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 NOVEMBER 30, 1999
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 247,136,805 Shares
- ---------------------------- ---------------------------------
CLASS OUTSTANDING AT NOVEMBER 30, 1999
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
For the three months For the six months
ended November 30, ended November 30,
1999 1998 1999 1998
Service revenues:
Payroll $154,899 $131,035 $305,818 $259,017
HRS-PEO
(Net of PEO direct costs
billed and incurred of
$161,056, $139,033,
$322,043 and
$281,531, respectively (A)) 17,459 11,913 32,932 23,220
------- ------- ------- -------
Total service revenues 172,358 142,948 338,750 282,237
Operating costs 41,356 36,863 80,722 72,748
Selling, general and
administrative expenses 68,494 61,089 136,836 122,850
------- ------- ------- -------
Operating income 62,508 44,996 121,192 86,639
Investment income 3,854 3,006 7,542 5,967
------- ------- ------- -------
Income before income taxes 66,362 48,002 128,734 92,606
Income taxes 20,572 14,394 39,907 27,597
------- ------- ------- -------
Net income $ 45,790 $ 33,608 $ 88,827 $ 65,009
======= ======= ======= =======
Basic earnings per share $ .19 $ .14 $ .36 $ .27
======= ======= ======= =======
Diluted earnings per share $ .18 $ .14 $ .36 $ .26
======= ======= ======= =======
Weighted-average common shares
outstanding 246,839 245,295 246,634 245,110
======= ======= ======= =======
Weighted-average shares assuming
dilution 249,811 248,798 249,409 248,547
======= ======= ======= =======
Cash dividends per common share $ .09 $ .06 $ .15 $ .10
======= ======= ======= =======
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
(A) PEO direct costs billed to clients are equal to PEO direct costs incurred
for the wages and payroll taxes of worksite employees and their related
benefit premiums and claims.
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
November 30, May 31,
1999 1999
ASSETS (UNAUDITED) (AUDITED)
Cash and cash equivalents $ 23,845 $ 52,692
Investments 358,136 290,555
Interest receivable 19,973 18,045
Accounts receivable 84,260 62,941
Deferred income taxes 324 1,364
Prepaid expenses and other current assets 7,211 6,000
--------- ---------
Current assets before ENS investments 493,749 431,597
ENS investments 1,448,337 1,361,523
--------- ---------
Total current assets 1,942,086 1,793,120
Property and equipment - net 67,357 65,931
Deferred income taxes 2,438 1,417
Other assets 15,517 12,633
--------- ---------
Total assets $2,027,398 $1,873,101
========= =========
LIABILITIES
Accounts payable $ 10,946 $ 10,328
Accrued compensation and related items 39,277 36,574
Deferred revenue 3,732 4,643
Accrued income taxes - 4,281
Other current liabilities 20,588 17,905
--------- ---------
Current liabilities before ENS client deposits 74,543 73,731
ENS client deposits 1,451,733 1,358,605
--------- ---------
Total current liabilities 1,526,276 1,432,336
Long-term liabilities 5,302 4,965
--------- ---------
Total liabilities 1,531,578 1,437,301
STOCKHOLDERS' EQUITY
Common stock, $.01 par value,
600,000 authorized shares
Issued: 247,137/November 30, 1999 and
246,326/May 31, 1999 2,471 2,463
Additional paid-in capital 82,508 68,238
Retained earnings 414,080 362,269
Accumulated other comprehensive income/(loss) (3,239) 2,830
--------- ---------
Total stockholders' equity 495,820 435,800
--------- ---------
Total liabilities and stockholders' equity $2,027,398 $1,873,101
========= =========
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the six months
ended November 30,
1999 1998
OPERATING ACTIVITIES
Net income $ 88,827 $ 65,009
Adjustments to reconcile net income
to cash provided by operating activities:
Depreciation and amortization
on depreciable and intangible assets 11,629 10,576
Amortization of premiums and
discounts on available-for-sale securities 6,123 4,747
Provision for deferred income taxes 3,462 4,117
Provision for bad debts 889 835
Net realized (gains)/losses on sales
of available-for-sale securities 1,052 (1,556)
Changes in operating assets and liabilities:
Interest receivable (1,928) (933)
Accounts receivable (22,208) (20,304)
Prepaid expenses and other current assets (1,211) (1,012)
Accounts payable and other current liabilities 9,100 (3,701)
Net change in other assets and liabilities 1,523 148
------- -------
Net cash provided by operating activities 97,258 57,926
INVESTING ACTIVITIES
Purchases of available-for-sale securities (402,085) (270,419)
Proceeds from sales of
available-for-sale securities 275,014 200,181
Proceeds from maturities of
available-for-sale securities 9,820 7,425
Net change in ENS money market securities
and other cash equivalents (53,410) 62,330
Net change in ENS client deposits 93,128 (27,149)
Purchases of property and equipment,
net of disposal proceeds (12,468) (13,576)
Purchases of other assets (4,656) (665)
------- -------
Net cash used in investing activities (94,657) (41,873)
FINANCING ACTIVITIES
Dividends paid (37,016) (24,522)
Proceeds from exercise of stock options 5,568 2,274
------- -------
Net cash used in financing activities (31,448) (22,248)
------- -------
Decrease in Cash and cash equivalents (28,847) (6,195)
Cash and cash equivalents, beginning of period 52,692 35,571
------- -------
Cash and cash equivalents, end of period $ 23,845 $ 29,376
======= =======
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
November 30, 1999
A) 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 and six
months ended November 30, 1999, are not necessarily indicative of the results
that may be expected for the full year ended May 31, 2000.
