Insperity Inc (NSP) 2005 Q2 法說會逐字稿

Welcome to the Administaff second-quarter 2005 earnings conference call. My name is Jen and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be conducting a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson, or Mr. Sharp that are not historical facts are considered to be forward-looking statements within the meaning of the federal securities laws. Words such as outlook, guidance, plans, expects, intends, believes, estimates, likely, goal, assume, and similar expressions are used to identify such forward-looking statements and involve a number of risks and uncertainties that have been described in detail in Administaff's filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements.

I would now like to turn your presentation over to Mr. Doug Sharp, Chief Financial Officer for Administaff. Sir, please go ahead.

Thank you. We appreciate you joining us today. Let me begin by outlining our plan for this morning's call. First I'll discuss our second-quarter financial results. Paul will add his comments about the quarter and on our outlook for the remainder of 2005. Then Richard, who is out of the office, will join the call to discuss trends in our direct costs, including benefits, workers' compensation, and payroll taxes, and the impact of such trends on our pricing. I will return to provide financial guidance for the third quarter and the remainder of 2005. Then we will be available to answer any questions.

Let me begin by summarizing the financial highlights from the quarter. Year-over-year unit growth accelerated to 12.5% for the second quarter, above our expected range of 11.1% to 11.7%. Revenue per worksite employee per month increased 6.9% over Q2 of 2004 to 1,074 for the quarter, as we continue to demonstrate our pricing strength. This increase in revenue combined with continued favorable trends in benefits and workers' compensation costs resulted in gross profit per worksite employee per month of $216 for the quarter, significantly above our guidance, which conservatively assumed only modest contribution to gross profit from these areas.

Operating expenses on a per worksite employee per month basis declined from $190 in the 2004 period to $175 in the 2005 period. We reported second-quarter earnings of $7.3 million and $0.28 per share, a 180% increase in earnings per share over the second quarter of 2004. As for the balance sheet we generated significant working capital during Q2, ending the quarter with a balance of approximately $76 million, up from $50 million at March 31, 2005.

Now let's review some of the details of our second-quarter results. The average number of paid worksite employees per month increased 12.5% compared to the second quarter of 2004, from 77,209 to 86,868. This resulted in an average net monthly growth of approximately 1,300 worksite employees compared to our budgeted range of 800 to 1,000 per month. Paul will provide further details on the drivers of our unit growth acceleration, including sales, client retention, and net growth within the existing base, in a few minutes.

Second-quarter revenues increased approximately 20% over Q2 of 2004 to $280 million as a result of a 12.5 increase in the average paid worksite employees and the 6.9% increase in revenue per worksite employee per month for the quarter.

Looking at second-quarter revenue contribution and growth by region, the Southeast region, which represents 9% of total revenue, grew by 10%. The Northeast region, which represents 15% of total revenue, grew by 37%. The Central region, which represents 13% of total revenue, grew by 7%. The West region, which represents 23% of total revenue, grew by 24%. And the Southwest region, which represents 40% of total revenue, grew by 19%.

Now as for gross profit, as I mentioned a moment ago gross profit per worksite employee per month for the quarter was $216, up from $210 in Q2 of 2004, and significantly above our forecasted range of $202 to $204. These results were achieved through a slight increase in the markup related to our HR services and a higher surplus generated from the pricing and the management of our direct cost program. As you are aware healthcare and workers' compensation costs are driven primarily by claims activity, and our effective management of this activity has resulted in favorable claims trends over the past year and a half. However, since this claims activity continues to emerge through a reporting period, we have conservatively forecasted only modest contribution to gross profit from these areas at the outset of both Q1 and Q2 of this year.

Similar to the first quarter, favorable trends in workers' compensation claims costs continued to emerge throughout Q2 as we effectively managed both the runoff of incurred claims and new claims activity. Additionally, healthcare claim costs were lower than forecasted during the quarter. These two factors, when combined with recently negotiated lower health plan administrative fees, resulted in a significant contribution to gross profit during the quarter.

As for further details behind our direct costs, as discussed during the first-quarter conference call, we expected the administrative fee credit associated with the negotiation of our new three-year agreement with UnitedHealthcare to offset the anticipated sequential quarterly increase in our healthcare claims cost. However, Q2's actual claims trend was lower than anticipated. Therefore, rather than the cost per covered employee remaining relatively flat from the first quarter as forecasted, we actually experienced a 1.9% decline from $589 in Q1 to $578 in Q2. Approximately 72% of the worksite employee base was covered by our medical plans during the second quarter resulting in a cost of $416 on a per worksite employee per month basis.

