Insperity Inc (NSP) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the 4th quarter and full year 2004 earnings conference call. My name is Michelle and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the the end of this conference. If at any time during the call your require assistance please press star followed by zero and a coordinator will be happy to assist you. I would like to remind that you any statements made by Mr. Paul Sarvadi, Mr. Rawson or Mr. Sharp that are not historical facts are considered to be forward-looking statements within the meaning of the federal securities laws. Words such as outlook, expects, intends, believes, estimates, likely, goal, assume, and similar expressions are used to identify such forward-looking statements and involve a number of risks and uncertainties that have been described in detail in Administaff's filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements. On the line with us today is Mr. Paul Sarvadi, Chairman and Chief Executive Officer, Mr. Richard Rawson, President, and Mr. Doug Sharp, Chief Financial Officer. I would now like to turn your presentation over to Mr. Doug Sharp, Chief Financial Officer from 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 am going to discuss our 4th quarter and 2004 full-year financial results. Paul will add his comments about the quarter and on our outlook for 2005. Then Richard will discuss trends in our direct costs, including benefits, worker's compensation, and payroll taxes, and the impact of such trends on our pricing. I will return to provide financial guidance for the 1st quarter and the full year 2005. We will then end the call with the question-and-answer session. Now, let me begin by summarizing the financial highlights from the quarter. Year-over-year, unit growth accelerated to 9 percent for the 4th quarter up from 6 percent experienced in the 3rd quarter and 3 percent experienced in the 2nd quarter of 2004. Gross profit for work site employee per month of $212 was above our expected range, due primarily to continued favorable trends in our worker's compensation costs. Operating expenses were in line with our expectations with the exception of a 4th quarter increase in incentive compensation, resulting from operating results and client retention, exceeding our expectations during the quarter. We reported 4th quarter earnings of $3.5 million, or $0.14 per share, and full-year earnings of 19.2 million, or $0.72 per share. We ended the year with approximately $47.5 million of working capital. Now, let's review some of the details of our 4th quarter results. The average number of paid work site employees per month increased 8.9 percent over the 4th quarter of 2003 from 74,332 to 80,926, above the high end of our expected range.

Paul will provide further details regarding our unit growth drivers, including sales, client retention, and net growth within the existing client base in a few minutes. Before we further discuss the details of our 4th quarter financial results, remember that the quarterly comparisons of the 2004 and 2003 periods have been significantly impacted by our new billing system which invoices the comprehensive service fee at a higher rate earlier in the year to more closely reflect the annual pattern of employer-related payroll tax costs. Beginning in 2004, substantially all of the client base was invoiced on the new billing system compared to only 20 percent in 2003. Therefore, prior to 2004, our earnings pattern included losses in the 1st quarter, followed by improved profitability in subsequent quarters throughout the year. Now, as for revenues, consistent for increase in the average paid work site employees, 4th quarter revenues increased 9 percent over Q4 of 2003, to $249 million. The 4th quarter revenue per work site employee per month of $1,024 is flat with the 4th quarter of 2003. However, increased sequentially from $998 experienced in the 3rd quarter of this year as additional revenue associated with year-end compensation more than offset the quarterly sequential decline in revenue per work site employee associated with our new billing system. Due to the difficult comparisons to the prior year, for reasons I just discussed, I will report revenue contribution and growth by region when I discuss our full-year results in a few minutes.

Moving to gross profit, as I mentioned a moment ago, gross profit per work site employee per month for the quarter was $212, above our expected range of $205 to $209, as revenue allocations came in as expected, and favorable results were achieved on the direct cost side. As for the components of these direct costs, total benefits, costs per covered employee per month, increased 1.6 percent sequentially over the 3rd quarter, to $580 at the high end of our expectations. Approximately 72 percent of the work site employee base was covered by our medical plans during the 4th quarter, resulting in a cost of $418 on a per work site employee per month basis. Worker's compensation costs were 1.28 percent of non-bonus payroll for the quarter which reflects the favorable experience in both the frequency and severity of claims that Richard has discussed throughout the past year. Richard will provide further details regarding our claim experience and the impact of these 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 declined to 6.17 percent, in Q4 2004, from 6.46 percent in the 4th quarter of 2003. As you may recall, prior year's expense reflects an accrual related to the California unemployment tax assessment of 5.6 million or .52 percent of total payroll costs. Now, let's talk about operating expenses. Operating expenses totaled $46.1 million for the quarter, approximately 1.3 million above the high end of our expected range.

This variance was primarily attributable to a 4th quarter adjustment to the incentive compensation accrual related to the improved operating results and work site employee retention achieved during the quarter. Operating expenses on a per work site employee per month basis decreased from $195 in the 4th quarter of 2003 to $190 this quarter. As for the details, compensations costs increased by approximately $1.3 million or 5.7 percent over the 4th quarter of 2003, resulting from a 2.5 percent increase in average pay, $600,000 less capitalized internal software development costs, and an increase in incentive compensation of $175,000 over the 4th quarter of 2003. Depreciation and amortization costs declined by $700,000, 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 increased by approximately 1.8 million over the 4th quarter 2003, due primarily to our sponsorship of the Administaff small business classic professional golf tournament, and a shift in advertising costs from the 3rd to the 4th quarter of this year. General and administrative costs and commission costs remained relatively flat. As for interest income, in the 4th quarter of 2004, we reported net interest income of approximately $302,000 compared to $229,000 in the 4th quarter of 2003, due primarily to interest earned on higher investment funds in our worker's compensation program. Now, I would like to discuss our full year results. We reported full-year 2004 earnings from continuing operations of $19.2 million or $0.72 per share, compared to net income from continuing operations of 15 million or $0.55 per share for 2003.

