Insperity Inc (NSP) 2007 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2007 earning conference call. My name is Aikida and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question -and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I now like to introduce your host for today's call, Paul Sarvadi, Chairman and CEO; Richard Rawson, President; and Doug Sharp, CFO. I will now turn the presentation over to Doug Sharp, CFO. Please proceed sir.

Thank you. We appreciate you joining us this morning. Before we begin, I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson or myself, they are not historical facts or considered to be forward-looking statements within the meaning of the federal securities laws. Words such as expects, intense, projects, believes, likely, probably, goal, objective, outlook, guidance, appears, target and similar expressions are used to identify such forward-looking statements involved a number of risk and uncertainty that let me 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 to take a minute to outline our plan for this morning's call.

First, I am going to discuss our third quarter financial results. Paul will add his comments about the quarter or outlook for the remainder of 2007, and then provide some preliminary comments on 2008. Richard will then discuss trends and our direct calls including benefits, Worker's Compensation and payroll taxes and the impact of such trends on our pricing. I will return to provide financial guidance for the fourth quarter and also comment on preliminary outlook for 2008. We will then follow with a question-and-answer session.

Now, let me begin by summarizing the financial highlights from the third quarter. We reported third quarter earnings per share of $0.45 at the high end of our expectation.

As for key metrics, we achieved double digit unit growth over as the average number payed work site employees to increase by 10% over Q3 of 2006, (inaudible) for the quarter. Gross profit per work site employee per month averaged $222 per quarter, above our expected range, due primarily to a positive outcomes in our direct cost programs. Operating expenses came in below forecasted levels with the exception of an additional accrual for instead of compensation high to the achievement of higher operating results. We re-purchased 408,000 shares during Q3 at a cost of approximately $13.4 million and ended the quarter with $110 million in working capital.

Now let's review the details of our third quarter results. Third quarter revenues increased 13% over 2006 to $383 million as a result of 10% increase in average pay work site employees and a 3% increase in revenue per work site employee per month.

Looking at third quarter revenue contribution and growth by region, the southeast region which represents 11% of total revenue grew by 10%. The northeast region which represents 20% of total revenue grew by 21%. The central region which represents 14% of total revenue grew by 12%. The southwest region which represents 35% of total revenue grew by 18% and the west region which represents 20% of total revenue grew by 2% and was impacted by the loss of a large mid market client in our 2006 year-end client renewal period.

Now moving to gross profit, we have forecasted growth profit for work site employee per month to be in a range of 216 to $219. This guidance was below the $234 achieved in Q3 of 2006 appeared in which we experienced unusually low benefit costs. We exceeded our expectations this quarter averaging %222. Pricing of our H. R. services came in as expected with the upside generated from our direct cost program.

As for the details, our Worker's Compensation Program continued to generate positive results. Worker's Compensation cost were 0.52% of non-bonus payroll for the quarter consistent with the prior quarter and below the low-end of our forecasted range. After our loss estimates continue to reflect our favorable claims trends and resulted in a $6million reduction in previously reported loss estimates. This reduction is generally consistent with that reported in the previous two quarters. Third quarter benefit costs were generally in line with our expectations as the cost per covered employee per month increased just over 9.5% to $683.

Payroll tax cost as a percentage of total payrolls declined from 6.67% in Q3 of 2006 to 6.55% in Q3 of this year as a result of lower state unemployment tax rates and higher payroll averages and bonuses of our work site employees. In a few minutes, Richard will provide further details on this quarter's positive developments and the expected impact on direct cost trend and pricing for the reminder of 2007 and into 2008.

Now, let's move on to operating expenses which increased only 7% of Q3 2006 to $59.2 million. This was approximately $700,000 above the midpoint of our expected range and included the additional accrual for incentive compensation tried to improve operating results partially offset by expense savings in other areas. The 7% increase in operating expenses on a 10% increase in unit growth resulted in a decline in expense on a pro-work site employee per month basis from $181 in Q3 of 2006 to $176 this quarter.

As expected, stock based compensation costs increased by $2 per work site employee per month as a result of the annual restricted share grant to employees. This was more than offset by lower salaries depreciation and G&A costs. As for net interest income, we reported approximately $2.9 million dollars for the quarter. This is just below the low end of expected range due to primarily to the utilization of invested funds in executing our share repurchases. Our effective income tax rate for Q3 of 35.1% was slightly less in the forecasted rate of 35.7% reflecting lower than expected state tax rates.

Now let's review several sheet balance sheet and cash flow items. We ended the quarter with approximately $110 million of working capital and only $1.2 million of debt. During the quarter, we generated $23 million of EBITDA, cash outlays included cash dividends of $3 million, capital expenditures of $4 million and share repurchases totaling 408,000 share at a cost of $13 million. We have now repurchased 1.8 million shares year to date of over 6% of the total outstanding shares at the beginning of this year. There are currently 724,000 shares remained for repurchase under our authorization. Now, before providing our financial guidance, I would like to turn the call over to Paul.

Thank you, Doug. In my part of the call today, I will discuss our continuing strong execution of our growth plan in both our core and middle market segments. I will also update our progress on our fall sales and retention campaign which is critical to our 2008 starting point and lastly I will provide some thoughts on our outlook for the economy and the effect on our business model for 2008. The third quarter growth acceleration was the result of solid performance in both of the key drivers to unit growth, sales and client retention. The paid work site employees added from sales of new account increased 22% over the same period last year and this was the primary driver of our 10% unit growth for the quarter.

Our sales success continues to be driven by our growth in the number of trained sales personnel with over 18-month experience with the company. We averaged 264 trained reps for the quarter and 306 total reps up 4% and 7% respectively over Q3 of 2006 from 253 trained reps and 285 total reps. The number of sales people with more than 18-month experience increased 22% and reached 150 for the first time in our company history. Our office opening plan is also on track with six offices open through the third quarter including our second Boston, Phoenix and Denver offices. Our third Washington DC and New York offices and a new market opened in Jacksonville, Florida.

We expect to open our fourth New York office and one more new market in Kansas City in the fourth quarter, bringing the total new office openings to eight for 2007. We have also had early sales success in our recently reengineered middle market client segment, which we define as clients with greater than 150 work site employees.

In the third quarter, we sold five accounts total 1300 employees, most of which will become paid work site employees in January. We have already sold three more middle market accounts during the fall campaign, so we have nice momentum in this new segment.

Last year at this time, our middle market segment had slightly more than 14,000 work site employees representing just under 14% of our total work site employee base. As we reported earlier this year, we experienced a 15% decline in this segment due to a difficult year end sales and renewal cycle. We have rebounded over the last six months through new sales and growth of existing customers and the segment is recovered and is now slightly larger and absolute number of employees than it was at this time last year. Our 10% unit growth rate for the third quarter was a combination of this mid market recovery to a slight year-to-year growth rate of 3% and our core business year-over-year growth rate of 11%.

Currently, the mid market segment is 13% of our total business. Our client retention and satisfaction numbers for the quarter were also solid. The number of work site employees related to terminating clients averaged 1.7% of the employee base per month for the third quarter which is slightly higher than our target of 1.5% but better than last year's 1.9%. Our overall service satisfaction rate for the quarter was 90% consistent with our year-to-date number of 91%.

Now, this time of year we are focused on fall sales and retention campaign which is designed to take advantage of the natural inclination for prospective small business clients to transition to our services at year end. Each year, we invest in advertising and promotion plans to generate a way of leads and appointments for sale staff leading to strong Q4 sales. Historically, we sold about the same number of the (inaudible) last four months of the year as we sell in the first eight months. This year, we have invested heavily in television and radio advertising featuring our company's spokesperson, Arnold Palmer. We have client testimonials from business owners in each of our major markets in our radio ads to localize the message.

We have launched personalized direct mail programs with follow up from our corporate cost center to set additional appointments for sales staff. Although it is much too early to measure the success of the campaign, the first step has been accomplished with a 14% increase over last year in qualified leads supplied to our sales staff. Another important element of this year's campaign is the addition of new benefits for client owners and work site employees to encourage client retention.

Clients are receiving personal and business identity theft protection and a new web-based business research tool as a gift from Administaff. Employees are receiving new benefit options including (inaudible), long-term care, cancer coverage and even pet insurance. The fall campaign begins with sales staff visiting current clients to share the new benefit of information and obtained client referrals. This blitz of activity which was saved well by client and generated a significant level of energy and most importantly sales prospects.

One other element of this year's fall campaign is a new approach to mid market renewals. Since this was an area of difficulty last year and we have made major changes to the service model, we are scheduling face to face meetings with senior management with both companies.

In these meetings, we are conducting a financial stewardship review and explaining the changes we are making in our service month. So far, these meetings have been productive. All of these sales and retention efforts underway are directed towards maximizing the number of paid work site employees in January 2008. This number has a dramatic effect on a 2008 year-over-year growth rate due to the cumulative effect of our recurring revenue business month.

Last year, we had no net gain from December to January in work site employees for the reasons I mentioned earlier regarding our mid market segment. The opportunity before us now is to have a successful fall campaign resulting in an increase and paid work site employees from December to January. Nearby accelerating our unit growth rate and stepping up our revenue base for the new year.

So in summary, our outlook for growth for 2008 is positive based on our growth in number of experienced sales personnel, our progress in the mid market segment and continuing our market expansion. Our 2008 plan up includes an additional eight office openings throughout the year and an increase of approximately 15% in the number of trained sales staff. The economic environment is also an issue we are watching closely as we look ahead to next year.

So far, we are not seeing a negative change in what clients are actually doing in compensation and hiring. However, our client-owner sentiment about the economy, going into an election year seems a bit more hesitant and they are somewhat more conservative as a result.

For the third quarter, average compensation increases were up just under 6% (inaudible). Commissions were up over 12%, indicating a nice pipeline for new business in the near term.

As a percent of base pay, 11%, which is historically high. (audio problems). We continued to believe there is a greater market perception of economic impact on our business model than actually exists. This is due to the last economic down cycle when we have a company specific event which occurred at the same time as it was down economy and had more of the (inaudible) and effect on growth than the economy get. Our service is equally necessary maybe more so in the down economic cycle when employment cost and liabilities raise. We continued to see strong demand for our services as small businesses continue to seek a competitive edge in the marketplace, the guidance of the economic environment.

Now our business model is effected when lay offs exceeding new hires in our client base but not to a degree experienced from the last cycle. We believe we will continue to grow unit and profitability, even if the economy slows and we expect to continue to generate strong free cash flow. At this time I would like to phases call on to Richard.

