FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ______
COMMISSION FILE NUMBER 0-11330
PAYCHEX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1124166
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
911 PANORAMA TRAIL SOUTH, ROCHESTER, NEW YORK 14625-0397
(Address of principal executive offices) (Zip Code)
(716) 385-6666
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes[X] No[ ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 Par Value 374,300,271 Shares
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CLASS OUTSTANDING AT AUGUST 31, 2001
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
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For the three months ended
----------------------------------------
August 31, August 31,
2001 2000
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Revenues:
Service revenues $216,176 $186,470
Interest on funds held for clients 18,638 17,413
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Total revenues 234,814 203,883
Operating costs 53,756 45,927
Selling, general and administrative expenses 87,296 79,130
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Operating income 93,762 78,826
Investment income 7,527 5,534
-----------------------------------------
Income before income taxes 101,289 84,360
Income taxes 31,096 25,730
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Net income $ 70,193 $ 58,630
=========================================
Basic earnings per share $ .19 $ .16
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Diluted earnings per share $ .19 $ .16
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Weighted-average common shares outstanding 373,978 372,015
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Weighted-average shares assuming dilution 377,747 377,165
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Cash dividends per common share $ .09 $ .06
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
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August 31, May 31,
2001 2001
(Unaudited) (Audited)
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ASSETS
Cash and cash equivalents $ 59,325 $ 45,784
Corporate investments 593,649 568,217
Interest receivable 23,276 28,281
Accounts receivable 112,682 100,640
Prepaid expenses and other current assets 8,227 7,306
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Current assets before funds held for clients 797,159 750,228
Funds held for clients 1,879,740 2,041,045
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Total current assets 2,676,899 2,791,273
Property and equipment - net 96,699 96,078
Intangible assets - net 9,476 9,612
Deferred income taxes 266 1,361
Other assets 8,909 8,872
--------------------------------------
Total assets $2,792,249 $2,907,196
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LIABILITIES
Accounts payable $ 13,136 $ 16,377
Accrued compensation and related items 33,087 57,418
Deferred revenue 3,239 4,421
Accrued income taxes 22,877 9,783
Deferred income taxes 12,993 4,996
Other current liabilities 20,920 19,282
--------------------------------------
Current liabilities before client fund deposits 106,252 112,277
Client fund deposits 1,864,581 2,031,565
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Total current liabilities 1,970,833 2,143,842
Long-term liabilities 5,682 5,512
--------------------------------------
Total liabilities 1,976,515 2,149,354
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 600,000 authorized shares
Issued: 374,300 at August 31, 2001 and 373,647 at May 31, 2001 3,743 3,736
Additional paid-in capital 153,982 139,897
Retained earnings 637,656 601,142
Accumulated other comprehensive income 20,353 13,067
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Total stockholders' equity 815,734 757,842
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Total liabilities and stockholders' equity $2,792,249 $2,907,196
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
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For the three months ended
--------------------------------------
August 31, August 31,
2001 2000
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OPERATING ACTIVITIES
Net income $ 70,193 $ 58,630
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization on depreciable and intangible assets 7,130 6,272
Amortization of premiums and discounts on available-for-sale securities 3,941 3,037
Provision for deferred income taxes 5,042 3,015
Provision for bad debts 262 488
Net realized (gains)/losses on sales of available-for-sale
securities (4,172) 177
Changes in operating assets and liabilities:
Interest receivable 5,005 1,983
Accounts receivable (12,304) (6,850)
Prepaid expenses and other current assets (921) (169)
Accounts payable and other current liabilities (6,211) 6,697
Net change in other assets and liabilities 109 310
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Net cash provided by operating activities 68,074 73,590
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INVESTING ACTIVITIES
Purchases of available-for-sale securities (316,007) (196,941)
Proceeds from sales of available-for-sale securities 267,415 87,982
Proceeds from maturities of available-for-sale securities 14,730 8,420
Net change in funds held for clients' money market securities and other
cash equivalents 181,328 57,348
Net change in client fund deposits (166,984) (1,694)
Purchases of property and equipment (7,154) (6,066)
Proceeds from sale of property and equipment 5 3
Purchases of other assets (564) (2,994)
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Net cash used in investing activities (27,231) (53,942)
--------------------------------------
FINANCING ACTIVITIES
Dividends paid (33,679) (22,334)
Proceeds from exercise of stock options 6,377 3,553
--------------------------------------
Net cash used in financing activities (27,302) (18,781)
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Increase in cash and cash equivalents 13,541 867
Cash and cash equivalents, beginning of period 45,784 47,136
--------------------------------------
Cash and cash equivalents, end of period $ 59,325 $ 48,003
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
August 31, 2001
Note A: Significant Accounting Policies
The accompanying unaudited Consolidated Financial Statements of Paychex, Inc.,
and its wholly owned subsidiaries have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, the Consolidated Financial Statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, the information
furnished herein reflects all adjustments (consisting of items of a normal
recurring nature) which are necessary for a fair presentation of the results for
the interim period. Operating results for the three months ended August 31, 2001
are not necessarily indicative of the results that may be expected for the full
year ended May 31, 2002.
