Earnings Call Transcript - NSP Q1 2024

Operator, Operator

Good morning. My name is Jenny, and I will be your conference operator today. I would like to welcome everyone to the Insperity First Quarter 2024 Earnings Conference Call. Please note, the conference is being recorded. 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 Sharp, Executive Vice President of Finance, Chief Financial Officer and Treasurer. At this time, I'd like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.

Douglas Sharp, CFO

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 2024 financial results. Paul will then comment on our recent accomplishments, including the progress we have made in implementing our Workday strategic partnership solution. 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. 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 more detailed discussions 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 first quarter results in which we reported earnings above the high end of our guidance. We reported Q1 adjusted EBITDA of $142 million and adjusted earnings per share of $2.27. These results reflect the average number of paid worksite employees within the range of our forecast, continued strong pricing, lower-than-expected benefit costs, and operating expenses in line with our budget. As for our growth metric, the average number of paid worksite employees in Q1 was approximately 304,000, a decline of less than 1% when compared to Q1 of 2023. As you may recall from our prior earnings call, this slight decline was expected due to net layoffs in our client base over the second half of 2023 into January of 2024 and the loss of a handful of large accounts during our year-end transition. Additionally, we experienced a 42% decline in net hiring in our client base in Q1 of 2024 when compared to the first quarter of '23. Worksite employees paid from sales was at a similar level compared to Q1 of 2023, and when combined with client retention, came in at forecasted levels. Gross profit increased by 4% over Q1 of 2023 as strong pricing through our year-end transition of new and renewing accounts combined with a lower-than-expected benefit cost trend. This lower Q1 benefit cost was associated with a favorable adjustment to our reserves at the end of 2023 based primarily on subsequent claims runoff through the end of February of 2024. Regarding the last month of Q1, we believe the timing of claim payments under our plan in March was affected by the industry-wide impact of the cybersecurity breach at Change Healthcare. Upon a detailed review of our claims data and discussions with our insurance carrier, we believe we have appropriately reserved additional amounts for Q1 2024 claims incurred but not yet reported due to the impact of this breach. The combination of our other direct cost areas, including workers' compensation and payroll taxes, were generally in line with our forecast. Q1 operating expenses were also managed to budgeted levels, increasing 12% over Q1 of 2023. Operating expenses reflected our continued investment in our growth, in our service and technology offerings, including approximately $5 million of costs related to the initial phase of implementation of our Workday strategic partnership. First quarter's effective tax rate came in at 29%, which was higher than our Q1 of 2023 rate of 23% and our forecasted rate of 26%. This was primarily due to changes in our stock price that resulted in less tax benefit on employee stock awards vesting at the end of February. Now we believe that our financial position and liquidity remains strong as we continue to invest in our long-term growth plans while providing returns to our shareholders. During the quarter, we repurchased 233,000 shares of stock at a cost of $23 million and paid out $21 million in cash dividends. We ended Q1 with $206 million of adjusted cash, an increase of $35 million over the December 31, 2023, balance. And we continue to have $280 million available under our credit facility. Now at this time, I'd like to turn the call over to Paul.

