FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
| [X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES EXCHANGE ACT OF 1934 | |
| For the fiscal year ended June 30, 2006 | |
| OR | |
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES EXCHANGE ACT OF 1934 | |
| Commission file number 1-5397 | |
| AUTOMATIC DATA PROCESSING, INC. | |
| (Exact name of registrant as specified in its charter) | |
| Delaware | 22-1467904 |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| One ADP Boulevard, Roseland, New Jersey | 07068 |
| (Address of principal executive offices) | (Zip Code) |
| Registrant’s telephone number, including area code: 973-974-5000 | |
| Securities registered pursuant to Section 12(b) of the Act: | |
| Name of each exchange on | |
| Title of each class | which registered |
| Common Stock, $.10 Par Value | New York Stock Exchange |
| (voting) | Chicago Stock Exchange |
| Pacific Exchange | |
| Liquid Yield Option Notes due 2012 | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ x ] No [ ]
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes [ ] No [ x ]
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ x ] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [ x ] No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $26,483,888,874. On August 23, 2006 there were 555,570,420 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
| Portions of the Registrant’s Proxy Statement for Annual Meeting of Stockholders to be held on November 14, 2006. |
Part III |
Part I
Item 1. Business
Automatic Data Processing, Inc., incorporated in Delaware in 1961 (together with its subsidiaries “ADP” or the “Company”), is one of the largest providers of computerized transaction processing, data communication and information services in the world. For financial information by segment and by geographic area, see Note 18 of the “Notes to Consolidated Financial Statements” contained in this Form 10-K. The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports, the Proxy Statement for its Annual Meeting of Stockholders and its Annual Report to Stockholders are made available, free of charge, on its website at www.adp.com as soon as reasonably practicable after such reports have been filed with or furnished to the Securities and Exchange Commission. The following summary describes ADP’s activities.
Employer Services
Employer Services offers a comprehensive range of human resource (HR) information, payroll processing and benefits administration products and services, including traditional and Web-based outsourcing solutions, that assist approximately 545,000 employers in the United States, Canada, Europe, South America (primarily Brazil), Australia and Asia to staff, manage, pay and retain their employees. Employer Services markets these products and services through its direct marketing sales force and, on a limited basis, through indirect sales channels, such as marketing relationships with banks and accountants, among others. In fiscal 2006, 85% of Employer Services’ revenues were from the United States, 10% were from Europe, 4% were from Canada and 1% was from South America (primarily Brazil), Australia and Asia.
United States and Canada
Employer Services’ approach to the market is to match a client’s needs with the products and services that will best meet expectations. To facilitate this approach, in the United States and Canada, Employer Services is comprised of the following groups: Small Business Services (“SBS”) (primarily companies with fewer than 50 employees); Major Accounts Services (primarily companies with between 50 and 999 employees); and National Account Services (primarily companies with 1,000 or more employees).
SBS processes payroll for smaller companies and provides them with market leading solutions, including a range of value-added services that are specifically designed for small business clients. Major Accounts Services and National Account Services offer a full suite of best-of-breed employer services solutions for clients ranging from mid-size through many of the world’s largest corporations.
ADP enables its largest clients to interface their major enterprise resource planning (ERP) applications with ADP’s outsourced payroll services. For those companies that choose to process payroll in-house, ADP currently delivers in the United States stand-alone services such as payroll tax filing, check printing and distribution, year-end tax statements ( i.e . , form W-2) and wage garnishment services.
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In order to address the growing business process outsourcing (BPO) market for clients seeking human resource information systems and benefit outsourcing solutions, ADP offers its integrated comprehensive outsourcing services (COS) solution that allows a client to outsource its HR, payroll, payroll administration, employee service center, benefits administration, and time and labor management functions to ADP.
In the United States and Canada, ADP provides payroll services that include the preparation of client employee paychecks and electronic direct deposits, along with supporting journals, summaries and management reports. In the United States, ADP also supplies the quarterly and annual social security, medicare and federal, state and local income tax withholding reports required to be filed by employers and employees, and analogous services are provided in the Canadian market.
ADP’s Tax, Retirement and Pre-Employment Services division includes the following ADP businesses: Tax and Financial Services, Retirement Services, Screening and Selection Services and Tax Credit Services. These businesses primarily support and are sold through SBS, Major Accounts and National Accounts. ADP’s Tax and Financial Services business in the United States and its money movement business in Canada process and collect federal, state, provincial and local payroll taxes on behalf of, and from, ADP clients and remit these taxes to the appropriate taxing authorities. These businesses are also responsible for the efficient movement of information and funds from clients to third parties through service offerings such as new hire reporting, ADP’s TotalPay ® payroll check (ADPCheck ™ ), full service direct deposit (FSDD) and, in conjunction with major bank partners, stored value payroll card (TotalPay ® Card) products, and the collection and payment of wage garnishments. In the United States and Canada, these businesses support large, mid-size and small clients and provide an electronic interface between approximately 420,000 ADP clients and over 2,200 federal, state, provincial and local tax agencies, from the Internal Revenue Service and Canada Customs and Revenue Agency, to local governments. In fiscal 2006, ADP’s Tax and Financial Services business in the United States and its money movement business in Canada together processed and delivered over 52 million year-end tax statements to its clients’ employees ( i.e. , form W-2 in the United States and analogous statements in Canada) and over 41.2 million remittances and employer payroll tax returns, and moved over $1 trillion in client funds to taxing authorities and its clients’ employees via electronic transfer, direct deposit and ADPCheck ™ . ADP’s Screening and Selection Services business provides background checks, reference verifications and a HR help desk. In the United States, ADP’s Tax Credit Services business provides job tax credit services that assist employers in the identification of, and filing for, special tax credits based on geography, demographics and other criteria. In the United States, ADP Retirement Services business provides recordkeeping and/or related administrative services with respect to various types of retirement (primarily 401(k)) plans, deferred compensation plans and “premium only” cafeteria plans.
