Insperity Inc (NSP) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen and thank you for standing by. Welcome to the First Quarter 2005 Administaff Earnings Conference Call. My name is Angela and I will be your operator for today. [OPERATOR INSTRUCTIONS] As a reminder, ladies and gentlemen, this conference is being recorded.

Before we begin the Company has asked me to read the following statement. I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson, or Mr. Sharp 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 filing 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 the presentation over to Mr. Doug Sharp, Chief Financial Officer of 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 first quarter financial results. Paul will add his comments about the quarter and on our outlook for the remainder of 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 second quarter and the remainder of 2005. We will then end the call with a question and answer session.

Now let me begin by summarizing the financial highlights from the quarter. Year-over-year unit growth accelerated to 12% for the first quarter, up from 9% experienced in the fourth quarter of 2004 and above our expected range. Revenue per worksite employee per month increased 6% or $67 over the first quarter of 2004 to $1,190 per worksite employee for the quarter. This increase in revenue when combined with benefit and worker's compensation costs coming in at better than expected levels resulted in gross profit per worksite employee per month of $215 for the quarter, above our expected range. Operating expenses on a per worksite employee per month basis declined from $191 in the 2004 period to $188 in the 2005 period. We experienced this decline despite the inclusion of $4 per worksite employee per month related to stock based compensation expense and $11 related to the sales conference incentive trip and spring sales campaign which were not included in the 2004 reporting period. We reported first quarter earnings of $4.6 million and $0.18 per share, a 20% increase in earnings per share over the first quarter of 2004, excluding the impact of the Aetna law suit settlement. We ended quarter with approximately $50 million in working capital up from $48 million at December 31, 2004 in spite of $5 million of share repurchases, a cash dividend of approximately $2 million and $1.4 million of capital expenditure.

Now let's review some of the details of our first quarter results. The average number of paid worksite employees per month increased 12% over the first quarter of 2004 from 74,792 to 83,729, above the expected growth rate of 11% and demonstrating continued acceleration in our unit growth. Paul will provide further details on the drivers of this unit growth acceleration including sales, client retention and net growth within the existing client base in a few minutes. First quarter revenues increased approximately 19% over Q1 of 2004 to $299 million as a result of the 12% increase in the average paid worksite employees and a 6% increase in revenue per worksite employee per month to $1,190 for the quarter.

Looking at first quarter revenue contribution and growth by region, the northeast region which represents 15% of total revenue, grew by 25%. The central region which represents 14% of total revenue grew by 10%. The west region, which represents 24% of total revenue, grew by 24%. The southwest region, which represents 38% of total revenue, grew by 19%. The southeast region, which represents 9% of total revenue, grew by 8%.

Moving to gross profit, as I mentioned a moment ago, gross profit per worksite employee per month for the quarter was $215. Above our guidance of 202 to $204 which conservatively assumed only modest contribution to gross profit resulting from expected favorable trends in health care and workers compensation claims activity. Such trends continued to emerge through the first quarter and therefore resulted in lower than expected benefit and worker’s compensation cost. Richard will provide further details regarding our claim experience and the impact of these trends on our first quarter and future costs in a few minutes. Now when comparing to last year, gross profit results are only slightly down from $223 per worksite employee per month in Q1 of 2004 which included worker’s compensation insurance proceeds of $1.1 million or $5 per worksite employee.

As for the components of direct costs, total benefit costs per covered employee per month increased 6.9% over the first quarter of 2004 to $589, within the range of our expectations. Approximately 73% of the worksite employee base was covered by our medical plans during the first quarter resulting in a cost of $429 on a per worksite employee per month basis. Worker’s compensation costs were 1.13% of non-bonus payroll for the quarter, significantly below the low end of our guidance of 1.37% reflecting the favorable experience in both the frequency and severity of claims trends that Richard has discussed over the past year. Payroll taxes including FICA, FUTA and state unemployment taxes as a percentage of total payroll costs declined to 9.48% in Q1 2005 from 9.50% in the first quarter 2004. This decline was experienced in spite of an increase in state unemployment tax rates as more worksite employees reached their taxable wage limit earlier in the 2005 period due to increased bonus levels and payroll averages. Bonuses per worksite employee increased by 32% and the payroll average of worksite employees increased by 8% over the first quarter of 2004.

Now let's talk about operating expenses. We continue to experience operating expense leverage as we accelerate unit growth over our existing infrastructure and operating expense base. This leverage was demonstrated by a decline in operating expense per worksite employee, per month from $191 in the 2004 period to $188 in the 2005 period. We experienced this decline despite the inclusion of the $11 per worksite employee, per month, related to sales conference, incentive trip, and spring campaign and the $4 related to stock based compensations expense, all of which were not included in the 2004 reporting period. Operating expenses in dollars totaled 47.1 million for the quarter, approximately $850,000 above the high-end of our range. This was primarily due to a $790,000 non-cash stock compensation charge relating to accelerating divesting of employee stock options which occurred subsequent to providing our first quarter guidance. As for further operating expense details; salaries, wages and payroll taxes increased by approximately $1 million or 4.6% over the first quarter of 2004, due to primarily to an increase in the accrual for incentive compensation expense based upon our improved operating results outlook. Our corporate head count has remained relatively flat.

