Insperity's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Insperity, Inc. (NSP)

Insperity, Inc (NYSE:NSP)

Q4 2013 Earnings Conference Call

February 10, 2013 10:00 ET


Paul Sarvadi - Chairman & CEO

Richard Rawson - President

Douglas Sharp - SVP, Finance, CFO & Treasurer


Tobey Sommer - SunTrust Robinson Humphrey

Jim Macdonald - First Analysis Securities

Michael Baker - Raymond James & Associates

Mark Marcon - Robert W. Baird & Company

Jeff Martin - ROTH Capital Partners


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

Douglas Sharp

Thank you we appreciate you going us this morning. Before we begin, I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson or myself they 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 fourth quarter and full year 2013 financial results. Richard will discuss the gross profit results and our expectation for 2014. Paul will recap our 2013 year and then discuss the major initiatives of our 2014 operating plan. I will provide our financial guidance for the first quarter and full year 2014 and then we will 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 $0.24 per share which was just above by the implied EPS from the mid-point of our forecasted key metric ranges. Adjusted Q4 earnings excluded key special items including after tax impairment charge of $0.11 per share associated with the 2010 acquisition largely offset by the recognition of the tax credit totaling $0.08 per share. As for our Q4 key metric results paid worksite employees averaged a 130,732 for the quarter. Below the low end of our forecasted range of our 131, 250 to a 131,750.

Gross profit per worksite employee per month averaged $229 for the quarter which was just slightly below our expected range of $230 to $232. Operating expenses totaled $83 million however when excluding the $3.3 million impairment charge expenses were below our forecasted range of $81 million to $82 million. During the quarter we generated $18 million of adjusted EBITDA and we ended the year with a $129 million of working capital and no debt. Now for some of the details behind our fourth quarter results. Revenues increased 5% over Q4, 2012 to $557 million on a 1% year-over-year increase in average paid worksite employees. As for the components of our worksite employee growth client retention averaged just over 99% for the quarter. Hiring in our client base exceeded layoffs during the first two months of the quarter however turned slightly negative during December contributing to the short fall in Q4 paid worksite employee.

Sales for the quarter were strong, however as you’re probably aware Q4 sales are generally converted to paid worksite employees in January the following year. Paul will update you on the results of our fall sales campaign and year-end client renewals in just a few minutes.

Moving to gross profit our Q4 results were just slightly below our expectations due primarily to healthcare cost coming in above our forecast. This was partially offset by favorable outcomes in the payroll tax and workers’ compensation area. Also gross profit contributions from our adjacent businesses came in at $2 per worksite employee per month above our forecast.

As for the comparison to Q4 of 2012, a $12 decline gross profit per worksite employee per month was primarily the result of an increased deficit in our benefit cost area. During the same period gross profit contribution from our adjacent businesses increased by 36% or $4 per worksite employee.

As for some of the details of our direct cost program approximately 72% of worksite employees were covered under our health plans in Q4 at an average cost of $955 per covered employee per month. As for our workers’ compensation program costs totaled 0.58% of non-bonus payroll below our forecast of 0.61%.

And payroll tax cost would increase slightly from 5.5% of total payroll before 2012 to 5.6%. Richard will provide further detail behind our Q4 results and discuss our 2014 outlook in a few minutes. So now let’s shift to operating expenses. We reported Q4, cost totaling 83 million including the $3.3 million impairment charge. This charge was associated with a write-down of good will and certain assets associated with the 2010 acquisition of our expenses management business.

We have recently restructured various aspects of this business including the incorporation of a new spend card product into our expense management offering. Excluding impairment charges operating expenses increased 9% over Q4, 2012 to $80 million and included cost associated with a 27% increase in the Q4 average number of trained Business Performance Advisors and cost associated with our healthcare reform strategy.

Our Q4 reported income tax rate of 23% includes the impact of the tax treatment associated with the impairment charge and a $2 million tax credit associated with the recently completed study of the extent of credits allowed for our internal development of software product. Excluding the impact of these two items, our effective tax rate for Q4 was 39%. Now I would like to take a few minutes to review the full year 2013 in which we reported adjusted EPS of a $1.39 after excluding impairment charges and the tax credits.

Revenues increased by 4.5% over 2012 to $2.3 billion on a 1.5% unit growth. Sales were up slightly while net hiring in our client base was relatively flat and client retention slightly less in 2012.

Gross profit per worksite employee per month increased from $253 in 2012 to $257 in 2013 and was within the range of our expectation going into the year. As for our recap of our direct cost benefit cost per covered employee per month increased by just 4.7% for the year from $864 in 2012 to $905 in 2013. This was only $2 over our 2013 budget, as lower claims activity in the first half of the year largely offset our utilization and large claim activity experienced in the latter part of the year.

Workers’ compensation cost as a percentage of non-bonus payroll remained at a historically low level of 0.55% up only slightly from 0.54% in 2012. And included a $9 million reduction in previously reported loss reserve in 2013 compared to 13 million in 2012. Payroll taxes as a percentage of total payroll decreased slightly from 7.05% in 2012 to 7.04% in 2013.

As for our operating expenses excluding cost associated with the impairment charges we reported 7.5% increase over 2012 to $334 million. As mentioned earlier this increase includes investments in future growth including a 27% increase in a number of trained Business Performance Advisors and the investments in our healthcare reform strategy.

We also experienced an increase in depreciation and amortization associated with investments in our adjacent businesses and Workforce Optimization solution. Net interest income declined by approximately $450,000 from 2012 to approximately $160,000 in 2013 on lower interest rates.

