自動資料處理 (ADP) 2006 Q3 法說會逐字稿

Good afternoon.

My name is Jennifer and I will be your conference operator.

I would like to welcome everyone to the Automatic Data Processing, Inc. third quarter, fiscal 2006 earnings conference call.

[OPERATOR INSTRUCTIONS] I will now turn the conference over to Miss Elena Charles, Vice President of Investor Relations.

Please go ahead, ma'am.

Good afternoon, I'm Elena Charles, ADP's Vice President of Investor Relations.

I have spoken with many of you for some time now, but for those of you who don't know me, I have been in this role for about three years, I'm stepping in for Karen on this call, because, as you know, Karen will be leaving ADP very soon.

As usual, Art Weinbach, our Chairman and CEO, and Gary Butler, our President and Chief Operating Officer are here today and we're all happy to take your questions.

We issued our earnings release for the quarter earlier today.

We posted strong results with 10% revenue growth and 24% growth in earnings per share from continuing operations.

We are confirming our full-year guidance for 10% revenue growth and earnings per share from continuing operations of $1.83 to $1.86, which is 24 to 26% growth.

As a reminder, claims services as well as our brokerage services financial business which we divested earlier this year, as well as the related stock compensation expense for these businesses were reclassified as discontinued operations.

The revenues and pretax earnings from both these businesses are not included in the continuing operations in the current and prior year periods.

All reported prior periods reflect these discontinued operations and we have provided the reclassified numbers on our Web site.

As you know, ADP was required to expense stock compensation expense beginning this fiscal year.

The impact of stock compensation expense is shown in "other" this fiscal year and not in each of the results.

Recall in the press release that the $4.6 million decline in the quarter from stock comp expense is shown in other.

I hope these comments, as far as claims and the brokerage divestiture as well as our stock comp expense give you a little more clarification.

Now Art will share his opening comments with you.

Thanks, Elena.

And welcome, everyone, here who's joining us on the call.

It seems to me that ADP's results have been so easy to understand in the past that maybe there's confusion in the current results because, as Elena was saying, we have discontinued operations, we have the sale of claimed services, we have the restatements for stock based compensation.

And it's all hitting at the same time.

And for ADP, it's very unusual because usually our financials are so straightforward and so clean.

But if you step back, the reality is we had a really good quarter.

We beat our expectations, and even with the inclusion of the $10 million repatriation expense and that amounts to about $0.016 or $0.017 a share and even with the inclusion of that $10 million repatriation, we remain confident in being toward the high end of our 24 to 26% earnings per share growth forecast.

And we're going to go into some of the other numbers later, but you can really see particular strength in employer services.

Our revenue growth is strong, the growth in the number of pays, the number we had in the release was 2.7%.

It's really the strongest it's been in five years.

Our client retention was again at a record level for both the quarter and the year-to-date.

You may recall that a quarter ago, people had some concerns whether or not, we hasn't improved in the quarter, but we had a strong quarter, so even on a year-to-date basis, we're at record levels.

Our sales growth and employer services slight by behind what we would be, but we're still quite confident in our full-year, 10% growth forecast.

I'm sure Gary as we get into the Q&A will have more comments on that.

And we're also well on our way to 100 basis point margin improvement in services.

We got 90 basis points through March and we're doing this again while we're incurring significant expenses through the expansion of our sales and implementation staff.

I'm sure Gary will comment more through this.

Maybe the one area during the quarter to me that was disappointing were our brokerage margins.

While they're disappointing, I think the results are pretty clear and pretty easy to understand.

Even though they declined a lot, even though our margin declined a lot during this quarter, we're still forecasting a 40 basis point improvement for the year.

Although that is down from where we were earlier in the year.

So what happened, what happened that's triggering this large drop in margin?

And first, you have to understand that even though the margin numbers look big, we're really talking about $10 or 12 million.

We're not talking about a giant number in the ADP world, but the largest reason was the change in the mix of mailings.

That's the lower weight than fewer mutual fund mailings, as well as changes in the methodology of mailing between and among first class and bulk mail and priority mail.

But that was a single -- that change in the mix was the single biggest issue.

The next was implementation costs that we had on getting new business up.

And while those costs are included and that's a pretty good problem.

In a recurring revenue business, we'll get the revenues from that implementation over the future.

And a number of small items, including the thing like the cost of research.

And the equal access to the SEC proposal in that area where we engaged and did a fair amount of research.

But anyway, none of this -- none of it really causes concerns about our forecast.

So overall, things feel very good and I remain quite optimistic about where we are and where we're heading.

Before I turn it back, I think Gary also wanted to add a comment before we start.

Thanks, Art.

I just wanted to let you folks know about an announcement that we'll be making coming out this Tuesday about a new service we will be publishing called the ADP National Employment Report.

This employment report is being developed in a partnership with Macroeconomic Advisers, a leading economic consulting firm.

And basically this report takes advantage of ADP's rich data set around employment in the United States.

You may recall that we pay one out of six people in the United States, represent about 25 million active paychecks with some 500,000 clients, or thereabouts.

Plus, this employment gauge is relevant ment for both small business, middle size business, all the way up to very large companies.

And we have a statistically valid sampling across all industry codes.

That data is also being mined in an aggregate sense where all individual company or employee data is completely anonymous.

The real interesting thing here is that the methodology that we'll be using to analyze this data is very similar to the BLS data that is released every Friday after the first of the month.

The interesting thing about the ADP employment data is that it is realtime data and will actually be released on Wednesday, two days prior to the BLS results.

