Insperity Inc (NSP) 2002 Q3 法說會逐字稿

Good day. All sites are now online in a listen only mode. I would like now to introduce your speakers today. Mr. Paul Sarvadi, President and Chief Executive Officer and Mr. Richard Rawson Executive Vice President and Chief Financial Officer. I would like to turn it over now to your speaker Mr. Richard Rawson. Please go ahead sir.

Thank you. Good morning everyone. We appreciate you joining us today. Let me begin by outlining our plan for this morning's call. First Paul is going to come in and cover the details of our operating plan that we have been working and the excuse risk that we see in the near term. Then I will come back and cover the details of our third quarter results. I'll also provide some financial related comments for the remainder of this year and some general thoughts about 2003. We'll end the call with a brief question and answer session. First I would like to remind you that any statements that Paul or I make today that are not historical facts will be considered forward-looking statements within the meaning of the federal securities laws. Words such as expects, intends, plans, believes, estimates, likely and similar expressions are used to identify such forward looking statements. Forward-looking statements involve a number of risks and uncertainties that has been described in details in the company's filings with the securities and exchange commissions. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements. Now I would like to turn the call over to Paul.

Thank you, Richard and thank each of you for joining us today to review our third quarter results. Today I'll provide some brief comments on the plan that we have been working that caused our results to improve dramatically in the third quarter. I'll also discuss how continuing to execute this plan through year end positions the company to reach our 20 to $30 per employee per month operating income goal for 2003. I'll also cover the operating and execution risk that I see in the near term and finish with the outlook for the company for the long term.

In the first half of this year, we experienced a margin squeeze caused by a rapid increase in the benefit cost and a revenue shortfall due to the decline in the average pay of work site employees in our client base. Now our plan to respond to these issues included four elements. 1. Recalibrating pricing for clients that experienced a decline in average payroll cost per work site employee. 2. Matching price and costs for health insurance on new and renewing client contracts. 3. Reducing operating expenses and capital expenditures and 4. Improving our liquidity. During the third quarter we were successful in recalibrating rates on over 800 clients eliminating the revenue shortfall. The progress we have been making throughout the year matching price and cost per benefits on new and renewing clients was previously masked by this short fall. So now this progress is now evident in the gross markup reflected in our third quarter results. We were also successful in renewing existing clients and adding new clients during the quarter at rates that we believe reflect expected costs for benefits for the next year. If we continue to be successful in this regard for the balance of the year, our margin squeeze will be a thing of the past. The issues we faced earlier this year also led us to take a hard look at operating expenses of the company. Management decided to implement controls that resulted in better than expected numbers in this area for the third quarter as well. The primarily elements of our operating expense control plan revolved around head count and elimination of non-essential initiatives. We decided to freeze head count and promotion. And evaluate activities across the company that could be postponed or eliminated entirely. This process resulted in elimination of approximately 50 positions by the end of the third quarter. We also thoroughly evaluated capital expenditures and confirmed we're in a position to continue our long term gain plan with a much lower annual level of capital expenditures than we have experienced in the last few years. This is the direct result of the investment and infrastructure now pretty much complete that we've made over the last few years. Our objective for next year is to return to our historical level of operating margin per work site employee of $20 to $30 per month. Our plan is to conservatively estimate the expected average gross profit per employee the next year based on the pricing of the base of business at year end. We'll then adopt an operating expense budgets that reflects the starting points of the number of work site employees and our target operating margin. I do see execution risks associated with our new term strategy in four areas. Sales, renewals, price increases, and cost increases. First the selling environment has been difficult due to general uncertainty surrounding the economy and the potential for war and we have also seen an effect from the negative press in competitive tactics as a result of our own difficulties earlier in the year. We have been able to muscle our way through so far and we have a very focused professional trained sales force hard at work. However, we need a strong year end sales effort to offset the normal attrition we experience in January. The attrition rate for January historically averages around 6% of the employee base. In 2001 the rate was 6.8% and this January the number was 6.1% near our historical average. This quarter we're passing through substantial benefit cost increases in making some modest plan design changes at the same time. While our belief this is necessary for managing the benefit costs and the benefit plan for the long haul, it's also best for our clients and employees to control costs for the future. This does increase the difficulty renewing clients for 2003. We're also implementing a long term solution to insulate our gross profit from payroll variations by replacing our pricing and billing system effective January 1st for new and renewing business. Although early receptivity to this approach has been excellent, this change is a new factor in the near-term risk in selling and renewing accounts.

The other risk I would point out it the risk of health care costs increasing beyond our expectations. Although we have made great strides in the third quarter and our information and visibility is much better than earlier in the year, we're still in the temporary situation where unusual fluctuation can flow into our results. Before I pass the call over to Richard I would like to briefly comment on the long-term prospects for the company as we get past the short term challenges we face this year. Although we have been focused on resolving immediate issues we have not in anyway altered our view of the vast market opportunity in front of us nor our opinion of our ability to capitalize on this opportunity. The challenge is that small to medium sized companies face to be successful are tremendous. The need for our unique comprehensive solution has never been greater. Our high-tech high-touch human resources services program creates a competitive advantage for our clients and helps their businesses succeed. Our objective remains to aggregate the best small businesses in the country and our service providers continue to exceed customer expectations on a broad scale. Our sales organization continues to locate clients that fit our target client profile and we have continued to grow and develop effectively. I firmly believe that the next five years represents an excellent opportunity for all of Administaff's stake holders including clients, employees, investors and the communities across the country where we provide our services. At this point I would like to pass it onto Richard.

Thank you, Paul. Now, let me begin by summarizing the significant financial highlights from the quarter. The year over year growth rate in work site employees paid was 13% this quarter. Revenue for the quarter increased 12% over the third quarter of 2001 exceeding 1.2 billion dollars. Gross profit for work site employee per month of 196 dollars was near the top end of our range primarily as a result of the pricing stream that we experienced during the quarter. Finally, operating expenses of 40.9 million or 171 dollars per work site employee per month came in below the low end of our range as we're continuing to execute the plan to reduce operating expenses. We've reported third quarter earnings per share of 14 cents. Although earnings have not yet returned to the 30 cent per share reported for the third quarter 2001, we're extremely pleased with these results.

Let's get into the details. Looking at revenues first, the drivers are number one, the growth and the number of paid work site employees, number two, the payroll average of those work site employees, and number three, our gross markup. The average number of work site employees paid increased by 12.7% over Q3 of 2001 and increased sequentially from 76,477 paid in Q2 of this year to 79,812 paid this quarter. A net increase of approximately 1,100 work site employees per month. The net change in existing clients increased slightly in July and August and was offset by significant decline in September reflecting the continuation of a soft economy. This resulted in a net loss of approximately 200 work site employees. The planned attrition improved throughout the quarter going from a loss of 1.68% of the client base in July to 1.4% in September. Work site employees added from new sales were enough to offset the net effect of the layoffs and client terminations such that we still exceeded our unit growth objective of adding 1,000 work site employees per month. As expected, the average pay of our work site employees was down 2.43% over the same period last year which put pressure on our third component of revenue which is gross markup. As mentioned in our September 24 2002 press release we successfully recalibrated pricing or clients that experienced a decline in their payroll average. Additionally we have successfully matched price and costs for health insurance on new and renewing client contracts during the quarter. Each of these factors resulted in a sequential increase in gross markup per work site employee per month going from 886 dollars last quarter to 905 dollars this quarter. These metrics combined with 56 million dollars in bonus payrolls produced revenue growth of 12% over Q3 2001 to 1.2 billion dollars for the quarter. Now our revenue growth by region for this quarter was as follows. The northeast region which represents 13% of total revenue grew by 30%. The southeast region which represents 11% of total revenue grew by 19%. The central region which represents 15% of total revenue grew by 7%. The west region which represents 21% of total revenue grew by 12%. And the southwest region which represents 41% of total revenue grew by 4%. We entered the third quarter averaging 249 trained sales reps up 7% from the third quarter 2001.

