Business context and reporting period
Automatic Data Processing, Inc. (ADP) filed this Form 10-K for the fiscal year ended June 30, 2014; the fourth quarter ended on that date. ADP provides payroll, human capital management (HCM), and related outsourcing services, as well as services to vehicle dealers. Its reportable segments are Employer Services, Professional Employer Organization (PEO) Services, and Dealer Services. ADP served approximately 637,000 clients in more than 125 countries.
Financial performance and liquidity
| Metric | FY2014 | FY2013 | Change |
|---|---|---|---|
| Revenue | $12.21 billion | $11.29 billion | +8% |
| Gross profit / gross margin | $4.99 billion / 40.8% | $4.65 billion / 41.2% | Margin down about 0.4 percentage point |
| Continuing-operations pretax earnings / margin | $2.27 billion / 18.6% | $2.08 billion / 18.4% | +10% earnings |
| Continuing-operations net earnings | $1.50 billion | $1.36 billion | +11% |
| Diluted EPS from continuing operations | $3.11 | $2.79 | +11% |
| Operating cash flow | $1.82 billion | $1.58 billion | +$244 million |
Adjusted, non-GAAP continuing-operations pretax earnings were $2.29 billion, adjusted net earnings were $1.52 billion, and adjusted diluted EPS was $3.14, up 8%, 8%, and 9%, respectively. These measures exclude specified separation costs and, for the prior year, a goodwill impairment charge; they are not substitutes for GAAP results.
Segment revenue and pretax earnings grew across all three businesses: Employer Services revenue was $8.54 billion (+8%) and pretax earnings $2.52 billion (+14%); PEO Services revenue was $2.27 billion (+15%) and pretax earnings $234 million (+17%); Dealer Services revenue was $1.95 billion (+7%) and pretax earnings $428 million (+14%). PEO revenue includes substantial benefits and insurance-related pass-through amounts.
At June 30, 2014, cash, cash equivalents, and marketable securities totaled $4.07 billion, including $2.2 billion associated with commercial paper borrowings. Commercial paper outstanding was $2.17 billion and was repaid July 1, 2014; long-term debt was $11.5 million. ADP reported $6.67 billion of equity and working capital, excluding client funds and obligations, of $1.63 billion. It also had $7.5 billion of committed revolving credit facilities and $3.25 billion available under committed reverse-repurchase arrangements. Client funds are restricted for payroll and tax obligations and should not be treated as unrestricted corporate liquidity.
ADP paid $883 million in dividends and repurchased $667 million of shares in FY2014. Declared dividends were $1.88 per share, compared with $1.70 in FY2013. Capital expenditures were $219 million; systems development and programming investment was approximately $834 million.
Material changes versus the prior comparable period
- Revenue growth accelerated to 8% from 7%; continuing-operations pretax margin improved to 18.6% from 18.4%. Adjusted pretax margin was flat at 18.8%.
- Interest income on funds held for clients fell 11% to $374 million as the average yield declined to 1.8% from 2.2%, partly offset by an 8% increase in average client funds to $20.7 billion.
- Employer Services’ worldwide client retention reached 91.4%, and U.S. pays per control increased 2.8%. PEO worksite employees increased 15% on average.
- FY2014 included $14.9 million in Dealer Services separation costs. FY2013 included a $42.7 million non-tax-deductible goodwill impairment related to ADP AdvancedMD. FY2014 net earnings also included $13.3 million from discontinued operations, including a net disposal gain on the Occupational Health and Safety business.
Outlook, commentary, risks and contingencies
ADP expected client-fund interest revenue to increase in FY2015, but more slowly than underlying processing revenue. It forecast FY2015 capital expenditures of $250–$275 million and additional Dealer Services separation costs of $40–$50 million. The planned tax-free spin-off of 100% of Dealer Services was expected by October 2014, subject to regulatory approvals and other conditions, including a favorable tax opinion. ADP expected to receive at least $700 million in connection with the separation and intended to return it through share repurchases, subject to market conditions. It also expected to monetize Dealer Services financing notes for $195–$205 million. Management anticipated slower dividend growth than earnings while returning to a 55%–60% payout ratio in about two years. The filing provides no specific consolidated revenue or EPS guidance.
Key risks include low interest rates reducing high-margin client-fund income; cyberattacks, privacy breaches, or processing-system disruptions; regulatory changes affecting payroll, money transmission, benefits, and PEO operations; economic, employment, foreign-exchange, and financing-market conditions; and execution, cost, and approval risks relating to the spin-off. ADP reported ongoing patent-infringement litigation involving ADP AdvancedMD and an EEOC charge concerning employment practices; it could not estimate reasonably possible losses for the described matters. ADP stated that ordinary-course litigation was not expected to materially affect its financial condition, results, or cash flows. Workers’ compensation exposures are estimated actuarially and substantially reinsured, but ADP disclosed counterparty exposure if its insurer cannot meet contractual obligations. The auditor expressed unqualified opinions on the financial statements and internal control over financial reporting.
Investor facts to verify
- Whether the Dealer Services spin-off closed on schedule, met tax and regulatory conditions, and produced the anticipated proceeds and separation costs.
- Whether client-fund yields and interest revenue improved as management expected, and how rate changes affect margins.
- Underlying growth in recurring processing revenue, client retention, pays per control, PEO worksite employees, and segment margins, separate from PEO pass-through amounts.
- Use of spin-off proceeds, subsequent share repurchases, dividend growth, and progress toward the stated payout-ratio target.
- Developments in the disclosed patent and EEOC matters, workers’ compensation claims and reinsurance recoverability, and any material cybersecurity or service interruptions.