Earnings Call Transcript - NSP Q1 2022

Operator, Operator

Good morning. My name is Jane, and I will be your conference operator today. I would like to welcome everyone to the Insperity First Quarter 2022 Earnings Conference Call. 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, Senior Vice President of Finance, Chief Financial Officer and Treasurer. At this time, I would 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 evening's call. First, I'm going to discuss the details behind our first quarter 2022 financial results. Paul will then comment on the key drivers behind our Q1 results 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. Sarvadi or I may make forward-looking statements during today's call, which are subject to risks, uncertainties, and assumptions. In addition, some of our discussion may include non-GAAP financial measures. For a more detailed discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, please see the company's public filings, including the form 8-K filed today, which are available on our website. Now, let's discuss our strong first quarter results in which we exceeded both our worksite employee growth and earnings expectations. We achieved adjusted EBITDA of $119 million, a 14% increase over Q1 of 2021, and adjusted earnings per share of $1.99. These results reflect growth in the average number of paid worksite employees above the high end of our forecasted range, pricing above target levels, effective management of our direct cost programs, and operating leverage. As for our growth metrics, the average number of paid worksite employees increased by 19.5% over Q1 of 2021. As most of you are aware, the year is transitioning from 2021 to 2022, during which we enroll new clients from our fall sales campaign and renew approximately 45% of our existing clients, which was important to our 2022 starting point and therefore our full year growth expectations. We were pleased to report a very strong year in transition, as demonstrated by a 3.6% sequential increase in the average number of paid worksite employees from Q4 of last year to Q1 of this year. As for the drivers of this growth, worksite employees paid for new client sales increased 37% over the first quarter of 2021. First-quarter client attrition was near our historical low, totaling only 8.5%, an improvement over Q1 of 2021's attrition of 12%. Our clients continue to experience robust hiring despite the current tight labor market. First-quarter gross profit was managed above forecast due to the outperformance in worksite employee growth, pricing above target levels, and a favorable contribution from our direct cost areas. As for our payroll tax area, while unemployment levels have fluctuated over the course of the pandemic, our state unemployment tax rates have remained below anticipated levels, resulting in a favorable contribution to gross profit. Our workers' compensation program continues to perform well due to our ongoing management of safety practices and claims. Workers' compensation costs also include the favorable impact from the reduction in the number of claims due to the work-from-home status of many of our client employees. Q1 benefit costs came in at expected levels while benefit pricing allocation exceeded our targets. We continue to maintain what we believe is a conservative approach in estimating our benefit cost trend at budgeted levels for the full year in what appears to be an improving, although still uncertain, environment. Now let's put the gross profit comparison to Q1 of 2021 in perspective, in which we achieved 14% growth. This is affected by the additional payroll tax surplus in the first quarter of 2021, including the receipt of prior period payroll tax refunds and the quarterly fluctuations in health care costs related to the pandemic last year. Now looking at our operating expenses, our Q1 spend reflects the initiatives in our five-year plan discussed in our previous earnings call. This spend includes investments in our service capacity relative to our worksite employee growth, national marketing initiatives, and technology, including the ongoing implementation of Salesforce. We implemented a new quarterly incentive program for our BPAs during the quarter to drive further improvements in sales efficiency. We also made targeted adjustments to the compensation levels of our corporate staff given the current labor market dynamics and our ongoing management of recruiting and retention goals. While making these investments, the overall leverage in our cost structure resulted in a 7% decline in operating expense for worksite employee from Q1 of 2021. Our financial position and liquidity remain strong as we continue to invest in our growth and provide returns to our shareholders. During the quarter, we repurchased 308,000 shares of stock at a cost of $27 million and paid out $17 million in cash dividends. We ended Q1 with $153 million of adjusted cash and $370 million of debt. 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. My comments today will address three key areas for Insperity stakeholders. First, I'll provide specifics regarding the momentum drivers behind our strong Q1 results. Second, I'll comment on how this momentum and our key initiatives provide confidence in raising our guidance for the balance of 2022. Then I'll finish by providing some color around the extraordinary shareholder return opportunity of our recently launched five-year plan. Our strong Q1 performance was the result of continuing momentum in all our growth drivers, namely new client sales, retention, and client hiring. Our dramatic 37% increase in worksite employees paid resulted from our successful conversion of book sales from our fall campaign into new clients, coupled with near historical high retention from our successful campaign and continued strong hiring within our client base that drove nearly 20% unit growth. New book sales in the first quarter continued this strong momentum, with both core and mid-market sales coming in over 120% of sales budget. Book sales came in 28% higher than the comparable period last year, with 3% fewer business performance advisors demonstrating significant increases in sales efficiency over 30%. In the first quarter, BPAs' tiered levels were determined based on final 2021 sales levels. Sales management was successful last year in increasing the number of BPAs at tier three or above by 18%. This movement in our most experienced and productive BPAs was a significant contributor to the sales efficiency gain. This strong sales momentum also flowed over into book sales of our traditional employment solution, workforce acceleration, coming in at 126% of sales budget, and a 140% increase over the comparable period last year. The traction we've gained in this initiative is evident, with revenues on this service up 39% over the same period one year ago. Several key initiatives are behind these strong sales results, including recent marketing success and capitalizing on increased demand in the marketplace for our sophisticated HR solutions. Both worksite employees sold for marketing programs were up 29% over Q1 of 2021. Inbound leads converted into book sales increased 34%, and worksite employees’ books from these inbound leads more than doubled. Sales efficiency for marketing-assisted deals booked in the quarter increased 36%, contributing to the overall sales efficiency improvement. Another key driver of these impressive sales results is the recent implementation of a new quarterly bonus component of BPA compensation. BPAs now have quarterly targets based on their respective tier levels and earn a bonus for achieving and exceeding these targets. This first quarter showed immediate signs of validation of this approach in generating excitement, extra effort, and strong results. Another highlight of the quarter was the excellent client satisfaction and retention from the fall campaign that continued throughout the quarter. Our service team and all those that support them across the country have done an outstanding job serving clients and meeting their needs in the face of this considerable growth. Client net hiring was also impressive in Q1. Despite the tight labor market, our clients are continuing to do well in the battle to recruit and retain employees with the support of our services. Demand for employees continues to be high, driving wage increases within our client base of over 7%, and overtime was above 11% of base pay. Commissions and bonuses paid to employees at client locations also provide some insight into the sales success in the small to medium-sized business community and efforts to compensate and retain staff. Both measures were significantly higher in the first quarter than we have seen historically. At the same time, business owner confidence has weakened somewhat, with inflation concerns moving to the top of the owner's significant issues list in the recent NFIB survey. At this point, the real-time metrics we have as the HR department for over 11,000 businesses across the country do not reflect a slowdown in hiring. For now, it appears to be more of a general concern that small business owners have about the future. Another welcome highlight from this quarter was the contribution from gross profit drivers, including slightly higher surpluses than forecasted due to effective management of price allocations and cost. The noise we've experienced in the health care plan during the pandemic appears to have waned somewhat. We believe our conservatism in pricing allocations and cost estimation is appropriate. As Doug mentioned, we also saw significant operating leverage in the quarter, which is also an important factor in our business model. So, overall, the first quarter was an excellent start to 2022. Now as we look ahead to the balance of the year, our confidence in raising guidance is due to our expectation that many of these recent positive trends will continue. We expect our growth to be fueled by our higher starting point and paid worksite employees, BPA performance at their current tiers, and continued strong retention. We are cautious about private hiring continuing at recent levels due to the tightness of the labor market and business owner concerns