EXHIBIT 13: PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR
ENDED MAY 31, 1999
MANAGEMENT'S DISCUSSION
Management's Discussion reviews the Company's operating results for each of the
three years ended May 31, 1999 (fiscal 1999, 1998 and 1997), and its financial
condition at May 31, 1999. 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 reivew are qualified by the
cautionary statement at the beginning of this Annual Report (Exhibit 99).
RESULTS OF OPERATIONS
In thousands,
except per share amounts 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Service revenues $597,296 21.0% $493,704 23.5% $399,733
Operating income $187,562 39.2% $134,700 39.4% $ 96,625
Income before income taxes $200,143 38.8% $144,173 39.1% $103,656
Net income $139,099 36.1% $102,219 36.0% $ 75,150
Basic earnings per share $ .57 35.7% $ .42 35.5% $ .31
Diluted earnings per share $ .56 36.6% $ .41 32.3% $ .31
==============================================================================
The financial results for Paychex, Inc., in 1999, reflect the ninth consecutive
year of record service revenues and net income, and the eighth consecutive year
of net income growth of 36% or more. The Company's ability to continually grow
its client base, increase client utilization of ancillary services, implement
modest price increases, and decrease operating expenses as a percent of service
revenues has resulted in nine years of average compounded annual growth in
service revenues of 19% and net income of 36%.
See Note A of the Notes to Consolidated Financial Statements for a detailed
description of the Company's business activities and reportable segments.
Payroll segment
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Payroll service revenue $545,249 19.8% $455,227 23.4% $368,855
Investment revenue included in
Payroll service revenue $ 52,335 20.5% $ 43,429 27.3% $ 34,105
Payroll operating income $235,710 30.8% $180,265 33.2% $135,364
==============================================================================
Payroll clients 322.6 9.9% 293.6 11.8% 262.7
Taxpay clients 254.3 15.2% 220.7 22.0% 180.9
Direct Deposit clients 135.4 29.7% 104.4 36.5% 76.5
Check Signing clients 39.5 17.9% 33.5 23.2% 27.2
==============================================================================
Revenues: Payroll service revenue includes service fees and investment
revenue. Service fee revenue is earned primarily from Payroll, Taxpay, Direct
Deposit, Check Signing and other ancillary services. Investment revenue is
earned during the period between collecting client funds and remitting the
funds to the applicable tax authorities for Taxpay clients and employees of
Direct Deposit clients. Investment revenue also includes net realized gains
and losses from the sale of available-for-sale securities.
The increases in service revenue for 1999 and 1998 are primarily related to the
growth of the Payroll client base, including improvement in client retention,
and increased utilization of ancillary services such as Taxpay, Direct Deposit
and Check Signing by both new and existing clients. During 1998 and 1997, the
growth of the Taxpay client base was accelerated by the Internal Revenue
Service's Electronic Federal Tax Payment System mandate, which required many
small businesses to remit payroll tax payments electronically as of July 1,
1997. Remitting payroll tax payments electronically by the Company, results in
the payments becoming "good funds" one day earlier, and a one-day reduction in
investment revenue.
At May 31, 1999, 79% of Payroll clients utilized the Taxpay service, compared
with 75% at the end of 1998, and 69% at the end of 1997. Client utilization of
this product is expected to mature within the next several years within a range
of 82% to 87%. Client utilization of Direct Deposit was 42% at May 31, 1999,
versus 36% and 29% at May 31, 1998 and 1997, respectively. At May 31, 1999,
only 25% of the total employees paid by the Company's payroll service utilized
direct deposit. This service is expected to provide growth opportunities for
fiscal 2000 and beyond.
The decrease in year-over-year percentage growth in Payroll service revenue in
1999 compared to 1998 reflects the impact of lower interest rates and the
maturing of Taxpay. Fiscal 2000's percentage growth in Payroll revenue is
expected to be within the long-term historical range of 17% to 19%. Additional
discussion on interest rates and related risk is included in the Liquidity and
Capital Resources section of this review under the caption "Investments and ENS
investments."
Operating income: Operating income for 1999 and 1998 increased as a result of
continued growth of the client base, record levels of client retention,
increased utilization of ancillary services, modest price increases, and
leveraging of the segment's operating expense base, as evidenced by the
increases in the segment's operating margins year-over-year.
HRS-PEO segment
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
HRS-PEO service revenue $ 52,047 35.3% $ 38,477 24.6% $ 30,878
PEO direct costs billed 578,132 15.7% 499,741 49.2% 334,966
----------------------------------------------
Total HRS-PEO revenue 630,179 17.1% 538,218 47.1% 365,844
PEO direct costs 578,132 15.7% 499,741 49.2% 334,966
HRS-PEO operating income $ 12,598 89.7% $ 6,642 18.7% $ 5,596
==============================================================================
401(k) Recordkeeping clients 10.1 68.3% 6.0 100.0% 3.0
401(k) client funds managed
externally (in millions) $ 757.6 97.7% $ 383.3 177.2% $ 138.3
Section 125 clients 20.2 23.2% 16.4 24.2% 13.2
PEO worksite employees 18.3 -4.7% 19.2 39.1% 13.8
==============================================================================
Revenues: The significant increases in service revenue for 1999 and 1998 are
primarily related to the benefits of developing and growing a recurring revenue
stream from 401(k) recordkeeping clients, section 125 plan clients, and the
number of Professional Employer Organization (PEO) worksite employees. During
fiscal 1999, additions to worksite employees exceeded expectations, but were
offset by the loss of two large PEO clients during November 1998. Fiscal
2000's growth in HRS-PEO service revenue is expected to be comparable to 1999's
rate and continue to grow at a rate higher than Payroll segment revenue.
