We previously posted an analysis of Cisco Systems' (CSCO) preliminary report on the October 2007 quarter. Cisco subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC.
The additional data in the 10-Q did not affect the analysis results, and the gauge scores were unchanged. For details, please see the earlier posting.
It was interesting to read in the 10-Q about the Cisco's stock repurchase program. Over the last 6 years, Cisco spent $46.2 billion on its own shares. The authorized amount was $52 billion, so we can give Cisco credit for doing what they said they would -- unlike some other companies that are better at gaining the positive publicity that results from a large authorization than they are at spending the full amount. Some companies repurchase the shares but then grant them to employees in the the form of stock options.
On 15 November 2007, Cisco added another $10 billion to the repurchase authorization. Coupled with the $5.8 billion remaining from earlier authorizations, the company, therefore, is postured to spend another $15.8 billion on its shares. If we assume an average per-share cost of $30 billion, Cisco could buy 527 million more shares. This would be 8.7 percent of the 6.082 million shares outstanding on 31 October 2007.
21 November 2007
20 November 2007
WPI: Financial Analysis through September 2007 (Updated)
We previously posted an analysis of Watson Pharmaceuticals' (WPI) preliminary report on the September 2007 quarter. The company's initial report was limited in that the Balance Sheet omitted various details, including those characterizing Watson's inventory, current liabilities, and stockholder's equity.
Watson subsequently filed with the SEC a more complete quarterly report in a 10-Q, and we adjusted our evaluation to incorporate the new information. The additional data did not materially affect the analysis results. The gauge scores did not change.
For details, please see the earlier posting.
One point of interest worth noting is that Finished Goods/Inventory moved up to 67.1 percent (believed to be a record high for Watson), from 65.5 percent in June, and 52.3 percent in September 2006 (before the acquisition of Andrx Corporation). An increase in this ratio can hint that a company's products sold at a slower pace than expected. When this is the case, the company might have to cut production or take back unsold goods from wholesalers.
Watson subsequently filed with the SEC a more complete quarterly report in a 10-Q, and we adjusted our evaluation to incorporate the new information. The additional data did not materially affect the analysis results. The gauge scores did not change.
For details, please see the earlier posting.
One point of interest worth noting is that Finished Goods/Inventory moved up to 67.1 percent (believed to be a record high for Watson), from 65.5 percent in June, and 52.3 percent in September 2006 (before the acquisition of Andrx Corporation). An increase in this ratio can hint that a company's products sold at a slower pace than expected. When this is the case, the company might have to cut production or take back unsold goods from wholesalers.
19 November 2007
BUD: Financial Analysis through September 2007 (Update)
We previously posted an analysis of Anheuser-Busch's (BUD) preliminary report on the September 2007 quarter. The company's initial report was, for our purposes, reasonably complete. The only missing data was the breakout of Inventory into its Raw Materials, Work in Process, and Finished Goods components. We obtained the Inventory breakout figures when BUD filed a complete quarterly report in a 10-Q with the SEC.
Our evaluation, adjusted to account for Inventory information, is reported in this post. The additional data did not change the gauge scores.
Separate from the Inventory situation, the gauges increased because we previously overlooked the degree to which BUD had reduced the number of its shares outstanding. BUD repurchased 16.1 million shares during the third quarter. As a result of these and earlier transactions, the average diluted number of common shares dropped from 775.9 million in the third quarter of 2006 to 745.4 million in the third quarter of 2007. Fewer shares increases Earnings per Share (EPS) and decreases the company's Market Value. In this case, it increased the Value gauge from 2 to 3 points, and it increased the Overall gauge from 25 to 27 points.
With respect to the Inventory data, Finished Goods/Inventory is the metric of interest. The ratio, which contributes to our Cash Management gauge, was 39.4 percent on 30 September 2007, a rather substantial increase from 28.6 percent in December 2006. In general, we do not like to see unusual increases in the Finished Goods ratio because the rise could be an early warning sign that sales were below expectations. Our concern is somewhat mitigated by the drop in Inventory/CGS from 24.2 to 22.7 days.
Our evaluation, adjusted to account for Inventory information, is reported in this post. The additional data did not change the gauge scores.
Separate from the Inventory situation, the gauges increased because we previously overlooked the degree to which BUD had reduced the number of its shares outstanding. BUD repurchased 16.1 million shares during the third quarter. As a result of these and earlier transactions, the average diluted number of common shares dropped from 775.9 million in the third quarter of 2006 to 745.4 million in the third quarter of 2007. Fewer shares increases Earnings per Share (EPS) and decreases the company's Market Value. In this case, it increased the Value gauge from 2 to 3 points, and it increased the Overall gauge from 25 to 27 points.
With respect to the Inventory data, Finished Goods/Inventory is the metric of interest. The ratio, which contributes to our Cash Management gauge, was 39.4 percent on 30 September 2007, a rather substantial increase from 28.6 percent in December 2006. In general, we do not like to see unusual increases in the Finished Goods ratio because the rise could be an early warning sign that sales were below expectations. Our concern is somewhat mitigated by the drop in Inventory/CGS from 24.2 to 22.7 days.
18 November 2007
BEAS: Financial Analysis through October 2007 (Preliminary)
BEA Systems (BEAS), a developer of software that connects an enterprise's diverse information technology assets, has, at long last, produced 10-Q and 10-K financial statements for the periods that ended in July 2006, October 2006, January 2007, April 2007, and July 2007. The company also released a preliminary report on the October 2007 quarter.
The financial statements had been delayed while the company investigated its practices for granting and accounting for employee stock options. Last February, BEA announced the principal findings, which covered a period of about 10 years. The investigation determined that historical financial statements would have to be revised to include additional non-cash, pre-tax compensation expenses totaling between $340 and $390 million. The estimated charge was subsequently bumped up to $425 million. To put this charge in perspective: BEA had once reported net income totaling $441 million for the five fiscal years that ended on 31 January 2006.
NASDAQ could have suspended trading of BEA shares for failure to submit timely reports in accordance with regulatory requirements. Although the anticipated date for filing these reports repeatedly slipped, a "delisting" decision was never put into effect. This risk is now less of a concern since the 10-Q and 10-K reports identified above were filed on 15 November 2007.
The SEC has asked for, and received, information about BEA's stock option practices. SEC inquiries into these practices are on-going.
Activist investor Carl Icahn purchased shares in BEA this year, and by 3 October Mr. Icahn owned 11 percent of the company. The ownership level increased to 13 percent soon thereafter. Mr. Icahn publicly contended that the company should be put up for sale. On 12 October 2007, Oracle Corp. offered to purchase BEA for $17.00 per share in cash, but BEA rejected the overture as inadequate. Oracle set a 21 October deadline for BEA to accept the $17 offer; however, BEA refused to negotiate unless Oracle first raised its bid. The BEA board set $21 per share as price at which they would negotiate the sale of the company. Oracle refused to meet this demand and withdrew the original offer when the deadline expired.
