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Administaff, Inc. (ASF)

Q2 2007 Earnings Call

August 1, 2007 10:00 am ET

Executives

Doug Sharp - Chief Financial Officer

Paul Sarvadi - Chairman of the Board, Chief Executive Officer

Richard Rawson - President

Analysts

Tobey Sommer - SunTrust Robinson Humphrey

Jim Macdonald - First Analysis

Thomas Giovine - Giovine Capital Group

Mark Marcon - Robert W. Baird

Kevane Wong - JMP Securities

Presentation

Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2007 Earnings Call. My name is [Angelique], I will be your coordinator for today. (Operator Instructions) On your call today, we have Mr. Paul Sarvadi, Chairman of the Board and Chief Executive Officer, Mr. Richard Rawson, President of the Company. I would now like to turn the call over Mr. Doug Sharp, Chief Financial Officer. Please proceed sir.

Doug 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, goals, 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 our second quarter financial results. Paul will add his comments about the quarter and on our outlook for the remainder of the year. Then Richard will discuss trends in our direct cost including benefits, Workers’ Compensation and payroll taxes, and the impact of such trends on our pricing. I will return to provide financial guidance for the third quarter and the remainder of 2007. We will then end the call with a question-and-answer session.

Now let me begin by summarizing the financial highlights from the second quarter. We reported a 35% increase in second quarter earnings per share to $0.50. This was significantly above our expectations, primarily as a result of higher unit growth and gross profit for worksite employee. The average number of worksite employees paid increased 9% to a 108,336 for the quarter, above the high end of our forecasted range of 107,750.

Continued pricings strength for our HR services combined with favorable outcomes in each of direct cost programs resulted in an increase in second quarter gross profits for worksite employee per month from $228 in 2006 to $241 this year. These results also significantly exceeded our forecasted range of $221 to $225.

Operating expenses came in at forecasted levels with the exception of an additional accrual for incentive compensation tied to the achievement of higher operating results. Our working capital position remained relatively flat compared to the first quarter at approximately a $119 million, even though we repurchased the million shares during Q2 at a total cost of approximately $35 million. Now let’s review the details of our second quarter results.

As I just mentioned the average number of paid worksite employees per month increased 9% over the second quarter 2006 from 99,839 to 108,336. Unit growth exceeded our forecasts due to the contributions from our unit growth drivers, including sales and net growth within the existing client base. Paul will provide further details on these drivers in a few minutes.

Second quarter revenues increased 12% over 2006 to $377 million as a result of the 9% increase in average paid worksite employees, and a 3% increase in revenue per worksite employee per month. Looking at second quarter revenue contribution and growth by region, the Southeast region which represents 11% of total revenue grew by 10%; the Northeast region which represents 20% of total revenue grew by 20%, the Central region which represents 14% of total revenues grew by 10%, the Southwest region which represents 34% of total revenues grew by 14% and the West region which represents 21% of total revenue grew by 2% and was impacted by the loss of a large mid market client during the 2006 year end client renewal period.

Now let's move to gross profit, which was obviously a strong contributor to this quarter’s result. As I mentioned earlier, gross profit per worksite employee per month for the quarter was $241, up from $228 reported in Q2 of 2006 and significantly above our expectations. While we continue to effectively increase the markup on our HR services, the upside of the quarter was generated from our direct cost programs.

First of all, our workers’ compensation program continues to generate positive results. Our effective management of both the number and severity of claims has given us the ability to offer lower pricing to our clients and prospects, while also contributing to our bottom line results. Workers’ compensation costs were 0.52% of non-bonus payroll for the quarter, below our forecasted range of 0.75% to 0.80%.

Actuarial loss estimates continue to reflect our favorable claims trend and resulted in a $6.4 million reduction in previously reported loss estimates. This reduction is generally consistent with that reported in the previous quarter. Secondly, benefit cost came in slightly better than expected. On a per covered employee per month basis, cost increased 6.4% over the 2006 period to $656 and included the expected $3.3 million reduction in administrative costs negotiated under the new United Healthcare contract.

A third piece of good news was the receipt of $2.9 million unemployment tax refund from the State of Texas during the quarter. You may recall us mentioning in last quarter’s conference call, that state funds were generating surpluses due to continuing low unemployment levels. We anticipated that statutory requirements would mandate return of these surpluses to employers through either lower rate of tax credits. The receipts of these monies resulted in a decline in payroll tax costs as a percentage of total payroll from 7.45% in Q2 of 2006 to 7.14% in Q2 of this year.

In a few minutes, Richard will provide further detail on this quarter’s positive developments and the expected impact on direct cost trends in pricing for the remainder of 2007.