PEO direct costs billed and PEO direct costs: Consistent with PEO industry
practice, total PEO revenues reported in the Consolidated Statements of Income
include the Company's service fee, plus the PEO direct costs billed to clients
for the wages and payroll taxes of worksite employees, their related benefit
premiums and claims and other direct costs of employment. The lower percentage
growth in 1999 for PEO direct costs billed and PEO direct costs is primarily
due to the loss of the two large clients discussed above.
Operating income: For 1999 and 1998, the increases in operating income are
primarily related to gains in service revenue and leveraging operating
expenses. Fiscal 1999 also benefited from the February 1998 consolidation of
the PEO administrative functions from Florida to Rochester, New York. During
the first half of 1999, the segment increased its 401(k) recordkeeping sales
force by approximately 50 individuals to attain the goal of servicing more than
10,000 clients by the end of 1999, and to build a selling infrastructure for
future years.
Full-year fiscal 2000's HRS-PEO service revenue and operating income are
anticipated to continue to grow at a rate that is higher than the Payroll
segment's. Fiscal 2000'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.
Corporate expenses
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Corporate expenses $60,746 16.4% $52,207 17.8% $44,335
==============================================================================
For 1999 and 1998, the increases in expenses are primarily due to additional
employees required to support the continued growth of the Company's business
segments. In addition, 1999 and 1998 expenses reflect increased national
marketing efforts, which began in the latter part of the third quarter of
fiscal 1998. Fiscal 2000's expenses are expected to increase at a rate
slightly lower than 1999's growth rate.
Investment income
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Investment income $12,581 32.8% $ 9,473 34.7% $ 7,031
==============================================================================
Investment income earned from the Company's Investments, which does not include
the investment revenue earned from ENS investments, has grown mainly as a
result of increases in investment balances generated from increases in overall
cash flows. Fiscal 1999's growth was slightly impacted by lower comparable
interest rates. Additional discussion on interest rates and related risk is
included in the Liquidity and Capital Resources section of this review under
the caption "Investments and ENS investments." Investment income for fiscal
2000, subject to changes in market rates of interest, is expected to grow at a
rate slightly lower than the Company's net income growth.
Income taxes
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Income taxes $61,044 45.5% $41,954 47.2% $28,506
Effective income tax rate 30.5% 1.4 29.1% 1.6 27.5%
==============================================================================
For 1999 and 1998, 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 the Taxpay and Direct Deposit
services that provide investment revenue. In addition, the higher effective
rate for 1999 was due to higher than anticipated investments in taxable
financial instruments, which were yielding a higher net of tax return than
tax-exempt investments. Fiscal 2000's effective income tax rate is expected to
range from 30.5% to 31.0%, as taxable income is expected to grow at a faster
rate than tax-exempt income.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
In thousands 1999 Change 1998 Change 1997
- ------------------------------------------------------------------------------
Operating cash flows $174,120 27.3% $136,761 27.8% $107,027
==============================================================================
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 $343.2 million in available cash and investments and $297.5 million
of available, uncommitted, unsecured lines of credit.
Investing activities
In thousands 1999 Change 1998 Change 1997
- -------------------------------------------------------------------------------
Net Investments and
ENS activities $ (82,724) -6.8% $ (88,728) 152.4% $(35,151)
Purchases of P&E, net (22,104) -21.6% (28,197) 56.6% (18,008)
Purchases of other assets (3,590) 599.8% (513) -73.5% (1,935)
- ------------------------------------------------------------------------------
Net cash used in investing
activities $(108,418) -7.7% $(117,438) 113.2% $(55,094)
==============================================================================
Investments and ENS investments: Investments are primarily available-for-sale
debt securities, and ENS investments consist of short-term funds and available-
for-sale debt securities, which are detailed in Note D of the Notes to Consoli-
dated Financial Statements.
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
Direct Deposit clients.
At May 31, 1999, the Company had $770.6 million of ENS funds and $47.6 million
of Corporate cash equivalents invested in money market securities and other
cash equivalents with an average maturity of less than 30 days, and $879.6
million invested in available-for-sale securities with an average duration of
2.5 years. At May 31, 1999, the market value of the available-for-sale
securities exceeded their cost basis by $4.5 million compared to $5.4 million
at the end of May 1998.
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 does not utilize derivative financial instruments to manage
interest rate risk. 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.
During the fiscal 1999 quarter ended November 30, 1998, the federal funds rate
was reduced by 75 basis points to 4.75%. The earnings impact of these rate
reductions 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, 1999, the Company had $879.6 million invested in
available-for-sale securities at fair value, with a weighted-average yield to
maturity of 4.10%. Assuming a hypothetical increase in interest rates of 75
basis points given the May 31, 1999 portfolio of securities, the resulting
potential decrease in fair value would be approximately $16.2 million, or
approximately 2% of the portfolio. 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, 1998.
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, A-1 rated short-term securities and by limiting
amounts that can be invested in any single instrument. At May 31, 1999,
approximately 96% 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.
Purchases of property and equipment, net: In addition to the $22.1 million of
purchases of property and equipment for the year ended May 31, 1999, the
Company had committed to purchase approximately $4.0 million of additional
items at May 31, 1999. To support the Company's continued client and ancillary
product growth, significant purchases and commitments were made in 1999 and
1998 for data processing and personal computer equipment, and for the expansion
and upgrade of various operating facilities. Purchases of property and
equipment in fiscal 2000 are expected to range from $27 million to $30 million.
Financing activities
In thousands,
except per share amounts 1999 Change 1998 Change 1997
- -------------------------------------------------------------------------------
Dividends paid $(54,055) 50.7% $(35,871) 48.7% $(24,117)
Proceeds from exercise of
stock options 5,535 178.1% 1,990 -8.7% 2,180
Other (61) -- (84) -- 218
- ------------------------------------------------------------------------------
Net cash used in financing
activities $(48,581) 43.0% $(33,965) 56.4% $(21,719)
- ------------------------------------------------------------------------------
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 seven 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 five fiscal years.