When this saga was unfolding, BEA's non-compliance with regulatory requirements certainly didn't help the company's negotiating position. And, it complicated plans to hold an overdue annual meeting, which was demanded by Mr. Icahn in a lawsuit. Had audited financial statements remained unavailable, company management wouldn't have been able to solicit proxies for seats on the board of directors. An outside investor, not subject to this constraint, could have exploited this situation to his advantage. These factors might have given management the extra impetus needed to complete and file the delinquent financial reports, which took place on 15 November.
We have performed a financial analysis of BEA using data from BEA's new SEC filings and the preliminary report on the October 2007 quarter. There was a lot of information to examine, and we caution readers to consider the results described below as tentative and subject to change. We relied on (with one exception noted below) the data prepared in accordance with GAAP; however, comparisons of different time periods using GAAP data can sometimes be misleading. Non-GAAP comparisons might have been more valid in some cases.
In the analysis, we reluctantly made one exception to our normal rules. We excluded from the Income Statement for the 31 January 2007 quarter an asset impairment write-down of $201.615 million on land in San Jose. The magnitude of this loss is so great that it obscures our view of company's software business. However, since shareholders' money was, in fact, forfeited on this land, we did not exclude the loss from the Cash Flow Statement.
The data for the October 2007 quarter is limited in that the Balance Sheet was condensed and a Cash Flow Statement wasn't provided. We will update our evaluation after the company submits a complete report for the October 2007 quarter to the SEC in a 10-Q filing.
Using the available data, our gauges display the following scores:
Before we examine the factors that affected each gauge, let's compare Income in the last four quarters to income in the four previous quarters. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. The standardization is simply for convenience and to facilitate cross-company comparisons.
Year-over-year Revenue was up 10 percent. The Cost of Goods Sold (CGS) was steady at a little less than 24 percent of Revenue in both four-quarter periods. Research and Development (R&D) expenses as a percentage of Revenue declined a little from 16.6 to 16.2 percent. Sales, General, and Administrative (SG&A) expenses were trimmed from 46.7 to 46.5 percent of Revenue.
The increase in Revenue pushed up Operating Income by 16 percent.
The recent four-quarter period benefited from an increase in non-operating income of $43 million and a reduction in the effective Income Tax Rate from 34.7 to 28.2 percent. As a result, year-over-year Net Income rose by 33 percent.
Cash Management. This gauge reads 13 points.
The following measures pushed the score up the most:
Growth. This gauge reads an impressive 19 points.
The following measures pushed the score up the most:
The following measures held the score down:
Profitability. This gauge reads 5 points.
The following measure pushed the score up the most:
Value. BEA's stock price moved up to $16.90 on 31 October as investors waited to see if Oracle would return with a higher offer or if another potential purchaser would step forward. The share price increase pushed the valuation metrics we track into regions the Value gauge is calibrated to deem expensive.
On 15 November, BEA gave us a plethora of new and restated data to digest. Given the change in options accounting, the acquisition of companies such as Plumtree Software, and company's real estate transactions, our understanding of the company's status might be flawed. We encourage readers to check the analysis and confirm the validity of the numbers used and the assumptions made.
The solid Cash Management gauge score indicates a fairly strong and improving Balance Sheet, with debt levels that shouldn't be worrisome. The impressive Growth gauge score hints at why management has expressed confidence about the company's future. The Profitability gauge isn't that encouraging, but it seems have been depressed by the large real estate impairment charge. Current price and earnings metrics are higher than the comfort level of most value investors, but this is often the case for high-growth companies. Whether the company will be able to grow fast enough to stir the Value gauge is an open question.
The financial statements had been delayed while the company investigated its practices for granting and accounting for employee stock options. Last February, BEA announced the principal findings, which covered a period of about 10 years. The investigation determined that historical financial statements would have to be revised to include additional non-cash, pre-tax compensation expenses totaling between $340 and $390 million. The estimated charge was subsequently bumped up to $425 million. To put this charge in perspective: BEA had once reported net income totaling $441 million for the five fiscal years that ended on 31 January 2006.
NASDAQ could have suspended trading of BEA shares for failure to submit timely reports in accordance with regulatory requirements. Although the anticipated date for filing these reports repeatedly slipped, a "delisting" decision was never put into effect. This risk is now less of a concern since the 10-Q and 10-K reports identified above were filed on 15 November 2007.
The SEC has asked for, and received, information about BEA's stock option practices. SEC inquiries into these practices are on-going.
Activist investor Carl Icahn purchased shares in BEA this year, and by 3 October Mr. Icahn owned 11 percent of the company. The ownership level increased to 13 percent soon thereafter. Mr. Icahn publicly contended that the company should be put up for sale. On 12 October 2007, Oracle Corp. offered to purchase BEA for $17.00 per share in cash, but BEA rejected the overture as inadequate. Oracle set a 21 October deadline for BEA to accept the $17 offer; however, BEA refused to negotiate unless Oracle first raised its bid. The BEA board set $21 per share as price at which they would negotiate the sale of the company. Oracle refused to meet this demand and withdrew the original offer when the deadline expired.
When this saga was unfolding, BEA's non-compliance with regulatory requirements certainly didn't help the company's negotiating position. And, it complicated plans to hold an overdue annual meeting, which was demanded by Mr. Icahn in a lawsuit. Had audited financial statements remained unavailable, company management wouldn't have been able to solicit proxies for seats on the board of directors. An outside investor, not subject to this constraint, could have exploited this situation to his advantage. These factors might have given management the extra impetus needed to complete and file the delinquent financial reports, which took place on 15 November.
We have performed a financial analysis of BEA using data from BEA's new SEC filings and the preliminary report on the October 2007 quarter. There was a lot of information to examine, and we caution readers to consider the results described below as tentative and subject to change. We relied on (with one exception noted below) the data prepared in accordance with GAAP; however, comparisons of different time periods using GAAP data can sometimes be misleading. Non-GAAP comparisons might have been more valid in some cases.
In the analysis, we reluctantly made one exception to our normal rules. We excluded from the Income Statement for the 31 January 2007 quarter an asset impairment write-down of $201.615 million on land in San Jose. The magnitude of this loss is so great that it obscures our view of company's software business. However, since shareholders' money was, in fact, forfeited on this land, we did not exclude the loss from the Cash Flow Statement.
The data for the October 2007 quarter is limited in that the Balance Sheet was condensed and a Cash Flow Statement wasn't provided. We will update our evaluation after the company submits a complete report for the October 2007 quarter to the SEC in a 10-Q filing.
Using the available data, our gauges display the following scores:
- Cash Management: 13 of 25
- Growth: 19 of 25
- Profitability: 5 of 25
- Value: 0 of 25
- Overall: 24 of 100
Before we examine the factors that affected each gauge, let's compare Income in the last four quarters to income in the four previous quarters. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | 4 Quarters Ending October 2007 | 4 Quarters Ending October 2006 | |
| Revenue | 1487 | 1352 | |
| Op expenses | |||
| CGS | (355) | (322) | |
| R&D | (241) | (224) | |
| SG&A | (692) | (631) | |
| Other | (2) | (5) | |
| Operating Income | 197 | 169 | |
| Other income | |||
| Investments | 0 | 0 | |
| Interest, etc. | 52 | 36 | |
| Pretax income | 249 | 206 | |
| Income tax | (70) | (71) | |
| Net Income | 179 | 134 | |
| 0.43/sh | 0.32/sh | ||
Year-over-year Revenue was up 10 percent. The Cost of Goods Sold (CGS) was steady at a little less than 24 percent of Revenue in both four-quarter periods. Research and Development (R&D) expenses as a percentage of Revenue declined a little from 16.6 to 16.2 percent. Sales, General, and Administrative (SG&A) expenses were trimmed from 46.7 to 46.5 percent of Revenue.
The increase in Revenue pushed up Operating Income by 16 percent.
The recent four-quarter period benefited from an increase in non-operating income of $43 million and a reduction in the effective Income Tax Rate from 34.7 to 28.2 percent. As a result, year-over-year Net Income rose by 33 percent.
Cash Management. This gauge reads 13 points.
The following measures pushed the score up the most:
- Current Ratio =2.7; a sign of strength, up from 2.0 in October 2006
- LTD/Equity = 10.1 percent, a relatively low value that is down from 16.9 percent
- Debt/CFO = 0.7 years, compared to 1.6 years 12 months ago
- Working Capital/Market Capitalization = 15.0 percent, up from 11.7 percent
- Days of Sales Outstanding (DSO) = 70.0 days, a small decline from 70.6 days one year ago.
- Cash Conversion Cycle Time (CCCT) = 51 days, up from 34.4 days, for this measure of efficiency. The validity of using CCCT for a company without Inventory on its Balance Sheet is worth investigating.
Growth. This gauge reads an impressive 19 points.
The following measures pushed the score up the most:
- Net Income growth = 33.2 percent year-over-year, up from -13.4 percent
- Revenue/Assets = 64.4 percent, up from 54.6 percent in a year; sales efficiency is improving.
- Revenue growth = 10 percent year-over-year, down from 17.6 percent.
Net income benefited from a 6.5 percent drop in the effective income tax rate.
The following measures held the score down:
- CFO growth = -30.8 percent year-over-year, down from 20.8 percent. CFO (Oct 2007 value was estimated) was reduced by the land impairment charge mentioned above.
Profitability. This gauge reads 5 points.
The following measure pushed the score up the most:
- ROIC = 16.5 percent, up from 14.4 percent in a year
- FCF/Equity = 9.1 percent (affected by impairment charge), down from 21 percent in a year.
- Accrual Ratio = 1.7 percent, up from -6.2 percent in a year.
- Operating Expenses/Revenue = 86.6 percent, down from 87.1 percent in a year
The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.
Value. BEA's stock price moved up to $16.90 on 31 October as investors waited to see if Oracle would return with a higher offer or if another potential purchaser would step forward. The share price increase pushed the valuation metrics we track into regions the Value gauge is calibrated to deem expensive.
- Enterprise Value/Cash Flow = 27.7, up from 18.9 in October 2006. To be sure, the large land impairment charge significantly reduced CFO and we might have underestimated CFO in Oct 2007 quarter.
- P/E = 39, down from 50 one year ago, when the share price was $16.27, but no bargain unless earnings growth going forward is substantial. The average P/E for the Software and Programming industry is currently a less expensive 27.
- P/E to S&P 500 average P/E = 140 percent premium
- Price/Revenue ratio = 4.7. The average Price/Revenue for the industry is currently 6.5.
On 15 November, BEA gave us a plethora of new and restated data to digest. Given the change in options accounting, the acquisition of companies such as Plumtree Software, and company's real estate transactions, our understanding of the company's status might be flawed. We encourage readers to check the analysis and confirm the validity of the numbers used and the assumptions made.
The solid Cash Management gauge score indicates a fairly strong and improving Balance Sheet, with debt levels that shouldn't be worrisome. The impressive Growth gauge score hints at why management has expressed confidence about the company's future. The Profitability gauge isn't that encouraging, but it seems have been depressed by the large real estate impairment charge. Current price and earnings metrics are higher than the comfort level of most value investors, but this is often the case for high-growth companies. Whether the company will be able to grow fast enough to stir the Value gauge is an open question.
16 November 2007
HD: Financial Analysis through October 2007
We have analyzed Home Depot's (HD) preliminary report for the October 2007 quarter, and this post reports our tentative results. The financial statements in the company's report were limited in that the Balance Sheet was abbreviated and the Cash Flow Statement was omitted. We will update our evaluation after the company submits a complete quarterly report to the SEC in a 10-Q filing.
It has been a momentous year for the largest retailer of "do-it-yourself" merchandise, which includes building materials, home improvement supplies, and lawn and garden products. Robert Nardelli was forced out as Chairman and CEO because of dissatisfaction with the company's operating performance, stagnant stock price, and bountiful executive compensation. His elephantine severance package became a cause célèbre. After Frank Blake took over, the company decided to sell the Home Depot Supply division, which served professional contractors. The purchase by a consortium of private equity firms closed on 31 August 2007 for $8.5 billion. The final price was $1.8 billion less than the figure originally negotiated, after problems surfaced in the housing and credit markets. The company used the proceeds and other funds to complete a $10.7 billion Dutch Auction tender offer for its own shares. The offer is part of a larger $22.5 billion "recapitalization" plan, although there has been speculation that the further share repurchases will be delayed considerably.
A fund controlled by Sears Holdings chairman and successful investor Edward Lampert acquired 16.7 million Home Depot shares, valued at $541.3 million, during the third quarter.
We analyzed Home Depot after the April 2007 quarter, but we passed on the July quarter because there was speculation the Home Depot Supply sale might fall through. We have more data now, but we will defer gauge score calculations for another quarter to allow the dust to settle.
Before we examine the metrics associated with each gauge, let's review the latest quarterly Income Statement. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
1. Primarily HD Supply
Revenue in the October 2007 quarter was 3.5 percent less than in the year-earlier quarter. The Cost of Goods Sold (CGS) was 66.6 percent of Revenue, up slightly from 66.4 percent last year. Depreciation expenses were 2.3 percent of Revenue, up from 2.0 percent. Sales, General, and Administrative (SG&A) expenses were 21.9 percent of Revenue, much greater than the 20.3 percent one year ago.
The lose-lose combination of lower Revenue and higher costs, as a percentage of Revenue, led to 20.6-percent decrease in Operating Income.
Net interest expenses were $33 million more than last year. The Income Tax Rate was 34.7 percent, down from 37.4 percent. Net Income from continuing operations declined by 19.7 percent.
Key metrics are reviewed gauge-by-gauge in the lists below. The values should be considered tentative and we are deferring gauge score calculations because of missing data and because some historical data hasn't been adjusted to reflect the new corporate structure.
Cash Management.
The following measures have improved:
Growth.
The following measures have improved:
Profitability.
The following measures have improved:
Value. Home Depot's stock price fell from $40.16 on 31 December 2006 to $31.51 on 31 October 2007, and it has continued to drop in November. The following metrics were calculated using October's closing price.
