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Insperity (NYSE:NSP)

Q4 2012 Earnings Call

February 08, 2013 10:00 am ET

Executives

Douglas S. Sharp - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance and Treasurer

Richard G. Rawson - President and Director

Paul J. Sarvadi - Co-Founder, Executive Chairman and Chief Executive Officer

Analysts

James R. MacDonald - First Analysis Securities Corporation, Research Division

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Operator

Good morning. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the Insperity Fourth Quarter 2012 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'd like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.

Douglas S. Sharp

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 meanings 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 fourth quarter and full year 2012 financial results. Richard will discuss our Q4 and full year 2012 gross profit results and our expectations for 2013. Paul will recap the 2012 year and then discuss the major initiatives of our 2013 operating plan. I will provide our financial guidance for the first quarter and full year 2013. We will then end the call with a question-and-answer session.

Now let me begin today's call by discussing our fourth quarter results. Today, we reported adjusted fourth quarter earnings of $0.47 per share, above both the implied EPS from the midpoint of our range of $0.45 in Q4 2011 earnings of $0.42 per share. Adjusted Q4 earnings exclude 2 special items, including an after-tax impairment charge of $0.10 per share associated with a 2006 acquisition, and $0.03 per share related to the accounting treatment associated with $1 per share special dividend.

As far as Q4 key metrics, paid work-site employees averaged 129,345 for the quarter, just below the low-end of our forecasted range of 129,500 to 130,000, and a 2% sequential increase over Q3 of 2012. Gross profit per work-site employee per month averaged $241 for the quarter, which was above our forecasted range of $238 to $240.

Operating expenses totaled $77.6 million. However, when excluding the $4.2 million write-down, expenses were at the low end of our forecasted range of $73.25 million to $74.25 million.

During the quarter, we generated $28 million of adjusted EBITDA plus stock-based compensation. We ended the year with $116 million of working capital and no debt. And this was after paying a special dividend of $1 per share, totaling $26 million, and repurchasing 81,000 shares at a cost of $3 million during the fourth quarter.

Now for some of the details behind our fourth quarter results. Revenues increased 7.5% over Q4 of 2011 to $532 million, and a 6% year-over-year increase in average paid work-site employees. As for the drivers to our work-site employee growth, client retention averaged just over 99% for the quarter. Hiring in our client base exceeded layoffs during the first 2 months of the quarter. However, this metric turned slightly negative during December. And as you are probably aware, Q4 sales are generally converted to paid work-site employees in January the following year. But Paul will update you on these results in just a few minutes.

Moving to gross profit, our results were above expectations due to favorable outcomes in the payroll tax and Worker's Compensation areas, partially offset by health care costs coming in just slightly above our forecast. Richard will discuss the Q4 details and our 2013 outlook in a few minutes. I'll just provide some brief comments. As for our benefits program, approximately 72% of work-site employees were covered under our health plans in Q4 at an average cost of $897 per covered employee per month. Although the level of large claim activity came in higher than expected, benefit cost increased only 4.6% over Q4 of 2011.

As for our workers' compensation program, cost totaled 0.51% for non-bonus payroll for Q4 2012, and included a $4.8 million reduction in previously reported loss reserves. Reported cost was below both our forecast of 0.56% in Q4 of 2011 costs of 0.55%. Payroll tax costs declined from 5.7% of total payroll in Q4 of 2011 to 5.5% as an increase in SUTA rates was more than offset by higher work-site employee payroll and bonuses.

Now shifting to operating expenses, we reported Q4 costs totaling $77.6 million, including the $4.2 million impairment charge. This charge was associated with a write-down of assets dating back to our 2006 HRTools acquisition. These products became the basis of our new suite of Performance Management products, including our PerformSmart SaaS offering. Excluding this impairment, operating expenses increased less than 1% over Q4 2011 to $73.4 million. As for the year-over-year comparison, you may recall that Q4 2011 expenses included advertising cost associated with our re-branding and the Insperity Champions Golf Tournament, which was moved to Q2 of this year.

Net interest and other income for the quarter totaled approximately $193,000 and our effective income tax rate of 41% came in as expected. Now I'd like to take a few minutes to review our full-year results.

Excluding the 2 special items mentioned earlier, full year EPS was $1.67 and came in right on budget, increasing by approximately 26% over 2011 adjusted earnings of $1.33 per share. As for some of the details of our full-year results, revenues increased by 9% over 2011 to $2.2 billion on a 7.5% increase in average paid work-site employee.

Gross profit per work-site employee per month increased from $251 in 2011 to $253 in 2012. As for our recap of our direct costs, benefit cost per covered employee per month increased by just 3.5% for the year from $835 in 2011 to $864 in 2012, due to effective management of our plans and some migration of employees into high deductible plan. Workers' compensation cost as a percentage of non-bonus payroll remained at historically low level of 0.54%, on favorable claim frequency and severity trends to include a $13.1 million reduction in previously reported loss reserves.

Payroll taxes as a percentage of total payroll decreased slightly from 7.15% in 2011 to 7.05% in 2012. As for operating expenses, and excluding costs associated with the Q4 impairment charge, we reported just a 5.5% increase over 2011 to $311 million. This increase reflected ongoing investment in our Workforce Optimization offering including our enhanced Employee Service Center and a planned investment in our adjacent business units, including the headcount, back-office systems and amortization associated with acquisitions. These additional costs were partially offset by the non-recurrence of re-branding costs in 2012.

