自動資料處理 (ADP) 2005 Q3 法說會逐字稿

Good afternoon. My name is Cheryl and I will be your conference facilitator. At this time, I would like to welcome everyone to the Automatic Data Processing, Incorporated third quarter earnings conference call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you. I would now turn the conference over to Karen Dykstra, Chief Financial Officer. Please go ahead, ma'am.

Good afternoon. I'm Karen Dykstra, Chief Financial Officer for ADP and I'm here, as usual today with Art Weinbach, our Chairman and Chief Executive Officer. And I would like to welcome everyone to our third quarter 2005 conference call.

I've issued our earnings release earlier today and reported 11% revenue growth and earnings per share of $0.57 for the quarter. We had a very strong quarter overall with key metrics improving and we're feeling great about the momentum right now in our businesses, particularly in Employer Services. So based on some of these improvements, we will likely be at the high end of both our revenue and earnings per share guidance this year. And with those very few comments, I will turn it back to the operator.

Before I do, though, I need to say that we will discuss forward-looking statements that involve some risks, and some of these are disclosed in our periodic filings. And as usual, ask that we try to keep our questions down to one at a time.

So at this point, I will turn it back over to the operator.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Adam Frisch with UBS.

Great. Thanks. Good afternoon. Just on the payroll side, I wanted to address the new sales growth. Can you give us a little bit more color on why it accelerated, and specifically was it an increase in customer and market demand? Or better execution by your sales force? And what can we expect throughout the remainder of the year?

Adam, as we have expressed to you in the past, in any individual quarter, you can get some variations and some aberrations as a result, so even as we had slowed to an 8% growth in the last quarter, we were still very confident that it was really one-time type things as opposed to anything unusual. And I think while we had a stronger quarter, I would say -- I would say the same thing, at this point in time.

We did especially well in our national accounts business, our PEO world, international was stronger, so it was spread pretty much across the board. But I think this type of variation can occur within a quarter, and we're still comfortable with where we've been and with our double-digit forecast for the year in terms of our overall sales growth.

Okay. Can you talk about the margins as well and why they were up?

The margins in Employer Services specifically?

In Employer specifically, yes.

Sure. The margins were up and, of course, they are over 2% in the third quarter. Now, we've been expecting for the full year, that we would be up about 1 -- 1 to 1.5%. Some of it is because of some better performance on acquisitions that we made at the end of '03, and integration and some of them from '04, and some of it is from actions that we took last year to consolidate locations, for example, in our benefits business. A small part is because we had some one-time charges in our third quarter in Employer Services last year. And a good part of it is because it is just leverage, our business is a scalable business and we've got revenue growth improvement and we're seeing the results on the bottom line.

Okay. Great. And final question. Can you just give us an update on your progress on two fronts. First the BPO initiatives, and second, your on-demand product development with Microsoft?

The BPO effort, which we call COS, or Comprehensive Outsourcing Services in Employer Services is continuing along the path that we've outlined before. So we think we're very well positioned in the market. We have successfully been able to close a number of deals. We're in the implementation stage on several transactions. And our pipeline remains very positive. So we're feeling very good about the direction. I think it would be appropriate to look for continuing good growth coming out of our Comprehensive Outsourcing Services.

The other part of the question was our low-end product, the joint venture or the deal that we have with Microsoft where we are integrating our payroll into their system for the small business client. We are in the -- still in an early stage, kind of a preannouncement stage of that. We have a number of test clients. And I would say that as far as the quality of our ability to deliver software -- to deliver service and the quality of the integrated software, we're feeling very comfortable at this point. But the announcement is still going to be -- when is it?

The rollout is in September, the fall.

September, so basically --.

So when are you expecting like any kind of material data points where you can say it's either off to a good start or not? Is that going to be kind of like midway through '06?

We wouldn't have anything until after the initial launch, so it would be some point in the latter half of '06 we will at least have some more feel for the amount of volume that we're getting. I wouldn't expect it to impact our revenues very much in '06, but yes, it would be later in fiscal '06.

Okay, great. Thanks so much.

Your next question comes from the line of David Togut with Morgan Stanley. Sir, please go ahead. Your line is open. That question has been withdrawn. Your next question comes from the line of Bryan Keane with Prudential.

Hi, good afternoon. Just wanted to talk about the full percentage point improvement in retention. What do you think is behind that, Art?

I would like to think it is all the things we talk about all the time. We have had a significant focus on Client Service and on Client Service levels for several years. The -- I would say that within our culture today, the concept of world class service is embedded and is very real. We continue to improve. We continue to improve our processes and our experience and our -- the technology that we're using. But an awful lot of it is just the quality of the people that we have, the experience of the people, the attitude of our associates internally. But putting it all together, we're making the client experience better than it has been, and we've had a steady progression in terms of our retention.

