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, 2000
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 372,910,268 Shares
---------------------------- ---------------------------------
CLASS OUTSTANDING AT November 30, 2000
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
For the three months ended For the six months ended
November 30, November 30, November 30, November 30,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Service revenues:
Payroll $167,133 $142,866 $331,654 $281,578
ENS investment revenue 17,353 12,033 34,766 24,240
------- ------- -------- -------
Total payroll service
revenues 184,486 154,899 366,420 305,818
HRS-PEO 23,612 17,459 45,561 32,932
------- ------- ------- -------
Total service revenues 208,098 172,358 411,981 338,750
Operating costs 47,095 41,356 93,022 80,722
Selling, general and
administrative expenses 77,578 68,494 156,708 136,836
------- ------- ------- -------
Operating income 83,425 62,508 162,251 121,192
Investment income 5,965 3,854 11,499 7,542
------- ------- ------- -------
Income before income taxes 89,390 66,362 173,750 128,734
Income taxes 27,264 20,572 52,994 39,907
------- ------- ------- -------
Net income $ 62,126 $ 45,790 $120,756 $ 88,827
======= ======= ======= =======
Basic earnings per share $ .17 $ .12 $ .32 $ .24
======= ======= ======= =======
Diluted earnings per share $ .16 $ .12 $ .32 $ .24
======= ======= ======= =======
Weighted-average common
shares outstanding 372,618 370,258 372,326 369,951
======= ======= ======= =======
Weighted-average shares
assuming dilution 377,839 374,717 377,511 374,113
======= ======= ======= =======
Cash dividends per common
share $ .09 $ .06 $ .15 $ .10
======= ======= ======= =======
------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
November 30, May 31,
2000 2000
(UNAUDITED) (AUDITED)
--------- ---------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 32,561 $ 47,136
Corporate investments 491,212 412,357
Interest receivable 23,297 22,436
Accounts receivable 108,251 87,608
Deferred income taxes - 9,539
Prepaid expenses and other current assets 6,222 6,531
--------- ---------
Current assets before ENS investments 661,543 585,607
ENS investments 1,843,526 1,776,968
--------- ---------
Total current assets 2,505,069 2,362,575
Property and equipment - net 80,272 75,375
Goodwill and intangible assets - net 6,442 5,584
Deferred income taxes 2,915 2,494
Other assets 9,131 9,549
--------- ---------
Total assets $2,603,829 $2,455,577
========= =========
LIABILITIES
Accounts payable $ 14,346 $ 17,086
Accrued compensation and related items 45,022 52,631
Deferred revenue 4,521 4,719
Accrued income taxes 827 2,969
Deferred income taxes 4,314 -
Other current liabilities 22,200 24,400
--------- ---------
Current liabilities before ENS client deposits 91,230 101,805
ENS client deposits 1,842,179 1,785,140
--------- ---------
Total current liabilities 1,933,409 1,886,945
Long-term liabilities 5,157 5,200
--------- ---------
Total liabilities 1,938,566 1,892,145
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value,
600,000 authorized shares
Issued: 372,910/November 30, 2000 and
371,769/May 31, 2000 3,729 3,718
Additional paid-in capital 125,127 98,904
Retained earnings 534,215 469,385
Accumulated other comprehensive income/(loss) 2,192 (8,575)
--------- ---------
Total stockholders' equity 665,263 563,432
--------- ---------
Total liabilities and stockholders' equity $2,603,829 $2,455,577
========= =========
------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the six months ended
November 30, November 30,
2000 1999
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 120,756 $ 88,827
Adjustments to reconcile net income
to cash provided by operating activities:
Depreciation and amortization
on depreciable and intangible assets 12,574 11,629
Amortization of premiums and
discounts on available-for-sale securities 6,150 6,123
Provision for deferred income taxes 7,315 3,462
Provision for bad debts 880 889
Net realized losses on sales
of available-for-sale securities 431 1,052
