Administaff Q1 2007 Earnings Call Transcript

May. 1.07 | About: Insperity, Inc. (NSP)
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Administaff, Inc. (ASF)

Q1 2007 Earnings Call

May 1, 2007 11:00 am ET


Douglas S. Sharp - Chief Financial Officer

Richard G. Rawson - President

Paul J. Sarvadi - Chairman of the Board, Chief Executive Officer


Tobey Sommer - SunTrust Robinson Humphrey

James Macdonald - First Analysis Securities Corp.

Mark Marcon - Robert W. Baird & Co.

Tom Giovine - Giovine Capital Group



Good day and welcome, ladies and gentlemen, to the first quarter 2007 earnings conference call. My name is Audrey and I will be your conference coordinator for today. (Operator Instructions) On today’s call, we have Mr. Richard Rawson, President of the company; Mr. Paul Sarvadi, Chairman of the Board and Chief Executive Officer; and lastly, Mr. Douglas Sharp, Chief Financial Officer. Mr. Sharp, you may proceed, sir.

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 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 our first quarter financial results. Richard will discuss trends in our direct costs, including benefits, workers’ compensation and payroll taxes, and the impact of such trends on our pricing. Then Paul will add his comments about the quarter and our outlook for the remainder of the year. I will return to provide financial guidance for the second quarter and the remainder of 2007. We will then end the call with a question-and-answer session.

Now let me begin by summarizing the first quarter financial results, which are consistent with that provided in our release from last week. We reported first quarter earnings of $8.4 million or $0.30 per share. This was below our expectation, primarily as a result of higher than expected healthcare costs. These higher healthcare costs contributed to an average gross profit per worksite employee per month of $216 for the quarter, below our forecasted range of $224 to $230.

The average number of worksite employees paid increased 9% for the quarter, slightly less than our forecasted growth of 10%.

Operating expenses increased 8%, below forecasted levels and declined on a per worksite employee per month basis from $186 in Q1 of 2006 to $184 in Q1 of 2007.

Now, let's review the details of our first quarter results.

As I just mentioned, the average number of paid worksite employees per month increased 9% over the first quarter of 2006 from 96,006 to 104,881. While worksite employee growth was relatively flat through the first two months, we ended the quarter paying just over 106,000 worksite employees in the month of March.

In a few minutes, Paul will provide the details behind our unit growth drivers, including sales, client retention and net growth within the existing client base.

First quarter revenues increased 13% over 2006 to $408 million, primarily as a result of the 9% increase in the average paid worksite employee and a 4% increase in revenue per worksite employee per month.

Looking at first quarter revenue contribution and growth by region: the Southeast region, which represents 10% of total revenue, grew by 11%; the Northeast region, which represents 20% of total revenue, grew by 25%; the Central region, which represents 14% of total revenue, grew by 10%; the West region, which represents 22% of total revenue, grew by 7%; and the Southwest region, which represents 33% of total revenue, grew by 12%.

Moving to gross profit, gross profit per worksite employee per month for the quarter was $216, down from $236 reported in Q1 of 2006 and below our expectations. As you will recall from last quarter's conference call, we experienced a high number of large healthcare claims during the fourth quarter of 2006. With this in mind, we provided an estimate of 2007 full year healthcare cost increases in the range of 7% to 9%.

Claims incurred during Q1 of 2007 increased year over year at the high end of our Q1 expected range. Additionally, the large claims incurred in 2006 developed at a higher cost than estimated and therefore resulted in additional first quarter cost.

When you combine the impact of these two components, benefit cost per covered employee per month increased 13% over the first quarter of 2006 to $685.

Just over 73% of the worksite employee base was covered by our medical plans during the first quarter, resulting in a cost of $502 on a per worksite employee per month basis. In a few minutes, Richard will discuss the recent claims activity, expected trends going forward, and how these cost trends will impact pricing.

As for our other direct costs, payroll taxes as a percentage of total payroll cost declined from 9.46% in Q1 of 2006 to 8.93% in Q1 of this year as a result of lower state unemployment tax rates and higher payroll averages and bonuses of worksite employees.

