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Hewitt Associates, Inc. (HEW)

F4Q07 Earnings Call

November 12, 2007 8:30 AM ET

Executives

Genny Pennise - IR

Russ Fradin - Chairman and CEO

John Park - CFO

Analysts

Ashwin Shirvaikar - Citigroup

Jason Kupferberg - UBS

Elizabeth Grausam - Goldman Sachs

[Ajit Karsha] - Royal Capital

Tien-tsin Huang – JP Morgan

Bhavan Suri - William Blair

Analyst – Capital Management

Mark Marcon - R.W. Baird

Todd Van Fleet - First Analysis

Presentation

Operator

Welcome to the Hewitt Associates fourth quarter and fiscal 2007 earnings conference call. (Operator Instructions) As a reminder, today's conference is being recorded. At this time I'd like to introduce the host, Director of Investor Relations, Ms. Genny Pennise. Please go ahead.

Genny Pennise

Good morning and thank you for joining us. On the call today are Russ Fradin, our Chairman and CEO, and John Park, our CFO. Before we get started let me highlight that when we discuss revenues we're referring to net revenues or revenues before reimbursements. During this call, we'll be introducing a new adjusted EBITDA metric and disclosing underlying operating income and earnings per share amounts. These are non-GAAP financial measures that provide a better understanding of our underlying performance. Please refer to the Investor Relations section of our website to obtain a full reconciliation of these measures to U.S. GAAP.

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

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

Now I'll turn it over to Russ.

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Russ Fradin

Thank you, Genny and good morning, everyone. Thank you for joining us. Fiscal 2007 truly was a critical year for Hewitt and we're very encouraged with the progress we made against our key objectives. We spent a great deal of time and resources repositioning the company for the future: stabilizing the HR BPO business; making necessary investments in the benefit outsourcing and consulting businesses; better managing our overall cost structure; and putting the right team in place to build this enterprise.

We took significant charges in the year related to the write-off of goodwill resulting from our revised growth expectations for the HR BPO business as well as a number of other restructuring actions. Some of the restructuring activities will carry into 2008, but overall we're entering the year in a better position to improve the long-term growth and margin profile of the company.

In terms of our performance in 2007, we're pleased with the strong revenue and margin performance in the consulting business, particularly in the fourth quarter. In benefit outsourcing we continue to see strong underlying margin expansion. Our challenge in this business is reaccelerating growth. While we're encouraged by our progress in stabilizing the HR BPO business, we have a long way to go to improve the long-term financial profile of the business.

Overall, we've seen positive trends in our associate retention, particularly in consulting. John will speak to our results in greater detail, but let me touch quickly on some of the highlights. We achieved impressive margin expansion in our benefit outsourcing business. While we're not satisfied with flat revenue, we're seeing positive signs on the sales front.

One of the most important elements of our strategy going forward is to accelerate the top line performance of this business. We've increased our sales resources and sharpened the sales process. We recently announced the acquisition of RealLife HR which enables us to further expand our presence in the middle market. These are examples of the types of things we're doing more of as we invest in future growth. As a reminder however, it will take time to realize the return on these investments, given the long sales and implementation cycles typical of these types of contracts.

In HR BPO, while the overall loss improved only modestly, it was roughly in line with our expectations and the volatility of the business has been significantly reduced. The majority of our clients in this business are pleased with the services we provide and we have seen some modest increase in project work which to us is an indication of growing customer satisfaction with our core service levels.

We're also making progress in some of the more challenging contract situations. We've had success partnering with some of these clients and are actually in the final stages of negotiation with a few of them. The likely outcome with these is a reduction in scope or restructuring of our original contract rather than terminations. Even with this progress, there are still a couple of situations that remain quite sensitive.

Going forward, HR BPO will continue to be an important element of our overall growth strategy. As it relates to new deals, we're reshaping our model to best fit our client needs and meet our financial objectives. We'll continue to evaluate new contracts that fit our refined model as we have for the last couple of years, focusing on a core set of services where we have deep expertise and can leverage standardized processes and platforms. Although we don't have any new deals to announce this quarter, we feel good about the three deals we signed in 2007 and believe this is about the right pace of new signings for us going forward.

Overall, consulting had a strong finish to the year with broad-based strength across all major practices and geographies. Demand for our retirement services remains healthy, particularly in North America and in Europe. We've regained momentum in health management and in certain areas of the talent and organization change practice and the strategically important Asia Pac region continues to be very strong. Consulting margins were solid, even after reflecting our higher year-over-year compensation costs.

As it relates to our efforts to reduce our cost structure, we've begun to rationalize our real estate footprint by consolidating -- and in some cases exiting -- certain facilities. We've also driven increased productivity and downsized in certain areas and continue to evaluate the balance of associates onshore versus offshore. The recent strength in benefit outsourcing margins is an example of how we're already realizing the benefits from these efforts. The actions will not only allow us to operate more effectively, they are also critical in allowing us the flexibility to reinvest in the business, including investments in our associates.

