Item 8. Financial Statements and Supplementary Data

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Item 8. Financial Statements and Supplementary Data

TABLE OF CONTENTS


Description	Page
Report on Management’s Assessment of Internal Control Over Financial Reporting	33
Report of Independent Registered Public Accounting Firm	34
Consolidated Statements of Income and Comprehensive Income for the Years Ended May 31, 2018, 2017, and 2016	36
Consolidated Balance Sheets as of May 31, 2018 and 2017	37
Consolidated Statements of Stockholders’ Equity for the Years Ended May 31, 2018, 2017, and 2016	38
Consolidated Statements of Cash Flows for the Years Ended May 31, 2018, 2017 and 2016	39
Notes to Consolidated Financial Statements	40
Schedule II — Valuation and Qualifying Accounts for the Years Ended May 31, 2018, 2017, and 2016	67

REPORT ON MANAGEMENT’S ASSESSMENT OF

INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Paychex, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of May 31, 2018. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control — Integrated Framework” (2013). Based on our assessment, management determined that the Company maintained effective internal control over financial reporting as of May 31, 2018.

The Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, is appointed by the Company’s Audit Committee. PricewaterhouseCoopers LLP has audited the Consolidated Financial Statements included in this Annual Report on Form 10-K and the effectiveness of the Company's internal control over financial reporting as of May 31, 2018, and as a part of their integrated audit, has issued their report, included herein, on the effectiveness of the Company’s internal control over financial reporting.


/s/ Martin Mucci Martin Mucci President and Chief Executive Officer		/s/ Efrain Rivera Efrain Rivera Senior Vice President, Chief Financial Officer, and Treasurer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Paychex, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Paychex, Inc. and its subsidiaries as of May 31, 2018 and 2017, and the related consolidated statements of income and comprehensive income, of stockholders’ equity, and of cash flows for each of the three years in the period ended May 31, 2018, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of May 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of May 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of May 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report on Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

/s/ PricewaterhouseCoopers LLP

Rochester, New York

July 20, 2018

We have served as the Company’s auditor since 2013.

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

In millions, except per share amounts



Year ended May 31,		2018		2017		2016
Revenue:
Service revenue	$	3,317.4	$	3,100.7	$	2,905.8
Interest on funds held for clients		63.5		50.6		46.1
Total revenue		3,380.9		3,151.3		2,951.9
Expenses:
Operating expenses		1,017.8		919.6		857.1
Selling, general and administrative expenses		1,075.6		992.1		948.2
Total expenses		2,093.4		1,911.7		1,805.3
Operating income		1,287.5		1,239.6		1,146.6
Investment income, net		8.6		5.2		4.5
Income before income taxes		1,296.1		1,244.8		1,151.1
Income taxes		362.4		427.5		394.3
Net income	$	933.7	$	817.3	$	756.8

Other comprehensive (loss)/income, net of tax		(56.2)		(9.2)		21.7
Comprehensive income	$	877.5	$	808.1	$	778.5

Basic earnings per share	$	2.60	$	2.27	$	2.10
Diluted earnings per share	$	2.58	$	2.25	$	2.09
Weighted-average common shares outstanding		359.0		359.8		360.7
Weighted-average common shares outstanding, assuming dilution		361.5		362.6		362.5
Cash dividends per common share	$	2.06	$	1.84	$	1.68

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED BALANCE SHEETS

In millions, except per share amount



As of May 31,	2018		2017
Assets
Cash and cash equivalents	$	358.2	$	184.6
Corporate investments		66.0		138.8
Interest receivable		32.2		35.9
Accounts receivable, net of allowance for doubtful accounts		531.4		507.5
Prepaid income taxes		17.0		45.0
Prepaid expenses and other current assets		75.8		58.3
Current assets before funds held for clients		1,080.6		970.1
Funds held for clients		4,703.8		4,301.9
Total current assets		5,784.4		5,272.0
Long-term corporate investments		295.5		454.0
Property and equipment, net of accumulated depreciation		393.5		337.2
Intangible assets, net of accumulated amortization		141.4		57.6
Goodwill		814.0		657.1
Prepaid income taxes		—		24.9
Other long-term assets		34.9		30.9
Total assets	$	7,463.7	$	6,833.7
Liabilities
Accounts payable	$	74.5	$	57.2
Accrued compensation and related items		320.6		280.5
Deferred revenue		24.3		22.9
Other current liabilities		132.9		91.9
Current liabilities before client fund obligations		552.3		452.5
Client fund obligations		4,734.9		4,272.6
Total current liabilities		5,287.2		4,725.1
Accrued income taxes		18.4		45.6
Deferred income taxes		48.8		33.9
Other long-term liabilities		84.8		73.8
Total liabilities		5,439.2		4,878.4
Commitments and contingencies — Note P
Stockholders’ equity
Common stock, $0.01 par value; Authorized: 600.0 shares; Issued and outstanding: 359.0 shares as of May 31, 2018 and 359.4 shares as of May 31, 2017, respectively.		3.6		3.6
Additional paid-in capital		1,126.8		1,030.0
Retained earnings		930.3		901.7
Accumulated other comprehensive (loss)/income		(36.2)		20.0
Total stockholders’ equity		2,024.5		1,955.3
Total liabilities and stockholders’ equity	$	7,463.7	$	6,833.7

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

In millions



								Accumulated
				Additional				other
	Common stock			paid-in		Retained		comprehensive
	Shares	Amount		capital		earnings		(loss) / income		Total
Balance as of May 31, 2015	361.2	$	3.6	$	880.1	$	894.3	$	7.5	$	1,785.5
Net income							756.8				756.8
Unrealized gains on securities, net of tax									21.7		21.7
Cash dividends declared							(606.5)				(606.5)
Repurchases of common shares	(2.2)				(4.1)		(103.8)				(107.9)
Stock-based compensation					34.6						34.6
Activity related to equity-based plans	1.4				42.1		(14.6)				27.5
Balance as of May 31, 2016	360.4		3.6		952.7		926.2		29.2		1,911.7
Net income							817.3				817.3
Unrealized losses on securities, net of tax									(9.2)		(9.2)
Cash dividends declared							(662.3)				(662.3)
Repurchases of common shares	(2.9)				(5.4)		(160.8)				(166.2)
Stock-based compensation					35.4						35.4
Activity related to equity-based plans	1.9				47.3		(18.7)				28.6
Balance as of May 31, 2017	359.4		3.6		1,030.0		901.7		20.0		1,955.3
Net income							933.7				933.7
Unrealized losses on securities, net of tax									(47.6)		(47.6)
Cash dividends declared							(739.7)				(739.7)
Repurchases of common shares	(2.5)				(4.5)		(138.6)				(143.1)
Acquisition of businesses	0.6				33.2						33.2
Stock-based compensation					44.6						44.6
Foreign currency translation adjustment									(8.6)		(8.6)
Activity related to equity-based plans	1.5				23.5		(26.8)				(3.3)
Balance as of May 31, 2018	359.0	$	3.6	$	1,126.8	$	930.3	$	(36.2)	$	2,024.5

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

In millions



Year ended May 31,	2018		2017		2016
Operating activities
Net income	$	933.7	$	817.3	$	756.8
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization on property and equipment and intangible assets		138.0		126.9		115.1
Amortization of premiums and discounts on available-for-sale securities, net		65.4		72.5		75.7
Stock-based compensation costs		44.6		35.4		34.6
Provision for deferred income taxes		19.2		17.4		7.1
Provision for allowance for doubtful accounts		3.6		4.9		2.5
Net realized gains on sales of available-for-sale securities		(0.1)		(0.1)		(0.1)
Changes in operating assets and liabilities:
Interest receivable		3.7		0.2		1.8
Accounts receivable		13.6		(103.7)		(37.5)
Prepaid expenses and other current assets		17.7		(34.1)		(5.0)
Accounts payable and other current liabilities		42.6		39.1		63.3
Net change in other long-term assets and liabilities		(5.6)		(15.4)		3.9
Net cash provided by operating activities		1,276.4		960.4		1,018.2
Investing activities
Purchases of available-for-sale securities		(50,220.2)		(50,462.3)		(12,572.2)
Proceeds from sales and maturities of available-for-sale securities		51,592.9		49,903.0		11,984.3
Net change in funds held for clients’ money market securities and other cash equivalents		(1,677.5)		237.6		927.6
Purchases of property and equipment		(154.0)		(94.3)		(97.7)
Acquisition of businesses, net of cash acquired		(180.4)		—		(296.1)
Purchases of other assets		(39.8)		(8.6)		(9.0)
Net cash used in investing activities		(679.0)		(424.6)		(63.1)
Financing activities
Net change in client fund obligations		462.4		317.3		(304.8)
Dividends paid		(739.7)		(662.3)		(606.5)
Repurchases of common shares		(143.1)		(166.2)		(107.9)
Activity related to equity-based plans		(3.4)		28.5		25.6
Net cash used in financing activities		(423.8)		(482.7)		(993.6)
Increase/(decrease) in cash and cash equivalents		173.6		53.1		(38.5)
Cash and cash equivalents, beginning of fiscal year		184.6		131.5		170.0
Cash and cash equivalents, end of fiscal year	$	358.2	$	184.6	$	131.5

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note A — Description of Business, Basis of Presentation, and Significant Accounting Policies

Description of business: Paychex, Inc. and its wholly owned subsidiaries (collectively, the “Company” or “Paychex”) is 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 in the United States (“U.S.”). The Company also has operations in Europe.

Paychex, a Delaware corporation formed in 1979, reports as one segment. Substantially all of the Company’s revenue is generated within the U.S. The Company also generates revenue within Europe, which represented less than one percent of the Company's total revenue for each of the years ended May 31, 2018 (“fiscal 2018”), 2017 (“fiscal 2017”), and 2016 (“fiscal 2016”). Long-lived assets in Europe were approximately 13% of total long-lived assets of the Company as of May 31, 2018 and were insignificant as of May 31, 2017.

Total revenue is comprised of service revenue and interest on funds held for clients. Service revenue is comprised primarily of the fees earned on our portfolio of HCM services, which include payroll processing and complementary HR management and administration services. Payroll service revenue is earned primarily from payroll processing, payroll tax administration services, employee payment services, and other ancillary services. Payroll processing services include the calculation, preparation, and delivery of employee payroll checks; production of internal accounting records and management reports; preparation of federal, state, and local payroll tax returns; and collection and remittance of clients’ payroll obligations.

Our Human Resource Services (“HRS”) portfolio of services and products provide small- to medium-sized businesses with retirement services administration, insurance services, HR administration services, and other HR services and products. Our comprehensive HR outsourcing service is available through Paychex HR Solutions, an administrative services organization (“ASO”), and Paychex PEO, a professional employer organization (“PEO”). Both options offer businesses a combined package of services that includes payroll, employer compliance, HR and employee benefits administration, risk management outsourcing, and the on-site availability of a professionally trained HR services representative, among other services. These comprehensive bundles of services are designed to make it easier for businesses to manage their payroll and related benefits costs while providing a benefits package equal to that of larger companies. The PEO differs from the ASO in that Paychex serves as a co-employer of the clients’ employees, offers health care coverage to PEO client employees, and assumes the risks and rewards of workers’ compensation insurance and certain health insurance products. PEO services are sold through the Company’s registered and licensed subsidiary, Paychex Business Solutions, LLC. Paychex HR Essentials is an ASO product that provides support to the Company’s clients over the phone or online to help manage employee-related topics.

In connection with the automated payroll tax administration services, the Company electronically collects payroll taxes from clients’ bank accounts, typically on payday, prepares and files the applicable tax returns, and remits 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. The Company handles regulatory correspondence, amendments, and penalty and interest disputes, and is subject to cash penalties imposed by tax or regulatory agencies for late filings and late or under payment of taxes. With employee payment services, employers are offered 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 Paychex. For the first three methods, Paychex electronically collects net payroll from the clients’ bank accounts, typically one business day before payday, and provides payment to the employees on payday. Same Day Automated Clearing House (“ACH”) functionality is also available for clients using direct deposit.

The Company earns fees for funding of temporary staffing agencies’ payroll via purchasing of accounts receivable invoices. The fees are deducted from the funding payment and revenue is recognized over an average collection period of 35 to 45 days.

In addition to service fees paid by clients, the Company earns interest on funds held for clients that are collected before due dates and invested until remittance to the applicable tax or regulatory agencies or client employees. The funds held for clients and related client fund obligations are included in the Consolidated Balance Sheets as current assets and current liabilities, respectively. The amount of funds held for clients and related client fund obligations varies significantly during the year.

Basis of presentation: The consolidated financial statements include the accounts of Paychex, Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Subsequent Events: The Company has evaluated subsequent events for potential recognition and/or disclosure through the date of issuance of these financial statements. On July 12, 2018, Paychex announced that its Board of Directors (the “Board”) declared a regularly quarterly dividend of $0.56 per share payable August 23, 2018 to shareholders of record August 1, 2018.

Cash and cash equivalents: Cash and cash equivalents consist of available cash, money market securities, and other investments with a maturity of 90 days or less at acquisition.

Accounts receivable, net of allowance for doubtful accounts: Accounts receivable balances are shown on the Consolidated Balance Sheets net of the allowance for doubtful accounts. These balances include: 1) PEO receivables primarily related to client wages and related tax withholdings since the last payroll processed, 2) trade receivables for services provided to clients and 3) purchased receivables related to payroll funding arrangements with clients in the temporary staffing industry. The Company maintains an allowance for doubtful accounts to reserve for potentially uncollectible receivables. Accounts receivable are written off and charged against the allowance for doubtful accounts when the Company has exhausted all collection efforts without success. Refer to Note H for further discussion of the Company’s accounts receivable activity and balances.

Funds held for clients and corporate investments: Marketable securities included in funds held for clients and corporate investments consist primarily of securities classified as available-for-sale and are recorded at fair value obtained from an independent pricing service. The funds held for clients portfolio also includes cash and cash equivalents such as money market securities. Unrealized gains and losses, net of applicable income taxes, are reported as other comprehensive income in the Consolidated Statements of Income and Comprehensive Income. Realized gains and losses on the sale of available-for-sale securities are determined by specific identification of the cost basis of each security. On the Consolidated Statements of Income and Comprehensive Income, realized gains and losses from the funds held for client portfolio and corporate investment portfolio are included in interest on funds held for clients and investment income, net, respectively.

Concentrations: Substantially all of the Company’s deposited cash is maintained at large well-capitalized (as defined by their regulators) financial institutions. These deposits may exceed the amount of any insurance provided. All of the Company’s deliverable securities, primarily municipal bond securities, are held in custody with certain of the aforementioned financial institutions, for which that institution bears the risk of custodial loss. Non-deliverable securities are primarily time deposits and money market funds.

Property and equipment, net of accumulated depreciation: Property and equipment is stated at cost, less accumulated depreciation. Depreciation is based on the estimated useful lives of property and equipment using the straight-line method. The estimated useful lives of depreciable assets are generally as follows:



Category		Depreciable life
Buildings and improvements		10 to 35 years or the remaining life, whichever is shorter
Data processing equipment		Three to four years
Furniture, fixtures, and equipment		Three to seven years
Leasehold improvements		10 years or the life of the lease, whichever is shorter

Normal and recurring repairs and maintenance costs are charged to expense as incurred. The Company reviews the carrying value of property and equipment for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Software development and enhancements: Expenditures for software purchases and software developed for internal use are capitalized and depreciated on a straight-line basis over the estimated useful lives, which are generally three to five years. Software developed as part of the Company's main processing platform is depreciated over twelve years. For software developed for internal use, certain costs are capitalized, including external direct costs of materials and services associated with developing or obtaining the software, and payroll and payroll-related costs for employees who are directly associated with internal-use software projects. Capitalization of these costs ceases no later than the point at which the project is substantially complete and ready for its intended use. Costs associated with preliminary project stage activities, training, maintenance, and other post-implementation stage activities are expensed as incurred. The carrying value of software and development costs is reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Goodwill and other intangible assets, net of accumulated amortization: The Company had $814.0 million and $657.1 million of goodwill as of May 31, 2018 and 2017, respectively. 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. The Company performs its annual impairment testing in its fiscal fourth quarter. For fiscal 2018, it was determined that the Company has three reporting units. A qualitative analysis was performed for all reporting units in fiscal 2018, to determine if it is more-likely-than-not that the fair value of the reporting units had declined below its carrying value. The qualitative assessment considered various financial, macroeconomic, industry, and reporting unit specific qualitative factors. During fiscal 2017, a qualitative assessment was performed on the Company’s Paychex Advance LLC (“Paychex Advance”) reporting unit, and for all other reporting units a quantitative analysis was performed. During fiscal 2016, a quantitative analysis was performed for the Company’s European reporting unit, and for all other reporting units a qualitative analysis was performed. Based on the results of the Company’s testing, no impairment loss was recognized in the results of operations for fiscal years 2018, 2017, or 2016. Subsequent to the latest review, there have been no events or circumstances that indicate any potential impairment of the Company’s goodwill balance.

Intangible assets are comprised primarily of client list acquisitions and are reported net of accumulated amortization on the Consolidated Balance Sheets. Intangible assets are amortized over periods generally ranging from three to twelve years. Certain client lists use an accelerated method, while other intangible assets use the straight-line method of amortization. The Company tests intangible assets for potential impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Impairment of Long-Lived Assets: Long-lived assets, including intangible assets with finite lives, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. The Company has determined that there was no impairment of long-lived assets for the fiscal years 2018, 2017, or 2016.

Foreign Currency: The financial statements of the Company’s foreign subsidiaries have been translated into U.S. dollars. Assets and liabilities are translated into U.S. dollars at period-end exchange rates. Income and expenses are translated at the average exchange rate for the reporting period. The resulting non-cash foreign currency translation adjustments, representing unrealized gains or losses, are included in consolidated stockholders’ equity as a component of accumulated other comprehensive (loss)/income. The Company did not have any realized gains and losses resulting from foreign exchange transactions during the fiscal years 2018, 2017, or 2016.

Revenue recognition: Revenues are primarily attributable to fees for providing services as well as investment income earned on funds held for clients. Fees associated with services are 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. The Company’s service revenue is largely attributable to processing services where the fee is based on a fixed amount per processing period or a fixed amount per processing period plus a fee per employee or transaction processed. Fees earned for funding of payrolls for temporary staffing agency clients via the purchase of accounts receivable are based on a percentage of funding amounts as specified in the client contract. These fees are then recognized over the average collection period of 35 to 45 days. 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 the delivery are included in operating expenses on the Consolidated Statements of Income and Comprehensive Income.

For certain of the Company's service offerings, it receives advance payments for set-up fees from its clients. The Company defers revenue associated with these advance payments, recognizing the revenue and related expenses over the expected life of its clients.

PEO revenue is included in service revenue and is reported net of certain direct pass-through costs billed and incurred, which primarily include payroll wages, payroll taxes, and certain benefit premiums. Direct costs related to certain benefit plans where the Company retains risk are recognized as operating expenses rather than as a reduction in service revenue. Direct pass-through costs billed and incurred recognized as a reduction in service revenue were $7.9 billion, $5.9 billion, and $5.1 billion for fiscal years 2018, 2017, and 2016, respectively.

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. The interest earned on these funds is included in total revenue on the Consolidated Statements of Income and Comprehensive Income because the collecting, holding, and remitting of these funds are components of providing these services. 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, the Company offers 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 insurance 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 PEO workers' compensation insurance reserves, the Company uses an independent actuarial estimate of undiscounted future cash payments that would be made to settle the claims.

The Company’s maximum individual claims liability, excluding HR Outsourcing Holdings, Inc. (“HROI”), was $1.3 million under both its fiscal 2018 and 2017 workers' compensation insurance policy. HROI’s maximum individual claims liability was $0.5 million under its fiscal 2018 workers’ compensation insurance policy. As of May 31, 2018 and May 31, 2017, the Company had recorded current liabilities of $19.4 million and $18.0 million, respectively, and long-term liabilities of $31.2 million and $22.3 million, respectively, on its Consolidated Balance Sheets for workers’ compensation insurance costs.

With respect to the PEO health insurance, the Company offers 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 insurance arrangement, the Company's health benefits insurance reserves are established to provide for the payment of claims liability charges in accordance with its 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. The Company's maximum individual claims liability, excluding HROI, was $0.3 million under both its calendar 2018 and 2017 minimum premium insurance plan policies. HROI’s maximum individual claims liability was $0.3 million under its minimum premium insurance plan policies ending June 30, 2018. Amounts accrued related to the health insurance reserves were $25.4 million and $15.7 million as of May 31, 2018 and May 31, 2017, respectively. These amounts are included in current liabilities on the Consolidated Balance Sheets.

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, final claim settlements may vary from the present estimates, particularly with workers' compensation insurance where those payments may not occur until well into the future. The Company regularly reviews the adequacy of its 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 be significant, reflecting any combination of new and adverse or favorable trends.

Stock-based compensation costs: All stock-based awards to employees are recognized as compensation costs in the consolidated financial statements based on their fair values measured as of the date of grant. The Company estimates 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. Volatility is estimated based on a combination of historical volatility, using stock prices over a period equal to the expected option life, and implied market volatility. Expected option life is estimated based on historical exercise behavior. The Company periodically reassesses its assumptions as well as its choice of valuation model. The Company 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.

The fair value of stock awards is determined based on the stock price at the date of grant. For grants that do not accrue dividends or dividend equivalents, the fair value is the stock price reduced by the present value of estimated dividends over the vesting period or performance period.

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

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

Refer to Note E for further discussion of the Company’s stock-based compensation plans.

Income taxes: The Company accounts for deferred taxes by recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities, using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. Refer to Note K for further discussion on deferred taxes and the tax impacts of the Tax Act.

The Company also maintains a reserve for uncertain tax positions. The Company evaluates tax positions taken or expected to be taken in a tax return for recognition in its consolidated financial statements. Prior to recording the related tax benefit in the consolidated financial statements, the Company 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 the consolidated financial statements is the amount the Company expects 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 the Company’s results of operations or financial position. The Company’s reserve for uncertain tax positions, including interest and net of federal benefits, was $14.7 million as of May 31, 2018 and $39.2 million as of May 31, 2017. Refer to Note K for further discussion of the Company’s reserve for uncertain tax positions.

Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenue, and expenses during the reporting period. Actual amounts and results could differ from these estimates.

Recently adopted accounting pronouncements: In March 2018, the Company early-adopted Accounting Standards Update (“ASU”) No. 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting.” ASU No. 2017-09 provides guidance concerning which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The adoption of ASU 2017-09 did not have a material impact on the Company’s consolidated financial statements.

In January 2018, the Company early-adopted ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” ASU No. 2017-01 clarifies the definition of a business to allow for the evaluation of whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The adoption of ASU 2017-01 did not have a material impact on the Company’s consolidated financial statements.

Recently issued accounting pronouncements: In June 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-07, “Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” ASU No 2018-07 expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The guidance also specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. This guidance is applicable to the Company’s fiscal year beginning June 1, 2019. The Company is currently evaluating the potential effects of this guidance on its consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU No. 2018-02 allows entities to reclassify certain stranded income tax effects from accumulated other comprehensive income to retained earnings resulting from the Tax Act, enacted on December 22, 2017. The guidance also requires additional financial statement disclosures to clarify the effects of adoption. ASU No. 2018-02 should be applied either in the period of adoption or retrospectively to each period or periods in which the effect of the change in the U.S. federal corporate income tax rate from the Tax Act was recognized. This guidance is effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years, with early adoption permitted. This guidance is applicable to the Company’s fiscal year beginning June 1, 2019. The Company is currently evaluating the potential effects of this guidance on its consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” The amendments in ASU No. 2017-08 require that the premium on purchased callable debt securities be amortized to the earliest call date. The amendments do not, however, require an accounting change for securities held at a discount; instead, the discount continues to be amortized to maturity. This guidance is effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, and is applicable to the Company’s fiscal year beginning June 1, 2019. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating this guidance but does not anticipate it will have a material impact on its consolidated financial statements.

In February 2017, the FASB issued ASU No. 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.” ASU No. 2017-05 clarifies that a financial asset is within the scope of Subtopic 610-20 if it is deemed an “in substance non-financial asset.” ASU No. 2017-05 is effective at the same time the revenue standard in ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” goes into effect, which is for the Company’s fiscal year beginning June 1, 2018. The Company evaluated this guidance as part of its revenue recognition implementation efforts, and does not anticipate it will have a material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairments.” ASU No. 2017-04 establishes a one-step process for testing goodwill for a decrease in value, requiring a goodwill impairment loss to be measured as the excess of the reporting unit’s carrying amount over its fair value. The guidance eliminates the second step of the current two-step process that requires the impairment to be measured as the difference between the implied value of a reporting unit’s goodwill with the goodwill’s carrying amount. ASU No. 2017-04 is effective for public entities for annual or interim periods in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual impairment tests after January 1, 2017. This guidance is applicable to the Company's fiscal year beginning June 1, 2020, and is not anticipated to have a material impact on the Company’s consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash: A Consensus of the FASB Emerging Issues Task Force.” ASU No. 2016-18 will require a company’s cash flow statement to explain the changes during a reporting period of the totals for cash, cash equivalents, restricted cash, and restricted cash equivalents. Additionally, amounts for restricted cash and restricted cash equivalents are to be included with cash and cash equivalents if the cash flow statement includes a reconciliation of the total cash balances for a reporting period. ASU No. 2016-18 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. This guidance is applicable to the Company's fiscal year beginning June 1, 2018, and is not anticipated to have a material impact on its consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” ASU No. 2016-16 will require that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs instead of when the asset is sold. ASU No. 2016-16 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. This guidance is applicable to the Company's fiscal year beginning June 1, 2018, and is being evaluated to determine the potential impact on its consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” ASU No. 2016-15 clarifies and provides specific guidance on eight cash flow classification issues that are not currently addressed by current GAAP and thereby reduce the current diversity in practice. ASU No. 2016-15 is effective for public companies for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. This guidance is applicable to the Company's fiscal year beginning June 1, 2018, and is not anticipated to have a material impact on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU No. 2016-13 requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU No. 2016-13 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. This guidance is applicable to the Company's fiscal year beginning June 1, 2020. The Company is currently evaluating this guidance to determine the potential impact on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” ASU No. 2016-02 improves transparency and comparability among companies by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU No. 2016-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. This guidance is applicable to the Company's fiscal year beginning June 1, 2019. The Company is in the preliminary stages of gathering data and assessing the impact of the new lease accounting standard and the Company anticipates that the adoption of the new lease accounting standard will result in additional assets and liabilities being recorded on its Consolidated Balance Sheet.

In January 2016, the FASB issued ASU No. 2016-01 “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU No. 2016-01 provides updated guidance for the recognition, measurement, presentation, and disclosure of certain financial assets and liabilities. ASU No. 2016-01 is effective for public business entities for annual and interim periods beginning after December 15, 2017. This guidance is applicable to the Company's fiscal year beginning June 1, 2018, and is not anticipated to have a material impact on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This guidance, as amended by subsequent ASUs on the topic, outlines a single comprehensive model for determining revenue recognition for contracts with customers, and supersedes current guidance on revenue recognition in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition.” ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods.

The Company will adopt and begin reporting under the new standard in its fiscal year beginning June 1, 2018, using the full retrospective method. As of the date of this report, the Company has finalized the analysis of the new standard and its impact to the Company. As anticipated, the primary impact of adopting the new standard is on the way the Company treats certain costs to obtain contracts and costs to fulfill contracts. Generally, in relation to these items, the new standard will result in the Company deferring additional costs than those deferred under current U.S. GAAP on the Consolidated Balance Sheets and subsequently amortizing them to the Consolidated Statements of Income and Comprehensive Income over the estimated average life of the client. As the Company’s revenue grows, the impact of deferring and amortizing additional costs creates higher overall pre-tax income, net earnings, and earnings per share, when compared to current U.S. GAAP. The Company has concluded that the provisions of the new standard will not have a material impact on the timing or the amount of revenue it recognizes on an annual basis in its Consolidated Statements of Income and Comprehensive Income. However, the Company has concluded that the provisions of the new standard will have a material impact on its Consolidated Balance Sheets.

The Company is nearly complete in determining the impacts of the disclosure requirements under the new standard, including the way it will disaggregate revenue into categories that show how economic factors affect the nature, timing, and uncertainty of revenue and cash flows generated from contracts with customers. The Company is in the process of assessing its accounting considerations to ensure its ability to record, report, and analyze results under the new standard.

Other recent authoritative guidance issued by the FASB (including technical corrections to the FASB Accounting Standards Codification), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission (“SEC”) did not, or are not expected to have a material effect on the Company’s consolidated financial statements.

Note B — Basic and Diluted Earnings Per Share

Basic and diluted earnings per share were calculated as follows:



	Year ended May 31,
In millions, except per share amounts	2018		2017		2016
Basic earnings per share:
Net income	$	933.7	$	817.3	$	756.8
Weighted-average common shares outstanding		359.0		359.8		360.7
Basic earnings per share	$	2.60	$	2.27	$	2.10
Diluted earnings per share:
Net income	$	933.7	$	817.3	$	756.8
Weighted-average common shares outstanding		359.0		359.8		360.7
Dilutive effect of common share equivalents		2.5		2.8		1.8
Weighted-average common shares outstanding, assuming dilution		361.5		362.6		362.5
Diluted earnings per share	$	2.58	$	2.25	$	2.09
Weighted-average anti-dilutive common share equivalents		0.7		0.7		0.5

Weighted-average common share equivalents that had an anti-dilutive impact are excluded from the computation of diluted earnings per share.

In July 2016, the Company announced that the Board approved a program to repurchase up to $350.0 million of the Company's common stock, with authorization expiring in May 2019 (the “July 2016 Program”). During fiscal 2018, the Company repurchased 2.5 million shares for $143.1 million under the July 2016 Program. During fiscal 2017, the Company repurchased 2.9 million shares for $166.2 million. Of the shares repurchased during fiscal 2017, $59.7 million were repurchased under a previously authorized common stock repurchase program. The purpose of the program is to manage common stock dilution. All shares repurchased were retired.

Note C — Business Combinations

Effective February 28, 2018, the Company completed its acquisition of Lessor Group (“Lessor”). Upon closing, Lessor became a wholly owned subsidiary of the Company. Lessor is a market-leading provider of payroll and HCM software solutions headquartered in Denmark and serving clients in Northern Europe. The Company believes that the acquisition will provide additional opportunities for growth in Europe. The purchase price was $162.5 million, net of $13.4 million in cash acquired. Goodwill in the amount of $111.5 million was recorded as a result of the acquisition, which is not tax-deductible. The purchase accounting is provisional and subject to change, pending completion of a final valuation of Lessor. However, further changes to goodwill resulting from the acquisition are not anticipated to be material to the Company’s Consolidated Balance Sheets.

