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 FEBRUARY 28, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------- ----------------
COMMISSION FILE NUMBER 0-11330
PAYCHEX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1124166
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
911 PANORAMA TRAIL SOUTH, ROCHESTER, NEW YORK 14625-0397
(Address of principal executive offices) (Zip Code)
(716)385-6666
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 Par Value 373,323,010 Shares
- ---------------------------- ---------------------------------
CLASS OUTSTANDING AT FEBRUARY 28, 2001
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 ended For the nine months ended
February 28, February 29, February 28, February 29,
2001 2000 2001 2000
----------- ----------- ----------- -----------
Service revenues:
Payroll $177,842 $155,466 $509,496 $437,044
ENS investment revenue 25,905 16,355 60,671 40,595
------- ------- -------- -------
Total payroll service
revenues 203,747 171,821 570,167 477,639
HRS-PEO 25,509 20,362 71,070 53,294
------- ------- ------- -------
Total service revenues 229,256 192,183 641,237 530,933
Operating costs 54,376 45,964 147,398 126,686
Selling, general and
administrative expenses 87,998 78,316 244,706 215,152
------- ------- ------- -------
Operating income 86,882 67,903 249,133 189,095
Investment income 7,234 4,012 18,733 11,554
------- ------- ------- -------
Income before income taxes 94,116 71,915 267,866 200,649
Income taxes 27,764 22,294 80,758 62,201
------- ------- ------- -------
Net income $ 66,352 $ 49,621 $187,108 $138,448
======= ======= ======= =======
Basic earnings per share $ .18 $ .13 $ .50 $ .37
======= ======= ======= =======
Diluted earnings per share $ .18 $ .13 $ .50 $ .37
======= ======= ======= =======
Weighted-average common
shares outstanding 373,057 370,973 372,560 370,284
======= ======= ======= =======
Weighted-average shares
assuming dilution 377,681 377,723 377,558 375,309
======= ======= ======= =======
Cash dividends per common $ .09 $ .06 $ .24 $ .16
share ======= ======= ======= =======
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
February 28, May 31,
2001 2000
(UNAUDITED) (AUDITED)
--------- ---------
ASSETS
Cash and cash equivalents $ 106,796 $ 47,136
Corporate investments 506,273 412,357
Interest receivable 20,173 22,436
Accounts receivable 89,898 87,608
Deferred income taxes -- 9,539
Prepaid expenses and other current assets 8,185 6,531
--------- ---------
Current assets before ENS investments 731,325 585,607
ENS investments 1,833,417 1,776,968
--------- ---------
Total current assets 2,564,742 2,362,575
Property and equipment - net 86,291 75,375
Goodwill and intangible assets - net 8,843 5,584
Deferred income taxes 2,294 2,494
Other assets 8,961 9,549
--------- ---------
Total assets $2,671,131 $2,455,577
========= =========
LIABILITIES
Accounts payable $ 14,116 $ 17,086
Accrued compensation and related items 59,246 52,631
Deferred revenue 6,093 4,719
Accrued income taxes 21,963 2,969
Deferred income taxes 1,190 --
Other current liabilities 22,305 24,400
--------- ---------
Current liabilities before ENS client deposits 124,913 101,805
ENS client deposits 1,823,693 1,785,140
--------- ---------
Total current liabilities 1,948,606 1,886,945
Long-term liabilities 5,134 5,200
--------- ---------
Total liabilities 1,953,740 1,892,145
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value,
600,000 authorized shares
Issued: 373,323/February 28, 2001 and
371,769/May 31, 2000 3,733 3,718
Additional paid-in capital 133,434 98,904
Retained earnings 566,993 469,385
Accumulated other comprehensive income/(loss) 13,231 (8,575)
--------- ---------
Total stockholders' equity 717,391 563,432
--------- ---------
Total liabilities and stockholders' equity $2,671,131 $2,455,577
========= =========
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the nine months ended
February 28, February 29,
2001 2000
--------- --------
OPERATING ACTIVITIES
Net income $ 187,108 $ 138,448
Adjustments to reconcile net income
to cash provided by operating activities:
Depreciation and amortization
on depreciable and intangible assets 19,344 17,639
Amortization of premiums and
discounts on available-for-sale securities 9,183 9,274
Provision for deferred income taxes (1,413) (3,634)
Provision for bad debts 968 1,359
Net realized (gains)/losses on sales
of available-for-sale securities (3,531) 2,292
Changes in operating assets and liabilities:
Interest receivable 2,263 114
Accounts receivable (3,258) (15,755)
Prepaid expenses and other current assets (1,654) 962
Accounts payable and other current liabilities 47,070 39,598
Net change in other assets and liabilities 159 2,588
------- -------
Net cash provided by operating activities 256,239 192,885
------- -------
INVESTING ACTIVITIES
Purchases of available-for-sale securities (543,624) (623,829)
Proceeds from sales of
available-for-sale securities 398,188 443,225
Proceeds from maturities of
available-for-sale securities 17,230 15,770
Net change in ENS money market securities
and other cash equivalents 6,754 (413,702)
Net change in ENS client deposits 38,553 478,994
Purchases of property and equipment (28,971) (25,685)
Proceeds from sale of property and equipment 41 1,263
Purchases of other assets (6,773) (6,416)
------- -------
Net cash used in investing activities (118,602) (130,380)
------- -------
FINANCING ACTIVITIES
Dividends paid (89,457) (59,281)
Proceeds from exercise of stock options 11,480 8,923
------- -------
Net cash used in financing activities (77,977) (50,358)
------- -------
Increase in Cash and cash equivalents 59,660 12,147
Cash and cash equivalents, beginning of period 47,136 52,692
------- -------
Cash and cash equivalents, end of period $ 106,796 $ 64,839
======= =======
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
February 28, 2001
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 nine
months ended February 28, 2001 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 ENS investments 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 particular 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 (in thousands) were $238,027 and $193,047 for the
three months ended February 28, 2001 and February 29, 2000, respectively, and
$639,973 and $515,090 for the nine months ended February 28, 2001, and February
29, 2000 respectively.
There is no significant seasonality to the Company's business. However, during
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
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, 2000. Certain amounts from the prior year have been reclassified to conform
to the current year presentation.
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 insurance administration, section 125 plan
administration, group benefits, state unemployment insurance, employee
handbooks and management services, and 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.
For the three months ended For the nine months ended
February 28, February 29, February 28, February 29,
(In thousands) 2001 2000 2001 2000
-------- -------- -------- ---------
Service revenues:
Payroll $177,842 $155,466 $509,496 $437,044
ENS investment revenue 25,905 16,355 60,671 40,595
------- ------- ------- -------
Total payroll service
revenues 203,747 171,821 570,167 477,639
HRS-PEO 25,509 20,362 71,070 53,294
------- ------- ------- -------
Total service revenues $229,256 $192,183 $641,237 $530,933
======= ======= ======= =======
Operating income:
Payroll $ 94,259 $ 77,683 $272,121 $222,434
HRS-PEO 9,349 6,831 26,942 17,064
------- ------- ------- -------
Segment operating income 103,608 84,514 299,063 239,498
Corporate expenses 16,726 16,611 49,930 50,403
------- ------- ------- -------
Total operating income 86,882 67,903 249,133 189,095
Investment income 7,234 4,012 18,733 11,554
------- ------- ------- -------
Income before income taxes $ 94,116 $ 71,915 $267,866 $200,649
======= ======= ======= =======
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 nine
months ended February 29, 2000, 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.
For the three months ended For the nine months ended
February 28, February 29, February 28, February 29,
2001 2000 2001 2000
----------- ----------- ----------- -----------
(In thousands, except per share amounts)
Basic earnings per share:
Net Income $ 66,352 $ 49,621 $187,108 $138,448
------- ------- ------- -------
Weighted-average common
shares outstanding 373,057 370,973 372,560 370,284
------- ------- ------- -------
Basic earnings per share $ .18 $ .13 $ .50 $ .37
======= ======= ======= =======
Diluted earnings per share:
Net income $ 66,352 $ 49,621 $187,108 $138,448
------- ------- ------- -------
Weighted-average common
shares outstanding 373,057 370,973 372,560 370,284
Net effect of dilutive stock
options at average market
price 4,624 6,750 4,998 5,025
------- ------- ------- -------
Weighted-average shares
assuming dilution 377,681 377,723 377,558 375,309
------- ------- ------- -------
Diluted earnings per share $ .18 $ .13 $ .50 $ .37
======= ======= ======= =======
Weighted-average anti-dilutive
stock options 261 - 221 572
======= ======= ======= =======
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 nine months ended February 28, 2001, stock options were
exercised for 413,000 and 1,554,000 shares of the Company's common stock,
respectively.
