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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2009
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 001-31351
HEWITT ASSOCIATES, INC.
(Exact name of registrant as specified in its charter)
Delaware | 47-0851756 | |
(State or other jurisdiction of incorporation) | (I.R.S. Employer Identification No.) |
100 Half Day Road; Lincolnshire, Illinois | 60069 | |
(Address of principal executive offices) | (Zip Code) |
847-295-5000
(Registrant’s telephone number, including area code)
N/A
(Former Name, Former Address & Former Fiscal Year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each class of the issuer’s common stock, as of the latest practical date.
Class | Outstanding shares at December 31, 2009 | |
Class A Common Stock - $0.01 par value | 94,014,933 |
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FORM 10-Q
For the Period Ended
December 31, 2009
INDEX
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Item 1. | Financial Statements |
HEWITT ASSOCIATES, INC.
(In thousands except for share and per share amounts)
December 31, 2009 | September 30, 2009 | |||||
(Unaudited) | ||||||
ASSETS | ||||||
Current Assets: | ||||||
Cash and cash equivalents | $ | 596,978 | $ | 581,642 | ||
Short-term investments | 74,308 | 60,994 | ||||
Client receivables and unbilled work in process, less allowances of $14,670 and $14,381 at December 31, 2009 and September 30, 2009, respectively | 564,128 | 527,272 | ||||
Prepaid expenses and other current assets | 147,741 | 169,533 | ||||
Funds held for clients | 106,274 | 131,801 | ||||
Short-term deferred contract costs, net | 92,071 | 89,919 | ||||
Deferred income taxes, net | 37,271 | 34,119 | ||||
Total current assets | 1,618,771 | 1,595,280 | ||||
Non-Current Assets: | ||||||
Deferred contract costs, less current portion | 247,065 | 254,905 | ||||
Property and equipment, net | 374,367 | 384,254 | ||||
Other intangible assets, net | 186,574 | 191,479 | ||||
Goodwill | 412,437 | 412,745 | ||||
Long-term investments | 54,264 | 54,442 | ||||
Other non-current assets, net | 28,348 | 31,535 | ||||
Total non-current assets | 1,303,055 | 1,329,360 | ||||
Total Assets | $ | 2,921,826 | $ | 2,924,640 | ||
LIABILITIES | ||||||
Current Liabilities: | ||||||
Accounts payable | $ | 27,146 | $ | 20,790 | ||
Accrued expenses | 170,208 | 164,724 | ||||
Funds held for clients | 106,274 | 131,801 | ||||
Advanced billings to clients | 175,411 | 137,447 | ||||
Accrued compensation and benefits | 269,178 | 393,463 | ||||
Short-term deferred contract revenues, net | 63,107 | 61,356 | ||||
Current portion of long-term debt and capital lease obligations | 49,338 | 36,282 | ||||
Total current liabilities | 860,662 | 945,863 | ||||
Non-Current Liabilities: | ||||||
Deferred contract revenues, less current portion | 183,685 | 192,056 | ||||
Debt and capital lease obligations, less current portion | 601,865 | 618,561 | ||||
Other non-current liabilities | 220,658 | 223,835 | ||||
Deferred income taxes, net | 101,266 | 84,023 | ||||
Total non-current liabilities | 1,107,474 | 1,118,475 | ||||
Total Liabilities | $ | 1,968,136 | $ | 2,064,338 | ||
The accompanying notes are an integral part of these financial statements.
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HEWITT ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS—Continued
(In thousands except for share and per share amounts)
December 31, 2009 | September 30, 2009 | |||||||
(Unaudited) | ||||||||
STOCKHOLDERS’ EQUITY | ||||||||
Stockholders’ Equity: | ||||||||
Class A common stock, par value $0.01 per share, 750,000,000 shares authorized, 133,672,366 and 132,844,269 shares issued, 94,014,933 and 93,535,270 shares outstanding, as of December 31, 2009 and September 30, 2009, respectively | $ | 1,337 | $ | 1,328 | ||||
Additional paid-in capital | 1,696,984 | 1,662,687 | ||||||
Cost of common stock in treasury, 39,657,433 and 39,308,999 shares of Class A common stock as of December 31, 2009 and September 30, 2009, respectively | (1,291,511 | ) | (1,277,815 | ) | ||||
Retained earnings | 538,177 | 469,777 | ||||||
Accumulated other comprehensive income, net | 8,703 | 4,325 | ||||||
Total stockholders’ equity | 953,690 | 860,302 | ||||||
Total Liabilities and Stockholders’ Equity | $ | 2,921,826 | $ | 2,924,640 | ||||
The accompanying notes are an integral part of these financial statements.
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HEWITT ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except for share and per share amounts)
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Revenues: | ||||||||
Revenues before reimbursements | $ | 770,145 | $ | 770,763 | ||||
Reimbursements | 25,390 | 23,209 | ||||||
Total revenues | 795,535 | 793,972 | ||||||
Operating expenses: | ||||||||
Compensation and related expenses | 473,447 | 480,908 | ||||||
Goodwill and asset impairment | — | 2,615 | ||||||
Reimbursable expenses | 25,390 | 23,209 | ||||||
Other operating expenses | 135,806 | 134,008 | ||||||
Selling, general and administrative expenses | 36,021 | 40,875 | ||||||
Total operating expenses | 670,664 | 681,615 | ||||||
Operating income | 124,871 | 112,357 | ||||||
Other (expense) income, net: | ||||||||
Interest expense | (9,656 | ) | (10,685 | ) | ||||
Interest income | 919 | 4,301 | ||||||
Other (expense) income, net | (2,907 | ) | 1,281 | |||||
Total other expense, net | (11,644 | ) | (5,103 | ) | ||||
Income before income taxes | 113,227 | 107,254 | ||||||
Provision for income taxes | 44,827 | 42,488 | ||||||
Net income | $ | 68,400 | $ | 64,766 | ||||
Earnings per share: | ||||||||
Basic | $ | 0.73 | $ | 0.69 | ||||
Diluted | $ | 0.71 | $ | 0.68 | ||||
Weighted average shares: | ||||||||
Basic | 93,796,731 | 93,932,257 | ||||||
Diluted | 95,926,701 | 95,441,054 |
The accompanying notes are an integral part of these financial statements.
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HEWITT ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 68,400 | $ | 64,766 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization, including amortization of deferred contract revenues and costs | 43,566 | 39,668 | ||||||
Share-based compensation | 10,510 | 12,554 | ||||||
Deferred income taxes | 13,171 | 42,065 | ||||||
Fair value adjustment related to financial assets | 15 | 889 | ||||||
Asset impairment | — | 2,615 | ||||||
Changes in operating assets and liabilities, net of effect of acquisitions and dispositions: | ||||||||
Client receivables and unbilled work in process | (35,817 | ) | 18,955 | |||||
Prepaid expenses and other current assets | 25,092 | (16,805 | ) | |||||
Deferred contract costs | (17,051 | ) | (25,725 | ) | ||||
Other assets | 2,284 | (2,023 | ) | |||||
Accounts payable | 6,373 | 9,180 | ||||||
Accrued compensation and benefits | (125,322 | ) | (109,143 | ) | ||||
Accrued expenses | 6,165 | 3,728 | ||||||
Advanced billings to clients | 37,952 | 19,650 | ||||||
Deferred contract revenues | 6,596 | 11,446 | ||||||
Other long-term liabilities | (3,505 | ) | (7,379 | ) | ||||
Net cash provided by operating activities | 38,429 | 64,441 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of investments | (16,110 | ) | — | |||||
Proceeds from sales of investments | 3,050 | 2,525 | ||||||
Additions to property and equipment | (16,514 | ) | (34,958 | ) | ||||
Cash paid for acquisitions and transaction costs, net of cash received | 403 | — | ||||||
Net cash used in investing activities | (29,171 | ) | (32,433 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from the exercise of stock options | 19,884 | 1,165 | ||||||
Excess tax benefits from the exercise of share-based awards | 2,452 | 2,185 | ||||||
Proceeds from short-term borrowings | — | 11,720 | ||||||
Repayments of short-term borrowings, capital leases and long-term debt | (3,653 | ) | (129,543 | ) | ||||
Purchase of Class A common shares for treasury | (13,696 | ) | (11,822 | ) | ||||
Net cash provided by (used in) financing activities | 4,987 | (126,295 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | 1,091 | (16,108 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 15,336 | (110,395 | ) | |||||
Cash and cash equivalents, beginning of period | 581,642 | 541,494 | ||||||
Cash and cash equivalents, end of period | $ | 596,978 | $ | 431,099 | ||||
Supplementary disclosure of cash paid during the period: | ||||||||
Interest paid | $ | 5,903 | $ | 8,140 | ||||
Income taxes paid | $ | 8,323 | $ | 4,124 |
The accompanying notes are an integral part of these financial statements.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands except for share and per share amounts unless otherwise noted)
1. Description of Business
Hewitt Associates, Inc., a Delaware corporation, and its subsidiaries (“Hewitt” or the “Company”) provide global human resources benefits, outsourcing and consulting services. Benefits Outsourcing includes administrative services for health and welfare, defined contribution and defined benefit plans, and absence management, in addition to standalone HR outsourcing services. Human Resource Business Process Outsourcing (“HR BPO”) includes workforce administration, rewards management, recruiting and staffing, payroll processing, performance management, learning and development, talent management, time and attendance, procurement expertise and vendor management. Hewitt’s Consulting business provides a wide array of consulting and actuarial services covering the design, implementation, communication and operation of health and welfare, compensation and retirement plans, and broader human resources programs and processes.