Service revenues are recognized in the period services are rendered and earned.
PEO revenues are included in service revenues and are reported net of direct
costs billed and incurred. Direct costs billed and incurred include wages,
taxes, benefit premiums and claims of worksite employees and totaled $234.8
million and $193.8 million for the quarter ended August 31, 2001 and 2000,
respectively. Paychex provides delivery service for many of its client's
payrolls. The revenue earned from delivery service is included in service
revenues and the costs for the delivery are included in operating costs on the
Consolidated Statements of Income.
Interest on funds held for clients is earned on Taxpay and Employee Pay Services
funds that are collected before due dates and invested (funds held for clients)
until remittance to the applicable tax authorities for Taxpay clients and
employees of Employee Pay Services clients. These collections from clients are
typically remitted between one and thirty days after receipt, with some items
extending to ninety days. The interest earned on these funds is included in
total revenues on the Consolidated Statements of Income as the collection,
holding and remittance of these funds is a critical component of providing these
particular product services. Interest on funds held for clients also includes
net realized gains and losses from the sale of available-for-sale securities.
There is no significant seasonality to the Company's business. However, during
the third fiscal quarter, the number of new Payroll clients, 401(k)
Recordkeeping clients and new PEO worksite employees tends to be higher than the
rest of the fiscal year. Consequently, greater sales commission expenses are
reported in the third quarter.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 141, "Business Combinations" (SFAS No. 141) and
Statement of Financial Accounting Standard 142, "Goodwill and Other Intangible
Assets" (SFAS No. 142). SFAS No. 141 requires that all future business
combinations be accounted for using the purchase method of accounting and the
use of the pooling-of-interest method is prohibited for transactions initiated
after July 1, 2001. SFAS No. 142 addresses financial accounting and reporting
for acquired goodwill and other intangible assets. This statement recognizes
that goodwill has an indefinite useful life and will no longer be subject to
periodic amortization, but rather periodically evaluated for impairment. The
statement also requires an evaluation of existing acquired goodwill and other
intangible assets for proper classification under the new requirements. The
Company adopted these standards in the first quarter of fiscal 2002. Adoption of
these standards did not have a material impact on the results of operations or
financial position of the Company.
The accompanying Consolidated Financial Statements should be read in conjunction
with the Consolidated Financial Statements and related Notes presented in the
Company's Annual Report on Form 10-K for the year ended May 31, 2001. Certain
amounts from the prior year have been reclassified to conform to the current
year presentation.
Note B: Segment Financial Information
The Company is a national provider of payroll, human resource and employee
benefits outsourcing solutions for small- to medium-sized businesses in the
United States.
During the second half of fiscal 2001, the Company completed consolidation
efforts to streamline certain operations and improve customer service. These
efforts resulted in certain service operations supporting multiple products for
both Payroll and Human Resource and Benefits product lines. Due to these
changes, the Company no longer prepares internal reporting reflecting the
operating results of the Payroll and Human Resource and Benefits segments. As a
result, in fiscal 2002, the Company changed its segment reporting from two
segments to one segment based upon the provisions of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information."