Having said all that, I've still been surprised on the upside. So I have been extremely pleased with the very strong year-end we had this year, and our overall retention results.

I think I would add, Bryan, that the better we are at bundling some products, and further penetration with our add-on products, particularly products like time and labor management, that the better our retention is. And we have really been making important strides in terms of that penetration, so that definitely helps our client retention.

Where does that take annual retention rate to? Is that like 88, 89%? Or where are we now?

Generally, when we talk overall retention, we have to blend a lot of different numbers. We have to blend in the very low end of the business, our major accounts. The very large accounts. And obviously, the kind of the larger the client, usually the longer that they stay with us. But we're starting to get up in the 89 -- 88, 89% range right now.

Okay. And then I just wanted to ask a question, on the release, one of the things that popped out to me was a lot of the growth, future growth opportunities is going to come, we talked a little bit about Comprehensive Outsourcing already, but I was interested in the new distribution channels and then any update on the sales force and growth there.

I think the new distribution channels are the type of things that we were talking about when we were talking about the Microsoft transaction that we were talking about before. We're talking about things like the SAP relationship, which we've announced on an international -- on a global basis. And we also have some alternatives to our direct sales approach that we're trying in telemarketing and other arenas that are showing some early signs of success. So those are the basic areas that we're focused on.

And in addition to that, we do continue to add to our sales force, and we had been adding for the last couple of years, and we continue to add. We're already ramping up in anticipation of next year as well.

Okay. And then what is that annual sales growth been growing at, I guess recently, and where do we expect that to go?

The headcount growth, you mean?

Yes, right.

I believe it was about 10% last year. We were planning on somewhere around 6, 7% this year. I don't think we're quite at the number we planned. So we're a little lower than that. And I can't say yet for next year. We're not through our planning process. So the number for next year, we don't have yet, but I can't imagine it will be much lower than what we did this year in '05.

Okay. Great. Thanks.

Your next question comes from Pat Burton with Smith Barney.

Hi, congratulations on the quarter. Karen, could you give us an update, please on the investment portfolio in terms of the yield and the outlook for the remainder of the year?

Sure. We had our yield, total yield, which is corporate and client fund yield was 3.4% for the quarter. Now, that excludes the losses that we took in the portfolio, if you looked into the details of the release, we did take about $10 million of losses in the portfolio in the quarter. But the 3.4 excludes the losses. It compares to 2.9% last year. And that's probably the biggest gap that we saw so far this year. Clearly, bigger improvement than we had in the first and second quarter. And if you look back at the stats from last year, that was really our low point was in the third quarter of last year when we hit down as low as 2.9% overall.

Looking towards next quarter, I think we will be around 3.5%, and we will end the year somewhere around 3.3%.

And the yield dollars and float?

Oh, the average daily balances, if that's what you're referring to --

Yes.

-- was 14.8 billion for the third quarter. Which is -- the third quarter is always our largest quarter. So -- and it was 14.8 billion, it was somewhere around 11% growth for the quarter.

Thank you.

You're welcome.

Your next question comes from David Togut with Morgan Stanley.

Thanks. I was accidentally dropped out of the queue. I just had two quick questions. First, it looks like the decline in revenue portrayed this quarter was a little less than we've seen historically. Have you seen a pickup in the retail mix?

We actually saw a little bit of pickup in the retail mix, but it came a lot from the electronic retail clients, so our mix was 39% retail, 61% institutional, the way we used to count it or we originally pluck it in those two. But of the retail mix, clearly all of the growth came from the electronic portion of it. So that is at a lower revenue portrayed than the normal retail. Having said that, it did help and our decline of 8% was clearly lower than it has been for the last couple of quarters.

And how does the electronic pricing compare to straight institutional?

It is somewhere in between. It does depend on the client. And it is -- a lot of it has to do with the mix and which client is growing and so on, but I would call it somewhere in between.

And then what have you seen so far in the key processes in Investor Communications?

Well, it is really -- it is a mixed bag. I think so far, we've seen a lot of volume from the Mutual Funds still. Mutual Fund meetings picking up, and more of the Mutual Fund special communications, whether those are supplements the prospectus, or other kinds of special communication. So clearly, a big part of our growth that we saw in the third quarter which are drove 25% growth in pieces was Mutual Fund mailings.

Our normal corporate issuer type proxies we're expecting about 4% growth for the year in what we call "stock record growth" and that would probably equate very much to the kind of volumes that we will see. For the most part, we will see that in the next quarter. We don't -- there was clearly some in the third quarter, but the fourth quarter is normally a bigger quarter for us.