D) Corporate investments and ENS investments:
February 28, May 31,
(In thousands) 2001 2000
(UNAUDITED) (AUDITED)
---------------------- ---------------------
COST FAIR VALUE COST FAIR VALUE
Type of issue:
Money market securities and
other cash equivalents $1,195,910 $1,195,910 $1,202,664 $1,202,664
Available-for-sale
securities:
General obligation
municipal bonds 477,957 486,541 405,214 399,190
Pre-refunded municipal
bonds 286,074 291,946 301,271 298,706
Revenue municipal bonds 356,165 362,381 291,157 286,294
Other securities 20 73 20 92
--------- --------- --------- ---------
Total available-for-sale
securities 1,120,216 1,140,941 997,662 984,282
Other 2,980 2,839 1,802 2,379
--------- --------- --------- ---------
Total Corporate investments
and ENS investments $2,319,106 $2,339,690 $2,202,128 $2,189,325
========= ========= ========= =========
Classification of investments
on Consolidated Balance Sheets:
Corporate investments $ 495,413 $ 506,273 $ 416,988 $ 412,357
ENS investments 1,823,693 1,833,417 1,785,140 1,776,968
--------- --------- --------- ---------
Total Corporate investments
and ENS investments $2,319,106 $2,339,690 $2,202,128 $2,189,325
========= ========= ========= =========
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 February 28, 2001, approximately 98% of the
available-for-sale bond securities held an AA rating or better, and all short-
term securities classified as cash equivalents held an A-1 or equivalent rating.
The Company does not utilize derivative financial instruments to manage
interest rate risk.
E) Property and equipment - net:
February 28, May 31,
(In thousands) 2001 2000
(UNAUDITED) (AUDITED)
--------- -------
Land and improvements $ 2,919 $ 2,919
Buildings and improvements 31,091 30,195
Data processing equipment and software 100,337 84,490
Furniture, fixtures and equipment 72,178 64,729
Leasehold improvements 11,606 10,536
------- -------
218,131 192,869
Less accumulated depreciation and amortization 131,840 117,494
------- -------
Property and equipment - net $ 86,291 $ 75,375
======= =======
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 ended For the nine months ended
(In thousands) February 28, February 29, Feburary 28, February 29,
2001 2000 2001 2000
------- ------- ------- -------
Net income $66,352 $49,621 $187,108 $138,448
Unrealized gains/
(losses) on
securities, net of
reclassification
adjustments 11,039 (3,737) 21,806 (9,806)
------ ------ ------- -------
Total comprehensive
income $77,391 $45,884 $208,914 $128,642
====== ====== ======= =======
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 nine months ended February 28, 2001 (fiscal 2001) and February
29, 2000 (fiscal 2000), and its financial condition at February 28, 2001 for
Paychex, Inc. and its subsidiaries (the "Company"). The focus of this review
is on the underlying business reasons for significant changes and trends
affecting revenues, net income and financial condition. This review should be
read in conjunction with the accompanying February 28, 2001 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 February 28, Feburary 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Service revenues $229,256 19.3% $192,183
Operating income $ 86,882 28.0% $ 67,903
Operating margin 37.9% 35.3%
Income before income taxes $ 94,116 30.9% $ 71,915
Net income $ 66,352 33.7% $ 49,621
% of service revenues 28.9% 25.8%
Basic earnings per share $ .18 38.5% $ .13
Diluted earnings per share $ .18 38.5% $ .13
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Service revenues $641,237 20.8% $530,933
Operating income $249,133 31.8% $189,095
Operating margin 38.9% 35.6%
Income before income taxes $267,866 33.5% $200,649
Net income $187,108 35.1% $138,448
% of service revenues 29.2% 26.1%
Basic earnings per share $ .50 35.1% $ .37
Diluted earnings per share $ .50 35.1% $ .37
==============================================================================
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 nine
months ended February 28, 2001.
The year-over-year growth in total service revenues is expected to be
approximately 20% for the full year fiscal 2001.
In fiscal 2001, operating expenses increased 18% and 16% for the respective
third quarter and nine months over the prior year periods. For the full year,
the growth in operating costs is expected to be consistent with the first nine
months. Selling, general and administrative expenses (SG&A) for the third
quarter and nine months increased 12% and 14%, respectively, over the prior
year. Combined, operating costs and SG&A increased 15% on a year-over-year
basis for both the third quarter and year-to-date periods.