Note C: Basic and Diluted Earnings Per Share
Basic and diluted earnings per share were calculated as follows:
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For the three months ended
------------------------------------------
(In thousands, except per share August 31, August 31,
amounts) 2001 2000
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Basic earnings per share:
Net income $ 70,193 $ 58,630
------------------------------------------
Weighted-average common shares outstanding 373,978 372,015
------------------------------------------
Basic earnings per share $ .19 $ .16
------------------------------------------
Diluted earnings per share:
Net income $ 70,193 $ 58,630
------------------------------------------
Weighted-average common shares outstanding 373,978 372,015
Net effect of dilutive stock options at
average market prices 3,769 5,150
------------------------------------------
Weighted-average shares assuming dilution 377,747 377,165
------------------------------------------
Diluted earnings per share $ .19 $ .16
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For the three months ended August 31, 2001 and 2000, weighted-average
anti-dilutive stock options to purchase shares of common stock in the amount of
1,419,000 and 403,000, respectively, were excluded from 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; therefore,
the effect would have been anti-dilutive.
For the three months ended August 31, 2001, stock options were exercised for
653,000 shares of the Company's common stock.
Note D: Funds Held for Clients and Corporate Investments
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----------------------------------------------------------------------
(In thousands) August 31, 2001 May 31, 2001
(Unaudited) (Audited)
----------------------------------------------------------------------
Type of issue: Cost Fair value Cost Fair value
----------------------------------------------------------------------
Money market securities and other cash
equivalents $1,085,370 $1,085,370 $1,266,698 $1,266,698
Available-for-sale securities:
General obligation municipal
bonds 658,659 674,153 582,249 590,806
Pre-refunded municipal bonds 246,053 251,932 293,109 298,058
Revenue municipal bonds 448,405 458,849 443,667 450,635
Other securities 20 58 20 64
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Total available-for-sale securities 1,353,137 1,384,992 1,319,045 1,339,563
Other 3,328 3,027 3,099 3,001
----------------------------------------------------------------------
Total funds held for clients
and corporate investments $2,441,835 $2,473,389 $2,588,842 $2,609,262
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Classification of investments on
Consolidated Balance Sheets:
Funds held for clients $1,864,581 $1,879,740 $2,031,565 $2,041,045
Corporate investments 577,254 593,649 557,277 568,217
----------------------------------------------------------------------
Total funds held for clients and
corporate investments $2,441,835 $2,473,389 $2,588,842 $2,609,262
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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 as rate volatility will cause 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 by investing in short- to
intermediate-term instruments whose market value is less sensitive to interest
rate changes. At August 31, 2001, approximately 98% 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,
and, therefore, adopting Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" had no impact on
the results of operations or financial condition of the Company for the first
quarter of fiscal 2002.
Note E: Property and Equipment - Net
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August 31, May 31,
2001 2001
(In thousands) (Unaudited) (Audited)
-------------------------------------------------------------------------------------------------------------------
Land and improvements $ 3,040 $ 2,919
Buildings and improvements 36,941 36,923
Data processing equipment and software 110,461 106,359
Furniture, fixtures and equipment 77,102 75,243
Leasehold improvements 13,202 12,545
--------------------------------------
240,746 233,989
Less: accumulated depreciation and amortization 144,047 137,911
--------------------------------------
Property and equipment - net $ 96,699 $ 96,078
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Note F: Comprehensive Income
Comprehensive income is comprised of two components: net income and other
comprehensive income. Comprehensive income includes all changes in equity during
a period except those resulting from transactions with owners of the Company.
The unrealized gains and losses, net of applicable taxes, related to
available-for-sale securities is the only component reported in accumulated
other comprehensive income in the Consolidated Balance Sheets for the Company.
