Hewitt Associates Inc. F4Q09 (Qtr End 09/30/09) Earnings Call Transcript

Hewitt Associates Inc. (HEW)

F4Q09 Earnings Call

November 10, 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.

Jason Kupferberg - UBS

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

Todd Van Fleet - First Analysis Corp.

Tim McHugh – William Blair & Co.

Analyst for Tien-tsin Huang – JP Morgan

Paul Ginocchio – Deutsche Bank

Julio Quinteros – Goldman Sachs

Presentation

Operator

Welcome to the Hewitt Associates fiscal 2009 fourth quarter earnings release. (Operator Instructions) With that being said, I will turn the conference over to the Vice President of Investor Relations, Mr. Sean McHugh. Please go ahead, Sir.

Sean McHugh

Thank you and good morning. On the call today are Russ Fradin, our Chairman and CEO, and John Park, our CFO.

During this call when we discuss revenues we are referring to net revenues or revenues before reimbursements, and when we mention underlying revenue, operating income, net income, earnings per share and adjusted EBITDA amounts we are using non-GAAP financial measures that provide a better understanding of our underlying performance after excluding unusual items. This morning's press release provides a reconciliation of U.S. GAAP to these and other 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 will conduct a question-and-answer session. During the Q&A session we ask that you please limit yourself to one question.

Now I will turn it over to Russ.

Russell Fradin

Thanks, Sean, and good morning, everyone. Thank you for joining us. 2009 was a very positive year for Hewitt overall. We saw real progress against our four strategic priorities; keeping clients first, creating a rewarding work experience for our associates, growing with intention and getting lean.

Over the past year we have focused on high quality service delivery and our client satisfaction scores improved. We worked hard to improve our associates’ work experience and saw significant gains in engagement and reductions in turnover. We challenged ourselves to continually improve our cost structure and margins improved in all three of our businesses.

As a result of this we delivered record financial results in the face of unprecedented economic headwinds. These results were truly a team effort and I couldn’t be prouder of our 23,000 associates around the world. Let me highlight a few of our more noteworthy accomplishments over the past year.

First, we reduced the underlying loss in our HR BPO business by $80 million and effectively reached breakeven in the second half of the fiscal year. These results reflect continued stabilization in the business, increased productivity and the successful, mutual renegotiation of several contracts.

Second, in benefits outsourcing we maintained revenue and expanded margins despite a very challenging business environment. Our recurring revenue model proved resilient and new client starts helped to offset the employment weakness and soft project work environment that we saw during the year.

Third, we expanded our underlying consulting margins by 70 basis points despite lower revenue and significant severance expense. Growth in parts of the business with more recurring revenue, namely retirement and financial management and health management partially offset slowdowns in the more discretionary practices of talent and organization consulting and communications.

Fourth, our solid overall operating margins and earnings were accompanied by strong cash flow. We improved free cash flow by $95 million with a disciplined focus on collections while also increasing our capital investments.

Lastly, we made progress in building for the future by investing in several key growth areas. We continue to invest to improve our outsourcing sales capabilities which paid off with increased bookings compared to last year. Our wins covered the benefits spectrum; defined benefit, defined contribution and health and welfare in both the large and mid-market and our point solutions group had a very strong sales year.

In HR BPO, we have been proceeding cautiously with building the business. Our new offer reflects our experience and lessons learned as a pioneer in the business and it is getting a good reception with clients and prospects. I am very pleased to announce we recently signed a significant HR BPO contract expanding our relationship with a Fortune 100 company.

On the consulting side we acquired the remaining interest in our former German Consulting RFM joint venture and thus expanded our presence in one of Europe’s leading pension markets. We also took advantage of the downturn to restructure our talent and organization consulting business to better position the practice for growth as demand returns with the recovery. Across both outsourcing and consulting we invested in new products, product enhancements and operational capabilities that we are bringing to market in fiscal 2010 and beyond.

In summary, fiscal 2009 is a year we are very proud of. Before I turn the call over to John I wanted to provide some initial perspective on fiscal 2010. In our plan for the coming year we have made the assumption the tougher economic outlook will continue. We are not economists and we thought it was appropriate to plan along these lines until we see a more meaningful pickup in corporate spending.

So what you are seeing in our 2010 revenue guidance is a carryover from the soft revenue environment from fiscal 2009. We hope the trend is more positive but we thought this was the more prudent planning approach. Despite this approach we have a lot to look forward to. We have strong sales momentum in benefits outsourcing, a new contract in HR BPO with improving demand in the marketplace and we are making good investments in the right areas to drive our long-term success.

Now here is John with our financial results and our guidance for fiscal 2010.