So overall, when I look at the year, we are still thinking we're going to have around 11 or 12% increase in total number of pieces delivered, which is a combination of Mutual Funds and corporate issues and so on. With the fourth quarter being our biggest volume because it always is, but it is probably going to be the lowest growth quarter, because the volume in the fourth quarter will come from the corporate issuers and that is at a slower rate, and does not include all of this extra activity that we've been seeing from the Mutual Funds.

So the number of one-time mailings that we've been talking about over the last few quarters, we don't see those coming right now in the fourth quarter, but the -- so the kind of business as usual will give us the normal growth that we would be getting.

In addition to that, I guess I would add that in the fourth quarter of last year, we had a very large mailing that we're not anticipating as well. So we are anticipating a slower growth in terms of number of pieces, and revenue in the fourth quarter for the Investor Communications Group.

Great. Thank you.

You're welcome.

Your next question comes from Greg Gould with Goldman Sachs.

I wanted to understand, Art, where do you see in Employer Services the fastest or the greatest customer activity over the next several quarters? Is it in national, majors, or SMB?

It is an interesting question. Probably the place we've seen the greatest activity has been in our PEO world, which is in the -- it is kind of in the low end of the market, but it is -- it is really in the professional employer organizations where we have a broader array of services than we do in our regular small business. But other than that, I think I mentioned earlier that in this last quarter, our national account sales were pretty good. And I would expect for the full year, we would end up at that same point.

And in addition, international, which has been quite weak over the last couple years has really been rebounding, and I would expect that rebound to continue at least for a couple quarters more in the future and hopefully a lot more.

What caused the weakness in international to reverse? Is it purely economic or things that were changed on the sales force?

Well, I think it is -- it is always a combination of things. It is never as simple as just the economy. Although I believe the economy has firmed up in a number of countries in Europe. Part of it is product. We have some product that has come to market, which is new and has really given a kick, a boost to our sales in some -- in some individual countries. And our sales force. We have, as we've seen, some momentum in sales. We've had more confidence in terms of adding some sales people.

Okay. And then one last question. What was the beyond payroll growth in the quarter?

Beyond payroll growth was 19%, and payroll and tax was 6, and that is a United States-only figure.

Okay. Thanks.

You're welcome.

Your next question comes from Brandt Sakakeeny with Deutsche Bank.

Thanks. Hi, Art and Karen. A couple quick questions. Karen did you give us the pace per control number? I'm not sure I heard that figure.

Not yet. It was a growth of a little under 2% for the quarter. It was about 1.8%. It was, as it has been for the last couple of quarters, higher on the small business side, and a little bit lower as you move up to the national accounts segment.

Okay. Great. And, Art, a question for you, I guess, I think I read somewhere that the SEC is looking into potentially changing the way that Mutual Fund and corporations have to communicate with the public, and also I guess looking at perhaps just signaling where investors can find the data on a website. Any thoughts in terms of how that business -- how that change potentially could affect the communications side of the business?

Well, anything that improves the -- or increases the number of communications has generally been a benefit to us. If the issue is access to data that is put on a website without any notification, that would probably be a negative for us. If on the other hand there is a notification, and then it could very well be a positive or a net positive. But it is not at all clear to me exactly how that -- how that whole area will sort out. So I don't want to get ahead of the curve on it.

Okay. Okay. And just to come back quickly on the PEO business, that business has really accelerated nicely the last several quarters in the mid-20s I think was the growth rate. What can we think about and model for sort of sustainable growth rate over the next several quarters in the business? And why has it been so successful recently?

I think it has been a successful business for us for the last few years, once we basically solidified our base, and we changed the demographics of the type of client that we were targeting. We have really had a consistent success for a number of years. Part of the revenue growth we get is from increased Workers Comp rates and increased health insurance and so some of that is a pass-through. But the basic momentum in the business, in our ability to expand into incremental cities, and in some cases incremental states, gives us a geographic expansion opportunity in addition to the normal momentum, so it is also a very good solution.

I mean if you really look at the solution for a small business, where they can hand off similar to the way we think about business process, outsourcing, in general, hand off most of their payroll human resource activities, in a single place, and have high confidence it is going to get done well, it really is a very good solution. So it is a sell that works in the marketplace right now. So I think you could expect to see continued buoyancy in the future.

Great. Thank you.

Your next question comes from Steve Weber with S.G. Cowen & Company.

Good afternoon. A couple of questions on brokerage systems. I'm looking here, and you actually did better in revenue in DSG than I thought, but the incremental margin looked pretty light, as compared to the prior year, and a typical third quarter progression. Is there something else going on there? And could you comment on kind of where you think the margin is going to end up for the year?

Yes, I -- you're right, that the revenue growth was overall 5%, and the margins were slightly lower in the third quarter than the year before, and it really all has to do with where the revenues came from, which were primarily Investor Communications, which in general has a lower margin than the traditional back office business, because of the postage component which is the pass-through.

