Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2018.
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from  _______________ to _______________

Commission File No. 1-13998
 Insperity, Inc.

(Exact name of registrant as specified in its charter)
Delaware
 
76-0479645
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
19001 Crescent Springs Drive
 
 
Kingwood, Texas
 
77339
(Address of principal executive offices)
 
(Zip Code)

(Registrant’s Telephone Number, Including Area Code):  (281) 358-8986

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes ý  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company.  See definition of “large accelerated filer,” “accelerated filer”, “non-accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   
Yes o No ý
 
As of July 25, 2018, 41,923,815 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.



 
TABLE OF CONTENTS
 
 
 
 
 
Part I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II
 
 
 
Item 1.
 
 
 
Item 1a.
 
 
 
Item 2.
 
 
 
Item 6.


Table of Contents

PART I

ITEM 1.  FINANCIAL STATEMENTS

INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS

 
 
June 30,
2018
 
December 31, 2017
 
 
(Unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
308,711

 
$
354,260

Restricted cash
 
41,827

 
41,137

Marketable securities
 
7,207

 
1,960

Accounts receivable, net:
 
 

 
 

Trade
 
4,066

 
12,292

Unbilled
 
344,685

 
318,431

Other
 
3,003

 
3,258

Prepaid insurance
 
17,648

 
10,782

Other current assets
 
22,640

 
26,991

Income taxes receivable
 

 
9,824

Total current assets
 
749,787

 
778,935

 
 
 
 
 
Property and equipment:
 
 

 
 

Land
 
6,215

 
6,215

Buildings and improvements
 
98,332

 
95,615

Computer hardware and software
 
108,665

 
105,060

Software development costs
 
65,348

 
60,568

Furniture, fixtures and other
 
44,603

 
42,891

 
 
323,163

 
310,349

Accumulated depreciation and amortization
 
(224,135
)
 
(214,690
)
Total property and equipment, net
 
99,028

 
95,659

 
 
 
 
 
Other assets:
 
 

 
 

Prepaid health insurance
 
9,000

 
9,000

Deposits – health insurance
 
5,300

 
5,300

Deposits – workers’ compensation
 
165,150

 
154,215

Goodwill and other intangible assets, net
 
12,732

 
12,762

Deferred income taxes, net
 
4,538

 
4,283

Other assets
 
5,533

 
3,541

Total other assets
 
202,253

 
189,101

Total assets
 
$
1,051,068

 
$
1,063,695


- 3 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands)

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
June 30,
2018
 
December 31,
2017
 
 
(Unaudited)
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
4,123

 
$
6,447

Payroll taxes and other payroll deductions payable
 
213,432

 
303,247

Accrued worksite employee payroll cost
 
295,596

 
267,402

Accrued health insurance costs
 
24,127

 
26,075

Accrued workers’ compensation costs
 
45,376

 
42,974

Accrued corporate payroll and commissions
 
41,059

 
52,595

Other accrued liabilities
 
24,094

 
27,741

Income taxes payable
 
6,984

 

Total current liabilities
 
654,791

 
726,481

 
 
 
 
 
Noncurrent liabilities:
 
 
 
 

Accrued workers’ compensation costs
 
174,017

 
166,493

Long-term debt
 
104,400

 
104,400

Total noncurrent liabilities
 
278,417

 
270,893

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Stockholders’ equity:
 
 

 
 

Common stock
 
555

 
555

Additional paid-in capital
 
27,363

 
25,337

Treasury stock, at cost
 
(263,764
)
 
(256,363
)
Retained earnings
 
353,706

 
296,792

Total stockholders’ equity
 
117,860

 
66,321

Total liabilities and stockholders’ equity
 
$
1,051,068

 
$
1,063,695

 
See accompanying notes.

- 4 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Revenues (gross billings of $5.550 billion, $4.742 billion, $11.473 billion and $9.758 billion, less worksite employee payroll cost of $4.628 billion $3.947 billion, $9.537 billion, and $8.080 billion, respectively)
 
$
922,295

 
$
795,552

 
$
1,936,667

 
$
1,678,216

 
 
 
 
 
 
 
 
 
Direct costs:
 
 

 
 

 
 

 
 

Payroll taxes, benefits and workers’ compensation costs
 
767,751

 
664,999

 
1,582,403

 
1,388,317

 
 
 
 
 
 
 
 