There is no significant seasonality to the Company's business. However, during
the third fiscal quarter, the number of new payroll segment 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.
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, 1999. Certain amounts from the prior year are reclassified to conform to
current year presentations.
B) Segment Financial Information: The Company has two business segments:
Payroll and Human Resource Services-Professional Employer Organization
(HRS-PEO). 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. The HRS-PEO segment specializes in providing small-
to medium-sized businesses with cost-effective outsourcing solutions for their
employee benefits. HRS-PEO products include 401(k) plan recordkeeping
services, section 125 plan administration, Professional Employer Organization
(PEO) services, workers' compensation, group benefits, and state unemployment
insurance services, employee handbooks and management services. Corporate
expenses are primarily related to the Information Technology, Organizational
Development, Finance, Marketing and Senior Management functions of the Company.
For the three months For the six months
(In thousands) ended November 30, ended November 30,
1999 1998 1999 1998
Service revenues:
Payroll $154,899 $131,035 $305,818 $259,017
HRS-PEO (A) 17,459 11,913 32,932 23,220
------- ------- ------- -------
Total service revenues $172,358 $142,948 $338,750 $282,237
======= ======= ======= =======
ENS investment revenue included
in Payroll revenue $ 12,033 $ 11,984 $ 24,240 $ 23,760
======= ======= ======= =======
Operating income:
Payroll $ 72,155 $ 56,675 $143,927 $110,563
HRS-PEO 6,141 2,575 11,057 5,186
------- ------- ------- -------
Segment operating income 78,296 59,250 154,984 115,749
Corporate expenses 15,788 14,254 33,792 29,110
------- ------- ------- -------
Total operating income 62,508 44,996 121,192 86,639
Investment income 3,854 3,006 7,542 5,967
------- ------- ------- -------
Income before income taxes $ 66,362 $ 48,002 $128,734 $ 92,606
======= ======= ======= =======
(A) Net of PEO direct costs billed and incurred of $161,056 and $139,033 for
the three months ended November 30, 1999 and 1998, respectively, and
$322,043 and $281,531 for the six months ended November 30, 1999 and 1998,
respectively. PEO direct costs billed to clients are equal to PEO direct
costs incurred for the wages and payroll taxes of worksite employees and
their related benefit premiums and claims.
C) Basic and diluted earnings per share and stock split information: Basic
earnings per share, diluted earnings per share, cash dividends per common
share, weighted-average common shares outstanding, weighted-average shares
assuming dilution and all other applicable information for the three months and
six months ended November 30, 1998, have been adjusted to reflect a three-for-
two stock split effected in the form of 50% stock dividends on outstanding
shares payable to shareholders of record as of May 13, 1999, and distributed on
May 21, 1999.
For the three months For the six months
(In thousands, ended November 30, ended November 30,
except per share amounts) 1999 1998 1999 1998
Basic earnings per share:
Net income $ 45,790 $ 33,608 $ 88,827 $ 65,009
------- ------- ------- -------
Weighted-average common
share outstanding 246,839 245,295 246,634 245,110
------- ------- ------- -------
Basic earnings per share $ .19 $ .14 $ .36 $ .27
======= ======= ======= =======
Diluted earnings per share:
Net income $ 45,790 $ 33,608 $ 88,827 $ 65,009
------- ------- ------- -------
Weighted-average common
shares outstanding 246,839 245,295 246,634 245,110
Net effect of dilutive stock
options at average market
price 2,972 3,503 2,775 3,437
------- ------- ------- -------
Weighted-average shares
assuming dilution 249,811 248,798 249,409 248,547
------- ------- ------- -------
Diluted earnings per share $ .18 $ .14 $ .36 $ .26
======= ======= ======= =======
Weighted-average anti-dilutive
stock options $ - $ - $ 571 $ 134
======= ======= ======= =======
Weighted-average anti-dilutive stock options to purchase shares of common stock
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 and, therefore, the effect would have been
anti-dilutive.
