We are pleased by the outstanding performance of our company during 2005. We achieved solid year over year growth in our key business segments and significantly improved our balance sheet and cash flow.
So said Kevin Noland, CEO of health information publisher ADAM (NASDAQ:ADAM), in reviewing his company's results two weeks ago. But the CEO's pleasure notwithstanding, ADAM's shares are trading roughly 30% lower today than they were before he announced these "significantly improved" results. So what gives?
At first, it wasn't entirely clear. When ADAM published its Q4 and full-year 2005 results, the company included a full income statement -- but only an abridged balance sheet, and no cash flow statement whatsoever. It's taken nearly half a month for the company to cough up those documents, but it finally did so in a Form 10-KSB filing on Friday evening. With this information in hand, we can now check out ADAM's story.
Margins
On a trailing-12-month basis, ADAM still boasts nearly an 80% net margin, and an operating margin of 12.8%. (As for the 70.2% net margin -- ignore it. As I mentioned in my preview of the company's earnings news, it was inflated by a one-time, $5.6 million tax credit recorded in Q3.)
Free cash flow
ADAM generated $3.8 million in free cash flow (FCF) in 2005, a 15% increase over last year's $3.3 million. Not impressive, considering that the company grew its sales 19%. Moreover, it's a far cry from the 344% increase in net income (also thanks to that hefty tax credit).
Still, the rap against ADAM today seems to be that it lost money in Q4. On a cash profits basis, however, that's simply not true. ADAM had racked up $2.9 million in FCF over the first three quarters of the year. To reach the $3.8 million it reported for the year, therefore, I calculate that the firm generated another $0.9 million in FCF during Q4.
Valuation
Last month, I declared ADAM "a bargain" at its then-current price of 20 times trailing free cash flow. With the share price now 30% lower, is the company still a buy? Let's see:
Thanks to Mr. Market's fit of March madness, ADAM now sells for just 15 times FCF. To justify that valuation, you'll probably want ADAM to grow its earnings at least 15% per annum over the next few years. Here are four factors that could help you make up your mind:
- Over the last four years, ADAM grew FCF at an annualized rate of 56%.
- ADAM did grow its cash profits 15% in 2005.
- Analysts expect the health-care information sector as a whole to grow at 14% per annum in the long term.
- Larger rival Emdeon (NASDAQ:HLTH) is expected to grow at 20%.
Put all those together, and yes, I think ADAM's growth prospects more than justify today's price.
Fool contributor Rich Smith does not own shares of either company named above.