In addition, just to add a little bit more color, the Investor Communications side where the growth came in that group was from the Mutual Fund activity and mailings. And that itself has also lower -- a lower margin component than the traditional issuer or proxy business. So it is really all about the mix, and that's what's going on that led us to a slightly lower margin than last year in the third quarter.

Having said that, we still believe that for the full year, we will have higher margins for the Group, on a year-to- date basis, we're still well ahead of last year's margins, and for the year, we will be somewhere in the 16 to 17% margin range. That's our current forecast.

If I can just follow up, did you give us the -- what the trend was in ICD and BPSD year-to-year in revenue? And maybe for the year-to-date?

Sure. The BPSD which is a combination of our traditional back office business, plus some other businesses, like Wilco and our ICI fixed income business, declined 8% for the quarter or 4% year-to-date. Now we did have a divestiture of a company called Ellimar [ph] last year, so the internal number for that group was -1% for the quarter. On the Investor Communications side, the revenue growth for the quarter was 11%. It would have been 14% if you just looked at the internal growth. And on a year-to-date basis, it is about 10% growth.

Okay. And then if I could follow up, I heard something at the analyst meeting that you expected that you would be in the black -- I thought I heard that you would be in the black in the clearing business, in fiscal 2006. I don't know whether you intended to mean that was on a run rate basis sometime during the year or for the full year, and that sort of contrasted with I think an earlier comment that you -- you were going to have ongoing losses in the high single digits on a quarterly basis, or something like that. Could you just straighten us out on that?

Sure. If we were saying something like that, we're probably talking about as we were exiting the year, we might be turning the corner, but our original guidance and still our guidance is that for the first two years, we would be -- it would be dilutive to us, and then it would turn around. So I would think that we would be, as we were leaving fiscal '06, perhaps breaking even and then we would turn profitable in '07.

Okay. Thank you very much.

You're welcome.

Your next question comes from Cindy Shaw with Moors & Cabot.

Thank you. A couple things. On the client fund balances, you've had some better-than-expected growth now for several quarters. Just wondering if that is changing your view of where that is going to be going forward?

I think it certainly changed our view of how we would finish this year. Originally we weren't forecasting a double-digit growth this year and now we are. The higher-than-anticipated growth has come largely from bonuses, and higher than we had planned, paid for control, and things that are actually helping our overall Employer Services business growth.

So, yes, it changed our view for this year, and then as I said, we really haven't gone through our planning process for next year to determine what all of our assumptions are, but some of those things are hard to repeat. It is going to be depend on what we think wage growth is going to be in calendar '05, and we could get into some of '06 and what we think is going to happen with state rates, SUI rates and those kinds of things all come into play. So it is a little hard to project what is going to be going beyond this year, but those are the reasons why it is higher this year and it certainly increased our overall forecast to a double-digit rate this year.

Okay. And then there was a minor privacy breach recently. It sounds like it was pretty small and it sounds like it is pretty much behind you. I would just like to confirm that it is pretty much no more than we've been hearing about. It is not going to cause any steps that are going to increase any costs. And of course, the regulatory environment around that could be increasing, with the attention it is getting. Is that going to be changing anything going forward?

Well, what happened was relatively modest, although we treat every issue of security extremely seriously here. We would believe that this is contained, and we really haven't heard anything at the 2,000 people who were involved.

For those who haven't heard about this, this was an inadvertent mailing of Social Security information in a public way to clients of -- in our -- one of our benefits businesses. We immediately notified everyone who was involved, and have put in processes to make sure that we perfect the people who were involved -- who might have been involved, although the reality is we haven't heard anything yet. Although we still may.

Having said that, we have always treated security as a major issue. And there are a whole bunch of different ways have you too think about security. You have to think about the physical security issues. You have to think about the technology of that security, that we build into our electronic systems. We have to think of the processes that we have. And we've been doing this and have been very focused on it for many years.

Having said that, we are relooking at it again, just to make sure that with all of the stuff that's been hitting the press lately, that we're not one of those people in any significant way. So we have a task force that will be looking to say, in addition to all of the processes we've already put in, what additional supplements should we put in to protect ourselves even further.

So we are certainly -- don't treat this in anyway lightly. This is a very serious issue for us and we will make sure we are doing the right thing. It is really not a cost issue. At the end of the day, it is not a cost issue. It is a focus on making sure you have the right systems, and making sure you have the right processes and making sure you have the right compliance going on. And that's what we're focused on.

Great. That sounds like that's pretty much behind you. One last question. Any change in the stock option expensing, maybe postpone it until the September quarter until June?

Well, we are scheduled to go in the September quarter because our fiscal year end is June 30th, so we are scheduled to go in the September quarter. That's still what our plan is.

