PAYCHEX INC (PAYX) FY 2026 MD&A

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations reviews the operating results of Paychex, Inc. and its wholly owned subsidiaries (“Paychex,” the “Company,” “we,” “our,” or “us”) for our fiscal year ended May 31, 2026 (“fiscal 2026” or the “fiscal year”), as compared to our fiscal year ended May 31, 2025 (“fiscal 2025”), and our financial condition as of May 31, 2026. A detailed review of our fiscal 2025 performance compared to our fiscal year ended May 31, 2024 performance and our financial condition as of May 31, 2025 is set forth in Part II, Item 7 of our Annual Report on Form 10-K (“Form 10-K”) for fiscal 2025. This review should be read in conjunction with the accompanying consolidated financial statements and the related Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K and the “Risk Factors” discussed in Item 1A of this Form 10-K. Forward-looking statements in this review are qualified by the cautionary statement under the heading “Cautionary Note Regarding Forward-Looking Statements” contained at the beginning of Part I of this Form 10-K.

Overview

We are an industry-leading human capital management (“HCM”) company providing comprehensive technology and advisory solutions in human resources (“HR”), payroll processing, employee benefits, and insurance across the U.S. and parts of Europe.

We support our customers with three proprietary SaaS-based HCM platforms: SurePayroll®, Paychex Flex®, and Paycor®, each designed to meet diverse customer needs and business requirements. For example, larger customers often have more complex HCM demands. Our integrated HCM solutions span the entire employee life cycle, enabling customers to choose from a broad range of solutions that seamlessly integrate with leading HR, accounting, enterprise resource planning, and point-of-sale applications. Our technology is complemented by a wide array of advisory, benefits, and insurance solutions. In today's dynamic, complex regulatory landscape, we see growing demand for HR outsourcing solutions.

Our offerings are disaggregated into two categories, (1) Management Solutions and (2) PEO and Insurance Solutions, as discussed under the heading “Our Solutions” in Part I, Item 1 of this Form 10-K.

As a digitally driven HR leader, our mission is to help businesses succeed. Our strategy includes growing our customer base; increasing product penetration; driving technology innovation; and pursuing strategic acquisitions, all aimed at achieving long-term financial success.

We maintain industry-leading margins by efficiently managing costs while strategically investing in our business, particularly in sales and marketing and leading-edge, AI-driven technology and advisory solutions, which we view as critical to our ongoing success. Looking ahead, we believe that investing in our solutions, people, and AI capabilities positions us to capitalize on long-term growth opportunities.

By closely monitoring customer needs and challenges, we proactively assist our customers in navigating legislative changes and other employment complexities. Our unique blend of innovative technology and extensive HR expertise enables customers to more effectively hire, develop, and retain top talent in this tight labor market. Ongoing investments in our platforms have equipped us well to meet the current business demands and regulatory compliance, resulting in high levels of customer satisfaction and retention.

On April 14, 2025, we completed the acquisition of Paycor, a leading provider of HCM, payroll, and talent software. This acquisition expands our upmarket position, suite of HCM technology and cross-sale potential. Refer to the "Results of Operations" and “Liquidity and Capital Resources” section of this Item 7 for additional information.

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Fiscal 2026 Business Highlights

Highlights compared to fiscal 2025 are as follows:

(1)
Adjusted operating income, adjusted net income, and adjusted diluted earnings per share are not United States ("U.S.") generally accepted accounting principles (“GAAP”) measures. Adjusted net income and adjusted diluted earnings per share in both periods include an adjustment for net tax windfall benefits related to employee stock-based compensation payments. Adjusted operating income, adjusted net income and adjusted diluted earnings per share in both periods also include adjustments for acquisition-related costs. Refer to the “Non-GAAP Financial Measures” section of this Item 7 for a discussion of non-GAAP measures and a reconciliation to the U.S. GAAP measures of operating income, net income and diluted earnings per share.

(2)
Dividends paid to stockholders represented approximately 90% of net income for fiscal 2026 compared to approximately 87% of net income for fiscal 2025.

(3)
Percentage changes are calculated based on unrounded numbers.

For further analysis of our results of operations for fiscal years 2026 and 2025, and our financial position as of May 31, 2026, refer to the tables and analysis in the “Results of Operations” and “Liquidity and Capital Resources” sections of this Item 7.