Thank you, Paul. This morning I am going to discuss the details of our third quarter gross profit results and the new relationships we have in the worker's compensation insurance program. I will comment briefly on our expectations for the fourth quarter of 2007 and and then I will update you on our pricing strategy and direct cost trends that were shared by gross profit for work site employee for month for 2008. Our gross profit comes from the market we earn on H. R. services combined with the surplus that is generated when our direct cost pricing allocations exceed the corresponding direct costs.

For this quarter, our gross profit for work site employee per month was $222 which was above our forecasted range of $216 to $219. These results came from achieving $199 per work site employee per month of mark up and generating a surplus of $23 per work site employee per month or 2.5% of the total dollars allocated to cover the direct cost.. This quarter surplus came from better than expected contribution from Worker's Compensation cost centers while payroll tax and the benefit cost centers came in at about what we had expected. Here are the details beginning what is benefit cost center.

In this quarter our expense per covered work site employee was $683, at the high end of our expected range. We continued to see a migration of employees out of the United Health Care Choice Plus 250 plan into a lower cost plans, which help to reduce our costs. We did have a few more claims over $50,000 than what we have forecasted but nothing like what we experienced at the end of 2006. So we ended the quarter about where we expected our costs to be.

Our largest contributor to the gross profit surplus in the quarter came from positive results in our Worker's Compensation Program. The current policy year just ended on September 30th and for this policy year the number of claims reported as 7% lower than last year. This decline is particularly impressive when you consider that we have had a 10% growth in the number of paid work site employees over the year that incurred those claims. Obviously, the work of our safety professionals in the field is paying off nicely.

Our claims management personnel continued to settle Worker's Compensation claims for amounts lower than expected as our back-to-work programs continue to produce favorable results.

As a result, we had a nice surplus from our Worker's Compensation Program as the expense was 0.52% of non-bonus payroll, well below our estimate of 0.60%. Before we talk about Q4 of 2007 and 2008, I would like to share with you the details of our Worker's Compensation Insurance Program structure beginning October 1, 2007. We now have ACE Insurance Company as our new Worker's Compensation insurance carrier. Their coverage is identical to the previous year programs that we had with AIG but at a lower cost and with policy administration function carved out.

Prior to 1998, our Worker's Compensation insurance carrier had to issue only one policy which covered all the clients of a P.E.O. Beginning in 1998, a few states changed their requirements and made the Worker's Compensation insurance carrier issue a separate policy in the name of both the P.E.O. and client doing business in that state.

Now eight years later, most states require the carrier to issue what is called a multiple coordinated policy, naming the P.E.O. and client as policyholders. Our carrier went from issuing one policy several years ago, just several thousand policies this last year.

As you can imagine, the administrative costs have gone up rapidly but more importantly we discovered that several really good Worker's Compensation carriers would not do business with P.E.O.'s because our background operations could not handle a volume of work required for a P.E.O.

I am happy to report that we have found a solution to the rising cost and the market limitations through an arrangement with our insurance brokerage firm (inaudible). They are the world's largest privately owned independent insurance brokerage firm. This new arrangement is with their (inaudible) subsidiary called (inaudible) Infinity Group.

This organization has a successful cost center which cross sells insurance products and a policy administration business that issued more than 60,000 Worker's Compensation policies each year for its customers. We have partnered with them to issue all of the Worker's Compensation policies on behalf of ACE Insurance Company to our clients which is why our our administrative expenses of the program will be lower than last year.

Additionally, this new venture will make these services available to other carriers facing the same P.E.O policy administration issues. Should there be additional business that comes to the new Administaff lack in venture, we will get to share in that revenue. The third feature of this new arrangement is an agreement whereby where the lack in cost center operation will set appointments with their clients for Administaff sales personnel to meet and discuss the possibility of becoming an Administaff client. This new structure creates a distinct and unique advantage for Administaff, and we are very excited to open up our long-term options and reduce our costs of our Worker's Compensation program.

Now, let me update you on gross profit expectations for the fourth quarter this year. The mark up on our service fee is still tracking toward our goal of averaging $200 per work site employee per month for the fourth quarter and the full year of 2007 as our renewals completed in the third quarter were up over $5 per work site employee per month. The surplus component of gross profit should add about $30 to $33 of additional gross profit per work site employee per month based on the following information. We should get a larger contribution to surplus from the payroll tax cost center this quarter because more of the employees with new clients that were added throughout this year will reach their individual wage limits, so our costs will go down as our allocations remain unchanged.

As for the benefits cost center, we have seen our pricing allocations increase from the second quarter. At the same time, we have started to see a meaningful shift of employees move from a higher cost plans to the lower cost plans.

Also, as you may recall from the fourth quarter of last year, we had a high number of large loss claims. Therefore, we expect our fourth quarter costs to increase 6-7% over Q4 of 2006 which is lower than our full year forecast for 2007 of 9%. Our Worker's Compensation cost center should continue to add to our surplus. As I mentioned a few minutes ago, the administrative costs will decline from last year since our new structure went into place on October 1st. Our current incident since severity rates would indicate a lower cost being Q4 of last year. So, an expense of 0.55 to 0.65% of non-bonus payroll for the fourth quarter is certainly implied.

In summary, our solid gross profit performance this quarter gives us the platform to finish 2007 with good results. Now, let me give you our up-to-date outlook for gross profit for work site employee per month 2008.