Comprehensive income, net of related tax effects, is as follows:
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For the three months ended
--------------------------------------
August 31, August 31,
(In thousands) 2001 2000
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Net income $70,193 $58,630
Unrealized gains on securities, net of
reclassification adjustments 7,286 11,341
--------------------------------------
Total comprehensive income $77,479 $69,971
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations reviews the operating results for the three months ended August 31,
2001 (fiscal 2002) and 2000 (fiscal 2001), and its financial condition at August
31, 2001 for Paychex, Inc. and its subsidiaries (the "Company"). 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 August 31, 2001 Consolidated
Financial Statements and the related Notes to Consolidated Financial Statements
contained in this Form 10-Q. Forward-looking statements in this review are
qualified by the cautionary statement included in the "Other" section of this
review under the sub-heading "Safe-Harbor Statement under the Private Securities
Litigation Reform Act of 1995."
RESULTS OF OPERATIONS
For the first quarter of fiscal 2002, the Company generated record total
revenues, net income and diluted earnings per share. These results were closely
aligned with management's expectations as described in the Company's fiscal 2001
year-end disclosures.
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(In thousands, except per share amounts)
For the three months ended August 31, 2001 Change 2000 Change
----------------------------------------------------------------------------------------------------------------------
Revenues:
Payroll $189,430 15.1% $164,521 18.6%
Human Resource and Benefits 26,746 21.9% 21,949 41.9%
-----------------------------------------------------------------
Total service revenues 216,176 15.9% 186,470 20.9%
Interest on funds held for clients 18,638 7.0% 17,413 42.6%
-----------------------------------------------------------------
Total revenues 234,814 15.2% 203,883 22.5%
Combined operating and SG&A expenses 141,052 12.8% 125,057 16.1%
-----------------------------------------------------------------
Operating income 93,762 18.9% 78,826 34.3%
Investment income 7,527 36.0% 5,534 50.1%
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Income before income taxes 101,289 20.1% 84,360 35.3%
Income taxes 31,096 20.9% 25,730 33.1%
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Net income $ 70,193 19.7% $ 58,630 36.2%
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Diluted earnings per share $ .19 18.8% $ .16 33.3%
-----------------------------------------------------------------
Operating income as a % of total revenues 39.9% 38.7%
Net income as a % of total revenues 29.9% 28.8%
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Total revenues are comprised of Payroll and Human Resource and Benefits service
revenues and interest on funds held for clients. Payroll service revenues are
earned primarily from Payroll, Taxpay, Employee Pay Services and other ancillary
services. Employee Pay Services includes the Direct Deposit, Readychex (Service
Mark) and Access Card products. The 15% increase in Payroll service revenues in
the first quarter of fiscal 2002 compared with the prior year quarter is
attributable to the addition of new clients, new services, price increases and
increased utilization of ancillary services by both new and existing clients. As
of August 31, 2001 83% of Paychex clients utilized Taxpay, the Company's tax
filing and
payment feature, compared with 82% utilization at August 31, 2000. Client
utilization of the Taxpay product is expected to mature in the range of 83% to
87%. The Company's Employee Pay Services was utilized by 54% of its clients at
August 31, 2001 compared with 48% utilization at August 31, 2000.
The Company believes Payroll service revenue growth in the first quarter was
impacted by slowing economic conditions that contributed to a decrease in
average check volume per client. The Company expects this trend to continue and
currently projects Payroll service revenue growth to be in the range of 13% to
15% for full year fiscal 2002.
Human Resource and Benefits service revenue increased 22% in the first quarter
of fiscal 2002 compared with the prior year quarter. This increase is primarily
related to an increase in clients for 401(k) Recordkeeping, Workers'
Compensation Insurance Administration and Section 125 Plan Administration
services, and an increase in Paychex Administrative Services (PAS) and
Professional Employer Organization (PEO) client employees serviced. The increase
in 401(k) clients reflects the continuing interest of small- to medium-sized
businesses to offer retirement savings benefits to their employees. 401(k)
Recordkeeping revenues in the first quarter of fiscal 2002 were $12.3 million, a
26% increase over $9.8 million for the prior year quarter. Full year fiscal
2002's Human Resource and Benefits service revenue is expected to grow at a rate
in excess of 25%.
