UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
---------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From to
Commission File Number 0-14278
----------------------
Automatic Data Processing, Inc.
(Exact name of registrant as specified in its charter)
------------------------
Delaware 22-1467904
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One ADP Boulevard, Roseland, New Jersey 07068
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (973) 974-5000
--------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock as of
April 28, 2005 was 583,343,711.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Automatic Data Processing, Inc. and Subsidiaries
Consolidated Statements of Earnings
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ ---------------------
REVENUES: 2005 2004 2005 2004
---- ---- ---- ----
Revenues, other than interest
on funds held for Employer
Services clients and PEO
revenues $2,060,301 $1,894,672 $5,473,928 $5,063,394
Interest on funds held for
Employer Services clients 124,425 96,531 300,217 261,667
PEO revenues (A) 164,237 130,232 423,084 344,051
---------- ---------- ---------- ----------
TOTAL REVENUES 2,348,963 2,121,435 6,197,229 5,669,112
---------- ---------- ---------- ----------
EXPENSES:
Operating expenses 1,068,073 944,373 2,850,812 2,548,914
Selling, general, and
administrative expenses 512,886 487,410 1,424,407 1,373,581
Systems development and
programming costs 154,362 144,824 453,156 409,703
Depreciation and amortization 77,757 77,185 228,339 225,520
Other income, net (2,065) (11,997) (25,995) (44,656)
---------- ---------- ---------- ---------
TOTAL EXPENSES 1,811,013 1,641,795 4,930,719 4,513,062
---------- ---------- ---------- ----------
EARNINGS BEFORE INCOME TAXES 537,950 479,640 1,266,510 1,156,050
Provision for income taxes 199,579 179,390 469,875 432,370
---------- ---------- ---------- ---------
NET EARNINGS $ 338,371 $ 300,250 $ 796,635 $ 723,680
========== ========== ========== =========
BASIC EARNINGS PER SHARE $ 0.58 $ 0.51 $ 1.37 $ 1.22
========== ========== =====================
DILUTED EARNINGS PER SHARE $ 0.57 $ 0.50 $ 1.35 $ 1.21
========== ========== =====================
Basic weighted average
shares outstanding 583,991 591,210 583,578 592,575
========== ========== ========== ==========
Diluted weighted average
shares outstanding 590,512 599,479 590,503 599,127
========== ========== ========== ==========
Dividends per common share $ 0.1550 $ 0.1400 $ 0.4500 $ 0.4000
========== ========== ========== ==========
(A) Net of pass-through costs of $1,531,884 and $1,136,832 for the three
months ended March 31, 2005 and 2004, respectively, and $4,033,375 and
$3,086,265 for the nine months ended March 31, 2005 and 2004,
respectively.
See notes to the consolidated financial statements.
Automatic Data Processing, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share amounts)
(Unaudited)
March 31, June 30,
Assets 2005 2004
- ------ ----------- ----------
Current assets:
Cash and cash equivalents $ 1,069,191 $ 712,998
Short-term marketable securities 492,825 416,077
Accounts receivable, net 1,258,468 1,057,938
Securities clearing and outsourcing
receivables 1,109,088 -
Other current assets 559,768 574,576
----------- ----------
Total current assets 4,489,340 2,761,589
Long-term marketable securities 422,950 963,501
Long-term receivables, net 193,190 196,828
Property, plant and equipment, net 658,203 642,353
Other assets 820,934 720,936
Goodwill 2,401,472 2,195,539
Intangible assets, net 762,311 736,281
----------- ----------
Total assets before funds held for clients 9,748,400 8,217,027
Funds held for clients 23,024,327 12,903,532
----------- -----------
Total assets $32,772,727 $21,120,559
=========== ============
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable $ 177,523 $ 175,175
Accrued expenses and other liabilities 1,541,412 1,482,703
Securities clearing and outsourcing payables 818,585 -
Income taxes payable 216,757 110,546
----------- -----------
Total current liabilities 2,754,277 1,768,424
Long-term debt 75,937 76,200
Other liabilities 360,942 319,495
Deferred income taxes 252,842 283,781
Deferred revenues 463,574 414,764
----------- -----------
Total liabilities before client funds
obligations 3,907,572 2,862,664
Client funds obligations 23,095,513 12,840,225
----------- -----------
Total liabilities 27,003,085 15,702,889
Stockholders' equity:
Preferred stock, $1.00 par value:
authorized 300 shares, issued, none
Common stock, $0.10 par value: - -
authorized 1,000,000 shares; issued 638,702
shares 63,870 63,870
Capital in excess of par value - 96,608
Retained earnings 7,821,010 7,326,918
Deferred compensation (16,844) (16,962)
Treasury stock, at cost: 55,251 and 51,587
shares, respectively (2,112,422) (2,033,254)
Accumulated other comprehensive income (loss) 14,028 (19,510)
----------- ----------
Total stockholders' equity 5,769,642 5,417,670
----------- ----------
Total liabilities and stockholders' equity $32,772,727 $21,120,559
=========================
See notes to the consolidated financial statements.
Automatic Data Processing, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended
March 31,
2005 2004
---------- ----------
Cash Flows from Operating Activities:
- -------------------------------------
Net earnings $ 796,635 $ 723,680
Adjustments to reconcile net earnings to net
cash flows provided by operating activities:
Depreciation and amortization 228,339 225,520
Deferred income taxes 31,660 34,068
Amortization of premiums and discounts on
available-for-sale securities 93,421 93,916
Other 92,793 97,286
Changes in operating assets and liabilities, net
of effects from acquisitions of businesses:
Increase in accounts receivable and other
assets (225,112) (179,843)
Net change in securities clearing and
outsourcing receivables and payables (131,246) -
Increase in accounts payable and accrued
expenses 160,876 137,339
---------- ----------
Net cash flows provided by operating activities 1,047,366 1,131,966
---------- ----------
Cash Flows from Investing Activities:
- -------------------------------------
Purchases of marketable securities (5,492,232) (5,978,737)
Proceeds from the sales or maturities of
marketable securities 5,067,456 3,762,755
Net change in client funds money market
securities (9,456,746) (3,867,491)
Net change in client funds obligations 10,255,288 5,394,417
Capital expenditures (132,893) (125,028)
Additions to intangibles (71,146) (111,036)
Acquisitions of businesses, net of cash acquired (346,227) (228,823)
Proceeds from sale of businesses 17,234 5,294
Other 5,410 7,726
---------- ----------
Net cash flows used in investing activities (153,856) (1,140,923)
---------- ----------
Cash Flows from Financing Activities:
- -------------------------------------
Payments of debt (954) (1,201)
Proceeds from issuance of notes 358 325
Repurchases of common stock (430,647) (435,113)
Proceeds from stock purchase plan and exercises
of stock options 148,501 116,116
Dividends paid (254,575) (225,460)
---------- ----------
Net cash flows used in financing activities (537,317) (545,333)
---------- ----------
Net change in cash and cash equivalents 356,193 (554,290)
Cash and cash equivalents, beginning of period 712,998 1,410,218
---------- ----------
Cash and cash equivalents, end of period $1,069,191 $ 855,928
========== ==========
See notes to the consolidated financial statements.
Automatic Data Processing, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
(Unless otherwise noted, amounts in thousands, 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, 2004. The results of operations for the three
and nine months ended March 31, 2005 may not be indicative of the results to be
expected for the fiscal year ending June 30, 2005.
Note 2. New Accounting Pronouncement
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 123R, "Share-Based Payment" (SFAS No.
