Insperity Inc (NSP) 2004 Q3 法說會逐字稿

Welcome to be Administaff third quarter 2004 earnings conference call. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session toward the end of today's conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

We have with us today Mr. Paul Sarvadi, Chairman and Chief Executive Officer, Mr. Richard Rawson, President, and Mr. Douglas Sharp, Chief Financial Officer of Administaff.

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 other 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 differ materially from those stated in such forward-looking statements. I would now like to turn your presentation over to Mr. Doug Sharp, Chief Financial Officer for Administaff. Please go ahead, 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 third-quarter financial results; Paul will add his comments about the quarter, our outlook for the remainder of 2004 and some general comments on 2005; then Richard will discuss trends in our direct costs, including benefits, workers compensation, and payroll taxes, and the impact of such trends on our pricing; I will return to provide financial guidance for the remainder of 2004, and we will end the call with a question-and-answer session.

Let me begin by summarizing the financial highlights from the quarter. Year-over-year unit growth accelerated to 6 percent for the third quarter, up from 3 percent experienced in the second quarter 2004. Strong pricing, combined with lower-than-expected benefit costs, resulted in gross profit per work site employee per month of $202, above our expected range.

Operating expenses for the third quarter totaled 42.6 million, near the bottom of our expected range and relatively flat compared to Q3 of 2003. On a per work-site employee per-month basis, operating expenses declined from $192 in Q3 2003 to $180 per work-site employee in Q3 2004.

We reported third-quarter earnings of 3.6 million, or 14 cents per share, compared to net income from continuing operations of 8.4 million, or 31 cents per share for the third quarter of 2003. These results are not comparable, as 2003 results included the effect of the quarterly earnings pattern of losses in the first quarter and improving profitability throughout the year related to our former billing system, and a 2.4 million and 9 cents per share after-tax credit related to the settlement of Texas unemployment tax rates. We ended the quarter with approximately $50 million in working capital, net of $9 million of share repurchases during the third quarter and $17 million year-to-date.

Now let's review some of the details of our third-quarter results. The average number of paid work-site employees per month increased 6.1 percent over the third quarter of 2003, from 74,281 to 78,817. Paul will provide further details regarding our unit growth drivers, including sales, client attrition and net growth within the existing client base, in a few minutes.

Third-quarter revenues increased 8 percent over Q3 of 2003 to 236 million, as a result of the 6 percent increase in the average paid work-site employee and a 2 percent increase in revenue per work-site employee per month to $998 for the quarter. The Q3 revenue per work-site employee declined sequentially from 1005 (ph) in Q2, consistent with the revenue pattern associated with our new billing system.

As a reminder, the new billing system accelerates invoicing of the payroll tax allocation NRP (ph) to correspond to the higher payroll tax cost early in the year, while the older system invoiced this component ratably over the year. Substantially all of our base was on our new billing system in January of 2004, compared to only 20 percent in January 2003.

Now let's look at our third-quarter revenue contribution and growth by region. Remember the growth numbers are not comparable this year due to the impact of the new billing system, as I just explained. The Northeast region, which represents 14 percent of total revenue, grew by 17 percent. The Central region, which also represents 14 percent of total revenue, grew by 1 percent. The West region, which represents 23 percent of total revenue, grew by 17 percent. The Southwest region, which represents 39 percent of total revenue, grew by 8 percent. And the Southeast region, which represents 9 percent of total revenue, declined by 9 percent, reflecting in part the attrition of a few large clients, as we reported to you during our last conference call. We averaged 230 trained sales reps for the third quarter, which is relatively flat compared to the second quarter of 2004.

Now moving to gross profit. As I mentioned a few months ago, gross profit per work-site employee per month for the quarter was $202. This result was above the high end of our expected range as the result of continued strong pricing and lower-than-expected benefit costs. Due to the impact of the billing system change on our earnings trend and the 2003 Texas unemployment tax settlement, Q3 2004 results are not comparable to the $254 per work-site employee per month reported in Q3 of 2003.

As for the components of our direct costs, benefit cost per covered employee per month increased 3.3 percent over Q3 of the prior year, to $571 for the quarter. Approximately 71 percent of the work-site employee base was covered by our medical plans during the third quarter, resulting in a cost of $405 on a per work-site employee per month basis.

Workers' compensation costs were 1.41 percent of non-bonus payroll for the quarter, down from 1.54 percent in Q3 of 2003. Five-years (ph) cost included approximately $600,000, or 0.07 percent of non-bonus payroll of termination costs related to a workers' compensation program with the previous carriers.