Net interest income declined by approximately $360,000 from 2011 on lower interest rates, and our effective full-year income tax rate increased slightly from 40% in 2011 to 41% in 2012. As for our balance sheet and cash flow, EBITDA plus stock-based compensation adjusted for the impairment charge totaled $101 million for the full-year 2012. Cash outlays included cash dividends of $43 million, repurchases of approximately 596,000 shares at a cost of $17 million, capital expenditures of $18 million and acquisitions and other investments totaling $4 million.

In summary, we are pleased with the execution of our 2012 plan, increasing adjusted earnings per share by 26% and generating adjusted EBITDA plus stock-based compensation at a record level. These results allow for continuing investment in the company throughout 2012, while providing a return to shareholders in the form of a special dividend in our ongoing dividend and share repurchase programs. At this time, I'd like to turn the call over to Richard.

Richard G. Rawson

Thank you, Doug. This morning, I will fill you in on the details of our fourth quarter and full-year gross profit results. Then I will update everyone on our gross profit outlook for 2013 and I will conclude my remarks with comments about health care reform.

As Doug just reported, our fourth quarter gross profit per work-site employee per month was $241, which was $2 per work-site employee per month above the midpoint of our range. The gross profit consisted of $191 of average markup, $39 of surplus and $11 from the adjacent businesses.

Now let me give you the details of each component. The average markup and the adjacent business contributions were right on forecast. Meaning, that the additional -- $2 additional gross profit per work-site employee per month came from the surplus component. Now this $2 per work-site employee per month of additional surplus came from, number one, $3 higher contribution from the payroll tax cost center; and number two, $6 higher contribution from the workers' compensation cost center, partially offset by number three, an additional $7 deficit from the benefits cost center. So here's the breakdown for each cost center. The extra $3 per work-site employee per month from the payroll tax cost center came primarily from higher allocations related to higher bonuses that were paid to work-site employees in December. The extra $6 per work-site employee per month from the workers' compensation cost center also came from same higher allocations due to the year-end bonuses and better-than-expected claim settlements during the quarter. The benefits cost center's extra $7 deficit was due to lower allocations of $4 per work-site employee per month and $3 per work-site employee per month of higher cost. The lower allocations are the result of participants selecting the lower cost, higher deductible health plans.

In summary, the fourth quarter was very consistent with our overall forecast, and we are very pleased with the results. Now let me comment briefly on the full year's gross profit results. This year, our total gross profit grew $30.4 million from 2011 to a total of $382.2 million. This is an 8.7% increase and is particularly good when considering that our work-site employee growth that increased 7.5% over 2011. I believe this demonstrates both pricing strength and effective direct cost management, resulting in another good year. So let's move forward to 2013 and our expectations for gross profit, beginning with our markup.

We would expect to see the average markup increase slightly from $190 per work-site employee per month in 2012 to $192 in 2013, due primarily to the mix of customers in the January base and a conservative outlook of further price increases. Now let's look at the surplus component of gross profit, beginning with the payroll tax cost center.

This year, some states have lowered their unemployment tax rates to us and we have adjusted client allocations accordingly. So at this point, we will forecast a slight decline in the surplus from this cost center for the full year.

Moving to the workers' compensation cost center, we expect the pricing side of workers' compensation allocations for new and renewing business to continue to remain fairly constant with where they are now. On the cost side of the workers' compensation cost center, we continue to have positive results and ended the year with an expense of 0.54% on non-bonus payroll. We want to be conservative, so we'll forecast our expense for 2013 to be approximately 0.56% of non-bonus payroll and let the upside evolve as claims are settled for amounts less than their reserves.

Therefore, we will initially forecast our surplus for the workers' compensation cost center to be slightly lower than 2012.

Switching to the benefits cost center, let me tell you how we see our deficit changing for the positive, beginning with the pricing allocations. As we move into 2013, we have seen a slowdown in the migration of work-site employees to lower cost, higher deductible plans. In addition, we have also seen an increase in our pricing allocations because those clients that left at the end of the year had lower allocations than the client base that stayed. Therefore, we have a nice improvement in our allocations automatically built into our forecast for 2013. On the expense side of the benefits cost center, we added -- we ended 2012 with an overall trend increase of 3.5% over 2011. It would not be prudent to forecast a trend that low for 2013 even though we did make a few small plan design changes to help reduce trend. So to be conservative, we'll forecast a 4% to 5% increase in benefit cost for the full-year over 2012.

The bottom line is, that we expect the deficit in the benefits cost center to decline in 2013 compared to 2012.

When you combine all of the forecasted direct cost surpluses and the benefits cost centers deficit, we should generate a surplus of $52 to $55 per work-site employee per month for the full-year of 2013.

Now our last contributor to gross profit, which is our adjacent business services, should also add more to gross profit in 2013. We have seen an increase in sales over the last few months and the pipeline for new business looks good for most of our Adjacent Businesses. So at this time, we are conservatively projecting an increase of $2 per work-site employee per month in gross profit for the year from $11 to $13.

In summation, when you combine the service fee, the surplus and the adjacent business contribution, we expect to see our gross profit per work-site employee per month end up in a range of $257 to $260, which is a slight increase from the $253 of gross profit per work site employee per month for 2012.

Before I turn the call over to Paul, I would like to comment on health care reform and what we are doing to prepare for it. Last spring, we launched a task force comprised of 3 members of our senior management team and 13 other individuals from various departments within the company. The purpose of this task force was to study all aspects of the 2,500 page legislation and to develop and implement appropriate strategies, which will bring the best solutions for clients and prospects beginning later in 2013. Just since the election, HHS has added almost 1,000 pages of regulations to the already mammoth law and there are still thousands of pages of regulations to come.

We started the task force with 2 full-time people, but now that number will be growing to 14 this year, as we digest the rules and regulations and execute the strategies, which we have developed. We do see how health care reform can allow us to expand our current offerings, and we will speak to those opportunities as they come to fruition later this year. At this time, I'd like turn the call over to Paul.

Paul J. Sarvadi

Thank you, Richard. Today my comments will fall into 3 categories: First, I will comment on our 2012 financial and nonfinancial highlights; second, I will describe specific inputs into our starting point for paid work-site employees and the resulting plan for 2013; and third, I'll provide some color surrounding investments we expect to make throughout 2013, including expanding the number of business performance advisors, opportunities related to healthcare reform and growth of our Adjacent Businesses.

We are very pleased with our 2012 financial results in a period of a high level of uncertainty throughout the year. Our adjusted earnings per share increase of 26% year-over-year on 9% revenue growth is strong performance in any environment. Adjusted EBITDA exceeded $100 million for the first time in our company history, and continued to demonstrate the strong cash flow dynamic of our recurring revenue business model. We also had an excellent year, laying the groundwork for a very bright future for Insperity. The most significant accomplishment was completing our business transformation, establishing Insperity as a leading HR and business performance solutions provider. We began this effort over 2 years ago, and each of the fundamental components that are necessary to broaden our reach and accelerate our growth are in place.

Over this period, we established an array of business performance solution to help businesses run better, grow faster, and make more money. These targeted solutions complement our Workforce Optimization service and are also sold on a standalone basis to extend our reach in the small to medium-sized business community. We have established a powerful new brand in the marketplace that leverages our key strengths in HR and business performance, consistent with our positioning as a premium service provider. We also retrained our entire sales force, established a business performance advisor role and completed the Insperity selling system training program. We are now ready to grow the number of business performance advisors with the sales efficiency level that creates unlimited growth potential. We established an inside sales operation that extends the daily activity of our business performance advisors into a major channel for each of our adjacent businesses, adding new customers and driving additional gross profit contribution. These fundamental changes now provide a platform for faster growth and profitability into the years ahead. The potential for revenue and income from a wide array of services to a much broader customer base is in sharp contrast to our previous business model with one offering to a narrow target customer.

Now this transition did not occur without some risk to the former business model, which was solely driven off of paid work-site employee growth in our only business that existed, our Workforce Optimization service.

One of the biggest risks of the transition was some interruption in the work-site employee growth pattern while we retrain the core sales team and before we were ready to increase the number of BPA. The time of year with the least visibility into work-site employee growth in the Workforce Optimization model is in the fourth quarter in attempting to determine the January paid work-site employee count. This is due to the 3 factors that determine the starting point of paid work-site employees including year-end client attrition, net change in existing clients from layoffs and new hires and Fall Campaign sales.

All the way through mid-December, we were on track for a promising year end attrition as termination notices were in line with our previous record-setting client retention year. The client base has experienced a small, but positive net gain from new hires exceeding layoffs in November, and the pipeline for new business was good in both MidMarket and core sales. It seems that the risk related to the year-end churn of customers leading to a material decline in the starting point in paid work-site employees was low. However, our client base is comprised of what I would like to refer -- or what I'd like to refer to as the best small businesses in America. The owners of these businesses are precisely the individuals and companies most affected by the recent tax, health care and regulatory activities in Washington. But with this backdrop, 2 of the factors that affect our starting point, attrition and layoffs, increased, resulting in a significant difference compared to last year. The number of clients terminating in the January, February combined period, was identical in both periods at 496 attempts. However, the number of work-site employees associated with these accounts was 32% higher, driving attrition to levels we have not seen since 2010.

To put this in perspective, in all 3 years including 2008, 2009 and 2010, the percentage of work-site employees from terminating Workforce Optimization clients was approximately 11%. In 2011 and '12, this metric was 9%. This year, the number came back up to 11%. Due to the loss of a number of large, cost sensitive accounts that terminated very late in the year-end cycle. So the loss of work-site employees from client attrition reverted back to historical levels generating approximately 3,600 more work-site employees than last year to make up from in new sales. Compared to last year, 8 more MidMarket accounts and 18 more emerging growth segment accounts terminated in the January, February combined period, and account for just over 3,400 of these work-site employees. Also in December and January last year, we had new hires exceed layoffs by approximately 1,900 employees. This year for the same period, we had a soft spot and layoffs exceeded new hires by 700. The difference creates an additional 2,600 employees to replace with new sales compared to last year. In new sales we have some good news and some bad news. The good news is that our core sales team had an excellent Fall Campaign, and achieved 103% of our goal of 13,000 work-site employees. Sales efficiency was 1.18 sales per BPA per month during the campaign, which is critical for our going forward plan. The number of business performance advisors and their sales efficiency is the centerpiece of our long-term growth strategy. This is an excellent efficiency number for a newly retrained sales force in the midst of a difficult market. This confirms our new sales strategies and our decision we made in the fall to grow the number of business performance advisors.

For the full year, core sales came in at 98% of target and efficiency was up slightly by 4% to 0.73 during this transition to Bundle Plus selling. The bad news is our MidMarket sales results, which were 68% of target for the Fall Campaign and only 55% of target for the year. We have been working this issue for a number of years and we were quite disappointed with this outcome, especially in light of the loss of a number of larger accounts. Our analysis of the January, February terminating accounts reveals the gross profit per work-site employee was only $216, which is 15% lower than the $253, Richard just reported for the entire base last year. This was due to the mix of larger cost-sensitive customers that left the Workforce Optimization service. So we lost the right accounts, but did not replace them with enough MidMarket sales as we expected from the pipeline we generated.