Workers' compensation costs were 1.19% of nonbonus payroll for the quarter, below the low-end of our budgeted range of 1.30%. This is reflecting the favorable experience in both the frequency and severity of claims trends resulting from our safety and claims management program.

Payroll taxes including FICA, FUTA, and state unemployment taxes as a percentage of total payroll cost were 7.56%, compared to 7.41% in Q2 of 2004. As you may recall a credit of $2.3 million, or 0.23% of total payroll cost, related to a California state unemployment tax matter was recorded in the second quarter of last year.

Now let's talk about operating expenses. This is an area where we continue to experience operating leverage, as demonstrated by a decline in the operating expense per worksite employee per month from $190 in the 2004 period to $175 in the 2005 period. Operating expenses totaled $45.5 million for the quarter, although at the high end still within our expected range, in spite of an additional accrual for incentive compensation tied to our improved operating results.

The $1.4 million increase in operating expenses over the second quarter of 2004 was primarily as a result of the following. Salaries, wages, and payroll taxes increased by approximately 3.6 million, of which $2.7 million relates to additional incentive compensation expense and the remainder due to merit increases. Our corporate headcount has remained relatively flat since Q2 of last year. As expected, advertising costs declined by approximately $1.2 million compared to Q2 of 2004, due primarily to the shift of marketing effort associated with the launch of our spring sales campaign from the second quarter in 2004 to the first quarter of 2005.

Depreciation and amortization cost declined by $921,000 as the effect of certain fixed assets becoming fully amortized more than offset depreciation resulting from our reduced levels of capital expenditures.

As for interest income, in the second quarter of 2005 we reported net interest income of approximately $759,000 compared to $126,000 in Q2 of 2004, due primarily to interest earned on higher cash balances. During the quarter, we revised our estimated 2005 effective annual income tax rate from 38.3% to 37.7%.

Now let's discuss the balance sheet. We ended the quarter with $168 million in unrestricted cash and marketable securities, of which approximately $52 million relates to customer prepayments for early July payrolls and another $52 million was payable in early July for withheld federal and state income taxes, employment taxes, and other payroll deductions. Working capital increased by approximately $29 million over December 31, 2004, to $76 million (technical difficulty) cash dividend totaling 3.6 million and capital expenditures of 3.8 million.

Additionally, 558,000 shares have been repurchased at a cost of $9.3 million and approximately $8.2 million in proceeds were received from the exercise of stock options during the first half of this year. Working capital was also positive positively impacted by the return of a $17.5 million security deposit previously held by UnitedHealthcare.

As for other balance sheet details, prepaid expenses and other current assets totaled $16 million, including $9 million of surplus funded to UnitedHealthcare over and above the agreed-upon $11 million maintenance surplus level. As you may be aware, UnitedHealthcare sets funding levels two quarters in advance of the reporting period. Subsequent favorable claims trends have resulted in lower costs over the past two quarters and therefore have generated a higher short-term surplus. In accordance with our agreement with United, the short-term surplus of $9 million is to be returned to us by the end of the year.

Deposits have been reduced by approximately $20 million since December 31, 2004, due primarily to the return of the $17.5 million security deposit as I mentioned a moment ago. The June 30 balance of $51 million consists primarily of $49 million related to our workers' compensation program, which includes $36 million set aside for expected future claims and $13 million in collateral.

Now before providing our updated financial guidance, I'd like to turn the call over to Paul for his comments about the quarter and on our outlook for the remainder of 2005.

Thank you, Doug. Today my comments will cover three topics. First, I'll provide some color on the outstanding execution and results we experienced in the second quarter; then I will highlight several key initiatives we're working on over the balance of the year to increase the long-term potential for the business; and I will finish with the discussion of some mid-year adjustments to our game plan that have been enabled by our success in the first half of the year.

The recent quarter was certainly one of the best in the history of the Company due to the solid execution across the enterprise. From sales and service to pricing and direct cost management, and as a result of each department's hard work towards their specific objectives, this was a great quarter.

Our sales engine is shifting into high gear. Sales for the quarter were 44% higher than the same period last year, with 8% fewer sales staff. In fact this was the best second quarter in the history of the Company in total sales, breaking our previous record by more than 17%. This total was 103% of our internal targets for the quarter, and we are at 104% of budget for the year to date sales.

