Insperity Inc (NSP) 2003 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Administaff third quarter 2003 earnings results conference. My name is Katelynn and I will be your coordinator today. Speaking on today's call will be Mr. Richard Rawson, President of Administaff, Mr. Paul Sarvadi, Chairman and Chief Executive Officer and Mr. Douglas Sharp, Vice President of Finance and Chief Financial Officer. At this time, all participants in a listen-only mode. We will be facilitating a question and answer session toward the end of this conference. If at any time during the call, you need caller assistance, press star 0 and a coordinator will be happy to assist you. This conference is being recorded for replay purposes.

Any statements made by Mr. Paul Sarvadi, Mr. Rawson or Mr. Sharp 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, believes, estimates, likely, goal, assume and similar expressions are used to identify such forward-looking statements and 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 defer materially from those stated in such forward-looking statements. I would like to now turn the program over to your host, Douglas Sharp, Vice President of Finance and Chief Financial Officer. Please go ahead.

Thank you. We appreciate you joining us today to hear what we believe are solid third quarter results. Let me outline our plan for this morning's call. First, I'm going to discuss our third quarter financial results. Paul will add his comments about the quarter and on our efforts to re-establish growth momentum going into 2004. Then Richard will discuss our general outlook on trends and our direct costs, including benefits, worker's compensation and payroll taxes and the impact of such trends on our pricing. I will return to provide financial guidance for the remainder of this year and some general comments about 2004. We will end the call with a question and answer session.

Now, let me begin by summarizing the financial highlights from the quarter. As a result of pricing increases over the past year, revenue per work site employee per month increased 7.4%, or $67 over Q3 of 2002 to $978 for the quarter. Gross profit for work site employee per month increased by 30% over Q3 of 2002 to $254 dollars, including $18 related to the receipt of our final 2002 and 2003 Texas unemployment rates. The remainder of the increase was a result of benefit costs coming in at the low end of our expected range and improved pricing. Operating expenses for the third quarter were $42.8 million dollars, within our expected range. We reported third quarter earnings from continuing operations of 31 cents per share compared to 15 cents per share for the third quarter of 2002.

Now let me explain the details. As we mentioned in last quarter's conference call, we expected the decline in the average number of paid work site employees per month to be approximately $74,000 in Q3 primarily due to the expected loss of a single low margin account. The average work site employees paid in Q3, 2003 ended up slightly higher at $74,281. Third quarter revenues were flat compared to Q3 of 2002 at $218 million as a result of increased pricing, which offset the decline in paid work site employees. -- [ loss of audio ] -- billing system beginning January 1st of this year was minimal in Q3 of 2003. Total non-bonus payroll costs per work site employee per month averaged $4,004 for Q3 of 2003.

As you may have noted, in the press release issued this morning, we have provided a reconciliation of total payroll costs, which is a GAAP amount to non-bonus payroll costs, which is a non-GAAP amount. We feel that this measurement is a key metric of our business. This metric is particularly useful as we typically discuss trends in worker's compensation costs as a percentage of non-bonus payroll. Looking at revenue growth by region, the northeast region, which represents 13% of total revenue, grew by 8%. The southeast region, which represents 11% of total revenue, grew by 1%. The central region which represents 15% of total revenue, grew by 3%.

The west region, which represents 22% of total revenue, grew by 12% and the southwest region which represents 39% of total revenue, declined by 9%, even though the region, which includes 27% of our total sales reps generated 31% of our sales during the quarter. We averaged 213 trained sales reps for the third quarter, down slightly from an average of 219 sales reps for Q2 of 2003. Moving to gross profit, as I mentioned a few homes ago, gross profit per work site employee per month increased significantly from $195 dollars in Q3 of 2002 to $254 dollars in the third quarter of 2003. Benefit costs per covered employee per month was $553 dollars for the quarter, increasing 3% over Q2 of 2003 at the low end of our expected range and increasing 9% over Q3 of the prior year.

Worker's compensation costs were 1.54% of non-bonus payroll for the quarter. This compares to 1.67% of non-bonus payroll in Q2 of 2003, which included a $2.5 million dollars charge related to a worker's compensation dividend associated with our former policy. As we have previously announced, we entered into a new lost sensitive worker's compensation program effective September 1 of 2003. And therefore, have only one month of experience under the new program in this quarter.

Payroll taxes, including FICA, FUDA and state unemployment taxes as a percentage of total payrolls costs was 6.62% in Q3 of 2003, including the TWC unemployment tax credit previously mentioned of $3.9 million or .42% of total payroll. This compares to a cost of 7.05% of total payroll incurred in Q3 of 2002. Now let's talk about operating expenses. As expected, operating expenses increase by $2.5 million over Q3 of last year and increased on a per work site employee per month basis from $168 in Q3 of 2002, to $192 in Q3 of 2003, however declined from $196 in Q2 of this year. The increase in operating expenses over Q3 of the prior year included the following: Compensation costs increased by $831,000, of which $665,000 was due to an accrual related to our 2003 incentive compensation plan, payable only upon the achievement of certain annual goals.