In January, I spent the better part of 3 days working with the MidMarket sales team as they dissected the activity and the obstacles they were unable to overcome. There's silver lining here in that we were much improved in 2012 in each of the steps of the sales process that received the final closing space. The number and quality of discovery calls, Business Alignment Surveys conducted and proposals presented, all showed marked improvement. This makes the lack of production even more frustrating in some ways, but the reality is we have honed in on the final stage of the sales process and isolated key obstacles to closing business and have resolutions ready to implement in 2013. So the bottom line is, the starting point for paid work-site employees will be lower than expected since our last conference call. Higher attrition of large accounts and less hiring within the base compared to last year was not offset by new sale. Even with a highly successful fall selling campaign in the core market, the shared number of business performance advisors was not enough to overcome the higher attrition, less hiring in the base and lack of success in MidMarket sales.

Now with this information, you would immediately want to kickstart hiring of business performance advisors. Fortunately for all of us, we made that decision in October after validating our training program and announced a hiring plan on our call in November. As a result, we will begin the year with a step down from the fourth quarter in paid work-site employees, which has a significant effect on this year's guidance, which Doug will provide in a few minutes. However, the effect on our growth plan will be very short-lived and sales increase as we increase the number of business performance advisors. We've been very successful in hiring and training business performance advisors since our last call. We are over 300 business performance advisors hired as we speak, and we expect to ramp up the trained advisor count to that number by the end of the first quarter.

Trained BPAs are expected to average around 260 in Q1 and 300 in Q2. This 25% increase in trained BPAs from the 239 in Q4 to 300 in Q2, represents an investment of approximately $4 million in 2013.

We also have a near-term investment of approximately $2 million to make 2013 to comply with healthcare reform legislation and to capitalize on the opportunities created by the new law. Our first opportunity is to use the complexity and confusion surrounding health reform requirements into more opportunities in front of qualified prospects. We have prepared an executive briefing for small and midsized firms to be delivered by our business performance advisors and also to be offered as a WebEx group presentation. BPAs will go through training on this executive briefing at our sales convention this month. And shortly thereafter, we will include this offering -- this offer in our advertising. Our second opportunity is to offer more options for coverage in our prospects and clients within and outside our co-employment Workforce Optimization model. This will be accomplished as we add our Insurance Services offerings and ramp up our insurance agency to include these service.

We also are considering, and will be prepared to establish a private exchange under the new law if the opportunity pans out the way it looks right now. It appears providing a private exchange alternative to the public exchanges may provide a competitive advantage in the ability to offer the full spectrum of purchasing options to our clients and prospects. In addition, these health care alternatives under the new law puts the finishing touch on our adjacent business strategy. We will now be able to describe a full continuum of offerings from which prospects and clients can choose with a wider range of cost and value. We will simply have more solutions to match more prospects and client needs.

Two years ago, we had 1 service for only the perfect fit customer at just the right time. Now we have the right range of solutions for a wide range of customers over the entire life-cycle of their company. Insperity now has a platform of products and services and a delivery system of business performance advisors to engage a customer for life. We can start where their most critical need exist and grow the relationship with solutions to match made their needs as they change. This approach to the marketplace translates into a powerful business model with more recurring revenue opportunities for more businesses and lower risk. These seeds we planted are now sprouting out of the ground. Our capability to develop new products and grow new businesses is increasing and so are the results. In 2012, we saw some nice revenue growth in our adjacent businesses as we refined the operations to grow faster and more efficiently. For the full year, Retirement Services grew 94%; recruiting services, 29%, Employment Screening, 16%; Performance Management, 12%; Time & Attendance, 9%; Expense Management 7%; and the portfolio as a whole over 10%. A number of SaaS seats increased 37% to over 116,000 at year-end in our 3 SaaS solutions we had last year. And recently, we launched 3 new powerful SaaS applications including Insperity HCM, or plus realtime and Insperity Reveal. In the fourth quarter, we saw an increase of 32% over Q3 in the purchase of additional ABU solution by Workforce Optimization clients. 1,474 additional ABU solutions were purchased in 2012 by Workforce Optimization clients validating our cross and up-selling strategy. So in summary, we are full steam ahead and ready for growth on every front. We are disappointed with the starting point in paid work-site employees in our Workforce Optimization business, but far from discouraged by it. We had an excellent year last year and established a dynamic foundation for growth in the years ahead. At this point, I'll pass the call to Doug to provide our initial guidance for 2013.

Douglas S. Sharp

Thanks, Paul. Now before we open up the call for questions, I'd like to provide our initial 2013 financial guidance. As Paul discussed earlier, our forecasted unit growth takes into account the lower January starting point. We expect client retention to return to historical levels over the course of the year and are conservatively budgeting for slightly less net hiring by our client base than last year. Our unit growth guidance also considers a 25% increase in the number of business performance advisors at initial sales efficiency levels, combined with the improving sales efficiency on our more experienced BPAs. In considering these factors, we expect to begin the year with average work-site employees paid in a range of 123,250 to 123,750 for Q1.

Thereafter, we expect sequential growth between 3% and 4% for the remaining quarters of 2013 to end the year around 138,000 work-site employees. This results in average paid work-site employees in the range of 129,500 to 130,500 for the full year. As for gross profit per work-site employee per month, based upon Richards earlier comments, we expect to be in a range of $257 to $260 for the full year. The expected improvement over the $253 achieved in 2012 is due to slightly higher service fees, health care pricing and gross profit contribution from our adjacent businesses.