Our efforts to improve sales efficiency are clearly hitting the mark, as sales efficiency exceeded one sale per salesperson for the quarter. This brings the year to date number to 0.90 sales per salesperson per month. Last year at this time this number was 0.73' and when the fall campaign was averaged into annual sales efficiency for the full-year 2004, it came in at 0.93 sales per salesperson per month. Assuming typical results for the last half of the year, we are on track to exceed our 1.0 efficiency target for the full year of 2005.

One of the reasons for this improvement is our spring sales campaign. The second-year refinements we put in place this year to the timing and tactics for the campaign have proven to be effective. I believe we have validated a spring campaign to be a viable second selling season, complementing our historical fall campaign. We believe our marketing efforts, including localizing the radio spots with our national spokesperson, Arnold Palmer, played a role in improving our census to first call and closing rates. Year-over-year the census rate moved from 42% to 47%, and the closing rate increased from 17% to 20%. The combination of these two metrics determine sales efficiency, which improve 35%. This improvement in sales efficiency and the ability to drive this number through our marketing effort presents an opportunity to grow more profitably in the future.

We are also able to rely more on finesse and execution than just muscling our way by adding and churning more sales staff. As anticipated we did turn the corner and increase the number of trained sales reps in the second quarter for the first time in over a year. The average number for the quarter increased to 215 trained sales staff; and the total hired at the end of the quarter increased to 260.

Another record-setting highlight for the quarter came from our service organization. Over the last year we've seen steady improvement in client retention, in tandem with improving client satisfaction survey results. This was true once again in the second quarter. Average monthly client attrition, measured by the number of paid worksite employees that left Administaff due to client terminations, fell to 1.4% in Q2. This was the best result in this metric since 1998. This was driven by overall service satisfaction, which continued to trend upward, reaching 91% for the quarter.

Several other client satisfaction measures have also trended up over 90%. 92% agreed Administaff is good value for the money; 94% agreed they would recommend Administaff to other business owners; and 97% planned to continue using services at their next renewal.

Our clients also got into the act in the quarter through net employment growth in the client base. Last quarter I mentioned all the indicators, including average pay raises, commissions, bonuses, and overtime, all pointed toward net employment growth. In April and June clients hired more staff then they laid off, adding to the paid worksite employee count and offsetting the drop we saw in May, which mirrored the national employment picture. These indicators continue to show significant strength in Q2. Pay raises averaged over 5%, and average bonuses are up 9%. Average commissions are up over 8% indicating a strong pipeline for new business in our client base. Overtime continues to exceed 8.5% of total pay, indicating that companies are at capacity. When these factors are in place, hiring new staff is a good business decision, so this trend may continue into Q3.

With all three factors, sales, retention, and client growth, coming in better than expected, we exceeded our paid worksite employee growth guidance and accelerated our unit growth rate from 11.9% to 12.5% year over year. Another highlight for the quarter was the continued success we are having in pricing and direct cost management. However, I'll leave that for Richard to describe in a few minutes.

I'd also like to emphasize for you today three key initiatives we're working on over the balance of the year to increase the long-term potential for the business. They are our Siebel customer relationship management implementation, our midmarket sales initiative, and our marketplace alliance development activities.

We successfully launched our new customer relationship management software recently, and this new tool is now available to all Administaff personnel. At the time of launch more than 70 instructor-led training classes have been held and 95% of the user community had been trained. The user reaction has been very encouraging to this point, with a great deal of acceptance and positive feedback. This indicates a desire to use the system and fully leverage this new capability, which of course is the most important factor in achieving our return on this investment.

I believe the implementation of this new technology changes our service potential as a Company. This new CRM system increases the availability of timely, accurate information and therefore our ability to increase responsiveness and consistency of service delivery. This new tool gives us an opportunity to continue increasing client service satisfaction and retention.

The second initiative with long-term growth and profitability potential is our midmarket sales effort focused on clients with 150 to 2,000 employees. In June we expanded the midmarket sales team considerably, from the two senior sales staff that executed our pilot program to eight salespeople strategically placed across the country. We estimate adding these six trained sales reps to the midmarket group is the equivalent of approximately 18 regular sales staff in terms of expected production. Once again, this represents a significant improvement in efficiency and profitability, as growth is leveraged over our existing infrastructure.

We also recently implemented our first marketing promotion to midmarket prospects, sending out a series of postcards with a baseball theme to top-level executives. These executives then received a personalized Louisville Slugger baseball bat expressing our desire to go to bat for them. Early responses to this campaign have been exceptional, boosting our activity level and helping our new staff get off to a fast start.