We finished the year on a strong note and feel good about our position heading into the new year. Fiscal 2008 will be a year in which we focus on the investments required to accelerate future revenue growth, even while we drive continued margin expansion.

I'll provide some additional color on our expectations for 2008 later in the call, but first I'm going to turn it over to John Park to provide more detail on our results.

John Park

Thanks, Russ and good morning, everyone. Let me start by recapping the highlights of our consolidated results. In the fourth quarter, net revenues increased 5% over the prior year quarter. After excluding the effect of currency, the decline in third-party supplier revenues and acquisitions, revenues increased 4%.

The operating loss in the fourth quarter was $281 million compared with operating income in the prior year quarter of $42 million. The decline reflects $363 million of pre-tax charges in the current quarter related to a number of unusual items which I'll go through in a moment, as well as a significantly higher bonus accrual, offset in part by a $7 million benefit related specifically to the timing impact of our bonus methodology. Adjusting for these items in the appropriate periods, operating income grew 67%.

The net loss for the fourth quarter was $266 million compared with net income of $23 million in the prior year quarter.

For the full year, net revenues grew 5% over the prior year to $2.9 billion and again, after adjusting for the decline in third-party revenues, currency and acquisitions, net revenues grew 4%. The operating loss for the full year was $143 million compared with a loss of $64 million in fiscal 2006, including approximately $409 million of pre-tax charges in the current year related to unusual items as well as $271 million of pre-tax charges in the prior year primarily related to the HR BPO business.

Adjusting for these items, operating income for the full year increased 29% over fiscal 2006, even after accruing for a significantly higher level of bonuses as a result of our improved underlying performance. The net loss for the year was $175 million compared with a loss of $116 million in fiscal 2006.

Because of the number of charges we took in fiscal 2007, I thought it would be worth a few minutes to summarize all of the charges taken throughout the course of the year and add some color on each. First, we wrote off $280 million of goodwill in the fourth quarter. You'll recall that in last year's third quarter, we wrote off $172 million of goodwill related to the HR BPO business. Over the past year with a new management team on board and with the help of outside strategy consultants, we've reassessed the growth prospects as well as our margin expectations for this business. As a result of this assessment, we wrote off the balance of the goodwill related to HR BPO.

To be clear, we do still expect to grow the business, but it will be at a slower rate than we previously expected with only three to four new profitable contracts a year. As we have said before, the HR BPO business remains a strategically important part of Hewitt, particularly as it complements our benefits outsourcing and consulting businesses.

It is also worth pointing out that the charge is not indicative of additional deterioration in the existing contract portfolio. We did not take any additional significant loss reserves in our HR BPO business this year and the few contracts that we've signed over the past two years are tracking to expectation and are expected to generate solid levels of profitability over their lives.

Second, as a result of the goodwill assessment, we wrote off $39 million of intangible assets largely related to the HR BPO business; $36 million of this was recorded in the fourth quarter with the remainder in the second quarter as previously disclosed.

Third, we took $32 million in severance charges this year related to productivity initiatives across the business. $8 million of this was taken in the fourth quarter. A portion of the severance was incurred as we completed HR BPO implementations and wound down the related teams.

Fourth, we took a $29 million charge in the fourth quarter related to our previously announced plans to consolidate our real estate footprint. Russ is going to talk about some additional opportunities we have on the real estate front in the few minutes.

Fifth, the results reflect a $15 million pre-tax charge related to the anticipated restructuring of one of our troubled HR BPO contracts, $12 million of which you'll recall we disclosed in the second quarter and the remainder of which was recorded in both the third and the fourth quarters.

Sixth, we recorded $10 million of loss provisions in the fourth quarter related to our UK pension administration business. As many of you know, we have a large presence in the UK in retirement consulting. What you may not be aware of is that we also have a closely related pension administration business. We performed an extensive review of the business over the last year and concluded that we needed to take loss provisions against multiple contracts. We're actively looking at ways to restructure this business to improve profitability and have already made some important changes.

Seventh, we recorded a $6 million non-operating gain in the fourth quarter related to the sale of an investment.

Eighth, the fiscal year results included a $5 million pre-tax charge resulting from the second-quarter resolution of a legal dispute with one of our benefits outsourcing vendors.

For comparability I would remind you that our fiscal 2006 results included $264 million of non-cash pre-tax charges related to the HR BPO business, as well as a $7 million pre-tax severance charge and a $7 million non-operating gain related to our actuarial business in Germany.

Despite the number and magnitude of these charges, I would point out that they are all consistent with our strategic and operational plans with the exception of the UK loss provisions. Also it's worth noting that of the $409 million of total charges in the year, we estimate that about $330 million of this is non-cash in nature.

Excluding a number of unusual items, the tax rate would have been about 39% in both years.

Our cash flow generation remains very strong. For the year, cash flow from operations was $435 million compared with $381 million in fiscal 2006. Free cash flow was $347 million compared with $251 million in fiscal 2006. The increase in free cash flow was driven primarily by lower net deferrals, lower CapEx, a decrease in working capital and higher underlying income. The improvement was offset in part by higher performance-based compensation paid in 2007 for 2006 performance as compared to the payment in 2006 for 2005 performance, and lower tax refunds.

CapEx was $88 million in fiscal 2007 compared with $130 million in the prior year. This level of CapEx was unusually low as we put a lot of major systems investments on hold while we sorted out our strategy and saw low implementation activity related to new HR BPO contracts, so you should expect higher levels of capital spending going forward.

We have heard from several of you that it would be helpful to better understand the underlying cash flow generating capabilities of our business, excluding some of the unusual fluctuations we have experienced over the past few years. To that end, we will begin disclosing a non-GAAP adjusted EBITDA metric. This metric represents EBITDA adjusted for a number of non-cash items, including goodwill and asset impairment, revenue and compensation deferrals, stock-based compensation and internal software development costs as well as a few other smaller items.

As Genny mentioned, you will find a full reconciliation to GAAP on the Investor Relations section of our website. For the full year, adjusted EBITDA was $436 million as compared with $318 million in 2006. Note that these amounts are adjusted for the unusual items I discussed earlier.

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

Starting with benefits, in the fourth quarter revenues declined slightly as increases in services to new and existing clients and organic growth of existing clients was more than offset by the impact of lost clients and longer implementation cycles required for some of our large and more complex clients. Adjusting for $41 million of charges in the current quarter, benefits outsourcing margins increased more than 500 basis point year over year, primarily as a result of our global sourcing, improved productivity and other cost management efforts.

It's important to note that while we feel good about the margin performance of the benefits business, we will be accelerating our investment in this business to regain top line growth and expand future margins. So you should keep that in mind as to set your future margin expectations.

The HR BPO business posted strong top line growth in the fourth quarter. Overall, after adjusting for the decline in third-party revenue and currency, revenue grew 9%, driven primarily by growth of existing clients including an increase in project work as well, as by contracts that went live in the 12-month period.

Excluding $[360] million of charges the underlying HR BPO operating loss came in at $37 million in the fourth quarter bringing the loss to $152 million for the full year, after adjusting for $343 million of charges. This reflects modest improvement compared with an underlying loss of $159 million in fiscal 2006 which is adjusted for $264 million of charges.

These results include a $10 million expected increase in intangible asset amortization this year related to the previously announced non-renewal of the BP contract, so we have seen solid improvement in the underlying operating performance.

Our efforts to stabilize existing client base and manage our overall costs drove the improvement that we saw in the second half of the year. We expect to see continued year-over-year improvement in the underlying operating loss of the business, especially after lapsing the post-implementation period for some of the large contracts that negatively impacted our performance in the first half of the year. But it's worth reminding you that while we feel good about the direction of the business overall, this is not a business that will track evenly from quarter to quarter given its lack of maturity and size, particularly as we continue to bring new clients live.

Turning to the backlog and pipeline, for benefits, the backlog was essentially flat compared to last quarter as new contract wins were roughly offset by adjustments to existing contracts and services that went live in the quarter. The pipeline was down slightly on a sequential basis as new prospects were more than offset by lost opportunities as well as some other adjustments. But it's important to note that excluding the impact of one large client that withdrew its RFP from the market, the pipeline saw a nice sequential increase. For HR BPO, the backlog declined sequentially as a result of a large contract going live. The HR BPO pipeline was also down sequentially, reflecting one of the wins announced on last quarter's call in addition to our continued selectivity.

The consulting business reported a particularly strong fourth quarter with organic constant currency revenue growth of 11%. On this basis, the talent and organization business grew in the high teens; both the retirement and the health businesses grew in the low double-digits; and the communications consulting business grew in the low single-digits. Demand for our retirement services remained solid, and we're regaining growth momentum in the critical areas of health management and certain areas of the talent practice. We are also particularly pleased with the tremendous growth being generated by our Asia Pac business, given its long-term strategic importance.

On an underlying basis, top line growth drove over 300 basis points of margin expansion despite higher overall compensation costs. This is after adjusting for the $6 million benefit related to the timing impact of our bonus methodology, as well as $3 million of charges recorded in the current quarter. Some of improvement that we saw in the fourth quarter is sustainable, assuming that the demand for our services remains strong, but keep in mind that the fourth quarter is a seasonally strong period for this business. Again, like benefits outsourcing, consulting is a business where we will continue to accelerate our investment.

Reported unallocated shared services costs were about 4.5% of net revenue in the fourth quarter versus 3.6% of net revenue in the prior year quarter. The increase is primarily a result of higher professional services fees related to specific strategy and improvement projects.

Finally, we weren't as successful with our share repurchase program since our last earnings announcement as we would have liked. This was mostly due to the fact and our tender offer was undersubscribed and under SEC rules, we were unable to be active in the market during the tender period itself and for a short time thereafter. As part of our existing $750 million share repurchase authorization, as of Friday's market close we've repurchased a total of 6.7 million shares for a total of about $205 million. This leaves us with about $545 million remaining under the existing authorization.

