Part I. FINANCIAL INFORMATION

Item 1. Financial Statements.

 

Automatic Data Processing, Inc. and Subsidiaries

Statements of Consolidated Earnings

(In millions, except per share amounts)

(Unaudited)

 

 

(A) Professional Employer Organization (“PEO”) revenues are net of direct pass-through costs, primarily consisting of payroll wages and payroll taxes, of $3,359.8 and $3,043.9 for the three months ended March 31, 2009 and 2008, respectively, and $9,441.8 and $8,413.0 for the nine months ended March 31, 2009 and 2008, respectively.

 

 

Automatic Data Processing, Inc. and Subsidiaries

Consolidated Balance Sheets

(In millions, except per share amounts)

(Unaudited)

 

 

See notes to the consolidated financial statements.

 

Automatic Data Processing, Inc. and Subsidiaries

Statements of Consolidated Cash Flows

(In millions)

(Unaudited)

 

 

See notes to the consolidated financial statements.

 

 

Automatic Data Processing, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

(Tabular dollars in millions, except per share amounts)

(Unaudited)

 

Note 1. Basis of Presentation

 

The accompanying unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods. Adjustments are of a normal recurring nature. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes of Automatic Data Processing, Inc. and subsidiaries (“ADP” or the “Company”) as of and for the year ended June 30, 2008 (“fiscal 2008”). The results of operations for the three and nine months ended March 31, 2009 may not be indicative of the results to be expected for the fiscal year ending June 30, 2009 (“fiscal 2009”).

 

Note 2. New Accounting Pronouncements

 

In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides additional guidance for determining the fair value of assets and liabilities when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate an observed transaction used to determine fair value is not orderly and, therefore, is not indicative of fair value. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009. The Company does not anticipate the adoption of this FSP will have a material impact on its results of operations, cash flows or financial condition.

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”). FSP FAS 115-2 and FAS 124-2 changes the method for determining whether an other-than-temporary impairment exists for debt securities by requiring a company to assess whether it is probable that it will not be able to recover the cost basis of a security utilizing several factors, including the length of time and the extent to which fair value has been less than the cost basis, adverse conditions related to a particular security and volatility of a particular security. FSP FAS 115-2 and FAS 124-2 also requires that an other-than-temporary impairment charge for debt securities be recorded in earnings if it is more-likely-than-not that the entity will sell or be required to sell a security before anticipated recovery of the cost basis. In addition, if any portion of a decline in fair value below the cost basis of a security is related to credit losses, such amount should be recorded in earnings. Lastly, FSP FAS 115-2 and FAS 124-2 expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities to all interim and annual periods. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009. The Company is currently evaluating the impact that the adoption of FSP FAS 115-2 and FAS 124-2 will have on its results of operations, cash flows or financial condition.

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 increases the frequency of certain fair value disclosures from annual to quarterly. Such disclosures include the fair value of all financial instruments within the scope of Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures about Fair Value of Financial Instruments,” as well as the methods and significant assumptions used to estimate fair value. FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009. The Company does not anticipate the adoption of this FSP will have a material impact on its results of operations, cash flows or financial condition.

 

In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP FAS 132(R)-1 requires additional disclosures in relation to plan assets of defined benefit pension or other postretirement plans. FSP FAS 132(R)-1 is effective for fiscal years ending after December 15, 2009 with early application permitted. The Company does not anticipate the adoption of this FSP will have a material impact on its results of operations, cash flows or financial condition.

 

In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Upon adoption, companies are required to retrospectively adjust earnings per share data (including any amounts related to interim periods, summaries of earnings and selected financial data) to conform to provisions of FSP EITF 03-6-1. The Company determined the adoption of FSP EITF 03-6-1 will not have a material impact on its results of operations or financial condition.

 

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company is currently evaluating the impact that the adoption of FSP FAS 142-3 will have on its results of operations, cash flows or financial condition.

