1

 
     Any of these factors could cause our actual results to differ materially from our anticipatedresults. The information provided in this document is based upon the facts and circumstances knownat this time. We undertake no obligation to update these forward-looking statements after the dateof issuance of this Form 8-K to reflect events or circumstances after such date, or to reflect theoccurrence of unanticipated events.**Overview**     We are a leading provider of payroll, human resource, and benefits outsourcing solutions forsmall- to medium-sized businesses. Our Payroll and Human Resource Services offer a portfolio ofservices and products that allow our clients to meet their diverse payroll and human resourceneeds. Our payroll services are the foundation of our service portfolio. They are providedthrough either our core payroll or Major Market Services (“MMS”), which is utilized by clients thathave more sophisticated payroll and benefits needs, and include: **•** payroll processing;  **•** payroll tax administration services;  **•** employee payment services; and  **•** regulatory compliance services (new-hire reporting and garnishment processing).     In addition to the above, our software-as-a-service option through our MMS platform provideshuman resource management, employee benefits management, time and attendance systems, onlineexpense reporting, and applicant tracking.     Our Human Resource Services primarily include: **•** Paychex HR Solutions, under which we offer our administrative services organization(“ASO”) and our professional employer organization (“PEO”). We also offer Paychex HREssentials, our new ASO product that provides support to our clients over the phone oronline to help manage employee-related topics;  **•** retirement services administration;  **•** insurance services;  **•** eServices; and  **•** other human resource services and products.     We earn revenue mainly through recurring fees for services performed. Service revenue isprimarily driven by the number of clients, checks or transactions per client per pay period, andutilization of ancillary services. We also earn interest on funds held for clients between the timeof collection from our clients and remittance to the applicable tax or regulatory agencies orclient employees. Our business strategy is focused on achieving strong long-term financialperformance by providing high-quality, timely, accurate, and affordable services; growing ourclient base; increasingutilization of our ancillary services; leveraging our technology and operating infrastructure;and expanding our service offerings.     Our financial results for fiscal 2011 reflected year-over-year growth. We continued to seeimprovement in many of our key business indicators, especially in checks per client. Checks perclient increased 2.1% for fiscal 2011, compared to a decline of 2.6% for fiscal 2010. Checks perclient began to show year-over-year growth in the three months ending May 31, 2010 with 1.1% growthfor that quarter and continued to improve throughout the year, reflecting increases of 1.2%, 2.5%,2.8%, and 2.0% for each of the sequential quarters of fiscal 2011. Our revenue growth has beenmodest, as new sales units were relatively flat compared to the prior year largely due to lack ofgrowth in new business starts.     Our financial results continue to be adversely impacted by the interest rate environment. Theequity markets hit a low in March 2009, with interest rates available on high quality financialinstruments remaining low since that time. The Federal Funds rate has been at a range of zero to0.25% since December 2008. Our combined funds held for clients and corporate investment portfoliosearned an average rate of return of 1.3% for fiscal 2011, compared to 1.5% for fiscal 2010 and 2.1%for fiscal 2009.
2

 
     We continue to manage our headcount and expenses while investing in our business,particularly in areas related to selling and servicing our clients,product development, and thetechnology required to support these areas. We believe these investments are critical to oursuccess. Looking to the future, we continue to focus on investing in our products, people, andservice capabilities, positioning ourselves to capitalize on opportunities for long-term growth.     Highlights of our financial results for fiscal 2011 compared to fiscal 2010 are as follows: **•** Payroll service revenue increased 2% to $1.4 billion.  **•** Human Resource Services revenue increased 10% to $597.4 million.  **•** Interest on funds held for clients decreased 13% to $48.1 million.  **•** Total revenue increased 4% to $2.1 billion.  **•** Operating income increased 8% to $786.4 million, and operating income, net of certainitems, increased 7% to $738.3 million. Refer to the “Non-GAAP Financial Measure” discussionbelow for further information on operating income, net of certain items.  **•** Operating income for fiscal 2010 reflected an expense charge of $18.7 million to increase the litigationreserve related to the Rapid Payroll court decision, whichreduced diluted earnings per share for fiscal 2010 by $0.03 per share.  **•** Net income and diluted earnings per share increased 8% to $515.3 million and $1.42 pershare, respectively.  **•** Cash flow from operations increased 17% to $715.3 million, primarily related to theincrease in net income and fluctuations in operating assets and liabilities.  **•** Dividends of $448.8 million were paid to stockholders, representing 87% of net income.     During fiscal 2011, we completed the acquisition of two software-as-a-service companies, opening upadditional areas of the markets we serve. SurePayroll, Inc. (“SurePayroll”), a provider ofpayroll processing for small businesses was acquired on February 8, 2011 for$114.9 million, net of cash acquired. SurePayroll serves small businesses with its easy-to-use,online payroll product and mobile application. This acquisition allows us entry into a new area ofthe online payroll market, and provides our clients with a mobile self-service alternative. Theacquisition of SurePayroll was dilutive to fiscal 2011 by less than $0.01 per share. ePlanServices, Inc. (“ePlan”), a provider of recordkeeping and administrative solutions to the definedcontribution marketplace, was acquired on May 3, 2011 for $15.2 million, net of cash acquired.Both entities now operate as wholly owned subsidiaries of Paychex. Our financial results includethe results of these entities from their respective dates of acquisition. Neither acquisition issignificant to our consolidated financial statements.
