Automatic Data Processing Inc. (ADP) reported first quarter 2012 earnings of 61 cents per share, in line with the Zacks Consensus Estimate. Earnings per share increased 9.0% year over year driven by strong revenue growth.
Operating Performance
In the reported quarter, total expenses increased 14.6% year over year to $2.10 billion, due to higher operating expenses (up 15.8% year over year), systems development & programming (up 11.0% year over year) and selling, general & administrative expense (up 14.3% year over year).
ADP reported pre-tax earnings of $459.3 million, up 5.2% on year-over-year basis. However, pre-tax margin declined 140 basis points (bps) year over year to 18.2% in the reported quarter.
Margin growth was affected by decline in high-margin client interest revenues due to a lower yield on the balances. Moreover, dilutive acquisitions in fiscal 2011 also contributed to the decline.
Employer Services’ pre-tax margin declined 50 bps on a year-over-year basis. PEO Services pre-tax margin improved 90 bps, while Dealer Services pre-tax margin improved 115 bps on a year-over-year basis in the reported quarter.
Net income increased 8.7% year over year to $302.7 million. Net margin decreased 50 bps to 12.0% in the quarter.
Revenue
Revenues increased 13.1% year over year to $2.52 billion, and were well above the Zacks Consensus Estimate of $2.43 billion. Organic growth was 10.0% in the quarter.
The better-than-expected result was driven by broad-based strength across all major business segments, favorable foreign exchange, strong new business sales, improving client retention and incremental revenue from recent acquisitions.
Employer Services revenue increased 9.4% year over year (7.0% organically) to $1.75 billion. The number of employees on clients’ payrolls in the United States grew 2.7% in the quarter on a same-store-sales basis.
PEO Services revenue was up 17.3% year over year to $400.5 million in the first quarter.
Dealer Services revenue increased 17.8% year over year (6.0% organically) to $407.9 million.
Interest on funds held for clients declined 3.9% year over year to $126.8 million, due to a decline of 50 bps in the average interest yield to 3.2%, partially offset by a 10% increase in average client funds balances to $15.2 billion.
Balance Sheet
As of September 30, 2011, cash and cash equivalents (including short-term marketable securities) were $1.27 billion, compared with $1.43 billion in the previous quarter. Long-term debt decreased to $26.0 million in the first quarter from $34.2 million in the prior quarter. ADP purchased 5.9 million shares for $280.0 million during the reported quarter.
Guidance
For fiscal 2012, ADP expects total revenue to increase in the range of 7.0%-9.0%. EPS is expected to increase 8%-10% over earnings per share of $2.52 in fiscal 2011. The Zacks Consensus Estimate for fiscal 2012 is pegged at $2.74 per share.
Employer Services is expected to grow approximately 7% (prior forecast 6.0% to 7.0%) and pre-tax margins to expand 50 bps. ADP expects pays per control to increase approximately 2.0% (prior outlook 1.0%-2.0%) for fiscal 2012.
PEO Services revenue is forecasted to improve 17.0% (prior outlook 15.0%-17.0%). Pre-tax margin is expected to remain flat on a year-over-year basis. For fiscal 2012, ADP expects Dealer Services revenue to increase in the 8%-9% range with a pre-tax margin expansion of about 50 bps.
New business sale from Employer Services and PEO Services is expected to achieve 8%-10% growth over the prior-year level of $1.1 billion.
The company expects interest on funds held for clients to decline $40.0 million or 7% -9% from $540.1 million in fiscal 2011. However, the company expects 7%-8% increase in the average client funds balances.
Our Take
ADP shares have surged 8.0% year to date compared to a 2.3% decline in S&P 500. We believe ADP will continue to outperform the broader market based on strong new business sales, diversified product portfolio, improving customer retention, accretive acquisitions, strong balance sheet and shareholder-friendly programs (aggressive share buybacks, dividend) over the long term.
However, sluggish US economy and persisting debt problems in Europe are the primary headwinds in our view. Moreover, we believe ADP faces significant integration risks due to frequent acquisitions. We believe increase in expenses due to acquisitions will continue to hurt margins in the near term. Further, ADP continues to face stiff competition from Paychex Inc. (PAYX) and Insperity Inc. (NSP), which will hurt profitability going forward.
We have a Neutral recommendation on ADP over the long term. Currently, ADP has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.
