This post describes our model of
Automatic Data Processing's (
NASDAQ: ADP) Income Statement for the December-ending second quarter of fiscal 2011.
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 well over 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 U.S. companies with a
AAA bond rating. An
S&P 500 Dividend Aristocrat, ADP recently announced its
36th-consecutive annual dividend increase.
The company has a
market value of about $23 billion.
As the processor of many payrolls across the U.S., ADP quickly senses macroeconomic changes in
Employment. ADP uses the data it collects to issue the monthly
ADP National Employment Report on non-farm private employment.
Fortune Magazine deemed ADP to be
Most Admired in the Financial Data Services industry.
In fiscal 2010, which ended 30 June, ADP's earnings fell to $1.21
billion from $1.33 billion in the prior year. Revenue increased to
$8.93 billion from $8.84 billion. The company's results in fiscal 2010
were weakened by high unemployment, which reduces the demand for payroll
services, and low interest rates, which limits the company's interest
income.
ADP 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 companies that sell vehicles and machinery manage their business
activities.
The Employer Services business segment contributed 72 percent of total revenue in fiscal 2010. Competitors include
Paychex (
NASDAQ:PAYX), the now-private
Ceridian, and India's
Wipro (
NYSE: WIT).
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.
Automatic Data Processing earned $0.56 per diluted share on a
GAAP basis in the September-ending
first quarter of fiscal 2011. Earnings per share were unchanged from the same three months of last year.
Now, we are ready to look ahead to ADP's results for the December 2010 quarter.
In the press release on 27 October 2010 announcing its results for the
September quarter, ADP updated its guidance for fiscal 2011. Some changes to the
guidance reflect the company's better-than-expected performance during
the first fiscal quarter, and other adjustments are reactions to recent
corporate acquisitions.
Including the results of the newly acquired companies, ADP now believes it can achieve full-year
Revenue growth between 7 percent and 8 percent. Since
Revenue
in fiscal 2010 was $8.93 billion, the guidance translates into a
Revenue range of $9.56 billion to $9.65 billion for the fiscal
year that will end in June 2011. Let's say $9.6 billion.
In the
September 2010 quarter, ADP brought in Revenue of $2.23 billion. This
leaves $9.6 billion - $2.23 billion = $7.37 billion for the final nine
months of the fiscal year.
December quarters are not typically
biggest producers of Revenue for ADP, so we can't simply divide $7.37
billion divided by 3. Our specific target is $2.36
billion, 32 percent of the nine-month total.
ADP's guidance indicates that pretax operating margin
expansion is expected at the company's Employer Services, but margin
declines are expected at PEO Services and Dealer Services. Acquisition
costs will put negative pressure on margins. However, since Employer
Services is much bigger than the other units, the company-wide margin
may be flat to slightly positive.
In fiscal 2010, the
Gross Margin
as a percentage of Revenue was 52.1 percent, but it was closer to 50
percent in each of the last two quarters. Given this information and
the seasonal pattern, we are setting our target for the Gross Margin in
the December quarter at 51 percent. When combined with our Revenue
estimate, the margin target leads to a forecast for the
Cost of Goods Sold -- what ADP calls "Operating Expenses" -- of (1 - 0.51) * $2.36 billion = $1.16 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 December 2010 quarter.
Research and Development
expenses ("Systems Development and Programming Costs") were $135
million in the September 2010 quarter. We are looking for a similar
figure in the current quarter.
Sales, General, and Administrative
expenses are more variable. In the last five fiscal years, the amount
per quarter has ranged from $436 million to $697 million. As a
percentage of Revenue, SG&A has varied between 20.7 percent and 32.5
percent. The percentages have generally been falling from year to
year. Given this data, we are expecting SG&A expenses in the
December 2010 quarter will be 24 percent of Revenue, or 0.24 * $2.36
billion = $566 million.
Rolling up these estimates yields a target for
Operating Income, as we define it, of $442 million. This is 2.4 percent less than Operating Income in the December 2009 quarter.
As
for non-operating items (i.e., other income less interest expense), $15
million would seem to be a conservative estimate based on recent
history.
We're assuming the effective Income Tax Rate will match fiscal 2010's 35 percent. This assumption leads to an estimate for
Net Income
of $297 million ($0.60 per share, depending on the share count). In
the year-earlier quarter, Net Income from continuing operations was $316
million ($0.62 per share).
Please
click here
to see a 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.
The Employer Services business segment contributed nearly three-quarters of the total revenue in fiscal 2000. Competitors include 
Automatic Data Processing
In November, we 
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