Insperity, Inc.

Good morning. My name is Holly and I will be your conference operator today. I would like to welcome everyone to the Insperity First Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. At this time, I would like to introduce today's speakers. Joining us are Paul Cervati, Chairman of the Board and Chief Executive Officer, and Douglas Sharpe, Executive 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 first quarter 2023 financial results. Paul will then comment on our recent accomplishments and our plan over the remainder of the year. I will return to provide our financial guidance for the second quarter and an update to the full year 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. Sarvati 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 more detailed discussions of the risks and uncertainties that could cause actual results that 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 on our website. Now let's discuss our first quarter results in which we reported earnings above our expectations. We achieved a 29% increase in adjusted EBITDA over Q1 of 2022 to $152 million and a 34% increase in adjusted earnings per share to $2.67. These results reflect double-digit worksite employee growth, strong pricing, operating costs in line with our forecast. As for our growth metric, the average number of paid worksite employees increased by 10% over Q1 of 2022, which was within our guidance. This growth reflects a successful year-end transition associated with our recent sales campaign and heavy client renewal periods. Both worksite employees paid from new client sales and client retention were near our forecasted levels. As expected, net hiring by our clients slowed and was about 50% of the Q1 2022 level. Gross profit increased by 16% over Q1 of the prior year on the 10% worksite employee growth and strong pricing through the year-end transition, which was a key objective given the current inflationary environment. The first quarter contribution from our direct cost programs, including benefits and workers' compensation, were in line with our expectations. As forecasted, Q1 operating expenses increased 13% and included an 11% increase in the average number of hired business performance advisors as we plan for our future growth. The operating expense increase also included additional service and support personnel necessary to maintain our premium service level in a period of continued growth. We also continue to invest in our technology, including the ongoing implementation of Salesforce. Net interest income increased $4 million over Q1 of 2022 on higher interest rates and invested balances. And first quarter's effective tax rate was 23.5%, which is lower than our expected full-year rate due to the tax benefit associated with the vesting of employees' stock awards during Q1. Our financial position and liquidity remain strong as we continue to invest in our growth while providing returns to our shareholders. During the quarter, we repurchased 289,000 shares of stock at a cost of $35 million and and paid out $20 million in cash dividends. We ended Q1 with $231 million of adjusted cash and $370 million of debt. Now, at this time, I'd like to turn the call over to Paul. Thank you, Doug, and thank you all for joining our call.

Today, I'll provide some detail regarding our excellent results in the first quarter and the challenges we observed in the small to medium-sized business community. I'll also comment on the plans for the balance of the year to continue to capitalize on our market opportunity, and I'll finish with some perspective regarding how this year fits into our current five-year plan. One key factor to our first quarter every year is a successful completion of our heaviest selling and retention period to achieve a solid starting point for the year and paid worksite employees. This year results were strong on both fronts, and when combined with some hiring within the client base over the quarter, led us to achieve double-digit growth. The other important factor in every first quarter is the pricing reflected once the year-end transition is completed. This was also a strong highlight in the quarter. We believe the combination of these two key factors puts us in position for a solid year in both growth and profitability, despite the current economic climate. These were strong results against a backdrop of a changing dynamic in the marketplace due to persistent inflation, rising borrowing costs, a weakening economy, and elevated uncertainty in the small to medium-sized business community. In Q1, new booked workforce optimization sales reflected this dynamic coming in below our budget. A degree of hesitation in the decision-making process was reflected across the country and to a greater degree in California, coinciding with the turmoil in the financial system sparked by the collapse of Silicon Valley Bank and Signature Bank. This was also reflected in the recently reported National Federation of Independent Businesses Optimism Index decline in March. These survey results were in alignment with our internal client survey. The most significant change in our client-based outlook was the expected impact of the economic climate. One quarter ago, those expecting a negative impact was less than 10%, and it's now over 20%. Those expecting a positive impact from the economic climate dropped from 65% to 55%. Our internal data we monitor in our client base also reflects some slowdown in the economy. Both the average increase in pay year over year dropped below 4% in overtime pay as a percentage of total payroll, dropped below a 10% threshold for the first time in a couple years. The commissions we paid to worksite employees of our clients, which reflects the recent strength of the sales pipeline in our client companies, was down to mid-single digits for the second quarter in a row compared to strong double digits seen in prior quarters. Now, none of these developments we're seeing in our client base and the overall small to medium-sized business marketplace are unfamiliar to us over our 37 years of experience. We understand what our clients and prospects are experiencing and how their needs for sophisticated HR solutions change in this environment. We also know what tweaks to make in our sales, service, and support organizations that have worked before to meet these types of challenges and continue solid growth and profitability performance. The most important factor to drive growth in this environment is the number of sales opportunities we generate. The two most important drivers for this factor are the number of business performance advisors and the number of discovery calls. We believe we are in excellent shape on the most critical long-term growth driver for the company, the number of business performance advisors. As Doug mentioned, currently we've ramped up to more than 700 BPAs, an 11% increase in this key metric over last year. Now our focus is on driving the activity numbers up across the board in discovery calls and opportunities to bid our services. Our marketing efforts are an important driver of these opportunities and we're off to an excellent start this year with marketing leads up 13%, discovery calls up 11% in Q1 year over year. We also launched our Spring Brand Awareness Campaign early this month which continues into mid-June. This includes market-specific media plans designed to continue this momentum in all our markets across the country. The combination of our growth in the number of BPAs, our marketing plans, and our sales management focus on activity levels gives us confidence in our growth plan for the balance of the year and beyond. We also believe we're in excellent position for solid profitability for the year, as you will see as Doug provides specific guidance in a few minutes. Our strong pricing is the key driver of our raised guidance in the near term, and our progress in our workforce acceleration offering is contributing to our long-term outlook. New booked workforce acceleration sales were up 36% year-over-year in Q1, reflecting the increased focus of our sales organization on this offering. Recent adjustments to our sales compensation and recognition programs have successfully enhanced this effort. Our workforce acceleration offering has significant long-term potential to enhance our business model by leveraging our current sales process that allows us to see nearly 40,000 business owners face-to-face each year. Workforce acceleration has the potential to further improve our sales efficiency, lower BPA turnover, and enhance our customer for life strategy for client retention. So as we look at this year in the context of our five-year plan, We remain on track to meet and exceed our year two targets on our two key metrics, paid worksite employees and adjusted EBITDA. Even in a challenging economic environment, we have the potential for high single-digit growth in worksite employees and double-digit growth in adjusted EBITDA this year. A look back at our 10-year history, compound annual growth rates on these key metrics demonstrates the strength of our business model with rates of 10% in worksite employee growth and 15% in adjusted EBITDA, even with the pandemic during this period. We provide the best-in-class small and mid-sized companies with premium, sophisticated HR solutions that elevate their likelihood and degree of success. These services are provided by an incredible team of professionals here at Insperity that are dedicated to the success of every client. We expect this level of commitment to continue to produce excellent results for clients worksite employees, communities, and our shareholders. At this point, I'd like to pass the call back to Doug to provide our specific guidance.

Thanks, Paul. Now let me provide our Q2 guidance and an update to our full year guidance in which we are refining our forecast to paid worksite employee growth and raising our 2023 earnings expectations. We are now forecasting 7% to 9% worksite employee growth for the full year 2023 compared to our initial guidance of 7.5% to 10.5% growth. Our updated guidance still points to high single-digit worksite employee growth in a period of economic uncertainty and what appears to be some caution and negative sentiment in the marketplace. As for Q2, we are forecasting year-over-year worksite employee growth of 7% to 8%. We're now forecasting four-year 2023 adjusted EBITDA in a range of $370 million to $410 million, and adjusted EPS in a range of $5.62 to $6.39. We have increased the midpoint of this updated guidance to include our Q1 outperformance and an expected improvement in profitability over the remainder of the year. This improvement in profitability is based upon our recent strong pricing, direct cost trends, and operating expenses generally in line with our budget, and higher interest income on rising interest rates. Our operating plan continues to include the necessary investments to meet our five-year plan objectives, including the growth in BPAs and service personnel, and the necessary marketing and technology investments. We are now estimating a full-year 2023 effective income tax rate of 26%. As for Q2 earnings, we are forecasting adjusted EBITDA in a range of $81 million to $90 million and adjusted EPS from $1.16 to $1.32. This guidance considers our typical quarterly earnings pattern, and as you may recall, our Q1 results are typically higher than subsequent quarters As we earn a higher level of payroll tax surplus prior to worksite employees reaching their taxable wage limits, and benefit costs are typically lower in Q1 and step up over the remainder of the year as deductibles are met. Now, at this time, I'd like to open up the call for questions.