Now I'd like to turn it back to Russ for a moment.

Russ Fradin

Thanks, John. 2007 was a year of stabilization and rebuilding for the future. You've heard me talk previously us about our four strategic priorities:

  1. Keeping clients first.
  2. Creating a rewarding work experience for our associates.
  3. Growing with intention.
  4. Getting lean.

Our actions in 2007 were guided by these priorities, growing with intention by extending more aggressively in the middle market through our acquisition of RealLife HR. Contributing to lean by consolidating our real estate footprint to improve efficiency; freeing up resources to enhance the overall work experience for our associates; and invest in growth and other value creation initiatives while at the same time contributing to margin expansion. And restructuring in certain areas of the organization to ensure that we are aligned properly to the needs of our clients, to offer just a few examples. These four priorities will continue to guide our actions in the future as well as we focus on accelerating revenue growth while driving continued underlying margin improvement.

Let me provide some context as you start to think specifically about fiscal 2008. As many of you know, about a year ago we began to introduce this concept of recentering our business. Our work over the last 12 months has helped us regain an appreciation for the growth and margin opportunities that exist in our more established benefit outsourcing and consulting businesses. We're heading into 2008, well positioned to deliver solid margin, even as we fund important investments that will better position us to capture the opportunities to energize our growth rate in 2009 and beyond.

Our sales process in benefits outsourcing will be a key area of investment, primarily as we increase the overall size of the salesforce and enable their success by appropriately aligning their structure and focus with aggressive sales goals. Other key areas of investment will include new product development, initiatives to further enhance our service quality, and talent needed to grow in certain areas of consulting.

As I mentioned earlier, we're pleased to see that we've started to see positive indications with benefits sales as a result of some of these efforts. Savings resulting from actions taken in fiscal 2007 will partially fund these investments. Our real estate and severance actions, for example, will yield savings of about half on a run rate basis, and broader efforts related to the lean program are expected to yield gross savings that run much higher. We'll provide further updates on material developments as they arise.

So with that as a framework, in fiscal 2008 we're expecting mid single-digit total company net revenue growth comprised of solid growth in consulting, modest growth in benefit outsourcing and relatively flat revenue in HR BPO which includes a continued decline in third-party supplier revenues.

In order to gain a better understanding of our underlying performance, we assess our results once all unusual items have been removed. Our guidance for fiscal 2008 is therefore on an underlying basis, excluding the impact of unusual items in both years. In addition to GAAP, we'll report on this basis in 2008.

We're expecting underlying operating income of approximately $300 million to $315 million in fiscal 2008. This compares to underlying operating income in 2007 of $266 million. Each of the businesses will contribute to the year-over-year improvement, particularly HR BPO, given the improvement we're expecting in the operating loss in 2008.

Assuming we continue to execute on the $545 million of remaining share repurchase authority, this would translate into underlying EPS of between $1.70 and $1.80, which compares to $1.53 on an underlying basis in fiscal 2007. A full reconciliation of 2007 underlying operating income and EPS to GAAP has been posted on the investor relations portion of our website.

It's important to point out that the guidance excludes our previously announced real estate charges. You'll recall that in June we announced plans to consolidate facilities and exit certain properties in connection with our ongoing review of our real estate portfolio which were expected to result in pretax charges of $30 million to $45 million. Today we announced $29 million pretax charges related to these actions.

As we've made further progress in our real estate evaluation, it has become clear that we have even greater opportunity to consolidate our space. So in addition to the approximately $15 million that remains under the previously communicated range that we expect to incur over the next couple of quarters, we estimate and it is likely we'll incur an additional $20 million to $30 million in the second half of fiscal 2008.

In summary, we have taken a $29 million charge and it is likely that we'll take approximately $35 million to $45 million of additional charges in the coming year.

The guidance also assumes that we won't incur any additional significant charges beyond the real estate charges. At this point we don't foresee additional charges, but if that changes we will certainly keep you apprised. We're also expecting the adjusted EBITDA metric that John mentioned to grow roughly in line with EPS, again on an underlying basis.

In summary, we're pleased with our performance in 2007. We've added a number of new leaders to our team who have brought new energy and perspectives resulting in new ideas and plans and together we've made good progress against our key objectives in a short period of time. But we're just getting started. Establishing a plan is only the beginning. We now have a clear sense of our direction and going forward it's all about execution. I look forward to reporting our continued progress in the years to come.

Finally, John and I would like to thank Genny for all of her good work in trying to keep all of you informed and happy. She's been promoted to a new role within Hewitt and we will announce her successor shortly.

So with that, thank you for joining us today. Operator, we're ready to take questions.

Question-and-Answer Session

Operator

Your first question comes from Ashwin Shirvaikar - Citigroup.

Ashwin Shirvaikar - Citigroup

Thank you. Congratulations on the results and the fact that you're providing guidance must mean you must be feeling pretty good about your ongoing business.

