AUTOMATIC DATA PROCESSING INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular dollars are presented in millions, except per share amounts) FORWARD-LOOKING STATEMENTS This document and other written or oral statements made from time to time by Automatic Data Processing, Inc. and its subsidiaries (“ADP” or the “Company”) may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and depend upon or refer to future events or conditions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements or that could contribute to such difference include: ADP's success in obtaining and retaining clients, and selling additional services to clients; the pricing of products and services; the success of our new solutions; compliance with existing or new legislation or regulations; changes in, or interpretations of, existing legislation or regulations; overall market, political and economic conditions, including interest rate and foreign currency trends; competitive conditions; our ability to maintain our current credit ratings and the impact on our funding costs and profitability; security or cyber breaches, fraudulent acts, and system interruptions and failures; employment and wage levels; changes in technology; availability of skilled technical associates; the impact of new acquisitions and divestitures; the adequacy, effectiveness and success of our business transformation initiatives; and the impact of and uncertainties related to major natural disasters or catastrophic events, including the coronaviru s ("COVID-19") pandemic. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. These risks and uncertainties, along with the risk factors discussed under “Item 1A. - Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2020 (“fiscal 2020”), and in other written or oral statements made from time to time by ADP, should be considered in evaluating any forward-looking statements contained herein. NON-GAAP FINANCIAL MEASURES In addition to our U.S. GAAP results, we use adjusted results and other non-GAAP metrics to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods. Adjusted EBIT, adjusted EBIT margin, adjusted net earnings, adjusted diluted earnings per share, adjusted effective tax rate and organic constant currency are all non-GAAP financial measures. Please refer to the accompanying financial tables in the “Non-GAAP Financial Measures” section for a discussion of why ADP believes these measures are important and for a reconciliation of non-GAAP financial measures to their comparable GAAP financial measures. 24 EXECUTIVE OVERVIEW Highlights from the three months ended September 30, 2020 include: We are a leading global provider of cloud-based Human Capital Management (“HCM”) technology solutions to employers around the world. The global COVID-19 pandemic has had a significant impact on the global business environment and on our clients, but our priority has been and continues to be the safety of our associates and the needs of our clients, and we have continued to provide HCM services, including process payroll and tax obligations, to our clients during this time. ADP's efforts have also been focused on providing information and tools to help clients understand and navigate the governmental relief that has been adopted globally. In addition, we released a Return to Workplace solution that assists our clients in bringing their employees back to work safely through a comprehensive set of tools designed to streamline the entire process. Despite on-going headwinds related to COVID-19, we have seen some improvements in our reported metrics. Our pays per control metric, which represents growth of the employee base for a large portion of our client base, showed a decline of 9% in the three months ended September 30, 2020 compared to a decline of 11% in the three months ended June 30, 2020. Employer Services New Business Bookings grew 2% for the three months ended September 30, 2020, as economic conditions began to stabilize and we saw our clients and prospects show a greater willingness to engage and invest in new HCM solutions. The PEO average number of Worksite Employees decreased 3% for the three months ended September 30, 2020. In addition, we continue to move forward with our digital and procurement transformation initiatives and delivered profit growth and margin expansion for the three months ended September 30, 2020. We continue to drive innovation by anticipating our clients' evolving needs as the world of work changes as we are always designing for people. We are leading the HCM industry with innovations like our next gen platforms and driving growth through our strategic, cloud-based HCM solutions. We further enable these solutions by supplementing them with organic, differentiated investments such as the ADP Marketplace and ADP Datacloud, and through our compliance expertise. The recognition we have received in the market for our next gen payroll platform and in winning this year's HR Executive 'Top HR Product' award reflect our commitment to innovation and strong execution by our associates. We have a strong business model, a highly cash generative business with low capital intensity, and offer a suite of products that provide critical HCM support to our clients. We generate sufficient free cash flow to satisfy our cash dividend and our modest debt obligations, which enables us to absorb the impact of downturns and remain steadfast in our reinvestments, our longer term strategy, and our commitments to shareholder friendly actions. We are committed to building upon our past successes by investing in our business through enhancements in research and development and by driving meaningful transformation in the way we operate. Our financial condition remains solid at September 30, 2020 and we remain well positioned to support our associates and our clients. 