Paul Sarvadi, CEO

Thank you, Doug, and thank you all for joining our call. Today, I'll begin with comments on our solid first quarter performance, including initiatives supporting our plans for future growth. Second, I'll provide insights from our view of the economic climate and the reactions within the small and midsized business community. Third, I'll provide an update on the initiation of our new strategic partnership with Workday and provide a glimpse into our upcoming Investor Day. Overall, we had an excellent quarter, exceeding the high end of our adjusted EBITDA range against the backdrop of an economic slowdown. Our fundamentals are solid, and we expect our plan for the balance of the year will help mitigate the effects of the economic climate on our target small- to medium-sized business clients. New book sales for Workforce Optimization solution were strong in the first quarter. We experienced a double-digit increase over the same period last year, reflecting the growth of our BPA team and an improvement in closing rates driving sales efficiency. This improvement reflects the experience gained over the last year by business performance advisers and effective incentives for prospective clients and the sales team. Booked sales by our mid-market Business Performance Consultants was the highlight of the quarter. They continued their excellent performance since the last half of last year, exceeding budget. Sales of our larger accounts have become more consistent over the last year. The steady flow from BPA's funneling qualified leads into this process and our growing number of BPCs is the reason for this improvement. This is well-timed for our new Workday strategic partnership I will discuss in a few minutes. We also had a strong quarter in our traditional Employment Workforce Acceleration business as our WX employee count on this service increased 21% over the same period last year, including a notable improvement in client retention. Total client retention in our Workforce Optimization business for the first quarter was in line with last year, except for the large accounts we discussed last quarter. We also achieved an important marketing objective exceeding our lead generation goal for the quarter. However, conversion of these leads into discovery call appointments was just under 90% of target. Reaching sales activity objectives remains challenging in this environment. We have several initiatives to drive sales activity, including the launch of our account-based experience, marketing and sales strategy. This approach, made possible by our investment in Salesforce, provides insights from advanced technologies to leverage the ideal client profile and buyer intent signals to improve BPA effectiveness. This is a more strategic approach in sales research planning and execution focused on high-value accounts and building relationships with key decision makers. All BPAs will begin with assigned target accounts this quarter, which we believe can lead to more BPA time in front of qualified prospects. We have additional initiatives underway, leveraging our investment in Salesforce and AI-enabled technology to drive efficiencies, speed, quality and insights for our teams as they serve our clients and operate and grow the business. The move to our enterprise-wide Salesforce platform, as well as our implementation of modern data engineering and analytics technologies, are well underway, allowing us to put in place a data strategy that we believe will accelerate predictive analytics, AI, and other emerging capabilities. Now let me provide some insight regarding the economic climate our clients are facing, evident from our client data, our interaction directly with business owners and our recent national survey. The key data elements we monitor to assess the small, medium-sized business climate are net hiring, wage inflation, overtime hours worked, and commissions paid to the sales staff of our clients. As Doug mentioned, net layoffs incurred in our client base over the second half of 2023 have continued through the first quarter of this year. Wage inflation, which peaked nearly 7% in 2022, has continued a downward trend all the way to slightly below 2%. Overtime as a percentage of regular pay is down to 9%, the lowest number in a few years. The most important metric that provides some insight into client sales and near-term revenues in their businesses is commissions paid to their sales organization. This metric was down to 6%, also the lowest number in the last couple of years. Recently, we've also had the opportunity to have direct discussions with a representative number of clients. While normal business owner optimism is still alive and well, comments about the effect of interest rates, inflation, and the economic slowdown were common. Our recent client survey reinforced these anecdotal comments across the broader nationwide client base. Clients who feel their organization will perform better during 2024 than during 2023 have decreased to 66% from 74% just one quarter ago. The percent of clients who expect to increase staffing has dropped to 39% compared to 54% a year ago. One-third of the respondents expected the economic climate to have at least a somewhat positive impact on their organization, while 42% anticipate a negative impact. Consistent with past quarters and looking forward to 2024, client optimism about their own business performance exceeds that of their expectations for the economy. Two-thirds of client survey respondents were still optimistic about their own company performance, which was similar to January. Now let me shift to the exciting update about our newest significant catalyst for growth, our exclusive Workday strategic partnership. My enthusiasm for this opportunity was evident on our last call, and after the first three months working together and gathering client feedback, has been reaffirmed. Our view of this strategic partnership as a potential game-changer in the marketplace and at the same time significantly elevating the trajectory of our company, driving long-term growth, profitability, and value creation for Insperity, has been strengthened. As a reminder, through our strategic partnership, Workday and Insperity are committed to jointly developing, marketing, selling, and supporting the preeminent solution for targeted small and medium-sized businesses that combines Workday's HR technology with Insperity's HR services. We expect to offer this unique combined solution to the target market for less upfront capital cost, ongoing expense, complexity, and implementation time than currently available to those businesses. We believe this new solution has the potential to be competitively disruptive. Insperity and Workday are now strategic partners focused on four major objectives. All four of these priorities are off and running after just the first few months working together. First, the foundational step for this strategic partnership to be effective is Insperity becoming a Workday customer for our corporate staff, which is ideal for our 4,300-employee company with dynamic future growth. We believe it's important to have our entire staff on Workday to be ready to support our clients as we launch this new solution. Our corporate Workday tenant project plan is progressing on schedule. A significant milestone for this to be started and completed effectively is the completion of the initial corporate HR data workbook in order to build the foundation tenant to use in configuration sessions. This was submitted to Workday and the development site is up and running. Second, we are developing and embedding an instance of Workday as the client-facing HR technology within our Workforce Optimization offering to create this new joint solution for the target market of larger accounts. Now this new Insperity-Workday client tenant instance is a significantly more complex implementation. It's challenging to even describe how much work and detailed planning has already happened on this project. We are very pleased significant progress has been accomplished detailing out the master plan for this project, and the teams are working together extremely well. Third, we're establishing a deployment and enablement team within the Insperity service organization with the help of Workday. Our goal for this team is to deliver implementations and provide support for the new solution in a similar, efficient and effective manner as we do today. We're also off to a great start establishing this Insperity enablement team. A significant number of our service professionals have already completed training programs to establish a foundation for this team. The fourth major objective of this strategic partnership is a go-to-market plan for Insperity and Workday to address this target market, including co-branding, co-marketing, and co-selling. The most significant effort accomplished since the launch has been the organization, staffing, and alignment of teams to ensure the success of this strategic partnership and the go-to-market plan. We're very pleased with the demonstrated commitment reflected in the leadership of both companies' roles and responsibilities to make this partnership dynamic and effective for both companies. The first three months establishing the framework for this strategic partnership has not been without challenges as this type of relationship is new to both companies. However, the corporate culture match between the two firms continues to reaffirm my confidence around our opportunity for long-term success. My confidence is also supported by the client-centric nature of this strategic partnership and the potential to deliver a highly scalable HR technology and service solution to a significantly underserved market. Dialogue with clients and prospects about this solution has also been exceptional. We were able to have personal interaction with over 200 business owners at our recent client event, and the energy from these discussions was encouraging. We're very excited about our upcoming Investor Day coming up on May 16 at our corporate office and available remotely online. The focus of this event will be an update on the fundamental drivers to our powerful business model and the specific ways we expect our new Workday strategic partnership to be a catalyst to improve the likelihood, degree, and speed of our success into the future. At this point, I'd like to pass the call back to Doug.