As expected, advertising costs increased by approximately $1.2 million over the first quarter of 2004, due to the shift of our marketing efforts associated with the launch of our spring sales campaign from the second quarter of 2004 to the first quarter of 2005. Also, as expected, general and administrative costs increased by approximately $2 million due primarily to the annual sales conference and incentive trip which had historically been incurred during the second quarter. Commissions remained relatively flat while depreciation and amortization costs declined by $794,000 as the effect of certain fixed assets becoming fully amortized more than offset depreciation resulting from our reduced level of capital expenditures. As for interest income in the first quarter of 2005, we reported net interest income of approximately $578,000 compared to net interest expense of $161,000 in the first quarter of 2004 due primarily to an interest earned on higher cash balances including funds held in our worker’s compensation program. Other income for the first quarter of 2004 included the $8.25 million related to the Aetna lawsuit settlement proceeds.

Now let's discuss the balance sheet. We ended the quarter with $152 million in unrestricted cash and marketable securities of which approximately $73 million was payable in April for withheld federal and state income taxes, employment taxes and other payroll deductions. Working capital increased by approximately $2 million over December 31, 2004 to $50 million. This is net of 348,000 shares repurchased during the quarter totaling 4.9 million, cash dividends totaling 1.8 million, and capital expenditures of 1.4 million.

As for further details, let me explain the impact of our new relationship with United Healthcare on our balance sheet. As you may recall, we entered into a new three year relationship for health benefit coverage with United Healthcare during the quarter. Under the new arrangement the previous requirement for the $17.5 million security deposit was eliminated. Since the refund of the deposit will not take place until execution of the definitive agreement, this change has been reflected in our March 31, 2005, balance sheet as a re-class from deposits of a long-term asset to prepaid expenses which is a short term asset. Remaining deposits of approximately $61 million at March 31 consists primarily of $60 million related to our worker’s compensation program including $13 million in collateral and $47 million set aside for payment of future claims beyond 2005.

The new United Healthcare arrangement also addresses the maintenance of a funding surplus defined as the cumulative amounts funded into the plan in excess of estimated costs. We have agreed to maintain the $11 million surplus which was in the plan at December 31, 2004, over the next three years. Since this surplus level will be maintained beyond one year, the March 31, 2005, balance sheet reflects a re-class of the $11 million surplus from a short term to a long-term asset. Additionally, as a measurement of this surplus level will occur one quarter beyond the reporting period, any surplus generated during that reporting period will be reported on the balance sheet as a current asset. Accordingly, the estimated surplus generated during the first quarter of approximately $5 million is reported as a short term asset in the March 31 balance sheet. Under the arrangement any surplus generated in excess of the $11 million maintenance level is to be returned to us in the subsequent quarter.

This new three year arrangement with United Healthcare is another positive step that we have taken to further strengthen the financial condition of the Company. Our return to double digit unit growth at better than expected gross profit levels combined with the operating expense leverage currently inherent in our business model have increased our expectations for the balance of the year.

Before providing our updated financial guidance I would like to turn the call over to Paul for his comments about the quarter and on our outlook for the remainder of 2005.

Thank you, Doug. Our results for this quarter demonstrate three powerful drivers that are increasing the value of Administaff. These drivers are number one, our organic unit growth model; number two, our gross profit enhancement strategy; and number three, our operating leverage. Today I will discuss each of these drivers and the value acceleration that is ahead of us.

Our organic unit growth model includes our systematic approach to finding, attracting and aggregating our target small business client base onto our human resource services platform. This quarter we continued our unit growth acceleration from a decline in the first quarter of 2004 to 3% year-over-year in Q2, 6% in Q3, 9% in Q4, and 12% in the first quarter of this year. This growth acceleration was due to improving metrics in both sales and client retention. As I mentioned last quarter we had a successful fall selling campaign selling clients with over 16,000 worksite employees. This momentum carried over into the first quarter and sales were 106% of budget helping us off to a good start for 2005. Sales efficiency and activity numbers were also on target with our expectations so our selling system is continuing to work well.

Now that activity and efficiency rates are on track the driver for future growth in 2006 and beyond will be the growth in the number of trained sales personnel. As I mentioned last quarter, this number had been declining over the last half of last year as we enforced activity standards. We expected this metric to bottom out in the first quarter before beginning to ramp up. Sales person count for the first quarter did bottom out at an average of 210 trained sales personnel. However the pipeline for new trained sales people ramped up in the quarter, with the total sales personnel hired increasing from 220 at the end of January to 250 as we entered the second quarter. These new hires are added into the trained sales person count as they complete their classroom and field training over a three month period. Our target is to move this metric up above 250 by the end of the third quarter to continue to fuel our growth into 2006 and we are on plan to do so.

We held our annual sales convention and reward trip in February and this also contributed to a fast start for this year. Sales training was specific to the level of experience of individual sales personnel and the impact of the convention achieved both the educational and motivational objectives.