about inflation in the economy. We still expect some client hiring, but we believe it's prudent to account for a lower rate moving forward. Our confidence in our profitability expectations is based on a combination of this higher growth and our gross profit contribution and operating leverage trends. This profitability aligns with how our model has performed historically in periods of high worksite employee growth. We also have key initiatives that support these expectations, including a clear focus on sales efficiency, effective pricing, and growing our service organization. This quarter, we're implementing some new incentives for our sales management compensation, which we believe will continue the sales efficiency improvements and the new business pricing priorities. Additionally, the marketing and business development team applied the learnings from the successful fall marketing campaign in ten markets to enhance the spring program, further expanding into all Insperity markets. We recently launched a fully integrated marketing program in all 41 markets to continue this momentum. We’re also going live this quarter on our Salesforce implementation across our growth organization, which we believe will improve our efficiency going forward. We expect to implement the implementation across the rest of the company early next year. Another important initiative we have over the balance of this year is an aggressive corporate recruiting plan to add both service and sales staff. We've also felt the effects of the tight labor market and have made enhancements that we believe will allow us to achieve staffing targets to support our growth and client retention priorities. So it's apparent we're off to an excellent start for our first quarter of our five-year plan, and our guidance implies a strong first year in 2022. Additionally, our key initiatives are laying the groundwork to capitalize on the growth and profitability outlook we foresee ahead. This new five-year plan has extraordinary potential beyond what we have seen in previous successful five-year runs. For example, from 2014 to 2019, our compound annual growth rate in paid worksite employees was over 12%, and adjusted EBITDA exceeded 24%. Our total return to shareholders was even more remarkable at 434% over that period, and quarterly dividends increased an average of 27% each year, with the share price growing more than fivefold. This was not surprising over that period because our business model is designed to produce double-digit unit growth, slightly higher gross profit growth, and some operating leverage producing adjusted EBITDA growth north of 20%. Historically, this double-digit growth has been fueled by increasing the number of BPAs at a double-digit pace. For example, during the period I just described, the compound annual growth rate for BPA growth was 12%. The five-year plan we've just launched has three significant distinctions that I believe can drive adjusted EBITDA growth rates even higher. The first distinction is the marketplace demand I've described over the last several quarters. The impact of the pandemic and all the aftereffects drove home the importance and the direct connection between a sophisticated HR function and business survival and success. We have seen this reaction from our clients’ prospects and those who invest in small to medium-sized businesses. This increase in demand and receptivity is the initial reason we thoroughly developed and implemented this plan. I believe it is a significant industry-specific wave we can capitalize on over the next five years. The other two distinct differences are within our business model. First, the traction we have with our traditional employment solution, workforce acceleration, has the potential to add to gross profit in a way we have not seen before. Small increases in gross profit for worksite employee within our model drive significant increases in adjusted EBITDA. This source of gross profit also is not healthcare cost-dependent, and if it were to grow significantly, could help to mitigate our overall volatility. Workforce acceleration has the potential to improve our sales efficiency, lower BPA turnover, and enhance our customer-for-life strategy for long-term client retention. The second distinctive difference in our business model for this five-year plan is the sales efficiency gain we have begun to see and will strive to further improve. This creates the potential for us to grow faster, with a BPA growth rate below the unit growth rate, which would add operating leverage we have not seen before. I see the potential for us to grow faster, add to gross profit for worksite employees, and have more operating leverage than during our last run. This could mean significantly higher adjusted EBITDA growth, creating extraordinary returns for shareholders. Insperity is laser-focused across the company on the ten critical success factors expected to drive home the goals of this new five-year plan. We are off to a great start and hopeful for a bright future for all Insperity stakeholders. At this point, I'd like to pass the call back to Doug.

Douglas Sharp, CFO

Thanks Paul. Now let me update our guidance, which we are raising based on our outperformance in Q1 and an improvement in our growth and profitability outlook over the remainder of the year. We're now forecasting 15.5% to 17.5% worksite employee growth for the full year, improving from our initial guidance of 14.5% to 16.5% growth. This expected increase is based on our higher starting point going into Q2, continuing sales momentum, maintaining client retention at our budgeted high levels, and continuing net hiring by our clients, however slightly below recent trends given the potential impact of further tightening in the labor market and inflationary pressures on the business environment. We are forecasting Q2 paid worksite employee growth of 18% to 19% over Q2 of 2021. We also now expect 2022 gross profit to be higher than our initial budget based on the Q1 outperformance and recent positive trends in both pricing and direct costs. We continue to be mindful of the ongoing uncertainty associated with the pandemic and therefore continue to forecast the benefit cost trend over the remainder of the year in line with our initial budget. While we expect to get some further upside from the payroll tax and workers' compensation areas, keep in mind that our performance in the payroll tax area is largely concentrated in Q1 as we earn a surplus prior to worksite employees reaching their state unemployment tax wage limits. Our forecasted operating costs continue to reflect our 2022 plan of investing in our five-year plan initiatives with the expectation of achieving overall operating leverage at our expected worksite employee growth rates. We are now estimating a 2022 effective income tax rate of 28%. So when accounting for these factors, we have raised and narrowed our range of 2022 adjusted EBITDA from initial guidance of $251 million to $311 million, to our updated guidance of $285 million to $327 million. As for full year 2022 adjusted EPS, we now forecast a range of $4.31 to $5.09, up from our previous guidance of $3.74 to $4.86. For Q2, we forecast adjusted EBITDA in a range of $60 million to $73 million and adjusted EPS from $0.88 to $1.12, taking into account our typical quarterly earnings pattern. As you may recall, our Q1 results typically exceed 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 increase 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

[Operator Instructions] Our first question comes from the line of Andrew Nicholas of William Blair.

Andrew Nicholas, Analyst

Hi, good morning. Thank you for taking my questions. First one is just on kind of salesforce productivity. Obviously, it seems to be increasing at a relatively strong rate. I'm wondering how much of that is a consequence of a longer tenure or longer average tenure in the salesforce? And maybe kind of within that, have you seen any change in retention levels or I guess the opposite being attrition within your salesforce? Obviously, it is a tight labor market. You're seeing that in your client base as well, just wondering how you're thinking about retaining that talent and how big of a component that is to productivity growth.

Paul Sarvadi, CEO

Yes, thanks for the question; it is a very important aspect of our effort to improve sales efficiency. Within the numbers I talked about today, you can kind of see the picture there because we had about a 30% improvement or increase in sales efficiency. We have an 18% increase in the number of BPAs that are in tier level three and above. That's a big chunk of the natural effect of sales efficiency gained from more experienced BPA growth. Now, the other balance of that, the other 12% came from a combination of other things, the marketing results that were so strong in terms of bringing qualified leads in, for example, but also the recent compensation tweak that we put in place, which allows each BPA within their tiers to have targeted objectives each quarter, and earn bonuses each quarter. But it also drives them to work hard to get to the next tier level, where the bonuses are higher for being in that tier. We have multiple factors that lead to improved sales efficiency. This is a perfect time for that because the overriding factor allowing all these to gain traction sooner is the demand we see in the marketplace at large and the opportunity for BPAs to have enough repetitions. Another key factor is the way we have really optimized the remote selling element. We'll be mixing back in face-to-face visits at the right time to further enhance the closing rate. These are all factors, and this is why we're really excited about the great strides already in sales efficiency, with many factors that we believe will continue that trend.

Andrew Nicholas, Analyst

That's very helpful. Thank you. As a follow-up to the last part of your answer, in terms of the new sales momentum, are you seeing any material difference in kind of the competitive nature of the market? Or are you seeing better win rates coming against other competitors? I'm just curious if this is primarily execution on a large runway for growth, or if there are some competitive takeaways and higher win rates as a consequence of some of those other items you mentioned. Thank you.

Paul Sarvadi, CEO

Another very good question. I'll just tell you, this is more of an intuitive answer than it is supported by a lot of detailed information. What I see happening is that the result of the pandemic and all these aftereffects really highlighted the need for a sophisticated HR function for survival and success. What's unique about Insperity is that we are the premium service in the marketplace, differentiated by the breadth of our services, the depth of our services, and the level of care. These three components sum to create an incredibly sophisticated HR function. I believe we have our competitive advantage. It's always been there but is highlighted dramatically right now because that level of service is what companies truly want and need. I think that's an uphill climb for a lot of other companies in our space that offer good services to reduce costs or administrative effort, but that sophisticated, complete HR function is something we're a category of one.