And any take on the numbers?

Still looking at the numbers for next year, but I think what we said at the March meeting was that what it has been running, somewhere between $0.18, $0.20, or in that range, call it $0.20 a share, if you look at our footnotes in our financial statements, that it will likely be when we get to the point of next year, a couple of pennies less than that. And that is because of the change in the programs that we've made, which reduces the number of options that we're issuing every year, primarily. That's the primary reason.

There are other things we look at as we look at the different models and so on. But our best guess at this point is that it will be a couple pennies less for the impact for '06 when we ultimately implement in the first quarter of next fiscal year.

Great. Thanks very much.

Okay.

Your next question comes from Chris Penny with FBR.

Thank you. Art, I'm just curious, your thoughts on Key Corp.'s recent purchase of a payroll online processing company saying that they're going to look to market to the small to medium and larger corporate clients. From a competitive standpoint, but also from an opportunity standpoint with ADP maybe working through or with some other financial institutions?

I think this is the type of thing that happens in our competitive world from time to time. A large number of people have started up in this business. We have startups that go on all the time. We have had various banks who have been both in and out of the business over time. And I think it is -- we treat all competition seriously. And we should treat this competition seriously. But I think it is business as usual. It is -- we win in the market because of the strengths that we bring.

We bring product, we bring service, we bring great sales capabilities. We know how to implement. So we -- it is basics done on a very large scale that we do and we do very well. So we treat all new entrants seriously, but I don't see this as anything extraordinary.

Would ADP be working towards any other third party relationships possibly that doesn't already have in maybe that type of structure?

I'm not sure what you mean by "that type of structure."

I guess would you look for other financial institutions to partner with?

We have relationships with a large number of financial institutions today that vary from referral relationships to broader relationships, and we're always looking for those types of alliances. So if the right relationship could be formed in a way that would be positive for us, we're always looking for those.

Okay. Just one other question in terms of just kind of longer-term kind of earnings growth. You've had some investments in the dealer services, and clearly margins have been impacted in the near term and you've talked about, I think in the press release, how those should kind of reverse itself next year. Is there anything else that you're investing that would take -- would reverse kind of the earnings leverage that the Company is currently having right in terms of revenue growth of 9% and earnings growth of 14 or whatever percent. That -- is there anything that you are doing that would potentially reverse that operational leverage or do you see that playing out over the next several years?

Well, I will answer the question. I think that you look at the different businesses, and there's pieces of Employer Services for example, that are said have pass-through components that have been growing quite fast, like the PEO. So, yes, I see that as the PEO continues to grow at a much faster rate than the rest of Employer Services, and it has that large pass-through component, that will lower the overall margin and we won't see the same kind of leverage on the same kind of total revenue growth.

As I look at other fast-growing pieces of the business, like Comprehensive Outsourcing, that also has somewhat of a pass-through component. There is a labor component when you do the payroll admin or managed payroll piece of it, and so that will have a slightly lower margin to it. Plus we're investing a lot in those businesses. And they're still small. And so as these smaller businesses continue, until they get up to a larger, more scalable size, that could possibly change the relationship.

But having said that, in a pure -- a pure payroll side, I don't see it happening and for the most part, in the businesses like brokerage, Investor Communications, and the back office, I still see the same kind of relationship with the revenue turning into higher margins because of the basic model.

I think if you think of us as a scale business, and it is almost impossible for us to think of ADP as a single business, you actually have to think of it by its components, but if you think very broadly about scale, and you recognize that even as you introduce new products, you ultimately build scale on those products. Once you reach scale -- some rational scale level, the incremental benefit that you get from revenue, a significant amount of it drops to the bottom line.

Having said all that, it has always been our intention to continue to invest in growth. And we will continue to invest in growth. So I think -- you can think of an incremental scale margin benefit in a normal -- when you're not in a rebounding environment, part of which we're in right now, although a half a point of overall margin from scale, but over a long period of time, our revenue growth is going to dictate what our overall growth is going to be. And I think that's an appropriate way. There will be some margin improvement. We want to continue to reinvest, and therefore, over a long period of time we want to think about revenue growth driving the future of ADP.

Okay. Thank you very much.

Your next question comes from Greg Smith with Merrill Lynch.

Hi. Karen, hopefully you didn't give this already, but an overall companywide internal revenue growth number for the quarter?

I don't think I did. It was 10% for the quarter.

Okay. And then on the Comprehensive Outsourcing side, are you seeing your average deal size increase there? And can you remind us what the average sort of employer size is that you're catering to currently?

We have actually looked below what we call the very largest clients as our target market, so where most of the people in the BPO or Comprehensive Outsourcing world are focusing on the top 100 or the top 200 clients. We've actually focused at a level beneath that. And whether you define that as 15,000 pays and lower, 10,000 pays and lower, I think that's an appropriate way to think about our primary target market.

