filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This document and other written or oral statements made from time to time by ADP may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could” “is designed to” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and depend upon or refer to future events or conditions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements or that could contribute to such difference include: ADP's success in obtaining, and retaining clients, and selling additional services to clients; the pricing of products and services; the success of our new solutions; compliance with existing or new legislation or regulations; changes in, or interpretations of, existing legislation or regulations; overall market, political and economic conditions, including interest rate and foreign currency trends; competitive conditions; our ability to maintain our current credit ratings and the impact on our funding costs and profitability; security or cyber breaches, fraudulent acts, and system interruptions and failures; employment and wage levels; changes in technology; availability of skilled technical associates; the impact of new acquisitions and divestitures; and the adequacy, effectiveness and success of our business transformation initiatives. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. These risks and uncertainties, along with the risk factors discussed under “Item 1A. Risk Factors,” and in other written or oral statements made from time to time by ADP, should be considered in evaluating any forward-looking statements contained herein.
EXECUTIVE OVERVIEW
We are a leading global provider of cloud-based Human Capital Management (“HCM”) technology solutions - including payroll, talent management, Human Resources management, benefits administration, and workforce management - to employers around the world. As a leader in this industry, we deliver on our global HCM strategy and invest in highly strategic
areas and technology in order to strengthen our underlying business model and prospects for continued growth.
Highlights from the year ended June 30, 2019 (“fiscal 2019”) include:
| • | Employer Services New Business Bookings increased 8% |
| • | Average number of Worksite Employees increased 8% to 547,000 |
| • | Revenue increased 6% |
| • | EBIT Margin improved 410 basis points to 21.2% and Adjusted EBIT Margin improved 160 basis points to 22.3% |
| • | Diluted earnings per share (“EPS”) increased 23% to $5.24; adjusted diluted EPS increased 20% to $5.45 |
| • | Our shareholder friendly actions continued as we returned approximately $1.3 billion via dividends and approximately $940 million via share repurchases |
In fiscal 2019, we launched our new brand platform which represents an evolution in our journey to enhance the employee experience through innovation and insights designed with the worker as a central theme. At ADP, we are always designing for people and we continue to innovate by anticipating our clients' evolving needs as the world of work changes. We are reshaping the HCM industry with leading innovations like our next gen platforms and driving growth through our strategic cloud-based HCM solutions. We are further enabling these solutions through strategic acquisitions such as Global Cash Card, Work Market and Celergo, which we supplement with organic, differentiated investments such as the ADP Marketplace and ADP Datacloud, and through our compliance expertise.
With these investments, we are enhancing our position as a leading global HCM provider that can help businesses address the entire worker spectrum from full-time to freelancer through hire to retire. As the HCM market continues to evolve rapidly, we remain focused on rethinking a better, more personalized world at work and helping our clients and their workers achieve their full potential.
As we continue our transformation journey, our Voluntary Early Retirement Program (“VERP”) and Workforce Optimization initiatives are yielding operating efficiencies in conjunction with our Service Alignment Initiatve, which is focused on changing how we work. Through our transformation initiatives, we remain on track to continue to deliver balanced revenue growth, profit growth and margin expansion, and ultimately drive long-term shareholder value.
We are pleased with our progress and execution on these initiatives while also delivering improvements in our client satisfaction scores yielding an improvement in Employer Services revenue retention of 40 basis points to 90.8%. Also, our Employer Services New Business Bookings increased 8% in fiscal 2019, as compared to fiscal 2018, and our PEO Services' average number of Worksite Employees increased 8% to 547,000 in fiscal 2019, as compared to fiscal 2018.
We have a strong business model and operate in a growing global market. We continue to generate a high percentage of recurring revenues, healthy and improving margins, and consistent strong cash flows. Our financial condition and balance sheet remain solid at June 30, 2019. Through our investments in technology, service, and distribution, we are positioned to maintain our positive momentum into fiscal 2020.
RESULTS OF OPERATIONS
ANALYSIS OF CONSOLIDATED OPERATIONS
Prior period amounts have been restated for the impact of certain accounting standards adopted (refer to Note 1 of our Consolidated Financial Statements for additional information).
(In millions, except per share amounts)
| Years Ended | % Change | |||||||||||||||||||||||
| June 30, | Constant Currency Basis | |||||||||||||||||||||||
| 2018 | 2017 | 2018 | 2018 | |||||||||||||||||||||
| 2019 | *As Restated | *As Restated | 2019 | *As Restated | 2019 | *As Restated | ||||||||||||||||||
| Total revenues | $ | 14,175.2 | $ | 13,327.7 | $ | 12,372.0 | 6 | % | 8 | % | 7 | % | 7 | % | ||||||||||
| Costs of revenues: | ||||||||||||||||||||||||
| Operating expenses | 7,145.9 | 6,901.0 | 6,386.2 | 4 | % | 8 | % | 5 | % | 7 | % | |||||||||||||
| Systems development and programming costs | 636.3 | 635.4 | 632.1 | — | % | 1 | % | 2 | % | (1 | )% | |||||||||||||
| Depreciation and amortization | 304.4 | 274.5 | 226.2 | 11 | % | 21 | % | 12 | % | 20 | % | |||||||||||||
| Total costs of revenues | 8,086.6 | 7,810.9 | 7,244.5 | 4 | % | 8 | % | 5 | % | 7 | % | |||||||||||||
| Selling, general and administrative costs | 3,064.2 | 2,959.4 | 2,773.8 | 4 | % | 7 | % | 4 | % | 6 | % | |||||||||||||
| Interest expense | 129.9 | 102.7 | 80.0 | n/m | n/m | n/m | n/m | |||||||||||||||||
| Total expenses | 11,280.7 | 10,873.0 | 10,098.3 | 4 | % | 8 | % | 5 | % | 7 | % | |||||||||||||
| Other (income)/expense, net | (111.1 | ) | 172.1 | (343.2 | ) | n/m | n/m | n/m | n/m | |||||||||||||||
| Earnings before income taxes | $ | 3,005.6 | $ | 2,282.6 | $ | 2,616.9 | 32 | % | (13 | )% | 32 | % | (14 | )% | ||||||||||
| Margin | 21.2 | % | 17.1 | % | 21.2 | % | ||||||||||||||||||
| Provision for income taxes | $ | 712.8 | $ | 397.7 | $ | 829.1 | 79 | % | (52 | )% | 80 | % | (53 | )% | ||||||||||
| Effective tax rate | 23.7 | % | 17.4 | % | 31.7 | % | ||||||||||||||||||
| Net earnings | $ | 2,292.8 | $ | 1,884.9 | $ | 1,787.8 | 22 | % | 5 | % | 22 | % | 4 | % | ||||||||||
| Diluted earnings per share | $ | 5.24 | $ | 4.25 | $ | 3.97 | 23 | % | 7 | % | 24 | % | 6 | % |
*See Note 1 of the Consolidated Financial Statements for a summary of adjustments.
n/m - not meaningful
Note 1. Non-GAAP measures
In addition to our GAAP results, we use the adjusted results and other non-GAAP metrics set forth in the table below to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods:
| Adjusted Financial Measures | U.S. GAAP Measures |
| Adjusted EBIT | Net earnings |
| Adjusted provision for income taxes | Provision for income taxes |
| Adjusted net earnings | Net earnings |
| Adjusted diluted earnings per share | Diluted earnings per share |
| Adjusted effective tax rate | Effective tax rate |
| Constant Currency Basis | U.S. GAAP P&L line items |
We believe that the exclusion of the identified items helps us reflect the fundamentals of our underlying business model and analyze results against our expectations and against prior period, and to plan for future periods by focusing on our underlying operations. We believe that the adjusted results provide relevant and useful information for investors because it allows investors to view performance in a manner similar to the method used by management and improves their ability to understand and assess our operating performance. The nature of these exclusions are for specific items that are not fundamental to our underlying business operations. Since these adjusted financial measures and other non-GAAP metrics are not measures of performance calculated in accordance with U.S. GAAP, they should not be considered in isolation from, as a substitute for, or superior to their corresponding U.S. GAAP measures, and they may not be comparable to similarly titled measures at other companies.