And our effective full year income tax rate excluding the impact of impairment charges and tax credits declined slightly from 41% in 2012 to 40% in 2013. As for our balance sheet and cash flow adjusted EBITDA totaled $92 million for the full year 2013. Cash outlays included cash dividends of $17 million, repurchases of approximately 597,000 shares at a cost of $17 million and capital expenditures of $12 million.

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

Richard Rawson

Thank you Doug. This morning I will comment briefly on the details of our fourth quarter gross profit results and then I will give you our gross profit outlook for 2014. As Doug just reported, our gross profit per worksite employee per month for the fourth quarter was $229 which was $2 below the midpoint of our range. Gross profit consisted of a $191 of average markup, $23 of direct cost surplus and $15 from our adjacent business. Now let me give you the details of each component. The $2 per worksite employee per month short fall in gross profit came from a $4 short fall in the surplus offset by a $2 per worksite employee per month improvement in the contribution from our adjacent businesses. The additional $2 per worksite employee per month of adjacent business gross profit was the result of an 8% increase in revenue over forecast and an 11% increase in gross profit above the same forecast. We continue to see increases in both cross selling opportunities and our channel sales.

The $4 per worksite employee per month declined in our surplus was a combination of the benefits cost center deficit at $12 per worksite employee per month higher than expected offset by the payroll tax cost center surplus and the workers’ compensation surplus each $4 per worksite employee per month above forecast.

The benefits cost in our deficit was due to higher than expected cost as we experienced the continuation of large loss claims similar to the third quarter. With two sequential quarters of higher than expected large loss claims we believe it will be prudent to use it wider range for our benefits cost forecast for 2014. So, let’s shift our discussion to 2014 gross profit outlook beginning with our markup. Our starting point for the markup component is slightly lower than our average for last year. This reflects a combination of year-end renewal pricing, the amount of new business sold and the lower cost, lower service co-employment offering that only midmarket prospects and clients can choose. In fact we had several mid-market clients that renewed at year-end into this lower cost option which reduces our market slightly.

Therefore, these mixed changes start us at about $2 per worksite employee per month lower than last year and then gradually increases back to the $191 level by the end of the year. We should see less pricing pressure going forward due to increases in the marketplace as a result of healthcare reform. Now let’s discuss surplus component of gross profit beginning with payroll tax cost center.

For 2014 we had received unemployment rate reductions in many of the states that we do business. Therefore we’re lowering our allocations to our clients to reflect this benefit but maintain our same spread on a per worksite employee per month basis. However, when our unit growth accelerates from one quarter to the next our payroll tax expense on the new business increases but the allocations remain constant.

Therefore we do not get the full benefit of the budgeted surplus until the following year. As a result Q1 surplus should be several dollars per worksite employee per month better than last year. Then the surplus declines in each of the remaining quarters of 2014 as our unit growth accelerate thus making our full year surplus in this cost center within about a $1 per worksite employee per month of our 2013 results.

Switching to the workers’ compensation cost center we began our new policy year on October 1st. Historically we have forecasted a slightly higher cost trend than the recently completed policy period.

Then as we see how the incidents rates and severity rates change based on delivery of safety services and effective claims management we refine those estimates each quarter. We were recently notified that our worksite employee suffered a very severe injury and as a result we need to increase our reserves this quarter slightly more than usual, therefore we will increase our expense forecast to 0.67% to 0.69% of non-bonus payroll for Q1 and then our expense should return to the previously forecasted levels of 0.60% to 0.62% of non-bonus payroll, consistence with the levels that we have budgeted in recent years.

On the allocation side of this cost center we’re beginning to see workers’ compensation insurance price increases in the marketplace therefore we will budget a slight increase in our allocations for new and renewing business throughout the year and net effect of these changes including the large claim should only reduce our surplus by a couple of dollars per worksite employee per month for the full year.

Now let me tell you what we see happening in the benefits cost center for 2014. As we have previously said and you’re all now hearing daily Obama Care is creating massive disruption in the marketplace for employers with less than 50 employees. We have been told that as many as 60% of the employers renewed their health insurance before January 1st, 2014 so that they could escape major cost increases for one more year. So, for the next few months the 40% that did not renew early will get to see what their new health insurance policy is going to cost them.

The biggest increases will be for employers with young, healthy employees. We’re already hearing about 25% to a 100% increases for employers with younger workforce. So from a pricing perspective we should be able to continue increasing our allocation throughout 2014 at appropriate levels for both new and renewing business. On the expense side of the benefits cost center we have a number of factors that will affect our ultimate cost. Last quarter I mentioned that we were concerned on uncertainties surrounding the cost and coverage of health insurance which could cause an increase in utilization as people fear the loss of coverage or anxiety over significant 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 could affect our expense in 2014. In addition we’re factoring in the potential continuation of larger than average large loss claims.

As well as the new healthcare reform taxes and fees, however there are some mitigating factors that could help reduce our cost to 2014. You will recall from our last quarter earnings call we explained how much the COBRA participant cost our client.

We also explained that the launch of State Exchanges could create a potential lower cost insurance option with all those people currently enrolled on COBRA. In December we launched a communication plan to inform current COBRA participants in any new eligible COBRA participants about this new option for them to evaluate. Remember a COBRA participant cost Insperity about 2.3 times the cost of an active participant. However we’re only allowed to collect 2% above the rate charged to a regular participant which covers about half of the actual expense to our client.

So reducing COBRA participation helps reduce our healthcare cost and the deficit therefore if this plan is successful we could see a significant offset to our benefits expense throughout 2014.