Having said that, we do have accounts that are larger, and I'm certainly not saying that we're not going to continue to accept clients that are larger.

Okay. And then lastly, Art, can you comment on the acquisition pipeline please?

The acquisition pipeline has still not heated up. I think a month ago, I said that I thought it was weaker -- I don't remember the exact words, but certainly the concept was it was a lot weaker than I'd like. I think we have a lot of efforts going on, or a lot of communications going on, but I don't feel as positive as I would like about the level of activity or the number of transactions. But we have placed a significantly increased focus in this area, and so it would be my hope that if you keep asking me this question on a regular basis, my answer will start to change.

We will test you next quarter. Thank you.

Okay.

Your next question comes from Rod Bourgeois with Sanford Bernstein.

Great. I wanted to talk about the BPO signing trends that you're seeing. In tracking the BPO signings for the industry, we're noticing a pretty nice uptick in your contract wins, and it is a noteworthy improvement in just the last quarter. And I wanted to see if you could comment on whether that is just starting to get traction with your model or whether you've increased your aggression in that market? Or whether it is just a market in general starting to gain traction? I think there's potential sort of impacts from all of those factors.

I would say that I think we are getting some more recognition as a provider in the market. And that's -- and yes, we have continued to increase our focus, and the attention and so on. I don't know that we have, as -- in the quarter, closed more than we had in the prior quarter, I think it is more of a -- we are getting some name recognition. And going after -- and actively talking to a lot of companies. But we are still very excited about the pipeline, and are working on a lot of projects. I just don't know that I would say that the number of deals in the quarter escalated in any way notable.

Okay. And do you see that continuing to stay at sort of the same pace in the next few quarters? Or given the state of the pipeline, would you expect that to kind of start in an upward trend?

I would say that we have been adding to our resources, and the more name recognition that we have that we are in this market and the more traction we have and the more we are successful working on these smaller transactions, as Art said, our target is actually to go to the lower end, than the traditional BPO that you hear about, that will start to get more and more activity. So I see it growing, albeit not the big names that most people talk about in the market.

Got it. And then I want to turn to the dealer side where you experienced the margin decline in that unit. To what extent are those margin declines stemming from the merger integration cost versus the start-up costs on the new site. Can you kind of break that -- the effect on the margins out between those two categories?

I think when we originally plan for the year, we had planned to slightly lower margin than in fiscal '04. By somewhere around a half a percent lower. And that was due to the acquisitions that we had done in fiscal '04, and maybe some carryover from '03. Since then, we did do another small acquisition in Dealer Services this year, a small acquisition in Spain of a dealer management systems provider. Plus then I would say that the rest of it comes with our ramping up to handle these large implementations.

Got it. And can you give us any indication on how the startup costs on the new sites will play out over time? Are we starting at the low point now and the investments are going to scale down from here? Or when do you reach peak on those investments? If you can give us any pattern there, it would be helpful?

The investments will grow as the number of implementations -- as the number of implementations continue to grow. However, at some point, we will start generating revenue from some of those sites. So that the impact -- it is not just going to be pure increments, as we go out over a 30-month period. In terms of the implementation period. So I don't know exactly when it will peak in terms of where the lines cross between increased implementation expense and revenue starting to offset it, but certainly I think over the next several months, at least the next couple quarters, we ought to be anticipating increased expense levels.

Okay. So getting back -- getting your margins and Dealer Services back to where it was a year ago, that -- will that take more than a year to get back to that level? Is that the way to think about it?

Probably. Although as we complete this again with a higher base, I think you could look for very positive margins as we complete the -- as we complete all this activity.

Okay. Thank you.

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

Good afternoon. I'm wondering with regards to ES, did you give us where you thought the margins would end up for the year?

Yes, somewhere between 100 and 150 basis point improvement in margins for the year. We're about one full point over last year at the moment.

Yes.

Through the third quarter.

Great. And obviously, the margins are improving. So can you comment a little bit in terms of how much potentially decreased competition might be helping that, and maybe a better pricing environment?

I don't think those are the issues. I think what happened, it certainly as we look to going from the 1% to the 1.5% as Karen was just talking about, is we took some one-time costs within the business last year. I don't think that the competitive scene or the pricing scene has changed in any way dramatically over this period. So I think it is relatively stable right now.

Great. Thank you.

Your next question comes from Lloyd Zygman with Bernstein Investment Research.

Hi, this is Lloyd Zygman. Could you just tell us the level of PEO employees at the end of the quarter?

Yes, we grew 20% to 108,000.

Okay. Thanks.

You're welcome.

And my other questions were taken. So you can just move right along.

Thanks, Lloyd.

Your next question comes from Michael Baker with Raymond James.