| Years Ended | % Change | |||||||||||||||||||||||
| June 30, | Constant Currency Basis (h) | |||||||||||||||||||||||
| 2018 | 2017 | 2018 | 2018 | |||||||||||||||||||||
| 2019 | *As Restated | *As Restated | 2019 | *As Restated | 2019 | *As Restated | ||||||||||||||||||
| Net earnings | $ | 2,292.8 | $ | 1,884.9 | $ | 1,787.8 | 22 | % | 5 | % | 22 | % | 4 | % | ||||||||||
| Adjustments: | ||||||||||||||||||||||||
| Provision for income taxes | 712.8 | 397.7 | 829.1 | |||||||||||||||||||||
| All other interest expense (a) | 59.9 | 59.4 | 59.3 | |||||||||||||||||||||
| All other interest income (a) | (32.4 | ) | (25.5 | ) | (22.4 | ) | ||||||||||||||||||
| Gain on sale of businesses | — | — | (205.4 | ) | ||||||||||||||||||||
| Gain on sale of assets | (15.7 | ) | — | — | ||||||||||||||||||||
| Transformation initiatives (b) | 138.3 | 404.8 | 85.0 | |||||||||||||||||||||
| Proxy contest matters (c) | — | 33.3 | — | |||||||||||||||||||||
| Adjusted EBIT | $ | 3,155.7 | $ | 2,754.6 | $ | 2,533.4 | 15 | % | 9 | % | 15 | % | 7 | % | ||||||||||
| Adjusted EBIT Margin | 22.3 | % | 20.7 | % | 20.5 | % | ||||||||||||||||||
| Provision for income taxes | $ | 712.8 | $ | 397.7 | $ | 829.1 | 79 | % | (52 | )% | 80 | % | (53 | )% | ||||||||||
| Adjustments: | ||||||||||||||||||||||||
| Gain on sale of businesses (d) | — | — | (84.0 | ) | ||||||||||||||||||||
| Gain on sale of assets (e) | (3.9 | ) | — | — | ||||||||||||||||||||
| Transformation initiatives (e) | 34.5 | 122.1 | 32.0 | |||||||||||||||||||||
| Proxy contest matters (e) | — | 10.4 | — | |||||||||||||||||||||
| Tax Cuts and Jobs Act (f) | 0.5 | 183.2 | — | |||||||||||||||||||||
| Adjusted provision for income taxes | $ | 743.9 | $ | 713.4 | $ | 777.1 | 4 | % | (8 | )% | 4 | % | (9 | )% | ||||||||||
| Adjusted effective tax rate (g) | 23.8 | % | 26.2 | % | 31.1 | % | ||||||||||||||||||
| Net earnings | $ | 2,292.8 | $ | 1,884.9 | $ | 1,787.8 | 22 | % | 5 | % | 22 | % | 4 | % | ||||||||||
| Adjustments: | ||||||||||||||||||||||||
| Gain on sale of businesses | — | — | (205.4 | ) | ||||||||||||||||||||
| Provision for income taxes on gain on sale of businesses (d) | — | — | 84.0 | |||||||||||||||||||||
| Gain on sale of assets | (15.7 | ) | — | — | ||||||||||||||||||||
| Provision for income taxes on gain on sale of assets (e) | 3.9 | — | — | |||||||||||||||||||||
| Transformation initiatives (b) | 138.3 | 404.8 | 85.0 | |||||||||||||||||||||
| Income tax benefit for transformation initiatives (e) | (34.5 | ) | (122.1 | ) | (32.0 | ) | ||||||||||||||||||
| Proxy contest matters (c) | — | 33.3 | — | |||||||||||||||||||||
| Income tax benefit for proxy contest matters (e) | — | (10.4 | ) | — | ||||||||||||||||||||
| Tax Cuts and Jobs Act (f) | (0.5 | ) | (183.2 | ) | — | |||||||||||||||||||
| Adjusted net earnings | $ | 2,384.3 | $ | 2,007.3 | $ | 1,719.4 | 19 | % | 17 | % | 19 | % | 15 | % | ||||||||||
| Diluted EPS | $ | 5.24 | $ | 4.25 | $ | 3.97 | 23 | % | 7 | % | 24 | % | 6 | % | ||||||||||
| Adjustments: | ||||||||||||||||||||||||
| Gain on sale of businesses (d) | — | — | (0.27 | ) | ||||||||||||||||||||
| Gain on sale of assets (e) | (0.03 | ) | — | — | ||||||||||||||||||||
| Transformation initiatives (b) (e) | 0.24 | 0.64 | 0.12 | |||||||||||||||||||||
| Proxy contest matters (c) (e) | — | 0.05 | — | |||||||||||||||||||||
| Tax Cuts and Jobs Act (f) | — | (0.41 | ) | — | ||||||||||||||||||||
| Adjusted diluted EPS | $ | 5.45 | $ | 4.53 | $ | 3.82 | 20 | % | 19 | % | 21 | % | 17 | % |
*See Note 1 of the Consolidated Financial Statements for a summary of adjustments.
(a) We include the interest income earned on investments associated with our client funds extended investment strategy and interest expense on borrowings related to our client funds extended investment strategy as we believe these amounts to be
fundamental to the underlying operations of our business model. The adjustments in the table above represent the interest income and interest expense that are not related to our client funds extended investment strategy and are labeled as “All other interest expense” and “All other interest income.”
(b) The charges within transformation initiatives are comprised of charges related to our VERP, Service Alignment Initiative, Workforce Optimization and other transformation initiatives. Charges related to our VERP in fiscal 2019 include $48.2 million for non-cash pension settlement charges and special termination benefits, and $23.6 million of expenses related to the continuing health coverage, respectively. We also recorded severance charges in accordance with ASC 712 totaling $33.6 million primarily relating to our Workforce Optimization initiative to reduce management layers and increase spans of controls and $56.8 million related to our other transformation initiatives during fiscal 2019. These charges were partially offset by net reversals of charges and gain on sale of assets related to our Service Alignment Initiative totaling $23.9 million for fiscal 2019. Unlike certain other severance charges in prior periods which are not included as an adjustment to get to adjusted results, these specific charges relate to actions that are part of our broad-based, company-wide transformation initiatives. Refer to Note 5 and 12 of the Consolidated Financial Statements for a description of charges associated with Service Alignment Initiative and VERP.
(c) Represents non-operational costs relating to proxy contest matters.
(d) The taxes on the gains on the sale of the businesses were calculated based on the annualized marginal rate in effect during the quarter of the adjustment. The tax amount was adjusted for a book vs. tax basis difference for the year ended June 30, 2017 due to the derecognition of goodwill upon the sale of the business.
(e) The tax benefit/provision on the transformation initiatives, gain on sale of asset, and non-operational charges related to proxy contest matters was calculated based on the annualized marginal rate in effect during the quarter of the adjustment.
