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Financial Highlights
In millions, except per share amounts
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 Increase
- -------------------------------------------------------------------------------
Service revenues $728.1 $597.3 22%
Operating income $258.9 $187.6 38%
As a percent of service revenues 36% 31%
Net income $190.0 $139.1 37%
As a percent of service revenues 26% 23%
Diluted earnings per share $ .51 $ .37 38%
Cash dividends per common share $ .22 $ .15 47%
Return on stockholders' equity 38% 36%
===============================================================================
[Graphics on this page omitted]
The following table was depicted in bar graphs in the printer material.
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
Service Revenues (millions $) $333.3 $399.7 $493.7 $597.3 $728.1
Operating Income (millions $) $ 69.9 $ 96.6 $134.7 $187.6 $258.9
Net Income (millions $) $ 55.0 $ 75.2 $102.2 $139.1 $190.0
Payroll Clients (thousands) 234.3 262.7 293.6 322.6 351.9
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To Our Shareholders
The year 2000 was a very successful year for Paychex, and I am pleased to
review the highlights.
For the tenth straight year our service revenues and net income set new
records. It was the ninth consecutive year of net income growth of 36% or more.
For the year ended May 31, 2000, Paychex earned net income of $190.0 million,
a 37% increase over 1999. Total service revenue increased 22% over last year to
$728.1 million and operating income grew 38% to $258.9 million during the same
period. Our balance sheet remains strong, with $459.5 million of cash and
investments. Return on equity was 38%. Cash flow from operations was $249.0
million. Paychex has no outstanding notes or mortgages.
Diluted earnings per share were $.51, compared to $.37 a year ago. During
October 1999, we increased out dividend by 50% for the eighth consecutive year.
In April 2000, the board of directors approved a three-for-two stock split.
That was the tenth split of this type since our initial public offering in
1983, and the sixth in the last six years.
Successful application of our growth formula, which has generated consistent
results for many years, was the primary force creating our strong
year-over-year profits. Our business model focuses on increasing client counts,
implementation of modest price increases, higher client utilization of
ancillary products, and introducing new products that leverage off our fixed
infrastructure and the capabilities Paychex brings to its clients.
During fiscal 2000, payroll service revenue grew 20% to $653.2 million, with
operating income increasing 28% to $303.4 million. This growth was led by our
new Flexible Pay Package, which significantly increased the use of ancillary
services by clients.
We were especially pleased this year by the presentation of the George
Mitchell Payment Systems Excellence Award to Paychex. This was conferred by the
National Automated Clearing House Association, which oversees electronic money
transfers between businesses and the nation's 13,000 depository financial
institutions. The award was particularly appreciated because it represented the
financial industry's recognition of Paychex as a leader in electronic payment
services.
We have expanded our Major Market Services (MMS) payroll offering to include
forty-four of the markets served by our core payroll service. MMS revenues were
up 55% this fiscal year. Businesses served by MMS are larger, more likely to be
interested in ancillary services, and deliver per-client revenues that are
substantially more than those of our smaller clients. Therefore, we expect MMS
to be a solid contributor and one that should show continued growth into the
future.
For the year, HRS-PEO service revenue increased 44% to $74.9 million with
operating income advancing 111% to $23.4 million. This segment now produces
over 10% of our total revenue and has become an increasingly significant
producer for Paychex. A 46% increase in the number of 401(k) recordkeeping
clients reflected expansion of the sales force during fiscal 1999.
At the beginning of the new millennium two topics were foremost for American
business; the Y2k computer problem and the impact of the Internet. For Paychex,
the Y2k bug was a non-event, with zero systems problems encountered. However,
it was not without effort and will return dividends in coming years.
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The Internet has opened a dynamic communications channel that is without
geographic or time boundaries. Our corporate Web site - www.paychex.com - has
been operational since 1996. It, together with our other Internet initiatives,
has continuously evolved as a resource for expanding our geographic reach,
improving the efficiency of product delivery, providing another channel for
communication of the Paychex brand, and delivery of products and services to
both clients and the professional accounting community.
We believe the Internet will continue to enhance the way prospects, clients,
and their accountants interact with us. This year, the rollout of Paychex
Online, and several other Paychex Internet initiatives provided proof of this.
An online payroll sales presentation placed on our site last March quickly
began providing a stream of high-quality, low-cost sales leads with a high
closing rate. Two new services - Internet Time Sheet and Ledger Reporting
Online - were introduced this year, joining our enhanced Reports Online, which
was introduced during fiscal 1999. Available twenty-four hours a day, seven
days a week, these Internet capabilities bring added convenience and utility to
the business owners and accountants who use our payroll services. Soon we will
provide retirement account Internet access for the employees of our clients who
have 401(k) plans.
Each of these capabilities establishes a new means by which our
clients or their employees can exchange information with Paychex in a fast,
convenient, and cost-effective manner. These services demonstrate that the
technology of the Internet can be profitably integrated with an established
business model without the need to radically transform the model.
We are poised to capitalize on the service and trust of the past and the
technologies of the future, to compete as the premier employer and employee
services company for small- and medium-size businesses in the new economy. The
growth of revenue and profitability, the successful pursuit of our sales
process, and the delivery of quality service continue to be our objectives. I
thank our stockholders, our clients, and our employees for the achievement of
those goals in 2000, and look forward to their continued support in the future.
/s/ B. Thomas Golisano
B. Thomas Golisano
Chairman, President, and Chief Executive Officer
July 13, 2000
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Putting It All Together For Employers
Paychex helps companies focus on their core strengths by minimizing the effort
to perform payroll and human resource tasks. By constructing a diverse
portfolio of products of high value, Paychex has built a solid reputation of
service to employers and their employees and a record of strong financial
performance for shareholders.
A View of Our Company
Paychex serves businesses everywhere in the United States. They are in business
districts, in malls, anywhere where commerce flows. Look down any busy street
and you are likely to see a professional office complex, a popular family
restaurant, an accountant's office, a rapidly growing manufacturing firm, or
even an entrepreneur working out of his or her home. Each has similar, but
individual, payroll and human resource requirements. Paychex serves them all,
and over 350,000 companies like them, by putting together solutions tailored to
the unique needs of each employer. This personal attention originates from over
100 Paychex offices across the United States and extends to our support staff
of 6,200 employees.
Our service and financial achievements are frequently recognized by the
press. Some of the honors received this year include the following:
* Business Week's Performance Rankings of the S&P 500. Paychex was ranked #68
in a comparison of financial success that weighed factors such as sales,
profits, and return to shareholders.
* Forbes 500s. This measures the top companies in the United States. In the
list of 500 companies ranked by market value, Paychex moved from last year's
position of #271 to #212. The company entered the profits category at #458. In
the 895-company "super rank" listing, which combines sales, profits, assets, and
value, Paychex rose from #521 in 1999 to #470 this year.
* Forbes Global A-List. In this listing of the 400 best companies in the world,
Forbes Global magazine divided the group into twenty-one sectors - "the
companies to watch in each industry; the ones that create their own destinies."
Paychex was awarded the #1 position in the business services category.
* Barron's 500. The best performing corporations for investors, reviewed on the
basis of stock market performance, top-line revenue growth, and real cash
returns on capital invested in a company, provides the basis for this ranking.
Paychex was positioned #21.
* The Business Week Global 1000. This list ranks companies, worldwide, by
market value. The Paychex position in the United States was #206, and
internationally #405.
Paychex employs approximately 6,200 people, 13% more than last year.
Organizational goals include internal promotion, employee recognition, and a
rigorous schedule of headquarters and field instruction that emphasizes personal
development, positive client relationships, and strong financial performance.
This year, the corporate training and development center logged 815,000
employee-hours of field training, formal classroom instruction, and testing,
including many courses certified for college credit.
Clients and Competitors
Paychex began as a payroll processor for smaller businesses. While we now serve
clients of more diverse sizes and
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needs, small- to medium-sized companies remain our primary focus. Of the 5.8
million firms in the markets we serve, 98% have fewer than 100 employees. The
average Paychex core payroll client employs fourteen people, and has thirty-one
payrolls processed each year.
Comparing the Paychex client base to the number of American businesses shows
that market penetration is still relatively small. In fact, research estimates
that all payroll processors combined serve less than 15% of the potential
market, presenting the opportunity for substantial continued growth by all
competitors.
While many small businesses utilize personal computer programs or manual
record books, our true competition is not specific brands of software or
ledger books. Instead, our challenge is to show business owners that
outsourcing is a better decision than a do-it-yourself approach . . . to
demonstrate that their time is best spent concentrating on growing their
businesses rather than being distracted by repetitive and time-consuming
administrative tasks like payroll.
The Power of Outsourcing
From a $100 billion industry in 1996, outsourcing has grown to a projected $300
billion industry this year. Business owners cite the following as some of the
top reasons for turning important tasks over to outside suppliers: it frees
[Graphics on this page omitted]
Sidebar caption:
Putting It All Together for Businesses
This main street restaurant has twenty-three servers, cooks, and bartenders.
Turnover is frequent and no two employees work exactly the same schedule. The
tips are good and the tip-sharing arrangement is complicated. The restaurant
owner relies on Paychex to accurately cut checks, remit taxes, provide W-2s,
and make reports of newly hired employees in what he calls "a payroll situation
as complicated as a plate of spaghetti."
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resources for other purposes, brings difficult to manage functions under
control, improves company focus, provides capabilities not available
internally, reduces risk, and provides access to world-class capabilities. As
the acceptance of outsourcing as part of a dynamic business model continues to
grow, Paychex stands well prepared to bring these benefits to a growing
audience of businesses of all sizes.
Partnership for Success
Thousands of accounting professionals nationwide have formed a strategic
alliance with Paychex to provide our services to their clients. We recognize
the important role that these professionals play in the business world, and
continually seek additional ways to bring value to this mutually beneficial
relationship.
Our presence within the accounting community was strengthened this year with
our participation in a comprehensive Web site called AccountantsWorld (Service
Mark), which is accessible via the Paychex Web site. This site offers
accountants and CPAs daily accounting and tax news via e-mail, Web site
development for their practices, a convenient portal to tax agencies and forms,
free online seminars, and a host of other links and resources that help them
manage and grow their businesses. The introduction of Reports Online and Ledger
Reporting Online (Service Mark) has provided accountants with a convenient new
way to access client payroll records. These services, combined with our
established programs and services such as seminar programs and informational
publications, build on the long-standing relationship for mutual success that
we have with the accounting community.
[graphics on this page omitted]
Sidebar caption:
Putting It All Together for Accountants
Businesses depend on accountants, and many accountants depend on Paychex. In a
mutually beneficial partnership, this CPA relies on Paychex to aid her clients
with reliable payroll services. This gives her more freedom to provide the best
one-on-one accounting and business consulting. "The knowledgeable personal
service and expanding Internet services that Paychex has provided have helped
me make the important transition from mundane compliance work to diversified
financial consulting."
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Services and Products
Paychex continuously spends considerable resources to expand its lineup of
services and products. New payroll and human resource offerings, as well as
expanded Internet capabilities, make the content of our product line
significantly different than it was just two years ago.