As you may recall, we entered into our loss-sensitive workers' compensation program effective September 1, 2003, and therefore, had only one month of experience under the new program in the third quarter of 2003. Claim experience has developed favorably over the past year, and when combined with lower administrative costs, has resulted in a corresponding reduction in our workers' compensation costs. Richard will provide further details regarding our claim experience and the impact of expected favorable trends on our future costs in a few minutes.

Payroll taxes, including FICA, FUTA and state unemployment taxes, as a percentage of total payroll costs increased from 6.26 percent in Q3 of 2003, which reflects the Texas unemployment tax credit of 0.42 percent, to 6.88 percent in Q3 of 2004. This increase is primarily the result of higher state unemployment tax rates.

As you may recall, during the second quarter of 2004 we reached an agreement with the settlement department of the Employment Development Department of the State of California related to a 2003 unemployment tax assessment from the State. Based upon receipt of written acknowledgment of this agreement we reduced our estimate for the related liability to 3.3 million from the initial $5.6 million assessment.

We reported that this settlement agreement was subject to final approval by other parties, including the California Attorney General's Office and an administrative law judge of the California Unemployment Insurance Appeals Board. Although we received no written response advising us that the settlement offer is unacceptable, the legal department of the California Employment Development Department recently verbally indicated that the amount of the proposed settlement may be insufficient and suggested a settlement amount of 5.2 million. Discussions with the State of California are ongoing, and we continue to believe that the settlement amount of 3.3 million is appropriate based upon the merits of our case and the range of likely outcomes. Therefore, the Company has recorded no adjustment related to this matter during the third quarter 2004.

Now let's talk about operating expenses. Operating expenses totaled 42.6 million for the quarter, near the bottom-end of our expected range. Because we have held operating expenses flat from Q3 of last year while growing the work-site employee base, operating expenses per work-site employee per month declined from $192 in Q3 2003 to $180 this quarter.

As for the details, compensation costs increased by 1.8 million over Q3 of 2003, resulting primarily from a 3 percent increase in headcount, a 4 percent increase in average pay, and a $500,000 decrease in capitalized software development costs.

Depreciation and amortization costs declined by approximately 950,000, as the effect of certain fixed assets becoming fully amortized more than offset depreciation resulting from this and last year's reduced capital expenditures. Advertising costs declined by approximately 750,000 from Q3 of 2003, as approximately 500,000 of advertising was shifted from the third to the fourth quarter of this year. General and administrative costs declined by approximately 300,000, while commission costs remained relatively flat.

As for interest income, in the third quarter of 2004 we reported net interest income of approximately 89,000, compared to 47,000 in Q3 2003, due primarily to increased cash balances in our workers' compensation program. During the quarter, we revised our estimated effective annual income tax rate from 39.5 percent to 37.5 percent, based on the favorable impact of our captive insurance subsidiary on state income tax rates.

To clarify, certain states preclude the consolidation of operating results of captive insurance companies in the computation of state income tax liabilities, as most captive insurance companies report losses. However, as expected, our captive subsidiary has generated profits since its inception which are not subject to certain state income taxes. As a result of the reduction in the estimated tax rate, the Company recorded a cumulative tax adjustment of approximately $400,000 in the third quarter.

Now I'd like to make some comments on our balance sheet. Total assets were 357 million, including current assets of 225 million. Prepaid insurance and other current assets totaled 17.1 million, including 9.6 million funded to United Healthcare which represents the cumulative funding in excess of actual costs since inception of the plan nearly three years ago.

Year-to-date capital expenditures have totaled 4.2 million. This run rate is significantly down for prior years when we were investing heavily in our facility and technology infrastructure. Deposits of 63 million consist primarily of 44 million related to our workers' compensation program, which includes $31 million set aside for expected future claims and $13 million in collateral. Additionally, we currently have a $17.5 million deposit balance with United Healthcare related to our medical plan.

Working capital has declined by approximately $6 million since December 31, 2003, to $50 million at September 30, 2004. Specifically, working capital generated from operations and the first-quarter $8.25 million legal settlement, has been offset by share repurchase activity totaling 17 million, collateral payments and excess funding of our workers' compensation program of approximately 10 million, capital expenditures of 4 million, and estimated tax payments of approximately 5 million.

Now I'd like to turn the call over to Paul.

Thank you, Doug. Today I'll begin with a few thoughts about the recent quarter and the position we are in for a strong finish in 2004. I'll also discuss our fall campaign sales and retention effort that I expect to drive our growth acceleration into double digits as we enter the new year. I will complete my comments with a brief discussion of our 2005 plan (technical difficulty) analyst day meeting at our corporate offices on November 18th.