123R). SFAS No. 123R is effective for the Company's fiscal year beginning July
1, 2005. Among other things, SFAS No. 123R requires that compensation cost
relating to share-based payment transactions be recognized in the consolidated
financial statements. Note 5, Fair Value Accounting for Stock-Based
Compensation, of the Notes to the Consolidated Financial Statements of this
Quarterly Report on Form 10-Q, contains pro forma disclosures regarding the
effect on net earnings and earnings per share as if the Company had applied the
fair value method of accounting for stock-based compensation under SFAS No. 123,
"Accounting for Stock-Based Compensation" (SFAS No. 123). The Company changed
its fair value option pricing model from the Black-Scholes model to a binomial
model for all options granted after January 1, 2005. The Company believes that
the binomial model is more indicative of the stock option's fair value because
it considers characteristics that are not available under the Black-Scholes
model. SFAS No. 123R may be adopted either prospectively or using a
retrospective method. The Company has not yet determined which method it will
use to adopt SFAS No. 123R and is assessing the anticipated impact of the
adoption.
Note 3. Acquisitions
The Company acquired five businesses during the nine months ended March 31, 2005
for approximately $337 million, net of cash acquired. These acquisitions
resulted in approximately $142 million of goodwill. Intangible assets acquired,
which total approximately $44 million, consisted primarily of software, and
customer contracts and lists that are being amortized over a weighted average
life of 13 years. The Company also made $9 million of contingent payments
relating to previously consummated acquisitions. These acquisitions did not have
a material impact, either individually or in the aggregate, on the Company's
results of operations, financial position or cash flows.
The largest acquisition during the nine months ended March 31, 2005 was the
acquisition, on November 1, 2004, of the U.S. Clearing and BrokerDealer Services
divisions of Bank of America Corporation (U.S. Clearing and BrokerDealer
Business), which provide third-party clearing operations. The acquisition of the
U.S. Clearing and BrokerDealer Business enables the Company to offer traditional
clearing services to retail and institutional broker-dealers in the United
States that want to outsource their entire back-office and clearing operations
while maintaining their status as clearing brokers.
Note 4. Earnings Per Share (EPS)
For the periods ended March 31, 2005
-----------------------------------------------------
Three Months Ended Nine Months Ended
------------------------ -------------------------
Net Average Net Average
Earnings Shares EPS Earnings Shares EPS
-------- ------ --- -------- ------- ---
Basic $338,371 583,991 $0.58 $796,635 583,578 $1.37
Effect of zero coupon
subordinated notes 262 1,189 791 1,211
Effect of stock
options - 5,332 - 5,714
-------- ------- -------- -------
Diluted $338,633 590,512 $0.57 $797,426 590,503 $1.35
======== ======= ===== ======== ======= =====
For the periods ended March 31, 2004
-----------------------------------------------------
Three Months Ended Nine Months Ended
------------------------- -------------------------
Net Average Net Average
Earnings Shares EPS Earnings Shares EPS
-------- ------ --- -------- ------ ---
Basic $300,250 591,210 $0.51 $723,680 592,575 $1.22
Effect of zero coupon
subordinated notes 322 1,548 1,140 1,585
Effect of stock
options - 6,721 - 4,967
-------- ------- -------- -------
Diluted $300,572 599,479 $0.50 $724,820 599,127 $1.21
======== ======= ===== ======== ======= =====
Options to purchase 35.0 million and 32.5 million shares of common stock for the
three months ended March 31, 2005 and 2004, respectively, and 35.0 million and
32.8 million shares of common stock for the nine months ended March 31, 2005 and
2004, 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 each respective period.
Note 5. Fair Value Accounting for Stock-Based Compensation
The Company accounts for its stock options and employee stock purchase plans
under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations, as permitted by SFAS No. 123. No stock-based employee
compensation expense related to the Company's stock options and employee stock
purchase plans is reflected in net earnings, as all options granted under the
stock option plans had an exercise price equal to the market value of the
underlying common stock on the date of grant, and for the employee stock
purchase plans, the discount does not exceed fifteen percent.
The following table illustrates the effect on net earnings and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation. 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.
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ -------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net earnings, as reported $338,371 $300,250 $796,635 $723,680
Add: Stock-based employee compensation
expense for restricted stock included
in reported net earnings, net of
related tax effects 2,163 1,947 6,777 6,005
Deduct: Total stock-based employee
compensation expense determined
using the fair value-based method
for all awards, net of related
tax effects (28,607) (31,094) (93,736) (87,334)
-------- -------- -------- --------
Pro forma net earnings $311,927 $271,103 $709,676 $642,351
======== ======== ======== ========
Earnings per share:
Basic - as reported $0.58 $0.51 $1.37 $1.22
===== ===== ===== =====
Basic - pro forma $0.53 $0.46 $1.22 $1.08
===== ===== ===== =====
Diluted - as reported $0.57 $0.50 $1.35 $1.21
===== ===== ===== =====
Diluted - pro forma $0.53 $0.45 $1.20 $1.07
===== ===== ===== =====
Note 6. Other Income, net
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- ---------
Interest income on corporate
funds $(15,976) $(13,521) $(67,960) $ (59,263)
Interest expense 3,569 1,965 22,476 11,966
Realized gains on available-
for-sale securities (805) (1,775) (9,466) (7,216)
Realized losses on available-
for-sale securities 11,147 1,334 28,955 9,857
-------- -------- -------- ---------
Other income, net $ (2,065) $(11,997) $(25,995) $ (44,656)
======== ======== ======== =========
Proceeds from the sales or maturities of marketable securities were $1.5 billion
and $1.0 billion for the three months ended March 31, 2005 and 2004,
respectively, and $5.1 billion and $3.8 billion for the nine months ended March
31, 2005 and 2004, respectively.
Note 7. Comprehensive Income
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- ------------------
2005 2004 2005 2004
---- ---- ---- ----
Net earnings $338,371 $300,250 $796,635 $723,680
Other comprehensive income:
Foreign currency translation
adjustments (8,142) 27,667 121,385 53,457
Unrealized net (loss) gain on
available-for-sale securities,
net of tax (89,014) 28,004 (87,847) (54,811)
-------- -------- -------- --------
Comprehensive income $241,215 $355,921 $830,173 $722,326
======== ======== ======== ========
Note 8. Interim Financial Data by Segment
As discussed in Note 3, the Company acquired the U.S. Clearing and BrokerDealer
Business on November 1, 2004. The Company has determined that the acquired
operations constitute a separate reportable segment in accordance with SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information." The
Company established a reportable segment called Securities Clearing and
Outsourcing Services as of November 1, 2004 to report the results of this
acquired business.
Employer Services, Brokerage Services, Dealer Services, and Securities Clearing
and Outsourcing Services are the Company's reportable segments. The primary
components of "Other" are Claims Services, miscellaneous processing services,
and corporate allocations and expenses.
The Company evaluates the performance of its segments based on operating results
before interest on corporate funds, foreign currency gains and losses, and
income taxes. Certain revenues and expenses are charged to segments at a
standard rate for management reasons. Other costs are charged to segments based
on management's responsibility for the applicable costs. The prior year's
segment revenues and earnings before income taxes have been adjusted to reflect
updated fiscal year 2005 budgeted foreign exchange rates. Reconciling items
include foreign exchange differences between the actual foreign exchange rates
and the fiscal year 2005 budgeted foreign exchange rates, and the adjustment for
the difference between actual interest income earned on invested funds held for
clients and interest credited to Employer Services at a standard rate of 4.5%.
Both of these adjustments are eliminated in consolidation and as such represent
a reconciling item to revenues and earnings before income taxes. The segment
results also include an internal cost of capital charge related to the funding
of acquisitions and other investments. This charge is eliminated in
consolidation and as such represents a reconciling item to earnings before
income taxes.
Segment Results (In millions):
Revenues
-------------------------------------------
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- ------------------
2005 2004 2005 2004
------ ------ ------ ------
Employer Services $1,494 $1,367 $3,906 $3,638
Brokerage Services 475 452 1,161 1,107
Dealer Services 246 226 727 655
Securities Clearing and
Outsourcing Services 22 - 37 -
Other 100 99 356 334
Reconciling items:
Foreign exchange 51 28 108 33
Client fund interest (39) (51) (98) (98)
------ ------ ------ ------
Total revenues $2,349 $2,121 $6,197 $5,669
====== ====== ====== ======
Earnings Before Income Taxes
-------------------------------------------
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ ------------------
2005 2004 2005 2004
------ ------ ------ ------
Employer Services $ 449 $ 386 $ 954 $ 856
Brokerage Services 70 68 158 121
Dealer Services 36 39 108 108
Securities Clearing and
Outsourcing Services (9) - (14) -
Other (16) - 29 64
Reconciling items:
Foreign exchange 12 4 23 6
Client fund interest (39) (51) (98) (98)
Cost of capital
charge 35 34 107 99
------ ------ ------ ------
Total earnings before
income taxes $ 538 $ 480 $1,267 $1,156
====== ====== ====== ======
Note 9. Corporate Investments and Funds Held for Clients
March 31, 2005 June 30, 2004
------------------------ ------------------------
Cost Fair Value Cost Fair Value
----------- ----------- ----------- -----------
Type of issue:
Money market securities
and other cash
equivalents $12,573,381 $12,573,381 $ 2,903,284 $ 2,903,284
----------- ----------- ----------- -----------
Trading securities: U.S.
Treasury and direct
obligations of U.S.
government agencies 26,613 26,613 - -
----------- ----------- ----------- -----------
Available-for-sale
securities:
U.S. Treasury and
direct obligations
of U.S. government
agencies 6,084,988 6,039,160 5,449,694 5,485,632
Asset backed securities 2,055,010 2,040,900 2,570,424 2,580,609
Corporate bonds 2,475,046 2,449,708 2,342,017 2,341,015
Canadian government
obligations and Canadian
government agency
obligations 919,584 929,840 765,908 774,877
Other debt securities 953,255 948,742 899,216 900,550
Other equity securities 1,465 949 5,696 10,141
----------- ---------- ----------- -----------
Total available-for-sale
securities 12,489,348 12,409,299 12,032,955 12,092,824
----------- ----------- ----------- -----------
Total corporate investments
and funds held for
clients $25,089,342 $25,009,293 $14,936,239 $14,996,108
=========== =========== =========== ===========
Classification of
investments on the
Consolidated Balance
Sheets:
Corporate investments $ 1,993,829 $ 1,984,966 $ 2,096,014 $ 2,092,576
Funds held for clients 23,095,513 23,024,327 12,840,225 12,903,532
---------- ----------- ----------- -----------
Total corporate investments
and funds held for
clients $25,089,342 $25,009,293 $14,936,239 $14,996,108
=========== =========== =========== ===========
The Company's "trading" securities have been pledged as collateral to exchanges
and clearinghouses for security transactions of the Securities Clearing and
Outsourcing Services segment. These investments are recorded at fair value with
the resulting net unrealized gains and losses reflected in "Revenues, Other Than
Interest on Funds Held for Employer Services Clients and PEO revenues" in the
Consolidated Statements of Earnings.
Gross unrealized gains and losses on the available-for-sale securities are as
follows:
Gross Gross Unrealized
unrealized gains unrealized losses (losses)gains, net
---------------- ----------------- ------------------
March 31, 2005 $ 58,032 $(138,081) $(80,049)
June 30, 2004 $125,585 $ (65,716) $ 59,869
The Company's "available-for-sale" securities are carried on the Consolidated
Balance Sheets at fair value at March 31, 2005 and June 30, 2004. The Company
believes that the available-for-sale securities that have fair values that are
below cost are not other-than-temporarily impaired since it is probable that
principal and interest will be collected in accordance with the applicable
contractual terms and the Company has the ability and intent to hold the
available-for-sale securities until maturity.
Expected maturities of available-for-sale securities at March 31, 2005 are as
follows:
Due in one year or less $ 2,832,680
Due after one year through two years 3,187,806
Due after two years through three years 2,094,228
Due after three years through four years 1,752,522
Due after four years through ten years 2,542,063
-----------
Total available-for-sale securities $12,409,299
Note 10. Securities Clearing and Outsourcing Services
As discussed in Note 3, the Company acquired the U.S. Clearing and BrokerDealer
Business on November 1, 2004. The operations of the acquired business are
reported in the Securities Clearing and Outsourcing Services segment. The
summary of the significant accounting policies associated with the Securities
Clearing and Outsourcing Services segment are as follows:
Receivables from and Payables to Clearing Customers
Receivables from and payables to clearing customers represent the amounts
receivable from and payable to clearing customers in connection with cash
and margin securities transactions. Clearing customer receivables are
included in "Securities Clearing and Outsourcing Receivables" and clearing
customer payables are included in "Securities Clearing and Outsourcing
Payables" on the Consolidated Balance Sheets. Receivables from customers
are collateralized by securities that are not reflected in the Consolidated
Balance Sheets.
Securities Borrowed and Securities Loaned
Securities borrowed and loaned represent deposits made to or received from
other broker-dealers. Securities borrowed and securities loaned are
recorded on the settlement date based upon the amount of cash advanced or
received. Securities borrowed are included in "Securities Clearing and
Outsourcing Receivables" and securities loaned are included in "Securities
Clearing and Outsourcing Payables" on the Consolidated Balance Sheets. The
Company takes possession of securities borrowed, monitors the market value
of securities loaned and obtains additional collateral as appropriate.
Revenue Recognition
Customer clearing security transactions and the related revenues, primarily
consisting of customer margin interest, and expenses, primarily consisting
of brokerage clearing expenses and interest expense, are recorded on a
settlement date basis. Revenues for the fees charged to an introducing
broker-dealer to process trades in clearing accounts are recorded on a
trade date basis.
Securities clearing and outsourcing receivables and payables consist of the
following as of March 31, 2005:
Receivables
Clearing customers $ 831,527
Securities borrowed 81,008
Broker-dealers and other 17,840
Clearing organizations 8,115
Securities failed to deliver 170,598
--------
Total $1,109,088
=========
Payables
Clearing customers $ 395,057
Securities loaned 280,526
Broker-dealers and other 71,341
Securities failed to receive 71,661
--------
Total $ 818,585
=========
Securities failed to deliver and failed to receive represent the contract value
of securities that have not been delivered or received as of the settlement
date.
As of March 31, 2005, the Company has received collateral, primarily in
connection with securities borrowed and customer margin loans, with a market
value of approximately $2.0 billion which it can sell or repledge. Of this
amount, approximately $0.3 billion has been pledged or sold as of March 31, 2005
in connection with securities loaned and deposits with clearing organizations.
Note 11. Goodwill and Intangible Assets, net
Changes in goodwill for the nine months ended March 31, 2005 are as follows:
Securities
Clearing and
Employer Brokerage Dealer Outsourcing
Services Services Services Services Other Total
-------- -------- -------- -------- ----- -----
Balance as of
June 30, 2004 $1,314,579 $366,299 $324,111 $ - $190,550 $2,195,539
Additions 8,970 515 33,655 110,142 2,859 156,141
Sale of business (140) - (1,445) - - (1,585)
Cumulative
translation
adjustments 35,590 2,253 2,080 - 11,454 51,377
---------- -------- -------- -------- ----------------------
Balance as of
March 31,
2005 $1,358,999 $369,067 $358,401 $110,142 $204,863 $2,401,472
========== ======== ======== ======== ======== ===========
Components of intangible assets are as follows:
March 31, June 30,
2005 2004
---------- ----------
Intangible assets:
Software and software licenses $ 824,340 $ 729,399
Customer contracts and lists 695,789 594,841
Other intangibles 347,897 391,906
---------- ----------
1,868,026 1,716,146
Less accumulated amortization (1,105,715) (979,865)
---------- ----------
Intangible assets, net $ 762,311 $ 736,281
========== ==========
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 10 years (3 years for
software and software licenses, 13 years for customer contracts and lists and 11
years for other). Amortization of intangibles totaled $38.9 million and $36.5
million for the three months ended March 31, 2005 and 2004, respectively, and
totaled $112.0 million and $104.6 million for the nine months ended March 31,
2005 and 2004, respectively. Estimated amortization expense of the Company's
existing intangible assets for the remaining three months of fiscal year 2005
and the succeeding five fiscal years is as follows:
Amount
------
2005 $ 38,012
2006 140,975
2007 117,471
2008 86,262
2009 49,022
2010 42,876
Note 12. Short-term Financing
In June 2004, the Company entered into two new unsecured revolving credit
agreements, each for $2.25 billion, with certain financial institutions,
replacing a previous $4.5 billion credit agreement. The two unsecured revolving
credit agreements expire in June 2005 and June 2009, respectively. 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 unsecured commercial paper program and to provide
funding for general corporate purposes, if necessary. The Company had no
borrowings through March 31, 2005 under the two new credit agreements.