The Paychex Administrative Services (PAS) product is a combined package of
payroll, employer compliance, employee benefit administration and risk
management outsourcing services designed to make it easier for small businesses
to manage their payroll and benefit costs. This product was introduced in May
2000 and was available nationwide by the end of fiscal 2001. The Company's PEO
product provides the same bundled services as the PAS product, but as a
co-employer of the client's employees. The PEO service is available primarily in
the states of Florida and Georgia where PEOs are popular and operate under a
favorable regulatory environment. Sales of the PAS and PEO products have been
strong with administrative fee revenue from these products increasing 48% in the
first quarter of fiscal 2002 compared with the prior year first quarter.
Interest on funds held for clients increased 7% for the first quarter compared
with the prior year quarter. This increase is the result of net realized gains
on the sale of available-for-sale securities and higher average daily portfolio
balances offset by lower interest rates in the fiscal 2002 first quarter. In the
first quarter of fiscal 2002, net realized gains on the sale of
available-for-sale securities were $3.2 million compared with net realized
losses of $.1 million in the prior year quarter. The average daily portfolio
balance totaled $1.7 billion and $1.4 billion in the first quarter of fiscal
2002 and 2001, respectively. The increase reflects higher utilization of Taxpay
and Employee Pay Services by new and existing clients. Market rates of interest
have declined significantly with the Federal Funds rate decreasing 3.0
percentage points from January 2001 through August 2001. On September 17, 2001,
the Federal Funds rate was decreased an additional 50 basis points. Due to the
decrease in interest rates and subject to potential further interest rate
reductions, the Company anticipates that interest on funds held for clients for
the full year fiscal 2002 will be lower than in fiscal 2001. The impact of
decreases in interest rates on comparisons of interest on funds held for clients
will be higher in the second half of fiscal 2002. Refer to the "Market Risk
Factors" section of this review for further discussion of interest rates and
related risks.
Total revenue growth including service revenue and interest on funds held for
clients for the full year fiscal 2002 is currently expected to be in the range
of 13% to 15%.
Operating costs increased 17% and selling, general and administrative (SG&A)
expenses increased 10% in the first quarter of fiscal 2002 compared with the
prior year period. Combined operating and SG&A expenses increased 13% in the
first quarter compared with the prior year quarter. This reflects increases in
personnel, information technology and facility costs necessary to support the
growth of the Company. At August 31, 2001 the Company had approximately 7,300
employees compared with approximately 6,500 at August 31, 2000. To improve
overall customer service, the Company implemented an initiative to decrease the
number of clients serviced per payroll specialist in fiscal 2001. Salaries of
payroll specialists were increased in an effort to improve retention. Also,
during fiscal 2001, the Company increased personnel necessary to service the
Company's PAS product. These initiatives were implemented throughout fiscal
2001, and the impact of the higher expenses on year-over-year growth rates will
be less in the second half of fiscal 2002. For the full year fiscal 2002,
combined operating and SG&A expenses are expected to grow at a rate comparable
with or slightly lower than in fiscal 2001.
Investment income represents earnings from the Company's cash and cash
equivalents and investments in available-for-sale securities. Investment income
does not include interest on funds held for clients, which is included in total
revenues. The 36% increase in investment income is primarily due to net realized
gains on the sale of available-for-sale securities and the increase in average
daily invested balances offset by lower interest rates in the fiscal 2002 first
quarter. Net realized gains included in investment income were $1.0 million for
the first quarter of fiscal 2002 compared with net realized losses of $.1
million in the prior year period. Average daily balances invested were $.6
billion and $.5 billion for the first quarter of fiscal 2002 and 2001,
respectively. The increase in the average portfolio balances was driven by
additional net cash inflows from operations. As a result of the decrease in
interest rates and subject to potential further rate reductions, investment
income for the full year in fiscal 2002 is expected to grow at a rate
significantly lower than in the prior year. The impact of decreases in interest
rates on comparisons of investment income will be higher in the second half of
fiscal 2002. Refer to the "Market Risk Factors" section of this review for
further discussion of interest rates and the related risks.
The decreases in interest rates have resulted in an increase in the market value
of the Company's available-for-sale portfolios. The combined funds held for
clients and corporate available-for-sale investment portfolios reflected
unrealized gains of $31.9 million at August 31, 2001 and $20.5 million at May
31, 2001 compared with unrealized losses of $13.4 million at May 31, 2000.
