ADP Automatic Data Processing Inc

Automatic Data Processing Inc. (ADP) reported second quarter 2012 earnings of 68 cents per share, in line with the Zacks Consensus Estimate. Earnings per share increased 9.7% year over year on the back of strong revenue growth.

Revenue

Revenues increased 7.4% year over year to $2.58 billion and was in line with the Zacks Consensus Estimate. Organic growth was 6.0% in the quarter. The better-than-expected result was driven by strong new business sales, improving client retention and incremental revenue from recent acquisitions.

Employer Services revenue increased 7.0% year over year (5.0% organically) to $1.83 billion. The number of employees on clients' payrolls in the United States grew 2.8% in the quarter on a same-store-sales basis.

PEO Services revenue spiked 15.5% year over year to $413.8 million in the second quarter. Dealer Services revenue climbed 6.9% year over year to $412.6 million.

Interest on funds held for clients declined 9% year over year to $117.9 million, due to a decline of 50 bps in the average interest yield to 3.0%, partially offset by a 6.0% increase in average client funds balances to $15.6 billion.

Operating Performance

Total expenses in the reported quarter increased 7.5% year over year to $2.10 billion, due to higher operating expenses (up 11.4% year over year) and selling, general & administrative expense (up 1.3% year over year).

The company reported pre-tax earnings of $513.7 million, up 6.0% on year-over-year basis. However, pre-tax margin declined 20 basis points (bps) year over year to 19.9% in the reported quarter.

Employer Services' pre-tax margin declined 120 bps on a year-over-year basis. PEO Services pre-tax margin improved 20 bps, while Dealer Services pre-tax margin enhanced 220 bps year over year in the reported quarter.

Net income increased 7.6% year over year to $333.8 million. Net margin, however, remained flat at 12.9% in the quarter.

Balance Sheet

As of December 31, 2011, cash and cash equivalents (including short-term marketable securities) were $1.36 billion, compared with $1.27 billion as of September 30, 2011. Long-term debt decreased to $25.5 million at the end of second quarter from $26.0 million in the prior quarter. ADP purchased 6.3 million shares for $305.0 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%-9% over the year-ago earnings per share of $2.52. The Zacks Consensus Estimate for fiscal 2012 is pegged at $2.74 per share.

Employer Services is expected to grow approximately 7% and pre-tax margins to expand 30 bps. The company expects pays per control to increase approximately 2.5% (prior outlook 2.0%) for fiscal 2012.

PEO Services revenue is forecasted to improve 17.0%. Pre-tax margin is expected to grow slightly on a year-over-year basis. For fiscal 2012, ADP expects Dealer Services revenue to increase in the 9.0%-10.0% range (prior forecast 8%-9%) with a pre-tax margin expansion of at least 50 bps.

The company expects interest on funds held for clients to decline $45.0 million-$55.0 million or 8%-10% from $540.1 million in fiscal 2011. However, the company expects 6%-7% increase in the average client fund balances.

Our Recommendation

We believe that 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, increasing competition from Paychex Inc. (PAYX) and Insperity Inc. (NSP) and a gloomy macro outlook in North America and Europe are major headwinds in the near term. Additionally, higher unemployment rates and low interest rates remain concerns for the company’s payroll processing business.

We have a Neutral recommendation on ADP over the long term. Currently, ADP has a Zacks #4 Rank, which implies a Sell rating on a short-term basis.

 
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