ADP’s HR services provide comprehensive HR recordkeeping services, including benefits administration and outsourcing, employee history and position control. In the United States, ADP’s Benefit Services business provides benefits administration across all market segments, including management of the open enrollment of benefits, COBRA and flexible spending account administration.
In the United States, ADP TotalSource ® , ADP’s professional employer organization (PEO) business, provides clients with comprehensive employment administration outsourcing solutions through a co-employment relationship, including payroll, payroll tax filing, employee background checks, HR guidance, 401(k) plan administration, benefits administration, compliance services, workers’ compensation and healthcare coverage and supplemental benefits for employees. ADP TotalSource ® is the largest PEO in the United States based on the number of total paid worksite employees. ADP also offers ADP Resource SM , an integrated, flexible HR and payroll service offering that provides a menu of optional services, such as 401(k), FSA and pay-as-you go workers’
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compensation, without the co-employment relationship. Together, ADP TotalSource ® and ADP Resource SM have 41 offices located in 20 states and serve approximately 5,800 clients and approximately 141,000 worksite employees in all 50 states.
ADP complements its payroll, payroll tax and HR services with additional employer services that include time and labor management and other products provided by the Tax, Retirement and Pre-Employment Services division.
Outside the United States and Canada
There is increasing demand from multinational companies for global payroll and human resource management services. In Europe, ADP is the leading provider of payroll processing (including full departmental outsourcing) and various human resource administration services. Employer Services is present in nine countries in Europe: France, Germany, Italy, the Netherlands, Poland, Spain, Switzerland, the Czech Republic and the United Kingdom. It also offers services in Ireland (from the United Kingdom) and in Portugal (from Spain). In South America (primarily Brazil), Australia and Asia, Employer Services provides traditional service bureau payroll and also offers full departmental outsourcing of payroll services. In fiscal 2006, ADP continued to expand its GlobalView SM offering, making it available in 31 countries. GlobalView SM is built on the mySAP TM ERP Human Capital Management and the SAP NetWeaver TM platform and offers multinational companies an end-to-end outsourcing solution enabling standardized payroll processing and human resource administration. In 2006, ADP opened two representative offices in China, one located in Shanghai and the other in Beijing, to better understand the developing market in China and serve the needs of multinational companies with operations in China.
Brokerage Services
Brokerage Services provides transaction processing services, desktop productivity applications and investor communications solutions to the financial services industry worldwide. Brokerage Services’ products and services include: (i) global order entry, trade processing and settlement systems that enable firms to trade virtually any financial instrument, in any market, at any time; (ii) Internet delivery; personalized on-demand statements, confirmations, fulfillment, content management, and imaging, archival, and workflow solutions that enhance communications with investors; proxy distribution and vote processing, regulatory mailings, tax reporting and corporate actions/reorganization solutions that help clients meet regulatory and compliance needs; (iii) automated, browser-based desktop productivity tools for financial consultants and back office personnel; and (iv) integrated delivery of multiple products and services through ADP’s Global Processing Solution.
Brokerage Services serves a large client base in the financial services industry, including: retail and institutional brokerage firms; global banks; mutual funds; annuity companies; institutional investors; specialty trading firms; clearing firms; and publicly owned corporations. Brokerage Services provides securities transaction processing, printing and electronic distribution of shareholder communications and other services to clients that conduct business in more than 90 countries in North America, Europe, Asia and Australia. Brokerage Services also provides computerized proxy vote tabulation and shareholder communication, distribution and fulfillment services, including Web-enabled products and services. In fiscal 2006, ADP served approximately 13,000 United States publicly traded companies and 450 mutual funds and annuity companies with proxy services on behalf of more than 850 brokerage firms and banks.
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On August 2, 2006, ADP announced that its Board of Directors approved a plan to spin-off the Brokerage Services Group business, comprised of Brokerage Services and Securities Clearing and Outsourcing Services. See Item 9B – “Other Information”.
Securities Clearing and Outsourcing Services
ADP’s Securities Clearing and Outsourcing Services segment furthers Brokerage Services’ business process outsourcing strategy by positioning ADP to provide any brokerage firm, regardless of size, an appropriate range of outsourcing services to best meet its individual needs on a single technology platform: service bureau, operations outsourcing, or correspondent clearing services.
Securities Clearing and Outsourcing Services provides clearing, custody, financing, securities lending, trade execution and outsourcing solutions to broker-dealers. Securities Clearing and Outsourcing Services derives revenues from commissions and service charges related to clearing and execution activities and from interest income on margin financing, client short selling activity, and uninvested balances. Securities Clearing and Outsourcing Services also extends margin loans directly to correspondents to finance their proprietary activity.