For the three months and six months ended November 30, 1999, stock options were
exercised for 546,000 and 811,000 shares of the Company's common stock,
respectively.
D) Investments and ENS investments:
November 30, May 31,
(In thousands) 1999 1999
(UNAUDITED) (AUDITED)
---------------------- ---------------------
COST FAIR VALUE COST FAIR VALUE
Type of issue:
Money market securities and
other cash equivalents $ 824,058 $ 824,058 $ 770,648 $ 770,648
Available-for-sale
securities:
General obligation
municipal bonds 379,813 377,432 313,485 314,636
Pre-Refunded municipal
bonds 310,035 309,403 295,359 297,621
Revenue municipal bonds 295,336 293,275 266,264 267,290
Other securities 21 75 21 73
--------- --------- --------- ---------
Total available-for-sale
securities 985,205 980,185 875,129 879,620
Other 1,703 2,230 1,424 1,810
--------- --------- --------- ---------
Total Investments and
ENS investments $1,810,966 $1,806,473 $1,647,201 $1,652,078
========= ========= ========= =========
Classification of investments
on Consolidated Balance Sheets:
Investments $ 359,233 $ 358,136 $ 288,596 $ 290,555
ENS investments 1,451,733 1,448,337 1,358,605 1,361,523
--------- --------- --------- ---------
Total Investments and
ENS investments $1,810,966 $1,806,473 $1,647,201 $1,652,078
========= ========= ========= =========
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 November 30, 1999, 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.
E) Property and equipment - net:
November 30, May 31,
(In thousands) 1999 1999
(UNAUDITED) (AUDITED)
Land and improvements $ 2,908 $ 2,896
Buildings and improvements 24,514 26,932
Data processing equipment and software 76,820 70,000
Furniture, fixtures and equipment 61,299 59,818
Leasehold improvements 9,692 8,838
------- -------
175,233 168,484
Less accumulated depreciation and amortization 107,876 102,553
------- -------
Property and equipment - net $ 67,357 $ 65,931
======= =======
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:
For the three months For the six months
(In thousands) ended November 30, ended November 30,
1999 1998 1999 1998
Net income $ 45,790 $ 33,608 $ 88,827 $ 65,009
Unrealized gains/(losses)
on securities, net of
reclassification
adjustments (832) 710 (6,069) 2,960
------- ------- ------- -------
Total comprehensive
income $ 44,958 $ 34,318 $ 82,758 $ 67,969
======= ======= ======= =======
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis reviews the operating results for the three
months and six months ended November 30, 1999 (fiscal 2000) and 1998 (fiscal
1999), and its financial condition at November 30, 1999 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 November 30, 1999 Consolidated Financial Statements, and the
related Notes to Consolidated Financial Statements contained in this Form 10-Q.
Forward-looking statements in this Management's Discussion and Analysis are
qualified by the cautionary statement in Exhibit 99, contained in this Form
10-Q.
RESULTS OF OPERATIONS
(In thousands, except per share amounts)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Service revenues $172,358 20.6% $142,948
Operating income $ 62,508 38.9% $ 44,996
Operating margin 36.3% 4.8 31.5%
Income before income taxes $ 66,362 38.2% $ 48,002
Net income $ 45,790 36.2% $ 33,608
% of service revenues 26.6% 3.1 23.5%
Basic earnings per share $ .19 35.7% $ .14
Diluted earnings per share $ .18 28.6% $ .14
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Service revenues $338,750 20.0% $282,237
Operating income $121,192 39.9% $ 86,639
Operating margin 35.8% 5.1 30.7%
Income before income taxes $128,734 39.0% $ 92,606
Net income $ 88,827 36.6% $ 65,009
% of service revenues 26.2% 3.2 23.0%
Basic earnings per share $ .36 33.3% $ .27
Diluted earnings per share $ .36 38.5% $ .26
==============================================================================
The Company's continued ability to grow its client base, increase client
utilization of ancillary services, develop new services, implement price
increases, and decrease operating expenses as a percent of service revenues has
resulted in record service revenues and net income for the three months and six
months ended November 30, 1999.
