ADP — Form 10-Q Summary
Business context and reporting period
Automatic Data Processing, Inc. provides cloud-based human capital management services, including payroll, HR, benefits, and time and attendance solutions. This unaudited report covers the three months ended September 30, 2016, the first quarter of ADP’s fiscal 2017. Comparisons are with the three months ended September 30, 2015. Amounts are in millions, except per-share data.
Financial performance and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Total revenue | $2,916.9 | $2,714.0 | +7% reported; +8% constant currency |
| Operating costs and SG&A | $2,391.3 | $2,251.8 | +6% |
| Pre-tax earnings from continuing operations | $528.7 | $505.0 | +5% |
| Net earnings from continuing operations | $368.7 | $337.5 | +9% |
| Diluted continuing-operations EPS | $0.81 | $0.72 | +13% |
| Operating cash flow | $329.8 | $109.1 | +$220.7 |
- GAAP pre-tax margin was 18.1%, down from 18.6%. Management’s adjusted EBIT margin was 19.8%, up from 17.6%; adjusted diluted EPS was $0.86 versus $0.68. These are non-GAAP measures.
- Employer Services revenue rose 6% to $2,261.2; pre-tax earnings increased 15% to $656.6, and segment margin rose to 29.0% from 26.8%. Pays per control increased 2.7%; client retention declined 100 basis points, partly due to an anticipated large client loss in CHSA.
- PEO Services revenue rose 13% to $794.7 and pre-tax earnings rose 21% to $107.1. Average worksite employees increased 13%. PEO revenue includes substantial pass-through costs; reported revenue growth should be viewed in that context.
- Cash and cash equivalents were $2,776.6 at September 30, versus $3,191.1 at June 30. Cash and short-term marketable securities totaled $2,817.6. Total assets were $34,337.4 and total liabilities were $30,087.3.
- Long-term debt was $2,007.7, principally $2.0 billion of senior notes due in 2020 and 2025. No borrowings under credit facilities or commercial paper were outstanding at quarter-end. ADP reported $9.25 billion of committed credit facilities and a $9.25 billion commercial paper program.
- Client funds assets of $24,787.2 and client funds obligations of $24,349.1 are tied to payroll and tax remittances. Large related cash-flow movements reflect client-fund activity, not solely corporate cash generation.
- ADP repurchased 4.0 million shares for $328.6 and paid $241.8 in dividends; dividends declared were $0.53 per share, up from $0.49.
Material changes and unusual items
- Q1 included a $39.9 pre-tax charge for the Service Alignment Initiative. ADP expects total charges of $100–$125 through fiscal 2018, principally employee separation costs and other one-time costs.
- The effective tax rate fell to 30.3% from 33.2%, including a $15.5 tax benefit from adopting stock-compensation accounting guidance. Management said the adoption added about $0.03 to reported and adjusted diluted EPS.
- Interest expense increased to $19.9 from $4.9, largely reflecting the $2.0 billion note issuance in September 2015. Prior-year results included a $29.1 gain on the sale of AdvancedMD.
- Other comprehensive income was a $31.3 loss, primarily reflecting unrealized losses on available-for-sale securities, compared with $13.2 of income a year earlier.
- In November 2016, ADP agreed to sell its CHSA and COBRA businesses for $235, subject to customary closing conditions. The company expects a fiscal 2017 pre-tax gain of approximately $200.
Outlook, risks, and contingencies
- Management expects full-year new-business bookings growth of 4%–6% versus fiscal 2016 bookings of $1.75 billion; bookings were flat year over year in Q1 and in line with expectations.
- Fiscal 2017 capital expenditures are expected to be about $250, compared with $165.7 in fiscal 2016.
- ADP cited client acquisition and retention, competition, economic and interest-rate conditions, foreign currency, regulation, cybersecurity and service interruptions, staffing, and execution of acquisitions and divestitures as risks to forward-looking results.
- A patent-infringement lawsuit filed by Uniloc seeks unspecified damages and injunctive relief; ADP said it could not estimate a reasonably possible loss. Separately, OFAC closed its review of previously disclosed service arrangements with designated entities by issuing a cautionary letter rather than pursuing a civil monetary penalty; the letter is not a final determination on whether a violation occurred.
- ADP said client-fund investment activities involve liquidity, interest-rate, and credit risks. A hypothetical 25-basis-point change in short- and intermediate-term rates was estimated to affect pre-tax earnings by approximately $11 over the following 12 months.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter. No material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- Whether bookings growth and client retention improve, particularly following the CHSA client loss and the planned CHSA/COBRA divestiture.
- How much of future earnings growth reflects underlying operating performance versus the lower tax rate and other adjustments; review both GAAP and non-GAAP reconciliations.
- The timing, cash cost, and total impact of the Service Alignment Initiative, and whether its projected benefits offset restructuring charges.
- The effect of interest rates and client-fund liquidity needs on investment income, borrowing costs, and cash-flow interpretation.
- Completion and final proceeds of the CHSA/COBRA sale, the estimated gain, and any related transition or partnership arrangements.