(f) The net benefit for fiscal 2018 is comprised of the re-measurement of deferred tax balances resulting in a one-time benefit, primarily as a result of ASC 606, using the lower tax rates enacted under the Tax Cuts and Jobs Act (“Act”), adjustments to the one-time transition tax on the earnings and profits of our foreign subsidiaries, foreign withholding taxes, and a valuation allowance against our foreign tax credits which may not be realized under the Act. Refer to Note 13 of our Consolidated Financial Statements for additional detail.
(g) The Adjusted effective tax rate is calculated as our Adjusted provision for income taxes divided by our Adjusted net earnings plus our Adjusted provision for income taxes.
(h) “Constant currency basis” provides information that isolates the actual growth of our operations. “Constant currency basis” is determined by calculating the current year result using foreign exchange rates consistent with the prior year.
Fiscal 2019 Compared to Fiscal 2018
Total Revenues
Our revenues increased 6% in fiscal 2019, as compared to fiscal 2018. Our revenue growth includes one percentage point of pressure from foreign currency partially offset by benefits from acquisitions. Revenues in fiscal 2019 increased primarily due to new business started from Employer Services New Business Bookings and continued strong retention. Refer to “Analysis of Reportable Segments” for additional discussion of the increases in revenue for both of our reportable segments, Employer Services and Professional Employer Organization (“PEO”) Services.
Total revenues in fiscal 2019 include interest on funds held for clients of $561.9 million, as compared to $466.5 million in fiscal 2018. The increase in the consolidated interest earned on funds held for clients resulted from the increase in our average interest rate earned to 2.2% in fiscal 2019, as compared to 1.9% in fiscal 2018, coupled with the increase in our average client funds balances of 4.6% to $25.5 billion in fiscal 2019 as compared to fiscal 2018.
Total Expenses
Our total expenses increased 4% in fiscal 2019, as compared to fiscal 2018. The increase is primarily due to an increase in PEO Services zero-margin benefits pass-through costs, costs related to our acquisitions, increased selling and marketing expenses related to our brand efforts and the impact of net charges related to our transformation initiatives. The increase was partially offset by the impact of foreign currency, operating efficiencies as a result of our continued successful execution on our broader transformation initiatives, and costs related to proxy contest matters in fiscal 2018.
Operating expenses increased 4% in fiscal 2019, as compared to fiscal 2018. PEO Services zero-margin benefits pass-through costs were $2,712.5 million for fiscal 2019 and $2,463.1 million for fiscal 2018. Additionally, operating expenses increased due to costs related to our acquisitions partially offset by the impact of foreign currency and operating efficiencies as a result of our continued successful execution on our broader transformation initiatives.
Systems development and programming costs were flat for fiscal 2019, as compared to fiscal 2018, due to the impact of foreign currency translation and reduced costs as a result of our transformation initiatives offset by increased investments in product innovation, primarily in our next gen platforms.
Selling, general and administrative expenses increased 4% in fiscal 2019, as compared to fiscal 2018. The increase was primarily due to increased selling and marketing expenses related to our brand efforts and increased costs related to our transformation initiatives and acquisitions. These increases were partially offset by efficiencies as a result of our transformation initiatives, the impact of foreign currency translation in fiscal 2019 and costs related to proxy contest matters in fiscal 2018.
Other (Income)/Expense, net
| (In millions) | ||||||||||||
| Years ended June 30, | 2019 | 2018 | $ Change | |||||||||
| Interest income on corporate funds | $ | (97.6 | ) | $ | (83.5 | ) | $ | 14.1 | ||||
| Realized gains on available-for-sale securities | (1.8 | ) | (2.0 | ) | (0.2 | ) | ||||||
| Realized losses on available-for-sale securities | 2.7 | 4.5 | 1.8 | |||||||||
| Impairment of intangible assets | 12.1 | — | (12.1 | ) | ||||||||
| Gain on sale of assets | (4.1 | ) | (0.7 | ) | 3.4 | |||||||
| Gain on sale of investment | (15.7 | ) | — | 15.7 | ||||||||
| Non-service components of pension expense, net | (6.7 | ) | 253.8 | 260.5 | ||||||||
| Other (income)/expense, net | $ | (111.1 | ) | $ | 172.1 | $ | 283.2 |
During fiscal 2019, we retrospectively adopted Accounting Standards Update (“ASU”) 2017-07 and as a result we reclassified the non-service cost components of the net periodic benefit cost from within the respective line items of our Statement of Consolidated Earnings to Other (income)/expense, net. During fiscal 2019, non-service components of pension expense included $48.2 million of non-cash settlement charges and special termination benefits, partially offset by $54.9 million related to other components of net periodic pension cost. See Note 1 and Note 12 of our Consolidated Financial Statements for additional details.
Other (income)/expense, net, increased $283.2 million in fiscal 2019, as compared to fiscal 2018. The increase was primarily due to the charges within non-service components of pension expense in fiscal 2018 noted in the table above and the gain on sale of assets of $4.1 million in relation to the Service Alignment Initiative and the gain on sale of investment of $15.7 million in relation to the sale of an investment held at cost acquired in prior years and subsequently sold in fiscal 2019. These are partially offset by the write down of $12.1 million related to internally developed software which was determined to have no future use due to redundant software identified as part of a recent acquisition in fiscal 2019.
Earnings before Income Taxes
Earnings before income taxes increased 32% in fiscal 2019 primarily due to increases in revenues partially offset by increases in expenses discussed above.
Overall margin increased from 17.1% in fiscal 2018 to 21.2% in fiscal 2019 primarily due to operating efficiencies and aided by an increase in interest earned on funds held for clients, a decrease in charges of $266.5 million related to our transformation initiatives and the impact of costs related to proxy contest matters in fiscal 2018, partially offset by costs related to our acquisitions and incremental pressure from growth in our zero-margin benefits pass-throughs in fiscal 2019. The efficiencies driving margin performance are the result of our continued successful execution of our broader transformation initiatives, including VERP and improvements in our systems infrastructure spend and automation efforts.
Adjusted EBIT
In fiscal 2019, adjusted EBIT increased 15% due to increases in revenues offset by the increases in expenses discussed above. Overall adjusted EBIT margin increased due to continued execution of transformation initiatives discussed above and aided by an increase in interest earned on funds held for clients, partially offset by incremental pressure from growth in our zero-margin benefits pass-throughs and costs related to our acquisitions.
Provision for Income Taxes
The effective tax rate in fiscal 2019 and 2018 was 23.7% and 17.4%, respectively. The increase in the effective tax rate is primarily due to the one-time benefit recognized on the re-measurement of deferred tax balances, primarily as a result of ASC 606, using the lower tax rates enacted under the Act, the release of reserves for uncertain tax positions during fiscal 2018 and the loss of qualified production activities tax deductions as a result of the Act during fiscal 2019. This is partially offset by reduction in the federal corporate statutory tax rate to 21% from our blended rate for fiscal 2018 of 28.1% as a result of the Act. Refer to Note 13, Income Taxes, within the Notes to the Consolidated Financial Statements for further discussion.
Adjusted Provision for Income Taxes
The adjusted effective tax rate in fiscal 2019 and 2018 was 23.8% and 26.2%, respectively. The decrease in the adjusted effective tax rate is primarily due to the reduction in the federal corporate statutory tax rate to 21% from our blended rate for fiscal 2018 of 28.1%, partially offset by the loss of qualified production activities tax deductions as a result of the Act in fiscal 2019, the release of reserves for uncertain tax positions and the benefit of a tax accounting method change filed with the IRS in fiscal 2018.
Net Earnings and Diluted Earnings per Share
Net earnings increased 22% in fiscal 2019 when compared to fiscal 2018 due to an increase in earnings before income taxes described above partially offset by an increase in our effective tax rate.