 

In December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any controlling interest in the business and the goodwill acquired. SFAS No. 141R further requires that acquisition-related costs and costs associated with restructuring or exiting activities of an acquired entity will be expensed as incurred. SFAS No. 141R also establishes disclosure requirements that will require disclosure on the nature and financial effects of the business combination. Additionally, in April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP FAS 141(R)-1”). FSP FAS 141(R)-1 amends and clarifies SFAS No. 141R to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. SFAS No. 141R and FSP FAS 141(R)-1 will impact business combinations that may be completed by the Company on or after July 1, 2009. The Company cannot anticipate whether the adoption of SFAS No. 141R and FSP FAS 141(R)-1 will have a material impact on its results of operations and financial condition as the impact depends solely on whether the Company completes any business combinations after July 1, 2009 and the terms of such transactions.

 

In March 2007, the FASB ratified EITF Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF 06-11”). EITF 06-11 requires companies to recognize, as an increase to additional paid-in capital, the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for non-vested equity-classified employee share-based payment awards. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. On July 1, 2008, the Company adopted EITF 06-11 and the adoption did not have a material impact on its results of operations, cash flows or financial condition.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. This statement provides companies with an option to measure selected financial assets and liabilities at fair value. On July 1, 2008, the Company adopted SFAS No. 159 and elected not to apply the fair value option to any financial instruments that were not already recognized at fair value. As such, the adoption of SFAS No. 159 did not have an impact on the Company’s results of operations, cash flows or financial condition.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, except for non-financial assets and liabilities recognized or disclosed at fair value on a non-recurring basis, for which the effective date is fiscal years beginning after November 15, 2008. On July 1, 2008, the Company adopted SFAS No. 157 for assets and liabilities recognized or disclosed at fair value on a recurring basis. The adoption of SFAS No. 157 did not have an impact on the Company’s consolidated results of operations, cash flows or financial condition (see Note 8). The Company will adopt SFAS No. 157 for non-financial assets that are recognized or disclosed on a non-recurring basis on July 1, 2009 and the Company is currently evaluating the impact, if any, on the Company’s results of operations, cash flows or financial condition.

 

Note 3. Earnings per Share (“EPS”)

 

 

Options to purchase 35.9 million and 24.3 million shares of common stock for the three months ended March 31, 2009 and 2008, respectively, and 29.6 million and 12.8 million shares of common stock for the nine months ended March 31, 2009 and 2008, respectively, were excluded from the calculation of diluted earnings per share because their exercise prices exceeded the average market price of outstanding common shares for the respective period.

 

Note 4. Other Expense (Income), net

 

 

 

Proceeds from sales and maturities of available-for-sale securities were $2,251.7 million and $3,455.7 million for the nine months ended March 31, 2009 and 2008, respectively.

 

On March 30, 2007, the Company completed the tax-free spin-off of its former Brokerage Services Group business, comprised of Brokerage Services and Securities Clearing and Outsourcing Services, into an independent publicly traded company called Broadridge Financial Solutions, Inc. (“Broadridge”). The Company has an outsourcing agreement with Broadridge pursuant to which the Company will continue to provide data center outsourcing, principally information technology services and service delivery network services, to Broadridge in the same capacity post-spin as had been provided pre-spin. As a result of the outsourcing agreement, the Company recognized income of $26.0 million and $27.0 million for the three months ended March 31, 2009 and 2008, respectively, which is offset by expenses directly associated with providing such services of $25.5 million and $26.5 million, respectively, both of which were recorded in other expense (income), net, on the Statements of Consolidated Earnings. The Company recognized income of $77.8 million and $79.8 million for the nine months ended March 31, 2009 and 2008, respectively, which is offset by expenses directly associated with providing such services of $76.1 million and $78.1 million, respectively, both of which were recorded in other expense (income), net, on the Statements of Consolidated Earnings. The Company had a receivable on the Consolidated Balance Sheets from Broadridge for the services under this agreement of $8.7 million and $9.7 million as of March 31, 2009 and June 30, 2008, respectively.

 

In December 2008, the Company sold a building and, as a result, recorded a gain of $2.2 million in other expense (income), net, on the Statements of Consolidated Earnings. Such building was previously reported in assets held for sale on the Consolidated Balance Sheets.

 

During the three and nine months ended March 31, 2009, the Company recorded a $15.0 million and $18.3 million loss, respectively, to other expense (income), net on the Statements of Consolidated Earnings related to the Primary Fund of the Reserve Fund (the “Reserve Fund”). Refer to Note 7 for additional information related to the Reserve Fund.