2. Basis of Presentation
The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q. In the opinion of management, these financial statements include all adjustments necessary to present fairly the financial position, results of operations and cash flows as of December 31, 2009, and for all periods presented. The consolidated financial statements are prepared on the accrual basis of accounting. All adjustments made have been of a normal and recurring nature. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted. The Company believes that the disclosures included are adequate and provide a fair presentation of interim period results. Interim financial statements are not necessarily indicative of the Company’s financial position or operating results for an entire year. It is suggested that these interim financial statements be read in conjunction with the audited financial statements and the notes thereto, together with management’s discussion and analysis of financial condition and results of operations, included in the Company’s Form 10-K for the fiscal year ended September 30, 2009, as filed with the Securities and Exchange Commission.
The Company’s significant accounting policies are included in the Company’s Form 10-K for the fiscal year ended September 30, 2009. The following is a summary of new accounting pronouncements impacting the Company which were issued or effective during the three months ended December 31, 2009.
New Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. Also, refer to FASB Accounting Standards Codification (“ASC”) 810-10-65,Consolidation – Overall – Transition and Open Effective Date Information. This guidance establishes accounting and reporting standards for noncontrolling interests and transactions between the reporting party and such noncontrolling interests. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (Hewitt’s fiscal year 2010). The Company adopted this guidance as of October 1, 2009. As of December 31, 2009, the Company does not have any noncontrolling interests included in the consolidated financial statements. As a result, the adoption of this guidance did not have a material effect on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R),Business Combinations (“SFAS No. 141(R)”). This guidance is included in FASB ASC 805,Business Combinations. This guidance requires the Company to continue to follow the guidance in SFAS No. 141 (also included in FASB ASC 805) for certain aspects of business combinations, and provides additional guidance defining the acquirer, recognizing and measuring the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, assets and liabilities arising from contingencies, defining a bargain purchase and recognizing and measuring goodwill or a gain from a bargain purchase. This guidance also requires transaction costs to be charged to earnings and requires contingent consideration to be recorded at its fair value on the acquisition date. In addition, under this guidance, adjustments associated with changes in tax contingencies that occur after the measurement period, not to exceed one year, are recorded as adjustments to income. This guidance is effective for all business combinations for which the acquisition date is on or after the beginning of an entity’s first fiscal year that begins after December 15, 2008 (Hewitt’s fiscal year 2010); however, the guidance regarding the treatment of income tax contingencies is retrospective to business combinations completed prior to October 1, 2009. The Company will adopt this guidance for any business combinations occurring subsequent to October 1, 2009. No business combinations occurred during the three months ended December 31, 2009.
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In December 2007, the FASB issued EITF 07-1,Accounting for Collaborative Arrangements. This guidance was included in FASB ASC 808,Collaborative Arrangements.This guidance defines a collaborative agreement as a contractual arrangement in which the parties are active participants to the arrangement and are exposed to the significant risks and rewards that are dependent on the ultimate commercial success of the endeavor. Additionally, the guidance requires that revenue generated and costs incurred on sales to third parties from a collaborative agreement be recognized on a gross basis in the financial statements of the party that is identified as the principal participant in a transaction. It also requires payments between participants to be accounted for in accordance with existing GAAP, unless none exists, in which case a reasonable, rational, consistent method should be used. The Company adopted this guidance as of October 1, 2009. The adoption did not have a material impact on the consolidated financial statements as of December 31, 2009.
In June 2008, the FASB issued FSP EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This guidance was included in FASB ASC 260-10-55,Earnings Per Share – Overall – Implementation Guidance and Illustrations.This guidance addresses whether securities granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in ASC 260-10-45-59A/60B,Earnings Per Share – Overall – Other Presentation Matters. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years (Hewitt’s first quarter of fiscal 2010). The Company adopted this guidance as of October 1, 2009. The Company has determined that this guidance does not currently impact its consolidated financial statements as it does not have participating securities with a non-forfeitable right to dividends or dividend equivalents pursuant to FASB ASC 260-10-55 as of December 31, 2009.
In June 2009, the FASB issued SFAS No. 167,Amendments to FASB Interpretation No. 46(R). Also refer to FASB ASC 810-10-65,Consolidation – Overall – Transition and Open Effective Date Information. This guidance relates to the consolidation of variable interest entities. It eliminates the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. This guidance also requires additional disclosures about an enterprise’s involvement in variable interest entities. This guidance is effective as of the beginning of an entity’s fiscal year, and interim periods within the fiscal year, beginning after November 15, 2009 (Hewitt’s fiscal year 2011). The Company will adopt this guidance in the first quarter of fiscal 2011. The Company is currently evaluating the potential impact, if any, of this guidance on its consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05,Fair Value Measurements and Disclosures, Measuring Liabilities at Fair Value(“ASU 2009-05”). ASU 2009-05 provides amendments to FASB ASC 820-10,Fair Value Measurements and Disclosures – Overall, for the fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, an entity is required to measure fair value using a valuation technique that uses a quoted price of the identical liability when traded as an asset, a quoted price for similar liabilities or similar liabilities when traded as an asset, or another valuation technique that is consistent with the principles of FASB ASC 820. This ASU is effective for the first period (including interim periods) beginning after issuance (Hewitt’s first quarter of fiscal year 2010). The Company adopted this ASU as of October 1, 2009. The adoption did not have a material effect on the consolidated financial statements. See Note 5 for additional information on fair value measurements.
In October 2009, the FASB issued ASU No. 2009-13,Revenue Recognition – Multiple Deliverable Revenue Arrangements(“ASU 2009-13”). ASU 2009-13 updates the existing multiple-element revenue arrangements guidance currently included in FASB ASC 605-25. The revised guidance provides for two significant changes to the existing multiple-element revenue arrangements guidance. The first change relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. This change will result in the requirement to separate more deliverables within an arrangement, ultimately leading to less revenue deferral. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. Together, these changes will result in earlier recognition of revenue and related costs for multiple-element arrangements than under previous guidance. This guidance also expands the disclosures required for multiple-element revenue arrangements. The Company early adopted the provisions of this ASU on a prospective basis for all new contracts and materially modified contracts on or after October 1, 2009.
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The adoption of ASU 2009-13 did not have a material effect on the consolidated financial statements for the three months ended December 31, 2009. The adoption did, however, modify the Company’s accounting policy related to revenue recognition that was included in the Company’s Form 10-K for the fiscal year ended September 30, 2009. To highlight these changes, the Company has included the revised accounting policy for revenue recognition. The accounting policy for revenue recognition included in the Company’s Form 10-K for the fiscal year ended September 30, 2009 remains effective for contracts that were in place as of, and were not materially modified after, September 30, 2009. The revised policy is as follows:
Revenue Recognition
Revenues include fees generated from outsourcing contracts and from consulting services provided to the Company’s clients. Revenues from sales or licensing of software are not material. The Company recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured.
The Company’s outsourcing contracts typically have three-to-five year terms for benefits services and five-to-ten year terms for HR BPO services. The Company recognizes revenues for non-refundable, up-front implementation fees evenly over the period that the related ongoing service revenues are recognized. Services provided outside the scope of the Company’s outsourcing contracts are recognized on a time-and-material or fixed-fee basis.
The Company provides consulting services to its clients either on a time-and-material or fixed-fee basis. Revenues are recognized monthly under time-and-material-based arrangements as services are provided. On fixed-fee engagements, revenues are recognized either as services are provided using a proportional-performance method or at the completion of a project based on facts and circumstances of the client arrangement.
Contract losses on outsourcing or consulting arrangements are recognized in the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Contract losses are determined to be the amount by which the estimated direct costs, including any remaining deferred contract costs, exceed the estimated total revenues that will be generated by the contract. When a loss is identified, it is first recorded as an impairment of deferred contract costs related to the specific contract, if applicable, with the remaining amount recorded as a loss reserve. Estimates are monitored during the term of the contract and any changes to the estimates are recorded in the period the change is identified and may result in an adjustment to the loss reserve.
The Company has contracts with multiple elements primarily in its Benefits Outsourcing and HR BPO segments. Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. The following criteria must be met in order for a deliverable to qualify as a separate unit of accounting:
• | The delivered items have value to the client on a stand-alone basis; and |
• | If the arrangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered items is considered probable and substantially in the control of the Company. |
The arrangement consideration is allocated to the separate units of accounting at the inception of the arrangement to all deliverables based on their relative selling price. Under this method, the selling price for each deliverable is determined using vendor specific objective evidence of selling price (“VSOE”), third-party evidence of selling price (“TPE”), or in the absence of VSOE and TPE, the Company’s best estimate of selling price. The best estimate of selling price is the price at which the Company would offer the service if the deliverable were sold regularly on a standalone basis. Due to the level of customization of the Company’s services to its clients, selling price is generally determined by best estimate.
For deliverables within Benefits Outsourcing, the Company typically determines the best estimate of selling price by analyzing market conditions and engagement specific risks. This includes the number of participants expected in a plan, the level of customization and the complexity of the services to be delivered, as well as knowledge of market competition in the bid process. For deliverables within HR BPO, the Company typically determines the best estimate of selling price using cost-plus pricing. This involves evaluating the expected costs required to deliver the services as well as profit margin objectives.
Revenue is then recognized using a proportional-performance method, such as recognizing revenue based on transactional services delivered, or on a straight-line basis (as adjusted primarily for volume changes), as appropriate.
The Company records revenues earned in excess of amounts billed as a current asset (unbilled work in process). The Company records amounts billed in excess of revenues earned, prior to rendering services, as a current liability (advanced billings to clients).
The Company considers the criteria established by FASB ASC 605-45-45,Revenue Recognition – Principal Agent Considerations,in determining whether revenue should be recognized on a gross or a net basis. In consideration of these criteria, the Company recognizes revenue primarily on a gross basis. Factors considered in determining if gross or net recognition is appropriate include whether the Company is primarily responsible to the client for the delivery of services, changes the delivered product, performs part of the service delivered, has discretion on vendor selection and bears credit risk.
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Reimbursements received for out-of-pocket expenses incurred are characterized as revenues and are shown as a separate component of total revenues in accordance with FASB ASC 605-45-45-23,Reimbursements Received for Out-of-Pocket Expenses Incurred. Similarly, related reimbursable expenses are also shown separately within operating expenses.
Subsequent Events
The Company has evaluated subsequent events after the balance sheet date of December 31, 2009 through February 1, 2010, which is the date that the accompanying financial statements were issued. Refer to Note 16 for additional information on subsequent events.
3. Investments
At December 31, 2009, the Company’s short- and long-term investments were comprised mostly of $112.5 million in auction rate securities (“ARS”). While the underlying securities generally have long-term nominal maturities that exceed one year, the interest rates on these investments reset periodically in scheduled auctions (generally every 7-35 days). The Company has the opportunity to sell its investments during such periodic auctions subject to buyer availability.
During February 2008, issues in the global credit and capital markets led to failed auctions with respect to the Company’s ARS. Since February 2008, all of the Company’s outstanding ARS were subject to failed auctions. During the first quarter of fiscal 2010, $3.1 million of the Company’s ARS issues were called by the issuers at par.
In November 2008, the Company accepted an offer from UBS AG (“UBS”), one of its investment brokers, to sell auction rate securities at par value originally purchased from UBS (par value of $64.2 million as of December 31, 2009) at any time during a two-year period beginning June 30, 2010. UBS also has the right to buy the ARS at par value from the Company at any time. By accepting this put option, the Company demonstrated it has the intent to sell these ARS under the terms of the UBS offer. At that time, the Company changed the classification of the UBS-brokered ARS from available-for-sale securities to trading securities. During the three months ended December 31, 2009, the Company recorded the change in fair value (unrealized loss) on the UBS-brokered ARS of $0.3 million in earnings within other expense, net, in the accompanying consolidated statements of operations.
The Company has elected the fair value measurement option under FASB ASC 825 for the put option. See Note 5 for additional information on fair value measurements. The Company recognized the initial fair value of the put option of $12.7 million as an asset within prepaid expenses and other current assets in the accompanying consolidated balance sheets and recorded the resulting gain within other expense, net, in the accompanying consolidated statements of operations. The unrealized loss from the subsequent decrease in fair value of the put option of $6.8 million is included within other expense, net, in the accompanying consolidated statements of operations. This includes the change in unrealized loss of $0.3 million recorded during the three months ended December 31, 2009. The total impact of the put option and changes in the fair value of the UBS-brokered ARS during the three months ended December 31, 2009 was not material.
At December 31, 2009, the Company’s ARS portfolio with a par value of $123.1 million had a fair value of $112.5 million, and the related put option had a fair value of $5.9 million. In the absence of observable market data, the Company used a discounted cash flow model to determine the estimated fair value of its ARS and related put option at December 31, 2009. Refer to Note 5 for additional information on the fair value measurement process for the Company’s auction rate securities and related put option.
Below is a reconciliation of the par value and estimated fair value of the Company’s auction rate securities for the three months ended December 31, 2009:
Trading | Available-For-Sale | Total ARS | ||||||||||||||||||||||
UBS-Brokered ARS | Non-UBS-Brokered ARS | |||||||||||||||||||||||
Par Value | Estimated Fair Value | Par Value | Estimated Fair Value | Par Value | Estimated Fair Value | |||||||||||||||||||
Balance at October 1, 2009 | $ | 67,150 | $ | 60,994 | $ | 59,000 | $ | 54,442 | $ | 126,150 | $ | 115,436 | ||||||||||||
Sold during the period | (3,000 | ) | (3,000 | ) | (50 | ) | (50 | ) | (3,050 | ) | (3,050 | ) | ||||||||||||
Change in unrealized loss included in other comprehensive income | — | — | — | (128 | ) | — | (128 | ) | ||||||||||||||||
Gains included in earnings (1) | — | 268 | — | — | — | 268 | ||||||||||||||||||
Balance at December 31, 2009 | $ | 64,150 | $ | 58,262 | $ | 58,950 | $ | 54,264 | $ | 123,100 | $ | 112,526 | ||||||||||||
(1) | Gains are recorded in other expense, net, within the consolidated statements of operations. |
As of December 31, 2009, approximately 97% of the Company’s ARS portfolio was comprised of federally insured, student loan-backed securities and 80% of the Company’s ARS portfolio was comprised of Aaa/AAA/AAA rated investments by Moody’s, S&P and Fitch, respectively.
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The impairment of the non-UBS-brokered available-for-sale ARS portfolio is considered to be temporary because the Company does not have the intent to sell, nor is it more-likely-than-not that the Company will be required to sell, any of its available-for-sale ARS before recovery of its cost basis, and because there has been no significant deterioration in the creditworthiness of the underlying issuers. However, the Company will reassess this conclusion in future reporting periods based on several factors, including possible failure of the investments to be redeemed, potential deterioration of the credit ratings of the investments, market risk, the Company’s continued intent to not sell any of the available-for-sale ARS before recovery of its cost basis and other factors. Such a reassessment may result in a conclusion that these investments are other-than-temporarily impaired. If it is determined that the fair value of these securities is other-than-temporarily impaired, the Company would record a loss in its consolidated statements of operations, which could have a material adverse effect on its results of operations and financial condition.
Based on the contractual maturities of the available-for-sale auction rate securities as of December 31, 2009 and September 30, 2009, respectively, the par value and estimated fair value of the securities were as follows:
December 31, 2009 | September 30, 2009 | |||||||||||
Par Value | Estimated Fair Value | Par Value | Estimated Fair Value | |||||||||
Due in less than one year | $ | — | $ | — | $ | — | $ | — | ||||
Due after one year through five years | — | — | — | — | ||||||||
Due after five years through ten years | — | — | — | — | ||||||||
Due after ten years | 58,950 | 54,264 | 59,000 | 54,442 | ||||||||
Total | $ | 58,950 | $ | 54,264 | $ | 59,000 | $ | 54,442 | ||||
Additionally, the Company’s trading auction rate securities with a par value of $64.2 million and an estimated fair market value of $58.3 million as of December 31, 2009, are expected to be redeemed pursuant to the UBS offer as discussed above.
The total unrealized loss recorded in accumulated other comprehensive income, net, related to available-for-sale securities was $4.7 million ($2.9 million net of tax) and $4.6 million ($2.8 million net of tax) as of December 31, 2009 and September 30, 2009, respectively.
Also included in short-term investments at December 31, 2009 is $16.0 million of fixed-rate money market investments denominated in foreign currency with a maturity greater than 90 days.
4. Derivative Instruments
In the normal course of business, the Company is exposed to the impact of foreign currency fluctuations and interest rate changes. The Company manages a portion of these risks by using derivative instruments to reduce the effects of changes in foreign currency exchange rates and interest rates on its operating results and cash flows.
As a result of the use of derivative instruments, the Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the Company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors. The Company also continually assesses the creditworthiness of counterparties.
In its hedging programs, the Company uses forward contracts and interest rate swaps. The Company does not use derivatives for trading or speculative purposes. A brief description of the Company’s hedging programs is as follows.
Currency Hedging
The Company has a substantial operation in India for the development and deployment of technology solutions as well as for client and business support activities. The Company utilizes a foreign currency risk management program involving the use of foreign currency derivatives to hedge up to 75% of the Indian rupee (“INR”) exposure. The Company uses cash flow hedges to hedge forecasted transactions with its India operations. The Company enters into non-deliverable forward exchange contracts as hedges of anticipated cash flows denominated in Indian rupees. These contracts protect against the risk that the eventual cash flows resulting from such transactions will be adversely affected by changes in exchange rates between the U.S. dollar and the Indian rupee.
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Interest Rate Risk Management
On August 8, 2008, the Company entered into a loan agreement that provides for a senior unsecured term loan in the amount of $270.0 million (the “Term Loan”). The Term Loan initially bears interest at a margin of 150 basis points over LIBOR and matures on August 8, 2013 without amortization. The Company is exposed to interest rate risk from this long-term, variable-rate debt. The Company uses cash flow hedges to hedge future interest payments on the Term Loan. The Company entered into interest rate swaps to partially convert this variable rate exposure into fixed rate. As of March 31, 2009, the Company had swapped $270.0 million of the Term Loan for the first three years, $185.0 million for the fourth year and $100.0 million for the fifth year. Only the variable LIBOR piece of the Term Loan was swapped to fixed rate. As of December 31, 2009, these hedges are still in place. These contracts protect against the risk that the eventual cash flows resulting from such transactions will be adversely affected by changes in interest rates.
All derivatives are recognized in the balance sheet at fair value. Fair values for the Company’s derivative financial instruments are based on quoted market prices of comparable instruments or, if none are available, on pricing models or formulas using current assumptions. Changes in the fair value of derivatives that are highly effective are recorded in other comprehensive income, net, until the underlying transactions occur. Realized gains or losses resulting from the cash flow hedges are recognized together with the hedged transaction in the consolidated statement of operations. The effectiveness of the cash flow hedges is evaluated on a quarterly basis. If a cash flow hedge is no longer highly effective, the unrealized gains or losses for the ineffective portion are recognized in other income (expense), net, in the consolidated statements of operations. At the inception date, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedging activities. This process includes matching all derivatives that are designated as cash flow hedges to specific forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. At December 31, 2009, all hedges were determined to be highly effective.
