Insperity Inc (NSP) 2011 Q2 法說會逐字稿

Good morning. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the Insperity second-quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). At this time, I would like to introduce today's speakers. Joining us are Paul Sarvadi, Chairman and Chief Executive Officer; Richard Rawson, President; and Douglas Sharp, Senior Vice President of Finance, Chief Financial Officer, and Treasurer. At this time, I would like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.

Thank you. We appreciate you joining us this morning. Before we begin, I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson or myself that are not historical facts are considered to be forward-looking statements within the meanings of the federal securities laws. Words such as expects, intends, projects, believes, likely, probably, goal, objective, outlook, guidance, appears, target and similar expressions are used to identify such Forward-looking Statements, involve a number of risks and uncertainties that have been described in detail in the Company's filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such Forward-looking Statements.

Now let me take a minute to outline our plan for this morning's call. First, I'm going to discuss the details of our second-quarter financial results. Richard will discuss trends and our direct costs including benefits, workers' compensation and payroll taxes and the impact of such trends on our pricing. Paul will then add his comments about the quarter and our plans for the remainder of 2011. I will return to provide our financial guidance for the third quarter, and an update to our full-year 2011 guidance. We will then end the call with a question-and-answer session.

Let me begin today's call by discussing our second-quarter results. Today, we reported second-quarter earnings of $0.25 per share, which were above our expectation and Q2 2010 earnings of $0.20 per share. These results includes a $0.07 per share impact of incremental rebranding costs, and, therefore, further demonstrate bottom line improvement over the prior year. As for our key metrics, paid work site employees averaged 114,656 for the quarter, an increase of 9% over Q2 of 2010, and just slightly below the low end of our forecasted range. Gross profit for work site employee per month averaged $244, which was within our forecasted range of $241 to $245, and significantly above the $226 reported in Q2 of 2010. Operating expenses totaled $72.4 million below our expected range of $75 million to $76 million. We generated $18 million of EBITDA plus stock-based compensation, and ended Q2 with $152 million of working capital.

Now let's review the details of our second quarter results. As I just mentioned, average paid work site employees increased 9% to 114,656 for the second quarter. Client retention continued at historical highs, averaging 99% for Q2. Net hiring by our client base continued to be weak, however, this was offset by the hiring of some summer help. Paul will provide further details on new sales and client retention in a few minutes. Second-quarter revenues increased 15% over Q2 of 2010 to $473 million. This was a result of the 9% increase in average paid work site employees, combined with a 5% increase in revenue per work site employee per month. Looking at second-quarter revenue contribution and growth by region, the southeast region, which represents 10% of total revenue, increased by 3%, the northeast region, which represents 26% of total revenue, increased by 25%, the central region, which represents 15% of total revenue, increased by 13%, the west region, which represents 20% of total revenue increased by 18%, and the Southwest region, which represents 29% of total revenue, increased by 7%.

As for our gross profit results, Richard will discuss the details in a few minutes, so I'll just provide some brief comments. Gross profit per work site employee per month averaged $244 for Q2. This was within our expected range, as favorable results in our payroll tax and workers' compensation cost centers offset higher than expected healthcare costs. Approximately 74% of work site employees were covered under our health plans in Q2, at an average cost of $828 per covered employee per month. The 5% increase over Q2 of 2010 was greater than anticipated, due primarily to an above-average volume of large claims.

Similar to Q1 of this year, we experienced a higher than expected surplus in our payroll tax area, as final state unemployment tax rates came in lower than our estimates. Payroll taxes as a percentage of total payrolls declined slightly from 7.3% in Q2 of 2010 to 7.2% in Q2 of this year, on higher client payroll and bonuses. As for our Workers' Compensation Program, costs totaled 0.59% of non-bonus payroll, below our forecasted Q2 cost of 0.63%. Actuarial loss estimates resulted in a $2.2 million reduction in previously-reported loss reserves. This compares to a $1.7 million reduction in Q2 of the prior year. Our adjacent businesses contributed approximately $11 to gross profit per work site employee per month during Q2 of this year, up from $5 in Q2 of 2010.

Now let's move to operating expenses which increased by 15% over Q2 2010 to $72.4 million. This increase included approximately $3.1 million in costs associated with our rebranding effort, and $2.9 million in operating expenses associated with our mid-2010 and January 2011 acquisitions. When excluding these two components, total operating expenses increased by just 6%. Q2 operating expenses were approximately $3 million below our forecast. These expense savings will be reflected in our revised full-year guidance, which I will discuss in a few minutes. Interest and other income for the quarter totaled approximately $300,000, within our expected range, and our effective income tax rate of 42% was consistent with both the forecasted and the Q2 2010 rate. As for our cash flow, EBITDA plus stock-based compensation increased from $15 million in Q2 2010 to $18 million in Q2 of this year. Cash outlays during the quarter included cash dividends of $4 million, repurchases of 120,000 shares at a cost of $3.6 million, and capital expenditures of $5.1 million. Working capital increased by $11 million during Q2 to $152 million, and included the receipt of a $9.6 million scheduled reimbursement from our Workers' Compensation Program.

