Automatic Data Processing Inc. (NASDAQ:ADP) reported second quarter 2011 earnings per share of 62 cents, beating the Zacks Consensus Estimate by a penny. Second quarter earnings was primarily driven by strong top-line growth partially offset by higher expenses.
Earnings per share were flat on a year over year basis but leaped 10.7% sequentially. Excluding a tax benefit of 2 cents a share in the second quarter of 2010, earnings increased 3.3% year over year in the second quarter 2011.
Net income from continuing operations decreased 2.0% year over year to $310.1 million, with net margin falling to 12.9% from 14.3% in the prior-year quarter. Excluding a tax benefit of $12.2 million in the second quarter of 2010, net income increased 2.4% year over year in second quarter 2011.
Total cost of expenses increased 11.7% year over year and 6.7% sequentially to $1.95 billion.
Operating income increased slightly (0.6%) on a year-over-year basis to $452.5 million. Operating income climbed 13.4% sequentially. Operating margin decreased 160 basis points (bps) year over year but increased 90 bps on a sequential basis to 18.8%.
Pre-tax income increased 1.2% year over year and 11.0% sequentially to $484.6 million in the second quarter. Pre-tax margin decreased 170 bps on a year-over-year basis but increased 50 bps sequentially to 20.1% in the quarter.
Employer Services, PEO Services and Dealer Services pre-tax margins fell 0.8%, 0.4% and 2.6%, respectively, in the quarter.
Revenues increased 9.4% year over year and 7.9% sequentially to $2.41 billion in the second quarter, comfortably surpassing the Zacks Consensus Estimate of $2.34 billion. Organic growth was 5.0% in the quarter. Unfavourable foreign currency exchange had a negative impact of 1% on revenue growth.
The strong year-over-year growth was primarily driven by new business sales from Employer Services and PEO Services that grew 16% in the quarter.
Employer Services revenue increased 7.0% year over year (4.0% organically) to $1.92 billion. In the United States, revenues from traditional payroll and payroll tax filing business were flat.
Excluding payroll, revenues grew 16% in the quarter, driven by acquisitions. The number of employees on clients' payrolls in the United States grew 2.4% in the quarter, on a same-store sales basis. Worldwide client retention improved 0.8% year over year.
PEO Services revenue was up 15.0% year over year at $355.7 million in the second quarter. Interest on funds held for clients increased 1.0% year over year to $129.0 million owing to a 9.0% rise in average client funds balances, partially offset by a decline of 30 bps in the average interest yield to 3.5%.
Balance Sheet and Cash Flow
As of December 31, 2010, cash and cash equivalents (including short-term marketable securities) were $1.34 billion compared with $1.22 billion in the previous quarter ended September 30, 2010.
Long-term debt decreased marginally to $35.1 million at the end of second quarter from $35.6 million in the prior quarter.
Year to date, Automatic Data Processing acquired nearly 2.4 million shares of its stock for treasury at a cost of about $102 million.
Automatic Data Processing expects year over year expense and earnings comparisons to alleviate in the second half of fiscal 2011.
Total revenue is expected to increase 5.0% year over year, up from the prior growth rate of 3.0% to 5.0%. Including acquisitions, the growth is expected to be 9.0% up from the prior forecast of 7.0% to 8.0%. The Zacks Consensus Estimate is currently pegged at $9.55 billion.
Employer Services is expected to achieve 5% revenue growth, up from the prior forecast of a 4% growth on continued positive trends in key business metrics. Including acquisitions, Automatic Data Processing anticipates 6% to 7% revenue growth, up from the prior forecast of about 5% growth.
The company expects pays per control to increase approximately 2.0%, up from the prior forecast of a growth of 1.0%. Client revenue retention is expected to increase over 0.5%, up from the prior forecast of approximately 0.5% for fiscal 2011.
Employer Services pre-tax margin is expected to increase 50 bps. Including acquisitions, management anticipates up to 20 bps of pre-tax margin improvement.
PEO Services revenue is projected to improve 15.0%, up from the previous forecast of 13.0% to 15.0% growth. Management continues to anticipate a decline in pre-tax margin due to increased benefits, pass through revenues and the grow-over impact of $9 million favourable state unemployment tax settlement in 2010.
Employer Services and PEO Services new business sales are estimated to see high single-digit growth as compared with $1.0 billion in fiscal 2010.
Dealer Services revenue is expected to increase 2% to 3%, up from 2% growth projected previously, due to the positive results achieved during the second quarter.
Automatic Data Processing anticipates at least 50 bps of pre-tax margin improvement, up from the prior forecast of a slight improvement. Including acquisitions, management continues to anticipate revenue growth of over 20%.
Interest on funds held for clients is expected to decline 3% to 4% from $542.8 million in fiscal 2010. This is based on an approximate 30 to 40 bps decline in the expected average interest yield to about 3.2% to 3.3%, partially offset by a 7% to 8% growth in average client funds balances.
Automatic Data Processing expects earnings per share to increase 5.0% from $2.37 in fiscal 2010. The Zacks Consensus Estimate is currently pegged at $2.47.
We remain Neutral on a long-term basis (6–12 months). We believe Automatic Data Processing’s second quarter results reflect the sluggish U.S. employment market and tough competition from Paychex Inc. (NASDAQ:PAYX). However, we believe the strong fiscal 2011 outlook suggests a positive second half, driven by higher client retention and new business sales from Employer Services and PEO Services.
Currently, Automatic Data Processing has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.