Douglas Sharp, CFO

Thanks, Paul. Now let me provide our Q2 guidance and an update to our full year 2024 guidance. While we outperformed our earnings guidance in Q1, we are forecasting adjusted EBITDA over the remainder of the year consistent with our initial guidance. We are now thinking uncertainty and weakness in the macroeconomic environment could persist over the remainder of the year. Based upon these factors and our starting point going into Q2, we have reduced our 2024 outlook for worksite employee growth to a range of flat to 2%. However, we expect the impact of this lower growth rate on our full year earnings to be mostly offset by continued strong pricing and slightly lower direct costs and operating expenses. We're now forecasting full year 2024 adjusted EBITDA in a range of $254 million to $293 million. While we have lowered our overall operating expenses from our initial budget, we expect 2024 operating costs relating to our Workday strategic partnership to remain in the neighborhood of $60 million. As for adjusted EPS, we are now forecasting full year 2024 in a range of $3.17 to $3.90. This revised guidance assumes an increase in our 2024 effective income tax rate from 26% to 29%, primarily due to less tax benefit on employee stock awards vesting in Q1, as I have previously mentioned. As for Q2, we are forecasting paid worksite employees to remain down by about 1% compared to Q2 of 2023. As for Q2 earnings, we are forecasting adjusted EBITDA in a range of $53 million to $66 million and adjusted EPS from $0.61 to $0.83. This guidance considers our typical quarterly earnings pattern where our Q1 results are typically higher than subsequent quarters as we are in a higher level of payroll tax surplus prior to worksite employees reaching their taxable wage limits, and benefit costs typically are lower in Q1 and step over the remainder of the year as deductibles are met. Now at this time, I'd like to open up the call for questions.

Operator, Operator

Your first question is coming from Andrew Nicholas of William Blair.

Andrew Nicholas, Analyst

Great. I wanted to start with a couple of questions on the Workday partnership. Paul, a lot of really good color here as you work through that partnership for the first couple of months. I guess two questions specifically. One, are there any kind of early signs on the productivity or opportunity around the sales leads that Workday is funneling your way? And then second, and I apologize if I missed it in your prepared remarks, but do you have any additional insight or detail on the expected timeline? Now that you've done, it sounds like, a pretty considerable amount of planning work and some implementation and integration conversations.

