Insperity Inc (NSP) 2002 Q4 法說會逐字稿

Good day. All sites are now on the conference line in a listen-only mode. Welcome to the Administaff fourth quarter earnings conference. Today we have Mr. Paul Sarvadi, President and Chief Executive Officer of Administaff; and Mr. Richard Rawson, Executive Vice President of Administration and Chief Financial Officer.

At this time, I would like to remind you that any statements made by Mr. Sarvadi or Mr. Rawson that are not historical facts are considered to be forward-looking statements within the meaning of the federal securities laws. Words such as expects, intends, plans, believes, estimates, likely goal, assume and similar expressions are used to identify such forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that have been described in detail in Administaff's filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements.

Now I'll turn the program over to Mr. Richard Rawson. Go ahead, sir.

Thank you. We do appreciate everyone's patience this morning as we talk about our fourth quarter and audited results for the full year of December 31st, 2002.

Let me just give you an outline of our plan this morning. I will first discuss the results for the fourth quarter and the full year. Paul will then add his comments about our progress and achievements for the year 2002, and then discuss our 2003 game plan. Then I will come back and provide some financial guidance for the full year of 2003, as well as for the first quarter of 2003, and then we'll end the call with a question and answer session.

Now, let me begin by summarizing some of the most significant financial highlights for the quarter. We reported fourth quarter earnings per share of 4 cents compared to earnings per share of 8 cents for the fourth quarter of 2001. Excluding the non-cash charge remitted to the write-off of our investment in eProsper, earnings per share would have been 15 cents for the fourth quarter of 2002. Gross markup, which reflects pricing to our customers, was $955 per worksite per employee per month for the fourth quarter of 2002, representing an increase of 8.5 percent or $75 per worksite employee per month over the fourth quarter of 2001. Now, these results reflect a $6 per worksite employee per month of additional markup over the preliminary results that we reported to you on February the 4th, 2003 press release.

This additional markup is due to the fact that the actual effect of our new pricing and billing system applied to the year-end accrued payroll of worksite employees was significantly better than our previous estimate. Gross profit per worksite employee per month of $219 exceeded the top end of our expected range, primarily as a result of acceleration in pricing during the quarter, and the impact of the new pricing system on our year-end accrual as I just mentioned.

Operating expenses for the fourth quarter increased 18% to $44.1 million, in excess of the top end of our expected range of 41 million to $42 million. This overage is attributable to $2.4 million of legal expenses incurred in the fourth quarter related to our lawsuit with Aetna, our former health insurance carrier. While we believe our fiduciary liability insurance policy allows for the reimbursement of a significant portion of these legal fees, we have taken an appropriately conservative position to expense all costs associated with this litigation. Now let's get into the details.

The average number of worksite employees paid in the fourth quarter increased by 10.9% over the fourth quarter of 2001, and went sequentially from paying 79,812 in Q3 of 2002 to 79,560 in the fourth quarter of '02. With increases in the pricing being our priority, we expected some pressure on the volume. Client terminations, in fact, were approximately 8% in January, above our historical 6 to 7 percent range. The decline in worksite employees paid in January was largely due to continued weakness in the labor market which resulted in net layoffs in the existing client base of approximately 1,800 worksite employees. However, worksite employees added from new sales offset those lost through client terminations for the fourth quarter, and through January of 2003.

So as we previously reported on February the 4th, we paid 77,966 worksite employees in January of 2003, representing a 7.2 percent increase over January of 2002. The fourth quarter revenues grew by 11% over the fourth quarter of 2001 to $1.3 billion, which includes $152 million in bonus payrolls.

Now, looking at our revenue growth by region, the northeast region, which represents 14% of total revenue, grew by 36%. The southeast region, which represents 10% of total revenue, grew by 11%. The central region, which represents 15% of total revenue, grew by 17%. The west region, which represents 22% of total revenue, grew by 17%. And the southwest region, which represents 39% of total revenue, was flat, as new sales offset both client terminations and continued unusually high net layoffs in this large base of business. We averaged 245 trained sales reps during the fourth quarter.

Now, moving to gross profit, as I mentioned a few moments ago, our gross profit per worksite employee per month increased from $215 in Q4 of 2001 to $219 in the fourth quarter of 2002, primarily as a result of acceleration in pricing.

As for the components of direct costs, our payroll taxes, which include FICA, FUTA, and state unemployment taxes, as a percent of payroll was 6.25% in Q4 of this year as compared to the 6.12% in the fourth quarter of 2001. Benefit cost per covered employee, which is currently 72% of our total worksite employee base, was $538 for the quarter, an increase of 21% over the fourth quarter of last year. This increase is consistent with our normalized trend of 5 to 6 percent sequential increases over the last three quarters. Workers' compensation costs were 1.38% of fee payroll for the quarter, compared to 1.32% in the fourth quarter of last year. The -- this increase is primarily attributable to an increase in bonus payrolls over last year, offset by the recognition of $350,000 related to the dividend feature in our policy.

Now, let's discuss operating expenses. This quarter, our operating expense on a per worksite employee basis increased from $174 in Q4 of 2001 to $185 in Q4 of this year. This increase in operating expenses included the following: Compensation costs declined by $4 per worksite employee, primarily due to our efforts to reduce corporate headcount in the last half of 2002. General and administrative costs increased by $10 per worksite employee per month due primarily to legal expenses related to our litigation with Aetna that I mentioned a few moments ago.

Depreciation and amortization cost increased by $2 per worksite per employee per month due to, number one, our investment in our technology infrastructure, and, number two, our L.A. service center opening in the first quarter of 2002, and number three, our corporate headquarter building placed into service in September of this year. Advertising costs increased by $2 per worksite employee per month, and commission cost increased by $1 per worksite employee per month.

In the fourth quarter, we wrote off our investment in eProsper, Inc., a privately held company, resulting in a non-cash charge of $3.1 million. We did not record an income tax benefit related to this write-off because it represented a capital loss, and capital losses can only be offset against future capital gains for income tax purposes.

Now I'd like to comment on the full-year's audited results. We reported a full-year 2002 loss of 15 cents a share compared to 36 cents of earnings per share for 2001. Now, excluding the non-cash charge related to the write-off of our investment in eProsper, loss per share would have been 4 cents for 2002. For the year, revenues grew 11% to $4.9 billion, driven primarily by a 11% growth in paid worksite employees. This unit growth was partially offset by a decline in the average fee payroll per worksite employee of 2%, going from $4,020 per worksite employee per month in 2001 to $3,949 per worksite employee per month in this year. Gross markup, which is our third component of revenue, increased 6% from $856 per worksite employee per month to 908 for this year. As for direct costs, payroll taxes as a percentage of total payroll increased from 7.2% in 2001 to 7.25% in 2002.

For the full year, benefits costs per covered employee per month increased 20.8% from $412 to $497. These same costs, on a paid worksite employee basis, grew from $296 in 2001 to $363 in 2002. This $67 increase in benefit cost per worksite employee, when compared to the $52 increase in gross markup per worksite employee highlights the difficulty we experienced early in 2002, and is in Stark contrast to the fourth-quarter numbers which reflect a significant improvement to this comparison. Workers' compensation costs as a percentage of fee payroll increased for the year -- excuse me -- from 1.07% in 2001 to 1.23% in 2002. This increase is primarily due to a $6.6 million credit received during the 2001 period, compared to credits totaling 2.5 million accrued during the 2002 period. Excuse me.

The $6.6 million credit in 2001 represented a cumulative benefit negotiated at the end of our prior three-year policy that ended September 30th of 2001. In contrast, our current policy includes a dividend feature that requires the recognition of the estimated credit earned throughout the policy period. The benefit of this policy is is that our costs are capped and we get the benefit of favorable claims experience that result from our safety and claims management processes.

Now, the short-fall in gross markup early in the year resulted in our gross profit per worksite employee per month declining by 10%, from $198 per worksite employee per month in 2001 to $179 in 2002. Our operating expense per worksite employee per month increased 3% from $176 in 2001 to $181 in 2002. Now, this increase in operating expenses included the following: Compensation costs increased $2 per worksite employee per month, which included a 13% increase in trained sales representatives and a 5% increase in other corporate staff headcount during 2002; general and administrative costs on a per worksite employee basis increased only $1 per worksite employee per month for the year, even with the significant fourth quarter litigation expenses; depreciation and amortization costs increased $3 per worksite employee per month due to the increased capital expenditures that we had in 2002; and commission costs declined by $1 per worksite employee; and advertising costs remained flat on a per worksite employee basis.

As for income taxes, even though we had a loss for the year, which would normally produce a tax benefit, we actually recognized income tax expense of approximately $484,000. This expense is primarily the result of, number one, having no tax benefit related to the eProsper write-off, and number two is the state and -- state income and franchise taxes at the subsidiary levels that we have to recognize despite our consolidated loss.

Now I'd like to make some comments on the balance sheet and cash flow. Excuse me. Total assets are $315 million, including current assets of $192 million. We ended the year with over 86.5 million dollars in cash, cash equivalents, and marketable securities, and $41.2 million of working capital, as compared to 36.6 million of working capital at December 31st, 2001, and $3.6 million at June 30th of 2002. When we began to implement our plan to improve profitability and liquidity. Prepaid expenses and other current assets totaled 22.6 million at the end of the year, and included the following items -- 10 million is related to the prepayment of our workers' compensation insurance premiums, which is scheduled to be refunded to the company by the end of March of this year. There's also a $2.7 million note receivable related to an amount previously funded for service center expansion which we expect to convert to cash in the second quarter of this year, and the estimated refund of the overpaid unemployment taxes from the state of Texas which remains at approximately $6 million.

Now, the Texas workforce commission has not yet issued our final 2002 unemployment tax rate resulting from the approval of our partial transfer of compensation experience that we received from them earlier in the year, and consequently, we have not yet received the refund. Capital expenditures during 2002 totaled $38 million, including 20 million related to the completion of our new corporate headquarters building, and 2 million in capitalized software development costs. Deposits of 26.6 million consist primarily of a $25 million security deposit with our national healthcare provider. And for the record, we plan to file our 10-K the week of March 17th of 2003.

At this point, I'd like to turn the call over to Paul.

Thank you, Richard. My update for you today is intended to provide added perspective in two areas. First, I'll comment regarding the successful execution of our plan over the last half of 2002 to reestablish our profitability for the future. I'll follow with a summary of how we are positioned as we begin 2003 and our game plan and priorities for this year.

Over the last half of 2002, we were working a very specific plan of action focused on four primary issues. First, we focused on matching the price of our service to clients with the rising costs for benefits in order to restore our profit margin. Secondly, we limited operating expenses to recalibrate our cost structure in order to achieve our operating margin targets going forward. Thirdly, we improved our liquidity to ensure our ability to grow in the future. And lastly, we made systemic improvements to mitigate future margin pressure risk.

The numbers we're reporting today clearly substantiate our progress in matching our pricing across our client base to the cost increase we experienced over the prior year. Our gross markup increased $75 from the fourth quarter of 2001 to the fourth quarter of 2002, while our benefit costs increased only $67. However, there was still some ground to be gained in that we did not have a perfect match between these costs and pricing in the fourth quarter of 2001 -- 2001 because the costs had spiked sharply just prior to that period.