Now, this strong cash flow and balance sheet have afforded us the ability to access the credit markets at very favorable terms, therefore, we are pursuing the possibility of putting a line of credit in place. Our working capital position, combined with the ability to access the credit facility, would position us over the long term to capitalize on growth opportunities, pursue strategic acquisitions, invest in our infrastructure, and continue our dividend and share repurchase program.

In summary, our strong start to the year has continued through the second quarter. Unit growth in the high single digits, combined with stable pricing and improvement in our direct cost programs has contributed to a 111% increase in earnings per share for the first half of 2011. These results are especially strong, when considering the incremental rebranding costs of $0.17 per share incurred during this period. At this time, I'd like to turn the call over to Richard.

Thank you, Doug. I will begin my remarks this morning by providing you with the details of our second-quarter gross profit results, and then I will share with you our gross profit outlook for the balance of 2011. As many of you know, our gross profit has historically come from the service fee component of our markup, combined with the surplus that is generated when the direct cost pricing allocation components of our markup exceed the corresponding direct costs. Now, we have added a third component to gross profit, which comes from our adjacent businesses that were developed through a build by, or partner, strategy.

As Doug just reported, our gross profit per work site employee per month this quarter was $244, which was near the top end of our expected range. The service fee component of our markup averaged $190 per work site employee per month. The surplus component was $43 per work site employee per month, and the adjacent businesses contributed $11 per work site employee per month to the gross profit. All three components were in line with our forecasted range. As for the surplus component, let me give you the details beginning with the payroll tax cost center. This surplus was $8 per work site employee per month better than our forecast, and was due to lower-than-expected state unemployment tax rates that we had originally forecasted.

Now let's discuss the workers' compensation cost center surplus results, which was $4 per work site employee per month better than expected. The additional surplus in this cost center came from lower costs that came from a combination of lower administrative fees and better-than-expected claims settlements on previously-filed workers' compensation claims. As for the benefits cost center, our deficit this quarter was $10 per work site employee per month higher than we expected, and was the result of a larger number of large loss claims than what we had estimated for the quarter.

In fact, most of the difference came from large claims of COBRA participants. We expect coverage for many of these participants will be terminating in the next few months, as they reach the end of their subsidy and eligibility periods. During the quarter, we experienced a further reduction in the number of COBRA participants, dropping from 4.5% of the base last quarter to 3.9% this quarter, and getting closer to our historical average of 3.6%. In summary, our second-quarter gross profit results were very good, considering the unusually large number and amount of healthcare claims that we experienced during the quarter.

Now let me tell you what gross profit expectations for Q3 and the balance of 2011 look like, beginning with the pricing. We increased our markup $5 per work site employee per month for customers that renewed during this quarter. Additionally, our new business sold in Q2 was $15 per work site employee per month higher than new business sold in Q2 of last year. If we continue to sell and renew clients at these levels, we should be able to achieve $192 per work site employee per month average markup on the entire base for Q3 and Q4 of this year. Looking at the surplus component of gross profit, here's what we see for the balance of 2011, beginning with the payroll tax cost center. You may recall that our payroll tax cost center's surplus declined each quarter throughout the year, as employees reach their specific wage limits. The surplus that we earned this quarter will continue into the third quarter, but certainly not at the same magnitude as Q1 and Q2. Then, Q4's surplus typically increases above the Q3 surplus, as part of the normal seasonality of how payroll taxes work in our business.

Moving to the workers' compensation cost center, here's what we see. On the expense side of this cost center, our incidence rate for this policy year has increased approximately 15%, but remember, our work site employee base that produces those claims has grown 9%. The severity rate has also increased this policy year, but our average cost per claim is the same as it was two years ago, when we were the same size Company as we are today. Therefore, we will keep our expense forecast at an average of 0.63% in non-bonus payroll for both the third and fourth quarter and let the upside come as we continue to effectively manage this direct cost. On the pricing side of workers' compensation cost center, our allocations for new and renewing business have not changed this year, and since our claims experience has been good, we do not need to see at this time to raise those allocations.

Now, switching to the benefits cost center, let me tell you how we see our deficit in this cost center changing, beginning with the pricing allocations. We still see employees migrating to lower-cost, higher-deductible medical plans which automatically reduce the allocation amount that we receive. This trend should continue, probably into 2012. The trend in health insurance costs across the country are still expected to increase about 13% year-over-year, partly due to the federal mandates included in the healthcare legislation that was passed last year. Most of those mandated costs have been baked into our trend for several years, so we do not have to increase our allocations as much as the marketplace, which should be good for our clients.

