Hewitt Associates F3Q07 (Qtr End 6/30/07) Earnings Call Transcript

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Hewitt Associates, Inc. (HEW)

F3Q07 Earnings Call

August 7, 2007, 8:30 AM ET

Executives

Genny Pennise - IR

Russ Fradin - Chairman and CEO

John Park - CFO

Analysts

Ashwin Shirvaikar - Citigroup

Jason Kupferberg - UBS

Laura Lederman - William Blair & Company

Mark Marcon - Robert W. Baird

Liz Grausam - Goldman, Sachs & Co.

Daniel Lifshitz - Fir Tree Inc.

Shlomo Rosenbaum - Stifel Nicolaus

Todd Van Fleet - First Analysis Securities

Tien-tsin Huang - J.P Morgan

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Hewitt Associates Third Quarter Fiscal 2007 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today's call is being recorded

At this time, then I'd like to turn the conference over to Ms. Genny Pennise. Please go ahead.

Genny Pennise - Investor Relations

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

Before we get started, let me highlight that when we discuss revenues, we are referring to net revenue or revenues before reimbursement. 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 the 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, we ask that you please limit yourself to one question out of courtesy to others. And now, I will turn it over to Russ.

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Russ Fradin - Chairman and Chief Executive Officer

Thank you Genny and good morning everyone. Thank you for joining us. Since I joined you at nearly a year ago now, we've been undergoing an important transition, with 2007 representing a period of stabilization and rebuilding for the future. Although, the last 11 months, we spent a great deal of time repositioning the company for improved growth and profitability.

You've heard us talk about this idea of recentering the company around the Benefits Outsourcing and Consulting businesses, with Human Resources BPO being the third leg of the stool, not the single theme of our strategy. We've under appreciated the opportunities for growth in our established businesses in the recent past and we're working quickly to further build on the enormous value of our franchise. We still have a lot of hard work ahead of us, since we refine and execute our plans, but the progress we've made in the last few months gives us confidence that we're strategically and operationally on the right track.

Let me touch quickly on the highlights of the quarter, before turning it over to John to speak about our results in greater detail. Overall, we're pleased with our performance in the third quarter, with continued demand for our services translating into solid revenue growth and our cost management efforts contributing to nice underlying margin expansion. All this reflects continued strength in our business fundamentals. In Benefit Outsourcing, revenues were roughly flat, which was in line with our expectations, but clearly not the kind of growth we know we can achieve longer time. One of the most important elements of our strategy to recentre the business is to accelerate the top line performance of this business.

We're pursuing opportunities to grow both organically and through selective acquisitions, but it will take time for the growth to be reflected in our results, given the relatively long lead time required to sell and implement work. Overall our consulting business posted another good quarter, with continued strength in the retirement business as well as in the talent in organization practice. We saw a solid margin expansion in both Benefits Outsourcing and Consulting, although it's important to highlight that both businesses were positively impacted by the timing of our bonus approvals as well as some other small unusual items that John will cover. Overall we feel good about both businesses.

In HR BPO, we saw strong revenue growth and we've begun to realize the benefits of our stabilization in cost management efforts which was reflected in the year-over-year improvement in the operating loss. Reducing the losses, while meeting service requirements in this offering, continues to be a tough priority. We remain actively engaged in discussions to renegotiate and/or improve our results on those contracts that are the most financially challenging. As we said before, these are complex conversations and we are partnering closely with most of the clients who identify solutions and serve our mutual needs. We have made good progress with about half of them, with improvements ranging from clarification of work statements and giving work back to the client with appropriate price adjustments, to in some cases improved pricing. We also continue to look for new contracts on which we have a high degree of confidence, we can successful execute.

We just completed negotiations with one of our large three service benefit outsourcing clients to provide payroll and workforce administration services to the roughly 40,000 U.S.-based employees. In addition, we have reached agreement with a large U.S. financial services company to provide HR services including all three benefit outsourcing services to their more then 25,000 employees. We have been working very closely with these organizations. They develop a solution that meets their needs as well as our requirements and we hope to be able share additional details on the contracts shortly.

In addition, to the previously announced Rogers Communications deal, these deals mark our second and third HR BPO wins this fiscal year. And as I had stated previously, we are looking to win about four new clients in the year. Since enforcing our more rigorous deal review process almost two years ago, we have signed a small number of new deals, couple of which are now either well into or beyond the implementation period. We track the performance of these contracts carefully and have seen them continue to achieve results roughly inline with our expectations, which gives us confidence that our selective criteria has allowed us to identify and sign deals that are good for clients and for us.

And finally, we are having success with some of our productivity initiatives across the business, improving cost effectiveness while always putting service quality first. Before I turn the call over to John, I want to comment on this morning's announcement that tomorrow, we will be commencing a tender offer to repurchase up to roughly 16 million shares of our common stock, which we view as the most efficient mechanism for executing our existing share repurchase authorization. This program is a good use of our excess cash balance and our strong free cash flow. Yet it allows us the flexibility to pursue internal growth initiatives and the appropriate level of M&A activity.