Payroll
Comprehensive payroll services - including calculation and delivery of employee
pay, management reports, and payroll tax returns for federal, state, and local
jurisdictions - form the core Paychex business. In fiscal 2000, we produced over
162 million payments, with over 5.2 million workers a month receiving a payment
generated by Paychex. At year's end, we delivered over 8.7 million W-2 forms.
In short, it all begins with payroll.
Payroll information comes to Paychex offices in a variety of ways. Typically,
our Payroll specialists telephone businesses on a scheduled basis and, in a few
minutes, obtain employee hours and wages. Others prefer to fax us their
information, while others use our Paylink(Registered Trademark) or Preview
(Registered Trademark)(MMS) software to transfer their data from a personal
computer. We also offer the ability to interface with time and attendance
systems, facilitating information transfers from companies using time clocks.
This year, Paychex introduced Internet Time Sheet, which allows employee
information to be submitted via a secure area of the Paychex Online Internet
site, any time of day, any day of the week. Another Internet service - Ledger
Reporting Online - facilitates the transfer of payroll numbers computed by
Paychex to client general ledger software. This eliminates time-consuming
manual entries and improves bookkeeping accuracy. These new Internet services
interlock with Reports Online, which was introduced in fiscal 1999. Reports
Online allows companies to access their current and historical payroll
information, reducing the cost and increasing the delivery speed of their
reports.
New-hire reporting, a payroll-related service, helps employers comply with
federal and state requirements that aid enforcement of child support orders,
and help reduce fraudulent workers' compensation and unemployment claims.
Paychex currently processes over 339,000 new-hire reports each month.
Electronic invoice payment provides clients with an easy, scheduled means of
paying their Paychex bill via an electronic account deduction. While adding
convenience and predictability to clients' cash management, this cuts the cost
of invoice processing for Paychex by reducing the number of unpaid or
delinquent bills. Over 58% of our core payroll clients use this payment method.
Paychex delivers core payroll sales, processing, and service from over 100
locations nationwide. In 2000, staffing included 795 sales representatives,
an increase of 10% from 1999.
In the past, Paychex focused primarily on services for smaller companies.
Paychex Major Market Services (MMS) was introduced in 1997 to meet the needs of
current clients who were outgrowing our core service, and for new clients, with
more complex payroll and human resource
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needs, who were seeking access to Paychex expertise. According to the Small
Business Administration, less than 2% of U.S. companies have more than one
hundred employees. However, the sector pays more than 60% of the nation's
non-farm paychecks, and takes in two thirds of its gross receipts (over $10
trillion). This market offers large numbers of employees to serve, is
positioned to purchase extended payroll and human resource services, and
understands the benefits of outsourcing. Most of these companies are located in
metropolitan areas, and Paychex has been both aggressive and successful,
acquiring more than half our new accounts from competitive providers.
During fiscal 2000, the number of metropolitan areas served by MMS was
expanded from twenty-six to forty-four of the markets served by our core
payroll service. Sales staff in these offices increased 32% to fifty. MMS
offices delivered payroll and human resource administration for over 6,000
clients, an increase of 40% over the prior year.
Taxpay (Registered Trademark)
Businesses are required to remit payroll taxes and file returns with tax
agencies on a regular schedule, and failure to do so results in penalties.
Making the payments, maintaining the proper records, and filing the returns
becomes a time-consuming routine for employers who would prefer to concentrate
on running their business. The Paychex Taxpay service eliminates this burden
by making sure that deposits and filing are done accurately and on time.
Throughout the last decade, Taxpay was a very successful ancillary service, with
client use growing from 25% in 1992 to 81% in 2000. We expect utilization to
mature in the 82% to 87% range.
In the past, Paychex handled federal and state taxes, but early this year
local taxes were added. Successfully tested in several cities during fiscal
1999, the local service is now available nationwide.
Paychex made $45.5 billion in payroll tax payments on behalf of clients during
fiscal 2000. Compared to the year before, this was an increase of $8.4
billion.
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Employee Pay Services
To meet the various needs and preferences of employers and employees, Paychex
provides a variety of ways for businesses to pay employees. These include the
traditional paper check, direct bank deposit, a debit and purchase card option,
and a special type of check called Readychex (Service Mark).
During the first quarter of this fiscal year, Paychex introduced a total
payroll solution called the Flexible Pay Package, which combines all our
employee payment options for one low price. Employers get the convenience and
confidentiality of check signing and insertion, plus the simplified account
reconciliation that comes from direct deposit and Readychex. Employees have
the choice of any one or a combination of payment options, including a paper
check, direct deposit, or Access Card.
Helping both employers and employees, direct deposit provides a safe,
convenient, and productive benefit. The number of client companies using
Paychex for direct deposit grew from 135,400 to 165,700, an increase of 22%.
Transfers for the year rose from $39.4 billion to $50.7 billion. Working as a
member of the National Automated Clearing House Association (NACHA), Paychex is
connected to 13,000 depository financial institutions. This year, in
recognition of our contribution to the financial services industry, NACHA
presented Paychex with the George Mitchell Payment Systems Excellence Award for
"using the automated clearing house to make the efficiencies of electronic
commerce available to every business owner in the United States."
The Paychex Access Card - in association with MasterCard(Registered Trademark)
- - provides an alternative way to electronically deposit wages. Many U.S.
workers do not have any kind of bank account, which ordinarily disqualifies
them from using direct deposit. They must rely on check cashing services
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Sidebar caption:
Putting It All Together for Employees
Four nurses and three medical administrators aid the two doctors at this
medical practice. The staff includes a working mother with a child in nursery
school, another with a disabled spouse, and one with recurring eye care
expenses not covered by insurance. In addition to their paychecks, each depends
on the section 125 plan administered by Paychex to provide favorable tax status
while budgeting their out-of-pocket health and dependent care expenses during
the year.
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and carry cash. The Paychex Access Card offers an alternative, combining the
convenience and safety of direct deposit with a purchase and ATM debit card. In
addition, Access Card fees are modest compared to those normally charged for
check cashing. The Access Card also provides a convenient method for employees
who frequently travel in their jobs, by enabling them to access cash through
ATMs or to use their card for purchases.
While an employer may be enthusiastic about the benefits of direct deposit,
some employees may still wish to receive a paper check. Paychex Readychex
resolves this by delivering an employee's net pay in a form that makes payday
convenient for both. For employees, Readychex is just like any other payroll
check. To an employer, a Readychex payment works as simply as direct deposit,
with Paychex bundling all Readychex wages into a single debit from the
business's payroll account. Reconciliation of Readychex payments becomes a
one-line accounting item on payday, making bookkeeping easier and providing
management with a reliable cash management tool. In addition, Readychex money
transfers employ banking system safeguards that reduce the opportunities for
check fraud.
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Sidebar caption:
Putting It All Together for Larger Companies
Five years ago this software company had ten employees. Today they have over
one hundred and fifty. The owner and president gives substantial credit to the
company's benefits package - particularly the 401(k) plan - for the ability to
attract and retain talented programmers and computer professionals. "Paychex
made it possible for a small start-up to have competitive benefits so we could
hire good talent, and allowed me to concentrate on growing the business at a
crucial time, particularly when we really took off and became a bigger
business."
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By having checks pre printed with authorizing signatures and then inserted and
sealed in envelopes, our clients add confidentiality and save time on payday.
Human Resource and PEO Services
A paycheck does more than quantify gross wages, deductions, and net pay. For
many workers, it shows their commitment to health care, insurance, retirement,
or other elements of their total wages. Because these issues go hand in hand
with payroll, Paychex is solidly positioned to leverage its core payroll
capabilities into human resource services at very profitable levels. Organized
under our Human Resource Services and Professional Employer Organization
division (HRS-PEO), these services are offered by a specially trained staff of
199 sales representatives that deals solely with human resource issues.
Retirement Plan Recordkeeping
Participation in retirement plans - and in 401(k) plans in particular -has
expanded at an enormous rate in recent years. The last decade of Department of
Labor statistics show that 401(k) plan participation doubled, the number of
plans more than quadrupled, and assets grew from $277 billion to $1.4 trillion.
Because of its unique position as a payroll processor, Paychex has been able to
make retirement plans economical for almost any employer, the most popular
being the 401(k) plan. Currently, 14,700 companies depend on Paychex for their
funds transfer and 401(k) plan recordkeeping, an increase of 46% over last
year. This represents $1.3 billion under recordkeeping, for 174,000 plan
participants.
In partnership with leading fund managers, Paychex offers affordable solutions
for a wide variety of needs. During fiscal 2000, we began offering SIMPLE
Individual Retirement Account plans to our clients. SIMPLE IRAs are
particularly well suited for the self-employed, business owners seeking a
successor to a SAR/SEP plan, or those for whom employee compensation does not
coincide with the compliance requirements of a traditional 401(k) plan.
Workers' Compensation Services
Workers' compensation provides benefits for employees who are unable to work
because of injuries incurred on the job, and, therefore, most employers carry
workers' compensation insurance. Risk factors, claims history, wage rates, and
the number of employees all affect workers' compensation rates. Typically,
companies pay estimated premiums at the beginning of the coverage period. At
the end of the period, an audit adjusts actual claims, wage rates, and job
classifications. Businesses that have increased their employment or had changes
in rates or risk can face significant period-end adjustments. This can create
cash management problems, particularly for smaller companies.
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The Paychex Pay-As-You-Go (Service Mark) program uses rate and job
classification information to initiate regular premium payments throughout the
year for clients, stabilizing their cash flow and minimizing period-end
adjustments. The integrity of Paychex payroll data helps eliminate the expense
of year-end audits, making Pay-As-You-Go attractive to major insurers (Paychex
acts, via its licensed agency, as a general agent providing insurance through a
variety of carriers who are the underwriters). Because of the number of firms
requiring worker's compensation insurance, Pay-As-You-Go has significant
potential for growth, with Paychex receiving revenue through fees and the
administration of the stream of premium payments.
Section 125 Plans
To encourage individuals to plan and manage their health and dependent care
costs, section 125 of the U.S. Internal Revenue Code was established. It
designates favorable tax considerations for persons who contribute to flexible
spending accounts and premium-only plans. Although these plans reduce employer
payroll taxes, administration remains time-consuming. Paychex eliminates this
burden and allows companies to add to their benefits package at very little
cost. During fiscal 2000, we administered plans for 23,900 clients.
PAS and PEO
Paychex Administrative Services (PAS) offers businesses a bundled package that
includes payroll, human resource administration, fringe benefit administration,
and risk management. Smaller companies have found this bundled approach to
human resource matters particularly attractive because it brings previously
unaffordable benefits within reach. PAS does not engage in co-employment of
workers. After successful testing in limited markets, Paychex Administrative
Services has been available nationwide since May 2000.
Professional employer organizations (PEOs) offer a specific approach to
payroll, human resource, and benefits administration. The PEO becomes
co-employer of a client company's employees, which permits a pooling of
workers from different client companies for the negotiation of advantageous
rates of insurance and benefit services. This course is popular in Florida
where Paychex Business Solutions (PBS) provides PEO services to companies with
a total of 20,200 worksite employees.
