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Good morning. My name is Kyle, and I will be your conference operator for today. I would like to welcome everyone to the Insperity Fourth Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] At this time, I would like to introduce today's speakers. Joining us are Paul Sarvadi, Chairman of the Board and Chief Executive Officer; Douglas Sharp, Senior Vice President of Finance, Chief Financial Officer and Treasurer.
At this time, I would like to turn the call over to Douglas Sharp. Mr. Sharp, please go ahead.
Thank you. We appreciate you joining us this morning. Let me begin by outlining our plan for this morning's call. First, I'm going to discuss the details of our fourth quarter and full year 2018 financial results. Paul will then recap the 2018 year and discuss the major initiatives of our 2019 plan. I will return to provide our financial guidance for the first quarter and full year 2019. We will then end the call with a question-and-answer session.
Now before we begin, I would like to remind you that Mr. Sarvadi or I may make forward-looking statements during today's call, which are subject to risks, uncertainties and assumptions. In addition, some of our discussion may include non-GAAP financial measures. For a more detailed discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statement, and reconciliations of non-GAAP financial measures, please see the company's public filings, including the Form 8-K filed today, which are available on our website.
Now let's discuss the details behind our fourth quarter results. We, once again, achieved record high operating results, reporting a 25% increase in adjusted EPS over Q4 2017 to $0.69 and a 24% increase in adjusted EBITDA to $47.6 million. These results were driven by continued acceleration of worksite employee growth and effective management of pricing, direct cost programs and operating costs.
As for the fourth quarter details, average paid worksite employees increased by 17% over Q4 of 2017 at the high end of our forecasted range. Client retention remained strong, again averaging over 99% for the quarter. As for our sales efforts, worksite employees paid from new sales increased by 36% on a 13% increase in the average number of trained Business Performance Advisors on continued sales momentum in both our core and mid-market clients segments.
As Paul will discuss in detail in a few minutes, this momentum continued through year end with a successful fall sales campaign and client renewal period, leading to a strong starting point for 2019. Our gross profit increased by 13% over Q4 of 2017, on continued pricing strength and favorable results in our workers' compensation and payroll tax direct cost areas. Positive results in these areas was partially offset by slightly higher-than-expected Q4 medical claims.
Our fourth quarter adjusted operating expenses increased 9% over Q4 of 2017 to $129 million and included a 13% increase in the number of Business Performance Advisors, the opening of seven new sales offices throughout 2018, additional sales commissions associated with higher Q4 sales volume, and continued investment in our technology and product and service offering. Our effective tax rate in Q4 came in at 27.5% just slightly lower than our forecasted rate of 28%.
During the quarter, we repurchased 986,000 shares at a cost of approximately $97 million taking advantage of the share price weakness during the recent period of market volatility and our transition from the Small-Cap 600 to the Mid-Cap 400 Index.
Now, before I turn the call over to Paul, let me summarize our record high full year 2018 operating results. Adjusted EPS increased 53% to $3.75 and adjusted EBITDA increased 35% over 2017 to $240 million.
Average paid worksite employees increased by 14.5% over 2017 accelerating off of the prior year's growth rate of 10%. Our growth was driven by 27% increase in worksite employees paid from new sales on a 16% increase in the average number of trained Business Performances Advisors and improved results in our mid-market segment. Client retention remained at historical highs of 86% and net gains in the client base improved over 2017.
Gross profit increased 19% on the 14.5% worksite employee growth as we effectively managed changes in client mix, pricing, and direct cost trend. The outcome of all three of our direct cost programs exceeded our initial expectations.
We managed benefit cost increases in our health plan to just 2% at the low end of our initial range for this metric. Additionally, workers' compensation cost as a percentage of non-bonus payroll, declined from 2017 levels due to continued discipline around our client selection and safety and claims management.
Adjusted operating expenses increased 12% over 2017 and declined on a per worksite employee per month basis from $201 in 2017 to $197 in 2018. Putting all the pieces together, our key profitability metric adjusted EBITDA per worksite employee per month increased 17% from $81 in 2017 to a record high of $95 in 2018.
Now a solid balance sheet combined with our strong cash flow allowed us to continue providing strong return to our shareholders in 2018 to our dividend and share repurchase programs. We repurchased a total of 1.2 million shares during 2018 at a cost of $113 million.
Additionally, we increased our dividend rate by 33% in February of 2018 and paid out a total of $33 million in dividends. We ended the year with $129 million of adjusted cash and $205 million of availability under our credit facility. This level of liquidity and credit availability, combined with the continued forecast for strong cash flow, should allow us to continue to provide excellent return to our shareholders in 2019.
Now at this time, I would like to turn the call over to Paul.
Thank you, Doug. And thank you for being with us today. We're very pleased with the impressive results we are reporting today demonstrating the strength of our business model and excellent execution of our strategic plan across Insperity. These results represent four years in a row, increasing adjusted EBITDA by more than 25% from $84 million to $240 million including 35% growth in this key metric in 2018.
Today I'd like to cover our successful fall campaign and year-end transition which capped-off our best year ever and set us up for continuing outstanding performance in 2019. I also want to discuss our priorities for this year which are intended to continue our strong momentum in growth and profitability.
I'll finish my comments with some color on how we view our vast market opportunity and how we are extending our competitive advantage in the marketplace. Our fall selling and retention campaign was very successful in four key areas including; core and mid-market sales, client retention and pricing on both new and renewing accounts.
We achieved a 103% of our sales forecast for Q4 and a 107% for the full year 2018. This represents a 21% increase in worksite employees sold as we successfully grew that trained Business Performance Advisors or BPA count by 16%, while improving sales efficiency 5%. This is quite an amazing accomplishment, clearly demonstrating the effectiveness of our sales, training and management.
Our mid-market sales results played a key role in 2018 as collaboration with our BPA channel provided a strong pipeline of qualified prospects in this segment. These efforts produced a 24% increase in proposals and a 77% increase in sold accounts and an increase of more than 100% in worksite employees sold in this segment.
Our three-pronged marketing approach including; digital, loyalty programs and channel programs also contributed to a strong fall campaign and full year results delivering an increase of more than 40% in leads to our BPAs.
Our retention for the full year of 2018 came in at 86% which continued a very positive trend over the last several years. This is significantly better than the 80% level we experienced for many years as our standard. Systemic improvements in several key areas resulted in this step up which is now clearly the new normal.
Our client retention results through our concentration of year-end renewals was also a highlight of our fall campaign. Some of the year-end attrition spills over into February so final numbers are not complete yet. However, our January retention was in line with our record low levels of the prior few years.
The third factor contributing to our worksite employee growth is the net change within the current client base from new hires and layoffs. This metric was slightly down from December to January similar to last year. However, other metrics including overtime, wage increases and commissions paid to the sales staff of our clients are at levels pointing to continued hiring for this year.
Another important measure of a successful fall campaign for Insperity is the effect on pricing of the book of business after accounting for the volume of new sales, client renewals, and client terminations occurring at year end.
We're able to see the full picture of this change each year in the first week of February, and we can confirm we are in excellent shape for the starting point for 2019. This view into pricing includes all the elements of our direct costs including benefits, payroll tax, and workers' compensation allocation in addition to HR service fees and other smaller items. The other side of the equation to evaluate is the cost expectations for these major components, which determines our ultimate expected gross profit.
2018 was our strongest year ever in both total gross profit dollars and in gross profit per worksite employee, as our team managing pricing in direct cost did an excellent job driving favorable results over the course of last year.
We are always conservative in our routine budget process. So we'll start this year, with the lower expectation in our guidance for gross profit per employee than last year's results and allow for upside as we continue to manage pricing cost over the course of this year.
So when you put the entire picture together, our starting point in paid worksite employees supports our expectation for 14% to 16% unit growth for 2019. We expect continuing strong sales and retention, our controllable factors and we have incorporated a slightly lower contribution from new hires and layoffs, just to be conservative.
We also expect year-over-year growth to be more even each quarter this year, unlike the ramp-up experience last year. This is largely due to the effect of adding our largest client with nearly 3,000 employees midyear in 2018. When you combine our starting point for gross profit and some operating leverage, we expect adjusted EBITDA to grow slightly faster than unit growth at the midpoint of our guidance.
So we are off to an excellent start for 2019, and have several important priorities to keep the momentum going. These priorities include continuing to fuel future growth, accelerating our growth of our traditional employment solutions, and leveraging our data analytics capabilities in both sales and service.