The last initiative I want to mention today is our efforts to renew our emphasis on marketing alliances directed toward offering other goods and services to our clients and worksite employees, to leverage the (technical difficulty) represented by our client base. This quarter Administaff has entered into a new alliance with Travelers Insurance to provide client and worksite employees with the opportunity to purchase home and auto insurance at rates generally better than employees can get on their own. This addition also adds a revenue opportunity for the Company to extend beyond the termination of a client or an employee.

We believe we are now at a critical mass in terms of number and variety of offerings available, for us to change the sales process from a passive to an active approach in encouraging clients and employees to take advantage of these offerings. We are developing alternatives to move in this direction, and we expect to test various approaches in order to find an optimal process for selling these products and services. Although the contribution to gross profit from these offerings is not material to date, I believe they can be; and we will provide more specifics as these contributions increase.

Now the last topic I want to discuss today is the modification of our game plan for the last half of the year that has been enabled by the great results we've had in the first half. We now have an opportunity to make a few adjustments and get a head start on our 2006 growth and profitability plan. Our goal for the balance of this year and throughout 2006 is to slowly accelerate unit growth each quarter on our way to our ultimate goal of 20% year-over-year growth. This deliberate growth plan allows us to maintain high levels of service satisfaction and retention, and maximize profitability.

In order to accomplish this we are tweaking some of the drivers and tactics to optimize results. First, as a result of our increased sales efficiency, recent marketing success, and midmarket sales expansion, we are able to ramp up the total trained sales rep count slower than previously planned. Obviously, our ability to reach our growth targets with fewer salespeople at higher sales efficiency is more profitable. Last quarter I mentioned the need for approximately 250 trained sales staff by the end of the third quarter or first part of the fourth quarter, to be comfortable with 2006 growth targets. Our updated planned now calls for only about 230 trained reps, including the eight midmarket staff I referred to earlier. This number of sales staff performing at current efficiency numbers is sufficient to fuel our growth at targeted levels.

The new plan also includes taking advantage of the marketing success we've had of late in pouring gas on the fire for the fall campaign. In order to do this I have authorized an additional $750,000 of advertising and business promotion expense. This will allow us to add local radio and extend the time period covered by our advertising to increase leads for the campaign. This additional expense, of course, is included in the guidance we published today.

Perhaps the most important change to our plan comes out of our favorable results in the direct cost areas, especially in workers' compensation and healthcare. We are now in a position to forego any healthcare price increases for the balance of the year, as Richard will explain in a moment. As a result I expect our pricing prospects and renewing clients to be exceptional for the fall selling season and provide a competitive advantage for sales and client retention.

In summary, we've had an exceptional quarter and first half of 2005, and the business is hitting on all cylinders. Our outlook for the balance of the year is very good; in fact our revised guidance for the full year implies a growth in earnings per share of 74% to 83% over 2004, on a comparable basis, when adjusting for stock based compensation and the Aetna settlement last year. Finally, our recent results combined with our revised plans for the last half of the year increases our confidence in continuing our growth and profitability into 2006. At this time I would like to pass the call on to Richard.

Thank you, Paul. Today I'm going to update you on the current trends in both our benefits and workers' compensation costs and how they affect our pricing strategy and gross profit. As Doug mentioned a few minutes ago, our benefits costs that include healthcare, prescription, dental, vision, life and accident insurance, and disability coverage came in at $578 per covered worksite employee per month, which was more favorable than we had forecasted. Last quarter I mentioned that our new contract with UnitedHealthcare would result in a lower administrative fee in the second quarter; therefore we were expecting only a 4% year-over-year increase in benefit costs versus the typical 7% trend.

As a result of lower-than-expected claims experience our benefit costs only increased 1.7% over last year versus the 4% we had anticipated. This lower claims experience is a result of three things. Number one is the continued migration of customers from higher copay, lower deductible plans to lower copay, higher deductible plans. Number two is a geographic shift from higher cost markets to lower cost markets. Number three is the conversion of UnitedHealthcare PPO customers to their new Choice Plus network.

Now looking forward to the balance of 2005, these same factors will help mitigate a typical 7% year-over-year trend in our healthcare cost, down to 3.5% to 4.5% year-over-year increase for the remaining two quarters of this year.

Now let's discuss our workers' compensation insurance expense. This expense is driven by the number of reported injuries, what we call the incident rate, and the ultimate cost of those injuries, including both medical and lost time, what we call the severity. Over the past five quarters I have continued to report lower trends in both the frequency and severity of claims. These results come from the ongoing work of our safety professionals, who provide training and safety recommendations to our clients and worksite employees. Additionally, our ongoing work with the medical case managers to reduce the medical cost component of these claims and the launch of the Administaff return to work program early in 2004 have also contributed to the lower costs.

For the current policy year our incidence rate of reported claims is 4.6% lower than last year, and the severity of those claims is down 8.6%. Our independent actuary uses this data to determine the basis for how much we should reserve each quarter to settle claims that are still open. Our estimate each quarter includes reserves for prior policy years plus another estimate for the current policy year. Again this quarter the actuary lowered the loss estimates for both the prior policy year and the current policy year, resulting in our expense for the third consecutive quarter being lower than previously forecasted.

Additionally, these same factors lead us to reduce our expected cost of workers' compensation for the balance of this policy year from a range of 1.3% to 1.35% of nonbonus payroll to a new range of 1.2% to 1.25% of nonbonus payroll.

Now let's shift from direct cost trends to pricing trends. As you know, our pricing model is built using individual allocations designed to match each of the direct costs, plus a separate allocation we call markup that is designed to generate our gross profit per worksite employee per month. Since all of the direct costs are not known in advance, we build in targeted allocations to cover those particular costs. Most of the time these targeted allocations exceed the direct cost, and we have a net surplus that, when added to our markup, produces the gross profit per worksite employee per month.

For 2005 we plan to have the market component of our service fee average $193 per worksite employee per month; and we conservatively estimated adding a surplus of about $10 per worksite employee per month. As you can see from our results so far this year, we are experiencing lower direct cost than we had budgeted for. This has caused our surplus to increase by an additional $10 per worksite employee per month for the second quarter.

During the first half of 2005 we instituted very nominal price increases and, considering the trends we are seeing in our direct cost, we should not have to have any additional price increases for the remainder of the year. This means that customers that are renewing from now to the end of the year will on average only experience a 6 to $10 per employee per month increase in the markup and a 6% to 8% increase in the allocation for benefits. We believe these types of increases will continue to be significantly below the small-business marketplace at large, and therefore very acceptable to our client base.

As you can see from our second-quarter results we are performing quite well within the current pricing level, and our surplus is above our original targets for 2005. Therefore we are raising our gross profit guidance range another $6.00 per worksite employee per month for the balance of the year, from $204 to $208 to a new range of $211 to $213 per worksite employee per month, which is slightly ahead of last year. Our results for the first half of the year plus this guidance for the last half of the year now implies an expectation of approximately a 2% surplus from our direct cost pricing allocations, or $20 per worksite employee per month.

Now before I turned the call back over to Doug, let me make a few comments about our 2006 plan. I believe we are very well positioned to continue our pricing and direct cost management strategy into 2006, which is to manage the pricing allocations and the direct cost so as to add $10 to $30 per worksite employee per month surplus to our gross profit. Generally speaking, I expect state unemployment tax rates to remain stable or even moderate into next year. We also expect healthcare cost to remain under control, because of plan design changes scheduled for implementation on January 1, 2006, along with the planned migration, geographic shift, and the planned conversion with UnitedHealthcare. Currently we are reviewing proposals for the renewal of our workers' compensation insurance program; and we are confident we will continue to have another cost-effective program in place for next year.

As for the outlook of our service fee markup, historically in periods where we had nominal increases in the direct cost we were able to increase this component of our service fee. Therefore, we anticipate the markup will be at least the same if not slightly higher than 2005. In summary, I have a good feeling about next year. Now I'd like to turn the call back over to Doug.

Thanks, Richard. Now for our guidance, let me begin by providing an update to our 2005 full-year guidance. As to worksite employees, based on better than expected results for the first half of this year, we have increased our range to 87,700 to 88,000 average paid worksite employees per month, which represents a 12.5% to 13% increase in unit growth over 2004. This guidance continues to assume that we add an average of 800 to 1,000 net worksite employees each month through November from new sales and client retention. It does not assume any growth or decline from new hires or layoffs within the existing client base.