The following table summarizes the fair value of derivative instruments and their respective balance sheet classifications at December 31, 2009 and September 30, 2009, respectively:
As of December 31, 2009 | ||||||
Asset Derivatives | Liability Derivatives | |||||
Derivatives designated as hedging instruments: | ||||||
Foreign exchange contracts(1) | $ | 7,107 | $ | 22 | ||
Interest rate contracts(1) | 958 | 8,712 | ||||
Total derivatives designated as hedging instruments | $ | 8,065 | $ | 8,734 | ||
Total derivatives | $ | 8,065 | $ | 8,734 | ||
As of September 30, 2009 | ||||||
Asset Derivatives | Liability Derivatives | |||||
Derivatives designated as hedging instruments: | ||||||
Foreign exchange contracts(1) | $ | 5,492 | $ | — | ||
Interest rate contracts(1) | 618 | 9,684 | ||||
Total derivatives designated as hedging instruments | $ | 6,110 | $ | 9,684 | ||
Total derivatives | $ | 6,110 | $ | 9,684 | ||
(1) | Asset derivatives are classified within prepaid expenses and other current assets in the consolidated balance sheets. Liability derivatives are classified within accrued expenses in the consolidated balance sheets. |
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The following tables summarize the effect of derivative instruments on the consolidated statements of operations for the three months ended December 31, 2009 and 2008.
Derivative Instruments in Cash Flow Hedging Relationships:
Amount of Gain (Loss) Recognized in Other Comprehensive Income (“OCI”) on Derivatives (effective portion) | Location of Gain (Loss) Reclassified from Accumulated OCI into Income (effective portion) | Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (effective portion) | ||||||||||||||
Three Months Ended December 31, | Three Months Ended December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Foreign exchange contracts | $ | 3,761 | $ | (2,267 | ) | Compensation and related expenses | $ | 2,169 | $ | (4,496 | ) | |||||
Interest rate contracts | 1,313 | (10,623 | ) | n/a | n/a | |||||||||||
Total | $ | 5,074 | $ | (12,890 | ) | $ | 2,169 | $ | (4,496 | ) | ||||||
At December 31, 2009, the notional value of the derivatives related to outstanding non-deliverable Indian rupee forward contracts maturing by September 2011 was $109.8 million (INR 5.5 billion) and the notional value of the derivatives related to the interest rate swaps was $270.0 million. The estimated net amount of gains and losses at December 31, 2009 that is expected to be reclassified from accumulated other comprehensive income into income within the next twelve months is a net gain of approximately $6.4 million.
5. Fair Value Measurements
FASB ASC 820 establishes a framework for measuring fair value, clarifies the definition of fair value within that framework and expands disclosures about the use of fair value measurements. FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., an exit price) in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.
FASB ASC 820 specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions that other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). Valuation techniques used to measure fair value under FASB ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. FASB ASC 820 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:
• | Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities; |
• | Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; and |
• | Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. |
When available, the Company uses unadjusted quoted market prices to measure fair value and classifies such items within Level 1. If quoted market prices are not available, fair value is based upon internally-developed models that use, where possible, current market-based or independently-sourced market parameters such as interest rates and currency rates. Items valued using internally-generated models are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be inputs that are readily observable. If quoted market prices are not available, the valuation model used depends on the specific asset or liability being valued.
Pursuant to FASB ASC 825,the Company elected to measure and report a put option relating to its auction rate securities (refer to Note 3 for more information) at fair value in order to account for the put option on the same basis (measured at fair value through earnings) as the associated asset (the auction rate securities).
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On October 1, 2009, the Company adopted the guidance of FASB ASC 820 for non-financial assets and non-financial liabilities. This guidance had deferred the adoption of FASB ASC 820 for non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008 (Hewitt’s fiscal 2010), and interim periods within those fiscal years.
The following table represents the Company’s fair value hierarchy for its financial assets and liabilities (cash equivalents, investments and derivatives) measured at fair value on a recurring basis as of December 31, 2009:
Fair Value Measurements at Reporting Date Using: | ||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||
Assets: | ||||||||||||||
Cash and money market funds | $ | 596,978 | $ | — | $ | — | $ | 596,978 | ||||||
Auction-rate securities(1) | — | — | 118,381 | 118,381 | ||||||||||
Other short-term investments | 16,046 | — | — | 16,046 | ||||||||||
Derivative assets | — | 8,064 | — | 8,064 | ||||||||||
Total assets | $ | 613,024 | $ | 8,064 | $ | 118,381 | $ | 739,469 | ||||||
Liabilities: | ||||||||||||||
Derivative liabilities | $ | — | $ | 8,734 | $ | — | $ | 8,734 | ||||||
Total liabilities | $ | — | $ | 8,734 | $ | — | $ | 8,734 | ||||||
Amounts included in: | ||||||||||||||
Cash and cash equivalents | $ | 596,978 | $ | — | $ | — | $ | 596,978 | ||||||
Prepaid expenses and other current assets(1) | — | 8,064 | 5,855 | 13,919 | ||||||||||
Short-term investments | 16,046 | — | 58,262 | 74,308 | ||||||||||
Long-term investments | — | — | 54,264 | 54,264 | ||||||||||
Accrued expenses | — | (8,734 | ) | — | (8,734 | ) | ||||||||
Total | $ | 613,024 | $ | (670 | ) | $ | 118,381 | $ | 730,735 | |||||
(1) | Includes the put option measured at fair value under FASB ASC 825 and classified as Level 3. |
Level 3 assets consist of trading and available-for-sale auction rate securities classified as short- and long-term investments, respectively, and a related put option as of December 31, 2009. In the absence of observable market data, the Company used a discounted cash flow model to determine the estimated fair value of its ARS and related put option at December 31, 2009.
The assumptions used in the preparation of the discounted cash flow model were based on data available as of December 31, 2009, and include estimates of interest rates, timing and amount of cash flows, credit and liquidity premiums and expected holding periods of the ARS and exercise date of the put option. These assumptions will be subject to change as the underlying data changes and market conditions evolve. The assumed interest income yields for the Company’s ARS used in the discounted cash flow model were based on the yields provided for in the prospectus of each of the Company’s ARS issues, factoring in the forward yield curve. The assumed discount rate used in the discounted cash flow model was based on the implied spreads on recent student loan issues and included an illiquidity factor, which reflects the illiquidity in the ARS market. The assumed discount period used in the discounted cash flow model was determined by assigning a set of probabilities based on how the Company views its ARS to be liquidated, and included the current pace of redemptions at par and the average term that students take to repay related student loans.
A one percentage point change on the interest income yields would impact the fair value of the ARS holdings and put option by approximately $3.8 million. A one percentage point change on the discount rate used for valuing the ARS holdings and put option would impact the fair value by approximately $2.6 million.
Refer to Note 3 for additional information on auction rate securities.
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The following table provides a reconciliation of the beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3):
Fair Value Measurements at Reporting Date Using Significant Unobservable Inputs (Level 3) | ||||||||||||
Auction rate securities | Put option | Total | ||||||||||
Balance at October 1, 2009 | $ | 115,436 | $ | 6,138 | $ | 121,574 | ||||||
Change in unrealized loss included in other comprehensive income | (128 | ) | — | (128 | ) | |||||||
Gains (losses) included in earnings(1) | 268 | (283 | ) | (15 | ) | |||||||
Sold during the period | (3,050 | ) | — | (3,050 | ) | |||||||
Balance at December 31, 2009 | $ | 112,526 | $ | 5,855 | $ | 118,381 | ||||||
(1) | Gains (losses) are recorded in other expense, net, within the consolidated statements of operations. |
6. Goodwill and Other Intangible Assets
The following is a summary of changes in the carrying amount of goodwill for the three months ended December 31, 2009:
Benefits Outsourcing | Consulting | Total | |||||||||
Balance at September 30, 2009 | $ | 100,818 | $ | 311,927 | $ | 412,745 | |||||
Additions | — | — | — | ||||||||
Adjustment and reclassifications | (403 | ) | — | (403 | ) | ||||||
Effect of changes in foreign exchange rates | (146 | ) | 241 | 95 | |||||||
Balance at December 31, 2009 | $ | 100,269 | $ | 312,168 | $ | 412,437 | |||||
Adjustments and reclassifications of goodwill for the three months ended December 31, 2009 related to the reduction in purchase price for the recovery of funds held in escrow relating to the 2008 acquisition of an absence management business within Benefits Outsourcing.
Intangible assets with definite useful lives are amortized over their estimated useful lives and are tested for impairment whenever indicators of impairment arise. The following is a summary of intangible assets at December 31, 2009 and September 30, 2009:
December 31, 2009 | September 30, 2009 | |||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net | Gross Carrying Amount | Accumulated Amortization | Net | |||||||||||||
Customer relationships | $ | 261,951 | $ | 102,394 | $ | 159,557 | $ | 260,664 | $ | 97,887 | $ | 162,777 | ||||||
Core technology | 48,558 | 22,603 | 25,955 | 48,551 | 21,310 | 27,241 | ||||||||||||
Trademarks and tradenames | 5,346 | 4,284 | 1,062 | 5,371 | 3,910 | 1,461 | ||||||||||||
Total | $ | 315,855 | $ | 129,281 | $ | 186,574 | $ | 314,586 | $ | 123,107 | $ | 191,479 | ||||||
Amortization expense related to definite-lived intangible assets for the three months ended December 31, 2009 and 2008 was as follows:
Three Months Ended December 31, | ||||||
2009 | 2008 | |||||
Customer relationships | $ | 4,009 | $ | 4,226 | ||
Core technology | 1,291 | 454 | ||||
Trademarks and tradenames | 391 | 382 | ||||
Total | $ | 5,691 | $ | 5,062 | ||
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7. Debt
Long-term debt at December 31, 2009 and September 30, 2009, consisted of the following:
December 31, 2009 | September 30, 2009 | |||||
Unsecured senior term loan | $ | 270,000 | $ | 270,000 | ||
Unsecured senior term notes | 276,000 | 276,000 | ||||
Term loan credit facility | 24,896 | 26,631 | ||||
Capital lease obligations | 80,261 | 82,161 | ||||
Other foreign debt | 46 | 51 | ||||
Subtotal | 651,203 | 654,843 | ||||
Current portion of long-term debt and capital lease obligations | 49,338 | 36,282 | ||||
Debt and capital lease obligations, less current portion | $ | 601,865 | $ | 618,561 | ||
On October 9, 2009, the Company entered into a three-year $250.0 million credit facility with a multi-bank syndicate. This credit facility contains a $25.0 million sub-limit for the issuance of letters of credit. This credit facility replaces the previous five-year $200.0 million credit facility. Borrowings under this facility accrue interest at LIBOR plus 200-300 basis points or a base rate plus 100-200 basis points. Borrowings are repayable at expiration of the facility on October 9, 2012 and quarterly commitment fees ranging from 30-50 basis points are charged under the credit facility. At December 31, 2009, there were no borrowings outstanding against this facility and the letters of credit secured by this facility were $10.0 million.
8. Restructuring Activities
During the third quarter of fiscal 2007 and throughout fiscal 2008 and 2009, the Company recorded charges related to the exit and consolidation of facilities in the U.S. and international locations. These charges consisted of the recognition of the fair value of lease vacancy obligations, lease termination and cancellation penalties and the reversal of prepaid and accrued rents. The charges also included adjustments to the fair value of the lease vacancy obligations related to an update of sublease assumptions.
The following table summarizes the activity in the restructuring reserves for the three months ended December 31, 2009 and 2008:
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Balance at beginning of period | $ | 52,207 | $ | 51,203 | ||||
Payments, net | (3,491 | ) | (4,991 | ) | ||||
Adjustments | 513 | 60 | ||||||
Balance at end of period | $ | 49,229 | $ | 46,272 | ||||
Adjustments include the accretion of fair values and the effect of foreign currency translation during the three months ended December 31, 2009 and 2008.
The Company anticipates that the remaining accrual will be paid out by fiscal 2018, based on the longest term remaining on the Company’s leased real estate.
9. Earnings Per Share
Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common stock equivalents. Treasury stock is not considered outstanding for either basic or diluted EPS as weighted from the date the shares were placed into treasury. For purposes of calculating basic and diluted EPS, vested restricted stock awards are considered outstanding. Under the treasury stock method, diluted EPS reflects the potential dilution that could occur if securities or other instruments that are convertible into common stock were exercised or could result in the issuance of common stock. Potentially dilutive common stock equivalents include unvested restricted stock units and unexercised stock options that are in-the-money. Restricted stock unit awards generally vest 25 percent at each fiscal year end following the grant date and are not considered outstanding in basic EPS until the vesting date.
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The following table presents computations of basic and diluted EPS in accordance with U.S. GAAP:
Three Months Ended December 31, | ||||||
2009 | 2008 | |||||
Net income as reported | $ | 68,400 | $ | 64,766 | ||
Weighted average outstanding shares – basic | 93,796,731 | 93,932,257 | ||||
Incremental effect of dilutive common stock equivalents: | ||||||
Unexercised stock options | 1,506,115 | 978,375 | ||||
Unvested restricted stock awards | 623,855 | 530,422 | ||||
Weighted average outstanding shares – diluted | 95,926,701 | 95,441,054 | ||||
Earnings per share – basic | $ | 0.73 | $ | 0.69 | ||
Earnings per share – diluted | $ | 0.71 | $ | 0.68 |
Of the outstanding stock options as of December 31, 2009 and 2008, 254,268 and 809,162 weighted average shares for each period, respectively, were not included in the computation of diluted earnings per share because the options were not in-the-money.
10. Pension and Postretirement Benefit Plans
Through various acquisitions, the Company has defined benefit pension plans, the largest of which was closed to new entrants in 1998, providing retirement benefits to eligible employees. The Company also has other smaller defined benefit pension plans to provide benefits to eligible employees. It is the Company’s policy to fund these defined benefit plans in accordance with local practice and legislation. The Company provides health benefits for retired U.S. and Canadian employees and certain dependents when those employees become eligible for these benefits by satisfying plan provisions, which include certain age and service requirements. The health benefit plans are contributory, and contributions are reviewed annually and adjusted as appropriate.
The components of net periodic pension benefit costs for the three months ended December 31, 2009 and 2008 were:
Pension Benefits | ||||||||
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Service cost | $ | 2,726 | $ | 2,415 | ||||
Interest cost | 3,041 | 2,939 | ||||||
Expected return on plan assets | (3,164 | ) | (2,386 | ) | ||||
Unrecognized prior service cost | (2 | ) | 16 | |||||
Unrecognized loss | 377 | 129 | ||||||
Net periodic benefit cost | $ | 2,978 | $ | 3,113 | ||||
During the three months ended December 31, 2009, the Company contributed $8.3 million to the pension plans.
The components of net periodic health benefit costs for the three months ended December 31, 2009 and 2008 were:
Health Benefits | ||||||
Three Months Ended December 31, | ||||||
2009 | 2008 | |||||
Service cost | $ | 61 | $ | 42 | ||
Interest cost | 227 | 220 | ||||
Unrecognized prior service cost | 11 | — | ||||
Unrecognized loss | 61 | 26 | ||||
Net periodic benefit cost | $ | 360 | $ | 288 | ||
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11. Share-Based Compensation Plans
During the three months ended December 31, 2009 and 2008, the Company recorded pretax share-based compensation expense of $10.5 million and $12.6 million, respectively, related to the Company’s stock options, restricted stock units and performance share units.
Under the Company’s Global Stock and Incentive Compensation Plan (the “Plan”), which was adopted in fiscal 2002, amended in January 2008 and administered by the Compensation and Leadership Committee (the “Committee”) of the Company’s Board of Directors, employees and directors may receive awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance share units and cash-based awards; employees can also receive incentive stock options. As of December 31, 2009, only restricted stock, restricted stock units, performance share units and stock options have been granted. A total of 32,000,000 shares of Class A common stock have been reserved for issuance under the Plan. As of December 31, 2009, there were 3,697,639 shares available for grant under the Plan.
Restricted Stock Units
The following table summarizes restricted stock units activity, including performance share units activity, during the three months ended December 31, 2009:
December 31, 2009 | ||||||
Restricted Stock Units | Weighted Average Grant Date Fair Value | |||||
Outstanding at beginning of period | 2,419,832 | $ | 29.42 | |||
Granted | 1,503,576 | $ | 41.20 | |||
Vested | (8,604 | ) | $ | 34.13 | ||
Forfeited | (64,042 | ) | $ | 29.63 | ||
Outstanding at end of period | 3,850,762 | $ | 34.00 | |||
Stock Options
The Committee may grant both incentive stock options and stock options to purchase shares of Class A common stock. Subject to the terms and provisions of the Plan, options may be granted to participants, as determined by the Committee, provided that incentive stock options may not be granted to non-employee directors. The option price is determined by the Committee, provided that for options issued to participants in the U.S., the option price may not be less than 100% of the fair market value of the shares on the date the option is granted and no option may be exercisable later than the tenth anniversary of its grant. The stock options generally vest in equal annual installments over a period of four years.
The fair value used to determine compensation expense for the three months ended December 31, 2009 and 2008 was estimated at the date of grant using a Black-Scholes option pricing model. The following table summarizes the weighted-average assumptions used to determine fair value for options granted during the three months ended December 31, 2009 and 2008:
December 31, | ||||||
2009 | 2008 | |||||
Expected volatility | 29.10 | % | 29.29 | % | ||
Risk-free interest rate | 2.50 | % | 2.12 | % | ||
Expected life (in years) | 6.17 | 6.17 | ||||
Dividend yield | 0 | % | 0 | % |
The Company uses the simplified method to determine the expected life assumption for all of its options. The Company continues to use the simplified method as it does not believe that it has sufficient historical exercise data to provide a reasonable basis upon which to estimate expected life due to the limited time its equity shares have been publicly traded.
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The following table summarizes stock option activity during the three months ended December 31, 2009:
December 31, 2009 | ||||||
Options | Weighted Average Exercise Price | |||||
Outstanding at beginning of fiscal year | 6,298,321 | $ | 26.04 | |||
Granted | 472,132 | $ | 41.33 | |||
Exercised | (819,493 | ) | $ | 24.26 | ||
Forfeited | (44,995 | ) | $ | 29.72 | ||
Expired | (12,425 | ) | $ | 25.71 | ||
Outstanding at end of period | 5,893,540 | $ | 27.48 | |||
Exercisable options at end of period | 4,137,372 | $ | 25.46 |
12. Commitments and Contingencies
Legal Proceedings
The Company is involved in disputes arising in the ordinary course of its business relating to outsourcing or consulting agreements, professional liability claims, vendors or service providers or employment claims. The Company is also routinely audited and subject to inquiries by governmental and regulatory agencies. Management considers such factors as the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss and records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. If the reasonable estimate of a probable loss is a range of outcomes, and no amount within the range is a better estimate than another, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. Insurance and other recoveries of book losses are separately evaluated and recognized only if such recoveries are also probable and reasonably estimable.
The Company does not believe that any unresolved dispute will have a material adverse effect on its financial condition or results of operation. However, litigation in general and the outcome of any matter, in particular, cannot be predicted with certainty. An unfavorable resolution of one or more pending matters could have a material adverse impact on the Company’s results of operations for one or more reporting periods.
In the normal course of business, the Company also enters into contracts in which it makes representations, warranties, guarantees and indemnities that relate to the performance of the Company’s services and products. The Company does not expect any material losses related to such representations, warranties, guarantees and indemnities.
13. Other Comprehensive Income (Loss)
The following table presents the after-tax components of the Company’s other comprehensive income (loss) for the periods presented:
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Net income | $ | 68,400 | $ | 64,766 | ||||
Other comprehensive income (loss): | ||||||||
Foreign currency translation adjustments | 2,422 | (54,651 | ) | |||||
Unrealized losses on investments | (79 | ) | (4,308 | ) | ||||
Net unrealized gain (loss) on hedging transactions | 1,806 | (5,184 | ) | |||||
Retirement plans | 229 | (2,962 | ) | |||||
Total comprehensive income (loss) | $ | 72,778 | $ | (2,339 | ) | |||
The foreign currency translation adjustments during the three months ended December 31, 2008 primarily related to the unfavorable changes in the value of the British pound sterling relative to the U.S. dollar.
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14. Income Taxes
The Company’s consolidated effective income tax rate was 39.6% for the three months ended December 31, 2009 and 2008. The Company reviews its expected annual effective income tax rates and makes changes on a quarterly basis as necessary based on certain factors such as changes in forecasted annual pretax income; changes to the valuation allowance for net deferred tax assets; changes to actual or forecasted permanent book to tax differences; impacts from future tax settlements with state, federal or foreign tax authorities; or impacts from tax law changes. Each quarter, the Company identifies items which are not normal and recurring in nature and treats these as discrete events. The tax effect of discrete items is booked entirely in the quarter in which the discrete event occurs. Due to the volatility of these factors, the Company’s consolidated effective income tax rate can change significantly on a quarterly basis. The Company had no material discrete events during the three months ended December 31, 2009.
Income tax-related interest expense and income tax-related penalties are reported as a component of the provision for income taxes in the consolidated statement of operations. The Company included interest and penalties of $0.3 million and $0.5 million for the three months ended December 31, 2009 and 2008, respectively, in the provision for income taxes in the consolidated statement of operations. As of December 31, 2009 and September 30, 2009, the total amount of accrued income tax-related interest and penalties included in the consolidated balance sheets was $13.4 million and $13.0 million, respectively.
The Company is subject to examination in the U.S. federal tax jurisdiction for the tax years ending September 30, 2007 and September 30, 2008. The U.S. federal tax examination for the tax years ending September 30, 2004 through September 30, 2006 has been completed, but the statutes of limitations for tax years 2003, 2004 and 2006 have not yet expired. The Company is also subject to examination in a number of state and foreign jurisdictions for the 2003, 2004, 2006, 2007 and 2008 tax years, for which no individually material unrecognized tax benefits exist. The Company has also filed an appeal with the IRS for the tax years ended September 30, 2003 and September 30, 2004. The Company believes appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.
As of December 31, 2009 and September 30, 2009, the total amount of unrecognized tax benefits was $49.4 million. If tax matters for the 2003, 2004 and 2006 tax years are effectively settled with the IRS within the next 12 months, that settlement could increase earnings by zero to $45.6 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.
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15. Segment Results
The Company has determined that it has three reportable segments – Benefits Outsourcing, HR BPO and Consulting.
The Company operates many of the administrative and support functions of its business through the use of centralized shared service operations to provide an economical and effective means of supporting the operating segments. These shared services include information technology services, human resources, management, corporate relations, finance, general counsel, real estate management, supplier management and other supporting services. Many of these costs, such as information technology services, human resources, real estate management and other support services, are assigned to the business segments based on usage and consumption factors. Certain costs within finance, general counsel, management, client and market leadership and corporate relations, are not allocated to the business segments and remain in unallocated shared service costs.
The table below summarizes the Company’s reportable segment results.
Three Months Ended December 31, | ||||||||
2009 | 2008 | |||||||
Benefits Outsourcing | ||||||||
Segment net revenues | $ | 404,026 | $ | 391,574 | ||||
Segment income | 103,934 | 102,456 | ||||||
HR BPO | ||||||||
Segment net revenues | $ | 114,079 | $ | 130,691 | ||||
Segment income (loss) | 6,472 | (5,153 | ) | |||||
Consulting | ||||||||
Segment net revenues | $ | 260,825 | $ | 259,160 | ||||
Segment income | 33,570 | 37,483 | ||||||
Total Company | ||||||||
Segment net revenues | $ | 778,930 | $ | 781,425 | ||||
Intersegment revenues | (8,785 | ) | (10,662 | ) | ||||
Net revenues | 770,145 | 770,763 | ||||||
Reimbursements | 25,390 | 23,209 | ||||||
Total revenues | $ | 795,535 | $ | 793,972 | ||||
Segment income | $ | 143,976 | $ | 134,786 | ||||
Charges not recorded at the segment level: | ||||||||
Unallocated shared costs | 19,105 | 22,429 | ||||||
Operating income | $ | 124,871 | $ | 112,357 | ||||
16. Subsequent Events
On January 28, 2010, the Company signed an agreement to divest a portion of its North America Executive Compensation (“EC”) consulting business focused on advising Boards of Directors in two phases. Its operations are included in the Consulting segment. This partial divestiture is in response to competitive issues stemming from recent regulations promulgated by the Securities and Exchange Commission regarding the independence of consulting firms that provide EC services. The first phase, which involves a select group of consultants leaving the Company to form Meridian Compensation Partners (“Meridian”), a fully-independent EC services boutique, closed on January 28, 2010. The second phase, which involves a second group of consultants leaving the Company to join Meridian, is expected to close during the first quarter of fiscal 2011. As a result of the divestiture, the Company will test the goodwill (which totaled $39.4 million at December 31, 2009) and related assets of the reporting unit impacted by this partial divestiture in the second quarter of fiscal 2010.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following information should be read in conjunction with the information contained in our consolidated financial statements and related notes presented earlier in this Quarterly Report on Form 10-Q. Please also refer to our consolidated financial statements and related notes and the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for additional information. In addition to historical information, this Quarterly Report on Form 10-Q may contain forward-looking statements that involve risks, uncertainties and assumptions, which could cause actual results to differ materially from management’s expectations. Some of the risks and uncertainties are described below and in the “Note Regarding Forward-Looking Statements” which appears later in this section and in our Annual Report on Form 10-K, in Item 1A under the heading “Risk Factors.”
We use the terms “Hewitt”, “the Company”, “we”, “us” and “our” to refer to the business of Hewitt Associates, Inc. and its subsidiaries. All references to years, unless otherwise noted, refer to our fiscal years, which end on September 30. For example, a reference to “2010” or “fiscal 2010” means the twelve-month period that ends September 30, 2010. References to and adjustments for “foreign currency translation” are made within our discussion of results so that the financial results can be viewed without the impact of fluctuating foreign currency exchange rates used in reporting results in one currency (U.S. dollar) and helps facilitate a comparative view of business results. Financial results described within this section, except for share and per share information, are stated in thousands of U.S. dollars unless otherwise noted.
Overview
First quarter net revenues were approximately unchanged as compared to the prior-year quarter. Excluding third-party supplier revenues and adjusting for the favorable effects of foreign currency translation of $12.4 million and the net favorable impact of an acquisition and divestitures of $2.5 million, net revenues decreased 2.2%. This decrease was the result of lower revenues in Consulting, principally due to lower demand in client discretionary services, and HR BPO, mostly due to client terminations and liquidations. This was offset by higher Benefits Outsourcing revenues, primarily the result of growth in all businesses and lower adjustments for client service issues, partially offset by the impact of lost clients, client renewals at lower price points and lower project revenues. Segment results are discussed in greater detail later in this section.
First quarter operating income increased $12.5 million, or 11.1%, compared to the prior-year quarter. The increase was primarily due to improved performance in HR BPO, mostly driven by infrastructure cost management efforts and lower asset impairment charges. The favorable impacts of foreign currency translation related to global operations and lower Consulting bad debt expense also contributed to the increase. This was partially offset by lower Consulting revenues. Consolidated results of operations are discussed in greater detail later in this section.
We continue to maintain a strong balance sheet with significant liquidity. Cash and cash equivalents were $597.0 million at December 31, 2009 and included investments in highly-rated money market funds and similar investments. At December 31, 2009, we had available credit facilities with domestic and foreign banks for various corporate purposes. The amount of unused credit facilities as of December 31, 2009 was approximately $273.5 million. During the quarter, we increased our available credit by $50.0 million when we replaced our existing $200.0 million credit facility with a new three-year, $250.0 million credit facility.
During the first quarter, we repurchased approximately 0.3 million of our outstanding shares at an average price of $39.56, for a total of $12.8 million. At December 31, 2009, we had approximately $213.0 million remaining under our current $300.0 million share repurchase authorization.
On January 28, 2010, we signed an agreement to divest a portion of our North America Executive Compensation (“EC”) consulting business focused on advising Boards of Directors. This partial divestiture, which will occur in two phases, is in response to competitive issues stemming from recent regulations promulgated by the Securities and Exchange Commission regarding the independence of consulting firms that provide EC services. Refer to Note 16 in the Notes to the Consolidated Financial Statements for additional information on this transaction.
For further discussion of our results, please see our discussion of consolidated and segment results in the following section.
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CONSOLIDATED RESULTS
The following table sets forth our historical results of operations.
