Insperity Inc (NSP) 2017 Q2 法說會逐字稿

Good morning. My name is Heidi, and I will be your conference operator today. I would like to welcome everyone to the Insperity Second Quarter 2017 Earnings Conference Call. (Operator Instructions) At this time, I would like to introduce today's speakers. Joining us are Paul Sarvadi, Chairman of the Board and Chief Executive Officer; Richard Rawson, President; 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.

Thank you. We appreciate you joining us this morning. Let me begin by outlining our plan for this morning's call. First, I'm going to discuss the details of our second quarter 2017 financial results. Paul will then comment on our strong recent results and our strategic plan for long-term growth and profitability. I will return to provide our financial guidance for the third quarter and an update to the full year 2017 guidance. We will then end the call with a question-and-answer session where Paul, Richard and I will be available.

Now before we begin, I would like to remind you that Mr. Sarvadi, Mr. Rawson or myself 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 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, included in the Form 8-K filed today, which are available on our website.

Now let me begin today's call by discussing our strong second quarter results. Adjusted EPS increased 37% over Q2 of 2016 to $0.82 and adjusted EBITDA increased 30% to $33.3 million, both significantly above the high end of our forecasted ranges. Through the first 6 months of 2017, we were ahead of our initial budget, having generated a 19% increase in adjusted EPS over 2016 to $2.65 and $96 million of adjusted EBITDA.

As for the details, average paid worksite employees increased 10% over Q2 of 2016 as all 3 drivers to growth produced positive results. Worksite employees paid from new client sales increased 26% over Q2 of 2016, on a 13% increase in the average number of trained Business Performance Advisors and the enrollment of recent mid-market sales. Secondly, client attrition improved 32% from Q2 of 2016, averaging only 0.5% during the quarter. And net gain in our client base, which had been weak in recent quarters, turned positive. This net gain included the typical seasonal summer help, along with modest growth of full-time employees at existing clients.

In addition to achieving double-digit worksite employee growth, we successfully managed gross profit to an increase of 15% over Q2 2016. Our pricing allocations were in line with budgeted levels, while each of our direct costs trended favorably. In particular, our benefit costs, which came in higher than budget in Q1 of this year, settled back down to our initially budgeted trend in Q2. Additionally, similar to recent quarters, our workers' compensation program continued to produce positive results.

Now you may recall that at the beginning of June, we announced the receipt of the Certified PEO designation from the IRS. A significant component of this designation included the elimination of double taxation of FICA and FUTA when a business contracts with a Certified PEO during the year. Due to the timing of the receipt of this designation, any favorable impact from the elimination of the double taxation was minimal during the second quarter; however, it will be more significant over the remainder of the year.

Second quarter operating expenses were managed through budgeted levels included planned investments in our growth, including the increase in the Business Performance Advisors and investments in our technology infrastructure, security and development. These investments were largely offset by operating leverage in other areas of our business to result in only a $1 increase in operating expense per worksite employee per month from $198 in Q2 of 2016 to $199 in Q2 of this year.

As the result of our growth and effective management of gross profit and operating costs, adjusted EBITDA per worksite employee per month, which is our measure of unit profitability, increased 19% from $52 in Q2 of 2016 to $62 in Q2 of this year.

As for our balance sheet and cash flow, we ended the quarter with $48 million of adjusted cash and have $95 million available under our line of credit. We continue to focus on shareholder return, having repurchased 211,000 shares of stock at a cost of $16 million and paying $6 million in cash dividends during the second quarter.

Now at this time, I would like to turn the call over to Paul.

Thank you, Doug. We are very pleased to report these strong results in the second quarter and the continuing excellent execution, driving our growth and profitability. We have a high level of confidence regarding the strategy we have in place and our ability to capitalize on the tremendous market opportunity in front of us.

Based upon our guidance updated today, our adjusted EBITDA for 2017 is expected to be approximately $170 million, which is more than doubled over the last 3 years from $84 million in 2014. Over the same period, adjusted EPS is expected to more than triple from $1.43 per share to approximately $4.50 per share.