John Park

Thanks Russ and good morning everyone. Let me start by highlighting our consolidated results for the fourth quarter. Reported net revenues declined 6% compared to the prior year quarter. Net revenues declined 4% after adjusting for currency translation, acquisitions and divestitures and third-party revenues.

Reported operating income grew 95% to $106 million compared to $54 million in last year’s quarter. Underlying operating income increased by 23% to $106 million compared to $86 million in last year’s quarter. Last year’s underlying results excluded $32 million in net charges mostly related to real estate rationalization. There were no unusual items in the fourth quarter of this year.

Underlying operating margin increased by 310 basis points to 14% in the fourth quarter. This was mostly driven by operating improvement in our HR BPO business. In this quarter’s results we absorbed $17 million in severance charges which was comparable to what we absorbed in last year’s quarter. This was higher than anticipated and reflects proactive steps we took to improve our cost structure on a sustainable basis. We also absorbed $6 million in real estate charges in the current quarter as we continue to trim our real estate footprint and the commercial real estate market continues to soften.

Our reported effective tax rate for the current quarter was 34.4% compared with 34.5% in the same quarter last year. On an underlying basis our effective tax rate was 34.4% for the current quarter and 39% in last year’s quarter reflecting the impact of discrete items in both periods and some structural improvements in our state tax rate.

Reported net income for the fourth quarter increased to $64 million or $0.68 per diluted share compared with $32 million or $0.32 per diluted share last year. Adjusting for unusual items underlying earnings grew 38% to $0.68 compared to $0.49 per diluted share last year.

Now turning to a summary of our full year results, reported net revenues for the full year declined 5% compared to the prior year. Net revenues were flat after adjusting for currency translation, acquisitions and divestitures, third-party revenues and the favorable impact of HR BPO contract settlements in the prior year.

Reported operating income grew 39% to $434 million compared to $313 million in the prior year. Underlying operating income increased by 29% to $425 million compared to $329 million in the prior year. Our underlying operating results exclude gains of $9 million in the current year and net charges of $16 million in the prior year both on a pre-tax basis. You can see the details of these unusual items in the earnings release.

Underlying operating margin increased by 350 basis points to 14.1% for the full year. This was mostly driven by operating improvement in our HR BPO business. In this year’s results we absorbed $35 million in severance charges most of which related to actions taken to improve productivity in our consulting business. This compares to $30 million in the prior year. We also absorbed $15 million in real estate charges in the current year due to a softening sublet market and ongoing initiatives to reduce space.

Our reported effective tax rate for the current year was 35.3% compared with 40.5% in the prior year. On an underlying basis our effective tax rate was 36.4% in the current year and 39% in the prior year, reflecting the impact of discrete items in both periods and some structural improvements in foreign and state tax rates.

Reported net income for the year increased to $265 million or $2.78 per diluted share compared with $188 million or $1.85 per diluted share in the prior year. Adjusting for unusual items, underlying earnings grew 35% to $2.67 per diluted share compared to $1.98 per diluted share in the prior year.

Cash flow from operations was $433 million compared with $328 million in the prior year. Free cash flow grew to $305 million compared with $210 million in the prior period. This increase reflects improved receivables collections and stronger operating performance partially offset by lower outsourcing net deferral and higher performance based compensation related to fiscal 2008 performance.

Capital expenditures were $128 million in fiscal 2009 compared with $118 million in the prior year. The increase was driven by investment in internal and client facing software applications and was partly offset by lower real estate spending.

Adjusted EBITDA increased by $49 million to $567 million compared with $517 million in the prior year. The year-over-year growth was driven by improved HR BPO operating performance but lagged operating income growth primarily due to lower outsourcing net deferrals.

Regarding our share repurchase authorization; we bought back 1 million shares for a total of $30 million during the fourth quarter. For the full year we bought back 2.6 million shares for a total of $74 million. In our first fiscal quarter through November 9^th we repurchased an additional 185,000 shares totaling $7 million. This brings our total to $81 million against the overall $300 million authorization. Note that the moderate pace of our buyback was impacted by our continued interest in M&A opportunities as a priority in deploying our cash.

Before I move on to a review of the businesses, let me comment on some recent financing activity. In October we entered into a new three-year $250 million revolving credit agreement. This replaces our existing 5-year $200 million agreement scheduled to expire next year. As can be expected in today’s market the spreads are higher but the conditions and the covenants are essentially consistent with our prior credit facility. Like the prior agreement we plan on using the new one for general corporate purposes.

Now let me give you a few fourth quarter segment highlights. As a reminder, my comments regarding underlying results are adjusted for unusual prior-year items I noted a moment ago.