We also redesigned our packages of healthcare offerings for 2014 to encourage selection of lower cost options by our client. We did not eliminate the richer plans but we setup packages of plans that make it easier for clients to consider offerings with less-rich plans. If we are successful, the migration savings should help reduce our cost in 2014 and beyond. Finally as I mentioned a few moments ago employers with younger employees will be facing a significant increase in their health insurance premiums this year. They are going to be looking for new solutions to solve their healthcare needs and our offerings will start to look a lot more attractive than ever before. This new opportunity will attract the right mix of prospects could result in lower plan cost for 2014 and beyond. The factors that I’ve just outlined produce a wider range of healthcare expense outcomes. We could see a potential increase in the expenses as low as 4.5% in 2014 over 2013 and we could see scenarios that could raise our expense by as much as 6% over 2013.

So you combine all of the forecasted direct cost surplus is in the wide range of possible benefits expense we should generate a net surplus of $43 to $53 per worksite employee per month with a year.

Our last contributor to gross profit comes from our adjacent business services. 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 made significant progress in 2013 toward achieving that objective as the gross profit contribution grew from $13 per worksite employee per month in Q1 to $15 per worksite employee per month in Q4. Remember that a large portion of this gross profit contains a recurring revenue element which should continue to grow for a long time.

We continue to experience cross selling opportunities, we’re expanding our channel opportunities and we have a nice backlog in a few of these businesses. Therefore we will budget approximately a 20% revenue growth in 2014 over 2013. This translates to a gross profit contribution starting at $15 per worksite employee per month in Q1 and growing to $17 per worksite employee per month by Q4.

To summarize our outlook for 2014 when you combine the service fee markup, the surplus and the adjacent business contribution. Our gross profit per worksite employee per month will be in a range of $248 to $258 for the full year.

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

Paul Sarvadi

Thank you Richard. My objective today is to provide an overview of our 2014 plan and key initiatives against the backdrop of the major drivers of our success over the next three years. Our market opportunity over this period is unlike any we have seen as the complexity, compliance and cost of being an employer are intensified by healthcare reform and the speed of execution and business is enabled by HR technology. We started this enterprise in 1986 to improve the success equation for small and midsized company.

Our goal was to help improve both the likelihood and level of success for these businesses by reducing the complexity, compliance and cost of employment and freeing up business leaders to focus on their profit opportunities. In addition, we provided tools and support to improve productivity and execution to driving business performance. This combination of relief from obstacles and new tools to get the job done is a powerful value proposition in the marketplace. We believe that these two primary elements of our value proposition are center stage for our target market for the next several years and we had built our 2014 plan to take advantage of this opportunity. So with this increase in demand on our door step we have three critical elements to our 2014 plan. First, continuing to grow and gain efficiency in Business Performance Advisors in our core Workforce Optimization business. Secondly, making strategic identified investments in technology that drives success in our adjacent businesses and increase sales and retention of our largest account. And third capitalizing on the opportunity presented by healthcare reform to grow faster and improve results in our health plan increasing margins in the years ahead.

Let me begin with our outlook for growth in our core Workforce Optimization business. We expect growth acceleration to occur this year driven by the recent 27% increase in Business Performance Advisors building off a successful fall selling campaign just completed.

In recent years we have seen a shift in the pattern of client attrition which has increased the importance of our fall selling campaign. For many years of our history our client attrition was approximately 20% to 22% of our worksite employee each year. The pattern of this attrition was of that 6% to 7% in January, 2% to 3% in February and 1.3% to 1.5% each month thereafter with the exception of December which was negligible. More recently we have had greater attrition at year end, 11% to 13% and less than 1% throughout the year after February. The total for the year is same as past years but the result has been greater attrition at year end to overcome with the strong fall sales campaign.

In the 2012 to 2013 year-end transition we had a severe decline in paid worksite employee due to the combination of this attrition pattern and the sales force that had been reduced in size to retrain and retool. In 2013 we grew the sales staff and had much better results. Our fall campaign sales target was 17,500 worksite employees sold for mid-September through December.

We achieved 98% of this target just under 17,200. Sales efficiency was a respectable 1.1 sales per BPA per month which is pretty good for having so many new advisors. Our attrition for the year end including December, January and February was comparable on a year-over-year basis. Total attrition for the 2012, 2013 year-end period was 16,900 or 13.2% compared to this year which we expect will be approximately 17,100 worksite employees or 13.1% when February is completed.

Now since client terms happened immediately and new sales come in as in rolled over the quarter we still expect a sequential decline in Q1, 2014 over Q4, 2013 an average paid worksite employee. However we expect year-over-year growth in Q1 to be approximately 3% over Q1 last year. We also expect the successful fall campaign momentum the maturing of our new BPA and low attrition numbers for the balance of 2014 will lead to double digit unit growth later this year. We expect worksite employee year-over-year acceleration each quarter of the year to over 10% in Q4 which averages around 7% for the full year. The timing of this growth acceleration the double digit growth is following the increase in the number of Business Performance Advisors in the typical 12 to 18 month period we have experienced historically.

Our second key initiative for 2014 is to make strategic investments in our human capital management solutions, as a result of confirming the upside potential for our adjacent businesses and our mid-market segment. This investment is expected to drive further revenue and gross profit contribution in our adjacent businesses and improve sales and retention of our largest accounts.