Consistent with prior years, we are initially budgeting lower surpluses in our payroll tax and workers' compensation areas. As for the quarters, we are forecasting Q1 gross profit per work-site employee per month from $287 to $291. The quarterly pattern of -- the quarterly pattern for the year is expected to be similar to 2012. We expect gross profit to be higher in Q1 because of the surplus we generate on a higher level of payroll taxes prior to work-site employees reaching certain wage limits.

Additionally, with the recent growth in high deductible health plans, costs are lower in Q1 and step up in Q2 through Q4 as deductibles are met. So considering the seasonal impact of these factors and price increases rolling in throughout the year, we expect a sequential decline in Q2 of about $40 per work-site employee per month, an increase of approximately $5 in Q3 followed by a decline of about $15 in Q4.

Now shifting to operating expenses, we are forecasting total operating expenses in a range of $336.5 million to $340.5 million. This year's larger incremental items include costs associated with the increased number of business performance advisors and the implementation of our healthcare reform strategy.

As for some of the details behind our operating expenses, we expect salaries and wages to increase by about 10%. This is largely driven off of costs associated with the sales force expansion as other corporate headcount is budgeted to increase only 2%. As for stock-based compensation, we expect that 2013 restricted share grant to be at a similar level as that granted in 2012. However, with the 3-year vesting period, we have a lower priced 2010 grant, which occurred during the economic

the 2013 restricted share grant to be at a similar level as that granted in 2012. However, with the 3-year vesting period, we have a lower priced 2010 grant, which occurred during the economic downturn being replaced by grants at higher price level. This is expected to result in a 13% increase in 2013 expense over 2012.

Commissions are expected to increase by about 6% on higher projected sales with the sales force expansion. Advertising costs, which had historically included a component for government affairs, are expected to increase by approximately 11%. This increase includes activities surrounding health care reform and some additional marketing of our adjacent businesses.

G&A costs are expected to increase by just 5%. Depreciation and amortization is expected to be up by approximately $3 million over 2012, and includes purchase price amortization on recent acquisitions, including our new Financial Service and payroll SaaS offerings and our new Time and Attendance product offering and channel relationship. In 2012, we also invested in our infrastructure to support the growth of our adjacent businesses, and made significant enhancements to our website and Employee Service Center, including online enrollment.

Now as for the quarterly spend, Q1 operating expenses are expected to be in a range of $85.5 million to $86.5 million, and include the usual expenses associated with the restart of payroll taxes on our corporate employees, our annual sales convention and sales incentive trip. We expect a slight step up in operating expenses of approximately $1 million from Q1 to Q2, and then a sequential declines of about $4 million from Q2 to Q3 and a little over $1 million from Q3 to Q4. Now similar to prior years, the high end of our full year operating expense guidance is tied to additional incentive compensation, which will be accrued only upon achieving higher operating results.

We are forecasting net interest income in a range of $100,000 to $200,000 for the full year in this very low interest rate environment. And as a point of reference, we were earning as much as $12 million in interest income in 2007. We are estimating an effective income tax rate of 40% and 25.7 million average outstanding shares for both Q1 and the full year.

So looking at the full year's earnings expectation,s,our guidance implies an EPS range of $1.47 to $1.56 for 2013. This estimate includes the negative impact of a lower January starting point from our initial expectations of about $0.25 per share, and the investment in our health care reform strategy of about $0.05 per share. Also, the expansion in a number of Business Performance Advisors equates to about $0.10 per share. As for the quarterly pattern, our guidance implies a Q1 EPS range of $0.46 to $0.53 per share, with a sequential decline of about $0.30 per share from Q1 to Q2, an increase of $0.24 per share from Q2 to Q3 and a decline of about $0.03 per share from Q3 to Q4.

As for our cash flow, our full year guidance implies EBITDA plus stock-based compensation of approximately $97 million. We are budgeting 2013 capital expenditures of $15 million. And with our expectation of continued strong cash flow and the fact that we are beginning the year with $116 million of working capital and no debt, we are in a good position to invest in our initiatives and continue our ongoing dividend program.

Additionally, with the low participation in our tender offer at $31 per share repurchase price in Q4, we only used $3 million of the allocated $50 million. So we are entering the year with $47 million designated to repurchase shares.

At this time, I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Jeff Martin with Roth Capital Partners.

Our next question will come from the line of Jim Macdonald with First Analysis.

James R. MacDonald - First Analysis Securities Corporation, Research Division

So could we dig in a little more to the sales issue? I mean, 6,000 sequential draft seems pretty large. I mean, you talked about 3,400 from 3,600 from sort of the MidMarket extra losses, but then with the sales campaign going so well, it just seems like a particularly large drop. I guess you've explained it, but it -- I think as we thought we had the MidMarket in hand, what can we do about it?

Paul J. Sarvadi

Yes. Well, we -- like I said, I spent a few days with the MidMarket sales group, and there are a lot of things we can do about the closing rate, and that's where we fell short. As we came in to the fall, we had a very nice pipeline of MidMarket prospects and we just were unable to convert them. So we've got lots in-store to work on that for the coming year. But where the shortfall really comes from for this year was those termed accounts in the larger customer base that were very cost-sensitive. We looked at our -- we can look at that group as a whole and look at exactly how they're priced. And as I mentioned, their gross profit contribution is about $215 -- $216, I guess, $216 or so compared to our average. So we also sent out a consultant to do a full investigation of what happened on those accounts, and they literally were basically cost-sensitive accounts that right at year end decided they needed to make a change. And so the point I was making in my script was, we just didn't quite have the size of our core sales staff large enough to overcome that and especially without MidMarket sales hitting their level. So it's almost like a problem that appeared after the solution is already in place because we've already started ramping up the sales staff. So that's why this thing will be fairly short-lived.