3

 
**Non-GAAP Financial Measure**     In addition to reporting operating income, a U.S. generally accepted accounting principle(“GAAP”) measure, we present operating income, net of certain items, which is a non-GAAP measure.We believe operating income, net of certain items, is an appropriate additional measure, as it isan indicator of our core business operations performance period over period. It is also the basisof the measure used internally for establishing the following year’s targets and measuringmanagement’s performance in connection with certain performance-based compensation payments andawards. Operating income, net of certain items, excludes interest on funds held for clients andthe expense charge in fiscal 2010 to increase the litigation reserve. Interest on funds held forclients is an adjustment to operating income due to the volatility of interest rates, which are notwithin the control of management. The expense charge to increase the litigation reserve is also anadjustment to operating income due to its unusual and infrequent nature. It is outside the normalcourse of our operations and obscures the comparability of performance period over period.Operating income, net of certain items, is not calculated through the application of GAAP and isnot the required form of disclosure by the SEC. As such, it should not be considered as asubstitute for the GAAP measure of operating income and, therefore, should not be used inisolation, but in conjunction with the GAAP measure. The use of any non-GAAP measure may produceresults that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAPmeasure used by other companies. Operating income, net of certain items, increased 7% to $738.3million for fiscal 2011 compared to $688.5 million for fiscal 2010 and $729.7 million for fiscal2009.**Business Outlook**     Our client base was approximately 564,000 clients as of May 31, 2011, compared toapproximately 536,000 clients as of May 31, 2010, and approximately 554,000 clients as of May 31,2009. Our client base increased 5.2% for fiscal 2011, compared to declines of 3.2% for fiscal 2010and 3.1% for fiscal 2009. Excluding the impact of the 33,000 SurePayroll clients, our client basewould have declined 0.9% for fiscal 2011. This reduction reflects the impact of lack of growth innew business starts on our client base, as our new sales units were relatively flat compared tofiscal 2010. On a positive note, our sales to clients who previously utilized the services oflocal and regional competitors improved for fiscal 2011.     For fiscal 2011, payroll services client retention was approximately 79% of our beginningfiscal year client base, a two percentage point improvement over the prior year, as clients lostdecreased 9% for fiscal 2011 compared to fiscal 2010. The decrease in client losses was largelyattributable to fewer clients going out of business or having no employees for fiscal 2011 comparedto fiscal 2010. In addition, we lost fewer clients to local and regional competitors for fiscal2011. Through our focus on providing high-quality service to our customers to maximize clientretention, we received the highest client satisfaction results in thepast several years.     Ancillary services effectively leverage payroll processing data and, therefore, are beneficialto our operating margin. The following statistics demonstrate the growth in our ancillary serviceofferings:             **As of May 31,** **2011**  **2010**  **2009**    Paychex HR Solutions client employees (1)  567,000   502,000   453,000 Paychex HR Solutions clients(1)  21,000   19,000   18,000 Insurance services clients(2)  100,000   92,000   86,000 Health and benefits services applicants  99,000   80,000   58,000 Retirement services clients(3)  57,000   51,000   50,000  (1) Includes Paychex HR Essentials as of May 31, 2011. (2) Includes workers’ compensation insurance services clients and health and benefits services clients. (3) Includes ePlan clients as of May 31, 2011.     Continued investment in our business is critical to our success. In fiscal 2011, we madeinvestments in our sales  force and product development. Our sales force increased 2% to 2,380 salesrepresentatives for fiscal 2011, and is expected to grow 1% to 2,400 sales representatives for thefiscal year ending May 31, 2012 (“fiscal 2012”). This growth is driven primarily by increases ininsurance services and other Human Resource Services offerings.     We have continued to expand our enhanced payroll processing platform to includeadditional service offerings. This new platform allows us to leverage efficiencies in ourprocesses and continue to provide excellent customer service to our clients. Our
4

 
enhanced platformhas led to improved productivity within our operations, contributing to the increase in ouroperating income, net of certain items, as a percentage of service revenue to 36.3% for fiscal2011, compared to 35.4% for the prior year.     Over the next few years, we will continue to invest in our product development, as we believeit is critical to our success. We have introduced new product offerings to add value for ourclients. In fiscal 2011, we introduced Paychex HR Essentials, a new ASO offering that providessupport to our clients over the phone or online to help manage employee-related topics. We alsointroduced Paychex SmartTimeTM time clocks for small businesses. This self-containedsystem offers small businesses an economical, easy-to-use time and attendance solution thatautomatically collects and calculates employee hours, and integrates with Paychex payroll.     We continued expansion of our insurance services nationwide, simplifying the processrequired to obtain coverage through our network of national and regional insurers. We now serviceover 100,000 clients through our subsidiary, Paychex Insurance Agency, Inc. We believe insurance services isan area that continues to offer significant opportunities for future growth.     We strengthened our position as an expert in our industry by serving as a source of educationand information to clients and other interested parties. We provide free webinars, white papers,and other information on our website to aid existing and prospective clients with the impact ofregulatory changes. In addition, the Paychex Insurance Agency website, www.paychexinsurance.com,helps small business owners navigate the area of insurance coverage.     Looking to the future, we continue to focus on investing in our products, people, and servicecapabilities. This will position us to capitalize on opportunities for long-term growth.**Financial position and liquidity**     The volatility in the global financial markets that began in September 2008 continues tocurtail available liquidity and limit investment choices. Despite this macroeconomic environment,as of May 31, 2011, our financial position remained strong with cash and total corporateinvestments of $671.3 million and no debt.     Our investment strategy focuses on optimizing liquidity and protecting principal. Yields onhigh quality financial instruments remain low, negatively impacting our income earned on funds heldfor clients and corporate investments. We invest predominately in municipal bonds — generalobligation bonds; pre-refunded bonds, which are secured by a U.S. government escrow; and essentialservices revenue bonds. Our primary short-term investment vehicle has been U.S. agency discountnotes. Starting in November 2009, we began to invest in select A-1/P-1-rated variable ratedemand notes (“VRDNs”) and have gradually increased our investment in VRDNs to $828.3 millionas of May 31, 2011. During fiscal 2011, we earned an after-tax rate of approximately 0.23% forVRDNs compared to approximately 0.06% for U.S. agency discount notes.     We invest primarily in high credit quality securities with AAA and AA ratings and short-termsecurities with A-1/P-1 ratings. We limit the amounts that can be invested in any single issuerand invest in short- to intermediate-term instruments whose fair value is less sensitive tointerest rate changes. We believe that our investments as of May 31, 2011 were notother-than-temporarily impaired, nor has any event occurred subsequent to that date that wouldindicate any other-than-temporary impairment. All investments held as of May 31, 2011 were tradedin active markets.     Our primary source of cash is our ongoing operations. Cash flow from operations was $715.3million for fiscal 2011. Historically, we have funded our operations, capital purchases, businessacquisitions, and dividend payments from our operating activities. Our positive cash flows infiscal 2011 allowed us to support our business growth and to pay substantial dividends to ourstockholders. During fiscal 2011, dividends paid to stockholders were 87% of net income. It isanticipated that cash and total corporate investments as of May 31, 2011, along with projectedoperating cash flows, will support our normal business operations, capital purchases, and dividendpayments for the foreseeable future.     For further analysis of our results of operations for fiscal years 2011, 2010, and 2009, andour financial position as of May 31, 2011, refer to the tables and analysis in the “Results ofOperations” and “Liquidity and Capital Resources” sections of this review.
5

 
**Outlook**     Our outlook for fiscal 2012 is based upon current economic and interest rate conditionscontinuing with no significant changes. Consistent with our policy regarding guidance, ourprojections do not anticipate or speculate on future changes to interest rates. Our fiscal 2012guidance reflects anticipated results for SurePayroll and ePlan. The anticipated service revenueimpact is approximately 2% and the earnings dilution is expected to be approximately $0.01 pershare, mainly due to amortization of acquired intangible assets. Our fiscal 2012 guidance is as follows:               **Low**     **High**Payroll service revenue  5%  —   7%Human Resource Services revenue  12%  —   15%Total service revenue  7%  —   9%Interest on funds held for clients  (14%)  —   (12%)Investment income, net  —   —   2%Net income  5%  —   7%     Operating income, net of certain items, as a percentage of service revenue is expected tobe in the range of 35% to 36% for fiscal 2012. The effective income tax rate is expected toapproximate 35% for fiscal 2012.     Interest on funds held for clients and investment income for fiscal 2012 are expected to beimpacted by the continuing low interest rate environment. The average rate of return on ourcombined funds held for clients and corporate investment portfolios is expected to be 1.2% forfiscal 2012. As of May 31, 2011, the long-term investment portfolio had an averageyield-to-maturity of 2.6% and an average duration of 2.4 years. In the next twelve months,slightly more than 20% of this portfolio will mature, and it is currently anticipated that theseproceeds will be reinvested at a lower average interest rate of approximately 1.0%. Investmentincome is expected to benefit from ongoing investment of cash generated from operations, though ata lower growth rate as a result of cash outlays in fiscal 2011 for business acquisitions.     Under normal financial market conditions, the impact to our earnings from a 25-basis-pointincrease or decrease in short-term interest rates would be in the range of $3.5 million to $4.0million, after taxes, for a twelve-month period. Such a basis point change may or may not be tiedto changes in the Federal Funds rate.     Purchases of property and equipment for fiscal 2012 are expected to be in the range of$90 million to $95 million. This includes costs for internally developed software as we continueto invest in our product development. Fiscal 2012 depreciation expense is projected to be in therange of $75 million to $80 million, and we project amortization of intangible assets for fiscal2012 to be in the range of $20 million to $25 million. Intangible assets acquired from SurePayroll andePlan are expected to increase amortization expense for fiscal 2012, partially offset by the impactof fully amortized intangibles.
6

 
**Results of Operations****Summary of Results of Operations for the Fiscal Years Ended May 31:**                     **In millions, except per share amounts** **2011**  **Change**  **2010**  **Change**  **2009** **Revenue:**                    Payroll service revenue $1,438.8   2% $1,404.9   (5%) $1,483.7 Human Resource Services revenue  597.4   10%  540.9   3%  523.6                   Total service revenue  2,036.2   5%  1,945.8   (3%)  2,007.3 Interest on funds held for clients  48.1   (13%)  55.0   (27%)  75.5                   **Total revenue**  **2,084.3**   **4****%**  **2,000.8**   **(4****%)**  **2,082.8** Combined operating and SG&A expenses  1,297.9   2%  1,276.0   —   1,277.6                   **Operating income**  **786.4**   **8****%**  **724.8**   **(10****%)**  **805.2** As a % of total revenue  38%      36%      39%Investment income, net  5.8   29%  4.5   (34%)  6.9                   **Income before income taxes**  **792.2**   **9****%**  **729.3**   **(10****%)**  **812.1** As a % of total revenue  38%      36%      39%Income taxes  276.9   10%  252.3   (9%)  278.6                   Effective income tax rate  35.0%      34.6%      34.3%**Net income** **$****515.3**   **8****%** **$****477.0**   **(11****%)** **$****533.5**                   As a % of total revenue  25%      24%      26%**Diluted earnings per share** **$****1.42**   **8****%** **$****1.32**   **(11****%)** **$****1.48**                        We invest in highly liquid, investment-grade fixed income securities and do not utilizederivative instruments to manage interest rate risk. As of May 31, 2011, we had no exposure tohigh-risk or illiquid investments. Details regarding our combined funds held for clients andcorporate investment portfolios are as follows:               **Year ended May 31,** **$ in millions** **2011**  **2010**  **2009** Average investment balances:            Funds held for clients $3,350.3  $3,167.9  $3,323.3 Corporate investments  662.4   653.8   538.2    Total $4,012.7  $3,821.7  $3,861.5    Average interest rates earned (exclusive of net realized gains):            Funds held for clients  1.4%  1.6%  2.2%Corporate investments  0.9%  0.8%  1.4%Combined funds held for clients and corporate investments  1.3%  1.5%  2.1%   Net realized gains:            Funds held for clients $1.3  $3.2  $1.1 Corporate investments  —   —   —    Total $1.3  $3.2  $1.1                 **$ in millions**         **As of May 31,** **2011**  **2010**  **2009** Net unrealized gains on available-for-sale securities (1) $59.3  $66.6  $66.7 Federal Funds rate (2)  0.25%  0.25%  0.25%Three-year “AAA” municipal securities yield  0.80%  0.99%  1.35%Total fair value of available-for-sale securities $2,737.2  $2,151.8  $1,780.9 Weighted-average duration of available-for-sale securities in years(3)  2.4   2.5   2.5 Weighted-average yield-to-maturity of available-for-sale securities(3)  2.6%  2.9%  3.3% (1) The net unrealized gain of our investment portfolios was approximately $59.4 million as ofJune 17, 2011. (2) The Federal Funds rate was a range of zero to 0.25% as of May 31, 2011, May 31, 2010, and May31, 2009. (3) These items exclude the impact of VRDNs held as of May 31, 2011 and May 31, 2010, as they aretied to short-term interest rates. We did not hold any VRDNs as of May 31, 2009.
7

 
     ***Payroll service revenue:***Payroll service revenue increased 2% to $1.4 billion for fiscal2011, compared to a 5% decline for fiscal 2010. Fiscal 2011revenue benefited from an increase in checks per client and revenue per check. Checks per client increased2.1% for fiscal 2011 compared to fiscal 2010. Revenue per check was positively impacted by lower discounting within our overall client base and price increases. Our client base,excluding the impact of SurePayroll, declined 0.9% during fiscal 2011. This was largelyattributable to the adverse impact on the sales of new units from lack of growth in new businessstarts. Client retention improved for fiscal 2011, with client losses that were 9% lower than forfiscal 2010, largely a result of fewer clients going out of business or having no employees. Inaddition, fiscal 2011 new sales units and client losses related to local and regionalcompetitors improved compared to the prior year.     The decrease in payroll service revenue for fiscal 2010 was a result of the cumulative adverseeffects of weak economic conditions on our client base and check volume. Our client basedecreased 3.2% during fiscal 2010 and checks per client decreased 2.6% for fiscal 2010 compared tofiscal 2009.     ***Human Resource Services revenue:***Human Resource Services revenue increased 10% for fiscal2011 and 3% for fiscal 2010 to $597.4 million and $540.9 million, respectively. Human ResourceServices revenue growth for both fiscal 2011 and fiscal 2010 was impacted by the revenue earnedfrom Stromberg time and attendance operations (“Stromberg”), an immaterial component of Paychex, prior to itssale in October 2009. In addition, retirement services revenue growth for fiscal 2010 was impactedby billings in fiscal 2009 related to restatements of clients’ retirement plans required bystatute, which are not expected to recur for approximately six years. This favorably impactedretirement services revenue growth for fiscal 2009 by $12.4 million and did not recur in fiscal2010. Excluding the impact of Stromberg in both fiscal 2011 and fiscal 2010, and the impact ofretirement plan restatement billings for fiscal 2010, Human Resource Services revenue growth wouldhave been as follows:         **% Change** **2011**  **2010** Human Resource Services revenue, as reported  10%  3%Human Resource Services revenue excluding Stromberg revenueand retirement plan restatement billings  12%  8%     This growth was generated from the following:                     **$ in billions**               **As of May 31,** **2011**  **Change**  **2010**  **Change**  **2009** Paychex HR Solutions client employees (1)  567,000   13%  502,000   11%  453,000 Paychex HR Solutions clients(1)  21,000   9%  19,000   8%  18,000 Insurance services clients(2)  100,000   8%  92,000   7%  86,000 Health and benefits services applicants  99,000   23%  80,000   38%  58,000 Retirement services clients(3)  57,000   12%  51,000   3%  50,000 Asset value of retirement services client employees’funds(3) $15.3   35% $11.3   33% $8.5  (1) Includes Paychex HR Essentials as of May 31, 2011. (2) Includes workers’ compensation insurance services clients and health and benefits services clients. (3) Includes ePlan as of May 31, 2011. Excluding ePlan clients, retirement services clients would have increased 5% for fiscal 2011.     Human Resource Services revenue growth  for fiscal 2011 reflects modest improvements in economicconditions, the client growth noted above, and  price increases. Paychex HR Solutionsrevenue for fiscal 2011 was positively impacted by increases in both clients and client employees.Contributing to this growth in the clients and client employees is our new product offering,Paychex HR Essentials. Growth in certain products that are primarily beneficial to our MMS clientscontributed positively to Human Resource Services revenue growth for both fiscal 2011 and fiscal2010. Also, insurance services revenue continued to grow as a result of increases in both health andbenefits services and workers’ compensation insurance services revenue. Health and benefitsservices revenue continued its accelerated growth since inception, increasing 29% for fiscal 2011 and 49% for fiscal 2010, driven primarily by the number ofapplicants.     Somewhat offsetting these positive factors, fluctuations in our PEO revenue had an adverseimpact on Human Resource Services revenue growth for fiscal 2011. PEO net service revenue is morevariable quarter to quarter than our other revenue streams due to fluctuations in adding andretaining client employees as healthcare rates change.
8

 
     For fiscal 2010, client growth as noted above positively impacted Human Resource ServicesRevenue; however, the rates of growth were adversely affected by the cumulative impact of weakeconomic conditions on our client base. This particularly affected retirement services, althoughclient growth for retirement services rebounded somewhat late in fiscal 2010 as client lossesimproved compared to the prior year.     In fiscal 2011 and fiscal 2010, the 35% and 33% increases in the asset value of retirementservices client employees’ funds were driven by recovery in the financial markets and increasedlevels of larger plans converting to Paychex. For both fiscal 2011 and fiscal 2010, retirementservices revenue growth was adversely impacted by a shift in the mix of assets in the retirementservices client employees’ funds to investments earning lower fees from external fund managers.     ***Total service revenue:***Total service revenue increased 5% for fiscal 2011 and declined 3% forfiscal 2010, attributable to the factors previously discussed.     ***Interest on funds held for clients:***The decrease of 13% in interest on funds held for clientsfor fiscal 2011 compared to fiscal 2010 was the result of lower average interest rates earned,offset somewhat by an increase in average investment balances. The decrease of 27% in interest onfunds held for clients for fiscal 2010 compared to fiscal 2009 was the result of lower averageinterest rates earned and lower average investment balances, offset somewhat by higher net realizedgains on sales of available-for-sale securities.     Average investment balances for funds held for clients increased 6% for fiscal 2011 anddecreased 5% for fiscal 2010. The increase in average investment balances for fiscal 2011 was theresult of increases in state unemployment insurance rates for the 2011 calendar year and theincrease in checks per client, offset somewhat by the lingering effects of the difficult economicconditions on our client base. The decline in average investment balances for fiscal 2010 was theresult of the cumulative adverse effect of weak economic conditions on our client base and lowertax withholdings for client employees resulting from the American Recovery and Reinvestment Act of2009 (the “economic stimulus package”). In the second half of fiscal 2010, the impact of thesefactors was partially offset by increases in state unemployment insurance rates for the 2010calendar year. The economic stimulus package went into effect in April 2009, and its impact onyear-over-year comparisons of average invested balances had abated in the fourth quarter of fiscal2010. This factor, along with the increases in state unemployment insurance rates, resulted inaverage invested balances for funds held for clients growing 3% for the fourth quarter of fiscal2010 compared to the same period in fiscal 2009.     ***Combined operating and SG&A expenses:***The following table summarizes total combined operatingand selling, general and administrative (“SG&A”) expenses for fiscal years:                     **In millions** **2011**  **Change**  **2010**  **Change**  **2009** Compensation-related expenses $877.7   3% $854.9   (1%) $860.8 Facilities expenses  60.0   (1%)  60.4   1%  59.6 Depreciation and amortization  88.7   3%  86.5   1%  85.8 Other expenses  271.5   6%  255.5   (6%)  271.4                      1,297.9   3%  1,257.3   (2%)  1,277.6 Expense charge to increase the litigation reserve  —   (100%)  18.7   100%  —                   Total operating and SG&A expenses $1,297.9   2% $1,276.0   —  $1,277.6                        During fiscal 2010, we recorded an expense charge of $18.7 million to increase our litigationreserve. Excluding this expense charge, combined operating andSG&A expenses increased 3% for fiscal 2011 and decreased 2% for fiscal 2010. The increase forfiscal 2011 was primarily driven by personnel-related costs, in part due to reinstatement of salaryincreases and 401(k) match as indicated below. In addition, we continued to invest in our productdevelopment and supporting technology. Improvements in operations productivity with related lowerheadcount have somewhat offset this increase. Fiscal 2011 compensation-related expenses includeone-time costs related to the separation agreement entered into during the three months endedAugust 31, 2010 with Jonathan J. Judge, our former President and Chief Executive Officer. Growthin operating and SG&A expenses was higher for the full year fiscal 2011 than for the first ninemonths, mainly due to the expenses of SurePayroll and ePlan, which are included in our resultssince their respective acquisition dates.     The decline in combined operating and SG&A expenses for fiscal 2010 was generated from costcontrol measures and lower headcount, offset slightly by costs related to continued investment inour sales force, customer service, and product development and supporting technology. In fiscal2010, we saved approximately $30.0 million from a freeze on salary increases and providing no matchingcontributions to our 401(k) plan. We reinstituted salary increases beginning March 1, 2010 andreinstated a 401(k)
9

 
match effective January 1, 2011. As of May 31, 2011, we had approximately12,400 employees compared with approximately 12,200 employees as of May 31, 2010 and 12,500employees as of May 31, 2009.     Depreciation expense is primarily related to buildings, furniture and fixtures, dataprocessing equipment, and software. Increases in depreciation expense were due to capitalexpenditures as we invested in technology and continued to grow our business. Amortization ofintangible assets is primarily related to client list acquisitions, which are amortized usingeither straight-line or accelerated methods. Depreciation and amortization increased in fiscal 2011due to the acquisitions of SurePayroll and ePlan. Other expenses include items such as delivery,forms and supplies, communications, travel and entertainment, professional services, and othercosts incurred to support our business. The increase in other expenses for fiscal 2011 was primarily attributable to the largely fourthquarter impact from our two acquisitions.     ***Operating income:***Operating income increased 8% for fiscal 2011 and declined 10% for fiscal2010. The fluctuations in operating income were attributable to the factors previously discussed.     Operating income, net of certain items, is as follows for fiscal years:                     **In millions** **2011**  **Change**  **2010**  **Change**  **2009** Operating income $786.4   8% $724.8   (10%) $805.2 Excluding:                    Interest on funds held for clients  (48.1)  (13%)  (55.0)  (27%)  (75.5)Expense charge to increase the litigation reserve  —   (100%)  18.7   100%  —                   Operating income, net of certain items $738.3   7% $688.5   (6%) $729.7                   Operating income, net of certain items, as a % oftotal service revenue  36.3%      35.4%      36.4%     Refer to the previous discussion of operating income, net of certain items, in the “Non-GAAPFinancial Measure” section of this review.     ***Investment income, net:***Investment income, net, primarily represents earnings from our cashand cash equivalents and investments in available-for-sale securities. Investment income does notinclude interest on funds held for clients, which is included in total revenue. The increase of29% in investment income for fiscal 2011 compared to fiscal 2010 was the result of higher averageinvested balances and a slight increase in average interest rates earned. The 1% increase in averageinvestment balances for fiscal 2011 was the result of investment of cash generated fromoperations, partially offset by cash utilized to fund the acquisitions of SurePayroll and ePlan during the second half of fiscal 2011. The increase in average interest rates earned oncorporate investments was primarily driven by higher yields on funds invested into our longer-terminvestment portfolio compared to the prior year. The decrease of 34% in investment income forfiscal 2010 compared to fiscal 2009 was the result of lower average interest rates earned offsetsomewhat by higher average investment balances resulting from investment of cash generated fromoperations.     ***Income taxes:***Our effective income tax rate was 35.0% for fiscal 2011, compared with 34.6%for fiscal 2010, and 34.3% for fiscal 2009. The increase in our effective tax rate for fiscal 2011was primarily attributable to lower tax-exempt income on available-for-sale securities during fiscal2011 compared to fiscal 2010. The increase in our effective income tax rate for fiscal 2010 wasprimarily the result of higher state income tax rates from state legislative changes.     ***Net income and earnings per share:***Net income increased 8% to $515.3 million for fiscal 2011and decreased 11% to $477.0 million for fiscal 2010. Diluted earnings per share increased 8% to1.42 per share for fiscal 2011 and decreased 11% to $1.32 per share for fiscal 2010. Thesefluctuations were attributable to the factors previously discussed. In particular, the $18.7million expense charge to increase the litigation reserve reduced diluted earnings per share by$0.03 per share for fiscal 2010. Combined interest on funds held for clients and corporateinvestment income for fiscal 2010 decreased 28% or $22.8 million, reducing diluted earnings pershare by $0.04 per share.**Liquidity and Capital Resources**     The volatility in the global financial markets that began in September 2008 continues tocurtail available liquidity and limit investment choices. Despite this macroeconomic environment,our financial position as of May 31, 2011 remained strong with cash and total corporate investmentsof $671.3 million and no debt. We also believe that our investments as of May 31, 2011 were notother-than-temporarily impaired, nor has any event occurred subsequent to that date that wouldindicate any other-than-temporary impairment. We anticipate that cash and total corporateinvestments as of May 31, 2011, along with projected operating
10

 
cash flows, are expected to supportour normal business operations, capital purchases, and dividend payments for the foreseeablefuture.**Operating Cash Flow Activities**               **Year ended May 31,** **In millions** **2011**  **2010**  **2009** Net income $515.3  $477.0  $533.5 Non-cash adjustments to net income  166.5   161.3   134.4 Cash provided by/(used in) changes in operating assets and liabilities  33.5   (27.4)  20.9    Net cash provided by operating activities $715.3  $610.9  $688.8         The increase in our operating cash flows for fiscal 2011 resulted mainly from an increase innet income and fluctuations in operating assets and liabilities. The decrease in our operatingcash flows for fiscal 2010 related primarily to lower net income adjusted for non-cash items andchanges in operating assets and liabilities. The increase in non-cash adjustments to net income infiscal 2010 is primarily due to the $18.7 million expense charge to increase the litigationreserve, partially offset by the related increase in deferred tax benefit. The fluctuations in ouroperating assets and liabilities between periods for both fiscal 2011 and fiscal 2010 wereprimarily related to the timing of collections from clients and payments for compensation, PEOpayroll, income tax, and other liabilities.**Investing Cash Flow Activities**               **Year ended May 31,** **In millions** **2011**  **2010**  **2009** Net change in funds held for clients andcorporate investment activities $(179.8) $(341.2) $491.4 Purchases of property and equipment, net ofproceeds from the sale of property and equipment  (100.5)  (61.3)  (64.1)(Acquisition)/sale of businesses  (126.4)  13.1   (6.4)Purchases of other assets  (2.8)  (11.9)  (16.4)   Net cash (used in)/provided by investing activities $(409.5) $(401.3) $404.5         ***Funds held for clients and corporate investments:***Funds held for clients consist ofshort-term funds and available-for-sale securities. Corporate investments are primarily comprisedof available-for-sale securities.     The fluctuations in the net change in funds held for clients and corporate investmentactivities reflect the changing mix of investments. As a result of volatility in the financialmarkets, in September 2008 we divested of any VRDN securities held and began to utilize U.S. agencydiscount notes as our primary short-term investment vehicle. U.S. agency discount notes are cashequivalents. VRDNs, although priced and traded as short-term securities, are classified asavailable-for-sale securities and the cash paid and proceeds received for these securities areincluded in investing activities. As a result of the divestiture, the proceeds from sales ofavailable-for-sale securities exceeded the purchases of available-for-sale securities in fiscal2009. Much of these proceeds were held as cash equivalents in the funds held for clients’portfolio. In November 2009, we began to again invest in select A-1/P-1-rated VRDNs, although atconsiderably lower levels than in the prior year. We utilized some of our cash equivalents topurchase these VRDNs, and in fiscal 2010 these purchases of available-for-sale securities were inexcess of funds received from any sales of available-for-sale securities. Also in fiscal 2010,more corporate funds have been invested in longer-term municipal bonds. In fiscal 2011, wecontinued to increase our investment in VRDNs and the amounts of purchases and sales foravailable-for-sale securities increased. However, partially offsetting this impact was the relatedliquidation of cash equivalents and the impact on cash equivalents from timing within the fundsheld for clients’ portfolio of remittances versus collections. See further discussion of thistiming in the financing cash flows discussion of net change in client fund obligations.     In general, fluctuations in net funds held for clients and corporate investment activitiesprimarily relate to timing of purchases, sales, or maturities of investments. The amount of fundsheld for clients will vary based upon the timing of collecting client funds, and the relatedremittance of funds to applicable tax or regulatory agencies for payroll tax administrationservices and to employees of clients utilizing employee payment services.     ***Purchases of long-lived assets:***To support our continued client and ancillary productgrowth, purchases of property and equipment were made for data processing equipment and software,and for the expansion and upgrade of various operating facilities. During fiscal 2011, fiscal 2010,and fiscal 2009, we purchased approximately $5.7 million, $3.2 million, and
11

 
$4.5 million,respectively, of data processing equipment and software from EMC Corporation. The Chairman,President, and Chief Executive Officer of EMC Corporation is a member of our Board of Directors(the “Board”).     During fiscal 2011, we paid $126.4 million for the acquisition of SurePayroll and ePlan. During fiscal 2010, we received $13.1 million from the sale of Stromberg, an immaterialcomponent of the Company. The purchases of other assets were for customer lists.**Financing Cash Flow Activities**               **Year ended May 31,** **In millions, except per share amounts** **2011**  **2010**  **2009** Net change in client fund obligations $(34.9) $42.3  $(346.0)Dividends paid  (448.8)  (448.6)  (447.7)Proceeds from exercise and excess taxbenefit related to stock-based awards  12.6   8.2   9.0    Net cash used in financing activities $(471.1) $(398.1) $(784.7)   Cash dividends per common share $1.24  $1.24  $1.24         ***Net change in client fund obligations:***The client fund obligations liability will vary basedon the timing of collecting client funds, and the related required remittance of funds toapplicable tax or regulatory agencies for payroll tax administration services and to employees ofclients utilizing employee payment services. Collections from clients are typically remitted fromone to 30 days after receipt, with some items extending to 90 days. The outflow of funds forfiscal 2011 as compared to fiscal 2010 is the result of timing of collections and remittancessurrounding the Federal holiday on May 31, 2010, offset by an increase in client fund obligationsfor higher withholdings for state unemployment insurance related to rate increases for calendaryear 2011. As a result of May 31, 2010 being a Federal holiday, client fund obligations werehigher as collections were made on Friday, May 28, 2010 that were not remitted to client employeesand tax or regulatory agencies until June 2010. This resulted in a positive cash flow impact forfiscal 2010. Also, for fiscal 2010 there was an increase in client fund obligations as a result ofhigher withholdings for state unemployment insurance related to rate increases for the 2010calendar year. May 31, 2011 did not fall on a Federal holiday, so we did not have the samelevel of client fund holdings at the end of fiscal 2011.     ***Dividends paid:***A quarterly dividend of $0.31 per share was paid to stockholders ofrecord during fiscal 2011, fiscal 2010, and fiscal 2009. The dividends paid as a percentage of netincome totaled 87%, 94%, and 84% for those respective fiscal years. The payment of future dividendsis dependent on our future earnings and cash flow and is subject to the discretion of our Board.     ***Exercise of stock options:***Proceeds from exercise and excess tax benefit related tostock-based awards increased for fiscal 2011 and decreased for fiscal 2010 as compared to therespective prior years. Common shares acquired through exercise of stock options were 0.4 millionshares for each of fiscal 2011, fiscal 2010, and fiscal 2009. The increase for fiscal 2011 was theresult of a higher average exercise price than for fiscal 2010.
12