September 3, 2010

 

Dear Paychex Stockholder:

 

The Board of Directors cordially invites you to attend our Annual Meeting of Stockholders (the “Annual Meeting”) on Wednesday, October 13, 2010 at 10:00 a.m. Eastern Time at the Dryden Theatre at George Eastman House, 900 East Avenue, Rochester, New York. Please note this is a change in venue from prior years.

 

This booklet includes the formal Notice of Annual Meeting of Stockholders and the Proxy Statement. The Proxy Statement tells you about the agenda items and the procedures for the Annual Meeting. It also provides certain information about Paychex, Inc., its Board of Directors, and its named executive officers.

 

It is important that your shares be represented at the Annual Meeting. Whether or not you plan to attend the Annual Meeting, you are encouraged to vote. You may vote by Internet, telephone, proxy card, or written ballot at the Annual Meeting. We encourage you to use the Internet as it is the most cost-effective way to vote. If you elected to electronically access the Proxy Statement and Annual Report, you will not be receiving a proxy card and must vote via the Internet.

 

We hope you will be able to attend the Annual Meeting and would like to take this opportunity to remind you that your vote is important. If you need special assistance at the Annual Meeting, please contact the Corporate Secretary at (800) 828-4411, or write to Paychex, Inc., 911 Panorama Trail South, Rochester, New York 14625-2396, Attention: Corporate Secretary.

 

Sincerely,

 

 

B. Thomas Golisano

Chairman of the Board of Directors

 

 

PAYCHEX, INC.

 

911 Panorama Trail South •  Rochester, New York 14625-2396

 

 

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

 

 

 

 

IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE 2010 ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON OCTOBER 13, 2010

 

Paychex, Inc.’s Proxy Statement and Annual Report for the year ended May 31, 2010 are available at
http://investor.paychex.com/annual.aspx

 

 

TABLE OF CONTENTS

 

 

This Proxy Statement is being mailed to stockholders of Paychex, Inc. (“Paychex,” the “Company,” “we,” or “our”), a Delaware corporation, on or about September 3, 2010, in connection with the solicitation of proxies by the Board of Directors of the Company (the “Board”) to be voted at the 2010 Annual Meeting of Stockholders (the “Annual Meeting”). The Annual Meeting will be held on Wednesday, October 13, 2010 at 10:00 a.m. Eastern Time at the Dryden Theatre at George Eastman House, 900 East Avenue, Rochester, New York, 14607.

 

Paychex has one class of shares outstanding, designated common stock, $0.01 par value per share. The Board has fixed the close of business on August 16, 2010 as the record date for determining the holders of common stock entitled to notice of, and to vote at, the Annual Meeting. As of the record date, 361,990,308 shares of common stock were issued and outstanding. A majority of the issued and outstanding shares (180,995,155 shares) present at the Annual Meeting in person or by proxy will constitute a quorum. A quorum is necessary to hold a valid meeting. Stockholders will be entitled to one vote for each share of common stock held as of the record date.

 

Your vote is very important and we hope that you will attend the Annual Meeting. However, whether or not you plan to attend the Annual Meeting, please vote by proxy.

 

Registered Stockholders.  If your shares are registered directly in your name with the Company’s transfer agent, American Stock Transfer & Trust Company, LLC, you are considered a stockholder of record of those shares. Please vote by proxy in accordance with the instructions on your proxy card, or the instructions you receive through electronic mail.

 

There are three convenient ways to submit your vote by proxy:

 

 

The deadline for Internet or telephone voting is 11:59 p.m. Eastern Time on Tuesday, October 12, 2010. If you vote by telephone or the Internet, you do not need to return your proxy card. Signing and returning your proxy card or submitting your proxy via the Internet or by telephone does not affect your right to vote in person if you attend the Annual Meeting and your shares are registered in your name.

 

Beneficial Stockholders.  If you hold your shares through a broker, bank, or other holder of record, you are not a registered stockholder, but rather are considered a “beneficial owner” of those shares. In order to vote your shares, please refer to the voting instruction form or other materials forwarded to you by your broker, bank, or other holder of record. If your shares are held in the name of a broker, bank, or other holder of record, you must obtain a proxy, executed in your favor, from the holder of record to be able to vote in person at the Annual Meeting.

 

Voting by Participants in the Paychex Employee Stock Ownership Plan Stock Fund.  If a stockholder is a participant in the Paychex Employee Stock Ownership Plan Stock Fund (“ESOP”) of the Paychex 401(k) Incentive Retirement Plan (the “401(k) Plan”), the stockholder can vote using the previously described methods. This will serve as a voting instruction for Fidelity Management Trust Company (the “Trustee”), where all accounts are

registered in the same name. As a participant in the ESOP, the stockholder has the right to direct the Trustee, who is the holder of record, regarding how to vote the shares of common stock credited to the participant’s account at the Annual Meeting. The participant’s voting instructions will be tabulated confidentially. Only the Trustee and/or the tabulator will have access to the participant’s individual voting direction. If voting instructions for the shares of common stock in the ESOP are not received, those shares will be voted by the Trustee in the same proportions as the shares for which voting instructions were received from other participants in the ESOP. Voting by ESOP participants will close at 11:59 p.m. Eastern Time on October 7, 2010. The Trustee will then vote all shares of common stock held in the ESOP by the established deadline.

 

Registered stockholders can revoke their proxy at any time prior to it being voted at the Annual Meeting by:

 

 

Beneficial stockholders should contact their broker, bank, or other holder of record for instructions on how to change their vote.

 

All votes properly cast and not revoked will be voted at the Annual Meeting in accordance with the stockholder’s directions. Shares voted by proxy card received without choices specified will be voted as follows:

 

 

If a broker holds your shares in its name, and you do not provide your voting instructions to them, that broker is permitted to use its own discretion and vote your shares on routine matters. Proposal 3 to ratify the selection of the independent accountants is a routine matter. However, a broker does not have discretion to vote your shares on non-routine matters. Proposal 1, the election of directors, and Proposal 2, the amendments to the 2002 Plan, are non-routine matters. Therefore, we urge you to give voting instructions to your broker on all three voting items. Shares that are not permitted to be voted by your broker are called “broker non-votes.” Broker non-votes are not considered votes for or against a proposal and therefore will have no direct impact on any proposal since they are not deemed to be duly cast nor entitled to vote, but they will be counted for the purpose of determining the presence or absence of a quorum.

 

Abstentions are also counted for the purposes of establishing a quorum, but will have the same effect as a vote against a proposal, except in regards to the election of directors. For the election of directors, abstentions will have no direct impact.

 

Our by-laws provide that each director shall be elected by a majority of the votes cast for the director at any meeting for the election of directors at which a quorum is present. However, if the number of nominees exceeds the number of directors to be elected, the directors shall be elected by the vote of a plurality of the shares represented in person or by proxy at any such meeting and entitled to vote on the election of directors. A majority of the votes cast means that the number of shares voted “for” the election of a director nominee must exceed the number of votes cast “against” the nominee. If a nominee that is an incumbent director does not receive a required majority of the votes cast, the director shall offer to tender his or her resignation to the Board. The Governance and Compensation Committee of the Board shall consider such offer and will make a recommendation to the Board on whether to

accept or reject the resignation, or whether other action should be taken. The Board will consider the committee’s recommendation and will determine whether to accept such offer.

 

The table below shows the vote required to approve each of the proposals described in this Proxy Statement, assuming the presence of a quorum at the Annual Meeting.

 

 

The following table sets forth information, based upon reports filed by such persons with the Securities and Exchange Commission (“SEC”), as of July 31, 2010, with respect to the beneficial ownership of common stock of the Company by: (i) any person (including any “group” as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) who is known by the Company to be the beneficial owner of more than 5% of the Company’s voting securities; (ii) each director and nominee for director of the Company; (iii) each of the named executive officers (“NEOs”) of the Company named in the Fiscal 2010 Summary Compensation Table on page 33 of this Proxy Statement; and (iv) all directors, NEOs, and executive officers of the Company as a group.

 

 

 

 

Stockholders annually elect directors to serve for one year and until the directors’ successors have been elected and qualified. The six persons listed below, each of whom currently serves as a director, have been nominated for election to the Board by the Company’s Governance and Compensation Committee. Five of the six nominees are neither employees nor former employees of the Company. If elected, each nominee will hold office until the 2011 Annual Meeting of Stockholders and until his or her successor is elected and has qualified. Although the Board believes that all of the nominees will be available to serve as a director, the persons named in the enclosed proxy may exercise discretionary authority to vote for substitute nominees proposed by the Board. Below we identify and describe the key experience, qualifications, and skills our directors bring to the Board that are important in light of our business and structure. Also included below are any public company directorships held during the past five years and directors’ periods of service to our Board.