Now, let's move to operating expenses, which increased to 11% over Q2, 2006 to $60.2 million. This was approximately $2 million over the midpoint of our expected range, which reflects the amount of an additional accrual for incentive compensation tied to our improved operating results.

On a per worksite employee per month basis, operating expenses increased from a $181 in Q2 of 2006 to $185 this quarter. As expected, stock-based compensation costs increased by $4 per worksite employee per month as a result of the annual restricted share grant to employee. Otherwise, increases in cash compensation and advertising costs were offset by lower G&A and depreciation cost.

As for the net interest income, we reported approximately $3 million for the quarter. This is at the low end of our expected range due primarily to the utilization of invested funds in executing our share repurchases. Now let’s review several key balance sheet and cash flow items.

We ended the quarter with approximately $119 million of working capital, and only $1.5 million in debt. During the quarter, we generated $25 million of EBITDA and received $24 million of excess funding from our workers’ compensation program. Cash outlays included share repurchases totaling a million shares at a cost of $35 million, cash dividends of $3 million and capital expenditures of $4 million.

As of today, we have a 1.55 million shares remaining for repurchase under our authorization. Now before providing financial guidance, I would like to turn the call over to Paul.

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Paul Sarvadi

Thank you, Doug. In my part of the call today, I’ll discuss several factors contributing to our continuing success growing our core business. I’ll also describe progress we have made, re-engineering our middle market strategy to improve results and to take advantage of the significant opportunity represented by this segment.

In addition, I'll provide some insight into new opportunities we are also investing into the future, centered around our HRTools business plan. Over the first half of this year we’ve experienced strong unit growth in our core business, offset by a decline in the middle market segment for our clients above the 150 employee level. The number of worksite employees in our core business increased by nearly 8% in the six months from December 2006 to June 2007.

Over the same period, the middle markets bottomed out at a 15% decline from year end in March before recovering nicely in the second quarter to only a 6% deficit by the end of June. On a year over year basis, our 9% unit growth this quarter was a combination of an 11% growth rate in the core business offset by a 4% decline in the middle market. Currently the middle market is 12% of our base and the core is 88%. Now, before I describe our plan to remedy the mid market segment, let me take a few minutes to highlight the strength of our core business growth.

During the second quarter we averaged 254 trained sales personnel, up 7% over the same quarter last year. This team however, is substantially more experienced due to the reduction in turnover, from 40% one year ago to 30% today. In fact, the number of trained sales personnel with more that twelve months tenure with the company, is up more than 25% over this period and the number with more than 18 months has increased over 20%. The benefit of this level of experience is just beginning to appear in our growth results.

We exceeded our paid worksite employee target for the second quarter through strong conversion in the paid worksite employee from sale and better than expected net gain and employment within the existing client base. Offset by slightly higher than expected client attrition.

Early in the second quarter we implemented a plan to improve visibility and successful conversion of sold accounts in the paid worksite employee. This plan included linking the timing of payments to first payroll and establishing a contact program with new accounts, during the pre-involvement period to smooth in the onboarding process. The result has a better throughput than those paid accounts and a substantial improvement in visibility of first-time paid employees.

Our small business client had a good quarter in hiring much needed new staff and also added summer help, which was evident in the net gain in the client base in June. This net gain was also facilitated by an increase in the effectiveness and efficiency in our recruiting divisions.

Since the establishing of the recruitment centre of excellence at the beginning of this year, the number of new hires per recruiter has nearly doubled from approximately four per month to nearly eight per month and in total over 1600 new hires were placed, in the first half of 2007 by our recruiters adding to our worksite employee growth.

Client attrition in the second quarter was acceptable, but slightly higher than our historical 1.5% for month. Attrition for April, May, and June was 2.0%, 1.3%, and 1.8% respectively, averaging 1.7% for the quarter. Service satisfaction rates remain high at 90% overall satisfaction for the quarter.

Now, I’d like to take a few minutes to address our new plan for the middle market. As I mentioned on our last call, during the first quarter we conducted an in depth analysis of our strength, weakness, opportunities and threat within sales, service and infrastructure for our mid-market segment. This analysis was the foundation for reengineering the sales process, the service model, and the financial model for this segment.

This specific items identified in the resolution are proprietary and too numerous to recount on this call. However, there are four basic issues that have been addressed in the new model. They are relationship management, full service perception, service delivery complexity and unwanted bureaucracy. Besides, the nature of these middle market clients' typically involved higher numbers of decision makers and influences that make the buying and renewal decision than in our core business clients.

We have implemented a metrics relationship management model in both sales and service to address this need. We have also developed our lower based training program intended to improve communication and deepen relationships at various levels in the prospect organization.

