Hewitt Associates, Inc. F4Q08 (Qtr End 9/30/08) Earnings Call Transcript

Hewitt Associates, Inc. (HEW)

F4Q08 Earnings Call

November 14, 2008 8:30 am ET

Executives

Sean McHugh - Investor Relations

Russell P. Fradin - Chairman of the Board, Chief Executive Officer

John J. Park - Chief Financial Officer

Analysts

Ashwin Shirvaikar - Citigroup Investment

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

Mark Marcon - Robert W. Baird & Co., Inc.

Tien-Tsin Huang - J.P. Morgan

Todd Van Fleet - First Analysis Corp.

Jason Kupferberg - UBS

[Vincent] - Goldman Sachs

Paul Ginocchio - Deutsche Bank

Aki Karja - Royal Capital

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Hewitt Associates fiscal 2008 fourth quarter earnings call. (Operator Instructions)

With that being said, I'll turn the conference now to the Vice President Investor Relations, Sean McHugh. Please go ahead, sir.

Sean McHugh

Good morning and thank you for joining us. On the call today are Russ Fradin, our Chairman and CEO, and John Park, our CFO.

Before we get started, let me highlight that when we discuss revenues we're referring to net revenues or revenues before reimbursements. And during this call we will discuss underlying operating income, net income, earnings per share and adjusted EBITDA amounts. These are non-GAAP financial measures that provide a better understanding of our underlying performance. Please refer to this mornings press release and the Investor Relations section of our website to obtain a reconciliation of U.S. GAAP to these measures.

On this call we may make forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Please refer to our most recent SEC filings for more information on risk factors that could cause actual results to differ. Hewitt disclaims any obligation to update or revise any forward-looking statements made on this call.

At the conclusion of the call we'll conduct a question-and-answer session. During the Q&A session we ask that, as a courtesy to others, you please limit yourself to one question.

Now I'll turn it over to Russ.

Russell P. Fradin

Thanks, Sean, and good morning, everyone. Thank you for joining us today.

I am pleased to be able to provide this update on Hewitt today. I am sure that all of you are anxious to hear how we are doing in light of the economic situation and we will do our best to cover all the relevant issues.

Fiscal 2008 was a strong year for Hewitt as we made great progress executing on each of our four strategic priorities - keeping clients first, creating a rewarding work experience, growing with intention, and getting lean. Specifically, I want to mention several noteworthy accomplishments over the past year.

First, we achieved healthy growth in our Consulting and Benefit Outsourcing business while investing for the future.

Our Consulting business delivered strong double-digit organic constant currency growth in fiscal 2008 with all practices and geographies contributing to the improvement. We saw particularly good demand for our retirement and financial management services in North America and in Europe, in addition to talent and organization consulting services in Asia-Pacific, North America and Europe.

After a flat 2007, Benefit Outsourcing showed modest growth by adding new clients, expanding into the mid-market with our new core benefits administration solution, and adding new services such as absence management.

To support this growth in 2008 we made investments in both Consulting and Benefit Outsourcing by making some acquisitions that leverage our sales force. We also invested in internal growth initiatives.

Second, we significant reduced the losses from the HR Business Process Outsourcing business. Through successful contract renegotiations and cost management efforts, we reduced the underlying operating loss by almost $70 million this year. The portfolio continues to stabilize nicely. Looking ahead, we are focused on continued reduction in the cost and, more importantly, delivering quality to our clients.

Third, we meaningfully lowered our overhead costs by restructuring our real estate portfolio and better aligning our work force for future growth. During fiscal 2008 we took $45 million in charges related to the real estate rationalization plan initially announced last year. We realized good savings in 2008 from our fiscal 2007 actions to exist and consolidate facilities and we expect to begin to see additional savings in fiscal 2009.

We also took steps to further lower overhead costs through targeted work force reductions. This year we achieved nice productivity gains in HR Outsourcing by leveraging our staffing levels on a global basis.

As we've said on our last earnings call, we absorbed significant severance in Q4 as part of our plan to improve our productivity across all of our businesses, leaving us well positioned to start the new fiscal year.

Fourth, we further strengthened our financial position by securing $500 million in new financing on attractive terms during the fourth quarter. This gives us a lot of flexibility and we intend to use it. A key priority will be to build on our strong strategic position to pursue our growth agenda through acquisitions, particularly if attractive valuations become apparent.

Our strong position also allows us to improve our capital structure, as evidenced by today's $300 million share repurchase announcement.

Before I turn the call over to John, I want to provide additional color on the quarter given the current business environment. In the fourth quarter we delivered a strong finish to an already very good year for Hewitt. We were able to consistently improve our performance against our guidance as the year progressed while absorbing sizeable severance charges due to restructuring actions across our businesses, actions now more important than ever in this challenging economic environment.

Despite the barrage of bad economic news globally, demand for our services in the fourth quarter was robust. We see good sales prospects in our outsourcing businesses and the demand in Consulting appears to continue.

We talk frequently to our clients and other business leaders as we are as anxious as anyone given the fear and uncertainty that is prevalent in the world economy. That said, we can only report on the results we see and the sales opportunities in front of us, and these trends remain positive. I will remind everyone once again that we could be a lagging indicator for the broader economy. Later in the call I'll provide some additional perspective on why our finish to the year was strong and why we are optimistic about fiscal 2009.