Payroll segment
(In thousands)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Payroll service revenue $154,899 18.2% $131,035
ENS investment revenue included in
Payroll service revenue $ 12,033 0.4% $ 11,984
Payroll operating income $ 72,155 27.3% $ 56,675
Payroll operating margin 46.6% 3.3 43.3%
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Payroll service revenue $305,818 18.1% $259,017
ENS investment revenue included in
Payroll service revenue $ 24,240 2.0% $ 23,760
Payroll operating income $143,927 30.2% $110,563
Payroll operating margin 47.1% 4.4 42.7%
==============================================================================
Payroll clients 337.9 9.8% 307.8
Taxpay clients 269.3 13.8% 236.6
% of Payroll clients 79.7% 2.8 76.9%
Flexible Pay Package clients 147.8 22.2% 120.9
% of Payroll clients 43.7% 4.4 39.3%
==============================================================================
Revenues: Payroll service revenue includes service fees and investment
revenue. Service fee revenue is earned primarily from Payroll, Taxpay,
Flexible Pay Package and other ancillary services. The Flexible Pay Package
includes the Direct Deposit, Readychex, and Access Card products. ENS
investment revenue is earned during the period between collecting client funds
(ENS investments) and remitting the funds to the applicable tax authorities for
Taxpay clients and employees of Flexible Pay Package clients. ENS investment
revenue also includes net realized gains and losses from the sale of
available-for-sale securities. 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".
The increases in payroll service revenue are primarily related to the addition
of new clients, improved client retention, new services, price increases, and
increased utilization of ancillary services, such as Taxpay and Flexible Pay
Package by both new and existing clients. Client utilization of the Taxpay
product is expected to mature within the next several years within a range of
82% to 87%. Client utilization of Flexible Pay Package is expected to provide
growth opportunities for fiscal 2000 and beyond.
Fiscal 2000's percentage growth in Payroll revenue is expected to be on the
high end of the long-term objective of 17% to 19%.
Operating income: Operating income increased as a result of the increases in
revenue and continued leveraging of the segment's operating expense base.
During the three months ended November 30, 1999, the Company began the process
of expanding its Major Market Services payroll product offering to include
thirty cities that are currently serviced by its core Payroll product. The
Company will continue to evaluate additional expansion efforts for this product
in the future. The estimated full-year impact of this expansion is
approximately $2.2 million. Effective September 1, 1999, the Company increased
its sales force compensation package in an effort to increase the retention of
its payroll sales representatives. The estimated quarterly impact of this
increase is approximately $1.5 million.
HRS-PEO segment
(In thousands)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
HRS-PEO service revenue $ 17,459 46.6% $11,913
HRS-PEO operating income $ 6,141 138.5% $ 2,575
HRS-PEO operating margin 35.2% 13.6 21.6%
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
HRS-PEO service revenue $ 32,932 41.8% $23,220
HRS-PEO operating income $ 11,057 113.2% $ 5,186
HRS-PEO operating margin 33.6% 11.3 22.3%
==============================================================================
401(k) recordkeeping clients 12.4 55.0% 8.0
401(k) client funds managed
externally (in millions) $1,018.3 95.9% $ 519.9
Section 125 clients 22.3 23.2% 18.1
Workers' compensation
insurance clients 6.8 300.0% 1.7
PEO worksite employees 19.0 20.3% 15.8
==============================================================================
Revenues: The increases in service revenue are primarily related to increasing
401(k) recordkeeping, Section 125 and Workers' compensation insurance clients.
The increase in 401(k) clients reflects the continuing interest of small- to
medium-sized businesses to offer retirement savings benefits to their
employees. During the first quarter of fiscal 1999, the Company began a
national rollout of its Workers' compensation insurance product, which provides
insurance for qualified clients through a leading insurance provider and a
method to stabilize their cash flows throughout the year. Full-year fiscal
2000's growth in HRS-PEO service revenue is expected to be slightly higher than
1999's rate of 35.3%.
Operating income: The increases in operating income are primarily related to
the service revenue gains, and the leveraging of operating expenses.
