Item 1 of this report, we redefined our company in 2001 as an information services company that operates principally in the human resource, transportation and retail markets. Our HRS business enables customers to outsource a broad range of employment processes. HRS operations are located primarily in the U.S. with significant subsidiary operations in Canada (Ceridian Canada) and the United Kingdom (Ceridian Centrefile). Through Ceridian Centrefile we are expanding our payroll services by engaging partners in other countries in Europe. Comdata is a payment processor and issuer of credit, debit and stored value cards principally for the transportation and retail industries. Comdata’s operations are located substantially in the U.S. with some operations in Canada and prospects of expanding into Mexico and Europe.
The period covered by this discussion featured a number of events or arrangements that had or will have a significant effect on our financial condition and performance. You will find the following matters described in this discussion or through a reference to the notes to our consolidated financial statements.
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New services offerings. New offerings have contributed significantly to revenue growth in 2003 in our HRS segment (examples include eSource, Official Ceridian Check/Ceridian Direct Deposit, Human Resource Outsourcing and SourceWeb) and in our Comdata segment (examples include BusinessLink and eCash). These service offerings are more fully described in Part I, Item 1 of this report.
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Growth in orders and customers in 2002 and 2003. After experiencing growth in the value of HRS orders of 15% from 2001 to 2002, HRS order values grew an additional 7.5% in 2003. Major contributors to HRS order growth in 2003 included customers for our Human Resource Outsourcing offering and a mid-year contract with the U.S. Department of Defense for work-life effectiveness and employee assistance for members of the military services. For Comdata, new customer and order growth was particularly strong in our stored value card business in both 2002 and 2003 while transportation services also added new customers to a lesser degree in both years. Our measurements of customer retention for both segments also showed improvement over the prior year in both 2002 and 2003.
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Acceleration of W-2 information delivery. In 2003, we succeeded in advancing the processing, delivery and billing of W-2 information for our customers. This accomplishment resulted in the recognition of $9.5 million of revenue in December 2003 that would otherwise been recognized in January 2004. Because the costs associated with W-2 activities are reported as incurred throughout the year, essentially this entire amount was reflected in 2003 earnings before income taxes. This means that 2003 revenue included two contributions for W-2 activities and 2004 results will include W-2 revenue only in December.
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The effect of changing currency exchange rates. The strength of the Canadian dollar and British pound sterling against the U.S. dollar, particularly in 2003, contributed significantly to the revenue increases for our Ceridian Canada and Ceridian Centrefile subsidiaries.
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Restatement for change in revenue recognition policy. On February 18, 2004, we announced that we are changing our revenue recognition policy at our Stored Value Systems (“SVS”) unit of Comdata. SVS provides stored value card and related processing principally to the retail industry. The change has been applied retroactively to all periods subsequent to January 1, 2000. The revised policy supercedes the revenue recognition policy adopted in July 2003 as well as the policy applied for periods prior to July 1, 2003. We present the revenue recognition policies for all our businesses in the section entitled “Revenue Recognition” in Note A, “Accounting Policies,” to our consolidated financial statements contained in this report.
The change in revenue recognition extends the period over which we recognize revenue and related costs from retail card sales and processing. The cumulative effect of the adjustment for the years 2000 through 2003 decreased retained earnings as of December 31, 2003 by $10.3 million. As a result, we have restated our consolidated financial statements for the years 2000 through 2003 and filed an amended 2002 Form 10-K and amended quarterly reports on Form 10-Q for the each of the quarters in 2003. The impact of the policy change is summarized below and more fully described in Note B, “Restatement of Financial Statements,” to our consolidated financial statements contained in this report.
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Our software development arrangement with Ultimate Software. We contracted with The Ultimate Software Group, Inc. (“Ultimate”) in 2001 to obtain a license to use their software as part of a Web-enabled integrated payroll/HR/self-service offering to small business customers. This arrangement involved up front payments of $10.0 million in 2001 and $6.5 million in 2002 and a commitment for additional minimum monthly payments beginning with January 2004 totaling $26.7 million over the remaining noncancelable term of the contract including March 2008. These payments included $10.5 million for a paid-up license and a $6.0 million prepayment of the minimum royalty for 2003. We spent an additional $16.9 million during 2002 and early 2003 to incorporate the licensed software into a new product offering that we call SourceWeb. We offered SourceWeb to our customers in the first quarter of 2003 and began monthly amortization of the $10.5 million capitalized license cost and $13.9 million of the $16.9 million of additional software development cost. Also in the first quarter of 2003, we entered into a services agreement with Ultimate for extended technical support that required quarterly payments during 2003 totaling $2.3 million. We commenced monthly charges to operations for the services agreement and the $6.0 million prepaid royalty for 2003 as of January 2003. We estimate that our incremental costs in 2003 compared to 2002 in connection with the introduction of SourceWeb amounted to $20.5 million. We discuss this arrangement and SourceWeb in the “Results of Operations” and “Liquidity and Capital Resources” subsections of this discussion.
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Our principal defined benefit pension plan. Declines in equity securities market values and in interest rates resulted in our principal pension plan, which had been over-funded for many years, becoming an under-funded plan. This change in funded status required that we reclassify the amount reported as a pension asset at the end of 2000 into a combined reduction of our equity and an increase in our liabilities. As a further result of this change in funded status, our earnings before income taxes was reduced by $12.3 million in 2003 compared to 2002. We made cash contributions to this plan during 2003 of $103.7 million. We do not presently plan to make additional contributions to this plan in 2004 although subsequent investment performance, interest rate changes or regulatory actions may require a reconsideration of this position. We discuss our pension and postretirement obligations in the “Liquidity and Capital Resources” section of this discussion and in Note H, “Retirement Plans,” to our consolidated financial statements contained in this report.
Comparison of Annual Periods Ended December 31, 2003, 2002 and
Consolidated Statements of Operations Highlights As Reported
(Dollars in millions, except per share data)
Results of Operations Overview for the Three Years Ended December 31, 2003
Revenue of $1,253.2 million for 2003 increased by $62.2 million over 2002 revenue as both HRS and Comdata contributed to the improved results. Revenue for 2002 of $1,191.0 million showed an increase of $12.0 million over the comparable 2001 amount. Earnings from continuing operations increased to $124.8 million (83¢ per diluted share) in 2003 from $92.1 million (61¢ per diluted share) in 2002 and
$46.9 million (32¢ per diluted share) in 2001. If we eliminated goodwill amortization and related income taxes from the 2001 amounts to compare with the 2002 treatment, earnings from continuing operations for 2001 would have been $77.2 million (52¢ per diluted share). The gain from discontinued operations included in net earnings in 2001 related to the spin-off of Arbitron Inc., discussed in the section entitled “Discontinued Operation” of Note D, “Supplementary Data to Statement of Operations,” to our consolidated financial statements contained in this report.
Further information on results of operations is presented in the following section of this discussion entitled “Results of Operations.”
Consolidated Statements of Cash Flows Highlights
(Dollars in millions)
Cash Flows Overview for the Three Years Ended December 31,
Our cash and equivalents decreased by $10.1 million to $124.2 million during 2003, increased by $18.1 million to $134.3 million during 2002 and increased $11.1 million to $116.2 million during 2001. Cash flows from operating activities in 2003 reflected employer contributions to our principal defined benefit pension plan trust of $103.7 million where there had been no such contributions in the comparative prior years.
Net cash outflows for investing activities amounted to $57.4 million in 2003, $115.9 million in 2002 and $106.7 million in 2001. Investing cash outflows included capital expenditures of $80.5 million during 2003, $66.1 million in 2002 and $94.0 million in 2001. Cash outflows for businesses acquired amounted to $1.7 million in 2003, $50.3 million in 2002 and $30.2 million in 2001. We received proceeds from sale of businesses and assets of $24.8 million in 2003, $0.5 million in 2002 and $18.7 million in 2001.
Net cash outflows for financing activities amounted to $37.5 million in 2003, $15.1 million in 2002 and $56.1 million in 2001. In 2001, we completed the Arbitron spin-off, which required new financing arrangements. We combined a $225.0 million contribution by Arbitron with net new borrowings under revolving credit agreements and cash balances to pay off $456.6 million of outstanding senior notes. Net new borrowings under revolving credit agreements in 2001 amounted to $166.4 million. We reduced the debt remaining at December 31, 2001 by $44.6 million in 2002 and $49.6 million in 2003. We also made payments of capital lease obligations of $1.4 million in 2003. Financing cash outflows for repurchase of Ceridian common stock amounted to $28.8 million in 2003 and $5.4 million in 2002. Cash inflows from financing activities included exercises of stock options and employee stock purchases of $42.3 million in 2003, $34.9 million in 2002 and $9.1 million in 2001.
Significant changes in currency exchange rates resulted in adding $5.2 million to the carrying value of cash and equivalents in 2003 compared to negligible impacts in 2002 and 2001.
Further information on cash flows is presented in a following section of this discussion entitled “Financial Condition,” including the impact on cash flows of our reclassification of benefits services customer funds and obligations in 2003.
Results of Operations
Compared to 2002
Statements of Operations Comparisons
(Dollars in millions, except per share data)
Consolidated Results - Overview
The following factors, which significantly influenced the revenue and profitability performances of our business segments in 2003, are discussed in the following section of this discussion entitled “Business Segment Results.”
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Contributions from businesses acquired for HRS in
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Impact of currency rate changes on HRS international results of operations
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Growth in Comdata’s retail cards in use and processing
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New customers and service offerings in both business segments
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Higher levels of HRS invested customer funds and lower interest rates
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Acceleration of W-2 processing, delivery and billing into 2003 from 2004
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Lower sales of equipment and permitting services by Comdata
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Lower employment levels of our HRS customers
Our 2003 interest income decreased by $0.1 million compared to 2002 as the benefit of a higher average level of cash and equivalents was more than offset by lower interest rates.
Our 2003 interest expense declined by $1.8 million compared to 2002 as a result of a lower level of outstanding debt and lower interest rates. Our average outstanding borrowings under U.S. credit facilities decreased from $207.3 million for 2002 to $174.5 million for 2003. Our average effective interest rate on these facilities declined from 2.67% for 2002 to 2.25% for 2003. A further discussion of our financing arrangements can be found in Note J, “Financing,” to the consolidated financial statements and in the “Financial Condition” section of this discussion under the heading “Financing.”
Income taxes increased by $17.1 million from 2002 to 2003 due largely to the increase in earnings before income taxes. The reported effective tax rate decreased from 35.3% for 2002 to 35.0% for 2003.
Business Segment Results
Segment Comparisons
(Dollars in millions)
We measure the business performance of our business segments by reference to earnings before interest and taxes since consolidated interest income and interest expense are not allocated to those segments.
HRS. The increase of $57.0 million in HRS revenue in 2003 compared to 2002 reflected increases of $39.0 million from U.S. operations and $18.0 million from Ceridian Canada and Ceridian Centrefile operations. Businesses acquired during 2002 contributed $18.2 million of post-acquisition revenue growth to U.S. operations in 2003. The accelerated processing, delivery and billing of 2003 W-2 forms in December 2003, described in the section entitled “Management’s Summary” earlier in this discussion, contributed $9.5 million to the revenue increase from U.S. operations. Strengthening of the Canadian dollar and British pound sterling against the U.S. dollar added $19.2 million to 2003 revenue for our international operations.
Revenue from the return on invested customer funds increased by $1.3 million in 2003 with the benefit of a higher average invested balance contributing $10.3 million while a lower average yield reduced revenue by $9.0 million. The average balance of invested customer funds increased by $212.1 million, or 11.1%, to $2,138.4 million in 2003 from $1,926.2 million in 2002 largely due to growth in a new direct deposit payroll service and the effect of the strengthening Canadian dollar on Ceridian Canada invested customer funds. The average yield on invested customer funds declined to 4.41% in 2003 from 4.83% in 2002, including the benefit of our interest rate hedges.
Revenue from U.S. operations benefited in 2003 from increases of $25.5 million in payroll and tax filing services, $11.5 million in benefits services revenue and $2.0 million from our work life effectiveness and employee assistance programs (“LifeWorks”). In addition to the increased return on invested customer funds and the $9.5 million of additional W-2 revenue, the 2003 increase in payroll and tax filing revenue included an additional $17.4 million from net additions of customers receiving repetitive services and growth in sales of add-on services. The net benefit to payroll and tax filing revenue from price increases in 2003 amounted to $5.3 million. Employee populations for our continuing customers declined about 1% from the 2002 level, reducing payroll and tax filing revenue by $8.0 million in 2003. The $11.5 million increase in benefits services revenue in 2003 substantially related to the contribution of Great Lakes Strategies, a business that we acquired in December 2002. The $2.0 million increase in LifeWorks revenue reflected an additional $6.1 million from the commencement of service deliveries during the last
half of 2003 under a U.S. Department of Defense contract, which largely offset the revenue decrease from customer losses.
Ceridian Canada revenue increased by $14.4 million in U.S. dollar terms in 2003 and by $1.8 million without regard to changes in currency exchange rates. Increased revenue at Ceridian Canada from small business customers, add-on services and employee assistance services more than offset the decrease in revenue resulting from a reduced number of customer employees. Ceridian Centrefile reported $3.6 million more revenue in 2003 in U.S. dollar terms. Without regard to currency changes, Ceridian Centrefile revenue declined by $3.4 million in 2003. Major factors contributing to Ceridian Centrefile’s revenue decline included 2002 non-repetitive services for a major customer that was not replaced, lower levels of customer employees, and slippage of installations from late 2003 to 2004.
HRS costs and expenses increased by $17.3 million in 2003. If we exclude a net reduction in other expense (income) from 2003 compared to 2002 of $30.5 million, the increase in HR costs and expenses would be $47.8 million, in 2003. Other expense (income) for HRS in 2002 included unusual items that resulted in a net expense of $26.1 million that included write-downs of marketable securities and software, severance and other exit costs. We discuss these items in a section of this discussion entitled “Unusual Items.” In 2003, HRS other expense (income) reflects income of $4.4 million largely from a net gain from the sale of marketable securities and land not used in our business. Factors generally affecting the comparison of 2003 HRS costs and expenses to 2002 included costs associated with businesses acquired in 2002, the effect of currency exchange rate changes in 2003, and higher 2003 SourceWeb and pension costs.
Cost of revenue for HRS increased by $14.0 million in 2003. In U.S. operations, cost of revenue increased by $7.5 million in 2003 compared to 2002. Cost of revenue for U.S. payroll and tax filing operations increased by $6.2 million as costs associated with the 2003 offering of SourceWeb added $9.7 million and 2002 acquisitions added $4.4 million. Lower production and supplies costs and external contract and consulting costs reduced cost of revenue by $7.9 million. The acceleration of 2003 W-2 revenue into December 2003 did not have a material effect on the cost of revenue comparison, since the timing of incurrence of related costs was largely unaffected. Cost of revenue for benefits services increased by $3.4 million. The additional cost of revenue for Great Lakes Strategies, acquired in December 2002, and the impact of staff increases were offset in part by a reduction of external consulting costs incurred in connection with the transfer of certain benefits services operations begun in 2002 and completed in 2003. Cost of revenue for LifeWorks decreased by $2.1 million in 2003 due to staff reductions.
Cost of revenue in Ceridian Canada operations increased by $1.5 million in 2003 as currency rate changes added $5.2 million to the 2003 amount. Without regard to the currency effect, Ceridian Canada cost of revenue declined by $3.7 million due to changes in services mix and cost reduction efforts, particularly in the last half of 2003. Cost of revenue in Ceridian Centrefile operations increased by $5.0 million as currency rate changes added $3.5 million and additional costs, primarily associated with geographic market expansion and new customer implementations, added $1.5 million.
The 2003 increase in SG&A expense for HRS amounted to $29.1 million over the 2002 amount. Selling expense in HRS grew by $24.9 million in 2003 of which $19.4 million occurred in U.S. operations and $5.5 million in international operations. The increase of $19.4 million in U.S. operations reflected a higher staffing level, higher commissions related to the continued growth in orders, and incremental costs associated with businesses acquired in 2002 as well as $6.4 million related to the introduction in 2003 of SourceWeb. The $5.5 million increase in selling expense for Ceridian Canada and Ceridian Centrefile operations included a $2.1 million impact from currency rate changes and $3.4 million related in large part to increased marketing efforts and small business development.
General and administrative expense in HRS increased in 2003 by $4.2 million including an increase of $5.6 million for Ceridian Canada and Ceridian Centrefile operations that was offset in part by a reduction of $1.4 million in U.S. operations The $5.6 million increase included $3.8 million for Ceridian Canada of which $3.4 million related to currency rate changes and $1.8 million for Ceridian Centrefile, which included an addition of $2.2 million for currency rate changes. The $1.4 million decrease for
U.S. operations included a $9.2 million increased pension allocation that was more than offset by the effects of staff reductions and reduced provisions for incentive payouts in 2003.
R&D expense increased by $4.7 million over 2002 including $4.3 million of additional product development efforts related to SourceWeb in U.S. operations and the reassignment of resources from capitalized projects completed in 2002. The increase in other expense (income) from an expense of $26.1 million in 2002 to income of $4.4 million in 2003 is further discussed in the section below entitled “Unusual Items.”
Comdata. Comdata revenue increased by $5.2 million in 2003 compared to 2002 as revenue from retail card sales and processing grew significantly and improving general economic conditions began to benefit transportation revenue performance. Revenue from retail card sales and transaction processing increased by $14.8 million in 2003 over 2002 due to a higher level of cards in use and transaction volume and the addition of new customers. Revenue in the over-the-road business in 2003 was essentially unchanged compared to 2002. Revenue from sales of equipment to truck stops decreased by $7.2 million in 2003 as we believe customers continued to restrain their capital spending. Truck stop service fees decreased by $0.7 million. Business fleet revenue grew by $2.8 million in 2003 over 2002 as major local fueling customers increased their utilization of Comdata products and services. Phone services revenue declined by $2.9 million in 2003. Regulatory compliance revenue, including permitting and pilot services, declined by $2.0 million compared to 2002 as cooperative efforts by permit issuers continued to reduce the volume of transactions.
Comdata costs and expenses decreased by $7.3 million in 2003 compared to 2002. Cost of revenue increased by $5.6 million in 2003. Costs related to SVS card sales and processing increased by $9.2 million. The change in cost of revenue included a $4.6 million reduction for equipment sales to truck stops and an increase in bank fees of $1.7 million.
Comdata SG&A expense decreased by $2.7 million in 2003 compared to 2002. The decrease related primarily to a reduction of $2.1 million in the provision for doubtful accounts and $3.7 million due to the conclusion of certain contracted services and amortization on certain intangible assets in late 2002. The reduction in the provision for doubtful accounts reflected continued improvement in the quality of receivables in 2003 and a bankruptcy filing by a major customer in 2002. These decreases were offset in part by higher compensation expense and an increase of $3.1 million in allocated corporate costs due to higher pension costs. Other expense (income) decreased by $11.0 million in 2003 due primarily to the 2002 factoring receivables loss of $9.8 million and a September 2003 payment of $1.9 million to settle a dispute with a vendor. These costs are further described in the section below entitled “Unusual Items.”
Other. The reported other income of $4.1 million for 2002 results from reduction of a previously established accrual for environmental cleanup, based on a periodic review that took place in the first quarter of 2002. Further details on this other expense (income) item appears in the section of this discussion entitled “Unusual Items.”
2002 Compared to 2001
Statements of Operations Comparisons
(Dollars in millions, except per share data)
(*)
We eliminated goodwill amortization from reported 2001 amounts in order to compare with the required treatment for 2002. Its elimination reduced SG&A expense by $35.1 million and increased income taxes by $4.8 million. In turn, this increased earnings from continuing operations by $30.3 million and earnings per diluted share by 20 cents.
