27 April 2010

ADP: Income Statement Analysis for the March 2010 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.80 per share in the third quarter of fiscal 2010, which ended 31 March 2010.  Earnings per share were unchanged from the March 2009 quarter.

Earnings from continuing operations were slightly less than the comparable result in the year-earlier quarter, but overall net earnings were a shade higher.

This post examines ADP's Income Statement for the latest quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings exceeded the $0.76 per share we had forecast by $0.04.

The principal sources for the income statement analysis were the earnings announcement, the webcast presentation [pdf], and the 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 Business Services for over 500,000 clients, large and small.  ADP pays one of every six private sector employees in the United States.  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 increased from $2.37 billion in the March 2009 quarter to $2.44 billion in the latest period, a rise of 3.1 percent.  Revenue exceeded our $2.40 billion estimate by a relatively minor 1.8 percent.

The economic downturn continued to affect Revenue negatively in the latest quarter.  Changes in foreign exchange rates had a 2-percent positive effect on Revenue in the quarter.

Employer Services, the company's largest business segment, experienced Revenue growth of 1 percent, from $1.77 billion to $1.79 billion. Revenue from the company's "traditional" payroll businesses slipped 3 percent, but Revenue growth in other areas was robust enough to offset the payroll-related drop.  ADP reported, "The number of employees on our clients' payrolls in the U.S. declined 2.5 percent."

Revenue grew a relatively robust 15 percent at the Professional Employer Organization Services segment, from $329 million to $379 million. 

The Dealer Services business that does work for automobile dealers reported a 3-percent Revenue decline.  Not surprisingly, this unit has been harmed by the large number of dealerships that have or will soon close.

Operating Expenses added up to $1.14 billion, or 46.7 percent of Revenue.  (Note we treat this item as the Cost of Goods Sold for consistency with our other analyses, but the item is only a subset of what ADP classifies as Total Costs of Revenues.)  This ratio translates into a Gross Margin of 53.3 percent, nearly 300 basis points less than last year's 56.2 percent. 

Our target for the Gross Margin was 54.0 percent, or 70 basis points higher than what the company actually achieved.

Depreciation and amortization expenses were steady at about $60 million, which was the same amount as last year and what we expected for the latest quarter.

ADP spent $130 million on "Systems Development and Programming Costs," which we treat as analogous to Research and Development.  The expense was up $11 million (almost 10 percent) from last year.  As a percentage of Revenue, this expense increased from 5.0 percent to 5.3 percent.  The latest figure was 4 percent more than our $125 million estimate.

Sales, General, and Administrative expenses were trimmed 2.7 percent to $505 million.  The latest amount was a substantial 8.5 percent less than our $552 million estimate for the quarter.  Reported SG&A expenses equaled 20.7 percent of Revenue, down from 21.9 percent last year.

Subtracting the various operating expenses from Revenue yields Operating Income of $608 million, which fell short of last year's $635 million by 4.3 percent.  The latest Operating Income amount was 8.8 percent more than our $559 million target because Revenue was a little more than expected and the SG&A expense was so much lower than expected.

As previously disclosed, ADP received $14.8 million (pretax) in the March quarter from the Reserve Fund.  The company had previously written off some or all of this investment.   We separated the Reserve Fund items from the Other income and expenses category.

The net amount of Interest income and expenses, net, was a few million more than last year, but $14 million less than we anticipated.  Low interest rates reduce how much ADP earns on client funds.

The effective Income Tax Rate was 36.6 percent in the March 2010 quarter, compared to 36.0 percent in the same period of 2009.   We had estimated the tax rate would be 36.0 percent.

Including $2 million in earnings from discontinued operations, Net Income of $403.6 million ($0.80 per share) for the quarter was less than one percent higher than the previous March's $402.5 million ($0.80 per share). Our Net Income estimate of $383 million ($0.76 per share) was 5 percent less than the reported amount.

In summary, the March quarter was consistent with ADP's expectations and, with a couple of exceptions, our estimates.  Revenue slightly beat expectations.  The Gross Margin was a little less lucrative than we had anticipated, but a healthy reduction in SG&A expenses more than made up the difference.   The company's prior restructuring and cost-cutting initiatives were evidently more effective than we had projected.  The difference helped ADP keep its EPS from falling despite challenging economic conditions.  It also enabled the reported EPS to exceed our estimate by $0.04.

Full disclosure: Long ADP at time of writing.

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