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.