Operator, Operator

Next question comes from the line of Tobey Sommer of Truist.

Tobey Sommer, Analyst

Thanks Paul. I was wondering if you could give us an update on how the benefit trends progressed during the quarter post-Omicron. Or at least the first Omicron variant. And whether you think that the effects of that are sort of clearly visible to you, or do we still have a couple of months of data to be collected from United to kind of have a real clear picture about how that unfolded.

Paul Sarvadi, CEO

Yes, let me let Doug provide more details about it. From my perspective, what we've seen is pretty clear that you had the two variants that drove up COVID-related costs. We discussed that a lot during the last period. We trended off of those high results just to be conservative. We have seen some waning, as I discussed, in the COVID-related areas. We're also just cautious about the potential for acute issues and longer-term effects from the pandemic that can still arise. We're going to continue to be conservative about that. But I'll pass it on to Doug.

Douglas Sharp, CFO

Yes, I think as you're probably aware, Tobey, in the fourth quarter, we had the convergence of Delta and the beginnings of Omicron. As we moved into the first quarter, you still had some hangover effects of Omicron, at least through January and probably part of February, as a result of increased testing and some increased vaccination during those months. I think since then, we have seen it wane a little bit. As we look forward for the remainder of the year, I think there's still uncertainty regarding utilization—whether it be care that was previously deferred, particularly elective surgeries—that needs catching up, or if the waning effect of COVID costs can replace it. We're hopeful for some upside, but it’s too early to tell, so we’ll continue to forecast at our initial budgeted levels on the cost side. On the pricing side, we’re doing an effective job of maintaining pricing through the pandemic stage. We have looked through the pandemic and priced over the long term, maintaining alignment across that period. Our first-quarter pricing and cost levels remained well-matched. I believe we are positioned for the remainder of the year, especially if utilization doesn’t replace COVID costs and we don’t see another significant wave.

Tobey Sommer, Analyst

Okay, thank you. I appreciate all the insight. I wanted to ask a question about your total addressable market and how you think about that. Several years ago, you started offering some non-co-employment options, and now the pandemic, as you said, highlighted the value of the PEO service. How do you perceive your addressable market and has it grown? Certainly, the growth in WSEEs has been remarkable. Thank you.

Paul Sarvadi, CEO

Yes, that's a great question, Tobey. We still see clearly, within the data that we can evaluate, that there are over 600,000 perfect fit clients that fit the demographic and psychographic profile of the 11,000 clients we possess. We see a huge market that we have a long time to keep penetrating. What’s exciting to me now is that we also have clients to whom we offer workforce acceleration, allowing us to cast a wider net into that 600,000 target customer base, bringing in clients who may want to move off the co-employment model and back to the traditional employment solution. I think our long-term view and ability to bring them in and move them across into other services is really strong. When I look at our five-year plan, I truly see the potential to grow our core business at historical double-digit rates while also having our traditional employment service and sales contribute to our gross profit meaningfully. This reinforces the two distinctive elements of our model that differ for this five years: growing at an above-historical double digit rate while having the traditional employment services contribute significantly to our gross profit.

Operator, Operator

Next question comes from the line of Jeff Martin of ROTH Capital Partners.

Jeff Martin, Analyst

Thanks. Good morning. Paul, I was just curious if you could talk about the concentration of the BPAs in various tiers? How many are at tier three or above? And what kind of progression timeline is there for that? It sounds like the incentive changes you implemented are having a significant impact.

Paul Sarvadi, CEO

Yes, thank you. We've discussed in the past that the typical length of time for a new BPA coming on board to reach tier two level is about a 12 to 18 month period. They start off in tier one early on, and achieving tier two typically takes around 18 months to a couple of years, but we’re seeing folks achieve that earlier, which is a good sign. We’re evaluating the entire flow and pushing to move as many as possible at an individual level. Over the balance of this year, we will be growing our BPA team, starting to ramp up growth, expecting to get to around 700 BPAs by year’s end. This would get us back to about 10% growth in BPAs early next year, which is the right pace for sales efficiency gains to put us into the mid-teens for ongoing double-digit growth—our target to reach our goals. Much of this focus on moving individual BPAs up through the tiers has strong alignment across the sales organization, not just sales management trying to do their job, but also BPAs are now deeply linked to that goal via the new compensation system.

