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 third quarter 2023 earnings conference call. At the moment, all participants are in a listen-only mode. 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 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 third 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 fourth quarter and an update to the full year guidance. We will then end the call with a question and answer session. Now, before I begin, I would like to remind you that Mr. Sabati or I may look forward to 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 8-K file today, which are available on our website. Now let's discuss our third quarter 2023 financial results in which we significantly exceeded our earnings expectations. Continued works on employee growth combined with strong pricing, favorable direct cost trends, and effective management of operating costs resulted in a 19% increase in Q3 adjusted EPS to $1.46 and an 18% increase in adjusted EBITDA to $94 million. As for our growth metric, the average number of paid worksite employees increased by 4% over Q3 of 2022, in spite of a continued slowdown in hiring by our client base and a more challenging sales environment. Client retention remains strong, averaging 99% for the quarter. At this point in the year, we are focused on our fall sales campaign, which generally converts to paid worksite employees In the first couple of months of the subsequent year, Paul will provide some comments on our recent sales activity in a few minutes. Moving to gross profit, we continued to exceed our pricing objectives and achieved favorable results in our workers' compensation program through the effective management of claims. As for our healthcare claims, excuse me, you may recall that Q2's costs were negatively impacted both the number and severity of large healthcare claims, and to a lesser extent, higher pharmacy costs. Accordingly, at that time, our earnings guidance over the second half of 2023 incorporated two scenarios. A lower earnings scenario generally assumed the large claim activity continued at Q2's level for the remainder of the year. while the higher earnings scenario assumed a return to lower, more normalized activity. We are pleased to report that Q3 pharmacy costs came in at forecasted levels and a severity of large claims declined significantly. These factors contributed to favorable development of Q2's claim activity and our positive Q3 earnings. Now when we look at the full year 2023, we're now forecasting a full year benefit cost trend to be slightly below the low end of our previous estimate of seven to eight and a half percent. This includes what we believe is a conservative Q4 forecasted cost trend that is generally consistent with our previous guidance despite the favorable Q3 healthcare cost results. Moving to operating expenses, we continue to invest in our sales, service, and technology. Our growth investment included a 13% increase in the number of business performance advisors, which we believe puts us in a good position as we head into 2024. Our operating costs also reflected the impact of the inflationary environment on our costs. And we're partially offset by a lower incentive compensation accrual and a shift in the timing of the quarterly marketing spend when compared to the 2022 periods. Interest income earned on our investments and operating cash continue to benefit from the current interest rate environment. And we believe that 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 took the opportunity to be more aggressive than our typical share repurchase activity. We repurchased 873,000 shares of stock during Q3 at a cost of $86 million and paid out $21 million in cash dividends. We ended Q3 with $190 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'd like to provide commentary on the following three topics. I'll begin with highlights behind our strong Q3 financial and operating performance. Secondly, I'll provide an update on the economic environment in the small to medium-sized business community, which is the backdrop of our fall selling and retention campaign opportunity. I'll finish with some thoughts regarding the outlook for 2024 and beyond. This recent quarter was a welcome rebound in our financial results from Q2 with 4% unit growth driving 5.5% gross profit growth and over 18% growth in adjusted EBITDA and EPS. We're pleased with these results considering some marketplace challenges continuing to deepen within the small to medium-sized business community, and I'll discuss this more in a few minutes. The most direct impact on our results from this environment is in net hiring within our client base, which reflected a continued slowdown we've seen throughout the year. For the first time in several years, client net hiring was flat this quarter. The net gain in our client base declined significantly when compared to Q3 2022, while client retention and the number of worksite employees paid from new client sales remained consistent compared to the same period last year. In addition to the lower large health claim costs Doug mentioned, our pricing and cost management were the strong drivers of our outperformance. This reflects solid execution across the company and contributed to a strong quarter and our outlook for the long term. Another highlight was our increased service capacity and client satisfaction levels as utilization of many of our HR services increased. Our hiring and training results over the last year have improved our service efficiency ratios to handle growth and resulted in a notable increase and our net promoter scores. During the third quarter, we completed the implementation of our Salesforce CRM system across our service organization. We now have the entire company on a common platform that provides the opportunity for more timely, precise, and efficient client service interaction and potentially greater client satisfaction. We can see in our service utilization metrics the changing needs of clients in the current environment. Many HR services that are used more in a slower growth environment increased significantly over last year. This included support for worksite employee terminations, such as separation agreements, and support for employment practices and unemployment-related claims. These services have been at historically low levels in the past couple years, so this increase is expected in a more neutral hiring environment and further demonstrates our ability to bring value to clients in any economic environment. Book sales for the third quarter were mixed with strong performance in workforce acceleration, our traditional employment service offering, while our workforce optimization core and mid-market book sales were below our expectations. Our workforce acceleration book sales reflect adoption of this offering across the sales organization and has helped our newest BPAs experience earlier success. This has led to lower turnover rates, which has excellent potential to drive sales efficiency going forward. Now, in early September, we had a successful national kickoff to our fall selling and retention campaign and increased marketing efforts to continue to drive sales activity levels. Our discovery call activity was a strong point in Q3, up double digits, which we expect to be a solid indicator