We also kicked off our spring marketing campaign and we have seen the desired ramp up in activity that will drive sales for the second quarter. In addition to our national television, radio, print, Internet and direct mail programs we introduced new client testimonial radio spots. These ads featuring 16 clients from our 21 markets are the highlight of this spring campaign. These spots use our national spokesperson, Arnold Palmer, to get the attention of our target small business client and then a local client testimonial to drive home the advantages our services offers area small businesses.

The second important component that drives our organic growth model is client retention, which was excellent for Q1. We measure the number of worksite employees that left due to client attrition as a percentage of the total base each month to compare to prior periods. And in the first quarter attrition was 6.8%, 2.3% and 1.2% for January, February and March. This compares to 7.4%, 3.2% and 1.5% in the same month in 2004. We are clearly on track for retention levels for 2005 that are similar to the pre 2001 levels we are targeting.

The third factor that contributes to or takes away from our organic growth is the net effect of layoffs and new hires within our client base. We experienced a surprisingly small contribution from the client base in the first quarter. In fact, at the same modest level of the first quarter of 2004. This is a bit inconsistent with the much more aggressive hiring plans and recruiting activity that we are seeing this year. I believe it is simply taking longer to find employees to fill available positions and this recruiting activity may lead to a more significant tail wind from the client base in the next couple of quarters. So our organic unit growth model is producing solid double digit unit and revenue growth, all the underlying trends and drivers to this growth are on target to produce consistent predictable growth that we believe adds significant value to Administaff.

Now the second driver for Administaff in terms of value is the gross profit enhancement strategy related to the management of our primary direct cost areas including payroll taxes, worker’s compensation and employee benefits. This strategy is to match the allocations within our comprehensive service fee to the cost of each of these areas in order to generate a small surplus that adds to our gross profit. Each year the primary component of our gross profit is the service fee markup per worksite employee, built into our comprehensive service fee. Our gross profit per employee, per month is enhanced by any contribution from a net surplus from our direct costs management programs. As an example, last year our gross profit per employee, per month was $211. As a result of subtracting $826 of direct costs per employee from the $1,037 of total revenue per employee, per month. This $211 was made up of approximately $193 of service fee markup and $18 of net surplus from our direct cost programs. This $18 represents a 2.1% net surplus from the $844 per employee, per month allocated in our pricing to cover the direct cost.

As we begin each year we conservatively budget gross profit to include the service fee markup and any known surplus at the beginning of the year. This year our original gross profit estimate of 200 to $204 included approximately $193 of service fee markup and about $10 of estimated surplus. As the year progresses and we're successful in managing the direct costs, we're able to enhance our gross profit expectations which is exactly what's happening this year. In a few minutes Richard will detail the success we are having in each of these areas.

In recent years we have invested heavily in internal and external resources and competencies in order to improve our ability to manage the pricing and direct costs. We are now seeing the return on these investments and the contribution to the increasing value of the Company.

The third driver to increasing value of Administaff is the operating expense leverage now visible in our first quarter results and in our expectations for the balance of the year. As we grow from this point our primary expense increases, our sales and service personnel, and certain G&A expenses directly related to selling and serving new accounts. The rest of the expense base is relatively fixed, allowing for considerable leverage going forward and increasing the value of the Company. As a result of these three drivers, our unit growth model, our gross profit enhancement strategies, and operating our leverage we are seeing a rapid acceleration in our earnings growth outlook.

During last quarter's conference call I mentioned on a comparable basis, excluding the Aetna settlement received in 2004 and stock based compensation, our guidance implied a range for the increase in net income and earnings per share of 2005 of 20 to 40%. The updated guidance published today moves this range up to 47 to 63%. This range is the direct result of the benefit derived from the three value drivers I discussed today.

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 details associated with the improving trends in our direct costs. The trends in how we are pricing our service and the resulting effects on gross profit.

Let's begin with our worker’s compensation insurance expense. The number of reported injuries, we call it the incident rate, and the ultimate cost of those injuries including both medical and lost time are the drivers of this expense. We receive regular updates regarding the status of open claims including changes to the incurred -- excuse me, including changes to the injured worker’s physical condition as well as our independent claims managers' ongoing revisions in the estimate of the ultimate cost to close the claim. Our independent actuary uses this data to determine the basis for how much we should reserve each quarter to settle claims that are still open.

Our estimate each quarter includes reserves for prior policy years plus another estimate for the current policy year. Over the past year I have reported lower trends in both the frequency and the severity of claims. These very positive results come from the ongoing work of our safety professionals who provide training and safety recommendations to our client and worksite employees. Additionally, our ongoing work with the medical case managers to reduce the medical cost component of these claims and the launch of the Administaff return to work program early in 2004 has also contributed to the lower costs. As a result of these efforts during the first quarter the actuary lowered the reserve estimate of claims incurred for the prior policy year. The estimated cost for the current policy year has also been reduced primarily because of an 11% reduction in the number of claims reported this year over last coupled with a 15% reduction in the estimated cost of these claims. The combination of successful claims management on existing claims and the ongoing efforts to reduce current incident rates resulted in a significant reduction to our expense in the first quarter. Additionally, these same factors lead us to reduce our expected cost of worker’s compensation for the balance of the year from a range of 1.38 to 1.42% of non-bonus payroll to a new range of 1.3 to 1.35% of non-bonus payroll.