Our progress in the third quarter was very positive in both financial and non-financial measures. From a financial perspective, we demonstrated strong pricing and direct-cost management, combined with responsible operating expense controls, to produce solid profitability. We also continued to improve the blocking and tackling necessary for future revenue and unit growth.

In the recent quarter, we accelerated our unit growth, achieving a year-over-year growth rate of over 6.1 percent, up from 2.8 percent last quarter. This was accomplished in spite of the soft patch in employment which occurred over the late summer. Our unit growth, measured in work-site employees pay each month, is the result of adding employees from new client sales, subtracting employees leaving due to client attrition, and adding or subtracting the net effect of new hires and layoffs in the client base. The net effect of new hires and layoffs in the client base is a reflection of the employment environment and the overall economy.

During the third quarter, this net number was a positive in the first and last months but a negative 600 employees in August, consistent with the lower-than-expected general employment numbers reported over the summer. This factor contributed to our unit growth falling slightly below the low-end of our range for the third quarter.

The other two drivers, which are much more in our control, showed marked improvement during the quarter. Client attrition averaged 1.9 percent but trended down, from 2.2 percent to 1.9 percent to our targeted 1.5 percent in September. We are also aware today that this improvement has continued into Q4 as employees lost from client attrition was also 1.5 percent in October. I attribute this improvement to the combination of high service satisfaction levels, the implementation of a new renewal process, and an increase in face-to-face client interactions on joint sales and service calls, which I will address in more detail in a moment.

The third and most important factor in our growth is the sale of new clients. As I discussed last quarter, our sales activity for the second quarter was not up to our standard. This issue was corrected in the third quarter. We implemented an activity rebound initiative focusing on what we can control and monitor on a daily basis in order to meet specific activity standards. This program included a progressive discipline program for any salesperson not meeting the standard. We combined this strict compliance standard with an appeal to the sales organization's sense of pride and emphasis on the financial benefit of filling the pipeline prior to our strongest selling season, which we call our Fall campaign.

The goal of this initiative was to increase the two most important lead indicators in sales -- the number of first calls or initial appointments with a qualified prospect, and the number of (indiscernible), which represents the number of new opportunities to close an account. The results were very good. First calls per salesperson increased more than 20 percent over the second quarter and exceeded our standard of 10 first calls per salesperson per month.

Our census (ph) per salesperson per rep followed with a 21 percent increase, and the number of new employees sold -- which, of course, lags behind the activity -- increased 17 percent. This improvement in sales and retention in the third quarter caused us to achieve an important milestone for the Company and played a significant role in building a full head of steam as we kicked off our Fall campaign on September 21.

In October, we paid the most work-site employees in any one month in our history, exceeding 80,500 employees and surpassing our high watermark from August of 2002. This is significant in demonstrating our full recovery from the challenges we faced over the last couple of years. This increase in October also brings our year-to-date average net growth in monthly paid work-site employees up to 691. For the last seven months we averaged a net increase in work-site employee of 761, within the range of our guidance for this metric, in spite of the soft patch in employment during this period.

Now let me remind you that historically, November and December are not growth months for the Company. In fact, the last couple of years we saw a decline in November and December. This is primarily due to the tendency for the pipeline of new sales to generally defer enrollment to January 1st of the next year, and therefore, the new sales do not offset terminations or layoffs in this period. Our fourth-quarter guidance reflects this possibility.

Our efforts now are on our Fall campaign selling and retention initiative and achieving a step-up in growth momentum in January. At our Fall campaign kick-off meeting on September 21, we launched our most comprehensive and targeted marketing campaign in our 18-year history. We are using television, radio, the Internet, e-mail, print, three-dimensional direct mail, telemarketing, alliances, and our most significant business promotion ever to establish our new national positioning message and increase sales.

We are driving home the message of our new byline, small business is good for America and Administaff is good for small business. We are emphasizing the clear, concise advantages Administaff brings to the table for the best small businesses in the country -- administratively (ph), big company benefits, and a systematic way to improve productivity.

We are very excited about this campaign because the message is on point and will be seen and heard by a much larger segment of our target market than ever before. The message is positive and emotional, and delivered by an individual who is highly recognized and respected by a majority of small to medium-sized business owners.

During the third quarter, we began our relationship with golf legend and small-business owner Arnold Palmer as our national spokesperson and integrated him into all facets of our marketing. We are running television advertising on Fox News, CNN, CNBC, MSNBC and the Golf Channel, reaching an estimated 46 million adults ages 35 to 64. This truly represents our first national impression.

