Q2 2023 Insperity Inc Earnings Call
Participants
Douglas S. Sharp; Executive VP of Finance, CFO & Treasurer; Insperity, Inc.
Paul J. Sarvadi; Co-Founder, Chairman & CEO; Insperity, Inc.
Andrew Owen Nicholas; Analyst; William Blair & Company L.L.C., Research Division
Jeffrey Michael Martin; Co-Director of Research & Senior Research Analyst; ROTH MKM Partners, LLC, Research Division
Mark Steven Marcon; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Tobey O'Brien Sommer; MD; Truist Securities, Inc., Research Division
Presentation
Operator
Good morning. My name is Jenny, and I will be your conference operator today. I would like to welcome everyone to the Insperity Second Quarter 2023 Earnings Conference Call. (Operator Instructions) Please note, this 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 S. Sharp
Thank you. We appreciate you joining us. Let me begin by outlining our plan for this morning's call. First, I'm going to discuss the details behind our second quarter 2023 financial results. Paul will then comment on the quarter and our plan over the remainder of the year. I will return to provide our financial guidance for the third quarter and an update to the full year guidance, and then we will end the call with a question-and-answer session.
Now before 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 second quarter '23 financial results in which we effectively executed on our plan in sales, service, pricing and other areas of the business, however, experienced a shortfall from our forecasted earnings due to substantially higher healthcare costs. We reported adjusted EPS of $0.64 and adjusted EBITDA of $51 million for the quarter. As for our growth metric, the average number of paid worksite employees increased by 7.2% over Q2 of 2022, which was just below the midpoint of our guidance as net hiring by our clients came in slightly lower than expected. Worksite employees paid from a combination of sales and client retention came in on target.
Moving to gross profit. We continue to achieve pricing above targeted levels, and we combined with our workers' compensation program, payroll tax area and traditional employment offering, we experienced a favorable outcome. However, Q2 healthcare costs came in approximately $42 million higher than expected. This was primarily due to both the number and the severity of large claims up to our $1 million per person insurance claim limit.
Large claim activity accounted for approximately 75% of the higher costs with claims over $750,000 being the primary driver of this increase. The remaining 25% related to higher-than-expected pharmacy costs. And as for the higher pharmacy costs, we experienced an increase in utilization of specialty drugs, including a significant step-up in the use of diabetes and weight loss drugs, and behavioral health drugs.
Now while large claim activity persisting over more than 1 consecutive quarter has been rare over the course of our history, our updated range of earnings guidance incorporates a continued high level of large claim activity over the remainder of the year on the low earnings side and a return to more normal activity on the high earnings side. In both cases, we anticipate that pharmacy costs will remain elevated. When considering these factors, along with our results over the first half of the year, we are now forecasting a benefit cost trend of 7% to 8.5% for 2023, up from our prior estimates in a range around 5%.
On top of the pricing improvements that we have achieved, we intend to further adjust our pricing to mitigate the impact of this potential increased cost trend. And Paul will provide additional comments on our benefit pricing and cost trends in a few minutes.
Now moving to operating expenses. Costs increased 9% over Q2 of 2022 and included continued investment in our sales, service and technology, and the impact of the inflationary environment on our costs. Our growth investment included a 15% increase in the number of hired Business Performance Advisors, putting us in a good position as we approach our fall selling season. Net interest income increased by $3 million over Q2 of 2022 on higher interest rates and invested balances. Second quarter's effective tax rate was 25%, which we are also now forecasting as our full year rate.
Our financial position and liquidity remains strong, and we continue investment in our growth while providing returns to our shareholders. During the quarter, we repurchased 98,000 shares of stock at a cost of $11 million and paid out $22 million in cash dividends. We ended Q2 with $219 million of adjusted cash and $370 million of debt. And as announced this morning, we have increased our share repurchase authorization by 2 million shares and intend to be more aggressive than our typical repurchase activity, depending on market conditions. Now at this time, I'd like to turn the call over to Paul.