These value measures all suggest the shares have become less expensive:
The slowdown in home sales has trimmed Home Depot's Revenue and slashed its Earnings. The stock market has punished Home Depot (HD) shares mercilessly, especially since the completion of tender offer, which provided some support to the shares during the summer. The shares now appear to be on sale, but that may be illusionary. Investors probably fear (quite reasonably) that a recovery in the housing business is a long way in the future. Home Depot appears able to, um, weather the storm, although we would have to reconsider this assessment if they borrow another $10 billion to buyback more stock.
It has been a momentous year for the largest retailer of "do-it-yourself" merchandise, which includes building materials, home improvement supplies, and lawn and garden products. Robert Nardelli was forced out as Chairman and CEO because of dissatisfaction with the company's operating performance, stagnant stock price, and bountiful executive compensation. His elephantine severance package became a cause célèbre. After Frank Blake took over, the company decided to sell the Home Depot Supply division, which served professional contractors. The purchase by a consortium of private equity firms closed on 31 August 2007 for $8.5 billion. The final price was $1.8 billion less than the figure originally negotiated, after problems surfaced in the housing and credit markets. The company used the proceeds and other funds to complete a $10.7 billion Dutch Auction tender offer for its own shares. The offer is part of a larger $22.5 billion "recapitalization" plan, although there has been speculation that the further share repurchases will be delayed considerably.
A fund controlled by Sears Holdings chairman and successful investor Edward Lampert acquired 16.7 million Home Depot shares, valued at $541.3 million, during the third quarter.
We analyzed Home Depot after the April 2007 quarter, but we passed on the July quarter because there was speculation the Home Depot Supply sale might fall through. We have more data now, but we will defer gauge score calculations for another quarter to allow the dust to settle.
Before we examine the metrics associated with each gauge, let's review the latest quarterly Income Statement. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | October 2007 (actual) | October 2006 (actual) | |
| Revenue | 18961 | 19648 | |
| Op expenses | |||
| CGS | (12622) | (13044) | |
| Depreciation | (431) | (401) | |
| SG&A | (4144) | (3981) | |
| Other | 0 | 0 | |
| Operating Income | 1764 | 2222 | |
| Other income | |||
| Investments | 0 | 0 | |
| Interest, etc. | (125) | (92) | |
| Pretax income | 1639 | 2130 | |
| Income tax | (568) | (797) | |
| Net Income | 1071 | 1333 | |
| $0.59/sh | $0.65/sh | ||
| Discontinued operations (1) | 20 | 157 |
Revenue in the October 2007 quarter was 3.5 percent less than in the year-earlier quarter. The Cost of Goods Sold (CGS) was 66.6 percent of Revenue, up slightly from 66.4 percent last year. Depreciation expenses were 2.3 percent of Revenue, up from 2.0 percent. Sales, General, and Administrative (SG&A) expenses were 21.9 percent of Revenue, much greater than the 20.3 percent one year ago.
The lose-lose combination of lower Revenue and higher costs, as a percentage of Revenue, led to 20.6-percent decrease in Operating Income.
Net interest expenses were $33 million more than last year. The Income Tax Rate was 34.7 percent, down from 37.4 percent. Net Income from continuing operations declined by 19.7 percent.
Key metrics are reviewed gauge-by-gauge in the lists below. The values should be considered tentative and we are deferring gauge score calculations because of missing data and because some historical data hasn't been adjusted to reflect the new corporate structure.
Cash Management.
The following measures have improved:
- Days of Sales Outstanding (DSO) = 11.9 days, less than the 13.8-day level one year earlier
- Cash Conversion Cycle Time (CCCT) = 44.8 days, down from 46.0 days, for this measure of efficiency.
- Current Ratio =1.1; much weaker than we prefer, but not too much below the five-year median value of 1.3.
- LTD/Equity = 65 percent; the company has, intentionally, become much more leveraged as it borrows money to repurchase shares.
- Debt/CFO = 1.7 years (based on an estimate of CFO), up from 1.2 years in October 2006. Debt may be on the rise, but it appears to be affordable.
- Inventory/CGS = 89.2 days, compared to 87.3 days 12 months ago. The five-year median is much less at 76 days, which suggests that sales have been slower than expected.
- Working Capital/Market Capitalization = 2.5 percent, down not too much from 3.2 percent in October 2006.
Growth.
The following measures have improved:
- Revenue/Assets = 176 percent, way up from 154 percent in a year; stock repurchases decrease assets, which create the illusion of improved sales efficiency.
- CFO growth = 11 percent year-over-year (estimated), up from +4.7 percent.
- Revenue growth = -1.4 percent year-over-year, down from +2.9 percent
- Net Income growth = -22 percent year-over-year, down from +2 percent.
Profitability.
The following measures have improved:
- FCF/Equity = 22 percent (estimated), up from 12 percent
- Accrual Ratio = 1.2 percent (estimated), down from 4.7 percent.
- Operating Expenses/Revenue = 90.5 percent, up from 88.3 percent in a year
- ROIC = 16.4 percent, down just a tad from 16.6 percent in a year.
Value. Home Depot's stock price fell from $40.16 on 31 December 2006 to $31.51 on 31 October 2007, and it has continued to drop in November. The following metrics were calculated using October's closing price.
These value measures all suggest the shares have become less expensive:
- Enterprise Value/Cash Flow = 9.3 (estimated), down from 12.6 in October 2006
- P/E = 12.8, down from 13.4. The five-year median P/E is 15.6 (when the company was growing)
- P/E to S&P 500 average P/E = 20 percent discount, compared to a five-year median of a 9 percent discount
- Price/Revenue ratio = 0.72, xx percent (higher, lower) than its five-year median of 1.07.
The average P/E for the Retail (Home Improvement) Industry is currently 12.7. The average Price/Revenue for the Industry is currently 0.76.
The slowdown in home sales has trimmed Home Depot's Revenue and slashed its Earnings. The stock market has punished Home Depot (HD) shares mercilessly, especially since the completion of tender offer, which provided some support to the shares during the summer. The shares now appear to be on sale, but that may be illusionary. Investors probably fear (quite reasonably) that a recovery in the housing business is a long way in the future. Home Depot appears able to, um, weather the storm, although we would have to reconsider this assessment if they borrow another $10 billion to buyback more stock.
14 November 2007
WMT: Financial Analysis through October 2007
We have analyzed Wal-Mart's (WMT) preliminary report on the October 2007 quarter, and this post reports our results. The financial statements in the company's report are sufficiently complete for our purposes. We will determine if our evaluation needs to be updated after the company submits a complete quarterly report to the SEC in a 10-Q filing.
Wal-Mart's figures moved the stock market upward, perhaps in relief they didn't show a decline in consumer spending rates. When looked at the day after, there doesn't appear to be much in the report to justify the excitement.
With annual sales over $350 billion, or about 10 percent of U.S. retail sales, Wal-Mart squeezed ahead of Exxon Mobil (XOM) to garner the top spot on the 2007 edition of the Fortune 500 list of America's largest corporations. Wal-Mart transformed retailing (for better or for worse, depending on your perspective) by using information technology to manage its supply chain and by pressuring manufacturers to squeeze every penny out of their costs. Wal-Mart's visibility and role in advancing globalization have made it a lightning rod for criticism.
Wal-Mart's growth has weakened in recent years. Competition, market saturation, the slowing U.S. economy, and questionable merchandising choices have combined to shrink Wal-Mart's same-store sales growth to the low single digits. Target, which appeals to a somewhat more affluent customers, has been eroding Wal-Mart's market share from above. From below, high gas prices have taken a bite out of the wallets and pocketbooks of Wal-Mart's core customers. The company has responded by cutting back on plans to open new stores and by luring customers with generic prescriptions drugs for $4.
When we analyzed Wal-Mart after the July quarter, the Overall score was 30 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 11 points. Profitability was weakest at 3 points.
Now, with the available data from the October 2007 quarter, our gauges display the following scores:
Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. Please note that the presentation format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
1. Revenue "predictions" for Wal-Mart are based on the company's publicly announced monthly sales reports.
2. The company includes some income in operating income that we treat as non-operating income.
Revenue in the October quarter was 0.66 percent below the predicted value and 8.8 percent higher than in the October 2006 quarter. Year-over-year revenue growth is now 9.0 percent.
We thought the Cost of Goods Sold (CGS) would be 76.8 percent of Revenue, and the actual value was 76.2 percent. Sales, General, and Administrative (SG&A) expenses were 19.5 percent of Revenue, compared to our forecast of 18.5 percent.
Operating Income was 10.2 percent above the value in the October 2006 quarter. However, Operating Income was 9.2 percent below the forecast value because of the slightly lower than expected revenue and the higher SG&A expenses
Non-operating income was $71 million greater than expected. The Income Tax Rate was 35.3 percent, instead of the predicted 35 percent. As a result, Net Income missed the prediction by 7.3 percent.
Cash Management. This gauge stayed at 6 points from July through October.
The following measures pushed the score up the most:
The following measures pushed the score up the most:
Profitability. This gauge held steady at the 3 points from July.
None of the following measures pushed the score up appreciably:
Value. Wal-Mart's stock price slipped over the quarter from $45.95 to $45.21. The Value gauge, based on the latter price, increased to 12 points from 11 points three months ago (and 13 points twelve months ago).
All of the following measures made small positive contributions to the score:
Now at a so-so 29 out of 100 possible points, the Overall gauge wasn't moved by the third quarter results. Year-over-year revenue growth of 9 percent, which happened to be driven by international operations, can be seen as a deceleration. Net income growth of 7.6 percent wouldn't normally get anyone excited, but (unlike cash flow from operations) at least it was positive. Profitability is, at best, stable.
Wal-Mart's figures moved the stock market upward, perhaps in relief they didn't show a decline in consumer spending rates. When looked at the day after, there doesn't appear to be much in the report to justify the excitement.
With annual sales over $350 billion, or about 10 percent of U.S. retail sales, Wal-Mart squeezed ahead of Exxon Mobil (XOM) to garner the top spot on the 2007 edition of the Fortune 500 list of America's largest corporations. Wal-Mart transformed retailing (for better or for worse, depending on your perspective) by using information technology to manage its supply chain and by pressuring manufacturers to squeeze every penny out of their costs. Wal-Mart's visibility and role in advancing globalization have made it a lightning rod for criticism.
Wal-Mart's growth has weakened in recent years. Competition, market saturation, the slowing U.S. economy, and questionable merchandising choices have combined to shrink Wal-Mart's same-store sales growth to the low single digits. Target, which appeals to a somewhat more affluent customers, has been eroding Wal-Mart's market share from above. From below, high gas prices have taken a bite out of the wallets and pocketbooks of Wal-Mart's core customers. The company has responded by cutting back on plans to open new stores and by luring customers with generic prescriptions drugs for $4.
When we analyzed Wal-Mart after the July quarter, the Overall score was 30 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 11 points. Profitability was weakest at 3 points.
Now, with the available data from the October 2007 quarter, our gauges display the following scores:
- Cash Management: 6 of 25
- Growth: 4 of 25
- Profitability: 3 of 25
- Value: 12 of 25
- Overall: 29 of 100
Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. Please note that the presentation format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($ M) | | Oct 2007 (actual) | Oct 2007 (predicted) | Oct 2006 (actual) |
| Revenue | | 90880 | 91480 | 83543 |
| Op expenses | | | | |
| | CGS | (69292) | (70256) | (63765) |
| | SG&A | (17685) | (16924) | (16237) |
| | Other | (0) | (0) | (0) |
| Operating Income | | 3903 | 4300 | 3541 |
| Other income | | | | |
| | Invest- ments | (99) | (110) | (84) |
| | Interest, etc. | 610 | 550 | 500 |
| Pretax income | | 4414 | 4740 | 3957 |
| Income tax | | (1557) | (1659) | (1363) |
| Net Income | | 2857 | 3081 | 2594 |
| | | $0.70/sh | 0.75/sh | 0.62/sh |
| Discontinued operations | | | 53 |
2. The company includes some income in operating income that we treat as non-operating income.
Revenue in the October quarter was 0.66 percent below the predicted value and 8.8 percent higher than in the October 2006 quarter. Year-over-year revenue growth is now 9.0 percent.
We thought the Cost of Goods Sold (CGS) would be 76.8 percent of Revenue, and the actual value was 76.2 percent. Sales, General, and Administrative (SG&A) expenses were 19.5 percent of Revenue, compared to our forecast of 18.5 percent.
Operating Income was 10.2 percent above the value in the October 2006 quarter. However, Operating Income was 9.2 percent below the forecast value because of the slightly lower than expected revenue and the higher SG&A expenses
Non-operating income was $71 million greater than expected. The Income Tax Rate was 35.3 percent, instead of the predicted 35 percent. As a result, Net Income missed the prediction by 7.3 percent.
Cash Management. This gauge stayed at 6 points from July through October.
The following measures pushed the score up the most:
- Cash Conversion Cycle Time (CCCT) = 14.6 days, shorter from 17.3 days in October 2006, for this measure of efficiency.
- LTD/Equity = 47.7 percent, a manageable figure but up from 41.1 percent in one year.
- Current Ratio =0.8; weaker than we like; just slightly below the five-year median
- Debt/CFO = 2.3 years; compared to 2.0 and 1.9 years 3 and 12 months ago, respectively.
- Days of Sales Outstanding (DSO) = 2.8 days, longer than the 2.3-day duration one year earlier.
- Working Capital/Market Capitalization = -4.2 percent, down from -3.5 percent
- Inventory/CGS = 50.8 days, compared to 44 and 53 days 3 and 12 months ago, respectively.
The following measures pushed the score up the most:
- Net Income growth = 7.6 percent year-over-year, down from 8.5 percent a year ago, but a little better than the last few quarters.
- Revenue growth = 9.0 percent year-over-year, down from 10.7 percent
- CFO growth = -1.6 percent year-over-year, down from 24.7 percent
- Revenue/Assets = 2.22, down slightly from 2.23 in a year; sales efficiency didn't improved.