2004 earnings include $8.25 million or $0.19 per share after taxes of proceeds related to a 1st quarter legal settlement with our former health insurance carrier, Aetna. Revenues grew by 9 percent to $970 million as a result of a 4 percent increase in paid work site employees, and a 5 percent increase in revenue per work site employee associated with pricing increases. As for 2004, revenue contribution, and growth by region, the northeast region which represents 14 percent of total revenue, grew by 16 percent, the central region which represents 14 percent of total revenue, increased by 4 percent, the west region which represents 23 percent of total revenue, grew by 18 percent; the southwest region which represents 39 percent of total revenue grew by 7 percent; and the southeast region, which represents 10 percent of total revenue, declined by 5 percent resulting in part due to the attrition of a few large clients as we reported during our 2nd quarter conference call. While revenue per work site employee increased by 5 percent, our direct costs increased by 7 percent, which is primarily reflective of our decision to moderate health care allocation increases over the last half of 2003 and the 1st half of 2004. Accordingly, gross profit per work site employee per month declined by 4 percent from $219 in 2003 to $211 in 2004. Benefit costs per covered employee per month increased 5.7 percent from $537 to $568, while the percentage of work site employees covered under our health insurance plan increased from 70.7 percent to 71.1 percent. Worker's compensation costs as a percentage of fee payroll declined for the year from 1.56 percent in 2003 to 1.35 percent in 2004. Due to lower costs associated with the improved claim experience, and $4.5 million in charges during 2003 related to a prior policy.

These 2003 charges included a $2.5 million charge related to the write-off of a worker's compensation dividend, and approximately $2 million of contract termination costs in state surcharges on that -- related to that prior policy. Payroll taxes as a percentage of total payroll increased from 7.23 percent in 2003 to 7.41 percent in 2004. This increase was a result of higher state unemployment rates in 2004 compared to 2003, partially offset by a $2.3 million reduction in our accrual related to settlement discussions with the state of California associated with the 4th quarter 2003 unemployment tax assessment. Operating expenses increased only 1.6 percent from 172.8 million in 2003, to 175.6 million in 2004, and included the following. Compensation costs increased by $5.5 million or 6.6 percent. Including a 2.7 percent increase in corporate head count, and a 3.6 percent increase in average pay. Incentive compensation expense declined by 1.3 million, but was offset by 1.5 million less capitalized internal software development costs. General and administrative costs declined by $750,000. 2003 general and administrative costs included Aetna related legal costs and consulting fees associated with the formation of our retirement services business unit and our cap insurance company. While these costs were not incurred in 2004, higher corporate insurance and repair and maintenance costs partially offset the declines.

Advertising costs increased by $1.4 million, due primarily to the launch of our corporate branding and market positioning plan which includes the sponsorship of the first Administaff small business classic professional golf tournament in October of 2004. For the year, depreciation and amortization costs declined by $3.2 million, due primarily to the reduction in the level of capital expenditures over the past two years. Now, I would like to make some comments on our balance sheet. Total assets were $355 million, including current assets of $214 million. Prepaid expenses and other current assets totaled $18 million, including 11 million funded to United Health Care which represents a cumulative funding in excess of actual costs since inception of the plan over three years ago. Deposits of approximately $71 million consists primarily of 52 million related to our worker's compensation program, which includes $13 million in collateral and $39 million set aside for payment of future claims beyond 2005. Additionally, we currently have a $17.5 million deposit balance with United Health Care related to our medical plan. Working capital decreased by approximately $9 million since December 31, 2003, to $47.5 million at the end of 2004, and included the impact of share repurchase activity totaling $17 million and capital expenditures of $8 million. Now, I would like to turn the call over to Paul.

Thank you, Doug. Today, my comments will cover three basic topics. First, I will add some color to the excellent execution we demonstrated in the 4th quarter of 2004. Secondly, I will discuss the solid foundation we have for growth and profitability in 2005, and the assumptions that support our guidance we released earlier today. I will finish my remarks with the big picture view of where the company stands financially, and our recent announcement declaring our first dividend to shareholders. The 4th quarter of 2004 results validate the continued acceleration of our growth momentum, balanced with solid profitability. Our year-over-year unit growth accelerated over the 4th quarter of 2004, from a 2 percent decline in the 1st quarter, to 3 percent growth in Q2, 6 percent in Q3 and then 9 percent in Q4. In December, we achieved our stated goal of achieving double digit growth at 10.5 percent unit growth over the same period in 2003. Now, last year when I set this goal, I said in order to achieve this, we would need improvement in both client retention and sales, and that is exactly what drove these results. Our client retention numbers for the quarter were particularly strong with our monthly attrition averaging 1.4 percent, down from 1.9 percent in Q2 and Q3. Now, although December attrition is historically low, it is important to note September and October were 1.5 percent and November 1.3 percent. This demonstrates a 4-month trend of retention numbers back to pre-2001 levels. Our retention has been improving throughout the year. In fact, client attrition has been a smaller percentage in 9 out of 12 months of 2004, compared to the 2003 period.

This trend is consistent with an increase we're seeing in client satisfaction survey results as well. Satisfaction is measured every month through an online survey of clients in the 6 months of their current annual contract period. Now, the percentage that indicated they're either completely satisfied or mostly satisfied with Administaff services increased from 82 percent on average 2003 to 87 percent for 2004, with the last three months of the year at 86, and 91 and 90 percent respectively. Several other data points in the survey validate the value of our service to clients and the excellent service our teams are providing. 90 percent of the respondents agreed with the statement Administaff is a good value for the price. 93 percent indicated they plan to renew their contract next year. And 90 percent said they would recommend Administaff to other business owners. These are the kind of numbers that drive retention. Growth within the client base was nominal for the quarter. New hires within existing clients added over 500 employees in October, but was basically a wash for November and December. So the primary drivers to our growth and paid work site employees was our improvement in retention and the sale of new clients from prior periods that were enrolled to pay 50,000 in Q4 of 2004. Another area of successful execution in the quarter was our fall sales campaign. It is particularly important to have a successful campaign to offset the year-end attrition of clients that is a seasonal factor in our business. We exceeded our fall campaign goal with sales of over 16,000 work site employees in the September through December period.

Sales for the quarter were 23 percent higher than the same period in 2003, with the same number of trained sales personnel. This is a 23 percent improvement in our key sales efficiency metric, the number of sales per sales person per month at an average size client of 13 employees. This metric increased from 1.23 to 1.51 sales -- per sales person for the quarter. For the full year, sales efficiency improved by 17 percent as the number of sales per sales person per month increased from .79 to .93. Now, part of the success for the quarter and the fall campaign was our improvement in our middle market sales of clients with greater than 100 employees. In Q4, we sold 9 accounts totaling over 1,500 employees. This brought the total for the year to 19 accounts and approximately 3,000 employees, compared to only 3 accounts and 500 employees in all of 2003. Three of these middle market accounts sold in Q4 were directly attributable to the availability of flexible spending accounts. The introduction of flexible spending accounts and healthcare savings accounts was successfully implemented in the 4th quarter and clients are now taking advantage of these new alternatives. You may also recall one of our priorities and a key success factor for the fall campaign was to increase the activity that leads to sales, including first call, and census or opportunities to bid on qualified prospects. I reported last quarter, we had an increase of more than 20 percent in both of these measures in the 3rd quarter.

And we were able to capitalize on this increase with a closing rate in the 4th quarter of over 27 percent. Now, the emphasis on meeting a specific standard for first call's and census activity did work against one of our goals for the last half of the year. We set the target to begin to grow the sales staff by 5 or 6 trained reps each of the last two quarters of the year. However, by eliminating those individuals unable to meet the activity standards, the number of trained sales personnel was trimmed in Q4 to an average of 225. The good news is the activity and sales increases we experienced were accomplished by this smaller number of sales people. The bad news, however, is we're starting the new year at a lower number than I would like, so increasing this metric will be a priority throughout 2005. Another contributor to the activity improvement was an increase in the number of corporate generated leads from our marketing effort. First call was increased by 8 percent over the prior year and the quality of those appointments also improved as demonstrated by an 11 percent increase in the number of census from those calls. These improvements were the result of the launch of our new brand development program and our television advertising highlighting Arnold Palmer as our company spokesperson. Now, I would like to shift gears from Q4, and discuss why we're so energized about 2005, and explain what's behind our guidance for the year. First, the solid improvement in the basic blocking and tackling in sales and retention that we demonstrated in the 4th quarter has produced an increase to the base of clients for the new year, which we expect will lead to continuing our double digit unit growth for 2005.

Client attrition for the important January starting point in paid work site employees continued to decline from the peak rate of 7.85 percent in January 2003 and 7.4 percent in January 2004 down to 6.8 percent for January of 2005. This is particularly strong in light of the potential for our new pricing and billing methodology to increase January attrition. Substantially all of our clients were billed at higher rates at the beginning of 2004 and then lower rates over the course of the year to more closely match the pattern of payroll tax costs. In the new system each January, the billing rates go back up to their highest levels, and there was a possibility of shifting even more of our annual client attrition into January. As you can see from the lower attrition rate, this did not occur. When you add the work site employees we enrolled and paid from the sale of new clients in the fall campaign, we reach a starting point for January to comfortably forecast Q1 of this year as the first double digit unit growth quarter for the company since the 4th quarter of 2002. Now, in order to continue this level throughout 2005, we have conservatively budgeted an average net gain of 800 to 1,000 work site employees per month. To hit these number, we need to sell at least the same efficiency as last year for the 221 trained sales personnel that we're beginning the year with in order to enroll approximately 2,500 work site employees per month. We also need to keep attrition down below the 1.9 percent that we have as we have over the last half of 2004.

This level of sales in client attrition produces a unit growth released in our 2005 guidance in our press release, without considering any net gain in new hires within the client base. However, the indicators we've watched regarding layoffs and new hires point toward a good year in the labor market for the small business community. When comparing the 4th quarter of 2004 with the same period in 2003, average bonuses were up 15 percent, and average commissions increased 8 percent. These two factors indicate that business activity and results are quite a bit better than the prior year. In addition, overtime pay was 9 percent of regular pay. So we believe capacity is strained, and hiring more staff is justified financially for these companies in our client base. Our year-end survey of our client base has also added to our optimism. 78 percent of the respondents expected 2005 to be better than 2004. With 59 percent expecting an increase in hiring and 49 percent expecting to increase capital spending. Perhaps the most telling indicator for hiring was in the open-ended question regarding the biggest and immediate challenge facing these businesses. The answer most often cited by these respondents was finding the right employees to fill the jobs. Now, what this indicates to me is that hiring is top of mind for business leadership and they are engaged in the hiring process. Another reason we're bullish about 2005 is our progress in the middle markets.

We intend to continue to add emphasis in resources in this area to take advantage of the infrastructure we've built to serve these clients. As we discussed at our analyst day meeting in November, mid market accounts have a lower gross profit for work site employee than our base business. But contribute very nicely at the operating margin line. When you weigh in the contribution from these accounts, we expect a slightly lower gross profit per work site employee for the year, but a slightly higher operating income per work site employee. With the levels -- with these levels, we expect the unit growth and gross profit per employee, total gross profit is expected to increase at a faster pace than operating expenses in 2005. Now, this leverage is in spite of the addition of $2.2 million in non-cash stock-based compensation expense that is not included in 2004 results. In order to evaluate the increase in net income and earnings per share that's implied in our guidance for 2004 -- for 2005 over the 2004 results on a comparable basis, the Aetna settlement received in 2004 should be excluded along with the stock-based compensation. On this basis, our guidance that Doug will detail in a few minutes implies a range for the increase in net income and earnings per share for 2005 of 20 to 40 percent. Now, I would like to take a few minutes to back away from the details and look at the big picture of our financial position and strategy. Over the last 3 years, Administaff has matured to a new level with a strong financial base, a capital efficient business model, and a positive outlook for ongoing financial performance.

