自動資料處理 (ADP) 2002 Q4 法說會逐字稿

This is premiere conferencing. Please stand by, we're about to begin. Good afternoon, everyone. Welcome to this ProBusiness fourth quarter 2002 teleconference. Today's conference is being recorded. At this time I'd like to turn the call over to the executive vice-president of finance and chief financial officer, Mr. Steve Klei. Mr. Klei, please go ahead.

Thank you. Good afternoon, and thank you for joining us for today's fourth quarter and year-end conference call and financial results. We reported our results after the market closed today. Joining me today is Tom Sitton [phonetic], ProBusiness' chairman and CEO. We will discuss both the quarter and the year's highlights. I will follow with the financial review, update you on the guidance going forward, and then we'll take your questions.

This conference call discusses the business outlook and contains forward looking statements regarding future events and the future financial performance of the company. These particular forward looking statements and all other statements may be made on this call that are not historical facts are subject to a number of risks and uncertainties. Actual results could differ materially from those projected in these forward looking statements. As a result of risks that the company faces. Please refer to our press release or a recent filings with the SEC for more information on the risk factors that could cause actual results to differ. The specific forward looking statements cover expectations for product mix and demand, interest rates, employment levels, revenue, gross margins, expenses, client acquisition costs and operating profits. This conference call will be posted on our web site and we disclaim any intent or obligation to update the forward looking statements, included in this conference call.

Now I'll turn the call over to Tom.

Thanks, Steve.

This afternoon I'd like to review our accomplishments for the quarter and year-ended June 30th and follow that with our perspective for FY '03. ProBusiness Services had a good year under '02 under difficult conditions. Even with the dramatic challenges of a slow economy and volatile market we hit our objectives on the top and bottom line. Most important, we made significant progress in approaching profitability, a commit commitment we made well over a year ago. Even with interest rates declining we executed according to our plans and continue to invest for the future without compromising the Corning stones of our business, high quality service and innovative technology. Taking a look at just one aspect of this improvement, our overall gross margin for Q4 increased to 58 percent from 55 percent last year, which is a significant achievement in this market. Fiscal '02 was yet another year of record revenues, approximately 169 million within the guidance we gave you in April. Implicit in this result is the fact we have slowed our growth rate recorded 12 and a half percent year over year revenue growing. This reflects in large part the efforts we've made throughout ProBusiness Services to achieve profitability in fiscal '03 as well as a weak economy in particular the contribution of lower interest rates. And teen though our revenue growth rate is slow, it is still higher than the industry norm. Despite the challenges of '02, this performance clearly demonstrates that we have created a successful business with a sustainable recurring revenue base. We accomplished these results while might meeting the three key requirements for success in this business. Delivering services clients want to buy, selling those services profitably, and retaining clients for a long time. Let me discuss the first requirement for success, that you have services clients want to buy. The best measure of that is our ability to start new business. The prospects voted [inaudible] as they usually do. We continued to sell and start significant amounts of new business during the year. This was a solid sales year for us, one of our top three, comparable to fiscal year '99. Today we serve more employees than we ever have, 5 million individuals in more than 10 percent of the fortune 1,000. So while you hear how tough it is in the marketplace from analysts and other companies, note that our team continued to perform very well in this tough environment. With continue to win business from the competition. This last year just under 60 percent of our new payroll business came from our two direct competitors, consistent with past results. At the same time we increased our penetration of the in-house market. These numbers demonstrate two important points. First, we continue to be effective against our competitors regardless of what you hear, read about discounting and sales tactics. Second, we continue to see a long term trend toward increased penetration of the in-house market. Both of these points are good news for ProBusiness Services.

In our tax business, consistent with prior years, about 80 percent of our business came from clients who process taxes in-house previously. This last year we sold new tax services to about 3 percent of the Fortune 500 demonstrating good sales minimum and lots of opportunity in front of us. Let's now talk about client profitability in FY '02. Second requirement for success in this business is that you bring clients in at a good gross margin. As I previously mentioned, our overall gross margin for Q4 increased to 58 percent from 55 percent last year. This demonstrates that we're capable of managing our gross margins under difficult economic conditions. In fact, in our core payroll and tax business our gross margin is at 60 percent, a level we believe to be the best in the industry. And central to our long term profitability. Margins on new payroll and tax business are coming in higher than our averages. I'm particularly encouraged by progress in our comprehensive outsourcing division. As you know, this is a relatively new business where we're offering managed services and payroll and benefits and [inaudible] departments and interact directly with client employees. We believe this is an area of great opportunity for us. Gross margins last year comprehensive outsourcing were the mid to high teens which is excellent for this early stage of the business. Let's move on to retention. File core requirement for success in this business is to keep clients for a long time. There are two relevant measures here. First client satisfaction, which is an indicator of future retention. This past year we retained an independent market research firm to conduct a blind survey of 30,000 professionals who work for the 11,000 companies in our target market. This research confirmed that we continue to be the market leader and satisfaction in our core payroll business and that our clients are significantly more satisfied than those of our direct competitors. While we're ahead, we're not resting on our laurels. Over the next year we're rolling out a major set of [inaudible] centers of excellence and we believe those initiatives will come competitive advantage. My personal goal is to lap the competition in service. After satisfaction, actual retention is the critical measure. We measure retention as static revenue retention. Let me make sure you understand that. That means if you have a client on July 1 who builds $100,000 a year and you still have that client on June 30th of the next year, you have 100 percent retention on $100,000 of revenue. This calculation weights clients by size and excludes any impact from price increases, employment growth, mergers, additional business and other factors. We know our calculation is the most conservative method of measuring retention in the industry, and we caution you about comparing our results with others which may include one or more of the other factors. We are the retention leader in the industry. This last year consistent with our prior history we experienced over 90 percent retention in our payroll HRMS division and right at 90 percent in our tax division. Which is better than we would normally expect in this kind of economy and market. Of the clients we lost, most were M and A related as in previous years. These numbers tell you that clients are staying with us for a long time, which is our goal to assure success and provide an excellent ROI on our invested client acquisition costs. And we're very pleased with that in this challenging environment. So my summary of the year is that FY '02 was a good year for ProBusiness. Even with dramatic challenges slow economy volatile market we hit our objectives on the top and bottom line, made significant progress [inaudible] and continue to invest for the future in service and technology.

