Insperity Inc (NSP) 2013 Q3 法說會逐字稿

Good morning. My name is Ginger and I will be your conference operator today. I would like to welcome everyone to the Insperity third-quarter 2013 earnings conference call. (Operator Instructions) At this time I would like to introduce today's speakers. Joining us are Paul Sarvadi, Chairman of the Board and Chief Executive Officer; Richard Rawson, President; and Douglas Sharp, Senior Vice President of Finance, Chief Financial Officer, and Treasurer.

At this time I would like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.

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 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, target, 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'm going to discuss the details of our third-quarter 2013 financial results. Richard will discuss trends in our direct costs, including benefits, workers compensation, and payroll taxes, and the impact of such trends on our pricing.

Paul will then add his comments about the quarter and provide an update on our initiatives as we head into 2014. I will return to provide our financial guidance for the fourth quarter. We will then and the call with a question-and-answer session.

Now let me begin today's call by discussing our third-quarter results. Today we reported third-quarter earnings of $0.39 per share, a higher than expected number, and associated cost of large healthcare claims contributed to these results being just below the low end of the implied EPS range from our key metrics guidance. As for our key metrics, paid worksite employees averaged 129,248 for the quarter, which was a sequential increase of 2% over Q2 of 2013, however below our forecasted rate of 130,000 to 130,500.

Gross profit per worksite employee per month average $251, which was below our Q3 forecasted range of $260 to $262, on a higher than expected deficit in our benefits direct cost center. The impact of the shortfall on these two metrics on Q3 earnings was partially offset by lower operating expenses, which totaled $80.3 million. We generated $25 million of adjusted EBITDA during Q3 and ended the quarter with $123 million of working capital and no debt.

Now let's review the detail of our third-quarter results. Revenues increased 5.5% over Q3 of 2012 to $540 million on a 2% increase in average paid worksite employees. Client retention remained high, averaging over 99% for the quarter; however, net hiring by our client base during the quarter was minimal and below trends experienced earlier in the year. Paul will share the details of our sales efforts, including our fall sales campaign activity with you in a few minutes.

As I just mentioned, our key pricing metric, gross profit per worksite employee per month, averaged $251 for the quarter or approximately $10 below the midpoint of our forecasted range. The benefit cost per covered employee came in at $908, a sequential increase of 2% over Q2 2013 and above our expectations.

This was largely the result of a higher than expected number of large healthcare claims. While this healthcare -- while this higher claim activity was experienced during the quarter, the year-to-date increase in benefit cost per covered employee per month has increased just 4%. Richard will provide further details behind our healthcare costs in a few minutes.

Workers compensation costs totaled 0.55% of non-bonus payroll in Q3, which was slightly below our forecasted cost of 0.58%. This quarter's costs included a $1.9 million reduction in previously reported loss reserves.

Payroll taxes as a percentage of total payroll were 6.3%, which is relatively flat compared to Q3 of 2012. Gross profit contribution from our adjacent businesses came in higher than forecast, increasing 40% over Q3 of 2012.

Now let's move on to Q3 operating expenses, which totaled $80.3 million. This was about $4 million below the midpoint of our forecasted range due primarily to lower G&A costs and lower incentive compensation, which is tied to our worksite employee gross profit and operating income targets.

The year-over-year increase in Q3 total operating expenses of 1% included costs associated with our healthcare reform initiative and the recent ramp-up in the number of Business Performance Advisors. We averaged 302 trained Business Performance Advisors during the quarter, an increase of 20% over Q3 of 2012. Costs associated with these additional BPAs and other budgeted headcount were offset by the lower incentive compensation, resulting in salaries and wages being relatively flat compared to Q3 2012.

Stock-based compensation increased 13% over Q3 2012. Consistent with our budget, our 2013 restricted share grant was at a similar level as that granted in 2012. With a three-year vesting period, we have a lower-priced 2010 grant which occurred during the economic downturn being replaced by grants at higher price levels.

Advertising increased by approximately 16% over Q3 2012, as we shifted the timing of marketing activities as well as the level of advertising surrounding healthcare reform. Depreciation and amortization increased by approximately 14% due primarily to the amortization of recent system and software enhancements to support our Workforce Optimization solution and our more recent adjacent businesses.