Now, as we move from December '02 to January 2003, two major initiatives that contribute to balancing this equation have already been accomplished, providing greater confidence that this issue is behind us. First, consistent with our pattern of selling and renewing a significant block of business on January 1st each year, 20% of our January clients were new or renewing accounts at higher pricing than the fourth quarter. So this step up in pricing will roll into our results in the first quarter of this year.

The second major contributor is on the cost side of this equation. On January 1st of this year, several benefit plan design changes went into effect which reduce our costs across the board. With a full year of accurate health claims data under our belts, and these two steps accomplished, I am confident the series healthcare pricing dilemma we experienced last year is now behind us. We also focused on our operating cost structure over the last half of the year, anticipating that our emphasis on pricing could affect growth in the near term. We scaled back headcount by 5%, eliminated nonessential activities, located ongoing cost savings, and limited going forward capital spending. This effort produced the desired result for the last half of the year, but also improved our cost structure for the future.

We also focused and were successful in improving our financial strength over the last half of the year, which Richard detailed in his comments about our balance sheet. But the most significant initiative accomplished during the fourth quarter was our effort to permit a recurrence of the pricing and margin dynamic we experienced last year. There are two major systemic changes that greatly increase my confidence in this area. The first one is the capability we now have inside Administaff to monitor and analyze and manage our benefit plans. We have a team of professionals within the company, and advisers to the company, that have established processes and methodology at a much higher level of sophistication designed to increase predictability.

We have also identified and quantified changes that can be made to control and reduce costs within the benefit plans. And most importantly, we have sufficient reliable data to integrate into our expectations of expense and pricing on an ongoing basis.

The second systemic change is the development and implementation of our new pricing and billing system. This new system gives us the ability to price a client as aggressively as possible for the benefit of our client while locking in the agreed-upon markup for Administaff. This systemic -- I'm sorry. This system dynamically responds in real-time to changes in gross pay, benefit elections, and associated payroll taxes. This means that these changes can no longer alter our gross profit priced into an individual employee rate. This implementation has far-reaching short- and long-term effects for Administaff.

For 2003, over 20% of the employees paid in January were paid on the new system, confirming excellent receptivity from both current clients and prospects. Over the balance of this year, all other current clients and employees will migrate to the new system upon their renewal date. And of course all new business will be added on the new system as well.

So as we move into 2004, we expect no clients on the legacy pricing and billing system. This also means that this year, for 20% of our client base, we will no longer experience our historical quarterly earnings pattern of losses in the first quarter followed by increasing profitability in subsequent quarters throughout the year. This was caused by the flat rate historically charged to clients while the costs for various payroll taxes was front-end loaded each year as employees earn their wages until reaching predetermined wage base limits. We will be able to monitor the profitability on this group throughout the year as a subset, fore-shadowing how the entire client base will perform in 2004.

My last item regarding 2002 is to comment on the results of our sales and retention efforts at year-end. Last quarter, I explained the challenge ahead, including the difficulty selling through the economic uncertainty, negative reports and press we were receiving, and competitive tactics. I added we definitely would need a strong year-end sales effort to offset the attrition we experienced -- or we expect to experience in January.

I also highlighted the probability of a difficult renewal period with significant price increases, benefit plan design changes, and a new pricing and billing system going into place. In fact, our client retention for January was our highest ever at 7.8%, almost 1% higher than our previous high in 2001, but this was well within the range of our expectation under these circumstances. Although we did not achieve our sales goal for the fourth quarter, we did sell enough clients to achieve our goal of offsetting this attrition in January which, in my view, represents a strong effort.

In fact, if not for the continued weakness and layoffs exceeding new hires, we would not have experienced the slight decline in worksite employee count for our starting point for 2003. Now I'd like to direct my comments to how we are positioned as we begin '03, and our priorities for the coming year. The combination of our pricing initiatives and our operating cost controls have accomplished the desired effect of setting Administaff up for 2003 to reach our target of at least $20 of operating income for worksite employee per month.

Now, that pricing and cost are matched, we're ready to refocus our efforts on three primary objectives for 2003. The first objective is to regain our sales momentum and grow our core business. In order to accomplish this, we are increasing our emphasis on sales activity, aligning compensation in our service organization with specific client retention targets, and eliminating any distractions from sales staff and from the company at large. Even though we're still battling an uncertainty in the marketplace over geo political issues and the weak employment environment it produces, I believe we are well-positioned to move back into a growth mode.

We intend to increase the number of sales opportunities through an increase in our marketing efforts in the first quarter. This will allow us to take advantage of the maturity of our current sales staff, which includes our highest number of trained sales personnel with over 18 months experience in our company history. The other major driver of unit growth is client retention.

In addition to aligning compensation with the service organization with the monthly retention targets, I expect price increases moderating over the course of this year will improve our performance on this metric. In line with the objective of eliminating distractions, we have decided to divest ourselves of our financial management services business that we've been incubating. We intend to complete the selection process of an appropriate broker within the next two weeks and sell this business this year. We have also delayed our new office openings as previously announced until the back half of this year. We will restart expansion only as growth and profitability targets are reached in -- over the first half of the year.

The second major objective for this year is to continue to refine our healthcare cost and pricing strategy to take advantage of opportunities uncovered by the analysis of our plans and the accuracy of our new pricing and billing system. The analysis of our benefit plans have identified opportunities in three areas to tighten our pricing to clients and slow our healthcare cost escalation. We intend to update and include new insurance risk factors such as age and gender factors incorporating into our pricing model in order to align each client or prospect allocation for benefits more closely with the marketplace. We intend to enhance our risk management standards relating to client size, employer contribution, and cobra takeovers to improve client selection and control plan costs. And third, we intend to aggressively pursue active plan management cost savings opportunities with our carriers, including case management, prescription discounts, and other contractual issues to achieve a more balanced financial relationship.

The last major objective for this year is to take advantage of the opportunity presented to Administaff by last year's Internal Revenue Service decision, which allows us to expand our retirement service offerings to our clients. I believe this opportunity will deepen our relationship with our customers and possibly even improve retention as we provide a customized retirement program for each client. We intend to add plan administration services provided by internal staff, utilizing a web-based application service provider to offer these options and benefit from the large asset base already in place in our current plan. This will result in compliance with the IRS decision, while offering more options at favorable participant and client costs, with nominal new costs to Administaff in the short term and significant potential financial benefit in the long term.

In summary, our plan for this year is to regain our growth momentum, further refine our healthcare cost and pricing strategy, and expand our retirement services offering. Accomplishing these priorities will put us back on track, taking advantage of the tremendous market opportunity we have.

At this time, I'd like to pass the call back to Richard to cover how these plans translate into guidance for the year 2003.

Thank you, Paul. In our press release, we again reiterated our target of having $20 per worksite employee per month of operating income. Let me explain what I mean. First, we are excluding the risks and uncertainties of FMS, the financial management services, business from this discussion, as that division is currently for sale and we will be reporting it as a discontinued operation during 2003. Second, although our efforts are focused on growing our worksite employee base, we're going to take a conservative viewpoint because of the level of uncertainty over the war and the unstable economy.

With that in mind, we have targeted a 3 to 6 percent growth in paid worksite employees, but we have also prepared, for the no-growth scenario over our current base, of approximately 78,000 worksite employees. And of course we do have a plan of growth that would exceed these numbers, should that happen. Third, continuing with our conservative approach, we are budgeting gross profit per worksite employee per month metric to be in the range of 195 to $200 per worksite employee per month, even though we're continuing to pass on appropriate price increases. Incorporated into this metric is a 15 to 18 percent annual increase in healthcare costs. Fourth, our various operating plans will allow us to manage operating expenses that would produce our operating income target of $20 per worksite employee per month.

Having said all that, if we see a severe economic downturn that results in a deterioration of our worksite employee base, we would have difficulty achieving that target. Under any scenario, however, we assume interest expense of approximately $1.5 million and a 39.5 percent tax rate, and as of today, we have approximately 28 million shares outstanding. Another item you need to consider is that our estimate of 2003 revenue assumes that the average pay of our worksite employees per month remains flat compared to the 2002 average of approximately $3,950 per month.

Last, but not least, our capital expenditure budget is $10 million, down from $38 million in 2002 and down 50% from the prior years of 2002. Excuse me. The years prior to 2002. Now, let me discuss further guidance for the first quarter. We expect an increase in the unit growth of paid worksite employees of 5.5 to 6 percent over the first quarter of 2002, which basically assumes no growth from our 78,000 worksite employee base. Average pay per worksite employee is not expected to increase over Q1 of last year. We expect gross profit per worksite employee per month to be in the range of $153 to $157 this year.

Now, this is higher than what we have historically experienced during the first quarter, but it is due primarily to the accelerated payroll tax allocation that's built into the new pricing and billing system. Normally, gross markup for the first quarter of the current year and fourth quarter of the prior year are relatively the same. However, this year, with the conversion of 20% of our business to the new pricing and billing system in January, we expect gross markup per worksite employee per month in Q1 of '03 to exceed the Q4 of '02. It's this acceleration in our gross markup that would be the primary factor for our Q1 increase in gross profit per worksite employee per month.

When you consider the impact of the new billing system on the remaining quarters of the year, we would expect a somewhat mitigated quarterly trend, with sequential increases in gross profit per worksite employee per month of approximately 25% increase from Q1 to Q2, then 10% increase from Q2 to Q3, and then 5% increase from Q3 to Q4. We expect our operating expenses to be in a range of 43 to $44 million for Q1, which is higher than our expected quarterly run rate of approximately 41.5 to 42.5 million for each of the remaining quarters of 2003.

Now, the three factors that are causing this increase are, first, $600,000 of the increase will be due to corporate payroll taxes, which are always higher in the first quarter of the year due to employer related payroll taxes being front-end loaded. Second, as you heard from Paul, our emphasis is to regain our growth momentum, and we have moved $400,000 of the annual advertising budget forward into the first quarter to help accomplish this goal. Third, we are conservatively budgeting additional professional fees, including those related to our lawsuit with Aetna and our dialog with the Securities and Exchange Securities and Exchange Commission. Obviously, we will be tightly managing our operating expenses, and we will make necessary adjustments if we begin to track toward the low end of our worksite employee projection. Net interest expense for the quarter should be approximately $400,000, and our effective tax rate should be 39.5 percent.

So in summary, with our improved working capital position and gross profit margins, our focus is now to get our growth back on track and return to our long-term plan.

At this point, I'd like to open up the call for questions.

At this time, if you would like to ask a question, press star 1 on your phone. To withdraw yourself, press the pound key. Again, to ask a question, press star 1 on your phone.

Our first question comes from Chris Gutek from Morgan Stanley.

Sorry. Sorry about that. Good morning, Paul and Richard.

Good morning.

I wanted to ask you actually about how you're thinking about the healthcare costs in the fourth quarter of '02 relative to the fourth quarter of '01 because when we refer back to the fourth quarter of '01 result, management was presenting the $6.6 million incremental healthcare cost from Aetna as a basically nonrecurring charge and you excluded that from your gross profit calculation and presented pro forma earnings per share in that press release a year ago.