These 3 years represent the full implementation of our strategic plan, which has resulted in this strong performance. However, we believe we are just beginning to demonstrate the potential for long-term growth and profitability from this strategy. Today, I'd like to focus on the major elements of this proven strategy, which we expect to continue to drive double-digit unit growth, increased gross profit contribution, operating leverage and financial performance in 2018 and beyond.

There are 5 strategic elements driving our performance in our unique business model. These include clear and concise strategies around growth, products and services, competitive positioning, gross profit contribution and operational excellence. The Insperity growth engine is based upon our wealth of experience and deep understanding of our target market, comprised of the best small and midsized companies in America. Our overarching strategy is to aggregate these best businesses onto a common platform, offering services and support to improve both the likelihood and degree of their success. This laser focus on the customer is at the heart of Insperity's success.

Our growth strategy is built around a dedicated team of highly trained and experienced professionals we call Business Performance Advisors that serve in a consultative role to business owners. The 3 key metrics: the number of BPAs, their sales efficiency selling our flagship Workforce Optimization co-employment solution and their proficiency selling other traditional employment solutions drive the growth model. The objective of our growth strategy is to produce consistent, predictable, double-digit unit growth in paid worksite employees in the co-employment relationship and supplement this growth with additional gross profit contribution from traditional employment offerings.

In order to achieve this goal, the key success factors are the recruiting and training of BPA s and district managers, and driving sales activity. Over the last 3 years, we've demonstrated our proficiency growing our BPA channel at double-digit rates, resulting in double-digit unit and revenue growth at targeted levels. This core sales team, now with approximately 450 BPAs, is continuing to meet or exceed sales and sales efficiency objectives which adds to our confidence in continuing this strong growth rate.

Another important element of our growth strategy is our marketing effort positioning Insperity as the premium business service in the marketplace. Targeting qualified prospects through channels, loyalty programs and a robust digital presence is designed to achieve both volume and price objectives. The right volume of high-quality leads improve sales efficiency and positioning our offering appropriately supports our premium pricing. Year-to-date, our marketing programs have delivered an increase greater than 30% in discovery calls, business profiles and closed business, resulting in 53% of our worksite employees sold year-to-date. This demonstrates our capability to drive sales activity and feeds our optimism for the future.

Another significant aspect to our growth strategy is our mid-market segment, which represents a premium to our growth rate and doubles our addressable market. In years past, accounts that started out small and grew to several hundreds or more employees, many times, were required or opted to take HR services in-house. This success penalty resulted in a higher level of volatility and a governor to our growth rate. Over the last several years, in this new model, we have solved our success penalty by improving our service model, retaining more large accounts and developing a capability to sell accounts of this size. With this progress, our likelihood to continue double-digit growth rates from period to period has greatly improved.

As an example, we expect to see growth acceleration this quarter even though one of our largest clients, with over 1,500 worksite employees, was recently acquired. Our mid-market success, especially during our critical year-end transition over the last 3 years, has been essential in achieving our recent growth targets. Success in this segment of our business is another reason for confidence in our ability to grow at targeted rates going forward.

Our product and service strategy has also proven effective over the last several years. Insperity Workforce Optimization, our co-employment solution, has been the most comprehensive business service in the marketplace for many years. By adding a wide array of business performance solutions in the traditional employment space, we have developed a breadth of services to cast a wider net in the marketplace and increase the return on our investment in the BPA Channel.

The objectives of our product and service strategy are: to increase Workforce Optimization sales, establish a Customer for Life capability in order to grow our customer base faster and create a mass customization capability to improve retention and maintain our pricing strength. A major catalyst to move this strategy forward at a faster pace is the recent introduction of our traditional employment bundle called Workforce Administration.