 
Gross profit
 
154,544

 
130,553

 
354,264

 
289,899

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

Salaries, wages and payroll taxes
 
68,748

 
61,458

 
155,934

 
123,915

Stock-based compensation
 
5,752

 
5,303

 
8,887

 
9,806

Commissions
 
6,979

 
5,664

 
13,045

 
10,140

Advertising
 
6,585

 
6,175

 
10,150

 
10,147

General and administrative expenses
 
27,419

 
24,610

 
57,271

 
50,802

Depreciation and amortization
 
5,480

 
4,405

 
10,693

 
8,659

 
 
120,963

 
107,615

 
255,980

 
213,469

Operating income
 
33,581

 
22,938

 
98,284

 
76,430

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 

 
 

 
 

 
 

Interest income
 
1,807

 
678

 
3,263

 
1,143

Interest expense
 
(1,108
)
 
(803
)
 
(2,178
)
 
(1,426
)
Income before income tax expense
 
34,280

 
22,813

 
99,369

 
76,147

Income tax expense
 
9,720

 
8,795

 
24,818

 
26,501

Net income
 
$
24,560

 
$
14,018

 
$
74,551

 
$
49,646

 
 
 
 
 
 
 
 
 
Less distributed and undistributed earnings allocated to participating securities
 
(346
)
 
(248
)
 
(1,064
)
 
(909
)
 
 
 
 
 
 
 
 
 
Net income allocated to common shares
 
$
24,214

 
$
13,770

 
$
73,487

 
$
48,737

 
 
 
 
 
 
 
 
 
Basic net income per share of common stock
 
$
0.59

 
$
0.33

 
$
1.78

 
$
1.18

 
 
 
 
 
 
 
 
 
Diluted net income per share of common stock
 
$
0.58

 
$
0.33

 
$
1.77

 
$
1.18


See accompanying notes.

- 5 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2018
(in thousands)
(Unaudited)
 
 
 
Common Stock Issued
 
Additional Paid-In Capital
 
Treasury Stock
 
Retained Earnings and AOCI
 
Total
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
 
55,489

 
$
555

 
$
25,337

 
$
(256,363
)
 
$
296,792

 
$
66,321

Purchase of treasury stock, at cost
 

 

 

 
(16,227
)
 

 
(16,227
)
Issuance of long-term incentive awards and dividend equivalents
 

 

 
(5,764
)
 
6,619

 
(855
)
 

Stock-based compensation expense
 

 

 
7,005

 
1,882

 

 
8,887

Other
 

 

 
785

 
325

 

 
1,110

Dividends paid
 

 

 

 

 
(16,786
)
 
(16,786
)
Unrealized gain on marketable securities, net of tax
 

 

 

 

 
4

 
4

Net income
 

 

 

 

 
74,551

 
74,551

Balance at June 30, 2018
 
55,489

 
$
555

 
$
27,363

 
$
(263,764
)
 
$
353,706

 
$
117,860

 
See accompanying notes.

- 6 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

 
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
74,551

 
$
49,646

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
10,693

 
8,659

Stock-based compensation
 
8,887

 
9,806

Deferred income taxes
 
(255
)
 
8,465

Changes in operating assets and liabilities:
 
 

 
 

Accounts receivable
 
(17,773
)
 
8,715

Prepaid insurance
 
(6,866
)
 
(12,029
)
Other current assets
 
4,351

 
1,533

Other assets
 
(1,957
)
 
(2,375
)
Accounts payable
 
(2,324
)
 
(1,057
)
Payroll taxes and other payroll deductions payable
 
(89,815
)
 
(57,826
)
Accrued worksite employee payroll expense
 
28,194

 
13,342

Accrued health insurance costs
 
(1,948
)
 
219

Accrued workers’ compensation costs
 
9,926

 
12,832

Accrued corporate payroll, commissions and other accrued liabilities
 
(15,183
)
 
(11,974
)
Income taxes payable/receivable
 
16,808

 
(1,929
)
Total adjustments
 
(57,262
)
 
(23,619
)
Net cash provided by operating activities
 
17,289

 
26,027

 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Marketable securities:
 
 

 
 

Purchases
 
(11,849
)
 
(919
)
Proceeds from dispositions
 
5,439

 

Proceeds from maturities
 
1,125

 
805

Property and equipment:
 
 
 
 
Purchases
 
(14,025
)
 
(20,802
)
Net cash used in investing activities
 
(19,310
)
 
(20,916
)

- 7 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
(Unaudited)

 
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
Cash flows from financing activities:
 
 
 
 
Purchase of treasury stock
 
$
(16,227
)
 
