and no debt. Our investment strategy focuses 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 that are secured by a United States (“U.S.”) government escrow, and essential services revenue bonds. During fiscal 2015, our primary short-term investment vehicles were high quality variable rate demand notes (“VRDNs”) and bank demand deposit accounts.

A substantial portion of our portfolio is invested in high credit quality securities with AAA and AA ratings 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, 2015 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 was $895.2 million for fiscal 2015. Historically, we have funded our operations, capital purchases, business acquisitions, share repurchases, and dividend payments from our operating activities. Our positive cash flows in fiscal 2015 allowed us to support our business growth and to pay substantial dividends to our stockholders. During fiscal 2015, dividends paid to stockholders were 82% of net income. It is anticipated that cash and total corporate investments as of May 31, 2015, 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.

For further analysis of our results of operations for fiscal years 2015, 2014, and 2013, and our financial position as of May 31, 2015, 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, 2016 (“fiscal 2016”) is based upon current market, economic, and interest rate conditions continuing with no significant changes. Our expected fiscal 2016 payroll revenue growth rate is based upon anticipated client base growth and increases in revenue per check. Our anticipated HRS revenue growth for fiscal 2016 reflects the impact of the minimum premium plan offering within our PEO being in place for a full year in fiscal 2015.

Our fiscal 2016 guidance is as follows:

		Low					High
Payroll service revenue		4	%		—		5	%
HRS revenue		10	%		—		13	%
Total service revenue		7	%		—		8	%
Net income		8	%		—		9	%

Operating income, net of certain items, as a percent of total service revenue, is expected to be approximately 38% for fiscal 2016. The effective income tax rate for fiscal 2016 is expected to be consistent with that experienced in fiscal 2015.

Interest on funds held for clients for fiscal 2016 is expected to be relatively flat. The average rate of return on our combined funds held for clients and corporate investment portfolios is expected to be approximately 1.0% for fiscal 2016. As of May 31, 2015, the long-term investment portfolio had an average yield-to-maturity of 1.6% and an average duration of 3.2 years.

Purchases of property and equipment for fiscal 2016 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 2016 depreciation expense is projected to be in the range of $95 million to $105 million, and we project amortization of intangible assets for fiscal 2016 to be in the range of $10 million to $15 million.

Results of Operations

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

In millions, except per share amounts		2015				Change			2014				Change			2013
Revenue:
Payroll service revenue		$	1,656.8			4	%		$	1,599.3			4	%		$	1,539.2
HRS revenue		1,040.7				18	%		878.9				18	%		746.0
Total service revenue		2,697.5				9	%		2,478.2				8	%		2,285.2
Interest on funds held for clients		42.1				3	%		40.7				(1	)%		41.0
Total revenue		2,739.6				9	%		2,518.9				8	%		2,326.2
Combined operating and SG&A expenses		1,686.0				10	%		1,536.2				8	%		1,421.4
Operating income		1,053.6				7	%		982.7				9	%		904.8
Investment income, net		6.4				17	%		5.4				(18	)%		6.6
Income before income taxes		1,060.0				7	%		988.1				8	%		911.4
Income taxes		385.1				7	%		360.6				5	%		342.4
Effective income tax rate		36.3		%					36.5		%					37.6		%
Net income		674.9				8	%		$	627.5			10	%		$	569.0
Diluted earnings per share		$	1.85			8	%		$	1.71			10	%		$	1.56

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, 2015, we had no exposure to high-risk or illiquid investments and had insignificant exposure to European investments. Details regarding our combined funds held for clients and corporate investment portfolios are as follows:

		Year ended May 31,
$ in millions		2015				2014				2013
Average investment balances:
Funds held for clients		$	4,080.0			$	3,968.7			$	3,811.9
Corporate investments		1,011.5				973.8				834.7
Total		$	5,091.5			$	4,942.5			$	4,646.6
Average interest rates earned (exclusive of net realized gains):
Funds held for clients		1.0		%		1.0		%		1.1		%
Corporate investments		0.7		%		0.7		%		0.8		%
Combined funds held for clients and corporate investments		1.0		%		1.0		%		1.0		%
Total net realized gains		$	0.3			$	0.6			$	0.9

$ in millions As of May 31,		2015				2014				2013
Net unrealized gains on available-for-sale securities(1)		$	13.6			$	34.5			$	34.7
Federal Funds rate(2)		0.25		%		0.25		%		0.25		%
Total fair value of available-for-sale securities		$	3,595.6			$	3,391.4			$	3,691.4
Weighted-average duration of available-for-sale securities in years(3)		3.2				3.0				3.1
Weighted-average yield-to-maturity of available-for-sale securities(3)		1.6		%		1.6		%		1.8		%

(1)	The net unrealized gain on our investment portfolios was approximately $20.9 million as of July 16, 2015.

(2)	The Federal Funds rate was a range of zero to 0.25% as of May 31, 2015, 2014, and 2013.

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

Payroll service revenue: Payroll service revenue was $1.7 billion for fiscal 2015 and $1.6 billion for fiscal 2014, reflecting growth of 4% compared to each of the respective prior fiscal year periods. Both fiscal 2015 and fiscal 2014 benefited from increases in revenue per check and clients. In addition, fiscal 2014 revenue benefited from an increase in checks per payroll. Growth in checks per payroll was flat for fiscal 2015. Revenue per check was positively impacted by price increases and increased product penetration, partially offset by discounting during the fiscal year.

For fiscal 2015 and fiscal 2014, our total payroll client base growth was approximately 2%. Client retention reached record levels for both years and was in excess of 82% of the beginning of the year client base for fiscal 2015 and was approximately 82% of the beginning of the year client base for fiscal 2014.

Human Resource Services revenue: HRS revenue was $1.0 billion for fiscal 2015 and $878.9 million for fiscal 2014, reflecting growth of 18% compared to each of the respective prior fiscal year periods. This growth was positively impacted by the minimum premium plan health insurance offering for our PEO clients and their employees, which was introduced in the second half of fiscal 2014. This product offering contributed six percentage points of the fiscal 2015 growth in HRS revenue compared to three percentage points for fiscal 2014.

For both fiscal 2015 and fiscal 2014, the growth in HRS revenue was attributable to client base growth, as reflected in the table below. The most significant of these contributors are as follows:

•

Paychex HR Services revenue, our largest HRS revenue stream at slightly less than one-half of HRS revenue for fiscal 2015, was positively impacted by an 11% growth in clients and a 12% growth in client worksite employees. For fiscal 2014, Paychex HR Services revenue benefited from a 13% increase in clients and a 14% increase in client worksite employees. During both fiscal 2015 and fiscal 2014, the PEO experienced strong demand contributing to the increase in the growth rate for Paychex HR Services revenue.

•

Retirement services revenue is our second largest HRS revenue stream. Retirement services revenue for fiscal 2015 benefited from pricing, along with a 6% growth in the number of plans served and 7% growth in the average asset value of retirement services participants' funds. Retirement services revenue for fiscal 2014 reflected a 5% increase in the number of plans served, price increases, and a 13% increase in the asset value of retirement services participant's funds. The asset fee revenue earned on the value of participants' funds for fiscal 2014 was partially offset by the impact from a shift in the mix of assets within these funds to investments that earn lower fees from external managers.

•

Insurance services revenue growth for both fiscal 2015 and fiscal 2014 reflected increases in premiums and clients for workers' compensation insurance services and in the number of health and benefits applicants. In fiscal 2015, insurance services revenue benefited from the introduction of our full service product aimed at assisting clients with health care reform requirements, which has gained market acceptance.

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

HRS product key statistics are as follows:

$ in billions As of May 31,		2015				Change			2014				Change			2013
Paychex HR Services client worksite employees		858,000				12	%		766,000				14	%		672,000
Paychex HR Services clients		31,000				11	%		28,000				13	%		25,000
Health and benefits services applicants		142,000				6	%		134,000				3	%		131,000
Retirement services plans		70,000				6	%		66,000				5	%		62,000
Asset value of retirement services participants’ funds		$	23.5			7	%		$	21.9			13	%		$	19.3

Total service revenue: Total service revenue increased 9% for fiscal 2015 and 8% for fiscal 2014, attributable to the factors previously discussed.

Interest on funds held for clients: Interest on funds held for clients increased 3% for fiscal 2015 after decreasing 1% for fiscal 2014. For fiscal 2015, the increase was primarily due to an increase in average investment balances, while average interest rates earned were flat. For fiscal 2014, the decline was the result of lower average interest rates earned, partially offset by an increase in average investment balances. The lower average interest rates earned in fiscal 2014 were the result of lower yields on high quality financial instruments.

Average investment balances for funds held for clients increased 3% for fiscal 2015 and 4% for fiscal 2014. The increase in average investment balances for fiscal 2015 was mainly driven by increases in client base and wage inflation. The increase for fiscal 2014 was largely due to the expiration of certain payroll tax cuts on December 31, 2012, which resulted in higher employee social security withholdings, along with increases in checks per payroll and 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.

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

In millions		2015				Change			2014				Change			2013
Compensation-related expenses		$	1,096.8			9	%		$	1,003.9			5	%		$	955.8
Depreciation and amortization		106.6				2	%		105.0				7	%		98.2
Other expenses		482.6				13	%		427.3				16	%		367.4
Total expenses		$	1,686.0			10	%		$	1,536.2			8	%		$	1,421.4

Total expenses increased 10% for fiscal 2015 and 8% for fiscal 2014. Both fiscal 2015 and fiscal 2014 were impacted by costs relating to the new minimum premium plan health insurance offering within our PEO, which contributed three percentage points of the increase in total expenses for fiscal 2015 and two percentage points for fiscal 2014.

The increases in total expenses were driven largely by growth in compensation-related expenses. 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. For fiscal 2014, compensation-related expenses increased due to higher wages and performance-based compensation costs. The increase in wages was largely related to investments in product development and supporting technology, as well as sales force investment initiatives that began in fiscal 2013. As of May 31, 2015, we had approximately 13,000 employees, compared with 12,700 employees as of May 31, 2014.

Depreciation expense is primarily related to buildings, furniture and fixtures, data processing equipment, and software. Increases in depreciation expense were due to capital expenditures as we invested in technology and continued to grow our business. The higher growth rate for fiscal 2014 was related to additional internally developed software related to our leading-edge, cloud-based platform that was placed in service during the year. Amortization of intangible assets is primarily related to client list acquisitions, which are amortized using either straight-line or accelerated methods.

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 costs relating to the new minimum premium plan health care offering in the PEO. In addition, continued investment in product development and supporting technology impacted other expense growth for both fiscal 2015 and fiscal 2014.

Operating income: Operating income increased 7% for fiscal 2015 and 9% for fiscal 2014. 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		2015				Change			2014				Change			2013
Operating income		$	1,053.6			7	%		$	982.7			9	%		$	904.8
Excluding: Interest on funds held for clients		(42.1		)		3	%		(40.7		)		(1	)%		(41.0		)
Operating income, net of certain items (1)		$	1,011.5			7	%		$	942.0			9	%		$	863.8

(1) Operating income, net of certain items is a non-GAAP measure. Refer to further discussion under "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 2015, 2014, and 2013. Operating income, net of certain items, for fiscal 2015 and fiscal 2014 was impacted by the growth in the minimum premium plan within the PEO. This product offering is a lower-margin product.

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.