Our effective income tax rate was 41% for Q3, slightly higher than our forecasted rate of 40%, and contributing approximately $0.01 per share to our Q3 EPS shortfall.

As for our Q3 cash flow, adjusted EBITDA totaled $25 million. Through the end of the third quarter we have generated adjusted EBITDA of $74 million.

Year-to-date cash outlays have included the repurchase of approximately 594,000 shares at a cost of $17 million; cash dividends of $13 million; and capital expenditures of $9 million. We ended the third quarter with $123 million of working capital, an increase of $7 million over the end of 2012.

At this time I would like to turn the call over to Richard.

Thank you, Doug. This morning I will fill you in on the details of our third-quarter gross profit results, then I will comment on our gross profit outlook for the balance of 2013, and I will conclude my remarks with an update on how we see Obamacare affecting our gross profit picture in 2014.

As Doug just reported, our third-quarter gross profit per worksite employee per month was $251, and was $10 per worksite employee per month below the midpoint of our range. The gross profit consisted of $191 of average markup, $45 of direct cost surplus, and $15 from our adjacent businesses.

Now let me give you the details of each component. The $10 per worksite employee per month shortfall in gross profit was the result of an $11 per worksite employee per month shortfall in the surplus, offset by a $1 per worksite employee per month improvement in the contribution from our adjacent businesses. Our service fee component was right on forecast at $191 per worksite employee per month.

Now, the additional $1 per worksite employee per month of adjacent business gross profit came from better-than-expected revenues as we continued to see increases in both cross-selling opportunities and channel sales. The $11 per worksite employee per month decline in our surplus was the combination of the payroll tax cost center surplus being $1 per worksite employee per month lower than forecast; the workers compensation cost center surplus being $3 per worksite employee per month better than expected; and the benefits cost centers deficit was $13 per worksite employee per month higher than expected.

The benefits cost centers' deficit was due to a combination of both lower than expected allocations and higher than expected costs. Now, the lower allocations were a result of a fewer number of participants enrolling this quarter than what we had expected, combined with a continued migration of participants to lower-cost, meaning lower allocations for us, and higher-deductible plans, meaning lower costs for us. The higher than expected benefits cost was due primarily to an unforeseen spike in our large loss claims paid in the quarter.

In summary, this quarter's gross profit results were certainly not what we expected, but we have a plan which should mitigate some of this volatility for 2014.

Before we talk about 2014, let me tell you what we see for the balance of 2013, beginning with our markup. We expect our average markup to remain at the current levels for the rest of 2013, because there is typically not much change between Q3's average markup and the full year's average markup.

Now let's look at the surplus component of gross profit, beginning with the payroll tax cost center. Based on our third quarter's results and our seasonal pattern of surpluses in this cost center, we will increase our forecasted surplus for Q4 by a few dollars per worksite employee per month compared to our last quarter's estimate.

Switching to the workers compensation cost center, we began a new policy year on October 1. Historically, we have forecasted a slightly higher cost trend than the recently completed policy period, and we conservatively forecast our allocations for new and renewing business to remain at their current levels. Then, as we see how the incident rates and severity rates change, based on delivery of safety services and effective claims management, we refine our estimates for each quarter.

This is the same strategy that has worked for us successfully for 10 years. Therefore, as in prior years we will forecast the same level of allocation that we currently get and conservatively increase our expense forecast to a range of 0.60% to 0.62% of non-bonus payroll, which slightly reduces the surplus in this cost center from our previous Q4 forecast.

Moving to the benefits cost center, we do need to adjust our expectations from our last quarterly call. As I mentioned last quarter, we continue to increase our benefits allocations; but as participants select lower-cost plan options, the total allocation amounts do not increase as much. Additionally, since the starting point of covered worksite employees for Q4 is lower than our previous forecast, our benefits allocation will be less than what we forecasted last quarter for Q4.

On the expense side of the benefits cost center, we know that our costs go up each quarter throughout the year as participants, deductibles, and co-pays are satisfied. As a result, we had previously forecasted an increase in benefits cost per covered employee of approximately 4% over Q4 2012.

The recent publicity surrounding Obamacare has added additional uncertainty surrounding cost and coverage. Even though our plans are unaffected, historically health plan utilization increases when there is a fear of loss of coverage or anxiety over health plan changes. While we are doing everything we can to reduce this anxiety for our clients, worksite employees, and their families, we believe it is prudent to adjust our forecast for Q4 from a 4% increase to a 5% to 5.5% increase in benefits cost per covered worksite employee over the same period last year.

When you combine all of the forecasted direct cost surpluses and the higher deficit in the benefits cost center, we should generate a net surplus of $25 to $27 per worksite employee per month for Q4, which is $10 per worksite employee per month below our previous forecast.

Our last contributor to gross profit is our adjacent business services. If you recall, part of the reason we developed this additional profit stream was to add a third contributor to gross profit that doesn't have insurance-related volatility. We have made significant progress in 2013 toward achieving that objective.

This contributor has steadily increased throughout this year and now represents more than 5% of our total gross profit for 2013. This additional gross profit contains a recurring revenue element, which should continue to grow for a long time.

In summation, when you combine the service fee markup, the surplus, and the adjacent business contribution, we expect to reduce our fourth-quarter gross profit per worksite employee per month to a range of $230 to $232. This reduction to our forecast is attributable to the higher deficit in the benefits cost center.

Now let's shift gears to 2014 so that I can outline our game plan to reduce this deficit in the benefits cost center for next year. To begin with, the introduction of the marketplace exchanges, both public and private, will provide new ways for us to manage the cost of our health plan.

One of our bigger opportunities comes from being able to manage COBRA obligations differently. COBRA costs for Insperity will be over $40 million this year and represent 6.4% of our total claims cost. This cost comes from 3% of plan participants who will now be eligible for lower-cost coverage options and possible subsidies through these new exchanges.

In the exchanges, individual coverage is community rated and the law has removed any exclusions for pre-existing conditions, thus creating a new option for individuals to consider compared to the high cost of COBRA coverage. We are developing a proactive communication and assistance program through our Insperity insurance agency to help individuals understand and evaluate other insurance options. Every time we help a COBRA participant find a better option they win and we reduce our deficit.

Remember, a COBRA participant costs Insperity about 2.3 times the cost of an active participant. However, we are only allowed to collect 2% above the rate charged to a COBRA participant, which covers about half of the actual expense to our plan. So reducing COBRA participation helps reduce our healthcare cost and the deficit dramatically.

This new communication and assistance program will be offered to both existing participants on COBRA as well as newly eligible participants. Implementing this program should permanently reduce our healthcare claims cost, with the biggest impact being in 2014 as the number of participants is managed downward.

There may also be an opportunity to help our smallest clients find a less-expensive health plan option through the exchanges, as part of our Workforce Optimization solution. In addition, companies with fewer than 25 employees may be eligible for the Small Business Health Care Tax Credit, which will only be available for employers that buy health insurance in the public exchanges. Because these smaller businesses have the highest healthcare cost volatility, transitioning them to the exchanges would also reduce our health plan cost volatility.

Finally, we have redesigned our packages of healthcare offerings for 2014 to encourage selection of more lower-cost options by our clients. We did not eliminate the richer plans, but we set up packages of plans that make it easier for clients to consider offerings with less rich plans. If we are successful in helping accelerate this movement, the migration savings on the cost side of our equation could materially help us in 2014 and beyond.

At this point I will turn the call over to Paul.

Thank you, Richard. Today I will provide a brief update on several initiatives focused on accelerating revenue growth in 2014. I will also dedicate a considerable portion of my time explaining community ratings for small businesses under healthcare reform and the sticker shock we expect to drive customers our way very soon.

I will begin, however, by explaining factors which have caused a shortfall in paid worksite employees for the last half of 2013. The primary drivers for falling below our expectations on our worksite employees in Q3 and rolling into Q4 were, number one, a lag in converting worksite employees sold into paid worksite employees; and number 2, a soft spot in hiring we have seen in our client base.

Two of the three months this past quarter, the net change in new hires versus layoffs was negative. We previously budgeted a small tailwind from hiring at the rate we were experiencing in the first half of the year. The cumulative effect of this reversal compounds over the balance of the year and accounts for about 35% of the shortfall.

This soft spot in hiring is consistent with survey results from our client base we reported today and other recent reports about hiring in the small business community at large. Therefore, we have adjusted our forecast to reflect weak hiring through year-end.

The second factor relates to the timing of enrollment of sold accounts, as sales activity ramped up in Q3. We achieved 102% of our sales targets in the quarter; however, 50% of the total were sold in September, as growth in the number of new trained Business Performance Advisors began to contribute to sales. Unfortunately, the later in the year sales occur, the more likely accounts will schedule their start date on January 1 of the coming year.

In addition, we sold a large mid-market account in July that was originally scheduled to start in September, which was delayed to January. The good news is these employees are added to an impressive pipeline we are building for our all-important year-end transition, which leads to the starting point in paid worksite employees in January 2014. At this time last year we had approximately 4,000 employees in the queue, sold, and scheduled to be paid by January, compared to over 6,200 today, an increase of 55%.

In addition, our most recent information on activity associated with our fall selling campaign is very good. Since the kickoff, the number of discovery calls, which are initial face-to-face meetings with prospects, and the number of business profiles, which provide the information necessary to bid Workforce Optimization, are increasing on pace to hit our campaign target.

As we stand today, our number of potential worksite employees within current outstanding bids is up 18% over this time last year, reflecting the ramp-up in Business Performance Advisors. This number includes a solid increase from both mid-market and core sales teams and provides some nice momentum for our fall selling season.

As expected, we achieved our goal, increasing the number of trained Business Performance Advisors to an average of 302 for the third quarter, a 28% increase since the beginning of the year. This is the centerpiece of our growth plan for 2014.

Historically, growth acceleration follows a ramp-up in Advisors within the 12- to 18-month training cycle for this position. In fact, the lag I just discussed reflects the decline in Advisors over the last half of last year while we retrained and retooled the sales organization on our new selling system.

In addition to growing the number of Advisors, we are working on four other drivers to accelerate growth next year. They are -- number one, growing our SaaS and other adjacent businesses. Number two, refining our mid-market sales and service as a result of the ongoing pilot program. Number three, developing substantial channel programs; and number 4, capitalizing on the disruption of healthcare reform.

Our efforts to grow revenues and gross profit contribution from our SaaS and other adjacent business services are progressing very well and point toward a strong 2014. This quarter, the gross profit contribution from the portfolio grew 40% and SaaS seats grew at the same 40% rate on a year-over-year basis.

The gross profit per worksite employee per month is a good representation of how these businesses flow into our overall business model. Last quarter, this metric reached $15 compared to $11 last year; and this 36% increase points to the traction we are gaining in our adjacent businesses and the potential to contribute substantially to gross profit in the future.

Last quarter, I introduced our pilot program in our mid-market segment, expanding our offerings to include a total of four bundled HR solutions. We have continued to test these solutions in sales and retention of clients of approximately 150 employees and greater.

Early indicators are very good that we have solutions that resonate with these customers, that could dramatically improve our results in this segment. We have already saved accounts that were considering termination and have a growing pipeline of new opportunities with these new offerings.

Although we've had some good early response, it remains to be seen how much our year-end transition will be affected by this new pilot program. However, since the pilot is completed at year-end, we will refine our messaging and organize resources in order to attack the mid-market opportunity in 2014.

Another growth initiative for 2014 is an emphasis on channel marketing and sales programs. Our suitability as a channel partner has been greatly enhanced by the wide array of business performance solutions we now offer. Since we have grown the sales staff and have our adjacent businesses ready to scale, effective channel partnerships can raise all ships together.

Our corporate channel strategy will be primarily focused on four key verticals including accounting, technology, banking, and a category which includes chambers, trade organizations, and HR and insurance professionals. Much of the foundational work to organize and execute on this strategy has been completed, and our capability to develop a strong lead flow through channels should help accelerate growth in 2014.

The last major growth initiative for 2014 that I would like to address today is capitalizing on imminent healthcare reform changes in the small business marketplace. A tremendous opportunity for Insperity is on the immediate horizon due to the implementation of mandatory community rating.

Small business group plans' policies effective from January 1, 2014, forward will be subject to community rating pricing requirements under the Affordable Care Act. Insurers will no longer be able to use drivers of cost to price the coverage, such as health claims experience and gender.

In addition, the range in the difference companies can charge for factors they can consider, like age and tobacco use, will generally narrow from a range of 8-to-1 to 3-to-1. This is exactly the dynamic we have all been hearing about all week, resulting in sticker shock in the individual market, which also requires community rating under the ACA.

Younger, healthier individuals are seeing dramatic increases in coverage cost and scrambling to seek alternatives. This dynamic is about to play out in the small business community for employers of 50 or fewer employees, and will be expanded to 100 and fewer employees in 2016.

So beginning this month and continuing for the next couple of years, our most attractive prospects from a benefits/risk perspective will be receiving increases in healthcare cost that may exceed the entire cost of our premium service. It is likely a large segment of our target market will be able to add our comprehensive services and eliminate the complexity and compliance of healthcare reform for less than the price increase they will see from their carriers.

Insperity is uniquely positioned to benefit from offering our Workforce Optimization solution to small businesses and get the most for the money they will now be required to spend. The magnitude of this change is just beginning to emerge, as seen in the first of what I believe will be many articles on this subject, as insurers get past the early renewals they have moved into 2013 to avoid passing on the increases.

Last week several benefits advisors commented on the expected impact of community rating on their client base, and one estimated 75% to 80% of their small business clients would see increases between 30% and 105%.

Although estimates vary and the exact numbers are not available, I believe approximately 60% of small businesses will see an increase over 20%. But whether it is 30%, 50%, or 70%, it will still be a very large number of highly motivated prospects for Insperity.

We are responding to this opportunity by positioning Insperity as a resource for businesses to deal with the complexity, compliance, and now the cost of healthcare reform. Yesterday we announced the introduction of Pulse Check, which is now available on our website. Pulse Check is an interactive healthcare reform assessment tool specifically designed to help business leaders understand and prepare for the impact of the Affordable Care Act.

In addition we have provided new information on our site regarding the community rating change in 2014. This information will help our Business Performance Advisors explain the coming price increases that are about the hit the marketplace.

During the third quarter, we also trained sales staff on the coming impact of community rating, and we are ready to react as this change is implemented. It is hard to predict how significant this could be to our growth next year, but I could not have devised a better way to get the attention of our most attractive prospects to seek a better solution. I also cannot imagine an offering better than Insperity Workforce Optimization to solve the healthcare reform-driven problems for small business.

In conclusion, let me just say we are disappointed in recent health claim levels and the lower worksite employee growth over the last half of the year and the associated lower earnings expectation. However, none of these short-term factors change our outlook for 2014 and beyond in any way.

We are in a strong position to return to double-digit unit growth in the typical 12- to 18-month period following a double-digit growth in Business Performance Advisors. If we have a great fall campaign, the growth acceleration will be earlier in 2014; and if the campaign is not as successful as we would like, it will be later next year. Either way, we are excited about our growth prospects for 2014.

At this point I will turn the call back over to Doug.

Thanks, Paul. I would like to now provide our guidance for the fourth quarter. We are forecasting average paid worksite employees in a range of 131,250 to 131,750 for Q4. This guidance incorporates the lower starting point coming out of Q3 and a continued trend of lower hiring in our client base through the end of the year.

As Richard mentioned, we now expect gross profit per employee per month to be in a range of $230 to $232 for Q4. As for Q4 operating expenses, we are forecasting a range of $81 million to $82 million, a slight sequential increase over Q3.

We are estimating 25.6 million average outstanding shares and an effective income tax rate of 41% for Q4. This estimated tax rate excludes an expected tax credit associated with our investment in software development, as allowed under a recent interpretation of IRS guidelines.

We will be finalizing this project in Q4 and therefore expect to take the tax credit of $2 million to $3 million associated with software development activities dating back to 2009. Going forward, we would expect a reduction in our effective tax rate of approximately 1% associated with this credit at current software development levels.

In summary, our updated key metrics guidance implies a range of 2013 full-year earnings per share of $1.35 to $1.40, or approximately $0.20 per share below our previous guidance. This expected shortfall is generally split evenly between the forecasted lower level of paid worksite employees and the higher deficit in our healthcare plan.

As Paul mentioned we are now focused on closing out a successful fall sales campaign and year-end renewal period. We look forward to a strong 2014 and will be providing detailed 2014 guidance in our next earnings call. At this time I would like to open up the call for questions.

(Operator Instructions) Tobey Sommer, SunTrust.

Thank you. It sounds like you've got a lot going on, a lot of developments and seeing some interesting progress. My first question has to do with the healthcare assumption, so maybe it is for Richard. Do you assume a higher level of healthcare expenses from this recent trend of a large number or larger healthcare claims?

