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Executives

Elena Charles - Vice President of Investor Relations

Gary Butler - President and Chief Executive Officer

Chris Reidy - Chief Financial Officer

Analysts

James Kissane - BAS-ML

Jim McDonald – First Analysis

Julio Quinteros - Goldman Sachs

Glenn Greene - Oppenheimer & Co.

Rod Bourgeois – Sanford Bernstein

David Grossman - Thomas Weisel Partners

Gary Bisbee - Barclays Capital

Tien-Tsin Huang - J.P. Morgan

Analyst for Kelly Flynn - Credit Suisse

Franco Turrinelli - William Blair & Company, LLC

Michael Baker - Raymond James

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

Jason Kupferberg - UBS

Automatic Data Processing, Inc. (ADP) F3Q09 Earnings Call May 5, 2009 8:30 AM ET

Operator

Welcome everyone to the Automatic Data Processing, Inc. third quarter fiscal 2009 earnings conference call. (Operator Instructions) I will now turn the conference over to Ms. Elena Charles, Vice President of Investor Relations. Ms. Charles, please go ahead.

Elena Charles

Thank you and good morning everyone. I'm here today with Gary Butler, ADP's President and CEO and Chris Reidy, ADP's Chief Financial Officer. Thank you for joining us this morning our fiscal 2009 third quarter earnings call and web cast. A slide presentation accompanies today's call and web cast and it is available for you to print from the Investor Relations homepage of our website at www.ADP.com.

Just to remind you, the quarterly history of revenue and pre-tax earnings for our reportable segments has been posted to the IR section of our website. These schedules have been updated to include the third quarter of fiscal 2009.

During today's conference call we will make some forward-looking statements that refer to future events and as such involve some risks and these are discussed on page 2 of the slide presentation and in our periodic filings with the SEC.

With that, I'll now turn the call over to Gary for his opening remarks.

Gary Butler

Thank you, Elena. Good morning, everyone. I will begin today’s call with some opening comments about our third quarter results. This will include the impact we are seeing here at ADP from the current recessionary environment. Then I will turn the call over to Chris Reidy, our CFO, to take you through the detailed results. Then I will return a little later to provide you with an update to our fiscal 2009 forecast. Then I will give some concluding remarks before we take your questions at the end.

To begin with, as you obviously know we are in a severe economic recession. As a result, we expected the second half of this fiscal year 2009 to be tougher than the first half. ADP is continuing to operate quite successfully in this difficult economy. However, for the third quarter ADP reported a decline in revenues of 2% and pre-tax earnings declined 1% while earnings per share grew 4%. Our key business metrics have been weakened by the recession. This is evident in revenue in our core payroll business declining this quarter. The level of new business sales is down 10% from a year ago for both the third quarter and year-to-date. The selling environment remains quite challenging as companies are reluctant to commit to new decisions to spend.

On a positive note, however, we are seeing an increase in the sales pipeline with large companies. However, it is still very difficult to close these transactions at this point but a lot of new interest. Client revenue retention was down one percentage point on a year-to-date basis which is about where we thought we would be for the full year. The calendar year end period was difficult and as a result the remainder of the year may be down over one percentage point with out of businesses and pricing pressures expected to continue.

As anticipated, the number of employees on our client’s payroll on a same-store sales basis also declined in the quarter from a year ago. This decline of 4.2% in the quarter is indicative of unemployment rising to the highest levels reported in decades in the U.S. This is the largest year-over-year quarterly decline we have seen in this metric since we have been tracking it. In addition this is the most precipitous quarter-to-quarter drop we have seen in the quarterly metrics.

Dealer services, as you well know, continues to be impacted by the recession and the difficulties of the auto industry. That being said, I think the results achieved by dealer albeit down are actually quite remarkable considering this environment. While we are on the topic of dealer services as you know Chrysler recently declared bankruptcy and GM has publicly announced plans to accelerate the reduction of its number of dealerships.

This does not change the estimated financial impact to ADP that we provided at our March analyst conference in New York of approximately $75 million. However, the time frame is now more likely over the next two or so years versus over the next five years that we talked about at the analyst meeting. The sensitivities that we provided you on page four of dealer services’ March analyst presentation are still valid should dealership closings exceed the 3,000 currently estimated.

While losing revenues near term is not what we would like to see obviously, this is hardly insurmountable and we still believe we will emerge with an overall healthier auto industry which long-term is good for ADP.

With that I will turn it over to Chris to provide the details on our results.

Chris Reidy

Thanks Gary. Good morning everyone. We are on slide four. As Gary said earlier total revenues declined 2% to $2.4 billion. This decline reflects the impact of the severe economic recession and over 3% negative impact from unfavorable foreign exchange rates due to a stronger U.S. dollar. As you will hear a bit later in our presentation as part of our full year forecast, we expect that FX will continue to work against us in the fourth quarter.

Pre-tax earnings were also down 1% and net earnings were essentially flat with a year ago. Earnings per share from continuing operations increased 4% to $0.80 per share on fewer shares outstanding. We continued to repurchase shares in the quarter though less than the prior quarters, buying back 3.3 million shares for almost $118 million. Fiscal year-to-date we have repurchased 13.8 million shares for about $550 million.