The second area we addressed was the difference in the perception of a full service HR department for middle market accounts compared to our core counts. When we say we are full service human resource department for your company, a middle market client envisions a broader array of services than the small business account. This created a service gap perception that we documented and resolved. Going forward, will see us having a much better fit between mid-market client expectations and our services provided.

In this process, we also evaluated the actual impact we had on our mid-market client that we served, both the successes and the failures. Out of this process, we developed a new service model, structure, contract in process to address the uniqueness and complexity in these accounts. Changes include establishment of a separate business unit for the segment, which we refer to as a center of excellence.

We also have created a new high level service position as a single point of contact to facilitate the implementation of the service plan. And in addition, we plan to add and reorganize resources to improve responsiveness and effectiveness serving these larger accounts.

The new model includes implementation of best practices for fundamental, programmatic and strategic HR services over a longer period than our previous one year contract. The clients of this size implementation and impact is more comprehensive and our two-year plan makes more sense for both the client and service provider perspective. As a result, we have created a new two-year contract centered around implementation and progress reporting on the unique service plan designed for the mid-market account. This contract became available at the end of June and is now in place with two brand new clients sold in July.

And lastly, we address the multitude of bureaucratic issues that have evolved overtime and became a source of frustration for clients and service providers. Although, these issues were more prevalent and frequent in large accounts, they are also experienced throughout our core business. Resolving this issue should increase client satisfaction and help retention across our entire client base.

This mid-market reengineering effort has been very enlightening and our chance to be successful in this segment has been greatly improved. However, these changes do not come without some investments. We expect to increase our operating expense by approximately $3 million from now through 2008 to make these improvements.

That will take a considerable length of time to determine how successful we'll be ultimately in this space, and the return on this investment. We will measure the sales changes after a sufficient number of prospects go through the pipeline, most likely next spring.

Implementation of the new service model will be evaluated in the back half of 2008, and what's the number of clients have been in enrolled and the service plans have been implemented. And finally, we will take a number years before renewal rates can be determine, due to the new two-year initial contract period.

We consider this new mid-market plan a good investment with the potential to turn our unit growth detractor into our unit growth contributor. As per profitability, we validated the operating income for worksite employee on this segment of our business last year to be about 10% to 15% higher than the core business. We expect the cost of the improvements to lower operating income per employee within this segment, and be more in line with the core business over the next 12 to 18 months before returning to 2006 levels.

The second investment decision to discuss today is our business plan we have approved for HRTools. Many of you are familiar with our effort to demonstrate our HR expertise and extend our brand through HRTools.com and our subscription in this stock HR Point Solutions. These solutions provide four separate applications to perform HR testing including creating job description, completing performance reviews, developing employee handbooks, and an application call People Manager, which maintains information about employees.

Our priorities for this enterprise beyond branding have been to provide leads for our PEO offering and secondarily to provide a new source of revenue and gross profit for Administaff. The thorough review of the assets we have and the market opportunities in this phase has resulted in a new business plan for a venture worthy of an investment.

In addition to the product and website, the user base for this product has grown substantially. We currently have over 250,000 registered users of HRtools.com, more then 167,000 users with online applications and over 92,000 previous purchasers of the desktop product.

The opportunities we see here is to rewrite the product offering into an integrated package that can be sold either as a desktop solution or as a software as a service model. This integrated package would use People Manager as the foundational element in each other applications, which shared this basic information. So as an example on employee job description would be the basis for the annual performance review and the record would be maintained in the system.

What's rewritten is all current users would be prior candidates for the new offering and an additional opportunity would be created for our core PEO businesses. The new software as a service offering would be provided to our PEO clients as a service enhancement to our employee services center applications currently provided to the Administaff clients. This should be a valuable new addition to the service provided, that can stay with the client if they exit our offering, continuing an income strength for Administaff.

We expected best approximately $3 million over the next 12 months in this venture, of which approximately two-thirds would be capitalized and other one-third expense. The revenue potential outside the PEO is significant and the ongoing revenue stream from software service users including current existing clients could be substantial.

Let me finished my comments, with our outlook for growth over the balance of 2007. Year-to-date, we've averaged an increase of slightly more than 1000 employees each month. However, the second quarter averaged over 1500 employees, as our middle market termination stabilized paid sales number improved and we experienced some net growth from new hires.

If we use those two extremes of 1000 to 1500 employee per month, you would essentially land in the range for our guidance that Doug will provide for the third quarter and full year. At the mid point of this range, we would see acceleration each quarter over the balance of the year in our growth rate and return to our double digit unit growth rate that we had historically.

It's important to note that the experience with which we are charge staff has responded to the bumps in the road we experience at year end. This shallow dip and quick recovery in our growth rate is a tribute to them. We had a similar effort by our staff managing the direct cost and their results are equally impressive.

At this time I’ll pass the call to Richard to provide details about these direct cost results.

Richard Rawson

Thank you, Paul. This morning I am going to discuss the details of our second quarter gross profit results. Then I will explain how our pricing strategy and direct cost trends should shape our gross profit per worksite employee per month for the balance of this year and into 2008.

As many of you know our gross profit comes from the markup on our HR services, combined with the surplus that is generated when our direct cost pricing allocations exceed the corresponding direct costs.

For this quarter, our gross profit per worksite employee per month was $241, significantly above our forecasted range of $221 to $225. These results came from achieving our targeted average markup for the quarter of $200 per worksite employee per month and generating a surplus of $41 per worksite employee per month, a 3.6% of the total markup. This surplus came from contributions in all three of our direct cost centers, which are payroll taxes, workers' compensation and benefits. So, let me give you the detail.

The surplus in the payroll tax cost center came primarily from the State of Texas unemployment tax refund that Doug had mentioned a few minutes ago. Last quarter, I had mentioned the possibility and we might be getting a refund due to the increased level of surpluses in state unemployment tax funds. So, we were not surprised when we got a refund check in the mail. Without this refund, we still generated a surplus in this cost center, but not quite as much as we had forecasted. In this case, that's a good thing.

Remember, after the first quarter of the year, if we are growing faster than we forecasted, we will have more payroll tax expense than our allocations for each new employee until their wages exceed the state unemployment taxable wage base.

Since, we did grow faster this quarter, we had more expense than our allocation, but that situation typically reverses itself in the future course. I'll refer back to this topic when I discuss the outlook for the balance of 2007 in just a few minutes.

Our second contributor to the surplus in this quarter came from the positive results and our workers' compensation program. These results occurred because our claims management personnel continue to settle workers compensation claims for amounts lower than expected.

Additionally, we experienced lower than expected incidence and severity rates associated with the current policy year due to our ongoing safety programs. Again this quarter just like last quarter our incidence rate is down almost 8% on a worksite employee base that has grown 9% and our severity rate associated with these claims is down almost 6% over the last year.

As a result our workers' compensation expense was lower than expected at 0.52% of non-bonus payroll. Our third contributor to the surplus this quarter came from slightly better than expected benefits cost, if you remember for the last two quarters our benefits cost has been at or above the top end of our expected range. The primary reason was because we experienced a significant increase and our large lost claims over $50,000 in the fourth quarter of last year followed by an increase to our reserves in the first quarter of this year to cover the run out of those claims.

For the second consecutive quarter, we have seen a further reduction in the number of large lost claims, such that our trend has settled back into our historical range. The average large lost claim is still a bit higher than we would like to see but that number was driven by a very few really large claims.

A final result is that our healthcare claims during the second quarter were $2 per covered employee, lower than what we had expected at the midpoint of our range for the second quarter.

In summary our strong gross profit results this quarter increased our likelihood to have another very good year. Now, I would like to update everyone on our outlook for gross profit for worksite employee for month for the remainder of 2007 and going into 2008. Let me explain each component beginning with pricing.

We are well in our way to achieving our targeted average markup on HR services, at $200 per worksite employee per month by Q4 of this year. Since we have added more new business than previously forecasted, the pricing for new business typically reduces the average on the whole book of business. Therefore, we should average somewhere between $200 and $201 per worksite employee per month for the full year, which is up $2 to $3 over last year. The demand for our service is still very high and renewal pricing in the second quarter increased to slightly more then $6 per worksite employee per month.

The second component of gross profit for worksite employee per month comes from the payroll tax cost center. A few minutes ago I mentioned how payroll tax expense in the corresponding billing allocation work in our model. Faster growth later in the year can reduce the surplus for a quarter or two. Since we are experiencing slightly faster growth, we should see a lower surplus in this cost center in Q3 and Q4, than our previous forecast.

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As for 2008, the surpluses in the payroll tax cost center should increase. A primary reason for the expected increase comes as result of the surpluses that are sitting in many state unemployment employment tax funds. Therefore we should be giving lower unemployment employment tax rates for 2008.

And from an allocation perspective, we could see a moderate decline at the beginning of the 2008 commensurate with this lower state unemployment tax rate, but the overall surplus should increase in 2008, over 2007.

Our third component of gross profit comes from our workers’ compensation cost center. The better than expected incidences in severity rates that we have experienced throughout this policy year, coupled with effective claims settlement, should translate into lower costs than we had previously forecasted.

Additionally, we are nearing the end of the renewal process for our workers compensation insurance policy beginning October 1st 2007. And I believe we should be able to benefit somewhat from reduced administrative fees next year. Therefore, we now would expect our cost to trend downward from the previously forecasted range of 0.75% to 0.80% of non-bonus payroll to a new range of 0.60% to 0.70% for the balance of the year and into 2008.

