自動資料處理 (ADP) 2007 Q2 法說會逐字稿

Good morning.

My name is Carol, and I will be your conference operator.

At this time, I would like to welcome everyone to the Automatic Data Processing, Inc. second quarter fiscal 2007 earnings conference call.

[OPERATOR INSTRUCTIONS]

Thank you.

I will now turn the conference over to Ms. Elena Charles, Vice President of Investor Relations.

Please, go ahead.

Thank you.

Good morning.

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

I am here this morning with Gary Butler, ADP's President and CEO, and Chris Reidy, our Chief Financial Officer.

A slide presentation accompanies today's earnings call and webcast, and it is available for you to print from the Investor Relations' home page of our website at ADP.com.

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

With that, I'll turn the call over now to Gary Butler.

Thank you, Elena.

I'm going to begin today's agenda with a few opening remarks, and then I'll turn the program over to Chris Reidy, our CFO, who will give you more detail on the quarter, and then I'll come back in and give you the full-year outlook, including our improved forecast for the full year.

Before we get to the Q&A, I'll also update you with some detail on the Brokerage spinoff, and then we'll adjourn to our typical Q&A session that we have at the end of the call.

Let me begin by giving you a high-level perspective on the quarter.

I think, in totality, I am extremely pleased with the second quarter results as well as the overall strong first half that we had across the enterprise.

As I mentioned, Chris is going to give you the detail of the quarter in just a few moments when I hand the program off to you -- to him.

But in general, we're executing well on our strategic initiatives that we've laid out for you over the last year or so.

We've got strong revenue growth, great momentum in all three of the businesses, and the investments that we've made over the last several years are continuing to pay off.

And I'm particularly pleased with some of the revenue acceleration programs that we've put in place around new sales, etc.

In the quarter, as expected and as we tried to indicate to you in our correspondence and talking to you over the first half of the year, we did have expected tough pretax margin compares in both the first quarter and the second quarter, and we do anticipate some drag similar to this will continue into our third quarter.

But we do expect to continue to get a full-year improvement in margins, which will be driven by particularly strong fourth-quarter margin comparison in this particular year.

I am especially pleased with the continued strong sales momentum that we have in Employer Services and the overall strong revenue and EPS growth that we're seeing across all of ADP.

And I think the additional piece of good news, which I'll give you more detail on, is that we are progressing as planned on the Brokerage spinoff.

So at this point, I'll turn it over to Chris and give you our full-year forecast as he concludes the Q2 remarks.

Chris?

Thanks, Gary, and good morning, everyone.

As Gary said, our second quarter results were terrific.

Revenues reached $2.3 billion for the quarter, growing 14%, and our internal growth rate was a very strong 12% in the quarter.

ADP's pretax margin declined 80 basis points as we anticipated, primarily due to the planned incremental expenses in ES of approximately $30 million, the impact of previously discussed acquisitions in ES, the $8 million of Brokerage spin cost, as well as the tougher comparables from the grow-over impact of the Kerridge acquisition in Dealer Services in December of 2005.

You'll see when Gary speaks about our full-year forecast a little later on, that we continue to anticipate margin expansion for the full year, driven by strength in our fourth quarter.

EPS grew 16% or $0.07, from $0.44 to $0.51.

About $0.02 is from lower share count in the quarter versus a year ago.

Share buybacks totaled 18.1 million shares through early January, and, as discussed on our last earnings call, the pace of buyback activity did slow from our first quarter activity.

At this time, we anticipate significantly moderating the pace of share buybacks until the completion of the Brokerage spin-off.

At the time, we would anticipate resuming aggressive share buybacks, of course, depending on market conditions.

Also during the second quarter, we raised our dividend by 24%, reflecting our optimism of ADP's future prospects.

I would also note that we will maintain this dollar amount of dividend after the Brokerage spin.

Now turning to the next slide 5, we'll review the segment results, where all of our businesses had good momentum in the quarter.

Internal revenue growth for ES was strong at 11%.

Revenues from our traditional payroll and payroll tax filing business again grew 9%, and this is important, as this is our most profitable business and it creates additional opportunities to cross-sell our beyond payroll products.

It's also important to note that this does not include any impact from the change in interest rates, as ES has held to a constant 4.5% rate.

This healthy 9% growth reflects accelerating new business sales, growth in client fund balances, and an increase in the number of pays on our client's payrolls.

Beyond payroll revenues grew a strong 19%.

PEO, COS, and time and attendance all posted strong growth in the quarter.

We anticipated the decline in pretax margin due to our higher step-off expense level from last year, and we believe our sales force investments are paying off.

Once again, new business sales growth was strong, with 13% growth in the quarter worldwide and 11% in the U.S.

At pays per control, a same-store sales metric was up 1.7% in the quarter, with even stronger pay growth in the small business services market and nearly as strong growth in national accounts.

And we continue to see some growth in the number of pays in Europe.

Overall, we continue to anticipate 2% growth in pays per control for the full year, and we continue to see growth in client fund balances, and retention continues at strong levels.

Now moving down the page to Dealer Services, we had strong revenue growth of 19% which was assisted by the December 2005 Kerridge acquisition.

Internal growth -- revenue growth rate was over 5% in the quarter.

Overall, margins improved 30 basis points compared with a year ago and are anticipated to continue to expand as the year progresses.

We are pleased with the new business sales growth in Dealer and particularly in the International business.

Now let's move to slide 6 to review Brokerage.

Internal revenue growth for Brokerage was 9%.

This increase was driven by our investor communications business, primarily due to increased volumes, fulfillment, and registered mutual funds, as well as higher posted revenues.

Our proxy season is still ahead, and that's where you get the scale in this business, so we anticipate better pretax margins ahead, particularly in the fourth quarter.

In the clearing and operations outsourcing business, revenue growth was strong in the quarter at 17%, all internal, and, as anticipated, the pretax loss is lower than a year ago.

So the bottom line is that Employer Services, our most profitable business, is heading in the right direction with 12% revenue growth and continued double-digit sales growth.

We're also pleased with the growth we are seeing in Dealer Services and Brokerage.

Margin comparisons were tough this quarter and we did expect this.

Incremental expenses began to ramp late in the third quarter last year, and this year we have the impact of the acquisitions we've previously announced.

Putting that together, the third quarter pretax margins will continue to be a tough compare to the prior year, and the full-year margin expansion of 20 basis points is anticipated to be driven by strength in the fourth quarter.

Overall, we're very pleased as we enter the second half of the year.

Now let's move ahead to slide 7, and I'll turn it back to Gary to review our full-year forecast.

Thank you, Chris.

As you can all see on the ADP forecast page, we had a great second quarter.

Results were very strong.

We also are confident in our 11% revenue growth forecast for the full fiscal year.

The momentum in all of our businesses is strong, including the announced additional strategic acquisition activity that we announced and closed on in the second quarter.

At this point, we're also highly confident in our ability to attain the high end of our 17 to 20% earnings per share growth forecast.

And to be clear, what is included or excluded from this forecast, this forecast does include the estimated $0.03 dilution from the acquisitions we've announced to date, it does exclude the net one-time items that increased earnings per share by $0.03 from the first quarter, so this is over and above the high end of the forecast.

And it does exclude any Brokerage spin-related costs.

This includes the $10.6 million of spin costs that we have recorded through the end of the second quarter, because this will be reclassified to discontinued operations upon completion of the spin, which, again, is on target for the late March/early April timeframe.

Our forecast also does not contemplate further share buybacks.

Our forecast for client funds includes interest revenue increases of approximately 18%.

This is driven by a pretax yield of about 40 basis points for the full year to 4.5% and increased balances of over 8%.

So this 8% is lower than our previous forecast of nearly 10% growth in client balances, and this is primarily driven by lower state unemployment rates, or SUE rates, that had been implemented by the states over the course of the first quarter, reflecting the low unemployment levels that we've seen across the United States.

Also, you will see in our press release that this quarter we sold the Sandy Corporation, a non-core Dealer Services business that was reported as discontinued operations in this second quarter.

This business would have contributed $.01 to earnings per share, but is now reported within discontinued operations.

So if you now go to slide 8, the next page, to review the forecast with you by segment.

First, in Employer Services, there's really no change in the full-year forecast.

The key business metrics remain terrific.

Our current revenue growth forecast of 12% reflects strong internal growth in revenue of 11%, plus around 1% growth from the acquisitions we've announced to date.

Also, with the momentum in our new business sales, we continue to anticipate higher than planned double-digit growth for the first -- for the full year.

I would remind you, however, at this point, that we will have a difficult fourth quarter comparison to the fourth quarter of '06 as our sales in that quarter were up 24% in the fourth quarter.

So, we expect to have a great fourth quarter in '07, but it will be against a difficult compare in the fourth quarter.

We also anticipate full-year pretax margin expansion of around 20 basis points.

Again, as Chris mentioned, driven by a strong fourth-quarter comparison.

As Chris said earlier, we do anticipate some drag on the pretax margin in our third quarter for ES, and the full-year margin expansion is anticipated to be driven by the strength in the fourth quarter.

Secondly, in Dealer Services, our revenue growth forecast of 14% is up slightly from our previous forecast of 13% growth as a result of the recent sale of the slower-growing Sandy Corporation in the Dealer Services business that I mentioned a few moments ago.

Again, the total revenue growth is assisted by the Kerridge acquisition, but we do anticipate 5 to 6% internal revenue growth for the full year, and we continue to expect full-year tax -- full-year pretax margin improvement of over 100 basis points.

Finally, in our Brokerage Services unit, our revenue growth forecast is 6%, up slightly from the previous forecast of 5 to 6% growth, due primarily to higher posted revenues, which also yield lower margins.

This is anticipated to drive pretax margin improvement down from nearly a 100-basis point improvement that we previously forecast to about a 70-basis point improvement for the full year.

Now, I think the really good news in the Brokerage Services business is the spinoff is progressing as planned, and I'll give you more detail here in a moment.

In our clearing and operations Outsourcing business, we continue to anticipate 20% revenue growth with lower pretax loss than a year ago.

Now let's go to more detail on the next page on the Brokerage spinoff.

As I mentioned, the spinoff is progressing as planned.

You also probably saw the press release in mid-January with the name announcement for the Brokerage Service business unit of Broadridge Financial Solutions, Incorporated.

It will also be listed on the New York Stock Exchange under the symbol BR.

We remain solidly on track to complete this spin in late March/early April, and there will by a pre-spin road show in the days or a couple weeks ahead of the actual spinoff.

We are in the midst of our discussions at this point with the rating agencies, and it is still our goal to achieve an investment-grade rating for Broadridge debt at the spin, but I want to remind you that this is a work in progress.

As you know, we also filed a preliminary Form 10 with the SEC on December 19th, and as disclosed in that Form 10, our best estimate at this point of the dividends to be paid back to ADP is approximately $800 million.

And we continue again to remind you to anticipate an investment-grade credit rating on the Broadridge debt.

We are maintaining our previously announced goal to remain cost neutral, which means taking out roughly 30 to $40 million from the new ADP as we go forward.

We also anticipate providing continued operations guidance, which will exclude Brokerage at our upcoming March 22 analyst conference which will be held in New York on March 22.

So the message is, we are, overall, moving forward as planned, and before I -- as you turn the slide, I would like to leave you with a couple of closing comments before we go to the Q&A session.

We are very pleased, as I'm sure you can tell from our comments, with our progress to date.

We are ahead of our internal plan.

We have a clear strategic direction as a corporation, and we are executing well on the strategic initiatives that we've laid out for you over the last year or so.

We are very well-positioned to continue on the course that we've laid out, and I remain highly confident in our ability to grow this business in the months and years ahead.

So with that, I will turn the session back to the operator, and we'd be delighted to take your questions.

[OPERATOR INSTRUCTIONS]

Our first question come will come from the line of Bryan Keane with Prudential.

Hi, good morning.

I just wanted to talk about the major account services.

I know that's the most penetrated division, yet it's still growing double-digit sales.

Can you just talk about what's going on there and how that division is able to grow double digits despite the penetration?

Really, a couple things happening there.

One is that we've expanded the sales force there over the last year or two, which is good news.

Secondly, we are selling larger product bundles, so more and more of our new sales include our time and labor management products as well as our benefits products, particularly from our employee's acquisition that we announced awhile back, as well as we were in a strategic alliance with them for almost a year prior to the acquisition.

I think the really great news that's happening with the employee's acquisition as we bundle it with our core payroll is, almost half of the business we're selling in employees brings new payroll clients with it, which has been our toughest challenge, because the market, as you indicated, is relatively penetrated.

So we're very delighted with the success we're having there in this first half of the year, and we're looking forward to a great finish in major accounts and couldn't be more pleased with what's happening there.

Okay.

I just want to ask about the national employment report that you guys do on a monthly basis.

The predictions have been off some from what the government's been reporting.

Can you just talk about the differences between your numbers and the government, and can you get that -- close that gap going forward?

Well, as you know, most of the actual commentary and work is done by macro economic advisers.

Joel Prakken is the Chairman there, and he's really the guy that's best capable of really answering the economic kind of questions that you have.

We do have, in any kind of statistical comparison, you have occasional outliers where these kind of things do happen.

December has been one of those months where, typically, our comparison against the BLS is more negatively skewed, and theirs tends to be more positively skewed in the December month.

So we weren't all that surprised with the comparison -- or Joel wasn't all that surprised with the comparison in December.

But the methodology remains the same that we've used that was statistically verified over a five-year period.

We remain confident in the algorithms that they're using.

And we're also announcing some revisions and additional expansion of that report, which will be announced here this month, that will begin for the February results.

So we remain confident, and we're going to continue the course.

Okay.

So the December weakness that you guys reported didn't necessarily correlate to exactly what ADP had?

You don't see it in the fundamentals here.

No.

We still had positive growth for the quarter.

And one of the things you have to be careful about with these quarterly, our pays per control numbers, is, the months tend to be up and down, and the quarter is the most true reflection of what's happening in the business.

We saw 1.7 pays per control growth in the quarter, and we also had a strong January.

But, again, you can't read too much into that until you see the full quarter because of the fact that you have 13 weeks in a quarter and you have ins and outs from quarter to quarter, depending upon four-week months versus five-week months and holiday cutoffs etc.

But, again, we see it as business as usually, and that's why, as Chris mentioned, we've maintained our forecast of 2% same-store sales comparison for the full year.

But Bryan, I think you're right.

You cannot correlate that report directly to ADP performance, given some of the extrapolation and what have you that they do on the economic side.

Okay.

Finally, and I'll turn it over after this, but in the Brokerage division, can you guys just talk about some of the pluses and minuses that Brokerage will be dealing with on a going-forward basis, maybe even some on a macro level that are good and bad?

Can you be a little bit more specific?

Are you talking about post-spin or for the third quarter or --?

I guess third and then post-spin, just any -- some of the -- any client losses that we have to be aware of, any client adds that are going to make much of a difference in the Brokerage revenue.

In particular, if you look at it, Brokerage has had such a strong first half of the year, it tails off a little bit.

You're expecting 6% revenue growth for the full year, so I'm just trying to get a sense of the difference there.

In the third and the fourth quarter, obviously, Brokerage drops a little.

And then going forward, any things we should be aware of?

Bryan, this is Elena, let me start.

On the revenue forecast that we have for the year, you're right, there was stronger revenue growth in the first quarter as well as the second quarter.

A lot of the first quarter revenue we had said was driven by specials, some one-time, very large, mailing events that we had.

And then as -- continuing still is the higher postage that we're seeing.

Part of it is, there was a January 1st postage increase January of '06.

So, of course, that's going to give us easier comps on the revenue this year in the first half of the year.

So those numbers are really because of the one-time nature, the grow-over of the postage.

That's not going to continue for the second half of the year, but it doesn't suggest that there's any drop-off in the business at all.

In terms of the client losses that you spoke about, maybe you saw in the Form 10, we did talk in there about the -- I think that the number was $39, $40 million.

That is TD Waterhouse that we've spoken about with everyone for the last couple of years, with Ameritrade's intent to bring them back in-house.

That's something that's out there.

There's nothing new that is foreseen.

I know that Form 10 went through many of the risks and uncertainties, and the management team will dive in a lot deeper on the Brokerage road show -- or I should say the Broadridge road show, when that comes up.

So, does that help -- help you out a little bit?

That's perfect.

Thank you very much.

Our next question comes from the line of Rod Bourgeois with Bernstein.

Yes.

I wanted to talk a little bit about the share buyback and if there's any way you can dimension for us how aggressive you're positioned to get with the share buyback.

If I look at your cash balance, the free cash flow over the next year, and the cash that you're extracting from Brokerage, you have the capacity to get pretty aggressive.

And if there's any way that you can give us a way to dimension what's in your plan, that would be very helpful.

Let me make a couple of comments first, Rod, and then I'll let Chris chime in at the end.

As I've communicated consistently over the last nine months or so, ADP clearly had excess cash on its balance sheet.

And I think we have continued to execute, as I have laid out, to return that value to our shareholders through fairly aggressive share buybacks.

Obviously, any comments I make are going to be contingent upon market conditions.

But, again, we're sitting at $1.7 billion today, we'll get $800 million or thereabouts from the Brokerage unit, and to your point, we will continue to create cash flow based upon the strong business model that we have.

So, again, depending on market conditions, we would be returning to the market in a fairly aggressive way starting in the fourth quarter and would continue on that course until we get to a point where we think we have taken out the excess cash on the balance sheet as we go forward.

So Chris, I don't know if you have other comments to what I've said?

No, I think that about sums it up.

As we have said previously, we will and we intend to utilize the Brokerage dividend of $800 million.

And as you've seen, we had $2.7 billion of cash after we sold the claims business, and that's come down steadily to the current balance of $1.7 billion.

I would expect to spend some of that cash down in the future.

Again, based on market conditions and being opportunistic in the market over time.

So once the brokerage spin occurs and we receive that dividend, you can see us get more aggressive.

And we can buy back more shares at, obviously, the lower ADP price after we spin Broadridge.

Got it.

One clarification on Broadridge.

You mentioned the goal of being cost neutral across the new ADP and Broadridge.

In the Form 10, you also disclosed that Brokerage will incur about $30 million of expenses to run as a separate company.

I'm wondering if that $30 million expense figure is an increase over the plan you had in place when you first announced the spinoff, or whether that's exactly what you expected and fully in line with the plan?

The $30 million that you're referencing, we've anticipated that since the very beginning.