Paul Sarvadi, CEO

Thank you for your question. I'll address your second question first. We are not yet ready to confirm a specific launch date, but we are making significant progress in preparing for it and are confident that it will happen within the timeframe we initially anticipated. This process is becoming clearer each week, and our teams are collaborating effectively, aiming to treat this as a product launch. We are focused on ensuring that the final product aligns with our design objectives while moving quickly to capitalize on market opportunities. Although I cannot provide an exact timeline now, we will share more details during our upcoming Investor Day meeting. Regarding the lead front, as I mentioned last quarter, our go-to-market strategy involves a comprehensive planning process for managing lead flow between our two companies. Our emphasis is on establishing a seamless transition rather than merely exchanging a list of names. We aim to create a co-branded experience for potential clients and ensure that leads are managed collaboratively, especially when it comes to specific accounts. We are making solid progress in this area, and we have also made advancements in the technology necessary to implement these processes. Our original plan was to finalize this planning in the first quarter and implement it in the second quarter so we can start seeing sales results in the latter half of the year. I believe we are on track to achieve that.

Andrew Nicholas, Analyst

Great. That's really helpful. And then I guess for my second question, I wanted to revert back to the core business. It does sound like net hiring expectations have come in a bit versus maybe what you expected at the beginning of the year with your initial guidance. If you could just kind of clarify or quantify that, that would be helpful. And then also, what is the assumption now on the worksite employee front in terms of the back half of the year? I think even at the low end of your revised worksite employee growth guidance, there's a decent amount of sequential improvement baked in, in the second half. So is that a function of some of those warm leads converting from Workday? Is it an expectation that the macro environment stabilizes or even improves some? Any additional context on kind of macro assumptions embedded in the worksite employee guidance would be super helpful.

Paul Sarvadi, CEO

Thank you for your question. The business model influences how our sales fluctuate throughout the year. Each quarter, both our sales and our budget increase. Retention improves after the first quarter, which we have already surpassed. We have factored in our current outlook based on client behaviors; although there is an optimistic sentiment, clients are not acting in alignment with that feeling. They seem to be playing it safe. Given this environment, particularly in an election year, we are not expecting to gain significant benefits from changes within our existing client base. Consequently, I am not planning for a significant upside from new leads, as it is unwise to assume success from a strategy that we have not yet fully implemented. While I am hopeful about future results, this forecast mainly reflects ongoing success from our BPA team’s current effectiveness, which is already evident in our sales efficiency this first quarter, along with our efforts to ensure a steady lead flow. Our self-generated leads have been strong this quarter, though some economic conditions have impacted our ability to set appointments. We are exploring additional strategies to enhance our effectiveness, particularly focusing on account-based experiences by specifically targeting high-value accounts that are more prepared to engage and find solutions. This strategy should aid us moving forward. In our business model, as sales improve over the year, retention tends to decline for the rest of the year, which is essential for understanding our quarter-to-quarter growth.

Operator, Operator

Your next question is coming from Tobey Sommer of Truist.

Tobey Sommer, Analyst

How do you compare and contrast the seemingly mixed signals you made about higher mid-market client turnover around the year-end transition with what you described to sort of enhance new sales momentum in that category over the last few quarters?

Paul Sarvadi, CEO

Yes. Reflecting on our discussion from last quarter, we had seven major accounts transition at the end of the year. Four of these changes were specifically due to technology reasons, which highlights our success penalty. Additionally, two of them occurred because the business was sold. Therefore, contrasting the two situations isn't entirely relevant. We are confident that we are delivering an excellent service to an underserved community. We believe that once we introduce this new solution for these clients, it will secure their loyalty for a much longer duration. I truly have a vision of ultimate scalability in both our technology and services, which we are about to launch in the market. Throughout the first quarter, dialogues with customers have shown increased interest, and we have promising prospects in the pipeline. We'll discuss this further in a couple of weeks, as we are engaging not just with business owners and CFOs, but also with technology and HR personnel within these larger accounts. Their enthusiasm regarding this solution is very high.

Tobey Sommer, Analyst

Makes a lot of sense. So is it fair to say that the customers that churned were probably larger than the new sales achieved in recent quarters? Is it kind of a size difference?

Paul Sarvadi, CEO

Yes, on average, we brought on accounts that started at a smaller size and significantly grew them over several years. Two of those accounts transitioned to a Workday solution, while two others went to UKG. Interestingly, when I spoke with other large clients that fit a similar profile, they had evaluated those two options. They faced the challenge of investing in a scalable technology solution while risking the loss of key service capabilities we provide. The new solution integrates both aspects, allowing customers to avoid that impossible choice. I'm feeling positive about this, even though it's based on anecdotal feedback from a representative sample of customers whose opinions we value.