 

Note 5. Acquisitions

 

The Company acquired one business during the nine months ended March 31, 2009 for approximately $28.1 million, which includes $8.9 million in accrued contingent payments expected to be paid in future periods and which is net of cash acquired. This acquisition resulted in approximately $26.6 million of goodwill. Intangible assets acquired, which totaled approximately $8.5 million, consisted primarily of customer contracts and lists and software that are being amortized over a weighted average life of approximately 9 years. The acquisition was not material to the Company’s results of operations, financial position or cash flows.

 

The Company made $7.2 million of contingent payments relating to previously consummated acquisitions during the nine months ended March 31, 2009.

 

Note 6. Divestitures

 

On June 30, 2007, the Company entered into a definitive agreement to sell its Travel Clearing business for approximately $116.0 million in cash. The Company completed the sale of its Travel Clearing business on July 6, 2007. The Travel Clearing business was previously reported in the “Other” segment. In connection with the disposal of this business, the Company has classified the results of this business as discontinued operations for all periods presented. During the three and nine months ended March 31, 2008, the Company reported a gain of $7.2 million, or $4.9 million after taxes, and $95.7 million, or $62.1 million after taxes, respectively, within earnings (loss) from discontinued operations on the Statements of Consolidated Earnings.

 

On January 23, 2007, the Company completed the sale of Sandy Corporation, a business within the Dealer Services segment, which specializes in sales and marketing training, for approximately $4.0 million in cash and the assumption of certain liabilities by the buyer, plus an additional earn-out payment if certain revenue targets are achieved. The Company has classified the results of this business as discontinued operations for all periods presented. In March 2008, the Company received a payment of $2.5 million, which represented a purchase price adjustment for the sale of Sandy Corporation. As a result, the Company recorded an additional gain of $2.5 million, or $1.6 million, net of tax, within earnings from discontinued operations during the three and nine months ended March 31, 2008. During the three and nine months ended March 31, 2008, the Company also recorded a net gain of $3.5 million and $2.8 million, net of tax, respectively, within earnings (loss) from discontinued operations related to a change in estimated taxes on the divestiture of businesses, partially offset by professional fees incurred in connection with the divestitures of businesses.

 

During the nine months ended March 31, 2009, the Company recorded charges of $1.0 million within earnings from discontinued operations on the Statements of Consolidated Earnings related to a change in estimated taxes on the divestitures of businesses.

 

There were no assets or liabilities of discontinued operations as of March 31, 2009 or June 30, 2008.

 

Note 7. Corporate Investments and Funds Held for Clients

 

Corporate investments and funds held for clients at March 31, 2009 and June 30, 2008 are as follows:

 

 

 

  

 

At March 31, 2009, U.S. Treasury and direct obligations of U.S. government agencies primarily include debt directly issued by Federal Home Loan Banks, Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) with fair values of $2,145.4 million, $1,472.3 million and $1,467.5 million, respectively. At June 30, 2008, U.S. Treasury and direct obligations of U.S. government agencies primarily include debt directly issued by Federal Home Loan Banks, Fannie Mae and Freddie Mac with fair values of $2,344.7 million, $1,471.3 million and $1,611.2 million, respectively. U.S. Treasury and direct obligations of U.S. government agencies represent senior, unsecured, non-callable debt that carries a credit rating of AAA and has maturities ranging from April 2009 through February 2019.

 

At March 31, 2009, asset-backed securities include senior tranches of securities with predominately prime collateral of fixed rate credit card, rate reduction, auto loan, student loan and equipment lease receivables with fair values of $803.7 million, $394.3 million, $280.7 million, $52.4 million and $44.3 million, respectively. At June 30, 2008, asset-backed securities include senior tranches of securities with predominately prime collateral of fixed rate credit card, rate reduction, auto loan, student loan and equipment lease receivables with fair values of $954.8 million, $448.1 million, $315.9 million, $55.3 million and $62.4 million, respectively. These securities are collateralized by the cash flows of the underlying pool of receivables. The primary risk associated with these securities is the collection risk of the underlying receivables. All collateral on such asset-backed securities has performed as expected through March 31, 2009.