Full-year fiscal 2000's HRS-PEO service revenue and operating income are
expected to continue to grow at a rate that is higher than the Payroll
segment'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)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Corporate expenses $15,788 10.8% $14,254
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Corporate expenses $33,792 16.1% $29,110
==============================================================================
Corporate expenses are primarily related to the Information Technology,
Organizational Development, Finance, Marketing and Senior Management functions
of the Company. The increases in expenses are primarily due to additional
employees and other expenditures required to support the continued growth of
the Company's business segments. These increases are reduced by the costs
capitalized for the development of internal-use software, in accordance with
the adoption of Statement of Position 98-1 (SOP 98-1), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", effective
June 1, 1999. Additional discussion is included in the Liquidity and Capital
Resources section of this review under the caption "Purchases of property and
equipment, net of disposal proceeds." Full-year fiscal 2000's expenses are
expected to increase at a rate lower than 1999's full-year growth rate of 16%,
reflecting the capitalization of certain internal costs under the provisions of
SOP 98-1, and reduced spending on national marketing efforts.
Investment income
(In thousands)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Investment income $3,854 28.2% $3,006
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Investment income $7,542 26.4% $5,967
==============================================================================
Investment income represents earnings from the Company's cash and cash
equivalents and investments in available-for-sale securities. Investment
income does not include earnings from the ENS investments which are recorded as
ENS investment revenue within the Payroll segment. The increases in Investment
income are primarily due to the increases in average daily invested balances
generated from the increases in overall cash flows. These increases were
slightly reduced by the impact of lower comparable yields earned on the
Company's portfolio of tax-exempt bonds during the first half of fiscal 2000.
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 full-year fiscal
2000, subject to changes in market rates of interest, is expected to grow at a
rate lower than the Company's net income growth.
Income taxes
(In thousands)
For the three months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Income taxes $20,572 42.9% $14,394
Effective income tax rate 31.0% 1.0 30.0%
==============================================================================
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Income taxes $39,907 44.6% $27,597
Effective income tax rate 31.0% 1.2 29.8%
==============================================================================
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 Flexible Pay Package products that provide ENS
investment revenue. Full-year fiscal 2000's effective income tax rate is
expected to approximate 31%.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
(In thousands)
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Operating cash flows $97,258 67.9% $57,926
==============================================================================
The increase 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 November 30,
1999, the Company had $382.0 million in available cash and investments and
$320.0 million of available, uncommitted, unsecured lines of credit.
Investing activities
(In thousands)
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Net Investments and ENS activities $(77,533) 180.6% $(27,632)
Purchases of P&E, net of disposal proceeds (12,468) -8.2% (13,576)
Purchases of other assets (4,656) 600.2% (665)
-------------------------------
Net cash used in investing activities $(94,657) 126.1% $(41,873)
==============================================================================
Investments and ENS investments: Investments are primarily available-for-sale
debt securities. ENS investments are primarily short-term funds and
available-for-sale debt securities. The portfolio of Investments and ENS
investments is detailed in Note D of the Notes to the Consolidated 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 clients utilizing the Flexible Pay Package.
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 second quarter of fiscal 1999, the federal funds rate was reduced by
75 basis points to 4.75%. During the first quarter of fiscal 2000, the federal
funds rate was increased by 50 basis points to 5.25%, and during the second
quarter of fiscal 2000, the rate was increased by 25 basis points to 5.50%. The
earnings impact of these rate changes is not precisely quantifiable because
many factors influence the return on the Company's portfolio. These factors
include, among others, daily interest rate changes, the proportional mix of
taxable and tax-exempt investments, and changes in tax-exempt and taxable
investment rates, which are not synchronized, nor do they change
simultaneously. Subject to the aforementioned factors, a 25 basis point change
normally affects the Company's tax-exempt interest rates by approximately 17
basis points.
At November 30, 1999, the Company had $824.1 million of ENS funds and $11.6
million of Corporate cash equivalents invested in money market securities and
other cash equivalents with an average maturity of less than 30 days, and
$980.2 million invested in available-for-sale securities with an average
duration of 2.5 years. At November 30, 1999, the available-for-sale securities
portfolio had a market value less than its cost basis by $5.0 million, compared
with the portfolio at May 31, 1999, which had a market value greater than its
cost basis by $4.5 million. The decrease in the portfolio's market value is
due to the increase in relative interest rates experienced during the six
months ended November 30, 1999.
As of November 30, 1999 and May 31, 1999, the Company had $980.2 million and
$879.6 million invested in available-for-sale securities at fair value, with a
weighted-average yield to maturity of 4.3% and 4.1%, respectively. Assuming a
hypothetical increase in interest rates of 75 basis points given the November
30, 1999 and May 31, 1999 portfolio of securities, the resulting potential
decrease in fair value would be approximately $18.1 million and $16.2 million,
respectively. Conversely, a corresponding decrease in interest rates would
result in a comparable increase in fair value. This hypothetical increase or
decrease in the fair value of the portfolio would be recorded as an adjustment
to the portfolio's recorded value, with an offsetting amount recorded in
stockholders' equity, and with no related or immediate impact to the results of
operations. The Company's interest rate risk exposure has not changed
materially since May 31, 1999.
