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Friday, August 11, 2006

Hewitt (Part 5) - What We Don’t Like

By William Trent of Stock Market Beat

One of the things we like about the HR Outsourcing business is that the complexity of the HR function makes many companies prefer not to do it themselves. For the same reason, we wonder why there are so many companies willing to do it for others.Hewitt’s multi-class stock structure is a relic of a partnership that was unwilling to give up control to financial owners. We believe such companies should remain privately held.

The idea that contracts can be priced anticipating improved cost management over time appears unrealistic optimistic in light of the recent announcements.

Attributing of increased “other operating expense” partially to “client service delivery expense” gives us concern that some project implementations were not working well. If customer service has been suffering it may result in higher than normal levels of turnover at contract renewal.
The need to adjust contract profitability presents a conundrum: will employees receive the performance pay to which they are accustomed. If they are they will be rewarded for going after unprofitable contracts, but if they aren’t it could increase employee turnover. Either is unpalatable. The company has contributed to this being an issue by the fact that out-of-money options received accelerated vesting and that goodwill shares are also now fully vested, removing many of the incentives to stay. Two senior employees (Brian Doyle, President of HR Consulting and Dale Gifford, CEO) have already left or announced plans to leave, though the timing of the resignations may suggest they are partly related to the recent problems.

In a related issue, the company said in the latest 10Q that:
This year, we are recognizing a higher level of performance-based compensation than in the prior year based on our performance against internal targets to date.

Ay, ay ay. Given the shrinking profitability (even before the contracts needed to be restated) their internal targets appear awfully low.

They also say:
During the second quarter of fiscal 2006, we continued to focus heavily on making progress toward achieving more profitable growth, while continuing to invest in the implementation of our early stage HR BPO outsourcing contracts.

Translation: We have not achieved profitable growth, nor have we made any progress toward doing so. However, we continue to focus on doing so.

Our take: if recent results are an indicator of what focus can do we’d prefer they stop

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