EXHIBIT 13: PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR ENDED MAY 31, 1999 MANAGEMENT'S DISCUSSION Management's Discussion reviews the Company's operating results for each of the three years ended May 31, 1999 (fiscal 1999, 1998 and 1997), and its financial condition at May 31, 1999. 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 reivew are qualified by the cautionary statement at the beginning of this Annual Report (Exhibit 99). RESULTS OF OPERATIONS In thousands, except per share amounts 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Service revenues $597,296 21.0% $493,704 23.5% $399,733 Operating income $187,562 39.2% $134,700 39.4% $ 96,625 Income before income taxes $200,143 38.8% $144,173 39.1% $103,656 Net income $139,099 36.1% $102,219 36.0% $ 75,150 Basic earnings per share $ .57 35.7% $ .42 35.5% $ .31 Diluted earnings per share $ .56 36.6% $ .41 32.3% $ .31 ============================================================================== The financial results for Paychex, Inc., in 1999, reflect the ninth consecutive year of record service revenues and net income, and the eighth consecutive year of net income growth of 36% or more. The Company's ability to continually grow its client base, increase client utilization of ancillary services, implement modest price increases, and decrease operating expenses as a percent of service revenues has resulted in nine years of average compounded annual growth in service revenues of 19% and net income of 36%. See Note A of the Notes to Consolidated Financial Statements for a detailed description of the Company's business activities and reportable segments. Payroll segment In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Payroll service revenue $545,249 19.8% $455,227 23.4% $368,855 Investment revenue included in Payroll service revenue $ 52,335 20.5% $ 43,429 27.3% $ 34,105 Payroll operating income $235,710 30.8% $180,265 33.2% $135,364 ============================================================================== Payroll clients 322.6 9.9% 293.6 11.8% 262.7 Taxpay clients 254.3 15.2% 220.7 22.0% 180.9 Direct Deposit clients 135.4 29.7% 104.4 36.5% 76.5 Check Signing clients 39.5 17.9% 33.5 23.2% 27.2 ============================================================================== Revenues: Payroll service revenue includes service fees and investment revenue. Service fee revenue is earned primarily from Payroll, Taxpay, Direct Deposit, Check Signing and other ancillary services. Investment revenue is earned during the period between collecting client funds and remitting the funds to the applicable tax authorities for Taxpay clients and employees of Direct Deposit clients. Investment revenue also includes net realized gains and losses from the sale of available-for-sale securities. The increases in service revenue for 1999 and 1998 are primarily related to the growth of the Payroll client base, including improvement in client retention, 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 mandate, which required many small businesses to remit payroll tax payments electronically as of July 1, 1997. Remitting payroll tax payments electronically by the Company, results in the payments becoming "good funds" one day earlier, and a one-day reduction in investment revenue. At May 31, 1999, 79% of Payroll clients utilized the Taxpay service, compared with 75% at the end of 1998, and 69% at the end of 1997. 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 was 42% at May 31, 1999, versus 36% and 29% at May 31, 1998 and 1997, respectively. At May 31, 1999, only 25% of the total employees paid by the Company's payroll service utilized direct deposit. This service is expected to provide growth opportunities for fiscal 2000 and beyond. The decrease in year-over-year percentage growth in Payroll service revenue in 1999 compared to 1998 reflects the impact of lower interest rates and the maturing of Taxpay. Fiscal 2000's percentage growth in Payroll revenue is expected to be within the long-term historical range of 17% to 19%. Additional discussion on interest rates and related risk is included in the Liquidity and Capital Resources section of this review under the caption "Investments and ENS investments." Operating income: Operating income for 1999 and 1998 increased as a result of continued growth of the client base, record levels of client retention, increased utilization of ancillary services, modest price increases, and leveraging of the segment's operating expense base, as evidenced by the increases in the segment's operating margins year-over-year. HRS-PEO segment In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ HRS-PEO service revenue $ 52,047 35.3% $ 38,477 24.6% $ 30,878 PEO direct costs billed 578,132 15.7% 499,741 49.2% 334,966 ---------------------------------------------- Total HRS-PEO revenue 630,179 17.1% 538,218 47.1% 365,844 PEO direct costs 578,132 15.7% 499,741 49.2% 334,966 HRS-PEO operating income $ 12,598 89.7% $ 6,642 18.7% $ 5,596 ============================================================================== 401(k) Recordkeeping clients 10.1 68.3% 6.0 100.0% 3.0 401(k) client funds managed externally (in millions) $ 757.6 97.7% $ 383.3 177.2% $ 138.3 Section 125 clients 20.2 23.2% 16.4 24.2% 13.2 PEO worksite employees 18.3 -4.7% 19.2 39.1% 13.8 ============================================================================== Revenues: The significant increases in service revenue for 1999 and 1998 are primarily related to the benefits of developing and growing a recurring revenue stream from 401(k) recordkeeping clients, section 125 plan clients, and the number of Professional Employer Organization (PEO) worksite employees. During fiscal 1999, additions to worksite employees exceeded expectations, but were offset by the loss of two large PEO clients during November 1998. Fiscal 2000's growth in HRS-PEO service revenue is expected to be comparable to 1999's rate and continue to grow at a rate higher than Payroll segment revenue. PEO direct costs billed and PEO direct costs: Consistent with PEO industry practice, total PEO revenues reported in the Consolidated Statements of Income include the Company's 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 of employment. The lower percentage growth in 1999 for PEO direct costs billed and PEO direct costs is primarily due to the loss of the two large clients discussed above. Operating income: For 1999 and 1998, the increases in operating income are primarily related to gains in service revenue and leveraging operating expenses. Fiscal 1999 also benefited from the February 1998 consolidation of the PEO administrative functions from Florida to Rochester, New York. During the first half of 1999, the segment increased its 401(k) recordkeeping sales force by approximately 50 individuals to attain the goal of servicing more than 10,000 clients by the end of 1999, and to build a selling infrastructure for future years. Full-year fiscal 2000's HRS-PEO service revenue and operating income are anticipated to continue to grow at a rate that is higher than the Payroll segment's. Fiscal 2000's quarter-over-quarter percentage comparisons in HRS-PEO service revenue and operating income may vary significantly throughout the year, and any one particular quarter's results may not be indicative of expected full-year results. Corporate expenses In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Corporate expenses $60,746 16.4% $52,207 17.8% $44,335 ============================================================================== For 1999 and 1998, the increases in expenses are primarily due to additional employees required to support the continued growth of the Company's business segments. In addition, 1999 and 1998 expenses reflect increased national marketing efforts, which began in the latter part of the third quarter of fiscal 1998. Fiscal 2000's expenses are expected to increase at a rate slightly lower than 1999's growth rate. Investment income In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Investment income $12,581 32.8% $ 9,473 34.7% $ 7,031 ============================================================================== 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 increases in overall cash flows. Fiscal 1999's growth was slightly impacted by lower comparable interest rates. Additional discussion on interest rates and related risk is included in the Liquidity and Capital Resources section of this review under the caption "Investments and ENS investments." Investment income for fiscal 2000, subject to changes in market rates of interest, is expected to grow at a rate slightly lower than the Company's net income growth. Income taxes In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Income taxes $61,044 45.5% $41,954 47.2% $28,506 Effective income tax rate 30.5% 1.4 29.1% 1.6 27.5% ============================================================================== For 1999 and 1998, the increases in the effective income tax rate are due to the growth in taxable income exceeding the growth in tax-exempt income. Tax-exempt income is derived primarily from the Taxpay and Direct Deposit services that provide investment revenue. In addition, the higher effective rate for 1999 was due to higher than anticipated investments in taxable financial instruments, which were yielding a higher net of tax return than tax-exempt investments. Fiscal 2000's effective income tax rate is expected to range from 30.5% to 31.0%, as taxable income is expected to grow at a faster rate than tax-exempt income. LIQUIDITY AND CAPITAL RESOURCES Operating activities In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------ Operating cash flows $174,120 27.3% $136,761 27.8% $107,027 ============================================================================== The increases in operating cash flows resulted primarily from the consistent achievement of record net income. Projected operating cash flows are expected to adequately support normal business operations, forecasted growth, purchases of property and equipment and dividend payments. Furthermore, at year-end, the Company had $343.2 million in available cash and investments and $297.5 million of available, uncommitted, unsecured lines of credit. Investing activities In thousands 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------- Net Investments and ENS activities $ (82,724) -6.8% $ (88,728) 152.4% $(35,151) Purchases of P&E, net (22,104) -21.6% (28,197) 56.6% (18,008) Purchases of other assets (3,590) 599.8% (513) -73.5% (1,935) - ------------------------------------------------------------------------------ Net cash used in investing activities $(108,418) -7.7% $(117,438) 113.2% $(55,094) ============================================================================== Investments and ENS investments: Investments are primarily available-for-sale debt securities, and ENS investments consist of short-term funds and available- for-sale debt securities, which are detailed in Note D of the Notes to Consoli- dated Financial Statements. Investments have increased due to the investment of increasing cash balances provided by operating activities less purchases of property and equipment and dividend payments. The reported amount of ENS investments will vary significantly based upon the timing of collecting client funds, and remitting the funds to the applicable tax authorities for Taxpay clients and employees of Direct Deposit clients. At May 31, 1999, the Company had $770.6 million of ENS funds and $47.6 million of Corporate cash equivalents invested in money market securities and other cash equivalents with an average maturity of less than 30 days, and $879.6 million invested in available-for-sale securities with an average duration of 2.5 years. At May 31, 1999, the market value of the available-for-sale securities exceeded their cost basis by $4.5 million compared to $5.4 million at the end of May 1998. Interest rate risk - The Company's available-for-sale debt securities are exposed to market risk from changes in interest rates, as rate volatility will cause fluctuations in the market value of held investments. Increases in interest rates normally decrease the market value of the available-for-sale securities, while decreases in interest rates increase the market value of the available-for-sale securities. In addition, the Company's available-for-sale securities and short-term funds are exposed to earnings risk from changes in interest rates, as rate volatility will cause fluctuations in the earnings potential of future investments. Increases in interest rates quickly increase earnings from short-term funds, and over time increase earnings from the available-for-sale securities portfolio. Earnings from the available-for-sale securities do not reflect changes in rates until the investments are sold or mature, and the proceeds are reinvested at current rates. Decreases in interest rates have the opposite earnings effect on the available-for-sale securities and short-term funds. The Company does not utilize derivative financial instruments to manage interest rate risk. The Company directs investments towards high credit-quality, tax-exempt securities to mitigate the risk that earnings from the portfolio could be adversely impacted by changes in interest rates in the near term. The Company invests in short- to intermediate-term, fixed-rate municipal and government securities, which typically have lower interest rate volatility, and manages the securities portfolio to a benchmark duration of 2.5 to 3.0 years. During the fiscal 1999 quarter ended November 30, 1998, the federal funds rate was reduced by 75 basis points to 4.75%. The earnings impact of these rate reductions is not precisely quantifiable because many factors influence the return on the Company's portfolio. These factors include, among others, daily interest rate changes, the proportional mix of taxable and tax-exempt investments, and changes in tax-exempt and taxable investment rates which are not synchronized, nor do they change simultaneously. Subject to the aforementioned factors, a 25 basis point change normally affects the Company's tax-exempt interest rates by approximately 17 basis points. As of May 31, 1999, the Company had $879.6 million invested in available-for-sale securities at fair value, with a weighted-average yield to maturity of 4.10%. Assuming a hypothetical increase in interest rates of 75 basis points given the May 31, 1999 portfolio of securities, the resulting potential decrease in fair value would be approximately $16.2 million, or approximately 2% 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 with no related or immediate impact to the results of operations. The Company's interest rate risk exposure has not changed materially since May 31, 1998. Credit risk - The Company is exposed to credit risk in connection with these investments through the possible inability of the borrowers to meet the terms of the bonds. The Company attempts to limit credit risk by investing primarily in AAA and AA rated securities, A-1 rated short-term securities and by limiting amounts that can be invested in any single instrument. At May 31, 1999, approximately 96% of the available-for-sale securities held an AA rating or better, and all short-term securities classified as cash equivalents held an A-1 or equivalent rating. Purchases of property and equipment, net: In addition to the $22.1 million of purchases of property and equipment for the year ended May 31, 1999, the Company had committed to purchase approximately $4.0 million of additional items at May 31, 1999. To support the Company's continued client and ancillary product growth, significant purchases and commitments were made in 1999 and 1998 for data processing and personal computer equipment, and for the expansion and upgrade of various operating facilities. Purchases of property and equipment in fiscal 2000 are expected to range from $27 million to $30 million. Financing activities In thousands, except per share amounts 1999 Change 1998 Change 1997 - ------------------------------------------------------------------------------- Dividends paid $(54,055) 50.7% $(35,871) 48.7% $(24,117) Proceeds from exercise of stock options 5,535 178.1% 1,990 -8.7% 2,180 Other (61) -- (84) -- 218 - ------------------------------------------------------------------------------ Net cash used in financing activities $(48,581) 43.0% $(33,965) 56.4% $(21,719) - ------------------------------------------------------------------------------ Cash dividends per common share $ .22 46.7% $ .15 50.0% $ .10 ============================================================================== Dividends paid: The Company has increased its quarterly cash dividend rate per share by 50% in each of the last seven fiscal years. The Company has distributed three-for-two stock splits effected in the form of 50% stock dividends on outstanding shares each May in the past five fiscal years. Proceeds from exercise of stock options: The increase in proceeds from exercise of stock options reflects the issuance of 1,032,000 shares of common stock for stock option exercises in 1999, versus 277,000 shares in 1998 and 267,000 shares in 1997, on a pre-split-adjusted basis. See Note F of the Notes to Consolidated Financial Statements for additional disclosure on the Company's stock option plans. OTHER Recently issued accounting standards: Through the end of 1999, the Company expensed as incurred certain costs to develop and enhance its internal computer programs and software. Expenditures for vendor-provided software were capitalized and amortized by the straight-line method over their estimated useful lives, ranging from 3 to 5 years. In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP requires the capitalization of internal use computer software costs if certain criteria are met, including all external direct costs for materials and services and certain payroll and related fringe benefit costs. The Company will adopt the SOP as of June 1, 1999. The effect of adopting the SOP is expected to increase net income by approximately $2.0 million to $3.0 million for the year ended May 31, 2000. Year 2000 readiness disclosure: 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 and the Board of Directors. Processes and procedures are in place to ensure the following: all future internal development and testing follow 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. The Company's internal mission-critical systems were year 2000 compliant by the end of the first quarter of calendar year 1999. The remainder of calendar year 1999 will be used to assess and address year 2000 issues for internal desktop computers and software, complete interface testing with external agencies and partners, enhance existing normal business contingency plans to address any identified year 2000 issues, and to react to yet unknown changes dictated by third parties, such as government agencies, hardware and software vendors, financial institutions, or utility companies. Third-party interface testing and resolution of year 2000 issues with external agencies and partners is dependent upon those third parties completing their own year 2000 remediation efforts. The Company expects minimal business disruption will occur as a result of year 2000 issues for systems that the Company directly controls. The Company is in the process of enhancing existing normal business contingency plans to address any identified year 2000 issues based on actual testing experience with third parties and assessment of outside risks. There can be no assurance that there will not be an adverse effect on the Company if third parties, such as government agencies, hardware and software vendors, financial institutions or utility companies, do not convert their systems in a timely manner and in a way that is compatible with the Company's systems. However, management believes that ongoing communication with and assessment of these third parties will minimize these risks, and expects minimal business disruption at the turn of the century. The Company currently anticipates expenditures for year 2000 efforts to approximate $5 million, with approximately eighty percent spent through May 31, 1999. The remaining twenty percent will be spent on desktop computers and software, continued interface testing with external agencies and partners, enhancing existing contingency plans, and to react to yet unknown changes dictated by third parties. 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. as of May 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended May 31, 1999. 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. at May 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended May 31, 1999, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Syracuse, New York June 25, 1999 CONSOLIDATED STATEMENTS OF INCOME In thousands, except per share amounts Year ended May 31, -------------------------------- 1999 1998 1997 Service revenues: ---------- --------- --------- Payroll $ 545,249 $ 455,227 $ 368,855 HRS-PEO 52,047 38,477 30,878 ------- ------- ------- Total service revenues 597,296 493,704 399,733 PEO direct costs billed (A) 578,132 499,741 334,966 ------- ------- ------- Total revenue 1,175,428 993,445 734,699 PEO direct costs (A) 578,132 499,741 334,966 Operating costs 151,956 131,731 115,034 Selling, general and administrative expenses 257,778 227,273 188,074 ------- ------- ------- Operating income 187,562 134,700 96,625 Investment income 12,581 9,473 7,031 ------- ------- ------- Income before income taxes 200,143 144,173 103,656 Income taxes 61,044 41,954 28,506 ------- ------- ------- Net income $ 139,099 $ 102,219 $ 75,150 ======= ======= ======= Basic earnings per share $ .57 $ .42 $ .31 ======= ======= ======= Diluted earnings per share $ .56 $ .41 $ .31 ======= ======= ======= Weighted-average common shares outstanding 245,521 244,514 243,002 ======= ======= ======= Weighted-average shares assuming dilution 248,788 247,219 245,636 ======= ======= ======= Cash dividends per common share $ .22 $ .15 $ .10 ======= ======= ======= 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, ---------------------------- 1999 1998 ASSETS ---------- ---------- Cash and cash equivalents $ 52,692 $ 35,571 Investments 290,555 214,967 Interest receivable 18,045 13,227 Accounts receivable 62,941 54,596 Deferred income taxes 1,364 1,525 Prepaid expenses and other current assets 6,000 4,391 --------- --------- Current assets before ENS investments 431,597 324,277 ENS investments 1,361,523 1,154,501 --------- --------- Total current assets 1,793,120 1,478,778 --------- --------- Property and equipment - net 65,931 64,698 Deferred income taxes 1,417 517 Other assets 12,633 5,794 --------- --------- Total assets $1,873,101 $1,549,787 ========= ========= LIABILITIES Accounts payable $ 10,328 $ 10,496 Accrued compensation and related items 36,574 33,649 Deferred revenue 4,643 4,443 Accrued income taxes 4,281 2,628 Other current liabilities 17,905 13,960 --------- --------- Current liabilities before ENS client deposits 73,731 65,176 ENS client deposits 1,358,605 1,150,484 --------- --------- Total current liabilities 1,432,336 1,215,660 Other long-term liabilities 4,965 4,520 --------- --------- Total liabilities 1,437,301 1,220,180 ========= ========= STOCKHOLDERS' EQUITY Common stock, $.01 par value, 300,000 authorized shares Issued: 246,326/1999 and 163,188/1998 2,463 1,632 Additional paid-in capital 68,238 46,463 Retained earnings 362,269 278,107 Accumulated other comprehensive income 2,830 3,405 --------- --------- Total stockholders' equity 435,800 329,607 --------- --------- Total liabilities and stockholders' equity $1,873,101 $1,549,787 ========= ========= 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, 1996 71,632 $ 716 $ 30,112 $161,536 $(1,292) $191,072 Net income 75,150 75,150 Unrealized gains on securities, net of tax 1,831 1,831 ------- Total comprehensive income 76,981 Cash dividends declared (24,117) (24,117) 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 ------- ----- ------ ------- ----- ------- Balance at May 31, 1997 108,519 1,085 37,531 212,387 539 251,542 Net income 102,219 102,219 Unrealized gains on securities, net of tax 2,866 2,866 ------- Total comprehensive income 105,085 Cash dividends declared (35,871) (35,871) 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) ------- ----- ------ ------- ----- ------- Balance at May 31, 1998 163,188 1,632 46,463 278,107 3,405 329,607 Net income 139,099 139,099 Unrealized losses on securities, net of tax (575) (575) ------- Total comprehensive income 138,524 Cash dividends declared (54,055) (54,055) Exercise of stock options 1,032 10 5,525 5,535 Tax benefit from exercise of stock options 16,250 16,250 Shares issued in connection with three- for-two stock split 82,106 821 (882) (61) ------- ----- ------ ------- ----- ------- Balance at May 31, 1999 246,326 $2,463 $68,238 $362,269 $2,830 $435,800 ======= ===== ====== ======= ===== ======= See Notes to Consolidated Financial Statements. CONSOLIDATED STATEMENTS OF CASH FLOWS In thousands Year ended May 31, ----------------------------- 1999 1998 1997 -------- -------- -------- Operating Activities Net income $139,099 $102,219 $ 75,150 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization on depreciable and intangible assets 22,097 18,764 15,329 Amortization of premiums and discounts on available-for-sale securities 10,814 8,497 6,115 Provision for deferred income taxes (427) (1,030) (2,053) Provision for bad debts 1,886 1,648 1,328 Net realized gains on sales of available-for-sale securities (2,866) (934) (164) Changes in operating assets and liabilities: Interest receivable (4,818) (2,765) (3,077) Accounts receivable (10,231) (10,717) (4,779) Prepaid expenses and other current assets (1,609) (1,905) (583) Accounts payable and other current liabilities 21,847 22,154 19,189 Net change in other assets and liabilities (1,672) 830 572 ------- ------- ------- Net cash provided by operating activities 174,120 136,761 107,027 ======= ======= ======= Investing Activities Purchases of available-for-sale securities (755,335) (529,413) (306,488) Proceeds from sales of available-for-sale securities 488,662 338,818 185,161 Proceeds from maturities of available-for- sale securities 31,535 7,232 2,125 Net change in ENS money market securities and other cash equivalents (55,707) (159,769) (210,669) Net change in ENS client deposits 208,121 254,404 294,720 Purchases of property and equipment, net of disposal proceeds (22,104) (28,197) (18,008) Purchases of other assets (3,590) (513) (1,935) ------- ------- ------- Net cash used in investing activities (108,418) (117,438) (55,094) ======= ======= ======= Financing Activities Dividends paid (54,055) (35,871) (24,117) Proceeds from exercise of stock options 5,535 1,990 2,180 Other (61) (84) 218 ------- ------- ------- Net cash used in financing activities (48,581) (33,965) (21,719) ======= ======= ======= Increase/(decrease) in Cash and cash equivalents 17,121 (14,642) 30,214 Cash and cash equivalents, beginning of fiscal year 35,571 50,213 19,999 ------- ------- ------- Cash and cash equivalents, end of fiscal year $ 52,692 $ 35,571 $ 50,213 ======= ======= ======= See Notes to Consolidated Financial Statements. Notes to Consolidated Financial Statements Note A - Significant Accounting Policies Business activities and reportable segments: Paychex, Inc., and its wholly-owned subsidiaries (the "Company") operate within the continental United States of America, and have two business activities and reportable segments: Payroll and Human Resource Services-Professional Employer Organization (HRS-PEO). The Company reports segment financial information consistent with the presentation made to the Company's management for decision-making purposes and resource allocation. The Company's reportable segments are business units that are each managed separately because they offer and provide services through different means. The Company's Corporate function and expenses are comprised of the Information Technology, Organizational Development, Finance, Marketing and Senior Management organizations. The Company evaluates segment performance based on operating income, utilizing the Company's accounting policies described in this summary of significant accounting policies. There are no intersegment sales. Payroll segment: The Payroll segment is engaged in the preparation of payroll checks, internal accounting records, federal, state and local payroll tax returns, and collection and remittance of payroll obligations for small- to medium-sized businesses. In connection with Taxpay, an automated tax payment and filing service, Electronic Network Services (ENS) collects payroll taxes from clients on payday, files the applicable tax returns and pays taxes to the appropriate taxing authorities on the due date. These collections from clients are typically paid between one and thirty days after receipt, with some items extending to ninety days. The ENS Direct Deposit service collects net payroll from client accounts one day before payday and provides electronic salary deposit for employees. The funds collected before the due dates are invested and classified as ENS investments until remittance to the appropriate entity. The ENS investments and related client deposit liabilities are included in the Consolidated Balance Sheets as current assets and current liabilities. The amount of ENS funds held and related liabilities varies significantly during the year. Investment revenue from these ENS investments is included in Payroll service revenue on the Consolidated Statements of Income. HRS-PEO segment: The HRS portion of the HRS-PEO segment provides small- to medium-sized businesses with 401(k) plan recordkeeping services, section 125 plan administration, workers' compensation, group benefits, and state unemployment insurance services, employee handbooks and management services. The 401(k) plan 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 provides human resource management and personnel administration services to a diverse client base of small- to medium-sized businesses as a co-employer of the client's employees. The PEO provides certain managed care services, including managed health care and other benefits, employee assistance 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 of employment. Principles of consolidation: The Consolidated Financial Statements include the accounts of Paychex, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Cash and cash equivalents: Cash and cash equivalents consist of available cash, money market securities and other investments with a maturity of three months or less when purchased. 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 obtained from an independent pricing service. Unrealized gains and losses, net of applicable income taxes, are reported as Accumulated other comprehensive income in the Consolidated Statements of Stockholders' Equity. Realized gains and losses on the sale of securities are determined by specific identification of the security's cost basis. Realized gains and losses from ENS investments are included in Payroll service revenue, and realized gains and losses from Investments are included in Investment income on the Consolidated Statements of Income. Concentrations: Substantially all of the Company's deposited cash is maintained at two large credit-worthy financial institutions. These deposits may exceed the amount of any insurance provided. All of the Company's deliverable securities are held in custody with one of the two aforementioned financial institutions, for which that institution bears the risk of custodial loss. Non-deliverable securities, primarily time deposits and money market securities, are restricted to credit-worthy broker-dealers and financial institutions. Property and equipment - net: Property and equipment - net is stated at cost, less accumulated depreciation and amortization. Depreciation is based on the estimated useful lives of property and equipment using the straight-line method. The typical estimated useful lives of depreciable assets are 35 years for buildings and 2 to 10 years for all others. Software development and enhancement: Through the end of 1999, the Company expensed as incurred certain costs to develop and enhance its internal computer programs and software. Expenditures for vendor-provided software were capitalized and amortized by the straight-line method over their estimated useful lives, ranging from 3 to 5 years. In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP requires the capitalization of internal use computer software costs if certain criteria are met, including all external direct costs for materials and services and certain payroll and related fringe benefit costs. The Company will adopt the SOP as of June 1, 1999. The effect of adopting the SOP is expected to increase net income by approximately $2,000,000 to $3,000,000 for the year ended May 31, 2000. Revenue recognition: Payroll service revenues are recognized in the period services are rendered. Included in Payroll service revenues are investment revenues earned from ENS investments and net realized gains and losses from the sale of available-for-sale securities. HRS service revenues are recognized in the period service is rendered. PEO total revenues are recognized in the period the worksite employees perform 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: Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," establishes accounting and reporting standards for stock-based employee compensation plans. As permitted by the SFAS, the Company continues to account for such arrangements under Accounting Principles Board (APB) 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 13, 1999, May 8, 1998, and May 8, 1997, with respective distribution dates of May 21, 1999, May 22, 1998, and May 29, 1997. Basic and diluted earnings per share, cash dividends per common share, weighted-average shares outstanding and all applicable footnotes have been adjusted to reflect the aforementioned stock splits. 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 prior year amounts have been reclassified to conform to current year presentation. Note B - Basic and Diluted Earnings Per Share In thousands, except per share amounts Year ended May 31, ---------------------------- 1999 1998 1997 -------- -------- -------- Basic earnings per share: Net income $139,099 $102,219 $ 75,150 ------- ------- ------- Weighted-average common shares outstanding 245,521 244,514 243,002 ------- ------- ------- Basic earnings per share $ .57 $ .42 $ .31 ======= ======= ======= Diluted earnings per share: Net income $139,099 $102,219 $ 75,150 ------- ------- ------- Weighted-average common shares outstanding 245,521 244,514 243,002 Effect of dilutive stock options at average market price 3,267 2,705 2,634 ------- ------- ------- Weighted-average shares assuming dilution 248,788 247,219 245,636 ------- ------- ------- Diluted earnings per share $ .56 $ .41 $ .31 ======= ======= ======= For the years ended May 31, 1999, 1998, and 1997, weighted-average options to purchase shares of common stock in the amount of 99,000, 1,440,000, and 1,529,000, 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 - Segment Financial Information See Note A for a description of the Company's business activities and reportable segments. In thousands Year ended May 31, ---------------------------------- 1999 1998 1997 ---------- ---------- ---------- Revenue: Payroll $ 545,249 $ 455,227 $ 368,855 HRS-PEO revenue: Service revenue 52,047 38,477 30,878 PEO direct cost billed (A) 578,132 499,741 334,966 ---------- ---------- ---------- Total HRS-PEO revenue 630,179 538,218 365,844 ---------- ---------- ---------- Total revenue 1,175,428 993,445 734,699 PEO direct costs (A) 578,132 499,741 334,966 ---------- ---------- ---------- Total revenue less PEO direct costs $ 597,296 $ 493,704 $ 399,733 ---------- ---------- ---------- Investment revenue included in Payroll revenue $ 52,335 $ 43,429 $ 34,105 ========== ========== ========== Operating income: Payroll $ 235,710 $ 180,265 $ 135,364 HRS-PEO 12,598 6,642 5,596 ---------- ---------- ---------- Segment operating income 248,308 186,907 140,960 Corporate expenses 60,746 52,207 44,335 ---------- ---------- ---------- Total operating income 187,562 134,700 96,625 Investment income 12,581 9,473 7,031 ---------- ---------- ---------- Income before income taxes $ 200,143 $ 144,173 $ 103,656 ========== ========== ========== Purchases of long-lived assets: Payroll $ 13,597 $ 17,146 $ 12,984 HRS-PEO 539 2,015 1,747 Corporate 11,570 9,591 5,716 ---------- ---------- ---------- Total purchases of long-lived assets $ 25,706 $ 28,752 $ 20,447 ========== ========== ========== Depreciation and amortization expense: Payroll $ 20,050 $ 17,187 $ 13,128 HRS-PEO 1,070 1,078 585 Corporate 11,791 8,996 7,731 ---------- ---------- ---------- Total depreciation and amortization expense $ 32,911 $ 27,261 $ 21,444 ========= ========== ========== Identifiable assets: May 31, ---------------------------------- Payroll $1,463,606 $1,244,272 $ 967,688 HRS-PEO 32,144 30,726 24,477 Corporate 377,351 274,789 209,158 ---------- ---------- ---------- Total identifiable assets $1,873,101 $1,549,787 $1,201,323 ========== ========== ========== (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims. Note D - Investments and ENS Investments Investments and ENS investments are as follows: In thousands May 31, ---------------------------------------------- 1999 1998 ---------------------- ---------------------- Type of issue: Cost Fair Cost Fair value value Money market securities and other cash equivalents $ 770,648 $ 770,648 $ 714,941 $ 714,941 Available-for-sale securities: General obligation municipal bonds 313,485 314,636 212,222 213,940 Pre-Refunded municipal bonds 295,359 297,621 236,151 238,462 Revenue municipal bonds 266,264 267,290 199,545 200,850 Other securities 21 73 21 65 --------- --------- --------- --------- Total available-for-sale securities 875,129 879,620 647,939 653,317 Other 1,424 1,810 1,210 1,210 --------- --------- --------- --------- Total Investments and ENS investments $1,647,201 $1,652,078 $1,364,090 $1,369,468 ========= ========= ========= ========= Classification of investments on Consolidated Balance Sheets: Investments $ 288,596 $ 290,555 $ 213,606 $ 214,967 ENS investments 1,358,605 1,361,523 1,150,484 1,154,501 --------- --------- --------- --------- Total Investments and ENS investments $1,647,201 $1,652,078 $1,364,090 $1,369,468 ========= ========= ========= ========= The Company is exposed to credit risk from the possible inability of the borrowers to meet the terms of their bonds. In addition, the Company is exposed to interest rate risk as rate volatility will cause fluctuations in the market value of held investments and the earnings potential of future investments. The Company does not utilize derivative financial instruments to manage interest rate risk. The Company attempts to limit these risks by investing primarily in AAA and AA rated securities, A-1 rated short-term securities, limiting amounts that can be invested in any single instrument, and by investing in short- to intermediate-term instruments whose market value is less sensitive to interest rate changes. At May 31, 1999, approximately 96% 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. Cost, gross unrealized gains and losses, and the fair value of the available-for-sale securities are as follows: Gross Gross In thousands unrealized unrealized Fair May 31, Cost gains losses value -------- ---------- ---------- -------- 1999 $875,129 $ 6,180 $ 1,689 $879,620 1998 $647,939 $ 5,524 $ 146 $653,317 Gross realized gains and losses are as follows: In thousands Year ended May 31, ------------------------ 1999 1998 1997 ------ ------ ------ Gross realized gains $3,129 $1,481 $ 602 Gross realized losses $ 263 $ 547 $ 438 The cost and fair value of available-for-sale securities at May 31, 1999, 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. In thousands May 31, 1999 ------------------- Fair Cost value -------- -------- Maturity date: Due in one year or less $105,696 $106,358 Due after one year through three years 463,838 466,939 Due after three years through five years 259,194 260,003 Due after five years 46,401 46,320 ------- ------- Total available-for-sale securities $875,129 $879,620 ======= ======= NOTE E - PROPERTY AND EQUIPMENT - NET In thousands May 31, -------------------- 1999 1998 -------- -------- Land and improvements $ 2,896 $ 2,815 Buildings and improvements 26,932 24,914 Data processing equipment and software 70,000 64,247 Furniture, fixtures and equipment 59,818 52,752 Leasehold improvements 8,838 7,323 ------- ------- 168,484 152,051 Less accumulated depreciation and amortization 102,553 87,353 ------- ------- Property and equipment - net $ 65,931 $ 64,698 ======= ======= NOTE F - STOCK OPTION PLANS The Company reserved 5,209,500 shares to be granted to employees in the form of non-qualified and incentive stock options under the 1998 Stock Incentive Plan, with 4,954,000 shares available for future grants at May 31, 1999. The 1995, 1992, and 1987 Stock Incentive Plans expired in August 1998, 1995, and 1992, respectively; however, options to purchase 6,993,000 shares under these plans remain outstanding at May 31, 1999. The exercise price for the shares subject to options of the Company's common stock is equal to the fair market value on the date of the grant. All stock option grants have a contractual life of ten years from the date of the grant. Non-qualified stock option grants vest at 33.3% after two years of service from the date of the grant, with annual vesting at 33.3% thereafter. In November 1996, the Company granted options to purchase 2,103,000 shares in a broad-based incentive stock option grant, for which 50% vested on May 3, 1999, and 50% will vest on May 1, 2001. At May 31, 1999, options to purchase 1,264,000 shares remained outstanding, with 601,000 exercisable at an exercise price of $17.30 per share. Subsequently, each April and October, the Company has granted options to newly hired employees that meet certain criteria, which vest at 50% after two years and four years of service from the date of the grant. The following table summarizes stock option activity for the three years ended May 31, 1999: Shares Weighted- subject average to exercise In thousands, except per share amounts options price ------- --------- Outstanding at May 31, 1996 6,615 $ 4.29 Granted 2,961 $ 17.09 Exercised (900) $ 2.43 Forfeited (719) $ 10.98 ------ -------- Outstanding at May 31, 1997 7,957 $ 8.66 Granted 1,788 $ 18.41 Exercised (650) $ 3.94 Forfeited (467) $ 16.38 ------ -------- Outstanding at May 31, 1998 8,628 $ 10.62 Granted 753 $ 29.39 Exercised (1,545) $ 3.89 Forfeited (588) $ 18.55 ------ -------- Outstanding at May 31, 1999 7,248 $ 13.36 ====== ======== Exercisable at May 31, 1997 2,951 $ 2.71 ====== ======== Exercisable at May 31, 1998 3,569 $ 3.52 ====== ======== Exercisable at May 31, 1999 3,619 $ 7.49 ====== ======== The following table summarizes information about stock options outstanding at May 31, 1999: 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 - -------------- ----------- ----------- ----------- ----------- ----------- $ 0.00 -$ 7.50 2,208 $ 3.53 4.0 2,205 $ 3.53 $ 7.51 -$15.00 1,100 $ 9.50 6.4 666 $ 9.40 $15.01 -$22.50 3,082 $ 17.48 7.8 748 $ 17.45 $22.51 -$30.00 729 $ 28.09 9.1 - $30.01 -$37.50 129 $ 33.08 9.7 - ----------- ----------- 7,248 $ 13.36 6.6 3,619 $ 7.49 In applying APB Opinion No. 25, no expense was recognized for stock options granted. SFAS No. 123 requires that a fair market value of all awards of stock-based compensation be determined using standard techniques and that pro forma net income and earnings per share be disclosed as if the resulting stock-based compensation amounts were recorded in the Consolidated Statements of Income. The table below depicts the effects of SFAS No. 123: In thousands, except per share amounts Year ended May 31, ---------------------------- 1999 1998 1997 -------- ------- ------- Pro forma net income $134,642 $97,448 $72,060 Pro forma basic earnings per share $ .55 $ .40 $ .29 Pro forma diluted earnings per share $ .54 $ .39 $ .29 The pro forma effect on net income is not representative of future pro forma effects, since these calculations only take into account the options granted since June 1, 1995. 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: Year ended May 31, ------------------------ 1999 1998 1997 ---- ---- ---- Risk-free interest rate 5.0% 5.8% 6.2% Dividend yield .8% .9% .9% Volatility factor .40 .29 .28 Expected option term life in years 4.5 4.5 4.9 The weighted-average fair value of stock options granted for the years ended May 31, 1999, 1998, and 1997 were $11.17, $5.87, and $5.59 per share, respectively. NOTE G - INCOME TAXES The components of net deferred tax assets are as follows: In thousands May 31, ----------------- 1999 1998 ------ ------ Deferred tax assets: Accrued vacation pay $1,257 $1,170 Allowance for bad debts 1,822 1,355 Accrual for future medical claims 1,337 1,169 Reserve for workers' compensation claims 659 1,186 Other 3,225 1,940 ------ ------ Gross deferred tax assets 8,300 6,820 ====== ====== Deferred tax liabilities: Revenue not subject to current taxes 3,631 2,388 Unrealized gains on available-for-sale securities 1,661 1,973 Other 227 417 ----- ----- Gross deferred tax liabilities 5,519 4,778 ===== ===== Net deferred tax asset $2,781 $2,042 ===== ===== The components of the provision for income taxes are as follows: In thousands Year ended May 31, ---------------------------- 1999 1998 1997 ------- ------- ------- Current: Federal $51,224 $34,888 $24,699 State 10,247 8,096 5,860 ------ ------ ------ Total current 61,471 42,984 30,559 ====== ====== ====== Deferred: Federal (131) (857) (1,719) State (296) (173) (334) ------ ------ ------ Total deferred (427) (1,030) (2,053) ====== ====== ====== Provision for income taxes $61,044 $41,954 $28,506 ====== ====== ====== Reconciliations of the U.S. federal statutory tax rate with effective tax rates reported for income before income taxes are as follows: Year ended May 31, -------------------------- 1999 1998 1997 ----- ----- ----- Federal statutory rate 35.0% 35.0% 35.0% Increase/(decrease) resulting from: State income taxes, net of federal benefit 3.2 3.6 3.5 Tax-exempt municipal bond interest (7.7) (10.4) (10.9) Other items - .9 (.1) ----- ----- ----- Effective income tax rate 30.5% 29.1% 27.5% ===== ===== ===== Note H - 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: In thousands Year ended May 31, --------------------------- 1999 1998 1997 ------- ------- ------- Unrealized holding gains $ 1,979 $ 5,420 $ 3,215 Less: Income tax expense related to unrealized holding gains 716 1,955 1,279 Gain on sale of securities realized in net income 2,866 934 164 Plus: Income tax expense on gain on sale of securities 1,028 335 59 ------ ------ ------ Other comprehensive income/(loss) $ (575) $ 2,866 $ 1,831 ====== ====== ====== Note I - Supplemental Cash Flow Information Income taxes paid: The Company paid income taxes of $43,251,000, $35,191,000, and $24,256,000 for the years ended May 31, 1999, 1998 and 1997, respectively. Non-cash financing transactions: The Company recorded the tax benefit from the exercise of stock options as a reduction of its income tax liability in the amount of $16,250,000, $6,945,000, and $5,208,000 for the years ended May 31, 1999, 1998, and 1997, respectively. Note J - Commitments and Contingencies Employee benefits: The Company's 401(k) Incentive Retirement Plan allows employees with one or more years of service to participate. The Company currently matches 50% of an employee's voluntary contribution, with a maximum of 3% of eligible compensation. Company contributions for the years ended May 31, 1999, 1998, and 1997 were $3,525,000, $3,239,000, and $2,712,000, respectively. Lines of credit: At May 31, 1999, the Company has several available, uncommitted, unsecured lines of credit from various banks totaling $297,500,000 at market rates of interest. No amounts were outstanding against these lines of credit at May 31, 1999 and 1998. Contingencies: 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. Lease commitments: 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 years ended May 31, 1999, 1998, and 1997 was $23,038,000, $20,336,000, and $17,314,000, respectively. At May 31, 1999, future minimum lease payments under various noncancelable operating leases with terms of more than one year are $17,579,000 in fiscal 2000, $17,989,000 in fiscal 2001, $11,725,000 in fiscal 2002, $8,959,000 in fiscal 2003, $5,841,000 in fiscal 2004, and $8,046,000 thereafter. Note K - Business Combinations The following table summarizes business combinations completed in the year ended May 31, 1997: Common shares Method of issued (In Entity name Business Date accounting thousands) - ------------------ ---------------- -------------- ---------- ---------- National Business Solutions, Inc. PEO August 1996 Pooling 9,904 The Payroll Service, Inc. Payroll services August 1996 Pooling 186 Olsen Computer Systems, Inc. Payroll services November 1996 Pooling 1,326 Results of operations prior to completion of the pooling of interests trans- action with National Business Solutions, Inc. were restated. Results of operations prior to completion of the other two business combination trans- actions were not restated as the effects were not material. ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA In thousands, except per share amounts and other statistics
For the years ended May 31, 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 Results of Operations Service revenues: Payroll $ 545,249 $455,227 $368,855 $309,517 $254,093 $215,663 $184,004 $156,652 $133,886 $118,157 $100,488 HRS-PEO 52,047 38,477 30,878 23,791 18,020 11,290 7,700 5,253 3,289 2,043 666 Total service revenues 597,296 493,704 399,733 333,308 272,113 226,953 191,704 161,905 137,175 120,200 101,154 PEO direct costs billed (A) 578,132 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - - Total revenue 1,175,428 993,445 734,699 566,443 412,066 323,905 252,138 183,680 139,792 120,200 101,154 PEO direct costs (A) 578,132 499,741 334,966 233,135 139,953 96,952 60,434 21,775 2,617 - - Operating costs 151,956 131,731 115,034 101,235 81,663 70,034 61,877 53,700 50,054 45,031 35,557 Selling, general and administrative expenses 257,778 227,273 188,074 162,151 138,186 119,477 102,893 89,393 73,854 63,042 51,480 Operating income 187,562 134,700 96,625 69,922 52,264 37,442 26,934 18,812 13,267 12,127 14,117 % of total service revenues 31.4% 27.3% 24.2% 21.0% 19.2% 16.5% 14.0% 11.6% 9.7% 10.1% 14.0% Investment income 12,581 9,473 7,031 5,467 3,458 2,220 1,379 821 764 1,081 857 Income before income taxes 200,143 144,173 103,656 75,389 55,722 39,662 28,313 19,633 14,031 13,208 14,974 % of total service revenues 33.5% 29.2% 25.9% 22.6% 20.5% 17.5% 14.8% 12.1% 10.2% 11.0% 14.8% Net income 139,099 102,219 75,150 55,035 40,389 28,746 20,241 13,788 9,606 8,566 9,446 % of total service revenues 23.3% 20.7% 18.8% 16.5% 14.8% 12.7% 10.6% 8.5% 7.0% 7.1% 9.3% Basic earnings per share $ .57 $ .42 $ .31 $ .23 $ .17 $ .12 $ .09 $ .06 $ .04 $ .04 $ .04 Diluted earnings per share $ .56 $ .41 $ .31 $ .23 $ .17 $ .12 $ .09 $ .06 $ .04 $ .04 $ .04 Weighted-average common shares outstanding 245,521 244,514 243,002 240,590 237,344 236,648 235,670 234,038 232,976 222,797 222,255 Weighted-average shares assuming dilution 248,788 247,219 245,636 243,284 239,377 238,723 237,532 235,375 233,325 223,247 222,898 Cash dividends per common share $ .22 $ .15 $ .10 $ .07 $ .04 $ .03 $ .02 $ .01 $ .01 $ .01 $ .01 Financial Position Working capital $360,784 $263,118 $194,614 $138,639 $100,009 $ 68,888 $ 46,776 $ 28,245 $ 19,230 $ 21,257 $ 22,951 Purchases of property and equipment 22,116 28,386 18,536 17,806 12,535 11,667 8,822 13,580 18,420 15,447 9,132 Total assets 1,873,101 1,549,787 1,201,323 831,585 647,366 474,786 322,214 221,771 133,342 74,501 55,638 Total debt - - - - 728 948 1,634 2,024 2,431 2,137 2,770 Stockholders' equity 435,800 329,607 251,542 191,072 141,976 109,124 85,365 67,623 54,512 47,160 40,245 Return on stockholders' equity 35.9% 36.0% 33.9% 32.3% 32.2% 29.6% 26.5% 22.6% 18.9% 19.6% 26.3% Client Statistics Payroll clients 322,600 293,600 262,700 234,300 207,900 185,900 167,500 150,400 135,200 120,600 105,600 Branch service centers 79 79 79 75 71 70 70 70 70 74 68 Sales offices 29 25 23 23 23 24 20 17 16 15 16 401(k) Recordkeeping clients 10,100 6,000 3,000 1,300 200 - - - - - - 401(k) client funds managed externally (in millions) $ 757.6 $ 383.3 $ 138.3 $ 35.0 - - - - - - - Section 125 clients 20,200 16,400 13,200 11,400 8,800 7,400 5,000 2,800 500 - - PEO worksite employees 18,300 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 1999, May 1998, May 1997, May 1996, May 1995, August 1993, and May 1992. (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims. QUARTERLY FINANCIAL DATA (UNAUDITED) In thousands, except per share amounts Fiscal 1999 August 31, November 30, February 28, May 31, Year --------- ----------- ----------- --------- -------- Service revenues: Payroll $127,982 $131,035 $144,257 $141,975 $ 545,249 HRS-PEO 11,307 11,913 14,166 14,661 52,047 -------- -------- -------- -------- ---------- Total service revenues 139,289 142,948 158,423 156,636 597,296 PEO direct costs billed (A) 142,498 139,033 148,292 148,309 578,132 -------- -------- -------- -------- ---------- Total revenue 281,787 281,981 306,715 304,945 $1,175,428 PEO direct costs(A) 142,498 139,033 148,292 148,309 578,132 Operating costs 35,885 36,863 40,989 38,219 151,956 SG&A expenses 61,761 61,089 68,941 65,987 257,778 -------- -------- -------- -------- ---------- Operating income 41,643 44,996 48,493 52,430 187,562 Investment income 2,961 3,006 3,073 3,541 12,581 -------- -------- -------- -------- ---------- Income before income taxes 44,604 48,002 51,566 55,971 200,143 Income taxes 13,203 14,394 15,366 18,081 61,044 -------- -------- -------- -------- ---------- Net income $ 31,401 $ 33,608 $ 36,200 $ 37,890 $ 139,099 ======== ======== ======== ======== ========== Basic earnings per share $ .13 $ .14 $ .15 $ .15 $ .57 Diluted earnings per share $ .13 $ .14 $ .15 $ .15 $ .56 Cash dividends per common share $ .04 $ .06 $ .06 $ .06 $ .22 Market value per share: High $ 30.00 $ 36.71 $ 35.33 $ 36.67 $ 36.71 Low $ 23.83 $ 24.33 $ 27.33 $ 24.17 $ 23.83 Fiscal 1998 August 31, November 30, February 28, May 31, Year --------- ----------- ----------- --------- -------- Service revenues: Payroll $104,865 $108,528 $122,239 $119,595 $ 455,227 HRS-PEO 8,082 8,645 9,634 12,116 38,477 -------- -------- -------- -------- ---------- Total service revenues 112,947 117,173 131,873 131,711 493,704 PEO direct costs billed (A) 105,636 118,048 139,482 136,575 499,741 -------- -------- -------- -------- ---------- Total revenue 218,583 235,221 271,355 268,286 993,445 PEO direct costs(A) 105,636 118,048 139,482 136,575 499,741 Operating costs 30,306 31,891 35,347 34,187 131,731 SG&A expenses 52,284 52,710 61,674 60,605 227,273 -------- -------- -------- -------- ---------- Operating income 30,357 32,572 34,852 36,919 134,700 Investment income 2,188 2,291 2,349 2,645 9,473 -------- -------- -------- -------- ---------- Income before income taxes 32,545 34,863 37,201 39,564 144,173 Income taxes 9,471 10,145 10,825 11,513 41,954 -------- -------- -------- -------- ---------- Net income $ 23,074 $ 24,718 $ 26,376 $ 28,051 $ 102,219 ======== ======== ======== ======== ========== Basic earnings per share $ .09 $ .10 $ .11 $ .11 $ .42 Diluted earnings per share $ .09 $ .10 $ .11 $ .11 $ .41 Cash dividends per common share $ .03 $ .04 $ .04 $ .04 $ .15 Market value per share: High $ 18.33 $ 20.17 $ 23.42 $ 26.56 $ 26.56 Low $ 14.44 $ 14.89 $ 17.81 $ 22.08 $ 14.44 (A) Wages and payroll taxes of PEO worksite employees and their related benefit premiums and claims. 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 1999 and May 1998.