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Executives

Paul Sarvadi - Chairman and Chief Executive Officer

Richard Rawson - President

Douglas Sharp - Chief Financial Officer and Vice-PresidentFinance

Analysts

James MacDonald - First Analysis Securities Corp.

Michael Baker - Raymond James & Associates

Cynthia Houlton - RBC Capital Markets Corporation

Mark Marcon - Robert W. Baird & Co., Inc.

Tobey Sommer - SunTrust Robinson Humphrey

Bob Bennett – Groundswell Equity Partners

Administaff Inc. (ASF) Q3 2007 Earnings Call November 1, 2007 10:00 AM ET

Operator

Good day, ladies and gentlemen. Welcome to the thirdquarter 2007 earnings conference call. My name is Ikeda (sic) and I will beyour coordinator for today. At this time all participants are in listen-onlymode. We will be facilitating a question and answer session towards the end ofthis conference. (Operator Instructions). As a reminder, this conference isbeing recorded for replay purposes.

I would now like to introduce your hosts for today’scall. Paul Sarvadi, Chairman and CEO, Richard Rawson, President, and DougSharp, CFO. I will now turn the presentation over to Doug Sharp, CFO. Pleaseproceed, sir.

Douglas Sharp

Thank you. Weappreciate you joining us this morning. Before we begin I would like to remindyou that any statements made by Mr. Sarvadi, Mr. Rawson or myself that are nothistorical facts are considered to be forward-looking statements within themeaning of the federal securities laws. Words such as expects, intends,projects, believes, likely, probably, goals, objectives, outlooks, guidance,appears, targets, and similar expressions are used to identify suchforward-looking statements and involve a number of risks and uncertainties thathave been described in detail in the company’s filings with the SEC. Theserisks and uncertainties may cause actual results to differ materially fromthose stated in such forward-looking statements.

Now let me take a minute to outline our plan for thismorning’s call. First I’m going to discuss our third quarter financial results.Paul will add his comments about the quarter, our outlook for the remainder of2007, and then provide some preliminary comments on 2008. Richard will thendiscuss trends in our direct costs, including benefits, workers’ compensationand payroll taxes, and the impact of such trends on our pricing. I will returnto provide financial guidance for the fourth quarter and also comment on ourpreliminary outlook for 2008. We will then end the call with a question andanswer session.

Now let me begin by summarizing the financialhighlights from the third quarter. We reported third quarter earnings per shareof $0.45 at the high end of our expectations. As for our key metrics, weachieved double-digit unit growth as the average number of paid worksiteemployees increased by 10% over Q3 of 2006 to 112,496 for the quarter.

Gross profit per worksite employee per month averaged$222 for the quarter, above our expected range due primarily to a positiveoutcome in our direct costs programs.

Operating expenses came in below forecasted levels withthe exception of an additional accrual for incentive compensations tied to theachievement of higher operating results.

We’ve repurchased 408,000 shares during Q3 at a cost ofapproximately $13.4 million and entered the quarter with $110 million inworking capital.

Now let’s review the details of our third quarterresults. Third quarter revenues increased 13% over 2006 to $383 million as aresult of the 10% increase in average paid worksite employees and a 3% increasein revenue per worksite employee per month.

Looking at third quarter revenue contributions andgrowth by region, the southeast region, which represents 11% of total revenue,grew by 10%. The northeast region, which represents 20% of total revenue, grewby 21%. The central region, which represents 14% of total revenue, grew by 12%.The southwest region, which represents 35% of total revenue, grew by 18%. Andthe west region, which represents 20% of total revenue, grew by 2% and wasimpacted by the loss of a large mid-market client during the 2006 year-endclient renewal period.

Now moving to gross profits, we had forecasted grossprofit per worksite employee per month to be in the range of $216 to $219. Thisguidance was below the $234 achieved in Q3 of 2006, a period in which weexperienced unusually low benefit costs. We exceeded our expectations thisquarter, averaging $222. The pricing of our HR services came in as expected,with the upside generated from our direct cost programs.

As for the details, our workers’ compensation programcontinues to generate positive results. Workers’ compensation costs were 0.52%of non-bonus payroll for the quarter, consistent with the prior quarter andbelow the low end of our forecasted range. Actuarial loss estimates continue toreflect our favourable claims trend and resulted in a $6 million reduction inpreviously reported loss estimates. This reduction is generally consistent withthat reported in the previous two quarters.

Third quarter benefit costs were generally in line withour expectations as the cost per covered employee per month increased just over9.5% to $683. Payroll tax costs as a percentage of total payroll declined from6.7, 6.67% in Q3 of 2006 to 6.55% in Q3 of this year as a result of lower stateunemployment tax rates and higher payroll averages and bonuses of our worksiteemployees.

In a few minutes, Richard will provide further detailson this quarter’s positive developments and the expected impact on direct costtrends and pricing for the remainder of 2007 and into 2008.

Now let’s move on to operating expenses, whichincreased only 7% over Q3 2006 to $59.2 million. This was approximately$700,000 above the midpoint of our expected range and included the additionalaccrual for incentive compensation tied to our improved operating results,partially offset by expense savings in other areas. The 7% increase inoperating expense on a 10% increase in unit growth resulted in a decline inexpense on a per worksite employee per month basis from $181 in Q3 of 2006 to$176 this quarter.

As expected, stock-based compensation costs increasedby $2 per worksite employee per month as a result of the annual restrictedshare grants to employees. This was more than offset by lower salaries,depreciation, and G&A costs.

As for net interest income, we reported approximately$2.9 million for the quarter. This is just below the low end of our expectedrange due primarily to the utilization of invested funds and executing our sharerepurchases.

Our effective income tax rate for Q3 of 35.1% wasslightly less than the forecasted rate of 35.7%, reflecting lower than expectedstate tax rates.

Now let’s review several balance sheet and cash flowitems. We entered the quarter with approximately $110 million of workingcapital and only $1.2 million of debt. During the quarter we generated $23million of EBIDTA, cash outlays included cash dividends of $3 million, capitalexpenditures of $4 million, and share repurchases totally 408,000 shares at acost of $13 million.