Let me explain each component beginning with the pricing. We are well on our way to achieving our targeted average mark up on our H.R. services of $200 per work site employee per month for 2007. With nominal increases on renewing business, we should see the average mark up increase by a couple of dollars in 2008. Our view about the surplus component of gross profit for 2008 has not changed from last quarter. The surplus generated from the payroll cost center should increase. From an allocation perspective, we could see a moderate decline at the beginning of 2008 due to lower state unemployment tax rates. The reason for the expected lower tax rate comes as a result of the surpluses that are sitting in many state unemployment tax funds.

By all the states are required to lower the rates and/or give credits to employers. The net effect is a projected increase for in our surplus for a 2008. We also expect to see the continuation of a nice contribution to a gross profit surplus from our Worker's Compensation insurance program from the new structure that I discussed earlier. The better than expected incident in severity rates that we have experienced throughout this policy year coupled with effective claims management translated the lower cost as well. We expect lower no change within the allocation side of this cost center. So the bottom line is that we still expect to see a nice surplus contribution to gross profit into 2008. Benefits cost center is where we could see some improvement in 2008.

A few minutes ago, I mentioned that we continue to see migration of covered work site employees from the United Health Care Plus 250 plan to higher deductible lower cost plans. The result is an immediate reduction in our benefits allocation followed by a corresponding expense reduction several months later.

Last quarter, I also mentioned that for 2008 we have some additional factors that will effect the benefits of cost center. They are, number one, benefit plan design changes that reduce claim costs, number two, lower administrative fees previously negotiated with United Health Care for 2008. Number three, double digit health care cost increases from our fixed rate plans which cover about 10% of our total book of business, and number four, ongoing allocation increases to match future expected costs. These factors should allow us to mitigate total benefits trend increases and further deficits in this cost center for 2008.

In summary for 2008, we have a very solid game plan for being able to generate a few dollars more of gross profit per work site employee per month. Now I would like to turn the call back over the Doug to give further financial guidance.

Thanks Richard. Now let's discuss guidance for the fourth quarter. We expect average paid work site employee per month to be in a range of 115,500 to 116,000 reflecting unit growth of approximately 11% over Q4 of 2006.

As a reminder, clients sold during the fourth quarter of any year and in particular during our fall sales campaign. Our typically converted to pay work site employees during the first quarter the following year. As for gross profit per work site employee per month, we expect to be in a range of $230 to $233 for the quarter. An expected sequential increase in this metric over Q3 is consistent with the quarterly pattern that we have experienced in prior years. Specifically we expect a higher surplus in our payroll cash direct cost center. This is because work site employees added to our base mid year typically reach their taxable wage limits for Q4. So for this employee related payroll tax cost diminished while we continued to collect the pricing allegations that were set upon enrollment.

Fourth quarter operating expenses are expected to be in a range of $63.25 to 63.75 million. This is sequentially up from the third quarter operating expenses by approximately $4 million and includes approximately $2.2 million of additional advertising costs related to our fall sales campaign. We are also expecting a $1.5 million sequential increase and compensation expense associated with the additional sales and service personnel and additional incentive compensation to be accrued only upon achieving forecasted results. Our achieved for guidance also includes approximately $700,000 of G&A costs associated with the services offered to certain clients and work site employees in connection with the missing laptop issue.

We are currently reviewing our insurance coverage which may provide up to 90% of reimbursement of these costs. We expect Q4 net interest income to be between $2.9 million and $3.1 million and a forecasting an effective income tax rate of 35.5%. We are also forecasting 26.8 million average diluted outstanding shares for the fourth quarter and 27.3 million shares for the full year 2007 based upon our current sales price.

Now, before we open up the call for questions, I would like to comment on our preliminary outlook for 2008. We plan to provide detailed guidance during next quarter's conference call based on results of our 2007 fall sales campaign and year-end client renewal period.

Based upon Paul's earlier comments, we expect to accelerate from the 10% forecasted unit growth the unit growth for 2007 to around 12% for 2008. As Richard mentioned, we currently expect a slight increase in gross profit for work site employees for month over 2007. Consistent with prior years, we are forecasting about a 1-2% increase in the mark up on our H.R. services. We are also budgeting a slightly higher surplus from direct cost programs based upon on our initial outlook for healthcare and Worker's Compensation cost trends. We expected an impact of benefit plan design changes and a preliminary estimate of lower state unemployment tax rates.

As for the quarterly train in this key metric, we expect gross profit per work site employee to be highest in Q1 as we typically earn more surplus in the payroll tax cost center prior to work site employees reaching their wage limits. Additionally, our benefit plan design changes typically had a greater impact during the first quarter of the year implemented. They are after we would expect a decline in this metric in Q2 and then sequential increases in the third and fourth quarter which is consistent with our typical gross profit patterns.

As for operating expenses, while we continued to expect leverage in our core P.E.O. business, we plan to make investments next year in our mid market initiatives, H.R. tools, software and other Ancillary Products. When combined with continued investment in national sales and service expansion plan, we expect an increase in 2008 operating expenses slightly above projected unit growth. Similar to prior years, we are budgeting for a step up in operating expenses from the fourth quarter of 2007 to the first quarter 2008. This step up in cost is associated with the expected hiring of sales and service personnel and certain G&A costs including our annual sales convention and employee in (inaudible).