Consolidated Results - Overview
The following factors significantly influenced our revenue and profitability performances in 2002:
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Lower employment levels of our HRS customers
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Impact of lower interest rates on our investments of HRS customer funds
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Higher level of HRS payroll and tax filing installations
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Acquisitions and dispositions of businesses in HRS
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Higher levels of Comdata retail cards in use and processing
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Lower revenue from the sale of equipment and permitting services by Comdata
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Changes in fuel prices and transaction volumes at Comdata
As publicly reported employment levels in the private sector continued to fall during 2002, so did employment levels for our HRS customers, although at a slower rate of decline than we experienced in 2001. These lower employment levels translated into fewer fee-producing transactions and lower balances of customer funds available for revenue-producing investment. Interest rates continued to decline in 2002, though not as steeply as in 2001. Our strategy of investing a portion of customer funds in long-term securities and using interest rate contracts to reduce the variability in investment yields limited the adverse
effect of lower rates. While we continued to experience HRS customer deferrals of installations in 2002, the install rate increased significantly during the last half of the year. We disposed of our Usertech business in the third quarter of 2001; and in 2002, we acquired SYLINQ Corporation in March, HR Comply in June and certain assets of Great Lakes Strategies in December. We further describe our business and asset acquisitions in a note to our consolidated financial statements entitled “Investing Activity” and in the “Financial Condition” section of this discussion under the heading “Investing.”
Growth in Comdata’s retail card sales and processing business in 2002 compared to 2001 contributed significantly to revenue. Sales of point of sale terminals by Comdata slowed in 2002 along with the economy. Over the course of 2002, the volume of Comdata transportation card transactions increased modestly, while fuel prices rose over the prior year level in the fourth quarter of 2002. Further details are provided in the following section of this discussion entitled “Business Segment Results.”
Our total costs and expenses (without goodwill amortization of $35.1 million in 2001) for 2002 decreased by $15.3 million from the 2001 amount. Cost of revenue decreased by $0.7 million while SG&A expense increased by $7.0 million. R&D expense changed little between the two years. Other expense (income) amounted to $34.3 million in 2002 compared to $48.2 million in 2001, down $13.9 million. The principal contributors to other expense (income) in 2002 included unusual items consisting of asset write-downs of $24.6 million involving minority investments, software and factoring receivables and net charges of $10.2 million largely related to business consolidation efforts. Other expense (income) for 2001 included unusual items consisting of $53.7 million of litigation costs and $12.8 million of asset write-downs and consolidation costs, offset by gains of $18.2 million from marketable and derivative securities. Unusual items reported in other expense (income) are described in the section of this discussion entitled “Unusual Items.” Further details on total costs and expenses are provided in the following section entitled “Business Segment Results.”
Our 2002 interest income decreased by $4.4 million compared to 2001 due largely to lower rates. We also received interest income in 2001 related to a tax refund and from yields on an accumulation of cash in the first quarter of 2001 in preparation for the Arbitron spin-off.
Our 2002 interest expense declined by $12.4 million compared to 2001 as a result of a lower level of outstanding debt and lower interest rates. By the end of 2001, we had paid all amounts outstanding under our Canadian revolving credit agreements. At the time of the Arbitron spin-off in March 2001, we retired $430.0 million of 7.25% senior notes by using a $225.0 million payment by Arbitron, a drawing of $235.0 million on our U.S. revolving credit facility and existing cash balances. The Canadian facility and the senior notes contributed $8.3 million to 2001 interest expense. During 2002, we reduced our borrowings under U.S. credit facilities from $235.0 million to $190.0. The average outstanding balance under these facilities decreased from $208.6 million in 2001 to $207.3 million in 2002. Our average effective interest rate on these facilities declined from 4.73% in 2001 to 2.67% in 2002. A further discussion of our financing arrangements can be found in a note to the consolidated financial statements entitled “Financing” and in the “Financial Condition” section of this discussion under the heading “Financing.”
Income taxes, excluding the effect of goodwill, increased by $12.4 million from 2001 to 2002 due largely to the increase in earnings before income taxes. The reported effective tax rate decreased from 41.3% for 2001 to 35.3% for 2002 largely due to the elimination of goodwill amortization for financial reporting purposes in 2002. Much of the goodwill amortization was not tax deductible.
Business Segment Results
Segment Comparisons
(Dollars in millions)
We measure the business performance of our business segments by reference to earnings before interest and taxes since consolidated interest income and interest expense are not allocated to those segments.
(*)
We eliminated goodwill amortization from reported 2001 amounts in order to compare with the required treatment for 2002. Its elimination reduced SG&A expense and increased EBIT by $26.2 million for HRS and $8.9 million for Comdata.
HRS. The increase in HRS revenue in 2002 compared to 2001 reflected increases of $3.6 million from ongoing U.S. operations and $7.8 million from HRS operations at Ceridian Canada and Ceridian Centrefile. The sale of our Usertech employee training business in August 2001 adversely affected the comparison by $7.1 million, reducing the net increase over 2001 to $4.3 million. Businesses acquired during 2002 provided $6.4 million of the U.S. operations revenue benefit to the comparison, as well as post-acquisition revenue growth.
Revenue from U.S. operations in 2002 benefited from increases of $8.3 million in benefits services revenue and $4.3 million from LifeWorks, due primarily to acquisitions. Payroll and tax filing services in the U.S. experienced a $9.0 million reduction in revenue compared to 2001. The reduced revenue largely reflected lower customer employment levels and lower investment yields. The decline in customer employment levels was at approximately 1.5% at the end of 2002 compared to approximately 3% at the end of 2001. We estimate that 1.5% decline represents approximately $20.6 million of lost revenue in 2002. Interest income from investment of customer funds included in HRS revenue decreased by $13.0 million as the average yield fell from 5.50% for the 2001 period to 4.83% for the 2002 period. The revenue comparison benefited from a higher level of payroll and tax filing installations, particularly in the last half of the year, and a targeted price increase effected in the first quarter of 2002. The average balance of these investments for 2002 remained at the 2001 level as the benefit from a pickup in installations offset the adverse effect of the decline in the number of employees of existing customers and lower U.S. federal income tax withholding resulting from tax rate reductions effective in July 2001 and January 2002.
Revenue performance for Ceridian Canada changed little from the 2001 level in 2002 as the adverse effects of lower employment levels at larger customers and lower investment yields were largely offset by growth in the small business market and nonrecurring sales. Ceridian Centrefile produced $7.8 million more revenue in 2002 than in 2001 due to growth in outsourcing revenue and expansion of services offerings. Changes in foreign currency exchange rates benefited the international operations revenue comparison by $1.6 million in 2002.
During 2002, we had in place active interest rate contracts covering an average of $800.0 million of short-term customer funds investments that, at December 31, 2002, had an average floor of 5.08% and cap
of 5.91%. These contracts, along with longer term investments and floating rate debt, reduced the impact of the decline in interest rates during 2002. During 2002, use of these interest rate contracts benefited revenue cash flows by $26.9 million and is expected to benefit 2003 revenue cash flows by $29.0 million based on expected future interest rates. Interest rate contracts are further discussed in Note A, “Accounting Policies,” (under the heading “Cash and Investments, including Derivatives”) and Note K, “Commitments and Contingencies,” and in Part II, Item 7A of this report.
HRS costs and expenses (without 2001 goodwill amortization of $26.2 million in SG&A expense) increased by $28.6 million from 2001 to 2002. An increase in other expense (income) of $22.5 million represented the largest part of the increase. The sale of Usertech in August 2001 resulted in reductions of $5.4 million in the cost of revenue comparison, $3.3 million in the SG&A comparison and $3.3 million in the other expense (income) comparison.
Cost of revenue (without Usertech) increased by $5.3 million in 2002 compared to 2001. The consolidation of 25 district processing centers into four regional centers and other productivity efforts during the past two years reduced U.S. payroll and tax filing cost of revenue by $15.6 million compared to 2001, primarily by staff reductions. Higher levels of depreciation and amortization and increased royalties added $3.2 million to payroll and tax filing cost of revenue in 2002.
In 2002, we benefited from a full year of cost of revenue savings of $4.0 million from the 2001 LifeWorks consolidation of our Boston, Massachusetts operation into our Philadelphia, Pennsylvania operation. We also incurred incremental costs in LifeWorks of $1.2 million in 2001 related to the 9/11 event. We reduced our LifeWorks costs in 2002 by another $4.4 million largely by bringing research activities in-house that had been provided by outside consultants. Cost of revenue of $3.8 million from the addition of HR Comply in 2002 offset these LifeWorks savings.
Cost of revenue in benefits services operations increased by $17.1 million of which $3.3 million resulted from the added costs of SYLINQ and Great Lakes Strategies in 2002. Early in 2002, we closed facilities in California and Virginia and transferred their retirement planning services activities into other benefits services operations. In connection with this consolidation, we incurred transitional and additional systems costs of approximately $6.8 million in the third and fourth quarter of 2002 that were included in cost of revenue. Other increases in benefits services operations cost of revenue of $7.0 million in 2002 related primarily to a higher volume of activity and reassignment of staff to administrative functions.
Cost of revenue in Ceridian Canada operations increased by $2.6 million in 2002 due primarily to an increase in the proportion of revenue from nonrecurring sales and the introduction of new service offerings. Cost of revenue in Ceridian Centrefile operations increased by $3.8 million primarily as a result of revenue growth and geographic market expansion.
The 2002 increase in SG&A expense (without goodwill amortization and Usertech) for HRS amounted to $7.3 million over the 2001 amount. Selling expense in HRS grew by $11.9 million in comparison to 2001 reflecting increased marketing efforts in the U.S. operations and at Ceridian Centrefile, and higher commissions arising from the continued growth in orders. The increased marketing effort in U.S. operations related in large part to acquired businesses and small business development. Usertech expenses, eliminated by its sale, reduced the increase in selling expense by $0.9 million. General and administrative expense in 2002 decreased by $4.6 million, primarily in U.S. operations, due to the elimination of 2001 Usertech expenses of $2.4 million from the comparison. Cost savings from facility consolidations and reduced provisions for incentive compensation further reduced these costs. R&D expense increased by $2.2 million over 2001, reflecting additional U.S. payroll, benefit services and tax filing services product development efforts. The increase in other expense (income) from $3.6 million in 2001 to $26.1 million in 2002 is further discussed in the section of this discussion entitled “Unusual Items.”
Comdata. Comdata revenue increased by $7.7 million in 2002 compared to 2001. Over-the-road transportation revenue decreased by $1.0 million as a 1% increase in transaction volume was more than offset by the impact of lower fuel prices. Revenue from retail card sales and processing for 2002 increased
by $12.1 million. Revenue from sales of equipment to merchants decreased by $4.5 million in 2002 as we believe customers restricted their capital spending; while truck stop service fees increased by $2.8 million. Business fleet revenue grew by $2.1 million in 2002 over 2001 as major local fueling customers increased their utilization of Comdata products and services. Phone services revenue declined by $2.0 million in 2002. Regulatory compliance revenue, including permitting and pilot services, declined by $4.6 million compared to 2001 as cooperative efforts by permit issuers continued to reduce the volume of transactions. Factoring operations contributed an additional $3.9 million to 2002 revenue over 2001.
Comdata reduced costs and expenses (without 2001 goodwill amortization of $8.9 million) by $46.1 million in 2002 compared to 2001. Costs of revenue related to retail card sales and transaction processing increased by $9.0 million in 2002 compared to 2001. Reductions in cost of revenue included $1.5 million of lower phone services costs. The lower levels of sales of equipment to merchants and regulatory compliance services and renegotiated telecommunications rates also contributed $2.5 million to reducing cost of revenue. Cost savings in 2002 from operating efficiency efforts in customer relations and technology functions produced a $3.6 million reduction in cost of revenue and a $1.9 million reduction in R&D expense compared to 2001. Comdata increased its provision for doubtful accounts in general expense by $1.3 million in 2002 over 2001 due largely to a bankruptcy filing by a major customer. Other expense (income) included a $9.8 million factoring receivables loss in the third quarter of 2002 and $52.4 million of litigation costs in the second quarter of 2001. Costs related to the cancellation of the outsourced transaction processing contract and facility consolidations, included in other expense (income), declined from $6.6 million in 2001 to $3.0 million in 2002. These other expense (income) items are further described in the section below entitled “Unusual Items.”
Other. The reported other income of $4.1 million for 2002 results from reduction of a previously established accrual for environmental cleanup, based on a periodic review that took place in the first quarter of 2002. The reported other income for 2001 includes a gain of $15.6 million related to sales of marketable securities described in the note to consolidated financial statements entitled “Investing Activity.” The 2001 gain was reduced by a provision for litigation costs not allocated to the business segments. Further details on these unusual gains and losses appear in the following section of this discussion entitled “Unusual Items.”
Unusual Items
The comparison of our earnings from continuing operations is significantly affected by a number of unusual events and transactions. We also have presented information on this subject in a note to our consolidated financial statements entitled “Supplementary Data to Statements of Operations.”
Unusual Losses (Gains or Recoveries)
(Dollars in millions)
During September 2003, we sold 785,000 common shares of Ultimate for proceeds of $5.9 million and a net gain of $3.0 million. In addition we sold 137,158 common shares of U.S.I. Holdings Corporation (“USIH”)for proceeds of $1.8 million and a net gain of $0.4 million. During the fourth quarter of 2003, we sold parcels of land not used in operations in St. Petersburg, Florida and New Albany, Indiana for a gain of $1.6 million. We further describe these transactions in a note to our consolidated financial statements entitled “Investing Activity.” During the third quarter of 2003, Comdata settled a contract dispute with a vendor by making a payment of $1.9 million.
During the first quarter of 2002, we announced a series of actions intended to consolidate certain operations in both of our business segments and recorded accrued exit costs of $9.0 million. A plan to consolidate certain HRS payroll and tax filing processing services, previously conducted in 25 district offices, into four regional processing centers resulted in the accrual of $7.5 million for exit costs. We completed this effort before the end of 2002 and estimate that we saved approximately $6.5 million during 2002, primarily from staff reductions, and anticipate that we will reduce our costs by approximately $12 million annually going forward. Of the $7.5 million accrual, $5.3 million related to severance costs for 317 employees all of whom were terminated by December 31, 2002, and $2.2 million represented other exit costs, primarily related to lease terminations. Consolidation of certain Comdata facilities resulted in accrued severance costs of $1.0 million for 76 employees, including 67 terminated by December 31, 2002 with the remainder in 2003, and other exit costs of $0.5 million, primarily related to lease terminations.
HRS recorded a $4.9 million asset write-down of internally developed software costs in the first quarter of 2002 as a result of the February 2002 acceptance of the software technology provided under a March 2001 agreement with Ultimate. Also during the first quarter of 2002, we conducted a periodic reassessment of our environmental obligation. This obligation relates to the 1989 sale by our predecessor (Control Data Corporation) of its disk drive operations, which involved remediable environmental sites. The sale agreement provided terms describing how remedial costs related to remediable environmental sites would be shared between the buyer and us as the seller. The terms of the agreement included periodic joint reviews of the obligation by the buyer and us. Our obligations covered only those sites identified prior to the fifth anniversary of the sale. At the time of the sale, we established an accrual for our estimated costs that might occur as a result of this agreement. During the first 10 years following the sale, both parties incurred significant costs, which then began to reduce as these sites entered a water extraction and monitoring stage. During the first quarter of 2002, we participated in a periodic review of the status of this obligation with the environmental officer of the buyer. A site visit was made by our environmental representative at that time, and it was determined that our estimated liability was
$4.1 million less than previously determined. The excess accrual was then credited back to earnings as a component of other expense (income).
During the third quarter of 2002, we examined purchases of receivables from certain trucking companies by Comdata’s factoring business that had grown rapidly during 2002 and found that the debtors could not be verified. In the meantime, the parties that had sold us the receivables declared bankruptcy. We also made certain modifications to our policies and procedures related to the factoring business. We recorded the full amount of the loss of $9.8 million, including $0.3 million of investigative costs incurred. Due to the unusual and non-recurring nature of the loss, we have reported the loss as other expense (income).
In the fourth quarter of 2002, we reviewed the status of accrued exit costs and revised the estimated amounts to reduce the severance cost provisions made by HRS in the first quarter of 2002 by $0.8 million and in the first quarter of 2000 by $0.3 million and by Comdata in the first quarter of 2002 by $0.3 million. We also incurred additional expense in HRS for severance costs of $1.3 million, involving 81 employees, and other exit costs of $2.9 million and in Comdata for severance costs of $0.6 million, involving 41 employees, and other exit costs of $1.1 million. We paid all of the additional HRS severance costs during the fourth quarter of 2002. The other exit costs largely represented lease commitments, net of expected recoveries.
Also in the fourth quarter of 2002, HRS recorded a $7.8 million write-down of the carrying values of certain marketable equity and cost-based investments, recorded a $1.8 million loss related to derivatives and wrote off the $0.3 million carrying value of an abandoned software product. The investment write-down related primarily to our December 2001 cost-based investment in USIH preferred stock in connection with a joint marketing agreement, which was converted to common stock as a result of an initial public offering in October 2002. The $1.8 million loss on derivatives represented the amortization of a portion of the previously deferred $2.6 million gain on derivatives recorded in the first quarter of 2001. The remaining $0.8 million was charged to operations during 2003 as the derivatives to which the deferred gain relates expired. We also recorded $0.8 million of other unusual costs in HRS for a litigation settlement.
The 2001 gain on sale of marketable securities of $15.6 million related to our sale of HotJobs.com, Ltd. common stock and is further described in Note G, “Investing Activity,” to our consolidated financial statements. The gain on derivative securities of $2.6 million resulted from the application of FAS 133 as amended and interpreted at that date. The second quarter 2001 litigation costs include a settlement of $49.0 million and associated costs of $3.4 million related to litigation involving Comdata and a provision of $1.3 million for litigation costs not allocated to our business segments. The litigation settlement and associated costs at Comdata related to an action brought by Flying J, Inc. The nature and facts and circumstances of this litigation are fully disclosed in Note K, “Legal Matters,” to our consolidated financial statements for the year ended December 31, 2000, and the resulting settlement is fully disclosed in Part II, Item 1, “Legal Proceedings,” of our Quarterly Report on Form 10-Q, for the quarterly period ended June 30, 2001. The additional provision of $1.3 million for litigation costs not allocated to our business segments related to disputes involving postretirement benefits.
During the first quarter of 2001, we took certain actions in Comdata and HRS that were expected to improve operational efficiency, take advantage of technological opportunities and further focus our HRS businesses. These actions resulted in accrued exit costs of $9.9 million and asset write-downs of $6.1 million. We paid these accrued exit costs in full by the end of 2001. We also recovered $3.2 million of costs accrued during the first quarter of 2000, due to a revision of the estimated cost related to those actions.
In February 2001, Comdata terminated an outsourced contract for transaction processing and software development and brought those activities in-house. This action was intended to improve management control over these activities and reduce costs. The termination charge of $6.6 million was recorded and paid during the first quarter of 2001. In order to implement the in-house operation, Comdata hired a number of personnel from the outsourcing contractor and made incremental investments in
capitalized equipment and software of $7.4 million in the same quarter. During the course of 2001, Comdata realized cost savings of approximately $10.8 million related to this action.