We have now repurchased 1.8 million shares year-to-dateor over 6% of the total outstanding shares at the beginning of this year.

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There are currently $724,000 –

Paul Sarvadi

-- third quarter growth acceleration was the result ofsolid performance in both of the key drivers to unit growth, sales and clientretention. The paid worksite employees added from sales of new accountsincreased 22% over the same period last year and this was the primary driver ofour 10% unit growth for the quarter.

Our sales success continues to be driven by our growthin the number of trained sales personnel with over 18 months experience withthe company. We averaged 264 trained reps for the quarter and 306 total reps,up 4% and 7% respectively, over Q3 of 2006 from 253 trained reps and 285 totalreps. The number of sales people with more than 18 months experience increased22% and reached 150 for the first time in our company history.

Our office opening plan is also on track with sixoffices open through the third quarter, including our second Boston, Phoenix,and Denver offices, our third Washington, DC, and New York offices, and a newmarket opened in Jacksonville, Florida. We expect to open our fourth New Yorkoffice and one more new market in Kansas City in the fourth quarter, bringingtotal new office openings to eight for 2007.

We’ve also had some early sales success in our recentlyre-engineered middle market client segment, which we define as clients withgreater than 150 worksite employees. In the third quarter we sold five accountstotalling 1,300 employees, most of which will become paid worksite employees inJanuary. We’ve already sold three more middle market accounts during the fallcampaign, so we have some nice momentum in this new segment.

Last year at this time our middle market segment hadslightly more than 14,000 worksite employees representing just under 14% of ourtotal worksite employee base. As we reported early this year, we experienced a15% decline in this segment due to a difficult year-end sales and renewalcycle. We have rebounded over the last six months through new sales and growthof existing customers and the segment has recovered and is now slightly largerin absolute number of employees than it was at this time last year.

Our 10% unit growth rate for the third quarter was acombination of this mid-market recover to a slight year-over-year growth rateof 3% and our core business year-over-year growth rate of 11%. Currently themid-market segment is 13% of our total business.

Our client retention and satisfaction numbers for thequarter were also solid. The number of worksite employees related toterminating clients averaged 1.7% of the employee base per month for the thirdquarter, which is slightly higher than our target of 1.5%, but better than lastyear’s 1.9%. Our overall service satisfaction rate for the quarter was 90%,consistent with our year-to-date number of 91%.

Now, this time of year we’re focused on our fall salesand retention campaign, which is designed to take advantage of the naturalinclination for prospective small business clients to transition to ourservices at year-end. Each year we invest in advertising and promotion plans togenerate a wave of leads and appointments for sales staff leading to strong Q4sales. Historically we’ve sold about the same number of accounts in the lastfour months of the year as we sell in the first eight months.

This year we’ve invested heavily in television andradio advertising featuring our customer spokesperson Arnold Palmer. We haveclient testimonials from business owners in each of our major markets in ourradio ads to localize the message. We’ve also launched personalized direct mailprograms to follow up from our corporate call centre to set additionalappointments for sales staff. Although it’s much to early to measure thesuccess of the campaign, the first step has been accomplished with a 14%increase over last year in qualified leads supplied to our sales staff.

Another important element of this year’s campaign isthe addition of new benefits for client owners and worksite employees toencourage client retention. Clients are receiving personal and businessidentity theft protection and a new web-based business research tool as a giftfrom Administaff. Employees are receiving new benefit options, including theRaw 401K, long-term care, cancer coverage, and even pet insurance. The fallcampaign began with the sales staff visiting current clients to share the newbenefit information and obtain client referrals. This bliss of activity wasreceived well by clients and generated a significant level of energy and, mostimportantly, sales prospects.

One other element of this year’s fall campaign is a newapproach to mid-market renewals. Since this was an area of difficulty lastyear, and we’ve made major changes to the service model, we are schedulingface-to-face meetings with senior management from both companies. In thesemeetings we are conducting a financial stewardship review and explaining thechanges we are making in our services model. So far these meetings have beenproductive.

All of these sales and retention efforts under way aredirected towards maximizing the number of paid worksite employees in January of2008. This number has a dramatic effect on the 2008 year-over-year growth ratedue to the cumulative effect of our recurring revenue business model.

Last year we had no net gain from December to Januaryin worksite employees for the reasons I mentioned earlier regarding our mid-marketsegment. The opportunity before us now is to have a successful fall campaignresulting in an increase in paid worksite employees from December to January,thereby accelerating our unit growth rate and stepping up our revenue base forthe new year.

So in summary, our outlook for growth for 2008 ispositive based upon our growth in the mid-market, I’m sorry, growth in thenumber of experienced sales personnel, our progress in the mid-market segment,and continuing our market expansion. Our 2008 plan includes an additional eightoffice openings throughout the year and an increase of approximately 15% in thenumber of trained sales staff.

The economic environment is also an issue we’rewatching closely as we look ahead to next year. Now so far we’re not seeing anegative change in what clients are actually doing in compensation and hiring.However, our client-owner sentiment about the economy going into an electionyear seems a bit more hesitant and they are somewhat more conservative as aresult.

For the third quarter average compensation increaseswere up just under 6%. Commissions were up over 12% indicating a nice pipelinefor new business in the near term. Overtime pay as a percentage of base pay(inaudible) 7%, which is historically high (inaudible).

We continue to believe there is a greater marketperception of economic impact on our business model than actually exists. Thisis due to the last economic down cycle when we had a company specific eventwhich occurred at the same time as the down economy and had more of asignificant effect on our growth than the economy did. Our service is equallynecessary, maybe more so, in a down economic cycle when employment costs andliabilities rise. We continue to see strong demand for our services as smallbusinesses continue to seek a competitive edge in the marketplace regardless ofthe economic environment.

Now, our business model is affected when layoffs exceednew hires in our client base, but not to the degree experienced in the lastcycle. We believe we will continue to grow units and profitability even if theeconomy slows, and we expect to continue to generate strong free cash flow.

