PAYCHEX INC
10-Ks and 10-Qs
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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C.
20549
FORM 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended
May 31, 2010
Commission file number 0-11330
Paychex, Inc.
911 Panorama Trail South
Rochester, New York
14625-2396
(585) 385-6666
A Delaware Corporation
IRS Employer Identification Number:
16-1124166
|
Securities registered pursuant to Section 12(b) of the
Act:
|
Common Stock, $0.01 Par Value | ||||
|
Name of exchange on which registered:
|
NASDAQ Global Select Market | ||||
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes
þ
No
o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
o
No
þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such
files). Yes
þ
No
o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K.
þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in
Rule 12b-2
of the Exchange Act.
| Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o |
(Do not check if a smaller
reporting
company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of
the Act). Yes
o
No
þ
As of November 30, 2009, the last business day of the most
recently completed second fiscal quarter, shares held by
non-affiliates of the registrant had an aggregate market value
of $10,119,675,949 based on the closing price reported for such
date on the NASDAQ Global Select Market.
As of June 30, 2010, 361,463,054 shares of the
registrant’s common stock, $.01 par value, were
outstanding.
Documents
Incorporated by Reference
Portions of the registrant’s definitive proxy statement to
be issued in connection with its Annual Meeting of Stockholders
to be held on October 13, 2010, to the extent not set forth
herein, are incorporated by reference into Part III,
Items 10 through 14, inclusive.
PAYCHEX,
INC.
INDEX TO
FORM 10-K
For the
fiscal year ended May 31, 2010
i
Table of Contents
“SAFE
HARBOR” STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995
Certain written and oral statements made by management of
Paychex, Inc. and its wholly owned subsidiaries (“we,”
“our,” “us,” “Paychex,” or the
“Company”) may constitute “forward-looking
statements” as defined in the Private Securities Litigation
Reform Act of 1995 (the “Reform Act”). Forward-looking
statements are identified by such words and phrases as “we
expect,” “expected to,” “estimates,”
“estimated,” “current outlook,” “we
look forward to,” “would equate to,”
“projects,” “projections,” “projected
to be,” “anticipates,” “anticipated,”
“we believe,” “could be,” and other similar
phrases. All statements addressing operating performance,
events, or developments that we expect or anticipate will occur
in the future, including statements relating to revenue growth,
earnings, earnings-per-share growth, or similar projections, are
forward-looking statements within the meaning of the Reform Act.
Because they are forward-looking, they should be evaluated in
light of important risk factors. These risk factors include, but
are not limited to, the following risks as well as those
described in “Risk Factors” under Item 1A and
elsewhere in this Annual Report on
Form 10-K
(“Form 10-K”):
| • | general market and economic conditions including, among others, changes in United States (“U.S.”) employment and wage levels, changes in new hiring trends, legislative changes to stimulate the economy, changes in short- and long-term interest rates, changes in the fair value and the credit rating of securities held by us, and accessibility of financing; | |
| • | changes in demand for our services and products, ability to develop and market new services and products effectively, pricing changes and the impact of competition, and the availability of skilled workers; | |
| • | changes in the laws regulating collection and payment of payroll taxes, professional employer organizations, and employee benefits, including retirement plans, workers’ compensation, health insurance, state unemployment, and section 125 plans; | |
| • | changes in workers’ compensation rates and underlying claims trends; | |
| • | the possibility of failure to keep pace with technological changes and provide timely enhancements to services and products; | |
| • | the possibility of failure of our operating facilities, computer systems, and communication systems during a catastrophic event; | |
| • | the possibility of third-party service providers failing to perform their functions; | |
| • | the possible failure of internal controls or our inability to implement business processing improvements; and | |
| • | potentially unfavorable outcomes related to pending legal matters. |
Any of these factors could cause our actual results to differ
materially from our anticipated results. The information
provided in this
Form 10-K
is based upon the facts and circumstances known at this time. We
undertake no obligation to update these forward-looking
statements after the date of filing of this
Form 10-K
with the Securities and Exchange Commission (“SEC” or
“Commission”) to reflect events or circumstances after
such date, or to reflect the occurrence of unanticipated events.
| Item 1. | Business |
We are a leading provider of payroll, human resource, and
benefits outsourcing solutions for small- to medium-sized
businesses. As of May 31, 2010, we serviced approximately
536,000 clients and had approximately 12,200 employees. We
maintain our corporate headquarters in Rochester, New York, and
have more than 100 offices nationwide.
As of May 31, 2010, we serviced approximately 1,700 clients
in Germany through four offices.
Our company was formed as a Delaware corporation in 1979. We
report our results of operations and financial condition as one
business segment. Our fiscal year ends May 31.
1
Table of Contents
Company
Strategy
We are focused on achieving strong, long-term financial
performance by:
| • | providing high-quality, timely, accurate, and affordable comprehensive payroll and integrated human resource services; | |
| • | delivering these services utilizing a well-trained and responsive work force through a network of local and corporate offices servicing more than 100 of the largest markets in the U.S.; | |
| • | growing our client base, primarily through the efforts of our direct sales force; | |
| • | continually improving client service to maximize client retention; | |
| • | capitalizing on the growth opportunities within our existing client base and from new clients by increasing utilization of our payroll and human resource ancillary services and products; | |
| • | capitalizing on and leveraging our highly developed technological and operating infrastructure; | |
| • | investing in our business through expansion of our service and product offerings to continually add value for our clients; and | |
| • | supplementing our growth through strategic acquisitions when appropriate opportunities arise. |
Services
and Products
We offer a comprehensive portfolio of services and products that
allow our clients to meet their diverse payroll and human
resource needs. These include:
| • | payroll processing; | |
| • | payroll tax administration services; | |
| • | employee payment services; | |
| • | regulatory compliance services (new-hire reporting and garnishment processing); | |
| • | Paychex HR Solutions; | |
| • | retirement services administration; | |
| • | insurance services; | |
| • | eServices; and | |
| • | other human resource services and products. |
By offering ancillary services that leverage the information
gathered in the base payroll processing service, we are able to
provide comprehensive outsourcing services that allow employers
to expand their employee benefits offerings at an affordable
cost. We mainly earn our revenue through recurring fees for
services performed. Service revenue is primarily driven by the
number of clients, checks or transactions per client per pay
period, and utilization of ancillary services.
Payroll
Payroll processing is the foundation of our service portfolio.
Our payroll service includes the calculation, preparation, and
delivery of employee payroll checks; production of internal
accounting records and management reports; preparation of
federal, state, and local payroll tax returns; and collection
and remittance of clients’ payroll obligations. Our payroll
services are provided through either our core payroll or Major
Market Services (“MMS”) and are made available to
clients via traditional or Internet-based methods.
Paychex Online is our secure Internet site, which offers core
payroll clients a suite of self-service, interactive services
and products twenty-four hours a day, seven days a week. These
include Paychex Online
Payroll
®
,
Internet Time Sheet, Paychex Online Reports, and General Ledger
Reporting Service. Using these services, clients can
2
Table of Contents
communicate payroll information, access current and historical
payroll information, and transfer payroll information calculated
by us to their general ledger accounting software, eliminating
manual entries and improving the accuracy of bookkeeping. More
than one-half of our clients are currently utilizing some form
of Paychex Online payroll service.
Major Market Services:
MMS primarily
targets companies that have more sophisticated payroll and
benefits needs. We currently offer this service in all of our
significant markets. Our proprietary MMS software,
Preview
®
,
provides a powerful payroll solution and allows smooth
integration with other Paychex service offerings. Preview can be
used as an
on-site,
PC-based system or via a secure web-hosted environment.
We offer a software-as-a-service solution to meet the payroll
and human resource administrative needs of our MMS clients. This
allows Preview to be integrated with various Internet-based
services offered to assist clients with their administrative
human resource and payroll needs through every step of the
employee life cycle. Ancillary services particularly beneficial
to our MMS clients include the following:
| • | Paychex HR Online, our Internet-based human resource management system, offers powerful tools for managing employee benefits, personnel information, and critical human resource compliance and reporting needs. In addition, its self-service features allow for better communication between management and employees. | |
| • | BeneTrac, our employee benefits management and administration system, provides our MMS clients a simple, accurate, and cost-effective solution for streamlined benefits management. | |
| • | Paychex Time and Labor Online makes the time and attendance process more efficient. This solution can reduce time spent on preparing timesheets, minimize redundant data entry, increase awareness of critical labor information, and aid in compliance with federal time recording requirements. | |
| • | Paychex Expense Manager is an integrated payroll and expense management solution that allows clients to control discretionary spending while giving employees an easy-to-use, secure tool to prepare and submit expense reports online. | |
| • | Applicant tracking, offered through our partnership with Taleo Corporation, provides our MMS clients with a tool to manage their recruiting process in order to better hire and retain talented employees. |
MMS clients can select Paychex One-Source Solutions, which
seamlessly integrates Preview, Paychex Time and Labor Online,
and Paychex HR Online applications through a single, web-based
client portal. MMS clients also have the option to select from a
number of á la carte payroll and human resource ancillary
services or opt for our comprehensive human resource and payroll
outsourcing solution, Paychex HR Solutions. This flexibility
allows our clients to define the solution that best meets their
particular needs.
Payroll tax administration services:
As
of May 31, 2010, 94% of our clients utilized our payroll
tax administration services (including
Taxpay
®
),
which provide accurate preparation and timely filing of
quarterly and year-end tax returns, as well as the electronic
transfer of funds to the applicable tax or regulatory agencies
(federal, state, and local). Nearly all of our new clients
purchase our payroll tax administration services. In connection
with these services, we electronically collect payroll taxes
from clients’ bank accounts, typically on payday, prepare
and file the applicable tax returns, and remit taxes to the
applicable tax or regulatory agencies on the respective due
dates. These taxes are typically paid between one and
30 days after receipt of collections from clients, with
some items extending to 90 days. We handle regulatory
correspondence, amendments, and penalty and interest disputes,
and we are subject to cash penalties imposed by tax or
regulatory agencies for late filings and late or under payment
of taxes.
Employee payment services:
As of
May 31, 2010, 77% of our clients utilized our employee
payment services, which provide the employer the option of
paying their employees by direct deposit, payroll debit card, a
check drawn on a Paychex account
(Readychex
®
),
or a check drawn on the employer’s account and
electronically signed by us. More than 80% of new clients select
some form of employee payment services. For the first three
methods, we electronically collect net payroll from the
clients’ bank account, typically one business day before
payday, and provide payment to the employee on payday. Our
flexible payment options provide a cost-effective solution that
offers the benefit of convenient, one-step payroll account
reconciliation for employers.
3
Table of Contents
Regulatory compliance services:
We
offer new-hire reporting services, which enable clients to
comply with federal and state requirements to report information
on newly hired employees. This information aids the government
in enforcing child support orders and minimizes fraudulent
unemployment and workers’ compensation insurance claims.
Our garnishment processing service provides deductions from
employees’ pay, forwards payments to third-party agencies,
including those that require electronic payments, and tracks the
obligations to fulfillment. These services enable employers to
comply with legal requirements and reduce the risk of penalties.
Human
Resource Services
Paychex HR Solutions:
We offer
comprehensive human resource outsourcing solutions that provide
businesses a full-service approach to the outsourcing of
employer and employee administrative needs. Our Paychex HR
Solutions offering is available as an administrative services
organization (“ASO”), previously known as Paychex
Premier
®
Human Resources, and a professional employer organization
(“PEO”). Both options offer businesses a combined
package of services that includes payroll, employer compliance,
human resource and employee benefits administration, risk
management outsourcing, and the
on-site
availability of a professionally trained human resource
representative. These comprehensive bundles of services are
designed to make it easier for businesses to manage their
payroll and related benefit costs while providing a benefits
package equal to that of larger companies. Our PEO differs from
the ASO in that we serve as a co-employer of the clients’
employees, assume the risks and rewards of workers’
compensation insurance, and provide more sophisticated health
care offerings to PEO clients. PEO services continue to be sold
through our registered and licensed subsidiary, Paychex Business
Solutions, Inc. The integration of the sales and service models
of the ASO and PEO under Paychex HR Solutions has reduced
redundancies and created more flexible options for businesses
owners to find the solution that best meets their needs. As of
May 31, 2010, Paychex HR Solutions were utilized by 19,000
clients with approximately 502,000 client employees.
Retirement services administration:
Our
retirement services product line offers a variety of options to
clients, including 401(k) plans, 401(k) SIMPLE, SIMPLE IRA,
401(k) plans with safe harbor provisions, profit sharing, and
money purchase plans. These services provide plan
implementation, ongoing compliance with government regulations,
employee and employer reporting, participant and employer online
access, electronic funds transfer, and other administrative
services. Auto enrollment is an optional plan feature allowing
employers to automatically enroll employees in their
company’s 401(k) plan and increase overall plan
participation. Clients have the ability to choose from a group
of pre-defined fund selections or to customize their investment
options within their plan. Selling efforts for these services
are focused primarily on our existing payroll client base, as
the processed payroll information allows for data integration
necessary to provide these services efficiently. We are one of
the largest 401(k) recordkeepers for small businesses in the
U.S. We earn a fee of approximately twenty-five basis
points from the external fund managers based on the total asset
value of client employee 401(k) funds. As of May 31, 2010,
retirement services were utilized by approximately 51,000
clients and the asset value of client employee 401(k) funds
externally managed totaled approximately $11.3 billion.
Insurance services:
Our licensed
insurance agency, Paychex Insurance Agency, Inc., provides
insurance through a variety of carriers. Insurance offerings
include property and casualty coverage such as workers’
compensation; business-owner policies; commercial auto; and
health and benefits coverage including health, dental, vision,
and life. Our insurance services simplify the insurance process
to make it easy to find plans with the features and
affordability to meet the client’s needs. With access to
over 150 of the top national and regional carriers, our
professional insurance agents enjoy a wide selection of plans
from which to best match the insurance needs of small business.
Clients also have the option to integrate with Paychex payroll
processing for easy, accurate plan administration. Paychex
Insurance Agency has a website,
www.paychexinsurance.com
,
with information and interactive tools to help educate visitors
on insurance and aid in making business insurance decisions. As
of May 31, 2010, approximately 92,000 clients have
appointed Paychex Insurance Agency as their agent for servicing
their business insurance needs.
eServices:
We offer online human
resource administration software products for employee benefits
management and administration and time and attendance solutions.
Paychex HR Online offers powerful tools for managing employee
benefits, personnel information, and human resource compliance
and reporting. Time and
4
Table of Contents
Labor Online helps minimize the time spent compiling time sheet
information. It allows the employer to handle multiple payroll
scenarios and results in improved productivity, accuracy, and
reliability in the payroll process.
Other human resource services and
products:
We offer the outsourcing of plan
administration under section 125 of the Internal Revenue
Code, allowing employees to use pre-tax dollars to pay for
certain health insurance benefits and health and dependent care
expenses not covered by insurance. All required implementation,
administration, compliance, claims processing and reimbursement,
and coverage tests are provided with these services. We offer
state unemployment insurance services, which provide clients
with prompt processing for all claims, appeals, determinations,
change statements, and requests for separation documents. Other
Human Resource Services products include employee handbooks,
management manuals, and personnel and required regulatory forms.
These products are designed to simplify clients’ office
processes and enhance their employee benefits programs.
Sales and
Marketing
We market our services primarily through our direct sales force
based in the metropolitan markets we serve, with sales
representatives specializing within our portfolio of services.
For the year ending May 31, 2011 (“fiscal 2011”),
our sales force is expected to total approximately 2,380
representatives. Our sales representatives are also supported by
marketing, advertising, public relations, trade shows, and
telemarketing programs. We have grown and expect to continue to
grow our direct sales force. In recent years, we have increased
our emphasis on the selling of ancillary services and products
to both new clients and our existing client base.
In addition to our direct selling and marketing efforts, we
utilize relationships with existing clients, certified public
accountants (“CPAs”), and banks for new client
referrals. More than 60% of our new core payroll clients
(excluding acquisitions) come from these referral sources. To
further enhance our strong relationship with CPAs, we have
partnered with the American Institute of Certified Public
Accountants (“AICPA”) as the preferred payroll
provider for its AICPA Business Solutions Partner Program since
2003.
Our website at
www.paychex.com
, which includes online
payroll sales presentations and service and product information,
is a cost-efficient tool that serves as a source of leads and
new sales while complementing the efforts of our direct sales
force. This online tool allows us to market to clients in more
geographically remote areas. In addition, our insurance services
website at
www.paychexinsurance.com
provides information
to help small businesses navigate the insurance industry, and
generates leads by allowing interested parties to get in contact
with a one of our professional insurance agents.
In addition, Advantage Payroll Services Inc.
(“Advantage”), a wholly owned subsidiary of Paychex,
Inc., has license agreements with independently owned associate
offices (“Associates”), which are responsible for
selling and marketing Advantage payroll services and performing
certain operational functions, while Paychex and Advantage
provide all centralized back-office payroll processing and
payroll tax administration services. The marketing and selling
by the Associates is conducted under their own logos.
Markets
and Competition
Industry data indicates there are approximately ten million
employers in the geographic markets that we currently serve
within the U.S. Of those employers, approximately 99% have
fewer than 100 employees and are our primary customers and
target market. We remain focused on servicing small- to
medium-sized businesses based upon the growth potential that we
believe exists in this market segment.
We serve a diverse base of small- to medium-sized clients
operating in a broad range of industries located throughout the
U.S. As of May 31, 2010, we serviced approximately
536,000 clients. We utilize service agreements and arrangements
with clients that are generally terminable by the client at any
time or upon relatively short notice. For the fiscal year ended
May 31, 2010 (“fiscal 2010”), client retention
was approximately 77% of our beginning of the fiscal year client
base. While this is relatively consistent with the prior year,
we have begun to see some signs of improvement, as clients lost
in fiscal 2010 decreased 6% compared to the fiscal year ended
May 31, 2009 (“fiscal 2009”). No single client
has a material impact on total service revenue or results of
operations.
5
Table of Contents
The composition of the U.S. market and the client base we
serve by number of employees is as follows:
|
Business size
|
Paychex, Inc. distribution
|
|||||||
| (Number of employees) | Estimated market distribution (1) | of client base | ||||||
|
1-4
|
77% | 41% | ||||||
|
5-19
|
17% | 41% | ||||||
|
20-49
|
4% | 12% | ||||||
|
50-99
|
1% | 4% | ||||||
|
100+
|
1% | 2% | ||||||
| (1) | Based on currently available market data from Dun & Bradstreet. |
The market for payroll processing and human resource services is
highly competitive and fragmented. We believe our primary
national competitor,
ADP
®
(“Automatic Data Processing, Inc.”), is the largest
U.S. third-party provider of payroll processing and human
resource services in terms of revenue. We compete with other
national, regional, local, and online service providers, all of
which we believe have significantly smaller client bases than us.
In addition to traditional payroll processing and human resource
service providers, we compete with in-house payroll and human
resource systems and departments. Payroll and human resource
systems and software are sold by many vendors. Our Human
Resource Services also compete with a variety of providers of
human resource services, such as retirement services companies,
insurance companies, and human resources and benefits consulting
firms.
Competition in the payroll processing and human resource
services industry is primarily based on service responsiveness,
product quality and reputation, breadth of service and product
offering, and price. We believe we are competitive in each of
these areas.
Software
Maintenance and Development
The ever-changing mandates of federal, state, and local tax and
regulatory agencies require us to regularly update the
proprietary software we utilize to provide payroll and human
resource services to our clients. We are continually engaged in
developing enhancements to and the maintenance of our various
software platforms to meet the changing requirements of our
clients and the marketplace.
In fiscal 2010, we completed implementation of an enhanced
platform for our core processing capability, which allows us to
leverage efficiencies in our processes and continue to provide
excellent customer service. Over the next few years, we expect
to expand this platform to additional service offerings.
Employees
As of May 31, 2010, we employed approximately
12,200 people. None of our employees were covered by
collective bargaining agreements.
Intellectual
Property
We own or license and use a number of trademarks, trade names,
copyrights, service marks, trade secrets, computer programs and
software, and other intellectual property rights. Taken as a
whole, our intellectual property rights are material to the
conduct of our business. Where it is determined to be
appropriate, we take measures to protect our intellectual
property rights, including, but not limited to,
confidentiality/non-disclosure agreements or policies with
employees, vendors, and others; license agreements with
licensees and licensors of intellectual property; and
registration of certain trademarks. We believe that the
“Paychex” name, trademark, and logo are of material
importance to us.
Seasonality
There is no significant seasonality to our business. However,
during our third fiscal quarter, which ends in February, the
number of new payroll clients, new retirement services clients,
and new Paychex HR Solutions worksite employees tends to be
higher than during the rest of the fiscal year, primarily
because a majority of new
6
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clients begin using our services in the beginning of a calendar
year. In addition, calendar year-end transaction processing and
client funds activity are traditionally higher during the third
fiscal quarter due to clients paying year-end bonuses and
requesting additional year-end services. Historically, as a
result of these factors, our total revenue has been slightly
higher in the third fiscal quarter, with greater sales
commission expenses also reported in this quarter.
Other
Information about our services and products, stockholder
information, press releases, and filings with the SEC can be
found on our website at
www.paychex.com.
Our
Form 10-Ks,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
and other SEC filings, and any amendments to such reports and
filings, are made available, free of charge, on the Investor
Relations section of our website as soon as reasonably practical
after such material is filed with, or furnished to, the SEC.
Also, copies of our Annual Report to Stockholders and Proxy
Statement, to be issued in connection with our 2010 Annual
Meeting of Stockholders, will be made available, free of charge,
upon written request submitted to Paychex, Inc.,
c/o Corporate
Secretary, 911 Panorama Trail South, Rochester, New York
14625-2396.
| Item 1A. | Risk Factors |
Our future results of operations are subject to a number of
risks and uncertainties. These risks and uncertainties could
cause actual results to differ materially from historical and
current results and from our projections. Important factors
known to us that could cause such differences include, but are
not limited to, those discussed below and those contained in the
“Safe Harbor” statement at the beginning of
Part I of this
Form 10-K.
We may be adversely impacted by volatility in the
financial and economic environment:
During
periods of weakening economic conditions, employment levels may
decrease and interest rates may become more volatile. These
conditions may impact our business due to lower transaction
volumes or an increase in the number of clients going out of
business. Current or potential clients may decide to reduce
their spending on payroll and other outsourcing services. In
addition, new business starts may be affected by an inability to
obtain credit. The interest we earn on funds held for clients
may decrease as a result of a decline in funds available to
invest and lower interest rates. In addition, during periods of
volatility in the credit markets, certain types of investments
may not be available to us or may become too risky for us to
invest in, further reducing the interest we may earn on client
funds. Constriction in the credit markets may impact the
availability of financing, even to borrowers with the highest
credit ratings. We historically have not borrowed against
available credit arrangements to meet liquidity needs. However,
should we require additional short-term liquidity during days of
large outflows of client funds, a credit constriction may limit
our ability to access those funds or the flexibility to obtain
them at interest rates that would be acceptable to us. If all of
these financial and economic circumstances were to remain in
effect for an extended period of time, there could be a material
adverse effect on our results of operations.
Our interest earned on funds held for clients may be
impacted by changes in government regulations mandating the
amount of tax withheld or timing of
remittance:
We receive interest income from
investing client funds collected but not yet remitted to
applicable tax or regulatory agencies or to client employees. A
change in regulations either decreasing the amount of taxes to
be withheld or allowing less time to remit taxes to applicable
tax or regulatory agencies would adversely impact this interest
income.
Our services may be adversely impacted by changes in
government regulations and policies:
Many of
our services, particularly payroll tax administration services
and employee benefit plan administration services, are designed
according to government regulations that continually change.
Changes in regulations could affect the extent and type of
benefits employers are required, or may choose, to provide
employees or the amount and type of taxes employers and
employees are required to pay. Such changes could reduce or
eliminate the need for some of our services and substantially
decrease our revenue. Added requirements could also increase our
cost of doing business. The recently enacted Hiring Incentives
to Restore Employment (“HIRE”) Act provides temporary
tax breaks to companies that hire the unemployed and will impact
our payroll tax administration service clients. The recently
enacted health care reform legislation will have a direct impact
on insurance services clients. Failure to educate and assist our
client regarding these legislations could have an adverse impact
on our reputation. Failure by
7
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us to modify our services in a timely fashion in response to
regulatory changes could have a material adverse effect on our
business and results of operations.
We may not be able to keep pace with changes in
technology:
To maintain our growth strategy,
we must adapt and respond to technological advances and
technological requirements of our clients. Our future success
will depend on our ability to enhance capabilities and increase
the performance of our internal use systems, particularly our
systems that meet our clients’ requirements. We continue to
make significant investments related to the development of new
technology. If our systems become outdated, we may be at a
disadvantage when competing in our industry. There can be no
assurance that our efforts to update and integrate systems will
be successful. If we do not integrate and update our systems in
a timely manner, or if our investments in technology fail to
provide the expected results, there could be a material adverse
effect to our business and results of operations.