The Company maintains a U.S. short-term commercial paper program providing for
the issuance of up to $4.5 billion in aggregate maturity value of commercial
paper at the Company's discretion. 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 270 days. At March 31, 2005 and 2004, there was no
commercial paper outstanding. For the three months ended March 31, 2005 and
2004, the Company had average borrowings of $0.3 billion and $0.2 billion,
respectively, at an effective weighted average interest rate of 2.3% and 1.0%,
respectively. For the nine months ended March 31, 2005 and 2004, the Company had
average borrowings of $1.1 billion and $0.9 billion, respectively, at an
effective weighted average interest rate of 1.8% and 1.0%, respectively. The
weighted average maturity of the Company's commercial paper during the three and
nine months ended March 31, 2005 was less than two days for both periods.
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 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, 2005 and 2004, there
were no outstanding repurchase agreements. For the three months ended March 31,
2005 and 2004, the Company had an average outstanding balance for repurchase
agreements of $152.2 million and $35.2 million, respectively, at a weighted
average interest rate of 2.1% and 1.9%, respectively. For the nine months ended
March 31, 2005 and 2004, the Company had an average outstanding balance for
repurchase agreements of $313.8 million and $20.8 million, respectively, at a
weighted average interest rate of 1.7% and 2.1%, respectively.
Note 13. Pension Plans
The components of net pension expense were as follows:
Three months ended Nine months ended
March 31 March 31
--------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------
Service cost- benefits
earned during the period $ 7,444 $ 5,743 $ 22,333 $ 17,230
Interest cost on projected
benefits 9,451 8,422 28,353 25,267
Expected return on plan
assets (13,058) (12,624) (39,174) (37,873)
Net amortization and
deferral 2,779 2,549 8,335 7,646
-------- ------- -------- --------
Net pension expense $ 6,616 $ 4,090 $ 19,847 $ 12,270
======== ======== ======== ========
The minimum required contribution to the Company's pension plans is $0 in fiscal
year 2005. For the nine months ending March 31, 2005, the Company contributed
$44 million to the pension plans. The Company does not expect to make any
additional contributions to the pension plans during fiscal year 2005.
Note 14. Commitments and Contingencies
It is not the Company's practice to enter into off-balance sheet arrangements.
However, in the normal course of business, the Company does enter into contracts
in which it guarantees the performance of the Company's products and services.
In addition, the securities transactions of the Securities Clearing and
Outsourcing Services segment involve collateral arrangements required by various
regulatory and internal guidelines, which are monitored daily. The Company does
not expect any material losses related to such guarantees or collateral
arrangements.
The Company is a member of numerous exchanges and clearinghouses. Under the
membership agreements, members are generally required to guarantee the
performance of other members. Additionally, if a member becomes unable to
satisfy its obligations to the clearinghouse, other members would be required to
meet these shortfalls. To mitigate these performance risks, the exchanges and
clearinghouses often require members to post collateral. The Company's maximum
potential liability under these arrangements cannot be quantified. However, the
Company believes that it is unlikely that the Company will be required to make
payments under these arrangements. Accordingly, no contingent liability is
recorded in the consolidated financial statements for these arrangements.
A subsidiary of the Company, included in the Securities Clearing and Outsourcing
Services segment, is subject to the Uniform Net Capital Rule of the Securities
and Exchange Commission. At March 31, 2005, the aggregate net capital of such
subsidiary was $229.4 million, exceeding the net capital requirement by $207.8
million. This subsidiary has secured unlimited Securities Industry Protection
Corporation (SIPC) insurance coverage for its customers. Under the terms of this
program, this subsidiary is required to maintain an aggregate net capital of
$200 million.
Note 15. Income Taxes
On October 22, 2004, the American Jobs Creation Act (the AJCA) was signed into
law. The AJCA includes a deduction of 85% of certain foreign earnings that are
repatriated, as defined in the AJCA. The Company may elect to apply this
provision to qualifying earnings repatriations in either the balance of fiscal
year 2005 or in fiscal year 2006. The Company has started an evaluation of the
effects of the repatriation provision; however, the Company does not expect to
be able to complete this evaluation until Congress acts on the pending Technical
Corrections Bill and the Treasury Department provides additional clarifying
language on key elements of the provision. The Company expects to complete its
evaluation of the effects of the repatriation provision within a reasonable
period of time following these actions. The range of possible amounts that the
Company could repatriate under this provision is between zero and $500 million.
The related potential range of income tax is between zero and $35 million. The
actual cost to the Company is dependent on the factors discussed above.
Item 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations
(Tabular dollars are presented in millions, except per share amounts)
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 below.
Revenue Recognition. Our revenues are primarily attributable to fees for
providing services (e.g., Employer Services' payroll processing fees and
Brokerage Services' trade processing fees) as well as investment income on
payroll funds, payroll tax filing funds and other Employer Services'
client-related funds. We typically enter into agreements for a fixed fee per
transaction (e.g., number of payees or number of trades). Fees associated with
services are recognized in the period services are rendered and earned under
service arrangements with clients where service fees are fixed or determinable
and collectibility is reasonably assured. Interest income on collected but not
yet remitted funds held for clients is recognized in revenues as earned, as the
collection, holding and remittance of these funds are critical components of
providing these services.
We also recognize revenues associated with the sale of software systems and
associated software licenses. For a majority of our software sales arrangements,
which provide hardware, software licenses, installation and post-customer
support, revenues are recognized ratably over the software license term as
vendor-specific objective evidence of the fair values of the individual elements
in the sales arrangement does not exist. Changes to the elements in an
arrangement and the ability to establish vendor-specific objective evidence for
those elements could affect the timing of the revenue recognition.
The majority of our revenues are generated from a fee for service model (e.g.,
fixed-fee per transaction processed) in which revenue is recognized when the
related services have been rendered under written price quotations or service
agreements having stipulated terms and conditions which do not require
management to make any significant judgments or assumptions regarding any
potential uncertainties.
We assess collectibility of our revenues based primarily on the creditworthiness
of the customer as determined by credit checks and analysis, as well as the
customer's payment history. We do not believe that a change in our assumptions
utilized in the collectibility determination would result in a material change
to revenues as no single customer accounts for a significant portion of our
revenues.
Goodwill. We review the carrying value of all our goodwill in accordance with
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets," by comparing the carrying value of our reporting units to
their fair values. We are required to perform this comparison at least annually
or more frequently if circumstances indicate possible impairment. When
determining fair value, we utilize a discounted future cash flow approach using
various assumptions, including projections of revenues based on assumed
long-term growth rates, estimated costs, and appropriate discount rates based on
the particular businesses' weighted average cost of capital. Our estimates of
long-term growth and costs are based on historical data, various internal
estimates and a variety of external sources, and are developed as part of our
routine long-range planning process. The estimated fair value of the Company's
reporting units exceeds the carrying value of the reporting units. We had
approximately $2.4 billion of goodwill as of March 31, 2005. Given the
significance of our goodwill, an adverse change to the fair value could result
in an impairment charge, which could be material to our consolidated earnings.