In March 2001, HRS transferred most of its LifeWorks employee effectiveness services operation in Boston, Massachusetts into a related operation in Philadelphia, Pennsylvania; and we decided to sell our Usertech employee training business. As a result of these actions, unrecoverable goodwill of $1.9 million related to Usertech and $1.1 million of equipment related to the Boston operation were recorded as asset write-downs. We sold Usertech in the third quarter of 2001. In addition, HRS charged $2.3 million of severance costs for approximately 250 employees and $1.0 million of excess facility costs to operations and recorded these costs as accrued exit costs. These charges were offset in part by the recovery of $3.2 million of the estimated severance costs accrued in the first quarter of 2000, due primarily to a reduction in the scale of the downsizing of the St. Louis, Missouri customer services operations. Also in March 2001, HRS reassessed its strategy for developing software to serve its middle market payroll and tax filing customers and conducted an impairment review of internally developed software related to this effort. As a result, $3.1 million of unrecoverable cost related to this software development effort was recognized as an asset write-down.
Financial Condition
Consolidated Statements of Cash Flows Highlights
(Dollars in millions)
Reconciliation of Earnings to Cash Inflows (Outflows) from Operating Activities
(Dollars in millions)
We describe in the note to our consolidated financial statements entitled “Customer Funds” the effect on the consolidated statements of cash flows of a reclassification of benefit services customer funds effective in 2003. Prior periods have been conformed to the current presentation.
Cash Flows
Cash Balances and Operations
Our cash and equivalents decreased by $10.1 million to $124.2 million during 2003 as we used operating cash flows and cash balances to fund investing activities, repay debt and contribute to our retirement plan trusts. The operating cash flows for 2003 included payments of $105.5 million for employer contributions to our pension plans for employees in the U.S. and the United Kingdom. In 2002, our cash and equivalents increased by $18.1 million to $134.3 million as operating cash flows provided funds for investing and to reduce debt. During 2001, cash and equivalents increased by $11.1 million to $116.2 million as strong operating cash flows fully funded investing activities and provided funding for debt reduction.
During 2003, our operating cash flows were $79.6 million compared to $148.9 million in 2002. This decrease of $69.3 million was due mostly to an increase in pension contributions of $102.2 million. When comparing the working capital cash flows for 2003 and 2002, the $36.6 million additional cash usage of other current assets and liabilities is largely due to an increase in Comdata receivables and a decrease in Comdata drafts and settlements payable.
Our operating cash flows from continuing operations decreased by $25.8 million during 2002 as compared to 2001 primarily due to an increase in receivables at the end of 2002. Cash provided by earnings from continuing operations grew by $24.1 million in 2002 while cash outflows from continuing operations working capital activities reduced operating cash flows by $49.9 million. Our 2001 operating cash flows from earnings included the $34.1 million after-tax effect of the nonrecurring Comdata litigation costs described in the previous section of this discussion entitled “Unusual Items.” The decrease in the amount of depreciation and amortization largely reflects the elimination from earnings of the charge for goodwill amortization effective for 2002. The increased use of cash for working capital activities reflected a net cash outflow from a build-up of receivables in 2002 of $37.9 million compared to a $42.8 million net cash inflow from liquidation of receivables in 2001. When comparing the working capital cash flows for 2002 to 2001, the total $80.7 million increase in cash utilized by receivables related substantially to Comdata receivables activity and was offset in part by an increase of $26.4 million in cash provided by Comdata drafts payable in those periods. Comdata receivables increased by $26.2 million during 2002 compared to a decrease of $55.5 million during 2001. The increase during 2002 reflected increases in factoring, business fleet and retail card receivables, offset in part by a decrease in other transportation receivables. The relationship of the period-end date and the timing of weekly draft clearing operations at Comdata at December 31, 2001 also affected the comparison of net cash provided by or utilized for drafts payable and receivables outstanding in 2002 and 2001.
Investing
Our 2003 investing activity related to capital expenditures of $30.3 million for property and equipment and $50.2 million for software and development costs, including an additional $6.9 million for SourceWeb, which we offered to customers in the first quarter of 2003. In March 2003, we spent $3.0 million to acquire 750,000 shares and a warrant to purchase an additional 75,000 shares of Ultimate. During September 2003, we sold 785,000 Ultimate common shares purchased on the open market in years prior to 2003 for $5.9 million and 137,158 common shares of USIH for $1.8 million. Also during 2003, we received $1.4 million returned from an earn-out escrow related to the acquisition of Great Lakes Strategies, $12.1 million for assets sold relative to two sale leaseback transactions, and $4.3 million for sale of land not used in our businesses.
During 2002, our investment in capital expenditures included $31.1 million for property and equipment and $35.0 million for software and development costs. The software development costs included $10.0 million for development of SourceWeb. During 2002, we also spent $15.6 million to acquire SYLINQ, $8.9 million for HR Comply, $19.0 million for Great Lakes Strategies and a total of $6.8 million for other acquisitions. We described these transactions further in the note to consolidated financial statements entitled “Investing Activity.”
During 2001, our investment in capital expenditures included $43.2 million for property and equipment and $50.8 million for software and development costs, of which $23.6 million of software and development spending took place during the first quarter. Software and development costs also included a payment of $10.0 million to Ultimate to acquire a non-exclusive software license to be used in the development of a web-enabled payroll/HR/self-service offering for HRS called SourceWeb. Cash expended for acquisitions during 2001 included $20.2 million for minority investments, including $15.0 million for USIH, intended to expand product offerings in HRS as further discussed in the note to the consolidated financial statements entitled “Investing Activity.” Proceeds from sales of businesses and assets of $18.7 million for 2001 principally represented our sale of common stock of HotJobs.com, Ltd., which provided proceeds of $15.6 million.
Financing
During 2003, we repurchased 1,844,100 shares of our common stock for $28.8 million on the open market at an average net price of $15.60 per share. Proceeds from exercises of stock options and employee stock plan purchases amounted to $42.3 million during 2003 compared to $34.9 million in 2002. Also during 2003, we entered into two capital lease arrangements resulting in an obligation of $22.2 million to be paid over a 60-month period. We also reduced our borrowings under our domestic revolving credit facility by $40.0 million and our receivable securitization facility by $10.0 million. At December 31, 2003, under our $350.0 million domestic revolving credit facility, we had $347.7 million of unused borrowing capacity. Of that amount, we have designated $140.0 million as backup for the amount outstanding under the receivables securitization facility, which leaves $207.7 million available for other purposes.
In June 2002, Comdata entered into a $150.0 million receivables securitization facility. The facility has up to a three-year term and uses certain of Comdata’s trade receivables as collateral for borrowings. At December 31, 2002, $150.0 million had been drawn against and remained outstanding under this facility. We used those proceeds and additional payments of $45.0 million to reduce borrowings under our $350.0 million revolving credit facility to $40.0 million at the end of 2002. These advances, along with a $2.3 million letter of credit, left us with unused borrowing capacity of $307.7 million, of which we designated $150.0 million as backup to the Comdata receivables securitization facility. Proceeds from exercises of stock options and employee stock plan purchases during 2002 amounted to $34.9 million compared to $9.1 million in 2001. Higher market prices for Ceridian stock, particularly in the second quarter of 2002, resulted in a higher level of option exercises, which produced the increased proceeds. We purchased 393,000 shares of our common stock on the open market during the last half of 2002 for $5.4 million at an average price, including commissions, of $13.74 per share. When we disposed of the $182.9 million net liabilities of Arbitron discontinued operations at the time of the Arbitron spin-off, our retained earnings increased by that amount. During the third quarter of 2002, we reduced this amount and our net deferred tax asset by $5.7 million based on the filing of 2001 tax returns for the entities involved in the Arbitron spin-off. We discuss the Arbitron spin-off in the section entitled “Discontinued Operations” of the note to our consolidated financial statements entitled “Supplementary Data to Statements of Operations.”
Our financing activities in 2001 largely involved transactions related to the Arbitron spin-off. At the time of the Arbitron spin-off, advances of $235.0 million from the January 2001 credit facility, a $225.0 million Arbitron payment and existing cash balances funded the required early retirement of the $430.0 million of senior notes outstanding and payment of the $50.0 million balance outstanding under the $250.0 million domestic revolving credit facility dated July 1997. The redemption of senior notes required a payment of $456.5 million. The establishment of the January 2001 credit facility resulted in the payment of $1.0 million for origination costs to be amortized over the term of the facility. During the second quarter of 2001, we drew an additional $50.0 million of advances on the January 2001 credit facility in connection with the litigation settlement described earlier in this discussion under the heading “Unusual Items.” During 2001, we reduced outstanding advances by payments of $50.0 million to $235.0 million. Another $2.0 million of the credit line was utilized for letters of credit at December 31, 2001. In addition, payments of $18.8 million and currency translation adjustments of $0.3 million extinguished the balance of
$19.1 million outstanding on our Canadian revolving credit agreements at December 31, 2000 leaving only a $0.9 million letter of credit outstanding at December 31, 2001. Financing cash flows in 2001 also included cash inflows of $9.1 million from exercises of stock options and employee stock plan purchases.
For further information on financing cash flows, see a note to our consolidated financial statements entitled “Financing,” and the following section entitled “Liquidity and Capital Resources.”
Liquidity and Capital Resources
We expect to meet our liquidity needs from existing cash balances, cash flows from operations and borrowings under external credit facilities. Cash balances and cash flows are discussed under the section of this discussion entitled “Financial Condition.” Cash flows from operations are primarily influenced by the same factors that influence revenue as discussed in a preceding section of this discussion entitled “Results of Operations” and in several of the items in the following section entitled “Cautionary Factors That Could Affect Future Results.” Cautionary factors of particular relevance include those that refer to the effects of government regulations on such matters as the timing of tax payments, interest rates, employee benefits, and funds transfer activities; our ability to attract new customers and retain our existing customers; and general economic conditions.
Our expenditures for capital assets and software presently planned for 2004 are expected to be in a range between $75.0 million and $80.0 million with an estimated allocation of 90% to HRS and 10% to Comdata. We also plan to continue to grow our businesses through strategic acquisitions.
As described in the preceding discussion of financing activities in the “Financial Condition” section of this discussion, we have been opportunistically repurchasing Ceridian common stock since late 2002. We repurchased 393,000 shares in 2002 and 1,844,100 shares in 2003. In 2004, we plan to utilize approximately half of our free cash flow (defined as operating cash flows minus capital expenditures) to continue this opportunistic repurchase program. We presently estimate that free cash flow for 2004 may be in the range of $140 million to $150 million. As of December 31, 2003, we were authorized to purchase up to 10,362,900 additional shares of our common stock under an existing authorization from our board of directors. We generally use our treasury stock to address our obligations under our stock compensation and employee stock purchase plans.
As of December 31, 2003, we have unused borrowing capacity under the $350.0 million revolving credit facility amounting to $347.7 million of which we have designated $140.0 million as backup to the Comdata receivables securitization facility. We are in compliance with all covenants related to these facilities.
We have entered into lease and other contractual commitments that are not reflected on our consolidated balance sheet at December 31, 2003, under generally accepted accounting principles. The table below describes the annual cash payments for which we are obligated under our financing agreements, which are reported on our balance sheet, and our lease agreements and significant contractual commitments, which are not on our balance sheet, at that date.
Contractual Obligations at December 31,
(Dollars in millions)
(*)
See discussion at the end of this section
Our long-term debt and capital lease obligations are described in the preceding comments on financing cash flows in the “Financial Condition” section of this discussion and in a note to our consolidated financial statements entitled “Financing.” Since we have the capability and intention of continuing our use of short-term borrowings under our Comdata receivables securitization facility until it matures in June 2005 and our revolving credit facility until the facility matures in 2006, the outstanding balances are treated as due on those maturity dates. We expect that we will renew or replace these facilities when they mature.
We conduct a substantial portion of our operations in leased facilities. Most of these leases contain renewal options and require payments for taxes, insurance and maintenance. We also lease equipment for use in our businesses. In the table above, we include our on-balance-sheet capital lease obligations with our debt payments and our off-balance-sheet operating lease commitments as lease payments.
In March 2001, we entered into an agreement with Ultimate that provided us with a non-exclusive license to use Ultimate’s software as part of a Web-enabled integrated payroll/HR/self-service offering to our small business customers. Our initial payment to Ultimate amounted to $10.0 million, which provided us with a non-exclusive license to use its software product in our product offerings. This payment was partially refundable pending successful transfer of the technology. Amendments to the license agreement in August 2001 and February 2002 eliminated any refundable nature of the initial payment and deemed the technology transfer complete as of February 2002. In February 2002, we additionally agreed to pay Ultimate $0.5 million if an upgraded release were to be delivered prior to August 31, 2002, which did occur. The $10.5 million is accounted for as purchased software under SOP 98-1 and amortized on a straight-line basis over a seven-year period that began in March 2003 when our SourceWeb software product incorporating this Ultimate software was placed in service.
Pursuant to the February 2002 amendment, the license agreement also provided for a monthly royalty commencing in January 2003, which is based on the number of our customers’ employees paid by using the software and subject to minimum and maximum amounts. Pursuant to the February 2002 amendment, we made an advance payment of $6.0 million to Ultimate at that time representing the minimum royalty commitment for 2003. We remain obligated to future minimum monthly payments of $0.5 million per month from January 2004 until January 1, 2006, when the per-employee monthly charge will escalate at a rate of 5% per annum until the end of the noncancellable term in March 2008. We recorded the $6.0 million payment as prepaid expense and amortized this amount to cost of revenue on a straight line basis over the 12 months of 2003. Royalty costs under this agreement will be charged monthly to cost of revenue and paid according to the terms of the agreement.
In connection with the acquisition of certain call center assets in December 2002, we entered into royalty and services arrangements that are noncancelable for the first 36 months. Under these arrangements, we are obligated to make minimum payments of $2.2 million in each of 2004 and 2005.
With regard to other long-term obligations, we report on our accompanying balance sheet as of December 31, 2003 a liability for employee benefit plans of $196.4 million. This liability includes a minimum pension benefit obligation of $145.1 million and employee benefit plan obligations of $51.3 million. During 2003, we reduced the minimum pension benefit obligation for our principal pension plan by making employer contributions of $103.7 million. We do not presently plan to make additional contributions to the principal pension plan in 2004. Subsequent developments in investment performance, interest rates or regulatory actions may require a reconsideration of this position. Annual contributions to our supplemental U.S. pension plan and the curtailed Ceridian Centrefile plan are not expected to exceed $4.0 million in 2004.
Expected future payments toward our postretirement and post-employment benefit obligations of $51.3 million at December 31, 2003 are more difficult to assess. We expect that employer contributions toward these obligations for 2004 will be $7.0 million. With the prospective effects of assumed increased health care costs and the offsetting benefit provided by the Medicare Act (Medicare Prescription Drug, Improvement and Modernization Act of 2003) as described in a note to the consolidated financial
statement entitled “Retirement Plans,” we do not believe that we can make a reliable estimate of future employer payments toward these obligations at this time.
Critical Accounting Policies and Estimates
The preparation of the financial statements in accordance with generally accepted accounting principles requires us to make judgments, estimates, and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Areas that require significant judgments, estimates, and assumptions include the assignment of fair values upon acquisition of goodwill and other intangible assets and testing for impairment, the capitalization, amortization and impairment testing of software and development costs, the determination of our liability for pensions and other postretirement benefits, and tax matters. We use historical experience, qualified independent consultants and all available information to make these judgments and estimates, and actual results will inevitably differ from those estimates and assumptions that are used to prepare the company’s financial statements at any given time. Despite these inherent limitations, we believe that our Management’s Discussion and Analysis of Financial Condition and Results of Operations and consolidated financial statements and related notes provide a meaningful and fair perspective of our company. Further discussion of the judgments and uncertainties associated with our business can be found in the section of this discussion entitled “Cautionary Factors That Could Affect Future Results” and Part II, Item 7A of this report.
A summary of our significant accounting policies is included in Note A, “Accounting Policies,” to our consolidated financial statements. We believe that the application of these policies on a consistent basis enables us to provide our shareholders with useful and reliable information about our operating results and financial condition.
Assignment of fair values upon acquisition of goodwill and other intangible assets and testing for impairment.
In 2002, we adopted new standards of accounting for business combinations (FAS 141) and for goodwill and intangible assets (FAS 142). We discuss the effect of the adoption of these standards in the section entitled “Goodwill and Other Intangibles” in Note A. In the event of a business combination where we are the acquiring party, we are required to assign fair values to all identifiable assets and liabilities acquired, including intangible assets such as customer lists, trademarks, technology and covenants not to compete. We are also required to determine the useful life for amortizable assets acquired. These determinations require significant judgments, estimates, and assumptions; and, when material amounts are involved, we generally utilize the assistance of independent valuation consultants. The remainder of the purchase cost of the acquired business not assigned to identifiable assets or liabilities is then recorded as goodwill. Although goodwill is no longer subject to amortization after January 1, 2002, the carrying value is subject to periodic review, at least annually, for impairment of that value.
We reassess the carrying value of goodwill annually, or more frequently when certain developments occur, using a discounted cash flow model (DCF model) to determine the current fair value of the business. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market share, sales volumes and prices, costs to produce, and working capital changes. We consider historical experience and all available information at the time the fair values of our businesses are estimated. However, actual fair values that could be realized in an actual transaction may differ from those used to evaluate the impairment of goodwill. The evaluation of impairment involves comparing the current fair value of the business to the recorded value (including goodwill).
We also test long-lived assets, including other intangible assets, under the guidance of FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” whenever events or changes in
circumstances indicate that the carrying value of such an asset or group of assets may not be recoverable. Events or circumstances that might indicate an impairment of carrying value include:
•
a significant decrease in the market value of the asset or asset group
•
a significant adverse change in the extent or manner in which the asset or asset group is used or in its physical condition
•
a significant adverse change in legal factors or in the business climate that could affect the value of the asset or asset group, including an adverse action or assessment by a regulator
•
an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset or asset group
•
a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the asset or asset group.
When the need for such a test is indicated, we consider such factors as whether the amortization of the carrying values for these assets for each operating unit can be recovered through forecasted undiscounted cash flows over their remaining economic life.
Capitalization, amortization and impairment testing of software and development costs
Our software and development efforts are substantially for internal use and, as indicated in Note A, “Accounting Policies” to our consolidated financial statements, in the section entitled “Software and Development Costs,” of Note A, “Accounting Policies,” we rely on SOP 98-1 for accounting guidance. Therefore, for our modification or development efforts, we need to identify by nature and by stage of development those costs which are to be capitalized rather than charged to operations as incurred. We also need to identify the point at which the modified or developed software is ready for use, capitalization of cost will cease and amortization of that cost will begin. Costs incurred subsequent to the ready for use date will generally be charged to operations and only capitalized if justified as a material improvement in the functionality of the capitalized software product.
With regard to the recoverability of capitalized software and development costs, we regularly perform an assessment of our ability to recover the costs invested in these assets. The net amount of these costs shown on our consolidated balance sheet at December 31, 2003 was $136.9 million. The elements of software and development costs were purchased software of $34.3 million and internally developed software of $102.6 million. These amounts represent the costs we have invested in these assets, reduced by amortization expense charged against our earnings as the software was used in our operations and by any write-downs as a result of our recoverability analysis. Our recoverability analysis considers projected future cash flows from the utilization of the underlying software. Our projections of future cash flows are affected by such factors as technological change, competitive offerings, marketplace expectations and project development. Changes in any of these factors may result in future write-downs of the carrying value of these assets. The amount of the write-down, if any, is largely dependent on our estimates of future cash flows and the selection of an appropriate discount rate. As a result of software recoverability testing during the past three years, we recorded no asset write-down losses in 2003, $5.2 million in 2002 and $3.1 million in 2001.
Determination of our liability for pensions and other postretirement benefits
We present information about our pension and postretirement benefit plans in Note H, “Retirement Plans” to our consolidated financial statements. The determination of the liabilities and expenses for pensions and other postretirement benefits are accomplished with the assistance of independent actuaries using actuarial methodologies and incorporating significant assumptions, including the rate used to discount the future estimated liability, the long-term rate of return on plan assets, and several assumptions relating to the employee workforce (salary increases, medical costs, retirement age, and mortality). The rate used
to discount future estimated liabilities is determined considering the rates available at year-end on debt instruments that could be used to settle the obligations of the plan. The impact on the liabilities of a change in the discount rate of 1/4 of 1% is approximately $16.5 million and a change of $0.4 million to pre-tax earnings in the following year. The long-term rate of return is estimated by considering historical returns and expected returns on current and projected asset allocations and is generally applied to a five-year average market value of assets. A change in the assumption for the long-term rate of return on plan assets of 1/4 of 1% would impact pre-tax earnings by approximately $1.3 million for 2004.
Tax matters
As a company with operations in many states in the U.S. as well as in the United Kingdom and Canada, we record an estimated liability and expense for income and other taxes based on what we determine will likely be paid in the various tax jurisdictions in which we operate. The liabilities ultimately realized and paid are dependent on various matters including the resolution of the tax audits in the various affected tax jurisdictions and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which it becomes probable that the amount of the actual liability differs from the amount recorded.
Cautionary Factors That Could Affect Future Results
In connection with the “safe harbor” provisions of the Private Securities Reform Act of 1995, we present the cautionary statements set forth below, identifying important factors that could cause our actual results to differ materially from those projected in forward-looking statements made by us. You should carefully consider each of the following risks and all of the other information in this report. The risks and uncertainties described below and in this report are not the only ones we will face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our businesses. If any of the risks and uncertainties develops into actual events, our business, financial condition or results of operations could be materially affected. If that happens, the trading price of our common stock could decline significantly.
Our revenue depends in large part on our ability to retain customers.
Customer retention is an important factor in the amount and predictability of revenue and profits in each of our businesses. Our ability to retain our customers depends on a number of factors, including:
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customer satisfaction
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product and service offerings by competitors
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customer service levels
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price
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customer viability
In providing some of our solutions and services, particularly at our HRS business, we incur installation and conversion costs in connection with new customers that will need to be recovered before the contractual relationship will provide incremental profit. Longer customer relationships are likely to be more profitable.
Changes in governmental regulations relating to employee benefits, taxes, funds transfer and other matters may negatively impact our revenue and earnings.
Changes in or the elimination of governmental regulations may adversely affect our revenue and earnings and the way we conduct our businesses. Changes in governmental regulations are difficult to predict and could be significant. For example, the extent and type of benefits that employers are required to or may choose to provide employees and the amount and type of federal or state taxes employers and employees are required to pay will affect the associated new products or services that we may sell. As
another example, Comdata is currently licensed on the state level by the banking or financial institutions departments of numerous states. Continued licensing by these states is subject to ongoing satisfaction of compliance requirements regarding safety and soundness, including, for example, posting of surety bonds to guarantee payment of funds in transit. Changes in this regulatory environment, including the implementation of new or varying measures by the U.S. federal government, may significantly affect or change the manner in which Comdata currently conducts some of the aspects of its business.
Our future revenue growth will depend on our ability to continue selling our products and services to our existing customers, introducing new or enhanced products and services, attracting and retaining new customers and selling additional products and services to existing customers.
We expect that a portion of our anticipated future revenue growth in each of our business segments will be derived from:
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the continued selling of products and services to our existing customers
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the introduction of new or enhanced products and services in our businesses
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the selling of products and services to new customers
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the selling of additional products and services to our existing customers
How successful we will be in these efforts will depend on a variety of factors, including:
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the quality and perceived value of our product and service offerings
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effective sales and marketing efforts
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our ability to attract new and retain new and existing customers
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the level of market acceptance and the avoidance of difficulties or delays in development or introduction of new products and services
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our ability to integrate technology and information systems into our products and services
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our successful implementation of products and services for new and existing customers
There can be no assurance that we will achieve our revenue growth objectives from our cross-selling efforts and selling of new products and services. The inability to cross-sell our products and services, attract and retain new customers or successfully develop and implement new and enhanced products and services could harm our businesses.
Economic factors may harm our business and operating results.
Trade, monetary and fiscal policies, and political and economic conditions may substantially change, with corresponding impacts on the industries that we serve, particularly those more economically sensitive industries such as trucking and retail. Approximately 75.6 percent of Comdata’s revenue for 2003 was attributable to its transportation business. Comdata’s results of operations are, therefore, dependent on the level of activity in the transportation industry, which, in turn, is affected by general economic conditions. For example, a decrease in the number of truck drivers would decrease the number of Comchek transactions and could adversely affect Comdata’s revenues. Similarly, since a significant portion of our fueling transactions are priced by reference to the amount spent on the transaction, our revenue can be significantly affected by changes in diesel fuel prices. Falling diesel fuel prices directly reduce the amounts of revenue and earnings related to these transactions. Rising diesel fuel prices increase our revenue and earnings but also increase the working capital requirements of Comdata and subject Comdata to greater credit or bad debt risks with respect to its customers that purchase diesel fuel using a Comdata payment method.
Changes in trade, monetary and fiscal policies, and political and economic conditions could also affect employment levels, with a corresponding impact on our payroll processing and tax filing businesses.
Decreased employment levels, as well as slowed economic conditions, could negatively affect wage and bonus payments, orders and the timing of product installations, and negatively impact the operating results of our HRS business.
Litigation and governmental investigations may harm our financial results.
Our future operating results may be harmed by adverse judgments, settlements, unanticipated costs or other effects of legal and administrative proceedings now pending or that may be instituted in the future, or from investigations by administrative agencies.
We are currently responding to a document request from the Securities and Exchange Commission, and we have been advised that the SEC has issued a formal order of investigation. We are fully cooperating with the SEC on its investigation. Although we believe that our accounting is in accordance with generally accepted accounting principles, we cannot predict the outcome of the SEC’s investigation or when the investigation will be resolved. An adverse outcome of this investigation could have a material adverse effect on us and result in:
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the institution of administrative or civil proceedings;
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sanctions and the payment of fines and penalties;
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the restatement of our financial results for the years under review;
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stockholder lawsuits; and
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increased review and scrutiny of us by regulatory authorities, the media and others.
In addition, we are restating our financial results for the fiscal years ended December 31, 2003, 2002, 2001 and 2000 to reflect a change in accounting relating to the revenue recognition policy of Comdata’s Stored Value Systems unit. The restatement could result in litigation and the judgment, settlement and costs of such litigation could have an adverse effect on our financial results.
Any problems or delays we may experience in implementing system upgrades and conversions could harm our business.
We expect to continue our efforts to transition to new or enhanced data processing systems and/or software in several of our business units, including systems that process customer data and internal management information systems which provide enhanced data and information services. The successful implementation of these new or enhanced systems will be critical to the effective delivery of products and services and the efficient operation of our businesses. Problems or delays with the installation or initial operation of new or enhanced systems could disrupt or increase costs in connection with our delivery of services and with our operations planning, financial reporting and management. From time to time, we have experienced these types of problems or delays.
Our ability to remain competitive depends on our ability to adapt to changing technology.
As a provider of information management and data processing services, we will need to adapt and respond to the technological advances offered by our competitors and the technological requirements of our customers, including those related to the Internet, in order to maintain and improve upon our competitive position. For example, management is implementing a strategy for our HRS business to provide services over the Internet. As another example, Comdata’s credit, debit and cash cards could be replaced by a next-generation payment method. There can be no assurance that we will develop and release new products and services or product and service enhancements within the required time frames and within targeted costs. Significant delays, difficulties or added costs in introducing new products and services or enhancements, either through internal development, acquisitions or cooperative relationships with other companies, could adversely affect the market acceptance of our products and services and our operating results.
Our strategy to make acquisitions of and investments in complementary businesses, products and technologies involves risks that could harm our business and operating results.
One of our growth strategies is to make acquisitions of and investments in complementary businesses, products and technologies that will enable us to add products and services for our core customer base and for adjacent markets, and to expand each of our businesses geographically. Our ability to make these acquisitions and investments will depend on:
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the availability of suitable acquisition candidates and investments at acceptable costs
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our ability to compete effectively for these acquisition candidates and investments
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the availability of capital to complete these acquisitions and investments
These risks could be heightened if we complete several acquisitions or investments within a relatively short period of time. The benefits of an acquisition or investment may often take considerable time to develop, and we cannot guarantee that any acquisition or investment will in fact produce the revenue, earnings or business synergies that we anticipated.
In addition, implementation of this strategy entails a number of risks, including:
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inaccurate assessment of undisclosed liabilities
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entry into markets in which we may have limited or no experience
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potential loss of key employees or customers of the acquired businesses
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difficulties in assimilating the operations and products of an acquired business or in realizing projected efficiencies and cost savings
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reallocation of significant amounts of capital from operating initiatives to acquisitions
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increase in our indebtedness and a limitation in our ability to access additional capital when needed
In addition, some acquisitions and investments may require the consent of the lenders under our $350 million revolving credit facility, and we cannot predict whether approvals would be forthcoming or the terms on which the lenders would approve these transactions. Also, from an accounting perspective, acquisitions and investments may involve non-recurring charges and significant charges from periodic reassessments of the recoverable value of goodwill and other intangible assets arising from acquisitions that could harm our operating results.
Our $350 million revolving credit and Comdata Receivables Securitization facilities may restrict our operating flexibility.
The governing documents for our $350 million revolving credit and Comdata Receivables Securitization facilities contain a number of significant provisions that, among other things, restrict our ability to:
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sell assets
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incur more indebtedness
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grant or incur liens on our assets
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make investments or acquisitions
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enter into leases or assume contingent obligations
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engage in mergers or consolidations
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engage in transactions with our affiliates
These restrictions could hurt our ability to finance our future operations or capital needs or make acquisitions that may be in our best interest. In addition, our credit facilities require that we satisfy several financial covenants. Our ability to comply with these financial requirements and other restrictions may be affected by events beyond our control, and our inability to comply with them could result in a default under a credit facility. If a default occurs under one of our credit facilities, the lenders under the other facility could elect to declare all of the outstanding borrowings, as well as accrued interest and fees, to be due and payable and require us to apply all of our available cash to repay those borrowings. In addition, a default may result in higher rates of interest and the inability to obtain additional capital.
The markets we serve may attract new competitors or cause current competitors to focus more on these markets, which could harm our business.
New competitors could decide to enter the markets we serve or current competitors could decide to focus more on these markets, and thereby intensify the highly competitive conditions that already exist. These new entrants and existing competitors could offer or introduce new technologies or a different service model, or could treat the services to be provided by one of our businesses as one component of a larger product or service offering. These developments could enable these new and existing competitors to offer similar products or services at reduced prices. Any of these or similar developments could harm our business and results of operations.
We will be subject to risks related to our international operations, which may harm our operating results.
Approximately 22 percent of HRS’ revenue was obtained from customers outside of the United States. Our Ceridian Centrefile subsidiary provides human resource services, payroll processing services and human resource information systems software in the United Kingdom. Ceridian Centrefile is expanding its payroll services into numerous countries, primarily in Europe, by engaging a partner within a country to provide us with payroll administration and processing services for that country. Our Canadian operations handle and hold payroll as well as tax filing funds for our Canadian customers. Comdata also operates primarily in the United States and Canada, and is expanding its business into Mexico and Europe. Apart from the risks described in this section of the report, international operations are subject to various additional risks which could adversely affect those operations or our business as a whole, including:
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costs of customizing products and services for foreign customers
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difficulties in managing and staffing international operations
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difficulties with or inability to engage partners
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reduced protection for intellectual property rights in some countries
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longer sales and payment cycles
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the burdens of complying with a wide variety of foreign laws
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exposure to local economic conditions
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unfavorable currency exchange rates
We expect to continue to implement our plans to improve the performance of our U.S. HRS business, and we cannot assure you that our efforts and the amount we invest in these plans will improve the financial performance of our U.S. HRS business.
We have ongoing and continued initiatives to invest in and improve the performance of our U.S. HRS business. These initiatives include:
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transitioning small and medium size business customers to our Internet payroll products
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improving our customer service model
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improving customer retention
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continuing product enhancements
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investing in our Six Sigma program, an effort that focuses on helping organizations design and produce products and services better, faster and cheaper
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consolidating and improving efficiencies at our payroll processing centers and benefits administration operations
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increasing the effectiveness of our sales efforts
We cannot assure you that our efforts and the amount we invest in this process will improve the financial performance of our U.S. HRS business, and if so, by how much. If these initiatives are less successful than planned, or the level of investment needs to be increased, our business could be harmed.
Government regulation changes on timing or amount of remittances and changes in interest rates may reduce our investment income from customer deposits.
Our payroll and tax filing business in the United States and Canada has historically derived significant revenue and earnings from the investment of customer deposits, and these revenue and earnings are an integral part of our payroll and tax filing business. Changes in governmental regulations on the timing and amount of remittances may reduce the period of time we are allowed to hold these remittances, as well as the amount of such remittances, and may decrease our revenue and earnings from this source. If governmental regulations change in this fashion, we would likely seek to require customers who permit us to retain earnings on their deposits to pay us additional fees in lieu of a portion of this lost investment income.
In addition, changes in interest rates will affect our revenue and earnings from this source. Interest rate changes are difficult to predict and could be significant. We expect to continue to lessen the impact of interest rate decreases by the use of derivative securities such as interest rate contract transactions that are described in more detail in a note to our consolidated financial statements entitled “Commitments and Contingencies” and under Part II, Item 7A of this report. There can be no assurance that we will be able to use derivative securities such as collars and swaps or obtain them on favorable terms, or to what extent any decrease in investment income would be offset by the use of these derivative securities. If we were unable to secure derivative securities on favorable terms and interest rates decrease, our financial results would be harmed.
Our ability to improve operating margins in our HRS business will depend on the degree to which and the speed with which we will be able to increase operational efficiencies and reduce operating costs.
Our ability to improve profit margins in our HRS business will depend on factors that include the degree to which and the speed with which we will be able to increase operational efficiencies and reduce operating costs. Delays or difficulties in implementing and consolidating process improvements, such as those designed to reduce printing, telecommunication and customer service costs, or quickly and effectively installing new customers or new products and services, and in consolidating various functions, including administrative functions, eliminating duplicate operations and consolidating facilities could adversely affect the timing or effectiveness of cost reduction and margin improvement efforts.
The failure of our benefit services subsidiary to comply with applicable laws relating to employee benefits administration could result in substantial taxes, penalties and liabilities that could harm our business.
As a result of the benefits services our benefit services subsidiary provides, it may be subject to potential legal liability as a provider of portability compliance services. As a provider of COBRA (Consolidated Omnibus Budget Reconciliation Act) compliance services, our benefit services subsidiary is subject to excise taxes for noncompliance with provisions of COBRA. In addition to the excise tax liability that may be imposed on our benefit services subsidiary, substantial excise taxes may be imposed under COBRA on our customers. In addition, as a provider of HIPAA (Health Insurance Portability and Accountability Act of 1996) compliance and administration services, our benefit services subsidiary is
subject to ERISA (Employee Retirement Income Security Act of 1974) penalties for noncompliance with various provisions of HIPAA.
Under various service agreements with its customers, our benefit services subsidiary assumes financial responsibility for the payment of the taxes and/or penalties assessed against its customers if a court of competent jurisdiction in a final nonappealable decision determines that our benefit services subsidiary failed to comply with COBRA, failed to comply with HIPAA or liabilities were incurred by its customers arising out of the failure of our benefit services subsidiary to fulfill the obligations under its agreements with its customers, unless these taxes, penalties or liabilities are attributable to the customer’s failure to comply with COBRA or HIPAA or with the terms of the agreement the customer has with our benefit services subsidiary. These taxes, penalties and liabilities could, in some cases, be substantial and could harm our business and operating results. Additionally, the failure of our benefit services subsidiary to comply with applicable provisions of COBRA or HIPAA or to fulfill its obligations under its customer agreements could harm its reputation, its relationship with its customers and its ability to gain new customers.
The failure of our HRS business to comply with applicable laws relating to payroll tax and retirement plan administration could result in substantial taxes, penalties and liabilities that could harm our business.
Our HRS customers transfer to our HRS division or its subsidiaries contributed employer and employee tax funds. Our HRS division or its subsidiaries process the data received from its customers and remit the funds along with a tax return to the appropriate taxing authorities when due. Retirement plan assets are remitted directly by our customers to investment vehicles selected by the plan administrator or plan sponsor. Tracking, processing and paying these tax liabilities and administering retirement plans is complex. Mistakes may occur in connection with this service. Our HRS division or its subsidiaries and its customers are subject to large cash penalties imposed by tax authorities for late filings or underpayment of taxes or required plan contributions. Under various service agreements with its customers, our HRS division or its subsidiaries assume financial responsibility for the payment of the penalties assessed against its customers arising out of the failure of our HRS division or its subsidiaries to fulfill its obligations under its agreements with these customers, unless these penalties are attributable to the customer’s failure to comply with the terms of the agreement the customer has with our HRS division or its subsidiaries. These penalties could, in some cases, be substantial and could harm its business and operating results. Additionally, the failure of our HRS division or its subsidiaries to fulfill its obligations under its customer agreements could harm our reputation, its relationship with our customers and its ability to gain new customers.
Our business and results of operations are dependent on several vendors and suppliers, the loss of whom could adversely affect our consolidated results of operations.
Our business is dependent on several significant vendors and suppliers, the loss of whom could adversely affect our consolidated results of operations. In particular, Comdata’s current business relies upon its relationships with third party suppliers, such as MasterCard, to effect and support transactions, including access to the Cirrus ATM network and the Maestro point-of-sale debit network. The ability of Comdata to continue to provide some of its services in the manner in which it currently delivers them may be affected by actions taken by MasterCard or other similar card associations. Any adverse change in Comdata’s relationship with these vendors could likely adversely affect Comdata’s business and results of operations and could harm our consolidated results of operations as well.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Our market risk exposure is primarily due to the variability of interest income earned on the investment of customer funds in lieu of fees and reported as revenue. Due to the short-term nature of customers’ obligations paid by funds in our possession, investments of these funds must have very short maturities. This exposes our interest revenue from customer funds to changes in short-term interest rates which are highly volatile. Our objective in managing interest revenue is to provide a stable and predictable
source of such revenue. To achieve this objective we coordinate a risk management program of investing in longer-term assets, issuing floating rate debt, and purchasing interest rate derivative securities (e.g. collars, swaps) that have the effect of converting variable short-term rates into fixed long-term rates. By converting the short-term interest rate exposure to fixed rates, or offsetting short-term interest earned with short-term interest payments on debt, we achieve a high degree of stability and predictability of net interest income. The fair value of our interest rate derivative securities was $55.7 million at December 31, 2003 and $71.4 million at December 31, 2002.
The table below illustrates the hypothetical change in our after-tax investment income, net of interest expense over a one year period due to an immediate and sustained change in interest rates from the assumed base case of 1% Federal Funds rate at December 31, 2003.
Computations in the table above are based on assumed levels of customer funds, floating rate debt, and U.S. and Canadian interest rates. This table should not be relied on as precise indicators of future expected results. The computations reflect the expected changes in interest revenue and interest income including the impact of derivative securities, net of interest expense on a consolidated basis. Derivative securities that will be in effect for 2004 will cover an average of $800 million of short-term investment balances of customer funds, with a combined average floor of 5.10% and cap of 5.87%. Maturities of existing contracts extend to December of 2007.
