ADP Q2 FY2018 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2017. ADP provides cloud-based human capital management services, including payroll, HR, benefits, and time and attendance solutions. Unless otherwise noted, amounts are in millions of dollars.
Financial performance
| Metric | Quarter ended Dec. 31, 2017 | Quarterly change | Six months ended Dec. 31, 2017 | Six-month change |
|---|---|---|---|---|
| Total revenue | $3,235.4 | +8% reported; +7% constant currency | $6,314.2 | +7% reported; +6% constant currency |
| Net earnings | $467.5 | -8% | $869.0 | -1% |
| Diluted EPS | $1.05 | -7% | $1.96 | +1% |
| Adjusted net earnings | $440.4 | +13% | $846.3 | +8% |
| Adjusted diluted EPS | $0.99 | +14% | $1.90 | +10% |
| Adjusted EBIT margin | 18.6% | Down from 19.8% | 18.5% | Down from 19.8% |
Reported earnings before taxes were $565.7 for the quarter and $1,113.9 for the six months, down 28% and 15%, respectively. Reported pretax margin was 17.5% for the quarter and 17.6% for the six months. The effective tax rates fell to 17.4% and 22.0%, respectively, from 35.0% and 33.1% in the comparable periods.
- Segments: Employer Services revenue grew 6% for the quarter and 4% for the six months; pretax earnings grew 4% and 1%. PEO Services revenue grew 15% and 14%; pretax earnings grew 12% and 11%. PEO growth reflected a 10% increase in average worksite employees, as well as higher pass-through benefit revenues.
- Cash flows: Six-month operating cash flow was $675.1, down from $841.1; investing cash flow was $(1,326.3), including $487.4 for acquisitions; financing cash flow was $6,280.3, primarily reflecting a $7,207.1 net increase in client funds obligations. ADP paid $506.7 in dividends and repurchased $408.3 of shares.
- Balance sheet and liquidity: At December 31, cash and cash equivalents were $1,773.4 and long-term debt was $2,002.4. ADP reported $1.8 billion of cash and short- and long-term marketable securities for corporate liquidity. Funds held for clients were $34,451.3, against client funds obligations of $34,508.1; these client funds are restricted for client obligations and should not be treated as corporate cash. ADP had no commercial paper or revolving-credit-facility borrowings outstanding at period end.
- Shareholder returns: Dividends declared were $0.63 per share for the quarter, versus $0.57 a year earlier. ADP repurchased 3.6 million shares during the six months at an average $108.70 per share.
Material changes and unusual items
- Prior-year results included a $205.4 pretax gain on the sale of the CHSA and COBRA businesses. This materially elevated prior-year reported earnings and margins; the businesses were not classified as discontinued operations.
- The Tax Cuts and Jobs Act reduced the U.S. federal corporate tax rate. ADP recorded a provisional $45.7 net one-time tax benefit, included in reported results; its accounting was not final. The filing also cites an approximately $15.9 provisional transition-tax liability and estimates $23.1 of foreign tax credits may expire unused.
- ADP incurred $22.9 of non-operational proxy-contest costs in the quarter and $33.3 in the six-month period. Adjusted measures exclude these costs, as well as specified tax, divestiture, and restructuring items; they are non-GAAP measures.
- In October 2017, ADP acquired Global Cash Card for approximately $490 million net of cash acquired. In January 2018, after the reporting date, ADP acquired Work Market for approximately $125 million in cash.
- Goodwill rose to $2,164.3 and net intangible assets to $832.7, largely reflecting the Global Cash Card acquisition. Acquisition purchase-price allocations remained preliminary.
Outlook, management commentary, and risks
Management reported six-month new business bookings growth of 2% and said it saw momentum entering the second half of fiscal 2018. It cited improved overall revenue retention of 70 basis points for the six months, while noting quarterly Employer Services retention declined 20 basis points amid continued losses on legacy platforms. Management attributed growth to new business, higher pays per control, client implementation, and PEO worksite employee growth. It also cited investments in sales, implementation, operations, and product development as cost pressures.
- Management estimated fiscal 2018 adjusted effective tax rate of 26.9%, and projected 25%–26% beyond fiscal 2018, excluding one-time items.
- Fiscal 2018 capital expenditures were expected to be about $200 million. ADP expected approximately $25 million in pretax Service Alignment Initiative charges for the remainder of fiscal 2018.
- Management said corporate liquidity, operating cash flow, financing access, and committed credit facilities should be adequate for expected needs. Client-fund liquidity nevertheless depends on investment liquidity and continued access to short-term funding during periods of market stress.
- Disclosed risks include client retention and sales, competition, regulation, interest and currency movements, credit ratings and funding costs, security or privacy breaches, service interruptions, labor and technology constraints, and acquisition and divestiture execution. ADP said there were no material changes to the risk factors in its fiscal 2017 Form 10-K.
- ADP said pending claims and litigation were not expected to have a material adverse effect. A patent dispute appeal remained pending, but the company said a license and release made a material adverse impact unlikely. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile reported earnings declines with the prior-year $205.4 divestiture gain, the current-year tax benefit, and ADP’s non-GAAP adjustments.
- Track whether adjusted EBIT margins recover from 18.5%–18.6%, given rising service, sales, acquisition, and PEO pass-through costs.
- Monitor bookings, retention on legacy versus strategic platforms, pays per control, and PEO worksite employee growth.
- Review operating cash flow and working-capital trends, acquisition spending, and the distinction between corporate liquidity and restricted client funds.
- Follow final tax-law accounting, the foreign transition-tax and tax-credit estimates, and preliminary Global Cash Card purchase accounting; assess the integration and contribution of both acquisitions.