Note E — Stock-Based Compensation Plans

The Paychex, Inc. 2002 Stock Incentive Plan, as amended and restated, effective on October 14, 2015 (the “2002 Plan”), authorizes grants of up to 44.1 million shares of the Company’s common stock. As of May 31, 2016, there were 22.2 million shares available for future grants under the 2002 Plan.

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

Stock-based compensation expense was $34.6 million, $31.4 million, and $26.3 million for fiscal years 2016, 2015, and 2014, respectively. Related income tax benefits recognized were $12.9 million, $11.7 million, and $10.1 million for the respective fiscal years. Capitalized stock-based compensation costs related to the development of internal use software for these same fiscal years were not significant.

As of May 31, 2016, the total unrecognized compensation cost related to all unvested stock-based awards was $60.8 million and is expected to be recognized over a weighted-average period of 2.9 years.

Black-Scholes fair value assumptions: The fair value of stock option grants and performance stock options was estimated at the date of grant using a Black-Scholes option pricing model. There were no performance stock options granted in fiscal 2016. The weighted-average assumptions used for valuation under the Black-Scholes model are as follows:



	Year ended May 31,
	2014			2016			2015			2014
	Performance stock options			Stock options
Risk-free interest rate		1.5	%		1.9	%		2.1	%		2.0	%
Dividend yield		3.9	%		3.6	%		3.7	%		4.1	%
Volatility factor		0.20			0.18			0.21			0.22
Expected option life in years		4.5			6.1			6.0			6.4
Weighted-average grant-date fair value of stock options granted (per share)	$	3.85		$	5.25		$	5.68		$	4.90

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

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

Stock options: Stock options entitle the holder to purchase, at the end of the vesting term, a specified number of shares of Paychex common stock at an exercise price per share set equal to the closing market price of the common stock on the date of grant. All stock options have a contractual life of ten years from the date of the grant and a vesting schedule as established by the Board. The Company issues new shares of common stock to satisfy stock option exercises. Non-qualified stock option grants to officers and outside directors are typically approved by the Board in July. Grants of non-qualified stock options to officers vest 25% per annum and grants to members of the Board vest after one year.

The following table summarizes stock option activity for the year ended May 31, 2016:



				Weighted-
		Weighted-		average
	Shares	average		remaining	Aggregate
	subject	exercise price		contractual	intrinsic
In millions, except per share amounts	to options	per share		term (years)	value(1)
Outstanding as of May 31, 2015	4.7	$	35.21
Granted	0.8	$	47.42
Exercised	(0.9)	$	34.77
Forfeited	(0.1)	$	38.46
Expired	—	$	35.89
Outstanding as of May 31, 2016	4.5	$	37.42	6.3	$	75.9
Exercisable as of May 31, 2016	2.6	$	33.84	4.9	$	53.1

(1)

Market price of the underlying stock as of May 31, 2016 less the exercise price.

Other information pertaining to stock option grants is as follows:



	Year ended May 31,
In millions, except per share amounts	2016		2015		2014
Total intrinsic value of stock options exercised	$	14.5	$	17.6	$	18.9
Total grant-date fair value of stock options vested	$	4.0	$	3.6	$	3.0

Performance stock options: In July 2011, the Board approved a special award of performance-based stock options under a Long-Term Incentive Plan. Subsequent grants of this award have been made upon hire of new officers. Under this award, stock options were granted to officers with vesting dependent on achievement against long-term strategic and financial objectives. Total shares earned and vested are based on achievement against pre-established targets for fiscal 2016. However, the terms of the award allowed for accelerated vesting of up to 50% of the award at target depending on achievement against pre-established targets for fiscal 2014. Based on achievement against pre-established targets for fiscal 2016, a total of 63.0% of the award was earned. In July 2014, 23.5% of the awards accelerated and vested based on achievement against performance targets for fiscal 2014. The remaining 39.5% of the awards will vest in July 2016.