Let me move on to our most recent results in Q4. In the fourth quarter we continued to attract great new clients to ProBusiness Services, winning business from our competitors and gaining significant penetration in the large employer market. Compared to our competitors, we continue to win far more business than we lose. In fact, for every dollar of business we lose we bring in $4 from our largest competitors. The fact I think you'll agree underscores our competitive position. We recognize revenue from a new client once they have started service. During the fourth quarter we added important clients such as DHL Worldwide Express, Exponets [phonetic], the nation's largest provider of converged communications to small business, Garden Ridge [phonetic], a large provider of home decor and craft supplies in the south and mid west, MTD Consumer Group, a leading provider of consumer products for lawn and garden power industry, [inaudible] service and technology provider to the petroleum and petrochemical industry and performance food group a large food service provider to the hotel restaurant school and cafeteria trade. All these wins were highly competitive. Our most frequent competitors remained ADP and Seridian. [phonetic]. In fact with the [inaudible] which I'll talk about in a Minute, every company in this particular group happens to come from ADP and Seridian. Progress and comprehensive outsourcing continues. Last year at this time we had four clients up and running. Today we have 7, among them DHL. All these clients are receive being an integrated front and back office solution that helps them turn fix $costs into variable expenses, expenses over which they can exert greater control with greater visibility. DHL has been a payroll processing client of ProBusiness Services for several years. When they pace the global slow down in overnight package shipment due to the recession they needed to right size their payroll department. Rather than relocate it or handle the reductions in-house, they outsourced the whole department to us. So they could down^size the department while continuing to prove their processes, procedures and overall quality of service to their employees. Exactly the outcome we sought when we started this business two years ago. Despite the challenging economy, we've been able to develop a good pipeline of prospects who are interested in comprehensive services, so I continue to feel very positive about the future. On the golden gait front we focused in FY '02 on processes, specifically increasing the scale ability of our deployment and implementation processes and on tools that can help speed implementations and speed service. We are on track to deliver our on golden gait this fiscal year. That positions in FY '04 to increase the ramp rate. This past year we introduced employee service portal for golden gait, clients which is actually our highest rated new product ever. We launched [inaudible] golden gait, we integrated R B R I and developed web based tax services. The important take away here is that at the beginning of our product cycle. We have created the core technology infrastructure. It works and clients are satisfied. We are now focused on adding internal service tools, new services for clients as well as features and functions to that infrastructure so that we can increase our ability to deploy services on it and begin to cross sell. We believe our integrated application infrastructure is a competitive advantage which allows us to bring new products to market faster while enhancing margins. We further believe the competitors who retain legacy mainframe processing engines at the core of their systems will be unable to deliver competitive levels of service in functionality to their clients over the next few years giving us an advantage in both service and functionality.

As we look ahead to the rest of the year, we foresee the same kind of tough economic environment continuing into FY '03. This is an environment we're very familiar with and where we've proven we can sell our services at good gross margins, increase our overall base of employees served and sustain high rates of client retention consistent with past experience. Given that experience and environment, we expect to start about the same amount of new business as we did in FY '02 at similar margins and see similar retention rates as in the past. In other words, we expect to have a good year and achieve our targets. There are two variables we do not control. First, employment growth. We expect to see flat to slight growth in employment this year. This is well below historical norms, but improvement over losses of 6 percent this past year. Second, interest rates. We expect to see historically low interest rates throughout FY '03. Because of these negative impacts on our revenue, we will not see much reported growth on the top line in FY '03, even though we continue to grow our actual business in all segments, in terms of employees served. In terms of the bottom line, we continue to believe we're on track for profitability in this difficult environment.

I'm proud of this year's achievements. We had a good sales year, financially we improved our cash flow, improved our bottom line and strengthened our balance sheet all with with singular focus on delivering profitability. Not one of these achievements was easy, yet we were successful without having to compromise our ability to sell or implement, our industry leading service or our vision on golden gait. I'm confident in the strength of our existing business and excited about the prospects for FY '03. On a personal note, I want to tell you in March of this year when the stock price was over 20, I entered into a 10 B 5 plan to sell some of my holdings to meet a long term commitment I made three years ago. That commitment involved building a modest beach front home which is now almost complete. As you know, an executive with a 10 B 5 plan sets up the plan well in advance and then does not control the timing of the sale. My plan is a long term commitment for small and regular sales on a quarter basis, 50,000 shares a quarter over the next year. The first sale is scheduled to occur in the next trading period for insiders and according to the plan the timing of the sale and the size cannot be changed. If necessary, I intend to extend the plan beyond a year on the same regular basis until the home is fully paid. When I meet the commitment over the next couple of years, I expect that approximately 90 percent of my assets will consist of ProBusiness Services stock and I will still hold between 80 and 90 percent of my current ProBusiness Services shares. Naturally as you can imagine, this would not be the time I would elect to sell my shares. However, I believe the benefits of the plan are that it's long term, most of the sales occur in future quarters, and the overall plan aligns well with ProBusiness Services' commitment to profitability this year, increasing profitability thereafter, and roll out of new service initiatives in technology. Consequently I believe it aligns well with shareholder interest. And as you know, I am and will remain one of the largest shareholders.

