Hewitt Associates, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

Hewitt Associates, Inc. (HEW)

F1Q09 Earnings Call

February 9, 2009 8:30 am ET

Executives

Sean McHugh - Vice President, Investor Relations

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

John J. Park - Chief Financial Officer

Analysts

Ashwin Shirvaikar - Citigroup Investment

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

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

Jason Kupferberg - UBS

Todd Van Fleet - First Analysis Corp.

Timothy McHugh - William Blair & Company

Paul Ginocchio - Deutsche Bank

Tien-Tsin Huang - J.P. Morgan

Julio Quinteros - Goldman Sachs

Presentation

Operator

Ladies and gentlemen, good morning. Thank you for standing by and welcome to the Hewitt Associates fiscal 2009 first quarter earnings conference call. (Operator Instructions)

At this time, I'd like to turn the conference over to our host, Vice President Investor Relations, Sean McHugh. Please go ahead.

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 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 morning's press release in 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 the call over to Russ.

Russell P. Fradin

Thanks, Sean, and good morning to everyone. Thank you for joining us on the call today.

This morning I'll cover the highlights of our first quarter, including comments on the business environment, before turning the call over to John for a more detailed review of our financial results.

Let me begin by saying how pleased I am with our team's strong performance in this quarter. The knowledge, skills and commitment of our associates allowed us to overcome many of the obstacles present in the current business environment. Let me highlight the following key points for the quarter.

First, our professional approach and focus on our clients resulted in strong 9% organic constant currency growth in our Consulting business, led by our retirement and financial management and health management practices.

Second, we grew our participants served in our Benefit Outsourcing business by over 6%. We're pleased that this metric advanced nicely in light of the weak employment environment.

Third, we significantly improved the operating loss in our HR Business Process Outsourcing business through a combination of underlying revenue growth, process redesign, and solid cost management efforts.

Fourth, we expanded our underlying operating margins by 160 basis points to 14.6%. I'm particularly pleased with this achievement as it came against our toughest comparative quarter of the year.

We continue to execute against a clear plan despite enormous economic headwinds; however, we're not seeing anything better in this economic environment than those around us. In the first quarter we experienced softness in several areas. In our Consulting business, we slowdowns in our more discretionary services, like talent and organization consulting and communications. In our Benefit Outsourcing business we saw a decline in project revenue, again, a discretionary item for clients.

Clearly, our challenge is to continue to actively manage the business to address the mounting pressures associated with this recession. Specifically, higher unemployment rates, tighter credit, and more bankruptcies have led to declines in discretionary project spending and benefit outsourcing and consulting and can eventually lead to more pressure on our ongoing revenue.

We've done well so far, and I'm grateful for the hard work and persistence of our team. This is why we are maintaining our previous operating income outlook, though, as John will explain, there are reasons related to share count and tax rate that lead us to raise our EPS guidance.

Now I'll turn the call over to John.

John J. Park

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

First quarter reported net revenues declined 3% over the prior year quarter; however, net revenues grew 3% after adjusting for currency, acquisitions and divestitures, third-party revenues and the favorable impact of an HR BPO contract settlement in the prior year quarter.

Reported operating income grew 3% in the first quarter to $112 million. Underlying operating income increased by 12% when adjusting for a $5 million benefit due to the HR BPO contract restructuring and a $3 million favorable contribution from our divested Cyborg operations, both in the prior year quarter.

Underlying operating margin increased by 160 basis points to 14.6% - as Russ noted, a very good quarter versus a tough comparison. Margin expansion was driven by the reduction in our HR BPO loss as well as FX.

Our reported effective tax rate for the current quarter was 39.6% compared with 43.6% in last year's quarter. Last year's rate reflects one-time impacts related to the adoption of FIN 48. Our mix of income among various jurisdictions this quarter also contributed to the lower rate.

Reported net income for the first quarter increased to $65 million or $0.68 per diluted share compared with $64 million or $0.59 per diluted share last year. Reported and underlying EPS grew 15% year-over-year because in the prior year period the benefit of normalizing the tax rate offset the impact of the one-time operating adjustments.

For the quarter, cash flow from operations was $64 million compared with $14 million in the prior year quarter. Free cash flow was $29 million compared with negative $10 million in last year's quarter. This increase in free cash flow was partly timing related and was driven primarily by lower receivables and lower tax-related payments which more than offset the impact of lower client implementation fees, higher capital expenditures, and higher bonus payouts.

Capital expenditures were $35 million in the first quarter compared with $23 million in the prior year. This higher CapEx reflects an increased level of spending related to our real estate rationalization initiative and investment in information technology. For 2009, we continue to anticipate capital investments slightly about 2008 levels.

Adjusted EBITDA for the quarter remained relatively flat to last year at $152 million. This reflects lower implementation fees in our outsourcing businesses and favorable operating results.

Regarding our $300 million share repurchase program, during the first quarter we bought back 407,000 shares for a total of $11 million. Through February 6 we repurchased an additional 187,000 shares for $5 million, giving us a total of $16 million against the overall program. I'll remind everyone that our open market repurchase window did not begin until the midpoint of the quarter, after the release of our fourth quarter results. As we stated before, we intend to be cautious in our repurchase execution due to market volatility and our belief that attractive acquisition opportunities are becoming available at reasonable valuations.

Now let me give you a few highlights of the performance of each of the businesses.

In Benefit Outsourcing, reported first quarter segment revenues declined 3%. Revenues declined 2% when adjusting for acquisitions, currency and last year's one-time item. The decline was driven by current period adjustments related to client service issues in prior years and reduced project work that more than offset increased participant counts. End user participant counts increased year-over-year by 6% to $20.1 million.

First quarter reported Benefit Outsourcing margin was 26.2% compared to 29.8% last year. Adjusting for last year's one-time item, the prior year period margin was 29.6%. The underlying margin decline versus last year was principally the result of lower revenues and higher compensation expenses related to investments in several large and complex clients. Infrastructure cost management actions related to our lean program provided some offsetting savings. The current quarter margin reflects a lesser impact from project revenue and a greater level of investment in the business compared to last year. We remain comfortable with our medium-term margin target of the low to mid 20s for this business.

Regarding the sales environment for Benefit Outsourcing, we continued to see good activity both in the large company and the middle markets. We have a solid pipeline and remain focused on trying to close business in this demanding environment.

In HR BPO, reported revenue declined 12%; however, segment revenues grew 6% when adjusting for one-time items, currency and excluding third-party revenue. Growth came from existing clients, mostly project work and new clients that went live over the past 12 months. This growth more than offset planned service reductions to certain current and former clients.

The HR BPO reported operating loss improved to $5 million in the first quarter compared to a loss of $27 million in the first quarter of last year. Adjusting for last year's one-time items, the prior quarter's loss was $34 million. The underlying improvement versus last year was due to revenue growth, staffing leverage and lower client settlement fees. Infrastructure cost savings related to our lean productivity program also contributed to the improvements.

This was a very good quarter for us in HR BPO, one that exceeded our targets. However, as we've said before, future progress is likely to be choppy due to the relatively small number of contracts in the portfolio and client-specific opportunities and costs in any given quarter. I will provide additional color on the HR BPO outlook in a few minutes. We continue to see interest for our services, but actual results are not yet apparent. Overall market demand remains very measured, as the client decision-making process has slowed.

Consulting segment revenues increased 2% on a reported basis and grew 9% when adjusting for currency and acquisitions. From a practice perspective, retirement and financial management grew in the low teens and health management grew in the low double digits. The talent and organizational consulting and communications practices both declined in the mid single digits. We were proactive in this challenging environment. The economic volatility led to more work in assessing pension liabilities and realigning investment strategies. We also sought to help clients reduce their costs and deal with various acquisitions and divestitures.

Demand was particularly strong in retirement and financial management in Europe and the U.S., along with health management services in the U.S. Discretionary spending slowdowns impacted our overall TOC practice, particularly in Europe and the U.S., however, the Asia-Pacific region continued to grow at a very solid rate.

Consulting's first quarter segment margin was 14.5% compared with 14.3% last year, both on a reported and underlying basis. This increase is mostly due to revenue growth and compensation leverage that were partly offset by higher SG&A expenses.

Unallocated shared service costs were 2.9% of net revenues in the first quarter versus 2.6% of net revenues in the prior year quarter, both on a reported and underlying basis. The increase as a percent of net revenues was primarily related to the timing of accrual adjustments to both incentive compensation in the prior year quarter and share-based compensation expenses in the current quarter.

Now I'd like to briefly comment on two additional items. First, we paid off our $110 million Exult convertible senior notes during the first quarter. We ended up with a very solid cash position of $431 million. We continue to feel good about the strength of our balance sheet.

Second, earlier this month we closed on the sale of net assets relating to our Latin America HR BPO business, which we acquired with Exult. This relatively small divestiture is consistent with our strategy to streamline and eventually grow a targeted, scalable set of HR services. As a result of the sale, we expect to record a one-time pre-tax gain of approximately $10 million in the second quarter primarily related to the recognition of currency translation adjustments.

Now turning to the outlook for the balance of the year, it's important to note that our operating outlook is unchanged for the year; however, we're making some adjustments to our guidance  namely, lowering revenue estimates primarily to reflect foreign exchange volatility and raising estimates of diluted earnings per share by $0.10 to reflect lower share count expectations and some tax rate benefit.

With that, here's a recap of our fiscal outlook. This reflects our performance expectations on an underlying basis after excluding the previously disclosed unusual items.

We now anticipate a low single-digit decline in consolidated net revenue. This is comprised of a low single-digit decline in Consulting, an approximately flat performance in Benefit Outsourcing, and a low double-digit decline in HR BPO. This compares to our prior view of low single-digit consolidated net revenue growth.

We continue to anticipate operating income in the range of $420 million to $435 million. HR BPO and Consulting are expected to be the most significant contributors to the improvement, with solid margin improvement anticipated for both. We anticipate roughly flat margins in Benefit Outsourcing as we continue to invest in the business.

Regarding HR BPO, we now expect a segment loss in the range of $45 to $55 million in fiscal 2009. This reflects the great progress we have made in the first quarter but contemplates lower levels of ongoing project and client transition revenue along with selective investment in the business over the balance of the year. This compares to our previous view of a segment loss in the range of $50 to $60 million.

We now anticipate diluted EPS of $2.45 to $2.55, an increase over our prior view of $2.35 to $2.45. This incorporates lower share count expectations and a revised effective tax rate of approximately 39%.

Our guidance excludes the one-time expected gain of $10 million related to the sale of our HR BPO business in Latin America.

We continue to anticipate fiscal 2009 free cash flow about in line with net income.

Lastly, we're now expecting modest growth in our adjusted EBITDA metric, lagging diluted EPS growth, again, on an underlying basis. This reflects strong operating performance partially offset by lower net deferrals.

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

Russell P. Fradin

Thanks, John.

Before I wrap up, I want to briefly update you on two client developments - the U.S. Office of Personnel Management or OPM and a large, HR BPO client.

First, OPM and Hewitt have settled their dispute and OPM has rescinded its October 16, 2008 termination of the contract for default. The contract has been terminated by mutual agreement between OPM and Hewitt.

Second, one of our long-standing HR BPO clients recently signed a new agreement with us. This is the same client that announced plans to end our relationship in 2008. We are delighted we were able to turnaround this situation and renew this partnership. This new agreement represents a big win for our HR BPO.

In closing, once again I want to congratulate our leaders and associates for maintaining their client and operational focus and delivering a great quarter. Our results speak to the quality and commitment of Team Hewitt.

Despite our strong quarter, we remain very aware of the challenges we face for the balance of the year. In today's uncertain environment, what we can't predict in the short term may create some bumps in the road. However, our business metrics are holding up well, sales opportunities are apparent, and we remain focused on the hard work required to achieve our long-term objectives.

We're actively managing our business to guide it through these tough times and continue to build for the future, and we look forward to updating you on the next call.

I thank you for joining us today. Operator, we're ready to take some questions.

Question-and-Answer Session

Operator

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

Ashwin Shirvaikar - Citigroup Investment

My first question is can you talk about what portion of your revenues in each segment comes from what you would consider discretionary client spending and also what one-time items we should be aware of for year-over-year comparisons in the March quarter?

Russell P. Fradin

I guess I'll start with a more general answer to the first quarter. If you look at the outsourcing businesses, both the BPO business and the Benefit Outsourcing business, by far the bulk of our revenue is based on participant count. And so you can see that what's happened in this quarter is that the sales and the new installations that we've had have more than offset the weakness in the labor market.

And it's also clear, by the way, just looking at individual client participant counts, that the announced layoffs that you read about in the press every day for the most part have not hit the unemployment lines yet, at least according to our participant counts. And as you know, there are various reasons, like where we do defined benefit recordkeeping, where we don't expect them to ever leave the participant count. So we feel that there's a lag there and that in addition the participant counts just seem to be remaining more robust.

But when we look at our outlook, Ashwin, we have factored into the outlook as if all those layoffs will fully occur and will be reflected in our participant counts. So we're not starry optimized optimists.

I'd say in each of those businesses, if you were looking at a number of project revenue, which is the more discretionary item, again, it's the minority but it is a good 15% of the revenue in those businesses, so that's what's - and it came under pressure in benefit outsourcing. It didn't come under pressure in HR BPO, but we are anticipating that it will.

In terms of Consulting, again, the bulk of the revenue from Consulting comes from services that you would expect to be repeated, so to speak, or even intensified in this environment, so it results from the valuation work and the work of our actuaries and the work of our investment management practice as well as things like executive compensation where, again, clients and Boards are going to ask the same questions every year about whether their compensation's competitive and, particularly in this environment, what changes they need to make. And I think the President is helping us, in a sense, in talking about all of the changes there.

And again there I feel a little bit less comfortable giving out percentages, but I think you can assume that it's reasonably substantial, but it's not the majority of what we do.

John J. Park

Ashwin, on the second part of your question, in terms of unusual items in the upcoming quarter, we just stated that we do anticipate a gain on the sale of our Latin America HR BPO business this quarter. In last year's quarter there are some amounts for an HR BPO client settlement and we'll also have to adjust for the impact of the divestiture of the Cyborg payroll operations.

Ashwin Shirvaikar - Citigroup Investment

And your $5 million loss in HR Outsourcing, but you also have an unchanged, I think, annual outlook. Does that sort of imply that things could deteriorate significantly in the back half? I mean, I can understand things don't get better in a big way from here, but why should they get so much worse?

John J. Park

Yes, to your point, this is obviously an environment where we're going to be cautious, but we view the $5 million adjustment in the HR BPO guidance to be really just fine-tuning. And, you know, our guidance does represent a range, so I wouldn't read anything into any fundamental changes in our outlook on the other business segments. I think we're just fine-tuning within the segments.

Russell P. Fradin

The other thing, Ashwin, just to put it out there that it's going on, is that, aside from being cautious about what could happen with project revenue, the large client that I referenced that renewed, renewed for the bulk of its work, the scope, given the nature of the systems that it's going on, is a lesser scope. And therefore we know that right now we're getting some benefit from the broader scope with this particularly large client and, although we've renewed it, it is down scoped and so we're going to have to overcome that headwind a bit in the second half of the year.

Operator

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

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

Can you talk a little bit about the company that ended up changing its mind and did renew you and what the underlying factors were for that?

Russell P. Fradin

Well, I mentioned essentially what happened - and interestingly enough, this was right after I joined, over two years ago now; it was maybe even two and a half years ago now. We had had a fair number of service bumps in the road and the client had basically informed us - in fact, I think it was in writing - that they were going to terminate the contract at the end of 2008.

We told the client we understood their decision and we would do everything we could to improve the service regardless of their decision to terminate, that it wasn't Hewitt's way of doing business, that we wanted to deliver superb service for all of our clients and certainly didn't want to in any way put our reputation at risk, and so we kind of redoubled our efforts to make sure that we were doing all the right things.

They went out and they tested the market, and so they had a very active RFP process where they looked at a range of our competitors and, after, I guess it was, this summer, they came back to us and they said, gee, you know, your service has improved so much and we've been so pleased and, frankly, the testing of the market showed us that your pricing really is competitive and we'd rather renew with you rather than going with one of the competitors.

So we had a very detailed statement of work negotiation and contract negotiation that's been going on for many months now and we signed it the end of the quarter we just reported. And so they've reupped for another five years.

We frankly re-scoped some of the services, as I mentioned, where it was to our benefit and their benefit to do a lesser scope of work, but it still is a very large contract, in fact, it's certainly one of our largest clients. I don't know if it is our very largest at this point. And we're really very, very excited that our efforts to improve the service paid off and that it turned out that our market test really was very much in our favor.

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

And can you talk also a little bit about you had some new clients that went live. Can you talk about what sort of impact those ended up having? And how are you feeling just in general now that you've got some contracts that have been there for awhile what the longer-term outlook is on the HR BPO side, aside from just the loss minimization for this year and the good progress there. Are you starting to feel like we actually have some contracts now that will ultimately prove to be profitable and that we have a way figured out to ultimately get the whole division that way?

John J. Park

Mark, let me comment on the short-term effects of the contracts going live and then Russ is going to comment on longer-term outlook.

As we've said before, typically, when HR BPO contracts do come live, there's a period of time where it takes time for the margins to reach a steady state. So I would say that what you're seeing now with a few contracts that have gone live is a positive impact on participant count and revenue, but a very moderate impact on profitability.

I think the improvement in our profitability is really much more focused on our ability to stabilize contracts that have been live for some period of time and also really embed some of the cost initiatives that we've put into place.

Russell P. Fradin

Yes, the other thing that I was going to mention - and it really goes back to Ashwin's first quarter about why the second half of the year may be a little bit rocky - but it's pretty well known that in this business we're currently servicing two large retailers that are in the midst of liquidation. And so no great secret - Mervyns and Circuit City are two of our clients.

Fortunately, they're smaller clients compared to the rest of our base, but again, that's going to create a little bit of headwind. We're assuming that those liquidations fully occur. The Mervyns one is pretty close to that; the Circuit City one will probably take a little bit of time to wind down, but obviously the fate is known at that point and that's factored into the outlook.

In terms of your question about the longer-term outlook, I really feel incredibly positive, meaning that we now have a business model that we think does prove out. It's clear that we can make money and provide really good service in these. It's clear that the market's taking a pause. And, again, there's no great mystery to the fact that one or two of our competitors in particular are having some real difficulty and that puts a little bit of a cloud over the short-term sales environment. But I really think this is an area where we can make money and grow this thing in the future.

It's challenged like everything else in this economic environment and all that, but I really think as you look to the longer term it's an area that we really believe we can do well.

Remember also that as we serve these clients virtually all these clients are very large benefit outsourcing and consulting clients, so though we report it as a separate line of business, from a client standpoint it's a very important thing for us.

And the final comment I'd make is that if you look on an individual client basis, the vast majority of our client base makes money for us and it really is the size of the overhead costs that we're whittling away at which over time will be the key to unlocking the profitability in this segment.

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

The clients that just went live, when we take a look at the guidance for the year and take into account the puts and the takes, you had some clients that just went live that probably didn't help profitability in this quarter just because of the nature of what happens when you first go live. And at the same time relative to when you ended up originally giving the guidance for the year, at that point Circuit City had filed for bankruptcy but had not indicated that it would liquidate and you weren't putting into account that they would liquidate or that they would completely go out. Is that a correct assumption?

John J. Park

No, actually, what we've been doing - this is a small point and I don't wish any ill towards any client - but when we see the storm clouds emerging, we pretty much factor in more the downside than the upside. And so we've literally got a group upstairs that works every day pouring over the employment reports, the credit reports of our clients, and when we see deterioration we factor that in. And that was pretty much of a known risk that was factored in, interestingly enough.

Russell P. Fradin

Yes, Mark. And as we had said earlier, the couple of liquidation situations we have are relatively smaller, so it's cutting it kind of fine in terms of how much that's impacting our numbers. Obviously, if things were to happen that have not happened yet on larger clients, it may have a larger potential impact. But we'll keep everyone informed.

John J. Park

And by the way, just to clarify, I think it's fair to say that the bulk of the lift in the participant counts was due to the benefit outsourcing business, not necessarily the BPO business, which was a relatively small contributor.

Operator

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

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

I just want to get a little bit deeper into the guidance on HR BPO. Given the $5 million in losses, I just want to understand exactly the full year guidance for the losses. It seems like you're expecting a sharp increase in those losses. We've been seeing the losses go down. When we were just discussing some of the clients that are going out of business, it seems like that's actually a very small portion of the impact of profitability, so why are we expecting the losses to increase over the second half of the year? Is it project-related work you're expecting to get? Can you just go through some of the other puts and takes?

Russell P. Fradin

Yes, the first thing that we've said pretty consistently about this business is don't expect improvement on a straight line every quarter. There's so few clients that sometimes what one client decides to do in a given quarter or not do in a given quarter can fairly dramatically impact what's going on. And also if there's sales activity going around one particular client, that could affect a particular quarter. So I just want to recast what we've said many times before.

I would say that in terms of this particular year, one of the things that we're cautious of is that we did do very well in terms of project revenue this particular quarter and part of the reason why we did well in project revenue is that you tend to see project revenue kind of spike up towards the beginning of an economic downturn when people are evaluating a lot of different scenarios and also planning for changes within their work force.

And then if the economic malaise continues for some period of time, that project is going to die off because then companies are in a position where they're looking to cut discretionary spend. And I think that's a generic cycle that you're going to see actually across all of our businesses if the economy stays down for a long period time. We've said that before. I think HR BPO is very much going to be affected by that cycle, we think, and that's reflected within our guidance.

The other thing that we want to remind you is that when there are transitions - so companies either de-scoping or companies that are going into liquidation - there tends to be project revenue that's driven by that and obviously it's a double whammy because their revenues go away later, but right before they go away they are driving significant project revenue.

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

If I could just follow up on that HR BPO client that re-signed, if I recall correctly, when they announced they were not going to re-sign, you guys accelerated some of the amortization of the assets over there, so it would seem to me that if they are re-signing, even if you have less scope, you should have some kind of lift in terms of just less cost going forward. What are you expecting in terms of the profitability of this client now?

John J. Park

Well, the client - obviously, we don't want to be too specific - but the client is a solidly profitable client. As Russ has said before, though, the scope is a little bit less. And beyond that, we really don't want to make too many comments on specific clients.

Russell P. Fradin

The other thing to remember there is that the contract was going to end naturally about this time, so the amortization period for that would have ended anyway. So there's not a lift, meaning we wouldn't extend the amortization for necessarily that reason.

Operator

Your next question comes from Jason Kupferberg - UBS.

Jason Kupferberg - UBS

I want to ask a question on the revenue guidance and get a sense of how much of a currency headwind you had anticipated last quarter when you originally provided the outlook versus what you're currently assuming.

And then as a related question on that, I think you've used the word primarily to describe the reduction in revenue guidance as it relates to the impact of currency, so I just wanted to understand to what extent is there any softer outlook in the core operations? It sounded like the Consulting business is where there's a bit of a downtick, at least in reported terms, where the revenue growth is moving lower.

John J. Park

When we put out our guidance, which is right after we finish our planning process for the year, we try not to never have a point of view on currency, so we will not take our guidance or our internal plans and then make any judgments versus the forward rates that we see in the market. So clearly, if you look at the time perspective, the significant appreciation in the dollar really occurred after we had provided our guidance, so we had not anticipated, to use your term, we had not anticipated any headwinds in terms of FX. And obviously, we've had some dramatic developments over the past three months.

I would say in terms of the revenue guidance, most of the revision reflect FX. Obviously, we are finetuning and there are different assumptions that we have internally across the business segments, some of them related to what we're seeing in some of the discretionary spending and consulting but also some of it related to timing of sales cycles, etc. But I think you can take away that the vast majority of the reason why we're changing our guidance is because of FX. It probably would have not resulted in a change in our guidance if FX had not changed so dramatically on us in the last three months.

Russell P. Fradin

Just to reinforce that, you mentioned the Consulting business and you can see the business between the reported and the organic constant currency. And so I'd hardly call 9% organic constant currency growth a slowdown in today's environment and I think our Consulting associates have just done a fabulous job of really fighting some very strong headwinds out there and coming out on top so far in this thing. And that's why you see there's been some acceleration in the larger practices and some deceleration in the more discretionary practices.

Jason Kupferberg - UBS

Okay, a quick follow up on M&A. I know you had made - John, I think it was in your prepared remarks  some comments about maybe a little bit more conservatism on the buyback because some M&A opportunities might be emerging. Can you provide us some more color there in terms of where your aspirations might be specifically in terms of focus areas and potential size, how large you're comfortable doing transactions there?

John J. Park

We don't want to get too specific, obviously, Jason, but nothing has really changed from what we've stated before. We're looking for moderate-sized acquisitions. The things that you've seen in the past couple of years is probably indicative of the type of targets that we're looking at. And we're looking at businesses that are near in to our business model, extensions of services that were already in areas that we're already in or spreading our geographic reach, so no major change there.

Russell P. Fradin

Yes, in terms of size, but also I think what we're expecting - and we'll see what happens - is that there's just a psychology of the new, lower valuations having to be factored into sellers' thinking, and what we're seeing is in some cases that's true and in some cases people are still looking in the rear view mirror a little bit too much. And depending on how that works, we're going to play that pretty conservatively. But we are seeing a handful of situations right now that we would be very pleased if we could bring them to fruition.

Operator

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

Todd Van Fleet - First Analysis Corp.

I wanted to ask you about the Benefit Outsourcing segment. In the press release you talked about there being a decline in revenue driven by current period adjustments related to client service issues from prior years. I'm just wondering if you can quantify that issue and the impact that it had in the quarter and is that something that we should expect to continue moving forward into 2009? How long should we expect that to be kind of a drag, I guess, on the top line?

John J. Park

Order of magnitude, it's about $7 or $8 million that we incurred in the quarter, which is why we spelled it out. These types of issues are a part of being in the administration business, as you probably all know. I would say that compared to our historical trends, this was unusually high, so it's certainly not something that we plan on incurring in the future.

Todd Van Fleet - First Analysis Corp.

John, was it part of any sort of contract renegotiation, I guess, heading into fiscal 2009? So, for example, you might have signed a multi-year agreement with a customer or customers that you, based on some issues - I'm just trying to get a better understanding as to why this issue would come about - so based on perhaps past servicing levels that, on the renewal, you agreed to certain concessions and you expect that sort of concession to happen for fiscal 2009, but in fiscal 2010 that concession will go away? Just trying to understand a little bit better what the issue might be.

John J. Park

No. No, these issues have nothing to do with contract renegotiations. Obviously, since there are clients involved, there's a level of sensitivity in terms of what we can discuss. What we can say is that they were related to prior years and they were related to service issues, but beyond that we're really not allowed to comment. But no, they did not have to do with renegotiations.

Todd Van Fleet - First Analysis Corp.

And so then - I'm sorry just to keep on digging in on this a little bit - but was there servicing to correspond to or at least there was servicing for which there was no revenue received, so perhaps this was a drag on margin in Q1, but then moving forward perhaps, as revenue comes back, the serving will continue? I'm just trying to understand how we should think about cost to match that revenue that was not received in Q1 but might be received moving forward. Because it's a significant enough piece of revenue that maybe it could move the pennies one way or the other.

John J. Park

Just to be clear on this, this was an adjustment to our revenue that related to service issues that occurred in prior years. So what we do basically is we take that against revenue, but the occurrences were in prior years. It's much like refund accounting in the retail space.

Russell P. Fradin

Because it is a big item, there was basically some specific issues where, frankly, we discovered some problems. And it related very much to previous years. There's nothing going on in the current period that we believe in any way resembles this.

But as John said, there's always some level of this kind of stuff that goes on in the business, but this was unusual. We'd never seen it to this level and, frankly, we were the ones who were proactive and brought it to the client's attention, that really some adjustments were warranted. Obviously, we're getting through that issue, but it was a drag on the quarter.

Todd Van Fleet - First Analysis Corp.

In terms of cash usage or priorities of cash usage, in any given quarter would it be fair to say that your priorities are attractive acquisitions, then storm restorations then debt reduction or how would you characterize that?

John J. Park

Yes, I'd say, yes, loosely, that's a good set of priorities even though I think we're comfortable with making meaningful progress in our share repurchase. We think we can do that while still making good progress against our M&A agenda.

But as we stated before, we're being very selective in terms of how we look at acquisition targets. In other words, we don't go into any given quarter saying we need to close something and use the cash. And so we always try to keep a construct around how much cash do we need given the pipeline of acquisitions and then also what could we comfortably buy back given that the probability of some of that pipeline closing?

Russell P. Fradin

And in today's environment, unfortunately, we're all learning the hard way, cash is a good thing. And so we're being as parsimonious as anybody in dealing with those issues. And if you remember, the quarter that we just finished - and who could forget it - the market volatility was just staggering and we didn't really get the authorization until midway through the quarter, as John talked about, but it wasn't the time to go out and throw fistfuls of money at any of these problems. And so we're going to be a bit conservative, so it's going to have to be the right deals.

Operator

Your next question comes from Timothy McHugh - William Blair & Company.

Timothy McHugh - William Blair & Company

First I wanted to ask about the Latin America HR BPO business. Is there anything meaningful  I assume it's a relatively small operation - but the ongoing impact of that sale? Was it profitable and how is that factored into your guidance?

John J. Park

The only thing that's going to impact our financials meaningfully is the one-time gain next quarter, which is really just a currency translation adjustment gain, so non-cash. No, it is a small operation. It's not going to have any material impact going forward. It was a non-core asset. Divesting was very much a part of our desire to streamline the BPO business. In fact, it was primarily a finance and accounting outsourcing operation, which is not a service that's strategic to us.

Russell P. Fradin

And the seller is someone we're familiar with and, to the extent that we need to provide service for those sort of things in that part of the world, it's a partnership that will benefit us.