Three Months Ended December 31, 2009 and 2008
Unaudited
Three Months Ended December 31, | % of Net Revenues | ||||||||||||||||
($ in thousands) | 2009 | 2008 | % Change | 2009 | 2008 | ||||||||||||
Revenues: | |||||||||||||||||
Net revenues(1) | $ | 770,145 | $ | 770,763 | (0.1 | )% | |||||||||||
Reimbursements | 25,390 | 23,209 | 9.4 | % | |||||||||||||
Total revenues | 795,535 | 793,972 | 0.2 | % | |||||||||||||
Operating expenses: | |||||||||||||||||
Compensation and related expenses | 473,447 | 480,908 | (1.6 | )% | 61.5 | % | 62.4 | % | |||||||||
Asset impairment | — | 2,615 | (100.0 | )% | — | 0.3 | |||||||||||
Reimbursable expenses | 25,390 | 23,209 | 9.4 | % | 3.3 | 3.0 | |||||||||||
Other operating expenses(1) | 135,806 | 134,008 | 1.3 | % | 17.6 | 17.4 | |||||||||||
Selling, general and administrative expenses | 36,021 | 40,875 | (11.9 | )% | 4.7 | 5.3 | |||||||||||
Total operating expenses | 670,664 | 681,615 | (1.6 | )% | 87.1 | 88.4 | |||||||||||
Operating income | 124,871 | 112,357 | 11.1 | % | 16.2 | 14.6 | |||||||||||
Other (expense) income, net: | |||||||||||||||||
Interest expense | (9,656 | ) | (10,685 | ) | (9.6 | )% | (1.3 | ) | (1.4 | ) | |||||||
Interest income | 919 | 4,301 | (78.6 | )% | 0.1 | 0.5 | |||||||||||
Other (expense) income, net | (2,907 | ) | 1,281 | n/m | (0.3 | ) | 0.2 | ||||||||||
Total other expense, net | (11,644 | ) | (5,103 | ) | 128.2 | % | (1.5 | ) | (0.7 | ) | |||||||
Income before income taxes | 113,227 | 107,254 | 5.6 | % | 14.7 | 13.9 | |||||||||||
Provision for income taxes | 44,827 | 42,488 | 5.5 | % | 5.8 | 5.5 | |||||||||||
Net income | $ | 68,400 | $ | 64,766 | 5.6 | % | 8.9 | % | 8.4 | % | |||||||
(1) | Net revenues include $11.2 million and $10.3 million of third-party supplier revenues for the three months ended December 31, 2009 and 2008, respectively. Generally, the third-party supplier arrangements are marginally profitable. The related third-party supplier expenses are included in other operating expenses. |
Net Revenues
Net revenues were approximately unchanged as compared to the prior-year quarter. Excluding third-party supplier revenues and adjusting for the favorable effects of foreign currency translation of $12.4 million and the net favorable impact of an acquisition and divestitures of $2.5 million, net revenues decreased 2.2%. This decrease was the result of lower revenues in Consulting, principally due to lower demand in client discretionary services, and HR BPO, mostly due to client terminations and liquidations. This decrease was offset by higher Benefits Outsourcing revenues, primarily the result of growth in all businesses and lower adjustments for client service issues, partially offset by the impact of lost clients, client renewals at lower price points and lower project revenues. Segment results are discussed in greater detail later in this section.
Compensation and Related Expenses
Compensation and related expenses decreased $7.5 million, or 1.6%. The decrease is mostly the result of lower costs due to staff reductions associated with lost clients, partially offset by the unfavorable impacts of foreign currency translation related to global operations.
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Asset Impairment
The prior-year impairment charge of $2.6 million resulted from the write-off of deferred set-up costs associated with certain HR BPO client contracts, in addition to the impairment of customer relationship intangible assets.
Other Operating Expenses
The increase in other operating expenses of $1.8 million, or 1.3%, was primarily due to the unfavorable impacts of foreign currency translation related to global operations.
Selling, General and Administrative (“SG&A”) Expenses
The decrease in SG&A expenses of $4.9 million, or 11.9%, was mostly due to lower bad debt expense which was partially offset by the unfavorable impacts of foreign currency translation related to global operations.
Total Other Expense, Net
Total other expense, net, increased $6.5 million resulting from lower gains on foreign currency transactions and lower interest income, mostly a result of lower average interest rates as compared to the prior year.
Provision for Income Taxes
The Company’s consolidated effective income tax rate was 39.6% for the three months ended December 31, 2009 and 2008. The Company had no material discrete events during the three months ended December 31, 2009 impacting the effective income tax rate.
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Segment Results
Operating income before unallocated shared service costs is referred to as “segment income” throughout the discussion.
Reconciliation of Segment Results to Total Company Results
Three Months Ended December 31, 2009 and 2008
Unaudited
Three Months Ended December 31, | % Change | ||||||||||
($ in thousands) | 2009 | 2008 | |||||||||
Benefits Outsourcing | |||||||||||
Segment net revenues | $ | 404,026 | $ | 391,574 | 3.2 | % | |||||
Segment income | 103,934 | 102,456 | 1.4 | % | |||||||
Segment income as a percentage of segment revenues | 25.7 | % | 26.2 | % | |||||||
HR BPO | |||||||||||
Segment net revenues(1) | $ | 114,079 | $ | 130,691 | (12.7 | )% | |||||
Segment income (loss) | 6,472 | (5,153 | ) | n/m | |||||||
Segment income (loss) as a percentage of segment revenues | 5.7 | % | (3.9 | )% | |||||||
Consulting | |||||||||||
Segment net revenues | $ | 260,825 | $ | 259,160 | 0.6 | % | |||||
Segment income | 33,570 | 37,483 | (10.4 | )% | |||||||
Segment income as a percentage of segment revenues | 12.9 | % | 14.5 | % | |||||||
Total Company | |||||||||||
Segment net revenues(1) | $ | 778,930 | $ | 781,425 | (0.3 | )% | |||||
Intersegment revenues | (8,785 | ) | (10,662 | ) | (17.6 | )% | |||||
Net revenues | 770,145 | 770,763 | (0.1 | )% | |||||||
Reimbursements | 25,390 | 23,209 | 9.4 | % | |||||||
Total revenues | $ | 795,535 | $ | 793,972 | 0.2 | % | |||||
Segment income | $ | 143,976 | $ | 134,786 | 6.8 | % | |||||
Unallocated shared service costs | 19,105 | 22,429 | (14.8 | )% | |||||||
Operating income | $ | 124,871 | $ | 112,357 | 11.1 | % | |||||
(1) | HR BPO net revenues include $11.2 million and $10.3 million of third-party supplier revenues for the three months ended December 31, 2009 and 2008, respectively. Generally, the third-party supplier arrangements are marginally profitable. The related third-party supplier expenses are included in other operating expenses. |
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Benefits Outsourcing
Benefits Outsourcing net revenues increased 3.2% compared to the prior-year quarter. Adjusting for the favorable effect of foreign currency translation of $1.6 million, net revenues increased 2.8%. This increase was primarily the result of higher revenues associated with growth in all businesses and lower adjustments for client service issues. This increase was partially offset by the impact of lost clients, client renewals at lower price points and lower project revenues.
Benefits Outsourcing operating income increased 1.4% compared to the prior-year quarter. The increase was due to the impact of new clients, lower adjustments for client service issues and the favorable expense impacts of foreign currency translation related to global operations. This was mostly offset by the impact of lost clients, client renewals at lower price points and lower project revenues.
HR BPO
HR BPO net revenues decreased 12.7% compared to the prior-year quarter. Excluding third-party supplier revenues and adjusting for the prior-year benefit of $7.2 million related to two divested businesses and the favorable effect of foreign currency translation of $2.7 million, net revenues decreased 11.4%. This decrease was primarily due to client terminations and liquidations.
HR BPO operating income was $6.5 million in the current-year quarter as compared to an operating loss of $5.2 million in the prior-year quarter. The improvement was primarily the result of lower costs due to staff reductions associated with lost clients, infrastructure cost management efforts and lower asset impairment charges. This improvement was offset by lower revenues.
Consulting
Consulting net revenues increased 0.6% compared to the prior-year quarter. Adjusting for the favorable effect of foreign currency translation of $8.1 million and the favorable impact of a fiscal 2009 acquisition of $9.7 million, net revenues decreased 6.2%. This decrease was due to lower revenues from Talent and Organization Consulting services globally and Communication services in North America, both a result of a continued adverse economic environment.
Consulting operating income decreased 10.4% compared to the prior-year quarter. The decrease was mostly due to lower revenues, partially offset by lower bad debt expense and the favorable effect of foreign currency translation related to global operations.
Unallocated Shared Service Costs
Unallocated shared service costs are global expenses that are incurred on behalf of the entire Company and are not specific to a business segment. These costs include finance, legal, human resources, management and corporate relations and other related costs.
Unallocated costs decreased $3.3 million, or 14.8%. The decrease was primarily due to lower performance-based compensation.
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Critical Accounting Policies and Estimates
For a description of our critical accounting policies and estimates, see our Annual Report on Form 10-K for the fiscal year ended September 30, 2009. Refer to Note 2 in the Notes to the Consolidated Financial Statements for an update to our accounting policy for Revenue Recognition related to the adoption of Accounting Standards Update No. 2009-13,Revenue Recognition – Multiple Deliverable Revenue Arrangements.
Liquidity and Capital Resources
We have historically funded our growth and working capital requirements with internally generated funds, credit facilities and term notes. We believe we have broad access to the capital markets.
Summary of Cash Flows | Three Months Ended December 31, | |||||||
(in thousands) | 2009 | 2008 | ||||||
Cash provided by operating activities | $ | 38,429 | $ | 64,441 | ||||
Cash used in investing activities | (29,171 | ) | (32,433 | ) | ||||
Cash provided by (used in) financing activities | 4,987 | (126,295 | ) | |||||
Effect of exchange rates on cash and cash equivalents | 1,091 | (16,108 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 15,336 | (110,395 | ) | |||||
Cash and cash equivalents at beginning of period | 581,642 | 541,494 | ||||||
Cash and cash equivalents at end of period | $ | 596,978 | $ | 431,099 | ||||
Cash and cash equivalents were $597.0 million and $581.6 million as of December 31, 2009 and September 30, 2009, respectively. The Company intends to fund working capital requirements, principal and interest payments on the Company’s debt, potential acquisitions and other liabilities with cash provided by operations and cash on hand, supplemented by short-term and long-term borrowings under existing credit facilities.