Effective August 18, 2017, the Company acquired HROI and all of its operating subsidiaries. HROI is a national PEO that provides HR solutions to small- and medium-sized businesses in more than 35 states. The acquisition expands the Company’s presence in the PEO industry. The purchase price was $75.4 million and was comprised of $42.2 million of cash plus $33.2 million issued in the form of Paychex common stock. Goodwill in the amount of $51.1 million was recorded as a result of the acquisition, which is not tax-deductible.

Effective December 22, 2015, substantially all of the net assets of Advance Partners, a leading provider of integrated financial, operational, and strategic services to support independent staffing firms, were acquired by a wholly owned subsidiary of the Company. Advance Partners offers customizable solutions to the temporary staffing industry, including payroll funding and outsourcing services, which include payroll, invoicing, and tax preparation. The acquisition consideration was comprised of a base purchase price of $190.5 million plus immediate settlement of debt totaling $118.4 million, net of $12.8 million in cash acquired. Accounts receivable balances acquired, net of allowance for doubtful accounts, and less amounts due to clients related to funding arrangements, totaled $164.8 million. This acquisition allows the Company access to a growing industry serving small- to medium-sized businesses. Goodwill in the amount of $95.6 million was recorded as a result of the acquisition, which is tax-deductible.

The financial results of Lessor, HROI, and Advance Partners are included in the Company’s consolidated financial statements from the respective dates of acquisition. The Company concluded that these acquisitions were not material to its results of operations and financial position. Therefore, pro-forma financial information has been excluded.

Note D — Investment Income, Net

Investment income, net, consisted of the following items:



	Year ended May 31,
In millions	2018		2017		2016
Interest income on corporate funds	$	11.9	$	9.9	$	8.4
Interest expense		(3.9)		(2.5)		(1.1)
Net gain/(loss) from equity-method investments		0.6		(2.2)		(2.8)
Investment income, net	$	8.6	$	5.2	$	4.5

Note E — Stock-Based Compensation Plans

The Paychex, Inc. 2002 Stock Incentive Plan, as amended and restated effective on October 14, 2015 (the “2002 Plan”), authorizes grants of up to 44.1 million shares of the Company’s common stock. As of May 31, 2018, there were 19.4 million shares available for future grants under the 2002 Plan.

All stock-based awards to employees are recognized as compensation costs in the consolidated financial statements based on their fair values measured as of the date of grant. These costs are recognized as an expense in the Consolidated Statements of Income and Comprehensive Income on a straight-line basis over the requisite service period and an increase in additional paid-in capital.

Stock-based compensation expense was $44.6 million, $35.4 million, and $34.6 million for fiscal years 2018, 2017, and 2016, respectively. Additional stock-based compensation expense was recognized in fiscal 2018 when the Company made a decision to maximize its tax benefit by accelerating the vesting of restricted stock units (“RSUs”) into fiscal 2018 that would have otherwise vested in August 2018. Related income tax benefits recognized were $14.5 million, $13.4 million, and $12.9 million for the respective fiscal years. Capitalized stock-based compensation costs related to the development of internal use software for these same fiscal years were not significant.

As of May 31, 2018, the total unrecognized compensation cost related to all unvested stock-based awards was $66.6 million and is expected to be recognized over a weighted-average period of 2.8 years.

Black-Scholes fair value assumptions: The fair value of stock option grants and performance stock options was estimated at the date of grant using a Black-Scholes option pricing model. The weighted-average assumptions used for valuation under the Black-Scholes option pricing model are as follows:



	Year ended May 31,
		2018			2018			2017			2016
	Performance stock options			Stock options
Risk-free interest rate		2.4	%			2.1	%		1.2	%		1.9	%
Dividend yield		3.3	%			3.4	%		3.6	%		3.6	%
Volatility factor		0.18				0.17			0.18			0.18
Expected option life in years		6.5				6.1			6.1			6.1
Weighted-average grant-date fair value of stock options granted (per share)	$	7.45			$	6.47		$	5.74		$	5.25

Risk-free interest rates are yields for zero coupon U.S. Treasury notes maturing approximately at the end of the expected option life. The estimated volatility factor is based on a combination of historical volatility, using stock prices over a period equal to the expected option life, and implied market volatility. The expected option life is based on historical exercise behavior.

The Company has determined that the Black-Scholes option pricing model, as well as the underlying assumptions used in its application, are appropriate in estimating the fair value of its stock option grants. The Company periodically assesses its assumptions as well as its 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.

Stock options: Stock options entitle the holder to purchase, at the end of the vesting term, a specified number of shares of Paychex common stock at an exercise price per share set equal to the closing market price of the common stock on the date of grant. All stock options have a contractual life of ten years from the date of the grant and a vesting schedule as established by the Board. The Company issues new shares of common stock to satisfy stock option exercises. Non-qualified stock option grants to officers and outside directors are typically approved by the Board in July. Prior to fiscal 2018, grants of non-qualified stock options to officers vested one-quarter per annum. Beginning in fiscal 2018, grants of non-qualified stock options to officers vest one-third per annum. Grants to members of the Board vest after one year.

The following table summarizes stock option activity for fiscal 2018:



				Weighted-
		Weighted-		average
	Shares	average		remaining	Aggregate
	subject	exercise price		contractual	intrinsic
In millions, except per share amounts	to options	per share		term (years)	value(1)
Outstanding as of May 31, 2017	4.2	$	42.02
Granted	0.7	$	57.40
Exercised	(0.4)	$	37.86
Forfeited	(0.1)	$	53.41
Expired	—	$	38.48
Outstanding as of May 31, 2018	4.4	$	44.60	6.1	$	93.0
Exercisable as of May 31, 2018	2.8	$	38.72	4.9	$	76.3

	(1)		Market price of the underlying stock as of May 31, 2018 less the exercise price.

Other information pertaining to stock option grants is as follows:



	Year ended May 31,
In millions	2018		2017		2016
Total intrinsic value of stock options exercised	$	9.1	$	23.8	$	14.5
Total grant-date fair value of stock options vested	$	4.0	$	4.1	$	4.0

Restricted stock units: The Board grants RSUs to non-officer management. An RSU is an agreement to issue shares at the time of vesting with no associated exercise cost for the employee. For each unit granted, the holder will receive one share of stock at the time of vesting. RSUs do not have voting rights or earn dividend equivalents during the vesting period. These awards vest one-fifth per annum over five years. The Company made a decision in fiscal 2018 to accelerate the vesting of the August 2018 tranche into fiscal 2018. The fair value of RSUs is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the vesting period.

The following table summarizes RSU activity for fiscal 2018:



				Weighted-
		Weighted-		average
		average		remaining
		grant-date		vesting	Aggregate
		fair value		period	intrinsic
In millions, except per share amounts	RSUs	per share		(years)	value(1)
Nonvested as of May 31, 2017	1.6	$	43.53
Granted	0.6	$	51.15
Vested	(1.0)	$	42.12
Forfeited	(0.1)	$	46.27
Nonvested as of May 31, 2018	1.1	$	48.79	3.2	$	69.2

	(1)		Intrinsic value for RSUs is based on the market price of the underlying stock as of May 31, 2018.

Other information pertaining to RSUs is as follows:



	Year ended May 31,
In millions, except per share amounts	2018		2017		2016
Weighted-average grant-date fair value per share of RSUs granted	$	51.15	$	53.76	$	42.60
Total intrinsic value of RSUs vested	$	60.9	$	32.3	$	25.9
Total grant-date fair value of RSUs vested	$	42.4	$	19.3	$	17.3

Restricted stock awards: The Board has approved grants of restricted stock awards to the Company’s officers and outside directors. All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. The recipients of the restricted stock have voting rights and earn dividends, which are paid to the recipient at the time the awards vest. If the recipient leaves Paychex prior to the vesting date for any reason, the shares of restricted stock and the dividends accrued on those shares will be forfeited and returned to Paychex.

Time-vested restricted stock awards granted to officers vest one-third per annum. Restricted stock awards granted to outside directors vest on the one-year anniversary of the grant date. The fair value of restricted stock awards is equal to the closing market price of the underlying common stock as of the date of grant and is expensed over the requisite service period on a straight-line basis.

The following table summarizes restricted stock activity for fiscal 2018:



		Weighted-
		average
		grant-date
	Restricted	fair value
In millions, except per share amounts	shares	per share
Nonvested as of May 31, 2017	0.1	$	53.05
Granted	0.1	$	57.50
Vested	(0.1)	$	50.64
Forfeited	—	$	56.53
Nonvested as of May 31, 2018	0.1	$	56.89

Other information pertaining to restricted stock is as follows:



	Year ended May 31,
In millions, except per share amounts	2018		2017		2016
Weighted-average grant-date fair value per share of restricted stock granted	$	57.50	$	60.83	$	47.46
Total grant-date fair value of restricted stock vested	$	3.0	$	3.0	$	3.0

Performance shares: Performance shares primarily have a two-year performance period, after which the amount of restricted shares earned will be determined based on achievement against established performance targets. The restricted shares earned will then be subject to a one-year service period. Performance shares do not have voting rights or earn dividend equivalents during the performance period. The fair value of performance shares is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the performance period.

The following table summarizes performance share activity for fiscal 2018:



		Weighted-
		average
		grant-date
	Performance	fair value
In millions, except per share amounts	shares	per share
Nonvested as of May 31, 2017	0.4	$	45.66
Granted (1)	0.2	$	53.08
Vested	(0.2)	$	38.68
Forfeited	—	$	48.89
Nonvested as of May 31, 2018	0.4	$	51.53

	(1)		Performance shares granted assuming achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

Other information pertaining to performance shares is as follows:



	Year ended May 31,
In millions, except per share amounts	2018		2017		2016
Weighted-average grant-date fair value per share of performance shares granted	$	53.08	$	54.97	$	42.48
Total grant-date fair value of performance shares vested	$	6.6	$	7.8	$	5.9

Long-term Incentive Plan (“LTIP”): The Company has two long-term incentive performance-based stock awards. In July 2011, the Board approved a special award of performance-based non-qualified stock options under an LTIP. Subsequent grants of this award were made upon hire of new officers. Under this award, stock options were granted to officers with vesting dependent on achievement against long-term strategic and financial objectives. Total stock options earned and vested were based on achievement against pre-established targets for fiscal 2016. The performance period was completed in fiscal 2016. Although the performance period was completed and the stock options were earned and vested, there are still stock options outstanding as of May 31, 2018.