With that, I'll turn it over to Steve to talk about the financials.

Thanks, Tom.

I think the overriding theme fiscal year '02 of ProBusiness Services was our ability to deliver results in the face of a rapid unprecedented unanticipated decline in both interest rates and the employment rates at our existing clients. Not to mention the challenging sales environment. We delivered more revenue than our plan or even the guidance we gave in October of last year, and we brought EPS at the better end of the range. This success I think is a strong demonstration of our ability to manage our business and the commitment to deliver results. As a format today, I'm going to talk first about the quarter, then make a few comments on the entire year, and then I'm going to move to guidance. And after guidance we'll open it up for Q and A.

Throughout our financial discussions today, you'll hear about two recurring themes, the interest rate environment and decline in employment in our clients. Both impacted the results we're reporting today, and we believe that they will continue to impact our forecasted results. At neither interest rate nor employment decline, the results for fiscal year '02 would have been dramatically different. So as I discuss each result in greater detail, I will also provide you with the perspective on a result that shows the underlying strength of our business that these factors have obscured. The analysis I'll provide should also allow comparison to others in our industry who also report based on hypothetical standard interest rates, rather than actual declining interest rates we saw in fiscal year '02. Both interest rates and employment will reverse course. And as they return to normal levels, our results will be positively impacted and in a big way. Significantly reducing the gap to achieve our long term goal of reaching 20 percent profit. I'll go into that in a little bit more later.

Let's talk about the quarter. Revenue for the quarter was $40.3 million, this compares to 42.2 million in the same period last year, this represents a 6 percent decline. This was caused by two factors, interest rates that have fallen about 200 basis points year over year, and we've experienced a 6 percent decline in our payroll employees in our base, i.e., this is same store sales. The latter of which reflects the corporate layoffs that we've all been reading about. I'd like to highlight that despite the decline in employees in our install base, the total number of employees served by ProBusiness Services in both payroll and taxes is at a historical 5 of 1.5 million individuals in payroll and about 3.5 million in clients using our stand alone tax service.

Interest rates were 4.2 percent in Q4. This is versus 6.2 percent last year. On an average daily balance of $975 million for the quarter, that equates to a reduction in revenue of $4.9 million in the quarter. Our employment base on payroll clients that were processing as of June 30th, 2002 declined 1 percent in the quarter for a year to date cumulative total of 6 percent. The segment in our payroll base into four broad categories, retail, that represents around 25 percent; manufacturing represents around 10 percent; technology represents around 25, and then all else represents around 40 percent. For the year, the contraction that we're talking about has really come in two areas. First and foremost is technology. This fell 20 percent. So meeting our technology companies had 20 percent less employees as of June 30th, 2002 than they did at June 30th of 2001. Manufacturing fell 5 percent during the year and the other two remain relatively flat. At the point of reference in fiscal year '01 we saw overall employment in our employment base end up the year at 2 percent and fiscal '99 and fiscal 2000 we saw employment in our basin crease even more than that. Had interest rates stayed the same and had the number of employees covered in employees stayed flat, those two changes alone would have aloud us to show at worst [inaudible] and possibly break even. In terms of revenue composition for the fourth quarter, payroll services totaled $21 million or 52 percent total revenue. This is up 3 points of the percent of revenue from last year. Our average payroll client size grew to approximately 2,400 employees, up from 2200 last year at the same time. During the year we wrote 43 million payroll checks. Tech services accounted for around 36 percent of revenues, about $14.6 million. And this is significantly less than last year's Q4 levels and this owes to the decline in their interest income and although interest rates continue to fall during the quarter, fees were higher than last year, compensating somewhat for the declining interest payments. The average daily balance for the quarter was approximately $975 million. This compares with about $1.2 billion last quarter, and $875 million in the fourth quarter last year. The decline from the third quarter seasonal, the third quarter always has the highest average daily balance and this is due to the unemployment funds that we hold. For the fourth quarter we were approximately 60 percent hedged. Comprehensive outsourcing accounted for the remaining 12 percent of revenues or 4.8 million dollars for the quarter, and this was up about 9 percent from last year. Our average number of employees per managed payroll client is up 55 percent, though, to 9,900 and this was up from 6,400 last year. And if you remember two years ago we had no clients at all in the division. Our managed payroll service is a source of our revenue growth and comprehensive outsourcing, and this is an offering that we believe we are a leader. This is a service where we manage the entire payroll department for a client. Gross margin for the quarter which we compute as total revenue plus the cost of providing serves was approximately 58 percent versus 55 percent last year. I think you'll note that every quarter in fiscal year '02 we produced year over year improvements in gross margins. You will notice that for the first time we have broken out depreciation and amortization on the face of our income statement. We have moved to this new format to provide greater visibility into our model to allow the comparison of our operating margins with those of some of our peers as well as to provide greater visibility into cash flow. In the past we allocated depreciation and amortization among all the line items reflect the depreciation of fixed assets as well as amortization on the capitalized software. Our depreciation amortization expense reflects that of a growth company with relatively high levels of investments in new leading technology and is indicative of a business investing in the future. For the quarter this noncash expense represented 13 percent of revenues at 5.1 million. For comparison purposes, last year this expense was about 3.7 million or 8 percent of revenue. In the increase in dollars is primarily a result of the increase in the amortization of the software we placed in service during the year. This is primarily golden gait. As a percentage of revenue, [inaudible] increases slightly due lower revenues in fiscal '02. To allow historical comparisons, we have posted the unought Ted quarterly results for fiscal '02 with the depreciation and amortization broken out on our web site and this is now available on the investor tab so you can go to that and get the numbers on your own. General administrative expenses in Q4 were $6.1 million or about 15 percent of revenue. This is a little higher at a percentage basis than last year and this is due to the lower revenue from lower interest rates. R and D expense rose to 5.5 million, about 14 percent of revenues versus 10 percent a year ago. This reflects the ongoing investments in the latest technology and increased services. G and A R and D were both in line with our internal expectations for the quarter. Clearly the big news for the quarter as well as the year is the progress that we have made in reducing our client acquisition costs. We're reporting 12.8 million in the fourth quarter, approximately 32 percent of revenues. This is 23 percent lower than last year on an absolute dollar basis, and 7 points lower as a percentage of revenue. As we've been talking about, we expect positive and significant year over year comparisons in these costs as a percentage of revenue as we head to profitability. A process that began in fiscal year '02 and will continue to fiscal year '03.