We actively monitor and control our overall interest rate risk exposure such that over the year income from net assets exposed to changes in interest rates remains fairly constant. During 2003 our net assets exposed to short-term assets increased $170 million due to increased customer assets, adding $277,000 after tax per 25 basis points of sensitivity to changes in interest rates. We currently anticipate generally rising interest rates in the U.S. and stable to falling interest rates in Canada. We also intend to obtain additional interest rate derivative securities when market conditions are favorable to replace maturing interest rate contracts. We have no forward interest rate contracts starting effectiveness for periods beginning after 2004. We refer you to Note K, “Commitments and Contingencies,” in our consolidated financial statements for additional information on derivative securities.
Other secondary market risk exposures we face include fuel price risk and foreign exchange risk. Our Comdata transportation services business revenue and net income is exposed to variability based on changes in the prices of diesel fuel. For a large portion of its transportation services customers, Comdata earns fee revenue for card transactions based on a percentage of the total amount of each fuel purchase. An increase/decrease in the price of diesel fuel increases/decreases the total dollar amount of fuel purchases and Comdata revenue, accordingly. We estimate that for each $.10 change in the average price of diesel fuel per year, Comdata revenue and pretax profit are impacted by $1.8 million, before impact of any fuel price hedging program.
Our risk management objective of managing fuel price risk is to protect Comdata revenue and net income from the effects of falling diesel fuel prices by entering into derivative contracts that convert the floating price of fuel used in revenue calculations to a fixed price. In providing services to certain of our trucking customers, Comdata calculates a portion of the fees it charges as a fixed percentage of the total cost of fuel purchased. As fuel prices rise and fall, Comdata’s revenue rises and falls accordingly. During 2003, Comdata entered into fuel price derivative contracts to swap the floating price of fuel for a fixed price. These contracts had the effect of reducing the exposure to price variability of diesel fuel noted above by approximately one half for the period April 1 to December 31, 2003. In March 2004, Comdata entered into similar fuel price derivative contracts at an average fixed price of $1.51 per gallon from June 30, 2004 through December 31, 2004. We continuously monitor fuel price volatility and the cost of hedging and may enter into additional fuel price derivative contracts solely for the purpose of managing fuel price risk when market conditions are favorable to such transactions.
Our exposure to foreign exchange risk is related to our HRS operations at Ceridian Canada and Ceridian Centrefile, and is not considered material to our financial condition or results of operations. These foreign operations principally serve their respective domestic markets with nearly all revenues and expenses denominated in local currency. Other intercompany charges between U.S. and non-U.S. based operations are not material. Translation adjustments on investments in foreign operations are reported in “other comprehensive income” in our accompanying Statements of Stockholders’ Equity and are not hedged.
Item 8.
Financial Statements and Supplementary Data
1. Index to Consolidated Financial Statements.
The following financial statements and reports are filed as part of this report:
2. Index to Financial Statement Schedules.
The following financial statement schedule and report is filed as part of this report and should be read in conjunction with the Consolidated Financial Statements:
Independent Auditors’ Report
To the Board of Directors and Stockholders of
Ceridian Corporation:
We have audited the accompanying consolidated balance sheets of Ceridian Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ceridian Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note B to the consolidated financial statements, the Company has restated its consolidated financial statements for the years ended December 31, 2002 and 2001.
As discussed in Note A to the consolidated financial statements, the Company adopted the provision of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002.
/s/ KPMG LLP
Minneapolis, Minnesota
March 12, 2004
CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in millions, except per share data)
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (Dollars in millions, except per share data)
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in millions)
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Dollars in millions)
See notes to consolidated financial statements.
(Dollars in millions, except per share data)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(For the three years ended December 31, 2003)
A. ACCOUNTING POLICIES
Basis of Consolidation
As presented in these consolidated financial statements, we are Ceridian Corporation, which includes subsidiaries and investments in which we have a majority interest. We provide human resource solutions to employers through our Human Resource Solutions (“HRS”) business segment operations located in the United States, Canada and the United Kingdom. We also provide transaction processing and related services primarily to the transportation and retail industries through our Comdata business segment operations located principally in the United States. Our products and services and business segments are more fully described in Note E.
We include in our consolidated financial statements grantor trusts that hold funds provided by our payroll and tax filing customers pending remittance to employees of those customers or tax authorities in the United States and Canada. The customer funds held in trust and customer deposits related to our benefits services business are separately identified as “customer funds” in our consolidated balance sheet. Further information on our accounting for these funds is provided in the section entitled “Revenue Recognition” of Note A and in Note M.
When we acquire between a 20% to 50% equity interest in another entity, we account for that investment under the equity method and record our share of its earnings or losses. During the reporting period, we held no investments representing an equity interest between 20% and 50%. Our other investments may include debt or equity securities that may or may not be marketable securities. We discuss these other investments in the section entitled “Cash and Investments, including Derivatives” of Note A and in Note G. We review our less-than-20%-owned investments to determine whether we exercise a degree of significant influence over their management that would require the application of the equity method through one or more of the following factors: (a) our representation on the investee’s board of directors; (b) our participation in the investee’s policy making decisions; (c) material intercompany transactions with the investee; (d) interchange of managerial personnel with the investee; or (e) technological dependency.
All material intercompany transactions have been eliminated from our consolidated financial statements.
Recently Issued Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities,” which FASB further amended during 2003. FIN 46 is intended to provide guidance on whether a beneficiary of a variable interest entity should include that entity in its consolidated financial statements. FIN 46 becomes effective for our quarterly report for the period ended March 31, 2004. We are currently evaluating whether our payroll and tax filing trusts are variable interest entities. We currently believe that the trusts would be considered variable interest entities that will continue to be included in our consolidated financial statements.
In December 2003, FASB reissued Financial Accounting Standard (“FAS”) No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” in order to provide additional disclosures on pension and postretirement benefits provided by employers to employees. FAS 132 does not change the accounting methods for these arrangements. These additional disclosures are discussed in Note H.
(Dollars in millions, except per share data)
On January 12, 2004, the FASB issued Financial Staff Position No. (“FSP”) 106-1, “Accounting and disclosure requirement regarding the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“Medicare Act”).” FSP 106-1 allows companies to recognize or defer recognizing the effect of the prescription-drug provisions of the new Medicare Act, signed into law on December 8, 2003, on their accumulated postretirement benefit obligation in 2003 financial statements. Specific authoritative guidance regarding accounting for the federal subsidy feature of the Medicare Act is pending and, when such guidance is issued, it could require a change to previously reported information. Accordingly, we have elected to defer (1) recognizing the effects of the Medicare Act on postretirement benefit expense and on the accumulated projected benefit obligation pursuant to FAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” and (2) providing the information related to the effect of the Medicare Act on these plans called for in FAS 132. Therefore, the information on postretirement benefits included in Note H does not reflect the effects of the Medicare Act.
We adopted FAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” on its effective date of January 1, 2003. FAS 148 amended FAS 123, “Accounting for Stock-Based Compensation,” and provided alternative methods of transition for the adoption of the fair value method of accounting for stock-based employee compensation under FAS 123. FAS 148 also amended the disclosure provisions of FAS 123 and Accounting Principles Board Opinion No. (“APB”) 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. FAS 148 did not amend FAS 123 to require accounting for employee stock options by the fair value method. As a result of FAS 148, we provided in our 2003 quarterly reports on Form 10-Q information on the pro forma effect of applying the fair value method to determine stock compensation expense that is similar to what we provide in Note I.
We adopted Emerging Issue Task Force (“EITF”) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” at its effective date of July 1, 2003. EITF 00-21 addresses certain aspects of the accounting for arrangements under which there are multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. EITF 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. EITF 00-21 does not change otherwise applicable revenue recognition criteria. We have concluded that the adoption of EITF 00-21 did not have a material effect on our consolidated financial position or results of operations.
Our current accounting for revenue recognition at SVS is provided in the section entitled “Revenue Recognition” of Note A.
Stock-Based Compensation
We account for stock-based compensation under APB 25, “Accounting for Stock Issued to Employees,” and related interpretations. Therefore, we do not record compensation expense with respect to our fixed stock option plans, since the exercise price is set at the market price on the date of grant, or for our employee stock purchase plan, which is noncompensatory. Compensation expense for our outstanding restricted stock awards, none of which is performance-based, is recognized by charging the fair value of the award at the time of grant to operations ratably over the vesting period. Grants of stock options to
(Dollars in millions, except per share data)
consultants or independent contractors are accounted for under the fair value method. We also report under the disclosure-only provisions of FAS 123 and FAS 148.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our financial statements and our reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates that could significantly affect our results of operations or financial condition involve accounting for software and development costs, goodwill and other intangible assets, pensions and postretirement benefits, hedging of interest rates on payroll and tax filing fund investments, actions to restructure or discontinue operations, and the assessment of contingencies. Further discussion on these estimates can be found in related disclosures elsewhere in our Notes.
Changes in Presentation
As further described in Note M, effective in 2003, we added our benefits services customer deposits to our payroll and tax filing funds to present the combined amount as “customer funds” in our consolidated balance sheet. The related obligations are similarly reported on a combined basis. We believe that such a presentation better reflects our practice of utilizing benefits services customer deposits to meet the related customer obligation. We also reclassified the Comdata provision for doubtful accounts from cost of revenue to general expense to conform to our classification for the HRS provision. Amounts for prior periods have been reclassified to conform to the current presentation. We have reclassified certain other prior year amounts to conform to the current year’s presentation.
Cash and Investments, including Derivatives
We classify investments that are readily convertible to cash within three months of purchase as cash equivalents in our consolidated balance sheet and report those amounts at amortized cost (which does not differ materially from fair market value). We account for our investments in marketable securities under FAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments other than marketable or derivative securities under APB 18, “The Equity Method of Accounting for Investments in Common Stock.” Our investments of customer funds in marketable securities are classified as held-to-maturity, carried at amortized cost and separately presented in our balance sheet as further described in Note M. Our other investments in marketable equity or debt securities are considered available-for-sale and reported in the balance sheet as investments.
We account for derivatives under FAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted. FAS 133 requires that derivative securities be measured at fair value and reflected as assets or liabilities on the balance sheet. Changes in the carrying value of a derivative are included in earnings unless the derivative serves as a fully effective hedge against a related gain or loss. Gains and losses from the ineffective portion of our hedges, including the time value of certain hedging instruments, are classified in “other expense (income).” We hold derivative securities for the purpose of hedging interest rate risk and not for speculative activity. Our hedging activities may include the use of interest rate contracts such as swaps, collars, caps and floors, designated as hedges of variable income from investments of customer funds and corporate cash. We also utilized fuel price hedges in 2003. These derivative securities typically function as cash flow hedges of the designated item. We further discuss derivatives in Note K.
(Dollars in millions, except per share data)
Property, Plant and Equipment
Our property, plant and equipment assets are carried at cost and depreciated for financial statement purposes using straight-line and accelerated methods at rates based on the estimated lives of the assets, which are generally as follows:
We charge repairs and maintenance to expense as the costs are incurred. We include gains or losses on dispositions in other expense (income) when realized.
We review the carrying value of long-lived assets whenever events or changes in circumstances such as market value, asset utilization, physical change, legal factors or other matters indicate that the carrying value may not be recoverable. When the review indicates that the carrying value of the asset or group of assets representing the lowest level of identifiable cash flows exceeds the sum of the expected future cash flows (undiscounted and without interest charges), we recognize an asset write-down charge against operations. The amount of the impairment loss is the amount by which the carrying value exceeds the fair value of the impaired asset or group of assets.
Earnings Per Share
Basic earnings per share represents earnings divided by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share represents earnings divided by the sum of the weighted average number of common shares outstanding plus shares derived from other potentially dilutive securities. Our other potentially dilutive securities include “in the money” fixed stock options outstanding. The numbers of shares added for stock options is determined by the treasury stock method, which assumes exercise of these options and the use of any proceeds to repurchase a portion of these shares at the average market price for the period. The option shares excluded from the calculation of our other potentially dilutive securities (because the exercise price exceeded the average market price for the year) at each December 31 were 9,051,000 for 2003, 9,847,000 for 2002 and 5,691,000 for 2001.
Goodwill and Other Intangibles
Goodwill, which represents the excess purchase price over the fair value of net assets of businesses acquired, is assigned to operating units based on the benefits derived from the acquisition. On January 1, 2002, FAS 141, “Business Combinations,” and FAS 142, “Goodwill and Other Intangible Assets,” became effective for us. Prior to that date, we amortized goodwill on a straight-line basis over the expected periods to be benefited, ranging up to 40 years. As a result and from that date forward, goodwill is no longer amortized against earnings and goodwill balances are subject to impairment review on at least an annual basis. Furthermore, classes of other intangible assets were further defined under these rules, which caused us to transfer the $1.3 unamortized balance of an intangible asset, representing the estimated value of an assembled workforce, to goodwill as of January 1, 2002. Certain minor amounts were reclassified between classes of intangibles under the new rules. The pro forma effect of cessation of goodwill amortization and reclassification of intangibles would have increased earnings from continuing operations for 2001 by $30.3, or $.20 per diluted common share. Pursuant to the transitional requirements of the new accounting rules, we, assisted by an independent business valuation firm, completed an impairment review in June 2002. This impairment review determined that there was no impairment of our goodwill as of January 1, 2002,
(Dollars in millions, except per share data)
the measurement date prescribed by these rules. The operating units identified for this assessment included our U.S.-based HRS operations, the HRS operations of Ceridian Centrefile and Ceridian Canada, and Comdata. Furthermore, after consideration of the factors prescribed in these rules that might indicate a risk of impairment, we, through our own self assessment, found no indication of goodwill impairment at December 31, 2003 and 2002.
Our other intangible assets represent amounts assigned to specifically identifiable intangible assets at the time of a purchase acquisition. These costs are amortized on a straight-line basis over the following periods:
We regularly review these recorded amounts and assess their recoverability. Our review considers factors such as whether the amortization of other intangible assets for each operating unit can be recovered through forecasted undiscounted cash flows over their remaining economic life.
Software and Development Costs
We capitalize purchased software that is ready for service and development costs for marketable software incurred from the time of technological feasibility until the software is ready for use. Under the provisions of current accounting rules AICPA Statement of Position (“SOP”) 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use,” we capitalize costs associated with software developed or obtained for internal use when both the preliminary project stage is completed and our management has authorized further funding for the project which it deems probable of completion and use for the function intended. Capitalized internal-use software costs include only (1) external direct costs of materials and services consumed in developing or obtaining the software; (2) payroll and payroll-related costs for employees who are directly associated with and who devote time to the project; and (3) interest costs incurred, when material, while developing the software. Capitalization of these costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose.
We charge research and development costs and other computer software maintenance costs related to software development to operations as incurred. We amortize software development costs using the straight-line method over a range of three to seven years, but not exceeding the expected life of the product.
We regularly review the carrying value of software and development costs and recognize a loss when the value of estimated undiscounted cash flow benefit related to the asset falls below the unamortized cost.
Income Taxes
We base our provision for income taxes on income recognized for financial statement purposes, which includes the effects of temporary differences between financial statement income and income recognized for tax return purposes. We file a consolidated U.S. federal income tax return for our parent company and its eligible subsidiaries. Except for selective dividends from future earnings, we intend to reinvest the unremitted earnings of our non-U.S. subsidiaries, approximately $58.1, in their operations and postpone their remittance indefinitely. No such dividends have been declared or paid during the three years ended December 31, 2003.
(Dollars in millions, except per share data)
Accordingly, we have not provided for U.S. income taxes on our non-U.S. earnings during the three years ended December 31, 2003.
Revenue Recognition
We recognize revenue from sale of our products and services when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed or determinable; and (4) collectibility is reasonably assured. Generally, we rely on a signed contract between us and the customer as the persuasive evidence of a sales arrangement. We address these and the other criteria for revenue recognition in the following discussion of types of revenue within our business.
HRS
Repetitive Business
The majority of our HRS revenue is generated by recurring monthly or quarterly fees from our payroll processing, tax filing services, benefit administration services, work-life effectiveness and employee assistance services, and human resource outsourcing products. This revenue is generated by service fees, income from investment of customer funds in lieu of fees, software licenses and subscription fees.
Payroll Processing. Generally, service fees for HRS payroll transaction processing are contracted on a per transaction basis and recognized as revenue when transaction services are provided and the amount is billable. Ceridian Canada also recognizes payroll services revenue from customer funds held temporarily pending remittance to the customer’s employees. These payroll deposits are invested through grantor trusts. We derive and recognize investment income in lieu of fees as a component of revenue as earned.
Tax Filing Services. Our payroll tax filing services consist primarily of: (1) collecting funds for federal, state and local employment taxes from customers based on payroll information provided by the customers; (2) remitting funds collected to the appropriate taxing authorities; (3) filing applicable returns; and (4) handling related regulatory correspondence and amendments for customers. Revenue from these tax filing services is billed and recognized as the services are provided, generally on a monthly basis.
We hold our customers’ tax filing deposits for the period between collection and remittance of the funds to the applicable taxing authority. These tax filing deposits are invested through a grantor trust. We derive and recognize this investment income in lieu of fees as a component of revenue as earned.
Payroll processing and tax filing services are all sold separately, so we have standalone value for each service. Separate sales also establish the fair value of each of the services sold in the event a customer contracts with us for multiple services.
Benefits Administration Services. We provide employee health and welfare benefits administration and qualified administration services to our customers. Employee health and welfare benefits administration services include health insurance portability compliance services related primarily to COBRA (Consolidated Omnibus Budget Reconciliation Act). Health and welfare benefits administration services also encompass benefits provided to active employees, such as (1) annual health plan enrollment, (2) ongoing employee enrollment and eligibility services, (3) tuition refund plans, (4) transportation reimbursement under the Transportation Equity Act, and (5) Internal Revenue Code Section 125 plans (Flexible Spending), which include fully administered and self-administered flexible spending accounts and premium-only plans.
(Dollars in millions, except per share data)
We also provide retirement planning services that include: (1) administration services for benefits provided to retired and inactive employees, which include retiree healthcare, disability, surviving dependent, family leave and severance benefits; and (2) qualified plan administration services which include 401(k) plan administration, profit sharing administration, defined benefit plan administration, ESOP administration and Qualified Domestic Relations Order administration.
Revenue for COBRA services is earned and recognized as the services are provided. Revenue associated with other health and welfare benefits administration and retirement planning services is recognized monthly based on the number of customer employees that receive or participate in the benefit.
Benefits services are all sold separately, so we have standalone value for each service. Separate sales also establish the fair value of each of the services sold in the event a customer contracts with us for multiple services.
Work-Life Effectiveness and Employee Assistance Services (“LifeWorks”). We provide work-life effectiveness and employee assistance programs to our clients. LifeWorks are delivered through on-line access and telephonically, and through face-to-face meetings provided by referral resources. Contracted fees for these services are generally billed monthly. Revenue is earned and recognized over the term of the contract based on the number of customer employees served and the level of service.
Human Resource Outsourcing. In 2003, we began marketing comprehensive human resource outsourcing (HRO) solutions to our customers. HRO services can provide an entire suite of any of the HRS services outlined above, but to date typically involve: (1) conversion and implementation consulting services; and (2) processing services related to payroll, tax filing services and benefit needs.
HRO services are all sold separately, so we have standalone value for each service. Separate sales also establish the fair value of each of the services sold in the event a customer contracts with us for multiple services.
