Our evaluation is incomplete because the Balance Sheet in the press release was abbreviated and the Cash Flow Statement was omitted. These shortfalls are not unusual in an ADP preliminary report, and they will certainly be rectified in the 10-Q the company will submit to the SEC. To compute gauge scores, we estimated values for data items not yet published.
Automatic Data Processing, Inc. (NYSE: ADP) is a top provider of payroll and other personnel-related information technology services. It competes with firms such as Paychex, Inc. (NASDAQ:PAYX). ADP is one of a mere handful of U.S. companies with a AAA bond rating, and it is an S&P 500 Dividend Aristocrat. The company is also known for the monthly ADP National Employment Report on non-farm private employment, and Last year, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).
Three months ago, when we analyzed ADP's June financial statements, the GCFR Overall gauge was essentially unchanged at 55 of 100 possible points. The score has been over 50 points, an attractive level, for three straight quarters. The last time the Overall score had crossed this threshold was 2003. The Growth and Value gauges -- the latter advancing as the share price gave back earlier gains -- were particularly strong at the end of June.
Now, with the available and assumed data for the September 2008 quarter, our gauges display the following scores:
- Cash Management: 17 of 25 (up from 8 in June)
- Growth: 20 of 25 (unchanged)
- Profitability: 14 of 25 (up from 13)
- Value: 16 of 25 (unchanged)
- Overall: 63 of 100 (up from 55)
These scores will be recalculated when the 10-Q is submitted. Please note that the scores for the June quarter are slightly different from those originally published because of algorithm adjustments.
Before we examine the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously communicated expectations.
Please note that the tabular 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) | | September 2008 (actual) | September 2008 (predicted) | September 2007 (actual) |
| Revenue (1) | | 2,182 | 2,132 | 1,992 |
| Operating expenses | | | | |
| | CGS (2) | (1,047) | (959) | (908) |
| | Depreciation (3) | (59) | (58) | (59) |
| | R&D (4) | (130) | (128) | (124) |
| | SG&A | (527) | (576) | (534) |
| | Other | 0 | 0 | (0) |
| Operating Income | | 418 | 412 | 366 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. | 23 | 15 | 15 |
| Pretax income | | 441 | 427 | 382 |
| Income tax | | (163) | (156) | (141) |
| Net Income from continuing operations | | 278 $0.54/sh | 271 $0.52/sh | 240 $0.45/sh |
| Income from discontinued operations (5) | (1) $0.00/sh | (0) $0.00/sh | 57 $0.11/sh | |
| Shares used in per-share calculations | 514 | 520 | 536 |
2. Operating expenses
3. Depreciation and amortization.
4. System development and programming
5. Net of tax
The Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- was 48.0 percent of Revenue, which translates into a Gross Margin of 52 percent. This fell significantly short of our expectation of a 55-percent Gross Margin. The margin was 54.4 percent in the year-earlier quarter.
Depreciation and amortization expenses were 2.7 percent of Revenue, which matched our forecast.
Research and Development (R&D) expenses ("Systems Development and Programming Costs") were 6.0 percent of Revenue, which also matched our forecast.
Sales, General, and Administrative (SG&A) expenses were 24.1 percent of Revenue. These expenses were much less than our 27 percent estimate.
Good Revenue growth and lower SG&A expenses overcame the lower Gross Margin. The quarter's Operating Income, as we define it, was 14.1 percent greater than the amount attained in September 2007. This was a little higher than our forecast of 12.6-percent growth, but we were only off by $6 million.
Non-operating income was $8 million above our target value. On the other side of the ledger, the Income Tax Rate in the recent quarter was 37.0 percent, compared to the predicted 36.5 percent.
Net Income from continuing operations was a solid 15.6 percent above the level attained a year ago, whereas we had expected growth of 12.9 percent. Our prediction was off by 2.6 percent. When measured on a per-share basis, earnings grew at an even more impressive 21 percent. ADP reduced the number of shares outstanding, on a diluted basis, by 4.2 percent by repurchasing its stock.
| Cash Management | September 2008 | 3 mos. ago | 12 mos. ago |
| Current Ratio | 1.4 | 1.7 | 1.6 |
| LTD/Equity | 0.8% | 1.0% | 0.9% |
| Debt/CFO | 0.7 yrs | 0.0 yrs | 0.0 yrs |
| Inventory/CGS | N/A | N/A | N/A |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 39.0 days | 43.2 days | 48.5 days |
| Working Capital/Market Capitalization | 5.7% | 6.2% | 4.5% |
| Cash Conversion Cycle Time (CCCT) | 29.6 days | 31.4 days | 35.1 days |
| Gauge Score (0 to 25) | 17 | 8 | 13 |
Debt is managed well by this AAA company, but a couple of our liquidity metrics were skewed by overnight commercial paper borrowing of $1.4 billion that extended past the quarter's end.
The Inventory metrics aren't applicable to this Services company. Increases we had seen a few quarters ago in Days of Sales Outstanding have been reversed, which indicates more efficient cash management.
| Growth | September 2008 | 3 mos. ago | 12 mos. ago |
| Revenue growth | 11.6% | 12.5% | 13.2% |
| Revenue/Assets | 102% | 107% | 90% |
| CFO growth | 36% (est.) | 36.5% | -10.8% |
| Net Income growth | 15.1% | 13.8% | 16.0% |
| Gauge Score (0 to 25) | 20 | 20 | 17 |
Given current economic conditions, it isn't surprising that ADP's Revenue growth has slowed slightly. (The company forecasts much slower Revenue growth in future quarters.) We anxiously await the Cash Flow statement to see if CFO growth was as robust as estimated. Net income for the trailing four quarters benefited from a decrease in the effective income tax rate from 37.0 to 35.9 percent.
| Profitability | September 2008 | 3 mos. ago | 12 mos. ago |
| Operating Expenses/Revenue | 80.2% | 80.3% | 80.4% |
| ROIC | 34.1% | 31.1% | 28.7% |
| FCF/Equity | 35% (est) | 31.1% | 22.8% |
| Accrual Ratio | -1.4% (est) | +3.0% | -6.0% |
| Gauge Score (0 to 25) | 14 | 13 | 13 |
Operating Expenses have been extremely stable when assessed on a trailing four quarters basis. The high levels of ROIC are comforting. We don't have the Cash Flow data needed to determine the exact values for two of the key Profitability metrics.
| Value | September 2008 | 3 mos. ago | 12 mos. ago |
| P/E | 18.3 | 18.7 | 23.6 |
| P/E to S&P 500 average P/E | 109% | 102% | 138% |
| Price/Revenue | 2.4 | 2.5 | 3.1 |
| Enterprise Value/Cash Flow (EV/CFO) | 10.7 (est) | 11.4 | 16.4 |
| Gauge Score (0 to 25) | 16 | 16 | 5 |
The price of ADP shares increased from $41.90 to $42.75 during the September quarter. However, the broad stock market decline in October broughtADP's price per share into the low to mid-$30s. The Value gauge score in the table above is based on the price when the quarter ended, which is our standard practice. It would be 7 points higher, at 23, if recalculated with the 3 November closing share price
ADP shares have become less expensive by the metrics we follow most closely. The valuation ratios can be compared with other companies in the Business Software and Services industry.
| Overall | September 2008 | 3 mos. ago | 12 mos. ago |
| Gauge Score (0 to 100) | 63 | 55 | 42 |
The current Overall gauge score is very good and it implies ADP shares hold significant value. Because the preliminary financial statements were incomplete, we will need to re-assess the analysis findings when the 10-Q is filed with the SEC.
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