Note E — Stock-Based Compensation Plans

The Paychex, Inc. 2002 Stock Incentive Plan, as amended and restated effective on October 14, 2015 (the “2002 Plan”), authorizes grants of up to 44.1 million shares of the Company’s common stock.  As of May 31, 2018, there were 19.4 million shares available for future grants under the 2002 Plan.

All stock-based awards to employees are recognized as compensation costs in the consolidated financial statements based on their fair values measured as of the date of grant.  These costs are recognized as an expense in the Consolidated Statements of Income and Comprehensive Income on a straight-line basis over the requisite service period and an increase in additional paid-in capital.

Stock-based compensation expense was $44.6 million, $35.4 million, and $34.6 million for fiscal years 2018,  2017, and 2016, respectively.  Additional stock-based compensation expense was recognized in fiscal 2018 when the Company made a decision to maximize its tax benefit by accelerating the vesting of restricted stock units (“RSUs”) into fiscal 2018 that would have otherwise vested in August 2018. Related income tax benefits recognized were $14.5 million, $13.4 million, and $12.9 million for the respective fiscal years.  Capitalized stock-based compensation costs related to the development of internal use software for these same fiscal years were not significant.

As of May 31, 2018, the total unrecognized compensation cost related to all unvested stock-based awards was $66.6 million and is expected to be recognized over a weighted-average period of 2.8 years.

Black-Scholes fair value assumptions:   The fair value of stock option grants and performance stock options was estimated at the date of grant using a Black-Scholes option pricing model.  The weighted-average assumptions used for valuation under the Black-Scholes option pricing model are as follows:







Risk-free interest rates are yields for zero coupon U.S. Treasury notes maturing approximately at the end of the expected option life.  The estimated volatility factor is based on a combination of historical volatility, using stock prices over a period equal to the expected option life, and implied market volatility.  The expected option life is based on historical exercise behavior.

The Company has determined that the Black-Scholes option pricing model, as well as the underlying assumptions used in its application, are appropriate in estimating the fair value of its stock option grants.  The Company periodically assesses its assumptions as well as its choice of valuation model, and will reconsider use of this model if additional information becomes available in the future indicating that another model would provide a more accurate estimate of fair value, or if characteristics of future grants would warrant such a change.

Stock options:  Stock options entitle the holder to purchase, at the end of the vesting term, a specified number of shares of Paychex common stock at an exercise price per share set equal to the closing market price of the common stock on the date of grant.  All stock options have a contractual life of ten years from the date of the grant and a vesting schedule as established by the Board.  The Company issues new shares of common stock to satisfy stock option exercises.  Non-qualified stock option grants to officers and outside directors are typically approved by the Board in July.  Prior to fiscal 2018, grants of non-qualified stock options to officers vested one-quarter per annum.  Beginning in fiscal 2018, grants of non-qualified stock options to officers vest one-third per annum.  Grants to members of the Board vest after one year.

The following table summarizes stock option activity for fiscal 2018:









Other information pertaining to stock option grants is as follows:





Restricted stock units:   The Board grants RSUs to non-officer management.  An RSU is an agreement to issue shares at the time of vesting with no associated exercise cost for the employee.  For each unit granted, the holder will receive one share of stock at the time of vesting.  RSUs do not have voting rights or earn dividend equivalents during the vesting period.  These awards vest one-fifth per annum over five years.  The Company made a decision in fiscal 2018 to accelerate the vesting of the August 2018 tranche into fiscal 2018.  The fair value of RSUs is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the vesting period.

The following table summarizes RSU activity for fiscal 2018:









Other information pertaining to RSUs is as follows:







Restricted stock awards:  The Board has approved grants of restricted stock awards to the Company’s officers and outside directors.  All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest.  The recipients of the restricted stock have voting rights and earn dividends, which are paid to the recipient at the time the awards vest. If the recipient leaves Paychex prior to the vesting date for any reason, the shares of restricted stock and the dividends accrued on those shares will be forfeited and returned to Paychex.

Time-vested restricted stock awards granted to officers vest one-third per annum.  Restricted stock awards granted to outside directors vest on the one-year anniversary of the grant date.  The fair value of restricted stock awards is equal to the closing market price of the underlying common stock as of the date of grant and is expensed over the requisite service period on a straight-line basis.

The following table summarizes restricted stock activity for fiscal 2018:







Other information pertaining to restricted stock is as follows:







Performance shares:   Performance shares primarily have a two-year performance period, after which the amount of restricted shares earned will be determined based on achievement against established performance targets.  The restricted shares earned will then be subject to a one-year service period.  Performance shares do not have voting rights or earn dividend equivalents during the performance period.  The fair value of performance shares is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the performance period.



The following table summarizes performance share activity for fiscal 2018:











Other information pertaining to performance shares is as follows:





Long-term Incentive Plan (“LTIP”):  The Company has two long-term incentive performance-based stock awards. In July 2011, the Board approved a special award of performance-based non-qualified stock options under an LTIP.  Subsequent grants of this award were made upon hire of new officers.  Under this award, stock options were granted to officers with vesting dependent on achievement against long-term strategic and financial objectives.  Total stock options earned and vested were based on achievement against pre-established targets for fiscal 2016.  The performance period was completed in fiscal 2016.  Although the performance period was completed and the stock options were earned and vested, there are still stock options outstanding as of May 31, 2018.



In July 2016, the Board approved an LTIP award comprised of both performance-based non-qualified stock options and performance-based restricted stock.  This award was granted to senior executives down to the vice president level with vesting dependent on achievement against long-term strategic and financial objectives.  Total stock options and restricted shares to be earned are based on achievement against pre-established targets for the fiscal year ending May 31, 2020. 

The following table summarizes performance stock option activity for fiscal 2018:









Other information pertaining to performance stock options is as follows:





 LTIP performance-based restricted stock do not have voting rights or earn dividend equivalents during the performance period.  The fair value of these performance-based restricted stock is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the performance period.  If the recipient leaves Paychex prior to the vesting date for any reason, the shares of restricted stock will be forfeited and returned to Paychex.

The following table summarizes performance restricted stock activity for fiscal 2018:





Non-compensatory employee benefit plan:  Prior to January 1, 2016, the Company offered a non-qualified Employee Stock Purchase Plan (“ESPP”) to all employees under which the Company’s common stock could be purchased through a payroll deduction with no discount to the market price and no look-back provision.  This ESPP was discontinued as of December 31, 2015.  Effective January 1, 2016, the Company began offering a qualified ESPP to all employees.  Under this qualified ESPP, the Company’s common stock can be purchased through a payroll deduction at a discount to the market price.  The qualified ESPP allows for a discount of up to 15% based on the sole discretion of the committee established to administer the plan.  For offering periods during fiscal 2018, fiscal 2017, and fiscal 2016 the discount was set at 5% of the market price.  Transactions under the non-qualified ESPP occurred directly through the Company’s transfer agent and no brokerage fees were charged to employees, except for when stock was sold.  Transactions under the qualified ESPP occur through the Company’s third-party stock plan administrator.  The plans have been deemed non-compensatory and therefore, no stock-based compensation costs have been recognized for fiscal years 2018,  2017, or 2016 related to either plan.