Yes, our forecast, we believe that it is possible that there could be increased utilization in the fourth quarter, which would reflect just the normal utilization being stepped up, as well as potentially a step-up in large loss claims. You just can't tell.

But really it is all centered around the mindset that we have seen over the years. When people get concerned about their health plan, or potentially losing it, or it changing, or whatever, they say -- well, I know what I've got right now, so I will go get this taken care of or I'll go get that taken care of. And they do it in the fourth quarter because anyway the new year starts a restart on their co-pays and their deductible, so there is already a natural tendency to do that. But we believe it is possible it could even be more accentuated this quarter.

Yes, a lot of that anxiety goes away once they get their new card in their hand for the next year.

Yes.

Right. Paul, for the metrics that you have seen so far or the selling campaign -- and I know it is early -- what would you point to as the most encouraging and maybe most concerning elements of what you can see so far?

Sure, the most encouraging would be, of course, that you have a 20% increase in the number of Advisors on a year-over-year basis, a 28% increase since the first of the year. But, you start looking to see if the activity tracks that. We have a 20% increase in the year-over-year number of trained Advisors and an 18% increase in the number of outstanding worksite employees in the bid system. That is perfect, exactly what you want, roll it on through.

You add to that that we have a really strong increase in the number of worksite employees that are in the queue that will be paid by January -- that is 6,200-plus instead of 4,000 a year ago. That is obviously -- that is the whole point right now is to build that pipeline of employees flowing into the pay count in January. So we're off to a good start there.

On the other side, we are always in that nervous point, as you come toward the end of the year and don't know how terminations are going to go. We obviously have had great results this year on client retention, 99% again this quarter. But the big tossup in the air is how well we do over the balance of the year.

With our new approach to mid-market we've had some successes. That is just a pilot program, just started. We feel really good about that going forward.

But it is hard to turn that ship in just a one-year period, so we'll see. We will see how we do. The range of our possibilities is still wide; it always is at this time of year.

So we will be working diligently on that. Like Doug said, that is the focus, the selling and the retention.

Thank you very much. I will get back in queue.

Jim Macdonald, First Analysis.

Yes, good morning, guys. Yes, Paul, you mentioned that, whether it is earlier or whether it is later, you expect 2014 to be a good year. What kind of factors could result in an earlier or later result?

Well, mostly it is just the result of this fall campaign. If the starting point is better, how that rolls in, in our recurring revenue model, it just gets you off to a better start for the year. If the ramp-up is later in the year then we don't make quite as much profit on companies that come on later in the year, in that year.

But as far as growth rate, it is -- the normal is 12 to 18 months after you have a double-digit growth in the number of reps, you see it flow into the employee count. The second quarter was the first quarter that we had an increase in trained Advisors that hit 10%. So if it happens sooner than that, than the 12 months, it is because we had a great fall campaign. If it happens a little after that, it is still on track.

Okay. You talked about your mid-market initiative. I think some of that also involved more unbundling. Any idea of what impact that could have on gross profit, if it is a less bundled offering?

Actually it is not really less bundled, it is four total bundles instead of selling one all-in comprehensive bundle. It is two versions of co-employment -- Workforce Optimization and workforce synchronization -- that simply allows the customer to have a little more control over project-related HR cost.

And there's pros and cons to that. In the all-in Workforce Optimization your speed of delivery, speed of execution is way better, because there is no pricing of every project, and trying to decide when to do it, and the decision-making process.

So in the workforce synchronization you have lower cost and more control over incremental costs, but you have slower execution potentially. So there are trade-offs there.

But on the other side of the non-co-employment offerings we have workforce administration, which takes our HCM product as the centerpiece, adds Time and Attendance and Payroll Service; and then also adds HR services that are through a call center, and HR support, and some other services as well.

But that base offering we think is a fantastic entry level. We have got a lot of interest in that, in this pilot program, as a way to bundle some of these ABU services that we have developed offerings into a nice introductory bundle.

Now some customers will want to go beyond that to a higher level of service, add benefits that would be through our insurance agency, and have the flexibility to have their benefit designed however they want to. But they want a more comprehensive service, and we have that available now through workforce collaboration.

So early interest is good on that front. We are managing through how that is presented. And that is what we are learning right now, exactly how the sales process works, how this works with renewing accounts to either validate their current buying decision or put them into another offering. There is a little learning curve to that.

So as a follow-up, I guess my question is -- so, the latter two options you just described, would those be considered ABU revenues? Or would those be considered worksite employees with a lower gross profit?

No, we are --

They would be ABUs. Yes, yes.

We will be evaluating how all this comes together into our financial picture and how to best assess that as we move forward.

Yes. What could happen, dependent upon the volumes -- and of course we don't -- it is still too early to tell. But if you thought about it in terms of the average markup might go down slightly on the ones that go to those other two traditional employment offerings. But the gross profit on the ABU side would go up.

Right. If you had to hazard a guess, any idea? Would potentially 20% go to the last two offerings? Or any idea what the mix might be?

We don't know yet.

I don't think any -- I don't think we would lose any Workforce Optimization customers to any of those where that really fits for them. We have seen that already; it really validates their decision.

But for those that would have otherwise left us, this is all upside, because they would have been gone. And to keep them in one of those is definitely new upside.

We are managing through it, and this is why it is a pilot program and didn't get moved out more dramatically, because we want to make sure you manage any of that migration, because you don't want to cause some cannibalization and things of that nature.

So we are carefully working our way through it, and so far we feel good about how that is coming together.

Okay. Then just quickly two questions on the Affordable Care Act impact. Do you think that has impacted your customers' ability to make a decision here on your services, all the confusion around that right now?

And second of all, you mentioned a private exchange. Will you have your new customers have access to a private exchange as an alternative?

We'll start with the private exchange. We are looking at that as a potential option, but at this stage of the ballgame it is really not necessary.

And we haven't seen anything cause us to want to move in that direction and bear that expense to get that set up. But we are monitoring it very closely. So this is really all about the public exchange that may present quite a few options for our folks.

There also enough private exchanges being formed where if we need to work with someone else on that, that may be a better approach. So we are keeping all the options open. We do think it is important to be able to support any customers who might be better off in that environment.

So we are -- specifically even the smallest of the small that might even get a tax credit. We estimate about 15% of the companies under the 25 employee level may be eligible for a subsidy or tax credit actually for coverage in an exchange. You have to buy it through an exchange as of January 1. So we will be ready to support that if that is a better option for people.

I forgot your first question already.

The first question was, is the ACA impacting your customers' timing of their decision?

Yes, I think there has been a lot of craziness, as you know, in the marketplace and people trying to figure out how they are going to be impacted. So yes, there has been some, but we -- our sales came in; we were 102% of our budget.

They came in later in the quarter than expected. So I don't know if that is driven by the healthcare reform or the economic climate or -- but it did come in a little later than we normally would see in a quarter.

However, the biggest sense of urgency is just now about to hit. We want to make sure our investors really understand this. The community rating that begins for policies effective January 2014 and on, that is going to be a huge driver for our most attractive prospects from a benefits selection point of view.

The reason that hasn't hit yet, it is just now hitting. We are now seeing substantial increases that prospects are receiving from their carriers. But the strategy that most of the carriers used was to take their January renewals and move them into December, so they could avoid handing this 20%, 30%, 50%, 70% increase to their best customers.

So now that the February renewals will have to be delivered to people soon, in the next 30 days or so, and those folks, there was no way to move all of them into December this year, so we are just now starting to see the sticker shock and the disruption that is about to occur in the small business community, the sweet spot of our core.

So these customers with 10 to 50 employees, they are going to need some serious help. And the better prospect they offer us, the more likely their increase is more than enough to pay for our entire service.

So we will be going out to them and saying -- look, if you have to pay more, what are you getting for that? Why not get a complete infrastructure, better benefits, and have an opportunity to make that money back by having your business run better, grow faster? That's the whole point, is to make more money. And I would think we are uniquely positioned to address that.

Great. Thanks very much.

Mark Marcon, Robert W. Baird.

Good morning. I was wondering, Paul, if you could just give a little more granularity with regards to the last comments that you were providing. Like if you gave an example of, say, a 10 employee company; say that they are one of those 60% that is going to see a 20% increase; how much would they typically end up seeing? How much would be absorbed by the employee versus by the company?

And how does that match up with your total -- the total expense? And then how quickly do you think a business owner would be able to react to that? It seems like that would just cause another level of paralysis, at least initially.