Next I would like to discuss our employee related payroll tax expense. Employee related payroll taxes decline or terminate throughout the year as employees reach certain wage levels. We now have been assigned all of our 2005 state unemployment tax rates and a high percentage of the cost has already been incurred for the year. Therefore this direct cost as a percentage of payrolls should go down sequentially each quarter just like the pattern we experienced in 2004.

The third direct cost to discuss is our benefits cost which include health care costs, prescriptions, dental, vision, life and accident insurance and disability coverage. As Doug mentioned a few minutes ago, our benefits cost came in at the low end of expected range. We had a 1.6% sequential increase in benefit cost per covered worksite employee that was right in line with the 7% annual increased guidance we gave last quarter. A real highlight this quarter relates to the recent announcement of new three year contract with United Healthcare. Under of the terms of the agreement, United Healthcare eliminated the security deposit of $17.5 million. Additionally we agreed to maintain an $11 million funded surplus in the health plan which was the balance we had on our books at December 31, 2004. Now this amount represents about 4% of expected annual claims and demonstrates, I believe, the comfort both companies have in the underlying cost of the plan.

They also agreed to reduce the administrative fees associated with operating our health plan beginning in 2005. We were able to negotiate lower administrative fees for the next three years as well as an immediate credit upon signing the final agreement which we expect will occur during the second quarter. This reduction in cost is expected to offset the trend increase in the second quarter and allow us to moderate pricing declines going forward. We also agreed to move a majority of our PPO plan participants from the existing Options PPO network to United Healthcare's new Choice Plus network beginning in June of 2005. This is a relatively seamless transfer for our clients and worksite employees but we should see some slight reduction in our claim costs beginning in the third quarter of this year. This new agreement demonstrates the value that United Healthcare and Administaff place on the relationship and we look forward to working with United Healthcare to provide an even better health care offering to our employees in the future. When we look at our current trend increases in claims, coupled with the information about our new contract, we should see our total cost per covered worksite employee going up about 4% year-over-year for the second quarter and 6% to 7% for the full year.

As you can see from our first quarter results, we are performing quite well with the current pricing levels and our surplus is above the original targets for 2005. Therefore, we are raising our gross profit guidance range $4 per worksite employee, per month for the balance of the year.

Now I would like the turn the call back over to Doug.

Thanks, Richard. Now let's discuss guidance for the remainder of 2005 beginning with the full year. As for worksite employees, based on better than expected first quarter results and assuming we continue to add an average of 800 to 1,000 net worksite employees each month based on new sales and client retention, while continuing to assume no growth or decline from new hires or layoffs in our existing client base, we expect a range of 86,700 to 87,300 for the full year. This is an increase of the initial range 86,000 to 87,000 average paid worksite employees per month and represents an 11% to 12% increase in unit growth over 2004.

As for gross profit we initially set a range of 200 to $204 per worksite employee, per month which assumed only modest contribution from our direct cost areas. Now that we have seen favorable trends impacting our 2005 results, we are raising our guidance of this metric. Based upon these trends, combined with our first quarter results, ongoing pricing strategy, and lower administrative fees under our new contract with United Healthcare, we are increasing the full year 2005 gross profit guidance to a range of $204 to $208 per worksite employee, per month.

As for operating expenses, as I previously mentioned we have been seeing improving leverage. When combined with our revised 2005 expected range of average paid worksite employees, operating expenses on a per worksite employee, per month basis are now expected to decline from $188 in 2004 to approximately $178 for 2005. This decline is in spite of $2 per worksite employee per month of stock based compensation expense which was not included in our 2004 results. In total dollars we now expect total operating expenses to be in a range of 184.5 million to 186.5 million. This increase over the prior year guidance consists primarily of additional accruals for incentive compensation due to our improved outlook for remainder of the year and additional accounting and consulting fees. As a result of increased cash balances from our improved operating results we now expect net interest income to be in a range of $2.2 million to $2.6 million for the full year. We are now forecasting $26.2 million average outstanding shares and continue to expect a 38.3% income tax rate and annual capital expenditures of $10 million.

Now for second quarter's guidance, based upon the average number of paid worksite employees during the first quarter and the metrics I just provided for the remainder of the year, we expect average paid worksite employees per month to be in a range of 85,750 to 86,250 for the second quarter. As for gross profit, we expect to be in a range of $202 to $204 per worksite employee per month. As a reminder gross profit per worksite employee generally declines from the first to second quarter of each year, as new business added after January 31 has a lower gross profit than our base in the first three months paid, approximately same as our base in the next three months and higher than the base there after. This is because the payroll tax allocation in our fee for new business is billed ratably over the remainder of the year while the payroll tax cost is incurred as worksite employees earn their wages up to specified wage levels. Second quarter operating expenses are expected to be in a range of $44.5 million to 45.5 million including approximately $700,000 of stock based compensation expense. This is down from first quarter operating expenses of approximately $47 million which included $2.7 million of costs associated with the annual sales conference, incentive trip and spring sales campaign. We expect net interest income to be between 500 and $600,000 for the second quarter.

