Insperity, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Insperity provides PEO human-resources outsourcing, payroll, benefits, workers’ compensation, and related business services. Financial statements are unaudited. Unless stated otherwise, dollar amounts below are in millions.
Financial performance
| Metric | Q3 2020 | Q3 2019 | First 9 months 2020 | First 9 months 2019 |
|---|---|---|---|---|
| Revenue | $1,007.8 | $1,043.4 | $3,230.7 | $3,239.7 |
| Gross profit | $185.0 | $170.5 | $639.3 | $571.0 |
| Operating income | $28.8 | $34.7 | $187.0 | $158.9 |
| Net income | $20.0 | $25.9 | $134.0 | $130.7 |
| Diluted EPS | $0.51 | $0.63 | $3.43 | $3.18 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $106.6 | $47.1 |
- Q3 revenue fell 3.4%, while gross profit rose 8.5%. Gross margin on reported revenue was approximately 18.4%, versus 16.3% a year earlier; operating margin was approximately 2.9%, versus 3.3%.
- For the first nine months, revenue was down 0.3%, gross profit increased 12.0%, and operating income increased 17.7%. Gross margin was approximately 19.8%, versus 17.6%; operating margin was approximately 5.8%, versus 4.9%.
- Adjusted EBITDA, a non-GAAP measure, increased 12.5% to $57.6 million in Q3 and 19.8% to $250.8 million year to date. Adjusted EPS was $0.91 and $4.15, respectively. These measures add back stock-based compensation; Q3 stock-based compensation rose to $20.9 million from $6.5 million, contributing to the decline in GAAP net income and EPS.
- Q3 average paid worksite employees (WSEEs) declined 3.8% year over year; the nine-month decline was 0.1%. Gross profit per WSEE per month rose 12.7% in Q3 to $266 and 12.1% year to date to $305.
Liquidity, debt, and cash flows
- At September 30, cash and cash equivalents were $372.4 million, restricted cash $45.3 million, and marketable securities $34.0 million. The company’s adjusted cash, cash equivalents, and marketable securities measure was $212.7 million after excluding payroll-related amounts and client prepayments.
- Working capital was $207.8 million, compared with $105.7 million at December 31, 2019. Long-term debt was $369.4 million, up from $269.4 million at year-end. The $500 million revolving facility had $129.6 million of available borrowing capacity, net of a $1.0 million letter of credit; it matures in September 2024. Insperity reported compliance with its financial covenants.
- Nine-month operating cash flow was $106.6 million. Investing activities used $68.4 million, including $68.8 million of property and equipment purchases. Financing activities used $31.4 million, including $91.2 million of share repurchases or withholding and $46.5 million of dividends, partly offset by $100.0 million of borrowings.
- Management said available cash, securities, operating cash flow, and facility capacity were expected to meet liquidity needs for the remainder of 2020, while noting that longer-term capital needs were being monitored amid pandemic uncertainty.
Material changes and management commentary
- Management attributed the pandemic-related decline in employment to client layoffs and furloughs. In Q3, WSEEs returning to work and new hires exceeded layoffs, supporting a 1.7% sequential increase, although the average remained 3.8% below Q3 2019. New-client WSEEs were 92% of the prior-year quarter level; client retention averaged 99%.
- Management expected Q4 average paid WSEEs to decline 2.1%–3.0% year over year, implying 2%–3% sequential growth from Q3. It expected reduced employment levels to weigh on results through at least the remainder of 2020.
- Q3 benefits cost per covered employee increased 1.1% year over year after lower utilization and deferred care had reduced costs in Q2. Management expected higher costs from deferred elective procedures and COVID-19-related factors through the remainder of 2020 and possibly into 2021. The pandemic’s ultimate effect on workers’ compensation remained uncertain.
- Gross profit benefited from pricing and lower direct costs, including workers’ compensation claim-estimate reductions. Workers’ compensation costs were reduced by $11.4 million in Q3 and $32.4 million year to date for favorable prior-period estimates. Health-claim run-off reduced costs by $7.7 million in Q3; year-to-date health run-off reduced costs by $1.9 million, compared with a $2.9 million charge in 2019.
- CARES Act FICA deferrals and related credits affected reported revenue and direct costs: $40.2 million in Q3 and $85.0 million year to date. The filing says these deferrals and credits reduced both revenue and direct costs and had no net effect on gross profit. A separate $11.6 million of client service-fee credits was accrued in Q2.
Risks, contingencies, and unusual items
- A federal securities class action filed in July 2020 against Insperity and certain officers seeks unspecified damages. Insperity disputes the allegations and intends to defend the case; no provision was recorded.
- A 401(k) class action had a proposed settlement in principle between plaintiffs and a co-defendant. Insperity said it would make no financial contribution; court final approval was scheduled for March 2021. The suit had alleged damages of up to approximately $146 million against all defendants.
- Key risks include the duration and economic effects of COVID-19, client cancellations and retention, regional economic exposure, healthcare and workers’ compensation claims and pricing, insurance contract renewals, regulatory changes, litigation, and information-security or technology disruptions.
- The board declared a $0.40-per-share dividend for each of the first three quarters of 2020, compared with $0.30 per share in each corresponding 2019 quarter. The company repurchased 1.186 million shares under its program during the first nine months and had authorization for 227,833 additional shares at September 30.
Important facts for investors to verify
- Whether WSEE growth and client retention recover, and whether management’s Q4 employment outlook is achieved.
- How deferred healthcare utilization, COVID-19 claims, and changes in benefit and workers’ compensation estimates affect future gross profit.
- The sustainability of margins and adjusted results after considering the substantial increase in stock-based compensation and the non-GAAP add-backs.
- Cash available for corporate use after payroll withholdings and client prepayments, and the effect of debt, repurchases, and dividends on liquidity and covenant headroom.
- Developments and potential financial exposure in the securities class action and final approval of the 401(k) settlement.