Insperity Inc (NSP) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Administaff fourth quarter and full year 2005 earnings conference call. My name is Cindy, and I will be your audio 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 end of this conference. [OPERATOR INSTRUCTIONS] Joining us today are Mr. Richard Rawson, President, Mr. Paul Sarvadi, Chairman and Chief Executive Officer, and Douglas Sharp, Chief Financial Officer.

I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson, or Mr. Sharp that are not historical facts are considered to be forward-looking statements within the meaning of the Federal Securities laws. Words such as expects, intends, plans, projects, believes, estimates, likely, possibly, probably, goal, objective, assume, outlook, guidance, predicts, appears, indicator, 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.

I would now like to turn the presentation over to Mr. Doug Sharp, Chief Financial Officer for Administaff. Sir, please go ahead.

Thank you, we appreciate you joining us this morning. Let me take a minute to outline our plan for this morning's call. First, I'm going to discuss our fourth quarter and 2005 full-year financial results. Paul will add his comments about the quarter and on our outlook for 2006. Then Richard will discuss trends and our direct costs, including benefits, workers' compensation, and payroll taxes, and the impact of such trends on our pricing. I will return to provide 2006 financial guidance, and then we will end the call with a question and answer session.

Let me begin by summarizing the financial highlights. We reported a 208% increase in fourth quarter earnings to $11 million, or $0.39 per share. And full-year earnings of $1.12 per share, completing our best year ever. Fourth quarter earnings significantly exceeded our expectations, and were primarily driven by favorable results in two of our key metrics.

First of all, year-over-year unit growth accelerated to 16% for the quarter, averaging just over 94,000 worksite employees. This compares to the high end of our forecasted range of 93,250 worksite employees. Secondly, gross profit per worksite employee per month averaged $238, significantly above our forecasted range of 217 to $221, as both the markup related to our HR services and surpluses in our direct cost programs, came in better than expected.

Operating expenses increased 12%, however, on a per worksite employee per month basis, they declined from $190 in Q4 2004, to $184 in Q4 of '05, as we continue to realize operating leverage. For the year, we generated EBITDA of approximately $65 million, and we increased working capital by $46 million, to a balance of $93 million at the end of the year.

Now let's review the details of our fourth quarter results. The average number of paid worksite employees per month increased 16.2% over the fourth quarter of 2004, from 80,926 to 94,031. In a few minutes, Paul will provide the details behind our unit growth drivers, including sales, client retention, and net growth within the existing client base. Fourth quarter revenues increased 23% over 2004 to $306 million, as a result of the 16% increase in the average paid worksite employees, and a 6% increase in revenue per worksite employee per month.

Looking at fourth quarter revenue contribution and growth by region, the southeast region, which represents 9% of total revenue, grew by 18%. The northeast region, which represents 15% of total revenue grew by 34%. The central region, which represents 13% of total revenue grew by 21%. The west region, which represents 23% of total revenue grew by 22%. And the southwest region, which represents 39% of total revenue grew by 21%.

Moving to gross profit, as I mentioned a moment ago, gross profit per worksite employee per month for the quarter was $238, up from $212 in the fourth quarter of 2004. This was also significantly above our expected ranges, both the markup related to our HR services and surpluses in our direct cost programs, came in better than our forecast. The higher surplus continues to be driven primarily by favorable trends in both the healthcare and workers' compensation claims cost.

Total benefits cost per covered employee per month increased only 1.8% over the fourth quarter 2004 to $591, below our expected cost increase of 4.5%. Approximately 73% of the worksite employee base was covered by our medical plans during the fourth quarter, resulting in a cost of $430 on a per worksite employee per month basis. Workers' compensation costs were 1.01% of nonbonus payroll for the quarter, below our forecasted range of 1.10 to 1.15%. Updated actuarial loss estimates reflected continued favorable claims trends, and therefore this quarter's $2.3 million reduction in previously reported loss estimates.

As for our third significant direct cost, payroll taxes, as a percentage of total payroll costs, increased from 6.17% in Q4 2004, to 6.26% in Q4 of 2005. In a few minutes, Richard will provide further details on what drove the lower-than-expected benefit in workers' compensation costs, and also comment on our outlook for 2006.

Now let's move to operating expenses, which increased 12% over Q4 2004, to $51.8 million. This was approximately $800,000 above the high end of our forecast, and resulted from additional marketing investments, and increases in certain general and administrative costs, primarily associated with higher levels of corporate and worksite employees.

However, we continue to experience a decline in our total operating expenses on a per worksite employee basis, from $190 in Q4 2004, to $184 in the fourth quarter of 2005. As for net interest income, we reported approximately $1.8 million for the quarter, in excess of our expected range of 1.2 to $1.4 million, due to higher invested balances and rising interest rates.

At this time, I'd like to take a few minutes to review our full-year results. We reported 2005 earnings of $30 million, or $1.12 per share. This compares to 2004 net earnings of $0.53 per share, excluding $0.19 per share of proceeds, related to the legal settlement with our former health insurance carrier. Revenues grew 21% to $1.2 billion. As a result of a 14% increase in paid worksite employees, and a 6% increase in revenue per worksite employee per month.

