07 December 2008

ADP: Look Ahead to December 2008 Quarterly Results

The GCFR Overall Gauge of Automatic Data Processing (NASDAQ: ADP) increased from 55 to 61 of the 100 possible points in the first quarter of the company's fiscal 2009, which consisted of the three months that ended on 30 September 2008. Our initial and updated analysis reports explained this score in some detail.

Of the individual gauges contributing to the composite result, Growth (surprisingly?) led the way with 20 of the 25 possible points. The Cash Management gauge registered the greatest change in the September quarter, rising from 8 to a strong 17 points. The contrary Value gauge, which tends to move in the opposite direction of the share price, was attractive at 16 points and would have been even higher if we had recalculated it after the market meltdown.

The September quarter featured good Revenue growth and lower SG&A expenses, which overcame a lower Gross Margin. Non-operating income was also better than expected.

In the last four quarters, Cash Flow from Operations was up 35 percent, Net Income was up 15 percent, and Revenue was up almost 12 percent.

To look ahead, we've modeled ADP's Income Statement for the December 2008 quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that the company will announce on, or about, 2 February 2009. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

Automatic Data Processing, Inc. (NASDAQ: ADP) provides payroll and other personnel-related information technology services to well over 500,000 employers worldwide. It competes with firms such as Paychex, Inc. (NASDAQ:PAYX). 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 is also known for the monthly ADP National Employment Report on non-farm private employment.

ADP changed its share listing, as of 21 October 2008, from the New York Stock Exchange (NYSE: NYX) to the NASDAQ Stock Market (NASDAQ: NDAQ).

Last year, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).

As a payroll processor, decreased employment in the U.S. will put pressure on ADP. However, the company demonstrated its confidence in the future by recently raising its dividend by 14 percent. ADP has hiked the dividend for 34 consecutive years.

In ADP's press release announcing September's quarterly earnings, the company reduced its original forecast for Revenue growth in fiscal 2009 from between 7 and 8 percent to between 2 and 3 percent. The company indicated that weaker business conditions and the stronger dollar would both trim Revenue growth. More positively, ADP management indicated that they could improve operating margins enough to achieve a 10 to 14 percent growth rate in earnings per share from continuing operations. (We've noted previously that Earnings per Share (EPS) guidance enables management to satisfy expectations by increasing share repurchases if Net Income is weaker than anticipated.)

Since Revenue in fiscal 2008 was $8.8 billion, the guidance above translates into a fiscal 2009 Revenue projection of 1.025 * $8.8 billion = $9.0 billion. Revenue in the first quarter of fiscal 2009 was $2.2 billion, which leaves $6.8 billion for the final three quarters of the year. In the last five fiscal years, Revenue in the December quarter averaged about 31 percent of the Revenue in year's last nine months. Therefore, our target for Revenue in the December 2008 quarter is 0.31 * $6.8 billion = $2.1 billion.

The Gross Margin in fiscal 2008 was 55.4 percent. However, it was only 52 percent in the September quarter. This suggests shows that expanding margins discussed in management's guidance are going to come from elsewhere on the Income Statement. For the December quarter, we project a Gross Margin of 54 percent. This is equivalent to forecasting the Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- will equal (1 - 0.54) * $2.1 billion = $970 million.

We expect Depreciation and amortization expenses to continue to be about $60 million per quarter.

Similarly, recent quarters suggest that Research and Development (R&D) expenses ("Systems Development and Programming Costs") will probably be about $130 million.

The first fiscal quarter signaled that ADP plans to cut into Sales, General, and Administrative (SG&A) expenses to improve operating margins. These expenses were 27 percent of Revenue in fiscal 2008. Our target for these expenses becomes in the December quarter is 24.5 percent of Revenue, or 0.245 * $2.1 billion = $515 million.

Rolling up the figures identified above, our estimate for Operating Income, as we define it, is $430 million. This is not even 1 percent more than Operating Income in the year-earlier quarter.

For net non-operating income (i.e., other income less interest expense), $20 million would seem to be a reasonable estimate based on recent data.

If the Income Tax Rate remains at 36 percent, Net Income will be $288 million ($0.57 per share). In the year-earlier quarter, Net Income from continuing operations was $292 million ($0.55 per share). Therefore, the growth rates on an absolute and per-share basis are predicted to be -1 and +4 percent, respectively. TheEPS growth rate will be higher if the ADP repurchases more shares than estimated.

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)

December 2008
December 2007
Revenue (1)


CGS (2) (968)

Depreciation (3)

R&D (4) (130)

SG&A (515)


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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