James R. MacDonald - First Analysis Securities Corporation, Research Division

So where did these -- what did the MidMarket accounts do to save cost? I mean, you have a pretty attractive health offering and they're going to need health offerings, so what was their solution? Is it different PEO or a different type of solution?

Paul J. Sarvadi

It was a -- it was about the same mix as we've seen in the past of some going to take it back in-house, and some going to other PEOs and then some using kind of a hybrid or finding some other bundled solutions but not a full solution and just not having as much as they used to have. So we reflected a cost-cutting mindset that we saw right there at year end.

James R. MacDonald - First Analysis Securities Corporation, Research Division

And just you mentioned that your customers are specifically affected by the fiscal cliff. Could you just kind of remind me why you think that would be the case?

Paul J. Sarvadi

Well, if you look at the most successful small and medium-sized business owners, they're in a situation where all the regulation that's coming out affects their businesses directly, both the regulation, and then on top of that, health care reform, which is really huge. But at the same time, the tax increases that came at year end also play indirectly for those individuals. And were significant enough to cause some actions. There's some steps to take place. We saw that significantly at bonuses at year end with people doing tax planning, and a large bonus deal this year for those owners and management.

James R. MacDonald - First Analysis Securities Corporation, Research Division

And that was another question I had. You're bonuses are up dramatically in Q4. Are they going to be presumably down in Q1? So was there sort of a big shifting there that also impacts results?

Paul J. Sarvadi

Not a lot. We do make some fees on bonuses because you're processing transactions and so forth. And certainly, bonuses will be substantially lower. But that wasn't a big contributor to the change.

James R. MacDonald - First Analysis Securities Corporation, Research Division

I just had one more general question and I'll get back in the queue. But you mentioned starting up a health exchange. Would you do that by yourself or with United Health, and the cost of that could be large, I believe. So maybe you could talk about what would be involved in starting up your own exchange?

Richard G. Rawson

Well, Jim, this is Richard. We have spent quite a bit of time in that project. Remember I talked about this task force that we have, and one of the groups in the task force is working on that particular program all by itself. Oddly enough, there are some opportunities out there that I think could work for us. But we're still in the research phase, and so don't want to start making commitments about what we are or what we're not going to do until we've got it all put in place a little bit later on in the year, because business owners by the time we get to July are going to be needing to have answers for their work-site employees because these exchanges, theoretically, are supposed to go and be open for business to start enrolling on October 1, and I'm still not sure if that's even possible. But having said that, we're going to be prepared with our full array of opportunities for the business owners by the time we get to the summer.

Paul J. Sarvadi

Yes, we have a variety of options. But I think it's important for you to understand, when you think about what an exchange does, which is to bring together plans from various providers, line them up side by side and help customers choose from among them and make a choice and implement a plan, that's what we do. We do that already. So in terms of the mechanics of what you actually do to make that happen, we do that. Now would it be on a different platform? We're proud to be working with some other outsiders and we have various options for different size of accounts, but we're well down the path to be prepared to do that if the need and the opportunity arises.

Operator

Our next question will come from the line of Tobey Sommer with SunTrust.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Paul, just wanted to see if you could elaborate a little bit more on what your assessment is of why the customers left and see if there's a change in the value that they're looking for?

Paul J. Sarvadi

Sure. Now we -- that's a good question and obviously, that's one we would be all over, it's why we've spent a lot of time over the last 4 weeks or so really digging in on that. And comparing to previous information that we look at with customers as they depart, with exit interviews, so on and so forth. And in some ways it's unfortunate there's not a lot of difference there. You basically you had cost-sensitive accounts that felt like they were in a position in their own economic environment that they needed to try to come up with another way to literally save dollars. So it wasn't very exotic. That's what happened. Now we also had, of course, the usual number of companies that, I call it, our success penalty that sold at year end and moved to somebody else. We actually were able to sell one of those, the new company, and bring extra's on [ph]. So we had some of that. We also had some companies that were in more desperate financial shape, either going into bankruptcy or near. And obviously, those with credit reasons, we had to let go. But no, it's as plain as I laid it out in the script. We just had a higher number of larger accounts that were cost-sensitive, and at year-end, there's kind of a sour tone and they departed.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

When I think about your initiatives on the expense side, how do you think about your ability to moderate or accelerate those throughout the year? And how would you -- what kind of milestones or signs would you look for to step on the gas pedal or the brake?

Paul J. Sarvadi

Sure. Well, what we are really looking for right now and all over is making sure that, that business performance advisor count ramps on up. I'm not talking about the training count. We already have more than 300 hired. That number needs to get to about 320 or so to have the training count be at that 300 number. And then we're going to be looking very closely at the sales efficiency of the 240 or so that were here at year end and the new 60 that are here, and making sure that all gets managed well. Very excited about that because we just had a successful Fall Campaign, so those 240 went through the whole new training system, the whole new selling system and they were successful. So they are ramping up. They're at the bottom of that nice curve that moves up for sales efficiency as you succeed. And then the other factor that's interesting is that our new BPAs, the new ones don't have the old system to get rid of. They get to come in and learn the new system and go out, so I'm very excited to see how new BPAs are able to perform with the new selling system.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

My last question is, how much in earnings did the adjacent business unit -- business cost in 2012, and what's your assumption for '13? And the reason I ask is that with a 37% growth in seats, I'm wondering about the timeline of potential conversion from a drag to breakeven and ultimately, profitability.