25 RESULTS AND ANALYSIS OF CONSOLIDATED OPERATIONS Total Revenues For the three months ended September 30: Growth: â 1% Organic constant currency: â 1% Revenues for the three months ended September 30, 2020 decreased due to an impact from lower New Business Bookings during the fourth quarter of fiscal 2020, a decrease in our pays per control and a decrease in our interest earned on funds held for clients discussed below. These decreases were partially offset by strong retention . Refer to “Analysis of Reportable Segments” for additional discussion of the changes in revenue for both of our reportable segments, Employer Services and Professional Employer Organization (“PEO”) Services, respectively. Total revenues for the three months ended September 30, 2020 include interest on funds held for clients of $106.5 million, as co mpared to $133.9 million for the three months ended September 30, 2019. The decrease in the consolidated interest earned on funds held for clients resulted from th e decrease in our average interest rate earned to 1.9% for the three months ended September 30, 2020, as compared to 2.3% for the three months ended September 30, 2019, coupled wi th a decrease in our average client funds balance of 7.2% to $22.0 billion for th e three months ended September 30, 2020, as compared to the three months ended September 30, 2019. Total Expenses Three Months Ended September 30, 2020 2019 % Change Costs of revenues: Operating expenses $ 1,762.1 $ 1,787.7 (1) % Systems development and programming costs 168.7 168.2 — % Depreciation and amortization 103.5 88.9 16 % Total costs of revenues 2,034.3 2,044.8 (1) % Selling, general and administrative expenses 681.0 726.5 (6) % Interest expense 15.1 39.9 (62) % Total expenses $ 2,730.4 $ 2,811.2 (3) % Operating expe nses decreased due to reduced costs from certain cost and headcount actions as a result of our broad-based transformation initiatives, including digital and procurement transformation initiatives, and excess capacity headcount actions. Additionally, operating expenses decreased due to reduced travel and entertainment expenses, decreased pension costs as a result of eliminated U.S. pension service costs with the July 1, 2020 cessation of U.S. participants accruing any future service benefits, and a favorable c hange in our estimated losses related to ADP Indemnity in the three months ended September 30, 2020 . These decreases were partially offset by an increase in our PEO Services zero-margin benefits pass-through costs to $741.0 million fro m $699.1 million for the three months ended September 30, 2020 and 2019, respectively. 26 Systems development and programming costs were flat for the three months ended September 30, 2020 due to increased investments and costs to develop, support, and maintain our products, offset by capitalization of costs related to our strategic projects, including our next gen platforms. Depreciation and amortization expense increased due to the amortization of our acquisitions of intangibles and internally developed software. Selling, general and administrative expenses decreased for the three months ended September 30, 2020 due to decreased selling and marketing expenses and reduced facilities costs and travel and entertainment expenses. Additionally, selling, general and administrative expenses decreased due to reduced costs from certain cost and headcount actions as a result of our broad-based transformation initiatives, including procurement transformation initiatives, and excess capacity headcount actions. Interest expense decreased for the three months ended September 30, 2020 due to a decrease in average interest rates for commercial paper borrowings to 0.1% for the three months ended September 30, 2020, as compared to 2.3% for the three months ended September 30, 2019 coupled with a decrease in average daily borrowings under our commercial paper program to $2.4 billion for the three months ended September 30, 2020, as compared to $4.0 billion for the three months ended September 30, 2019 . Other (Income)/Expense, net Three Months Ended September 30, 2020 2019 $ Change Interest income on corporate funds $ (13.8) $ (32.3) $ (18.5) Realized (gains) / losses on available-for-sale securities, net (0.3) (2.3) (2.0) Impairment of assets 2.8 — (2.8) Gain on sale of assets (0.2) (1.9) (1.7) Non-service components of pension income, net (13.4) (18.1) (4.7) Other (income)/expense, net $ (24.9) $ (54.6) $ (29.7) Other (income)/expense, net, decreased $29.7 million for the three months ended September 30, 2020, as compared to the three months ended September 30, 2019. The decrease is primarily due to a decrease in interest income on corporate funds due to lower interest rates earned, a decrease in non-service components of pension income, net, and impairment charges of $2.8 million recorded in the three months ended September 30, 2020 as a r esult of recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale. Earnings Before Income Taxes For the three months ended September 30: Growth: á 4% á 90bps Earnings bef ore income taxes increased for the three months ended September 30, 2020 due to the decreases in expenses discussed above. 