Diluted earnings per share increased 23% in fiscal 2019 as a result of an increase in net earnings and the impact of fewer shares outstanding, resulting from the repurchase of approximately 6.5 million shares in fiscal 2019 and 8.5 million shares in fiscal 2018, partially offset by the issuances of shares under our employee benefit plans.
Adjusted Net Earnings and Adjusted Diluted Earnings per Share
Adjusted net earnings increased 19% in fiscal 2019, when compared to fiscal 2018, due to the increase in adjusted EBIT combined with the reduction in our adjusted effective tax rate described above.
For fiscal 2019, our adjusted diluted EPS increased 20% and reflects the changes described above in our net earnings and shares outstanding.
Fiscal 2018 Compared to Fiscal 2017
Total Revenues
Our revenues increased 8% in fiscal 2018, as compared to fiscal 2017. Our revenue growth includes two percentage points of combined benefit from foreign currency and acquisitions, partially offset by the impact of the disposition of our COBRA and CHSA businesses in fiscal 2017. Revenues in fiscal 2018 increased primarily due to new business started from Employer Services New Business Bookings. Refer to “Analysis of Reportable Segments” for additional discussion of the increases in revenue for both of our reportable segments, Employer Services and PEO Services.
Total revenues in fiscal 2018 include interest on funds held for clients of $466.5 million, as compared to $397.4 million in fiscal 2017. The increase in the consolidated interest earned on funds held for clients resulted from the increase in our average interest rate earned to 1.9% in fiscal 2018, as compared to 1.7% in fiscal 2017, coupled with the increase in our average client funds balances of 5.7% to $24.3 billion in fiscal 2018 as compared to fiscal 2017.
Total Expenses
Our total expenses increased 8% in fiscal 2018, as compared to fiscal 2017. The increase is primarily due to an increase in PEO Services zero-margin benefits pass-through costs, increased costs to service our client base in support of our growing revenue, and increases in selling expense. Total expenses also increased due to costs related to acquisitions, the impact of foreign currency, and costs related to proxy contest matters in fiscal 2018.
Operating expenses increased 8% in fiscal 2018, as compared to fiscal 2017. PEO Services zero-margin benefits pass-through costs were $2,463.1 million for fiscal 2018 and $2,173.9 million for fiscal 2017. Additionally, operating expenses increased due to costs related to acquisitions, higher costs to service our client base in support of our growing revenue as well as the impact of foreign currency.
Systems development and programming costs increased 1% in fiscal 2018, as compared to fiscal 2017, due to increased investments in product innovation and costs to develop, support, and maintain our products, impact of foreign currency translation, partially offset by a higher proportion of capitalized costs of our strategic projects.
Selling, general and administrative expenses increased 7% in fiscal 2018, as compared to fiscal 2017. The increase was primarily due to increases in selling expense to support our 8% new business bookings growth, charges related to our transformation initiatives, costs related to acquisitions, costs related to proxy contest matters, and the impact of foreign currency translation.
Other Expense/(Income), net
| (In millions) | ||||||||||||
| Years ended June 30, | 2018* | 2017* | $ Change | |||||||||
| Interest income on corporate funds | $ | (83.5 | ) | $ | (76.7 | ) | $ | 6.8 | ||||
| Realized gains on available-for-sale securities | (2.0 | ) | (5.3 | ) | (3.3 | ) | ||||||
| Realized losses on available-for-sale securities | 4.5 | 3.1 | (1.4 | ) | ||||||||
| Gain on sale of businesses (see Note 4 of the Consolidated Financial Statements) | — | (205.4 | ) | (205.4 | ) | |||||||
| Gain on sale of assets | (0.7 | ) | — | 0.7 | ||||||||
| Non-service components of pension expense, net | 253.8 | (58.9 | ) | (312.7 | ) | |||||||
| Other expense/(income), net | $ | 172.1 | $ | (343.2 | ) | $ | (515.3 | ) |
*Restated for impact of ASU 2017-07.
During fiscal 2018, non-service components of pension expense included $319.6 million of special termination benefits related to our VERP, partially offset by $65.8 million related to other components of net periodic pension cost. See Note 1 and Note 12 of our Consolidated Financial Statements for additional details.
Other expense/(income), net, decreased $515.3 million in fiscal 2018, as compared to fiscal 2017. The decrease was primarily due to the charges within non-service components of pension expense discussed above in fiscal 2018 and the gain on sale of the CHSA and COBRA businesses of $205.4 million in fiscal 2017.
Earnings before Income Taxes
Earnings before income taxes decreased 13% primary due to $319.6 million related to the special termination benefit charges and $17.5 million of other charges related to our VERP in fiscal 2018 and the gain on the sale of the CHSA and COBRA businesses in fiscal 2017 offset by the increases in revenues and increases in expenses discussed above.
Overall margin decreased from 21.2% in fiscal 2017 to 17.1% in fiscal 2018 primarily due to $319.6 million related to the special termination benefit charges and $17.5 million of other charges related to our VERP in fiscal 2018, the gain on the sale of the CHSA and COBRA businesses in fiscal 2017, costs related to acquisitions and incremental pressure from growth in our zero-margin benefits pass-through revenues in fiscal 2018. These drivers were partially offset by operating and selling efficiencies in fiscal 2018.
Adjusted EBIT
In fiscal 2018, adjusted EBIT increased 9% due to the increases in revenues offset by the increases in expenses discussed above. Overall adjusted EBIT margin increased slightly due to operating and selling efficiencies offset by pressure from fiscal 2018 acquisitions and incremental pressure from growth in our zero-margin benefits pass-through revenues.
Provision for Income Taxes
The effective tax rate in fiscal 2018 and 2017 was 17.4% and 31.7%, respectively. The decrease in the effective tax rate is due to the one-time benefit recognized on the re-measurement of deferred tax balances, primarily as a result of ASC 606, using the lower tax rates enacted under the Act, the reduction in the federal corporate statutory tax rate to 28.1% from 35% as a result of the Act and the release of reserves for uncertain tax positions, partially offset by the impact in the prior period of the sale of the CHSA and COBRA businesses and the impact of the benefit due to tax incentives associated with the domestic production activity deduction and research tax credit in fiscal 2017. Refer to Note 13, Income Taxes, within the Notes to the Consolidated Financial Statements for further discussion.
Adjusted Provision for Income Taxes
The adjusted effective tax rate in fiscal 2018 and 2017 was 26.2% and 31.1%, respectively. The decrease in the adjusted effective tax rate is due to the reduction in the blended federal corporate statutory tax rate to 28.1% from 35% as a result of the Act and the release of reserves for uncertain tax positions in fiscal 2018, partially offset by the impact of a benefit due to tax incentives associated with the domestic production activity deduction and research tax credit in fiscal 2017.
Net Earnings and Diluted Earnings per Share
Net earnings increased 5% in fiscal 2018 due to the reduction in our effective tax rate described above, offset by $319.6 million related to the special termination benefit charges and $17.5 million of other charges related to our VERP in fiscal 2018 and the gain on the sale of the CHSA and COBRA businesses in fiscal 2017.
Diluted earnings per share increased 7% as a result of an increase in net earnings and the impact of fewer shares outstanding, resulting from the repurchase of approximately 8.5 million shares in fiscal 2018 and 13.5 million shares in fiscal 2017, partially offset by the issuances of shares under our employee benefit plans.