Our strong financial foundation is evidenced by increasing our working capital from approximately zero at the end of 2002 to $50 million at the end of 2004 in spite of using $80 million to repurchase shares, reduce our debt, and improve our core gross profit enhancement opportunities. Over this period, we repurchased 3.5 million shares of our stock at a total cost of $42 million. And we reduced our debt by 7.5 million. Our remaining long-term debt is less than 35 million and is almost entirely to mortgage on our corporate headquarters. We capitalized our captive worker's compensation insurance company over this period with $13 million, and have funded an additional surplus of approximately 15 million. This program is now structured for optimal cost control, and ensures that Administaff and its shareholders will benefit from our ability to select and improve risk in this area. We also committed resources and internal staff and outside advisors to greatly improve our ability to match price and cost, especially in the benefits area. We reduced our risk by increasing the number of carriers from 1 to a nationwide network of 7 carriers, 6 with fixed price contracts. The core healthcare program with United is on a solid foundation, with monthly analysis of accurate, timely claims data, and a surplus of $11 million in addition to the $17.5 million deposit. Since 2002, we've also demonstrated the capital efficiency of our business model. By generating over $117 million in earnings before interest, taxes, depreciation, and amortization, increasing the run rate in this measure to over $40 million per year. This rate is 4 to 5 times the level of capital expenditures needed to grow and develop the business, which is at a comfortable run rate of 8 to $10 million per year.

We also see leverage from our previous capital spending and expansion plans continuing for the next several years. We believe the technology and physical infrastructure we have today can support 2 to 3 times our current client and work site employee base. We also have the national sales and service footprint in place covering over 70 percent of our target market, and the most expensive markets are fully absorbed in the operation. In addition to the strong financial base, and a capital efficient business model, the systemic and foundational improvements we've made in our business over the last three years point toward a positive outlook for ongoing financial performance. Perhaps the most significant for both managing the business and improving performance is the change in our client contracts and the corresponding billing methodology. Which has changed the quarterly earnings pattern for the business. As we demonstrated last year, we now expect positive income each quarter as opposed to losing money every year in the 1st quarter and making our money over the balance of the year. As we did prior to the change. Although sequential quarterly gross profit is still affected by the addition of new business, the underlying gross profit on the client base we begin each year with is much more stable and predictable. The metrics that are now reported at the work site employee level on the entire client base due to this change provides an astonishing level of granularity of the data on the key revenue allocations in our comprehensive service fee.

This gives the company a much more reliable and predictable base of information to confirm price changes have been effective, to identify unexpected or negative trends, and to forecast operating results. So in summary, we have a very strong financial foundation, including carefully and conservatively funding our programs that carry the most risk. We have a business model that is generating significant cash flow to fund our capital needs, our share repurchase programs, and pay down debt. Our unit growth rate is back to double digits, and our ability to manage the business to desired levels of profitability is greatly improved. With this picture of our financial position and our outlook for the future, the board of directors declared the 1st quarterly dividend to our shareholders of record on March 7 to be paid on April 1 of 2005. This dividend of $0.07 annualizes to $7.3 million or approximately 17 percent of our estimated 2005 EBITDA. Since we were incorporated on March 6, 1986, we began our 20th year on March 7th, we also served our first clients in paid work site employees beginning on April 1 of the same year. I can't think of a better way to begin our 20th year than to reward those who believe in and own Administaff. At this time, I would like to pass the call over to Richard.

Thank you, Paul. Today, I would like to update you on the two drivers that affected our gross profit for 2004. They are number one, the growth pricing strategy that we initiated back in the 4th quarter of 2003 and then modified in June of 2004. And number two, the direct cost results for 2004. In addition, I would like to comment on how we incorporated these drivers into our forecast for 2005. In the fall of 2003, we announced the launch of a growth pricing strategy that was designed to stimulate growth. There were two primary goals for this strategy as we entered 2004. One was to regain our growth momentum and the second goal was to produce $209 to $215 of gross profit per work site employee per month. Which was our guidance for 2004. The most visible component of our pricing to clients for both new and renewing business is the benefits allocation, and the mark-up built into our comprehensive service fee above the allocations to cover the cost of worker's compensation payroll taxes and benefits. In order to boost sales and retention, we held the benefits allocation component of our service fee relatively flat on September of 2003, through May of 2004. At the same time, we emphasized and rewarded growth anticipating that this would result in a slight decline in our mark-up. The strategy for the other two components, worker's compensation and payroll taxes, was to increase the work's compensation insurance allocation about 12 percent and the payroll tax allocation was increased anticipating related cost increases. These increases applied to both new and renewing business.

As you can see from our results, this growth pricing strategy was successful in ending our decline in placing and paid work site employees throughout 2003, and returning to a growth trend in 2004 that we've just spoken about. At the same time, we experienced only a slight 2.2 percent decline in the mark-up component of our service fee by mid year. Once we established the unit growth momentum, it was time to modify our pricing strategy to match healthcare cost increases and reverse the mark-up decline. So in June of 2004, we began to increase the annual medical allocation component 8 to 14 percent. We also reintroduced a focus on pricing in the sales organization by improving the residual commission component of the sales compensation plan. We also extended our -- or expanded our internal renewal department and implemented an incentive program for those individuals tied to mark-up and timely renewal of accounts. Over the balance of 2004, this group reduced the 90-day outstanding renewal from 8.67 percent to 3.62 percent. They were also successful in increasing the mark-up component to regain the 2.2 percent decline we had experienced in the 1st half of the year. Now, let's shift to a discussion of the direct cost results for 2004. As for payroll taxes, Doug mentioned that state unemployment tax rates went up significantly in 2004 as expected. This was the case for most employers and reflected the high number of unemployment claims of both 2003 and 2004.

The second direct cost is our benefits cost which includes healthcare costs, prescription, dental, vision, life and accident insurance, and disability coverage. At the beginning of 2004, we reported that the cost of health care in the United States, was expected to trend upward at a rate of 10 to 12 percent over 2003. However, because of the cost containment strategies we have employed, including selection, age gender mix and plan design, we budgeted for an 8 percent increase. As Doug just reported, we experienced a 5.7 percent increase in total benefits cost per covered employee for 2004 over 2003. Coming in better than expected. The third direct cost to discuss is our worker's compensation insurance program. Last quarter, I reported that for the policy year just ended in September, we had had an approximate 7 percent decline in the number of reported claims, and an approximate 9 percent lower average cost per claim over the prior policy period. And as of December 31, 2004, both the reported claims and the average cost per claim have remained relatively the same. It is this positive experience that has caused our outside actuaries to lower the estimate of the ultimate cost of these claims. Reducing the ultimate estimate means that we have reduced our reserves which resulted in a reduction to our expense in the 4th quarter. Now, for the current policy, the number of recorded -- reported claims is down 10.3 percent from the claims reported in the 4th quarter of 2003, and the incurred claim dollar amount of those claims is just too new to evaluate at this time.