Credit risk - The Company is exposed to credit risk in connection with these
investments through the possible inability of the borrowers to meet the terms
of the bonds. The Company attempts to limit credit risk by investing primarily
in AAA and AA rated securities, A-1 rated short-term securities and by limiting
amounts that can be invested in any single instrument. At November 30, 1999,
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.
Purchases of property and equipment, net of disposal proceeds: To support the
Company's continued client and ancillary product growth, purchases of property
and equipment were made for data processing and personal computer equipment,
and for the expansion and upgrade of various operating facilities. During the
first quarter ended August 31, 1999, the Company sold an office facility for
approximately $1.2 million in cash proceeds. The Company expects to purchase
a branch facility for approximately $6.1 million during the quarter ended
February 29, 2000. Purchases of property and equipment in fiscal 2000 are
expected to approximate $36 million, which includes the expected aforementioned
purchase of the branch facility.
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 adopted the SOP
effective 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.
Financing activities
(In thousands, except per share amounts)
For the six months ended November 30, 1999 Change 1998
- ------------------------------------------------------------------------------
Dividends paid $(37,016) 51.0% $(24,522)
Proceeds from exercise of stock options 5,568 144.9% 2,274
-------------------------------
Net cash used in financing activities $(31,448) 41.4% $(22,248)
- ------------------------------------------------------------------------------
Cash dividends per common share $ .15 50.0% $ .10
==============================================================================
Dividends paid: On October 7, 1999, the Company's Board of Directors increased
the quarterly dividend rate from $.06 per share to $.09 per share, and declared
a dividend payable November 15, 1999, for shareholders of record as of
November 1, 1999. The Company has increased its quarterly cash dividend rate
per share by 50% in each of the last eight fiscal years. The Company has
distributed three-for-two stock splits effected in the form of 50% stock
dividends on outstanding shares each May in the past five fiscal years.
Proceeds from exercise of stock options: The increase in proceeds from the
exercise of stock options is primarily due to higher comparable exercise prices
per share, plus an increase in the number of shares exercised. The Company has
recognized a tax benefit from the exercise of stock options of $8.7 million and
$6.6 million for the six months ended November 30, 1999 and 1998, 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.
OTHER
Year 2000 readiness disclosure: 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.
In response to year 2000 issues, the Company initiated and has substantially
completed a program to manage 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.
As part of the year 2000 compliance program, processes and procedures were put
in place to ensure the following: internal development and testing followed
year 2000 development and testing standards, new projects delivered year 2000
compliant solutions, third-party hardware and software acquisitions were year
2000 compliant, and commercial third-party service providers were queried
regarding their year 2000 compliance plans and status. In addition, the
Company actively worked with all government agency partners to determine their
year 2000 compliance plans and status, and made year 2000 changes based on
their mandates.
As a result of these efforts, the Company's internal mission-critical systems
are year 2000 compliant and the Company expects minimal business disruption
will occur as a result of year 2000 issues for systems that the Company
directly controls. The Company has also addressed year 2000 issues for internal
desktop computers and software. The Company has completed interface testing
with external agencies and partners. Through the remainder of December 1999,
the Company will continue to monitor and react to any year 2000 related changes
from external agencies and partners, which include hardware and software
vendors, governmental agencies, financial institutions, and service providers.
There can be no assurance that there will not be an adverse effect on the
Company if these third-party, external agencies and partners 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 the ongoing communication
with these third parties has minimized these risks, and expects minimal
business disruption at the turn of the century.
Year 2000 contingency plans have been developed and existing business
contingency plans have been enhanced to provide guidelines and instructions for
reacting to year 2000 issues that may be encountered. These contingency plans
will continue to be updated and modified where necessary through the remainder
of December 1999.
The Company's estimated expenditures for year 2000 efforts are substantially
complete and approximate $5 million.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information called for by this item is provided under the caption
"Investments and ENS investments" at subheading "Interest rate risk:" under
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, within this Form 10-Q.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on October 7, 1999. Stockholders
elected eight Directors nominated in the August 9, 1999 Proxy Statement,
incorporated herein by reference, to hold office until the next Annual Meeting
of Stockholders. Additionally, the stockholders ratified the proposals to
amend the Certificate of Incorporation to increase the authorized shares of
common stock from 300,000,000 to 600,000,000, and to amend the Paychex, Inc.