 

 

The Board of Directors recommends the election of each of the nominees identified above. Unless otherwise directed, the persons named in the enclosed proxy will vote the proxy FOR the election of each of these six nominees.

 

Jonathan J. Judge resigned from his position of President and CEO of Paychex effective July 31, 2010, and has decided not to stand for re-election to the Board.

 

Director compensation is set by the Governance and Compensation Committee and approved by the Board. The Board’s authority cannot be delegated to another party. The Company compensates the independent directors of the Board using a combination of cash and equity-based compensation. The Company’s management does not play a role in setting Board compensation. Jonathan J. Judge, President and CEO of the Company during the fiscal year ended May 31, 2010 (“fiscal 2010”), received no compensation for his services as a director. The compensation received by Mr. Judge in his role as President and CEO is shown in the Fiscal 2010 Summary Compensation Table on page 33 of this Proxy Statement.

 

The annual cash compensation paid to the independent directors in effect for fiscal 2010 is as follows:

 

 

The cash compensation component is comprised solely of annual retainers, which are paid in quarterly installments. The retainers for the chairmen of the Audit Committee and Governance and Compensation Committee were included to provide compensation for those Board members who contribute additional time in preparation for committee meetings. Effective July 7, 2010, the annual cash retainer was increased by $25,000, the Audit Committee and Governance and Compensation Committee member annual retainers each increased by $2,500, and both the Audit Committee and Governance and Compensation Committee Chairmans’ annual retainers increased by $5,000.

 

Prior to January 1, 2010, Mr. Golisano, who is not an independent director, received an annual salary of $140,000 for his services as Chairman of the Board. Beginning on January 1, 2010, Mr. Golisano’s cash compensation was changed to a director’s annual retainer of $140,000 annually, paid in quarterly installments. The Chairman does not receive any equity-based compensation. Effective July 7, 2010, the Board approved an increase to the Chairman’s annual retainer of $60,000, in conjunction with the other increases to director cash compensation.

 

Equity-based compensation consists of a blend of stock options and restricted stock. In July 2009, the restricted stock award granted in July 2006 lapsed. There were 1,334 shares lapsed resulting in a value of $32,843 each for Mr. Flaschen, Mr. Horsley (who retired from the Board in October 2009), Mr. Inman, Ms. Joseph, and Mr. Tucci. In July 2009, each independent director received an annual award under the 2002 Plan as follows:

 

 

 

 

The equity-based compensation structure for the independent directors has been typically based on a total fixed value of $120,000 per director, with approximately 50% awarded in the form of stock options and 50% in the form of restricted stock. The quantity of equity awards granted varies based on the estimated fair value as of the grant date. The July 2009 award had a calculated total value of approximately $75,000, which represented a reduction from the established fixed value of $120,000. The Board determined that it was not in the best interest of the Company’s stockholders, given economic conditions at that time, to base directors’ equity compensation on the established total fixed value of $120,000.

 

In July 2010, the Board granted each independent director 7,686 options to purchase shares of the Company’s common stock at an exercise price of $26.02 per share and 1,922 shares of restricted stock, with terms similar to the equity awards granted in July 2009. The award quantities are based on an estimated total value of approximately $100,000. With the increases to director annual retainers as noted previously under “Cash Compensation,” the estimated total fixed value of equity awards was decreased.

 

We maintain a non-qualified and unfunded deferred compensation plan in which all independent directors are eligible to participate. Directors may elect to defer up to 100% of their Board cash compensation. Gains and losses are credited based on the participant’s selection of a variety of designated investment choices, which the participant may change at any time. We do not match any participant deferral or guarantee a certain rate of return. The interest rates earned on these investments are not above-market or preferential. Refer to page 41 of this Proxy Statement for a listing of investment funds available to participants and the annual rates of return on those funds. Mr. Flaschen defers 100% of his Board cash compensation under this plan. No other directors participate in the plan at this time.

 

We reimburse each director for expenses associated with attendance at Board and committee meetings. Prior to January 1, 2010, Mr. Golisano also received access to the Company’s standard health and life insurance plans and received Company matching contributions, when in effect for all employees, into his account in the 401(k) Plan.

 

The Governance and Compensation Committee set stock ownership guidelines for our independent directors with a value of four times his or her annual Board retainer, excluding any committee retainers. The ownership guidelines were established to provide long-term alignment with stockholders’ interests. The independent directors are expected to attain the ownership guideline within five years after the later of first becoming a director or the initial adoption of the guideline. Directors must hold all equity received from the Company until their service on the Board is complete, with the exception of those shares sold as necessary to satisfy tax obligations. For the purpose of achieving the ownership guideline, unvested restricted stock awarded to the directors is included.

 

Directors must adhere to strict standards with regards to trading in the Company’s stock. They may not, among other things:

 

 

The table below presents the total compensation received from the Company by all directors for fiscal 2010.

 

 

 

 

Background

 

Our Board has approved, subject to the approval of our stockholders, (1) amendments to the Company’s 2002 Stock Incentive Plan (as amended and restated effective October 12, 2005) and (2) an increase in the aggregate number of shares of common stock available for issuance under the 2002 Plan by 10,000,000 to a total of 37,500,000 (the “Plan Amendments”). In addition, stockholder approval is required every five years in conjunction with Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). The 2002 Plan authorizes the granting of common stock-based awards in the form of incentive stock options, non-qualified stock options, stock appreciation rights, stock awards, restricted stock, restricted stock units, and performance awards. No additional forms of awards are being added as a result of the Plan Amendments.

 

Our Board believes that the effective use of stock-based long-term incentive compensation is vital to our ability to achieve continued strong performance in the future by providing a direct link between compensation and the creation of long-term stockholder value. The increasing use of full-value stock awards motivates employees while minimizing dilution to stockholders. The 2002 Plan encourages ownership in the Company on the part of those employees who are primarily responsible for the overall success and growth of the Company. Through the granting of options to purchase stock and the awarding of a portion of compensation in the form of equity subject to certain restrictions, the 2002 Plan provides these individuals with an incentive to remain with the Company and ensures alignment of their interest with those of the Company’s other stockholders.

 

Other key changes in the Plan Amendments include:

 

 

Our Board is recommending approval to increase shares available for issuance to enable us to meet our anticipated needs. For the three years ended May 31, 2010, the Company’s average annual burn rate was approximately 0.69%, which is well within the range of RiskMetrics Group expectations of 2.89% for the commercial services industry. Our burn rate has been below the median for the three-year average annual burn rate of a select group of comparable companies (the “Peer Group”) and industry, falling within the lowest quartile of both groups. Burn rate is defined as the total shares underlying all stock-settled awards granted during the period divided by the weighted-average common shares outstanding for the period. Burn rate does not consider cancellations or forfeitures of awards. For purposes of calculating the number of shares granted by us in any given year, any full-value stock awards will count as the equivalent to two shares.

 

As of May 31, 2010, 21.2 million shares have been granted subject to awards under the 2002 Plan and 14.1 million shares remain available for grant under the 2002 Plan.

 

If approved by the stockholders, the Plan Amendments will be effective as of the date of the Annual Meeting.

 

Required Vote

 

Assuming the presence of a quorum, the affirmative vote of at least a majority of the shares of common stock present at the Annual Meeting, in person or by proxy, and entitled to vote is required to approve the Plan Amendments. Abstentions and broker non-votes will be counted as present for purposes of determining the presence of a quorum. Broker non-votes will not have any effect on the outcome of this proposal, but abstentions will have the same affect as a vote against the proposal.

 

If this proposal is not approved by the Company’s stockholders, the Company’s flexibility may be limited, which will impact the Company’s ability to provide incentives and rewards to its employees and directors, to attract and retain such persons on a competitive basis, and to align the interests of such persons with those of the Company and its stockholders.

The Board of Directors recommends a vote FOR the proposal to amend the 2002 Plan, including an increase in the shares available under the 2002 Plan. Unless otherwise directed, the persons named in the enclosed proxy will vote such proxies FOR this proposal.