As for gross profit, we are now forecasting gross profit per worksite employee per month to be in a range of $211 to $213 for the full year. We initially set a range of $200 to $204 per worksite employee per month, which assumed the $193 of markup on our services and the $10 of surplus from our direct cost programs. After the first quarter, as claim information further developed on both our healthcare and workers' compensation programs, we raised this guidance to a range of $204 to $208, reflecting additional surplus from the effective management of these direct costs. We now expect further contribution to gross profit from our direct cost management, and when combined with the markup on our HR services have increased our guidance to $211 to $213, slightly above the 2004 results.

As for operating expenses, we now expect to be in a range of $188.5 million to $189.5 million for the full year. The increase over the prior guidance of $184.5 to $186.5 million consists primarily of additional marketing efforts planned around our fall sales campaign, as Paul mentioned a moment ago, and additional accruals for our incentive compensation due to our improved outlook for the remainder of the year. On a per worksite employee per month basis, we now expect a decline from $188 in 2004 to approximately $179 for 2005 as we continue to reflect our operating leverage.

As a result of increased cash balances we now expect net interest income to be in a range of $3 million to $3.2 million for the full year. We are forecasting 26.7 million average diluted outstanding shares based upon our current share price. We are estimating a 37.7% income tax rate for the year, and continue to forecast annual capital expenditures of approximately $10 million.

Now for third-quarter's guidance, based upon the average number of paid worksite employees during the second quarter and the metrics just provided for the remainder of the year, we expect average paid worksite employees per month to be in a range of 89,200 to 89,600, which reflects the acceleration of our year-over-year growth rate 13 to 14%.

As for gross profit we expect to be in a range of $207 to $211 per worksite employee per month. Keep in mind that during the second quarter an administrative fee credit on our health plan, combined with the lower than expected claims experience, resulted in our benefit cost per covered employee increasing only 1.7% over the prior year. As Richard mentioned earlier we expect healthcare cost to increase 3.5% to 4.5% year-over-year for the remaining two quarters.

Third-quarter operating expenses are expected to be in a range of 47.25 million to 47.75 million. This is up from second quarter operating expenses of approximately 45.5 million, due primarily to an increase in advertising costs coinciding with the kickoff of our fall sales campaign, reflecting our investment in 2006 unit growth, and compensation expense with additional sales reps and service personnel. We expect net interest income to be between $800,000 and $900,000 for the third quarter. At this time I'd like to open up the call for questions.

(OPERATOR INSTRUCTIONS) Josh Rosen with CSFB.

It's Josh and Jeremy at Credit Suisse First Boston. First, just wanted to go back to something that Richard was commenting on, just to put it in the same language you guys did last quarter, so we have a full handle on it. In terms of the surplus versus the markup component, if you looked at second-quarter results and you had $193 for service fee markup, Richard, were you saying that effectively the net surplus was in the $20 range per worksite employee per month for the second quarter as well?

Yes.

So the expectations for the year, then, are in that same ballpark, correct?

Yes, that is correct.

Okay. That helps. The second thing that I just wanted to touch upon is, Paul, you talked about the midmarket strategy a little bit more aggressively than you have talked about it in the past. I just wanted a little more clarity in terms of your expectations there, in terms of -- you talked about the client size that you are looking at -- but what the price point might look like in that client base, and what you expect from a sales cycle standpoint, any success you have had thus far. Just a little more color there would be helpful.

Sure, Josh, I'd be glad to provide that. In the midmarket segment, as you know, we've had a pilot program going on now for a little over a year with two of our senior sales staff. We had pretty good results really in the last half of last year on our fall campaign. So during the first part of this year, we validated some of those things, worked on some marketing and training, and then decided to move ahead with expanding the sales staff by adding six additional senior sales staff from across the county.

This is all in anticipation of a strong last half of the year. As I mentioned last quarter, I believe that the midmarket sales may even favor the January 1 startup cycle even more so than our small to medium-sized business marketplace. We've got a good pipeline, we've got a good flow of prospects coming in. We felt the need to increase the sales staff and further capitalize on the success we're having in that market.

As far as pricing, we feel strong about the co-employment model with the client. They are receiving that very well. I have mentioned before the large account business does have a slightly lower gross profit per employee built into it in the service fee, but a slightly higher operating margin built into it, because of the leverage on the raw numbers of employees associated with those accounts.

That is very helpful. The last question I had, just any sense in terms of office expansion at this point? Or is it really just continuing to flesh out the existing infrastructure with additional sales resources?

Yes, right now we are continuing to backfill into the current markets. No openings for the last half of the year. But we will be back at that, I'm sure, sometime next year.

All right, thanks for the update.

Tobey Sommer with Administaff (sic).

