Insperity, Inc. — Q3 2019 Form 10-Q
Business and period: Insperity provides HR, payroll, benefits, workers’ compensation and related services, primarily through its professional employer organization (PEO) solutions. This unaudited report covers the quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Reported revenue is gross billings less worksite employee (WSEE) payroll costs.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $1,043.4m (+12.8%) | $925.1m | $3,239.7m (+13.2%) | $2,861.8m |
| Gross profit | $170.5m (+2.7%) | $166.1m | $571.0m (+9.7%) | $520.3m |
| Operating income | $34.7m (-27.8%) | $48.1m | $158.9m (+8.5%) | $146.4m |
| Net income | $25.9m (-28.6%) | $36.2m | $130.7m (+18.0%) | $110.8m |
| Diluted EPS | $0.63 (-26.7%) | $0.86 | $3.18 (+20.9%) | $2.63 |
| Adjusted EBITDA | $51.2m (-16.9%) | $61.6m | $209.3m (+9.0%) | $192.0m |
| Adjusted EPS | $0.75 (-21.9%) | $0.96 | $3.57 (+16.7%) | $3.06 |
| Average WSEEs paid | 240,939 (+12.0%) | 215,051 | 232,825 (+13.6%) | 204,895 |
Margins: Q3 gross margin was approximately 16.4% of reported revenue, versus 17.9% a year earlier; operating margin was approximately 3.3%, versus 5.2%, and net margin approximately 2.5%, versus 3.9%. Nine-month gross margin was approximately 17.6%, versus 18.2%; operating margin approximately 4.9%, versus 5.1%; net margin approximately 4.0%, versus 3.9%.
Cash flow and liquidity: Nine-month operating cash flow was $47.1m, down from $70.3m; investing cash outflow was $35.6m, including $36.0m of property and equipment purchases. Financing cash outflow was $88.2m, including $153.7m of share repurchases or withholding and $36.8m in dividends, partly offset by $95.0m of borrowings. At September 30, cash and cash equivalents were $243.4m and marketable securities $60.9m. The company reported $132.5m working capital and $130.9m adjusted cash, cash equivalents and marketable securities after excluding payroll-related funds and client prepayments.
Debt and obligations: Long-term debt was $239.4m. The revolving facility was increased to $500m; after borrowings and a $1.0m letter of credit, $259.6m was available. The facility matures in September 2024, carries variable interest, and the company reported compliance with its financial covenants. Adoption of lease accounting added operating lease right-of-use assets of $58.2m and total lease liabilities of $75.3m at quarter-end.
Material changes and management commentary
- WSEE growth drove revenue gains, but Q3 profit declined as operating expenses rose 15.2%, faster than gross profit. Per-WSEE monthly gross profit fell 8.2% to $236; per-WSEE operating expenses increased 2.7% to $188.
- Q3 health benefits costs rose $33 per WSEE per month, reflecting large claims; prior-period claims development added $7.0m to Q3 costs, compared with a $0.7m reduction in Q3 2018. Health-plan participation was 66.0%, versus 66.7%.
- Workers’ compensation costs per WSEE declined 9.6% in Q3. Favorable prior-period claim development reduced Q3 costs by $7.5m, compared with $2.4m in Q3 2018. For the nine-month periods, the respective reductions were $26.0m and $13.4m.
- Management said new-client WSEE additions were lower than the prior-year comparison, which included onboarding the company’s largest client in 2018. Client retention averaged just above 99% in Q3. Nine-month per-WSEE revenue fell 0.4%, primarily due to lower medical-plan participation.
- Management expected cash, marketable securities, operating cash flow and credit availability to meet liquidity needs for the remainder of 2019. The filing provides no numerical earnings or revenue guidance.
Risks, contingencies and unusual items
- Health and workers’ compensation costs rely on estimates of claims and claim development; actual experience may differ. Effective October 1, 2019, Insperity’s workers’ compensation responsibility increased to the first $1.5m per occurrence, from $1.0m, while the stated aggregate layer for excess claims remained $6m.
- A certified class action concerning the Insperity 401(k) plan remained pending. Plaintiffs allege damages of up to $128m; certain claims were dismissed, a bench trial was set for March 2020, and the company recorded no provision because the outcome was uncertain.
- The company was transitioning payroll-tax reporting for certain self-employed client owners following an IRS Chief Counsel memorandum. Insperity warned that failure to transition successfully could adversely affect operations and client relationships.
- Other stated risks include economic conditions, regulatory and tax changes, insurance costs and availability, client cancellations, competition, regional concentration, data security, IT system failures and litigation.
- Q3 and nine-month results included substantial favorable workers’ compensation reserve development, while health-claim development was unfavorable. Nine-month tax expense also reflected a $14.5m tax benefit associated with vesting of incentive and restricted stock awards.
Important facts for investors to verify
- Whether rising medical claims and health costs persist, and how benefit participation and pricing affect gross profit per WSEE.
- Whether favorable workers’ compensation reserve releases continue and the effect of the higher retention level effective October 1, 2019.
- Underlying operating cash generation, given the $47.1m nine-month operating cash flow and significant payroll-funding timing effects.
- Debt usage, variable-rate exposure, covenant headroom and the pace of share repurchases and dividends.
- Developments in the 401(k) class action and the transition in payroll-tax reporting for self-employed client owners.