On a per work site employee basis, compensation costs increased by $10 over Q3 of 2002 with the incentive compensation accrual accounting for $3 of this increase. The remaining $7 per work site employee per month increase was a result of corporate head count and base compensation remaining relatively flat in total dollars while the number of paid work site employees declined by 7% since Q3 of 2002. Advertising costs increased by $4 per work site employee per month, due primarily to an increase in marking efforts associated with this year's fall sales campaign that Paul will update you in a few minutes. Commission costs declined by $1 per work site employee per month.

Depreciation and amortization costs in total dollars remained flat from Q3 of last year, however, increased by $2 on a per work site employee per month basis. General and administrative costs increased by $1.4 million dollars, including Aetna-related legal costs of approximately $1.1 million. Since inception of the lawsuit in the fourth quarter of 2001, we have expensed $6.1 million dollars in Aetna-related legal costs. On a per work site employee per month basis, general administrative costs increased by $9 over the third quarter of 2002 with the Aetna-related legal fees accounting for $5 of this increase. The remaining $4 increase was primarily the result of holding other G&A costs flat in total dollars while experiencing a decline in our work site employee base.

In the third quarter of 2003, we reported net interest income of approximately $47,000 dollars due to interest earned on higher investment balances and our security deposit with United Healthcare more than offsetting interest expense related to the mortgage on our corporate headquarters. This compares to net interest income of $250,000 dollars in Q3 of 2002. We reported a net loss from discontinued operations of 3 cents per share, including an after-tax impairment charge of $700,000, associated with the writedown of the assets of financial management services. We have been in the process of selling these assets and had recently entered into a letter of intent with an interested third party. Unfortunately, we were recently notified that the party did not intend to follow through on the proposed sale. We will continue our efforts to sell these assets, including the possibility of a different structure with this same party.

Now I'd like to make some comments on our balance sheet and cash flow. Total assets were $302 million dollars, including the current assets of $190 million. We ended the quarter with approximately $48.6 million dollars of working capital, a sequential increase of $744,000 over the second quarter of 2003 after funding $10 million dollars of cash collateral related to our new worker's compensation program. Prepaid expenses and other current assets totaled $28.5 million and included the following items. $10 million dollarsfunded to United Healthcare in excess of actual costs since the inception of the plan.

We experienced a $2 million dollar increase in this balance during the third quarter, which is bound from the $6 million dollar increase experienced during Q2, 2003, as funding rates continue to be brought more in line with actual costs experienced. The next component is $7.5 million dollars related to the security deposit with United Healthcare, which was previously announced will be refunded to us in January of 2004. Finally, $5.3 million dollars related to the Texas unemployment tax credit, which we intend to apply to future state unemployment tax liabilities. Year-to-date capital expenditures total $5.9 million dollars, which include $1.3 million in capitalized software development costs.

This is down significantly from prior years when we were investing heavily in our office and technology infrastructure. Deposits of $30.9 million dollars consist primarily of the remaining $17.5 million dollar deposit balance with United Healthcare and $12.3 million dollars related to our new worker's compensation program, including the $10 million dollar collateral payment which I mentioned earlier. Now I'd like to turn the call over to Paul.

Thank you, Doug. Today my comments will address three important topics for Administaff shareholders, employees, clients and other constituents of the company. First, I want to discuss the turning point I believe we have come to as a company and the prospects we have for the long-term. Second, I will provide information regarding our intermediate plan to focus on our operating income per work site employee. Third, I will spend most of our time discussing our progress on our short-term plan to re-establish our growth momentum. I'd like to take a few minutes to discuss Administaff from a 50,000 foot view.

As I look back and see what we've come through since we became a public company in 1997 and look ahead to see the opportunity in front of us, I'm energized and confident about the future. The first five years as a public company, we had an excellent run, including compound annual growth rates of 27% in unit growth, mid-30s in revenue and gross profit growth and over 24% in earnings growth. We developed a very good business model and we certainly benefited from growth in the economy, trends toward outsourcing and a lot of hard work by great people we have here at Administaff. However, as we came into 2001 and 2002, we certainly faced the most challenging period in our 17-year history.

We experienced a barrage of potentially devastating issues including legal, regulatory, insurance and economic obstacles and under these pressures, the need for structural business model improvements became evident. Today we can look back and declare victory over the myriad of issues we faced. We most certainly fixed the critical business model issues, including matching price and cost for key direct cost items and developing a pricing and billing method that's independent of payroll in response to client profile changes in real-time. We also worked through industry regulatory issues with the IRS and the SEC.

We successfully resolved a dispute with the Texas workforce commission and met the challenge of the financial collapse of two A-rated worker's compensation carriers. And most recently, we received a favorable jury verdict, finding that Aetna breached our insurance contract in 2001 in several ways. Now, since this is our first opportunity to discuss this case since the verdict, I want to spend just a moment to describe the outcome of the trial. The jury found that Aetna failed to use the care and diligence of a reasonably prudent financial manager in providing financial reports concerning our plan. This type of information is essential in order to match price and cost in our client contracts.