 

Summary of the Plan

 

A summary of the 2002 Plan, as amended and restated October 13, 2010 (the “amended and restated Plan”), appears below. It does not purport to be complete and is qualified in its entirety by reference to the provisions of the amended and restated Plan itself. The complete text of the amended and restated Plan is attached to this Proxy Statement as Appendix A. Unless otherwise defined in this summary, capitalized terms used in this summary have the meanings given such terms in the amended and restated Plan.

 

Effective Date. The amendment and restatement of the 2002 Plan was adopted by the Board of Directors on July 6, 2010, and will become effective if approved by the stockholders of the Company at the Annual Meeting.

 

Administration. The amended and restated Plan will be administered by the Governance and Compensation Committee, or such other committee as may be designated by the Board to administer the amended and restated Plan (the “Committee”). The Committee must be comprised of not less than such number of directors as is required to permit Awards to qualify under Rule 16b-3 under the Exchange Act, and each member of the Committee must be a “Non-Employee Director” within the meaning of Rule 16b-3 of the Exchange Act and an “outside director” within the meaning of Section 162(m) of the Code.

 

The Committee will have broad authority in its administration of the amended and restated Plan including, but not limited to, the authority to interpret the amended and restated Plan; to establish rules and regulations for the administration of the amended and restated Plan; to select those eligible individuals to receive Awards; to determine the type, size, terms, conditions, limitations, and restrictions of Awards; and to take all other action it deems necessary or advisable to administer the amended and restated Plan. Notwithstanding the Committee’s broad authority, the exercise price of any Option and the strike price of any Stock Appreciation Right granted pursuant to the amended and restated Plan may not be subsequently “repriced” without stockholder approval.

 

Eligibility. All officers, non-employee Directors, employees, consultants, and advisors providing services to the Company or an Affiliate are eligible to participate in the amended and restated Plan. As of May 31, 2010, all six executive officers, all five non-employee Directors, and approximately 12,000 other officers and employees were eligible for participation in the amended and restated Plan. The selection of those persons within a particular class who will receive Awards is entirely within the discretion of the Committee.

 

Shares Available. The amendment and restatement of the 2002 Plan would increase the number of Shares that may be issued thereunder by 10,000,000 to 37,500,000. However, of the total number of Shares available for Awards under the amended and restated Plan, no more than 12,000,000 Shares would be available for issuance pursuant to grants of Stock Awards, Restricted Stock, or Restricted Stock Units.

 

Types of Awards. Awards under the amended and restated Plan may be in the form of Options, Stock Appreciation Rights, Stock Awards, Restricted Stock, Restricted Stock Units, and Performance Awards, or any combination thereof.

 

Award Limits. Eligible individuals may not be granted any Award, the value of which is based solely on an increase in the value of Shares after the date of grant of such Award, for more than 1,500,000 Shares in the aggregate in any calendar year. In addition, the maximum amount payable pursuant to all Performance Awards to any Participant in the aggregate in any calendar year is $8,000,000 in value, whether payable in cash, Shares, or other property.

 

Stock Options. Options may be Incentive Stock Options or Non-Qualified Stock Options for federal income tax purposes. Options vest and become exercisable at such times and upon such terms and conditions as determined by the Committee; provided, however, (a) an Option may not be exercisable more than ten years after the date it is granted, and (b) the per-Share exercise price for any Option may not be less than 100 percent of the fair market value of a Share on the day that the Option is granted, except for Options granted in assumption or replacement of outstanding stock options in connection with specified corporate transactions.

Stock Appreciation Rights. A Stock Appreciation Right entitles the Participant upon exercise to receive a per-Share amount equal to the excess of the fair market value on the exercise date of one Share over the strike price. Stock Appreciation Rights vest and become exercisable at such times and upon such terms and conditions as determined by the Committee; provided, however, the per-Share strike price for any Stock Appreciation Right may not be less than 100 percent of the fair market value of a Share on the day that the Stock Appreciation Right is granted, except for Stock Appreciation Rights granted in assumption or replacement of outstanding stock appreciation rights in connection with specified corporate transactions.

 

Stock Awards. A Stock Award is an outright grant of Shares to a Participant. Stock Awards may only be made to officers and directors, must be made in lieu of salary or cash bonus, and the number of Shares awarded must be reasonable.

 

Restricted Stock and Restricted Stock Units. Restricted Stock is a grant to a Participant of Shares that are subject to a vesting schedule. The holder of Restricted Stock is a stockholder of record with respect to the underlying Shares, and is entitled to vote such Shares and to receive any dividends paid on the Shares. A Restricted Stock Unit is a right that entitles the holder to receive Shares at some future date; the holder of a Restricted Stock Unit does not have the right to vote, and generally is not entitled to receive dividends on the Shares underlying the Restricted Stock Unit until such Shares are actually issued. Restricted Stock and Restricted Stock Units must have a minimum vesting period of three years, except in the case of Restricted Stock and Restricted Stock Units that are conditioned on performance, or that are awarded to non-employee directors, which may have a minimum vesting period of one year.

 

Performance Awards. Performance Awards are structured to qualify as deductible “performance-based” compensation for purposes of Section 162(m) of the Code. A Performance Award is conditioned upon the achievement of one or more Performance Criteria, as set forth in the amended and restated Plan. Performance Goals may reflect the performance of the Company as a whole or that of a particular business unit, or a relative comparison to the performance of the Company’s peer group. In addition, the Committee may designate Performance Goals to include or exclude the effect of certain items or events.

 

Adjustments Upon Certain Corporate Events. In the event that the Committee determines that any dividend or other distribution, recapitalization, stock split, reverse stock split, reorganization, merger, consolidation, split-up, spin-off, combination, repurchase or exchange of Shares or other securities of the Company, issuance of warrants or other rights to purchase Shares or other securities of the Company, or other similar corporate transaction or event affects the Shares, then the Committee will, in such manner as it may deem equitable, appropriately adjust: (a) the number and type of Shares available under the amended and restated Plan; (b) the number and type of Shares subject to outstanding Awards; or (c) the per-Share exercise price, strike price, or purchase price of any outstanding Award.

 

Vesting in the Event of Termination following a Change in Control. If set forth in the applicable Award Agreement, then in the event of the involuntary termination of employment other than for Cause within two years following a Change of Control, all of a Participant’s outstanding Awards shall immediately vest. In addition, if set forth in the applicable Award Agreement, then all of the Participant’s outstanding Performance Awards shall be deemed to have achieved target level performance, and the Participant shall be entitled to receive a pro rata portion of such Awards.

 

Clawback. The Company will, to the extent permitted by governing law, require reimbursement of a portion of any compensation received under any or all awards to a Participant where: (a) the payment was predicated upon the achievement of certain financial results that were subsequently the subject of a substantial restatement; (b) in the Committee’s view the Participant engaged in fraud or misconduct that caused or partially caused the need for the substantial restatement; and (c) a lower payment would have been made to the Participant based upon the restated financial results. In each such instance, the Company will, to the extent practicable, seek to recover the amount by which the individual Participant’s compensation for the relevant period exceeded the lower payment that would have been made based on the restated financial results, plus a reasonable rate of interest; provided that the Company will not seek to recover compensation paid more than three years prior to the date the applicable restatement is disclosed.

Amendment and Termination. The Board may amend, alter, suspend, discontinue, or terminate the amended and restated Plan without stockholder approval; provided, however, that the prior approval of the stockholders of the Company is required for any amendment to the amended and restated Plan that: (a) requires stockholder approval under the rules or regulations of the SEC, The NASDAQ Stock Market^® (“NASDAQ”) or other securities exchange that are applicable to the Company; (b) increases the number of Shares authorized under the Plan; (c) increases the limitations on Awards contained in the amended and restated Plan; (d) permits repricing of Options or Stock Appreciation Rights; (e) permits the grant of Options or Stock Appreciation Rights at a per-Share price less than 100 percent of the fair market value of a Share on the date of grant; or (f) would cause Section 162(m) to become unavailable with respect to Awards granted under the Plan.

 

Equity Compensation Plan Information

 

The following table summarizes, as of May 31, 2010, the number of shares subject to currently outstanding equity awards, their weighted-average exercise price, and the number of shares available for future grants under the 2002 Plan, before taking into account the additional number of shares that would be authorized for issuance if the Plan Amendments are approved:

 

 

 

 

New Plan Benefits

 

Because awards under the amended and restated Plan are discretionary, we are not able to determine the benefits or amounts that will hereafter be received by or allocated to each NEO, all current executive officers as a group, or all employees, including officers who are not executive officers, as a group.

