Insperity, Inc.

Good morning. My name is Jenny and I will be your conference operator today. I would like to welcome everyone to the Insperity second quarter 2023 earnings conference call. Currently all participants are in a listen only mode and 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 phone keypad. Please note this conference is being recorded. At this time, I would like to introduce today's speakers. Joining us are Paul Savody, 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 second quarter 2023 financial results. Paul will then comment on the quarter and our plan over the remainder of the year. I will return to provide our financial guidance for the third quarter and an update to the full year guidance, and then we will end the call with a question and answer session. Now, before I begin, I would like to remind you that Mr. Servati 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 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 8K file today, which are available on our website. Now let's discuss our second quarter 23 financial results in which we effectively executed on our plan and sales, service, pricing, and other areas of the business. However, experienced a shortfall from our forecasted earnings due to substantially higher healthcare costs. We reported adjusted EPS of 64 cents and adjusted EBITDA of $51 million for the quarter. As for our growth metric, the average number of paid worksite employees increased by 7.2% over Q2 of 2022, which was just below the midpoint of our guidance as net hiring by our clients came in slightly lower than expected. Worksite employees paid from a combination of sales and client retention came in on target. Moving to gross profit, we continue to achieve pricing above targeted levels And we combined with our workers' compensation program, payroll tax area, and traditional employment offering, we experienced a favorable outcome. However, Q2 health care costs came in approximately $42 million higher than expected. This was primarily due to both the number and the severity of large claims up to our $1 million per person insurance claim limit. Large claim activity accounted for approximately 75% of the higher costs, with claims over 750,000 being the primary driver of this increase. The remaining 25% related to higher than expected pharmacy costs. And as for the higher pharmacy costs, we experienced an increase in utilization of specialty drugs including a significant step up in the use of diabetes and weight loss drugs and behavioral health drugs. Now, while large claim activity persisting over more than one consecutive quarter has been rare over the course of our history, our updated range of earnings guidance incorporates a continued high level of large claim activity over the remainder of the year on the low earnings side, and a return to more normal activity on the high-earning side. In both cases, we anticipate that pharmacy costs will remain elevated. When considering these factors, along with our results over the first half of the year, we are now forecasting a benefit-cost trend of 7% to 8.5% for 2023, up from our prior estimate in a range around 5%. On top of the pricing improvements that we have achieved, we intend to further adjust our pricing to mitigate the impact of this potential increased cost trend. And Paul will provide additional comments on our benefit pricing and cost trends in a few minutes. Now moving to operating expenses, costs increased 9% over Q2 of 2022 and included continued investment in our sales, service and technology and the impact of the inflationary environment on our costs. Our growth investment included a 15% increase in the number of higher business performance advisors, putting us in a good position as we approach our fall selling season. Net interest income increased by $3 million over Q2 of 2022 on higher interest rates and invested balances. Second quarter's effective tax rate was 25%. which we are also now forecasting as our full-year rate. Now, our financial position and liquidity remain strong, and we continue investment in our growth while providing returns to our shareholders. During the quarter, we repurchased 98,000 shares of stock at a cost of $11 million and paid out $22 million in cash dividends. We ended Q2 with $219 million of adjusted cash and $370 million of debt. And as announced this morning, we have increased our share repurchase authorization by 2 million shares and intend to be more aggressive than our typical repurchase activity, depending on market conditions. 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'd like to provide comments on the following three topics. First, I'll comment on the second quarter excellent execution and the results across key long-term performance drivers in our business. Second, I'll discuss how Insperity is positioned to capitalize on our vast market opportunity with a focus on the future of the workplace and the corresponding changing needs in our target markets. I'll finish with comments on the outlook for the company into next year and beyond, despite the unexpected large healthcare claims in the recent quarter. Our most important key drivers for long-term success and growth and profitability, more within our control, are new sales, pricing, client service, and retention. All these areas were strong in Q2 and contribute toward a positive outlook for the future. Our workforce optimization book sales were solid, driven by an outstanding effort in our mid-market business performance consultant team. This team experienced one of their strongest quarters in history in book sales in both deal count and worksite employees sold. In addition to substantial book sales, excellent progress was made by our BPA's driving sales activity, which was a priority coming into the quarter. Our 15% higher number of BPAs increased discovery calls nearly 30% over Q2 of last year, making our prospective client pipeline significantly stronger as we go into the second half of the year. One of the other highlights of the quarter was workforce acceleration, or WX, continuing to gain traction across the sales organization and coming in well above budget in booked sales. One of the reasons this is exciting is the opportunity to test one of our assumptions regarding WX. At this level of WX adoption and incentives and a large number of new BPAs over the last 12 months, we can begin to assess the potential for WX to lower BPA turnover. Historically, the 18 months ramp up period for training BPAs and workforce optimization sales has resulted in a level of frustration from the complexity of the sale and relatively few closes over the learning period. This caused higher turnover rates in less tenured Tier 1 and Tier 2 BPAs. WX is a less complex sale and provides opportunity for earlier success as the ultimate WO sales training is accomplished. The early read for this first half of the year appears to be validating as the WX sales adoption has considerably lowered turnover in both tiers. Now, sales efficiency is down somewhat year-to-date, which is to be expected with the high number of new BPAs in the mix and a different economic climate in the first half of the year. Our refined sales compensation incentive programs are encouraging exactly the behavior we want to drive efficiency going forward. Not only does strong WX sales by Tier 1 and Tier 2 BPAs create a client base to upgrade to WO over time, but they also provide an opportunity for sales efficiency to improve sooner if this lower BPA turnover continues. Now, our strong pricing allocations will also highlight this quarter. This is particularly critical considering the higher than expected claim cost in Q2. In a few minutes, I'll address how this pricing trend and our plans going forward will contribute to offset cost trends. Q2 was also another strong quarter in execution reflected in our client service and retention results. Retention was 99% each month of the quarter at historically high levels. Our success in our recruiting and training efforts of corporate staff over the last few quarters has resulted in appropriate client service ratios, to support our changing client needs. So through the first half of the year, we've experienced solid execution of our plans across the company, and we believe the business is on sound footing for growth going forward. As we look ahead, we are seeing fundamental changes to the future of the workplace, and therefore the needs for small and medium-sized businesses to compete as an employer of choice. This was clear to us more than a year ago, and we established a new division in the company and a new role on our executive leadership team. Our strategic planning and development organization, led by Executive Vice President Kathy Johnson, is focused on strategic corporate and organizational development to continue our industry leadership position in the breadth and depth of services provided and the level of care for our clients. This team is focused on purposeful transformation to the changing HR environment including everything from data analytics and artificial intelligence to employee generational and psychological demands for flexibility and resources to support personal wellness and development. Examples of these critical drivers to employee engagement include adjustments to work mode and locations, changes to payroll and access to wages, and inclusion of mental, physical, and financial wellness offerings. We are planning upgrades to many of these areas over the last half of the year to support our clients changing needs. I believe with our focus and innovation in these areas, we are well positioned to meet small and medium sized employer needs to remain competitive in the tight labor market and succeed in the marketplace. These demands require cultural changes in companies to attract and retain the best people. Our history of working with clients on these issues combined with our efforts to provide the appropriate benefits and dynamic employee experience platform for these businesses positions Insperity as the provider of choice into the future. So we believe that our long-term outlook remains very strong, driven by effective ongoing execution and enhanced strategic planning and development. Our level of confidence is not impeded at all. by the recent large claims and the effect on the quarter or the projected year. The best place to start to put this claim quarter in proper perspective is to look at our five-year compounded annual growth rate in both pricing and cost of our benefits plan with this year's estimate included. Our estimated benefits cost compound annual growth rate is 4.2% to 4.6% including the wide range of potential claims we've estimated for the full year. Our compound annual growth rate for benefits allocations over the same period is 4.1%. Now, these rates demonstrate effective healthcare cost management compared to the marketplace and achieving our goal of aligning our pricing with cost increases over time. Our long-term historical cost trends are solid, and our pricing strategy has performed well. Now this year we're running ahead of target allocation increases and we've already initiated a plan to add a moderate incremental amount of pricing for 2024 of approximately one to one and a half percent, which we believe is in line with marketplace trends and should put us in a solid position to align our pricing and costs going forward. When we look ahead to next year and beyond, we believe we'll be able to continue to appropriately align our pricing strategy to our cost trends over time like we have in the past. We are in year two of our current five-year plan, and this quarter's results do not change our strategy to achieve our goals. Throughout our history, from time to time, we've had quarters in which we experienced unexpected large claims. In each such instance, we've successfully managed through the situation and continued our long-term growth and profitability. For the company to stay on plan, the most important focus is on our growth drivers over the balance of the year. Our focus includes continuing the investment in BPA hiring and training and additional marketing to drive sales over the balance of the year. We also have the organization ready, willing, and able to continue solid execution on our pricing and client service and retention strategies. We remain confident in our ability to achieve these goals, which we believe will drive future performance, and position us well to continue our history of superior returns to 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 guidance for Q3 and an update for the full year 2023. Our updated earnings guidance includes assumptions around a possible range of outcomes in our benefit costs over the remainder of the year, Outside of this area, we continue to expect favorable trends in our pricing and other areas of gross profit, and are forecasting slightly lower paid worksite employees and operating expenses. As for the details, we are now forecasting 6.5% to 7% worksite employee growth for the full year 2023, slightly lower than our previous guidance, and a tighter rain since we are now more than halfway through the year. The lower growth outlook is primarily a result of Q2's average paid worksite employees coming in a little light due to lower hiring in our client base and an assumption that this lower hiring continues over the remainder of the year. As for Q3, we are forecasting year-over-year worksite employee growth of 4% to 4.5%. Now, this is lower than our full-year growth forecast due to our assumption of significantly less hiring in Q3 of 2023 compared to Q3 of 2022. However, this guidance reflects continuing sequential worksite employee growth over the remaining two quarters of 2023 and improving year-over-year growth in Q4. We have revised our earnings guidance based upon our results through the first half of 2023 and our updated outlook for worksite employee growth and the range of expectations around our benefit costs as previously discussed. So after putting together the pieces, we are now forecasting full year 2023 adjusted EBITDA in a range of $300 million to $350 million. and adjusted EPS in a range of $4.35 to $5.32. As for Q3 earnings, we are forecasting adjusted EBITDA in a range of $57 million to $81 million, and adjusted EPS from $0.69 to $1.14. Now, at this time, I'd like to open up the call for questions.