But now, in the current press release, you're referring to the gross profit in the fourth quarter of '01 as the 215, basically including the healthcare costs, and not -- no longer treating those incremental costs as nonrecurring. I guess a couple questions flow out of that. One is, why make the change in how you're presenting or thinking about the fourth quarter of '01 results, and what does that say about what you view as the recurring healthcare costs, then, and therefore the ultimate sustainable level of profitability once you get your prices fully rematched?

And finally, what does that also say about the -- the potential liability in the Aetna lawsuit?

All right. Well, let me just try to address part of that. First of all, we're not going to comment today at all about the Aetna lawsuit because we are in the middle of that effort and we've been advised not to comment specifically on that.

But I will address your issue about the last quarter of '01. I think I really addressed it in my comments when I talked about the fact that even though when you look at just the two quarters and the increase in our gross markup going up $75 while the increase in benefit costs went up 67, I did mention in my script that there was a Step-up in those costs in '01 that had just occurred, and that was what I was referring to was what you identified, which was the additional cost we had to pay in to Aetna.

Now, I also mentioned that, you know, since that wasn't a perfect match back in '01, that there was still some ground to be made up but the reality is, we made that ground up as we came into this year and I'm very comfortable that we have a match now comparable to prior periods before the heavy period of cost escalation, including the Aetna billing, which was outside of what they were contractually, in our view, allowed as to charge us during that period. So I hope that answers that.

But the key point that I believe is important for us as a company and for investors is that as we came into '03, you know, 20% of our client base had a step up in the pricing, the normal process, of course, as people renewed and as we added new business.

And then secondly, we also wanted to make sure that that picture snapped into place on the matching of price and cost and that's why we implemented the benefit plan design changes that also went into effect on January 1. So we're comfortable that we're starting this year with that whole healthcare pricing dilemma behind us, and have that very much under control going forward.

And just to be clear, if I understand, Paul, if I could follow up, it sounds as if you're continuing to dispute the incremental healthcare cost that Aetna charged in the back half of 2001, more from a legal technicality perspective because it wasn't technically allowed by the contract but it sounds as if you now recognize those incremental healthcare costs were actually consistent with the spot market healthcare rates that Aetna should have been charging you ...

No, sir, I did not say anything of the sort like that, and -- I really want to refrain from getting into any details about how we might view that, in light of the fact that we are in a lawsuit, but I certainly did not say anything similar to what you just stated.

Okay. Thanks, Paul.

Thank you.

Our next question comes from Josh Rosen of CSFB.

Yes. Thanks. Just to talk a little bit in greater detail on the fourth quarter and both the customer attrition as well as the layoff/new hire trends that you experienced, could you give a little more granularity as it relates as to how that trended through the quarter? You gave quite a bit of comment area on January but not so much on the quarter.

Well, Josh, as I had said, we lost -- during the entire quarter, the client attrition for the quarter, we lost in total about -- let's see. It was over -- about 3,000 employees during the quarter. And we also lost -- over the three months of November, December, and January, the total was 1,800 that we lost. So ...

But that was from the net change in ...

Yes.

... within the base.

Right.

So the 1,800 refers to the net change more macro related.

Right. We were ...

And the 3,000 is more attrition related?

Right. If you look at -- if you look at the total attrition for the year, we ended up this year with client attrition was -- or client retention was 75% and for 2001, it was 74%.

Okay. No, that's extremely helpful.

Good.

And then just to follow up, on the pricing, if you could characterize the portion of your clients now that you feel is on, you know, what you'd call appropriately matched pricing -- I know 20% are on the newer system, but you were also raising prices as you moved through '02 so, you know, what would you characterize as the mix that are now, you know, appropriately priced from a matching standpoint?

Well, the way we run the business, Josh, you know, you look at two things. You do look at each client within the context of their annual cycle, you know, from when they come on to their renewal and from renewal to renewal. Then you look at the whole book of business in aggregate. And what I'm stating clearly today is that we're back in the normal state of having a balance there in the aggregate between what's included in our total allocation to client and what we expect our cost is.

On an individual client basis, each client would be in the mode of, you know, wherever they are relative to their renewal, and from our view, we've been right pricing the clients now for nearly a year. So we're -- we're right where we want to be on that. It just took a while for us to get that all done and, you know, like I say, we wanted to honor our client contracts through their renewal date.

Okay. Thanks, guys.

Our next question comes from Randy Mehl of Robert W. Baird.

Yeah. Good morning, Paul and Richard.

Hello, Randy.

I wanted to discuss the 20% number. It sounds like 20% of new -- of your total base now is on the new pricing schedule and I'm a little surprised that's as low as it is. Did that surprise -- was that a surprise to you? And why didn't some of the renewed clients come onto the new system?

All right. Let me clarify that for you, because all renewing accounts, effective in January, converted to the new system. All. All the ones that were scheduled to renew for January renewed under our new pricing and billing system. All new business we enrolled for January 1st came on on the new pricing and billing system. Now, the reason it's 20% of the base is, of course, because, you know, you add those two together and you compare it to the -- you know, the total we paid in January, that's how the numbers come out.

I actually think that number is very favorable and includes all of those customers we intended to put on the system. The receptivity of the new pricing and billing system is really a highlight here. People are very, very excited about it. Our former system was hard to understand and was really a -- both a selling obstacle and an obstacle for current clients and we're confident at this point that this conversion is going to be one of the greatest things that ever happened for our customers and for Administaff.

So at this time next year, we can assume that about a hundred -- well, all of the base will be on the new system? Is that correct?