 

At March 31, 2009, other securities and their fair value primarily represent AAA rated commercial mortgage-backed securities of $732.3 million, municipal bonds of $461.3 million, AAA rated mortgage-backed securities of $197.1 million that are guaranteed by Fannie Mae and Freddie Mac, Canadian provincial bonds of $158.3 million, corporate bonds backed by the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program of $148.4 million and supranational bonds of $80.4 million. At June 30, 2008, other securities and their fair value primarily represent AAA rated commercial mortgage-backed securities of $737.3 million, municipal bonds of $423.5 million, AAA rated mortgage-backed securities of $186.7 million that are guaranteed by Fannie Mae and Freddie Mac, Canadian provincial bonds of $153.0 million and supranational bonds of $57.1 million. The Company’s AAA rated mortgage-backed securities represent an undivided beneficial ownership interest in a group or pool of one or more residential mortgages. These securities are collateralized by the cash flows of 15-year and 30-year residential mortgages and are guaranteed by Fannie Mae and Freddie Mac as to the timely payment of principal and interest.

 

Classification of corporate investments on the Consolidated Balance Sheets is as follows:

 

 

 

Funds held for clients represent assets that, based upon the Company’s intent, are restricted for use solely for the purposes of satisfying the obligations to remit funds relating to our payroll and payroll tax filing services, which are classified as client funds obligations on our Consolidated Balance Sheets. Funds held for clients have been invested in the following categories:

 

 

 

Client funds obligations represent the Company’s contractual obligations to remit funds to satisfy clients’ payroll and tax payment obligations and are recorded on the Consolidated Balance Sheets at the time that the Company impounds funds from clients. The client funds obligations represent liabilities that will be repaid within one year of the balance sheet date. The Company has reported client funds obligations as a current liability on the Consolidated Balance Sheets totaling $21,007.4 million and $15,294.7 million as of March 31, 2009 and June 30, 2008, respectively. The Company has classified funds held for clients as a current asset since these funds are held solely for the purposes of satisfying the client funds obligations.

 

The Company has reported the cash flows related to the purchases of corporate and client funds marketable securities and related to the proceeds from the sales and maturities of corporate and client funds marketable securities on a gross basis in the investing section of the Statements of Consolidated Cash Flows. The Company has reported the cash inflows and outflows related to client funds investments with original maturities of 90 days or less on a net basis within “net increase in restricted cash and cash equivalents and other restricted assets held to satisfy client funds obligations” in the investing section of the Statements of Consolidated Cash Flows. The Company has reported the cash flows related to the cash received from and paid on behalf of clients on a net basis within “net increase in client funds obligations” in the financing section of the Statements of Consolidated Cash Flows.

 

At March 31, 2009, approximately 82% of the available-for-sale securities held an AAA or AA rating, as rated by Moody’s, Standard & Poor’s and, for Canadian securities, Dominion Bond Rating Service. All available-for-sale securities were rated as investment grade at March 31, 2009 with the exception of the Reserve Fund investment discussed below.

 

Expected maturities of available-for-sale securities at March 31, 2009 are as follows:

 

 

 

 

The Company has an investment in a money market fund called the Reserve Fund. During the quarter ended September 30, 2008, the net asset value of the Reserve Fund decreased below $1 per share as a result of the full write-off of the Reserve Fund’s holdings in debt securities issued by Lehman Brothers Holdings, Inc., which filed for bankruptcy protection on September 15, 2008. The Reserve Fund has suspended redemptions and is in the process of being liquidated. At September 30, 2008, the Company reclassified $211.1 million of its investment from cash and cash equivalents to short-term marketable securities on the Consolidated Balance Sheet due to the fact that these assets no longer met the definition of a cash equivalent. Additionally, the Company reflected the impact of such reclassification on the Statements of Consolidated Cash Flows for the nine months ended March 31, 2009 as reclassification from cash equivalents to short-term marketable securities.

 

On February 26, 2009, the Board of Trustees of the Reserve Fund announced their decision to initially set aside $3.5 billion in a special reserve under the plan of liquidation to cover potential liabilities for damages and associated expenses related to lawsuits and regulatory actions against the fund. The special reserve may be increased or decreased as further information becomes available. Amounts in the special reserve will be distributed to shareholders once claims, if any are successful, and the related expenses have been paid or set aside for payment.

