ADP 10-Q Summary — Quarter Ended December 31, 2012
Business context: Automatic Data Processing, Inc. (ADP) provides employer, professional employer organization (PEO), and dealer services. This filing covers fiscal 2013’s second quarter and first six months; comparisons are with the corresponding periods ended December 31, 2011. Financial statements are unaudited. Amounts below are in millions of dollars except per-share data.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Total revenue | $2,747.8, up 7% | $5,385.3, up 6% |
| Revenue excluding client-fund interest | $2,646.1, up from $2,452.8 | $5,176.9, up from $4,841.8 |
| Continuing-operations pretax earnings | $528.8, down 8%; pretax margin 19% vs. 22% | $994.4, down 4%; pretax margin 18% vs. 20% |
| Continuing-operations net earnings | $352.0, down 6% | $654.4, down 3% |
| Diluted continuing-operations EPS | $0.72 vs. $0.76 | $1.34 vs. $1.37 |
| Total net earnings, including discontinued operations | $390.9 vs. $375.0 | $696.1 vs. $677.7 |
| Operating cash flow | Not provided for the quarter | $383.4 vs. $747.9 |
- All three reportable segments grew revenue in the quarter: Employer Services 7% to $1,907.7; PEO Services 13% to $465.7; and Dealer Services 11% to $449.8. Segment pretax earnings rose 10%, 17%, and 22%, respectively.
- Client-fund interest revenue fell to $101.7 from $117.9 for the quarter and to $208.4 from $239.8 year to date. Average client-fund yields declined to 2.4% from 3.0% in the quarter and 2.5% from 3.1% year to date, partly offset by higher average balances.
- The effective tax rate was 33.4% for the quarter and 34.2% year to date, down from 35.3% and 34.8%, respectively.
- Quarterly diluted EPS from continuing operations was down year over year as reported, but up 7% against the prior-year quarter adjusted to exclude a $66.0 pretax asset-sale gain ($41.2 after tax). The comparable six-month adjusted EPS comparison was up 5%.
Financial position and liquidity
- At December 31, 2012, cash and cash equivalents were $1,390.9; corporate marketable securities were $126.3; and total cash and marketable securities were $1,517.2. Working capital excluding client funds was $1,419.6, versus $1,337.0 at June 30, 2012.
- Long-term debt was $15.8 and stockholders’ equity was $6,395.3. ADP reported no commercial paper outstanding and no borrowings under its revolving credit agreements at period end. It had $6.75 billion of revolving credit facilities and a $6.75 billion commercial-paper program; $3.0 billion of reverse-repurchase capacity was committed.
- Funds held for clients were $23,759.0, against client-fund obligations of $23,064.7. These client-related balances are restricted/operational balances, not freely available corporate liquidity. The filing reports that $13.5 of reverse-repurchase obligations outstanding at period end were repaid by January 2, 2013.
- Year-to-date operating cash flow declined to $383.4 from $747.9. Management attributed the decrease to a $141.4 reinsurance premium, higher pension contributions, timing of tax payments, and unfavorable working-capital movements. Capital expenditures were $75.3 in the cash-flow statement; management’s continuing-operations measure was $76.6.
- ADP repurchased 5.4 million shares for $306.9 and paid $384.3 in dividends during the six months. The declared dividend per share increased to $0.830 from $0.755 for the comparable six months.
Material changes and unusual items
- ADP sold its Taxware Enterprise Service business on December 17, 2012, recognizing a $58.8 pretax gain, less costs to sell, in discontinued operations. The net gain after tax was $36.7; Taxware’s results are presented as discontinued operations for all periods.
- The prior-year comparison included a $66.0 gain from selling rights and obligations related to a third-party expense-management platform. Its absence was a major reason reported pretax earnings and margins declined; ADP also cited lower client-fund interest and acquisition-related margin pressure.
- Revenue growth excluding the effects of fiscal 2012 acquisitions and the prior-year platform-asset sale was approximately 6% for the quarter and 5% for the six months, according to management.
- No businesses were acquired during the six months ended December 31, 2012. ADP paid a $141.4 premium for a reinsurance arrangement covering substantially all relevant ADP Indemnity losses up to the $1 million per-occurrence retention for fiscal 2013.
Outlook, management commentary, and risks
- Management described the core business as resilient, citing recurring revenue, client retention, new-business sales, same-store-sales growth, and margin improvements in the operating segments. It did not provide a specific revenue or earnings forecast in the supplied filing text.
- Fiscal 2013 capital expenditures were expected to be $180–$200, compared with $146.2 in fiscal 2012.
- Management identified continued low interest rates and declining client-fund yields as pressures on interest revenue and margins. A hypothetical 25-basis-point change in short- and intermediate-term rates was estimated to affect pretax earnings by about $9 over the following 12 months.
- Other stated risks include client retention and sales, pricing, regulation, economic and employment conditions, interest and currency movements, competition, technology, auto-industry conditions, and acquisition or divestiture impacts. The filing warns that short-term financing may become less available during economic turmoil.
- Pending matters include a patent-infringement suit involving ADP AdvancedMD and an EEOC investigation concerning alleged employment discrimination. ADP said it was defending the suit and cooperating with the investigation; it could not estimate reasonably possible losses. It reported no material change to the risk factors in its fiscal 2012 Form 10-K.
Important facts for investors to verify
- Whether underlying revenue, retention, and payroll-employee growth continue to offset lower client-fund yields and acquisition-related margin pressure.
- How much of reported earnings growth or decline reflects one-time disposal gains and other nonrecurring items; compare reported results with ADP’s adjusted, non-GAAP comparisons.
- Whether operating cash flow recovers after the reinsurance payment, pension contributions, tax-payment timing, and working-capital outflows.
- The investment, liquidity, and interest-rate exposure of client funds, and the distinction between restricted client funds and corporate cash available for general use.
- Developments in the AdvancedMD litigation and EEOC matter, for which the filing provides no clear estimate of potential loss.