Well, they will react very quickly and once they get up off the floor. Then they will start saying -- what do I do about this?

Let me answer your question directly with an analysis I have done that is a depiction. There is no way to precisely pin this down, because it varies client by client, account by account, and all the specific factors of their business profile.

But if we use averages, we use the Kaiser Permanente average cost for a small to medium-sized business benefit plan for 2013, and if you look at just the employer-paid portion, that average cost is $982.

Per month?

Per employee per month. Per covered employee per month.

Now, if you -- under the former rules, the way you can price accounts prior to 2014, where you could look at experience, you could look at gender, you could look at age, you could look at a whole list of other things, geography and so forth, under those rules there was an 8-to-1 ratio around pricing. That gave you a price range off of the average that would go from basically around $218 per employee per month all the way up to $1,744 per employee per month. That is a wide range.

Now what is happening under the Affordable Care Act is a compression related to the range and the factors that you can use to price coverage. So you can no longer use actual claims experience, which is actually the biggest driver of cost. And you can no longer use gender.

You can still use age. You can still use tobacco use. But the range from the lowest to the highest price, the factor that you use to determine the price, can only be 3-to-1. So what happens is that compresses the range between the lowest price and the highest price plan.

So taking an average of $982 and just using that average, that published average, and if you look at the cost increases going in place for 2014, there are two factors you have to consider this year. One is the normal trend in healthcare. Which for small businesses, the best numbers we can see out there that are being used are around 6% to 7%.

Then you have to add the tax and penalty -- or I'm sorry, tax and fees that are going into effect in January for all plans that are coming through insurance policies. That add up to about 3.5% to 4% of premium.

So you are looking at 9% to 11% increase in cost. So if no community rating was happening and everybody just got those increases, you would go up from $982 to almost $1,100, over $100 a month for that type of plan.

However, if you are on the low end of price today, where you are only paying say $218, the lowest increase you might receive would put you at $545 a month. So our most attractive customer would be getting an increase of over $300 a month.

So if you look at -- if you are in the average, that is going up. I believe you got about 60% of the market, the best I can tell, is going to have an increase of $100 to $300 per employee per month.

Although, obviously, it entirely depends on the specifics of every account, but I tell you what; over the next -- it will start now and will continue through next year for customers with fewer than 50 employees. They are going to receive these types of increases. And then, shortly thereafter, it starts on customers from 50 to 100 employees.

So for the next -- our outlook is really strong because we believe this is going to drive people to look at options. And we are a tremendous option, because at least we can get them a lot more services and a lot better opportunity for them to make this money back by coming on our service. They're going to use the same dollars and buy our service instead of just paying more money for less coverage.

So this would -- so there would be a subsector of this group, where it would be optimal. Because when I take a look at your average benefit cost per month, if we compare it to -- if there was a company that was comprised entirely of people who were getting the low end, how would your benefit costs compare to that?

Well, remember, our cost is an all-in proposal. So it is the full value of the service, which adds up all the cost related to being an employer that you pay for an HR department. So when you take our cost of payroll taxes, workers comp, benefits, our markup for our service --

Employment practices, liability.

Employment practices coverage, all that. That typically ends up costing a potential buyer around $100 a month above their cost, and they get administrative relief, better benefits, reduce liability, a technology platform, and a systematic way to improve productivity.

That is the value proposition. But it typically costs someone $100 per employee per month above their cost, even though our markup is $200. So that is $200 above our cost, or if you look at gross profit $250 or so above our cost.

So what I am saying is that most customers, when they analyze this, they see a cost above their current cost of about $100 and they justify that on getting rid of a lot of administrative stuff, sometimes having improvement or at least a better opportunity to manage benefits. They see a nice technology infrastructure to help them, and they think they can make more money doing business this way.

But now, for 60% of the marketplace the mandatory increase is equal to the difference.

Right.

And for the exact same type of healthcare plan?

Right.

Or better.

Or better in a lot of cases.

Great. That's what I thought you were saying, but I just wanted to get it down to a granular level. Thank you.

This concludes our Q&A session. Mr. Sarvadi, do you have any closing remarks?

No, just to say thanks for everybody for participating, and we look forward to getting through our year-end transition and giving you information about 2014 on our next call. Thank you all very much.

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time you may now disconnect.