Business Context and Reporting Period
Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2007
Business Overview: ADP is a leading global provider of business outsourcing solutions, primarily offering HR, payroll, tax, and benefits administration services (Employer Services), professional employer organization (PEO) services, and integrated computing solutions for automotive and powersports dealers (Dealer Services). The company serves approximately 585,000 clients worldwide.
Key Financial Metrics
| Metric | Fiscal 2007 | Fiscal 2006 | Change |
|---|---|---|---|
| Total Revenues | $7,800.0 million | $6,835.6 million | +14% |
| Net Earnings (Continuing Ops) | $1,021.2 million | $841.9 million | +21% |
| Diluted EPS (Continuing Ops) | $1.83 | $1.45 | +26% |
| Operating Cash Flow | $1,298.0 million | $1,812.5 million | -28% |
| Long-Term Debt | $43.5 million | $74.3 million | -41% |
| Cash & Marketable Securities | $1,884.6 million | $2,461.3 million | -24% |
| Return on Equity | 23.7% | 17.4% | +6.3 pts |
Note: Operating cash flow decreased primarily due to the exclusion of discontinued operations and timing of working capital items.
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues grew 14% to $7.8 billion. Employer Services grew 11%, PEO Services grew 26%, and Dealer Services grew 14%. Growth was driven by new business sales, increased client funds balances, and acquisitions.
- Profitability: Earnings from continuing operations before income taxes increased 19% to $1.62 billion. The effective tax rate decreased to 37.1% from 38.2% due to a favorable mix of income among jurisdictions.
- Divestitures and Spin-offs:
- Broadridge Spin-off: On March 30, 2007, ADP completed the tax-free spin-off of its Brokerage Services Group into Broadridge Financial Solutions, Inc. Results are classified as discontinued operations.
- Travel Clearing Sale: ADP agreed to sell its Travel Clearing business for approximately $116 million (completed July 2007).
- Sandy Corporation Sale: Sold for approximately $4.0 million, resulting in an $11.2 million pre-tax gain.
- Share Repurchases: ADP repurchased 40.2 million shares of common stock for approximately $1.9 billion in fiscal 2007, reducing the share count and boosting EPS.
Guidance, Outlook, and Risks
- Outlook: Management expressed confidence in the company's growth potential following the spin-off, noting a more focused business model. Capital expenditures for fiscal 2008 are expected to be approximately $200 million.
- Key Risks:
- Regulatory Changes: Changes in payroll tax laws or regulations could decrease revenues and earnings.
- Security Breaches: As a custodian of sensitive personal and financial data, ADP faces risks related to data privacy and security breaches.
- System Disruptions: Heavy reliance on data processing systems creates operational risk if systems fail.
- Economic Conditions: Economic slowdowns could lead to reduced employment levels and lower demand for outsourcing services.
- Accounting Changes: ADP adopted SFAS No. 158 (pension accounting) and SAB 108 (prior year misstatements), resulting in a $63.1 million reduction to equity and a $44.3 million increase to opening retained earnings, respectively.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the separation of results for the Broadridge spin-off and Travel Clearing sale to understand the "new" ADP's standalone performance.
- Client Funds Interest: Confirm the sensitivity of revenue to interest rate fluctuations on the $14.7 billion in average client funds held.
- PEO Pass-Through Costs: Review the high volume of pass-through costs in the PEO segment ($640.7 million in 2007) to understand margin dynamics.
- Goodwill Valuation: Assess the $2.35 billion goodwill balance against potential impairment risks given the competitive outsourcing landscape.
- Share Count Reduction: Monitor the impact of the aggressive share repurchase program on future EPS growth versus organic earnings growth.