Insperity Inc (NSP) 2003 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Administaff fourth quarter and year end 2003 earnings call. At this time all participants are in a listen-only mode. If at any time you require assistance please press star followed by zero. As a reminder this conference is being recorded. I would like to remind you that any statements made by Mr. 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 risk factors may cause actual results to differ materially from those stated in such forward-looking statements. The presenters today will be Mr. Paul Sarvadi, Chairman of the Board and Chief Executive Officer; Mr. Richard Rawson, President; and Mr. Douglas Sharp, Chief Financial Officer. I would now like to turn the call over to Mr. Douglas Sharp. Please proceed, sir.

Thank you. We appreciate you joining us today. Let me outline our plan for this morning's call. First I'm going to discuss our solid fourth quarter and full year 2003 financial results. Paul will add his comments about the quarter, and on our plans for 2004; then Richard will discuss our general outlook on trends and our direct costs including benefits, workers' compensation, and payroll taxes; and the impact of such trends on our pricing. Richard will also briefly comment on our retirement services business. I will return to provide financial guidance for the first quarter and full year of 2004. We will end the call with a question and answer session. Now let me begin by summarizing the financial highlights from the quarter.

Revenue per work site employee per month increased 6.9% or $66 over the fourth quarter of 2002, to $1,027 per work site employee for the quarter. This increase in revenue when combined with benefits costs, coming in at the low end of our expected range, were more than enough to offset an increase in unemployment taxes during the quarter. This resulted in a 20% increase in gross profit per work site employee per month to $263, at the high-end of our expected range. Operating expenses for the fourth quarter were $44.3 million, within our expected range, resulting in an operating income increase of 66.1%, to $14.3 million for the quarter. We reported fourth quarter earnings from continuing operations of 32 cents per share. This compares to five cents per share for the fourth quarter of 2002. A highlight on our balance sheet, which I'd like to point out, is an increase of $7.3 million in working capital during the fourth quarter, to approximately $56 million at year end. Now let's review some of the details of our fourth quarter results.

As expected the average number of paid work site employees per month increased only slightly over the third quarter of 2003 to 74,332. The number of work site employees added from client sales during the quarter offset client attrition, while work site employees in our existing client base remained relatively flat. Fourth quarter revenues were flat compared to the fourth quarter of 2002, at $229 million, as increased pricing throughout the year; and the impact of our new pricing and billing system applied to the year end accrued payrolls of substantially all of our work site employee base, offset the 6.6% decline in the average paid work site employee. To clarify the impact of the new pricing and billing system on our year end accrued payroll, remember that we have always accrued for wages earned in December but not paid until January at a higher payroll tax cost. This is due to FICA, FUDA, and SUDA wage limits restarting at the beginning of each year. Prior to the implementation of our new pricing and billing system, we billed for the payroll tax allocation in our fee at a constant rate over the course of a year.

However, the new system accelerates the billing of this component of our fee and, therefore, our revenue to correspond the higher payroll tax cost. Substantially all of our work site employee base was on the new system in December of this year versus only approximately 20% of our base on the new system last year. This resulted in the acceleration of more revenue at the end of 2003. Now looking at fourth quarter revenue by region, the northeast region which represents 13% of total revenue grew by 2%. The southeast region which represents 10% of total revenue declined by 5%. The central region which represents 15% of total revenue was flat. The west region which represents 22% of total revenue grew by 9%, and the southwest region which represents 40% of total revenue declined by 5%. We averaged 226 trained sales reps for the fourth quarter, up from an average of 213 sales reps for the third quarter of 2003, as we continue to shift our focus towards unit growth.

Moving to gross profit, as I mentioned a few moments ago, gross profit per work site employee per month increased significantly; from $219 in the fourth quarter of 2002 to $263 in the fourth quarter of 2003. Benefit costs per covered employee per month was $526 for the quarter, at the low end of our expected range and declined by 5% from the third quarter of 2003, and 2% from the fourth quarter of the prior year. These results were the affect of plan design changes implemented in January of 2003, and favorable changes in the demographics of our plan participants. These demographic changes were the result of our improvement in client selection and risk management standards. workers' compensation costs were 1.57% of non-bonus payroll for the quarter compared to 1.54% in the third quarter of 2003. Payroll taxes including FICA, FUDA, and state unemployment taxes as a percentage of total payroll costs was 6.46% in the fourth quarter of 2003, up from 6.25% in the fourth quarter of 2002.

During the quarter we received an assessment from the State of California for the payment of additional unemployment taxes retroactive to the beginning of 2003 through December of 2003. Prior to the receipt of this assessment we had expensed and paid California SUDA taxes at the unemployment tax rate approved and issued by the state during the first quarter for each of our two PEO entities. However, during the fourth quarter the state claimed that it should be able to collapse our subsidiaries into the original PEO entity which had a higher rate. Although we strongly disagree with the assessment particularly in light of the initial first quarter approval of the SUDA rates by the state, we have conservatively accrued for the entire assessment. In addition we have accrued a fourth quarter SUDA expense at the higher rate. These two accruals resulted in a $4.7 million increase in payroll tax expense during the quarter. We have filed a petition for an appeal and are currently having ongoing discussions with the state. Now let's talk about operating expenses.

Operating expenses totaled $44.3 million for the quarter, within our expected range, an increase by $677,000 over the fourth quarter of last year. This increase in operating expenses over Q4 of the prior year included the following: Compensation costs increased by $4 million, of which $2.2 million was due to an accrual related to our 2003 incentive compensation plan, and approximately $550,000 due to expense associated with our retirement service personnel; which in our new recordkeeping role is offset by approximately the same amount of revenue. Depreciation and amortization costs declined by approximately $1 million, as the effects of certain fixed assets becoming fully amortized more than offset depreciation resulting from this years reduced capital expenditures. General & administrative costs declined by approximately $1.8 million, due primarily to the $2 million reimbursement of Aetna related legal costs from our insurance carrier during the quarter. Emission costs declined by $490,000 while advertising costs remained flat. In the fourth quarter of 2003 we reported net interest income of approximately $229,000, due to interest earned on higher investment balances, and our security deposit with the United Healthcare; more than offsetting interest expense related to the mortgage on our corporate headquarters. This compares to net interest expense of $92,000 in the fourth quarter of 2002. Now I'd like to briefly discuss our full year results.

We reported full year 2003 earnings from continuing operations of $15 million, or 55 cents per share. This compared to a loss of $2.9 million, or 11 cents per share for 2002. Revenues grew 5% to $892 million, as a result of an 8% increase in revenue per work site employee; partially offset by a 3% decline in paid work site employees. These changes were driven by significant price increases passed onto clients in order to match our benefit costs and to regain our profitability. Gross profit per work site employee per month increased 23%, from $179 in 2002 to $220 in 2003; resulting from price increases exceeding increases in our direct costs. Benefit costs per covered employee per month increased 8 percent, from $497 to $537. Workers' compensation costs as a percentage of fee payroll increased for the year from 1.23% in 2002 to 1.56% in 2003. Payroll taxes, as a percentage of total payroll, declined slightly from 7.25% in 2002 to 7.23% in 2003.

Operating expenses increased 4.8% from $166 million in 2002 to $174 million in 2003, and included the following: Compensation costs increased by $8.2 million, of which $5.6 million was due to an accrual related to our 2003 incentive compensation plan. General & Administrative costs increased by only $330,000, or less than 1% over 2002. With Aetna related legal costs totaling approximately $2.6 million, net of the $2 million insurance reimbursement in 2003, compared to $3 million in 2002. Commission costs declined by $1.5 million, consistent with the decline in the work site employees in 2003. Advertising costs increased by $1.4 million, resulting from efforts to regain our growth momentum in the last half of 2003. For the year depreciation and amortization costs declined by $538,000. In terms of operating income, you may recall that our stated objective was to return to our historical range of operating income per work site employee of $20 to $30 per month. The results for 2003 came in at $27 per work site employee per month, representing a turnaround in operating income from only $67,000 last year to $24.3 million this year.

Before we comment on the balance sheet, I would like to briefly update you on our discontinued operations. During the fourth quarter we ceased operations of our subsidiary, Financial Management Services, and recorded all related costs. Therefore, there will be no more expense related to this discontinued operation in 2004. We reported a net loss from discontinued operations of three cents per share during the quarter, and eight cents per share for the full year of 2003. Now I'd like to make some comments on our balance sheet.

Total assets were $348 million, including current assets of $228 million. Prepaid expenses and other current assets totaled $30 million and included the following items: $10 million funded to United Healthcare in excess of our actual costs since inception of the plan two years ago. This surplus increased only slightly from the third quarter of 2003 as a result of United's agreement to lower our funding requirements by $6 million during the fourth quarter due to our better than expected healthcare claim trends. The next component is $7.5 million related to the security deposit with United Healthcare which was refunded to us in January of 2004, along with approximately $700,000 in interest. Finally, $5.1 million relates to the Texas unemployment tax credit which we intend to apply to future state unemployment tax liability. Year-to-date capital expenditures totaled $8.7 million, which included $1.9 million in capitalized software development costs. This is down from over $36 million in capital expenditures in each of the two previous years, when we were investing heavily in our facility and technology infrastructure. Deposits of $40 million consists primarily of the remaining $17.5 million deposit with United Healthcare, and $21 million related to our new workers' compensation program which includes the $11 million in collateral. We ended the quarter with approximately $56 million of working capital, a sequential increase of $7.3 million over the third quarter of 2003, and an increase of $14.7 million over December of 2002. Now I'd like to turn the call over to Paul.

Thank you, Doug. Today I will comment on our successful execution in 2003, including our fall selling campaign. I will also discuss our priorities, key success factors and execution risks related to our 2004 plan. I will finish with some thoughts on our long-term strategy for growth and profitability. The year 2003 was an outstanding year for Administaff in a number of ways. First and foremost, we returned to a level of profitability that demonstrates the excellent business model we've developed. In November of 2002, I communicated our objective to return to a $20 to $30 range for operating income per work site employee per month in 2003. We were successful in reaching this target as the numbers we reported today reflect a $27 operating income per work site employee per month. We improved from just $67,000 of operating income in 2002 to over $24 million of operating income in 2003; which is a record year for the company, even beyond the year 2000, when we were growing at 45% over the prior year. We went from our worse year to our best year in one year.

We've also moved all doubt surrounding our financial strength, which was questioned by some in the latter part of 2002. The increase in working capital to $56 million is also the highest level in our history and demonstrates the magnitude and the speed of our recovery. Although we are proud of the progress we made financially, the non-financial highlights are even more impressive. One example was the systemic improvement we have made in managing and matching price and cost in all three major direct cost areas. The structural changes in our workers' compensation program allow us to benefit from our demonstrated expertise in controlling these costs through safety and claims management. Our information integrity and analysis improvements have increased predictability of cost and our competitiveness in the marketplace relative to the healthcare component of our service. And our complete migration of our client base to our real time pricing and billing system improves our ability to manage and pass through changes in payroll taxes.

We also made strides in 2003 in controlling operating expenses and capital spending and shifting the company focus to a mindset of running volume over our infrastructure as we ramp up growth. We reorganized to align resources with our priorities and key success factors to execute on our five-year plan, and we are already seeing some improvements directly related to this reorganization. We began to execute on our long-term strategy of adding revenue streams and leveraging our client relationships through entering the retirement services business. Another highlight of the year was the stellar performance in meeting and exceeding client expectations, evident in the high ratings we received in our annual client satisfaction survey. In an environment of higher pricing, our people demonstrated real value to our clients and our service offering. Last, but certainly not least, we eliminated a host of legal, regulatory and insurance issues that were quite a distraction for the company. The combination of the financial and non-financial accomplishments for 2003, caused by the effort, commitment, and character of our 1,350 corporate employees was truly impressive.

One other priority for 2003 was to redirect our efforts toward regaining our growth momentum by reinvigorating our sales effort. The progress in this area is best understood by comparing the first eight months of last year with the last four months of the year during our fall campaign. For the first eight months of last year, macroeconomic issues combined with internal pricing challenges, to weigh heavily on attitudes and sales results. We only achieved 60% of our internal sales targets, and averaged only 1,700 employees sold per month during those first eight months of the year. Two of our key sales metrics were at an all time low. Our census, or opportunity to bid, to first call rate fell below 40%; and our closing rate for census fell below 15%. As we looked ahead in August to the balance of the year, we knew that client attrition rates, although improved, were still running higher than historical levels and would create the need to replace as many as 11,000 to 12,000 employees in January. The run rate from sales in the first eight months would only produce 6,800 employees, so we needed to nearly double that number just to offset the attrition in January.

I went into meticulous detail on the last conference call describing the strategy and tactics employed to jump start our sales effort, so I won't repeat myself today. However, the results of those efforts are evident today. Each of the last four months of the year, sales were over 3,000 employees which represented 99% of our threshold internal target. Our census to first call rate moved back up above 40%, and our closing rate vaulted to 25% of census from less than 15%. We implemented some new client retention strategies in an attempt to lower attrition levels for the last four months of the year, and for the critical January and February renewal cycle. The average monthly attrition rate did decline from 2.4% and 2.5% for the second and third quarter respectively, to 1.7% in Q4. This was a good improvement, however, not all the way back to historical levels for Q4 which would be approximately 1.2%. As for the January and February heavy renewal period, client retention levels were better than last year in January, and February looks like it should be better than last year; however, of course, February is not over yet. Although the numbers are an improvement they are still not back to historical levels.

So with both sales and retentions showing significant improvement, we were in fact able to more than offset attrition and grow our paid work site employee count by more than 1,000 employees, from 73,721 paid in December, to 74,857 paid in January. I would like to reiterate, that in my view, we still have a way to go before we are hitting on all cylinders in both sales and retention. The fourth quarter results represent reaching only our threshold level target, however, improvement is steady and solid. Now let's shift our focus to 2004.

Our priorities for this year are simple and straightforward. Our goal is to continue the improvement in sales and retention in order to accelerate our growth back into double digits late in the year. In order to accomplish this we need to sell over 3,000 employees per month, like we have every month since September. Then allowing for some shrinkage between the numbers sold versus the number enrolled, and factoring in current attrition rates, we should be able to grow the base at around a thousand employees per month. As usual we must also consider the possibility of layoffs exceeding new hires, to be conservative, which could reduce this number. Our current read on the economy and job growth is not negative. In fact we see some signs of steady improvement. However, until we see real job growth in our base we will consider the possibility of some downside to this number. We also intend to accelerate growth to this level without increasing operating expenses allowing for a healthy increase in our profitability for the year.

This year we have budgeted operating expenses in a way that future initiatives are tied to exceeding growth and profitability targets. Accordingly, our capital spending will be limited similar to last year. As for market expansion we have room for increasing the size of our sales staff within the markets and offices that we have currently, so we do not plan to open new markets at this time. We do intend to continue to make systemic improvements in providing useful management information this year as a result of the detailed information available from our new approach to pricing and billing. This information combined with service, cost and value information we are formulating, will provide a level of client profitability analysis that we believe will be very useful. Our key success factors for this year are simply to focus on continuous improving in the blocking and tackling it takes to grow and manage the business, and the discipline to hold the line on spending. The risks we face this year, although always present, are greatly reduced from prior periods. Our benefits in workers' compensation programs are healthy and well managed, as Richard will discuss in a few minutes; however, a sudden unexpected significant increase in claims can affect our results. Unemployment taxes are on the rise and can also be challenging. In terms of execution risk on the operations, for a service company the challenge remains: staffing appropriately to balance meeting and exceeding client expectations, and controlling costs.

Before I pass the baton over to Richard, I'd like to conclude my remarks with a few thoughts about the long-term. We have simply never been in a better position to capitalize on our market opportunity than we are today. We have a service offering that is unique and highly valued by our target market. We have a proven business model that has survived and thrived in the face of adversity. We have the financial strength to take advantage of our market opportunity. We have the structure and capabilities to continue to improve our service and increase our competitive advantage. We have the beginnings of new revenue streams to leverage as we grow our client base, and we have the management and corporate staff to execute on whatever priorities we establish. Our strategy is to aggregate the best small businesses in the United States, on the common platform of our unique human resource service offering; and leverage the buying power in order to provide additional valuable services to our clients and new income streams to Administaff. We remain focused on what we believe to be a winning strategy for the future. At this time I'd like to pass the call on to Richard Rawson, our president.

Thank you, Paul. Let me begin by describing our pricing strategy for 2004. This strategy is designed to cover all of the direct cost centers, and produce a level of gross profit per work site employee per month in the $209 to $215 range; while we add significant numbers of work site employees to our base of business. Since, as Paul mentioned a minute ago, our operating expenses should be in the same range as last year, then increasing work site employees will generate more operating income per work site employee per month. We call this our growth pricing strategy. Now let's look at how we expect each cost center to affect gross profit in 2004.

Last quarter I mentioned that the large number of layoffs in this country over the last couple years has left state unemployment tax funds in severe deficits. Many states are increasing wage limits, passing on surcharges, and/or moving employer tax rate to the maximum allowable amount to recover these deficits and to meet ongoing future unemployment obligations. This situation is translating into much higher unemployment tax expense for all employers in 2004. As for statutory rate increases, we have a provision in our contract that allows us to pass on these increases as they are levied. We have now received final state unemployment tax rate notices for about 60% of our base of business. When we compare our weighted-average state unemployment tax rate for 2003 to our expected weighted-average state unemployment tax rate for 2004, we should experience about a 55% to 70% increase in these rates. Last quarter I also mentioned that we had built in estimated increases into our pricing allocations for 2004 to cover these costs.

So far our pricing changes for new and renewing business are in line with these increases. If, however, any state levied a retroactive rate change then we could be facing additional expense. The settlement of the state of Texas unemployment rate issue in 2003 created a significant surplus for us in the payroll tax cost center, that will not exist in 2004. Therefore, we should experience some reduction in the gross profit to work site employee per month coming from this particular cost center. Now let's discuss a more positive topic, that being our workers' compensation insurance program results.

After four months ended December 31 of '03 the number of claims incurred is down 12% from the same period last year. The expected cost of these claims that have been incurred is up about 13 percent, reflecting a higher cost of the medical component of a workers' compensation insurance claim. This implies that our ultimate costs could be in line with our prior policy expense. However, this information is still very preliminary, which is normal for workers' compensation claims that are only four months old, since some claims stay open for as long as seven years. Therefore, we will maintain our conservative estimates of a 12 to 14% increase over the payroll run rate that we experienced in the prior policy, which was 1.35% of fee payroll. Since we began increasing our allocations to cover these costs increases last summer, we do not expect to have a deficit in this cost center for 2004. The next component of our pricing strategy deals with the matching of benefit allocations to their costs.

Throughout 2003 we experienced better than expected results in eliminating the deficit from this cost center by increasing our pricing allocations and implementing some cost containment strategies. In addition to just raising our allocations across the board, we also implemented an age, gender, SIC code modification factor to our base rate. This feature, which was initiated in April of 2003, is allowing us to more accurately match the pricing with the cost on a client by client basis. One of the reasons that our costs were lower in 2003 was because we made health plan design changes back in January. Some of the changes included increasing deductibles, increasing co-payments, and the creation of a low cost, hi deductible plan option. By the end of 2003 approximately 4.5% of the plan participants had migrated to this plan from a higher cost plan. Another one of the reasons that our healthcare costs were lower in 2003, was because we adjusted our pricing allocations to allow participants to move from higher cost PPO options to lower cost HMO options. At the start of 2003, 58.2% of our participants were in the PPO option; and by year end that number had declined to 55.8%, while HMO participation increased from 41.8% to 44.2% by year end.