Proceeds from exercise of stock options: The increase in proceeds from
exercise of stock options reflects the issuance of 1,032,000 shares of common
stock for stock option exercises in 1999, versus 277,000 shares in 1998 and
267,000 shares in 1997, on a pre-split-adjusted basis. See Note F of the Notes
to Consolidated Financial Statements for additional disclosure on the Company's
stock option plans.
OTHER
Recently issued accounting standards: Through the end of 1999, the Company
expensed as incurred certain costs to develop and enhance its internal computer
programs and software. Expenditures for vendor-provided software were
capitalized and amortized by the straight-line method over their estimated
useful lives, ranging from 3 to 5 years. In March 1998, the Accounting
Standards Executive Committee issued 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. The Company will adopt the SOP as of June 1, 1999. The effect of
adopting the SOP is expected to increase net income by approximately $2.0
million to $3.0 million for the year ended May 31, 2000.
Year 2000 readiness disclosure: The Company is actively pursuing resolution of
year 2000 issues. The year 2000 problem originated with the advent of
computers, when dates were stored without century indicators, in an effort to
reduce the need for expensive storage space used for input, output and storage
media. In order to process and calculate dates correctly, internal computer
systems must be changed to handle the year 2000 and beyond. Year 2000 efforts
extend past the Company's internal computer systems and require coordination
with clients, vendors, government entities, financial institutions and other
third parties to understand their plans for making systems and related
interfaces compliant.
In response to year 2000 issues, the Company initiated a program to manage
progress in year 2000 compliance efforts. The managers of the Company's year
2000 compliance program report directly to the Vice President of Information
Technology and provide regular reports to the Company's Senior Management and
the Board of Directors.
Processes and procedures are in place to ensure the following: all future
internal development and testing follow year 2000 development and testing
standards, all projects undertaken in the interim deliver year 2000 compliant
solutions, all future third-party hardware and software acquisitions are year
2000 compliant, and all commercial third-party service providers are being
queried regarding their year 2000 compliance plans. In addition, the Company
is actively working with all government agency partners to determine their year
2000 compliance plans, and has begun making year 2000 changes based on their
mandates.
The Company's internal mission-critical systems were year 2000 compliant by the
end of the first quarter of calendar year 1999. The remainder of calendar year
1999 will be used to assess and address year 2000 issues for internal desktop
computers and software, complete interface testing with external agencies and
partners, enhance existing normal business contingency plans to address any
identified year 2000 issues, and to react to yet unknown changes dictated by
third parties, such as government agencies, hardware and software vendors,
financial institutions, or utility companies. Third-party interface testing
and resolution of year 2000 issues with external agencies and partners is
dependent upon those third parties completing their own year 2000 remediation
efforts.
The Company expects minimal business disruption will occur as a result of year
2000 issues for systems that the Company directly controls. The Company is in
the process of enhancing existing normal business contingency plans to address
any identified year 2000 issues based on actual testing experience with third
parties and assessment of outside risks. There can be no assurance that there
will not be an adverse effect on the Company if third parties, such as
government agencies, hardware and software vendors, financial institutions or
utility companies, do not convert their systems in a timely manner and in a way
that is compatible with the Company's systems. However, management believes
that ongoing communication with and assessment of these third parties will
minimize these risks, and expects minimal business disruption at the turn of
the century.
The Company currently anticipates expenditures for year 2000 efforts to
approximate $5 million, with approximately eighty percent spent through May 31,
1999. The remaining twenty percent will be spent on desktop computers and
software, continued interface testing with external agencies and partners,
enhancing existing contingency plans, and to react to yet unknown changes
dictated by third parties. The cost of the project and the date on which the
Company plans to complete the year 2000 modifications are based on management's
best estimates. These estimates were derived from internal assessments and
assumptions of future events. The estimates may be adversely affected by the
continued availability of personnel and system resources, as well as the
failure of third-party vendors, service providers, and agencies to properly
address year 2000 issues. There is no guarantee that these estimates will be
achieved, and actual results could differ significantly from those anticipated.
Report of Independent Auditors
Board of Directors
Paychex, Inc.
We have audited the accompanying consolidated balance sheets of Paychex, Inc.
as of May 31, 1999 and 1998, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended May 31, 1999. 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 generally accepted auditing
standards. 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, 1999 and 1998, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
May 31, 1999, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Syracuse, New York
June 25, 1999
CONSOLIDATED STATEMENTS OF INCOME
In thousands, except per share amounts Year ended May 31,
--------------------------------
1999 1998 1997
Service revenues: ---------- --------- ---------
Payroll $ 545,249 $ 455,227 $ 368,855
HRS-PEO 52,047 38,477 30,878
------- ------- -------
Total service revenues 597,296 493,704 399,733
PEO direct costs billed (A) 578,132 499,741 334,966
------- ------- -------
Total revenue 1,175,428 993,445 734,699
PEO direct costs (A) 578,132 499,741 334,966
Operating costs 151,956 131,731 115,034
Selling, general and
administrative expenses 257,778 227,273 188,074
------- ------- -------
Operating income 187,562 134,700 96,625
Investment income 12,581 9,473 7,031
------- ------- -------
Income before income taxes 200,143 144,173 103,656
Income taxes 61,044 41,954 28,506
------- ------- -------
Net income $ 139,099 $ 102,219 $ 75,150
======= ======= =======
Basic earnings per share $ .57 $ .42 $ .31
======= ======= =======
Diluted earnings per share $ .56 $ .41 $ .31
======= ======= =======
Weighted-average common
shares outstanding 245,521 244,514 243,002
======= ======= =======
Weighted-average shares
assuming dilution 248,788 247,219 245,636
======= ======= =======
Cash dividends per common share $ .22 $ .15 $ .10
======= ======= =======
See Notes to Consolidated Financial Statements.
(A) Wages and payroll taxes of PEO worksite employees and their related
benefit premiums and claims.