The jury also found that Aetna breached our contract by imposing immediate and retroactive rate increases, contrary to the agreed upon two-quarter waiting period. This provision was the element of our contract we specifically negotiated to mitigate our pricing risk and allow us time to pass on increases to clients. The jury also found Aetna and breached our contract in September 2001 by threatening to terminate our health plan unless we paid the immediate and retroactive increases in the third and fourth quarter of that year. This breach necessitated an abrupt change of carriers and uncertainties surrounding costs in 2002 until new planned data could be developed. The jury also rejected Aetna's claim that we made a negligent misrepresentation or an oral agreement to repay Aetna's planned deficit, if any.

This is important in -- in that this finding confirms that Aetna had the insurance risk and the plan was fully insured. The jury awarded $15.5 million dollars in damages and may include applicable interest. From our perspective, the findings of the jury are substantially more important than the award. Although this verdict is subject to entry of a final judgment, post-judgment motions and appeal, this will not be near the distraction it has been in the past. Now that all of these issues are behind us, the time for renewing our long-term plan is at hand. We intend to be the national dominant player in the outsourcing of human resources in the small to medium-size business community.

We plan to capitalize on our opportunity to serve a strategic 10% segment of the small business community consisting of approximately 600,000 potential clients. We intend to aggregate the best small businesses in the country on our intimate human resources services platform and help these companies succeed. Now for the intermediate term, we are positioned as a company to benefit most by running volume over our infrastructure and focus on increasing our operating income per work site employee per month. Over the last five years, we've successfully positioned our company at the forefront of the business services companies in developing a high-tech, high touch service model.

These investments have improved the client service experience and lowered direct service costs. Historically, the efficiency gains have been masked by other needed investments in infrastructure and developing other competencies in the company. However, the time has come for the benefit of greater volume to improve our bottom line. Now that we have fully recovered at the gross profit line by matching price and cost, the highest return for the company comes out of growing the business while holding operating expenses in check. Now, this will be our focus throughout 2004.

Now, I'd like to direct the rest of my remarks on the most immediate priority for the company, regaining our growth momentum. The key to accomplishing this goal is to execute a successful fall campaign. Almost every year since the late '80s, we have held such a campaign focused on selling and retaining clients in order to have a step up in the size of our client base as we enter the new year. This effort capitalizes on the tendency for small to medium-size business owners look to improve their business in the coming year and in the fall we have found they are more important to new ideas.

This year, we have launched the most comprehensive strategic and decisive campaign in our history. The early returns are excellent, but before I get to the results, let me provide the details behind the goals, plans, tactics and the activities included in this year's campaign. In the analysis of what it would take to re-establish momentum through this fall campaign, four issues had to be addressed that affected our results last year. They are pricing, activity, attitude and the general macroeconomic factors. We've developed a specific tactical plan to remove distractions we've had in the past and turn these factors into a positive from a negative.

First, as I mentioned earlier in the year, we addressed pricing through improved client-specific pricing and selection processes to be more competitive on more desireable prospective clients. The strives we've made in controlling our direct costs have resulted in our costs increasing less over this year than the marketplace for all three of our direct costs, including payroll taxes, worker's compensation and benefits cost. Richard will provide more detail on these costs in a few minutes, but the bottom line is we're comparing much more favorably with other options small businesses have in the marketplace.

The investment of prospect or a renewing client makes for our services back in line with levels we associate with our historical growth pricing strategy. The second critical factor in the successful fall campaign is an immediate and significant boost in sales activity, beginning with leads in appointments with qualified perspective clients. Let me touch on some of the programs we initiated that are resulting in the desired boost in activity. We've initiated a dynamic new client referral reward program, which includes an online incentive site where clients choose rewards from our alliance partners for providing referrals.

Clients receive $50 for referring a prospect with 10 or more employees when the first call is made. They receive $100 when the census is completed and $800 when the prospect becomes a client. In addition, every client who's total referrals add up to 50 or more employees sold during the campaign, will be flown with their guest to a plush multimillion-dollar villa in Acapulco for a Valentine's Day weekend. Now, our alliance partners underwrite this entire program and our clients are reacting as referrals are running 60% ahead of last year.

This program has been introduced with a brochure mail to each client and a follow-up call made by our service team to introduce the program. Clients also will receive a gift package during during this campaign that will further attract attention to the referral program. This gift package is a special promotion being utilized in several ways throughout this campaign. Over the summer, we tested delivering a gift box of pistachios with a marketing message to get in front of small business owners. We are sending this ice-breaking prospecting tool to carry scrub the prospect list and as a retest program to qualify prospects we failed to convert over the last year and to clients to introduce the client referral program.

In all of these cases, we've automated the process of notification of the salesperson, service person, or call center person responsible for a follow-up phone call within the 24 hours of the delivery of the gift package. We also are leveraging the call center competencies we have developed through the American Express agreement for the first time in this fall campaign. We've ramped up the call center from 5 employees to 22 employees and they're making appointments for our sales staff for both inbound and outbound calls. We've also extended a coordinated radio, direct mail and e-mail marketing campaign called the "Uh, Oh" campaign.