That's exactly the right thing to assume.

Okay. And what's the current status of your workers' comp agreement?

Our current policy expires September 30th of 2003, so we will be in the midst of working on renewal for that program. But, you know, we're already in the middle of working on renewal for that program, but we'll announce that at the appropriate time.

Okay. So I'm just wondering what the $20 per employee per month assumes. Or should we just -- I guess that won't -- the new policy won't have kicked into effect so, you know, what are the assumptions around the dividends that you've been receiving on the old policy through this year?

Well, I can tell you I never assume any dividend. I just assume our current, you know, run rate as a percent of payroll, and if the -- and if the experience is actually proved out to be better, then there's a dividend feature which we've -- you know, we've had several of them throughout the year. But I just don't assume any of that.

Okay. And just one other question here. What was the difference between your healthcare expense, benefits expense in the quarter, and what you ended up paying Aetna -- or United?

Yeah. Actually -- well, in total, because I talked about this in the aggregate, which includes all the carriers, but the surplus and deficit scenario usually relates to -- usually relates to the United piece of it. There will be a -- there will be a 2 -- about a 2.5 million dollar liability on our books at the end of the quarter -- or for the -- you know, the end of the quarter and the end of the year. In other words, we experienced about 12.5 million dollars more than what we funded.

You expensed 2.5 million dollars more than what you funded?

That we funded during the quarter. So it will be a -- it will be showing up as a liability or a deficit on the books.

Okay. And I guess just one last question. What is your expected growth in benefits costs over the next couple quarters? You had been running, you know, 5% sequential growth in the healthcare side of that, and what can we assume for overall benefits for the next couple quarters?

Well, what I said was for the year, I expect it to be up about 15 to 18 percent, so it appears to be on a fairly normalized, you know, equal run rate of about 4% a quarter.

Okay. So that's a fair assumption. Okay. Thank you very much. I appreciate it.

You bet, Randy.

Our next question comes from Thomas Geovine (ph) from the Geovine Capital Group.

Hi, guys.

Hi, Tom.

A couple questions. If essentially your entire book of business is back to historical profitability numbers, I guess I'm trying to figure out why it is you're being so conservative on the $20 as opposed to pointing to something closer to 30. And one of the things I think about is in 2001, I think you opened up five offices, and just kind of back of the envelope, that was probably around $10 plus per worksite employee per month and in 2001, you did $30 of operating income per employee per month, so I guess I'm just trying to find it hard to figure out why we're pointing to 20 and not more towards 30, or is that just conservatism?

Well, I think do need to be conservative in this environment, and you have uncertainty out there in the business community that we're all dealing with, and a weak labor market. Obviously, if you have that employee count number affected by either geo political issues or just a continued did you tough marketplace out there, well, then, you know, that moves your denominator down and that makes it harder to make that number on a per worksite employee.

But, you know, the $20 to $30 range is our historical range and we just have designed various scenarios, even some pretty do you remember scenarios, to make sure we can reach that $20 target. Above that, we're all going to be happy, so, you know, being conservative, we think, is the right approach to take.

Okay. But my math is correct as I go through that?

Yes, it is.

Okay. The other question I wanted to ask you is that, again, just kind of using back of the envelope, if you use the $20 number, you should do about 10 million of -- 10 million plus in net income, about 20 something of G&A and about 10 million of cap ex, which would leave you around $25 million worth of free cash. And with a $6 stock price, will -- should we expect that the board will consider some buybacks? I mean, you can buy back a significant amount of stock just from your free cash.

Tom, you're exactly correct. Just to reiterate for everyone's information, we still have under our existing authorization from the board of directors, about 900,000 shares that we can, in fact, buy back. So we will be -- we would be exercising that right and finishing off that before we would go back to the board for any additional amounts.

Okay. Well, I guess I would welcome to see the board increase that authorization, for what it's worth.

Duly noted.

And the last question I have is that I think you said that you have 25 million on -- or I'm sorry, 20 million on deposit with United. Is that right?

25 million, yes.

25 million. Should we expect at least some of that being freed up between now and -- I think the expiration is in June? And if so, is that additional money that could be freed up for buybacks?

Well, certainly if there is a change to that deposit, the dollar amounts that would be freed up, you know, we could use, obviously, for whatever, whether they're buying back shares or if there's a change in the law about paying dividends or anything like that. I'm-- I'm not going to make a -- any comment at the moment about whether or not we think there's going to be any of that coming back in June of this year because that's obviously all part of our ongoing dialog with United Healthcare.

But clearly, I mean, for you guys to deposit $25 million, I mean it's a -- it's a significant percentage of your current market value, and I can't imagine that the -- the business plan is to go on with these guys -- with United having such a significant amount of cash of yours. So I mean, you know, unless -- unless there's some pretty negative results that they're experiencing, we should expect something to come off there. Is that fair?

I think it's fair to say that that will be all couched in part of our ongoing dialog and negotiation with them. And your characterizations are certainly correct and we will be having that as part of our dialog.

Great. I should let someone go. Thank you very much.

As a reminder, due to time constraints, we do ask that you only ask one question.

And our next question comes from Jim Janesky from Janney Montgomery Scott.

Yes, good morning. Richard, can you -- when you were going through some of the expectations for 2003 -- I seem to have missed them. What was your -- what was your expectation for gross profit per worksite employee in the March quarter?

Let's see. If you'll hang on just a second, we had talked about a -- a range of $153 to $157 in this first quarter.

Okay. And then because of the -- because of the price increases, you know, eventually working up to, as Randy asked and you commented, eventually a hundred percent by 2004 - right ...

Right.