Yes, I was wondering, in terms of the beyond payroll segment, if you're seeing any processing opportunities emerge around consumer directed health, or is it just too nascent at this point?

It is a very interesting area and it is one that we are continuing to look at, certainly in the way we provide services out of our Benefit Services arena. My view is that we have to -- we have to be available and to take advantage of changes that are taking place in the market. And hopefully as these changes become clearer, we will put ourselves in good position to take advantage of them.

Just one follow-up, in terms of kind of the health care expertise aspect of that, would you consider bringing some of that in-house? Or would you look to do alliance?

We'd consider both. So I think we consider a number of options. But I wouldn't want to go beyond that at this point.

Thank you, sir.

Yes.

Your next question comes from Carmelle Gerber with Thomas Weisel.

Good afternoon. I was wondering if you could give the breakout for Internal Revenue growth for each of the segments?

Sure. The overall was 10% for the quarter. ES was 9%. Brokerage was 9%. Dealer was 4. And Claims was 2%.

Okay. Great. And also, do you have average trades per day?

Sure. The average trades per day were close to 1.6 million trades per day for the quarter.

Okay. Great. Thanks so much.

Your next question comes from Robert Maina with Cramer Rosenthal.

Yes, my question has to do with the 16% new sales growth in Employer Services. Much of it has been addressed, but I was hoping maybe you could provide some insight into the dynamics there. If you could maybe attribute some to additional sales people, feet on the street, or, more lax competitive environment given some of the challenges faced by one of your competitors, anything around that would help us understand that a little bit better would be great. Thank you.

I think we're seeing both an increase in so-called feet on the street and increase in the number of sales people that we have. As Karen mentioned earlier, we had targeted around 7% and we're running a little bit behind that in terms of the number of people. So if I look at that and I focus on it, in relation, that's a U.S. comment and if I focus -- is that a global comment?

Yes.

And so if I look at that, and I look at that number in relation to our overall growth, it becomes pretty clear that we're also getting effective productivity improvements over the same period of time. And those are the things that are driving us.

The competitive scene is still there. We still have good competitors, effective competitors, and we treat our competitors with great respect, and we respect them a great deal. And they deserve it. So we're competing and we're competing hard in this market against good competitors and right now we're doing quite well.

Is the velocity of the pipeline or the deal activity, has that increased materially over the last three or six months?

What we're feeling very positive about, not just the results, but also our pipeline. So the answer would be, it is hard for me to measure exactly where it was six months ago, because it was already in a strengthening period at that point in time. So whether it is strengthening beyond that, I can't answer, but I would say we feel very positive that we have a strong pipeline.

Thank you.

Your next question comes from Tenjeng Wang with J.P. Morgan.

Hi, thanks. Just curious what is the expected revenue contribution from the two large dealer wins you had in the release? And was that a competitive take-away or an in-house conversion?

First, we won't give the specifics on the dollars of individual clients or individual transactions. Both of these transactions were consolidators who use multiple systems, some of which were ADP systems, and some of which were with other competitors. They made a decision to go to a single supplier. And we won the accounts. So that is how we got there.

Okay. That's helpful. And also, I was hoping maybe you could comment a little on the consolidation taking place in HR outsourcing with the Melon [ph] and ACS getting together, Towers and EDS, et cetera. How do these deals impact your competitive position if at all? And I guess on a relationship side, I guess you have -- you work as a sub with some of these vendors as well, so how does that -- what is the impact there to ADP?

Similar to what we were seeing before when we were looking at this space. A lost these transactions that you're looking at are targeting the very high end of the market, and they have more customized solutions and in some cases broader solutions than what our offering is. So I think that's a reality. We continue to look for appropriate alliances. We do provide services to a number of people who are doing other parts of BPO environment, where we can supply pieces, and we do that, also. So we're always looking for ways that we can continue to expand our participation.

Very good. Thanks.

Your next question comes from Tim Willi with A.G. Edwards.

Thank you. Good afternoon. A question I had on your hiring plans and the sales force. Is it generally broad-based in terms of where you're looking to hire staff? Or are there one or two sort of particular areas that would see a majority of the attention?

I assume we're talking about Employer Services in the question?

Yes.

Clearly, in the areas where we're strongest, and we're gaining the most productivity, we're more likely to target our incremental hires into those areas. But we really are feeling pretty good in each of the market segments that we're in right now. So clearly, it would get weighted towards some of the stronger arenas, but I think you could expect to see increases across the board.

And then just a follow-up on that. Over the last couple of years, as you've put money back into product and process and your people, in terms of the training and the ramp-up of new hires, and sales people, have you noticed or do you expect any change in that ramp time, where people are becoming more productive and effective now than maybe they had been in the past?