Tobey Sommer, Analyst

Terrific. I just have two more questions. Could you sort of dimensionalize the change in your assumption for health care expenses throughout the year as a result of Change, whatever that commentary you could give? And then, Paul, from a strategic standpoint, I wanted to ask how significant could Insperity's Workday implementation be in a handful of years? And do you envision the company performing implementations for non-PEO customers? So I'm trying to get a sense for the TAM.

Paul Sarvadi, CEO

That's a great question that we will explore further in a couple of weeks. For now, I want to emphasize that I have no doubts about the total addressable market associated with mid-market accounts, which includes over 40 million worksite employees. We have always believed we can capture a portion of that market with our existing capabilities. However, a significant part of this market will find that our solution is the best available, unmatched by any competitors. This is due to its highly scalable nature in both technology and services. While some clients may eventually need a more customized version of Workday as they grow, we will have already established our support infrastructure with them. This will facilitate a natural transition for us to assist with their implementation of a new solution, which will be more easily defined and developed since we have been providing services to them. Our strategy is not to become an implementer in the general market for those types of clients. While we could do that, it is not our plan. Our goal is to onboard them to our service, retain them for an extended period, and offer a slightly different version of the service when they are ready to use their own instance of Workday, all while continuing to provide the support they need as they scale. Doug will now provide more insights on the benefits side.

Douglas Sharp, CFO

Yes...

Operator, Operator

And we have a final question from Andre Childress who is representing Mark Marcon of Baird & Company.

Andre Childress, Analyst

My first question is just, as you look back at the key selling and enrollment period, what did you see from a competitive perspective, particularly on the pricing front?

Paul Sarvadi, CEO

Yes, during this period, as I mentioned last quarter, tougher market conditions tend to bring out more competitive strategies. We experienced a peak in competition during the fall, and while it remains, our response has been effective. Our strong performance in the first quarter, which showed a significant double-digit increase from last year, is evidence of this. This success came from enhancing our experience factor, increasing the number of BPAs, and providing the right incentives for both clients and our sales team. We feel confident about our position, though I anticipate ongoing competition. Regarding the Workday comparison, that's unique due to its exclusive relationship, which distinguishes our offering. Long-term, this is a positive frame for us. For this year, we expect competition to continue, but we're satisfied with our ability to attract the right clients, which puts us in a solid position.

Andre Childress, Analyst

Great. And then as a follow-up, in your prepared remarks, you talked about various initiatives to drive BPA productivity. Could you provide an update on just how you are leveraging AI or how you plan to leverage AI across both the sales service and maybe even the R&D organization?

Paul Sarvadi, CEO

Yes, absolutely. I think the main point to take away on that front is we are really structured and staffed and organized and working through processes, and even the technology investments we've already made, have put us in a very strong position to flesh out all these possibilities. And there are so many possibilities. And certain things are pretty obvious. And like I mentioned in the prepared remarks, we're talking about things that drive efficiency or provide insights and things of that nature. And we're on a great track to bring those forward. Now we also believe that a lot of this is not there yet. We've fleshed out certain areas we've looked and we said, 'Wow, that's going to be really good.' It's not really that good yet. But we're in a good position to capitalize on these things as they happen. And it was great timing for us to put Salesforce in place, which was significant to making sure that all our internal data is in one place. That's powerful for this. And we've done a tremendous amount of work relative to the implementation of modern data engineering and other analytics technologies. And I just think we're in a great position to do this, but it's not time to go into a lot of detail about that. But that's coming soon.

Operator, Operator

Thank you very much. That appears to be the end of our question-and-answer session. I will now turn the conference back over to Mr. Sarvadi for any closing remarks.

Paul Sarvadi, CEO

Well, once again, I'd like to thank everyone for being with us today for this update. And I'd like to have a special invite to all of you on to be a part of our Investor Day coming up later this month. There is also an opportunity for you to be here in person and a way to go through that process on our website. There's also a link within our announcement that we put out today. But we'd love to have as many as possible, either in person or remotely. And I look forward to answering a lot more questions not only about the status of our current business model and the drivers, but how those are linked to this new strategic partnership and our expectations about how that will directly affect our likelihood, degree, and speed of success going forward here in Insperity in delivering shareholder value. So thank you again for your participation today. We look forward to seeing you soon.

Operator, Operator

Thank you very much, everyone. This does conclude today's conference. You may now disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.