Workers’ compensation costs were 0.60% of non-bonus payroll for the quarter, below our forecasted range of 0.85% to 0.90%. Updated actuarial loss estimates reflected continued favorable claims trends and resulted in this quarter's $6 million reduction in previously reported loss estimates. Richard will discuss the drivers resulting in this positive reserve adjustment in a few minutes.

Now let's move on to operating expenses, which increased 8% over Q1 of 2006 to $58 million, slightly below our expected range. On a per worksite employee per month basis, operating expenses declined from $186 in Q1 of 2006 to $184 this quarter, as expected increases in cash and stock-based compensation were more than offset by lower general and administrative, depreciation and advertising costs.

As for net interest income, we reported approximately $3 million for the quarter.

We are now estimating an annual effective income tax rate of 35.4%, reflecting a higher percentage of tax-exempt interest income.

Now let's review several key balance sheet and cash flow items. We generated approximately $17 million of EBITDA during the quarter. Cash outlays during the quarter included share repurchases totaling 346,000 shares at a cost of $12.7 million, cash dividends of $3.1 million and capital expenditures of $1.8 million. As a result, working capital declined slightly, from $128 million at December 31, 2006 to $120 million at March 31, 2007.

As of today, we have 953,000 shares remaining for repurchase under our authorization.

Now, before providing our financial guidance, I'd like to turn the call over to Richard.


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Richard G. Rawson

Thank you, Doug. This morning I am going to discuss the details of our first quarter gross profit results. Then I will explain how our pricing strategy and direct cost trends should shape our gross profit per worksite employee per month for the second quarter and beyond.

Let me remind you that our gross profit comes from the markup on our HR services, combined with the surplus that is generated when our direct cost pricing allocations exceed the corresponding direct costs.

For this quarter, as Doug just reported, our gross profit per worksite employee per month was $216 and below our forecasted range. These results came from achieving our targeted average markup for the quarter of $200 per worksite employee per month and generating a surplus of $16 per worksite employee per month. This surplus came from contributions in payroll tax and workers’ compensation direct cost centers, offset by higher than expected costs in the benefits cost center.

Here are the details. The surplus in the payroll tax cost center came from better-than-expected state unemployment tax rates that we received near the end of the quarter compared to our pricing allocations that we adjusted for last fall. This surplus was higher than what we had forecasted last quarter.

Our second contributor to the surplus in this quarter came from our workers’ compensation program. As Doug reported a few minutes ago, our workers’ compensation expense was reduced primarily by a $6 million reduction to our reserves for claims. We have been seeing a $2.5 million to $3 million reduction to our reserves each quarter for the last couple of years.

These better-than-expected results continue to come from our people being able to settle workers’ compensation claims for amounts lower than expected.

The other factors that affect a lower-than-expected cost are the incidence and severity rates associated with the current policy year. This quarter the incidence rate was down more than 7% on a worksite employee growth base of 9%. The severity rate associated with these claims is down almost 8% over last year and also contributed to this quarter's lower-than-expected costs.

As we have previously announced, the benefits cost center did not contribute to gross profit surplus. Specifically, healthcare claims during the quarter were $15 per covered employee higher than what we had forecasted as the top end of our range for the quarter. This excess primarily related to higher costs associated with prior period health claims that got paid in this quarter. Excluding these prior period claims, our first quarter trend was 9%.

In the fourth quarter, we experienced a rather large increase in healthcare claims that exceeded $50,000 each and I had said that if this was a trend, then our costs would be increasing 9% over 2006. Well, the good news is that the large claim increase in the fourth quarter was a spike and this quarter we settled back into a much more familiar pattern in both the number and dollar amount of large claims. So the 9% trend increase came from normal utilization and healthcare inflation.

In summary, the other direct cost surpluses offset the 9% trend in healthcare cost but could not absorb the increased dollar amounts associated with the prior period claims.

Now I would like to update everyone on the changes to our gross profit per worksite employee per month expectations for Q2 and the remainder of 2007. Let me explain each component beginning with pricing. Our plan is to continue to increase the average markup from the 2006 average of $198 per worksite employee per month to $201 per worksite employee per month for 2007. The demand for our service is still very high and renewal pricing in the first quarter increased slightly more than $3 per worksite employee per month.

