15 June 2008

ADP: Look Ahead to June 2008 Results

Our earlier analysis of ADP's 10-Q financial statements for the quarter ending in March 2008, which was the third quarter of ADP's fiscal year, determined that the GCFR Overall gauge score had risen to 56 points. The score had been 52, of 100 possible, points after the December 2007 quarter.

The latest Overall gauge reading was ADP's highest score in more than 4 years. All four individual gauges displayed double-digit scores on a scale of 0 to 25.

Automatic Data Processing, Inc. (ADP) is a top provider to corporations of payroll and other personnel-related information technology services. ADP, which is one of a mere handful of U.S. companies with a AAA bond rating, publishes the monthly ADP National Employment Report (SM) on non-farm private employment. Last year, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (BR).

Despite the improved score, we did have some concerns. For one thing, the Broadridge spin-off and other other restructuring actions might have skewed the results. In addition, ADP revised the way it accounts for funds held for clients and client fund obligations. This seemingly arcane reclassification involves big numbers -- $6.2 billion for the nine months ending March 2007 -- and makes some elements of new Cash Flow Statements incomparable with historic results. We observed that Net Income rose, in part, due to a reduction in the income tax rate. And, we need to keep an eye on the tepid growth in Cash Flow from Operations.

On 31 July 2008, ADP is scheduled to announce its results for the fourth quarter of the company's fiscal year. In anticipation of this report, we've modeled ADP's Income Statement for the quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the company's historical financial results and guidance provided by company management.

ADP management, in its report on the third fiscal quarter, reiterated a forecast for 12 to 13 percent Revenue growth during the fiscal year. Applying the midpoint of this growth rate to last year's Revenue of $7.8 billion establishes $8.8 billion as the target for the current fiscal year. Revenue in the first nine months of the fiscal year was $6.6 billion, which indicates the company expects sales to equal about $2.2 billion in the June quarter.

The Gross Margin in the last four sequential quarters has averaged 55.7 percent. If we assume ADP will attain this same margin in the June quarter, the Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- will total (1 - 0.557) * $2.2 billion = $975 million.

Depreciation and amortization expenses have been about 2.7 percent of Revenue in the last year. Given our Revenue estimate, it seems reasonable to expect these expenses to equal about $60 million in June quarter.

Our estimate for Research and Development (R&D) expenses ("Systems Development and Programming Costs") is 6.1 percent of Revenue. This would equate to $134 million

Sales, General, and Administrative (SG&A) expenses average 27 percent of Revenue. However, the ratio was closer to 32 percent in the last two fiscal fourth quarters. If we assume 30 percent for the latest quarter, our target for these expenses becomes 0.3 * $2.2 billion = $660 million.

Rolling up the figures identified above, our estimate for Operating Income, as we define it, in the quarter is $370 million. This is 28 percent above the $290 million of Operating Income in the year-earlier quarter.

For net non-operating income (i.e., other income less interest expense), $15 million would seem to be a reasonable estimate based on recent data.

If the Income Tax Rate is 36.5 percent, Net Income from continuing operations will be $246 million ($0.47 per share).

ADP management expressed confidence that they would achieve "the high end of our earnings per share growth forecast of 18% to 21% in diluted earnings per share from continuing operations, up from $1.80 in fiscal 2007, which excludes the net one-time gain recorded in the first quarter of fiscal 2007.”

In other words, management told investors to expect earnings between, and towards the upper end of, $2.12 to $2.18 per share. If 530 million is the average number of diluted shares for the fiscal year, then the Net Income guidance for the year must be $1.124 to $1.155 billion. Net Income from continuing operations for the first three quarters was $936 million, which leaves $188 to $219 million for the fourth quarter.

Our $246 million estimate for Net Income exceeds our interpretation of management's guidance by at least $27 million ($0.05 per share).

Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)

June 2008
June 2007
Revenue (1)


CGS (2) (975)

Depreciation (3)

R&D (4) (134)

SG&A (660)


Other income


Interest, etc.
Pretax income

Income tax

Net Income from continuing operations

Income from discontinued operations (5)

Shares used in per-share calculations

1. Total revenues includes interest on funds held for clients and Professional Employer Organization revenues.
2. Operating expenses
3. Depreciation and amortization.
4. System development and programming
5. Net of tax

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