Automatic Data Processing (NASDAQ:ADP), the largest payroll processing and human capital management solutions provider in the U.S., released its earnings results for the fourth quarter fiscal year 2014 (fiscal year ends June 30) on July 31 2014. Its fourth quarter revenue grew 8% year-on-year, to reach $3.07 billion, driven by 5% growth in new business bookings for its Employer and Professional Employer Organization (PEO) Services divisions.  However, declining interest earned from client funds partially tempered growth.
For the full fiscal year 2014, ADP’s revenue grew 8%, in line with the company’s guidance. The company’s net earnings for the quarter grew 27%, to reach $288.7 million, driving 30% growth in earnings per share. Full fiscal year 2014 earnings per share grew 9%. Along with the fiscal year 2014 results, ADP also shared its outlook for the fiscal year 2015, indicating high-single digit revenue growth. However, the growth includes the contribution of it’s soon to be spun off Dealer Services segment.
Client retention and worksite employees growth drive Employer and PEO Services
Growth in jobs during the quarter ending June 30 2014 helped drive ADP’s Employer and PEO Services divisions. According to ADP’s monthly national employment report, over 680,000 jobs  were added to the private sector during the quarter, driving 2.8% growth in Employer Services’ employees per client. The increase in employees per client helped boost Employer Services’ revenue by 8% during the fourth quarter fiscal year 2014. Client retention rate, which indicates the percentage of clients continuing to avail ADP’s Employer services every year, reached an all time high at 91.4%. This bodes well for ADP since it will ensure a regular stream of revenue in the future.
Revenue from PEO services grew 19% driven by 15% growth in average worksite employees during the fourth quarter.  Worksite employees are employees co-employed by ADP and its clients in order to facilitate outsourced human resource services at the client’s location. For the full fiscal year, revenues from PEO services grew 15%.
Interest on funds held for clients continues to drag revenues
For the past few years, low interest rates in the U.S. have led to consistent declines in ADP’s interest earned on client funds. The company earned $684 million as interest on client funds in fiscal year 2008, which declined to $421 million in fiscal year 2013, even as average client fund balances increased from $15.5 billion to $19.2 billion over the same period.
In the fourth quarter, ADP’s interest on funds held for clients declined 5% year-over-year to reach $95.1 million due to a 20 basis point decrease in the average interest yield to 1.7%.  However, this was partially offset by a 7% increase in average funds held for clients from $20.4 billion to $21.8 billion. For the full fiscal year, interest on funds held for clients declined 11%, to reach $373.7 million, partially offset by an increase of 8% in average client funds balances from $19.2 billion to $20.7 billion.
We expect the low interest rate scenario to continue in the short term and present headwinds for ADP’s interest earned on funds held for clients. However, once the Quantitative Easing program in the U.S. comes to an end in late 2014, the Fed may begin to increase rates in mid-2015.  This may help drive growth in ADP’s interest earned on funds held for clients.
Strong performing Dealer Services segment will soon become an independent company
The growing U.S. automotive industry helped ADP add new clients to its Dealer Services segment, which drove up the segment’s revenue by 8% in the fourth quarter, partially tempered by weakness in European markets.  Higher digital advertising revenue also contributed to the growth. ADP’s Dealer Services provides integrated dealer management systems, digital marketing solutions, and other business management solutions to auto, truck, motorcycle, marine, recreational vehicle (RV), and heavy equipment retailers, distributors, and manufacturers.
In April 2014, ADP decided to spin off its Dealer Services segment into an independent publicly-traded company. The rationale behind the decision was that it will enable the two separate entities to focus on their core businesses. ADP will solely focus on human capital management and Dealer services on automobile dealer management and marketing solutions. ADP will rake in $700 million from the spin-off, which will be utilized to repurchase its own shares. However, we can expect to see a 15%-16% decline in ADP’s quarterly revenues once the spin-off is completed by October 2014. The deal comes with its own costs, of which $15 million was incurred in the fourth quarter.  Additional spin-related expenses of approximately $40-$50 million will be recorded in discontinued operations in fiscal 2015.
Outlook for 2015
Following these results, ADP has announced its outlook for fiscal year 2015. The management expects revenues to grow 7-8%, with new business bookings increasing 8-10%.  The revenue growth takes into account the anticipated 7-8% growth in Dealer Services segment for the fiscal year 2015. Employer services are expected to grow by 6-7% driven by 2-3% growth in pays per control metric. Additionally, PEO services are expected to grow 13-15%. Interest on funds held for clients is expected to increase $5-$15 million based on an anticipated growth in average client funds balances of approximately 5-7%. However, this may be partially offset by decline of up to 10 basis points in the expected average interest yield to 1.7-1.8%
We are in the process of updating our $64 price estimate for ADP based on the recent results.Notes: