Insperity, Inc.

Good afternoon. My name is Jerome, and I'll be your conference operator today. I would like to welcome everyone to the Inspirity Second Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. At this time, I would like to introduce today's speakers. Joining us are Paul Sarvadi, Chairman of the Board and Chief Executive Officer and Douglas Sharpe, Senior Vice President of Finance, Chief Financial Officer and Treasurer. At this time, I'd like to turn the call over to Mr. Douglas Sharpe. Mr. Sharpe, please go ahead.

Thank you. We appreciate you joining us. Let me begin by outlining our plan for this evening's call. First, I'm going to discuss the details behind our second quarter 2020 financial results which were strong considering the current economic environment brought upon by the pandemic. Paul will then comment on the key drivers behind our Q2 results and our outlook for the remainder of the year. I will return to provide our financial guidance for the third quarter and an update to the full year 2020 guidance. We will then end the call with a question and answer session. Now, before we begin, I would like to remind you that Mr. Sarvadi or I may make forward-looking statements during today's call which are subject to risks, uncertainties, and assumptions. In addition, some of our discussion may include non-GAAP financial measures. For a more detailed discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, please see the company's public filings, including the Form 8-K file today, which are available on our website. Now let's discuss our second quarter results in which we achieved $1.54 in adjusted EPS, an 86% increase over Q2 of 2019, and adjusted EBITDA of $92 million, an increase of 62%. Average paid worksite employees declined by just 1.8% from Q2 of 2019. compared to our forecast of a 1% to 5% decline that took into account the impact of the COVID-19 pandemic on our clients and prospects. All three drivers, including worksite employees paid from new sales, client retention, and net losses in our client base from layoffs and hiring were better than expected. Worksite employees paid from new client sales were approximately 20% above forecasted levels. driven by a 15% increase in trained business performance advisors and success in our mid-market segment. Client retention held up at our historical high level of just over 99% during Q2. This points to financial strength and actions taken by our clients during the pandemic and our quick and effective response to assist our clients with our premium level of HR services. Net losses in our client base in Q2 were lower than expected as the level of worksite employees laid off, returning to work from furlough, and general hiring were all favorable. This was particularly the case in the month of June. In a few minutes, Paul will share the details on the actions we've taken recently to assist our clients and provide thoughts around more recent trends in our updated 2020 worksite employee outlook. So let's move on to gross profit, which increased by 27% over Q2 of 2019. These results included lower than forecasted benefits and workers' compensation costs, partially offset by our decision to provide comprehensive service fee credits to our clients. Lower benefit costs were primarily due to lower utilization, especially lower levels of elective health care procedures, some of which is expected to be offset in subsequent quarters with the resumption of deferred care and future COVID-19 costs. Lower workers' compensation costs were primarily a result of the effective management of claims incurred in prior periods and largely unrelated to the pandemic. Due to the structure of our workers' compensation program, any reduction in the number and severity of workers' compensation claims associated with the work-from-home status Many of our clients and employees would likely impact our costs in later periods as these claims develop over time. During the quarter, we proactively engaged with our vendors in successfully negotiating savings to support our clients through this difficult period. As a result, we provided a comprehensive service fee credit to our clients based upon their worksite employee levels at June 30th. These credits totaled approximately $12 million and were accrued in the second quarter. Also, under the CARES Act and Family First Act, clients were able to take advantage of payroll tax deferrals and credits offered through government stimulus packages. These deferrals and credits totaled approximately $45 million during Q2 and were reported as both a reduction to revenue and direct costs. So in total, these two items reduced Q2 reported revenues by approximately $57 million and gross profit by approximately $12 million. Second quarter operating expenses increased by 9% and included continued investments in our growth, including costs associated with the increase in the number of business performance advisors. Other corporate employee headcount has remained level over the first half of this year, Even though HR demands have increased with the pandemic and its impact on the economy and a number of HR issues, including diversity and inclusion. Second quarter compensation costs included an acceleration in the timing of a portion of our corporate employees' annual incentive compensation to reward them in a period of increased service demands. Additionally, Q2 operating costs included an increase in paid time off accrual associated with higher than normal unused vacation hours during the pandemic. These expenditures were partially offset by cost savings in other areas, including travel, training, and business promotion costs. Our effective tax rate in Q2 came in at 27%, and we expect a similar rate over both the latter half of this year and for the full year 2020. Our strong financial position and liquidity continued to improve over the first half of 2020 in the face of the challenges and dynamics of the pandemic. Adjusted cash totaled $269 million at June 30, up from $108 million at December 31, 2019, while borrowings totaled $370 million at the end of Q2, up from $270 million at December 31, 2019. Over the first half of this year, we have repurchased 879,000 shares of stock at a cost of $61 million, paid $31 million in cash dividends, and invested $39 million in capital expenditures. Now, at this time, I'd like to turn the call over to Paul.

Thank you, Doug, and thank you all for joining us. Today, I'll begin with the discussion of our efforts over the recent quarter to support our small and medium-sized business clients throughout the historic disruption arising from the pandemic. Secondly, I'll cover our view of the dynamics driving our expectations over the balance of the year for growth and profitability. And I'll finish my remarks with some thoughts about the long-term effect on demand for Insperity Services, which represents a silver lining in the cloud of COVID-19. This quarter was an eye-opener in many ways, including highlighting the absolute necessity and the tangible value of a sophisticated HR function for small to medium-sized businesses. The unexpected events that played out over the course of the quarter cast a spotlight on the HR department, which, of course, is what Insperity is to our clients. The sequence of events beginning with the health crisis evolved into economic disruption and the transformation to working from home, followed by the emotionally charged dynamic of prolonged stay-at-home orders and political and social unrest. When you add in federal, state and local legislative and regulatory responses with new obligations and opportunities for businesses, you have a monumental challenge and opportunity for an HR services provider to demonstrate value to clients. Insperity Workforce Optimization has long been the most comprehensive business service offered in the marketplace, and our competitive distinction is the breadth and the depth of our services and the level of care of our service providers. Our clients were relying on us to help them work through decisions that directly affected the livelihood of their businesses, employees, and families. Our service teams continued to serve our clients and worksite employees with genuine care and excellence in an unprecedented time of need and constant change. In more than 30 years, I've never seen a quarter where clients experienced more of what we are designed to offer in such a compressed time period. The effort put forth was exceptional and could have only been delivered by the combination of an amazing team and an incredible culture like we have at Insperity. The workload across the company escalated substantially with call volumes and length doubled, service interactions tripled, and a long list of other services spiking. HR solutions were required for the myriad of issues businesses were facing, including layoffs and staffing strategies, PPP loan application, forgiveness and reporting, work from home, return to work, FICA deferral and diversity and inclusion, just to name a few. Allow me to say we could not be prouder of our staff across the board for the way they stepped up and delivered on our mission to help businesses succeed so communities prosper through a very challenging period. Now, in addition to passing this service stress test with flying colors, we also were able to see our business model perform well Under the pressure of these unprecedented events, we were pleased with the dynamics across the business from sales and retention to pricing, direct cost, and operating expenses. On our last call, we indicated our objective in new account sales operating in this virtual selling environment would be to fall within a range of 60% to 80% of our original 2020 pre-COVID sales budget. As you may recall, the sales budget is the internal metric we use to monitor and track performance in our sales organization. Our entire sales organization, both core and mid-market, performed remarkably well, achieving total booked sales above 70% of our original 2020 pre-COVID sales budget and in the higher end of our revised targeted range. As a reminder, once the sales booked, our service teams worked to onboard those clients and actually generate revenue as paid worksite employees. In this environment, client retention may also be a concern due to an increase in the business failure rate in the marketplace at large. As Doug mentioned, our client retention has remained solid, reflecting the strong client base we have and demonstrating the benefit of our strategy of targeting the best small and mid-sized businesses onto our premium services platform. Another stress test during a period like this was around pricing of our services on both new and renewing accounts. It is certainly another credit to our staff and further validation of the value of our services that our standard pricing on our book of business did not reflect unusual pricing pressure in this environment. We were also very responsive to the immediate financial needs of our clients in providing a COVID-19 related service fee credit. During the quarter we worked with vendors and negotiated $12 million in fee reductions to pass along to clients. We felt it was important to act quickly in this regard and get the funds to clients as soon as possible, and clients will begin seeing this credit on invoices starting this week. Another area to evaluate during