In benefits outsourcing reported revenues were flat in the fourth quarter. Revenues increased 1% when adjusting for unfavorable currency translation. The adjusted revenue increase was principally due to growth in our large market and mid-market businesses, partially offset by lower project revenue. End user participant counts of 20.5 million increased 4% compared to last year. New large company and mid-market implementations drove the increase and more than offset some client losses and modest labor market weakness among existing large clients. We think that this is a very positive sign that participant counts continue to grow nicely despite the challenging business environment.

Benefits margins improved by 160 basis points to 22.4% on an underlying basis in the fourth quarter. This was principally due to foreign currency translation, lower performance based compensation, cost management efforts and lower severance. These were partially offset by lower project revenue and higher healthcare costs. Severance in the current quarter was $5 million compared to $7 million in the prior year. This was another positive quarter for sales closing and the pipeline for 2010 continues to look solid.

In HR BPO reported revenue declined 16%, revenue decreased 10% when adjusting for unfavorable currency translation, divestitures and third-party revenue. The decline was driven by client terminations and liquidations that were in line with our expectations. This was partly offset by new client go-live and certain contractual adjustments. The HR BPO underlying segment loss was $2 million in the quarter compared to a loss of $12 million in the same quarter last year.

The improvement versus last year was due to staffing leverage and infrastructure cost management partially offset by lower revenue. This brought our full year underlying loss to $15 million, a significant improvement over the loss of $95 million in fiscal 2008.

In consulting, segment revenue declined 10% on a reported basis for the quarter. Revenue declined 9% when adjusting for unfavorable currency translation and the impact of an acquisition. On this same basis our retirement and financial management practice grew in the low single digits. Recall that the business faced a difficult comparison as the business grew in the mid teens in the prior year. Demand for these services remains solid.

Health management declined in the mid single digits. We think this is very much a result of a wait and see attitude on the part of our customers regarding healthcare reform. We continue to play an active role in Washington and maintain a strong dialogue with our customers so we are well positioned for growth.

Talent and organizational consulting revenue softened with declines in the high 20’s and communications declined approximately 20%. The good news is we have taken actions in both of these practices to restructure the organization so when corporate spending returns we will have a stronger business than ever. Consulting margins declined by 20 basis points to 16.5% on an underlying basis in the fourth quarter. The decline was principally due to lower revenues and higher severance expense. This was partially offset by lower performance based compensation and discretionary cost controls. Severance totaled $9 million for the quarter. This compares to $5 million of severance charges in last year’s fourth quarter.

Finally, unallocated share service costs declined 90 basis points to 3% of net revenue on an underlying basis in the fourth quarter. The improvement was principally due to lower third-party professional fees and lower performance based compensation.

Now turning to our outlook. We plan to build on last year’s achievements in fiscal 2010 to drive continued improvement in our financial performance. Before I go into detail I will note the following regarding our guidance. One, as Russ stated earlier we are not basing our guidance on expectations of an economic recovery. Two, our currency expectations are based on current forward rates. Three, we are not factoring in any M&A activity that has not already occurred. If deal activity does occur note that accounting changes require us to expense deal costs this year.

With that in mind our guidance for fiscal 2010 includes the following: First, we expect consolidated revenue growth in the low to mid single digit range. This growth reflects solid growth in consulting, roughly flat revenues in benefits outsourcing and a decline in HR BPO reflecting the full-year impact of client losses, liquidations and scope reductions. It also reflects some favorability from FX.

Second, we expected diluted EPS of $2.85 to $2.95. We expect underlying operating income growth to moderately exceed diluted EPS growth. This reflects some improvement in consulting margins largely due to savings related to severance actions, about breakeven performance in HR BPO and a roughly flat contribution from benefits outsourcing as productivity gains and new implementations are offset by participant losses and price concessions.

We expect an effective tax in a range of 37-38%. It is worth noting we believe the 37-38% range is sustainable based on some restructurings we completed this year. We also expect to make good progress against our share repurchase authorization.

Third, we anticipate fiscal 2010 free cash flow solidly in excess of net income. Lastly, we are expecting solid growth in our adjusted EBITDA metric but slightly lagging diluted EPS growth as improved operating performance will be partially offset by lower outsourcing net deferrals.

Now I would like to turn the call back to Russ.

Russell Fradin

Thanks John. I want to close the call by once again expressing my deep appreciation for the tremendous efforts of our leaders and associates over the past year. They served our clients extremely well and that allowed us to deliver great results in light of the difficult economic environment.