Changes in operating assets and liabilities:
Interest receivable (861) (1,928)
Accounts receivable (21,523) (22,208)
Prepaid expenses and other current assets 309 (1,211)
Accounts payable and other current liabilities 4,360 9,100
Net change in other assets and liabilities 549 1,523
------- -------
Net cash provided by operating activities 130,940 97,258
------- -------
INVESTING ACTIVITIES
Purchases of available-for-sale securities (368,215) (402,085)
Proceeds from sales of
available-for-sale securities 189,267 275,014
Proceeds from maturities of
available-for-sale securities 12,590 9,820
Net change in ENS money market securities
and other cash equivalents 31,035 (53,410)
Net change in ENS client deposits 57,039 93,128
Purchases of property and equipment (16,714) (13,670)
Proceeds from sale of property and equipment 3 1,202
Purchases of other assets (3,489) (4,656)
------- -------
Net cash used in investing activities (98,484) (94,657)
------- -------
FINANCING ACTIVITIES
Dividends paid (55,883) (37,016)
Proceeds from exercise of stock options 8,852 5,568
------- -------
Net cash used in financing activities (47,031) (31,448)
------- -------
Decrease in Cash and cash equivalents (14,575) (28,847)
Cash and cash equivalents, beginning of period 47,136 52,692
------- -------
Cash and cash equivalents, end of period $ 32,561 $ 23,845
======= =======
------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
November 30, 2000
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 and six months
ended November 30, 2000, are not necessarily indicative of the results that may
be expected for the full year ended May 31, 2001.
Service revenues are recognized in the period services are rendered. Total
payroll service revenues include service fees and investment revenue. Service
fee revenue is earned primarily from Payroll, Taxpay (Registered Trademark),
Employee Pay Services and other ancillary services. Employee Pay Services
includes the Direct Deposit, Readychex and Access Card products. In addition to
fees paid by clients for these services, the Company earns investment revenue
on Taxpay and Employee Pay Services funds that are collected by the Company's
Electronic Network Services division (ENS) before due dates and invested (ENS
investments) until remittance to the applicable tax authorities for Taxpay
clients and employees of Employee Pay Services clients. These collections from
clients are typically remitted between one and thirty days after receipt, with
some items extending to ninety days. Investment revenue from these funds is
included in Total payroll service revenues on the Consolidated Statements of
Income as the collection, holding and remittance of these funds is a critical
component of providing these product services. ENS investment revenue also
includes net realized gains and losses from the sale of available-for-sale
securities.
PEO revenues are reported net of direct costs billed and incurred, which
include wages, taxes, benefit premiums and claims of worksite employees.
Direct costs billed and incurred were $208,134 and $161,056 for the three
months ended November 30, 2000 and 1999, respectively, and $401,946 and
$322,043 for the six months ended November 30, 2000 and 1999, respectively.
There is no significant seasonality to the Company's business. However, in
the third fiscal quarter, the number of new payroll segment clients, 401(k)
recordkeeping clients and new PEO worksite employees tends to be higher than in
the rest of the fiscal year. Consequently, greater sales commission expenses
are incurred 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, 2000. 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, workers'
compensation, section 125 plan administration, group benefits, state
unemployment insurance, employee handbooks and management services, Paychex
Administrative Services (PAS) and Professional Employer Organization (PEO)
services. Corporate expenses are primarily related to the Information
Technology, Organizational Development, Finance, Marketing and Senior
Management functions of the Company.
<TABLE>
<CAPTION>
For the three months ended For the six months ended
November 30, November 30, November 30, November 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Service revenues:
Payroll $167,133 $142,866 $331,654 $281,578
ENS investment revenue 17,353 12,033 34,766 24,240
------- ------- ------- -------
Total payroll service
revenues 184,486 154,899 366,420 305,818
HRS-PEO 23,612 17,459 45,561 32,932
------- ------- ------- -------
Total service revenues $208,098 $172,358 $411,981 $338,750
======= ======= ======= =======
Operating income:
Payroll $ 90,328 $ 72,567 $177,862 $144,751
HRS-PEO 9,199 5,729 17,593 10,233
------- ------- ------- -------
Segment operating income 99,527 78,296 195,455 154,984
Corporate expenses 16,102 15,788 33,204 33,792
------- ------- ------- -------
Total operating income 83,425 62,508 162,251 121,192
Investment income 5,965 3,854 11,499 7,542
------- ------- ------- -------
Income before income taxes $ 89,390 $ 66,362 $173,750 $128,734
======= ======= ======= =======
</TABLE>
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 and six
months ended November 30, 1999, 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 12, 2000, and distributed on May
22, 2000.
<TABLE>
<CAPTION>
For the three months ended For the six months ended
(In thousands, November 30, November 30, November 30, November 30,
except per share amounts) 2000 1999 2000 1999
<S> <C> <C> <C> <C>
Basic earnings per share:
Net Income $ 62,126 $ 45,790 $ 120,756 $ 88,827
------- ------- -------- -------
Weighted-average common
share outstanding 372,618 370,258 372,326 369,951
------- ------- -------- -------
Basic earnings per share $ .17 $ .12 $ .32 $ .24
======= ======= ======== =======
Diluted earnings per share:
Net income $ 62,126 $ 45,790 $ 120,756 $ 88,827
------- ------- ------- -------
Weighted-average common
shares outstanding 372,618 370,258 372,326 369,951
Net effect of dilutive
stock options at average
market price 5,221 4,459 5,185 4,162
------- ------- ------- -------
Weighted-average shares
assuming dilution 377,839 374,717 377,511 374,113
------- ------- ------- -------
Diluted earnings per share $ .16 $ .12 $ .32 $ .24
======= ======= ======= =======
Weighted-average anti-
dilutive stock options - - 201 858
======= ======= ======= =======
</TABLE>
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; therefore, the effect would have been anti-
dilutive.
For the three and six months ended November 30, 2000, stock options were
exercised for 655,000 and 1,141,000 shares of the Company's common stock,
respectively.
D) Corporate investments and ENS investments:
<TABLE>
<CAPTION>
November 30, May 31,
(In thousands) 2000 2000
(UNAUDITED) (AUDITED)
---------------------- ---------------------
COST FAIR VALUE COST FAIR VALUE
<S> <C> <C> <C> <C>
Type of issue:
Money market securities and
other cash equivalents $1,171,628 $1,171,628 $1,202,664 $1,202,664
Available-for-sale
securities:
General obligation
municipal bonds 483,613 484,743 405,214 399,190
Pre-refunded municipal
bonds 312,798 314,324 301,271 298,706
Revenue municipal bonds 361,008 361,754 291,157 286,294
Other securities 20 80 20 92
--------- --------- --------- ---------
Total available-for-sale
securities 1,157,439 1,160,901 997,662 984,282
Other 1,802 2,209 1,802 2,379
--------- --------- --------- ---------
Total Corporate investments
and ENS investments $2,330,869 $2,334,738 $2,202,128 $2,189,325
========= ========= ========= =========
Classification of investments
on Consolidated Balance
Sheets:
Corporate investments $ 488,690 $ 491,212 $ 416,988 $ 412,357
ENS investments 1,842,179 1,843,526 1,785,140 1,776,968
--------- --------- --------- ---------
Total Corporate investments
and ENS investments $2,330,869 $2,334,738 $2,202,128 $2,189,325
========= ========= ========= =========
</TABLE>
The Company is exposed to credit risk from the possible inability of the
borrowers to meet the terms of their bonds. In addition, the Company is
exposed to interest rate risk from rate volatility causing fluctuations in the
market value of held investments and the earnings potential of future
investments. The Company attempts to limit these risks by investing primarily
in AAA and AA rated securities and A-1 rated short-term securities, limiting
amounts that can be invested in any single instrument, and investing in short-
to intermediate-term instruments whose market value is less sensitive to
interest rate changes. At November 30, 2000, approximately 98% of the
available-for-sale bond securities held an AA rating or better, and all short-
term securities classified as cash equivalents held an A-1 or equivalent rating.
