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Hewitt Q3 Loss Tied to HRO Difficulties

August 15, 2006
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Despite announcing a third-quarter loss because of troubles with implementing its HRO contracts, Hewitt Associates says it is remaining in the business.

On August 14, the Lincolnshire, Illinois-based company posted a net loss of $202.2 million, or $1.88 per share, for the third quarter ended June 30, compared with net income of $44 million, or 31 cents per share, in the third quarter last year.

These results included a $249 million noncash charge related to the company’s HRO business, Hewitt announced. The $249 million includes a $70 million loss provision based on the expectation that one-third of its 2005 contracts and two earlier contracts would lose money.

"It is clear with the benefit of 20/20 hindsight that we underestimated the complexity and therefore the cost of taking on multiple contracts," Dale Gifford, chairman and CEO, said during an August 14 earnings conference call. Gifford is retiring at the end of August.

On the call, Gifford and CFO John Park attributed Hewitt’s troubles largely to taking on too much too quickly. Specifically, they cited payroll and recruiting as two areas where Hewitt was facing significant challenges.

The company spent the past several weeks reviewing its HRO business, and is making a number of changes to get back on track, Gifford said.

The company has reorganized to increase accountability, he said. In an advisory to analysts, Hewitt explained that under the new structure its leadership team "will have focused attention on the HR BPO portfolio and the benefits portfolio." By reorganizing the division, Hewitt hopes to better align its technology resources with its delivery teams and improve alignment overall.

According to the advisory, Hewitt also is "involving senior domain leaders earlier in client implementations to provide oversight and clear feedback loops."

Hewitt also has changed its approach "to place more emphasis on profitability growth," Park said on the earnings call. To that end, the company will focus more on clients that are not just looking to cut costs, but to "transform their human resources organizations and leverage their human capital," Park said.

To that end, the company is in discussions with clients to restructure existing contracts to improve financial performance, Gifford said.

Despite its troubles, Gifford and Park emphasized that they believe the company has learned from its mistakes.

"We are further along in the learning curve than many of our competitors," Park said. "Now we have a better understanding of the requirements."

"Our board of directors and our leadership remain firmly committed to our direction: Hewitt remains uniquely positioned to serve and lead the HRO market," the company said in its advisory.

Hewitt needs to change its pricing, says Neil McEwen, an analyst with PA Consulting Group. In the past, Hewitt has made it a habit of just undercutting the lowest bidder during requests for proposals, he says.

"They just come in with a ‘We will do it for 25 percent less’ type of deal," he says. "Now they have the experience to have done some due diligence on what it would really cost to do certain things."

"We do not take what a client has identified as their cost and simply create a percent savings from that number," says Jennifer Frighetto, a spokeswoman at Hewitt. Typically before sending out a request for proposal, buyers will specify their costs to do the HR processes in-house, she says. Like other HRO providers Hewitt determines its pricing by identifying what it believes it costs will be to implement and deliver its services. "The difference between the two is the targeted savings that the client uses as a basis for delivering their business case to management," she says.

Despite its assurances, some analysts still wonder whether the company might sell off its HRO business.

"I for one don't see how they avoid at least considering a breakup or sale as a whole," says Naomi Bloom, an HRO consultant. "They lost a lot of talent when they failed to elevate the very capable people they acquired with Exult."

But the fact that the company hired a new CEO seems to say that Hewitt is willing to make a go of the business, analysts say. On August 10, Hewitt announced that it is bringing on Russ Fradin to replace Gifford as chairman and CEO. Fradin, who most recently was president and CEO of the Bisys Group, a provider of outsourcing for the financial services business, starts September 5.

Jessica Marquez

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