We spent a lot of time on training and on addressing the training function, and re-addressing the training function, all in the interest of trying to make our sales people more productive. And clearly, if they can get more productive sooner, that's a benefit. I can't tell you that there is a clear trend that I'm aware of right now that says that we're accelerating the pace towards the average productivities that we would like to see.

When you're in a period like we're in right now where productivity overall is going up, some of this gets masked, so it is a little bit harder to measure. But I couldn't make a clear comment that said that I definitely knew that we were increasing the -- that the training was helping us accelerate the time to increase productivity.

Okay. Thank you.

Your next question comes from Kartik Mehta with FTN Midwest Securities.

Good afternoon, Art and Karen. I had a question, there has been some press out or some stories out that small businesses are starting to spend less, and maybe they're finally being impacted by oil prices. Now, listening to the anecdotes you've provided, and listening to the pace per control number you provided, that does not appear to be what you're seeing. I just wanted to get your thoughts on if in the last month or so, if you've seen anything that would indicate that small businesses might be getting in trouble all of a sudden.

There is nothing at all that I've seen that would indicate that. Our -- probably the best indicator we have is our sales activity. And our new account sales activity has continued to be strong within our small business sector. So if there is something, it is not something that is showing up in our numbers right now.

Are you seeing -- are there any particular areas in small businesses which are maybe stronger than others? Are the service-based small businesses doing better than maybe the manufacturing base? Or is there strength pretty much across the board in your opinion?

If you look at the mix of our business overall, we're probably stronger in services than we are in manufacturing. And therefore, our numbers get biased a little bit by strength in the service organization -- in the service industry. Having said that, I couldn't go beyond that in terms of really telling you what is going on in today's market.

Thank you very much.

Your next question comes from Steve Weber with S.G. Cowen & Company.

If I could just follow-up, thank you. Could you give -- Karen, could you give us some of those adjustment numbers that are -- always come out in the 10-Q? Do you have any of those handy? The corporate investment income is clear, but a couple of those other things are not, like the capital charge, and the FX adjustment, the floating income adjustment.

I'm glad you asked me the question, Steve, because I wanted to tell you we have now posted that schedule to our website in full detail. So if you go on our website, ADP.com and look under the Investor Relations section, under the financials, you will see all of the detail of that information that you normally look for.

Okay. Thank you very much.

You're welcome.

Your next question comes from Todd Smith with Wisconsin Investment Board.

Good afternoon, Art and Karen. Congratulations on a great quarter. Actually, my question was already asked, but maybe I will re-ask it and see if I get any better answer. So, we have been getting varied news from the government sources, government statistics, and also from companies across the economy, through the first quarter here, talking about worries of inflation. One week, inflation is an issue. Next week, it is not. Employee hiring, one week, it is not so bad. Then the next week, government statistics suggest it is not very good at all. New business spending question, one week, it seems like maybe businesses are spending, depending on their size. The next week, or the next month, no, that's not true. Oil prices, Sarbanes-Oxley, we hear all of these various things.

Is there anything that you can add perhaps to give us a sense as to what the mood is or whether there is good optimism? And understanding, of course, that you guys continue to have new -- very good new business signings, but is there anything that you can refer, that you can report to us on sentiment or mood within the economy?

I think it is hard for us to talk about things that we're really not expert in. I think when we look at the -- one of the things we are I think expert in is looking at the employee hiring that goes on within the country. And as those numbers have vacillated in the government statistics that you're reporting, we've seen remarkable consistency that's been going on for over a year right now, of a relatively steady growth that has been going on. And our numbers haven't had the same monthly and quarterly aberrations that we have heard in some of these -- in some of these other statistics.

So I think I can, with confidence, say that employment growth is continuing to grow, and there's certainly nothing in our statistics through the end of March, which is the last time we've looked at it, which would contradict that in any way. I think our average increase in that pace per control number Karen was referring to was 1.8% in the quarter is running around 2% for the year, and that's just a very small distinction. So that I think you would think of it is as showing a relatively steady improvement during that period.

In terms of other statistics, like inflation, or new business spending. We're not feeling price pressure in the market to the degree that we talked about at certainly a year and a half and two years ago. And at least our clients are buying our services, so I'm not sure that talks about new business spending the way people talk about major capital increments, but for us, they're still spending, at least in our area. So I think I -- overall, I still feel very positive about what we're seeing in terms of the overall economy.

Thank you.

At this time, there are no further questions. I will now turn the conference back to Ms. Dykstra.

Thank you. As we close, we had about 120 people on the call. Our shares were at $44.84 as of I guess a few minutes ago, or a few moments ago. And Art and I, as always, would like to thank you for your interest and questions.

This concludes today's Automatic Data Processing, Incorporated third quarter earnings conference call. Thank you for participating. You may now disconnect.