Adjusted Net Earnings and Adjusted Diluted Earnings per Share
Adjusted net earnings increased 17% in fiscal 2018 due to the increase in adjusted EBIT combined with the reduction in our adjusted effective tax rate described above when compared to fiscal 2017.
For fiscal 2018, our adjusted diluted EPS increased 19% and reflects the changes described above in our adjusted net earnings and shares outstanding.
ANALYSIS OF REPORTABLE SEGMENTS
In the first quarter of fiscal 2019, our chief operating decision maker (“CODM”) began reviewing segment results reported at actual interest rates and the results of the PEO segment inclusive of the results of ADP Indemnity. Additionally, the CODM reviews results with the effects of changes to certain corporate allocations. These changes represent a change in the measure of segment performance. Effective July 1, 2018, we adopted ASC 606 (see Note 1 of the Consolidated Financial Statements). The segment results in the table below reflect the impacts of the adoption of ASC 606, the inclusion of client funds interest in our segments at actual interest rates, the inclusion of ADP Indemnity in the PEO segment, and changes to certain corporate allocations. We reflected these new segment measures beginning in fiscal 2019 and prior period segment results are restated for comparability.
Revenues
(In millions)
| Years Ended | % Change | |||||||||||||||||||||||
| June 30, | As Reported | Constant Currency Basis | ||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
| Employer Services | $ | 9,942.8 | $ | 9,454.8 | $ | 8,914.2 | 5 | % | 6 | % | 6 | % | 5 | % | ||||||||||
| PEO Services | 4,242.7 | 3,882.3 | 3,468.4 | 9 | % | 12 | % | 9 | % | 12 | % | |||||||||||||
| Other | (10.3 | ) | (9.4 | ) | (10.6 | ) | n/m | n/m | n/m | n/m | ||||||||||||||
| $ | 14,175.2 | $ | 13,327.7 | $ | 12,372.0 | 6 | % | 8 | % | 7 | % | 7 | % |
Earnings before Income Taxes
(In millions)
| Years Ended | % Change | |||||||||||||||||||||||
| June 30, | As Reported | Constant Currency Basis | ||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
| Employer Services | $ | 2,957.0 | $ | 2,598.1 | $ | 2,396.8 | 14 | % | 8 | % | 14 | % | 7 | % | ||||||||||
| PEO Services | 620.1 | 544.6 | 463.4 | 14 | % | 18 | % | 14 | % | 18 | % | |||||||||||||
| Other | (571.5 | ) | (860.1 | ) | (243.3 | ) | n/m | n/m | n/m | n/m | ||||||||||||||
| $ | 3,005.6 | $ | 2,282.6 | $ | 2,616.9 | 32 | % | (13 | )% | 32 | % | (14 | )% |
Employer Services
Fiscal 2019 Compared to Fiscal 2018
Revenues
Employer Services' revenues increased 5% in fiscal 2019, as compared to fiscal 2018. Revenues increased primarily due to new business started from New Business Bookings and continued strong retention. Our revenue growth includes one percentage point of pressure from foreign currency offset by benefits from acquisitions. Our revenues also increased due to the interest earned on funds held for clients, which benefited from improvement in the average yield earned on our client funds investments and growth in average client funds balances, and an increase in the number of employees on our clients' payrolls as our pays per control increased 2.7% in fiscal 2019, as compared to fiscal 2018. Our pays per control metric measures the number of employees on our clients' payrolls as measured on a same-store-sales basis utilizing a representative subset of payrolls ranging from small to large businesses that are reflective of a broad range of U.S. geographic regions. In addition, the Employer Services client revenue retention rate for fiscal 2019 improved 40 basis points to 90.8% as compared to our rate for fiscal 2018. This improvement was driven by higher retention across our cloud-based solutions and our focus on improving the client experience.
Earnings before Income Taxes
Employer Services’ earnings before income taxes increased 14% in fiscal 2019, as compared to fiscal 2018. The increase was due to increased revenues discussed above and partially offset by increases in expenses of $129.1 million, which were primarily due to increased selling and marketing expenses, costs related to acquisitions offset by operating efficiencies and impact from foreign currency.
Employer Services' overall margin increased from 27.5% to 29.7% for fiscal 2019, as compared to fiscal 2018. This increase is primarily due to operating efficiencies and aided by an increase in interest earned on funds held for clients, partially offset by increased costs related to our acquisitions. The efficiencies driving margin performance are the result of our continued successful execution of our broader transformation initiatives, including VERP and improvements in our systems infrastructure spend and automation efforts.
Fiscal 2018 Compared to Fiscal 2017
Revenues
Employer Services' revenues increased 6% in fiscal 2018, as compared to fiscal 2017. Revenues increased primarily due to new business started from new business bookings. Our revenue growth includes two percentage points of combined benefit from foreign currency and acquisitions, partially offset by the impact of the disposition of our COBRA and CHSA businesses in fiscal 2017. Our revenues also benefited from the impact of an increase in the number of employees on our clients’ payrolls as our pays per control increased 2.7% in fiscal 2018 as compared to fiscal 2017. Employer Services client revenue retention rate for fiscal 2018 improved 50 basis points to 90.4% as compared to our rate for fiscal 2017. This improvement was driven by higher retention across our cloud-based solutions, our focus on improving the client experience, and the loss of a large client within our former CHSA business in fiscal 2017.
Earnings before Income Taxes
Employer Services’ earnings before income taxes increased 8% in fiscal 2018, as compared to fiscal 2017. The increase was due to increased revenues discussed above, which was partially offset by an increase in expenses of $339.3 million, primarily due to investments in operational resources to support our revenue growth coupled with increased selling expenses in fiscal 2018.
Employer Services' overall margin increased from 26.9% to 27.5% for fiscal 2018, as compared to fiscal 2017. This 60 basis point increase was driven by operating efficiencies in fiscal 2018 partially offset by the impact of costs related to acquisitions.
PEO Services
Fiscal 2019 Compared to Fiscal 2018
Revenues
PEO Services' revenues increased 9% in fiscal 2019, as compared to fiscal 2018. PEO Services' revenues, excluding zero-margin benefits pass-through costs, increased from $1,419.2 million to $1,530.2 million for fiscal 2019. The increase was due to an 8% increase in the average number of Worksite Employees in fiscal 2019 driven by an increase in the number of new PEO Services clients and growth in our existing clients.
PEO Services' revenues includes zero-margin benefits pass-through costs associated with benefits coverage, which increased to $2,712.5 million in fiscal 2019 from $2,463.1 million in fiscal 2018.
Earnings before Income Taxes
PEO Services’ earnings before income taxes increased 14% in fiscal 2019, as compared to fiscal 2018. The increase was due to the increased revenues discussed above offset by an increase in expenses of $284.9 million. This increase in expenses was primarily related to an increase in zero-margin benefits pass-through costs of $249.4 million described above.
PEO Services' overall margin increased from 14.0% to 14.6% for fiscal 2019, as compared to fiscal 2018, due to operating efficiencies partially offset by increases in selling expenses and changes in our estimated incurred losses related to ADP Indemnity in fiscal 2019 as compared to fiscal 2018.