Now I'll turn the call over to John to discuss our detailed financial results and guidance for next year.

John J. Park

Thanks, Russ, and good morning, everyone. Let me start by highlighting our consolidated results for the fourth quarter.

Fourth quarter net revenues increased a solid 8% over the prior year quarter. Net revenues also grew 8% after excluding the effects of currency, third-party supplier revenues and acquisitions and divestitures. Reported operating income in the fourth quarter was $54 million compared with an operating loss in the prior year quarter of $281 million.

Our underlying operating income grew 8% to $87 million in the fourth quarter compared to $80 million last year. Our underlying results include $17 million in severance charges, but exclude the following one-time items: In the current quarter, a $34 million pre-tax charge related to the rationalization of our real estate portfolio and a favorable $2 million pre-tax adjustment related to a previous HR BPO contract restructuring. In last year's quarter there were $361 million in unusual items primarily related to goodwill and asset impairment and real estate restructuring. You can see the full detail in our earnings release.

Our reported effective tax rate for the current quarter was 34.5%. This relatively low rate is mostly due to discrete events which occurred during the quarter, such as a reversal of certain tax contingency reserves and return to provision adjustments. On an underlying basis, our normalized effective tax rate was approximately 39% in this period and last year.

Reported net income for the fourth quarter increased to $32 million or $0.32 per diluted share, impaired with a net loss of $266 million or a loss of $2.51 per diluted share last year. On an underlying basis, we recorded earnings of $0.50 per diluted share in the fourth quarter as compared to $0.47 per diluted share last year, an increase of 6%. This adjusts for the onetime items and normalizes the tax rates.

For the full fiscal year, net revenues grew a solid 8% over the prior year to $3.2 billion. Net revenues grew 7% after adjusting for third-party revenues, currency, acquisitions and divestitures, and the favorable impact of HR BPO contract settlements.

Reported operating income was $313 million compared with an operating loss in the prior period of $143 million. Our underlying operating income grew 30% to $334 million for fiscal 2008 compared to $257 million last year. These results include $31 million in severance charges but exclude the following one-time items: For fiscal 2008, a $45 million pre-tax charge related to the rationalization of our real estate portfolio, a pre-tax net gain of $35 million related to the divestiture of our Cyborg business, and pre-tax net charges of $12 million related to HR BPO contract restructurings. For fiscal 2007, unusual items totaled $400 million, primarily related to goodwill and asset impairment, severance and real estate restructuring. Again, full details are available in our earnings release.

Our reported effective tax rate was 40.5% for the year compared to 40.4% in 2007. On an underlying basis, our normalized effective tax rate was 39% in both periods. Reported net income for the year increased to $188 million or $1.85 per diluted share compared with a net loss of $175 million or a loss of $1.62 per diluted share last year. Adjusting for the one-time items and normalizing the tax rates, we recorded underlying earnings of $2.02 per diluted share for the year as compared to $1.48 per diluted share last year, an increase of 36%.

For the year, cash flow from operations was $328 million compared with $435 million in fiscal 2007. Free cash flow was $210 million compared with $347 million in fiscal 2007. This decrease in free cash flow was driven primarily by higher performance-based compensation paid in 2008 for 2007 performance and higher tax payments.

Capital expenditures were $118 million in fiscal 2008 compared with $88 million in the prior year. This higher level of CapEx reflects an increased level of investment in technology, particularly IT hardware for our outsourcing businesses and real estate relocations, renovations and upgrades related to our rationalization initiative. Recall that last year's spending was unusually low as we put a lot of major systems investments on hold while we sorted out our strategy and saw lower implementation activity related to our new HR BPO contracts. For 2009 we anticipate capital investment slightly above 2008 levels.

Adjusted EBITDA for the full year increased by $89 million over the prior year to $524 million due to improvements in our HR BPO business.

I'd like to make a few brief comments on our capital structure now. First, regarding our share repurchase program, during the fourth quarter we completed our existing $750 million share repurchase authorization by buying back 4.1 million shares for a total of $155 million. In fiscal 2008, we bought back 15.1 million shares for a total of $566 million.

Second, in conjunction with our $500 million in new debt financing in August, we executed interest rate swaps on most of the $270 million syndicated loan. This makes the financing 80% fixed and 20% floating, with a current pre-tax cost of debt below 6%.

This financing augmented an already strong balance sheet. We ended the fourth quarter with $541 million in cash and cash equivalents and no outstanding borrowings against our $200 million revolving credit facility.

Now let me give you a few highlights of the performance of each of the businesses. In order to leave plenty of time for your questions, I'll keep my comments to our performance in the fourth quarter and all of my remarks will be based on underlying results, adjusted for the charges that I detailed a moment ago.

In Benefit Outsourcing, reported fourth quarter segment revenues grew 5%. Revenues increased 3% when adjusting for acquisitions and currency. Growth was driven primarily by increased project work and higher participant counts, partially offset by client losses. End user participant counts increased by 7% to 19.7 million. Fourth quarter underlying Benefit Outsourcing margins declined 700 basis points to 20.8%. This was due to higher compensation and client service delivery expenses related to several large and complex clients that recently went live and included higher severance and performance-based compensation. Severance in the current quarter was $8 million.

