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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