John, can you break out the cash/non-cash portion of the HR BPO results and expectations? That's obviously important to figuring out the forward health of the business. And then just to clarify, you did say you're expecting about $500 million of EBITDA next year, adjusted?

John Park

We gave you guidance based upon growth that would be roughly in line with our income growth on adjusted EBITDA. Just to take you very quickly through the cash versus non-cash for the full year, of the $490 million of total charges, $333 million of that we estimate to be non-cash. So the non-cash pieces are of course goodwill which is $280 million; asset impairment of $39 million is non-cash; $11 million of the real estate charges which total $29 million are non-cash; and then $3 million of the $10 million in loss provisions related to the UK pension administration business are non-cash.

Ashwin Shirvaikar - Citigroup

Can you break it out on a basis of business segments?

John Park

We'd rather not do that on this call. We can always give you a little more color in a follow-up call, Ashwin.

Operator

Your next question comes from Jason Kupferberg - UBS.

Jason Kupferberg - UBS

Congratulations to you Genny, first of all. A question here on the HR BPO business. If you can help us understand what has transpired here in the last quarter as you wrapped up your ongoing analysis? The charges here are a bit higher than at least I was expecting, understanding that a lot of it is non-cash. Can you maybe just paint a picture of where we stand now in terms of forward expectations for that business?

In that context, maybe a little bit more granularity on how much year-over-year operating income improvement you foresee in fiscal '08, obviously on a pro forma basis?

Russ Fradin

Let me start with the HR BPO question and what I think we've said and continue to say all along is it's going to be an important part of our future. It's important as are the other two businesses. From that perspective, I think what you're seeing here is what the honest conservative assessment of the growth prospects for that business are.

We had looked earlier in the year at the sales pipeline, we had undertaken a strategy review with some outside advisors that's been ongoing for the last few months. And as it became apparent that the growth in that business -- although we still expect growth -- is going to be more modest than previous expectations, the logical outcome of that was that the remainder of the goodwill had to be written off in an accounting sense. So really, that's all that's happened here.

I think that we haven't changed our guidance and expectations about the future growth, but as that was confirmed through the outside strategy assessment, I think the accounting implication was fairly obvious in terms of what needed to be done.

As John said, these are non-cash items; they do relate to goodwill. Although let me tell you, we take them very, very seriously. From that perspective this was just a natural accounting outcome. But to be clear, we are staying in this business and we expect future growth in this business, just more modest than had previously been projected.

John Park

Jason, on the second part of your question which I believe was trying to characterize the earnings improvement within the HR BPO segment, what we're comfortable saying at this point is that improvement is a significant part of the earnings growth that we expect in 2008 versus 2007. Right now, we want to leave it at that. I think we really view this business as a business that we manage across all three lines of business and we think all three lines of business are going to contribute nicely to growth year over year.

Russ Fradin

The last thing that's worth adding, because people ask about this all the time, is that all of the new contracts we've signed are performing very well against expectations and what our model was in signing them. So it really is dealing with the legacy the issue to call it that. But we are quite pleased with the contracts we've signed this year and the last couple from last year.

Operator

Your next question comes from Elizabeth Grausam - Goldman Sachs.

Elizabeth Grausam - Goldman Sachs

I am wondering what some of the initiatives are that you have in place to reignite some of the growth in your benefits outsourcing business? If you could give us some color of how you think that business might evolve over the course of the year, because people are guiding to modest growth at least on the top line there?

Russ Fradin

I think the issue, as we mentioned earlier, is that we had gotten to a point where the HR BPO business had become a bit of a distraction in really understanding the full growth prospects in benefit outsourcing. As I said, though we still see real opportunity in HR BPO, we began to feel -- and I think it's proven out there -- that we were under appreciating the true growth prospects for benefit outsourcing that we see on a global basis.

From that standpoint, I think you can see investments along the following lines:

First, we clearly are adding sales resources and we have put in place management of those sales resources, some of the outsiders we've brought in that are we think very experienced and will bring the right level of focus, reaccelerating the sales growth within that business.

Second, we are going to make investments in the quality of the product that I think will be reflected to both the corporations and their participants in all three lines of business: health and welfare, defined benefit and defined contribution record keeping. So part of the issue is balancing that right level of investment.

Third, although we are pleased with quality, you're never pleased enough. I think we are putting investment into the actual tools that our call center people work with and the internal tools that help drive the internal quality. We are becoming zealous about the Six Sigma quality improvement efforts and all those kinds of things. From that standpoint, improved retention will also play into the growth rate in reigniting growth.

Finally, we've said that we really have not been a significant player in the middle market and, as we look at the real-life HR investment, we really believe that that combined with some other things we're doing around defined benefit recordkeeping in particular, will allow us to offer a much more robust and price competitive offer to the mid-market. A portion of our sales investment is obviously going against the mid-market.

So I really think you're going to see all four of those priorities play out, meaning that the larger and better management of the salesforce, the product investment, the continued quality investments and the focus on retention and the mid-market investment.

