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Executives

Douglas S. Sharp - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance, Treasurer and Chairman of Enterprise Risk Management Steering Committee

Richard G. Rawson - President and Director

Paul J. Sarvadi - Co-Founder, Executive Chairman and Chief Executive Officer

Analysts

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

James R. MacDonald - First Analysis Securities Corporation, Research Division

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Insperity (NSP) Q3 2013 Earnings Call November 1, 2013 10:00 AM ET

Operator

Good morning. My name is Ginger, and I will be your conference operator today. I would like to welcome everyone to the Insperity Third Quarter 2013 Earnings Conference Call. [Operator Instructions] At this time, I would like to introduce today's speakers. Joining us are: Paul Sarvadi, Chairman of the Board and Chief Executive Officer; Richard Rawson, President; and Douglas Sharp, Senior Vice President of Finance, Chief Financial Officer and Treasurer. At this time, I'd like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.

Douglas S. Sharp

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

Now let me take a minute to outline our plan for this morning's call. First, I'm going to discuss the details of our third quarter 2013 financial results. Richard will discuss trends in our direct costs, including benefits, workers' compensation and payroll taxes and the impact of such trends on our pricing. Paul will then add his comments about the quarter and provide an update on our initiatives as we head into 2014. I will return to provide our financial guidance for the fourth quarter. We will then end the call with a question-and-answer session.

Now let me begin today's call by discussing our third quarter results. Today, we reported third quarter earnings of $0.39 per share, a higher-than-expected number, and associated cost of large health care claims contributed to these results being just below the low end of the implied EPS range from our key metrics guidance. As for our key metrics, paid worksite employees averaged 129,248 for the quarter, which was a sequential increase of 2% over Q2 of 2013, however, below our forecasted rate of 130,000 to 130,500. Gross profit per worksite employee per month averaged $251, which was below our Q3 forecasted range of $260 to $262 on a higher-than-expected deficit in our benefits direct cost center. The impact of the shortfall on these 2 metrics on Q3 earnings was partially offset by lower operating expenses, which totaled $80.3 million. We generated $25 million of adjusted EBITDA during Q3 and ended the quarter with $123 million of working capital and no debt.

Now let's review the details of our third quarter results. Revenues increased 5.5% over Q3 of 2012 to $540 million on a 2% increase in average paid worksite employees. And client retention remained high, averaging over 99% for the quarter. However, net hiring by our client base during the quarter was minimal and below trends experienced earlier in the year. Paul will share the details of our sales efforts, including our fall sales campaign activity, with you in a few minutes.

Now as I just mentioned our key pricing metrics, gross profit per worksite employee per month averaged $251 for the quarter or approximately $10 below the midpoint of our forecasted range. Benefit cost per covered employee came in at $908, a sequential increase of 2% over Q2 2013 and above our expectations. This was largely a result of a higher-than-expected number of large health care claims. While this health care -- while this higher claims activity was experienced during the quarter, the year-to-date increase in benefit cost per covered employee per month has increased just 4%. Richard will provide further details behind our health care costs in a few minutes.

Workers' compensation costs totaled 0.55% of non-bonus payroll in Q3, which was slightly below our forecasted cost of 0.58%. This quarter's costs included a $1.9 million reduction in previously reported loss reserves. Payroll taxes as a percentage of total payroll were 6.3%, which was relatively flat compared to Q3 of 2012. Gross profit contribution from our adjacent businesses came in higher than forecast, increasing 40% over Q3 of 2012.

Now let's move on to Q3 operating expenses, which totaled $80.3 million. This was about $4 million below the midpoint of our forecasted range due primarily to lower G&A costs and lower incentive compensation, which is tied to our worksite employees' gross profit and operating income targets. The year-over-year increase in Q3 total operating expenses of 1% included costs associated with our health care reform initiative and the recent ramp-up in a number of Business Performance Advisors. We averaged 302 trained Business Performance Advisors during the quarter, an increase of 20% over Q3 of 2012. Costs associated with these additional BPAs and other budgeted headcounts were offset by the lower incentive compensation, resulting in salaries and wages being relatively flat compared to Q3 2012.

Stock-based compensation increased 13% over Q3 2012. Consistent with our budget, our 2013 restricted share grant was at a similar level as that granted in 2012. With a 3-year vesting period, we have a lower-priced 2010 grant, which occurred during the economic downturn, being replaced by grants at higher price levels. Advertising increased by approximately 16% over Q3 2012 as we shifted the timing of marketing activities, as well as the level of advertising surrounding health care reform. Depreciation and amortization increased by approximately 14% due primarily to the amortization of recent system and software enhancements to support our Workforce Optimization solution and our more recent adjacent businesses.