I think we mentioned it even back as long ago as August when we announced that it would be a significant -- not a significant, but an uplift in terms of their expenses.

Most of the people that have been transferred to Brokerage to build out the corporate nucleus that they need have not been replaced at ADP.

And, as I had mentioned in some of our previous conversations, obviously, the new ADP, which is only ES and Dealer, there are some synergies between the ES infrastructure and the corporate infrastructure as we are consolidating those two units going forward.

Because we don't need a corporate infrastructure to the same extent that we did before when the primary business is Employer Services and Dealer going forward.

So, there are some savings that we're working on there in addition to not replacing the people that have been transferred.

And our goal remains that in the aggregate between the new ADP and Broadridge that we will be cost neutral from an overhead or an infrastructure cost standpoint.

So the aggregate guidance you had for the fiscal year, for the new ADP and the old Brokerage business, that aggregate guidance should not be affected by this event; is that correct?

Right, that would be correct.

Okay.

Thank you guys, very much.

Our next question comes from the line of Adam Frisch with UBS Warburg.

Thanks, good mornings guys.

Good morning.

Adam.

Kudos to you again.

I'll say this one last time, on the presentation of everything with the slides and the press release and everything, much improved.

Easy comp, but much improved versus what you guys used to do.

I had a question on the investments made in the quarter in both the sales and in the HR BPO.

Could you just provide a little bit more color on what you invested in in your sales force, where and for what opportunities are you gearing up for in that initiative?

And then on the HR side, $20 million, what do -- how do you spend $20 million in that business, and how did you prioritize it?

The investments in the sales force last year in '07 -- I mean, in '06, if you may recall, we were actually behind our manpower plan from '05.

So we not only staffed up for '05, but we staffed up for '06.

And as we exited the year, we started staffing up for '07.

So that's the reason why we've had these difficult comparisons in the first and second quarter.

And you'll also see some continuation at a lower level in the third quarter, but still a continuation until we get into the fourth quarter.

So that's pretty much as planned, and the basic reason we've done it is, we've tried to step up the level of new business accretion across the enterprise.

And, fortunately, over the last couple of years, we've had the earnings wherewithal to be able to do that and still meet our commitments to the street and to our shareholders.

Now included beyond the sales force ramp-up has been a significant investment in our HR BPO in a box, which I had talked to you about for some period of time.

That includes significant investments in our GlobalView platform as we build out our ability there to implement across 40 countries, up from in the 20s a year ago.

It includes a substantial expansion of the PEO, including sales and implementation capability in California where we've got a large market opportunity there, and it also includes a significant investment in our COS national accounts BPO product.

Take care of that big opportunity that we had.

So, again, this is all good news as far as I'm concerned, and we're seeing returns in terms of new sales based on those investments.

And you'll start to see a more normal compare as we get into the fourth quarter.

On the sales front, are you now up to -- are you caught up and where you want to be in term of your investment initiative there?

We are, I would say, through the accelerated step-up period that I've been talking to you folks about for the last couple of years.

We will do our normal uplift in staffing as we prepare for '08, but that really won't take place until the latter part of the third quarter or the first part of the fourth quarter.

So we're going to return to the normal pattern that we've had historically as we've gotten through this step-up in expense in '05 and '06.

Okay.

And then on the HR side, do you expect in future quarters for there to be chunky investments like this, or is -- now that you've made this one -- I don't know if you're viewing this as a one-time thing with -- you're always going to be investing in it obviously, but is this like a big, one-time thing and then each quarter will be more measured?

We've clearly, in the last two years, had what I would call step- up levels of investment, and as you think about where we are today, they're going to be more ratable over time after we've gotten through these initial step-up investments to kick start these businesses.

Our strategic direction today is the same as it was a year ago, and it's clear and we're on the path and we're through some of the initial investment periods that we've had to kick start these businesses.

Okay.

Two strategic questions and then I'll turn it over.

First, any update on the First Data relationship?

Anything material happening there yet, or are you still in the early stages?

Still in pilot stage.

Nothing overly positive or negative at this point.

Again, I think it's really still too early to report, but I would be happy to update you when we get to the March analyst meeting.

Okay.

And then just on the small -- on the SMB marketplace, can you discuss your current capabilities or whatever future plans you might have as it relates to health insurance and 401(k) plan for that market?

When you say S&P, did you mean SBS?

Small and mid -- yes, okay.

We clearly think, in both the small business below 50 employees as well as in the low end of our major accounts, that there are clear opportunities for workers' comp distribution to our base as well as clear opportunities to sell healthcare into our base.

And we are committed to both at this point, and we will share that direction with you in considerable detail, again, at the March analyst meeting.

Okay.

Thank you.

You're welcome.

Our next question will come from the line of Jim Kissane with Bear, Stearn.

Thanks.

Just following up on the margin question, can you give us some more details on the third quarter Employer Services margin outlook and your confidence in getting to your 4Q objectives?

Because it's a pretty big step up in 4Q margins.

You want to -- ?

Well, I just want to say as a rule, Jim, we don't give quarterly guidance, but we did feel it necessary to give you some feel of how we were seeing the second half play out.

As we mentioned, we began ramping those incremental expenses in the third quarter of last year throughout the year, so it didn't all happen on January 1st.

Combined with the acquisition -- acquisitions that were previously announced, we just wanted to make sure everybody understood that third quarter was still a tough compare.

Our margins typically increase, if you look at our cyclicality of our margins you'll see increases, but the compare is difficult.

And where we have the easier compare is in the fourth quarter.

So as we look at that all-in, all-in, we would -- we're still confident in the 20 basis point improvement in ES margins.

But we see that coming from the fourth quarter, and we didn't want to set the expectation that you would begin to see that in the third quarter.

And that's been true -- that's the way we've always seen that happening.

Jim, just to give you a little color there.

Clearly, our '07 plan and our '07 results are going to be more back end loaded than we would "prefer".

But because of these step-up investments, it was kind of the way it was, and it was supportive of the overall strategic environment or the initiative that we're on.

And clearly, we would hope to return to more of a historical pattern as we go into '08.

But we've scrubbed this to a fare thee well and, obviously, expected these concerns.

And we still remain confident that we're going to have a very strong fourth quarter and that we'll honor our commitment that we've made around margins where we are today.

Okay, great.

