ADP Meets Earnings, Misses Revenue

Automatic Data Processing Inc. (ADP - Snapshot Report) reported fourth quarter 2012 earnings of 53 cents per share, which came in line with the Zacks Consensus Estimate. Earnings increased 10.4% year over year primarily due to strong revenue growth.

Quarter Details

Revenues increased 5.2% year over year to $2.64 billion, which marginally missed the Zacks Consensus Estimate of $2.65 billion. Organic growth was 4.0% in the quarter. The better-than-expected revenue was driven by strong new business sales and better sales execution in the Employer Services and PEO Services segments.

Employer Services revenue increased 7.0% year over year (5.0% organically) to $1.88 billion. The number of employees on clients' payrolls in the United States grew 3.2% in the quarter on a same-store-sales basis.

PEO Services revenue expanded 12.0% year over year to $443.3 million in the reported quarter. Dealer Services revenue climbed 7.0% year over year to $431.4 million.

Interest on funds held for clients declined 11.3% year over year to $120.3 million, due to a decline of 40 basis points (bps) in the average interest yield to 2.5%, partially offset by a 4.0% increase in average client funds balances to $19.2 billion.

Total expenses in the reported quarter increased 4.0% year over year to $2.27 billion, attributable to higher operating expenses (up 4.2% year over year), selling, general & administrative expense (up 2.6% year over year) and systems development & programming costs (up 8.0% year over year).

The company reported pre-tax earnings of $397.5 million, up 10.8% from the year-ago quarter. Pre-tax margin increased 80 bps year over year to 15.1%, driven by higher Employer Services' pre-tax margin, PEO Services pre-tax margin and Dealer Services pre-tax margin, which increased 40 bps, 130 bps and 70 bps, respectively, in the reported quarter.

Net income increased 6.9% year over year to $258.4 million. Net margin increased by 20 bps to 9.8% in the quarter.

ADP exited the quarter with cash and cash equivalents (including short-term marketable securities) of $1.59 billion, compared with $1.69 billion in the previous quarter. Long-term debt decreased to $16.8 million in the quarter from $17.3 million in the prior quarter. ADP purchased 6.4 million shares for $342.0 million during the reported quarter.

Guidance

For fiscal 2013, ADP expects total revenue to increase in the range of 5.0%-7.0% year over year. This includes unfavorable foreign exchange rates, expected decline in interest on client funds and year-over-year comparisons relating to sale of assets and expiration of certain employment tax credits. For fiscal 2013, earnings are expected to increase 5.0%-7.0% over the year-ago level of $2.74 per share.

Employer Services revenue is expected to grow approximately 6%-7% with a pre-tax margin expansion of approximately 50bps. PEO Services revenue is forecasted to improve 13.0%-15.0%. Pre-tax margin is expected to grow slightly on a year-over-year basis. ADP expects Dealer Services revenue to increase in the 7.0%-9.0% range with a pre-tax margin expansion of at least 50 bps.

The company expects interest on funds held for clients to decline $65.0 million-$75.0 million or 13.0%-15.0% from $493.3 million in fiscal 2012. However, the company expects 5%-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 - Snapshot Report) and a gloomy macroeconomic condition are the major headwinds in the near term.

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.