for Q4 sales. Now, I'd like to provide some data points and survey results from our client base reflecting decisions and sentiments in the small and medium-sized business community that we see across the country. This provides a picture of how we believe the challenging economic climate related to interest rates, inflation, and the labor market are affecting many of these businesses. I mentioned that hiring within the client base was flat this past quarter, and additional underlying data is consistent with this metric. Lower pay increases, overtime pay, and commissions paid to the sales staff of our clients all reflect some economic pressure. Average pay increases dropped to a low point of approximately 3% for the first time in several years. Overtime pay was below the 10% level, which historically aligns with the lower need to hire personnel. Commissions we pay on behalf of our clients to their salespeople, which provides some insight into the pipeline for new business in the client base, was well below the 6% level, which typically indicates employment growth. Now, our quarterly survey of the client base, which provides insight into the client sentiment, included a ranking of top four concerns for their organization. The top four were managing operating costs, driving sales, external economic uncertainty, and the labor market, especially the quality of the applicants. We also asked survey participants their top HR concerns. The top three concerns, all cited by over 50% of those surveyed, were retaining employees, keeping employee engagement high, and building or maintaining a strong culture. Right behind those three was managing healthcare costs. Now, throughout our history, this type of challenging backdrop translates into quite an opportunity for disparity. These needs for consultative HR services, increased demand for our comprehensive HR service solutions, and highlight our competitive advantage. Historically, we've seen competition become somewhat desperate for sales growth when net hiring within the client base falls this low, and we've seen some of that over the last quarter. As the premium service provider in the marketplace, we are well able to compete on short-term promotional tactics from competitors But they cannot match the breadth and depth of our services and the level of care we provide our clients and worksite employees at their greatest time of need. Over the first two weeks of this quarter, our sales leadership did a deep dive evaluating Q3 workforce optimization sales drivers, including input from BPAs and potential clients. This provided sufficient information to take specific action, which led to an immediate boost to fall campaign sales and retention efforts. This boost came in the form of a dramatic increase in sales activity, including both closing business and new opportunities to quote potential clients. Attitudes and energy levels across the company also benefited, reflecting the Insperity culture of rising to the occasion to take advantage of a specific opportunity. So we believe we're well positioned for a successful fall selling and retention campaign, which is important to achieve a starting point in paid worksite employees to start the new year. As we look ahead to 2024 and beyond, we continue to be excited about the vast market opportunity and strong demand for our services in the marketplace. Excuse me. We're also in a strong position in staffing levels in both sales and service to capitalize on this opportunity. For next year, it's too early to provide any specific guidance, but there are general considerations for growth and profitability to weigh in mind. Historically, our lead indicator for future growth has been the growth rate in business performance advisors combined with expected sales efficiency gains based upon their tenure. As Doug mentioned, our continuing investment into BPA growth was a highlight this quarter, coming in at 13%. So over the next year, we believe we're in excellent position for new client sales. Client retention has been solid all year, and our focus on this measure across the company provides confidence into next year on this key growth driver. The other growth factor to consider is the economic climate ahead and the effect on net hiring in the client base. Historically, in an average year, we expect a client net hiring contribution of 4% to 6% in our growth rate of worksite employees. This year, the contribution to our growth from net hiring was below the low end of that range. Although we believe net hiring will eventually revert to historical levels, a number of factors are posing obstacles that may make this more gradual. In addition to the interest rates, inflation, and the labor market effect we've seen recently, 2024 is an election year that historically adds some uncertainty. Now, based upon these growth factors and assuming a successful year-end transition, I see next year similar to this year in full-year growth rate of mid-single digits, but the opposite on timing. Instead of higher single digits early in the year and lower single digits toward the end like this year, I see lower single digits early and high single digits toward the end of the year on our way back to our historical target of double-digit unit growth. Now, beyond unit growth, the most important factors in our outlook for profitability are trends in our pricing, direct cost, and operating expenses. Our pricing strength continued this quarter with the recovery in direct cost. We believe we are in a strong position to achieve pricing and direct cost alignment targets going forward. Our operating expenses have included some significant investments over the last couple years, including BPA growth and sales incentive plans, increasing service capacity, and implementing Salesforce CRM. Although we continue to expect investments going forward, we believe the historical operating leverage of our business model will begin to reemerge. So as I look ahead to next year and beyond, I expect the level of growth and profitability to ultimately return to historical levels. Our historical business model performance includes five-year periods with double-digit compound annual growth rates of 10% to 12% in worksite employees, driving mid-teens growth rates in gross profit and rates above 20% in adjusted EBITDA and APS. Now we have had historical five-year periods that include a year like this year where we absorbed a growth challenge from client net hiring and or a profitability challenge from a direct cost aberration. We are in the second year of our current five-year plan and our eyes remain on the objectives similar to historical levels. There are two reasons for my level of confidence. The clients we serve and the dedicated team of people we have at Insperity. Our position in the marketplace as a premium provider to the best small to medium-sized businesses in the country has allowed us to observe the resiliency and innovation that are key to addressing economic challenges and creating market opportunities. In addition, our corporate team has demonstrated the capability to achieve extraordinary results, and they are focused on the appropriate strategies and objectives that provide consistent value to our clients and help their businesses succeed. At this point, I'd like to pass the call back to Doug.