Now let’s turn to slide five and we will look at employer services results for the third quarter. As you may recall we anticipated slower revenue growth during the second half of this fiscal year due to the impact of the recession on our business so 1% revenue growth in employer services is in line with our expectations. Revenue in our payroll and tax filling business in the United States declined 3% in the quarter. This decline in revenue growth is due to a number of factors; primarily lower client fund balances from slower sales, lower wage growth and fewer employees on our clients’ payrolls.

Our beyond payroll revenues in the U.S. grew 6% led by growth in our time and labor management solutions and HR benefits which is the employees platform that we acquired early in fiscal 2007. These increases were partially offset by a decline in retirement services revenues which have been negatively impacted by the stock market contraction with lower retirement asset value on which a portion of our fees are based.

ES’s pre-tax margin expanded 70 basis points and continued expense control and lower selling expenses from lower new business sales. As anticipated, pays per control which is our same store sales employment metric declined 4.2% in the quarter compared to the third quarter last year. You may recall this metric was about flat through the first six months. Now for the nine months the decline in pays per control was 1.5%.

The number of pays in Europe turned slightly negative compared with a year ago on a same store sales basis. You may recall last quarter that we said pays were still positive but beginning to slow as we were seeing the weakened economy beginning to impact our international business. The decline in client retention was one percentage point fiscal year-to-date. This is a revenue retention stat and continues to be impacted by increased data businesses and price sensitivity, both related to the economic pressures.

Having said all that, retention is still at historically strong levels. As we expected, the dollar value of new business sold declined 10% in the quarter for ES and PES services on the continued weak economy and its impact on the sales cycle. To remind you, new business sales represent the expected new annual recurring dollar value of these sales and our incremental recurring revenues through our existing recurring revenue base.

Now turning to slide six. The PEO continues to grow with 10% revenue growth, all organic. Pre-tax margin expanded 80 basis points from operating leverage and continued expense control partially offset by higher pass through revenues and expenses. Year-over-year for the third quarter average worksite employees increased 8% to over 195,000 employees.

Now let’s turn to slide seven. As you know dealer services results continue to be under pressure due to the incredibly tough market for the automotive industry. Despite the significantly lower car sales, increased dealership closings and implementation delays, dealer services revenues declined just 3% for the quarter with 20 basis points in pre-tax margin expansion. Dealer is doing a great job controlling expenses and continues to be effective at gaining market share compared with a year ago while the overall market is consolidating.

Now let’s turn to slide eight. You will see we have expanded our disclosure of the client fund extended investment strategy this quarter by providing the breakdown of the client funds portfolio into the short, extended and long components which you can see in orange at the top of the slide. The top of the slide you can see the breakdown of the average balances as well as the average interest yields. The orange section at the bottom of the slide gives you the corresponding pre-tax P&L impact with the total representing the interest unfunds held for clients P&L revenue line items.

The purpose of this slide has not changed. It provides a clear and succinct view of the overall impact of our extended investment strategy. The additional data is being provided in response to feedback received after our March financial analyst conference as there still is a bit of confusion as to how interest rates and the shape of the yield curve factor into the overall strategy. With the ongoing state of the financial markets I want to again remind you that the safety and liquidity of our client funds continue to be the foremost objectives of our investment strategy. Client funds are invested in fixed income securities in accordance with ADP’s prudent and conservative investment guidelines.

Now getting back to the details for the quarter, near the top right of the slide you can see that the average plan fund balances were down $1.1 billion compared with the year-ago period. Average plan fund balances declined in the quarter due to the slower sales, lower wage growth, fewer pays, lower bonus payment and negative translation impact of Canadian foreign exchange rates compared with a year ago. In addition the average yield on the client fund portfolio declined 50 basis points to 3.7% this quarter resulting in a decline of $34 million in interest on funds held for clients on the P&L.

The impact from lower new purchase rates was most pronounced in the client short portfolio where the average yield earned was 260 basis points lower this quarter compared to last year. The average corporate extended balances, the purple section on the slide, up about $500 million compared to last year reflecting the $500 million increase in average borrowings, the blue section on the slide.

The average yield on the corporate extended declined slightly, about 30 basis points. At the bottom of the slide you see a $4 million positive impact to the P&L as a result of the increased balance, partially offset by the lower yield. As I just stated, average borrowings were up in the quarter. However, the average interest paid on the borrowings dropped significantly; 340 basis points with a blended average borrowing rate of 0.3%. The result was a $6 million positive impact to the P&L but the lower rate was only partially offset by higher borrowings.

When you take into consideration the entire extended strategy for the year, the results are the $24 million P&L decrease before tax. The bottom line, $175 million of pre-tax dollars generated by this strategy in the quarter resulted in an overall yield of 4% compared with 4.3% in last year’s third quarter. This shows the benefit of the extended laddered strategy in a declining interest rate environment as the 30 basis point decline in the bottom line yield is not anywhere near as precipitous as the corresponding decline in market rates over the same time period.

Now let’s turn to slide nine where I will take you through the full-year forecast for the extended investment strategy. This slide gives you the full year view which is basically unchanged from the forecast we provided on March 25th at our annual analyst conference. I would focus your attention on the P&L impact on the lower portion of this slide. When you take into consideration the overall extended investment strategy which is shown in the last row of this chart, the anticipated year-over-year P&L impact is less than one might have assumed given the precipitous decline in market rates.

The expected decline in client funded interest income of $75-80 million was partially offset by the increase in the client extended interest income and significantly lower borrowing costs. The net result is the $5-15 million year-over-year anticipated decline. The overall yield and the bottom line impact when calculated is expected to be almost 10 basis points higher than the 2008 overall yield of 4.4% again reinforcing the benefit of our extended investment strategy.

Now I will turn it back to Gary to take you through the remainder of the updated forecast for fiscal 2009. Gary?

Gary Butler

Thank you Chris. For those of you following along we are on slide ten. Our forecast has not changed from the update we gave you back in March at our analyst conference. This forecast reflects the difficulties present in the economy today and we are assuming no change to the current recessionary environment. We are confirming our 1-2% revenue growth forecast for the year, albeit certainly negatively impacted by about 2 percentage points from unfavorable FX rates resulting from a stronger dollar.

For employer services we continue to forecast about 4% revenue growth. PEO services 12-13% growth and a decline of 2-3% for dealer services. I would like to remind you that the dealer services forecast does include revenues of about $7 million from the recent European acquisition of Auto Master which we announced in late January. Again, no change to our pre-tax margin forecast. We continue to anticipate about 100 basis points of pre-tax margin expansion for employer services and up to 30 basis point expansion for the PEO. We are confirming our sales forecast for employer services and PEO services combined.

As I stated earlier the sales environment continues to be quite tough and we continue to forecast a decline of up to 13% this year but we remain on track to add over $1 billion in new annual recurring revenues. For dealer services we anticipate the pre-tax margin including the acquisition will be flat compared with a year ago. I am also confident in our ability to achieve the low end of our earnings per share growth forecast of 10-14%. This is up from last year’s $2.18 per share from continuing operations which excludes the gain on the sales of building in last year’s fourth quarter. I believe this is quite a solid forecast despite the extreme economic headwinds.

Turning to slide eleven, I would like to leave you with some closing remarks before we open it up to your questions.

As I look at the results for the quarter I want to be clear that we are not satisfied by ADP standards. Revenue growth is certainly under pressure from the weak economy and the difficult selling environment and there is no doubt that the economy for the remainder of fiscal 2009 will continue to be challenging. However, I recognize that ADP is doing well relative to the pressures on the global economy. We remain highly disciplined about controlling expenses and are appropriately aligning our expense structure with our revenue growth.

I am pleased with our prudent and conservative investment strategy for the client funds portfolio which has served us very well and I remain committed to returning excess cash to our shareholders. ADP is a great company and I am especially proud of ADP’s AAA credit rating. We are keenly focused on executing against our five-point strategic growth program which I believe positions ADP well to leverage an inevitable recovery in the economy.

Now we would be happy to take your questions and we will turn the call back over to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James Kissane - BAS-ML.

James Kissane - BAS-ML

Just wondering if you have any guess on when or where pays per control might peak out?

Gary Butler

My guess is we started to see flat to negative growth there in about November of last year. As you recall, if you go back to the third quarter of 2007 we were actually at a 3% positive and really starting about that time it started tweaking down and over the course of last year it went from 2% to 1.5% to 1%, etc. Assuming the economy doesn’t get dramatically worse than where we are today I would expect we would anniversary that decline some time in the late fall as we go into calendar 2010. But I would expect similar negative comparisons at least for the next quarter or two until we anniversary that [date].

James Kissane - BAS-ML

It sounds like the declines should ramp a little more from here just given the trends. Is that fair to say?

Gary Butler

I think it potentially could. I think you are going to see in the job report my guess is a little less of a drop this month than what we have seen in previous months. I would expect it will kind of flatten to maybe get slightly worse. I am not expecting another precipitous drop like we saw in the third quarter. I think really what happened is all the lay offs that started late summer and early fall that were announced last year a lot of people get some period of time before they actually lose their job. A lot of people remain on severance for a couple of months and then I think there was a pretty dramatic drop off on retail hiring or retail right sizing based on the poor holiday season and then I think it all started pouring out in January and February which is what we are seeing. That is just an informed guess. I don’t have any digital data to back that up.

Chris Reidy

Having said that, our forecast for the year assumes it is going to get a little worse in the fourth quarter versus the 4%. You remember back we had been saying our down side or what we were looking at in terms of stressing our guidance early on was potentially a 3% down for the year. Given where we are at 1.5% year-to-date that would assume like a 6% for the fourth quarter. So we kind of have it built in that it will get a little bit worse in the fourth quarter but as Gary said it is carrying into the first half of next year. The first quarter you have a tough compare because we actually grew the first quarter this year. The second quarter was down about 0.6% so you still have a tough compare there and then it gets a little bit easier as you anniversary that.

James Kissane - BAS-ML

On retention, the decline in retention, how much of that is lost market share versus bankruptcies and customers going out of business?

Gary Butler

The biggest up tick on the low end of the market was out of business. The biggest up tick in the middle part of the market was more price concessions, price losses from that standpoint. So, I mean obviously there is some loss of market share to the extent that you have people going out of business or you lose something based on price to a local supplier but I don’t think it is significant at this point.

Operator

The next question comes from Jim McDonald – First Analysis.

Jim McDonald – First Analysis

Could you going on that theme talk about the sales impact of the recession? Is it started to [unfile] at all?

Gary Butler

Well, as we said we are still forecasting around $1 billion in new sales for fiscal 2009. This is annual value of new bookings. That is down from about $1.150 billion last year, so down roughly 13% or so. I would say it is just kind of still bumping along. It is not getting worse. We are seeing some improvement in our perspective business outlook at the high end of the market. One of the reasons why we are forecasting 13% potentially down versus 10% year-to-date is during the fourth quarter of last year we had a lot of big deals that occurred in the May/June timeframe. I am not as comfortable at this point in time that we can get the new big deals over the transom to the same extent which is why we are being a little bit more conservative in our full-year forecast. So again it looks okay. It is not getting worse. But again we are not seeing any real noticeable improvement either.

Operator

The next question comes from Julio Quinteros - Goldman Sachs.

Julio Quinteros - Goldman Sachs

Just to rehash a point on Jim Kissane’s question about the guidance and what it implies in terms of unemployment, are you expecting to see 10% unemployment or not relative to your fourth quarter expectations?

Gary Butler

We don’t build our forecast around unemployment numbers but I would be shocked if we don’t see 10% unemployment.

Julio Quinteros - Goldman Sachs

Just in the margin levers, really nice performance on the operating margin side of the business relative to our expectations. What can we expect to see in terms of other levers you would have left into fiscal year 2010? Any sort of new prioritization if you can sort of stack what would be the most important levers you would have left at your disposal if the environment stays as challenging as we are seeing right now?

Gary Butler

Again, as we have said in earlier calls, one of the beauties of having 90% recurring revenue is you can see a few months down the road. So we have been in a “right sizing” our expense structure to revenue forecast for quite some time. Even though revenues are not what we would like them to be, our expense structure is in pretty good shape. Additionally, we have announced that we are not doing merit increases in our FY10 which is a $50 million plus kind of number that will help the bottom line and we will continue to right size our labor base to the appropriate revenue projections as we look into fiscal 2010. So I think we are okay. I am not expecting any big surprises. Obviously assuming there is not another dramatic decline in an already tough situation.

Chris Reidy

Then we have just continued some of the things we have talked about quite awhile with continued smart shoring, off shoring, telesales, and centralization of certain functions. Just continuing those actually continues to drive margin improvement.

Operator

The next question comes from Glenn Greene - Oppenheimer & Co.

Glenn Greene - Oppenheimer & Co.

I just wanted to drill down a little bit more on the retention and decline of it looks like 240 basis points in the quarter which you articulated was pretty steep. My question really relates to the implication on margins and ES and PEO going into fiscal 2010 if there is any sort of lag effect that we should realize related to margins. Obviously you are doing things to sort of right size the cost base but it seems like with the commissioned benefits you have had on the expense side this year with the sales growth being slow this year and retention falling off there could be a margin disconnect going into next year.

Gary Butler

I don’t think so. I think we have taken into account that increase in lost business or lessening of retention. We are pretty comfortable with our full-year forecast and in the fourth quarter those revenues are already out of it in terms of the margin. But certainly it is something we don’t take lightly because that is very high margin contribution business but I think we are out in front of it.

Glenn Greene - Oppenheimer & Co.

In pricing can you drill down a little bit more between what you are seeing for both going after new business and existing business? I guess just sort of your rate card expectations and the order of magnitude of the price pressure you are seeing going after competing for new business?

Gary Butler

It is pretty much as it has been. On the low end of the market there is pressure on getting implementation or set up fees. It is not uncommon for us to discount those either in part or in total in order to get new business. A lot of our business in the low end of the market comes from referrals from banks and CPA’s so we tend not to have the same kind of discounting. In a pure head to head new sales where you can appropriately sell the values of dealing with ADP and the AAA and all the features that we bring to the table we typically do quite well against local competitors. Our other national competition as a general statement is pretty rational. So there is not crazy stuff going on in new business.

Where we get kind of blind sided sometimes is in existing clients where somebody comes in and says let me see your ADP invoice and I will do it for $0.60 on the dollar. If we know about it we can counteract it. On the low end that is the problem where we have run into those kinds of issues. So it is okay. It is tightly worse than it has been and I expect it is going to remain tough for another 3-6 months.

Glenn Greene - Oppenheimer & Co.

What are your expectations for the rate card increase coming into fiscal 2010?

Gary Butler

We are still having that debate at the moment. I think it is clear to us that it won’t be as much as we have seen historically. But certainly those clients who are under our “book price” would certainly be eligible for price increases and in the high end of the market those price increases are pretty much contractually driven so they are what they are. I don’t think we will get the same 1.5-2% we have gotten historically but we will get some.

Operator

The next question comes from Rod Bourgeois – Sanford Bernstein.

Rod Bourgeois – Sanford Bernstein

I wonder if there is anything you can comment on in terms of your margin trajectory as you head into fiscal 2010? It seems that pricing is somewhat under pressure and with your payroll business posting growth that was negative and part of that was due to currency you are not seeing the same volume based margin leverage that you normally would see. How does that set us up for a margin outlook for fiscal 2010 if you can give any commentary along those lines?

Chris Reidy

Obviously we hesitate in giving any indication on 2010. We are right in the middle of our operating plan process and no different than any other year. We would give that guidance at the end of July. What I would say is the biggest driver obviously is sales and if sales turns around that will obviously be a good situation but would put pressure on our margins and that would be a good thing. So a lot of variables between now and the end of the year so we will hold off on saying any more about that.

Gary Butler

That being said, obviously the more organic internal revenue growth you have the easier it is to get margin improvement. To the extent we are in a lessened organic revenue growth environment it would be more difficult although I would expect we will be fine.

Rod Bourgeois – Sanford Bernstein

I mean if you look at your current pricing situation, if you look at the net change in your realized price over the last year can you give us a sense on how you are tracking there? You have been fighting client retention pretty diligently even though it is down 1% and in the kind of environment we are in that is still a pretty strong number…

Gary Butler

You are asking us to forecast 2010 which we are not going to do. So I’m not going to respond to that question.

Chris Reidy

The good news is we are driving 100 basis points of improvement in ES margins this year which is just an indication of how serious we are in terms of addressing margin issues and balancing margin growth like that.

Rod Bourgeois – Sanford Bernstein

Just to clarify, I was moving off of the fiscal 2010 question recognizing you can’t give an update on that but can you just give an update on where you are with price on a year-over-year basis. If you look at the net change in your realized price after discounting and so on where are you tracking right now on a year-over-year basis just to give us a gauge on where you may be as you enter 2010?

Gary Butler

That is not a number that we track on a monthly basis. Again, our margins were up this quarter and we are expecting the margin improvement for the full year which would imply that we are doing okay.

Operator

The next question comes from David Grossman - Thomas Weisel Partners.

David Grossman - Thomas Weisel Partners

I think you said that you are expecting still a $75 million impact from the dealer closures but now two years versus the next I think it was maybe three or four. How should we think about…or the next five years…how should we think about how that rolls out over the next two years? Will it be more significant in year two or more significant in year one?

Gary Butler

The difficulty right now is that it is unclear because we don’t know what GM is going to do and Chrysler has not officially said, nor the bankruptcy court officially agreed on how many dealerships will actually close. Originally GM came out with a plan that was over four years they were going to reduce a certain amount of dealerships. They now changed that plan and said that they will reduce the number of dealerships over 40% in the next two years. We do all the Saturn stores and we think there is about 400 Saturn stores and we think there is a reasonable possibility and have had discussions with GM about that another party will potentially buy that distribution channel in which case we already do all the systems and infrastructure for all of those dealerships so it would be a natural thing for them to go with us.

Secondly, there are only like 30 stand-alone Pontiac stores so we don’t think that is going to affect the outcome one way or the other because most of them are dual with either GMC or Buick. That being said, if they close of the 6,000 stores they have they close call it 2,200 of them or something then we know about what the average billings are per dealership. We know what market share we have and we also believe that it is going to be the bottom half of the dealers, not the top half obviously in terms of performance and size. I think our estimates are pretty good in terms of when you do that and kind of the industry scuttlebutt is once GM starts down that path they are going to do like a couple of hundred dealerships per month as they go through that process. That is really kind of the scenario that we have priced out for you and kind of hung that $75 million number over the two years just to put it in the ballpark for you.

David Grossman - Thomas Weisel Partners

If there is any change, since it seems to be somewhat of a dynamic situation, is there enough flexibility in that business to appropriately manage the margins if in fact it accelerates any more?

Gary Butler

First of all, we are appropriately sizing our expense structure today. Obviously we couldn’t be flat on margin if we weren’t doing that. We have reduced headcount there close to 10% over the last two years and obviously are very tight on any kind of optional expense. Most dealers have multiple franchises so even if some of the GM franchises close they may still have a Honda or a Toyota store or whatever it may be in which case they are still going to keep our system. They may just have fewer seats in terms of licenses in terms of using it. So we think we are in pretty decent shape as we have done that. That being said if it indeed is $75 million and it is more in the first year than the second year we are going to be moving pretty quick to get expenses out.

David Grossman - Thomas Weisel Partners

One other question on the PEO business. I know you don’t break out the sales separately but is there any reason to think that business other than being smaller than the core payroll business that it wouldn’t follow pretty much the same patterns?

Gary Butler

We have seen fairly dramatic shrinkage in employment in the PEO. You have to remember the PEO is a really fully featured service. It includes healthcare, 401K, all the other compliance issues and so when people are looking to downsize the benefits or whatever we have seen significant shrinkage there. But beyond that I think you are right in assuming it would follow the normal course of the payroll business although we continue to sell pretty good ratios of new business as it compares to the revenue in the business. So we will still get better growth in the PEO near-term than we will in the core ES business just because of the size of new sales versus the trailing revenue base.

Operator

The next question comes from Gary Bisbee - Barclays Capital.

Gary Bisbee - Barclays Capital

Someone got it and sort of asked it earlier and I will try it a little differently. Have you seen any sequential stabilization in the new business sales trend? It sounded like just from a lot of companies I have talked to companies went into a total standstill last fall and maybe there has been some easing. Secondly, what is sort of the typical seasonality of new business sales? Is the lion’s share done earlier in the calendar year or is it with your business more spread out over the course of the year?

Gary Butler

There was about four questions there. Let me see if I can find them. Seasonality wise, it is pretty even across the course of the year. You shouldn’t really look to see any difference there. Clearly the markets went into a virtual freeze almost last October and early November and we have certainly seen an improvement since that point in time. It is clearly easier today to sell down market because you are basically selling core payroll and tax. It is clearly more difficult up market because corporate America or global companies just aren’t spending money right now. So our declines on the low end of the market are single digit and our declines at the high end of the market are over 20% in terms of new sales. We have seen that trend pretty much kind of that level for the course of the last 4-5 months and we are not expecting it to be any different in the three months in front of us.

Gary Bisbee - Barclays Capital

So would it be right to assume from that maybe there has been some sequential stabilization over a few months that as we look forward to 2010 if things don’t change dramatically it could be sort of a flattish number if we remain in a difficult economy?

Gary Butler

We don’t want to get into too much FY10 kind of discussion but obviously I would be disappointed in 2010 if we didn’t sell at least as much as what we sold in 2009.

Gary Bisbee - Barclays Capital

Any reason or rationale behind the slow down of buybacks? Is it just sort of timing issues? How should we think about that?

Gary Butler

I think it is a combination of our levels of excess cash are clearly down from what they were a year ago and we just have been kind of looking at timing and what the market is doing and trying to figure out if the market is kind of stable and what is going to happen there. Again, as I mentioned earlier, we are still committed long-term to continue to buy back shares and return excess cash to shareholders.

Operator

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

Tien-Tsin Huang - J.P. Morgan

In the past I think you have suggested that a bad case scenario for retention would be down I think 100 bips or so year-over-year. Is that still a good stress test or could it be worse over the next 12 months?

Gary Butler

It is hard to say. It was more severe in the third quarter than I think I have ever seen in terms of impact on that. That is why you are hearing us talk a little conservatively about it being potentially over 1% for this fiscal year. That being said, as I look at 2010 I think it is really a little hard to kind of give you too much of an insight there. Obviously our objective is to improve retention, not see it go down. If the economy starts to turn in the fall I would expect some lessening around the out of business and the pricing pressures as we get into fiscal 2010. I think it is too early to really take a firm stand on that.

Tien-Tsin Huang - J.P. Morgan

If you look back historically over sort of a 12 month period what was the biggest rate of decline you have seen in retention?

Gary Butler

I think it is probably this year.

Tien-Tsin Huang - J.P. Morgan

So we are at sort of the peak?

Gary Butler

Yes.

Tien-Tsin Huang - J.P. Morgan

The new sales environment, what is sort of selling above plan and what is coming in below plan? Maybe just give a little sketch on the products.

Gary Butler

We are doing absolutely phenomenal selling new Cobra administration. I kid you not. It is absolutely going gangbusters. That is the one bright spot we have. Again, the low end of the market is moving along pretty good. Again, we have CPA’s and banks referring and it is a relatively minor investment for small business in terms of the benefits that they get from the services. We continue to see a slow down in global view getting corporate America to make those kinds of decisions although our PBR there and interest levels are as high as I have ever seen them. We continue to sell things like time systems and benefit systems because they have very demonstrable kind of returns on investment. The softer things like HR systems and some of those kinds of things are a little bit tougher right now.

Tien-Tsin Huang - J.P. Morgan

The global view and [limitations] are still moving as planned?

Gary Butler

Believe it or not we are on our revenue plan for global view for the year but obviously we had very large backlogs and a lot of those are multi-year implementations. As we look into next year I think we will be fine there in the first half of the year but we are hopeful we will start picking up new sales as the economy starts to turn.

Operator

The next question comes from Kelly Flynn - Credit Suisse.

Analyst for Kelly Flynn - Credit Suisse

Could you clarify the comment you made earlier about maybe seeing some stabilizing with large companies and is this maybe different from what you were seeing in prior recessions?

Gary Butler

I’m not sure when you say stabilizing with larger companies.

Chris Reidy

In our prepared remarks talking about just seeing a little bit more in the pipeline.

Gary Butler

We are just seeing more interest particularly in the global view area in the high end of the market where clients when you have economic uncertainty a lot of times it is easy to stop for awhile but over time clients are continuing to show interest. We have quite a nice increase in our prospective business outlook at the high end of the market. But again I am cautious here because of the difficulty in getting big decisions over the transom and into the boat.

Chris Reidy

Obviously the sales perspective is kind of a leading indicator of what we see going on with the economy and that was the first thing if you go back over a year ago now we started talking about how we started to see it scale back a little bit and sure enough that is what happened. So it is our leading indicator. As Gary said the pipeline has a lot more activity but we haven’t yet seen the ability to close at a greater rate. You would expect as our guidance lays out that our growth in sales is actually going to decline in the fourth quarter more over the fact that it has a hard year-over-year compared to the fourth quarter of last year but we haven’t begun to see the closings of those sales at a greater rate. As soon as we do we will let you know. We are seeing more in the pipeline and more activity but nothing at a greater rate of closing yet.

Analyst for Kelly Flynn - Credit Suisse

Any differences in things you are seeing in the pipeline between the U.S. and international?

Gary Butler

We are actually seeing a little bit of a slowing internationally because they are dragging us. They are behind us 6-9 months. We are seeing some improvement here but some decline particularly as we look at Europe.