Securities transactions are effected for customers on either a cash or margin basis. In a margin transaction, Securities Clearing and Outsourcing Services extends credit to a customer for a portion of the purchase price of the security. Such credit is collateralized by securities in the customer’s accounts in accordance with regulatory and internal requirements. Securities Clearing and Outsourcing Services receives income from interest charged on such loans. Securities Clearing and Outsourcing Services also borrows securities from banks and other broker-dealers to facilitate customer and proprietary short selling activity, and lends securities to broker-dealers and other trading entities to cover short sales and to complete transactions that require delivery of securities by settlement date.
Dealer Services
Dealer Services provides integrated dealer management systems (such a system is also known in the industry as a “DMS”) and business solutions to automotive, heavy truck, and powersports ( i.e. , motorcycle, marine and recreational) vehicle retailers in the United States, Canada, South Africa, Asia, Europe and the Middle East. Nearly 25,500 automotive, heavy truck and powersports dealers use ADP’s DMS, other software based solutions, networking solutions, data integration, consulting and/or marketing services.
Clients use ADP’s DMS products to manage business activities such as accounting, inventory management, factory communications, scheduling, vehicle financing and insurance, sales and service. In addition to its DMS products, Dealer Services also offers its clients a full suite of web-enabled business solutions to address each department and functional area of the dealership (including customer relationship management solutions (CRM) and “front-end” applications), and an IP telephony phone system that can help dealerships with their sales processes and business development initiatives. All of Dealer Services’ business solutions are supported by comprehensive training offerings and business process consulting services. Dealer Services also offers its dealership clients computer hardware, hardware maintenance services, licensed software support, system design and network consulting services. ADP’s DMS and other software products are available as “on-site” applications or through ADP’s application service provider (ASP) managed services solution (in which clients license and outsource the information technology management to Dealer Services).
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Dealer Services also designs, establishes and maintains communications networks for its dealership clients that allow interactive communications among multiple site locations as well as links between franchised dealers and their vehicle manufacturer franchisors. These networks are used for activities such as new vehicle ordering and status inquiry, warranty submission and validation, parts and vehicle locating, dealership customer credit application submission and decisioning, vehicle repair estimation and acquisition of vehicle registration and lien holder information.
In fiscal 2006, ADP acquired Kerridge Computer Company Ltd, which provides dealer management systems and related products and services to nearly 6,000 automotive dealers in Europe, the Middle East, South Africa and Asia. ADP also acquired the digital marketing and consulting company BZ Results.
Sale of Claims Services
On April 13, 2006, ADP completed the sale of its Claims Services business to Solera, Inc. for $975.0 million in cash. See “Management’s Discussion and Analysis” (MD&A) and Note 4 of the “Notes to Consolidated Financial Statements” contained in this Form 10-K.
Markets and Marketing Methods
ADP’s services are offered broadly across North America and Europe. Some services within the Employer Services and Brokerage Services business units are also offered in Australia and Asia, and Employer Services also provides services in South America (primarily Brazil).
None of ADP’s major business groups have a single homogenous client base or market. For example, Brokerage Services and Securities Clearing and Outsourcing Services serve a large client base in the financial services industry, including retail and institutional firms, banks and individual non-brokerage corporations. Dealer Services primarily serves automobile dealers, but also serves heavy truck, powersports ( i.e. , motorcycle, marine and recreational), and agricultural equipment dealers, auto repair shops, used car lots, state departments of motor vehicles and manufacturers of automobiles, trucks and agricultural equipment. Employer Services has clients from a large variety of industries and markets. Within this client base are concentrations of clients in specific industries. Employer Services also sells to auto dealers and brokerage clients. While concentrations of clients exist, no one client or industry group is material to ADP’s overall revenues.
ADP’s businesses are not overly sensitive to price changes. Economic conditions among selected clients and groups of clients may and do have a temporary impact on demand for ADP’s services. In fiscal 2006, Employer Services continued to grow, primarily due to the increase in its United States payroll and payroll tax businesses, including new business started in the fiscal year, an increase in the number of employees on our clients’ payrolls, price increases, strong growth in its “beyond payroll” products, and improved client retention; Brokerage Services grew primarily due to the increased volume in its investor communication services resulting from an increase in the number of holders of equities and an increase in mutual fund meeting activity; Dealer Services grew primarily due to the acquisition of Kerridge Computer Company Ltd in the United Kingdom in December 2005; and our investment income on our client funds increased due to the increase in our average client fund balances and higher interest rates.
ADP enjoys a leadership position in each of its major service offerings and does not believe any major service or business unit in ADP is subject to unique market risk.
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Competition
The computing services industry is highly competitive. ADP knows of no reliable statistics by which it can determine the number of its competitors, but it believes that it is one of the largest providers of computerized transaction processing, data communication and information services in the world.
ADP’s competitors include other independent computing services companies, companies providing enterprise resource planning services, divisions of diversified enterprises and banks. Another competitive factor in the computing services industry is the in-house computing function, whereby a company installs and operates its own computing systems.
Competition in the computing services industry is primarily based on service responsiveness, product quality and price. ADP believes that it is very competitive in each of these areas and that there are no material negative factors impacting ADP’s competitive position in the computing services industry. No one competitor or group of competitors is dominant in the computing services industry.
Clients and Client Contracts
ADP provides its services to more than 570,000 clients. In fiscal 2006, no single client or group of affiliated clients accounted for revenues in excess of 2% of annual consolidated revenues.
Our business is typically characterized by long-term customer relationships that result in recurring revenue. Sales orders from customers are not considered firm until they are installed and begin producing revenue. ADP receives sales orders in all of our businesses and is continuously in the process of performing implementation services for our clients. Depending on the service agreement and/or the size of the client, the installation or conversion period for new clients could vary from a short period of time (up to two weeks) for an SBS client to a longer period (generally six to twelve months) for a National Account Services, Brokerage or Dealer Services client with multiple deliverables. Although we monitor the sales orders from our clients that have not yet been billed or installed, we do not view this metric as material in light of the recurring nature of our business. This is not a reported number, but it is used by management as a planning tool relating to resources needed to install services, and a means of assessing our performance against our installation timing expectations and the expectations of our clients.
ADP’s average client retention is estimated at more than 9 years in Employer Services and is 10 or more years in Brokerage Services and Dealer Services, and has not varied significantly from period to period.
ADP’s services are provided under written price quotations or service agreements having varying terms and conditions. No one price quotation or service agreement is material to ADP. Discounts, rebates and promotions offered by ADP to clients are not material.
Systems Development and Programming
During the fiscal years ended June 30, 2006, 2005 and 2004, ADP invested $678 million, $622 million, and $646 million, respectively, from continuing operations, in systems development and programming, migration to new computing technologies and the development of new products and maintenance of our existing technologies, including purchases of new software and software licenses.
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Product Development
ADP continually upgrades, enhances and expands its existing products and services. Generally, no new product or service has a significant effect on ADP’s revenues or negatively impacts its existing products and services, and ADP’s products and services have significant remaining life cycles.
Licenses
ADP is the licensee under a number of agreements for computer programs and databases. ADP’s business is not dependent upon a single license or group of licenses. Third-party licenses, patents, trademarks and franchises are not material to ADP’s business as a whole.
Number of Employees
ADP employed approximately 46,000 persons as of June 30, 2006.
Item 1A. Risk Factors
Our businesses routinely encounter and address risks, some of which may cause our future results to be different than we currently anticipate. Risk factors described below represent our current view of some of the most important risks facing our businesses and are important to understanding any statement in this Form 10-K. The following information should be read in conjunction with MD&A, Quantitative and Qualitative Disclosure About Market Risk and the consolidated financial statements and related notes included in this Form 10-K. This discussion includes a number of forward-looking statements. You should refer to the description of the qualifications and limitations on forward-looking statements in the first paragraph under MD&A included in this Form 10-K. Unless otherwise indicated or the context otherwise requires, reference in this section to “we,” “ours,” “us” or similar terms means ADP, together with its subsidiaries. The level of importance of each of the following risks may vary from time to time.
Changes in laws and regulations may decrease our revenues and earnings
Portions of ADP’s business are subject to governmental regulations. Changes in governmental regulations may decrease our revenues and earnings and may require us to change the manner in which we conduct some of the aspects of our business. For example, a change in regulations either decreasing the amount of taxes to be withheld or allowing less time to remit taxes to government authorities would adversely impact interest income from investing funds that we collect from clients but have not yet remitted to the applicable taxing authorities or client employees, thus reducing our revenues and income from this source. Also, recently proposed regulatory changes in investor communications requirements could, if implemented, reduce our revenues and earnings.
Security and privacy breaches may hurt our business
We store electronically personal information, including social security numbers, about our clients and employees of our clients. In addition, our brokerage and trading systems maintain account and trading information for our customers and their clients, and our retirement services systems maintain investor account information for retirement plans. There is no guarantee that the systems and procedures that we maintain to protect against unauthorized access to such information are adequate to
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protect against all security breaches. Any significant violations of data privacy could result in the loss of business, litigation and regulatory investigations and penalties that could damage our reputation and the growth of our business could be materially adversely affected.
Our systems may be subject to disruptions that could adversely affect our business and reputation
Many of our businesses are highly dependent on our ability to process, on a daily basis, a large number of complicated transactions. We rely heavily on our payroll, financial, accounting and other data processing systems. If any of these systems fail to operate properly or become disabled even for a brief period of time, we could suffer financial loss, a disruption of our businesses, liability to clients, regulatory intervention or damage to our reputation. We have disaster recovery plans in place to protect our businesses against natural disasters, security breaches, military or terrorist actions, power or communication failures or similar events. Despite our preparations, in the event of a catastrophic occurrence, our disaster recovery plans may not be successful in preventing the loss of customer data, service interruptions, disruptions to our operations, or damage to our important facilities.
If we fail to adapt our technology to meet customer needs and preferences, the demand for our services may diminish
Our businesses operate in industries that are subject to rapid technological advances and changing customer needs and preferences. In order to remain competitive and responsive to customer demands, we continually upgrade, enhance and expand our existing products and services. If we fail to respond successfully to the technology challenges, the demand for our services may diminish.
Political and economic factors may adversely affect our business and financial results
Trade, monetary and fiscal policies, and political and economic conditions may substantially change. When there is a slowdown in the economy, employment levels, interest rates and trading volumes may decrease with a corresponding impact on our businesses. Customers may react to worsening conditions by reducing their spending on payroll and other outsourcing services, curtailing their trading operations or renegotiating their contracts with us. If any of these circumstances remain in effect for an extended period of time, there could be a material adverse effect on our financial results.