Our effective income tax rate was 41% for Q3, slightly higher than our forecasted rate of 40% and contributing approximately $0.01 per share to our Q3 EPS shortfall. As for our Q3 cash flow, adjusted EBITDA totaled $25 million. Through the end of the third quarter, we have generated adjusted EBITDA of $74 million. Year-to-date, cash outlays have included the repurchase of approximately 594,000 shares at a cost of $17 million, cash dividends of $13 million and capital expenditures of $9 million. We ended the third quarter with $123 million of working capital, an increase of $7 million over the end of 2012. At this time, I'd like to turn the call over to Richard.

Richard G. Rawson

Thank you, Doug. This morning, I will fill you in on the details of our third quarter gross profit results, then I will comment on our gross profit outlook for the balance of 2013. And I will conclude my remarks with an update on how we see Obamacare affecting our gross profit picture in 2014.

As Doug just reported, our third quarter gross profit per worksite employee per month was $251 and was $10 per worksite employee per month below the midpoint of our range. The gross profit consisted of $191 of average markup, $45 of direct cost surplus and $15 from our adjacent businesses.

Now let me give you the details of each component. The $10 per worksite employee per month shortfall in gross profit was the result of an $11 per worksite employee per month shortfall in the surplus, offset by a $1 per worksite employee per month improvement in the contribution from our adjacent businesses. Our service fee component was right on forecast at $191 per worksite employee per month. Now the additional $1 per worksite employee per month of adjacent business gross profit came from better-than-expected revenues as we continue to see increases in both cross-selling opportunities and channel sales. The $11 per worksite employee per month decline in our surplus was the combination of the payroll tax cost center surplus being $1 per worksite employee per month lower than forecast, the workers' compensation cost center surplus being $3 per worksite employee per month better-than-expected and the benefits cost center's deficit was $13 per worksite employee per month higher-than-expected.

The benefits cost center's deficit was due to a combination of both lower-than-expected allocations and higher-than-expected costs. Now the lower allocations were a result of a fewer number of participants enrolling this quarter than what we had expected. Combined with a continued migration of participants to lower costs, meaning lower allocations for us, and higher deductible plans, meaning lower costs for us, the higher-than-expected benefits cost was due primarily to an unforeseen spike in our large loss claims paid in the quarter. In summary, this quarter's gross profit results were certainly not what we expected, but we have a plan which should mitigate some of this volatility for 2014.

Before we talk about 2014, let me tell you what we see for the balance of 2013, beginning with our markup. We expect our average markup to remain at the current levels for the rest of 2013 because there is typically not much change between Q3's average markup and the full year's average markup. Now let's look at the surplus component of gross profit, beginning with the payroll tax cost center. Based on our third quarter's results and our seasonal pattern of surpluses in this cost center, we will increase our forecasted surplus for Q4 by a few dollars per worksite employee per month compared to our last quarter's estimate.

Switching to the workers' compensation cost center. We began a new policy year on October 1. Historically, we have forecasted a slightly higher cost trend than the recently completed policy period and we conservatively forecast our allocations for new and renewing business to remain at their current levels. Then as we see how the incident rates and severity rates change based on delivery of safety services and effective claims management, we refine our estimates for each quarter. This is the same strategy that has worked for us successfully for 10 years. Therefore, as in prior years, we will forecast the same level of allocation that we currently get and conservatively increase our expense forecast to a range of 0.60% to 0.62% of non-bonus payroll, which slightly reduces the surplus in this cost center from our previous Q4 forecast.

Moving to the benefits cost center. We do need to adjust our expectations from our last quarterly call. As I mentioned last quarter, we continue to increase our benefits allocations. But as participants select lower-cost plan options, the total allocation amounts do not increase as much. Additionally, since the starting point of covered worksite employees for Q4 is lower than our previous forecast, our benefits allocation will be less than what we forecasted last quarter for Q4. On the expense side of the benefits cost center, we know that our costs go up each quarter throughout the year as participants' deductibles and co-pays are satisfied. As a result, we had previously forecasted an increase in benefits cost per covered employee of approximately 4% over Q4 2012.