At some point we will see a turn in the economy. We are more than prepared for the recovery and remain confident that our expertise and our services are more relevant than ever. We are now three years down the road implementing an improvement plan that has produced solid results. There is more to come in the areas of higher service quality, happier clients, more engaged associates, greater productivity, lower cost structure and additional top line growth.

You can count on Hewitt to keep our focus on the type of performance we delivered in 2009 with a strong emphasis on growth. We will be building on the solid sales momentum we generated in 2009 and putting our resources to work to add new clients and services in the coming year. Operator, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Ashwin Shirvaikar - Citigroup Investment.

Ashwin Shirvaikar - Citigroup Investment

My first question is in terms of forward growth what is the impact you assume for the strong bookings you said you had in benefit and healthcare reform or for that matter HR outsourcing contracts that you signed?

Russell Fradin

That covers a lot of ground but let me try and comment one each of the areas. In terms of the benefits outsourcing essentially what we are seeing is that we are having terrific sales results and I can’t compliment our team enough. We are winning a lot of bookings in the marketplace. What we are dealing with are a few things. One, as you probably know our sales implementation time is longer than we would like. So it takes time to implement those and in fact I think if you think of the revenue cycle now as closer to 12 months that is probably pretty accurate. Frankly the sales results were stronger in the second half of the year. The pipeline was growing and the signings were certainly stronger in the second half of the year. That just influences the revenue curve to be more out in 2011. It will help a little bit in the second half of 2010 but you won’t see the full year impact of that until 2011.

Related to benefits outsourcing we have also tried to make people aware that even though we are seeing participant growth we are being impacted by a couple of things. One is the project revenue which is a small portion of the overall revenue but it really is discretionary has suffered a bit in this tough economy. Those project revenue issues are the ones we are dealing with. That is why in John’s guidance we tried to be very explicit in saying we are just not assuming that is going to get any better.

Now, if the economy starts to get some lift will we get some lift there? Our speculation would be of course, but until we actually see it and until those things are turning into dollars we don’t want to sit here and predict that. So that is a portion of it. The other thing you have to think about in benefits outsourcing is in these tough economic times we are under a bit of pricing pressure with the renewals.

So if you think of our contracts as being on 5-year cycles you have some portion of the business that renews but it renews at sometimes lower price points and we fight that by trying to add on additional services and that is just a little bit tougher in these economic times. So that is really what we are seeing right now. We are seeing the great bookings there, you are not going to see the full results of that until 2011 and we are still planning on the project revenue headwinds and some of the pricing pressure we have seen in benefits outsourcing.

In terms of BPO, it is actually quite a planful approach we are taking here. Meaning what you are seeing in BPO is next year we will get the anniversary in of the full year losses we had this year with Circuit City and Mervyn’s liquidations where they frankly didn’t impact us until the fourth quarter so you have the full year impact of that. Then we have had the re-scoping and restructuring of several contracts which obviously have improved the profit margins dramatically but we did give up revenue there. That was a very conscious impact to turn back revenue that wasn’t profitable.

Then again in terms of the new contract signing of the Fortune 100 company, what I will tell you there is we are a slave to right now this 12 month implementation cycle and we are working hard to improve that over time but again we are assuming it is going to take 12 months and the contract signing was in the fourth quarter and you really won’t see the revenue until the fourth quarter of 2010 and the full impact in 2011. By then we will have anniversaried in the losses of the client liquidations and client restructuring. So that will be behind us.

I also want to add that in BPO benefits we are seeing great pipeline. There I have said again and again we don’t want to go back to a pace that is not sustainable but we really do believe that three or four contract signings in the year is sustainable for that business. So we would like to be on a pace of one contract per quarter. So this quarter kind of gets us back on the bicycle so to speak and we feel good about that.

In consulting again we are feeling good about our prospects but we are dealing with the realities of the economic environment. In RFM and in health management I think we are being a little bit cautious. I think they are very healthy businesses. We expect good things. Until we see what comes out of Washington we don’t want to predict anything but I can’t imagine anything coming out of Washington that isn’t going to anything but improve the prospects for our health management practice. We have been deeply involved and we think we are the lead player in terms of understanding what is in all of these various congressional proposals and I think we are going to be just fine there.

Then the question becomes when is the discretionary spending going to recover a bit in TOC and the communications practice. Again what we said on the call is we don’t want to sit here and play economists and predict the turn, so we are saying that we are looking at the softening environment continuing through the bulk of the year. So that is kind of the color commentary on the underlying growth rate. We feel very positive. We feel when the economy turns we will be well positioned. Our sales results are in very great shape. There are some mindful changes we are making in BPO and then some pressure we are under in benefits outsourcing that are influencing those results right now.

Operator

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

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

I was wondering if you could talk a little bit about the guidance as it relates to HR BPO and hitting breakeven with the expectation of potentially signing three or four contracts? Can you talk a little bit about what is different about these contracts relative to the prior ones? How we should think about the profitability as those projects unfold?

Russell Fradin

I wish we had all morning because it is a topic that deserves a fair amount of discussion. Let me be as brief as possible. The scope of these contracts is very much in the wheel house of what we are looking for in terms of the business model that we are trying to build here. I can’t tell you how disciplined we are being about contract approvals, making sure we understand the implementation requirements, making sure we understand the economics of every domain we are taking on. There is a level of commitment and due diligence there I really think the team can be rightfully proud of.

Some of the newer contracts we have been implementing over the last 18 months that we haven’t been tooting our horn over we have been right on plan in terms of the cost structure and the revenue being exactly what we predicted. That is part of what is giving us some lift in the business, by the way. We were able to renegotiate some of the less favorable contracts and now that we are implementing some contracts we feel good about, you can think about the domains and the scope of being a lesser scope than the previous contracts and you can think of the geographic footprint as being more concentrated than the previous contracts.

So with all that going on, it is narrower scope, fewer geographies, it is a more standardized model. What we didn’t know was how well it would play in the market. That is why we are gratified to see this important contract signing and we are gratified to see the pipeline growing in that business.

What we have said overall is I would say over the long-term, whether you want to call it the next 3 years or the next 5 years, we really are looking at a business we hope to get to mid-teen margins. That aspiration hasn’t changed and that is what we are looking at on the newer contracts.

So it is a combination of continuing to whittle away at the overhead. We also have been able to sign some new contracts we feel good about. It is an industry that has undergone a lot of changes and you have seen what has happened as a number of competitors have fallen by the wayside. It has only made clients more educated about what works and what doesn’t work and the last thing they want to do is have a long-term arrangement with a vendor that is going to fail. So we really do view these as win-win situations.

So I am actually very optimistic about the business. Obviously we are more than a year ahead of plan in terms of when we had originally thought we would hit breakeven and so we are feeling good.

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

Breakeven plan basically assumes you may end up getting three or four total new contracts? Those won’t detract from that?

Russell Fradin

Right now that is the assumption. In essence how the contract accounting works, which John can speak to more than I can, in essence we would tend to defer the costs of the new signings to reflect when they would go live. But yes we are at this point looking to add sales capability and sign new contracts within the scope of the breakeven forecast.

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

Does that imply existing contracts you weren’t planning on new contracts? The existing contracts would be profitability?

John Park

I think there is an assumption of underlying improvement. Like all of our businesses we are going to expect the BPO business to improve and that is going to help offset some of the investment costs that are expensed in terms of new customer development.

Russell Fradin

Also we have said this before and we didn’t put it in the script this time and I would just add it because I think it is important. Remember, this is a more concentrated business. So quarter-to-quarter you are going to see a speed bump here and there. Is it going to be breakeven every quarter? I don’t want anybody walking away thinking we promised that. I think from our standpoint we are making the commitment for the year here but this is a different business because we are dealing with a smaller, more concentrated book of business. As it grows it will smooth itself out but I think we are still looking at the early days of the rebirth of this business.

Operator

The next question comes from the line of Jason Kupferberg – UBS.

Jason Kupferberg - UBS

Just to start with a question on severance and real estate going forward. You obviously have taken up a lot of actions over the last couple of years as you outlined. Is the business kind of right-sized now in your mind for the current environment? In your EPS guidance for fiscal 2010 have you assumed any material amount of additional severance or real estate charges?

Russell Fradin

There is an underlying amount of severance that in our experience is just going to occur. So yes we have built some. But clearly when we look back at 2009 there was a lot more restructuring activity than we would consider normal. Going into 2010 we certainly wouldn’t expect the level of severance to be of the magnitude we saw in 2009.

On real estate, that is a continuously shifting opportunity in that as we think about new ways to configure the business and as we think about investing in certain areas of our business we are going to see opportunities in real estate come up. I would say going forward it is more of a continual process. Not certainly of the structural magnitude we saw a couple of years ago but that is not to say at some point in the future we may see an opportunity that is large enough so that we do go after it in a much bigger way and we will certainly keep investors advised of that if we do that.

Jason Kupferberg - UBS

I just wanted to probe your comments on M&A a little bit and get a sense of how the pipeline looks now. Obviously your HR BPO business is a lot more stable and presumably that gives you a bit more comfort in maybe opening aperture a little bit on the M&A side and deploying some cash. How does that pipeline look? Valuation? Any general commentary you can give us regarding areas that might seem particularly appealing and are we just sort of talking about the small, bolt on kind of stuff we have seen from Hewitt over the last three years or could we be looking at something larger?