So with that, I will turn it over to John.

John Park - Chief Financial Officer

Thanks Russ and good morning everyone. Let me start by recapping the highlights of our consolidated results. In the third quarter, net revenues increased 4% over the prior quarter. After excluding the decline in third party supplier revenues and the effective currency in acquisitions, revenues increased 3%. Operating income increased to $72 million compared with a loss of $208 million in the prior-year quarter.

Let me provide some additional color on some of the unusual items that impacted the quarter. First, the results reflect $13 million of lower compensation expense, driven by the fact that we are now accruing bonuses evenly throughout the year as opposed to accruing based on the seasonal patterns of the business. This is purely timing within the fiscal year. You will recall that way that we are now accruing bonuses negatively impacted our results in the first half of the year and we expect it to benefit our results again in the fourth quarter, as the first half impact continues to reverse out.

Second, we recorded a $9 million severance charge in the third quarter related to reductions primarily in the HR BPO business as well as in overhead functions. And of course, recall that last year's third quarter included $249 million of non-cash pretax charges related to the HR BPO business, including $172 million of goodwill impairment, $70 million of contract loss provisions and $7 million of intangible asset impairment. After adjusting for these items in the appropriate periods, operating income in the third quarter increased to $82 million from $54 million in the prior-year quarter, reflecting the strong underlying performance of the business.

Net income increased to $48 million compared with a loss of $202 million in the prior-year quarter, of course including the unusual items I just referenced. Our effective tax rate was 37% for the quarter, compared to a tax benefit at a rate of 2.5% in the prior-year quarter. The prior-year quarter was impacted by a number of discreet items, including the non-deductible goodwill impairment charge, increases to valuation allowances related to certain foreign operations and the reversal of certain tax contingencies upon the close of tax audits for a certain period. Excluding these discreet items, the tax rate in the prior-year quarter would have been 39%.

Cash flow from operations was $258 million for the nine-month period, compared with $289 million for the prior-year period. Free cash flow was a $195 million, compared with $211 million in the prior-year period. The decrease in the free cash flow was driven primarily by lower tax refunds and higher tax prepayments in the period, as well as higher performance-based compensation paid in the current year. The decrease was mostly offset by lower net deferrals and CapEx, as well as favorability from changes in the timing of our compensation payments. As Russ mentioned, we continue to feel good about the underlying cash generating capabilities of the business, as evidenced by the tender we announced this morning. CapEx was $63 million for the nine-month period, compared with $78 million in the prior year nine-month period.

Turning to the segments; before I dig into the numbers, it's worth noting the results reflect changes made to our segment reporting, last quarter. So starting with Benefits Outsourcing, overall excluding currency, Benefits revenues were roughly flat in the third quarter. An increase in project work was offset by the impact of lost clients and longer implementation cycles required for some of our large and more complex clients. We are pleased with the gains we saw in Benefits margins in the quarter, expanding to 26.6% from 21.1% in the prior-year quarter. The gains came from both fundamental operating improvements, such as increase global sourcing as well as some favorability related to an increase in project work, and a $3 million benefit from the timing of our bonus accrual.

The HR BPO business reported strong top line growth in the third quarter. Overall, after adjusting for the decline in third party revenue and currency, revenues grew 14%, driven primarily by growth of existing clients, including an increase in the project work as well as by contracts that went live in the twelve-month period. Clearly our efforts to drive down the operating loss of this business have begun to payoff with the loss coming in at $38 million in the third quarter compared with a loss of $45 million in the prior-year quarter adjusted for the $249 million of the pretax charges. The year-over-year improvements reflect some pluses and some minuses including a $2 million benefit related to the timing of our bonus accruals, a $6 million severance charge and increased intangible asset amortization related to the previously announced non-renewal of the BP contract.

The underlying loss improved in line with our expectations primarily due to the stabilization of the existing client base as well as our overall cost management efforts. We expect to see continued year-over-year improvement in the underlying operating loss of the business, particularly now that we have lapsed the post implementation period for some of the large contracts that negatively impacted our performance in the first half of the year. It's worth reminding you however that this was not a business that will track evenly from quarter-to-quarter given its maturity and size. For example, keep in mind in the third quarter we saw an unusual level of project work. So the magnitude of the improvement may not be as large in future quarters, but overall we are moving in the right directions for both our clients and our shareholders.

Turning to the backlog and pipeline, for Benefits, the backlog is up compared to the last quarter, primarily as a result of new clients. The pipeline is up sequentially as well reflecting solid activity in the market including a couple of rather sizeable prospects. For HR BPO, the backlog is roughly flat sequentially given that we didn't see a lot of activity in the quarter. The HR BPO pipeline was down sequentially, reflecting a continued selectivity. Just as a reminder, these comments reflect activity through the end of the quarter. Any activity subsequent to June 30th, including the two new deals mentioned earlier, will be reflected in the trends reported next quarter.

The Consulting business reported another good quarter with organic constant currency revenue growth of 5%. On this basis, both of the timing and the talent in organizational business grew in the high single-digits. Health management grew in the mid single-digits and the Communication Consulting business grew in the low single-digits. Consulting margins were 17%, compared with 13.8% in the prior-year quarter. The increase was driven by revenue growth as well as $8 million lower compensation expense, due to the timing impact of our bonus accrual. Excluding these last items, margins were down year-over-year, but we were pleased to see them improve sequentially on an underlying basis. Reported unallocated shares services costs were about 3.6% of net revenues in the third quarter versus 2.7% of net revenues in the prior-year quarter. The increase is primarily a result of higher professional services fees related to specific strategy in improvement projects.

Turning to our outlook for the remainder of the year, for the full year we continue to expect that we will deliver a solid year-over-year earnings growth on an underlying basis. That means excluding the unusual items in both 2007 and 2006. As we continue to reposition the company, some of the critical initiatives underway will continue into the fourth quarter and beyond, including renegotiation of our more challenging contracts and refinement of our go-forward strategy in HR BPO, rationalization of our real estate portfolio and the focus on prudent fiscal management. So again, it's important to point out that our comments on the full year exclude the impact of any significant restructuring and/or impairment charges that may arise in the fourth quarter as a result of any of these activities.

And as it relates specifically to HR BPO, we're encouraged that our stabilization in cost management efforts are showing results, and we expect this to continue over the remainder of the year. As a result, we continue to expect a modest year-over-year reduction in the underlying loss of the business in fiscal 2007. Before we move on, I want to provide some themes for you as you start to think about fiscal 2008. Given the opportunities we have to reduce cost across the business, next year story will benefit from cost management, as we make continued progress in this area.

Recall that in June we announced that we will be taking as $30 million to $45 million charge over the next two to three quarters, as a result of our plans to consolidate some of our real estate and exit certain properties. This is one example of actions we're taking and we will continue to look for and execute on other similar opportunities to improve productivity, which could result in additional charges. As you know, we're also evaluating ways to accelerate growth but it will take a bit longer for this to be reflected in our top line, given sales in implementation cycles and outsourcing. We do expect to provide annual earnings guidance for fiscal 2008 on our next quarterly call. And as it has become increasingly important to track the cash performance in the business, given the outflows associated with HR BPO, we also expect to introduce the cash earnings metric when we report next quarter.

And finally, as part of our existing $750 million share repurchase authorization, as of last night's market close, we've repurchased a total of 5.9 million shares for a total of about $177 million. After factoring in the $500 million tender offer, this leaves us with about $73 million remaining under the existing authorization. Now, I'd like to turn it back to Russ for a moment.

Russ Fradin - Chairman and Chief Executive Officer

Thanks John. Before we take your questions, I want to reiterate and report on progress on the four key strategic priorities, we introduced last quarter, which are all focused on recentering the company to capture the growth in margin potential of the Benefits Outsourcing and Consulting businesses, while we address the issues with some of our contracts and selectively grow the HR BPO business.

We made strides in each of these areas in the third quarter. And in the coming months, you'll see us continue to take actions consistent with these themes. The first theme, keep plans first. Our number one focus will always be on continuous improvement to ensure that we're all providing top-notch service to our clients. We're increasing our investment in quality and benefits, by continuing to reengineer our processes, improve our product service delivery and increased resource levels in some key areas. In Consulting, we're focused on providing thought leadership on the critical issues of managing human capital, and on driving greater standardization in our offers to deliver consistently best-in-class work more efficiently than we do today. And at HR BPO, we're continuing to assess the most efficient rate of server [ph] clients. In accordance, new client and market leadership organization is up and running ensuring that we remain focused on driving the right solutions for our clients across our full array of services.

The second priority; creating a rewarding work experience that leads to improved engagement retention of our people. We are very much focused on making improvements in this area. It's too early to size the magnitude of this segment. Tracy Keogh, our new Head of Human Resources is actively looking at ways to change our culture, to further enhance our work environment and it is a critical priority for entire senior management team.

Third priority; grow with intention. My leadership team, we spent the last few months gathering data and crunching numbers and what did they gain? An intimate understanding of our industry and the market for our services. All the data points to the same conclusion; HR outsourcing and consulting all terrific opportunities for robust growth for the foreseeable future and we are working aggressively to capitalize on it.

Let me share some high level thoughts on areas of particular intention. In the Benefits Outsourcing business, there's still a sizeable opportunity for us to grow our existing client base by continuing to penetrate the untapped portion of the large employer market and improve our cross-selling into that base. The regional organization will be critical in this regard. As many of you know, we are also actively looking at the middle market and its complementary add-on acquisitions as ways to accelerate our growth in this business. In Consulting, we are looking at ways to expand our offer, capitalizing on the transformation of the retirement business, continued M&A activity in our clients that we can advise on, and reward for talent among other things and by redoubling our efforts to grow internationally.