Our proposed spin-off of our Brokerage Services Group is subject to inherent risks
The proposed spin-off of our Brokerage Services Group discussed in Item 9B – “Other Information” is subject to inherent risks and uncertainties including, among others: risks that the spin-off will not be consummated; increased demands on our management team to accomplish the spin-off; significant transaction costs; risks of changes in our credit rating as a result of the spin-off (see “Risk Factors – Change in our credit ratings could adversly impact our operations and lower our profitability” below); and risks from changes in the results of operations of our reportable segments.
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Change in our credit ratings could adversely impact our operations and lower our profitability
The major credit rating agencies periodically evaluate our creditworthiness and have consistently given us their highest long-term debt and commercial paper ratings. Failure to maintain high credit ratings on long-term and short-term debt could increase our cost of borrowing, reduce our ability to obtain intra-day borrowing required by our Employer Services business, and ultimately reduce our client interest revenue.
We may be unable to attract and retain qualified personnel
Our ability to grow and provide our customers with competitive services is partially dependent on our ability to attract and retain highly motivated people with the skills to serve our customers. Competition for skilled employees in the outsourcing and other markets in which we operate is intense and if we are unable to attract and retain highly skilled and motivated personnel, expected results from our operations may suffer.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
ADP leases space for 26 of its principal processing centers. In addition, ADP leases numerous other operational offices and sales offices. All of these leases, which aggregate approximately 7,918,000 square feet in North America, Europe, South America (primarily Brazil), Asia, Australia and South Africa, expire at various times up to the year 2020. ADP owns 19 of its processing facilities, other operational offices and its corporate headquarters complex in Roseland, New Jersey, which aggregate approximately 3,914,000 square feet. None of ADP’s owned facilities is subject to any material encumbrances. ADP believes its facilities are currently adequate for their intended purposes and are adequately maintained.
Item 3. Legal Proceedings
In the normal course of business, the Company is subject to various claims and litigation. While the outcome of any litigation is inherently unpredictable, the Company believes it has valid defenses with respect to the legal matters pending against it and the Company believes that the ultimate resolution of these matters will not have a material adverse impact on its financial condition, results of operations or cash flows. Among the various claims and litigation pending against the Company is the following:
The Company and its indirect wholly-owned subsidiaries Dealer Solutions, L.L.C. and Dealer Solutions Holdings, Inc. (“DSI”) are named as defendants in a lawsuit filed on March 4, 1999 in the 133rd Judicial District Court of Harris County, Texas by Universal Computer Systems, Inc., Universal Computer Consulting, Ltd., Universal Computer Services, Inc., and Dealer Computer Services, Inc. (collectively, “UCS”), which lawsuit was tried before an arbitration panel in June 2003. This lawsuit alleges trade secret violations by DSI in the creation by DSI of the CARMan automobile dealership software product and misappropriation of those trade secrets by the Company through its acquisition of DSI. UCS sought injunctive relief and damages of $56 million. On November 11, 2003, the arbitration panel appointed by the District Court entered an award in favor of DSI and its co-defendants (“the Award”). The Award denied all relief to UCS. The Award has been affirmed and adopted by the District
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Court as a final judgment of the Court. That judgment has been affirmed by the Court of Appeals for the First District of Texas, and the Texas Supreme Court denied UCS’s Petition for Review of that judgment on June 9, 2006. The judgment in Company’s favor is now final, subject only to a possible petition for certiorari from the United States Supreme Court, for which the filing deadline is August 31, 2006. The Company believes it has valid defenses with respect to the above matter and should prevail.
Item 4. Submission of Matters to a Vote of Security Holders
None
Part II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for the Registrant’s Common Equity
The principal market for the Company’s common stock (symbol: ADP) is the New York Stock Exchange. The following table sets forth the reported high and low sales prices of the Company’s common stock based on the NYSE composite transactions and the cash dividends per share of common stock declared during the past two fiscal years. As of June 30, 2006, there were 40,514 holders of record of the Company’s common stock. As of such date, 346,188 additional holders held their common stock in “street name.”
| Price Per Share | Dividends | ||||
| High | Low | Per Share | |||
| Fiscal 2006 quarter ended | |||||
| June 30 | $46.93 | $43.31 | $0.185 | ||
| March 31 | $47.95 | $43.25 | $0.185 | ||
| December 31 | $48.11 | $42.19 | $0.185 | ||
| September 30 | $45.07 | $41.21 | $0.155 | ||
| Fiscal 2005 quarter ended | |||||
| June 30 | $45.56 | $40.37 | $0.155 | ||
| March 31 | $45.50 | $41.13 | $0.155 | ||
| December 31 | $46.31 | $39.79 | $0.155 | ||
| September 30 | $43.12 | $38.60 | $0.140 | ||
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| Issuer Purchases of Equity Securities | ||||
| (a) | (b) | (c) | (d) | |
| Total Number | ||||
| of Shares | Maximum | |||
| Purchased as Part | Number of Shares | |||
| of the Publicly | that may yet be | |||
| Announced | Purchased under | |||
| Common Stock | the Common | |||
| Total Number of | Average Price | Repurchase Plan | Stock Repurchase | |
|
Period |
Shares Purchased | Paid per Share (3) | (1) | Plan (1)(4) |
| April 1, 2006 to | ||||
| April 30, 2006 | 559,343 | $46.37 | 556,200 | 50,985,800 |
| May 1, 2006 to | ||||
| May 31, 2006 | 8,791,655 | $44.67 | 8,789,200 | 42,196,600 |
| June 1, 2006 to | ||||
| June 30, 2006 | 8,210,564 | $45.00 | 8,199,200 | 33,997,400 |
| Total | 17,561,562 (2) | 17,544,600 | ||
(1) In March 2001, the Company received the Board of Directors’ approval to repurchase up to 50 million shares of the Company’s common stock. In November 2002 and 2005, the Company received the Board of Directors’ approval to repurchase an additional 35 million and 50 million shares, respectively, of the Company’s common stock. There is no expiration date for the common stock repurchase plan.
