Insperity Inc (NSP) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2006 Administaff's earnings conference call. My name is Michelle, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] And as a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today, Mr. Paul Sarvadi, Chairman of the Board and CEO of Administaff. Please proceed.

In fact, this is Doug Sharp, the CFO, and I'll start the call off, and we'll talk about how we are going to proceed with the call. First of all, I would like to thank you for joining this morning.

Before we begin, I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson, or myself 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, projects, believes, likely, probably, goal, objective, outlook, guidance, appears, targets, 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 the Company's filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements.

Now let me take a minute to outline our plan for this morning's call. First, I'll discuss our third quarter financial results. Richard will then discuss recent trends in our direct costs, including benefits, worker's compensation and payroll taxes, and how these trends impact pricing and gross profit. Then Paul will add his comments about the quarter and the remainder of 2006, and some preliminary comments on 2007. I'll return to provide financial guidance for the fourth quarter, and also provide some preliminary guidance for 2007. We will then end the call with a question-and-answer session.

Now let me begin by summarizing the financial highlights from the quarter. We reported a 65% increase in third quarter earnings per share to $0.43 on a 19% increase in revenues, and a 24% increase in gross profit. Consistent with the 6 previous quarters, third quarter's earnings were driven by double-digit unit growth, pricing strength and effective direct cost management. Paid worksite employees increased 13%, within our expected range, while gross profit per worksite employee per month averaged $234, significantly above the high end of our guidance.

These strong results have given us the opportunity to further invest in growth, service, and product initiatives over the past couple of quarters. These initiatives included a 13% increase in the number of trained sales reps to an average of 253 for the third quarter. Even with the various investments, we achieved a 36% increase in operating income per worksite employee per month over Q3 of 2005, to an average of $53 for the quarter.

Since the beginning of the year, we have generated EBITDA of approximately $65 million, which compares to $43 million for the first 3 quarters of 2005. Working capital has increased by $20 million since December 31, 2005, to a balance of $113 million. This is in spite of the payoff of our $32 million mortgage on our corporate headquarters during the second quarter, and repurchase of 605,000 shares at a cost of $24 million.

Now let's review the details of our third quarter results. The average number of paid worksite employees per month increased 13% from 90,493 in the third quarter of 2005, to 102,530 this quarter, at the low end of our expected range. Paul will provide further details on the drivers of our unit growth, including sales, client retention, and net growth within the existing client base in a few minutes. The 13% unit growth, combined with a 5% increase in revenue per worksite employee per month resulted in a 19% increase in revenue over Q3 of 2005 to approximately $338 million.

Looking at third quarter revenue contribution in growth by region, the Southeast region, which represents 10% of total revenue, grew by 29%; the Northeast region, which represents 18% of total revenue, grew by 38%; the Central region, which represents 14% of total revenue, grew by 25%; the West region, which represents 22% of total revenue, grew by 15%; and the Southwest region, which represents 36% of total revenue, grew by 8%. The growth rate in the Southwest region continues to reflect the termination of the 2 big market accounts in January that was sold prior to our mid-market initiative at below standard pricing. In addition our sales rep hiring has been in other areas of the country to mitigate any risk associated with a single geographic region.

Now let's shift to gross profit. As I mentioned a moment ago, gross profit per worksite employee per month for the quarter was $234, up significantly from the $214 reported in Q3 of 2005. This was also above our expected range of $219 to $223, as higher surpluses were generated from our direct cost programs. We have also continued to increase the mark-up on our HR services over the course of this year, as initially forecasted.

Now let's take a couple of minutes to talk about our direct costs, beginning with benefits. You may recall from last quarter's conference call, that our benefit costs have been running near the high end of our expected range for the first half of 2006, due primarily to a couple of factors. These included a larger than expected migration to lower deductible-type plans at the beginning of the year, and an unusually large shock loss claim during the second quarter. We further commented that our detailed analysis of the plan indicated normal hospital utilization and only slight shifts in the demographics of our worksite employees.

As a result we conservatively forecasted benefit cost increase of 5% to 6% for the full year, expecting to be near the high end of this range for the latter half of 2006. The good news is that third quarter benefit costs per covered employee per month increased only 3.4% over the 2005 period. The favorable third quarter results in our benefit plans were complemented by the ongoing favorable trends in our worker's compensation program. Worker's compensation costs were 0.90% of non-bonus payroll for the quarter, slightly below both our Q2 costs and forecasted Q3 costs of 0.95%.

Updated actuarial loss estimates continue to reflect these favorable claim trends and resulted in a $2.8 million reduction in worker's compensation costs for changes in estimated losses and tax surcharges. Payroll taxes as a percentage of total payroll cost declined from 6.87% in Q3 of 2005, to 6.7% -- 6.67% in Q3 of this year, as more worksite employees reached their taxable wage limits earlier in 2006, due to increased payroll averages and bonus levels.

In a few minutes, Richard will provide further details on both the recent and projected trends in our direct costs and the impact of such trends on our pricing strategy. So now let's move on to operating expenses which totaled $55.6 million for the quarter. This was about $1.4 million above the high end of our expected range, which reflects the amount of an additional accrual for incentive compensation tied to our improved operating results. The largest component of our incentive compensation program is tied to the achievement of operating income per worksite employee at predetermined threshold, target and maximum levels.

Under this program, incentive compensation is adjusted such that both shareholders and employees are appropriately compensated with our improved financial performance. When combined with divisional and individual goals, total estimated 2006 incentive compensation is 10% of total corporate compensation, which is consistent with 2005. The year-over-year increase in incentive compensation expense accounts for 3% of the reported 17% increase in operating expenses over Q3 of 2005.

In addition, operating expenses have been impacted by our mid-year decision to accelerate the hiring of sales and service personnel, and further develop and market our recently acquired product offering, HRTools. This quarter's expenses also include travel costs associated with our fall sales campaign kickoff, which was canceled in the 2005 period due to Hurricane Rita. Therefore, the bottom line is that we continue to see operating expense leverage in the business over the long term. However, we have capitalized on our strong 2006 operating results to further invest in the growth of the business.

As for interest income, in the third quarter of 2006 we reported net interest income of approximately $2.6 million compared to $1.1 million in Q3 of 2005, due to higher invested balances and rising interest rates. Interest income came in below our forecasted range, as we utilized a portion of our available cash to repurchase shares during the quarter. Also, we shifted some investments into tax exempt securities, which lowers our interest income, but has a favorable impact on our effective income tax rate.

Now let's review several key balance sheet and cash flow items. As I mentioned earlier, working capital has increased by approximately $20 million since December 31st, 2005, to $113 million, in spite of the following year-to-date cash outlays: The payoff of the mortgage on our corporate headquarters totaling $32 million, repurchase of 605,000 shares at a cost of $24 million, cash dividends totaling $7.5 million, and capital expenditures of approximately $10 million. These outlays were more than offset by year-to-date EBITDA of $65 million, proceeds and tax benefit from the exercise of stock options of $26 million, and reimbursement from our worker's compensation program of $30 million.

Now, before providing our financial guidance, I would like to turn the call over to Richard for his comments.

Thank you, Doug. This morning, I'm going to comment briefly on the details of our third quarter gross profit results. Then I will explain how we see our pricing strategy and direct cost trends affect our gross profit per worksite employee per month for Q4 and 2007. 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 that our mark-up. And that is designed to generate most of our gross profit per worksite employee per month.

Since all of these direct costs are not known in advance, we build in targeted allocations to cover those particular costs. Our pricing strategy is to have these allocations match or exceed the direct costs, and produce a surplus of approximately 3%, that when added to our mark-up, produces the desired gross profit per worksite employee per month.

As Doug just reported, our gross profit per worksite employee per month of $234 was above the top end of our forecasted range. These results came from achieving our targeted average mark-up of $198 per worksite employee per month, and generating a surplus of $35 per worksite employee per month, or approximately 3.7% of total direct cost allocations. For Q3, we had forecasted a $23 per worksite employee per month surplus. The better than expected surplus of $12 per worksite employee per month came from slightly higher allocations and lower than expected costs in all 3 of our primary direct costs. Let me explain each one.

The surplus in the payroll tax cost center has continued to come from better than expected state unemployment tax rates that we received earlier in 2006 compared to our pricing allocations, and contributed $2 of the $12. Our healthcare claims cost trended lower than expected, and we also did not have any significant shock loss claims like we did in the second quarter of this year.

Additionally, price increases that began in the second quarter contributed to the better than expected gross profit results. For the current policy that ended on 9-30-2006, our worker's compensation claim count, i.e. the incidence rate, is up 2% on a worksite employee base that has grown 14%. The dollar amount of those claims, i.e. the severity rate, has declined by 2.7%.