Beginning a New Century
Paychex enters the twenty-first century having established a broad base of
products, well-trained and motivated employees, and healthy markets for
continued growth. These all provide an exciting outlook for the future. As a
result, Paychex has never been better positioned to deliver added value to our
clients, opportunities for our employees, and profits for our shareholders.
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MANAGEMENT'S DISCUSSION
Management's Discussion reviews the Company's operating results for each of the
three fiscal years in the period ended May 31, 2000 (fiscal 2000, 1999, and
1998), and its financial condition at May 31, 2000. The focus of this review
is on the underlying business reasons for significant changes and trends
affecting revenues, net income, and financial condition. This review should be
read in conjunction with the accompanying Consolidated Financial Statements,
the related Notes to Consolidated Financial Statements, and the Eleven-Year
Summary of Selected Financial Data. Forward-looking statements in this review
are qualified by the cautionary statement at the beginning of this Annual
Report (Exhibit 99).
Results of Operations
In thousands, except per share amounts
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Service revenues $728,119 21.9% $597,296 21.0% $493,704
Operating income $258,893 38.0% $187,562 39.2% $134,700
Operating margin 35.6% 31.4% 27.3%
Income before income
taxes $275,372 37.6% $200,143 38.8% $144,173
Net income $190,007 36.6% $139,099 36.1% $102,219
% of service revenues 26.1% 23.3% 20.7%
Basic earnings per share $ .51 34.2% $ .38 35.7% $ .28
Diluted earnings per
share $ .51 37.8% $ .37 32.1% $ .28
===============================================================================
The financial results for Paychex, Inc., in 2000, reflect the tenth consecutive
year of record service revenues and net income, and the ninth consecutive year
of net income growth of 36% or more. The Company's ability to continually grow
its client base, add new services, increase client utilization of ancillary
services, implement price increases, and decrease operating expenses as a
percent of service revenues has resulted in ten years of average compounded
annual growth in service revenues of 20% and net income of 36%.
The Company has two reportable business segments: Payroll and Human Resource
Services-Professional Employer Organization (HRS-PEO). See Note A of the
Notes to Consolidated Financial Statements for a detailed description of these
reportable segments and related business activities.
Payroll segment
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Payroll service revenue $653,245 19.8% $545,249 19.8% $455,227
ENS investment revenue
included in Payroll
service revenue $ 58,800 12.4% $ 52,335 20.5% $ 43,429
Payroll operating income $303,360 27.9% $237,236 30.6% $181,585
Payroll operating margin 46.4% 43.5% 39.9%
- -------------------------------------------------------------------------------
Payroll clients 351.9 9.1% 322.6 9.9% 293.6
Taxpay clients 285.9 12.4% 254.3 15.2% 220.7
Employee Pay Services
clients 165.7 22.4% 135.4 29.7% 104.4
===============================================================================
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[graphics on this page omitted]
Revenues: Payroll service revenue includes service fees and investment revenue.
Service fee revenue is earned primarily from Payroll, Taxpay, Employee Pay
Services, and other ancillary services. Employee Pay Services include the
Direct Deposit, Readychex, and Access Card products. ENS (Electronic Network
Services) investment revenue is earned during the period between collecting
client funds (ENS investments) and remitting the funds to the applicable tax
authorities for Taxpay clients and employees of Employee Pay Services clients.
ENS investment revenue also includes net realized gains and losses from the
sale of available-for-sale securities.
The increases in Payroll service revenue for 2000 and 1999 are primarily
related to the addition of new clients, new services, price increases, and
increased utilization of ancillary services, such as Taxpay and Employee Pay
Services, by both new and existing clients. At May 31, 2000, 81% of Payroll
clients utilized the Taxpay service, compared with 79% at the end of 1999 and
75% at the end of 1998. Client utilization of this product is expected to
mature within a range of 82% to 87%. Client utilization of Employee Pay
Services was 47% at May 31, 2000, versus 42% and 36% at May 31, 1999 and 1998,
respectively. At May 31, 2000, only 27% of the total employees paid by the
Company's core payroll service utilized Employee Pay Services. These services
are expected to provide growth opportunities for fiscal 2001 and beyond.
ENS investment revenue, which is included in Payroll service revenue, has
increased due to more clients utilizing Taxpay and Employee Pay Services and
higher daily client balances. The growth rate in ENS investment revenue is also
affected by factors such as the maturing of the Taxpay product, volatile
interest rate movements in both fiscal 2000 and 1999, and the level of realized
gains and losses. Average daily ENS investment portfolio balances were
approximately $1.4 billion, $1.1 billion, and $1.0 billion in fiscal 2000,
1999, and 1998, respectively. The first half of fiscal 2000 reflected lower
comparable rates of return, while the second half of fiscal 2000, especially
the fourth quarter, benefited from increasing interest rates. In fiscal 2000,
ENS investments incurred realized losses of $2.9 million, compared with realized
gains of $2.4 million and $0.8 million in fiscal 1999 and 1998, respectively.
Payroll revenue growth for the fourth quarter of fiscal 2000 was 23.7%, compared
with 19.8% for the full year. The higher than normal growth was due to higher
interest rates and the timing of billing days in the quarter. Fiscal 2001's
percentage growth in Payroll revenue is expected to be toward the upper end of
a range of 18% to 20%.
Operating income: Operating income for 2000 and 1999 increased as a result of
increased revenue and leveraging of the segment's operating expense base, as
evidenced by the increases in the segment's operating margins year-over-year.
Effective September 1, 1999, the Company increased its sales force compensation
package to increase the retention and quality of its payroll sales
representatives. This compensation increase resulted in additional annualized
pre-tax expense of approximately $6.0 million, of which $4.5 million was
reflected in fiscal 2000. Sales related expenses were also impacted in the
fourth quarter of fiscal 2000 as the Company accelerated the hiring and
training of Payroll sales representatives for fiscal 2001 selling efforts.
During fiscal 2000, the Company continued expansion of its Major Market
Services payroll product offering to include forty-four of the slightly more
than one hundred sales territories covered by its core Payroll product. The
Major Market Services product now services over 6,000 clients and generated
approximately $30 million in revenue for fiscal 2000. The Company will
continue to expand into new cities for the next several years.
Page 15
[graphics on this page omitted]
HRS-PEO segment
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
HRS-PEO service revenue $ 74,874 43.9% $52,047 35.3% $38,477
HRS-PEO operating income $ 23,395 111.3% $11,072 108.0% $ 5,322
HRS-PEO operating margin 31.2% 21.3% 13.8%
- -------------------------------------------------------------------------------
401(k) Recordkeeping
clients 14.7 45.5% 10.1 68.3% 6.0
401(k) client funds
managed externally
(in millions) $1,337.5 76.5% $ 757.6 97.7% $ 383.3
Section 125 clients 23.9 18.3% 20.2 23.2% 16.4
Workers' Compensation
Insurance clients 10.4 160.0% 4.0 100.0% --
PEO worksite employees 20.2 10.4% 18.3 -4.7% 19.2
===============================================================================
Revenues: The significant increases in service revenue for 2000 and 1999 are
primarily related to the benefits of growing a recurring revenue stream from
401(k) Recordkeeping clients, Workers' Compensation Insurance clients, Section
125 clients, and the number of Professional Employer Organization (PEO)
worksite employees. The increase in 401(k) clients reflects the continuing
interest of small- to medium-sized businesses to offer retirement savings
benefits to their employees. During the first quarter of fiscal 1999, the
Company began a national rollout of its Workers' Compensation Insurance
product, which provides insurance for qualified clients through several leading
insurance providers and a method to enhance their cash flows. The decline in
PEO worksite employees in 1999 was caused by the loss of two large PEO clients,
which offset the additions to worksite employees. The loss of these clients
did not have a material impact on fiscal 2000 or 1999.
Operating income: For 2000 and 1999, the increases in operating income are
primarily related to gains in recurring service revenue and leveraging of
operating expenses.
In fiscal 2000, the Company began a nationwide expansion of Paychex
Administrative Services (PAS), a combined payroll and human resource
outsourcing solution designed to make it easier for small businesses to manage
their payroll and benefit costs. The Company also added SIMPLE IRA Plans to
its retirement services product line and continued to expand the Workers'
Compensation Insurance product.
Full-year fiscal 2001's HRS-PEO service revenue and operating income are
expected to grow at a rate lower than fiscal 2000's rate, but at a rate much
higher than the Payroll segment's growth rate. Fiscal 2001's quarter-over-
quarter percentage comparisons in HRS-PEO service revenue and operating income
may vary significantly throughout the year, and any one particular quarter's
results may not be indicative of expected full-year results.
Page 16
Corporate expenses
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Corporate expenses $67,862 11.7% $60,746 16.4% $52,207
===============================================================================
Corporate expenses are primarily related to the Information Technology,
Organizational Development, Finance, Marketing, and Senior Management functions
of the Company. For 2000 and 1999, the increases in expenses are primarily due
to additional employees and other expenditures required to support the
continued growth of the Company's business segments. In fiscal 2000, the
Company also continued to invest in numerous Internet-based product
enhancements, which will be utilized by both CPAs and clients in fiscal 2001.
In fiscal 2000, these increases were offset by lower spending on national
marketing efforts during the last half of the year and by the internal payroll-
related costs capitalized for the development of internal-use software. These
capitalized costs are in accordance with the adoption of Statement of Position
98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," which became effective for the Company on
June 1, 1999.
In fiscal 2001, Corporate expenses are expected to grow at a rate lower than
in fiscal 2000.
Investment income
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Investment income $16,479 31.0% $12,581 32.8% $9,473
===============================================================================
Investment income primarily represents earnings from the Company's cash and
cash equivalents and investments in available-for-sale securities. Investment
income does not include earnings from the ENS investments, which are recorded
as ENS investment revenue within the Payroll segment. The increases in
Investment income are primarily due to the increases in the average daily
invested balances generated from increases in overall cash flows. In fiscal
2000, these increases were offset by realized losses of $0.8 million on
available-for-sale securities compared with realized gains of $0.5 million and
$0.1 million in fiscal 1999 and 1998, respectively. For fiscal 2000, the
twelve-month average long-term rate of return was slightly higher than the
average rate of return earned in fiscal 1999, reflecting lower comparable rates
of return in the first half of fiscal 2000 and higher comparable rates in the
second half of the fiscal year. Investment income for fiscal 2001, subject to
changes in market rates of interest, is expected to grow at a rate higher than
fiscal 2000, reflecting the expected benefit of higher comparable rates of
return.
Income taxes
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Income taxes $85,365 39.8% $61,044 45.5% $41,954
Effective income tax rate 31.0% 30.5% 29.1%
===============================================================================
For 2000 and 1999, the increases in the effective income tax rate are due to
the growth in taxable income exceeding the growth in tax-exempt income. Tax-
exempt income is derived primarily from income earned on municipal debt
securities. Fiscal 2001's effective income tax rate is expected to be in the
range of rates experienced in fiscal 2000 and 1999.
