Insperity, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Insperity provides PEO human resources outsourcing, payroll and related business services, primarily to small and medium-sized businesses. Dollar amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $993.4 | $1,043.3 | $2,222.8 | $2,196.3 |
| Gross profit | $220.2 | $173.7 | $454.3 | $400.5 |
| Operating income | $73.0 | $38.7 | $158.2 | $124.2 |
| Net income | $51.9 | $28.6 | $113.9 | $104.8 |
| Diluted EPS | $1.33 | $0.69 | $2.91 | $2.54 |
- Q2 revenue fell 4.8%, while gross profit rose 26.8%, operating income 88.5%, and net income 81.6%. First-half revenue grew 1.2%, gross profit 13.4%, and net income 8.7%.
- Approximate gross margin increased to 22.2% in Q2 from 16.7% a year earlier; approximate operating margin rose to 7.3% from 3.7%. These are calculated from reported revenue and profit.
- Average paid worksite employees (WSEEs) declined 1.8% in Q2, but increased 1.8% for the first half. Q2 revenue per WSEE per month declined 3.1%; gross profit per WSEE per month rose 28.8% to $322.
- Management reported Q2 adjusted EBITDA of $92.0 million, up 62.2%, and adjusted EPS of $1.54, up 85.5%. These are non-GAAP measures.
- Six-month cash from operating activities was $114.9 million, versus $72.4 million in 2019. Investing used $36.8 million, including $39.5 million of property and equipment purchases. Financing provided $11.9 million.
- At June 30, cash and cash equivalents were $459.4 million, marketable securities $32.0 million, and working capital $228.1 million. Management’s non-GAAP adjusted cash, cash equivalents and marketable securities was $269.0 million after excluding payroll-related amounts and client prepayments.
- Debt under the $500 million revolving facility was $369.4 million; including a $1.0 million letter of credit, available capacity was $129.6 million. The facility matures September 2024; the company reported compliance with its financial covenants. First-half average interest rate was 2.82%.
Drivers and changes versus prior periods
- COVID-19-related client layoffs and furloughs contributed to lower Q2 WSEEs and revenue. Revenue also reflected $44.8 million in client FICA deferrals and CARES Act/FFCRA credits, which reduced direct costs correspondingly, and $11.6 million of service-fee credits provided to clients.
- Q2 gross profit benefited from lower healthcare claims and favorable prior-period cost estimate changes. Benefits costs per covered employee fell 10.7%; prior-period health claim runoff reduced Q2 costs by $10.4 million, compared with a $7.3 million increase in Q2 2019. Workers’ compensation costs fell 15.7% per WSEE; favorable prior-period estimate changes reduced Q2 costs by $13.9 million.
- Operating expenses increased 9.1% in Q2, mainly from higher salaries and stock compensation, partially offset by lower advertising and general and administrative costs. The company cited higher corporate headcount, incentive compensation timing and paid-time-off accruals; travel, events and training declined amid the pandemic.
- Interest income declined and interest expense increased, reflecting lower investment returns and higher facility borrowings. The company borrowed $100 million in March 2020.
- First-half cash and cash equivalents increased from $367.3 million at year-end to $459.4 million. The balance is affected by payroll timing and includes funds due for payroll taxes, deductions and client prepayments.
Outlook, risks and contingencies
- Management expected average paid WSEEs in Q3 2020 to decline 4.5%–5.6% year over year, equivalent to flat to 1% sequential growth from Q2. It expected reduced employment levels to pressure results at least through the remainder of 2020.
- Management anticipated higher healthcare costs in the second half as deferred elective procedures resumed, making claims costs less reflective of historical quarterly patterns. The ultimate COVID-19 impact on workers’ compensation remained uncertain.
- Management said cash, operating cash flow and available credit were expected to meet liquidity needs for the remainder of 2020, while noting that longer-term capital needs were being monitored given pandemic uncertainty.
- A 401(k) fiduciary class action had completed trial; plaintiffs alleged damages of up to approximately $146 million. Judgment was pending, and no provision was recorded. A securities class action filed in July 2020 also remained unresolved; no provision was recorded. The company said it intended to defend both matters.
- The Board adopted a rights plan in May 2020, with specified ownership thresholds generally at 10% (20% for certain 13G investors); the rights were scheduled to expire May 20, 2021, absent earlier redemption or exchange.
- Key risks include pandemic duration and economic effects, client cancellations and retention, healthcare and workers’ compensation claims and insurance availability, regulation, regional economic concentration, information systems, and litigation outcomes.
Important facts for investors to verify
- Whether Q2 margin improvement is sustainable after favorable insurance claim developments and unusually low healthcare utilization.
- Actual WSEE trends and client retention against management’s Q3 expectations, and the continuing effects of COVID-19 on client payrolls.
- Healthcare claim costs as deferred procedures resume, and any changes to workers’ compensation estimates or funding.
- Use of revolving credit, available capacity, covenant compliance, and liquidity after excluding payroll-related cash and client prepayments.
- Developments and potential financial exposure in the 401(k) litigation and the July 2020 securities lawsuit.