In order to be successful with our efforts in both Benefits and Consulting, we are taking steps to build a more aggressive sales culture, for example by creating new quarter and reward systems and hiring more sales people. And in HR BPO, as we continue to refine the new business model, we expect narrow of the scope of the services that we provide to our core offering, including Benefits workforce administration payroll and a limited set of additional services. And we'll begin to sell unbundled point solutions.

Finally, the fourth priority; get lean. The recent announcement that John mentioned a moment ago, about some of our real estate plans is just a part of a broader company-wide program that will reshape our operating model to improve efficiency and free up resources to allow us to invest in our growth and other value creation initiatives, while at the same time contributing to margin expansion. For example, in addition to our real estate consolidation, we are doing the same in the IT area driving toward more common technology platforms. The program is designed to not only rationalize our cost structure but also introduce a way of life to the organization that is centered on service quality and process improvement.

You should think of these four priorities not as areas of short-term focus, rather as the support system for all of our strategies and actions going forward. Each of our senior leaders is working hard on these objectives and committed to ensuring, we meet our goals.

In summary, we are pleased with our performance in the quarter, and are cautiously optimistic heading into the fourth quarter. We have taken some critical actions that lay the ground work for improved growth and profitability in '08 and beyond. And there is certainly more to come. As those that know me would tell you, I'd much rather we admire our accomplishments in our plans. We are seeing measurable progress, we've a good feel for what needs to be done, and now it's all about successful execution. We are in the right place at the right time and I am confident we have the right team of senior leaders to make it happen. We look forward to sharing our progress with you in the quarters and years to come. I thank you for joining us today. And operator, I think we are ready to take questions at this point.

Question And Answer

Operator

Great, thank you very much. [Operator Instructions]. And our first question this morning comes from the line of Ashwin Shirvaikar with Citigroup. Please go ahead.

Ashwin Shirvaikar - Citigroup

Thank you and congratulations on the fabulous quarter here. My question is with regards to the free cash flow for both this year and may be the expectation for next year. TQ obviously was quite good but, could you sort of walk us through the components? Were there any one-time events that we should watch out for? Are they going to be one-time events as we look at how free cash flow comes through?

John Park - Chief Financial Officer

Well Ashwin, it's probably worth me reiterating what we have just said in terms of the cash flow discussion for nine months. Then I will add a little bit color to it. We did say that overall there was a slight decrease in the free cash flow year-over-year for the nine-month period and that was primarily driven by lower tax refunds and higher tax prepayments, and then some higher compensation... performance-based compensation payments in this year. But that was also offset by some favorabilities, lower deferrals, obviously the deal activity is lower and then favorable CapEx. So if you factor that in, I would say that overall we did feel like there was some favorabilities in the nine-month period, but we continue to feel that on a full year basis, we are going to see free cash flow that is nicely in excess of our underlying earnings and we will continue to say that don't want to be too much more specific, I think on a go-forward basis I don't want to comment on next year specifically, but we don't see why that relationship in terms of favorable cash flow to our underlying earnings won't continue for some years now.

Ashwin Shirvaikar - Citigroup

Okay and if I could have one more; the share count in spite of your buyback, did not go down. Could you go through the explanation for that? Has it something to do with you convert.

John Park - Chief Financial Officer

I am sorry, can you repeat the first part Ashwin; we didn't hear the first part of the question.

Ashwin Shirvaikar - Citigroup

The share count for your... in spite of the buyback, the share count did not go down.

John Park - Chief Financial Officer

Well first of all remember the share count is on a weighted average basis. So you're not going to necessarily see the full impact of what we repurchased. It was selective in that count, and also recognize that we do have some continuing dilution from options that we are investing.

Ashwin Shirvaikar - Citigroup

So it had nothing to do with the convert.

Genny Pennise - Investor Relations

Share repurchases [ph] of the EPS calculation that continued convertible did have an impact on the third quarter Ashwin.

Ashwin Shirvaikar - Citigroup

Okay, thank you.

Genny Pennise - Investor Relations

It's about 1.9 million shares.

Ashwin Shirvaikar - Citigroup

Okay. Thank you.

Operator

Thanks and we have a question now from the line of Jason Kupferberg with UBS. Please go ahead.

Jason Kupferberg - UBS

Thanks and good morning. Russ just want to get a sense that you have got to fiscal '08. Obviously you have been referring fiscal 07 as the transaction year for sometime understandably. We are talking about the potential for some more charges coming down the pike here I guess part of your press release, in the middle of June. So we know about the real estate and there's been some numbers put around that. The order of magnitude, can help us understand what you're thinking about beyond the real estate charges in terms of what might be happening, and then do we need to think about fiscal '08 to some extent as a transition year as well, if these reconstructing actions are going to continue for few more quarters?