The Company does not utilize derivative financial instruments to manage
interest rate risk.
E) Property and equipment - net:
<TABLE>
<CAPTION>
November 30, May 31,
(In thousands) 2000 2000
(UNAUDITED) (AUDITED)
--------- -------
<S> <C> <C>
Land and improvements $ 2,919 $ 2,919
Buildings and improvements 30,632 30,195
Data processing equipment and software 95,079 84,490
Furniture, fixtures and equipment 69,883 64,729
Leasehold improvements 10,558 10,536
------- -------
209,071 192,869
Less accumulated depreciation and amortization 128,799 117,494
------- -------
Property and equipment - net $ 80,272 $ 75,375
======= =======
</TABLE>
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:
<TABLE>
<CAPTION>
For the three months ended For the six months ended
(In thousands) November 30, November 30, November 30, November 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $ 62,126 $ 45,790 $ 120,756 $ 88,827
Unrealized gains/
(losses) on
securities, net of
reclassification
adjustments (574) (832) 10,767 (6,069)
------- ------- ------- -------
Total comprehensive
income $ 61,552 $ 44,958 $ 131,523 $ 82,758
======= ======= ======= =======
</TABLE>
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, 2000 (fiscal 2001) and 1999 (fiscal
2000), and its financial condition at November 30, 2000 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, 2000 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 included in the "Other" section of this
review under the sub-heading "Safe-Harbor Statement under the Private Securities
Litigation Reform Act of 1995."
RESULTS OF OPERATIONS
(In thousands, except per share amounts)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Service revenues $208,098 20.7% $172,358
Operating income $ 83,425 33.5% $ 62,508
Operating margin 40.1% 36.3%
Income before income taxes $ 89,390 34.7% $ 66,362
Net income $ 62,126 35.7% $ 45,790
% of service revenues 29.9% 26.6%
Basic earnings per share $ .17 41.7% $ .12
Diluted earnings per share $ .16 33.3% $ .12
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Service revenues $411,981 21.6% $338,750
Operating income $162,251 33.9% $121,192
Operating margin 39.4% 35.8%
Income before income taxes $173,750 35.0% $128,734
Net income $120,756 35.9% $ 88,827
% of service revenues 29.3% 26.2%
Basic earnings per share $ .32 33.3% $ .24
Diluted earnings per share $ .32 33.3% $ .24
==============================================================================
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, 2000.
Payroll segment
(In thousands)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Payroll service revenue $167,133 17.0% $142,866
ENS investment revenue 17,353 44.2% 12,033
--------------------------------
Total payroll service revenues $184,486 19.1% $154,899
Payroll operating income $ 90,328 24.5% $ 72,567
Payroll operating margin 49.0% 46.8%
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Payroll service revenue $331,654 17.8% $281,578
ENS investment revenue 34,766 43.4% 24,240
---------------------------------
Total payroll service revenues $366,420 19.8% $305,818
Payroll operating income $177,862 22.9% $144,751
Payroll operating margin 48.5% 47.3%
==============================================================================
Revenues: Total payroll service revenue includes service fees and investment
revenue. Service fee revenue is earned primarily from Payroll, Taxpay,
Employee Pay Services and other ancillary services. Employee Pay Services
includes the Direct Deposit, Readychex and Access Card products. In addition to
fees paid by clients for these services, the Company earns investment revenue
on Taxpay and Employee Pay Services funds that are collected by the Company's
Electronic Network Services division (ENS) before due dates and invested (ENS
investments) until remittance to the applicable tax authorities for Taxpay
clients and employees of Employee Pay Services clients. Investment revenue
from these funds is included in Total payroll service revenues on the
Consolidated Statements of Income as the collection, holding and remittance of
these funds is a critical component of providing these product services. ENS
investment revenue also includes net realized gains and losses from the sale of
available-for-sale securities.