Thereafter, operating expenses are expected to remain relatively flat through the second and third quarters with the usual step up in Q4 for costs associated with our fall sales campaign.

So in conclusion, our initial plan for 2008 targets operating income for work site employee per month at a slight increase over 2007 as an increase in gross profit per work site employee is expected to be partially offset in investment in our growth and other initiatives. When combined with projected unit growth, we are currently expecting 2008 earnings growth of somewhere between 15-20% over 2007. As for capital expenditures, we are looking at a base budget of about $20 million which is up from approximately 13 million projected of 2007 . This increase is tied primarily to the plan in national sales and service expansion.

We plan to provide detailed 2008 guidance during next quarter's conference call in early February. This guidance will be largely based upon the results of our 2007 fall sales campaign in the year end and client renewal and we will also factor in any changes in economic climate of the small business community that may occur in early 2008. At this time, I would like to open up the call for

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Tobey Sommer of Suntrust Robinson Humphrey. Please proceed.

Thanks. I just wanted to ask a clarification question on Doug. Your preliminary cannot high level look at 2008, did you say that you expected earnings growth of 15-20% based on the slightly better work site offset and the volume growth offset by the incremental investments that you planned.

A little clarification. Yes, 15-20% is what we are currently targeting and it is on unit growth and is up to about a 12% unit growth number that we are looking at and then a slight increase in the operating income per work site employee over 2007.

Okay and then I wanted to ask a question about the mix of marketing versus sales force head count growth going forward. You know, you have had a descent amount of opportunity to, I guess, experiment over the years with marketing versus actually just kind of raw brute force increasing the head count and opening up new offices. Any changes in philosophically cannot, in which levers you think you are going to pull harder in 2008, you know, comparing and contrasting your opportunities in marketing to improved sales force productivity versus actually increasing increasing the head count? Thanks.

That is a good question Tobey. What we are looking at for 2008 -- of course, you know, if you look at this year, we have had such a nice increase in the number of trained sales personnel with over18 month experience that we are getting the benefit of, you know, some better sales efficiency and, you know, what you get from a more experienced sales staff, relative to the marketing program next year is an election year. Costs go up and we will be spending more money but we also are going to grow the sales staff faster than we did this year. We have about a 7% increase in number of total reps, right now over a year ago and we expect to move up to around, you know, 15% over the course of next year. So we are going to invest more in, you know, sales person head count, which are back filling into these offices as we have opened. We will open eight by the end of this year and another eight next year. So you know, we we are going to rely a little more for '09 on sales person head count in '08. It is more the experience of the sales staff that we have in place and then growing the new sales staff.

As a follow up, regarding the perspective eight new offices next year, any change in the composition by that? I mean, do you plan more green field offices or is the mix of green field to additional offices in markets that you are already represented in relatively similar to this year.

It is pretty similar. I mean there may be, you know, two to three new. We will have two this year. You know, we may have one more than this year in next year's plan. We make those decisions, you know, as we get a little closer to each market or office opening.

And then lastly, another question on capital allocation and M&A opportunities. You invested quite a bit of your cash flow recently in stock repurchases. I was wondering if you could comment on what your outlook for capital plan would be in 2008 and if the slow down in term loan in the credit markets has brought increasingly, I guess, more attractive acquisition opportunities to Administaff. Thanks.

Sure, certainly we are more well equipped to evaluate opportunities in the marketplace and we are doing that. We think there are some things out there that we can do that, you know, add ancillary services or, you know, add to our opportunities. Sometimes it kind of effects both sides of the fence. It lowers our cost on the P.E.O. side, but then also potential to offer a point solution in the H.R. tools side of our business, which is kind of a growing new venture for us. So, you know, we are keeping an eye out there and although I don't see us be in a position to make, you know, blockbuster type of acquisitions or very large acquisitions. They are smaller strategic opportunities that we see. As far as use of capital, yes, I think we are still very bullish about, you know, our value of the company compared to how we are being valued the market right now. So, we will continue to buy shares back in a deliberate fashion. And also I think there is room for us to, you know, periodically move the dividend up to kind of keep our pay out ratio and dividend yield at the levels we would like to in. So, that kind of our priority at this point request first priority is, you know, investing in the business growing that sale staff and service staff where that is all expense to the income statement. That is kind how we see using our capital.

Right. And just as a follow up and I will get back in the queue, there is no change in your view of actually acquiring other P.E.O.'s because most of them probably would not fit with your business model and target customer basis? Am I correct?

That is correct. We have not seen any P.E.O. opportunity that made sense to this point.

Thank you.

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

Morning guys.

Hi Jim.

Hi, I'm in economy in general. Start there, you said you haven't see much impact. Are you seeing any regional impact, maybe a western, anything that is may be different in different parts to your business.

Yes, a little bit on out west but, you know, not so much so that, you know, that is significant to our game plan in anyway. More that west effect and we were more (inaudible) growth rate in the west coast but that was more driven by the loss of a major customer early in the year and how that, you know, effects the (inaudible) effects in our model.

OK. And on the middle market, you talked about some successes. Could you may describe those a little bit further, you know, which ones have already hit the numbers and what is yet to come?

