Notes to the Consolidated Financial Statements

(Tabular dollars in millions, except per share amounts)
(Unaudited)

Note 1. Basis of Presentation
 

The accompanying unaudited consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods. Adjustments are of a normal recurring nature. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes of Automatic Data Processing, Inc. and subsidiaries (“ADP” or the “Company”) as of and for the year ended June 30, 2009 (“fiscal 2009”). The results of operations for the three and six months ended December 31, 2009 may not be indicative of the results to be expected for the fiscal year ending June 30, 2010 (“fiscal 2010”).
 

Note 2. New Accounting Pronouncements
 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Codification (“ASC”) 105.10.05, “Generally Accepted Accounting Principles” (“ASC 105.10.05”). ASC 105.10.05 establishes the FASB ASC as the single source of authoritative generally accepted accounting principles (“GAAP”). Pursuant to the provisions of ASC 105.10.05, the Company has updated references to GAAP in its financial statements issued subsequent to September 15, 2009. The adoption of ASC 105.10.05 did not have any impact on the Company’s consolidated results of operations, financial condition or cash flows.
 

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-6, “Improving Disclosures about Fair Value Investments.” ASU 2010-6 amends the disclosure requirements in ASC 820.10 “Fair Value Measurements and Disclosures,” which the Company adopted on July 1, 2008, and requires new disclosures regarding transfers in and out of Level 1 and 2 asset categories as well as more detailed information for the Level 3 reconciliation of activity, if required. Since the Company adopted ASC 820.10, the Company has not had any transfers in or out of Level 1 or Level 2, nor has the Company had any Level 3 assets or liabilities. ASU 2010-6 also clarifies existing disclosure requirements regarding the level of disaggregation expected, valuation techniques and inputs to fair value measurements. ASU 2010-6 is effective for interim and annual reporting periods beginning after December 15, 2009. The Company does not anticipate the adoption of ASU 2010-6 will have any impact on its consolidated results of operations, financial condition or cash flows.
 
In October 2009, the FASB issued ASU 2009-13, “Multiple Deliverable Revenue Arrangements.” ASU 2009-13 modifies the guidance related to accounting for arrangements with multiple deliverables by providing an alternative when vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”) does not exist to determine the selling price of a deliverable. The alternative when VSOE or TPE does not exist is the best estimate of the selling price of the deliverable. Consideration for multiple deliverables is then allocated based upon the relative selling price of the deliverables and revenue is recognized as earned for each deliverable. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, unless the election is made to adopt ASU 2009-13 retrospectively. In either case, early adoption is permitted. The Company is currently evaluating the impact, if any, that the adoption of ASU 2009-13 will have on its consolidated results of operations, financial condition or cash flows.
 
In October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements that Include Software Elements” (“ASU 2009-14”). ASU 2009-14 modifies the scope of the software revenue recognition guidance to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s functionality. ASU 2009-14 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, unless the election is made to adopt ASU 2009-14 retrospectively. In either case, early adoption is permitted. The Company is currently evaluating the impact, if any, that the adoption of ASU 2009-14 will have on its consolidated results of operations, financial condition or cash flows.
 

In August 2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value” (“ASU 2009-05”). ASU 2009-05 provides additional guidance which clarifies measuring liabilities at fair value under ASC 820.10. ASU 2009-05 is effective for the first reporting period (including interim periods) beginning after August 2009. On October 1, 2009, the Company adopted ASU 2009-05 and the adoption did not have a material impact on its consolidated results of operations, financial condition or cash flows.

In December 2008, the FASB issued ASC 715.20.65, “Retirement Benefits – Defined Benefit Plans.” ASC 715.20.65 requires additional disclosures in relation to plan assets of defined benefit pension or other postretirement plans. ASC 715.20.65 is effective for fiscal years ending after December 15, 2009 with early application permitted. The Company does not anticipate the adoption of ASC 715.20.65 will have a material impact on its consolidated results of operations, financial condition or cash flows.
 

In June 2008, the FASB issued ASC 260.10.45, “Earnings per Share.” ASC 260.10.45 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. ASC 260.10.45 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Upon adoption, companies are required to retrospectively adjust earnings per share data (including any amounts related to interim periods, summaries of earnings and selected financial data) to conform to provisions of ASC 260.10.45. On July 1, 2009, the Company adopted ASC 260.10.45 and the adoption did not have a material impact on its consolidated results of operations, financial condition or cash flows.

In April 2008, the FASB issued ASC 350.30, “Intangibles – Goodwill and Other.” ASC 350.30 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC 350.30 also requires expanded disclosure related to the determination of intangible asset useful lives. ASC 350.30 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years for intangible assets acquired after the effective date. On July 1, 2009, the Company adopted ASC 350.30 and the adoption did not have a material impact on its consolidated results of operations, financial condition or cash flows.

In December 2007, the FASB issued ASC 805.10, “Business Combinations.” ASC 805.10 establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any controlling interest in the business and the goodwill acquired. ASC 805.10 further requires that acquisition-related costs and costs associated with restructuring or exiting activities of an acquired entity will be expensed as incurred. ASC 805.10 also establishes disclosure requirements that will require disclosure on the nature and financial effects of the business combination. Additionally, in April 2009, the FASB issued ASC 805.20, “Identifiable Assets and Liabilities, and Any Noncontrolling Interest.” ASC 805.20 amends and clarifies ASC 805.10 to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. On July 1, 2009, the Company adopted ASC 805.10 and ASC 805.20 and the adoption did not have a material impact on its consolidated results of operations, financial condition or cash flows as no business combinations had been completed at the time of adoption.

In September 2006, the FASB issued ASC 820.10. ASC 820.10 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. ASC 820.10 is effective for fiscal years beginning after November 15, 2007, except for non-financial assets and liabilities recognized or disclosed at fair value on a non-recurring basis, for which the effective date is fiscal years beginning after November 15, 2008. On July 1, 2008, the Company adopted ASC 820.10 for assets and liabilities recognized or disclosed at fair value on a recurring basis. On July 1, 2009, the Company adopted ASC 820.10 for non-financial assets that are recognized or disclosed on a non-recurring basis. The adoption of ASC 820.10 did not have an impact on its consolidated results of operations, financial condition or cash flows.

Options to purchase 15.6 million and 35.2 million shares of common stock for the three months ended December 31, 2009 and 2008, respectively, and 22.5 million and 25.1 million shares of common stock for the six months ended December 31, 2009 and 2008, respectively, were excluded from the calculation of diluted earnings per share because their exercise prices exceeded the average market price of outstanding common shares for the respective period.

Proceeds from sales and maturities of available-for-sale securities were $1,693.0 million and $1,496.4 million for the six months ended December 31, 2009 and 2008, respectively.

The Company has an outsourcing agreement with Broadridge Financial Solutions, Inc. (“Broadridge”) pursuant to which the Company provides data center outsourcing services, which principally consist of information technology services and service delivery network services. As a result of the outsourcing agreement, the Company recognized income of $26.2 million and $26.0 million for the three months ended December 31, 2009 and 2008, respectively, which is offset by expenses directly associated with providing such services of $25.6 million and $25.4 million, respectively, both of which were recorded in other income, net, on the Statements of Consolidated Earnings. The Company recognized income of $52.2 million and $51.8 million for the six months ended December 31, 2009 and 2008, respectively, which is offset by expenses directly associated with providing such services of $51.1 million and $50.7 million. The Company had a receivable on the Consolidated Balance Sheets from Broadridge for the services under this agreement of $8.8 million and $8.7 million as of December 31, 2009 and June 30, 2009, respectively.
 

At September 30, 2009, the Company concluded that it had the intent to sell certain securities for which unrealized losses of $5.3 million were previously recorded in accumulated other comprehensive income on the Consolidated Balance Sheets. As such, the Company realized impairment losses of $5.3 million in other income, net on the Statements of Consolidated Earnings during the three and six months ended December 31, 2009. During October 2009, the Company sold these securities.

During the six months ended December 31, 2008, the Company recorded a $3.3 million loss to other income, net on the Statements of Consolidated Earnings related to the Primary Fund of the Reserve Fund (the “Reserve Fund”).
 

During the six months ended December 31, 2009, the Company sold a building and, as a result, recorded a gain of $1.5 million in other income, net, on the Statements of Consolidated Earnings. Additionally, during the three and six months ended December 31, 2008, the Company sold a building and, as a result, recorded a gain of $2.2 million in other income, net on the Statements of Consolidated Earnings. These buildings were previously reported in assets held for sale on the Consolidated Balance Sheets.
 

Note 5. Acquisitions
 

The Company acquired one business during the six months ended December 31, 2009 for approximately $4.5 million. The purchase price includes $1.5 million in accrued contingent payments expected to be paid in future periods. This acquisition resulted in approximately $3.9 million of goodwill. Intangible assets acquired, which totaled approximately $0.7 million, consisted of customer contracts and lists and software that are being amortized over a weighted average life of approximately 4 years. The acquisition was not material to the Company’s results of operations, financial position or cash flows.
 
The Company made $0.7 million of contingent payments relating to previously consummated acquisitions during the six months ended December 31, 2009.

Note 6. Divestitures

During the three and six months ended December 31, 2008, the Company recorded income of $0.1 million and expenses of $1.0 million, respectively, within earnings (loss) from discontinued operations on the Statements of Consolidated Earnings, both of which related to a change in estimated provision for income taxes associated with the divestitures of businesses.
 

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

At December 31, 2009, U.S. Treasury and direct obligations of U.S. government agencies primarily include debt directly issued by Federal Home Loan Banks, Federal Home Loan Mortgage Corporation (“Freddie Mac”) and Federal National Mortgage Association (“Fannie Mae”) with fair values of $1,912.2 million, $1,241.4 million and $1,289.3 million, respectively. At June 30, 2009, U.S. Treasury and direct obligations of U.S. government agencies primarily include debt directly issued by Federal Home Loan Banks, Freddie Mac and Fannie Mae with fair values of $1,906.4 million, $1,463.6 million and $1,352.5 million, respectively. U.S. Treasury and direct obligations of U.S. government agencies represent senior, unsecured, non-callable debt that primarily carries a credit rating of AAA, as rated by Moody’s and Standard & Poor’s and has maturities ranging from January 2010 through August 2019.
 
At December 31, 2009, asset-backed securities include senior tranches of securities with predominately prime collateral of fixed rate credit card, rate reduction, auto loan and equipment lease receivables with fair values of $681.1 million, $364.7 million, $157.4 million and $23.0 million, respectively. At June 30, 2009, asset-backed securities include senior tranches of securities with predominately prime collateral of fixed rate credit card, rate reduction, auto loan, student loan and equipment lease receivables with fair values of $808.4 million, $384.2 million, $244.9 million, $49.8 million and $34.4 million, respectively. These securities are collateralized by the cash flows of the underlying pools of receivables. The primary risk associated with these securities is the collection risk of the underlying receivables. All collateral on such asset-backed securities has performed as expected through December 31, 2009.
 
At December 31, 2009, other securities and their fair value primarily represent AAA rated commercial mortgage-backed securities of $735.5 million, municipal bonds of $442.4 million, AAA rated mortgage-backed securities of $172.4 million that are guaranteed by Fannie Mae and Freddie Mac, Canadian provincial bonds of $202.5 million, supranational bonds of $262.6 million, corporate bonds backed by the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program of $132.6 million and sovereign bonds of $133.3 million. At June 30, 2009, other securities and their fair value primarily represent AAA rated commercial mortgage-backed securities of $759.3 million, municipal bonds of $462.0 million, AAA rated mortgage-backed securities of $186.8 million that are guaranteed by Fannie Mae and Freddie Mac, Canadian provincial bonds of $170.2 million, supranational bonds of $160.0 million, corporate bonds backed by the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program of $137.6 million and sovereign bonds of $51.8 million. The Company’s AAA rated mortgage-backed securities represent an undivided beneficial ownership interest in a group or pool of one or more residential mortgages. These securities are collateralized by the cash flows of 15-year and 30-year residential mortgages and are guaranteed by Fannie Mae and Freddie Mac as to the timely payment of principal and interest.
 
Classification of corporate investments on the Consolidated Balance Sheets is as follows: