ADP Form 10-Q Summary
Business context and period: Automatic Data Processing, Inc. (ADP) reported unaudited results for the first quarter of fiscal 2011, the three months ended September 30, 2010, with comparison to the quarter ended September 30, 2009. Its reportable segments are Employer Services, PEO Services and Dealer Services.
Financial performance and position
- Revenue: $2.229 billion, up 6% year over year. Growth excluding recently completed acquisitions was approximately 4%. Revenue excluding client-fund interest and PEO revenue was $1.764 billion; client-fund interest was $126.8 million; PEO revenue was $338.9 million.
- Earnings: Pretax income from continuing operations was $436.4 million, down 2%; net earnings from continuing operations were $278.5 million, down 2%. Diluted EPS from continuing operations was $0.56, unchanged. The effective tax rate was 36.2%, versus 36.5%.
- Margins and expenses: Pretax margin declined to 20% from 21%. Total expenses rose 9% to $1.830 billion, faster than revenue; operating expenses rose 11%, partly reflecting acquisitions, PEO costs and increased service staffing.
- Segments: Employer Services revenue rose 6% to $1.559 billion and pretax income rose 2% to $376.7 million. PEO Services revenue rose 15% to $341.3 million, while pretax income fell 20% to $28.3 million. Dealer Services revenue rose 12% to $336.4 million and pretax income rose 14% to $50.8 million.
- Cash flow: Operating cash flow was $222.3 million, compared with $243.7 million. Investing activities used $4.156 billion, primarily reflecting a $3.380 billion increase in restricted cash for client funds and $475.3 million of net acquisition spending. Financing activities provided $3.439 billion, largely reflecting a $3.639 billion increase in client-fund obligations. Cash and cash equivalents decreased to $1.177 billion from $1.643 billion at June 30, 2010.
- Liquidity and debt: Working capital excluding funds held for clients and client-fund obligations was $1.173 billion, down from $1.569 billion at June 30. Cash and marketable securities totaled $1.316 billion. Total debt was $38.4 million, including $35.6 million long-term and $2.8 million current; long-term debt-to-equity was 0.6%. No commercial paper, reverse-repurchase obligations or credit-facility borrowings were outstanding at quarter-end. ADP reported $6.25 billion of committed revolving credit facilities.
- Client funds and investments: Funds held for clients were $22.650 billion against $21.821 billion of client-fund obligations. Approximately 86% of available-for-sale securities were rated AAA or AA, and all were investment grade.
- Shareholder returns: ADP declared dividends of $0.34 per share, versus $0.33 a year earlier, and paid $168.0 million in dividends. It repurchased approximately 1.2 million shares for $49.8 million.
Material changes versus the prior-year quarter
- Revenue growth was led by Employer Services and PEO Services, with acquisitions contributing to reported growth; ADP estimated revenue would have risen about 4% without recent acquisitions.
- Expenses increased faster than revenue, reducing pretax margin by one percentage point. Net earnings from continuing operations declined, while diluted continuing-operations EPS held steady.
- Employer Services cited improved client retention, 1.7% growth in pays per control and increased use of “beyond payroll” services. PEO worksite employees rose 9% on average, but the prior-year comparison benefited from a $9.2 million state-unemployment settlement.
- Dealer Services’ reported revenue included $32.2 million from acquisitions; excluding acquisitions, segment revenue growth was approximately 1%. Dealership closures and cost pressure contributed to client losses.
- Operating cash flow declined, with higher pension contributions and bonus payments partly offset by tax refunds and collection timing. Investing and financing cash flows were heavily affected by client-fund balances and timing.
Outlook, commentary, risks and unusual items
- Outlook: ADP provided no overall earnings or revenue guidance in the supplied filing text. It expected fiscal 2011 capital expenditures of $160 million to $180 million, versus $90.2 million in fiscal 2010.
- Acquisitions: ADP acquired Cobalt for approximately $402.5 million net of cash acquired, plus two other businesses for approximately $72.8 million, during the quarter. Three additional businesses were acquired after quarter-end for approximately $125 million; these were not expected to be material.
- Unusual items: ADP recorded an $8.6 million impairment charge on two buildings classified as held for sale and a $1.8 million gain on building sales. Prior-year results included $5.3 million of securities impairment and a $9.2 million PEO state-unemployment settlement benefit.
- Interest-rate sensitivity: Portfolio yield declined to 3.5% from 3.8%. ADP estimated that a 25-basis-point change in short- and intermediate-term rates would affect pretax earnings by approximately $9 million over the following 12 months; a 25-basis-point change in short-term rates alone would have an estimated $4 million effect.
- Risks and contingencies: Key disclosed risks include client retention and sales, pricing, employment and wage levels, interest rates, foreign currency, competition, technology, regulation, auto-industry conditions and acquisitions. A purported California class action alleges unlawful handling of certain client calls; ADP intended to defend the case and cited a vendor indemnification right, but said potential exposure was too early to determine. ADP did not expect other litigation or product/service warranty matters to have a material impact.
- Contract and controls: Broadridge will not extend its outsourcing agreement beyond June 30, 2012; ADP did not then anticipate a material impact. Management concluded disclosure controls were effective as of September 30, 2010, with no material change in internal control over financial reporting reported during the quarter.
Important facts for investors to verify
- Whether expense growth moderates and margins recover after the quarter’s acquisition and service-cost increases.
- Organic growth and profitability trends in PEO Services and Dealer Services, including PEO’s prior-year settlement comparison and dealership client losses.
- Cash generation and working capital excluding client-fund balances; client-fund assets and obligations should be assessed separately from corporate liquidity.
- Integration, purchase accounting and returns from Cobalt and other acquisitions, including the post-quarter acquisitions.
- The effects of lower interest rates on client-fund and corporate investment income, and continued access to short-term funding markets.
- Developments in the California lawsuit and the expected transition following the Broadridge agreement’s expiration.
- Whether fiscal 2011 capital expenditures fall within the stated $160 million to $180 million range.