Can you break out new orders for the national accounts segment?

Because it seemed like major accounts was very strong, but that national may have slowed a little bit from last quarter.

We don't give the actual detail by segment, but national accounts, it was still very strong.

It's strong double-digit new sales growth for the quarter.

Okay.

You shouldn't read into our comments around major that we've seen any lessening of success in national accounts.

We still remain really pleased with our national accounts sales results as well as our GlobalView results that kind of overlay that around the world.

You shouldn't read any negatives into the national account results.

Excellent.

If I can get one last question.

Any update on the impact that the new regulations will have on the Brokerage revenue?

I think last March you indicated about $150 million, I think two-thirds of which would be postage, any update?

Yes.

That was a year ago, I think, on this earnings call exactly.

We really don't have any update on numbers.

When we had put that together, that was based on proposed rules of worst case scenario.

I think right now with the way the rules have been written, there are some puts and takes, there's going to be some pluses and minuses.

Some of them we did discuss on the call a year ago in terms of, while there won't be the bulk distribution of the paper proxies so the postage weights will go down, our revenues will go down as a result of that.

However, and we don't know at this point how many of the corporate issuers their shareholders will still elect to have paper copies.

That's something that our Brokerage company is very prepared to fulfill, we'll be involved in that process.

But, of course, those will be at higher prices because it won't be the bulk processing anymore.

So there are some pluses and minuses, and, at this point, we're really not ready to give an exact amount on that.

Jim, this situation there is still very fluid, and this thing is still playing out.

And I expect that as we approach the road show, they'll have a much clearer perspective and detailed -- ability to answer detailed questions that you'll see in March when they go out on the road show.

But, again, I think it's really still too early to tell.

It could be a plus, it could be a minus, but I don't think we're expecting a material degradation to the business.

Great.

Thank you very much.

Our next question will come from the line of David Grossman with Thomas Weisel Partners.

Thanks.

Gary, not to belabor the margin question, but it just seems like there's so many moving pieces here, particularly as we go through the third quarter into the fourth.

Can you give us just a sense, on a longer term basis once you get through the spin in this fiscal year, how we should think about the opportunity for continued margin expansion?

Yes.

Again, I've been fairly consistent as we talk about this.

We have been on, over the course of the last year, a course to get our business more focused with the -- with the divestiture of claims and the tax-free spin now on Brokerage.

You can see what we're doing with the further pruning of some of our slower growth businesses, like the Sandy Corporation, which we announced.

We have a couple of other smaller kind of things that are going to pan out over the next quarter or two.

But as we enter '08, I expect us to be into the strategic business positioning of the go-forward model.

I think as a general rule of thumb, again, sans acquisitions because that -- and big buybacks, that you should expect a half a point of margin improvement from the company on a year-in and year-out basis based on the scale that we get in the business.

And I understand that in particularly '07, we've had a lot of puts and takes between discontinued operations, divestiture of things, as well as the ramp-up of expenses to get up the nose of the ship, so to speak.

But I would expect us to achieve a more normal state of course as we enter '08 and beyond.

So there's no obvious headwinds, then, as we enter fiscal '08?

I think we got -- Employer Services and the Employer Services market is a fantastic market.

It's a growing market in its own right, it's underpenetrated, and we have a great global opportunity to boot on top of a strong U.S. market.

And the Dealer market is almost the same way.

Even though it's a highly penetrated market in the U.S., it has an enormous opportunity on a global basis.

So, I think we're in great markets, I think we've got a great management team across both businesses, and we're going to continue to execute as we've laid out.

Okay.

And just -- I know this number moves around and the comparisons maybe are a little bit difficult, but it looks like there was a little bit of a deceleration on the pays per control number on a year-over-year basis.

And it coincided, obviously, with lower client balance growth in your forecast.

I know you mentioned there was other factors impacting that, but is there anything in that number, or is it pretty much as you would have anticipated for the quarter?

Well, the 1.7% is clearly a lower quarterly pays per control growth than we've seen over the last seven or eight quarters.

That's a fact.

But, again, in January, again, you can't use that as a proxy, but it's at least good news.

We had strong growth in pays per control across the enterprise in January.

And as we talk to the business units, they're not seeing any significant lessening in that category, which, again, is why we were confident in maintaining our forecast of 2% growth for the full year.

And I think, as a general statement, in the employment statistics that have been reported, both by the National Employment Report and also by the Bureau of Labor Statistics, is that we've seen continued good growth in employment.

The real issue around balances is almost solely due to state unemployment drops.

Because as unemployment levels remain low over several years, they don't need the excess and they continue to drop rates.

This generally lags what's happening in employment by a year or so, and we've seen this trend many times over the course of the multiple decades that we've been in this business.

So, again, we're not surprised, but it did -- it will affect us this year with the drop to 8%.

I would just add, David, that you saw that it was higher in the first quarter, and we stuck to our 2% projection for the year.

So we did anticipate seeing some swing in that pays per control number.

As Gary said, we have looked at January, and we're encouraged by where January came in.

So there is some correction between December and January that often occurs.

So we're comfortable with that 2% going forward.

Thanks, Chris.

And, actually, Chris, a couple of very quick questions for you.

It looked like the tax rate dropped modestly.

I don't know if you're still expecting a 37.5-ish type number for the year?

And also, if you could maybe just comment on the uptick in capital gains, is there something structurally going on in the portfolio, or is that just time and place?

Sure.

On the tax rate, we're continuing to anticipate about 37.6%.

Last year was 38.5%, and that included about 0.6 for the tax repatriation.

So, on an apples to apples basis, it was 37.9, so we got about 30 basis points improvement.

And it's basically due to the favorable tax jurisdiction mix that results from consolidating our data center operations in Georgia.

So you will see a little bit of that going forward as we continue to do some [smart churring] and move some of the other data centers into Georgia and that will hit going forward.

Again, not huge step-down impacts, but kind of like what you've seen.

In terms of the gain on the sale of securities.

Really, when you think about that, you've got to look back over many quarters, and we have some net gains and some net losses.

And with a portfolio of this size in excess of $13 billion, you're going to get that kind of movement.

In this particular quarter, we funded our previously announced acquisition, so we took the opportunity at the same time to reposition the portfolio and that resulted in taking some gains.

Also as part of this, we extended the duration of the portfolio from 2.2 to 2.3.