$
(25,528
)
Dividends paid
 
(16,786
)
 
(11,579
)
Other
 
1,110

 
830

Net cash used in financing activities
 
(31,903
)
 
(36,277
)
 
 
 
 
 
Net decrease in cash, cash equivalents and restricted cash
 
(33,924
)
 
(31,166
)
Cash, cash equivalents and restricted cash beginning of period
 
549,612

 
472,609

Cash, cash equivalents and restricted cash end of period
 
$
515,688

 
$
441,443

 
Supplemental schedule of cash and cash equivalents and restricted cash:
 
 
 
 
Cash and cash equivalents
 
$
354,260

 
$
286,034

Restricted cash
 
41,137

 
42,637

Deposits – workers’ compensation
 
154,215

 
143,938

Cash, cash equivalents and restricted cash beginning of period
 
$
549,612

 
$
472,609

 
 
 
 
 
Cash and cash equivalents
 
$
308,711

 
$
241,890

Restricted cash
 
41,827

 
41,703

Deposits – workers’ compensation
 
165,150

 
157,850

Cash, cash equivalents and restricted cash end of period
 
$
515,688

 
$
441,443



See accompanying notes.

- 8 -

Table of Contents

INSPERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)


1.
Basis of Presentation

Insperity, Inc., a Delaware corporation (“Insperity,” “we,” “our,” and “us”), provides an array of human resources (“HR”) and business solutions designed to help improve business performance. Our most comprehensive HR services offerings are provided through our professional employer organization (“PEO”) services, known as Workforce Optimization® and Workforce SynchronizationTM solutions (together, our “PEO HR Outsourcing solutions”), which encompass a broad range of HR functions, including payroll and employment administration, employee benefits, workers’ compensation, government compliance, performance management, and training and development services, along with our cloud-based human capital management solution, the Insperity PremierTM platform.

In addition to our PEO HR Outsourcing solutions, we offer a number of other business performance solutions, including Human Capital Management, Payroll Services, Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Expense Management Services, Retirement Services and Insurance Services, many of which are offered as a cloud-based software solution. These other products and services are offered separately, along with our PEO HR Outsourcing solutions or as a bundle, such as our Workforce AdministrationTM solution that provides a comprehensive human capital management and payroll services solution.

The Consolidated Financial Statements include the accounts of Insperity and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

The accompanying Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements at and for the year ended December 31, 2017. Our Consolidated Balance Sheet at December 31, 2017 has been derived from the audited financial statements at that date, but does not include all of the information or footnotes required by GAAP for complete financial statements. Our Consolidated Balance Sheet at June 30, 2018 and our Consolidated Statements of Operations for the three and six month periods ended June 30, 2018 and 2017, our Consolidated Statements of Cash Flows for the six month periods ended June 30, 2018 and 2017, and our Consolidated Statement of Stockholders’ Equity for the six month period ended June 30, 2018, have been prepared by us without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows, have been made. Certain prior year amounts have been reclassified to conform to the 2018 presentation.

The results of operations for the interim periods are not necessarily indicative of the operating results for a full year or of future operations.
2.
Accounting Policies

Health Insurance Costs

We provide group health insurance coverage to our worksite employees in our PEO HR Outsourcing solutions through a national network of carriers, including UnitedHealthcare (“United”), UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield of Hawaii, and Tufts, all of which provide fully insured policies or service contracts.

The policy with United provides the majority of our health insurance coverage. As a result of certain contractual terms, we have accounted for this plan since its inception using a partially self-funded insurance accounting model. Accordingly, we record the costs of the United plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”) as benefits expense, a component of direct costs, in our Consolidated Statements of Operations. The estimated incurred claims are based upon: (i) the level of claims processed during the quarter; (ii) estimated completion

- 9 -

Table of Contents

rates based upon recent claim development patterns under the plan; and (iii) the number of participants in the plan, including both active and COBRA enrollees. Each reporting period, changes in the estimated ultimate costs resulting from claim trends, plan design and migration, participant demographics and other factors are incorporated into the benefits costs.