The increases in Payroll service revenue are primarily related to the addition
of new clients, price increases and increased utilization of ancillary services
by both new and existing clients. As of November 30, 2000, 82% of Paychex
clients utilized Taxpay, the Company's tax filing and payment feature. Client
utilization of the Taxpay product is expected to mature within the next several
years within a range of 82% to 87%. The Company's Employee Pay Services was
utilized by 50% of its clients at November 30, 2000. During the first six
months of fiscal 2001, the Company continued expansion efforts of its Major
Market Services (MMS) payroll product offering. MMS revenue increased 56% and
55% for the second quarter and six-month periods to $10.6 million and $20.2
million, respectively. Employee Pay Services and MMS are expected to provide
growth opportunities for the remainder of fiscal 2001 and beyond. In the first
half of fiscal 2001 the Company also introduced new payroll product
enhancements including employee garnishments and After-The-Fact payroll.
ENS investment revenue increased due to the growth in Taxpay and Employee Pay
Services utilization and higher comparative rates of return. In the second
half of fiscal 2001, this revenue growth will be affected by the fact that the
last increase in the federal funds rate was during the fourth quarter of fiscal
2000. Realized losses included in ENS investment revenue were $.1 million and
$.2 million for the second quarter and six-month periods of fiscal 2001
compared with $.5 million and $.8 million for the respective prior year periods.
Additional discussion on interest rates and related risk is included in the
"Market Risk Factors" section of this review.
Subject to future changes in interest rates, the Company expects full year
fiscal 2001's percentage growth in Total payroll service revenues to be in the
range of 18% to 20%.
Operating income: Operating income increased as a result of the increases in
revenue and continued leveraging of the segment's operating expense base as
evidenced by the improvement in operating margins. The Payroll operating
margin for the first six-months of fiscal 2001 demonstrated strong growth.
Effective September 1, 1999, the Company increased its sales force compensation
package by approximately $6.0 million on an annualized basis to increase the
retention and quality of its payroll sales representatives. This compensation
increase resulted in an additional expense of approximately $1.5 million in the
first quarter of fiscal 2001 compared to the prior year period.
HRS-PEO segment
(In thousands)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
HRS-PEO service revenue $ 23,612 35.2% $17,459
HRS-PEO operating income $ 9,199 60.6% $ 5,729
HRS-PEO operating margin 39.0% 32.8%
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
HRS-PEO service revenue $ 45,561 38.3% $32,932
HRS-PEO operating income $ 17,593 71.9% $10,233
HRS-PEO operating margin 38.6% 31.1%
==============================================================================
Revenues: The increase in service revenue is primarily related to increasing
401(k) recordkeeping, workers' compensation insurance and Section 125 clients,
and PEO worksite employees. The increase in 401(k) clients reflects the
continuing interest of small- to medium-sized businesses to offer retirement
savings benefits to their employees. 401(k) recordkeeping revenues increased
41% and 45% in the second quarter and six-month periods to $10.4 million and
$20.1 million, respectively.
The Company continued its expansion of its workers' compensation insurance
product, which provides insurance for qualified clients through leading
insurance providers and a method to stabilize their cash flows throughout the
year. The Company also continued expansion efforts related to its Paychex
Administrative Services (PAS) product, a combined payroll and human resource
outsourcing solution designed to make it easier for small businesses to manage
their payroll and benefit costs.
Operating income: The increases in operating income are primarily related to
the service revenue gains, and the leveraging of operating expenses.
Full year fiscal 2001's HRS-PEO service revenue is expected to be a little
under $100 million. Segment operating income is expected to continue to grow
at a rate lower than in fiscal 2000, but at a rate that is much higher than the
Payroll segment's growth rate. Quarter-over-quarter percentage comparisons in
HRS-PEO service revenue and operating income may vary significantly throughout
the year, and any one quarter's results may not be indicative of expected
full-year results.