As for 2005, revenue contribution and growth by region, the southeast region, which represents 9% of total revenue, grew by 12%. The northeast region, which represents 15% of total revenue, grew by 32%. The central region, which represents 13% of total revenue, grew by 13%. The west region, which represents 23% of total revenue, grew by 22%. And the southwest region, which represents 39% of total revenue grew by 20%.

Gross profit per worksite employee per month increased 5% from $211 in 2004, to $221 in 2005. This is reflective of a $2 per worksite employee per month increase in the markup on our HR services, and an $8 increase in the surplus generated on our direct cost programs. Taking a step back to review the details of our direct costs, benefit costs per covered employee per month increased 3.9% for the year, from $568 to $590. While the percentage of worksite employees covered under a health insurance plan increased from 71.1% to 72.4%.

Workers' compensation costs, as a percentage of nonbonus payroll, declined from 1.35% in 2004, to 1.09% in 2005. Our ongoing efforts in managing workers' compensation claims contributed to this year's $4.6 million reduction in previously-reported loss estimates. Payroll taxes as a percentage of total payroll, increased slightly from 7.41% in 2004, to 7.46% in 2005. Reflecting an increase in state unemployment tax rates, partially offset by a higher payroll average of our worksite employees.

Now let's move on to operating expenses, which increased $16.4 million over 2004. This 9.4% increase on 14% unit growth resulted in a decline on a per worksite employee per month basis from $188 in 2004, to $180 in 2005.

As for the details, compensation costs increased $13.3 million, making up the majority of the increase in the total operating expense dollars. And included a $6.1 million increase in incentive compensation, tied to our significantly improved operating results, and $2.1 million in stock-based compensation. The remaining $5.1 million increase in compensation costs was due to a 3% increase in corporate head count, and a 3.4% increase in average pay. Advertising costs increased by $2.1 million, as we continue to focus efforts on driving our unit growth, and on our corporate branding.

General and administrative costs increased $3.7 million, or 7.5%. Commission costs declined slightly as an increase in sales commissions was more than offset by cost savings, resulting from the termination of our American Express marketing and commission arrangement in December of 2004. And depreciation and amortization costs declined by $2.3 million, as the effect of certain fixed assets becoming fully amortized more than offset the incremental expense associated with 2005 capital additions.

Before discussing the balance sheet, I'd like make a few comments on net interest and other income. Net interest income increased from only $356,000 in 2004, to $4.2 million in 2005. This increase was a result of rising interest rates and increased cash balances, which generated from our improved operating results, the reimbursement of deposits and excess funding under our primary health plan, and proceeds received from the exercise of stock options. As previously mentioned, other income in 2004 included $8.25 million of proceeds, related to a legal settlement with our former health insurance carrier.

Now let's review several key balance sheet and cash flow items. Working capital increased by approximately $46 million since December 31 of 2004 to $93 million, net of the following cash outlays. Cash dividends totaled $7.4 million, approximately 649,000 shares were repurchased at a cost of $12.2 million. Capital expenditures totaled $28.6 million, including $19 million related to the replacement of our corporate aircraft. And HR software products were required from [Recruit Max] for $6.3 million. These cash outlays were partially offset by $30 million in proceeds, received from the exercise of stock options this year.

As for a couple of other balance sheet details, prepaid expenses and other current assets totaled $14 million at December 31 2005, including $7 million related to our primary healthcare plan, and $1 million related to our workers' compensation program. The profit of $67 million consists primarily of $55 million related to our workers' compensation program, and $11 million related to the primary healthcare plan.

Now before I provide our financial guidance, I'd like to turn the call over to Paul for his comments about the quarter, and on our outlook for 2006.

Thank you, Doug. I would like to begin today by discussing the excellent execution of our business plan, which drove the dramatic financial results reported today, for both the fourth quarter and the full year 2005. I will follow that discussion with details about our record-setting fall campaign sales efforts, and the specific components of the year end retention cycle that established a solid starting point for 2006. Then I will finish with comments describing our 2006 goals for growth, profitability and development, including our plans for HR tools, which we purchased at year-end.

Our business model relies on three simple drivers to grow profits at the desired rates. They are growing at double-digit unit growth, achieving gross profit per worksite employee target, and demonstrating operating expense leverage. In 2005, we improved sales and client retention metrics, which resulted in accelerating unit growth each quarter of the year. We also moved pricing up and held direct costs down, driving gross profit up significantly. And we held the line on operating costs as growth accelerated, which resulted in substantial operating leverage.

Simply put, this combination resulted in the best year in the 20-year history of Administaff, and record-setting performance in many areas of the business. In 2005, our sales team sold new accounts with over 42,000 employees, a 27% increase over 2004. This was accomplished with 5% fewer trained sales personnel. We achieved our highest sales efficiency rate ever of 1.24 sales per salesperson per month, at our standard metric of 13 employees per client.

This was driven by improvements in sales training and marketing strategies supporting our sales team. As a result, other metrics improved, including our census to first call rate, increasing from 42% to 47%. And our closing rate moving up from 19% to 23% in 2005 over 2004.

Our new middle market initiative played an increasing role as 4800 of these sold employees were related to clients with more than 150 employees. This was a 50% increase over the middle market contribution in 2004. The markup on new business sold in 2005 also increased by 3%, over $5 per worksite employee per month, capping off our best sales year ever. Our financial results were also driven by improved client retention, due to increased client satisfaction levels.

For the year, our overall client satisfaction improved from 88% to 91%. Additionally, a 2 percentage point gain was achieved in three other survey measures. 94% of clients surveyed said they would refer Administaff to other companies. 96% say they're planning to renew their contracts. And 92% agree with the statement, "Administaff is a good value for the money." During the year, we implemented our client relationship management solution, laying the foundation for continuing to improve client services and retention. These high levels of client satisfaction have resulted in a client retention rate of 79.5% for the year 2005, our highest level in five years.

Our solid execution of our plan also extended into pricing on renewed accounts. Over 99% of all renewals were completed on schedule, with an average increase in the markup of 3%, or over $6 per worksite employee per month. The combination of these markup increases in new and renewing accounts throughout the year, resulted in moving the weighted average markup on the entire client base up $5 over the course of the year. We also exceeded our target average markup for the full year by $2 per worksite employee per month.

Now, we added an exclamation point to these annual sales and client retention results by conducting a record-setting fall campaign. The fall campaign sales exceeded 20,500 employees, 14% ahead of internal targets, and 27% ahead of last year's campaign. Sales efficiencies for the campaign reaches an all-time high of 1.74 sales per salesperson per month, exceeding the previous high water mark of 1.55. Although not all clients sold historically convert to paid worksite employees, the campaign helped us exceed unit growth targets during the quarter, and loaded the pipeline for new clients scheduled to enroll.

Retention during the fourth quarter was also exceptional. The average percentage of employees that left the Administaff through client attrition was less than 0.9% for the quarter, down from 1.35% in the same period last year. This low level of attrition also contributed to exceeding unit growth expectations in the quarter, and toward laying a strong foundation for 2006.

The pipeline for new business from the fall campaign, and the strong pricing in client retention during the fourth quarter, also provided an opportunity to eliminate two middle market accounts at year-end, which were sold prior to our mid market initiative, and were below our standard pricing. These two accounts totaled 1,440 employees, priced at an average markup of only $115 per worksite employee per month. Determination of these two unprofitable accounts lowers unit growth in the short-term, but increases profitability, and creates capacity to enroll more profitable targeted accounts that were sold during the fall campaign.

Also a highlight of 2005 was the management of price and cost of benefits, workers' compensation, and payroll taxes. New contracts were negotiated to improve products and services to clients while reducing costs. Targets for pricing were achieved while costs were mitigated, resulting in a substantial increase to the surplus component of our gross profit for the year.

So to summarize, 2005 was a tremendous year, driven by employees of Administaff across the business units, executing their specific duties in sn effective, efficient manner, producing superior financial and operational results. As we look ahead to 2006, the starting point for our operating plan is the number of worksite employees paid in January, and the markup associated with those employees. Last quarter I discussed the typical year-end turnover of accounts, which is the net effect of our fall selling campaign, and our year-end renewal results.

As I stated last quarter, our client attrition in January is typically 6 to 7% of our client base, due to the large number of accounts that renew at this time. Our fall campaign typically adds another 7 to 9% of the base. This represents a change in the client base of approximately 15%, and usually causes a step-up in January of 1 to 3% in the paid worksite employee base. This year, our year-end attrition was 6.5%, excluding the elimination of the two accounts I referred to earlier, when you include these two accounts, attrition was 8%. New accounts enrolled and paid came in at 8.3%, which would normally provide a step-up of 1.8% over the 6.5% attrition.

However, eliminating the two mid market accounts offset the difference between new sales and normal attrition, and we started the year with only a nominal increase in the paid worksite employee. Our guidance, which Doug will cover in a few minutes, factors in both the fewer units and the higher margin expectations associated with the decision to eliminate the two unprofitable accounts.

Now, as we look forward, I'd like to discuss our goals for growth, profitability and development for 2006. First, we anticipate a net increase in paid worksite employees of 1,200 to 1,400 per month. This increase is expected to come from an efficiency rate of 1.20 sales per salesperson on an average number of trained sales personnel of approximately 250. Also, we have combined that with the retention levels consistent with last year. As usual, we've not included any contribution from the net gain or loss within the client base from new hires or layoffs. Significant upside would also come from achieving an internal stretch goal that's not built into our guidance, but it is within our reach.

Over a year and a half ago, I set a possibility in front of our staff to hit 100,000 paid worksite employees at a $220 gross profit per worksite employee per month by our 20th anniversary, which is April of 2006. Now at that time, we had fewer than 80,000 worksite employees at just over $200 gross profit per month. As you can see from our 2005 results and our 2006 guidance, we have achieved what I thought would be the harder goal of over $220 of gross profit per employee, and we are closing in on the 100,000 employee goal.

Our guidance, however, indicates we would reach the 100,000 employee level in May or June at the 1,200 to 1,400 net monthly employee growth rates. In order to reach this target by our anniversary, we would have to stretch considerably, enrolling clients that have already been sold, keeping attrition below normal levels, and selling slightly more than our budget for the next two months. Although this is certainly possible, and we'll be working hard to achieve this, the likelihood is not at the level to build into a forecast. If we are successful, however, there would be significant upside to our unit growth outlook for the full year 2006.