this unusual time was the matching of price and cost on our primary direct cost items, including payroll taxes, workers' compensation, and employee benefits. As I mentioned, pricing has remained on track, and although our quarterly direct cost pattern has changed, we anticipate a strong year overall at the gross profit line. So we have navigated the disruption and the immediate aftermath of the pandemic and related events of Q2 successfully, and our business model demonstrated substantial resiliency. Now, in order to determine our expectation for the balance of the year, We need to zero in on the most recent behavior of our clients, particularly in layoffs and new or rehires in the base, and consider the economic outlook for small business. Now, in the second quarter, layoffs due to COVID drove a 6% reduction in paid worksite employees from March, reaching a low point at the end of May. Since then, we've recovered approximately 40% of this reduction, primarily due to the return to work of just over 50% of furloughed employees. At the same time, approximately 17% of furloughed or temporarily laid off employees have been reclassified to permanent layoffs. So the number of potential rehires has been reduced by two-thirds. At this point, the rate of both layoffs and furloughed employees returning to work have moderated considerably. So determining what happens in the near term in net change in employment in our client base is somewhat of a toss-up. On one hand, it seems the small to medium-sized business community is adapting and dealing well with the new realities they're facing. We believe our client base has been particularly impressive in this regard. However, the continuing spread of the virus and the corresponding economic uncertainty may temper the rebound we've seen recently. Also in our experience, there's sometimes a pause or hesitancy in decision-making with the uncertainty of an upcoming election, which may weigh in over the second half of the year. We do expect new account sales to ramp up over the last half of the year. However, most of the booked sales in Q4 typically do not become paid worksite employees until Q1 of the following year. These sales would contribute to growth in 2021, but not contribute significantly to this year's results. With this backdrop, our guidance for growth is somewhat conservative over the balance of the year. Although the pandemic-driven circumstances make us appropriately cautious about the near term, recent events have made us even more bullish about the long-term prospects for prosperity. Our outlook for profitability over the last half of the year also has an appropriate measure of conservatism built in. The wild card here is in our direct costs, and particularly Our health plan where some portion of lower cost experience in Q2 is expected to shift to Q3 and Q4. This creates an unusual quarterly pattern to our profitability for 2020, shifting more of the profits to the first half than usual. With this in mind, I believe it's very important for investors to look at the range of expectations for the full year 2020 in context of the pandemic and focus on how we are positioned for 2021. Our full year guidance for 2020 implies a range of minus 1% to minus 3% unit growth in paid worksite employees. We expect a range of adjusted EBITDA growth that straddles the level we achieved last year at minus 6% to plus 2%. So the big picture for the full year 2020 is layoffs due to COVID and the economic shutdown are expected to be partially offset by higher gross profit per worksite employee and lower operating expenses than our original budget. So while we're continuing to focus on meeting the intense need of our client base in the current environment, we are also looking to the longer term and the straightest path to regaining our growth momentum in 2021 as COVID-19 moves further into the rearview mirror. We believe we are very well positioned for growth as we look ahead to next year. The front of our growth engine is the number of trained business performance advisors, which is currently at the highest level in our history. We have deliberately continued to invest in this team throughout this economic disruption due to the likelihood of a quicker and stronger growth surge once the uncertainty diminishes. We also believe we have an opportunity to hone our marketing message utilizing the recent positive client experiences and we intend to increase our marketing spend in the fall to drive leads and test this new messaging. In many ways, the unexpected and unusual developments of the last quarter validated the need for our services and the distinct advantage we provide to improve the success equation for small and medium-sized companies. Even though the pandemic has been quite a challenge over the long term, we believe this experience will serve to increase demand within the small to medium-sized business community for Insperity Services in the years ahead. At this time, I'd like to pass the call back to Doug.