Business context and reporting period
Automatic Data Processing, Inc. (ADP) provides payroll, human capital management, benefits and related business-processing services, as well as services to automotive dealerships. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2013, the second quarter of fiscal 2014. Comparisons are with the corresponding periods a year earlier.
Financial results and position
| Metric | Three months ended Dec. 31, 2013 | Six months ended Dec. 31, 2013 |
|---|---|---|
| Total revenue | $2,982.8 million, up 9% | $5,822.5 million, up 8% |
| Continuing-operations pretax earnings | $561.1 million, up 6% | $1,058.4 million, up 6% |
| Continuing-operations net earnings | $377.0 million, up 7% | $705.6 million, up 8% |
| Diluted continuing-operations EPS | $0.78, up 8% | $1.46, up 9% |
| Operating cash flow | Six months: $473.0 million, versus $383.4 million |
Quarterly total net earnings were $377.0 million, down from $390.9 million a year earlier; the prior-year figure included $38.9 million of net earnings from discontinued operations, including the Taxware disposal gain. For the six-month periods, total net earnings were $705.6 million versus $696.1 million.
Revenue growth came from all three reportable segments. Quarterly Employer Services revenue was $2,087.0 million (+9%), PEO Services $531.1 million (+14%), and Dealer Services $484.2 million (+7%). PEO revenue is reported net of substantial direct pass-through costs; reported PEO pass-through costs were $400.9 million for the quarter.
Consolidated pretax margin was 18.8% for the quarter versus 19.2%, and 18.2% for the six months versus 18.5%. ADP attributed the declines principally to reduced interest income on client funds. Segment pretax margins improved: Employer Services was 28.5% for the quarter, PEO Services 11.2%, and Dealer Services 21.6%.
At December 31, cash and cash equivalents were $1,267.1 million; cash and marketable securities totaled $1,349.5 million. Stockholders’ equity was $6,258.5 million and long-term debt $12.6 million; long-term debt-to-equity was 0.2%. Working capital excluding client funds assets and obligations was $1,447.4 million, compared with $1,195.7 million at June 30, 2013.
Six-month investing cash outflow was $6,223.8 million and financing cash inflow was $5,317.1 million; cash declined $432.0 million to $1,267.1 million. These movements were substantially affected by timing and growth in restricted client funds and related client-fund obligations. Client funds held were $28,414.3 million, against client-fund obligations of $28,205.6 million; these restricted assets are intended to satisfy those obligations and are not ordinary corporate liquidity.
Changes versus the prior comparable period
- Revenue rose 9% in the quarter and 8% year to date; management said quarterly growth would have been about 8% excluding recent acquisitions.
- Client-fund interest revenue fell to $89.2 million from $101.7 million for the quarter, as the average earned rate declined to 1.9% from 2.4%, partly offset by a 9% increase in average client-fund balances.
- Continuing-operations EPS growth also benefited from lower weighted-average shares following repurchases. ADP repurchased 5.6 million shares in the six-month period and declared dividends of $0.915 per share, versus $0.830.
- The prior-year comparison included Taxware discontinued-operation earnings and a $36.7 million after-tax disposal gain; there were no discontinued-operation earnings in the current period.
Outlook, commentary, risks and unusual items
- Management cited solid revenue retention, growth in employees on client payrolls, segment margin improvement, and contributions from acquisitions. Pays per control increased 2.9% for the quarter; worldwide client revenue retention declined 50 basis points year over year.
- No explicit full-year revenue or earnings guidance is provided in the supplied filing text. ADP expected fiscal 2014 capital expenditures of $190 million to $210 million, compared with $174.8 million in fiscal 2013.
- Management identified low interest rates and further declines in client-fund yields as a headwind. A hypothetical 25-basis-point change in short- and intermediate-term rates was estimated to affect pretax earnings by about $8 million over the following 12 months.
- Liquidity resources include a $7.25 billion commercial paper program, committed reverse-repurchase capacity of $3.0 billion, and $7.25 billion of revolving credit facilities. No commercial paper, reverse-repurchase obligations, or credit-agreement borrowings were outstanding at December 31. ADP reported average commercial-paper borrowings of $3.2 billion for the six months, used for short-term client-fund needs.
- About $0.6 billion of cash and marketable securities was held by foreign subsidiaries; management said it intended to permanently reinvest these funds outside the U.S.
- ADP disclosed an athenahealth patent-infringement case and an EEOC investigation. The company could not estimate a reasonably possible loss or range for the described matters. It also extended a contract, adding obligations of $64.5 million and $43.5 million in fiscal 2018 and 2019, respectively.
- Investment and funding risks include interest-rate, credit, and liquidity risks. ADP said all available-for-sale securities were investment grade and approximately 84% were rated AAA or AA. The filing reported no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether client-fund yields stabilize or continue to pressure revenue and consolidated margins.
- Whether client retention and pays-per-control growth remain sufficient to support Employer Services growth.
- How acquisition contributions, operating costs, severance and sales-force investment affect future margins and earnings.
- Whether operating cash generation remains strong after separating ordinary corporate cash flows from client-fund timing movements.
- Developments in the athenahealth and EEOC matters, for which the filing provides no estimable loss range.
- Execution against the $190 million to $210 million fiscal 2014 capital-expenditure expectation and continued shareholder distributions.