ADP 10-Q Summary
Business context and reporting period
Automatic Data Processing, Inc. (ADP) reported unaudited results for the quarter and six months ended December 31, 2015 (fiscal 2016 Q2). ADP provides human capital management services, including payroll, HR, benefits, and time and attendance solutions. Its reportable segments are Employer Services and PEO Services.
Key financial metrics
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 |
|---|---|---|
| Total revenue | $2.807 billion; up 6% reported and 8% constant currency | $5.521 billion; up 6% reported and 8% constant currency |
| Continuing-operations net earnings | $341.4 million; up 3% | $678.9 million; up 8% |
| Diluted continuing-operations EPS | $0.74, versus $0.69 | $1.47, versus $1.31 |
| Continuing-operations pretax margin | 18.1%, versus 18.8% | 18.3%, versus 18.2% |
| Operating cash flow | $492.7 million for six months, versus $607.1 million | |
| Capital expenditures | $89.0 million for continuing operations for six months |
Q2 adjusted EBIT margin was 18.0%, versus 18.7%; six-month adjusted EBIT margin was 17.8%, versus 18.1%. Adjusted diluted EPS was $0.72 for Q2 and $1.40 for six months; these non-GAAP measures exclude specified items, including gains on asset sales.
At December 31, 2015, corporate cash and marketable securities totaled $2.843 billion, long-term debt was $1.995 billion, and stockholders’ equity was $4.206 billion. Long-term debt-to-equity was 47.4%. ADP issued $2.0 billion of senior notes in September, with five- and ten-year maturities. It had no commercial paper or revolving-credit-facility borrowings outstanding at quarter-end. The reported $30.336 billion of funds held for clients is restricted to client obligations and should not be treated as unrestricted corporate liquidity.
Six-month investing cash outflow was $5.866 billion and financing cash inflow was $6.550 billion; cash increased $1.156 billion to $2.795 billion. These flows were substantially affected by client-fund investment and obligation activity, as well as the debt issuance. ADP repurchased 9.4 million shares for $773.0 million and paid $458.8 million in dividends during the six months. Dividends declared per share were $0.53 for Q2.
Material changes versus the prior comparable period
- PEO Services revenue rose 18% in both the quarter and six-month period; average worksite employees increased 14% and 13%, respectively. Segment pretax earnings increased 19% for Q2 and 25% for six months.
- Employer Services revenue increased 3% reported (6% constant currency) for both periods. Pays per control rose 2.5% in Q2 and 2.4% for six months, while client revenue retention fell 120 and 140 basis points, respectively, due to elevated losses on legacy platforms.
- Q2 pretax margin declined year over year, reflecting spending on sales, implementation, and servicing new business—particularly ACA-related products—and higher interest expense after the note issuance. Six-month reported pretax margin was slightly higher, aided by asset-sale gains.
- Foreign-currency translation reduced reported growth. Client-funds interest revenue fell to $89.3 million in Q2 from $90.9 million, and to $177.1 million for six months from $181.0 million, as lower average yields outweighed growth in average client-fund balances.
- Basic and diluted weighted-average shares declined year over year, partly reflecting share repurchases. Diluted EPS growth therefore exceeded growth in continuing-operations earnings.
Outlook, commentary, risks, and unusual items
- Management expected foreign-currency pressure to persist through the rest of fiscal 2016, though with a reduced impact. It also expected pressure from client-funds interest revenue to continue.
- ADP expected increased implementation and servicing investment in ACA-related products to begin generating higher recurring revenue in the second half of fiscal 2016. Capital expenditures for fiscal 2016 were forecast at $200 million to $225 million.
- Management cited strong new-business bookings, product demand, and growth in both segments, but noted weaker retention associated with legacy platforms. It emphasized its recurring-revenue model, cash generation, and client-funds investment discipline.
- Unusual gains included $13.9 million from a building sale in Q2 and $29.1 million from the AMD sale in the six-month period. AMD was sold in September 2015 and remained in continuing operations under the applicable accounting rules. A $3.6 million impairment charge was recorded on securities ADP intended to sell.
- ADP disclosed that subsidiaries had provided managed services to several OFAC-designated entities, including three Iranian banks, under historical arrangements. ADP terminated the arrangements, voluntarily notified OFAC, and was continuing a broader compliance review. Potential fines or penalties were not reasonably estimable. The filing also describes an ongoing EEOC investigation alleging race discrimination; possible losses for the matters discussed were not estimable.
- Key stated risks include client retention and new-business execution, competition and pricing, regulatory changes, interest rates and foreign exchange, cybersecurity and system disruptions, access to short-term funding, and the outcome of legal or regulatory matters. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether retention improves as clients migrate from legacy platforms, and whether bookings convert into recurring revenue as planned.
- The pace and profitability of ACA-related implementation and servicing investments, including the expected second-half revenue contribution.
- Client-funds yields, investment portfolio performance, and the sensitivity of earnings to interest-rate changes.
- How share repurchases funded in part by new debt affect leverage, interest expense, and per-share results.
- Developments in the OFAC compliance review and EEOC matter, including any eventual penalties or liabilities.
- Fiscal 2016 capital spending versus the $200 million to $225 million outlook.