Tobey Sommer with SunTrust Robinson Humphrey last time I checked. Just wanted to ask you a couple of questions. Paul, you talked about raises, bonuses, commissions, and the overtime as a percent of total pay. Any particular strength or commentary that you could share with us regarding industries or geographic strength that you are seeing?

Well, I can. Again it is early in terms of the information that we get at the end of the period here and then kind of dig in further. But the strength is really solid pretty much across the board. You still have on the healthcare side and some of the services businesses are strong. As far as geographic, the Northeast has been strong. But I tell you it's amazing to me how the perception of the economic climate still hasn't lined up with what it really is. The economy is very strong right now, and I think continuing to move forward on a good pace.

Thanks. If we look back and kind of take a step back here, and it looks like with the implementation of Siebel and etc. your customer satisfaction is going up very nicely; retention is improving; and you seem to be able to get better sales force productivity and efficiency as you described. Are you evaluating maybe how much you need to spend on marketing vis-a-vis maybe hiring less? Something you alluded to, but I am just kind of wondering whether you think your sustainable sales force productivity and efficiency may be somewhat elevated relative to expectations six or nine months ago.

Yes, I think a few months ago we had talked about the potential for our sales efficiency to go up based on success in the marketing effort and new training that was implemented at both the salesperson and the district manager level. But when you have an increase in efficient like that, or you are hoping for one, you really don't want to rely on that until you really start to see it.

But right away we have started to see some real upside there. I'm very comfortable because we have a lot of control in terms of driving the activity with the marketing efforts, and measuring the success of sales staff in terms of their training, and really kind of helping their district managers do their job in coaching and bringing salespeople along. So it's a little too early to tell whether it is a systemic change that we're going to build in forever, on having higher sales efficiency. But all the signs look very good, and I am very comfortable about the last half of the year and where we are headed for '06.

In terms of the levers available to you to drive volume growth now and accelerate it from here, the two primary ones I guess being working on that efficiency together with marketing dollars, as well as adding employees, do you have any other initiatives that you would consider from a marketing standpoint to perhaps propel that efficiency higher?

Well I certainly think we are only sink the beginning of what will come out of this sales training effort. We revamped that completely and timed the training to the point of need of the salesperson over their ramp up time of about a year to 18 months. I think that is going to pay significant dividends as we are able to help more sales staff, a higher percentage of those, reach that 18-month maturity level that we are after.

Okay. Then I guess one last question. From a balance sheet perspective, your working capital improved nicely. Could you give us an update on what you're thinking regarding uses of that cash?

Sure. Of course our Board when we meet each quarter discuss that at length. At this point I think what you have seen from us in the past is that we are a buyer of our shares, and we still have some allotment available for us to buy when we have an opening in terms of a trading window for the Company.

Also we've started a dividend program this year and will continue to review that and the yield associated with that dividend program. We are frankly not anxious to be an acquirer out in the marketplace; those have not fit when it comes to the PEO model. But there may be some other adjacent businesses that may be helpful in moving the ball forward on either in the marketing alliance area and some of the new revenue streams. So we will just have to see how things play out there.

But we believe, I believe the highest and best use for our capital is to invest back in this business model, to enhance it and to accelerate the plan. This is why I felt strongly about investing more in the advertising effort in the fall to even increase the certainty about our growth expectations in the next year.

Thank you very much.

Mark Marcon with R.W. Baird.

Good morning and congratulations on the strong results. I was wondering, you obviously had some fairly significant differences in some of the geographies just in terms of the growth rate. I was wondering if you could describe what could cause some of those differences, besides this level of penetration. Or is that primarily it?

Sure, good question, Mark. The key issue for us on where the growth occurs is really the number of trained sales staff in each of those regions, also coupled with sometimes market-related local-related issues. For example, the Midwest was a little bit light this time around; some of that is driven by some issues in the healthcare market with particular providers that are no longer in the UnitedHealthcare group up there. So you have little things like that that affect your effectiveness in a market from time to time.

But it is largely driven by where we put the sales staff and when they reach that 18-month maturity. That is something you will see us work on more into the future, as we target which new markets to open to boost the growth, kind of more across the board than what you are seeing today.

The receptivity, in terms of what you are seeing from the individual fully-trained salespeople, the productivity levels, are relatively constant once we equalize for that?

Yes. Like I mentioned earlier, I think actually we are seeing those efficiency rates improving, and hopefully we will continue to do so.