Another reason that our healthcare costs were lower in 2003 was because we eliminated prospects with less than five eligible participants and we made the decision not to renew any customer with less than three participants. The last reason that our healthcare costs were lower in 2003 is because our administrative fees paid to United Healthcare were reduced beginning in the fourth quarter. Now for 2004 we continue to expect the cost of claims to trend upward at a rate of ten to 12 percent, which is in line with national averages. However, we expect to see some continuing benefit from the demographic changes that I just mentioned, resulting in an effective cost increase in the 8% range over 2003. Therefore, we will only have to pass on nominal increases in 2004 for renewing customers to break even in this cost center. Now I'd like to shift gears and talk about our new retirement services recordkeeping business.

As many of you remember, we had a multi-year, I'll call it, technical discussion with the Internal Revenue Service, that focused around the topic of how 401(k) and other retirement plans would be delivered and administered by PEOs. In April of 2002, the Internal Revenue Service issued revenue procedure 2002-21; and in November of 2003, they issued revenue procedure 2003-86. Both of which described how we would be able to provide this extremely valuable benefit to work site employees and their families. After many months of research and business case analysis we determined that it would be beneficial to the company, it's shareholders, it's clients, and it's work site employees to create a 401(k) recordkeeping business, in conjunction with the conversion of our old retirement plan, to comply with these new IRS revenue procedures. On October 1, 2003, we took over the recordkeeping responsibilities and I am very pleased to report that we were in full compliance with both revenue procedures by December 31, 2003, which was the deadline.

That process involved converting one plan covering over 23,000 participants with over $400 million in invested assets to one corporate plan, one terminating spin-off plan, 11 proto-type plans, and one amended 401(k) plan with about 2000 sub-plans. For the first three months of operation we achieved break even operating results, but had about $300,000 worth of non-reimbursable expenses. Under ERISA, an employer is prohibited from making money from any benefit that is offered to an employee. However, in 2004, because we established a recordkeeping service we now have the opportunity to make money on clients and participants that leave the PEO/co-employment relationship. While we do not expect to add additional profit from this new business in 2004, revenues will continue if clients leave the PEO relationship and allow us to continue to provide recordkeeping services for a fee. We already have incurred most of the expense to provide this service, therefore, it's just a matter of increasing the volume. At this time I'd like to turn the call back over to Doug.

Thanks, Richard. Now let's discuss guidance for the full year and the first quarter of 2004. Let's begin with work site employees. As Paul mentioned, we expect to grow at an average of 1,000 per work site employees paid per month. However, to be conservative, we have budgeted a range of 700 to 1,000 per month. Based upon our starting point of just under 75,000 work site employees paid, this would result in a decline in the first quarter year over year comparison and would accelerate to double-digit unit growth by the fourth quarter. This translates into a 5% to 7% growth in average work site employees paid for the full year. Based upon the pricing and direct cost trends, just mentioned by Richard, we expect the full year 2004 gross profit per work site employee per month to be in a range of $209 to $215. Now let's discuss the quarterly trend expected in this metric.

The best way to understand this is to look at our clients as two separate groups. The base of work site employees on our new pricing and billing system at January 1, and new employees sold and paid subsequent to January 1. As we have previously discussed, substantially all of our work site employee base at January 1, 2004, was on our new pricing and billing system. For this group of work site employees the system accelerates billing of the payroll tax allocation in our fee to correspond to the higher payroll tax cost early in the year. So the gross profit per work site employee throughout the year will be relatively constant and approximate the full year metric, except for any pricing change at renewal for these clients. However, billings for work site employees enrolled after January 1 of each year are similar to prior years in which the payroll tax allocation in our fee is billed ratably over the remainder of the year, while the payroll tax cost is incurred as work site employees earn their wages up to specified wage levels. In other words the historical earnings pattern, which use to apply to all of our business; now only applies to new business sold throughout the year.

Now let's look at how the second group of work site employees, related to new business added, will affect this gross profit metric on our entire business each quarter of 2004. Initially new business has a lower gross profit than our base in the first three months paid; approximately the same as our base in the next three months and higher than our base thereafter. Therefore, adding a constant rate of work site employees from new business over the course of a year would result in the first and third quarter gross profit per work site employee to be relatively in line with the full year metric while the second quarter would be $5 to $10 per work site employee lower, and the fourth quarter would be $5 to $10 per work site employee higher. Now moving to operating expenses. With our continued focus on operating expense control we have budgeted a flat to 2% increase in operating expenses, resulting in a range of $173.5 million to $177.5 million for the full year. The high-end of this range assumes a higher incentive compensation accrual upon achieving the high-end of our work site employee in gross profit per work site employee targets.

For the first quarter we expect operating expenses to be in a range of $42.5 million to $43.5 million, and increasing by approximately $2 million during the second quarter of 2004; for expenses associated with our annual sales and client conferences and our incentive sales trip. We assume net interest expense of approximately $150,000 for the year, and $70,000 for the first quarter. A 39.5% tax rate, and as of today, we have 27.5 million shares outstanding. Last but not least, our capital expenditure budget is approximately $10 million. Now I'd like to open the call up for questions.

Ladies and gentlemen, if you wish to ask a question, please press star one on your telephone. The first question comes from Josh Rosen with CSFB. Please proceed.

Thanks. Just to follow up on the unit growth trends. First on the sales channel side if you could comment a little bit further about where you are having the most success relative to the variety of sales channels that you have? And then second, you had commented in the past about changing the way that you went after renewals; and if you could comment on the impact that has had on your business that would be helpful.

Sure, Josh. We had very good improvement in the fourth quarter, in both the sales and the client retention metrics; as I mentioned. The key things to note, of course, are the closing rates going up to 25% from 15%; it really means that things are the way they need to be from, in terms of bringing on the appropriate amount of business for the dollars we spend and the amount of effort that it takes. I really can't point to a single particular channel. It was more accomplishing all those things I talked about last quarter, in terms of getting the attitudes right, getting the pricing right, and getting the total sum of activity up to a certain level that we would produce a more normal sales result for us; which is up to that one sale per salesperson per month type metric. That's the one that's real important to keep the ball rolling. So we are showing some steady improvement there.

On the retention side, we did several things related to who actually followed up to do the renewals, so that we could remove that distraction from the sales staff and, of course, you have a double benefit from that in that the salespeople could place their time out selling new business; and we had the been of--of course there was some training to do and teaching to get these other folks inside our organization to manage the renewal process, but that turned out to be effective and I think that can be a good improvement in the processes internally going forward.

Okay. Just to follow up on a few of Richard's comments on the pricing side, is there any way, I know to put all the pricing together in one basket is a difficult thing to do; but can you talk what a typical or a standard client might see as far as pricing increases go, '04 over '03 as you look at renewals in '04?

Yeah, Josh. The only area that we see that will have any increase to it is in the area of healthcare, and as I mentioned in my prepared remarks, they are going to be seeing nominal increases there. We are expecting kind of a net trend of about 8% or so. So if you look at the allocation component for the healthcare piece, it should go up nominally; but it shouldn't go up a lot of. Certainly much more in line with what people would be expecting. On the workers' comp side, we are still seeing obviously some increase there. Not because of the number of incidents that we had, but just because of the healthcare component of a workers' comp claim. So 10 to 12% there would not be unreasonable in that allocation. And then last, but not least, on the unemployment side everybody is seeing more than 55 to 70% increases in their state unemployment rates, kind of across the board, so that would not be an unreasonable amount either. So when you put it all together there will be nominal increases and we really expect to see customers continue to renew at those kind of rates.

Josh, one good way to look at it is our billing is-- total gross billing is around $5,000 an employee, just using some round numbers, the actual numbers are in the release; but gross paid being around $4,000, that means the mark up above payroll is about $1,000. If you take an 8 or 10% increase on the medical component, a little bit on comp, you are still--and even with the unemployment, you're still looking at, for a typical customer, maybe $40 or $50 increase on that $1,000, 4 to 5%. So we think in the aggregate that's going to be easily tolerable, and maybe could even leave some room for us to improve margins; once we get our volume up to where we want to be.

That's very helpful, Paul. Thanks, guys.

The next question comes from Randy Mehl with Robert W. Baird.

Good morning, Paul, Richard and Doug, and congratulations for a very nice year. I wanted to--and thanks for the detail here. I wanted to follow up on a couple of those details. First of all, the seasonality, trying to understand that. How are benefits costs expected to trend throughout the year? It seems like you're expecting, you mentioned an 8% annualized type increase, so we could assume something along the lines of a couple percent a quarter. But if that's the case, shouldn't we expect that to sort of eat into the unit GP from Q1 down to Q4 and, if not, how are you putting in escalaters related to the benefits cost?

Yes, well, when we look at--you're correct about a sequential increase year-over-year, or sequentially on a quarterly basis on the cost side because that's just kind of how it happens. In terms of our pricing, we have been certainly in good shape in that category and actually if you look at the fourth quarter results, our benefits costs were at the low end of our range. So we don't have to do a lot of step up increases to make sure that we are covering that cost category. So I think it's going to be fairly nominal that you will see the increases in the cost, and we will be able to obviously pass on the pricing to match that as we go. Renewal business is one category, then you've got new business of course; and they didn't have anything to compare to so they are starting out fresh with us and we are able to price those effectively for the next 12 months.

Right. So it's the renewal business where you are obviously able to pass on the higher costs associated with benefits, I'm sorry, the new business, I don't know if I said renewal, and that's going to offset the renewal business. Then that's going to offset the renewal business, obviously, unit cost just being higher there.

Sure, because remember we always look at the experience with the customer. So renewing business is a lot easier to hone in on what the expected increase is going to be for them, because you've got the pass of the current pass that we have the detail on.

Then on the workers' comp., could you repeat what that, I think you told us what you expected workers' comp. to be for the year. What was that number?

That was, in looking at our run rate last year of workers' compensation cost as a percent of fee payroll, it was about 1.35% for the full policy year. And what we said was that we were going to continue to maintain our conservative estimates of about a 12 to 14% increase over that for 2004. But the early returns of the day would seem to indicate that we could be better than that, but we are not ready to go there yet.

Thanks very much. I appreciate it.