The second component of our gross profit per worksite employee per month comes from the surpluses that we generate by managing the direct costs so that they are lower than what we allocate in our pricing to cover those costs.

As for the payroll tax cost center, we should continue to generate a surplus from the lower unemployment tax rates we have received from the states. As a result of continued low unemployment levels, state funds are continuing to generate surpluses and we anticipate statutory requirements will mandate the return of these surpluses to employers through lower rates and/or tax credits.

Because of how payroll tax expense and the corresponding billing allocation in our model work, we should see a nominal surplus in Q2 and Q3 and then increasing to a moderate surplus in Q4. These expectations remain unchanged from last quarter.

As for workers’ compensation, we see a surplus contribution continuing throughout the balance of 2007, generated by the difference between our allocations and the ultimate cost of the program.

Last fall, we began to lower our allocations to match the lower costs associated with our workers' compensation program and have no plans to further reduce this allocation. In addition, we have had an increase in the percent of white collar workers which have lower pricing allocations.

But we expect our costs to trend downward from the previously forecasted range of 0.85% to 0.90% of non-bonus payroll to a new range of 0.75% to 0.80% of non-bonus payroll. This lower rate is further substantiated by the refund of approximately $25 million coming to us from AIG during the second quarter. This return of excess funding is the result of our losses being lower than AIG's original loss pick on the prior years' policies.

The bottom line is we still expect to see a nice surplus contribution to gross profit from this cost center.

Now, as for the benefits cost center, we have some deficits that need to be reduced. For the last several quarters, we have observed that our claim costs above our expectations has come from participants enrolled in the ChoicePlus 250 plan. This plan is the lowest deductible, highest-cost plan that we offer through United Healthcare and was available to all employees.

Therefore, last fall we began to increase our allocations for this particular plan at much higher amounts than our other types of offerings. Additionally, in January we changed our offering to limit enrollment into the ChoicePlus 250 plan by restricting access only to employees of clients that choose our richest PPO offering.

If our efforts are successful, we should see a reduction to the current 9% trend in healthcare costs as people migrate to a lower-cost, higher-deductible plan. Historically, when we have made these types of adjustments, there has been a couple of months lag before we see claim costs improve, so to be conservative we will forecast a 9% increase per covered worksite employee over 2006, except for the second quarter.

As you may remember, last week we announced the renewal of our healthcare contract with United Healthcare for three years beginning in 2008. One of the provisions in this new agreement included a credit to administrative expenses of $3.3 million for the second quarter of 2007. The second quarter's expense will reflect this credit therefore, and our trend for Q2 should be lower than 9%.

In summary, for the balance of 2007 we continue to see the average markup per worksite employee per month to gradually increase throughout the year from an average of $198 to $201. We should continue to see surpluses generated from two of our three direct cost centers. Therefore, the surplus component of gross profit for the full year could be $22 to $27 per worksite employee per month, or approximately 2.5% of the dollars allocated within our pricing to cover the direct costs.

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

Paul J. Sarvadi

Thank you, Richard. In my part of the call today I will discuss three topics of importance to Administaff and investors. First, I will comment on each of the drivers to our unit growth in the first quarter, sales of new accounts, client attrition, and the net affect of new hires and layoffs within the client base. I will also provide details surrounding systemic improvements that are underway to reinvigorate each of our growth contributors. Then I will conclude with our outlook for growth in both the near and long- term.

Our announcement last week included the average number of paid worksite employees for the quarter and the actual number paid in March. As you can tell from these numbers, we experienced two weak months in unit growth and then finished the quarter with a nice increase in worksite employees in March. Several factors combined to produce these results.

First, the total number of worksite employees lost from attrition of current clients was slightly higher than historical numbers in the first two months of the quarter. As I mentioned last quarter, the number of accounts terminating has actually been below historical levels. However, the average number of worksite employees associated with terminating clients has been higher than historical levels due to mid market terminations. The net affect has been a slightly higher total number of worksite employees from terminating clients coming out of the employee count.

Our typical monthly attrition rates are 6% to 7% of worksite employees in January, 2.5% to 3% for February and approximately 1.5% for March through the balance of the year. This year, we were above our range at 8% for January, at the high end of our range of 3% for February, and then right on our historical numbers for March at 1.5%.

