Moody's Downgrades ADP's (ADP) Issuer Rating to 'Aa3'; Outlook Stable

Moody's Investors Service ("Moody's") downgraded Automatic Data Processing, Inc.'s (Nasdaq: ADP) Issuer Rating to Aa3 from Aa1. As part of the rating action, Moody's downgraded the senior unsecured rating on a revenue bond backed by ADP to Aa3 from Aa1, and affirmed the company's P-1 Short-term Rating. The rating outlook remains stable.

RATINGS RATIONALE

The downgrade of ADP's ratings follows the company's announcement that it is planning a $2 billion debt issuance with proceeds largely to be used for share repurchases, its first-ever debt-funded buyback, which represents an abrupt shift away from the company's historically conservative financial practices. Moody's analyst Gerald Granovsky added, "The significant planned increase in ADP's funded debt signals a meaningful change in financial policy and sets the stage for the possibility of further credit weakening through future debt raises." Future long-term debt issuances could diminish ADP's financial flexibility, including its ability to pursue prudent strategic opportunities and to defend its market share against emerging competition. The company's credit profile had previously been weakened by asset divestitures, which diminished its scale and decreased diversification of its product portfolio.

Supporting the Aa3 rating and stable outlook are ADP's predictable profit and cash flow that result from its dominant market positions in human capital management ("HCM") markets, and ADP's significant recurring revenue base that is spread over a large and diverse group of customers. As a result of the company's investments in new business growth, systems development/programming and client service initiatives, Moody's expects near-term pressure to operating margin improvement and lower free cash flow generation over the next two years, compared to levels generated over the past 4 years. Following that period, Moody's believes ADP's operating margins will improve to around 19% as the company benefits from its investments.

Rating actions:

Issuer Rating downgraded to Aa3 from Aa1

Senior Unsecured Debt Rating downgraded to Aa3 from Aa1

Short-term Rating affirmed at P-1

Rating Outlook - Stable

Rating Outlook

The stable rating outlook reflects Moody's expectation that ADP's broadly diversified customer base, new business sales growth, penetration into new markets, enhanced product offerings, and large, recurring fee-based business model will sustain healthy profitability, margins and cash flow.

What Could Change the Rating - Up

Ratings could be upgraded if ADP demonstrates a diversified business and sustainable free cash flow profile, and scale consistent with that of issuers rated at the Aa2 level, and reestablishes highly conservative financial policies.

What Could Change the Rating - Down

ADP's Aa3 rating or outlook could face downward pressure if increased competition from other HCM service providers causes market share losses or if operating expense growth outpaces revenue growth leading to significant margin pressure and a material decline in free cash flow generation. This margin deterioration would result in financial leverage remaining above 1.5x total debt to EBITDA (after standard adjustments) or free cash flow to debt (after standard adjustments) declining to under 20% for an extended period. The rating would also be pressured if management continues with more aggressive financial policies resulting in significant increases in funded debt, acquisition spending, share repurchases and/or dividend payouts above internal cash flow generation for a sustained period.

For additional analysis, please refer to Automatic Data Processing, Inc.'s credit opinion on www.moodys.com.

The principal methodology used in these ratings was Business and Consumer Service Industry published in December 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

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