27 Margin increased for the three months ended September 30, 2020 as a result of reduced costs from certain cost and headcount actions as a result of our broad-based transformation initiatives, including digital and procurement transformation initiatives, and excess capacity headcount actions. In addition, our margin improvement was aided by decreased interest expense, decreased selling and marketing expenses, reduced facilities costs and travel and entertainment expenses, decreased pension costs and a change in our estimated losses related to ADP Indemnity. These were partially offset by incremental pressure from growth in our zero-margin benefits pass-throughs and an increase in amortization expense. Adjusted Earnings before certain Interest and Taxes ("Adjusted EBIT") For the three months ended September 30: Growth: á 5% á 120bps Adjusted EBIT and Adjusted EBIT margin exclude certain interest amounts, net charges related to our broad-based transformation initiatives and the impact of the net severance charges related to excess capacity as applicable in the respective periods. Provision for Income Taxes The effective tax rate for the three months ended September 30, 2020 and 2019 was 21.3% and 21.2%, respectively. The increase in the effective tax rate is primarily due to a decrease in the excess tax benefit on stock-based compensation partially offset by favorable adjustments to prior year tax liabilities in the three months ended September 30, 2020. Adjusted Provision for Income Taxes The adjusted effective tax rate for the three months ended September 30, 2020 and 2019 was 21.3% and 21.2%, respectively. The drivers of the adjusted effective tax rate are the same as the drivers of the effective tax rate discussed above. 28 Net Earnings and Diluted EPS For the three months ended September 30: Growth: á 3% á 4% For the three months ended September 30, 2020, net earnings reflect the changes described above in our earnings before income taxes and our effective tax rate. For the three months ended September 30, 2020, diluted EP S increased as a result of an increase in net earnings and the impact of fewer shares outstanding resulting from the repurchase of approxima tely 1.7 million shares during the three months ended September 30, 2020 and 1.9 million shares for the three months ended September 30, 2019, partially offset by the issuances of shares under our employee benefit plans. Adjusted Net Earnings and Adjusted Diluted EPS For the three months ended September 30: Growth: á 4% á 5% For the three months ended September 30, 2020, adjusted net earnings reflect the changes described above in our adjusted EBIT and our adjusted effective tax rate. For the three months ended September 30, 2020, adjusted diluted EPS reflects the changes described above in our adjusted net earnings and shares outstanding. 29 ANALYSIS OF REPORTABLE SEGMENTS Revenues Three Months Ended September 30, % Change 2020 2019 As Reported Organic constant currency Employer Services $ 2,376.8 $ 2,441.4 (3) % (3) % PEO Services 1,095.9 1,056.9 4 % 4 % Other (2.0) (2.6) n/m n/m $ 3,470.7 $ 3,495.7 (1) % (1) % Earnings before Income Taxes Three Months Ended % Change September 30, 2020 2019 As Reported Employer Services $ 689.3 $ 679.4 1 % PEO Services 159.4 149.3 7 % Other (83.5) (89.6) n/m $ 765.2 $ 739.1 4 % n/m - not meaningful Employer Services Revenues Revenues decreased for the three months ended September 30, 2020 due to an impact from lower New Business Bookings during the fourth quarter of fiscal 2020, a decrease in our pays per control of 9% and a decrease in interest earned on funds held for clients. These decreases were partially offset by strong retention. Our pays per control metric measures the number of employees on our clients' payrolls as measured on a same-store-sales basis utilizing a representative subset of payrolls ranging from small to large businesses that are reflective of a broad range of U.S. geographic regions. Earnings before Income Taxes Employer Services' earnings before income taxes increased for the three months ended September 30, 2020 due to decreases in expenses. The decreases in expenses were due to reduced costs from certain cost and headcount actions as a result of our broad-based transformation initiatives, including digital and procurement transformation initiatives, and excess capacity headcount actions. Additionally, decreases in expenses were due to a decrease in selling and marketing expenses and reduced facilities costs and travel and entertainment expenses. These decreases were partially offset by an increase in amortization expense. 