It will also employ similar methodology, as I mentioned earlier, and will include the week of the 12th of each month, which is the timing around BLS.

This will be private industrial employment, and will not be representative of either farm or government data.

And we have done a five-year correlation of this data against the different statistics published by BLS.

And the correlation is actually quite remarkable.

The data in the report will also be released as a public good.

There will be no economic circumstances around it for ADP.

But we think it's an excellent opportunity for ADP to share the vast and rich data source that we have here regarding employment and obviously, it will be an excellent branding opportunity for ADP employer services.

So with that, I'll turn the call back over to the operator.

Okay.

If I could just make a comment first.

During today's conference call, we will discuss some forward-looking statements that involve some risks and some of these are discussed in our periodic filings with the SEC.

Currently, we have about 95 people on the call.

So we're ready to start the Q&A and I'll turn it over to the operator for your questions.

[OPERATOR INSTRUCTIONS].

We'll pause for a moment to compile the Q&A roster.

Your first question comes from Greg Gould of Goldman Sachs.

Thanks.

Art and Gary, on the brokerage portion and the lower operating pretax margin, can you give a little bit more color on how big the one-time items were in the quarter?

And were they others return in the June quarter?

I think the, in total, you're probably talking 4 to $5 million in one time.

So you're not talking any significant, large number.

Whether or not the others will occur will depend on some of the elections that get made in the fourth quarter, in terms of the types of mailings people will use.

I think it was a little unusual this quarter.

So we would anticipate that it would go back to what had been a more normal trend.

And there were some cutoff issues.

But our big mailing period, especially for the annual report on the beneficial side occurs in the April, May, June period.

It's by far the largest period during the year.

So I don't think you can automatically trace some of this items exactly because there are different dynamics going on in the market.

Just one other question.

You reiterated the target for new sales and employer services of 10% growth this year.

To do that, it looks like you probably need to have around 16% year-over-year growth of new sales in the fourth quarter.

How confident are you in that and because it looks like a tough compare, new sales are up 16% in the June quarter a year ago.

Greg, this is Gary.

We're still pretty confident.

Obviously, we had a lot of conversations about that subject before this call and we are very confident still that we will hit the 10% number.

I think we're strong internationally.

We had a very good quarter internationally and we have some good pent up momentum within the international world and the head of our employer services sales told me, we're going to make it.

So I absolutely believe him.

What's driven -- the international sales.

That's been a tough market for you before, what's turned around?

Two things, Greg.

As you may recall on some of the earlier calls we had, we indicated to you that we had an extremely strong quarter last fourth quarter internationally.

And consequently got off to a slow start the first quarter this year.

We were also behind in our manpower count overall, but particularly in international.

The thing I find most encouraging is the ramp-up in our global view sales.

We had great activity in the fourth quarter.

Thank you.

Your next question comes from Pat Burton of Citigroup.

Hi, congratulations on the quarter.

In the employer services unit, Art, could you go through the factors that are driving the substantial operating margin, expansion, and then on the corporate basis, could you talk about interest and float, thanks?

The margin enhancement in employer services is really not atypical.

When you look at our performance in a good market period when we're getting good revenue growth, the scale opportunities are the primary item that help us drive that growth.

So I don't -- I wouldn't point to any unusual thing.

Now, we have to overcome some things, like as our PEO business is growing as fast as it is, we have more passthroughs that creates a lower margin, but even with that, it's really a function of on the incremental revenue, the passthrough margin is very high on most of the, many of the products once they get to scale.

one other thing that you may not think about, Pat, this is Gary, is the fact that when we have strong pay growth on a same store sales kind of basis, we typically don't plan all of that pay growth.

And so as a result, we keep our expenses in line at a level below what we're actually experiencing.

So the incremental margin on that incremental pay growth is quite high.

Thank you.

And at the corporate level, the pickup in float dollars and yield, is there any changes in your assumptions moving forward there?

Thanks.

I think the numbers are very similar in terms of where we're going.

We talk about the client balance numbers in terms of our tax filing.

We're still looking for double digit growth in overall in terms of that number.

It's down a little bit from where it was because, actually, the some of the rates impacted us a little bit in the first quarter and it reduced the growth in the balance.

So that's the kind of thing as unemployment gets better within this country and as states adjust to it as an impact.

But other than, we're feeling very, very positive about the growth we're seeing in balances.

And our interest rate yield obviously is continuing to inch its way up and I think we're looking at 4% as our average yield for the year at this point.

Is that right?

Yes.

Thank you.

Your next question comes from Rob Bourgeois of Bernstein.

Yeah, Rob here.

The margin forecast for fiscal '06 in both the brokerage and dealer units are materially below where we started the year from a guidance perspective.

And it looks like that's mostly because of one time costs, kind of an odd mix shift in the brokerage unit, and then some acquisition integration-related expenses.

Would you expect some of those impacts to be recovered in fiscal '07, which hopefully would give us some confidence in the fiscal '07 margin outlook.

Rod, Gary Butler.

The brokerage thing, I think Art pretty well spoke to it.

The $10 million that caused the 2.6% margin decline in the third quarter really translates into the full year assumption of about $10 million difference in margin assumption than what we started off the year at.

So those two numbers line up pretty much the same and art spoke to the one-time effect of that versus some of the mix shift already.

So again, we can't predetermine mixed shift for next year, but certainly going forward, we wouldn't expect to have the one-time events in our normal kind of forecast.

As it relates to dealer, literally, the whole decline is based on integration costs for our Kerridge acquisition which we actually announced back in December.

And part of that was for the fact that when we did do the integration, we had some severance on both sides of the acquired company as well as us.