Investment income, net: Investment income, net, primarily represents earnings from our cash and cash equivalents and investments in available-for-sale securities. Investment income does not include interest on funds held for clients, which is included in total revenue. Investment income, net, increased 17% for fiscal 2015 as the result of an increase in average investment balances, while interest rates earned remained relatively flat. Investment income decreased 18% for fiscal 2014 as a result of lower average interest rates earned on investments, partially offset by an increase in average investment balances. Average investment balances increased 4% for fiscal 2015 and 17% for fiscal 2014. The increases were the result of investment of cash generated from operations. The lower rate of growth in average investment balances for fiscal 2015 is the result of cash outflows for stock repurchases in fiscal 2015 and the later half of fiscal 2014.

Income taxes: Our effective income tax rate was 36.3% for fiscal 2015 compared to 36.5% for fiscal 2014 and 37.6% for fiscal 2013. The higher effective tax rate for fiscal 2013 was the result of the settlement of a state income tax matter. Refer to Note I 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 8% to $674.9 million for fiscal 2015 and 10% to $627.5 million for fiscal 2014. Diluted earnings per share increased 8% to $1.85 per share for fiscal 2015 and 10% to $1.71 per share for fiscal 2014. These fluctuations were attributable to the factors previously discussed. The growth rates for fiscal 2014 were impacted by the settlement of a state income tax matter, which reduced diluted earnings per share by approximately $0.04 per share for fiscal 2013.

Liquidity and Capital Resources

Our financial position as of May 31, 2015 remained strong with cash and total corporate investments of $936.4 million and no debt. We believe that our investments as of May 31, 2015 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, 2015, 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, 2015, 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 28, 2016
Bank of America, N.A.	$250 million	February 28, 2016
PNC Bank, National Association	$150 million	February 28, 2016
Wells Fargo Bank, National Association	$150 million	February 28, 2016

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 2015 or as of May 31, 2015.

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

Credit facility: In June 2013, we entered into a committed, unsecured, five-year syndicated credit facility, expiring on June 21, 2018. Under the credit facility, Paychex of New York LLP (the “Borrower”) may, subject to certain restrictions, borrow up to $750 million to meet short-term funding requirements. In July 2014, supplemental agreements were executed increasing the maximum borrowing capacity under the facility from $500 million to $750 million. The obligations under this facility have been guaranteed by us and certain of our 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 June 2018, any borrowings outstanding will mature and be payable on such date.

There were no amounts outstanding under this credit facility as of May 31, 2015. During fiscal 2015, we borrowed against this facility, for one day each, as follows:

$ in millions Fiscal quarter		Amount borrowed				Interest rate
First quarter		$	100.0			3.25	%
Second quarter		$	150.0			3.25	%
Third quarter		$	—			—
Fourth quarter		$	—			—

Certain lenders under this credit facility, and their respective affiliates, have performed, and may in the future perform for us and our subsidiaries, 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.

Letters of credit: As of May 31, 2015, 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 2015 and April 2016, and are collateralized by securities held in our investment portfolios. No amounts were outstanding on these letters of credit during fiscal 2015 or as of May 31, 2015. Subsequent to May 31, 2015, the letter of credit expiring in July 2015 was renewed through July 2016.

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, 2015. The table below summarizes our estimated annual payment obligations under these commitments as of May 31, 2015:

		Payments due by period
In millions		Total				Less than 1 year				1-3 years				4-5 years				More than 5 years
Operating leases(1)		$	127.7			$	37.5			$	54.3			$	27.4			$	8.5
Purchase obligations(2)		104.8				71.2				31.2				2.2				0.2
Total		$	232.5			$	108.7			$	85.5			$	29.6			$	8.7

(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 $9.5 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.

The liability for uncertain tax positions, including interest and net of federal benefits, was approximately $29.1 million as of May 31, 2015. Refer to Note I 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 $62.4 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 2015, 2014, and 2013 was $15.1 million, $14.4 million, and $12.6 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, 2015.