At this time I’d like to pass the call on to Richard.

Richard Rawson

Thank you, Paul. This morning I’m going to discuss thedetails of our third quarter gross profit results and the new relationships wehave in the workers’ compensation insurance program. I will comment briefly onour expectations for the fourth quarter of 2007, and then I will update you onour pricing strategy and the direct cost trends that will shape our grossprofit per worksite employee per month for 2008.

Our gross profit comes from the markup we earn on ourHR services combined with the surplus that is generated when our direct costpricing allocations exceed the corresponding direct costs. For this quarter ourgross profit per worksite employee per month was $222, which was above ourforecasted range of $216 to $219. These results came from achieving $199 perworksite employee per month of markup and generating a surplus of $23 perworksite employee per month or 2.5% of the total dollars allocated to cover thedirect cost. This quarter’s surplus came from better than expectedcontributions from the workers’ compensation cost centers while payroll tax andthe benefit cost centers came in at about what we had expected.

Here are the details, beginning with benefits costcenter. In this quarter our expense per covered worksite employee was $683, atthe high end of our expected range. We continue to see a migration of employeesout of the United Health Care Choice Plus 250 Plan into lower cost plans, whichhelp to reduce our costs. We did have a few more claims over $50,000 than whatwe had forecasted, but nothing like what we experienced at the end of 2006. Sowe ended the quarter about where we expected our costs to be.

Our largest contributor to the gross profit surplus inthe quarter came from positive results in our workers’ compensation program.The current policy year just ended on September 30th and for thispolicy year the number of claims reported at 7% lower than last year. Now thisdecline is particularly impressive when you consider that we have had a 10%growth in the number of paid worksite employees over the year that incur thoseclaims. Obviously the work of our safety professionals in the field is payingoff nicely.

Our claims management personnel continue to settleworkers’ compensation claims for amounts lower than expected as ourback-to-work programs continue to produce favourable results. As a result, wehad a nice surplus from our workers’ compensation program as the expense was0.52% of non-bonus payroll, well below our estimate of 0.60% .

Before we talk about Q4 of 2007 and 2008 I would liketo share with you the details of our workers’ compensation insurance programstructure beginning October the 1st, 2007. We now have Ace InsuranceCompany as our new workers’ compensation insurance carrier. They’re coverage isidentical to the previous year’s programs that we had with AIG, but at a lowercost and with policy administration function carved out.

Prior to 1998, a workers’ compensation insurance carrier had to issueonly one policy which covered all the clients of a PEO. Beginning in 1998, a few states changed theirrequirement and made the workers’ compensation insurance carrier issue aseparate policy in the name of both the PEO and the client doing business inthat state. Now, eight years later, most states require the carrier to issuewhat is called a multiple coordinated policy naming the PEO and the client aspolicy holders.

Our carrier went from issuing one policy several yearsago to several thousand policies this last year. As you can imagine, theadministrative costs have gone up rapidly, but more importantly, we discoveredthat several really good workers’ compensation carriers would not do businesswith PEOs because their backroom operations could not handle the volume of workrequired for a PEO.

I am happy to report that we have found a solution tothe rising cost and the market limitations through an arrangement with ourinsurance brokerage firm, Lockton Companies Inc. they are the world’s largestprivately owned independent insurance brokerage firm. This new arrangement iswith their wholly owned subsidiary called The Lockton Affinity Group. Thisorganization has a successful call center which cross sells insurance productsand a policy administration business that issues more than 60,000 workers’compensation policies each year for its customers. We have partnered with themto issue all of the workers’ compensation policies on behalf of Ace InsuranceCompany to our clients, which is why our administrative expenses of the programwill be lower than last year.

Additionally, this new venture will make these servicesavailable to other carriers facing the same PEO policy administration issues.Should there be additional business that comes to the new Administaff-Locktonventure we will get to share in that revenue.

The third feature of this new arrangement is anagreement whereby the Lockton call center operation will set appointments withtheir clients for Administaff sales personnel to meet and discuss thepossibility of becoming an Administaff client.

This new structure creates a distinct and uniqueadvantage for Administaff and we are very excited to open up our long-termoptions and reduce our cost of our workers’ compensation program.

Now, let me update you on our gross profit expectationsfor the fourth quarter of this year. The mark up on our service fee is stilltracking toward our goal of averaging $200 per worksite employee per month for thefourth quarter and the full year of 2007 as our renewals, completed in thethird quarter, were up over $5 per worksite employee per month.

The surplus component of gross profit should add about$30 to $33 of additional gross profit per worksite employee per month based onthe following information. We should get a larger contribution to surplus fromthe payroll tax cost center this quarter because more of the employees with newclients that were added throughout the year will reach their individual wagelimits, so our cost will go down as our allocations remain unchanged.

As for the benefits cost center, we have seen our pricingallocations increase from the second quarter. At the same time we have startedto see a meaningful shift of employees moving from the higher-cost plans to thelower-cost plans. Also as you may recall from the fourth quarter of last yearwe had a high number of large loss claims. Therefore, we expect our fourth quartercosts to increase 6% to 7% over Q4 of 2006, which is lower than our full-yearforecast for 2007 of 9%.

Our workers’ compensation cost center should continue toadd to our surplus. As I mentioned a few minutes ago, the administrative costswill decline from last year since our new structure went into place on October the1st. Our current incidence and severity rates would indicate a lower cost thanQ4 of last year, so an expense of 0.55% to 0.65% of non-bonus payroll for the fourthquarter is certainly in play.

In summary our solid gross profit performance thisquarter gives us the platform to finish 2007 with good results.

Now let me give you our up to date outlook for grossprofit per worksite employee per month for 2008. Let me explain each componentbeginning with pricing. We are well on our way to achieving our targetedaverage mark up on our HR services of $200 per worksite employee per month for2007. With nominal increases on new and renewing business we should see theaverage mark up increase by a couple of dollars in 2008.