30 For the three months ended September 30, respectively: Growth: á 120bps Employer Services' m argin increased for the three months ended September 30, 2020 as a result of reduced costs from certain cost and headcount actions as a result of our broad-based transformation initiatives, including digital and procurement initiatives, and excess capacity headcount actions. In addition, our margin improvement was aided by decreased selling and marketing expenses and reduced travel and entertainment expenses. These were partially offset by an increase in amortization expense. PEO Services Revenues PEO Revenues Three Months Ended Change September 30, 2020 2019 $ % PEO Services' revenues $ 1,095.9 $ 1,056.9 $ 39.0 4 % Less: PEO zero-margin benefits pass-throughs 741.0 699.1 41.9 6 % PEO Services' revenues excluding zero-margin benefits pass-throughs $ 354.9 $ 357.8 $ (2.9) (1) % PEO Services' revenu es increased 4% fo r the three months ended September 30, 2020, due to an increase in zero-margin benefits pass-throughs partially offset by a 3% decrease in the average number of Worksite Employees for the three months ended September 30, 2020. Additionally, PEO Services' revenues, excluding zero-margin benefits pass-through costs, decrea sed by 1% for the three months ended September 30, 2020. Earnings before Income Taxes PEO Services' earni ngs before income taxes increased 7% for the three months ended September 30, 2020 due to a change in our estimated losses related to ADP Indemnity and a decrease in selling expenses in the three months ended September 30, 2020, as com pared to the three months ended September 30, 2019. 31 For the three months ended September 30, respectively: Growth: á 40bps PEO Services' ma rgin increased for the three months ended September 30, 2020 , due to a change in our estimated losses related to ADP Indemnity and a decrease in selling expenses in the three months ended September 30, 2020, as compared to the three months ended September 30, 2019. ADP Indemnity provides workers’ compensation and employer’s liability deductible reimbursement insurance protection for PEO Services’ worksite employees up to $1 million per occurrence. PEO Services has secured a workers’ compensation and employer’s liability insurance policy that has a $1 million per occurrence retention and, in fiscal years 2012 and prior, aggregate stop loss insurance that covers any aggregate losses within the $1 million retention that collectively exceed a certain level, from an admitted and licensed insurance company of AIG. We utilize historical loss experience and actuarial judgment to determine the estimated claim liability, and changes in estimated ultimate incurred losses are included in the PEO segment. ADP Indemnity recorded a pre-tax benefit of approximately $10.4 million for the three months ended September 30, 2020, compared to approximately $3.4 million for the three months ended September 30, 2019, which were primarily a result of changes in our estimated actuarial losses. Beginning in fiscal year 2013, ADP Indemnity paid premiums to enter into reinsurance arrangements with ACE American Insurance Company, a wholly-owned subsidiary of Chubb Limited, to cover substantially all losses incurred by ADP Indemnity during these policy years. Each of these reinsurance arrangements limits our overall exposure incurred up to a certain limit. We believe the likelihood of ultimate losses exceeding this limit is remote . For the three months ended September 30, 2020, ADP Indemnity paid a premium of $240 million t o enter into a reinsurance arrangement with Chubb Limited to cover substantially all losses incurred by ADP Indemnity for the fiscal 2021 policy year on terms substantially similar to the fiscal 2020 reinsurance policy. Other The primary components of “Other” are certain corporate overhead charges and expenses that have not been allocated to the reportable segments, including corporate functions, costs related to our transformation office, severance costs, non-recurring gains and losses, the elimination of intercompany transactions, and other interest expense. 32 Non-GAAP Financial Measures In addition to our U.S. GAAP results, we use the adjusted results and other non-GAAP metrics set forth in the table below to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods: Adjusted Financial Measure U.S. GAAP Measures Adjusted EBIT Net earnings Adjusted provision for income taxes Provision for income taxes Adjusted net earnings Net earnings Adjusted diluted earnings per share Diluted earnings per share Adjusted effective tax rate Effective tax rate Organic constant currency Revenues We believe that the exclusion of the identified items helps us reflect the fundamentals of our underlying business model and analyze results against our expectations and against prior period, and to plan for future periods by focusing on our underlying operations. We believe that the adjusted results provide relevant and useful information for investors because it allows investors to view performance in a manner similar to the method used by management and improves their ability to understand and assess our operating performance. The nature of these exclusions is for specific items that are not fundamental to our underlying business operations. Since these adjusted financial measures and other non-GAAP metrics are not measures of performance calculated in accordance with U.S. GAAP, they should not be considered in isolation from, as a substitute for, or superior to their corresponding U.S. GAAP measures, and they may not be comparable to similarly titled measures at other companies. 