Business Outlook

During fiscal 2026, we served approximately 840,000 total customers across the U.S. and parts of Europe, of which approximately 800,000 are payroll clients. During fiscal 2025, we served approximately 800,000 payroll clients. Payroll client retention was in the range of 82% to 83% of our beginning client base for both fiscal 2026 and fiscal 2025 and we have sustained high revenue retention.

We continue to increase penetration of our integrated solutions beyond payroll processing, including our HR outsourcing (ASO and PEO) and retirement solutions. The following table illustrates selected customer metrics:

(1)
Percentage changes are calculated based on unrounded numbers.

In fiscal 2026, we continued to make investments in technology a priority as companies look to leverage technology solutions to increase productivity, enhance decision-making, and deliver better outcomes. We implemented enhancements to our Paychex Flex, Paycor, and SurePayroll platforms designed to improve the customer and customer employee experiences from hiring and onboarding throughout employee retention. In fiscal 2026, we successfully implemented several innovative AI capabilities that enhanced value for Paychex and our customers, including WISE. WISE, our AI-powered intelligence engine extends our existing capabilities into agentic AI. Today, it powers approximately 600 AI features and agents across our solutions and operations. We also continue to focus on AI and related technology to leverage innovative technology and advanced analytics to gain deeper insights into prospects and customers regarding their behavior, preferences, and evolving needs.

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We have further strengthened our position in the industry by serving as a source of education and information to customers, businesses of all sizes, and other interested parties. We provide free webinars, white papers, and other information on our website (www.paychex.com) to aid existing and prospective customers with the impact of regulatory changes. In addition, the Paychex Insurance Agency, Inc. website, www.paychex.com/group-health-insurance, helps small-business owners navigate the area of insurance coverage.

Results of Operations

Summary of Results of Operations for Fiscal Years:

(1)
Percentage changes are calculated based on unrounded numbers.

n/m – not meaningful

Total revenue increased to $6.5 billion for fiscal 2026, reflecting an increase of 17% compared to the prior year. Paycor, acquired in April 2025, contributed approximately 12% to total revenue growth for fiscal 2026. The changes in revenue as compared to the prior year were primarily driven by the following factors:

•
Management Solutions revenue: $4.9 billion for fiscal 2026, reflecting an increase of 20%. Paycor contributed approximately 15% to Management Solutions revenue growth for fiscal 2026. Management Solutions revenue increased due to the following:

o
Growth in the number of average clients served, primarily driven by the acquisition of Paycor, and HR outsourcing solutions worksite employees; and

o
Higher revenue per client driven by Paycor's upmarket customer base, price realization, and product penetration.

•
PEO and Insurance Solutions revenue: $1.4 billion for fiscal 2026, reflecting an increase of 7%:

o
Continued growth in the number of average PEO worksite employees; and

o
Increase in PEO insurance revenues.

•
Interest on funds held for clients: $210.9 million for fiscal 2026, reflecting an increase of 30%:

o
Higher average investment balances, resulting from the acquisition of Paycor; and

o
Higher realized gains due to the strategic repositioning of our investment portfolio during the second quarter of fiscal 2026.

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We invest in highly liquid, investment-grade fixed income securities. As of May 31, 2026, we had no exposure to high-risk or non-liquid investments. Details regarding our combined funds held for clients and corporate cash equivalents and investment portfolios are as follows:

(1)
The net unrealized loss on our investment portfolios was approximately $69.9 million as of July 15, 2026. Refer to Note G in the Notes to Consolidated Financial Statements contained in Item 8 and the "Market Risk Factors" section contained in Item 7A of this Form 10-K for more information regarding AFS securities held in an unrealized loss position.

(2)
The Federal Funds rate was in the range of 3.50% to 3.75% as of May 31, 2026 and in the range of 4.25% to 4.50% as of May 31, 2025.

(3)
These items exclude the impact of variable rate demand notes (“VRDNs”), as they are tied to short-term interest rates. Refer to the “Market Risk Factors” section contained in Item 7A of this Form 10-K for more information on changing interest rates.

Total expenses: Total expenses, which reflects the total combined cost of service revenue and selling, general and administrative expenses, increased 19% to $4.0 billion compared to the prior year. The following table summarizes the components of total expenses:

(1)
Percentage changes are calculated based on unrounded numbers.

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The changes in total expenses as compared to the prior year were primarily driven by the following factors:

•
Compensation-related expenses: $2.1 billion for fiscal 2026, reflecting a 13% increase:

o
Increase in average headcount, driven by the acquisition of Paycor.

•
PEO direct insurance costs: $563.2 million in fiscal 2026, reflecting an 8% increase:

o
Increase in PEO direct insurance costs related to growth in average worksite employees, and PEO insurance revenues.

•
Depreciation and amortization: $200.6 million in fiscal 2026, reflecting a 19% increase:

o
Higher property and equipment balances compared to the prior year, including increased development and enhancement of our customer-facing internal-use software, as well as the impact of the acquisition of Paycor; and

o
Higher intangible asset balances compared to the prior year.

•
Other expenses: $841.6 million in fiscal 2026, reflecting a 28% increase:

o
Continued investment in technology, selling, and marketing investments driven by the acquisition of Paycor and continued investments in our strategic priorities; and

o
General cost increases to support business growth.

•
Acquisition-related costs: $304.2 million in fiscal 2026, reflecting an 87% increase:

o
Acquisition of Paycor in April 2025. Acquisition-related costs include the amortization of intangibles acquired in the acquisition of Paycor, compensation costs related to the acquisition and integration of Paycor, including replacement awards, severance, and retention bonuses, and other acquisition-related costs, primarily reflecting professional service fees.

Operating income: Fiscal 2026 operating income was $2.5 billion, an increase of 14% compared to fiscal 2025. Adjusted operating income(1) of $2.8 billion, which excludes the acquisition related costs noted above, increased 19%.

Operating margin (operating income as a percentage of total revenue) and adjusted operating margin(1) (adjusted operating income(1) as a percentage of total revenue) were as follows:

(1)
Adjusted operating income and adjusted operating margin are not U.S. GAAP measures. Refer to the “Non-GAAP Financial Measures” section below for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measure of operating income and operating margin.

Interest expense: Interest expense increased $164.1 million to $269.5 million in fiscal 2026, primarily due to the issuance of incremental debt in April 2025 to finance the acquisition of Paycor. The prior-year period also included acquisition-related financing costs.

Other income, net: Other income, net decreased 5% to $69.9 million in fiscal 2026, primarily as a result of lower average interest rates earned on our corporate investments.

Income taxes: Our effective income tax rate was 23.8% for both fiscal 2026 and fiscal 2025. The effective income tax rates in both periods were affected by the recognition of discrete tax impacts related to employee stock-based compensation payments. Refer to Note L of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on income taxes.

Net income and diluted earnings per share: Net income was $1.8 billion for fiscal 2026 and $1.7 billion for fiscal 2025, reflecting an increase of 6%. Diluted earnings per share was $4.89 per diluted share for fiscal 2026 and $4.58 per diluted share for fiscal 2025, reflecting an increase of 7%. Refer to Note C of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for information on dilutive shares outstanding.

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Adjusted net income(1) was $2.0 billion and $1.8 billion for fiscal 2026 and fiscal 2025, respectively, reflecting an increase of 10%. Adjusted diluted earnings per share(1) was $5.51 per diluted share and $4.98 per diluted share for fiscal 2026 and fiscal 2025, respectively, reflecting an increase of 11%.

(1)
Adjusted net income and adjusted diluted earnings per share are not U.S. GAAP measures. Refer to the “Non-GAAP Financial Measures” section below for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measure of net income and diluted earnings per share.

Non-GAAP Financial Measures: Adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, earnings before interest, taxes, depreciation, and amortization (“EBITDA”), and adjusted EBITDA are summarized as follows:

(1)
Percentage changes are calculated based on unrounded numbers.

(2)
Acquisition-related costs included in selling, general and administrative expenses include:

•
$242.0 million for fiscal 2026 compared to $40.7 million for the prior year period, in amortization of intangibles acquired in the acquisition of Paycor,

•
$52.1 million for fiscal 2026 compared to $70.8 million for the prior year period, in compensation costs related to the acquisition and integration of Paycor, including replacement awards, severance and retention bonuses, and

•
$10.1 million for fiscal 2026 compared to $50.8 million for the corresponding prior year period in other acquisition-related costs primarily consisting of professional service fees.

