ADP FY2017 Form 10-K Summary
Period: Fiscal year ended June 30, 2017, with fiscal 2016 as the prior-year comparison. Although the request metadata says “2016 Q4,” this filing reports FY2017; it also includes unaudited fourth-quarter results.
Business context
ADP provides payroll, human resources and other human capital management services to employers. Its reportable segments are Employer Services and Professional Employer Organization (PEO) Services. The company served approximately 700,000 clients in more than 110 countries and territories.
Financial performance
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $12.38 billion | $11.67 billion | +6% |
| Earnings before tax | $2.53 billion | $2.23 billion | +13% |
| Net earnings from continuing operations | $1.73 billion | $1.49 billion | +16% |
| Diluted EPS from continuing operations | $3.85 | $3.25 | +18% |
| Adjusted net earnings from continuing operations | $1.67 billion | $1.49 billion | +11% |
| Adjusted diluted EPS | $3.70 | $3.26 | +13% |
| Operating cash flow | $2.13 billion | $1.90 billion | +$228.6 million |
Pre-tax margin rose to 20.4% from 19.2%; adjusted EBIT margin increased to 19.8% from 19.5%. The 31.5% GAAP effective tax rate was down from 33.2%; the adjusted rate was 30.9% versus 33.3%.
- Segments: Employer Services revenue was $9.54 billion (+4%) and pre-tax earnings were $2.92 billion (+4%). PEO revenue was $3.48 billion (+13%) and pre-tax earnings were $448.6 million (+21%); PEO growth reflected a 12% increase in average worksite employees and includes substantial benefit and workers’ compensation pass-through costs.
- Cash and liquidity: Cash and short-term marketable securities were $2.78 billion at year-end, versus $3.22 billion. ADP reported $9.5 billion of committed credit facilities, with no facility borrowings at June 30, 2017.
- Debt: Long-term debt was $2.00 billion, principally $1.0 billion of notes due 2020 and $1.0 billion due 2025. No commercial paper or reverse-repurchase obligations were outstanding at year-end.
- Client funds: Funds held for clients were $27.29 billion against $27.19 billion of client-fund obligations. These balances support payroll and tax remittances and should be distinguished from corporate liquidity.
- Capital returns: ADP repurchased approximately 13.5 million shares for $1.26 billion and paid $995 million in dividends. Dividends declared per share increased to $2.24 from $2.08.
Material changes and unusual items
- Reported revenue growth included about one percentage point of combined pressure from the CHSA/COBRA divestiture and foreign exchange translation. The sale of those businesses generated a $205.4 million pre-tax gain, which materially supported GAAP earnings and margins; adjusted results exclude the gain.
- Bookings declined 5% to $1.65 billion, partly because fiscal 2016 had unusually strong demand for ACA-compliance solutions. Employer Services revenue retention fell 50 basis points to 90.0%, primarily due to lower retention on legacy platforms and the loss of a large former CHSA client. Management said retention on strategic platforms remained strong.
- The Service Alignment Initiative generated $90 million of FY2017 charges, mainly employee separation costs, as ADP aligned service operations with strategic platforms. Management expected about $30 million of additional pre-tax charges in FY2018.
- ADP acquired The Marcus Buckingham Company in January 2017; total upfront cash consideration for two FY2017 acquisitions was approximately $90 million, with contingent consideration of up to $35 million.
- FY2017 operating cash flow increased, but investing and financing cash flows were heavily affected by timing and movements in restricted client-fund cash and related obligations. Investing cash flow was $5.73 billion provided; financing cash flow was $8.28 billion used.
- Unaudited FY2017 fourth-quarter revenue was $3.06 billion, pre-tax earnings $388.4 million, net earnings $265.8 million and diluted EPS $0.59. The filing attributes $43.5 million of pre-tax Q4 charges to the Workforce Optimization Effort and Service Alignment Initiative.
Outlook, risks and contingencies
Management expressed optimism about its product pipeline and sales capabilities, but did not provide a specific FY2018 revenue or earnings forecast in the supplied filing text. It expected approximately $200 million of FY2018 capital expenditures and approximately $30 million of additional Service Alignment Initiative charges. Management cited recurring revenue, cash generation, client retention and investment in cloud-based platforms as strengths.
- Key risks include cybersecurity or privacy incidents, system or data-center disruptions, regulatory and licensing changes, competition and failure to adapt technology, economic and employment conditions, foreign-exchange movements, interest-rate and liquidity risks in the client-funds investment strategy, and reliance on banking partners.
- Unrecognized tax benefits were $74.6 million, up from $27.4 million. Management said favorable settlements could increase earnings by up to $35 million within the next 12 months, but timing and outcomes are uncertain.
- A patent-infringement lawsuit filed by Uniloc in 2016 seeks unspecified damages and injunctive relief; ADP said it could not estimate a reasonably possible loss or range. Management stated that other ordinary-course litigation was not expected to have a material adverse impact.
- ADP disclosed potential tax exposure if the 2014 CDK Global spin-off were found not to qualify for tax-free treatment; it noted that CDK may be unable to fully indemnify ADP for related taxes and expenses.
Important facts for investors to verify
- How much FY2017 earnings growth came from the $205.4 million CHSA/COBRA sale gain versus ongoing operations; compare GAAP with the company’s non-GAAP adjustments.
- Whether bookings recover and Employer Services retention improves, particularly on legacy platforms, as clients migrate to strategic cloud platforms.
- Whether the expected FY2018 restructuring charges and capital spending track management’s estimates, and whether the initiatives deliver operating efficiencies.
- How client-fund assets, obligations and short-term financing behave under interest-rate or market stress; these large client-related balances are not equivalent to unrestricted corporate cash.
- Developments in tax examinations and the Uniloc case, as well as implementation effects from the planned revenue-recognition standard adoption in FY2019.
The auditor issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of June 30, 2017.