ADP Beats, Raises Outlook

| About: Automatic Data (ADP)

Automatic Data Processing Inc. (ADP) announced results for the first quarter of fiscal 2011. Net earnings from continuing operations were 56 cents per share, up 3 cents as compared with the Zacks Consensus Estimate.

Earnings per share were in line year over year, primarily due to fewer shares outstanding in the quarter. Increase in operating expenses had a negative impact on earnings growth in the quarter.

Revenues were $2.23 billion, up 6.4% year over year as compared with $2.09 billion reported in the prior-year quarter. This was well above the Zacks Consensus Estimate of $2.14 billion. Organic growth was 4.0%, whereas unfavorable foreign exchange fluctuations had a negative impact of 1.0% in the quarter.

The year-over-year growth was primarily driven by a strong demand for Employer Services and PEO Services. Increase in client retention rate and pays per control also contributed to the growth.

Automatic Data Processing completed three strategic acquisitions during the third quarter in the Employer Services and Dealer Services business.

Total operating expenses increased 8.7% year over year to $1.83 billion, due to higher selling, general and administrative expenses.

Pre-tax earnings from continuing operations declined 2.0% year over year to $436.4 million while margin decreased 170 basis points to 19.6% in the quarter. The weak result was primarily due to higher compensation expense.

Segment Information

Employer Services revenues increased 6.0% year over year to $1.56 billion, with organic growth of 5.0% in first quarter. The year-over-year growth was primarily driven by strong results in United States payroll and payroll tax filing business, which increased 2.0% year over year. Beyond Payroll revenues were up 9.0% year over year in the quarter.

On a same-store sales basis, number of employees on clients’ payroll in the United States increased 1.7% in the quarter. Worldwide client retention rate inched up 1.7% in the quarter.

Pre-tax margin contracted 80 basis points in the first quarter, due to increasing compensation expense and sales and client service investments, including higher headcount.

PEO Services revenues came at $341.3 million, up 15.0% year over year, based on strong new business sales. Pre-tax margin declined significantly (310 basis points) year over year, reflecting settlement of a state unemployment tax matter, higher pass-through costs and increasing compensation expense. Average worksite employees paid by PEO Services increased 9.5% in the first quarter to approximately 214,000.

Combined Employer Services and PEO Services worldwide new business sales were flat year over year.

Dealer Services revenues increased 12.0% year over year to $336.4 million, primarily driven by a robust growth from acquisitions in the quarter, market share gains and strong competitive win rates, partially offset by the cumulative impact of dealership closings.

Pre-tax margin expanded 30 basis points year over year to 15.1%, benefiting from the $7.0 million intangible asset impairment charge in the year-ago quarter related to General Motors’ announced closure of its Saturn brand.

In the quarter, interest on funds held for clients declined 0.9% to $126.8 million, due to 40 basis points fall in the average interest yield to 3.7%, partially offset by an increase of 9.0% in average client funds balances to $13.8 billion.

Balance Sheet
Automatic Data Processing ended the first quarter with $1.32 billion in cash and marketable securities (including long-term) as compared with $1.78 billion reported in the prior quarter. Long-term debt was $35.6 million as compared with $39.8 million in the prior quarter.

Automatic Data Processing acquired 1.2 million shares at a cost of approximately $50.0 million during the reported quarter.

Management provided a cautious outlook on the overall economic condition and does not expect any major changes in the current economic environment. Increased investment and higher expenses related to increased sales and service started during the second half of 2010 are expected to remain a drag on earnings growth in fiscal 2011.

For fiscal 2011, diluted earnings per share are expected to increase 3.0% to 5.0%, versus a previous guidance of 1.0% to 3.0% growth. The current Zacks Consensus Estimate for 2011 calls for $2.42 in EPS.

Automatic Data Processing expects revenue growth of 3.0% to 5.0% as compared with previous guidance of 1.0% to 3.0% growth. Revenues at Employer Services are expected to increase 4.0% (previous guidance 1.0% to 3.0%), PEO Services will grow 13.0% to 15.0% and Dealer Services will increase 2.0% in fiscal year 2011.

Management expects pays per control to increase 1.0% for fiscal 2011 and client revenue retention to increase 0.5%.

Automatic Data Processing continues to expect a high single-digit growth for Employer Services and PEO Services new business sales as compared with $1.0 billion sold in fiscal 2010.

Automatic Data Processing expects Employer Services to achieve 50 basis points expansion in pre-tax margin for fiscal 2011. However, the company continues to expect declining pre-tax margin for PEO Services and Dealer Services due to higher acquisition related costs.

Our Take
Strong first quarter 2011 results prompted ADP to revise its outlook upward. The company has a strong client base and balance sheet. However, increasing compensation expense and investments will continue to weigh on margins over the long term. Moreover, the company faces tough competition from Administaff Inc. (ASF) and ,.. This compels us to maintain a Neutral rating on a long-term basis (6-12 months).

Automatic Data Processing has a Zacks #3 Rank, which implies a short-term Hold rating on the stock.