The next question comes from David Farina with William Blair. Please proceed.

Good morning. A question on your administrative product that you could potentially offer. If I did my math right, let's just say we roll in healthcare costs, SUDA, unemployment and your other costs. Let's say it comes to $700, give or take. Would that imply that administrative stuff, HR, blah, blah, blah, is roughly $300 per month, am I doing my math right?

No, I think you have some math not working in your favor there but I mean-- you really ought to look at our gross profit, of about $220 last year, we are anticipating $209 to $215 this year. And your operating expenses last year were around, we ended up with a $27 operating income per employee.

Let me ask a different question, then. How much are you getting roughly for the administrative side of things per employee?

That's what you would see in the coming out near that gross profit number. Actually, though, the way we work the business, David, as we talked about few times before; we look at each of these cost centers and we price in with an intent of having either a surplus nor a deficit in those areas, but you do on a want to budget conservatively and try and make sure each of those cost centers comes out ahead. When that happens then your entire service fee becomes that gross profit number.

Fair enough. I can probably work that out. Is there a business out there, I know some people are talking about an ASO type of model. Are you guys ever heading that way, or is it something that might happen for clients who were once getting the whole PEO service, or is it kind of something you don't know about?

Let me explain where our head is at on that. We believe we've demonstrated that this particular model using the co-employment structure in the PEO business, provides the most value to a client and offers us the best opportunity for our profitability. So we are very happy with the co-employment model. It works for our target customer. Our target customers are the best small businesses in the country, they are people with a definitive game plan to improve their business, they are not just cost type buyers, they are trying to improve their company and they really connect to the role people play in their business. They are heavy users of the HR services that they are able to access through us and so it's a fit between charging an appropriate rate and having the higher operating cost to deliver a deeper, more comprehensive service. So we are very happy with that model and we believe there is 400,000 to 600,000 clients that fit that model out there. We only have less than 5,000 today so we have plenty of room to grow it.

Now, however, at the same time it makes sense, you bring in people into this model and because it's a small business community you are going to have 20% or so turnover, 75 to 80% retention year over year. It would be nice if you could add some other products and services that can create an ongoing revenue stream on those that leave. That's what you are seeing on the retirement services opportunity that we have. We already absorbed the acquisition cost of that customer to come into the PEO. When, and if, they needed to leave us; holding on to that revenue stream is a great way to go. So you may see us move more that direction with other things. We even have the other marketplace that's still out there, just slightly more than covers it's cost these days, so that has great potential to do the same thing. So I don't see us gravitating away from the PEO model and the co-employment model, but we do anticipate adding some other services that will allow us to increase our gross profit.

Thanks, Paul.

The next question comes from Jim Macdonald with First Analysis. Please proceed.

Good quarter, guys. On the healthcare surplus can I take it that you had about a $6 million surplus less what was returned in the quarter?

Yes, that's correct. We ended the third quarter with just under $10 million cash funding surplus and that's where we are at the end of the fourth quarter; and, yes, the $6 million reduction in the funding for the fourth quarter really offset the increase. So we had no increase and a resulting surplus balance.

What do you expect going forward? Are we going to have lower funding rates to get that surplus down? What are your expectations there?

Yeah, Jim, this is Richard. We have already had some dialogue with United. They agreed to lower again, for the second time, our funding rates for the first quarter of 2004. And we are looking at a potential lowering of the funding rates for the second quarter depending on how the first quarter results come out. This is a great position to be in and our goal is to try to reduce that surplus down by several million dollars a quarter, over the quarter as we go. Yet at the same time United healthcare is protected because in the event something did go really bad they've still got a $17.5 million security deposit that they could call on. So the relationship is working extremely well. They are pleased. They understand that we don't need to be carrying these huge surpluses, and so they are helping us in that regard.

While we are on the subject, any other plan design changes we should know about that took effect this year?

No. As a matter of fact, we chose at this point in the ballgame not to make any plan design changes for 2004; because we like how the results have come out for 2003. I can tell you that there's some other things going on at the federal government level that we might look at, some changes going forward. But that would be a future discussion that we would have.

Switching to unemployment taxes, Texas has also some big increases. Am I right to assume that you are able to pass those, you think you will be able to pass those through in Texas and then also in California, is that kind of lost, if you lose your case with California, is that kind of lost profitability there that you would not be able to pass through?

Let's break them down one at a time. First of all, the increases that we have already been building into allocations since the fall are, we are fine on those. The fact that we, obviously we had the big surplus left over in 2003, that's the item that would be--unless our results are better than what we are projecting on the comp and the health and the other categories, that's the part that kind of shrinks the gross profit for 2004. But in terms of the situation out in California, Doug and the team took the most conservative route and we booked the whole expense; and if it ends up being less than that we are going to end up having a positive in that area.

One thing you ought to note is that the 2004 rate for California was really not impacted by this assessment. We had priced the California SUDA at the proper rate when we implemented our pricing in the fall of 2003.

So you have the proper rates going forward in Texas and California.

Correct.

Just one other quick one. The benefit in 2003, I guess from the rebate, was that one time benefit that won't be recurring, right, and that was.