In HR BPO, reported revenue declined 1%; however, segment revenues grew 11% when adjusting for one-time items, currency, and excluding third-party revenue. Growth was driven primarily by several contracts that went live over the past 12 months as well as project work. This growth more than offset planned service reductions to certain current and former clients. The underlying operating loss improved to $11 million compared to a loss of $38 million in the fourth quarter last year.

The improvement reflects staffing leverage and infrastructure savings related to our lean productivity program and the successful renegotiation of some contracts. This brought out full year loss to $90 million, a meaningful improvement over the loss of $158 million in fiscal 2007, reflecting a dramatic improvement in the stabilization of the business as well as cost reductions.

Let me make a few comments on our outsourcing sales prospects. In Benefit Outsourcing, we continue to see good activity in the large company marketplace across our health and welfare, defined contribution and defined benefits offerings, and our pipeline remains solid. As mentioned earlier on the call, our new middle market core benefits administration health and welfare offer has truly struck a cord and seems to be meeting a real need in the market. We continue to expect this business to grow nicely.

We're also seeing increased activity relative to our new absence management offering due to our LCG acquisition in FY '08. Our ability to offer solutions that show real cost savings by improving wellness and reducing employee absences is gaining ground in the market.

With respect to HR BPO, we have incorporated the many lessons we've learned as a first mover in this space. Today we have a solid set of core offers that we are confident will serve our clients well, but the market remains slow.

Now I'll look at Consulting. Consulting reported very strong top line growth in the fourth quarter, with net revenues increasing by 16% on both a reported and constant currency basis. This reflects organic growth of 14% and another 2% of growth from acquisitions. From a practice perspective, retirement and financial management and talent and organizational consulting grew in the mid-teens, health management and communications grew in the mid single digits.

Legislative and accounting changes in the U.S. and Europe, combined with market and economic volatility, have driven demand for retirement and financial management services. Asia-Pacific continues to grow nicely, driven by demand for our market-leading talent and organization consulting services.

The fourth quarter's underlying margin was 16.6% compared to 18.6% last year. This decline reflects higher compensation costs principally related to investments in the business, including $5 million in severance.

Unallocated shared service costs on an underlying basis were 3.9% of net revenues in the fourth quarter versus 4.3% of net revenues in the prior year quarter. The decrease as a percentage of net revenue is primarily a result of some one-time favorable items.

Looking ahead to fiscal 2009, we plan to build on last year's achievements to drive continued improvements in our financial performance. We anticipate the following for fiscal 2009:

Low single-digit total company net revenue growth comprised of mid to high single-digit growth in Consulting, modest growth in Benefit Outsourcing, and a high single-digit decline in HR BPO;

Operating income of $420 million to $435 million; Consulting and HR BPO are expected to be the most significant contributors to the improvement, with solid margin improvement anticipated for both on an underlying basis;

We anticipate roughly flat margins in Benefit Outsourcing on an underlying basis as we continue to invest in the business.

Regarding HR BPO, we've learned many lessons from the school of hard knocks. Today we're back in the market with a focused service offering and a sales and marketing strategy that will selectively look for growth opportunities. We expect a segment loss in the range of $50 to $60 million in fiscal 2009, which, by the way, is about the adjusted EBITDA breakeven point. Beyond 2009, we anticipate steady progress towards segment income breakeven over the follow two years as we invest in the business.

Finally, we anticipate diluted EPS of $2.35 to $2.45, with a normalized tax rate of 39.6%.

We anticipate fiscal 2009 free cash flow about in line with net income. We expect free cash flow to be impacted by cash payments related to severance and real estate restructuring actions taken in fiscal 2008 in addition to higher bonus payments related to fiscal 2008 performance. We're also expecting good growth in our adjusted EBITDA metric, but lagging diluted EPS growth, again, on an underlying basis.

As a reminder, I want to point out that last year's fiscal first quarter was a particularly strong one with unusually high margins in our benefits outsourcing business. Therefore, we expect Q1 to be our most challenging quarter from a year-over-year comparison.

Now I'd like to turn the call back to Russ.

Russell P. Fradin

Thanks, John.

Once again, I am pleased with our performance in fiscal year 2008 and very proud of our leaders and associates for keeping focused on our clients and delivering on our plan.

We are fully aware of the economic turmoil and the risks it poses to our business. We have taken decisive steps to offer services that help clients cope with the downturn. We have real knowledge and capability that can support them under these stressful conditions. We have been proactive in positioning Hewitt in the market, and we have been equally decisive in preparing our cost structure and capital structure for the new realities we face.

It is the quality of Team Hewitt that enabled us to navigate these difficult times. We have had setbacks, like everyone else, but the resourcefulness and knowledge of our associates has allowed us to continue to grow in the face of unprecedented events.

Furthermore, I want to highlight several aspects of Hewitt that give us some comfort that we will continue to build our strong market position given the current economic challenges.

First, we are a trusted name in the human capital space, with expertise in many areas that clients seek in times of great change and upheaval.

Second, our business model is resilient, with a high degree of year-to-year revenue retention.