This effort is designed to illustrate to prospects that HR issues are volatile and potentially costly when you make the least little mistake and that Administaff can help avoid such problems. Through interactive e-mails, we are engaging prospects by asking them the best thing do to a potentially troublesome yet common HR situation. Prospects click through to a special "Uh, Oh" website where they can check their answer, test their knowledge of how HR impacts their business by taking a quiz or read case studies or contact Administaff. We are contacting qualified prospects through several propriety client bases through relationships with American Express, Pitney Bowes, E-rewards, BuyerZone, Biz Journals and our own HR powerhouse site, which now has over 50,000 members.

We have many other initiatives underway to generate lead and appointment activity, which is the front end of the sales engine, but the bottom line is that we have an 80% increase after last year's campaign so far in this activity and I'd also point out that many of these programs are just now kicking in. In addition to generating the right kind of sales activity, we've implemented programs to eliminate distractions from the sales staff to make them more productive. The most important program is our early renewal program. Clients scheduled to renew in November through January have been contacted and offered an opportunity to get their renewal out of the way early before the holiday season and save some money at the same time.

Once again, we're utilizing internal service and support personnel to provide this direct renewal support to the client and eliminate the distraction from sales personnel. So far, the reaction to this program and this effort from our clients has been overwhelmingly positive. Through this program, we get the double benefit of eliminating the distraction from these sales and an early rate on retention for next year. We have also provided incentives for sales, service and management personnel around specific objectives of the campaign, including both new clients sold and clients retained over the several months of the campaign.

We've also extended the campaign through January this year because of the staying power of many of the programs that we've implemented. Now the third important factor to ensure a successful campaign and re-establish our growth momentum is to address the attitude of the sales force. The immediate boost in this area came from uniting all sales personnel at the corporate headquarters for the kickoff in September. We introduced all of the programs and the pricing dynamics and the strategy behind this year's effort. We also reintroduced fun into the equation with a quickoff theme and activities surrounding the event.

The best evidence that we hit the mark in this area is the immediate sales results in September as we exceeded 3,000 employees sold for the first time this year and achieved our historical sales metrics. We had the highest closing percentage in two years and closed more than 1 sale per salesperson using our 13 employee per client equivalent standard. The most convincing evidence that we're on the right track is the increase in paid work site employees in October. Our September employees lost from client attrition was below 2% for the first time this year and at 1.6% is near our historical norm. The combination of this factor and the recent sales results resulted in paying over 75,000 employees in October.

Now, we still have a long way to go in this campaign in order to confirm that we will have a step-up in the number of paid work site employees to start the year, but we are certainly on the right course to this point. The last area to address is the macroeconomic factor that have been a significant headwind to our growth over the last couple of years. We determined early on that would have to overcome these factors during the fall campaign by increasing activity levels to levels that would produce favorable results even if outside factors persist. In the event that these factors continue to ease or don't reappear, then the results would just be that much better.

So far, we're encouraged by the marketplace receptivity to make decisions that will affect their business next year. While a terrorist attack or other calamity could most certainly affect the attitudes in the marketplace, we have tried to reduce the potential impact on us next year by getting off to a fast start in this sales campaign and renewing accounts early. In summary, I believe we have truly crossed over to a new period for the company, with so many significant challenges in the rear-view mirror. We're in a great position to increase profits by running volume over our infrastructure and by getting back the investments over the last five years. And we are on track for the level of activity and success needed to regain our growth momentum. At this point, I'd like to pass the call over to Richard.

Thank you, Paul. As many of you know, we've recently announced a realignment of duties and responsibilities within Administaff so that we can focus our efforts on the areas of the business that can drive major growth in earnings over the next five years. My area of responsibility includes integrating the class, selection and pricing departments with the benefits, worker's compensation and retirement services departments. The objective of our team is to make sure that our pricing for new and renewing business, excuse me, not only matches our direct cost, but that we also maintain our competitive advantage in the marketplace.

Today, I would like to update you on our progress as it relates to each of the direct cost areas, benefits, worker's compensation and payroll taxes. We've recently announced the resolution of our state unemployment tax rate dispute with the Texas workforce commission and as a result we now have better-than-expected unemployment tax rates for 2003. However, the high level of layoffs in the marketplace over the last couple of years have left state unemployment tax funds in a severe deficit. Many states are passing on surcharges and other forms of statutory rate increases to cover these deficits and to meet ongoing future unemployment obligations. This situation will translate into higher unemployment tax rates for all employers in 2004.

We have engaged Pricewaterhouse Coopers as our tax advisor to assist us in forecasting the non-statutory rate changes that are coming. These anticipated increases are built into our pricing allocations for next year. As for statutory rate increases, we have a provision in our contract that allows to us pass on statutory rate increases as they occur. Our new billing system allows for the changes to be reflected immediately once the new rates are entered into the system. So, we don't expect to have any negative impact on gross profit due to rising unemployment tax rates in 2004.

Now, to deal with the increasing cost of worker's compensation insurance, we made excellent progress to stablize this very important direct cost for the long-term. During the third quarter, we announced the formation and licensing of our wholly-owned insurance subsidiary as well as the establishment of a new insurance carrier relationship with AIG. We engaged Tower's parent to perform an initial actuarial analysis of the worker's compensation claims that we have had since 1999 to help us determine future costs on a state by state basis. Because our mix of business has not changed significantly and since we've had the same claims administrator for several years, Tower's parent was able to have a much higher confidence level in predicting these future costs.

I am pleased to report that our expected worker's compensation costs should only be increasing by about 12 to 15% next year instead of the 20% that we had previously discussed. We are pricing new and renewing clients to reflect these increases which are generally lower than what these clients would have experienced out on their own. Now, the third direct cost to report on is healthcare and other benefits. We are continuing to see the stablization of our healthcare costs resulting from both the effect of planned design changes at the beginning of 2003 and the effect of other cost control techniques that we implemented in April of 2003.

Therefore, I would expect that our benefits cost on a per-covered work site employee per month basis for 2003 should end up about 9 to 10% higher than 2002. We modified our pricing model to include new risk factors for age and gender of work site employees. We've successfully improved client selection through enhanced risk management analysis relating to client size, employer contribution and Cobra takeovers and we also increased our pricing to employees electing healthcare coverage under Cobra.

Previously, we announced that our administrative costs with United Healthcare would be reduced beginning in Q4 of this year and now I'm pleased to announce that we have completed the negotiations for health insurance coverage for 2004 with the remaining four carriers. While these 2004 rates are higher than last year, they fit comfortably into our previous expectations. We have also renewed our dental insurance plan with a two-year fixed rate program with rates that are approximately 10% lower than what we experienced this year. Last but not least, we were able to secure a slightly lower rates than we had for 2003 for most of our other benefits such as life and disability insurance. It's this information provided by our carriers and consultants that lead us to anticipate total benefit increases for 2004 to be in the 12 to 14% range over 2003.

We are building our plan around these ranges even though we still have not seen the full effect of some of the cost control changes that I mentioned a few moments ago. This is significantly better than the increases small to medium-size businesses are getting today so I believe we are also in good shape from a competitive standpoint in this area for the future. Now, for 2004, our growth pricing strategy is designed to cover all the direct costs and produce a level of gross profit in the current range, while we add a significant number of work site employees to our base of business, which will increase our operating income per work site employee per month. At this point, I'd like to turn the call back over to Doug to discuss guidance for the balance of this year.

Thanks, Richard. Now let's discuss guidance for the remainder of this year. As a reminder, we are excluding the results of financial management services from our guidance as the division is currently for sale and is being reported as a discontinued operation in 2003. As Paul mentioned earlier, we have seen early indications of an increase in sales and retention levels during our fall selling season.

Although the majority of work site employees sold during the fourth quarter are typically paid in the first quarter of the following year, we expect a slight increase in work site employees paid in Q4 of 2003 to an average of $75,000. Gross profit per work site employee per month for the fourth quarter is expected to be in a range of $240 to $245. This is slightly below our previous expectations of $245 to $253, partially due to additional payroll tax expense associated with the expected increase in work site employees during the quarter. As for benefit cost per covered employee, our fourth quarter guidance includes an expected range of $553 to $563 with a low end of this range remaining flat from Q3 of this year.

This expected range includes a continued trend increase, offset by reduced administrative costs of approximately $7 per covered employee per month. These gross profit estimates also include the effects of our transition to the new billing system which had accelerated some of our gross profits earlier in the year. We expect the average non-bonus payroll for work site employee per month to be approximately $4,020 in the fourth quarter, a slight increase over Q3 of this year. Last quarter, operating expenses totaled $42.8 million. We expect operating expenses to be in a range of $42 million to $42.5 million in the fourth quarter.

This expected range includes the following: Reimbursement of Aetna-related legal costs of $2 million dollars, which is subject to the execution of standard settlement documents with our insurance carrier. An increase in our incentive compensation accrual of approximately $1 million dollars over Q3 of 2003, based upon the expected improvement in our 2003 operating results. An incremental $500,000 dollars in expenses related to our new 401(k) recordkeeping division, which will be accompanied by a similar amount of new revenue. Fourth quarter operating expenses also include an estimate of legal costs associated with our lawsuit with Aetna of $750,000 dollars. These legal expenses should decline significantly after this quarter.

Interest income on higher investment balances and our security deposit with the United Healthcare should offset interest expense on our mortgage during the fourth quarter. Our effective tax rate for the fourth quarter should be 39.5%. As for 2004, we are still early in our budgeting process so we are not providing any guidance today. However, as both Paul and Richard mentioned, our objective will be focused on improving our operating income per work site employee. In order to accomplish this goal, we will continue to focus on work site employee growth, while holding gross profits for work site employees constant and holding operating expenses in total dollars down. I look forward to discussing 2004 guidance in detail with you during our fourth quarter conference call. Thank you. Now we'd like to open up the call to questions.

Ladies and gentlemen, if you'd wish to ask a question at this time, you may do so by keying star 1 on your touch-tone phone. If your question has been answered or you wish to withdraw it, key star 2. Questions will be taken in the order received. Please key star 1 to begin. Sir, your first question is from Randy Mehl of Robert W. Baird.

Good morning, Paul, Richard and Doug and nice quarter.

Thank you, Randy.

And congratulations for getting some of the big issues behind you. I know it's been kind of a pain in the neck at the very least over the last couple of years. But the -- I just wanted to follow-up on a couple of comments. Richard, you mentioned gross profit in the current range as we look to next year. Is that -- do I understand that to be the average 2003 GP, your goal is to hold that constant next year?

Yes, it is, Randy.

Okay. And then could you talk about the seasonal factors going forward? You've changed to the new billing system and so things will look a little bit differently throughout next year, particularly on the GP side. I'm wondering if you can, you know, comment what we could expect as we start to look out.

Yeah, this is Doug. For the base business that comes on January 1 of next year, you know, we expect the quarterly earnings to go away on the business. Now, new sales that we bring on throughout the -- throughout next year, will have some quarterly earnings that pattern to those, to the new sales, but the larger part of your base business, the quarterly earnings pattern, will go away.

Okay.

Consistent with the new billing system.

Okay. So -- so what -- what if any impact would accelerated new sales growth have, then, on the GP?

Yeah, I would say it would have a minimal impact.

Okay, good.

Due to the large base of business.

Okay, great. Thanks a lot. I appreciate it.

Your next question from Josh Rosen, Credit Suisse First Boston.

Thanks, just wanted to follow up a little bit on the new sales activity and just get a little perspective on referral activity in the past, I think Paul you had mentioned it was up, correct me if I am wrong, something on the order of 60% or so relative to where you were in the past in terms of new referrals? And what sort of impact has it had in the past?

Sure, Josh, of course referrals have always been our very best lead source because of the high closing rate, you know, when -- when we're referred by a client to another perspective client. And as I mentioned, just in the very early stages, the campaign, we're up 60% over prior periods for that, you know, for the number of actual referrals we're getting from current clients.

And I actually expect that to continue to move up dramatically because just, you know, we just now introduced this new program that has caused, you know, quite a bit of enthusiasm. So, you know, it's -- it's still too early to tell, really, how successful that's going to be, but, you know, again, the more of those kind of appointments we get our folks out on, the better all of the sales metrics will be throughout the campaign.

And then any update or additional color on, you know, the changes that are coming on the retirement services side? And how you guys are prepared for that? I know this has been a topic of the past, but what changes might come forward in '04 there?

Josh, this is Richard, I purposely left out a lot of discussion about that because we have -- we've already achieved one of the milestones of that conversion on the retirement services business to Administaff being our own record keeper. And on October 1 of this year, we actually did convert from a prior record keeper and now we are the record keeper for all the existing plans. The second phase of this conversion will take place December 31 and we'll go into all the new plan design changes, the -- the multiple type employer plan, the prototype plans, all of those will be effective on January 1 for all of our clients.

As we move forward into 2004, we -- we see that obviously the amount of income coming in is going to increase throughout the year. At this point, the expenses will have a little bit more expense but I would say conservatively that we will be easily at a break-even on that business for 2004 and it's possible, dependent upon the number of clients and employees that convert out of the -- the existing plan, we could see some upside there, but we're not ready to talk about that yet today.

Okay, thanks a lot.

Your next question, Thomas Giovone, Giovone Capital.

Hi, guys.

Hey, Tom.

I was curious whether you can give us guidance in term of what the management and/or the board is thinking in term of a capital plan? Because you still have a decent amount of cash on the books, next year if we just kind of chug along you're looking at maybe generating, I don't know, about $40 million of cash, maybe $10 million of Cap Ex and with the stock trading as cheaply as it is, it seems like you can buy yourassets at a pretty decent price here. I've also been kind of pushing to see if you can put in a dividends help earnings and cash dividend for street? And can you comment on both of those things, you clearly don't need capital to grow. I'm curious as to why we're not being more aggressive now in getting this lawsuit is settled?

Certainly, the Aetna lawsuit just got settled last week. So, we've had this type of dialogue at our board, which is the appropriate place for us to make these kinds of determinations, I am sure we will discuss that again in our meeting in November. But, you know, where we are at this point is we certainly have enough, you know, cash and we're generating a lot of cash and so, you know, we -- we got, you know, a little bit of debt that we have today, I'm not sure how that kind of plays into the picture, it's another consideration. But we definitely, you know, we don't have big capital needs, you know, we've kind of estimated this year would be around $10 million in Cap Ex and we're not going to hit that number. Next year we don't see, you know, any kind of big change in that area so we will have excess cash in the business and we'll be making the appropriate considerations to determine where we go from here. We still have some room left in our buyback program and, you know, we'll be making those kind of judgments now that the Aetna lawsuit is behind us.

Maybe just as a final comment, it's certainly having debt in the capital structure, I think is very positive -- is very cheap as it relates to the cost of equity. So, just from my perspective, I'd like to see you not pay off any debt but rather increase your buyback and pay dividends.

Our thoughts on that is that the debt is at such a low rate, you know that that's -- that's not a big concern but it's just one of the factors that you weigh in.