Our view about the surplus component of gross profit for2008 has not changed from last quarter. The surplus generated from the payrolltax cost center should increase. From an allocation perspective, we could see amoderate decline at the beginning of 2008 due to lower state unemployment taxrates. The reason for the expected lower tax rates comes as a result of thesurpluses that are sitting in many state unemployment tax funds. By law thestates are required to lower the rates and/or give credits to employers. Thenet effect is a projected increase in our surplus for 2008.

We also expect to see the continuation of a nicecontribution to gross profit surplus from our workers’ compensation insuranceprogram from the new structure that I discussed earlier. The better thanexpected incidence and severity rates that we have experienced throughout thispolicy year, coupled with effective claim settlements, should translate intolower costs as well. We expect little or no change within the allocation sideof this cost center. So the bottom line is that we still expect to see a nicesurplus contribution to gross profit from in 2008.

The benefits cost center is where we could see someimprovement in 2008. A few minutesago I mentioned that we continue to see migration of covered worksite employeesfrom the United Health Care Choice Plus 250 Plan to a higher-deductible, lower-costplans. The result is an immediate reduction in our benefits allocation followedby a corresponding expense reduction several months later.

Last quarter I also mentioned that for 2008 we have someadditional factors that will affect the benefits cost center. They are: numberone, benefit plan design changes that reduce claim costs; number two, loweradministrative fees previously negotiated with United Health Care for 2008;number three, double-digit health care cost increases from our fixed-rate planswhich cover about 10% of our total book of business; and number four, ongoingallocation increases to match future expected costs. These factors should allowus to mitigate total benefits trend increases and further deficits in this costcenter for 2008.

In summary for 2008, we have a very solid game plan forbeing able to generate a few dollars more of gross profit per worksite employeeper month.

Now, I would like to turn the call back over to Doug togive further financial guidance.

Douglas Sharp

Thanks, Richard. Now let’sdiscuss our guidance for the fourth quarter. We expect average paid worksiteemployees per month to be in a range of 115,500 to 116,000, reflecting unitgrowth of approximately 11% over Q4 of 2006. As a reminder, clients sold duringthe fourth quarter of any year, and in particular during our fall salescampaign, are typically converted to paid worksite employees during the firstquarter of the following year.

As for gross profit per worksite employee per month, weexpect to be in a range of $230 to $233 for the quarter. An expected sequentialincrease in this metric over Q3 is consistent with the quarterly pattern thatwe have experienced in prior years. Specifically, we expect to earn a highersurplus in our payroll tax direct cost center. This is because worksiteemployees added to our base mid-year typically reach their taxable wage limitsby Q4. So for these employees related payroll tax costs diminish while wecontinue to collect the pricing allocation that was set upon their enrolment.

Fourth quarter operating expenses are expected to be in arange of $63.25 to $63.75 million. This is sequentially up from the thirdquarter operating expenses by approximately $4 million and includesapproximately $2.2 million of additional advertising costs related to our fallsales campaign. We are also expecting a $1.5 million sequential increase incompensation expense associated with the additional sales and service personneland additional incentive compensation to be accrued only upon achievingforecasted results.

Our Q4 guidance also includes approximately $700,000 ofG&A costs associated with the services offered to certain clients andworksite employees in connection with the missing laptop issue. We arecurrently reviewing our insurance coverage, which may provide up to 90%reimbursement of these costs.

We expect Q4 net interest income to be between $2.9million and $3.1 million and are forecasting an effective income tax rate of35.5%.

We are also forecasting 26.8 million average dilutedoutstanding shares for the fourth quarter and 27.3 million shares for the fullyear 2007, based upon our current share price.

Now, before we open up the call for questions, I’d liketo comment on our preliminary outlook for 2008. We plan to provide detailedguidance during next quarter’s conference call, based upon the results of our2007 fall sales campaign and the year-end client renewal period. Based uponPaul’s earlier comments, we expect to accelerate from the 10% forecasted unitgrowth for 2007 to around 12% for 2008.

As Richard mentioned, we currently expect a slightincrease in gross profit per worksite employee per month over 2007. Consistentwith prior years, we are forecasting about a 1% to 2% increase in the mark up on our HRservices. We are also budgeting a slightly higher surplus from our direct costprograms based upon our initial outlook for health care and workers’compensation cost trends, the expected impact of benefit plan design changes,and a preliminary estimate of lower state unemployment tax rates.

As for the quarterly trend in this key metric, we expectgross profit per worksite employee to be highest in Q1 as we typically earnmore surplus in the payroll tax cost center prior to worksite employeesreaching their wage limits. Additionally, our benefit plan design changestypically have a greater impact during the first quarter of the year implemented.Thereafter, we would expect a decline in this metric in Q2 and then sequentialincreases in the third and the fourth quarters, which is consistent with ourtypical gross profit pattern.

As for operating expenses, while we continue to expectleverage in our core PEO business, we plan to make investments next year in ourmid-market initiative, HR Tools software, and other ancillary products. Whencombined with the continued investment in our national sales and serviceexpansion plan, we expect an increase in 2008 operating expenses slightly aboveprojected unit growth.

Similar to prior years, we are budgeting for a step up inoperating expenses from the fourth quarter of 2007 to the first quarter of2008. This step up in costs is associated with expected hiring of sales andservice personnel and certain G&A costs, including our annual salesconvention and employee incentive trip. Thereafter, operating expenses areexpected to remain relatively flat through the second and third quarters, withthe usual step up in Q4 for costs associated with our fall sales campaign.

So, in conclusion, our initial plan for 2008 targetsoperating income per worksite employee per month at a slight increase over 2007as an increase in gross profit per worksite employee is expected to bepartially offset by investments in our growth and other initiatives. Whencombined with our projected unit growth, we are currently expecting 2008earnings growth of somewhere between 15% to 20% over 2007.

As for capital expenditures, we are looking at a basebudget of about $20 million, which is up from approximately $13 millionprojected for 2007. This increase is tied primarily to the planned nationalsales and service expansion.

We plan to provide detailed 2008 guidance during next quarter’sconference call in early February. This guidance will be largely based upon theresults of our 2007 fall sales campaign and the year-end client renewal period,and we will also factor in any changes in the economic climate of the smallbusiness community that may occur in early 2008.

At this time I’d like to open up the call forquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes fromthe line of Tobey Sommer of SunTrust Robinson Hum. Please proceed.

Tobey Sommer –SunTrust Robinson Humphrey

Thanks. I just wanted to ask a clarification questionon, Doug, your preliminary kind of high-level look at 2008. Did you say thatyou expected earnings growth of 15% to 20% based on the slightly betterworksite employee volume growth offset by the incremental investments thatyou’re planning.

Douglas Sharp

A little clarification there. Yeah, 15% to 20% is whatwe’re currently targeting in earnings growth and it’s off of about a 12% unitgrowth number that we’re looking at. And then a slight increase in the operatingincome for worksite employee over 2007.

Tobey Sommer –SunTrust Robinson Humphrey

Okay. And then, I wanted to ask a question about themix of marketing versus sales force head count growth going forward. You know,you’ve had a decent amount of opportunity to, I guess, experiment over theyears with marketing versus actually just kind of raw brute force increasingthe head count and opening up new offices. Any changes philosophically kind ofwhich levers you think you’re going to pull harder in 2008? You know, comparingand contrasting your opportunities in marketing to improve sales forceproductivity versus actually increasing the head count?

Douglas Sharp

That’s a good question, Tobey, and what we’re lookingat for 2008, of course, if you look at this year, we’ve had such a niceincrease in the number of trained sales personnel with over 18 monthsexperience that we’re getting the benefit of some better sales efficiency and,you know, what you get from a more experienced sales staff. Relative to themarketing program, next year is an election year, costs go up, we will bespending more money, but we also are going to grow the sales staff faster thanwe did this year. We’ve got about a 7% increase in the number of total repsright now over a year ago. And we expect to move up to around 15% over thecourse of next year. So we’re going to invest more in sales person head count,which are backfilling into these offices that we’ve opened. We opened eight,we’re going to open eight by the end of this year and another eight next year.So we’re going to rely a little more for ’09 on sales person head count. In ’08is more the experience of the sales staff that we have in place and thengrowing the new sales staff.

Tobey Sommer –SunTrust Robinson Humphrey

As a follow up, regarding the prospective eight newoffices next year, any change in the composition? By that I mean, do you planmore Greenfield offices or is the mix of Greenfield to additional offices andmarkets that you’re already represented in relatively similar to this year?

Douglas Sharp

Pretty similar. I mean, there may be two or three new.We’ll have two this year. We may have one more than this year in next year’splan. But we make those decisions as we get a little closer to each market oroffice opening.

Tobey Sommer –SunTrust Robinson Humphrey

And lastly I’ll ask you a question on capitalallocation and M&A opportunities. You’ve invested quite a bit of your cashflow recently in stock repurchases. I was wondering if you could comment onwhat you think your outlook for capital reployment would be in 2008 and if the slowdownin turmoil in the credit markets hasbrought incrementally, I guess, more attractive acquisition opportunities toAdministaff? Thanks.

Douglas Sharp

Sure. Certainly we are more well equipped to evaluateopportunities in the market place and we are doing that. We think there aresome things out there that we can do that add ancillary services or add to ouropportunities. Sometimes it kind of affects both sides of the fence. It lowersour cost on the PEO side, but then also potential to offer a point solution inthe HR tools side of our business, which is kind of a growing new venture forus. So we are keeping our out there, although I don’t see us being in aposition to make blockbuster-type of acquisitions or very large acquisitions.They’re more smaller strategic opportunities that we see.

As far as the rest of the use of capital, I think we’restill very bullish about our value of the company compared to how we’re beingvalued in the market right now, so we’ll continue to buy shares back in adeliberate fashion. And also I think there’s room for us to periodically movethe dividends up and to kind of keep our payout ratio and our dividend yield atthe levels we’d like to see. So that’s kind of our priority at this point, andof course first priority is investing in the business, growing that sales staffand service staff. That’s all expense through the income statement. But that’skind of how we see using our capital.

Tobey Sommer –SunTrust Robinson Humphrey

Right. And just as a follow up and then I’ll get backin the cue, there’s no change in your view of actually acquiring other PEOsbecause most of them probably would not fit with your business model and targetcustomer base. Is that correct?

Douglas Sharp

That’s correct. We’ve not seen any PEO opportunity thatmade sense to this point.

Tobey Sommer –SunTrust Robinson Humphrey

Thank you.

Operator

Your next question comes from the line of Jim MacDonaldof First Analyst. Please proceed.

James MacDonald– First Analysis Securities Corp.

Morning, guys.

All

Morning. Hi, Jim. Hey, Jim.

James MacDonald– First Analysis Securities Corp.

On the economy in general, I’ll start there, you saidyou hadn’t seen much impact. Are you seeing any regional impact maybe out Westor anything that’s maybe different in different parts of your business?

Douglas Sharp

Yeah, a little bit out West, but not so much so that,you know, that it’s significant to our game plan in any way. More the Westaffects, you know, we were a little light there in the year-over-year growthrate in the west coast, but that was more driven by the loss of a majorcustomer early in the year and how that affects the cumulative effects in ourmodel.

James MacDonald– First Analysis Securities Corp.

And on the middle market you talked about somesuccesses. Could you maybe describe those a little bit further? Which ones havealready hit the numbers and what’s yet to come?

Douglas Sharp

Yeah. Of course, we had a few sales early in the yearin the first and second quarter and those have all kind of rolled in and comeon board. We sold five accounts in the third quarter. One of those is enrollingnow. The others are enrolling on January 1st. We sold three more inOctober. They’re scheduled for January start ups. So we’re starting to build anice little pipeline of new business there. The exciting part to us is thatthese accounts in the third and fourth quarter are signing our new two-year agreementand being implemented in our new service model. That we’re really excited aboutthe opportunity to methodically and deliberately impact these client locationsand, I think, have much better results for the client and for our service team.So we’re excited about that. We have a pretty good pipeline of prospects thatwe continue to work on and we’ll just have to see how we do in the campaign.

James MacDonald– First Analysis Securities Corp.

So you think that the changes you made are causing thisincrease in activity?

Douglas Sharp

There’s no question in my mind that the sales changeshave had a positive impact in being more in control of the sales process andknowing more about where we stand with prospects as we go through the process.That’s about all we can measure right now because it’s so early and there’s notthat much data yet. But I’ll be excited to get into next year and see how thetransition plans and the service model implementations and how that flows intoclient satisfaction in our larger base.

James MacDonald– First Analysis Securities Corp.

Okay. Just one more area. Could you talk a little bitabout any kind of revenue expectations from the Lockton joint venture and justin general the kind of beyond PEO profit centers, like HR tools and otherthings. When, if ever, do you expect those to be material?

Douglas Sharp

Yeah, we’ve had, I’ll let Richard comment on theLockton program, but on the rest of the activities, which would be HR tools,our marketplace, and some other new things we’re kind of working on that we’llprobably talk about next time, but when you put all those together, you know,we haven’t broken it out because it’s been in the $1.50 range or there peremployee at the gross profit line. But we do expect to see that starting togrow more modestly in ’08, but we are hopeful that that will begin toaccelerate some as we get into ’09 because of some of the investments we’re making as I mentionedlast quarter about the HR tools game plan.

James MacDonald– First Analysis Securities Corp.

Thanks.

Richard Rawson

On the Lockton side I would tell you that we just putthis program in place on October the 1st, so there hasn’t beenanything yet. I don’t really expect to see much this year. I think that as weopen up their call center, calling into their existing customer base, that’sprobably where we’ll see, if we’re going to see anything positive, that’sprobably where we’ll see, you know, beginning next year where some appointmentsget set and maybe that will lead into some closing. I think that is theshortest view that we can see about upsiding that relationship. And then overthe next year I think we’ll see how it, what happens in other aspects of thatrelationship with our back office administration business.

Operator

Your next question comes from the line of Mark Marconof R. W. Baird. Please proceed.

Mark Marcon –Robert W. Baird & Co., Inc.

Good morning. I’m just wondering if you could talk alittle bit about some of the incremental costs that you would anticipate forthe mid-market for next year.

Douglas Sharp

Yeah. First of all, we talked about how we’d beenhancing the service offerings. So some of it’s going to be putting someservice personnel in place, both to address the different products and servicesthat a mid-market client needs. And also, there will be some scalable aspect tothat service growth. If we increase the mid-market client base, which we hopeto do, there’ll also be some service personnel that we’ll have to hire to servethose larger clients. A key role being the account executive role that handlesthe service relationship with those type of clients.

Mark Marcon –Robert W. Baird & Co., Inc.

Have you kind of pinned down the incremental cost forthis program?

Douglas Sharp

Yeah. I think Paul had mentioned that in the lastconference call, you know, what we expected in the latter half of ’07 and thenin ’08. I think it’s about $2.5 million or so in the ’08 period.

Mark Marcon –Robert W. Baird & Co., Inc.

Okay. I was under the impression that that was kind ofa preliminary estimate and was still being finalized. But it sounds like that’spretty much the area where it’s going to settle out.

Douglas Sharp

Yeah, that still looks like a good number to us.

Mark Marcon –Robert W. Baird & Co., Inc.

Okay. Great. And then, Paul, you mentioned that you’rehaving some face-to-face discussions with some of your existing mid-marketaccounts and I think the word that was used to describe that was productive.Can you give us a little bit more colour there in terms of exactly what you’reseeing?

Paul Sarvadi

Sure. We’ve essentially, as part of the whole revampingof the mid-market strategy, you know, looked at the process that we’ve gonethrough in the past renewing these customers. And once again, you know, kind ofleft over from our previous strategy was more of an incremental approach. Wedidn’t do a lot of things differently with mid-market customers at renewal thanwe did with smaller customers. But in recognizing what the needs are and thedifferent influencers and decision makers that are involved in the renewalprocess, we now are working through holding high-level meetings where I’ve beenin several of them or half a dozen of them myself, where we sit down and talkthrough how the relationship’s going and really look at the economics of it andkind of remind our prospects of what we do day in and day out and how itaffects them and their cost structure for the long haul. I think, as anyonemight expect, when you have that level of dialogue, you know, senior officer tosenior officer, and are able to look at specifics of what we did over the lastyear from a service perspective and what the game plan is for the coming year,you know, these have been very productive dialogues where they feel good aboutthe relationship and we find out more, and different ways we can meet theirneeds and find out new needs and so forth. I just found it to be a refreshing,you know, and I think the customer has too in terms of compared to previousrenewals.

Now, in the new two-year structure that we have withour clients on our new contract we will be holding this type of meeting oneyear into the relationship where it’s not centered around the renewal and Ithink those may even be more productive. So again, we’re learning in this area,but I think the early returns on how we’re dealing with this larger customerhas got some pretty exciting possibilities.

Mark Marcon –Robert W. Baird & Co., Inc.

And so your sense from these discussions is that theretention rate of the existing mid-market accounts should be how compared tolast year?

Paul Sarvadi

Well, of course compared to last year was where we had,you know, somewhat of a surprise as we got toward the year end and somecustomers who didn’t give us notice about leaving. To this point we do have60-day notice on these type of customers, we’re right at that point right now,so it’s kind of hard to tell yet what we’ll see. Of course, we do have a fewcustomers that we already are aware of that won’t be with us in the new year.Some that have been acquired. In fact, a couple of them over the last week orso that we were notified of that there’s been a deal done and they’ve been acquiredand are being integrated into a larger firm and won’t need our service anymore.

But this is the part where I don’t want to get too outon a limb because I feel good about it today. I know it’s a pipeline, it’s anew business. I know what we’re doing to renew customers and dialogues aregoing well. But a year ago I felt pretty good and then over the following monthor so we had some surprises. But I think we’ve got a whole different plan inplace for this year and hopefully we’ll be successful.

Mark Marcon –Robert W. Baird & Co., Inc.

Yeah. I mean, it sounds good. I guess what I was tryingto figure out was, you’re presuming, you know, or the preliminary guns,obviously you’re not really going to know until things really finalize, but itsounds like we’re talking about potentially about 12% worksite employee growthfor next year. I was kind of trying to figure out what were you presuming ifyou have a normal client retention rate of 80% across the entire base or 81%across the entire base. What are you assuming on the mid-market side for thistime around?

Paul Sarvadi

I’m assuming, you know, at this point I think we’re beingappropriately conservative about the starting point of the paid worksiteemployees for ’08. I think there’s very significant upside to that if we reallyhave a good fall campaign. Relative to mid-market, you know, like I said in myscript, we’ve recovered. We basically had about 3% growth in the mid-marketyear over year. But I’m not relying on that to be, I’m not relying on any kindof increase in mid-market to be at a 12% up.

Mark Marcon –Robert W. Baird & Co., Inc.

Yeah. So, I mean, your general assumption is probablyhave attrition that would probably be a little bit greater than the overallcore, but you’ve got some new clients coming on board and so at the end of theday that mid-market should be a positive for next year.

Paul Sarvadi

Yeah. I think we should at least, you know, prior tolast year-end we were selling enough new business to replace the ones that weregoing away. As we go to this fall campaign I already see the sales coming in.Don’t know yet about the terms, but I feel pretty good about at least being atthat level where it’s an offset. And you know, if it’s better than that, youknow, that really becomes a premium. It becomes kind of gravy to the model hereand adds a nice step up in the first of the year. But we’re not going to buildthat until we see it.

Mark Marcon –Robert W. Baird & Co., Inc.

Okay. Great. And then, just a housekeeping question andthen I’ll jump back in the cue. What was the percentage of the worksiteemployees that were actually using the health care benefit?

Douglas Sharp

It’s been running I’d say about 73% or so.

Mark Marcon –Robert W. Baird & Co., Inc.

Okay. Great. I’ll jump back on the cue. Thanks.

Douglas Sharp

Thank you, Mark.

Operator

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

Michael Baker –Raymond James & Associates

Yeah, thanks. I was wondering, as your sales force hasconversations with prospects how important is your health benefit offering interms of the overall package?

Douglas Sharp

Yeah, it’s definitely an important component of what wedo for our customer. Of course, benefits and providing high-quality benefitsfor employees and keeping the costs under control is a very important issue forsmall businesses. A lot of times the part of our service that’s most visible toa customer revolves around the benefit programs. So sometimes it operatessimilar to a proxy for the total service. So it’s important and we highlight itin a way that can demonstrate the benefit that we really bring to small businesses.

Michael Baker –Raymond James & Associates

Now, my understanding is that you kind of use bundledpricing. Are you finding prospects increasingly trying to spike out theunderlying costs so that they can compare it to other offerings? Say the BlueCross/Blue Shield plans out there?

Richard Rawson

Not too much. There’s always some of that and some ofthat happens more in the larger customer and that’s why on these largercustomers we’re having these financial stewardship dialogues where we provide alittle bit more information. But for the typical small to medium size company,you know, whether you break it out in our program or not, it all comestogether. So it’s kind of like buying acar and saying, hey, I want to know how much the tires are. Well, it doesn’tmatter because the tires are going to be on the car and it’s not going to betaken off, so they are, it is what it is. So it’s more of what’s the totalall-in price compared to what their cost would be without us. That comparesvery favourably for small to medium sized businesses and it becomes arelatively easy decision to make.

Michael Baker –Raymond James & Associates

And then I was just wondering if you could provide justone final comment in general about you seen health care pricing out there todate and what you expect in terms of next year. Specifically as it relates tothe Blues, which tend to be kind of the strong players in a particular region.

Richard Rawson

Yeah, we’re looking at trend increases next year in theaggregate for the marketplace, and specifically the small business marketplace,are definitely going to be in the 10% to 12% range. Now, for us, because ofplan design changes and a number of the other things that I mentioned in myscript, you know, we won’t see that kind of an increase. But small businessesare in for a big surprise next year. It’s going to be pretty ugly for a lot ofthem. And we think that positions us really well in the small businessmarketplace for this coming year.

Michael Baker –Raymond James & Associates

And what do you think the primary driver of the pickupis? Is it more the competitive dynamics of the Blues were aggressive this yearand then are kind of lightening up a bit? Or is there some underlying costdynamic that’s driving it?

Richard Rawson

It’s, I mean, it’s, you know, I can’t speakspecifically for the Blues. I mean, we have a little bit of that out in thewest coast and the northwest part of the United States, and I think it’sprobably your first remark more so than the latter. It’s just that they werelower and now they’re having to catch up. And that’s what we’ve seen in ourpricing with them for next year.

But, you know, I mean, just the demand for health careand the prescriptions and all of those factors, health care inflation is aliveand well and it’s not going away.

Michael Baker –Raymond James & Associates

And then just one final question, Richard, in terms ofgetting a little bit more colour on the benefit design changes, are thosepretty much set up to try and drive towards those lower cost plans?

Richard Rawson

There is some of that, absolutely. Of course, you getthere a couple of different ways. But you know, our customer base has oddlyenough always been a little bit more interested in the richer plains. So whenwe start talking about those kind of plans and making some tweaks, like goingfrom $15 to $20 for an office visit and things like that, it’s not a hugeproblem for them to deal with. Because of the richness of our plans what we seeis that there are less and less of them available in the marketplace for thesmall business customer to buy, and that’s what attracts or continuesattraction for our relationship.

Michael Baker –Raymond James & Associates

And just one final question. In terms of therelationship with United, obviously it’s kind of out there that United’s havingsome service issues. I was wondering if any of those were kind of comingthrough and impacting your client base?

Richard Rawson

You know what, we have not, we have not seen anything,I have not heard of anything on the service side negatively in our book ofbusiness. I know that it happens. I know that there are incidents that takeplace from time to time; they’re just kind of one-offs. But we’re not seeinganything that would adversely affect us right now.

Paul Sarvadi

And we have service standards that are agreed to in ourcontract and we certainly haven’t been anywhere near the, you know, any ofthose service standards not being met.

Michael Baker –Raymond James & Associates

Thanks for the commentary, guys.

Operator

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

Cynthia Houlton– RBC Capital Markets Corporation

Morning. I just had a question. I think in the preferredcomments I think there was a mention of kind of offering I guess existingcustomers newer services like identities theft, some different retirementpackages, etcetera. Could you elaborate on that in terms of any cost associatedwith that? Is that something that you’re providing in house or you’re workingwith partners? Could you just discuss that a little bit more in terms of who’sbeing offered these other services, how broadly, and kind of, you know, arethey in-house services or third party?

Richard Rawson

Sure. Let me kind of explain a little bit. We puttogether some additional benefits for the client owner which involve identitytheft protection for the individual client owner and for their company. Andthen also we made an arrangement with an operation that has what we believe isa one-of-a-kind business research service, web-based business research service,which I’ll probably talk more about next quarter, but it’s a really valuabletool. Kind of a small business destination site that we’re being able toprovide to our customers that we think really helps their business and helpsthem be more informed and get quicker answers to business questions. So that weprovided to our customer. We are paying for those. We were able to negotiatetremendously low discounted costs and we think it’s a good investment for us toprovide those to our client owners free of charge.

Then there were other benefits provided to employees. Forexample the Roth 401(k) that was introduced to our retirement servicesorganization, and then we also made arrangements, a relationship with Aflac toprovide several of their programs that are options that employees can buy; andthen we also even added a pet insurance program through an external providerthat employees can buy as well.

Cynthia Houlton – RBCCapital Markets

Again, this is something that you are broadly pushing out toexisting customers as a way to incent renewals or again, this is something thatis going to be part of all customer packages?

Paul Sarvadi

Yes, it’s something that you keep adding things that keepthings fresh for our clients and it really happens on behalf of ourclient-owners who are going to their employees and saying, “ hey, here are somenew benefits we have, some new options.” Some of our clients when they come torenewal sometimes they need to pass on more of the benefits costs to employees.So here is an offset to that where they have got some new things they areproviding at the same time. So it’s a benefit to our clients for us to beactive in adding to our offerings and making it better year after year.

Operator

Your final question comes from the line of Bob Bennett –Groundswell Equity Partners.

Bob Bennett –Groundswell Equity Partners

Particularly when Jim Macdonald was talking about thesoftening in the economy, I wanted you to go into little detail in terms ofparticularly for your middle market clients, what kind of financialunderwriting you do for new clients as will as current clients, particularly atthe renewal process? Do you do that for each client?

The second thing was, you talked about a 20% attrition rateand I wanted to better understand how many of those clients when they areleaving are clients that you are basically terminating?

From that, how does that tie to, if you think about it, thegeneral business marketplace with companies sort of failing or going south interms of laying people off and things like that?

Third in summary, your bad debt expense is very nominal --almost non-existing -- and how does that tie to your underwriting process, aswell as to your attrition rates? How can it be so low, is really the question Ihave for you?

Paul Sarvadi

. Let’s try to address those one at a time. But on the midmarket like all of our customers, we get paid by our clients by wire transferor direct debit prior to submission of payroll. Then we have a very experiencedteam that manages the credit risk with our client base. Our mid marketcustomers, obviously the dollars are much higher. So we have a process we gothrough with each customer to make sure we know that we have our relationshipsecured properly with each customer.

Bob Bennett –Groundswell Equity Partners

Could you go into little bit more detail on the color ofthat underwriting process particularly on the company that’s been with you fora couple of years?

Paul Sarvadi

We do monitor, we have a watchlist of customers we keep aneye on based on the size and the credit risk that’s associated; we have a groupthat monitor and keep track of those customers. If there is any indication ofany issue -- which a lot of times we will get from a different source --sometimes within our service organization, we will hear about maybe there is apotential layoff or maybe there are other indications that there may be someissues going on at the client location and that will prompt us to put them outof watch list or contact the financial officer and have a dialog about what’sgoing on in their operations.

Of course some of them public companies, so we will keeptrack of the things that are going on there. But this group that we haveinternally that managed credit is doing a phenomenal job of making sure that we don’t have a risk out there thatwe are not comfortable with.

The little bit of bad debt we do have, it is unusual, but Ithink they do a super job there.

Bob Bennett –Groundswell Equity Partners

What percentage of your trade customers – call it 20% onannual basis -- come from clients that you have effectively terminated, becausethey didn’t hit your criteria or they didn’t do what you wanted them to do interms of an underwriting process?

Paul Sarvadi

I am trying to think of the rest of the question…

:

No, it was long-winded, I understand.

Paul Sarvadi

No problem. Of the 20% that got away, typically half ofthose relate to financial related decisions. These are clients that said, heywe have a change in our operations, we can’t make it so they leave or we makethe decision that is based on, if they are having any trouble financiallymaking our commitment, we need to separate, unless we could get fully securedon that risk.

Beyond that, we do have the other 10% that ago awaytypically one-third related to customers that have a compliance-related issue,and if they won’t comply with the requirement, a government requirement whatever,we have to let those go.

About another one-third are what we call kind our successpenalty customers that get purchased by another company and become a part of alarger organization. They are in about one-third of the 10%.

Our service issues, where we don’t meet the expectation ofthe client -- in a down economicclimate, the financial difficulties go up some and sometimes even thecompliance issues go up a little bit. So that’s why historically we do see that20% of attrition go up during a down economic period; although we don’t seethat we are in a situation right now where we are seeing any indication thatthere is an increase in terms for those types of reasons.

I appreciate the question and it appears that we are gettingnear to the end of our time. I justwanted to thank everybody for participating in the call today, and we lookforward to having an update for you next quarter.

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