Operating Cash Flow Activities

		Year ended May 31,
In millions		2015				2014				2013
Net income		$	674.9			$	627.5			$	569.0
Non-cash adjustments to net income		211.4				198.6				183.3
Cash provided by/(used in) changes in operating assets and liabilities		8.9				54.8				(77.0		)
Net cash provided by operating activities		$	895.2			$	880.9			$	675.3

The increase in our operating cash flows for fiscal 2015 compared to fiscal 2014 is primarily the result of higher net income, adjusted for non-cash items, partially offset by the impact of fluctuations in our operating assets and liabilities. The increase in our operating cash flows for fiscal 2014 compared to fiscal 2013 was primarily the result of higher net income, adjusted for non-cash items, along with the positive impact from fluctuations in operating assets and liabilities. Non-cash adjustments to net income increased for both fiscal 2015 and fiscal 2014, compared to the respective prior year periods, 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 periods were primarily related to the timing of collections from clients and payments for compensation, PEO payroll, income tax, and other liabilities. Income taxes contributed significantly to the fluctuations as a result of a higher prepaid income tax position as of May 31, 2013 that arose from the federal benefit on the settlement of a state tax matter during fiscal 2013.

Investing Cash Flow Activities

		Year ended May 31,
In millions		2015				2014				2013
Net change in funds held for clients and corporate investment activities		$	(151.8	)		$	(211.4	)		$	306.8
Purchases of property and equipment		(102.8		)		(84.1		)		(98.7		)
Acquisition of businesses, net of cash acquired		(27.1		)		(9.3		)		(21.3		)
Purchases of other assets		(3.3		)		(11.3		)		(5.1		)
Net cash (used in)/provided by investing activities		$	(285.0	)		$	(316.1	)		$	181.7

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 E 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 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. For fiscal 2014 compared to fiscal 2013, there was a significant timing impact. There was a large cash outflow on Friday, May 31, 2013 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 2013. See further discussion of this timing in the financing cash flows discussion of net change in client fund obligations. Our net cash inflow from funds held for clients and corporate investment activities for fiscal 2013 was partially offset by higher purchases than sales of VRDN securities during the year.

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 2015, 2014, and 2013, we purchased approximately $6.9 million, $4.7 million, and $6.5 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 years 2015, 2014, and 2013, we paid, net of cash acquired, $27.1 million, $9.3 million, and $21.3 million, respectively, for immaterial business acquisitions.

Financing Cash Flow Activities

		Year ended May 31,
In millions, except per share amounts		2015				2014				2013
Net change in client fund obligations		$	93.0			$	127.4			$	(454.6	)
Dividends paid		(551.8		)		(510.6		)		(476.7		)
Repurchases of common shares		(182.4		)		(249.7		)		—
Equity activity related to stock-based awards		48.5				113.3				72.8
Net cash used in financing activities		$	(592.7	)		$	(519.6	)		$	(858.5	)
Cash dividends per common share		$	1.52			$	1.40			$	1.31

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.

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. May 31, 2015 fell on a Sunday, May 31, 2014 fell on a Saturday, and May 31, 2013 fell on a Friday. 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.

Timing did have an impact for fiscal 2013, resulting in a net cash outflow position. May 31, 2012 was a Thursday, a large cash collection day for direct deposit funds, so we had higher client funds on hand at that date. As May 31, 2013 was a Friday and a cash outflow day for direct deposit, client funds on hand were lower. As a result, there was a net cash outflow over the period in fiscal 2013.

Dividends paid: In July 2014, the Board increased our quarterly dividend to stockholders by 9% to $0.38 per share from $0.35 per share. In July 2013, the Board increased our quarterly dividend to stockholders by 6% to $0.35 per share from $0.33 per share. The dividends paid as a percentage of net income totaled 82%, 81%, and 84% for fiscal years 2015, 2014, and 2013, 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. During fiscal 2015, we repurchased 3.9 million shares for a total of $182.4 million. In fiscal 2014, we repurchased 6.2 million shares for a total of $249.7 million under a previously authorized program to purchase up to $350 million of Paychex common stock, with authorization for that program expiring in May 2014.

