Insperity, Inc.
Q1 2008 Earnings Call Transcript

Published: 1 May 2008

[Operator:]

Welcome to the first quarter 2008 earnings conference call with Richard Rawson, President; Paul Sarvadi, Chairman of the Board and Chief Executive Officer; and Douglas Sharp, Chief Financial Officer. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Douglas Sharp.

[Douglas Sharp:]

Before we begin, I would like to remind you that any statements made by Mr. Sarvadi, Mr. Rawson, or myself, that are not historical facts are considered to be forward-looking statements within the meaning of the Federal Securities laws. Words such as expects, intends, believes, likely, probably, goal, objective, outlook, guidance, appears, target, and similar expressions are used to identify such forward-looking statements and involve a number of risks and uncertainties that have been described in detail in the company’s filings with the SEC. These risks and uncertainties may cause actual results to differ materially from those stated in such forward-looking statements. Now let me take a minute to outline our plan for this morning’s call

[Richard Rawson:]

This morning I’m going to discuss the details of our excellent first quarter gross profit results, and then I will update you on the pricing and direct cost trends that we are seeing and how they will affect gross profit per worksite employee per month for the balance of 2008. Our gross profit comes from the markup that we earn on our HR services combined with the surplus that is generated when our direct cost pricing allocations exceed the corresponding direct cost. Doug just reported that our gross profit per worksite employee per month was $254, which was at the top end of our forecasted range of $250 to $254. These results came from achieving $198 per worksite employee per month of markup, and generating a surplus of $56 per worksite employee per month or 4.2% of our total markup. We had a decline in the average markup per worksite employee per months in Q1 primarily driven by slight reductions in pricing for renewing business. On the brighter side, our new business sold increased almost $5 per worksite employee per month over the first quarter of last year. Now this quarter’s better than expected surplus came primarily from the payroll tax cost center. Last fall we knew what most of the state unemployment tax rates would be for 2008 and we adjusted our pricing accordingly to maintain our targeted spread for this year. The first quarter spread is typically the largest of the four quarters, and when there are more payroll dollars subject to payroll taxes than forecasted, you automatically get more surplus dollars. This is exactly what we experienced this quarter. From the benefits cost center, we had benefits cost of $681 per covered employee per month, which is slightly less than our expectations and was directly related to the planned design changes that we implemented in January. On the pricing side, we have continued to see migration of employees out of the United Health Care Choice Plus 250 Plan, which reduces our allocation, but it also reduces our ultimate cost. Last but not least, is the contribution from our Workers Compensation cost center. The number of claims reported this policy period to date is exactly the same number as last year’s comparable period. This continues to be impressive when you consider that we’ve had an 8% growth in the number of paid worksite employees that incur those claims. These positive results are directly related to the great job our safety professionals in the field continue to do. The severity rate of those claims that were filed through the end of the first quarter is down 22% over the same period as last year, continuing to demonstrate the effectiveness of our claims management personnel. We had a nice surplus from our Workers Compensation program as expected. These excellent metrics were off set by the $1 million of higher costs related to the discount rate calculation that Doug referred to a few minutes ago. In summation, we’re very pleased with our first quarter results. Now let me share with you what we see for the second quarter and beyond, beginning with pricing

[Paul Sarvadi:]

Today my goal is to provide some insight into the resiliency of our business model and our opportunity for growth and profitability through out a weak economic cycle. I will discuss the transition we experienced in the first quarter, and the acceleration in sales that we are driving as the platform for future growth. I’ll conclude my remarks with a discussion of what we expect as an economic rebound emerges later this year or into 2009. Our first quarter results clearly demonstrate the value of our recurring revenue stream business model. As I mentioned on our last call in February, we had just seen the effects of the economic slow down reach our client base in the form of lower commission indicating lower sales for our clients, products, and services. We saw hiring and lay offs become dead even and we had an increase in client attrition at year-end to 9.6% in January. Now this did not sound like the backdrop that would produce the first quarter results you’ve seen today. In fact, this quarter was our all time record for earnings per share at $0.51. We also had 12% year-over-year revenue growth and 8% unit growth. We continue to invest in growing the sales and service staff, developing new products and the purchase of a new division to offset costs and add a revenue stream. These results are in sharp contrast to many other companies in the business services sector, and validate that Administaff has a much lower economic sensitivity. Our first quarter growth was driven by the combination of solid client retention numbers for February and March, continued enrollment of accounts sold in our fall campaign and no loss or gain from the net effect of layoffs and new hires in the client base. During the quarter we initiated a company wide focus on client retention as part of our annual incentive plan for 2008. This initiative includes the formation of teams to tackle specific areas targeted for improvement, including segmentation, pricing strategy, cost value communication, customer touch program and the renewal process. We also have enlisted the entire staff to innovate through our reward program, established for client retention improvement ideas. Early returns are good with both February and March attrition below historical levels at 2.1% and 1.3% respectively. The outlook for the second quarter also looks positive for continuing this improvement. During the first quarter we had a 9% increase in paid worksite employees from the sale of new accounts