33 Three Months Ended % Change September 30, 2020 2019 As Reported Net earnings $ 602.1 $ 582.4 3 % Adjustments: Provision for income taxes 163.1 156.7 All other interest expense (a) 14.1 14.8 All other interest income (a) (1.8) (8.4) Transformation initiatives (b) 0.8 (0.6) Excess capacity severance charges (c) 2.4 — Adjusted EBIT $ 780.7 $ 744.9 5 % Adjusted EBIT Margin 22.5 % 21.3 % Provision for income taxes $ 163.1 $ 156.7 4 % Adjustments: Transformation initiatives (d) 0.2 (0.2) Excess capacity severance charges (d) 0.6 — Adjusted provision for income taxes $ 163.9 $ 156.5 5 % Adjusted effective tax rate (e) 21.3 % 21.2 % Net earnings $ 602.1 $ 582.4 3 % Adjustments: Transformation initiatives (b) 0.8 (0.6) Income tax (benefit)/ provision for transformation initiatives (d) (0.2) 0.2 Excess capacity severance charges (c) 2.4 — Income tax benefit for excess capacity severance charges (d) (0.6) — Adjusted net earnings $ 604.5 $ 582.0 4 % Diluted EPS $ 1.40 $ 1.34 4 % Adjustments: Transformation initiatives (b) (d) — — Excess capacity severance charges (c) (d) — — Adjusted diluted EPS $ 1.41 $ 1.34 5 % (a) We include the interest income earned on investments associated with our client funds extended investment strategy and interest expense on borrowings related to our client funds extended investment strategy as we believe these amounts to be fundamental to the underlying operations of our business model. The adjustments in the table above represent the interest income and interest expense that are not related to our client funds extended investment strategy and are labeled as “All other interest expense” and “All other interest income.” (b) In the three months ended September 30, 2020 , transformation initiatives include charges of $2.8 million related to impairment charges as a result of recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale and net reversals of charges related to transformation initiatives of $2.0 million. Unlike certain other severance charges in prior periods that are not included as an adjustment to get to adjusted results, these specific charges relate to actions that are part of our broad-based, company-wide transformation initiatives. (c) Represents net severance cost related to excess capacity. Unlike certain other severance charges in prior periods that are not included as an adjustment to get to adjusted results, these specific charges relate to actions that are part of our broad-based, company-wide initiatives to address excess capacity across our business and functions. (d) The income tax (benefit)/ provision was calculated based on the annualized marginal rate in effect during the quarter of the adjustment. 34 (e) The Adjusted effective tax rate is calculated as our Adjusted provision for income taxes divided by the sum of our Adjusted net earnings plus our Adjusted provision for income taxes. The following table reconciles our reported growth rates to the non-GAAP measure of organic constant currency, which excludes the impact of acquisitions, the impact of dispositions, and the impact of foreign currency. The impact of acquisitions and dispositions is calculated by excluding the current year revenues of acquisitions until the one-year anniversary of the transaction and by excluding the prior year revenues of divestitures for the one-year period preceding the transaction. The impact of foreign currency is determined by calculating the current year result using foreign exchange rates consistent with the prior year. The PEO segment is not impacted by acquisitions, dispositions or foreign currency. Three Months Ended September 30, 2020 Consolidated revenue growth as reported (1) % Adjustments: Impact of acquisitions — % Impact of foreign currency — % Consolidated revenue growth, organic constant currency (1) % Employer Services revenue growth as reported (3) % Adjustments: Impact of acquisitions — % Impact of foreign currency — % Employer Services revenue growth, organic constant currency (3) % FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2020, cash and cash equivalents w ere $1.6 billion, which were primarily invested in time deposits and money market funds. For corporate liquidity, we expect existing cash, cash equivalents, short-term marketable securities, cash flow from operations together with our $9.7 billion of co mmitted credit facilities and our ability to access both long-term and short-term debt financing from the capital markets will be adequate to meet our operating, investing, and financing activities such as regular quarterly dividends, share repurchases, and capital expenditures for the foreseeable future. Our financial condition remains solid at September 30, 2020 and we have sufficient liquidity as noted above; how ever, given the continuing uncertainty in the rapidly changing market and economic conditions related to the COVID-19 pandemic, we will continue to evaluate the nature and extent of the impact to our financial condition and liquidity. For client funds liquidity, we have the ability to borrow through our financing arrangements under our U.S. short-term commercial paper program and our U.S., Canadian and United Kingdom short-term reverse repurchase agreements, together with our $9.7 billion of committed credit facilities and our ability to use corporate liquidity when necessary to meet short-term funding requirements related to client funds obligations. Please see “Quantitative and Qualitative Disclosures about Market Risk” for a further discussion of the risks, including with respect to the COVID-19 pandemic, related to our client funds extended investment strategy. See Note 9 of our Consolidated Financial Statements for a description of our short-term financing including commercial paper. 