As a side note during the quarter, we reduced our head count in the high single digits to the percentage of our employee base and paid severance and other termination related benefits of approximately $2 million. These costs were included in our results of operations. The vast majority of these reductions were in client acquisition costs. This was necessary to align our capacity with our cost structure going forward, and to eliminate the excess capacity we were carrying during fiscal year '02 in anticipation of the economic recovery. These reductions are completed. Our net loss before preferred dividend for the third quarter of fiscal '02 was 5.5 million or 19 cents per share. We made important progress throughout the fiscal year sequentially, producing our quarterly loss in every quarter during the year. Now I'd like to turn to our financial performance for the full year highlighting a couple key points.

For fiscal year '02 [inaudible] almost 169 million compared to 150 million last year, 12 percent growth. Our guidance at the beginning of the year was 160, to 165 million which we later revised upward to 168 to 170 million last quarter. Payroll services represented 51 percent of revenues for the year. Tax 38 percent, and comprehensive outsourcing 11 percent. For the full year our average daily balance was approximately $900 million with an overall effective interest rate of about 5.2 percent. These two numbers compare to 735 million and 6.1 percent in fiscal year '01. The change in interest rates accounted for approximately 8.5 million of lost revenue and profit. Overall, our core payroll and tax business grew about 11 percent while the comprehensive outsourcing business grew a healthy 25 percent. Gross margins for the whole year was 56 percent. 200 basis points Bether than '01 but the core business [inaudible] very strong at approximately 60 percent. The margin improvement was due to a focus on bringing on profitable new clients, focusing on efficiency in our work processes and importantly the improvement in our comprehensive outsourcing margins. This is in the area that is making great progress. In fiscal year '02 the gross margin in the business improved to the mid to high teens. This is a significant improvement from fiscal year '01 and is due to the focus on bringing on profitable new clients and leveraging fixed costs with increased volume. On an overall basis, had interest rates remained the same as last year, the gross margin would have been 200 basis points higher at about 58 percent overall. Our G and A and R and D expenses came in as planned, relatively stable to the prior year.

Client acquisition costs dropped more than 10 percent on a year over year basis, moving down to 34 percent of revenue from 42 percent last year. We are closely managing this area to align costs with expected revenues. If you look at field operating profits, this is a number that we calculate by subtracting client acquisition costs from gross margin as a percentage of revenue, we've moved as an overall company from 11 to 22 percent, double where we were a year ago. In the core business this is the payroll and tax business, field operating profit is now at 29 percent versus 19 percent last year. This is important as it represents the business unit contribution to the overall company in fiscal year '02 this is higher than it's ever been. The field operating profit in our comprehensive outsourcing business still remains at a also. This reflects our continued investment in new clients as well as we're not yet operating at full scale. We're planning to see significant improvement in FY '03 in this area. For fiscal '02 our net loss the forecast dividends, noncash dividends was 27.5 million or a dollar 5 per share. This loss was narrower than our per share guidance that we gave in October. Our balance sheet at fiscal year-end remains strong with approximately $93 million of cash, cash equivalents and investments. This was the most cash we have ever ended the year with. As you remember through a private equity round we added 56 million to our balance sheet during the year, an important effort undertaken to reinforce our staying power with potential clients. Excluding the financing activities during the year, we used approximately $25 million of cash, the least cash we have used in a fiscal year since fiscal '98 and in fact in the second half of fiscal year '02 we generated $2 million of free cash. This is indicative of the exciting changes that are occurring inside of our financial model. You can expect significantly reduced uses of cash in fiscal year '03. Furthermore we have virtually no debt. Also during the quarter we extended our $30 million unused line of credit to January of 2005. I think this is quite an accomplishment in today's environment.