Income taxes. We account for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which establishes financial accounting and
reporting standards for the effect of income taxes. The objectives of accounting
for income taxes are to recognize the amount of taxes payable or refundable for
the current year and deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an entity's financial
statements or tax returns. Judgment is required in addressing the future tax
consequences of events that have been recognized in our financial statements or
tax returns (e.g., realization of deferred tax assets, changes in tax laws or
interpretations thereof). In addition, we are subject to the continuous
examination of our income tax returns by the Internal Revenue Service and other
tax authorities. A change in the assessment of the outcomes of such matters
could materially impact our consolidated financial statements.
RESULTS OF OPERATIONS
Analysis of Consolidated Operations
(In millions, except per share amounts)
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------- -----------------------
2005 2004 Change 2005 2004 Change
---- ---- ------ ---- ----- ------
Total revenues $2,349 $2,121 11% $6,197 $5,669 9%
---------------------- -----------------------
Total expenses $1,811 $1,641 10% $4,930 $4,513 9%
---------------------- -----------------------
Earnings before income
taxes $ 538 $ 480 12% $1,267 $1,156 10%
Margin 22.9% 22.6% 20.4% 20.4%
---------------------- -----------------------
Provision for income
taxes $ 200 $ 180 11% $ 470 $ 432 9%
Effective tax rate 37.1% 37.4% 37.1% 37.4%
---------------------- -----------------------
Net earnings $ 338 $ 300 13% $ 797 $ 724 10%
Diluted earnings per
share $ 0.57 $ 0.50 14% $ 1.35 $ 1.21 12%
----------------------- -----------------------
Revenues
Our consolidated revenues for the quarter ended March 31, 2005 grew 11% to $2.3
billion primarily due to increases in Employer Services of 9%, or $127 million,
to $1.5 billion, Brokerage Services of 5%, or $23 million, to $475 million,
Dealer Services of 9%, or $20 million, to $246 million as well as $22 million
from the Securities Clearing and Outsourcing Services segment. Our consolidated
revenues, excluding the impact of acquisitions and divestitures, grew 10% in the
quarter ending March 31, 2005 as compared with the prior year.
Our consolidated revenues for the quarter ending March 31, 2005 includes
interest on funds held for Employer Services clients of $124 million as compared
to $97 million in the prior year. The increase in the consolidated interest
earned on funds held for Employer Services clients primarily resulted from the
increase of 11% in our average client fund balances to $14.8 billion for the
quarter. The difference between the 4.5% standard rate allocation in Employer
Services and the actual interest earned is a reconciling item that is eliminated
in consolidation and reduces revenues by $39 million and $51 million in the
quarters ending March 31, 2005 and 2004, respectively.
Our consolidated revenues for the year-to-date period ended March 31, 2005 grew
9% to $6.2 billion primarily due to increases in Employer Services of 7%, or
$268 million, to $3.9 billion, Brokerage Services of 5%, or $54 million, to $1.2
billion, Dealer Services of 11%, or $72 million, to $727 million, as well as $37
million from the Securities Clearing and Outsourcing Services segment. Our
consolidated revenues, excluding the impact of acquisitions and divestitures,
grew 9% in the year-to-date period ending March 31, 2005 as compared with the
prior year. Revenue growth for the year-to-date period was also favorably
impacted by $70 million, or 1.2%, due to fluctuations in foreign currency
exchange rates.
Our consolidated revenues for the year-to-date period ending March 31, 2005
includes interest on funds held for Employer Services clients of $300 million,
as compared to $262 million in the prior year. The increase in the consolidated
interest earned on funds held for Employer Services clients resulted from the
increase of 10% in our average client fund balances to $11.9 billion for the
year-to-date period. The difference between the 4.5% standard rate allocation in
Employer Services and the actual interest earned is a reconciling item that is
eliminated in consolidation and reduces revenues by $98 million in both
year-to-date periods ending March 31, 2005 and 2004.
Expenses
Our consolidated expenses for the quarter ending March 31, 2005 increased by
$169 million, from $1.6 billion to $1.8 billion. The increase in our
consolidated expenses is primarily due to our increase in revenues, including
the additional expenses associated with acquisitions. Operating expenses
increased by $124 million, or 13%, primarily due to the increase in revenues,
including the increases in the Professional Employer Organization (PEO) business
and investor communications activity, which both have pass-through costs.
Selling, general and administrative expenses increased by $25 million to $513
million primarily due to the additional sales force to generate the revenue
growth. Systems development and programming costs increased by $10 million to
$154 million due to continued investments in sustaining our products, primarily
in our Employer Services business, and the maintenance of our existing
technology throughout all of our businesses. In addition, other income, net,
decreased $10 million primarily due to the net realized loss of $10 million as
compared to the net realized gain of $0.4 million in the prior year on our
available-for-sale securities.
Our consolidated expenses for the year-to-date period increased by $418 million,
from $4.5 billion to $4.9 billion. The increase in our consolidated expenses is
primarily due to our increase in revenues, including the additional expenses
associated with acquisitions. In addition, consolidated expenses increased by
$49 million, or 1.1%, due to fluctuations in foreign currency exchange rates.
Operating expenses increased by $302 million, or 12%, primarily due to the
increase in revenues, primarily in the PEO business and investor communications
activity, which both have pass-through costs. Selling, general and
administrative expenses increased by $51 million to $1.4 billion primarily due
to the additional sales force to generate the revenue growth. Systems
development and programming costs increased by $43 million to $453 million due
to continued investments in sustaining our products, primarily in our Employer
Services business, and the maintenance of our existing technology throughout all
of our businesses. In addition, other income, net, decreased $19 million due to
the increase in interest expense of $11 million due to the increase in the
interest rates on our short-term financing arrangements and an increase of $17
million in net realized losses on our available-for-sale securities.
Earnings Before Income Taxes
Earnings before income taxes increased by $58 million, or 12%, to $538 million
for the quarter ending March 31, 2005 and $110 million, or 10%, to $1.3 billion
during the year-to-date period ending March 31, 2005 due to the increase in
revenues and expenses discussed above.
Provision for Income Taxes
Our effective tax rate for both the quarter and year-to-date period ending March
31, 2005 was 37.1% as compared to 37.4% for the comparable period of the prior
year. The decrease in the effective tax rate for both periods is attributable to
a favorable mix in income among tax jurisdictions.
Net Earnings
Net earnings for the quarter increased 13% to $338 million from $300 million and
the related diluted earnings per share increased 14% to $0.57. Net earnings for
the year-to-date period increased 10% to $797 million from $724 million and the
related diluted earnings per share increased 12% to $1.35. The increase in net
earnings for both the quarter and year-to-date period reflects the increase in
earnings before income taxes and the impact of the lower effective tax rate. The
increase in diluted earnings per share for both the quarter and year-to-date
period reflects the increase in net earnings and the impact of fewer shares
outstanding due to the repurchase of 10.0 million shares during the year-to-date
period and 15.8 million shares in fiscal year 2004.