35 Operating, Investing and Financing Cash Flows Our cash flows from operating, investing, and financing activities, as reflected in the Statements of Consolidated Cash Flows for the three months ended September 30, 2020 and 2019, respectively, are summarized as follows: Three Months Ended September 30, 2020 2019 $ Change Cash provided by / (used in): Operating activities $ 481.9 $ 432.8 $ 49.1 Investing activities 264.2 122.2 142.0 Financing activities 2,524.1 (5,045.9) 7,570.0 Effect of exchange rate changes on cash, cash equivalents, restricted cash, and restricted cash equivalents 37.9 (33.1) 71.0 Net change in cash, cash equivalents, restricted cash, and restricted cash equivalents $ 3,308.1 $ (4,524.0) $ 7,832.1 Net cash flows provided by operating activities for the three months ended September 30, 2020 and September 30, 2019 include cash payments for reinsurance agreements of $240.0 million and $215.0 million, respectively, which represent the policy premium for the entire fiscal ye ar. The increase in operating cash provided is primarily due to growth in our business supplemented by net favorable change in the components of working capital as compared to the three months ended September 30, 2019. Net cash flows from investing activities changed due to the timing of proceeds and purchases of corporate and client funds marketable securities of $140.1 million, lower payments related to acquisitions of intangibles and payments related to capital expenditures partially offset by lower proceeds from the sale of assets i n the three months ended September 30, 2020. Net cash flows from financing activities changed due to a net increase in the cash flow from client funds obligations of $11,266.6 million, w hich is due to the timing of impounds from our clients and payments to our clients' employees and other pay ees, proceeds from debt issuance, and less cash paid for share repurchases. These were partially offset by a decrease of net proceeds of commercial paper, payments of debt, a net repayment of reverse repurchase agreements, more cash returned to shareholders via dividends, and settlement of cash flow hedges in the three months ended September 30, 2020. We purchase d approxima tely 1.7 million shares of our common stock at an average pric e per share of $136.55 duri ng the three months ended September 30, 2020, as compared to purchases of 1.9 million shares at an average price per share of $164.80 during the three months ended September 30, 2019. From time to time, the Company may repurchase shares of its common stock under its authorized share repurchase program. The Company considers several factors in determining when to execute share repurchases, including, among other things, actual and potential acquisition activity, cash balances and cash flows, issuances due to employee benefit plan activity, and market conditions. Capital Resources and Client Funds Obligations We have $2.0 billion of senior unsecured notes with maturity dates in 2025 and 2030. We may from time to time revisit the long-term debt market to refinance existing debt, finance investments including acquisitions for our growth, and maintain the appropriate capital structure. However, there can be no assurance that volatility in the global capital and credit markets would not impair our ability to access these markets on terms acceptable to us, or at all. See Note 10 of our Consolidated Financial Statements for a description of our long-term financing. Our U.S. short-term funding requirements related to client funds are sometimes obtained on an unsecured basis through the issuance of commercial paper, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. This commercial paper program provides for the issuance of up to $9.7 billion in aggregate maturity value. Our commercial paper program is rated A-1+ by Standard & Poor’s and Prime-1 (“P-1”) by Moody’s. These ratings denote the highest quality commercial paper securities. Maturities of commercial paper can range from overnight to up to 364 day s. At September 30, 2020 and June 30, 2020, the Company had no commercial paper borrowing outstanding. Det ails of the borrowings under the commercial paper program are as follows: 36 Three Months Ended September 30, 2020 2019 Average daily borrowings (in billions) $ 2.4 $ 4.0 Weighted average interest rates 0.1 % 2.3 % Weighted average maturity (approximately in days) 1 day 2 days Our U.S., Canadian, and United Kingdom short-term funding requirements related to client funds obligations are sometimes obtained on a secured basis through the use of reverse repurchase agreements, which are collateralized principally by government and government agency securities, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. These agreements generally have terms ranging from overnight to up to five business days. We have successfully borrowed through the use of reverse repurchase agreements on an as-needed basis to meet short-term funding requirements related to client funds obligations. At September 30, 2020, there were no outstanding obligations related to reverse repurchase agreements. At June 30, 2020, the Company had $13.6 million of outstanding obligations related to the reverse repurchase agreements. Details of the reverse repurchase agreements are as follows: Three Months Ended September 30, 2020 2019 Average outstanding balances $ 152.4 $ 426.6 Weighted average interest rates 0.3 % 2.0 % We vary the maturities of our committed credit facilities to limit the refinancing risk of any one facility. We have a $3.2 billion, 364-day credit agreement that matures in June 2021 with a one year term-out option. In addition, we