The increases in operating income and the improvement in operating margins
reflect the Company's ability to add highly profitable ancillary services and
leverage our infrastructure to grow profits faster than revenue growth.
Looking forward, in comparing the fourth quarter fiscal 2001 to the fourth
quarter fiscal 2000, the fourth quarter of last year reflected higher than
normal total payroll revenue growth (24%) and higher than normal growth in
consolidated combined operating and selling, general and administrative
expenses (22%).
Payroll segment
(In thousands)
For the three months ended February 28, Feburary 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Payroll service revenue $177,842 14.4% $155,466
ENS investment revenue 25,905 58.4% 16,355
---------------------------------
Total payroll service revenues $203,747 18.6% $171,821
Payroll operating income $ 94,259 21.3% $ 77,683
Payroll operating margin 46.3% 45.2%
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Payroll service revenue $509,496 16.6% $437,044
ENS investment revenue 60,671 49.5% 40,595
---------------------------------
Total payroll service revenues $570,167 19.4% $477,639
Payroll operating income $272,121 22.3% $222,434
Payroll operating margin 47.7% 46.6%
==============================================================================
Revenues: Total payroll service revenues include service fees and investment
revenue. Service fee revenue is earned primarily from Payroll, Taxpay,
Employee Pay Services and other ancillary services. The 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 ENS investments 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 particular 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, new services, price increases and increased utilization of
ancillary services, by both new and existing clients. As of February 28, 2001
83% of Paychex clients utilized Taxpay, the Company's tax filing and payment
feature. Client utilization of the Taxpay product is expected to mature within
a range of 83% to 87%. The Company's Employee Pay Services was utilized by 52%
of its clients at February 28, 2001. During the first nine months of fiscal
2001, the Company continued expansion of its Major Market Services (MMS)
payroll product offering. MMS revenue increased 64.8% and 58.7% for the third
quarter and nine-month periods to $13.7 million and $34.0 million,
respectively. Employee Pay Services and MMS are expected to provide growth
opportunities for the remainder of fiscal 2001 and beyond. In fiscal 2001, the
Company also introduced new payroll product enhancements including employee
garnishments and After-The-Fact payroll.
The increases in ENS investment revenue are due to growth in the utilization of
Taxpay and Employee Pay Services by new and existing clients, higher
comparative rates of return and net realized gains on the sale of
available-for-sale securities. ENS investment revenue included net realized
gains on available for sale securities of $3.4 million and $3.1 million in the
third quarter and nine months of fiscal 2001 compared with net realized losses
of $.8 million and $1.6 million in the respective prior year periods.
Additional discussion on interest rates and related risk is included in the
"Market Risk Factors" section of this review.
Payroll service revenue comparisons for the third quarter and fourth quarter of
fiscal 2001 are impacted by the fact that there is one less billing day in the
third quarter and two less billing days in the fourth quarter when compared to
the prior year quarters. Subject to the impact of further changes in interest
rates, the Company expects that full year fiscal 2001's percentage growth in
total payroll service revenues to be in the range of 18% 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 as
evidenced by the improvement in operating margins.
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 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 February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
HRS-PEO service revenue $25,509 25.3% $20,362
HRS-PEO operating income $ 9,349 36.9% $ 6,831
HRS-PEO operating margin 36.6% 33.5%
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
HRS-PEO service revenue $71,070 33.4% $53,294
HRS-PEO operating income $26,942 57.9% $17,064
HRS-PEO operating margin 37.9% 32.0%
==============================================================================
Revenues: The increases in service revenue are 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
34.1% and 40.5% in the third quarter and nine-month periods to $11.4 million
and $31.5 million, respectively.
The Company continued to expand 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 slightly
under $100 million. Segment operating income for the full year fiscal 2001 is
expected to be slightly higher than the growth rate through the first nine
months. 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 or future results.
Corporate expenses
(In thousands)
For the three months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Corporate expenses $16,726 .7% $16,611
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Corporate expenses $49,930 -.9% $50,403
==============================================================================
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 nine
months of fiscal 2001 with additional expenditures to support the continued
growth of the Company being offset by lower spending on national marketing
efforts and other areas. Looking forward, the Company expects the growth in
corporate expenses to be flat in the fourth quarter and up less than 10% in
fiscal 2002.