Secondly, enrollment and first payroll on new clients sold during the fall campaign, extended further into the first quarter than we experienced in the past. The large number of new accounts sold in the fall campaign typically more than offset the year-end client attrition. Of course, the worksite employees associated with terminating clients come out of the employee count immediately and the new accounts do not roll in to the count until the first payroll run.

The timing between terminating accounts and slower enrollment of new accounts in the queue also contributed to a lower-than-expected average worksite employee count for the quarter.

Another factor in our worksite employee count is the net affect of new hires and layoffs within the client base, which reflects the economic climate and more specifically the job market within the small business community.

Although new hires are exceeding layoffs, we have continued to experience a lower number of new hires than we would expect, considering the economic climate. This reflects a continuing challenge we see for small businesses in finding qualified employees for open positions.

In addition, new sales during the first quarter were below budget, largely due to two process improvements we are making to improve our visibility in our growth projections. The first improvement is our mid-market reengineering process, initiated after the year-end transition yielded more client terminations and fewer sales than expected within this segment.

During the first quarter, we conducted an in-depth analysis of our strengths, weaknesses, opportunities and threats within our sales, service, and infrastructure for our mid-market segment. We have identified specific obstacles, leveragable strengths and target opportunities which we believe will lead to a step up in both sales and retention of clients in this segment. These changes will be implemented throughout the second quarter and begin to affect results in the second half of 2007.

Although I will not discuss the specific changes we are making in the mid-market on this call for competitive reasons, I am very encouraged by the creative solutions from this process and the likelihood of improving results. In addition, many improvements that have emerged from the mid-market reengineering process are also likely to improve sales and retention in our core small business segment.

The second systemic improvement we are making is to address better throughput from sales of new clients to enrollment and payment of new worksite employees on an accurate, timely basis.

In order to accomplish this, we have tied sales compensation and rewards such as qualifying for the annual incentive trip, to the actual payment of employees sold in new accounts. Previously sales credit was awarded on certain current accounts that added a new line of business or acquisition and on accounts sold before the first payroll was run. This change aligns the entire organization around enrolling new clients and should reduce the shrinkage we experienced historically between employees sold versus employees paid.

Another systemic change that we are investing in at this time is designed to reinvigorate the internal growth within our client base. During the first quarter, we reorganized our recruiting organization to respond to changes in the labor market and improve our clients' competitiveness in finding qualified new employees.

We have formed recruiting specialty units for the top seven types of employees our clients have used our recruiters to find in the past. This includes sales, technology, professional, administrative, healthcare, accounting and finance, and light industrial recruiting segments. Each of these units have dedicated staff working together and focused on recruiting their specialty employee category.

We have also redesigned job functions separating candidate interaction from administrative tasks to increase efficiency and speed up the recruiting process.

We also developed new and deeper alliance relationships to leverage our collective buying power into significant discounts on services utilized in the recruiting and selection process. These alliances include CareerBuilder for job posting, Hire Right for background check needs, Psychometrics for pre-employment testing, and a variety of national advertising alternatives.

We also introduced skills-based testing through Reliant in order for clients to validate the skill level of applicants or identify gaps to fill utilizing available training programs.

We have made these changes due to the shortage of qualified people available in an environment with historically low unemployment rates and changing demographics. We believe these changes will help our clients win the race to attract and retain the best employees in today's competitive labor market, and help Administaff grow as our clients grow.

Each of these three growth initiatives are focused on improving long-term growth prospects for the company. These initiatives are expected to combine with our accelerated expansion plan and lower sales personnel turnover to return the company to our historical double-digit year-over-year unit growth rates.

While these changes are taking hold, we believe the current number of trained sales personnel will produce sales at a rate that when combined with expected client attrition, should produce a net increase of 1,100 to 1,300 worksite employees per month. At this level, we return to double-digit growth by the fourth quarter of this year.

We averaged 251 trained sales personnel for the first quarter and achieved a record low turnover rate at approximately 30%. The percentage of the sales staff with more than 18 months experience with the company also increased to 47%.

Our expansion plan for this year includes eight office openings, two in new markets, and six in existing markets. We have opened two offices in the first quarter and have three more opening in the second quarter. By the end of the year, we expect a total of 49 sales offices in 24 markets. This expansion of offices and associated trained sales staff is the lead indicator of our future growth.

Another important contributor to our long-term growth outlook is our recently announced renewal of our healthcare coverage with United Healthcare. In spite of recent higher-than-expected claims activity, our health plans continue to outperform the marketplace and create a competitive advantage for our clients. The administrative efficiencies and costs reductions we negotiated create the opportunity for this competitive advantage to continue in the future.

One final note I would like to make concerns our second press release today regarding a change at a senior level within our organization. Administaff has had the high honor of having John Spurgin as our Vice President, General Counsel and Secretary of the Corporation for the last 10 years. It is difficult to describe the value of his contribution to the success of the company, leading us through the legal and regulatory maze of establishing an industry-leading company in a brand new industry.

It will have to suffice to simply say we have all been well served. John will be resigning from this role this week, opting for a well-deserved slower pace of life but we are pleased to announce he will remain available to the company in the role of Special Counsel. His experience and insight will continue to be invaluable to the company and our new General Counsel.

In a typical demonstration of John's professional capability, he has prepared well for his succession. He will be replaced by Dan Herink from within our organization. Dan has been with the company for seven years and played a critical role in successfully defending the company, reducing our litigation docket and associated expense, and advising our property and casualty group on our workers' compensation plan and other coverages. He is an excellent lawyer, recognized by his peers and we look forward to Dan's contribution to the company and the management team in his new role.

At this time I would like to pass the call back to Doug to summarize our guidance for the balance of the year.

Douglas S. Sharp

Thanks, Paul. At this time, I'd like to provide financial guidance for the second quarter and an update to our full-year forecast. As for worksite employees, we expect to average 107,250 to 107,750 for the second quarter, and add an average of 1,100 to 1,300 each month for the latter half of the year.

As Paul just mentioned, client attrition is expected to return to historical levels over the balance of the year and sales are expected to ramp up from our spring sales campaign. This expected net monthly growth results in a forecasted range of 109,000 to 110,000 for the full year.

As Richard mentioned, we now expect full-year guidance for gross profit per worksite employee per month to be in a range of $223 to $228. This is a combination of an expected average markup on our HR services of $201 and a surplus on our direct cost programs in the range of $22 to $27.

As for the second quarter, we expect gross profit per worksite employee per month to be between $221 and $225, which includes the impact of a $3.3 million reduction in administrative costs negotiated under the new United Healthcare contract.

When forecasting this metric over the remainder of the year, we would expect Q3 to be relatively consistent with Q2, and a 5% sequential increase in Q4 over Q3, as payroll tax costs decline and price increases continue to roll in through the remainder of the year.

As for operating expenses, we now expect to be in a range of $237 million to $239 million for the full year, with the high-end of the range including additional incentive compensation tied to achieving higher unit growth and gross profit goals.

Cost savings from our previous guidance include a reduction in salaries and wages of approximately $2.8 million, related primarily to less incentive compensation based on our updated 2007 outlook, and approximately $700,000 less in G&A costs. When combined with our 2007 expected range of average paid worksite employees, operating expenses on a per worksite employee per month basis are now expected to decline from $183 in 2006 to approximately $181 for 2007.

As for the second quarter, operating expenses are expected to be in a range of $57.75 million to $58.5 million. This is slightly above Q1 operating expenses, as anticipated sequential declines in cash compensation and G&A of $1.2 million each are expected to be offset by additional advertising costs of approximately $1.5 million and additional stock-based compensation of approximately $1.2 million.

As a reminder, cash compensation is typically higher in Q1 of each year due to the restart of corporate payroll taxes, while first quarter G&A costs include expenses associated with our annual sales conference and employee incentive trip.

During the second quarter, we increase our advertising spend surrounding our spring sales campaign and typically grant restricted shares to our employees and directors, resulting in higher stock-based compensation.

We now expect net interest income to be in a range of $12.5 million to $13.5 million for the full year and a range of $3 million to $3.3 million for the second quarter. We are now forecasting 28 million average outstanding shares for Q2 and for the full year. We have estimated our annual effective income tax rate of 35.4%, and our annual capital expenditures budget remains at approximately $15 million.

Finally, as Richard mentioned a moment ago, working capital is expected to be positively impacted in the second quarter by the return of approximately $25 million in excess funding in our workers' compensation program.

Now, 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 Robinson Humphrey. Please proceed.

Tobey Sommer - SunTrust Robinson Humphrey

Thank you. I wanted to ask you a question about the spring marketing campaign, and if you have any plans to do anything different this go-around. I know it is probably at least partially underway and under your belt, but any changes you can describe would be useful. Thank you.

Richard G. Rawson

Sure. Thank you, Tobey. We actually really refined our spring campaign program last year and had a very strong campaign, so we have pretty much mirrored what we did last year. Our advertising is up and running and generating the leads that we want to. So things are going fine in that respect.

We did have our sales convention during the first quarter. It was very successful and attitudes are good and with the advertising, et cetera, we are boosting activity to the levels that should produce the results we are looking for.

We are always changing a few things and working out some things. We actually came up with a contest where we actually are providing capital to a small business that qualifies in the contest. One of the things they have to do is actually watch the seven-minute video about our service online, and that has been very successful in the first -- once we launched it in terms of how many folks we are getting through that process and how often that turns into a first-call opportunity.

We are always tweaking things but we have done a great job in that area and are expecting good results from the spring campaign.

Tobey Sommer - SunTrust Robinson Humphrey

Could you walk us through some of the metrics that you typically describe in terms of the sales funnel? I apologize if you have already gone through some of those productivity measures, but if you could repeat them, that would be terrific.

Richard G. Rawson

We generally quote somewhere between 45% and 50% of the accounts that we make first calls on, and then we close anywhere from 20% to 23% of the accounts that we have an opportunity to bid. Obviously those numbers are affected somewhat by the growth in the sales staff and the tenure of our trained sales reps.

As I mentioned on this call, we really are doing a great job on the hiring and training of our reps, and our turnover rate, which peaked at a little over 40% last year, is down over the last half of last year and into the first-half of the first quarter of this year down to 30%. We are really feeling good about that and of course, in that respect the number of trained reps that have over 18 months experience has risen to 47%. So we expect to see good results on those key sales metrics of the number of first calls and how they convert into bids and then how those convert into sales. That should affect our sales efficiency number.

Tobey Sommer - SunTrust Robinson Humphrey

I will ask one more question and then get back in the queue; could you refresh us on the number of trained sales reps and hired now, and maybe what your target is as you enter the fall campaign? Thanks.

Richard G. Rawson

We are at 251 average for the first quarter, and of course that is ramping up. We are actively hiring and having training classes and so forth. It is an exciting time in that respect. We should ramp up somewhere between 280 to 300 as we get into the latter part of this year. Then we will be in great shape for ’08 growth.

Tobey Sommer - SunTrust Robinson Humphrey

And the number of hired that you have already?

Richard G. Rawson

I believe it is around 280 or so.

Tobey Sommer - SunTrust Robinson Humphrey

Thank you very much.


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

James Macdonald - First Analysis Securities Corp.

I wanted to dig into the healthcare a little more. Are you going to raise prices in general faster or maybe cull out some higher cost accounts or anything else, other than the ChoicePlus stuff you talked about?

Richard G. Rawson

Jim, the answer to your question, the first one is yes, we already started back last fall, as we observed the cost of this particular plan. With the change that we made at the beginning of the year, we see that the migration of those customers coming out of that plan, because to a certain extent, they will seek a lower cost plan with a higher deductible.

And we are continuing to increase pricing for that particular plan, as well as nominal increases in the rest of our program because trend is -- I mean, healthcare inflation is alive and well and we have been historically, for many, many years, a lot lower on the trend side of costs than the market at large. So with the pricing strategy we have, we should be able to continue to select the right kind of customers and give them a great benefit at the same time.

Paul J. Sarvadi

Jim, I’d like to add to that that also at renewal, we do look at each individual account and it is part of our normal process and we use an approach that we call a partial pooling approach where certainly everyone gets the benefit of being a part of a much larger group but you do not ignore each entity’s contribution to the total, and so those who had higher incidence of large claims will see higher rates, so that is all part of our normal process.

James Macdonald - First Analysis Securities Corp.

Just a follow-up; were you caught up at all -- it sounds like United Healthcare had some or were surprised themselves. Were you getting good information from United Healthcare or was their guidance maybe also a surprise to you in terms of properly pricing plans?

Richard G. Rawson

Jim, that’s a good question, actually. After hearing United Healthcare’s conference call, what they were talking about that was a surprise to them was they have a fairly large book of business in the small business market segment that the employees and clients are enrolled in the high deductible health plan. And so that was the part that was kind of different for them because that deductible expires at the end of the year, and so according to their, according to what they said on their call, that part of their small business book was a surprise and therefore that is why they increased their reserve I think $170 million or whatever.

Now for us, the customers that we have in the high deductible health plan, we have -- and I am going to be pushing the envelope, maybe 1.5% of our base is in a high deductible health plan. That really wasn’t a specific area that drove our costs.

The data and information that we get from United is certainly -- we do annual audits of our plan with United and their rate of quality in paying claims and reporting claims accurately is very close to 100% in most cases, and so that is not an issue of us just getting paid late. It is a matter of, in our case, having claims that were incurred in a prior period that just took a long time to get paid and that is the nature of -- unfortunately, that’s a little bit of the nature of healthcare. That’s why we have to each period look at what’s called our incurred but not reported claims and come up with an estimate of what that amount is.

It was just more than what we were expecting.

James Macdonald - First Analysis Securities Corp.

Just one more and I will finish here. Paul, you mentioned that the sales in Q1 was below plan. Can you say how much below plan?

Paul J. Sarvadi

It was actually below our budget but it was still higher than last year on a comparable basis. It is nothing for us to be excited about. In fact, it is probably just enough for us to be able to really beat the drum and get everybody really focused properly on getting back on target, not just for a second quarter budget but making up for where we were in the first quarter. So nothing to be concerned about there, but a little ahead of last year, although we are ahead of last year in number of trained reps, so it should be more than last year.

But things are going fine there, but I do expect things to ramp up even more now with the spring campaign.

James Macdonald - First Analysis Securities Corp.

Thanks very much.


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

Mark Marcon - Robert W. Baird & Co.

Good morning. I’m just wondering if you could give us just a little more color just in terms of what you are seeing with the mid market. Obviously that was an area that was a little bit softer during the fourth quarter and I’m just wondering to what extent that carried over into the first quarter. You had mentioned that there were a number of accounts that there was still no decision on. I’m wondering how those panned out.

Paul J. Sarvadi

I sure can. First of all, of course, I announced that we were going to take a deep dive into the sales service and our service infrastructure for those accounts. When you do that, you do have some suspension or put some things in abeyance on how you are moving forward with specific accounts. So it is pretty much on an account-by-account basis.

As we dug into it, we have found what I believe will be some very effective improvements in each of the components -- how we sell, how we serve, and what the under girding infrastructure is for meeting the expectations of those accounts.

We didn’t sell very much in the mid-market in the first quarter. That is also part of being below budget, because we didn’t take it out of the budget just because we were going to reengineer the processes. But I think it is not unusual to expect that when you are doing that, you are not going to have a -- I had a lot of the sales staff in working on these changes and the service team working on these changes, so we have been in the foxhole together working out the next strategy, so that is kind of understandable.

But we are ready to start to deploy these new things. There are several things that will take the second quarter to put in place and then we will start actually using the new processes in the third quarter, which we are trying to ramp all this to be effective in the latter half of the year, as you are going to have a lot of customers renewing and a lot of new accounts making decisions.

Mark Marcon - Robert W. Baird & Co.

When we take a look at the January and February performance relative to budget, to what extent was that due to mid market as opposed to your traditional client base?

Paul J. Sarvadi

It was about half and half.

Mark Marcon - Robert W. Baird & Co.

Half and half. Okay, and then can you talk a little bit about regional differences, and specifically in the west, what are you seeing there in terms of that west region and growth prospects going forward? Anything that may have impacted growth during this last quarter?

Paul J. Sarvadi

I think I mentioned last go-round that over the past year-and-a-half or two, we really had to rework the whole San Francisco market all the way up to not only the district managers but a regional manager change, and so pretty much a whole sale change out. We have been through that and in fine fashion, they are doing fine up there now.

I think you will start to see those numbers come around some, but we are all excited about the West region. We will open a couple of other new offices out there. We are going to open up another Phoenix office. We are going to open up another L.A. office, so we are doing fine out there in terms of the demand is strong.

Mark Marcon - Robert W. Baird & Co.

No change in competitive environment?

Paul J. Sarvadi

No, none that we’ve seen to hurt our game plan. However, we do I think -- we have really made a move to be more aware of other options. You may have seen the announcement last fall of adding a new senior person on our team to help us on the strategy side. In fact, formerly in the research business, Mark Allen, who is now our VP of Strategic Planning, he is helping us keep good tabs on what is happening in the competitive environment from the big picture, but we also have quite a bit of activity just making sure that our sales staff are fully equipped to point out the differences when we are in a competitive bid situation, which is still not that often but you want to make sure people are prepared that when that happens, we can really come out on top.

Mark Marcon - Robert W. Baird & Co.

Okay, great, and then last question just on the healthcare, just to be clear, it sounds like the healthcare costs, the primary reason for the higher healthcare cost this quarter was primarily the spillover effect from the prior quarter, where things were a little bit higher. In terms of looking ahead, and then of course there is this adjustment with regard to the low deductible plan, in terms of spilling over into this quarter, should we see any of those, the effects from the first quarter spill over into the second quarter? I am talking about specifically the above $50,000 type claims?

Paul J. Sarvadi

No, Mark, we should not. We saw this phase out over the first quarter and when we look at our large lost claims that were in excess of $50,000, they were almost, I mean almost to the number in line with growth of our business from the third quarter of 2006 to the first quarter of 2007, just implying a normal growth.

The dollar amount was up compared to the third quarter of 2006. The claim amount was up compared to the third quarter of 2006 but they were certainly a lot lower than what we had experienced in the fourth quarter.

We are in the safe zone again. We don’t expect to see any spike in that, in the large loss claims. They do happen and it’s stuff that you just can’t -- you just can’t know that it’s going to take place but based on where we are right now, we don’t see that.

Mark Marcon - Robert W. Baird & Co.

Thank you.


Our next question will come from the line of Tom Giovine with Giovine Capital Group. Sir, you may proceed.

Tom Giovine - Giovine Capital Group

With regard to share count, buy-back and sort of the capital plan, and I guess I find it a little frustrating why we are not being a little bit more aggressive with the buy-back. I understand that there are buy-back rules and you have put in a -- what is it, a 10B5, 12B5 plan, but why has not the board maybe been a little bit more aggressive about considering a Dutch tender? I have not historically been a big proponent there, but with a stock like yours where you have a relatively short window because of material information, it seems like you could tender for 2 million, 3 million shares and still have plenty of capital to execute your strategic plans as contemplated and allow shareholders to benefit from reducing the shareholder base here at a relatively depressed level.

Paul J. Sarvadi

Tom, you bring up a good point and obviously we have been trying to execute a buy-back game plan, obviously with the limitations. Unfortunately, the relatively thin trading on our shares does make the limitations quite restrictive. We actually did fairly well during our open period and then put a 10B51 plan in place for our quiet period, but not much was able to be executed during that game plan.

We are going to revisit that. We have our Board meeting tomorrow. We are going to talk more about that. As you know, even from putting that plan in place, we have designated a significant dollar amount to be utilized to buy back our own shares because we believe this is a tremendous value. Of course, our window will open back up again shortly, so we should be able to be active again like we were.

But we will revisit that tomorrow and I am not sure where we will land on it but we were not happy with being able to acquire so few number of shares over the last quarter.

Tom Giovine - Giovine Capital Group

Great to hear. Thanks.


Ladies and gentlemen, this does conclude our Q&A session. I would now like to turn the call over to Mr. Paul Sarvadi, Chairman and CEO. Sir, please proceed.

Paul J. Sarvadi

Thank you very much and once again, thank you everyone for participating on the call today. We look forward to better results in the second quarter. Thank you.


Ladies and gentlemen, at this time the call has concluded. You all may disconnect and enjoy the rest of your day.


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