04 April 2009

ADP: Look Ahead to March 2009 Quarterly Results

The GCFR Overall Gauge of Automatic Data Processing (NASDAQ: ADP) edged down from 57 to 55 points of the 100 possible points in the three months ending on 31 December 2008, which was the second quarter of the company's fiscal 2009.  Our initial and updated analysis reports explained in some detail how this score was attained.  (Recent tweaks to our gauges were quite kind to ADP:  the current score rose by six points to 63.)

We have now modeled ADP's Income Statement for the March 2009 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 is scheduled to announce on 5 May 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

Automatic Data Processing, Inc. 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).  The company is also known for the monthly ADP National Employment Report on non-farm private employment. 

ADP is one of a mere handful of U.S. companies with a AAA bond rating, and it is a member of the "shrinking universe," as David Templeton so aptly expressed it, of S&P 500 Dividend Aristocrats.  ADP has hiked its dividend for 34 consecutive years, including a 14 percent increase last November.

The company retained its eponymous three-character ticker symbol in October 2008 when it changed its share listing from the New York Stock Exchange (NYSE: NYX) to the NASDAQ Stock Market (NASDAQ: NDAQ).

In 2007, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).

As a payroll processor, ADP is feeling the effects of decreased employment in the U.S.  Although we had expected that Revenue in the December 2008 quarter would be a little less than in the December 2007 quarter, we were impressed that ADP managed to eke out Revenue growth of 2.5 percent.  Higher Revenue went to the bottom line, resulting in growth in Net Income from continuing operations of 2.7 percent.  Fewer common shares outstanding boosted earnings per share growth to a more impressive 7.3 percent.

All four individual gauges that contribute to the composite result are now between 13 and 18 points, where 25 points is the maximum score.  The Growth Gauge is most robust, led by a 33 percent increase in Cash Flow from Operations and rising ratio of Revenue to Assets.  The contrary Value gauge, which tends to move in the opposite direction of the share price, reacted positively to the lower price per share.

In ADP's press release announcing December's quarterly earnings, which was issued on 3 February 2009, the company updated its forecast for the fiscal year that will end on 30 June 2009.  Some excerpts are listed below:

"We continue to anticipate 2% to 3% revenue growth, and 10% to 14% growth in diluted earnings per share from continuing operations, up from $2.18 in fiscal 2008 (which excludes the net one-time gain of $0.02 per share recorded in the fourth quarter of fiscal 2008). Our revenue growth forecast for the year is negatively impacted about two percentage points due to our assumption of unfavorable foreign exchange rates continuing for the remainder of the fiscal year."

"Interest on funds held for clients is expected to decline $75 to $80 million, or 11% to 12%, from $684.5 million in fiscal 2008 based on an approximate 40 basis point decline in the expected average interest yield to about 4.0%, and an anticipated decline of 1% to 2% in average client funds balances. This updated forecast includes an unfavorable Canadian foreign exchange rate which is expected to negatively impact our full-year average client funds balance forecast by 1.5 percentage points. The forecasted interest on funds held for clients is $10 to $20 million lower than our previous estimate primarily due to the expected lower average client funds balances as a result of lower forecasted wage growth, including lower bonuses, and an increased negative impact expected from the Canadian foreign exchange rate."

"Interest expense is expected to decline about $50 million from $80.5 million in fiscal 2008, primarily from lower interest expense on our short-term financing related to our client funds extended investment strategy due to an expected decline of approximately 320 basis points in average commercial paper borrowing rates, partially offset by an expected increase of about $0.4 billion in average daily commercial paper borrowings to about $1.9 billion. This interest expense forecast is $10 to $15 million favorable to our previous estimate primarily due to expected lower borrowing costs."
"The changes in the interest on funds held for clients and interest expense forecasts result in an estimated net $5 million reduction to pretax earnings, or less than $0.01 per share."
[emphasis added]

This forecast was updated again on 25 March 2009 when ADP made the following announcement:

"Automatic Data Processing, Inc. (Nasdaq: ADP) announced today that fiscal 2009 revenues are anticipated to grow 1% to 2%, a slight decrease from the previous forecast of 2% to 3% growth. ADP expects to achieve the low end of its 10% to 14% range for growth in earnings per share from continuing operations compared with $2.18 in fiscal 2008 which excludes a net one-time gain of $0.02 per share recorded in fiscal 2008’s fourth quarter. The earnings per share from continuing operations forecast includes a charge relating to the Primary Fund of the Reserve Fund (the “Reserve Fund”). On February 26, 2009 the Reserve Fund announced the establishment a special reserve to cover legal fees and potential claims against the Reserve Fund, resulting in expected lower distributions to its shareholders than previously estimated. As a result, ADP will record a $15 million charge, about $0.02 per share in the quarter ending March 31, 2009."

[emphasis added]

We've noted previously that guidance in terms of Earnings per Share (EPS), instead of Net Income, enables management to satisfy expectations by increasing share repurchases.

Since Revenue in fiscal 2008 was $8.776 billion, the latest guidance translates into a fiscal 2009 Revenue projection of (1.01 to 1.02) * $8.776 billion = $8.864 billion to $8.952 billion.  We will split the difference and use $8.90 billion as the projection for the fiscal year.  Revenue in the first half of fiscal 2009 was $4.385 billion, which leaves $4.515 billion for the second half of the year.  Based on the previous five fiscal years, we project that 51.5 percent of the remaining Revenue will be realized in the March quarter and 48.5 percent will be realized in the June quarter.

Therefore, our target for Revenue in the March 2009 quarter is 0.515 *  $4.515 billion = $2.325 billion.

The Gross Margin in fiscal 2008 was 55.4 percent.  However, it was only 53.2 percent in the first half of fiscal 2009.  For the March 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) * $2.325 billion = $1.07 billion. 

We expect Depreciation and amortization expenses to continue to be about $60 million (2.6 percent of Revenue) per quarter. 

Similarly, recent quarters suggest that Research and Development (R&D) expenses ("Systems Development and Programming Costs") will probably be about $130 million (5.6 percent of Revenue).

ADP is limiting the growth of 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 March quarter is 25 percent of Revenue, or 0.25 * $2.325 billion = $581 million.

Rolling up the figures identified above, our estimate for Operating Income, as we define it, is $484 million.  This is 23.6 percent less than Operating Income in the year-earlier quarter.

For net non-operating income (i.e., other income less interest expense), $27 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 $327 million ($0.65 per share, depending on share repurchases).  In the very strong year-earlier quarter, Net Income from continuing operations was $404 million ($0.77 per share).  The EPS 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.


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