06 May 2009

ADP: Financial Analysis through March 2009

Automatic Data Processing, Inc. (NASDAQ: ADP) earned $0.80 per share in the three months that ended on 31 March 2009.  This post provides the GCFR analysis of the period, which was the third quarter of the company's fiscal 2009.

The earnings announcement included an Income Statement and a greatly condensed Balance Sheet, but it did not have a Cash Flow Statement.  Since we need some undisclosed values to compute GCFR gauge scores, we estimated, as an interim solution, the omitted figures on the basis of historical results.

We will adjust the scores after ADP files a complete 10-Q report with the SEC.

First, we present some background information.

Automatic Data Processing, Inc. provides payroll and other personnel-related information technology services to well over 500,000 employers worldwide.  It competes with firms such as Paychex, Inc. (NASDAQ:PAYX).  The company is also known for the monthly ADP National Employment Report on non-farm private employment. 

ADP is one of a mere handful of U.S. companies with a AAA bond rating, and it is a member of the "shrinking universe," as David Templeton so aptly expressed it, of S&P 500 Dividend Aristocrats.  ADP has hiked its dividend for 34 consecutive years, including a 14 percent increase last November.

The company retained its eponymous three-character ticker symbol in October 2008 when it changed its share listing from the New York Stock Exchange (NYSE: NYX) to the NASDAQ Stock Market (NASDAQ: NDAQ).

In 2007, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).

Looking back to the December 2008 quarter, ADP, a payroll processor, couldn't help but be affected by decreased employment in the U.S.   Nevertheless, ADP managed to eke out positive Revenue growth of 2.5 percent.  Higher Revenue went to the bottom line, lifting Net Income from continuing operations by 2.7 percent.  Fewer common shares outstanding boosted earnings per share growth to 7.3 percent.

December's results caused the GCFR Overall Gauge to slip, but only by a single point, from 64 to 63 points.  The Cash Management gauge had a negative effect on the Overall score, as this component lost 6 points due to small changes in Days of Sales Outstanding and Days of Payables Outstanding.  While the Growth gauge fell back a couple points, the score remained strong due to improvements in Revenue/Assets and Cash Flow from Operations.  The contrary Value gauge got a minor boost from the lower price per share, although ADP shares have held up better than many others.

On 25 March 2009, ADP announced, "fiscal 2009 revenues are anticipated to grow 1% to 2%, a slight decrease from the previous forecast of 2% to 3% growth."  ADP also stated that it would record a $15 million charge in the March 2009 quarter to reflect lower recovery from the Primary Fund of the Reserve Fund.

Now, with the available and estimated data for the March 2009 quarter, our gauges display the following scores:

  • Overall: 60 of 100 (down from 63)
These scores will be recalculated when the 10-Q is submitted. 

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.


Revenue was 2.2 percent less than in March 2008 quarter.  ADP attributed the decline to the weak economy and to the stronger dollar, which discounts the value of the company's non-U.S. sales.  Revenue was a little higher than our estimate, which assumed a drop of 4.2 percent.

The Cost of Goods Sold (CGS) -- what ADP calls "Operating Expenses" -- was 43.8 percent of Revenue, which translates into a Gross Margin of 56.2 percent.  The margin was down from 57.4 percent in the year-earlier quarter, but it held up better than we expected.  We predicted the Gross Margin would fall to 54 percent.

Depreciation and amortization expenses were essentially unchanged from last year, and the current value matched our $60 million estimate.

Research and Development expenses ("Systems Development and Programming Costs") were down almost 10 percent from last year's value.  The R&D expense was 5.0 percent of Revenue, a little less than our 5.6 percent estimate.

Sales, General, and Administrative expenses were cut 11 percent from the March 2008 quarter.  Now at 21.9 percent of Revenue, SG&A costs haven't been this low relative to Revenue since March 2005.  Our estimate for SG&A expense as a percentage of Revenue was a much higher 25 percent. 

Although Revenue was lower than in last year's first quarter, reduced costs allowed Operating Income to increase by 2.9 percent.  We certainly didn't anticipate ADP's success in cutting its operating costs (especially SG&A). Our estimate for Operating Income was short by 24 percent. 