... the percentages increase per quarter you gave were like 25, 10, and 5, right?

Yes.

And that was on gross profit, right?

Yes, it was.

Okay.

You bet.

And so the operating expenses, you think that the spike in the first quarter -- or actually it's not a spike. It's pretty consistent with the fourth quarter. You expect that to dramatically decline throughout the year?

Right, primarily for the reasons that I outlined. There is -- certainly we had a step-up in advertising expenses of about $400,000. Our corporate payroll taxes are always higher ...

Sure.

... in the first quarter of the year. And we're still, you know, trying to be conservative in our budgeting for professional fees related to the Aetna lawsuit and our dialog with the SEC, so we're -- that's why we're stepping those up. But if you look at 2002, with the exception of the fourth quarter, you'll see that our operating expenses have been was.

Okay.

You bet.

And so the operating in the 41.5 to 42.5 million dollar range ...

Right.

... and outside of these three items, we'll be going back to that level.

Right, right. And again, Paul, your comment about $20 in operating profit per worksite employee, do you feel that at this point you can average that for the year, or will that be a number that you intend to achieve at some point during the year and either, you know, the second half of the year or exit 2003 or do you think that will be the average?

No, that -- my point of view on that is that that will be the average for the year, taking into account how our quarterly earnings pattern works. But the way we've budgeted our lives around here is as we are performing throughout the year, and depending on what's happening with employee count and so forth, you know, we have various operating plans and contingencies, all working around that goal of being at least at $20 in those plans.

And I think what Richard kind of alluded to is the only plan that you really can't get to that 20 that's in our view today is if employee count goes down, you know, because of the environment that we're in out there relative to, you know, the uncertainty and the weak labor market.

Sure. That makes sense. And did you also work into account -- just getting back to that original point, Richard, you -- your last negotiated workers' compensation contract was two years ago, right?

That's correct.

So, you know, since that time, obviously -- I'm sure that you've budgeted for an increase in that amount, just considering -- I know that's not a significant exposure item to you, but is it fair to assume you've budgeted for an increase?

Yes, sir, I certainly have.

Okay. Great. All right. Thank you.

You bet.

Our next question comes from Tony Tristani from Halpern Capital.

Okay. Thank you. First thing I want to say is congratulations on the tremendous improvement in profitability in the second half of the year and, you know, for 2002. I mean, nobody thought you guys could do it and it was just tremendous. Congratulations.

Second thing is, can -- I guess your -- if you keep operating expenses flat from where they were in like Q3 after the first quarter bump-up, it seems like you'll enter 2004 back to your kind of 2001 model. Can you -- can you -- first of all, can you run the business effectively at 41 million, 42 million of operating expenses per quarter?

Absolutely. I think -- I think we've proved that we could do that even with less worksite employees in the second and third quarter, and of course we grew both of those quarters, so we've got -- you know, we have a certain level of fixed costs and then the rest is variable as we decide to, you know, grow based on our profitability. And I think people will remember Paul and I have said historically that we are not going to sacrifice profitability for growth.

Okay. Thank you. And I guess the second thing I want to focus on is now that you have your margins back in line, can you talk about the -- the -- you talked about the maturity of the sales force, 245 salespeople, they're the most mature sales group you've ever had. Can you talk about the dynamic, you know, that you're -- you're -- in your 3% to 6% growth this year, what kind -- of the three pieces, you know, of that growth, can you talk about it -- you know, the gross kind of adds per salesperson and the churn and the net layoffs? It just seems like it's fairly conservative, if you have 245 mature salespeople and I guess 75% kind of recurring base.

Yeah, I'll tell you we basically just -- for purposes of budgeting and going forward this year, we basically would just rather have the performance, you know, show up for all of us, and so we'll all feel more confident about the going-forward scenario. So we budgeted in very conservatively for this year a couple of scenarios. You know, flat, worksite employee count over the first quarter, and I think to get to the 3%, you know, you only add 1,000 employees a month again starting in about April.

Well, in July.

Oh -- April is for the 6% case.

Yeah.

I had them backwards.

Right.

And, you know, you go out to about July 1 and start adding about 1,000 a month to get to the 6% case.

That would be a very unhappy case for our sales organization here at Administaff but I think you've got to remember there's three things that go into that number. Although I feel much better about client retention, because pricing escalation is moderating and we have a good focus on that factor, so I feel good about client retention. You know, I'm -- I'm very comfortable about our sales staff and the professionalism and how we can perform. But there's always that wildcard about the uncertainty over the war that could happen anytime and uncertainty is the hardest thing for us to fight against because everybody just doesn't want to do anything, so ...

I mean -- but what I don't understand is in 2002, in the second quarter and the third quarter, you added 3,000 net work site employees and the sales force now is more mature. In addition, the economy seems about where it was last year. Service employment is kind of bumping along, you know, up to flat, so it seems like it -- you know, what are you expecting this year? Is it a different competitive environment with your competitors or just a conservative view on, you know, where the economy is going to be?

It's really mostly just that. I mean, remember, we just -- we announced we had three months in a row of layoffs exceeding new hires, and a total of 1800 employees. That's a pretty big number.

So, you know, that presents a pretty stiff headwind. But don't let the conservative budgeting process, you know, make anybody think that we're not really geared up to begin to grow the business again. And that's where -- that's where our head's at. That's what we're going out to do. You know, how long it takes for that momentum to really be reestablished at the levels that we're used to around here, you know, hopefully sooner than later, but I think being conservative is the right approach.

And one final -- thank you. One final question for Richard. Is D&A budgeted at about 24 million this year and you say cap ex 10 million?