Now last quarter, I had reported that the incidence rate was up 5.82% and the severity rate was down 1.2%. So you can see that our third quarter results in this direct cost area were very good, and contributed $4 per worksite employee per month to the better than expected surplus. I am very pleased with the solid execution by our pricing and direct cost management group that continues to produce such great results.

Now moving to the fourth quarter, we see a very similar outcome for gross profit like we did this quarter. On the pricing side, the mark-up has continued to increase each quarter throughout the year, from less than $196 per worksite employee per month, to our expected level of more than $199 per worksite employee per month for the fourth quarter. The surplus generated all year from our payroll tax cost center should continue because the state unemployment tax rates that were assigned at the beginning of 2006 were lower than originally forecasted and priced.

We have said all year that our benefit costs should increase 5% to 6% per covered worksite employee per month. Year-to-date these costs are up 4.24%. We are not aware of any issues that would cause us to alter our forecasts. So we would expect benefit costs per covered employee to increase about 1% to 1.5% sequentially, and result in a 5% annual increase. At this level, we should not have any negative effect on gross profit per worksite employee per month.

The surpluses generated from the worker's compensation program should continue into the fourth quarter and beyond, due to cost reductions in the following areas of the program: Our new policy with AIG that went into effect on October 1st has lower administrative fees than the previous year's policy. The other cost reductions come from our ongoing successful efforts in managing the incidence and severity of worker's compensation claims. Therefore, current period reserve estimates should be lower.

Additionally, we would also expect to see some future reductions to prior policy year reserves as those claims get closed. So, we are currently going to forecast worker's compensation expense to be 0.9% to 0.95% of non-bonus payroll for Q4, similar to the third quarter results. This expected level of expense is further validated by the 29% reduction in funding rates proposed by AIG and agreed to in this recent renewal. When you add it all up, gross profit per worksite employee per month should be in the $235 to $238 range for the fourth quarter, and punctuate another great year for Administaff.

Now, let me share with you what we currently see for pricing and direct cost expectations for 2007. On the mark-up side of gross profit, we have already begun renewing customers for next year. In a few minutes, Paul will share with you the positive trends we are seeing in the marketplace for new business and how they factor into pricing.

So as for the average mark-up component of gross profit, we see it going up from the current level of $198, to about $201 per worksite employee per month for 2007. Looking at the surplus component of our gross profit, we see a total contribution in the same range that we have right now. However, the expected contribution by cost center will be different than they have been in 2006.

Let me explain, beginning with the benefits area. We currently have a network of 8 health insurance carriers that provide coverage through our worksite employee base from coast to coast. United Healthcare is our national PPO provider in all states, except California. They also have a Choice Plus product that operates like an HMO.

We have about 78% of our total covered worksite employee base enrolled in 1 of these 2 plans. The remaining 22% of our covered worksite employee base are enrolled in PPO and HMO plans with the other 7 carriers. Each of these 7 carriers provides us with a fixed dollar premium per covered worksite employee per month for the full year.

We have now completed the negotiations with all of these 7 carriers, and have rates for 2007 that will result in a step-up of our cost per covered employee beginning in January. We have made very minor changes to the United Healthcare offerings for 2007. Therefore, this component of our benefits cost is expected to increase 7% to 8% for 2007 over 2006, which is substantially lower than what most small businesses should experience.

The total combined cost step-up in the first quarter of 2007 should be about 7% higher than the first quarter of 2006, and maintain that level of increase each quarter of the year for 2007. From a pricing and matching perspective, we have begun to build in increases in benefit allocations for new and renewing businesses that will match the cost for the full year. However, the step-up in cost beginning in January will -- should minimize any contribution to gross profit earlier in the year.

Now let's discuss employee-related payroll taxes. At this time, we have not received our 2007 state unemployment tax rates. Most states do not assign these rates until January. Therefore, for several years, we have used Price Waterhouse Coopers to assist us in forecasting these rates.

Again, this year we expect state rates should come down significantly, because overall unemployment rates have been down for an extended period of time. So our cost, as a percent of payroll, could likely be lower than 2006. From a pricing perspective, we will slightly reduce our allocations in several states, but the surplus in this cost center will likely contribute more to gross profit in 2007 than it did in 2006. Last, but not least, the surplus contribution from our worker's compensation program should continue throughout 2007, based on the factors I mentioned a few minutes ago, that positively affect us beginning in this current quarter, fourth quarter of 2006.

