Business context and reporting period
Automatic Data Processing, Inc. (ADP) filed this unaudited Form 10-Q for the three months ended September 30, 2017, its first quarter of fiscal 2018. ADP provides cloud-based human capital management services, including payroll, HR, benefits, and time and attendance solutions. Reportable segments are Employer Services and PEO Services.
Financial performance and liquidity
| Metric | Quarter ended September 30, 2017 | Prior-year quarter |
|---|---|---|
| Total revenue | $3,078.8 million | $2,916.9 million |
| Earnings before income taxes | $548.2 million | $528.7 million |
| Net earnings | $401.5 million | $368.7 million |
| Diluted EPS | $0.90 | $0.81 |
| Operating cash flow | $244.7 million | $329.8 million |
- Revenue grew 6% as reported and 5% on a constant-dollar basis. Net earnings rose 9%; diluted EPS rose 11%. Adjusted diluted EPS, a non-GAAP measure, was $0.91 versus $0.86, up 6%.
- Pre-tax margin declined to 17.8% from 18.1%; adjusted EBIT margin declined to 18.3% from 19.8%. The adjusted measures exclude specified restructuring and proxy-contest costs.
- Effective tax rate was 26.8%, down from 30.3%; management attributed the decline to a foreign-exchange-related tax benefit, releases of uncertain-tax-position reserves, and higher excess tax benefits on stock compensation, partly offset by a lower foreign-tax-credit benefit.
- Operating cash flow fell $85.1 million, mainly from unfavorable working-capital timing. Investing cash outflow was $292.6 million; financing cash outflow was $2,064.7 million, including a $1,674.3 million net decrease in client-fund obligations, $250.1 million of share repurchases, and $253.7 million of dividends paid.
- At September 30, cash and cash equivalents were $2,363.6 million; corporate cash and marketable securities totaled approximately $2.5 billion. Long-term debt was $2,002.1 million. ADP had no commercial paper or credit-facility borrowings outstanding, but had $129.4 million of reverse-repurchase obligations, paid by October 3, 2017.
- Client funds held were $25,686.2 million against client-fund obligations of $25,596.6 million. These client-related balances are restricted for satisfying client obligations and should be distinguished from corporate liquidity.
Material changes versus the prior-year quarter
- Employer Services revenue increased 2%, while segment pre-tax earnings declined 1%; its margin fell to 27.9% from 29.0%, reflecting investments in implementation, operations, sales, products, and service.
- PEO Services revenue increased 14% and pre-tax earnings increased 9%. Average worksite employees grew 10%; the segment margin declined to 12.9% from 13.5%, partly due to higher pass-through costs.
- New business bookings declined 3%. ADP said bookings had begun to stabilize relative to the second half of fiscal 2017. Pays per control rose 2.4%, and overall revenue retention improved 160 basis points.
- Quarterly share repurchases were 2.2 million shares for $250.1 million; dividends declared increased to $0.57 per share from $0.53.
- Prior-year cash-flow figures were retrospectively adjusted for adoption of the restricted-cash accounting standard, so the presented comparison reflects the revised basis.
Outlook, commentary, risks, and unusual items
- ADP expects approximately $200 million of capital expenditures in fiscal 2018, compared with $249.1 million in fiscal 2017. It also expects about $30 million of additional pre-tax Service Alignment Initiative restructuring charges for the remainder of fiscal 2018, primarily cash severance costs. No specific revenue or EPS guidance is provided in the filing text.
- In October 2017, ADP acquired Global Cash Card, Inc. for approximately $490 million net of cash acquired; results will be included in Employer Services.
- The quarter included $10.5 million of non-operational proxy-contest costs. The Service Alignment Initiative recorded a net $3.3 million reversal/benefit for the quarter; ADP expects the initiative to continue through fiscal 2018.
- Management cited competition, client retention and bookings, regulatory uncertainty, interest-rate and foreign-exchange movements, cybersecurity and system interruptions, staffing, and access to financing among factors that could affect results. A dissident investor had launched a proxy contest.
- ADP reported that a patent-infringement suit by Uniloc was dismissed with prejudice on September 28, 2017. Other claims and regulatory matters remain; management did not expect them, individually or in aggregate, to materially adversely affect results, financial condition, or cash flows. ADP reported no material change in its previously disclosed risk factors.
Important facts for investors to verify
- Assess whether bookings stabilization, improved retention, and 2.4% pays-per-control growth persist, particularly given the 3% decline in bookings.
- Track margin performance and whether planned investments in service, implementation, sales, and technology translate into improved profitability.
- Review operating cash flow and working-capital trends, and distinguish corporate liquidity from restricted client funds.
- Monitor client-fund investment and financing risks, including interest-rate sensitivity; ADP estimated a 25-basis-point rate change could affect pre-tax earnings by approximately $9 million over the following 12 months.
- Verify the impact and integration of the Global Cash Card acquisition, and progress toward the announced fiscal 2018 capital spending and restructuring expectations.
- Reconcile capital expenditures: the cash-flow statement reports $73.3 million, while MD&A cites $61.4 million for the quarter; the filing text does not explain this difference clearly.