Certainly. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we poll for questions. Your first question for today is coming from Jeff Martin at Roth MKM.

Thanks. Good morning. I'm Doug. Hope you're doing well. Good morning. Good morning. We're wondering if you could provide some additional detail with respect to the California market. Were sales impacted in California in the period, and was there any material loss to worksite employees as a result of the financial turmoil? Thanks.

Sure. Thank you for your question. I appreciate that. Now, what we experienced in the month of March was more what I would describe as just a shock effect of the financial market or banking industry issues that came up. And what happens in an environment like that is there's just a hesitation in making decisions. And, of course, in our case, the decision to use the PEO service is a significant one. And so, in fact, it's more in the framework almost like a capital decision they make. So it's very natural to kind of have a hesitation if there's something significant that happens. So we've already seen that begin to wane, you know, which it usually does once things have, you know, settled out a bit. And, you know, in California, you know, we – and even in the New York area where there's more technology and financial-type companies, we saw that a little bit heavier than we did, but it did happen across the rest of the country as well. So I consider it a blip, a brief one, and that's why you can see in our expectations for the rest of the year, we still had a great quarter in double-digit unit growth, And we're still expecting high single-digit growth this year. And we're really in good shape on that front.

Great. And then my second question is a two-part. One is, did you notice any change in the net hiring trend throughout the quarter as we progressed from January, even through most of April now? And then secondly, I actually forgot the second part of my question. So we'll just leave it at that. Thanks.

Yeah, so, you know, we expected a significantly reduced hiring rate compared to last year. And we had seen it, you know, really slow down in the third quarter and then even in the fourth quarter, you know, dramatically. And so we were expecting, you know, around, you know, 50% of the level of the first quarter last year. And that's where we came in. So it met our expectations, but it's certainly significantly lower than last year, and that's what we expect to continue for the rest of the year. We do a lot of research with our client base about their hiring expectations, and we still have about a little over half of the client base that expect to have more employees in their organization as the year progresses. And it's still a small number that expect less and a little bit bigger number than usual that expect to stay the same.

And then the other part of my question was with respect to pricing. Is there anything you directly attribute to the strong pricing trend?

So we really had a focus on that effort across the entire year last year in our new and renewing business. and this was because you know in an inflationary environment it's really important to drive those numbers the right direction especially you know when a service organization with you know over 60 percent of your total cost or your own labor cost and when you have wage inflation likes going on and you want to hire and retain the best people you just need to really have a good focus on your pricing strength we did that and that group It was just an out-of-the-park home run for the full year. And so this is absolutely a perfect position for us to be in on the front end of, you know, who knows what this turns out to be. But we do know it's a slowdown in the economy. We know it's weakened to a degree. And, you know, you have some challenging environment out there. But for us to be at this point, with a double-digit growth in the number of BPAs, strong marketing effort, and having a strong pricing foundation. That's the best position for us to be in. We've been through these kind of positions before, and this is right down the middle of the fairway of where we want to be when you're facing a time period like this so we can support our clients well and continue to grow the business. and continue to improve our profitability.

Your next question for today is coming from Toby Sommer at Truist Securities.

Thank you. Good morning. I was wondering if you could talk to us about the Salesforce productivity measures, how those are trending how you think about pulling the levers of increasing the sales force as well as and or marketing over the course of the year. Thanks.