Page 17
Liquidity and Capital Resources
Operating activities
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Operating cash flows $249,028 43.0% $174,120 27.3% $136,761
===============================================================================
[graph omitted]
The increases in operating cash flows resulted primarily from the consistent
achievement of record net income. Projected operating cash flows are expected
to adequately support normal business operations, forecasted growth, purchases
of property and equipment, and dividend payments. Furthermore, at year-end,
the Company had $459 million in available cash and investments. The Company
also had $140 million of available, uncommitted, unsecured lines of credit and
$350 million available under an uncommitted, secured line of credit, which was
entered into during the third quarter of fiscal 2000.
Investing activities
In thousands
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
------------------------------------------------------
Net investments and
ENS activities $(144,322) 74.5% $ (82,724) -6.8% $ (88,728)
Purchases of P&E, net (32,888) 48.8% (22,104) -21.6% (28,197)
Purchases of other
assets (6,964) 94.0% (3,590) 599.8% (513)
------------------------------------------------------
Net cash used in
investing activities $(184,174) 69.9% $(108,418) -7.7% $(117,438)
===============================================================================
Corporate investments and ENS investments: Corporate investments are primarily
available-for-sale debt securities. ENS investments are primarily short-term
funds and available-for-sale debt securities. The portfolio of Corporate
investments and ENS investments is detailed in Note D of the Notes to
Consolidated Financial Statements.
Corporate investments have increased due to the investment of increasing cash
balances provided by operating activities less purchases of property and
equipment and dividend payments. The reported amount of ENS investments will
vary significantly based upon the timing of collecting client funds, and
remitting the funds to the applicable tax authorities for Taxpay clients and
employees of clients utilizing the Employee Pay Services.
At May 31, 2000, the Company had $1,202.7 million of cost and fair value
invested in money market securities and other cash equivalents with an average
maturity of less than 30 days, and $984.3 million of fair value invested in
available-for-sale securities with an average duration of 2.4 years. At
May 31, 2000, the market value of the available-for-sale securities was lower
than their cost basis by $13.4 million, compared with a market value exceeding
cost basis by $4.5 million at the end of May 1999.
Additional discussion of interest rates and related risks is included in the
Market Risk Factors section of this review.
Purchases of property and equipment, net: In fiscal 2000, the Company made net
purchases of property and equipment of $32.9 million. During the past year,
the Company sold an office facility in California for approximately $1.2
million and purchased a branch office facility in Pennsylvania for $6.1 million.
Purchases of property and equipment in fiscal 2001 are expected to range from
$30 million to $35 million. In addition, the Company is in the process of
evaluating the construction of an additional facility at Corporate headquarters
with a cost ranging from $20 million to $30 million. The proposed building
would primarily be occupied by employees who are currently occupying leased
facilities and would be completed in the summer of 2002.
Effective June 1, 1999, the Company adopted SOP 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." The SOP requires
the capitalization of internal-use computer software costs if certain criteria
Page 18
are met, including all external direct costs for materials and services and
certain payroll and related fringe benefit costs. Prior to fiscal 2000, the
Company expensed as incurred certain payroll and related fringe benefit costs
to develop and enhance its internal computer programs and software. The effect
of adopting the SOP increased net income by approximately $2.4 million for the
year ended May 31, 2000.
Financing activities
In thousands, except per share amounts
- -------------------------------------------------------------------------------
2000 Change 1999 Change 1998
-----------------------------------------------------
Dividends paid $(81,583) 50.9% $(54,055) 50.7% $(35,871)
Proceeds from exercise
of stock options 11,242 103.1% 5,535 178.1% 1,990
Other (69) 13.1% (61) -27.4% (84)
-----------------------------------------------------
Net cash used in
financing activities $(70,410) 44.9% $(48,581) 43.0% $(33,965)
- -------------------------------------------------------------------------------
Cash dividends per
common share $ .22 46.7% $ .15 50.0% $ .10
===============================================================================
Dividends paid: The Company has increased its quarterly cash dividend rate
per share by 50% in each of the last eight fiscal years. The Company has
distributed three-for-two stock splits effected in the form of 50% stock
dividends on outstanding shares each May in the past six fiscal years.
[graph omitted]
Proceeds from exercise of stock options: The increase in proceeds from
exercise of stock options reflects the issuance of 1,532,000 shares of common
stock for stock option exercises in 2000, versus 1,032,000 shares in 1999 and
277,000 shares in 1998, on a pre-split-adjusted basis. In May 1999, 50% of the
November 1996 broad-based incentive stock option grant vested, resulting in an
increase in shares available for exercise. See Note G of the Notes to the
Consolidated Financial Statements for additional disclosure on the Company's
stock option plans.
Market Risk Factors
Interest rate risk: The Company's available-for-sale debt securities are
exposed to market risk from changes in interest rates, as rate volatility will
cause fluctuations in the market value of held investments. Increases in
interest rates normally decrease the market value of the available-for-sale
securities, while decreases in interest rates increase the market value of the
available-for-sale securities.
In addition, the Company's available-for-sale securities and short-term funds
are exposed to earnings risk from changes in interest rates, as rate volatility
will cause fluctuations in the earnings potential of future investments.
Increases in interest rates quickly increase earnings from short-term funds,
and over time increase earnings from the available-for-sale securities
portfolio. Earnings from the available-for-sale securities do not reflect
changes in rates until the investments are sold or mature, and the proceeds
are reinvested at current rates. Decreases in interest rates have the opposite
earnings effect on the available-for-sale securities and short-term funds.
The Company directs investments toward high credit-quality, tax-exempt
securities to mitigate the risk that earnings from the portfolio could be
adversely impacted by changes in interest rates in the near term. The Company
invests in short- to intermediate-term fixed-rate municipal and government
securities, which typically have lower interest rate volatility, and manages
the securities portfolio to a benchmark duration of 2.5 to 3.0 years. The
Company does not utilize derivative financial instruments to manage interest
rate risk.
Page 19
Over the twelve-month period of fiscal 2000, the federal funds rate increased
a total of 175 basis points. The following table summarizes the federal funds
rate activity over the last three years:
- -------------------------------------------------------------------------------
2000 1999 1998
----------------------------------
Federal funds rate - beginning of fiscal year 4.75% 5.50% 5.50%
Rate increase/(decrease):
First quarter .50 - -
Second quarter .25 (.75) -
Third quarter .25 - -
Fourth quarter .75 - -
----------------------------------
Federal funds rate - end of fiscal year 6.50% 4.75% 5.50%
===============================================================================
The earnings impact of these rate changes is not precisely quantifiable because
many factors influence the return on the Company's portfolio. These factors
include, among others, daily interest rate changes, the proportional mix of
taxable and tax-exempt investments, and changes in tax-exempt and taxable
investment rates, which are not synchronized, nor do they change simultaneously.
Subject to the aforementioned factors, a 25 basis point change normally affects
the Company's tax-exempt interest rates by approximately 17 basis points.
As of May 31, 2000 and May 31, 1999, the Company had approximately $984.3
million and $879.6 million, respectively, invested in available-for-sale
securities at fair value, with weighted-average yields to maturity of 4.5% and
4.1%, respectively. Assuming a hypothetical increase in interest rates of 25
basis points given the May 31, 2000 and May 31, 1999 portfolios of securities,
the resulting potential decrease in fair value would be approximately $6.0
million and $5.4 million, respectively. Conversely, a corresponding decrease
in interest rates would result in a comparable increase in fair value. This
hypothetical increase or decrease in the fair value of the portfolio would be
recorded as an adjustment to the portfolio's recorded value, with an offsetting
amount recorded in stockholders' equity, and with no related or immediate
impact to the results of operations. The Company's interest rate risk exposure
has not changed materially since May 31, 1999.
Credit risk: The Company is exposed to credit risk in connection with these
investments through the possible inability of the borrowers to meet the terms
of the bonds. The Company attempts to limit credit risk by investing primarily
in AAA and AA rated securities and A-1 rated short-term securities, and by
limiting amounts that can be invested in any single instrument. At
May 31, 2000, approximately 99% of the available-for-sale securities held an AA
rating or better, and all short-term securities classified as cash equivalents
held an A-1 or equivalent rating.
Other
Recently issued accounting standards: In December 1999, the Securities and
Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue
Recognition in Financial Statements." This SAB formalizes the SEC's position
on application of revenue recognition rules. Adoption of this SAB is for the
fourth quarter of fiscal years beginning after December 15, 1999. The Company
believes that adoption of the provisions of this SAB will not have a material
impact on the Company's results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, which establishes
accounting and reporting standards for derivative instruments and for hedging
activities, is effective for fiscal years beginning after June 15, 2000.
The Company will adopt the provisions of SFAS No. 133 in the first quarter of
fiscal 2002. The Company currently does not utilize derivative instruments
and does not expect that adoption of SFAS No. 133 will have any significant
effect on its consolidated results of operations or financial position.
Page 20
Report of Ernst & Young LLP Independent Auditors
Board of Directors
Paychex, Inc.
We have audited the accompanying consolidated balance sheets of Paychex, Inc.
as of May 31, 2000 and 1999, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended May 31, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Paychex, Inc. at May 31, 2000 and 1999, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
May 31, 2000, in conformity with accounting principles generally accepted in
the United States.
/s/ Ernst & Young LLP
Buffalo, New York
June 23, 2000
Page 21
Consolidated Statements of Income
In thousands, except per share amounts
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Service revenues:
Payroll $594,445 $492,914 $411,798
ENS investment revenue 58,800 52,335 43,429
-----------------------------------
Total payroll service revenues 653,245 545,249 455,227
HRS-PEO (A) 74,874 52,047 38,477
-----------------------------------
Total service revenues 728,119 597,296 493,704
Operating costs 173,481 151,956 131,731
Selling, general, and administrative
expenses 295,745 257,778 227,273
-----------------------------------
Operating income 258,893 187,562 134,700
Investment income 16,479 12,581 9,473
-----------------------------------
Income before income taxes 275,372 200,143 144,173
Income taxes 85,365 61,044 41,954
-----------------------------------
Net income $190,007 $139,099 $102,219
===================================
Basic earnings per share $ .51 $ .38 $ .28
-----------------------------------
Diluted earnings per share $ .51 $ .37 $ .28
-----------------------------------
Weighted-average common shares
outstanding 370,603 368,282 366,771
-----------------------------------
Weighted-average shares assuming dilution 375,081 373,182 370,829
-----------------------------------
Cash dividends per common share $ .22 $ .15 $ .10
===============================================================================
See Notes to Consolidated Financial Statements.
(A) The HRS-PEO service revenues indicated above are net of PEO direct costs
billed and incurred of $731,266, $578,132, and $499,741 for the fiscal
years 2000, 1999 and 1998, respectively. PEO direct costs billed to clients
are equal to PEO direct costs incurred for the wages and payroll taxes of
worksite employees and their related benefit premiums and claims.
Page 22
Consolidated Balance Sheets
In thousands
- -------------------------------------------------------------------------------
May 31, 2000 1999
- -------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 47,136 $ 52,692
Corporate investments 412,357 290,555
Interest receivable 22,436 18,045
Accounts receivable 87,608 62,941
Deferred income taxes 9,539 1,364
Prepaid expenses and other current assets 6,531 6,000
-----------------------------------
Current assets before ENS investments 585,607 431,597
ENS investments 1,776,968 1,361,523
-----------------------------------
Total current assets 2,362,575 1,793,120
Property and equipment - net 75,375 65,931
Goodwill and intangible assets - net 5,584 4,418
Deferred income taxes 2,494 1,417
Other assets 9,549 8,215
-----------------------------------
Total assets $2,455,577 $1,873,101
===================================
Liabilities
Accounts payable $ 17,086 $ 10,328
Accrued compensation and related items 52,631 36,574
Deferred revenue 4,719 4,643
Accrued income taxes 2,969 4,281
Other current liabilities 24,400 17,905
-----------------------------------
Current liabilities before ENS client
deposits 101,805 73,731
ENS client deposits 1,785,140 1,358,605
-----------------------------------
Total current liabilities 1,886,945 1,432,336
Other long-term liabilities 5,200 4,965
-----------------------------------
Total liabilities 1,892,145 1,437,301
Stockholders' equity
Common stock, $.01 par value, 600,000
authorized shares
Issued: 371,769/2000 and 246,326/1999 3,718 2,463
Additional paid-in capital 98,904 68,238
Retained earnings 469,385 362,269
Accumulated other comprehensive
income/(loss) (8,575) 2,830
-----------------------------------
Total stockholders' equity 563,432 435,800
-----------------------------------
Total liabilities and stockholders' equity $2,455,577 $1,873,101
===============================================================================
See Notes to Consolidated Financial Statements.
Page 23
Consolidated Statements of Stockholders' Equity
In thousands
- -------------------------------------------------------------------------------
Accumulated
other
comprehen-
Common Stock Additional sive
--------------- paid-in Retained income/
Shares Amount capital earnings (loss) Total
- -------------------------------------------------------------------------------
Balance at May 31,
1997 108,519 $1,085 $37,531 $212,387 $ 539 $251,542
- ------------------------------------------------------------------------------
Net income 102,219 102,219
Unrealized gains
on securities,
net of tax 2,866 2,866
--------
Total comprehensive
income 105,085
Cash dividends
declared (35,871) (35,871)
Exercise of
stock options 277 3 1,987 1,990
Tax benefit from
exercise of
stock options 6,945 6,945
Shares issued in
connection with
three-for-two
stock split 54,392 544 (628) (84)
- ------------------------------------------------------------------------------
Balance at May 31,
1998 163,188 1,632 46,463 278,107 3,405 329,607
- ------------------------------------------------------------------------------
Net income 139,099 139,099
Unrealized losses
on securities,
net of tax (575) (575)
--------
Total comprehensive
income 138,524
Cash dividends
declared (54,055) (54,055)
Exercise of stock
options 1,032 10 5,525 5,535
Tax benefit from
exercise of
stock options 16,250 16,250
Shares issued in
connection
with three-
for-two stock
split 82,106 821 (882) (61)
- ------------------------------------------------------------------------------
Balance at May 31,
1999 246,326 2,463 68,238 362,269 2,830 435,800
- ------------------------------------------------------------------------------
Net income 190,007 190,007
Unrealized
losses on
securities,
net of tax (11,405) (11,405)
--------
Total comprehensive
income 178,602
Cash dividends
declared (81,583) (81,583)
Exercise of
stock options 1,532 16 11,226 11,242
Tax benefit from
exercise of
stock options 19,440 19,440
Shares issued in
connection with
three-for-two
stock split 123,911 1,239 (1,308) (69)
- ------------------------------------------------------------------------------
Balance at May 31,
2000 371,769 $3,718 $98,904 $469,385 $ (8,575) $563,432
==============================================================================
See Notes to Consolidated Financial Statements.
Page 24
Consolidated Statements of Cash Flows
In thousands
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Operating activities
Net income $ 190,007 $ 139,099 $ 102,219
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization on
depreciable and intangible assets 23,903 22,097 18,764
Amortization of premiums and discounts on
available-for-sale securities 12,581 10,814 8,497
Benefit for deferred income taxes (2,786) (427) (1,030)
Provision for bad debts 1,871 1,886 1,648
Net realized (gains)/losses on sales of
available-for-sale securities 3,728 (2,866) (934)
Changes in operating assets and
liabilities:
Interest receivable (4,391) (4,818) (2,765)
Accounts receivable (26,538) (10,231) (10,717)
Prepaid expenses and other current
assets (531) (1,609) (1,905)
Accounts payable and other current
liabilities 48,276 21,847 22,154
Net change in other assets and
liabilities 2,908 (1,672) 830
------------------------------------
Net cash provided by operating activities 249,028 174,120 136,761
------------------------------------
Investing activities
Purchases of available-for-sale securities (869,795) (755,335) (529,413)
Proceeds from sales of available-for-sale
securities 711,184 488,662 338,818
Proceeds from maturities of available-for-
sale securities 19,770 31,535 7,232
Net change in ENS money market securities
and other cash equivalents (432,016) (55,707) (159,769)
Net change in ENS client deposits 426,535 208,121 254,404
Purchases of property and equipment, net
of disposal proceeds (32,888) (22,104) (28,197)
Purchases of other assets (6,964) (3,590) (513)
-------------------------------------
Net cash used in investing activities (184,174) (108,418) (117,438)
-------------------------------------
Financing activities
Dividends paid (81,583) (54,055) (35,871)
Proceeds from exercise of stock options 11,242 5,535 1,990
Other (69) (61) (84)
-------------------------------------
Net cash used in financing activities (70,410) (48,581) (33,965)
-------------------------------------
Increase/(decrease) in Cash and
cash equivalents ( 5,556) 17,121 (14,642)
Cash and cash equivalents, beginning
of fiscal year 52,692 35,571 50,213
-------------------------------------
Cash and cash equivalents,
end of fiscal year $ 47,136 $ 52,692 $ 35,571
===============================================================================
See Notes to Consolidated Financial Statements.
Page 25
Notes to Consolidated Financial Statements
Note A - Significant Accounting Policies
Business activities and reportable segments: Paychex, Inc. and its wholly owned
subsidiaries (the "Company") is a national provider of payroll, human resource,
and employee benefits outsourcing solutions for small- to medium-sized
businesses.
Paychex, Inc. operates within the continental United States of America, and
has two reportable segments: Payroll and Human Resource Services-Professional
Employer Organization (HRS-PEO).
Payroll segment: The Payroll segment is engaged in the preparation of payroll
checks, internal accounting records, federal, state, and local payroll tax
returns, and collection and remittance of payroll obligations for small- to
medium-sized businesses. In connection with Taxpay, an automated tax payment
and filing service, Electronic Network Services (ENS) collects payroll taxes
from clients on payday, files the applicable tax returns, and pays taxes to the
appropriate taxing authorities on the due date. These collections from clients
are typically paid between one and thirty days after receipt, with some items
extending to ninety days. In connection with Employee Pay Services, employers
are offered the option of paying their employees by direct deposit, Access
Card, a check drawn on a Paychex account, or a check drawn on the employer's
account. For the first three methods, ENS collects net payroll from the
client's account one day before payroll and provides payment to the employee
on payday. Taxpay and Employee Pay Services funds that are collected before
due dates are invested and classified as ENS investments until remittance to
the appropriate entity. The ENS investments and related client deposit
liabilities are included in the Consolidated Balance Sheets as current assets
and current liabilities. The amount of ENS funds held and related liabilities
varies significantly during the year. Investment revenue from these ENS
investments is included in Payroll service revenue on the Consolidated
Statements of Income.
HRS-PEO segment: The HRS portion of the HRS-PEO segment provides small- to
medium-sized businesses with 401(k) plan recordkeeping, workers' compensation
insurance, section 125 plan administration, group benefits, state unemployment
insurance, and employee management services. HRS offers these services either
on an individual basis or bundled through its Paychex Administrative Services
product.
The PEO portion of the HRS-PEO segment provides human resource management and
personnel administration services to a diverse client base of small- to medium-
sized businesses as a co-employer of the client's employees. The PEO provides
certain managed care services, including managed health care and other benefits,
comprehensive workers' compensation management, employee assistance programs,
risk management, and loss containment services.
Principles of consolidation: The Consolidated Financial Statements include the
accounts of Paychex, Inc. and its wholly owned subsidiaries. All intercompany
accounts and transactions have been eliminated in consolidation.
Cash and cash equivalents: Cash and cash equivalents consist of available cash,
money market securities, and other investments with a maturity of three months
or less when purchased. Amounts reported in the Consolidated Balance Sheets
approximate fair values.
Page 26
Corporate investments and ENS investments: Marketable securities included in
Corporate investments and ENS investments consist primarily of debt securities
classified as available-for-sale and are recorded at fair value obtained from
an independent pricing service. ENS investments also include cash, money market
securities, and short-term investments. Unrealized gains and losses, net of
applicable income taxes, are reported as Accumulated other comprehensive income
in the Consolidated Statements of Stockholders' Equity. Realized gains and
losses on the sale of securities are determined by specific identification of
the security's cost basis. Realized gains and losses from ENS investments are
included in Payroll service revenue, and realized gains and losses from
Corporate investments are included in Investment income on the Consolidated
Statements of Income.
Concentrations: Substantially all of the Company's deposited cash is
maintained at two large credit-worthy financial institutions. These deposits
may exceed the amount of any insurance provided. All of the Company's
deliverable securities are held in custody with one of the two aforementioned
financial institutions, for which that institution bears the risk of custodial
loss. Non-deliverable securities, primarily time deposits and money market
securities, are restricted to credit-worthy broker-dealers and financial
institutions.
Property and equipment - net: Property and equipment is stated at cost, less
accumulated depreciation and amortization. Depreciation is based on the
estimated useful lives of property and equipment using the straight-line
method. The typical estimated useful lives of depreciable assets are thirty-
five years for buildings and two to ten years for all others.
Software development and enhancement: Effective June 1, 1999, the Company
adopted Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." The SOP requires
the capitalization of internal use computer software costs if certain criteria
are met, including all external direct costs for materials and services and
certain payroll and related fringe benefit costs. Prior to fiscal 2000, the
Company expensed as incurred certain payroll and related fringe benefit costs
to develop and enhance its internal computer programs and software.
Capitalized software development and enhancement costs are amortized on a
straight-line basis over estimated useful lives ranging from three to five
years. The effect of adopting the SOP increased net income by approximately
$2,400,000 for the year ended May 31, 2000.
Goodwill and intangible assets - net: Goodwill and intangible assets result
from business acquisitions and client acquisitions and are reported net of
accumulated amortization in the Consolidated Balance Sheets. Goodwill and
intangible assets are amortized over periods ranging from five to ten years
using either straight-line or accelerated methods. The Company regularly
reviews and assesses the recoverability of such assets.