Over the last half of 2013 we conducted a pilot program for our clients and prospects with greater than a 150 and upto 2000 employees. This program included three new product bundles based on market research we conducted in Q1 of last year. In the fourth quarter we had large enough sample of new and renewing accounts to test the new offerings and the selling process allowing customers to self-select based upon their own preferences. Clients can now select the service bundle based upon service levels, liability tolerance, flexibility, cost and speed of execution. The level of acceptance and engagement from this pilot became the catalyst and realigning the resources to capitalize on this midmarket segment opportunity. This new approach results in 20 accounts with 4600 worksite employees in our Workforce Synchronization offering from renewals of 10 midmarket accounts, 8 emerging growth clients and 2 new midmarket sales.

This is our co-employment solution which element HR project work that’s included in Workforce Optimization so it has a lower ongoing cost structure for both the client and Insperity. The presentation of multi-option is also as clients confirmed their Workforce Optimization buying decisions in many cases. 38 midmarket customers renewed their Workforce Optimization in Q4 representing over 10,000 worksite employees.

This pilot program helps to set a clear direction for sales service and product development for the long run and led to specific actions, improved results in this segment for 2014. So this year we are bringing sales, service implementation and development of midmarket products and services all into a single business unit. Our adjacent business development team who work directly with this new division to apply the processes we have used successfully, improved results within our other adjacent businesses. We expect better alignment with the needs of this customer segment will lead to greater sales and service success.

One another key outcome of the pilot program was the validation of the importance of our human capital management solution as a key driver for growth in our adjacent businesses and in retention of these larger accounts. Our human capital management system is the hub for our new traditional employment alternatives to co-employment, workforce administration and workforce collaboration.

It is also the platform for our standalone payroll business and we have found substantial demand for this HCM offering combined with our time and attendance solutions and payroll services. We have also found the demand for HCM solutions in the marketplace will require a more open opportunity for companies to use a competitive HCM solution even if they are at one of our co-employment offering. We have accommodated several of these request from clients as a one-off but it's apparent we need a solution to bring your own HCM into co-employment. Solving this will also provide the opportunity to upsell our own HCM client into Workforce Synchronization or Workforce Optimization co-employment offering.

We have developed our HCM solution through the purchase of the source code at the end of 2011. In 2012 we launched our payroll service on this platform and in 2013 we sold our first four client on the core workforce administration combination. In this process we’ve identified the investment needed to optimize these solutions to fit this target customer base and create a competitive advantage in the marketplace.

We expect a cost of approximately 5.6 million or $0.13 per share to accomplish this objective. We expect this investment to payoff in a number of ways in the near term. We’re confident in our ability to sell new accounts, retain current customers and sell a variety of other adjacent business offerings along with this HCM solution. We expect this will help considerably to improve our year-end retention of midmarket clients and therefore our growth rate in the years ahead.

Over the past several years we had developed an impressive array of HR technology based business performance solutions that are gaining traction in the marketplace. In 2013 we were successful growing our original ABUs to a cash flow breakeven. The ABUs that started prior to 2012 include expense management, time and attendance, performance management, organization planning, recruiting, employment screening and retirement services. These businesses as a portfolio lost $0.22 per share in 2012 and we budgeted a loss of $0.18 per 2013 at the start of last year.

Our out performance in 2013 resulted in a loss of only $0.11 per share which was breakeven on a cash flow basis after adding back non-cash items for those businesses. This portfolio is ready for continued growth and is expected to contribute more at the gross profit line and be cash flow positive for 2014. The new businesses started since 2012 included payroll, HCM and financial services are in a period of investment as expected in representing great opportunity going forward.

Now the third critical element to our 2014 plan is to improve our capability to drive long term growth and profitability by capitalizing on the disruption caused by healthcare reforms. We have an amazing opportunity in front of us over the next three years as ACA market reforms and the employer mandate reached the small or midsized business market.

In order to understand this opportunity and the foundation we’re laying for growth in profitability we need to understand the roll out of healthcare reform by market segment. Think of healthcare reform hitting in ways reaching employers with less than 50 employees, then 50 to 150 employees and a 150 to 2000 employees.

Richard explained the first way creating an immediate opportunity for accounts with less than 50 employees. The disruption from new policy requirements, network shrinkage, repricing and other market reforms is already evident in the marketplace in causing prospects to look for new solutions. The opportunity presented to Insperity in this segment is very exciting because we can drive growth and reduce cost at the same time. Driving the growth is very straightforward. We estimate over 50% of these accounts who will face increases of more than 20% with coverage that may have higher out of pocket cost and more narrow networks. This will drive our prospects to seek out an out of the box solutions and the investments to implement our co-employment solution will be more economical than ever.

Our Workforce Optimization offering is an opportunity for these firms to get a much bigger bank for their buck than just renewing an insurance plan. In many cases the increase for market reforms will be on par with the cost for Insperity Workforce Optimization making our value proposition better than ever. So for the same cost of their insurance renewal they can address the broader problem of complexity, compliance and cost of being an employer and have the full infrastructure of a large HR company a large company HR department. As Richard also mentioned the prospects getting the highest health insurance price increases in the marketplace also have the best demographics for reducing claim cost in our benefit plan.

So the focus on this small business segment pays off in growth and profitability. The wave from healthcare reform comes as the employer mandate kicks in on January 1, 2015 affecting all employers with more than 50 employees. This is where HR technology and health reform converge. The reporting requirements under health reform require information residing in multiple systems for most employers and for some the information is not currently collected at all. Employers will need a payroll benefits, and time and attendance system that is eight day compliant and we will be ready with the solution. Our midmarket prospects and clients will be solving these reporting issues and exploring new health plan approaches over the next few years through the investment we have made and are making this year in our insurance agency and HR technology will position us well to meet their needs.