Profitability. This gauge held steady at the 3 points from July.
None of the following measures pushed the score up appreciably:
- ROIC = 11.2 percent, down from 11.9 percent in a year.
- FCF/Equity = 6.5 percent, down from 6.8 percent in a year
- Accrual Ratio = 5.2 percent, unchanged from Oct 2006
- Operating Expenses/Revenue = 95.2 percent, essentially the same as last year's 95.1 percent.
Value. Wal-Mart's stock price slipped over the quarter from $45.95 to $45.21. The Value gauge, based on the latter price, increased to 12 points from 11 points three months ago (and 13 points twelve months ago).
All of the following measures made small positive contributions to the score:
- Enterprise Value/Cash Flow = 11.5, down from 12.1 in October 2006, and significantly below its five-year median of 14.2.
- P/E = 14.4, down from 17.4 a year ago, and below its five-year median of 19.
- P/E to S&P 500 average P/E = 12 percent discount, much lower than its five-year median of a 13 percent premium
- Price/Revenue ratio = 0.5, lower than its five-year median of 0.7.
The average P/E for the Retail - Department and Discount industry is currently 15. The average Price/Revenue for the industry is currently 0.6.
Now at a so-so 29 out of 100 possible points, the Overall gauge wasn't moved by the third quarter results. Year-over-year revenue growth of 9 percent, which happened to be driven by international operations, can be seen as a deceleration. Net income growth of 7.6 percent wouldn't normally get anyone excited, but (unlike cash flow from operations) at least it was positive. Profitability is, at best, stable.
12 November 2007
NT: Financial Analysis through September 2007
We have analyzed Nortel Networks (NT) financial statements for the September 2007 quarter as filed with the SEC in a 10-Q. This post reports the results of our evaluation.
Nortel is the Canadian-based supplier of products and services to telecom carriers, other networking enterprises, and businesses. Nortel has defied the worst-case predictions and managed to stay in business and even independent, unlike fellow fallen telecom Lucent. Losses have been the norm at Nortel for most of this decade, resulting in an unfathomable accumulated earnings deficit of $35 billion (U.S.).
Tougher times also revealed shortfalls in the company's internal financial controls, resulting in numerous restatements, and allegations of fraud. The restatements complicate any financial analysis of Nortel.
When we analyzed Nortel after the June quarter, the Overall score was a still-disappointing 25 points. Of the four individual gauges that fed into this composite result, Cash Management was (surprisingly) the strongest at 14 points. Growth was weakest at 0 points.
Now, with the available data from the September 2007 quarter, our gauges display the following scores:
1. Total revenues includes products and services.
2. Amortization of intangible assets + Special charges.
3. Minority interests + Equity in net income of associated companies. Both figures are net of tax.
4. Other income - Interest expense
5. Shareholder litigation settlement expense.
Revenue was 7.6 percent less than in the year-earlier quarter. On a year-over-year basis, Revenue was down 0.5 percent. On a more positive note, Gross Margin increased as Cost of Goods Sold dropped from 61.6 to 57.0 percent of Revenue. Similarly, Research and Development (R&D) expense declined from 16.2 to 15.4 percent of Revenue. The cost control was less successful with Sales, General, and Administrative (SG&A) expenses, which increased from 20.0 to 22.7 percent of revenue.
The lower levels of CGS and R&D outweighed the higher SG&A and greater "special" charges, leading to a near doubling of Operating Income.
Net non-operating income was a substantial $55 million more in the Sept 2007 quarter than the Sept 2006 quarter. The income tax rate is hard to understand in both quarters: 65 percent in the recent quarter and incalculable (pre-tax income was negative) in the year-earlier quarter.
It has been unusual in recent years for Nortel to have a positive Net Income, but they managed to eke out earnings in the last quarter.
Cash Management. This gauge decreased from 14 points in June to 6 points now.
The following measures pushed the score up the most:
The following measure was the one small positive contributor:
The following measures pushed the score up the most:
Value. Nortel's stock price dropped over the course of the quarter from $24.05 to $16.98. Based on the latter price, the Value gauge increased from 5 points in June to 9 points.
The following measures pushed the score up the most:
Now at 26 out of 100 possible points, the best we can say about the Overall gauge score for Nortel is that has been worse. The positive Net Income in the last quarter could be viewed favorably, but the amount is insignificantly low and CFO remains negative. More than 6 years after the high-tech bubble burst, we don't yet see any firm signs that Nortel has turned the corner towards sustained profitability. Over the years, there have been a couple of encouraging moments. But, they proved evanescent. We need to see more.
Nortel is the Canadian-based supplier of products and services to telecom carriers, other networking enterprises, and businesses. Nortel has defied the worst-case predictions and managed to stay in business and even independent, unlike fellow fallen telecom Lucent. Losses have been the norm at Nortel for most of this decade, resulting in an unfathomable accumulated earnings deficit of $35 billion (U.S.).
Tougher times also revealed shortfalls in the company's internal financial controls, resulting in numerous restatements, and allegations of fraud. The restatements complicate any financial analysis of Nortel.
When we analyzed Nortel after the June quarter, the Overall score was a still-disappointing 25 points. Of the four individual gauges that fed into this composite result, Cash Management was (surprisingly) the strongest at 14 points. Growth was weakest at 0 points.
Now, with the available data from the September 2007 quarter, our gauges display the following scores:
- Cash Management: 6 of 25
- Growth: 2 of 25
- Profitability: 4 of 25
- Value: 9 of 25 (attributable to a new low in Price/Sales)
- Overall: 26 of 100
| ($M) | | September 2007 (actual) | September 2006 (actual) |
| Revenue (1) | | 2705 | 2926 |
| Op expenses | | | |
| | CGS | (1542) | (1803) |
| | R&D | (416) | (474) |
| | SG&A | (613) | (585) |
| | Other (2) | (68) | (30) |
| Operating Income | | 66 | 34 |
| Other income | | | |
| | Investments (3) | (42) | (12) |
| Asset sales | (3) | 15 | |
| | Interest, etc. (4) | 56 | (47) |
| Pretax income | | 77 | (10) |
| Income tax | | (50) | (15) |
| Net Income | | 27 | (25) |
| | | $0.06/sh | ($0.06)/sh |
| Extraordinary items (5) | | | (38) |
2. Amortization of intangible assets + Special charges.
3. Minority interests + Equity in net income of associated companies. Both figures are net of tax.
4. Other income - Interest expense
5. Shareholder litigation settlement expense.
Revenue was 7.6 percent less than in the year-earlier quarter. On a year-over-year basis, Revenue was down 0.5 percent. On a more positive note, Gross Margin increased as Cost of Goods Sold dropped from 61.6 to 57.0 percent of Revenue. Similarly, Research and Development (R&D) expense declined from 16.2 to 15.4 percent of Revenue. The cost control was less successful with Sales, General, and Administrative (SG&A) expenses, which increased from 20.0 to 22.7 percent of revenue.