Paul J. Sarvadi
Thank you, Doug, and thank you all for joining our call. Today, I'd like to provide comments on the following 3 topics: First, I'll comment on the second quarter, excellent execution and the results across key long-term performance drivers in our business. Second, I'll discuss how Insperity is positioned to capitalize on our vast market opportunity with a focus on the future of the workplace and the corresponding changing needs in our target markets. I'll finish with comments on the outlook for the company into next year and beyond despite the unexpected large healthcare claims in the recent quarter.
Our most important key drivers for long-term success in growth and profitability more within our control, are new sales, pricing, client service and retention. All these areas were strong in Q2 and contribute toward a positive outlook for the future. Our Workforce Optimization booked sales were solid, driven by an outstanding effort in our mid-market business performance consultant team. This team experienced one of their strongest quarters in history in booked sales in both deal count and worksite employees sold. In addition to substantial booked sales, excellent progress was made by our BPAs driving sales activity, which was a priority coming into the quarter. Our 15% higher number of BPAs increased discovery calls, nearly 30% over Q2 of last year, making our prospective client pipeline significantly stronger as we go into the second half of the year.
One of the other highlights of the quarter was Workforce Acceleration, or WX, continuing to gain traction across the sales organization and coming in well above budget in booked sales. One of the reasons this is exciting is the opportunity to test one of our assumptions regarding WX. At this level of WX adoption and incentives, and the large number of new BPAs over the last 12 months, we can begin to assess the potential for WX to lower BPA turnover.
Historically, the 18 months ramp-up period for training BPAs and workforce optimization sales has resulted in a level of frustration from the complexity of the sale and relatively few closes over the learning period. This caused higher turnover rates in less tenured Tier 1 and Tier 2 BPAs. WX is a less complex sale and provides opportunity for earlier success as the ultimate WO sales training is accomplished.
The early read for this first half of the year appears to be validating as the WX sales adoption has considerably lowered turnover in both tiers. Now sales efficiency is down somewhat year-to-date, which is to be expected with a high number of new BPAs in the mix in a different economic climate in the first half of the year. Our refined sales compensation incentive programs are encouraging exactly the behavior we want to drive efficiency going forward.
Not only does strong WX sales by Tier 1 and Tier 2 BPAs create a client base to upgrade to WO over time, but they also provide an opportunity for sales efficiency to improve sooner if this lower BPA turnover continues.
Now our strong pricing allocations were also a highlight this quarter. This is particularly critical considering the higher-than-expected claim cost in Q2. In a few minutes, I'll address how this pricing trend and our plans going forward will contribute to offset cost trends.
Q2 was also another strong quarter in execution reflected in our client service and retention results. Retention was 99% each month of the quarter, at historically high levels. Our success in our recruiting and training efforts of corporate staff over the last few quarters has resulted in appropriate client service ratios to support our changing client needs.
So through the first half of the year, we've experienced solid execution of our plans across the company, and we believe the business is on sound footing for growth going forward. As we look ahead, we are seeing fundamental changes to the future of the workplace and therefore, the needs for small and medium-sized businesses to compete as an employer of choice. This was clear to us more than a year ago, and we established a new division in the company and a new role on our executive leadership team.
Our strategic planning and development organization, led by Executive Vice President, Kathy Johnson, is focused on strategic corporate and organizational development to continue our industry leadership position in the breadth and depth of services provided and the level of care for our clients. This team is focused on purposeful transformation to the changing HR environment, including everything from data analytics and artificial intelligence to employee generational and psychological demands for flexibility and resources to support personal wellness and development.
Examples of these critical drivers to employee engagement include adjustments to work mode and locations, changes to payroll and access to wages and inclusion of mental, physical and financial wellness offerings. We are planning upgrades to many of these areas over the last half of the year to support our clients' changing needs. I believe with our focus and innovation in these areas, we are well positioned to meet small and medium-sized employer needs to remain competitive in the tight labor market, and succeed in the marketplace. These demands require cultural changes in companies to attract and retain the best people. Our history of working with clients on these issues, combined with our efforts to provide the appropriate benefits and dynamic employee experience platform for these businesses, positions Insperity as the provider of choice into the future.