So in summary, as we look to 2007, we see the average mark-up per worksite employee per month to gradually increase throughout the year from an average of $198 to $201. As for the surplus for the full year, we continue to expect to see a solid $29 to $33 per worksite employee per month range, or approximately 3% of total direct cost allocations.

Now at this point, I would like to turn the call over to Paul.

Thank you, Richard. Today I'll comment on our effective execution of our 2006 game plan year-to-date. Then I'll provide some key success factors that during this quarter, which set up the starting point for growth and profitability for 2007. And then finally, I'll describe our plan to increase the value of Administaff in the years ahead. The third quarter was very good across the board, from sales and service, to direct cost management and new product development.

We are continuing to see double-digit unit revenue and gross profit growth, combined with operating expense control, delivering impressive earnings growth of 65% over last year. The highlight for the quarter was the progress we made concerning our leading indicator for future growth, the number of trained sales personnel. During the quarter we averaged 253 trained sales personnel, a 13% increase over the same period last year, and a 6% sequential increase from 238 last quarter.

In addition, we were successful in growing the sales staff, while slightly improving sales efficiency. Sales for the period were at 100% of internal targets, with sales efficiency exceeding our 1.0 sales per sales person per month requirement. Sales metrics continue to be on track, with a 50% census to first call rate and a 22% closing rate, in spite of the increase in new sales staff.

Our mid-market initiative is continuing to develop some early successes. We closed 4 accounts in the quarter, totaling over 1,200 employees, most of which will roll into the paid worksite employee account in January. We also have a strong pipeline and are hopeful this effort will make a nice contribution to our fall campaign. Our unit growth overall came in slightly above the low end of our expected range. The reason for this was primarily a 1-month aberration in [inaudible] attrition in July, which included 1 large account with 250 employees.

The average monthly attrition rate was 1.8% for the third quarter, slightly higher than the 1.5% in the second quarter, which is more line with our historical norms. However, the monthly numbers were 2.7% in July, followed by 1.4% in both August and September. We're continuing to see strong service satisfaction levels, with an average of 91% for the third quarter, and our visibility into future client terminations indicates our full year client retention should be at expected levels.

I also mentioned last quarter we add nearly 1,000 employees that appeared to be summer help, that would likely depart during the third quarter. These employees did in fact exit the base, mostly in September. And as a result, the net gain or loss of paid worksite employees for new hires and layoffs in the base was a slight positive in 2 months, and a slight negative in 1 month during the quarter.

The compensation data we use to gauge employment trends continue to indicate high, and in many cases, unmet demand for skilled positions. Overtime as a percentage of base pay, was over 10% for the third quarter, indicating client operations at full capacity. Average pay increases are running more than 6.5% over last year, and commissions are up 5%. The sentiment from recent survey information, combined with this compensation data, indicates we are in a very stable employment and general economic environment, which provides a nice backdrop for our fall campaign.

We kicked off our fall campaign this year in early September, and introduced new television and radio ads featuring Arnold Palmer and local clients across our 22 markets. Although we are still very early in the campaign, we have seen the increase in activity associated with the increased marketing programs, which is the first sign of a successful fall campaign. We also announced and implemented an improvement in sales compensation during the fall campaign kickoff, which is designed to reduce turnover of sales staff.

Previously, sales personnel began with a base level of compensation which included 2 components, a salary and a draw against future commissions. Salespeople also earned commission in the form of an enrollment bonus with each sale and a residual income based upon the mark-up level of each client. The residual commission earned was the source of funds to credit against the draw.

Although salespeople can earn significant variable pay from enrollment bonuses, the net effect of this plan was new sales personnel do not see an increase in base pay from residual commissions for a considerable length of time. The new plan eliminates the draw component, and the total base pay level is all salary. Now the salesperson sees their residual pay begin to build from the very first sale.

Although this change will create a higher than normal increase in commission expense over the next year, we believe this investment will be offset by lower turnover in the future. However, if the reaction from the sales staff at our fall campaign kickoff is any indication, the payoff may come even sooner, in the form of increased fall campaign sales.

Now as we look ahead to 2007, it's important to look at key success factors during the fourth quarter that lay the foundation for next year. The starting point in the number of paid worksite employees in January is the foundation for growth and profitability in our business model. The key to a solid starting point each year is a successful fall campaign in both new sales and client retention.

We have held a fall campaign every year to leverage the prospect's inclination to join Administaff as a new year begins. This means we have more renewals of accounts on January -- in January than any other month of the year. We typically see a 15% change in employee base, driven by a 6% to 8% attrition rate and an 8% to 9% new sales rate.

This fall campaign, we have an excellent opportunity to accelerate our unit growth rate as we enter 2007. Last year, we essentially had no increase in paid worksite employees from December 2005 to January 2006, due to a decision to eliminate 2 large accounts that were inadequately priced. We do not have this situation this year, so we have a chance to have a nice step-up in January, and start the year with a nice increase in our unit growth rate.

Although it is certainly way too early to predict a starting point for January, we are comfortable providing a preliminary unit growth range for the full year of 2007 of 14% to 16%. The low end of this range assumes a monthly increase in 2007 of 1,200 worksite employees. The high end assumes 800 employees more in January above the low case, and a 1,400 employee monthly net gain thereafter.

These targets certainly fit within our historical metrics for sales and retention at the level of trained sales staff we have today. Upside to these preliminary unit growth numbers would come from either a better starting point due to a more successful fall campaign, or an increase in trained sales staff into next year, or improved sales efficiency or client retention. The risk to this range would be from a significant economic slow-down or terrorist attack introducing substantial uncertainty in the marketplace.

Now, since our business model creates a recurring revenue stream, a large percentage of our gross profit for next year is determined by the number and pricing of the worksite employees paid in January. As you have heard from Richard, we have significant visibility into our pricing for both the mark-up and direct cost for next year. Our preliminary look into 2007 gross profit indicates a $201 mark-up per employee per month, and a 3% surplus between the pricing and the cost for payroll taxes, benefits and worker's compensation of approximately $29 to $33.

Historically, these have been the only 2 contributors to gross profit. However, we have been working to add a third factor. We have made solid progress on our strategy for providing other goods and services to our prospective, current, and former clients and employees. And as a result, we are including approximately $2 per worksite employee per month from this new factor into our preliminary gross profit per employee per month outlook of a total of $232 to $236 for 2007.

This additional revenue will come primarily from our HRTools.com site and associated point solution HR offerings to prospects. Other contributors will include offerings to current customers included in our Employee Service Center marketplace, and new fee service offerings we plan to introduce over the course of next year.

One other area of emphasis over the last couple of years that we have had, has been Administaff Retirement Services. We entered the 401K plan record keeping business with 3 objectives in mind. The first objective was to ensure compliance with new IRS requirements on 401K plans provided within our specific industry to client companies.

The second objective was to lower costs for providing these plans for clients and employees. And thirdly, was to establish a foundation for providing other wealth management programs for clients and worksite employees, and add revenues-- add to Administaff's revenues and profits.

The first goal was achieved in the first year of administering the plans, converting 3 plans into thousands to meet IRS requirements. I am pleased to announce today that we have achieved another significant milestone in this area. Our second goal of reducing cost, has reached an unprecedented level. In our unique role as a co-employer, record keeper income is used to offset plan administration costs that are typically passed on to participants as quarterly fees.

In the third quarter, income Administaff earned by replacing an outside record keeper has offset all costs associated with managing these plans. This means our clients and worksite employees have the only no-cost 401K plan that I know of.

All income earned by employee funds set aside for retirement in their 401K plans, is theirs to keep. This is a tremendous, unique advantage for Administaff clients only. We will begin now to move forward on our third objective to establish an income stream for the Company by providing expanded wealth management services to our small business owner/clients and worksite employees.

I believe Administaff is in a powerful and rare position today. And in closing, I would like to describe the opportunity I see. First, we have a proven business model, generating more than $90 million per year in EBITDA, with a base level capital requirement of less than $15 million. We have a large unpenetrated market, with 600,000 perfect fit clients, of which we are serving less than 6,000 today.

We have demonstrated consistent performance and execution, producing optimal levels of growth and profitability that can continue for many years to come by just doing what we have proven we know how to do. We are the premium brand in the growing HR outsourcing marketplace, and we have effectively established a niche where the profits are the highest and the risks are controlled. We have a management team and staff that are the envy of our industry, that have demonstrated competency in managing growth, service, cost, and risk.

We have a strong client base, comprised of the best small to medium sized businesses in each market. We have industry-leading service satisfaction levels, providing an unmatched product offering. We have a plan to layer in other offerings to prospects in current and former clients and worksite employees that add pricing and margin improvement into the future.

But perhaps the most meaningful opportunity we have from an investor point of view is the low valuation for the Company, in spite of the premium valuation characteristics I just described. When the third quarter ended, the market cap for Administaff was less than $1 billion, just 10 times 2006 EBITDA, and barely over 4 times current book value. Our investors can look forward to value appreciation, driven by both double-digit earnings growth and higher multiples, as we continue on our established path from small cap, to mid cap, to a large cap Company.

At this point, I would like to pass the call back to Doug to summarize our guidance for the fourth quarter and our preliminary outlook for 2007.

Thanks, Paul. Now let's discuss our guidance for the fourth quarter. We expect average paid worksite employees per month to be in a range of 105,500 to 106,000. As a reminder, clients sold during the fourth quarter of any year, and in particular, our fall sales campaign, are typically converted to paid worksite employees during the first quarter of the following year.

As for gross profit, we expect to be in a range of $235 to $238 per worksite employee per month for the quarter. This assumes a slight increase in the mark-up on our HR services and a surplus from our direct cost programs, consistent with the third-- the third quarter. Fourth quarter operating expenses are expected to be in a range of $57.8 million to $58.3 million. This is up from third quarter operating expenses of approximately $55.6 million.

We are forecasting an increase of approximately $1.6 million in advertising costs related to our fall sales campaign and sponsored PGA Champions Tour golf event. Additionally we are expecting a $1.3 million increase in compensation expense associated with additional sales and service personnel, and additional incentive compensation to be accrued only upon achieving forecasted results.

These increases from Q3 are expected to be partially offset by reductions in general and administrative costs, totaling approximately $450,000. We expect net interest income to be between $2.6 million and $2.8 million, and are forecasting 28.1 million average diluted outstanding shares for the fourth quarter, based upon our current share price.

Now before we open up the call for questions, I'd like to comment on our preliminary outlook for 2007. We plan to provide more detailed guidance during next quarter's conference call, based upon the results of our 2006 fall sales campaign, and the year-end client renewal period, which typically results in a 15% turnover in the worksite employee base.

As Richard and Paul mentioned earlier, our preliminary 2007 outlook includes an increase in the average paid worksite employees of 14% to 16%, and gross profit per worksite employee per month in a range of $232 to $236. As for the quarterly trend in this key metric, we expect gross profit per worksite employee to have a similar pattern as 2006. As for operating expenses, we are expecting a 13% to 14% increase, of which 2% relates to stock-based compensation. Operating expenses will also be impacted by the staffing run rate associated with our mid-year 2006 decision to accelerate the hiring of sales reps and service providers.

Also, for the first half of 2007, we have budgeted further increases for sales rep head count, associated with new sales office openings. Similar to prior years we are budgeting for a step-up in operating expenses from the fourth quarter of 2006 to the first quarter of 2007. Included in this projected $2.5 million step-up are costs associated with our annual sales convention and employee incentive trip, and an increase in payroll taxes related to the restart of taxable wages of our corporate employees. We will further refine our 2007 guidance during our year end conference call, scheduled for early February.

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

[OPERATOR INSTRUCTIONS] Mark Marcon, R. W. Baird

Good morning, and congratulations on the terrific results.

Thank you.

I was wondering with regards to the gross profit per worksite employee guidance, what sort of increase are you assuming in terms of your healthcare costs? And how should we think about worker's comp looking out towards next year?

Yes, Mark, as I mentioned in my prepared remarks, we are expecting in the total cost of healthcare, increases in the 7% to 8% for the full year, and that includes a combination of the step-up that we're going to get from the 7 carriers where we have fixed rate premium contracts. And then our plan with United, which is obviously a larger part of our business. We look at and get information from them regarding our actual experience and what they are expecting those trends to be for next year. And realizing that we're not making any significant changes to the plan for 2007. So a 7 to 8% in the total package seems to be certainly very much in line and a really good opportunity for our clients and worksite employees as we go into 2007.

On the worker's compensation side, we talk about all of the factors that have driven down cost beginning in the fourth quarter, because we just renewed our policy with AIG. They reduced the administrative costs, or the administrative fee component of the program for 2007, and that begins right now, beginning October 1st. And then in addition to that, we have also seen a continued reduction in the incidence rate and severity rate of claims. So when you kind of put all of that together, we're expecting kind of a run rate of in the 0.9% to .95% of non-bonus payroll as our cost for the fourth quarter, and then on in to next year, which is similar to where we are right now.

Great. And then I got onto the call a little bit late, so I apologize if this was asked before. But in terms of, you ramped up the sales force. Can you talk about the productivity levels with regards to new folks? I know you were working on some areas of improvement there. Can you give us any color there?

Yes, I'll tell you, I'm really excited about it. It looks like our significant efforts we made in the training area and also in the recruiting area to better match who we are hiring, and even the incentive of new sales staff to get on the fast-start program, all of those things appear to be working well. We were able to increase the number of trained sales reps to 253 on an average for the fourth quarter.

Keep in mind, in order to accomplish our objectives, we were trying to reach 250 by the end of the quarter. So we're really running ahead on that number. And the other thing that is really the trick, if you can pull it off, is to have a pretty significant step-up in growth and not see a decline in sales efficiency. Because you have a lot of new people coming on.

Yes.

Well, we had actually a 6% sequential increase, and 13% year-over-year. And for the full year, we actually have a 2% improvement in sales efficiency. So, our folks are doing a great job out there, and we have got a good balance between tenured reps and new reps.

We're a little over 40% are over -- actually I think it's 43% over the 18 months, about 40% less than 12, and you have got the rest in the middle. So we have got good throughput of sales staff moving through. And you also really kind of have a wave about to move through that critical time period. So with the fall campaign ahead of us, that gives people an opportunity to really have some success and should leverage us into next year.

So you are maintaining that 1.2 sales efficiency ratio? And is that what you are expecting for next year, or are you expecting even further improvements in productivity?

I think it's better for us when we're looking at just preliminary numbers for next year, not no look at any improvement in sales efficiency, especially when you are growing the sales force at the rate we are. So we haven't included any increase in efficiency into next year. I think that would be something you would want to leave as upside.

Jim MacDonald, First Analysis.

Good quarter, guys.

Thanks, Jim.

Maybe I missed this, but you usually give out -- I think you gave a percentage, but the healthcare cost per covered employee, and the percent covered employees?

Yes, Jim, I think we talked about---- I think you are referring to the third quarter, and it was an increase of 3.4% over the third quarter, the prior year. And the actual amount was $623.

623, and percent covered?

72%.

72%. And you talked -- it sounded like you were going to tell us that you are making some change with the 7 carriers. But I really didn't detect -- it is still a fixed-price policy?

Yes, that's correct, Jim.

There's no fundamental change in the -- it's not going to more self-insured or more kind of a variable basis?

No, not at all. And remember, we don't even have a self-insured plan with the eighth carrier, which is United. We are not allowed to have a self-insured plan. They all have to be fully insured. It's just how you -- how you are assigned the costs and the premiums are different.

The 7 carriers have a fixed rate that is negotiated and goes into effect in January of each year. And it's the same rate for the full year. The United plan, which covers the biggest portion of our business, is an experience-rated plan. And so what you are really looking at there, is what are the costs going to be on a trended basis, based on your current book of business for the next 12 months.

Right. And Richard, you talked about some, I think the term you used was like "less help" early in the year matching costs and pricing of healthcare. Could you explain that a little more?

Yes, I sure can. Because of the step-up in the rate on the 7 carriers, if every one of the clients that was within those 7 carriers all renewed on January the 1st, then we wouldn't have a squeeze at the margin for that particular cost center.

But because we have got customers that are renewing throughout the year that are in that 22% in the 7 carriers, some of them, you are going to have -- you are going to be underpriced at the beginning of the year. And then as they renew, then you'll be back to matching on that particular group for the full year. Does that make sense?

That makes sense. And then just a technical question, you said you have gone to more municipal bonds. Can we expect a tax rate lowering at some point?

I don't believe -- I think the share repurchase probably had the larger impact in the third quarter, and our guidance going forward is still at that 36.7% or so, tax rate.

Okay. Thanks very much.

Jeremy Davis, Credit Suisse First Boston.

I think last quarter you had mentioned total number of sales reps that you had at 280 to 290. Wondering if you are still hiring or comfortable with the levels that you have right now? And clearly your trained reps came up in the third quarter. Should we expect that to continue to trend upward to that 280 to 290 range as we look through 2007?

Yes, we should consider continuing to increase the size of the trained sales force. We are continuing to hire. The way things have gone getting ahead on profitability and so forth, we are continuing to kind of pour gas on the fire.

We're going to open up 6 offices next year, and probably mostly first half. So we plan -- once you get ahead on this key metric, you really want to say ahead on that one, because that increases the likelihood, anyway, of being ahead on that unit growth number.