Russell Fradin

From my standpoint let me comment on the question around the number of opportunities and our thoughts on M&A and I will let John answer the question on the cash position. From my standpoint, in all honesty we are seeing a good pipeline. So the direct answer to your question is we are seeing nice opportunities. We are really looking at this as ways to improve our growth rate. In other words, can we buy into applications or books of business that we believe over time will be able to cross sell to other clients within our base or add a book of business that we feel confident we can cross sell what we already have to that.

You see what is going on. There is a lot on the market. We are just being very picky. We have very clear criteria about kind of what passes the bar and for us it is a discounted cash flow analysis and is it going to pay off to our shareholders and all that kind of stuff. Again, being frank what I would say to you is I am a little disappointed. I thought we would get a little bit more done in the fourth quarter of this year. Things take a little bit longer than you assume or diligence shows up some stuff that you didn’t expect and so you take a pass on some properties. But yes we see a good pipeline in each of the businesses. We want to be very careful about what it is we take on and make sure we have the management capacity to manage it well. But that is what we would like to do and it is really our first priority. To say if we can find stuff that really produced profitable growth for us in the future you will see us jump on it.

Yes, we are more likely to be in the term I think I have used before and what you are alluding to is to be bite-sized deals. We are not looking to solve world hunger here. We are looking to add incrementally to the growth rates of the business. I think we can do that.

John Park

The only thing I would add in terms of our financing capabilities is that we really ended up finishing fiscal year 2009 in a stronger position than we had anticipated because our cash flow did come in nicely in excess of what we had anticipated, truly a result of the great effort from the businesses in terms of making sure our collections processes were tightened as well as just good fundamental management of the businesses.

We are going into fiscal year 2010 with even more resources. Clearly as we commented earlier our bias is to probably hold a little more cash than we think we need than a little less cash. This is an environment where we would still rather be on the safe side and it is a reflection of the fact we do have an active M&A pipeline. So we feel very good about the flexibility we have on our balance sheet in terms of being able to make acquisitions and return capital to shareholders.

Russell Fradin

What we have done, again just to reiterate what John said in the script, but what we have done in the past and what we will continue to do here to be clear is our guidance we don’t anticipate or try to guess which deals are going to occur. As things were to happen, if it has any impact, you will be the first to know about it loud and often. So you can assume right now the guidance is for the base business.

Operator

The next question comes from the line of Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

I just wanted to ask you on the guidance what are you seeing that is telling you consulting is going to grow solidly next year after this declines we have seen in each of the last four quarters?

Russell Fradin

I will just give you my commentary. What we are predicting is what we think is actually pretty modest growth. So I think that is what we tried to say. We are actually trying to be a bit conservative. Remember that from our standpoint we saw as you can see very sharp declines in TOC and in communications. Obviously the RFM and health management to a large extent have held their own through this recession. What we are saying going into next year is you never want to give a plan to a business that says no growth is acceptable. So from that standpoint we sort of view mid single digit growth, even if the economy stays as flat as it is, is a reasonable set of expectations for that business.

From that standpoint I would just pick on your adjective a little bit there and say that I don’t think we are looking for really robust growth there. I think we are being a bit cautious. But only time will tell.

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

If I could sneak in a couple of housekeeping things. The $5.7 million of real estate charges, how much are ongoing initiatives and how much are true-ups from the sub-leases?

John Park

It is an element of both. They were both contributors to that charge.

Shlomo Rosenbaum - Stifel Nicolaus & Company, Inc.

On the free cash flow for this coming year, you did a really good job on AR this year. I am assuming we are not going to see that kind of magnitude. Should we see a year-over-year decline in free cash flow?

John Park

We continue to think we can improve our collections. Obviously not at the pace we realized in 2009 though.

Russell Fradin

I don’t often get a chance to thank the whole finance team publicly but we set as an objective this year given the toughening economy we wanted to make sure our collections remained in good shape. We really, now that we have gotten into it, we saw the opportunity and you saw the great results. We actually, as John said, think we can still improve that a little bit. So actually we are feeling pretty good about that as well.

Operator

The next question comes from the line of Todd Van Fleet - First Analysis Corp.

Todd Van Fleet - First Analysis Corp.

I wanted to ask you about the benefits outsourcing business. You have given us some color commentary on the outlook for margins in fiscal 2010 and we have observed over the course of the past fiscal year you have essentially changed price for volume. It seems you have maybe 4% higher volume of participants but the revenue is basically remaining flat. As you think about the good sales activity you think will show itself in fiscal 2011 how should we think about the scalability of the benefits outsourcing platform if not necessarily in fiscal 2010 but beyond?