As for allocation side of this cost center, I had mentioned last quarter that we have had an increase in the percentage of white collared workers, which have lower pricing allocations. That increase still exists today, so while our allocation in this cost center may decline slightly, so would our cost. The bottom line is as we still expect to see a nice surplus contribution to gross profit from this cost center for the remainder of 2007 and into 2008.

The forth and last component of gross profit is the benefits cost center. Last quarter you may remember that I mentioned that we were just beginning to see a migration of covered worksite employees from the United HealthCare ChoicePlus 250 plan to a higher deductible lower cost plan.

That means, that we immediately experience a reduction in our benefits allocation and then typically a few months later we see the corresponding expense reduction. However, until we see a meaningful decline in the cost we are still going to forecast 8% to 9% year-over-year increase and benefit cost for the full year of 2007. Therefore, considering these two factors, we are now forecasting less contribution to gross profit from the benefits cost centers for the reminder of 2007.

Now for 2008, we have some additional factors that will affect the surplus or deficit in the benefit cost center. They are number one, benefit plan design changes that should reduce claim cost. Number two, lower administrative fees previously negotiated with United Healthcare beginning in 2008. Number three, double-digit healthcare cost increases from our fixed rate carriers that will only affect about 15% of our total book of business. Number four, ongoing allocation increases to match future expected cost. And number five, continued migration of participants into lower cost plans. These factors should allow us to mitigate total benefits trend increases and further deficits in this cost center for 2008.

Now, let's summarize the outlook for gross profit for the balance of 2007. We continue to see the average markup per worksite employee per month to gradually increase throughout the year from an average of $198 to $200. We should continue to see surpluses generated from two of our three direct cost centers. Therefore, the surplus component of our gross profit for the full year is expected to be $24 to $27 per worksite employee per month or approximately 2.5% of the dollars allocated within our pricing to cover the direct cost.

For 2008, we have a very solid game plan, so we've been able to generate the appropriate amount of gross profit per worksite employee per month.

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

Doug Sharp

Thanks Richard. Now, let me begin by providing an updated forecast, of our full year key metrics beginning with unit growth. But the rebound in our unit growth during the second quarter and the positive sales metrics that Paul just discussed, we are now forecasting an increase from our previous full year guidance. To a new range of our 110,000 to 111,000 average paid worksite employees per month.

As for gross profit, we are forecasting a fairly similar range to our previous guidance for the reasons mentioned by Richard a few moments ago. Our updated range is $224 to $227 per worksite employee per month.

As for operating expenses, we now expect to be in the range of $239 million to $241 million for the full year, as our better than expected first half results have given us the opportunity to make further investments and our growth in new product offerings. The increase over our prior guidance includes costs associated with additional service personnel to support our improved mid-market service plan. And costs associated with further developing new product offerings including in HRTools product enhancement.

The high-end of the expected range of operating expenses includes additional incentive compensation high to achieving higher unit growth in gross profit goal. When combined with our 2007 expected range of average paid worksite employees, operating expenses on a per worksite employee per month basis are now expected to decline from $183 in 2006, so approximately $181 for 2007.

We now expect net interest income to be in a range of $12 million to $12.5 million for the full year, down slightly from our prior forecasts due to the use of funds to repurchase shares. Utilization of these funds which were previously invested in tax exempt securities has resulted in a slight increase in our expected annual affected income tax rate to 35.7%.

We were now forecasting 27.5 million average diluted outstanding shares for the full year, down from prior forecasts of 28 million shares as a result of share repurchase activity during the first half of this year.

Now for third quarter guidance, based upon my earlier comments we expect average paid worksite employees per month to be in a range of 112,250 to 112,750 for the quarter. As for gross profit based upon Richard's earlier discussion, we expect to be in a range of $216 to $219 per worksite employee per month for Q3.

Third quarter operating expenses are expected to be in a range of $58.25 million to $58.75 million. This is down sequentially from Q2 by approximately $1.7 million as higher cost associated with our new service and product initiatives are more weighted to Q4 and into 2008. We expect net interest income to be between $3 million $3.2 million and are forecasting 27.2 million average diluted outstanding shares for the quarter.

Now at this time I would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instruction) Your first question comes from the line of Tobey Sommer with SunTrust Robinson Humphrey. Please proceed.

Tobey Sommer - SunTrust Robinson Humphrey

Thank you. I had a question about the sales force, you gave some mentioning metrics about how the ten years improving in that likely bodes well for sales trends and productivity over time. I didn’t catch, and I apologize if you mentioned it, the number of trained and hired sales people and maybe also in that context if you could update us on your office expansion plan? That'd be appreciated, thanks.

Paul Sarvadi

Sure, Tobey. The number trained for the quarter was 254, the number hired was between 290 and 300 at this point, and we had a lot of success there of late, so we are excited about how that’s ramping up. As far as the new office openings, we have announced four, the fifth one is imminent. Right in front of us, we have three more opening up over the balance of the year, and I think that’s going to put us in good stead for growing the sales force at the right rate.

Tobey Sommer - SunTrust Robinson Humphrey

Thanks. So at the mid point that looks like kind of 16% delta between hired and trained, given the fact the tenure is improving and sales force turnover is down and you're having success hiring, any thoughts about the potential productivity of the overall sales force? Do you think upper limit of that productivity -- you think that it may be higher than you had thought previously?

Paul Sarvadi

Well, this could be interesting. As you go into the fall we are going to have two things happen. First of all, you have this significant increase in the number of tenured reps as you go into the fall campaign. Obviously that should be very beneficial for our selling season. But we also have a significant new crop, that 16% that you were talking about sales staff that were not in the training number will be enrolling in as new reps. So you will have some little bit of account of balance to that, but I think we have just positioned very nicely for a strong fall selling season.

Tobey Sommer - SunTrust Robinson Humphrey

And shifting gears, I wanted to talk about the plan redesign with United. Historically, that has lowered your cost, and obviously you got some negotiated lower administrative fees as well. I think the last time you did that was in 2005 and you had generated a lot of earnings growth. I just want to get a sense for -- looking back historically and maybe 2005, I know it's back a couple of years, what sort of contribution did -- and how meaningful was that plan redesigned in 2005 to the very good year that you had at that time?

Paul Sarvadi

Tobey, it was significant, I guess, is the best way to say it. We have almost -- I don't know 70 somewhat thousand participants on our benefits plan today. It doesn't take a lot of change in a plan design to bring some significant reduction in cost to our program. Now, you have to realize that, obviously we are little bit early in talking about 2008, but we know that the trend in healthcare cost is certainly going to be in the 10% to 12% range, at least that's what people are saying today.

And so, any plan design changes that we implement will actually reduce that trend for 2008. And we like that because that actually makes our total package offering to our customers more attractive because if our cost normally go up say 7%, as opposed to 12%, then that's a real benefit to our client owners worksite employees and their families. So, we are thinking about how we may benefit from this, it will be more than just a financial, it will also potentially before new growth.

Tobey Sommer - SunTrust Robinson Humphrey

Right, that makes good sense. In terms of the percentage worksite employees on the healthcare plans and maybe breaking it down in terms of percentage of eligible also? And then I'll get back in the queue. Thank you.

Paul Sarvadi

Yeah, we have about, I don't know, 72.5 or so percent of the total worksite employee basis in one of our health plans on any given day. But when you look at eligible it's closer to 88% to 90%. People, they select their spouse to be in another plan and so the worksite employee with Administaff will go in the spousal plan and so that eligible number is a significant number as well and it makes for a good solid operation.

Tobey Sommer - SunTrust Robinson Humphrey

Thank you very much.

Operator

Your next question comes from the line of Jim Macdonald from First Analysis. Please proceed.

Jim Macdonald - First Analysis

Yeah, great quarter guys.

Richard Rawson

Thanks Jim.

Jim Macdonald - First Analysis

Just following up on the healthcare, it seems like you have been a little bit behind in terms of pricing versus cost, do you think there will be any catch-up you will need to do next year or do you think you can offset that with plan design changes?

Paul Sarvadi

Well, definitely plan design changes are going to be a big factor of that but we are still continuing to increase our allocations, because we want to make sure that we are doing that very best that we can to match the price and the cost, and so, on both new and renewing business.

So there will be another increase in the allocation site coming very shortly. But then as we move into 2008, we will also be looking to see how the participants act in terms of which plans they migrate to and that may cause us to not have to do much of the increase in the allocation.

I think we are really comfortable as the allocation rate increases that we are planning though it still created a nice advantage for our current customers and also the markets at large.

Doug Sharp

Yeah.

Jim Macdonald - First Analysis

Okay. And just one -- and I think just going back and you said you had number of summer hires. Can you kind of quantify that? Is that going to be an issue going into the Q3 of Q4?

Paul Sarvadi

That's kind of hard to tell exactly which ones are summer help, but it was probably around 1000 or so employees and you can generally expect those to come out in the third quarter beginning in the September timeframe. So you just kind have to factor that into the whole picture here.

Jim Macdonald - First Analysis

And that’s what your guidance was based on?

Paul Sarvadi

Yeah.

Jim Macdonald - First Analysis

Thanks very much.

Operator

Your next question comes from the line of Thomas Giovine of Giovine Capital Group.

Thomas Giovine - Giovine Capital Group

Hi guys. Well done.

Paul Sarvadi

Hi Tom, thanks, I am back.

Thomas Giovine - Giovine Capital Group

Can you just describe maybe what the current thinking is in the Board regarding buybacks and I think in last first quarter I was trying to see if I can -- and wished you guys would be a little more aggressive in terms of that or putting in a 12b1, whatever you may call that, but clearly you were very aggressive during the quarter, but you still have a capital structure that still kind of defy gravity, and then can you tell me maybe what the current thinking is there?

Paul Sarvadi

Yeah, I think we had a better quarter in trying to execute on our own game plan. We bought back 1 million shares and we were able to, once we got beyond our open window, we went ahead and filed the 10b5-1 plan so we could keep taking advantage of the low valuation that we foresee.

We are going to have our Board meeting next week, so we'd get kind of an update from everybody and how we feel about that. I like the way we executed this particular quarter. And I think that, steady as you go approach, but with aggressively setting a size capital to return to shareholders, this perhaps is appropriate for where we are.

Thomas Giovine - Giovine Capital Group

And just, I am sorry, just to go backward, but you did buyback shares for the year? I think it was at 35?

Paul Sarvadi

Yes, we did.

Thomas Giovine - Giovine Capital Group

All right, thank you very much.

Operator

Your next question comes from the line of Mark Marcon of Robert W. Baird. Please proceed sir.

Mark Marcon - Robert W. Baird

Good morning and let me add my congratulations.

Paul Sarvadi

Thank you, Mark.

Doug Sharp

Thanks Mark.

Mark Marcon - Robert W. Baird

I'd like to ask you, you outlined a number of initiatives you have got, you know kind of reengineering of your mid-market service offering. You have also got the HR tools that you are going through. What I was wondering is as we look towards this guidance that you've given us for the back half of this year, is the full expense of those initiatives included in that guidance and could there be any spillover in terms of additional expense going into 2008 or should you be done by the end of this year?

Doug Sharp

Yeah, Mark, this is Doug, I will answer that. Basically, the increase in the operating expense guidance over the initial guidance of $2 million does relate to the initiative that we are putting in place with mid-market and the HRTools and the product initiative. So, we have considered that in the balance for 2007.

Yes, there will be some additional investment going into 2008, as Paul mentioned. I think he was quantifying in total dollars, to some extent to the mid-market and the HRTools investments over a 12, 18 months period. So, obviously some of this investment goes into 2008.

Mark Marcon - Robert W. Baird

So, it doesn't look like it's going to, I mean, even with this additional investment, you are still actually going to see a decline in terms of your operating expense per worksite employee and it sounds like that could potentially continue to be the case going forward. Is that correct?

Doug Sharp

That's correct. That's what we are forecasting, yes, for the '07 period and we should hope to see that going forward, the leverage we have.

Mark Marcon - Robert W. Baird

Okay. Terrific. And then, with regards to, kind of one-time gains that you had this quarter. Can you just summarize those, it sounded like you had the Texas payroll tax refund, I think you also had something from CNA, if I recall correctly?

Doug Sharp

Let me try to clear that out for you. And the best way to explain it is by looking at the gross profit per worksite employee number, which was about $19 and $20 in excess of the midpoint of the forecast that we provided.

The payroll tax refund from the State of Texas was about $9 of that. Now, we did not included in our forecast, although as Richard mentioned in last quarter's conference call, by when till the unexpected considering the environment of the state funds out there. But plus nine bucks of the twenty, the other is attributable to the workers comp cost coming in lower than expected. That makes up the majority of the variance.

Mark Marcon - Robert W. Baird

Okay, great. So, that basically addresses that. And then, in the Southwest it looks like you had a nice rebound in terms of your revenue growth rate, was there anything particularly driving that?

Doug Sharp

No, I don't think so. Our success rate across the markets are pretty good, the only one that kind of lagged behind was the West Coast, but that was more driven by the loss of mid-market accounts that regards -- that too early in the year, how that lost to subsequent quarter.

Mark Marcon - Robert W. Baird

How was the West Coast that we strip out the mid-market, have you looked at the core?

Doug Sharp

Yeah, the core business, but I can say it's been growing nicely throughout the year and was certainly fine out in the West Coast as well. A little better in Southern California and Phoenix than in the North, both acceptable.

Mark Marcon - Robert W. Baird

Are they around the national average, in terms of what you are seeing in the West Coast?

Doug Sharp

Yes.

Mark Marcon - Robert W. Baird

Great. And then finally, you mentioned, you have got the benefit of your sales forces, is become more effective, you are seeing an increase in terms of the number of employees per client, and then on the foot side the attrition rate is slightly higher, is that all mid-market or is that also in the core?

