08 February 2011

BR: Income Statement Analysis for the December 2010 Quarter

Broadridge Financial (NYSE: BR) earned $0.08 per diluted share on a GAAP basis in the December-ending second quarter of fiscal 2011, down 66 percent from $0.24 in the same three months of last year. 

The year-earlier quarter included a $17.9 million ($0.13 per share) loss from discontinued operations.

This post examines Broadridge's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were a disappointing $0.13 per share lower than the $0.21 we had forecast.

The principal sources for this income statement analysis were the earnings announcement and the ensuing webcast and conference call presentation.

In a second article, we will report Broadridge's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Broadridge Financial Solutions, Inc., provides brokerage and other services to financial companies.  Broadridge has been ranked the top Brokerage Process Services Outsourcing Provider for the last three consecutive years in the Black Book of Outsourcing.

Automatic Data Processing (NASDAQ: ADP) spun off Broadridge on 30 March 2007.  (GCFR articles related to ADP can be found here.)

Broadridge earned $190 million ($225 million from continuing operations) in fiscal 2010, which ended in June, on revenue of $2.2 billion.  The company earned $223 million and had revenue of $2.1 billion in 2009.

The market value of Broadridge is currently about $3.0 billion.

Broadridge, for financial data reporting, divides its operations into two business segments: Investor Communication Solutions (ICS) and Securities Processing Solutions (SPS).  The ICS segment, which contributed more than 75 percent of Broadridge's revenue and pretax earnings in fiscal 2010, distributes and processes proxies for public companies and mutual funds.

The SPS business, as described by the company, provides real-time transaction processing services, including order capture and execution, trade confirmation, settlement and accounting to financial institutions to support global trading of equity, option, mutual fund, and fixed income securities.  Broadridge in fiscal 2010 "processed on average over 1.5 million equity trades per day and over $3.5 trillion in fixed income trades per day of U.S. and Canadian securities." [emphasis added]

In 2009, Broadridge entered into a seven-year agreement with Morgan Stanley Smith Barney to provide "customer communications services."  MSSB combines the wealth management businesses of Morgan Stanley (NYSE: MS) with those of Citi Smith Barney.

Broadridge sold its Securities Clearing business, in a deal that closed in June 2010, to Penson Worldwide (NASDAQ: PNSN).  The final purchase price, in income and equity securities, was $35.2 million.  As part of the transaction, Penson hired Broadridge to provide securities processing and other services.

In May 2010, Standard & Poor's raised Broadridge's credit rating to BBB-/A-2 from BBB-/A-3, with a stable outlook.  Fitch Ratings on 1 July 2010 upgraded Broadridge's credit rating from "BBB" to "BBB+," with a stable outlook.  Fitch noted that Broadridge's cash flow should be more stable as a result of the deal with Penson.

Broadridge's board in August 2010 hiked its annual dividend 7 percent to $0.60 per share.  The board also authorized the repurchase of 10 million shares of the company's common stock.

Additional background information about Broadridge and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue in the December quarter decreased 16.5 percent, from $529.7 million in 2009 to $442.3 million in the most recent three months.  Reported revenue was 7.9 percent, a substantial amount, less than our $480 million estimate.  Our target was based on Broadridge's earlier guidance to expect fiscal 2011 Revenue growth between 1 percent and 4 percent.

Broadridge blamed the Revenue decline on "lower event-driven mutual fund proxy fee revenues and related distribution revenues."

The Investor Communication Solutions business experienced a 25 percent revenue decrease, from $393.3 million to $294.1 million.  This business, which is the one that distributes proxies and other pieces of documentation, was responsible for 66.5 percent of the company's total revenue in the quarter.

Revenue from the smaller Securities Processing Solutions business rose 9.2 percent, from $133.8 million to $146.1 million.  This rise was due to sales gained from the Penson transaction and from the acquisition of City Networks, Ltd.

The Cost of Revenues -- it's listed as Cost of Goods Sold on our spreadsheet -- fell to $356.6 million (80.6 percent of Revenue) from $399.7 million in the December 2009 quarter.  The latest amount translates into a Gross Margin of 19.4 percent, which is much less profitable than the 24.5 percent margin achieve in the December 2009 quarter. 

The Gross Margin was a stunning 310 basis points worse than the 22.5 percent we had estimated. The lower margin is a consequence of the drop in event-driven fee revenues.

Sales, General, and Administrative expenses increased 14.6 percent, from $58.4 million to $66.9 million. As a percentage of Revenue, SG&A rose from 11.0 percent to 15.1 percent. 
The company noted it had incurred costs to implement "strategic initiatives" including acquisitions.

The latest SG&A expense was 7.2 percent more than our $62.4 million estimate.

Subtracting the various operating expenses mentioned above from Revenue yields Operating Income, as we define it, of $18.8 million, down 74 percent from $71.6 million in the year-earlier quarter.  The decrease was due to lower Revenue, the less profitable Gross Margin, and the rise in SG&A expenses.

The latest Operating Income value was far below our $45.6 million target.  Although we didn't expect the results to match those achieved last year, both Revenue and the Gross Margin were significantly worse than we had anticipated.

Other items, which we classify as non-operating (generally interest income and expense, plus foreign exchange gains and losses), summed to a $2.3 million net expense.  Our target was $3.0 million.

The effective Income Tax Rate was 35.8 percent, up from 24.8 percent last year.  The earlier rate benefited from a one-time tax benefit.  The latest tax rate was slightly less than the 37-percent tax rate we expected. 

After-tax GAAP Net Income from continuing operations in the latest quarter was $10.6 million ($0.08 per share), down sharply from last year's $51.5 million ($0.38 per share). 

Our Net Income estimate was $26.8 million ($0.21 per share).

In summary, Revenue and Earnings in the December 2010 quarter were far below those achieved in the year-earlier quarter.  The figures were also much less our more modest targets.  Mutual fund event-driven revenues can fluctuate wildly from quarter to quarter, but Broadridge asserts that the magnitude of the current decline was "unprecedented."  Nevertheless, the company does "not believe there has been a secular change in the causes of mutual fund proxy campaigns which are the main drivers of our event-driven revenues.”  Time will tell.

Full disclosure: Long BR at time of writing.

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