Why did ADP's earnings decline in fiscal 2003 despite revenue growth?

Total expenses grew faster than revenue (about 5% versus 2%), and interest income fell sharply because interest rates dropped. Brokerage Services, with a 9% revenue decline, also saw earnings fall 35%. Restructuring charges of about $60 million added to costs. Net earnings fell 8%, and diluted EPS fell 4%, helped by a lower share count from buybacks.

What is the outlook for fiscal 2004?

Management forecasts mid-single-digit revenue growth and diluted EPS of $1.50 to $1.60. The guidance reflects a continued weak economy affecting Employer and Brokerage Services, a $60 to $80 million decline in interest income, and $90 to $100 million of incremental investment, plus $40 to $45 million for employee retention initiatives. The ProBusiness acquisition is expected to contribute about $150 million of revenue.

How significant is the ProBusiness Services acquisition?

ADP acquired ProBusiness Services on June 20, 2003 for about $517 million in cash, net of cash acquired. The deal created about $417 million of goodwill and about $79.8 million of intangibles. Only about $351 million had been paid by June 30, with the remaining $166 million due as shareholders tender their shares. It strengthens the National Accounts segment of Employer Services.

What are the main legal and financial risks disclosed?

The most specific legal risk is the UCS lawsuit, which alleges trade secret misappropriation related to the CARMan dealer software and seeks $56 million in damages and injunctive relief. An arbitration decision was expected in October 2003, and ADP says it has valid defenses. Other risks include goodwill of about $2.0 billion, which could require a material impairment charge if fair values fall, and sensitivity to interest rates, where a 25-basis-point change affects earnings by about $11 million.

Is ADP's balance sheet and cash generation strong enough to support its capital returns?

Yes. ADP generated about $1.57 billion in operating cash flow and held $2.3 billion in cash and marketable securities, against long-term debt of only $85 million. It paid $285 million in dividends and repurchased $939 million of stock in fiscal 2003, and it still had authorization for 43.5 million more shares. Its $4.0 billion revolving credit facility, expiring in October 2003, had no borrowings outstanding.

ADP 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 12, 2003. Cited figures are marked; the original filing is the authoritative source.

Automatic Data Processing (ADP) reported fiscal 2003 (year ended June 30, 2003) results that showed modest top-line growth but weaker profitability.

Total revenues rose 2% to $7.15 billion^a, led by Employer Services (up 5% to $4.4 billion), while Brokerage Services fell 9% on industry consolidation and lower trade and proxy volumes. Earnings before income taxes declined 8% to $1.65 billion and diluted EPS fell 4% to $1.68, held up somewhat by share repurchases of about 27.4 million shares for roughly $940 million. Lower interest rates (average yield on client and corporate funds down to 3.9% from 4.9%) were a significant drag on interest income.

Management guided fiscal 2004 to mid-single-digit revenue growth and diluted EPS of $1.50 to $1.60^b, below fiscal 2003's $1.68, citing a continued weak economy, lower interest income of $60 to $80 million, and incremental investments of $90 to $100 million. Growth drivers include the June 2003 acquisition of ProBusiness Services (about $517 million cash, expected to add roughly $150 million of fiscal 2004 revenue), the PEO business, and Dealer Services, which grew 12%. The balance sheet remains very strong, with about $2.3 billion in cash and marketable securities, long-term debt of only $85 million, and shareholders' equity of $5.4 billion.

Operating cash flow was about $1.6 billion^c. Investors should note the roughly $2.0 billion of goodwill, the pending $56 million UCS trade-secret arbitration (decision expected October 2003), and the continued sensitivity of earnings to interest rates.

02—Key points

Key Highlights

Total revenues grew 2% to $7.15 billion, while earnings before income taxes fell 8% to $1.65 billion and net earnings fell 8% to $1.02 billion.
Diluted EPS declined 4% to $1.68, partly offset by repurchasing about 27.4 million shares for roughly $940 million.
Brokerage Services revenue fell 9% and its pre-tax earnings fell 35%, reflecting industry consolidation and a 13% drop in trades per day.
Employer Services revenue rose 5% to $4.4 billion, and Dealer Services revenue rose 12% to $788 million.
Lower interest rates cut the average yield on funds to 3.9% from 4.9%, and management expects a further $60 to $80 million decline in interest income in fiscal 2004.
Fiscal 2004 guidance calls for mid-single-digit revenue growth and diluted EPS of $1.50 to $1.60, below fiscal 2003 levels.
The balance sheet is strong, with $2.3 billion in cash and marketable securities, only $85 million of long-term debt, and $5.4 billion of shareholders' equity.

03—Questions

Frequently Asked Questions

Why did ADP's earnings decline in fiscal 2003 despite revenue growth?
Total expenses grew faster than revenue (about 5% versus 2%), and interest income fell sharply because interest rates dropped. Brokerage Services, with a 9% revenue decline, also saw earnings fall 35%. Restructuring charges of about $60 million added to costs. Net earnings fell 8%, and diluted EPS fell 4%, helped by a lower share count from buybacks.
What is the outlook for fiscal 2004?
Management forecasts mid-single-digit revenue growth and diluted EPS of $1.50 to $1.60. The guidance reflects a continued weak economy affecting Employer and Brokerage Services, a $60 to $80 million decline in interest income, and $90 to $100 million of incremental investment, plus $40 to $45 million for employee retention initiatives. The ProBusiness acquisition is expected to contribute about $150 million of revenue.
How significant is the ProBusiness Services acquisition?
ADP acquired ProBusiness Services on June 20, 2003 for about $517 million in cash, net of cash acquired. The deal created about $417 million of goodwill and about $79.8 million of intangibles. Only about $351 million had been paid by June 30, with the remaining $166 million due as shareholders tender their shares. It strengthens the National Accounts segment of Employer Services.
What are the main legal and financial risks disclosed?
The most specific legal risk is the UCS lawsuit, which alleges trade secret misappropriation related to the CARMan dealer software and seeks $56 million in damages and injunctive relief. An arbitration decision was expected in October 2003, and ADP says it has valid defenses. Other risks include goodwill of about $2.0 billion, which could require a material impairment charge if fair values fall, and sensitivity to interest rates, where a 25-basis-point change affects earnings by about $11 million.
Is ADP's balance sheet and cash generation strong enough to support its capital returns?
Yes. ADP generated about $1.57 billion in operating cash flow and held $2.3 billion in cash and marketable securities, against long-term debt of only $85 million. It paid $285 million in dividends and repurchased $939 million of stock in fiscal 2003, and it still had authorization for 43.5 million more shares. Its $4.0 billion revolving credit facility, expiring in October 2003, had no borrowings outstanding.

04—Continue

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