CONSOLIDATED BALANCE SHEETS
In thousands May 31,
----------------------------
1999 1998
ASSETS ---------- ----------
Cash and cash equivalents $ 52,692 $ 35,571
Investments 290,555 214,967
Interest receivable 18,045 13,227
Accounts receivable 62,941 54,596
Deferred income taxes 1,364 1,525
Prepaid expenses and other current assets 6,000 4,391
--------- ---------
Current assets before ENS investments 431,597 324,277
ENS investments 1,361,523 1,154,501
--------- ---------
Total current assets 1,793,120 1,478,778
--------- ---------
Property and equipment - net 65,931 64,698
Deferred income taxes 1,417 517
Other assets 12,633 5,794
--------- ---------
Total assets $1,873,101 $1,549,787
========= =========
LIABILITIES
Accounts payable $ 10,328 $ 10,496
Accrued compensation and related items 36,574 33,649
Deferred revenue 4,643 4,443
Accrued income taxes 4,281 2,628
Other current liabilities 17,905 13,960
--------- ---------
Current liabilities before ENS client deposits 73,731 65,176
ENS client deposits 1,358,605 1,150,484
--------- ---------
Total current liabilities 1,432,336 1,215,660
Other long-term liabilities 4,965 4,520
--------- ---------
Total liabilities 1,437,301 1,220,180
========= =========
STOCKHOLDERS' EQUITY
Common stock, $.01 par value,
300,000 authorized shares
Issued: 246,326/1999 and 163,188/1998 2,463 1,632
Additional paid-in capital 68,238 46,463
Retained earnings 362,269 278,107
Accumulated other comprehensive income 2,830 3,405
--------- ---------
Total stockholders' equity 435,800 329,607
--------- ---------
Total liabilities and stockholders' equity $1,873,101 $1,549,787
========= =========
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
In thousands Common Stock Accumulated
------------ Other
Additional Compre-
paid-in Retained hensive
Shares Amount capital earnings income Total
------- ----- -------- -------- ------- ---------
Balance at May 31, 1996 71,632 $ 716 $ 30,112 $161,536 $(1,292) $191,072
Net income 75,150 75,150
Unrealized gains on
securities, net of tax 1,831 1,831
-------
Total comprehensive income 76,981
Cash dividends declared (24,117) (24,117)
Exercise of stock options 267 3 2,177 2,180
Tax benefit from exercise
of stock options 5,208 5,208
Shares issued in
connection with three-
for-two stock split 36,172 362 (389) (27)
Shares issued in
connection with mergers 448 4 34 207 245
------- ----- ------ ------- ----- -------
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
======= ===== ====== ======= ===== =======
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands Year ended May 31,
-----------------------------
1999 1998 1997
-------- -------- --------
Operating Activities
Net income $139,099 $102,219 $ 75,150
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization on
depreciable and intangible assets 22,097 18,764 15,329
Amortization of premiums and discounts
on available-for-sale securities 10,814 8,497 6,115
Provision for deferred income taxes (427) (1,030) (2,053)
Provision for bad debts 1,886 1,648 1,328
Net realized gains on sales of
available-for-sale securities (2,866) (934) (164)
Changes in operating assets and liabilities:
Interest receivable (4,818) (2,765) (3,077)
Accounts receivable (10,231) (10,717) (4,779)
Prepaid expenses and other current assets (1,609) (1,905) (583)
Accounts payable and other current liabilities 21,847 22,154 19,189
Net change in other assets and liabilities (1,672) 830 572
------- ------- -------
Net cash provided by operating activities 174,120 136,761 107,027
======= ======= =======
Investing Activities
Purchases of available-for-sale securities (755,335) (529,413) (306,488)
Proceeds from sales of available-for-sale
securities 488,662 338,818 185,161
Proceeds from maturities of available-for-
sale securities 31,535 7,232 2,125
Net change in ENS money market securities
and other cash equivalents (55,707) (159,769) (210,669)
Net change in ENS client deposits 208,121 254,404 294,720
Purchases of property and equipment,
net of disposal proceeds (22,104) (28,197) (18,008)
Purchases of other assets (3,590) (513) (1,935)
------- ------- -------
Net cash used in investing activities (108,418) (117,438) (55,094)
======= ======= =======
Financing Activities
Dividends paid (54,055) (35,871) (24,117)
Proceeds from exercise of stock options 5,535 1,990 2,180
Other (61) (84) 218
------- ------- -------
Net cash used in financing activities (48,581) (33,965) (21,719)
======= ======= =======
Increase/(decrease) in Cash and cash equivalents 17,121 (14,642) 30,214
Cash and cash equivalents,
beginning of fiscal year 35,571 50,213 19,999
------- ------- -------
Cash and cash equivalents, end of fiscal year $ 52,692 $ 35,571 $ 50,213
======= ======= =======
See Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
Note A - Significant Accounting Policies
Business activities and reportable segments: Paychex, Inc., and its
wholly-owned subsidiaries (the "Company") operate within the continental United
States of America, and have two business activities and reportable segments:
Payroll and Human Resource Services-Professional Employer Organization
(HRS-PEO). 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's Corporate function and expenses are
comprised of the Information Technology, Organizational Development, Finance,
Marketing and Senior Management organizations.
The Company evaluates segment performance based on operating income, utilizing
the Company's accounting policies described in this summary of significant
accounting policies. There are no intersegment sales.
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. The ENS Direct Deposit service collects net payroll
from client accounts one day before payday and provides electronic salary
deposit for employees. The funds collected before the 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 services, section 125
plan administration, workers' compensation, group benefits, and state
unemployment insurance services, employee handbooks and management services.
The 401(k) plan recordkeeping service provides plan implementation, ongoing
compliance with government regulations, employee and employer reporting and
other administrative services.
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, employee assistance programs, comprehensive workers' compensation
management, risk management and loss containment services. Consistent with PEO
industry practice, PEO direct costs billed include the wages and payroll taxes
of worksite employees, their related benefit premiums and claims, including
workers' compensation, and other direct costs of employment.