 

Securities Act Registration

 

The Company intends to register the additional 10,000,000 Shares issuable and purchasable under the amended and restated Plan pursuant to a Registration Statement on Form S-8 as soon as practicable, subject to the stockholders’ approval of the amended and restated Plan at the Annual Meeting.

 

Tax Status of Plan Awards

 

Unless otherwise defined in this tax status, capitalized terms used in this summary have the meanings given such terms in the amended and restated Plan.

 

Introduction. The following discussion of the United States federal income tax consequences of Awards under the amended and restated Plan, as proposed, is based on present federal tax laws and regulations and does not purport to be a complete description of the federal income tax laws. Participants may also be subject to certain foreign, state, and local taxes which are not described below.

 

Incentive Stock Options. Pursuant to the requirements of Section 422 of the Code, only employees are eligible to receive Incentive Stock Options. If an Option is an Incentive Stock Option, no income is realized by the employee upon grant or exercise of the Incentive Stock Option, and no deduction is available to the Company at such times. If the Shares purchased upon the exercise of an Incentive Stock Option (although the spread on the exercise date is a

preference item for alternative minimum tax purposes) are held by the employee for at least two years from the date of the grant of such Incentive Stock Option and for at least one year after exercise, any resulting gain is taxed at the long-term capital gains rates. If the Shares purchased pursuant to an Incentive Stock Option are disposed of before the expiration of that period, any gain on the disposition, up to the difference between the fair market value of the Shares at the time of exercise and the exercise price of the Incentive Stock Option, is taxed at ordinary income rates as compensation paid to the employee, and the Company is entitled to a deduction for an equivalent amount. Any amount realized by the employee in excess of the fair market value of the Shares at the time of exercise is taxed at capital gains rates.

 

Non-Qualified Stock Options. If an Option is a Non-Qualified Stock Option, no income is realized by the Participant at the time of grant of the Non-Qualified Stock Option, and no deduction is available to the Company at such time. At the time of exercise, ordinary income is realized by the Participant in an amount equal to the difference between the exercise price and the fair market value of the Shares on the date of exercise, and the Company receives an income tax deduction for such amount. Upon disposition, any appreciation or depreciation of the Shares after the date of exercise will be treated as capital gain or loss depending on how long the Shares have been held.

 

Stock Appreciation Rights. No income is realized by a Participant at the time a Stock Appreciation Right is granted, and no deduction is available to the Company at such time. When a Stock Appreciation Right is exercised, ordinary income is realized in the amount of the fair market value at such time the Shares are received by the Participant, and the Company is entitled to a deduction of equivalent value.

 

Stock Awards. Upon the grant of a Stock Award, a Participant realizes taxable income equal to the fair market value at such time the Shares are received by the Participant under such Award (less the purchase price therefore, if any), and, subject to the limitations of Section 162(m) of the Code, the Company is entitled to a corresponding tax deduction at that time.

 

Restricted Stock. Upon the grant of Restricted Stock, no income is realized by a Participant (unless the Participant timely makes an election under Section 83(b) of the Code), and the Company is not allowed a deduction at that time. When the Award vests and is no longer subject to a substantial risk of forfeiture for income tax purposes, the Participant realizes taxable ordinary income in an amount equal to the fair market value at the time of vesting of the Shares of Restricted Stock which have vested (less the purchase price therefore, if any), and, subject to the limitations of Section 162(m) of the Code, the Company is entitled to a corresponding deduction at such time. If a Participant makes a timely election under Section 83(b) of the Code, then the Participant recognizes taxable ordinary income in an amount equal to the fair market value at the time of grant of the Restricted Stock (less the purchase price therefore, if any), and, subject to the limitations of Section 162(m) of the Code, the Company is entitled to a corresponding deduction at such time.

 

Restricted Stock Units. Upon the grant of Restricted Stock Units, no income is realized by a Participant, and the Company is not allowed a deduction at that time. When the Award vests and is no longer subject to a substantial risk of forfeiture for income tax purposes, the Participant realizes taxable ordinary income in an amount equal to the fair market value at the time of vesting of the Shares received by the Participant under such Award (less the purchase price therefore, if any), and, subject to the limitations of Section 162(m) of the Code, the Company is entitled to a corresponding deduction at such time.

 

Performance Awards. A Participant receiving a Performance Award will not recognize income and the Company will not be allowed a tax deduction at the time the Award is granted. When the Participant receives payment of the Performance Award, the amount of cash and the fair market value of any Shares received will be ordinary income to the Participant and the Company is entitled to a corresponding deduction at such time.

 

Stock Price

 

The closing price of a Share reported on NASDAQ on August 16, 2010, was $25.02 per share.

 

The Audit Committee has appointed the firm of Ernst & Young LLP as the Company’s independent accountants for the fiscal year ending May 31, 2011. Although action by stockholders in this matter is not required, the Audit Committee believes that it is appropriate to seek stockholder ratification of this appointment and to seriously consider stockholder opinion on this issue. If the stockholders do not ratify the appointment, the Audit Committee will review its future selection of the independent accountants, but may still retain them.

 

Representatives from Ernst & Young LLP, the Company’s independent accountants since 1983, will be present at the Annual Meeting, will be afforded the opportunity to make any statements they wish, and will be available to respond to appropriate questions from stockholders.

 

To ratify the appointment of Ernst & Young LLP, a majority of the shares present in person or by proxy and entitled to vote at the Annual Meeting must be voted for the proposal.

 

The Board of Directors recommends a vote FOR the proposal to ratify the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending May 31, 2011.

 

The following table shows the aggregate fees for professional services rendered for the Company by Ernst & Young LLP:

 

 

Audit fees for fiscal 2010 and for the fiscal year ended May 31, 2009 (“fiscal 2009”) were for professional services rendered for the audits of the Company’s annual consolidated financial statements, reviews of the financial statements included in the Company’s Quarterly Reports on Form 10-Q, and for the audits of the effectiveness of internal control over financial reporting.

 

Audit-related fees for fiscal 2010 and fiscal 2009 were for employee benefit plan audits and other reports.

 

There were no tax or other non-audit-related services provided by the independent accountants for fiscal 2010 and fiscal 2009.

 

The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services provided by the independent accountants. The Audit Committee pre-approved all such audit and audit-related services provided by the independent accountants during fiscal 2010 and fiscal 2009.

 

The Audit Committee of the Board of Directors oversees the Company’s financial reporting process on behalf of the Board and is composed entirely of independent directors. The Audit Committee is governed by a written charter and its primary responsibilities are highlighted in the Corporate Governance section of this Proxy Statement.

 

Paychex management is responsible for the preparation of the consolidated financial statements, the financial reporting process, and for the Company’s internal controls over financial reporting. Ernst & Young LLP, the Company’s independent accountants, is responsible for performing independent audits of the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board. The independent accountants are also responsible for expressing an opinion on the effectiveness of the Company’s internal controls over financial reporting. The Audit Committee monitors and oversees these processes.

 

As part of the oversight processes, the Audit Committee regularly meets with management, the Company’s internal auditors, and the independent accountants. The Audit Committee meets with the internal auditors and independent accountants, with and without management present, to discuss the overall scope and plans for various audits, results of their examinations, their evaluations of the Company’s internal controls, and the overall quality and effectiveness of the Company’s financial reporting process and legal and ethical compliance programs, including the Company’s Code of Business Ethics and Conduct. The Audit Committee held seven meetings during fiscal 2010 and had full access to each of the aforementioned parties.

 

In fulfilling its oversight responsibilities, the Audit Committee has reviewed and discussed with management and the independent accountants the consolidated financial statements for fiscal 2010, including a discussion on the quality and acceptability of the Company’s accounting policies, the reasonableness of significant judgments and estimates, and the clarity of disclosures in the consolidated financial statements. The Audit Committee also monitored the progress and results of testing of internal controls over financial reporting, reviewed reports from management and internal audit regarding design, operation, and effectiveness of internal controls over financial reporting, and reviewed the report from the independent accountants regarding the effectiveness of the Company’s internal control over financial reporting.

 

The Audit Committee has discussed with the independent accountants the matters required to be discussed by Statement on Auditing Standards No. 61, as amended, as adopted by the Public Company Accounting Oversight Board in Rule 3200T. The independent accountants have provided the Audit Committee with the written disclosures and the letter required by the Public Company Accounting Oversight Board regarding independent accountants’ communications with the audit committee concerning independence, and the Audit Committee has discussed with the independent accountants and management the accountants’ independence. There were no non-audit services provided to the Company by the independent accountants during fiscal 2010 that required consideration by the Audit Committee.

