06 February 2010

ADP: Income Statement Analysis for the December 2009 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.62 per share in the second quarter of fiscal 2010, which ended 31 December 2009.  This amount was 5 percent greater than the $0.59 per share earned one year earlier. 

If a favorable tax item in the latest quarter is excluded, earnings would only have increased $0.01 to $0.60 per share.

This post examines ADP's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Our target for Net Income in the latest quarter was $0.59 per share, which ADP exceeded by $0.03.

The principal sources for the income statement analysis were the earnings announcement, the webcast presentation [pdf], and the conference call transcript (available from Seeking Alpha).

In a second article, we will report ADP's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value. 

Automatic Data Processing performs payroll, tax, and other personnel-related services for over 500,000 clients, large and small.  Additional background information about ADP and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue of $2.20 billion was basically unchanged from that in the December 2008 quarter.  Revenue would have been about 2 percent less, according to ADP, if foreign exchange rates had not been favorable.  The reported figure for Revenue exceeded our $2.19 billion estimate, which was derived from the company's guidance for the fiscal year, by less than 1 percent.

Looking at ADP's various business segments, starting with the largest, we see that quarterly Revenue fell 2 percent at ADP Employer Services.  As a major payroll processor, lower Employment in the latest period put downward pressure on this unit's Revenue.

The business that provides services to automobile dealers reported a Revenue decline of 5 percent.  Not surprisingly, this unit has been harmed by the large number of dealerships that have or will soon close.

The Professional Employer Organization Services segment was the bright spot, growing Revenue a relatively robust 9 percent.  In explaining this performance, ADP's CFO said during the conference call:

"This growth was due to increased benefits pass through revenues that resulted from increases in both benefit rates and the number of work site employees."

Operating Expenses, what we list as Cost of Goods Sold, were 47.7 percent of Revenue, which translates into a Gross Margin of 52.3 percent.  The latest margin was 2 points lower than December 2008's 54.3 percent.  Our 52.1 percent estimate for the Gross Margin was 20 basis points too low.

Depreciation and amortization expenses matched our $60 million estimate.

ADP spent $121 million on Research and Development ("Systems Development and Programming Costs"), which was about $2 million (1.6 percent) less than last year.  We had estimated that R&D expenses would increase $2 million, so our estimate proved to be 3.3 percent too high.

Sales, General, and Administrative expenses of $520 million exceeded our estimate by only 0.6 percent.  These expenses were 9.25 percent less than in the December 2008 quarter.

Operating Income, as we define it, was $453 million, which exceeded the equivalent amount in the previous December quarter by 2.3 percent.  The $53 million reduction in SG&A expenses more than made up for the $43 million rise in Operating Expenses.

Operating Income exceeded our $438 million estimate by 3.4 percent.

Other income less interest expense of $27 million was $4 million less than last year, but it was $2 million more than we anticipated.

The effective Income Tax Rate was 34.2 percent in the December 2009 quarter, more than 200 basis points less than the previous December's 36.5 percent.  The tax rate was lower because the recent quarter included a favorable item that reduced the provision for income taxes by $12.2 million.  The tax rate, excluding the benefit, was 36.8 percent.  We had estimated the tax rate would be 36.0 percent.

Net Income of $316 million ($0.62 per share) for the quarter was 5.6 percent higher than the previous December's $301 million ($0.59 per share).  Excluding the special tax benefit, Net Income would have been $303.6 million ($0.60 per share), bringing the increase down to 1 percent.

Our Net Income estimate of $296 million ($0.59 per share) was 6.2 percent less than the reported amount and 2.5 percent less than earnings excluding the tax benefit.

ADP concluded its earnings presentation by noting that the "U.S. economy appears to be at bottom of downturn; however, we remain cautious about near-term outlook."   The company then noted the effort it is making to increase sales; adding new customers or providing new services for existing customers is a way the company can offset the negative effects of lower employment.  Management also asserted that "ADP is well positioned to leverage the inevitable economic recovery."

Full disclosure: Long ADP at time of writing.

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