In July 2016, the Board approved an LTIP award comprised of both performance-based non-qualified stock options and performance-based restricted stock. This award was granted to senior executives down to the vice president level with vesting dependent on achievement against long-term strategic and financial objectives. Total stock options and restricted shares to be earned are based on achievement against pre-established targets for the fiscal year ending May 31, 2020.

The following table summarizes performance stock option activity for fiscal 2018:



				Weighted-
		Weighted-		average
	Shares	average		remaining	Aggregate
	subject	exercise price		contractual	intrinsic
In millions, except per share amounts	to options	per share		term (years)	value(1)
Outstanding as of May 31, 2017	2.4	$	47.52
Granted(2)	0.1	$	59.93
Exercised	(0.3)	$	30.70
Forfeited	(0.1)	$	60.84
Expired	—	$	—
Outstanding as of May 31, 2018	2.1	$	49.26	6.3	$	34.5
Exercisable as of May 31, 2018	0.8	$	31.99	3.4	$	28.5

	(1)		Market price of the underlying stock as of May 31, 2018 less the exercise price.

	(2)		LTIP performance stock options granted assumes achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

Other information pertaining to performance stock options is as follows:



	Year ended May 31,
In millions	2018		2017		2016
Total intrinsic value of stock options exercised	$	7.9	$	12.4	$	1.0
Total grant-date fair value of stock options vested	$	4.9	$	4.9	$	—

LTIP performance-based restricted stock do not have voting rights or earn dividend equivalents during the performance period. The fair value of these performance-based restricted stock is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the performance period. If the recipient leaves Paychex prior to the vesting date for any reason, the shares of restricted stock will be forfeited and returned to Paychex.

The following table summarizes performance restricted stock activity for fiscal 2018:



		Weighted-
		average
		grant-date
	Restricted	fair value
In millions, except per share amounts	shares	per share
Nonvested as of May 31, 2017	0.2	$	53.74
Granted(1)	—	$	54.77
Vested	—	$	—
Forfeited	—	$	53.61
Nonvested as of May 31, 2018	0.2	$	53.86

	(1)		LTIP performance shares granted assumes achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

Non-compensatory employee benefit plan: Prior to January 1, 2016, the Company offered a non-qualified Employee Stock Purchase Plan (“ESPP”) to all employees under which the Company’s common stock could be purchased through a payroll deduction with no discount to the market price and no look-back provision. This ESPP was discontinued as of December 31, 2015. Effective January 1, 2016, the Company began offering a qualified ESPP to all employees. Under this qualified ESPP, the Company’s common stock can be purchased through a payroll deduction at a discount to the market price. The qualified ESPP allows for a discount of up to 15% based on the sole discretion of the committee established to administer the plan. For offering periods during fiscal 2018, fiscal 2017, and fiscal 2016 the discount was set at 5% of the market price. Transactions under the non-qualified ESPP occurred directly through the Company’s transfer agent and no brokerage fees were charged to employees, except for when stock was sold. Transactions under the qualified ESPP occur through the Company’s third-party stock plan administrator. The plans have been deemed non-compensatory and therefore, no stock-based compensation costs have been recognized for fiscal years 2018, 2017, or 2016 related to either plan.

Note F — Funds Held for Clients and Corporate Investments

Funds held for clients and corporate investments are as follows:



	May 31, 2018
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
In millions	cost		gains		losses		value
Type of issue:
Funds held for clients' money market securities and other cash equivalents	$	1,942.3	$	—	$	—	$	1,942.3
Available-for-sale securities:
Corporate bonds		328.6		0.1		(7.3)		321.4
General obligation municipal bonds		1,231.6		1.3		(11.2)		1,221.7
Pre-refunded municipal bonds(1)		50.9		0.1		(0.1)		50.9
Revenue municipal bonds		813.5		0.9		(8.0)		806.4
U.S. government agency securities		410.2		—		(14.1)		396.1
Variable rate demand notes		308.3		—		—		308.3
Total available-for-sale securities		3,143.1		2.4		(40.7)		3,104.8
Other		16.1		2.1		—		18.2
Total funds held for clients and corporate investments	$	5,101.5	$	4.5	$	(40.7)	$	5,065.3



	May 31, 2017
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
In millions	cost		gains		losses		value
Type of issue:
Funds held for clients' money market securities and other cash equivalents	$	264.8	$	—	$	—	$	264.8
Available-for-sale securities:
Corporate bonds		208.6		2.7		(0.5)		210.8
General obligation municipal bonds		1,422.0		21.2		(0.9)		1,442.3
Pre-refunded municipal bonds(1)		54.6		0.9		—		55.5
Revenue municipal bonds		929.2		12.5		(0.8)		940.9
U.S. government agency securities		328.9		0.5		(3.6)		325.8
Variable rate demand notes		1,637.9		—		—		1,637.9
Total available-for-sale securities		4,581.2		37.8		(5.8)		4,613.2
Other		14.8		1.9		—		16.7
Total funds held for clients and corporate investments	$	4,860.8	$	39.7	$	(5.8)	$	4,894.7

	(1)		Pre-refunded municipal bonds are secured by an escrow fund of U.S. government obligations.

Included in money market securities and other cash equivalents as of May 31, 2018 were bank demand deposit accounts, time deposits, commercial paper, and money market funds. Included in money market securities and other cash equivalents as of May 31, 2017 were bank demand deposit accounts and money market funds.

Classification of investments on the Consolidated Balance Sheets is as follows:



	May 31,
In millions	2018		2017
Funds held for clients	$	4,703.8	$	4,301.9
Corporate investments		66.0		138.8
Long-term corporate investments		295.5		454.0
Total funds held for clients and corporate investments	$	5,065.3	$	4,894.7

The Company’s available-for-sale securities reflected a net unrealized loss of $38.3 million as of May 31, 2018, compared to a net unrealized gain of $32.0 million as of May 31, 2017. Included in the net unrealized loss as of May 31, 2018 were 970 available-for-sale securities in an unrealized loss position. Included in the net unrealized gain as of May 31, 2017 were 216 available-for-sale securities in an unrealized loss position. The available-for-sale securities in an unrealized loss position were as follows:



	May 31, 2018
	Securities in an unrealized loss position for less than twelve months				Securities in an unrealized loss position for more than twelve months				Total
	Gross				Gross				Gross
	unrealized		Fair		unrealized		Fair		unrealized		Fair
In millions	losses		value		losses		value		losses		value
Type of issue:
Corporate bonds	$	(6.0)	$	271.5	$	(1.3)	$	34.6	$	(7.3)	$	306.1
General obligation municipal bonds		(8.7)		856.4		(2.5)		68.9		(11.2)		925.3
Pre-refunded municipal bonds		(0.1)		18.5		—		0.5		(0.1)		19.0
Revenue municipal bonds		(6.3)		540.9		(1.7)		50.9		(8.0)		591.8
U.S. government agency securities		(6.4)		219.7		(7.7)		176.4		(14.1)		396.1
Total	$	(27.5)	$	1,907.0	$	(13.2)	$	331.3	$	(40.7)	$	2,238.3



	May 31, 2017
	Securities in an unrealized loss position for less than twelve months				Securities in an unrealized loss position for more than twelve months				Total
	Gross				Gross				Gross
	unrealized		Fair		unrealized		Fair		unrealized		Fair
In millions	losses		value		losses		value		losses		value
Type of issue:
Corporate bonds	$	(0.5)	$	43.6	$	—	$	—	$	(0.5)	$	43.6
General obligation municipal bonds		(0.9)		188.8		—		—		(0.9)		188.8
Pre-refunded municipal bonds		—		9.2		—		—		—		9.2
Revenue municipal bonds		(0.8)		154.8		—		1.0		(0.8)		155.8
U.S. government agency securities		(3.6)		210.0		—		—		(3.6)		210.0
Total	$	(5.8)	$	606.4	$	—	$	1.0	$	(5.8)	$	607.4

The Company regularly reviews its investment portfolios to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the investments held as of May 31, 2018 that had gross unrealized losses of $40.7 million were not other-than-temporarily impaired. The Company believes that it is probable that the principal and interest will be collected in accordance with contractual terms, and that the unrealized losses on these securities were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. A majority of the securities in an unrealized loss position as of May 31, 2018 and May 31, 2017 held an AA rating or better. The Company does not intend to sell these investments until the recovery of their amortized cost basis or maturity, and further believes that it is not more-likely-than-not that it will be required to sell these investments prior to that time. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.

Realized gains and losses from the sale of available-for-sale securities were as follows:



	Year ended May 31,
In millions	2018		2017		2016
Gross realized gains	$	0.3	$	0.1	$	0.1
Gross realized losses		(0.2)		—		—
Net realized gains	$	0.1	$	0.1	$	0.1

The amortized cost and fair value of available-for-sale securities that had stated maturities as of May 31, 2018 are shown below by contractual maturity. Expected maturities can differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.



	May 31, 2018
	Amortized		Fair
In millions	cost		value
Maturity date:
Due in one year or less	$	356.0	$	355.7
Due after one year through three years		807.4		803.6
Due after three years through five years		926.5		915.3
Due after five years		1,053.2		1,030.2
Total	$	3,143.1	$	3,104.8

Variable rate demand notes are primarily categorized as due after five years in the table above as the contractual maturities on these securities are typically 20 to 30 years. Although these securities are issued as long-term securities, they are priced and traded as short-term instruments because of the liquidity provided through the tender feature.

Note G — Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The accounting standards related to fair value measurements include a hierarchy for information and valuations used in measuring fair value that is broken down into three levels based on reliability, as follows:

	·		Level 1 valuations are based on quoted prices in active markets for identical instruments that the Company can access at the measurement date.

	·		Level 2 valuations are based on inputs other than quoted prices included in Level 1 that are observable for the instrument, either directly or indirectly, for substantially the full term of the asset or liability including the following:

	o		quoted prices for similar, but not identical, instruments in active markets;

	o		quoted prices for identical or similar instruments in markets that are not active;

	o		inputs other than quoted prices that are observable for the instrument; or

	o		inputs that are derived principally from or corroborated by observable market data by correlation or other means.

	·		Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement.

The carrying values of cash and cash equivalents, accounts receivable, net of allowance for doubtful accounts, accounts payable and short-term borrowings, when used by the Company, approximate fair value due to the short maturities of these instruments. Marketable securities included in funds held for clients and corporate investments consist primarily of securities classified as available-for-sale and are recorded at fair value on a recurring basis.

The Company’s financial assets and liabilities measured at fair value on a recurring basis were as follows:



	May 31, 2018
			Quoted		Significant
			prices in		other		Significant
	Carrying		active		observable		unobservable
	value		markets		inputs		inputs
In millions	(Fair value)		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash equivalents:
Commercial paper	$	655.0	$	—	$	655.0	$	—
Time deposits		200.0		—		200.0		—
Money market securities		7.1		7.1		—		—
Total cash equivalents	$	862.1	$	7.1	$	855.0	$	—
Available-for-sale securities:
Corporate bonds	$	321.4	$	—	$	321.4	$	—
General obligation municipal bonds		1,221.7		—		1,221.7		—
Pre-refunded municipal bonds		50.9		—		50.9		—
Revenue municipal bonds		806.4		—		806.4		—
U.S. government agency securities		396.1		—		396.1		—
Variable rate demand notes		308.3		—		308.3		—
Total available-for-sale securities	$	3,104.8	$	—	$	3,104.8	$	—
Other	$	18.2	$	18.2	$	—	$	—
Liabilities:
Other long-term liabilities	$	18.2	$	18.2	$	—	$	—



	May 31, 2017
			Quoted		Significant
			prices in		other		Significant
	Carrying		active		observable		unobservable
	value		markets		inputs		inputs
In millions	(Fair value)		(Level 1)		(Level 2)		(Level 3)
Assets:
Available-for-sale securities:
Corporate bonds	$	210.8	$	—	$	210.8	$	—
General obligation municipal bonds		1,442.3		—		1,442.3		—
Pre-refunded municipal bonds		55.5		—		55.5		—
Revenue municipal bonds		940.9		—		940.9		—
U.S. government agency securities		325.8		—		325.8		—
Variable rate demand notes		1,637.9		—		1,637.9		—
Total available-for-sale securities	$	4,613.2	$	—	$	4,613.2	$	—
Other	$	16.7	$	16.7	$	—	$	—
Liabilities:
Other long-term liabilities	$	16.7	$	16.7	$	—	$	—

In determining the fair value of its assets and liabilities, the Company predominately uses the market approach. Money market securities, which are cash equivalents, are valued based on quoted market prices in active markets. Commercial paper and time deposits, which are cash equivalents, are considered Level 2 investments as they are valued based on similar, but not identical, instruments in active markets. Available-for-sale securities, including municipal bonds, variable rate demand notes, corporate bonds, and U.S. government agency securities, are included in Level 2 and are valued utilizing inputs obtained from an independent pricing service. To determine the fair value of the Company’s Level 2 available-for-sale securities, the independent pricing service uses a variety of inputs, including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, new issue data, and monthly payment information. The Company has not adjusted the prices obtained from the independent pricing service because it believes that they are appropriately valued.

Assets included as other are mutual fund investments, consisting of participants’ eligible deferral contributions under the Company’s non-qualified and unfunded deferred compensation plans. The related liability is reported as other long-term liabilities. The mutual funds are valued based on quoted market prices in active markets.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

Note H — Accounts Receivable, Net of Allowance for Doubtful Accounts

The components of accounts receivable, net of allowance for doubtful accounts, consisted of the following:



	May 31,		May 31,
In millions	2018		2017
PEO receivables(1)	$	140.1	$	137.8
Purchased receivables(2)		267.0		257.3
Other trade receivables(3)		131.3		118.4
Total accounts receivable, gross		538.4		513.5
Less: Allowance for doubtful accounts		7.0		6.0
Accounts receivable, net of allowance for doubtful accounts	$	531.4	$	507.5

	(1)		PEO receivables are primarily client wages and related tax withholdings since the last payroll processed. Balances will vary based on timing of the last payroll processed and the end of the reporting period. In addition, balances as of May 31, 2018 include receivable balances for HROI, acquired in August 2017. Refer to Note C for further details.

	(2)		Purchased receivables relate to payroll funding arrangements with clients in the temporary staffing industry.

	(3)		Other trade receivables primarily relate to other ongoing services provided to our clients and can vary based on the timing of these services and the end of the reporting period.

No single client had a material impact on total accounts receivable, service revenue, or results of operations.

Note I — Property and Equipment, Net of Accumulated Depreciation

The components of property and equipment, at cost, consisted of the following:



	May 31,
In millions	2018		2017
Land and improvements	$	10.6	$	8.3
Buildings and improvements		126.4		103.5
Data processing equipment		211.3		199.7
Software (1)		545.5		496.1
Furniture, fixtures, and equipment		114.5		115.2
Leasehold improvements		111.4		109.5
Construction in progress (1)		63.0		18.7
Total property and equipment, gross		1,182.7		1,051.0
Less: Accumulated depreciation		789.2		713.8
Property and equipment, net of accumulated depreciation	$	393.5	$	337.2

	(1)		Software includes both purchased software and costs capitalized related to internally developed software placed in service. Capitalized costs related to internally developed software that has not yet been placed in service is included in construction in progress.

Depreciation expense was $116.9 million, $108.8 million, and $99.2 million for fiscal years 2018, 2017, and 2016, respectively.

In August 2017, the Company announced its plan for a new multi-building Paychex campus based in Rochester, NY. This involves the purchase of five buildings and the renovation of over 300,000 square feet of existing space. The new campus will result in the consolidation of currently leased space in the Rochester area. The Company completed the purchase of these buildings during the three months ended November 30, 2017, for a combined cost of approximately $34.7 million and placed approximately $16.0 million in escrow for building renovations, which are in-process. As of May 31, 2018, $32.0 million is included in the Company’s construction in progress balance with a remaining balance in escrow of $14.2 million. In addition, in September 2017, the Company entered into a transaction with the County of Monroe Industrial Development Agency for purposes of obtaining public benefits and inducements, expiring on December 31, 2039. The public inducements include exemption from sales and use taxes for goods and services directly related to the renovations of the new multi-building campus as well as other property tax incentives.

Note J — Goodwill and Intangible Assets, Net of Accumulated Amortization

The Company had goodwill balances on its Consolidated Balance Sheets of $814.0 million as of May 31, 2018 and $657.1 million as of May 31, 2017. The increase of $156.9 million in goodwill since May 31, 2017 was the result of the acquisitions of HROI in August 2017 and Lessor in February 2018. Refer to Note C for further details.

The Company has certain intangible assets on its Consolidated Balance Sheets. The components of intangible assets, at cost, consisted of the following:



	May 31,
In millions	2018		2017
Client lists(1)	$	308.5	$	293.5
Other intangible assets		13.3		5.4
Total intangible assets, gross		321.8		298.9
Less: Accumulated amortization		180.4		241.3
Intangible assets, net of accumulated amortization	$	141.4	$	57.6

	(1)		During fiscal 2018, the Company resolved a contractual dispute within certain licensees. As part of this agreement, the Company acquired rights to certain client lists for approximately $30.0 million. Refer to Note P for further details. In addition, the balance as of May 31, 2018 includes client lists from the HROI and Lessor acquisitions. Refer to Note C for further details.

During fiscal 2018, the Company acquired intangible assets with weighted-average amortization periods as follows: customer lists — 8.8 years; other intangible assets — 3.0 years; and total — 8.8 years. Amortization expense relating to intangible assets was $21.1 million, $18.1 million, and $15.9 million for fiscal years 2018, 2017, and 2016, respectively.

The estimated amortization expense for the next five fiscal years relating to intangible asset balances is as follows:


In millions	Estimated amortization
Year ending May 31,	expense
2019	$	25.5
2020		22.4
2021		19.3
2022		16.4
2023		14.1

Note K — Income Taxes

The components of deferred tax assets and liabilities are as follows:



	May 31,
In millions	2018		2017
Deferred tax assets:
Compensation and employee benefit liabilities	$	15.0	$	23.1
Other current liabilities		6.5		9.1
Tax credit carry forward		0.2		39.3
Depreciation		3.6		7.3
Stock-based compensation		11.6		21.8
Unrealized losses on available-for-sale securities		9.2		—
Net operating loss ("NOL") carry forward		5.9		2.9
Tax benefit of uncertain tax positions		3.7		6.4
Other		2.3		4.7
Gross deferred tax assets		58.0		114.6
Deferred tax liabilities:
Capitalized software		39.4		54.8
Depreciation		—		1.6
Goodwill and intangible assets		49.0		66.8
Revenue not subject to current taxes		18.4		13.6
Unrealized gains on available-for-sale securities		—		11.7
Gross deferred tax liabilities		106.8		148.5
Net deferred tax liability	$	(48.8)	$	(33.9)

The deferred tax asset related to tax credit carry forward consists primarily of alternative minimum tax credits, which were fully utilized during the current fiscal year. The deferred tax asset related to NOL carry forward is comprised of $4.1 million of federal NOL carry forwards and $1.8 million of state NOL carry forwards. The federal NOL carry forwards were acquired through various acquisitions and expire between the fiscal years ending May 31, 2020 through May 31, 2035. The state NOL carry forwards expire between the fiscal years ending May 31, 2019 through May 31, 2038.

The components of the provision for income taxes are as follows:



	Year ended May 31,
In millions	2018		2017		2016
Current:
Federal	$	289.1	$	362.0	$	336.4
State		54.1		48.1		50.8
Total current		343.2		410.1		387.2
Deferred:
Federal		18.4		15.9		5.5
State		0.8		1.5		1.6
Total deferred		19.2		17.4		7.1
Income taxes	$	362.4	$	427.5	$	394.3

A reconciliation of the U.S. federal statutory tax rate to the Company’s effective income tax rate is as follows:



	Year ended May 31,
	2018		2017		2016
Federal statutory tax rate	29.2	%	35.0	%	35.0	%
Increase/(decrease) resulting from:
Statutory tax rate reduction resulting from the Tax Act	(2.0)	%	—	%	—	%
State income taxes, net of federal tax benefit	3.0	%	2.8	%	3.0	%
Section 199 - Qualified production activities	(0.3)	%	(0.5)	%	(2.4)	%
Tax-exempt municipal bond interest	(1.1)	%	(1.3)	%	(1.4)	%
Stock option windfall benefit	(0.8)	%	(1.5)	%	—	%
Other items	—	%	(0.2)	%	0.1	%
Effective income tax rate	28.0	%	34.3	%	34.3	%

The effective income tax rate for fiscal 2018 was significantly impacted by the enactment of the Tax Act. In addition, the effective income tax rates for fiscal 2018 and fiscal 2017 were impacted by the recognition of a net discrete tax benefit related to employee stock-based compensation payments.