As the centerpiece of our national brand positioning strategy, we also held a tremendously successful inaugural Administaff Small Business Classic. This nationally televised PGA Champions Tour event was held in Houston and dovetailed beautifully with our Arnold Palmer relationship. Mr. Palmer's involvement elevated the event, and the event accentuated the Palmer relationship. The impact of the event exceeded our expectations on every level, including client and prospect relationship development, employee and community involvement, and local and national positioning and exposure.

Our Fall campaign also includes radio advertising reaching 1.3 million small-business owners each week through live radio endorsements on the Rush Limbaugh talk show. This relationship also includes banner advertising and Internet lead generation. We are also publishing our third advertorial insert in the city business journals reaching 750,000 leaders in 23 markets. This advertorial is focused on how small businesses contribute to their local community and ties in with the charitable aspect of the Administaff Small Business Classic.

We have also expanded an initiative tested in the third quarter which affects both new sales and client retention. Sales and service teams made joint calls on a small percentage of our current clients to personally thank clients for their business and introduce them to our online referral rewards program. This new site tracks points earned by current clients when they refer new clients to Administaff. Points can be redeemed for a wide variety of rewards from our alliance partners. In the third quarter this process nearly doubled the number of referral calls made by our sales staff.

In this quarter we are personally visiting all 577 clients with more than 10 employees that are renewing in January or February. We are giving each of them a gift box containing almonds and coffee from our client and alliance partner Fresh Success. This three-dimensional direct-mail program was used successfully last year to get appointments (ph) with larger qualified prospects, and we are also using these gift boxes in the same way this year.

There are many more marketing components of this year's campaign that I don't have time to detail on this call, but the bottom line is we are encouraged about the activity and the energy surrounding this year's campaign, and optimistic about both sales and client retention. Assuming tomorrow's election takes away uncertainty instead of adding more to the mix, we should be heading toward a step-up in work-site employees pay in January.

Before I pass the call to Richard to update you on our trends in direct cost, pricing and expense, I'd like to reiterate a few thoughts about 2005 that I mentioned on the last call and briefly outline our agenda for our analyst day coming up this month.

We plan to continue the trends that our now discernible from the last couple of quarters as we move into 2005. We intend to continue to accelerate our unit growth into double digits as planned. We intend to continue to pass along direct cost increases and a small increase in our service fee. This would produce revenue growth in the 15 to 20 percent range. We are also planning to hold our capital spending and operating expense to a relatively small increase over this year, which would continue the recent downward trend on operating expense per work-site employee which was down $12 this quarter and $4 year-to-date for 2004.

One major capital investment we are making is in our Customer Relationship Management software we have recently purchased. This implementation is the last step in a three-stage process to improve client satisfaction and retention. The first two steps -- reorganizing into multidisciplinary teams and re-engineering service processes -- were completed first in order to ensure proper selection of the CRM tools to support our service personnel and our clients.

During the fourth quarter we will begin implementation of this application, and we expect to complete the initial phase of this implementation during 2005. I believe this is a major step forward in our efforts to exceed the expectations of our clients, improve retention and manage costs.

We are holding an analyst day at our corporate offices in our Houston, Texas on Thursday, November 18 from 8:30 AM to 1 PM. At this meeting we will cover our outlook for growth, including our sales and marketing strategy. We'll also discuss our outlook for client services and retention, and provide more details regarding direct costs and opportunities for gross profit enhancement. We will also summarize how these factors role into our overall company outlook for 2005 and beyond. I invite each of you to come and be a part of this event in person and meet our entire management team.

At this time, I would like to hand the call over to Richard.

Thank you, Paul. Today I'd like to update you on the status of our direct cost management strategies and how they have affected pricing for new and renewing business as we have moved through 2004 and get into 2005. As a reminder, our primary direct costs include payroll taxes, benefits cost and workers' compensation cost.

Let's look at payroll taxes first. Employee-related payroll taxes have three cost components. These include Social Security and Medicare tax, or as we call it, FICA tax, Federal Unemployment Tax, or FUTA, and State Unemployment Tax, or SUTA. We already know what the statutory rates for FICA and FUTA are for 2005, but we do not have rates for SUTA yet. That's not unusual, because SUTA is an experienced rated employer tax that is determined differently by each state.