The recent publicity surrounding Obamacare has added additional uncertainty surrounding cost and coverage. Even though our plans are unaffected, historically, health claim utilization increases when there is a fear of loss of coverage or anxiety over health plan changes. While we are doing everything we can to reduce this anxiety for our clients' worksite employees and their families, we believe it is prudent to adjust our forecast for Q4 from a 4% increase to a 5% to 5.5% increase in benefits cost per covered worksite employee over the same period last year. When you combine all of the forecasted direct cost surpluses and the higher deficit in the benefits cost center, we should generate a net surplus of $25 to $27 per worksite employee per month for Q4, which is $10 per worksite employee per month below our previous forecast.

Our last contributor to gross profit is our adjacent business services. If you recall, part of the reason we developed this additional profit stream was to add a third contributor to gross profit that doesn't have insurance-related volatility. We have made significant progress in 2013 toward achieving that objective. This contributor has steadily increased throughout this year and now represents more than 5% of our total gross profit for 2013. This additional gross profit contains a recurring revenue element which should continue to grow for a long time. In summation, when you combine the service fee markup, the surplus and the adjacent business contribution, we expect to reduce our fourth quarter gross profit per worksite employee per month to a range of $230 to $232. This reduction to our forecast is attributable to the higher deficit in the benefits cost center.

Now let's shift gears to 2014 so that I can outline our game plan to reduce this deficit in the benefits cost center for next year. To begin with, the introduction of the marketplace exchanges, both public and private, will provide new ways for us to manage the cost of our health plan. One of our bigger opportunities comes from being able to manage COBRA obligations differently. COBRA costs for Insperity will be over $40 million this year and represents 6.4% of our total claims costs. This cost comes from 3% of planned participants who will now be eligible for lower-cost coverage options and possible subsidies through these new exchanges.

In the exchanges, individual coverage is community rated. And the law has removed any exclusions for preexisting conditions, thus creating a new option for individuals to consider compared to the high cost of COBRA coverage. We are developing a proactive communication and assistance program through our Insperity insurance agency to help individuals understand and evaluate other insurance options. Every time we help a COBRA participant find a better option, they win and we reduce our deficit. Remember, a COBRA participant costs Insperity about 2.3x the cost of an active participant. However, we are only allowed to collect 2% above the rate charged to a COBRA participant, which covers about half of the actual expense to our plan. So reducing COBRA participation helps reduce our health care costs and the deficit dramatically. This new communication and assistance program will be offered to both existing participants on COBRA, as well as newly eligible participants. Implementing this program should permanently reduce our health care claims costs with the biggest impact being in 2014 as the number of participants is managed downward.

There may also be an opportunity to help our smallest clients find a less-expensive health plan option through the exchanges as part of our Workforce Optimization solution. In addition, companies with fewer than 25 employees may be eligible for the small business health care tax credit, which will only be available for employers that buy health insurance in the public exchanges. Because these smaller businesses have the highest health care cost volatility, transitioning them to the exchanges would also reduce our health plan cost volatility.

Finally, we have redesigned our packages of health care offerings for 2014 to encourage selection of more lower-cost options by our clients. We did not eliminate the richer plans, but we set up packages of plans that make it easier for clients to consider offerings with less-rich plans. If we are successful in helping accelerate this movement, the migration savings on the cost side of our equation could materially help us in 2014 and beyond.

At this point, I will turn the call over to Paul.

Paul J. Sarvadi

Thank you, Richard. Today, I'll provide a brief update on several initiatives focused on accelerating revenue growth in 2014. I'll also dedicate a considerable portion of my time explaining community rating for small businesses under health care reform and the sticker shock we expect to drive customers our way very soon. I will begin, however, by explaining factors which have caused a shortfall in paid worksite employees for the last half of 2013. The primary drivers falling below our expectations on our worksite employees in Q3 and rolling into Q4 were: number one, a lag in converting worksite employees sold into paid worksite employees; and number two, a soft spot in hiring we have seen in our client base.

2 of the 3 months this past quarter, the net change in new hires versus layoffs was negative. We previously budgeted a small tailwind from hiring at the rate we were experiencing in the first half of the year. The cumulative effect of this reversal compounds over the balance of the year and accounts for about 35% of the shortfall. This soft spot in hiring is consistent with survey results from our client base we reported today and other recent reports about hiring in the small business community at large. Therefore, we have adjusted our forecast to reflect weak hiring through year end.