The Tax Act makes broad and complex changes to U.S. federal corporate income taxation including, but not limited to: (i) reducing the statutory corporate tax rate from 35% to 21% (a blended statutory tax rate of 29.2% for fiscal 2018); (ii) repeal of the Section 199 qualified production activities deduction; (iii) creating new or furthering limitations to the deductibility of certain officer compensation, interest, meals, entertainment and other expenses; and (iv) changing from a worldwide to a territorial taxation system. In December 2017, the staff of the SEC issued guidance under Staff Accounting Bulletin (“SAB”) No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act,” allowing taxpayers to record provisional amounts for reasonable estimates when they do not have the necessary information available, prepared or analyzed in reasonable detail to complete their accounting for certain income tax effects of the Tax Act. The SEC also issued rules that would allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the related tax impacts.

As a result of the Tax Act, the Company derived estimated tax benefits of $102.6 million, including a net tax benefit of $25.5 million related to the revaluation of the Company’s net deferred tax liabilities and a net tax benefit of $77.1 million related to the reduction in the Company’s statutory income tax rate for fiscal 2018 applied to income before taxes. These amounts totaled $0.07 per diluted share and $0.21 per diluted share, respectively. This analysis is complete except for provisional amounts that were determined in accordance with SAB No. 118 related to certain equity compensation arrangements. Further Internal Revenue Service guidance related to whether these compensation arrangements meet the transition rule under the Tax Act is expected to be released within the next nine months and any change to the provisional amounts as a result of this further guidance is not anticipated to be material.

During fiscal 2016, the Company engaged tax specialists to assess the qualification of its customer-facing computer software for the federal “Qualified Production Activities Deduction” under Internal Revenue Code (“IRC”) Section 199, and the regulations thereunder. Based on this assessment, the Company concluded that certain of its software offerings qualified for this tax deduction for fiscal 2016 and prior tax years that remained open to Internal Revenue Service (“IRS”) examination. The Company submitted claims to recover these tax benefits for prior tax years and claimed the fiscal 2016 tax benefits when it filed its 2016 tax return. Accordingly, the Company recognized the tax benefits, and related tax reserves, for its qualified customer-facing activities for these years in fiscal 2016.

Uncertain income tax positions: The Company is subject to U.S. federal income tax, numerous local and state tax jurisdictions within the U.S., and taxes in Europe. The Company maintains a reserve for uncertain tax positions. As of May 31, 2018 and May 31, 2017, the total reserve for uncertain tax positions, including interest and net of federal benefits, was $14.7 million and $39.2 million, respectively, and was included in long-term liabilities on the Consolidated Balance Sheets.

A reconciliation of the beginning and ending amounts of the Company’s gross unrecognized tax benefits, not including interest or other potential offsetting effects, is as follows:



	Year ended May 31,
In millions	2018		2017		2016
Balance as of beginning of fiscal year	$	43.7	$	64.7	$	39.9
Additions for tax positions of the current year		2.3		8.2		7.3
Additions for tax positions of prior years		0.1		4.8		20.7
Reductions for tax positions of prior years		(1.2)		(2.5)		(0.1)
Settlements with tax authorities		(28.6)		(29.5)		(2.2)
Expiration of the statute of limitations		(1.4)		(2.0)		(0.9)
Balance as of end of fiscal year	$	14.9	$	43.7	$	64.7

In December 2016, the Company executed a closing agreement that resolved tax matters related to the audits by New York State for the fiscal year ended May 31, 2012 (“fiscal 2012”) through the fiscal year ended May 31, 2014 (“fiscal 2014”). As a result, the reserve for uncertain tax positions was decreased by $28.9 million in December 2016. The resolution and execution of the closing agreement in December 2016 on the open tax matters for fiscal 2012 through fiscal 2014 had a minimal impact on the Company’s effective income tax rate for fiscal 2017.

In May 2018, the Company settled its IRS examination for fiscal 2012 through fiscal 2017. As a result of the settlement, the reserve for uncertain tax positions was decreased by $27.2 million and income tax expense of $2.7 million was recorded.

The reserve as of May 31, 2018 substantially relates to the Company’s uncertain tax positions for certain federal and state income tax matters. The Company believes the reserve for uncertain tax positions, including interest and net of federal benefits, of $14.7 million as of May 31, 2018 adequately covers open tax years and uncertain tax positions up to and including fiscal 2018 for major taxing jurisdictions. As of May 31, 2018 and May 31, 2017, the entire $14.7 million and $39.2 million, respectively, of unrecognized tax benefits, including interest and net of federal benefit, if recognized, would impact the Company’s effective income tax rate.

The Company has concluded all U.S. federal income tax matters through fiscal 2017. With limited exception, state income tax audits by taxing authorities are closed through fiscal 2014, primarily due to expiration of the statute of limitations.

The Company continues to follow its policy of recognizing interest and penalties accrued on tax positions as a component of income taxes on the Consolidated Statements of Income and Comprehensive Income. The amount of accrued interest and penalties associated with the Company’s tax positions is immaterial to the Consolidated Balance Sheets. The amount of interest and penalties recognized for fiscal years 2018, 2017, and 2016 was immaterial to the Company’s results of operations.

Note L — Accumulated Other Comprehensive (Loss)/Income

The change in unrealized gains and losses, net of applicable taxes, related to investments in available-for-sale securities and foreign currency translation adjustments are the primary components reported in accumulated other comprehensive (loss)/ income in the Company’s Consolidated Balance Sheets. The changes in accumulated other comprehensive (loss)/income are as follows:



	Year ended May 31,
In millions	2018		2017		2016
Beginning balance	$	20.0	$	29.2	$	7.5
Other comprehensive (loss)/income:
Unrealized holding (losses)/gains		(70.2)		(14.7)		34.2
Income tax benefit/(expense) related to unrealized holding (losses)/gains		22.6		5.6		(12.4)
Reclassification adjustment for the net gain on sale of available-for-sale securities realized in net income		—		(0.1)		(0.1)
Foreign currency translation adjustment		(8.6)		—		—
Total other comprehensive (loss)/income, net of tax		(56.2)		(9.2)		21.7
Ending balance	$	(36.2)	$	20.0	$	29.2

Total tax (benefit)/expense included in other comprehensive (loss)/income	$	(22.6)	$	(5.6)	$	12.4

Reclassification adjustments out of accumulated other comprehensive income are for realized gains on the sales of available-for-sale securities and impacted interest on funds held for clients on the Consolidated Statements of Income and Comprehensive Income.

Note M — Short-term Financing

The Company maintains credit facilities, letters of credit, and lines of credit as part of its normal and recurring business operations.

Credit Facilities: The Company maintains three committed, unsecured credit facilities, as follows:



Bank	Borrower (1)	Date Entered	Expiration Date	Maximum Amount Available	Purpose
JP Morgan Chase Bank, N.A.(2)	Paychex of New York, LLC	August 5, 2015	August 5, 2020	$1 Billion	To meet short-term funding requirements.
JP Morgan Chase Bank, N.A.(2)	Paychex of New York, LLC	August 17, 2017	August 17, 2022	$500 Million	To meet short-term funding requirements.
PNC Bank, National Association (“PNC”)	Paychex Advance, LLC	March 17, 2016	March 17, 2020	$150 Million	To finance working capital needs and general corporate purposes.

	(1)		Borrower is a wholly owned subsidiary of the Company.

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

For all credit facilities, obligations under any facility are guaranteed by the Company and certain of its subsidiaries and will bear interest at competitive rates based on options provided to the borrower. Upon the expiration date, any borrowings outstanding will mature and be payable on such date.

JPM $1 Billion Credit Facility: There were no borrowings outstanding under this credit facility as of May 31, 2018 or May 31, 2017. Details of borrowings under this credit facility during fiscal 2018 and fiscal 2017 are as follows:



	Year ended May 31,
$ in millions	2018			2017
Number of days borrowed		22			30
Maximum amount borrowed	$	700.0		$	450.0
Weighted-average amount borrowed	$	319.1		$	196.7
Weighted-average interest rate		4.27	%		2.89	%

The Company typically borrows on an overnight basis. In addition to overnight borrowings, the Company also borrowed:

	·		Fiscal 2018 - $100.0 million for a three-day period at a weighted-average interest rate of 4.25%;

	·		Fiscal 2017 - $150.0 million for seven days and $50.0 million for a period of eighteen days at a weighted-average LIBOR-based interest rate of 1.40%.

Subsequent to May 31, 2018, the Company borrowed two times, on an overnight basis, $171.8 million on a weighted-average basis under this line.

JPM $500 Million Credit Facility: There were no borrowings outstanding under this credit facility as of May 31, 2018. Details of borrowings under this credit facility during fiscal 2018 is as follows:


	Year ended May 31,
$ in millions	2018
Number of days borrowed		42
Maximum amount borrowed	$	400.0
Weighted-average amount borrowed	$	144.8
Weighted-average interest rate		2.80	%

In addition to overnight borrowings, during fiscal 2018, the Company borrowed $300.0 million for seven days and $75.0 million for 30 days at weighted average LIBOR-based interest rates of 2.13% and 2.19%, respectively. Subsequent to May 31, 2018, the Company borrowed three times, on an overnight basis, $103.5 million on a weighted-average basis under this line.

PNC $150 Million Credit Facility: There were no borrowings outstanding under this credit facility as of May 31, 2018 or May 31, 2017. Details of borrowings under this credit facility during fiscal 2018 and fiscal 2017 are as follows:



	Year ended May 31,
$ in millions	2018			2017
Number of days borrowed		358			353
Maximum amount borrowed	$	59.9		$	55.6
Weighted-average amount borrowed	$	57.2		$	52.8
Weighted-average interest rate		1.94	%		1.21	%

Subsequent to May 31, 2018, Paychex Advance borrowed approximately $56.8 million under this line, which remains outstanding as of the date of this report.

All of the Company’s credit facilities contain various financial and operational covenants that are usual and customary for such arrangements. The Company was in compliance with all of these covenants as of May 31, 2018.

Certain lenders under these credit facilities, and their respective affiliates, have performed, and may in the future perform for the Company, 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: The Company had irrevocable standby letters of credit outstanding totaling $56.8 million and $47.3 million as of May 31, 2018 and 2017, respectively, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between July 2018 and May 2019. No amounts were outstanding on these letters of credit during fiscal 2018 or fiscal 2017, or as of May 31, 2018 and May 31, 2017. Subsequent to May 31, 2018, the letter of credit expiring in July 2018 was renewed through July 2019, and the total amount available under the letters of credit was increased $4.1 million to $60.9 million.