Keep in mind the downside for us on the unit growth comes from one uncontrollable factor, which is when clients have more layoffs than new hires. Although the general labor market is solid, it's been difficult for clients to fill positions, and more employees are finding opportunities to change jobs. This means the net change in the current client employee base can be pretty bumpy and unpredictable in the near-term.

This month, we will celebrate our 20th anniversary by bringing employees and spouses to Houston, coinciding with our annual sales conference. Although this adds a significant one-time expense, this represents an important opportunity to bring everyone together to celebrate this milestone, but also to look everyone in the eye, and refocus on our mission for the future, and our short-term intermediate and long-term goals.

Now, before I address 2006 profitability targets, I'd like to comment on development plans for the year. Our most important developments include building our new benefits administration system, and advancing our new product and services initiatives, including our recent purchase of certain assets from Recruit Max. These assets included HR tools.com, the most successful online portal in the marketplace for human resource information, products, and services. The acquisition also included online and desktop products available through the site. This acquisition is part of our strategy to be the premium HR solution provider to the best small businesses in the country.

We plan to take the best attributes of our own HR Powerhouse site, the HR tool site and our marketplace site, and create a dynamic small business website destination. This site will be strategic to Administaff in three important ways. First, the site will demonstrate our human resource expertise, and extend our brand as the HR department for the best small businesses in America. Secondly, the site will offer products and services to small businesses, creating a new revenue stream for Administaff from our target client base. And third, it will provide opportunities for prospective PEO clients, to experience a point solution to a specific problem, as a taste of what Administaff can do in a full service solution.

The HR tools acquisition included online human resource solutions sold on a per-use or subscription basis, to create job descriptions, employment practices policies, and performance reviews. The purchase also included a broader and deeper desktop solution for each of these needs called descriptions now, policies now, and performance now. We plan to leverage our business relationships and alliances to grow these businesses, establish our brand, and generate more leads for full-service PEO clients.

As an example, we're currently rebranding the desktop products with Administaff, and plan to include a CD introduction to our PEO services called five reasons to choose Administaff, with every purchase of these products. We envision sales personnel also using these products as a sample during the sales process of what kind of tools are available from Administaff. We also plan to integrate these solutions into our Employee Service Center for current clients, adding new desired tools and features to our web-based human resource services platform, the Employee Service Center.

I expect these additions to be well-received, adding functionality, increasing value for the clients, and reducing service costs for Administaff. Although I'm very excited about the long-term prospects for this business, this year will be a transition year, and I do not expect the results of this operation to be material.

The second major development for 2006 is building our new benefits administration system. We have thoroughly researched benefits situations in the marketplace against our specific PEO needs. The results of that research is a multi-phased project to increase flexibility and efficiency, and provide more timely management information in this important area for our clients and for the Company. The first phase was completed at year-end and the other phases represent a significant percentage of our development resources for 2006.

Now I'd like to finish my remarks today by addressing our profitability objectives for 2006. In a few minutes, you will hear Richard and Doug provide details behind the drivers and the metrics that flow into our guidance released today. The picture that emerges from their discussions, is a strong year of profit growth at an unprecedented operating income per worksite employee. Our business model has been fine-tuned over the last couple of years, and is humming along beautifully.

Our guidance provided today infers double-digit unit growth, strong gross profit per worksite employee, and continued operating leverage. When you put it all together, these metrics imply a range of earnings growth for 2006 of approximately 25 to 35%. Our focus, as we move forward, will be to exceed the unit growth targets, to continue the steady upward trend in pricing, and manage direct costs to increase the surplus, and to control operating expenses in order to exceed these expectations.

At this point, I'd like to pass the call on to Richard.

Thank you, Paul. Today, I'm going to update you on the results of our pricing strategy for 2005, the direct cost trends that we see for 2006, and how together they will affect our gross profit per worksite employee per month for 2006.

As you know, our pricing model is built by using individual allocations designed to match each of the direct costs, plus a separate allocation for our HR services we call the markup, that is designed to generate most of our gross profit per worksite employee per month. Since all of our direct costs are not known in advance, we build in targeted allocations to cover those particular costs.

Our pricing strategy is to target these allocations to slightly exceed the direct costs and produce a net surplus, that when added to our markup produces the gross profit per worksite employee per month. At the outset of 2005, we plan to have the markup component of our service fee average $193 per worksite employee per month, without including the effect of any price increases on new or renewing business throughout the year.

Additionally, we conservatively estimated adding a surplus of about $10 per worksite employee per month, or 1% of the total allocated amount for direct costs. As the year has progressed, we have continued to report an increase in both our markup and our surplus. For the full year of 2005, our average service fee was just slightly above $195 per worksite employee per month, and our surplus was $26 per worksite employee per month. Or 3% of the $877 per worksite employee per month that we had allocated to cover those costs.

As Doug just reported, our direct costs for the quarter and the full year all came in lower than expected, which created the $26 per worksite employee per month surplus for the year. So, let me explain this surplus beginning with benefits.

For the quarter, our benefits costs that include healthcare, prescriptions, dental, vision, life and accident insurance, and disability coverage, came in at $591 per covered worksite employee per month. Approximately $12 lower than we had expected. Now, $4 of this business was due to lower-than-expected shop loss claims, that is claims that exceed $100,000 each. The remaining $8 was due to our current claims experience only trending up at a 3.9% year-over-year rate, which was lower than our fourth quarter estimate of 4.5%, and significantly lower than the market at large.