The following table summarizes performance stock option activity for the year ended May 31, 2016:



				Weighted-
		Weighted-		average
	Shares	average		remaining	Aggregate
	subject	exercise price		contractual	intrinsic
In millions, except per share amounts	to options	per share		term (years)	value(1)
Outstanding as of May 31, 2015	2.7	$	31.31
Granted	—	$	—
Exercised	(0.1)	$	31.11
Forfeited	(0.1)	$	29.85
Expired	—	$	—
Outstanding as of May 31, 2016	2.5	$	31.36	5.4	$	57.9
Exercisable as of May 31, 2016	0.4	$	31.22	5.2	$	9.6

(1)

Market price of the underlying stock as of May 31, 2016 less the exercise price.

For fiscal 2016, the total intrinsic value of the performance stock options exercised was $1.0 million.

Restricted stock units: The Board grants restricted stock units (“RSUs”) to non-officer management. An RSU is an agreement to issue shares at the time of vesting with no associated exercise cost. For each unit granted, the holder will receive one share of stock at the time of vesting. RSUs do not have voting rights or earn dividend equivalents during the vesting period. These awards vest 20% per annum over five years. The fair value of RSUs is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the vesting period.

The following table summarizes RSU activity for the year ended May 31, 2016:



				Weighted-
		Weighted-		average
		average		remaining
		grant-date		vesting	Aggregate
		fair value		period	intrinsic
In millions, except per share amounts	RSUs	per share		(years)	value(1)
Nonvested as of May 31, 2015	1.8	$	33.57
Granted	0.7	$	42.60
Vested	(0.5)	$	31.34
Forfeited	(0.2)	$	35.97
Nonvested as of May 31, 2016	1.8	$	37.58	3.0	$	96.5

(1)

Intrinsic value for RSUs is the market price of the underlying stock as of May 31, 2016.

Other information pertaining to RSUs is as follows:



	Year ended May 31,
In millions, except per share amounts	2016		2015		2014
Weighted-average grant-date fair value of RSUs granted	$	42.60	$	36.64	$	36.37
Total intrinsic value of RSUs vested	$	25.9	$	21.7	$	18.3
Total grant-date fair value of RSUs vested	$	17.3	$	14.8	$	12.1

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

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

The following table summarizes restricted stock activity for the year ended May 31, 2016:



		Weighted-
		average
		grant-date
	Restricted	fair value
In millions, except per share amounts	shares	per share
Nonvested as of May 31, 2015	0.2	$	38.99
Granted	—	$	47.46
Vested	(0.1)	$	37.70
Forfeited	—	$	40.54
Nonvested as of May 31, 2016	0.1	$	43.99

Other information pertaining to restricted stock follows:



	Year ended May 31,
In millions, except per share amounts	2016		2015		2014
Weighted-average grant-date fair value of restricted stock granted	$	47.46	$	41.70	$	38.53
Total grant-date fair value of restricted stock vested	$	3.0	$	3.5	$	3.3

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

The following table summarizes performance share activity for the year ended May 31, 2016:



		Weighted-
		average
		grant-date
	Performance	fair value
In millions, except per share amounts	shares	per share
Nonvested as of May 31, 2015	0.6	$	34.24
Granted (1)	0.1	$	42.48
Vested	(0.2)	$	29.10
Forfeited	—	$	37.09
Nonvested as of May 31, 2016	0.5	$	38.89

(1)

Performance shares granted assuming achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

Non-compensatory employee benefit plan: Prior to January 1, 2016, the Company offered a non-qualified
Employee Stock Purchase Plan (“ESPP”) to all employees under which the Company’s common stock could be purchased through a payroll deduction with no discount to the market price and no look-back provision. This ESPP was discontinued as of December 31, 2015. Effective January 1, 2016, the Company began offering a qualified ESPP to all employees. Under this new ESPP, the Company’s common stock can be purchased through a payroll deduction at a discount to the market price. The Plan allows for a discount of up to 15% based on the sole discretion of the committee established to administer the plan. For offering periods during fiscal 2016 the discount was set at 5% of the market price. Transactions under the non-qualified ESPP occurred directly through the Company’s transfer agent and no brokerage fees were charged to employees, except for when stock was sold. Transactions under the qualified ESPP occur through the Company’s third party stock plan administrator. The plans have been deemed non-compensatory and therefore, no stock-based compensation costs have been recognized for fiscal years 2016, 2015, or 2014 related to either plan.