Now I would like to open up the call for questions.

[OPERATOR INSTRUCTIONS] Josh Rosen, Credit Suisse First Boston.

Thanks, it's Josh and Jeremy. Just a couple of questions. First, Paul, you had talked about moving the sales conference a little bit earlier in the year, into February. And would just be curious as to what impact that would have perhaps on the seasonality of when new sales might happen throughout the year? If you might have pulled sales into the first quarter that might have happened later or if it's something that really sets the table a little bit earlier in the year for better sales throughout? Just the thought process there would be helpful.

Yes, we actually see it as a potential to just boost the level of sales over the course of the entire year by simply moving up that time period when you reinvigorate the pipeline and add new potential clients. So, compared to prior years it's kind of less of a dead space in there coming off of the fall campaign, and hopefully will lead to more consistent sales throughout that earlier part of the year.

Then the second question I had, probably more for you Richard, just if you could walk back through a little bit on the worker’s comp side and perhaps there is a way to quantify. It sounds like there were two elements to the favorable worker’s comp trends on the quarter or two elements outside of the incident rate -- incidence rate and the cost of injuries, but the two elements that I can separate it into would be that there's a catch up component from prior periods as well as just a lower accrual for the first quarter. And is there any way to disaggregate those two just in terms of whether it's a total dollar number or what it might mean per worksite employee?

Yes, sure Josh, you're right about the separation between our expense that relates to an adjustment on reserves based on prior policy versus an estimated outlook on the current policy. And the combination of those two expenses was the was the thing that drove our costs from 1.38 or 1.40% of non-bonus payroll all the way down to 1.13. So it was a couple million dollars and a combination of the two. Of course you realize in that that amount of adjustment relates to adjustment on about a program that's running about $60 million at the current levels between the old -- the first year and the second year. So it's just a nominal adjustment in the process that goes on. And going forward, we'll continue to have those kind of adjustments. It is absolutely normal to have the actuaries looking at both the results of the prior year's policies plus a look at what's going on with the current year's program as well.

Josh, I would also add one other thing. That is that the way our business works is that when a policy period is over, our work is not over relative to claims incurred in that period. We continue to do a lot of work to manage the claims settling process in terms of getting people back to work as early as possible, managing where employees go to get services and all those things help to reduce the cost. These are things that Richard has kind of been pointing to over the last year or so on our conference calls that where we continue to keep working to hopefully have our prior policy year expenses settle out lower than the initial actuarial estimates.

I think. I think there is one last piece to that. These numbers reflected the fact that because of the kinds of injuries that we have, meaning they're not as severe as companies who have -- take on business with high risk of injury on the job, these claims close out pretty quickly. And so what happens is you start to have adjustments sooner in a program like ours than you would in say a program where there's a whole bunch of roofers that are involved.

Okay, now that makes sense. The last question I had was just looking for a little bit more color. Richard, you alluded to a shift in PPO policies and what type of impact that might have, how many of your clients is that going to impact and how that plays out, just a little more color would be helpful.

Sure. It is kind of a behind the scenes transfer between United Healthcare, their old PPO network and their new one, this Choice Plus. And what's happened is in the new network, they've actually had some negotiated rates with the doctors and the hospitals that's better than the old one and so they're just in cities as the network becomes available, we'll just be migrating our folks over into that. It will be almost a perfectly seamless situation. But the end effect on us will be we should see for those customers that are in our PPO network, which is about, I am going to say -- I can't remember exactly, but it's over 50% of our employees are in the PPO network. We will see some minor reduction in our costs there. We've kind of baked that into our trended expectation of the 6% to 7%, so we've considered that. And of course the pricing to go along with that because obviously when you have a lower cost option you're going to have some adjustments to the pricing as well.

Okay. Thank you very much.

Tom Giovine (ph), Giovine Group.

Hi, guys, well done.

Thank you, Tom.

My first question has to do with your gross margin guidance and if you were at 215 for the first quarter and your guidance for the full year is 204 to 208, that would contemplate a gross margin for the remaining nine months somewhere between 200 and 205. I'm just curious, why are you -- you're effectively guiding down a drop of 10 to $15 for the remaining nine months of the year. Is that conservatism or is there something I am missing there?

It is a combination but don't forget how the business actually works relative to new business we add throughout the year. Remember as we add new business the service fee on new business includes an allocation for the payroll tax that is ratable over the balance of the year. And our cost related new clients has the old trend of being front end loaded. So when you weigh that in, that's what Doug was referring to at the end of his script there about the fact that our new business has a lower gross profit per employee in the first quarter we have them, about the same as what the average is for the year and then is better than the average in the third quarter.

Right. But I mean -- and again maybe I am missing something, but you're talking about a net of 1,000 which is effectively 9,000 employees. Over your entire client base that would be -- you know, you're assuming a pretty significant deterioration and I am assuming that's just conservatism.