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 are approximate fair values.
Investments and ENS investments: Debt securities included in Investments and
ENS investments are classified as available-for-sale and are recorded at fair
value obtained from an independent pricing service. 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 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 - net 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 35 years
for buildings and 2 to 10 years for all others.
Software development and enhancement: Through the end of 1999, the Company
expensed as incurred certain costs to develop and enhance its internal computer
programs and software. Expenditures for vendor-provided software were
capitalized and amortized by the straight-line method over their estimated
useful lives, ranging from 3 to 5 years. In March 1998, the Accounting
Standards Executive Committee issued 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. The Company will adopt the SOP as of June 1, 1999. The effect of
adopting the SOP is expected to increase net income by approximately $2,000,000
to $3,000,000 for the year ended May 31, 2000.
Revenue recognition: Payroll 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. HRS service revenues are recognized in
the period service is rendered. PEO total revenues are recognized in the
period the worksite employees perform service.
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 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
arrangements 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 13, 1999, May 8,
1998, and May 8, 1997, with respective distribution dates of May 21, 1999, May
22, 1998, and May 29, 1997. Basic and diluted earnings per share, cash
dividends per common share, weighted-average shares outstanding 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.
Reclassifications: Certain prior year amounts have been reclassified to
conform to current year presentation.
Note B - Basic and Diluted Earnings Per Share
In thousands, except per share amounts Year ended May 31,
----------------------------
1999 1998 1997
-------- -------- --------
Basic earnings per share:
Net income $139,099 $102,219 $ 75,150
------- ------- -------
Weighted-average common shares outstanding 245,521 244,514 243,002
------- ------- -------
Basic earnings per share $ .57 $ .42 $ .31
======= ======= =======
Diluted earnings per share:
Net income $139,099 $102,219 $ 75,150
------- ------- -------
Weighted-average common shares outstanding 245,521 244,514 243,002
Effect of dilutive stock options
at average market price 3,267 2,705 2,634
------- ------- -------
Weighted-average shares assuming dilution 248,788 247,219 245,636
------- ------- -------
Diluted earnings per share $ .56 $ .41 $ .31
======= ======= =======
For the years ended May 31, 1999, 1998, and 1997, weighted-average options to
purchase shares of common stock in the amount of 99,000, 1,440,000, and
1,529,000, 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 C - Segment Financial Information
See Note A for a description of the Company's business activities and
reportable segments.
In thousands Year ended May 31,
----------------------------------
1999 1998 1997
---------- ---------- ----------
Revenue:
Payroll $ 545,249 $ 455,227 $ 368,855
HRS-PEO revenue:
Service revenue 52,047 38,477 30,878
PEO direct cost billed (A) 578,132 499,741 334,966
---------- ---------- ----------
Total HRS-PEO revenue 630,179 538,218 365,844
---------- ---------- ----------
Total revenue 1,175,428 993,445 734,699
PEO direct costs (A) 578,132 499,741 334,966
---------- ---------- ----------
Total revenue less PEO direct costs $ 597,296 $ 493,704 $ 399,733
---------- ---------- ----------
Investment revenue included in Payroll
revenue $ 52,335 $ 43,429 $ 34,105
========== ========== ==========
Operating income:
Payroll $ 235,710 $ 180,265 $ 135,364
HRS-PEO 12,598 6,642 5,596
---------- ---------- ----------
Segment operating income 248,308 186,907 140,960
Corporate expenses 60,746 52,207 44,335
---------- ---------- ----------
Total operating income 187,562 134,700 96,625
Investment income 12,581 9,473 7,031
---------- ---------- ----------
Income before income taxes $ 200,143 $ 144,173 $ 103,656
========== ========== ==========
Purchases of long-lived assets:
Payroll $ 13,597 $ 17,146 $ 12,984
HRS-PEO 539 2,015 1,747
Corporate 11,570 9,591 5,716
---------- ---------- ----------
Total purchases of long-lived assets $ 25,706 $ 28,752 $ 20,447
========== ========== ==========
Depreciation and amortization expense:
Payroll $ 20,050 $ 17,187 $ 13,128
HRS-PEO 1,070 1,078 585
Corporate 11,791 8,996 7,731
---------- ---------- ----------
Total depreciation and amortization
expense $ 32,911 $ 27,261 $ 21,444
========= ========== ==========
Identifiable assets: May 31,
----------------------------------
Payroll $1,463,606 $1,244,272 $ 967,688
HRS-PEO 32,144 30,726 24,477
Corporate 377,351 274,789 209,158
---------- ---------- ----------
Total identifiable assets $1,873,101 $1,549,787 $1,201,323
========== ========== ==========
(A) Wages and payroll taxes of PEO worksite employees and their related
benefit premiums and claims.
Note D - Investments and ENS Investments
Investments and ENS investments are as follows:
In thousands May 31,
----------------------------------------------
1999 1998
---------------------- ----------------------
Type of issue: Cost Fair Cost Fair
value value
Money market securities and
other cash equivalents $ 770,648 $ 770,648 $ 714,941 $ 714,941
Available-for-sale
securities:
General obligation municipal
bonds 313,485 314,636 212,222 213,940
Pre-Refunded municipal bonds 295,359 297,621 236,151 238,462
Revenue municipal bonds 266,264 267,290 199,545 200,850
Other securities 21 73 21 65
--------- --------- --------- ---------
Total available-for-sale
securities 875,129 879,620 647,939 653,317
Other 1,424 1,810 1,210 1,210
--------- --------- --------- ---------
Total Investments and
ENS investments $1,647,201 $1,652,078 $1,364,090 $1,369,468
========= ========= ========= =========
Classification of investments on
Consolidated Balance Sheets:
Investments $ 288,596 $ 290,555 $ 213,606 $ 214,967
ENS investments 1,358,605 1,361,523 1,150,484 1,154,501
--------- --------- --------- ---------
Total Investments and ENS
investments $1,647,201 $1,652,078 $1,364,090 $1,369,468
========= ========= ========= =========
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 does not utilize derivative financial instruments to
manage interest rate risk. The Company attempts to limit these risks by
investing primarily in AAA and AA rated securities, 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 May 31, 1999, approximately 96% 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.
Cost, gross unrealized gains and losses, and the fair value of the
available-for-sale securities are as follows:
Gross Gross
In thousands unrealized unrealized Fair
May 31, Cost gains losses value
-------- ---------- ---------- --------
1999 $875,129 $ 6,180 $ 1,689 $879,620
1998 $647,939 $ 5,524 $ 146 $653,317
Gross realized gains and losses are as follows:
In thousands Year ended May 31,
------------------------
1999 1998 1997
------ ------ ------
Gross realized gains $3,129 $1,481 $ 602
Gross realized losses $ 263 $ 547 $ 438
The cost and fair value of available-for-sale securities at May 31, 1999, by
contractual maturity 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, 1999
-------------------
Fair
Cost value
-------- --------
Maturity date:
Due in one year or less $105,696 $106,358
Due after one year through three years 463,838 466,939
Due after three years through five years 259,194 260,003
Due after five years 46,401 46,320
------- -------
Total available-for-sale securities $875,129 $879,620
======= =======
NOTE E - PROPERTY AND EQUIPMENT - NET
In thousands May 31,
--------------------
1999 1998
-------- --------
Land and improvements $ 2,896 $ 2,815
Buildings and improvements 26,932 24,914
Data processing equipment and software 70,000 64,247
Furniture, fixtures and equipment 59,818 52,752
Leasehold improvements 8,838 7,323
------- -------
168,484 152,051
Less accumulated depreciation and
amortization 102,553 87,353
------- -------
Property and equipment - net $ 65,931 $ 64,698
======= =======
NOTE F - STOCK OPTION PLANS
The Company reserved 5,209,500 shares to be granted to employees in the form of
non-qualified and incentive stock options under the 1998 Stock Incentive Plan,
with 4,954,000 shares available for future grants at May 31, 1999. The 1995,
1992, and 1987 Stock Incentive Plans expired in August 1998, 1995, and 1992,
respectively; however, options to purchase 6,993,000 shares under these plans
remain outstanding at May 31, 1999.
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.
In November 1996, the Company granted options to purchase 2,103,000 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, 1999, options to purchase
1,264,000 shares remained outstanding, with 601,000 exercisable at an exercise
price of $17.30 per share. Subsequently, each April and October, the Company
has granted options to newly hired employees that meet certain criteria, which
vest at 50% after two years and four years of service from the date of the
grant.
The following table summarizes stock option activity for the three years ended
May 31, 1999:
Shares Weighted-
subject average
to exercise
In thousands, except per share amounts options price
------- ---------
Outstanding at May 31, 1996 6,615 $ 4.29
Granted 2,961 $ 17.09
Exercised (900) $ 2.43
Forfeited (719) $ 10.98
------ --------
Outstanding at May 31, 1997 7,957 $ 8.66
Granted 1,788 $ 18.41
Exercised (650) $ 3.94
Forfeited (467) $ 16.38
------ --------
Outstanding at May 31, 1998 8,628 $ 10.62
Granted 753 $ 29.39
Exercised (1,545) $ 3.89
Forfeited (588) $ 18.55
------ --------
Outstanding at May 31, 1999 7,248 $ 13.36
====== ========
Exercisable at May 31, 1997 2,951 $ 2.71
====== ========
Exercisable at May 31, 1998 3,569 $ 3.52
====== ========
Exercisable at May 31, 1999 3,619 $ 7.49
====== ========
The following table summarizes information about stock options outstanding at
May 31, 1999:
Options outstanding Options exercisable
------------------------------------ ------------------------
Shares Weighted- Weighted- Shares
subject average average subject Weighted-
Range to exercise remaining to average
of exercise options price contractual options exercise
prices per (In per life (In price per
share thousands) share in years thousands) share
- -------------- ----------- ----------- ----------- ----------- -----------
$ 0.00 -$ 7.50 2,208 $ 3.53 4.0 2,205 $ 3.53
$ 7.51 -$15.00 1,100 $ 9.50 6.4 666 $ 9.40
$15.01 -$22.50 3,082 $ 17.48 7.8 748 $ 17.45
$22.51 -$30.00 729 $ 28.09 9.1 -
$30.01 -$37.50 129 $ 33.08 9.7 -
----------- -----------
7,248 $ 13.36 6.6 3,619 $ 7.49
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,
----------------------------
1999 1998 1997
-------- ------- -------
Pro forma net income $134,642 $97,448 $72,060
Pro forma basic earnings per share $ .55 $ .40 $ .29
Pro forma diluted earnings per share $ .54 $ .39 $ .29
The pro forma effect on net income is not representative of future pro forma
effects, since these calculations only take into account the options granted
since June 1, 1995.
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,
------------------------
1999 1998 1997
---- ---- ----
Risk-free interest rate 5.0% 5.8% 6.2%
Dividend yield .8% .9% .9%
Volatility factor .40 .29 .28
Expected option term life in years 4.5 4.5 4.9
The weighted-average fair value of stock options granted for the years ended
May 31, 1999, 1998, and 1997 were $11.17, $5.87, and $5.59 per share,
respectively.
