EXHIBIT 13: PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR ENDED MAY 31, 1998 (PAGES 16 THROUGH 39). MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis reviews the Company's operating results for each of the three fiscal years in the period ended May 31, 1998, and its financial condition at May 31, 1998. The focus of this review is on the underlying business reasons for significant changes and trends affecting revenues, net income and financial condition. This review should be read in conjunction with the accompanying Consolidated Financial Statements, the related Notes to Consolidated Financial Statements, and the Eleven-Year Summary of Selected Financial Data. Forward-looking statements in this Management's Discussion and Analysis are qualified by the cautionary statement at the beginning of this Annual Report. Results of Operations For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands, except per share amounts) - ------------------------------------------------------------------------------- Service revenues $ 493,704 +23.5% $ 399,733 +19.9% $ 333,308 Operating income $ 134,700 +39.4% $ 96,625 +38.2% $ 69,922 Income before income taxes $ 144,173 +39.1% $ 103,656 +37.5% $ 75,389 Net income $ 102,219 +36.0% $ 75,150 +36.5% $ 55,035 Basic earnings per share $ .63 +37.0% $ .46 +35.3% $ .34 Diluted earnings per share $ .62 +34.8% $ .46 +35.3% $ .34 - ------------------------------------------------------------------------------- The financial results for Paychex, Inc., in 1998 reflected the eighth consecutive year of record revenues and net income, and the seventh consecutive year of net income growth of 36% or more. The Company's ability to continually grow its client base, increase the utilization of ancillary services and decrease operating expenses as a percent of service revenues resulted in eight years of average compounded annual growth in service revenues of 19% and net income of 36%. Business and reportable segments: In May 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Company has two business segments: Payroll and Human Resource Services-Professional Employer Organization (HRS-PEO). The Statement requires the Company to report segment financial information consistent with the presentation made to the Company's management for decision-making purposes. Prior year segment disclosures have been restated to be consistent with the year ended May 31, 1998. Payroll segment: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- Payroll service revenue $455,227 +23.4% $368,855 +19.2% $309,517 Payroll operating income $180,265 +33.2% $135,364 +25.4% $107,957 Investment revenue included in Payroll service revenue $ 43,429 +27.3% $ 34,105 +26.2% $ 27,025 Client statistics at May 31, Payroll clients 293.6 +11.8% 262.7 +12.1% 234.3 Taxpay clients 220.7 +22.0% 180.9 +38.0% 131.1 Direct Deposit clients 104.4 +36.5% 76.5 +49.1% 51.3 Check Signing clients 33.5 +23.2% 27.2 +21.4% 22.4 - ------------------------------------------------------------------------------- Revenues: Payroll, Taxpay and Direct Deposit revenues include service fees and investment revenue. Investment revenue is earned during the period between collecting client funds and remitting the funds to the applicable tax authorities for Taxpay clients and client employees for Direct Deposit clients. The increase in service revenue for 1998 and 1997 is primarily related to the continued growth of the Payroll client base and increased utilization of ancillary services such as Taxpay, Direct Deposit and Check Signing by both new and existing clients. During 1998 and 1997, the growth of the Taxpay client base was accelerated by the Internal Revenue Service's Electronic Federal Tax Payment System (EFTPS) mandate, which required many small businesses to remit payroll tax payments electronically as of July 1, 1997. Remitting payroll tax payments electronically resulted in the payments becoming "good funds" one day earlier, which reduced tax-exempt investment revenue in 1998. The revenue loss was offset by a modest price increase for Taxpay services. As of May 31, 1998, approximately 75% of Payroll clients utilize the Taxpay service. Client utilization of this product is expected to mature within the next several years within a range of 82% to 87%. Client utilization of Direct Deposit at the end of fiscal 1998 was approximately 36%, and will provide additional growth opportunities in fiscal 1999 and beyond. During the second quarter of fiscal 1998, the Payroll segment also began to earn new revenues from the reporting of clients' newly hired employees to meet federal and state requirements. Fiscal 1999's percentage growth in revenue is expected to approximate 1997's rate, as the growth benefits from EFTPS diminish. Operating income: Operating income for 1998 and 1997 increased as a result of continued growth of the client base, record levels of client retention, increased utilization of ancillary services and leveraging of the segment's operating expense base. HRS-PEO segment: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- HRS-PEO service revenue $ 38,477 + 24.6% $ 30,878 + 29.8% $ 23,791 PEO direct costs billed 499,741 + 49.2% 334,966 + 43.7% 233,135 -------- ------- -------- ------- -------- Total HRS-PEO revenue 538,218 + 47.1% 365,844 + 42.4% 256,926 PEO direct costs 499,741 + 49.2% 334,966 + 43.7% 233,135 HRS-PEO operating income $ 6,642 + 18.7% $ 5,596 +109.4% $ 2,672 Client statistics at May 31, 401(k) clients 6.0 +100.0% 3.0 +130.8% 1.3 401(k) client funds managed externally (in millions) $ 383.3 +177.2% $ 138.3 +295.1% $ 35.0 Section 125 clients 16.4 + 24.2% 13.2 + 15.8% 11.4 PEO worksite employees 19.2 + 39.1% 13.8 + 50.0% 9.2 - ------------------------------------------------------------------------------- Revenues: The growth in service revenue for 1998 and 1997 was due to gains in the number of 401(k) recordkeeping clients, section 125 cafeteria plan clients and Professional Employer Organization (PEO) worksite employees. Fiscal 1999 revenues are expected to grow at a rate higher than Payroll segment revenues. Operating income: Improvements in HRS-PEO operating income for 1998 and 1997 resulted primarily from revenue growth. Operating income for 1998 and 1997 was also impacted by start-up costs for continued HRS-PEO expansion and costs to centralize PEO administrative functions in Rochester, New York, which were completed in February 1998. During the first half of fiscal 1999, the Company will increase its 401(k) sales force by approximately 40 individuals to facilitate the goal of attaining 10,000 clients by the end of that fiscal year. Operating income for the full year of fiscal 1999 is expected to increase due to continued client base growth and from efficiencies gained from centralized operations. PEO direct costs billed and direct costs: Consistent with industry practices and generally accepted accounting principles, total PEO revenues reported in the Consolidated Statements of Income include the service fee, plus the PEO direct costs billed to clients for the wages and payroll taxes of worksite employees, their related benefit premiums and claims and other direct costs. The increases in PEO direct costs billed and direct costs