Moving to gross profits as you know our key profitability benchmark it gross profit per work site employee per month which was $196 in Q3 of this year versus $232 in the third quarter of 2001. This decline in gross profit is primarily due to a $31 per work site employee per month credit received from our workers' compensation insurance carrier in the third quarter of 2001. As for the components of our direct cost, our payroll taxes including fica, federal unemployment and state unemployment taxes as a percent of total payroll was 7.05% in Q3 of this year as compared to 6.82% in Q3 of last year.

As announced last week the Texas workforce commission has approved our previous application for a partial transfer of compensation experience. The third quarter payroll tax expense reflects our current estimate of the ultimate tax rate to be derived from the partial transfer. Should the final official tax rate to be determined be different than our estimate, we would incur additional payroll tax expense or benefit in the period that such determination is made. Benefit cost per covered employee which is currently 72% of our total work site employee base was 507 dollars for the quarter representing a 16% increase over the third quarter of last year. This increase is consistent with our expectations in the normalized quarterly sequential trend of 5% for the last two quarters. Workers compensation costs were 1.16% of payroll for the quarter compared to 0.45% of payroll in the third quarter of last year. As mentioned in the press release the third quarter of 2001 we received a 6.6 million dollar credit representing a cumulative benefit for the prior three-year policy. This credit was negotiated at the end of that policy period. In contrast, our current policy includes a dividend feature that requires the recognition of the credit throughout the policy period when it is earned. The benefit of this policy is this. Our costs are caped the up side. And we get the benefit of favorable claims experience that results from our safety and claims management processes. During the third quarter, we earned a $685,000 dividend which resulted in a decrease in our workers' compensation insurance costs for the quarter. Now let's discuss operating expenses. On a year over year basis this quarter our operating expenses increased by only 13% to 40.9 million dollars. Having originally thought that these expenses would need to increase more, we're very pleased with these results. On a per work site employee per month basis this results in operating expenses of $170 in Q3 of last year versus $171 in Q3 of this year and is reflected as follows. Compensation costs increased $2 per work site employee per month due to the ramping up of our sales staff, benefit support staff and new subsidiary Administaff financial management services. General administrative costs declined by $5 per work site employee per month due to a reduction in travel cost, data communication costs and bad debt expense. Depreciation and amortization cost increased $3 per work site employee per month due to: 1.Computer hardware and software expenditures related to our technology infrastructure, 2. Our service center expansion and 3. Our new corporal headquarter building completed in September of this year. Commission costs increased by $1 per work site employee per month and advertising costs remain flat. Other income declined by approximately a half million dollars from the second quarter of this year. This 78% decline from the prior year is a result of a decrease in interest income brought about by a decline in both the level of marketable securities and interest rates.

Now would I like to make some comments on our balance sheet and liquidity. Total assets are $287 million including current assets of $162 million. We ended the quarter with over $50 million in cash, cash equivalence and marketable securities. As of September 30th, current liabilities exceeded current assets by $5.2 million. In October, we have obtained an additional 4.5 million dollars of working capital through a long-term note secured by our corporate airplane and we're currently negotiating a $36 million dollars long term real estate loan which will repay the existing $30 million short-term credit facility. The combination of having the note on the airplane and completion of the real estate financing should increase working capital by approximately $40 million. Prepaid expenses and other current assets have increased $2 million this quarter to $23 million. This balance is comprised primarily of the of the following items. 11 million related to the prepayment of our workers' compensation insurance premiums. That should be refunded in the second quarter of 2003. A $3 million note receivable related to amounts funded for future service expansion and the estimated refund from the state of Texas for overpaid unemployment taxes remains at approximately $6 million. During the quarter, capital expenditures total $12.6 million including approximately $11 million related to the completion of our new corporate office building and $400,000 in capitalized software development costs. Year to date capital expenditures total $36 million including $17 million related to our new corporate office building and $1.1 million in capitalized software development costs.