In the event of a catastrophe, our business continuity
plan may fail, which could result in the loss of client data and
adversely interrupt operations:
Our
operations are dependent on our ability to protect our
infrastructure against damage from catastrophe or natural
disaster, severe weather including events resulting from climate
change, unauthorized security breach, power loss,
telecommunications failure, terrorist attack, or other events
that could have a significant disruptive effect on our
operations. We have a business continuity plan in place in the
event of system failure due to any of these events. Our business
continuity plan has been tested in the past by circumstances of
severe weather, including floods and snowstorms, and has been
successful. However, these past successes are not an indicator
of success in the future. If the business continuity plan is
unsuccessful in a disaster recovery scenario, we could
potentially lose client data or experience material adverse
interruptions to our operations or delivery of services to our
clients.
We may be adversely impacted by any failure of third-party
service providers to perform their
functions:
As part of providing services to
clients, we rely on a number of third-party service providers.
These service providers include, but are not limited to,
couriers used to deliver client payroll checks and banks used to
electronically transfer funds from clients to their employees.
Failure by these service providers, for any reason, to deliver
their services in a timely manner could result in material
interruptions to our operations, impact client relations, and
result in significant penalties or liabilities to us.
Our business and reputation may be affected by our ability
to keep clients’ information
confidential:
Our business involves the use
of significant amounts of private and confidential client
information including employees’ identification numbers,
bank accounts, and retirement account information. This
information is critical to the accurate and timely provision of
services to our clients, and certain information may be
transmitted via the Internet. There is no guarantee that our
systems and processes are adequate to protect against all
security breaches. If our systems are disrupted or fail for any
reason, or if our systems are infiltrated by unauthorized
persons, our clients could experience data loss, financial loss,
harm to reputation, or significant business interruption. Such
events may expose us to unexpected liability, litigation,
regulation investigation and penalties, loss of clients’
business, unfavorable impact to business reputation, and there
could be a material adverse effect on our business and results
of operations.
We may be exposed to additional risks related to our
co-employment relationship within our PEO
business:
Many federal and state laws that
apply to the employer-employee relationship do not specifically
address the obligations and responsibilities of the
“co-employment” relationship. As a result, there is a
possibility that we may be subject to liability for violations
of employment or discrimination laws by our clients and acts or
omissions of client employees, who may be deemed to be our
agents, even if we do not participate in any such acts or
violations. Although our agreements with the clients provide
that the client will indemnify us for any liability attributable
to its own or its employees’ conduct, we may not be able to
effectively enforce or collect such contractual obligations. In
addition, we could be subject to liabilities with respect to our
employee benefit plans if it were determined that we are not the
“employer” under any applicable state or federal laws.
We may have an adverse outcome of legal matters, which
could harm our business:
We are subject to
various claims and legal matters that arise in the normal course
of business. These include disputes or potential disputes
related to breach of contract, breach of fiduciary duty,
employment-related claims, tax claims, and other matters. Refer
to Item 3 of this
Form 10-K
for additional disclosure regarding legal proceedings. Legal
matters are
8
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subject to inherent uncertainties and there exists the
possibility that their ultimate resolution could have a material
adverse effect on our financial position and results of
operations in the period in which any such effect is recorded.
Quantitative and qualitative disclosures about market
risk:
Refer to Item 7A of this
Form 10-K
for a discussion on Market Risk Factors.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Properties |
We owned and leased the following properties as of May 31,
2010:
| Square feet | ||||
|
Owned facilities:
|
||||
|
Rochester, New York
|
668,000 | |||
|
Other U.S. locations
|
280,000 | |||
|
Total owned facilities
|
948,000 | |||
|
Leased facilities:
|
||||
|
Rochester, New York
|
141,000 | |||
|
Other U.S. locations
|
2,295,000 | |||
|
Germany
|
1,000 | |||
|
Total leased facilities
|
2,437,000 | |||
Our facilities in Rochester, New York house various
distribution, processing, and technology functions; certain
ancillary functions; a telemarketing unit; and other back-office
functions. Facilities outside of Rochester, New York are at
various locations throughout the U.S. and Germany and house
our regional, branch, and sales offices and data processing
centers. These locations are concentrated in metropolitan areas.
We believe that adequate, suitable lease space will continue to
be available for our needs.
| Item 3. | Legal Proceedings |
We are subject to various claims and legal matters that arise in
the normal course of our business. These include disputes or
potential disputes related to breach of contract, breach of
fiduciary duty, employment-related claims, tax claims, and other
matters.
In August 2001, the Company’s wholly owned subsidiary,
Rapid Payroll, Inc. (“Rapid Payroll”) informed
76 licensees that it intended to stop supporting their
payroll processing software in August of 2002. The communication
was sent due to the licensee contract assumed by us during the
acquisition of Rapid Payroll in 1996 being very unfavorable to
us. Thereafter, lawsuits were commenced by licensees asserting
various claims, including breach of contract and related tort
and fraud causes of action.
On March 9, 2010, the Court of Appeal of the State of
California upheld a jury verdict issued on June 27, 2007 in
litigation brought by one of the licensees. In that case, the
California Superior Court, Los Angeles County jury awarded to
the plaintiff $15.0 million in compensatory damages and
subsequently awarded an additional $11.0 million in
punitive damages. We satisfied the judgment, including statutory
interest, without further appeal. This was the final pending
matter in the Rapid Payroll litigation.
During fiscal 2010, we increased our litigation reserve by
$18.7 million for the Rapid Payroll litigation. Our
management currently believes that resolution of outstanding
legal matters will not have a material adverse effect on our
financial position or results of operations. However, legal
matters are subject to inherent uncertainties and there exists
the possibility that the ultimate resolution of these matters
could have a material adverse impact on the Company’s
financial position and the results of operations in the period
in which any such effect is recorded.
9
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| Item 4. | Reserved |
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our common stock trades on the NASDAQ Global Select Market under
the symbol “PAYX.” Dividends have historically been
paid on our common stock in August, November, February, and May.
The level and continuation of future dividends are dependent on
our future earnings and cash flows, and are subject to the
discretion of the Board of Directors.
As of June 30, 2010, there were 15,961 holders of record of
our common stock, which includes registered holders and
participants in the Paychex, Inc. Dividend Reinvestment and
Stock Purchase Plan. There were also 7,891 participants in the
Paychex, Inc. Employee Stock Purchase Plan and 6,463
participants in the Paychex, Inc. Employee Stock Ownership Plan.
The high and low sale prices for our common stock as reported on
the NASDAQ Global Select Market and dividends for fiscal 2010
and fiscal 2009 are as follows:
| Fiscal 2010 | Fiscal 2009 | |||||||||||||||||||||||
|
Cash
|
Cash
|
|||||||||||||||||||||||
|
dividends
|
dividends
|
|||||||||||||||||||||||
| Sales prices |
declared per
|
Sales prices |
declared per
|
|||||||||||||||||||||
| High | Low | share | High | Low | share | |||||||||||||||||||
|
First quarter
|
$ | 28.74 | $ | 23.84 | $ | 0.31 | $ | 35.53 | $ | 30.26 | $ | 0.31 | ||||||||||||
|
Second quarter
|
$ | 31.85 | $ | 27.16 | $ | 0.31 | $ | 35.29 | $ | 23.22 | $ | 0.31 | ||||||||||||
|
Third quarter
|
$ | 32.88 | $ | 28.50 | $ | 0.31 | $ | 27.95 | $ | 21.83 | $ | 0.31 | ||||||||||||
|
Fourth quarter
|
$ | 32.82 | $ | 28.11 | $ | 0.31 | $ | 28.20 | $ | 20.31 | $ | 0.31 | ||||||||||||
The closing price of our common stock as of May 28, 2010,
as reported on the NASDAQ Global Select Market, was $28.54 per
share.
10
Table of Contents
The following graph shows a five-year comparison of the total
cumulative returns of investing $100 on May 31, 2005, in
Paychex, Inc. common stock, the S&P 500 Index, and the
S&P Data Processing and Outsourced Services (the
“S&P S(DP)”) Index. We are a participant in the
S&P 500 Index, a market group of companies with a larger
than average market capitalization. The S&P S(DP) Index
includes a representative peer group of companies, and includes
Paychex, Inc. All comparisons of stock price performance shown
assume reinvestment of dividends.
STOCK
PRICE PERFORMANCE GRAPH
| May 31, | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | ||||||||||||||||||
|
Paychex, Inc.
|
100.00 | 129.17 | 145.14 | 128.13 | 106.00 | 115.53 | ||||||||||||||||||
|
S&P 500
|
100.00 | 108.64 | 133.40 | 124.47 | 83.93 | 101.54 | ||||||||||||||||||
|
S&P S(DP)
|
100.00 | 115.46 | 140.15 | 127.33 | 98.78 | 106.65 | ||||||||||||||||||
There can be no assurance that our stock performance will
continue into the future with the same or similar trends
depicted in the graph above. We will neither make nor endorse
any predictions as to future stock performance.
11
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| Item 6. | Selected Financial Data |
|
In thousands, except per share amounts
|
||||||||||||||||||||
| Year ended May 31, | 2010 (1) | 2009 | 2008 | 2007 (2) | 2006 | |||||||||||||||
|
Service revenue
|
$ | 1,945,789 | $ | 2,007,305 | $ | 1,934,536 | $ | 1,752,868 | $ | 1,573,797 | ||||||||||
|
Interest on funds held for clients
|
55,031 | 75,454 | 131,787 | 134,096 | 100,799 | |||||||||||||||
|
Total revenue
|
$ | 2,000,820 | $ | 2,082,759 | $ | 2,066,323 | $ | 1,886,964 | $ | 1,674,596 | ||||||||||
|
Operating income
|
$ | 724,795 | $ | 805,200 | $ | 828,267 | $ | 701,548 | $ | 649,571 | ||||||||||
|
As a % of total revenue
|
36 | % | 39 | % | 40 | % | 37 | % | 39 | % | ||||||||||
|
Net income
|
$ | 476,999 | $ | 533,545 | $ | 576,145 | $ | 515,447 | $ | 464,914 | ||||||||||
|
As a % of total revenue
|
24 | % | 26 | % | 28 | % | 27 | % | 28 | % | ||||||||||
|
Diluted earnings per share
|
$ | 1.32 | $ | 1.48 | $ | 1.56 | $ | 1.35 | $ | 1.22 | ||||||||||
|
Cash dividends per common share
|
$ | 1.24 | $ | 1.24 | $ | 1.20 | $ | 0.79 | $ | 0.61 | ||||||||||
|
Purchases of property and equipment
|
$ | 61,262 | $ | 64,709 | $ | 82,289 | $ | 79,020 | $ | 81,143 | ||||||||||
|
Cash and total corporate investments
|
$ | 656,918 | $ | 574,713 | $ | 434,762 | $ | 1,224,211 | $ | 962,011 | ||||||||||
|
Total assets
|
$ | 5,226,299 | $ | 5,127,415 | $ | 5,309,791 | $ | 6,246,519 | $ | 5,549,302 | ||||||||||
|
Total debt
|
$ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
|
Stockholders’ equity
|
$ | 1,401,979 | $ | 1,341,478 | $ | 1,196,642 | $ | 1,952,248 | $ | 1,654,843 | ||||||||||
|
Return on stockholders’ equity
|
34 | % | 41 | % | 39 | % | 28 | % | 30 | % | ||||||||||
| (1) | Includes an expense charge of $18.7 million to increase the litigation reserve. | |
| (2) | Includes $25.7 million of stock-based compensation costs and an expense charge of $38.0 million to increase the litigation reserve. |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Management’s Discussion and Analysis of Financial Condition
and Results of Operations reviews the operating results of
Paychex, Inc. and its wholly owned subsidiaries
(“Paychex,” “we,” “our,” or
“us”) for each of the three fiscal years ended
May 31, 2010 (“fiscal 2010”), May 31, 2009
(“fiscal 2009”), and May 31, 2008 (“fiscal
2008”), and our financial condition as of May 31,
2010. This review should be read in conjunction with the
accompanying Consolidated Financial Statements and the related
Notes to Consolidated Financial Statements contained in
Item 8 of this Annual Report on
Form 10-K
(“Form 10-K”)
and the “Risk Factors” discussed in Item 1A of
this
Form 10-K.
Forward-looking statements in this review are qualified by the
cautionary statement under the heading “Safe Harbor
Statement under the Private Securities Litigation Reform Act of
1995” contained at the beginning of Part I of this
Form 10-K.
Overview
We are a leading provider of payroll, human resource, and
benefits outsourcing solutions for small- to medium-sized
businesses. Our Payroll and Human Resource Services offer a
portfolio of services and products that allow our clients to
meet their diverse payroll and human resource needs. Our payroll
services are the foundation of our service portfolio. They are
provided through either our core payroll or Major Market
Services (“MMS”), which is utilized by clients that
have more sophisticated payroll and benefits needs, and include:
| • | payroll processing; | |
| • | payroll tax administration services; | |
| • | employee payment services; and | |
| • | regulatory compliance services (new-hire reporting and garnishment processing). |
12
Table of Contents
In addition to the above, our software-as-a-service option
through our MMS platform provides human resource management,
employee benefits management, time and attendance systems,
online expense reporting, and applicant tracking.
Our Human Resource Services primarily include:
| • | Paychex HR Solutions, under which we offer our administrative services organization (“ASO”) and our professional employer organization (“PEO”); | |
| • | retirement services administration; | |
| • | insurance services; | |
| • | eServices; and | |
| • | other human resource services and products. |
We mainly earn revenue through recurring fees for services
performed. Service revenue is primarily driven by the number of
clients, checks or transactions per client per pay period, and
utilization of ancillary services. We also earn interest on
funds held for clients between the time of collection from our
clients and remittance to the applicable tax or regulatory
agencies or client employees. Our business strategy is focused
on achieving strong long-term financial performance by providing
high-quality, timely, accurate, and affordable services; growing
our client base; increasing utilization of our ancillary
services; leveraging our technological and operating
infrastructure; and expanding our service offerings.
Our financial results for fiscal 2010 were impacted by the
cumulative adverse effects of the economic recession in the
United States (“U.S.”) and global financial crisis
that began in 2008. Unemployment rates in the U.S. reached
a high in October 2009, and have remained high. The equity
markets hit a low in March 2009, with interest rates available
on high quality instruments remaining low since then. The
Federal Funds rate has been at a range of zero to 0.25% since
December 2008. Our combined funds held for clients and corporate
investment portfolios earned an average rate of return of 1.5%
for fiscal 2010, compared to 2.1% for fiscal 2009 and 3.7% for
fiscal 2008.
The weak economy affects our ability to acquire and retain
clients, reduces our transaction volumes related to fewer
employees in our client base, and results in lower average
invested balances in our funds held for clients portfolio. Our
results, while reflecting a decline compared to fiscal 2009,
were in line with our expectations. Although the economy has
remained weak throughout fiscal 2010, our key indicators have
reflected modest improvement as the fiscal year progressed.
Highlights of our financial results for fiscal 2010 compared to
fiscal 2009 are as follows:
| • | Payroll service revenue decreased 5% to $1.4 billion. | |
| • | Human Resource Services revenue increased 3% to $540.9 million. | |
| • | Interest on funds held for clients decreased 27% to $55.0 million. | |
| • | Total revenue decreased 4% to $2.0 billion. | |
| • | Operating income decreased 10% to $724.8 million, and operating income, net of certain items, decreased 6% to $688.5 million. Refer to the “Non-GAAP Financial Measure” discussion on page 14 for further information on operating income, net of certain items. | |
| • | Operating income reflected an expense charge of $18.7 million to increase the litigation reserve for the Rapid Payroll court decision during the third quarter of fiscal 2010, which reduced diluted earnings per share by $0.03 per share. | |
| • | Net income and diluted earnings per share decreased 11% to $477.0 million and $1.32 per share, respectively. |
13
Table of Contents
| • | Cash flow from operations decreased 11% to $610.9 million, primarily related to the decline in net income and fluctuations in operating assets and liabilities. | |
| • | Dividends of $448.6 million were paid to stockholders, representing 94% of net income. |
Non-GAAP Financial
Measure
In addition to reporting operating income, a U.S. generally
accepted accounting principle (“GAAP”) measure, we
present operating income, net of certain items, which is a
non-GAAP measure. We believe operating income, net of certain
items, is an appropriate additional measure, as it is an
indicator of our core business operations performance period
over period. It is also the basis of the measure used internally
for establishing the following year’s targets and measuring
management’s performance in connection with certain
performance-based compensation payments and awards. Operating
income, net of certain items, excludes interest on funds held
for clients and the expense charge in fiscal 2010 to increase
the litigation reserve. Interest on funds held for clients is an
adjustment to operating income due to the volatility of interest
rates, which are not within the control of management. The
expense charge to increase the litigation reserve is also an
adjustment to operating income due to its unusual and infrequent
nature. It is outside the normal course of our operations and
obscures the comparability of performance period over period.
Operating income, net of certain items, is not calculated
through the application of GAAP and is not the required form of
disclosure by the Securities and Exchange Commission
(“SEC”). As such, it should not be considered as a
substitute for the GAAP measure of operating income and,
therefore, should not be used in isolation, but in conjunction
with the GAAP measure. The use of any non-GAAP measure may
produce results that vary from the GAAP measure and may not be
comparable to a similarly defined non-GAAP measure used by other
companies. Operating income, net of certain items, decreased 6%
to $688.5 million for fiscal 2010 compared to
$729.7 million for fiscal 2009 and $696.5 million for
fiscal 2008.
Business
Outlook
Our client base was approximately 536,000 clients as of
May 31, 2010, compared to approximately 554,000 clients as
of May 31, 2009, and approximately 572,000 clients as of
May 31, 2008. Our client base declined 3.2% for fiscal
2010, compared to a decline of 3.1% for fiscal 2009 and growth
of 2.0% for fiscal 2008. The reduction in our client base for
fiscal 2010 reflects the impact of weaker economic conditions on
our ability to acquire and retain clients. The environment for
new sales remained difficult and new sales units decreased 4.9%
for fiscal 2010 compared to fiscal 2009 as a result of low
levels of new business formation and fewer companies moving to
outsourcing.
For fiscal 2010, client retention was approximately 77% of our
beginning of the fiscal year client base. While this was
relatively consistent with the prior year, we have begun to see
some signs of improvement, as clients lost in fiscal 2010
decreased 6% compared to fiscal 2009. Clients lost due to
companies going out of business or no longer having any
employees decreased 11% for fiscal 2010, compared to an increase
of 17% for fiscal 2009. We focus on satisfying customers to
maximize client retention, and for fiscal 2010 we again received
high client satisfaction results.
Ancillary services effectively leverage payroll processing data
and, therefore, are beneficial to our operating margin. Although
the growth rates for our ancillary services for fiscal 2010 were
slower than we have seen
14
Table of Contents
historically due to the impacts of the weak economy, we continue
to see opportunities within these services. The following
statistics demonstrate the growth in our ancillary service
offerings:
| As of May 31, | 2010 | 2009 | 2008 | |||||||||
|
Payroll tax administration services penetration
|
94 | % | 93 | % | 93 | % | ||||||
|
Employee payment services penetration
|
77 | % | 75 | % | 73 | % | ||||||
|
Paychex HR Solutions client employees served
|
502,000 | 453,000 | 439,000 | |||||||||
|
Paychex HR Solutions clients
|
19,000 | 18,000 | 16,000 | |||||||||
|
Insurance services
clients
(1)
|
92,000 | 86,000 | 79,000 | |||||||||
|
Retirement services clients
|
51,000 | 50,000 | 48,000 | |||||||||
| (1) | Includes workers’ compensation insurance clients and health and benefits services clients. |
Continued investment in our business is critical to our success.
In fiscal 2010, we made investments in our sales force and in
our technological infrastructure. Our sales force increased 2%
to 2,340 sales representatives for fiscal 2010, and is expected
to grow 2% to 2,380 sales representatives for the fiscal year
ending May 31, 2011 (“fiscal 2011”). This growth
is driven primarily by increases in insurance services and other
Human Resource Services offerings.
We have invested over $60 million in an enhanced platform
for our core payroll processing capability, which was fully
implemented in fiscal 2010. This new platform allows us to
leverage efficiencies in our processes and continue to provide
excellent customer service to our clients. Over the next few
years, we expect to expand our enhanced platform to additional
service offerings.
We continued expansion of our insurance services nationwide,
simplifying the process for our clients to obtain coverage
through our network of national and regional insurers. We see
our insurance services as an area that continues to offer
significant opportunities for future growth.
We also strengthened our position as an expert in our industry
by serving as a source of education and information to clients
and other interested parties. The new Paychex Insurance Agency
website,
www.paychexinsurance.com
, helps small business
owners navigate the area of insurance coverage. In addition, we
provide information for existing and prospective clients on the
impacts of regulatory changes, such as the Hiring Incentives to
Restore Employment (“HIRE”) Act and the recently
passed federal health care reform bill.
Our ASO and PEO are now being offered under Paychex HR
Solutions. We integrated the sales and service model to support
and expand our comprehensive human resource outsourcing services
nationwide. This allowed us to eliminate redundancies, and
create more flexible options for potential clients. PEO services
will continue to be sold by the registered and licensed Paychex
Business Solutions, Inc. and its affiliates.
Looking to the future, we continue to focus on investing in our
products, people, and service capabilities. This will position
us to capitalize on opportunities for long term growth.
Financial
position and liquidity
The current credit crisis has resulted in unprecedented
volatility in the global financial markets, which has curtailed
available liquidity and limited investment choices. Despite this
macroeconomic environment, as of May 31, 2010, our
financial position remained strong with cash and total corporate
investments of $656.9 million and no debt.
We continue to follow our conservative investment strategy of
optimizing liquidity and protecting principal. In the past
twenty months, this has translated to significantly lower yields
on high quality instruments, negatively impacting our income
earned on funds held for clients and corporate investments.
Since September 2008, our primary short-term investment vehicle
has been U.S. agency discount notes. Since then, we have
seen gradual improvement in liquidity in certain money market
sectors, and starting in November 2009 we began to invest in
select
A-1/P-1-rated
variable rate demand notes (“VRDNs”). During fiscal
2010, we earned an after-tax rate of approximately 0.21% for
VRDNs compared to approximately 0.07% for U.S. agency
discount notes. We invest primarily in high credit quality
securities with AAA and AA ratings and short-term securities
with
A-1/P-1
ratings.
15
Table of Contents
We limit the amounts that can be invested in any single issuer.
As of May 31, 2010, we had no exposure to British Petroleum
(BP) or any of its subsidiaries. We believe that our investments
as of May 31, 2010 were not
other-than-temporarily
impaired, nor has any event occurred subsequent to that date
that would indicate any
other-than-temporary
impairment. All investments held as of May 31, 2010 are
traded in active markets.
Our primary source of cash is our ongoing operations. Cash flow
from operations was $610.9 million for fiscal 2010.
Historically, we have funded our operations, capital purchases,
and dividend payments from our operating activities. Our
positive cash flows in fiscal 2010 allowed us to support our
business and to pay substantial dividends to our stockholders.
During fiscal 2010, dividends paid to stockholders were 94% of
net income. It is anticipated that cash and total corporate
investments as of May 31, 2010, along with projected
operating cash flows, will support our normal business
operations, capital purchases, and dividend payments for the
foreseeable future.
For further analysis of our results of operations for fiscal
years 2010, 2009, and 2008, and our financial position as of
May 31, 2010, refer to the tables and analysis in the
“Results of Operations” and “Liquidity and
Capital Resources” sections of this Item 7 and the
discussion in the “Critical Accounting Policies”
section of this Item 7.
Outlook
Our outlook for fiscal 2011 is based upon current economic and
interest rate conditions continuing with no significant changes.
Consistent with our policy regarding guidance, our projections
do not anticipate or speculate on future changes to interest
rates. We project that payroll service revenue for fiscal 2011
will be flat compared to fiscal 2010. Human Resource Services
revenue is anticipated to increase in the range of 10% to 13%.
Interest on funds held for clients is expected to decrease in
the range of 12% to 17%, while investment income, net is
expected to increase in the range of 24% to 27%.
Operating income, net of certain items, as a percentage of
service revenue is expected to range from 34% to 35% for fiscal
2011. The effective income tax rate is expected to approximate
35% for fiscal 2011. Net income is expected to improve slightly
over fiscal 2010. However, when the impact of the expense charge
to increase the litigation reserve is excluded from fiscal 2010,
net income growth for fiscal 2011 is expected to be flat.
Interest on funds held for clients and investment income for
fiscal 2011 are expected to be impacted by the low-interest-rate
environment. The average rate of return on our combined funds
held for clients and corporate investment portfolios is expected
to be 1.3% for fiscal 2011. As of May 31, 2010, the
long-term investment portfolio had an average
yield-to-maturity
of 2.9% and an average duration of 2.5 years. In the next
twelve months, slightly over 15% of this portfolio will mature,
and it is currently anticipated that these proceeds will be
reinvested at a lower average interest rate of approximately
1.0%. Investment income is expected to benefit from ongoing
investment of cash generated from operations.
Under normal financial market conditions, the impact to our
earnings from a 25-basis-point increase or decrease in
short-term interest rates would be approximately
$3.5 million, after taxes, for a twelve-month period. Such
a basis point change may or may not be tied to changes in the
Federal Funds rate.
Purchases of property and equipment for fiscal 2011 are expected
to be in the range of $80 million to $85 million, as
we continue to invest in our technological infrastructure.
Fiscal 2011 depreciation expense is projected to be in the range
of $65 million to $70 million, and we project
amortization of intangible assets for fiscal 2011 to be
approximately $20 million.