Doug Sharp

Yeah, it's still there, in the attrition side, we still see, this year we have had fewer accounts terminate but the average size is higher. So, the 150 employee line in the sand between mid-market and core isn't an absolute gradation in there that some we do have. What I think are, some things we've addressed in this middle market initiative that will help us keep a larger and growing account. So that’s why is called a reengineering effort, is not just after the 500 or 1000 personal account, but what about those when they go from a 100 to 130 to 140. Let's do a better job on this as well.

Mark Marcon - Robert W. Baird

Great, thank you.

Operator

Your next and final question comes from line Kevane Wong of JMP Securities. Please proceed.

Kevane Wong - JMP Securities

Hi, how are you guys doing?

Paul Sarvadi

Great, Hi Kevane.

Kevane Wong - JMP Securities

And just first of all, a point of clarification on the worker comp cost upside, I am assuming that wasn’t in guidance and as you wouldn't have anything like that in guidance going forward at this point?

Unidentified Company Representative

Well you know every quarter we get -- well first to answer your first question, it wasn’t in the guidance. That happens, but we have been receiving these kind of, what I would call, positives to the reserve adjustment on both the current policy and the prior year's policy about every quarter for about nine to ten quarters now and so that fact is that like in the first quarter of this year Kevane I think that adjustment was about $6 million in this year and in this quarter its about $6.4 million. They’ve ranged anywhere from $2.5 million to this $6 million level and you never what it’s going to be until the outside actuary looks at the number of the claims that were incurred during the period, plus they look at the number of claims that were settled during the period that related to prior period. So no one advances until that happens.

Doug Sharp

And Kevane, as Richard mentioned in his script, we look at the workers comp that relates to the guidance more in total cost. So we have lowered the range as a percentage of payroll from 0.75 to 0.80 to the 0.60 to 0.70 and so we consider it more as a whole when we included it in coming up with the guidance on that gross profit metric.

Kevane Wong - JMP Securities

And I am assuming though the guidance is -- as far as the numbers you are giving are really excluding sort of these benefits that come to, truly sort of a, hey if you don’t have these benefits where would be and therefore we should be looking for, the fall season upside based on these sort of refunds coming back?

Doug Sharp

Yeah, and we just again look at it more in total.

Kevane Wong - JMP Securities

Great.

Doug Sharp

That’s also how our costs are trending.

Kevane Wong - JMP Securities

Got you. And also I’m sort of curious about generally what the sales environment is like, I mean, it sounds like it's not like the environment seems to be good, I am trying to figure out if you guys have actually sort of seen an easier sort of pace the sales as far as people understanding the PEO model etcetera and that’s sort helping drive stuff and I guess sort of conversely, had the economy been where it should have been, had that coverage any sites or is that really not been an excuse so far for you guys?

Paul Sarvadi

I think so far so good on the economy side within the small business community. We are still -- companies are meeting or exceeding their business plans. They are still hiring, the number one issue is finding and attracting key people. We still see that there is a labor shortage out there and it's hard to find the right folks. So that’s the good environment for us. Obviously it would be better if more people are available to put in these positions, we'd grow faster. But all in all I think we are in a good environment and I think the attitude in our sales staff is good and we’ve had a good solid year. We have made some adjustments on commission and so forth and paying, tying payment to the initial payroll of the paid worksite employee. So, we are trying to fit things up there and I think we are doing well in that area.

Kevane Wong - JMP Securities

Okay. Well, this is maybe a little bit of a broader thing, in the mid-market effort, the one thing you talked a bit about before is the benefits system you are rolling out, which really gives a lot more flexibility on choice of what people would have. I was just curious on sort of the feedback on that system, has it helped as far as attracting mid-market guys, or is it too early yet to out list on that?

Paul Sarvadi

Yeah, it's really too early yet. Even though we kind of took mid market offline, it's simply reengineering. It didn't, obviously didn't stop, we have customers in the pipeline; we made sales this quarter and already have some going in the Q3. So, we're moving along, but relative to the benefits of flexibility, I don't think that's been a big part of it yet. We still think it will be achieved kind of going to next year, but at this point not.

Kevane Wong - JMP Securities

All right, thanks guys. I appreciate it.

Operator

Ladies and gentlemen, I would now like to turn the call back over to Mr. Douglas Sharp, Chief Financial Officer. But before I do, I would like to remind you, if you have any further questions, please contact Mr. Douglas Sharp, Chief Financial Officer.

Doug Sharp

Okay. We thank you for joining us today and we look forward to talking to you soon.

Operator

Ladies and gentlemen, this does conclude the presentation. Thank you for your participation in today's conference. You may now disconnect and have a great day.

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