Costs incurred from the construction of the new corporate building from inception to total approximately $32 million. Deposits of $27 million consisted primarily of $25 million security deposit with our national health care provider. Deposits increased by $5 million this quarter which represents the final deposit required for the period through December 2003. Finally stockholders equity was $115 million at the end of the quarter.

Now let's shift gears and discuss the fourth quarter for a moment. We continue to expect work site employees to grow approximately 12% over the fourth quarter of 2001. As new sales made in this quarter usually don't appear as paid work site employees until January of the next year. Looking at the current base of our business, we expect that the average pay of our work site employees to be consistent with our third quarter results which ended up being $3935 per month. The maturity of the benefits data continues to improve each month with the result that cost predictability has improved as well. Our currents expectation is for benefit cost per covered employee to increase 5% to 6% sequentially. We expect gross profit per work site employee to continue to improve and should produce a gross profit per work site employee of from $202 to $206 per month for the fourth quarter. We expect our fourth quarter operating expenses to be in the range of $41 to $42 million. As a result of the completion of our corporate headquarters expansion in the third quarter and the expected completion of long term financing, we expect net interest expense to be less than $100,000 for the fourth quarter. Finally we expect the effect of income tax rate to remain unchanged at 39.5%.

Before we open up the call for questions I would like to comment briefly about 2003. We're still early in our 2003 budgeting process so I'll be fairly general today and follow up with more detail in our year end conference call. To begin with, there is some good news for 2003. I expect us to make continued progress with our pricing initiatives that better matching revenues with our direct costs. I also expect us to enter 2003 with operating expenses well under control, and not increasing significantly from 2002 unless economic conditions warrants and acceleration of our expansion plan. Additionally, we have completed our new corporate facilities and we expect capital expenditures to return to a run rate at pre 1999 level of approximately $10 million. These are the reasons we expect our annual operating income in 2003 to return to our target range of $20 to $30 per work site employee per month and our liquidity position to be improved considerably.

That's enough of the good news. Let's discuss the challenges we may face. First to achieve a range of $20 to $30 of operating income per work site employee per month in 2003 requires that benefit costs increase no more than the 5% to 6% per quarter. Although this is what we currently expect we obviously can't promise anything. Second, our 2003 results are of course dependent upon client retention and new clients sales. As Paul just mentioned, this is certainly a potential risk at a time when we're passing along significant pricing increases to match rising health care costs. So for budget purposes, we're not planning for any growth in the number of work site employees paid for the first couple months of next year and for only modest growth for the balance of the year. Don't be confused by this. It doesn't mean that we're not going to be working hard to increase our work site employee base. Nothing could be further from the truth. Third, on the non-operating front let me add a final caution. As you know, we have a $3 million investment in a development stage web-based company. Although we will remain enthusiastic about their prospects, these are uncertain times for such companies and I can't promise that they will be successful. We'll continue to evaluate their prospects and any non-operating impact it may have on our results. With those warnings let me conclude by saying that although we find ourselves in the midst of perhaps the longest economic downturn since the great depression. When it comes to Administaff, I am a cautious optimist. We're committed to balancing growth and profitability for the long term. We're laying a disciplined foundation right now and expect good progress in 2003. I will look forward to discussing this in greater detail with you during our fourth quarter conference call. Now let's open up the call for questions.

At this time if you would like to ask a question press the 1 on your touchtone phone. To withdraw a question press the pound key. Once again if you would like to ask a question press the 1 on your touchtone phone. We will take the first question from the side of John Lingenfeld Robert W. Baird. Please go ahead.

Good morning Richard, Paul. Good job on the progress. A couple things here. First off, just looking at the client loss trend in the quarter, sounds like you had a couple good months then September tapered off. Can you put that in perspective in terms of what you have seen in October and how this kind of relates to -- I don't want to get confused with trends versus seasonality.

I think what we -- we continued to see within the client base what you were referring to is the net effect of layoffs and new hires in which there were two months July and August that were positive but then September the layoffs exceeded new hires by enough to even be a couple hundred greater than the number that it increased in the prior two months. So from our point of view what we're seeing is the small business community continuing to kind of bounce along the bottom, if you will, being cautious before they are willing to hire new people. And you know we haven't budgeted that changing for the near term because that's what we're seeing.

Ok. I guess I was a little confused there then. When you look at the client losses, how did those look in the quarter and how did those trend?

As far as our retention of clients, that was definitely one of the highlights of the quarter. I think we averaged for the full quarter 1.6% of our base monthly which is almost our pre 2000 numbers. So it was very good quarter, we actually had the number improve throughout the quarter to 1.68 percent of our base that [attrited] in July to 1.4% in September. So our people are doing an excellent job of execution on renewing clients even though we're passing on significant increases. So a lot of heavy communication going on and so far so good on that front.

Thank you for the clarification. Two other things. On the workers comp dividends, is that something we should expect to see at various points over the next year and then secondly when would you expect to receive or have you received the payment on that dividend?

We won't receive the payment on the dividend until according to the contract four years after the policy expires. That's when we do the final reconciliation. I can tell you that as the -- as it's earned. As claims experience comes in because this new policy that went into effect October the 1st is the same policy as we had the one that just expired. So you know if claims experience is good, i.e., you know we continue to do a great job on safety services and managing the people getting back to work, then we could experience dividends into the future periods. But until we do we won't know until we see it happen.

Then the rate on the debt that we should expect, the combination, when you get things ironed out?

I'm not prepared to comment on that at the moment.

Can you comment on the rate you are receiving on the $4.5 million you received from G.E.?

I don't have the exact rate in front of me but it's somewhere between 4% and 5%.

Thanks a lot.

You bet.

We will take our next question from the side of Jim McDonald with Burst Analyst. Please go ahead

Good morning guys, good quarter. A couple quick questions. In terms of how much you expensed in the quarter for health care and how that compared to the premium you paid in the quarter, can you comment on that?

We don't get into that level of detail, Jim.

Could you give us some more details on the new pricing system that Paul mentioned? Will you be pricing on a different basis next year? For example for other differences in the system?

Yes, I'll be glad to comment about that. We're well on our way in the transition process to a new pricing billing system that corrects the issues about having our billing as a percent of payroll. And having our deficiency or shortfall created in revenue if payroll goes down. So in the new pricing and billing system there will be much more of a pass through effect on the taxes. That will have a positive effect for us in several ways. In the items that are fixed dollar amounts will be billed through as a fixed dollar amount so we won't have any deterioration in that number. So we have built the system, we're now quoting all of our new and renewing business for January on, on the new system. And we'll be renewing clients throughout the year next year when we get to 04, the entire client base will be on the new system.

Does that mean it will be billed as incurred so new clients and renewing clients in January will not have a loss in the first quarter like they might have otherwise?

Over the transition we will start to see our historical quarterly earnings pattern diminish. What we'll end up with is for this first quarter of '03 only the accounts that are renewing for January 1 and the new business we bring on for January 1 will have that effect. The rest of the base will still be on the same type of a system until they renew and so it will be 04 before you see the full effect of that. And then for the long haul we'll always be bringing on new business in a fashion where we're absorbing some of the costs of transition relative to the taxes. If you think about it a new client in the month of June has already paid a bunch of their taxes prior in the year so we want to be selling all year long so we absorb some of that impact until the year end then they go onto the same kind of system as everybody else.

And will the new system cover for the possibility that on health care where you have kind of a fixed amount per employee and it matters substantially whether it's a high paid or low paid employee?

Yeah, I mean any shrinkage we have ever had due to changes in payroll, whether it be a shrinkage in medical collected or any one of these other areas in the business, those are all corrected in the new model panhandle this is truly a dramatic change for the business.

Thanks very much.

Thank you. We'll take our next question from the site of Thomas Giovine with Giovine Capital Group.

Hi guys. First question, when you talk about $20 to $30 of operating profit per work site employee, is that a target how you plan on exiting the year or is that a number that people can look at for modeling versus purposes for the entire year?

We're talking terms of $20 to $30 operating income average for the year next year.

And then the next question if I go back and look at historical years, you kind of averaged within that range, but you are going to be opening up fewer offices which I'm guessing added around $6 million to $10 million of operating profit. So the question I have is are the business that you are adding now and the business that you are pricing, is this business in -- is it being added using historical ranges? I guess what I'm having trouble with, if you are adding fewer offices, especially that should have a pretty significant impact in your operating line. And if you are putting in business in this $20 to $30 today then it seems to me your margins should be higher than that for next year.

We provided a range of 20 to 30 and we have kind of put it all on the context of recovering in pricing the business by year end. So we're just not being aggressive about that number. You know you are correct if you look back at how we described our earnings per work site employee to you look at the costs of new market, office opens and the depreciation and amortization which is at its peak right now as we've opened up our new building. As you look into next year we're comfortable with that range 20-30 and we'll be looking to improve that over time.

Ok. Thanks.

We would like to remind all participants that if you can please limit your time to one question due to time restraints. We will now take our next question David Furino with [Inaudible]

Good morning gentlemen. Can you talk about -- conjecture about the quality of the clients you are signing? Are you seeing those 10% clients or dipped down in the quality pool in terms of however you want to define quality.

We have done nothing to change our target client base. Our service is a perfect fit for companies that have the definitive getting better agenda and understand the role people play in the business and certainly companies that were selling in this environment today are those trying to improve their businesses through improving human resource practices. So we have done nothing to change the target of the client base. We're having to work harder because the economy is kind of soft. And you know the cost issues are significant out there so it's taken some muscling and some hard work, but we're doing it.

How can we feel confident in that client base isn't deteriorating?

You would see things like comp claims going crazy or something like that if you were looking at companies with less -- with higher risk. You would see other things where we would have to manage risk would be causing a problem.

We wouldn't see that for a while, though. Right?

But we would see it in different categories of business that we're bringing on and we have no change there.

Ok.

I was going to say in terms of N.A.I.C.S. code analysis that we do every quarter, the manufacturing sector has gone down from 10% in the year end of 2001, it's down to 8.5% now while the management administrative and consulting services has gone from 10% to 12.5%.

That's the change in types of companies that we brought on and it's going the other way from the premise of your question was.

Thank you.

And we will take our next question from the side of Jim Jensky with Montgomery Scott.

Good morning. I guess as a follow-up to the question on operating income per work site employee per month. That came in at $25 this quarter. I mean based upon what you see out there, it looks as if it could come in a little bit higher next quarter. And that would bring it in at somewhere around break even to a slight loss for all of 2002. I guess based upon the what you are seeing out there in terms of work site employees being, you know, flat, and then only up a little bit, is that really a goal for all of 2003 or is that exiting 2003 with that goal? That would actually average that for the entire year would have to be, you know, 25 dollar turn around at its low point.

Jim, I think it's important to remember that if the first quarter of the year we lose money. So we're going to have negative operating income per work site employee in Q1. When we talk about exiting, we should be exiting the year next year at higher than $30.Or $20 to $30 and we should average $20 to $30 for the full year.

Is that dependent upon -

It's the normal earnings pattern of the business.

Even if your top line expectations come through of very limited work site employee growth?

Sure.

So you expect to just continue to control costs?

Well, the point is that what we experienced early this year had to do with our pricing on business. The margin squeeze. We're moving and have made great progress and continue to make progress every day correcting that which puts us back on track to our normal gross profit per employee then as Richard mentioned in his dialogue we have got the operating expenses under control and we're comfortable, we'll be able to keep those relationships in the appropriate--throughout the year. So that's why we're looking to return to our historical level of operating margin per employee of $20 to $30.