Analysis of Business Segments
Revenues
(In millions)
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------- -----------------------
2005 2004 Change 2005 2004 Change
------ ------ ------ ------ ------ ------
Employer Services $1,494 $1,367 9% $3,906 $3,638 7%
Brokerage Services 475 452 5 1,161 1,107 5
Dealer Services 246 226 9 727 655 11
Securities Clearing and
Outsourcing Services 22 - - 37 - -
Other 100 99 1 356 334 7
Reconciling items:
Foreign exchange 51 28 108 33
Client fund interest (39) (51) (98) (98)
------ ------ ------ ------
Total revenues $2,349 $2,121 11% $6,197 $5,669 9%
====== ====== ====== ======
Earnings Before Income Taxes
(In millions)
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------- ------------------------
2005 2004 Change 2005 2004 Change
---- ---- ------ ------ ------ ------
Employer Services $449 $386 16% $ 954 $ 856 12%
Brokerage Services 70 68 4 158 121 32
Dealer Services 36 39 (7) 108 108 -
Securities Clearing and
Outsourcing Services (9) - - (14) - -
Other (16) - - 29 64 (55)
Reconciling items:
Foreign exchange 12 4 23 6
Client fund interest (39) (51) (98) (98)
Cost of capital charge 35 34 107 99
---- ---- ------ ------
Total earnings before
income taxes $538 $480 12% $1,267 $1,156 10%
==== ==== ====== ======
Revenues
Employer Services' revenues increased 9% for the quarter and 7% for the
year-to-date period ended March 31, 2005 as compared to the prior year primarily
due to new business started in the period, the number of employees on our
clients' payrolls, strong client retention, price increases and an increase in
interest earned on client fund balances. Internal revenue growth, which
represents revenue growth excluding the impact of acquisitions and divestitures,
was approximately 9% for the quarter and 7% for the year-to-date period. New
business sales grew 16% for the quarter and 13% for the year-to-date period due
to the increased growth in the salesforce and productivity. The number of
employees on our clients' payrolls, "pays per control," increased 1.8% for the
quarter and 1.9% for the year-to-date period in the United States. This
employment metric represents over 125 thousand payrolls across a broad range of
U.S. geographies ranging from small to very large businesses. Our client
retention in the United States improved by 1.1 percentage points in the quarter
and 0.8 percentage points for the year-to-date period from record retention
levels in fiscal year 2004 due to our continued investment and commitment to
client service.
Interest income is credited to Employer Services at a standard rate of 4.5%.
Interest income increased for the quarter and year-to-date periods due to the
increase in the average client funds balance as compared to the prior year. The
average client funds balance was $14.8 billion during the quarter as compared to
$13.3 billion in the third quarter of fiscal year 2004 and $11.9 billion during
the year-to-date period as compared to $10.8 billion for the prior year,
representing an increase of 11% for the quarter and 10% for the year-to-date
period.
Revenues from our "beyond payroll" products continued to grow at a faster rate
than the traditional payroll and payroll tax revenues. Our PEO revenues grew
26%, to $164 million, during the quarter and 23%, to $423 million, for the
year-to-date period primarily due to 20% growth in the number of PEO worksite
employees and additional pass-through benefits. In addition, "beyond payroll"
revenues increased due to increased number of clients utilizing services such as
Time and Labor Management and TotalPay Services.
Earnings Before Income Taxes
Earnings before income taxes increased 16%, from $386 million to $449 million,
for the quarter and 12%, from $856 million to $954 million, for the year-to-date
period, primarily due to the increase in revenues in the respective periods.
Operating expenses, selling, general and administrative expenses and systems
development and programming costs increased 8% for the quarter and year-to-date
period due to the increase in operating and sales personnel, and the maintenance
of our products and services to support the revenue growth. Our expenses at
Employer Services did not increase comparably with our revenue primarily due to
the leveraging of our increasing revenues. In addition, earnings before income
taxes increased approximately $3 million during the quarter and $13 million
during the year-to-date period as a result of the completion of the integration
of certain acquisitions, primarily ProBusiness Services, Inc., in the prior
year.
Brokerage Services
Revenues
Brokerage Services' revenues increased 5% for the quarter and the year-to-date
period ended March 31, 2005 due to the increase in certain investor
communications activity, offset by the decrease in our back-office services
revenue. Revenues from investor communications increased by 11%, to $361
million, for the quarter and by 10%, to $831 million, for the year-to-date
period primarily due to increases in the volume of our proxy and interim
communications services, as well as increases in our distribution services
revenues for post-sale mutual fund documents and statements, and new business
sales. Our proxy and interim communication pieces delivered increased 25% for
the quarter, from 204 million to 254 million, and 22% for the year-to-date
period, from 516 million to 626 million. The increase in the quarterly and
year-to-date proxy and interim communication activity resulted from more holders
of equities, increased activity related to additional mutual fund meetings, and
more mutual fund special communications. Our back-office trade processing
revenues decreased by 5%, to $88 million, for the quarter and by 2%, to $254
million, for the year-to-date period due to a number of offsetting items. The
average revenue per trade declined 8% for the quarter and 13% for the
year-to-date period primarily due to the volume processed under tiered pricing
agreements and the retail/institution mix, due to the increase in electronic
retail trades. In addition, the acquisition of the U.S. Clearing and
BrokerDealer Services Divisons of Bank of America, which was previously a
customer of Brokerage Services, reduced revenues slightly, as the back-office
services previously provided to such third-party became an internal
(intercompany) service. These decreases were offset by an increase in the
average trades per day of 5%, from 1.52 million to 1.59 million, for the quarter
and 11%, from 1.36 million to 1.50 million, for the year-to-date period. Average
trades per day increased primarily due to net new business sales and growth in
our existing client base.
Earnings Before Income Taxes
Earnings before income taxes increased $2 million, to $70 million, for the
quarter primarily due to the increased revenues in our investor communication
activities. This increase was offset by the 8% increase in operating expenses,
primarily due to increase in the pass-through costs associated with the investor
communications activity. Earnings before income taxes increased $37 million, to
$158 million, for the year-to-date period primarily due to increased revenues in
our investor communication activities. Selling, general and administrative
expenses decreased by 9% for the year-to-date period due to the reduction in
professional fees and collections of receivables which were previously reserved.
In addition, earnings before income taxes increased approximately $1 million
during the quarter and $9 million during the year-to-date period as a result of
the elimination of unprofitable business lines and alignment of our cost
structure in our underperforming businesses that occurred during fiscal year
2004.
Dealer Services
Revenues
Dealer Services' revenues increased 9% for the quarter and 11% for the
year-to-date period ended March 31, 2005 when compared to the prior year.
Internal revenue growth was approximately 4% for the quarter and 6% for the
year-to-date period. Revenues increased for our dealer business systems in North
America by $24 million, to $205 million, for the quarter and by $77 million, to
$603 million, for the year-to-date period primarily due to growth in our key
products and the effect of acquisitions. The growth in our key products was
primarily driven by the increased users for Application Service Provider (ASP)
managed services, increased new site Credit Check installations, new network
installations and increased market penetration of our Customer Relationship
Management (CRM) product.
Earnings Before Income Taxes
Earnings before income taxes declined $3 million, to $36 million, for the
quarter and remained flat for the year-to-date period primarily due to the
additional sales expenses relating to headcount additions to generate the
current revenue growth and additional implementation expenses to support the new
sales contracts awarded for two of the largest dealership groups in the United
States. In addition, earnings before income taxes was negatively impacted by the
integration costs of acquisitions that occurred during the fourth quarter of
fiscal year 2004.
Securities Clearing and Outsourcing Services
On November 1, 2004, the Company acquired the U.S. Clearing and BrokerDealer
Services divisions of Bank of America Corporation (U.S. Clearing and
BrokerDealer Business), which provides third-party clearing operations. The
results of the acquired business are reported in the Securities Clearing and
Outsourcing Services segment.
The Securities Clearing and Outsourcing Services segment provides execution,
clearing, margin lending and securities borrowing to facilitate customer short
sales to clearing clients. Our clients engage in either the retail or
institutional brokerage business.
As part of the integration of the U.S. Clearing and BrokerDealer Business, we
will be deconverting two correspondent clearing clients, Bank of America
Investments (previously Quick and Reilly) and Strong, as contemplated by the
acquisition agreement. These clients are expected to be deconverted by June 30,
2005.
Revenues
Revenues for Securities Clearing and Outsourcing Services was $22 million for
the quarter and $37 million for the year-to-date period ended March 31, 2005 as
compared to $0 in the prior year due to the acquisition of the business on
November 1, 2004. Average customer margin balances were $1.0 billion during the
quarter and the year-to-date period. The average number of trades that were
cleared per day was 24 thousand for the quarter and 25 thousand for the
year-to-date period.