(2) During 2006, pursuant to the terms of the Company’s restricted stock program, the Company (i) made repurchases of 2,643 shares during April 2006, 2,455 shares during May 2006 and 8,589 shares during June 2006 at the then market value of the shares in connection with the exercise by employees of their option under such program to satisfy certain tax withholding requirements through the delivery of shares to the Company instead of cash and (ii) made purchases of 500 shares during April 2006 and 2,775 shares during June 2006 at a price of $.10 per share under the terms of such program to repurchase stock granted to employees who have left the Company.
(3) The average price per share does not include the repurchases described in clause (ii) of the preceding footnote.
(4) In August of 2006, the Company received the Board of Directors’ approval to repurchase an additional 50 million shares of the Company’s common stock. There is no expiration date for the common stock repurchase authorization. This additional authorization is not reflected in the table above, as it occurred subsequent to June 30, 2006.
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Item 6. Selected Financial Data
| (Dollars and shares in millions, except per share amounts) | ||||||||||||||||||||
| Years ended June 30, | 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||||||
| Total revenues | $ | 8,881.5 | $ | 7,983.7 | $ | 7,279.4 | $ | 6,693.0 | $ | 6,570.5 | ||||||||||
| Earnings from continuing operations before income taxes | $ | 1,743.0 | $ | 1,593.1 | $ | 1,434.9 | $ | 1,594.0 | $ | 1,722.1 | ||||||||||
| Net earnings from co ntinuing operations | $ | 1,072.4 | $ | 998.3 | $ | 897.7 | $ | 985.3 | $ | 1,059.0 | ||||||||||
| Basic earnings per share from continuing operations | $ | 1.87 | $ | 1.71 | $ | 1.52 | $ | 1.64 | $ | 1.71 | ||||||||||
| Diluted earnings per share from continuing operations | $ | 1.85 | $ | 1.69 | $ | 1.50 | $ | 1.63 | $ | 1.68 | ||||||||||
| Basic weighted average shares outstanding | 574.8 | 583.2 | 591.7 | 600.1 | 618.9 | |||||||||||||||
| Diluted weighted average shares outstanding | 580.3 | 590.0 | 598.7 | 605.9 | 630.6 | |||||||||||||||
| Cash dividends declared per share | $ | .7100 | $ | .6050 | $ | .5400 | $ | .4750 | $ | .4475 | ||||||||||
| Return on equity (No te 1) | 19.5 | % | 18.3 | % | 16.9 | % | 19.0 | % | 21.7 | % | ||||||||||
| At year end: | ||||||||||||||||||||
| Cash, cash equivalents and marketable securities | $ | 2,602.5 | $ | 1,997.3 | $ | 1,984.4 | $ | 2,267.0 | $ | 2,695.1 | ||||||||||
| Total assets before funds held for clients | $ | 10,006.2 | $ | 9,717.9 | $ | 8,217.0 | $ | 8,025.9 | $ | 7,051.3 | ||||||||||
| Total assets | $ | 27,490.1 | $ | 27,615.4 | $ | 21,120.6 | $ | 19,833.7 | $ | 18,276.5 | ||||||||||
| Long-term debt | $ | 74.3 | $ | 75.7 | $ | 76.2 | $ | 84.7 | $ | 90.6 | ||||||||||
| Stockholders’ equity | $ | 6,011.6 | $ | 5,783.9 | $ | 5,417.7 | $ | 5,371.5 | $ | 5,114.2 | ||||||||||
Note 1. U.S. GAAP requires net earnings of discontinued operations to be displayed separately in the Statements of Consolidated Earnings. As a result, we believe the numerator of net earnings that is used in our calculation of return on equity should exclude those net earnings from discontinued operations. Further, we believe it is appropriate to exclude from the denominator of average total stockholders’ equity, the average cumulative net earnings from discontinued operations for each of the five years since fiscal 2002 for which such returns are presented. As a result, return on equity, excluding the effects of discontinued operations has been calculated as net earnings from continuing operations divided by average stockholders’ equity, excluding the effects of discontinued operations as noted below.
| (In millions) | |||||||||
| June 30, | 2006 | 2005 | 2004 | 2003 | 2002 | ||||
| Average total equity | $5,897.7 | $5,600.7 | $5,394.5 | $5,242.8 | $4,907.6 | ||||
| Less: | |||||||||
| Cumulative effect of earnings from discontinued operations | 410.5 | 141.2 | 93.7 | 58.3 | 20.9 | ||||
| Average total equity, excluding effects of discontinued operations | $5,487.2 | $5,459.5 | $5,300.8 | $5,184.5 | $4,886.7 |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This report and other written or oral statements made from time to time by ADP may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements include: ADP’s success in obtaining, retaining and selling additional services to clients; the pricing of products and services; changes in laws regulating payroll taxes, professional employer organizations, employee benefits and registered clearing agencies and broker-dealers; overall market and economic conditions, including interest rate and foreign currency trends; competitive conditions; stock market activity; auto sales and related industry changes; employment and wage levels; changes in technology; availability of skilled technical associates and the impact of new acquisitions and divestitures. In addition, the proposed spin-off of the Brokerage Services Group is subject to inherent risks and uncertainties, including: risks that the spin-off will not be consummated; increased demands on our management team to accomplish the spin-off; significant transaction costs; risks of changes in our credit rating and risks from changes in results of operations of our reportable segments. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
DESCRIPTION OF THE COMPANY AND BUSINESS SEGMENTS
Automatic Data Processing, Inc. (“ADP” or the “Company”) provides technology-based outsourcing solutions to employers, the brokerage and financial services community and vehicle retailers and manufacturers. The Company’s reportable segments are: Employer Services, Brokerage Services, Securities Clearing and Outsourcing Services and Dealer Services. A brief description of each segment’s operations is provided below.
Employer Services
Employer Services offers a comprehensive range of human resource (“HR”) information, payroll processing and benefit administration products and services, including traditional and Web-based outsourcing solutions, that assist approximately 545,000 employers in the United States, Canada, Europe, South America (primarily Brazil), Australia and Asia to staff, manage, pay and retain their employees. Employer Services categorizes its services between traditional payroll and payroll tax, and “beyond payroll.” The traditional payroll and payroll tax business represents the Company’s core payroll processing and payroll tax filing business. The “beyond payroll” business represents the products that extend beyond the traditional payroll and payroll tax filing services, such as the Professional Employer Organization (“PEO”) business, Time and Labor Management, and benefit and retirement administration. Within Employer Services, the Company collects client funds and remits such funds to tax authorities for payroll tax filing and payment services, and to employees of payroll services clients.
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Brokerage Services
Brokerage Services provides transaction processing services, desktop productivity applications and investor communications solutions to the financial services industry worldwide. Brokerage Services’ products and services include: (i) global order entry, trade processing and settlement systems that enable firms to trade virtually any financial instrument, in any market, at any time; (ii) Internet delivery; personalized on-demand statements, confirmations, fulfillment, content management, and imaging, archival, and workflow solutions that enhance communications with investors; proxy distribution and vote processing, regulatory mailings, tax reporting and corporate actions/reorganization solutions that help clients meet regulatory and compliance needs; (iii) automated, browser-based desktop productivity tools for financial consultants and back-office personnel; and (iv) integrated delivery of multiple products and services through ADP’s Global Processing Solution.
Securities Clearing and Outsourcing Services
Securities Clearing and Outsourcing Services furthers Brokerage Services’ business process outsourcing strategy by positioning ADP to provide any brokerage firm, regardless of size, an appropriate range of outsourcing services to best meet its individual needs on a single technology platform: service bureau, operations outsourcing, or correspondent clearing services. Securities Clearing and Outsourcing Services provides clearing, custody, customer financing (such as margin lending), securities borrowing to facilitate customer short sales, trade execution and outsourcing solutions to broker-dealers. Our clients engage in either the retail or institutional brokerage business.
Dealer Services
Dealer Services provides integrated dealer management systems (such a system is also known in the industry as a “DMS”) and business solutions to automotive, heavy truck and powersports ( i.e. , motorcycle, marine and recreational) vehicle retailers in the United States, Canada, South Africa, Asia, Europe and the Middle East. Nearly 25,500 automotive, heavy truck and powersports dealers use our DMS, other software-based solutions, networking solutions, data integration, consulting and/or marketing services.
EXECUTIVE OVERVIEW
Our fiscal 2006 results were terrific. Consolidated revenues in fiscal 2006 grew 11%, to $8,881.5 million, as compared to $7,983.7 million in fiscal 2005, which surpassed our original expectations. Employer Services’ revenues increased 10% for the year. Employer Services’ new business sales, which represent annualized recurring revenues anticipated from sales orders to new and existing clients, grew 13% worldwide to approximately $950 million, in fiscal 2006 with sales growth of 28% worldwide in the fourth quarter, our strongest quarterly sales growth in nearly nine years.
Earnings from continuing operations before income taxes and net earnings from continuing operations increased 9% and 7%, respectively. Diluted earnings per share from continuing operations increased 9%, to $1.85 in fiscal 2006, from $1.69 per share in fiscal 2005 on fewer shares outstanding. These results were impacted by our adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R using the modified prospective method, effective July 1, 2005, which required the expensing of our stock compensation programs. On a comparable basis, including stock compensation expense in fiscal 2005, earnings from continuing operations before income taxes increased 23% and diluted earnings per share from continuing operations grew 25% from $1.48 per share in fiscal 2005.
