Insperity, Inc.

Good morning. My name is Lara, and I will be your conference operator today. I would like to welcome everyone to the Insperity Third Quarter 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker's remarks, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you wish to remove yourself from the queue, please press the pound key. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. Thank you. 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 Douglas Sharpe. Mr. Sharpe, please go ahead.

Thank you. We appreciate you joining us. Let me begin by outlining our plan for this morning's call. First, I'm going to discuss the details behind our third quarter 2020 financial results. Paul will then comment on the key drivers behind our Q3 results, our outlook for the remainder of 2020, and some general comments on 2021. I will return to provide our financial guidance for the fourth quarter and an update to the full year 2020 guidance. 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 filed today, which are available on our website. Now let's discuss our third quarter results, in which we achieved $0.91 in adjusted earnings per share, a 21% increase over Q3 of 2019, and adjusted EBITDA of $58 million, a 13% increase. These results reflect outperformance in worksite employee growth and pricing relative to our expectations in this uncertain and challenging business environment and upside in our direct cost programs brought about by the dynamics of the pandemic and the structure and ongoing management of these programs. As for our growth metric, the average number of paid worksite employees in Q3 of 2020 increased by 1.7% sequentially over the Q2 period to $231,750, which was above the high end of our expected range. Now, you may recall that employee layoffs in our client base drove a 6% reduction in paid worksite employees from the outset of the pandemic in March through the low point in May of this year. Since then, worksite employees have grown sequentially as employees returning to work and being hired by our clients have outpaced any further layoffs. Additionally, client retention for both Q2 and Q3 has remained at our historical level of 99% and worksite employees continue to be added from new client sales. Given these recent positive trends, we now expect paid worksite employees to return to near pre-pandemic levels by the end of this year. Now let's move on to gross profit, which increased by 8% over Q3 of 2019. Worksite employee volume and pricing above targeted levels, combined with upside in our benefit and workers' compensation programs, resulted in significantly higher than expected gross profit. This quarter's benefit costs included some favorable development from Q2, a period of highly unusual claim activity due to the impact of the shutdown orders. In addition, healthcare utilization began trending toward more normalized levels in the third quarter, although not to the degree of our expectations. Going forward, we expect further normalization along with the resumption of some deferred care and COVID-19 testing and treatment costs, the extent and timing of which is still uncertain. Our workers' compensation program continues to perform well due to ongoing management of safety practices and claims. Recent favorable claims development has been associated primarily with periods prior to the pandemic, and any favorable impact from the reduction in severity of workers' compensation claims associated with the work-from-home status of many of our clients' employees would likely favorably impact our costs in future periods as this claim experience develops over time. As for our pricing, we charge our clients a comprehensive service fee inclusive of our HR services and direct cost programs. We entered 2020 with certain pricing targets set prior to the outset of the pandemic, and we continue to manage toward these budgeted targets. As you may recall, certain savings resulting from the disruption caused by the pandemic were negotiated with our vendors and were passed along to our clients in the form of a comprehensive service fee credit as reflected in our Q2 financials. Now turning to operating expenses, Q3 operating expenses included continued investment in our growth, including costs associated with a 10% increase in the average number of trained business performance advisors. Other corporate employee headcount has remained level over the past three quarters due to the effort and effectiveness of our staff in the face of increased HR service demands from within our client base. Cost savings have been realized in other areas of the business, including travel, training, and other G&A costs as we manage through the current business environment. The Q3 year-over-year increase in total operating expenses of 15% was impacted by increased stock-based compensation costs. This increase was driven by a few items. First, our outperformance in the level of paid worksite employees and earnings during the pandemic. Second, the shift in the weighting to performance stock awards from performance cash awards for 2020 to further align our employees' interests with shareholders during these challenging times. Third, the acceleration of expense for employees meeting retirement eligibility requirements under recent modifications to our plan. And fourth, a comparison to prior year's quarter in which earnings and related performance-based compensation were adversely impacted by large healthcare claim activity. Operating expenses excluding stock-based compensation and depreciation and amortization increased just 4.6% over Q3 of 2019. As far as our financial position and liquidity, it remains strong as we manage through the pandemic conditions, continue investments in our growth, and provide returns to our shareholders. Adjusted cash has increased from $108 million at December 31, 2019 to $213 million at September 30th, while repurchasing 1.3 million shares of stock at a cost of $91 million, paying out $47 million in cash dividends and investing $69 million in capital expenditures to date during 2020. Borrowings increased by $100 million over the nine months, and $130 million remains available under our credit facility. 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 provide comments on three topics, starting with some thoughts on our significant outperformance in the recent quarter. I will then discuss how the primary drivers to our business model reacted to the pandemic, resulting in the opportunity implied by the guidance we are providing today to attain double-digit growth in adjusted EBITDA this year. I'll finish with some comments on our view of these factors going forward, which will ultimately drive our outlook for 2021. We are certainly pleased with our execution in the third quarter, which resulted in a variety of factors contributing to better than expected results. The resiliency of our client base, supported by our dedicated service providers, combined with solid sales and retention to drive a nice rebound in sequential growth in our key metric paid worksite employees. Net gain in worksite employees from within our client base exceeded our expectation as client hiring of furloughed and new employees occurred sooner and at a faster pace. As Doug mentioned, client retention continued at historical levels of 99%, despite the economic pressure on small businesses in the current environment. In addition, our booked sales since the pandemic have been approximately 70% of our pre-pandemic sales budget, which we believe is solid performance in a virtual selling environment. In the third quarter, paid worksite employees from previously booked sales was 92% compared to the same period last year, demonstrating continued demand for our services and strong execution in enrolling new clients. Another highlight of the quarter was our strong pricing of both new and renewing accounts in service fees and allocations for direct costs, including our benefit programs. The matching of price and direct cost is critical to our model, and exceeding our targets in this area is important as direct costs affected by the pandemic normalize. We've also been able to continue to grow and develop our BPA team through this quarter. During this period, we virtually trained over 350 BPAs in our Level 1, 2, and 3 and our Certified Business Performance Advisor programs. Our trained BPA count increased 10% over the same period last year, positioning us well for our fall selling season. This quarter, we were also able to divert some operating expense savings to develop client testimonial videos and increase advertising to support our fall selling season and our retention campaign. These videos captured the emotion we were hoping for, demonstrating the value of a sophisticated HR function in a crisis. We were also able to continue important technology development beyond responding to the many compliance needs that emerged earlier this year. We are extending our people analytics platform, which has been very well received by our mid-market and enterprise clients, to our emerging growth segment just in time for our critical renewal period. We are continuing to make strides improving Inspirity Premier, our proprietary human capital management system, rolling out a new time and attendance user interface and using new behavioral analytics tool to guide roadmaps, making Premier easier and more efficient for clients. The bottom line for the third quarter was that we experienced the ideal combination of higher volume and pricing and lower direct and operating costs. Each of these elements contributed to our strong outperformance in the quarter. So we have responded quickly and effectively to the unusual events we've experienced in 2020, meeting client needs and achieving better than expected growth and profitability. We've also kept our eye on the long term, making progress on many important initiatives. Now that we have three quarters under our belt in our estimate for Q4, We can evaluate how our business model has reacted during the pandemic. When the pandemic hit, we did not expect our business model would have the potential to generate double-digit growth in adjusted EBITDA that we have within the guidance we're providing today. The effects from the pandemic on our business model ran the full gamut from obvious expected negatives to completely unexpected positives. It's worth taking a moment to summarize these factors that drive the model since, as we all know too well, this pandemic is not over and it appears the effects will carry into 2021.