Third, we remain very strong financially.

So despite the tough business environment, our metrics are holding up well. We are pleased to say that we expect another year of revenue and earnings growth.

Operator, we're ready to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ashwin Shirvaikar - Citigroup Investment.

Ashwin Shirvaikar - Citigroup Investment

I'm trying to get to a normalized free cash flow estimate going forward if possible, so if you could help me with a couple of items like, you know, what kind of benefit do you expect to see from the cost actions you've taken, what's your D&A, what's your CapEx, if you could put some numbers on those?

John J. Park

Well, Ashwin, we gave you some indication of what we expect for next year, and as a practice I don't think I want to go much further than that in the outgoing years on CapEx.

What I will tell you, to add a little bit of flavor, is that I think we're probably back up to CapEx levels that are more normal to the business. I think that last year was unusually low - or, I'm sorry, FY 2007 was unusually low because we were really resetting our strategy and we really held back on making any significant capital investments at the time. And there was a bit of a hiatus in terms of new contract activity.

I think we're now back to being very bullish on new Benefit Outsourcing contracts, selectively signing some MPHRO contracts, and getting back to what's a more normal level of investment in our information technology infrastructure.

And I'd say in terms of depreciation and amortization, we have seen a fairly steady falloff of D&A over the past couple of years. That's going to happen, but at a more moderate rate than what you've seen recently.

And I think tax payments will continue to be up or down based upon the timing of refunds and payments. It's a very difficult thing to forecast, but I don't see anything unusual happening with our tax payments over a longer term period.

Operator

Your next question comes from Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

I just want to ask two things. Number one, in the Benefit Outsourcing business, on the margins you talked about some large complex projects that were sort of weighing on the margins. I want to know if it was complexity that you guys had anticipated or are there any challenges on the implementations? That's one side. And the other side is was there anything unusual on the Consulting business that made the revenue growth be that high? It's really higher than any of your competitors in this space and you seem to be doing a very good job there.

Russell P. Fradin

Well, Shlomo, let me deal with the second question first. And I'll tell you, it's something I'm particularly proud of, meaning I think our Consulting team and all of our associates there have really done just a superb job of navigating just incredibly tumultuous times.

And to give you an example of how the demand for our services has changed, we have a group that specializes in corporate transactions, both acquisitions and divestitures, and unfortunately all this economic turmoil has caused a lot of these forced marriages. And the financial services industry, as you know better than I, has been roiled by these unanticipated events. And our people have proactive in positioning our strength and have gotten us really positioned as the experts to handle many of these large-scale integrations in an HR sense which, as you know, were very much anticipated.

And so it's just one of the things that gives you sort of a little different flavor of some expertise that we have that we believe differentiates us from our competition as well as the fact that in our RFM group - our retirement and financial management group - again, we have put together a whole bunch of pension and risk management material and expertise and investment management expertise that frankly now is in even higher demand given the market volatility. And I'd be remiss if I didn't mention Asia-Pacific and how well we continue to do over there  by the way, not just with global multinationals but also with the local market in India and China.

So from my perspective, we were as gratified, as you mentioned, to see that it looks like we gained a little bit of ground and we're certainly going to do everything we can to keep that up, but it's a lot of hard work and I'm very proud of the team.

From a Benefit Outsourcing perspective, I think you're right, meaning we've had some particularly large implementations, which I will tell you in the core benefits business is actually terrific news. And so you've seen the participant count grow and you're seeing some growth come back into that business.

What I would tell you is it really wasn't unanticipated, the fact that it takes more elbow grease to bring these things live, and that's why, as you've seen, we've stayed true and, in fact, even been a little better than our guidance all year. So I think from that perspective we certainly anticipated that. And the fact that we have these large clients in the fold, over time they stabilize very nicely and we've got a great history there, and that's precisely what our expectations are and that all seems to be going according to plan.

We mention those, we call them out, but also, as you know, part of the reason for that depressed margin or margin below our long-term guidance is also some work force restructuring we did, and I think we called out $7 or $8 million of severance in that business, which also depressed the margin. And again, we anticipated that and that's why we tried to be conservative in our guidance. But we are really pleased that the growth engine is coming back into the benefits business and that's what it'll take to make sure it gets going.

I think all the implementations aren't going to be quite as large as some of the ones we've taken on this year, but we feel real good about it, actually.

Operator

Your next question comes from Mark Marcon - Robert W. Baird & Co., Inc.

Mark Marcon - Robert W. Baird & Co., Inc.

I just wanted to ask, with regards to HR BPO, can you talk a little bit about kind of the longer-term outlook there and how you're thinking about things? When we get to breakeven? Exactly how you're thinking about that because, if we strip out the real estate charges, clearly huge progress, particularly in the last two quarters, and it looks like you're trending quite nicely. It also sounds, from what we know, that there's been a couple of clients - actually three clients - that have had some unusual events that have occurred, and so I'm wondering how that impacts things.

Russell P. Fradin

Let me try to give you the best perspective I can and also rely on John, who can talk a little bit more about the financial.