Equity activity related to stock-based awards: The decrease in activity related to stock-based awards for fiscal 2015 compared to fiscal 2014 was largely driven by a decrease in proceeds from the exercise of stock options. The increase in activity for stock-based awards for fiscal 2014 compared to fiscal 2013 was driven by an increase in proceeds from the exercise of stock options. Common shares acquired through the exercise of stock options were 1.6 million shares, 3.4 million shares, and 2.4 million shares for fiscal years 2015, 2014, and 2013, respectively. Refer to Note D of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, for additional disclosures on our stock-based compensation plans.

Other

Recently adopted accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, for a discussion of recently adopted accounting pronouncements.

Recently issued accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, for a discussion of recently issued accounting pronouncements.

Critical Accounting Policies

Note A of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, discusses the significant accounting policies of Paychex. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenue, and expenses. On an ongoing basis, we evaluate the accounting policies and estimates used to prepare the consolidated financial statements. We base our estimates on historical experience, future expectations, and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates. Certain accounting policies that are deemed critical to our results of operations or financial position are discussed below.

Revenue recognition: Service revenue is recognized in the period services are rendered and earned under service arrangements with clients where service fees are fixed or determinable and collectability is reasonably assured. Certain processing services are provided under annual service arrangements with revenue recognized ratably over the service period. Our service revenue is largely attributable to processing services where the fee is based on a fixed amount per processing period or a fixed amount per processing period plus a fee per employee or transaction processed. The revenue earned from delivery service for the distribution of certain client payroll checks and reports is included in service revenue, and the costs for delivery are included in operating expenses on the Consolidated Statements of Income and Comprehensive Income.

For certain of our service offerings, we receive advance payments for set-up fees from our clients. We defer revenue associated with these advance payments and the related costs, recognizing the revenue and related expenses over the expected life of clients.

PEO revenue is included in service revenue and is reported net of certain direct pass-through costs billed and incurred, which include wages, taxes, and certain benefit premiums. In fiscal 2014, with the addition of a new health care offering within the PEO, direct costs related to certain benefit plans where the Company retains risk were classified as operating expenses rather than as a reduction in service revenue.

Interest on funds held for clients is earned primarily on funds that are collected from clients before due dates for payroll tax administration services and for employee payment services, and invested until remittance to the applicable tax or regulatory agencies or client employees. These collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days. The interest earned on these funds is included in total revenue on the Consolidated Statements of Income and Comprehensive Income because the collecting, holding, and remitting of these funds are critical components of providing these services. Interest on funds held for clients also includes net realized gains and losses from the sales of available-for-sale securities.

PEO insurance reserves: As part of the PEO service, we offer workers’ compensation insurance and health insurance to client companies for the benefit of client employees. Workers' compensation insurance is provided under a fully insured high deductible workers’ compensation policy with a national insurance carrier. Workers’ compensation insurance reserves are established to provide for the estimated costs of paying claims up to per occurrence liability limits. In establishing the workers' compensation insurance reserves, we use an independent actuarial estimate of undiscounted future cash payments that would be made to settle the claims.

Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss experience and actuarial loss projections, and is subject to change due to multiple factors, including economic trends, changes in legal liability law, and damage awards, all of which could materially impact the reserves as reported in the consolidated financial statements. Accordingly, workers' compensation final claim settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.

With respect to our PEO health insurance, we offer various health insurance plans that take the form of either fully insured fixed cost plans with various national insurance carriers or a fully insured minimum premium insurance arrangement with coverage provided through a single national carrier. Under the minimum premium arrangement, our health benefits insurance reserves are established to provide for the payment of claims liability charges in accordance with our service contract with the carrier. The claims liability charges include estimates for reported losses, plus amounts for those claims incurred but not reported, and estimates of certain expenses associated with processing and settling the claims.

We regularly review the adequacy of our estimated insurance reserves. Adjustments to previously established reserves are reflected in the results of operations for the period in which the adjustment is identified. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.

Goodwill and other intangible assets: Goodwill is not amortized, but instead is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change in a way to indicate that there has been a potential decline in the fair value of a reporting unit. We have the option to perform a qualitative assessment to determine if it is more-likely-than-not that the fair value of a reporting unit has declined below its carrying value. This assessment considers various financial, macroeconomic, industry, and reporting unit specific qualitative factors. Our business is largely homogeneous and, as a result, goodwill is associated with one reporting unit. We perform our annual impairment testing in our fiscal fourth quarter. Based on the results of our reviews, no impairment loss was recognized in the results of operations for fiscal years 2015, 2014, or 2013. Subsequent to this review, there have been no events or circumstances that indicate any potential impairment of our goodwill balance.

We also test intangible assets for potential impairment when events or changes in circumstances indicate that the carrying value may not be recoverable.

Stock-based compensation costs: All stock-based awards to employees, including grants of stock options, are recognized as compensation costs in our consolidated financial statements based on their fair values measured as of the date of grant. We estimate the fair value of stock option grants using a Black-Scholes option pricing model. This model requires various assumptions as inputs including expected volatility of the Paychex stock price and expected option life. We estimate volatility based on a combination of historical volatility using stock prices over a period equal to the expected option life and implied market volatility. Expected option life is estimated based on historical exercise behavior. We periodically reassess our assumptions as well as our choice of valuation model, and will reconsider use of this model if additional information becomes available in the future indicating that another model would provide a more accurate estimate of fair value, or if characteristics of future grants would warrant such a change.

We are required to estimate forfeitures and only record compensation costs for those awards that are expected to vest. Our assumptions for forfeitures were determined based on type of award and historical experience. Forfeiture assumptions are adjusted at the point in time a significant change is identified, with any adjustment recorded in the period of change, and the final adjustment at the end of the requisite service period to equal actual forfeitures.

The assumptions of volatility, expected option life, and forfeitures all require significant judgment and are subject to change in the future due to factors such as employee exercise behavior, stock price trends, and changes to type or provisions of stock-based awards. Any change in one or more of these assumptions could have a material impact on the estimated fair value of a future award.

Refer to Note D of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, for further discussion of our stock-based compensation plans.

Income taxes: We account for deferred taxes by recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record a deferred tax asset related to the stock-based compensation costs recognized for certain stock-based awards. At the time of non-qualified stock options are exercised or stock awards vest, we account for the resulting tax deduction by reducing our accrued income tax liability with an offset to the deferred tax asset and any excess of the tax benefit over the deferred tax asset as an increase to additional paid-in capital. We currently have a sufficient pool of excess tax benefits in additional paid-in capital to absorb any deficiency in tax benefits that fall short of the related deferred tax asset related to stock-based awards.

We maintain a reserve for uncertain tax positions. We evaluate tax positions taken or expected to be taken in a tax return for recognition in our consolidated financial statements. Prior to recording the related tax benefit in our consolidated financial statements, we must conclude that tax positions will be more-likely-than-not to be sustained, assuming those positions will be examined by taxing authorities with full knowledge of all relevant information. The benefit recognized in our consolidated financial statements is the amount we expect to realize after examination by taxing authorities. If a tax position drops below the more-likely-than-not standard, the benefit can no longer be recognized. Assumptions, judgment, and the use of estimates are required in determining if the more-likely-than-not standard has been met when developing the provision for income taxes and in determining the expected benefit. A change in the assessment of the more-likely-than-not standard could materially impact our results of operations or financial position. Refer to Note I of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K, for further discussion of our reserve for uncertain tax positions.