[Douglas Sharp:]

At this time I’d like to provide financial guidance for the second quarter and an update to our full year forecast. Before we get into the details, I’d like to point out that we are essentially reiterating our guidance for the full year. Based upon the factors discussed by Paul a few moments ago, and in particular taking into account the expected range of possibilities from a slowing economy on our sales and hiring within our client base, as he mentioned, we are revising our forecasted unit growth to a range of 6% to 8% for the full year. This revised forecast assumed average paid worksite employees in a range of $115,500 to $116,000 for the second quarter and net additions of $700 to $1400 each month for the later half of the year. This results in a forecasted range of $117,000 to $119,000 average paid worksite employees for the full year. As Richard mentioned, we now expect full year guidance for gross profit per worksite employee per month to be in a range of $239 to $243. This is an increase from our initial range of $235 to $240 based upon our improved outlook and our direct cost program, in spite of the higher Workers Compensation cost resulting from the decline in interest rates. As for the second quarter, we expect gross profit per worksite employee per month to be between $235 and $238, also slightly higher than initially expected. As for operating expenses, we now expect to be in a range of $274 million to $277 million for the full year, with the high end of the range, including additional incentive compensation tied to achieving higher unit growth in gross profit goals. The increase from our previous guidance of approximately $1.2 million is directly related to operating costs associated with our recently announced acquisition of USDatalink. While we are hopeful that we can transition the PEO background check activities from our current vendors before the end of the year, we have conservatively not included these savings in our 2008 forecast; however, we have included revenues from services currently being performed by USDatalink to their existing client base and we expect the operations to be slightly accretive to our 2008 earnings. As for the second quarter, operating expenses are expected to be in a range of $67.25 million to $67.75 million. This is below Q1 operating expenses due primarily to an anticipated sequential decline in cash compensation and G&A costs. As a reminder, first quarter operating expenses included higher corporate payroll taxes and expenses associated with our annual sales conference employee incentive trip. We continue to forecast net interest income in a range of $9.5 million to $10.5 million for the full year, as expected in cash balances should offset the recent decline in interest rates. We are forecasting a range of $2.3 million to $2.5 million for the second quarter. As for average outstanding shares, we are now forecasting $25.7 million for Q2 and for the full year, and we are estimating and annual effective income tax rate of 35.7%. At this time, I’d like to open up the call for questions.

[Operator:]

(Operator Instructions) Your first question comes from Michael Baker - Raymond James.

[Michael Baker:]

United Health continues to face some service issues, and I’m wondering if that had any impact on retention.

[Paul Sarvadi:]

No, Michael. We have just continued to have great service experience. We are such a large customer for United Health Care, and most of their service issues were out in the, right on the California market that dealt with the conversion from them going from the Pacific Air platform to the United platform. I would say that, from all of the qualitative feedback that we’ve had, it’s just been very nominal. So, we may have lost a few because of that, but we just didn’t see that much taking place.

[Michael Baker:]

Doug in terms of the sequential downtick in D&A it looked a little bit more pronounced than what we’ve seen in the past. If you could just provide some sense of maybe what drove that and just give us a sense of how that might trend for the year?

[Douglas Sharp:]

I think for the full year it’s fairly consistent with 2008, our estimate for the full year with the previous years. We did have some assets become fully amortized, going from the fourth of last year to the first of this year. We do have some capital expenditures coming online still. I think the bottom line is, to the full year we expect to be relatively consistent.

[Operator:]

Your next question comes from Tobey Sommer - SunTrust Robinson.

[Tobey Sommer:]

I had a question about your sales force growth, which seems to be pretty impressive in terms of the higher figure at 15%; what is the distribution of them? Is your new sales office initiative absorbing the bulk of that increase, or are you also fleshing out some of your recent office openings over the last couple years?

[Paul Sarvadi:]

We’re pretty aggressive in our office openings over the course of last year and we still have four new office openings this year, but it’s a mix between adding to those new offices and then selling out our other current offices and making sure we’re fully staffed to take advantage of this climate in terms of having really better candidates available for us. We’ve had a great run in hiring and also in training. This first quarter’s been very exciting. Our office has been full of new sales staff and the quality level looks fantastic; so we’re very excited about that going forward.

[Tobey Sommer:]

In terms of the sales, distribution geographically speaking, I was wondering if you could comment specifically on what the California market is like. It seems to be one that has been impacted relatively significantly from a real estate decline perspective.

[Paul Sarvadi:]

We do look at the geographic climate in terms of the economy and certainly the southwest is stronger that the rest, largely driven by the energy sector. In terms of our sales effort, I think our business model, which focuses on aggregating the best small businesses from within our targeted industry categories, is one that continues to provide advantages even in a tougher market place, because in any market, especially California, such a large market, there are always strong small businesses that are doing well, or that are trying to really improve during a tough economic time and those are perfect candidates for our service. We’ve had a good sales effort going on across all the markets, in spite of the weak economy.

[Tobey Sommer:]

Based on the new guidance for gross profit towards that employee per month, how much of that is related, how much of the surplus, this year that’s embedded in the guidance is related to all of the positive impacts that come from the health care plan redesign with United?

[Paul Sarvadi:]

It’s hard to break those three out exactly, but I’ll tell you that like the first quarter is largely driven by the payroll tax component, which we anticipated and mentioned over the last year continually; but I think it’s also important to point out that the Workman’s Compensation components affected this year by the lower interest rate, so the other two areas are not only performing well, but even offset a little bit of a declining contribution from the Workers Comp area.

[Richard Rawson:]

When you look specifically at the medical side, when we set the plan design changes in place last year we anticipated that the value from the calculations we looked at, we anticipated that the value proposition would reduce the trend by about 5%, so that’s what we’re seeing. At the end of last year when we looked at our pricing increases, we were expecting normalized trends in the 8% to 9% and if you back off of 5% of that for just strictly plan design changes, that takes you down to about a 4% year-over-year trend. Then utilization comes into play and all that, so that’s why we’re seeing lower utilization in the plan and that’s why our trended increases looks like it’s going to be lower than what we originally expected in the 2.5% range for the year. So, on the pricing side you’re trying to make sure that you don’t get too far out of wack there, because it takes a long time, if you let that spread get too far away, it takes a long time for it to turn itself around and we’re just not going to allow that to happen.

[Douglas Sharp:]

The last component of the reduction in benefit costs versus the prior year is, we’re in a new three year contract with United and we need negotiated lower administrative costs over the next three years, so that began in January of this year. So that factor should be ongoing over the next three years.

[Operator:]

Your next question comes from Mark Marcon - Robert W. Baird.

[Mark Marcon:]

With regards to Workers Comp, can you tell us the Workers Comp accrual reversal for this quarter?

[Richard Rawson:]

$2.3 million for the quarter.

[Mark Marcon:]

Can you talk a little bit about the improvements in terms of the mid market? It sounds like you’re seeing better retention there. What specifically, you’ve talked in the past about some of the plans that you had for improving the service level. Can you talk a little bit more about what’s actually been implemented and the feedback you’re getting?

[Douglas Sharp:]

We’re very excited about the changes we implemented. Of course last year we did a deep dive to really dig in and understand this target and try to make our service a more hand-in-glove fit for this target customer base. We have implemented some very interesting things. First and foremost on the services side was establishing high level single point of contact, a new role called an account executive that literally just manages the implementation of the service plan with the client. We’ve gotten great results out of that in terms of the dialogue we’ve had with clients as we have moved our current clients over to this new model and we’re not near fully transitioned yet in that respect. Also, all the new accounts that have come on, it has really added a level of touch with these clients that are being well received. We also are doing much more to make sure we’re connected properly with our mid market client and the multiple contacts that have a view of what it means to have a good service relationship with Administaff; so we’re doing a better job of managing the multiple relationships and making sure we’re meeting the expectations of the larger number of decision makers at these size clients. I think there have been a lot of other improvements across the company to support our mid market customer differently in terms of escalation on issues and responsiveness, and these things are really starting to pay some dividends.

[Mark Marcon:]

What percentage of your revenue is now being derived from these mid market accounts?

[Richard Rawson:]

It’s in the 11.5% or so, which is, I really expect to see over the next 12 months or so that we’ll start to see some recognizable improvements in terms of market share coming out of mid market, if these trends continue.

[Mark Marcon:]

It sounds like in the last couple of months, the stick rates been really good.

[Richard Rawson:]

Yes, we’ve had really a nice couple months in client retention. The year-end retention number or attrition number was high and that was still reflecting things that were going on. I mentioned that we’ve started to have these stewardship meetings with these customers and go through the details of where the money goes and what the costs are to do what we do and how much we make and that’s all good information for them. We were only able to implement that with about 11 or so customers during that year-end renewal cycle, but since then we are continuing to do those on a regular basis. We’ve also uncovered other needs they had in terms of being able to reconcile invoices and things of that nature, and so we’ve got some plans coming up soon that we’ll address a little bit at our investors day, Analysts Day coming up on May 8. But, we’re not near finished on what we’re implementing to make this a great fit for our mid market customers.

[Mark Marcon:]

On the benefits side, what percentages of the participants are actually participating in the plan?

[Richard Rawson:]

A little under 74% in the first quarter.

[Mark Marcon:]

So it actually increased?

[Richard Rawson:]

Yes, it increased from the Q4 of last year a little bit.

[Mark Marcon:]

Did you see any impact at all from this flu season in terms of the benefits costs?

[Richard Rawson:]

No, we looked at the utilization and from what we could tell we didn’t see anything that was specific to that.

[Paul Sarvadi:]

And, all the health carriers, that was an issue, but that affects generally an older population and didn’t really affect us very much.

[Mark Marcon:]

With regards to your sales force, what retention levels are you seeing now?

[Richard Rawson:]

Our turn over rates are continuing to run in the low 30’s range and I think one important factor though is, it’s normally up when you go from the fourth quarter to the first quarter. Our trained rep count normally goes down in the first quarter and actually we held even from the fourth to the first quarter and that’s a very positive sign, both on the retention and for going forward. I think that’s been improved by a little bit of a tweak that we made in the compensation side that we mentioned a couple quarters ago and also we’ve got a lot of enthusiasm around our sales staff right now; our sales convention was fantastic; we’ve got some good momentum there. It didn’t reflect that much in the first quarter actual sales, because we were transitioning the message. You slow down the activity for a short time while you convert the message over and then ramp back up. Now that that transitions over, we’re ready to rock and roll.

[Mark Marcon:]

Do you think that means that for next year, maybe the economy is still weak, but on the flip side you’re going to have more trained sales people, they’re all going to be on message, and you’ll have probably some better retention. So therefore maybe the growth in units ends up going back towards more traditional levels?

[Paul Sarvadi:]

Yes, that’s certainly our goal. We have seen historically, we’ve been at this for 22 years now and when we grow sales staff double digits within 12 months, you grow the units in double-digits, our target for this year is to get up into that 14%, 15% range and increase in trained sales reps

[Operator:]

Your next question comes from Cynthia Houlton - RBC Capital Markets.

[Cynthia Houlton:]

From your comments during the call, you mentioned that renewals, there was some pricing pressure with renewals in the March quarter, but that you felt that that would reach a reverse trend going forward. Could you just talk a little bit more about that in terms of why you think renewals on the pricing side will improve as you go out into the next quarter?

[Douglas Sharp:]

Most of the renewal pressure that we had was the result of some mid market customers that we had still been dealing with in terms of the old contracts where there’s some single-year pricing. The larger customers want a discount when it comes time for renewal’ so the effect of this going from an average of $200 to $198 on the renewing business or for the full book this quarter, was really the year end clients that we did renew. Now that we’re into the first quarter, we’re seeing each month that the customers that are renewing are actually renewing at really substantial amounts, which in terms of dollars per employee per month, we’re looking at the $7 to $8 range, even as recent as April. That gives us a lot of confidence that the worst is behind us now, and so we’re not concerned about pricing pressure going forward.

[Cynthia Houlton:]

Is there industry alignment and/or geographic concerns in terms of where you’re seeing greater layoffs or where you saw some spike in layoffs, just any more detail on that?

[Paul Sarvadi:]

I think it’s consistent with what you see in the broader market. With the southwest, like I said, was a little stronger because of the energy sector. We have seen a little bit more in the northeast than the west and in the southeast in terms of layoffs exceeding new hires. In terms of industry categories, we still see actually on the technology side better than I think expected on growth there; so health care is still growing, even though I know health care companies are running into some struggles, but that’s pretty much the picture. Obviously the financial side and we saw previously on the mortgage and that type of business being worse.

[Operator:]

That concludes the Q&A for today’s conference call.

[Paul Sarvadi:]

Well thank you all once again for being with us today, we appreciate it. We look forward to anyone who would like to come to our analyst day presentation, which is on May 8, here in Houston, Texas. We’d love to have any of you come, if you can be here in person, but we’ll also be webcasting that presentation; we invite you to participate in that way as well. Thank you once again.