ADP Indemnity provides workers’ compensation and employer’s liability deductible reimbursement insurance protection for PEO Services’ worksite employees up to $1 million per occurrence. PEO Services has secured a workers’ compensation and employer’s liability insurance policy that has a $1 million per occurrence retention and, in fiscal years 2012 and prior, aggregate stop loss insurance that covers any aggregate losses within the $1 million retention that collectively exceed a certain level, from an admitted and licensed insurance company of AIG. The Company has obtained approximately $242 million of irrevocable standby letters of credit in favor of licensed insurance companies of AIG to secure TotalSource workers’ compensation obligations if ADP were to fail to reimburse AIG for workers’ compensation payments. The Company had no drawdowns during June 30, 2019 and 2018 under the letters of credit. We utilize historical loss experience and actuarial judgment to determine the estimated claim liability, and changes in estimated ultimate incurred losses are included in the PEO segment. ADP Indemnity recorded a pre-tax benefit of approximately $39 million in fiscal 2019, $40 million in fiscal 2018 and $20 million in fiscal 2017, which is primarily a result of changes in our estimated incurred losses. For the fiscal years 2013 to 2019, ADP Indemnity paid premiums to enter into reinsurance arrangements with ACE American Insurance Company, a wholly-owned subsidiary of Chubb Limited, to cover substantially all losses incurred by ADP Indemnity during these policy years. Each of these reinsurance arrangements limits our overall exposure incurred up to a certain limit. We believe the likelihood of ultimate losses exceeding this limit is remote. During fiscal 2019, ADP Indemnity paid a premium of $218.0 million to enter into a reinsurance arrangement with Chubb Limited to cover substantially all losses incurred by ADP Indemnity for the fiscal 2019 policy year to $1 million per occurrence related to the workers' compensation and employer's liability deductible reimbursement insurance protection for PEO Services' worksite employees. ADP Indemnity paid a premium of $215.0 million in July 2019 to enter into a reinsurance agreement with Chubb to cover substantially all losses incurred by ADP Indemnity for fiscal 2020 policy year on terms substantially similar to the fiscal 2019 reinsurance policy.
Fiscal 2018 Compared to Fiscal 2017
Revenues
PEO Services' revenues increased 12% in fiscal 2018, as compared to fiscal 2017. PEO Services' revenues excluding zero-margin benefits pass-through costs increased from $1,294.5 million to $1,419.2 million for fiscal 2018. The increase in revenues was due to a 9% increase in the average number of Worksite Employees, driven by an increase in the number of new PEO Services clients.
PEO Services' revenues includes zero-margin benefits pass-through costs associated with benefits coverage, which increased to $2,463.1 million in fiscal 2018 from $2,173.9 million in fiscal 2017.
Earnings before Income Taxes
PEO Services’ earnings before income taxes increased 18% in fiscal 2018, as compared to fiscal 2017. The increase was due to the increased revenues discussed above, which was partially offset by an increase in expenses of $332.7 million. This increase in expenses was primarily related to an increase in zero-margin benefits pass-through costs of $289.2 million.
PEO Services' overall margin increased from 13.4% to 14.0% for fiscal 2018, as compared to fiscal 2017, due to reductions in selling expenses and changes in our estimated incurred losses related to ADP Indemnity in fiscal 2018 as compared to fiscal 2017, partially offset by pressure from growth in our zero-margin benefits pass-through revenues.
For impact of ADP Indemnity to PEO services, refer to discussion above.
Other
The primary components of “Other” are certain corporate overhead charges and expenses that have not been allocated to the reportable segments, including corporate functions, costs related to our transformation office, non-recurring gains and losses, the elimination of intercompany transactions, and other interest expense.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
For corporate liquidity, we expect existing cash, cash equivalents, short-term marketable securities, long-term marketable securities, cash flow from operations together with our $10.3 billion of committed credit facilities and our ability to access both long-term and short-term debt financing from the capital markets will be adequate to meet our operating, investing, and financing activities such as regular quarterly dividends, share repurchases, and capital expenditures.
For client funds liquidity, we have the ability to borrow through our financing arrangements under our U.S. short-term commercial paper program and our U.S., Canadian and United Kingdom short-term reverse repurchase agreements, together with our $10.3 billion of committed credit facilities and our ability to use corporate liquidity when necessary to meet short-term funding requirements related to client funds obligations. Please see Quantitative and Qualitative Disclosures about Market Risk for a further discussion of the risks of our client funds investment strategy. See Note 10 of our Consolidated Financial Statements for a description of our short-term financing including commercial paper.
As of June 30, 2019, cash and cash equivalents were $1.9 billion, which were primarily invested in time deposits and money market funds.
Operating, Investing and Financing Cash Flows
Our cash flows from operating, investing, and financing activities, as reflected in the Statements of Consolidated Cash Flows for the years ended 2019, 2018, and 2017, are summarized as follows:
| (In millions) | Years ended June 30, | $ Change | ||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | ||||||||||||||||
| Cash provided by (used in): | ||||||||||||||||||||
| Operating activities | $ | 2,688.3 | $ | 2,515.2 | $ | 2,125.9 | $ | 173.1 | $ | 389.3 | ||||||||||
| Investing activities | (2,197.7 | ) | (2,504.6 | ) | (1,113.2 | ) | 306.9 | (1,391.4 | ) | |||||||||||
| Financing activities | (207.7 | ) | (1,655.9 | ) | (8,281.7 | ) | 1,448.2 | 6,625.8 | ||||||||||||
| Effect of exchange rate changes on cash, cash equivalents, restricted cash, and restricted cash equivalents | (28.8 | ) | 5.8 | (8.0 | ) | (34.6 | ) | 13.8 | ||||||||||||
| Net change in cash, cash equivalents, restricted cash, and restricted cash equivalents | $ | 254.1 | $ | (1,639.5 | ) | $ | (7,277.0 | ) | $ | 1,893.6 | $ | 5,637.5 |
Fiscal 2019 Compared to Fiscal 2018
Net cash flows provided by operating activities in fiscal 2019 and fiscal 2018 include cash payments for reinsurance agreements of $218.0 million and $235.0 million, respectively, which represent the policy premium for the entire fiscal year. The increase in operating cash provided is primarily due to growth in our business offset by a net decrease in the components of working capital as compared to fiscal 2018.
Net cash flows from investing activities changed due to lower payments made related to acquisitions, the timing of proceeds offset by purchases of corporate and client funds marketable securities of $91.8 million, and reduced capital expenditures, partially offset by the payments made related to acquisitions of intangible assets in fiscal 2019.
Net cash flows from financing activities changed primarily due to a net increase in the cash flow from client funds obligations of $1,355.6 million, which is due to the timing of impounds from our clients and payments to our clients' employees and other payees, more cash returned to shareholders via dividends in fiscal 2019, partially offset by an increase in net proceeds from reverse repurchase agreements and less cash paid for share repurchases.
We purchased approximately 6.5 million shares of our common stock at an average price per share of $143.02 during fiscal 2019, as compared to purchases of 8.5 million shares at an average price per share of $116.07 during fiscal 2018. From time to time, the Company may repurchase shares of its common stock under its authorized share repurchase program. The Company
considers several factors in determining when to execute share repurchases, including, among other things, actual and potential acquisition activity, cash balances and cash flows, issuances due to employee benefit plan activity, and market conditions.
Fiscal 2018 Compared to Fiscal 2017
Net cash flows provided by operating activities in fiscal 2018 increased primarily due to growth in our underlying business (net income adjusted for non-cash adjustments such as the VERP in fiscal 2018 and the gain on the sale of COBRA and CHSA in fiscal 2017).
Net cash flows from investing activities changed due to the timing of proceeds offset by purchases of corporate and client funds marketable securities of $632.6 million, payments made related to acquisitions in fiscal 2018 and proceeds from the sale of the CHSA and COBRA businesses of $234.0 million in fiscal 2017.
Net cash flows from financing activities changed due to net increase in the cash flow from client funds obligations of $6,461.0 million, which is due to the timing of impounds from our clients and payments to our clients' employees and other payees and less cash paid for share repurchases.