 

Based upon the reviews and discussions referred to above, the Audit Committee recommended and the Board approved that the audited consolidated financial statements be included in the Company’s Form 10-K for fiscal 2010 for filing with the SEC. The Audit Committee has recommended for approval by the Board the selection of the Company’s independent accountants.

 

The Audit Committee:

 

David J. S. Flaschen, Chairman

Grant M. Inman

Pamela A. Joseph

 

The Board is elected by the stockholders to oversee the overall success of the Company, review its operational and financial capabilities, and periodically assess its long-term strategic objectives. The Board serves as the final decision-making body of the Company, except for those matters for which authority is reserved for, or shared with, the stockholders. The Board selects and oversees the members of senior management, who are charged by the Board with conducting the day-to-day business of the Company.

 

The Board currently separates the role of Chairman of the Board from the CEO. The Board believes that the Company is best served by having a Chairman who has in-depth knowledge of the Company’s operations and the industry. Mr. Golisano’s extensive experience as founder and former CEO qualify him to lead the Board, particularly as it focuses on strategic risks and opportunities facing the Company. Our corporate governance guidelines also provide that the Board will designate a Lead Independent Director, currently Mr. Tucci, who has the responsibility for conducting regularly scheduled executive sessions of the independent directors.

 

The Board held four meetings during fiscal 2010. To the extent practicable, directors are expected to attend all Board meetings and meetings of the committees on which they serve. During fiscal 2010, each director attended 80% or more of the Board meetings and committee meetings on which the director served. Directors are encouraged to attend annual meetings of stockholders. All directors attended the 2009 Annual Meeting of Stockholders.

 

Regularly scheduled executive sessions of the independent members of the Board, without members of management, are held in conjunction with meetings of the Board. When required or as appropriate, matters presented to the Board by the Governance and Compensation Committee are discussed and decided upon in executive session by the independent directors, which in fiscal 2010 were all directors except for Mr. Golisano and Mr. Judge.

 

One of the functions of the Board is oversight of risks inherent in the operation of the Company’s business. The Board fulfills this function through regular reports from officers for oversight of particular risks within the Company, through review of the Company’s strategic plan, and through delegation of certain risk oversight functions to various committees. The Audit Committee has oversight responsibility for risks related to the integrity of our financial statements and internal controls over financial reporting. The Investment Committee has established a policy outlining risk-tolerance and detailing requirements for the Company’s investment portfolios and oversees compliance with that policy. The Governance and Compensation Committee oversees risks related to compensation programs, as discussed in greater detail below, as well as risks related to corporate governance matters including succession planning, director independence, and related-person transactions. The responsibilities of each committee are detailed in the individual committee charters, which are available on the Company’s website and are summarized on page 21 of this Proxy Statement.

 

As part of its risk oversight, the Board conducted an assessment of risks arising from the Company’s compensation programs. The Governance and Compensation Committee reviewed such programs with its independent compensation consultant. The Governance and Compensation Committee’s assessment included a review of mitigating factors including the performance metrics used in each compensation arrangement, the balance of fixed and variable and short-term and long-term compensation, stock ownership guidelines, and recoupment and other forfeiture provisions. Based on this review, the Governance and Compensation Committee concluded that its compensation policies and procedures are not reasonably likely to have a material adverse effect on the Company.

 

The Board has established four standing committees with the following director assignments and independence determination:

 

 

 

 

The Board has determined that all members of the Audit Committee meet the independence, experience, and other applicable NASDAQ listing requirements and applicable SEC rules regarding independence, and that Mr. Flaschen qualifies as an “Audit Committee Financial Expert,” as defined by applicable SEC rules. The Board has also determined that all members of the Governance and Compensation Committee meet the NASDAQ independence criteria.

 

Executive Committee.  The primary responsibility of the Executive Committee is to exercise all the powers and authority of the Board except as limited by law.

 

Audit Committee.  The primary responsibilities of the Audit Committee are to:

 

 

Investment Committee.  The primary responsibilities of the Investment Committee are to:

 

 

Governance and Compensation Committee.  The primary responsibilities of the Governance and Compensation Committee are to:

 

 

The Audit, Investment, and Governance and Compensation Committees’ responsibilities are more fully described in each committee’s charter adopted by the Board, which are accessible on the Company’s website at www.paychex.com at the Investor Relations section under “Corporate Governance.”

 

The Governance and Compensation Committee functions as our nominating committee. The Board has determined that it is necessary for the continued success of the Company to ensure that the Board is composed of individuals having a variety of complementary experience, education, training, and relationships relevant to the then-current needs of the Board and the Company. The Board’s Nomination Policy included in the Governance and Compensation Committee Charter is intended to achieve this result.

 

In evaluating candidates for nomination to the Board, including candidates for nomination recommended by a stockholder, the Nomination Policy requires Governance and Compensation Committee members to consider the contribution that a candidate for nomination would be expected to make to the Board and the Company, based upon the current composition and needs of the Board, and the candidate’s demonstrated business judgment, leadership abilities, integrity, prior experience, education, training, relationships, and other factors that the Board determines relevant. In identifying candidates for nomination to fill vacancies created by the expiration of the term of any incumbent director, the Nomination Policy requires Governance and Compensation Committee members to determine whether such incumbent director is willing to stand for re-election and, if so, to take into consideration the value to the Board and to the Company of their continuity and familiarity with the Company’s business. The Board has previously used a third-party search firm to identify director candidates and the charter authorizes the Governance and Compensation Committee to continue this practice.

 

The Nomination Policy requires the Governance and Compensation Committee to consider candidates for nomination to the Board recommended by any reasonable source, including stockholders. Stockholders who wish to do so may recommend candidates for nomination by identifying such candidates and providing relevant biographical information in written communications to the Chairman of the Governance and Compensation Committee in accordance with the policy described on page 23 in the section entitled “Communications with the Board of Directors.”

 

It is the Company’s policy to avoid transactions with related persons. However, there may be occasions when a transaction with a related person is in the best interest of the Company. The Company’s policies and procedures for review and approval of related-persons transactions appear in the Company’s Standards of Conduct, Conflict of Interest, and Employment of Relatives Standards, which are internally distributed, and in the Company’s Code of Business Ethics and Conduct, which is posted on the Company’s website.

 

All employees are required to disclose specified transactions, which include certain financial interests in or relationships with any supplier, customer, partner, subcontractor, or competitor; serving on the board of non-profit organizations; and engaging in any activity that could create the appearance of a conflict of interest, including financial involvement or dealings with employees or representatives of the types of entities listed above. The Company reviews and determines if a conflict of interest exists related to any such transactions. For officers, the Company’s Chief Financial Officer (“CFO”) oversees the review of such transactions.

 

Members of the Board are required to disclose to the Chairman of the Board or the Chairman of the Governance and Compensation Committee any situation that involves, or may reasonably be expected to involve, a conflict of interest with the Company, including engaging in any conduct or activities that would impair the Company’s relationship with any person or entity with which the Company has or proposes to enter into a business or contractual relationship.

 

The Company’s finance department annually reviews the Company’s listing of related parties for determination of potential related-person transactions that would be disclosable in the Company’s periodic reports or proxy materials under United States generally accepted accounting principles (“GAAP”) and SEC rules.

The Governance and Compensation Committee is required to consider all questions of possible conflicts of interest of Board members and executive officers, including review and approval of transactions of the Company in excess of $120,000 in which a director, executive officer, or an immediate family member of a director or executive officer has an interest.

 

Mr. Tucci, a member of the Board, is the Chairman, President, and Chief Executive Officer of EMC Corporation. During fiscal 2010, the Company purchased through negotiated transactions approximately $3.2 million of data processing equipment and software from EMC Corporation. Mr. Tucci was not personally involved in the negotiation of these transactions and such transactions were approved by the Board.

 

Mr. Judge, the Company’s President and CEO, is a member of the Board of Directors of Dun & Bradstreet Corporation. During fiscal 2010, the Company purchased $0.4 million of services from Dun & Bradstreet Corporation.

 

None of the members of the Governance and Compensation Committee were at any time during fiscal 2010, or at any other time, an officer or employee of the Company. Mr. Tucci, a member of the Board, is Chairman of the Governance and Compensation Committee, and is also an executive of EMC Corporation. As noted above, the Company purchases data processing equipment and software from EMC Corporation. During fiscal 2010, no member of the Governance and Compensation Committee or Board was an executive officer of another entity on whose compensation committee or board of directors an executive officer of Paychex served.