 

During the three and nine months ended March 31, 2009, the Company recorded a $15.0 million and $18.3 million loss to other expense (income), net, respectively, on the Statement of Consolidated Earnings to recognize our pro-rata share of the estimated losses of the fund. The $15.0 million loss recorded during the three months ended March 31, 2009 was recorded as a result of the Reserve Fund’s announcement and the likelihood that the Company will not receive distributions for its pro-rata share of the amount that the Reserve Fund set aside in the special reserve. As the Reserve Fund may increase or decrease this special reserve as further information becomes available, the total amount of distributions the Company will ultimately receive may increase or decrease.

 

As of March 31, 2009, the Company received approximately $188.6 million in distributions from the Reserve Fund. On April 17, 2009, the Company received an additional $9.9 million in distributions from the Reserve Fund. Subsequent to the distributions received from the Reserve Fund and the charges recorded during the three and nine months ended March 31, 2009, the Company has a remaining balance of $3.9 million in short-term marketable securities related to the Reserve Fund.

 

The Company evaluates unrealized losses on available-for-sale securities for other-than-temporary impairment based upon whether the unrealized losses were interest rate related or credit related, and based upon the length of time and the extent to which the fair value for each individual security has been below cost. During the three months ended March 31, 2009, the Company recorded $17.4 million in other-than-temporary losses for securities held at March 31, 2009, including $15.0 million of losses related to the Reserve Fund. During the nine months ended March 31, 2009, the Company recorded $20.7 million of other-than-temporary losses for securities held at March 31, 2009, including $18.3 million of losses related to the Reserve Fund. As of March 31, 2009, with the exception of such realized losses recorded during the three and nine months ended March 31, 2009, the Company determined that none of the unrealized losses were other-than-temporary.

 

Note 8. Fair Value Measurements

 

On July 1, 2008, the Company adopted SFAS No. 157 for assets and liabilities recognized or disclosed at fair value on a recurring basis. SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. SFAS No. 157 establishes market or observable inputs as the preferred source of fair value, followed by assumptions based on hypothetical transactions in the absence of market inputs.

The valuation techniques required by SFAS No. 157 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following three-level hierarchy to prioritize the inputs used in measuring fair value. The levels within the hierarchy are described below with Level 1 having the highest priority and Level 3 having the lowest priority.

Available-for-sale securities included in Level 1 are valued using closing prices for identical instruments that are traded on active exchanges. Available-for-sale securities included in Level 2 are valued utilizing inputs obtained from an independent pricing service. To determine the fair value of our Level 2 investments, a variety of inputs are utilized, including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, new issue data, and monthly payment information. Over 99% of our Level 2 investments are valued utilizing inputs obtained from a pricing service. The Company reviews the values generated by the independent pricing service for reasonableness by comparing the valuations received from the independent pricing service to valuations from at least one other observable source. The Company has not adjusted the prices obtained from the independent pricing service. The Company has no available-for-sale securities included in Level 3.

The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the classification of assets and liabilities within the fair value hierarchy. In certain instances, the inputs used to measure fair value may meet the definition of more than one level of the fair value hierarchy. The significant input with the lowest level priority is used to determine the applicable level in the fair value hierarchy.

The following table presents the Company’s assets measured at fair value on a recurring basis at March 31, 2009. Included in the table are available-for-sale securities within corporate investments of $110.2 million and funds held for clients of $14,928.3 million. Refer to Note 7 for additional disclosure in relation to corporate investments and funds held for clients.

 

 

 

Note 9. Allowance for Doubtful Accounts

 

Accounts receivable is net of an allowance for doubtful accounts of $46.8 million and $38.4 million at March 31, 2009 and June 30, 2008, respectively.

 

Note 10. Assets Held for Sale

 

During the nine months ended March 31, 2009, the Company reclassified assets related to three buildings as assets held for sale on the Consolidated Balance Sheets. Such assets were previously reported in property, plant and equipment, net on the Consolidated Balance Sheets.

 

In December 2008, the Company sold one of the buildings and realized a gain of $2.2 million in other expense (income), net. The Company intends to complete the sale of the remaining two buildings by the end of calendar year 2009.

 

At March 31, 2009, the Company had $12.1 million classified as assets held for sale on the Consolidated Balance Sheets.

 

Note 11. Goodwill and Intangible Assets, net

 

Changes in goodwill for the nine months ended March 31, 2009 are as follows:

 

 

 

 

 

 

 

Other intangibles consist primarily of purchased rights, covenants, patents and trademarks (acquired directly or through acquisitions). All of the intangible assets have finite lives and, as such, are subject to amortization. The weighted average remaining useful life of the intangible assets is 7 years (3 years for software and software licenses, 9 years for customer contracts and lists, and 8 years for other intangibles). Amortization of intangible assets totaled $36.5 million and $32.2 million for the three months ended March 31, 2009 and 2008, respectively and totaled $107.2 million and $99.5 million for the nine months ended March 31, 2009 and 2008, respectively. Estimated future amortization expense of the Company’s existing intangible assets is as follows:

 

 

 

 

 

The Company has a $2.25 billion credit facility, a $1.5 billion credit facility and a $2.25 billion credit facility that mature in June 2009, June 2010 and June 2011, respectively. The credit facilities maturing in June 2010 and June 2011 are five-year facilities that contain accordion features under which the aggregate commitments can each be increased by $500.0 million, subject to the availability of additional commitments. The interest rate applicable to the borrowings is tied to LIBOR or prime rate depending on the notification provided by the Company to the syndicated financial institutions prior to borrowing. The Company is also required to pay facility fees on the credit agreements. The primary uses of the credit facilities are to provide liquidity to the commercial paper program and to provide funding for general corporate purposes, if necessary. The Company had no borrowings through March 31, 2009 under the credit agreements.

 

The Company maintains a U.S. short-term commercial paper program providing for the issuance of up to $6.0 billion in aggregate maturity value of commercial paper. The Company’s commercial paper program is rated A-1+ by Standard and Poor’s and Prime-1 by Moody’s. These ratings denote the highest quality commercial paper securities. Maturities of commercial paper can range from overnight to up to 364 days. At March 31, 2009 and June 30, 2008, there was no commercial paper outstanding. For the three months ended March 31, 2009 and 2008, the Company’s average borrowings were $1.1 billion and $0.5 billion, respectively, at a weighted average interest rate of 0.2% and 3.6%, respectively. For the nine months ended March 31, 2009 and 2008, the Company’s average borrowings were $2.0 billion and $1.5 billion, respectively at a weighted average interest rate of 1.2% and 4.7%, respectively. The weighted average maturity of the Company’s commercial paper during the three and nine months ended March 31, 2009 and 2008 was less than two days.

 

The Company’s U.S. and Canadian short-term funding requirements related to client funds obligations are sometimes obtained on a secured basis through the use of reverse repurchase agreements, which are collateralized principally by government and government agency securities. These agreements generally have terms ranging from overnight to up to five business days. At March 31, 2009, the Company had no obligation outstanding related to reverse repurchase agreements. At June 30, 2008, the Company had an $11.8 million obligation outstanding related to a reverse repurchase agreement that matured on July 2, 2008 and was repaid. For the three months ended March 31, 2009 and 2008, the Company had average outstanding balances under reverse repurchase agreements of $70.1 million and $169.8 million, respectively, at a weighted average interest rate of 0.8% and 3.8%, respectively. For the nine months ended March 31, 2009 and 2008, the Company had average outstanding balances under reverse repurchase agreements of $411.5 million and $266.5 million, respectively, at a weighted average interest rate of 1.7% and 4.3%, respectively.

 

Note 13. Employee Benefit Plans

 

A. Stock Plans. The Company accounts for stock-based compensation in accordance with SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”), which requires the measurement of stock-based compensation expense to be recognized in net earnings based on the fair value of the award on the date of grant. Stock-based compensation consists of the following:

 

 

 

 

 

 

The Company currently utilizes treasury stock to satisfy stock option exercises, issuances under the Company’s employee stock purchase plan and restricted stock awards. Stock-based compensation expense of $22.9 million and $31.4 million was recognized in earnings from continuing operations for the three months ended March 31, 2009 and 2008, respectively, as well as related tax benefits of $7.1 million and $9.2 million, respectively. Stock-based compensation expense of $85.5 million and $94.8 million was recognized in earnings from continuing operations for the nine months ended March 31, 2009 and 2008, respectively, as well as related tax benefits of $25.0 million and $28.3 million, respectively.