Great. Thank you.

Your next question, Jim MacDonald, First Analysis.

Yeah, good quarter, guys, I have two lines of question, if that's okay.

You bet. Go ahead, Jim.

Can you give us a little more on kind of a likely progression here of the Aetna lawsuit after last week? I mean how long do they have to appeal? How would the process go? You know, when will this thing be totally resolved?

Well, my understanding is that, you know, there are some specific things that will take place this week relative to, you know, post-trial motions, pre-- you know, before the judgment is entered by the court but we expect that to happen fairly soon. Then I'm sure Aetna will appeal the outcome of the case. I mean it's their decision, but that would be normal with kind of what we've seen up to this point. And an appeal, like I said in my script, is, you know, is not near the distraction that the actual lawsuit has been, but, you know that process can take a year to two years before it ends up, you know, before an appeals court and in the meantime, the expense won't be that great. You know, there are filings to do and -- and some things that have to be done there by the lawyers, but, you know, just kind of be hanging out there, but for all practical purposes from our perspective, like I said, the jury's findings that line up exactly with how we have discussed this plan and the circumstances surrounding those events, you know, the jury's findings line up exactly with -- with our position and -- and, you know that was a main thing from our perspective.

Yeah. Is there any chance of additional damages or, you know, other than the interest? Like...

Well, I guess, you know, we could appeal the damages, you know, we certainly had -- had argued for greater damage levels than what were provided as an award from the jury. We certainly believe we were damaged more severely than the award we received, but like I said, you know, that -- that certainly wasn't the main thing for us, you know, when you take the $15.5 million and add interest since the breach took place two years ago, you know that could be an additional, you know, several million dollars. We'll also get a couple million back from the legal fees, you know, all in all around $20 million dollars, you know, we want to be back about our business and, you know, we can make a lot more money than that on an ongoing basis with this business. We want to grow the work site employees and keep our operating expenses in tact and -- and make money.

Okay. That's great. And let me move to the worker's comp side. I was -- I -- maybe you can repeat the amount for the quarter, I didn't quite hear it, but looking at the data, it looks like it was, you know, above the levels you've generally been running at for the last couple of years and I'm just surprised to see an increase in the final quarter of your previous plan and maybe you could describe how that happened?

Yeah, I believe if we compare as a percentage of fee payroll, the second quarter this year versus the -- versus the third quarter, now, remember the second quarter included the $2.5 million write-off. So, with the $2.5 million write-off, I don't -- have it backed out. Without that it was 1.39% of fee payroll versus I believe 1.55% in Q3 of this year. So, I think that, you know, that trend, off of the old program, the 1.39, going what we recorded in the third quarter and the new program of 1.55, goes along with what Richard had indicated as far as we expect, but for the fourth quarter guidance, because the third quarter included only one month under the new program I look at the [INAUDIBLE] quarter, obviously you have to look at all three months of that program so we'd expect it to go higher than the 1.55% of non-bonus payroll in the third quarter to get to more of the trend that Richard indicated. If that answers your question.

Let me just say this, before I think all of these one-time items you were typically running in the 1.25 to 1.30% range. So, I want to figure out what happened in the quarter and what is the -- the new guidance, you know, the -- the lower increase guidance? Is it based off of kind of the old trend or where you've been recently? What's the basis of the increase?

In the third quarter of this year we did have some termination costs related to the Kemper contract of about $600,000 or so. So, you do have that amount in your third quarter number. That answers part of your question there.

Out of the basis for the guide of the worker's comp increase...

I think that, Jim, basically the -- the real message to take away is kind of all the craziness in worker's comp is kind of behind us and now in the new program we've got much more stable environment and we've got the one month under our belt. We have the actuaries that have done there thing with. And we're real confident about where we're going on the comp side and the numbers that we -- that we have estimated going forward that Richard went through, including those factors.

Okay. Thanks, guys.

Your next question comes from Chris Gutek, Morgan Stanley.

Thanks, good morning, guys. A couple of quick follow-up questions here on the volume growth drivers. You talk about the attrition being below recent trend. What about the net hiring versus firing within the [INAUDIBLE] part of that trend? How did it trend month by month for the quarter?

Yeah, you know, I keep saying that I can't wait to see three months in a row that go in the right direction, but the quarter had, you know, a month of about even at the beginning, it had a significant down month in the second month of the quarter in August and then, you know, back up some in September. And then up some in October, too, so, you know, hopefully we're, you know, going get the ball rolling here on that front, but again, we're kind of assuming that -- that that is not a positive force in -- in our own planning process.

Fair enough. And then regarding the fall selling campaign, I noticed you guys are much more focused on growth than you were a year ago. What are you targeting for gross additions, work site employees, this year versus last year?

