ADP is a top provider of payroll and other personnel-related IT services to corporate customers. It publishes the monthly ADP National Employment Report that reports changes in total non-farm private employment. (The ADP report has painted a much rosier picture of the U.S. employment than the Bureau of Labor Statistics, but we digress.)
ADP, which is one of a mere handful of U.S. companies left with an AAA bond rating, has been restructuring. There have been several changes, the most significant of which was the divestiture on 30 March 2007 of the Brokerage Services Group business. The spun-off company, which will have annual Revenues over $1 billion, was renamed Broadridge Financial Solutions (BR). With each new set of quarterly results, we get a better understanding of the financial metrics of the ADP's current organization.
When we analyzed the company after the September quarter, the Overall Gauge score of 44 points (out of 100 possible) was the highest mark achieved by ADP since December 2003. However, we noted that the Broadridge spin-off and other changes could have skewed the calculations. Of the four individual gauges that fed into September's composite result, Growth was the strongest at 18 points. Value was weakest at 5 points.
Now, with the available data from the December 2007 quarter, our gauges display the following scores:
- Cash Management: 14 of 25
- Growth: 19 of 25
- Profitability: 14 of 25
- Value: 8 of 25
- Overall: 49 of 100
Before we examine the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously communicated expectations. The differences were minor enough to give us confidence that our model for ADP has stabilized.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($ M) | | Dec 2007 (actual) | Dec 2007 (predicted) | Dec 2006 (actual, 6) |
| Revenue (1) | | 2150 | 2100 | 1874 |
| Operating expenses | | | | |
| | CGS (2) | (980) | (903) | (822) |
| | Depreciation (3) | (60) | (63) | (51) |
| | R&D (4) | (129) | (137) | (120) |
| | SG&A | (555) | (567) | (515) |
| | Other | 0 | 0 | (0) |
| Operating Income | | 427 | 431 | 368 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. | 13 | 15 | 28 |
| Pretax income | | 441 | 446 | 396 |
| Income tax | | (149) | (165) | (148) |
| Net Income (5) | | 292 | 281 | 248 |
| | | $0.55/sh | 0.52/sh | 0.45/sh |
2. Operating expenses
3. Depreciation and amortization.
4. System development and programming
5. Net Income from continuing operations
6. Restated
Revenue in the quarter was 14.7 percent above the restated value in the year-earlier period. Year-over-year Revenue Growth was 13.8 percent, or about 1 percent more than we expected. The Cost of Goods Sold (CGS) -- called Operating Expenses on ADP's Income Statement -- was 45.6 percent of Revenue, significantly more than the 43 percent target. However, other costs were than we expected. Depreciation was 2.8 percent of Revenue, a little better than our 3 percent forecast. Research and Development (R&D) expenses were 6.0 percent of Revenue, compared to our prediction of 6.5 percent. Sales, General, and Administrative (SG&A) expenses were 25.8 percent of Revenue, nicely under our 27 percent forecast.
The various differences between actual and predicted numbers basically canceled each other out. Operating Income was a mere $4 million below our forecast. The actual value was 16.2 percent more than the amount attained in December 2006.
Non-operating income was only $2 million below our target value. Provisions for income taxes were, however, much less. The Income Tax Rate in the recent quarter was only 33.8 percent, compared to the predicted 37.0 percent.
The reduced tax burden enabled Net Income from continuing operations to beat our prediction by 4 percent. This Net Income exceeded the level attained a year ago by 17.6 percent. The growth rate was even higher, about 22 percent, on a per-share basis because the company has repurchased enough of its stock to reduce the number of shares outstanding, on a diluted basis, by 4.5 percent.
At least one press report after the recent earnings announcement indicated that ADP experienced declining profits, and the shares subsequently fell in value. If one looked strictly at the bottom line Net Income figure, this was true. However, we chose to focus on Net Income from continuing operations. While we are pro-GAAP analysts that don't typically exclude "special" or "non-recurring" gains and losses, we don't see how it makes sense to compare current company operations with previous results that included business since sold. Nevertheless, this hammers home an important point: when speaking of earnings, it is important to know exactly what income and expenses have been included and excluded. It often seems as if there are as many definitions of earnings as there are analysts.
Cash Management. This gauge was unchanged from September at 14 points. However, the recent score is suspect because we had to fill in missing Balance Sheet data with estimates.
The following measures all helped the gauge:
- Debt/CFO = nil
- Current Ratio = 1.8; up slightly from 1.7 one year ago
- LTD/Equity = 0.7 percent; down for 1.2 percent last year. Both values are insignificant.
- Days of Sales Outstanding (DSO) = 52.5 days, well down from 62.4 days at December 2006, but up a little from 48.4 days at the end of September.
- Cash Conversion Cycle Time (CCCT) = 39.8 days, compared to 42.3 days last year and 35.0 days last quarter.
- Working Capital/Market Capitalization = 5.7 percent, down somewhat from 6.3 percent one year ago
Growth. This gauge increased from 17 points in September to 19 points now.
The following measures all helped the gauge:
- Revenue growth = 13.8 percent year-over-year, making up for last year's -3.4 percent
- Revenue/Assets = 101.3 percent, up dramatically from 75.7 percent in a year; sales efficiency is improving. The spin off and share repurchases both helped reduce Assets.
- Net Income growth = 18.1 percent year-over-year, up from -4.9 percent
Net income for the year benefited from a change in the income tax rate from 37.9 to 36.1 percent
The following measure may have held the score down:
- CFO growth = 1.3 percent year-over-year (estimated), compared to -15.6 percent one year ago.
Profitability. This gauge was unchanged from September at 14 points.
The measures that helped the gauge were:
- ROIC = 26.2 percent, up from 17.9 percent in a year
- FCF/Equity = 24.5 percent (estimated), up from 20.6 percent in a year
- Operating Expenses/Revenue = 80.3 percent, down from last year's 81.5 percent
- Accrual Ratio = -2.1 percent, up from -3.0 percent in a year
Value. ADP's stock price inched down from $45.93 to $44.53 over the course of the quarter -- it has since fallen under $40. The Value gauge, based on the year-end closing price, moved up from 5 to 8 points.
The measures that helped the gauge were:
- Enterprise Value/Cash Flow = 15.6, down from 18.4 in December 2006, but matching the 5-year median value
- P/E = 21.7, quite a bit below the 5-year median of 26.4
- P/E to S&P 500 average P/E = 27 percent premium, nearly half its five-year median value
- Price/Revenue ratio = 2.8, compared to a five-year median of 3.3
The average P/E for the Business Services industry is currently 18.5. The average Price/Revenue for the industry is currently 2.2.
If it holds up once we get the 10-Q data, 49 out of 100 possible points for the Overall gauge would qualify as a good score for ADP and the best in four years. We do have to note that some of the out-performance was due to a lower effective tax rate, and we don't know whether this reflects temporary conditions. We would like to see reduced Operating Expenses as a percentage of Revenue.
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