So, nothing unusual.

You're going to see gains and losses from time to time on a portfolio like this, so I wouldn't see that as anything unusual.

Great.

Thank you.

Our next question will come from the line of Liz Grausam with Goldman Sachs.

Hi.

I just wanted to ask you a few questions on Dealer.

What are some of the strategic plans you may have in place, you may explain these more in March at your meeting, to really accelerate the internal growth rate there?

I know you've had some good announcements recently, and certainly the international markets look like they're picking up for you.

So, could you help us -- what gets us from 5% upward in some of the out years?

There are really three things going on in Dealer Services.

One is, even though we have a highly penetrated market in the U.S., we continue to gain share and will continue to see momentum in our business as usual.

In addition, in the U.S. market, we have a new front end product which I have spoken about several times, which you'll, again, get more detail in March, that helps dealers convert advertising dollars into search spin and lead generation through the internet, which is where this marketplace is moving.

The average sale, we -- this was from an acquisition that we made, I guess now going about nine months back of BZ Results.

And we've seen BZ Results accelerate from selling like 15 to 20 new units to over 40 units per month.

And each one of these units is worth $50,000 a year in annual recurring revenue to ADP.

So this is going to really help us accelerate our growth in North America.

On top of that, as evidenced by the recent announcement that we made of BMW in -- to be their provider for the Pacific Rim and, specifically, China, we are very excited about the opportunity that Kerridge has brought us on a global basis.

And we have more activity going on there than I've seen in my entire 30 years at ADP.

So I'm very opportunistic about Dealer's international prospects, because we are, by far and away, the largest leading supplier of these kind of services, particularly as you leave the United States.

And the manufacturers need us.

So, we're very excited about the international opportunity there, and I think it's going to be a major growth vehicle for Dealer in the years ahead.

Is there any difference in the margin structure of this business, domestically versus internationally?

And are there any incremental sales expenses that you might need to pick up in the Dealer division to capture that international opportunity better?

The margin expansion or the margin attributes are slightly lower international because we don't have quite the scale by country that we would have clearly in the United States, so you can't compare those two.

But we're clearly seeing margin expansion in our international efforts, particularly in Europe as we're gaining scale there.

But clearly, as we build out to service China and some of the Pacific Rim, there are up-front investments that will have to occur, but we think it's absolutely the right thing to do long-term for the business.

But in our internal strategic plans, as we look at the five-year view, we still expect to get, in aggregate, modest margin improvement year-over-year for the foreseeable future.

And to address this year, margins have begun to improve as we anniversaried the Kerridge acquisition in December.

And so we do anticipate somewhat easier comps in the second half of the year to our guidance of over 100 basis points of margin improvement in Dealer.

The thing that happened there, just to help you, mostly in the U.S. market, we sell a dealer at a time or a consolidator at a time.

Typically, for example, in China, we're getting all of BMW, and we're in conversations with a number of other manufacturers to, hopefully, get their entire dealership network across China.

So our sales costs is lower for those kind of sales.

Great.

Thank you very much.

Our next question will come from the line of Michael Baker with Raymond James.

Yes.

Thank you.

I wanted to get a little bit more color on the performance of the PEO, more specifically, how the workers' comp program fared, as well as health benefits, how claims costs trended relative to your expectation.

In the PEO, our workers' comp is doing perfectly fine.

As you know, that market has softened somewhat over the last 12 months, and so we have not had to increase our rates.

And, in fact, some cases actually brought our rates down over the course of the last 12 months.

Our claims experience is below our internal plan.

We do have a captive insurance unit within ADP that serves as the insurance captive for the PEO, and our claims experience is beating our internal plan.

So, our claims experience is good, and we don't see any significant risk there in the year ahead.

How about on the health side?

What are you seeing in terms of claims relative to expectation?

Well, we don't really self-insure on the claims side with healthcare, and so our suppliers there, which are multiple across the United States, continue to be very positive about our relationships there, and we continue to have a pretty positive claims experience versus their internal plans with us.

Thanks a lot.

Our next question will come from the line of Franco Turrinelli with William Blair and Company.

Gosh, I'm sorry.

My questions have been asked and answered.

Thank you.

Thank you, Franco.

Our next question will come from the line of Gary Bisbee with Lehman Brothers.

Hi, guys.

Good morning.

A couple questions.

On -- following up on the questions on Dealer, it sounds like you've got a lot going on in Asia.

We've seen a couple press releases and heard some rumblings in the U.S. about Microsoft developing a DMS product right now to roll out at some point in the next 12 to 18 months.

Given your entrenched market share, what do you have to think about that?

Is that a big deal?

Do you think they have any chance to make any significant inroads, or do you have any sense how competitive their product may end up being?

Well, first of all, the market is somewhat of a duopoly in the sense that you have the Reynolds UCS consolidation and ADP, and then there are a number of smaller providers.

So that being said, it's not surprising that companies like Microsoft see this as an opportunity.

The market also is moving to consolidators and higher end suppliers, which is a much more difficult implementation and sophistication level of the software product.

And you also have to remember that all these dealers have to interface with all these third parties, including a lot of manufacturers who sell product in the U.S.

And Microsoft is also using a third party distribution in terms of their resellers to try to attack this market.

So I'm sure they're capable of doing a lot of things if they throw a lot of money at it, but it's not as easy as it may look to be a major supplier here.

So I think this is going to play out, and we're not surprised by it.

But we don't see any near-term threat to our efforts here.

Okay.

And then, obviously, we saw the announcement in China, are -- and you said there's some other dealers you're talking about.

China is obviously a huge opportunity.

What are the other countries or areas?

Is it mostly Asia that's the biggest opportunity over the next few years in addition to China, or are there some remaining untapped areas in Europe that you're going to go after as well?

First of all, in Europe, the Kerridge had terrific relationships with major OEMs in Europe.

And we have a much smaller share, and the share itself across Europe is more spread over many different suppliers.

So we think the combination of ADP and Kerridge is going to be a much more preeminent force in the European market, and Eastern European, than we previously had the ability to execute.

So we do see strong growth in Europe, and there is no company like ADP Dealer Services across the Pacific Rim.

So we expect even larger growth across the Pacific Rim.