Russ Fradin - Chairman and Chief Executive Officer

Yes, I think... let me comment on the different areas and then I don't know if John wants to add anything but I doubt we want to be overly specific. If you take our comments that we have made about each of the different areas, I couldn't imagine that some of these charges won't flow into '08. And if you look at it sort of category by category, the real estate charges will reflect our activity in terms of consolidating facilities and it just takes time to make that happen, you can't snap your fingers and make it happen and that's way we tries to indicate that that's going to bleed out into the next few quarters and I think we've tried to put some parameters around that, so you have some sense to that. Second, the issues around finding some productivity and improvements as well as winding down some of the large implementation activity in the HR BPO segment lead to the severance charges, and again there's some of that stuff that as we continue to proceed in this Get Lean program, I think there's more parts of the business that we're going to be putting the spotlight on and so, we certainly are signaling to you that you'll see more charges like that, as we get the business to where it needs to be over time.

And then the third piece is that it's very difficult to predict if we're able to restructure some of these HR BPO contracts. In a way, that may result in a charge that on the end will advantage both the cash position and the net present value. So, we kind of hold that out there as a marker that as we said in the script that the negotiations are complex and because of that, they do take a period of time. I couldn't imagine that all will be wrapped in the next 90 days and that's why again, I think you'll see the potential for some of that to flow into '08 and frankly if we knew exactly what they were and we could put a marker around it like we did with real estate, obviously we do that. But we don't know how some of that will turn out and that's why, we just want to make sure everyone remain cognizant that as we clean up some of these things, it's unlikely that it's all going to be done in the next 90 days.

Jason Kupferberg - UBS

Would your best guess be that order of magnitude or the non-real estate area charges would be less than or greater than the real estate is?

Russ Fradin - Chairman and Chief Executive Officer

I think, I'd give you an unusual answer for me on that one and that it is a clear no comment.

Jason Kupferberg - UBS

Okay.

Russ Fradin - Chairman and Chief Executive Officer

I just want to be cautious on that.

Jason Kupferberg - UBS

I understand.

John Park - Chief Financial Officer

And the only thing I would add is, when we do provide guidance for next year, we'll obviously give you our best thought at that point. Even though, I think there will be some ranges around it, because there will still be a level of uncertainty before we actually get into the next fiscal year.

Russ Fradin - Chairman and Chief Executive Officer

And just to make the comment which I don't think John is going to take credit from, so that I'd like to give him a little bit of extra credit for him, the finance people and that is that, as we go through all this, actually the accounting and the details in making sure that we have a good handle on the underlying business versus some of these special charges that are flowing through is really what gives us the confidence that you see in the scripts. As John says, the underlying business performance we feel we feel is trending more positively in '07 than '06. And it takes a fair amount of accounting to make that work and John and his team have actually done a terrific job this year, making sure that we have confidence in those statements.

Jason Kupferberg - UBS

And can you just clarify the Benefits Outsourcing margins quickly, 26.6 this quarter, obviously very strong there but some help from the lower bonus accruals. How should we think about the margin profile of that business over the net few quarters? Should we still think about that kind of low or low to mid 20's number as really being more of a normalized figure?

Russ Fradin - Chairman and Chief Executive Officer

Let me make an overall comment. And then let John comment on the specifics. I think that we remain fully accrued for our bonuses internally and so, it really is the timing of how we're taking those charges that you are seeing the swings from quarter-to-quarter and doing it more on a straight-line basis than the previous way we done it trying to match the seasonal patterns. But there is no... you shouldn't read any implication in that that we are not fully accrued for bonuses. And I would just make a blanket statement that says in both Benefit Outsourcing and Consulting they were some of these unusual items that I just referenced that probably advantaged the third quarter in both businesses. I think John may want to talk to that specifically in both Benefits Outsourcing and Consulting.

John Park - Chief Financial Officer

Yes, I think in both of our more established businesses, we had a variety of items not only which will be large enough to identify separately but were very much timing-related cost favorabilities and I would say that in the Benefits business, we also had some timing benefits of recognizing some project work revenue. So I would go back to just affirming the statement or question you have made Jason, which is around, we still think that the ongoing margin for the Benefits business is low to mid 20s. You're going to see fluctuations up as you saw this quarter and in certain cases you might see some fluctuations down.

Operator

Okay, thank you. And we have a question now from the line of Laura Lederman with William Blair. Please go ahead.

Laura Lederman - William Blair & Company

Yes, just a few questions. One, can you talk about the acquisitions you have mentioned, now for a couple of quarters and will they be relatively small, because some would be large, will they more likely in U.S. or they would be more likely overseas? Just a little bit of color on that, and also if you look at the profitability kind of ramp long-term for the three new HR BPO projects. What do you think that it looks like and I have realized it's early days but just give us a sense of is it two years to profitability? Just any general view you can give us on that? Thank you.