Loss Before Income Taxes
Loss before income taxes was $9 million for the quarter and $14 million for the
year-to-date period due to the current alignment of the cost structure
associated with the revenues of the business as well as the integration costs
incurred since the acquisition of the business on November 1, 2004.
Other
The primary components of "Other" are Claims Services, miscellaneous processing
services, and corporate allocations and expenses.
Reconciling Items
The prior year's business unit revenues and earnings before income taxes have
been adjusted to reflect updated fiscal year 2005 budgeted foreign exchange
rates. Reconciling items include foreign exchange differences between the actual
foreign exchange rates and the fiscal year 2005 budgeted foreign exchange rates,
and the adjustment for the difference between actual interest income earned on
invested funds held for clients and interest credited to Employer Services at a
standard rate of 4.5%. Both of these adjustments are eliminated in consolidation
and as such represent a reconciling item to revenues and earnings before income
taxes. The business unit results also include an internal cost of capital charge
related to the funding of acquisitions and other investments. This charge is
eliminated in consolidation and as such represents a reconciling item to
earnings before income taxes.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Our financial condition and balance sheet remain strong. At March 31, 2005, cash
and marketable securities were $2.0 billion. Stockholders' equity was $5.8
billion and the ratio of long-term debt-to-equity was 1.3% at March 31, 2005.
At March 31, 2005, working capital was $1.7 billion compared to $1.0 billion at
June 30, 2004. The increase in the Company's working capital arose primarily as
a result of the acquisition of the U.S. Clearing and BrokerDealer Business.
Our principal sources of liquidity are derived from cash generated through
operations and our cash and marketable securities on hand. We also have the
ability to generate cash through our financing arrangements under our U.S.
short-term commercial paper program and our U.S. and Canadian short-term
repurchase agreements. In addition, we have two unsecured revolving credit
agreements that allow us to borrow up to $4.5 billion in the aggregate. Our
short-term commercial paper program and repurchase agreements are utilized as
the primary instruments to meet short-term funding requirements related to
client funds obligations. Our revolving credit agreements, totaling $4.5
billion, are in place to provide additional liquidity, if needed. We have never
had borrowings under the current or previous revolving credit agreements. The
Company believes that the internally generated cash flows and financing
arrangements are adequate to support business operations and capital
expenditures.
Cash flows generated from operations were $1.0 billion for the nine months ended
March 31, 2005. This amount compares to cash flows from operations of $1.1
billion in the comparable period for the prior fiscal year. The decrease in cash
flow from operations was primarily due to the net change of $131 million in
securities clearing and outsourcing receivables and payables due to the
increased activity of security clearing transactions, and the change in accounts
receivable and other assets of $45 million primarily due to the increase in
accounts receivable as a result of the increase in billings. These decreases in
cash generated from operations were offset by the increase in net earnings of
$73 million and the change in accounts payable and accrued expenses primarily
due to the timing of income tax payments made during the current year.
Cash flows used in investing activities in the nine months ended March 31, 2005
totaled $154 million compared to $1.1 billion in the comparable period for the
prior fiscal year. The fluctuation between periods was primarily due to the
timing of purchases and proceeds of marketable securities and the net change in
client funds obligations, offset by the increase in cash paid for acquisitions
in the current year-to-date period.
Cash flows used in financing activities in the nine months ended March 31, 2005
totaled $537 million compared to $545 million in the comparable period for the
prior fiscal year. The decrease in cash used in financing activities was
primarily due to the increase in proceeds received from the stock purchase plan
and exercises of stock options, offset by the increase in dividends paid due to
the increase in the amount of dividends per common share. We purchased 10.0
million shares of our common stock at an average price per share of $41.65
during the year-to-date period. As of March 31, 2005, we had remaining Board of
Directors' authorization to purchase up to 17.6 million additional shares.
In June 2004, we entered into two new unsecured revolving credit agreements,
each for $2.25 billion, with certain financial institutions, replacing a
previous $4.5 billion credit agreement. The two unsecured revolving credit
agreements expire in June 2005 and June 2009, respectively. 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 unsecured commercial paper program and to provide funding for
general corporate purposes, if necessary. We had no borrowings through March 31,
2005 under the two new credit agreements.
We maintain a U.S. short-term commercial paper program providing for the
issuance of up to $4.5 billion in aggregate maturity value of commercial paper
at our discretion. Our commercial paper program is rated A-1+ by Standard &
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 270 days. We use the commercial paper issuances as a primary
instrument to meet short-term funding requirements related to client funds
obligations that occur as a result of our decision to extend maturities of our
client fund marketable securities. We also use commercial paper issuances to
fund general corporate purposes, if needed. This commercial paper program allows
us to take advantage of higher extended term yields, rather than liquidating
portions of our marketable securities, in order to provide more cost effective
liquidity to the Company. At March 31, 2005 and 2004, there was no commercial
paper outstanding. For the three months ended March 31, 2005 and 2004, the
Company had average borrowings of $0.3 billion and $0.2 billion, respectively,
at an effective weighted average interest rate of 2.3% and 1.0%, respectively.
For the nine months ended March 31, 2005 and 2004, the Company had average
borrowings of $1.1 billion and $0.9 billion, respectively, at an effective
weighted average interest rate of 1.8% and 1.0%, respectively. The weighted
average maturity of our commercial paper during the three and nine months ended
March 31, 2005 was less than two days for both periods.
Our U.S. and Canadian short-term funding requirements related to client funds
obligations are sometimes obtained on a secured basis through the use of
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, 2005 and 2004, there were no
outstanding repurchase agreements. For the three months ended March 31, 2005 and
2004, the Company had an average outstanding balance of $152.2 million and $35.2
million, respectively, at a weighted average interest rate of 2.1% and 1.9%,
respectively. For the nine months ended March 31, 2005 and 2004, the Company had
an average outstanding balance of $313.8 million and $20.8 million,
respectively, at an average interest rate of 1.7% and 2.1%, respectively.
For the nine months ended March 31, 2005, capital expenditures were $133
million. Capital expenditures for fiscal year 2005 are expected to be
approximately $200 to $230 million compared to $204 million in fiscal year 2004.
It is not our business practice to enter into off-balance sheet arrangements.
However, in the normal course of business, we do enter into contracts in which
we guarantee the performance of our products and services. In addition, the
securities transactions of the Securities Clearing and Outsourcing Services
segment involve collateral arrangements required by various regulatory and
internal guidelines, which are monitored daily. We do not expect any material
losses related to such guarantees or collateral arrangements.
We are a member of numerous exchanges and clearinghouses. Under the membership
agreements, members are generally required to guarantee the performance of other
members. Additionally, if a member becomes unable to satisfy its obligations to
the clearinghouse, other members would be required to meet these shortfalls. To
mitigate these performance risks, the exchanges and clearinghouses often require
members to post collateral. Our maximum potential liability under these
arrangements cannot be quantified. However, we believe that it is unlikely that
the Company will be required to make payments under these arrangements.
Accordingly, no contingent liability is recorded in the consolidated financial
statements for these arrangements.
Quantitative and Qualitative Disclosures about Market Risk
During the nine months ended March 31, 2005, approximately twenty percent of our
overall investment portfolio was invested in cash and cash equivalents, and
therefore was impacted almost immediately by changes in short-term interest
rates. The other eighty percent of our investment portfolio was invested in
fixed-income securities, with varying maturities of less than ten years, which
were also subject to interest rate risk including reinvestment risk. We have
historically had the ability and intent to hold these investments until
maturity.
Details regarding our overall investment portfolio are as follows:
Three Months Ended Nine Months Ended
(In millions) March 31, March 31
------------------- --------------------
2005 2004 2005 2004
---- ---- ----- ----
Average investment balances
at cost:
Corporate investments $ 2,272.2 $ 2,493.8 $ 3,269.7 $ 3,165.7
Funds held for clients 14,817.6 13,316.0 11,883.4 10,766.4
--------- --------- --------- ---------
Total $17,089.8 $15,809.8 $15,153.1 $13,932.1
========= ========= ========= =========
Average interest rates earned
exclusive of realized gains/
(losses) on corporate investments
and funds held for clients 3.4% 2.9% 3.3% 3.1%
Realized gains on available-
for-sale securities $ 0.8 $ 1.8 $ 9.5 $ 7.2
Realized losses on available-
for-sale securities (11.1) (1.4) (29.0) (9.8)
-------- -------- -------------------
Net realized (losses) gains $ (10.3) $ 0.4 $ (19.5) $ (2.6)
========= ======== ========= ========
March 31, June 30,
2005 2004
--------- ---------
Net unrealized pre-tax (losses) gains
on available-for-sale securities $ (80.0) $ 59.9
Total available-for-sale securities $12,409.3 $12,092.8
The return on our portfolio is impacted by interest rate changes. Factors that
influence the earnings impact of the interest rate changes include, among
others, the amount of invested funds and the overall portfolio mix between
short-term and long-term investments. This mix varies during the year and is
impacted by daily interest rate changes. A hypothetical change in both the
short-term interest rates and the long-term interest rates of 25 basis points
applied to the estimated fiscal year 2005 average investment balances and any
related borrowings would result in approximately a $12.0 million impact to
interest revenues on funds held for Employer Services clients and approximately
an $8.0 million impact to earnings before income taxes over a twelve-month
period. A hypothetical change in only short-term interest rates of 25 basis
points applied to the estimated fiscal year 2005 average short-term investment
balances and any related short-term borrowing would result in approximately a
$1.0 million impact to earnings before income taxes over a twelve-month period.
The Company is exposed to credit risk in connection with our available-for-sale
securities through the possible inability of the borrowers to meet the terms of
the bonds. The Company limits credit risk by investing primarily in AAA and AA
rated securities, as rated by Moody's, Standard & Poor's, and Dominion Bond
Rating Service, and by limiting amounts that can be invested in any single
issuer. At March 31, 2005, approximately 95% of our available-for-sale
securities held a AAA or AA rating.
In the normal course of business, the securities activities of the Securities
Clearing and Outsourcing Services segment involve execution, settlement and
financing of various securities transactions for a nationwide client base. These
activities may expose the Company to risk in the event customers, other
broker-dealers, banks, clearing organizations or depositories are unable to
fulfill contractual obligations.
For securities activities of the Securities Clearing and Outsourcing Services
segment in which the Company extends credit to customers and non-customers, we
seek to control the risk associated with these activities by requiring customers
and non-customers to maintain margin collateral in compliance with various
regulatory and internal guidelines. We monitor margin levels and, pursuant to
such guidelines, request the deposit of additional collateral or the reduction
of securities positions, when necessary. In addition, broker-dealers may be
required to maintain deposits relating to any security clearance activities we
perform on their behalf.
We record customers' security clearing transactions on a settlement date basis,
which is generally three business days after trade date. The Company is
therefore exposed to off-balance sheet risk of loss on unsettled transactions in
the event customers and other counterparties are unable to fulfill contractual
obligations.
New Accounting Pronouncement
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R,
"Share-Based Payment" (SFAS No. 123R). SFAS No. 123R is effective for the
Company's fiscal year beginning July 1, 2005. Among other things, SFAS No. 123R
requires that compensation cost relating to share-based payment transactions be
recognized in the consolidated financial statements. Note 5, Fair Value
Accounting for Stock-Based Compensation, of the Notes to the Consolidated
Financial Statements of this Quarterly Report on Form 10-Q, contains pro forma
disclosures regarding the effect on net earnings and earnings per share as if we
had applied the fair value method of accounting for stock-based compensation
under SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123). We
changed our fair value option pricing model from the Black-Scholes model to a
binomial model for all options granted after January 1, 2005. We believe that
the binomial model is more indicative of the stock option's fair value because
it considers characteristics that are not available under the Black-Scholes
model. SFAS No. 123R may be adopted either prospectively or using a
retrospective method. We have not yet determined which method we will use to
adopt SFAS No. 123R and we are assessing the anticipated impact of the adoption.
Income Taxes
On October 22, 2004, the American Jobs Creation Act (the AJCA) was signed into
law. The AJCA includes a deduction of 85% of certain foreign earnings that are
repatriated, as defined in the AJCA. We may elect to apply this provision to
qualifying earnings repatriations in either the balance of fiscal year 2005 or
in fiscal year 2006. We have started an evaluation of the effects of the
repatriation provision; however, we do not expect to be able to complete this
evaluation until Congress acts on the pending Technical Corrections Bill and the
Treasury Department provides additional clarifying language on key elements of
the provision. We expect to complete our evaluation of the effects of the
repatriation provision within a reasonable period of time following these
actions. The range of possible amounts that the Company could repatriate under
this provision is between zero and $500 million. The related potential range of
income tax is between zero and $35 million. The actual cost to the Company is
dependent on the factors discussed above.
FORWARD-LOOKING INFORMATION
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, employee benefits and registered clearing agencies and
broker-dealers; overall market and economic conditions, including interest rate
and foreign currency trends; competitive conditions; stock market activity; 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The information called for by this item is provided under the caption
"Quantitative and Qualitative Disclosures about Market Risk" under Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Item 4. Controls and Procedures.
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
Company's disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures as of March 31, 2005 were effective
to ensure that information required to be disclosed by the Company in reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission's rules and forms.
There were no changes in the Company's internal control over financial reporting
that occurred during the quarter ended March 31, 2005 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
Except as noted below, all other items are either inapplicable or would result
in negative responses and, therefore, have been omitted.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
(a) (b) (c) (d)
Total Number of
Shares Purchased Maximum Number
as Part of the of Shares that
Publicly may yet be
Announced Purchased under
Total Number Average Price Common Stock the Common Stock
of Shares Paid per Repurchase Repurchase
Period Purchased Share (3) Plan (1) Plan (1)
------ --------- --------- -------- --------
January 1, 2005
to January 31,
2005 960,559 $43.36 873,300 20,484,100
February 1, 2005
to February 28,
2005 1,722,805 $42.72 1,710,000 18,774,100
March 1,
2005 to
March 31,
2005 1,130,931 $43.70 1,125,300 17,648,800
--------- ---------
Total 3,814,295(2) 3,708,600
(1) In March 2001, the Registrant received the Board of Directors' approval to
repurchase up to 50 million shares of the Registrant's common stock. In November
2002, the Registrant received the Board of Directors' approval to repurchase an
additional 35 million shares of the Registrant's common stock. There is no
expiration date for the common stock repurchase program.
(2) During fiscal year 2005, pursuant to the terms of the Registrant's
restricted stock plan, the Registrant (i) made repurchases of 63,259 shares
during January 2005, 9,805 shares during February 2005 and 5,631 shares during
March 2005 at the then market value of the shares in connection with the
exercise by employees of their option under such program to satisfy certain tax
withholding requirements through the delivery of shares to the Registrant
instead of cash and (ii) made purchases of 24,000 shares during January 2005 and
3,000 shares during February 2005 at a price of $.10 per share under the terms
of such program to repurchase stock granted to employees who have left the
Registrant.
(3) The average price per share does not include the repurchases described in
clause (ii) of the preceding footnote.
Item 6. Exhibits.
(a) Exhibits
Exhibit Number Exhibit
-------------- -------
31.1 Certification by Arthur F. Weinbach pursuant to
Rule 13a-14(a) of the Securities Exchange Act of
1934
31.2 Certification by Karen E. Dykstra pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934
32.1 Certification by Arthur F. Weinbach pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification by Karen E. Dykstra pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AUTOMATIC DATA PROCESSING, INC.
-------------------------------
(Registrant)
Date: May 6, 2005 /s/ Karen E. Dykstra
--------------------
Karen E. Dykstra
Chief Financial Officer
-----------------------
(Title)