Okay, great. Then you mentioned a coming change with regards to the healthcare plan. I was wondering if you could give us a little more color on that.

Sure. Let me just say that one of the things that Administaff does and is obligated to do for our clients, of course our goal is to provide big company benefits into the small to medium-sized business community. Part of that is staying in step with what larger companies are doing in their benefit plan, to maximize the value. You know, the benefits received for the price.

So about every few years, and this again would be -- I think it has been three years since we tweaked some of the benefit program deductibles, coinsurances, etc. So what we have done is kind of recalibrate to what large companies are providing in the marketplace in terms of deductible to coinsurance. Very nominal changes going from $25 to $30, for example, copay on a prescription. Things of that nature just keep the benefit plan in step with what is going on in the big business community so our small-business customers aren't overpaying compared to what it takes to be competitive in the marketplace.

So those are the kind of changes you will see going into next year. Of course those lower the cost of the program overall; and that is why we're going to be able to keep pricing very advantageous to our prospects and to our current clients for renewals. That should help us boost sales and retention.

Are you going to pass along all the savings to them, or is there a portion of that that you are going to keep?

Well, remember our overriding concept is to match price and cost on the direct cost items to a small surplus, preferably in that $10 to $30 range like we did last year; at 20 this year; we are kind of forecasting 20. That is a nice place to be. The year before that we were at 30. Actually 31, so just a little bit outside that range on the high side. So our goal is to manage the pricing cost on all three of those direct cost (technical difficulty) so that we have approximately a 2% (technical difficulty) around $20 to add to the markup component, which now we also expect to move up slightly as we go into next year.

Great. Then with workers' comp it sounds like you are making some good progress in terms of reducing the incidence as well as the severity. I'm wondering where do you think, in terms of all the drivers and initiatives that you have in place that has accomplished that thus far, how much further do we have to go? How many more quarters can we see improvements? Or is that something you can keep up through next year, or are we starting to max out?

That is one of those things that is just hard to tell. You are just thankful every quarter as you perform well, and as the safety efforts bear fruit, and the claim management back to work programs, etc., are effective. So it is really not something we are able to pinpoint ahead of time. That is why we are pretty conservative as how we look to going forward, further contributions from direct cost coming out lower than expected.

And last (technical difficulty)

Ladies and gentlemen, at the request at the Company, please limit your question to one. Jim Macdonald with First Analysis.

Good quarter, guys. Just so I understand it, you talked about on the sales rep front that you currently had 260. But then you are talking 230 at the end of the year. I guess I didn't understand something there.

That is just the trained rep count versus total hire, Jim. Remember with turnover you always have some that are in the 90-day ramp up to being trained. You are always replacing some. Right now we are at 260, and you saw the average for the quarter at 215 in trained reps. But that number is moving up. So I would anticipate trained rep count around 230 by the time we get to the end of the third quarter, first of the fourth.

Keep in mind within that 230 you have eight midmarket reps, which we hope and expect they will be, in terms of productivity, about 3 to 1. So it's almost like the equivalent of having 248 or so at that time anyway or 245. But when we get to the point and have 230 trained, you would have more or a higher number of hired reps. You might be in the 280 range or so, 275.

Okay. Maybe if I can sneak in a follow-up. Just to clarify on the health, you say there is a holiday on increases going forward. But does that mean you are kind of continuing at the current rate; it will still be an increase over last year, but at a lower rate?

Yes. Remember we do price changing each quarter on the base. So when we say we are not going to increase any further for the balance of the year that means customers who renew in this quarter will have the prior quarterly increases in their numbers; as you get toward the end of the year customers will only be having a couple of quarter increases. So it will be far less than the market.

Thanks very much.

Jim Wilson with JMP Securities.

I was trying to back into the actual number of gross additions in terms of actual WSEs in; and then the attrition out. Am I roughly correct roughly correct to come up with something like 6,600, 6,700 gross additions; and then 3,500 out, if I'm taking your percentage changes correctly?

That would be right.

That is correct.

So right around in that neighborhood. Okay that is what I thought I was getting. So for a full annualized rate, you are sort of maybe high teens on attrition; and the total growth though, you are, what is that, 25, 30%. It is a pretty high number.

Right.

Yes, something like that. Okay, I just wanted to make sure I had those numbers correct (multiple speakers) pretty strong. Okay, very good. That is it, thanks.

All right. If there are no more questions we would just like to say we appreciate everyone participating today and look forward to talking with you next quarter.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.