On the cost side of the equation, we have the same factors in place for the balance of 2011 that we've had so far this year, which have helped us keep a lower cost trend than the market. As I mentioned a few minutes ago, the number of COBRA participants has returned to the historical low level of participation, which should help lower our costs. Second, we have continued to see migration of plan participants moving to the lower-cost, higher-deductible plans which should also help keep our costs trending lower. Third, the plan design changes that went into effect on January 1st of this year which added a deductible to our pharmacy benefit and contributed substantially to our lower costs earlier this year, will become less of a factor in reducing our expense as the year goes by. And, last, you may remember that we entered into a new three-year agreement with United Healthcare, which went into effect January the first of this year and has built-in reductions to the administrative fees as our covered work site employee base grows. Since we have been growing, that base will be getting another fee reduction, beginning in Q3.

Overall, if our large loss claims experience returns to more normal levels, we should expect benefit costs per covered work site employee to increase 3.5% to 4.5% over last year, moving towards the higher end of the range in Q4 as the deductibles and co-pays of participants are met. Therefore, our total surplus should be in a range of $40 to $44 per work site employee per month for Q3 and $49 to $51 per work site employee per month for the full year which is just slightly better than our forecast last quarter.

Finally, our adjacent business services, which added $11 per work site employee per month in gross profit in both Q1 and Q2, should increase about $1 per work site employee per month for the balance of the year, as we help them continue to grow with sales and marketing support. So, when you combine the service fee, the surplus, and the adjacent business contribution, we should see our gross profit per work site employee per month end up in a range of $244 to $248 for Q3, reflecting the seasonal quarterly payroll tax effect on this metric. And, for the full year, we still expect to reach a record level of gross profit per work site employee per month in a range of $252 to $254. Now, at this point, I'd like to turn the call over to Paul.

Thank you, Richard. This morning, my comments will include some details behind our excellent second-quarter results, including factors contributing to our growth. I will also discuss the increasing momentum we're seeing in new sales and our plan to establish our foundational long-term growth strategy as part of our fall selling campaign. I will also cover the data points and influences we see in the persistent sluggish labor market, and how this feeds into our outlook for the balance of the year.

The second quarter growth in profitability results were solid in the face of a weak economy. We continued our historically high monthly client retention in Q2, averaging 99%. This high level of client retention has allowed us to grow, while we transitioned and retooled the sales effort under the new Insperity brand. Paid work site employees from sales in prior periods ramped in slower than expected early in the quarter, before finishing with a very strong month in June. The timing of enrollment of these prior period sales was the primary reason we came in slightly below the low end of our forecast for average monthly paid work site employees in the quarter.

The net gain or loss of paid work site employees from hiring and layoffs in the client base reflected a similar pattern in the quarter, with weak months in April and May, and a rebound in June, largely due to the addition of part-time and temporary summer help. New sales in the quarter came in at 92% of our internal forecasts, which was decent, considering the amount of change in the organization has been contending with and the nature of our sales forecast, which increases each quarter of the year. Another highlight as sales volume has increased is the recovery we experience in pricing, our service fees on new accounts, which as Richard indicated, increased $15 per work site employee, which was up 8% over last year.

We also made good progress ramping up our adjacent business development cross selling effort. During the quarter, 1,314 leads were provided to our adjacent business unit with 328 becoming new customers. In addition, self-generated leads from within the adjacent business units increased by 69% in Q2 over Q1, from 1,695 to 2,870, as marketing efforts kicked in. While the financial and sales results for the quarter were quite good, the most important developments for Insperity are not reflected in the numbers at all. These developments relate to progress we're making in our transition to the Insperity long-term growth strategy.

The new Insperity brand is the vehicle to launch our new strategy to align multiple synergistic businesses along side our highly-successful workforce optimization PEO solution and accelerate our growth and profitability. This plan involves aligning the entire organization, from marketing and sales to customer service and technology, around our goal to help businesses succeed in ways beyond and in addition to our workforce optimization solution. This transition began with the introduction of the adjacent businesses and the referral efforts last fall, followed by our rebranding and full strategy announcement in Q1 of this year.

In Q2, our entire organization learned new messaging and positioning, and began efforts to gain momentum in sales activity. These efforts have been successful, and we are seeing an increase in sales activity that leads to future workforce optimization sales. Both the mid-market and core business pipelines for new business are gaining steam. The mid-market has the largest number in our history of potential work site employees near the closing phase, and we added three new business performance consultants to the sales team in the quarter.

In the core business segment, we had a 7% year-over-year increase in census count from 6% fewer business performance advisors, yielding a 13% increase in the number of census per advisor. Our new brand and messaging appears to be off to a good start, contributing to this increase and selling opportunity. As we move through the third quarter, the business performance advisor transformation will continue as we initiate our bundle-plus selling system which will launch with our fall campaign in September. We are on a deliberate path to engage our sales organization in a new way to capitalize on the 25,000 to 30,000 business owner prospects we call on each year.

In our bundle-plus selling system, our business performance advisors that have historically focused exclusively on our workforce optimization solutions will also offer our customizable solutions from our adjacent business offerings to our small and mid-sized business clients. Beginning this fall, every prospect visited by our business performance advisors will be introduced to the full array of HR and business performance solutions available from Insperity. Our emphasis will still be on our workforce optimization offering, which is the most comprehensive business services bundle in the marketplace. However, we will proactively add solutions to the bundle from our new adjacent business offerings, to further tailor our solution to meet the unique needs of each client.

We will also begin to offer our adjacent business solutions on a standalone basis, when our prospect is not ready for the full workforce optimization solution. This will place our 275 trained business performance advisor team in a much more active role, growing our adjacent businesses. Each of the adjacent businesses will still have their own sales operation and our business performance advisors will hand off the prospect to their respective channel to go through the sales process. The advisor will continue to be responsible for workforce optimization sales, but will also facilitate the adjacent business offering sales process. So in the second quarter, and continuing at a fever pitch into this quarter, we are preparing for this transition, including marketing, sales tools, training, and technology enhancements to manage prospects and sales activity across all business units to facilitate the bundle-plus selling system. We are also finalizing pricing, client incentives for multiple product purchases, and commission enhancements to drive behavior and results. We are preparing our adjacent business sales and service operations to handle a higher volume of sales opportunities and new customer on-boarding in anticipation of this bundle-plus selling implementation.

Our fall campaign kickoff in September, for our fall campaign kickoff, we are focused on and driving a higher level of sales activity in our workforce optimization core business, and cross-selling our adjacent business offering as an integral part of our selling system. We believe implementation of the bundle-plus selling system this fall will be a pivotal step to establish our long-term plan to accelerate growth and profitability of Insperity. Now, before I pass the call back to Doug, let me update you on the economic and labor market indicators we are seeing in our client and prospect base, and explain how we are integrating these factors into our near term guidance for the balance of the year.

Today, we also released our quarterly client survey results, along with some key metrics from the actual data in our system, reflecting the most recent hiring and compensation decisions from our clients. Comparing recent decisions to current sentiment provides some valuable insight regarding what we may expect in the coming months from our client base and the small to medium sized business community at large. The broad market economic weakness and uncertainty was evident in both recent decisions and sentiments about the future. The economic weakness was visible in a 2.8% decline in year-over-year commission payments we made on behalf of our clients to their sales personnel in Q2. This indicates sales for the quarter in the small to medium sized business community reflected the economic slowdown evident in recent GDP numbers.

In addition, overtime as a percentage of base pay was at 8.5%, which is solid, but below the 10% level that typically indicates the need for hiring. So as a small business, if you're within your capacity to meet current customer orders and your pipeline for new business is down, you're not likely to hire new staff soon unless you're embarking on and investing in new initiatives. The likelihood of stepping out to invest and take risk is certainly driven by business owner sentiment, which fills in the other half of the picture. In our survey, we asked business owners specifically about their outlook for sales in their business, the economy as a whole, and their specific hiring plan. When survey respondents were asked about the economy as a whole, only 18% thought we are currently in an economic recovery, or expect to be by year-end. 82% delayed their expectation of an economic rebound to next year, or are unsure when it might happen.

On the flip side, when asked about their specific business, 52% expect increasing sales in 2011, 32% expect to add employees, and 23% expect to increase compensation. Only 11% expect decreasing sales, 6% expect to lay off employees, and 4% to decrease compensation. This level of optimism about the future is what makes the small to medium-sized business community such a powerful engine for our economy. They really do want things to improve, and want to grow their businesses. It's what they do and who they are. But when you ask about their level of concern about the long-term, we found a high level of anxiety to offset this natural entrepreneurial optimism. Over 70% said their level of concern was elevated or very concerned on the long-term outlook for the economy. 74% expressed the same level of concern over the federal deficit and national debt. 63% are worried about government expansion and the effect on business, and 61% are anxious about potential tax increases. So, when we consider all the data and survey results, we see long-term concerns and recent actual data weighing the labor market down for the near-term, offset by the natural optimism business owners have for their own Company.

For Insperity, from an internal perspective, we have sales momentum building and record client retention. This is in contrast to the macro picture with a weak economy and labor market, and a considerable level of uncertainty and concern in the small to medium-sized business community. Now, even though we are extremely bullish about our own plans and our long-term growth opportunities, we believe a little caution regarding the near-term is appropriate. We have averaged a net gain of 1,000 work site employees per month since the year-end transition ended in February. This was below our expectations by a couple hundred employees, and was largely driven by the timing of enrollment and sales slightly below forecast.

We are also weighing in the possibility of the departure of 800 employees that came on as summer help in the client base. When the summer ends and school begins, many employers replace a percentage of summer help with full-time positions. Against the backdrop of the economy and the current sentiment, we believe this hiring is less likely to occur. To be prudent, we have decided to tweak our forecast for the net gain in work site employees over the last half of the year. We are budgeting an increase in average paid work site employees per month in the range of 600 to 900 per month. This slight adjustment to the growth rate for the second half of the year has a nominal effect on anticipated revenue, and we expect no impact on profitability. Any effect on gross profit will be offset with lower operating expenses.

There is certainly some chance that our internal momentum in sales and retention entirely offsets the weak economic outlook and the elimination of summer help. In this case, our forecast would prove to be too conservative, but will be easier to live with that outcome as opposed to being too optimistic, ignoring the economic climate and client sentiment, and being disappointed. In the meantime, we could not be more enthusiastic about our long-term growth prospects. We are certainly on track with our new strategy implementation, and we continue to validate each tactical element of our new growth plan. Our confidence in the new brand and strategy is high. Over the long-term, we believe we can grow our new adjacent businesses substantially and profitably, and in turn this will create a larger prospect base to accelerate growth in our core workforce optimization business.

In summary, the second quarter results were very strong in a difficult environment. We are gaining sales momentum, and we made great progress establishing fundamental elements of our long-term growth and profitability plan. I continue to believe that over the next five years, we are heading for our most significant period of value creation in our history, for our clients, employees and shareholders. At this time, I'd like to pass the call back to Doug to provide guidance for the balance of the year.

Thanks, Paul. Before we open up the call to questions, I'd like to provide our financial guidance for the third quarter and an update to our full-year 2011 forecast. In general, we are forecasting slightly lower unit growth due to the economic uncertainty and the weak labor market. We expect gross profit per work site employee to remain consistent with our previous guidance, operating expenses will be managed based upon our revised unit growth outlook, which will result in savings from our previous budget.

So as for the details, we are forecasting average paid work site employees in a range of 117,250, to 117,750 for Q3, or about a 2.5% sequential growth over Q2. We are now forecasting average paid work site employees in a range of 116,000 to 116,500 for the full year, for the reasons Paul just mentioned. We are forecasting gross profit per work site employee per month to be in a range of $244 to $248 for Q3, and $252 to $254 for the full year, which is generally consistent with our previous forecast.

As for operating expenses, we are now forecasting a range of $298 million to $299 million for the full year. This is a decrease of approximately $6 million from our previous forecast, as we continue to manage expenses based upon our revised unit growth outlook. For the third quarter, operating expenses are expected to be in a range of $73.5 million to $74.5 million, and include approximately $2.2 million or $0.05 per share of incremental costs related to our rebranding effort. As for our interest income, we are forecasting $1.2 million to $1.4 million for the full year, and $300,000 to $400,000 for the third quarter. We are estimating an effective income tax rate of 42%, and 26.6 million average outstanding shares.

In summary, this key metrics guidance implies a range of 2011 full-year earnings per share of $1.18 to $1.25, or 37% to 45% increase over 2010. Excluding the expected incremental costs associated with our rebranding effort of $0.27 per share, our updated guidance implies a range of $1.45 to $1.52 per share or a 69% to 77% increase over 2010. At this time, I'd like to open up the call for questions.

Our first question comes from the line of Tobey Sommer with SunTrust.

Thank you. Paul, I was wondering if you could discuss the hiring and training of salespeople as -- just next month, we're going to start your fall selling campaign, and I know that's an important time for maintaining and maybe even invigorating growth.

Sure. In terms of our -- I mentioned I think in my prepared remarks that we had ramped up the number of mid-market consultants by actually doubling the number. It's still a small number; there are 6 of them total, but we're really excited about the way that's moving along, and the way our mid-market is developing.

On the core business, we're at about 275 trained reps. We haven't made accelerating growth in the number of reps a huge priority, of course, because we're in a transition to the new messaging and the Insperity brand, and you will see some hiring as we go throughout the year, but not enough to substantially affect this fall campaign. We want to make sure that we get the sales efficiency right, which, the signs from the second quarter were very good in that respect, having a 13% increase in the census per-rep count. That's the type of thing we were looking for in terms of ramping up sales activity, and now, as we get to closing activity in the fall, as that ramps up on schedule, then we'll be more aggressive about growing the sales staff as we get into next year.

Thanks. Could I ask a question about the pricing on that new business up $15? Nice, solid percentage, as well. Could you identify what might be the biggest drivers of that pricing leverage? Is it the favorable healthcare, or what might be behind that?

I think that certainly weighs in some. When we don't have as much pressure -- remember, as Richard mentioned, our benefits costs have been going up at a slower rate than the market at large because a lot of the marketplace costs are being driven by healthcare reform, and some other requirements that have been placed on plan design that were already included in our plans, and have been for years, because of course, one of our key advantages is that we bring big-company benefits into the small-business community. And so those big-company plan elements were already included in our plan. So healthcare costs have been rising slower for us than they are for our prospects in the marketplace, so that definitely feeds into it.

But I think also beyond that, pricing getting back to normal is a step in a recovery process. First you have to recover on volume in sales, which we have been doing nicely over the last 6 or 9 months. And I mentioned, actually last quarter, that I expected pricing to start to follow because that's the natural thing. Sales staff get confident; they're starting to have sales, and so then they can be a little more focused on price and margins, and fortunately our compensation program has the sales organization tied into all those elements that are priorities for the Company. So I think it's pretty much a natural progression for that to occur.