Yeah. Cap ex is -- shouldn't be any more than 10 million, and it's -- D&A is probably going to end up being about 22 million for the year because we've got some assets that are -- that are rolling off now, and we don't have any new cap ex to replace them. So that's good news.

But still a 12 million delta?

Yes.

Okay. Thank you.

Our next question comes from Ty Divotas (ph) from CL King.

Hi, fellows. How are you?

Good, Ty. Good to hear from you.

My question's mostly technical. The others have been answered. You've got a fairly high tax rate again in the fourth quarter. Could you explain why that is?

Yes, I can. The tax rate is -- the reason that it's high is because we had a $3.1 million write-off of our investment in that privately held company in the fourth quarter. Because we invested in that a couple of years ago, we don't get to take the ordinary income tax benefit from that. It's a capital loss and the only way that you can offset capital losses is via capital gains of assets held for more than one year. So we didn't get any of the benefit of that write-off to begin with.

And then the second item is that because the -- you know, we have several entities that are subsidiaries of the holding go company, the state income tax and franchise tax and some of in some of those states where the subsidiaries are, we have to pay, even though on a consolidated basis we have an operating loss. So that's why we had to book about $458,000, 400 -- I think that's the number -- of income tax expense, which shows a huge tax rate, and that's just because of the subsidiary state income tax and franchise tax in those states that we had the entities.

Okay. Thanks an awful lot. Appreciate it.

Yeah, you bet.

Congratulations.

Thank you.

Our next question comes from Jim MacDonald of First Analysis.

Hi, gentlemen. It's Grant Jackson (ph) in for Jim. I just -- just with regard to the 20% of old clients being repriced, the way I understand it is that you're pretty much there in terms of your overall correct total pricing, and that you're about 20% there in terms of the allocation of that pricing so the right quarter is based on clients taxed. I guess that's the first question, just to make sure we're looking at it from the same perspective.

And then can you compare the retention of those clients versus the clients -- your -- the other 80% that rolled over in January?

I want to just make sure we have one clarification. The 20% number we're talking about for January 1 represents the -- the total base of our clients that are on our new pricing and billing system, and certainly they're a big -- that's a big number for one month to step up to both a higher price and to be on the new system. But remember, there are customers every month moving to a higher price. That happened throughout the quarter of the fourth quarter, and is happening for February 1 and will happen every month again for this year. So I just want to make sure we have that distinction.

The 20% is just a big number for any one month to have a step up in pricing. We've been moving pricing consistently every month throughout all of last year. That's how we came out of that margin squeeze that was so severe in the middle of the year.

Okay. So pricing is going to continue to increase, but as far as -- there was a question earlier that was asked as to do you feel comfortable that overall, your pricing is, you know, at a high enough level for today, and the answer was yes.

Yes, absolutely. In the aggregate -- you know, I want to make that clear today. I want to state it and announce it. We've -- you know, what we set out to do over the last six months of last year has been accomplished, and we do have price and cost matched he effectively in the aggregate and what we are pricing in to customers is appropriate.

Okay. And so any difference in the retention between clients who are being transferred to the new billing allocation method as to those who have not?

No, there's -- no. The ones that -- the ones that renewed on January -- in the month of January, our retention of those customers was what we expected. And we haven't lost any customers that I'm aware of that were due to the fact of converting to the new billing system. We may have lost ...

Actually, to the contrary, we actually have had some that, you know, were very excited to see the new pricing and billing system because it has been a frustration for customers in the past. It -- the billing system was somewhat of a mystery to them. So having one that's so much easier to understand and makes so much sense and reacts in the aggregate to how these costs have reacted to them in the past, they were -- you know, we actually had some customers who renewed that may otherwise would have not.

Okay. And along those lines, when you're looking at gross profit across the year, you've given us how the quarters are going to progress. Does that mean that the stabilization point is around 200 to $225 gross profit per worksite employee per month? Once you reach the end of this year and you've got everybody on that? And are we going to see any variation across the quarters next year?

We're really not ready to go there yet. You know, I think we all ought to -- let's monitor, you know, how we convert the customers over the course of the year. You know, how this year comes out, both at the gross and -- you know, from the pricing element and the cost side on the gross profit, and -- but the one thing that's certain is that that as we go to '04. Instead of the quarterly earnings pattern that we've had in the past and that you kind of have a mitigated or hybrid version this year, next year we don't have that earnings pattern at all. You'll be able to look at sequential quarters in a whole different light.

And the last thing is just regarding the $2.5 million liability, do you think that will impact in any way the amount of money you need to have with United?

No, because -- no, that won't change any of the security deposit at all.

It won't change their view in terms of whether you need to add to that or whether they're going to give anything back?

No. The -- you know, the difference between what we expense -- in other words, we expense 2.5 million dollars more than what we funded during the fourth quarter, so for us, it's just a matter of we already have locked-in rates for the first and second quarter on the funding side already, so if, in fact, the expense ends up being -- you know, continues to exceed what we're funding, in our view, then that -- that amount of liability would continue to increase on the books.

The -- on the other side is that if the funding caps that we have put in -- that we have agreed to for the first and second quarter with United are lower -- excuse me, are higher than what our actual expense is, then that entry will just basically reverse itself out. So, you know, the game plan has always been to try to keep that funding, that deficit or surplus, at a -- you know, a fairly nominal rate, in terms of not much surplus and not much deficit, and I think 2.5 million on $90 million worth of expense isn't that bad.

Our final question comes from David Farina from William Blair & Company.

Hi. All our questions have been answered. Thanks.

We have no further questions at this time.

Well, thank you all for joining us today. We appreciate your attentiveness and once again, sorry for the difficulties there at the beginning with the technology. Thank y'all again. We'll see you next time.