ADP

Business Context and Reporting Period

Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007 (Nine months ended March 31, 2007)
Business Overview: ADP provides payroll, human resource, and business process outsourcing services. The reporting period is significantly impacted by the tax-free spin-off of its Brokerage Services Group into Broadridge Financial Solutions, Inc. on March 30, 2007, which is now classified as discontinued operations.

Key Financial Metrics

Note: Interest on funds held for Employer Services' clients is a significant revenue component ($198.3M for Q1 2007; $475.3M for 9M 2007).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 14% for both the three and nine-month periods ended March 31, 2007, compared to the prior year. This was driven by 12% growth in Employer Services and 8-16% growth in Dealer Services.
• Profitability: Net earnings from continuing operations increased 16% (Q1) and 17% (9M). Diluted EPS from continuing operations rose 20% (Q1) and 23% (9M), aided by share repurchases.
• Discontinued Operations: Earnings from discontinued operations decreased significantly due to the spin-off of Broadridge. Net earnings from discontinued operations were $24.6M (Q1 2007) and $103.6M (9M 2007) compared to $56.0M and $134.0M in the prior year periods.
• Expense Increases: Total expenses rose 13% (Q1) and 14% (9M). Increases were attributed to higher pass-through costs in the PEO business, increased salesforce and implementation personnel, and spending on new business opportunities (HR BPO).
• Investing Activities: Net cash provided by investing activities turned positive ($336.2M for 9M 2007) compared to a use of cash ($505.9M) in the prior year, largely due to a $690.0M cash dividend received from Broadridge and proceeds from asset sales.

Guidance, Outlook, and Risks

• Capital Allocation: ADP repurchased 18.1 million shares of common stock during the nine months ended March 31, 2007, at an average price of $47.18. The Board has authorization to purchase up to 65.9 million additional shares.
• Dividends: Dividends declared per common share increased to $0.2300 for the quarter (from $0.1850 prior year) and $0.6450 for the nine months (from $0.5250 prior year).
• Accounting Changes: The company is evaluating the impact of new accounting standards (SFAS 158, SFAS 159, FIN 48). Adoption of SFAS 158 is expected to reduce stockholders' equity by approximately $116 million (net of tax) due to reclassification of unrecognized pension losses.
• Risk Factors: Key risks include changes in laws/regulations affecting payroll taxes and PEOs, security/privacy breaches of client data, system disruptions, and economic slowdowns affecting employment levels and client spending.
• Outlook: Management expects capital expenditures for fiscal 2007 to be approximately $190.0 million. The company maintains strong liquidity with $5.5 billion in available credit facilities and a commercial paper program.

Investor Verification Checklist

• Spin-off Impact: Verify the separation of Broadridge Financial Solutions and the classification of its results as discontinued operations to ensure accurate year-over-year comparisons.
• PEO Pass-Through Costs: Review the proportion of revenue versus pass-through costs in the Professional Employer Organization (PEO) segment, as high pass-through costs can inflate revenue without proportional margin growth.
• Client Funds Interest: Assess the sensitivity of revenue to interest rate changes, as a significant portion of revenue ($198.3M in Q1) is derived from interest on funds held for clients.
• Share Count Reduction: Confirm the impact of the 18.1 million share repurchases on EPS growth versus organic earnings growth.
• Pension Liability: Monitor the upcoming adoption of SFAS 158 and its potential $116 million reduction to stockholders' equity.