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Our diluted earnings per share for fiscal 2006 was $2.68, which includes earnings from discontinued operations. On April 13, 2006, we completed the sale of the Claims Services business, which was previously reported in our “Other” segment, for $975 million. In addition, on January 20, 2006, we completed the sale of our Brokerage Services’ financial print business. In connection with the sale of both of these businesses, we have classified the results of operations of these businesses as discontinued operations. The sale of the Claims Services business resulted in a gain of $561 million, or $453 million after tax.
With the proceeds received in the United States from the sale of the Claims Services business and our cash flows from operations we accelerated our share buy-back activity and acquired over 29 million of our shares for treasury for approximately $1,327 million, demonstrating our confidence in the long-term growth prospects of our business.
Our net cash flows provided by operating activities increased $380 million, to $1,813 million in fiscal 2006 from $1,433 million in fiscal 2005. Our net cash flows provided by operating activities for all businesses, excluding the Securities Clearing and Outsourcing Services segment, increased $66 million, to $1,692 million in fiscal 2006 from $1,626 million in fiscal 2005. Our financial condition and balance sheet remain solid with cash and marketable securities of $2,602.5 million at June 30, 2006.
We are pleased with our strong results in each of our business segments during fiscal 2006. Employer Services’ revenues grew 10% for fiscal 2006. We credit Employer Services with interest revenues at a standard rate of 4.5%; therefore, Employer Services’ results are not influenced by changes in interest rates. During fiscal 2006, Employer Services grew average client funds balances 11% as a result of new business and growth in our existing client base. The increase in average client funds balances resulted in an increase of interest revenues within Employer Services, which accounted for approximately 1% growth in Employer Services’ revenues as compared to fiscal 2005. The key metrics in Employer Services were the strongest they have been in six years. The number of employees on our clients’ payrolls, “pays per control,” increased in all market segments with 2.4% overall growth in the United States, and client retention improved by 0.2 percentage points worldwide over last year’s record level. Brokerage Services’ revenues grew 10% for the fiscal year. Revenue growth was primarily from our investor communications business as the volume of pieces delivered increased 8%, driven by an increase in mutual fund meetings and other required mutual fund communications, as well as 4% stock record growth. Back-office average trades per day increased 16% for the fiscal year, but the volume increase was offset by a decline in average revenues per trade of 10%. Securities Clearing and Outsourcing Services’ revenues were $80.6 million for fiscal 2006 as compared to $61.5 for the period from its acquisition date of November 1, 2004 through June 30, 2005. Dealer Services’ revenues grew 14% for fiscal 2006 primarily due to the effect of acquisitions.
Our fiscal 2007 guidance is revenue growth of approximately 10% and earnings per share growth of 17% to 20%, from our earnings per share from continuing operations of $1.85 reported in fiscal 2006. We are anticipating pretax margin improvement of about 100 basis points in each of our businesses. Our plans reflect strong momentum in Employer Services, with about 11% revenue growth in the United States and 10% worldwide, double digit new business sales growth (annualized recurring revenue from new orders) and continued improvement in client retention. We anticipate 4% to 5% revenue growth in Brokerage Services and 12% to 13% revenue growth in Dealer Services in fiscal 2007. Interest income on client funds is anticipated to grow approximately 20% based on expected growth of nearly 10% in client funds balances and an improvement of 40 basis points in the overall average interest rate earned on our client funds portfolio to 4.5%.
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Lastly, on August 2, 2006, we announced that our Board of Directors approved a plan to spin-off the Brokerage Services Group business, comprised of Brokerage Services and Securities Clearing and Outsourcing Services, into an independent publicly traded company through a tax-free spin-off of 100% of Brokerage Services Group to ADP shareholders. The spin-off is subject to required regulatory approvals and reviews. We expect to complete the separation before the end of fiscal 2007.
RESULTS OF OPERATIONS
ANALYSIS OF CONSOLIDATED OPERATIONS
Fiscal 2006 Compared to Fiscal 2005
| (Dollars in millions, except per share amounts) | ||||||||||||||||
| Y ears ended June 3 0, | C han ge | |||||||||||||||
| 2005 - As | 2005 - As | 2006 vs 2005 - As | 2006 vs 2005 - As | |||||||||||||
| 2006 | Reported | Adjusted | Reported | Adjusted | ||||||||||||
| Total revenues | $ | 8,881.5 | $ | 7,983.7 | $ | 7,983.7 | 11 | % | 11% | |||||||
| Total expenses | $ | 7,138.5 | $ | 6,390.6 | $ | 6,563.6 | 12 | % | 9% | |||||||
| Earnings from continuing operations | ||||||||||||||||
| before income taxes | $ | 1,743.0 | $ | 1,593.1 | $ | 1,420.1 | 9 | % | 23% | |||||||
| Margin | 20 | % | 20 | % | 18 | % | ||||||||||
| Provision for income taxes | $ | 670.6 | $ | 594.8 | $ | 546.3 | 13 | % | 23% | |||||||
| Effective tax rate | 38.5 | % | 37.3 | % | 38.5 | % | ||||||||||
| Net earnings from continuing operations | $ | 1,072.4 | $ | 998.3 | $ | 873.8 | 7 | % | 23% | |||||||
| Diluted earnings per share from | ||||||||||||||||
| continuing operations | $ | 1.85 | $ | 1.69 | $ | 1.48 | 9 | % | 25% | |||||||
The comparison between the results of operations for fisca