As these claims are settled and new information about these claims is received, our reserve estimates will continue to be adjusted accordingly. The bottom line is that with the execution of our pricing strategy and the manner that I just described, taken together with our direct costs coming in slightly better than expected, our gross profit per work site employee per month came in in the middle of our expected range at $211 of gross profit per work site employee per month for 2004. Now, let's talk about our expectations for pricing and direct costs for 2005. Last quarter, I mentioned that we already knew what the statutory rates for social security, Medicare, and Medicare tax, and federal unemployment tax would be for 2005, but that we did not have state unemployment tax rates yet. Therefore, we would have to use estimated state rates and build those increases into our pricing for 2005. Now, we have almost all of the state rates for 2005, and I can report that the actual results came in almost exactly on target with our estimates. So we are comfortable that the 8 percent rate increases that we implemented in October of 2004 will be sufficient to match the cost of this cost center in 2005. Last quarter, I also mentioned that we had received final 2005 rates from the 6 carriers that have fixed premium annual contracts. The aggregate increases amounted to approximately 6 percent for these carriers beginning in January of 2005. As for our cost estimates associated with the United Health Care plan, we look first to our actual claims experience on an incurred basis, and then we apply a quarterly trend assumption to that amount to calculate our future health care claims cost. Then we add the forecasted claims cost to the negotiated administrative fee to come up with our total forecasted expense for the United Health Care plan.

We did not make any plan design changes for 2005, which could have lowered our trend assumptions. But we do expect a reduction in the administrative fee. Additionally, we continue to see some migration by employees to higher co-pay, higher deductible plans. So when you combine all these facts, we believe that the United Health Care plan costs should increase about 8 percent throughout 2005 over 2004. Then adding all of the other benefit cost increases together, we should see about an 8 percent increase in the 1st quarter of 2005 over the 1st quarter of 2004 because of the premium step-up from the 6 carriers just mentioned and then stabilize at about a 7 percent increase in each subsequent quarter over the same period 2004. Since we had started increasing allocations 8 to 14 percent in the middle of 2004, we have already partially offset these increases and we expect to offset the balance as price increases meter in over 2005.

As for worker's compensation insurance costs we will continue to conservatively forecast these costs in a range of 1.38 percent 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 favorable claims experience over the last 15 months, and continuing with our current pricing strategy for this allocation, we expect to effectively match pricing costs in this cost center going forward. In summary, our direct costs management strategies and our pricing have produced the good results for 2004, and we feel confident that we can continue this type of performance in 2005. At this point, I would like to turn the call back over to Doug.

Thanks, Richard. Now, let me provide the specific guidance for the full year and the 1st quarter of 2005. Beginning with work site employees, based on a successful fall campaign retaining clients and selling new customers, we expect the average paid work site employees to be in a range of 83,000 to 83,250 for the 1st quarter. Thereafter, as in an average of 800 to 1,000 work site employees each month, will result in an expected range between 86,000 and 87,000 average paid work site employees per month for the full year. Based upon our pricing strategy and the expected direct cost trends just mentioned by Richard, we expect full-year 2005 gross profit per work site employee per month to be in a range of $200 to $204. Now, let's discuss the quarterly trends expected in this metric. As you may remember from last year's discussion, the best way to understand this is to look at our clients as two separate groups. The base of work site employees in January, and the second group being the new work site employees sold and paid subsequent to January 31. For the base group of work site employees in January, billing of the payroll tax allocation in our fee is accelerated to correspond to the higher payroll tax costs early in the year. For the gross profit per work site employee throughout the year will be relatively constant and approximate the full year metric except for the impact of any pricing change at renewal for these clients.

However, for work site employees enrolled after January 31 of each year, 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 earned their wages up to specified wage levels. Therefore, new business added after January 31 has a lower gross profit than our base in the 1st three months paid, approximately the same as our base in the next three months, and higher than the base thereafter. As I just mentioned, expected pricing changes upon client renewals also impact the quarterly gross profit trends. As Richard just discussed, the impact of these price increases should result in slightly higher gross profit dollars in the latter half of 2005, as such increases are implemented upon client renewals. Based upon both the impact of our billing system and the impact of expected price changes on our quarterly gross profit pattern, assuming a constant rate of work site employees are added from new business over the course of the year, the 1st and the 3rd quarter gross profit per work site employee should be relatively in line with the full-year metric, while the 2nd quarter should be 8 to $12 lower and the 4th quarter 8 to $12 higher. Specifically, we expect the 1st quarter gross profit per work site employee per month to be in a range of $202 to $204. Now let's discuss operating expenses beginning with the full year 2005. We have budgeted a 4 percent to 5 percent increase in operating expenses, resulting in a range of $183 million to $185 million.

For the full year. Including stock-based compensation of 2.2 million. This stock-based compensation includes expense associated with any unvested stock options at June 30, 2005, the implementation date of the new accounting guidance, and the restricted shares granted in February of this year. We combined with our 2004 expected -- when combined with our 2005 expected range of average paid work site employees, operating expenses on a per work site employee per month basis are expected to decline from $188 in 2004 to $177 for 2005. Now, as for the operating expense details, salaries and wages are expected to increase by approximately 7.5 percent due primarily to the addition of sales reps and some corporate corporate head count, particularly in the service area as work site employee growth is achieved. With the continued lower run rate of capital expenditures, we expect depreciation and amortization expense to continue to decline from the 17.5 million in 2004 to a level between 15 and $16 million in 2005. As for commission expense, in December, 2004, we restructured our relationship with American Express to discontinue the marketing agreement in which we formerly paid residual commissions based upon the number of work site employees referred to us. Primarily, as a result of this change, we expect commission expense to decline by approximately 6 percent. However, if work site employee unit growth exceeds our budgeted levels, we would not experience the decline at such levels.

Advertising expense is expected to increase between 4 and 5 percent as we reallocate the savings from the change in the American Express commission structure to other marketing efforts. General and administrative expenses are expected to increase slightly. Now, for the 1st quarter operating expenses, this year we will be holding our annual sales conference and incentive sales trip in February. Allowing for more immediate reward of our 2004 sales award winners, also moving these events up from the 2nd quarter will allow for an extended spring sales campaign, which was tested with positive results in 2004. Expenses associated with the conference trip and spring campaign marketing efforts will result in shifting approximately $2.3 million of expense from the 2nd to the 3rd quarter. Therefore, in total, we expect operating expenses to be in a range of 45.75 million to 46.25 million for the 1st quarter. We assume quarterly net interest income between 400 and $500,000, a 38.3 percent income tax rate and 26.6 million average outstanding shares. Finally, we continue to budget capital expenditures at $10 million. Now I would like to open the call up to questions.

Thank you, sir. Ladies and gentlemen, if you wish to ask a question, please key star followed by one on your touch-tone telephone. If your question has been answered, or you wish to withdraw your question, please key star followed by two. Once again that is star, one to ask a question. Our first question comes from the line of Josh Rosen of Credit Suisse First Boston. Please proceed.

Yes, thank you. It's Josh Rosin and Jeremy Davidson from CSFB. I wanted to follow-up on just a couple of points. First, just would be curious as to -- as you've seen increasing sales strength, if you could qualify that a little bit by geography in terms of where you're seeing this trend. Clearly you gave us annual numbers for where growth has been as a whole but would be curious more recently where you've seen some of the sales momentum build?

Well, certainly when have you an increase of this level, 23 percent over the prior year, it is really coming across the board. But Josh, as we've mentioned many times, our success really depends a lot on our district manager, and so when you have 38 offices, you always have offices where -- that are outperforming, some kind of in the middle of the pack, and some where you're working to improve. You can tell from last year and the year-over-year numbers are an area where we've had the most difficulty was in the southeast, and but as far as increasing the units growth on a sales -- on a per sales person basis, it is really been where the managers are having the best results.

And just given the results you reported, is that west -- west coast, northeast, sort of California, the New England and New York area? Is that a fair assessment? Or --

Sure. You know, those markets are a little hotter than the others.

Okay. And then just as you look at bringing more sales professionals aboard, do you have a tangible plan that you could share in terms of how many more trained sales reps you would like to have at year-end '05, or what direction that might take as we move through the year?

Yeah, we want to get up into around 245, 250, at the end of the year. And kind of work our way up to that over the year. A lot of emphasis on that right now in the recruiting area and that's a metric we need to move in that direction.

Okay. But implicit in your guidance is basically the 221 trained sales reps working at sort of where we exited '04 from a productivity standpoint?

Right.

Okay. And the last thing just would be curious with the Sarbanes-Oxley deadline coming from a compliance standpoint, where you stand with those issues, any update there would be would be helpful.

Yeah, things have been progressing very well there, so when we file our 10-K, we will be incorporating the results of the section 404 in our anticipation with respect to the 404 but we're on course there.

All right. Thanks for the help.

Our next question comes from the line of Randy Mehl of Robert W. Baird. Please proceed.

Good morning, Paul, Richard and Doug, thanks for all the detail. I'm trying to reconcile the 1st quarter GP per unit guidance that you provided with the results in the 1st quarter of '04, and I understand, Doug, your comments around seasonality, but I don't think that I would apply as much here, so I guess going back, Paul, to your comments about client mix, how much of the decline on a year-over-year basis should we attribute to that versus other factors?

I'm sorry, what was the decline receipted to what, Randy?

The 1st quarter gross profit per unit expectation versus the 1st quarter of last year.

Right.

And that's adjusting, obviously for the benefit that you got -- the one-time benefit that you got last year.

Yeah, if you -- when you adjust that out, you're right, we're forecasting a little bit lower gross profit per employee for the 1st quarter but most of that is driven more by what Richard commented on, which is you have a step-up in the benefits cost on the 6 carriers other than United, and you have pricing kind of rolling in over the course of the year. You know, we started mid year last year so we got about it half it in. You will get the other half as the year progresses That would be the bigger issue, is basically the net of the cost centers in the 1st quarter compared to last year. Last year was our first year on the new pricing billing system. And so we've got a real good handle now on how all of that flows in.

Okay. So I guess the point there is we should expect those year on year comparisons to improve throughout the year?

Right, right. I would also say, I know you asked about the gross profit line, but at the operating expense line, there is a significant change in the 1st quarter, and that is the movement of our sales conference, the reward trip, and starting our spring campaign earlier this year, as a result of those changes. That is going to shift $2.3 million of operating expenses into the 1st quarter from the 2nd quarter.

Right.

And that's having a dramatic effect down to the -- to the bottom line.

Okay. And then Paul, you also made some -- excuse me, some comments around the FSA, HSA trends, or that you've added that, and it is getting a positive response. I'm wondering if you could quantify -- I mean is this coming from new clients that are coming on? Is this existing clients that are adopting?

Yeah, Randy this is Richard. Yeah, we've had -- specifically, I can't tell you whether it is new ones that have -- that are adopting or renewing customers, but everyone who has had an opportunity to renew in January on the FSA, they had that automatic enrollment. So they were able to come in and we had a nice step-up there. On the HSAs and the high deductible health plan, we've had, I would say, it's probably an expectation of a limited number that have come into that, but I think that's just because it is really the first year and there's still a lot of people that are still asking questions about the program, and understanding it. I think we're going to see an increase in that as we go forward, but it is still too minimal at this point to affect how we forecast our trends and healthcare costs for 2005.