Lines of credit: Effective August 17, 2017, the Company terminated four uncommitted, secured, short-term lines of credit totaling $900.0 million. The lines of credit were available to the Company at market rates of interest and were primarily used to meet short-term funding requirements related to deposit account overdrafts and client fund obligations arising from electronic payment transactions made on behalf of our clients in the ordinary course of business. There were no amounts outstanding under these lines of credit during fiscal 2018 or fiscal 2017, or as of May 31, 2018 and May 31, 2017. The Company does not have any other open lines of credit as of the date of this report.

Note N — Supplemental Cash Flow Information

Income taxes paid were $319.1 million, $462.6 million, and $369.9 million for fiscal years 2018, 2017, and 2016, respectively.

Lease incentives received in the form of tenant allowances and free rent were $7.7 million, $5.8 million, and $4.3 million for fiscal years 2018, 2017, and 2016, respectively.

$33.2 million in Paychex common stock was issued in connection with the Company’s acquisition of HROI.

Note O — Employee Benefit Plans

401(k) plan: The Company maintains a contributory savings plan that qualifies under section 401(k) of the IRC. The Paychex, Inc. 401(k) Incentive Retirement Plan (the “Plan”) allows all employees to immediately participate in the salary deferral portion of the Plan, contributing up to a maximum of 50% of their salary, subject to IRS limitations. Employees who have completed one year of service and a minimum of 1,000 hours worked are eligible to receive a Company matching contribution, when such contribution is in effect. The Company provided a matching contribution of 50% of up to 8% of eligible pay that an employee contributed to the Plan through March 29, 2018. Beginning March 30, 2018, the Company provides a matching contribution of 100% of the first 3% and 50% on the next 2% of eligible pay for a total matching contribution of 4%. Company contributions to the Plan for fiscal years 2018, 2017, and 2016 were $23.6 million, $22.4 million, and $21.4 million, respectively.

The Plan is 100% participant directed. Plan participants can fully diversify their portfolios by choosing from any or all investment fund choices in the Plan. Transfers in and out of investment funds, including the Paychex, Inc. Employee Stock Ownership Plan Stock Fund, are not restricted, with the exception of certain restricted trading periods for individuals designated as insiders as specified in the Company’s Insider Trading Policy. The Company match contribution, when in effect, follows the same fund elections as the employee compensation deferrals.

Deferred compensation plans: The Company offers non-qualified and unfunded deferred compensation plans to a select group of key employees, executive officers, and outside directors. Eligible employees are provided with the opportunity to defer up to 50% of their annual base salary and bonus and outside directors may defer 100% of their Board cash compensation. Gains and losses are credited based on the participant’s election of a variety of investment choices. The Company does not match any participant deferral or guarantee its return. Distributions are paid at one of the following dates selected by the participant: the participant’s termination date, the date the participant retires from any active employment, or a designated specific date. The amounts accrued under these plans were $18.2 million and $16.7 million as of May 31, 2018 and May 31, 2017, respectively, and are reflected in other long-term liabilities on the accompanying Consolidated Balance Sheets.

Note P — Commitments and Contingencies

Contingencies: The Company is subject to various claims and legal matters that arise in the normal course of its business. These include disputes or potential disputes related to breach of contract, tort, patent, breach of fiduciary duty, employment-related claims, tax claims, and other matters.

The Company’s management currently believes that resolution of outstanding legal matters will not have a material adverse effect on the Company’s 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.

During the three months ended February 28, 2018, the Company began negotiations to terminate certain license agreements and acquire rights to certain client lists in order to resolve a contractual dispute with certain licensees. The negotiations were completed in March 2018. The Company recorded $34.8 million on its Consolidated Balance Sheets within other current liabilities as of May 31, 2018, and $24.7 million, net of tax, in its Consolidated Statements of Income and Comprehensive Income during fiscal 2018 related to the termination of these license agreements. In addition, the Company acquired rights to certain client lists as it relates to this agreement in March 2018 for approximately $30.0 million, which is recorded on its Consolidated Balance Sheets within intangible assets, net of accumulated amortization as of May 31, 2018.

Lease commitments: The Company leases office space and data processing equipment under terms of various operating leases. Rent expense for fiscal years 2018, 2017, and 2016 was $39.9 million, $39.7 million, and $39.8 million, respectively. As of May 31, 2018, future minimum lease payments under various non-cancelable operating leases with terms of more than one year are as follows:



	Minimum
In millions	lease
Year ending May 31,	payments
2019	$	35.1
2020		26.8
2021		19.8
2022		12.8
2023		6.8
Thereafter		8.8

Other commitments: As of May 31, 2018, the Company had outstanding commitments under purchase orders and legally binding contractual arrangements with minimum future payment obligations of approximately $130.2 million, including $6.7 million of commitments to purchase capital assets. These minimum future payment obligations relate to the following fiscal years:



	Minimum
In millions	payment
Year ending May 31,	obligation
2019	$	83.9
2020		39.1
2021		6.1
2022		1.0
2023		0.1
Thereafter		—

In the normal course of business, the Company makes 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, the Company has entered into indemnification agreements with its officers and directors, which require the Company to defend and, if necessary, indemnify these individuals for certain pending or future claims as they relate to their services provided to the Company.

Paychex currently self-insures the deductible portion of various insured exposures under certain employee benefit plans. The Company’s estimated loss exposure under these insurance arrangements is recorded in other current liabilities on the Consolidated Balance Sheets. Historically, the amounts accrued have not been material and are not material as of the reporting date. The Company also maintains insurance coverage in addition to its 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 its captive insurance company.

Note Q — Related Parties

During fiscal years 2018, 2017, and 2016, the Company purchased approximately $0.5 million, $0.6 million, and $4.9 million, respectively, of data processing equipment and software from EMC Corporation. The former Chairman, President, and Chief Executive Officer of EMC Corporation is a member of the Company’s Board.

During fiscal years 2018, 2017, and 2016, the Company purchased approximately $2.7 million, $2.9 million, and $2.3 million, respectively, of office supplies from Staples, Inc. The former Vice Chairman of Staples, Inc. is a member of the Company’s Board.

Note R — Quarterly Financial Data (Unaudited)

In millions, except per share amounts



	Three Months Ended
Fiscal 2018	August 31		November 30		February 28		May 31		Full Year
Service revenue	$	803.1	$	812.5	$	848.4	$	853.4	$	3,317.4
Interest on funds held for clients		13.7		14.0		18.1		17.7		63.5
Total revenue	$	816.8	$	826.5	$	866.5	$	871.1	$	3,380.9
Operating income	$	345.0	$	332.2	$	292.5	$	317.8	$	1,287.5
Investment income, net		2.1		1.7		2.3		2.5		8.6
Income before income taxes		347.1		333.9		294.8		320.3		1,296.1
Income taxes(3)		119.3		116.9		34.4		91.8		362.4
Net income	$	227.8	$	217.0	$	260.4	$	228.5	$	933.7
Basic earnings per share(1)	$	0.63	$	0.60	$	0.72	$	0.64	$	2.60
Diluted earnings per share(1)	$	0.63	$	0.60	$	0.72	$	0.63	$	2.58
Weighted-average common shares outstanding		358.9		359.1		359.2		359.0		359.0
Weighted-average common shares outstanding, assuming dilution		361.3		361.4		362.0		361.5		361.5
Cash dividends per common share	$	0.50	$	0.50	$	0.50	$	0.56	$	2.06
Total net realized gains(2)	$	—	$	—	$	0.1	$	—	$	0.1



	Three Months Ended
Fiscal 2017	August 31		November 30		February 28		May 31		Full Year
Service revenue	$	773.5	$	760.0	$	782.6	$	784.6	$	3,100.7
Interest on funds held for clients		12.0		11.4		13.2		14.0		50.6
Total revenue	$	785.5	$	771.4	$	795.8	$	798.6	$	3,151.3
Operating income	$	323.0	$	311.1	$	306.6	$	298.9	$	1,239.6
Investment income, net		1.5		0.9		1.2		1.6		5.2
Income before income taxes		324.5		312.0		307.8		300.5		1,244.8
Income taxes		107.1		109.9		105.3		105.2		427.5
Net income	$	217.4	$	202.1	$	202.5	$	195.3	$	817.3
Basic earnings per share(1)	$	0.60	$	0.56	$	0.56	$	0.54	$	2.27
Diluted earnings per share(1)	$	0.60	$	0.56	$	0.56	$	0.54	$	2.25
Weighted-average common shares outstanding		361.0		360.2		359.0		359.3		359.8
Weighted-average common shares outstanding, assuming dilution		364.1		362.6		361.8		362.1		362.6
Cash dividends per common share	$	0.46	$	0.46	$	0.46	$	0.46	$	1.84
Total net realized gains(2)	$	0.1	$	—	$	—	$	—	$	0.1

	(1)		Each quarter is a discrete period and the sum of the four quarters’ basic and diluted earnings per share amounts may not equal the full year amount.

	(2)		Total net realized gains on the combined funds held for clients and corporate investment portfolios.

	(3)		As a result of the Tax Act, the effective income tax rate for the three months ended February 28, 2018 was significantly impacted by certain one-time net tax benefits. Refer to Note K for further details.

Schedule II — Valuation and Qualifying Accounts

PAYCHEX, INC.

CONSOLIDATED FINANCIAL STATEMENT SCHEDULE

FOR THE YEAR ENDED MAY 31,

(In millions)



					Additions to/
	Balance as of		Additions		(deductions				Balance as
	beginning		charged to		from) other		Costs and		of end
Description	of fiscal year		expenses		accounts(1)		deductions(2)		of fiscal year
2018
Allowance for doubtful accounts	$	6.0	$	3.6	$	—	$	2.6	$	7.0
Reserve for client fund losses	$	3.0	$	3.1	$	—	$	3.7	$	2.4
2017
Allowance for doubtful accounts	$	4.2	$	4.9	$	—	$	3.1	$	6.0
Reserve for client fund losses	$	2.0	$	4.1	$	—	$	3.1	$	3.0
2016
Allowance for doubtful accounts	$	1.4	$	2.5	$	2.0	$	1.7	$	4.2
Reserve for client fund losses	$	1.8	$	2.4	$	—	$	2.2	$	2.0

	(1)		Amounts related to business acquisitions.

	(2)		Uncollectible amounts written off, net of recoveries.

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