Revenue recognition: Service revenues are recognized in the period services
are rendered. Included in Payroll service revenues are investment revenues
earned from ENS investments and net realized gains and losses from the sale of
available-for-sale securities. PEO revenues are reported net of direct costs
billed and incurred, which include wages, taxes, benefit premiums, and claims
of worksite employees. In December 1999, the Securities and Exchange
Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue
Recognition in Financial Statements." This SAB formalizes the SEC's position
on application of revenue recognition rules. Adoption of this SAB is for the
fourth quarter of fiscal years beginning after December 15, 1999. The Company
believes that adoption of the provisions of this SAB will not have a material
impact on the Company's results of operations.
Page 27
Income taxes: The Company accounts for deferred taxes by recognition of
deferred tax assets and liabilities for the expected future tax consequences
of events that have been included in the 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 bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. The Company accounts for the tax benefit
from the exercise of non-qualified stock options by reducing its accrued income
tax liability and increasing additional paid-in capital.
Stock-based compensation costs: Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation," establishes
accounting and reporting standards for stock-based employee compensation plans.
As permitted by the SFAS, the Company continues to account for such arrange-
ments under Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly, no
compensation expense is recognized for stock-option grants because the exercise
price of the stock options equals the market price of the underlying stock on
the date of grant.
Stock splits effected in the form of stock dividends: The Company declared
three-for-two stock splits effected in the form of 50% stock dividends on
outstanding shares payable to shareholders of record as of May 12, 2000,
May 13, 1999, and May 8, 1998, with respective distribution dates of May 22,
2000, May 21, 1999, and May 22, 1998. Basic and diluted earnings per share,
cash dividends per common share, weighted-average shares outstanding, weighted
average shares assuming dilution, and all applicable footnotes have been
adjusted to reflect the aforementioned stock splits.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect reported amounts of assets, liabilities, revenues,
and expenses during the reporting period. Actual amounts and results could
differ from those estimated.
New accounting standard: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement,
which establishes accounting and reporting standards for derivative instruments
and for hedging activities, is effective for fiscal years beginning after
June 15, 2000. The Company will adopt the provisions of SFAS No. 133 in the
first quarter of fiscal 2002. The Company currently does not utilize
derivative financial instruments and does not expect that adoption of SFAS
No. 133 will have any significant effect on its consolidated results of
operations or financial position.
Reclassifications: Certain prior year amounts have been reclassified to
conform to current year presentation. These reclassifications had no effect
on reported consolidated earnings.
Page 28
Note B - Segment Financial Information
The Company operates in two reportable business segments - Payroll and Human
Resource Services-Professional Employer Organization (HRS-PEO). Refer to
Note A for a description of these segments. The Company reports segment
financial information consistent with the presentation made to the Company's
management for decision-making purposes and resource allocation. The Company's
reportable segments are business units that are each managed separately because
they offer and provide services through different means. The Company evaluates
segment performance based on operating income, utilizing the Company's
accounting policies described in the summary of significant accounting
policies. There are no intersegment sales. The Company's Corporate function
and expenses are comprised of the Information Technology, Organizational
Development, Finance, Marketing, and Senior Management organizations.
Financial information for each segment is as follows:
In thousands
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Service revenues:
Payroll $ 653,245 $ 545,249 $ 455,227
HRS-PEO (A) 74,874 52,047 38,477
-------------------------------------
Total service revenues $ 728,119 $ 597,296 $ 493,704
-------------------------------------
ENS Investment revenue included
in Payroll service revenue $ 58,800 $ 52,335 $ 43,429
===============================================================================
Operating income:
Payroll (B) $ 303,360 $ 237,236 $ 181,585
HRS-PEO (B) 23,395 11,072 5,322
------------------------------------
Segment operating income 326,755 248,308 186,907
Corporate expenses 67,862 60,746 52,207
------------------------------------
Total operating income 258,893 187,562 134,700
Investment income 16,479 12,581 9,473
------------------------------------
Income before income taxes $ 275,372 $ 200,143 $ 144,173
===============================================================================
Purchases of long-lived assets:
Payroll $ 18,367 $ 13,597 $ 17,146
HRS-PEO 1,184 539 2,015
Corporate 21,567 11,570 9,591
-----------------------------------
Total purchases of long-lived assets $ 41,118 $ 25,706 $ 28,752
===============================================================================
Depreciation and amortization expense:
Payroll $ 22,177 $ 20,050 $ 17,187
HRS-PEO 1,115 1,070 1,078
Corporate 13,192 11,791 8,996
-----------------------------------
Total depreciation and amortization expense $ 36,484 $ 32,911 $ 27,261
===============================================================================
Identifiable assets: May 31,
-----------------------------------
Payroll $1,889,554 $1,463,606 $1,244,272
HRS-PEO 57,822 32,144 30,726
Corporate 508,201 377,351 274,789
-----------------------------------
Total identifiable assets $2,455,577 $1,873,101 $1,549,787
===============================================================================
(A) Net of PEO direct costs billed and incurred of $731,266, $578,132, and
$499,741 for the years ended May 31, 2000, 1999, and 1998, respectively.
PEO direct costs billed to clients are equal to PEO direct costs incurred
for the wages and payroll taxes of worksite employees and their related
benefit premiums and claims.
(B) In 2000, the Company began allocating a portion of operating facilities
costs from the Payroll segment to the HRS-PEO segment. Prior years
segment results have been restated to reflect the allocation of these
facilities costs with no impact to total Segment operating income. The
total amount of these allocations were $1,650,000, $1,526,000, and
$1,320,000 in fiscal 2000, 1999, and 1998, respectively.
Page 29
Note C - Basic and Diluted Earnings Per Share
Basic and diluted earnings per share were calculated as follows:
In thousands, except per share amounts
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Basic earnings per share:
Net income $190,007 $139,099 $102,219
---------------------------------
Weighted-average common shares outstanding 370,603 368,282 366,771
---------------------------------
Basic earnings per share $ .51 $ .38 $ .28
=================================
Diluted earnings per share:
Net income $190,007 $139,099 $102,219
---------------------------------
Weighted-average common shares outstanding 370,603 368,282 366,771
Effect of dilutive stock options at
average market price 4,478 4,900 4,058
-----------------------------------
Weighted-average shares assuming dilution 375,081 373,182 370,829
-----------------------------------
Diluted earnings per share $ .51 $ .37 $ .28
===============================================================================
For the years ended May 31, 2000, 1999, and 1998, weighted-average options
to purchase shares of common stock in the amount of 495,000, 149,000, and
2,160,000, respectively, were not included in the computation of diluted
earnings per share. These options had an exercise price that was greater
than the average market price of the common shares for the period and,
therefore the effect would have been antidilutive.
Note D - Corporate Investments and ENS Investments
Corporate investments and ENS investments held at May 31, 2000 and 1999 are as
follows:
In thousands
- -------------------------------------------------------------------------------
2000 1999
- -------------------------------------------------------------------------------
Type of issue: Cost Fair value Cost Fair value
------------------------------------------------
Money market securities
and other cash equivalents $1,202,664 $1,202,664 $ 770,648 $ 770,648
Available-for-sale securities:
General obligation municipal
bonds 405,214 399,190 313,485 314,636
Pre-refunded municipal
bonds 301,271 298,706 295,359 297,621
Revenue municipal bonds 291,157 286,294 266,264 267,290
Other securities 20 92 21 73
-------------------------------------------------
Total available-for-sale
securities 997,662 984,282 875,129 879,620
Other 1,802 2,379 1,424 1,810
-------------------------------------------------
Total Corporate investments
and ENS investments $2,202,128 $2,189,325 $1,647,201 $1,652,078
===============================================================================
Classification of invest-
ments on Consolidated
Balance Sheets:
Corporate investments $ 416,988 $ 412,357 $ 288,596 $ 290,555
ENS investments 1,785,140 1,776,968 1,358,605 1,361,523
-------------------------------------------------
Total Corporate investments
and ENS investments $2,202,128 $2,189,325 $1,647,201 $1,652,078
===============================================================================
Page 30
The Company is exposed to credit risk from the possible inability of the
borrowers to meet the terms of their bonds. In addition, the Company is
exposed to interest rate risk from rate volatility causing fluctuations in the
market value of held investments and the earnings potential of future
investments. The Company attempts to limit these risks by investing primarily
in AAA and AA rated securities and A-1 rated short-term securities, limiting
amounts that can be invested in any single instrument, and investing in short-
to intermediate-term instruments whose market value is less sensitive to
interest rate changes. At May 31, 2000, approximately 99% of the available-
for-sale bond securities held an AA rating or better, and all short-term
securities classified as cash equivalents held an A-1 or equivalent rating. The
Company does not utilize derivative financial instruments to manage interest
rate risk.
Cost, gross unrealized gains and losses, and the fair value of the available-
for-sale securities are as follows:
In thousands
- -------------------------------------------------------------------------------
Gross Gross
unrealized unrealized
May 31, Cost gains losses Fair Value
- -------------------------------------------------------------------------------
2000 $997,662 $ 401 $13,781 $984,282
--------------------------------------------------------
1999 $875,129 $6,180 $ 1,689 $879,620
===============================================================================
Gross realized gains and losses are as follows:
In thousands
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Gross realized gains $ 590 $ 3,129 $ 1,481
-----------------------------------------
Gross realized losses $4,318 $ 263 $ 547
===============================================================================
The cost and fair value of available-for-sale securities by contractual
maturity at May 31, 2000 are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to prepay
obligations without prepayment penalties.
In thousands
- -------------------------------------------------------------------------------
May 31, 2000 Cost Fair value
- -------------------------------------------------------------------------------
Maturity date:
Due in one year or less $ 51,091 $ 51,130
Due after one year through three years 480,946 475,451
Due after three years through five years 333,764 328,369
Due after five years 131,861 129,332
------------------------------
Total available-for-sale securities $997,662 $984,282
===============================================================================
Page 31
Note E - Property and Equipment - Net
The components of Property and equipment - net are as follows:
In thousands
- -------------------------------------------------------------------------------
May 31, 2000 1999
- -------------------------------------------------------------------------------
Land and improvements $ 2,919 $ 2,896
Buildings and improvements 30,195 26,932
Data processing equipment and software 84,490 70,000
Furniture, fixtures, and equipment 64,729 59,818
Leasehold improvements 10,536 8,838
------------------------------
192,869 168,484
Less: accumulated depreciation and amortization 117,494 102,553
------------------------------
Property and equipment - net $ 75,375 $ 65,931
===============================================================================
Depreciation expense was $22,442,000, $20,853,000, and $17,677,000 for fiscal
years 2000, 1999, and 1998, respectively.