So we believe that our long-term outlook remains very strong, driven by effective ongoing execution and enhanced strategic planning and development. Our level of confidence is not impeded at all by the recent large claims and the effect on the quarter or the projected year. The best place to start to put this claim quarter in proper perspective is to look at our 5-year compounded annual growth rates in both pricing and cost of our benefits plan with this year's estimate included.
Our estimated benefits cost compound annual growth rate is 4.2% to 4.6%, including the wide range of potential claims we've estimated for the full year. Our compound annual growth rate for benefits allocations over the same period is 4.1%. Now these rates demonstrate effective healthcare cost management compared to the marketplace and achieving our goal of aligning our pricing with cost increases over time. Our long-term historical cost trends are solid, and our pricing strategy has performed well. Now this year we're running ahead of target allocation increases, and we've already initiated a plan to add a moderate incremental amount of pricing for 2024 of approximately 1% to 1.5%, which we believe is in line with marketplace trends and should put us in a solid position to align our pricing and costs going forward.
When we look ahead to next year and beyond, we believe we'll be able to continue to appropriately align our pricing strategy to our cost trends over time like we have in the past. We are in year 2 of our current 5-year plan, and this quarter's results do not change our strategy to achieve our goals. Throughout our history from time to time, we've had quarters in which we experienced unexpected large claims. In each such instance, we've successfully managed through the situation and continued our long-term growth and profitability.
For the company to stay on plan, the most important focus is on our growth drivers over the balance of the year. Our focus includes continuing the investment in BPA hiring and training and additional marketing to drive sales over the balance of the year. We also have the organization ready, willing and able to continue solid execution on our pricing and client service and retention strategy. We remain confident in our ability to achieve these goals, which we believe will drive future performance and position us well to continue our history of superior returns to shareholders.
At this point, I'd like to pass the call back to Doug to provide our specific guidance.
Douglas S. Sharp
Thanks, Paul. Now let me provide our guidance for Q3 and an update for the full year 2023. Our updated earnings guidance includes assumptions around a possible range of outcomes in our benefit costs over the remainder of the year. Outside of this area, we continue to expect favorable trends in our pricing in other areas of gross profit and are forecasting slightly lower paid worksite employees and operating expenses. As for the details, we are now forecasting 6.5% to 7% worksite employee growth for the full year 2023, slightly lower than our previous guidance and a tighter range since we are now more than halfway through the year. The lower growth outlook is primarily a result of Q2's average paid worksite employees coming in a little light due to lower hiring in our client base and an assumption that this lower hiring continues over the remainder of the year.
As for Q3, we are forecasting year-over-year worksite employee growth of 4% to 4.5%. Now this is lower than our full year growth forecast due to our assumption of significantly less hiring in Q3 of 2023 compared to Q3 of 2022. However, this guide reflects continuing sequential worksite employee growth over the remaining 2 quarters of 2023 and improving year-over-year growth in Q4.
We have revised our earnings guidance based upon our results through the first half of 2023 and our updated outlook for worksite employee growth, and the range of expectations around our benefit costs, as previously discussed. So after putting together the pieces, we are now forecasting full year 2023 adjusted EBITDA in a range of $300 million to $350 million and adjusted EPS in the range of $4.35 to $5.32. As for Q3 earnings, we are forecasting adjusted EBITDA in a range of $57 million to $81 million and adjusted EPS from $0.69 to $1.14. Now at this time, I'd like to open up the call for questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question is coming from Andrew Nicholas of William Blair.
