Business context and reporting period
Automatic Data Processing, Inc. (ADP) filed this unaudited Form 10-Q for the quarter and nine months ended March 31, 2017, its fiscal 2017 third quarter. The request metadata says “2016 Q3,” but the filing itself covers 2017 Q3. ADP provides human capital management services, principally through Employer Services and PEO Services.
Financial performance
| Metric | Three months ended March 31, 2017 | Nine months ended March 31, 2017 |
|---|---|---|
| Total revenue | $3.411 billion, up 5% | $9.315 billion, up 6% |
| Continuing-operations earnings before tax | $827.9 million, up 4%; 24.3% margin versus 24.5% | $2.143 billion, up 19%; 23.0% margin versus 20.6% |
| Net earnings from continuing operations | $587.9 million, up 10% | $1.468 billion, up 21% |
| Diluted continuing-operations EPS | $1.31, up 12% | $3.25, up 24% |
| Operating cash flow | Not provided for the quarter | $1.669 billion, versus $1.234 billion |
| Capital expenditures | Not provided for the quarter | $174.5 million in cash-flow statement; $180.2 million for continuing operations in MD&A |
Nine-month adjusted diluted EPS was $3.04, up 19%, excluding specified gains and Service Alignment Initiative charges. Adjusted EBIT margin was 21.6%, versus 20.4%. These are non-GAAP measures; reported nine-month results benefited materially from the divestiture gain described below.
At March 31, 2017, cash and cash equivalents were $2.996 billion and long-term debt was $2.003 billion. Corporate investments totaled $3.006 billion, including cash and marketable securities. Funds held for clients were $33.887 billion, against client-fund obligations of $33.817 billion; these restricted client funds are not general corporate liquidity. Stockholders’ equity was $4.103 billion.
Nine-month cash flows included $867.0 million used in investing and $986.5 million used in financing; cash declined $195.6 million to $2.996 billion. Investing and financing comparisons with 2016 are substantially affected by movements in restricted client funds and the prior-period $2.0 billion debt issuance.
Material changes versus the prior comparable period
- Employer Services revenue grew 4% year to date; PEO Services revenue grew 12%. PEO Services’ average worksite employee count also rose 12%.
- ADP’s November 2016 sale of its CHSA and COBRA businesses generated a $205.4 million pretax gain, included in nine-month other income. The businesses were not classified as discontinued operations. The gain contributed to reported earnings growth; adjusted results exclude it.
- New business bookings declined 5% year to date, which management attributed to unusually strong ACA-related demand in the prior-year period. Revenue retention declined 80 basis points year to date, mainly from elevated losses on legacy platforms and the anticipated loss of a large former CHSA client; quarterly retention declined 170 basis points.
- The effective tax rate fell to 29.0% for the quarter from 33.0%, and to 31.5% year to date from 33.0%. Prior-year tax incentives and the adoption of stock-compensation accounting guidance contributed to the decline. The new guidance provided tax benefits of $9.5 million for the quarter and $29.9 million year to date.
Outlook, management commentary, risks and unusual items
- Management said its pipeline for future bookings remained strong, citing investment in strategic platforms, product innovation and service capabilities. It also identified client retention, especially on legacy platforms, as an area of focus. No specific revenue or EPS guidance was provided in the supplied filing text.
- ADP expects $100 million–$125 million of pretax Service Alignment Initiative charges through fiscal 2018. It recorded $41.6 million in the first nine months of fiscal 2017; the initiative includes employee separation, relocation, lease and accelerated-depreciation costs.
- Fiscal 2017 capital expenditures were expected to be about $250 million, compared with $165.7 million in fiscal 2016.
- Management said corporate liquidity and committed facilities were expected to support operations, investment, dividends and repurchases. ADP reported $9.25 billion of committed credit facilities, with no facility borrowings or commercial paper outstanding at March 31, 2017. Client-fund funding depends in part on access to short-term financing and timely liquidity in the investment portfolio.
- Market risks include changes in interest rates, security values, credit conditions and foreign exchange rates. A hypothetical 25-basis-point rate change was estimated to affect pretax earnings by about $12 million over the following 12 months when applied to short- and intermediate-term rates, or about $7 million for short-term rates alone. ADP reported that all available-for-sale securities were investment grade and approximately 81% were rated AAA or AA.
- A patent infringement lawsuit filed by Uniloc in July 2016 seeks unspecified damages and injunctive relief. ADP said it could not estimate a reasonably possible loss or range; it intends to defend the case. Management said other claims were not expected to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors.
- Other notable items include $956.8 million of share repurchases and $739.4 million of dividends paid year to date, and the January 2017 acquisition of The Marcus Buckingham Company. The two acquisitions during the nine-month period were described as immaterial to consolidated results.
Most important facts for investors to verify
- Confirm the period: this is the quarter ended March 31, 2017, not 2016 Q3.
- Assess underlying growth and profitability separately from the $205.4 million divestiture gain and the Service Alignment Initiative costs; reconcile reported and adjusted measures.
- Track bookings and retention trends, particularly whether legacy-platform client losses moderate and whether strategic-platform retention remains strong.
- Review the distinction between unrestricted corporate liquidity and client funds, as well as short-term funding access and the June 2017 maturity of the 364-day credit agreement.
- Monitor execution and total costs of the Service Alignment Initiative, the capital spending outlook, and the outcome or developments in the Uniloc litigation.