Non-Repetitive Business
Less than 5% of our consolidated revenue in 2003 was generated from the sale and installation of software and data conversion services in our HRS businesses. These services may also include training and other consulting. These services have standalone value as they can be performed by independent contractors or purchased separately. The fees for these services are based upon published hourly rates that are considered competitive with other providers and are consistent with hourly rates billed for customization and consulting services performed by us on a standalone basis. Revenue from consulting services is non-refundable; is primarily determined on a time and materials basis; and is recognized over the installation and conversion period, generally two to four months.
Comdata
Comdata revenue is primarily generated from funds transfer services and stored value card sales and transaction services. Comdata also generates revenue from regulatory permit and receivables factoring services as well as the sale of point of sale terminals and other equipment to fueling centers.
Transportation
Comdata’s funds transfer system is designed to enable truck drivers to obtain funding for purchases and cash advances at truck stops and other locations en route to their destinations. Drivers may use Comdata’s proprietary Comdata card to purchase fuel, lodging and other approved items, obtain cash advances from
(Dollars in millions, except per share data)
ATM machines or through the use of Comchek drafts, make long distance phone calls and make direct deposits of pay, settlements or trip advances to personal bank accounts. Revenue from funds transfer transactions is based on a per transaction fee that is based on either a fixed amount or a percentage of the face value of the transaction and is recognized when the transaction takes place.
In connection with its transportation services business, Comdata purchases accounts receivable due to trucking companies from manufacturers and shippers at a discount and with recourse back to the trucking company in the event of non-payment. The service that Comdata provides permits trucking companies to receive payment on shipping invoices sooner. The non-refundable discount represents adequate compensation charged for servicing the receivables over a 30-day period. If the collection period extends beyond 30 days, a non-refundable additional fee is charged for each month of servicing. After 90 days, an uncollected receivable can be returned to the seller for its face value.
Comdata recognizes revenue from the discounted fee in the month of the purchase and the additional fees for servicing as we become entitled to collect the fee.
Merchant Services
Comdata’s merchant services division primarily provides fueling centers with: (1) PC-based, point of sale systems that automate the various transactions that occur at a fuel purchase desk; and (2) “pay at the pump” systems which enable customers to transact card-based fuel purchases at the pump. Revenue from the sale of PC-based point of sale equipment and pay at the pump equipment is recognized at the time the equipment is shipped. Recurring service revenues for the merchant services division are recognized as earned. Support and maintenance contracts are generally for 12 month periods and are invoiced annually with the revenues recognized on a straight-line basis over the maintenance period.
Comdata’s merchant services’ products and services are all sold separately, so we have standalone value for each product and service. Separate sales also establish the fair value of each of the products and services sold in the event a customer contracts with us for multiple products and/or services.
Retail Services
SVS sells stored value cards and provides subsequent activation, reporting and transaction processing services (“services”). Customers may also choose to purchase cards alone, without a continuing obligation for services from SVS. SVS recognizes revenue for card sales without services upon shipment.
For card sales with services, revenue on both the card sales and services are deferred and reported on the balance sheet as deferred income. Costs of the cards sold is deferred and reported on the balance sheet as prepaid expense. Costs on the services are recognized as incurred. The deferred income and prepaid expense on the card sale are recognized in earnings over the transaction processing period (up to approximately 30 months), which begins upon activation of the card. The deferred income on the services where we charge a fee for unlimited transactions processed on a card is recognized in earnings over the same transaction processing period which begins upon activation of the card. The deferred income on the services where we charge a fee each time a transaction is processed on a card is recognized in earnings over the same transaction processing period which begins each time a transaction is processed. Our history of providing services to our customers indicates that (1) we can expect activation of a card within approximately 7 months following card shipment, and (2) during the six months following the activation of a card, approximately 90% of the services have been performed.
Sales of cards under either arrangement do not include a right of return of the cards shipped.
(Dollars in millions, except per share data)
Gross Versus Net Revenue
We include in revenue amounts that we bill for and remit to third-party vendors for associated products and services as required on a gross basis as a principal rather than net as an agent when the following conditions are met: (1) we are the primary obligor in the arrangement with the customer; (2) we have credit risk and inventory risk; (3) we have latitude in the establishment of pricing, subject to general economic restraints; and (4) we have full discretion in vendor selection.
Cost of Revenue
We assign to cost of revenue those costs that directly benefit the delivery of our revenue-producing products and services. Most of these costs are recognized as incurred, that is, as we become obligated to pay for them. Some costs of revenue are recognized in the period that a product is sold and delivered. Other costs of revenue are recognized over the period of use or in proportion to the related revenue.
For HRS, a substantial portion of the costs included in cost of revenue are recognized as incurred and the other costs are recognized over the period of use. The costs recognized as incurred consist primarily of customer service staff costs, consulting and purchased services, delivery services and royalties. The costs of revenue recognized over the period of use are depreciation and amortization of tangible and software assets and rentals of facilities and equipment.
For Comdata, the principal types of costs included in cost of revenue that are recognized as incurred include customer service staff costs, banking fees and telecommunications costs. The principal Comdata cost of revenue that is recognized when the product is delivered is equipment sold to customers. The principal Comdata costs of revenue that are recognized over the period of use include depreciation and amortization of tangible and software assets, and rentals of facilities and equipment. The purchase cost of retail card stock is deferred and recognized in proportion to and over the same period as the related revenue.
Translation of Foreign Currencies
We have determined that local currencies serve as functional currencies for our international operations. We translate foreign currency balance sheets at the end-of-period exchange rates and earnings statements at the weighted average exchange rates for each period. We report the effect of changes in the U.S. dollar carrying values of assets and liabilities of our international operations that are due to changes in exchange rates between the U.S. dollar and their functional currency as “foreign currency translation” in “accumulated other comprehensive income (loss)” in the accompanying Statements of Stockholders’ Equity. Gains and losses from translation of assets and liabilities denominated in other than the functional currency of the international operation are recorded in results of operations as “other expense (income).”
Receivables Securitization
We maintain a credit facility under which we “sell” Comdata receivables to third parties through a consolidated subsidiary of Comdata. The subsidiary is consolidated since Comdata owns 100% of the equity, the subsidiary’s activities are virtually all on Comdata’s behalf, and the substantive risks and rewards of the assets rest directly with Comdata. Additionally, the subsidiary has a unilateral right to reclaim all of the transferred assets. Therefore, we account for the outstanding advances as secured borrowings under FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and the sold receivables and borrowings remain in our consolidated balance sheet. We further explain our policy and the operation of this facility in Note J.
(Dollars in millions, except per share data)
B. RESTATEMENT OF FINANCIAL STATEMENTS
As announced on February 18, 2004 and as described in a note to our amended Annual Report on Form 10-K/A for the year ended December 31, 2002, we have corrected our application of SEC Staff Accounting Bulletin No. 101 (“SAB 101”) to arrangements that include the sale of retail cards and related services such as activation, processing and reporting and restated all prior periods subsequent to December 31, 1999. The change in revenue and related cost recognition defers and extends the period over which we recognize revenue and related costs from retail card sales and processing.
We present our revenue recognition policies in Note A of this report in the section entitled “Revenue Recognition.” Under our previous application of SAB 101, we recognized revenue and related cost from card sales under these arrangements on a straight line basis over a period of 12 months following shipment. We recognized revenue from related transaction processing services when the transaction occurred.
The following table presents the effect of the corrections described above. The corrections had no effect on operating, investing or financing cash flows.
(Dollars in millions, except per share data)
C. INCOME TAXES
At December 31, 2003, we had U.S. net operating loss carryforwards of $5.5 from acquired operations. The acquired net operating loss carryforwards expire through the year 2021.
Our income tax returns remain subject to income tax audits in various jurisdictions for 1989 and subsequent years as a result of tax sharing agreements related to the disposition of certain operations. We consider our tax accruals adequate to cover any U.S. and international tax deficiencies not recoverable through deductions in future years.
(Dollars in millions, except per share data)
(Dollars in millions, except per share data)
D. SUPPLEMENTARY DATA TO STATEMENTS OF OPERATIONS
Unusual Losses (Gains)
During September 2003, we sold 785,000 common shares of The Ultimate Software Group, Inc. (“Ultimate”) for proceeds of $5.9 and a net gain of $3.0. In addition we sold 137,158 common shares of U.S.I. Holdings Corporation (“USIH”) for proceeds of $1.8 and a net gain of $0.4. We further describe these transactions in Note G.
During the first quarter of 2002, we announced two separate series of actions intended to consolidate certain operations in each of our business segments and recorded accrued exit costs of $9.0. A plan to consolidate certain HRS payroll and tax filing processing services, previously conducted in 25 district offices, into 4 regional processing centers resulted in the accrual of $7.5 for exit costs. Of the $7.5 accrual, $5.3 related to severance costs for 317 employees all of whom were terminated by December 31, 2002, and $2.2 represented other exit costs, primarily related to lease terminations. Consolidation of certain Comdata facilities resulted in accrued severance costs of $1.0 for 76 employees, all of whom were terminated by December 31, 2003, and other exit costs of $0.5, primarily related to lease terminations.
HRS recorded a $4.9 asset write-down of internally developed software costs in the first quarter of 2002 as a result of the February 2002 acceptance of the software technology provided under a March 2001 agreement further described in Note K. Also during the first quarter of 2002, we conducted a periodic reassessment of our environmental obligation. This obligation relates to the 1989 sale by our predecessor (Control Data Corporation) of its disk drive operations, which involved remediable environmental sites. The sale agreement provided terms describing how remedial costs related to remediable environmental sites would be shared between the buyer and us as the seller. The terms of the agreement included periodic joint reviews of the obligation by the buyer and us. Our obligations covered only those sites identified prior to the fifth anniversary of the sale. At the time of the sale, we established an accrual for our estimated costs that might occur as a result of this agreement. During the first 10 years following the sale, both parties incurred significant costs, which then began to reduce as these sites entered a water extraction and monitoring stage. During the first quarter of 2002, we participated in a periodic review of the status of this obligation with the environmental officer of the buyer. A site visit was made by our environmental representative at that time, and it was determined that our estimated liability was $4.1 less
(Dollars in millions, except per share data)
than previously determined. The excess accrual was then credited back to earnings as a component of other expense (income).
During the third quarter of 2002, we examined purchases of receivables from a certain trucking company by Comdata’s factoring business that had grown rapidly during 2002 and found that the debtors could not be verified. In the meantime, the parties that had sold us the receivables declared bankruptcy. We also made certain modifications to our policies and procedures related to the factoring business. We recorded the full amount of the loss of $9.8, including $0.3 of investigative costs incurred. Due to the unusual and non-recurring nature of the loss, we have reported the loss as other expense (income).
In the fourth quarter of 2002, we reviewed the status of accrued exit costs and revised the estimated amounts to reduce the severance cost provisions made by HRS in the first quarter of 2002 by $0.8 and in the first quarter of 2000 by $0.3 and by Comdata in the first quarter of 2002 by $0.3. We also incurred additional expense in HRS for severance costs of $1.3, involving 81 employees, and other exit costs of $2.9 and in Comdata for severance costs of $0.6, involving 41 employees, and other exit costs of $1.1. We paid all of the additional HRS severance costs during the fourth quarter of 2002. The other exit costs largely represented lease commitments, net of expected recoveries.
Also in the fourth quarter of 2002, HRS recorded a $7.8 write-down of the carrying values of certain marketable equity and cost-based investments, further described in Note G, recorded a $1.8 loss related to derivatives and wrote off the $0.3 carrying value of an abandoned software product. The investment write-down related primarily to our December 2001 cost-based investment in preferred stock of USIH, which was converted to common stock as a result of an initial public offering in October 2002. The $1.8 loss on derivatives represented the amortization of a portion of the $2.6 gain on derivatives recorded in the first quarter of 2001. The remaining $0.8 was charged to operations during 2003 as the derivatives to which the deferred gain relates expired. We also recorded $0.8 of other unusual costs in HRS for a litigation settlement.
The 2001 gain on sale of marketable securities of $15.6 related to our sale of HotJobs.com, Ltd. common stock and is further described in Note G. The gain on derivative securities of $2.6 resulted from the application of FAS 133 as amended and interpreted at that date. The second quarter 2001 litigation costs include a settlement of $49.0 and associated costs of $3.4 related to litigation involving Comdata and a provision of $1.3 for litigation costs not allocated to our business segments. The litigation settlement and associated costs at Comdata related to an action brought by Flying J, Inc. The nature and facts and circumstances of this litigation are fully disclosed in Note K to our consolidated financial statements for the year ended December 31, 2000, and the resulting settlement is fully disclosed in Part II, Item 1, “Legal Proceedings”, of our Quarterly Report on Form 10-Q, for the quarterly period ended June 30, 2001. The additional provision of $1.3 for litigation costs not allocated to our business segments related to disputes involving postretirement benefits.
During the first quarter of 2001, we took certain actions, described below, that were expected to improve operational efficiency, take advantage of technological opportunities and further focus our human resource businesses. These actions resulted in accrued exit costs of $9.9 and asset write-downs of $6.1. We paid these accrued exit costs in full by the end of 2001. We also recovered $3.2 of costs accrued during the first quarter of 2000, due to a revision of the estimated cost related to those actions.
In February 2001, Comdata terminated an outsourced contract for transaction processing and software development and brought those activities in-house. This action was intended to improve management control over these activities and reduce costs. The termination charge of $6.6 was recorded and paid during the first quarter of 2001. In order to implement the in-house operation, Comdata hired a number of
(Dollars in millions, except per share data)
personnel from the outsourcing contractor and made incremental investments in capitalized equipment and software of $7.4 in the same quarter.
In March 2001, HRS transferred most of its LifeWorks employee effectiveness services operation in Boston, Massachusetts into a related operation in Philadelphia, Pennsylvania and we decided to sell our Usertech employee training business. As a result of these actions, unrecoverable goodwill of $1.9 related to Usertech and $1.1 of equipment related to the Boston operation were recorded as asset write-downs. We sold Usertech in the third quarter of 2001. In addition, HRS charged $2.3 of severance costs for approximately 250 employees and $1.0 of excess facility costs to operations and recorded these as accrued exit costs. These charges were offset in part by the recovery of $3.2 of the estimated severance costs accrued in the first quarter of 2000, due primarily to a reduction in the scale of the downsizing of the St. Louis, Missouri customer services operations. Also in March 2001, HRS reassessed its strategy for developing software to serve its middle market payroll and tax filing customers and conducted an impairment review of internally developed software related to this effort. As a result, $3.1 of unrecoverable cost related to this software development effort was recognized as an asset write-down.
Discontinued Operations
On March 30, 2001, we separated our HRS division and subsidiaries and Comdata subsidiaries from our former media information business, Arbitron Inc., to form two independent, publicly-traded companies (“spin-off”).
The spin-off required that we establish new financing arrangements further described in Note J. Under the terms of agreements related to the spin-off, Arbitron furnished $225.0 from its own borrowings toward the retirement of Ceridian debt outstanding immediately prior to the spin-off. The $225.0 payment liability, combined with other assets and liabilities of Arbitron, resulted in net liabilities of discontinued operations of $182.9 at the time of the spin-off, which increased our retained earnings in that amount when the spin-off took place. The filing of 2001 income tax returns during the third quarter of 2002 for the parties involved in the spin-off resulted in the transfer of an additional deferred tax asset to Arbitron Inc., which reduced our deferred tax asset and retained earnings by $5.7.
Additionally, the par value of our common stock was established as 1¢ per share, compared to a par value of 50¢ per share for the predecessor’s common stock, and none of the predecessor’s treasury common stock was distributed to us, resulting in a reduction of $262.2 in our additional paid-in capital. The effects of these transactions are also presented in the Statements of Stockholders’ Equity.
(Dollars in millions, except per share data)
A summary of results for Arbitron for the year ended December 31, 2001 includes revenue of $60.2, earnings before income taxes of $9.0 and net earnings of $5.2 (net of income taxes of $3.8). Since the net earnings of $5.2 were derived from operations subsequent to the measurement date of July 18, 2000, this amount was applied as an adjustment of the loss on disposition reported in 2000. The 2001 gain from disposition amounted to $.04 per basic and $.03 per diluted share.
E. SEGMENT DATA
We operate in the information services industry principally in the U.S. and provide products and services primarily to the human resource, transportation and retail information markets. Our businesses collect, manage and analyze data and process transactions on behalf of customers, report information resulting from such activities to customers, and provide customers with related products, software applications and services. Our technology-based products and services of these businesses are typically provided through long-term customer relationships that result in a high level of recurring revenue. Our HRS and Comdata business segments are distinguished primarily by reference to the markets served and the nature of the services provided. Selected business segment information is provided in an accompanying table.
HRS offers a broad range of services and software designed to help employers more effectively manage their work forces and information that is integral to human resource processes. These activities are conducted primarily in the U.S. and, to a lesser extent, through subsidiaries located in Canada and the United Kingdom.
Comdata provides transaction processing and decision support services to the transportation industry, including assistance in obtaining regulatory permits and other services, in its markets. Comdata sells stored value cards and provides card-based services primarily to retailers in the form of gift cards and certificates, credits for product returns and retail promotions.
Further information about our business segments is presented in the section of Note A entitled “Revenue Recognition.”
The Other reporting element includes the unallocated amounts related to our corporate center operations. The assets of corporate center operations include cash and equivalents as well as deferred income tax and pension-related assets and liabilities.
We measure business segment results by reference to earnings before interest and taxes (“EBIT”) and exclude goodwill amortization in years prior to the adoption of FAS 142 in 2002. Expenses incurred by corporate center operations are charged or allocated to the business segments except for certain unusual gains and losses, which are reported as “Other”.
Revenue from sales between business segments is not material. Our operations are conducted primarily in the U.S. and revenue from sales between U.S. and non-U.S. entities is not material. Operations in Canada and the United Kingdom relate largely to the HRS segment. Geographic data for or at the end of
(Dollars in millions, except per share data)
each of the last three years, presented in an accompanying table, is determined by reference to the location of operation.
(Dollars in millions, except per share data)
BUSINESS SEGMENTS
(Dollars in millions, except per share data)
F. CAPITAL ASSETS
We estimate that amortization of other intangible assets held at December 31, 2003 will be $16.2 for 2004, $15.8 for 2005, $13.1 for 2006, $10.9 for 2007 and $8.7 for 2008.
(Dollars in millions, except per share data)
G. INVESTING ACTIVITY
Investments
At December 31, 2003 and 2002, we held the following publicly- or privately-held investments that were accounted for under FAS 115 as “available for sale” for the publicly-held securities and on a cost basis for the private holdings.
During March 2003, we paid to Ultimate $3.0 to acquire 750,000 unregistered shares of Ultimate common stock and a warrant to purchase an additional 75,000 unregistered Ultimate common shares at a price of $4.00 per share. At December 31, 2002, we also held 785,000 Ultimate common shares purchased on the open market, which we sold in September 2003 for proceeds of $5.9 and a net gain of $3.0 reported in other expense (income). In addition, we held 919,227 common shares of USIH at December 31, 2002 and 782,069 common shares at December 31, 2003. During September 2003, we sold 137,158 common shares of USIH for proceeds of $1.8 and a gain of $0.4, which we reported in other expense (income).
The Ultimate and USIH securities are treated as “available for sale” securities. The carrying value of these securities has been adjusted at each balance sheet date to reflect the market price reported by the stock exchange that lists those securities. The amount of this change is reported as unrealized gain or loss from marketable securities in comprehensive income. At December 31, 2003, the net unrealized gain related to these securities amounted to $3.9, after reduction for deferred income taxes of $2.4, and is reported in accumulated other comprehensive income. This compares to a net unrealized gain of $1.0, after reduction for deferred income taxes of $0.6, at December 31, 2002. The unrealized gain for these securities during 2003 amounted to $8.1 ($4.9 net of tax) and $1.5 ($1.0 net of tax) during 2002. During 2001 the unrealized loss for these securities was $2.9 ($1.9 net of tax). The realized gain for these securities during 2003 amounted to $3.4 ($2.0 net of tax). For 2002 the realized loss for these securities was $0.5 ($0.3 net of tax). The realized gain of $15.6 ($10.1 net of tax) in 2001 was related to our sale of the common stock of HotJobs.com, Ltd.
In March 2002, we acquired all of the outstanding stock of SYLINQ Corporation, a national employee benefits administration outsourcer specializing in automated enrollment and eligibility management
(Dollars in millions, except per share data)
(“SYLINQ”), for $15.6. As a result of the acquisition, we recorded net liabilities of $2.4, $11.6 of goodwill and $6.4 of other intangible assets. During the first quarter of 2003, we finalized the amount of purchase cost allocated to intangible assets, which increased intangible assets and decreased goodwill by $0.8.
In May 2002, we paid $8.9 for certain assets and assumed liabilities of HR Comply, a provider of online human resource and payroll employment compliance services that is associated with our LifeWorks business. The acquisition of HR Comply brought $1.0 of net liabilities, $7.9 of goodwill and $2.0 of other intangibles to the balance sheet.
In December 2002, we acquired selected assets of GLS Benefit Services LLC, a benefits administration outsourcing firm (“Great Lakes Strategies”), for $19.0. Under the purchase agreement, we paid $15.7 to the sellers and placed $3.3 in escrow. Of the total escrow amount, $0.5 would apply to the representations and warranties provisions of the purchase agreement. The $2.8 escrow deposit represented an estimate of an additional amount that could be paid to the sellers in February 2004 under a revenue sharing arrangement that applied when revenue earned from the acquired business during 2003 rose above a stated amount. We recorded the escrowed funds as other noncurrent assets. The remaining $15.7 of recorded net assets included $8.8 of goodwill and $4.0 of other intangible assets, subject to further evaluation of the intangibles acquired.
During July 2003, we settled in advance the revenue sharing arrangement associated with the acquisition of Great Lakes Strategies by paying the sellers $1.4 of the $2.8 escrowed for this purpose at the time of acquisition. At the same time, we released to the sellers the $0.5 of escrowed funds related to representations and warranties. These transactions reduced other current assets by $0.5 and other noncurrent assets by $2.8 while increasing goodwill by $1.9 and cash and equivalents by $1.4. Also during 2003, we finalized the amount of purchase cost allocated to the acquired intangible assets, which increased intangible assets and decreased goodwill by $2.2.
During 2002, we also paid $6.8 to acquire certain call center assets and cost-based investments.
In 2001, we made minority investments in strategic alliance partners to expand our HRS product offerings. The aggregate amount included in cost-based investments for these purchases was $20.2. Of this amount, we paid $15.0 for preferred stock of USIH in connection with a marketing arrangement. In October 2002, USIH made an initial public offering of its common stock, which required the conversion of our preferred stock into common stock. The offering price of the common stock was below our cost basis for the investment and, as a result, we recorded an asset write-down of $5.8 in the fourth quarter of 2002.
Proceeds from the sales of businesses and assets of $18.7 in 2001 principally represented our sale of common stock of HotJobs.com, Ltd., which provided proceeds of $15.6.
Equipment Under Capital Lease
During the second quarter of 2003, we entered into two leasing agreements with different lessors intended to provide us with greater flexibility to take advantage of future data storage technology at a lower cost. One arrangement involved the sale and leaseback of storage equipment recently acquired by us. We received $6.3 as cash proceeds from the sale of the equipment, which is reported as an investing cash inflow. We accounted for the leaseback of this equipment, which has a 3-year term commencing on May 1, 2003 and a negligible residual value, as a capital lease. We recorded the capital lease asset in machinery and equipment at $6.5, net of a deferred gain, and the related capital lease obligation in long term debt at $6.9 with no effect on cash flows. The carrying value of the capital lease asset will be amortized on a straight line basis over the term of the lease.
(Dollars in millions, except per share data)
The other leasing arrangement involved the replacement with new data storage equipment of data storage equipment we owned or leased. Under this arrangement, we received $5.8 as cash proceeds from the sale of owned equipment at its carrying value, which is reported as an investing cash inflow. We accounted for the lease of new storage equipment, which has a 5-year term commencing on June 1, 2003 and negligible residual value, as a capital lease. We recorded the capital lease asset in machinery and equipment at $13.4, net of a deferred gain, and the capital lease obligation in long-term debt at $15.3 with no effect on cash flows. The lease allows us access to increased levels of data storage capacity at months 10 and 22 according to a contractual schedule that correlates additional capacity with the lease payment schedule.
H. RETIREMENT PLANS
Pension Benefits
We provide retirement income benefits to our employees through a combination of defined benefit and defined contribution plans. Our principal pension plan is a contributory (salary reduction) defined benefit plan for U.S. employees that closed to any new participants on January 2, 1995. Assets of this plan are held in an irrevocable trust, do not include any Ceridian securities and consist principally of equity securities, U.S. government securities, and other fixed income obligations. Benefits under this plan are generally calculated on final or career average earnings and years of participation in the plan. Most participating employees are required to contribute to the plan as a condition of active participation. Former employees are inactive participants in this plan and constitute approximately 94% of the plan participants. This plan is funded in accordance with funding requirements under the Employee Retirement Income Security Act of 1974, based on determinations of an independent consulting actuary.
We also sponsor a nonqualified supplemental defined benefit plan for selected U.S. employees and a pension benefit plan for our employees in the United Kingdom (the “UK Plan”). The UK plan contains both defined benefit and defined contribution elements. Effective in October 2003, the UK Plan was amended to freeze the defined benefit element and enhance the defined contribution element of the plan. For U.S. reporting, this resulted in both a $1.8 reduction of the projected benefit obligation and an equal reduction in the net unrecognized loss of the plan. The net loss will be amortized over the average expected remaining service life of ex-defined benefit participants of 10 years. The accompanying tables reflect the combined funded status and net periodic pension cost (credit) and blended supporting assumptions for the defined benefit elements of all three plans.
We account for our defined benefit pension plans using actuarial models required by present accounting rules under FAS 87, “Employers’ Accounting for Pensions”. This model uses an attribution approach that generally spreads the effect of individual events over the service lives of the employees in the plan. These events include plan amendments and changes in actuarial assumptions such as the expected long-term rate of return on plan assets, discount rate related to the benefit obligation, rate of active participants’ compensation increases and mortality rates. The principle underlying the required attribution approach is that employees render service over their service lives on a relatively smooth basis and, therefore, the income statement effects of pensions are earned in, and should follow, the same pattern.
One of the principal components of the net periodic pension calculation is the expected long-term rate of return on plan assets. The required use of expected long-term rate of return on plan assets may result in recognized pension income that is greater or less than the actual returns of those plan assets in any given year. Over time, however, the expected long-term returns are designed to approximate the actual long-term returns and, therefore, result in a pattern of income and expense recognition that more closely matches the pattern of the services provided by the employees. Differences between actual and expected returns are
(Dollars in millions, except per share data)
recognized in the net periodic pension calculation over five years. We use long-term historical actual return information, the mix of investments that comprise plan assets, and future estimates of long-term investment returns by reference to external sources to develop our expected return on plan assets.
In the table below we present the allocation of the principal pension plan assets, which is by far the largest of our defined benefit plans, as of the measurement date.
The investment policy for our principal pension plan specifies the objective is to earn the highest possible total returns consistent with the preservation of capital and anticipated liquidity requirements while minimizing the volatility of returns. Target asset allocation ranges specified in the policy are designed to achieve policy objectives and are based upon actuarial and capital market studies performed by experienced outside consultants. On a regular basis we rebalance assets to maintain asset allocations within policy ranges. Within asset categories we use a range of passive and active investment management styles to achieve our principal pension plan’s investment objectives and hire outside managers to manage all assets. The principal pension plan currently has no allocation to real estate, derivative securities, or other alternative investment strategies; however a small amount of real estate and venture capital investments from prior investments is shown in “Cash and Other Assets.” Certain asset managers may use futures contracts within limitations to achieve objectives under their assigned investment mandate. Investment of the principal pension plan assets in securities of Ceridian Corporation is prohibited by the investment policy.
In November 2003, upon completion of a trading cost optimization study conducted by a plan consultant, the target ranges were changed to the following:
During December of 2003, we undertook rebalancing of plan assets to bring allocations within the new target ranges.
The discount rate assumptions used for pension plan accounting reflect the rates available on high-quality fixed-income debt instruments on December 31 of each year. That rate is used to determine the benefit obligation at that date and the interest portion of the net periodic pension cost or credit for the following year. We determine the assumed rate of compensation increase based upon our long-term plans for such increases.
Due to the combined adverse effects of falling stock market values on the valuation of plan assets and of falling interest rates on the benefit obligation, the accumulated benefit obligation of our principal pension plan exceeded the fair value of plan assets by $104.6 at December 31, 2003 and $189.4 at December 31,
(Dollars in millions, except per share data)
2002. Under pension accounting rules, this condition required that we reclassify the prepaid pension cost related to this plan to recognize this unfunded liability and record the remainder (net of deferred income taxes and a small intangible asset amount) as a loss in accumulated other comprehensive income, which reduces stockholders’ equity. During 2003, we made employer contributions to the principal plan amounting to $103.7 including $75.0 in the fourth quarter of 2003. We do not presently plan to make additional contributions to the principal pension plan in 2004. Subsequent developments in investment performance, interest rates or regulatory actions may require reconsideration of this position.
The amount included in other comprehensive income arising from the change in the additional minimum pension liability for each of the past three years is presented in the accompanying Statements of Stockholders’ Equity. In our 2004 financial statements, we will be required to also provide the benefits expected to be paid by our defined benefit plans in each of the following 5 years and in the aggregate for the five years thereafter.
At December 31, 2003 and 2002, our prepaid pension cost asset included $11.8 and $11.3 held in benefit protection trusts for certain nonqualified plan participants and an intangible pension asset of $0.3 and $0.4.
We recognized expense of $12.7 in 2003, $13.4 in 2002 and $9.7 in 2001 with respect to employer contributions to our defined contribution retirement plans.
(Dollars in millions, except per share data)
(Dollars in millions, except per share data)
________________________________________________________________________________
Postretirement Benefits
We provide health care and life insurance benefits for eligible retired employees, including individuals who retired from operations we subsequently sold or discontinued. We sponsor several health care plans in the U.S. for both pre- and post-age 65 retirees. Our contributions to these plans differ for various groups of retirees and future retirees. Most retirees outside the U.S. are covered by governmental health care programs, and our cost is not significant. As reported in the section of Note A entitled “Recently Issued Accounting Pronouncements,” we have elected to defer recognizing the effect of the recently-passed Medicare Act on our postretirement benefit obligation and expense and providing the information related to these plans called for in FAS 132.
The accompanying tables present the amounts and changes in the aggregate benefit obligation at the beginning and end of and for each of the last two measurement periods and the components of net periodic postretirement benefit cost for the plans for the last three years. We do not prefund these costs.
(Dollars in millions, except per share data)
________________________________________________________________________________
The assumed health care cost trend rate used in measuring the benefit obligation is 11% in 2003 with rates declining at a rate of 1% per year to an ultimate rate of 5% in 2010. A one percent increase in this rate would increase the benefit obligation at September 30, 2003 by $3.8 and the aggregate service and interest cost for the 2003 measurement period by $0.2. A one percent decrease in this rate would decrease the benefit obligation at September 30, 2003 by $3.6 and the aggregate service and interest cost for the 2003 measurement period by $0.2. The weighted average discount rates used in determining the net periodic postretirement benefit costs were 6.75% for 2003, 7.50% for 2002 and 7.75% for 2001. The weighted average discount rates used in determining the benefit obligation at the measurement dates were 6.00% for 2003 and 6.75% for 2002. We expect to make payments of $3.0 on behalf of participants in our postretirement plans in 2004.
I. STOCK PLANS
During the three-year period ended December 31, 2003, we maintained stock-based compensation plans for directors, officers, other employees, consultants and independent contractors.
Our Amended and Restated 2001 Director Performance Incentive Plan authorizes the issuance of up to 350,000 shares in connection with awards of stock options, non-performance restricted stock and deferred stock to non-employee directors. An annual grant of a non-qualified stock option to purchase 4,000 shares is made to each eligible director with such grants becoming fully exercisable six months after the date of grant. The exercise price of the options is the fair market value of the underlying stock at the date of grant, and the options expire in ten years.
A one-time award of non-performance restricted shares is made to each non-employee director when the director first joins the Board with restrictions on transfer that will ordinarily lapse annually over a five-year period. The number of shares awarded will have a fair market value equal to two and one-half times the then current annual retainer paid to non-employee directors.
Additionally, at least one-half of the annual Board retainer for each non-employee director is also provided in the form of restricted stock, deferred stock or a combination of the two. The restrictions on transfer of the retainer awards will lapse at the conclusion of the director’s service.
Our 2002 Employee Stock Incentive Plan (“2002 ESIP”) authorizes the issuance until January 29, 2012 of up to 4,000,000 common shares in connection with awards of stock options, restricted stock awards and performance unit awards. Eligible participants in the 2002 ESIP include employees who are not executive officers or directors.
Our Amended and Restated 2001 Long-Term Stock Incentive Plan (“2001 LTSIP”) authorizes the issuance until November 27, 2010 of up to 27,000,000 common shares in connection with similar awards.
(Dollars in millions, except per share data)
Eligible participants in the 2001 LTSIP include our employees and non-employee directors, consultants and independent contractors.
At the time of the spin-off, holders of 18,127,045 Ceridian stock options and 59,870 unvested restricted stock awards had their awards adjusted in number, kind and exercise price to preserve the intrinsic value of their holdings based upon their employment status, as indicated in the Stock Plans table. Other terms of the options were not changed.
Stock options awarded under the 2002 ESIP and 2001 LTSIP generally vest annually either over a three-year period or on a specific date if certain performance criteria were satisfied, have either a 5-year or 10-year term and have an exercise price that may not be less than the fair market value of the underlying stock at the date of grant.
The Compensation and Human Resources Committee of our Board has the discretion to determine the effect that a change of control of Ceridian will have upon awards made under these plans. In most cases, the vesting of stock options and restricted stock awards granted under these plans will accelerate upon a change of control of Ceridian.
We have reserved 725,495 common shares for issuance under “Save-As-You-Earn” stock-based compensation plans for our employees in the United Kingdom (the “SAYE Plans”). At December 31, 2003, there were 145,574 options outstanding under the SAYE Plans.
Our Employee Stock Purchase Plan (“ESPP”) provides for the issuance of up to 1,000,000 shares of newly issued or treasury common stock of Ceridian to eligible employees. The purchase price of the stock to ESPP participants is 85% of the lesser of the fair market value on either the first day or the last day of the applicable three-month offering period. In connection with the spin-off, we suspended activity in the ESPP from December 16, 2000 until June 16, 2001.
For holders of Ceridian common stock at November 9, 2001, we distributed one right for each outstanding share entitling the holder to purchase from us one ten-thousandth of a share of an unissued class of preferred stock for $75 dollars. In the event of a certain effort to acquire Ceridian, the holder would have the right to exercise the right for cash, property or securities of the issuer with a value of twice the exercise price. At December 31, 2003, no such event had occurred.
As reported in Note A, we adopted the disclosure-only provisions of FAS 123 and FAS 148 and continue to account for stock-based compensation. Therefore, since all option exercise prices are at or above fair market value on the date of grant and the ESPP is a non-compensatory plan, no expense is recorded with respect to our stock option or employee stock purchase plans. We recognized compensation expense of $1.2 in 2003, $0.4 in 2002 and $1.2 in 2001 related to restricted stock awards.
We provide the following disclosure, including referenced tables, with respect to the provisions of FAS 123. We employ the Black-Scholes option pricing model for determining the fair value of stock option grants and ESPP purchases as presented in an accompanying table. Weighted average exercise
(Dollars in millions, except per share data)
prices for stock option activity and options outstanding at December 31, 2003, 2002 and 2001 are included in the Stock Plans table.
(Dollars in millions, except per share data)
Further information on outstanding and exercisable stock options by exercise price range as of the end of the current year is disclosed in an accompanying table. We are required to report the pro forma effect on net earnings and earnings per share that would have resulted if the fair value method of accounting for stock-based compensation issued in those years had been adopted. This compensation cost is allocated to the related periods of service. The results of this calculation and the assumptions used appear in the accompanying pro forma table.
(Dollars in millions, except per share data)
J. FINANCING
Debt Instruments and Capital Lease Obligations
We describe in Note G under the heading “Equipment Under Capital Lease,” two leasing arrangements that became effective during the second quarter of 2003 that are accounted for as capital leases.
Revolving Credit Facility
Under an agreement with a syndicate of commercial banks dated January 31, 2001, we entered into a $350.0 domestic revolving credit facility, of which $50.0 may be used for letters of credit, that expires in March 2006. This January 2001 credit facility also permits us to request that the bank syndicate use its best efforts to provide additional commitments so long as the total commitment does not exceed $500.0. The January 2001 credit facility is unsecured and its pricing for both loans and letters of credit is based on our senior unsecured debt ratings and LIBOR. Under the terms of the January 2001 credit facility, our consolidated debt must not exceed our stockholders’ equity, as defined in the agreement, as of the end of any fiscal quarter, and the ratio of earnings before interest and taxes to interest expense on a rolling four quarter basis must be at least 2.75 to 1. This facility also contains covenants that, among other things, limit liens, subsidiary debt, contingent obligations, operating leases, minority equity investments and divestitures. We have remained in compliance with all of these covenants. The January 2001 credit facility replaced a $250.0 domestic revolving credit facility with similar terms that was arranged with a commercial bank syndicate in July 1997.
Under the January 2001 credit facility, in addition to the spin-off financing, we borrowed $50.0 in June 2001 in connection with the settlement of litigation and repaid a total of $50.0 during 2001. At December 31, 2001, advances of $235.0 and a letter of credit in the amount of $2.0 were outstanding under the January 2001 credit facility. We used the $150.0 proceeds from the receivables securitization facility and additional payments of $45.0 during 2002 to reduce the advances outstanding under the January 2001 credit facility to $40.0 at December 31, 2002. During 2003, we paid off the $40.0 of advances outstanding since December 31, 2002 while $2.3 of letters of credit remain outstanding. At December 31, 2003, we have unused borrowing capacity under the domestic revolving credit facility of $347.7, of which we have designated $140.0 as backup to the Comdata receivables securitization facility.
Receivables Securitization Facility
In June 2002, Comdata entered into a $150.0 receivables securitization facility with up to a three-year term involving certain of its trade receivables (“the Receivables”). The securitization facility is subject to
(Dollars in millions, except per share data)
financial covenants similar to those included in our $350.0 revolving credit facility and consists of two steps.
In the first step, Comdata Funding Corporation (“CFC”), a bankruptcy-remote special purpose subsidiary of Comdata, buys and accepts capital contributions of the Receivables in transactions intended to constitute true sales or other outright conveyances.
In the second step, CFC “sells” undivided interests in those Receivables to a third-party multi-seller commercial paper conduit (the “Conduit”) or its liquidity banks (together with the Conduit, “Purchasers”) in transactions reported as secured loans.
