Insperity, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited results; filed July 29, 2019.
Business context
Insperity provides HR and business services, principally through professional employer organization (PEO) solutions. Reported revenue is gross billings less worksite employee (WSEE) payroll costs, so it does not represent total client payroll billings. Growth was driven mainly by increased WSEEs.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $1,043.3 million (+13.1%) | $922.3 million | $2,196.3 million (+13.4%) | $1,936.7 million |
| Gross profit | $173.7 million (+12.4%) | $154.5 million | $400.5 million (+13.0%) | $354.3 million |
| Operating income | $38.7 million (+15.3%) | $33.6 million | $124.2 million (+26.3%) | $98.3 million |
| Net income | $28.6 million (+16.3%) | $24.6 million | $104.8 million (+40.6%) | $74.6 million |
| Diluted EPS | $0.69 (+19.0%) | $0.58 | $2.54 (+43.5%) | $1.77 |
| Adjusted EBITDA (non-GAAP) | $56.7 million (+21.6%) | $46.6 million | $158.1 million (+21.2%) | $130.4 million |
| Adjusted EPS (non-GAAP) | $0.83 (+22.1%) | $0.68 | $2.81 (+34.4%) | $2.09 |
Q2 gross, operating and net margins were approximately 16.7%, 3.7% and 2.7%, respectively; comparable 2018 margins were approximately 16.8%, 3.6% and 2.7%. For the six-month periods, margins were approximately 18.2%, 5.7% and 4.8%, versus 18.3%, 5.1% and 3.8% in 2018.
- Average WSEEs paid rose 13.8% in Q2 and 14.5% year to date. Client retention was just above 99% in both Q2 periods.
- Revenue per WSEE per month declined 0.5% in Q2 and 0.9% year to date, largely due to lower medical-plan participation. Gross profit per WSEE per month fell 1.2% in Q2 and 1.0% year to date.
- Operating cash flow was $72.4 million for the first six months, compared with $17.3 million in 2018. Capital expenditures were $17.2 million; cash used for financing was $34.8 million.
- At June 30, cash and equivalents were $324.9 million, restricted cash $43.3 million, and marketable securities $61.1 million. Adjusted cash, cash equivalents and securities, excluding payroll-related funds and client prepayments, were $130.7 million. Working capital was $149.3 million.
- Long-term debt was $169.4 million under a $350 million revolving facility; $179.6 million of capacity remained available after the outstanding letter of credit. The facility matures in February 2023; the company reported covenant compliance. Average interest rate for the period was 4.00%.
Changes, management commentary and outlook
- Management attributed growth to WSEE expansion and effective management of gross profit and operating costs. Sales staff (Business Performance Advisors) increased 11.1% year over year in Q2; new-client sales grew, while net client-base gains were lower due to less full-time and seasonal hiring.
- Workers’ compensation cost estimates were reduced by $19.0 million in the first half, versus $10.9 million in 2018, reflecting claims closing below prior estimates. Health-claim run-off estimates increased costs by $3.5 million, versus a $1.9 million benefit in 2018. Management said the net year-over-year direct-cost benefit from these estimate changes was $2.7 million.
- Stock-based compensation and depreciation increased, partly reflecting incentive awards, software development and sales-office expansion. Year-to-date 2018 operating expenses included a nonrecurring $9.3 million tax-reform bonus.
- Insperity adopted lease accounting standard ASC 842 on January 1, 2019, recording operating lease right-of-use assets and liabilities of approximately $50.8 million and $63.7 million at adoption, without material impact on earnings or cash flows. At June 30, operating lease liabilities were $68.9 million.
- No specific full-year earnings guidance is provided in the supplied filing text. Management believed cash, operating cash flows and available facility capacity would meet liquidity needs for the remainder of 2019.
Risks and contingencies
- A certified class action concerning the Insperity 401(k) plan remains pending. Some claims, including excessive recordkeeping-fee claims, were dismissed; remaining plaintiffs allege damages up to $128 million. A bench trial was set for March 2020. Insperity disputes the claims and recorded no provision because the outcome is uncertain.
- The company is transitioning payroll reporting and tax processing for certain client-company owners following an IRS Chief Counsel memorandum. Failure to implement the change successfully could materially affect operations and client relationships.
- Other disclosed risks include economic conditions, regulation and taxation, health and workers’ compensation cost trends and insurance availability, client cancellations, competition, geographic concentration, data security and IT disruptions, and litigation.
- Results depend in part on estimates of health claims and long-tail workers’ compensation liabilities; actual claims experience may differ from estimates. Borrowings carry variable-rate exposure.
Most important facts for investors to verify
- Whether WSEE growth and client retention continue, and whether lower revenue and gross profit per WSEE persist.
- How much earnings benefit comes from favorable workers’ compensation reserve development, and whether health-claim costs or large claims worsen.
- Underlying liquidity after separating company funds from payroll obligations and client prepayments; facility borrowing, interest costs and covenant headroom.
- Developments in the 401(k) litigation and the potential financial effect of the IRS-related payroll transition.
- Non-GAAP reconciliations and the role of stock compensation and other adjustments in reported adjusted EBITDA and adjusted EPS.