Corporate expenses
(In thousands)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Corporate expenses $16,102 2.0% $15,788
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Corporate expenses $33,204 -1.7% $33,792
==============================================================================
Corporate expenses are primarily related to the Information Technology,
Organizational Development, Finance, Marketing and Senior Management functions
of the Company. Corporate expenses remained relatively flat through the first
half of fiscal 2001 with additional expenditures to support the continued
growth of the Company being offset by lower spending on national marketing
efforts.
The relatively flat year-over-year increase in Corporate expenses is expected
to continue throughout fiscal 2001, as increases in expenditures to support the
Company's growth are offset by lower spending in other areas.
Investment income
(In thousands)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Investment income $ 5,965 54.8% $3,854
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Investment income $11,499 52.5% $7,542
==============================================================================
Investment income represents earnings from the Company's Cash and cash
equivalents and Corporate 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 increase in
Investment income is primarily due to the increase in average daily invested
balances and higher comparable rates of return. Net realized losses included
in Investment income were $.1 million and $.2 million for the second quarter
and six-month periods of fiscal 2001 compared with $.2 million and $.3 million
in the respective prior year periods. Investment income for the full year
fiscal 2001 is expected to continue grow at a rate higher than in fiscal 2000.
Refer to the "Market Risk Factors" section of this review for additional
discussion on interest rates and related risks.
Income taxes
(In thousands)
For the three months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Income taxes $27,264 32.5% $20,572
Effective income tax rate 30.5% 31.0%
==============================================================================
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Income taxes $52,994 32.8% $39,907
Effective income tax rate 30.5% 31.0%
==============================================================================
The decrease in the effective income tax rate is due to the growth in tax-exempt
income exceeding the growth in taxable income. Tax-exempt income is derived
primarily from income earned on municipal debt securities. Full-year fiscal
2001's effective income tax rate is expected to approximate 30.5%.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
(In thousands)
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Operating cash flows $130,940 34.6% $97,258
==============================================================================
The increase in operating cash flows resulted primarily from the consistent
achievement of higher net income. Projected operating cash flows are expected
to adequately support normal business operations, forecasted growth, purchases
of property and equipment and dividend payments. At November 30, 2000, the
Company had $524 million in available cash and Corporate investments. The
Company also has $140 million of available, uncommitted, unsecured lines of
credit and $350 million available under an uncommitted, secured line of credit.
Investing activities
(In thousands)
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Net Corporate investments and ENS activities $(78,284) 1.0% $(77,533)
Purchases of P&E (16,714) 22.3% (13,670)
Proceeds on the sale of P&E 3 -99.8% 1,202
Purchases of other assets (3,489) -25.1% (4,656)
-------------------------------
Net cash used in investing activities $(98,484) 4.0% $(94,657)
==============================================================================
Corporate investments and ENS investments: Investments are primarily comprised
of available-for-sale debt securities, and ENS investments are primarily
comprised of short-term funds and available-for-sale debt securities. The
portfolio of Corporate investments and ENS investments is detailed in Note D of
the Notes to the Consolidated Financial Statements.
Corporate investments have increased due to the investment of increasing cash
balances provided by operating activities less purchases of property and
equipment and dividend payments. The reported amount of ENS investments will
vary significantly based upon the timing of collecting client funds, and
remitting the funds to the applicable tax authorities for Taxpay clients and
employees of clients utilizing Employee Pay Services. At November 30, 2000,
the total available-for-sale portfolio, including Corporate investments and ENS
investments, had a market value exceeding the cost basis by $3.5 million.
Additional discussion of interest rates and related risks is included in the
"Market Risk Factors" section of this review.
Purchases of property and equipment: To support the Company's continued client
and ancillary product growth, purchases of property and equipment were made for
data processing equipment and software, and for the expansion and upgrade of
various operating facilities. Purchases of property and equipment in fiscal
2001 are expected to range from $30 to $35 million. The Company expects to
proceed with the construction of an additional facility at Corporate
headquarters at an estimated cost ranging from $35 to $40 million. The new
building will allow for a significant reduction in leased space in the
Rochester, New York area. Occupancy is expected in the summer of 2002.
Financing activities
(In thousands, except per share amounts)
For the six months ended November 30, 2000 Change 1999
------------------------------------------------------------------------------
Dividends paid $(55,883) 51.0% $(37,016)
Proceeds from exercise of stock options 8,852 59.0% 5,568
-------------------------------
Net cash used in financing activities $(47,031) 49.6% $(31,448)
------------------------------------------------------------------------------
Cash dividends per common share $ .15 50.0% $ .10
==============================================================================
Dividends paid: On October 10, 2000, the Company's Board of Directors
increased the quarterly cash dividend rate from $.06 per share to $.09 per
share, and declared a dividend payable November 15, 2000, for shareholders of
record as of November 1, 2000.
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 $17.4 million and
$8.7 million for the six months ended November 30, 2000 and 1999, respectively.
This tax benefit reduces the accrued income tax liability and increases
additional paid-in capital, with no impact on the expense amount for income
taxes.
MARKET RISK FACTORS
Interest rate risk - The Company's available-for-sale debt securities are
exposed to "market" risk from changes in interest rates, as rate volatility will
cause fluctuations in the market value of held investments. Increases in
interest rates normally decrease the market value of the available-for-sale
securities, while decreases in interest rates increase the market value of the
available-for-sale securities.
In addition, the Company's available-for-sale securities and short-term funds
are exposed to "earnings" risk from changes in interest rates, as rate
volatility will cause fluctuations in the earnings potential of future
investments. Increases in interest rates quickly increase earnings from
short-term funds, and over time increase earnings from the available-for-sale
securities portfolio. Earnings from the available-for-sale securities do not
reflect changes in rates until the investments are sold or mature, and the
proceeds are reinvested at current rates. Decreases in interest rates have
the opposite earnings effect on the available-for-sale securities and
short-term funds.
The Company directs investments towards high credit-quality, tax-exempt
securities to mitigate the risk that earnings from the portfolio could be
adversely impacted by changes in interest rates in the near term. The Company
invests in short- to intermediate-term, fixed-rate municipal and government
securities, which typically have lower interest rate volatility, and manages
the securities portfolio to a benchmark duration of 2.5 to 3.0 years. The
Company does not utilize derivative financial instruments to manage interest
rate risk.
During the first half of fiscal 2001, the federal funds rate has remained
unchanged at 6.50%. During fiscal 2000, the federal funds rate was increased
175 basis points from 4.75% to 6.5%, the timing of which is shown in the
following table:
-------------------------------------------------------------------------------
2000
--------
Federal funds rate - beginning of fiscal year 4.75%
Rate increase:
First quarter .50
Second quarter .25
Third quarter .25
Fourth quarter .75
-------
Federal funds rate - end of fiscal year 6.50%
===============================================================================
Calculating the future effect of changing interest rates involves many factors.
These factors include, but are not limited to, daily interest rate changes,
seasonal variations in investment balances, actual duration of short and
long-term investments, the proportional mix of taxable and tax-exempt
investments, and changes in tax-exempt municipal rates versus taxable
investment rates, which are not synchronized, 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. Realized gains are more prevalent in a decreasing rate
environment and realized losses are more prevalent in an increasing rate
environment. During fiscal 2001, the Company's total investment portfolio is
expected to average approximately $2.2 billion, of which 50% is invested in
intermediate-term municipal securities with an average duration of three years.
The duration of short-term investments is less than thirty days.
At November 30, 2000, the available-for-sale securities portfolio had a market
value greater than its cost basis by $3.5 million, compared with the portfolio
at May 31, 2000, which had a market value less than its cost basis by $13.4
million. In fiscal 2000, the available-for-sale portfolio had a market value
less than its cost basis as a result of the upward trend in interest rates
throughout the year. In the first half of fiscal 2001, short-term rates
have remained stable and certain intermediate-term rates have decreased when
compared to rates as of May 31, 2000, driving the improvement in the market
value of the available-for-sale portfolio.
As of November 30, 2000 and May 31, 2000, the Company had $1.2 billion and $1.0
billion invested in available-for-sale securities at fair value, with weighted
average yields to maturity of 4.6% and 4.5%, repectively. Assuming a
hypothetical increase in interest rates of 25 basis points given the November
30, 2000 portfolio of securities, the resulting potential decrease in fair
value would be approximately $6.9 million. 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, 2000.
Credit risk - The Company is exposed to credit risk in connection with these
investments through the possible inability of the borrowers to meet the terms
of the bonds. The Company attempts to limit credit risk by investing primarily
in AAA and AA rated securities and A-1 rated short-term securities, and by
limiting amounts that can be invested in any single instrument. At August 31,
2000, approximately 98% of the available-for-sale securities held an AA rating
or better, and all short-term securities classified as cash equivalents held an
A-1 or equivalent rating.
OTHER
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: Certain written and oral statements made by Paychex, Inc., (the
"Company") management may constitute "forward-looking statements" as defined in
the Private Securities Litigation Reform Act of 1995. Forward-looking
statements are identified by such words and phrases as "we expect", "expects",
"expected to", "we look forward to", "we believe", "could be" and other similar
phrases. Because they are forward-looking, they should be evaluated in light
of important risk factors. These risk factors include, but are not limited to,
general market conditions, including demand for the Company's products and
services, availability of internal and external resources, executing expansion
plans, competition, and price levels; changes in the laws regulating collection
and payment of payroll taxes, professional employer organizations, and employee
benefits, including 401(k) plans, workers' compensation, state unemployment,
and section 125 plans; delays in the development, timing of the introduction,
and marketing of new products and services; changes in technology including the
use of the Internet; the possibility of catastrophic events that could impact
the Company's operating facilities, computer technology and communication
systems; 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, all of which may cause actual results to differ
materially from anticipated results. The information provided in this document
is based upon the facts and circumstances known at this time. The Company
assumes no obligation to update this document for new information subsequent to
its issuance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information called for by this item is provided under the caption "Market
Risk Factors" under ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
PART II. OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on October 10, 2000. There were
present at the meeting, either in person or by proxy, holders of 317,902,798
Common Shares. Stockholders elected nine Directors nominated in the August 28,
2000 Proxy Statement, incorporated here by reference, to hold office until the
next Annual Meeting of Stockholders.
Results of stockholder voting are as follows:
Election of Directors Votes For Votes Withheld
B. Thomas Golisano 311,611,520 2,303,714
Steven D. Brooks 311,365,745 2,550,289
G. Thomas Clark 306,066,848 7,262,357
David J.S. Flaschen 311,397,240 2,522,639
Phillip Horsley 311,384,979 2,534,900
Grant M. Inman 311,383,199 2,536,680
Harry P. Messina, Jr. 310,103,852 2,592,663
J. Robert Sebo 311,557,168 2,362,711
Joseph M. Tucci 305,924,168 6,772,247
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 27 - "Financial Data Schedule" is filed electronically.
(b) Reports on Form 8-K:
(1) The Company filed a report on Form 8-K on October 10, 2000, that
included the Company's press release dated October 10, 2000,
announcing that the Board of Directors had declared an increase in
the quarterly dividend from $.06 per share to $.09 per share payable
on November 15, 2000 to shareholders of record on November 1, 2000.
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 20, 2000 /s/ B. Thomas Golisano
-----------------------
B. Thomas Golisano
Chairman, President and
Chief Executive Officer
Date: December 20, 2000 /s/ John M. Morphy
-----------------------
John M. Morphy
Vice President, Chief
Financial Officer and
Secretary