And when you are the acquirer, but you reduce expense on your side, you have to take all that expense in a period expense.

So all the severance that we took with ADP associates all had to be recorded in the quarter, which is why we had the dip there.

So all of that is one-time and should be out of the equation going forward, with the obvious issues around intangible expense, which would be normal for an acquisition.

And Gary, just real quick, in terms of how you're going to use your cash.

You now have tons of cash.

And also the acquisition strategy, can you just give an update on plans -- you've mentioned a plan to do a larger than normal acquisition.

Can you give us any idea on what the timing could be and how large of a deal you'd consider doing?

And in the meantime, are you going to aggressively use the cash for buybacks, et cetera?

Rod, we, in our previous conversations, we have talked about having a relatively strong appetite to do acquisitions across ADP, but particularly in employer services.

It's literally impossible for us to say when that will happen or how big it will be or whether it's this year or next year or whatever the case may be.

But asI've also shared with a number of people, even though we have an appetite to do larger employer services acquisitions, we don't have a particularly strong appetite to do larger acquisitions that had multi-year dilution.

So most of those would be tuck-in or similar kinds of businesses where, after a reasonable period of time, we could get redundant expense out of the way.

In terms of the cash, we are at this point close to $2.7 billion in cash across ADP.

And we have picked up the pace in terms of share buybacks.

And as we put out on the release today, we'll continue to pick up the pace as we exit this fiscal year.

All right.

I'm assuming when you say tuck-in acquisition, that would rule out buying a major competitor or a company that's $3 billion plus in revenue run rate?

I don't think it would be appropriate for me to get to that level of specificity.

But just as we acquired ProBusiness back in 2002 and integrated it in 2003, it was certainly what I would characterize as a tuck-in acquisition, and one where we could get to a very profitable state within the current fiscal year, within at least the current 12 months.

And that's played out successfully in your view, Gary?

I wish I had one every year.

Got it.

Thank you very much.

Your next question comes from Gary Bisbee of Lehman Brothers.

Following up on that last question, in terms of the buybacks, you've said a couple of times you'd likely accelerate the buybacks, looking back at the last 3 to 4 years , you've repurchased between 2 and 5.5 million shares over that time.

Can you give us sense either in number of shares or dollar amount what you're likely to do, particularly if the stock stays around this level?

Yes.

I think clearly the track that we've been on is there for a while.

I think one of the things you'll see when the 10-Q comes out shortly and we look at the purchases over the last quarter by month, you'll see that in the month of March, we acquired over 3 million shares, which is probably the largest we've had at any point in time.

As Gary mentioned, we had about $2 billion of cash at the end of the year.

We've added about $700 million plus as part of the claims divestiture.

And the reason we've talked about accelerating the repurchase of treasury shares is because we do have excess cash at this point in time.

So I think it would be prudent for you to assume that we would continue, as Gary said, a continued program of repurchasing our shares at an accelerated rate, or a larger rate than we had in the past.

And beyond that, I really don't want to get specific.

Okay, thanks.

The next question.

You gave some guidance in terms of the year-over-year or pre-tax margin expansion you expect by line item.

And it seems to me, unless I'm looking at the wrong numbers for last year, that in both employer and broker, that would mean that you need a pretty substantial, like 200 basis points plus year-over-year increase in the June quarter.

Is that correct, and where does the confidence comes from around those numbers?

I actually haven't looked at it broken down by the quarter, but we go through a reasonably sophisticated reforecasting each month here.

And our outlook, as we near -- because of the recurring revenue nature and expense controls we have -- as we get within the last few months of the year, the confidence levels that we have in our numbers are very high.

So I can't directly answer the question for you other than to tell you that confidence that says that there's accuracy in what we're seeing is very, very high.

The other thing is in the brokerage business, in the late March, but particularly in April and May, are very high volumes in our investor communications because that's when all the annual meetings are run for calendar year-end companies.

So we do see a fairly significant expansion of revenue during that time, and the incremental margins that occur during that part in time are also better than the previous period, the nine months that we're talking about.

So although to Art's point, we haven't done the -- dotted the Is and crossed the Ts on that question, my guess is we're pretty close to being right.

As Gary said, if you look at the quarters with the way we've got them laid out on the Web site, you see where that investor communications, the scale really kicks in there and that is the highest margin quarter for brokerage.

Yeah, I guess I was thinking about year-over-year change versus that same fourth quarter last year.

Let me ask it a different way.

It sounded like one of the things in the press release, for the revenues at least in brokerage made it sound like some of the revenue you may have historically gotten in March may have slipped out into the June quarter in the mailings.

Was I reading that correctly, and if so, maybe that's a reason you'd expect.

You have read that correctly, but this is cutoff issues and it can go either way in any given year.

It happened to go that way this year where there was less in March and more in April.

And that's a piece of it.

But also again, increased scale will increase margin and we are continuing to grow in that business.

One quick follow-up.

You haven't really talked about any plans in terms of replacing Karen.

Are you doing an external search, are you likely to consider one of the two internal candidates you've talked about?

Any color there?

We have started an external search and we are communicating with external people who we will evaluate along with the internal candidates prior to the time we finalize the decision.

Great.

Thanks a lot.

Your next question comes from Tien-tsin Huang of J.P. Morgan.

Thanks, where exactly did the softness come from in sales this quarter?

The U.S. business for the quarter was up in the 8% range for the quarter, whereas our international business was very strong, double digit growth for the third quarter, which gave us a blended average between the two of around 10%.

Right, but it sounded like sales came in a little bit softer than expected.