China is clearly where the bull's-eye is, but there's also great opportunity in Korea as well as in all the Asia-Pac countries across the lower side of that region.

So, we think it's a terrific opportunity for us, and we're really focused on it, and we're executing well against the opportunity.

And as I mentioned, there are several OEMs that we are in pretty detailed conversations with that we hope to be able to announce over the next six months or so.

Okay, great.

Moving on to the PEO, I think you've mentioned in the last few calls the potential -- or, I guess, you've already launched an ASO product where you wouldn't be providing the workers' comp and self-insuring a portion of that.

Can you give us an update as to where that is?

And given that that would seem to have a lot lower revenue, that business opportunity, although maybe it would be more profitable, how do you feel about real success with that business potentially slowing the revenue growth from the PEO?

And what's that going to mean for the P&L overall if you're successful with that?

As you think about the ASO, I think you have to think about a continuum of product.

And if I could speak to just the low end of the market, below 50, which is the sweet spot of [SBS] and the PEO.

Clearly, you have the PEO as the full outsource model, including co-employment and all the insurance products, which is a good thing.

And, clearly, you have single payroll sales in the SBS market.

And the ASO is kind of halfway in between.

So it's a significant uplift to a straight payroll sale because it has multiple products and it is a full compliance bundle that is a lot larger than a pure payroll sale, but not as big as the co-employment model of the PEO.

I suppose there is some risk that there will be a slight decline in PEO referrals from the SBS sales force, but at the same time, there's a significant uplift to a pure payroll sale by selling them the ASO bundle.

And we clearly believe that with the gives and takes, it is a clear upside opportunity for the below 50 marketplace.

And do you have any traction to date in that product, or is that -- are you still trying to educate the clients right now?

We are in a pilot mode.

We're using a subset of the PEO product, which doesn't include the insurance model.

You can still buy insurance product from us, but it's on a menu basis as opposed to a-- included in the self-employment -- I mean, in the co-employment model.

We've had great sales success in the areas where we're piloting it, and we have multiple hundred in clients installed.

And if things stay on course, we'll roll it out nationally in the year ahead.

Okay, great.

Just one last question.

As we look out, say six months or so past the spin of the Brokerage business, what's your appetite at this point looking forward to that period for acquisitions in Employer, and, specifically, mid- to large-sized acquisitions?

Any change versus what you've said over the last year or so?

I have been relatively clear over the last nine months that we do not have a real appetite for large acquisitions, particularly if they are dilutive beyond 12 months.

And in today's pricing environment for those kinds of acquisition, it's very difficult to make a large acquisition and not have multi-year dilution.

We still have a very strong appetite to do the kind of acquisitions that we've done over the last six months with our sales tax acquisition, with our acquisition of employees, with our acquisition of virtual edge where we can overlay our existing client base of 500,000 plus clients.

So you'll see us continue to focus there.

Now that being said, if the perfect acquisition came along that was an extension of our core product and I could make it accretive within a 12-month period, I would still look at those kind of things.

But I don't see that as high probability, but, again, you should never say never.

But it's not clearly -- it's clearly not our strategic course.

Great.

Thanks for all the color.

At this time, please limit your questions to one question and one follow-up question due to time.

Our next question will come from the line of Patrick Burton with Citigroup.

Hi.

Thanks for taking the call.

My question is, in the Brokerage guidance that ADP has given, does that include the customer loss that was broken out in the Form 10, or should that be factored in after the guidance is provided?

The guidance does include that.

They're still with us right now.

It's not going to have much of an impact on the fiscal '07 time period.

Okay.

So the loss of profitability from that client is included in the numbers?

Yes.

Because it's sometime in the fourth quarter.

For TD Waterhouse, specifically, it is included.

It is included?

Yes.

The other question, just to follow-up on the Form 10 is, the difference in the historical data provided in the Form 10 and the data that is reported on an ADP segment basis and your releases and 10-Qs are a little bit difference, what does that stem from?

That's the result of -- the Form 10 is put together based on what the historical Brokerage would look like as a stand-alone company.

So there's a lot of corporate allocations that we don't show within our segment results that are put back into the corporate number -- into the Brokerage numbers.

For example, the stock comp expense is something, is one item that's held in the corporate level that's put into the segment for Brokerage.

So there are some pluses and minuses, and that will be reconciled during the road show.

Okay.

Thank you.

You're welcome.

Our next question will come from the line of Mark Marcon with Baird.

I want to focus on the long-term opportunities within ES.

Specifically, I'm wondering if you can give us a break out on two facets.

One, how big is international now, and how do you view that long-term growth opportunity?

And then secondly, if you could split out the size of beyond payroll relative to the core, and, specifically, how we should think about beyond payroll in terms of whether or not you can keep up this growth rate, and how we should think about the margins within beyond payroll as some of the investments like HR BPO start becoming rationalized?

We may be here the next hour answering that question.

Let me give you some perspective on international.

I don't think, Elena, that we specifically break out that revenue per se.

Right.

But you ought to think about it in the order of, including Canada and the rest of the world, it's an $800 to $900 million kind of business and a great business.

We are experiencing single-digit revenue growth in that unit today, but we clearly see over the next couple of years that revenue growth accelerating to a double-digit kind of level.

Although we won't see the same kind of margins in that business, because that business doesn't have the benefit of the contribution that we get from float on tax balances, et cetera, that we achieve in the United States.

Again, I think the international prospects are very high.

Would you clarify again for me your question on the beyond payroll?

You were -- ?

Just the split-up, Gary, between -- currently, in terms of revenue in terms of beyond payroll versus the core.

And just as we think about beyond payroll, you're obviously making some investment in things like COS, how we should think about the margins progressing on the beyond payroll side?

Let me let Elena talk about the revenue split between beyond payroll and payroll in terms of how much is beyond payroll versus included in the standard payroll, to make sure we give you the right number.

Sure, yeah.

When we look at that and we talk about our beyond payroll, we're talking about as a percent of the U.S. payroll for ES.

So that, in '06, we said was about $4.9 billion, just under the $5 billion mark.

So for fiscal '05, that -- I'm sorry, fiscal '06, that revenue breakout was about 60% of our traditional payroll, payroll tax filing business, with that 40% being the beyond payroll.

Great.

And the margin progress going forward?