Jeff Martin, Analyst

Okay, great. And I was curious if you could speak a little bit more to the mid-market. It looks like it grew in line with the rest of the business. Are there specific initiatives in the mid-market that you're implementing to have that success? And maybe compare that to the past 12 months regarding what you've seen in mid-market from a sales perspective?

Paul Sarvadi, CEO

Yes, I appreciate the question. I’m very excited about the momentum in mid-market right now. The alignment around core sales, mid-market, and workforce acceleration being recognized as three equally significant prongs across the sales organization has had tremendous impact. Mid-market has already started off great this year, with our pipeline outpacing last year significantly because of the unified approach. Leads for mid-market emerge out of our BPA team, and now the agreement on how they're compensated and how they work together on these larger accounts creates a smooth operation. We’re off to a great start with a pipeline that’s in great shape. While mid-market is still a smaller piece of the business, its consistency is improving, which will also enhance our sales efficiency.

Operator, Operator

Next question comes from the line of Mark Marcon of Baird.

Mark Marcon, Analyst

Good morning, and thanks for taking my questions. Really strong growth with regards to the worksite employees. I'm wondering if you can comment on two aspects? One, what are you seeing, Paul, with regards to the broadening acceptance of the PEO concept outside of your biggest states? To what extent are we starting to see increased adoption in some of the less established states and the response to some of your marketing efforts? And then secondly, when we take a look at the fee revenue per worksite employee, can you talk a little bit about what you're observing from a pricing perspective? To what degree is your fee revenue per worksite employee directly tied to the level of compensation for the employees?

Paul Sarvadi, CEO

Great questions. Regarding the receptivity we’re witnessing across the country, there are two components to consider. One factor is our marketing effort—localized marketing plans that address specific market aspects. We've driven over 20% revenue growth across all our regions, indicating broad success. The second, I think a significant influence is how investors and board members—particularly from venture capital or private equity—used to be a hurdle in closing business deals. They would bring concerns about investing funds into HR functions. Now, however, awareness of this necessity has risen higher, showing its impact on profitability and overall company value, which has positively influenced broader acceptance. On the pricing side, we are proactive. One of our ten critical success factors this year focuses on effectively handling inflation and its impact over the years ahead. We have taken early steps to recruit and retain the right people. As Doug mentioned in his remarks, we have made internal compensation investments to maintain alignment between operating performance and pricing strategy. Our pricing plan adequately covers both our new and renewing business moving forward, ensuring full appropriateness while accounting for necessary price increases in the current environment. With wage increases occurring in the marketplace, the increases we pass on may appear moderate due to the percentage of wage correlation. Overall, the environment appears favorable for us to pass on those necessary increases.

Mark Marcon, Analyst

That’s great. Could you also talk a little bit more about your benefit cost expectations for the remainder of the year? Are you assuming an increase in elective surgeries that were deferred? Or how are you thinking about that?

Paul Sarvadi, CEO

Yes, to reiterate what Doug mentioned, as we look forward for the remainder of the year—even though we’re seeing some of the cost drivers wane, especially COVID-related costs—we feel it's prudent to stick with our initially established cost trend. Even if we experience a decrease in COVID-related costs, we might encounter acute care costs and/or deferred costs from elective surgeries that could surge later in the year. We will have better visibility in a quarter or so. If those do not materialize, we may see more upside than originally forecasted. It’s early to tell, so we’ll continue with the higher trend we adopted early this year.

Operator, Operator

Thank you, I would like to turn the call over to Paul Sarvadi for closing remarks.

Paul Sarvadi, CEO

Once again, I would just like to thank everybody for being on the call today. We look forward to continuing our success throughout this year and in year one of our five-year plan, which we believe will provide extraordinary shareholder return opportunities. Thank you again for your participation, and we look forward to providing information next quarter.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a great day.