Although title to the Receivables passes to CFC under the first step of the facility and the Receivables are no longer available to satisfy claims of Comdata’s creditors, Comdata has agreed to act as the servicing agent for the Receivables acquired by CFC in exchange for a servicing fee of 1% per annum on the average outstanding balance of the Receivables. We have guaranteed Comdata’s performance as both originator of and servicing agent for the Receivables.
CFC may increase or decrease its use of the securitization facility up to four times a month provided sufficient qualified Receivables exist to support the Purchasers’ investment under the second step. CFC is obligated to pay interest on the invested amount outstanding either at the Conduit’s pooled A-1/P-1 commercial paper rate (which was 1.51% at December 31, 2003), or, in the event the Conduit is unable to issue commercial paper, at CFC’s choice of the prime rate or LIBOR plus 1.5% per annum. In addition, CFC must pay a monthly program fee of 0.125% per annum on the average invested amount outstanding during the preceding month and a monthly facility fee equal to 0.25% per annum on 102% of the average facility size (whether used or unused) during the preceding month. Both of these fees are included in interest expense.
During September 2003, we made a payment of $10.0 on this facility. The amount outstanding under this facility was $140.0 at December 31, 2003, and $150.0 at December 31, 2002. The aggregate amount of receivables serving as collateral amounted to $187.0 at December 31, 2003 and $173.3 at December 31, 2002. The invested amount outstanding is accounted for as long-term debt and the receivables remain on our consolidated balance sheet, even though the Receivables are not available to satisfy claims of creditors of any of the companies other than CFC.
Senior Notes
Senior notes with a face amount of $450.0 were sold in a Rule 144A offering in June 1999. The senior notes had a five-year term with a coupon interest rate of 7.25% per annum payable semiannually beginning December 1, 1999. The senior notes were sold at an original issue discount of $4.4 that, along with $0.8 of issue costs, was amortized to interest expense based on the term of the notes. We applied the net proceeds from the sale of the senior notes, along with cash balances and an advance of $210.0 on the July 1997 credit facility, to fund the acquisition of ABR Information Services, Inc. in June 1999. During first quarter 2000, we repurchased on the open market senior notes with a face amount of $20.0.
In March 2001, at the time of the spin-off, advances of $235.0 from the January 2001 credit facility, the $225.0 Arbitron payment and existing cash balances funded the required early retirement of the $430.0 of senior notes outstanding and payment of the $50.0 balance outstanding under the $250.0 domestic revolving credit facility dated July 1997 at the time of the spin-off. The redemption of senior notes required a payment of $456.5. The establishment of the January 2001 credit facility also resulted in the payment of $1.0 for origination costs that are being amortized over its term. Further information on the spin-off appears under the heading “Discontinued Operations” in Note D.
(Dollars in millions, except per share data)
Other Financing
During 2001, payments of $18.8 and translation adjustments of $0.3 extinguished the balance of $19.1 outstanding at December 31, 2000 on revolving credit agreements of Ceridian Canada, leaving only a letter of credit valued at $0.8 at December 31, 2003 and 2002 outstanding under those agreements. Other indebtedness at December 31, 2003 and 2002 of $2.7 and $3.5 included an overdraft facility for Ceridian Centrefile and acquisition indebtedness.
Equity Instruments
During 2003, we repurchased 1,844,100 shares of our common stock for $28.8 on the open market at an average net price of $15.60 per share. We also repurchased 393,000 shares of our common stock during 2002 for $5.4 on the open market at an average net price of $13.74. As of December 31, 2003, we may repurchase up to 10,362,900 additional shares of our common stock under an existing authorization from our Board. We generally use our treasury stock to address our obligations under our stock compensation and employee stock purchase plans.
K. COMMITMENTS AND CONTINGENCIES
Derivative Securities
Interest Rate Hedges
In accordance with our risk management policy, we hedge a substantial portion of our interest rate exposure related to our investment of customer funds, as further described in Note M, viewed within the context of our expectation of the future economic environment. Due to liquidity requirements for these obligations, we hold a large percentage of customer funds in overnight-maturing investments that are subject to interest rate variability. We manage this variability in part by investing a portion of these funds in longer-term instruments and by offsetting the variable rate income with floating rates on our debt obligations. We also utilize derivative securities such as interest rate contracts to manage interest rate risk.
During the three-year period ended December 31, 2003, we maintained in effect interest rate contracts that function as cash flow hedges of the designated item for the purpose of hedging interest rate risk on customer funds. The counterparties to these arrangements are commercial banks with debt ratings of A or better. These arrangements, which do not require collateral, require the banks to pay us the amount by which a one-month LIBOR index of short-term interest rates falls below a specified floor strike level. Alternatively, when this index exceeds a specified cap strike level, we pay out to the banks the excess above the cap strike level. We believe that the risk of accounting loss through non-performance by the counterparties under any of these arrangements is negligible.
At December 31, 2003 and 2002, we had interest rate contracts in effect with an aggregate notional amount of $800.0. The active contracts at the end of 2003 had remaining terms of 2 to 41 months, floor strike levels ranging from 4.50% to 6.07% (averaging 5.22%) and cap strike levels ranging from 4.54% to 7.32% (averaging 6.04%). We report the carrying value of our derivative securities as a noncurrent asset on our balance sheet and any changes in the carrying value of these securities in other comprehensive income in our statement of stockholders’ equity. We recognize derivative gains and losses as cash settlements occur and include these amounts in revenue from HRS operations, along with the investment income hedged by these instruments. The gross unrealized gains from our derivative securities amounted to $16.1 ($10.5 net of tax) in 2003, $75.8 ($49.3 net of tax) in 2002 and $32.0 ($20.8 net of tax) in 2001. The gross realized gains of $31.2 ($20.3 net of tax) in 2003, $26.9 ($17.5 net of tax) in 2002 and $10.3 ($6.7 net of tax) in 2001 were included in HRS revenue. The gross unrealized gains result largely from a decline
(Dollars in millions, except per share data)
in forward interest rates. Based upon future expected interest rates as determined from LIBOR future prices in effect at the close of business on December 31, 2003, we expect to collect an additional $28.8 during 2004.
Fuel Price Hedges
The revenue and net income of Comdata’s transportation services business is exposed to variability based on changes in the prices of diesel fuel. For a large portion of its transportation services customers, Comdata earns fee revenue for card transactions based on a percentage of the total amount of each fuel purchase. An increase/decrease in the price of diesel fuel increases/decreases the total dollar amount of fuel purchases and Comdata revenue, accordingly. We estimate that for each 10¢ change in the average price of diesel fuel per year, Comdata revenue and pretax profit are impacted by $1.8, before impact of any fuel price hedging program.
Our risk management objective of managing fuel price risk is to protect Comdata revenue and net income from the effects of falling diesel fuel prices by entering into derivative contracts that convert the floating price of fuel used in revenue calculations to a fixed price. During 2003, Comdata entered into fuel price derivative contracts that serve as cash flow hedges to swap the floating price of fuel for a fixed price. These contracts had the effect of reducing the exposure to price variability of diesel fuel noted above by approximately one half for the period April 1 to December 31, 2003. Since the floating fuel price remained above the fixed price during the course of the hedges, we paid $0.7 to counterparties over the term of the agreement. These payments had the effect of reducing the revenue benefit received during the term of the hedges from the higher-than-expected floating prices. While the hedges were not fully effective, the loss related to ineffectiveness was not material. These contracts matured in December 2003. We continuously monitor fuel price volatility and the cost of hedging and may enter into additional fuel price derivative contracts solely for the purpose of managing fuel price risk when market conditions are favorable to such transactions.
Contracts
In March 2001, we entered into an agreement with Ultimate that provided us with a non-exclusive license to use Ultimate’s software as part of a Web-enabled integrated payroll/HR/self-service offering to our small business customers. Our initial payment to Ultimate amounted to $10.0, which provided us with a non-exclusive license to use its software product in our product offerings. This payment was partially refundable pending successful transfer of the technology. Amendments to the license agreement in August 2001 and February 2002 eliminated any refundable nature of the initial payment and deemed the technology transfer complete as of February 2002. In February 2002, we agreed to pay Ultimate an additional $0.5 if an upgraded release were to be delivered prior to August 31, 2002, which did occur. The $10.5 is accounted for as purchased software under SOP 98-1 and amortized on a straight-line basis over a seven-year period that began in March 2003 when our SourceWeb software product incorporating this Ultimate software was placed in service.
Pursuant to the February 2002 amendment, the license agreement also provided for a monthly royalty commencing in January 2003, which is based on the number of our customers’ employees paid by using the software and subject to minimum and maximum amounts. Pursuant to the February 2002 amendment, we made an advance payment of $6.0 to Ultimate at that time representing the minimum royalty commitment for 2003. We remain obligated to future minimum monthly payments of $0.5 per month from January 2004 until January 1, 2006, when the per-employee monthly charge will escalate at a rate of 5% per annum until the end of the noncancellable term in March 2008. We recorded the $6.0 payment as
(Dollars in millions, except per share data)
prepaid expense and amortized this amount to cost of revenue on a straight line basis over the 12 months of 2003. Royalty costs under this agreement will be charged monthly to cost of revenue and paid according to the terms of the agreement.
On February 10, 2003, we entered into a services agreement with Ultimate through December 31, 2003, under which we made quarterly payments totaling $2.25 during 2003 for technical support in connection with the introduction of our SourceWeb payroll services offering that incorporates the Ultimate software. We charged these services to operations as services were performed during 2003.
In connection with the acquisition of certain call center assets in December 2002, we entered into royalty and services arrangements that are noncancelable for the first 36 months. Under these arrangements, we are obligated to make minimum payments of $2.2 in each of 2003, 2004 and 2005.
Leasing
We conduct a substantial portion of our operations in leased facilities. Most of our leases contain renewal options and require payments for taxes, insurance and maintenance.
Virtually all our leasing arrangements for equipment and facilities are operating leases and the rental payments under these leases are charged to operations as incurred. The amounts in the accompanying tables do not include obligations recorded as liabilities.
Our rental expense and sublease income for each of the three years ended December 31, 2003 appear in the accompanying Rental Expense table.
Our future minimum noncancelable lease payments on existing operating leases at December 31, 2003, which have an initial term of more than one year, are presented in the accompanying Future Minimum Lease Payments table.
L. LEGAL MATTERS
We are involved in a number of judicial and administrative proceedings considered normal in the nature of their current and past operations, including employment-related disputes, contract disputes, government proceedings, customer disputes, and tort claims. In some proceedings, the claimant seeks damages as well as other relief, which, if granted, would require substantial expenditures on our part.
(Dollars in millions, except per share data)
Some of these matters raise difficult and complex factual and legal issues, and are subject to many uncertainties, including the facts and circumstances of each particular action, and the jurisdiction, forum and law under which each action is proceeding. Because of this complexity, final disposition of some of these proceedings may not occur for several years. As such, we are not always able to estimate the amount of our possible future liabilities. There can be no certainty that we may not ultimately incur charges in excess of presently or future established accruals or insurance coverage. Although occasional adverse decisions (or settlements) may occur, it is the opinion of our management that the final disposition of these proceedings will not, considering the merits of the claims and available reserves and based upon the facts and circumstances currently known, have a material adverse effect on our financial position or results of operations.
SEC Investigation
On January 22, 2004, we filed a Current Report on Form 8-K, under Item 5, stating that we announced that we are responding to a document request from the Securities and Exchange Commission, and that we have been advised that the SEC has issued a formal order of investigation. The SEC has informed us that this is a non-public fact finding inquiry and that the investigation and document request does not mean that the SEC has concluded that we have violated any securities laws. We are fully cooperating with the SEC.
M. CUSTOMER FUNDS
In connection with our U.S. and Canadian payroll and tax filing services, we collect funds for payment of payroll and taxes; temporarily hold such funds in trust until payment is due; remit the funds to the clients’ employees and appropriate taxing authority; file federal, state and local tax returns; and handle related regulatory correspondence and amendments. In connection with our HRS benefits services operation, we receive funds on behalf of our customers for remittances to employees, insurance providers and others. These funds are not held in a trust.
As indicated in the section entitled “Changes in Presentation” of Note A, in 2003 we changed our presentation of benefits services customer deposits in order to include these amounts with our payroll and tax filing customer funds in a combined amount described as “customer funds” on our consolidated balance sheet. The related obligations are similarly reported on a combined basis. The effect of this reclassification on our consolidated balance sheet moved amounts previously reported in “cash and equivalents” and “short-term investments” and into an asset entitled “customer funds.” The related obligations previously reported in “drafts and customer funds payable” moved into a liability entitled “customer funds obligations.” The reclassifications eliminated from our consolidated statements of cash flows the reclassified “cash and equivalents” balances, the effect on operating cash flows of changes in the reclassified “customer funds payable,” and the effect on investing cash flows from any changes in the reclassified “short-term investments.” This reclassification did not affect our consolidated statements of operations.
We invest the U.S. customer funds primarily in high quality collateralized short-term investments or money market mutual funds. We may also invest these funds in U.S. Treasury and Agency securities, AAA rated asset-backed securities and corporate securities rated A3/A- or better. Our Canadian trust funds are invested in securities issued by the government and provinces of Canada, highly rated Canadian banks and corporations, asset-backed trusts and mortgages.
Investment income from invested customer funds constitutes a component of our compensation for providing services under agreements with our customers. Investment income from invested customer funds
(Dollars in millions, except per share data)
included in revenue amounted to $93.1 in 2003, $91.4 in 2002 and $103.0 in 2001. These amounts include gross realized gains from interest rate contracts as further discussed in Note K. We further discuss our accounting for this investment income in the section of Note A entitled “Revenue Recognition.”
Due to our positive intent and ability to hold the marketable debt securities until maturity and supporting historical experience, we classify these securities as held-to-maturity and report them at amortized cost. Any disposition of these securities before maturity is expected to be limited to unusual circumstances such as significant deterioration of the issuer’s creditworthiness or a major business combination or disposition.
Customer funds and the offsetting obligations amounted to $3,132.1 at December 31, 2003 and $2,440.9 at December 31, 2002. This amount varies significantly during the year and averaged $2,138.4 and $1,926.2, respectively, for the years ended December 31, 2003 and 2002. The following tables provide information on cost and market price for various classifications of customer fund investments and amounts by maturity date.
(Dollars in millions, except per share data)
N. SUPPLEMENTARY QUARTERLY DATA (UNAUDITED)
(1)
The effect of the restatement for the corrections in revenue recognition for retail card sales and sales of related services, as described in Note B and in a note to our consolidated financial statements contained in our amended Quarterly Report on Form 10-Q/A for the period ended September 30, 2003, on pertinent categories for 2003 and 2002 in the table above was as follows:
(2)
Includes 2003 gain from sale of stock of $3.4 in the third quarter and 2002 unusual losses of $9.8 for the first quarter, $9.8 for the third quarter and $15.2 for the fourth quarter as described in Note D.
(3)
For information on the calculation of earnings per share, see the section entitled “Earnings per Share” in Note A.
SCHEDULE II
CERIDIAN CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(Dollars in millions)
(1)
Other adjustments include the effect of acquisitions and dispositions of businesses.
INDEPENDENT AUDITORS’ REPORT ON FINANCIAL STATEMENT SCHEDULE
THE BOARD OF DIRECTORS AND STOCKHOLDERS
CERIDIAN CORPORATION:
Under date of March 12, 2004, we reported on the consolidated balance sheets of Ceridian Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2003, as contained in Ceridian’s 2003 Annual Report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index (see Item 15.(a)2.). This financial statement schedule is the responsibility of Ceridian’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG Signature
Minneapolis, Minnesota
March 12, 2004
Item 9.
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of December 31, 2003, the end of the period covered by this report. Based upon that evaluation, our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that, as of December 31, 2003, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.
During the fourth quarter ended December 31, 2003, there has been no change in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected or is reasonable likely to materially affect, our internal control over financial reporting.
PART III
Item 10.
Directors and Executive Officers of the Registrant
We refer you to our Proxy Statement for our 2004 Annual Meeting of Stockholders and the heading “Election of Directors” for information regarding our directors and nominees for director. This information is incorporated by reference into this item of the report.
Information regarding our executive officers is found in Item 1A
Item 11.
Executive Compensation
We refer you to our Proxy Statement for our 2004 Annual Meeting of Stockholders and the headings “Director Compensation,” “Report of Compensation and Human Resources Committee,” “Stock Price Performance Graph,” “Executive Compensation,” and “Employment Agreements and Change of Control Arrangements.” This information is incorporated by reference into this item of the report.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stock Matters
We refer you to our Proxy Statement for our 2004 Annual Meeting of Stockholders and the heading “Share Ownership Information” and “Equity Compensation Plan Information.” This information is incorporated by reference into this item of the report.
Item 13.
Item 13.
Certain Relationships and Related Transactions
None.
Item 14.
Item 14.
Principal Accounting Fees and Services
We refer you to our Proxy Statement for our 2004 Annual Meeting of Stockholders and the heading “Independent Auditor Fees.” This information is incorporated by reference into this item of the report.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)1. Financial Statements of Registrant
We refer you to the “Index of Consolidated Financial Statements” included in Part II, Item 8 of this report.
(a)2. Financial Statement Schedules of Registrant
We refer you to the “Index of Financial Statement Schedules” included in Part II, Item 8 of this report.
(a)3. Exhibits
The following is a complete list of exhibits filed or incorporated by reference as part of this report.
*
Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.
We will provide our stockholders with copies of any of the exhibits listed above, upon request and payment of its reasonable expenses in furnishing such exhibits. We will also provide to the Securities and Exchange Commission, upon request, any exhibit or schedule to any of the foregoing exhibits which has not been filed.
(b)
Reports on Form 8-K
The following Reports on Form 8-K were filed or furnished during the fourth quarter of 2003 and through the date of this Form 10-K filing. The contents of Items 7 and 12 of the following Forms 8-K are not incorporated by reference herein or deemed “filed” within the meaning of Section 18 or the Securities Act:
On October 15, 2003, we filed a Current Report on Form 8-K, furnishing under Items 7 and 12, a press release reporting our third quarter 2003 results.
On January 22, 2004, we filed a Current Report on Form 8-K filing under Item 5, announcing that Ceridian is responding to a document request from the SEC and has been advised that the SEC has issued a formal order of investigation, and furnishing under Items 7 and 12, a press release reporting our fourth quarter and full year 2003 results.
On February 19, 2004, we filed a Current Report on Form 8-K filing under Items 5 and 7 a press release announcing a change in revenue recognition at our Stored Value Systems unit, the intention to restate our financial statements for the fiscal years ended December 31, 2003, 2002, 2001 and 2000 and revised guidance for 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, as of March 15, 2004.
CERIDIAN CORPORATION
By
/s/ Ronald L. Turner
Ronald L. Turner
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated as of March 15, 2004.
/s/ RONALD L. TURNER
Ronald L. Turner
Chairman, President and Chief Executive Officer (Principal Executive Officer)
/s/ JOHN R. EICKHOFF
/s/ LOREN D. GROSS
Loren D. Gross
Vice President and Corporate Controller (Principal Accounting Officer)
/s/ WILLIAM J. CADOGAN
William J. Cadogan, Director
/s/ ROBERT H. EWALD
Robert H. Ewald, Director and Executive Vice President and President, Ceridian Human Resource Solutions
/s/ NICHOLAS D. CHABRAJA
/s/ GEORGE R. LEWIS
George R. Lewis, Director
/s/ RONALD T. LEMAY
/s/ ALAN F. WHITE
Alan F. White, Director
/s/ CAROLE J. UHRICH
CERIDIAN CORPORATION
ANNUAL REPORT ON FORM 10-K
EXHIBIT INDEX
*
Incorporated by Reference