Many state rates are not even calculated until after the end of the calendar year when the employer's experience can be determined. We have to estimate what next year's rate is going to be now so that we can build that into our current pricing strategy. Therefore, again this year, we are using the services of Price Waterhouse Coopers to assist us in forecasting these costs for 2005. Based on their initial analysis, it appears that unemployment tax rates will be going up in 2005, as expected, for most of the states. We intend to continue to build these increases into our pricing for 2005, and feel comfortable that we'll be able to match price and cost for next year.

Our next direct cost to discuss is benefits, which include health-care costs, prescriptions, dental, vision, life and accident insurance and disability coverage. At the beginning of this year, we reported that the cost of health-care in the U.S. was expected to trend upward at a rate of 10 to 12 percent over 2003. However, because of the cost containment strategies that we have employed that effect selection, age/gender mix and plan design, we felt that an 8 percent increase would be more realistic.

In addition, we've had some cost reductions and just minor increases in other benefits that I mentioned, such that through nine months our benefits cost per covered work-site employee have only increased 4.2 percent over the same period of 2003 and less than a half of 1 percent over last quarter. Typically, our fourth-quarter claims costs are similar to the third quarter claims, but since we have been growing in number of work-site employees covered under the United plan, we are forecasting a 1.5 percent increase in claims cost for the fourth quarter over this quarter. As for 2005, we already have final rates from six of the seven carriers. We are currently discussing 2005 administrative fees with United Healthcare, so we don't have final numbers yet.

Regarding 2005 health-care claims trends, we are being told that these costs are expected to increase about 10 percent over 2004. We previously announced that we were increasing health-care allocations in the 8 to 14 percent range depending upon what state the customer is in. Therefore, we feel that our pricing strategy for 2005 should be very acceptable to customers and allow us to manage this cost center appropriately. We are not making any plan design changes for 2005, other than the introduction of the new High Deductible Health Plan offered in conjunction with the Health Savings Account, or HSA.

As we mentioned last quarter, this consumer-driven plan allows employees to set aside tax-free dollars to cover health-care expenses, but insurance coverage doesn't begin until the employee has paid the full cost of doctor, hospital, and pharmaceutical charges up to the deductible of $3000 for an individual and $6000 for a family. Since the insurance doesn't kick in immediately, this new option carries with it a substantially lower premium, which will lower both our pricing and our cost.

Our last major cost center to discuss today is our workers' compensation insurance program. In September, we completed the first full year under our new workers' comp insurance program structure. We successfully negotiated a favorable renewal policy with AIG which includes a 12 percent reduction in administrative costs. Also, there is no additional collateral requirement above the $13 million that we set aside for last year's policy.

Now I would like to discuss our favorable claims experience throughout this past year. Through wise client selection, inspection, safety training and thorough claims management, we had an excellent year. For the policy year ending in September, we had a 6.96 percent decline in the number of reported claims over the prior policy year, coupled with a 9.65 percent lower average cost per claim over the same period. With the decline in both of these early indicators, we anticipate that our total ultimate expense may be lower than our current estimates.

As these claims are settled and new information about those claims is received, our reserve estimates will be adjusted accordingly. For now, we will maintain our last quarter forecast of having workers' compensation insurance costs being in a range of 1.38 to 1.42 percent of non-bonus payroll. Our pricing related to this component of our service fee will continue to be based on client-specific characteristics. Given the stability of our cost and continuing with our current pricing strategy, we expect to effectively match price and cost going forward.

In summary, our direct cost management strategies and our pricing have produced the good results so far in 2004, and we feel confident that we can continue this in 2005.

Now I'd like to turn the call back over to Doug.

Thanks, Richard. Now let's discuss guidance for the remainder of 2004, beginning with the full year.

Although we expect gross profit for per work-site employee to be slightly higher and the work-site employee count to be slightly lower than previous guidance, we expect no change in the bottom-line results from the full-year guidance provided in our second-quarter conference call. Specifically, we expect the average paid work-site employees to be in a range of 77,600 to 77,800, the gross profit per work-site employee per month to be between $210 and $211, and operating expenses to be in a range of 173.7 million to 174.3 million.

As for the fourth quarter, based upon the average paid work-site employees coming in slightly below the third-quarter expected range, and keeping in mind that work-site employees sold during our Fall sales campaign will generally convert into paid work-site employee at the beginning of 2005, we expect the average paid work-site employees per month to be in a range of 79,500 to 80,500 for the fourth quarter, which would continue the acceleration of our unit growth rate to about 8 percent year-over-year. As for gross profit per work-site employee, based upon the strong third-quarter results we have increased our fourth quarter guidance to a range of $205 to $209.

As for operating expenses, you will recall that Q3 results were near the bottom-end of our range, due primarily to a shift in the timing of television advertising from the third quarter to the fourth quarter. Accordingly, we now expect fourth-quarter operating expenses to be in a range of 44.2 million to 44.8 million for the fourth quarter, slightly higher than our previous guidance.

We expect our effective annual income tax rate to be 37.5 percent for both the quarter and the full year 2004. As previously mentioned, the operating results of our captive insurance subsidiary have an impact on our effective income tax rate. As these operating results may fluctuate from period to period, our effective income tax rate in 2005 and beyond may fluctuate somewhat from the 2004 rate of 37.5 percent. Additionally, we assume diluted weighted average shares outstanding of 26 million in the fourth quarter and 27 million for the full year.

Now we would like to open up the call to questions.

(OPERATOR INSTRUCTIONS). Josh Rosen, Credit Suisse First Boston.

It's Josh and Jeremy at CSFB. First I would love if you could just review with us the typical renewal season that you guys go through from a seasonality standpoint, and what retention tends to look like to or attrition tends to look like as you move through the next few months.

Sure, Josh. I would be glad to do that for you. This of course is our period of highest number of customers that renew, from about -- from December 1 through February, the January/February renewal will be -- like I've mentioned, there's 577 clients that have more than 10 employees. The reason for this is that every year we have a Fall selling campaign as customers prefer to come on in January 1 a lot of times. So when you do that year-over-year, you have a lot of customers that come on at that time.

Our general pattern for attrition is to be around 6.5 to 7 percent of our client base going away in January, and then about 3 to 3.5 in February, then 1.5 to 2 the rest of the year. Obviously, when we're down -- when we're at the lower end of those ranges, that really helps surge our unit growth. So that is our objective for this year, is to have a successful selling campaign and a retention period, and see some good unit growth going into next year.

That was very helpful. Thank you. Also if you give review how you guys look at use of cash going forward. I know that you've made some share repurchases. What's left from an authorization standpoint there and what else might you use cash for?

Well, as you mentioned we've been fairly aggressive this year on $17 million in buybacks. We continue to believe that our stock is undervalued and we have a very active (indiscernible) when our window is open to buy shares back for us to continue that program.

As we look into next year, I mentioned our capital spending. We may have some increase over this year, but not in a range that is significant for the Company. So we have plenty to deal with the regular ongoing capital expenditures. So our priority for right now -- we have a little bit of debt, but a lot of that is so low in terms of the interest rate that it makes sense to pay that off. So we continue to believe share buyback is the most effective use of excess cash.

Okay, great. The last question was just relative to the competitive environment. If you could just give a little color on how things have changed from a competitive standpoint, even if you go back over the last three years. And what would be helpful is even a contrast between some of the markets where you're currently experiencing quite a bit of growth, and then as you mentioned you lost a couple of customers in the Southeast that were more significant in size. But the Texas, Florida markets being a little but more penetrated -- if the competitive environment differs there relative to the rest of the country?

The bottom-line to that question, Josh, is we are having a lot of fun out there these days. You go back a couple of years ago when we were going through some difficult times, we had to raise our medical pricing, insurance costs and so forth; our service fees had to go up quite a bit as our underlying costs were occurring faster than the market. But we are certainly not in that position today. Our pricing, matching the price and costs has been very effective. Our strategy to keep costs down on behalf of our clients has been effective, and we are winning lots of customers out there in the marketplace, and we, frankly, are enjoying going head-to-head when that occurs.

I'd like to remind you though that today, with our target market, there really isn't anybody that does what we do for a customer. And although we do run into other competitors out there, fee-per-service providers, other solutions, we still battle (ph) mostly with small to medium-sized business owners seeing this for the first time and trying to decide whether to go this route or continue with the traditional route. So I guess I would generally say that we are in a much better posture from a competitive standpoint when we are in a competitive environment.

Randy Mehl, Robert W. Baird.

Thanks for the good descriptions on the direct costs, Richard, appreciate that.

You're welcome.

I wanted to pursue a couple of items. One, you mentioned the captive, and it seems like there was a contribution from the captive. I am wondering what was the size of that contribution to the P&L in the quarter?

I think we talked about the income tax effect, right?

We talked about the impact of -- during the quarter we finalized our 2003 income tax returns. And at that point we were able to determine the impact of the captive on our effective tax rate. So that is the discussion I went through, is explaining how we went -- the client and income tax rate from 39.5 to 37.5 percent. But when you look at our results and how we report them on a consolidated basis, that's where Richard gets into just talking about the entire program on a consolidated basis. So I guess to clarify your question, if you're thinking that the captive contributed anymore or less in income in the quarter, then that's a little off base. It's really we were just trying to explain the impact of the captive on our effective income tax rate decline.

So it was not a meaningful change in terms of the contribution from the captive relative to prior quarters?

Randy, the effect was just a $400,000 production in our income tax rate. That was a cumulative tax adjustment.

That was a cumulative tax adjustment.

Just switching gears here. On the shift in advertising costs from Q3 to Q4, Paul, I think you explained that is. Was there any change in the timing of the Fall sales campaign overall? Is there a new strategy at work here?

No, Randy. The kick-off was held in the third week of September, like we've had in the past. A couple of differences though. I think that we had a significant ramp-up in activity preceding the kick-off, which is a very favorable thing. We're hoping that has a nice positive effect. But as far as the spending is concerned, it was just -- it was still kind of left open exactly when that some of the advertising would start and would hit. And it turned out instead of being over the last couple of weeks of September we got it through the first couple of October.

Okay. Then looking out longer-term, should we expect your advertising cost to move higher on a per-unit basis going forward, just based on what you're talking about as far as having more of a national reach? Or is this something that you should be able to keep pace on the unit side with those costs?

Right now I think we're fine. I think we're going to see units going up, and that will help drive down that cost per unit. But I think right now what we're thinking is kind of where we end up for this year, which was an increase from last year. It's probably the right range. We did test a lot of new things this year, and many times some of those don't work as well as others; we probably won't renew those, and we'll shift some money into things that work more effectively. I don't see a big -- any continuing increase in that amount as we go forward.

David Farina, William Blair.

Paul, you guys seem pretty optimistic about kind of a 10 percent number next year in unit growth, which would be the highest number we have seen in three or four years. What is it that makes you feel confident enough? Is it the Fall selling campaign? Is it just your advertising, the pricing, everything in line, give us a guidance level that's pretty optimistic based on what we have seen in the last couple of years?

That's a good point, David. And of course what we've executed this year is a real turnaround in that number. We were, remember, declining in work-site employees last year, and in last year's Fall campaign turned it around and saw the numbers start to move slightly up. We were up 2.8 percent year-over-year in the second quarter, 6.1 percent year-over-year in this most recent quarter. We're doing this -- continuing to do the same things we have been doing, and the effect of a good Fall campaign moves you right up to that number. And we're optimistic that we're doing the right thing to make that happen.

And that assumes there's nothing heroic in the economy, right?

That is correct. Like I mentioned in my prepared remarks, there's a little bit of a weird season right here. If you remember four years ago when the election turned into a significant amount of uncertainty, that had a dramatic effect on the economy overall. And that -- uncertainty is our biggest challenge in the sales arena, when business owners and business leadership just kind of clamp down any you have a wait-and-see attitude. We are hopeful that that's not what we're going to see this fall. We certainly know what we have seen up to this point. We've had a nice receptive marketplace, a nice surge of activity. We're comparing very favorably (technical difficulty). So things are great at this point. The other things that can happen -- terrorist attacks (technical difficulty) kind of things can have an effect. But in that case it's affecting everybody.

Fair enough. One clarification for Doug. Doug, if my recollection is right, starting in the first quarter, the comparisons in terms of the new pricing systems should be apples-to-apples, right?

In 2005?

Yes.

It should be more of an apples-to-apples comparison at that point.

Tobey Sommer, SunTrust Robinson Humphrey.

I had two questions. One kind of related to what you were just speaking of regarding the volume growth in 2005. I was curious what proportion of volume growth may be built into your estimate for volume growth among existing customers? So just sort of job growth within the current customer base. And then I was interested, if you could just comment on capacity in your software systems and IT platforms. With respect to CapEx, I know you said some increase in '05, but nothing too extraordinary giving you some firepower for stock repurchases. But if you could comment about that more broadly in terms of capacity. Thanks.

Thanks for your question, Tobey. Let me just explain that (technical difficulty) range, in the low double-digits into the first part of the year, is really just a matter of continuing what we have done and having a little bit of a bump here at year-end. You know, I mentioned we averaged 761 work-site employees, a net gain for the last seven months. That's near the low-end of our 700,000 range. If you continue that on now over this period and you're going to move -- ramp right on up into that range. So we're on track for that.