Russ Fradin - Chairman and Chief Executive Officer

Let me comment on the first question that is on the acquisitions. I think that what I have been saying both internally and externally is that, we are looking for good small tuck-in acquisitions that will advantage the growth rate or Benefit Outsourcing business and our Consulting business in particular. And this notion of what we mentioned about point solutions, meaning if we find a given application that we think we can cross-sell to our base of clients, we'd be quite anxious to do that. And so in all honesty, Matt Levin who we brought in, in the beginning of his calendar year has been working feverishly with a bunch of insiders and outsiders of the business, to identify a set of properties, to do screening, to due-diligence, to work with the business leaders, to make sure it's consistent with our strategy and it touches on both domestic and international markets to answers your question. So we've sort of factored all that in as we thought about the share repurchase program, and now its all rating a good portion of that. So I think what you can anticipate as we feel very comfortable that we have enough dry powder to do kind of small tuck-in deals we are looking to do. But obviously nothing to announce this quarter, but that gives you the sense of the overhead.

On a second question, yes I'd give you a simple, yes. We only know what we know at this point. We feel like we've done a real good job of scrubbing the good contracts and the bad contracts. We've obviously looked at wanting to stay in the business, and wanting to make sure that we take on good contracts. And we feel very positively that the Rogers deal and the two deals we are announcing this quarter, fit in that category or platforms we are very comfortable with and have a lot of experience with limited scope in the terms of both geography and domains. And if that will service well and if our cash flow projections as well as just the income statement warrant positive over a reasonable period of time and I don't want to comment over whether that's two years and I don't want to give competitors an exact feel of our deal models, but if things that we feel very comfortable over the life of the contract to payoff to the shareholders.

Operator

Thanks. And we have a question now from the line of Mark Marcon with Baird. Please go ahead.

Mark Marcon - Robert W. Baird

Alright Good Morning everyone. I would like to add my congratulations. Got questions on two separate fronts; first, on the consulting side looks like you've made really nice progress with regards to margins. I realize there's certain aspects that are related to the timing in terms of bonuses, but what's your feel for the long-term margin potential and the demand outlook, on the Consulting side?

Russ Fradin - Chairman and Chief Executive Officer

On the margins, let me ask John to address.

John Park - Chief Financial Officer

Yes I would say that we do feel good about the consulting margins, because on an underlying basis we felt like we saw some improvement from last quarter, however we are still very much at a point where we're building the margins up. We did have as I mentioned earlier, a number of small favorable past items for the quarter and if you really look at the underlying margins on Consulting, I think you'd have to adjust somewhere in the neighborhood of about 200 basis points of favorability from some unusual items. If you look at it on that basis and also on the basis of the bonus timings, on a year-over-year basis, margins are still down in the consulting business and so we're really looking forward to that opportunity when margins actually start advancing versus prior year, which is why we got such a focus now on driving productivity, particularly around utilization.

In terms of the second quarter the question, in terms of the demand picture we see for the Consulting services, I think you know form our standpoint, in honesty we have aspirations of higher growth rates than what we are achieving right now, and there's a whole bunch of stuff that's going on internally that will really try to figure how best to take advantage of some of the growth initiatives that we see. I do think it will take some time to the come to fruition [ph] the set expectations accordingly, because it involves hiring people, establishing some investments in some new practice areas and may be even some small M&A activities. So I don't want to set undue expectations. I don't think you will see big changes there. But as I say longer term, we really feel that there is a good robust market out there for HR consulting in general and that we can better take advantage of it than the performance we see today over the long term.

Mark Marcon - Robert W. Baird

Listen John this to be clear, where do you think the margins... once you get these initiatives underway, where do you think the margins can go and then the follow up that I had was basically, it sounds like your second priority is really to a continued increase the engagements or the engagement of your internal folks, how would you characterize the progress that you have made on that front?

John Park - Chief Financial Officer

Let me address the margin question, then I will turn it over to Russ on engagement. You will recall that prior to the changes in our allocation methodologies which we pushed through last quarter, we talked about the consulting business, being a business where we to be about 20% in terms of operating margin and perhaps a little bit better than 20% aspirationally. I don't think those targets are changed but with the new allocation methodology we do need to shave about 200 to 300 basis points off, for just higher allocated costs. So I think thinking about the normalized levels of consulting, getting back up to on a sustained basis about 17% to 18% and then aspirationally that's the medium-term target and then aspirationally getting a bit more and other 100 to 200 basis points on top of that is the right way to think about it.

Russ Fradin - Chairman and Chief Executive Officer

On the second part of the question, what I would say to you is there is an awful lot of change that's taking place. And whenever you go through periods of changes on settling for people and I think that the organization has been through a lot of change in the last few years, between going public and making some acquisitions and having some disappointments in the HR BPO business. And I think that as we get the business recentered as I have said all along, we are noting some positive trends in terms of the engagements and what I would say that, from my standpoint, I wished it were manifesting itself better than the results were actually seen. Meaning we are not seeing real changes in the turnover in the business, and if there's anything just sort of highlight as one of the areas, I am a bit disappointed at this point and part of the reason we are so anxious to be working with our new Head of HR in this area, is that I think we can do better in off calendar [ph] in that area.