The second factor relates to the timing of enrollment of sold accounts as sales activity ramped up in Q3. We achieved a 102% of our sales targets in the quarter. However, 50% of the total were sold in September as growth in the number of new trained Business Performance Advisors began to contribute to sales. Unfortunately, the later in the year sales occur, the more likely accounts will schedule their start date of January 1 of the coming year. In addition, we sold a large mid-market account in July that was originally scheduled to start in September, which was delayed to January. The good news is these employees are added to an impressive pipeline we're building for our all-important year end transition, which leads to the starting point in paid worksite employees in January 2014.

At this time last year, we had approximately 4,000 employees in the queue sold and scheduled to be paid by January, compared to over 6,200 today, an increase of 55%. In addition, our most recent information on activity associated with our fall selling campaign is very good. Since the kickoff, the number of discovery calls, which are initial face-to-face meetings with prospects, and the number of the business profiles, which provide the information necessary to bid Workforce Optimization, are increasing on pace to hit our campaign target. As we stand today, our number of potential worksite employees within current outstanding bids is up 18% over this time last year, reflecting the ramp-up in Business Performance Advisors. This number includes a solid increase from both mid-market and core sales teams and provides some nice momentum for our fall selling season. As expected, we achieved our goal increasing the number of trained Business Performance Advisors, an average of 302 for the third quarter, a 28% increase since the beginning of the year.

This is the centerpiece of our growth plan for 2014. Historically, growth acceleration follows a ramp-up in advisors within the 12- to 18-month training cycle for this position. In fact, the lag I just discussed reflects the decline in advisors over the last half of last year, while we retrained and retooled the sales organizations on our new selling system. In addition to growing the number of advisors, we are working on 4 other drivers to accelerate growth next year. They are: number one, growing our SaaS and other adjacent businesses; number two, refining our mid-market sales and service as a result of the ongoing pilot program; number three, developing substantial channel programs; and number four, capitalizing on the disruption of health care reform.

Our efforts to grow revenues and gross profit contribution from our SaaS and other adjacent business services are progressing very well and point toward a strong 2014. This quarter, the gross profit contribution from the portfolio grew 40% and SaaS seats grew at the same 40% rate on a year-over-year basis. The gross profit per worksite employee per month is a good representation of how these businesses flow into our overall business model. Last quarter, this metric reached $15 compared to $11 last year. This 36% increase points to the traction we are gaining in our adjacent businesses and the potential to contribute substantially to gross profit in the future.

Last quarter, I introduced our pilot program in our mid-market segment, expanding our offerings to include a total of 4 bundled HR solutions. We have continued to test these solutions in sales and retention of clients to approximately 150 employees and greater. Early indicators are very good that we have solutions that resonate with these customers that could dramatically improve our results in this segment. We've already saved accounts that we're considering termination and have a growing pipeline of new opportunities for these new offerings. Although we've had some good early response, it remains to be seen how much our year-end transition will be affected by this new pilot program. However, since the pilot is completed at year end, we will refine our messaging and organize resources in order to attack the mid-market opportunity in 2013.

Another growth initiative for 2014 is an emphasis on channel marketing and sales programs. Our suitability as a channel partner has been greatly enhanced by the wide array of business performance solutions we now offer. Since we have grown the sales staff and have our adjacent business ready to scale, effective channel partnerships can raise all shifts together. Our corporate general strategy will be a primarily focused on 4 key verticals, including accounting, technology, banking and a category which includes chambers, trade organizations and HR and insurance professions. Much of the foundational work to organize and execute on this strategy has been completed and our capability to develop a strong lead flow to channels should help accelerate growth in 2014.

The last major growth initiative for 2014 that I would like to address today is capitalizing on imminent health care reform changes in the small business marketplace. Tremendous opportunity for Insperity is on the immediate horizon due to the implementation of mandatory community rating. Small business group plans, policies effective from January 1, 2014, forward will be subject to community rating pricing requirements under the Affordable Care Act. Insurers will no longer be able to use drivers of cost to price the coverage, such as health claims experience and gender. In addition, the range in the difference companies can charge for factors they can consider, like age and tobacco use, will generally narrow from a range of 8:1 to 3:1.

This is exactly the dynamic we've all been hearing about all week, resulting in sticker shock in the individual market, which also requires community rating under the ACA. The younger, healthier individuals are seeing dramatic increases in coverage cost and scrambling to seek alternative. This dynamic is about to play out in the small business community for employers of 50 or fewer employees and will be expanded to 100 and fewer employees in 2016. So beginning this month and continuing for the next couple of years, our most attractive prospects from a benefits risk perspective will be receiving the increases in health care costs that may exceed the entire cost of our premium service. It is likely a large segment of our target market will be able to add our comprehensive services and eliminate the complexity and compliance of health care reform for less than the price increase they will receive from their carriers.

Insperity is uniquely positioned to benefit from offering our Workforce Optimization solution to small businesses and get the most for the money they will now be required to spend. A magnitude of this change is just beginning to emerge, as seen in the first of what I believe will be many articles on this subject, as insurers get past the early renewals they have moved into 2013 to avoid passing on the increases. Last week, several benefits advisors commented on the expected impact of community rating on their client base. And one estimated 75% to 80% of their small business clients will see increases between 30% and 105%. Although estimates vary and the exact numbers are not available, I believe approximately 60% of small businesses will see an increase of over 20%. But whether it's 30%, 50%, or 70%, it will still be a very large number of highly motivated prospects for Insperity. We are responding to this opportunity by positioning Insperity as a resource for businesses to deal with the complexity, compliance and now the cost of health care reform.

Yesterday, we announced the introduction of Pulse Check, which is now available on our website. Pulse Check is an interactive health care reform assessment tool specifically designed to help business leaders understand and prepare for the impact of the Affordable Care Act. In addition, we have provided new information on our site regarding the community rating change in 2014. This information will help our Business Performance Advisors explain the coming price increases that are about to hit the marketplace. During the third quarter, we also trained sales staff on the coming impact of community rating, and we are ready to react as this change is implemented. It's hard to predict how significant this could be to our growth next year. But I could not have devised a better way to get the attention of our most attractive prospects to seek a better solution. I also cannot imagine an offering better than Insperity Workforce Optimization to solve the health care reform-driven problems for small business.

In conclusion, let me just say we are disappointed in recent health claim levels and the lower worksite employee growth over the last half of the year and the associated lower earnings expectations. However, none of these short-term factors change our outlook for 2014 and beyond in any way. We are in a strong position to return to double-digit unit growth in the typical 12- to 18-month period following a double-digit growth in Business Performance Advisors. If we have a great fall campaign, the growth acceleration will be earlier in 2014. If the campaign is not as successful as we'd like, it will be later next year. Either way, we are excited about our growth prospects for 2014. At this point, I'll turn the call back over to Doug.

Douglas S. Sharp

Thanks, Paul. I'd like to now provide our guidance for the fourth quarter. We are forecasting average paid worksite employees in a range of 131,250 to 131,750 for Q4. This guidance incorporates the lower starting point coming out of Q3 and a continued trend of lower hiring in our client base through the end of the year. As Richard mentioned, we now expect gross profit per employee per month to be in a range of $230 to $232 for Q4.

As for Q4 operating expenses, we are forecasting a range of $81 million to $82 million, a slight sequential increase over Q3. We are estimating 25.6 million average outstanding shares and an effective income tax rate of 41% for Q4. This estimated tax rate excludes an expected tax credit associated with our investments in software development as allowed under a recent interpretation of IRS guidelines. We will be finalizing this project in Q4 and, therefore, expect to take a tax credit of $2 million to $3 million associated with software development activities dating back to 2009. Going forward, we would expect a reduction in our effective tax rate of approximately 1% associated with this spread at the current software development levels.

In summary, our updated key metrics guidance implies a range of 2013 full year earnings per share of $1.35 to $1.40 or approximately $0.20 per share below our previous guidance. This expected shortfall is generally split evenly between the forecasted lower level of paid worksite employees and the higher deficit in our health care plan. As Paul mentioned, we are now focused on closing out a successful fall sales campaign and year-end renewal period. We look forward to a strong 2014, and we'll be providing detailed 2014 guidance in our next earnings call.

At this time, I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] You do have a question from Tobey Sommer from SunTrust.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

It sounds like you've got a lot going on, a lot of developments and seeing some interesting progress. My first question has to do with the health care assumption, so maybe it's for Richard. Do you assume a higher level of health care expenses from this kind of recent trend of large number or larger health care claims?

Richard G. Rawson

Yes. But our forecast, we believe that it's possible that there could be increased utilization in the fourth quarter, which would reflect just the normal utilization being stepped up, as well as potentially a step-up in large loss claims. We can't -- you just can't tell. But really it's all centered around the mindset that we've seen over the years when people get concerned about their health plan or potentially losing it or changing or whatever. They say, "Well, I know what I've got right now, so I'll go get this taken care of or I'll go get that taken care of." And they do it in the fourth quarter because, anyway, the new year starts a restart on their co-pays and their deductibles, so there's already a natural tendency to do that. But we believe it's possible it could even be more accentuated this quarter.

Paul J. Sarvadi

Yes. A lot of that anxiety goes away once the -- if there's a new card in their hand for the next year.

Richard G. Rawson

Yes.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

And Paul, for the metrics you've seen so far for the selling campaign, and I know it's early, what would you point to as the most encouraging and maybe most concerning elements of what you can see so far?

Paul J. Sarvadi

Sure. The most encouraging would be, of course, that you have a 20% increase in the number of advisors on a year-over-year basis, a 28% increase since the first of the year. So you start looking to see if the activity tracks that. We have a 20% increase in the year-over-year number of trained advisors and an 18% increase in the number of outstanding worksite employees in the business. So that's perfect, exactly what you want rolling on through. You add to that, that we have a really strong increase in the number of worksite employees that are in the queue that will be paid by January. At 6,200-plus instead of 4,000 a year ago, that is obviously -- that's the whole point right now is to build that pipeline of employees flowing into the paid count in January. So we're off to a good start there. On the other side, we're always in that nervous point, as you come towards the end of year and don't know how terminations are going to go. We obviously have had great results this year on client retention, 99% again this quarter. But the big toss-up in the air is how well we do over the balance of the year. With our new approach to mid-market, we've had some successes, such as the pilot program just started. We feel really good about that going forward. But it's hard to turn that ship in just a 1-year period. So we'll see. We'll see how we do. The range of our possibilities is still wide and it always is at this time of year. So we'll be working diligently on that. Like Doug said, that's the focus, the selling and the retention.

Operator

Your next question is from Jim MacDonald from First Analysis.

James R. MacDonald - First Analysis Securities Corporation, Research Division

Paul, you mentioned that whether it's early or whether it's later, you expect 2014 to be a good year. What kind of factors could result in an earlier or later result?

Paul J. Sarvadi

Well, mostly it's just a result of this fall campaign. If the starting point is better, how that rolls in our recurring revenue model, it just gets you off to a better start for the year. And if the ramp-up is later in the year, then we don't make quite as much profit on companies that come on later in the year in that year. But as far as growth rate, it's -- the normal is 12 to 18 months after you have a double-digit growth in the number of reps you see it flow into the employee count. The second quarter was the first quarter that we had an increase in trained advisors that hit 10%. So if it happens sooner than that, than the 12 months, it's because we had a great fall campaign. If it happens a little after than that, it's still on track.

James R. MacDonald - First Analysis Securities Corporation, Research Division

And you talked about your mid-market initiative. I think some of that also involved more unbundling. Any idea of what impact that could have on gross profit because it's a less bundled offering?

Paul J. Sarvadi

Well, actually, it is not really less bundled, it's 4 total bundles instead of selling 1 all-in comprehensive bundle. It's 2 versions of co-employment, Workforce Optimization and workforce synchronization, that simply allows a customer to have a little more control over project-related HR cost. And there's pros and cons to that. In the all-in Workforce Optimization, your speed of delivery, speed of execution is way better because there's no pricing of every project and trying to decide when to do it and the decision-making process. So in the workforce synchronization, you have lower cost and more control over incremental cost, but you have slower execution potentially. So there are tradeoffs there. But on the other side of the non-co-employment offerings, we have workforce administration, which is -- takes our HCM product as the centerpiece, adds time and attendance and payroll service, and then also adds HR services that are through a call center and HR support and some other services as well. But that base offering, we think, is a fantastic entry level. We've got a lot of interest in that -- in this pilot program as a way to bundle some of these maybe new services that we've developed offerings into a nice introductory bundle. Now some customers will want to go beyond that to a higher level of service, add benefits that would be through our insurance agency and have the flexibility to have their benefit designed however they want to, but they want a more comprehensive service and we have that available now through workforce collaboration. So early interest is good on that front. We are managing through how that's presented. And that's what we're learning right now, exactly how the sales process works, how this works with renewing accounts to either validate their current buying decision or put them into another offering. There's a learning curve to that.

James R. MacDonald - First Analysis Securities Corporation, Research Division

So as a follow-up, I guess, my question is so the latter 2 options you just described, would those be considered ABU revenues? Or would those be considered worksite employees with a lower gross profit?