As far as capacity is concerned, that's kind of the exciting part of the story today. We have plenty of capacity for an extended. Our investments next year and capital spending won't be investing in capacity; it's the normal upgrades on computers and stuff like that. The biggest single investment I highlighted here, in that we will implement our customer relationship management software, which is a significant investment that we expect will have a real nice return for us. And it's very good timing to embark on that initiative. But there is a lot of leverage here. We don't see a lot of increase in operating expense. It would be very modest compared to the unit growth and revenue growth we expect.

Jim Macdonald, First Analysis.

Richard, on the workers' comp, it was up -- the cost was up, I think, a little bit sequentially. Any reason for that? And could you also give us a feel for the 12 percent reduction in administrative fee, what kind of dollars we are talking about there?

Well, let's see. The increase in (multiple speakers) -- yes, I thought it was pretty much flat from last quarter.

In the second quarter, the percentage of non-bonus payroll, I think. was about 1.34, 1.35 percent. We're up a little to the 1.41 percent. So I believe it was in the second quarter where we realized some of the benefit from the claim experience and the frequency of claims that were reflected in second-quarter results.

And the administrative fee reduction in dollar terms?

I'm not allowed to give that specific level of information out due to our contractual arrangements with the carrier.

Let me move on. Do you have any plans to increase your sales force, or are you about at the right level that you want to be at?

We're going to increase the cost next year, and earlier in the year I'd anticipated a very small increase as we move toward the end of this year. But in this last quarter when we implemented our compliance program with -- related to activity standards, you're going to have a little bit of a natural fallout here on that. So we expect the number to stay relatively flat through the end of the year, and we'll start picking that up in the next year, kind of prepared for '06.

How much do you think it might grow?

I haven't pinpointed that yet. We're still putting some of those numbers together. It will be using an iterative calculation of what we need for the following year to be in the double-digit growth, unit growth range, and timed with when we see profitability increasing and going to the bottom-line. So as I sit here today, without pinning the number down, it's probably getting back up into the 250 to 270 range or something like that. We'll pin that down, because that may be one of the things we talk more about at our analyst day meeting.

One more general question. Any thoughts -- we haven't revisited this in a while -- of offering an ASO option like one of your competitors is doing now?

That was an interesting development out there. We're actually seeing stronger and stronger attachment to the Cole (ph) employment model, and we're seeing it produce the results we want for us and that we want for -- that the clients want for them. The other surprise to us was that as we have really gotten some more experience with the larger, what we call our middle market -- from 150 to 1,000-employee client -- we had previously presumed that the Cole employment model might be some kind of detractor for that group. And that has not proven out to be the case at all, not in both the actual interactions we have had and the survey we have also put out. So we want to stay focused and be the very best at what we do, and that is our strategy.

Jim Wilson, JMP.

Two questions. First, I think earlier in the year you were talking about sort of a new strategy or new approach on the service side of adding people in the field. And I was wondering where that stood, unless I missed it earlier in the call, as far as additions or your approach to that, of service folks in the field? And then the second question is I've heard bits and pieces that out of Texas, the health-care environment -- sort of PEO versus non PEO -- had gotten such an environment that you if you were not serviced by a PEO health-care, cost you could get as a small business were actually lower. Could you comment on that a little bit, too?

Sure. I think on the last point, that's kind of always been the case depending on what you're comparing. There really isn't an apples-to-apples non-PEO benefit package available. That's one of the advantages of being a PEO, that you get big company benefits, including all the things Richard talked about. There's not just the health plan by itself, but the medical, dental, prescription, vision, everything from adoption of business (ph) to a 401(k) plan to disability coverage. The entire package that we offer is not really available any other way than through what we provide.

So you can always go, if you're small business, go buy a cheap health plan. They are out there. There's not really been any change in that regard that I am aware of. (multiple speakers)

We have no plan to increase service staff in the field; we actually already have a distributed service environment. We have the four major service centers -- one in the east in Atlanta, one on the west coast in LA, one in the Dallas area that services our (indiscernible) recovery sites, and here in the Houston service center. And we distribute other types of service personnel into the 38 sales and service offices in the markets, in the 21 markets that we (inaudible). So I'm not sure where you got that, but there wasn't any plan to increase that. We have continued to distribute people appropriately where the needs are, but that's really the change from the first of the year.

At this time we do not have time for any further questions. Please feel free to contact Mr. Sharp at Administaff with any further questions that you may have. Gentlemen, do you have any closing remarks?

That'll be it. Thank you all very much for participating. We hope to see everyone at our analyst day on November 18th.

Ladies and gentlemen, thank you for your participation in today's call. This does conclude your presentation.