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In addition, acquisition-related costs for fiscal 2025 include $34.0 million, respectively, reflecting the amortization of financing fees related to debt instruments associated with the financing of the Paycor acquisition and the excluded component of the initial fair value of the interest rate swaption contracts that are included in Interest expense in the Company's Consolidated Statements of Income.

(3)
Net tax windfall related to employee stock-based compensation payments recognized in income taxes. This item is subject to volatility and will vary based on employee decisions on exercising employee stock options and fluctuations in our stock price, neither of which is within the control of management.

(4)
The calculation of the impact of non-GAAP adjustments on diluted earnings per share is performed on each line independently. The table may not add down by +/- $0.01 due to rounding.

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

Liquidity and Capital Resources

Our financial position as of May 31, 2026 remained strong with cash, restricted cash, and total corporate investments of $1.2 billion. Long-term borrowings of $4.6 billion were outstanding as of May 31, 2026. Our unused capacity under our unsecured credit facilities was $2.0 billion as of May 31, 2026. Our primary source of cash is our ongoing operations, which was $2.6 billion for fiscal 2026. Our positive cash flows have allowed us to support our business, repurchase shares, and pay dividends. We currently anticipate that corporate cash, corporate restricted cash, and total corporate investments as of May 31, 2026, along with projected operating cash flows and available short-term financing, will support our business operations, capital purchases, primarily investment in our technology solutions, share repurchases, dividend payments, and debt service for the foreseeable future.

For client funds liquidity, we have the ability to borrow on our unsecured credit facilities or use corporate liquidity when necessary to meet short-term funding needs related to client fund obligations. Historically, we have borrowed, typically on an overnight basis, to settle short-term client fund obligations, rather than liquidate previously collected client funds invested in our long-term AFS portfolio. We believe that our investments in an unrealized loss position as of May 31, 2026 were not impaired due to increased credit risk or other valuation concerns, nor has any event occurred subsequent to that date to indicate any change in our assessment. We do not intend to sell these investments until recovery of their amortized cost basis or maturity and further believe that it is not more-than-likely that we would be required to sell these investments prior to that time.

Financing

Short-term financing: We maintain committed and unsecured credit facilities and irrevocable letters of credit as part of our normal and recurring business operations. The purpose of these credit facilities is to meet short-term funding requirements, finance working capital needs, and for general corporate purposes. We typically borrow on an overnight or short-term basis under our credit facilities. Refer to Note M in the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further discussion of our credit facilities.

Effective January 23, 2026, we entered into amendments of our $750.0 million, five-year, unsecured, revolving credit facility (the "2017 JPM Credit Facility") and our $1.0 billion, five-year, unsecured, revolving credit facility (the "2019 JPM Credit Facility") with a syndicate of lenders for which JP Morgan Chase Bank, N.A. ("JPM") acts as administrative agent. The amendments to these credit facilities, among other things, increase the aggregate amount of principal available under the 2017 Credit Facility from $750 million to $1.0 billion, extend its maturity date from September 17, 2026 to January 23, 2031, and amend certain interest provisions and covenants under both credit facilities. In connection with these amendments, we terminated our three-year, $250 million, unsecured, revolving credit facility for which PNC Bank, N.A. ("PNC") acted as administrative agent (the "2020 PNC Credit Facility"). As of the date of its termination, there were no outstanding loans under the PNC Credit Facility. Refer to Note M in the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K and our Current Report on Form 8-K filed on January 26, 2026, for additional information.

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Details of our credit facilities are as follows:

Details of borrowings under each credit facility during fiscal 2026 were as follows:

We primarily use short-term borrowings to settle client fund obligations, rather than liquidating previously collected client funds invested in our long-term AFS investment portfolio.

Subsequent to May 31, 2026, we borrowed seven times on an overnight basis, $478.2 million, on a weighted-average basis, under our JPM credit facilities.