1998 Stock Incentive Plan.
Results of stockholder voting are as follows:
1. Election of Directors Votes for Votes Withheld
B. Thomas Golisano 217,733,886 4,741,639
Steven D. Brooks 218,495,661 3,978,856
G. Thomas Clark 217,730,894 4,744,631
David J. S. Flaschen 218,479,659 3,995,866
Phillip Horsley 218,485,117 3,980,208
Grant M. Inman 218,458,397 3,980,126
Harry P. Messina, Jr. 216,674,174 5,801,341
J. Robert Sebo 217,717,098 4,758,427
2. Proposal to amend the Certificate of Incorporation to increase the
authorized shares of common stock from 300,000,000 to 600,000,000.
For Against Abstaining
206,348,320 16,301,210 825,983
3. Proposal to amend the Paychex, Inc. 1998 Stock Incentive Plan.
For Against Abstaining
214,206,560 3,724,158 1,423,972
ITEM 5: OTHER INFORMATION
The text portion of the Company's press release dated December 16, 1999,
regarding its financial results for the three months and six months ended
November 30, 1999, is attached. The related Consolidated Financial Statements
are contained in PART I. FINANCIAL INFORMATION of this Form 10-Q.
FOR IMMEDIATE RELEASE
John M. Morphy, Chief Financial Officer
Or
Jan Shuler 716-383-3406
Access Paychex, Inc. Second Quarter SEC Form 10-Q,
News Releases and related SEC filings at
http://www.paychex.com/paychex/finance/finance.html
PAYCHEX, INC. REPORTS RECORD SECOND QUARTER RESULTS
ROCHESTER, NY, December 16, 1999 -- Paychex, Inc. (NASDAQ: PAYX) today
announced record net income of $45.8 million or $.18 diluted earnings per share
for the second quarter ended November 30, 1999, a 36% increase over net income
of $33.6 million or $.14 diluted earnings per share for the same period last
year. Total service revenues were $172.4 million, an increase of 21% over
$142.9 million for the second quarter last year.
For the six months ended November 30, 1999, net income increased 37% to $88.8
million or $.36 diluted earnings per share as compared to net income of $65.0
million or $.26 diluted earnings per share for the same period last year.
Total service revenues were $338.8 million, an increase of 20% over $282.2
million for the same period last year.
PAYROLL SEGMENT
For the second quarter ended November 30, 1999, operating income for the
Payroll segment increased 27% to $72.2 million from $56.7 million for the same
period last year. Payroll service revenue was $154.9 million, an increase of
18% over $131.0 million for the second quarter last year.
For the six months ended November 30, 1999, operating income from Payroll
services increased 30% to $143.9 million from $110.6 million for the same
period last year. Payroll service revenue was $305.8 million, an increase of
18% over $259.0 million for the same period last year.
The increases in service revenue and operating income were primarily the result
of a 10% year-over-year increase in the Payroll client base and continued
growth of our ancillary services, Taxpay and Flexible Pay Package. Paychex
currently services 337,900 Payroll clients, with 269,300 utilizing Taxpay, the
Company's tax filing and payment feature, and 147,800 taking advantage of the
Company's Flexible Pay Package, which includes Direct Deposit, Readychex, and
Access Card.
HRS-PEO SEGMENT
For the second quarter ended November 30, 1999, operating income for the
HRS-PEO segment increased 138% from $2.6 million to $6.1 million. HRS-PEO
service revenue was $17.5 million, an increase of 47% over $11.9 million for
the second quarter last year.
For the six months ended November 30, 1999, operating income for the HRS-PEO
segment increased 113% from $5.2 million to $11.1 million. HRS-PEO service
revenue was $32.9 million, an increase of 42% over $23.2 million for the same
period last year.
The increases in service revenue and operating income are primarily related to
increasing 401(k) recordkeeping, Section 125 and Workers' compensation
insurance clients. As of November 30, 1999, 6,800 clients have taken advantage
of the Workers' compensation insurance product, since its national rollout in
the first quarter of fiscal 1999. As of November 30, 1999, the segment
serviced 12,400 401(k) recordkeeping clients, and 22,300 Section 125
administration plans, representing 55% and 23% year-over-year increases in
these client bases, respectively.
CORPORATE EXPENSES
Corporate expenses are primarily related to the Information Technology,
Organizational Development, Finance, Marketing and Senior Management functions
of the Company. For the second quarter ended November 30, 1999, Corporate
expenses increased 11% from $14.3 million to $15.8 million. For the six months
ended November 30, 1999, Corporate expenses increased 16% from $29.1 million to
$33.8 million. The increases are primarily due to additional employees and
other expenditures to support the continued growth of the Company. Full-year
fiscal 2000's Corporate expenses are expected to increase at a rate lower than
1999's growth rate of 16%.