Andrew Owen Nicholas
I wanted to ask on the benefits-cost side first. I was hoping you could provide a little bit more color on the benefit cost trend, particularly on the $750,000-plus side. Is there anything to pinpoint in terms of the underwriting approach or the risk management approach that would help to explain that? Or is it just some noise? And then I guess maybe the bigger picture question is, do quarters like this change your appetite for risk on the health care side or any kind of long-term amplifications to this kind of quarter.
Douglas S. Sharp
Yes. I think when you look at a little bit more of the detail behind the cost, obviously, we investigated some of the detailed claims data that was provided from our healthcare carrier very diligently. I think one thing that came out of that was that there was not a higher concentration of large claims from new clients, which would indicate that through our fall selling season and our year-end renewal, this is not the situation where there has been adverse client selection. That's obviously one of the first things that you want to rule out. When you look at the types of claims, it's really across the board as far as the $750,000 and above. You've got some cancer, you've got some heart attacks, you've got some accidents. And so it's really varied and diversified over as far as the nature of the type of claims. And so I think it was -- from what we can see thus far, yes, we did have a claim -- a period of large claim activity. It has happened in our history. But I think we still feel -- particularly when you look at Paul's comments with respect to over the long term in the 5-year compounded rates that we're still managing the healthcare cost trends even with the forecasted higher costs over the remainder of the year, within a range at a tolerable range and really within a range where our pricing with being above target recently and maybe some adjustment and some adjustment to that, we feel like the matching of pricing cost is still in play.
Paul J. Sarvadi
So let me address the second half of that question about the kind of appetite for risk because I think there's 2 different ways you have to look at it. First of all, we are comfortable with the way we have structured our program to align price and cost over the long term, and we know that it provides advantage to grow the business and it provides a more profitable long-term structure. But at the same time, we sure don't like when we have a large claim quarter like this. And as you know, when we did this in 2019, we did purchase a coverage limit on individuals at the $1 million level. We also will continue to look and evaluate that as this year goes by. We've quoted lower limits before. Sure, we'll take a look at that like we do every year. And I would just say also that we, on an ongoing basis, look at other possibilities to take out some of the volatility that relates to this type of quarter and how that affects us in the public markets. So we continue to pursue those things. So I would say our appetite to -- we still want to run the business this way. But certainly, as we can find other ways to reduce the volatility that's caused by these occasions, we'll continue to pursue that.
Andrew Owen Nicholas
That's helpful. I guess for my follow-up question, I wanted to ask on capital allocation and maybe the capacity you have for repurchases in 2023, especially in light of the increased authorization and I think, Doug, your comments on your intention to be a bit more aggressive there. Can you just flesh out the type of capacity you have this year to put back into buying the stock?
Douglas S. Sharp
Well, I think you see from the increased authorization of 2 million shares, that would give you some indication as to where the Board is currently feeling with respect to repurchase authorization, which would indicate a higher level than what we have done typically. But even if you look at it over the course of our history, we've always been a big purchaser of shares. I think if you go back to the 2019 events where we had some quarters of high elevated large claim activity, we were quite aggressive because we felt that over the long term, the business model remains very much intact. I think we obviously feel very confident in that today. So with the increased authorization, it does allow us to be more aggressive should opportunities present themselves coming off of this quarter's activity. Again, strong confidence that our long-term plans are still in place and still reasonable targets for us.
Operator
Your next question is coming from Tobey Sommer from Truist.
Tobey O'Brien Sommer
I was wondering if you could share with us your expectations and what you're hearing from your healthcare provider about whether the higher healthcare expense level may continue into 2024. I think it's been a theme and concern that people had sort of in the post-pandemic era.
Paul J. Sarvadi
Yes. I think we do continue these conversations on an ongoing basis. And Tobey, as you heard from our discussion here, we did go ahead and build in just a higher pharmacy trend because there's things in there that seem they're likely -- more likely to continue than be a short-term bubble. So we do continue to monitor those things. I think that's different from this -- the large claim component. However, since we had a difficult long difficult period in 2019, that covered multiple quarters. We just used a wider range of the expectation for this year. But we -- in the conversation with our advisers and outside the company, we think we're properly managing and aligning our cost and price with the underlying trends.