are reflective of the increases in the number of PEO worksite employees. Corporate expenses: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- Corporate expenses $ 52,207 +17.8% $ 44,335 +8.9% $ 40,707 - ------------------------------------------------------------------------------- Corporate expenses are primarily related to the Information Technology, Organizational Development, Finance and Senior Management functions of the Company. For fiscal 1998 and 1997, the increases in expenses are primarily related to additional employees and other expenditures necessary to support the continued growth of the Company's business. In addition, fiscal 1998 expenses reflect increased national marketing efforts which began during the third quarter. Fiscal 1999's expenses are expected to increase at a rate similar to fiscal 1998's. Investment income: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- Investment income $ 9,473 +34.7% $ 7,031 +28.6% $ 5,467 - ------------------------------------------------------------------------------- Investment income earned from the Company's Investments, which does not include the investment revenue earned from ENS investments, has grown mainly as a result of increases in investment balances generated from continual gains in operating cash flows. Investment income for 1999, subject to changes in market rates of interest, is expected to grow at a rate slightly lower than net income growth. Income taxes: The Company's effective tax rate for fiscal 1998, 1997 and 1996 was 29.1%, 27.5% and 27.0%, respectively. The increase in the 1998 effective tax rate is due to the implementation of EFTPS in July 1997, which reduced tax-exempt investment revenue. Fiscal 1999's effective tax rate is expected to range from 29.5% to 30.0%, as taxable income before income taxes is expected to grow at a faster rate than tax-exempt income. Liquidity and Capital Resources Operating cash flows: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- Operating cash flows $ 136,761 +27.8% $ 107,027 +51.9% $ 70,444 - ------------------------------------------------------------------------------- The continued increases in operating cash flows resulted primarily from the consistent achievement of record net income in each of the three years presented. Projected operating cash flows are expected to adequately support normal business operations and forecasted growth, planned purchases of property and equipment and planned dividend payments. Furthermore, at May 31, 1998, the Company had $250.5 million in available cash and investments and $262.5 million of available, uncommitted, unsecured and unused lines of credit. Investments and ENS investments: Investments and ENS investments consist of various government securities, investment grade municipal securities, money market securities and other short-term cash equivalents. The Company's Investments increased from year-over-year gains in operating cash flows. ENS investment balances increased from greater client utilization of the Company's Taxpay and Direct Deposit services. Credit Risk: The Company is exposed to credit risk in connection with these investments through the possible inability of the borrowers to meet the terms of the bonds. The Company attempts to limit credit risk by investing primarily in AAA and AA rated securities, A-1 rated short-term securities and limiting amounts that can be invested in any single instrument. At May 31, 1998, approximately 97% 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 rating or an equivalent rating. Interest Rate Risk and Quantitative and Qualitative Disclosures of Market Risks: The Company's available-for-sale securities (See Note C of the Notes to the Consolidated Financial Statements for a breakdown of the available-for-sale securities) are exposed to market risk from changes in interest rates, as rate volatility will cause fluctuations in the market value of held investments and the earnings potential of future investments. The Company's objective in managing interest rate risk is 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, as they are less sensitive to interest rate fluctuations, and manages the portfolio to a benchmark duration of 2.5 to 3.0 years. The Company has classified the debt securities portions of Investments and ENS investments as available-for-sale. Accordingly, these securities are reported on the Company's Consolidated Balance Sheets at fair value. Changes in market interest rates result in an unrealized gain or loss, which is included in the reported fair value of the recorded securities, with an offsetting amount recorded in stockholders' equity, and no related or immediate impact to the results of operations. During 1998, the balance of unrealized gains fluctuated from a low of $1.9 million to a high of $7.2 million. While this balance during 1998 was an unrealized gain, the fair value of the securities could potentially decrease to an unrealized loss position, depending upon changes in market rates. As of May 31, 1998, the Company had $654.5 million invested in available-for-sale securities at fair value, with a weighted-average yield to maturity of 4.5%. Assuming a hypothetical increase in interest rates of 75 basis points given the May 31, 1998 portfolio of securities, the resulting potential decrease in fair value would be approximately $13.4 million, or approximately 2.0% of the portfolio. Conversely, a corresponding decrease in interest rates would result in a comparable increase in fair value. This hypothetical increase or decrease in the fair value of the portfolio would be recorded as an adjustment to the portfolio's recorded value, with an offsetting amount recorded in stockholders' equity, and no related or immediate impact to the results of operations. Purchases of property and equipment: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands) - ------------------------------------------------------------------------------- Purchases of P&E $ 28,386 +53.1% $ 18,536 +4.1% $ 17,806 - ------------------------------------------------------------------------------- Due to the Company's continued client growth in 1998, significant purchases were made for upgrades to data processing equipment, including personal computers, and expansion and relocation of various facilities. During 1997, the Company implemented an upgrade of its laser printing equipment in branch offices through a five-year operating lease with future minimum lease payments of approximately $10 million. Purchases of property and equipment in fiscal 1999 are expected to be in the range of $30 million. Cash dividends and stock splits: For the years ended May 31, 1998 Change 1997 Change 1996 (In thousands, except per share amounts) - ------------------------------------------------------------------------------- Cash dividends $ 35,871 +48.7% $ 24,117 +36.4% $ 17,685 Cash dividends per share $ .22 +46.7% $ .15 +36.4% $ .11 - ------------------------------------------------------------------------------- The Company has increased the quarterly cash dividend rate per share each October by 50% for the past three fiscal years. Fiscal 1996's cash dividends include the effect of $2.6 million in distributions to stockholders of National Business Solutions, Inc. (NBS), prior to its merger with the Company in August 1996. The Company has distributed three-for-two stock splits effected in the form of 50% stock dividends on outstanding shares each May for the past three fiscal years. All financial information within this Annual Report has been adjusted for these stock splits. Other Business combinations: During 1997, Paychex merged with NBS, which now operates as Paychex Business Solutions, Inc., in a pooling of interests transaction with results of operations restated prior to completion of the transaction. The Company merged with Olsen Computer Systems, Inc., and the Payroll Service, Inc., in 1997 and Pay-Fone Systems, Inc., in 1996, in business combinations accounted for as pooling of interests. During 1996, the Company acquired the common stock of The Payroll Company, Inc., in a business combination accounted for as a purchase transaction. Each of these business combinations involved the issuance of Paychex common stock and did not have a significant impact on the Company's financial position and results of operations. Recently issued accounting standards: Effective June 1, 1997, the Company adopted SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components. 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 income taxes, related to available-for-sale securities, is the only component reported in other comprehensive income in the Consolidated Statements of Stockholders' Equity for the Company. Prior year financial statements have been reclassified to conform to the requirements of SFAS No. 130. The adoption of SFAS No. 130 did not have an effect on the Company's results of operations or financial position. The Company expenses as incurred certain costs to develop and enhance its computer programs. Expenditures for vendor-provided software are capitalized and amortized by the straight-line method over their estimated useful lives, ranging from 3 to 5 years. In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for Computer Software Developed for or Obtained for Internal Use," which is effective for fiscal years beginning after December 15, 1998. The SOP requires preliminary stage project costs to be expensed as incurred. Once a project is in the application development stage, the SOP requires all external direct costs for materials and services and payroll and related fringe benefit costs to be capitalized, and subsequently amortized over the estimated useful life of the project. The Company's management has not completed its assessment of what impact the SOP will have on future results of operations or financial position. Year 2000 date conversion: The Company is actively pursuing resolution of year 2000 issues. The year 2000 problem originated with the advent of computers, when dates were stored without century indicators, in an effort to reduce the need for expensive storage space used for input, output and storage media. In order to process and calculate dates correctly, internal computer systems must be changed to handle the year 2000 and beyond. Year 2000 efforts extend past the Company's internal computer systems and require coordination with clients, vendors, government entities, financial institutions and other third parties to understand their plans for making systems and related interfaces compliant. In response to year 2000 issues, the Company initiated a program to manage progress in year 2000 compliance efforts. The managers of the Company's year 2000 compliance program report directly to the Vice President of Information Technology and provide regular reports to the Company's Senior Management. The Company plans to have all internal mission-critical systems year 2000 compliant by the end of calendar year 1998. Processes and procedures are in place to ensure the following: all future internal development and testing follows year 2000 development and testing standards; all projects undertaken in the interim deliver year 2000 compliant solutions; all future third-party hardware and software acquisitions are year 2000 compliant; and all commercial third-party service providers are being queried regarding their year 2000 compliance plans. In addition, the Company is actively working with all government agency partners to determine their year 2000 compliance plans, and has begun making year 2000 changes based on their mandates. Calendar year 1999 will be used to react to yet unknown changes dictated by third parties, such as government agencies, hardware and software vendors, and financial institutions. Third-party interface testing with external agencies and partners is dependent upon those third parties completing their own year 2000 remediation efforts. The Company currently anticipates expenditures for year 2000 efforts to approximate $5 million. The cost of the project and the date on which the Company plans to complete the year 2000 modifications are based on management's best estimates. These estimates were derived from internal assessments and assumptions of future events. The estimates may be adversely affected by the continued availability of personnel and system resources, as well as the failure of third-party vendors, service providers, and agencies to properly address year 2000 issues. There is no guarantee that these estimates will be achieved, and actual results could differ significantly from those anticipated. REPORT OF INDEPENDENT AUDITORS Board of Directors Paychex, Inc. We have audited the accompanying consolidated balance sheets of Paychex, Inc. and subsidiaries as of May 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended May 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Paychex, Inc. and subsidiaries at May 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended May 31, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Syracuse, New York June 25, 1998 CONSOLIDATED STATEMENTS OF INCOME In thousands, except per share amounts For the years ended May 31, 1998 1997 1996 Service revenues: Payroll $ 455,227 $ 368,855 $ 309,517 HRS-PEO 38,477 30,878 23,791 ------- ------- ------- Total service revenues 493,704 399,733 333,308 PEO direct costs billed (A) 499,741 334,966 233,135 ------- ------- ------- Total revenue 993,445 734,699 566,443 PEO direct costs (A) 499,741 334,966 233,135 Operating costs 131,731 115,034 101,235 Selling, general and administrative expenses 227,273 188,074 162,151 ------- ------- ------- Operating income 134,700 96,625 69,922 Investment income 9,473 7,031 5,467 ------- ------- ------- Income before income taxes 144,173 103,656 75,389 Income taxes 41,954 28,506 20,354 ------- ------- ------- Net income $ 102,219 $ 75,150 $ 55,035 ======= ======= ======= Basic earnings per share $ .63 $ .46 $ .34 ======= ======= ======= Diluted earnings per share $ .62 $ .46 $ .34 ======= ======= ======= Weighted-average common shares outstanding 163,009 162,002 160,394 ======= ======= ======= Weighted-average shares assuming dilution 164,813 163,757 162,190 ======= ======= ======= Cash dividends per common share $ .22 $ .15 $ .11 ======= ======= ======= See Notes to Consolidated Financial Statements. (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims. CONSOLIDATED BALANCE SHEETS In thousands May 31, 1998 1997 Assets Current assets: Cash and cash equivalents $ 35,571 $ 50,213 Investments 214,967 132,780 Interest receivable 13,227 10,462 Accounts receivable 54,596 45,527 Deferred income taxes 1,525 2,560 Prepaid expenses and other current assets 4,391 2,486 --------- --------- Current assets before ENS investments 324,277 244,028 --------- --------- Electronic Network Services investments 1,154,501 896,633 --------- --------- Total current assets 1,478,778 1,140,661 Property and equipment--net 64,698 54,178 Deferred income taxes 517 72 Other assets 5,794 6,412 --------- --------- Total assets $1,549,787 $1,201,323 ========= ========= Liabilities Current liabilities: Accounts payable $ 10,496 $ 5,649 Accrued compensation and related items 33,649 26,969 Deferred revenue 4,443 4,335 Accrued income taxes 2,628 1,774 Other current liabilities 13,960 11,240 --------- --------- Current liabilities before ENS client deposits 65,176 49,967 --------- --------- Electronic Network Services client deposits 1,150,484 896,080 --------- --------- Total current liabilities 1,215,660 946,047 Other long-term liabilities 4,520 3,734 --------- --------- Total liabilities 1,220,180 949,781 Stockholders' Equity Common stock, $.01 par value, authorized 300,000 shares Issued: 163,188/1998 and 108,519/1997 1,632 1,085 Additional paid-in capital 46,463 37,531 Retained earnings 278,107 212,387 Accumulated other comprehensive income 3,405 539 --------- --------- Total stockholders' equity 329,607 251,542 --------- --------- Total liabilities and stockholders' equity $1,549,787 $1,201,323 ========= ========= See Notes to Consolidated Financial Statements. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY In thousands Common Stock Accumulated ------------- Other Additional Compre- paid-in Retained hensive Shares Amount capital earnings income Total ------- ----- -------- -------- ------- --------- Balance at May 31, 1995 46,988 $ 470 $ 17,843 $122,601 $ 1,062 $ 141,976 Exercise of stock options 320 3 2,810 2,813 Tax benefit from exercise of stock options 2,671 2,671 Shares issued in connection with three- for-two stock split 23,652 236 (281) (45) Shares issued in connection with merger and acquisition 672 7 6,777 1,866 8,650 Comprehensive income: Net income 55,035 Other comprehensive income, net of tax: Unrealized losses on securities, net of reclassification adjustments (2,354) Total comprehensive income 52,681 Cash dividends declared (17,685) (17,685) Other 11 11 ------- ----- ------ ------- ------ ------- Balance at May 31, 1996 71,632 716 30,112 161,536 (1,292) 191,072 Exercise of stock options 267 3 2,177 2,180 Tax benefit from exercise of stock options 5,208 5,208 Shares issued in connection with three- for-two stock split 36,172 362 (389) (27) Shares issued in connection with mergers 448 4 34 207 245 Comprehensive income: Net income 75,150 Other comprehensive income, net of tax: Unrealized gains on securities, net of reclassification adjustments 1,831 Total comprehensive income 76,981 Cash dividends declared (24,117) (24,117) ------- ----- ------ ------- ----- ------- Balance at May 31, 1997 108,519 1,085 37,531 212,387 539 251,542 Exercise of stock options 277 3 1,987 1,990 Tax benefit from exercise of stock options 6,945 6,945 Shares issued in connection with three- for-two stock split 54,392 544 (628) (84) Comprehensive income: Net income 102,219 Other comprehensive income, net of tax: Unrealized gains on securities, net of reclassification adjustments 2,866 Total comprehensive income 105,085 Cash dividends declared (35,871) (35,871) ------- ----- ------ ------- ----- ------- Balance at May 31, 1998 163,188 $1,632 $46,463 $278,107 $3,405 $329,607 ======= ===== ====== ======= ===== ======= See Notes to Consolidated Financial Statements. CONSOLIDATED STATEMENTS OF CASH FLOWS In thousands For the years ended May 31, 1998 1997 1996 Operating Activities Net income $102,219 $ 75,150 $ 55,035 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization on depreciable and intangible assets 18,764 15,329 13,940 Amortization of premiums and discounts on available-for-sale securities 8,497 6,115 3,225 Provision for deferred income taxes (1,030) (2,053) 2 Provision for bad debts 1,648 1,328 1,034 Net realized gains on sales of available-for-sale securities (934) (164) (2,696) Changes in operating assets and liabilities: Interest receivable (2,765) (3,077) (686) Accounts receivable (10,717) (4,779) (7,455) Prepaid expenses and other current assets (1,905) (583) 228 Accounts payable and other current liabilities 22,154 19,189 7,553 Net change in other assets and liabilities 830 572 264 ------- ------- ------- Net cash provided by operating activities 136,761 107,027 70,444 ======= ======= ======= Investing Activities Purchases of available-for-sale securities (529,413) (306,488) (565,557) Proceeds from sales of available-for-sale securities 338,818 185,161 479,087 Proceeds from maturities of available-for- sale securities 7,232 2,125 12,882 Net change in Electronic Network Services money market securities and other cash equivalents (159,769) (210,669) (88,676) Net change in Electronic Network Services client deposits 254,404 294,720 129,836 Purchases of property and equipment, net of disposals (28,197) (18,008) (17,511) Purchases of other assets (513) (1,935) (793) ------- ------- ------- Net cash used in investing activities (117,438) (55,094) (50,732) ======= ======= ======= Financing Activities Dividends paid (35,871) (24,117) (17,685) Proceeds from exercise of stock options 1,990 2,180 2,813 Other (84) 218 (465) ------- ------- ------- Net cash used in financing activities (33,965) (21,719) (15,337) ======= ======= ======= Increase (decrease) in Cash and cash equivalents (14,642) 30,214 4,375 Cash and cash equivalents, beginning of fiscal year 50,213 19,999 14,812 Cash obtained from merger and acquisition - - 812 ------- ------- ------- Cash and cash equivalents, end of fiscal year $ 35,571 $ 50,213 $ 19,999 ======= ======= ======= Supplemental cash flow information Income taxes paid $ 35,191 $ 24,256 $ 17,672 ======= ======= ======= Non-cash financing transaction Tax benefit from exercise of stock options $ 6,945 $ 5,208 $ 2,671 ======= ======= ======= See Notes to Consolidated Financial Statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation: The Consolidated Financial Statements include the accounts of Paychex, Inc., and its wholly-owned subsidiaries (the "Company"). All intercompany accounts and transactions have been eliminated in consolidation. Business activities and reportable segments: The Company has two business and reportable segments: Payroll and Human Resource Services-Professional Employer Organization (HRS-PEO). Effective May 31, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Statement requires the Company to report segment financial information consistent with the presentation made to the Company's management for decision-making purposes. Prior year segment disclosures have been restated to be consistent with the year ended May 31, 1998. Payroll segment: The Payroll segment is engaged in the preparation of payroll checks, internal accounting records, all federal, state and local payroll tax returns, and collection and remittance of payroll obligations for small- to medium-sized businesses. The Payroll segment collects and remits funds as part of its Electronic Network Services (ENS) products. In connection with Taxpay, the automated tax payment and filing service, the segment collects payroll taxes, files the applicable tax returns and pays taxes to the appropriate taxing authorities. The Direct Deposit product collects net payroll from client accounts and provides automatic salary deposit for employees. The ENS funds and related client deposit liabilities are included in the Consolidated Balance Sheets as current assets and current liabilities. Related income earned from these investments is included in Payroll service revenue. The amount of ENS funds held will vary significantly during the year. HRS-PEO segment: The HRS portion of the HRS-PEO segment provides businesses with 401(k) plan recordkeeping services, group benefits and workers' compensation insurance services, section 125 plans, employee handbooks and management services. The 401(k) recordkeeping service provides plan implementation, ongoing compliance with government regulations, employee and employer reporting and other administrative services. The PEO portion of the HRS-PEO segment operates as Paychex Business Solutions, Inc. (PBS), previously National Business Solutions, Inc. (NBS), before its merger with the Company in August 1996, and is engaged primarily in providing human resource management and personnel administration services to a diverse client base of small- to medium-sized businesses. The PEO provides certain managed care services, including managed health care, employee assistance programs, drug-free workplace programs, comprehensive workers' compensation management, risk management and loss containment services. Consistent with PEO industry practice, PEO direct costs billed include the wages and payroll taxes of worksite employees, their related benefit premiums and claims, including workers' compensation, and other direct costs. Cash and cash equivalents: Cash and cash equivalents consist of available cash, money market and municipal securities and other investments with a maturity of three months or less when purchased. The Company deposits available cash with creditworthy financial institutions. Amounts reported in the Consolidated Balance Sheets are approximate fair values. Investments and ENS Investments: Debt securities included in Investments and ENS investments are classified as available-for-sale and are recorded at fair value based on market prices obtained from an independent pricing service. Unrealized gains and losses are reported as a component of other comprehensive income in stockholders' equity, net of applicable income taxes. Realized gains and losses on sales of securities are determined by specific identification of the security's cost basis. Property and equipment--net: Property and equipment--net is stated at cost, less accumulated depreciation and amortization. Depreciation is computed by the straight-line method over the estimated useful lives. The typical estimated useful lives of depreciable assets are 35 years for buildings and improvements and 3 to 5 years for all others. Software development and enhancement: The Company expenses as incurred certain costs to develop and enhance its computer programs. Expenditures for vendor-provided software are capitalized and amortized by the straight-line method over their estimated useful lives, ranging from 3 to 5 years. In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98- 1, "Accounting for Computer Software Developed for or Obtained for Internal Use," which is effective for fiscal years beginning after December 15, 1998. The SOP requires preliminary stage project costs to be expensed as incurred. Once a project is in the application development stage, the SOP requires all external direct costs for materials and services and payroll and related fringe benefit costs to be capitalized, and subsequently amortized over the estimated useful life of the project. The Company's management has not completed its assessment of what impact the SOP will have on future results of operations or financial position. Revenue recognition: Revenues from Payroll activities include those amounts billed for services rendered, as well as investment revenue earned from ENS investments. Revenues and the related costs of wages, salaries and employment taxes from PEO activities of worksite employees are recognized in the period in which the employee performs the service. Income taxes: The Company accounts for deferred taxes by recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company accounts for the tax benefit from the exercise of stock options by reducing its accrued income tax liability and increasing additional paid-in capital. Stock-based compensation costs: SFAS No. 123, "Accounting for Stock-Based Compensation," establishes accounting and reporting standards for stock-based employee compensation plans. As permitted by that Statement, the Company continues to account for such arrangements under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, no compensation expense is recognized for stock-option grants because the exercise price of the stock options equals the market price of the underlying stock on the date of grant. Stock splits effected in the form of stock dividends: The Company declared three-for-two stock splits effected in the form of 50% stock dividends on outstanding shares payable to shareholders of record as of May 8, 1998, May 8, 1997, and May 2, 1996, with respective distribution dates of May 22, 1998, May 29, 1997, and May 23, 1996. Basic and diluted earnings per share, cash dividends per share, weighted-average shares outstanding and all applicable footnotes have been adjusted to reflect the aforementioned stock splits. Comprehensive income: Effective June 1, 1997, the Company adopted SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components. 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 income taxes, related to available-for-sale securities is the only component reported in other comprehensive income in the Consolidated Statements of Stockholders' Equity for the Company. Prior year financial statements have been reclassified to conform to the requirements of SFAS No. 130. The adoption of SFAS No. 130 did not have an effect on the Company's results of operations or financial position. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses during the reporting period. Actual amounts and results could differ from those estimated. Reclassifications: Certain amounts from prior years are reclassified to conform to fiscal year 1998 presentations. NOTE B - BASIC AND DILUTED EARNINGS PER SHARE The Company adopted SFAS No. 128, "Earnings Per Share," effective for periods ending after December 15, 1997. All earnings per share amounts have been restated to present basic and diluted earnings per share. The following table sets forth the computation of basic earnings per share and diluted earnings per share: For the years ended May 31, 1998 1997 1996 In thousands, except per share amounts -------- -------- -------- Basic earnings per share: Net income $102,219 $ 75,150 $ 55,035 ------- ------- ------- Weighted-average common shares outstanding 163,009 162,002 160,394 ------- ------- ------- Basic earnings per share $ .63 $ .46 $ .34 ======= ======= ======= Diluted earnings per share: Net income $102,219 $ 75,150 $ 55,035 ------- ------- ------- Weighted-average common shares outstanding 163,009 162,002 160,394 Effect of dilutive stock options at average market price 1,804 1,755 1,796 ------- ------- ------- Weighted-average shares assuming dilution 164,813 163,757 162,190 ------- ------- ------- Diluted earnings per share $ .62 $ .46 $ .34 ======= ======= ======= For the years ended May 31, 1998, 1997 and 1996, weighted-average options to purchase shares of common stock in the amount of 960,000, 1,019,000 and 142,000, respectively, were not included in the computation of diluted earnings per share. These options had an exercise price that was greater than the average market price of the common shares for the period and, therefore, the effect would have been antidilutive. NOTE C - INVESTMENTS AND ENS INVESTMENTS Investments and ENS investments consist of various governmental securities, investment grade municipal securities, money market securities and other cash equivalents. Investments and ENS investments are as follows: May 31, 1998 1997 In thousands ---------------------- ---------------------- Type of issue Cost Fair Cost Fair value value Money market securities and other cash equivalents $ 714,941 $ 714,941 $ 555,172 $ 555,172 Available-for-sale securities: General obligation municipal bonds 212,222 213,940 178,571 178,797 Pre-Refunded municipal bonds 236,151 238,462 193,135 193,635 Revenue municipal bonds 199,545 200,850 97,931 98,182 Other securities 1,231 1,275 3,712 3,627 --------- --------- --------- --------- Total available-for-sale securities 649,149 654,527 473,349 474,241 ========= ========= ========= ========= Total Investments and ENS investments $1,364,090 $1,369,468 $1,028,521 $1,029,413 ========= ========= ========= ========= Classification of investments on Consolidated Balance Sheets: Investments $ 213,606 $ 214,967 $ 132,441 $ 132,780 ENS investments 1,150,484 1,154,501 896,080 896,633 --------- --------- --------- --------- $1,364,090 $1,369,468 $1,028,521 $1,029,413 ========= ========= ========= ========= 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, A-1 rated short-term securities, limiting amounts that can be invested in any single instrument, and by investing in short- to intermediate-term instruments whose market value is less sensitive to interest rate changes. At May 31, 1998, no individual issue comprises greater than 1% of total assets, approximately 97% 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 rating or an equivalent rating. Cost, gross unrealized gains and losses, and the fair value of the available-for-sale securities are as follows: Gross Gross May 31, unrealized unrealized Fair In thousands Cost gains losses value -------- ---------- ---------- -------- 1998 $649,149 $ 5,524 $ 146 $654,527 1997 $473,349 $ 1,642 $ 750 $474,241 Net realized gains and losses on sales of available-for-sale securities are included in Payroll revenue and Investment income on the Consolidated Statements of Income. Gross realized gains and losses were as follows: For the years ended May 31, 1998 1997 1996 In thousands ------ ------ ------ Gross realized gains $1,481 $ 602 $3,770 Gross realized losses $ 547 $ 438 $1,074 The cost and fair value of available-for-sale securities at May 31, 1998, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties. May 31, 1998 Fair Cost value In thousands -------- -------- Maturity date: Due in one year or less $ 33,968 $ 34,123 Due after one year through three years 276,378 279,065 Due after three years through five years 207,813 209,455 Due after five years 130,990 131,884 ------- ------- Total available-for-sale securities $649,149 $654,527 ======= ======= NOTE D - PROPERTY AND EQUIPMENT--NET May 31, 1998 1997 In thousands -------- -------- Land and improvements $ 2,815 $ 2,789 Buildings and improvements 24,914 24,672 Data processing equipment and software 64,247 50,973 Furniture, fixtures and equipment 52,752 44,251 Leasehold improvements 7,323 3,582 ------- ------- 152,051 126,267 Less accumulated depreciation and amortization 87,353 72,089 ------- ------- $ 64,698 $ 54,178 ======= ======= NOTE E - STOCK OPTION PLANS The Company reserved 4,218,750 shares to be granted to employees in the form of non-qualified and incentive stock options under the 1995 Stock Incentive Plan, with 773,000 shares available for future grants at May 31, 1998. The 1992 and 1987 Stock Incentive Plans expired in August 1995 and 1992, respectively; however, options to purchase 2,346,000 shares under these plans remain outstanding. The exercise price for the shares subject to options of the Company's common stock may not be less than 100% of the fair market value on the date of grant. Stock option grants have a contractual life of ten years, and generally vest after a minimum two years of service from the date of grant, with annual vesting ranging from 33.3% to 50% of the original award granted. The following table summarizes stock option activity for the three years ended May 31, 1998: Shares subject Weighted- In thousands, except per share amounts to average options exercise price ------- --------- Outstanding at May 31, 1995 4,507 $ 4.15 Granted 1,117 $ 11.89 Exercised (1,080) $ 2.61 Forfeited (134) $ 5.71 ------ -------- Outstanding at May 31, 1996 4,410 $ 6.44 Granted 1,974 $ 25.64 Exercised (600) $ 3.64 Forfeited (479) $ 16.48 ------ -------- Outstanding at May 31, 1997 5,305 $ 12.99 Granted 1,192 $ 27.61 Exercised (433) $ 5.91 Forfeited (311) $ 24.59 ------ -------- Outstanding at May 31, 1998 5,753 $ 15.93 ====== ======== Exercisable at May 31, 1996 1,887 $ 3.11 Exercisable at May 31, 1997 1,967 $ 4.07 Exercisable at May 31, 1998 2,379 $ 5.28 The following table summarizes information about stock options outstanding at May 31, 1998: Options outstanding Options exercisable ------------------------------------ ------------------------ Shares Weighted- Weighted- Shares subject average average subject Weighted- Range to exercise remaining to average of exercise options price contractual options exercise prices per (In per life (In price per share thousands) share in years thousands) share - -------------- ----------- ----------- ----------- ----------- ----------- $ 1.33 - 4.80 1,237 $ 2.63 3.0 1,232 $ 2.62 $ 6.57 - 8.10 1,109 $ 6.85 5.9 919 $ 6.80 $13.44 - 19.61 879 $14.38 7.6 228 $13.52 $25.94 - 39.17 2,528 $26.95 8.9 - - ----------- ---------- $ 1.33 - 39.17 5,753 $15.93 6.8 2,379 $ 5.28 =========== ========== Pro forma information regarding net income, basic and diluted earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. This disclosure is not likely to be representative of the effects on reported pro forma net income, basic and diluted earnings per share for future years, because stock options generally vest over a range of 33.3% to 50% per year and additional awards generally are made each year. The Company's pro forma net income, basic and diluted earnings per share are as follows: For the years ended May 31, 1998 1997 1996 In thousands, except per share amounts ------- ------- ------- Pro forma net income $97,448 $72,060 $54,523 Pro forma basic earnings per share $.60 $.44 $.34 Pro forma diluted earnings per share $.59 $.44 $.34 For purposes of pro forma disclosures, the estimated fair value of the stock option is amortized to expense over the option's vesting period. The fair value of these stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: For the years ended May 31, 1998 1997 1996 ---- ---- ---- Risk-free interest rate 5.8% 6.2% 5.9% Dividend yield .9% .9% 1.6% Volatility factor .29 .28 .29 Expected option term life in years 4.5 4.9 4.5 The weighted-average grant-date estimated fair value of stock options granted for the years ended May 31, 1998, 1997 and 1996 were $8.81, $8.39 and $3.92 per share, respectively. NOTE F - INCOME TAXES The net deferred tax asset components are as follows: May 31, 1998 1997 In thousands ------ ------ Deferred tax assets: Accrued vacation pay $1,170 $1,330 Reserve for workers' compensation claims 1,186 1,105 Allowance for bad debts 1,355 987 Accrual for future medical claims 1,169 809 Other 1,940 1,338 ------ ------ Gross deferred tax assets 6,820 5,569 ====== ====== Deferred tax liabilities: Revenue not subject to current taxes 2,388 1,931 Depreciation 357 629 Unrealized gains on available-for-sale securities 1,973 353 Other 60 24 ----- ----- Gross deferred tax liabilities 4,778 2,937 ===== ===== Net deferred tax asset $2,042 $2,632 ===== ===== The components of the provision for income taxes are as follows: For the years ended May 31, 1998 1997 1996 In thousands ------- ------- ------- Current: Federal $34,888 $24,699 $15,400 State 8,096 5,860 4,952 ------ ------ ------ Total current 42,984 30,559 20,352 ====== ====== ====== Deferred: Federal (857) (1,719) (18) State (173) (334) 20 ------ ------ ------ Total deferred (1,030) (2,053) 2 ====== ====== ====== Provision for income taxes $41,954 $28,506 $20,354 ====== ====== ====== Reconciliations of the U.S. federal statutory tax rate with effective tax rates reported for income before income taxes were as follows: For the years ended May 31, 1998 1997 1996 ----- ----- ----- Federal statutory rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State income taxes, net of federal benefit 3.6 3.5 4.3 Tax-exempt municipal bond interest (10.4) (10.9) (11.3) Benefit from NBS income not subject to income taxes - - (1.3) Other items .9 (.1) .3 ---- ---- ---- Effective tax rate 29.1% 27.5% 27.0% ==== ==== ==== Prior to its merger with the Company, NBS elected to be taxed as a subchapter S corporation under federal and state provisions for the year ended May 31, 1996. Accordingly, no tax provision was recorded for that corporation in the restated Consolidated Financial Statements, resulting in a reduction of the Company's overall effective tax rate. NOTE G - OTHER COMPREHENSIVE INCOME The following table sets forth the related tax effects allocated to unrealized gains and losses on available-for-sale securities, the only component of other comprehensive income: For the years ended May 31, 1998 1997 1996 In thousands ------- ------- ------- Unrealized holding gains/(losses) $ 5,420 $ 3,215 $(1,289) Less: Income tax expense/(benefit) related to unrealized holding gains/(losses) 1,955 1,279 (661) Gain on sale of securities realized in net income 934 164 2,696 Plus: Income tax expense on gain on sale of securities realized in net income 335 59 970 ------ ------ ------ Other comprehensive income $ 2,866 $ 1,831 $(2,354) ====== ====== ====== NOTE H - EMPLOYEE BENEFITS The Company's 401(k) Incentive Retirement Plans allow employees with one or more years of service to participate. The Company currently matches 50% of an employee's voluntary contribution, up to a maximum of 3% of eligible compensation. Company contributions for the years ended May 31, 1998, 1997 and 1996 were $3,239,000, $2,712,000 and $2,264,000, respectively. The Company's PEO sponsors and administers a 401(k) plan and a profit-sharing plan on behalf of its worksite employees. PEO clients, at their discretion, may contribute a matching contribution on behalf of each participant for whom an elective contribution was made during the plan year. NOTE I - COMMITMENTS AND CONTINGENCIES At May 31, 1998, the Company has available, uncommitted, unsecured lines of credit from various banks totaling $262,500,000 at market rates of interest. No amounts were outstanding against the lines of credit at May 31, 1998. The Company is a defendant in various lawsuits as a result of normal operations and in the ordinary course of business. Management believes the outcome of these lawsuits will not have a material effect on the financial position or results of operations of the Company. The Company leases office space and data processing equipment under terms of various operating leases, with most data processing equipment leases containing a purchase option at prices representing the fair value of the equipment at expiration of the lease term. Rent expense for the year ended May 31, 1998, 1997 and 1996 was $20,336,000, $17,314,000 and $15,343,000, respectively. At May 31, 1998, future minimum lease payments under various noncancelable operating leases are $17,925,000 in fiscal 1999, $16,018,000 in fiscal 2000, $13,608,000 in fiscal 2001, $8,471,000 in fiscal 2002, $4,411,000 in fiscal 2003, and $2,685,000 thereafter. NOTE J - BUSINESS COMBINATIONS The following table summarizes business combinations completed in the years ended May 31, 1997 and 1996: Common Shares Issued (In Method of Entity Name Business Date thousands) Accounting - ------------------ ---------------- -------------- ---------- ---------- Olsen Computer Systems, Inc. Payroll software November 1996 884 Pooling The Payroll Service, Inc. Payroll services August 1996 124 Pooling National Business Solutions, Inc. PEO August 1996 6,603 Pooling The Payroll Company, Inc. Payroll services September 1995 391 Purchase Pay-Fone Systems, Inc. Payroll services June 1995 1,120 Pooling Results of operations prior to completion of the pooling of interests transaction with NBS were restated. For the year ended May 31, 1996, previously reported total revenue and net income for the Company was $325,285,000 and $52,333,000, respectively. For the year ended May 31, 1996, total revenue and net income reported by NBS was $241,158,000 and $2,702,000, respectively. Results of operations prior to completion of the other pooling of interests transactions were not restated as the effects were not material. The Payroll Company, Inc., acquisition was recorded at a fair value of $5,000,000, with goodwill of approximately $4,000,000, which is amortized on a straight-line basis over 10 years. The purchase agreement included a guarantee that stock issued and not sold prior to September 29, 2000, would appreciate to $15.26 per share, at a minimum. NOTE K - SEGMENT FINANCIAL INFORMATION See Note A for a description of the Company's Payroll and HRS-PEO business and reporting segments. The Company's reportable segments are business units that offer different services and products. The reportable segments are each managed separately because they offer and provide services and products through different means. The Company's Information Technology, Organizational Development, Finance and Senior Management functions are combined into the Corporate expenses. The Company evaluates segment performance and allocates resources based on profit and loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in Note A. There are no intersegment sales. OPERATING RESULTS For the years ended May 31, 1998 1997 1996 In thousands -------- -------- -------- Total revenue: Payroll $455,227 $368,855 $309,517 HRS-PEO revenue: Service revenue 38,477 30,878 23,791 PEO direct costs billed (A) 499,741 334,966 233,135 ------- ------- ------- Total HRS-PEO revenue 538,218 365,844 256,926 ======= ======= ======= Total revenue 993,445 734,699 566,443 PEO direct costs (A) 499,741 334,966 233,135 ------- ------- ------- Total revenue less PEO direct costs $493,704 $399,733 $333,308 ======= ======= ======= Operating income: Payroll $180,265 $135,364 $107,957 HRS-PEO 6,642 5,596 2,672 ------- ------- ------- Total operating income 186,907 140,960 110,629 Corporate expenses 52,207 44,335 40,707 Investment income 9,473 7,031 5,467 ------- ------- ------- Income before income taxes $144,173 $103,656 $ 75,389 ======= ======= ======= Investment revenue included in Payroll revenue $ 43,429 $ 34,105 $ 27,025 ======= ======= ======= (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims. OTHER FINANCIAL INFORMATION 1998 1997 1996 ---------- ---------- ---------- Purchases of long-lived assets Payroll $17,146 $12,984 $13,055 HRS-PEO 2,015 1,747 644 Corporate 9,591 5,716 5,052 ------ ------ ------ Total purchases of long-lived assets $28,752 $20,447 $18,751 ====== ====== ====== Depreciation and amortization expense: Payroll $17,187 $13,128 $11,081 HRS-PEO 1,078 585 453 Corporate 8,996 7,731 5,631 ------ ------ ------ Total depreciation and amortization expense $27,261 $21,444 $17,165 ====== ====== ====== Identifiable assets at May 31, Payroll $1,244,272 $ 967,688 $ 663,081 HRS-PEO 30,726 24,477 17,784 Corporate 274,789 209,158 150,720 --------- --------- --------- Total identifiable assets $1,549,787 $1,201,323 $ 831,585 ========== ========= ========= QUARTERLY FINANCIAL DATA (UNAUDITED) In thousands, except per share amounts 1998 August 31, November 30, February 28, May 31, Year --------- ----------- ----------- --------- -------- Service revenues $112,947 $117,173 $131,873 $131,711 $493,704 Total revenue 218,583 235,221 271,355 268,286 993,445 Operating income 30,357 32,572 34,852 36,919 134,700 Income before income taxes 32,545 34,863 37,201 39,564 144,173 Net income 23,074 24,718 26,376 28,051 102,219 Basic earnings per share .14 .15 .16 .17 .63 Diluted earnings per share .14 .15 .16 .17 .62 Cash dividends per share .04 .06 .06 .06 .22 Market value per share: High 27.50 30.25 35.13 39.83 39.83 Low 21.67 22.33 26.71 33.13 21.67 1997 August 31, November 30, February 28, May 31, Year --------- ----------- ----------- --------- -------- Service revenues $ 91,273 $ 95,266 $106,354 $106,840 $399,733 Total revenue 166,042 169,499 195,562 203,596 734,699 Operating income 22,097 23,349 25,022 26,157 96,625 Income before income taxes 23,582 25,094 26,786 28,194 103,656 Net income 17,073 18,068 19,286 20,723 75,150 Basic earnings per share .11 .11 .12 .13 .46 Diluted earnings per share .10 .11 .12 .13 .46 Cash dividends per share .03 .04 .04 .04 .15 Market value per share: High 24.89 28.28 25.22 24.92 28.28 Low 17.89 22.11 18.89 17.00 17.00 Note: Each quarter is a discrete period and the sum of the four quarters' basic and diluted earnings per share amounts may not equal the full year amount. Per share amounts have been adjusted for three-for-two stock splits in May 1998 and May 1997. ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA In thousands, except per share amounts and other statistics
For the years ended or at May 31, 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 Results of Operations Service revenues: Payroll $455,227 $368,855 $309,517 $254,093 $215,663 $184,004 $156,652 $133,886 $118,157 $100,488 $ 79,168 HRS-PEO 38,477 30,878 23,791 18,020 11,290 7,700 5,253 3,289 2,043 666 265 Total service revenues 493,704 399,733 333,308 272,113 226,953 191,704 161,905 137,175 120,200 101,154 79,433 PEO direct costs billed (A) 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - - - Total revenue 993,445 734,699 566,443 412,066 323,905 252,138 183,680 139,792 120,200 101,154 79,433 PEO direct costs (A) 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - - - Operating costs 131,731 115,034 101,235 81,663 70,034 61,877 53,700 50,054 45,031 35,557 27,860 Selling, general & administrative expenses 227,273 188,074 162,151 138,186 119,477 102,893 89,393 73,854 63,042 51,480 40,820 Operating income 134,700 96,625 69,922 52,264 37,442 26,934 18,812 13,267 12,127 14,117 10,753 % of total service revenues 27.3% 24.2% 21.0% 19.2% 16.5% 14.0% 11.6% 9.7% 10.1% 14.0% 13.5% Investment income 9,473 7,031 5,467 3,458 2,220 1,379 821 764 1,081 857 477 Income before income taxes 144,173 103,656 75,389 55,722 39,662 28,313 19,633 14,031 13,208 14,974 11,230 % of total service revenues 29.2% 25.9% 22.6% 20.5% 17.5% 14.8% 12.1% 10.2% 11.0% 14.8% 14.1% Net income 102,219 75,150 55,035 40,389 28,746 20,241 13,788 9,606 8,566 9,446 6,935 % of total service revenues 20.7% 18.8% 16.5% 14.8% 12.7% 10.6% 8.5% 7.0% 7.1% 9.3% 8.7% Basic earnings per share $ .63 $ .46 $ .34 $ .26 $ .18 $ .13 $ .09 $ .06 $ .06 $ .06 $ .05 Diluted earnings per share .62 .46 .34 .26 .18 .13 .09 .06 .06 .06 .05 Weighted-average common shares outstanding 163,009 162,002 160,394 158,229 157,766 157,113 156,026 155,318 148,532 148,170 147,392 Weighted-average shares assuming dilution 164,813 163,757 162,190 159,584 159,149 158,355 156,917 155,550 148,832 148,598 148,379 Cash dividends per share $ .22 $ .15 $ .11 $ .07 $ .05 $ .03 $ .02 $ .02 $ .01 $ .01 $ - Financial Position Working capital $263,118 $194,614 $138,639 $100,009 $ 68,888 $ 46,776 $ 28,245 $ 19,230 $ 21,257 $ 22,951 $ 17,311 Purchases of property & equipment 28,386 18,536 17,806 12,535 11,667 8,822 13,580 18,420 15,447 9,132 8,050 Total assets 1,549,787 1,201,323 831,585 647,366 474,786 322,214 221,771 133,342 74,501 55,638 42,485 Total debt - - - 728 948 1,634 2,024 2,431 2,137 2,770 3,322 Stockholders' equity 329,607 251,542 191,072 141,976 109,124 85,365 67,623 54,512 47,160 40,245 31,506 Return on stockholders' equity 36.0% 33.9% 32.3% 32.2% 29.6% 26.5% 22.6% 18.9% 19.6% 26.3% 25.0% Other Statistics Payroll segment: Payroll clients 293,600 262,700 234,300 207,900 185,900 167,500 150,400 135,200 120,600 105,600 87,300 Branch service centers 79 79 75 71 70 70 70 70 74 68 64 Sales offices 25 23 23 23 24 20 17 16 15 16 15 HRS-PEO segment: 401(k) clients 6,000 3,000 1,300 200 - - - - - - - 401(k) client funds managed externally (in millions) $ 383.3 $ 138.3 $ 35.0 - - - - - - - - Section 125 clients 16,400 13,200 11,400 8,800 7,400 5,000 2,800 500 - - - PEO worksite employees 19,200 13,800 9,200 5,300 3,400 1,800 500 - - - -
Note: Per share and weighted-average share amounts have been adjusted for three-for-two stock splits in May 1998, May 1997, May 1996, May 1995, August 1993, May 1992 and November 1987. (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims.