01—Abstract
Summary
Summary of the 10-K filed August 31, 2005. Cited figures are marked; the original filing is the authoritative source.
Automatic Data Processing, Inc. (ADP) closed fiscal 2005 (year ended June 30, 2005) with a strong year by its own account.
Total revenues rose 10% to $8,499.1 milliona, earnings before income taxes grew 12% to $1,677.9 million, and net earnings increased 13% to $1,055.4 million. Diluted EPS climbed 15% to $1.79, helped by a 14.1 million share repurchase program that reduced the diluted share count to 590.0 million from 598.7 million. Employer Services, the largest segment at $5,199.9 million of revenue, grew 8%, driven by new business sales up 13% to roughly $840 million of annualized recurring revenue, a pricing increase of about 2%, and higher client funds balances.
Brokerage Services and Dealer Services grew 5% and 10%, respectively. The main new item for investors is the November 2004 acquisition of Bank of America's U.S. Clearing and BrokerDealer business, which created the Securities Clearing and Outsourcing Services segment. That segment contributed $61.5 millionb of revenue but posted a $23.6 million pre-tax loss and used $193.0 million of operating cash flow, largely from segregating securities for customers.
Management excluded this subsidiary from its internal control assessment, which covers about 1% of revenues and 5% of assets. Balance sheet size is heavily influenced by client funds: total assets reached $27,615.4 millionc, of which $17,897.5 million is funds held for clients, offset by $17,859.2 million of client funds obligations. Corporate cash and marketable securities were $2,119.1 million, and long-term debt was minimal at $75.8 million.
Looking forward, management guided fiscal 2006 to high single-digit revenue growth and diluted EPS growth of 15% to 20% on a stock-compensation-expensed basis, or $1.81 to $1.88d per share. The company adopted SFAS 123R effective July 1, 2005, which is expected to reduce EPS by $0.18 to $0.19 in fiscal 2006. A pending 10-K item is a legacy trade secret lawsuit (UCS), which ADP won at arbitration and is now on appeal; management believes it should prevail.
02—Key points
Key Highlights
- Revenue grew 10% to $8,499.1 million; net earnings rose 13% to $1,055.4 million and diluted EPS rose 15% to $1.79.
- Employer Services (86% U.S. revenue) grew revenue 8% to $5,199.9 million, with new business sales up 13% to about $840 million of annualized recurring revenue and client retention improving 0.5 points.
- ADP repurchased 14.1 million shares for $591.4 million (average $41.98), and 13.6 million shares remained under authorization at June 30, 2005.
- The U.S. Clearing and BrokerDealer business acquired from Bank of America formed a new segment with $61.5 million of revenue but a $23.6 million pre-tax loss and $193.0 million of operating cash outflow.
- Client funds are a large balance-sheet driver: $17.9 billion of funds held for clients offset by $17.9 billion of client funds obligations, while corporate cash and marketable securities were $2.1 billion.
- Fiscal 2006 guidance calls for high single-digit revenue growth and 15% to 20% EPS growth (on a stock-expense basis), with SFAS 123R expected to reduce EPS by $0.18 to $0.19.
- Operating cash flow was $1,433.4 million, or $1,626.4 million excluding the clearing segment, and the company has never drawn on its $5.0 billion of revolving credit facilities.
03—Questions
Frequently Asked Questions
What drove ADP's earnings growth in fiscal 2005?
Earnings growth came mainly from Employer Services, where revenue rose 8% on new business, price increases of about 2%, more employees on client payrolls, and higher interest on client funds, which averaged $12.3 billion. Operating leverage also helped, as expenses grew 9% against 10% revenue growth. Share repurchases lifted EPS growth above net earnings growth, since diluted shares fell about 1.5%.
How significant is the Securities Clearing and Outsourcing segment to ADP's results?
It is still small. It contributed $61.5 million of revenue (under 1% of total) and a $23.6 million pre-tax loss from November 2004 through June 2005, reflecting integration costs and cost-structure alignment. It is a larger factor on the balance sheet, with $1.25 billion of assets and $193.0 million of negative operating cash flow, mainly from segregated customer securities. Management is expected to align costs and reduce this drag over time.
Will stock option expensing materially change ADP's reported earnings?
Yes, somewhat. Under SFAS 123R, ADP began expensing stock compensation on July 1, 2005. Management estimates this will reduce diluted EPS by $0.18 to $0.19 in fiscal 2006, compared with a pro forma impact of $0.22 in fiscal 2005. The smaller impact reflects roughly one-third fewer options granted in fiscal 2005 and a switch to a binomial pricing model.
Is ADP's balance sheet exposed to risk from client funds?
Client funds are offset by matching obligations, so they are not equity at risk. ADP invests them in high-quality fixed-income securities, about 95% rated AAA or AA, and it funds short-term needs through commercial paper and repurchase agreements. Interest rate changes affect earnings only modestly: a 25 basis point move would change pre-tax earnings by less than $10 million over twelve months. The company also reports that it has no material exposure from its guarantees to clearinghouses.
What legal or operational risks should investors monitor?
The main disclosed legal matter is a Texas lawsuit by Universal Computer Systems (UCS), which alleged trade secret misappropriation and sought $56 million. An arbitration panel ruled for ADP in 2003, and the plaintiffs are appealing. Management believes the outcome will not be material. Operationally, the 2004 Bank of America clearing integration and the reliance on a few large software and hardware vendors are worth tracking, along with the internal control exclusion of the new clearing subsidiary.
04—Continue