Investment income
(In thousands)
For the three months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Investment income $ 7,234 80.3% $ 4,012
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Investment income $18,733 62.1% $11,554
==============================================================================
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 increases
in investment income are primarily due to the increase in average daily
invested balances, higher comparable rates of return and net realized gains on
the sale of available-for-sale securities. Net realized gains included in
investment income were $.6 million and $.4 million for the third quarter and
nine-month periods of fiscal 2001 compared with net realized losses of $.4
million and $.7 million in the respective prior year periods. Refer to the
"Market Risk Factors" section of this review for further discussion of interest
rates and the related risks.
Income taxes
(In thousands)
For the three months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Income taxes $27,764 24.5% $22,294
Effective income tax rate 29.5% 31.0%
==============================================================================
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Income taxes $80,758 29.8% $62,201
Effective income tax rate 30.1% 31.0%
==============================================================================
The slight decrease in the effective income tax rate is due to the growth in
tax-exempt income exceeding the growth in taxable income and other tax
reduction opportunities. Tax-exempt income is derived primarily from income
earned on municipal debt securities. The effective income tax rate is expected
to be 29.5% and 30.0% for the fourth quarter and full year periods of fiscal
2001. The effective rate for fiscal 2002 is expected to be in the range of
30.0% to 31.0%.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
(In thousands)
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Operating cash flows $256,239 32.8% $192,885
==============================================================================
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 February 28, 2001 the
Company had $613.1 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 nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Net Corporate investments and ENS activities $ (82,899) -16.7% $ (99,542)
Purchases of P&E (28,971) 12.8% (25,685)
Proceeds from the sale of property and
equipment 41 -96.8% 1,263
Purchases of other assets (6,773) 5.6% (6,416)
--------------------------------
Net cash used in investing activities $(118,602) -9.0% $(130,380)
==============================================================================
Corporate investments and ENS investments: Corporate 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 February 28, 2001
the total available-for-sale portfolio, including corporate investments and ENS
investments, had a market value exceeding the cost basis by $20.7 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 approximate $35 million compared with expected full year
depreciation in the range of $25 million to $26 million. The Company is
proceeding with the construction of a new building to be utilized by ENS and
Information Technology personnel. This building is currently estimated to cost
approximately $40 million, but will allow for a significant reduction in leased
space in the Rochester, New York area. Occupancy is expected in the fall of
2002.
Financing activities
(In thousands, except per share amounts)
For the nine months ended February 28, February 29,
2001 Change 2000
- ------------------------------------------------------------------------------
Dividends paid $ (89,457) 50.9% $(59,281)
Proceeds from exercise of stock options 11,480 28.7% 8,923
--------------------------------
Net cash used in financing activities $ (77,977) 54.8% $(50,358)
- ------------------------------------------------------------------------------
Cash dividends per common share $ .24 50.0% $ .16
==============================================================================
Dividends paid: On October 10, 2000, the Company's Board of Directors
increased the quarterly cash dividend rate by 50% from $.06 per share to $.09
per share. During the quarter ended February 28, 2001 the Company's Board of
Directors declared a dividend which was paid February 15, 2001 to shareholders
of record as of February 1, 2001.
Proceeds from exercise of stock options: The increase in proceeds from the
exercise of stock options is primarily due to an increase in the number of
shares exercised and higher comparable exercise prices per share. The Company
has recognized a tax benefit from the exercise of stock options of $23.1
million and $14.2 million for the nine months ended February 28, 2001 and
February 29, 2000 respectively. This tax benefit reduces the accrued income
tax liability and increases additional paid-in capital, with no impact on the
expense amount for income taxes.
MARKET RISK FACTORS
Interest rate risk - The Company's available-for-sale debt securities are
exposed to interest rate risk as interest rate volatility will cause
fluctuations in the market value of held investments and the earnings potential
of future investments. Decreases in interest rates normally increase the
market value of the available-for-sale securities, while increases in interest
rates decrease the market value of the available-for-sale securities. The
Company's available-for-sale securities and short-term funds are exposed to
earnings risk from changes in interest rates, as rate volatility will cause
fluctuations in the earnings potential of future investments. Decreases in
interest rates quickly decrease earnings from short-term funds, and over time
decrease earnings from the available-for-sale securities portfolio. Increases
in interest rates have the opposite earnings effect on the available-for-sale
securities and short-term funds. Earnings from the available-for-sale
securities do not reflect changes in rates until the investments are sold or
mature, and the proceeds are reinvested at current rates. The immediate impact
of changing interest rates on earnings from short-term funds may be temporarily
offset by realized gains or losses from transactions in the Company's
available-for-sale portfolio. The Company estimates that the earnings effect of
a 25 basis point change in interest rates (17 basis points for tax-exempt
investments) at this point in time would equate to approximately $3.0 million
for fiscal 2002. As of February 28, 2001 unrealized gains on the
available-for-sale portfolio were $20.7 million.
The Company directs investments towards high credit-quality, tax-exempt
securities to mitigate the risk that earnings from the portfolio could be
adversely impacted by changes in interest rates in the near term. The Company
invests in short- to intermediate-term, fixed-rate municipal and government
securities, which typically have lower interest rate volatility, and manages
the securities portfolio to a benchmark duration of 2.5 to 3.0 years. The
Company does not utilize derivative financial instruments to manage interest
rate risk.
The recent trend in interest rates has been toward interest rate reductions
versus interest rate increases during fiscal 2000. The following table
summarizes recent changes in the Federal funds rate:
- -------------------------------------------------------------------------------
Nine Months Fiscal Year Fiscal Year
Ended Ended Ended
February 28, May 31, May 31,
2001 2000 1999
----------- ----------- ----------
Federal funds rate - beginning of period 6.50% 4.75% 5.50%
Rate increase/(decrease):
First quarter -- .50 --
Second quarter -- .25 (.75)
Third quarter (1.00) .25 --
Fourth quarter N/A .75 --
----------- ----------- ----------
Federal funds rate - end of period 5.50% 6.50% 4.75%
===============================================================================
Calculating the future effects of changing interest rates involves many
factors. These factors include, but are not limited to, daily interest rate
changes, seasonal variations in investment balances, actual duration of short
and intermediate-term investments, the proportional mix of taxable and
tax-exempt investments, and changes in tax-exempt municipal rates versus
taxable investment rates, which are not synchronized or simultaneous. Subject
to 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 (compared with an average of $1.8 billion for fiscal 2000), of which
approximately 50% is invested in intermediate-term municipal securities with an
average duration of three years. The duration of short-term investments is
generally less than thirty days.
At February 28, 2001, the available-for-sale securities portfolio had a market
value greater than its cost basis by $20.7 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. The decreasing interest rate environment in fiscal 2001
is driving the improvement in the market value of the available-for-sale
portfolio.
As of February 28, 2001 and May 31, 2000, the Company had $1.1 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 decrease in interest rates of 25 basis points given the February
28, 2001 portfolio of securities, the resulting potential increase in fair
value would be in the range of $6 million to $7 million. Conversely, a
corresponding increase in interest rates would result in a comparable decrease
in fair value. This hypothetical decrease or increase in the fair value of the
portfolio would be recorded as an adjustment to the portfolio's recorded value,
with an offsetting amount recorded in stockholders' equity, and with no related
or immediate impact to the results of operations.
Credit risk - The Company is exposed to credit risk in connection with these
investments through the possible inability of the borrowers to meet the terms
of the bonds. The Company attempts to limit credit risk by investing primarily
in AAA and AA rated securities and A-1 rated short-term securities, and by
limiting amounts that can be invested in any single instrument. At February 28,
2001, approximately 98% of the available-for-sale securities held an AA rating
or better, and all short-term securities classified as cash equivalents held an
A-1 or equivalent rating.
OTHER
"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 and economic conditions, including demand for the
Company's products and services, availability of internal and external
resources, executing expansion plans, competition, and price levels; changes in
the laws regulating collection and payment of payroll taxes, professional
employer organizations, and employee benefits, including 401(k) plans, workers'
compensation, state unemployment, and section 125 plans; delays in the
development, timing of the introduction, and marketing of new products and
services; changes in technology including 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 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 December 20, 2000 that
included the Company's press release dated December 20, 2000 reporting
the Company's results of operations for the second quarter and
six-month periods ended November 30, 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: March 19, 2001 /s/ B. Thomas Golisano
-----------------------
B. Thomas Golisano
Chairman, President and
Chief Executive Officer
Date: March 19, 2001 /s/ John M. Morphy
-----------------------
John M. Morphy
Vice President, Chief
Financial Officer and
Secretary