ASF Administaff, Inc.

Automatic Data Processing Inc. (ADP) reported third quarter 2011 earnings per share of 85 cents that were in-line with the Zacks Consensus Estimate. Earnings per share increased 8.0% year over year and 37.1% sequentially.

The third quarter earnings were primarily driven by strong Employer Services and PEO Services. Additionally, the Dealer Services segment continued its recovery.

Operating Performance

Net income from continuing operations increased 5.5% year over year to $423.8 million. A lower effective tax rate in the quarter positively impacted the net earnings from continuing operations. Net margin of 15.5% dropped from 16.4% in the prior year quarter.

This was mainly on account of higher cost and expenses related to the closing of two transactions during the third quarter.  This resulted in a 14.3% year over year increase in expenses to $2.10 billion.

Operating income increased 5.2% on a year-over-year basis to $638.0 million. Operating margin decreased 150 basis points (bps) to 23.3% from the year-ago quarter.

During the quarter, pre-tax income increased 3.2% year over year to $653.0 million. Pre-tax margin decreased 200 bps on a year-over-year basis to 23.9% for the quarter.

Employer Services pre-tax margin decreased 0.3% and Dealer Services margin dropped 2.0%. However, PEO Services inched up 0.5% in the quarter.

Revenue

Revenues increased 12.0% year over year and 13.7% sequentially to $2.74 billion, which was well above the Zacks Consensus estimate of $2.66 billion. Organic growth was 7.0% in the quarter.

The strong year-over-year growth was driven by broad-based strength across all major business segments.

Employer Services revenue increased 9.0% year over year (7.0% organically) to $1.93 billion. In the US, revenues from the traditional payroll and payroll tax filing business grew 5% in the quarter. Beyond payroll, revenues were up 15% in the quarter, driven by acquisitions.

The number of employees on clients' payrolls in the United States grew 2.7% in the quarter on a same-store-sales basis. Employer Services' pre-tax margin declined 30 bps due to the impact of acquisitions.

PEO Services revenue was up 18.0% year over year to $447.8 million in the third quarter. Interest on funds held for clients increased 0.5% year over year to $148.6 million and was driven by a 12.0% increase in average client funds balances, but was partially offset by a 30 bps decline in the average interest yield to 2.9%.

Dealer Services revenue increased 29.0% year over year (3.0% organically) to $391.5 million. The revenue was positively impacted by the Cobalt acquisition, which was closed in the first quarter 2011. Compared with the prior-year quarter, pre-tax margin for the segment plunged 200 bps due to acquisition related costs.

Balance Sheet and Cash Flow

As of March 31, 2011, cash and cash equivalents (including short-term marketable securities) were $1.64 billion, compared with $1.34 billion in the previous quarter.

Long-term debt decreased marginally to $34.6 million at the end of the third quarter, from $35.1 million in the prior quarter.

Year to date, Automatic Data Processing repurchased nearly 3.8 million shares of its stock for around $175.0 million compared to nearly 2.4 million shares of its stock for treasury at a cost of about $102 million that it acquired in the previous quarter.

Fiscal 2011 Outlook

Automatic Data Processing has raised its outlook on the strength of the robust third quarter earnings results. Total revenue for FY11 is expected to increase 6.0% year over year, up from prior growth expectations of 5.0%. Including acquisitions, the growth is expected to be 10.0% for fiscal 2011, up from the prior forecast of 9.0%.

Employer Services is expected to achieve 5%-6% revenue growth, up from the prior forecast of 5% growth, due to continued positive trends in key business metrics and an excellent third quarter performance. Including acquisitions, Automatic Data Processing anticipates 7% revenue growth, up from the prior forecast range of 6% to 7% growth.

Automatic Data Processing expects pays per control to increase approximately 2.5%, up from prior forecast of a growth of 2.0%. Client revenue retention for fiscal 2011 is expected to increase by over 1.0 percentage points, up from the prior forecast of approximately 0.5%.

Employer Services pre-tax margin is expected to increase 50 bps for fiscal 2011. Including acquisitions, management anticipates pre-tax margin to be flat on a yearly basis, versus the prior forecast of an increase of 20 basis points.

Driven primarily by higher benefits pass through revenues, PEO Services revenue is forecasted to improve 16.0%, up from the prior forecast of 15.0% growth. Management continues to anticipate a decline in pre-tax margin due to higher benefits pass-through revenues and the impact of last year's $9 million favourable state unemployment tax settlement.

High single-digit growth is expected in the new business sales of Employer Services and PEO Services, compared with $1.0 billion sold in fiscal 2010.

Given the positive results achieved during the third quarter, dealer services revenue is expected to increase 3%, up from prior forecast of 2% - 3% growth.

Automatic Data Processing anticipates at least 50 bps of pre-tax margin improvement, up from the prior forecast of slight improvement in pre-tax margin. Including acquisitions, management continues to anticipate revenue growth of over 20%.

Interest on funds held for clients is expected to be down about $5 million from $542.8 million in fiscal 2010. It is based on an approximate 30 to 40 basis point decline in the expected average interest yield to about 3.2% - 3.3%, partially offset by 9% - 10% growth in average client funds balances. ]

This is an upward revision from the previously forecasted decline of $15 - $20 million, or 3% - 4%, based on a 30 - 40 basis point decline in the average interest yield and growth in average client funds balances of 7% -8%.

Automatic Data Processing expects earnings per share to increase 6.0%-7.0% from $2.37 in fiscal 2010. The Zacks Consensus Estimate for the quarter is currently pegged at $2.50, much higher than the guided range.

Conclusion

We remain Neutral on the stock over the long term, though Automatic Data Processing has presented a strong 2011 outlook, suggesting a positive second half driven by higher client retention and revenue growth from new business.

However, competition from Paychex Inc. (PAYX) and Administaff Inc. (ASF) remain headwinds for the company.

Currently, Automatic Data Processing has a Zacks #2 Rank, which implies a Buy rating on a short-term basis.

 
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