There is not really a deterioration. It is looking at the gross profit on the book as it exists and kind of how it rolls in. But you are correct to assume that we're not going to build into our gross profit expectations further emerging claim benefit like on the comp program that Richard just discussed until that actually emerges.

Okay. I am sorry, how much again was that this quarter?

Well remember that what Richard referred to was that the expense for the quarter which was estimated to be 1.38 to 1.42 came in at 1.13.

Okay.

We have brought in some of that going forward by bringing it down to -- what is the estimate now, Richard?

About 1.3% to 1.35. So we brought down our cost estimate already.

It could be better than that.

Sure.

The proper way to do this is to continue to work hard to settle those claims out at lower costs and continue to keep that incident rate and the severity down and have that emerge into our results as it happens.

Okay. I got it now. And then my last question is -- I think we talked in the past that you would have again, you don't really need capital to expand the business. It seems to me that you have a minimum of about $30 million annually to buy back stocks. And finally your stock is getting a little bit of some life into it, but I just wanted to have some kind of idea that even with a 20% move in your stock today that you're still committed to kind of execute on your buy back plan in that and I am thinking about in terms of the dollar amount that would be free to buy back shares if you chose to do so.

Sure. Thank you for the question, Tom. We continue to buy back shares aggressively at any opportunity we have. Keep in mind the Company only can buy shares back when we don't have material non-public information. In the first quarter this year we were negotiating the United policy, the three year agreement. And we had only a few days after we announced that agreement where our window was still open to even buy shares. We bought the maximum allowable under the rules during that period which unfortunately was only 348,000 shares. But we are a buyer of our shares.

And would you consider doing a Dutch to get -- I am not a big believer in a Dutch, but it would be -- if you were blacked out of the market quite a bit, and the volume is relatively light, would you consider maybe doing a Dutch for a few million shares?

Well, let me tell you, there is nothing we're ruling out. But this is an area that our board is managing very carefully. We do see a significant amount of cash that's going to become available as this year progresses. We're at 50 million in working capital which we have said is where we're very comfortable at that level. Well we've got of course the earnings for this year plus several other things like the United deposit coming back. We have a surplus that eventually gets refunded in the comp program. We have possibly another $30 million that, in the not so distant future comes back into that working capital calculation. So we will continue to look at the total prospects and options that we have out there including buy back, dividends, and we're not ruling anything out.

Okay. Well done. I have been on too long. Thanks.

Tobey Sommer, SunTrust Robinson Humphrey.

Good morning.

Good morning.

I was wondering if you could describe sales trends maybe and segment the market for us, talk about it among the smaller businesses and then maybe what you're seeing in the middle market. Thanks.

Sure. You know as we mentioned from the fall, we had a real nice surge in middle market accounts with about, I believe, it was 19 accounts totaling around 3,000 employees. I think that's going to be a business that is weighted even more heavily toward year end. But we are continuing to make very good progress on both fronts although this quarter's results were more driven by our bread and butter small to medium size business accounts in terms of closing, closing business. So we believe both of those markets are very good and strong for us and we're not -- we've got the accelerator down in both areas, so we're happy with how both of those are performing.

And then, Paul, I was wondering if you could comment on the outlook for net new hires? I think in your prepared remarks you said that perhaps small businesses are having trouble finding the right people to fill their spots. I was wondering if you could give a little bit more color there because I think also you mentioned bonuses for worksite employee up pretty significantly. It looks like sales among your customers appear to be pretty good. Thanks.

You are correct. I will review a lot of information every month that kind of gives us a view of the economic climate and how things are going in client base, and commissions are up. High average overtime utilization, they're at capacity, and now we can add to that that recruiting activity is significantly higher than it has been. So all those things point to bringing new people on. We even did a survey not long ago with our client base about -- that indicated that senior management spending considerable amount of time in the recruiting process. But again, in the first quarter we didn't see the net gain from new hires step up with the -- in-line -- in step with the activity. As we go into the second quarter we're starting to see that come about more and I think we're seeing some acceleration there. But we're not willing to build that into our expectations until we see it.

Then one last question and I will get back into queue if I have a follow up. You have plans to add to your own sales force and appear to have a decent small group in the training pipeline. I was wondering if you could comment about whether you're having any difficulty finding people or whether high quality sales people appear to be available? Thank you.

You know, actually we are. It is the same experience we're having. It is harder to find them although early in the year and actually late last year we formed a task force or a strike force, if you will, to work on this. We're having great success there finding sales people that fit our profile. Just recently we updated the profile by having all the entire sales staff go through the profiling process to make sure we have honed the profile of who we're trying to hire. And so we're real pleased with that progress and made some progress in the first quarter but I expect us to hit our targets for growth in the sales staff.

Thank you very much.

Dave Koning, Robert W. Baird.

Good morning everyone and congratulations on a very good quarter. First of all just to piggy back on Josh's earlier question about the worker’s comp trends. I know you mentioned I think 1.13% in this quarter and you guided to somewhere around 1.3% for the full year. I am just wondering just what the adjustment was on really historical -- on your historical claims? I think you mentioned 2 million but I think that was a combination of both your previous adjustment and your go forward adjustment. I am wondering just though kind of one time -- the one time adjustment in this quarter, what that was?