That's correct.

What was the number for that, again.

I believe $3.9 million was the credit we recorded from the TWC.

That was just recorded in that one quarter, that was not from quarter to quarter. Is that correct.

That's correct.

Thanks very much.

Ladies and gentlemen, due to time limitations we ask that you limit yourself to one question. Thank you. Our next question comes from Thomas Giovine with Giovine Capital Group.

I have a question regarding the capital plan and working through numbers. If you do--kind of what you are looking at in terms of net income, maybe would be around $20 million plus another $20 of D&A and maybe $10 of cap ex still gives you relatively significant amount of free cash. I guess I've been somewhat frustrated in that why the board hasn't yet approved a dividend. Can you comment on what the capital plan is? We don't need a significant amount of capital in order to grow the business, why have we not seen more activity in buybacks given how cheap the stock price is, or a dividend?

Well, I think I'd like to address that if I could, Tom. That's an issue that the Board of Directors reviews each meeting throughout the year. Certainly we have contemplated the various approaches recently. What we would do with the capital as it builds on our balance sheet. But the mindset of the board essentially is that we came through a pretty tough time there back in '02, we obviously had a dramatic and successful turnaround in a very short period of time. But you don't just jump out and start doing some other stuff before you just make sure all--that you are hitting on all cylinders. We will be contemplating that throughout the year and see what direction we end up.

Okay. Great. Thanks.

You bet.

The next question comes from Jim Janesky with Janney Montgomery Scott.

Yes, good morning. I got off the call for five minutes so if I'm repetitive I apologize. Did you talk about cash and cash equivalents? It looks like--there isn't a cash flow statement, but it looks like it jumped almost $60 million in the quarter from the September quarter. Is that correct?

I believe that is, but some of that is really dependent on how the calendar month ends and the payroll and such. I think one thing you ought to take a look at is just the working capital number, and seeing the increase in working capital from even the third quarter. I believe it was about seven something million over-- working capital for the fourth quarter, $7 million over the third quarter and quite a bit over last year. So. I would focus on that.

Doug, based on your current range that you gave for 2004 in terms of expenses and such, what would you say free cash flow generation should be in a range of for 2004?

I think you probably just ought to start with, if you want to a rough calculation; start with the guidance that we gave for 2004 and do an EBITDA calculation and subtract out the cap ex expenditures that we forecasted for 2004 and that ought to get you close there minus the income tax payments. I don't have the number on hand but you ought to be able to go through that rough calculation.

Okay. Thanks.

And the next question comes from T. J. Marquez with Perot Investments, please proceed.

In both the press release and on the phone here you said that bonuses next year would be paid out on unit growth and gross profit. Is that correct?

Actually in the release it said that the incentive comp plan, with the operating expenses being at the end of that range, that it's in the release and we reinrated today; are dependent on hitting the high-end of our profitability charges.

I guess my question is, why wouldn't incentives be paid on operating profit and not gross profit?

They are. That's what I mean by profitability.

Okay.

Last year you remember the range we gave of the $20 to $30, that's how we structured the incentive comp plan. The incentive comp plan will be similar this year but obviously at a higher range.

Thank you very much.

You bet. Thank you, T. J.

The final question will come from Chris Gutek with Morgan Stanley. Please proceed.

Thanks. Good morning. A follow-up question on the growth expectations in terms of double-digit growth for your work site employees by the end of this year, I am a little confused as to what's expected to drive that growth acceleration. If you are not going to open any more sales offices and you are making pretty tight control on spending, presumably you will have to increasing your advertising spending and you'll have to hire more salespeople. Could you elaborate on that a little bit? Then as a followup, presumably customer attrition rates are expected to come down as well, what are you looking for for attrition and how are you expecting that to come down?

Sure let me be real clear about this. What we've anticipated--if you take 700 to a thousand employees per month added beginning in February and going throughout the year, you are going to get to double digits by the ends of the year. Now, how do you get to the 700 to 1,000? It's pretty simple. I didn't anticipate tremendous increases in the sales side. I basically said, keep selling 3,000 a month like we have since September. Hopefully we will do better but let's just say we only do the 3,000. Let's also assume there will be some shrinkage from the number you sell to the number that actually get paid and that's kind of a normal part of the process here, so we build that in.

If you factor in attrition rate at the slightly higher than historical averages that we've had over the last five or six months, then you would be, have 2,500 or so coming in from these sales and 1,500 or so going away from term. That gives you the thousand a month. Now if you have layoffs exceeding new hires, that could affect the number. Or one of those other two factors not being quite enough, so that's why we ended up with 700 to a thousand. Hopefully we will do quite a bit better.

That's helpful. Thanks, Paul.

You bet.

This concludes our question and answer session. Any further questions may be addressed to Mr. Douglas Sharp. Now I would like to turn the call back to Mr. Sarvadi. Please proceed, sir.

Once again, thank you all for participating today. We look forward to a great year in 2004. Thank you.

This concludes your Administaff fourth quarter and year end 2003 earnings call. Thank you for your participation today. You may now disconnect.