11 June 2010

ADP: Look Ahead to June 2010 Quarterly Results

This post describes our model of Automatic Data Processing's (NASDAQ: ADP) Income Statement for the fourth quarter of fiscal 2010, which will end on 30 June 2010.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

First, we present some background information about ADP and the business environment in which it is currently operating.

Automatic Data Processing performs payroll, human resource, data processing, and outsourcing Business Services for more than 500,000 clients, large and small, in the United States and other countries.  ADP pays one of every six private sector employees in the U.S.

ADP is one of four remaining of U.S. companies with a AAA bond rating.  It is also an S&P 500 Dividend Aristocrat, having hiked its dividend for 35 consecutive years.

Fortune Magazine deemed ADP to be Most Admired in the Financial Data Services industry.

ADP earned $1.3 billion on revenue of $8.9 billion in fiscal 2009, which ended June 2009.  It has a market capitalization of about $20 billion.

The company, according to its latest 10-K, has three main businesses:  Employer Services, Professional Employer Organization Services, and Dealer Services.  Employer Services processes payrolls, administers benefits, and performs other services to enable firms "to staff, manage, pay and retain their employees."  PEO Services, by establishing co-employment relationships with customers and their employees, enables businesses to outsource various functions.  In this arrangement, an ADP entity becomes the employer of record for the affected employees.  Dealer Services helps dealers of vehicles and machinery manage their business activities.

The Employer Services business segment contributed nearly three-quarters of the total revenue in fiscal 2000.  Competitors include Paychex (NASDAQ:PAYX), the now-private Ceridian, and India's Wipro (NYSE: WIT).

As a payroll processor, ADP is sensitive to changes in Employment.  From the payroll data it collects, the company issues the monthly ADP National Employment Report on non-farm private employment.

Dealer Services revenue has been adversely affected by the downturn in vehicle sales and the closing of many dealerships.

In 2007, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).  (GCFR articles related to Broadridge can be found here.)  In accordance with an outsourcing agreement between the two companies, ADP has been providing data center services to Broadridge.  In 2010, Broadridge notified ADP it would not extend the agreement beyond its 30 June 2012 expiration date.  ADP does not anticipate that end of this relationship will have a material impact.

In fiscal 2010's third quarter, which ended 31 March 2010, ADP earned $0.80 per share, the same as in 2009.

Now, we are ready to look ahead to ADP's results for the June 2010 quarter.

In the earnings announcement released in April 2010, ADP updated its Revenue and EPS forecasts for fiscal 2010.

"We are forecasting full year revenues will approximate last year's revenues. We anticipate achieving $2.36 to $2.38 diluted earnings per share from continuing operations compared with $2.38 in fiscal 2009, which excludes favorable tax items in both years. Earnings per share from continuing operations in fiscal 2010 and 2009 have each been reduced by $0.01 as a result of the restatement of Dealer Services' Commercial business to discontinued operations.

In accordance with the guidance, we are assuming Revenue in fiscal 2010 will match fiscal 2009's $8.87 billion of Revenue.  In the first three quarters of the current fiscal year, ADP had Revenue of $6.75 billion, which leaves $2.12 billion for the final quarter. 

This amount is only 0.6 percent greater than Revenue of $2.11 billion in the June 2009 period.

The only guidance ADP provided in regard to its operating margins is that "We continue to anticipate no improvement in segment pretax margins."  ADP's Gross Margin was 53.75 percent in fiscal 2009, and it has been 52.6 percent during the first three quarters of fiscal 2010.  We assume it will be only 52.0 percent in the June quarter.  This is equivalent to forecasting that the Cost of Goods Sold -- what ADP calls "Operating Expenses" -- will equal (1 - 0.52) * $2.12 billion = $1.02 billion. 

Depreciation and amortization expenses have been around $60 million per quarter for nearly three years.  We have no reason to expect a different figure in the June 2010 quarter. 

Similarly, it seems reasonable to assume Research and Development (R&D) expenses ("Systems Development and Programming Costs") will continue to be approximately $130 million per quarter.

Sales, General, and Administrative (SG&A) expenses are more variable -- the amount has been as low as 22 percent of Revenue and as high as 32 percent during the last five years --  and June quarters tend to have a relatively SG&A expense relative to Revenue.  With this in mind, we are expecting SG&A expenses in the current quarter will be 27 percent of Revenue, or 0.27 * $2.12 billion =  $572 million.

Rolling up these estimates yields a target for Operating Income, as we define it, of $340 million.  This is 1.9 percent more than Operating Income in the June 2009 quarter.

As for non-operating items (i.e., other income less interest expense), $10 million would seem to be a conservative estimate based on recent history. 

We're assuming the effective Income Tax Rate will match last quarter's 36.6 percent, and we threw in $5 million loss on discontinued operations.  With these assumptions, Net Income will be $217 million ($0.43 per share, depending on the share count).  In the year-earlier quarter, which benefited from a $120 million favorable tax settlement, Net Income from continuing operations was $353 million ($0.70 per share).

This earnings per share estimate for the quarter would result in annual earnings of $2.41 per share, which is several cents above the company's guidance.  If the actual EPS amount equals the guidance, it will be interesting to learn where we were (unintentionally) optimistic.

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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