But if you recall, going back over the last couple of years, as you cited we've tried to be as clear as we can be that, of the total portfolio, there was a group that clearly was the most challenging for us. And we've been through this period where, as you can see, we were able to restructure some of those contracts. And one of the things, I guess, I'm proudest of in doing all that with Jim and the team and we just have a fabulous team over there, is that we have kept every one of those as clients in our Benefit Outsourcing and our Consulting businesses.

So despite the hiccups and the problems that we've sort of been through with these clients, they have trusted us and they've been great partners as we've restructured these contracts that are beneficial to them. Obviously, we've made some large payments but also have helped us out as you can tell.

In terms of what we're down to, I think from our perspective you've seen that in some cases we've exited the most problematic of the contracts, and so it really is a shrink to grow strategy. And so the revenue reduction that we're going to take in '09 is very much planned for. In other words, we anticipated that in exiting these contracts it would hurt the revenue growth but very much help the profitability of the margins. And so that's what you're beginning to see. And so when you look at our overall growth rate, I'd focus more on Consulting and Benefit Outsourcing because it's a very deliberate strategy. You know, in my words, to shrink to grow.

Separately, we've put together a team that's been working on what's the right offer for that marketplace, and we feel very comfortable as we go out to market now as we've done very cautiously and selectively in a number of situations - and we've brought a few clients live during my tenure; in fact, I think we've brought three clients live during my tenure - that we really do want to get back on the horse, so to speak, because we do think we have a model that works.

We're out selling that. Buyers are cautious, just as we're cautious, and so the negotiations take some time. But after we're through this period of consolidation, which I think will continue through '09, we intend to get this back on the growth track, assuming that we have positive margins in the business.

In terms of the specifics of what's John been through, I think it's probably - I'll let him answer the specifics.

John J. Park

Yes, let me make some comments in terms of the financial performance. I think, first of all, the way we think about the state of the HR BPO business from a financial point of view is that it is now relatively stable. I think we've been able to see some good performance, some significant reductions in the losses, and internally we've been able to forecast the performance of the business in a way that we feel very comfortable with. So I think that's a big change from what you saw a couple of years ago.

We had a nice reduction in full year-over-year operating loss in the HR BPO. We expect another nice reduction full year over full year in FY '09 versus FY '08. And we expect the reductions to continue over the next couple of years. And as we said, we think that we'll reach an operating loss breakeven in the following couple of years.

Now one of the reasons that we say the next couple of years is clear, as Russ just articulated, we view this business as longer term having growth opportunities, so we are going to be selectively investing over that period of time in growing the business. And we also would encourage you to think about our total business, because as we've said on many occasions, the HR BPO services are just one of our product lines that we sell to our customers. And literally every single one of our HR BPO customers are important customers on the other side of the business, so Benefit and often case there's Consulting also.

So there's a balance here that we're going to execute fairly carefully but in the right way between driving the loss of the HR BPO business down while making sure that we're optimizing growth and profitability of the overall relationship that we have with our customers, and we really want to reflect that in terms of our longer-term guidance.

Russell P. Fradin

There was one other part of your question that I want to make sure we answer and be clear about and that is in terms of the companies within the portfolio that are involved in either difficulties or transactions at this point, but the large bank that's involved, we had restructured that contract before they were acquired. The contract restructuring anticipated us fully turning back the BPO activities to that client and pretty much that activity's been completed and it's fully contemplated in the '09 guidance.

Likewise, we fully recognize we've got a couple of retailers in there that have had financial difficulty and again, the potential fallout from those difficulties is fully contemplated in the '09 guidance, if that's helpful.

Operator

Your next question comes from Tien-Tsin Huang - J.P. Morgan.

Tien-Tsin Huang - J.P. Morgan

I just had sort of a historical perspective question on Consulting and Benefits. If we look back, what is the typical growth pattern you might expect in periods of rising unemployment for both Consulting and Benefits. And also I was curious how has it tracked in years with a change in administration in the White House, just to give us some perspective on the rate of change that we might see given those scenarios.

Russell P. Fradin

Well, what I would tell you is this. I think we're sort of in the same boat as everyone else, meaning trying to predict the future and even using past comparison. Both the economic recession and the political change, I think, are pretty much in the unprecedented category and I'm not sure of that. Since the last sea change in elections in the Kennedy administration pre-dated our Benefit Outsourcing business, I'm not going to speculate on that.

But let me tell you a little bit about how we think about it and that is, as I mentioned, in Consulting it's a little bit like the duck analogy, meaning that you've got the duck going across the water and if you don't see its legs paddling feverishly, you don't realize how hard it's working. But we are really doing our best to change over the services that we offer to our clients to focus on work force restructurings and on downsizings and on potential changes to pension plans and changes to their investment strategy, and all those sort of things that are required.

And so although the growth rate looks smooth and looks like everything's continuing, the reality is that our consultants are just doing an incredible job of revamping the product line and making sure that they're best addressing the needs of our clients. And all we can is that's what's been going on, and as you can see, the fourth quarter growth rate, when the storm was potentially at its fiercest, didn't decelerate. And so from that standpoint, in Consulting we feel very good.