I'd like to now turn to forward guidance. This section is particularly subject to the risks that I discussed with the safe harbor disclaimer earlier in the call. Over the last 18 to 24 months we've been communicating our intent on reaching profitability in fiscal year '03 and we are doing so again today. We are doing this in a much more difficult environment than we first made the commitment to you. Interest rates are down over 400 basis points and our client base is laying off employees instead of growing. We feel, however, that this is a very important milestone and one that must be reached. We're driving towards this goal with all the vigor you would expect and are making the necessary changes to achieve this objective. Our current models based on today's rates demonstrate flat to a slightly declining revenue growth in the first half of the year and accelerating second half of the year growth as we start to anniversary the lower interest rates. Overall, we're very cautious given the current interest rate and economic environment, but based upon the interest rates we're receiving today and the view of employment and retention that we'll go into in a Minute, we would anticipate low single digit top line growth for the year. The first half of fiscal year ''03 will be negatively impact due to the 5.8 plus percent effective interest rate that we experienced in the first half of '02. That represents the positive contribution of the hedging strategy that we've had in place. I'd like to lay^out our key assumptions now on interest rates, retention rates and employment levels. First on interest rates.

For fiscal year 2003 we are assuming an overall 4.0 to 4 touch-tone 1 percent rate for the year versus 5.2 percent in fiscal year '02. [4.1] with rates in the mid 4 percent range in the first half and in the high 3, the possibly as high as 4 percent range in the second half of the year. This rate represents the benefit of having locked into hedges on 50 percent of our base that will yield rates in the 5.1 percent range for fiscal year '03. Slightly higher than that in the first half. The other 50 percent of the average daily balance, we expect to yield 2.7 to 3.0 percent, depending on the quarter. Our forecasted interest rate decline of 110 to 120 basis points, this is the 5.2 versus the 4.0 to 4.1 percent, translates to a loss of about 10 to $11 million of revenue and profits, or about 6 to 7 percent of revenue. We're prepared to manage the company to profitability, even if rates go slightly lower. Our assumptions also include employee growth and zero to 2 percent, and client retention at normal levels.

Moving to costs and margins. We expect overall gross margin to move down slightly in fiscal year '03. Solely because of interest rates. We will continue to focus on bringing in profitability profitable new clients and on managing our costs. In comprehensive outsourcing division where interest rates do not impact results, we expect to see margin improvement. In fiscal year '03 we expect both G and A and R and D to decline substantially in the percentage of revenue from fiscal year '02 as we actually reduce the dollars we're spending here. We look for G and A to be in the 12.5 percent to 13.5 percent range and R and D in the 10 to 11 percent range. Maintaining a level of investment to make sure that we're successful in delivering on our vision of technology leadership.

Moving to client acquisition costs. This is the area that we'll experience the single biggest adjustment between fiscal year '02 and fiscal year '03. We're expecting to reduce these costs significantly both in absolute dollars and as a percentage of revenue. We are also expecting to see a big improvement in the cost to acquire a dollar revenue. In fiscal year '02 we spent approximately $57 million in client acquisition costs. In fiscal year '03 we expect to trim that to 17 to $20 million. We will do this by primarily reducing our excess resources, and secondly by modestly reducing our capacity. We carried a significant amount of excess capacity in fiscal year '02 and in anticipation of a recovery that did not materialize. We have eliminated this excess. In advertise fiscal year '03 we're looking to have the net cost to acquire dollar revenue, get close to our long term range of 80 cents to a dollar. We have been operating outside that range for the last three years due to a number of proactive company decisions and the negative impacts of the economy. Once we move past fiscal year '03, we're expecting to be in the range, once again.

In fiscal year '03 we expect depreciation and amortization to be in the 12 to 13 percent range, slightly higher than fiscal year '02. This is reflecting the increase in amortization of our software that has just now being placed in service. We expect over the next couple years to begin to see the increased revenues that will result from these investments. I would further expect to see fiscal year '03 as the peak year as a percentage of revenue and would expect steady decline in this number over the next few years.

Finally, as we have been stating for some time now, we would expect net income, the [inaudible] preferred cash dividends to be at a break even level for fiscal year '03. With shares out stand something where around the 28.6 million share level. For modeling purposes, we expect these pick dividends to be consistent with last year's amounts. This reflects break our break even results from operating activities. Our primary financial tar target for fiscal year '03 is going to be the full year numbers. As in the past, we'll be refining this guidance at each quarterly conference call, focusing primarily on how the year is shaping up as well as refining the next quarter's guidance. For the first quarter of fiscal year '03, this is the September quarter, we expect revenues in the range of 38.5 to $40.5 million, an EPS of before dividends of a loss of ten cents per share and 17 cents per share. We are expecting losses in the first half of the year in equal or better profitability in the second half of the year. One clear measure of our progress towards profitability is cash flow from operations. In the first quarter of fiscal '03 we expect to be cash flow negative at a reduced rate from fiscal year '02, and this is because the annual incentive payment that we will be making. We now tie the funding of all variable compensation of our employees to our annual results. However, we expect that beginning in the second half of fiscal year '03, we will achieve positive cash from operations and expect our first full year of cash from operations. On net cash cash usage, we will use approximately 15 to $20 million in the first half of the year, but the second half will be generating free cash flow just as we did in fiscal year '02. Capital expenditures will be approximately $25 million, slightly above where they were for fiscal year '02, but below the fiscal year '01 level. These numbers include software development costs that are a result our commitment to maintain a technological and enhancing are already strong competitive position. We expect to spend slightly more new capex as we see in depreciation and amortization. From top to bottom, we're making the changes necessary to achieve profitability and cash flow. For the past several years we have focused our organization on investing in those activities that will ensure our market leadership, our goal this year in fiscal year '03 is to reap the benefits of the profitable recurring revenue stream that we have built.