So I was hoping to get a little bit more color on the domestic side, where the softness may have come from.

We had very strong sales in our national accounts business.

Our SBS sales were good.

I mentioned internationally.

Our major account sales were not as robust as we would have like to have seen them.

Okay.

Then maybe if you could also comment on maybe the demand environment for comprehensive outsourcing.

Saw the recent win with Denovis , was that competitive win and if so, what were the factor that is drove the victory there?

I'm not familiar with the individual particulars on that particular account.

But most of those kinds of deals are highly competitive.

So if we wanted, I'm sure somebody else was at the table.

We still are quite excited about our opportunities and comprehensive outsources, which is our high end BPO offering.

That will be exiting this year at about $100 million kind of run rate.

We have a strong backlog of perspective business and continue to be quite pleased with the business.

Yes, and I just want to clarify, just one thing, Gary's correct with the $100 million.

That includes, some of it is backlog.

You're in the going to have the $100 million in our revenue starting July 1.

And the margin tracking to plan, within comprehensive outsourcing?

Yes.

You had -- there's quite a bit of infrastructure that needs to be built out there in terms of the support mechanism, but the actual core products underneath, whether it's payroll or HR benefits are scale products that we're already using.

And we are, I think, slightly losing money in that business to start with, I don't remember the exact amounts, but are still very confident that we'll scale through that as we move in to the subsequent years.

Yeah, we're in start-up loss mode, which is natural as we go into a new activity like this and also because our sales costs become relatively high relative to the profitability because of the potential pace of growth, the sales as a percentage of revenues becomes higher in this business, we have to grow over the new business expenses also.

This is part of -- with any new product we have or any new area of a normal start-up.

So I think our comfort level in terms of where we're going is quite high.

What's the current loss -- what's the current run rate in the losses today?

I don't remember the number either.

I think it's certainly under $20 million, probably somewhere less than that.

Thank you.

Your next question comes from T.C.

Robelard of Banc of America Security.

Thank you.

A quick question for you on the funds held for clients.

Just given the commentary you made about the strong new sales growth. the strong revenue growth, was surprised to see that the overrule balance there was not up relative to where it's been on a year on year basis relative to where it's been over the last couple of quarters.

Could you comment on that?

Are you talking about the amount that shows up on the balance sheet?

yes, I think it was a little over $16 billion, the average balance on funds for clients.

I'm sorry.

Are you looking at the average or point in time balance?

Looking at the average.

It was up 10% year on year, whereas the last few quarters, it's been running 11 to 13% year on year increases. and you obviously had strong metrics around employer services.

Was just wondering why there was a disconnect there.

That really ties to the comment I made earlier about the state unemployment rates coming down a little bit.

And therefore the amount of withholdings we get and the amount we end up remitting is lower.

And while you're dealing with breakage in terms of the percentage, it's enough to swing it by the type of change that you're talking about.

Other than that, I mean, all of the underlying dynamics of it, including the confidence that you would have in the continuity of the growth, they're all there.

So, was this something that started in the March quarter?

Yes.

In terms of the state unemployment rates.

So is that something we should expect to have a tough comparable for the next couple of quarters?

Yes, the new rates become effected January 1 so the first quarter that get affected is the January/February/March quarter.

There's breakage, enough to cause the difference between 10 and 11%, but that's what the impact is.

Okay.

Very helpful, thanks.

Just one additional question on the COS business.

The start-up costs and the ramp-up on the infra structure side.

Is that considered opex or CapEx for you guys?

Opex mostly.

Gary blinked at me and said I was a little high, that's all operating expenses, I wasn't talking about capital at all.

Basically when you convert somewhere over and take over their payroll department, you have to hire the people that didn't take all the calls from the employees, et cetera, you have to train them, there's overlap periods in that process, and it could take six to nine months to get the installation up and running.

So just getting the operating expense in place and the facilities and everything else that goes with that just takes a certain amount of time and when you're growing fairly quickly like we are here, it takes the revenue a while to catch up and.

On top of these operating expenses, are there significant capital expenses that go along with it?

No more than our normal kind of business as usual.

Nothing extraordinary there, other than when you hire people, you have to give them PCs and a place to sit, but other than that, there aren't big capital expenses.

Great, thanks so much.

Your next question comes from Greg Smith of Merrill Lynch.

Hi, good afternoon.

Just in the brokerage business, a little surprised that the retail brokerage activity hasn't been better.

You still facing a lot of pricing pressure from the shift, but why aren't we seeing a little better activity on the retail side?

I wish I could answer that question.

There's nothing that would make us happier than seeing the retail percentage kick up.

But the reality is that it hasn't, and I think our overall retail mix has been relatively constant for the last few quarters at this point in time.

The institutional volume is going up.

We had an increase of about 17% in our total volume with the retail percentage staying relatively the same.

So you realize that it's all institutional volume that's really kicking the number up.

I'd love to see more retail activity, but it's something that we are recipient of, we can't really make it happen.

What's the outlook for acquisitions in the securities clearing business?

I think you wanted to do some consolidation there, but we really haven't seen much.

How's the pipeline looking?

We have a number of medium to small kinds of opportunities, both here as well as in the U.K.

And we continue to pursue them and would hopefully expect to get one or two small ones over the course of the next year.

Okay.

And then one last question, we've seen a real nice uptick in pays per control.

I think before you highlighted that, being a little more focused in the smaller end.

Are you seeing a broadening at this point?

The pays increased actually across all of our market segments.