Operator

Your next question comes from [Ajit Karsha] - Royal Capital.

[Ajit Karsha] - Royal Capital

Congratulations on the quarter. If I do the math, it looks like you did $0.54 adjusted EPS for the quarter, is that correct?

John Park

I don't think we gave specific quarterly results.

Genny Pennise

We didn't disclose a normalized result for the quarter. We can follow up on some of the pieces with you.

John Park

Operator, I think the line may have dropped on Royal Capital.

[Ajit Karsha] - Royal Capital

Can you hear me? Sorry about that. So if I take the $82 million of adjusted operating income and then I add back the other income of $9.8 million and then tax impact that I get around $0.54. So would that be the right way of looking at it?

John Park

Well, we tried to put out there our best description of the charges and the ongoing performance so that everyone could make their own assumptions, but I don't think we want to comment on this call. We're not going to get into the practice of quarterly guidance. I think it's just a slippery slope that we're trying our best to avoid. That's why we're giving annual guidance for next year.

Genny Pennise

You have all the different pieces of the charges that impacted the quarter to make the assumptions.

[Ajit Karsha] - Royal Capital

Yes, I do. On the benefits outsourcing, the margin, if I add back whatever was in the press release, it looks like it was 28%. So just a question on how much of that are you planning on reinvesting back in the business in the sales and marketing?

John Park

Well again, from our perspective we're trying to give our best holistic assessment of the business in terms of guidance for next year. We made a fairly deliberate decision not to get into business segment by business segment guidance. I think I've said all along that this is an area that to reaccelerate growth we're going to have to make some investments.

You remember as we're doing that, we are continuing with the lean program next year. So again, it's hard to predict how much of the investment we'll recapture in margin, but I think you have a good enough sense of the overall guidance for next year to get some sense with the overall business of how much we're planning to reinvest in the business and that's why we wanted to be fairly holistic about the guidance.

[Ajit Karsha] - Royal Capital

Got it. Thank you.

Operator

Your next question comes from Tien-tsin Huang – JP Morgan.

Tien-tsin Huang - JP Morgan

Just a few benefits questions. Can you first give us a little more detail on the changes in your win rate and the retention rate? It sounds like there are still some changes going on there? And also by our count it looks like pricing per participant is trending a bit higher. Is this sustainable or is it really some of the project work that's contributing as well as the foreign exchange?

John Park

I think overall a few things that from our perspective what I'd tell you, we just had a sales rally about a month ago where we got the entire salesforce together including the new folks and the folks that have been around a while. I think that in understanding the kind of focus that we're looking to put on the whole sales effort and the focus we have in our win rate literally every week, it's a call that our head of outsourcing, Jay Rising, goes through with the entire salesforce.

All I can tell you is we're going looking to put out specific numbers, but I will tell you that sales is one of those things that we have a good feel for and we can certainly feel the momentum building and I'm a great believer that sales is a momentum gain. It feels a lot different than it did a year ago when we had sustained frankly some unexpected losses. So again, without commenting on a specific win rate, I think we feel very, very comfortable that the momentum has swung in that direction.

In terms of the other part of your question I'll look to John in terms of pricing, but with the project work, as you know, it is very difficult to look at the underlying pricing that goes on.

John Park

I think we would generally characterize the pricing environment per participant as being stable. Therefore, you can conclude that the calculations are up a little bit. We did see some healthy project revenue. We did also see the benefit of foreign exchange this past quarter.

Tien-tsin Huang - JP Morgan

The UK pension administration, the loss provision, it wasn't clear to me what triggered the change. Can you give us just a little bit more detail there? Thanks.

John Park

The UK pension administration business is a business that has actually been a loss making business for us for several years now. We took a pretty serious look at it this year. We spent quite a bit of time looking at the sales strategy and also the cost takeout strategy. And after a fairly rigorous review this year, we concluded that there were several contracts that we needed to take a loss provision against. It's obviously not something that we are pleased with, but we're spending quite a bit of time now focusing on restructuring that business and we expect to report out to you later.

One of the things that I will remind you of is, remember that this is a business that as we mentioned on the call, is pretty closely tied to the consulting business and also it's tied to our global business. Many of the customers in the UK pension administration business are large multinational companies that we have global relationships with. It's just based upon the structure of specific contracts and the way the accounting dictates that on that particular portion we do recognize that there is a short-term loss making potential for the business. We have to realize that in a reserve.

Russ Fradin

The only other thing that I would add in this area, because again it's something that we're focusing on and we're not pleased about, is that the contracts in this area are much more short-term in nature. They are multiyear contracts but they don't have the kind of tail that the BPO contracts have in terms of length of contract.

Operator

Your next question comes from Bhavan Suri - William Blair.

Bhavan Suri - William Blair

Congrats on the quarter. I had a couple of quick questions initially regarding the economy. Have you seen any impact in the various lines of business -- consulting, the benefits outsourcing, or the HR BPO -- around the impact in the economy especially as discretionary spend might come under pressure for project work?

Russ Fradin

What I would tell you is that the question you're asking is the question we've been asking internally on almost a constant basis for the last three or four months, particularly as the credit crisis has grown and all that kind of stuff. What I'll tell you is that, in my words, we haven't seen the canary in the coal mine yet, meaning there really hasn't been any impact on our business and we're not seeing any impact on our business.

In fact, where you might expect to see it in terms of discretionary spending vis-a-vis the consulting business, if anything, had just a terrific fourth quarter. So from that standpoint obviously the outsourcing contracts are longer-term in nature and you might see the project work impacted, but we really haven't seen it in either place. But don't take that remark of we haven't seen it as meaning we're not worried about it because it's something that I think we really need to really stay on top of.

Obviously we've got the consulting business which is discretionary spending, we have the project work and even in the benefit outsourcing business and the HR BPO business, remember that a lot of that revenue is based on participant counts so that you could even see an impact there. That's what we're keeping a very close eye on and we just haven't seen anything yet, but we're as worried as you are.

Bhavan Suri - William Blair

Back to the HR BPO, could you provide a little more color on the sensitive HR BPO contracts? Are you potentially concerned that those might just end up being a cancellation or would those be negotiated down to less contract value?

Russ Fradin

I think we've talked before about the majority of the book of the business here actually is performing, and performing pretty well. When we've talked before about the more challenging contracts we've put numbers around it like I think eight clients are in that category. So in this last quarter, we saw a real progress and pretty close to conclusion with two or three of those and it is lesser scoped work, lesser revenue but them continuing on as clients which we're quite pleased about.

But again, we wanted to put the marker out there that these are contracts, we do expect to obviously honor those contracts and we want to make sure that we do right by the clients. There are at least a couple of situations that remain sensitive or tense or whatever words you want to put around that. So I certainly hope to conclude them in an amicable fashion, but we wanted to put that out there that they are at a very sensitive stage at this point.

Bhavan Suri - William Blair

Great, thanks.

Operator

Over to Capital Management. Please go ahead.

Analyst – Capital Management

John, can you comment on what you expect the CapEx to be in '08?

John Park

We're not going to throw out a specific number, but I do want to say that this was an unusually low, low year.

Analyst – Capital Management

So more like '06, like 120 give or take?

John Park

I think, yes. I think going back to a more normal historical rate is probably a good assumption. We had so much going on from a strategic evaluation point of view that we really did hold back on making any major infrastructure investments. Also, just the nature of the cycle of timing on our HR BPO contracts and benefits contracts was such that you almost had a perfect situation in terms of lower CapEx this year.

Analyst – Capital Management

Now just taking that comment and translating your adjusted EBITDA guidance into free cash flow generation in '08, so if the CapEx is up give or take $30 million to $40 million and the adjusted EBITDA looks like it will be up about $50 million to $60 million, recognizing that year-over-year you're going to have a little bit of a drag from bonuses, it looks like you still should generate quite a bit of free cash flow, maybe slightly less than this year, but not materially less, still a pretty hefty number, right?

Russ Fradin

I just want to let you know, Scott, that coming in on a Monday morning early and hearing that New York accent just warms my heart. We are doing our best to put out as detailed a level as we can given all the questions. But I think we've said about as much as we want to say for people to do the appropriate math. Again, I have no doubt that you will do that.

Analyst – Capital Management

Last question, is there something below the line that's different this year than last year? Because if I take your $300 million to $315 million EBIT and take the midpoint of that which is $307.5 million, compare that to $266 million, that's basically $40 million. If you tax adjust that you get $24 million and even on the $105 million that's basically $0.23. So if I take last year's $1.53 and add the $0.23 that's $1.76. And you commented that the EPS is reflective of a buyback which doesn't look to be unless there's something below the EBIT line that's bigger in '08 than it was in '07. Is there something below the EBIT line that's different?

Russ Fradin

No, Scott, there isn't.

Analyst – Capital Management

So you're suggesting that it is reflective of the buyback, yet if I just merely take the EBIT guidance and tax effect it, you get to $1.76 versus $1.53, so it looks like the guidance you're giving is not that aggressive with regards to the buyback and other things of that nature.

Russ Fradin

What we're assuming when we give out our guidance is that we will complete our authorization as authorized. We've talked before about the fact that we intend to complete the buyback as authorized, but we'll also continue to look for opportunities to accelerate it if it's going to create value.

John Park

We did do that assumption. The other thing to remember, Scott, which may take a few minutes, is figuring out the weighted average share count for the year.

Analyst – Capital Management

I took the year end which is a very conservative 105. All I did was take the disparity in the EBIT guidance you gave is 300 to 315 versus last year's 266. That delta alone is basically $0.23. So if you add that $0.23 to the $1.56 you get to $1.76 which implies that you're not being that aggressive with regards to even the buyback, if you bought back any stock, I'm just taking the period end of 105, not anything beyond that. So it looks like the guidance isn't necessarily incorporating, unless there's something below the EBIT line that I'm not adjusting for.