B. Thomas Golisano, Chairman, President, and Chief Executive Officer of Paychex
said, "We are very pleased with our year-to-date results for fiscal 2000. We
are in the process of expanding our Major Market Services payroll product
offering to include thirty cities that are currently serviced by our core
payroll product. We reached another milestone as 401(k) client funds managed
externally exceeded a billion dollars during the quarter. We are looking
forward to the arrival of the next millennium, delivering the quality service
our clients rely on, and executing our growth objectives."
- --------------------------------------------------------------------------------
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 3 - "Articles of Incorporation". The Certificate of
Amendment of Certificate of Incorporation was filed with the Delaware
Secretary of State on October 7, 1999, and a copy is filed herewith at
the end of this Form 10-Q.
Exhibit 27 - "Financial Data Schedule" is filed electronically.
Exhibit 99 - "Safe Harbor" Statement under the Private Securities
Litigation Reform Act of 1995.
(b) Reports on Form 8-K:
None
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: December 16, 1999 /s/ B. Thomas Golisano
-----------------------
B. Thomas Golisano
Chairman, President and
Chief Executive Officer
Date: December 16, 1999 /s/ John M. Morphy
-----------------------
John M. Morphy
Vice President, Chief
Financial Officer and
Secretary
EXHIBIT 3
CERTIFICATE OF AMENDMENT
OF
CERTIFICATE OF INCORPORATION
OF
PAYCHEX, INC.
Under Section 242 of the General Corporation Law
The undersigned, being the President and Secretary of Paychex, Inc., do
hereby certify as follows:
1. The name of the Corporation is Paychex, Inc. The Corporation was
originally formed under the name Blase T. Golisano, Inc., the name having
been changed by Amendment contained in a Certificate of Merger filed on May
17, 1979.
2. The Certificate of Incorporation was filed by the Delaware Secretary
of State on April 26, 1979.
3. The Certificate of Incorporation is amended to increase the number of
authorized shares from 300,000,000 having a par value of $.01 each, to
600,000,000 having a par value of $.01 each.
Paragraph 4 of the Certificate of Incorporation is amended to read in its
entirety as follows:
"4 The total number of shares of stock which the Corporation shall
have authority to issue is 600,000,000 shares of common stock and
the par value of each of such shares is $.01, amounting in the
aggregate to $6,000,000."
4. The Amendment to the Certificate of Incorporation was adopted by the
Board of Directors and authorized at a meeting of stockholders by vote of the
holders of a majority of all outstanding shares entitled to vote.
IN WITNESS WHEREOF, the Corporation has caused this Certificate to be
signed by its President and attested by its Secretary as of the 7th day of
October, 1999.
/s/ B. Thomas Golisano
-----------------------------------
B. Thomas Golisano,
President
Attested By:
/s/ John M. Morphy
-----------------------------------
John M. Morphy,
Secretary
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
NOVEMBER 30, 1999 CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS OF PAYCHEX, INC., AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
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<NAME> PAYCHEX, INC.
<MULTIPLIER> 1,000
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<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAY-31-2000
<PERIOD-START> JUN-01-1999
<PERIOD-END> NOV-30-1999
<CASH> 23,845
<SECURITIES> 1,806,473
<RECEIVABLES> 104,233
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,942,086
<PP&E> 175,233
<DEPRECIATION> 107,876
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<COMMON> 2,471
<OTHER-SE> 493,349
<TOTAL-LIABILITY-AND-EQUITY> 2,027,398
<SALES> 0
<TOTAL-REVENUES> 660,793
<CGS> 0
<TOTAL-COSTS> 402,765
<OTHER-EXPENSES> 0
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<INCOME-PRETAX> 128,734
<INCOME-TAX> 39,907
<INCOME-CONTINUING> 88,827
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EXHIBIT 99: "Safe Harbor" Statement under the Private Securities Litigation
Reform Act of 1995.
"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 are looking forward to",
"expects", "we believe", "expected to" and "could be." Because they are
forward-looking, they should be evaluated in light of important risk factors.
These risk factors include general market 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; the possibility of catastrophic events that could impact the
Company's operating facilities, computer technology and communication systems,
including Year 2000 issues; and changes in short- and long-term interest rates
and the credit rating of cash, cash equivalents, and securities held in the
Company's investment portfolios.