Operator

Okay thank you. And we have a question then from the line of Liz Grausam with Goldman Sachs. Please go ahead.

Liz Grausam - Goldman, Sachs & Co.

Okay thanks. Turning back to Jason's question on the Benefits Outsourcing operating margin, this is what the part of benefit margin we have seen from the company in several years, quite outside and your operating expenses were actually down sequentially quite substantially from quarter-to-quarter which is not the bonus accruals if they were evenly spread. So wondering in terms of off shoring initiatives and cost cutting initials, do you have any division? How sustainable is the new operating expense level that you are seeing and I know you have the seasonality into the fourth quarter. So if you could give us a sense moving from third to fourth quarter how your expense structure may track on a sequential basis?

Russ Fradin - Chairman and Chief Executive Officer

Yes, well first of all I would say that Liz there are fundamental improvements in the Benefits Outsourcing business. We made a big push over the last couple of years to really reduce the cost structure primarily through outsourcing but there's also a variety of other initiatives that would have driven the lower operating costs. But again I think its worth reiterating that in this particular quarter, we did see some... a variety of one-time timing favorabilities and also some positive lumpiness as I'll call it in terms of project revenue, which always is higher margin than other revenue, which really helped us drive the margin up in Benefits. And looking forward, if you go back to some of the comments that we made earlier on this call, we do see some important investment opportunities within benefits, getting the top line growing but also investments in quality that will ultimately result long term, we think in better margins. But in the near term as we make those investments, we want to be careful not to necessarily say that every quarter we're going to able to hit a margin number that looks very attractive on a year-over-year basis. But I certainly think that there are lot of underlying things that have gone on within the business that make us feel good about advancing the overall cost structure.

Operator

Okay, thank you. And we have a question then from the line of Dan Lifshitz with Fir Tree Partners. Please go ahead.

Daniel Lifshitz - Fir Tree Inc.

Hi, good morning guys. Try to question, I guess more of a clarification about the timing with the bonus accruals. Just to make sure I am understanding properly, at this point under the current system it's smooth across the year, there's no quarter-to-quarter seasonality. So going forward, once you anniversary, I guess maybe this quarter, don't know which quarter it should be, I could have these timing issues any more and you could have a look on it... look at it as sort of an ongoing run rate from that point on. Is that sort of a correct characterization?

Russ Fradin - Chairman and Chief Executive Officer

Absolutely Dan. Effectively this year, we're accruing evenly on a time basis. Whereas in the prior year, we looked at it based upon the seasonal profit patterns of the business. The change is really one that I think is going to make it easier for you to see what's going on with the business, without unusual fluctuations in terms of the bonus accrual and you're correct in assuming that once we get beyond next quarter, so as we get into Q1 of FY '08, we will no longer be talking about bonus timing because of what... and accrual methodology because it will no longer be an issue. And that's why I think we're trying to say all along that we a comparative basis, we're going to look worse in the first half of this year. And that's what you're seeing and once it all anniversaries in, it'll be what it'll be and we don't think it will be on cost explaining, it as a big swing in our results anymore which is really what we're looking get away from. When we're performing well, we want to remain fully accrued and the timing will be even over the year and that not be a cause of what's swinging our earnings one way or another.

Operator

Okay, thank you. [Operator Instructions]. We're going to a question from the line of Shlomo Rosenbaum with Stifel Nicolaus. Please go ahead.

Shlomo Rosenbaum - Stifel Nicolaus

Hi, thank you very much for taking my question. You guys did a very good job on the margins. Wonder people have asked questions about it. I just want to ask you, if there is some way you can quantify on the Benefits Outsourcing with some of the small one-time items added up to in terms of basis points. When talked about consulting you said you'd look at it as 200 to 300 basis points of additives to the margin. Do you have this similar figure that you can give us for the Benefits Outsourcing?

John Park - Chief Financial Officer

Yes. I would say that if you recall, we've talked about the Benefits business as being a low to mid 20's. If you look at the one-time items that occurred in the quarter, I would say that yes, somewhere in the neighborhood of one to 200 basis points in terms of unusual items in the quarter is a good estimate of what maybe non-recurring in nature. But again I want to remind you that in the upcoming quarters, we're going to have a lot of investment activity, particularly if it results to getting the top line going again and then investing in quality. So I would urge you to think about benefits margin in the longer term versus over the next two to three quarters.

Operator

Okay, thank you and our next question then comes from the line of Todd Van Fleet, with First Analysis. Please go ahead.

Todd Van Fleet - First Analysis Securities

Good morning guys. Nice quarter. I wanted to give you both an opportunity to elaborate on the cost savings initiatives that you are going to see in 2008. I think we are getting loud an clear regarding where the opportunities are in the, there are opportunities but I was thinking more in terms of specifically within benefits outsourcing and then separately HR BPO. If you guys could kind of get a little more granular in terms of the types of opportunities that you see in place to remove cost from the system and provide that margin lift. Thanks.