 

 

 

As of March 31, 2009, the total remaining unrecognized compensation cost related to non-vested stock options, the employee stock purchase plan and restricted stock awards amounted to $30.4 million, $11.4 million and $72.9 million, respectively, which will be amortized over the weighted-average remaining requisite service periods of 1.8 years, 0.8 years and 2.2 years, respectively.

 

During the nine months ended March 31, 2009, the following activity occurred under our existing plans:

 

 

 

 

 

The fair value of each stock option issued prior to January 1, 2005 was estimated on the date of grant using a Black-Scholes option pricing model. For stock options issued on or after January 1, 2005, the fair value of each stock option was estimated on the date of grant using a binomial option pricing model. The binomial model considers a range of assumptions related to volatility, risk-free interest rate and employee exercise behavior. Expected volatilities utilized in the binomial model are based on a combination of implied market volatilities, historical volatility of the Company’s stock price and other factors. Similarly, the dividend yield is based on historical experience and expected future changes. The risk-free rate is derived from the U.S. Treasury yield curve in effect at the time of grant. The binomial model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. The expected life of the stock option grants is derived from the output of the binomial model and represents the period of time that options granted are expected to be outstanding.

 

The fair value for stock options granted was estimated at the date of grant with the following assumptions:

 

 

 

 

B. Pension Plans.

 

The components of net pension expense were as follows:

 

 

 

During the nine months ended March 31, 2009, the Company made $4.6 million in contributions to the pension plans and expects to contribute an additional $1.3 million during the fiscal year ending June 30, 2009.

 

Note 14. Income Taxes

 

As of March 31, 2009, the Company’s liabilities for unrecognized tax benefits, which include interest and penalties, were $418.8 million. The amount that, if recognized, would impact the effective tax rate is $184.3 million. The remainder, if recognized, would principally affect deferred taxes.

 

Interest expense and penalties associated with uncertain tax positions have been recorded in the provision for income taxes on the Statements of Consolidated Earnings. During the three months ended March 31, 2009 and 2008, the Company recorded interest expense of $3.7 million and $4.9 million, respectively, and during the nine months ended March 31, 2009 and 2008, the Company recorded interest expense of $13.1 million and $15.9 million, respectively. At March 31, 2009, the Company had accrued interest of $132.1 million recorded on the Consolidated Balance Sheets, of which $59.9 million was recorded within income taxes payable, and the remainder was recorded within other liabilities. At June 30, 2008, the Company had accrued interest of $117.6 million recorded on the Consolidated Balance Sheets, of which $53.5 million was recorded within income taxes payable, and the remainder was recorded within other liabilities. At March 31, 2009 and June 30, 2008, the Company had accrued penalties of $26.6 million and $26.9 million, respectively, of which $26.3 million and $23.8 million, respectively, was recorded within income taxes payable, and the remainder was recorded within other liabilities on the Consolidated Balance Sheets.

 

The Company is routinely examined by the Internal Revenue Service (“IRS”) and tax authorities in foreign countries in which it conducts business, as well as tax authorities in states in which it has significant business operations, such as California, Illinois, Minnesota, New York and New Jersey. The tax years under examination vary by jurisdiction. Such examinations are as follows:

 

 

 

Additionally, the Company has been notified by the Province of Alberta that they will examine the 2007 tax return in the fiscal year ending June 30, 2009, and Canada has notified the Company that it will begin a joint audit with the Province of Ontario for the fiscal years ended June 30, 2005 through June 30, 2007 in the fiscal year ending June 30, 2009.

