ADP 10-Q Summary
Business context and reporting period
Automatic Data Processing, Inc. (ADP) reported unaudited results for the three and six months ended December 31, 2016, its fiscal 2017 second quarter and first half. ADP provides human capital management services, including payroll, HR, benefits, talent management, and PEO services. Its reportable segments are Employer Services and PEO Services.
Key financial metrics
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Total revenue | $2.987 billion, up 6% year over year | $5.904 billion, up 7% |
| Net earnings from continuing operations | $510.9 million, up 50% | $879.6 million, up 30% |
| Diluted continuing-operations EPS | $1.13, versus $0.74 | $1.94, versus $1.47 |
| Adjusted diluted continuing-operations EPS | $0.87, up 20% | $1.73, up 24% |
| Continuing-operations pretax margin | 26.3%, versus 18.1% | 22.3%, versus 18.3% |
| Adjusted EBIT margin | 19.8%, versus 18.0% | 19.8%, versus 17.8% |
Six-month operating cash flow was $841.1 million, compared with $515.4 million a year earlier. Investing activities provided $2.719 billion and financing activities used $4.029 billion; these flows were substantially affected by client-fund balances and related transactions. Cash and cash equivalents were $2.705 billion at December 31, 2016, down from $3.191 billion at June 30, 2016.
Long-term debt was $2.003 billion. ADP had no commercial paper outstanding at period-end and no borrowings under its $9.25 billion committed credit facilities. Corporate cash, cash equivalents, and short-term marketable securities totaled $2.746 billion. Separately, $30.426 billion of funds held for clients was matched by $30.403 billion of client-fund obligations; these restricted client-related balances should not be treated as ordinary corporate liquidity.
Material changes versus the prior comparable period
- Revenue grew in both segments. Six-month Employer Services revenue rose 5%, while PEO Services revenue rose 12%; PEO growth included a 12% increase in average worksite employees.
- Reported earnings benefited substantially from the $205.4 million pretax gain on the November sale of the CHSA and COBRA businesses. The $510.9 million quarterly and $879.6 million six-month continuing-operations earnings therefore include a significant nonrecurring item. Excluding specified items, adjusted net earnings rose 17% for the quarter and 21% for the six months.
- Operating performance also improved: adjusted EBIT increased 17% for the quarter and 19% for the first half, with margin expansion attributed to operating efficiencies and selling expenses growing more slowly than revenue.
- New business bookings declined 3% in the first half. Management cited prior-year ACA-related sales tailwinds and marketplace hesitation amid uncertainty around the U.S. elections. Six-month revenue retention declined 40 basis points year over year, primarily because of an anticipated large client loss in CHSA; quarterly retention increased 10 basis points.
- ADP repurchased 8.6 million shares for $765.3 million and paid $482.3 million in dividends during the first half. Weighted-average diluted shares fell year over year.
- Unrealized losses on available-for-sale securities increased materially: the portfolio had $123.0 million of gross unrealized losses at December 31, 2016, compared with $1.5 million at June 30, 2016. Accumulated other comprehensive loss widened to $566.7 million from $215.1 million.
Outlook, management commentary, risks, and unusual items
- Management described the business as recurring-revenue, cash-generative, and low in capital expenditure needs, and said it expects available corporate liquidity, operating cash flow, credit facilities, and debt-market access to meet operating and capital needs. The filing provides no specific revenue or EPS forecast.
- Fiscal 2017 capital expenditures for continuing operations were expected to be about $250 million, versus $165.7 million in fiscal 2016.
- The Service Alignment Initiative is expected to generate $100 million to $125 million of pretax charges through fiscal 2018. ADP recorded $41.1 million through December 31, 2016, primarily employee separation costs.
- In January 2017, after the reporting date, ADP acquired The Marcus Buckingham Company for approximately $70 million cash at closing, with up to $35 million of contingent consideration.
- ADP identified client retention and bookings, pricing, regulation, competition, economic and interest-rate conditions, foreign currency, credit ratings and funding access, cybersecurity and system reliability, staffing, technology change, and acquisition or divestiture execution as risks. It said risk factors were not materially changed from its fiscal 2016 Form 10-K.
- A patent-infringement lawsuit filed by Uniloc in July 2016 seeks unspecified damages and injunctive relief. ADP said the matter was in an early stage and it could not estimate a reasonably possible loss. Management stated other ordinary-course claims were not expected to have a material adverse impact.
- ADP estimated that a 25-basis-point change in both short- and intermediate-term rates could affect pretax earnings by approximately $12 million over the following 12 months; a 25-basis-point short-rate-only change could affect pretax earnings by approximately $6 million.
Important facts for investors to verify
- How much of reported earnings growth reflects the CHSA and COBRA sale gain versus underlying operating growth; review the company’s adjusted, non-GAAP reconciliations.
- Whether bookings and revenue retention recover, particularly after the CHSA client loss, and whether PEO growth and margins persist.
- Progress and final costs of the Service Alignment Initiative, compared with the $100 million to $125 million estimate.
- Client-fund liquidity and investment risks, including the effects of rate changes and the rise in unrealized securities losses.
- Integration and purchase accounting for the post-period TMBC acquisition, and any developments in the Uniloc litigation.