Yeah, thank you, Toby. So, yeah, when you, you know, when you grow your sales staff faster, you have some drag on some of the metrics, you know, your sales efficiency, etc., But those are all in line with where our expectations have been, with the exception of that brief pause in closing at the end of the quarter. So like I said, I feel like that's a blip. And everything we're doing on that front, we believe, are the right things to drive those metrics the right direction over the long term. So the focus now is, of course, on activity levels, because one of the things we've learned throughout our history is when you go through a tougher period where there is some hesitancy in the mindset of the small to medium-sized business community, you just need more opportunities. So we've had very successful marketing efforts that we're replicating. I mentioned the spring campaign that we just initiated at the beginning of this month. And so we're going to invest heavily in our marketing effort to drive those opportunities. Of course, we have other ways we do that through our partnership relationships, through our loyalty program. We're doing a lot of other things to really focus on driving activity, more opportunities. And, you know, that will, you know, we expect in this kind of environment some of your metrics are lower because of the economic environment, and that's what we're looking we're expecting and able to drive the growth in that environment. Now, the good news is all those opportunities turn into excellent training and experience for the sales organization. And the other reason we do it this way is because when we've seen these periods before, not only do we go down less than others because we keep growing, We also come out much sooner and much faster because of the double emphasis of growing the sales team and growing the number of opportunities. That is just a great way to go through a period like this. We don't like that the economy is in a tougher position, but I get excited about it because we know what to do in this kind of situation and it gives us an opportunity to really show our strengths.

Thanks. I wanted to ask a question about workforce acceleration. You've seen really good growth there over the last two or three years. Is there a point at which it would make sense to make any changes to the way that you either manage that or the way you report it to us externally?

Yeah, I believe we will be making some changes once we get that up to a level and have enough time period where the metrics have some consistency so we can measure them correctly. Right now, we're in that stage of getting more adoption of this in the sales process across the entire organization. That's the steps that are really taking place now, and we're really on a great track there. We see this as like a silver bullet for us in the business model And at the correct point, you know, we'll be discussing it differently. We won't be managing a lot differently because I think we're managing it in a way that, you know, makes sense to drive the results we want. But there will probably be more reporting of information that I know will be good for everybody to have more understanding.

If I could ask, like, one last one in terms of The health care benefit cost center, we've heard from public hospital companies talking about more activity levels, more patient volume, and some of the managed care companies talking about higher medical loss ratios. How did it trend so far year to date? What's your expectation for the balance of the year?

Yeah, so, you know, in the first quarter, obviously we take those factors into account, you know, going into the year, and we work with UnitedHealthcare, and we get some of that same information out of them. For the first quarter, you know, the benefit-cost side of things was just a little bit of hair above our expectations, but as we mentioned on the call in our prepared remarks, the pricing came in stronger. So in total, that program in the first quarter was, ran as expected. And I would say, you know, as we look over the remainder of the year, obviously things can change, but as we see it now, we sort of have stuck with that over the remainder of the year, what our expectations are. So we've, you know, bumped up the benefit-cost trend just a bit, but really the pricing coming in a little bit favorable relative to our expectations has helped to offset that. And just following up on our you know, the workers' comp program continues to be managed to our expectations and, you know, still getting nice contribution out of our workers' compensation program.

Your next question for today is coming from Mark Marcon at Baird.

Good morning. This is Andre Childress on for Mark. So you've spoken quite a bit about some of your marketing initiatives as well as the spring brand awareness campaign. Could you give a little bit more color on some of the initiatives that you're actually taking and maybe some early trends from that awareness campaign?

It's a little early for that because that just started, of course, at the beginning of this month. But I can tell you that the whole plan reflects the successful programs we had In the spring of last year, the first time, we did very specific media and marketing campaigns in every market of ours across the country. And then we repeated that in the fall, got excellent results from that. So what I mean by that is it's very localized. Even radio ads are done by local celebrities and voices. It shows us being really involved in the local community. And the plans are different based on whether billboards work in one environment, don't work in another environment, et cetera. So there's a lot of work in each marketplace, coordination with our team in each of those marketplaces so they understand what we're doing, why we're doing it. And that has proven to be very successful. And we expect to have great results in that. We believe we will based on how it's worked before.

Great. And switching over to demand, in this environment, are you seeing a greater preference for workforce acceleration over optimization? And how are you thinking about that for the remainder of the year?

