22 September 2008

ADP: Look Ahead to September 2008 Quarterly Results

Our earlier analysis of ADP's 10-K annual report for the fiscal year that ended in June 2008 determined that the GCFR Overall gauge score had slipped slightly to 54 points. The score had been 57 of the 100 possible points after the March quarter.

The recent 50-plus scores are quite good and were last achieved by ADP in 2003. This rock-solid company is growing, highly profitable, and trading at a discount relative to historical measures. The Value gauge is at a strong 16 of 25 possible points.

Automatic Data Processing, Inc. (NYSE: ADP) is a top provider of payroll and other personnel-related information technology services. ADP is one of a mere handful of U.S. companies with a AAA bond rating, and it is an S&P 500 Dividend Aristocrat. The company publishes the monthly ADP National Employment Report on non-farm private employment, and it competes with firms such as Paychex, Inc. (NASDAQ:PAYX). Last year, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).

Despite the favorable score, we did have some concerns. For one thing, the Broadridge divestiture and other other restructuring actions might have skewed comparisons with historical results. In addition, and more esoterically, ADP made two changes to the way it accounts for client funds and obligations. The first change, which doesn't concern us, reclassifies these amounts as Current Assets and Current Liabilities. The second change moves the net increase in Client Fund Obligations from the Investing to the Financing section of the Cash Flow Statement. This arcane but big-dollar change -- $3.5 billion in the last fiscal year -- significantly alters the Net Cash Used in Investing Activities. We use this figure to compute the Accrual Ratio, which is an indicator of Earnings Quality and Profitability. For consistency with historical data, we adjusted the newly reported Cash Flow figures to comply the older classification.

On 3 November 2008, ADP is scheduled to announce its results for fiscal 2009's first quarter, which will end on 30 September 2008. 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 at the end of fiscal 2008, provided guidance for fiscal 2009.

The guidance indicated that Revenue is projected to grow by 7 to 8 percent. This rate, lower than in fiscal 2008, reflects both more challenging comparison and the weaker economy.

Our working estimate for Revenue in the September quarter is $2.13 billion. This figure is 7.0 percent more than Revenue in the prior-year quarter. It also translates into year-over-year Revenue growth of 10.9 percent.

The Gross Margin in the last four sequential quarters has averaged about 55 percent. If we assume ADP will attain this same margin in the September quarter, the Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- will total (1 - 0.55) * $2.13 billion = $960 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 $58 million in the September quarter.

Our estimate for Research and Development (R&D) expenses ("Systems Development and Programming Costs") is 6.0 percent of Revenue. This would equate to $128 million

Sales, General, and Administrative (SG&A) expenses average 27 percent of Revenue, which is a reasonable expectation for the September quarter. Our target for these expenses becomes 0.27 * $2.13 billion = $580 million.

Rolling up the figures identified above, our estimate for Operating Income, as we define it, is $412 million. This is 12.6 percent above the $366 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 remains at around 36.5 percent, Net Income will be $271 million ($0.52 per share). In the year earlier quarter, Net Income from continuing operations was $240 million ($0.45 per share). Therefore, the growth rates on an absolute and per-share basis are predicted to be 12.9 and 15.6 percent, respectively.

ADP management forecast they would achieve diluted Earnings per Share growth of 10 to 14 percent.

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)

September 2008
September 2007
Revenue (1)


CGS (2) (959)

Depreciation (3)

R&D (4) (128)

SG&A (576)


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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