Thank you. At this time, we are opening the floor for questions. If you would like to ask a question, please press star 1 on your phone 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 anyone using speaker equipment, it may be necessary to pick up your handset before you press the keys. Please pause a moment whilst we poll for questions. Thank you. Your first question is coming from Andrew Nicholas of William Blair. Andrew, your line is live.

Thank you and good morning. I wanted to ask on the benefits cost side first. I was hoping you could provide a little bit more color on the benefits cost trend, particularly on the $750,000 plus side. Is there anything to pinpoint in terms of the underwriting approach or the risk management approach that would help to explain that? Or is it just some noise? And then I guess maybe the bigger picture question is, do quarters like this change your appetite for risk on the healthcare side or any kind of long-term ramifications to this kind of quarter? Thank you.

Yeah, I think when you look at a little bit more of the detail behind the cost, obviously we investigated some of the detailed claims data that was provided from our healthcare carrier very diligently. I think one thing that came out of that was that there was not a higher concentration of large claims from new clients. which would indicate that through our fall selling season and our year in renewal, this is not the situation where there has been adverse client selection. That's obviously one of the first things that you want to rule out. When you look at the types of claims, it's really across the board. As far as the $750,000 and above, you've got some cancer, you've got some heart attacks, you've got some accidents. And so it was really, you know, varied and diversified over as far as the nature of the type of claims. And so, you know, I think it was, from what we can see thus far, yeah, we did have a period of large claim activity. It has happened in our history, but I think we still feel, particularly when you look at Paul's comments with respect to over the long term in the five-year compounded rates that we're still managing the healthcare cost trends, even with the forecasted higher costs over the remainder of the year. Within a range, a tolerable range, and really within a range where our pricing with being above target recently and maybe some adjustment to that, you know, we feel like the matching of pricing costs is still in play.

So let me address the second half of that question about the kind of appetite for risk, because I think there's two different ways you have to look at it. First of all, You know, we are comfortable with the way we have structured our program to align price and cost over the long term. And we know that it provides advantage to grow the business and it provides a more profitable long-term structure. But at the same time, you know, we sure don't like when we have a large claim quarter like this. And as you know, when we did this in 2019, we did purchase a coverage limit on individuals at the million dollar level. We also will continue to look and evaluate that as this year goes by. We've quoted lower limits before. Sure, we'll take a look at that like we do every year. And I would just say also that we, on an ongoing basis, look at other possibilities to take out some of the volatility that relates to this type of quarter and how that affects us in the public markets. So, you know, we continue to pursue those things. So I would say our appetite to, you know, we still want to run the business this way, but certainly as we can find other ways to reduce the volatility that's caused by these occasions, we'll continue to pursue that.

That's helpful. Thanks to you both. I guess for my follow-up question, I wanted to ask on capital allocation and maybe the capacity you have for repurchases in 2023, especially in light of the increased authorization. And I think, Doug, your comments on your intention to be a bit more aggressive there. Can you just flesh out the type of capacity you have this year to put back into buying the stock? Thank you.

