AUTOMATIC DATA PROCESSING INC quarterly report, Q1 FY2019

Business context and reporting period

Automatic Data Processing, Inc. (ADP) provides cloud-based human capital management services, including payroll, HR, benefits, talent and time-management solutions. This filing covers the three months ended September 30, 2018—ADP’s first quarter of fiscal 2019, notwithstanding the request’s “2018 Q1” label. Prior-period figures are presented as adjusted for accounting and segment-reporting changes. Amounts below are in USD millions except per-share data.

Financial performance and position

Metric	Quarter ended Sep. 30, 2018	Prior-year quarter	Change
Total revenue	$3,323.2	$3,077.2	+8%
Earnings before income taxes	$646.8	$564.9	+14%
Net earnings	$505.4	$412.6	+22%
Diluted EPS	$1.15	$0.93	+24%
Operating cash flow	$149.2	$244.7	Down $95.5

GAAP pretax margin rose to 19.5% from 18.4%; the effective tax rate fell to 21.9% from 27.0%.
Adjusted EBIT was $686.7, up 18%, and adjusted EBIT margin was 20.7% versus 18.9%. Adjusted net earnings were $528.8, up 27%, and adjusted diluted EPS was $1.20 versus $0.94. These are non-GAAP measures.
Revenue by disclosed category: HCM $1,520.3 (+7%); HRO excluding PEO benefits pass-throughs $557.5 (+10%); PEO benefits pass-throughs $653.4 (+10%); Global $473.5 (+5%); client fund interest $118.5 (+19%).
Employer Services revenue was $2,338.2 (+7%) and pretax earnings were $637.6 (+19%). PEO Services revenue was $987.8 (+10%) and pretax earnings were $145.9 (+18%).
Cash and cash equivalents were $1,490.3 at quarter-end, versus $2,170.0 at June 30, 2018. Total assets were $37,416.7 and stockholders’ equity was $4,678.8.
Long-term debt was $2,002.4. ADP had no commercial paper outstanding and no borrowings under its credit facilities at quarter-end. Reverse-repurchase obligations were $453.0 and were fully repaid by October 4, 2018. The company reported $9.8 billion of committed credit facilities.
Quarterly dividends declared were $0.69 per share; $302.6 was paid in dividends and $227.1 was spent on common-stock repurchases.

Material changes and cash flows

Revenue growth primarily reflected new business, higher client employee counts, acquisitions and increased client-fund interest. Employer Services New Business Bookings grew 8%; pays per control increased 2.4%; average PEO worksite employees increased 9% to 528,000.
Operating cash flow declined to $149.2, with management citing unfavorable working-capital movements. Investing cash outflow was $452.7, including $119.7 for acquisitions; financing cash outflow was $1,817.7, driven mainly by a $1,711.5 net decrease in client funds obligations, dividends and share repurchases.
Client funds are a major balance-sheet component: funds held for clients were $25,402.7 and related client funds obligations were $25,798.9 at September 30. These balances reflect client payroll and remittance activity and are supported by ADP’s investment and short-term funding arrangements; they are not equivalent to unrestricted corporate liquidity.
ADP adopted ASC 606 retrospectively, including capitalizing and amortizing more contract acquisition and implementation costs. The adoption did not materially change revenue timing or amount but affected prior-period presentation and balance-sheet amounts. Pension-cost presentation and segment reporting also changed; comparative figures were adjusted.

Outlook, management commentary and risks

Management expects Employer Services New Business Bookings growth of 6%–8% for fiscal 2019. It reported continued momentum and said service, migration and transformation initiatives were improving client satisfaction and productivity.
Fiscal 2019 capital expenditures were expected to be about $225, compared with $192 in fiscal 2018. Management estimated an adjusted effective tax rate of 24.5% for fiscal 2019 and 25%–26% beyond fiscal 2019, excluding one-time items. No full-year revenue or EPS guidance is stated in the provided filing text.
Quarterly transformation-related charges totaled $32.5 on an adjusted-results basis, including VERP and other initiatives, partly offset by Service Alignment Initiative reversals. ADP recorded a $12.1 software impairment after identifying redundant software following an acquisition. It anticipated up to $26 of additional VERP health-coverage expense and up to $15 of additional non-cash pension settlement charges during the remainder of fiscal 2019, subject to participation and actuarial assumptions.
The Tax Cuts and Jobs Act reduced the federal corporate rate and contributed to the lower tax rate. ADP said its tax accounting remained provisional and expected to complete analysis during the quarter ending December 31, 2018; foreign tax credit limitations could leave approximately $19.2 of credits unused.
Available-for-sale securities had $430.6 of gross unrealized losses at quarter-end, compared with $392.4 at June 30. ADP stated that all securities were investment grade and approximately 79% were rated AAA or AA. A hypothetical 25-basis-point change in short- and intermediate-term rates was estimated to affect pretax earnings by about $10 over the following 12 months.
Potential Illinois class actions allege violations involving collection, use and storage of employee biometric data. ADP said the matters were at an early stage and it could not estimate a reasonably possible loss. Management did not expect other ordinary-course claims to have a material adverse effect. The filing reported no material change in previously disclosed risk factors.
Other risks identified include client retention and sales, competition, regulation, economic and interest-rate trends, foreign exchange, cybersecurity and system interruptions, staffing, technology changes, acquisitions, and access to financing during market stress.

Most important facts for investors to verify

Confirm the correct comparison and fiscal-period labeling: this is the quarter ended September 30, 2018, or fiscal 2019 Q1.
Review the reconciliation of adjusted results to GAAP, especially the $32.5 of transformation charges and the effects of the lower tax rate.
Assess whether the $149.2 of operating cash flow reflects temporary working-capital timing or a persistent change, and distinguish client funds from corporate cash.
Monitor client-fund investment yields, interest-rate sensitivity, liquidity sources and the maturity profile of securities relative to client obligations.
Track VERP costs, actuarial estimates for ADP Indemnity and the biometric-data litigation, for which losses were not estimable.
Evaluate execution against the 6%–8% bookings outlook and the disclosed fiscal 2019 capital-spending and tax-rate expectations.