TWST: May we begin with a brief historical sketch and overview of SurePayroll and a picture of things as they are now?

Mr. Alter: SurePayroll was founded in late 1999 by a group of entrepreneurs who had run small businesses and were fortunate enough to grow them into large businesses. Along the way, they realized that there was a huge opportunity to help small businesses by providing a better way to process payroll.

There's an interesting statistic in the payroll industry that was true then and is still true today. In small business payroll, which covers small businesses with 100 and fewer employees, three out of every four small business owners choose not to outsource their payroll. Yet almost all of them know that they can outsource their payroll.

So, we recognized that there's something about the traditional payroll service offering that just didn't appeal to three-quarters of small business owners.

The founders of SurePayroll set out to create a better way of doing payroll that would appeal to those three out of four small businesses that have not outsourced their payroll. We developed an all-online service geared exclusively towards small businesses.

We basically built a very simple system that uses the Internet around three key premises. First, we need to be reliable. That's a given. In the payroll industry, if you are not reliable, you are not in business. Second, we need to be economical. Small business owners, more so than even large business owners, care more and more about every dime of their money. Therefore, we have to be economical in order to be of value to small business owners. But, most importantly, the third piece that we differentiate ourselves on is being simple. So, our mission is to have the simplest, most reliable, and most economical way for small businesses to process their payroll.

In building our system, everything we did in terms of features and functions was centered around a Fisher-Price simple interface, delivering functionality that is so straight-forward and intuitive it's almost impossible to make a mistake. We've made processing payroll extremely simple.

Since we use the Internet to deliver our service, we don't have the same high infrastructure costs of a traditional payroll service company; therefore, we can offer this service at 30% to 50% the cost of a traditional payroll service.

The way our service works is relatively straightforward. We send an e-mail to the person in the company who is responsible for payroll saying it's time to run the payroll with a link to our Web site. From the Web site, they login in the three-screen experience, if you will. On the first screen, they enter their information. On the next screen, they preview it to make sure it's right, and we show them exactly down to the penny how much money they need to cover payroll. In the third screen, they approve payroll. Just a few clicks and payroll's done.

We then distribute the payroll electronically to everybody in the company. Those that have direct deposit receive an e-mail from us, which says, `Hey, congratulations, you've been paid' with a link to the Web site. They login and they can view their pay information right then and there.

Plus, they can see up to two years of payroll history. So, for example, when it's time for a mortgage and they need pay stubs for the application, they just logon and print their pay stubs. No need to bother the business owner or the accountant - it's employee self-service and it's win-win for the business and for the employees.

For those employees who have opted for direct deposit but who don't want to go online to view their information, the administrator can very easily select which employees to batch print the pay stubs out for.

For employees that prefer a physical check, we provide the ability for the company to print their own checks via the Internet with no software required. Just place some simple pre-printed check stock in their printer, hit a button, print up the checks, sign them, and hand them out to the employees.

So, in a nutshell, we offer the same thing as a traditional payroll service like an ADP or a Paychex in terms of the ability to enter your payroll, get it processed, run your payroll calculations, offer direct deposit or printed checks, and handle payment of your tax liabilities, but we also do it in a way that's much simpler, with far fewer hand-offs and, therefore, less chance of error, and at about 30% to 50% of the cost.

After spending 2000 building out the products and figuring out our channel strategy, we sit here today in early 2004 with more than 11,000 clients. We will process over $2.5 billion in employee and contractor payments this year, and we are the number one online payroll service in the US, meaning we have more clients that process payroll online than any other company.

TWST: The company has experienced phenomenal growth. Do you intend to retain the focus on small companies; companies with employees of 100 or less?

Mr. Alter: We do. Our focus is truly to be a small business payroll service. Where you will see us expanding in the next six months to a year is in providing more features and functions to broaden our appeal amongst small businesses. So, we will be adding some more features and functions such as additional deductions and additional earning codes. And, starting this summer, we will offer our clients an option to have their checks printed by us and delivered to their office. So, after they enter the information online, we'll have them printed and delivered.

TWST: Will you be offering services other than payroll services?

Mr. Alter: The services that we offer that go beyond payroll are all related to enhancing our customers' payroll experience and driving more small business towards our payroll service. So, as an example, we just started offering a pay-as-you-go workers' compensation insurance offering. That's something that small business owners need and it's all tied to the payroll. We will be getting into new higher-end reporting capabilities. We offer exports to certain general ledgers like QuickBooks.

So, all of these features are natural add-ons to payroll, but we will not be entering new categories that are not germane to payroll. We are not going to be offering checking accounts, credit cards or things like that in the near future.

TWST: You mentioned you are currently serving 11,000 clients. What's the competitive landscape like, Michael?

Mr. Alter: Prior to SurePayroll, there were essentially two types of payroll companies out there: software-based payroll service offerings and traditional legacy outsourced service bureaus.

The best example of a software-based service is QuickBooks, which offers tax tables for something like $150 per year. Their role for a small business owner is to provide software that calculates and figures out the tax liability, and then allows the small business to print out forms that they then fill in and send to the government. So, if you will, they work in software-like fashion, providing you with information, just like Microsoft Excel does when you ask it to make calculations. The support and service that you get is also very similar to that of, say, a Microsoft Excel or a Microsoft Word. If you can't figure it out on your own, you need to call for service and pay on an hourly basis or you find someone in your office you think can figure it out and you try to wing it, if you will. That's just the nature of software - very much a self-service model, very simple, but there's really no service in the software model.

In the second competitive category, you have traditional service bureaus like an ADP or Paychex. Beyond them, there are 8,000 payroll service bureaus in the US. It's a large and highly fragmented market, with ADP and Paychex each having only about a 5% share of the total market.

The principle difference between a traditional payroll service and a software company is that they are truly delivering a service. They handle and assume liability for the tax filing, assume the fiduciary responsibility for the tax funds, and facilitate direct deposits. Beyond that, they provide service that helps you make sure your information is correct and that you set somebody up correctly to file their taxes. If you have questions, there's somebody for you to call for customer service. But traditional payroll services tend to be much more expensive than a software-based product, on the order of $1,500 to $2,000 for a 5-person to 7-person company.

How does SurePayroll fit into the competitive landscape? In effect, we actually combine the best of both worlds. Most of what we do in terms of entering the data, setting up a new employee, changing the payroll information, and calculating the payroll is in a self-service software-type model where somebody logs online to our system and our wizards walk them through the whole process. They can do that at any time of day from any location, as long as they have an Internet connection. In contrast to software products, we do all the maintenance of the application. There's no need to worry about whether you upgraded to the latest version or did you purchase the most recent tax tables. We handle that for you.

Yet we also offer the full service capabilities of a service bureau in that we do assume liability for all the taxes. We guarantee those taxes. Forty percent of U.S. small businesses receive average annual payroll fines of $845; we completely eliminate the risk of penalties due to payroll errors. We provide all sorts of upfront checks on the enrolment process to make sure that somebody gets started correctly and we have unlimited customer service that's always just a phone call away.

Yet, we do this for a price that's midway between a software-based solution and a service bureau. Right now, about 50% of our customers have never outsourced payroll before. So, we are grabbing market share from that underpenetrated market by providing a distinctly different way of processing payroll. The other 50% of our customer base have previously used an outsource provider, whether it's software-based or a service bureau, and we are gaining market share there as well.

TWST: What are your thoughts regarding strategic partnerships and alliances?

Mr. Alter: For us, strategic partners and alliances are critical to our business. Our marketing strategy and our approach to market is all around using partnerships and leveraging the power and capabilities of our partners. Indeed, the primary way we get customers is through partnerships. These partnerships include large financial services firms like Wells Fargo. We also have relationships with small business associations such as The American Dental Association, where we are the only payroll service they endorse to their 120,000 member dentists. We use these partners to generate leads for us, or in some cases to close the full sale for us. We find it to be very effective for both us and for our partners.

TWST: I imagine that the technology SurePayroll uses is quite mature. Will there be any changes in the next few years or any new developments in that area?

Mr. Alter: We are always adding new features and functionality. We are always trying to make payroll a little bit simpler for our clients. There are lots of things that we will continue to do along those fronts in terms of added features and functions, as well as enhancements to our existing capabilities by making them simpler and easier to use.

TWST: Do you foresee any problems or challenges?

Mr. Alter: I think there are always challenges and opportunities when you are running a business. There are always things that you are concerned about that hopefully are different than what you were concerned about three and six months ago. The biggest challenge we face is continued growth, and when you grow as fast as we have grown, you can outgrow your infrastructure very quickly so you have to put all the right pieces in place to accommodate growth and never drop the ball on service.

We went from 4,000 customers at the end of 2002 to 10,000 customers at the end of 2003. So we more than doubled. When you grow that quickly, you have to make sure that your people, your systems, and your processes can keep up with that kind of growth, and we spend a tremendous amount of time focusing on that. And fortunately we have been, knock on wood, very successful till now and we continue to focus on that.

Just to give you an example, the absolute number of customer service phone calls that we received in the year-end period in 2003 was less than the number of calls we got in the year-end period for 2002. So, we had fewer phone calls in year-end 2003 than we did in year-end 2002, and yet we had twice as many customers. That metric is a by-product on our relentless focus on making sure the business can scale and making sure that we were ready for this growth.

And so, as we look to 2004, we've got similar challenges as we move through the year and continue to add thousands of customers. We want to make sure the business continues to scale. So, we spent a tremendous amount of time focused on that.

TWST: What is SurePayroll's corporate culture like?

Mr. Alter: That's a great question. That's another thing that we focus a lot of time and energy on. Our culture is very much a "small company can-do" culture.

It's not a very pretentious culture - we try and make do with less. We don't have fancy offices. We spend our money on getting customers and keeping customers as opposed to fancy offices and the latest and greatest stuff within the company.

In terms of the culture, there are things we do to focus everybody on the business. As an example, we have this thing we call "money days", the six peak days during the months when we process the most payrolls and have the most phone calls. The idea during money days is that everything is focused on serving our customers and being available for them on those days. So, if you have a dentist appointment, you schedule your appointment on days that aren't money days. If you're going to have to be out of the office for any reason, try not to do it on a money day. In terms of inter-company meetings, or even having potential partners or existing partners in the office, we don't do it on a money day, unless there is a special exception made, and you have to have my approval to have a visitor in the office on a money day. Again, the idea is keeping the company and the culture focused on the thing that's most important to our customers, which is managing their payroll or, if you will, moving their money correctly every time.

TWST: Are the majority of your employees in Skokie?

Mr. Alter: Every single one of our employees is in Skokie. We manage everything from one office. Yet we serve clients in all 50 states. It's another way that we keep our costs down so we can offer great value to our customers.

TWST: Can you give us some background on a few of the key members of your management team?

Mr. Alter: Our CFO, Mike Goldberg, has about 30 plus years of financial services experience, including a Masters in tax and a CPA, and he has worked with such big companies like Beatrice, Oil-Dri Corporation, and most recently served as a CFO of a very large insurance brokerage operation. So, he has tremendous depth in financial strategy and executional financial experience. That's very important in a business like ours, given that what we do for a living is calculate people's payroll and then move the money appropriately and pay the taxes.

Michael Fineberg runs Customer Service and Technology. Michael is an exceptional talent who came to us having run a small business, an IT consulting firm, and having spent time at Hewitt Associates, a very large HR service outsourcing firm. He brings a tremendous discipline of managing by the numbers and instilling a focus on customer service throughout the organization. Leveraging what he's learning on the customer service side, he's able to translate that into improvements in technology.

And then, regarding my background as President of the company, I come from a sales and marketing strategy and business development perspective. I spent almost five-and-a-half years at McKinsey & Company, a management consulting firm. I did lots of business development, strategy, growth, operations improvement work, both here in the United States and in Europe. I was one of founders of McKinsey's service operations practice, which is focused on helping service companies use stellar service as a differentiator, both in terms of the strategy and in terms of the operations. Prior to that, I worked at IBM in sales for about three years selling to distribution and media companies, and, in the middle there, I got my MBA from Harvard.

TWST: Your focus currently is primarily the United States. What are your thoughts regarding expanding into Canada and perhaps Europe?

Mr. Alter: For now, we're really focused on the domestic market. There is so much growth and there is so much market opportunity here that we're going to stay focused on our knitting if you will, and that is to serve the small businesses here in the US.

There are 10 million small businesses in the US, only 2.5 million of which are outsourced today. And we have been doubling in growth every year. So, we've got plenty of opportunities here.

TWST: Are there any political or economic factors that could affect the company in any way?

Mr. Alter: In some ways, the IRS is our best sales person. They say the two things that are always certain in life are death and taxes. Payroll taxes are one of those things that is not going away. As a matter of fact, in some ways, they get more complicated every year as the different states diverge in how they want payroll taxes to be calculated or handled. And so, the more complicated taxes get, the more opportunity there is for someone to outsource their payroll and the more value. So when the IRS changes its laws, that's a good thing for us.

No matter what happens politically or in the economy, payroll is not going away. Payroll taxes and the concept of outsourcing payroll are definitely not going away.

There are some macro-economic factors that do impact our business, both negatively and positively. Right now, I think the two main factors that affect us are trending in a direction that will help us more than hurt us. First, the number of employees we pay on a per-payroll basis drives our economics because one of the components of our pricing is number of employees. So, if the economy is growing and coming out of the recovery, we should naturally see our revenues grow as our 11,000 clients add more and more employees. So, there is just a natural lift on our revenues in process as opposed to what we saw over the last few years which was the opposite of that, a decline in the number of employees being paid.

And then the second big factor is interest rates. We hold our clients' tax monies and then pay those to the various government agencies. So, there is some float revenue in our model, as there is in all payroll company models. Interest rates are at an all-time low now. While conceivably they could go lower, I think most economists would bet that they're going to rise. Certainly over the long term, they will go back up to the more normal levels, and as that occurs, there are some built-in additional profits and profitability in the business.

So, those are the biggest macro impacts. But another big one is that as the economy recovers, there will be more new business growth, and new businesses need payroll services. So, as much as new businesses continue to grow and become less likely to go out of business, this factor also helps us.

TWST: Regarding barriers to entry, what's to stop, a large, well established staffing and outsourcing service from coming into this space and challenging you. What should stop them from pushing you aside?

Mr. Alter: That's a great question, and I think we've created a very defensible position in the marketplace where we are today. We're now the fifth largest payroll service in the country. The operation is solid, the customers are happy, and the brand now has a life of its own. When people think of payroll outsourcing, they think of "ADP, Paychex and SurePayroll". In terms of positioning, we've created a lot of white space around our brand; in the market, small businesses equate our brand with "simple" and a "better way to process payroll".

It takes years to create that. It makes it much more difficult for somebody who is a new clean-sheet start up, whether they're an existing business starting a subsidiary venture or somebody new who has got some venture money, or even if it's one of the big legacy payroll processors coming in and competing with us.

I'd lay this out in a couple of different pieces. First, we get the benefits of the standard barriers to entry inherent in the payroll service world. Switching services is a pain and switching costs money. So, for most people, inertia keeps them with their current payroll provider. Payroll is very sticky. There is this fear, uncertainty and doubt about, "If I switch my payroll service, what happens to my taxes? Do I really know they'll get paid in?"

And on top of that, beyond the switching cost hassles, there is this question of how much different is it really going to be? What's the difference between Paychex and ADP? Right? I'm calling an 800 number and I'm getting some envelopes on Friday. And so when I switch from ADP to Paychex, I'm going to call a different 800 number, and I'm going to get blue envelopes instead of red envelops, right? It's not that different.

So, why would I really want to go through these hassles of switching? That's one of the benefits we get from being a mature payroll company - there's a significant barrier to entry for newcomers in this market.

There are a few other notable items that further protect us from new competition. One is the interface. Everything about our success in our business is based on this simple Fisher-Price easy interface that we've created. We have these 11,000 clients that login every two weeks and run their payroll, and most of their employees' login and view their payroll information.

And so, if somebody wanted to come in and knock us out, steal those customers, it's a little bit like saying to 11,000 companies, "Hey listen, on Monday morning when you come in, we're going to switch out your PCs for Macs and we're switching from Microsoft Word to WordPerfect. So, Monday morning you need to run the business using Macs and WordPerfect, OK?" And most of you are going to say, "No way!" right?

Another strong asset we have is our partnerships. We get an additional benefit because we leverage the brand of the partner. Is a small business likely to go against the recommendation of The American Dental Association or leave Wells Fargo or LaSalle Bank? It's not likely.

Looking at it from the other side, from a partner perspective, it's difficult for our partners to leave us because their customer base loves our interface and doesn't want to leave. Right? So, our simple interface provides additional barriers to competition.

Finally, we have this other piece, which is that it's very expensive to challenge and become us. It's not that somebody can't do it, it's just very difficult to do. Simple is difficult. To create this simple three-screen experience that we have requires a whole bunch of infrastructure, a whole bunch of technology, and a whole bunch of intellectual property, and we have spent a tremendous amount of money and time invested in developing what we call a Storefront, which is what our customer sees, and developing what we call the SureSuite, which is our internal systems that drive our operations and make us more productive, allowing us to service our customers cost-effectively.

So, to build a business like us, you have to have a huge investment upfront in building out all the technology, and then you have to build out a money center banking security network with multiple redundancies. It costs a lot of money to become us, and it only starts to pay back once you start to get thousands and thousands of customers. You have to be willing to spend all of that money upfront with hopes that you are going to get thousands and thousands of customers down the line to pay for it. If you do, it becomes very profitable because the marginal cost of servicing an additional customer is very low, but you have got to cover all your fixed costs.

So, there is a big replication and scalability challenge that has to be overcome and we've accomplished that. It's different than starting a traditional payroll service where you just start calculating the payroll for somebody with no intentions of achieving massive scale.

Now, you asked about a legacy type provider coming after us. It turns out that there are some things inherent in our model that would require enormous changes at a traditional legacy payroll firm if they wanted to be come us. Sure, they can decide overnight that they want to get into the payroll business through private label and through our channels, but from an infrastructure standpoint they would have to completely redo all of their technology to do it.

As an example, we have what we call our MorphTech Technology, which is proprietary technology that we've designed and built from the ground up for our channel strategy which is through private label and co-branded partnerships. We can dynamically change the look and feel of our payroll service to support any partner. That customization covers everything from how we answer the customer service phones to what the end user sees. But we do that off of one code base, which means when the tax laws change or when something else changes, I only have to change it in one place as opposed to across twenty different partners.

At ADP and Paychex, all of their technology has grown up regionally from the different processing centers and so everything they have is hard coded. The word Paychex prints out six different times on every piece of paper or check they send. That and a million other things are hard-coded in their software, and so they would have to change that if they wanted to go after our channels through a private label or even a co-brand.

So, there is this big technology infrastructure hurdle that they have to get over. They also have a very big pricing challenge, which is that we are 30% to 50% less than them. They'd have to be willing to take some pretty big pricing hits across huge segment of their customer base, right? You could do that to come into our markets, but why would you take your overall pricing down 30% and what would happen to your valuation? Frankly, it would be pretty ugly.

The third thing is there is a big channel conflict there today. They have feet-on-the-street salespeople as opposed to our all telesales force. If they were to go through a bank channel, let's say a Wells Fargo or LaSalle Bank or somebody like that, they would have to be willing to pay some portion of their revenues to the bank to make it worthwhile for the bank to be in the business. They then still have to justify this physical feet-on-the-street sales person. And they have to figure out a way of making that work, whereas today, the physical feet-on-the-street sales person sells the Paychex brand or the ADP brand.

How do you make them productive if they are supposed to start selling the First American Bank brand? There isn't enough business in it to justify the cost of one physical rep out there on the street at 30% to 40% less revenue and paying a revenue share to the bank.

Bottom-line, there are some real challenges for them to go after us. Now, they certainly can and we certainly worry about them all the time. We have some great competitors in the payroll business, and we take that seriously.

In terms of establishing our business where we are today, we think we have some very strong barriers to entry. We get the benefit of being a payroll company and those implicit barriers to entry. We also have the interface, the cost, and the channel conflict challenges that a traditional payroll service would have.

TWST: How has SurePayroll been funded up to this point? Who have the investors been?

Mr. Alter: We are backed by a group of private investors and venture capitalists. Our lead investor is a company called Kettle Venture Partners. We've also received funding from BlueStar Ventures; Mesirow Financial; Wells Fargo Bank; and a group of our founders.

TWST: What do you realistically expect the company to look like, three years from now? What are some of the milestones you might pass along the way?

Mr. Alter: I think we'd like to be on our way to being the number one small business payroll service in the country. Today, we are the number one online payroll service in the United States, and I think I would like to have 30,000 or more new clients by then. We will be a very nice profitable business with good returns for all the investors at that point. In terms of milestones along the way, I think the keys for us are continuing to make sure that we can acquire customers cost effectively in large volumes and continuing to make sure that we deliver the best customer service in the industry.

Right now, we measure our customer service in real time after every payroll and our customers are rating us between 93% and 94% customer satisfaction, which we are very proud of. In a repeat annuity-based business, that's the key. We need to make sure that we continue to satisfy our customers today at a level they have become accustomed to, or even above that, and we need to make sure that we can get new customers cost effectively.

TWST: Would you say there's an IPO in your future somewhere down the road?

Mr. Alter: Keith, I'm not really sure. What I do, what I focus on, and what we try and focus the business on here is building a real business that is sustainable, that delivers great customer service, and that has an engine for acquiring customers cost effectively. If we can do continue to do that, in the future, we'll have all sorts of options available to us and to our investors.

If we can't, we've got no options. So, we don't spend our time worrying about what the exit is or what the IPO date is or anything like that. We spend it on building a real business, because success is what gives you options.

TWST: What is your own personal focus on a day-by-day basis?

Mr. Alter: I concentrate a lot on prioritization both for myself and for my team. Much of what I do is making sure that my management team is focused on those things that really matter to the business. There are only so many hours in a day and so many things we can do and there is only so much money we have. I focus a lot on making sure we are spending that in the most cost-effective manner and that we are using our time to get the best possible leverage. I spend a lot of my time building and developing my team. I spend a lot of my time on strategy both near term and longer term. I spend time managing the operations from a dashboard perspective that allows us to see areas we have opportunities for improvement. The management team and I then apply considerable effort to making the necessary improvements.

TWST: Are you set for cash these days?

Mr. Alter: Yes. We have plenty of cash to build a sustainable business. Going forward, the Board will make decisions as to whether we would like more cash to grow faster. That's always an option and always something that is discussed. But in terms of enough cash to run the business, we have enough operating cash today.

TWST: If you and your Board decided to go forward and seek another funding round, what two or three reasons would you give an investor to invest in SurePayroll?

Mr. Alter: There are two reasons an investor would likely be interested in investing in SurePayroll. First, there would be a belief that online payroll is really taking off. We are seeing that trend in our growth and across the industry in terms of numbers of businesses that are using or migrating towards online payroll. So, one piece is that online payroll is the future and that there is a lot of money to be made in it.

The investor has to believe, and this is certainly the case, that payroll is a good business to be in because it's an annuity-based business with a recurring revenue stream that is very profitable once you get up to scale, that online payroll is the future of payroll and where people are migrating.

Then the next question is "Who's my horse?" And I think we are very well positioned to continue to reap the benefits in this space and capitalize on the rapid growth of the online payroll market. You can see that by our rapid growth to date and you can see that after you think through how I've outlined our defensible market position and how well poised we are to keep growing.

So, if you believe that payroll is a great business from a recurring revenue stream and from a profitability perspective, and you believe that online payroll is important, then I think we are the leader in the industry today and are positioned to stay at the top.

TWST: I'm going to leave you with the last word here. Is there anything that we've left out today, anything you'd like to add?

Mr. Alter: I don't think so. I would just summarize by saying that what we really are focused on is very simple and very straight forward, and that is just to be a simple, reliable, economical payroll service for small businesses. It's pretty boring, but we like boring.

TWST: Thank you.

Mr. Alter: Thank you.

Copyright © 2004. The Wall Street Transcript.