This year, we expect to open nine new offices to support 14% growth in trained BPAs. We will enter new markets including Portland, Tampa, Las Vegas, Sacramento and Providence with the balance adding new offices in existing markets. We're also entering this year, with new confidence in our mid-market segment coming off quite a step-up in effectiveness last year.
Success in mid-market sales allows us to grow worksite employees at a faster rate than we grow the BPA team. This improvement in sales efficiency is important to the overall business model and our ability to improve our operating leverage in the future.
Our growth momentum was palpable at our recent annual sales convention in Houston last month. Our team of nearly 900 sales professionals including sales management, operations, marketing and 560 BPAs were all highly engaged and committed to building on our recent success. There was no sign of resting on our laurels in fact quite the opposite was readily apparent. Three days of training, recognition and sharing best practices resulted in an aligned and mobilized team for 2019.
One of the central elements of the sales convention was dedicated to our 2019 priority to ramp-up sales of our traditional employment bundle Workforce Acceleration or WX. We delivered three deep dive breakout sessions on the WX model to every BPA and District Manager. The messaging was clear, reinforced consistently across sales and executive leadership, and overall feedback has been very positive.
Another emphasis of the convention was training around our pricing transparency for our flagship Workforce Optimization offering. Insperity has the most sophisticated pricing and billing system in the PEO industry, offering deep insights, helping our clients understand and manage, total employment cost.
We believe these new tools and training support will improve our already impressive win rate and competitive sales and renewal situations, potentially increasing the lifetime value of the client company.
Another priority for this year is to extend our HR technology leadership position, introducing new features and functionality within Insperity Premier. Insperity Premier is the only human capital management system specifically designed to support co-employment and collaboration between managers, supervisors and worksite employees at client companies and service providers at Insperity.
In 2019 we will be introducing a powerful HR, data analytics combined with training for HR professionals to deliver a new level of software with a service unique in the marketplace. Our service providers will be able to proactively offer powerful insights and actionable information for clients that I believe will be a game changer.
Specifically our HR experts will have access to predictive data analytics and be able to monitor key HR metrics from headcount and turnover to compensation and overtime, allowing Insperity to truly deliver on our new tagline introduced last month, HR that Makes a Difference.
Insperity has a unique advantage over the myriad of HR technology and business service providers in our space. Our business model allows for real HR experts to learn our clients businesses and objectives then use leading technology to literally help their business succeed.
Insperity provides software with the service, allowing client companies to actually realize the potential of the analytics and insights the latest technology can provide. We believe HR from an HR company will win out over HR from a technology or business services company in the years ahead.
Our market opportunity continues to increase as our capabilities and offerings expand our total addressable market. We have extended our competitive advantage in our core PEO, taken the leadership position in the mid-market space, and set the stage for success offering traditional employment solution.
With these three drivers poised for continued high-growth, it's time we cast a wider net in our marketing effort and leverage the authority we've earned over 33 years proving HR makes a difference.
We believe in the direct link between an effective people strategy and likelihood and degree of business success. An effective people strategy is a force multiplier for all the other areas of the business from sales and operations to technology and finance. We know this from our own experience, achieving extraordinary results at Insperity, but also through delivery of our services to our clients, helping them do the same.
Since we have written the book, figuratively speaking, on HR and business successes, over the past year I made an effort to distill what we've learned into a roadmap for other businesses to follow. This resulted in a book recently released by Forbes Books called Take Care of Your People. This book is specifically designed to extend Insperity's thought leadership in the marketplace, elevate the conversation of how HR drives business success, and ultimately increase qualified leads in order to capitalize on the growing demand for our services.
Over the last several years, Insperity is number one in total shareholder return amongst identified peer public companies. Our leadership position is directly attributable to the performance of our more than 3,000 dedicated Insperity employees.
The discretionary effort, innovation, and caring attitude of these amazing people drove our past success and provides our confidence in the future for Insperity. This formidable team is aligned around our plan for continuing to cast a wider net to help more businesses succeed, extend our competitive advantage in the marketplace, and deliver extraordinary returns for our shareholders.
At this time, I'd like to pass the call back to Doug.