Well, the way to think about the margins is those are growth businesses, they are scaling, so, obviously, they are below our margins in our existing business, but they will ramp and begin contributing more.

But in the meantime, they do put some margin compression on our core business, which is why we're particularly happy with the growth that we see in our core business, particularly in the payroll and payroll tax filing business.

Great.

One last question, just on the Form 10, specifically with regard to the puts and takes and specifically the royalty payment.

Just to be clear, that's not going to have -- just in terms of an allocation, that's not going to have a negative impact with regards to new ADP in terms of the margins that you show there once post split, will it?

No, it's not, Mark.

Okay.

Because that's not -- right now, it's not in the other segment and it's not as a credit, for example, income, and it's not in Brokerage segment as we reported it as an expense.

So, no, it will have no impact.

Super.

Thank you.

Okay.

Our next question will come from the line of T.C.

Robillard with Banc of America Securities.

Great.

Thank you.

Gary, can you remind us what step-up investments were in Employer Services in the fourth quarter last year that's going to give you the easier margin comp?

Well, in the fourth quarter of last year, we did ramp up -- finish the ramp up for sales and implementation.

We concluded it at the end of the third quarter, so it was in full force during that fourth quarter.

So there's -- it just makes -- since those numbers were higher, it makes for an easier comparison over last fourth quarter.

Elena, I don't know if you've got some of the other detail of other things that occurred there?

No, that's primarily it.

It's really the fact that in the fourth quarter, like Gary said, you've got the full load of expenses in last year's quarter, making it comparable to what we expect to see this fourth quarter.

So, you've really got a good apples to apples comparison, so you'll see then the business momentum and the scale and everything that we've spoken about kick in with the margin expansion.

Okay.

Just a quick follow-up on the new sales growth in Employer Services, slowed down a little bit from the first quarter levels.

Is there some seasonality with that?

I'm just surprised given the sales force being in full swing, so to speak from the ramp-up levels coming through '06, I was surprised to see that tick down a little bit?

Can you just talk to that?

The sales numbers, and especially as we get more influence with GlobalView picking up steam, with the tremendous traction we have there, those are some of the large deals, same in national accounts, it's still very strong double-digit growth.

I think you're going to see a little bit of lumpiness from quarter to quarter.

I don't think you should expect to see really steady-state growth or a little tick-up each and every single quarter.

I think it is going to move around a bit, and then partially due to the mix now in the business and where the growth is coming from.

Great, thank you.

Our next question will come from the line of Craig Peckham with Jeffries.

Hi.

One question, I promise.

Thanks, Craig.

The $8 million spinoff expenses, just a geography question, does that fall in the Brokerage segment, or have you put that in the other?

It's in other.

Okay, great.

Thank you.

You're welcome.

Our next question will come from the line of Brandt Sakakeeny with Deutsche Bank.

Hi.

This is Richard Gray for Brandt.

All our questions have been answered.

Thanks.

Thank you, Richard.

Our next question will come from the line of Tien-tsin Huang with JPMorgan.

Hi.

This is David Cohen for Tien-tsin.

Just a quick clarification.

In the Form 10, it spoke about an investor communications client that didn't renew.

You said you've been talking about Waterhouse, is that the same or is that something different?

I don't know.

I'm sure it's the same one, but in terms of that language, didn't renew, let me get back to you to be sure on that one, but I believe it is the same.

Okay, because the dollar amounts didn't look the same, but that's fine.

The other question I had was -- ?

What was the dollar amount?

Yes, what was the dollar amount?

I had $44.8 million in FY '06 in revenues and $11.1 million of pretax income, which sounded higher than what you had mentioned with Waterhouse.

I had said about 40.

Yes, let -- .

And it said it was a nonrenewal as opposed to a loss in client.

Okay.

You know what, let me get back to you, then, to be sure.

Okay.

Yes, the question, really, was just -- is that in the guidance for Brokerage for the year?

And then I just had a quick question -- ?

Well, yes.

Whatever is -- no.

Certainly, if we were able to say it in the Form 10, it's in our guidance.

Okay.

Yes, I think that is an existing client that has advised us that they may potentially leave.

But they will be here for the rest of this fiscal year and will not change any of the guidance that we've given you thus far.

Okay.

That's very helpful.

And then my question, you asked -- you talked a little bit about the acquisitions in ES.

Any thoughts on acquisitions for Dealer or Brokerage?

Brokerage, I would not expect to see any acquisitions in the third quarter in our Brokerage unit.

Post the spin, it's really not for me to say, so it would really be where they decide to take the business.

I would expect from time to time for Dealer, as it expands internationally, to pick up smaller, integratable acquisitions as we build infrastructure country by country.

But nothing of any big magnitude, mostly smaller units that will rationalize in a 6- to 12-month period.

Great.

Thank you.

Our next question comes from the line of Lloyd Zeitman with Bernstein.

Hi, folks.

My questions have been answered.

Thank you.

Thank you, Lloyd.

And our final question will come from the line of Charlie Murphy with Morgan Stanley.

Thanks, Gary and Chris.

The '07 guidance for the client fund yield implies a modest pickup in the second half.

Could you tell us any specific drivers of that that we should be aware of?

And, then, I was wondering how much in realized gains you expect in fiscal year '07.

How much is included in your guidance?

The overall yield to go up to about 4.5%.

Our new purchase rate since Q4 of fiscal year '06 are just under 5.

So, as you roll, we would expect to be moving up towards the 4.5%.

What was the second?

The follow-up?

Yes, how much in realized gains are built into your '07 guidance?

We don't plan for realized gains in the guidance going forward --

Or losses.

Or losses, for that matter.

It really depends upon the positioning of the portfolio.

So we don't plan for anything in the guidance.

Thanks, very much.

Thank you.

Thank you.

So, in summary, we appreciate all the questions.

Hopefully, we've answered them as directly and forthright as we can.

I'll close by just summarizing how pleased we are with the quarter.

We're above our plan, we believe we're going to have an excellent second half to the year, and the businesses continue to execute on the strategic direction that we've laid out.

And we continue to see strong acceptance of our products and services, not only in the United States, but around the rest of the world as well.

So, we remain optimistic about the long-term future growth of the company, and we appreciate your interest and attendance at today's session.

Thank you and have a good day.

Thank you.

Thank you for participating in today's Automatic Data Processing conference call.

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