Note F - Goodwill and Intangible Assets - Net
The components of Goodwill and intangible assets - net are as follows:
In thousands
- -------------------------------------------------------------------------------
May 31, 2000 1999
- -------------------------------------------------------------------------------
Goodwill $3,955 $3,955
Less: accumulated amortization 1,918 1,536
------------------------------
Goodwill - net 2,037 2,419
Intangible assets:
Client acquisitions 6,748 4,120
Less: accumulated amortization 3,201 2,121
------------------------------
Client acquisitions - net 3,547 1,999
------------------------------
Goodwill and intangible assets - net $5,584 $4,418
===============================================================================
Goodwill amortization expense was $382,000, $402,000, and $409,000 for fiscal
years 2000, 1999, and 1998, respectively. Amortization expense for client
acquisitions was $1,079,000, $842,000, and $678,000 for fiscal years 2000,
1999, and 1998, respectively.
Note G - Stock Option Plans
The Company reserved 7,814,250 shares to be granted to employees in the form of
non-qualified and incentive stock options under the 1998 Stock Incentive Plan,
with 4,895,000 shares available for future grants at May 31, 2000. The 1995,
1992, and 1987 Stock Incentive Plans expired in August 1998, 1995, and 1992,
respectively; however, options to purchase 7,777,000 shares under these plans
remain outstanding at May 31, 2000.
The exercise price for the shares subject to options of the Company's common
stock is equal to the fair market value on the date of the grant. All stock
option grants have a contractual life of ten years from the date of the grant.
Non-qualified stock option grants vest at 33.3% after two years of service from
the date of the grant, with annual vesting at 33.3% thereafter.
Page 32
In November 1996, the Company granted options to purchase 3,157,000 shares in
a broad-based incentive stock option grant, for which 50% vested on
May 3, 1999, and 50% will vest on May 1, 2001. At May 31, 2000, options to
purchase 1,413,000 shares remained outstanding, with 537,000 exercisable at an
exercise price of $11.53 per share. In July 1999, the Company granted options
to purchase 1,381,000 shares in a second broad-based incentive stock option
grant, for which 25% will vest in July of each of the following four years.
Subsequent to each of the broad-based grants, each April and October, the
Company granted options to newly hired employees that met certain criteria.
The following table summarizes stock option activity for the three years ended
May 31, 2000:
In thousands, except per share amounts
- -------------------------------------------------------------------------------
Shares subject Weighted-average
to options exercise price
-----------------------------------------
Outstanding at May 31, 1997 11,936 $ 5.77
-----------------------------------------
Granted 2,682 $12.27
Exercised (975) $ 2.63
Forfeited (701) $10.92
-----------------------------------------
Outstanding at May 31, 1998 12,942 $ 7.08
-----------------------------------------
Granted 1,130 $19.59
Exercised (2,318) $ 2.59
Forfeited (882) $12.37
-----------------------------------------
Outstanding at May 31, 1999 10,872 $ 8.91
-----------------------------------------
Granted 2,991 $22.82
Exercised (2,281) $ 5.16
Forfeited (875) $17.62
-----------------------------------------
Outstanding at May 31, 2000 10,707 $12.88
=========================================
Exercisable at May 31, 1998 5,354 $ 2.35
-----------------------------------------
Exercisable at May 31, 1999 5,429 $ 4.99
-----------------------------------------
Exercisable at May 31, 2000 4,708 $ 6.59
===============================================================================
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2000:
- -------------------------------------------------------------------------------
Options outstanding Options exercisable
- -------------------------------------------------------------------------------
Weighted-
Weighted- average Weighted-
Range of Shares average remaining Shares average
exercise subject to exercise contractual subject to exercise
prices per options price life in options price
share (in thousands) per share years (in thousands) per share
- ------------------------------------------------------------------------------
$ 0.59-$ 7.12 3,121 $ 3.91 3.9 3,121 $ 3.91
$ 7.13-$14.24 3,884 $11.56 6.7 1,518 $11.60
$14.25-$21.36 924 $18.78 7.9 67 $17.41
$21.37-$28.48 2,525 $21.59 9.0 2 $21.46
$28.49-$35.60 253 $35.58 9.8 - -
-------------- --------------
10,707 $12.88 6.6 4,708 $ 6.59
===============================================================================
Page 33
In applying APB Opinion No. 25, no expense was recognized for stock options
granted. SFAS No. 123 requires that a fair market value of all awards of stock-
based compensation be determined using standard techniques and that pro forma
net income and earnings per share be disclosed as if the resulting stock-based
compensation amounts were recorded in the Consolidated Statements of Income.
The table below depicts the effects of SFAS No. 123:
In thousands, except per share amounts
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Pro forma net income $180,849 $134,642 $97,448
Pro forma basic earnings per share $ .49 $ .37 $ .27
Pro forma diluted earnings per share $ .48 $ .36 $ .26
===============================================================================
For purposes of pro forma disclosures, the estimated fair value of the stock
option is amortized to expense over the option's vesting period. The fair
value of these stock options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions:
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Risk-free interest rate 5.7% 5.0% 5.8%
Dividend yield 1.1% .8% .9%
Volatility factor .30 .40 .29
Expected option term life in years 5.0 4.5 4.5
===============================================================================
The weighted-average fair value of stock options granted for the years ended
May 31, 2000, 1999, and 1998 were $7.62, $7.45, and $3.92 per share,
respectively.
Note H - Income Taxes
The components of net deferred tax assets are as follows:
In thousands
- -------------------------------------------------------------------------------
May 31, 2000 1999
- -------------------------------------------------------------------------------
Deferred tax assets:
Compensation and employee benefit liabilities $ 4,163 $3,438
Allowance for bad debts 2,339 1,822
Other current liabilities 3,475 2,088
Unrealized losses on available-for-sale
securities 4,805 --
Other 2,851 952
------------------------------
Gross deferred tax assets 17,633 8,300
------------------------------
Deferred tax liabilities:
Revenue not subject to current taxes 4,440 3,631
Unrealized gains on available-for-sale
securities -- 1,661
Other 1,160 227
------------------------------
Gross deferred tax liabilities 5,600 5,519
------------------------------
Net deferred tax asset $12,033 $2,781
===============================================================================
Page 34
The components of the provision for income taxes are as follows:
In thousands
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Current:
Federal $76,327 $51,224 $34,888
State 11,824 10,247 8,096
-------------------------------------
Total current 88,151 61,471 42,984
-------------------------------------
Deferred:
Federal (2,398) (131) (857)
State (388) (296) (173)
-------------------------------------
Total deferred (2,786) (427) (1,030)
-------------------------------------
Provision for income taxes $85,365 $61,044 $41,954
===============================================================================
A reconciliation of the U.S. federal statutory tax rate to the effective rates
reported for income before taxes for the three years ending May 31, 2000 is as
follows:
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Federal statutory rate 35.0% 35.0% 35.0%
Increase/(decrease) resulting from:
State income taxes, net of federal benefit 2.7 3.2 3.6
Tax-exempt municipal bond interest (7.8) (7.7) (10.4)
Other items 1.1 - .9
-------------------------------------
Effective income tax rate 31.0% 30.5% 29.1%
===============================================================================
Note I - Other Comprehensive Income
The following table sets forth the related tax effects allocated to unrealized
gains and losses on available-for-sale securities, the only component of other
comprehensive income:
In thousands
- -------------------------------------------------------------------------------
Year ended May 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Unrealized holding gains/(losses) $(21,599) $ 1,979 $ 5,420
Income tax (expense)/benefit related to
unrealized holding (gains)/losses 7,806 (716) (1,955)
Reclassification adjustment for the
(gain)/loss on sale of securities
realized in net income 3,728 (2,866) (934)
Income tax expense/(benefit) on
reclassification adjustment for
gain/(loss) on sale of securities (1,340) 1,028 335
-------------------------------------
Other comprehensive income/(loss) $(11,405) $ (575) $ 2,866
===============================================================================
Page 35
Note J - Supplemental Cash Flow Information
Income taxes paid: The Company paid income taxes of $68,194,000, $43,251,000,
and $35,191,000 for the years ended May 31, 2000, 1999, and 1998, respectively.
Non-cash financing transactions: The Company recorded the tax benefit from the
exercise of non-qualified stock options as a reduction of its income tax
liability in the amount of $19,440,000, $16,250,000, and $6,945,000 for the
years ended May 31, 2000, 1999, and 1998, respectively.
Note K - Commitments and Contingencies
Employee benefits: The Company's 401(k) Incentive Retirement Plan allows all
employees to immediately participate in the salary deferral portion of the
plan. Employees who have completed one year of service are eligible to receive
a company matching contribution. The Company currently matches 50% of an
employee's voluntary contribution, with a maximum of 3% of eligible
compensation. Company contributions for the years ended May 31, 2000, 1999,
and 1998 were $4,235,000, $3,525,000, and $3,239,000, respectively.
Lines of credit: The Company has two available, uncommitted, unsecured lines
of credit from various banks totaling $140 million at market rates of interest.
The Company also has an available, uncommitted, secured line of credit totaling
$350 million at market rates of interest. No amounts were outstanding against
these lines of credit at May 31, 2000 and 1999.
Contingencies: In the normal course of business and operations, the Company is
subject to various claims and litigation. Management believes the resolution
of these matters will not have a material effect on the financial position or
results of operations of the Company.
Lease commitments: The Company leases office space and data processing
equipment under terms of various operating leases, with most data processing
equipment leases containing a purchase option at prices representing the fair
value of the equipment at expiration of the lease term. Rent expense for the
years ended May 31, 2000, 1999, and 1998 was $25,400,000, $23,038,000, and
$20,336,000, respectively. At May 31, 2000, future minimum lease payments
under various noncancelable operating leases with terms of more than one year
are $22,752,000 in fiscal 2001, $18,191,000 in fiscal 2002, $15,323,000 in
fiscal 2003, $11,558,000 in fiscal 2004, $6,945,000 in fiscal 2005, and
$11,280,000 thereafter.
Page 36
QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands, except per share amounts
- -------------------------------------------------------------------------------
Fiscal 2000 August November February May Year
31, 30, 29, 31,
- -------------------------------------------------------------------------------
Service revenues:
Payroll $150,919 $154,899 $171,821 $175,606 $653,245
HRS-PEO (A) 15,473 17,459 20,362 21,580 74,874
----------------------------------------------------
Total service revenues 166,392 172,358 192,183 197,186 728,119
Operating costs 39,366 41,356 45,964 46,795 173,481
SG&A expenses 68,342 68,494 78,316 80,593 295,745
-----------------------------------------------------
Operating income 58,684 62,508 67,903 69,798 258,893
Investment income 3,688 3,854 4,012 4,925 16,479
-----------------------------------------------------
Income before income
taxes 62,372 66,362 71,915 74,723 275,372
Income taxes 19,335 20,572 22,294 23,164 85,365
------------------------------------------------------
Net income $ 43,037 $ 45,790 $ 49,621 $ 51,559 $190,007
=======================================================
Basic earnings per share $ .12 $ .12 $ .13 $ .14 $ .51
Diluted earnings per
share $ .12 $ .12 $ .13 $ .14 $ .51
Weighted-average common
shares outstanding 369,627 370,258 370,972 371,576 370,603
Weighted-average shares
assuming dilution 373,493 374,717 377,723 376,407 375,081
Cash dividends per common
share $ .04 $ .06 $ .06 $ .06 $ .22
Market value per share:
High $ 22.13 $ 28.42 $ 34.13 $ 36.88 $ 36.88
Low $ 16.58 $ 19.17 $ 24.67 $ 29.54 $ 16.58
- -----------------------------------------------------------------------------
Fiscal 1999 August November February May Year
31, 30, 28, 31,
- -------------------------------------------------------------------------------
Service revenues:
Payroll $127,982 $131,035 $144,257 $141,975 $545,249
HRS-PEO (A) 11,307 11,913 14,166 14,661 52,047
----------------------------------------------------
Total service revenues 139,289 142,948 158,423 156,636 597,296
Operating costs 35,885 36,863 40,989 38,219 151,956
SG&A expenses 61,761 61,089 68,941 65,987 257,778
------------------------------------------------------
Operating income 41,643 44,996 48,493 52,430 187,562
Investment income 2,961 3,006 3,073 3,541 12,581
-----------------------------------------------------
Income before income
taxes 44,604 48,002 51,566 55,971 200,143
Income taxes 13,203 14,394 15,366 18,081 61,044
-----------------------------------------------------
Net income $ 31,401 $ 33,608 $ 36,200 $ 37,890 $139,099
=====================================================
Basic earnings per share $ .09 $ .09 $ .10 $ .10 $ .38
Diluted earnings per
share $ .08 $ .09 $ .10 $ .10 $ .37
Weighted-average common
shares outstanding 367,374 367,942 368,540 369,229 368,282
Weighted-average shares
assuming dilution 372,432 373,196 373,401 373,654 373,182
Cash dividends per common
share $ .03 $ .04 $ .04 $ .04 $ .15
Market value per share:
High $ 20.00 $ 24.47 $ 23.55 $ 24.45 $ 24.47
Low $ 15.89 $ 16.22 $ 18.22 $ 16.11 $ 15.89
===============================================================================
(A) Net of PEO direct costs billed and incurred of $160,987, $161,056,
$193,047, and $216,176 for the three months ended August 31, 1999,
November 30, 1999, February 29, 2000, and May 31, 2000, respectively,
and $142,498, $139,033, $148,292, and $148,309 for the three months ended
August 31, 1998, November 30, 1998, February 28, 1999, and May 31, 1999,
respectively. PEO direct costs billed to clients are equal to PEO direct
costs incurred for the wages and payroll taxes of worksite employees and
their related benefit premiums and claims.
Note: Each quarter is a discrete period and the sum of the four quarters'
basic and diluted earnings per share amounts may not equal the full year
amount. Per share amounts have been adjusted for three-for-two stock
splits in May 2000 and May 1999.
Page 37
QUARTERLY SEGMENT FINANCIAL DATA (UNAUDITED)
In thousands
- -------------------------------------------------------------------------------
Fiscal 2000 August November February May Year
31, 30, 29, 31,
- -------------------------------------------------------------------------------
Service revenues:
Payroll $150,919 $154,899 $171,821 $175,606 $653,245
HRS-PEO (A) 15,473 17,459 20,362 21,580 74,874
----------------------------------------------------
Total service revenues 166,392 172,358 192,183 197,186 728,119
-----------------------------------------------------
ENS investment revenue
included in Payroll
service revenue: $ 12,207 $ 12,033 $ 16,355 $ 18,205 $ 58,800
- ------------------------------------------------------------------------------
Operating income:
Payroll (B) $ 72,184 $ 72,567 $ 77,683 $ 80,926 $303,360
HRS-PEO (B) 4,504 5,729 6,831 6,331 23,395
----------------------------------------------------
Segment operating income 76,688 78,296 84,514 87,257 326,755
Corporate expenses 18,004 15,788 16,611 17,459 67,862
----------------------------------------------------
Total operating income 58,684 62,508 67,903 69,798 258,893
Investment income 3,688 3,854 4,012 4,925 16,479
----------------------------------------------------
Income before income taxes $ 62,372 $ 66,362 $ 71,915 $ 74,723 $275,372
===============================================================================
Fiscal 1999 August November February May Year
31, 30, 28, 31,
- -------------------------------------------------------------------------------
Service revenues:
Payroll $127,982 $131,035 $144,257 $141,975 $545,249
HRS-PEO (A) 11,307 11,913 14,166 14,661 52,047
---------------------------------------------------
Total service revenues 139,289 142,948 158,423 156,636 597,296
---------------------------------------------------
ENS investment revenue
included in Payroll
service revenue: $ 11,776 $ 11,984 $ 14,775 $ 13,800 $ 52,335
- ------------------------------------------------------------------------------
Operating income:
Payroll (B) $ 54,269 $ 57,056 $ 61,375 $ 64,536 $237,236
HRS-PEO (B) 2,230 2,194 2,854 3,794 11,072
----------------------------------------------------
Segment operating income 56,499 59,250 64,229 68,330 248,308
Corporate expenses 14,856 14,254 15,736 15,900 60,746
-----------------------------------------------------
Total operating income 41,643 44,996 48,493 52,430 187,562
Investment income 2,961 3,006 3,073 3,541 12,581
----------------------------------------------------
Income before income taxes $ 44,604 $ 48,002 $ 51,566 $ 55,971 $200,143
===============================================================================
(A) Net of PEO direct costs billed and incurred of $160,987, $161,056,
$193,047, and $216,176 for the three months ended August 31, 1999,
November 30, 1999, February 29, 2000, and May 31, 2000, respectively, and
$142,498, $139,033, $148,292, and $148,309 for the three months ended
August 31, 1998, November 30, 1998, February 28, 1999, and May 31, 1999,
respectively. PEO direct costs billed to clients are equal to PEO direct
costs incurred for the wages and payroll taxes of worksite employees and
their related benefit premiums and claims.
(B) In 2000, the Company began allocating a portion of operating facilities
costs from the Payroll segment to the HRS-PEO segment. Prior quarterly
segment results have been restated to reflect the allocation of these
facilities costs with no impact to total Segment operating income. The
amounts of these facilities allocations are approximately $412,500 per
quarter and $1,650,000 for the year for fiscal 2000, and approximately
$381,500 per quarter and $1,526,000 for the year for fiscal 1999.
Page 38 and 39
ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA
In thousands, except per share amounts and other statistics
For the years ended
May 31, 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
- --------------------------------------------------------------------------------------------------------------------------------
Results of operations
Service revenues:
Payroll $ 653,245 $ 545,249 $ 455,227 $ 368,855 $309,517 $254,093 $215,663 $184,004 $156,652 $133,886 $118,157
HRS-PEO (A) 74,874 52,047 38,477 30,878 23,791 18,020 11,290 7,700 5,253 3,289 2,043
------------------------------------------------------------------------------------------------------------
Total service
revenues 728,119 597,296 493,704 399,733 333,308 272,113 226,953 191,704 161,905 137,175 120,200
Operating costs 173,481 151,956 131,731 115,034 101,235 81,663 70,034 61,877 53,700 50,054 45,031
Selling, general and
administrative
expenses 295,745 257,778 227,273 188,074 162,151 138,186 119,477 102,893 89,393 73,854 63,042
------------------------------------------------------------------------------------------------------------
Operating income 258,893 187,562 134,700 96,625 69,922 52,264 37,442 26,934 18,812 13,267 12,127
% of total service
revenues 35.6% 31.4% 27.3% 24.2% 21.0% 19.2% 16.5% 14.0% 11.6% 9.7% 10.1%
Investment income 16,479 12,581 9,473 7,031 5,467 3,458 2,220 1,379 821 764 1,081
Income before income
taxes 275,372 200,143 144,173 103,656 75,389 55,722 39,662 28,313 19,633 14,031 13,208
% of total service
revenues 37.8% 33.5% 29.2% 25.9% 22.6% 20.5% 17.5% 14.8% 12.1% 10.2% 11.0%
Net income 190,007 139,099 102,219 75,150 55,035 40,389 28,746 20,241 13,788 9,606 8,566
% of total service
revenues 26.1% 23.3% 20.7% 18.8% 16.5% 14.8% 12.7% 10.6% 8.5% 7.0% 7.1%
- --------------------------------------------------------------------------------------------------------------------------------
Basic earnings per
share $ .51 $ .38 $ .28 $ .21 $ .15 $ .11 $ .08 $ .06 $ .04 $ .03 $ .03
Diluted earnings per
share $ .51 $ .37 $ .28 $ .20 $ .15 $ .11 $ .08 $ .06 $ .04 $ .03 $ .03
Weighted-average
common shares
outstanding 370,603 368,282 366,771 364,503 360,885 356,016 354,972 353,505 351,057 349,464 334,196
Weighted-average
shares assuming
dilution 375,081 373,182 370,829 368,454 364,926 359,066 358,085 356,298 353,063 349,988 334,871
Cash dividends per
common share $ .22 $ .15 $ .10 $ .07 $ .05 $ .03 $ .02 $ .01 $ .01 $ .01 $ .01
- --------------------------------------------------------------------------------------------------------------------------------
Financial position
Working capital $ 475,630 $ 360,784 $ 263,118 $ 194,614 $138,639 $100,009 $ 68,888 $ 46,776 $ 28,245 $ 19,230 $ 21,257
Purchases of property
& equipment 34,154 22,116 28,386 18,536 17,806 12,535 11,667 8,822 13,580 18,420 15,447
Total assets 2,455,577 1,873,101 1,549,787 1,201,323 831,585 647,366 474,786 322,214 221,771 133,342 74,501
Total debt - - - - - 728 948 1,634 2,024 2,431 2,137
Stockholders' equity 563,432 435,800 329,607 251,542 191,072 141,976 109,124 85,365 67,623 54,512 47,160
Return on stock-
holders' equity 37.8% 35.9% 36.0% 33.9% 32.3% 32.2% 29.6% 26.5% 22.6% 18.9% 19.6%
- --------------------------------------------------------------------------------------------------------------------------------
Client statistics
Payroll clients 351,900 322,600 293,600 262,700 243,300 207,900 185,900 167,500 150,400 135,200 120,600
Branch service
and processing
centers 81 79 79 79 75 71 70 70 70 70 74
Sales offices 29 29 25 23 23 23 24 20 17 16 15
401(k) Recordkeeping
clients 14,700 10,100 6,000 3,000 1,300 200 - - - - -
401(k) client funds
managed externally
(in millions) $ 1,337.5 $ 757.6 $ 383.3 $ 138.3 $ 35.0 - - - - - -
Section 125 clients 23,900 20,200 16,400 13,200 11,400 8,800 7,400 5,000 2,800 500 -
Workers' Compensation
Insurance clients 10,400 4,000 - - - - - - - - -
PEO worksite employees 20,200 18,300 19,200 13,800 9,200 5,300 3,400 1,800 500 - -
(A) Net of PEO direct costs billed and incurred. PEO direct costs billed to
clients are equal to PEO direct costs incurred for the wages and payroll
taxes of PEO worksite employees and their related benefit premiums and
claims.
Note: Per share and weighted-average share amounts have been adjusted for
three-for-two stock splits in May 2000, May 1999, May 1998, May 1997,
May 1996, May 1995, August 1994, and May 1992.