Thanks, Paul. Now, let me provide our 2019 guidance beginning with the full year. Paul just mentioned we are forecasting a 14% to 16% increase in average paid worksite employees over 2018 to a range of 238,400 to 242,600.
Our forecast is based upon our successful year-end transition of new and renewing accounts, 15% growth in the average number of trained Business Performance Advisors, while maintaining recent sales efficiency levels, and continued success in our mid-market client segment.
For the full year of 2019, we are budgeting client retention consistent with 2018 and slightly less net hiring in our client base as we intend to take a more conservative approach to this metric at the outset of the year.
As for our gross profit area, we have gone through our usual budget process of analyzing client mix, pricing, and direct cost, including healthcare and workers' compensation claim trends.
Similar to prior years, our budget process is intended to begin the year with a conservative forecast for direct cost trends and leave the upside to favorable developments as we manage pricing and direct cost over the course of the year.
Our operating plan includes further investment in our growth including the hiring of Business Performance Advisors, opening of nine new sales offices, and incremental marketing programs.
Also as we execute our long-term growth plan, we will continue to invest in our software-with-a-service model with personnel and technology infrastructure, security, and development.
The combination of improved worksite employee growth, stable gross profit, and continued investment in operating leverage leads to our forecast of 12% to 19% increase in adjusted EBITDA from $240 million in 2018 to a range of $268 million to $285 million for 2019.
We are forecasting a 17% to 25% increase in adjusted EPS from $3.75 in 2018 to a range of $4.37 to $4.69. This forecast assumes $41.5 million average outstanding shares and full year effective tax rate of 23% after giving effect to the tax benefit associated with the vesting of shares in our long-term incentive stock plan in Q1.
As for plan 2019 capital expenditures, we have budgeted for ongoing technology investments and sales and service expansion at an amount totaling approximately $40 million, just a slight increase over 2018 expenditures.
Additionally, due to the recent and planned future growth of the company, it is necessary to expand our corporate campus facilities. This expansion will include the construction of an additional building over a 24-month period at an estimated cost of approximately $70 million, $22 million of which we expect to incur in 2019.
Now as for the first quarter, we are forecasting a 14.5% to 15.5% increase in average paid worksite employees over Q1 of 2018, resulting in a range of $224,000 to $226,000. We are focusing Q1 adjusted EBITDA in a range of $96 million to $99 million, an increase of 15% to 18% over Q1 of 2018. And Q1 adjusted EPS from $1.85 to $1.91, an increase of 31% to 35%.
Our Q1 adjusted EPS guidance includes an effective tax rate of 13.5%, which is lower than our forecasted full year tax rate due to the tax benefit associated with the vesting of performance based on time vested restricted shares, which occurred during the first quarter of each year.
As for our quarterly earnings pattern, keep in mind that our Q1 earnings results are typically higher than the subsequent quarters. In particular, we earn a high level of payroll tax surplus prior to worksite employees reaching their taxable wage limits and benefit costs are lower in Q1 and step up over the remainder of the year as deductibles are met.
In conclusion, we are pleased with the record earnings results achieved in 2018 and our successful year-end sales and client renewal period, positioning us for another great year in 2019.
Now, at this time, I'd like to open up the call for questions.
[Operator Instructions] Your first question comes from the line of Tobey Sommer from SunTrust. Your line is now open.
Hey. This is Joseph on the line for Tobey this morning. My first question is about the growth you guys experienced in the mid-market this last quarter. What is driving this growth? Is it mainly related to the ramping of Workforce Acceleration? Or are you seeing more middle market clients that are interested in Workforce Optimization? Thank you.
Sure. Our effectiveness and the ramp up in the volume of sales in mid-market is really driven by two things. First of all, the collaboration with our core sales team is the group that serves up the prospects and they did a great job last year of providing a higher volume of qualified prospects for us to follow up on.
Then you combine that with the improved closing rates coming from our mid-market sales team and that just produced a lot better results. But as always, all of that’s based on the reality that we have really refined our offering to the mid-market customer in the co-employment space both Workforce Optimization and Workforce Synchronization and we're having tremendous service results and a lot of really happy customers who have really solved for the complexity of the mid-market customer and we're seeing those results and expect that to continue.
Thank you. And then one more from me. Which of your service bundles are growing the fastest? And which one of them are growing the slowest? And then, how did the mark-up or I guess service fee on stand-alone services grow versus last year? Thank you.
Sure. We have a – of the primary bundles that we have, our flagship Workforce Optimization continues to grow the fastest and we would expect that. And then, one that is, it's growing fast, but on a small base. So I still consider it kind of behind the curve yet is our Workforce Acceleration. Now we expect to see excellent growth in that offering this year, based on the training results we just completed at our sales convention. So we're really excited on all fronts that we got a great target market for each of our offerings and expect that growth across the board.
Thanks. I will jump back in the queue.
Your next question comes from the line of Jim MacDonald from First Analysis. Your line is now open.
Yeah. Great quarter, guys. Could you give us any more details on the net gains in your client account in 2018? And then more specifically what you're expecting in 2019? How much of deceleration? Are you seeing any signs of deceleration yet?
Yeah. It's really interesting. We obviously watched that real closely. And we have over our year-end transitioned last couple of years that's not unusual for us to have a slight decrease in the net gain from customers from December to January. And we saw that again this year, a slight decrease. The only driver of – that would – we would consider have been a negative, would have been the sentiment issues – business sentiment kind of over the December and January period, pretty much around the market volatility and some other things that were going on.
But if you look at the underlying metrics, as I mentioned in my script, if you look at average pay for example, was up over 5% on hourly employees, up over 3% for all employees. If you look at commissions that we pay to the clients – to the sales staff of our client companies that was at a number double, what we consider to be strong. So it was over 12%.
Overtime as a percentage of base pay, we consider if it's over 10% that new hiring it is in the forefront and that was over 12%. So, all the underlying metrics that drive, the hiring are still positive. However, we think it's appropriate to be conservative. And so we basically took down our expectation for net gain from the client base by about 10% to maybe 12% compared to last year. So maybe 1% total on the base and we think that's appropriate to do, because, it's the one thing we don't control, so might as well built in a little conservatism on that expectation.
Yeah, Jim the other factor we're seeing in that particular component of our growth is M&A activity. And so as we're having more success particularly in the mid-market segment is where we’re experiencing more M&A activity from those clients. And so we saw that through 2018 I think looking at that with our existing client base and what their plans are for 2019, it could also be a contributor to that growth in the existing base.
Great. Just one quick follow-up. You got 2% growth in health benefits trend last year, what are you of -- where you're really thinking this year?
I think, we're kind of looking at -- again being conservative at the beginning of the year around 3%. So look at a range around 2.5% to 3.5% and start working on it from there, and do we can to like we did last year make that number try to come out of that low end of the range.
Great. Thanks.
Your last question comes from the line of Mark Marcon from Baird. Please go ahead.
Good morning, and let me add my congratulations. So wondering with regards to the increased sales efficiency that you're seeing, can you differentiate a little bit in terms of regions of the country Paul, just in terms of where you're seeing the greatest uplift? Is it in the more mature markets where PEO has been established for a while? Or are you seeing a change in behavior in terms of some of the less matured states? And how did your new sales offices do over this last year?
Yeah. I think, I'll tell you if you want just really peel it back to what's the driver of our sales efficiency and effectiveness of efficiency gain, I really would have to go all the way to the training of our district managers because we really not seen a geographic difference. What we've seen is that between the District Manager's training, so their ability to keep all the different sales team at whatever tier of production they are, keep them moving and progressing.
You combine that with the sales training in our new BPAs because obviously we're having a lot of BPAs. But within the core BPA team, we've been able to grow at mid-double digits and keep that efficiency the same and then when you weigh in mid-market success that's driving a higher total sales efficiency. So those are things driving that and it's a lot of blocking and tackling it down at the very training level BPA-by-BPA level.
The other thing I would say is that our marketing success in terms of serving up qualified leads, a 40% increase last year. That means you're going to have our sales team is saying more time in front of qualified prospects instead of trying to find those qualified prospects. So a lot of those things together to be able to accomplish that really is amazing when you think about growing a sales team that fast and having the sales efficiency increase.
Yeah. It really is. And I was wondering if there is -- if you're seeing any change in terms of just the general acceptance of the PEO concept particularly with some of the legislative changes that have occurred nationally?
Yes. I absolutely do. I really think we really have moved up that adoption curve in the marketplace, just the energy behind it. And I think it goes - certainly, the PEO acceptance has improved, but also I think behind that is just the recognition of HR is a driver to business success.
And that's why we're really capitalizing on that theme, trying to cast a much wider net, really going after the thought leadership in the space. I can remember a time when we didn't really want to say HR, because it's kind of a Debbie downer moment to talk about that. But its front and center now because people realize, if you give the people strategy right, it makes a huge difference.
Well, you've certainly shown that and congratulations on your book, by the way.
Thank you.
I was wondering, can you talk a little bit about as it relates to the first quarter and the full year guidance. What are you expecting particularly for the first quarter in terms of gross profit for worksite employee? You've got a really tough comp there?
Yes. I think, generally speaking, I think, as you know, Mark, first quarter would always have most of our dollars generated during that quarter, because of how the payroll taxes and the medical trends work. We have deductibles, still being met the employees during that Q1. So I don't have the specific numbers in front of me, but you would expect somewhat of a similar step down from Q1 to Q2 because of those drivers.
I am just wondering how you were thinking about the Q1 number in terms of that's embedded in your guidance?
Yes. I think if you just look at the EBITDA expectation and you look at the employee growth and I think we've -- if you look at our expected growth on the operating expense side, you kind of back into that. But it will be strong, because the first quarter in terms of seasonality, we always have those two components that make the first quarter strong at the gross profit line.
Yes. I recognize that. I was just thinking about last year the severity and incidents on the healthcare side were really favorable. So I was just wondering, for assuming that the healthcare cost on a per employee basis are probably going to be a little bit -- maybe a little bit higher than they were last year?
Yes. We look at the trend on that with the underlying claims in there and kind of build it on a year-over-year basis. So we would expect that be down a little bit, because it was so exaggerated last year.
Yeah. Okay.
That make sense?
It does. I just want to make sure that, that was in fact the case. And then, with regards to what you said about the growth geographically. So you're seeing as faster level of growth out of Texas as you are out of some of the newer markets?
Yes. Actually, when you just evaluate the growth rate, I'd say, we're probably running little fast in the Northeast than we are in some areas. But it's really wherever we kind of grow the BPAs is where you're going to grow the business. So we do try to even that out as to where -- as we look at the regions and where we're opening offices and where we're growing the BPA base.
And then with the expanded client solution side, as well as the enhanced training, are you actually seeing an increase in BPA retention rates?
Yes. We are seeing what I would call them kind of a step up improvement in retaining our BPAs for a long time first 30 years in business or 28 may be years in business. We were north of 30% around the 30% to 35% mid -- sometimes even as high as that. And we're more in the 26%, 27% retention and I think we have room for improvement there. Success breeds success people are doing well and you're able to retain BPAs more effectively.
Then that 26% to 27% is the turn over rate and retention is running 63 to...
Sorry about that. Yes, I am thinking in turnover, right rather than retention, but yes.
Great. Terrific, congratulations.
Thank you.
[Operator Instructions] A follow-up question comes from the line of Tobey Sommer from SunTrust. Your line is now open.
Hey just one quick question about capital allocation. So you repurchased a lot of stock in 4Q, how does – how do repurchases rank as far as your plans for capital allocation going into 2019 with the stock price being significantly higher than the implied purchase price for the fourth quarter? Thank you.
Sure. Obviously we weigh in on a variety of factors at each Board meeting every quarter and get outside input from advisors etcetera. But in the fourth quarter last year it was obvious to us that there was a -- we think a reduction stock price didn't really relate to anything based on reality happening the business.
So we increased our allocation of our capital toward buying back shares. And you will see us from time-to-time emphasize different uses of our capital. So we wouldn’t have bought back a lot of shares, but we still have plenty on our authorization. We're generating a lot of cash and so we’ll weigh that accordingly each quarter.
Thank you.
There are no further questions at this time. I will now hand the call back to Mr. Paul Sarvadi.
Once again, we really appreciate your interest in Insperity and we will be out on the road some this quarter and next. So we look forward to seeing you and talking to you some more about our game plan for 2019. So thank you again for participating. We'll see you out there.
This concludes today's conference call. You may now disconnect. Thanks.