Business Context and Reporting Period
Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2006
Business Overview: ADP is a leading provider of technology-based outsourcing solutions, primarily in payroll processing, human resources, and benefits administration (Employer Services). Other segments include Brokerage Services, Securities Clearing and Outsourcing Services, and Dealer Services (automotive retail management systems). The company serves over 570,000 clients globally.
Key Financial Metrics
| Metric | Fiscal 2006 | Fiscal 2005 |
|---|---|---|
| Total Revenues | $8,881.5 million | $7,983.7 million |
| Net Earnings (Continuing Ops) | $1,072.4 million | $998.3 million |
| Diluted EPS (Continuing Ops) | $1.85 | $1.69 |
| Operating Cash Flow | $1,812.5 million | $1,433.4 million |
| Cash & Marketable Securities | $2,602.5 million | $1,997.3 million |
| Long-Term Debt | $74.3 million | $75.7 million |
| Stockholders' Equity | $6,011.6 million | $5,783.9 million |
| Return on Equity | 19.5% | 18.3% |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 11% to $8.88 billion, driven by 10% growth in Employer Services, 10% in Brokerage Services, and 14% in Dealer Services.
- Accounting Change: The company adopted SFAS No. 123R (Share-Based Payment) effective July 1, 2005. This required the expensing of stock-based compensation, adding $168.4 million in expenses for fiscal 2006 compared to $14.0 million in fiscal 2005. On an adjusted basis (excluding the accounting change impact), earnings from continuing operations before taxes grew 23%.
- Discontinued Operations: ADP sold its Claims Services business for $975 million in cash, resulting in a $561 million pre-tax gain ($453 million after-tax). This business is now classified as discontinued operations.
- Share Repurchases: The company accelerated buybacks, repurchasing 29.6 million shares for approximately $1.3 billion during fiscal 2006, reducing the share count and boosting EPS.
- Interest Income: Interest income on client funds held for Employer Services increased to $549.8 million (from $421.4 million) due to higher average client fund balances ($13.6 billion) and improved interest rates.
Guidance, Outlook, and Risks
- Fiscal 2007 Guidance: Management projects revenue growth of approximately 10% and diluted earnings per share growth of 17% to 20% (based on continuing operations). Pretax margins are expected to improve by about 100 basis points across businesses.
- Strategic Spin-off: On August 2, 2006, the Board approved a plan to spin off the Brokerage Services Group (Brokerage Services and Securities Clearing) into an independent, publicly traded company. The separation is expected to be completed before the end of fiscal 2007.
- Key Risks:
- Regulatory Changes: Changes in payroll tax laws or investor communication regulations could reduce revenues.
- Security Breaches: As a custodian of sensitive personal and financial data, ADP faces risks from data privacy violations and system disruptions.
- Economic Conditions: Slowdowns in employment levels or trading volumes could impact demand for services.
- Spin-off Execution: Risks associated with the complexity and costs of separating the Brokerage Services Group.
Investor Verification Checklist
- Spin-off Timeline: Verify the regulatory approval status and expected completion date for the Brokerage Services Group spin-off.
- Stock Compensation Impact: Review the pro-forma earnings adjustments to understand organic growth trends independent of the SFAS 123R adoption.
- Client Fund Balances: Monitor the $13.6 billion in client funds held, as interest income on these funds is a significant revenue driver.
- PEO Segment Margins: Assess the margin profile of the Professional Employer Organization (PEO) business, which has lower margins due to pass-through costs.
- Goodwill Valuation: Note the $2.47 billion in goodwill; verify that no impairment charges are anticipated given the company's growth trajectory.