Okay. I'm wondering, if this is an a retention tool, that you think is starting to work, or if this is a potentially just a -- fee generation tool over time. How are you looking at this?

Let me tell you how I'm looking at it, Randy, from what I'm hearing now from the sales staff and in the renewal process, first of all, I did mention three of the mid market accounts we could trace specifically to having the flexible spending plan available. That's a positive, in the past not having one was somewhat of a show stopper early in the process. So just being able to say yes could keep that momentum going. Also, though, what is interesting is for us, it was important to introduce both of those programs together, because a small business client can offer this flexible spending plan in their operations, and individual employees can choose that while the client owner can choose the high deductible health plan, and the healthcare savings accounts. That, I believe, is going to grow. That's the ones that have gone into the high deductible plan so far have been largely people in that position, client owners can't participate in the flexible spending plan, and they're choosing the other. It is a great combination, and really fits our target client base.

Okay. Thank you. That's helpful.

Our next question comes from the line of David Farina of William Blair. Please proceed.

Good morning. I just wanted to ask you a question about your assumptions for next year. In terms of the sales assumptions you are assuming no improvement in productivity to the sales force, no improvement in work site employee hiring, and no reduction in churn. So in all of the assumptions as of December were higher than what you are assuming; is that correct?

That would be correct. You know, we basically are just building in, be conservative and 800 to 1,000 net gain and work site employees, and what you just mentioned is what has to happen to kind kind of hit those numbers.

So if they stay at December levels, I know improvement from that, what would those numbers look like roughly per month?

I would have to run that through. You know, we, at this point in time, I think the safest bet is to look at the guidance for what it is, a conservative outlook, and let's see how things go on those individual metrics.

And then if there were upside in the client numbers would it likely come from middle market which means a little bit of gross margin pressure and a little bit of relief on the operating side or would it be -- could it be anywhere?

It really could be anywhere at this point. I would like to see, and we are certainly structuring for and putting some resources into middle market, but I would like to see both of those move up together ideally. And -- but you're right, the mix is important. It would put a little downward pressure on gross profit but would increase operating income, so we're happy with the way all that's working but it is something we all need to keep an eye on as you kind of project where we're going.

And one last quick question. Can you give us your definition of middle market and what the average middle market client size is? You probably did. There is so much information, I probably just missed it but --

We talk about it as being over 100 employees, but we have customers over 1,000, and we -- we did have a lot of those size customers in this fall campaign but we are improving in the area of how we address those opportunities.

And is the average middle market client close to the 100 level or are they kind of 3, 400.

Yes, more in the probably 2 to 300 range. I would have to go back and look at that.

Okay. Thank you.

Our next question comes from the line of Tobey Summer of SunTrust Robinson Humphrey. Please proceed.

Hi, it's a Tobey Summer. I just had a few questions. Curious about the share repurchasing activity so far in the 1st quarter, if you were able to do any. And I would also like to see if you could comment on what do you think you're actually taking some share from competitors? Although I know your number one competitor is the entrepreneur still doing it internally. And if you could comment on what the payroll data looks like for the 1st quarter in terms of bonuses, overtime and that kind of thing, all looked up in the 4th quarter, and the last question would be do you anticipate the deposit with United inching down this year, and if so, what may the timing of that be?

Let me address a couple of them and I will let Richard address the United relationship. But it is definitely too early to talk about anything we're seeing in the 1st quarter other than the stuff I mentioned about unit growth, so we don't have any -- any comments about that today on the 1st quarter.

Okay. I guess in terms of the share repurchase, our trading window closes at the end of the quarter, so it doesn't even open up until sometime after today, so we obviously we weren't able to do any share repurchases either. In terms of the United Health Care deposit there, I will tell that you we are in -- we've been having some very positive discussions on a number of things, as it relates to our relationship with the United Health Care. And I would -- would just like to leave it at that at the moment and tell everyone to stand by.

And then if you could comment on whether you think you're actually taking some share and getting sort of better volume growth than the market, and maybe you could update us on the share count at the end of the 4th quarter?

Sure, let me -- I'm sorry, I forgot about that question in the middle there on the competition, but my sense is that today is we obviously do run into some other players out there periodically. Over the course of last year, we certainly had customers come back to us who left us in the prior year, and found a significant difference in the service. That allowed us to really gather information from those customers that we've now incorporated into our dialogue in the selling process of both new and renewing business, and it is helping. You know, to have a good group of customers who left and said hey, it is not the same, and someone says they are just like Administaff, only cheaper, don't believe them. So we have done better in that area, but it is something you always keep working on.

Tell me, which share count were you referring to?

Just outstanding shares at the end of the quarter, as you exited December.

I think it is about the 26.1 million.

So it would be the same as the average?

Yeah.

Okay. Thank you very much.

All right.

Our next question comes from the line of Jim MacDonald of First Analysis. Please proceed.

Good morning, guys.

Hey, Jim.

Hi, Jim.

Just to follow up on the last question, you're forecasting a higher share count which seems unusual given your general repurchase activity despite the restricted stock. Any reason for that?

It is primarily restricted stock, and as the stock price goes up, the number of shares from options that you include in that number also goes up, so we're hoping that happens.

But it looks like pretty conservative share guidance from my point of view but -- you paid down some debt. Are you going to pay any more debt down?

Go ahead, Doug.

I mean we will continue to look at the mortgage itself. I think as we had mentioned in our earlier conversations there has been a prepayment penalty attached to the mortgage and when you look at that and the interest rate that we had it didn't make sense at that point in time, we will continue to evaluate that with alternative uses of our cash.

Okay. And could you just give me the attrition number for the full year 2004?

Sure, we had -- when you look at our client attrition customers going away, previously for '03, that number was 71 percent, a little under 71 percent, I believe, and this year, it was around 75.

Retention I assume you're talking about.

Yeah, correct. Retention. That's measuring retention, not attrition, obviously.

Okay. Thanks very much, guys.

Good catch there, Jim.

Our next question comes from the line of Jim Wilson of JMP Securities. Please proceed.