This better than average experience is due to three things. #1, the migration of employees from higher co-pay, low deductible PPO plans t lower co-pay, higher deductible PPO plans. #2, the conversion of United Healthcare PPO customers to their new Choice Plus network. And #3, a positive shift in the age of our covered worksite employee base.

The second contributor to our surplus came from lower than expected costs in our workers' compensation program. These costs are driven by the number of reported injuries, we call it the incidents rate, and the ultimate cost of those injuries, including both medical and lost time, i.e., the severity rate. Our independent actuary uses the data to determine the basis for how much we should reserve each quarter, to settle claims that are still open.

The estimate each quarter includes reserves for the current policy year plus another estimate for the prior policy years. We have continued to report lower trends in both the frequency and severity of claims incurred for those prior policies. It is this continuing effort by our people to manage and settle these claims at lower-than-expected reserve amounts, that produced the lower-than-expected costs for this quarter and throughout 2005.

Now for this current policy year, which began in October, our incident rate increased 14% over Q4 of last year, while our worksite employee base grew 16%. However, the average cost per claim offset this factor, therefore, the current policy results did not contribute to this quarter's surplus.

Now let's talk about our direct cost and surplus expectations for 2006, which are significantly more favorable at the outset than 2005. Let me begin with benefits. Unlike 2005, we made some healthcare plan design changes that went into effect January 1 of this year. We implement plan design changes every few years, to keep pace with healthcare trends. This year, our changes will include minor increases to co-pays for emergency room visits and prescription drugs.

Additionally, we made modest increases to the deductibles for several of our plans. When we factor in the planned design changes, coupled with previously-announced administrative fee reductions, the ongoing shift of PPO participants to the Choice Plus networks, and the annual resetting of participants' deductibles, we would expect to see our total benefits cost per covered worksite employee to increase 2 to 3% year-over-year in Q1 of 2006, and about 5 to 6% year-over-year for each of the subsequent quarters. We expect this level of increase to compare very favorably with marketplace trends, which our advisors have indicated could trend up about 9 to 10% year-over-year. Therefore, we will continue to increase the pricing allocations to match our expected cost trends, which should continue to be quite an advantage for our clients.

Our next direct cost to discuss is employer-related payroll taxes. Last quarter, I reported we were not expecting any significant rate increases for 2006. This is because the labor market has been stable for the last couple of years. We have now received almost all of our state unemployment tax rates for 2006. I am pleased to report that our weighted average forecasted rate for 2006 is almost exactly the same as our cost for 2005. Therefore, I am comfortable with our current allocations and would expect to have the same level of surplus contribution percentage as we did in 2005, but on a higher payroll base for 2006.

Now let me give you details regarding our current workers' compensation program and the associated direct cost expectations, for the new policy year that began October 1 of '05 and ends September 30 of 2006. Last quarter we announced the renewal of that workers' compensation policy with AIG. The success of the last two years' programs resulted in AIG reducing the future funding amounts, as well as a significant decrease in the administrative fees they charge to manage this program.

As mentioned a few minutes ago, the actuary lowered the loss estimates for the prior policy years, resulting in our expense for the fifth consecutive quarter being lower than previously-forecasted. When we consider the lower administrative fees coupled with current incident and severity rates from this quarter, we would expect our next four quarters of workers' compensation expense to be in the range of 1.10 to 1.15% of nonbonus payroll. With this level of expected cost, we do not plan to increase the associated pricing allocations.

So, let me summarize our 2006 plans for pricing and direct cost management and the implied gross profit per worksite employee forecasted range. Based on the starting point of our markup component, which is already known, and the nominal, if any, increases in our other allocations, we plan to increase the average markup per worksite employee per month from our current level of $195 to about $198 per worksite employee per month. The anticipated surplus component of our gross profit is a combination of the current pricing allocations, which are also already known, and our conservatively estimated cost for each direct cost item.

With the combination of plan design changes in healthcare, state unemployment tax expenses remaining flat, and the workers' compensation administrative cost reductions, we are beginning 2006 with a significantly higher expectation for our surplus, than the $10 per worksite employee per month starting point that we had in 2005. Therefore, we expect to produce a surplus per worksite employee per month in the $22 to $26 range. When we add the targeted $198 markup to this range, we expect the total gross profit per worksite employee per month estimate to be between $220 to $224 for the year.

Now, I will turn the call back over to Doug.

Thanks, Richard. As most of you are probably aware, we provided our preliminary 2006 outlook during our previous conference call. This outlook was provided prior to the completion of our fall sales campaign, year-end client renewal period, acquisition of HR tools, and finalization of our operating expense budget.

So, at this point, I'd like to provide more detailed guidance for the first quarter and full year 2006. Beginning with worksite employees, based upon Paul's earlier comments regarding the results of our fall sales campaign, and beginning of the year retention results, we expect average paid worksite employees, to be in a range of 95,500 to 96,000 for the first quarter. Thereafter, anticipating adding an average of 1,200 to 1,400 Worksite Employees each month, would result in an expected range of 101,000 to 102,000 average paid worksite employees per month for the full year.

