Lackluster 3Q for Hewitt

Hewitt Associates Inc. (HEW) reported third-quarter 2010 adjusted earnings per share of 60 cents, which missed the Zacks Consensus Estimate of 74 cents. Adjusted earnings per share were 81 cents per share in the third quarter of fiscal 2009.
 
Revenues
 
Net revenue (excluding reimbursements) in the third quarter was $730.6 million, almost flat, compared to $729.0 million in the year-ago quarter. However, after adjusting for foreign currency translation, acquisitions and divestitures, as well as third-party revenues, net revenue dipped only by 1% from the year-ago period.
 
Revenue Segments
 
The Benefits Outsourcing segment revenue in the quarter was $369.3 million, down 2.0% from $377.6 million in the prior-year quarter. Revenues dropped 3% after adjusting for a $1.5 million contribution from acquisitions. The decline may be attributed to lower revenues from projects that were hurt by the economic downturn, client losses, and higher adjustments for client service issues as well as renewals at decreased prices.
 
The Human Resource Business Process Outsourcing segment reported revenues of $110.5 million, down 5.0% from $115.7 million in the prior-year quarter. Excluding third-party supplier revenues and adjusting for $2.3 million of favorable foreign currency translation, revenues decreased 7%. Some contractual adjustments and client terminations led to the decline in the quarter’s adjusted revenues.
 
The Consulting segment posted revenues of $258.2 million, up 6% from $244.3 million in the prior-year quarter. Consulting revenues increased 5% after adjusting for a $6.5 million contribution from an acquisition, $0.4 million of unfavorable foreign currency translation and $3.1 million related to the partial divestiture of the North America EC business in the year-ago quarter. Growth in adjusted revenue is attributable to the growth in retirement and Financial Management services in the European region.
 
Operating Results
 
Total operating expenses in the quarter increased 5.2% year over year to $667.4 million. Excluding unusual items such as real estate exit and related costs, severance charges and asset impairment charges, adjusted operating income in the quarter was $104.9 million, down 15.6% compared to $124.3 million in the prior-year quarter. Adjusted operating margin was 14.4% compared with 17.1% in the prior-year quarter.
 
Reported net income in the quarter was $77.9 million, or 82 cents per diluted share, up from $68.4 million or 71 cents in the year-earlier quarter. Underlying net income (after excluding unusual items) in the quarter was $57.5 million or 60 cents per diluted share compared to $77.9 million, or 81 cents in the year-earlier quarter.
 
Balance Sheet & Cash Flow
 
Hewitt exited the quarter with cash, cash equivalents and short-term investments of $734.9 million, up from $669.8 million in the previous quarter. Receivables in the quarter declined $1.4 million from the previous quarter to $522.4 million. Debt and capital lease obligations (including current portion) in the quarter were $624.2 million, down from $638.5 million in the previous quarter.
 
Cash flow from operating activities was $196.3 million, compared to $158.9 million in the year-ago quarter. Capital expenditure in the quarter was $30.2 million, down from $31.4 million in the comparable period last year.
 
Share Repurchase
 
During the recently concluded quarter, Hewitt repurchased 1.6 million common shares at an average price of $37.35, or a total cost of $59.5 million. At quarter end, the company had approximately $95 million remaining under its current $300 million authorization.
 
Guidance
 
Given its pending acquisition by Aon Corp. (AON - Snapshot Report), the world’s largest insurance broker, Hewitt suspended its formal financial guidance for fiscal 2010. The transaction is expected to close by the end of the fourth quarter.
 
Our take
 
Given the fact that Hewitt has not been doing well lately, the deal with Aon Corp. would provide a high premium to existing shareholders. However, the share price increased rapidly since the announcement and has now reached the offer price. Hence, we cannot recommend the shares at this point.
 
Moreover, the quarter’s performance was unimpressive, with flat year-over-year revenue and earnings per share missing the Zacks Consensus Estimate. Revenues were severely impacted by the economic downturn last year and are still in a recovery mode.
 
Consequently, we are reiterating our short-term Sell rating (Zacks #4 Rank) on Hewitt.

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