ADP

Business Context and Reporting Period

Company: Automatic Data Processing, Inc. (ADP)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006 (Nine months ended March 31, 2006 also presented)
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

Note: Revenues include interest on funds held for Employer Services' clients ($166.2M for 3 months; $393.5M for 9 months).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 10% for both the three and nine months ended March 31, 2006, compared to the prior year. Employer Services grew 9%, Brokerage Services 6-9%, and Dealer Services 12-21%.
• Profitability: Net earnings from continuing operations increased 11% (3 months) and 9% (9 months) year-over-year. Diluted EPS from continuing operations rose 13% and 11%, respectively.
• Accounting Change Impact: The adoption of SFAS No. 123R (Share-Based Payment) effective July 1, 2005, significantly impacted comparability. Stock-based compensation expense increased to $41.9 million (3 months) and $125.7 million (9 months) in 2006, compared to $3.2 million and $10.4 million in 2005. On an "as adjusted" basis (excluding the accounting change impact), earnings growth was 22% (3 months) and 25% (9 months).
• Discontinued Operations: The Claims Services business was classified as discontinued operations following an agreement to sell it to Solera, Inc. for $975 million (completed April 2006). Net earnings from discontinued operations were $15.1 million (3 months) and $31.0 million (9 months).

Guidance, Outlook, and Risks

• Outlook: Management expects capital expenditures for fiscal 2006 to be approximately $290 million, an increase from $195.2 million in fiscal 2005, driven by data center and facility improvements.
• Dividends: Dividends per common share increased to $0.1850 for the quarter (up from $0.1550 in the prior year).
• Share Repurchases: The company repurchased 4.7 million shares in the quarter and 12.0 million shares in the nine-month period. As of March 31, 2006, authorization remained to purchase up to 51.5 million additional shares.
• Tax Repatriation: ADP plans to repatriate approximately $250 million of foreign earnings under the American Jobs Creation Act (AJCA), expecting a related income tax charge of approximately $10 million in the fourth quarter of fiscal 2006.
• Risks:
  • Market Risk: Exposure to interest rate fluctuations and foreign currency exchange rates. A 25 basis point change in interest rates could impact earnings by less than $10 million annually.
  • Legal Proceedings: Ongoing litigation regarding trade secret violations (Universal Computer Systems, Inc.) was affirmed in ADP's favor by the Texas Supreme Court in April 2006, though a rehearing motion was pending as of the filing date.
  • Clearing Risk: The Securities Clearing and Outsourcing Services segment faces potential liability if other clearinghouse members fail to meet obligations, though collateral requirements mitigate this risk.

Investor Verification Checklist

• Discontinued Operations: Verify the final closing adjustments and net cash proceeds from the sale of the Claims Services business to Solera, Inc.
• Stock-Based Compensation: Review the impact of SFAS No. 123R on future quarters, noting the remaining unrecognized compensation cost of $247.1 million ($186.3M options, $29.0M ESPP, $31.8M restricted stock).
• Client Funds: Confirm the stability of client funds balances ($22.4 billion held for clients) and the associated interest income, which is a significant revenue driver.
• Acquisition Integration: Monitor the integration costs and revenue contribution from recent acquisitions, specifically Kerridge Computer Company Ltd in Dealer Services.
• Tax Provision: Watch for the anticipated $10 million tax charge related to the AJCA repatriation in the fourth quarter.