Okay. And you outlined a couple of wins within your mid-market initiative. Wondering just qualitatively how you think about that initiative contributing to the 14% to 16% growth that you laid out for next year? And then just commentary, if you can provide it, on what you see as the current sales lead times and implementation times, and whether you experienced any implementation challenges?

Sure. On the mid-market side, it's still pretty early in that initiative. We are having early successes, and we're learning and improving. We definitely see that as part of our plan going forward, but we're not relying heavily on some huge increase in the mid-market area to fuel that 14% to 16% growth. Remember, I'm talking about only a net gain of 1,200 employees a month into December -- from December to January, and then throughout next year to reach that 14% level.

But we do expect mid-market to contribute during this fall campaign, and our goals -- of course, we've set goals for that group. And because it's new, it is more hit or miss, so you don't want to really rely on that for your base level of expectation as you go into next year. So that's kind of the mid-market front. I forgot, you had a second half to that question.

Sales implementation -- or, sales lead times, implementation times, and whether you have had any challenges that you have come up against?

No, we're-- this sales system that we have is pretty reliable. We had 50% census to first call rate in the quarter, and the census is our opportunity to bid, so that's exactly in line with historical levels. We had 22% closing rate.

We haven't seen any change in the length of time it takes for small business owners to make this decision. It still takes 60 to 90 days to get the 8 or 10 hours with the business owner that it takes to make this decision. So that's been pretty consistent.

But presumably in the mid-market initiative, those sales lead times might be a little bit longer than for the rest of your business?

No question about that. I was really referring on those metrics to kind of the typical sales. But mid-market is more like a 6 month lead time. It's also weighted more toward January 1st conversions, which hopefully we'll have success here in this fall campaign, and have pretty good increase there.

We didn't have much activity early in the year, in terms of closing business. But then started to see that ramp up in the third quarter, and hopefully we'll trend positively into the fourth.

All right. Sounds good. Thank you.

Jim Wilson, JMP Securities.

Had a couple of questions. I'm not sure -- I missed it along the way. I was wondering what sales force and client turnover was for the quarter?

You mean the third quarter?

Yes, the third quarter.

Yes, the client termination average for the quarter was 1.8% of the base, which is a little higher than our normal amount. But it was driven largely by kind of a weird month in July. June was low, August and September were both 1.4%, but July was high. So it's kind of a little choppiness there. So it averaged 1.8% for the quarter.

Okay. And then actually, sales force?

Sales force growth?

Sorry -- no, your turnover rates.

Oh, sales force turnover rate? It's still running in the high 30s.

That's kind of normal. All right.

The important part on the turnover side is this change that we just made in the remuneration and sales compensation that we're hopeful, through our analysis, maybe we found a little quirk in our system that may help us lower that rate some going forward.

Okay. Okay, that makes sense. And then just my only other question was, United Health -- I was just wondering because I don't think we ever talked about this. But what percentage worksite employee base actually used United versus your other 7 sort of regional carriers?

Yes, Jim, when-- our total worksite employee base, we have 72% of our total base that is enrolled in 1 of the 8 plans. 78% of the 72% is in the United program.

Okay. I thought it was probably most of it. Okay. That's good, that makes sense. All right. Thanks. Good quarter.

Mike [Vincent], SunTrust.

Congratulations on a good quarter. Most of my questions have been asked. I just wanted to ask a follow-up on the mid-market. Just wondering if you could comment on what the pricing and profitability looked like compared to the kind of the core business for the smaller accounts?

That's a good question. We have been surprised by that once we entered the mid-market, we were concerned we might have as much as a 20% or 25% lower mark-up on those accounts on a per employee basis. That's turned out to be only about a 10, maybe 10% to 11% lower than our standard, or average mark-up, which was very positive. And then beyond that, down to the operating income line, the margins are even better than our base. So those trends have continued to hold at those levels, and we'll see how that goes.

And then just a follow-up on that, if I could. Could you comment on the hiring? Are you hiring at the same pace in the mid-market as you are at the other levels?

No, most of our hiring on the sales side has been in our core business. We still have 7 trained sales staff in the mid-market area, and we'll start looking at that in the next year.

Thank you very much.

And there are no further questions at this time. I would like to turn it back to Mr. Paul Sarvadi for closing remarks.

Well once again, we would just like to thank you for participating on the call, and we look forward to getting back together after a successful fall selling campaign. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.