The lower levels of CGS and R&D outweighed the higher SG&A and greater "special" charges, leading to a near doubling of Operating Income.
Net non-operating income was a substantial $55 million more in the Sept 2007 quarter than the Sept 2006 quarter. The income tax rate is hard to understand in both quarters: 65 percent in the recent quarter and incalculable (pre-tax income was negative) in the year-earlier quarter.
It has been unusual in recent years for Nortel to have a positive Net Income, but they managed to eke out earnings in the last quarter.
Cash Management. This gauge decreased from 14 points in June to 6 points now.
The following measures pushed the score up the most:
- Current Ratio =1.4; rather weak, but above earlier lows.
- Working Capital/Market Capitalization = 20.2 percent, up from 19.5 percent in September 2006. (Ironically, the increase is partly due to the falling stock price)
- Days of Sales Outstanding (DSO) = 88 days, one day less than last year
- Finished Goods/Inventory = 36 percent, this ratio stabilized after having been much higher.
- LTD/Equity = 131 percent; down from 345 percent! Equity is so minimal that small reductions in debt are magnified.
- Debt/CFO = N/A (CFO has been negative)
- Inventory/CGS = 118 days, compared to 90 days last year
- Cash Conversion Cycle Time (CCCT) = 149 days, up from 133 days a year ago, for this measure of efficiency.
The following measure was the one small positive contributor:
- Revenue/Assets = 62 percent, up from 61 percent last year.
- Revenue growth = -0.5 percent year-over-year, down from 10.5 percent
- Net Income growth = N/A.
- CFO growth = N/A.
The following measures pushed the score up the most:
- Operating Expenses/Revenue = 98 percent, down from 101 percent in a year.
- ROIC = 2.7 percent
- FCF/Equity = -17 percent, it was worse last year
- Accrual Ratio = 3.0 percent, up from 1.9 percent in a year.
Value. Nortel's stock price dropped over the course of the quarter from $24.05 to $16.98. Based on the latter price, the Value gauge increased from 5 points in June to 9 points.
The following measures pushed the score up the most:
- Price/Revenue ratio = 0.7, down from 0.9 in September 2006.
- Enterprise Value/Cash Flow = N/A
- P/E = N/A
- P/E to S&P 500 average P/E = N/A
The average P/E for the Communication Equipment industry is currently 26. The average Price/Revenue for the industry is currently 4.6.
Now at 26 out of 100 possible points, the best we can say about the Overall gauge score for Nortel is that has been worse. The positive Net Income in the last quarter could be viewed favorably, but the amount is insignificantly low and CFO remains negative. More than 6 years after the high-tech bubble burst, we don't yet see any firm signs that Nortel has turned the corner towards sustained profitability. Over the years, there have been a couple of encouraging moments. But, they proved evanescent. We need to see more.
11 November 2007
ADP: Financial Analysis through September 2007 (Update)
We previously posted an analysis of ADP's (ADP) preliminary report on the quarter that ended 30 September 2007. The financial statements in this report were limited in that the Balance Sheet was abbreviated and the Cash Flow Statement was missing.
ADP subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC. Our evaluation, adjusted to account for new information, is reported in this post. The net effect on the analysis was to trim two points off the Cash Management gauge and one point each from the Profitability and Value gauges. Because of rounding and weighting factors, the Overall gauge only dropped by two points: from 45 to 43 points.
ADP, which is one of a mere handful of U.S. companies with a AAA bond rating, is a top provider of payroll and other personnel-related IT services to corporate customers. It also publishes the monthly ADP National Employment Report(SM) that measures total non-farm private employment.
ADP has invested about $20 billion of corporate and client funds (the latter being the lion's share) in debt securities. In the 10-Q, the company states:
ADP has been restructuring. It spun off its Brokerage Services Group business on 30 March 30 2007. The divested company was renamed Broadridge Financial Solutions, and it now trades publicly under the ticker symbol BR -- see our initial analysis of BR here. On 6 July 2007, ADP sold an airline ticket-clearing business based in Spain, which had annual revenues of about $75 million. The company also changed the way it accounts for Depreciation and Amortization expenses; this change led to restatements of Costs of Revenue and Sales, General, and Administrative (SG&A) expenses.
As a result of these corporate changes, we didn't publish an analysis of ADP after the June quarter. We were doubtful we had the data needed to make a fair comparison of the company's current performance with its historical norms. We knew that ADP's past financial statements needed to be modified, but we weren't sure how significant the changes would be. Our concerns were recently eased, at least partially, because ADP has now made two years of updated Income Statements available on its web site. We would have preferred more data, but the new figures were a consistent set with which we could work.
Employing the available data from the September 2007 quarter, our gauges display the following scores:
1. Total revenues includes interest on funds held for clients and Professional Employer Organization revenues.
2. Operating expenses
3. Depreciation and amortization.
4. System development and programming
ADP's Revenue in the recent quarter was 13.5 percent greater than in the year-earlier period. The Cost of Goods Sold (CGS) was 45.6 percent of Revenue, just a tad below the 45.8 percent in September 2006. Depreciation expenses were 3.0 percent of Revenue, up insignificantly from the year-earlier value of 2.9 percent. Research and Development (R&D) expenses were 6.2 percent of Revenue, compared to 6.5 percent in September 2006. Most significantly, Sales, General, and Administrative (SG&A) expenses were cut to 26.8 percent of Revenue from 28.1 percent one year ago.
The net effect of the higher Revenue and reduced SG&A expenses was Operating Income a substantial 24.3 percent above the amount attained in the September 2006 quarter.
Non-operating income was $40 million less in the recent quarter than the year-earlier quarter. The difference was the result of a one-time $38.6 million gain in the earlier quarter on the sale of an investment.
The Income Tax Rate in the recent quarter was 37.0 percent, compared to 37.2 percent. Net Income from continuing operations exceeded the level attained a year ago by 9.8 percent. Overall Net Income surpassed the year-earlier figure by 15.6 percent.
Cash Management. This gauge now reads 14 points.
The following measures contributed relatively more points to the score:
Growth. This gauge now reads 18 points.
The following measures contributed relatively more points to the score:
The following measures contributed relatively fewer points to the score:
Profitability. This gauge now reads 14 points.
The following measures contributed relatively more points to the score:
Value. ADP's stock price fell from $48.47 to $45.93 over the course of the quarter. The Value gauge, based on the latter price, is at 4 points.
The following measures contributed relatively more points to the score:
An Overall gauge score of 43 out of 100 possible points is the highest we've calculated for ADP since December 2003. However, the results need be considered with some skepticism. This summer, as a result of the Broadridge spin-off and other corporate restructuring, we suspended our efforts to analyze ADP. We were doubtful at that time that we had the data needed to make a fair comparison of the company's current performance with its historical norms. While more data has subsequently come to light, we still have doubts about comparability, especially with respect to cash flows and income for periods more than two years ago. Nevertheless, it should be clear from the details above that the ADP story is, generally speaking, a positive one.
ADP subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC. Our evaluation, adjusted to account for new information, is reported in this post. The net effect on the analysis was to trim two points off the Cash Management gauge and one point each from the Profitability and Value gauges. Because of rounding and weighting factors, the Overall gauge only dropped by two points: from 45 to 43 points.