NOTE G - INCOME TAXES
The components of net deferred tax assets are as follows:
In thousands May 31,
-----------------
1999 1998
------ ------
Deferred tax assets:
Accrued vacation pay $1,257 $1,170
Allowance for bad debts 1,822 1,355
Accrual for future medical claims 1,337 1,169
Reserve for workers' compensation claims 659 1,186
Other 3,225 1,940
------ ------
Gross deferred tax assets 8,300 6,820
====== ======
Deferred tax liabilities:
Revenue not subject to current taxes 3,631 2,388
Unrealized gains on available-for-sale
securities 1,661 1,973
Other 227 417
----- -----
Gross deferred tax liabilities 5,519 4,778
===== =====
Net deferred tax asset $2,781 $2,042
===== =====
The components of the provision for income taxes are as follows:
In thousands Year ended May 31,
----------------------------
1999 1998 1997
------- ------- -------
Current:
Federal $51,224 $34,888 $24,699
State 10,247 8,096 5,860
------ ------ ------
Total current 61,471 42,984 30,559
====== ====== ======
Deferred:
Federal (131) (857) (1,719)
State (296) (173) (334)
------ ------ ------
Total deferred (427) (1,030) (2,053)
====== ====== ======
Provision for income taxes $61,044 $41,954 $28,506
====== ====== ======
Reconciliations of the U.S. federal statutory tax rate with effective tax
rates reported for income before income taxes are as follows:
Year ended May 31,
--------------------------
1999 1998 1997
----- ----- -----
Federal statutory rate 35.0% 35.0% 35.0%
Increase/(decrease) resulting from:
State income taxes, net of federal benefit 3.2 3.6 3.5
Tax-exempt municipal bond interest (7.7) (10.4) (10.9)
Other items - .9 (.1)
----- ----- -----
Effective income tax rate 30.5% 29.1% 27.5%
===== ===== =====
Note H - 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,
---------------------------
1999 1998 1997
------- ------- -------
Unrealized holding gains $ 1,979 $ 5,420 $ 3,215
Less: Income tax expense related
to unrealized holding gains 716 1,955 1,279
Gain on sale of securities realized
in net income 2,866 934 164
Plus: Income tax expense on gain on sale of
securities 1,028 335 59
------ ------ ------
Other comprehensive income/(loss) $ (575) $ 2,866 $ 1,831
====== ====== ======
Note I - Supplemental Cash Flow Information
Income taxes paid: The Company paid income taxes of $43,251,000, $35,191,000,
and $24,256,000 for the years ended May 31, 1999, 1998 and 1997, respectively.
Non-cash financing transactions: The Company recorded the tax benefit from the
exercise of stock options as a reduction of its income tax liability in the
amount of $16,250,000, $6,945,000, and $5,208,000 for the years ended May 31,
1999, 1998, and 1997, respectively.
Note J - Commitments and Contingencies
Employee benefits: The Company's 401(k) Incentive Retirement Plan allows
employees with one or more years of service to participate. 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, 1999, 1998, and 1997 were $3,525,000, $3,239,000, and $2,712,000,
respectively.
Lines of credit: At May 31, 1999, the Company has several available,
uncommitted, unsecured lines of credit from various banks totaling $297,500,000
at market rates of interest. No amounts were outstanding against these lines
of credit at May 31, 1999 and 1998.
Contingencies: The Company is a defendant in various lawsuits as a result of
normal operations and in the ordinary course of business. Management believes
the outcome of these lawsuits 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, 1999, 1998, and 1997 was $23,038,000, $20,336,000, and
$17,314,000, respectively. At May 31, 1999, future minimum lease payments
under various noncancelable operating leases with terms of more than one year
are $17,579,000 in fiscal 2000, $17,989,000 in fiscal 2001, $11,725,000 in
fiscal 2002, $8,959,000 in fiscal 2003, $5,841,000 in fiscal 2004, and
$8,046,000 thereafter.
Note K - Business Combinations
The following table summarizes business combinations completed in the year
ended May 31, 1997:
Common
shares
Method of issued (In
Entity name Business Date accounting thousands)
- ------------------ ---------------- -------------- ---------- ----------
National Business
Solutions, Inc. PEO August 1996 Pooling 9,904
The Payroll
Service, Inc. Payroll services August 1996 Pooling 186
Olsen Computer
Systems, Inc. Payroll services November 1996 Pooling 1,326
Results of operations prior to completion of the pooling of interests trans-
action with National Business Solutions, Inc. were restated. Results of
operations prior to completion of the other two business combination trans-
actions were not restated as the effects were not material.
ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA
In thousands, except per share amounts and other statistics
For the years ended May 31, 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989
Results of Operations
Service revenues:
Payroll $ 545,249 $455,227 $368,855 $309,517 $254,093 $215,663 $184,004 $156,652 $133,886 $118,157 $100,488
HRS-PEO 52,047 38,477 30,878 23,791 18,020 11,290 7,700 5,253 3,289 2,043 666
Total service revenues 597,296 493,704 399,733 333,308 272,113 226,953 191,704 161,905 137,175 120,200 101,154
PEO direct costs billed (A) 578,132 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - -
Total revenue 1,175,428 993,445 734,699 566,443 412,066 323,905 252,138 183,680 139,792 120,200 101,154
PEO direct costs (A) 578,132 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - -
Operating costs 151,956 131,731 115,034 101,235 81,663 70,034 61,877 53,700 50,054 45,031 35,557
Selling, general
and administrative
expenses 257,778 227,273 188,074 162,151 138,186 119,477 102,893 89,393 73,854 63,042 51,480
Operating income 187,562 134,700 96,625 69,922 52,264 37,442 26,934 18,812 13,267 12,127 14,117
% of total service
revenues 31.4% 27.3% 24.2% 21.0% 19.2% 16.5% 14.0% 11.6% 9.7% 10.1% 14.0%
Investment income 12,581 9,473 7,031 5,467 3,458 2,220 1,379 821 764 1,081 857
Income before income taxes 200,143 144,173 103,656 75,389 55,722 39,662 28,313 19,633 14,031 13,208 14,974
% of total service
revenues 33.5% 29.2% 25.9% 22.6% 20.5% 17.5% 14.8% 12.1% 10.2% 11.0% 14.8%
Net income 139,099 102,219 75,150 55,035 40,389 28,746 20,241 13,788 9,606 8,566 9,446
% of total service
revenues 23.3% 20.7% 18.8% 16.5% 14.8% 12.7% 10.6% 8.5% 7.0% 7.1% 9.3%
Basic earnings
per share $ .57 $ .42 $ .31 $ .23 $ .17 $ .12 $ .09 $ .06 $ .04 $ .04 $ .04
Diluted earnings
per share $ .56 $ .41 $ .31 $ .23 $ .17 $ .12 $ .09 $ .06 $ .04 $ .04 $ .04
Weighted-average common
shares outstanding 245,521 244,514 243,002 240,590 237,344 236,648 235,670 234,038 232,976 222,797 222,255
Weighted-average shares
assuming dilution 248,788 247,219 245,636 243,284 239,377 238,723 237,532 235,375 233,325 223,247 222,898
Cash dividends per
common share $ .22 $ .15 $ .10 $ .07 $ .04 $ .03 $ .02 $ .01 $ .01 $ .01 $ .01
Financial Position
Working capital $360,784 $263,118 $194,614 $138,639 $100,009 $ 68,888 $ 46,776 $ 28,245 $ 19,230 $ 21,257 $ 22,951
Purchases of property
and equipment 22,116 28,386 18,536 17,806 12,535 11,667 8,822 13,580 18,420 15,447 9,132
Total assets 1,873,101 1,549,787 1,201,323 831,585 647,366 474,786 322,214 221,771 133,342 74,501 55,638
Total debt - - - - 728 948 1,634 2,024 2,431 2,137 2,770
Stockholders' equity 435,800 329,607 251,542 191,072 141,976 109,124 85,365 67,623 54,512 47,160 40,245
Return on stockholders'
equity 35.9% 36.0% 33.9% 32.3% 32.2% 29.6% 26.5% 22.6% 18.9% 19.6% 26.3%
Client Statistics
Payroll clients 322,600 293,600 262,700 234,300 207,900 185,900 167,500 150,400 135,200 120,600 105,600
Branch service centers 79 79 79 75 71 70 70 70 70 74 68
Sales offices 29 25 23 23 23 24 20 17 16 15 16
401(k) Recordkeeping clients 10,100 6,000 3,000 1,300 200 - - - - - -
401(k) client funds
managed externally
(in millions) $ 757.6 $ 383.3 $ 138.3 $ 35.0 - - - - - - -
Section 125 clients 20,200 16,400 13,200 11,400 8,800 7,400 5,000 2,800 500 - -
PEO worksite employees 18,300 19,200 13,800 9,200 5,300 3,400 1,800 500 - - -
Note: Per share and weighted-average share amounts have been adjusted for
three-for-two stock splits in May 1999, May 1998, May 1997, May 1996, May 1995,
August 1993, and May 1992.
(A) Wages and payroll taxes of PEO worksite employees and their related
benefit premiums and claims.
QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands, except per share amounts
Fiscal 1999 August 31, November 30, February 28, May 31, Year
--------- ----------- ----------- --------- --------
Service revenues:
Payroll $127,982 $131,035 $144,257 $141,975 $ 545,249
HRS-PEO 11,307 11,913 14,166 14,661 52,047
-------- -------- -------- -------- ----------
Total service
revenues 139,289 142,948 158,423 156,636 597,296
PEO direct costs
billed (A) 142,498 139,033 148,292 148,309 578,132
-------- -------- -------- -------- ----------
Total revenue 281,787 281,981 306,715 304,945 $1,175,428
PEO direct
costs(A) 142,498 139,033 148,292 148,309 578,132
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 $ .13 $ .14 $ .15 $ .15 $ .57
Diluted earnings
per share $ .13 $ .14 $ .15 $ .15 $ .56
Cash dividends
per common share $ .04 $ .06 $ .06 $ .06 $ .22
Market value
per share:
High $ 30.00 $ 36.71 $ 35.33 $ 36.67 $ 36.71
Low $ 23.83 $ 24.33 $ 27.33 $ 24.17 $ 23.83
Fiscal 1998 August 31, November 30, February 28, May 31, Year
--------- ----------- ----------- --------- --------
Service revenues:
Payroll $104,865 $108,528 $122,239 $119,595 $ 455,227
HRS-PEO 8,082 8,645 9,634 12,116 38,477
-------- -------- -------- -------- ----------
Total service
revenues 112,947 117,173 131,873 131,711 493,704
PEO direct costs
billed (A) 105,636 118,048 139,482 136,575 499,741
-------- -------- -------- -------- ----------
Total revenue 218,583 235,221 271,355 268,286 993,445
PEO direct
costs(A) 105,636 118,048 139,482 136,575 499,741
Operating costs 30,306 31,891 35,347 34,187 131,731
SG&A expenses 52,284 52,710 61,674 60,605 227,273
-------- -------- -------- -------- ----------
Operating income 30,357 32,572 34,852 36,919 134,700
Investment income 2,188 2,291 2,349 2,645 9,473
-------- -------- -------- -------- ----------
Income before
income taxes 32,545 34,863 37,201 39,564 144,173
Income taxes 9,471 10,145 10,825 11,513 41,954
-------- -------- -------- -------- ----------
Net income $ 23,074 $ 24,718 $ 26,376 $ 28,051 $ 102,219
======== ======== ======== ======== ==========
Basic earnings
per share $ .09 $ .10 $ .11 $ .11 $ .42
Diluted earnings
per share $ .09 $ .10 $ .11 $ .11 $ .41
Cash dividends
per common share $ .03 $ .04 $ .04 $ .04 $ .15
Market value
per share:
High $ 18.33 $ 20.17 $ 23.42 $ 26.56 $ 26.56
Low $ 14.44 $ 14.89 $ 17.81 $ 22.08 $ 14.44
(A) Wages and payroll taxes of PEO 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 1999 and May 1998.