John Park

We are very much anticipating completing the share repurchase as authorized when you look at what our guidance is based upon. What we'll be able to do, Scott, is off line we can give you a little more perspective on exactly what you're modeling and where it might be off.

Operator

Your next question comes from Mark Marcon - Robert W. Baird.

Mark Marcon - R.W. Baird

It sounds like you're basically saying that you're feeling good about having nailed down the charges, if I'm understanding you correctly. Yet at the same time, we still have a number of contracts that are still in a delicate situation. I'm wondering, are you fairly comfortable that even in those delicate situations that there may not be any more charges or how should we think about that?

Russ Fradin

No, I don't necessarily think that you should conclude that in the HR BPO business in total that there won't be any charges in the future. I think that we're now to a point where there's a range of outcomes that could occur across the HR BPO business and we want to make sure that we only talk about things that we know are likely to occur. At this point, we don't anticipate necessarily another large restructuring charge in the HR BPO business. That's not to say that we won't have a moderate charge or we won't have a large charge, but at this point we are not aware of anything that could occur that will create a significant charge.

Just to reiterate, we did say that though in the guidance that if we do have a situation where there is a significant restructuring charge large enough so that it will impact our guidance we'll certainly communicate that to you very clearly.

Mark Marcon - R.W. Baird

It sounds like you're assuming some improvement with regards to HR BPO in terms of the underlying profitability or diminution of the losses that we've experienced thus far. First of all, for the fourth quarter, stripping out all the charges, were you basically flattish relative to the third quarter or was there some improvement?

Russ Fradin

Basically flattish, yes, that's the right observation.

Mark Marcon - R.W. Baird

Relative to the third quarter?

Russ Fradin

Yes, but let me characterize that a bit. I would say that on an underlying operating basis we saw some nice improvement quarter over quarter sequentially. We had some compensation true-up items, specifically bonus items in Q4, that would offset that underlying improvement.

Mark Marcon - R.W. Baird

So just to be clear, in the third quarter I had you with an underlying loss of about $37.8 million. Are you saying that that's roughly equivalent to what you did in the fourth quarter?

Russ Fradin

Yes, we felt that the performance was roughly in line quarter to quarter.

Mark Marcon - R.W. Baird

Can you give us a little bit more of a sense, John, for the magnitude of the improvement that is going into the assumption with regard to the guidance for '08?

John Park

No, we'd rather not do that. As we said earlier, Mark, we really feel as though we're managing three businesses, that all three businesses are going to be significant contributors to year-over-year profit improvement and we feel relatively good about the operating momentum we have in all three businesses as it relates to profit including the HR BPO business.

Genny Pennise

Mark, excuse me, we only have time for one more question so we're going to have to move on here in a moment.

Mark Marcon - R.W. Baird

Okay. I'll follow up offline. Thanks.

Operator

Your final question comes from Todd Van Fleet - First Analysis.

Todd Van Fleet - First Analysis

Thanks for taking it. I wanted to stick with this theme of assumptions built into the guidance for 2008, I guess to kind of follow-on to the prior comment. It seems that for what you're guiding to from an operating profit standpoint for next year, it seems to be a bit of slight margin expansion overall for the business and that level of operating profit improvement coincides with the level of EPS improvement that you're forecasting, which again kind of begs the question as to what's happening below the operating line.

So let me ask you specifically, what is the diluted share count that you have assumed for your 2008 number? And then, can you perhaps elaborate on how you're viewing the buyback activity? Because if you're going to be kicking off $250 million plus in free cash flow next year, that adds a whole lot of interest income to the P&L. But at the same time it seems like the interest income would have to be coming down to arrive at the EPS number that you're talking about four next year. So I'm just hoping you can calibrate that a little bit more for us and maybe to start with the diluted share count? Thanks.

John Park

We're not going to get that specific because obviously it's very sensitive to be talking very specifically about our market activity as it relates to repurchasing shares. I think that we feel comfortable right now saying that our guidance is based on the assumption that we're going to continue executing a buyback program consistent with the authorization. I think giving any more detail than that is going to probably to be giving out too much market sensitive information.

We'd be happy to, offline, go through with how you are building up your share count assumptions and clarify any issues if we see any with the assumptions that you have in place. But we really can't be much more specific in terms of the repurchase. I would say that in terms of cash flow generation, we are also anticipating that we'll continue our M&A activity.

We did make one acquisition this year, we've stated that we're going to continue to look for tuck-in acquisitions will help to develop particularly our middle market offering. There will be other opportunities, too, that we'll find attractive. So we've built in the expectation that there will be utilization of cash for moderate-sized acquisitions.

Todd Van Fleet - First Analysis

John, regarding the acquisitions, is one of your criteria for completing an acquisition that it be accretive to earnings immediately?

John Park

Not necessarily, no. We do everything on a shareholder value basis.

Operator

Ladies and gentlemen, that does conclude our conference for today.

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