Yes, we had, of course, we had few sales early in the year and in the first and second quarter and those have all kind of rolled in and come on board. We sold five accounts in the third quarter. One of those is enrolling now. The others are enrolling on January 1st. We sold three more in October. They are scheduled for January start ups, so we are starting to build a nice little pipeline, a new business there. The exciting part is that these accounts in the third and fourth quarter are signing our new two-year agreement and being implemented in our new service model. And that, we are really excited about the opportunity to methodically and deliberately impact these client locations and I think I have much better results for the client into our service team. So, we are excited about that. We have a pretty good pipeline of prospects that we will continue to work on and we will just have to see how we do in the campaign.

So you think that changes you made are causing this increase in activity?

There is no question in my mind that the sales changes have had a positive impact in, you know, being more in control of the sales process and knowing more about where we stand with prospects as we go through the process. And you know, that is about all we can measure right now because it is so early and, you know, not have much data yet. But I will be excited to get into next year and see how the transition plans and the service model implementations and how that flows into client satisfaction in our larger base.

OK. Just one more area. Could you talk a little about any kind of revenue expectations from a (inaudible) and just in general kind of beyond payroll, beyond P.E.O. profit centers like H.R. tools and other things. When, if ever, do you expected those to be material.

Yes, I will let Richard comment on the (inaudible) program but on the rest of the activities which would be H. R. tools or marketplace and some other new things were kind of work on that would be probably talk about next time, but when you put all those together, you know, we have not broken it out because it has been, you know , back in a half range or there per employee at the gross profit line, but we do expect to see that starting to grow. More modestly in '08 but we are hopeful that will begin to accelerate some as we get into '09 because of some of the investments we are making I have mentioned the last quarter about the H.R.

Thank you. Sorry.

On the other side, I would tell you that we just put this program in place on October 1st, so there has not been anything yet. I don't really expect to see much this year. I think that as we open up their cost center, calling into their existing customer base, that is probably where we will see, if we are going see anything positive that is probably where we will see, you know, beginning next year where some appointments get set and may be that will lead into some closings. So, I that is the shortest view that we can see upside in that relationship. And then over the next year, I think we will see how what happens in other aspects of that relationship with our back office administration business.

Your next request comes from the line of Mark Marcon of R.W. Baird. Please proceed.

Good morning. I was wondering if you could talk a little about some of the incremental costs that you anticipate for the mid market for next year.

Yes, first of all, we talked about we would be enhancing the service offering. So, some of this is going to be putting some service personnel in place both to address different products and services in the mid market client needs and also there will be some scalable aspect to that service growth so if we increase the mid market client base which we hope to do, there will be some service personnel that we will have to hire to serve those larger clients. And the key role being the account key executive role that handles the service relationship with those type of clients.

Have you kind of pinned down the incremental costs for this program?

Yes, I think Paul mentioned in the last conference call, you know, what we had expected in the latter half of '07 and then in '08. I think it is positive 2.5 or so million dollars in the '08 period.

OK. I was under the impression that was kind of preliminary estimate and still being finalizing.

Yes.

It sounds like that is pretty much the area where it is kind to settle out?

Yes that still looks like a good number to us.

Okay, great and then Paul, you mentioned you are having some face to face discussions with some of your existing mid market accounts and I think the word that was used to describe that was productive. Can you give us a little bit more color there in terms of exactly what you are saying.

Sure. You know, we essentially, as part of the whole, you know, revamping of the mid market strategy, you know, looked at the process that we have gone through in the past, renewing these customers. Once again, you know, kind of left over from our previous strategy was more of an incremental approach. We did not do a lot of things differently with mid market customers than we know that we did with smaller customers. But in recognizing what the needs are in the different influencers and decision makers that are involved in the renewal process, we now are working through holding high level meetings where I am -- I have been in several of them have does of myself. Where we sit down and talk through how the relationship is going and really look at the economics of it and kind of remind our prospects of what we do day in and day out and how it effects them and their cost structure for the long haul. I think, as anyone might expect, when you have that level of dialogue, you know, senior officer to senior officer, and you know, are able to, you know, look at specifics of what we did over the last year from a service perspective and what the game plan is for the coming year. You know, these have been very productive dialogues where they feel good about the relationship and we find out more and different ways we can, you know, meet their needs and find out new needs and so forth. And I just find it to be a refreshing, you know, and I think the customer has, too, in terms of compared to previous renewals. Now, in the new two-year structure that we have with our clients on our new contract, we will be holding this type of meeting one year into the relationship where it is not centered around a renewal and I think those may even be more productive. So you know, we are, again, we are learning in this area, but I think the early returns on how we are dealing with this larger customer has got some pretty exciting possibility.

So your sense from these discussions is that the retention rate of the existing mid market accounts should be how compared to last year?

Well, of course, compared to last year is where we had, you know, somewhat of a surprise as we got towards the year end, we had customers who did not give us notice about leaving. You know, to this point, we do have 60-day notice on these type of customers. We are right at this point right now, so it is, you know, kind of hard to tell yet what, you know, what we will see. Of course, we do have a few customers that we are already aware of that will not be with us in the new year. Some that have been acquired. In fact a couple of (inaudible) week or so that we were notified of that there has been a deal done and they are being acquired or being integrated into a larger firm and will not need our service any more. But, you know, this is the part where I do not want to get too far out on a limb because I feel good about it today because I know what's the pipeline is a new business. I know what we are doing to renew customers and dialogues are going well. But, you know, a year ago, I felt pretty good and over the following month or so, we had some surprises. But, I think, you know, we have got a whole different plan in place for this year and hopefully will be successful.