And now we'd be pleased to take your questions. 00:56:36

Thank you. Our question and answer session will be conducted electronically today. If you have a question or a comment, please press star 1 on your touch tone phone at this time. Once again, that is star 1 on your, touch-tone phone. If you are using a per phone you will not be able to ask a question unless you pick up your handset before pressing the digit 1. It will take a few moments or us to assemble our roster.

[Pause.]

Michael Baker, Raymond James.

Yes. I was looking for two pieces of data. One would be long term deferred revenues. I see that it's now long term deferred revenues and liabilities. Interested in just the long term deferred revenue piece as well as the tax service fee number. I know you kind of gave the combined number. Be interested in the separate.

Yeah. Let us grab that here, Michael, for you. For the quarter, the interest component was $10.382 million of interest earnings for the quarter, Q4. And the remainder of that would have been fees. And then on the deferred revenue piece - yeah, I'm getting that number here.

And -

Do you have anything further, Mr. Baker?

On the deferred revenue, he's digging on that.

I am. I can give that to you right here. That is $8.5 million.

Thank you.

Robert Mayna [phonetic], CIBC world markets.

Hi, it's Lisa [phonetic] for Robert Mayna. I believe you said in your assumptions that you're looking for flat employee growth over the next forecast period. How would you expect to achieve profitability if employment continues to decline?

Well, I'm giving you a set of assumptions that we're using. So we said flat to a slight improvement in that. If, just like, you know, any assumption that you have, whether that's interest rates, employment growth, new sales, expense levels, etc., any one component can change and not impact our ability to deliver profitability. So I don't know how to answer that question exactly other than we're committed to delivering profitability even if the environment gets slightly worse than where it is today.

I was thinking more along the lines what would you cut costs in a particular area. Give us some reassurance that you'll get to profitability in the second half.

Well, we've not only committed to second half profitability, but full year profitability.

Right.

So our commitment is to make the adjustments. I don't want to - we're not going to speculate on where we would make adjustments. I think the prioritization is important given, number one is focus on the bottom line and achieving break even. Number 2 is ensuring that we maintain our competitive advantage, and that includes service levels and technology, and number 3 is growth. So given that sort of prioritization, you can make some assessments about how we would look at adjustments that we would make if results in different areas didn't pan out.

Great. Thank you very much.

Randy Mill, Robert W. Baird.

I have a couple questions based on the assumptions. First of all, what's the average balance that you expect [inaudible], average daily balance?

We're expecting a slight increase in average daily balance from today, probably equivalent to the revenue growth, Randy, so call it low single digits.

Okay. And did I understand that you expect to be on average 50 percent hedged for the year?

That's correct.

Okay. And then that - the rate on the hedge [inaudible] 5.1 percent on that?

That's correct. A little bit higher than that on the first half, a little lower in the second half.

Okay. And then, Tom, you made a comment about penetrating in-house segment of the market. I was just wondering if you can give us more color to that. Are you getting a better response from in-house clients and what might it be that's causing that?

I don't know that I know the answer about what is causing the increase penetration in-house. But this has been going on for awhile. There's been a steady rate of increase over the last three years, and if I were to attribute it to anything, I guess, Randy, is that we're better at what we do now than we were. And in-house clients tend to be larger and more sophisticated in general and require a more sophisticated set of services. And I think we've moved our skill level up into that level where it's a good value proposition for them. I think this is a long term friend trend.

And is there a difference in the attitude among in-house clients to support payroll service versus the comprehensive outsourcing or the managed payroll side?

I don't know that I - what I see, the last number I saw was that it's pretty similar. In other words, we're getting, we're getting about, you know, the same kind of response in back office processing as we are in managed payroll. So I can't say right now. I don't think we have enough experience to know that there's any difference. You know, there are a lot of people who are certainly looking at managed services today, and I think you can see that we did get substantial growth out of that. So I think that's an indicator that we think there will be a trend toward managed services.

Thank you very much. I appreciate it.

Just as a reminder, if you do have a question or comment today, it's star 1 on your touch tone phone. We'll take a question from David marina of William Blair.

Hello?

Hi, Dave, this is Steve.

Can you hear me, Steve?

Yes.

I'm at a remote location. What I'm losing here is, I know you cutback your selling expense, and I know interest rates are taking a couple million bucks out, employment a couple million bucks out, but your revenue growth rate still seems, even when you adjust for those, way below your historical - can you just tell me why we're not seeing a little bit of revenue growth besides kind of low single digits?

I think it will be higher than that. If you looked at two factors, I think new said if you said interest rates were stable [inaudible], I think when I did my calculation, that was about $6 million of revenue in the quarter.

So if normalize, what would you say your growth rate?

Off 6 million, call it 40, is 15 percent. So that would have been just for this quarter -

I'm talking about for next year. If you add back the 6 million bucks -

Yeah. For next year, impact on revenues, there's a difference of 110 to 120 basis points. And just to do the math average daily balance we expect is less than a billion start with that. But just to do the math, that's 11 to $12 million. Of growth. And that's about, I think 6 or 7 percentage points there.

So if we take your previous sums, Steve, and you add that, you're talking about 12 percent growth on apples to apples basis if you will? Doesn't that seem like good relative to where you were, trying to give us some commentary on where that is? Is it the economy, not as many prospects, cutting back the sales force?