Yes, Dave, I think that's in the $2 million range for the -- more of the one time adjustment, 2 to $2.5 million.

Okay.

Okay. And that's why we have revised the guidance going forward. So your first quarter as percentage of fee payroll is 1.13% and we have revised our, sort of, expectations along the workers comp lines to be more in the 1.30% range going forward, which is down from our initial outlook for the full year in the 1.40% range. So we did pick up some credit as a result of the lower claims stated in the first quarter but we also expect to experience some benefit from that for the remainder of the year also.

Okay. Well, you had great progress on that. And secondly, just as we think about the rest of the year, I know with the new billing system that has gone in place now over the last five quarters or so, is it pretty safe to assume that every quarter should be roughly in the same ball park? Now, I think you did $0.18 this past quarter, $0.19 or so is what your guidance is for Q2 and then the rest of the year it looks like kind of in that maybe 18 to $0.22 or so per quarter. Should we just think of every quarter as being kind of in the same ball park now given your new billing system?

Well that's one piece of it, looking at your numbers through the gross profit line. You also have to consider any shift in operating expenses from quarter to quarter when you're looking at the sequential numbers. So, as an example, when we move some of our operating expenses up in the first quarter from the second, so you also have to consider that. But on the gross profit line as far as the impact on gross profit. For the base itself that was on hand, in January, you would assume somewhat of a consistent gross profit for them depending upon your pricing and direct costs management. But then for the new clients we add subsequent to January 31 is where you will experience the old pattern. So it's a little bit of a combination there.

Okay. Sure. And then just one final question. I think at the end of Q4 you had about 11 million surplus in the health care plan. You mentioned adding 5 million more this quarter and are only required to really have 11. Did you say now that over the next quarter or so you will get back that 5 million?

Yes, that's the plan. Once again, the measurement period is about a one quarter lag because you have to look at the data as it comes forth. So we will get that back as soon as we sign the contract. But the way it will work going forward is any surplus generated in that particular reporting period would be returned going forward to get -- to maintain that $11 million surplus. There's just a lag involved in the measurement.

Okay. Sure. Thanks a lot.

Leonard Lee, The Seidler Company.

Good morning, great quarter. Just two questions actually. First is if you could provide some additional color as to geographically where some of the unit growth was. There was great growth in the west as well as the northeast. Is there anything regulatory market dynamic wise perhaps competitively that is driving growth pretty fast in those areas? And secondly, just with respect to sales people, I believe that you had 250 at the end of Q2. Is the anticipation to increase that toward the end of the year? Thanks.

Yes, the 250 number I used, Leonard, was the number of hired reps at the -- as we came into the second quarter here, and we are going to drive that higher. We need to to have the -- because I want to have 250 trained reps by the end of the third quarter. And so we will continue to move that up over the course of the year.

Do you have sort of a year end target?

Yes, we were still kind of pinning that down kind of based on how the efficiency rate goes. But it will accelerate a little bit more into the fourth quarter but not a lot. You want to have them in place as we kind of go into our fall selling campaign, so the big step up needs to happen by the time we get to that point.

Now on your question about the different parts of the country, I really -- we really aren't seeing a lot of differences. There are certain parts of the country where there is more competition on different accounts, down in the southeast there is a little more competition. So that's really about the only difference. But what we see that really affects our results most is not market condition, it is literally the district manager that's in that local office and their effectiveness. And I did mention in my prepared remarks, but that's why we have really stepped up our training efforts for our district manager role. And we have just finished our district manager meeting for the quarter and outlined the entire scope of that training which includes literally mapping out the time allocation for our district managers so that they can understand -- which -- our most successful managers how they spent their time and how they maximized their performance. So I would say we're really extending more of a best practices model out to the district manager role, and that's what's driving the regional results and the local results.

Just a follow on to that, are most of your new clients first time PEO clients or are you seeing perhaps more clients choosing you to replace a previous PEO?

Now certainly the large majority of our new clients come from what I would call greenfield.

Great. Thank you, guys.

Jim MacDonald, First Analysis.

Good quarter, guys.

Thanks.

Looking on the expense side, you talked about operating leverage. Can you estimate kind of what percent of your expense based or in dollars per employee is fixed versus kind of variable that you need to add? I guess it's also over some period, but --

It is hard to kind of pin down because it depends on -- like right now we want to hire a lot of new sales staff so that kind of feeds into, kind of how the comparisons work. But I think the way to look at it, if you look at our service base and sales base, that comes out to, around half of our total employees. And so a good way to look at it is that half needs to keep growing but the other half is pretty fixed. And people and compensation is the biggest driver of our operating expense is followed by then, the G&A expenses. But in G&A you have, strictly you have a few items that do move with the number of worksite employees and the client base, shipping costs and those kind of things. So I think it wouldn't be far off to kind of look at it as a 50/50 thing in general, but that will bounce around, when you are looking at a specific period.