Analyst for Kelly Flynn - Credit Suisse

On dealer services, could you maybe and I don’t know if you covered this earlier but could you help us understand what kind of cost containment you are taking in dealer services? A follow-up to that would be how much of a revenue decline could you absorb there before margins start to climb down in dealer services?

Gary Butler

That is a hard question. I really don’t know how much revenue is going to come down. Obviously we have about 7,000 associates in dealer services and clearly as the backlog of new business has contracted we have been right sizing our implementation there and some other organizational consolidations that we have done. Again, I think we are in pretty good shape with the forecast we have got now and until we really kind of right size what happens with GM and Chrysler I think it is pretty hard for us to make that kind of forecast in terms of what kind of one-time expense we might have versus recurring expense we might have. So it is a pretty difficult question to answer at this point.

Operator

The next question comes from Franco Turrinelli - William Blair & Company, LLC.

Franco Turrinelli - William Blair & Company, LLC

Could you help us think through a little bit the changes in the average client funds balance? Obviously it is affected by the pays per controls. I am assuming there is also probably some lower salaries impact offset by new sales. Can you kind of walk us through on what is going on there on a year-over-year basis?

Chris Reidy

Yes. It is obviously all of the above. We are expecting 2-3% decline in total. You also have an impact of foreign exchange in that so almost half of that decline in the 2-3% is related to the foreign exchange and primarily the Canadian Dollar, a little bit of the U.K. Pound as well. In the decline that we saw in this quarter it wasn’t quite half it was about one third would relate to foreign exchange of that 6%. The rest is just the continued impact of pays per control, low wage growth particularly in that quarter is when a lot of bonuses get paid out and obviously the bonuses were a lot less than they were last year. So those are the combination of things that impact those balances.

Franco Turrinelli - William Blair & Company, LLC

On the flip side it sounds like you are still having good success selling tax plans and other things that generate [flow] balances.

Chris Reidy

We are selling fewer new payroll clients this year than we did last year which also impacts that growth but our percentages of tax that are sold as percent of total sales has really not changed year-over-year.

Operator

The next question comes from Michael Baker - Raymond James.

Michael Baker - Raymond James

I was wondering if you could give us a sense for how the economy is impacting the different client segments kind of large, medium and small in terms of lay offs.

Gary Butler

Actually we really can’t see lay offs. We can see shrinkage in pays per control for a client who was here last year as well as this year. The largest decrease is in the mid market. Last recession the largest decrease was more at the high end of the market. We are seeing less decline at the high end of the market than we are at the mid point of the market. At the low end of the market it is less decline than what we are seeing in the mid market as well. So down but not as much as in the core auto pay.

Michael Baker - Raymond James

Then you provide some clear color on some detailed areas from a sales perspective. I was wondering if you could comment just overall on beyond payroll how that is coming along and give us some sense of what your thoughts are on the telesales staffing side of things?

Gary Butler

Well telesales of the $1 billion this year should approximate around $100 million worth of new sales that came out of telesales. We continue to staff up in telesales particularly in our insurance services, workers comp and healthcare. We are continuing to expand the telesales effort selling 401K plans particularly at the low end of the market. So those sales are continuing to do quite well. Again, beyond payroll whether it is time and labor management we are seeing a lot of activity in benefits outsourcing right now and as I mentioned earlier Cobra sales are great.

Michael Baker - Raymond James

On the point of Cobra sales obviously you have seen earlier cycles and in this cycle what is different is you have the government subsidy. Can you give us a degree of magnitude as to how much is up beyond what you would have normally thought?

Gary Butler

Again, it is more anecdotal because the Cobra business is not really that material to the business. If you went back and looked at the last time we had this kind of downturn in the economy the Cobra business was quite small. Our revenues today in Cobra are 30-40% over last year based on participation and also the government regulation that allows you to go back and file for past benefits all the way back to last October.

Operator

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

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

I wanted to ask about the dealer services from a longer-term perspective. Let’s say that Chrysler gets cut back materially. GM cuts back in line with the current plans that have been articulated and there is going to be an adjustment period. Over time if sales of autos normalize can you talk a little bit about how your revenue stream would work with the dealers that survive which presumably would all end up being stronger and therefore would ultimately end up needing more seats?

Gary Butler

The international market, if you look at the projections on global growth of automotive vehicles it is a pretty good positive trend around the world. Obviously that growth is not nearly as dramatic particularly historical comparison in Western Europe and the U.S. You will see us in North America move towards the applications like VoIP, our CRM applications and some of the things that we are doing in Internet marketing and VPO activities in the front end of the dealership. I think you will see more of a shift to new applications in the core markets in the U.S. I think you will see us drive a lot of those same kind of applications across Europe as we do that and you will see us get a lot of new share in Asia Pacific. I think it is going to be a tough year but I think once we get through it our relative position to the competition and our relationships with the manufacturers has never been stronger in the 30 years I have been watching this business.

Chris Reidy

I would also refer you back to Steve’s presentation back at the March meeting. Go back to page six on that deck and it kind of lays out what is going to drive the five-year growth in Dealer and I think that all still holds as we have said this morning the impact of GM and Chrysler basically just accelerate the issue that we had in the five-year plan. I think if you think about it that way you will see higher growth at the tail end of that five years coming off of slower growth in the early years. The rest of that presentation still holds pretty well.

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

I appreciate that. I was just trying to understand the core service offering in North America because it seems to me that part of the intent of scaling back the number of dealers is to make the remaining dealers stronger and therefore the volume that goes through those dealers is going to be higher. I was just trying to understand to what extent…

Gary Butler

You have to also remember that we are disproportionately skewed to the high end of the market. We have got 70% of the public companies in that market place and are continuing to gain share in the top 100 kind of dealer groups. We think our dealers in that segment will be stronger and will buy more applications and more services from ADP and at the same time I think there are going to be pressures on the low end of the market for consolidations and closings. That is one of the wild cards here. As they close some of these sites we don’t know if some of the larger dealers will buy those sites or whatever the case may be because if you already have a Chevy franchise and you get another location available in a geographic area you want to be in there is no reason why an Auto Nation or a Sonic or those kinds of folks wouldn’t buy one of those sites.

Chris Reidy

I would also say that our product offerings are broader now and they specifically address the issue you are raising which is making the remaining dealers stronger in terms of more cost efficient and getting to their customers easier. So things like digital marketing that we have talked about in the past which is a redirection of the advertising spend from the print media into the Internet should help do exactly that as would IP telephony in terms of making them more efficient within their dealership and addressing customer needs and customer service. I think we are well positioned to take advantage of exactly what you just described.

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

Can you talk a little bit about the retention issue as it relates to mid market on the core payroll and the comment about pricing? Are you seeing some of your competitors that are actively just trying to poach some of your clients on price? How do you respond to that? I apologize if this was asked earlier but I had to hop between different calls.

Gary Butler

Well in the mid market we are away and beyond the largest provider. Historically that is where a disproportionate amount of our base is because we have been selling that environment for a long period of time. In that area we are more the pricing umbrella than say we are at the high end of the market or the low end of the market. So when you have 50% outsourced and we have 50% of that 50% we are obviously easy to find in that market place. So again, this is not new but a lot of competitors whether local or nationals will typically try to unhook our base. We do find if we know they are there where we sometimes get surprised if we don’t know they are there and somebody comes along and offers a big discount in the hopes of then raising prices over time on that client.

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

From a processing scale perspective you have got the scale advantage and you presumably should have the lowest…you should be the lowest cost provider. That isn’t something they can ultimately win at is it?

Gary Butler

We clearly are the low cost provider. We clearly have the largest scale and the largest share and it is clearly tougher for them today because they can’t really earn a lot of interest on the float because they are not a AAA or have ADP’s extendibility to invest in the portfolio. Again, when you are desperate for new business sometimes desperate people do desperate things and are willing to take very low or no margins just to lock up a client. We are seeing some of that today.

Operator

The next question comes from Jason Kupferberg – UBS.

Jason Kupferberg - UBS

I wanted to start with a question on SG&A. I guess it was down 11% year-over-year on the quarter and it was nice to see the cost execution. I guess the last time we saw a decline of this magnitude checking back on our models is back during the last recession. I know you have said in the past you don’t plan to cut back on OpEx as much this time around. How should we reconcile what seems to be pretty significant cuts this time around relative to last time around? Maybe if you could parse out sort of the S piece versus the G&A piece of that line item so we can get a sense of where the cuts are coming from and how sustainable those might be when the economy eventually improves.

Chris Reidy

A couple of things going on there. Some of it is a geography on the P&L. You mentioned SG&A is down 11% but if you notice operating expenses are about flat. Operating expenses is where most of our service cost is. Service cost is actually up year-over-year and so we are very conscious of not focusing on cutting service back and duplicating the issue we had coming out of the last downturn. On the SG&A piece that is down 11%. Some of that is related to the selling expense on lower sales which naturally goes down but the remainder and the larges piece of the reduction is cost containment on the general and administrative side which is in areas that aren’t as close to the customer. We feel more comfortable in being able to take out process costs, etc. So continued aggressiveness in the G&A costs. We also see declines in our systems and programming or R&D costs. That actually is an interesting story in that although it is down we actually have more heads doing it and we are producing more and that is a direct result of our off shoring to India which was done over the last couple of years and so a significant number of our R&D heads are now in India at a much lower cost so we are actually able to produce more at a lower expense.

So we are very focused on where we are taking costs out.

Jason Kupferberg - UBS

If you roll everything together that we have heard with new sales and pricing and all the other leading indicator metrics here at the end of the day what is your overall confidence level that on an organic, constant currency basis your revenue base in aggregate can grow in fiscal 2010 versus fiscal 2009?

Gary Butler

Again, other than talking about the indicators we have talked about we are not going to make a forecast for fiscal 2010. There is still so much unknown and what is going to happen with dealers, there is a lot of unknown on what is going to happen with employment so I think it would be inappropriate for us to comment on fiscal 2010 other than my comments previously around retention and new sales being at current levels or above. I think it would be inappropriate for us to comment above and beyond that.

We appreciate everybody signing in today. Obviously this is a challenging time for the U.S. economy in general and ADP in particular but I feel pretty comfortable with where we are particularly on the expense side. We look forward to talking to you at the end of the fourth quarter when we give you our fiscal 2010 forecast. Thanks for coming.

Operator

This does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time. Have a great day.

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Source: Automatic Data Processing, Inc. F3Q09 (Qtr End 03/31/09) Earnings Call Transcript
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