Our wide array of business performance solutions are used by our Business Performance Advisors to develop a customized multiproduct solution for each prospect they encounter. BPAs are trained to use a Bundle Plus approach with either Workforce Optimization or Workforce Administration as the core bundle, along with additional offerings to meet client needs. This customized multiproduct approach in a Workforce Optimization sale can increase the likelihood of closing by adding cost-saving solutions with the core bundle to offset the investment typically required for this premium service.

For prospects not ready for the leap all the way to co-employment, Workforce Administration increases the likelihood of bringing a new customer into the fold, with an opportunity to upsell to Workforce Optimization later. These options also create more flexibility for Insperity to meet client needs throughout the life cycle of our client. Our significant improvement in client retention over the last 3 years, including another record this quarter, validates this strategy.

Our competitive positioning strategy also adds to our confidence in the future. Our breadth of services, depth of services and level of care for our customers has created quite a moat around our business model. These 3 factors differentiate Insperity in the marketplace as a category of one. Our depth of service capability is rooted in our mastery and domain expertise in all things HR. Our services are delivered on an advisory platform from our BPAs in the field designing solutions and our HR experts serving customers daily, through our professionals at our corporate headquarters managing employment costs and navigating the troubled waters of regulatory compliance.

We've demonstrated a unique capability over the years to also manage employment costs, from payroll taxes and workers' compensation, to employee benefits and other employer liabilities. This depth of expertise delivers on our strategic objective to bring group buying power to the small and medium-sized business marketplace, along with the advantage of stable costs. This expertise also provides the opportunity for Insperity to earn a fee for managing these employee costs, which contributes to our gross profit. In addition, our traditional employment solutions represent a third contributor at the gross profit line in our model, which has helped to fend off competitive pricing pressure in the marketplace. A further evidence of our depth of service capability is in our technology team delivering on our software-with-a-service objective.

Our announcement today of Insperity Premier is another milestone, providing a true HCM experience within our co-employment Workforce Optimization solution. We believe Insperity Premier is a game changer by adding new features and functionality, expanding and customizing client-specific data collection in reporting, integrating products into modules and delivering a more HCM-like user interface. This platform is specifically designed for our deep integrated relationship with our clients, including new co-browsing and click-to-chat capabilities, allowing our HR professionals to work even more closely with supervisors and managers at client locations in real time. The rollout of this upgrade is in process and will continue for the balance of the year. It's too early to accurately predict the benefit of this new platform on sales retention or cost reduction. However, early anecdotal evidence is very promising.

Insperity Premier is a perfect example of how technology can combine with service professionals to increase the level of care and improve the customer experience. This level of care has distinguished Insperity in the marketplace for many years and is the hardest for our competitors to replicate.

The true measure of operational excellence over the past several years is evident in the level of care we've provided clients, while at the same time, delivering operating leverage through efficiency gain. Our key metric in this area is the number of worksite employees served per service provider, which has increased from 200 to 1 to 265 to 1 over this period. Our Customer for Life and software-with-a-service strategies have proven successful at achieving these results and our improvement in client retention is validation of excellent execution in this area.

In summary, our strategic plan is in place with more ways than ever to achieve desired results, and we are optimistic about our ability to continue to deliver outstanding operating results and exceptional returns to our shareholders. As the result of executing this strategic plan over the last 3.5 years, we've returned over $400 million to investors, $290 million in share repurchases and an additional $123 million in dividends, demonstrating our ongoing commitment to exceptional shareholder returns.

At this time, I would like to pass the call back to Doug.

Thanks, Paul. Now before we open up the call for questions, I'd like to provide our financial guidance for the third quarter and an update to our full year 2017 forecast, which is substantially higher than our initial guidance.

We continue to forecast full year growth of average paid worksite employees in a range of 11% to 12%. We are forecasting Q3 worksite employee growth in the range of 11% to 11.5%. This is an acceleration off of Q2's growth of 10% when considering improved sales associated with the increase in the number of Business Performance Advisors, partially offset by the loss of a large mid-market client in July.