Well, you know, the first step, of course, is to get back to the kind of normal world we live in of selling over 3,000 employees a month and having, you know, 1.5% or so client attrition so that you have a net gain of, you know, in our view, of at least 1,000 employees a month, would be kind of a good base level of performance, you know, averaging a gain of 1,000 employees a month throughout the year. Now, remember we did that throughout 2002, even against a, you know, pretty ugly headwind out there. So, you know,, we think that's a good initial goal and, you know, soon as you hit that, then you set the next goal of exceeding those kind of numbers, but right now the focus is this fall campaign, you know, have a good year-end attrition number, retention number, if you will and, you know, have significant enough sales to have a decent step up to the first of year. I really can't quantify that for you right now because it's just too wide a range of possibilities for going to January 1, but hopefully, you know that picture will come together clearly as we move forward.

Is it too early to tell how the sales is tracking relative to the budget?

No, actually I think that the fact that the sales in September, you know, were -- was actually our first month overbudget in quite some time and -- but, you know that's -- that's a data point of one month, so, you know, we're not, you know, we're real happy about it, but we're not jumping off the deep end, you know, let's get some consistent performance at that level and we're going to have a lot of happy people around here.

Okay, great, thanks.

Your next question, sir, comes from Charlie Ackerman, Sagemore Hill.

Hi, guys, great quarter.

Thanks, Charlie.

Thanks, Charlie.

I was curious on your sales people and seniority. I know you had turnover in the past, but it sounds like they're on track to have a good quarter here.

Yeah, yeah, we're over 60% still on -- on trained sales reps with over 18 months experience. I'm really happy with the tenure and the quality of the sales organization right now and their capability and, you know, I believe our whole effort is to really help them and position them to have a great campaign.

Last year they had so many uphill battles, we changed the pricing system, we had huge increases in healthcare costs, we, you know, all the renewals were a huge distraction for our sales staff. This year, all of that stuff is the other way. We're, you know, none of that is in the way and we are boosting activity to levels that we've never done before. I mean, that was just the game plan and so, you know, everything's on track. We will just see -- see how we do.

And then just one last question: You guys have had fairly low Cap Ex this year. Should we look for kind of the same number going forward? Or do you have extra capacity there before you need to spend more?

We really haven't worked through all the numbers for next year yet, but as we sit here today, we don't know of any other, you know, capital spending need that would be out of line with kind of where we were this year. We have plenty of capacity, we have the -- the infrastructure, both physical infrastructure, technology infrastructure. We're in great shape there.

You know, even as we grow through next year, we're not going to have a lot of corporate staff growth, only the part that relates directly to work site employee growth, you know, which is not a big percentage. So, as I sit here today, we don't feel a lot of capital spending needs, we don't see it's going to change a whole lot.

All right, thanks very much.

And your final question, Jim Janesky, Janney Montgomery Scott.

Yes, good morning. Richard, did you -- did you make a comment about the price -- about -- or you did make a comment about pricing. Can you just talk about that environment a little bit. You said you'd be more "competitive" with pricing. Did you have to adjust your pricing one way or the other in the quarter? And how did you look at that as you're coming into the fall campaign?

Yeah, well obviously the -- the primary components that have been driving the pricing over the last year have been the -- have been the healthcare costs and as -- as now you see as well as everybody else our costs are really trending into a very favorable line that is certainly better than what people are experiencing in the marketplace at large, small businesses are, for healthcare costs.

So, what we have done, for pricing going into the fall campaign and into next year -- we haven't had to increase our allocation near as much because the costs are trending a very favorable line. So, that's what we were referring to and actually even in the worker's comp area as well, you know, to maybe a 12 to 15% increases at the top end, that's very competitive in the marketplace, also. So, we feel like that -- our competitive advantage is -- is in the right direction.

Okay. As you look into your head count in the fourth quarter, staying at 70 -- actually going up a bit in the 75,000 range, do you just -- I mean that's -- that's kind of an odd quarter, I'm sure you agree to get a head count increase and generally people will -- or customers will start off in -- on the new year with a new provider. Are you just, you know, finding it easier in this current environment to -- to convince people to come on board? You know, if I can get a little bit of color there?

Yeah, I mean it's basically we -- we've just had, you know, the numbers turned and start moving the positive direction and both in the sales side, again, I want to reemphasize the case of one month doesn't make a fall campaign, but, you know, we -- we had a very good initial month of the campaign. At the same time, as I mentioned last quarter, I think I told everyone that I -- I was expecting retention to start to come back in line. You know, we still only have a case of one there, but, you know, retention came back within the, you know, under 2% for the month down to 1.6 and that combination, you know that gets us growth again.

And, you know, had a little help from the growth within the existing client base and you add all that up and you get, you know, a bump of about 1,000 employees above what we were expecting from the fourth quarter. Now, we've also anticipated in that number that even though sales continue and retention is good through the quarter, that the new sales wouldn't generally come on until January 1.

Sure.

And so with that factor we're just kind of forecasting right at 75,000 for the quarter.

But you did drop or -- or you don't have in the numbers the thousand-employee low margin contract, right?

Correct.

Okay.

Yeah, I mean if you really take that into consideration that one went out in the third quarter and we've recovered from that and are moving on.

Great, okay, thanks very much.

And that ends your Q&A session, sir.

Okay, we'd like to thank everyone for participating today and we look forward to updating you after a successful fall campaign. Thank you.

Ladies and gentlemen, that concludes your program for today. You may now disconnect.