have a five-year $2.75 billion credit facility and a five-year $3.75 billion credit facility maturing in June 2024 and June 2023, respectively, each with an accordion feature under which the aggregate commitment can be increased by $500 million, subject to the availability of additional commitments. The primary uses of the credit facilities are to provide liquidity to the commercial paper program and funding for general corporate purposes, if necessary. We had no borrowings through September 30, 2020 under the credit facilities. We believe that we currently meet all conditions set forth in the revolving credit agreements to borrow thereunder and we are not aware of any conditions that would prevent us from borrowing part or all of the $9.7 billion available to us under the revolving credit agreements. See Note 9 of our Consolidated Financial Statements for a description of our short-term financing including credit facilities. Our investment portfolio does not contain any asset-backed securities with underlying collateral of sub-prime mortgages, alternative-A mortgages, sub-prime auto loans or sub-prime home equity loans, collateralized debt obligations, collateralized loan obligations, credit default swaps, derivatives, auction rate securities, structured investment vehicles or non-investment grade fixed-income securities. We own AAA-rated senior tranches of primarily fixed rate auto loan, credit card, equipment lease, and rate reduction receivables, secured predominantly by prime collateral. All collateral on asset-backed securities is performing as expected. In addition, we own senior debt directly issued by Federal Farm Credit Banks and Federal Home Loan Banks. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). This investment strategy is supported by our short-term financing arrangements necessary to satisfy short-term funding requirements relating to client funds obligations. See Note 6 of our Consolidated Financial Statements for a description of our corporate investments and funds held for clients. Capital expenditures for the three months ended September 30, 2020 were $45.2 million , as compared to $52.2 million for the three months ended September 30, 2019. We expect capital expenditures in fiscal 2021 to be between $175 million and $200 million , as compared to $168.3 million in fiscal 2020. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our overall investment portfolio is comprised of corporate investments (cash and cash equivalents, short-term marketable securities) and client funds assets (funds that have been collected from clients but have not yet been remitted to the applicable tax authorities or client employees). 37 Our corporate investments are invested in cash and cash equivalents and highly liquid, investment-grade marketable securities. These assets are available for our regular quarterly dividends, share repurchases, capital expenditures and/or acquisitions, as well as other corporate operating purposes. All of our short-term fixed-income securities are classified as available-for-sale securities. Our client funds assets are invested with safety of principal, liquidity, and diversification as the primary objectives. Consistent with those objectives, we also seek to maximize interest income and to minimize the volatility of interest income. Client funds assets are invested in highly liquid, investment-grade marketable securities, with a maximum maturity of 10 years at the time of purchase, and money market securities and other cash equivalents. We utilize a strategy by which we extend the maturities of our investment portfolio for funds held for clients and employ short-term financing arrangements to satisfy our short-term funding requirements related to client funds obligations. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). As part of our client funds investment strategy, we use the daily collection of funds from our clients to satisfy other unrelated client funds obligations, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. In circumstances where we experience a reduction in employment levels due to a slowdown in the economy, we may make tactical decisions to sell certain securities in order to reduce the size of the funds held for clients to correspond to client funds obligations. We minimize the risk of not having funds collected from a client available at the time such client’s obligation becomes due by impounding, in virtually all instances, the client’s funds in advance of the timing of payment of such client’s obligation. As a result of this practice, we have consistently maintained the required level of client funds assets to satisfy all of our obligations. There are inherent risks and uncertainties involving our investment strategy relating to our client funds assets. Such risks include liquidity risk, including the risk associated with our ability to liquidate, if necessary, our available-for-sale securities in a timely manner in order to satisfy our client funds obligations. However, our investments are made with the safety of principal, liquidity, and diversification as the primary goals to minimize the risk of not having sufficient funds to satisfy all of our client funds obligations. We also believe we have significantly reduced the risk of not having sufficient funds to satisfy our client funds obligations by consistently maintaining access to other sources of liquidity, including our corporate cash