The effective income tax rate was 30.7% in the first quarter of fiscal 2002
compared with 30.5% in the prior year first quarter. The full year fiscal 2002's
effective income tax rate is expected to be in the range of 30.5% to 31.0%.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
------------------------------------------------------------------------------------------------------------------
(In thousands)
For the three months ended August 31, 2001 Change 2000 Change
------------------------------------------------------------------------------------------------------------------
Operating cash flows $68,074 -7.5% $73,590 21.4%
------------------------------------------------------------------------------------------------------------------
The decrease in operating cash flows for the first quarter of fiscal 2002
reflects higher cash from net income offset by higher cash used for working
capital purposes. The higher use of working capital was related primarily to the
timing of payments for PEO and PAS client employee payroll liabilities and other
liabilities. Projected operating cash flows are expected to adequately support
normal business operations, forecasted growth, purchases of property and
equipment and dividend payments. At August 31, 2001 the Company had $653.0
million in available cash and corporate investments. The Company also has $140
million of available, uncommitted, unsecured lines of credit and $350 million
available under an uncommitted, secured line of credit.
Investing activities
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(In thousands)
For the three months ended August 31, 2001 Change 2000 Change
------------------------------------------------------------------------------------------------------------------
Net funds held for clients and corporate investment
activities $(19,518) -56.5% $(44,885) 77.4%
Purchases of property and equipment (7,154) 17.9% (6,066) -1.5%
Proceeds from the sale of property and equipment 5 66.7% 3 -99.8%
Purchases of other assets (564) -81.2% (2,994) 604.5%
------------------------------------------------------------
Net cash used in investing activities $(27,231) -49.5% $(53,942) 75.8%
------------------------------------------------------------------------------------------------------------------
Funds held for clients and corporate investments: Funds held for clients are
primarily comprised of short-term funds and available-for-sale debt securities,
and corporate investments are primarily comprised of available-for-sale debt
securities. The portfolio of funds held for clients and corporate investments is
detailed in Note D of the Notes to the Consolidated Financial Statements.
The reported amount of funds held for clients will vary significantly based upon
the timing of collecting client funds, and the related remittance of funds to
the applicable tax authorities for Taxpay clients and employees of clients
utilizing Employee Pay Services. Corporate investments have increased due to the
investment of growing cash balances provided by operating activities less
purchases of property and equipment and dividend payments. At August 31, 2001
the total available-for-sale portfolio, including funds held for clients and
corporate investments, had a market value exceeding the cost basis by $31.9
million. Additional discussion of interest rates and related risks is included
in the "Market Risk Factors" section of this review.
Purchases of property and equipment: To support the Company's continued client
and ancillary product growth, purchases of property and equipment were made for
data processing equipment and software, and for the expansion and upgrade of
various operating facilities. Purchases of property and equipment in fiscal 2002
are expected to be in the range of $50 million to $55 million including
additional expenditures anticipated for a new data center in Rochester, New
York. Fiscal 2002 depreciation expense is projected to be in the range of $28
million to $30 million.
Financing activities
------------------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
For the three months ended August 31, 2001 Change 2000 Change
------------------------------------------------------------------------------------------------------------------
Dividends paid $(33,679) 50.8% $(22,334) 51.1%
Proceeds from exercise of stock options 6,377 79.5% 3,553 150.7%
------------------------------------------------------------
Net cash used in financing activities $(27,302) 45.4% $(18,781) 40.5%
------------------------------------------------------------
Cash dividends per common share $ .09 50.0% $ .06 50.0%
------------------------------------------------------------------------------------------------------------------
Dividends paid: During the quarter ended August 31, 2001, the Company's Board of
Directors declared a dividend in the amount of $.09 per share, which was paid
August 15, 2001 to shareholders of record as of August 1, 2001. The increase in
dividend payments compared to the prior year quarter is the result of a 50%
increase in the dividend per share amount approved by the Board of Directors in
October 2000. Future dividends are dependent on teh Company's future earnings
and cash flow.