Russ Fradin - Chairman and Chief Executive Officer

The thing, before we get into this, that I want to be clear on and reiterate what John has been saying is that, we are really going about this in a way that says we need to right size the business in a way that produces the quality results that our clients expect, and by the way hopefully even exceeds that. Meaning in all these cases, as we look at the productivity improvements, whether it's normal process improvements, whether it's the things that we have talked about in terms of consolidating some of our facilities, whether it's reducing some of the excess resources in the HR BPO business and getting down the learning curve in that business little bit further, all those sorts of efforts are really taken and that's why I keep coming back to the client interest first and the importance of quality. That's what Hewitt really stands for and I think that's important to understand that.

The other thing that I just wanted to make clear and that I think that John has been saying as well is that, we are being very mindful that we are taking those productivity enhancement programs for two reasons; one is we want to be sure that we have the investment dollars available to accelerate the growth rate of the business, and so we are taking those in the best interest of both our clients and our shareholders to make sure that we can get better growth rates, in both Benefit Outsourcing and in Consulting and we are disappointed with our current growth rates and we are really need to change that and so that's one of the ways we are going fund that investment.

Second, clearly we are looking to do a better job for our shareholders and so we are going to share those gains between the right investment level for the business, and making sure we deliver for our shareholders. So as walking that balance where I don't want to begin itemizing each individual cost reduction, because we are making a separate set of decisions about how much of that to redeploy and reinvest in business. So I don't to get into the business now saying while the total for that cost reduction is X, even though I know there is an enormous level of curiosity about that. Because there's a substantial portion of that that we are going to redeploy to make sure that we are investing in the health and the growth of this business, and that is the primary reason we are doing this in fact.

John Park - Chief Financial Officer

Yes, what I would add to that Shlomo in terms of characterizing the cost opportunities is I think Russ mentioned a variety of opportunities and I would say that really the cost opportunities are nothing that are unusual. You know lot this is blocking in tackling. I would say that across our businesses and you would ask specifically about Benefits Outsourcing, clearly what we have is, we have an organization that works very hard and is very good at what they do, if there is a lot of opportunity to just standardize processes and to share best practices, and again that's just blocking and tackling. And I think another specific example is, we have a significant portion of our cost base obviously in information technology and we have groups that have been somewhat separate across the businesses as in our Central Corporate Group and there is a significant opportunity to just streamline and better coordinate the activities of all those groups. So, those we will give you, just a couple of examples and I think what are probably dozens of opportunities that we are working on and again, I would very much characterize it as blocking and tackling and not anything that is going to be revolutionary in nature.

Operator

Okay thank you and our last question for the morning comes form the line of Tien-tsin Huang with J.P Morgan. Please go ahead

Tien-tsin Huang - J.P Morgan

Thanks and congrats on the quarter as well. Question on the Benefits side; I'd had it Benefits revenue growth ex the project work performed versus planned. Is it all that the participant counts get down a bit sequentially? Are you seeing any change in the competitiveness from your peers?

Russ Fradin - Chairman and Chief Executive Officer

Well we are always very cognizant, it's an active marketplace, a very competitive marketplace and so that's always there with the head-to-head competition on both new business and renewals. What I'll tell you is that we are going through a cycle now where we're renewing a large number of clients they are all sort of Fortune 500 companies that you all regularly recognize the names of this clearly surprised concessions that we needed to make there that have not been very helpful to our growth rate. We think long term we are serving our clients well and we want to keep their retention there. In terms of the new business, we have some large clients in implementations that haven't factored into the participant count yet, but I wouldn't minimize the fact that there has been losses and that should be apparent from both the growth rate and the participant account. So you got all that swirling around but there is nothing... I don't anyone to read into that there's season change taking place. It's something that I think we need to work hard on, as I have said we are bit disappointed in and that's why you'll see some of that reinvestment growing to sales and product activity and some small acquisitions that we think will advantage that over the long term. But we are far from viewing that as a matured business. We are really want to reverse that situation and we are feeling pretty confident that over the long term we can really do that.

Operator

Management, thank you very much. And ladies and gentlemen, this conference will be available for a replay starting today Tuesday, August 7th at 12:45 PM Central Time and it will be available through next Tuesday, August 14th, at Midnight Central Time. And you may access the AT&T Executive Playback Service by dialing 1800-475-6701 for within the United States or Canada or from outside the United States or Canada, please dial 320-365-3844 and then enter the access code of 881288. So those numbers once again are 1800-475-6701 for within the U.S. or Canada, or 320-365-3844 from outside the U.S. or Canada, and again enter the access code of 881288.

And that does conclude our conference for today. Thank you for your participation and using AT&T's Executive Teleconference. You may now disconnect.

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