Operating activities
The Company’s cash provided by operating activities decreased $26.0 million in the current year compared to the prior year, mostly due to lower collection of receivables. This was partially offset by lower prepaid expenses and the impact of insurance recoveries related to a prior-year legal settlement.
Investing activities
Cash used in investing activities decreased $3.3 million in the current year. A decrease in capital expenditures was mostly offset by an increase in the purchase of short-term investments.
Financing activities
The Company generated more cash in the current year from financing activities primarily due to higher proceeds from the exercise of stock options. The Company used more cash in financing activities in the prior year to repay its $110.0 million convertible debt, partially offset by higher proceeds from short-term borrowings in the prior year.
We believe the cash on hand, together with funds from operations, other current assets and existing credit facilities will satisfy our expected working capital, contractual obligations, planned capital expenditures and investment requirements for the next twelve months and the foreseeable future.
At December 31, 2009, the Company had available credit facilities with domestic and foreign banks for various corporate purposes. During the first quarter of fiscal 2010, the Company increased its available credit by $50.0 million when it replaced an existing $200.0 million credit facility with a new three-year, $250.0 million credit facility. The amount of unused credit facilities as of December 31, 2009 was approximately $273.5 million.
Commitments
Significant ongoing commitments consist primarily of leases, debt, purchase commitments and certain other long-term liabilities. For a summary and description of our ongoing commitments and contractual obligations, see our Annual Report on Form 10-K for the fiscal year ended September 30, 2009 and the “Commitments” section of the Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. There were no material changes in these commitments during the three months ended December 31, 2009.
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Note Regarding Forward-Looking Statements
This report contains forward-looking statements relating to our operations that are based on our current expectations, estimates and projections. Words such as “anticipates”, “believes”, “continues”, “estimates”, “expects”, “goal”, “intends”, “may”, “opportunity”, “plans”, “potential”, “projects”, “forecasts”, “should”, “will”, and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecasted in these forward-looking statements. Actual results may differ from the forward-looking statements for many reasons. Important factors known to us that could cause such material differences are identified and discussed from time to time in our filings with the Securities and Exchange Commission, including those factors discussed in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended September 30, 2009. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or for any other reason. Such important factors include:
• | The outsourcing and consulting markets are highly competitive, and if we are not able to compete effectively, our revenues and profit margins may be adversely affected. |
• | A significant or prolonged economic downturn could have a material adverse effect on our revenues, financial condition and results of operations. |
• | The profitability of our engagements with clients may not meet our expectations due to unexpected costs, cost overruns, early contract terminations, unrealized assumptions used in our contract bidding process and the inability to maintain our prices. |
• | Our business will be negatively affected if we are not able to anticipate and keep pace with rapid changes in government regulations or if government regulations decrease the need for our services or increase our costs. |
• | We might not be able to achieve the cost savings required to sustain and increase our profit margins. |
• | Our accounting for our long-term contracts requires using estimates and projections that may change over time. Such changes may have a significant or adverse effect on our reported results of operations or consolidated balance sheet. |
• | The loss of a significantly large client or several clients could have a material adverse effect on our revenues and profitability. |
• | We may have difficulty integrating or managing acquired businesses, which may harm our financial results or reputation in the marketplace. |
• | If we are unable to satisfy regulatory requirements relating to internal controls over financial reporting, our business could suffer. |
• | Our business performance and growth plans will be negatively affected if we are not able to effectively apply technology in driving value for our clients through technology-based solutions or gain internal efficiencies through the effective application of technology and related tools. |
• | If our clients or third parties are not satisfied with our services, we may face damage to our professional reputation or legal liability. |
• | Improper disclosure of personal data could result in liability and harm our reputation. |
• | We depend on our employees; the inability to attract new talent or the loss of key employees could damage or result in the loss of client relationships and adversely affect our business. |
• | Our global operations and expansion strategy pose complex management, foreign currency, legal, tax and economic risks, which we may not adequately address. |
• | The demand for our services may not grow at rates we anticipate. |
• | If we fail to establish and maintain alliances for developing, marketing and delivering our services, our ability to increase our revenues and profitability may suffer. |
• | We rely on third parties to provide services and their failure to perform the service could do harm to our business. |
• | We have only a limited ability to protect the intellectual property rights that are important to our success, and we face the risk that our services or products may infringe upon the intellectual property rights of others. |
• | We rely heavily on our computing and communications infrastructure and the integrity of these systems in the delivery of services for our clients, and our operational performance and revenue growth depends, in part, on the reliability and functionality of this infrastructure as a means of delivering human resources services. |
• | Our quarterly revenues, operating results and profitability will vary from quarter to quarter, which may result in volatility of our stock price. |
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• | We may not be able to liquidate our auction rate securities at carrying value, which may result in an impairment of the fair value of these securities and may have an impact on our ability to fund our ongoing operations and growth initiatives. |
• | There are significant limitations on the ability of any person or company to buy Hewitt without the approval of the Board of Directors, which may decrease the price of our Class A common stock. |
• | Section 203 of the Delaware General Corporation Law may delay, defer or prevent a change in control that our stockholders might consider to be in their best interest. |
You should carefully consider each cautionary factor and all of the other information in this report. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any future disclosure we make on related subjects in future reports to the Securities and Exchange Commission.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We are exposed to market risk primarily from changes in foreign currency exchange rates and interest rates. As discussed below, in December 2007, we initiated a foreign currency risk management program involving the uses of financial derivatives. In August 2008, we initiated a debt risk management program. For analysis of the debt risk management program, refer to the Company’s Form 10-K for the fiscal year ended September 30, 2009. We do not hold or issue derivative financial instruments for trading purposes.
Foreign exchange risk
The Company has a substantial operation in India for the development and deployment of technology solutions as well as for client and business support activities. In December 2007, the Company initiated a foreign currency risk management program involving the use of foreign currency derivatives related to exposures in fluctuations in the Indian rupee and expects to hedge up to 75% of future exposures. As of December 31, 2009, the Company was a party to foreign currency derivative instruments related to exposures to the Indian rupee for approximately 56% of forecasted transactions of approximately $198.2 million over the next 21 months. A 10% change in the exchange rate on the related exposure would result in an increase or decrease in related expenses of approximately $19.8 million. Consistent with the use of the derivatives to offset the effect of exchange rate fluctuations, such increases or decreases in expenses would be offset by corresponding gains or losses, respectively, of approximately $11.0 million on settlement of the derivative instruments.
Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting.
There has been no significant change in our internal control over financial reporting that occurred during the three months ended December 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Item 1. | Legal Proceedings |
The Company is involved in disputes arising in the ordinary course of its business relating to outsourcing or consulting agreements, professional liability claims, vendors or service providers or employment claims. The Company is also routinely audited and subject to inquiries by governmental and regulatory agencies. Management considers such factors as the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss and records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. If the reasonable estimate of a probable loss is a range of outcomes, and no amount within the range is a better estimate than another, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. Insurance and other recoveries of book losses are separately evaluated and recognized only if such recoveries are also probable and reasonably estimable.
The Company does not believe that any unresolved dispute will have a material adverse effect on its financial condition or results of operation. However, litigation in general and the outcome of any matter, in particular, cannot be predicted with certainty. An unfavorable resolution of one or more pending matters could have a material adverse impact on the Company’s results of operations for one or more reporting periods.
In the normal course of business, the Company also enters into contracts in which it makes representations, warranties, guarantees and indemnities that relate to the performance of the Company’s services and products. The Company does not expect any material losses related to such representations, warranties, guarantees and indemnities.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
(c) Issuer Purchases of Equity Securities
The following table provides information about Hewitt’s share repurchase activity for the three months ended December 31, 2009:
Period | Total Number of Shares Purchased | Average Price Paid per Share(1) | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(2) | ||||||
October 1 – 31, 2009(1) | ||||||||||
Class A | 145,700 | $ | 37.07 | 145,700 | $ | 220,425 | ||||
November 1 – 30, 2009(1) | ||||||||||
Class A | 64,634 | $ | 36.23 | 39,600 | $ | 218,979 | ||||
December 1 – 31, 2009(1) | ||||||||||
Class A | 138,100 | $ | 43.06 | 138,100 | $ | 213,032 | ||||
Total Shares Purchased: | ||||||||||
Class A | 348,434 | $ | 39.29 | 323,400 | ||||||
(1) | The shares purchased relate to the Company’s share repurchase program and also shares employees have elected to have withheld to cover their minimum withholding requirements for personal taxes related to the vesting of restricted stock or restricted stock units. The average price paid per share for October 1, 2009 through December 31, 2009 represents a weighted average of the closing stock prices on the dates the shares were repurchased or withheld. |
(2) | During the first quarter of fiscal 2009, the Board of Directors authorized the Company to repurchase up to $300 million of its outstanding common shares through November 12, 2010. |
Item 6. | Exhibits |
a. Exhibits.
10.1 | Employment Letter to Robert Schriesheim dated December 1, 2009 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed December 7, 2009). | |
31.1 | Certification of Chief Executive Officer pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
31.2 | Certification of Chief Financial Officer pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
ITEMS 1A, 3, 4, and 5 are not applicable and have been omitted.
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Table of Contents
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HEWITT ASSOCIATES, INC. | ||||
(Registrant) | ||||
Date: February 1, 2010 | By: | /s/ JOSEPH A. TAUTGES | ||
Joseph A. Tautges | ||||
Corporate Controller | ||||
(principal accounting officer and duly authorized officer) |
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