Thanks. Good morning. Was wondering, in the new sales initiative just comparing any changes in pricing actually and administrative fee part level, either renewals or new business in Q4, was there really any change in that your -- in your theory gross profit within the business, anything material?

Well, yeah, I think what Richard mentioned, and I think I mentioned in my script, also, over the 1st half of the year of '04, we saw a decline in what we call the mark-up component, that's the component that we're building in to our total service fee that relates to our HR services we're providing and that number is -- the target number as gross profit at the end of the day, and that mark-up declined slightly over the 1st six months of the year, which was somewhat expected because of the growth pricing strategy that Richard talked about. Now, once we got into kind of the May time frame, we kind of saw what level that was, and adjusted our pricing strategy to put more focus on that, change the commission structure a little bit for sales people on new business, and put in an incentive for renewing personnel renewal department, and they did a great job over the last half of the year and we recovered that 2.2 percent on the base as -- over the balance of the year, so we got back to that starting point. So for '05, we will continue to work on that, and hopefully move that number along.

Yeah, Jim, I think because we -- because we recaptured that margin deficit on renewing customers for new business, they if you were a new customer that had come on in June, you would have seen one set of pricing and you would have seen a higher set if you waited until December to come on, because we had already begun to start increasing our allocations for the healthcare component in the middle of 2004. So all those rates for people that came in, in the 4th quarter as new business were higher than what they would have been if they had come in in the 3rd quarter.

Okay. But the mark-up itself from June till year-end was still similar? Even though the total service fee was higher?

No, you had to move that mark-up up in order to recover that 2.2 percent.

Okay, so you did it that way. Okay. That's what I was wondering. Just one other question. There's been I guess plenty of rumors, discussion circulating about some of your particularly senior sales staff and obviously two or three people went to Jebbe six months or so ago, but more recently any comments on sort of the senior level folks, rumors that have been around that your head of sales had a marketing of -- moved out or been moved out, same thing in California, and maybe just more general comments on what you're doing both senior level and then overall sales staff level as you look to grow the business.

Yeah, we're excite and energized about our leadership in the sales organization. We did make a change that I think is entirely misconstrued by the rumor mill, but in order to increase our emphasis on middle market and also to coordinate all of our activities with our non-PEO sales, which we include retirement services, our marketplace, HR power house, some of the other things we do, and even the general liability insurance that we started to incorporate in the fall and maybe some other things even in the future, personal line, things like that, we asked our Vice President of Sales to take middle market and these other sales areas, John Worth is particularly gifted in developing new things, he was a person who really was our pattern for our district office and our expansion plan. So we've asked John to move over and take those areas. And Jay Minks is going to have all of the regional managers for our PEO sales, non-middle market, are all going to report to him. So we think that is good efficient use of talented personnel, putting them in areas that help the business most, and take advantage of their strengths.

Our next question comes from the line of Tom Giovanni of Giovanni Capital Group. Please proceed.

I was really getting to be worried whether shareholders were going to be able to ask a question. First, guys, congratulations, very well done and a lot of different metrics, and operating and particularly I want to applaud the capital allocation decisions have been great.

Thank you.

A couple of questions. The first is, if I missed this, I apologize but did you talk about any plans for new office expansion either additional offices or new geography for '05 and would you comment as to whether there are no plans to open any new offices this year or is that on the table or where are we with that?

Thanks for the question, yeah, I did not put that in my script today, but where we stand today with the number of trained reps and the capacity in the offices that we already have, we're good to go in those areas for the balance of of the year by just adding staff in those areas, saving the cost of expansion, so we're not going to add any new markets or offices in the budget and forecast plan we have today. Now, things heat up considerably more than what we've got budgeted, at some point we will start to add some new offices in current markets and some new markets but that's more an '06 issue today than an '05.

Okay. And the next question I have, and again, I don't want to breach any sensitivity with United, but I'm just trying to understand kind of the -- why is it necessary to hold 28.5 million with United both with the deposit and with the overfunding. I mean you could buy back 2 million, or 1.8 million shares at the current level, and capital is a very scarce and precious thing, and just --

Well, as you would guess, we don't think they need to be holding that money, either and that's why we're having conversations that Richard alluded to earlier, and continuing that dialogue.

And is that -- can you also just refresh my memory in terms of when is that contract up for renewal?

Well, the contract is an evergreen contract, so it automatically renews from one year to the next.

Okay. Okay. The next question I had, this is maybe a softer question, but with regard to the HSA plan, will -- if you had widespread adoption to HSAs within your client base, I mean from a policy standpoint, from an administration, it seems like a very powerful tool to help drive down health costs, so -- and again, maybe you don't know at this point, but my question to you is, would it change your direct cost structure -- would it change the profitability? I'm assuming if everyone adopts an HSA you're going have a high premium but would what would it do to your profitability if that was widely adopted within your client base?

I'm sorry, Richard you want to go ahead?

I was going to say, yeah, what you would see, is you would first of all, you would see a reduction in our revenues because we're not allocating -- because we don't have to allocate as much to cover costs. So the revenue portion would go down. The expense portion would go down. And theoretically, if you're our customer, you would hope that there wouldn't be any effect on our gross profit.

Right.

So --

I'm curious whether the adoption would actually help your gross profit, but you're thinking it wouldn't change it materially, then?

Yeah, we -- yeah, that's correct.

And just, is there some reason -- is there a policy reason why on your current indemnity plan there is no policy maximum, but with your HSA plan, there is a policy maximum? What's the reason for that? And again, is that a reason to help -- to help drive down premium costs? Or what is the --

You know, I don't know the answer to that. As I sit here today. But I imagine, a high deductible health plan has to be a specific plan to allow for the healthcare savings account.

Right.

And I betcha that design was set by the legislation.

I see. Okay. Thank you very much.

Ladies and gentlemen, that's all we have time for today. Any further questions should be addressed to Mr. Sharp's office. Thank you.

Thank you all for being with us today. We appreciate it. And we will talk to you next time.

Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude the presentation, you may now disconnect. Good day.