16
Table of Contents
Results
of Operations
Summary
of Results of Operations for the Fiscal Years Ended May
31:
| In millions, except per share amounts | 2010 | Change | 2009 | Change | 2008 | |||||||||||||||
|
Revenue:
|
||||||||||||||||||||
|
Payroll service revenue
|
$ | 1,404.9 | (5 | )% | $ | 1,483.7 | 1 | % | $ | 1,462.7 | ||||||||||
|
Human Resource Services revenue
|
540.9 | 3 | % | 523.6 | 11 | % | 471.8 | |||||||||||||
|
Total service revenue
|
1,945.8 | (3 | )% | 2,007.3 | 4 | % | 1,934.5 | |||||||||||||
|
Interest on funds held for clients
|
55.0 | (27 | )% | 75.5 | (43 | )% | 131.8 | |||||||||||||
|
Total revenue
|
2,000.8 | (4 | )% | 2,082.8 | 1 | % | 2,066.3 | |||||||||||||
|
Combined operating and SG&A expenses
|
1,276.0 | — | 1,277.6 | 3 | % | 1,238.0 | ||||||||||||||
|
Operating income
|
724.8 | (10 | )% | 805.2 | (3 | )% | 828.3 | |||||||||||||
|
As a % of total revenue
|
36 | % | 39 | % | 40 | % | ||||||||||||||
|
Investment income, net
|
4.5 | (34 | )% | 6.9 | (74 | )% | 26.5 | |||||||||||||
|
Income before income taxes
|
729.3 | (10 | )% | 812.1 | (5 | )% | 854.8 | |||||||||||||
|
As a % of total revenue
|
36 | % | 39 | % | 41 | % | ||||||||||||||
|
Income taxes
|
252.3 | (9 | )% | 278.6 | — | 278.7 | ||||||||||||||
|
Effective income tax rate
|
34.6 | % | 34.3 | % | 32.6 | % | ||||||||||||||
|
Net income
|
$ | 477.0 | (11 | )% | $ | 533.5 | (7 | )% | $ | 576.1 | ||||||||||
|
As a % of total revenue
|
24 | % | 26 | % | 28 | % | ||||||||||||||
|
Diluted earnings per share
|
$ | 1.32 | (11 | )% | $ | 1.48 | (5 | )% | $ | 1.56 | ||||||||||
We invest in highly liquid, investment-grade fixed income
securities and do not utilize derivative instruments to manage
interest rate risk. As of May 31, 2010, we had no exposure
to high-risk or illiquid investments. Details regarding our
combined funds held for clients and corporate investment
portfolios are as follows:
| Year ended May 31, | ||||||||||||
| $ in millions | 2010 | 2009 | 2008 | |||||||||
|
Average investment balances:
|
||||||||||||
|
Funds held for clients
|
$ | 3,167.9 | $ | 3,323.3 | $ | 3,408.9 | ||||||
|
Corporate investments
|
653.8 | 538.2 | 716.7 | |||||||||
|
Total
|
$ | 3,821.7 | $ | 3,861.5 | $ | 4,125.6 | ||||||
|
Average interest rates earned (exclusive of net realized gains):
|
||||||||||||
|
Funds held for clients
|
1.6 | % | 2.2 | % | 3.7 | % | ||||||
|
Corporate investments
|
0.8 | % | 1.4 | % | 3.7 | % | ||||||
|
Combined funds held for clients and corporate investments
|
1.5 | % | 2.1 | % | 3.7 | % | ||||||
|
Net realized gains:
|
||||||||||||
|
Funds held for clients
|
$ | 3.2 | $ | 1.1 | $ | 6.4 | ||||||
|
Corporate investments
|
— | — | — | |||||||||
|
Total
|
$ | 3.2 | $ | 1.1 | $ | 6.4 | ||||||
17
Table of Contents
|
$ in millions
|
||||||||||||
| As of May 31, | 2010 | 2009 | 2008 | |||||||||
|
Net unrealized gains on
available-for-sale
securities
(1)
|
$ | 66.6 | $ | 66.7 | $ | 24.8 | ||||||
|
Federal Funds
rate
(2)
|
0.25 | % | 0.25 | % | 2.00 | % | ||||||
|
Three-year “AAA” municipal securities yield
|
0.99 | % | 1.35 | % | 2.65 | % | ||||||
|
Total fair value of
available-for-sale
securities
|
$ | 2,151.8 | $ | 1,780.9 | $ | 3,353.5 | ||||||
|
Weighted-average duration of
available-for-sale
securities in
years
(3)
|
2.5 | 2.5 | 2.7 | |||||||||
|
Weighted-average
yield-to-maturity
of
available-for-sale
securities
(3)
|
2.9 | % | 3.3 | % | 3.4 | % | ||||||
| (1) | The net unrealized gain of our investment portfolios was approximately $71.9 million as of July 12, 2010. | |
| (2) | The Federal Funds rate was a range of zero to 0.25% as of May 31, 2010 and May 31, 2009. | |
| (3) | These items exclude the impact of VRDNs held as of May 31, 2010 and May 31, 2008, as they are tied to short-term interest rates. We did not hold any VRDNs as of May 31, 2009. |
Payroll service revenue:
Payroll
service revenue decreased 5% to $1.4 billion for fiscal
2010 as a result of the cumulative adverse effects of weak
economic conditions on our client base and check volume. Our
client base decreased 3.2% during fiscal 2010 and checks per
client decreased 2.6% for fiscal 2010 compared to fiscal 2009.
Checks per client has shown modest improvement in each
sequential quarter of fiscal 2010, reflecting
year-over-year
declines of 5.0%, 3.7%, and 2.2% for the first through third
fiscal quarters, and an increase of 1.1% for the three months
ended May 31, 2010 (the “fourth quarter”). At the
end of fiscal 2010, checks per client were slightly higher than
at the end of fiscal 2009. Payroll service revenue increased 1%
to $1.5 billion for fiscal 2009 due to our annual price
increase and growth in utilization of our ancillary payroll
services, offset by impacts of weak economic conditions. During
fiscal 2009, our client base declined 3.1%, affected by a
decline in new client sales from new business starts and clients
lost due to companies going out of business or no longer having
any employees. Checks per client declined 2.9% for fiscal 2009.
Our payroll tax administration services were utilized by 94% of
all our clients as of May 31, 2010, compared with 93% as of
May 31, 2009 and May 31, 2008. Our employee payment
services were utilized by 77% of our clients as of May 31,
2010, compared with 75% as of May 31, 2009 and 73% as of
May 31, 2008. Nearly all new clients purchase our payroll
tax administration services and more than 80% of new clients
select a form of our employee payment services.
Human Resource Services revenue:
Human
Resource Services revenue increased 3% for fiscal 2010 and 11%
for fiscal 2009 to $540.9 million and $523.6 million,
respectively. The following factors contributed to Human
Resource Services revenue growth for fiscal 2010 and fiscal 2009:
|
$ in billions
|
||||||||||||||||||||
| As of May 31, | 2010 | Change | 2009 | Change | 2008 | |||||||||||||||
|
Paychex HR Solutions client employees served
|
502,000 | 11 | % | 453,000 | 3 | % | 439,000 | |||||||||||||
|
Paychex HR Solutions clients
|
19,000 | 8 | % | 18,000 | 10 | % | 16,000 | |||||||||||||
|
Insurance services
clients
(1)
|
92,000 | 7 | % | 86,000 | 9 | % | 79,000 | |||||||||||||
|
Retirement services clients
|
51,000 | 3 | % | 50,000 | 2 | % | 48,000 | |||||||||||||
|
Asset value of retirement services client employees’ funds
|
$ | 11.3 | 33 | % | $ | 8.5 | (12 | )% | $ | 9.7 | ||||||||||
| (1) | Includes workers’ compensation insurance clients and health and benefits services clients. |
In addition, growth in products that are primarily beneficial to
our MMS clients contributed positively to Human Resource
Services revenue growth for fiscal 2010. Health and benefits
service revenue increased 49% to $31.0 million for fiscal
2010 and increased 70% to $20.9 million for fiscal 2009.
18
Table of Contents
While the above factors contributed to the revenue growth in
both fiscal 2010 and fiscal 2009 as compared to the respective
prior year periods, the rates of growth have been adversely
affected by the cumulative impact of weak economic conditions on
our client base growth. This particularly affected retirement
services, although we have seen client growth for retirement
services rebound somewhat late in fiscal 2010 as client losses
have improved compared to the prior year.
Retirement services revenue growth was impacted in both fiscal
2010 and fiscal 2009 by billings in fiscal 2009 related to
restatements of clients’ retirement plans required by
statute, which are not expected to recur for approximately six
years. This favorably impacted retirement services revenue
growth for fiscal 2009 by $12.4 million and did not recur
in fiscal 2010.
In fiscal 2010, Human Resource Services revenue was also
impacted by the sale of Stromberg time and attendance
(“Stromberg”), an immaterial component of Paychex. Our
Human Resource Services revenue growth, excluding Stromberg
revenue and the retirement plan restatement billings, would have
been as follows:
| % Change | 2010 | 2009 | 2008 | |||||||||
|
Human Resource Services revenue, as reported
|
3 | % | 11 | % | 19 | % | ||||||
|
Human Resource Services revenue excluding Stromberg revenue and
retirement plan restatement billings
|
8 | % | 8 | % | 20 | % | ||||||
In fiscal 2010, the 33% increase in the asset value of
retirement services client employees’ funds was driven by
recovery in the financial markets and increased levels of larger
plans converting to Paychex. For fiscal 2009, the volatility in
the financial markets caused the asset value of retirement
services client employees’ funds to decline 12%. The
S&P 500 declined 34% during the same period. For both
fiscal 2010 and fiscal 2009, retirement services revenue growth
was adversely impacted by a shift in the mix of assets in the
retirement services client employees’ funds to investments
earning lower fees from external fund managers.
For fiscal 2009, the decline in asset value and the shift in
client employees’ retirement portfolios to investments
earning lower fees from external fund managers reduced
retirement services revenue growth by $8.9 million. Also
for fiscal 2009, Paychex HR Solutions revenue growth was
adversely impacted by fewer employees per client, decreasing
revenue by $8.7 million.
Total service revenue:
Total service
revenue declined 3% for fiscal 2010 and increased 4% for fiscal
2009. The cumulative effect of the weak economy had a negative
impact on service revenue growth as previously described.
Interest on funds held for clients:
The
decrease of 27% in interest on funds held for clients for fiscal
2010 compared to fiscal 2009 was the result of lower average
interest rates earned and lower average investment balances,
offset somewhat by higher net realized gains on sales of
available-for-sale
securities. The decrease of 43% in interest on funds held for
clients for fiscal 2009 compared to fiscal 2008 was the result
of lower average interest rates earned, lower average investment
balances, and lower net realized gains on sales of
available-for-sale
securities.
Average investment balances for funds held for clients decreased
5% for fiscal 2010 and 3% for fiscal 2009. These declines were
the result of the cumulative adverse effect of weak economic
conditions on our client base and lower tax withholdings for
client employees resulting from the American Recovery and
Reinvestment Act of 2009 (the “economic stimulus
package”). In the second half of fiscal 2010, the impact of
these factors was partially offset by increases in state
unemployment insurance rates for the 2010 calendar year. The
economic stimulus package went into effect in April 2009, and
its impact on
year-over-year
comparisons of average invested balances has abated in the
fourth quarter of fiscal 2010. This factor, along with the
increases in state unemployment insurance rates, resulted in
average invested balances for funds held for clients growing 3%
for the fourth quarter of fiscal 2010 compared to the same
period in fiscal 2009.
Refer to the “Market Risk Factors” section, contained
in Item 7A of this
Form 10-K,
for more information on changing interest rates.
19
Table of Contents
Combined operating and SG&A
expenses:
The following table summarizes
total combined operating and selling, general and administrative
(“SG&A”) expenses for fiscal years:
| In millions | 2010 | Change | 2009 | Change | 2008 | |||||||||||||||
|
Compensation-related expenses
|
$ | 829.3 | (1 | )% | $ | 835.1 | 4 | % | $ | 804.7 | ||||||||||
|
Stock-based compensation costs
|
25.6 | — | 25.7 | 1 | % | 25.4 | ||||||||||||||
|
Facilities expenses
|
60.4 | 1 | % | 59.6 | 4 | % | 57.4 | |||||||||||||
|
Depreciation of property and equipment
|
64.6 | 1 | % | 64.0 | 4 | % | 61.4 | |||||||||||||
|
Amortization of intangible assets
|
21.9 | — | 21.8 | 13 | % | 19.2 | ||||||||||||||
|
Other expenses
|
255.5 | (6 | )% | 271.4 | 1 | % | 269.9 | |||||||||||||
| 1,257.3 | (2 | )% | 1,277.6 | 3 | % | 1,238.0 | ||||||||||||||
|
Expense charge to increase the litigation reserve
|
18.7 | 100 | % | — | — | — | ||||||||||||||
|
Total operating and SG&A expenses
|
$ | 1,276.0 | — | $ | 1,277.6 | 3 | % | $ | 1,238.0 | |||||||||||
During fiscal 2010, we recorded an expense charge of
$18.7 million to increase our litigation reserve. Refer to
Note L of the Notes to Consolidated Financial Statements,
contained in Item 8 of this
Form 10-K,
for additional information on legal matters.
Excluding the expense charge to increase the litigation reserve,
combined operating and SG&A expenses decreased 2% for
fiscal 2010 and increased 3% for fiscal 2009. The decline for
fiscal 2010 was generated from cost control measures and lower
headcount, offset slightly by costs related to continued
investment in our sales force, customer service, and
technological infrastructure. In fiscal 2010, we had a freeze on
salary increases and made no matching contributions to our
401(k) plan. We reinstituted salary increases beginning
March 1, 2010, but the freeze saved us approximately
$15.0 million for fiscal 2010. As of May 31, 2010, no
decision had been made on the reinstatement of the 401(k) match,
although we saved approximately $15.0 million for fiscal
2010 from its suspension. The increase for fiscal 2009 was
primarily due to increases in personnel, though at a slower pace
than prior years, and other costs related to selling and
retaining clients and promoting new services. As of May 31,
2010, we had approximately 12,200 employees compared with
approximately 12,500 employees as of May 31, 2009 and
12,200 employees as of May 31, 2008.
Depreciation expense is primarily related to buildings,
furniture and fixtures, data processing equipment, and software.
Increases in depreciation expense were due to capital
expenditures as we invested in technology and continued to grow
our business. Amortization of intangible assets is primarily
related to client list acquisitions, which are amortized using
either straight-line or accelerated methods. The increase in
amortization in fiscal 2009 was a result of intangibles from
acquisitions and client list acquisitions. Other expenses
include items such as delivery, forms and supplies,
communications, travel and entertainment, professional services,
and other costs incurred to support our business.
Operating income:
Operating income
declined 10% and 3% for fiscal 2010 and fiscal 2009,
respectively. The fluctuations in operating income were
attributable to the factors previously discussed.
Operating income, net of certain items, is as follows for fiscal
years:
| In millions | 2010 | Change | 2009 | Change | 2008 | |||||||||||||||
|
Operating income
|
$ | 724.8 | (10 | )% | $ | 805.2 | (3 | )% | $ | 828.3 | ||||||||||
|
Excluding:
|
||||||||||||||||||||
|
Interest on funds held for clients
|
(55.0 | ) | (27 | )% | (75.5 | ) | (43 | )% | (131.8 | ) | ||||||||||
|
Expense charge to increase the litigation reserve
|
18.7 | 100 | % | — | — | — | ||||||||||||||
|
Operating income, net of certain items
|
$ | 688.5 | (6 | )% | $ | 729.7 | 5 | % | $ | 696.5 | ||||||||||
20
Table of Contents
Refer to the previous discussion of operating income, net of
certain items, in the “Non-GAAP Financial
Measure” section on page 14.
Investment income, net:
Investment
income, net, primarily represents earnings from our cash and
cash equivalents and investments in
available-for-sale
securities. Investment income does not include interest on funds
held for clients, which is included in total revenue. The
decrease of 34% in investment income for fiscal 2010 compared to
fiscal 2009 was the result of lower average interest rates
earned offset somewhat by higher average investment balances
resulting from investment of cash generated from operations. The
decrease of 74% in investment income for fiscal 2009 compared
with fiscal 2008 was primarily due to lower average interest
rates earned and lower average investment balances attributed to
funding the stock repurchase program, which was completed in
December 2007.
Income taxes:
Our effective income tax
rate was 34.6% for fiscal 2010, compared with 34.3% for fiscal
2009, and 32.6% for fiscal 2008. The increase in our effective
income tax rate for fiscal 2010 was primarily the result of
higher state income tax rates from state legislative changes.
The increase in the effective income tax rate for fiscal 2009
was primarily the result of lower levels of tax-exempt income
derived from municipal debt securities in the funds held for
clients and corporate investment portfolios. Refer to
Note H of the Notes to Consolidated Financial Statements,
contained in Item 8 of this
Form 10-K,
for additional disclosures on income taxes.
Net income and earnings per share:
Net
income decreased 11% for fiscal 2010 and 7% for fiscal 2009 to
$477.0 million and $533.5 million, respectively.
Diluted earnings per share decreased 11% for fiscal 2010 and 5%
for fiscal 2009 to $1.32 per share and $1.48 per share,
respectively. These fluctuations were attributable to the
factors previously discussed. In particular, the
$18.7 million expense charge to increase the litigation
reserve reduced diluted earnings per share by $0.03 per share
for fiscal 2010. Combined interest on funds held for clients and
corporate investment income for fiscal 2010 decreased 28% or
$22.8 million, reducing diluted earnings per share by $0.04
per share. For fiscal 2009, combined interest on funds held for
clients and corporate investment income decreased 48% or
$76.0 million, reducing diluted earnings per share by $0.14
per share. For fiscal 2009, diluted earnings per share decreased
at a lower rate than net income due to a lower number of
weighted-average shares outstanding resulting from the stock
repurchase program completed in December 2007.
Liquidity
and Capital Resources
The volatility in the global financial markets that began in
September 2008 curtailed available liquidity and limited
investment choices. Despite this macroeconomic environment, our
financial position as of May 31, 2010 remained strong with
cash and total corporate investments of $656.9 million and
no debt. We also believe that our investments as of May 31,
2010 were not
other-than-temporarily
impaired, nor has any event occurred subsequent to that date
that would indicate any
other-than-temporary
impairment. It is anticipated that cash and total corporate
investments as of May 31, 2010, along with projected
operating cash flows, are expected to support our normal
business operations, capital purchases, and dividend payments
for the foreseeable future.
Commitments
and Contractual Obligations
Lines of credit:
As of May 31,
2010, we had unused borrowing capacity available under four
uncommitted, secured, short-term lines of credit at market rates
of interest with financial institutions as follows:
| Financial institution | Amount available | Expiration date | ||||||
|
JP Morgan Chase Bank, N.A.
|
$ | 350 million | February 2011 | |||||
|
Bank of America, N.A.
|
$ | 250 million | February 2011 | |||||
|
PNC Bank, National Association
|
$ | 150 million | February 2011 | |||||
|
Wells Fargo Bank, National Association
|
$ | 150 million | February 2011 | |||||
Our credit facilities are evidenced by promissory notes and are
secured by separate pledge security agreements by and between
Paychex, Inc. and each of the financial institutions (the
“Lenders”), pursuant to which we have granted each of
the Lenders a security interest in certain of our investment
securities accounts. The collateral is maintained in a pooled
custody account pursuant to the terms of a control agreement and
is to be administered under an intercreditor agreement among the
Lenders. Under certain circumstances, individual Lenders may
require that
21
Table of Contents
collateral be transferred from the pooled account into
segregated accounts for the benefit of such individual Lenders.
The primary uses of the lines of credit would be to meet
short-term funding requirements related to deposit account
overdrafts and client fund obligations arising from electronic
payment transactions on behalf of our clients in the ordinary
course of business, if necessary. No amounts were outstanding
against these lines of credit during fiscal 2010 or as of
May 31, 2010.
JP Morgan Chase Bank, N.A. and Bank of America, N.A. are also
parties to our irrevocable standby letters of credit, which
arrangements are discussed below.
Letters of credit:
As of May 31,
2010, we had irrevocable standby letters of credit outstanding
totaling $50.3 million, required to secure commitments for
certain of our insurance policies. The letters of credit expire
at various dates between July 2010 and May 2011, and are
collateralized by securities held in our investment portfolios.
No amounts were outstanding on these letters of credit during
fiscal 2010 or as of May 31, 2010. Subsequent to
May 31, 2010, the letter of credit expiring in
July 2010 was renewed and will expire in July 2011.
Other commitments:
We have entered into
various operating leases and purchase obligations that, under
GAAP, are not reflected on the Consolidated Balance Sheets as of
May 31, 2010. The table below summarizes our estimated
annual payment obligations under these commitments as of
May 31, 2010:
| Payments due by period | ||||||||||||||||||||
|
Less than
|
More than
|
|||||||||||||||||||
| In millions | Total | 1 year | 1-3 years | 4-5 years | 5 years | |||||||||||||||
|
Operating
leases
(1)
|
$ | 147.9 | $ | 41.4 | $ | 59.8 | $ | 32.1 | $ | 14.6 | ||||||||||
|
Purchase
obligations
(2)
|
73.0 | 46.2 | 23.6 | 2.3 | 0.9 | |||||||||||||||
|
Total
|
$ | 220.9 | $ | 87.6 | $ | 83.4 | $ | 34.4 | $ | 15.5 | ||||||||||
| (1) | Operating leases are primarily for office space and equipment used in our branch operations. | |
| (2) | Purchase obligations include our estimate of the minimum outstanding commitments under purchase orders to buy goods and services and legally binding contractual arrangements with future payment obligations. Included in the total purchase obligations is $8.9 million of commitments to purchase capital assets. Amounts actually paid under certain of these arrangements may be higher due to variable components of these agreements. |
The liability for uncertain tax positions was approximately
$27.5 million as of May 31, 2010. Refer to Note H
of the Notes to Consolidated Financial Statements, contained in
Item 8 of this
Form 10-K,
for more information on income taxes. We are not able to
reasonably estimate the timing of future cash flows related to
this liability and have excluded it from the table above. We are
currently under a state income tax audit for the years ended
May 31, 2004 through 2007. The examination phase of the
audit is ongoing and we have received a summary of proposed
audit adjustments. It is not possible for us to reasonably
estimate the impact, if any, if resolution of these proposed
adjustments is ultimately unfavorable to us.
Certain deferred compensation plan obligations and other
long-term liabilities amounting to $46.9 million are
excluded from the table above because the timing of actual
payments cannot be specifically or reasonably determined due to
the variability in assumptions required to project the timing of
future payments.
Advantage Payroll Services Inc. (“Advantage”) has
license agreements with independently owned associate offices
(“Associates”), which are responsible for selling and
marketing Advantage payroll services and performing certain
operational functions, while Paychex and Advantage provide all
centralized back-office payroll processing and payroll tax
administration services. Under these arrangements, Advantage
pays the Associates commissions based on processing activity for
the related clients. When we acquired Advantage, there were
fifteen Associates. Over the past few years, some arrangements
with various Associates have been discontinued, and there are
currently fewer than ten Associates. Since the actual amounts of
future payments are uncertain, obligations under these
arrangements are not included in the table above. Commission
expense for the Associates for fiscal years 2010, 2009, and 2008
was $9.9 million, $12.3 million, and
$15.3 million, respectively.
22
Table of Contents
We guarantee performance of service on annual maintenance
contracts for clients who financed their service contracts
through a third party. In the normal course of business, we make
representations and warranties that guarantee the performance of
services under service arrangements with clients. Historically,
there have been no material losses related to such guarantees.
In addition, we have entered into indemnification agreements
with our officers and directors, which require us to defend and,
if necessary, indemnify these individuals for certain pending or
future legal claims as they relate to their services provided to
us.
We currently self-insure the deductible portion of various
insured exposures under certain employee benefit plans. Our
estimated loss exposure under these insurance arrangements is
recorded in other current liabilities on our Consolidated
Balance Sheets. Historically, the amounts accrued have not been
material. We also maintain insurance coverage in addition to our
purchased primary insurance policies for gap coverage for
employment practices liability, errors and omissions, warranty
liability, and acts of terrorism; and capacity for deductibles
and self-insured retentions through our captive insurance
company.
Off-Balance
Sheet Arrangements
As part of our ongoing business, we do not participate in
transactions with unconsolidated entities such as special
purpose entities or structured finance entities, which would
have been established for the purpose of facilitating
off-balance sheet arrangements or other limited purposes. We do
maintain investments as a limited partner in low-income housing
projects that are not considered part of our ongoing operations.
These investments are accounted for under the equity method of
accounting and are less than 1% of our total assets as of
May 31, 2010.
Operating
Cash Flow Activities
| Year ended May 31, | ||||||||||||
| In millions | 2010 | 2009 | 2008 | |||||||||
|
Net income
|
$ | 477.0 | $ | 533.5 | $ | 576.1 | ||||||
|
Non-cash adjustments to net income
|
161.3 | 134.4 | 125.4 | |||||||||
|
Cash (used in)/provided by changes in operating assets and
liabilities
|
(27.4 | ) | 20.9 | 23.2 | ||||||||
|
Net cash provided by operating activities
|
$ | 610.9 | $ | 688.8 | $ | 724.7 | ||||||
The decrease in our operating cash flows for fiscal 2010 related
primarily to lower net income adjusted for non-cash items and
changes in operating assets and liabilities. The increase in
non-cash adjustments to net income in fiscal 2010 is primarily
due to the $18.7 million expense charge to increase the
litigation reserve, partially offset by the related increase in
deferred tax benefit. The decrease in our operating cash flows
for fiscal 2009 was attributable to lower net income. The
increase in non-cash adjustments to net income in fiscal 2009 is
primarily due to higher depreciation and amortization on
property and equipment and intangible assets. The fluctuations
in our operating assets and liabilities between periods for both
fiscal 2010 and fiscal 2009 were primarily related to the timing
of collections from clients and payments for compensation, PEO
payroll, income tax, and other liabilities.
Investing
Cash Flow Activities
| Year ended May 31, | ||||||||||||
| In millions | 2010 | 2009 | 2008 | |||||||||
|
Net change in funds held for clients and corporate investment
activities
|
$ | (341.2 | ) | $ | 491.4 | $ | 1,067.3 | |||||
|
Purchases of property and equipment, net of proceeds from the
sale of property and equipment
|
(61.3 | ) | (64.1 | ) | (81.6 | ) | ||||||
|
Sale/(acquisition) of businesses
|
13.1 | (6.4 | ) | (32.9 | ) | |||||||
|
Purchases of other assets
|
(11.9 | ) | (16.4 | ) | (19.6 | ) | ||||||
|
Net cash (used in)/provided by investing activities
|
$ | (401.3 | ) | $ | 404.5 | $ | 933.2 | |||||
Funds held for clients and corporate
investments:
Funds held for clients consist
of short-term funds and
available-for-sale
securities. Corporate investments are primarily comprised of
available-for-sale
securities. The
23
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portfolio of funds held for clients and corporate investments is
detailed in Note D of the Notes to Consolidated Financial
Statements, contained in Item 8 of this
Form 10-K.
The fluctuations in the net change in funds held for clients and
corporate investment activities reflect the changing mix of
investments. As a result of volatility in the financial markets,
in September 2008 we divested of any VRDN securities held and
began to utilize U.S. agency discount notes as our primary
short-term investment vehicle. U.S. agency discount notes
are cash equivalents. VRDNs, although priced and traded as
short-term securities, are classified as
available-for-sale
securities and the cash paid and proceeds received for these
securities are included in investing activities. As a result of
the divestiture, the proceeds from sales of
available-for-sale
securities exceeded the purchases of
available-for-sale
securities in fiscal 2009. Much of these proceeds were held as
cash equivalents in the funds held for clients portfolio. In
November 2009, we began to again invest in select
A-1/P-1-rated
VRDNs, although at considerably lower levels than in the prior
year. We utilized some of our cash equivalents to purchase these
VRDNs, and in fiscal 2010 these purchases of
available-for-sale
securities were in excess of funds received from any sales of
available-for-sale
securities. Also in fiscal 2010, more corporate funds have been
invested in longer-term municipal bonds. There is a significant
decline in net cash received from changes in funds held for
clients and corporate investment activities in fiscal 2009
compared to fiscal 2008 related to proceeds from sales of
available-for-sale
securities in fiscal 2008 that were not reinvested as part of
the funding of the $1.0 billion stock repurchase program
completed in December 2007.
In general, fluctuations in net funds held for clients and
corporate investment activities primarily relate to timing of
purchases, sales, or maturities of investments. The amount of
funds held for clients will vary based upon the timing of
collecting client funds, and the related remittance of funds to
applicable tax or regulatory agencies for payroll tax
administration services and to employees of clients utilizing
employee payment services. Additional discussion of interest
rates and related risks is included in the “Market Risk
Factors” section, contained in Item 7A of this
Form 10-K.
Purchases of long-lived assets:
To
support our continued client and ancillary product growth,
purchases of property and equipment were made for data
processing equipment and software, and for the expansion and
upgrade of various operating facilities. During fiscal 2010,
fiscal 2009, and fiscal 2008, we purchased approximately
$3.2 million, $4.5 million, and $4.4 million,
respectively, of data processing equipment and software from
EMC Corporation. The Chairman, President, and Chief
Executive Officer of EMC Corporation is a member of our Board of
Directors (the “Board”).
During fiscal 2010, we received $13.1 million from the sale
of Stromberg, an immaterial component of the Company. During
fiscal 2009 and fiscal 2008, we paid $6.4 million and
$32.9 million, respectively, related to acquisitions of
businesses. The acquisitions in fiscal 2008 related mainly to
employee benefits products. The purchases of other assets were
for customer lists.
Financing
Cash Flow Activities
| Year ended May 31, | ||||||||||||
| In millions, except per share amounts | 2010 | 2009 | 2008 | |||||||||
|
Net change in client fund obligations
|
$ | 42.3 | $ | (346.0 | ) | $ | (198.7 | ) | ||||
|
Repurchases of common stock
|
— | — | (1,000.0 | ) | ||||||||
|
Dividends paid
|
(448.6 | ) | (447.7 | ) | (442.1 | ) | ||||||
|
Proceeds from and excess tax benefit related to exercise of
stock options
|
8.2 | 9.0 | 67.8 | |||||||||
|
Net cash used in financing activities
|
$ | (398.1 | ) | $ | (784.7 | ) | $ | (1,573.0 | ) | |||
|
Cash dividends per common share
|
$ | 1.24 | $ | 1.24 | $ | 1.20 | ||||||
Net change in client fund
obligations:
The client fund obligations
liability will vary based on the timing of collecting client
funds, and the related required remittance of funds to
applicable tax or regulatory agencies for payroll tax
administration services and to employees of clients utilizing
employee payment services. Collections from clients are
typically remitted from one to 30 days after receipt, with
some items extending to 90 days. As a
24
Table of Contents
result of May 31, 2010 being a Federal holiday, client fund
obligations were higher as collections were made on Friday,
May 28, 2010 that were not remitted to client employees and
tax or regulatory agencies until June 2010. Also, in fiscal 2010
we have seen an increase in client fund obligations as a result
of higher withholdings for state unemployment insurance related
to rate increases for the 2010 calendar year.
Repurchases of common stock:
We
repurchased 23.7 million shares of common stock for a total
of $1.0 billion under our stock repurchase program
completed in December 2007.
Dividends paid:
A quarterly dividend of
$0.31 per share was paid to stockholders of record during fiscal
2010 and fiscal 2009. In July 2008, our Board approved a 3%
increase in our quarterly dividend payment to $0.31 per share
from $0.30 per share. The dividends paid as a percentage of net
income totaled 94%, 84%, and 77% for fiscal 2010, fiscal 2009,
and fiscal 2008, respectively. The payment of future dividends
is dependent on our future earnings and cash flow and is subject
to the discretion of our Board.
Exercise of stock options:
Proceeds
from and excess tax benefit related to exercise of stock options
decreased for fiscal 2010 and for fiscal 2009 as compared to the
respective prior years. Common shares acquired through exercise
of stock options were 0.4 million shares for each of fiscal
2010 and fiscal 2009 and 2.0 million shares for fiscal
2008. Refer to Note B to the Notes to Consolidated
Financial Statements, contained in Item 8 of this
Form 10-K,
for additional disclosures on our stock-based compensation
incentive plans.
Other
Recently adopted accounting
pronouncements:
Refer to Note A of the
Notes to Consolidated Financial Statements for a discussion of
recently adopted accounting pronouncements.
Recently issued accounting
pronouncements:
At this time, we do not
anticipate that recently issued accounting guidance that has not
yet been adopted will have a material impact on our Consolidated
Financial Statements. Refer to Note A of the Notes to
Consolidated Financial Statements for a discussion of recently
issued accounting pronouncements.
Critical
Accounting Policies
Note A of the Notes to Consolidated Financial Statements,
contained in Item 8 of this
Form 10-K,
discusses the significant accounting policies of Paychex, Inc.
Our discussion and analysis of our financial condition and
results of operations are based upon our Consolidated Financial
Statements, which have been prepared in accordance with
U.S. GAAP. The preparation of these financial statements
requires us to make estimates, judgments, and assumptions that
affect reported amounts of assets, liabilities, revenue, and
expenses. On an ongoing basis, we evaluate the accounting
policies and estimates used to prepare the Consolidated
Financial Statements. We base our estimates on historical
experience, future expectations, and assumptions believed to be
reasonable under current facts and circumstances. Actual amounts
and results could differ from these estimates. Certain
accounting policies that are deemed critical to our results of
operations or financial position are discussed below.
Revenue recognition:
Service revenue is
recognized in the period services are rendered and earned under
service arrangements with clients where service fees are fixed
or determinable and collectibility is reasonably assured.
Certain processing services are provided under annual service
arrangements with revenue recognized ratably over the annual
service period. Our service revenue is largely attributable to
payroll-related processing services where the fee is based on a
fixed amount per processing period or a fixed amount per
processing period plus a fee per employee or transaction
processed. The revenue earned from delivery service for the
distribution of certain client payroll checks and reports is
included in service revenue, and the costs for delivery are
included in operating expenses on the Consolidated Statements of
Income.
PEO revenue is included in service revenue and is reported net
of direct costs billed and incurred, which include wages, taxes,
benefit premiums, and claims of PEO worksite employees. Direct
costs billed and incurred were $3.1 billion for fiscal
2010, and $2.6 billion for both fiscal 2009 and fiscal 2008.
Revenue from certain time and attendance solutions is recognized
when all of the following are present: persuasive evidence that
an arrangement exists, typically a non-cancelable sales order;
delivery is complete for the
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Table of Contents
software and hardware; the fee is fixed or determinable and free
of contingencies; and collectibility is reasonably assured.
Maintenance contracts are generally purchased by our clients in
conjunction with their purchase of certain time and attendance
solutions. Revenue from these maintenance contracts is
recognized ratably over the term of the contract.
In certain situations we allow a client a right of return or
refund. We maintain an allowance for returns, which is based on
historical data. The allowance is reviewed periodically for
adequacy with any adjustment to revenue reflected in our results
of operations for the period in which the adjustment is
identified.
Interest on funds held for clients is earned primarily on funds
that are collected from clients before due dates for payroll tax
administration services and for employee payment services, and
invested until remittance to the applicable tax or regulatory
agencies or client employees. These collections from clients are
typically remitted from one to 30 days after receipt, with
some items extending to 90 days. The interest earned on
these funds is included in total revenue on the Consolidated
Statements of Income because the collecting, holding, and
remitting of these funds are critical components of providing
these services. Interest on funds held for clients also includes
net realized gains and losses from the sales of
available-for-sale
securities.
PEO workers’ compensation
insurance:
Workers’ compensation
insurance reserves are established to provide for the estimated
costs of paying claims underwritten by us. These reserves
include estimates for reported losses, plus amounts for those
claims incurred but not reported and estimates of certain
expenses associated with processing and settling the claims. In
establishing the workers’ compensation insurance reserves,
we use an independent actuarial estimate of undiscounted future
cash payments that would be made to settle the claims.
Estimating the ultimate cost of future claims is an uncertain
and complex process based upon historical loss experience and
actuarial loss projections, and is subject to change due to
multiple factors, including economic trends, changes in legal
liability law, and damage awards, all of which could materially
impact the reserves as reported in the Consolidated Financial
Statements. Accordingly, final claim settlements may vary from
our present estimates, particularly when those payments may not
occur until well into the future.
We regularly review the adequacy of our estimated workers’
compensation insurance reserves. Adjustments to previously
established reserves are reflected in our results of operations
for the period in which the adjustment is identified. Such
adjustments could possibly be significant, reflecting any
variety of new and adverse or favorable trends.
Our maximum individual claims liability was $1.0 million
under both the fiscal 2010 and fiscal 2009 policies. As of
May 31, 2010 and May 31, 2009, we had recorded current
liabilities of $5.8 million and $7.9 million,
respectively, and long-term liabilities of $20.1 million
and $17.9 million, respectively, for workers’
compensation claims.
Goodwill and other intangible
assets:
We have $421.6 million and
$433.3 million of goodwill recorded on our Consolidated
Balance Sheet as of May 31, 2010 and May 31, 2009,
respectively, resulting from acquisitions of businesses. The
decrease in goodwill was due to the divestiture in fiscal 2010
of Stromberg, an immaterial component of the Company.
Goodwill is not amortized, but instead tested for impairment on
an annual basis and between annual tests if an event occurs or
circumstances change in a way to indicate that there has been a
potential decline in the fair value of the reporting unit.
Impairment is determined by comparing the estimated fair value
of the reporting unit to its carrying amount, including
goodwill. Our business is largely homogeneous and, as a result,
substantially all of the goodwill is associated with one
reporting unit. We perform our annual impairment testing in our
fiscal fourth quarter. Based on the results of our reviews, no
impairment loss was recognized in the results of operations for
fiscal 2010 or fiscal 2009. Subsequent to this review, there
have been no events or circumstances that indicate any potential
impairment of our goodwill balance.
We also test intangible assets for potential impairment when
events or changes in circumstances indicate that the carrying
value may not be recoverable.
Stock-based compensation costs:
All
stock-based awards to employees, including grants of stock
options, are recognized as compensation costs in our
Consolidated Financial Statements based on their fair values
measured
26
Table of Contents
as of the date of grant. We estimate the fair value of stock
option grants using a Black-Scholes option pricing model. This
model requires various assumptions as inputs including expected
volatility of the Paychex stock price and expected option life.
We estimate volatility based on a combination of historical
volatility using weekly stock prices over a period equal to the
expected option life and implied market volatility. Expected
option life is estimated based on historical exercise behavior.
We are required to estimate forfeitures and only record
compensation costs for those awards that are expected to vest.
Our assumptions for forfeitures were determined based on type of
award and historical experience. Forfeiture assumptions are
adjusted at the point in time a significant change is identified
with any adjustment recorded in the period of change, and the
final adjustment at the end of the requisite service period to
equal actual forfeitures.
The assumptions of volatility, expected option life, and
forfeitures all require significant judgment and are subject to
change in the future due to factors such as employee exercise
behavior, stock price trends, and changes to type or provisions
of stock-based awards. Any change in one or more of these
assumptions could have a material impact on the estimated fair
value of an award and on stock-based compensation costs
recognized in our results of operations.
We have determined that the Black-Scholes option pricing model,
as well as the underlying assumptions used in its application,
is appropriate in estimating the fair value of stock option
grants. We periodically reassess our assumptions as well as our
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.
Income taxes:
We account 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 Consolidated 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 basis of assets and liabilities using enacted
tax rates in effect for the year in which the differences are
expected to reverse. We record a deferred tax asset related to
the stock-based compensation costs recognized for certain
stock-based awards. At the time of exercise of non-qualified
stock options or vesting of stock awards, we account for the
resulting tax deduction by reducing our accrued income tax
liability with an offset to the deferred tax asset and any
excess tax benefit increasing additional paid-in capital. We
currently have a sufficient pool of excess tax benefits in
additional paid-in capital to absorb any deficient tax benefits
related to stock-based awards.
We maintain a reserve for uncertain tax positions. We evaluate
tax positions taken or expected to be taken in a tax return for
recognition in our Consolidated Financial Statements. Prior to
recording the related tax benefit in our Consolidated Financial
Statements, we must conclude that tax positions must be
“more likely than not” to be sustained, assuming those
positions will be examined by taxing authorities with full
knowledge of all relevant information. The benefit recognized in
our Consolidated Financial Statements is the amount we expect to
realize after examination by taxing authorities. If a tax
position drops below the “more likely than not”
standard, the benefit can no longer be recognized. Assumptions,
judgment, and the use of estimates are required in determining
if the “more likely than not” standard has been met
when developing the provision for income taxes and in
determining the expected benefit. A change in the assessment of
the “more likely than not” standard could materially
impact our results of operations or financial position. Our
reserve for uncertain tax positions was $27.5 million as of
May 31, 2010 and $25.7 million as of May 31,
2009. Refer to Note H of the Notes to Consolidated
Financial Statements for further discussion of our reserve for
uncertain tax positions.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Market
Risk Factors
Changes in interest rates and interest rate
risk:
Funds held for clients are primarily
comprised of short-term funds and
available-for-sale
securities. Corporate investments are primarily comprised of
available-for-sale
securities. As a result of our operating and investing
activities, we are exposed to changes in interest rates that may
materially affect our results of operations and financial
position. Changes in interest rates will impact the
27
Table of Contents
earnings potential of future investments and will cause
fluctuations in the fair value of our longer-term
available-for-sale
securities. We follow a conservative investment strategy of
optimizing liquidity and protecting principal. We invest
primarily in high credit quality securities with AAA and AA
ratings and short-term securities with
A-1/P-1
ratings. We limit the amounts that can be invested in any single
issuer and invest in short- to intermediate-term instruments
whose fair value is less sensitive to interest rate changes. We
manage the
available-for-sale
securities to a benchmark duration of two and one-half to three
years. All investments held as of May 31, 2010 are traded
in active markets.
Since September 2008, our primary short-term investment vehicle
has been U.S. agency discount notes. In September 2008, we
sold all of our holdings of VRDNs and prime money market funds
as a result of turmoil in the related markets. No losses were
recognized on those sales. The proceeds from the sales of these
investments were reinvested in U.S. agency discount notes.
Since then, we have seen gradual improvement in liquidity in
certain money market sectors, and starting in November 2009 we
began to invest in select
A-1/P-1-rated
VRDNs. During fiscal 2010, we earned an after-tax rate of
approximately 0.21% for VRDNs compared to approximately 0.07%
for U.S. agency discount notes. We have no exposure to
high-risk or illiquid investments such as auction rate
securities,
sub-prime
mortgage securities, asset-backed securities or asset-backed
commercial paper, collateralized debt obligations, enhanced cash
or cash plus mutual funds, or structured investment vehicles
(SIVs). We have not and do not utilize derivative financial
instruments to manage our interest rate risk.
During fiscal 2010, the average interest rate earned on our
combined funds held for clients and corporate investment
portfolios was 1.5%, compared with 2.1% for fiscal 2009 and 3.7%
for fiscal 2008. With the turmoil in the financial markets, our
conservative investment strategy has translated to significantly
lower yields on high quality instruments. When interest rates
are falling, the full impact of lower interest rates will not
immediately be reflected in net income due to the interaction of
short- and long-term interest rate changes. During a falling
interest rate environment, the decreases in interest rates
decrease earnings from our short-term investments, and over time
decrease earnings from our longer-term
available-for-sale
securities. Earnings from the
available-for-sale
securities, which as of May 31, 2010 had an average
duration of 2.5 years, would not reflect decreases in
interest rates until the investments are sold or mature and the
proceeds are reinvested at lower rates. In the next twelve
months, slightly over 15% of our
available-for-sale
portfolio will mature, and it is currently anticipated that
these proceeds will be reinvested at a lower average interest
rate of approximately 1.0%.
The amortized cost and fair value of
available-for-sale
securities that had stated maturities as of May 31, 2010
are shown below by contractual maturity. Expected maturities can
differ from contractual maturities because borrowers may have
the right to prepay obligations without prepayment penalties.
| May 31, 2010 | ||||||||
| In millions | Amortized cost | Fair value | ||||||
|
Maturity date:
|
||||||||
|
Due in one year or less
|
$ | 320.3 | $ | 324.0 | ||||
|
Due after one year through three years
|
756.3 | 783.1 | ||||||
|
Due after three years through five years
|
499.5 | 526.1 | ||||||
|
Due after five years
|
509.1 | 518.6 | ||||||
|
Total
|
$ | 2,085.2 | $ | 2,151.8 | ||||
VRDNs are primarily categorized as due after five years in the
table above as the contractual maturities on these securities
are typically 20 to 30 years. Although these securities are
issued as long-term securities, they are priced and traded as
short-term instruments because of the liquidity provided through
the tender feature.
28
Table of Contents
The following table summarizes the changes in the Federal Funds
rate over the past three fiscal years:
| 2010 | 2009 | 2008 | ||||||||||
|
Federal Funds rate — beginning of fiscal year
|
0.25 | % | 2.00 | % | 5.25 | % | ||||||
|
Rate decrease:
|
||||||||||||
|
First quarter
|
— | — | — | |||||||||
|
Second quarter
|
— | (1.00 | ) | (0.75 | ) | |||||||
|
Third quarter
|
— | (0.75 | ) | (1.50 | ) | |||||||
|
Fourth quarter
|
— | — | (1.00 | ) | ||||||||
|
Federal Funds rate — end of fiscal
year
(1)
|
0.25 | % | 0.25 | % | 2.00 | % | ||||||
|
Three-year “AAA” municipal securities
yields — end of fiscal year
|
0.99 | % | 1.35 | % | 2.65 | % | ||||||
| (1) | The Federal Funds rate was a range of zero to 0.25% as of May 31, 2010 and May 31, 2009. |
Calculating the future effects of changing interest rates
involves many factors. These factors include, but are not
limited to:
| • | daily interest rate changes; | |
| • | seasonal variations in investment balances; | |
| • | actual duration of short-term and available-for-sale securities; | |
| • | the proportional mix of taxable and tax-exempt investments; | |
| • | changes in tax-exempt municipal rates versus taxable investment rates, which are not synchronized or simultaneous; and | |
| • | financial market volatility and the resulting effect on benchmark and other indexing interest rates. |
Subject to these factors and under normal financial market
conditions, a 25-basis-point change in taxable interest rates
generally affects our tax-exempt interest rates by approximately
17 basis points.
Our total investment portfolio (funds held for clients and
corporate investments) averaged approximately $3.8 billion
for fiscal 2010. Our anticipated allocation is approximately 50%
invested in short-term securities and
available-for-sale
securities with an average duration of less than 30 days,
and 50% invested in
available-for-sale
securities with an average duration of two and one-half to three
years.
The combined funds held for clients and corporate
available-for-sale
securities reflected a net unrealized gain of $66.6 million
as of May 31, 2010, compared with a net unrealized gain of
$66.7 million as of May 31, 2009. During fiscal 2010,
the net unrealized gain on our investment portfolios ranged from
$55.1 million to $82.4 million. During fiscal 2009,
the investment portfolios ranged from a net unrealized loss of
$15.2 million to a net unrealized gain of
$86.6 million. The net unrealized gain of our investment
portfolios was approximately $71.9 million as of
July 12, 2010.
As of May 31, 2010 and May 31, 2009, we had
$2.2 billion and $1.8 billion, respectively, invested
in
available-for-sale
securities at fair value. The weighted-average
yield-to-maturity
was 2.9% and 3.3% as of May 31, 2010 and May 31, 2009,
respectively. The weighted-average
yield-to-maturity
excludes
available-for-sale
securities tied to short-term interest rates such as the VRDNs
held as of May 31, 2010. We held no VRDNs as of
May 31, 2009. Assuming a hypothetical decrease in both
short-term and longer-term interest rates of 25 basis
points, the resulting potential increase in fair value for our
portfolio of
available-for-sale
securities as of May 31, 2010, would be approximately
$12.0 million. Conversely, a corresponding increase in
interest rates would result in a comparable decrease 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. These fluctuations in
fair value would have no related or immediate impact on the
results of operations, unless any declines in fair value were
considered to be
other-than-temporary
and an impairment loss recognized.
29
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Credit risk:
We are exposed to credit
risk in connection with these investments through the possible
inability of borrowers to meet the terms of their bonds. We
regularly review our investment portfolios to determine if any
investment is
other-than-temporarily
impaired due to changes in credit risk or other potential
valuation concerns. We believe that the investments we held as
of May 31, 2010 were not
other-than-temporarily
impaired. While $73.6 million of our
available-for-sale
securities had fair values that were below amortized cost, we
believe that it is probable that the principal and interest will
be collected in accordance with the contractual terms, and that
the decline in the fair value to $0.4 million below
amortized cost was due to changes in interest rates and was not
due to increased credit risk or other valuation concerns. All of
the securities in an unrealized loss position as of May 31,
2010 and the majority of the securities in an unrealized loss
position as of May 31, 2009 held an AA rating or better. We
intend to hold these investments until the recovery of their
amortized cost basis or maturity, and further believe that it is
more likely than not that we will not be required to sell these
investments prior to that time. Our assessment that an
investment is not
other-than-temporarily
impaired could change in the future due to new developments or
changes in our strategies or assumptions related to any
particular investment.
30
Table of Contents
REPORT ON
MANAGEMENT’S ASSESSMENT OF
INTERNAL CONTROL OVER FINANCIAL REPORTING
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Paychex, Inc. (the “Company”) is
responsible for establishing and maintaining an adequate system
of internal control over financial reporting as such term is
defined in
Rules 13a-15(f)
and
15d-15(f)
under the Securities Exchange Act of 1934, as amended. The
Company’s internal control over financial reporting is
designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of the
Consolidated Financial Statements. Our internal control over
financial reporting is supported by a program of internal audits
and appropriate reviews by management, written policies and
guidelines, and careful selection and training of qualified
personnel.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements and
even when determined to be effective, can only provide
reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any
evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies
or procedures may deteriorate.
The Audit Committee of our Company’s Board of Directors
meets with the independent registered public accounting firm
(the “independent accountants”), management, and
internal auditors periodically to discuss internal control over
financial reporting and auditing and financial reporting
matters. The Audit Committee reviews with the independent
accountants the scope and results of the audit effort. The Audit
Committee also meets periodically with the independent
accountants and the chief internal auditor without management
present to ensure that the independent accountants and the chief
internal auditor have free access to the Audit Committee. The
Audit Committee’s Report can be found in the Definitive
Proxy Statement to be issued in connection with the
Company’s 2010 Annual Meeting of Stockholders.
Management assessed the effectiveness of the Company’s
internal control over financial reporting as of May 31,
2010. In making this assessment, management used the criteria
set forth by the Committee of Sponsoring Organizations of the
Treadway Commission in “Internal Control —
Integrated Framework.” Based on our assessment, management
believes that the Company maintained effective internal control
over financial reporting as of May 31, 2010.
The Company’s independent accountants, Ernst &
Young LLP, an independent registered public accounting firm, are
appointed by its Audit Committee. Ernst & Young LLP
has audited and reported on the Consolidated Financial
Statements of Paychex, Inc. and the effectiveness of the
Company’s internal control over financial reporting. The
reports of the independent accountants are contained in this
Annual Report on
Form 10-K.
|
/s/ Jonathan
J. Judge
President and Chief Executive Officer |
/s/ John
M. Morphy
Senior Vice President, Chief Financial Officer, and Secretary |
32
Table of Contents
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING
ON EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The Audit Committee of the Board of Directors
and the Stockholders of Paychex, Inc.
We have audited Paychex Inc.’s internal control over
financial reporting as of May 31, 2010, based on criteria
established in “Internal Control — Integrated
Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria).
Paychex Inc.’s management is responsible for maintaining
effective internal control over financial reporting, and for its
assessment of the effectiveness of internal control over
financial reporting included in the accompanying Report on
Management’s Assessment of Internal Control Over Financial
Reporting. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, Paychex, Inc. maintained, in all material
respects, effective internal control over financial reporting as
of May 31, 2010, based on the COSO criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets as of May 31, 2010 and 2009,
and the related consolidated statements of income,
stockholders’ equity, and cash flows for each of the three
years in the period ended May 31, 2010 of Paychex, Inc.,
and our report dated July 16, 2010, expressed an
unqualified opinion thereon.
/s/ Ernst &
Young LLP
Cleveland, Ohio
July 16, 2010
33
Table of Contents
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON CONSOLIDATED FINANCIAL STATEMENTS
ON CONSOLIDATED FINANCIAL STATEMENTS
The Audit Committee of the Board of Directors
and the Stockholders of Paychex, Inc.
We have audited the accompanying consolidated balance sheets of
Paychex, Inc. as of May 31, 2010 and 2009, and the related
consolidated statements of income, stockholders’ equity,
and cash flows for each of the three years in the period ended
May 31, 2010. Our audits also included the financial
statement schedule listed in the Index at Item 15(1). These
financial statements and schedule are the responsibility of
Paychex, Inc.’s management. Our responsibility is to
express an opinion on these financial statements and schedule
based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). 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 financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Paychex, Inc. at May 31, 2010 and
2009, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended
May 31, 2010, in conformity with U.S. generally
accepted accounting principles. Also, in our opinion, the
related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
Paychex, Inc.’s internal control over financial reporting
as of May 31, 2010, based on criteria established in
“Internal Control — Integrated Framework”
issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated July 16, 2010
expressed an unqualified opinion thereon.
/s/ Ernst &
Young LLP
Cleveland, Ohio
July 16, 2010
34
Table of Contents
PAYCHEX,
INC.
In
thousands, except per share amounts
| Year ended May 31, | 2010 | 2009 | 2008 | |||||||||
|
Revenue:
|
||||||||||||
|
Service revenue
|
$ | 1,945,789 | $ | 2,007,305 | $ | 1,934,536 | ||||||
|
Interest on funds held for clients
|
55,031 | 75,454 | 131,787 | |||||||||
|
Total revenue
|
$ | 2,000,820 | $ | 2,082,759 | $ | 2,066,323 | ||||||
|
Expenses:
|
||||||||||||
|
Operating expenses
|
653,585 | 680,518 | 660,735 | |||||||||
|
Selling, general and administrative expenses
|
622,440 | 597,041 | 577,321 | |||||||||
|
Total expenses
|
1,276,025 | 1,277,559 | 1,238,056 | |||||||||
|
Operating income
|
724,795 | 805,200 | 828,267 | |||||||||
|
Investment income, net
|
4,513 | 6,875 | 26,548 | |||||||||
|
Income before income taxes
|
729,308 | 812,075 | 854,815 | |||||||||
|
Income taxes
|
252,309 | 278,530 | 278,670 | |||||||||
|
Net income
|
$ | 476,999 | $ | 533,545 | $ | 576,145 | ||||||
|
Basic earnings per share
|
$ | 1.32 | $ | 1.48 | $ | 1.56 | ||||||
|
Diluted earnings per share
|
$ | 1.32 | $ | 1.48 | $ | 1.56 | ||||||
|
Weighted-average common shares outstanding
|
361,359 | 360,783 | 368,420 | |||||||||
|
Weighted-average common shares outstanding, assuming
dilution
|
361,728 | 360,985 | 369,528 | |||||||||
|
Cash dividends per common share
|
$ | 1.24 | $ | 1.24 | $ | 1.20 | ||||||
See Notes to Consolidated Financial Statements.
35
Table of Contents
| As of May 31, | 2010 | 2009 | ||||||
|
Assets
|
||||||||
|
Cash and cash equivalents
|
$ | 284,316 | $ | 472,769 | ||||
|
Corporate investments
|
82,496 | 19,710 | ||||||
|
Interest receivable
|
28,672 | 27,722 | ||||||
|
Accounts receivable, net of allowance for doubtful accounts
|
186,587 | 177,958 | ||||||
|
Deferred income taxes
|
3,799 | 10,180 | ||||||
|
Prepaid income taxes
|
6,653 | 2,198 | ||||||
|
Prepaid expenses and other current assets
|
25,540 | 27,913 | ||||||
|
Current assets before funds held for clients
|
618,063 | 738,450 | ||||||
|
Funds held for clients
|
3,541,054 | 3,501,376 | ||||||
|
Total current assets
|
4,159,117 | 4,239,826 | ||||||
|
Long-term corporate investments
|
290,106 | 82,234 | ||||||
|
Property and equipment, net of accumulated depreciation
|
267,583 | 274,530 | ||||||
|
Intangible assets, net of accumulated amortization
|
63,262 | 76,641 | ||||||
|
Goodwill
|
421,559 | 433,316 | ||||||
|
Deferred income taxes
|
21,080 | 16,487 | ||||||
|
Other long-term assets
|
3,592 | 4,381 | ||||||
|
Total assets
|
$ | 5,226,299 | $ | 5,127,415 | ||||
|
Liabilities
|
||||||||
|
Accounts payable
|
$ | 37,305 | $ | 37,334 | ||||
|
Accrued compensation and related items
|
163,219 | 135,064 | ||||||
|
Deferred revenue
|
3,447 | 9,542 | ||||||
|
Deferred income taxes
|
17,005 | 17,159 | ||||||
|
Litigation reserve
|
— | 20,411 | ||||||
|
Other current liabilities
|
41,225 | 44,704 | ||||||
|
Current liabilities before client fund obligations
|
262,201 | 264,214 | ||||||
|
Client fund obligations
|
3,479,977 | 3,437,679 | ||||||
|
Total current liabilities
|
3,742,178 | 3,701,893 | ||||||
|
Accrued income taxes
|
27,468 | 25,730 | ||||||
|
Deferred income taxes
|
7,803 | 12,773 | ||||||
|
Other long-term liabilities
|
46,871 | 45,541 | ||||||
|
Total liabilities
|
3,824,320 | 3,785,937 | ||||||
|
Commitments and contingencies — Note L
|
||||||||
|
Stockholders’ equity
|
||||||||
|
Common stock, $0.01 par value; Authorized:
600,000 shares;
Issued and outstanding: 361,463 shares as of May 31, 2010, and 360,976 shares as of May 31, 2009, respectively |
3,615 | 3,610 | ||||||
|
Additional paid-in capital
|
499,665 | 466,427 | ||||||
|
Retained earnings
|
856,290 | 829,501 | ||||||
|
Accumulated other comprehensive income
|
42,409 | 41,940 | ||||||
|
Total stockholders’ equity
|
1,401,979 | 1,341,478 | ||||||
|
Total liabilities and stockholders’ equity
|
$ | 5,226,299 | $ | 5,127,415 | ||||
See Notes to Consolidated Financial Statements.
36
Table of Contents
PAYCHEX,
INC.
In thousands
|
Accumulated
|
||||||||||||||||||||||||
|
Additional
|
other
|
|||||||||||||||||||||||
| Common stock |
paid-in
|
Retained
|
comprehensive
|
|||||||||||||||||||||
| Shares | Amount | capital | earnings | (loss)/income | Total | |||||||||||||||||||
|
Balance as of May 31, 2007
|
382,151 | $ | 3,822 | $ | 362,982 | $ | 1,595,105 | $ | (9,661 | ) | $ | 1,952,248 | ||||||||||||
|
Net income
|
576,145 | 576,145 | ||||||||||||||||||||||
|
Unrealized gains on securities, net of tax
|
25,708 | 25,708 | ||||||||||||||||||||||
|
Total comprehensive income
|
601,853 | |||||||||||||||||||||||
|
Common shares repurchased
|
(23,658 | ) | (237 | ) | (24,395 | ) | (975,367 | ) | (999,999 | ) | ||||||||||||||
|
Cash dividends declared
|
(442,146 | ) | (442,146 | ) | ||||||||||||||||||||
|
Stock-based compensation
|
25,535 | 25,535 | ||||||||||||||||||||||
|
Stock-based award transactions
|
2,007 | 20 | 67,517 | 67,537 | ||||||||||||||||||||
|
Cumulative effect of accounting change for uncertain tax
positions
|
(8,386 | ) | (8,386 | ) | ||||||||||||||||||||
|
Balance as of May 31, 2008
|
360,500 | 3,605 | 431,639 | 745,351 | 16,047 | 1,196,642 | ||||||||||||||||||
|
Net income
|
533,545 | 533,545 | ||||||||||||||||||||||
|
Unrealized gains on securities, net of tax
|
25,893 | 25,893 | ||||||||||||||||||||||
|
Total comprehensive income
|
559,438 | |||||||||||||||||||||||
|
Cash dividends declared
|
(447,732 | ) | (447,732 | ) | ||||||||||||||||||||
|
Stock-based compensation
|
25,827 | 25,827 | ||||||||||||||||||||||
|
Stock-based award transactions
|
476 | 5 | 8,961 | (1,663 | ) | 7,303 | ||||||||||||||||||
|
Balance as of May 31, 2009
|
360,976 | 3,610 | 466,427 | 829,501 | 41,940 | 1,341,478 | ||||||||||||||||||
|
Net income
|
476,999 | 476,999 | ||||||||||||||||||||||
|
Unrealized gains on securities, net of tax
|
469 | 469 | ||||||||||||||||||||||
|
Total comprehensive income
|
477,468 | |||||||||||||||||||||||
|
Cash dividends declared
|
(448,558 | ) | (448,558 | ) | ||||||||||||||||||||
|
Stock-based compensation
|
25,716 | 25,716 | ||||||||||||||||||||||
|
Stock-based award transactions
|
487 | 5 | 7,522 | (1,652 | ) | 5,875 | ||||||||||||||||||
|
Balance as of May 31, 2010
|
361,463 | $ | 3,615 | $ | 499,665 | $ | 856,290 | $ | 42,409 | $ | 1,401,979 | |||||||||||||
See Notes to Consolidated Financial Statements.
37
Table of Contents
| Year ended May 31, | 2010 | 2009 | 2008 | |||||||||
|
Operating activities
|
||||||||||||
|
Net income
|
$ | 476,999 | $ | 533,545 | $ | 576,145 | ||||||
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
||||||||||||
|
Depreciation and amortization on property and equipment and
intangible assets
|
86,445 | 85,772 | 80,614 | |||||||||
|
Amortization of premiums and discounts on
available-for-sale
securities
|
35,048 | 22,956 | 19,033 | |||||||||
|
Stock-based compensation costs
|
25,580 | 25,707 | 25,434 | |||||||||
|
(Benefit)/provision for deferred income taxes
|
(3,856 | ) | (1,866 | ) | 3,713 | |||||||
|
Provision for allowance for doubtful accounts
|
2,631 | 2,910 | 3,044 | |||||||||
|
Provision for litigation reserve
|
18,700 | — | — | |||||||||
|
Net realized gains on sales of
available-for-sale
securities
|
(3,232 | ) | (1,135 | ) | (6,450 | ) | ||||||
|
Changes in operating assets and liabilities:
|
||||||||||||
|
Interest receivable
|
(950 | ) | 6,713 | 19,189 | ||||||||
|
Accounts receivable
|
(10,190 | ) | 3,818 | (800 | ) | |||||||
|
Prepaid expenses and other current assets
|
(2,570 | ) | 8,356 | (5,080 | ) | |||||||
|
Accounts payable and other current liabilities
|
(15,003 | ) | (10,049 | ) | 2,715 | |||||||
|
Net change in other assets and liabilities
|
1,321 | 12,044 | 7,112 | |||||||||
|
Net cash provided by operating activities
|
610,923 | 688,771 | 724,669 | |||||||||
|
Investing activities
|
||||||||||||
|
Purchases of
available-for-sale
securities
|
(1,554,950 | ) | (16,365,721 | ) | (79,919,857 | ) | ||||||
|
Proceeds from sales and maturities of
available-for-sale
securities
|
1,152,019 | 17,958,518 | 81,568,872 | |||||||||
|
Net change in funds held for clients’ money market
securities and other cash equivalents
|
61,733 | (1,101,371 | ) | (581,738 | ) | |||||||
|
Purchases of property and equipment
|
(61,262 | ) | (64,709 | ) | (82,289 | ) | ||||||
|
Proceeds from sale of property and equipment
|
— | 618 | 716 | |||||||||
|
Acquisition of businesses, net of cash acquired
|
— | (6,466 | ) | (32,940 | ) | |||||||
|
Proceeds from sale of business
|
13,050 | — | — | |||||||||
|
Purchases of other assets
|
(11,912 | ) | (16,407 | ) | (19,599 | ) | ||||||
|
Net cash (used in)/provided by investing activities
|
(401,322 | ) | 404,462 | 933,165 | ||||||||
|
Financing activities
|
||||||||||||
|
Net change in client fund obligations
|
42,298 | (346,002 | ) | (198,649 | ) | |||||||
|
Repurchases of common stock
|
— | — | (999,999 | ) | ||||||||
|
Dividends paid
|
(448,558 | ) | (447,732 | ) | (442,146 | ) | ||||||
|
Proceeds from and excess tax benefit related to exercise of
stock options
|
8,206 | 9,033 | 67,844 | |||||||||
|
Net cash used in financing activities
|
(398,054 | ) | (784,701 | ) | (1,572,950 | ) | ||||||
|
(Decrease)/increase in cash and cash equivalents
|
(188,453 | ) | 308,532 | 84,884 | ||||||||
|
Cash and cash equivalents, beginning of fiscal year
|
472,769 | 164,237 | 79,353 | |||||||||
|
Cash and cash equivalents, end of fiscal year
|
$ | 284,316 | $ | 472,769 | $ | 164,237 | ||||||
See Notes to Consolidated Financial Statements.
38
Table of Contents
PAYCHEX,
INC.
| Note A — | Description of Business and Significant Accounting Policies |
Description of business:
Paychex, Inc.
and its wholly owned subsidiaries (the “Company” or
“Paychex”) is a leading provider of payroll, human
resource, and benefits outsourcing solutions for small- to
medium-sized businesses in the United States (“U.S.”).
The Company also has a subsidiary in Germany.
Paychex, a Delaware corporation formed in 1979, reports as one
segment. Substantially all of the Company’s revenue is
generated within the U.S. The Company also generates
revenue within Germany, which was less than one percent of its
total revenue for each of the years ended May 31, 2010
(“fiscal 2010”), 2009 (“fiscal 2009”), and
2008 (“fiscal 2008”). Long-lived assets in Germany are
insignificant in relation to total long-lived assets of the
Company as of May 31, 2010 and May 31, 2009.
Total revenue is comprised of service revenue and interest on
funds held for clients. Service revenue is comprised of the
Payroll and Human Resource Services portfolios of services and
products. Payroll service revenue is earned primarily from
payroll processing, payroll tax administration services,
employee payment services, and other ancillary services. Payroll
processing services include the calculation, preparation, and
delivery of employee payroll checks; production of internal
accounting records and management reports; preparation of
federal, state, and local payroll tax returns; and collection
and remittance of clients’ payroll obligations.
In connection with the automated payroll tax administration
services, the Company electronically collects payroll taxes from
clients’ bank accounts, typically on payday, prepares and
files the applicable tax returns, and remits taxes to the
applicable tax or regulatory agencies on the respective due
dates. These taxes are typically paid between one and
30 days after receipt of collections from clients, with
some items extending to 90 days. The Company handles
regulatory correspondence, amendments, and penalty and interest
disputes, and is subject to cash penalties imposed by tax or
regulatory agencies for late filings and late or under payment
of taxes. With employee payment services, employers are offered
the option of paying their employees by direct deposit, payroll
debit card, a check drawn on a Paychex account
(Readychex
®
),
or a check drawn on the employer’s account and
electronically signed by Paychex. For the first three methods,
Paychex electronically collects net payroll from the
clients’ bank account, typically one business day before
payday, and provides payment to the employee on payday.
In addition to service fees paid by clients, the Company earns
interest on funds held for clients that are collected before due
dates and invested until remittance to the applicable tax or
regulatory agencies or client employees. The funds held for
clients and related client fund obligations are included in the
Consolidated Balance Sheets as current assets and current
liabilities. The amount of funds held for clients and related
client fund obligations varies significantly during the year.
The Human Resource Services portfolio of services and products
provides small- to medium-sized businesses with retirement
services administration, insurance services, eServices, and
other human resource services and products. Paychex HR Solutions
is available as an administrative services organization
(“ASO”) and a professional employer organization
(“PEO”). Both options provide a combined package of
services that include payroll, employer compliance, human
resource and employee benefits administration, risk management
outsourcing, and the
on-site
availability of a professionally trained human resource services
representative. These comprehensive bundles of services are
designed to make it easier for businesses to manage their
payroll and related benefits costs while providing a benefits
package equal to that of larger companies. The PEO differs from
the ASO in that Paychex serves as a co-employer of the
clients’ employees, assumes the risks and rewards of
workers’ compensation insurance, and provides more
sophisticated health care offerings to PEO clients. PEO services
are sold through the Company’s registered and licensed
subsidiary, Paychex Business Solutions, Inc.
Basis of presentation:
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. The Company
has evaluated subsequent events for potential recognition
and/or
disclosure through the date of issuance of these financial
statements.
39
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Cash and cash equivalents:
Cash and
cash equivalents consist of available cash, money market
securities, U.S. agency discount notes, and other
investments with a maturity of three months or less as of the
balance sheet date.
Accounts receivable, net of allowance for doubtful
accounts:
Accounts receivable balances are
shown on the Consolidated Balance Sheets net of the allowance
for doubtful accounts of $1.9 million as of May 31,
2010 and $4.0 million as of May 31, 2009. The decrease
in allowance for doubtful accounts from May 31, 2009 was
the result of the sale of Paychex Time and Attendance Inc.
(“Stromberg”), an immaterial component of the Company.
No single client had a material impact on total accounts
receivable, service revenue, or results of operations.
Funds held for clients and corporate
investments:
Marketable securities included
in funds held for clients and corporate investments consist
primarily of securities classified as
available-for-sale
and are recorded at fair value obtained from an independent
pricing service. The funds held for clients portfolio also
includes cash, money market securities, and short-term
investments. Unrealized gains and losses, net of applicable
income taxes, are reported as comprehensive income in the
Consolidated Statements of Stockholders’ Equity. Realized
gains and losses on the sale of available-for-sale securities
are determined by specific identification of the cost basis of
each security. On the Consolidated Statements of Income,
realized gains and losses from their respective portfolios are
included in interest on funds held for clients and investment
income, net.
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 mutual
funds, are restricted to credit-worthy financial institutions.
Property and equipment, net of accumulated
depreciation:
Property and equipment 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 estimated
useful lives of depreciable assets are generally ten to
35 years or the remaining life, whichever is shorter, for
buildings and improvements; two to seven years for data
processing equipment; seven years for furniture and fixtures;
and ten years or the life of the lease, whichever is shorter,
for leasehold improvements. Normal and recurring repair and
maintenance costs are charged to expense as incurred. The
Company reviews the carrying value of property and equipment for
impairment when events or changes in circumstances indicate that
the carrying value of such assets may not be recoverable.
Software development and
enhancements:
Expenditures for software
purchases and software developed for internal use are
capitalized and depreciated on a straight-line basis over the
estimated useful lives, which are generally three to five years,
except for substantial changes in the functionality of
processing applications, for which the estimated useful life may
be longer. For software developed for internal use certain costs
are capitalized including external direct costs of materials and
services associated with developing or obtaining the software,
and payroll and payroll-related costs for employees who are
directly associated with internal-use software projects.
Capitalization of these costs ceases no later than the point at
which the project is substantially complete and ready for its
intended use. Costs associated with preliminary project stage
activities, training, maintenance, and other post-implementation
stage activities are expensed as incurred. The carrying value of
software and development costs is reviewed for impairment when
events or changes in circumstances indicate that the carrying
value of such assets may not be recoverable.
Goodwill and other intangible assets, net of accumulated
amortization:
The Company has recorded
goodwill in connection with the acquisitions of businesses.
Goodwill is not amortized, but instead tested for impairment on
an annual basis and between annual tests if an event occurs or
circumstances change in a way to indicate that there has been a
potential decline in the fair value of the reporting unit.
Impairment is determined by comparing the estimated fair value
of the reporting unit to its carrying amount, including
goodwill. The Company’s business is largely homogeneous
and, as a result, substantially all the goodwill is associated
with one reporting unit.
40
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company performs its annual impairment testing in its fiscal
fourth quarter. Based on the results of the Company’s
reviews, no impairment loss was recognized in the results of
operations for fiscal 2010, fiscal 2009, or fiscal 2008.
Subsequent to the latest review, there have been no events or
circumstances that indicate any potential impairment of the
Company’s goodwill balance.
Intangible assets are comprised of client list acquisitions and
are reported net of accumulated amortization on the Consolidated
Balance Sheets. Intangible assets are amortized over periods
generally ranging from five to twelve years using either the
straight-line method, an accelerated method, or based on client
attrition. The Company tests intangible assets for potential
impairment when events or changes in circumstances indicate that
the carrying value of such assets may not be recoverable.
Other long-term assets:
Included in
other long-term assets is the Company’s investment as a
limited partner in various low-income housing partnerships.
These partnerships were determined to be variable interest
entities (“VIEs”). The Company is not the primary
beneficiary of these VIEs and, therefore, does not consolidate
them in its results of operations or financial position. The
investments in these partnerships are accounted for under the
equity method of accounting, with the Company’s share of
partnership losses recorded in investment income, net on the
Consolidated Statements of Income. The net investment in these
entities recorded on the Consolidated Balance Sheets was
$0.6 million as of May 31, 2010 and $1.5 million
as of May 31, 2009.
Revenue recognition:
Service revenue is
recognized in the period services are rendered and earned under
service arrangements with clients where service fees are fixed
or determinable and collectibility is reasonably assured.
Certain processing services are provided under annual service
arrangements with revenue recognized ratably over the annual
service period. The Company’s service revenue is largely
attributable to payroll-related processing services where the
fee is based on a fixed amount per processing period or a fixed
amount per processing period plus a fee per employee or
transaction processed. The revenue earned from delivery service
for the distribution of certain client payroll checks and
reports is included in service revenue, and the costs for the
delivery are included in operating expenses on the Consolidated
Statements of Income.
PEO revenue is included in service revenue and is reported net
of direct costs billed and incurred, which include wages, taxes,
benefit premiums, and claims of PEO worksite employees. Direct
costs billed and incurred were $3.1 billion for fiscal
2010, and $2.6 billion for both fiscal 2009 and fiscal 2008.
Revenue from certain time and attendance solutions is recognized
when all of the following are present: persuasive evidence that
an arrangement exists, typically a non-cancelable sales order;
delivery is complete for the software and hardware; the fee is
fixed or determinable and free of contingencies; and
collectibility is reasonably assured. Maintenance contracts are
generally purchased by the Company’s clients in conjunction
with their purchase of certain time and attendance solutions.
Revenue from these maintenance contracts is recognized ratably
over the term of the contract.
In certain situations the Company allows a client a right of
return or refund. The Company maintains an allowance for
returns, which is based on historical data. The allowance is
reviewed periodically for adequacy with any adjustment to
revenue reflected in the results of operations for the period in
which the adjustment is identified.
Interest on funds held for clients is earned primarily on funds
that are collected from clients before due dates for payroll tax
administration services and for employee payment services, and
invested until remittance to the applicable tax or regulatory
agencies or client employees. These collections from clients are
typically remitted from one to 30 days after receipt, with
some items extending to 90 days. The interest earned on
these funds is included in total revenue on the Consolidated
Statements of Income because the collecting, holding, and
remitting of these funds are critical components of providing
these services. Interest on funds held for clients also includes
net realized gains and losses from the sales of
available-for-sale
securities.
Advantage Payroll Services Inc. (“Advantage”), a
subsidiary of the Company, has license agreements with
independently owned associate offices (“Associates”).
The Associates are responsible for selling and marketing
41
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Advantage payroll services and performing certain operational
functions. Paychex and Advantage provide all centralized
back-office payroll processing and payroll tax administration
services for the Associates, including the billing and
collection of processing fees and the collection and remittance
of payroll and payroll tax funds pursuant to Advantage’s
service arrangement with Associate customers. The marketing and
selling by the Associates is conducted under their respective
logos. Commissions earned by the Associates are based on the
processing activity for the related clients. Revenue generated
from customers as a result of these relationships and
commissions paid to Associates are included in the Consolidated
Statements of Income as service revenue and selling, general and
administrative expense, respectively.
PEO workers’ compensation
insurance:
Workers’ compensation
insurance reserves are established to provide for the estimated
costs of paying claims underwritten by the Company. These
reserves include estimates for reported losses, plus amounts for
those claims incurred but not reported and estimates of certain
expenses associated with processing and settling the claims. In
establishing the workers’ compensation insurance reserves,
the Company uses an independent actuarial estimate of
undiscounted future cash payments that would be made to settle
the claims.
Estimating the ultimate cost of future claims is an uncertain
and complex process based upon historical loss experience and
actuarial loss projections, and is subject to change due to
multiple factors, including economic trends, changes in legal
liability law, and damage awards, all of which could materially
impact the reserves as reported in the Consolidated Financial
Statements. Accordingly, final claim settlements may vary from
the present estimates, particularly when those payments may not
occur until well into the future.
The Company regularly reviews the adequacy of its estimated
workers’ compensation insurance reserves. Adjustments to
previously established reserves are reflected in the results of
operations for the period in which the adjustment is identified.
Such adjustments could possibly be significant, reflecting any
variety of new and adverse or favorable trends.
The Company’s maximum individual claims liability was
$1.0 million under both its fiscal 2010 and fiscal 2009
policies. As of May 31, 2010 and May 31, 2009, the
Company had recorded current liabilities of $5.8 million
and $7.9 million, respectively, and long-term liabilities
of $20.1 million and $17.9 million, respectively, on
its Consolidated Balance Sheets for workers’ compensation
claims.
Stock-based compensation costs:
All
stock-based awards to employees, including grants of stock
options, are recognized as compensation costs in the
Consolidated Financial Statements based on their fair values
measured as of the date of grant. The Company estimates the fair
value of stock option grants using a Black-Scholes option
pricing model. This model requires various assumptions as inputs
including expected volatility of the Paychex stock price and
expected option life. Volatility is estimated based on a
combination of historical volatility using weekly stock prices
over a period equal to the expected option life and implied
market volatility. Expected option life is estimated based on
historical exercise behavior.
The Company is required to estimate forfeitures and only record
compensation costs for those awards that are expected to vest.
The assumptions for forfeitures were determined based on type of
award and historical experience. Forfeiture assumptions are
adjusted at the point in time a significant change is identified
with any adjustment recorded in the period of change, and the
final adjustment at the end of the requisite service period to
equal actual forfeitures.
The assumptions of volatility, expected option life, and
forfeitures all require significant judgment and are subject to
change in the future due to factors such as employee exercise
behavior, stock price trends, and changes to type or provisions
of stock-based awards. Any change in one or more of these
assumptions could have a material impact on the estimated fair
value of an award and on stock-based compensation costs
recognized in the Company’s results of operations.
42
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company has determined that the Black-Scholes option pricing
model, as well as the underlying assumptions used in its
application, is appropriate in estimating the fair value of
stock option grants. The Company periodically reassesses 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.
Refer to Note B of the Notes to Consolidated Financial
Statements for further discussion of the Company’s
stock-based compensation plans.
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 Consolidated 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 basis of assets and liabilities
using enacted tax rates in effect for the year in which the
differences are expected to reverse. The Company records a
deferred tax asset related to the stock-based compensation costs
recognized for certain stock-based awards. At the time of the
exercise of non-qualified stock options or vesting of stock
awards, the Company accounts for the resulting tax deduction by
reducing its accrued income tax liability with an offset to the
deferred tax asset and any excess tax benefit increasing
additional paid-in capital. The Company currently has a
sufficient pool of excess tax benefits in additional paid-in
capital to absorb any deficient tax benefits related to
stock-based awards.
The Company maintains a reserve for uncertain tax positions. The
Company evaluates tax positions taken or expected to be taken in
a tax return for recognition in its Consolidated Financial
Statements. Prior to recording the related tax benefit in the
Consolidated Financial Statements, the Company must conclude
that tax positions must be “more likely than not” to
be sustained, assuming those positions will be examined by
taxing authorities with full knowledge of all relevant
information. The benefit recognized in the Consolidated
Financial Statements is the amount the Company expects to
realize after examination by taxing authorities. If a tax
position drops below the “more likely than not”
standard, the benefit can no longer be recognized. Assumptions,
judgment, and the use of estimates are required in determining
if the “more likely than not” standard has been met
when developing the provision for income taxes and in
determining the expected benefit. A change in the assessment of
the “more likely than not” standard could materially
impact the Company’s results of operations or financial
position. The Company’s reserve for uncertain tax positions
was $27.5 million as of May 31, 2010 and
$25.7 million as of May 31, 2009. Refer to Note H
of the Notes to Consolidated Financial Statements for further
discussion of the Company’s reserve for uncertain tax
positions.
Use of estimates:
The preparation of
financial statements in conformity with U.S. generally
accepted accounting principles (“GAAP”) requires
management to make estimates, judgments, and assumptions that
affect reported amounts of assets, liabilities, revenue, and
expenses during the reporting period. Actual amounts and results
could differ from these estimates.
Recently adopted accounting
pronouncements:
Effective June 1, 2009,
the Company adopted the following Financial Accounting Standards
Board (“FASB”) authoritative guidance, none of which
had a material impact on its Consolidated Financial Statements:
| • | Revised guidance on business combinations that establishes principles and requirements for recognizing and measuring the identifiable assets acquired (including goodwill), liabilities assumed, and noncontrolling interests, if any, acquired in a business combination. This guidance also requires that acquisition-related costs and costs associated with restructuring or exiting activities of an acquired entity be expensed as incurred; | |
| • | Guidance on subsequent events that establishes standards related to accounting for and disclosure of events that happen after the date of the balance sheet but before the release of the financial statements; |
43
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| • | Guidance on determination of the useful life of intangible assets that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset; and | |
| • | Updates to authoritative standards that provide additional application guidance and enhance disclosures regarding fair value measurements and impairment of debt securities. Refer to Notes D and E of the Notes to Consolidated Financial Statements for disclosures related to the Company’s investments in debt securities and fair value measurements. |
Effective September 1, 2009, the Company adopted the
following FASB authoritative guidance, which did not have a
material impact on its Consolidated Financial Statements:
| • | Guidance that establishes the FASB Accounting Standards Codification (the “Codification”). The Codification, released on July 1, 2009, became the single source of authoritative non-governmental U.S. GAAP and supercedes all previously existing accounting standards. The adoption changed certain disclosure references to U.S. GAAP; and | |
| • | Guidance providing acceptable valuation techniques for measuring the fair value of a liability in circumstances in which a quoted price in an active market for an identical liability may not be available. |
Effective December 1, 2009, the Company adopted the
following FASB authoritative guidance, which did not have a
material impact on its Consolidated Financial Statements:
| • | Guidance that clarifies that the stock portion of a dividend payment that is part cash and part stock be considered a share issuance in calculating earnings per share; and | |
| • | Guidance that clarifies the scope of the decrease-in-ownership provisions in the Codification and expands the information an entity is required to disclose upon the consolidation or deconsolidation of a subsidiary. |
Effective March 1, 2010, the Company adopted FASB
authoritative guidance aimed at improving disclosures about fair
value measurements. This guidance adds new disclosure
requirements for transfers into and out of fair value hierarchy
Levels 1 and 2 and separate disclosures about purchases,
sales, issuances, and settlements relating to Level 3
measurements. It also clarifies existing disclosure requirements
regarding the level of disaggregation for classes of assets and
liabilities, and about inputs and valuation techniques used to
measure fair value. The adoption of this guidance did not have a
material effect on the Company’s Consolidated Financial
Statements.
Recently issued accounting
pronouncements:
In June 2009, the FASB issued
the following authoritative guidance, which was incorporated
into the Codification in December 2009:
| • | Guidance amending the accounting and reporting standards for transfers and servicing of financial assets, including the removal of the concept of a qualifying special purpose entity; and | |
| • | Guidance to require a qualitative analysis rather than a quantitative-based risks and rewards calculation to determine the primary beneficiary of a VIE for consolidation purposes. This qualitative approach focuses on identifying which entity has the power to direct the activities of a VIE with the most significant impact on the VIE’s economic performance. |
Both of these items are effective for annual periods beginning
after November 15, 2009, and are applicable to the
Company’s fiscal year beginning June 1, 2010. The
Company does not expect the adoption of this guidance to have a
material effect on its Consolidated Financial Statements.
In October 2009, the FASB issued authoritative guidance related
to revenue recognition as follows:
| • | Guidance for arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance; and |
44
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| • | Guidance eliminating tangible products containing both software and non-software components that operate together to deliver a product’s functionality from the scope of current GAAP for software. |
Both of these items are effective prospectively for revenue
arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, with early adoption
permitted, and are applicable to the Company’s fiscal year
beginning June 1, 2011. The Company does not expect the
adoption of this guidance to have a material effect on its
Consolidated Financial Statements.
Other recent authoritative guidance issued by the FASB
(including technical corrections to the Codification), the
American Institute of Certified Public Accountants, and the
Securities and Exchange Commission did not, or are not expected
to have a material effect on the Company’s Consolidated
Financial Statements.
| Note B — | Stock-Based Compensation Plans |
The Paychex, Inc. 2002 Stock Incentive Plan, as amended and
restated (the “2002 Plan”), effective on
October 12, 2005 upon its approval by the Company’s
stockholders, authorizes grants of up to 29.1 million
shares of the Company’s common stock. As of May 31,
2010, there were 14.1 million shares available for future
grants under the 2002 Plan. No future grants will be made
pursuant to the Paychex, Inc. 1998 Stock Incentive Plan, which
expired in August 2002; however, options to purchase an
aggregate of 1.5 million shares under the plan remain
outstanding as of May 31, 2010.
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 on a straight-line basis over the requisite
service period and increase additional paid-in capital. For
grants prior to June 1, 2006, costs were recognized on an
accelerated basis over the requisite service period.
Stock-based compensation expense was $25.6 million,
$25.7 million, and $25.4 million for fiscal 2010,
fiscal 2009, and fiscal 2008, respectively. Related income tax
benefits recognized were $7.9 million, $8.0 million,
and $7.4 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, 2010, the total unrecognized compensation
cost related to all unvested stock-based awards was
$52.0 million and is expected to be recognized over a
weighted-average period of 1.7 years.
Stock option grants:
Stock option
grants 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 option
grants have a contractual life of ten years from the date of the
grant and a vesting schedule as established by the Board of
Directors (the “Board”). The Company issues new shares
of common stock to satisfy stock option exercises. Non-qualified
stock option grants to officers, outside directors, and
management are typically approved by the Board in July.
Non-qualified stock option grants to officers and management
vest 20% per annum while grants to the Board vest one-third per
annum.
The Company has granted stock options to virtually all
non-management employees with at least 90 days of service,
and shares remain outstanding for the following broad-based
stock option grants:
|
Exercise
|
Shares
|
|||||||||||||
|
Shares
|
price
|
outstanding as of
|
||||||||||||
| Date of broad-based grant | granted | per share | May 31, 2010 | Vesting schedule | ||||||||||
|
October 2001
|
1,295,000 | $ | 33.17 | 350,000 | 25% each October in 2002 through 2005 | |||||||||
|
April 2004
|
1,655,000 | $ | 37.72 | 755,000 | 25% each April in 2005 through 2008 | |||||||||
|
October 2006
|
2,033,000 | $ | 37.32 | 1,294,000 | 20% each October in 2007 through 2011 | |||||||||
45
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Historically, each April and October, the Company has granted
options to newly hired employees who met certain criteria.
Beginning with grants issued in October 2005, such grants of
options vest 20% per annum. Any future grants of stock-based
awards are subject to the discretion of the Board.
The following table summarizes stock option activity for the
three years ended May 31, 2010:
|
Weighted-average
|
||||||||||||||||
|
Shares subject
|
Weighted-average
|
remaining
|
Aggregate intrinsic
|
|||||||||||||
|
to options
|
exercise price
|
contractual term
|
value
(1)
|
|||||||||||||
| (thousands) | per share | (years) | (thousands) | |||||||||||||
|
Outstanding as of May 31, 2007
|
16,268 | $ | 34.12 | |||||||||||||
|
Granted
|
971 | $ | 40.99 | |||||||||||||
|
Exercised
|
(1,974 | ) | $ | 29.77 | ||||||||||||
|
Forfeited
|
(854 | ) | $ | 36.84 | ||||||||||||
|
Expired
|
(103 | ) | $ | 38.38 | ||||||||||||
|
Outstanding as of May 31, 2008
|
14,308 | $ | 35.00 | |||||||||||||
|
Granted
|
1,007 | $ | 30.10 | |||||||||||||
|
Exercised
|
(371 | ) | $ | 23.41 | ||||||||||||
|
Forfeited
|
(591 | ) | $ | 36.11 | ||||||||||||
|
Expired
|
(350 | ) | $ | 37.56 | ||||||||||||
|
Outstanding as of May 31, 2009
|
14,003 | $ | 34.84 | |||||||||||||
|
Granted
|
1,391 | $ | 26.34 | |||||||||||||
|
Exercised
|
(355 | ) | $ | 23.12 | ||||||||||||
|
Forfeited
|
(448 | ) | $ | 33.35 | ||||||||||||
|
Expired
|
(428 | ) | $ | 36.18 | ||||||||||||
|
Outstanding as of May 31, 2010
|
14,163 | $ | 34.31 | 5.4 | $ | 4,175 | ||||||||||
|
Exercisable as of May 31, 2010
|
9,770 | $ | 34.95 | 4.5 | $ | 232 | ||||||||||
| (1) | Market price of the underlying stock as of May 28, 2010 less the exercise price. |
Other information pertaining to stock option grants is as
follows:
| Year ended May 31, | ||||||||||||
| In thousands, except per share amounts | 2010 | 2009 | 2008 | |||||||||
|
Weighted-average grant-date fair value of stock options granted
(per share)
|
$ | 4.37 | $ | 6.52 | $ | 9.84 | ||||||
|
Total intrinsic value of stock options exercised
|
$ | 1,378 | $ | 2,576 | $ | 25,154 | ||||||
|
Total fair value of stock options vested
|
$ | 18,996 | $ | 25,842 | $ | 32,340 | ||||||
The fair value of stock option grants 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 model are as follows:
| Year ended May 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Risk-free interest rate
|
3.0 | % | 3.2 | % | 4.3 | % | ||||||
|
Dividend yield
|
4.5 | % | 3.6 | % | 2.9 | % | ||||||
|
Volatility factor
|
.28 | .28 | .26 | |||||||||
|
Expected option life in years
|
6.3 | 6.3 | 6.0 | |||||||||
46
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
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 weekly
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.
Restricted stock awards:
The Board has
approved grants of restricted stock awards to the Company’s
officers and outside directors in accordance with the 2002 Plan.
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 of
vesting of the awards. 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.
For restricted stock awards granted to officers, the shares vest
upon the fifth anniversary of the grant date provided the
recipient is still an employee of the Company on that date.
These awards have a provision for the acceleration of vesting
based on achievement of performance targets established by the
Board. If the established targets are met for a fiscal year, up
to one-third of the award may vest. If all the targets are met
for three consecutive years, the award will be fully vested. For
outside directors, the shares vest on the third 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 the
three years ended May 31, 2010:
|
Weighted-average
|
||||||||
|
grant-date
|
||||||||
|
Restricted
|
fair value
|
|||||||
| In thousands, except per share amounts | shares | per share | ||||||
|
Nonvested as of May 31, 2007
|
105 | $ | 36.87 | |||||
|
Granted
|
134 | $ | 43.91 | |||||
|
Vested
|
(33 | ) | $ | 36.87 | ||||
|
Forfeited
|
(16 | ) | $ | 41.09 | ||||
|
Nonvested as of May 31, 2008
|
190 | $ | 41.48 | |||||
|
Granted
|
140 | $ | 31.76 | |||||
|
Vested
|
(66 | ) | $ | 39.82 | ||||
|
Forfeited
|
(19 | ) | $ | 36.81 | ||||
|
Nonvested as of May 31, 2009
|
245 | $ | 36.74 | |||||
|
Granted
|
153 | $ | 24.60 | |||||
|
Vested
|
(9 | ) | $ | 35.79 | ||||
|
Forfeited
|
(19 | ) | $ | 32.66 | ||||
|
Nonvested as of May 31, 2010
|
370 | $ | 31.95 | |||||
Restricted stock units:
Beginning in
July 2007, the Board approved grants of restricted stock units
(“RSUs”) to non-officer management as a replacement of
non-qualified stock options. RSUs do not have voting rights or
earn dividend equivalents during the vesting period. These
awards vest 20% per annum over five years with a small
population of awards vesting on the fourth anniversary of the
grant date. The fair value of RSUs is equal to the
47
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
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 the three years
ended May 31, 2010:
|
Weighted-average
|
||||||||
|
grant-date
|
||||||||
|
fair value
|
||||||||
| In thousands, except per share amounts | RSUs | per share | ||||||
|
Nonvested as of May 31, 2007
|
— | — | ||||||
|
Granted
|
499 | $ | 40.60 | |||||
|
Vested
|
— | — | ||||||
|
Forfeited
|
(29 | ) | $ | 40.60 | ||||
|
Nonvested as of May 31, 2008
|
470 | $ | 40.60 | |||||
|
Granted
|
607 | $ | 28.30 | |||||
|
Vested
|
(93 | ) | $ | 40.60 | ||||
|
Forfeited
|
(44 | ) | $ | 34.65 | ||||
|
Nonvested as of May 31, 2009
|
940 | $ | 32.93 | |||||
|
Granted
|
567 | $ | 20.62 | |||||
|
Vested
|
(193 | ) | $ | 34.01 | ||||
|
Forfeited
|
(69 | ) | $ | 28.88 | ||||
|
Nonvested as of May 31, 2010
|
1,245 | $ | 27.39 | |||||
Non-compensatory employee benefit
plan:
The Company offers an Employee Stock
Purchase Plan to all employees under which the Company’s
common stock can be purchased through a payroll deduction with
no discount to the market price and no look-back provision. All
transactions occur directly through the Company’s transfer
agent and no brokerage fees are charged to employees, except for
when stock is sold. The plan has been deemed non-compensatory
and therefore, no stock-based compensation costs have been
recognized for fiscal 2010, fiscal 2009, or fiscal 2008 related
to this plan.
48
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note C — | Basic and Diluted Earnings Per Share |
Basic and diluted earnings per share were calculated as follows:
| Year ended May 31, | ||||||||||||
| In thousands, except per share amounts | 2010 | 2009 | 2008 | |||||||||
|
Basic earnings per share:
|
||||||||||||
|
Net income
|
$ | 476,999 | $ | 533,545 | $ | 576,145 | ||||||
|
Weighted-average common shares outstanding
|
361,359 | 360,783 | 368,420 | |||||||||
|
Basic earnings per share
|
$ | 1.32 | $ | 1.48 | $ | 1.56 | ||||||
|
Diluted earnings per share:
|
||||||||||||
|
Net income
|
$ | 476,999 | $ | 533,545 | $ | 576,145 | ||||||
|
Weighted-average common shares outstanding
|
361,359 | 360,783 | 368,420 | |||||||||
|
Dilutive effect of common share equivalents at average market
price
|
369 | 202 | 1,108 | |||||||||
|
Weighted-average common shares outstanding, assuming dilution
|
361,728 | 360,985 | 369,528 | |||||||||
|
Diluted earnings per share
|
$ | 1.32 | $ | 1.48 | $ | 1.56 | ||||||
|
Weighted-average anti-dilutive common share equivalents
|
13,020 | 13,503 | 6,465 | |||||||||
Weighted-average common share equivalents that had an
anti-dilutive impact are excluded from the computation of
diluted earnings per share.
In December 2007, the Company completed its stock repurchase
program commenced in August 2007 to repurchase shares of its
common stock, and repurchased 23.7 million shares for
$1.0 billion.
| Note D — | Funds Held for Clients and Corporate Investments |
Funds held for clients and corporate investments are as follows:
| May 31, 2010 | ||||||||||||||||
|
Gross
|
Gross
|
|||||||||||||||
|
Amortized
|
unrealized
|
unrealized
|
Fair
|
|||||||||||||
| In thousands | cost | gains | losses | value | ||||||||||||
|
Type of issue:
|
||||||||||||||||
|
Money market securities and other cash equivalents
|
$ | 1,754,545 | $ | — | $ | — | $ | 1,754,545 | ||||||||
|
Available-for-sale
securities:
|
||||||||||||||||
|
General obligation municipal bonds
|
951,085 | 33,653 | (248 | ) | 984,490 | |||||||||||
|
Pre-refunded municipal
bonds
(1)
|
539,809 | 19,545 | (26 | ) | 559,328 | |||||||||||
|
Revenue municipal bonds
|
368,075 | 13,726 | (121 | ) | 381,680 | |||||||||||
|
Variable rate demand
notes
(2)
|
226,280 | — | — | 226,280 | ||||||||||||
|
Other equity securities
|
20 | 49 | — | 69 | ||||||||||||
|
Total
available-for-sale
securities
|
2,085,269 | 66,973 | (395 | ) | 2,151,847 | |||||||||||
|
Other
|
7,484 | 15 | (235 | ) | 7,264 | |||||||||||
|
Total funds held for clients and corporate investments
|
$ | 3,847,298 | $ | 66,988 | $ | (630 | ) | $ | 3,913,656 | |||||||
49
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| May 31, 2009 | ||||||||||||||||
|
Gross
|
Gross
|
|||||||||||||||
|
Amortized
|
unrealized
|
unrealized
|
Fair
|
|||||||||||||
| In thousands | cost | gains | losses | value | ||||||||||||
|
Type of issue:
|
||||||||||||||||
|
Money market securities and other cash equivalents
|
$ | 1,816,278 | $ | — | $ | — | $ | 1,816,278 | ||||||||
|
Available-for-sale
securities:
|
||||||||||||||||
|
General obligation municipal bonds
|
849,594 | 32,698 | (136 | ) | 882,156 | |||||||||||
|
Pre-refunded municipal
bonds
(1)
|
527,864 | 21,334 | (24 | ) | 549,174 | |||||||||||
|
Revenue municipal bonds
|
336,675 | 12,818 | (32 | ) | 349,461 | |||||||||||
|
Variable rate demand notes
|
— | — | — | — | ||||||||||||
|
Other equity securities
|
20 | 42 | — | 62 | ||||||||||||
|
Total
available-for-sale
securities
|
1,714,153 | 66,892 | (192 | ) | 1,780,853 | |||||||||||
|
Other
|
7,477 | — | (1,288 | ) | 6,189 | |||||||||||
|
Total funds held for clients and corporate investments
|
$ | 3,537,908 | $ | 66,892 | $ | (1,480 | ) | $ | 3,603,320 | |||||||
| (1) | Pre-refunded municipal bonds are secured by an escrow fund of U.S. government obligations. | |
| (2) | Beginning in November 2009, the Company began to invest in variable rate demand notes (“VRDNs”) for the first time since September 2008. |
Included in money market securities and other cash equivalents
as of May 31, 2010 and May 31, 2009 are
U.S. agency discount notes, government money market funds,
and bank demand deposit accounts.
Classification of investments on the Consolidated Balance Sheets
is as follows:
| May 31, | ||||||||
| In thousands | 2010 | 2009 | ||||||
|
Funds held for clients
|
$ | 3,541,054 | $ | 3,501,376 | ||||
|
Corporate investments
|
82,496 | 19,710 | ||||||
|
Long-term corporate investments
|
290,106 | 82,234 | ||||||
|
Total funds held for clients and corporate investments
|
$ | 3,913,656 | $ | 3,603,320 | ||||
The Company is exposed to credit risk in connection with these
investments through the possible inability of 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 fair value of held investments and in the earnings
potential of future investments. The Company follows a
conservative investment strategy of optimizing liquidity and
protecting principal. The Company invests primarily in high
credit quality securities with AAA and AA ratings and short-term
securities with
A-1/P-1
ratings. It limits the amounts that can be invested in any
single issuer, and invests in short- to intermediate-term
instruments whose fair value is less sensitive to interest rate
changes. All the investments held as of May 31, 2010 are
traded in active markets. The Company has not and does not
utilize derivative financial instruments to manage interest rate
risk.
The Company’s
available-for-sale
securities reflected a net unrealized gain of $66.6 million
as of May 31, 2010 compared with a net unrealized gain of
$66.7 million as of May 31, 2009. The gross unrealized
losses of $0.4 million, included in the net unrealized gain
as of May 31, 2010, were comprised of 23
available-for-sale
securities, which had a total fair value of $73.6 million.
The gross unrealized losses of $0.2 million, included in
the
50
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
net unrealized gain as of May 31, 2009, were comprised of
14
available-for-sale
securities with a total fair value of $39.4 million. The
securities in an unrealized loss position were as follows as of
May 31, 2010 and May 31, 2009:
The securities in an unrealized loss position were as follows:
| May 31, 2010 | ||||||||||||||||||||||||
|
Less than
|
More than
|
|||||||||||||||||||||||
| twelve months | twelve months | Total | ||||||||||||||||||||||
|
Gross
|
Gross
|
Gross
|
||||||||||||||||||||||
|
unrealized
|
Fair
|
unrealized
|
Fair
|
unrealized
|
Fair
|
|||||||||||||||||||
| In thousands | losses | value | losses | value | losses | value | ||||||||||||||||||
|
Type of issue:
|
||||||||||||||||||||||||
|
General obligation municipal bonds
|
$ | (248 | ) | $ | 44,025 | $ | — | $ | — | $ | (248 | ) | $ | 44,025 | ||||||||||
|
Pre-refunded municipal bonds
|
(26 | ) | 4,135 | — | — | (26 | ) | 4,135 | ||||||||||||||||
|
Revenue municipal bonds
|
(121 | ) | 25,469 | — | — | (121 | ) | 25,469 | ||||||||||||||||
|
Total
|
$ | (395 | ) | $ | 73,629 | $ | — | $ | — | $ | (395 | ) | $ | 73,629 | ||||||||||
| May 31, 2009 | ||||||||||||||||||||||||
|
Less than
|
More than
|
|||||||||||||||||||||||
| twelve months | twelve months | Total | ||||||||||||||||||||||
|
Gross
|
Gross
|
Gross
|
||||||||||||||||||||||
|
unrealized
|
Fair
|
unrealized
|
Fair
|
unrealized
|
Fair
|
|||||||||||||||||||
| In thousands | losses | value | losses | value | losses | value | ||||||||||||||||||
|
Type of issue:
|
||||||||||||||||||||||||
|
General obligation municipal bonds
|
$ | (136 | ) | $ | 28,915 | $ | — | $ | — | $ | (136 | ) | $ | 28,915 | ||||||||||
|
Pre-refunded municipal bonds
|
(24 | ) | 4,490 | — | — | (24 | ) | 4,490 | ||||||||||||||||
|
Revenue municipal bonds
|
(21 | ) | 2,943 | (11 | ) | 3,010 | (32 | ) | 5,953 | |||||||||||||||
|
Total
|
$ | (181 | ) | $ | 36,348 | $ | (11 | ) | $ | 3,010 | $ | (192 | ) | $ | 39,358 | |||||||||
The Company regularly reviews its investment portfolios to
determine if any investment is
other-than-
temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the investments held as of May 31, 2010 were not other-than-temporarily impaired. While $73.6 million of available-for-sale securities had fair values that were below amortized cost, the Company believes that it is probable that the principal and interest will be collected in accordance with contractual terms, and that the decline in the fair value to $0.4 million below amortized cost was due to changes in interest rates and was not due to increased credit risk or other valuation concerns. All of the securities in an unrealized loss position as of May 31, 2010 and the majority of the securities in an unrealized loss position as of May 31, 2009 held an AA rating or better. The Company intends to hold these investments until the recovery of their amortized cost basis or maturity, and further believes that it is more likely than not that it will not be required to sell these investments prior to that time. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.
temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the investments held as of May 31, 2010 were not other-than-temporarily impaired. While $73.6 million of available-for-sale securities had fair values that were below amortized cost, the Company believes that it is probable that the principal and interest will be collected in accordance with contractual terms, and that the decline in the fair value to $0.4 million below amortized cost was due to changes in interest rates and was not due to increased credit risk or other valuation concerns. All of the securities in an unrealized loss position as of May 31, 2010 and the majority of the securities in an unrealized loss position as of May 31, 2009 held an AA rating or better. The Company intends to hold these investments until the recovery of their amortized cost basis or maturity, and further believes that it is more likely than not that it will not be required to sell these investments prior to that time. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.
Realized gains and losses from the sale of available-for-sale
securities were as follows:
| Year ended May 31, | ||||||||||||
| In thousands | 2010 | 2009 | 2008 | |||||||||
|
Gross realized gains
|
$ | 3,235 | $ | 1,269 | $ | 7,161 | ||||||
|
Gross realized losses
|
(3 | ) | (134 | ) | (711 | ) | ||||||
|
Net realized gains
|
$ | 3,232 | $ | 1,135 | $ | 6,450 | ||||||
51
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The amortized cost and fair value of
available-for-sale
securities that had stated maturities as of May 31, 2010
are shown below by contractual maturity. Expected maturities can
differ from contractual maturities because borrowers may have
the right to prepay obligations without prepayment penalties.
| May 31, 2010 | ||||||||
|
Amortized
|
Fair
|
|||||||
| In thousands | cost | value | ||||||
|
Maturity date:
|
||||||||
|
Due in one year or less
|
$ | 320,289 | $ | 323,966 | ||||
|
Due after one year through three years
|
756,267 | 783,097 | ||||||
|
Due after three years through five years
|
499,530 | 526,116 | ||||||
|
Due after five years
|
509,163 | 518,599 | ||||||
|
Total
|
$ | 2,085,249 | $ | 2,151,778 | ||||
VRDNs are primarily categorized as due after five years in the
table above as the contractual maturities on these securities
are typically 20 to 30 years. Although these securities are
issued as long-term securities, they are priced and traded as
short-term instruments because of the liquidity provided through
the tender feature.
| Note E — | Fair Value Measurements |
The carrying values of cash and cash equivalents, accounts
receivable, net of allowance for doubtful accounts, and accounts
payable approximate fair value due to the short maturities of
these instruments. Marketable securities included in funds held
for clients and corporate investments consist primarily of
securities classified as
available-for-sale
and are recorded at fair value on a recurring basis.
The accounting standards related to fair value measurements
include a hierarchy for information and valuations used in
measuring fair value that is broken down into three levels based
on reliability, as follows:
| • | Level 1 valuations are based on quoted prices in active markets for identical instruments that the Company has the ability to access. | |
| • | Level 2 valuations are based on quoted prices for similar, but not identical, instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; or other than quoted prices observable inputs. | |
| • | Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement. |
52
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company’s financial assets and liabilities measured at
fair value on a recurring basis were as follows:
| May 31, 2010 | ||||||||||||||||
|
Quoted
|
||||||||||||||||
|
prices in
|
Significant
|
|||||||||||||||
|
Carrying
|
active
|
Significant other
|
unobservable
|
|||||||||||||
|
value
|
markets
|
observable inputs
|
inputs
|
|||||||||||||
| In thousands | (Fair value) | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
|
Assets:
|
||||||||||||||||
|
Available-for-sale
securities:
|
||||||||||||||||
|
General obligation municipal bonds
|
$ | 984,490 | $ | — | $ | 984,490 | $ | — | ||||||||
|
Pre-refunded municipal bonds
|
559,328 | — | 559,328 | — | ||||||||||||
|
Revenue municipal bonds
|
381,680 | — | 381,680 | — | ||||||||||||
|
Variable rate demand notes
|
226,280 | — | 226,280 | — | ||||||||||||
|
Other equity securities
|
69 | 69 | — | — | ||||||||||||
|
Total
available-for-sale
securities
|
$ | 2,151,847 | $ | 69 | $ | 2,151,778 | $ | — | ||||||||
|
Other securities
|
$ | 7,264 | $ | 7,264 | $ | — | $ | — | ||||||||
|
Liabilities:
|
||||||||||||||||
|
Other long-term liabilities
|
$ | 7,254 | $ | 7,254 | $ | — | $ | — | ||||||||
| May 31, 2009 | ||||||||||||||||
|
Quoted
|
||||||||||||||||
|
prices in
|
Significant
|
|||||||||||||||
|
Carrying
|
active
|
Significant other
|
unobservable
|
|||||||||||||
|
value
|
markets
|
observable inputs
|
inputs
|
|||||||||||||
| In thousands | (Fair value) | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
|
Assets:
|
||||||||||||||||
|
Available-for-sale
securities:
|
||||||||||||||||
|
General obligation municipal bonds
|
$ | 882,156 | $ | — | $ | 882,156 | $ | — | ||||||||
|
Pre-refunded municipal bonds
|
549,174 | — | 549,174 | — | ||||||||||||
|
Revenue municipal bonds
|
349,461 | — | 349,461 | — | ||||||||||||
|
Variable rate demand notes
|
— | — | — | — | ||||||||||||
|
Other equity securities
|
62 | 62 | — | — | ||||||||||||
|
Total
available-for-sale
securities
|
$ | 1,780,853 | $ | 62 | $ | 1,780,791 | $ | — | ||||||||
|
Other securities
|
$ | 6,189 | $ | 6,189 | $ | — | $ | — | ||||||||
|
Liabilities:
|
||||||||||||||||
|
Other long-term liabilities
|
$ | 6,197 | $ | 6,197 | $ | — | $ | — | ||||||||
In determining the fair value of its assets and liabilities, the
Company predominately uses the market approach. In determining
the fair value of its
available-for-sale
securities, the Company utilizes the Interactive Data Pricing
service. Other securities are comprised of mutual fund
investments, which are valued based on quoted market prices.
Other long-term liabilities include the liability for the
Company’s non-qualified and unfunded deferred compensation
plans, and are valued based on the quoted market prices for
various mutual fund investment choices.
The preceding methods described may produce a fair value
calculation that may not be indicative of net realizable value
or reflective of future fair values. Furthermore, although the
Company believes its valuation methods are appropriate and
consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of
certain financial instruments could result in a different fair
value measurement at the reporting date.
53
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note F — | Property and Equipment, Net of Accumulated Depreciation |
The components of property and equipment, at cost, consisted of
the following:
| May 31, | ||||||||
| In thousands | 2010 | 2009 | ||||||
|
Land and improvements
|
$ | 4,200 | $ | 4,033 | ||||
|
Buildings and improvements
|
84,080 | 83,386 | ||||||
|
Data processing equipment
|
186,778 | 180,448 | ||||||
|
Software
|
178,793 | 165,959 | ||||||
|
Furniture, fixtures, and equipment
|
147,093 | 143,638 | ||||||
|
Leasehold improvements
|
91,418 | 88,509 | ||||||
|
Construction in progress
|
17,916 | 4,034 | ||||||
|
Total property and equipment, gross
|
710,278 | 670,007 | ||||||
|
Less: Accumulated depreciation and amortization
|
442,695 | 395,477 | ||||||
|
Property and equipment, net of accumulated depreciation
|
$ | 267,583 | $ | 274,530 | ||||
Depreciation expense was $64.6 million, $64.0 million,
and $61.4 million for fiscal years 2010, 2009, and 2008,
respectively.
| Note G — | Goodwill and Intangible Assets, Net of Accumulated Amortization |
The Company had goodwill balances on its Consolidated Balance
Sheets of $421.6 million as of May 31, 2010, and
$433.3 million as of May 31, 2009. The decrease in
goodwill was due to divesting of Stromberg, an immaterial
component of the Company.
The Company has certain intangible assets with finite lives. The
components of intangible assets, at cost, consisted of the
following:
| May 31, | ||||||||
| In thousands | 2010 | 2009 | ||||||
|
Client lists
|
$ | 194,339 | $ | 194,887 | ||||
|
Other intangible assets
|
4,935 | 5,675 | ||||||
|
Total intangible assets, gross
|
199,274 | 200,562 | ||||||
|
Less: Accumulated amortization
|
136,012 | 123,921 | ||||||
|
Intangible assets, net of accumulated amortization
|
$ | 63,262 | $ | 76,641 | ||||
Amortization expense for intangible assets was
$21.9 million, $21.8 million, and $19.2 million
for fiscal years 2010, 2009, and 2008, respectively.
54
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The estimated amortization expense for the next five fiscal
years relating to intangible asset balances is as follows:
|
In thousands
|
||||
| Year ending May 31, | Estimated amortization expense | |||
|
2011
|
$ | 19,312 | ||
|
2012
|
$ | 16,209 | ||
|
2013
|
$ | 11,342 | ||
|
2014
|
$ | 7,177 | ||
|
2015
|
$ | 4,574 | ||
| Note H — | Income Taxes |
The components of deferred tax assets and liabilities are as
follows:
| May 31, | ||||||||
| In thousands | 2010 | 2009 | ||||||
|
Deferred tax assets:
|
||||||||
|
Litigation reserve
|
$ | — | $ | 7,637 | ||||
|
Compensation and employee benefit liabilities
|
14,753 | 14,412 | ||||||
|
Other current liabilities
|
8,300 | 8,974 | ||||||
|
Tax credit carry forward
|
22,467 | 17,491 | ||||||
|
Depreciation
|
11,985 | 10,025 | ||||||
|
Stock-based compensation
|
25,218 | 20,770 | ||||||
|
Other
|
7,565 | 6,121 | ||||||
|
Gross deferred tax assets
|
90,288 | 85,430 | ||||||
|
Deferred tax liabilities:
|
||||||||
|
Capitalized software
|
27,578 | 26,711 | ||||||
|
Intangible assets
|
27,679 | 25,529 | ||||||
|
Revenue not subject to current taxes
|
10,513 | 10,896 | ||||||
|
Unrealized gains on
available-for-sale
securities
|
24,115 | 24,710 | ||||||
|
Other
|
332 | 849 | ||||||
|
Gross deferred tax liabilities
|
90,217 | 88,695 | ||||||
|
Net deferred tax asset/(liability)
|
$ | 71 | $ | (3,265 | ) | |||
55
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The components of the provision for income taxes are as follows:
| Year ended May 31, | ||||||||||||
| In thousands | 2010 | 2009 | 2008 | |||||||||
|
Current:
|
||||||||||||
|
Federal
|
$ | 230,143 | $ | 256,030 | $ | 252,623 | ||||||
|
State
|
26,022 | 24,366 | 22,334 | |||||||||
|
Total current
|
256,165 | 280,396 | 274,957 | |||||||||
|
Deferred:
|
||||||||||||
|
Federal
|
(3,812 | ) | (1,313 | ) | 4,036 | |||||||
|
State
|
(44 | ) | (553 | ) | (323 | ) | ||||||
|
Total deferred
|
(3,856 | ) | (1,866 | ) | 3,713 | |||||||
|
Provision for income taxes
|
$ | 252,309 | $ | 278,530 | $ | 278,670 | ||||||
A reconciliation of the U.S. federal statutory tax rate to
the Company’s effective income tax rate is as follows:
| Year ended May 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Federal statutory tax rate
|
35.0 | % | 35.0 | % | 35.0 | % | ||||||
|
Increase/(decrease) resulting from:
|
||||||||||||
|
State income taxes, net of federal tax benefit
|
2.3 | 1.9 | 1.7 | |||||||||
|
Tax-exempt municipal bond interest
|
(2.7 | ) | (2.6 | ) | (4.1 | ) | ||||||
|
Effective income tax rate
|
34.6 | % | 34.3 | % | 32.6 | % | ||||||
On June 1, 2007, the Company adopted authoritative
accounting guidance on uncertain tax positions. This guidance
prescribes minimum recognition thresholds for evaluating
uncertain income tax positions, and provides information on
derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure, and
transition. The impact of the adoption mainly affected the state
income tax rate, net of federal benefit.
Upon adoption, the Company recorded a cumulative effect
adjustment by increasing its reserve for uncertain tax positions
by $8.4 million, with an offsetting decrease to opening
retained earnings. As of May 31, 2010 and May 31,
2009, the total reserve for uncertain tax positions was
$27.5 million and $25.7 million, respectively, and is
included in long-term liabilities on the Consolidated Balance
Sheets.
A reconciliation of the beginning and ending amounts of the
Company’s gross unrecognized tax benefits, not including
interest or other potential offsetting effects, is as follows:
| Year ended May 31, | ||||||||||||
| In thousands | 2010 | 2009 | 2008 | |||||||||
|
Balance as of beginning of fiscal year
|
$ | 35,808 | $ | 25,673 | $ | 15,911 | ||||||
|
Additions for tax positions of the current year
|
464 | 10,749 | 9,650 | |||||||||
|
Adjustments for tax positions of prior years
|
25 | (167 | ) | 102 | ||||||||
|
Settlements with tax authorities
|
— | (102 | ) | 241 | ||||||||
|
Expiration of the statute of limitations
|
(472 | ) | (345 | ) | (231 | ) | ||||||
|
Balance as of end of fiscal year
|
$ | 35,825 | $ | 35,808 | $ | 25,673 | ||||||
56
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company is subject to U.S. federal income tax as well
as income tax in one foreign and numerous state jurisdictions.
Uncertain tax positions relate primarily to state income tax
matters. The Company believes it is probable that the reserve
for uncertain tax positions will increase in the next twelve
months, resulting from the settlement of open periods and the
effect of operations on anticipated tax benefits. It is
anticipated that this increase will impact the tax provision in
the range of $1.0 million to $3.0 million. The Company
is currently under a state income tax audit for fiscal years
2004 through 2007. The examination phase of the audit is
ongoing. On July 14, 2010, the Company received a summary
of proposed tax audit adjustments from the New York State
Department of Taxation and Finance, which are in excess of the
reserve recorded as of May 31, 2010. The Company is
currently evaluating the proposed tax audit adjustments and
preparing a response to those proposed adjustments. The Company
expects to vigorously defend its positions. While the Company
believes its reserve for uncertain tax positions is adequate, it
is not possible to reasonably estimate the impact, if any, if
resolution is ultimately unfavorable to the Company. An
unfavorable outcome of this matter could have a material adverse
impact on the Company’s financial position and results of
operations in the period in which the matter is concluded.
The Company has concluded all U.S. federal income tax
matters through its fiscal year ended May 31, 2007. Fiscal
2008 is currently under examination and fiscal 2009 and fiscal
2010 are still subject to potential audit. With limited
exception, state income tax audits by taxing authorities are
closed through fiscal 2005, primarily due to expiration of the
statute of limitations. Audit outcomes and the timing of audit
settlements are subject to a high degree of uncertainty. As of
May 31, 2010, substantially all of the $27.5 million
reserve for uncertain tax positions, if recognized, would
favorably affect the Company’s effective income tax rate.
The Company continues to follow its policy of recognizing
interest and penalties accrued on tax positions as a component
of income taxes on the Consolidated Statements of Income. The
amount of accrued interest and penalties associated with the
Company’s tax positions is immaterial to the Consolidated
Balance Sheets. The amount of interest and penalties recognized
for fiscal 2010 and fiscal 2009 was immaterial to the
Company’s results of operations.
| Note I — | Other Comprehensive Income |
Other comprehensive income results from items deferred on the
Consolidated Balance Sheets in stockholders’ equity. The
following table sets forth the components of other comprehensive
income:
| Year ended May 31, | ||||||||||||
| In thousands | 2010 | 2009 | 2008 | |||||||||
|
Unrealized holding gains
|
$ | 3,106 | $ | 42,965 | $ | 46,127 | ||||||
|
Income tax expense related to unrealized holding gains
|
(574 | ) | (16,357 | ) | (16,235 | ) | ||||||
|
Reclassification adjustment for the net gain on sale of
available-for-sale
securities realized in net income
|
(3,232 | ) | (1,135 | ) | (6,450 | ) | ||||||
|
Income tax expense on reclassification adjustment for net gain
on sale of
available-for-sale
securities
|
1,169 | 420 | 2,266 | |||||||||
|
Other comprehensive income
|
$ | 469 | $ | 25,893 | $ | 25,708 | ||||||
As of May 31, 2010, the accumulated other comprehensive
income was $42.4 million, which was net of taxes of
$24.1 million. As of May 31, 2009, the accumulated
other comprehensive income was $41.9 million, which was net
of taxes of $24.7 million.
| Note J — | Supplemental Cash Flow Information |
Income taxes paid were $258.0 million, $261.8 million,
and $258.6 million for fiscal years 2010, 2009, and 2008,
respectively.
57
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note K — | Employee Benefit Plans |
401(k) plan:
The Company maintains a
contributory savings plan that qualifies under
section 401(k) of the Internal Revenue Code. The Paychex,
Inc. 401(k) Incentive Retirement Plan (the “Plan”)
allows all employees to immediately participate in the salary
deferral portion of the Plan, contributing up to a maximum of
50% of their salary. Employees who have completed one year of
service are eligible to receive a company matching contribution,
when such contribution is in effect. Prior to April 2009, the
Company matched up to 100% of the first 3% of eligible pay and
up to 50% of the next 2% of eligible pay that an employee
contributed to the Plan. Prior to September 2007, the Company
matched 50% of an employee’s voluntary contribution up to
6% of eligible pay. Effective April 3, 2009, the Company
suspended the employer matching contribution and as of
May 31, 2010, had not yet made a decision related to its
reinstatement.
The Plan is 100% participant-directed. Plan participants can
fully diversify their portfolios by choosing from any or all
investment fund choices in the Plan. Transfers in and out of
investment funds, including the Paychex, Inc. Employee Stock
Ownership Plan (ESOP) Stock Fund, are not restricted in any
manner. The Company match contribution, when in effect, follows
the same fund elections as the employee compensation deferrals.
Company contributions to the Plan for fiscal 2009 and fiscal
2008 were $14.3 million and $15.1 million,
respectively.
Deferred compensation plans:
The
Company offers non-qualified and unfunded deferred compensation
plans to a select group of key employees, executive officers,
and outside directors. Eligible employees are provided with the
opportunity to defer up to 50% of their annual base salary and
bonus and outside directors to defer 100% of their Board cash
compensation. Gains and losses are credited based on the
participant’s election of a variety of investment choices.
The Company does not match any participant deferral or guarantee
its return. Distributions are paid at one of the following dates
selected by the participant: the participant’s termination
date, the date the participant retires from any active
employment, or a designated specific date. In fiscal 2009,
participants were allowed to make a one-time election for a
distribution under the Internal Revenue Service
Section 409A transition rules. The amounts accrued under
these plans were $7.3 million and $6.2 million as of
May 31, 2010 and May 31, 2009, respectively, and are
reflected in other long-term liabilities in the accompanying
Consolidated Balance Sheets.
| Note L — | Commitments and Contingencies |
Lines of credit:
As of May 31,
2010, the Company had unused borrowing capacity available under
four uncommitted, secured, short-term lines of credit at market
rates of interest with financial institutions as follows:
| Financial institution | Amount available | Expiration date | ||||||
|
JP Morgan Chase Bank, N.A.
|
$ | 350 million | February 2011 | |||||
|
Bank of America, N.A.
|
$ | 250 million | February 2011 | |||||
|
PNC Bank, National Association
|
$ | 150 million | February 2011 | |||||
|
Wells Fargo Bank, National Association
|
$ | 150 million | February 2011 | |||||
The credit facilities are evidenced by promissory notes and are
secured by separate pledge security agreements by and between
Paychex, Inc. and each of the financial institutions (the
“Lenders”), pursuant to which the Company has granted
each of the Lenders a security interest in certain investment
securities accounts. The collateral is maintained in a pooled
custody account pursuant to the terms of a control agreement and
is to be administered under an intercreditor agreement among the
Lenders. Under certain circumstances, individual Lenders may
require that collateral be transferred from the pooled account
into segregated accounts for the benefit of such individual
Lenders.
The primary uses of the lines of credit would be to meet
short-term funding requirements related to deposit account
overdrafts and client fund obligations arising from electronic
payment transactions on behalf of clients in
58
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
the ordinary course of business, if necessary. No amounts were
outstanding against these lines of credit during fiscal 2010 or
as of May 31, 2010.
JP Morgan Chase Bank, N.A. and Bank of America, N.A. are also
parties to the Company’s irrevocable standby letters of
credit, which arrangements are discussed below.
Letters of credit:
The Company had
irrevocable standby letters of credit outstanding totaling
$50.3 million and $65.8 million as of May 31,
2010 and May 31, 2009, respectively, required to secure
commitments for certain insurance policies. The letters of
credit expire at various dates between July 2010 and May 2011,
and are collateralized by securities held in the Company’s
investment portfolios. No amounts were outstanding on these
letters of credit during fiscal 2010 or as of May 31, 2010.
Subsequent to May 31, 2010, the letter of credit expiring
in July 2010 was renewed and will expire in July 2011.
Contingencies:
The Company is subject
to various claims and legal matters that arise in the normal
course of its business. These include disputes or potential
disputes related to breach of contract, breach of fiduciary
duty, employment-related claims, tax claims, and other matters.
In August 2001, the Company’s wholly owned subsidiary,
Rapid Payroll, Inc. (“Rapid Payroll”) informed
76 licensees that it intended to stop supporting their
payroll processing software in August of 2002. The communication
was sent due to the licensee contract assumed by Paychex during
the acquisition of Rapid Payroll in 1996 being very unfavorable
to the Company. Thereafter, lawsuits were commenced by licensees
asserting various claims, including breach of contract and
related tort and fraud causes of action.
On March 9, 2010, the Court of Appeal of the State of
California upheld a jury verdict issued on June 27, 2007 in
litigation brought by one of the licensees. In that case, the
California Superior Court, Los Angeles County jury awarded to
the plaintiff $15.0 million in compensatory damages and
subsequently awarded an additional $11.0 million in
punitive damages. The Company satisfied the judgment, including
statutory interest, without further appeal. This was the final
pending matter in the Rapid Payroll litigation.
During fiscal 2010, the Company increased its litigation reserve
by $18.7 million for the Rapid Payroll litigation. The
Company’s management currently believes that resolution of
outstanding legal matters will not have a material adverse
effect on the Company’s financial position or results of
operations. However, legal matters are subject to inherent
uncertainties and there exists the possibility that the ultimate
resolution of these matters could have a material adverse impact
on the Company’s financial position and the results of
operations in the period in which any such effect is recorded.
Lease commitments:
The Company leases
office space and data processing equipment under terms of
various operating leases. Rent expense for fiscal years 2010,
2009, and 2008 was $46.9 million, $46.6 million, and
$44.5 million, respectively. As of May 31, 2010,
future minimum lease payments under various non-cancelable
operating leases with terms of more than one year are as follows:
|
In thousands
|
||||
| Year ending May 31, | Minimum lease payments | |||
|
2011
|
$ | 41,441 | ||
|
2012
|
$ | 34,803 | ||
|
2013
|
$ | 25,042 | ||
|
2014
|
$ | 18,342 | ||
|
2015
|
$ | 13,743 | ||
|
Thereafter
|
$ | 14,573 | ||
59
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Other commitments:
As of May 31,
2010, the Company had outstanding commitments under purchase
orders and legally binding contractual arrangements with minimum
future payment obligations of approximately $73.0 million,
including $8.9 million of commitments to purchase capital
assets. These minimum future payment obligations relate to the
following fiscal years:
|
In thousands
|
||||
| Year ending May 31, | Minimum payment obligation | |||
|
2011
|
$ | 46,228 | ||
|
2012
|
$ | 16,226 | ||
|
2013
|
$ | 7,357 | ||
|
2014
|
$ | 1,186 | ||
|
2015
|
$ | 1,156 | ||
|
Thereafter
|
$ | 853 | ||
The Company guarantees performance of service on annual
maintenance contracts for clients who financed their service
contracts through a third party. In the normal course of
business, the Company makes representations and warranties that
guarantee the performance of services under service arrangements
with clients. Historically, there have been no material losses
related to such guarantees. In addition, the Company has entered
into indemnification agreements with its officers and directors,
which require the Company to defend and, if necessary, indemnify
these individuals for certain pending or future claims as they
relate to their services provided to the Company.
Paychex currently self-insures the deductible portion of various
insured exposures under certain employee benefit plans. The
Company’s estimated loss exposure under these insurance
arrangements is recorded in other current liabilities on the
Consolidated Balance Sheets. Historically, the amounts accrued
have not been material. The Company also maintains insurance
coverage in addition to its purchased primary insurance policies
for gap coverage for employment practices liability, errors and
omissions, warranty liability, and acts of terrorism; and
capacity for deductibles and self-insured retentions through its
captive insurance company.
| Note M — | Related Parties |
During fiscal years 2010, 2009, and 2008, the Company purchased
approximately $3.2 million, $4.5 million, and
$4.4 million, respectively, of data processing equipment
and software from EMC Corporation. The Chairman, President, and
Chief Executive Officer of EMC Corporation is a member of the
Company’s Board.
During fiscal years 2010, 2009, and 2008, the Company purchased
approximately $0.4 million, $0.5 million, and
$0.5 million, respectively, of services from
Dun & Bradstreet Corporation. Jonathan J. Judge, the
Company’s President and Chief Executive Officer, is a
member of the Board of Directors of Dun & Bradstreet
Corporation.
60
Table of Contents
PAYCHEX,
INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note N — | Quarterly Financial Data (Unaudited) |
In thousands, except per share
amounts
| Three Months Ended | ||||||||||||||||||||
| Fiscal 2010 | August 31 | November 30 | February 28 (1) | May 31 | Full Year | |||||||||||||||
|
Service revenue
|
$ | 486,491 | $ | 483,024 | $ | 493,790 | $ | 482,484 | $ | 1,945,789 | ||||||||||
|
Interest on funds held for clients
|
13,723 | 13,552 | 14,029 | 13,727 | 55,031 | |||||||||||||||
|
Total revenue
|
500,214 | 496,576 | 507,819 | 496,211 | 2,000,820 | |||||||||||||||
|
Operating income
|
189,867 | 193,065 | 168,249 | 173,614 | 724,795 | |||||||||||||||
|
Investment income, net
|
905 | 1,147 | 1,180 | 1,281 | 4,513 | |||||||||||||||
|
Income before income taxes
|
190,772 | 194,212 | 169,429 | 174,895 | 729,308 | |||||||||||||||
|
Income taxes
|
67,152 | 68,362 | 57,422 | 59,373 | 252,309 | |||||||||||||||
|
Net income
|
$ | 123,620 | $ | 125,850 | $ | 112,007 | $ | 115,522 | $ | 476,999 | ||||||||||
|
Basic earnings per
share
(2)
|
$ | 0.34 | $ | 0.35 | $ | 0.31 | $ | 0.32 | $ | 1.32 | ||||||||||
|
Diluted earnings per
share
(2)
|
$ | 0.34 | $ | 0.35 | $ | 0.31 | $ | 0.32 | $ | 1.32 | ||||||||||
|
Weighted-average common shares outstanding
|
361,208 | 361,392 | 361,417 | 361,451 | 361,359 | |||||||||||||||
|
Weighted-average common shares outstanding, assuming dilution
|
361,362 | 361,692 | 361,860 | 362,032 | 361,728 | |||||||||||||||
|
Cash dividends per common share
|
$ | 0.31 | $ | 0.31 | $ | 0.31 | $ | 0.31 | $ | 1.24 | ||||||||||
|
Total net realized
gains
(3)
|
$ | 285 | $ | 729 | $ | 1,275 | $ | 943 | $ | 3,232 | ||||||||||
| Three Months Ended | ||||||||||||||||||||
| Fiscal 2009 | August 31 | November 30 | February 28 | May 31 | Full Year | |||||||||||||||
|
Service revenue
|
$ | 509,867 | $ | 504,383 | $ | 512,196 | $ | 480,859 | $ | 2,007,305 | ||||||||||
|
Interest on funds held for clients
|
24,218 | 19,777 | 16,385 | 15,074 | 75,454 | |||||||||||||||
|
Total revenue
|
534,085 | 524,160 | 528,581 | 495,933 | 2,082,759 | |||||||||||||||
|
Operating income
|
221,585 | 211,900 | 197,401 | 174,314 | 805,200 | |||||||||||||||
|
Investment income, net
|
3,051 | 1,932 | 1,067 | 825 | 6,875 | |||||||||||||||
|
Income before income taxes
|
224,636 | 213,832 | 198,468 | 175,139 | 812,075 | |||||||||||||||
|
Income taxes
|
75,927 | 73,590 | 67,678 | 61,335 | 278,530 | |||||||||||||||
|
Net income
|
$ | 148,709 | $ | 140,242 | $ | 130,790 | $ | 113,804 | $ | 533,545 | ||||||||||
|
Basic earnings per
share
(2)
|
$ | 0.41 | $ | 0.39 | $ | 0.36 | $ | 0.32 | $ | 1.48 | ||||||||||
|
Diluted earnings per
share
(2)
|
$ | 0.41 | $ | 0.39 | $ | 0.36 | $ | 0.32 | $ | 1.48 | ||||||||||
|
Weighted-average common shares outstanding
|
360,629 | 360,812 | 360,821 | 360,892 | 360,783 | |||||||||||||||
|
Weighted-average common shares outstanding, assuming dilution
|
361,040 | 360,977 | 360,913 | 361,034 | 360,985 | |||||||||||||||
|
Cash dividends per common share
|
$ | 0.31 | $ | 0.31 | $ | 0.31 | $ | 0.31 | $ | 1.24 | ||||||||||
|
Total net realized
gains
(3)
|
$ | 300 | $ | 405 | $ | 173 | $ | 257 | $ | 1,135 | ||||||||||
| (1) | Includes an expense charge of $18.7 million to increase the litigation reserve. | |
| (2) | 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. | |
| (3) | Total net realized gains on the combined funds held for clients and corporate investment portfolios. |
61
Table of Contents
Schedule II —
Valuation and Qualifying Accounts
PAYCHEX,
INC.
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
FOR THE YEAR ENDED MAY 31,
In thousands
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
FOR THE YEAR ENDED MAY 31,
In thousands
|
Balance as of
|
Additions
|
Balance as
|
||||||||||||||
|
beginning
|
charged to
|
Costs and
|
of end
|
|||||||||||||
| Description | of year | expenses | deductions (1) | of year | ||||||||||||
|
2010
|
||||||||||||||||
|
Allowance for doubtful accounts
|
$ | 4,032 | $ | 2,631 | $ | 4,811 | $ | 1,852 | ||||||||
|
Reserve for client fund losses
|
$ | 3,188 | $ | 3,460 | $ | 4,057 | $ | 2,591 | ||||||||
|
2009
|
||||||||||||||||
|
Allowance for doubtful accounts
|
$ | 4,083 | $ | 2,910 | $ | 2,961 | $ | 4,032 | ||||||||
|
Reserve for client fund losses
|
$ | 2,888 | $ | 4,379 | $ | 4,079 | $ | 3,188 | ||||||||
|
2008
|
||||||||||||||||
|
Allowance for doubtful accounts
|
$ | 3,285 | $ | 3,044 | $ | 2,246 | $ | 4,083 | ||||||||
|
Reserve for client fund losses
|
$ | 2,543 | $ | 4,214 | $ | 3,869 | $ | 2,888 | ||||||||
| (1) | Uncollectible amounts written off, net of recoveries. For fiscal 2010, this column includes the amount disposed of with the divestiture of Stromberg, an immaterial component of the Company. |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
Disclosure Controls and Procedures and Internal Control
Over Financial Reporting:
Disclosure controls
and procedures are designed with the objective of ensuring that
information required to be disclosed in the Company’s
reports filed under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”), such as this report, is
recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms. Disclosure
controls and procedures are also designed with the objective of
ensuring that such information is accumulated and communicated
to the Company’s management, including the Company’s
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure.
Conclusion Regarding the Effectiveness of Disclosure
Controls and Procedures:
As of the end of the
period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of
the Company’s Chief Executive Officer and Chief Financial
Officer, of the effectiveness of disclosure controls and
procedures as defined in
Rules 13a-15(e)
and
15d-15(e)
of
the Exchange Act. Based on such evaluation, the Company’s
Chief Executive Officer and Chief Financial Officer have
concluded that as of the end of the period covered by this
report, the Company’s disclosure controls and procedures
were effective.
Changes in Internal Controls Over Financial
Reporting:
We also carried out an evaluation
of the internal control over financial reporting to determine
whether any changes occurred during the period covered by this
report. Based on such evaluation, there has been no changes in
the Company’s internal controls over financial reporting
that occurred during the Company’s most recently completed
fiscal quarter ended May 31, 2010, that materially
affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
The Report on Management’s Assessment of Internal Control
Over Financial Reporting and the Report of Independent
Registered Public Accounting Firm on Effectiveness of Internal
Control Over Financial Reporting are incorporated herein by
reference from Part II, Item 8 of this
Form 10-K.
| Item 9B. | Other Information |
None.
62
Table of Contents
| Item 10. | Directors, Executive Officers and Corporate Governance |
The following table shows the executive officers of the Company
as of May 31, 2010, and information regarding their
positions and business experience. Such executive officers hold
principal policy-making powers at the Company.
| Name | Age | Position and business experience | ||
|
Jonathan J. Judge
|
56 | Mr. Judge has been President and Chief Executive Officer of the Company since October 2004. Prior to joining Paychex, he served as President and Chief Executive Officer of Crystal Decisions, Inc., an information management software company from October 2002 through December 2003. Mr. Judge serves as a member of the Upstate New York Regional Advisory Board (UNYRAB) of the Federal Reserve Bank of New York. He is a director of PMC-Sierra, Inc. and Dun & Bradstreet Corporation. He also serves as a director of the Company and is chairman of the Executive Committee. | ||
|
John M. Morphy
|
62 | Mr. Morphy joined the Company in October 1995 and was named Senior Vice President in October 2002. He was named Chief Financial Officer and Secretary in October 1996. Prior to joining the Company, he served as Chief Financial Officer and in other senior management capacities for over ten years at Goulds Pumps, Incorporated, a pump manufacturer. | ||
|
Martin Mucci
|
50 | Mr. Mucci joined the Company in March 2002 as a consultant on operational issues of the Company, including responsibility for implementation of the Advantage Payroll Services Inc. acquisition, and was appointed Senior Vice President, Operations in October 2002. | ||
|
Delbert M. Humenik
|
48 | Mr. Humenik was appointed Senior Vice President of Sales and Marketing of the Company in September 2009. Prior to joining the Company, he served as Senior Vice President and General Manager for R.H. Donnelly Corporation, a leading national consumer and business-to-business local commercial search company, since 2007. From 2005 to 2006, he was Senior Vice President for R.H. Donnelly and from 2002 to 2005, he was Senior Vice President at Verizon Communications, a world leader in communication services. During his 20-year tenure with Verizon, Mr. Humenik held various sales management and executive leadership positions. | ||
|
Jennifer Vossler
|
47 | Ms. Vossler joined the Company in May 2009 as Vice President and Controller. Prior to joining the Company, she served as Vice President and Corporate Controller, and held various executive and senior management positions during her eleven years at Bausch & Lomb Incorporated. Previously in her career, she held leadership roles with a global facilities management outsourcing company and a public accounting firm. | ||
|
William G. Kuchta, Ed. D
|
63 | Mr. Kuchta joined the Company in February 1995 and was named Vice President, Organizational Development in April 1996. From 1993 to 1995, he was principal of his own consulting firm, and from 1989 to 1993, he served as Vice President of Human Resources of Fisons Corporation, a pharmaceutical company. |
On July 12, 2010, Paychex announced Mr. Judge’s
resignation from his position as President and Chief Executive
Officer effective July 31, 2010. Until his replacement is
in place, the Board has established an executive committee
comprised of Delbert M. Humenik, John M. Morphy, and Martin
Mucci. Chairman of the Board, B. Thomas Golisano, and the Board
will provide oversight for the executive committee.
63
Table of Contents
In connection with his resignation, Mr. Judge signed a
separation agreement. The following is a summary of terms and
conditions of that agreement.
| • | Mr. Judge will receive a severance payment of $1.9 million, as well as immediate acceleration on July 31, 2010 of unvested equity awards granted prior to July 1, 2007; and health insurance premiums for twelve months. | |
| • | An additional 11,111 shares of restricted stock and an additional 30,000 non-qualified stock options from the July 17, 2007 awards will also vest immediately on July 31, 2010. | |
| • | All vested and exercisable equity awards will continue to be governed by applicable plan documents. | |
| • | In consideration of the Company entering into the agreement, Mr. Judge has agreed to certain non-compete, non-disparagement, confidentiality, and non-solicitation provisions. In addition to the agreement and in consideration of benefits received as indicated above, Mr. Judge entered into a general release of all claims with the Company. | |
| • | Certain terms of Mr. Judge’s employment agreement dated November 30, 2007 survive the separation and remain in full force as do the non-competition, non-solicitation, confidentiality, and detrimental conduct provisions of Mr. Judge’s July 2008 and July 2009 equity compensation agreements with the Company. |
Mr. Judge is expected to continue to serve as a director of
the Company through the end of his term of service to the Board
in October 2010. On July 12, 2010, Mr. Judge informed
the Board that he does not intend to stand for re-election.
There were no disagreements between Mr. Judge and the
Company relating to the Company’s operations, policies, or
practices involved in Mr. Judge’s decision not to
stand for re-election as a director.
The additional information required by this item is set forth in
the Company’s Definitive Proxy Statement for its 2010
Annual Meeting of Stockholders in the sections
“PROPOSAL 1 — ELECTION OF DIRECTORS FOR A
ONE-YEAR TERM,” “CORPORATE GOVERNANCE,”
“CODE OF BUSINESS ETHICS AND CONDUCT,” and
“SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE,” and is incorporated herein by reference.
| Item 11. | Executive Compensation |
Refer to Part III, Item 10 for information on
Mr. Judge’s resignation and separation agreement.
The information required by this item is set forth in the
Company’s Definitive Proxy Statement for its 2010 Annual
Meeting of Stockholders in the sections “COMPENSATION
DISCUSSION AND ANALYSIS,” “NAMED EXECUTIVE OFFICER
COMPENSATION,” and “DIRECTOR COMPENSATION FOR THE
FISCAL YEAR ENDED MAY 31, 2010,” and is incorporated herein
by reference.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by this item is set forth below and in
the Company’s Definitive Proxy Statement for its 2010
Annual Meeting of Stockholders under the section “SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” and
under the sub-heading “Equity Compensation Plan
Information” within “PROPOSAL 2 — TO AMEND
THE PAYCHEX, INC. 2002 STOCK INCENTIVE PLAN AND INCREASE THE
SHARES AVAILABLE UNDER THE PLAN,” and is incorporated
herein by reference.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by this item is set forth in the
Company’s Definitive Proxy Statement for its 2010 Annual
Meeting of Stockholders under the
sub-headings
“Policy on Transactions with Related Persons” and
“Board of Directors Committees” within the section
“CORPORATE GOVERNANCE,” and is incorporated herein by
reference.
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Table of Contents
| Item 14. | Principal Accounting Fees and Services |
The information required by this item is set forth in the
Company’s Definitive Proxy Statement for its 2010 Annual
Meeting of Stockholders under the section
“PROPOSAL 3 — RATIFICATION OF SELECTION OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM,” and is
incorporated herein by reference.
| Item 15. | Exhibits and Financial Statement Schedules |
|
1.
|
Financial Statements and Supplementary Data | |
| See Financial Statements and Supplementary Data Table of Contents at page 31. | ||
|
2.
|
Financial statement schedules required to be filed by Item 8 of this Form 10-K include Schedule II — Valuation and Qualifying Accounts. See Financial Statements and Supplementary Data Table of Contents at page 31. All other schedules are omitted as the required matter is not present, the amounts are not significant, or the information is shown in the financial statements or the notes thereto. | |
|
3.
|
Exhibits |
| (3)(a) | Restated Certificate of Incorporation, incorporated herein by reference from Exhibit 3(a) to the Company’s Form 10-K filed with the Commission on July 20, 2004. | |||||
| (3)(b) | Bylaws, as amended, incorporated herein by reference from Exhibit 3(b) to the Company’s Form 10-K filed with the Commission on July 21, 2006. | |||||
|
#
|
(10.1) | Paychex, Inc. 1998 Stock Incentive Plan, incorporated herein by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-8, No. 333-65191. | ||||
|
#
|
(10.2) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005), incorporated herein by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-8, No. 333-129572. | ||||
|
#
|
(10.3) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Award Agreement for Non-Qualified Stock Options, incorporated herein by reference from Exhibit 10.3 to the Company’s Form 8-K filed with the Commission on October 17, 2005. | ||||
|
#
|
(10.4) | Paychex, Inc. Non-Qualified Stock Option Agreement, incorporated herein by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-8, No. 333-129571. | ||||
|
#
|
(10.5) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) 2008 Master Restricted Stock Award Agreement, incorporated herein by reference from Exhibit 10.2 to the Company’s Form 8-K filed with the Commission on July 18, 2007. | ||||
|
#
|
(10.6) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Restricted Stock Award Agreement, incorporated herein by reference from Exhibit 10.3 to the Company’s Form 8-K filed with the Commission on July 18, 2007. | ||||
|
#
|
(10.7) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Amended and Restated 2007 Master Restricted Stock Award Agreement, incorporated herein by reference from Exhibit 10.4 to the Company’s Form 8-K filed with the Commission on July 18, 2007. | ||||
|
#
|
(10.8) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) 2007 Master Restricted Stock Unit Award Agreement, incorporated herein by reference from Exhibit 10.1 to the Company’s Form 10-Q filed with the Commission on September 26, 2007. | ||||
|
#
|
(10.9) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Restricted Stock Award Agreement, incorporated herein by reference from Exhibit 10.1 to the Company’s Form 8-K filed with the Commission on July 16, 2008. | ||||
|
#
|
(10.10) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Non-Qualified Stock Option Award Agreement, incorporated herein by reference from Exhibit 10.2 to the Company’s Form 8-K filed with the Commission on July 16, 2008. |
65
Table of Contents
|
#
|
(10.11) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Unit Award Agreement, incorporated herein by reference from Exhibit 10(n) to the Company’s Form 10-K filed with the Commission on July 18, 2008. | ||||
|
#
|
(10.12) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Unit (Cliff Vest) Award Agreement, incorporated herein by reference from Exhibit 10(o) to the Company’s Form 10-K filed with the Commission on July 18, 2008. | ||||
|
#
|
(10.13) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Award Agreement for Directors, incorporated herein by reference from Exhibit 10(p) to the Company’s Form 10-K filed with the Commission on July 18, 2008. | ||||
|
#
|
(10.14) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Non-Qualified Stock Option Agreement for Directors, incorporated herein by reference from Exhibit 10(q) to the Company’s Form 10-K filed with the Commission on July 18, 2008. | ||||
|
#
|
(10.15) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Award Agreement (Officer), incorporated herein by reference from Exhibit 10.16 to the Company’s Form 10-K filed with the Commission on July 20, 2009. | ||||
|
#
|
(10.16) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) 2009 Non-Qualified Stock Option Award Agreement (Special Grant), incorporated herein by reference from Exhibit 10.17 to the Company’s Form 10-K filed with the Commission on July 20, 2009. | ||||
|
#
|
(10.17) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Award Agreement (Board), incorporated herein by reference from Exhibit 10.18 to the Company’s Form 10-K filed with the Commission on July 20, 2009. | ||||
|
*#
|
(10.18) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Restricted Stock Award Agreement (Officer). | ||||
|
*#
|
(10.19) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Non-Qualified Stock Option Award Agreement (Officer). | ||||
|
*#
|
(10.20) | Paychex, Inc. 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) Form of Officer Performance Incentive Award Agreement (Long Term). | ||||
|
*#
|
(10.21) | Paychex, Inc. Form of Performance Award Incentive Program Fiscal Year 2011. | ||||
|
#
|
(10.22) | Form of Indemnification Agreement for Directors and Officers, incorporated herein by reference from Exhibit 10.1 to the Company’s Form 10-Q filed with the Commission on March 21, 2003. | ||||
|
#
|
(10.23) | Paychex, Inc. Indemnification Agreement with Jonathan J. Judge, incorporated herein by reference from Exhibit 10(k) to the Company’s Form 10-K filed with the Commission on July 22, 2005. | ||||
|
#
|
(10.24) | Paychex, Inc. Employment Agreement with Jonathan J. Judge dated November 30, 2007, incorporated herein by reference from Exhibit 10.1 to the Company’s Form 8-K filed with the Commission on December 4, 2007. | ||||
|
#
|
(10.25) | Paychex, Inc. Board Deferred Compensation Plan, incorporated herein by reference from Exhibit 10.29 to the Company’s Form 10-K filed with the Commission on July 20, 2009. | ||||
|
#
|
(10.26) | Paychex, Inc. Employee Deferred Compensation Plan, incorporated herein by reference from Exhibit 10.30 to the Company’s Form 10-K filed with the Commission on July 20, 2009. | ||||
|
*
|
(21.1) | Subsidiaries of the Registrant. | ||||
|
*
|
(23.1) | Consent of Independent Registered Public Accounting Firm. | ||||
|
*
|
(24.1) | Power of Attorney. | ||||
|
*
|
(31.1) | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||
|
*
|
(31.2) | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||
|
*
|
(32.1) | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
66
Table of Contents
|
*
|
(32.2) | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||
|
**
|
101.INS | XBRL instance document. | ||||
|
**
|
101.SCH | XBRL taxonomy extension schema document. | ||||
|
**
|
101.CAL | XBRL taxonomy extension calculation linkbase document. | ||||
|
**
|
101.LAB | XBRL taxonomy label linkbase document. | ||||
|
**
|
101.PRE | XBRL taxonomy extension presentation linkbase document. | ||||
|
**
|
101.DEF | XBRL taxonomy extension definition linkbase document. |
| * | Exhibit filed with this report. | |
| ** | As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Exchange Act. | |
| # | Management contract or compensatory plan. |
67
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on July 16, 2010.
PAYCHEX,
INC.
By:
/s/ Jonathan
J. Judge
Jonathan J. Judge
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities indicated on
July 16, 2010.
/s/ Jonathan
J. Judge
Jonathan J. Judge, President and
Chief Executive Officer, and Director
(Principal Executive Officer)
/s/ John
M. Morphy
John M. Morphy, Senior Vice President,
Chief Financial Officer, and Secretary
(Principal Financial and Accounting Officer)
B. Thomas Golisano*, Chairman of the Board
David J. S. Flaschen*, Director
Grant M. Inman*, Director
Pamela A. Joseph*, Director
Joseph M. Tucci*, Director
Joseph Velli*, Director
*By:
/s/ Jonathan
J. Judge
Jonathan J. Judge, as
Attorney-in-Fact
68
TABLE OF CONTENTS
Part IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. ReservedPart IIItem 5. Market For Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 6. Selected Financial DataItem 7. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceItem 11. Executive CompensationItem 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related Transactions, and Director IndependenceItem 14. Principal Accounting Fees and ServicesPart IVItem 15. Exhibits and Financial Statement Schedules