We purchased approximately 8.5 million shares of our common stock at an average price per share of $116.07 during fiscal 2018 as compared to purchases of 13.5 million shares at an average price per share of $94.42 during fiscal 2017. The increased cash flow from client fund obligations and reduced share repurchases were partially offset by cash returned to shareholders via dividends, which increased by $68.5 million from fiscal 2017.
Capital Resources and Client Fund Obligations
We have $2.0 billion of senior unsecured notes with maturity dates in 2020 and 2025. We may from time to time revisit the long-term debt market to refinance existing debt, finance investments including acquisitions for our growth, and maintain the appropriate capital structure. However, there can be no assurance that volatility in the global capital and credit markets would not impair our ability to access these markets on terms acceptable to us, or at all. See Note 11 of our Consolidated Financial Statements for a description of our long-term financing.
Our U.S. short-term funding requirements related to client funds are sometimes obtained on an unsecured basis through the issuance of commercial paper, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. In June 2019, the Company increased its U.S. short-term commercial paper program to provide for the issuance of up to $10.3 billion from $9.8 billion in aggregate maturity value. Our commercial paper program is rated A-1+ by Standard and Poor’s and Prime-1 (“P-1”) by Moody’s. These ratings denote the highest quality commercial paper securities. Maturities of commercial paper can range from overnight to up to 364 days. In fiscal 2019 and 2018, our average daily borrowings were $2.8 billion at a weighted average interest rate of 2.2% and 1.4%, respectively. The weighted average maturity of our commercial paper during fiscal 2019 and 2018 was approximately two days. At June 30, 2019 and 2018, we had no outstanding obligations under our short-term commercial paper program.
Our U.S., Canadian, and United Kingdom short-term funding requirements related to client funds obligations are sometimes obtained on a secured basis through the use of reverse repurchase agreements, which are collateralized principally by government and government agency securities, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. These agreements generally have terms ranging from overnight to up to five business days. We have successfully borrowed through the use of reverse repurchase agreements on an as needed basis to meet short-term funding requirements related to client funds obligations. At June 30, 2019, the Company had $262.0 million of outstanding obligations related to the reverse repurchase agreements. All outstanding reverse repurchase obligations matured and were fully paid in early July 2019. At June 30, 2018, there were no outstanding obligations related to the reverse repurchase agreements. For fiscal 2019 and 2018, we had average outstanding balances under reverse repurchase agreements of $316.7 million and $374.4 million, respectively, at weighted average interest rates of 1.9% and 1.3%, respectively. See the Consolidated Balance Sheets of our Consolidated Financial Statements for client fund investments used as collateral for reverse repurchase agreements.
We vary the maturities of our committed credit facilities to limit the refinancing risk of any one facility. We have a $3.8 billion, 364-day credit agreement that matures in June 2020 with a one year term-out option. In addition, we have a five-year $3.75 billion credit facility and a five-year $2.75 billion credit facility maturing in June 2023 and June 2024, respectively, each with an accordion feature under which the aggregate commitment can be increased by $500 million, subject to the availability of additional commitments. The primary uses of the credit facilities are to provide liquidity to the commercial paper program and
funding for general corporate purposes, if necessary. We had no borrowings through June 30, 2019 under the credit facilities. We believe that we currently meet all conditions set forth in the revolving credit agreements to borrow thereunder, and we are not aware of any conditions that would prevent us from borrowing part or all of the $10.3 billion available to us under the revolving credit agreements. See Note 10 of our Consolidated Financial Statements for a description of our short-term financing including credit facilities.
Our investment portfolio does not contain any asset-backed securities with underlying collateral of sub-prime mortgages, alternative-A mortgages, sub-prime auto loans or sub-prime home equity loans, collateralized debt obligations, collateralized loan obligations, credit default swaps, derivatives, auction rate securities, structured investment vehicles or non-investment grade fixed-income securities. We own AAA rated senior tranches of fixed rate auto loan, credit card, equipment lease, and rate reduction receivables, secured predominantly by prime collateral. All collateral on asset-backed securities is performing as expected. In addition, we own senior debt directly issued by Federal Home Loan Banks and Federal Farm Credit Banks. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). This investment strategy is supported by our short-term financing arrangements necessary to satisfy short-term funding requirements relating to client funds obligations. See Note 7 of our Consolidated Financial Statements for a description of our corporate investments and funds held for clients.
Capital expenditures for fiscal 2019 were $162.7 million, as compared to $191.9 million for fiscal 2018. We expect capital expenditures in fiscal 2020 to be about $175 million.
Contractual Obligations
The following table provides a summary of our contractual obligations at June 30, 2019:
| (In millions) | Payments due by period | |||||||||||||||||||||||
| Contractual Obligations | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | Unknown | Total | ||||||||||||||||||
| Debt Obligations (1) | $ | 58.4 | $ | 1,081.5 | $ | 69.5 | $ | 1,054.6 | $ | — | $ | 2,264.0 | ||||||||||||
| Operating Lease Obligations (2) | $ | 147.9 | $ | 196.8 | $ | 117.7 | $ | 134.0 | $ | — | $ | 596.4 | ||||||||||||
| Purchase Obligations (3) | $ | 354.7 | $ | 118.9 | $ | 9.8 | $ | 0.2 | $ | — | $ | 483.6 | ||||||||||||
| Obligations Related to Unrecognized Tax Benefits (4) | $ | 9.6 | $ | — | $ | — | $ | — | $ | 44.6 | $ | 54.2 | ||||||||||||
| Other Long-Term Liabilities Reflected on our Consolidated Balance Sheets: | ||||||||||||||||||||||||
| Compensation and Benefits (5) | $ | 47.5 | $ | 83.0 | $ | 47.7 | $ | 177.2 | $ | 109.0 | $ | 464.4 | ||||||||||||
| Total | $ | 618.1 | $ | 1,480.2 | $ | 244.7 | $ | 1,366.0 | $ | 153.6 | $ | 3,862.6 |
| (1) | These amounts represent the principal and interest payments of our debt. |
| (2) | Included in these amounts are various facilities and equipment leases. We enter into operating leases in the normal course of business relating to facilities and equipment. The majority of our lease agreements have fixed payment terms based on the passage of time. Certain facility and equipment leases require payment of maintenance and real estate taxes and contain escalation provisions based on future adjustments in price indices. Our future operating lease obligations could change if we exit certain contracts or if we enter into additional operating lease agreements. |
| (3) | Purchase obligations are comprised of a $215.0 million reinsurance premium with Chubb for the fiscal 2020 policy year, as well as obligations related to software subscription licenses and purchase and maintenance agreements on our software, equipment, and other assets. |
| (4) | Based on current estimates, we expect to make cash payments up to $9.6 million in the next twelve months for obligations related to unrecognized tax benefits across various jurisdictions and tax periods. For $44.6 million of obligations related to unrecognized tax benefits we are unable to make reasonably reliable estimates as to the period in which cash payments are expected to be paid. |
| (5) | Compensation and benefits primarily relates to amounts associated with our employee benefit plans and other compensation arrangements. These amounts exclude the estimated contributions to our defined benefit plans, which are expected to be $9.3 million in fiscal 2020. |
In addition to the obligations quantified in the table above, we had obligations for the remittance of funds relating to our payroll and payroll tax filing services. As of June 30, 2019, the obligations relating to these matters, which are expected to be paid in fiscal 2020, total $29,144.5 million and were recorded in client funds obligations on our Consolidated Balance Sheets. We had
$29,434.2 million of cash and cash equivalents and marketable securities that were impounded from our clients to satisfy such obligations recorded in funds held for clients on our Consolidated Balance Sheets as of June 30, 2019.