As for our gross profit area, we have incorporated recent pricing and direct cost trends in our updated guidance. We have also considered some benefit in the payroll tax area associated with the elimination of double taxation of FICA and FUTA, resulting from our recent PEO certification under the Small Business Efficiency Act. The combination of this benefit, partially offset by the loss of the large mid-market client, should contribute approximately $2 million of additional gross profit over the second half of the year. As for operating expenses, these costs continue to track our budgeted plan.

So, with combining our better-than-expected results for the first half of 2017 with our outlook over the remainder of the year, we are increasing our forecast of adjusted EBITDA to a range of $169 million to $173 million, a 20% to 23% increase over 2016. As for Q3, we are forecasting adjusted EBITDA of $37.5 million to $39.5 million, a 20% to 26% increase over 2016. We are now forecasting full year 2017 adjusted EPS at $4.47 to $4.60, a 25% to 28% increase over 2016. This is an improvement over our initial guidance in which we were forecasting a 17% to 23% increase over the prior year. Q3 adjusted EPS is projected in the range of $0.94 to $1, an increase of 20% to 28% over Q3 of the prior year.

In conclusion, we are pleased with the strong top and bottom line growth trends in our business, and we look forward to updating you on our progress over the remainder of the year. Now at this time, I'd like to open up the call for questions.

(Operator Instructions) Your first question comes from the line of Tobey Sommer from SunTrust.

I was wondering if you could quantify the benefit from the lower taxes associated with the IRS change, just on an annual basis, maybe. And then what do you think it does in terms of growth or kind of presenting the concept in the sale to new small business customers?

Thanks, Tobey. Yes, we've -- I'll handle the second part of that, and I'll let Doug handle the quantification of that for you. But in terms of how it can affect us going forward, it's very positive for us, I believe, because of 2 things. One, we've always had to explain this unique aspect to the pricing and billing with our clients, and it's just another aspect of complexity that makes it harder to sell. So with that out of the way, again, any time you can make it simpler and not have to address another complexity, that's good for sales. The other thing is we're able to even things out in terms of the resistance to coming on late in the year from a prospect because of that double taxation that we used to have. That has always been something we had to overcome, so we're hopeful that it also kind of even things out as there is really no reason to delay. And when customers are ready, that's when you want to bring them on.

Yes. So on the second part of your question, we made the decision to adopt the certification prospectively. We received it on June 1 and just moving forward from there. If you look at the first quarter, you get very little benefit in the first quarter because a lot of your worksite employees haven't yet hit those limits. So most of the benefit is in the second half of the year anyway. If you look at, roughly speaking, we expect the benefit of a little less than $3 million in total this year on the impact of the certification I just spoke about. This year, unfortunately, we're going to have some offset with the loss of that large client through their acquisition by another company. And it's a rough number because there's some flexibility there that we want to provide ourselves in how we price certain clients and how we utilize that benefit going forward.

I think the last part of it is, you've got to think about it in terms of the growth. And the faster that we grow, the more the benefit is. So that will be something to think about going forward.

Right. Does it also somehow even out the seasonality of profitability in the quarters at all? Or anything in terms of your ability to forecast and manage the business, that it somehow made easier?

I wouldn't say that. I think that the -- first of all, of course, payroll taxes are still front-end loaded at beginning of the year. And you also have deductibles and coinsurance, et cetera, on the benefits. So you're still going to have some seasonality to the earnings in the model. But it is nice to have that out of the way and we do think it's very positive for the company.

Okay. And then from a general standpoint, Paul, how do you see the -- sort of the EBITDA or cash flow growth if you are able to sustain the double-digit kind of core worksite employee growth and supplement gross profit growth with other sales?

You bet. That's -- the model is designed for us to grow double-digit unit growth. We've got pretty good leverage in the operating expense side of the business. We've talked about, typically, about a 50-50 ratio between fixed and variable expenses. And then, of course, we're -- the managing the gross profit part is you can see we've been really consistent over the past several years, and I think we really have our arms around that nicely. And so you do have a little bit of movement up and down in that number, but the strategy of having a wide array of business performance solutions to feed in at that gross profit line has really been favorable in terms of at least maintaining that gross profit number and has potential to even add to that as time goes on. So you should, generally speaking, see adjusted EBITDA growth -- If we're in the low double-digits, 10%, 11%, 12% on units. You're going to be between 15% and 20%, at least, at the adjusted EBITDA line -- and I think a lot of times, well above that. You can see over the last few years, we've been well in the 25%, 30% EBIT -- adjusted EBITDA growth.

Your next question comes from the line of Jim MacDonald from First Analysis.

I wanted to dive into the mid-market. I think you said last quarter that some mid-market starts pushed to the September quarter, but I think in your prepared remarks you said you had some good mid-market starts this quarter. So I'm trying to figure out, is that new -- other new business? And what happened to the -- are you still expecting some of those larger clients this quarter?

Yes. We did -- we've rolled some in. Some rolled in late last quarter and some rolled in, in July. Those were the ones we were referring to. The thing that happened during that period that was more of a surprise was the large customer being acquired. But it's -- that's the whole idea of having this pipeline for mid-market business, so that it used to really put a knot in our head if we had a big customer like that go away. But with the other ones coming in, we're able to kind of weather that with no problem and continue to forecast our worksite employee growth for the year on budget.

And moving to the benefits side, it's good news that it came back to expectations. Any color around that? And then, also, any thoughts about what this regulation and legislation impasse in Washington is doing or will do for your business?

Well, Jim, I don't know which of those 2 hard questions are the easiest to answer. No, actually, the first one, we did obviously see the experience in our health plan kind of trend back to where it -- normally we were expecting it to be. And when we look at our annual trend for benefits from one year to the next, we are always really, really close when we look at the total year-over-year. So you obviously do have a little noise between the quarters, but that's just the nature of that situation. So this year, we're seeing in the low 2% range for the year, and that's still in line with where we were when we started 2017. So in the last couple of months of the second quarter, we actually saw the trend go back into where we were expecting it to be from the beginning of the year. I think the -- on the second question about the regulatory environment and the Affordable Care Act and what's going to happen there. The logic here is that if the exchanges or people leave the exchanges, the employment, the employer marketplace that was feeding and having employees to go to that exchange, they're going to be wanting to look to find solutions to provide quality benefits. And in the tight labor market that we seemed to be in, being able to offer a benefits plan that is competitive in the marketplace is really important. And so we don't see anything negative at this point coming out of what Washington may do. We see it more positive than that.

Your next question comes from the line of Mark Marcon from R.W. Baird.

I was wondering if you could talk a little bit about the expectations for the gross profit per worksite employee for the balance of the year? And how you think that's going to trend longer term, particularly with the introduction of some of the new solutions?

Yes. I would say that -- I mean, obviously, we don't give gross profit metric guidance anymore, but our...

Yes, just directionally.

Yes. Directionally, we see it kind of where -- the range that it's been in. It looks like it may be up $1 or so for the year over 2016. And going forward, obviously, as Paul talked about, our Workforce Administration contribution in the going forward scenario, longer term, we see that continuing to increase as receptivity of customers wanting to look at different options of our total package. So it's more positive than negative.

So Mark, I would say this directionally in the long term. When we first came out with that strategy with the -- where we saw that contribution coming in to gross profit line, we talked about it either adding to gross profit or offsetting any price pressure that we would have in the marketplace. And so I would say in the first 3 years this has been in place, we did have some pricing pressure. Some of it also was mix change in our business with mid-market growth and other things where you have different gross profit contribution levels. But all things in there, we were able to offset any reduction, whether it's from mix change or otherwise. And I believe as we ramp-up further on these solutions, and that contribution becomes more significant, we could see that start to fulfill the other objective, which is really to add to that gross profit per worksite employee number. So gradually, but it's nice to have that gross profit contribution that's not insurance related.

That's great. And then with regards to the fall selling season and as you prepare for that, you've got 450 trained BPAs. Where do you anticipate that number being towards the end of the year? And how much of an incremental contribution should we potentially end up seeing from Insperity Premier? Because it does sound like it's a really interesting solution, so I'm just trying to think about what the mix of the sales efforts are going to be and how that impacts efficiency.

Thank you. Yes. We're very, very excited about going into this fall season. We really kind of have 3 campaigns a year now internally in the sales organization and both the first 2 have gone really well this year, and we've been continuing to ramp up the number of BPAs. The training has really continued to be effective. Our manager training also has just been excellent. We've been able to really support our district managers, which are so key in the field to managing both the activity and getting the desired results. So as we go into fall, we do have Insperity Premier now to really be able to demo to customers. And we have found that, in that process -- these are just some of the early returns, if you will, because this has only been going on for about a month or so, but demoing the new technology has really been a nice boost in the process. It definitely builds on the energy of the process, which is very important because it's a pretty elaborate process to become a customer. And you need -- every step along the way needs to build momentum, not detract from it. So we think that's going to have a nice effect this fall and it's really all systems go. We should end up around -- I think, around 470 -- 475 or so toward the latter part of the year, and we'll be in great shape as we go into '18.

Great. And any regions or verticals that you're seeing particular strength in?

No. It's -- our strategy, obviously, is across the categories of -- we try to -- our strategy is more of a psychographic profile of the best small and midsized companies in a given area, and so we're continuing to target those. And it's good that the economy is doing pretty good. If we get tax reform, I think you really would see a lot happen in the small and midsized business community.

(Operator Instructions) The next question comes from the line of Michael Baker from Raymond James.

Richard, I was wondering if you could give us a sense for what the uptake rate is for health benefits and how that compares to last year?

Yes. Actually, when we look at the total number of worksite employees that are covered under our plan, it's about the same as it was last year. It's in the -- right at 70% of the eligible employees are in our plan. And the ones that -- we actually have started to see in the last couple of months a little bit of uptake in terms of not just the employees, but more families. And so but that's -- it's not that big of a deal, but it is a little bit of a change to the positive there, so...

So just for clarification. 70% of total employees, which is a much higher percentage of...

Right. Yes. I said eligible, I meant to say total employees, yes. We're in about 90%, 92% of eligible employees.

That's helpful. And then, Paul, I was wondering if you've seen the industry become more vocal with the benefit of a PEO in at least addressing part of the health care challenge?

Yes. We have been involved in Washington as health care reform or repeal/replace and all the dialogue that's going on. And we definitely see some recognition and I think this is another benefit of passing a law a couple of years ago, the Small Business Efficiency Act. It kind of gets us a seat at the table. There were some issues brought up around association plans and other group buying mechanisms, and we were able to kind of raise our hands and say, hey, we should be in that discussion, and we were welcomed in for that type of dialogue. So we're at the table and that's a good thing for us.

And then, finally, Doug, I was wondering if you could just give us a little bit of color around the -- it sounded like there might have been a workers' comp benefit and how that's shaped up relative to your expectations?

Yes. I mean, I think, it's generally running along expectations as it has been in recent quarters. And so we continue to do a good job, I believe, in managing our claims with our safety personnel, et cetera. And so fairly similar results -- a little bit lower, it's a little bit more favorable, but generally in line with recent results.

And just as a reminder. When we start every year, we have a more conservative view of how those claims will run out and then we go try to earn that benefit as the year progresses. And so this is a pretty typical year in that respect.

Right. And remember, our year for our workers' comp is in October 1 through September 30. So as we look, we'll be coming into the fourth quarter by the time we report next, which will be a full year on the comps. So we'll be making the -- potentially, more adjustments as it relates to how the claims turn out over the year.

There are no further questions in the queue. I'd like to turn the call back over to Mr. Sarvadi. Please go ahead.

Once again, thank you for joining us today. We appreciate your interest in Insperity and we hope to see you out on the road soon. Thank you.

This concludes today's conference call. You may now disconnect.