balances, available borrowings under our $9.7 billion commercial paper program (rated A-1+ by Standard and Poor’s and P-1 by Moody’s, the highest possible short-term credit ratings), and our ability to engage in reverse repurchase agreement transactions and available borrowings under our $9.7 billion committed credit facilities. The reduced availability of financing during periods of economic turmoil, including the COVID-19 pandemic, even to borrowers with the highest credit ratings, may limit our ability to access short-term debt markets to meet the liquidity needs of our business. In addition to liquidity risk, our investments are subject to interest rate risk and credit risk, as discussed below. We have established credit quality, maturity, and exposure limits for our investments. The minimum allowed credit rating at time of purchase for corporate, Canadian government agency and Canadian provincial bonds is BBB, for asset-backed securities is AAA, and for municipal bonds is A. The maximum maturity at time of purchase for BBB-rated securities is 5 years, for single A rated securities is 7 years, and for AA-rated and AAA-rated securities is 10 years. Time deposits and commercial paper must be rated A-1 and/or P-1. Money market funds must be rated AAA/Aaa-mf. 38 Details regarding our overall investment portfolio are as follows: Three Months Ended September 30, 2020 2019 Average investment balances at cost: Corporate investments $ 4,234.4 $ 6,055.0 Funds held for clients 21,970.9 23,681.4 Total $ 26,205.3 $ 29,736.4 Average interest rates earned exclusive of realized (gains)/losses on: Corporate investments 1.3 % 2.1 % Funds held for clients 1.9 % 2.3 % Total 1.8 % 2.2 % Net realized (gains)/losses on available-for-sale securities $ (0.3) $ (2.3) September 30, 2020 June 30, 2020 Net unrealized pre-tax gains on available-for-sale securities $ 851.9 $ 876.8 Total available-for-sale securities at fair value $ 21,205.1 $ 21,576.6 We are exposed to interest rate risk in relation to securities that mature, as the proceeds from maturing securities are reinvested. Factors that influence the earnings impact of interest rate changes include, among others, the amount of invested funds and the overall portfolio mix between short-term and long-term investments. This mix varies during the fiscal year and is impacted by daily interest rat e changes. The annualized interest rate earned on our entire portfolio decreased from 2.2% for the three months ended September 30, 2019 to 1.8% for t he three months ended September 30, 2020. A hypothetical change in both short-term interest rates (e.g., overnight interest rates or the federal funds rate) and intermediate-term interest rates of 25 basis points applied to the estimated average investment balances and any related short-term borrowings would result in approximately a $22 million im pact to earnings before income taxes over the ensuing twelve-month period ending September 30, 2021. A hypothetical change in only short-term interest rates of 25 basis points applied to the estimated average short-term investment balances and any related short-term borrowings would result in approximately a $7 million impact to earnings before income taxes over the ensuing twelve-month period ending September 30, 2021. We are exposed to credit risk in connection with our available-for-sale securities through the possible inability of the borrowers to meet the terms of the securities. We limit credit risk by investing in investment-grade securities, primarily AAA-rated and AA- rated securities, as rated by Moody’s, Standard & Poor’s, DBRS for Canadian dollar denominated securities, and Fitch for asset-backed and commercial-mortgage-backed securities. Approxi mately 79% of ou r available-for-sale securities held a AAA-rating or AA-rating at September 30, 2020. In addition, we limit amounts that can be invested in any security other than U.S. government and government agency, Canadian government, and United Kingdom government securities. We operate and transact business in various foreign jurisdictions and are therefore exposed to market risk from changes in foreign currency exchange rates that could impact our consolidated results of operations, financial position, or cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We may use derivative financial instruments as risk management tools and not for trading purposes. 39 CRITICAL ACCOUNTING POLICIES Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenues, expenses, and other comprehensive income. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. In addition, as the duration and severity of the COVID-19 pandemic are uncertain, certain of our estimates could require further judgment or modification and therefore carry a higher degree of variability and volatility. As events continue to evolve, our estimates may change materially in future periods. Refer to Note 2 of our Consolidated Financial Statements for changes to our accounting policies effective for the fiscal 2021. NEW ACCOUNTING PRONOUNCEMENTS See Note 2, New Accounting Pronouncements, of Notes to the Consolidated Financial Statements for a discussion of recent accounting pronouncements. Item 3. Quantitative and Qualitative Disclosures About Market Risk The information called for by this item is provided under the caption “Quantitative and Qualitative Disclosures about Market Risk” under Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations.