Paychex, Inc. 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 2007
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
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 is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ.
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
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Common Stock, $0.01 Par Value
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381,933,029 Shares |
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CLASS
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OUTSTANDING AS OF February 28, 2007 |
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
In thousands, except per share amounts
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For the three months ended |
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For the nine months ended |
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February 28, |
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February 28, |
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2007 |
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2006 |
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2007 |
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2006 |
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Revenue: |
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Service revenue |
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$ |
447,568 |
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$ |
401,883 |
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$ |
1,302,357 |
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$ |
1,165,326 |
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Interest on funds held for
clients |
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37,719 |
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28,703 |
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97,259 |
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68,790 |
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Total revenue |
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485,287 |
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430,586 |
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1,399,616 |
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1,234,116 |
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Expenses: |
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Operating expenses |
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158,543 |
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145,486 |
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457,497 |
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414,257 |
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Selling, general and
administrative expenses |
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153,760 |
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124,500 |
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400,453 |
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337,834 |
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Total expenses |
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312,303 |
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269,986 |
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857,950 |
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752,091 |
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Operating income |
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172,984 |
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160,600 |
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541,666 |
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482,025 |
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Investment income, net |
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10,494 |
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6,358 |
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29,851 |
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16,769 |
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Income before income taxes |
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183,478 |
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166,958 |
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571,517 |
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498,794 |
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Income taxes |
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56,878 |
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52,424 |
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177,170 |
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156,620 |
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Net income |
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$ |
126,600 |
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$ |
114,534 |
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$ |
394,347 |
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$ |
342,174 |
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Basic earnings per share |
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$ |
0.33 |
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$ |
0.30 |
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$ |
1.04 |
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$ |
0.90 |
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Diluted earnings per share |
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$ |
0.33 |
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$ |
0.30 |
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$ |
1.03 |
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$ |
0.90 |
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Weighted-average common shares
outstanding |
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381,475 |
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379,680 |
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380,879 |
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379,245 |
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Weighted-average common shares
outstanding, assuming dilution |
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383,335 |
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381,751 |
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382,566 |
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381,055 |
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Cash dividends per common share |
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$ |
0.21 |
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$ |
0.16 |
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$ |
0.58 |
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$ |
0.45 |
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See Notes to Consolidated Financial Statements.
2
PAYCHEX, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
In thousands, except per share amounts
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February 28, |
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May 31, |
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2007 |
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2006 |
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ASSETS |
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Cash and cash equivalents |
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$ |
80,921 |
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$ |
137,423 |
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Corporate investments |
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566,888 |
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440,007 |
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Interest receivable |
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38,628 |
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38,139 |
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Accounts receivable, net of allowance for doubtful accounts |
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163,673 |
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189,835 |
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Deferred income taxes |
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20,503 |
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18,314 |
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Prepaid income taxes |
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7,574 |
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Prepaid expenses and other current assets |
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25,759 |
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21,398 |
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Current assets before funds held for clients |
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896,372 |
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852,690 |
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Funds held for clients |
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3,547,269 |
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3,591,611 |
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Total current assets |
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4,443,641 |
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4,444,301 |
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Long-term corporate investments |
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578,896 |
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384,481 |
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Property and equipment, net of accumulated depreciation |
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253,485 |
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234,664 |
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Intangible assets, net of accumulated amortization |
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68,499 |
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60,704 |
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Goodwill |
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407,712 |
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405,842 |
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Deferred income taxes |
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13,632 |
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12,783 |
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Other long-term assets |
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5,949 |
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6,527 |
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Total assets |
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$ |
5,771,814 |
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$ |
5,549,302 |
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LIABILITIES |
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Accounts payable |
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$ |
55,954 |
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$ |
46,668 |
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Accrued compensation and related items |
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128,983 |
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130,069 |
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Deferred revenue |
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7,731 |
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5,809 |
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Accrued income taxes |
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12,516 |
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¾ |
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Litigation reserve |
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13,168 |
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15,625 |
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Other current liabilities |
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41,342 |
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34,008 |
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Current liabilities before client fund deposits |
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259,694 |
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232,179 |
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Client fund deposits |
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3,551,790 |
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3,606,193 |
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Total current liabilities |
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3,811,484 |
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3,838,372 |
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Deferred income taxes |
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11,659 |
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15,481 |
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Other long-term liabilities |
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45,635 |
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40,606 |
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Total liabilities |
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3,868,778 |
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3,894,459 |
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COMMITMENTS AND CONTINGENCIES NOTE I |
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STOCKHOLDERS EQUITY |
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Common stock, $0.01 par value; Authorized: 600,000 shares;
Issued and outstanding: 381,933 shares as of February
28, 2007 and 380,303 shares as of May 31, 2006,
respectively |
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3,819 |
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3,803 |
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Additional paid-in capital |
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348,929 |
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284,395 |
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Retained earnings |
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1,554,254 |
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1,380,971 |
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Accumulated other comprehensive loss |
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(3,966 |
) |
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(14,326 |
) |
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Total stockholders equity |
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1,903,036 |
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1,654,843 |
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Total liabilities and stockholders equity |
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$ |
5,771,814 |
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$ |
5,549,302 |
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See Notes to Consolidated Financial Statements.
3
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
In thousands
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For the nine months ended |
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February 28, |
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February 28, |
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2007 |
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2006 |
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OPERATING ACTIVITIES |
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Net income |
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$ |
394,347 |
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$ |
342,174 |
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Adjustments to reconcile net income to net cash provided by
operating activities: |
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Depreciation and amortization on property and equipment and
intangible assets |
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54,239 |
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49,165 |
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Amortization of premiums and discounts on
available-for-sale securities |
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18,248 |
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20,775 |
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Stock-based compensation costs |
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19,260 |
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Benefit for deferred income taxes |
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(12,475 |
) |
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(13,659 |
) |
Tax benefit related to exercise of stock options |
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7,531 |
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Provision for allowance for doubtful accounts |
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1,883 |
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1,563 |
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Provision for litigation reserve |
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13,000 |
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Net realized gains on sales of available-for-sale securities |
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(1,479 |
) |
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(624 |
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Changes in operating assets and liabilities: |
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Interest receivable |
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(489 |
) |
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2,848 |
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Accounts receivable |
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24,251 |
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5,067 |
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Prepaid expenses and other current assets |
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3,230 |
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989 |
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Accounts payable and other current liabilities |
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14,127 |
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34,497 |
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Net change in other assets and liabilities |
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4,104 |
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7,552 |
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Net cash provided by operating activities |
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532,246 |
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457,878 |
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INVESTING ACTIVITIES |
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Purchases of available-for-sale securities |
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(79,969,874 |
) |
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(66,541,674 |
) |
Proceeds from sales and maturities of available-for-sale
securities |
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79,369,237 |
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66,193,814 |
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Net change in funds held for clients money market securities
and other cash equivalents |
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324,744 |
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(720,129 |
) |
Net change in client fund deposits |
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(54,403 |
) |
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|
877,688 |
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Purchases of property and equipment |
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(61,456 |
) |
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(56,318 |
) |
Proceeds from sales of property and equipment |
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116 |
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27 |
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Acquisition of businesses, net of cash acquired |
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(3,100 |
) |
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(726 |
) |
Purchases of other assets |
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(18,238 |
) |
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(3,373 |
) |
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Net cash used in investing activities |
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(412,974 |
) |
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(250,691 |
) |
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FINANCING ACTIVITIES |
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Dividends paid |
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(221,064 |
) |
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(170,711 |
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Proceeds from exercise of stock options |
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37,812 |
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21,573 |
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Excess tax benefit related to exercise of stock options |
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7,478 |
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Net cash used in financing activities |
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(175,774 |
) |
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(149,138 |
) |
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(Decrease)/increase in cash and cash equivalents |
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(56,502 |
) |
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58,049 |
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Cash and cash equivalents, beginning of period |
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137,423 |
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77,669 |
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Cash and cash equivalents, end of period |
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$ |
80,921 |
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$ |
135,718 |
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See Notes to Consolidated Financial Statements.
4
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
February 28, 2007
Note A: Description of Business and Significant Accounting Policies
Description of business: Paychex, Inc. and its wholly owned subsidiaries (collectively, the
Company or Paychex) is a leading provider of comprehensive payroll and integrated human
resource and employee 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 one segment based upon the provisions of
Statement of Financial Accounting Standard (SFAS) No. 131, Disclosures about Segments of an
Enterprise and Related Information. Substantially all of the Companys revenue is generated
within the U.S. Revenue is also generated in Germany, which was less than one percent of total
revenue of the Company for the nine months ended February 28, 2007. Long-lived assets in Germany
are an insignificant portion of the total long-lived assets of the Company as of February 28, 2007.
Basis of presentation: The accompanying Consolidated Financial Statements have been prepared in
accordance with U.S. generally accepted accounting principles (GAAP) for interim financial
information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
GAAP for complete financial statement presentation. The Consolidated Financial Statements include
the consolidated accounts of the Company with all significant intercompany transactions eliminated.
In the opinion of management, the information furnished herein reflects all adjustments
(consisting of items of a normal recurring nature), which are necessary for a fair presentation of
the results for the interim period. The accompanying Consolidated Financial Statements should be
read in conjunction with the Companys Consolidated Financial Statements and related Notes to
Consolidated Financial Statements presented in the Companys Annual Report on Form 10-K as of and
for the year ended May 31, 2006 (fiscal 2006). Operating results and cash flows for the nine
months ended February 28, 2007 are not necessarily indicative of the results that may be expected
for other interim periods or the full fiscal year ending May 31, 2007 (fiscal 2007).
PEO revenue recognition: Professional Employer Organization (PEO) revenue is included in service
revenue and is reported net of direct costs billed and incurred for PEO worksite employees, which
include wages, taxes, benefit premiums, and workers compensation costs and claims of PEO worksite
employees. Direct costs billed and incurred for PEO worksite employees were $653.6 million and
$628.3 million for the three months ended February 28, 2007 and 2006, respectively, and $1.9
billion and $1.8 billion for the nine months ended February 28, 2007 and 2006, respectively.
PEO workers compensation insurance: Workers compensation insurance for PEO worksite employees is
provided under a deductible workers compensation policy with a national insurance company. Claims
are paid as incurred and the Companys maximum individual claims liability is $750,000 under both
the fiscal 2007 and fiscal 2006 policies.
5
Note A: Description of Business and Significant Accounting Policies continued
The Company has recorded the following amounts on its Consolidated Balance Sheets for workers
compensation claims:
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February 28, |
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May 31, |
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In thousands |
|
2007 |
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2006 |
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Prepaid expense |
|
$ |
2,569 |
|
|
$ |
3,150 |
|
Current liability |
|
$ |
7,482 |
|
|
$ |
7,061 |
|
Long-term liability |
|
$ |
19,964 |
|
|
$ |
18,374 |
|
|
The amount included in prepaid expense on the Consolidated Balance Sheets relates to the policy for
the fiscal year ended May 31, 2004, which was a pre-funded policy.
Estimated losses under the workers compensation policies, based on historical loss experience and
independent actuarial loss projections, are subject to change based on changes in claims experience
trends and other factors that management monitors on a regular basis. Any adjustment to previously
established reserves is reflected in the operating results of the period in which the adjustment is
identified. Such adjustments could possibly be significant, reflecting any variety of new and
adverse or favorable trends.
Stock-based compensation costs: Effective June 1, 2006, the Company adopted SFAS No. 123 (revised
2004) (SFAS No. 123(R)), Share-Based Payment, which replaces SFAS No. 123, Accounting for
Stock-Based Compensation and supersedes Accounting Principles Board Opinion No. 25 (APB 25),
Accounting for Stock Issued to Employees. This statement requires that all stock-based awards to
employees, including grants of employee stock options, be 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 over the
requisite service period and increase additional paid-in capital. The Company adopted this
standard using the modified-prospective transition method, and accordingly, results for prior
periods have not been restated. See Note B of the Notes to Consolidated Financial Statements for
further discussion of the Companys 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. With the adoption of SFAS No. 123(R), the Company records 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 restricted 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.
Newly issued accounting pronouncements: In June 2006, the Financial Accounting Standards Board
(FASB) issued Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109, to create a
6
Note
A: Description of Business and Significant Accounting Policies
continued
single model to address accounting for uncertainty in tax positions. FIN 48 clarified the accounting for income tax by prescribing a minimum recognition threshold a tax position is required
to meet before being recognized in the Consolidated Financial Statements. FIN 48 also provides
guidance on derecognition, measurement, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company will adopt FIN 48 as of June 1, 2007, as required. The Company has
not yet determined the effect, if any, the adoption of FIN 48 will have on its results of
operations or financial position.
In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, Determining the
Variability to Be Considered in Applying FASB Interpretation No. 46(R). This FSP provides
additional guidance on the determination of and accounting for variable interests under FASB
Interpretation No. 46(R). This FSP was effective for reporting periods beginning after June 15,
2006, and the Company implemented its guidance beginning in the second quarter of fiscal 2007
relative to our limited partner investments in low-income housing projects. The adoption of this
FSP did not have a material effect on the Companys results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement
clarifies the definition of fair value, establishes a framework for measuring fair value, and
expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. The Company has not yet determined the effect, if any, the
adoption of this statement will have on its results of operations or financial position.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension
and Other Post-Retirement Plans. This statement requires an employer to recognize the over-funded
or under-funded status of a defined benefit post-retirement plan and to recognize changes in the
funded status in the year of change through comprehensive income. The statement is effective as of
the end of the fiscal year ending after December 15, 2006. The Company currently does not have any
benefit plans subject to this new statement and, therefore, expects no impact on its results of
operations or financial position.
In October 2006, the FASB issued FSPs related to SFAS No. 123(R) as follows:
|
|
|
FAS 123(R)-5, Amendment of FASB Staff Position 123(R)-1; and |
|
|
|
|
FAS 123(R)-6, Technical Corrections of FASB Statement No. 123(R). |
Both FSPs are effective in the first reporting period beginning after the date the FSP is posted to
the FASB website, which for the Company was the three months ended February 28, 2007. The adoption
of these FSPs did not have a material effect on the Companys results of operations or financial
position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment to FASB Statement No. 115. This
statement allows a company to irrevocably elect fair value as a measurement attribute for certain
financial assets and financial liabilities with changes in fair value recognized in the results of
operations. The statement also establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement attributes for similar
types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. The Company does not expect this statement to have a material effect on its
results of operations or financial position.
7
Note B: Stock-Based Compensation Plans
As discussed in Note A of the Notes to Consolidated Financial Statements, effective June 1, 2006
(the adoption date), Paychex adopted SFAS No. 123(R). This statement requires that all
stock-based awards to employees, including grants of employee stock options, be 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 over the requisite service period and increase additional paid-in capital.
The Company adopted this standard using the modified-prospective transition method, and
accordingly, results for prior periods have not been restated. Under this transition method, the
Company recognized for the nine months ended February 28, 2007 compensation costs for (1)
stock-based awards granted after the adoption date based on grant date fair value in accordance
with the provisions of SFAS No. 123(R); and (2) the unvested portion of any grants issued prior to
the adoption date based on the grant date fair value estimated in accordance with the original
provisions of SFAS No. 123.
Prior to the adoption date, the Company accounted for stock-based compensation arrangements under
the intrinsic value method described in APB 25 and related interpretations, as permitted by SFAS
No. 123. Accordingly, no compensation costs were recognized for stock option grants because the
exercise price of the stock options granted was equal to the market price of the underlying stock
on the date of the grant.
Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits from the exercise
of stock options as cash flows from operating activities in the Consolidated Statements of Cash
Flows. SFAS No. 123(R) requires tax benefits in excess of compensation costs recognized in the
Consolidated Financial Statements (excess tax benefits) to be presented as cash flows from
financing activities. In accordance with SFAS No. 123(R), excess tax benefits recognized in
periods after the adoption date have been properly classified as cash flows from financing
activities. Total tax benefits recognized in periods prior to the adoption date remain classified
as cash flows from operating activities.
As a result of adopting SFAS No. 123(R), the Company recognized $7.0 million and $19.3 million in
stock-based compensation costs and $2.0 million and $5.6 million in income tax benefits in its
Consolidated Statements of Income for the three and nine months ended February 28, 2007,
respectively. Capitalized stock-based compensation costs related to the development of internal
use software for the nine months ended February 28, 2007 were not significant.
8
Note B: Stock-Based Compensation Plans - continued
The following table illustrates the impact of the adoption of SFAS No. 123(R) on the Companys
results of operations:
|
|
|
|
|
|
|
|
|
|
|
For the three |
|
|
For the nine |
|
|
|
months ended |
|
|
months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In thousands, except per share amounts |
|
2007 |
|
|
2007 |
|
Operating expenses |
|
$ |
2,274 |
|
|
$ |
6,320 |
|
Selling, general and administrative expenses |
|
|
4,698 |
|
|
|
12,940 |
|
|
|
|
Total expenses |
|
|
6,972 |
|
|
|
19,260 |
|
|
|
|
Income before income taxes |
|
|
(6,972 |
) |
|
|
(19,260 |
) |
Income taxes |
|
|
(2,005 |
) |
|
|
(5,640 |
) |
|
|
|
Net income |
|
$ |
(4,967 |
) |
|
$ |
(13,620 |
) |
|
|
|
Basic earnings per share |
|
$ |
(0.01 |
) |
|
$ |
(0.04 |
) |
Diluted earnings per share |
|
$ |
(0.01 |
) |
|
$ |
(0.04 |
) |
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
$ |
4,109 |
|
|
$ |
7,478 |
|
|
The following table illustrates the previously disclosed pro-forma effect on net income and
earnings per share as if the Company had applied the fair value recognition provision of SFAS No.
123 to stock-based compensation:
|
|
|
|
|
|
|
|
|
|
|
For the three |
|
|
For the nine |
|
|
|
months ended |
|
|
months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In thousands, except per share amounts |
|
2006 |
|
|
2006 |
|
Net income, as reported |
|
$ |
114,534 |
|
|
$ |
342,174 |
|
Deduct: Total stock-based
compensation costs determined under
fair value based method for all
awards, net of related tax effects |
|
|
5,034 |
|
|
|
14,369 |
|
|
|
|
Pro-forma net income |
|
$ |
109,500 |
|
|
$ |
327,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
Basic as reported |
|
$ |
0.30 |
|
|
$ |
0.90 |
|
Basic
pro-forma |
|
$ |
0.29 |
|
|
$ |
0.86 |
|
|
|
|
|
|
|
|
|
|
Diluted as reported |
|
$ |
0.30 |
|
|
$ |
0.90 |
|
Diluted
pro-forma |
|
$ |
0.29 |
|
|
$ |
0.86 |
|
|
Stock-based compensation costs for any awards granted subsequent to the adoption date are
recognized on a straight-line basis over the requisite service period to better align the costs
with the employee services provided. Compensation costs for stock-based awards granted prior to
the adoption date will continue to be recognized according to an accelerated amortization schedule
related to the graded vesting terms of the grant, as they were for
the pro-forma disclosures above.
9
Note B: Stock-Based Compensation Plans - continued
The Companys 2002 Stock Incentive Plan, as amended and restated, effective October 12, 2005 (the
2002 Plan), authorizes the granting of stock-based awards for up to 29.1 million shares
of the Companys common stock. Outstanding stock-based awards under the 2002 Plan as of
February 28, 2007 consisted primarily of grants of stock options. In July 2006, restricted stock
awards were issued under the 2002 Plan to officers and outside directors of the Company.
As of February 28, 2007, the total unrecognized compensation cost related to all unvested
stock-based awards was $66.5 million and is expected to be recognized over a weighted-average
period of 2.9 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. Stock option grants have a
ten-year contractual term and the vesting schedule is established by the Board of Directors (the
Board). Stock options granted during the nine months ended February 28, 2007 vest ratably over
periods ranging from three to five years. The Company issues new shares of common stock to satisfy
stock option exercises.
Stock option grants are normally approved in July by the Board, with a current annual grant
guideline of approximately 1% of total common stock outstanding. The grant guideline, reviewed
annually by the Board, does not include broad-based incentive stock options granted to
virtually all non-management employees with at least 90 days of service. On October 4,
2006, the Board approved a broad-based grant of 2.0 million stock options. The Board
previously issued a broad-based grant in April 2004.
The following table summarizes stock option activity for the nine months ended February 28, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
average |
|
|
|
|
|
|
Shares |
|
|
Weighted- |
|
|
remaining |
|
|
Aggregate |
|
|
|
subject |
|
|
average |
|
|
contractual |
|
|
intrinsic |
|
|
|
to options |
|
|
exercise |
|
|
term |
|
|
value (1) |
|
|
|
(thousands) |
|
|
price |
|
|
(years) |
|
|
(thousands) |
|
Outstanding as of May 31, 2006 |
|
|
13,510 |
|
|
|
$31.61 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
5,486 |
|
|
|
$37.04 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(1,630 |
) |
|
|
$23.20 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(662 |
) |
|
|
$36.40 |
|
|
|
|
|
|
|
|
|
Expired |
|
|
(89 |
) |
|
|
$36.29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding as of February
28, 2007 |
|
|
16,615 |
|
|
|
$34.00 |
|
|
|
7.3 |
|
|
|
$112,182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested or expected to
vest(2) as of
February 28, 2007 |
|
|
15,473 |
|
|
|
$33.59 |
|
|
|
7.2 |
|
|
|
$110,985 |
|
Exercisable as of February
28, 2007 |
|
|
5,964 |
|
|
|
$31.82 |
|
|
|
5.0 |
|
|
|
$ 54,602 |
|
|
|
|
|
|
|
|
(1) |
|
Market price of the underlying stock as of February 28, 2007 less the exercise
price. |
|
(2) |
|
The number of options expected to vest takes into account an estimate of expected
forfeitures. |
10
Note B: Stock-Based Compensation Plans continued
Other information pertaining to stock option grants is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
February 28, |
|
In thousands |
|
2007 |
|
|
2006 |
|
Weighted-average grant-date fair value of stock
options granted (per share) |
|
$ |
11.75 |
|
|
$ |
11.02 |
|
Total intrinsic value of stock options exercised |
|
$ |
26,400 |
|
|
$ |
20,990 |
|
Total fair value of stock options vested |
|
$ |
21,041 |
|
|
$ |
12,106 |
|
|
The fair value of stock option grants was estimated at the date of grant using a
Black-Scholes option pricing model for grants prior to and subsequent to the adoption
date. The weighted-average assumptions used for valuation under the Black-Scholes model for the
nine months ended February 28, 2007 (under SFAS No. 123(R)) and for the nine months ended February
28, 2006 (pro-forma impact under SFAS No. 123) are as follows:
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
|
February 28, |
|
|
|
2007 |
|
|
2006 |
|
Risk-free interest rate |
|
|
4.8 |
% |
|
|
4.0 |
% |
Dividend yield |
|
|
1.9 |
% |
|
|
1.6 |
% |
Volatility factor |
|
|
.31 |
|
|
|
.31 |
|
Expected option term life in years |
|
|
6.1 |
|
|
|
6.4 |
|
|
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 and implied market volatility, both over a period
equal to the expected option life. Prior to the adoption date, the Company had used historical
volatility based on monthly stock prices. The expected option life is determined from historical
exercise behavior.
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 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: In July 2006, the Board approved a grant of restricted stock awards to
the Companys 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
11
Note B: Stock-Based Compensation Plans continued
targets established by the Board. If the established targets are met for a fiscal year, one-third
of the award will vest. For 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 the Companys restricted stock activity for the nine months ended
February 28, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
Restricted |
|
|
average grant- |
|
In thousands, except per share amounts |
|
shares |
|
|
date fair value |
|
Nonvested as of May 31, 2006 |
|
|
|
|
|
|
$ |
|
Granted |
|
|
106 |
|
|
|
$36.87 |
|
Vested |
|
|
|
|
|
|
$ |
|
Forfeited |
|
|
(1 |
) |
|
|
$36.87 |
|
|
|
|
|
|
|
|
|
Nonvested as of February 28, 2007 |
|
|
105 |
|
|
|
$36.87 |
|
|
Employee Stock Purchase Plan: The Company offers an Employee Stock Purchase Plan to all employees
under which the Companys common stock can be purchased through a payroll deduction with no
discount to the market price. The plan has been deemed non-compensatory subject to the provisions
of SFAS No. 123(R) and, therefore, no stock-based compensation costs have been recognized
for the nine months ended February 28, 2007.
12
Note C: Basic and Diluted Earnings Per Share
Basic and diluted earnings per share were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In thousands, except per share amounts |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Basic earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
126,600 |
|
|
$ |
114,534 |
|
|
$ |
394,347 |
|
|
$ |
342,174 |
|
|
|
|
Weighted-average common shares
outstanding |
|
|
381,475 |
|
|
|
379,680 |
|
|
|
380,879 |
|
|
|
379,245 |
|
|
|
|
Basic earnings per share |
|
$ |
0.33 |
|
|
$ |
0.30 |
|
|
$ |
1.04 |
|
|
$ |
0.90 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
126,600 |
|
|
$ |
114,534 |
|
|
$ |
394,347 |
|
|
$ |
342,174 |
|
|
|
|
Weighted-average common shares
outstanding |
|
|
381,475 |
|
|
|
379,680 |
|
|
|
380,879 |
|
|
|
379,245 |
|
Effect of dilutive stock options at
average market price |
|
|
1,860 |
|
|
|
2,071 |
|
|
|
1,687 |
|
|
|
1,810 |
|
|
|
|
Weighted-average common shares
outstanding, assuming dilution |
|
|
383,335 |
|
|
|
381,751 |
|
|
|
382,566 |
|
|
|
381,055 |
|
|
|
|
Diluted earnings per share |
|
$ |
0.33 |
|
|
$ |
0.30 |
|
|
$ |
1.03 |
|
|
$ |
0.90 |
|
|
|
|
Weighted-average anti-dilutive stock
options |
|
|
6,708 |
|
|
|
1,214 |
|
|
|
7,346 |
|
|
|
3,196 |
|
|
Weighted-average common share equivalents that have an anti-dilutive impact are excluded from the
computation of diluted earnings per share.
For the three and nine months ended February 28, 2007, stock options were exercised for 0.8 million
and 1.6 million shares of the Companys common stock, respectively, compared with 0.1 million and
1.1 million shares for the respective prior year periods.
13
Note D: Funds Held for Clients and Corporate Investments
Funds held for clients and corporate investments consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 28, 2007 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
unrealized |
|
|
unrealized |
|
|
Market |
|
In thousands |
|
Cost |
|
|
gains |
|
|
losses |
|
|
value |
|
Type of issue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market securities and other cash
equivalents |
|
$ |
232,331 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
232,331 |
|
Available-for-sale securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General obligation municipal bonds |
|
|
823,013 |
|
|
|
1,443 |
|
|
|
(6,154 |
) |
|
|
818,302 |
|
Pre-refunded municipal bonds |
|
|
254,130 |
|
|
|
496 |
|
|
|
(1,817 |
) |
|
|
252,809 |
|
Revenue municipal bonds |
|
|
437,370 |
|
|
|
519 |
|
|
|
(3,083 |
) |
|
|
434,806 |
|
Auction rate securities and variable
rate demand notes |
|
|
2,495,914 |
|
|
|
84 |
|
|
|
|
|
|
|
2,495,998 |
|
U.S. government securities |
|
|
447,876 |
|
|
|
2,557 |
|
|
|
(172 |
) |
|
|
450,261 |
|
Other equity securities |
|
|
20 |
|
|
|
59 |
|
|
|
|
|
|
|
79 |
|
|
|
|
Total available-for-sale securities |
|
|
4,458,323 |
|
|
|
5,158 |
|
|
|
(11,226 |
) |
|
|
4,452,255 |
|
Other |
|
|
7,830 |
|
|
|
641 |
|
|
|
(4 |
) |
|
|
8,467 |
|
|
|
|
Total funds held for clients and corporate
investments |
|
$ |
4,698,484 |
|
|
$ |
5,799 |
|
|
$ |
(11,230 |
) |
|
$ |
4,693,053 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 31, 2006 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
unrealized |
|
|
unrealized |
|
|
Market |
|
In thousands |
|
Cost |
|
|
gains |
|
|
losses |
|
|
value |
|
Type of issue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market securities and other
cash equivalents |
|
$ |
557,074 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
557,074 |
|
Available-for-sale securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General obligation municipal bonds |
|
|
796,543 |
|
|
|
229 |
|
|
|
(12,201 |
) |
|
|
784,571 |
|
Pre-refunded municipal bonds |
|
|
215,491 |
|
|
|
153 |
|
|
|
(3,015 |
) |
|
|
212,629 |
|
Revenue municipal bonds |
|
|
423,922 |
|
|
|
12 |
|
|
|
(6,099 |
) |
|
|
417,835 |
|
Auction rate securities and
variable rate demand notes |
|
|
2,136,906 |
|
|
|
94 |
|
|
|
|
|
|
|
2,137,000 |
|
U.S. government securities |
|
|
301,573 |
|
|
|
|
|
|
|
(1,272 |
) |
|
|
300,301 |
|
Other equity securities |
|
|
20 |
|
|
|
57 |
|
|
|
|
|
|
|
77 |
|
|
|
|
Total available-for-sale securities |
|
|
3,874,455 |
|
|
|
545 |
|
|
|
(22,587 |
) |
|
|
3,852,413 |
|
Other |
|
|
6,148 |
|
|
|
515 |
|
|
|
(51 |
) |
|
|
6,612 |
|
|
|
|
Total funds held for clients and
corporate investments |
|
$ |
4,437,677 |
|
|
$ |
1,060 |
|
|
$ |
(22,638 |
) |
|
$ |
4,416,099 |
|
|
14
Note D: Funds Held for Clients and Corporate Investments continued
Classification of investments on the Consolidated Balance Sheets is as follows:
|
|
|
|
|
|
|
|
|
|
|
February 28, |
|
|
May 31, |
|
In thousands |
|
2007 |
|
|
2006 |
|
Funds held for clients |
|
$ |
3,547,269 |
|
|
$ |
3,591,611 |
|
Corporate investments |
|
|
566,888 |
|
|
|
440,007 |
|
Long-term corporate investments |
|
|
578,896 |
|
|
|
384,481 |
|
|
|
|
Total funds held for clients and corporate
investments |
|
$ |
4,693,053 |
|
|
$ |
4,416,099 |
|
|
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 market value of held
investments and in the earnings potential of future investments. The Company attempts to limit
these risks by investing primarily in available-for-sale securities with AAA and AA ratings and
short-term securities with an A-1 rating, limiting amounts that can be invested in any single
issuer, and by investing in short- to intermediate-term instruments whose market value is less
sensitive to interest rate changes. The Company does not utilize derivative financial instruments
to manage its interest rate risk.
The Companys available-for-sale securities reflected a net unrealized loss position of $6.1
million as of February 28, 2007 compared with a net unrealized loss position of $22.0 million as of
May 31, 2006. The gross unrealized losses as of February 28, 2007 were comprised of 346
available-for-sale securities, which had a total market value of $1.3 billion. The gross
unrealized losses as of May 31, 2006 were comprised of 441 available-for-sale securities with a
total market value of $1.6 billion.
The Company periodically 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 it held as of February 28, 2007 were not
other-than-temporarily impaired. While certain available-for-sale securities had market values
that were below 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 market value was due
to changes in interest rates and was not due to increased credit risk. As of February 28, 2007 and
May 31, 2006, substantially all of the securities in an unrealized loss position held an AA rating
or better. The Company currently believes that it has the ability and intent to hold these
investments until the earlier of market price recovery or maturity. The Companys assessment that
an investment is not other-than-temporarily impaired could change in the future due to new
developments or changes in the Companys strategies or assumptions related to any particular
investment.
The cost and market value of available-for-sale securities that had stated maturities as of
February 28, 2007 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.
15
Note D: Funds Held for Clients and Corporate Investments continued
|
|
|
|
|
|
|
|
|
|
|
February 28, 2007 |
|
In thousands |
|
Cost |
|
|
Market value |
|
|
Maturity date: |
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
560,500 |
|
|
$ |
558,897 |
|
Due after one year through three years |
|
|
554,325 |
|
|
|
549,528 |
|
Due after three years through five years |
|
|
600,465 |
|
|
|
599,886 |
|
Due after five years |
|
|
2,736,013 |
|
|
|
2,736,865 |
|
|
|
|
Total available-for-sale securities with stated maturities |
|
$ |
4,451,303 |
|
|
$ |
4,445,176 |
|
|
Variable rate demand notes (VRDNs) and auction rate securities 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 auction or tender
feature.
Note E: Property and Equipment, Net of Accumulated Depreciation
The components of property and equipment, at cost, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
February 28, |
|
|
May 31, |
|
In thousands |
|
2007 |
|
|
2006 |
|
|
Land and improvements |
|
$ |
3,555 |
|
|
$ |
3,552 |
|
Buildings and improvements |
|
|
81,728 |
|
|
|
79,875 |
|
Data processing equipment |
|
|
149,460 |
|
|
|
134,636 |
|
Software |
|
|
78,011 |
|
|
|
66,945 |
|
Furniture, fixtures, and equipment |
|
|
123,273 |
|
|
|
112,733 |
|
Leasehold improvements |
|
|
56,137 |
|
|
|
47,627 |
|
Construction in progress |
|
|
43,233 |
|
|
|
36,350 |
|
|
|
|
Total property and equipment, gross |
|
|
535,397 |
|
|
|
481,718 |
|
Less: Accumulated depreciation and amortization |
|
|
281,912 |
|
|
|
247,054 |
|
|
|
|
Property and equipment, net of accumulated depreciation |
|
$ |
253,485 |
|
|
$ |
234,664 |
|
|
Depreciation expense was $14.7 million and $42.3 million for the three and nine months ended
February 28, 2007, respectively, as compared with $13.2 million and $38.1 million for the three and
nine months ended February 28, 2006, respectively.
Within construction in progress, there were costs for software being developed for internal use of
$37.2 million and $29.4 million as of February 28, 2007 and May 31, 2006, respectively.
Capitalization of costs ceases when the software is ready for its intended use, at which time the
Company begins amortization of the costs.
16
Note F: Intangible Assets, Net of Accumulated Amortization
The Company accounts for certain intangible assets with finite lives in accordance with SFAS No.
142, Goodwill and Other Intangible Assets. The components of intangible assets, at cost,
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
February 28, |
|
|
May 31, |
|
In thousands |
|
2007 |
|
|
2006 |
|
|
Client lists and associate office license agreements |
|
$ |
142,647 |
|
|
$ |
122,909 |
|
Other intangible assets |
|
|
4,165 |
|
|
|
4,165 |
|
|
|
|
Total intangible assets, gross |
|
|
146,812 |
|
|
|
127,074 |
|
Less: Accumulated amortization |
|
|
78,313 |
|
|
|
66,370 |
|
|
|
|
Intangible assets, net of accumulated amortization |
|
$ |
68,499 |
|
|
$ |
60,704 |
|
|
Amortization expense relating to intangible assets was $4.7 million and $11.9 million for the three
and nine months ended February 28, 2007, respectively, as compared with $3.7 million and $11.1
million for the three and nine months ended February 28, 2006, respectively.
The estimated amortization expense relating to intangible asset balances for the full fiscal year
2007 and the following four fiscal years, as of February 28, 2007, is as follows:
|
|
|
|
|
|
|
Estimated |
|
In thousands |
|
amortization |
|
Fiscal year ending May 31, |
|
expense |
|
2007 |
|
$ |
16,538 |
|
2008 |
|
$ |
15,975 |
|
2009 |
|
$ |
13,333 |
|
2010 |
|
$ |
11,064 |
|
2011 |
|
$ |
8,759 |
|
|
Note G: Business Acquisition Reserves
As a result of business acquisitions made during the fiscal year ended May 31, 2003, the Company
recorded reserves for severance and redundant lease costs in the allocation of purchase price under
Emerging Issues Task Force 95-3, Recognition of Liabilities in Connection With a Purchase
Combination in the amounts of $10.0 million for severance and $5.9 million for redundant lease
costs. Activity for the nine months ended February 28, 2007 for these reserves is summarized as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as |
|
|
|
|
|
|
Balance as of |
|
|
|
of May 31, |
|
|
Utilization |
|
|
February 28, |
|
In thousands |
|
2006 |
|
|
of reserve |
|
|
2007 |
|
|
Severance costs |
|
$ |
191 |
|
|
$ |
(42 |
) |
|
$ |
149 |
|
Redundant lease costs |
|
$ |
1,539 |
|
|
$ |
(348 |
) |
|
$ |
1,191 |
|
|
The remaining severance payments will be completed during the fiscal year ending May 31, 2008.
Redundant lease payments are expected to be completed during the fiscal year ending May 31, 2016.
Payments of $0.9 million extend beyond one year and are included in other long-term liabilities on
the Consolidated Balance Sheets as of February 28, 2007.
17
Note H: Comprehensive Income
Comprehensive income is comprised of two components: net income and other comprehensive income.
Comprehensive income includes all changes in equity during a period except those resulting from
transactions with owners of the Company. The unrealized gains and losses, net of applicable taxes,
related to available-for-sale securities is the only component reported in accumulated other
comprehensive loss in the Consolidated Balance Sheets.
Comprehensive income, net of related tax effects, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In thousands |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Net income |
|
$ |
126,600 |
|
|
$ |
114,534 |
|
|
$ |
394,347 |
|
|
$ |
342,174 |
|
Change in unrealized
gains/(losses) of
available-for-sale
securities, net of taxes |
|
|
(2,087 |
) |
|
|
861 |
|
|
|
10,360 |
|
|
|
(5,653 |
) |
|
|
|
Total comprehensive income |
|
$ |
124,513 |
|
|
$ |
115,395 |
|
|
$ |
404,707 |
|
|
$ |
336,521 |
|
|
As of February 28, 2007, the accumulated other comprehensive loss was $4.0 million, which was net
of taxes of $2.1 million. As of May 31, 2006, the accumulated other comprehensive loss was $14.3
million, which was net of taxes of $7.8 million.
Note I: Commitments and Contingencies
Commitments: The Company has 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 2008 |
Bank of America, N.A.
|
|
$250 million
|
|
February 2008 |
PNC Bank, National Association
|
|
$150 million
|
|
February 2008 |
Wells Fargo Bank, National Association
|
|
$150 million
|
|
February 2008 |
|
The primary uses of the lines of credit would be to meet short-term funding requirements related to
deposit account overdrafts and client fund deposit obligations arising from electronic payment
transactions on behalf of clients in the ordinary course of business, if
necessary. No amounts were outstanding against these lines of credit as of or during the nine
months ended February 28, 2007.
As of February 28, 2007, the Company also had standby letters of credit outstanding totaling $59.8
million, required to secure commitments for certain insurance policies. These letters of credit
expire at various dates between May 2007 and December 2007. The letters of credit are secured by
investments held in the Companys corporate portfolio, including a $50.9 million letter of credit
for which funds have been segregated into a separate account. No amounts were outstanding on these
letters of credit as of or during the nine months ended February 28, 2007.
18
Note I: Commitments and Contingencies continued
The Company enters into various purchase commitments with vendors in the ordinary course of
business. As of February 28, 2007, the Company had outstanding commitments to purchase
approximately $5.1 million of capital assets.
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 its services under
service arrangements with clients. In addition, the Company has entered into indemnification
agreements with its officers and directors, which require it to defend and, if necessary, indemnify
these individuals for matters related to their services provided to the Company. Historically,
there have been no material losses related to such guarantees and indemnifications.
The Company currently self-insures the deductible portion of various insured exposures under
certain employee benefit plans. The Companys 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 has 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.
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, employment-related claims, and other matters.
In August 2001, the Companys wholly owned subsidiary, Rapid Payroll, Inc. (Rapid Payroll)
informed seventy-six licensees that it intended to stop supporting their payroll processing
software in August of 2002. Thereafter, lawsuits were commenced by licensees asserting various
claims, including breach of contract and related tort and fraud causes of action. As previously
reported in the prior periodic reports, these lawsuits sought compensatory damages, punitive
damages, and injunctive relief against Rapid Payroll, the Company, the Companys former Chief
Executive Officer, and its Senior Vice President of Sales and Marketing. In accordance with the
Companys indemnification agreements with its senior executives, the Company has agreed to defend
and, if necessary, indemnify them in connection with these pending matters.
On February 20, 2007, the Company resolved pending litigation
related to Rapid Payroll through settlement agreements resulting in the dismissal of all but two remaining cases, one of which is pending in the California Superior Court, Los Angeles County, and
one of which is pending in the United States Court of Appeals for the Ninth Circuit. The Company
intends to vigorously defend the two remaining cases.
The Company has recorded a reserve for
pending litigation matters. The litigation reserve has been adjusted in fiscal 2007 to account for settlements, increases in
reserves, and incurred litigation expenditures. During the three months ended February 28, 2007,
the Company increased its litigation reserve by $13.0 million to account for settlements and for
anticipated costs relating to pending litigation matters.
The Companys reserve for all pending litigation totaled $13.2 million as of February
28, 2007, and is included in current liabilities on the Consolidated Balance Sheets.
19
Note I: Commitments and Contingencies continued
In light of its reserve for all pending litigation matters, the Companys management currently
believes that resolution of outstanding litigation matters will not have a material adverse effect
on the Companys 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 Companys financial position and the results of
operations in the period in which any such effect is recorded.
Note J: Supplemental Cash Flow Information
Income taxes paid were $162.0 million and $135.9 million for the nine months ended February 28,
2007 and 2006, respectively.
Note K: Related Party Transactions
During the three and nine months ended February 28, 2007, the Company purchased approximately $1.2
million and $2.0 million, respectively, of data processing equipment and software from EMC
Corporation, compared with approximately $0.2 million and $2.7 million purchased in the respective
prior year periods. The Chairman, President, and Chief Executive Officer of EMC Corporation is a
member of the Companys Board.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements Discussion and Analysis of Financial Condition and Results of Operations reviews
Paychex, Inc. and its wholly owned subsidiaries (we, our, us) operating results for the three
and nine months ended February 28, 2007 and February 28, 2006, and our financial condition as of
February 28, 2007. The focus of this review is on the underlying business reasons for significant
changes and trends affecting our revenue, expenses, net income, and financial condition. This
review should be read in conjunction with the February 28, 2007 Consolidated Financial Statements
and the related Notes to Consolidated Financial Statements contained in this Quarterly Report on
Form 10-Q (Form 10-Q). This review should also be read in conjunction with our Annual Report on
Form 10-K (Form 10-K) for the year ended May 31, 2006. Forward-looking statements in this review
are qualified by the cautionary statement included in this review under the next sub-heading, Safe
Harbor Statement under the Private Securities Litigation Reform Act of 1995.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995: Certain written
and oral statements made by us 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,
those that are described in our filings with the Securities and Exchange Commission (SEC),
including our most recent Form 10-K filed on July 21, 2006. Any of these factors could cause our
actual results to differ materially from our anticipated results.
20
The forward-looking statements in this document are based upon facts and circumstances known to us
at this time. We undertake no obligation to update these forward-looking statements after the date
of filing of this Form 10-Q with the SEC to reflect events or circumstances after such date, or to
reflect the occurrence of unanticipated events.
Overview
We are a leading provider of comprehensive payroll and integrated human resource and employee
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 provided through either our Core Payroll or Major Market Services, which
is utilized by clients that have more sophisticated payroll and benefit needs. Our Payroll
services include:
|
|
|
payroll processing; |
|
|
|
|
payroll tax administration services; |
|
|
|
|
employee payment services; and |
|
|
|
|
other payroll-related services including regulatory compliance (new-hire reporting and
garnishment processing). |
Our Human Resource Services primarily include:
|
|
|
comprehensive human resource outsourcing services, which include Paychex
PremierSM Human Resources and our Professional Employer Organization (PEO); |
|
|
|
|
retirement services administration; |
|
|
|
|
workers compensation insurance services; |
|
|
|
|
employee benefits administration; |
|
|
|
|
time and attendance solutions; |
|
|
|
|
health benefits; 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, utilization of ancillary services, and checks or transactions per
client per pay period. 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 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 the three months ended February 28, 2007 as compared to the three months
ended February 28, 2006 include the following:
|
|
|
Total revenue increased 13% to $485.3 million. |
|
|
|
|
Payroll service revenue increased 8% to $345.4 million. |
|
|
|
|
Human Resource Services revenue increased 25% to $102.2 million. |
|
|
|
|
Net income increased 11% to $126.6 million. |
21
|
|
|
Diluted earnings per share increased 10% to $0.33. |
During the three months ended February 28, 2007, we recorded an expense charge of $13.0 million to
increase our litigation reserve. Refer to Note I of the Notes to Consolidated Financial Statements
for additional information on pending legal matters. On June 1, 2006, we adopted the new
accounting standard related to stock-based compensation costs, and recognized $7.0 million of
expense for the three months ended February 28, 2007.
In managing and evaluating the results of our day-to-day operations, we believe that operating
income excluding certain items is an appropriate measure. We also use this measure in evaluating
managements performance in generating those results. Operating income excluding interest on funds
held for clients, stock-based compensation costs, and the expense charge to increase the litigation
reserve increased 18% to $155.3 million for the three months ended February 28, 2007. Further
details are included in Operating Income under the Results of Operations section of this
review.
Our financial performance during the three months ended February 28, 2007 was largely due to strong
service revenue growth of 11% over the same period last year. This growth in service revenue was
attributable to higher check volume growth, client base growth,
price increases, and growth in the utilization of our ancillary
services.
Our financial performance was positively impacted by the effects of increases in interest rates
earned on our funds held for clients and corporate investment portfolios. The Federal Funds rate
was 5.25% as of February 28, 2007 compared with 4.50% as of February 28, 2006. For the three
months ended February 28, 2007, our combined interest on funds held for clients and corporate
investment income increased 38% and earned an average rate of return of 4.0%, compared with an
average rate of return of 3.2% for the same period last year. The impact of changing interest
rates and related risks is discussed in more detail in the Market Risk Factors section of this
review.
As of
February 28, 2007, we maintained a strong financial position
with cash and total corporate investments of $1.2 billion. Our primary source of cash is from our ongoing operations. Cash flow
from operations was $532.2 million for the nine months ended February 28, 2007, as compared with
$457.9 million for the nine months ended February 28, 2006. Historically, we have funded
operations, capital expenditures, purchases of corporate investments, and dividend payments from
our operating activities. It is anticipated that current cash and
corporate investment balances of $647.8 million, along with projected operating cash flows, will support our normal business
operations, capital expenditures, and dividend payments for the foreseeable future.
For further analysis of our results of operations for the three and nine months ended February 28,
2007, and our financial position as of February 28, 2007, refer to the analysis and discussion in
the Results of Operations, Liquidity and Capital Resources, and Critical Accounting Policies
sections of this review.
Stock-based compensation costs
Effective June 1, 2006 (the adoption date), we adopted Statement of Financial Accounting Standard
(SFAS) No. 123 (revised 2004) (SFAS No. 123(R)), Share-Based Payment. This statement requires that all stock-based awards to employees, including grants
of employee stock options, be 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 expense in the Consolidated Statement of Income over the requisite service period. We adopted
this standard using the modified-prospective transition method, and accordingly,
22
results for the
prior periods have not been restated. Comparisons between the results of operations for the three
and nine months ended February 28, 2007 and the same periods last year are impacted by this method
of adoption. Refer to Note B of the Notes to Consolidated Financial Statements for additional
information regarding stock-based compensation arrangements.
Prior to the adoption date, we accounted for stock-based compensation arrangements under the
intrinsic value method described in Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations, as permitted by SFAS No. 123, Accounting
for Stock-Based Compensation. Accordingly, no compensation costs were recognized for stock option
grants because the exercise price of the stock options granted was equal to the market price of the
underlying stock on the date of the grant.
The impacts to the results of operations for the three and nine months ended February 28, 2007 from
recognition of stock-based compensation costs under SFAS No. 123(R) are as follows:
|
|
|
|
|
|
|
|
|
|
|
For the three |
|
|
For the nine |
|
|
|
months ended |
|
|
months ended |
|
In millions, except per share amounts |
|
February 28, 2007 |
|
|
February 28, 2007 |
|
|
Operating expenses |
|
|
$ 2.3 |
|
|
|
$ 6.4 |
|
Selling, general and administrative expenses |
|
|
4.7 |
|
|
|
12.9 |
|
|
|
|
Total expenses |
|
|
7.0 |
|
|
|
19.3 |
|
|
|
|
Income before income taxes |
|
|
(7.0 |
) |
|
|
(19.3 |
) |
Income taxes |
|
|
(2.0 |
) |
|
|
(5.6 |
) |
|
|
|
Net income |
|
|
$ (5.0 |
) |
|
|
$(13.7 |
) |
|
|
|
Basic earnings per share |
|
|
$(0.01 |
) |
|
|
$(0.04 |
) |
Diluted earnings per share |
|
|
$(0.01 |
) |
|
|
$(0.04 |
) |
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
$ 4.1 |
|
|
|
$ 7.5 |
|
|
As of February 28, 2007, the total unrecognized compensation cost for all unvested stock-based
awards was $66.5 million and is expected to be recognized over a weighted-average period of 2.9
years. The impact on future periods may change based on the issuance of additional stock-based
awards as allowed under the Paychex, Inc. 2002 Stock Incentive Plan, as amended and restated,
effective October 12, 2005.
For grants of stock options, we estimate the fair value at the date of grant using a Black-Scholes
option pricing model. For grants of restricted stock, which were first granted in July 2006, the
fair value is equal to the closing market price of the underlying common stock as of the date of
grant. Stock-based compensation costs for any awards granted subsequent to the adoption
date are recognized on a straight-line basis over the
requisite service period to better align the costs with the employee services provided.
Compensation costs for stock-based awards granted prior to the adoption date will
continue to be recognized on an accelerated amortization schedule related to the graded vesting
terms of the grant.
As part of the adoption of SFAS No. 123(R), we did an in-depth review of all of our assumptions
used in calculating the fair value under a Black-Scholes option pricing model. For grants
subsequent to the adoption date, we calculated the estimated volatility factor based on a
combination of historical volatility using weekly stock prices and implied market volatility. We
incorporated implied volatility as it is generally more reflective of both historical volatility
and
23
expectations of how future volatility will differ from historical volatility. Prior to the
adoption date, we used historical volatility based on monthly stock prices. The expected option
life of our stock option grants is determined from historical exercise behavior.
Upon adoption of SFAS No. 123(R), we are required to estimate forfeitures and only record
compensation costs for those awards that are expected to vest.
Previously, in our pro-forma
disclosures under SFAS No. 123, we accounted for forfeitures as they occurred. Our assumptions for
forfeitures were determined based on type of award and historical experience.
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 types or provisions of stock-based awards. Any change in one or
more of these assumptions can have a material impact on the estimated fair value of an award and on
stock-based compensation costs recognized in our results of operations.
Outlook
Our
current outlook for our results of operations for the full year
ending May 31, 2007 is unchanged from
the guidance provided in our Form 10-Q for the quarter ended August 31, 2006.
|
|
|
Payroll service revenue growth is projected to be in the range of 9% to 11%. |
|
|
|
|
Human Resource Services revenue growth is expected to be in the range of 20% to 23%. |
|
|
|
|
Total service revenue growth is projected to be in the range of 11% to 13%. |
|
|
|
|
Interest on funds held for clients is expected to increase approximately 30% to 35%. |
|
|
|
|
Total revenue growth is estimated to be in the range of 12% to 14%. |
|
|
|
|
Corporate investment income is anticipated to increase approximately 55% to 60%. |
|
|
|
|
Stock-based compensation costs will be primarily included in selling, general and
administrative expenses, and are expected to be in the range of $25 million to $30
million. |
|
|
|
|
The effective income tax rate is expected to be approximately 31.0%. |
|
|
|
|
Net income growth is expected to be in the range of 13% to 15%. |
Purchases of property and equipment for fiscal 2007 are expected to be in the range of $70 million
to $75 million. Fiscal 2007 depreciation expense is projected to be
approximately $55 million, and we project amortization of intangible assets to be approximately $16
million.
Our projections are based on current economic and interest rate conditions continuing with no
significant changes.
24
RESULTS OF OPERATIONS
Summary of Results of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
|
For the nine months |
|
|
|
|
|
|
ended |
|
|
|
|
|
|
|
ended |
|
|
|
|
|
|
February 28, |
|
|
|
|
|
|
|
February 28, |
|
|
|
|
$ in millions, except per share amounts |
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
|
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payroll service revenue |
|
$ |
345.4 |
|
|
$ |
320.0 |
|
|
|
8 |
% |
|
|
$ |
1,012.9 |
|
|
$ |
932.5 |
|
|
|
9 |
% |
Human Resource Services
revenue |
|
|
102.2 |
|
|
|
81.9 |
|
|
|
25 |
% |
|
|
|
289.5 |
|
|
|
232.8 |
|
|
|
24 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total service revenue |
|
|
447.6 |
|
|
|
401.9 |
|
|
|
11 |
% |
|
|
|
1,302.4 |
|
|
|
1,165.3 |
|
|
|
12 |
% |
Interest on funds held
for clients |
|
|
37.7 |
|
|
|
28.7 |
|
|
|
31 |
% |
|
|
|
97.2 |
|
|
|
68.8 |
|
|
|
41 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
485.3 |
|
|
|
430.6 |
|
|
|
13 |
% |
|
|
|
1,399.6 |
|
|
|
1,234.1 |
|
|
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined operating and
SG&A expenses |
|
|
312.3 |
|
|
|
270.0 |
|
|
|
16 |
% |
|
|
|
857.9 |
|
|
|
752.1 |
|
|
|
14 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
173.0 |
|
|
|
160.6 |
|
|
|
8 |
% |
|
|
|
541.7 |
|
|
|
482.0 |
|
|
|
12 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As a % of total revenue |
|
|
36 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
39 |
% |
|
|
39 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income, net |
|
|
10.5 |
|
|
|
6.4 |
|
|
|
65 |
% |
|
|
|
29.8 |
|
|
|
16.8 |
|
|
|
78 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
183.5 |
|
|
|
167.0 |
|
|
|
10 |
% |
|
|
|
571.5 |
|
|
|
498.8 |
|
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As a % of total revenue |
|
|
38 |
% |
|
|
39 |
% |
|
|
|
|
|
|
|
41 |
% |
|
|
40 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes |
|
|
56.9 |
|
|
|
52.5 |
|
|
|
8 |
% |
|
|
|
177.2 |
|
|
|
156.6 |
|
|
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
126.6 |
|
|
$ |
114.5 |
|
|
|
11 |
% |
|
|
$ |
394.3 |
|
|
$ |
342.2 |
|
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As a % of total revenue |
|
|
26 |
% |
|
|
27 |
% |
|
|
|
|
|
|
|
28 |
% |
|
|
28 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share |
|
$ |
0.33 |
|
|
$ |
0.30 |
|
|
|
10 |
% |
|
|
$ |
1.03 |
|
|
$ |
0.90 |
|
|
|
14 |
% |
|
|
|
|
25
Details regarding our combined funds held for clients and corporate investment portfolios are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
|
February 28, |
|
$ in millions |
|
2007 |
|
|
2006 |
|
|
|
2007 |
|
|
2006 |
|
|
|
|
|
Average investment
balances: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds held for clients |
|
$ |
3,633.5 |
|
|
$ |
3,399.6 |
|
|
|
$ |
3,165.6 |
|
|
$ |
2,958.5 |
|
Corporate investments |
|
|
1,137.1 |
|
|
|
866.2 |
|
|
|
|
1,069.6 |
|
|
|
798.3 |
|
|
|
|
|
|
|
Total |
|
$ |
4,770.6 |
|
|
$ |
4,265.8 |
|
|
|
$ |
4,235.2 |
|
|
$ |
3,756.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average interest
rates earned: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds held for clients |
|
|
4.1 |
% |
|
|
3.3 |
% |
|
|
|
4.0 |
% |
|
|
3.1 |
% |
Corporate investments |
|
|
3.7 |
% |
|
|
2.9 |
% |
|
|
|
3.7 |
% |
|
|
2.7 |
% |
Combined funds held
for clients and
corporate investment
portfolios |
|
|
4.0 |
% |
|
|
3.2 |
% |
|
|
|
3.9 |
% |
|
|
3.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds held for clients |
|
$ |
0.5 |
|
|
$ |
0.4 |
|
|
|
$ |
1.3 |
|
|
$ |
0.5 |
|
Corporate investments |
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
0.2 |
|
|
|
0.1 |
|
|
|
|
|
|
|
Total |
|
$ |
0.6 |
|
|
$ |
0.5 |
|
|
|
$ |
1.5 |
|
|
$ |
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of: |
|
February 28, |
|
|
May 31, |
|
$ in millions |
|
2007 |
|
|
2006 |
|
|
Net unrealized loss on available-for-sale securities |
|
|
$ (6.1 |
) |
|
|
$ (22.0 |
) |
|
|
|
|
|
|
|
|
|
Federal Funds rate |
|
|
5.25 |
% |
|
|
5.00 |
% |
|
|
|
|
|
|
|
|
|
Three-year AAA municipal securities yield |
|
|
3.60 |
% |
|
|
3.65 |
% |
|
|
|
|
|
|
|
|
|
Total market value of available-for-sale securities |
|
|
$4,452.3 |
|
|
|
$3,852.4 |
|
|
|
|
|
|
|
|
|
|
Average duration of available-for-sale securities in years (A) |
|
|
2.5 |
|
|
|
2.0 |
|
|
|
|
|
|
|
|
|
|
Weighted-average yield-to-maturity of available-for-sale
securities (A) |
|
|
3.7 |
% |
|
|
3.0 |
% |
|
|
|
|
|
(A) |
|
These items exclude the impact of variable rate demand notes (VRDNs) and auction rate
securities as they are tied to short-term interest rates. |
26
Revenue: The increases in Payroll service revenue of 8% and 9% for the three and nine months ended
February 28, 2007 from the same periods last year were attributable to higher check volume growth,
client base growth, price increases, and growth in the utilization of our ancillary services.
As of February 28, 2007, 92% of all clients utilized our payroll tax administration services,
compared with 91% as of February 28, 2006. We believe that the client utilization percentage of
our payroll tax administration services is near maturity. Our employee payment services were
utilized by 70% of all clients as of February 28, 2007, compared with 68% as of February 28, 2006.
Approximately 95% of new clients purchase our payroll tax administration services and more than 75%
of new clients purchase employee payment services.
Human Resource Services revenue increased 25% and 24% for the three and nine months ended February
28, 2007 to $102.2 million and $289.5 million, respectively. The growth was generated from the
following: retirement services client base increased 15% to 43,000 clients; comprehensive human
resource outsourcing services increased 30% to 350,000 client employees; and workers compensation
insurance client base increased 16% to 59,000 clients. Additionally, the asset value of the
retirement services client employees funds increased 24% to $7.6 billion.
For the three and nine months ended February 28, 2007, interest on funds held for clients increased
31% and 41%, respectively. The increases in interest on funds held for clients were due to higher
average interest rates earned and higher average investment balances. The current effect of higher
average interest rates is expected to diminish as there have been no increases to the Federal Funds
rate since June 29, 2006. See the Market Risk Factors section of this review for further
information related to the effects of changing interest rates.
Combined operating and SG&A expenses: The following table summarizes total combined operating and
selling, general and administrative (SG&A) expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three |
|
|
|
|
|
|
|
For the nine |
|
|
|
|
|
|
months ended |
|
|
|
|
|
|
|
months ended |
|
|
|
|
|
|
February 28, |
|
|
|
|
|
|
|
February 28, |
|
|
|
|
$ in millions |
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
|
|
Compensation-related
expenses,
including
stock-based
compensation costs |
|
$ |
199.0 |
|
|
$ |
175.1 |
|
|
|
14% |
|
|
|
$ |
553.1 |
|
|
$ |
479.9 |
|
|
|
15% |
|
Facilities expense |
|
|
13.5 |
|
|
|
12.2 |
|
|
|
10% |
|
|
|
|
39.3 |
|
|
|
35.6 |
|
|
|
10% |
|
Depreciation of
property and
equipment |
|
|
14.7 |
|
|
|
13.2 |
|
|
|
11% |
|
|
|
|
42.3 |
|
|
|
38.1 |
|
|
|
11% |
|
Amortization of
intangible assets |
|
|
4.7 |
|
|
|
3.7 |
|
|
|
29% |
|
|
|
|
11.9 |
|
|
|
11.1 |
|
|
|
8% |
|
Other expenses |
|
|
80.4 |
|
|
|
65.8 |
|
|
|
22% |
|
|
|
|
211.3 |
|
|
|
187.4 |
|
|
|
13% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating and
SG&A expenses |
|
$ |
312.3 |
|
|
$ |
270.0 |
|
|
|
16% |
|
|
|
$ |
857.9 |
|
|
$ |
752.1 |
|
|
|
14% |
|
|
Stock-based compensation costs from the adoption of SFAS No. 123(R), included in
compensation-related expenses, were $7.0 million and $19.3 million for the three and nine months
ended February 28, 2007, respectively. During the three months ended February 28, 2007, we
recorded an expense charge of $13.0 million to increase our litigation reserve which is included in
other expenses. Refer to Note I of the Notes to Consolidated Financial Statements for additional
information on pending legal matters.
27
Excluding stock-based compensation costs and the expense charge to increase the litigation reserve,
total expense growth would have been 8% and 10% for the three and nine months ended February 28,
2007, respectively. The growth was a result of increases in personnel and other costs related to
retaining clients, promoting new services, and creating more efficient systems for selling and
servicing through new and enhanced technology.
As of February 28, 2007, we had approximately 11,500 employees compared with approximately 10,700
employees as of February 28, 2006.
Depreciation expense is primarily related to buildings, furniture and fixtures, data processing
equipment, and software. Amortization of intangible assets is primarily related to client list
acquisitions, which are amortized using either straight-line or accelerated methods. Other
expenses include such items as delivery, forms and supplies, communications, travel and
entertainment, professional services, and other costs incurred to support our business.
Operating income: The increases in operating income for the three and nine months ended February
28, 2007, as compared with the same periods last year are attributable to the factors previously
discussed. Operating income excluding interest on funds held for clients, stock-based compensation
costs and the expense charge to increase the litigation reserve is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
|
For the nine months |
|
|
|
|
|
|
|
ended February 28, |
|
|
|
|
|
|
|
ended February 28, |
|
|
|
|
|
In millions |
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
|
|
|
Operating income |
|
$ |
173.0 |
|
|
$ |
160.6 |
|
|
|
8% |
|
|
|
$ |
541.7 |
|
|
$ |
482.0 |
|
|
|
12% |
|
Excluding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest on
funds held for
clients |
|
|
(37.7 |
) |
|
|
(28.7 |
) |
|
|
|
|
|
|
|
(97.2 |
) |
|
|
(68.8 |
) |
|
|
|
|
Stock-based
compensation
costs |
|
|
7.0 |
|
|
|
|
|
|
|
|
|
|
|
|
19.3 |
|
|
|
|
|
|
|
|
|
Expense charge
to increase
litigation
reserve |
|
|
13.0 |
|
|
|
|
|
|
|
|
|
|
|
|
13.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income,
net of certain
items |
|
$ |
155.3 |
|
|
$ |
131.9 |
|
|
|
18% |
|
|
|
$ |
476.8 |
|
|
$ |
413.2 |
|
|
|
15% |
|
|
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 increases in investment income for the three and nine months ended February 28, 2007 as
compared to the same periods last year are due to higher average interest rates earned and growth
in average portfolio balances resulting from investment of cash generated from our ongoing
operations.
Income taxes: Our effective income tax rate was 31.0% for both the three and nine months ended
February 28, 2007 compared with 31.4% for both the respective prior year periods. The decrease in
our effective tax rate is attributable to higher levels of tax-exempt income derived from municipal
debt securities held in our funds held for clients and corporate investment portfolios, and a lower
effective state income tax rate, partially offset by the nondeductible compensation related to
incentive stock option grants.
28
Net income: The increases in net income for the three and nine months ended February 28, 2007, as
compared with the three and nine months ended February 28, 2006 are attributable to the factors
previously discussed.
LIQUIDITY AND CAPITAL RESOURCES
As of February 28, 2007, we had $1.2 billion in cash and total corporate investments. Current cash
and corporate investments of $647.8 million and projected operating cash flows are expected to
support our normal business operations, capital expenditures, and dividend payments for the
foreseeable future.
We have 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 2008 |
Bank of America, N.A. |
|
$250 million |
|
February 2008 |
PNC Bank, National Association |
|
$150 million |
|
February 2008 |
Wells Fargo Bank, National Association |
|
$150 million |
|
February 2008 |
|
The primary uses of the lines of credit would be to meet short-term funding requirements related to
deposit account overdrafts and client fund deposit 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 as of or during the nine months ended February 28,
2007.
As of February 28, 2007, we had standby letters of credit outstanding totaling $59.8 million,
required to secure commitments for certain of our insurance policies. These letters of credit
expire at various dates between May 2007 and December 2007. The letters of credit are secured by
investments held in our corporate portfolio, including a $50.9 million letter of credit for which
funds have been segregated into a separate account. No amounts were outstanding on these letters
of credit as of or during the nine months ended February 28, 2007.
We enter into various purchase commitments with vendors in the ordinary course of business. As of
February 28, 2007, we had outstanding commitments to purchase approximately $5.1 million of
capital assets.
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 our services under service arrangements with
clients. 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 matters
related to their services provided to us. Historically, there have been no material losses related
to such guarantees and indemnifications.
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 have insurance coverage in addition to our purchased primary insurance
policies for gap coverage for employment practices liability,
29
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.
Operating Cash Flow Activities
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In millions |
|
2007 |
|
|
2006 |
|
|
Net income |
|
$ |
394.3 |
|
|
$ |
342.2 |
|
Non-cash adjustments to net income |
|
|
92.7 |
|
|
|
64.8 |
|
Cash used by changes in operating assets and liabilities |
|
|
45.2 |
|
|
|
50.9 |
|
|
|
|
Net cash provided by operating activities |
|
$ |
532.2 |
|
|
$ |
457.9 |
|
|
The increase in our operating cash flows for the nine months ended February 28, 2007 reflects
higher net income adjusted for non-cash items, and decreased cash from operating assets and
liabilities. The increase in non-cash adjustments to net income is primarily attributable to
stock-based compensation costs of $19.3 million for the nine months ended February 28, 2007, and
the expense charge of $13.0 million to increase the litigation reserve. The fluctuation in
operating assets and liabilities between periods was primarily the result of timing of accounts
receivable billing and collections and timing of payments for compensation, PEO payroll, income
tax, and other liabilities.
Investing Cash Flow Activities
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In millions |
|
2007 |
|
|
2006 |
|
|
Net change in funds held for clients and
corporate investment activities |
|
$ |
(330.4 |
) |
|
$ |
(190.3 |
) |
Purchases of property and equipment, net of
proceeds from the sale of property and
equipment |
|
|
(61.3 |
) |
|
|
(56.3 |
) |
Acquisition of businesses, net of cash acquired |
|
|
(3.1 |
) |
|
|
(0.7 |
) |
Purchases of other assets |
|
|
(18.2 |
) |
|
|
(3.4 |
) |
|
|
|
Net cash used in investing activities |
|
$ |
(413.0 |
) |
|
$ |
(250.7 |
) |
|
Funds held for clients and corporate investments: 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. The portfolio of funds held for clients and corporate
investments is detailed in Note D of the Notes to Consolidated Financial Statements.
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
30
administration services and to employees of clients utilizing employee payment services.
Fluctuations in net funds held for clients and corporate investment activities mainly relate to timing of purchases, sales, or maturities of corporate investments. Additional discussion of
interest rates and related risks is included in the Market Risk Factors section of this review.
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. Construction in progress totaled $43.2
million as of February 28, 2007 and $36.3 million as of May 31, 2006. Of these costs, $37.2
million and $29.4 million represent software being developed for internal use as of February 28,
2007 and May 31, 2006, respectively. Capitalization of costs ceases when software is ready for its
intended use, at which time we will begin amortization of the costs.
We purchased approximately $2.0 million and $2.7 million of data processing equipment and software
from EMC Corporation during the nine months ended February 28, 2007 and 2006, respectively. The
Chairman, President, and Chief Executive Officer of EMC Corporation is a member of our Board of
Directors (the Board). Other assets increased for the nine months ended February 28, 2007 mainly
due to the termination of our client-servicing arrangement with New England Business
Services, Inc. and the purchasing of the right to service the related clients.
Financing Cash Flow Activities
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
February 28, |
|
|
February 28, |
|
In millions, except per share amounts |
|
2007 |
|
|
2006 |
|
|
Dividends paid |
|
$ |
(221.1 |
) |
|
$ |
(170.7 |
) |
Proceeds from exercise of stock options |
|
|
37.8 |
|
|
|
21.6 |
|
Excess tax benefit related to exercise of stock options |
|
|
7.5 |
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
$ |
(175.8 |
) |
|
$ |
(149.1 |
) |
|
|
|
Cash dividends per common share |
|
$ |
0.58 |
|
|
$ |
0.45 |
|
|
Dividends paid: During the nine months ended February 28, 2007, our Board declared quarterly
dividends aggregating $0.58 per share. The most recent quarterly dividend of $0.21 per share was
paid February 15, 2007 to stockholders of record as of February 1, 2007. 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: The increase in proceeds from the exercise of stock options is due to
an increase in the number of shares exercised from 1.1 million shares during the nine months ended
February 28, 2006 to 1.6 million shares during the nine months ended February 28, 2007. We
recognized an excess tax benefit related to the exercise of stock options of $7.5 million for the
nine months ended February 28, 2007 that is reflected in cash flows from financing activities in
accordance with SFAS
No. 123(R), as adopted on June 1, 2006. For the nine months ended February
28, 2006, we recognized a total tax benefit related to the exercise of stock options of $7.5
million which was reflected in cash flows from operating activities.
31
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, and 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 earnings potential of future
investments and will cause fluctuations in the market value of our longer-term available-for-sale
securities. In seeking to minimize the risks and/or costs associated with such activities, we
generally direct investments towards high credit quality, fixed-rate municipal and government
securities and manage the available-for-sale securities to a benchmark duration of two and one-half
to three years. We do not utilize derivative financial instruments to manage our interest rate
risk.
During the nine months ended February 28, 2007, the average interest rate earned on our combined
funds held for clients and corporate investment portfolios was 3.9% compared with 3.0% for the same
period last year. While interest rates were rising, the full benefit of higher interest rates was
not immediately reflected in net income due to the interaction of long- and short-term interest
rate changes as discussed below.
During a rising interest rate environment, the increases in interest rates increase earnings from
our short-term investments and over time increase earnings from our longer-term available-for-sale
securities. Earnings from the available-for-sale-securities, which as of February 28, 2007 had an
average duration of 2.5 years excluding the impact of VRDNs and auction rate securities tied to
short-term interest rates, would not reflect increases in interest rates until the investments are
sold or mature and the proceeds are reinvested at higher rates.
The cost and market value of available-for-sale securities that had stated maturities as of
February 28, 2007, 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.
|
|
|
|
|
|
|
|
|
|
|
February 28, 2007 |
|
In millions |
|
Cost |
|
|
Market value |
|
|
Maturity date: |
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
560.5 |
|
|
$ |
558.9 |
|
Due after one year through three years |
|
|
554.3 |
|
|
|
549.5 |
|
Due after three years through five years |
|
|
600.5 |
|
|
|
599.9 |
|
Due after five years |
|
|
2,736.0 |
|
|
|
2,736.9 |
|
|
|
|
Total available-for-sale securities with stated maturities |
|
$ |
4,451.3 |
|
|
$ |
4,445.2 |
|
|
VRDNs and auction rate securities 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 auction or tender feature.
32
The following table summarizes recent changes in the Federal Funds rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year |
|
|
Fiscal year |
|
|
|
Fiscal year |
|
|
ended |
|
|
ended |
|
|
|
2007 |
|
|
May 31, |
|
|
May 31, |
|
|
|
year-to-date |
|
|
2006 |
|
|
2005 |
|
|
Federal Funds rate beginning of period |
|
|
5.00 |
% |
|
|
3.00 |
% |
|
|
1.00 |
% |
Rate increase: |
|
|
|
|
|
|
|
|
|
|
|
|
First quarter |
|
|
0.25 |
% |
|
|
0.50 |
% |
|
|
0.50 |
% |
Second quarter |
|
|
|
|
|
|
0.50 |
% |
|
|
0.50 |
% |
Third quarter |
|
|
|
|
|
|
0.50 |
% |
|
|
0.50 |
% |
Fourth quarter |
|
NA |
|
|
|
0.50 |
% |
|
|
0.50 |
% |
|
|
|
Federal Funds rate end of period |
|
|
5.25 |
% |
|
|
5.00 |
% |
|
|
3.00 |
% |
|
|
|
Three-year AAA municipal securities yield end of period |
|
|
3.60 |
% |
|
|
3.65 |
% |
|
|
2.85 |
% |
|
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; and |
|
|
|
|
changes in tax-exempt municipal rates as compared to taxable investment rates, which are
not synchronized or simultaneous. |
Subject to these factors, a 25-basis-point change generally affects our tax-exempt interest rates
by approximately 17 basis points.
Our total investment portfolio (funds held for clients and corporate investments) is expected to
average approximately $4.5 billion for the full year ending May 31, 2007. Our normal and
anticipated allocation is approximately 60% invested in short-term and available-for-sale
securities with an average duration of 35 days and 40% invested in available-for-sale securities
with an average duration of two and one-half to three years. Based on these current assumptions,
we estimate that the earnings effect of a 25-basis-point change in interest rates (17 basis points
for tax-exempt investments) would be approximately $5.0 million to $5.5 million for the next
twelve-month period.
The combined funds held for clients and corporate available-for-sale securities reflected a net
unrealized loss of $6.1 million as of February 28, 2007, compared with a net unrealized loss of
$22.0 million as of May 31, 2006. The change resulted
from decreases in long-term market interest rates. During the nine months ended February 28, 2007,
the net unrealized loss position ranged from $29.5 million to
$1.1 million. Our total investment portfolio reflected a net
unrealized loss position of approximately $5.5 million as of March 23,
2007.
As of February 28, 2007 and May 31, 2006, we had $4.5 billion and $3.9 billion, respectively,
invested in available-for-sale securities at market value. Excluding auction rate securities and
VRDNs classified as available-for-sale securities which are tied to short-term interest rates, the
weighted-average yield-to-maturity was 3.7% and 3.0% as of February 28, 2007 and May 31, 2006,
respectively. Assuming a hypothetical increase in both short-term and longer-term interest rates
of 25 basis points, the resulting potential decrease in market value
for our available-for-sale securities as of February 28, 2007 would be approximately $12.0 million.
33
Conversely, a corresponding decrease in interest rates would result in a comparable increase in
market value. This hypothetical increase or decrease in the market value of the portfolio would be
recorded as an adjustment to the portfolios recorded value, with an offsetting amount recorded in
stockholders equity. These fluctuations in market value would have no related or immediate impact
on the results of operations, unless any declines in market value were considered to be
other-than-temporary.
Credit Risk: We are exposed to credit risk in connection with these investments through the
possible inability of the borrowers to meet the terms of the bonds. We attempt to limit credit
risk by investing primarily in available-for-sale securities with AAA and AA ratings and short-term
securities with an A-1 rating, and by limiting amounts that can be invested in any single issuer.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for the fiscal year ended
May 31, 2006, filed with the SEC on July 21, 2006. On an ongoing basis, we evaluate the critical
accounting policies used to prepare our Consolidated Financial Statements, including, but not
limited to, those related to:
|
|
|
revenue recognition; |
|
|
|
|
PEO workers compensation insurance; |
|
|
|
|
valuation of investments; |
|
|
|
|
goodwill and intangible assets; |
|
|
|
|
accrual for client fund losses; |
|
|
|
|
contingent liabilities; |
|
|
|
|
stock-based compensation costs; and |
|
|
|
|
income taxes. |
There have been no material changes in these aforementioned critical accounting policies during the
period covered by this report, other than as required by adoption of new accounting pronouncements.
Stock-based compensation costs: Effective June 1, 2006, we adopted SFAS No. 123(R), which requires
that all stock-based awards to employees, including grants of employee stock options, be recognized
as compensation costs in our Consolidated Financial Statements based on their fair values measured
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
and implied market volatility, both over a period equal to the expected option life. We estimate
expected option life based on historical exercise behavior.
Under SFAS No. 123(R), 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 catch-up adjustment recorded in the period of
change, with 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
34
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. With the adoption of SFAS No. 123(R), 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 restricted 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
benefit related to stock-based awards.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109,
to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarified
the accounting for income tax by prescribing a minimum recognition threshold a tax position is
required to meet before being recognized in the Consolidated Financial Statements. FIN 48 also
provides guidance on derecognition, measurement, classification, interest and penalties, accounting
in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006. We will adopt FIN 48 as of June 1, 2007, as required. We have not yet
determined the effect, if any, the adoption of FIN 48 will have on our results of operations or
financial position.
In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, Determining the
Variability to Be Considered in Applying FASB Interpretation No. 46(R). This FSP provides
additional guidance on the determination of and accounting for variable interests under FASB
Interpretation No. 46(R). This FSP was effective for reporting periods beginning after June 15,
2006 and we implemented its guidance beginning in the second quarter of fiscal 2007 relative to our
limited partner investments in low-income housing projects. The adoption of this FSP did not have
a material effect on our results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement
clarifies the definition of fair value, establishes a framework for measuring fair value and
expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. We have not yet determined the effect, if any, the adoption of
this statement will have on our results of operations or financial position.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension
and Other Post-Retirement Plans. This statement requires an
employer to recognize the over-funded or under-funded status of a defined benefit post-retirement plan and
35
to
recognize changes in the funded status in the year of change through comprehensive income. The
statement is effective as of the end of the fiscal year ending after December 15, 2006. We
currently do not have any benefit plans subject to this new statement and, therefore, expect no
impact on our results of operations or financial position.
In October 2006, the FASB issued FSPs related to SFAS No. 123(R) as follows:
|
|
|
FAS 123(R)-5, Amendment of FASB Staff Position 123(R)-1; and |
|
|
|
|
FAS 123(R)-6, Technical Corrections of FASB Statement No. 123(R). |
Both FSPs are effective in the first reporting period beginning after the date the FSP is posted to
the FASB website, which for us was the three months ended February 28, 2007. The adoption of these
FSPs did not have a material effect on our results of operations or financial position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment to FASB Statement No. 115. This
statement allows a company to irrevocably elect fair value as a measurement attribute for certain
financial assets and financial liabilities with changes in fair value recognized in the results of
operations. The statement also establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement attributes for similar
types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. We currently do not expect this statement to have a material effect on our
results of operations or financial position.
36
Item 3. Quantitative and Qualitative Disclosure of Market Risk
The information called for by this item is provided under the caption Market Risk Factors under
Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations and
is incorporated herein by reference.
Item 4. 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 our 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 SECs rules and forms. Disclosure controls and
procedures are also designed with the objective of ensuring that such information is accumulated
and communicated to our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures: As of the end of the period covered by this
report, we carried out an evaluation, under the supervision and with the participation of our 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 Chief Executive Officer and Chief Financial Officer have concluded that as of the
end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting: We also carried out an evaluation of our
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 change in our internal
control over financial reporting that occurred during the most recently completed fiscal quarter
ended February 28, 2007, that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note I of the Notes to Consolidated Financial Statements, which is incorporated herein by
reference thereto, for information regarding legal proceedings.
Item 6. Exhibits
Exhibit 31.1: Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as amended.
Exhibit 31.2: Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as amended.
Exhibit 32.1: Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2: Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
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PAYCHEX, INC.
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Date: March 28, 2007 |
/s/ Jonathan J. Judge
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Jonathan J. Judge |
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President and Chief Executive Officer |
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Date: March 28, 2007 |
/s/ John M. Morphy
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John M. Morphy |
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Senior Vice President, Chief Financial Officer, and Secretary |
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