Richard G. Rawson

They would be ABUs.

Paul J. Sarvadi

[indiscernible] ABUs. We'll be evaluating how all this comes together into our financial picture and how to best assess that as we move forward.

Richard G. Rawson

Yes. What could happen, dependent upon the volumes and, of course, we've don't -- I mean, it's too early to tell. But if you thought about it in terms of the average markup might go down slightly on the ones that go to those other 2 traditional employment offerings. But the gross profit on the ABU side would go up, so...

James R. MacDonald - First Analysis Securities Corporation, Research Division

Right. And if you had to hazard a guess, any idea? Or potentially 20% could go to the last 2 offerings or any idea what's the mix might be?

Paul J. Sarvadi

I don't think we'd lose any Workforce Optimization customers to any of those that were that really that extensive [ph] -- but I mean, we've seen that already, it really validates their decision. But for those that would have otherwise left us, so this is all upside because they would have been gone. And to keep them in one of those is definitely new upside. We are managing through -- and this is why it's a pilot program and didn't get moved out more dramatically, because we want to make sure that you manage any of that migration because you don't want to cause some cannibalization and things of that nature. So we're carefully working our way through it. And so far, we feel good about how that's coming together.

James R. MacDonald - First Analysis Securities Corporation, Research Division

Okay. And then just quickly, 2 questions on the Affordable Care Act impact. Do you think that has impacted your customers' ability to make a decision here on your services, all the confusion around there right now? And second of all, you mentioned a private exchange. Will you have your new customers have access to a private exchange as an alternative?

Richard G. Rawson

Let's start with private exchange. I mean, we're looking at that as a potential option. But at this stage of the ballgame, it's really not necessary. And so we haven't seen anything that causes us to want to move in that direction and bear that expense to get that set up. But we're monitoring it very closely. And this is really all about the public exchange that may present quite a few options for our folks.

Paul J. Sarvadi

There are also enough private exchanges being formed, where if we need to work with someone else on that, that may be a better approach. So we're keeping all the options open. We do think it's important they'll be able to support any customers who might be better off in that environment. So we're -- specifically even the smallest of the small that might even get a tax credit. We estimate about 15% of the companies under 25 employee level may be eligible for a subsidy or a tax credit, it's actually for coverage in an exchange. You have to buy through the exchanges as of January 1. So we won't ready to support that if that's a better option for people. I forgot your first question already.

James R. MacDonald - First Analysis Securities Corporation, Research Division

So the first question was is the ACA impacting your customers' timing of their decision?

Paul J. Sarvadi

Yes. I think there's been a lot of craziness, as you know, in the marketplace and people are trying to figure out how they're going to be impacted. And so yes, there has been some. But our sales came in, so we were 102% of our budget that came in later in the quarter than expected. So I don't know if that's driven by the health care reform or the economic climate. But it did come in a little later than we normally would see in a quarter. However, the biggest sense of urgency is just now about to hit. We want to make sure our investors really understand this. The community rating that begins the policies effective January 2014 and on, that is going to be a huge driver for our most attractive prospects from a benefits selection point of view. And the reason that hasn't hit yet -- it's just now hitting, we are now seeing substantial increases that prospects are receiving from their carriers. But the strategy that most of the carriers used was to take their January renewals and move them into December, so they could avoid handing this 20%, 30%, 50%, 70% increase to their best customers. So now that the February renewals will have to be delivered to people soon, in the next 30 days or so, and those folks, there's no way to move all of them into December this year, so we are just now starting to see the sticker shock and the disruption that is about to occur in the small business community, the sweet spot of our core. So these customers with 10 to 50 employees, they're going to need some serious help. And the better prospect they are for us, the more likely their increase is more than enough to pay for our entire service. So we'll be going after them and saying, "Look, if you have to pay more, what are you getting for that? Why not get a complete infrastructure, better benefits and have an opportunity to make that money back by having your business run better, grow faster?" So the whole point is to make more money. And I don't think we're uniquely positioned to address that.

Operator

Your next question is from Mark Marcon from Robert W. Baird.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And I was wondering, Paul, if you could just give just a little more granularity with regards to the last comments that you were providing. Like if you gave an example of, say, a 10 employee company, say, that they are one of those 60% that's going to see a 20% increase, how much would they typically would they end up seeing? How much would be absorbed by the employee versus by the company? And how does that match up with your total expense? And then how quickly do you think a business owner would be able to react to that? It seems like that would just cause another level of paralysis, at least initially.

Paul J. Sarvadi

Well, they will react very quickly. And once they get up off the floor, then they'll start to say, "What do I do about this?" Let me answer your question directly with an analysis I've done that is a depiction. There's no way to precisely pin this down because it varies client-by-client, account-by-account and all the specific factors of their business profile. But if we use averages, if you use the Kaiser Permanente average cost for a small to medium-sized business benefit plan for 2013 and if you look at just the employer paid portion, that average cost is $982 per employee per month, per covered employee per month. Now if you -- under the former rules, the way you can price accounts prior to 2014, where you could look at experience, you could look at gender, you could look at age, you could look at a whole list of other things, geography and so forth, under those rules, there was an 8:1 ratio around pricing. That gave you a price range off of the average that would go from basically around $218 per employee per month all the way up to $1,744 per employee per month. That's a wide range. Now what's happening under the Affordable Care Act is a compression related to the range and the factors that you can use to price coverage. So you can no longer use actual claims experience, which is actually the biggest driver of cost, and you can no longer use gender. You can still use age, you can still use tobacco use. But the range from the lowest to the highest price, a factor that you used to determine the price, can only be 3:1. So what happens is that compresses the range between the lowest price and the highest price plan. So taking an average of $982, I'm just using that average, that published average, and if you look at the cost increases going in place for 2014, there are 2 factors you have to consider this year. One is the normal trend in health care, which were small businesses, the best numbers we can see out there that are being used are around 6% to 7%. Then you had to add the tax and penalty -- or I'm sorry, tax and fees that are going into effect in January for all plans that are coming through insurance policies that add up to about 3.5% to 4% of premium. So you're looking at 9% to 11% increase in cost. So if no community rating was happening and everybody just got those increases, you'd go up from $982 to almost $1,100, over $100 a month for that type of plan. However, if you are on the low end of price today, where you are only paying, say, $218, the lowest increase you might receive would put you at $545 a month. So our most attractive customer would be getting an increase of over $300 a month. So if you look at -- if you're in the average, that is going up -- I believe, you've got about 60% of the market, the best I can tell, is going to have an increase of $100 to $300 per employee per month. And although obviously, it entirely depends on the specifics of every account, but I'd tell you what, over the next -- we'll start now and we'll continue through next year for customers with fewer than 50 employees. They're going to receive these types of increases. And then shortly thereafter, it starts on customers from 50 to 100 employees. So for the next -- our outlook is really strong because we believe this is going to drive people to look at options. And we are a tremendous option because at least we can get them a lot more services and a lot better opportunity for them to make this money back by coming on our service. They're going to use the same dollars and buy our service instead of just paying more money for less coverage.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And so this would -- so there would be a subsector of this group where it would be optimal. Because I mean, when I take a look at your average benefit cost per month, if we compare it to -- if there was a company that was comprised of entirely of people who were getting the low end, how would your benefit costs compare to that?

Paul J. Sarvadi

Well, remember, our cost is an all-in proposal. And so it's the full value of the service, which adds up all the costs related to being an employer and that you pay for an HR department. And so when you take our cost of the payroll taxes, workers' comp, benefits, our markup for our service, employment practices, coverage, all that, that typically ends up costing a potential buyer around $100 a month above their cost. And they get administrative relief, better benefits, reduced liability, a technology platform and a systematic way to improve productivity. That's the value proposition. But it typically costs someone $100 per employee per month above their cost, even though our markup is $200. So that's $200 above our cost or if you look at gross profit, $250 or so above our cost. So what I'm saying is that most customers when they analyze this, they see a cost above their current cost of about $100 and they justify that on getting rid of a lot of administrative stuff, sometimes having improvement or at least a better opportunity to manage benefits. They see nice technology infrastructure to help them. And they think they can make more money doing business this way. But now for a 60% of the marketplace, the mandatory increase is equal to the difference, so...

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And for the exact same type of health care plan?

Richard G. Rawson

Right.

Paul J. Sarvadi

Or better.

Richard G. Rawson

Yes. Or better, in a lot of cases.

Operator

This concludes our Q&A session. Mr. Sarvadi, do you have any closing remarks?

Paul J. Sarvadi

No. Just to say thanks for everybody for participating. And we look forward to getting through our year-end transition and giving you information about 2014 on our next call. Thank you all very much.

Operator

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

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