Typically, though, where you do see the employment trend up first, and it's been consistent since we first saw this pop up several quarters ago is in the small business services, and that continues to be where the highest growth is of the national accounts, though, is continuing to improve, so we do see improvement there as well as in the midmarket.

Okay, thank you.

Your next question comes from Adam Frisch of UBS.

Thanks, good afternoon.

Art and Gary, there seems to be a disconnect between what's going on in the fundamentals of your business, specifically an employer, not only the execution at ADP, but also the secular trends and what's going on with your current stock price.

I'm just noticing questions and conversations I'm having with bysiders.

Rather than focusing on the strength of the models and trends, we're focusing on little details about why were sales 8% instead of 9% or why were one-time events in brokerage 4 million instead of 5 million.

And I think the focus on those little details are an outgrowth of some frustration about the stock performance.

So are you seeing this frustration from your shareholders and does this intensify your consideration of doing certain things to shareholder value, increasing leveraging the balance sheet, increasing share repurchases, divesting certain segments and the like.

I wouldn't say we're experiencing significant pressure from our shareholders, we have received input along some of the lines you're talking about and so we've heard -- but I'm not saying we're feeling significant pressure.

I think we also have looked at the performance, I think, over the last seven quarters, certainly, once we really rebounded from the slower period that we had.

Our performance, we're feeling very good about.

We have momentum, we're moving in the right direction and if anything, I think we're all disappointed in terms of the stock price.

The place I worry the most about it, really, is the retention issues on some of our key employees and some of our associates because we do use stock as an important part of our overall compensation program.

So I would say that we are very focused on improving the share price, both for the internal reasons for associates and because we think good performance should drive it over time.

So we will consider alternatives, and we will look at alternatives, but basically, I feel that the key, the principal key to our doing well is continuing to perform and perform well, which I believe we're doing.

It just doesn't seem like, like even a dealer is doing well with growth or brokerage is having a little bit of a hiccup, but it's still expanding margins by 40% or whatever.

It doesn't seem like you're getting paid, like the Street doesn't really care as much for those types of achievements, they may seem important to you, but not as important to the Street.

How would you respond to that?

We certainly want to be cognizant to the things that drive shareholder value, and to the extent that we need to do things that are necessary to do that, I think that would be our focus.

I will also repeat what I said before, which is good performance had got to be the prime ingredient that drives results overtime.

Okay, looking forward to see you next week at your office.

Thanks.

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

A couple questions.

First, if you could update on both the Microsoft and the SAP relationships, and also, if you could update, you said you were doing some testing on the financial and accounting ops, seeing if if you could give us an update there.

Let me go to the Microsoft one first.

As we discussed with you in in March and I guess also again in late January, we continue to be somewhat disappointed in the levels of, say, new sales on the Microsoft with their small business accounting and the translation of that into ADP payroll sales.

Again, it's early in our relationship there.

We're still getting excellent reviews from the clients that we do have that sign up, but I would be remiss if I didn't say that we are disappointed or somewhat had hoped to be at higher levels in in terms of new signups in the Microsoft level.

Is there anything to make you think that the pace of signups might change and cease to disappoint you on that one?

I can't speak for Microsoft and Microsoft is really the gate keeper here in terms of how much money they spend marketing small business accounting, because the number of new payroll sales, whether it's do it yourself or full service outsourcing is still driven by the number of people who sign up for the small business accounting.

And I know Microsoft is spending a lot of time and doing a marketing campaign, working with the OEMs such as Dell and others to increase the rate, but at the end of the day, we're pretty much gated by their success in the market.

In terms of the SAP relationship, I think as evidenced by my earlier comments around our global view sales, we're very enthusiastic about the global view opportunity.

We have had very strong sales results in the third quarter.

We have very strong pipeline and are optimistic about the results for the fourth quarter.

We will have over 30 countries built out by the end of this fiscal year and we'll will adding another ten countries in fiscal '07.

We will also be featured at the SAP sapphire events, which are their large client events in Europe and in the U.S. over the next 60 days.

So we couldn't be any more thrills with the relationship with SAP.

In terms of the FNA outsourcing, I think you might have been referring to our accounts payable tests we were running with an alliance partner.

In it's very early stages and real too early to say one way or another, but we're continuing on the course of the pilot.

Great, thank you.

Your next question comes from David Grossman of Thomas Weisel Partners.

Thanks.

Art, I'm looking at the brokerage numbers and if I'm understanding them right, it looks like the brokerage processing business grew 4% on the quarter.

And that business, as I recall, has been experiencing negative comparisons for quite some time.

So I guess the first thing, A, am I understanding that correctly?

And if those are the right numbers, is there something more fundamental happening there where you're seeing that business, which I know has a lot of fixed costs associated with it getting better?

Well, first you're reading it exactly right.

We had actually a 17% growth in institutional, primarily institutional trades, but in trades overall.

But we also had a 13% decline in our revenue per trade, which is a function of that mix and the fact that the large institutions are doing most of the trades.

It is better performance than we've had for a while and we're feeling very good about it.

And it would be interesting that while we talk about the margin comments before, we actually improved our margins in the back office during this period so that the concept that you have, that you are expressing about the positive margin that we can get in a relatively fixed cost business is playing out as we pick up the incremental margin.

I think going back to an earlier question about retail trades, and we'd love to see more retail activity, we get paid more per trade on a retail trade than we do on an institutional trade and we do more work, but we'll have to see the way it plays out.

But that business as it does grow does have good opportunity for margin improvement.

Is the pricing strictly driven right now by tiering, or is pricing actually going down?

The primary issue is tiering.

It's the larger clients creating more and more volume.