All right. I had a couple of details to clear up. While we're talking about kind of last year related expenses, in terms of the stock based comp, some of what you took this quarter really related to prior -- all prior year vesting, right? So could you kind of break out --?

Let me go through that. I appreciate the question. Based on how options are going to be accounted for going forward which originally was going to be July 1 and obviously has gotten postponed recently. We've made a decision as a Company to go -- move away from options altogether and go to restricted shares for long-term incentive comp because of the clarity around what the value of those restricted shares and so we have just decided to do give out a fewer number of restricted shares going forward. So what we did on all the prior options that had been issued, most of which were under water, we accelerated the vesting on those because there was a future expense of about $13 million, most of which related to options that were under water. It just made no sense for us to continue to have those out there, so we accelerated vesting on all the old options and switched to restricted shares and the timing of that affects some of these results especially here in the first quarter.

And then the health credit have you taken that yet or will you take that upon signing?

No that's a -- that would be assuming that we complete the contract and sign it in the second quarter. That's when we would receive that adjustment. So we haven't taken it yet.

Okay. And one last thing, just to be specific on the layoffs versus new hires, was that actually up or down in --?

Just very slightly up, not near what we were hoping it would be. But remember in our guidance we don't build that in any way. It should just add to up side. Obviously we were higher than our expectations, but again this quarter was really driven by sales and retention, especially retention being quite a bit better. So -- but I am hopeful that the net effect of new hires over layoffs will be a little more appreciable going forward, but we will have to wait and see.

Thanks, very much.

Jeff Martin, Roth Capital Partners.

Thanks. Hi, guys. A lot of questions have already been answered. Good clarity. I appreciate it. Cold you just -- the only one I had left was on your 47 to 63% growth inferred by your guidance. Could you give us what reference point that is? Is that based on earnings and what -- off what number? I assume it is not the $0.72 from '04.

Yes, that's on the number excluding the impact of the Aetna settlement in 2004 which I think approximated about $0.19 a share for the full year 2004.

And the stock based compensation is eliminated in that comparison because you -- that's a kind of a one-off item.

Okay, so back that out. And on the net new hires, I assume you were referring to the first quarter in general. Was that also referring to April as well?

No, we didn't really talk about April, however, you can see from our guidance we're expecting a nice step up here into the second quarter. And we are starting to see a little bit more contribution from the client base. But it's -- we're still -- today is the second so we're just now getting that information to start to evaluate.

Okay. With the market somewhat shaky, referring to a soft patch in the economy, are you seeing with your clients any softening at all? And what kind of comments might you have about the economy in general?

Interesting. I haven't seen any soft patch in the commissions in our client base or in the overtime, or in the bonuses, so, where is the soft patch in the actual performance? I think we would see that happening and be able to corroborate what economists are doing more from a macro perspective. Right now what I am seeing in the base is not consistent with a soft patch if you will.

Great. Thanks very much.

Jim Wilson, JMP Securities.

Thanks, good morning. You had obviously very good growth in the quarter. I was -- a couple questions though. As you look at anywhere where actually you have any difficulty trying to get sales done could you maybe color what you see as obstacles that small businesses present to sales people when in instances you haven't been successful? And secondly, when you have any turnover that's occurring what seems to be the biggest reason companies give that they're deciding to drop benefits, switch, whatever it is they're doing?

We're really kind of back into our normal mode of operation, customers that don't come on, we have what we call the four myths, cost, and loss of control or loss of loyalty of employees, none of which are trueisms. And then you know, just getting comfortable with the new way of doing things and basically this sounded too good to be true. That is the biggest obstacle we have on the sales side and continues to be in the greenfield part of our target market which is most everybody. So that -- as far as on the retention side when they go away as a customer usually about half of the time it's financially related. Either business turn around there where things didn't go well for the customer for some reason. A lot of small businesses are -- their businesses rely on either a major customer or major key vendor, and that kind of situation is fairly volatile. So about half of the ones that go away, go away for some change in the economic environment of their own business. And then on other issues you run into where we have our success penalty. Sometimes our customers are acquired by somebody else, they sell their business or have a pay day for them is not a pay day for us because a lot of times they will go away and be absorbed into a larger organization, so that's part of it. We also have customers on occasion with a compliance issue and we have very clear standards on what risks we will take and what risks we will not take, so we do let customers go. And then also we have about -- out of the 20 to 22% that go away every year we have 3% or 4% that go away for service related issues. It's a service business, and that's the area we're always trying to get better on, but you do have customers go away for those reasons.

Okay. Very good. Thanks.

This concludes the question and answer session. Any additional questions may be directed to Mr. Sharp at his office and now I will turn the call back over to Mr. Doug Sharp for closing remarks.

Actually this is Paul Sarvadi and I'd like to close the call just by reminding you we do have our annual shareholders' meeting here at our corporate office coming up on Thursday afternoon. And I would encourage anyone to come if they have that inclination and certainly would ask everyone to consider and vote in favor of the management's and the board's recommendations in this year's proxy. Thank you again for being a part of our call today. We appreciate your involvement. Thank you.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Thank you and have a wonderful day.