Our introduction of traditional employment solutions for this segment will also allow us to accommodate movement toward either self-funded or defined contribution plans through private exchanges. For the employers with 50 to a 150 employees these two ways will hit in succession. They will be subject to their employer mandate and the associated reporting requirements on January 1, 2015 then they will get the full effect on smaller network and repricing as

insurance market reforms are extended to employers with 50 to 100 employees which occurs on

January 1, 2016.

We have evaluated the needs of each of these segments and we are preparing appropriate

messaging and education for our Business Performance Advisors to capitalize on this

market disruption. We are also exploring channels and other go to market strategies due to the urgency these changes will bring to the marketplace. In any business, when your prospects have a sense of urgency from outside factors, that is a good problem.

In summary, we could not be more excited about our outlook for the next few years as we capitalize on health care reform and the role HR technology and services will play

meeting the needs of our clients across all three of our segment. From our vantage point, this year finishes off the foundation for dramatic growth and profitability in 2015 and beyond. We look forward to returning to double digit unit growth later this year and the profitability that comes out of these higher growth rates in the years ahead.

At this point I will turn the call back over to Doug to provide our initial guidance for 2014.

Douglas Sharp

Thanks Paul. Now, before we open up the call for questions, I’d like to provide our financial guidance for the first quarter and full year 2014. As for our key metrics guidance, based largely upon the results of our 2013 year-end selling and renewal season, we are forecasting average paid worksite employees in a range of 127,000 to 128,000 for the first quarter, a roughly 3% over Q1 of 2013. Thereafter, we expect acceleration in year over year unit growth to 10% by the fourth quarter with an improvement in sales efficiency coming off of last year’s significant BPA hires, and as the impact of healthcare reform has an even greater impact within the small business community. We also expect client retention to remain at 2013 levels over the course of the year and are conservatively budgeting for some nominal net hiring by our client base. This equates to average paid worksite employees in a forecasted range of 136,000 to 137,000 for the full

year 2014, our unit growth of approximately 6.5% to 7.5% over 2013.

As for gross profit per worksite employee per month, based upon Richard’s earlier

comments, we expect to be in a range of $274 to $281 for the first quarter and $248 to

$258 for the full year. The quarterly pattern for the year is expected to be similar to 2013. We expect gross profit to be higher in Q1 because of the surplus we generate on a higher level of payroll taxes prior to worksite employees reaching certain wage limits. Additionally, with the

growth in high deductible health plans, healthcare costs are lower in Q1 then step up in Q2 through Q4 as deductibles are met.

So, considering the seasonal impact of these factors, we expect sequential declines of about $26 in Q2, $6 in Q3, and about $7 in Q4. As for operating expenses, we are forecasting a range of $362.5 million to $367.5 million for the full year. Our 2014 budget includes the full year impact of certain initiatives begun in 2013, including the ramp-up in a number of Business Performance Advisors and the implementation of the initial stages of our healthcare reform strategy.

Additionally, we have budgeted for several items which are incremental to 2013, including approximately $5.6 million of expenses associated with an investment in our HCM technology. Approximately $3 million of incremental expense associated with budgeting incentive compensation back to typical levels, which were not achieved in 2013, and an incremental $1.5 million related to our healthcare reform strategy.

As for some of the details behind our full year 2014 operating expenses, we expect salaries and wages to increase by about 10% over 2013. This is driven off of costs associated with the full year impact of the prior year’s ramp-up in the number of BPAs and an additional 20 BPAs to be hired in 2014. The budgeted increase also includes additional technology personnel associated with the HCM technology investment. And also as mentioned earlier, we are budgeting incremental incentive compensation over 2013 to return to our typical level. As for stock-based compensation, we expect a 2014 restricted share grant to be at a similar level as that granted in 2013. However, with the three year vesting period, we have a lower priced grant being replaced by grants at higher priced levels. This is expected to result in a 6% increase in 2014 expense over 2013.

Commissions are expected to increase by about 9% which is consistent with our projected Workforce Optimization unit growth and revenue growth in our adjacent businesses. Advertising costs are expected to remain relatively flat. G&A costs are expected to increase by about 11%, however include approximately $4.5 million in contract labor and IT costs primarily associated with HCM technology investment. Excluding these costs, G&A is expected to increase

by approximately 5% over 2013. Depreciation and amortization is expected to be up by approximately $1.5 million over 2013. 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.

Now, as for the quarterly spend, Q1 operating expenses are expected to be in a range of $90.5 million to $91.5 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 step up in operating expenses of approximately $3 million from Q1 to Q2 and then sequential declines of about $3.5 million from Q2 to Q3 and $1 million from Q3 to Q4. We are estimating an effective income tax rate between 41 and 42%, for both the first quarter and full year. As for average outstanding shares, we are forecasting 25.6 million for Q1 and for the full year excluding the impact of any future share repurchases. We are budgeting 2014 capital expenditures of approximately $25 million. This is above our historical CapEx spending in the $15 to $20 million range, as we are coming off of a lower spend in 2013 of $12 million and plan to invest approximately $8 million in office space related primarily to our growth in the technology area. A large part of this incremental spend is not expected to be placed into service until Q4 and therefore would have little impact on 2014 depreciation expense.