In Benefit Outsourcing, I think John mentioned that we see sales pipelines that are pretty robust at this point, and so we've done all of our kind of modeling internally to see what the labor market could wreak in terms of havoc on our portfolio. And so we've literally tried to look at individual client names and people who have announced downsizings and anticipating further downsizings that will occur that none of us can predict, and from that standpoint the question is can the sales and the new implementation activity overcome that? And, again, it's contemplated in the guidance, but it's going to be a very difficult, difficult period for any of us to get through.

But again, just as we see companies that are downsizing, we see companies that are saying wow, this is a time to consider outsourcing. And so you're seeing some of both going on and we're benefiting from the uptrend.

In terms of the particulars, you really do have to look at it by product line, meaning of our 19.7 million participants, there's a good percentage of those that are in defined benefit pension plans that really are not impacted by the labor force actions. In fact, as people are pushed out of the work force, many choose early retirement and in some cases you may actually see growth in the participant count in defined benefit. And we are by far the leader in that category.

In terms of health and welfare, it's a little more mixed, meaning the downsizings could affect that. On the other hand, in most of our clients we offer COBRA services, and so that continuation of benefits clicks in and we get paid for that as well. So we're a little bit more cushioned on the downside than most companies to the employment.

And then on defined contribution, again, it really depends on people's behavior. What we've modeled is in the past it's unusual that the day someone is laid off they walk out and move their 401(k) somewhere else or to an IRA rollover, so there's typically a pretty long lag factor on that and that's what we're seeing right now.

So again, we've tried to do our best to model what these extreme conditions could have, but I just want to add that caution that, if anyone thinks somehow that past guidelines are going to play out in this, I think we've been wrong every step of the way and so we've tried to look at stressful conditions beyond what we've certainly seen in the past.

Operator

Your next question comes from Todd Van Fleet - First Analysis Corp.

Todd Van Fleet - First Analysis Corp.

I'm curious to understand how you incorporated what's happened in the currency environment into your guidance for 2009 from a revenue standpoint, from an expense standpoint, and maybe if you could share with us some of the fundamental assumptions that you have embedded in your guidance where Forex is concerned.

John J. Park

When it comes to guidance and internal forecasting and planning, we try not to think that we're smarter than the market and so we incorporate the readily available information that's in the marketplace in terms of spot and forward rates. So as things deviate or if you have your own view that's different from that, you should certainly layer that on top of what our guidance is.

What I will tell you to just give you a little bit of flavor of our profile as it relates to FX is that overall we do tend to benefit when the dollar strengthens. It's because of the sizeable operations that we have offshore, primarily in India. We obviously have revenue and profit that's generated from outside the U.S., primarily in the U.K. and Canada, but that tends to be offset by the large cost base that we have supporting our U.S. business in our offshore locations.

Todd Van Fleet - First Analysis Corp.

Okay, so you're getting a benefit, then, John, an earnings benefit as the dollar strengthens?

John J. Park

That's correct, but I would caution you to not necessarily factor that as being significant because, as I said, there is a benefit because of our offshore operations that's partially offset by profits that we generate from outside the U.S.

Operator

Your next question comes from Jason Kupferberg - UBS.

Jason Kupferberg - UBS

Have you guys incorporated any additional share buyback since the fiscal '09 EPS guidance?

John J. Park

We have some assumptions of buyback. Obviously, we've announced the authorization. I don't want to get more specific than that because, as you know, as a matter of policy we don't like to comment on any specifics around how we're going to be executing any buyback activity.

Russell P. Fradin

Jason, one of the things that I just wanted to emphasize as you think about the buyback activity which I said on the call is, frankly, from our perspective, if we can find the right set of acquisitions that are inevitably going to come out of all this turmoil and we have our eye out there all the time, there are certainly things that will benefit our business. And so from that standpoint we want to use this tumult and this turmoil to really strengthen our strategic position.

And so we're really saying that in many ways buyback is right now the second-best use of cash, meaning to the extent we want to moderate - and we're certainly not going to go nuts; you've seen what we've done in the past, meaning we've done, I think now, four deals in two years that are all pretty bite-sized, so I'm not saying we're going to go out and do anything dramatic - n the other hand, as hopefully acquisition prices come down we want to buy low on the acquisition front as well.

So we're going to moderate the buyback activity, but we really feel very comfortable that we can do both given the position that John and the financial team have put us in. We're very comfortable with both.

Jason Kupferberg - UBS

And then on HR BPO, if I look at the fourth quarter operating loss, I think if you exclude the little bit of severance there you had about a $10 million loss so if you [inaudible] just annualize that, it would be about $40 million. I know you're guiding to $50 to $60 million, but I would think that, on a year-over-year basis, you would get more benefit from all the contract renegotiations you've done over the last 12 to 18 months. So what are some of the other moving parts there or is there just conservative baked in?

John J. Park

No. Great question. Actually what's going on there is that, as we unwound some of those contracts and as you do the extra work to turn that work back over to clients, which is project work for us which we charge for, there actually is some lift in unwinding those contracts a bit for us. And remember, we made large payments to those clients so, I mean, it's not as if we got great benefit. But we did get some earnings lift.

So I wouldn't do the $10 or $11 million times 4. It's not our conservatism; it's what we really expect given that we're still working down the remaining contracts and working to get improvement against it. So we got a little bit of lift from that unwinding activity.