We expect to have access to the amounts available under our current credit facilities to meet our ongoing financial needs. However, if we experience reductions in our operating cash flows due to any of the risk factors outlined in, but not limited to, Item 1A in this Form 10-K and other SEC filings, we may need to adjust our capital, operating, and other discretionary spending to realign our working capital requirements with the capital resources available to us. Furthermore, if we determine the need for additional short-term liquidity, there is no assurance that such financing, if pursued and obtained, would be adequate or on terms acceptable to us.

Letters of credit: As of May 31, 2026, we had irrevocable standby letters of credit available totaling $176.5 million, primarily to secure commitments for certain insurance policies. The letters of credit expire at various dates between June 1, 2026 and May 26, 2027. No amounts were outstanding on these letters of credit during fiscal 2026 or fiscal 2025, or as of May 31, 2026 and May 31, 2025. Subsequent to May 31, 2026, ten letters of credit expired and were renewed for one year terms.

Long-term financing: We have borrowed $4.2 billion through the issuance of three fixed rate corporate bonds ("Corporate Bonds") and $0.4 billion through the issuance of long-term private placement debt (“Senior Notes”). The following is information on each of our long-term financing arrangements related to future cash commitments:

During fiscal 2026, we repaid our long-term private placement debt Senior Note, Series A for $400.0 million, which matured on March 13, 2026.

Refer to Note N in the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further discussion on our long-term financing.

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Bridge Loan Commitment: On January 7, 2025, we and our subsidiary, Paychex of New York, LLC, entered into a bridge loan commitment with JPM, pursuant to which JPM committed to provide a 364-day senior unsecured credit facility not to exceed $3.5 billion for the acquisition of Paycor, including related fees and expenses. We incurred $14.9 million in debt financing fees, including structuring and commitment fees, which were capitalized as Prepaid expenses and other current assets on our Consolidated Balance Sheets and recognized as interest expense on a straight-line basis through the issuance date of our Corporate Bonds. The bridge loan commitment expired upon the issuance our Corporate Bonds. Refer to Note N of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for further discussion on our long-term financing.

Interest Rate Swaption Contracts: On January 31, 2025, we executed three Swaption Contracts with JPM. The Swaption Contracts qualified as cash flow hedges, had an aggregate notional amount of $3.0 billion, and were utilized to manage exposure to fluctuations in benchmark interest rates associated with the issuance of Corporate Bonds to fund our acquisition of Paycor. At inception, we recorded Swaption Contract assets related to paid premiums of $19.2 million. The fair value of the Swaption Contract assets were classified as Prepaid expenses and other current assets on the Company’s Consolidated Balance Sheets. Upon issuance of our Corporate Bonds, the Swaption Contracts expired unexercised.

Other commitments: The Company has various long-term contractual obligations as of May 31, 2026, which include:

•
operating leases for $83.4 million;

•
purchase obligations for $660.7 million;

•
workers’ compensation estimated obligations for $237.7 million; and

•
long-term Corporate Bonds and Senior Notes for $4.6 billion, plus interest payments of $1.4 billion.

Refer to Notes A, I, N, and Q of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for more information on these commitments.

The liability for uncertain tax positions, including interest and net of federal benefits, was approximately $120.6 million as of May 31, 2026. Refer to Note L of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for more information on income taxes. We are not able to reasonably estimate the timing of future cash flows related to this liability.

We are a limited partner in five limited partnership arrangements to contribute a maximum of $37.5 million to venture capital funds. As of May 31, 2026, we have contributed $33.6 million of the total funding commitment. The timing of future contributions to be made to these venture capital funds cannot be specifically or reasonably determined. Our investments in these venture capital funds are not considered part of our ongoing operations, are accounted for under the equity method, and represented less than one percent of our total assets as of May 31, 2026.

In the normal course of business, we make representations and warranties that guarantee the performance of services under service arrangements with customers. Historically, there have been no material losses related to such commitment. We have also entered into indemnification agreements with our officers, directors, and non-officer fiduciaries of our pooled employer plan retirement offering, which require us to defend and, if necessary, indemnify these individuals for certain pending or future legal claims as they relate to their services provided to us.

We currently self-insure the deductible portion of various insured exposures under certain corporate employee and PEO employee health and medical benefit plans. Historically, the amounts accrued for these plans have not been material and were not material as of May 31, 2026. We also self-insure the deductible portion of certain PEO workers' compensation benefit plans. Refer to Note A in the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information regarding our estimated loss exposure under these PEO workers' compensation benefit plans.