We're evaluating all that, but I really don't see that. It's interesting that when a client and a prospect is ready to move to that level, there's nothing to stop them. So presenting both is an appropriate approach, and then where they are as a company and whether the timing is right to go to the full model or take an initial step into workforce acceleration That's kind of apparent on a client-by-client basis. And the good news is over the long haul, those that come into workforce acceleration, many move up then into workforce opposition, expect to see more of that as the years go on. And then we also have a place for clients to drop back to if there's a need or a situation in their environment to do that. So, you know, we don't see it as one competing with the other, actually both of them kind of support. It's a way to support the client based on what their needs are at the time. And in this environment, the demand for making sure they're dealing with the HR issues properly really becomes a very important component element of what they're doing to keep their business on track through a difficult period. I see the demand continuing to be strong and people understanding what they need to do to keep their business going through a tough period.

I'd like to also clarify, you may know this, but the worksite employee guidance that we give is specific to the PEO. Then workforce acceleration, the gross profit we get out of that product is incremental to our total gross or PEO gross profit. Some people report a little bit differently, but our worksite employees is definitely specific to the PEO offering.

Yeah, that's a good point, Doug. What we mean is that nearly 60,000 or so employees that are at clients on the Workforce Acceleration Program are not in our over 300,000 worksite employees in the PEO model.

Great. Thank you for all the color. And just last one for me. So you repurchased 289,000 shares in the first quarter. Could you provide an update on your thoughts on capital allocation at this point?

You know, we really are kind of the same mindset. You know, we, we, like to take advantage of the market opportunity and to continue to move the dividend in the right direction. We have a target for what the payout ratio should be, et cetera, and what kind of dividend yield we like to have for our shareholders. And then we also have a policy of buying back at least enough shares to offset any potential dilution from incenting our teams. But in addition to that, if you look at our history, we've bought back a lot more shares than that. This is all about the fact that this is a cash flow machine. And so doing the right things with your cash, that's important. And we still would say that the return to shareholders is the highest priority. The amount of capital we need to invest is modest for this model. So we don't expect a lot of increases on that side, and that gives us continued expectation to have plenty of cash available to do.

Your next question for today is coming from Andrew Nicholas at William Blair.

Hi, good morning. Thanks for taking my questions. I wanted to start with one on the worksite employee growth guidance. It does look like it's a touch lower within your previous range. Is that primarily a function of being a bit on the lower end in Q1? It seems like, you know, retention was as you expected, existing client hiring was as you expected. Just trying to figure out if there are any other kind of incremental headwinds that you're baking in there or if it's solely a function of the lower Q1 start.

Yes, the lower Q1 number is the biggest issue, and we're just on the low end of our range. And then we are also just weighing in some of the effects on the sales side, but it's just minor. When you look at it over the full year, we're still within the range. I guess we had a wider range this year because of the of the uncertainty out there. We had a 7.5% to 10.5% range, and now we're 7% to 9%, so the midpoint goes down from 9% to 8%. The bulk of that is due to the first quarter being at the low end of the range because it's all about timing and when people come on into the model. And so when you have a little hesitation that pushes it out a little bit, you've got to factor all that in.

Makes sense. Yeah, I realize it's in the big picture, pretty small change. I just wanted to make sure. And then for my follow-up, on the operating expense side, you've talked quite a bit about BPA growth and staffing up on the support side. Are you in a good spot on the latter part in terms of service personnel and staffing, or do you still need to do some catch-up hiring given the strong growth over the past several years?

Well, we had a really strong... last half of last year on that front and were able to catch up significantly. The first quarter of this year we were digesting a lot of new great people that had joined our organization. We had just a hair of a pause there for a month or two and now we're back on to what I would call just the routine level of increased managing against our growth expectations So we're in a good, solid position on both the BPA front, which is, like we said, 11% growth year-to-date. We'll kind of be at that level, I think, for the year. And then also the service and support staff. We're much better shaped now than we were a year ago on that front. We're in a solid position. We don't see any dramatic operating expense changes based on any of that.

That's helpful. Thank you.

We have reached the end of the question and answer session, and I will now turn the call over to Mr. Servati for closing remarks.

Once again, I'd like to thank everyone for participating on the call today. We look forward to updating you again next quarter. Thank you very much.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.