Russell Fradin

I think in terms of scalability we are very comfortable. I think we have poured tens of millions of dollars into the ongoing development of the TBA platform. Let’s just say on the client front they are seeing a lot of improvement and will see continual improvement of that platform. We are putting a lot of investment into reducing the implementation time of that platform which will help the revenue realization cycle.

Then we are using a different platform for mid-market and that continues to go extremely well. That continues to really be a good thing. In terms of what you are seeing, I think what you are saying in terms of the business being flat in terms of revenue your observation is exactly right meaning we are delighted when everyone was going into the year we kept saying gosh the employment situation is going to be a real problem for you guys. We kept saying actually we feel very comfortable even with the downsizing our participant counts will hold up and in fact we have not only been able to do that but we have been able to grow through it.

Remember the pricing pressure comes in a few flavors. I think the project revenue issue is directly related to the economy. That is what clients tell us. We can see them reducing their discretionary expenditures. We can see them postponing projects. We do think that will come back. So when you get things like changes they have to make for healthcare reform that in the end are things that will result in revenue for us. We are feeling like that will come back.

In terms of the long-term industry issues all I would say to you is that we feel very comfortable with our position and with all of these recent transactions with City Street being sold to ING, EDS being sold to HP and now the potential ACS/HP transaction, we think all those things are to our long-term favor and as people think that through people will understand that we think the environment will be a good one for us in 2011 and beyond.

Operator

The next question comes from the line of Tim McHugh – William Blair & Co.

Tim McHugh – William Blair & Co.

Just to follow-up on an earlier question about the consulting business going into 2010. Can you comment maybe what impact currency will have there and also maybe just sequentially are you starting to see while they are down significantly or year-over-year are the TOC in communication practices starting to show any improvement on a month-to-month or quarter-over-quarter basis?

John Park

On the currency side we do expect from a revenue point of view the consulting business will be helped a bit by currency year-over-year. That is not based on any special forecast we create, we just simply take the forward rates that are available now and apply them and that would tell you on an effective base we are going to be helped a bit on currency based on our geographic spread.

In terms of more granular trends within the consulting business we really shouldn’t comment on monthly trends. I will reiterate on what Russ had said earlier in that what we do carry as an assumption going into next year and hopefully folks will agree this is a relatively conservative assessment is the economy while we don’t expect it to improve has kind of bottomed out and so what we are baking in are fundamental performance improvements that we have really asked the businesses to target and investments that we see that will yield those returns.

I think looking at the quarter-to-quarter can sometimes be misleading in practices like TOC because they are smaller. They are very much driven by large projects that either get recognized or not recognized within a quarter. But suffice it to say we are really expecting the business to fundamentally improve in a relative flat economic environment.

Russell Fradin

One other addition to that because I think John is exactly right and the overall guidance contemplates that, but as you think through next year remember that since we have this funny fiscal year that ends September 30^th the first quarter of last year, which was really the fall last year, we didn’t see the precipitous decline in the consulting business. So when you look at the comparisons I would just say you can draw your own conclusions but I suspect that will get better as the year progresses next year.

Operator

The next question comes from the line of Analyst for Analyst for Tien-tsin Huang – JP Morgan.

Analyst for Tien-tsin Huang – JP Morgan

I was hoping you could update us on the competitive landscape in consulting in the mid-market benefit admin and HR BPO especially in light of some of the M&A activity going on among your competitors.

Russell Fradin

As you can tell, I am always curious to wake up in the morning to see what is going to be in the news today and we have had more than our share. The only comment I would make is I think we see the restructuring and some of the weaker competitors being consolidated as a positive trend for the industry long-term. I think frankly that is true in consulting where I think the big merger that was announced, we talked about that on the last call. I don’t know if you were on the call but we talked about what was going on with Watson and Powers.

What I would say is until that deal closes on both an employee basis and a client basis it is fair to say everybody is in wait and see mode. We are not seeing a lot of changes in the marketplace. Watson and Towers are still competing as two separate entities for the most part. I don’t think we are going to see any real changes in the mid-market or the large market in consulting until you get to next year.

Whether there will be any disruption there with clients or employees I don’t want to speculate on that. Obviously it is up to those guys to manage and figure out. In terms of what is going on in both BPO and in the benefits outsourcing business again I just feel very good our focus on stick to your knitting and we are going to do well doing what we are doing by improving our performance every quarter and keeping everybody focused on that and not get distracted by all these competitors that are getting picked off, it is just going to serve us really well in the long term that clients do evaluate vendor stability, they do evaluate who has gotten taken over when they make their decisions and over the long-term that can only help us. I think that is why part of the why we are seeing the pipelines grow so nicely in those businesses in both BPO and in benefits outsourcing. Without getting into the specifics we feel very good about our long-term competitive position.

Operator

The next question comes from the line of Paul Ginocchio – Deutsche Bank.

Paul Ginocchio – Deutsche Bank

It looks like in the HR BPO division all the contracts have wound down, it is just based on the headcount. Is that correct? Then the same thing with HR with the benefits. If you could talk about maybe the same contract declines in headcount versus what you are adding in new wins and are most of those wins in the middle market?

Russell Fradin

On BPO yes. What you are saying is basically right. In the fourth quarter we finally saw some of the liquidations drifted on a little bit longer than frankly we had expected. There were some of the contract restructurings and then give back of work. There is always going to be a bit of give and take in that business. So I don’t want to over-emphasize and say we are done because you are never done. There is always something going on. I think in the fourth quarter you are finally seeing sort of the impact and that is why we are not predicting revenue increase in that business because we have the grow-over problem of the revenue in the first 2-3 quarters of that business. So that is right.

In terms of benefit outsourcing, actually the way you said it isn’t quite right. Meaning, in terms of participant growth we are seeing real success in the high end of the market in addition to the middle market. Some of our most gratifying wins have been brand name, household institutions that we would have loved to have added. That is why I say as they go live, and some have gone live already, it will be really good for us. So that is going on. That is why I am saying the participant count there has continued to go up.

John Park

That is not to say, by the way, that middle market and our other point solutions businesses aren’t contributing. They are growing nicely also. It has been a really balanced performance in terms of growth in participant counts.

Paul Ginocchio – Deutsche Bank

When we look at the same contract for these wins will it look similar to the total decline in U.S. employment?

Russell Fradin

Could you say that again?

Paul Ginocchio – Deutsche Bank

Would the same contract participant count look similar to the declines in total employment in the U.S.?

Russell Fradin

No it wouldn’t. Meaning our experience, my experience would be that if what we have said before is a lot of our businesses in benefits outsourcing. Defined benefit being a great example, the unemployment rate does not impact who is pension eligible. Therefore, our participant count is not going down at the same rate that unemployment has been impacted. In health and welfare, people are eligible for COBRA and so there is a good proportion of those people that chose COBRA, so they stay in our participant count. Then again in defined contribution, the day you are laid off typically you don’t walk out and roll over your 401K. That tends to take a little time and so there is a little bit of a lag there. Each of the benefits businesses is affected differently but we have said again and again the overall unemployment rate is not a good proxy for our participant counts for the base business. That is why the declines have been lower than some people anticipated in our business. The issue we are dealing with is a bit more of the pricing pressure than it is the employment count.

Paul Ginocchio – Deutsche Bank

The new win in HR BPO was that sort of an average size client and where was the existing relationship in consulting or benefits?

John Park

It is an average sized BPO.

Russell Fradin

It was a benefit client.

Operator

The next question comes from the line of Julio Quinteros – Goldman Sachs.

Julio Quinteros – Goldman Sachs

Real quickly, on the long-term comments you made about mid teen’s margin targets, can you just break down the composition of that by the various units as you think about the long-term prospects for BPO, benefits outsourcing and consulting?

Russell Fradin

When I said mid teen’s I was talking specifically about the BPO segment.

Julio Quinteros – Goldman Sachs

That was only for BPO?

Russell Fradin

Absolutely. The benefits outsourcing business we are targeting and we have no reason to believe that low to mid 20’s where we have been all along, we see no change in that. The benefits business is clearly going to be in the 20’s for the long-term. The BPO business our target is in that mid teen’s. That was all I was referring to.

John Park

I want to clarify something. We have had official medium term guidance which is what Russ was referring to, in terms of benefits being in the low to mid 20’s, consulting being in the mid to high teen’s and aspiring to be better than that. What we are talking about for the BPO business is a longer-term target. We are often asked eventually where do you see the potential of this business when it gets to full scale. We are not ready right now to put a timeframe on that even though we have put somewhat of a rough timeframe on our other medium term targets.

Russell Fradin

As I said, I think I have said, think of it in a 3-5 year timeframe just to be clear that we are not looking at that as being in the next couple of years. That is really the target there.

Thanks everyone. We appreciate your time and attention. Again, I want to thank my team for all the great work that went into what we thought was a very positive year. As in every year, now it is on to the next year and we just hope we can do as well.

Operator

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

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