Proceeds from exercise of stock options: The increase in proceeds from the
exercise of stock options is primarily due to an increase in the number of
shares exercised and higher comparable exercise prices per share. The Company
has recognized a tax benefit from the exercise of stock options of $7.7 million
and $5.5 million for the three months ended August 31, 2001 and 2000,
respectively. This tax benefit reduces the accrued income tax liability and
increases additional paid-in capital, with no impact on the expense amount for
income taxes.
MARKET RISK FACTORS
Interest Rate Risk: Funds held for clients are primarily comprised of short-term
funds and available-for-sale debt securities, and corporate investments are
primarily comprised of available-for-sale debt securities. The Company's
available-for-sale debt securities are exposed to interest rate risk as interest
rate volatility will cause fluctuations in the market value of held investments
and the earnings potential of future investments. Decreases in interest rates
normally increase the market value of the available-for-sale securities, while
increases in interest rates decrease the market value of the available-for-sale
securities. 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. Decreases in
interest rates quickly decrease earnings from short-term funds, and over time
decrease earnings from the available-for-sale securities portfolio. Increases in
interest rates have the opposite earnings effect on the available-for-sale
securities and short-term funds. 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. The immediate impact of changing
interest rates on earnings from short-term funds may be temporarily offset by
realized gains or losses from transactions in the Company's available-for-sale
portfolio. The Company estimates that the earnings effect of a 25-basis-point
change in interest rates (17 basis points for tax-exempt investments) at this
point in time would be approximately $3.0 million for the next twelve-month
period.
The Company directs investments towards 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.
The recent trend in interest rates has been toward interest rate reductions. The
following table summarizes recent changes in the Federal funds rate:
----------------------------------------------------------------------------------------------------------------
Fiscal Year 2002 Fiscal Year Fiscal Year
Year-to-date Ended Ended
May 31, 2001 May 31, 2000
----------------------------------------------------------------------------------------------------------------
Federal funds rate - beginning of period 4.00% 6.50% 4.75%
Rate increase/(decrease):
First quarter (.50) -- .50
Second quarter **(.50) -- .25
Third quarter N/A (1.00) .25
Fourth quarter N/A (1.50) .75
------------------------------------------------------
Federal funds rate - end of period 3.00% 4.00% 6.50%
----------------------------------------------------------------------------------------------------------------
Three-Year "AAA" Municipal Securities Yield - end of
period 2.93% 3.44% 4.96%
----------------------------------------------------------------------------------------------------------------
<FN>
**On September 17, 2001 the Federal Open Market Committee announced a decrease
in the Federal Funds rate by 50 basis points to 3.0%.
</FN>
Calculating the future effects of changing interest rates involves many factors.
These factors include, but are not limited to, daily interest rate changes,
seasonal variations in investment balances, actual duration of short- and
intermediate-term investments, the proportional mix of taxable and tax-exempt
investments, and changes in tax-exempt municipal rates versus taxable investment
rates, which are not synchronized or simultaneous. Subject to these factors, a
25-basis-point change generally affects the Company's tax-exempt interest rates
by approximately 17 basis points. Realized gains are more prevalent in a
decreasing rate environment and realized losses are more prevalent in an
increasing rate environment. During the first quarter of fiscal 2002, the
Company's total investment portfolio averaged approximately $2.3 billion and is
expected to average $2.6 billion for the full year fiscal 2002. The Company's
normal and anticipated allocation is approximately 50% invested in short-term
securities with a duration of less than thirty days and 50% invested in
intermediate-term municipal securities with an average duration of three years.
At August 31, 2001, the available-for-sale securities portfolio included
unrealized gains of $31.9 million, compared with the portfolio at May 31, 2001,
which included unrealized gains of $20.5 million. The decreasing interest rate
environment is driving the improvement in the market value of the
available-for-sale portfolio. As of August 31, 2001 and May 31, 2001, the
Company had $1.4 billion and $1.3 billion invested in available-for-sale
securities at fair value, with weighted average yields to maturity of 4.1% and
4.3%, respectively. Assuming a hypothetical decrease in both short-term and
intermediate-term interest rates of 25 basis points, the resulting potential
increase in fair value for the portfolio of securities at August 31, 2001 would
be in the range of $8 million to $9 million. Conversely, a corresponding
increase in interest rates would result in a comparable decrease in fair value.
This hypothetical decrease or increase 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.
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 August 31, 2001,
approximately 98% 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
Stock Market Volatility: The market price of the Company's common stock could be
influenced by factors such as quarterly variations in operating results,
announcements of new services or technological innovations by the Company or its
competitors, market conditions in the business process outsourcing industry,
changes in financial estimates by securities analysts, economic conditions,
price and volume fluctuations in the stock market that are not directly related
to the Company's operating performance, and other factors and events which are
beyond the Company's control. These factors can lead to fluctuations in the
Company's quoted stock price on the NASDAQ market and the related market
capitalization for the Company.
Catastrophic Events: On September 11, 2001 the United States was subject to
terrorist attacks at the World Trade Center buildings in New York City and the
Pentagon in Washington D.C. Paychex operations experienced minimal disruption as
a result of this tragic event and all Paychex locations have returned to normal
operations. At this time, the potential near- and long-term impact this event
may have in regards to the Company's third-party service providers and clients,
markets for the Company's investment portfolios, markets for the Company's
services and the U.S. economy are uncertain. As a result, there can be no
assurance that there will not be any adverse effects on the Company due to this
significant event.
New Accounting Pronouncements: In June 2001, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standard 141, "Business
Combinations" (SFAS No. 141) and Statement of Financial Accounting Standard 142,
"Goodwill and Other Intangible Assets" (SFAS No. 142). SFAS No. 141 requires
that all future business combinations be accounted for using the purchase method
of accounting and the use of the pooling-of-interest method is prohibited for
transactions initiated after July 1, 2001. SFAS No. 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets. This
statement recognizes that goodwill has an indefinite useful life and will no
longer be subject to periodic amortization, but rather periodically evaluated
for impairment. The statement also requires an evaluation of existing acquired
goodwill and other intangible assets for proper classification under the new
requirements. The Company adopted these standards in the first quarter of fiscal
2002. Adoption of these standards did not have a material impact on the results
of operations or financial position of the Company.
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995: Certain written and oral statements made by Paychex, Inc. (the "Company")
management may constitute "forward-looking statements" as defined in the Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
identified by such words and phrases as "we expect," "expected to," "estimates,"
"we look forward to," "would equate to," "projects," "projected to be,"
"anticipates," "we believe," "could be" and other similar phrases. Because they
are forward-looking, they should be evaluated in light of important risk
factors. These risk factors include, but are not limited to, general market and
economic conditions, including demand for the Company's products and services,
availability of internal and external resources, executing expansion plans,
competition, and price levels; changes in the laws regulating collection and
payment of payroll taxes, professional employer organizations, and employee
benefits, including 401(k) plans, workers' compensation, state unemployment, and
section 125 plans; delays in the development, timing of the introduction, and
marketing of new products and services; changes in technology, including use of
the Internet; the possibility of catastrophic events that could impact the
Company's operating facilities, computer technology, and communication systems;
stock market volatility; and changes in short- and long-term interest rates,
changes in the market value of available-for-sale securities, and the credit
rating of cash, cash equivalents, and securities held in the Company's
investment portfolios, all of which could cause actual results to differ
materially from anticipated results. The information provided in this document
is based upon the facts and circumstances known at this time. The Company
assumes no obligation to update this document for new information subsequent to
its issuance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information called for by this item is provided under the caption "Market
Risk Factors" under ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
PART II. OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: None
(b) Reports on Form 8-K:
(1) The Company filed a report on Form 8-K on June 25, 2001 that included
the Company's press release dated June 25, 2001 reporting the Company's
results of operations for the fourth quarter and year ended May 31,
2001 and a preliminary Management's Discussion and Analysis of Results
of Operating and Financial Condition for the fiscal years ended May 31,
2001, 2000, and 1999, respectively.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PAYCHEX, INC.
Date: September 20, 2001 /s/ B. Thomas Golisano
-----------------------
B. Thomas Golisano
Chairman, President and
Chief Executive Officer
Date: September 20, 2001 /s/ John M. Morphy
-----------------------
John M. Morphy
Vice President, Chief
Financial Officer and Secretary