When Insperity (NYSE:NSP) reported third quarter results on November 4th and missed analysts' average estimates on earnings by so much, a staggering 26%, I had to wonder if I was indeed missing the forest for the trees.
Trees In Third Quarter Results
For the 2019 third quarter, Insperity, an HR solutions provider, reported revenue of $1.04 billion, 12.8% better than the 2018 third quarter. The average number of worksite employees paid per month (WSEE) grew 12% to 240,939 from 215,051 in 2018. For the first nine months of 2019, revenue has improved 13.2% to $3.24 billion on WSEE growth of 13.6%.
Insperity's miss was on the bottom line. Adjusted earnings per diluted share declined 21.9% from $0.96 in the 2018 third quarter to $0.75. To date, for the year, diluted earnings are still registering a 16.7% increase in 2019, $3.57 per share compared to $3.06 in 2018. The company had guided for adjusted EPS in a range of $1.00 to $1.04 in the quarter. Analysts' average estimate was $1.01 per share.
A few years ago, Insperity noted its true measure of growth was in the lower lines of the income statement.
"But as you all know, it isn't about our revenue anyway. It's about the gross profit and the contribution at the operating income line because every worksite employee is a unit of revenue and unit of risk." (emphasis added)
Though revenue grew nearly 13% in the third quarter, gross profit registered just a 2.7% increase. The culprit was a higher-than-expected benefit cost of approximately $18 million. On the outstanding share count, this equates to nearly $0.45 per share.
In the past two quarters, Insperity has experienced an unusual number of occurrences of large medical claims (defined as $250,000 and above). The activity exceeding the company's expectations by approximately $27 million. Drilling down into the activity proved the randomness of the occurrences.
"Our insurance carrier confirmed that there is an element of randomness in the recent elevated large claim activity. And, there is an expectation that it will revert back to a normal level. The recent increase in the frequency of claimants with jumbo claims is above the level of our insurance carrier's fully insured book of business. Whereas, prior to this activity, we have historically been in line or below their book." (emphasis added)
But this wasn't the only "tree" worthy of focus in the report. Insperity also noted the growth of WSEEs is not pacing as it initially projected for the year. Initially, Insperity projected the average number of paid worksite employees per month would grow 14% to 16% to 238,400 to 242,600 with a midpoint of 240,500. Year to date, the average WSEE is 232,825.
"In the second and third quarters, we were surprised by the lower than expected net change in existing employees within the client base in the last month of each quarter." (emphasis added)
As a result, the company lowered its full-year expectation to a range of 235,700 to 236,300 reflecting growth of 12.7% to 13%. It is pertinent shareholders recognize this will still represent year-over-year growth at a double-digit clip and well within its long-term target of 10% to 15% annually.
Insperity points at a combination of factors impacting its original expectations.
The first factor Insperity noticed in the last quarter was there simply are not qualified applicants to hire.
"The tight labor market has made it more difficult to find employees making net gains in the client base less predictable." (emphasis added)
While this factor works against Insperity's WSEE growth metric, it does have the potential to benefit the company's hiring services.
Second, Insperity, itself, had fallen behind in hiring and training BPAs (Business Performance Advisors) due to the tight labor market. In the second quarter, it reported the delay.
"It's taking a lot more interviews and a lot more activity to bring the same number on."
In the third quarter, it finally caught up to its own needs.
"Historically, our unit growth follows the growth rate in the number of trained business performance advisors with an approximately two quarter lag as new trained sales personnel gain efficiency. We ended the third quarter with a 13% increase in trained BPAs, up from 10% in Q1. And, our fall campaign sales activity reflects this momentum. Sales for the first month of the campaign were 103% of budget. And, the number of business profiles or opportunities to bid our workforce optimization services is up 23% over the last year."
Third, Insperity developed a focused offering for a mid-market demographic in 2018. The company honed in on companies with 150 to 5,000 employees needing customized solutions. In July 2018, it closed its largest account in that segment to date. Obviously, this impacts the year-over-year comparisons.
"This year, we have nearly the same number of accounts sold year-to-date in our mid-market segment and a substantially larger pipeline for 2020. However, the biggest difference from last year in mid-market sales is the lower average size of account sold and the fact that we did not close a large enterprise account like we did last year." (emphasis added)
What is, again, pertinent for shareholders to recognize is the actual impact on growth.
"This is exaggerating the quarterly slowdown in unit growth over this year from mid double-digits to low double-digits." (emphasis added)
This combination of factors prompted the historically-conservative company to pare back its full-year guidance. Adjusted EBITDA was lowered to a range of $247 million to $253 million, and adjusted EPS was lowered to a range of $4.08 to $4.20. Initial guidance for the full year for adjusted EBITDA was a range of $268 million to $285 million and adjusted earnings were a range of $4.37 to $4.69 per share. After Insperity reported 2019 first quarter results, it bumped the adjusted EBITDA range to a range of $276 million to $289 million and adjusted earnings to a range of $4.55 to $4.80. The updated guidance now represents year-over-year growth of 3% to 6% in adjusted EBITDA and 9% to 12% in adjusted earnings.
No doubt, the market was disappointed in Insperity's results. It was probably more disappointed in the full-year impact to guidance than in the actual third-quarter results since each factor impacting results sported a somewhat reasonable explanation.
The share price has been sliding noticeably and has not yet settled. Insperity's share price closed at $107.67 on November 1st. It's dropped approximately 37% since reporting to less than $70 and set a new 52-week low on November 4th at $67.06.
This slide follows a similar slide after second quarter results were reported. On July 26th, the stock closed at $144.63 per share. Shares then dropped as much as 38% to as low as $89.23 in the next few weeks.
Since the beginning of the year, Insperity's share price has given up around 30%. From the high of the year, the price has given up nearly 54%. These resets are most likely focused on the multiple granted the company.
Prior to 2019, Insperity's growth trends of the past four years were enviable. Even Insperity acknowledged such growth was worthy of a dose of hesitation.
"After four years in a row increasing our adjusted EBITDA by more than 25%, a natural question is how sustainable are these strong results." (emphasis added)
Prior to these resets, it was not unusual for the market to grant Insperity a multiple averaging greater than 25. Using the updated midpoint in the 2019 adjust EPS range of $4.14, at a share price under $70, the P/E ratio is less than 17.
But the market is supposed to be forward-looking. And, Insperity offered an improving outlook for 2020.
"We expect to continue this growth plan [growth rate in paid worksite employees within our target range of 10% to 15%] into 2020 and enhance our business model with improving Workforce Acceleration [traditional employment bundled HR solution] results."
"We expect 2020 earnings growth to be improved and not indicative of the latter half of 2019." (emphasis added)
If Insperity grows the bottom line just 10% in 2020, the forward P/E ratio equates to less than 15.5. According to YCharts, the S&P 500 average forward P/E ratio is 18.18 based on IBES' S&P 500 2020 EPS growth estimate of 10% to 11%. Thus, the sell-off does appear overdone by nearly 20%.
Insperity's own outlook for 2020 is bolstered by the results from its Business Outlook Survey. The survey responses reflected optimism.
"Fifty-three percent of respondents feel the general outlook for 2020 is better than 2019, while 43 percent feel they will maintain the same level of performance. Sixty-one percent expect their sales pipelines to increase going into 2020." (emphasis added)
The survey also covered business concerns, and Insperity offers solutions geared directly at meeting some of these top concerns.
"Overall, driving revenue growth and recruiting/retaining talent were the top two at 56 percent and 51 percent, respectively. These were followed by managing operational costs at 48 percent and managing health care costs at 46 percent. However, in the larger client segment, managing operational costs and driving revenue growth at 63 percent and 60 percent, respectively, edged out recruiting/retaining talent and managing health care costs, both at 51 percent."
Yet again, it is pertinent for shareholders to remember Insperity now has a broadened arsenal of solutions. Mentioned already, its mid-market solution targets businesses with 150 to 5,000 employees, and its Workforce Acceleration solution offers traditional employment services. The 2019 fall sales campaign represents just the second year of these solutions being offered.
"We typically sell 1 out of 10 of our small-to-medium sized business prospects on our flagship Workforce Optimization co-employment bundle. Our traditional employment strategy is to ultimately convert some percentage of the 9 out of 10 that either don't qualify or are not ready for Workforce Optimization to our Workforce Acceleration option. These sales represent a value to Insperity of about 1/3 compared to Workforce Optimization clients without the benefit plan risk and contribute to improving gross profit." (emphasis added)
My investment club initially invested in Insperity in 2013, and we've long since recouped our original investment. The remaining shares continue to collect dividends that are then reinvested. Thus, though these price resets are alarming, they will not propel us into a paper loss scenario. In fact, for us, lower prices result in a larger accumulation of shares upon reinvestment.
Still, just as the company is often awarded a rosy multiple on potential growth, Insperity's share price is often slaughtered on disappointing news. Activity following both the second and third quarters of 2019 exemplifies this type of market reaction.
Insperity still targets growing its top line through the addition of paid worksite employees via its flagship service at a double-digit clip as well as its newer mid-market solution and traditional HR solution. A slowdown in its historical growth clip of 25+% may warrant a multiple reset. But it certainly does not warrant casting the company into a low or typical growth category.
Shareholders and potential investors should not miss the forest for the trees.
Disclosure: I am/we are long NSP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I belong to an investment club that owns shares in NSP.