Timothy McHugh - William Blair & Company

And then on the participant counts and the Benefit Outsourcing, obviously, very strong this quarter. You mentioned obviously you will see some delay in any impact from layoff announcements. What would be your expectation for that going forward here versus the new clients that you have coming on board? Should that be relatively flattish throughout the year or will you see potentially a decline by the end of the year relative to where we are now?

John J. Park

We don't like to forecast participant count, but I think that's obviously the dynamic that we're going to be managing. And one of the reasons why it's very difficult to forecast participant count is that every company is different in terms of the relationship between what they announce is going to be the reduction and ultimately what happens, right? And then also the timing in terms of what actually happens. And in certain cases companies provide ample detail in terms of geography and types of associates. In other cases, they don't. So what we try to do is we just try to stay on top of the most recent announcements and try to manage the relationship in the best way we can.

Timothy McHugh - William Blair & Company

Is it fair to assume that your guidance incorporates the announcements you've seen thus far, but does not anticipate additional weakness in the labor market or have you assumed beyond even what you've seen out there?

Russell P. Fradin

We've assumed a couple of things. One that everything that's been announced will play through and that the impact will largely be on the U.S. work force that we service. So we've factored that in. We've also factored unfortunately the inevitable rise in the unemployment rate. We'd love to see that not be the case, but it's clear we're going to break through 8% in the not-too-distant future. And whether we're on our way to 9% or 10%, we don't pretend to know, but we've looked more at the downside than the upside.

John J. Park

And clearly, as we've said before, a general rise in unemployment will statistically affect us and we certainly don't want that to happen, but that will not be as dramatic compared to if a few of our very large specific clients have events occur that really drive their participant count significantly down.

So it's difficult to predict. We obviously have factored in what we know now. We have some reasonable cushion. But that's not to say that if client-specific actions hit us in a very unfortunate way that won't have an impact on our ability to deliver performance.

Operator

Your next question comes from Paul Ginocchio - Deutsche Bank.

Paul Ginocchio - Deutsche Bank

On Benefit Outsourcing, I think most of the variation versus my expectation was explained by that $7 or $8 million on the client service issues in prior years. Can you just talk about when those large and complex contracts are going to go live and maybe if there's any way to size the potential impact on participant count?

And then the same thing with HR BPO; I think there's still one contract out there that hasn't gone live. Is that going to be incremental to participant count in HR BPO as well?

John J. Park

In the Benefits business, we're going to have a period of time when we are going to have several large complex clients that are in implementation stages, so I don't want to say that Q3 of this year, Q1 of next year, for example, is when, boom, you have a large number of participants go live and our implementation costs go down.

I think that we're right now going through a stage where we've been frankly successful in terms of signing on some very large, complex clients, and over the next few quarters you are going to see both services go live and participant counts go up. And we don't want to be much more precise than that in terms of forecasting.

I would say in the BPO business, don't necessarily look for anything dramatic in terms of changes in participant count going forward.

Paul Ginocchio - Deutsche Bank

So is it safe to assume that the $7 or $8 million versus prior client service issues is the bigger impact to the quarter on a year-on-year basis than the complex contracts?

John J. Park

In terms of margin impact, certainly.

Operator

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

Tien-Tsin Huang - J.P. Morgan

I had a revenue and an expense question, if that's okay. Just on revenue, I just wanted to clarify  because I heard a bunch of comments - how did short-term project-related work perform in the quarter versus plan in both Consulting and the non-Consulting business? And I ask because your revenue per participant, it looks like it was down in the Benefits unit?

John J. Park

Yes, I'd have to say that overall our project revenue in both Consulting and Outsourcing was solid this quarter, but remember last year on the Benefits side it was unusually strong on the project revenue side. We made it very clear that was a very unusual quarter where it seemed like there were several large clients that all decided to execute large projects as once. But we certainly felt like this quarter was a very good one in terms of project revenue.

Tien-Tsin Huang - J.P. Morgan

So this revenue per participant, I know that's not a perfect metric, but that's a better proxy going forward, I take it? It looks like Q1 was a tough comp.

John J. Park

Q1 was a tough comp. And obviously, when project revenues are strong, as you say, it's going to help our revenue per participant.

Tien-Tsin Huang - J.P. Morgan

On the expense side the big delta in our model was in lower comp and related expenses in the P&L. It looks like it was the biggest sequential decline we've seen in awhile. Anything unusual in here and is it sustainable?

John J. Park

Well, no, nothing unusual. As we've talked about before, for the last couple of years we've been really engaged in what we call our lean initiative and it's all about improving efficiency. And that not only means taking costs out but improving quality, which ultimately takes costs out also. And I would say that throughout our businesses and in our shared service areas, we've made excellent progress.

I'd also like to remind you that late last year we took some actions to really set ourselves up for what we knew would be a difficult economic environment, including some work force reductions, and the Consulting business got really serious last quarter also about leaning their operations so they'd be set to not only drive high revenue growth but do it with expanding margins and improved utilization. And I think this quarter is a good sign in terms of the Consulting margins improving slightly.

Operator

Your next question comes from Julio Quinteros - Goldman Sachs.

Julio Quinteros - Goldman Sachs

Could you first of all just rehash the segment organic growth expectations for each one of the units - BO, HR BPO and Consulting real quickly for '09? I want to try to just distinguish between that growth and the FX drag that you guys are not expecting for FY '09.