Thank you. Last question, I'll get back in the queue. I think you mentioned perhaps putting a credit line in place. Are you seeing more opportunities for you to add perhaps more sizable adjacent business acquisitions?

I think there's a lot of opportunities out there that we need to stay on top of. We're not super anxious to jump on anything that would be super sizable. But the availability of a credit facility at attractive terms is really hard to pass up in this environment, so we think it's just prudent to put that in place, and then we're in position to do whatever we need to do, and take advantage of opportunities we see in the marketplace, continue our share repurchase program, and all the other priorities that we have for our cash.

Thank you.

(Operator Instructions) Your next question comes from the line of Jim MacDonald with First Analysis.

Thanks, guys. Good quarter. Could you talk a little bit about any relation between raising prices and work-site employee growth? Do you see any drag there because of price increases?

Well, we certainly see that retention has continued to be at our record high levels. Sales was at 92% of our internal budget, which, like I said, was good numbers. Could it be better? Yes. Would it be better if the pricing were just slightly lower? I don't think so.

I think most of the resistance we're seeing in the marketplace is still related to uncertainty and trepidation that business owners have about what their future might look like, with the economic environment and other factors that weigh in, like I mentioned, including taxes and government compliance, et cetera. But those things also drive people toward us. It's that same -- I hate to say it's fear there, but that level of complexity that comes from government and other pressures also drives people toward us. So there is an offset in there.

And what are you seeing -- this may be a good time to ask in terms of competitive pricing, I guess in general, maybe from the PEO competitors, the health pricing in your market in general is a positive, but how about from the specific competitors?

Keep in mind that in our case, our primary competitor in the marketplace is still the propensity to do this on your own without using a workforce optimization solution. But if you get into those that provide a service in our space, like ADP and Paychex and other regional players or even local players, most of those are a different product proposition in terms of being more of a save-you-money approach. Our solution, of course, is the most comprehensive business services bundle in the marketplace, and it's an investment return analysis.

So when we are in the marketplace with a prospect, it usually is pretty clear whether that prospect is a customer that fits our profile, or a customer that fits a profile of our client base. Someone who is just trying to save a few bucks on insurance, or get some administrative relief, sometimes those other services are enough to fit the bill. But if a company's really trying to take their company to the next level, then the -- if the company wants to move ahead as far as it can, as fast as possible, then the Insperity workforce optimization solution is the answer.

Just a couple clean-up items. I missed what Doug said, I think it was, about the health cost per employee this quarter? And would your LOC allow you to repurchase shares, or do you think there would be any limitations on that?

As far as the benefit costs per covered employee for the quarter, I believe it was $828, about a 5% year-over-year increase on that item.

As far as the line of credit, we're still negotiating the final terms related to that. I'm not sure where we'll end up. There may or may not be some limitation with respect to how much we could repurchase shares, but I wouldn't think it would be that limiting. So the availability within the line still to repurchase shares along with our strong working capital position at $152 million would allow us to be appropriately aggressive on our share repurchases when opportunities dictate.

Thanks very much.

The next question comes from the line of Jeff Martin with ROTH Capital Partners.

Thanks. Good morning guys.

Good morning.

Was curious if you could give us kind of a second-quarter update on how you think the rebranding is going in terms of -- is it having the effect you intended? Is it helping the sales effort to a great degree? Just basically give us an update on what you're seeing and hearing from clients and prospective clients.

Sure. I can do that. In fact, our Executive Vice President of Sales actually went out to every office during the second quarter to try to get more of a direct qualitative gauge on that, and the report back was excellent in several ways. One, that we're getting the effect we were hoping for in terms of changing the initial dialogue with the prospect from a hill to climb to overcome the obstacle of describing what we're not, before you describe what we do, that we had with the previous brand.

And we're getting into much more productive discussion with our prospects earlier on. The name and the brand is more upbeat, and causing more and earlier, better discussions with our prospect base. So that was the main thing, and we believe that's really going well.

Then our next thing to see was to see whether that turns into more appointments and more census, and as I mentioned, our census per-rep count moved up considerably; that's a good sign. Once we get through our fall campaign, then we will do a market study to get a more quantitative look at how our brand is being perceived. But so far, we are very encouraged, and believe that this is a vehicle that's going to carry us a long way.

And then second question is -- and you touched on it earlier when you spoke about administrative burden relief rather than taking the business to the next level, but just curious if you have any additional commentary regarding Paychex and ADP posting PEO growth in their employee bases of 12% and 14%. I would have thought Insperity could have come in a little bit higher than it did. Wondering if you could shed some additional perspective on that.

First of all, I think that's a very good thing to see that our marketplace is growing, and I think both of those companies have figured out a way to market and cross-sell and upsell their client base into their PEO solution. And as far as I'm concerned, that just validates the strategy I've been describing to you this year, and why we're very excited about the future. This whole strategy is casting a much wider net, bringing customers into the family in some form or fashion, and we're able to take those in and then upsell them to accelerate our unit growth.

