1
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, 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)
(585) 385-6666
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes[X] No[ ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 Par Value 374,740,379 Shares
- ---------------------------- -----------------------------------------
CLASS OUTSTANDING AT NOVEMBER 30, 2001
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
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For the three For the six
months ended months ended
November November November November
30, 30, 30, 30,
2001 2000 2001 2000
- --------------------------------------------------------------------------------
Revenues:
Service revenues $217,509 $190,745 $433,685 $377,215
Interest on funds held for
clients 15,479 17,353 34,117 34,766
------------------------------------------
Total revenues 232,988 208,098 467,802 411,981
Operating costs 54,731 47,095 108,487 93,022
Selling, general and administrative
expenses 87,174 77,578 174,470 156,708
------------------------------------------
Operating income 91,083 83,425 184,845 162,251
Investment income 8,191 5,965 15,718 11,499
------------------------------------------
Income before income taxes 99,274 89,390 200,563 173,750
Income taxes 30,576 27,264 61,672 52,994
------------------------------------------
Net income $ 68,698 $ 62,126 $138,891 $120,756
==========================================
Basic earnings per share $ .18 $ .17 $ .37 $ .32
------------------------------------------
Diluted earnings per share $ .18 $ .16 $ .37 $ .32
------------------------------------------
Weighted-average common shares
outstanding 374,512 372,618 374,237 372,326
------------------------------------------
Weighted-average shares assuming
dilution 377,614 377,839 377,672 377,511
------------------------------------------
Cash dividends per common share $ .11 $ .09 $ .20 $ .15
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See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
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November 30, May 31,
2001 2001
(Unaudited) (Audited)
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ASSETS
Cash and cash equivalents $ 96,290 $ 45,784
Corporate investments 563,893 568,217
Interest receivable 24,646 28,281
Accounts receivable 112,911 100,640
Prepaid expenses and other current assets 8,330 7,306
--------------------------------
Current assets before funds held for clients 806,070 750,228
Funds held for clients 1,841,370 2,041,045
--------------------------------
Total current assets 2,647,440 2,791,273
Property and equipment - net 107,071 96,078
Intangible assets - net 9,316 9,612
Deferred income taxes -- 1,361
Other assets 8,713 8,872
--------------------------------
Total assets $2,772,540 $2,907,196
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LIABILITIES
Accounts payable $ 12,179 $ 16,377
Accrued compensation and related items 38,718 57,418
Deferred revenue 3,344 4,421
Accrued income taxes 3,196 9,783
Deferred income taxes 17,843 4,996
Other current liabilities 15,203 19,282
--------------------------------
Current liabilities before client fund deposits 90,483 112,277
Client fund deposits 1,829,619 2,031,565
--------------------------------
Total current liabilities 1,920,102 2,143,842
Long-term liabilities 5,866 5,512
--------------------------------
Total liabilities 1,925,968 2,149,354
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 600,000
authorized shares
Issued: 374,740 at November 30, 2001
and 373,647 at May 31, 2001 3,747 3,736
Additional paid-in capital 161,535 139,897
Retained earnings 665,145 601,142
Accumulated other comprehensive income 16,145 13,067
--------------------------------
Total stockholders' equity 846,572 757,842
---------------------------------
Total liabilities and stockholders' equity $2,772,540 $2,907,196
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See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
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For the six months ended
November 30, November 30,
2001 2000
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OPERATING ACTIVITIES
Net income $ 138,891 $ 120,756
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization on
depreciable and intangible assets 14,490 12,574
Amortization of premiums and discounts on
available-for-sale securities 8,017 6,150
Provision for deferred income taxes 12,670 7,315
Provision for bad debts 537 880
Net realized (gains) / losses on sales
of available-for-sale securities (8,164) 431
Changes in operating assets and liabilities:
Interest receivable 3,635 (861)
Accounts receivable (12,808) (21,523)
Prepaid expenses and other current assets (1,024) 309
Accounts payable and other current
liabilities (20,610) 4,360
Net change in other assets and liabilities 223 549
----------------------------
Net cash provided by operating activities 135,857 130,940
----------------------------
INVESTING ACTIVITIES
Purchases of available-for-sale securities (534,896) (368,215)
Proceeds from sales of available-for-sale securities 508,747 189,267
Proceeds from maturities of available-for-sale
securities 20,630 12,590
Net change in funds held for clients' money market
securities and other cash equivalents 214,576 31,035
Net change in client fund deposits (201,946) 57,039
Purchases of property and equipment (26,092) (16,714)
Proceeds from sale of property and equipment 9 3
Purchases of other assets (1,112) (3,489)
----------------------------
Net cash used in investing activities (20,084) (98,484)
----------------------------
FINANCING ACTIVITIES
Dividends paid (74,888) (55,883)
Proceeds from exercise of stock options 9,621 8,852
----------------------------
Net cash used in financing activities (65,267) (47,031)
----------------------------
Increase (decrease) in cash and cash equivalents 50,506 (14,575)
Cash and cash equivalents, beginning of period 45,784 47,136
----------------------------
Cash and cash equivalents, end of period $ 96,290 $ 32,561
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See Notes to Consolidated Financial Statements.
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
November 30, 2001
Note A: Significant Accounting Policies
The accompanying unaudited Consolidated Financial Statements of Paychex, Inc.,
and its wholly owned subsidiaries have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, the Consolidated Financial Statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, the information
furnished herein reflects all adjustments (consisting of items of a normal
recurring nature) which are necessary for a fair presentation of the results for
the interim period. Operating results for the six months ended November 30, 2001
are not necessarily indicative of the results that may be expected for the full
year ended May 31, 2002.
Service revenues are recognized in the period services are rendered and earned.
PEO revenues are included in service revenues and are reported net of direct
costs billed and incurred. Direct costs billed and incurred include wages,
taxes, benefit premiums and claims of worksite employees and totaled $247.2
million and $208.1 million for the three months ended November 30, 2001 and
2000, respectively, and $482.0 million and $401.9 million for the six months
ended November 30, 2001 and 2000, respectively. Paychex provides delivery
service for many of its clients' payrolls. The revenue earned from delivery
service is included in service revenues and the costs for the delivery are
included in operating costs on the Consolidated Statements of Income.
Interest on funds held for clients is earned on Taxpay(Registered Trademark) and
Employee Pay Services funds that are collected before due dates and invested
(funds held for clients) until remittance to the applicable tax authorities for
Taxpay clients and employees of Employee Pay Services clients. These collections
from clients are typically remitted between one and thirty days after receipt,
with some items extending to ninety days. The interest earned on these funds is
included in total revenues on the Consolidated Statements of Income, as the
collection, holding and remittance of these funds is a critical component of
providing these particular product services. Interest on funds held for clients
also includes net realized gains and losses from the sale of available-for-sale
securities.
There is no significant seasonality to the Company's business. However, during
the third fiscal quarter, the number of new Payroll clients, Retirement Services
clients and new PAS and PEO worksite employees tends to be higher than the rest
of the fiscal year. Consequently, greater sales commission expenses are reported
in the third quarter.
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard 141, "Business Combinations" (SFAS No. 141) and
Statement of Financial Accounting Standard 142, "Goodwill and Other Intangible
Assets" (SFAS No. 142). SFAS No. 141 requires that all future business
combinations be accounted for using the purchase method of accounting and the
use of the pooling-of-interest method is prohibited for transactions initiated
after July 1, 2001. SFAS No. 142 addresses financial accounting and reporting
for acquired goodwill and other intangible assets. This statement recognizes
that goodwill has an indefinite useful life and will no longer be subject to
periodic amortization, but rather periodically evaluated for impairment. The
statement also requires an evaluation of existing acquired goodwill and other
intangible assets for proper classification under the new requirements. The
Company adopted these standards in the first quarter of fiscal 2002. Adoption of
these standards did not have a material impact on the results of operations or
financial position of the Company.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which requires companies to record a liability at fair value for
asset retirement obligations in the period in which they are incurred. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This Statement is effective for the Company for the
fiscal year beginning June 1, 2003. The Company is currently evaluating the
provisions of this Statement, but does not believe adoption of this Statement
will result in a material impact to its results of operations or financial
position.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which provides a single accounting model for
long-lived assets to be disposed of. This Statement is effective for the Company
for the fiscal year beginning June 1, 2002. The Company is currently evaluating
the provisions of this statement, but does not anticipate that adoption will
result in a material impact to its results of operations or financial position.
The accompanying Consolidated Financial Statements should be read in conjunction
with the Consolidated Financial Statements and related Notes presented in the
Company's Annual Report on Form 10-K for the year ended May 31, 2001. Certain
amounts from the prior year have been reclassified to conform to the current
year presentation.
Note B: Segment Financial Information
The Company is a national provider of payroll, human resource and employee
benefits outsourcing solutions for small- to medium-sized businesses in the
United States.
During the second half of fiscal 2001, the Company completed consolidation
efforts to streamline certain operations and improve customer service. These
efforts resulted in certain service operations supporting multiple products for
both Payroll and Human Resource and Benefits product lines. Due to these
changes, the Company no longer prepares internal reporting reflecting the
operating results of the Payroll and Human Resource and Benefits segments. As a
result, in fiscal 2002, the Company changed its segment reporting from two
segments to one segment based upon the provisions of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information."
Note C: Basic and Diluted Earnings Per Share
Basic and diluted earnings per share were calculated as follows:
- --------------------------------------------------------------------------------
For the three For the six
months ended months ended
November November November November
(In thousands, except per 30, 30, 30, 30,
share amounts) 2001 2000 2001 2000
- --------------------------------------------------------------------------------
Basic earnings per share:
Net income $ 68,698 $ 62,126 $138,891 $120,756
------------------------------------------
Weighted-average common shares
outstanding 374,512 372,618 374,237 372,326
------------------------------------------
Basic earnings per share $ .18 $ .17 $ .37 $ .32
------------------------------------------
Diluted earnings per share:
Net income $ 68,698 $ 62,126 $138,891 $120,756
------------------------------------------
Weighted-average common shares
outstanding 374,512 372,618 374,237 372,326
Net effect of dilutive stock options
at average market prices 3,102 5,221 3,435 5,185
------------------------------------------
Weighted-average shares assuming
dilution 377,614 377,839 377,672 377,511
------------------------------------------
Diluted earnings per share $ .18 $ .16 $ .37 $ .32
- --------------------------------------------------------------------------------
Weighted-average anti-dilutive stock
options 1,717 - 1,568 201
- --------------------------------------------------------------------------------
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, 2001, stock options were
exercised for 440,000 and 1,093,000 shares of the Company's common stock,
respectively.
Note D: Funds Held for Clients and Corporate Investments
- --------------------------------------------------------------------------------
November 30, 2001 May 31, 2001
(In thousands) (Unaudited) (Audited)
-----------------------------------------------
Type of issue: Cost Fair value Cost Fair value
-----------------------------------------------
Money market securities and
other cash equivalents $1,052,122 $1,052,122 $1,266,698 $1,266,698
Available-for-sale securities:
General obligation municipal
bonds 691,160 703,608 582,249 590,806
Pre-refunded municipal bonds 231,014 236,531 293,109 298,058
Revenue municipal bonds 402,517 409,791 443,667 450,635
Other securities 20 62 20 64
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Total available-for-sale
securities 1,324,711 1,349,992 1,319,045 1,339,563
Other 3,364 3,149 3,099 3,001
-----------------------------------------------
Total funds held for clients
and corporate investments $2,380,197 $2,405,263 $2,588,842 $2,609,262
- --------------------------------------------------------------------------------
Classification of investments on
Consolidated Balance Sheets:
Funds held for clients $1,829,619 $1,841,370 $2,031,565 $2,041,045
Corporate investments 550,578 563,893 557,277 568,217
-----------------------------------------------
Total funds held for clients
and corporate investments $2,380,197 $2,405,263 $2,588,842 $2,609,262
- --------------------------------------------------------------------------------
The Company is exposed to credit risk from the possible inability of the
borrowers to meet the terms of their bonds. In addition, the Company is exposed
to interest rate risk as rate volatility will cause fluctuations in the market
value of held investments and the earnings potential of future investments. The
Company attempts to limit these risks by investing primarily in AAA and AA rated
securities and A-1 rated short-term securities, limiting amounts that can be
invested in any single instrument, and by investing in short- to
intermediate-term instruments whose market value is less sensitive to interest
rate changes. At November 30, 2001, approximately 98% of the available-for-sale
bond securities held an AA rating or better, and all short-term securities
classified as cash equivalents held an A-1 or equivalent rating. The Company
does not utilize derivative financial instruments to manage interest rate risk,
and, therefore, adopting Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" had no impact on
the results of operations or financial condition of the Company for the first
six months of fiscal 2002.
Note E: Property and Equipment - Net
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November 30, May 31,
2001 2001
(In thousands) (Unaudited) (Audited)
- --------------------------------------------------------------------------------
Land and improvements $ 3,040 $ 2,919
Buildings and improvements 35,508 36,923
Data processing equipment and software 123,648 106,359
Furniture, fixtures and equipment 79,577 75,243
Leasehold improvements 14,530 12,545
--------------------------------------
256,303 233,989
Less: accumulated depreciation and
amortization 149,232 137,911
--------------------------------------
Property and equipment - net $107,071 $ 96,078
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Note F: Comprehensive Income
Comprehensive income is comprised of two components: net income and other
comprehensive income. Comprehensive income includes all changes in equity during
a period except those resulting from transactions with owners of the Company.
The unrealized gains and losses, net of applicable taxes, related to
available-for-sale securities is the only component reported in accumulated
other comprehensive income in the Consolidated Balance Sheets for the Company.
Comprehensive income, net of related tax effects, is as follows:
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For the three For the six
months ended months ended
--------------------------------------
November November November November
30, 30, 30, 30,
(In thousands) 2001 2000 2001 2000
- --------------------------------------------------------------------------------
Net income $68,698 $62,126 $138,891 $120,756
Unrealized gains/(losses) on
securities, net of reclassification
adjustments (4,208) (574) 3,078 10,767
----------------------------------------
Total comprehensive income $64,490 $61,552 $141,969 $131,523
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations reviews the operating results for the three months and six months
ended November 30, 2001 (fiscal 2002) and 2000 (fiscal 2001), and the financial
condition at November 30, 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
November 30, 2001 Consolidated Financial Statements and the related Notes to
Consolidated Financial Statements contained in this Form 10-Q. Forward-looking
statements in this review are qualified by the cautionary statement included in
the "Other" section of this review under the sub-heading "Safe-Harbor Statement
under the Private Securities Litigation Reform Act of 1995."
RESULTS OF OPERATIONS
For the first six months of fiscal 2002, the Company generated record total
revenues, net income and diluted earnings per share. The results for the second
quarter and six-month periods of fiscal 2002 have been affected by the declining
U.S. economic conditions.
- --------------------------------------------------------------------------------
(In thousands, except per share amounts)
For the three months ended November 30, 2001 Change 2000 Change
- --------------------------------------------------------------------------------
Revenues:
Payroll $188,491 12.8% $167,133 17.0%
Human Resource and Benefits 29,018 22.9% 23,612 35.2%
--------------------------------------
Total service revenues 217,509 14.0% 190,745 19.0%
Interest on funds held for clients 15,479 -10.8% 17,353 44.2%
--------------------------------------
Total revenues 232,988 12.0% 208,098 20.7%
Combined operating and SG&A expenses 141,905 13.8% 124,673 13.5%
--------------------------------------
Operating income 91,083 9.2% 83,425 33.5%
Investment income 8,191 37.3% 5,965 54.8%
--------------------------------------
Income before income taxes 99,274 11.1% 89,390 34.7%
Income taxes 30,576 12.1% 27,264 32.5%
--------------------------------------
Net income $ 68,698 10.6% $ 62,126 35.7%
--------------------------------------
Diluted earnings per share $ .18 12.5% $ .16 33.3%
--------------------------------------
Operating income as a % of total revenues 39.1% 40.1%
Income before income taxes as a % of
total revenues 42.6% 43.0%
Net income as a % of total revenues 29.5% 29.9%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(In thousands, except per share amounts)
For the six months ended November 30, 2001 Change 2000 Change
- --------------------------------------------------------------------------------
Revenues:
Payroll $377,921 14.0% $331,654 17.8%
Human Resource and Benefits 55,764 22.4% 45,561 38.3%
--------------------------------------
Total service revenues 433,685 15.0% 377,215 19.9%
Interest on funds held for clients 34,117 -1.9% 34,766 43.4%
--------------------------------------
Total revenues 467,802 13.5% 411,981 21.6%
Combined operating and SG&A expenses 282,957 13.3% 249,730 14.8%
--------------------------------------
Operating income 184,845 13.9% 162,251 33.9%
Investment income 15,718 36.7% 11,499 52.5%
--------------------------------------
Income before income taxes 200,563 15.4% 173,750 35.0%
Income taxes 61,672 16.4% 52,994 32.8%
--------------------------------------
Net income $138,891 15.0% $120,756 35.9%
--------------------------------------
Diluted earnings per share $ .37 15.6% $ .32 33.3%
--------------------------------------
Operating income as a % of total revenues 39.5% 39.4%
Income before income taxes as a % of
total revenues 42.9% 42.2%
Net income as a % of total revenues 29.7% 29.3%
- --------------------------------------------------------------------------------
Total revenues are comprised of service revenues and interest on funds held for
clients. Total service revenues are comprised of the Payroll and Human Resource
and Benefits product lines. Payroll service revenues are earned primarily from
Payroll, Taxpay, Employee Pay Services and other ancillary services. Employee
Pay Services includes the Direct Deposit, Readychex(Service Mark) and Access
Card products.
The increases in Payroll service revenues in fiscal 2002 compared with the prior
year are attributable to the addition of new clients, new services, price
increases and increased utilization of ancillary services by both new and
existing clients. As of November 30, 2001 84% of Paychex clients utilized
Taxpay, the Company's tax filing and payment feature, compared with 82%
utilization at November 30, 2000. Client utilization of the Taxpay product is
expected to mature in the range of 84% to 87%. The Company's Employee Pay
Services was utilized by 55% of its clients at November 30, 2001 compared with
50% utilization at November 30, 2000. Major Market Services revenue increased
56% and 59% for the second quarter and six-month periods to $16.6 million and
$32.2 million, respectively.
The increases in Human Resource and Benefits service revenue in fiscal 2002
compared with the prior year are primarily related to increases in clients for
Retirement Services and increases in Paychex Administrative Services (PAS) and
Professional Employer Organization (PEO) client employees serviced. The increase
in Retirement Services clients reflects the continuing interest of small- to
medium-sized businesses to offer retirement savings benefits to their employees.
Retirement Services revenues increased 30% and 28% in the second quarter and
six-month periods to $13.6 million and $25.9 million, respectively.
The Paychex Administrative Services (PAS) product is a combined package of
payroll, employer compliance, employee benefit administration and risk
management outsourcing services designed to make it easier for small businesses
to manage their payroll and benefit costs. This product was introduced in May
2000 and was available nationwide by the end of fiscal 2001. The Company's PEO
product provides the same bundled services as the PAS product, but as a
co-employer of the client's employees. The PEO service is available primarily in
the states of Florida and Georgia, where PEOs are popular and operate under a
favorable regulatory environment. Sales of the PAS and PEO products have been
strong with administrative fee revenue from these products increasing 43% and
45% in the second quarter and six-month periods of fiscal 2002 compared with the
respective prior year periods.
The decreases in interest on funds held for clients are the result of lower
interest rates in fiscal 2002 offset by net realized gains on the sale of
available-for-sale securities and higher average daily portfolio balances. The
funds held for clients portfolio earned average rates of return of 3.1% and 3.4%
in the second quarter and first six months of fiscal 2002 compared with 4.8% in
both the respective prior year periods. Net realized gains on the sale of
available-for-sale securities were $2.2 million and $5.4 million in the second
quarter and six months of fiscal 2002 compared with net realized losses of $0.1
million and $0.2 million in the respective prior year periods. The average daily
portfolio balance totaled approximately $1.70 billion and $1.45 billion for the
six months ended November 30, 2001 and 2000, respectively. The increase reflects
higher utilization of Taxpay and Employee Pay Services by new and existing
clients.
The combined increases in operating and SG&A expenses reflect increases in
personnel, information technology and facility costs necessary to support the
growth of the Company. At November 30, 2001 the Company had approximately 7,400
employees compared with approximately 6,900 at November 30, 2000. To enhance
overall customer service, the Company implemented an initiative to decrease the
number of clients serviced per payroll specialist in fiscal 2001. Salaries of
payroll specialists were increased in an effort to improve retention. Also,
during fiscal 2001, the Company increased personnel necessary to service the
Company's PAS product. These initiatives were implemented throughout fiscal
2001, and the impact of the higher expenses on year-over-year growth rates will
be less in the second half of fiscal 2002.
Investment income represents earnings from the Company's cash and cash
equivalents and investments in available-for-sale securities. Investment income
does not include interest on funds held for clients, which is included in total
revenues. The increases in investment income are primarily due to net realized
gains on the sale of available-for-sale securities and the increase in average
daily invested balances, offset by lower interest rates in fiscal 2002. Net
realized gains included in investment income were $1.8 million and $2.8 million
for the second quarter and six months of fiscal 2002 compared with net realized
losses of $0.1 million and $0.2 million in the respective prior year periods.
Average daily balances invested were approximately $.65 billion and $.50 billion
for the six months ended November 30, 2001 and 2000, respectively. The increases
in the average portfolio balances were driven by additional net cash inflows
from operations. The Corporate investment portfolio earned an average rate of
return of 4.0% and 4.1% in the second quarter and first six months of fiscal
2002 compared with 4.6% in both the respective prior year periods.
The effective income tax rate was 30.8% in the second quarter and six-month
periods of fiscal 2002 compared with 30.5% in the prior year periods. The full
year fiscal 2002's effective income tax rate is expected to be in the range of
30.5% to 31.0%.
Economic Conditions:
The Company first experienced the effects of the recession in the first quarter
of fiscal 2002, and these effects have heightened during the second quarter. In
response to the declining economic conditions, the Federal Reserve has lowered
the Federal Funds rate eleven times since January 2001 to 1.75%, which
represents a cumulative 475 basis point reduction. The impact of the rate cuts
on year-over-year comparisons for interest on funds held for clients and
corporate investment income is expected to be more significant in the second
half of the fiscal year. Year-over-year comparisons for these income sources
combined were up 14% and 2% for the first and second quarters of fiscal 2002,
respectively. Year-over-year comparisons for these same income sources are
currently projected to be down approximately 30% for the second half of fiscal
2002.
The decrease in interest rates has resulted in an increase in the market value
of the Company's available-for-sale portfolios. The combined funds held for
clients and corporate available-for-sale investment portfolios reflected
unrealized gains of $25.3 million at November 30, 2001 and $20.5 million at May
31, 2001 compared with unrealized losses of $13.4 million at May 31, 2000.
Intermediate-term interest rates have increased slightly since November 30,
2001, resulting in a decline in the unrealized gain position of the Company's
portfolio to approximately $16 million as of December 17, 2001. Refer to the
"Market Risk Factors" section of this review for further discussion of interest
rates and related risks.
After the effects of volatile interest rates, the most significant impact of a
recessionary economy is lower checks per client as existing clients reduce the
size of their work forces. During the second quarter of fiscal 2002, the Company
experienced a 4.3% decline in checks per client compared to 2.6% in the first
quarter. During the recession of the early 1990's, the Company experienced an
approximate 3% total reduction in checks per client.
Despite the above factors, income before taxes remained strong at 43% of
revenues during the first half of fiscal 2002 compared with 42% for the same
period last year. If the interest rates and checks per client conditions
experienced in fiscal 2000 had prevailed throughout fiscal 2001 and the first
half of fiscal 2002, net income growth for fiscal 2001 would have been
approximately 25% compared with a reported 34% growth. Net income growth for the
first half of fiscal 2002 would have been approximately 25% compared with a
reported 15%.
The U.S. economic conditions and interest rate trends represent uncertainties
which are expected to continue to affect total revenue growth. For fiscal 2002,
the Company projects Payroll service revenue to grow in the range of 11% to 13%
and Human Resource and Benefits service revenue growth in the range of 20% to
23%. Total service revenue growth is anticipated to be in the range of 13% to
15%.
Taking the aforementioned factors into consideration and assuming no further
deterioration to interest rates or current economic conditions, total revenue
growth and net income growth for fiscal 2002 is anticipated to be in the range
of 9% to 11%.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities
- --------------------------------------------------------------------------------
(In thousands)
For the six months ended November 30, 2001 Change 2000 Change
- --------------------------------------------------------------------------------
Operating cash flows $135,857 3.8% $130,940 34.6%
- --------------------------------------------------------------------------------
The increase in operating cash flows for the first half of fiscal 2002 reflects
higher cash from net income offset by higher cash used for working capital
purposes. The higher use of working capital was related primarily to the timing
of payments for payroll-related, income tax and other liabilities. Projected
operating cash flows are expected to adequately support normal business
operations, forecasted growth, purchases of property and equipment and dividend
payments. At November 30, 2001 the Company had $660.2 million in available cash
and corporate investments. The Company also has $100 million of available,
uncommitted, unsecured lines of credit and $350 million available under an
uncommitted, secured line of credit.
Investing activities
- --------------------------------------------------------------------------------
For the six months ended November 30, 2001 Change 2000 Change
- --------------------------------------------------------------------------------
Net funds held for clients and corporate
investment activities $ 7,111 -- $(78,284) 1.0%
Purchases of property and equipment (26,092) 56.1% (16,714) 22.3%
Proceeds from the sale of property
and equipment 9 -- 3 --
Purchases of other assets (1,112) -68.1% (3,489) -25.1%
-------------------------------------
Net cash used in investing activities $(20,084) -79.6% $(98,484) 4.0%
- --------------------------------------------------------------------------------
Funds held for clients and corporate investments: Funds held for clients are
primarily comprised of short-term funds and available-for-sale debt securities,
and corporate investments are primarily comprised of available-for-sale debt
securities. The portfolio of funds held for clients and corporate investments is
detailed in Note D of the Notes to the Consolidated Financial Statements.
The reported amount of funds held for clients will vary significantly based upon
the timing of collecting client funds, and the related remittance of funds to
the applicable tax authorities for Taxpay clients and employees of clients
utilizing Employee Pay Services. Corporate investments have increased due to the
investment of growing cash balances provided by operating activities less
purchases of property and equipment and dividend payments. Additional discussion
of interest rates and related risks is included in the "Market Risk Factors"
section of this review.
Purchases of property and equipment: To support the Company's continued client
and ancillary product growth, purchases of property and equipment were made for
data processing equipment and software, and for the expansion and upgrade of
various operating facilities. Purchases of property and equipment in fiscal 2002
are expected to be in the range of $50 million to $55 million including
additional expenditures anticipated for a new data center in Rochester, New
York. Fiscal 2002 depreciation expense is projected to be in the range of $28
million to $30 million.
Financing activities
- --------------------------------------------------------------------------------
(In thousands, except per share amounts)
For the six months ended November 30, 2001 Change 2000 Change
- --------------------------------------------------------------------------------
Dividends paid $(74,888) 34.0% $(55,883) 51.0%
Proceeds from exercise of stock options 9,621 8.7% 8,852 59.0%
-------------------------------------
Net cash used in financing activities $(65,267) 38.8% $(47,031) 49.6%
-------------------------------------
Cash dividends per common share $ .20 33.3% $ .15 50.0%
- --------------------------------------------------------------------------------
Dividends paid: In October 2001 the Board of Directors approved a 22.2% increase
in the quarterly dividend payment to $.11 per share from $.09 per share. During
the quarter ended November 30, 2001, the Company's Board of Directors declared a
dividend in the amount of $.11 per share, which was paid November 15, 2001 to
shareholders of record as of November 1, 2001. Future dividends are dependent on
the Company's future earnings and cash flow.
Proceeds from exercise of stock options: The increase in proceeds from the
exercise of stock options is primarily due to an increase in the comparable
average exercise prices per share. Shares exercised in the six months of fiscal
2002 were slightly lower at 1,093,000 shares compared with 1,141,000 in the
prior year period. The Company has recognized a tax benefit from the exercise of
stock options of $12.0 million and $17.4 million for the six months ended
November 30, 2001 and 2000, respectively. This tax benefit reduces the accrued
income tax liability and increases additional paid-in capital, with no impact on
the expense amount for income taxes.
MARKET RISK FACTORS
Interest Rate Risk: Funds held for clients are primarily comprised of short-term
funds and available-for-sale debt securities, and corporate investments are
primarily comprised of available-for-sale debt securities. The Company's
available-for-sale debt securities are exposed to interest rate risk as interest
rate volatility will cause fluctuations in the market value of held investments
and the earnings potential of future investments. Decreases in interest rates
normally increase the market value of the available-for-sale securities, while
increases in interest rates decrease the market value of the available-for-sale
securities. The Company's available-for-sale securities and short-term funds are
exposed to earnings risk from changes in interest rates, as rate volatility will
cause fluctuations in the earnings potential of future investments. Decreases in
interest rates quickly decrease earnings from short-term funds, and over time
decrease earnings from the available-for-sale securities portfolio. Increases in
interest rates have the opposite earnings effect on the available-for-sale
securities and short-term funds. Earnings from the available-for-sale securities
do not reflect changes in rates until the investments are sold or mature, and
the proceeds are reinvested at current rates. The immediate impact of changing
interest rates on earnings from short-term funds may be temporarily offset by
realized gains or losses from transactions in the Company's available-for-sale
portfolio. The Company estimates that the earnings effect of a 25-basis-point
change in interest rates (17 basis points for tax-exempt investments) at this
point in time would be approximately $3.0 million for the next twelve-month
period.
The Company directs investments towards high credit-quality, tax-exempt
securities to mitigate the risk that earnings from the portfolio could be
adversely impacted by changes in interest rates in the near term. The Company
invests in short- to intermediate-term, fixed-rate municipal and government
securities, which typically have lower interest rate volatility, and manages the
securities portfolio to a benchmark duration of 2.5 to 3.0 years. The Company
does not utilize derivative financial instruments to manage interest rate risk.
The recent trend in interest rates has been toward interest rate reductions. The
following table summarizes recent changes in the Federal Funds rate:
- --------------------------------------------------------------------------------
Fiscal Year Fiscal Year Fiscal Year
2002 Ended Ended
Year-to-date May 31, 2001 May 31, 2000
- --------------------------------------------------------------------------------
Federal Funds rate - beginning
of period 4.00% 6.50% 4.75%
Rate increase/(decrease):
First quarter (.50) -- .50
Second quarter (1.50) -- .25
Third quarter** (.25) (1.00) .25
Fourth quarter N/A (1.50) .75
---------------------------------------------
Federal Funds rate - end of period 1.75% 4.00% 6.50%
- --------------------------------------------------------------------------------
Three-Year "AAA" Municipal Securities
Yield - end of period 2.80% 3.44% 4.96%
- --------------------------------------------------------------------------------
** The Federal Funds rate was decreased an additional 25 basis points on
December 11, 2001.
Calculating the future effects of changing interest rates involves many factors.
These factors include, but are not limited to, daily interest rate changes,
seasonal variations in investment balances, actual duration of short- and
intermediate-term investments, the proportional mix of taxable and tax-exempt
investments, and changes in tax-exempt municipal rates versus taxable investment
rates, which are not synchronized or simultaneous. Subject to these factors, a
25-basis-point change generally affects the Company's tax-exempt interest rates
by approximately 17 basis points. Realized gains are more prevalent in a
decreasing rate environment and realized losses are more prevalent in an
increasing rate environment. During the first six months of fiscal 2002, the
Company's total investment portfolio averaged approximately $2.35 billion and is
expected to average $2.55 billion for the full year fiscal 2002. The Company's
normal and anticipated allocation is approximately 50% invested in short-term
securities with a duration of less than thirty days and 50% invested in
intermediate-term municipal securities with an average duration of three years.
The decrease in interest rates has resulted in an increase in the market value
of the Company's available-for-sale portfolios. The combined funds held for
clients and corporate available-for-sale investment portfolios reflected
unrealized gains of $25.3 million at November 30, 2001 and $20.5 million at May
31, 2001 compared with unrealized losses of $13.4 million at May 31, 2000.
Intermediate-term interest rates have increased slightly since November 30,
2001, resulting in a decline in the unrealized gain position of the Company's
portfolio to approximately $16 million as of December 17, 2001. As of November
30, 2001 and May 31, 2001, the Company had $1.3 billion invested in
available-for-sale securities at fair value, with weighted average yields to
maturity of 4.0% and 4.3%, respectively. Assuming a hypothetical decrease in
both short-term and intermediate-term interest rates of 25 basis points, the
resulting potential increase in fair value for the portfolio of securities at
November 30, 2001 would be in the range of $7.5 million to $8.5 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 November 30, 2001,
approximately 98% of the available-for-sale securities held an AA rating or
better, and all short-term securities classified as cash equivalents held an A-1
or equivalent rating.
OTHER
Stock Volatility: The market price of the Company's common stock could be
influenced by factors such as quarterly variations in operating results,
announcements of new services or technological innovations by the Company or its
competitors, market conditions in the business process outsourcing industry,
changes in ratings or financial estimates by securities analysts, economic
conditions, price and fluctuations in the stock market that are not directly
related to the Company's operating performance, and other factors and events
which are beyond the Company's control. These and other factors can lead to
fluctuations in the Company's quoted stock price.
New Accounting Pronouncements: In June 2001, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standard 141, "Business
Combinations" (SFAS No. 141) and Statement of Financial Accounting Standard 142,
"Goodwill and Other Intangible Assets" (SFAS No. 142). SFAS No. 141 requires
that all future business combinations be accounted for using the purchase method
of accounting and the use of the pooling-of-interest method is prohibited for
transactions initiated after July 1, 2001. SFAS No. 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets. This
statement recognizes that goodwill has an indefinite useful life and will no
longer be subject to periodic amortization, but rather periodically evaluated
for impairment. The statement also requires an evaluation of existing acquired
goodwill and other intangible assets for proper classification under the new
requirements. The Company adopted these standards in the first quarter of fiscal
2002. Adoption of these standards did not have a material impact on the results
of operations or financial position of the Company.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which requires companies to record a liability at fair value for
asset retirement obligations in the period in which they are incurred. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This Statement is effective for the Company for the
fiscal year beginning June 1, 2003. The Company is currently evaluating the
provisions of this Statement but does not believe adoption of this Statement
will result in a material impact to its results of operations or financial
position.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which provides a single accounting model for
long-lived assets to be disposed of. This Statement is effective for the Company
for the fiscal year beginning June 1, 2002. The Company is currently evaluating
the provisions of this statement but does not anticipate that adoption will
result in a material impact to its results of operations or financial position.
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995: Certain written and oral statements made by Paychex, Inc. (the "Company")
management may constitute "forward-looking statements" as defined in the Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
identified by such words and phrases as "we expect," "expected to," "estimates,"
"we look forward to," "would equate to," "projects," "projected to be,"
"anticipates," "we believe," "could be," and other similar phrases. Because they
are forward-looking, they should be evaluated in light of important risk
factors. These risk factors include, but are not limited to, general market and
economic conditions, including demand for the Company's products and services,
availability of internal and external resources, executing expansion plans,
competition, and price levels; changes in the laws regulating collection and
payment of payroll taxes, professional employer organizations, and employee
benefits, including 401(k) plans, workers' compensation, state unemployment, and
section 125 plans; delays in the development, timing of the introduction, and
marketing of new products and services; changes in technology, including use of
the Internet; the possibility of catastrophic events that could impact the
Company's operating facilities, computer technology, and communication systems;
stock volatility; and changes in short- and long-term interest rates, changes in
the market value of available-for-sale securities, and the credit rating of
cash, cash equivalents, and securities held in the Company's investment
portfolios, all of which could cause actual results to differ materially from
anticipated results. The information provided in this document is based upon the
facts and circumstances known at this time. The Company assumes no obligation to
update this document for new information subsequent to its issuance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information called for by this item is provided under the caption "Market
Risk Factors" under ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
PART II. OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on October 11, 2001. There were
present at the meeting, either in person or by proxy, holders of 317,064,335
Common Shares. Stockholders elected seven Directors nominated in the August 24,
2001 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 292,168,090 24,896,245
G. Thomas Clark 311,634,334 5,430,001
David J. S. Flaschen 314,175,374 2,888,961
Phillip Horsley 314,375,543 2,688,792
Grant M. Inman 314,368,185 2,696,150
J. Robert Sebo 313,004,460 4,059,875
Joseph M. Tucci 312,800,423 4,263,912
- --------------------------------------------------------------------------------
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: None
(b) Reports on Form 8-K:
(1) The Company filed a report on Form 8-K on September 20, 2001 that
included the Company's press release dated September 20, 2001
reporting the Company's results of operations for the first quarter of
fiscal 2002.
(2) The Company filed a report on Form 8-K on October 12, 2001 that included
the Company's press release dated October 11, 2001 announcing that the
Company's Board of Directors declared an increase in the Company's
quarterly dividend from $.09 per share to $.11 per share payable
November 15, 2001 to shareholders of record November 1, 2001.
(3) The Company filed a report on Form 8-K on October 12, 2001 that included
the Company's press release dated October 11, 2001 announcing the
election of Betsy S. Atkins to the Board of Directors of Paychex, Inc.
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 19, 2001 /s/ B. Thomas Golisano
-----------------------
B. Thomas Golisano
Chairman, President and
Chief Executive Officer
Date: December 19, 2001 /s/ John M. Morphy
-----------------------
John M. Morphy
Vice President, Chief
Financial Officer and Secretary