And these things by their nature are very chunky, and I think John said before be very cautious about taking one quarter and projecting it and I think this is a great example of that, meaning we're anticipating that there'll still be some speed bumps and other things out there. So I would take the fiscal year '09 guidance seriously. It is what we really expect.

Russell P. Fradin

I'd also emphasize again what we said a few minutes ago, which is this is a business that we do want to continue to invest in, albeit at a moderate level, and our guidance reflects our desire to continue to look for the right opportunities to not only position this business better but the entire company better.

Operator

Your next question comes from [Vincent] - Goldman Sachs.

Vincent - Goldman Sachs

My first question is just on the overall margin improvement that's baked into your FY '09 guidance. I just wondering if you could provide a little bit more color in terms of how much margin benefit that you're expecting is the result of the work force reduction that you have done over the course of FY '08?

John J. Park

Well, there's certainly a significant benefit that we're going to see from the work force reductions that we took in FY '08. What I will tell you is that, like any year, the next year is going to be a year where we really balance driving income growth and revenue growth with investing in the business. So there's a lot of puts and takes here, but think about next year as a year that we actually feel very good about in terms of investing to create future growth and shareholder value.

So you take any one particular cost savings item, whether it's the severance and the lower compensation costs, the real estate savings, and I'd caution you to not think of that in an isolated way. I'd really encourage you to think about the fact that we're going to be positioning the business for much stronger, longer-term growth while delivering very strong bottom line growth and top line growth.

Vincent - Goldman Sachs

And then just on the Consulting segment, I know that you have said that you are expecting margin improvement for that segment in FY '09. Just in terms of how we should think about a trajectory, it looks like for that segment you had a pretty nice pickup in margin in the fourth quarter compared to the last three quarters. I'm just wondering whether the kind of level that we saw this quarter was sustainable throughout the next few quarters or should we think about the improvement more on a year-over-year basis?

John J. Park

Well, we don't want to get necessarily too specific beyond the guidance that we provided formally, for obvious reasons. But we really feel like the business is now at a point where we've really gotten the revenue to grow at a nice rate; we're very happy with that. The team is now focusing on operational improvements, which will really yield higher margins. I think you're starting to see the benefits of that in the fourth quarter. And we expect those kinds of trends to continue in 2009, but I don't want to get too much more specific than what we said formally.

Vincent - Goldman Sachs

Just regarding your reference in terms of potential margin benefit from the dollar's appreciation versus other currencies, more specifically, on the rupee, I know partially it's going to be offset by the negative impact on the top line, but just wondering whether you can provide any sense or any sort of rule of thumb to think about when maybe every 1% is your movement, how much potential margin benefit that we can see from that.

John J. Park

I would encourage you to not think of that as one of the real significant factors in our performance. Clearly we have some FX exposure, as I detailed, but that's really not going to be one of the factors that significantly moves our performance in one direction or the other.

Operator

Your next question comes from Paul Ginocchio - Deutsche Bank.

Paul Ginocchio - Deutsche Bank

Could you just talk about how you think about the defined benefits consulting business in '09 with the massive decline in the stock market?

Russell P. Fradin

Well, for us, we really have the traditional actuarial practice which, you know, it really is a crazy time, is the only way I can put it, meaning, as you can imagine, trustees around the world are trying to get their best handle on the liability side and that has driven the level of activity and we are doing our best to help them stay in front of that. And so we developed some techniques and ways of looking at that, frankly, before a lot of the turmoil started that we had started to market this year. If ever timing was our friend, this was very, very helpful and so I want to compliment our RFM team for doing that.

But you're right, in these kind of times, it's really very important that we stay very close with our clients and we've done that. We've won some new clients as well, and that feels pretty good. We also have what we call the investment management practice that is also part of this, so looking at how clients should be invested on the asset side to cover these liabilities. And so from that standpoint, again, you can only imagine that more people have gone out to bid, that more people want second opinions, so demand has been very robust.

And the only other thing I would add to all that is that with the requirements of the Pension Protection Act and what happened in 2006, one of the things that Congress has not fully contemplated is this enormous decline in now equity values on a global basis causes, because of the PPA, funding requirements on a lot of these companies with large pension plans that are just going to be unimaginable. And so one of the things that we're working on, not just with our clients but hopefully beginnings some dialogue with folks in Washington, is this whole question of how do we begin to relieve the cash burden that really no one anticipated?

So I don't see, you know, this isn't something that I think is going to calm down soon, and I think that our people have really been on top of it and done just a great job, but from our standpoint it's probably helped the growth rate in this business more than it's hurt it at this point.

John J. Park

I think it's also important to just remind people that we do not derive a meaningful portion of our revenue from asset-based contracts. Some of our competitors do so it's important to note that.

Russell P. Fradin

Yes, we don't have any market risk based on what we do today and, as John said, some of our competitors have gone in a different direction there.

Paul Ginocchio - Deutsche Bank

What's your exposure to benefits and investment consulting within Consulting? And then second, what was your growth rate like back the last time the equity market plummeted, which I guess is '01 and '02?

