Business context and reporting period
Insperity, Inc. filed this Form 10-K for the fiscal year ended December 31, 2013. Its principal business is Workforce Optimization, a professional employer organization (PEO) service providing HR administration, payroll, benefits, workers’ compensation and compliance support to small and midsized businesses. It also offers adjacent software and business services. Workforce Optimization customers averaged 130,732 paid worksite employees in Q4 2013; annual average paid worksite employment was 127,517.
Financial performance and liquidity
| Metric | FY 2013 | FY 2012 | Change |
|---|---|---|---|
| Revenue (net of worksite payroll costs) | $2,256.1 million | $2,158.8 million | +4.5% |
| Gross profit | $393.3 million | $382.2 million | +2.9% |
| Operating income | $56.2 million | $67.5 million | -16.7% |
| Net income | $32.0 million | $40.4 million | -20.7% |
| Diluted EPS | $1.25 | $1.56 | -19.9% |
| Operating cash flow | $34.7 million | $90.8 million | Lower |
Gross, operating and net margins were approximately 17.4%, 2.5% and 1.4%, respectively, compared with 17.7%, 3.1% and 1.9% in 2012. Annual revenue growth reflected a 2.9% increase in revenue per worksite employee per month and 1.5% growth in average paid worksite employees. Gross profit per worksite employee per month rose to $257 from $253, while operating expenses per employee per month increased to $220 from $208.
Q4 2013 revenue was $557.1 million, gross profit $90.0 million, operating income $6.9 million, net income $5.3 million and diluted EPS $0.21. Compared with Q4 2012, revenue increased from $532.4 million, but gross profit declined from $93.5 million, operating income from $15.9 million, net income from $9.4 million and diluted EPS from $0.34.
At year-end, cash and cash equivalents were $225.8 million, marketable securities $46.3 million and working capital $128.6 million. Cash, cash equivalents and marketable securities totaled $272.1 million, including $143.0 million of payroll-related withholdings and $24.5 million of customer prepayments due in early January. The $100 million revolving credit facility was undrawn and expires in September 2015; the company reported covenant compliance. Total assets were $766.6 million and stockholders’ equity $253.3 million. The filing reports no outstanding facility borrowings; other debt, if any, is not clearly quantified in the supplied filing text.
Cash flow from investing activities was an outflow of $43.0 million, including $11.6 million of capital expenditures and net investment in marketable securities. Financing activities used $30.4 million, principally for $17.2 million of share repurchases and $17.4 million of dividends.
Material changes versus the prior comparable period
- Profitability weakened despite higher revenue: operating expenses rose 7.1%, faster than gross profit’s 2.9% growth, and annual operating income and net income fell.
- Annual worksite employee growth slowed to 1.5% from 7.5% in 2012. Management said new client sales and net changes within existing clients were flat, while retention declined slightly; reported retention was approximately 81% in both years.
- Benefits costs rose $29 per covered employee per month, or 4.7%; workers’ compensation costs rose 6.3%, and payroll taxes rose 3.2% per worksite employee per month.
- Operating cash flow declined to $34.7 million from $90.8 million. Management noted that payroll timing, workers’ compensation funding and medical-plan funding can materially affect reported cash flows.
- Adjacent Businesses remained a small share of revenue: 1.4% in 2013 versus 1.2% in 2012, though their share of gross profit increased to 5.6% from 4.3%.
Outlook, risks, contingencies and unusual items
Management expected average paid worksite employees of 127,000–128,000 per month in Q1 2014, below the Q4 2013 average of 130,732. The filing does not provide clear full-year 2014 revenue or earnings guidance. Management stated that available cash, marketable securities, operating cash flows and credit-facility availability were expected to meet 2014 liquidity needs.
- Unusual items included a $3.3 million non-cash goodwill and intangible impairment in Expense Management; a $2.7 million non-cash impairment of the minority investment in The Receivables Exchange; and a $2.0 million tax benefit related to tax years 2009–2012. The 2013 workers’ compensation expense also included a $9.3 million reduction for revised prior-period loss estimates.
- Key cost and contract exposures include health claims and pricing, workers’ compensation losses, unemployment taxes, client nonpayment and short-notice client cancellations. The primary UnitedHealthcare health contract covers approximately 85% of health insurance and expires December 31, 2015, subject to cancellation on 180 days’ notice. ACE workers’ compensation coverage expires September 30, 2014; Insperity bears the first $1 million per claim occurrence and specified excess claims up to a $5 million annual aggregate.
- Healthcare reform provisions and their application to PEOs remained uncertain. Management could not determine the future effects of exchanges, insurance-market reforms, taxes and employer-responsibility rules on costs, pricing or client retention.
- Contingencies include disputed Texas aircraft sales/use tax assessments of approximately $782,000 and $933,000; a Massachusetts tax assessment of approximately $2.5 million; and potential recovery claims of approximately $1–$2 million related to the liquidation of former workers’ compensation carrier Lumbermens Mutual. Management disputed the assessments and claims; outcomes and any ultimate payment are uncertain.
- Other disclosed risks include economic weakness among small and midsized businesses, competition, regulatory uncertainty around co-employment, concentration in Texas, California and New York, and technology, cybersecurity and data-privacy disruptions. The filing states that the financial statements received an unqualified audit opinion and that internal control over financial reporting was effective.
Important facts for investors to verify
- Whether Q1 2014 worksite employee levels and subsequent client-retention trends supported a return to growth.
- Renewal terms and cost trends for ACE workers’ compensation coverage and the UnitedHealthcare health plan, and the extent to which cost increases can be passed through to clients.
- Cash-flow quality and availability: distinguish operating cash from payroll withholdings, customer prepayments, restricted cash and insurance deposits.
- Progress and profitability of Adjacent Businesses, and whether further impairment charges may be required.
- Developments in the Texas, Massachusetts and former-carrier contingencies, including any new accruals or payments.