In addition to our purchased primary insurance policies, we utilize our captive insurance company to provide insurance coverage for certain risks where commercial coverage is limited, unavailable, or not economically practical. Such coverage includes employment practices liability, errors and omissions, warranty liability, theft and embezzlement, cyber threats, and acts of terrorism. The captive also supplements our third-party insurance programs by funding certain deductibles, self-insured retentions, and providing excess coverage.

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Operating, Investing, and Financing Cash Flow Activities

Primary sources of cash, restricted cash, and equivalents are through collections for services rendered to our customers and interest earned on funds held for clients and corporate investments. Primary uses of cash include employee compensation and contractual obligations related to business operations, cash dividends paid, share repurchases, purchases of property and equipment, long term debt service, and acquisitions.

Our investment portfolio incorporates both corporate cash and funds held for clients. Interest rates, market conditions, and our variable cash flows are among several factors influencing our investment strategy directing the mix between long-term and VRDN AFS securities vs. short-term restricted cash and cash equivalents held in the portfolio. A portfolio strategy that favors larger balances held in restricted cash and cash equivalents may impact our investing activities due to the offsetting activity in the purchases and sales/maturities of AFS investments.

Our cash flows include certain activities that are short-term in nature and have an impact on short-term cash flows due to timing of collection and settlement of obligations as follows:

•
PEO receivables and worksite-employee ("WSE") accrued compensation: PEO receivables and WSE accrued compensation fluctuate based on either/both: (1) the timing of the payroll cut-off date and our month-end close, and (2) the timing of when cash is collected from clients, and when it is remitted to either the WSE for wages earned or applicable tax or regulatory agencies for payroll taxes. PEO accounts receivable collections and compensation payments to WSEs and applicable tax or regulatory agencies are settled through our corporate cash and the fluctuations impact our operating activities.

•
Client fund obligations: Client fund obligations liability will vary based on the timing of when cash is collected from the clients and when it is remitted to employees of the clients utilizing employee payment services or to applicable tax or regulatory agencies for payroll tax administration services. Collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days. Fluctuations in client fund obligations impact financing activities.

Summarized operating, investing, and financing cash flow information for fiscal 2026 and fiscal 2025:

The changes in our cash flows for fiscal 2026 and fiscal 2025 were primarily the result of the following key drivers:

Operating Cash Flow Activities

Fiscal 2026

•
Net income, adjusted for non-cash items including depreciation and amortization, provision on deferred taxes, stock-based compensation, and deferred costs, net, attributable to the reasons discussed in the “Results of Operations” section of this Item 7;

•
A net increase in accrued income taxes due to the timing of tax-related payments as compared to the accrual of income tax expense; and

•
Net increase in refunds owed to our customers and other cash collections related to tax benefits.

Fiscal 2025

•
Net income, adjusted for non-cash items including depreciation and amortization, provision on deferred taxes, stock-based compensation, and deferred costs, net, attributable to the reasons discussed in the “Results of Operations” section of this Item 7; and

•
An increase in accrued interest related to our Corporate Bonds; offset by

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•
A net decrease in refunds owed to our PEO customers related to tax benefits allowed under the Coronavirus Aid, Relief, and Economic Security Act.

Investing Cash Flow Activities

Fiscal 2026

•
Net purchases of AFS securities related to investment in our long-term portfolio;

•
Cash used to develop and enhance our customer-facing internal-use software and the acquisition of third-party customer lists; and

•
Net purchases of short-term accounts receivable and an increase in funding to existing customers.

Fiscal 2025

•
Cash used primarily for the acquisition of Paycor. We financed the acquisition of Paycor by issuing fixed-rate corporate bonds Refer to Note D and Note N of the Notes to the Consolidated Financial Statements for additional discussion on these transactions;

•
Net purchases of short-term accounts receivable due to an increase in our customer base, and funding to existing customer base, and the timing of net cash collections; and

•
Cash used to develop and enhance our customer-facing internal-use software and the acquisition of third-party customer lists.

