ADP

Business Context and Reporting Period

Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: ADP provides payroll, human resources, and benefits administration services through three primary segments: Employer Services, PEO Services, and Dealer Services. The company holds significant client funds which are invested to generate interest income.

Key Financial Metrics

Note: Interest on funds held for clients was $151.9 million for the quarter ended Sep 30, 2008, down from $154.5 million in the prior year due to lower interest rates.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 10% year-over-year. Employer Services grew 8%, PEO Services grew 18%, and Dealer Services grew 2%. Internal revenue growth (excluding acquisitions/divestitures) was 9%.
• Profitability: Earnings from continuing operations before income taxes rose 16% to $441.3 million. The operating margin improved from 19% to 20%.
• Expense Management: Total expenses increased 8%. Interest expense decreased 35% to $19.2 million due to lower average interest rates on commercial paper and reverse repurchase agreements, despite higher average borrowing volumes.
• Discontinued Operations: The prior year included a $57.0 million gain from the sale of the Travel Clearing business. The current quarter recorded a $1.1 million loss related to tax adjustments on divestitures.
• Investment Losses: The company recorded a $3.3 million loss related to its investment in the Reserve Fund (Primary Fund) due to the Lehman Brothers bankruptcy, impacting "Other income, net."

Guidance, Outlook, and Risks

• Liquidity and Capital Resources: Management states liquidity remains strong despite global market volatility. The company has $2.98 billion in cash and marketable securities and access to $6.0 billion in commercial paper and credit facilities. No borrowings were made under long-term credit facilities during the quarter.
• Reserve Fund Exposure: ADP holds $220.7 million in the Reserve Fund, which suspended redemptions following Lehman Brothers' bankruptcy. The company reclassified $211.1 million from cash equivalents to short-term marketable securities. Distributions are expected as assets mature, but the final recovery amount is uncertain.
• Capital Expenditures: Expected to be approximately $220 million for the fiscal year ending June 30, 2009, compared to $186.4 million in the prior fiscal year.
• Tax Contingencies: Unrecognized tax benefits totaled $411.5 million. Settlements within the next 12 months could impact earnings by up to $100 million and require net cash payments of up to $100 million.
• Market Risks: The company faces interest rate risk on its investment portfolio and foreign currency exchange risk. A hypothetical 25 basis point change in interest rates could impact earnings by approximately $7 million over the next 12 months.

Investor Verification Checklist

• Reserve Fund Recovery: Monitor the liquidation progress of the Reserve Fund and the timing/amount of future distributions to assess potential further losses or recoveries.
• Commercial Paper Usage: Verify the company's continued ability to access the commercial paper market given the $1.4 billion outstanding balance at quarter-end.
• PEO Segment Margins: Review the impact of rising healthcare costs on PEO Services margins, as pass-through costs increased significantly.
• Tax Resolution: Track the status of IRS and state tax examinations, particularly the potential $100 million impact on earnings from settlements.
• Stock Repurchases: Confirm the execution of the share repurchase program, which reduced share count by 5.4 million shares in the quarter.