Based on our pricing strategy and the expected direct cost trends, mentioned by Richard, we expect full year 2006 gross profit per worksite employee per month to be in the range of $220 to $224. Once again, this is a combination of $198 per worksite employee per month of expected markup on our HR services, and an expected surplus on our direct cost programs in a range of $22 to $26. For the first quarter, we expect gross profit per worksite employee per month to be in a range of $230 to $234. This is higher than our expected full year range, due to both an expected larger surplus on payroll taxes, which are higher earlier in the year, and our medical plan design changes, which should lower costs considerably for the first quarter.

Now let's discuss operating expenses beginning with the full year 2006. We have forecasted operating expenses in a range of 213 to $216 million. This expected 12% increase in operating expenses over 2005 would result in a decline on a per worksite employee per month basis from $180 in 2005 to approximately $176 for 2006. As for the operating expense details, we expect a 15% increase in cash compensation costs over 2005, and stock-based compensation of approximately $3.1 million. We expect depreciation and amortization expense to remain relatively flat when compared to 2005, between 15 and $16 million.

As for commission expense, we expect an increase between 10 and 11% over 2005, based upon forecasted worksite employee growth. Advertising expense is expected to increase in the same range, as we continue to invest in our marketing strategy to drive unit growth and expand our corporate branding. And general and administrative expenses are expected to increase at a lesser rate of approximately 8%. As for first quarter operating expenses, again this year, we will be holding our annual sales conference and incentive sales trip in February.

Additionally, we will be holding our 20th anniversary celebration during the first quarter. Expenses associated with these items will result in approximately $2.5 million of expected incremental first quarter expense over Q2 of 2006. In total, we expect operating expenses to be in a range of $53.3 million to $54 million for the first quarter. On a per worksite employee per month basis, this equates to a range of $185 to $188, compared to $188 in the first quarter of 2005.

We assume net interest income between $1.7 million and $2 million for the first quarter, and between $8.5 million and $9.5 million for the full year, based upon forecasted cash balances and current interest rates. We are forecasting an effective income tax rate of 37%, and expect average outstanding shares of $28.2 million for the first quarter and for the full year. Finally, we have budgeted capital expenditures at $13 million.

Now at this time, I would like to open the call up for some questions.

[ OPERATOR INSTRUCTIONS ] And your first question comes from the line of Tobey Sommer of SunTrust Robinson Humphrey. Please proceed.

Good morning, guys, this is Mike [Fitz] in for Tobey this morning. Congratulations on a good quarter.

Thank you very much.

I guess on the first question, regarding your guidance, is there any impact related to the recent acquisition included in there? And if so, what impact did that have, particularly in the gross profit line?

Actually, as I mentioned for this year, we don't consider that to be material. Certainly not the bottom line. It could have had a small contribution at the gross profit line, but generally pretty much immaterial to the whole game plan.

And is there anything you see on the horizon, that could hinder further margin expansion going forward?

I think, you know, if you look at big picture of where we are on that front, you know, there's three contributors. It's the markup, and it's the management of pricing and direct costs, which generates the surplus, and you know, I hope that next year we'll be talking about a third component, once we get the other product and services up and running. We should have a third contributor to gross profits.

More importantly probably for the near-term, is to look at that markup component. We're forecasting $198 for the year, up from 195 in '05, and that's driven by the pricing that we have in place, as we've come through this year-end transition in our client base.

So I think there's quite a bit of upside to that component. If we continue to move the markup up over the course of this year, the reason I think there is upside there is as Richard mentioned, we don't have allocation increases coming through for workers' comp benefits, allocations are going to be low because of the plan design changes, in terms of increasing pricing.

And that in environment, of course, payroll taxes don't need an increase at this point. So, we don't have much going on in terms of price escalation in the direct costs. That gives us an opportunity to move the margin up on the markup for our HR services. You know, we will see how that plays out, but that does leave us some upside on that front.

Okay. Great. And just a couple of more questions. Could you update us on your expansion plans? I know you said that you had mentioned in a previous call that maybe you were going to reinitiate that starting this year? And a follow-up to that, when you look at new geographic areas, are you comfortable with your current healthcare providers in those areas? Or do you think maybe there may be a need to add some additional providers?

Good question. Richard, you want to take the last part first?

You bet! In terms of the markets that we're in right now, we have experienced some really solid commitment by the carriers that we've got. There are a couple of markets that we will be looking at in 2006 to bolster our healthcare relationships, but I don't see those as a detriment for us moving into any of the markets that we're targeting expansion for this coming year. So, I feel like we're going to be just fine there.

We are going to add new offices this year, just as a reminder, an office to us is fixed at 8 salespeople and a district manager, a district administrator, and we have some new offices that will open in current markets, and some that will open in new markets.

We're targeting 4 to 6 over the course of the year. And I think we're in good shape on, you know, who our providers are, but when we see an opportunity, we won't be slow to move on it.

Great, thank you very much.

And your next question comes from the line of Jim Macdonald of First Analysis. Please proceed.

Very good. Thank you, guys.

Thank you, Jim.

Would you say in terms of the profitability that you're seeing now in your benefits that that were kind of at a peak level, or a high level? Can it get much better than this?

On the benefit side, you know, you always have to look at that in terms of where the market is going, what the contracts with the carriers are, and their relationship with the doctors and the hospitals. And so, you know, our continuation in that particular cost category, is, you know, we're just trying to maintain and make sure that our costs don't get ahead of our pricing allocations.

In the workers' compensation side of our business, you know, we've seen some definite surpluses generated in that area, and we feel like that we're probably at a normalized run rate right now, which is why we're forecasting our cost being at about 1.10% of nonbonus payroll.

And while we can still have, you know, some bits of upside in, or more surplus in that category, I don't think it's realistic to assume that. I think we are probably at a good spot right now, and we should probably maintain that level. So, we didn't bake it in.

Richard is referring to the cost component side. The fact that the pricing side of the allocations are known at this point means, this is why we're starting the year with 220 to 224 as a known surplus, if you will. Now, is there more upside? Our game plan is for that surplus to contribute $10 to $30. You know, we will see how it goes.

Obviously our people work every day to try to close out claims, you know, sooner and reduce the cost in each quarter, and so forth. That's still the game plan. But, you know, this is a very good run rate, and it's a good time for us to look at the other component, the 198, and keep moving that up.

Yes. And I assume that's taking into account kind of -- are you seeing some softening in California? It sounds like you built some conservativism in your workers' comp estimates for this year.

No, you know, our experience in California compared to where we were three years ago is excellent. And, you know, we like that market. Obviously they, you know, they have different sets of rules out there, and we have to -- you know, as an employer, we work real hard about doing, keeping track of what's going on and managing those claims appropriately and managing the risk out there, but we like that market. It's a good market for us.

Are you seeing some pricing deterioration?

You know what? We haven't.

Okay. Just quick question on sales force, where are we now, and where do you expect to be at the end of the year in sales men?

In terms if trained sales reps, if you go back, I think our target for year-end was 230. We averaged 227 for the fourth quarter. We did get up into December over the 230 number, but when we go into the first part of the year, there's usually a shakeout after the fall selling campaign. Because if you don't make it during that period, you're not going to make it generally. So we have had a little bit of a pullback on that number.

But I'm comfortable with our forecast for an average for the year of 250. That means you will go from the 225, 227 level on up to, you know, well above that 250 number for the full year, maybe in the 265 range or so. But I expect to average 250 trained sales reps for the year. That's what we're forecasting.

Just one last one, what are you going to do with all the cash you've got now?

That's for our Board to talk about at our next Board meeting. Definitely a topic for us. I think our priorities, you know, are pretty clear. You know, with the $65 million of cash flow this year offset by, you know, the capital spending, this business doesn't require a lot of capital spending, only $13 million for the coming year.

So, you know, we look at several things, things to think about, you know, do a small acquisition. Recently, if there are other acquisitions that are going to move our game plan forward, accelerate us in terms of our long-term plan, we would do some.

I think also, you know, we still have a mortgage on this facility and we're at the point where the interest rate that we're paying, there may be a benefit to pay that off, that's about $30 million. We also, you know, have what I think a dividend program that started out as one level and now is a much smaller yield percentage. We may look at that, as well.

So, those are the things we have in mind, you know, first and foremost is always move the business plan forward. You know, either in a more effective way, or a more efficient way, or a more profitable way, and then after that, it's just manage the funds appropriately.

Thanks very much.

And your next question comes from the line of Mark Marcon with Robert W. Baird and Company. Please proceed.

Good morning and congratulations on a great quarter and great year.

Thank you.

Just wondering with regards to the retention, you know, some impressive stats there, what would you attribute the increase in retention and increase in customer satisfaction?

There are a couple of things I think that are driving the increased satisfaction, basically that comes down to the real blocking and tackling in our service organization, in day by day communication with customers. I think if you look back over the last couple of years, we've made some major foundational changes that are allowing for more high-touch interaction.

You know, we implemented a call center approach for a lot of the routine calls, benefits, administration, questions and some of those types of activities, that's freed up more of our direct service contacts, to really be involved with the customer in their service delivery plans. We've had a nice increase over the last couple of years, a very healthy increase, where more and more of our accounts have a full blown service delivery plan in place that we're executing.

I hope we're making a difference with those customers. Now, as far as going forward, you know, we just implemented the client relationship management technology in the middle of the year last year, and got everybody on board with it.

So, we're now building a nice repository of information about our service interaction with customers, and we should be building some efficiency again, allowing us to have -- I'm sorry, our service providers, to have, you know, richer interaction with the client. That's what drives those satisfaction numbers. It's really what distinguishes us from anybody else in the marketplace, and it's what our target customer, the best small businesses in the country, what they really want and what they're willing to pay for it.

What are you assuming in terms of your guidance, in terms of the ending worksite employees, what are you assuming in terms of a client retention rate for 2006?

You know, again, if you look at our history, normally it retains 78 to 80% of our client base from one year to the next. Last year was 79.5. I don't see why we won't be in the same kind of range. You have to look at one off of us determining and eliminating those couple of large accounts that didn't really fit the picture. But, you know, other than that, you know, we're expect to be in that range.

Okay. And as it relates to those clients, do you know if they brought the administrative function in-house or did they switch over to somebody else?

You know, I don't know. I think they brought it in house.

Okay. And with regards to workers' comp, there is a legal change in the state of Florida, as I'm sure you're well more aware than I am, is that going to have any impact, with regards to potential accrual reversals, should we think about that? Or is that not going to have in a impact?

No, from what we know about what's going on down there, we don't see any adverse impact coming.