Financing Cash Flow Activities

Fiscal 2026

•
Cumulative dividends paid at $4.43 per share for fiscal 2026. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board;

•
Repurchases of 5.6 million shares of our common stock at a weighted-average price of $108.81. These shares were retired immediately upon purchase; and

•
Principal payments made on our Senior Notes A, which matured in March 2026, and short term borrowings on our Credit Facilities.

Fiscal 2025

•
Proceeds received from the issuance of Corporate Bonds. The proceeds received were used to acquire Paycor;

•
Cumulative dividends paid at $4.02 per share for fiscal 2025. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board; and

•
Repurchases of 0.8 million shares of our common stock at a weighted-average price of $125.50. These shares were retired immediately upon purchase.

Other

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

Critical Accounting Policies and Estimates

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

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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 when control of the contracted services is transferred to our clients, in an amount that reflects the consideration we expect to receive in exchange for such services. Our service revenue is largely attributable to processing services where the fee is based on a fixed amount per processing period, a fixed amount per processing period plus a fee per employee or transaction processed, or fee per employee per month or per processing period. Insurance Solutions revenues are recognized when commissions are earned on premiums billed and collected. Fees earned for the purchase of customer's accounts receivable under non-recourse arrangements are based on a percentage of funding amounts as specified in the customer contract. These fees are then recognized over the average collection period of 40 to 55 days for customers in the temporary staffing agency market and approximately 5 to 15 days for other customers. 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 cost of service revenue on the Consolidated Statements of Income and Comprehensive Income.

We receive advance payments for set-up fees from our customers. Advance payments received for certain of our service offerings for set-up fees are considered a material right. Therefore, we defer the revenue associated with these advance payments, recognizing the revenue and related expenses over the expected period to which the material right exists.

PEO Solutions revenue is included in service revenue and is reported net of certain pass-through costs billed and incurred, which include payroll wages, payroll taxes, including federal and state unemployment insurance, and certain health insurance benefit premiums, primarily costs related to our guaranteed cost benefit plans. Direct costs related to workers’ compensation and certain benefit plans where we retain risk are recognized as cost of service revenue rather than as a reduction in service revenue.

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

Assets Recognized from the Costs to Obtain and Fulfill Contracts: We recognize an asset for the incremental costs of obtaining a contract with a customer if it is expected that the economic benefit and amortization period will be longer than one year. Incremental costs of obtaining a contract include only those costs that are directly related to the acquisition of new contracts and that would not have been incurred if the contract had not been obtained. We do not incur incremental costs to obtain a contract renewal. We determined that certain sales commissions and bonuses, including related fringe benefits, meet the capitalization criteria under Accounting Standards Codification (“ASC”) Subtopic 340-40, “Other Assets and Deferred Costs: Contracts with Customers” (“ASC 340-40”). We also recognize an asset for the costs to fulfill a contract with a customer if the costs are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. We determined that substantially all costs related to implementation activities are administrative in nature and meet the capitalization criteria under ASC 340-40. These capitalized costs to fulfill a contract principally relate to upfront direct costs that are expected to be recovered and enhance our ability to satisfy future performance obligations.

The assets related to both costs to obtain and costs to fulfill contracts with customers are capitalized and amortized using either an accelerated method over an eight-year life or the straight-line method over a six-year life to closely align with the pattern of customer attrition over the estimated life of the customer relationship. We regularly review our deferred costs for potential impairment and did not recognize an impairment loss during fiscal 2026 or 2025.

PEO insurance reserves: As part of our PEO solution, we offer workers’ compensation insurance and health insurance to customers for the benefit of customer employees. Workers’ compensation insurance is primarily provided under fully insured high deductible workers’ compensation insurance policies. Workers’ compensation insurance reserves are established to provide for the estimated costs of paying claims up to per occurrence liability limits. These reserves include estimates of certain expenses associated with processing and settling these claims. In establishing the PEO workers’ compensation insurance reserves, we use an independent actuarial estimate of undiscounted future cash payments that would be made to settle claims. The determination of estimated ultimate losses by our independent actuary are based on accepted actuarial methods and assumptions. The estimated ultimate losses are primarily based upon loss development factors, and other factors such as the nature of employees’ job responsibilities, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates.

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With respect to our PEO health insurance, we offer various health insurance plans that take the form of either fully insured guaranteed cost plans or fully insured insurance arrangements where we retain risk. A reserve for insurance arrangements where we retain risk is established to provide for the payment of claims in accordance with our service contract with the carrier. The claims liability includes 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.

Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss experience and accepted actuarial methods and assumptions, 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. We regularly review the adequacy of our estimated insurance reserves. Adjustments to previously established reserves are reflected in the results of operations for the period in which the adjustment is identified. Such adjustments could possibly be significant, reflecting any combination of new and adverse or favorable trends. Adjustments to previously established reserves were not material for fiscal 2026 or 2025.

Goodwill and other intangible assets: Goodwill is not amortized, but instead is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change in a way to indicate that there has been a potential decline in the fair value of a reporting unit. We perform our annual impairment testing in our fiscal fourth quarter. During fiscal 2026 and 2025, a qualitative analysis was performed for all reporting units. The qualitative assessment considered various financial, macroeconomic, industry, and reporting unit specific qualitative factors. Based on the results of our testing, no impairment loss was recognized in the results of operations for fiscal 2026 or 2025. Subsequent to the latest review, there have been no events or circumstances that indicate any potential impairment of the Company’s goodwill balance.

We also test intangible assets with indefinite useful lives for potential impairment on an annual basis and between annual tests if events or changes in circumstances change in a way that indicate that the carrying value may not be recoverable. We have determined that there is no impairment of intangible assets with indefinite useful lives for fiscal 2026 or 2025 as a result of the qualitative analyses performed.

Impairment of Long-Lived Assets: Long-lived assets, including intangible assets with finite lives and operating lease right-of-use assets, 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. We have determined that there is no impairment of long-lived assets for fiscal 2026 or as of May 31, 2026.

Stock-based compensation costs: All stock-based awards to employees are recognized as compensation costs in our consolidated financial statements based on their fair values measured as of the date of grant. We estimate the fair value of stock option grants using a Black-Scholes option pricing model. This model requires various assumptions as inputs including expected volatility of the Paychex stock price and expected option life. 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. We periodically reassess our assumptions as well as our choice of valuation model. We 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 time-based 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 fair value of performance-based stock awards that include a market condition is estimated based on a Monte Carlo simulation. The Monte Carlo simulation requires various assumptions as inputs including the expected volatility of the Paychex stock price and the stock prices of the companies that comprise the designated peer group. Stock price volatility of the Company and the designated peer group is estimated based on historical volatility, using stock prices over a period equal to the measurement period of the award.

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

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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 a material impact on the estimated fair value of a future award. The Company periodically reassesses its assumptions as well as its choice of valuation models. The Company will reconsider use of its valuation models 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.

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

Business combinations: We account for acquisitions in accordance with the guidance in Financial Accounting Standards Board ASC Topic 805, Business Combinations, using the acquisition method of accounting. We allocate the purchase price consideration associated with its acquisitions to the fair values of assets acquired and liabilities assumed at their respective acquisition dates, with the excess recorded to goodwill. This allocation involves a number of assumptions, estimates, and judgments in determining fair value of the following:

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Intangible assets, including valuation methodology, estimations of future cash flows, discount rates, market segment growth rates, and our assumed market share, as well as the estimated useful life of intangible assets;

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Deferred tax assets and liabilities, uncertain tax positions, and tax-related valuation allowances, which are initially estimated as of the acquisition date;

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Goodwill as measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and liabilities assumed; and

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Pre-existing liabilities and legal claims, and contingent consideration, each as may be applicable.

Our assumptions and estimates are based upon comparable market data and information obtained from management and the management of the acquired companies. These assumptions and estimates are used to value assets acquired and liabilities assumed, and to allocate goodwill to the reporting units of the business that are expected to benefit from the business combination. Adjustments to the fair values of assets acquired and liabilities assumed may be recorded during the measurement period, which may be up to one year from the acquisition date, with the corresponding offset to goodwill. We may engage valuation specialists to assist in the fair value measurement of assets acquired and liabilities assumed for each acquisition.

Income taxes: We account for deferred taxes by recognizing 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. We record a deferred tax asset related to the stock-based compensation costs recognized for certain stock-based awards. At the time of the exercise of non-qualified stock options or vesting of stock awards, we recognize any excess tax benefit within income taxes in the Consolidated Statements of Income and Comprehensive Income.

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