Thanks for the explanation.

You bet.

We will take our next question from the side of Chris Gutek with Morgan Stanley. Please go ahead.

Good morning. Curious what the minimum cash balance was in the quarter then immediately after the quarter.

Pardon? I am sorry Chris I didn't understand your question.

Did you track the minimum cash balance over the course of the quarter then immediately following the quarter.

No, we don't.

Do you have a forecast for what cash balance you expect at the end of December?

No, I sure don't. Because it really dependd on how many -- when people take their pay check in the last days of December.

Paul I think your initial comments were that 80% have been re-priced. What percent of the customer base has been re-priced in terms of covering health care costs with more accurate pricing?

Let me correct one thing. What I mentioned in my dialogue was we re-priced 800 clients. There were 800 customers who had to be recalibrated during their contract period due to the payroll average decline issue that we ran into early in the year. That 800 would be about you know 15 to or so percent of the client base. Not 80. And the issue of matching price in costs and benefits is all about the fact that the cost increase happened significantly about this time last year, we began to build into pricing the higher benefits expense and that rolls in as clients renew month in and month out renewing customers and so now we have gone through nearly a year, and so essentially what's happened is we have been increasing matching pricing costs on new and renewing business all year long, have a couple months left to go. The issue was that was masked earlier in the year by the revenue shortfall from the average pay per employee being down. So now that you can see that that's been corrected now you can see our gross markup go up and you can see, we have been getting price increases. It looks like it's been happening all year long and we expect we're on track with matching pricing costs, clients by client. Month by month as we renew and sell new business.

You are saying by the end of this year you expect to have all the clients re-priced where the health care costs with appropriately matched?

That's the plan and that's been the plan since early this year.

Great, thanks.

We'll take our next question from the side of Josh Rosen with CSFB. Please go ahead.

Thanks and I apologize for the quality of my voice here. Could you just review the seasonal trends and renewals?

Historically the client attrition in the first month of the year, January has historically been 6% go away. In February that drops to about 2.5%. And then from there through the balance of the year, it drops down to about 1.5% of the employees go away each month. Except for December which December goes down to about a half percent.

Is that just fewer startups in December?

Most -- the reason there is not a lot of client terminations in December is because of the fact that they have to start over as -- on the employment relationship side by starting to pay all the employer related F.I.C.A. at higher rates. So why would you do that? That's just an expense the business doesn't need to bear. So when we explain that to customers they say you are right, we'll wait until January if I'm going to leave.

Paul just to follow up on Chris's question regarding the passing the health care price increases along. As you have gotten familiar with united and with what with the pricing structure looks like, just curious about as we look at this, your financial statements, and you start to match I guess the line item that would be benefits and payroll taxes and if you broke that down on a per work site employee per month basis, the year over year growth you see in that number relative to what you see in the year over year increase in gross markup what sort of relationship if we can look at those numbers can he see over time in terms of those starting to get at least closer in line to matching one another?

Just as you have seen this quarter over last, you should see some tremendous progress in there. And this quarter what you are seeing is both the re-pricing of mid term on current contracts of 800 clients, but the net effect of changing pricing month in and month out on renewals. So you'll see those numbers look more similar of the -- if you are looking at a per total work site employee and that's what you need to be careful not to be confused about per covered employee because there's only 71% or 72% of our total work site employees are covered on the benefit plan. Even though we charge for the coverage on a per covered employee, when you take the total numbers, you're dividing by the number of work site employees, that's what you have to do to compare it to the gross markup which relates to the total number of work site employees. Does that make sense?

Yes it does thank you.

We'll take our next question from the side of Jim Wilson with J.M.P. Securities. Please go ahead.