Well, I think you can see from the increased authorization of 2 million shares, it would give you some indication as to where the board is currently, you know, feeling with respect to repurchase authorization, which would indicate a higher level than what we have done typically. But even if you look at it over the course of our history, we've always been a big purchaser of shares. I think if you go back to the 2019 events where we had some quarters of high elevated large claim activity, we were quite aggressive because we We felt that, you know, over the long term, the business model remained very much intact. I think we obviously feel very confident in that today. So with the increased authorization, it does allow us to be more aggressive should opportunities present themselves, you know, coming off of this quarter's activity. Again, strong confidence that our long-term plans are still in place and still –

still reasonable targets for us. Thank you.

Thank you very much.

Your next question is coming from Toby Summer from Truist. Toby, your line is live.

Thanks. I was wondering if you could share with us your expectations and what you're hearing from your healthcare provider about whether the higher healthcare expense level you know, may continue into 2024. I think it's been a theme and concern that people had sort of in the post-pandemic era. Thanks.

Yeah, I think, you know, we do continue these conversations on an ongoing basis. And Toby, as you heard from our discussion here, we did go ahead and build in just a higher pharmacy trend because there's things in there that seem more likely to continue than to uh, than, than be a, uh, you know, a short term bubble. So we do continue to monitor those things. I think that's different from this, uh, the large claim component. Uh, however, you know, since we had a difficult, uh, uh, long, you know, difficult period, 2019 that covered multiple quarters, we've just used, uh, you know, wider range of the expectation for this year. In the conversation with our advisors and outside the company, we think we're properly managing and aligning our cost and price with the underlying trends.

Thanks, Paul. For my follow-up, I'll make it two-pronged if I could. The mid-year price hike you talk about, 1.5%, is that applicable to all clients or is that sort of a new and renewing client only and then maybe you could talk about and dig into your experience with bpa retention and maybe talk about something a little more exciting on the sales front away from the benefits thanks sure so you know we when we look at remember we're we are we are looking at pricing every day in our operation based on the trends that are that we're seeing

And we're pricing new and renewing business every day. And so when we talk about raising that, you know, adding another one to one and a half percent, that began, you know, immediately when we decided that. And that adds to the typical trend increases we've been building into clients. You know, clients typically, you know, get an increase from us. It varies based on their experience with us. But generally speaking, customers will get an increase in the high single digits. Some will get double digits, but most of the time it's on average, I would say, in high single digits. And then they will make their own decisions on how to lower that cost by plan selection or how they might share costs with employees or other issues that they'll look at. So, uh, what we're saying now is we'll continue to drive that, you know, higher than the average that's been, but it appears to us to be very much in line with what is going on in the marketplace at large. Uh, so we're not in a position where we've got to raise price considerably. And, uh, in response to what we see going on, we think we're comfortable with where we are and what we're able to pass on. And as you can see. We've just come off of a year and a half of really strong pricing success with our client base, so we're very comfortable with that going forward. So now onto the exciting part on the growth side. Yes, I'm very excited about really everything we're doing in our organization around the core business and the incentives that we've changed to direct behavior at the appropriate things at the appropriate time. also the wx element that we also incented in such a way that we're seeing the lower turnover year to date and that has a dramatic potential effect and then of course the other factor that i always want to focus on is how successful we were in mid-market and we are building that team and building that pipeline for more consistent and predictable growth on the mid-market front so All three of those pieces together really point to a positive growth outlook for the company. Even though we've been in a period of time when growth in the business is below the double-digit number, we still have had the highest growth rate in the industry. But I think as these things really take effect, there's this long-term potential for improved sales efficiency from less turnover. And in addition to that, It's also lower cost, dramatically lower cost when you have lower turnover. So that kind of has a double-dip positive effect, and we're excited about where we are on that front. Still a lot of work to do, but we're really poised for an excellent second half.

Thank you very much.

Your next question is coming from Mark Marcon of Baird. Mark, your line is live.

Thank you. I've got a couple of questions. The first one just basically relates, again, to a little bit more detail with regards to the higher healthcare claims. And what I'm wondering specifically is, can you talk a little bit more about what's going on on the pharmaceutical side? You know, which seems like it will be an ongoing trend. And then on the larger claims, did you find that it's just that you had more severe incidents? Or is there also some inflation for, you know, some higher um, you know, higher incidents. In other words, is, is treating the same type of cancer significantly more expensive today than it used to be? Or are heart attacks more expensive than they used to be? Obviously labor costs are going up within a hospital system. So I'm wondering if that's part of what we're seeing.

Well, I think on that front, um, know that's a good point and we do monitor exactly that and that's generally more in the typical year to year trend numbers and we work of course with our outside advisors and of course with our carriers uh to monitor those things but what we're really talking about this quarter um i don't think that factor you know is is an underlying factor all the time and not not different this quarter but on the pharmacy side I think most people have heard and you see in the marketplace a lot of discussion about various drugs that are being used, especially more recently on the weight loss front, some of the diabetes drugs and other drugs that maybe weren't originally designed for that but are being used that way, more of a fad type thing. I think that may wane also because there are some long-term effects that are not positive for people, but it takes time for that to run through. And so there's also, I think, an increase in behavioral health needs, and that is also a factor that, you know, if you think about being two years into a period of high inflation and kind of the squeeze of the wallet for a lot of people, that has a mental and nervous effect. It has a behavioral health cost effect. And so those are the things we kind of saw underlying here. And we said, look, that, you know, that is most, most important to build in as we see it. So we've done that. And, you know, like I said, we've, we've done stuff on the pricing side to make sure that's all aligned going forward.

Great. And then with, with regards to the, you know, implementing a modest price increase, you know, which can be mitigated to a certain effect by the behaviors of the clients. What sort of impact would that have on sales? And then offsetting that, you know, to what extent, Paul, can you, you know, accelerate WX to an even greater effect and, you know, and take out some of the healthcare risk from the initial pricing discussions?

Yeah, that's good. You know, we definitely, on the WX front, one of the advantages, of course, of growing that business is it's not, there is no medical risk in that business. So we do see that as a nice enhancement, and we are intending to drive that considerably as time goes forward. It makes sense to do that. And, you know, we are, what's happening right now is the sales team is really getting on board We incented their effort to close WX business, and that has so many strong effects. They're adding a client base of their own that can upgrade to WO as time goes on, and they're feeling more successful early in their tenure, and that's what's lowering the turnover. We just see a lot of advantages for WX. We are definitely moving that ball forward and expect that it can be much larger. There's other things that we're doing there that deal with some of these change in the workplace issues that I was discussing. For example, access to wages and things of that nature. Other tools that can be provided to employees for wellness. We're doing that both in WX and WO on the financial wellness and other types of services that employees are demanding more and more kind of post-COVID. So we are moving ahead there, and I think looking forward to some dramatic success in WX.

Toby, I think your other question with respect to the pricing adjustments that we're going to be making on the healthcare side, As we mentioned earlier, the good news is we've been above our targets on the medical pricing allocations over the course of this year. And when we look at our forecast and assuming a wide range and that some of this large claim activity continues, we're looking at making incremental pricing changes in the range of 1% to 1.5%. And looking out there in the marketplace, it's very much in line with the marketplace trends. So we don't think that our pricing is going to be outside of the marketplace trends and we'll be very consistent and shouldn't put it at a disadvantage.

Thank you very much.

Your next question is coming from Jeff Martin of Roth Capital Partners. Jeff, your line is live.

Thank you. Good morning. Doug, I wanted to get a sense when you think the potential price increases for the benefit-cost allocation may be fully implemented. Is that early next year, or is that going to be sooner than that?

Yeah, a significant chunk of it happens through the year-end transition, and then they'll continue on through the first quarter or so of the year. Um, but you know, that's, that's just that, that one, that's the increased component and we are, we've been having strong, uh, pricing increases that are flowing in every month.

Got it. Okay. And then on, on the new initiative in terms of helping small businesses position for the current, you know, environment and attracting and retaining employees, Is that an added component in terms of an additional service charge, or is that lumped in with the workforce optimization product?

I'm sorry, can you repeat that for me?

I'm just curious if that new service offering for small businesses where you hired Kathy Johnson or you elevated her to lead that, effort, is that going to be an offering that you specifically charge for as part of workforce optimization or is that built into the product itself?

That's good that you bring that up because what this strategic planning and development group is all about is carefully evaluating any new things that are offered to determine the appropriate structure for that addition. And so there will be things that will be charged for because they're outside of, you know, for us, we don't want to just keep adding to the bundle, so to speak. And there's certain services or products that people want to have outside of that bundle. So we'll be looking at a variety of things on every product, service, every improvement that we're going to make through that group. We'll be looking at those as financial benefits. investments and looking for the return on those investments.

Thank you.

Thank you very much.

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

Once again, we do want to thank everyone for participating today, and we look forward to a strong second half, continue to focus on our growth into the future and continuing our strong second year in our five-year plan. So thank you once again for being a part of this today, and we look forward to talking to you next quarter. Thank you.

Thank you, everybody. This does conclude today's conference call. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.