ADP

Business Context and Reporting Period

Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: ADP provides payroll, human resources, and financial services. Key segments include Employer Services, Brokerage Services, Dealer Services, and Securities Clearing and Outsourcing Services.

Key Financial Metrics

Segment Performance (Revenues): Employer Services ($1,299.4M), Brokerage Services ($374.8M), Dealer Services ($253.8M), Securities Clearing ($17.7M).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 10% year-over-year, driven by 9% growth in Employer Services, 12% in Brokerage Services, and 6% in Dealer Services.
• Accounting Change (SFAS 123R): Effective July 1, 2005, ADP adopted SFAS No. 123R, requiring the recognition of stock-based compensation expense. This resulted in an incremental expense of $45.4 million for the quarter (compared to $3.5 million in the prior year), reducing net earnings by $29.7 million after tax.
• Adjusted Performance: On an adjusted basis (excluding the impact of SFAS 123R adoption), net earnings increased 28% to $220.0 million, and diluted EPS increased 31% to $0.38.
• Interest Income: Interest on funds held for Employer Services' clients rose to $108.4 million from $84.7 million, reflecting a 12% increase in average client funds balances and higher interest rates.
• Investing Activities: Net cash used in investing activities was $46.8 million, a shift from $399.3 million provided in the prior year, primarily due to timing of marketable securities transactions and changes in client funds obligations.

Guidance, Outlook, and Risks

• Capital Expenditures: Expected to be approximately $300 million for fiscal 2006, an increase from $202.8 million in fiscal 2005, primarily for data center and facility improvements.
• Dividends: Dividends per common share increased to $0.1550 from $0.1400 in the prior year.
• Share Repurchases: The company repurchased 5.0 million shares during the quarter at an average price of $43.12. Approximately 8.6 million shares remain authorized for repurchase.
• Tax Contingency: Under the American Jobs Creation Act (AJCA), ADP is evaluating the repatriation of foreign earnings. The potential repatriation range is $0 to $500 million, with a related potential tax liability of $0 to $35 million.
• Market Risks: The company is exposed to interest rate risk (15% of portfolio in cash equivalents) and credit risk, though 95% of available-for-sale securities are rated AAA or AA. A 25 basis point change in interest rates is estimated to impact earnings by less than $10 million over a twelve-month period.
• Forward-Looking Statements: Results may differ due to competitive conditions, changes in laws regulating payroll/PEO, and economic conditions.

Investor Verification Checklist

• Impact of SFAS 123R: Verify the sustainability of earnings growth by analyzing the "As Adjusted" metrics versus GAAP reported numbers, given the significant one-time accounting change.
• Client Fund Balances: Monitor the $11.4 billion average client funds balance, as interest income on these funds is a material revenue component.
• Stock-Based Compensation: Review the remaining unrecognized compensation cost of $179.2 million for stock options and its future amortization impact.
• Capital Allocation: Confirm the execution of the $300 million capital expenditure plan and the continued share repurchase program.
• Foreign Repatriation: Track management's decision regarding the repatriation of foreign earnings under the AJCA and the associated tax impact.