There are some renewals, but mostly of really what have been very long-term contracts that are renewed at slightly lower rates than before.

But that's a lesser item than is the item of the tiering.

The good news on the ones that have been renewed, even though they are at these slightly lower rate, they're renewing for longer periods of time.

And we have no major renewals we're looking at anywhere over the next year, it's a figure of speech as opposed to an accurate period, but there's nothing really imminent in terms of significant renewals.

Is there any prospect for the negative impact of tiering to start flattening out, or is it somewhat infinite as the price goes down as they continue to increase volume?

The average price will continue to go down as they increase volume, because the price for the incremental trade is always lower.

So in other words --

Equal to or lower.

Yeah if the number of trades dropped, the average rate would go up.

But as long as they keep adding, since the first trades are in effect at a higher price, the average price will come down.

But in most of our larger accounts, they are already at the lowest level tier.

So they're not big incremental future drops, but new trades startpoints are at the lowest point on the tier.

I see.

One just other question, more broadly about the margin profile.

It seems that the year to year improvement in margins was fairly robust in the first half of the year and has slowed a little bit in terms of year to year improvements in the March quarter.

And I suspect some of that is because of comparisons and nonrecurring charges in the prior years.

Can you give us a better sense of how to think about margin enhancements over the next several quarters, based on the current profile of the business?

I don't think that the margin profile is -- again, I'm trying to exclude interest from these comments.

I don't think the margin profile is changing in any dramatic way.

I think that you would anticipate, as we always have, that incremental value volume give us incremental growth and incremental growth in margin.

We have elected and we'll continue to elect to introduce new products, to do some start up things, part of the things we were talking about on the comprehensive outsourcing services.

Things like Microsoft, things like the start-up on SAP, we will choose to spend some of the that incremental margin in terms of those investments.

So until we put together our operating plans and finalize the application, it's hard for us to tell you exactly where that will come out.

But normal course business, you can expect consistent margin improvements from our business.

Okay, great.

Thank you.

Your next question comes from Jeremy Davis of Credit Suisse.

Hi, guys.

It's Jeremy and Greg.

Just wanted to clarify on the implementation costs that you referenced that that was four new clients that are being signed up and kind of within the scope of the typical up front loss before you hit better profitability later rather than charges for existing clients that were unanticipated.

Exactly what you said.

Exactly what you said.

I was referencing a new client that we came in and implementation costs associated with getting that client up and running.

Okay, perfect.

And then you'd referenced record client retention levels in the U.S., but was wondering how retention was trending in some of your international markets and how far behind the U.S. it might lag and if it can get back or get to near U.S. levels sometime in the future?

Actually, in the employer services business in Europe, which is our primary international location or in Canada, the retention rates are actually better than in the United States.

And particularly strong in Europe.

You should also know that retention rates, as a general statement are higher with larger accounts, and lower with smaller accounts.

Europe has a much more of a weighted skewing toward larger accounts than our U.S. business.

So therefore, almost by definition, it will be higher retention, but even their national accounts business has higher retention than the U.S. national accounts business.

That's good.

And then last question and just with claims now gone from that other category, can you review with us what other smaller businesses are left in there, aside from the reconciling items and how we should think about that seasonality in terms of the revenue and profitability going forward, or if it will be more random quarter to quarter.

There aren't a lot of businesses left.

Claims was the only one of size, we have a couple of small operations that are included.

But the biggest things driving it is probably the offset to the 4.5% interest that we have in employer services.

And just to refresh everyone on what that means is that in order to have the management of our employer services business not focus on the changes and interest rates, which we let our treasury department focus on, we charge a standardized 4.5% to the business.

So when you look at them period to period, interest rates don't affect what's happening.

As interest rates vary, the difference between whatever the real interest rate was, I reference 4% as an average rate for this year, so the difference between 4 and 4.5% goes into other.

And that's probably the biggest m item driver other at this point.

It is, it is.

The other thing in there is the stock comp expense, which as you know is coming down year to year, but that's also in other and not in the businesses.

The other category also holds, right now, it's a net loss on the sale of our security, also the net corporate interest income, that's also part of the other category as well.

Okay, thank you very much.

Your next question comes from mark Marcon of R.W. Baird.

Good afternoon.

I was wondering with regards to employer services, looks to me like 40 basis points of margin improvement this.

I'm assuming part of the reason the margin improvement was a little bit less than what it has been throughout the balance of the year is due to a ramp-up in terms of sales, and maybe also a boost in terms of commissions with the selling season.

Is that correct, and how should we thinkabout that going forward?

I'm not following your margin improvement comment.

We're up 90 basis points for the year.

Right, 40 basis points year-over-year.

Yeah, I think mainly, the 40 basis points, and you're asking why is that a lower increase than you might have expected?

I'm assuming that's because of a ramp-up in terms of --

It's the people.

We spoke about, as you recall, ramping up the sales, the implementation staff.

So that's really was driving that.

And how much of that was due to commissions being up as well?

Did that much of an impact?

The commission expense since our sales results are running very close to our plan or slightly under our plan.

Those commission rates would have been budgeted and planned and reflected in the earlier comments we would have given you around margin.

What would be driving it is where we are advanced hirings, sales and complementary resource as we get ready for '07 as opposed to what was planned in '06.

Okay.

And then with regards to the brokerage margins, not to beat a dead horse, but just in terms of the weighting of some of the mailings, is there any reason to believe it should change going back to what's normal, or was there anything that was unusual that would change the weighting?

Most of the unusual items occurred in the mutual fund mailing arena.

So that is more volatile than the so-called normal equity annual report distribution, which is what makes up the bulk of the April/May period.