 

The Board has established procedures to enable stockholders and other interested parties to communicate in writing with the Board, including the chairman of any standing committee of the Board. These procedures cover recommendations by stockholders of candidates for nomination for election to the Board. Written communications should be clearly marked “Stockholder and Other Interested Parties — Board Communication,” and be mailed to Paychex, Inc. at 911 Panorama Trail South, Rochester, New York, 14625-2396, Attention: Corporate Secretary. In the case of communications intended for committee chairmen, the specific committee must be identified. Any such communications that do not identify a standing committee will be forwarded to the Board. The Corporate Secretary will promptly forward all stockholder and other interested party communications to the Board or to the appropriate standing committee of the Board, as the case may be.

 

 

Section 16(a) of the Exchange Act requires directors, executive officers, and beneficial owners of more than 10% of the Company’s common stock to file reports of their ownership and changes in their ownership of the Company’s equity securities with the SEC. Based solely on our review of information supplied to the Company and filings made with the SEC, the Company believes that during fiscal 2010, its directors, executive officers, and greater than 10% beneficial owners have complied in a timely manner with all applicable Section 16 filing requirements.

 

 

The Company has a Code of Business Ethics and Conduct that applies to all of its directors, officers, and employees. The Company requires all to adhere to this code in addressing legal and ethical issues that they encounter in the course of doing their work. This code requires our directors, officers, and employees to avoid conflicts of interest, comply with all laws and regulations, conduct business in an honest and ethical manner, and otherwise act with integrity and in the Company’s best interest. All newly hired employees are required to certify that they have reviewed and understand this code. In addition, each year all employees are reminded of and asked to affirmatively acknowledge their obligation to follow the code. The Code of Business Ethics and Conduct is available for review on the Company’s website at www.paychex.com at the Investor Relations section under “Corporate Governance.” The Company intends to disclose any amendment to, or waiver from, a provision of its Code of Business Ethics and Conduct that relates to any element of the code of ethics definition enumerated in Item 406 of SEC Regulation S-K by posting such information on its website at the address specified above.

 

Our financial results for fiscal 2010 were impacted by the cumulative adverse effect of the recession and global financial crisis that began in 2008. These results, while reflecting a decline compared to the prior fiscal year, were in line with our expectations. These expectations were considered in the Company’s goal setting process for fiscal 2010. The Company’s financial performance was a significant factor in the executive compensation decisions that were made for fiscal 2010. For more information about our fiscal 2010 business results, see the section of our Fiscal 2010 Annual Report on Form 10-K titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

The following highlights the Governance and Compensation Committee’s key compensation decisions for fiscal 2010, as reported in the Fiscal 2010 Summary Compensation Table on page 33 of this Proxy Statement:

 

 

		Performance Targets Established												Actual Results
$ In Millions		Threshold				Target				Maximum				Achieved
Annualized New Business Revenue		$	471			$	496			$	511			$	458
Annual Service Revenue		$	1,920			$	1,980			$	2,005			$	1,946
Annual Operating Income, Net of Certain Items		$	656			$	683			$	696			$	686
Annual Operating Income, Net of Certain Items, as a Percentage of Annual Service Revenue			33.7	%			34.5	%			34.7	%			35.2	%

 

The quantitative portion of the annual incentive program was based on achievement compared to the established targets. The cumulative impact of the weak economy on our client base and check volume resulted in annual service revenue for fiscal 2010 falling short of the established target but above the threshold. However, strong cost control measures aided in achieving the target result for annual operating income, net of certain items, with overachievement for annual operating income, net of certain items, as a percentage of annual service revenue. For fiscal 2010, the CEO received approximately 78% of the quantitative component of his target annual incentive program and NEOs, exclusive of Mr. Humenik, received 86% of the quantitative component of their target annual incentive program. Refer to pages 27 and 28 of this Proxy Statement for a more detailed discussion of the annual incentive program and the Board’s use of discretion in determining performance achievement.

 

 

 

Refer to the remainder of this Compensation Discussion and Analysis for a discussion of the overall compensation philosophy, practice, and analysis of elements of the compensation awarded to our NEOs as detailed in the Fiscal 2010 Summary Compensation Table on page 33 of this Proxy Statement.

 

The Company believes in a pay-for-performance approach to NEO compensation. The overall objectives of our officer compensation plan are to provide competitive opportunities when compared with companies of comparable size; attract, retain, and develop highly qualified NEOs; reward exceptional individual performance; tie compensation to our overall financial and strategic objectives; and align the interests of NEOs with the interests of stockholders.

 

To achieve these objectives, our officer compensation plan has been designed to:

 

 

As part of the committee’s responsibility to evaluate and determine NEO compensation, on an annual basis the committee:

 

 

As outlined in its charter, the committee has the authority to retain consultants and advisors, at the Company’s expense, to assist in the discharge of the committee’s duties. The committee can retain and dismiss such consultants and advisors at any time. The committee’s consultants report directly to the committee and have direct access to the committee through the chairman. The committee requires that any consultant it retains cannot be utilized by management for other purposes. Although management, particularly the Vice President of Organizational Development, may work closely with the committee’s consultant, the consultant is ultimately accountable to the committee on matters related to compensation.

 

Through April 2010, the committee utilized the compensation advisory services of Watson Wyatt Worldwide (“Watson Wyatt”). Beginning in May 2010, the committee retained the services of Steven Hall & Partners (“Steven Hall”), as its independent compensation consultant. Steven Hall has not provided any services to the Company prior to or subsequent to being retained as compensation consultant to the committee. The committee was solely responsible for the decision to retain Steven Hall as its consultant. In fiscal 2010, Watson Wyatt advised the committee on matters of NEO compensation, assisted the committee with analysis and research, and updated the committee on evolving best practices in compensation. Steven Hall was retained to perform these services for fiscal 2011. While Steven Hall may express an opinion on compensation matters, the committee is solely responsible for setting the type and amount of compensation for NEOs.

Management retains the services of First Niagara Consulting as a compensation consultant to advise management on overall compensation strategy and plan design. Generally, compensation plans are developed and proposed by management, with analytical and research assistance by First Niagara Consulting. The committee’s consultant reviews reports from management and First Niagara Consulting and offers the committee their opinions on the findings.

 

Our CEO and our Vice President of Organizational Development provide recommendations to the committee on design elements for compensation. These individuals, and from time to time invited guests including other officers, will be in attendance at the meetings of the committee to present and respond to questions on current or proposed plan design. Annually, our CEO reviews achievement of the recently completed fiscal year’s plans and also presents recommendations regarding: salary for each of the NEOs (other than himself); the upcoming fiscal year’s annual incentive program structure; and equity awards. Management is excluded from executive sessions of the committee where final decisions on compensation are made, particularly those on our CEO’s performance and compensation. Executive sessions occur at each meeting of the committee.

 

We use a combination of compensation elements, including base salary, annual incentive program, and equity awards delivered under our 2002 Plan. The committee compares our NEOs’ compensation plan with that of other NEOs at similar companies, when such information is available. The committee reviews compensation consultants’ reports to assess our cash compensation elements of base salary and annual incentive program. The committee strives for our NEOs’ compensation to be competitive with our Peer Group. The information provided by the compensation consultant indicates whether our compensation package, if target performance is achieved, is comparable to the median compensation of our Peer Group, given current competitive practices, overall best practices, and other compensation and benefit trends. The committee continues to review each of the elements annually to ensure that compensation is appropriate and competitive to attract and retain a high-performing executive team. The committee, in making its decisions, targets an equitable mix of compensation. For fiscal 2010, NEO compensation packages averaged 48% in cash compensation and 52% in equity-based compensation, based on the value of equity awards as provided in the Fiscal 2010 Summary Compensation Table on page 33 of this Proxy statement.

 

Annually, management provides the committee a summary for the upcoming fiscal year of total cash compensation and equity awards (based on grant date fair value) for all officer levels, from vice president to CEO. The summary is used to evaluate compensation recommendations and the impact to total compensation for each individual.

 

Management also provides the committee on an annual basis a three-year history of total compensation for all officers, including cash, annual incentive program payout, and equity-based compensation. This history provides a more complete picture of the internal trend of compensation to executive officers, both as a team and as individuals. This summary facilitates discussion that more accurately details individual officer compensation, noting differences that reflect officer tenure, performance, and position in the management structure.

 

The committee uses these management updates along with peer information as tools to evaluate executive compensation. This information is reviewed in a subjective manner. There is no implied direct or formulaic linkage between peer information and our compensation decisions.

 

Compensation for our officers is most closely compared to our Peer Group. The committee assesses total compensation at the median of the Peer Group, even though Paychex generally performs above the median. This is not the sole determining factor in the committee’s decisions on compensation, and the committee reserves the discretion to adjust compensation based on other factors as discussed above. The Peer Group consists of seventeen companies with comparable revenue and net income who are in a comparable industry, or who are direct competitors of Paychex. The Peer Group companies are not necessarily limited to the markets in which Paychex does business. The Peer Group is comprised of the following industries or segments: a direct competitor in the payroll industry; financial transaction management companies; business services and outsourcing companies; and a human resources outsourcing company.

Our current Peer Group consists of the following companies:

 

Paychex Peer Group

 

 

The committee annually reviews and approves the selection of Peer Group companies, adjusting the group from year to year based upon our business and changes in the Peer Group companies’ business or comparative metrics. The Peer Group may also be adjusted in the event of mergers, acquisitions, or other significant economic changes. During fiscal 2010, actions were taken by the committee to adjust the Peer Group. Metavante Technologies, Inc. (MV) was removed from the Peer Group as it was acquired by another company. The Western Union Company, TD AMERITRADE Holding Corporation, and The Brink’s Company were added to the Peer Group as these are companies with comparable size and operating structure to Paychex.

 

Annually, base salaries are reviewed to determine what, if any, increase is required. For fiscal 2010, there was no increase in base salaries of NEOs due to a Company-wide suspension of salary increases.

 

Our annual incentive program is a cash incentive plan in which payments are made upon the satisfaction of certain quantitative and qualitative components. The quantitative component consists of certain predetermined performance targets. The performance targets for the annual incentive program are established at the beginning of each fiscal year, typically based on the Board-approved fiscal year financial plan. The annual incentive program provides our NEOs the opportunity for additional cash compensation based primarily on the following goals: annualized new business revenue; annual service revenue; annual operating income, net of certain items; and annual operating income, net of certain items, as a percentage of annual service revenue. The targets for payout are

established by the committee with consultation of management. The program was established to motivate our NEOs to meet the financial goals set by the Company as presented to its stockholders.

 

Refer to the table in the Executive Summary on page 24 of this Proxy Statement for more information on the specific targets and actual results achieved for fiscal 2010.

 

The performance targets of the annual incentive program have both financial and strategic objectives. Targets for the annual incentive program are set at specific financial goals, which are in alignment with stockholder interests. Once the target is determined, it is set for the year and is normally not changed. For extraordinary circumstances, the committee reserves the right to apply discretion.

 

Historically, the sole exclusion from operating income, net of certain items, has been interest on funds held for clients. Operating income, net of certain items, is considered a non-GAAP measure. At the discretion of the committee, they may adjust for items that are unusual and infrequent in nature. For fiscal 2010, operating income for purposes of measuring performance was adjusted for an $18.7 million expense charge to increase the litigation reserve, the gain on sale of the Company’s Stromberg time and attendance operations (“Stromberg”), and an asset disposal. For fiscal 2010, all performance targets with the exception of annualized new business revenue were adjusted to remove the effect of Stromberg post disposition for all NEOs except the CEO. Mr. Judge’s performance targets remained unchanged at $1,990 million, $685 million, and 34.4% for annual service revenue, annual operating income, net of certain items, and annual operating income, net of certain items, as a percentage of annual service revenue, respectively.

 

For fiscal 2010, the annual incentive program applicable to the CEO and the other NEOs was structured into two components — quantitative and qualitative, similar to recent past years. The quantitative component is intended to comply with section 162(m) of the Code for NEOs affected by the $1 million limitation. The CEO’s quantitative target percentage as reflected in his separate incentive award agreement is 105% of base salary. The quantitative target percentage for Senior Vice Presidents (“SVPs”) is 65% of base salary. For all other vice presidents, the quantitative target percentage is 40% of base salary. As the committee adjusts the allocation of total compensation, the intent is to increase the percentage of total compensation that is performance-based. Mr. Humenik’s annual incentive program payout for fiscal 2010 was pro rated based on achievement at target as he was not employed by Paychex at the time the goals were set and had limited time with the Company in which to influence results against such goals.

 

Each NEO is also assigned a qualitative section under the annual incentive program, with the CEO potentially receiving 20% of base salary and all other NEOs potentially receiving 10% of base salary, the same at threshold, target, and maximum. Individual-specific qualitative goals are established at the beginning of the fiscal year based on functions unique to the individual. These goals are highly subjective and are not always based on quantifiable financial measurements. The committee may determine, at its sole discretion, whether satisfactory achievement has occurred, regardless of whether the officer has achieved the pre-established individual goals. The qualitative component of the annual incentive program is not considered material to the overall compensation for each NEO.

 

To align our NEOs’ interests with the long-term interests of our stockholders, the Company grants equity awards under the 2002 Plan. Annual grants of equity awards to the NEOs are approved during the regularly scheduled meeting of the Board in July. The exercise price of the award is typically the closing market price, but never less than 100% of fair market value, on the date of the grant. Historically, the July Board meeting has been scheduled to occur approximately two weeks after the release of our fiscal year-end earnings and upcoming fiscal year financial guidance. Our trading black-out period normally lifts on the third business day following such release of information. The committee anticipates continuing its granting practice. In fiscal 2010, the Board also granted equity awards to individuals upon hire or promotion to executive officer positions. These equity awards were not granted during any trading black-out periods. Recipients are notified shortly after Board approval of their grant, noting the number of stock options or shares of restricted stock granted, the vesting schedule, and exercise price. Any sales restrictions or other terms of the award are also communicated at that time.

In July 2009, the committee granted a blend of stock options and performance-accelerated restricted stock to provide pay for performance. A blend of stock options and restricted stock optimizes total equity awarded and balances risk and reward, aligning with stockholders’ interests over the long term. The quantity of stock options and shares of restricted stock awarded was based on an estimated total value, as determined by the committee, with that total value split 55% to stock options and 45% to restricted stock. The estimated total value may be adjusted by the committee at its discretion for individual performance and retention considerations.

 

The grants of restricted stock awards have time-based vesting with performance-based acceleration to recognize all aspects of the NEOs’ contributions to the Company, and to motivate the NEOs to meet our annual and long-term financial targets. The restricted stock granted in July 2009 will vest for active employees on the fifth anniversary of the grant date, unless performance criteria are met for the acceleration of vesting. The performance targets are operating income, net of certain items, and service revenue as established by the committee at the time of grant. If performance targets are met for a fiscal year, up to one-third of the award would vest at that time. If all targets are met for three consecutive years, then the award would be fully vested.

 

Beginning in fiscal 2009, the committee intended to base equity award grants on the estimated total value of the award as opposed to fixed quantities. The quantity of stock options in the July 2008 award was calculated based on an estimated Black-Scholes value. Subsequent to the committee’s approval of the July 2008 stock options, it was determined that the actual Black-Scholes value on the date of grant was lower than the estimated value, resulting in an option grant with a lower compensation value than the committee had approved. Therefore, a special award was granted on July 9, 2009 at an exercise price of $31.95. This exercise price is above the closing stock price of $24.21 on the date of grant, but consistent with the exercise price of the options granted in July 2008. In addition, the committee approved the acceleration of 20% of the award to vest on July 10, 2009, with 20% vesting on each of the next four anniversary dates. The award expires on July 9, 2018.

 

Information regarding the stock options and restricted stock granted to the NEOs in fiscal 2010 and in prior years are detailed in the Named Executive Officer Compensation tables of this Proxy Statement.

 

It is the responsibility of the committee to evaluate Mr. Judge’s performance annually and determine his total compensation. Mr. Judge receives compensation based on his leadership role and the overall performance of the Company. Mr. Judge receives a base salary comparable to the median of salaries for CEOs in our Peer Group. His annual incentive program, as described under “Annual Officer Performance Incentive Program,” is also comparable to the median of CEOs in our Peer Group, and is commensurate with his leadership role at the Company. Mr. Judge also receives equity awards under the 2002 Plan. During fiscal 2010, he received annual equity awards of 316,447 stock options and 48,018 shares of performance-accelerated restricted stock. The total value of the awards granted is comparable to the lowest quartile in our Peer Group. Mr. Judge also received a special award on July 9, 2009, as discussed above, for 58,275 options. For fiscal 2010, the committee also awarded Mr. Judge a discretionary bonus of $50,000 as a means to reward Mr. Judge for the successful disposition of Stromberg. Certain elements of Mr. Judge’s compensation are significantly higher than those of the SVPs due to the executive structure of the Company.

 

In addition to the above elements of compensation, Mr. Judge has a severance package, described in his employment agreement which expires November 30, 2010. No written or oral change of control or severance arrangements exist for our NEOs, except for this arrangement with Mr. Judge. For further detail refer to the Change of Control and Severance Arrangement information on page 39 of this Proxy Statement.

 

The committee set stock ownership guidelines for our CEO (two times his base salary) and SVPs (one times base salary). The ownership guidelines were established to provide an additional element of retention and to provide long-term alignment with stockholders’ interests. For the purposes of achieving the ownership guideline, unvested restricted stock awarded to the executive officers is included.

NEOs of the Company must also adhere to strict standards with regards to trading in the Company’s stock. They may not, among other things:

 

 

Our equity-based compensation agreements state that following termination of employment, certain benefits (including equity-based compensation) will be forfeited if the NEO engages in activities adverse to the Company. These activities include competition with the Company during a specified period after termination of employment, solicitation of the Company’s clients or employees during a specified period after termination of employment, breach of confidentiality either during or after employment, or engaging in conduct which is detrimental to the Company during the NEO’s employment with the Company. Should any of these activities occur, the Company may cancel all or any outstanding portion of the equity awards subject to this provision, and recover the gross value of any vested restricted shares, including all dividends. In the case of non-qualified stock options, the Company may suspend the NEO’s right to exercise the option and/or may declare the option forfeited. In addition, the Company may seek to recover all profits from certain prior exercises as liquidated damages and pursue other available legal remedies.

 

Our NEOs receive benefits in the form of vacation, medical, Company matching contributions to the 401(k) Plan when such contributions are in effect, and other benefits, which are generally available to all our employees. We do not provide our NEOs with pension arrangements, post-retirement health coverage, or other similar benefits, with the exception of access to a non-qualified and unfunded deferred compensation plan.

 

We offer a non-qualified and unfunded deferred compensation plan to our NEOs. The deferred compensation plan is intended to supplement the NEO’s 401(k) Plan account. Due to the limitations on the 401(k) Plan account provided by the Internal Revenue Service, this plan allows for further savings toward retirement for the NEOs and functions similarly to the 401(k) Plan account. Refer to the Non-Qualified Deferred Compensation discussion on page 41 of this Proxy Statement for more information on how our deferred compensation plan functions.

 

In July 2010, the following equity-based compensation was granted to the NEOs.

 

 

The award quantities granted were determined based on a total estimated value, split between stock options, time-vested restricted stock, and performance shares. A larger portion of the value of the equity was shifted to at-risk, performance-based awards in the form of performance shares and stock options. The balance of equity awards in the form of time-vested restricted stock was granted for retention purposes. The total estimated value for each NEO may have been adjusted for individual performance and retention considerations.

 

The stock options vest annually in 25% increments over four years. The time-vested restricted shares lapse ratably over three years. The number of performance shares to be received will be based on achievement against

targets over a two-year cumulative period. The performance targets are service revenue and operating income, net of certain items, as set by the Board. The NEO must be an employee of the Company at the end of a one-year period following the achievement of performance in order to receive the shares. During that one year, dividends shall accrue to be paid when the NEO receives the shares. As an incentive for long-term retention, in lieu of the above three types of equity awards, Mr. Morphy and Mr. Kuchta received time-vested restricted stock awards that vest ratably over 3 years.

 

In July 2010, the restrictions lapsed on one-sixth of the July 9, 2009 restricted stock award. This acceleration of lapsing was based on the achievement of the target for operating income, net of certain items. Actual operating income, net of certain items as adjusted based on Board discretion, was $685.5 million for fiscal 2010. The target for service revenue was not achieved. The targets for operating income, net of certain items, to accelerate the lapsing of the outstanding restricted stock awards granted in July 2008, 2007, and 2006 were not achieved, and therefore no lapse occurred.

 

On July 12, 2010, Paychex announced Mr. Judge’s resignation from his position as President and CEO effective July 31, 2010. Until his replacement is in place, the Board has established an executive committee comprised of Mr. Humenik, Mr. Morphy, and Mr. Mucci. Chairman of the Board, B. Thomas Golisano, and the Board will provide oversight for the executive committee.

 

In connection with his resignation, Mr. Judge signed a separation agreement. The following is a summary of terms and conditions of that agreement.

 

 

Section 162(m) of the Code generally limits the tax deductibility of annual compensation paid to certain officers to $1 million, unless specified requirements are met. The committee has carefully considered the impact of this provision as one factor among others in structuring NEO compensation. At this time, it is the committee’s intention to continue to compensate all NEOs based on overall performance. The committee expects that most compensation paid to NEOs will qualify as a tax-deductible expense. For fiscal 2010, our annual incentive program was designed to provide incentive compensation that would not count against the $1 million limitation, including the quantitative component of the NEOs’ annual performance incentive. However, within the NEOs’ annual incentive there is a portion of the payout which is qualitative and is not exempt from the application of Section 162(m). As a result of this qualitative component, $0.1 million of compensation expenses did not qualify as a tax-deductible expense during fiscal 2010.

 

The Governance and Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis included in the Proxy Statement with management. Based on such review and discussion, the committee recommends to the Board that the Compensation Discussion and Analysis be included in the Proxy Statement and the Company’s Form 10-K for fiscal 2010.

 

The Governance and Compensation Committee:

 

Joseph M. Tucci, Chairman
David J. S. Flaschen
Grant M. Inman
Joseph M. Velli

 

The table below presents the total compensation paid or earned by each of the NEOs.

 

																						Non-Equity
Name and Principal		Fiscal												Stock				Option				Incentive Plan				All Other
Position		Year				Salary				Bonus(1)				Awards(2)				Awards(3),(4)				Compensation(5)				Compensation(6)				Total
Jonathan J. Judge			2010			$	915,000			$	50,000			$	1,162,516			$	1,567,449			$	934,825			$	27,613			$	4,657,403
President and CEO			2009			$	915,000			$	—			$	1,461,393			$	1,340,675			$	320,250			$	30,221			$	4,067,539
			2008			$	908,606			$	—			$	1,463,696			$	1,765,500			$	1,055,388			$	39,652			$	5,232,842
John M. Morphy			2010			$	439,245			$	—			$	232,513			$	313,493			$	289,902			$	—			$	1,275,153
Senior Vice President,			2009			$	435,611			$	—			$	292,279			$	268,133			$	87,849			$	8,941			$	1,092,813
CFO, and Secretary			2008	(7)		$	411,498			$	—			$	1,610,048			$	353,100			$	296,851			$	8,712			$	2,680,209
Delbert M. Humenik			2010			$	275,385			$	—			$	224,976			$	274,439			$	225,000			$	18,648			$	1,018,448
Senior Vice President,
Sales and Marketing
Martin Mucci			2010			$	428,003			$	—			$	232,513			$	316,114			$	282,482			$	—			$	1,259,112
Senior Vice President,			2009			$	423,911			$	—			$	319,500			$	291,600			$	85,601			$	7,254			$	1,127,866
Operations			2008			$	398,300			$	—			$	292,748			$	353,100			$	286,550			$	8,359			$	1,339,057
William G. Kuchta			2010			$	305,513			$	—			$	116,256			$	156,757			$	135,902			$	—			$	714,428
Vice President,			2009			$	303,796			$	—			$	146,171			$	134,070			$	53,465			$	10,169			$	647,671
Organizational			2008			$	292,512			$	—			$	146,396			$	176,550			$	143,648			$	7,029			$	766,135
Development

 

 

 

 

 

 

The table below presents estimated possible payouts under the Company’s annual incentive program for fiscal 2010 based on achievement of performance objectives at various levels for the Company and individual NEOs. It also summarizes equity awards granted in fiscal 2010 to each of the NEOs. This information does not set forth the actual payout awarded to the NEOs for fiscal 2010.

 

 

 

 

 

No stock option exercises or restricted stock lapses occurred for the NEOs during fiscal 2010.

 

The following table presents the equity awards made to NEOs which are outstanding as of May 31, 2010.