29 July 2010

ADP: Income Statement Analysis for the June 2010 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.42 per share in fiscal 2010's fourth quarter, which ended 30 June 2010.  This EPS amount was 41 percent less than the $0.70 ADP made in the same quarter of 2009. 

The prior-year result was boosted by a tax benefit of $0.24 per share.  Excluding this one-time benefit, diluted quarterly earnings from continuing operations declined from $0.45 in June 2009 to $0.42 per share in June 2010.

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 fell $0.01 short of the $0.43 per share we had forecast.

The principal sources for the income statement analysis were the earnings announcement and the webcast presentation [pdf].

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, GrowthProfitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

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.  The company is one of four remaining of U.S. firms 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.  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 in the June quarter rose 4.3 percent, from $2.10 billion last year to $2.19 billion in the most recent period.  About 0.6 of the 4.3 percent was due to favorable foreign exchange rates.

Reported revenue exceeded our $2.12 billion estimate by 3.3 percent.

Employer Services, the company's largest business segment, achieved Revenue growth of 4.2 percent, from $1.53 billion to $1.59 billion.  Revenue from the company's "traditional" payroll businesses was up only slightly, but revenue in other areas grew a healthy 9-percent pace. 

Revenue grew a relatively robust 13 percent at the Professional Employer Organization Services segment, from $292 million to $331 million. 

The Dealer Services business that does work for automobile dealers reported a tiny Revenue decline, from $308 million to $307 million.  Not surprisingly, this unit has been harmed by the large number of dealerships that have or will soon close.

Operating Expenses added up to $1.09 billion, or 49.6 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 50.4 percent, a substantial 180 basis points less than last June's 52.2 percent. 

Our target for the Gross Margin was a more profitable 52.0 percent.

Depreciation and amortization expenses were down slightly to $58 million.  The difference from our $60 million estimate wasn't material.

ADP spent $138 million on "Systems Development and Programming Costs," which we treat as analogous to Research and Development.  The expense was up $11 million (8 percent) from last year.  As a percentage of Revenue, this expense increased from 6.1 percent to 6.3 percent.  The latest figure was 6 percent more than our $130 million estimate.

Sales, General, and Administrative expenses rose 6.6 percent to $612 million.  The latest amount was a substantial 6.9 percent more than our $572 million estimate for the quarter.  Reported SG&A expenses equaled 27.9 percent of Revenue, up from 27.3 percent last year.

Subtracting the various operating expenses from Revenue yields Operating Income of $296 million, which fell short of last year's $334 million by 11.4 percent.  The latest Operating Income amount was 12.9 percent less than our $340 million target primarily because the SG&A and R&D expenses were greater than expected.

As for non-operating items, Other Income less Interest Expense added up to $9.3 million, net.  This amount was much less than last year's $27 million, but it was consistent with expectations.  Other Income in the latest quarter included a $9.1 million impairment loss on available-for-sale securities.  This item merits clarification.

The effective Income Tax Rate was 32.0 percent in the June 2010 quarter, about 4 to 5 percent less than normal.   We had estimated the tax rate would be 36.6 percent.

Including $0.3 million in earnings from discontinued operations, Net Income of $208 million ($0.42 per share) for the quarter was a far cry from income of $353 million ($0.70 per share) in the June 2009 quarter.  However, the earlier period featured a $120 million ($0.24 per share) one-time tax benefit.  Excluding the tax benefit, quarterly earnings fell only a few cents per share.

Reporting earnings were $9 million ($0.01 per share) less than our target for the quarter.

In summary, the June quarter was mostly consistent with expectations.  Revenue was slightly better, in part due to currency exchange rate fluctuations.  However, the Gross Margin was softer than we had hoped, and expenses were a bit higher.  As a result, Operating Income was disappointing.  A lower-than-expected income tax rate closed much of the gap.

Full disclosure: Long ADP at time of writing.

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