Because that's when the annual meetings take place.

Mutual funds, annual meetings, the mailings aren't necessarily tied to annual meetings, they're tied to other things.

That's really what the difference is.

Okay.

And then on major accounts, the new sales you indicated were a little bit lower there.

Any particular reason driving that?

And can you give us an update in terms of the competitive environment and what you're seeing from pricing?

We're seeing really no difference in the competitive scene or really no difference in price pressures from any of the competition.

The issue with major accounts deals primarily from the fact that we were behind on head count in terms of hiring significantly in the first half of this fiscal year.

And we have just caught up in terms of the hiring levels that we had planned for the year.

And by definition, newer people sell less, and so when you take off six months' worth of tenure, you get a lower result.

There are always occasional execution issues, but it's primarily a head count issue.

And just so you know to be sure, majors did have growth in sales, it just wasn't as high, so there was still growth year-over-year.

Great.

And the price increase year-over-year, what are you generally seeing?

We generally plan 1.5 to 2% is the way to think about it and it varies by size of client and business, but that's a good general rule of thumb.

Terrific.

Thank you.

Your next question comes from Bryan Keane of Prudential.

I just wanted to clarify, I guess the way I was thinking about is if you were going to pull forward the sales cost in employer services, then I guess naturally, when we think that going into the next couple of quarters that the margins would expand because you've already pulled forward those costs.

Well, we actually were behind plan, as you may recall in the first part of this fiscal year.

And then we started releasing for hiring for '07 call it in the November, December time frame.

And we will not conclude all of that higher until the May/June kind of time frame.

So, if anything, we're pulling more expense into this year, but it should enable us to get off to a faster start in sales as we enter '07.

But the ultimate issue is what Gary was referring to earlier, which is the ability for the new people to ramp up in productivity.

We have significant experience, which pretty much says that given the amount of time someone is here, we can set expectations for productivity.

But it plays out over a period of months.

But just to clarify, those costs associated with the extra salespeople are in this fiscal year.

And that's earlier than typical.

Typically, you might start fiscal year '07 with those costs being in the first quarter, but now they're going to end up into fiscal year '06 numbers.

But they're in the base, keep in mind, they're in the base.

And they will go forward into '07.

I guess the productivity goes up going forward into '07.

Exactly.

We had -- we're starting to hiring, depending upon the business, three to six months sooner than we normally would have, because we're having a good year and it's prudent to go ahead and hire those people today.

And we also had a little bit of an unusual circumstance this year in the sense we're behind, which we're normally not in the October time frame, so we had to catch up.

And at the same time, we're doing some pull forward from '07.

So it's a little bit of a barbell effect, so to speak.

But I think at the end of the day, we're going to be in good shape as we go into '07.

And the reality is, and goes back to the very opening comments, we're strong enough we can do this right now because we're feeling very positive about our overall results.

And still have the 100 basis margin improvement.

Gary also talked about the growth rate, I was trying to go back in my notes.

Do you think that's a short-term phenomenon or a long-term phenomenon when you look at the employer services business?

In any service business, and particularly in a business like employer services where close to your revenue, close to 90% of your revenue is recurring in nature, but even if you have a great sales year this year, it takes you six to nine months to start that business in many cases.

That's why we work so hard at keeping the business, focusing on retention, as well as escalating the rate of new sales.

But it's hard to accelerate the recurring growth rate more than a point a year kind of thing.

If you could accelerate 2 points a year, I think we'd all be delighted.

But I think one point is kind of more in the realm of possibility.

Okay.

And then just a last question, I had some discussions --

That would be sans acquisitions, by the way.

Right, right.

I've had some discussions with some investors just talking about the AAA balance sheet, is that essential to running a large payroll company, or that's not necessarily the case?

I don't think it's necessarily the case.

At a minimum, our other competitors here are not AAA rated.

And they certainly manage to sell payroll.

It certainly is a selling aid in terms of, particularly in the tax filings and money movement to have the confidence that your processor, is a AAA rated company and there is no credit risk with your funds.

Certainly, as you are aware, we do borrow over the course of any given quarter to maintain the right maturity levels on our pretty good-sized portfolio, and certainly borrowing if you're a AAA company for the amount that we do is certainly expeditious and more cost effective for us, and we do move a lot of money around the country, both to taxing authorities as well as from companies.

And we may have intra-day deficits at any point in time at the billions of dollars with certain major banks, where we are not required to put up deposits or pay any kind of a significant interest charge.

But all that being said, it certainly helps us, but at the end of the day, it's not essential.

Okay, thanks a lot.

Your next question comes from Lloyd Zeitman with Bernstein.

Hi, Art, Gary.

I have three items that I wanted to ask you about.

Just a couple of housekeeping things first.

The client funds portfolio, could you give us some specifics on the duration, the runoff, and current reininvestment rate?

The duration is around 2.2 years, so I think it's relatively consistent with where it's been for the last couple of quarters.

I don't know what the runoff rate is.

It seems pretty clear to me that when you're dealing with $13 billion in two years or two plus years, you've got to be at five plus billion a year in terms of what the runoff rate is.

But I can't be more significant than that, Lloyd.

Unfortunately, I don't know the number better than that.

Some of that also depends how active we are in terms of share buybacks, plus we're generating cash during the course of the year, but I think the average amount we're looking at for fiscal '06 is around the $5 billion number Art mentioned.

Okay.

And could you tell us what your current reininvestment rate is on the portfolio right now.

It's a little over 5%.

Okay, thanks.