On the other hand, interest and other non-operating income and related expenses didn't have the positive effect we anticipated.  The Reserve Fund charge of about $15 million is probably embedded in this line item.

The effective Income Tax Rate matched the predicted 36 percent.

All in all, Net Income from continuing operations almost matched the amount attained a year ago, whereas we had expected this measure of Net Income to fall 19 percent.  The results appear rosier when evaluated on a per-share basis.  In the last nine months, ADP reports that it spent $550 million to repurchase nearly 14 million of its shares.

Now for the gauges:

Cash ManagementMarch 20093 months prior12 months prior
Current Ratio (1)
LTD/Equity 0.9%1.1%1.0%
Debt/CFO (2) 0.0 years0.0 years0.0 years
Inventory/CGS N/AN/AN/A
Finished Goods/Inventory N/AN/AN/A
Days of Sales Outstanding (DSO)46.6 days45.2 days44.6 days
Working Capital/Invested Capital 37.8%35.3%39.8%
Cash Conversion Cycle Time (CCCT)
38.3 days36.6 days34.7 days
Gauge Score (0 to 25)
1. Excludes Funds held for clients and Client funds obligations.
2. CFO in March 2009 quarter was estimated.

This AAA company has very little debt.  ADP has $1.4 billion in Cash and Short-term securities.  Working capital is also about $1.4 billion.

The CM score decreased from December because Days of Sales Outstanding and Cash Conversion Cycle Time indicate somewhat less efficiency.

GrowthMarch 20093 months prior12 months prior
Revenue growth (1)4.6%8.5%13.3%
Revenue/Assets (2)106%110%97%
CFO growth (1, 3)7.5%32.8%2.4%
Net Income growth (1)6.9%11.2%16.6%
Gauge Score (0 to 25)14
1. Growth rates are trailing four quarters compared to four previous quarters.
2. Assets excludes Funds held for clients

3. CFO in the March 2009 quarter was estimated.

Each Growth rate listed above has declined.  A positive factor is that Revenue has increased faster than a measure of Assets over the last year.

We anxiously await the Cash Flow statement to verify our CFO estimates.

ProfitabilityMarch 20093 months prior12 months prior
Operating Expenses/Revenue 79.8%80.1%80.1%
ROIC 31.6%32.3%28.1%
Free Cash Flow/Invested Capital (1)38.8%47.8%33.7%
Accrual Ratio (1)-0.3%-3.4%-3.0%
Gauge Score (0 to 25)15
1. CFO and FCF in the March 2009 quarter were estimated.

Operating Expenses have been extremely stable when assessed on a trailing four quarters basis, and the high ROIC is comforting.   The figures shown for the last two Profitability metrics were calculated with estimated Cash Flow data; they are likely to change.

ValueMarch 20093 months prior12 months prior
P/E 14.616.318.5
P/E vs. S&P 500 P/E 82%89%108%
Enterprise Value/Cash Flow (EV/CFO) (1)
Gauge Score (0 to 25)18
1. CFO in the March 2009 quarter was estimated.

The price of ADP shares decreased in the year ending 31 March 2009, from $42.39 to $35.16.  The falling price has lowered each of the valuation ratios, which can be compared with other companies in the Business Software and Services industry.

OverallMarch 20093 months prior12 months prior
Gauge Score (0 to 100)60

ADP's Revenue fell, but by less than we expected, and it cut its Operating Expenses by more than we thought likely.  These results were achieved in an economic environment that caused the number of employees on U.S. clients' payrolls to fall 4.2 percent by one measure.  Also, ADP has a business segment that provides services to auto dealers, which are not exactly prospering at the moment. 

Net Income from continuing operations was more or less flat, but the recent quarter included a one-time $15 million investment charge that depressed March 2009 results. 

The company's Balance Sheet remains AAA, and the Overall gauge score remains modestly attractive.

Because the preliminary financial statements were incomplete, we will need to re-assess the analysis findings when a 10-Q is filed with the SEC.

Full disclosure: Long ADP at time of writing.

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