I think it's a combination of different components, but certainly we're making conservative assumptions about what happens in our base. If we're talking about a zero to 2 percent, I can tell you in past years it's been dramatically higher than that. So even if you go to what a normal employment growth would look like, probably minimum of 3, maximum of 5 or 6 percent. We saw that plus in previous years. So that's going to be a component of it. The sales environment is challenging. We're not forecasting it to get better. In fiscal year '03. So that adds into the equation as well. And then on top of that we're cutting back some of our capacity in order to achieve the profitability. So we have - and if you listen to the statement I made about the cost to acquire getting down closer to the range, we're spending the money - we expect to spend in the fiscal year '03 as efficiently as we spent it over the last three years. So I'm really actually pleased with the relationship of our investment and the new revenue we're going to be bringing in.

Okay. Thank you, Steve.

Anthony Gellard [phonetic], Livingston Capital.

Hi, guys. Thanks for holding the call and I happen to think this is a great story because there's huge leverage. So that's where we fall on that. Any^way, my question was I was just talking about the business you won from other businesses. If you offer them any rebate or anything, just trying to clean up the accounting, is there anything below the line that gets added back that would reduce gross margins, so is that gross margin improvement really kind of the good news that we think it is?

It's the good news.

Nothing below the line there.

Nope.

And in winning those in this bake off against others, what do you think got them? Was it - I mean did you compete on price or not, just so we can clear that up?

No. We compete on our quality and we compete upon saving the client money, which is not having the lowest fees, it's reducing their total end to end process cost. And we track and manage gross margins on every new client coming in and ensure that they reach our targets.

Okay. Thank you.

[inaudible] ACI Capital.

Hi, guys. Good quarter in a tougher environment. I just wanted to follow-up on a couple things just in terms of understanding the capex better, understanding sort of the break even on the new clients and how many quarters that's taking and also your experience of clients in bankruptcy. My question on capex is primarily, how much was there in the quarter and how much was that versus last year? And of that capex how much was capitalized software expense versus capitalized software expense last year?

It's becoming more challenging, as you know. We operate under S O P 98-1 for capitalization of internally used software. So it's more challenging to break out than it ever has been. So I'm going to just talk about capex on an overall basis. So, during the quarter we spent, we're looking at the number right here, 10.$5 million.

Uh-huh.

In total. 4 million? Okay, 4 million in the quarter on capex.

4 million in the quarter on capex, and that was versus last year?

Last year would have been 8.9 million.

Your capex came down quite a bit in the quarter?

Yes. We reduced it.

But hard to break out how much of that was software versus other?

Yes.

And then I guess [inaudible] the prior question, in terms of your disappointed on bringing in new clients I heard you say previously it was 6 to 8 quarters to break even on a [inaudible] in term of the up front sales and depreciation cost. Is that number staying even despite like the interest rates coming down and perhaps like the employment growth of those new clients not -

That's a great question. Because one of the things that we're doing today is we are pricing our new business with low interest rate environment. And our margins that we're getting on the new business remain at or above our target level. So we have not had to discount in order to get the business.

As far as what's the break even point on this, you're looking at, you know, in round numbers a couple years. This is based upon our target of getting it to, you know, more than a dollar, per dollar revenue. As you look at the last couple years we've been actually running over a dollar per revenue, but by the time we get into fiscal year '03 we ingot to be getting close to that. So if you look at what's it really taking to bring on a client, I am very confident that the return is as good as it's ever been and the only difference on an overall basis is that we've been carrying excess capacity for awhile.

Sure. And then the final question is it's sort of a follow-up to something I think we talked about a few months ago, which is that there were a number of clients that you took on in the middle of last year, but subsequently ended up going into Chapter 11, Enron and Alamo National were the two that came to mind for me. Obviously I know Enron has had a lot of layoffs. I don't know about Alamo National. I'm wondering how much of a drag has that been on your business and, you know, in terms of sort of - I think you said you expected to sort of head count under management to be flat to up 2 percent. You know, what is the - how much have you built in on sort of - have you built in sort of those companies continuing to layoff people or what's your exposure there to current or future Chapter 11s?

Let me put it into perspective. First of all let me make the statement that there are very few clients that we have that have over 1 percent of our total revenue. So start with that as a statement. Secondly, during the year, when you look at our retention rate and the reason for losses, out of business became a more significant number this year than it has been in the past. We measure that once they're out of business. So the fact that Enron is not yet out of business still processing means they're included still in our numbers at the end of the year. So going forward, don't want to speculate on what might happen to any single one of our clients. I think - I would just point to we believe overall we're managing and forecasting the business to be zero to two which is better than '02, but worse than history.

The only thing I would say the client losses that we get and the out of business component of it is [inaudible].

Good point.

Historically in our large employer segment most of these companies don't get - don't go out of actually don't go out of business. They get recycled into some other business. So you don't see a lot of real [inaudible].

I guess it also depends on whether it's M and A and whether it's out of business [inaudible] the client, whether it becomes a net positive or net detractor from your overall cash flow.

Well, by the way, [inaudible] reflected overall Enrons and K-Marts and that sort of get real reflected in overall employment losses last year of 6 percent. So these numbers are fully - we're fully baked into the business. If you think, you know, if your prognosis for the economy is that it's going to be equally bad, tech is going to be - lose 20 percent of their employees this next year like they did last year, which would create a tech sector that's about half the size that it was in 1996, you know, then we have other problems in the economy. But, our forecasts don't actually include that.