Tobey O'Brien Sommer
And for my follow-up, I'll make it two-pronged, if I could. The midyear price hike, you talked about, 1.5%. Is that applicable to all clients? Or is that sort of a new and renewing client only? And then maybe you could talk about and dig into your experience with BPA retention and maybe talk about something a little more exciting on the sales front, away from the benefits.
Paul J. Sarvadi
Sure. So we -- when we look at -- remember, we are looking at pricing every day in our operations based on the trends that we're seeing. And we're pricing new and renewing business every day. And so when we talk about raising that -- adding another 1% to 1.5%, that began immediately when we decided that. And that adds to the typical trend increases we've been building into clients. Clients typically get an increase from us. It varies based on their experience with us. But generally speaking, customers will get an increase in the high single digits. Some will get double digits. But most of the time, it's on average, I would say, in high single digits. And then they will make their own decisions on how to lower that cost by plan, selection or how they might share cost with employees or other issues that they'll look at. So what we're saying now is we'll continue to drive that higher than the average its been, but it appears to us to be very much in line with what is going on in the marketplace at large. So we're not in a position where we've got to raise price considerably. And in response to what we see going on, we think we're comfortable with where we are and what we're able to pass on. And as you can see, we've just come off of 1.5 years of really strong pricing success with our client base. So we're very comfortable with that going forward.
So now on to the exciting part on the growth side, yes, I'm very excited about really, everything we're doing in our organization around the core business and the incentives that we've changed to direct behavior at the appropriate things at the appropriate time. Also the WX element that we also incented in such a way that we're seeing the lower turnover year-to-date, and that has a dramatic potential effect. And then, of course, the other factor that I always want to focus on is how successful we were in mid-market, and we are building that team and building that pipeline for more consistent and predictable growth on the mid-market front. So all 3 of those pieces together really point to a positive growth outlook for the company. even though we've been in a period of time when growth in the business is below the double-digit number, we still had the highest growth rate in the industry. But I think as these things really take effect, there's this long-term potential for improved sales efficiency from less turnover. And in addition to that, it's also lower cost, dramatically lower cost, when you have lower turnover. So that kind of has a double dip positive effect, and we're excited about where we are on that front. Still a lot of work to do, but we're really poised for an excellent second half.
Operator
Your next question is coming from Mark Marcon of Baird.
Mark Steven Marcon
I've got a couple of questions. The first one just basically relates again to a little bit more detail with regards to the higher healthcare claims. And what I'm wondering specifically is can you talk a little bit more about what's going on on the pharmaceutical side, which seems like it will be an ongoing trend. And then on the larger claims, did you find that it's just that you had more severe incidents? Or is there also some inflation for some higher incidents. In other words, is treating the same type of cancer significantly more expensive today than it used to be or are heart attacks more expensive than they used to be. Obviously, labor costs are going up within hospital systems. So I'm wondering if that's part of what we're seeing.
Paul J. Sarvadi
Well, I think on that front, that's a good point, and we do monitor exactly that. And that's generally more in the typical year-to-year trend numbers. And we work, of course, with our outside advisers and of course, with our carriers to monitor those things. But what we're really talking about this quarter, I don't think that factor is an underlying factor all the time and not different this quarter. But on the pharmacy side, I think most people have heard and you see in the marketplace, a lot of discussion about various drugs that are being used, especially more recently on the weight loss front, some of the diabetes drugs and other drugs that maybe weren't originally designed for that but are being used that way, more of a fad-type thing. And I think that's -- that may wane also because there are some long-term effects that are not positive for people. But it takes time for that to run through. And so there's also, I think, an increase in behavioral health needs, and that is also a factor that if you think about being 2 years into a period of high inflation and kind of the squeeze of the wallet for a lot of people, that has a mental and nervous effect. It has a behavioral health cost effect. And so those are the things we kind of saw underlying here. And we said look, now that is most important to build in as we see it. So we've done that. And like I said, we've done stuff on the pricing side to make sure that's all aligned going forward.
Mark Steven Marcon
Great. And then with regards to implementing a modest price increase, which can be mitigated to a certain effect by the behaviors of the clients. What sort of impact would that have on sales? And then offsetting that, to what extent, Paul, can you accelerate WX to an even greater effect and take out some of the healthcare risk from the initial pricing discussion.
Paul J. Sarvadi
Yes, that's good. We definitely -- on the WX front, one of the advantages, of course, of growing that business is it's not -- there is no medical risk in that business. So we do see that as a nice enhancement and we are intending to drive that considerably as time goes forward. It makes sense to do that. And we are -- what's happening right now is the sales team is really getting on board. We incented their effort to close WX business. And that has so many strong effects. They're adding a client base of their own that can upgrade to WO as time goes on, and they're feeling more successful early in their tenure, and that's what's lowering the turnover. So we just see a lot of advantages for WX and we are definitely moving that ball forward and expect that it can be much larger. There's other things that we're doing there that deal with some of these change in the workplace issues that I was discussing. For example, access to wages and things of that nature, other tools that can be provided to employees for wellness. We're doing that both in WX and WO on the financial wellness and other types of services that employees are demanding more and more kind of post-COVID. So we are moving ahead there. And I think looking forward to some dramatic success in WX.
Douglas S. Sharp
Tobey (sic) [Mark], I think your other question with respect to the pricing adjustments that we're going to be making on the healthcare side, as we mentioned earlier, the good news is we've been above our targets on the medical pricing allocations over the course of this year. And when we look at our forecast and assuming a wide range and that some of this large claim activity continues, we're looking at making incremental pricing changes in the range of 1% to 1.5%. And looking out there in the marketplace, it's very much in line with the marketplace trends. So we don't think that pricing is going to be outside of the marketplace trends and will be very consistent and shouldn't put us at a disadvantage.
Speaker 0
Operator
Thank you very much. Your next question is coming from Jeff Martin of Roth Capital Partners.
Jeffrey Michael Martin
Doug, I wanted to get a sense when you think the potential price increases for the benefit cost allocation may be fully implemented? Is that early next year? Or is that going to be sooner than that?
Paul J. Sarvadi
Yes, a significant chunk of it happens through the year-end transition and then they'll continue on through the first quarter or so of the year. But that's just that one -- that's the increased component. And we've been having strong pricing increases that are flowing in every month.
Jeffrey Michael Martin
Got it. Okay. And then on the new initiative in terms of helping small businesses position for the current environment and attracting and retaining employees. Is that an added component in terms of an additional service charge? Or is that lumped in with the workforce optimization product.
Paul J. Sarvadi
I'm sorry, can you repeat that for me?
Jeffrey Michael Martin
Well, I was just curious if that new service offering for small businesses where you hired Kathy Johnson or you brought -- elevated her to lead that effort. Is that going to be an offering that you specifically charge for as part of workforce optimization? Or is that built into the product itself?
Paul J. Sarvadi
That's good that you bring that up because what this strategic planning and development group is all about is carefully evaluating any new things that are offered to determine the appropriate the appropriate structure for that addition. And so there will be things that will be charged for because they're outside of -- for us, we don't want to just keep adding to the bundle, so to speak, and there's certain services or products that people want to have outside of that bundle. So we'll be looking at a variety of things on every product service, every improvement that we're going to make to that group. We'll be looking at those as financial investments and looking for the return on those investments.
Operator
Thank you very much. We have reached the end of our question-and-answer session. I will now turn the call over to Mr. Sarvadi for any closing remarks.
Paul J. Sarvadi
Once again, we do want to thank everyone for participating today, and we look forward to a strong second half, continue to focus on our growth into the future and continuing our strong second year in our 5-year plan. So thank you once again for being a part of this today, and we look forward to talking to you next quarter. Thank you.
Operator
Thank you, everybody. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.