Separately, ADP Indemnity paid a premium of $215.0 million in July 2019 to enter into a reinsurance agreement with Chubb to cover substantially all losses incurred by ADP Indemnity for the fiscal 2020 policy year. At June 30, 2019, ADP Indemnity had total assets of $575.8 million to satisfy the actuarially estimated unpaid losses of $448.1 million for the policy years since July 1, 2003. ADP Indemnity paid claims of $4.0 million and $4.6 million, net of insurance recoveries, in fiscal 2019 and 2018, respectively. Refer to the "Analysis of Reportable Segments - PEO Services" above for additional information regarding ADP Indemnity.
In the normal course of business, we also enter into contracts in which we make representations and warranties that relate to the performance of our services and products. We do not expect any material losses related to such representations and warranties.
Quantitative and Qualitative Disclosures about Market Risk
Our overall investment portfolio is comprised of corporate investments (cash and cash equivalents, short-term and long-term marketable securities) and client funds assets (funds that have been collected from clients but not yet remitted to the applicable tax authorities or client employees).
Our corporate investments are invested in cash and cash equivalents and highly liquid, investment-grade marketable securities. These assets are available for repurchases of common stock for treasury and/or acquisitions, as well as other corporate operating purposes. All of our short-term and long-term fixed-income securities are classified as available-for-sale securities.
Our client funds assets are invested with safety of principal, liquidity, and diversification as the primary objectives. Consistent with those objectives, we also seek to maximize interest income and to minimize the volatility of interest income. Client funds assets are invested in highly liquid, investment-grade marketable securities, with a maximum maturity of 10 years at the time of purchase, and money market securities and other cash equivalents.
We utilize a strategy by which we extend the maturities of our investment portfolio for funds held for clients and employ short-term financing arrangements to satisfy our short-term funding requirements related to client funds obligations. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). As part of our client funds investment strategy, we use the daily collection of funds from our clients to satisfy other unrelated client funds obligations, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. We minimize the risk of not having funds collected from a client available at the time such client’s obligation becomes due by impounding, in virtually all instances, the client’s funds in advance of the timing of payment of such client’s obligation. As a result of this practice, we have consistently maintained the required level of client funds assets to satisfy all of our obligations.
There are inherent risks and uncertainties involving our investment strategy relating to our client funds assets. Such risks include liquidity risk, including the risk associated with our ability to liquidate, if necessary, our available-for-sale securities in a timely manner in order to satisfy our client funds obligations. However, our investments are made with the safety of principal, liquidity, and diversification as the primary goals to minimize the risk of not having sufficient funds to satisfy all of our client funds obligations. We also believe we have significantly reduced the risk of not having sufficient funds to satisfy our client funds obligations by consistently maintaining access to other sources of liquidity, including our corporate cash balances, available borrowings under our $10.3 billion commercial paper program (rated A-1+ by Standard and Poor’s and P-1 by Moody’s, the highest possible short-term credit ratings), our ability to engage in reverse repurchase transactions and available borrowings under our $10.3 billion committed credit facilities. The reduced availability of financing during periods of economic turmoil, even to borrowers with the highest credit ratings, may limit our ability to access short-term debt markets to meet the liquidity needs of our business. In addition to liquidity risk, our investments are subject to interest rate risk and credit risk, as discussed below.
We have established credit quality, maturity, and exposure limits for our investments. The minimum allowed credit rating for corporate, Canadian government agency and Canadian provincial bonds is BBB, for asset-backed securities is AAA, and for municipal bonds is A. The maximum maturity at time of purchase for BBB-rated securities is 5 years, for single A rated securities is 7 years, and for AA-rated and AAA-rated securities is 10 years. Time deposits and commercial paper must be rated A-1 and/or P-1. Money market funds must be rated AAA/Aaa-mf.
Details regarding our overall investment portfolio are as follows:
| (In millions) | ||||||||||||
| Years ended June 30, | 2019 | 2018 | 2017 | |||||||||
| Average investment balances at cost: | ||||||||||||
| Corporate investments | $ | 4,817.3 | $ | 5,112.4 | $ | 6,143.3 | ||||||
| Funds held for clients | 25,458.5 | 24,332.6 | 23,023.5 | |||||||||
| Total | $ | 30,275.8 | $ | 29,445.0 | $ | 29,166.8 | ||||||
| Average interest rates earned exclusive of realized (gains)/losses on: | ||||||||||||
| Corporate investments | 2.0 | % | 1.6 | % | 1.2 | % | ||||||
| Funds held for clients | 2.2 | % | 1.9 | % | 1.7 | % | ||||||
| Total | 2.2 | % | 1.9 | % | 1.6 | % | ||||||
| Realized gains on available-for-sale securities | $ | (1.8 | ) | $ | (2.0 | ) | $ | (5.3 | ) | |||
| Realized losses on available-for-sale securities | 2.7 | 4.5 | 3.1 | |||||||||
| Net realized losses/(gains) on available-for-sale securities | $ | 0.9 | $ | 2.5 | $ | (2.2 | ) |
| As of June 30: | ||||||||||||
| Net unrealized pre-tax gains/(losses) on available-for-sale securities | $ | 287.5 | $ | (355.7 | ) | $ | 102.5 | |||||
| Total available-for-sale securities at fair value | $ | 24,859.1 | $ | 22,776.2 | $ | 21,901.1 |
We are exposed to interest rate risk in relation to securities that mature, as the proceeds from maturing securities are reinvested. Factors that influence the earnings impact of interest rate changes include, among others, the amount of invested funds and the overall portfolio mix between short-term and long-term investments. This mix varies during the fiscal year and is impacted by daily interest rate changes. The annualized interest rate earned on our entire portfolio increased from 1.9% for fiscal 2018 to 2.2% for fiscal 2019. A hypothetical change in both short-term interest rates (e.g., overnight interest rates or the federal funds rate) and intermediate-term interest rates of 25 basis points applied to the estimated average investment balances and any related short-term borrowings would result in approximately a $13 million impact to earnings before income taxes over the ensuing twelve-month period ending June 30, 2020. A hypothetical change in only short-term interest rates of 25 basis points applied to the estimated average short-term investment balances and any related short-term borrowings would result in approximately a $5 million impact to earnings before income taxes over the ensuing twelve-month period ending June 30, 2020.
We are exposed to credit risk in connection with our available-for-sale securities through the possible inability of the borrowers to meet the terms of the securities. We limit credit risk by investing in investment-grade securities, primarily AAA and AA- rated securities, as rated by Moody’s, Standard & Poor’s, DBRS for Canadian dollar denominated securities, and Fitch for asset-backed and commercial-mortgage-backed securities. Approximately 79% of our available-for-sale securities held a AAA or AA rating at June 30, 2019. In addition, we limit amounts that can be invested in any security other than U.S. government and government agency, Canadian government and United Kingdom Gilt securities.
We operate and transact business in various foreign jurisdictions and are therefore exposed to market risk from changes in foreign currency exchange rates that could impact our consolidated results of operations, financial position, or cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We may use derivative financial instruments as risk management tools and not for trading purposes. We had no derivative financial instruments outstanding at June 30, 2019 or 2018.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 1, Recently Issued Accounting Pronouncements, of Notes to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.
CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and other comprehensive income. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are Revenue Recognition (including Deferred Costs), Goodwill and Income Taxes. Refer to Note 1, Summary of Significant Accounting Policies, of Notes to the Consolidated Financial Statements for discussion of our policies.
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