So to summarize our 2014 outlook, let’s look at the impact of our key metrics guidance through our bottom line results. As we reported today, our 2013 non-GAAP earnings per share were $1.39. In order to bridge from these earnings to our implied 2014 EPS, it is helpful to take it in pieces. Our projected 6.5% to 7.5% unit growth and associated operating leverage would add between $0.10 and $0.17 per share to 2013’s earnings. We begin the year forecasting gross profit per worksite employee ranging from a decline of $9 to an increase of $1 compared to 2013. This would result in a reduction to EPS of $0.33 per share on the downside and an increase of $0.04 per share on the high side of our forecast. Now we stop here, we are looking at a 2014 implied EPS range of $1.16 to $1.60.

However, as I mentioned earlier, we are budgeting for our few operating expense items which are incremental to 2013. First, costs associated with the HCM technology investment are estimated at $0.13 per share. Secondly, costs associated with an incremental investment in healthcare reform are expected to total $0.03 per share. And thirdly, budgeting our cash incentive compensation plan back to typical levels results in a range of no incremental cost on the low end of our forecasted operating results to a cost of $0.11 per share on the high end.

Finally, we are forecasting an increase in our effective tax rate from 40% in 2013 to a range of 41 to 42% in 2014. This impacts earnings by $0.04 per share on the low end of our guidance and $0.02 on the high end. So when considering the impact of each of these items, our 2014 implied earnings range is $0.96 to a $1.31 per share.

As for the quarterly pattern of our earnings, our guidance implies a Q1 EPS range of $0.29 to

$0.40 per share with a sequential decline of about $0.20 from Q1 to Q2, an increase of $0.14 per share from Q2 to Q3 and an increase of about $0.06 from Q3 to Q4. As for our cash flow, our full year guidance implies adjusted EBITDA of approximately $83 million with our expectation of continued strong cash flow and the fact that we are beginning the year with $129 million of working capital and no debt. We are in a good position to invest in our initiatives and continue our ongoing dividend program and share repurchases.

At this time I would like to open up the call for questions.

Question-and-Answer Session


(Operator Instructions). Our first question will come from the line of Tobey Sommer with SunTrust. Please go ahead with your question.

Tobey Sommer - SunTrust Robinson Humphrey

I am curious just in general maybe this is for Paul. How do you feel your ability at the firm to predict the moving parts within the business and the financials is versus a couple of years ago? Thanks.

Paul Sarvadi

Actually I feel good about that relative to couple of the things that are happening in the core business have kind of always been around and that’s the fluctuation in the direct cost that comes time to time relative to the benefit programs, workers’ compensation et cetera but those I mean we’re, they are more predictable on the long term but they do have some volatility from time to time and quarter-to-quarter. But in the bigger picture the way the overall strategy is working is really starting to be exciting. We’re seeing adjacent businesses that we have brought to cash flow breakeven that are on their way now towards profitability. We see how those the synergy of those products working together with our core business and the cross selling that’s happening. We’re excited that I believe we have new levers and new ways to manage growth and profitability going forward.

Tobey Sommer - SunTrust Robinson Humphrey

Paul, could you share with us any kind of insights that you can gain from your customers' payroll about their hiring patterns and maybe need to add headcount?

Paul Sarvadi

Yeah I sure can. In the recent period we did see the same kind of soft spot I think we heard in the overall marketplace as you got toward year end. I know people are talking about whether they had to do with weather or whatever but certainly we saw softening in the labor market and it's continued just to kind of bounce along the bottom. We did see overtime as a percentage of base pay rates to 10% level which is kind of our trigger and meaning they are pretty much at capacity. You could still continue to use overtime but generally speaking you’re better off if you think your prospects for new business are good then you’re better off hiring somebody than loading up on overtime over 10%.

We saw that pipeline for new business which we look at the sales of our customer base through the commissions that we pay for the sales staff and it was up at a reasonable level but not enough to be supercharging and driving growth forward but I think if there is any uptick at all it looks to me like the decisions would be made to start hiring again. We haven't factored that in a lot into our going forward model. We’ve factored in just a very slight level of adds within the client base but if that happens more aggressively obviously that will be upside for us.

Tobey Sommer - SunTrust Robinson Humphrey

My last question, could you elaborate a little bit on the direction of the investment in HCM? Is there an aspect of the adjacent business units that requires some further investment or is it something additional?

Paul Sarvadi

Really it's the combination of two major things, one is the integration. What we found is that people like this array of offerings that we have and you would like them to work together better. Fortunately you’ve the onset of what’s called HR XML, which is kind of a standardization of HR technology offering so that all different types of HR Technology can talk to each other and play better together. So, part of this is bringing all of our products upto that standard so that it will work better together and we can work in a world where somebody had this expense management product and our time and attendance or any other kind of combination. So that’s part of it, I think that’s going to be very helpful in a lot of ways but then beyond that the core product, the core HCM product is tied to kind of give it a fresher look and feel and make it look and feel more in common with the other offerings. We were able to do some very effective in the field market testing with customers and our functionality is great. Look and feel improvement I think would make us compete even better. So, we’re feeling like that’s an important investment to make, because it's key to adding midmarket accounts and sales and retaining those accounts, it is the key to our traditional employment offering bundles that have just been introduced in the marketplace and we were really able to validate through this pilot testing that these investments will have a nice payoff in the not so distant future.


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

Jim Macdonald - First Analysis Securities

You have spent a lot of time retooling the business and things. When do you think we will see the profit leverage out of all of these exercises?

Paul Sarvadi


Jim Macdonald - First Analysis Securities

Can you talk a little bit about how much profit leverage there could be once you get to that point?

Paul Sarvadi

At this point, you are looking at about 50% of our costs being fixed and 50% variable. So you can pretty readily run the numbers out. As you get to the latter part of this year and you’re backup into double digit growth and your sales force is right sized and more efficient and your market opportunity is stronger than ever and has sense of urgency driven by outside factors. We’re not in this for the short term, we’re in this thing for the long term and we feel like this year’s investments will put us in a position to be well into the double digit unit growth next year which will drive significant profitability to bottom line in 2015.

Jim Macdonald - First Analysis Securities

And going back to the fall selling season, with all these employers renewing early as you mentioned, how did that impact your fall selling season?

Paul Sarvadi

Well that was definitely a factor because when the insurance companies and agents et cetera went out to the marketplace early and with the fear message, got them to renew early. That kind of took them out of the market for us because they just renewed the benefit plan, benefits is a significant part of what we do in our core market and so that kind of put them aside for a year. That's the bad news. The good news is we still made our numbers through the campaign which is real credit to our sales organization but it also positions us for an unbelievable fall campaign next year because they compressed all those renewals into a couple of months’ time period and as we ramp up through this year selling into selecting those right accounts that are experiencing the impacts of the healthcare reform we’re going to be able to really capitalize on that in the fall selling season next year.

Jim Macdonald - First Analysis Securities

So if people's healthcare if they renewed on December 1st, how is that going to look in the fourth quarter? Will you have a potentially unusual amount of people joining you December 1st or could they join you early and just cancel their health program in October or some earlier date? How is that going to look?

Paul Sarvadi

That’s going to be really interesting to see but I don’t know what flexibility carriers are going to have whether they can, in theory as we sit here today they can’t renew those plans again the way they are. So they may have to come often in October or November or December which is when that renewal takes place. So we’re going to be out there presenting our option as they see their increases which we expect in the cases on the accounts we want to go after the increase in healthcare pricing is enough to offset the investments they make for our service. It really is making lemonade out of the lemon that is served up by the health reforms. So I kind of like the way this works because early in this year we’re going to be able to work through all the selling motion that it takes to bring all this to the surface and help customers make these decisions while we’re working on the 40% of the customers that didn’t renew early but are renewing month in month and then we get to the big slug 60% as we get into our fall campaign that is right in our wheel house.

Jim Macdonald - First Analysis Securities

Just one numerical question. What was your number of trained BPAs in the fourth quarter?

Paul Sarvadi

It was like 30, 37 [ph] or something. I will get that number for you in just a second.


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

Michael Baker - Raymond James & Associates

Since healthcare is still kind of local or state driven, I was wondering given the dynamics that you see out there, which states are presenting bigger opportunities to you?

Paul Sarvadi

Well you know we’re looking, as mentioned in the script our opportunity really by segment and by demographics if you will of the customer base and there is a geography component to that as well but in our case since we are after the small to midsized decision, enough of those and just about any market to make us pretty excited everywhere we’re and so we’re not looking that as much as a state by state issue. Although there are states where the market reforms are going into place faster or more effectively and that does drive business our way.

Michael Baker - Raymond James & Associates

Okay. And then kind of pointed towards the latter part of your prepared remarks to channel options that you are considering. I was wondering, what are some of the triggers that may have you move in that direction?

Paul Sarvadi

Well we’re, actually testing some things out in the marketplace right now. We have got a strong, very strong relationship with our carriers and other partners in the marketplace and we think there is opportunity there and we’re exploring it.

Michael Baker - Raymond James & Associates

Okay. And then finally, in terms of your COBRA marketing approach, how is that developing in light of the public marketplace maybe not developing as expected?

Richard Rawson

Michael I will tell you that we have spoken to a lot of the COBRA participants at the end of the last year and the beginning of this year. It's too early to see what kind of final decisions these people are going to make because they have first of all they have 30 days to decide and then they have 45 days to make their payment before they get dropped off of the rolls. So, we will know something in the latter part of March about kind of where we’re.


Your next question will come from the line of Mark Marcon with Robert W. Baird. Please go ahead with question.

Mark Marcon - Robert W. Baird & Company

Can you talk a little bit more about the turnover that you saw earlier in the year this year, just the January-February? And where exactly you saw it?

Paul Sarvadi

Are you talking about the year-end transition in new business versus?

Mark Marcon - Robert W. Baird & Company


Paul Sarvadi

Yeah sure. Like I said you kind of have a shift over the last few years more towards year-end transition some of that’s due to larger accounts want to move at year-end and that kind of thing. So at year-end this year we had, like I said strong solid campaign and those you know are transitioning in and we’re enrolling and paying them now over this first quarter. Our renewals went well but we did have as I mentioned 4600 employees renewed into our new Workforce Synchronization solution. Actually a portion of those renewed into it and the portion of those were sold as new accounts so that was some nice uptake on that and the other thing we hadn’t been able to factor in going forward this year is those folks who select Workforce Synchronization have the opportunity to buy HR services on an as needed basis so we have got folks available to do that and to sell those services on an ongoing basis to those clients but we don’t know how much uptake it's going to be in those services on an ongoing basis.

In many cases we think we’re actually going to make more money on that client this year than we did last but that kind of remains to be seen what work we’re really able to budget that in.

Mark Marcon - Robert W. Baird & Company

Those are not included in the worksite employees, right?

Paul Sarvadi

That’s correct.

Mark Marcon - Robert W. Baird & Company

In terms of if we strip those out, what was the retention rate?

Paul Sarvadi


Douglas Sharp

Michael the 4600 if that’s what you’re talking about they are in, because they are in the co-employment model, they are considered in the total.

Mark Marcon - Robert W. Baird & Company

Oh, they are in the total. Okay.

Douglas Sharp

Yeah we thought you were talking about the adjacent business offerings.

Mark Marcon - Robert W. Baird & Company

No. Okay, so of the ones that did not renew in any way, shape, or form, the 13%, were they primarily in the midmarket, or were they smaller?

Paul Sarvadi

With the similar mix to last year which was, we had I don’t remember exactly the number, I’ve to look those up on a segment basis but it was very similar to last year.

Mark Marcon - Robert W. Baird & Company

Would it be similar reasons, you think?

Paul Sarvadi

Yes it was. Yeah we’re doing the same full analysis we did last year. The good thing is that we were able to test these new offerings out and it made a big difference in terms of giving us the feedback we need to. This year we will be able to start much earlier with customers, we have developed our new offerings last year throughout the year, got them into the marketplace about September or so and for a lot of midmarket customers they are kind of already pass their decision point. Our plan for this year we feel real strong about how we’re able to take what we developed last year into the market for the full year this year and see how results get even better at year-end.

Mark Marcon - Robert W. Baird & Company

And then on the ABU's, you are making really good progress there. What was the ABU that had or the two ABU's that had the biggest take out?

Paul Sarvadi

Well I would it was our time and attendance business which is growing substantially and then also our performance and organizational planning business ad quite a year as well. We are making progress on all the units. We really have learned to apply certain disciplines from operating disciplines to sales disciplines and it's really starting to pay off and that’s the same process we’re going to use on our midmarket going forward. That’s why we have brought them all together into one operating unit so we can apply the same disciplines to that business.

Richard Rawson

And we’re still getting a nice a number of leads every month from our Business Performance Advisors for these other services. So that hasn’t let up at all.

Paul Sarvadi

I think that will actually increase as people get more comfortable with cross sell.

Mark Marcon - Robert W. Baird & Company

So, would you, if I recall, you mentioned earlier that you hit breakeven last year. So, we should have a pretty nice swing factor on the ABU's from here on out?

Paul Sarvadi

Yeah I think we have got if you look at the ones we started prior 2012 our original businesses, adjacent businesses, that group, they were cash flow breakeven. We expect them marching toward profitability. We haven't budgeted them to be accretive this year but we expect them to be cash flow positive, it's really on the way to being accretive shortly thereafter.


Our final question will come from the line of Jeff Martin with ROTH Capital Partners. Please go ahead with question.

Jeff Martin - ROTH Capital Partners

It looks like the business is well-prepared for growth but 2014 is just going to be what it is in terms of the investments that you are making. My question centers around healthcare reform and how you think that is contributing to the sales process at this point and it would appear to me that the significant investments that you are making really aren't bearing fruit. Is that the right way to look at it? More of a 2014, 2015 impact? Have you seen much impact to date for those efforts?

Paul Sarvadi

Yeah I think there is two things, first of all we invest into accommodate health reform. We made a significant investment last year and then so many things change including the extension of the employer mandate, constant changes. It actually has increased the amount of investment we have had to make to accommodate healthcare reform that’s why you’ve got another $1.5 million on top of the 2 million or 3 million bucks last year on health reform. So you have some of the,

we always knew the cost would be on the front end, and then the return would be as the marketplace experienced the changes that we had to prepare for. So that’s happened but now it's happening it's stretched out over another year and so we have got some added cost this year while we’re now seeing the benefit of it which is the marketplace realizing how healthcare reform is going to affect them and it does give us more at-bats, more opportunities to talk to prospects that are thinking about more out of the box solutions and for this next few years between the market reforms on the small business and when those reforms get extended to the 50 to 100 employees, the employer mandate this is a great opportunity for us.

Jeff Martin - ROTH Capital Partners

But it just seems to me as though they are not being forced to make that decision just yet. I mean, the anxiety levels are high. That helps you get in the door, but in terms of actually converting those into sales, it seems like they are not being forced to make that decision just yet.

Paul Sarvadi

That’s a good way to look at it. Let’s talk about the ones that are being forced right now. Every month you’ve less than 50 employer employee groups that are seeing the full effect of market reform. Those are the ones that did not renew in November-December and we estimate that to be about 40% of the customers at large and that 40% between February 1 and say September 30, it is portion of that 40% every month getting their renewals and there is about 55% of that, 40% that are getting an increase of more than 20%. So for that part it's right now, it's happening right now and we have a plan for go to market strategy to be out in front of those customers, let them see another alternative. As opposed to just renewing with the 40% increase to get an inferior plan with the smaller network at higher price, they can come on our service. So that is right now. But right behind that in the fall you’ve people making decisions to accommodate the employer mandate. You’ve the 60% of the small less than 50 employers that will have to make a new decision beyond the band aid approach that they took last fall. So this year is going to be big on the selling side but as you sell those and enroll them that turns into significantly profitability in ‘15.

Jeff Martin - ROTH Capital Partners

Okay. Great. And then one more question, if I could. On your stock repurchase, how much is remaining under authorization and automatically be constructive this year in repurchasing stock?

Douglas Sharp

Yeah we have about 1.2 million shares remaining under authorization, so that’s even net of some we put a plan in place at the end of each quarter and that’s really through today and then we will have a Board Meeting next week where we typically make decisions with what to do with respect to how aggressive or conservative on the share repurchase side going forward. But as you saw we’ve plenty of working capital still, with the 2014 guidance $82 million or so of cash flow. So it puts us in a good position to continue the share repurchase program.


There are no further questions at this time. I will now turn the conference back over to Mr. Sarvadi for any closing remarks.

Paul Sarvadi

Thank you all very much for your participation and we look forward to continuing to implement our strategies throughout the year and we will see you out on the road. Thank you very much.


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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!