You know, it sounds good. I guess what I am trying to figure out was you are presuming, you know, the preliminary guidance and obviously you are not really going know until things really finalize but it sounds like we are talking about potentially abo12%. You know, work site employee growth for next year. And I was trying to figure out what were you presuming if you have a normal client retention rate of 80% across the entire base or 81% across the entire base, what are you assuming on the mid market side for this time?

I am assuming, at this point I think we are being appropriately conservative about the starting point for paid work site employees for '08. And I think there is very significant upside to that if we have a good fall campaign. Relative to mid market, you know, like what I said in my script, we recovered and basically had about 3% growth in the mid market year over year. But I am not relying on that to be, you know, I'm not relying on any kind of increase to mid market to be at a 12% number.

Yes. So, I mean your general assumption is probably have attrition that will be a little greater than the overall or but you have got some new clients coming on board. And so again at the end of the day, the mid market should be a positive for next year?

Yes, I think we should at least, you know, prior to the last year end. You know, we were selling enough new business to replace ones that were going away. You know, as we go this fall campaign, I already see the sales coming in. I don't know yet about the terms, but I feel pretty good about at least being at that level where it is an offset. And you know, if it is better than that, that really becomes a premium. It becomes, you know, kind of gravy to the model here and adds, you know, a nice step up in the 1st of the year, but we are not kind of build that until we see it..

Okay. Great. And just a housekeeping question and I will jump back in the queue. What was the percentage of the work site employees that were actually using the health care benefit?

It has been running about 73% or so.

Great. I'll jump back on the queue. Thanks.

Thank you, Mark.

Your next question comes from line of Michael Baker of Raymond James. Please proceed.

Yes. Thanks. I was wondering as your sales force has conversation with the prospect, how important is your health benefit offering in terms of the overall package?

Yes, it is definitely an important component of what we do for our customer. Of course, you know, benefits and providing high quality benefits for employees and keeping the custom controlled is a very important issue for small businesses. And, you know, a loft times, the part of our service that is most visible to a customer revolves around the benefit programs. So, you know, sometimes it operates similar to a proxy for the total service. So it is important and you know, we highlight it in a way that can demonstrate the benefit that we really bring to a small business.

My understanding is that you kind of use bundled pricing. Are you finding prospect increasingly trying to spike out the underlying costs to compare it to, you know, other offerings like the Blue Cross and Blue Shield plants out there?

Not too much. You know, there is always some of that and some of that happens more in the larger customer. And that is why on these larger customers we are, you know, having these financial stewardship dialogues where we provide a little more information. But for the typical small to medium sized company, you know, whether you break it out in our program or not, it all comes together. So it is kind of like, you know, buying a car and saying "hey I want to know how much are the tires?" It does not matter because the tires are going to be in the car and will not be taken off so, you know, they are, it is what it is. So, you know, It is more of what is the total all-in price compared to what their cost would be without us and that compares very favorably for small to medium sized business and becomes a, you know, relatively easy decision to make.

And then I just was wondering if you could provide just one final comment in general about how you seen health care pricing out there to date and what you expect in terms of next year specifically as it relates to the Blues which tend to be kind of the strong players in a particular region?

Yes, we are looking at trend increases next year in the aggregate for the marketplace and specifically if t small business marketplace are definitely going be in the 10-12% range. Now, for us because of plan design changes and a number of other things that I mentioned in my script, you know, we don't -- we won't see that kind of an increase. But small businesses are in for a big surprise next year. There is going to be a pretty ugly for a lot of them. And we think that positions us really well in the small business marketplace for this coming year.

What do you think the primary driver for the pick up is? Is it more the competitive dynamic that the Blues were aggressive this year and are kind of light enough of bit or is there some underlying cost dynamic describing it?

It is, you know, I cannot speak specifically for the blues. I mean we have a little bit of that out in the west coast and the northwest part of the United States and I think it is probably your first remark more so than the latter. Is that they were lower and now they are having to catch up. That is what we have seen in our pricing with them for next year. But, you know, I mean, just the demand for health care and, you know, the prescriptions and all of those factors. The health care inflation is -- it is alive and well and not going away.

And then just one final question, Richard in terms of getting a little ebit more color on the benefit design changes. Are those pretty much set up to try to drive towards to those lower cost plans?

There is some of that, absolutely. Of course you get there a couple of different ways. But, you know, our customer base has oddly enough, always been a little bit more interested in the richer plans. So when we start talking about those kind of plans and making some tweaks like going from $15-$20 for an office visit and things like that. It is not a huge problem for them to deal with because of the richness of our plans what we see is that there are less and less of them available in the marketplace for the small business customer to buy and that is what attracts or is a continued attraction for our relationship.

And then just one final question in terms of the relationship with United, obviously, it is kind out there that United is having service issues. I was wondering if those were coming through and impacting your client base.

You know what, we have not seen anything. I have not heard of anything on the service side negatively in our book of business. I know that it happens. I know that there are incident that had quite from time to time, they are just kind of run offs, but we are not seeing anything that would adversely affect us now.

And we have a service standards that we agreed to in our contract and and we certainly have not been anywhere near, you know, any of those service standards not being met.

Thank you for the commentary, guys.

Your next question comes from the line of Cynthia Houlten of RBC Capital Markets. Please proceed.

Good morning. I jut had a question. I think in the prepared comments, there was a mention of kind of offering, I guess, existing customers newer services like identity staff, some different retirement packages, etc. Could you elaborate on that in terms of any costs associated with that. Is that something that you are providing in-house or working with partners? Could you just discuss a little bit more in terms of (inaudible) other services, how broadly and kind of, you know, are they in-house services or third party.

Sure. Let me kind of explain a little bit. We put together some additional benefits for the client owner. Which involved identity theft protection for the individual client owner and for their company and then also we made an arrangement with an operation that has what we believe is one of a kind business research service, web based business research service which I probably talked more about next quarter. But, it is a really valuable tool, kind of small business destination site that we are being able to provide to our customer that we think helped their business and helped them be more informed and get quicker answers to business questions. So that, we provided to our customer. We are paying for those. We were able to negotiate, you know, tremendously discounted costs and we think it is a good investment for us to provide to our client owner, free of charge. There were other benefits provided to employees. For example, the (inaudible) 401K that was introduced from our retirement service organization and then we also made arrangements, a relationship with AFLAC to provide several of their programs that are, you know, options employees can buy and we also even added that pet insurance program through an external provider that employees can buy as well.

And again this is something that you are broadly pushing out to existing customers as a way to incent renewals or again this is something part of all customer packages?

You keep adding things that keep the, you know, keep things fresh for our clients. And it really happens on behalf of client owners as going to employ and say here are some new benefits we have some new options. Some of our clients, you know, when they come to renewal sometimes they need to pass on more of the benefits cost to employees so here is an offset to that where we have new things providing at the same time. You know, it is a benefit for our clients for us to be active in adding to our offerings and making it better year after year.

All right. Thank you.

Your final question comes from the line of [Bob Bennett] of Brown (inaudible) Equity Park. Please proceed.

Hi. It's Bob Bennett. Couple of questions for you. Particularly, when Jim Macdonald talking about the (inaudible) in the company, I wanted you to come and go into a little detail in terms, you know, particularly, for your middle market clients, what kind of financial underwriting you do for new clients as well as current clients, particularly at the renewal process and do you do that for each client. And the second thing was you talk about serving 20% attrition rate and I wanted to better understand how many of those clients, you know, are leaving or clients that you are basically terminating? And from that, you know, how is that high to, if you think about it, you know, the general business marketplace with companies sort of failing or you know, going south in terms of laying people off and things like that. And third, in summary is your bad debt expense is very nominal, almost non-existent, and how is that sort of tied to your underwriting process as well as to your sort of attrition rates? How can it be so low is really the question I have for you?

Sure, yes, you know, let's try to address to fill those one at a time. But on the mid market, like all of our customers, you know, we get paid by our clients by wire transfer or direct debit prior to submission of payroll. Then we have a very, you know, experienced team that manage the credit risk with our client base. Our mid market customers, obviously the dollars are much higher, so we have a process that we go through to each customer to make sure we have our relationship secured properly with each customer.

Yes, could you go into a little more detail on the color of that underwriting process, particularly on the, you know, company that has been with you a couple of years?

Yes, we do monitor and have a watch list of customers we keep an eye on based on size and the, you know, credit risk that is associated and, you know, we have a group that monitor and keep track of those customers. If there is any indication of any issue, which a lot of times we will get from a different source, you know, sometimes within our service organization, we will hear about, you know, maybe there is a potential lay off or may be there is, you know, other indications that there may be issues going on in the client location and that will prompt us, you know, put them on a watch list or contact the financial officer and have a dialogue about what is going on in their new operation. Some of them are public companies so we keep track of things that are going on there. But this group that we have internally that managed (inaudible) do a phenomenal job of you know, making sure that we don't have a risk out there that we are not comfortable with. The little bit of bad debt we do have, you know, it is unusual but I think they do a super job at it.

OK. So then, how does, you know, what percentage of your sort of the treated customers call 20% on annual basis come from clients that you have, you know, effectively terminated because they did not hit your criteria or did not do what you wanted them to do in terms of underwriting process?

Thank you. I needed reminded of the rest of the question.

No, it is kind of long winded. I understand.

So far, you know, of the 20% that go away typically half of those relate to financial related decisions. Even the client, you know, says here we have got a change in our operation and we cannot make it. So they leave, or, you know, we make the decision that, you know, based on they have -- if they have having any trouble financially making our commitment, we need to separate unless we can get fully secured on that risk. Beyond that, we do have the other 10% that go away typically a third related to customers that have a compliance related issue, and if they will not comply with the requirement of government requirement, we have to let those go. But another third are what we call our kind of success penalty customers that, you know, get purchased by another company and become a part of a larger organization and then another third is the 10%. Our service issues where, you know, we do not meet the expectations of the client and that is to be expected. In a down economic climate, you know, the financial difficulties go up some and sometimes even the compliance issues go up. So that is why historically, we do see that 20% of attrition go up during a down economic period, although we do not see that we are in a situation right now where we see any indication that there is an increase in terms for those types of reason. I appreciate the question and it appears that we are getting near to the end of our time. And I just want to thank everybody for participating in the call today and we look forward to having update for you next quarter.

Thank you for your participation. This concludes the presentation. You may now disconnect. Have a good day.