How Important Are Operating Expenses To ADP’s Expenses And Overall Profitability?

ADP’s (NASDAQ: ADP) total expenses have risen steadily, going from $10.58 billion in 2017 to $11.88 billion in 2019. However, as a percentage of total revenues, expenses dropped, going from 85.6% in 2017 to 83.8% in 2019.
Operating expenses are the biggest expense head for the company, coming in at 51.6% of revenue in 2017, before dropping to around 50.4% of revenue in 2019. In addition to this, a growth in revenue and a simultaneous drop in other expenses, has helped in bringing in an additional $1.28 in earnings per share between 2017 and 2019. Also, despite an expected growth in revenue in 2020, cost of sales as % of revenue is expected to rise slightly, leading to a projected drop in net income margin from 16.2% in 2019 to 15.1% in 2020.
However, in 2021, net income margin is set to rise to around 15.6%, and this, combined with a projected rise in revenue, has helped drive a ~30% rise in ADP’s share price over the past year.

In our interactive dashboard How Does ADP Spend Its Money?, we take a look at the key drivers of ADP’s expenses and net margins.

ADP’s Net Income Margins have remained volatile, dropping slightly from 14.5% in 2017 to 14.1% in 2018, before jumping to around 16.2% in 2019. Going forward, margins are expected to drop slightly, to 15.1% in 2020 and 15.6% in 2021.

Breakdown of ADP’s Total Expenses

• Operating expenses rose from $6.39 billion in 2017 to $7.15 billion in 2019. This is the largest expense head for the company, coming in at 51.6% of revenue in 2017 before dropping to around 50.4% in 2019. This metric largely includes any operation costs the company incurs in running its automated payroll systems and placing third-party employees at client locations. Going forward, we expect this expense to rise to over $8 billion by 2021, but a simultaneous growth in revenue means that it would still come in at around 50.7% of revenue.
• Systems development and programming costs have remained roughly flat over the past 2 years, despite a steady growth in revenue. These costs include research expenses and costs incurred in developing and maintaining the automated payroll and employee attendance systems. As a % of Revenue, this expense dropped from 5.1% to 4.5% during the same period. Despite a steady expected rise in revenue going forward, we expect this metric to rise to around 4.8% by 2021.
• Depreciation and amortization expense went from $226 million in 2017 to $304 million in 2019, growing at a rate faster than that of revenue growth. Going forward, we expect this metric to come in at roughly 2% of total revenue in 2020 and 2021.
• SG&A expense has risen from $2.77 billion in 2017 to $3.06 billion in 2019, albeit at a rate slower than that of revenue growth. Thus, as a % of revenue, this metric has gone from 22.4% to 21.6% in the same period. Going forward, we expect SG&A expense to rise to $3.3 billion in 2020 and $3.47 billion in 2021, at a rate roughly in line with that of revenue growth.
• Non-Operating Expense has increased from -$263 million in 2017 to $19 million in 2019. There was a rise in 2018 and 2019, as ADP’s interest expense exceeded interest income, and other non-operating expenses increased as well. Total debt has remained stagnant at around $2 billion over this period. Going forward, we expect non operating expenses to be around $120 million in 2020 and 2021.
• Income Tax Expense has decreased from $829 million in 2017 to $713 million in 2019, with Effective Tax rate falling from 31.7% to 23.7% during the same period. Effective tax rate is expected to be around 22.5% in the near term.

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