Good morning. I was wondering if you could comment on the sort of competitive environment as to whether the other PEO's are experiencing the same thing you are and how either in general or even regionally anybody else has changed pricing structure up or down [Inaudible] less fixed cost, whatever the case may be.

From the competitive standpoint what we have seen out there, again I just want to remind everybody our biggest competitor is companies continuing to do business the way they used to without Administaff service at all. So we did have a little bit more competitive pressure this past quarter primarily because of bad press and competitive tactics using the bad press to go back to our clients or using it with prospects. Frankly that was pretty much just a nuisance to us during the quarter. And you know your customer base basically are looking for a comprehensive service solution and nobody else really provides what we do for our client. I do believe that our new billing system, our new pricing and billing system will alleviate what we hear sometimes from competitors that you know because of the tax calculation working the way it will where clients will have a higher rate or percentage early in the year and lower in the latter part of the year, will take away what competitors used to use as a reason that to use their service instead of ours. Although it was never really accurate. We averaged it across the year which was somewhat of a benefit to the client. But so we expect to take that issue away from the competitive environment. But our competition is pretty much been more of a nuisance than a real competition.

I guess the other side, do they seem to be any falling by the wayside given the economic environment and pricing and benefit structure out there?

We had quite a bit of that happen in the second quarter and actually back all the way to January '02, several good-sized players have gone out of business primarily because of the capital requirements of the business and their benefit plans or their workers' compensation programs. So we have seen some of that and we looked at some of those businesses and generally what happens, our target client base is a pretty tight screen. It's 10% of the small business community. And so what we see is within the other companies, we usually don't get a big benefit if somebody goes out of business in our industry because a small percentage of that client base fit our target anyway.

Ok. Great. Thanks.

We will take our next question from the side of Tony Tustany with [Inaudible].

Hi guys. Congratulations on a nice quarter specially on the operating expenses. My question is focused on the forecast for next year or the guidance of not much growth in work site employees. Can you talk about the pieces of that dynamic? It seems like you would have to have a significant drop in your sales force productivity next year for that to happen.

What we built into our plan is just that as we go in this last quarter of the year, the starting point of the year is the critical number. You know see where we begin. And we have decided to look at worse case scenario approach that says we have a no growth scenario primarily only because of the number of renewals, the amount of new business you need to overcome that number of renewals. The fact that we're increasing health care costs significantly. Changing the health plan somewhat. Although modestly. We're changing the pricing and billing system. So we think it's just prudent to be cautious. Now, I know Richard mentioned in his dialogue, but I don't want anybody to be confused. We could have a blowout fall campaign selling season and continue the same kind of renewing success that we have had every quarter this year regardless of what the circumstances were and we could start the year far better off than what we're budgeting and have a blowout growth year. But we just don't think it's very prudent to plan that way.

Could you give us more details on the plan changes for January 1 and the benefits plan or are those being worked out.

We have already put those out there. They are very modest. It's like going up $5 per employee on prescriptions from $15 to $20 in certain circumstances. Increasing the doctor visits I think that was another $10, I'm sorry I don't have them exactly Tony. But for example the deductible on some plans, we have various plans, but various plans going up $50 from $250 to $300 for the deductible and increasing some of coinsurance limits.

So that should help mitigate the $5% benefit cost increase in the first quarter you are seeing currently?

Right.

The final question is on the mortgage, where are in you that process? I know you said you want it completed by year end. Term sheets out, where are they, how many people are bidding on it?

I would not give that kind of information because when you are negotiating with lenders you certainly wouldn't want to give anybody the one up. So I can tell you that we're quite a ways down the road in the process and expect to have term sheet commitments in the next couple weeks.

Ok. Thank you very much.

Due to time restraints this will conclude today's Q&A session. If you did not get your question answered you contact Mr. Richard Rawson. His Contact information is on the press release. I would like to turn it now back to management for any closing comments.

We don't have closing comments. Thanks everybody for joining us and we look forward to speaking again next time around. Thank you.

This concludes today's call. Thank you for joining us and you may now disconnect.