In the PEO business, could you tell us the number of employees at quarter end and also give us, I guess, an update on California, how that's going, and really just how you view the market overall, because it seems that as far as employment goes, the marketplace is really hopping right now.

Lloyd, the number is 127,000 work site employees, which is up about 17% from a year ago.

And Gary will talk to you about the PEO market.

We continue to be very pleased with our results in that business.

The research results, I guess up somewhere close around 20%.

And sales rate is still continues very strong.

We're expanding in California as we mentioned to you.

In previous calls and are quite pleased with the results we're getting there and we continue to invest aggressively in this business and try to expand our sales breadth as fast as we can manage it.

Okay.

And last, earlier in the call, there was some discussion about the price tiering in brokerage services.

And you have essentially, I guess, a double-edged sword here.

You have the pricing going down, of course, as the number of trades goes up into a certain tier.

But would I be correct if I were to say that you benefit more in terms of, let's say, overall profits with an increase in trades, whether or not it kicks a particularly client into another tier?

Because of the fixed cost nature of our brokerage business, the incremental volume at whatever rate will give us a very significant margin pulldown on that incremental amount.

It helps if it's a bigger number.

What he was asking was, these are step rate tiers, so if you have 15 trades, the first 5 are at $2, the next 5 are at $1.5 and the third 5 are at $1 any trade that you get incrementally as contribution, it doesn't change or lower the previous levels that you were billing the earlier trades.

Right.

Those numbers by the away were figurative, not literal.

We wish they were that high.

Okay, I got you, thank you.

Your next question comes from Brandt Sakakeeny and he is with Deutsche bank.

Question for you, as you and Gary look at the collection of businesses you have and I know this has been sort of beating around the bush, but do you have any sort of minimum threshold for revenue growth under which you wouldn't tolerate a business, particularly in light of a 4.5,5% growth environment.

In order to be an effective ADP business, you have to grow.

We believe growth the important.

I can't tell you we have established a fix rate number and at that rate it's automatically in or automatically out.

And it wouldn't be a one-year look, it would be much more dependent upon our outlook of the business over a period of time and the way we could look at the market, market opportunity and our position in terms of the way we would answer that question.

Obviously, if you look, this quarter was a 4% business brokerage of 6 and structurally, it seems like there's some issues and clearly it doesn't sound like this business is going to get materially better over the next several years.

Is that fair or unfair?

Well, I think that our outlook is more positive than what you've expressed, so I think we can all debate what the reality of it is, but certainly we just completed a reasonably significant strategic planning period and not that we're always right when we do that, but I think our outlook is significantly more positive than the way you've looked at it for both of these businesses.

Okay, great.

Thank you.

We now have time for one or two more questions.

Your next question comes from Charles Murphy with Morgan Stanley.

Go over some financial items, operating cash know, CapEx in the quarter, and then the revenue from the two IC businesses.

And I don't think we got all the question, Charlie.

I was just asking for a couple of financial items, number one, operating cash flow in the quarter, number two, CapEx in the quarter, and then I wanted the revenue from the two ICD businesses?

Yeah, the CapEx, I think I can come up with.

It was about $64, $65 million in the quarter.

Our cash from operations during the quarter, I don't know.

I know we're kind of on track with our forecast for the year, which would put us somewhere in the $1.7 billion range or somewhere around there.

We can get you that.

I don't want me exactly what that was and the, on the ICD, the question was how much growth in the pieces of it?

Yes, the two pieces?

Yeah, the IDS piece, had good growth during the quarter.

I think we referenced that as being up close to 20% range or in the 20% range.

And our ICS business had lesser growth in part because of some of those mailings we talked about, one period versus another period.

So that's my quick, my quick.

And that's really cut toward the beneficial type business and the beyond beneficial, we're calling it so even with the IDS being part of that 18, 20% that Art mentioned, there's also the register side in there that's not the beneficial mailings, but still might be proxy mailings.

So the ICD in that record or some other breakout in brokerage?

I just wanted the revenue numbers from the beyond beneficial business.

We really don't provide those on a regular basis.

So I don't have that here.

But I can tell you, when you look at brokerage revenues in total, about 75% of the revenues are in the investor communications business as a whole.

When you look at the breakout, it's roughly 50/50.

Okay, thanks.

Your next question comes from Craig Peckham of Jefferies,

We've talked a lot about acquisitions and picking up the pace of share buyback, but as we look at 2.7 billion of cash buybacks, a couple other options occur to me.

Maybe you could give us your thinking on the pluses or minuses on an offer for a share repurchase or even a special dividend.

I think it's neither one of those is likely, that would be my quick way of answering it.

Have we looked at the questions in the past, the answer is yes.

And while those are decisions that ultimately will occur at our board level in a board discussion, I don't think it's something that you should be planning on.

And kind of shifting back to the fundamental question, as you look at the order trends in employer services, any observations on order sizes and trends in win versus loss rates there?

In a small business service or in major accounts, win loss would be about what it's been.

In our major -- I mean in our national accounts business, particularly with the breadth of the offerings that we have today, which includes our COS offering and all of our benefits offering, I would say that our win-loss record is improving and up from prior period.

And the number of new clients to ADP is up on a year to year basis.

And I would certainly say in our PEO business that we're doing quite well from a win-loss perspective.

Okay, thanks for the insight.

Now I would like to turn the conference back over to Ms. Charles.

Thank you.

We'd hike to thank all of you for participating on the call with us today.

We appreciate your time and interest.

This concludes today's Automatic Data Processing incorporated third quarter fiscal 2006 earnings conference call.

Thank you for participating, you may now disconnect.