23 June 2009

ADP: Look Ahead to June 2009 Quarterly Results

The GCFR Overall Gauge of Automatic Data Processing (NASDAQ: ADP) slipped a bit, from 61 to 57 of the 100 possible points, in the March 2009 quarter.  Our initial and updated analysis reports for the third quarter of the company's fiscal 2009 explained this result in some detail.  (An algorithm adjustment after the update was published cut ADP's score from 59 to 57.)

In the March quarter, ADP's earnings per share increased from $0.79 in 2008 to $0.80 in 2009.  Revenue in the recent period slipped 2.2 percent, which ADP attributed to the weak economy and the stronger dollar.  Fortunately for ADP, lower operating costs (especially SG&A) more than compensated for the Revenue decline.  Operating Income increased by a small amount, and Net Income, which was adversely affected by a charge related to the company's investment in the Reserve Fund, was basically flat.

Of our four gauges, the contrary Value gauge is currently strongest for ADP at 16 of 25 possible points.

We have now modeled ADP's Income Statement for the final quarter of fiscal 2009, which will end on 30 June.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce on 30 JulyGCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about the company and the business environment in which it operates.

Automatic Data Processing, Inc. (NASDAQ: ADP), with over 500,000 clients, is the largest firm providing payroll and other personnel-related information technology services.   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.

As a payroll processor, ADP feels the effects of decreased employment in the U.S.

ADP competes for clients with numerous large and small, public and private, business software and services companies.  In the U.S., the IRS lists 24 payroll service providers that have satisfied its requirements for electronic submissions.  Paychex, Inc. (NASDAQ:PAYX) and now-private Ceridian are probably the names most familiar to investors.  We wouldn't be surprised if India's Wipro (NYSE: WIT) is also a competitor or will become one.

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

We're now ready to look ahead.

In ADP's press release announcing March's quarterly results, which was issued on 5 May 2009, the company updated its forecast for the remainder of the fiscal year.  Some excerpts are listed below:
Fiscal 2009 forecast

"We continue to anticipate achieving 1% to 2% revenue growth, and the low end of our 10% to 14% growth forecast 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 approximately two percentage points due to our assumption of unfavorable foreign exchange rates continuing for the remainder of the fiscal year.
"Our business segment forecasts are also unchanged.  [...]
"There is no change to our interest on funds held for clients forecast. We continue to anticipate a decline of $75 to $80 million, or 11% to 12%, from $684.5 million in fiscal 2008.  [...]
"We continue to expect interest expense 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. Our average commercial paper borrowing rates are expected to decline approximately 320 basis points to about 1.0%, partially offset by an expected increase of about $0.5 billion in average daily commercial paper borrowings to about $2.0 billion.
[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 $8.91 billion as the projection for the fiscal year.  Revenue in the first three quarters of fiscal 2009 was $6.76 billion, which leaves $2.15 billion for the June quarter.

The Gross Margin was 54.2 percent of Revenue in the first three quarter of fiscal 2009.  From ADP's historic record, we have observed that the Gross Margin in the June quarter is typically between 0 and 0.4 percent less than the average of the three previous quarters.  Therefore, for the June quarter, we project a Gross Margin of 54.2 - 0.2 = 54.0 percent.  This is equivalent to forecasting that the Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- will equal (1 - 0.54) * $2.15 billion = $990 million. 

Depreciation and amortization expenses have been around $60 million in each of the last seven quarters.  We have no reason to expect a different figure in the June 2009 quarter. 

Similarly, recent quarters suggest that Research and Development (R&D) expenses ("Systems Development and Programming Costs") will probably be about $120 million.

At $520 million, Sales, General, and Administrative (SG&A) expenses in the March quarter were much lower than recent quarterly figures.  However, the historical record would argue against expecting a similar value in the June 2009 quarter.  In the last five years, the June quarter has been responsible for between 27 and 29 percent of the fiscal year's total SG&A expense.  With this as a guide, our June target for these expenses becomes $630 million.

Rolling up these expense estimates yields a target for Operating Income, as we define it, of $350 million.  This is 11.6 percent greater than Operating Income in the June 2008 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 $237 million ($0.47 per share, depending on share repurchases).  In the year-earlier quarter, Net Income from continuing operations was $226 million ($0.435 per share).

Please click here to see a full-sized, normalized depiction of the projected results next to ADP's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long ADP at time of writing.

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