ADP, which is one of a mere handful of U.S. companies with a AAA bond rating, is a top provider of payroll and other personnel-related IT services to corporate customers. It also publishes the monthly ADP National Employment Report(SM) that measures total non-farm private employment.
ADP has invested about $20 billion of corporate and client funds (the latter being the lion's share) in debt securities. In the 10-Q, the company states:
At September 30, 2007 approximately 95% of the available-for-sale securities held an AAA or AA rating, as rated by Moody’s, Standard & Poor’s and, for Canadian securities, Dominion Bond Rating Service. ADP’s investment portfolio does not include any asset-backed securities with underlying collateral of sub-prime mortgages or home equity loans, nor does it contain any collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs). ADP’s investment portfolio does include senior tranches of AAA-rated, fixed rate credit card, auto loan, and other asset-backed securities.
ADP has been restructuring. It spun off its Brokerage Services Group business on 30 March 30 2007. The divested company was renamed Broadridge Financial Solutions, and it now trades publicly under the ticker symbol BR -- see our initial analysis of BR here. On 6 July 2007, ADP sold an airline ticket-clearing business based in Spain, which had annual revenues of about $75 million. The company also changed the way it accounts for Depreciation and Amortization expenses; this change led to restatements of Costs of Revenue and Sales, General, and Administrative (SG&A) expenses.
As a result of these corporate changes, we didn't publish an analysis of ADP after the June quarter. We were doubtful we had the data needed to make a fair comparison of the company's current performance with its historical norms. We knew that ADP's past financial statements needed to be modified, but we weren't sure how significant the changes would be. Our concerns were recently eased, at least partially, because ADP has now made two years of updated Income Statements available on its web site. We would have preferred more data, but the new figures were a consistent set with which we could work.
Employing the available data from the September 2007 quarter, our gauges display the following scores:
- Cash Management: 14 of 25
- Growth: 18 of 25
- Profitability: 14 of 25
- Value: 4 of 25
- Overall: 43 of 100
| ($ M) | | September 2007 (actual) | September 2006 (actual) |
| Revenue (1) | | 1992 | 1755 |
| Op expenses | | | |
| | CGS (2) | (908) | (804) |
| | Depreciation (3) | (59) | (50) |
| | R&D (4) | (124) | (114) |
| | SG&A | (534) | (493) |
| | Other | 0 | (0) |
| Operating Income | | 366 | 295 |
| Other income | | | |
| | Investments | 0 | 0 |
| | Interest, etc. | 15 | 55 |
| Pretax income | | 382 | 349 |
| Income tax | | (141) | (130) |
| Net Income | | 240 | 219 |
| | | $0.45/sh | 0.39/sh |
| Discontinued operations | | 57 | 38 |
2. Operating expenses
3. Depreciation and amortization.
4. System development and programming
ADP's Revenue in the recent quarter was 13.5 percent greater than in the year-earlier period. The Cost of Goods Sold (CGS) was 45.6 percent of Revenue, just a tad below the 45.8 percent in September 2006. Depreciation expenses were 3.0 percent of Revenue, up insignificantly from the year-earlier value of 2.9 percent. Research and Development (R&D) expenses were 6.2 percent of Revenue, compared to 6.5 percent in September 2006. Most significantly, Sales, General, and Administrative (SG&A) expenses were cut to 26.8 percent of Revenue from 28.1 percent one year ago.
The net effect of the higher Revenue and reduced SG&A expenses was Operating Income a substantial 24.3 percent above the amount attained in the September 2006 quarter.
Non-operating income was $40 million less in the recent quarter than the year-earlier quarter. The difference was the result of a one-time $38.6 million gain in the earlier quarter on the sale of an investment.
The Income Tax Rate in the recent quarter was 37.0 percent, compared to 37.2 percent. Net Income from continuing operations exceeded the level attained a year ago by 9.8 percent. Overall Net Income surpassed the year-earlier figure by 15.6 percent.
Cash Management. This gauge now reads 14 points.
The following measures contributed relatively more points to the score:
- Debt/CFO = nil
- Days of Sales Outstanding (DSO) = 48.5 days, compared to 58 days in Sept 2006
- LTD/Equity = less than 1 percent; insignificant
- Cash Conversion Cycle Time (CCCT) = 35.1 days, compared to 37.0 days, for this measure of efficiency.
- Working Capital/Market Capitalization = 4.5 percent, compared to 7.5 percent one year ago.
- Current Ratio =1.6; down from 1.9 in June 2007 and 1.8 in Sept 2006.
Growth. This gauge now reads 18 points.
The following measures contributed relatively more points to the score:
- Revenue growth = 13.8 percent year-over-year, making up for last year's -9 percent
- Revenue/Assets = 96.9 percent, up dramatically from 73.5 percent in a year; sales efficiency has improved
- Net Income growth = 17.4 percent year-over-year, up from -9.2 percent.
Net income benefited from a change in the income tax rate from 38 to 37 percent.
The following measures contributed relatively fewer points to the score:
- CFO growth = -10.8 percent year-over-year, compared to 0.3 percent. (We suspect the negative figure is erroneous. CFO increased nicely in the most recent quarter over the year-earlier quarter. Prior-year Cash Flows might need to be adjusted downward to account for corporate restructuring actions.)
Profitability. This gauge now reads 14 points.
The following measures contributed relatively more points to the score:
- ROIC = 27.5 percent, rather impressive and up from 18.1 percent in a year
- FCF/Equity = 24.7 percent, up from 22.9 percent in a year.
- Accrual Ratio = -2.3 percent, up from -4.7 percent in a year. (This increase might also be an artifact of using invalid historical cash flow data).
- Operating Expenses/Revenue = 80.4 percent, down but only slightly from last year's 81.4 percent.
Value. ADP's stock price fell from $48.47 to $45.93 over the course of the quarter. The Value gauge, based on the latter price, is at 4 points.
The following measures contributed relatively more points to the score:
- P/E = 23.6, down from a 5-year median of 26.5
- P/E to S&P 500 average P/E = 46 percent premium, less than the five-year median premium of 53 percent
- Price/Revenue ratio = 3.1, compared to a five-year median of 3.3.
- Enterprise Value/Cash Flow = 16.4, up from 15.6 in September 2006. The five-year median value for this parameter is also about 15.6.
The average P/E for the Business Services industry is currently 23. The average Price/Revenue for the industry is currently 2.5.
An Overall gauge score of 43 out of 100 possible points is the highest we've calculated for ADP since December 2003. However, the results need be considered with some skepticism. This summer, as a result of the Broadridge spin-off and other corporate restructuring, we suspended our efforts to analyze ADP. We were doubtful at that time that we had the data needed to make a fair comparison of the company's current performance with its historical norms. While more data has subsequently come to light, we still have doubts about comparability, especially with respect to cash flows and income for periods more than two years ago. Nevertheless, it should be clear from the details above that the ADP story is, generally speaking, a positive one.
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