Paul J. Sarvadi

Yes, just in a general sense, and Doug has specific numbers, but I'm going to -- we had talked in terms of a drag of about $0.25 coming from all these businesses we've established, et cetera. And now you have to look at the ABUs that were in place last year, and those are going to be less of a drag next year than they were. But we also added the Payroll Service and some financial service offerings late in the year, and they are going to cost a little bit. And so we're expecting this year to be that year -- should be about the same as a budget. We budgeted that to be about the same, we're hoping to blow that number away. But at the beginning of the year, we believe in budgeting fairly conservatively on each component.

Richard G. Rawson

And of course, when you look at, which is really the way that we're really measuring these guys right now, is in their gross profit contribution. And we do see a nice step-up coming, even though it sounds like a couple of bucks per work-site employee per month for the year. Well, that's several million dollars of gross profit contribution, and that's been our game plan all along, was to bring those adjacent businesses to a point that they could materially contribute at the gross profit line because they're such high-margin businesses. So we're seeing some real positive there.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Right. Doug, do you have the numbers for the EPS impact in '12 and what it's model for '13?

Douglas S. Sharp

Yes, I mean, It goes back what Paul mentioned earlier. It's about $0.25 drag or so in 2012 and we expect a similar drag. But if you look at 2 different components on the businesses that we've had, the recurring-type ABUs, we expect about a $0.05 improvement on those and then a $0.05 investment on the new ones, which are the Financial Services, the new payroll product that came out mid to late last year and then on the financial service product, the Reveal software that we've announced.

Paul J. Sarvadi

And the HCM...

Douglas S. Sharp

And the HCM, right.

Paul J. Sarvadi

The major movement, very promising.

Operator

Our next question will come from the line of Mark Marcon with Robert W. Baird.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

I was wondering what's the percentage now of the clients that are in the MidMarket?

Paul J. Sarvadi

Well, we were up to about 19. I think at this point, it is, I think, 17. But -- yes, that's right.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And within sales, what's the -- the business process advisors, how many of them are dedicated to the MidMarket?

Paul J. Sarvadi

Right. We have 8 business performance consultants. In the MidMarket, we use that term to describe them and differentiate them from business performance advisors.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Okay, okay. And then with regards to the -- we have the starting base, and in terms of the -- achieving the sequential growth, does it imply any sort of ramp up in terms of productivity levels within the core BPAs?

Paul J. Sarvadi

In the core BPAs, you'll have some ramp-up in their sales efficiency that will offset the lower sales efficiency at the new folks. But it's very modest. Strictly -- and we all know how these numbers work. When you grow your sales about 25%, you're going to get a lot more sales. So it's a -- we think it's a more than a doable forecast for that component.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Can you remind us how many BPAs you had at the beginning of 2012?

Paul J. Sarvadi

Yes, we had -- for most of the year, we were right around the 250 number. And basically, this -- in the Fall Campaign this year, the slightly smaller sales staff produced more than -- or actually produced the same amount of sales as the group the year prior, so -- in the new selling system. So I was really pleased with how that worked out.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And with regards to the new Affordable Care Act, and there are certain provisions of that, that go into effect even starting this year, how does that -- how are they -- how would a smaller company view themselves from the perspective of -- and this is something that a number of investors have been asking about. Is this -- if you're part of a PEO, do you suddenly become -- if you had 20 employees and you weren't subject to the Affordable Care Act but you joined a PEO and you now become part of an organization with 120,000 employees, that you are now subject to it or how should we think about that?

Paul J. Sarvadi

Well, yes. Here's how we should actually think about that. When you think about customers that are in our universe, the Workforce Optimization, there are customers providing benefits, want to provide benefits, they're the best small businesses in the country, they are competing to hire and keep the best people. So whether they have to provide it or don't have to provide it is really a nonissue. They want to provide it. But the real issue for them is, does this open up any new options or new ways to provide the coverage that is going be better for them? And what we're prepared to do, and Richard's group has done an amazing job on getting prepared for this, but we believe we're going to be able to offer more of a continuum of solutions for companies that, both in the Workforce Optimization solution and outside, to where you can mix in either brokerage solutions or being involved in our large plans depending on which is better for that particular customer. So we think it opens up a lot of opportunity for us to do more for more customers.

Richard G. Rawson

I think the other item that's important to be aware of is that, while there is no specific requirement for those that have less than 50 full-time equivalents, and by the way, that has still not been defined yet, so...

Paul J. Sarvadi

You mean, full-time equivalent....

Richard G. Rawson

Full-time equivalent employees, right. But the other thing is this whole topic of cost, you haven't heard people talk about yet because it is the -- if you use the colloquialism, it's the light at the end of the tunnel. And it's not light, it's a train. The whole health care reform is requiring the transition to community-rating kind of concept. And what that does is that forces all of -- in this particular bill, it forces all of the way that the insurance companies rate their prospect, if their covered people goes to a new rating system, whereby people are going to get -- a number of people are going to get really nice decreases, and a number of people are going to get really huge increases. So if you're forced into that environment, you're going to be, as a small business owner, seeing increases in the 30- to 40-plus percent beginning in 2014. And of course, in our situation, because of our plan and how it works, they won't be having to experience that kind of a situation. So it's not just about offering it or not. It's about the cost of offering it and what that's really going to mean.

Paul J. Sarvadi

I think one other factor that's really significant here is that the amount of data and information and reporting that a business is going to have to do to comply with the Health Care Reform Act is really significant. It has to do with the things they're not even calculating today or a data they're not even collecting today. And that's one of the reasons we've created, we've developed this executive briefing. A PowerPoint presentation and information that we're going to train our advisors on this month when they come in for the convention, so that we can offer that to small and midsized business owners, so that they can get briefed on what the requirements are going to be. And basically, we're going to be able to lay out an option where you can handle all this complexity, all this compliance and all this cost, or you can just sign up with Insperity.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Great. And then when we take a look at your client base in terms of roughly 73% getting the health care coverage, do you have any clients that don't participate in the health care? I'm assuming that 73% is basically 3 out of every 4 employees at your clients opt for the health care.

Richard G. Rawson

Right, yes. Actually, when you look at the number that are eligible, it's the -- the coverage is over 90%. The thing that report every quarter is just the pure math of that month of the number that we've got on the plan. But...

Paul J. Sarvadi

And some are ineligible because of part-time or temporary, some are new and aren't eligible...

Richard G. Rawson

Yes, some of them are -- and the rest of them are covered under a spouse's plan or whatever.

Paul J. Sarvadi

Or military coverage, or...

Richard G. Rawson

Right. So I don't know if that answers your...

Paul J. Sarvadi

So we really don't...

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

That answers the question. And then I would imagine that your medical loss ratio is more favorable. Is there any opportunity to -- with your medical loss ratio being what it is, that you could actually utilize that in terms of negotiating even better rates with UnitedHealthcare?

Paul J. Sarvadi

Well, I think the answer to the question is, the way that our plan operates, it's a -- it is called -- it's a fully insured plan with a partial self-funding treatment from an accounting perspective. So our plan includes the -- all of the cost of the claims is the basic part of the plan that we're responsible for and then we negotiate with the carriers for administrative fees and other things. So the real opportunity is -- I mean, we just posted a year where our trend for health care, the total book of business that we've got on $900 million of health care expense this year was 3.5%. So I mean, it doesn't need to get any lower than that because I don't think there's too many people that are walking around the streets talking about a 3.5% increase in health care cost for 2013 and beyond.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

No, it's terrific. I was just wondering, I was under the impression that there might be the potential for UnitedHealthcare to actually use your population in terms of calculating their medical loss ratio. And given that yours is superior, presumably that there's an arbitrage there and that they might be able to capture some of that.

Richard G. Rawson

Yes. No, no, they're not able to do that because it's our nickel.

Operator

Our next question will come from the line of Michael Baker with Raymond James.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

In terms of your work=site employee base, what percentage are with employers with less than 10 employees?

Paul J. Sarvadi

A very small.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Okay, that's helpful. And then with the private exchange, can you give us a sense of what part of the market you think that works best with as it relates to the small business dynamic and their needs?

Richard G. Rawson

Well, I think that -- I think the answer to that question is still unknown. And so as a result, maybe in 1 year from now, we might be able to, Michael, be able to answer that question. But in the meantime, we've got to be prepared to have that as a solution so that for those that decide to go that route can use it. I think the other thing that's pretty important to realize here about this exchange and all of that kind of stuff is that, if you'll recall the work-site employee base that we have, the average compensation is about $60,000 a year. And so they are not going to fit in the -- be able to go into the exchange to get a subsidy from the Federal government because of their base wage. So I think -- and as we answer some of these questions for you all, they're going to be different than what like the Darden's restaurant group is going to be dealing with or Sear's are going to be dealing with. So it's different.

Paul J. Sarvadi

I think the other way you have to think about it though, and I think this is important. You have to think about customers in a life cycle. Customers may need to be in an exchange when they're not very profitable, they're small and young and trying to make it. And then they -- maybe you can grow out of that as they get -- not just in size but in profitability, and can afford more better and do more things to hire and attract key people. So we want to be able to provide the full spectrum of possibilities. I want to be able to analyze their options side-by-side with them and help them choose what their best option is.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Would one of the potential implications be moving away from the bundled pricing on the PEO side as people consider shifting from one or making adjustments or doing hybrids?

Paul J. Sarvadi

I think we can look at possibly some tiered pricing within the co-employment model. We can look at pricing in a brokerage solution that's in an exchange within the bundled price. There's a lot of different options out there. And these are the things that -- and this is why we're investing another nickel of share in health reform because it's moving fast.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

And as you guys kind of dug around and done your work, is there -- what's the potential that it actually gets pushed back? My understanding is the National Association of Insurance Commissioners, there was some cry out to the administration. What do you think the probability of that happening is?

Richard G. Rawson

It's hard for me to tell, Michael. We -- my gut says, and it has said all along, that I just don't think that the country is going to be ready to handle all these stuff in less than 6 months. I mean, it's not January 2014. The current rules say that you got to have these exchanges in place to start enrolling people in October. And I just -- I know what we're going through and what's -- and being involving for us to be ready for all these kind of different eventualities. And I think we're a little bit more efficient than the federal and state governments, so...

Operator

I will now turn the call back over to Mr. Sarvadi for any closing remarks.

Paul J. Sarvadi

Well, once again, we thank everybody for participating today and for your interest in following the company. So thank you, and we'll see you next quarter.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you all for joining, and you may now disconnect.

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