Okay. Are you going to change the state mandated rate or --?

You know, we will you know, because of the way our program works, it's a loss sensitive kind of program and so, you know, we're going to continue with our experiences in the pricing side, but we've also got to obviously, you know, make sure that we comply with all the laws that our carrier will help guide us through.

Okay. So, that shouldn't have much of an impact either way?

Well, it won't, Mark. And part of the reason has to do with the in fact that we don't have a lot of business down there. So, we just don't see that as a very big issue for us.

Okay. And then with regards to the increase in the sales efficiency, what would you attribute that to? And, you know, it's been very impressive, do you think there's going to be any impact the all in terms of sales efficiency, with some of the other competitors getting more excited about your space, I'm talking about, you know, ADP and Paychex, talked about ramping up a little bit more. Are most of the sales kind of missionary sales? Or are you seeing more competitive situations? It seems like you're not, based on your sales efficiency numbers.

Remember, our approach is very much a targeted approach so we are -- you know, we spend quite a bit in terms of time, effort and money to locate the customer that fits best in our environment. I've said it many times, but the ones that fit here would be terribly disappointed going to any one of those folks. And it's just, that's just the way it is.

In fact, I just got an e-mail yesterday about a competitive account where we won the account against one of those that you just mentioned, and when they actually lined up what we would do for what they would pay, compared to what the others would do or better yet said maybe what they wouldn't do, it just made, you know, sense this is where they belong, this is what they want. And we do a good job of differentiating that out there.

Honestly, that competitive type of situation is the exception, not the rule. There are people out there that I would say probably more so now than ever before, I view Administaff as a category of one.

Great, well, congratulations and continued success.

Thank you.

And your next question comes from the line of Jeremy Davis with Credit Suisse First Boston. Please proceed.

Hi, guys, congratulations on the quarter.

Thanks, Jeremy.

Just looking for an update on I guess your mid market strategy, you certainly eluded to it in your prepared comments, and just wondering if you're seeing a shift in the marketplace, in terms of their receptivity at that size of a client, and what kind of led to them being priced out at a price point, that you later determined wasn't probably acceptable.

Yes, well, remember the two accounts that we eliminated were brought on before the mid-market initiative, at a lower markup than what we have been able to achieve once we put the initiative in place. So, we're very excited about the mid market initiative. You know, we had a 50% increase last year over the year prior, but remember, it wasn't until mid-year that we went from two salespeople to eight and, you know, it's quite a long cycle to ramp up, in terms of the actual sales cycle on a specific account.

So, I look for this year to be a nice breakout year for middle market. We've got a great team of people there. We've developed some awesome tools that help a customer validate their need for a more sophisticated HR function, and our delivery to that size customer is getting better all the time. We still have a few gaps there, but I'm very optimistic about it. I think the receptivity of mid-market accounts to this approach is very encouraging.

Okay, thank you, guys.

And your last question comes from the line of Michael Baker from Raymond James. Please proceed.

Thank you. Just a follow-up on the mid-market. What percentage contribution are you looking from in the mid-market, as it relates to your worksite employee targets for the year? For '06?

That's a good question. You know, it was 4,800 on 42,000 last year, just looking at it from a sales perspective.

You know, I would expect that percentage to be up, you know, slightly, when you're working on a new initiative, we don't like to build that in as something we're relying on as much. But I expect to be a little more than it was this year. That could be some upside if we do really well, it would be a bigger percentage.

As you're kind of going through the process, where are you finding the sweet spot, in terms of range of worksite employee? Or put differently, how do you define your mid-market size from a client perspective?

Yes, we describe that as 150 to 2,000 employees.

And then, in terms of as you look at that segment, do you find that you change the offering any? In other words, do you find that the insurance market is more efficient, and therefore, they're less willing to take that value proposition?

No, actually we thought that might be the case, that's the kind of supposition you have before you do the research and start into it, but, you know, it still makes sense for someone with 1,000 employees, to become a part of somebody with 100,000, and they don't have the same way to manage a benefit plan like we do. So it is an advantage to them.

I think also though, what makes us a better fit for these middle market accounts is, you know, is that we have an approach of customizing the service plan for every account, even the small ones. So, obviously each middle market account is truly a custom set of services. It's a service plan that is a case of one. It fits only that customer. But that's what we know how to do. That is a no-brainer for us.

So, to go into these accounts and to evaluate their situation, and line up our service offering to be a hand and glove fit for that larger customer, that's nothing new for us, and we're finding, we're having quite a bit of success with it.

I was going to add, you know, one of the things that's really positive about our business model is we have a national footprint. We're everywhere in the United States.

And so when you have a customer of 1,000 employee range, that's got offices in multiple states, we already have the infrastructure in place to manage that, from not only just the healthcare side, the workers' compensation side, all the states that they have employees in, so,unemployment tax, payroll side, everything is done, we've got the infrastructure for that. And that allows them to actually, in a lot of cases, reduce some of their costs. So, it makes sense to try to look at this as an offering when you're a multistate employer.

Thank you very much.

Well, we'd like to thank everyone for joining us today. It's been a good call. We appreciate your interest and your questions, and we'll see you next quarter.

Ladies and gentlemen, this concludes your participation in today's conference. You may now disconnect your lines. Have a wonderful day.