I also think something that weighs in, in this most recent period, is that we're in a transition, so this is like changing the tires, going 100 miles-an-hour down the road. We've got 3 out of 4 tires changed right now. And we've continued to grow nicely, not quite as fast as those have in the quarter, but also I think it's important to note that our proposition is different. It's not a save-you-money proposition necessarily, although over time it certainly is the most economical way to run the business. So we think it's a good thing that they're growing, and we think it validates our strategy.

Great. Thanks, Paul. Good luck.

Your next question comes from the line of Michael Kim with Imperial Capital.

Hi. Good morning, guys. Could you talk a little bit about the pipeline for mid-market, how that new business pipeline is looking? And if you could expand on the sales cycle and conversion? Thanks.

Thank you. Yes, we are very excited about the mid-market pipeline. If you'll recall, we've been really working on that sales process over the last couple of years, and we believe we're at a level of refinement that we're all very excited about, excited enough to start ramping up the number of business performance consultants that sell to the mid-market, of 150 or more work site employees up to about 2,000. As we sit here today, we do have the highest number of potential paid work site employees from new mid-market sales that we've ever had in our history, and we're very excited about that. You have to get through that.

You have to close them and bring them on, and so, as far as the cycle goes, it's a longer cycle. We would expect that this third quarter, at the time that we'll be closing a lot of the mid-market business, and really getting a better feel for how we're doing on that front, and that most of those sales will lead to January 1 start-ups or January 1 paid work site employees. So even though we're very enthusiastic and excited about the level of mid-market prospects we have very close to the closing point, most of those employees would enroll and be paid in January of next year, so they don't roll into this last half of the year.

And are you seeing some initial reception or stronger reception on the adjacent businesses, or is it primarily still core PEO?

We're still heavily focused on the workforce optimization solution as the centerpiece of that, but actually many of our adjacent businesses have a real attractiveness to mid-market customers. And we also are continuing to see, even in the sales process -- one thing that I really like about the adjacent businesses relating to mid-market is that we're able to bring a customer on, on one of our adjacent businesses in the workforce optimization selling process.

For example, we have a high level of success with prospects using our recruiting solution on a standalone basis, while we're in a dialogue about workforce optimization. In some cases, it actually furthered the dialogue. Once we recruited a few people, then they said -- wow, this is really good, let's look at that full solution. And so, that, we think is very powerful and positive, and what we'll be doing this fall in this bundle-plus selling implementation is making that more of a process where we drive that behavior and incent that behavior.

Okay, and then switching gears to the guidance and your expectations for paid work site employees, is that growth primarily driven by net hiring by a comparatively smaller group of companies that are maybe pockets of growth doing better than maybe across the board, or how are you guys seeing that growth progress through the year?

For the balance of the year, we really have enough concern that there could be either layoffs exceeding new hires or very tepid offset between the 2 for the balance of the year. And that's just driven by the sentiment, by the fact that summer help may go away this time without being replaced. And we're seeing that kind of -- we look at winners and losers, or what we call gainers and losers in our base in terms of each -- from month to month, how many of our clients gain employees, how many lose employees? And then also we look at how much did the gainers gain on average, and how much did the losers lose on average? And we just think there's enough weakness in those numbers that it makes sense to be cautious about the last half of the year, and we hope we're wrong. And we have a good chance that our selling momentum and our client retention would even offset some decline in net hiring, but we just don't want to get out there and predict that, when you have these other factors that we really think it's prudent to weigh in.

I think that makes sense. Just lastly, on incremental rebranding expense. It looks like for the back half of the year, $0.05 in 3Q, and probably another $0.05 in 4Q. Do you see any additional incremental rebrand spending into next year, or does it essentially get rolled into the overall spending mechanism?

I really think by the time we get into the first quarter of next year, that we'll have the rebranding elements completed, and we'll be at more of our normal run rate of marketing and advertising, and we'll be beyond the rebranding incidental expense.

Great. Thank you very much.

Our next question comes from the line of Mark Marcon with Robert W. Baird.

Good morning, just following on the rebranding. The ad spend was a little bit less than what I was anticipating for this quarter, based on your prior comments. I was wondering, did you pull back a little bit on that as the quarter unfolded? Was that due to the sentiment that you were hearing from some clients? Or how should we think about that?

Not really. I mean, some of it's just going into the year, the exact timing of the ad placements and such weren't in stone, so there's been a little bit of slippage from one quarter to the next. For the full year, we're still expecting to spend about $12 million, which is a little bit down from the $13 million where we started the year. There's just been some movement between the quarters. For the second quarter, I think we spent between $1 million, $1.5 million less than where we initially forecasted Q2, which will just be pushed into the third and the fourth quarters. But for the full year, still spending the same incremental dollars.

Still an incremental $12 million?

Right.

Relative to a year ago?

Right.

Okay. And are there going to be more executions or different executions in the fall? What did you learn from the initial forays that could be optimized further?

We did, obviously did do some learning in the second quarter, shifting some of the dollars related simply to how long it takes to implement a lot of the stuff that we're doing. We were also able to shift some advertising dollars from that second quarter, where we thought we were getting enough exposure, and we can put those dollars into the fall campaign, and we think that's going to be beneficial as we look at the bundle-plus selling approach being implemented with a little bit stronger advertising support in the fall.

Great. So will we see different executions in the fall?

There will be a couple of adjustments. We have a couple of ads that will be coming out, both on radio and television, and we also are ramping up some of our search engine marketing programs. We saw a nice kick-up in the second quarter in some of that activity, and we just started it. So we're excited about the way that should feed into the picture as we go through the last half of the year.

Great. And then, can you talk a little bit about -- and I know it's not a new dynamic. We've seen it for quite some time. But just the regional variances with regards to the revenue growth. Looks like the northeast continues to do extremely well. What's driving that? It looks like the west is starting to come back, too. Can you talk a little bit about that? And then the areas where it's a little bit slower, what's driving that?

Sure. When you look at those regional numbers, our business is still driven mostly by our local sales office success, compared to the client retention in those areas. So it's really driven off of the number of salespeople we have in each of those areas, and where we put new ones, where we lose sales staff, and then how effective that sales operation is against the backdrop of terminations. That can still be somewhat choppy with a large customer loss over here, or one over there, but generally speaking, in answer to your question, I'd say the northeast has done well with some real strong sales operations going on up in that part of the country where we've got some good leadership and good things happening, and they deserve the kudos for doing a good job up there.

And on the west coast, we've had some good sales success out there of kind of re-established some good growth up in northern California as well, so things are going well in that area. And the areas where you have maybe not as fast growth, if we dig down a little deeper, you'd find that's where maybe the weighting of some of the terminations of accounts is still folded into year-over-year numbers.

Got it. And then with regards to the adjacent units, which ones are you seeing the strongest success from, and what are the expectations just in terms of that ramp again for the back half of this year, in terms of gross profit per work site employee stemming from that?

Sure. I'll let Richard fill in the numbers on the gross profit expectation, but in terms of more qualitatively how things are going, we've got -- I would say that -- I'm very, very excited about our HR cloud bundle, if you will, our Software-as-a-Service technology offerings that include our organization planning tool, our expense management tool, our time and attendance tool, and our performance management tool. And I believe that each of those tools have unique competitive advantages that put us in a very good spot.

Those businesses are also small, and when you put a 275-person sales operation as an engine on top of those businesses, you're going to see some really nice growth. Those are businesses with high margins, 85% to 90% margin businesses. The technology is robust, and you just start leveraging that as you put more users on the system. So I'm excited about those businesses, and how they weigh into the total picture of where we're going. And each of those applications also allow us an opportunity to offer a service on top of the technology, as we evolve down the road, that will help lead them into a more intimate relationship, hopefully ultimately a workforce optimization solution relationship.

So, as far as which ones are doing best, certainly our time and attendance has had the most new business directly from the workforce optimization solution, but that's one of the things we're going to be really interested in seeing as we go into the fall, once our business performance advisors are describing all of the solutions in the context to see what demand there is for each solution, and how we're able to convert those.

And the expectation that the gross profit per work site employee that would come during the second half?

Right. Yes, we've had -- I think gross profit's contributed $11 per work site employee per month for the first and second quarter, and as I mentioned in my remarks earlier, we see that actually increasing about $1 per work site employee per month for the balance of the year. So that's a positive. I think we had originally, at the beginning of the year forecasted that to be a little bit higher, but it's just because of all of the activity that's going on within getting these businesses to be able to support extra volume that we slowed down just a little bit there. And, one of the offerings has actually reduced our operating expenses, so it doesn't reflect up in the gross profit as much.

So $12 for the second half?

Yes.

Okay. Great. That's still good progress relative to a year ago.

Yes, absolutely. I think we were up $5 a year ago.

Thank you very much.

Your final question comes from the line of Michael Baker with Raymond James.

Thanks a lot. Richard, you indicated that in terms of the high dollar claims, that the majority came from COBRA. I was just wondering if you had a percentage of the dollar amount that was COBRA versus actives?

Let's see. It was about -- when we look at the large claims in total, it was about probably 20%, wasn't it? Yes, about 20% of the claims, the large claims this quarter were related to COBRA, which is a good-sized number.

Thanks a lot. Thanks for the update.

That's all the time we have today for questions. I would like to turn the call back over to Mr. Sarvadi for any closing remarks.

Thank you all very much for participating today. We look forward to continuing our business transformation, and moving into our fall campaign, and we look forward to reporting back next quarter. Thank you.

Ladies and gentlemen, this does conclude today's conference. Thank you all for participating, and you may now disconnect.