Russell P. Fradin

Hard for me to answer since I wasn't here at the time, but again, I wouldn't compare this to the '01  '02 timeframe, meaning the '01  '02 timeframe was a much more concentrated technology bubble. This is a true global recession, and it seems to be affecting literally every sector that you have out there. That's why I say I just think we're looking at stress like we've never seen, and so we really are just trying to deal with it as best we can at this point.

Paul Ginocchio - Deutsche Bank

And the exposures to defined benefits and investment consulting within Consulting?

John J. Park

Well, defined benefits obviously is a sizeable portion overall of our Administration and Consulting business. The formal investment consulting piece is a relatively small but growing piece of our business, so a little bit of a double-edged sword in that we feel it's an important growth vehicle for us, but at the same time right now as it relates to the financial exposure, it's relatively small for us, [inaudible] investment consulting side.

Operator

Your next question comes from Aki Karja - Royal Capital.

Aki Karja - Royal Capital

I had a question on your guidance. Russ talked a lot about the stress scenarios that you guys ran, but what was the underlying assumption of the economy? Did you guys assume that unemployment really ticks up and bankruptcies could tick up as well or how did you think about that?

Russell P. Fradin

I'll make my comment and John, I think, can certainly add to that. From the standpoint, as I said, if you really look at what happened to us in the fourth quarter, we were able to sort of navigate that storm. I think we certainly see that storm intensifying and worsening, and so we looked at our underlying participant counts and what would happen under various scenarios and even got down to the level of individual client analysis in terms of each of the announced downsizings and things like that and then on top of that - and said, well, assume that on top of that some worsening certainly continues.

I don't think we contemplated Armageddon and I think that, to the extent that you begin to see Depression-like unemployment of 26%, we have certainly not contemplated that. It's just more saying can we navigate the storm we see in front of us would be the way I'd position it.

John J. Park

Yes, that's exactly right, and I would say that that's what our range is actually built around. I feel like we've tried to contemplate reasonable changes in the economic environment within our EPS guidance range.

Aki Karja - Royal Capital

And secondly, could you walk us through how some of these bankruptcies will impact your business and if there is a lot more of them coming in '09. Let's say Circuit City, if their receivables write off, do you lose that business? So how do those impact HR BPO and how would they impact the Benefits Admin business?

Russell P. Fradin

Well, this is true of all of the outsourcing services that we provide, to make that distinction between that and consulting. But in terms of the outsourcing services that we provide, we are inevitably one of the approved expenditures; otherwise we don't continue services. And so from that standpoint in all of the bankruptcies or even liquidations that have occurred, we keep a very close eye on receivables and we make sure that that happens. And the court inevitably appoints us as one of the approved expenditures.

And then, you know, you play it out. And so whether each of the retailers will emerge, couldn't tell you. We certainly are not planning that every one of them will, and so from that standpoint we're really - you know, could you be at risk for a month of receivables at a time? Yes, but certainly we wouldn't let anything go beyond that before taking action.

So it's happening already. We're dealing with it. We're not happy about it and I'm sure the companies are not happy about it, but that's the reality of it.

Operator

Your last question comes from Ashwin Shirvaikar - Citigroup Investment.

Ashwin Shirvaikar - Citigroup Investment

I wanted to get back to the growth in the Benefits business, the number of participants being up and what you might continue to add on this enrollment season that's ongoing right now. Is that growth coming with your typical clients, the 10,000 plus, 15,000 plus size clients, or is it a lot of smaller, RealLife category clients, and what's the incremental profitability, if you can comment on that.

Russell P. Fradin

I was going to say, it's clearly a mix. And we got, as John said, we really struck a chord when we went into the mid-market with what we call the Core Benefit Administration platform, which is a more scaled-down version of what we offer. So clearly both the acquisition of RealLife HR and then the extraordinary growth that that's produced in the last year has been helpful. But then there's been real, normal, what I would call clients above 15,000 growth as well. So we've seen both kinds of growth.

And again, in the mid-market, since it typically is a narrower set of services, you see that the price is not as robust as we'd get for the larger clients because we're offering a scaled down service and it's just health and welfare and it doesn't usually include defined benefit and defined contribution. So it was a nice pop with CBA, but we've also seen real growth on the other side as well.

Again, you know, how that will continue given what's going on, that's where I was commenting that it really will vary by type of service we offer, that we feel that there's more protection in the defined benefit, where were are clearly the market leader, and then there's some cushioning and some lag on the other side. But clearly we are contemplating that the unemployment levels will rise and that the layoffs are going to continue.

John J. Park

I would add that the newer services that we're offering, like [leave] in the middle market health and welfare are businesses that we're investing in aggressive growth. and they're still relatively small compared to our core benefits business. The margins are lower than on our core business; that's actually incorporated into our guidance. When we talked about the benefits margins being flattish, part of the investment that we're referring to is continuing to aggressively invest and growing in these areas.

But we see the long-term margin potential of these businesses to be at or greater, actually, than our core services, so I would really encourage you to view our guidance for next year comprehending a significant piece of investment related to growing these newer services.

Russell P. Fradin

I just want to thank everyone. I know these are extraordinary times, both from an economic perspective and a political perspective. It causes a lot of late nights for all of us, I think, the entire team included. And I just wanted to thank all of our associates and all of you for being so patient through all this, so thanks.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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