Sean McHugh

Julio, we can follow up offline a little bit. As you see in the guidance that's in there, it's the combination of the revised view with the currency impacts that John talked about, how we've changed and updated that in the year, and within that didn't cut out the details specifically about what was organic in terms of constant currency growth, if that was the nature of your question.

Julio Quinteros - Goldman Sachs

And then secondly, when I kind of line up a couple of the things here, you talk a little bit about incremental potential for pricing risk from some of your competitors. In what area would that be?

Secondly, anything on the renegotiations front that you guys are expecting going forward?

And then I think you've addressed more or less most of the unemployment commentary  participant counts - but I'm just curious what you guys think is the actual unemployment rate or what you guys are sort of planning for as we kind of go forward from here.

Russell P. Fradin

I'm not sure I'll hit all of those. On the pricing environment what I would say to you is I don't recall saying anything about what our competitors were doing there. I don't think we've seen any major changes in that. What I said is that the competitors - and one in particular that I'm sure you're all aware of in the BPO segment - were experiencing some financial difficult and had said that they were going to slow down or stop bidding on work in that area. And that's consistent with what we're seeing in the marketplace in the BPO segment.

But I'd say competition's alive as well. Really no major changes, particularly in Benefit Outsourcing or Consulting that we've seen caused by this environment other than we're all being a little bit hungrier.

I think for us a lot of the way we've tried to handle that is to try to go to clients on any of these competitive situations and see if we can drag other service areas into the negotiation. I'd rather help them save money on somebody else's contract rather than my contract is the approach we've tried to take and, you know, sometimes it works and it's worked pretty well and sometimes it's going to work less well.

But again, it's a tough environment, as you can imagine, but nothing really changed based on that environment, meaning it had always been a very competitive area.

John J. Park

On the second question, on major renegotiations, yes, typically contracts in the Benefit Outsourcing space are three to five years, so you're always going to have a number of contracts that are being renewed in any given year. This year isn't an exception to that and we don't necessarily see anything unusual there. You're always going to have a combination of some very large clients and smaller clients. The balance of the year we do have a couple of larger clients that are coming up for renewal.

And in terms of your third question on unemployment, yes, we have built in the assumption that there could be some deterioration in the unemployment market. We don't want to get too precise there, but again, remember, that's much less of an impact on our ability to deliver this year's earnings than what happens on a client-specific basis.

Russell P. Fradin

In terms of the renegotiations, we have one particularly large client that's involved in an M&A situation and we don't know how that's going to break. It could break to the positive for us; it could break to the negative for us. That would be an issue that's more of a 2010 issue. It wouldn't impact this year.

We've got several large clients in the industries you read about every day that are under pressure, whether it's your own financial services industry or whether it's automotive or things like that, and again, if a Lehman-like event or something like that were to happen where one of our large clients were taken out in its entirety, that would be much more detrimental to us than the normal course of renegotiations.

Julio Quinteros - Goldman Sachs

And then lastly, on the HR BPO side, obviously it sounds like a lot of the work that you guys have been doing over the last couple of years in trying to get that back on track seems to be paying off. The numbers are moving in the right direction in terms of the profits, the expectation for profit and losses, at least this year. But at what point do you guys have that really being at breakeven or better? Is that a fiscal year '10 event or should we see that by some point at the end of fiscal year '09 at this point? Or is there still too much uncertainty around what's going on with kind of more macro than it is more specific to some of your specific client contracts right now?

John J. Park

Well, we haven't changed our outlook. We had said previously that breakeven is two to three years away and we're still confident about that. Again, that progress is going to happen in fits and spurts, and you need to factor in how much we invest in the business in terms of new client opportunities. So some of that's going to depend; where you fall in that range is going to depend upon what happens to the market. And right now the market is very cautious given everything that's going on in terms of problems with our competitors and also the economic downturn. But there's no reason for us to change that guidance at this point.

Julio Quinteros - Goldman Sachs

And then just lastly, on the BPO side I think there was some translation benefits from currency. Is that associated with some of your offshore headcount, maybe even in India, where you've had some rupee depreciation?

John J. Park

That's correct.

Julio Quinteros - Goldman Sachs

How much would that be? Do you guys have any sense of that?

John J. Park

We're not going to give that out, but largely we do hedge our rupee exposure and what's unhedged is largely an offset to the translation exposure on the other side from the profits that we get from primarily the U.K. and Canada.

Russell P. Fradin

I'd just reinforce John's remarks earlier, where we see the FX obviously having a big impact on our revenue, as we mentioned. But as I think we said on the last call, actually given the number of associates we have in India without the same exposure or the revenue, we don't see that changing our operating income outlook.

Operator

There are no other participants in queue at this time.

Russell P. Fradin

Well, again, we want to thank everyone. Again, I want to thank all of our associates for just what I thought was outstanding performance in the last quarter. We all see what's happening out there with the economic headwinds and we've got a lot of people that are working hard to offset that, and so we really appreciate that. And we look forward to the next quarterly update.

Operator

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and for using the AT&T executive teleconference service. You may disconnect.

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