 

In April 2009, the Company received a favorable ruling in the settlement of a state tax matter, for which the Company had previously recorded a liability for unrecognized tax benefits of $22.0 million and a related deferred tax asset of $7.8 million. We expect to record a reduction in the provision for income taxes of approximately $7 million during the fourth quarter of fiscal 2009 related to the liability for unrecognized tax benefits. In addition, the Company expects to receive a tax refund or tax credit of approximately $5 million related to the same matter, which is expected to further reduce the provision for income taxes during the fourth quarter of fiscal 2009.

 

The Company regularly considers the likelihood of assessments resulting from examinations in each of the jurisdictions. The resolution of tax matters is not expected to have a material effect on the consolidated financial condition of the Company, although a resolution could have a material impact on the Company’s Statements of Consolidated Earnings for a particular future period and on the Company’s effective tax rate.

If certain pending tax matters settle within the next twelve months, the total amount of unrecognized tax benefits may increase or decrease for all open tax years and jurisdictions. Based on current estimates, settlements related to various jurisdictions and tax periods could increase earnings up to $110 million and expected net cash payments could be up to $110 million. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. We continually assess the likelihood and amount of potential adjustments and adjust the income tax provision, the current tax liability and deferred taxes in the period in which the facts that give rise to a revision become known.

 

Note 15. Commitments and Contingencies

 

The Company is subject to various claims and litigation in the normal course of business. The Company does not believe that the resolution of these matters will have a material impact on the consolidated financial statements.

 

It is not the Company’s business practice to enter into off-balance sheet arrangements. However, the Company is exposed to market risk from changes in foreign currency exchange rates that could impact its financial position, results of operations and cash flows. The Company manages its exposure to these market risks through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company uses derivative financial instruments as risk management tools and not for trading purposes. The Company had no derivative financial instruments outstanding at March 31, 2009 or June 30, 2008. In the normal course of business, the Company also enters into contracts in which it makes representations and warranties that relate to the performance of the Company’s services and products. The Company does not expect any material losses related to such representations and warranties.

 

Note 16. Comprehensive Income

 

 

 

Note 17. Interim Financial Data by Segment

 

The Company’s strategic business units are aggregated into the following three reportable segments: Employer Services, PEO Services and Dealer Services. The primary components of “Other” are financing transactions related to the sale of computer systems, corporate allocations and certain expenses that have not been charged to the reportable segments, including stock-based compensation expense. Certain revenues and expenses are charged to the reportable segments at a standard rate for management reasons. Other costs are recorded based on management responsibility. The prior year reportable segments’ revenues and earnings from continuing operations before income taxes have been adjusted to reflect updated budgeted foreign exchange rates for the fiscal year ending June 30, 2009. In addition, there is a reconciling item for the difference between actual interest income earned on invested funds held for clients and interest credited to Employer Services and PEO Services at a standard rate of 4.5%. The reportable segments’ results also include an internal cost of capital charge related to the funding of acquisitions and other investments. All of these adjustments/charges are reconciling items to the Company’s reportable segments’ revenues and/or earnings from continuing operations before income taxes and results in the elimination of these adjustments/charges in consolidation.

 

Segment Results:

 

 

 

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

(Tabular dollars are presented in millions, except per share amounts)

 

FORWARD-LOOKING STATEMENTS

 

This report and other written or oral statements made from time to time by ADP may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements include: ADP’s success in obtaining, retaining and selling additional services to clients; the pricing of products and services; changes in laws regulating payroll taxes, professional employer organizations and employee benefits; overall market and economic conditions, including interest rate and foreign currency trends; competitive conditions; auto sales and related industry changes; employment and wage levels; changes in technology; availability of skilled technical associates and the impact of new acquisitions and divestitures. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. These risks and uncertainties, along with the risk factors discussed under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008 and under “Item 1A. Risk Factors” in our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2008, should be considered in evaluating any forward-looking statements contained herein.

 

CRITICAL ACCOUNTING POLICIES

 

Our consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect reported amounts of assets, liabilities, revenues and expenses. We continually evaluate the accounting policies and estimates used to prepare the consolidated financial statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are discussed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008 in the Critical Accounting Policies section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

RESULTS OF OPERATIONS

 

Analysis of Consolidated Operations

 

 

 

 

 

Total Revenues

 

Our consolidated revenues for the three months ended March 31, 2009 declined $52.5 million, or 2%, to $2,374.7 million due to fluctuations in forei