Got it. I sure hope that doesn't happen.

We don't actually see that as the numbers, either.

Thank you very much for answering my questions.

And just as a final reminder, if you do have a question or comment, please press star 1 on your touch phone phone.

We'll go to Michael Baker Raymond James.

Yes. Steve, I was wondering if you could give us a flavor of some of those liabilities, if you will, on that long term deferred revenue and liability line.

We have the deferred revenue that we talked about and the other component of it is about $5 million long term compensation. This year what we did was instead of paying all the variable compensation in the current fiscal year, we elected to pay it over a longer period of time.

So the two numbers, then, were 8.5 or 18.5?

Long term we've got 18.$2 million, short term is $8.5 million.

Okay. And that's for the liability side?

That's for the liability side.

And then if you could give us a sense of the trend in same store, if you will, the employment levels?

Sure. Up through the first three quarters, and let me state that this is for our payroll base. This is the one we can measure most exactly. For our payroll base we saw employment at clients that were with us at June 30th of 2001 decline 5 percent for the first three quarters, and then 1 percent additional in the fourth quarter that we just completed for a total year to date of 6 percent.

Thank you.

Mark mar kin, Wachovia Securities.

Good afternoon. Your service reputation continues to grow from what I could tell, and I'm wondering what sort of implications does that have with regards to pricing going forward? And particularly with regards to implementation and covering these [inaudible]?

Would you be implying that can we improve our margins by leveraging our reputation?

That would be the implication, wouldn't it?

Okay. I can tell you we certainly try to price - to do two things. One is to get us a very good margin, and two, to provide a great ROI for the client. So we have to factor both of those components in. And today environment, well, you hear some of our competitors talking about some of the price pressures that they're feeling. Our margins are holding up. I think that's an indication from my perspective that we are able to leverage the reputation. In today's challenging environment, we're not able to get more up front. This has been a real challenging year. Fiscal year '02 we improved a little bit from fiscal year '01. I'm going to be hard-pressed to see if we can improve in '03. In fact, I would believe that it might come down a little bit in '03 given the pressures. That's an area the clients hit back on the most, is the up front fees.

I understand. What sort of ROI story do you have to go out with at this point for it to become compelling for clients, you know, given, you know, the greater hesitancy on corporations to engage in anything?

Well, it's an interesting question, and it varies dramatically from where we could actually charge them more than what we were paying to 10 to 20 percent less. And it depends upon what issues they're experiencing. So, for instance, leveraging our service reputation and - service is both our ability to actually deliver, increase a good working relationship with the client. If the client, the potential client is having serious issues with the actual delivery of the operational delivery of paychecks or tax services, we can come in, at or above on the price because they're just not getting what they want. For those clients that are reasonably happy, looking to modify their cost structure, that creates a different challenge, and I think in that environment, you're looking to get anywhere from 5 to 20 percent of savings out of their model. And again, I want to reemphasize that is not by us lowering our price, it's about changing the way they do business so that they can reduce their cost structure.

Would that be first year savings generally speaking in terms of -

That would be recurring.

Okay, great. Thank you.

Randy mill, Robert D W bared.

A quick follow-up, very different [inaudible].

We don't actually measure checks per client in the tax business, Randy. And checks per client is something that don't have that statistic that we manage. We manage the average number of employees per client.

Right.

And then the tax business is actually gone up during the year, and the payroll business it went up as well.

I would say that the tax business tends to behave like the Dow. These are on average the, you know, in terms of employment level, so they have been hit in general left in the overall economy.

Isn't the impact, though, a little bit greater of a loss [inaudible]?

Again, we don't measure the employees, but I would suggest to you based upon the proxies for that measure that we look at, which is their revenue, annualized revenue, I would agree with Tom that we're not seeing the same sort of decline. I don't believe that they decline 6 percent. And I think, again, let me reemphasize, in the national tax business, the average size of the client there is 18 to 20,000 employees.

Okay. Thanks.

Final question will come from Dan Berkstrum [phonetic], RBC Capital Markets.

Hi, guys, it's actually George Sutton. Quick question on your analyst talked about some of the new initiatives, some of the things that weren't [inaudible] expect Asians, one of them was an HRMS system you also did [inaudible]. Can you give us an update on those, where they are? Are they in beta yet [inaudible]?

Yes, George. The HRMS system is the integrated golden gait application. It's actually installed out at over 10 clients today. It is apartment one [inaudible] we'll double that install base this year. So that's all out and functioning and it's in release. And then we're going to ramp that in beginning of '04. And we are working actively on the time and attendance piece and that's probably an '04 release as well. That won't be introduced into the sales force until [inaudible]. We'll be working on that this year.

And then benefits was the other -

Benefits is also an '04 target, target product. So that should - we should complete work on that right after the some^time right after the first of the calendar year in '03, and then because of the way the sales cycle is on that, first clients on that will really be in the open enrollment period in the fall of calendar year '03 and our fiscal year '04.

Thanks, guys.

Thanks, George.

Mr. Klei, there are no further questions at this time. I'll now turn the call back to you.

Thanks for joining us today. Tom and I will be available for follow-up calls the remainder of today. If you'd like to spend some time with Tom or I, please feel free to call us. For more details on our upcoming conference schedule or to be alerted by E-mail of our upcoming events, please visit our web site at www.ProBusinessServices.com and we look forward to meeting with you and thanks again for your continued interest and support.

That concludes today's ProBusiness Services teleconference. You may now disconnect.