Additionally, since the plan’s inception, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the premiums paid and owed to United, a deficit in the plan would be incurred and a liability for the excess costs would be accrued in our Consolidated Balance Sheets. On the other hand, if the Plan Costs for the reporting quarter are less than the premiums paid and owed to United, a surplus in the plan would be incurred and we would record an asset for the excess premiums in our Consolidated Balance Sheets. The terms of the arrangement require us to maintain an accumulated cash surplus in the plan of $9.0 million, which is reported as long-term prepaid insurance. In addition, United requires a deposit equal to approximately one day of claims funding activity, which was $5.1 million as of June 30, 2018, and is reported as a long-term asset. As of June 30, 2018, Plan Costs were less than the net premiums paid and owed to United by $12.3 million. As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $3.3 million difference is included in prepaid health insurance, a current asset, in our Consolidated Balance Sheets. The premiums, including the additional quarterly premiums, owed to United at June 30, 2018 were $19.0 million, which is included in accrued health insurance costs, a current liability in our Consolidated Balance Sheets. Our benefits costs incurred in the first six months of 2018 included a decrease of $1.9 million for changes in estimated run-off related to prior periods.

Workers’ Compensation Costs

Our workers’ compensation coverage for our worksite employees in our PEO HR Outsourcing solutions has been provided through an arrangement with the Chubb Group of Insurance Companies or its predecessors (the “Chubb Program”) since 2007. The Chubb Program is fully insured in that Chubb has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. Under the Chubb Program, we have financial responsibility to Chubb for the first $1 million layer of claims per occurrence and, for claims over $1 million, up to a maximum aggregate amount of $5 million per policy year for claims that exceed $1 million. Chubb bears the financial responsibility for all claims in excess of these levels.

Because we bear the financial responsibility for claims up to the levels noted above, such claims, which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing health care and indemnity coverage whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which take into account the ongoing development of claims and therefore requires a significant level of judgment.

We utilize a third party actuary to estimate our loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates. During the six months ended June 30, 2018 and 2017, we reduced accrued workers’ compensation costs by $10.9 million and $8.0 million, respectively, for changes in estimated losses related to prior reporting periods. Workers’ compensation cost estimates are discounted to present value at a rate based upon the U.S. Treasury rates that correspond with the weighted average estimated claim payout period (the average discount rate utilized in the 2018 period was 2.5% and in the 2017 period was 1.5%) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.



- 10 -

Table of Contents

The following table provides the activity and balances related to incurred but not paid workers’ compensation claims:

 
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
 
(in thousands)
 
 
 
 
 
Beginning balance, January 1,
 
$
207,630

 
$
183,928

Accrued claims
 
33,260

 
34,242

Present value discount
 
(3,360
)
 
(2,008
)
Paid claims
 
(21,686
)
 
(20,044
)
Ending balance
 
$
215,844

 
$
196,118

 
 
 
 
 
Current portion of accrued claims
 
$
41,827

 
$
41,703

Long-term portion of accrued claims
 
174,017

 
154,415

 
 
$
215,844

 
$
196,118


The current portion of accrued workers’ compensation costs on our Consolidated Balance Sheets at June 30, 2018 includes $3.5 million of workers’ compensation administrative fees.

As of June 30, 2018 and 2017, the undiscounted accrued workers’ compensation costs were $230.4 million and $207.2 million, respectively.

At the beginning of each policy period, the workers’ compensation insurance carrier establishes monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”). The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers’ compensation loss rates, as determined by the insurance carrier. Monies funded into the program for incurred claims expected to be paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds are included in deposits – workers’ compensation, a long-term asset in our Consolidated Balance Sheets. As of June 30, 2018, we had restricted cash of $41.8 million and deposits – workers’ compensation of $165.2 million.

Our estimate of incurred claim costs expected to be paid within one year is included in short-term liabilities, while our estimate of incurred claim costs expected to be paid beyond one year is included in long-term liabilities on our Consolidated Balance Sheets.

Recently Adopted Accounting Standards

On January 1, 2018, we adopted Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) using the modified retrospective approach. Under this method, the guidance is applied only to the most current period presented in the financial statements. ASU No. 2014-09 outlines a single comprehensive revenue recognition model for revenue arising from contracts with customers and superseded most of the previous revenue recognition guidance, including industry-specific guidance. Under ASU No. 2014-09, an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. Our revenue recognition policies remained substantially unchanged as a result of adoption ASU No. 2014-09 and we did not have any significant changes in our business processes or systems.    

We enter into contracts with our customers for human resources services based on a stated rate and price in the contract. Our contracts generally have a term of 12 months, but are cancellable at any time by either party with 30-days’ notice. Our performance obligations are satisfied as services are rendered each month. The term between invoicing and when our performance obligations are satisfied is not significant. Payment terms are typically due concurrently with the invoicing of our PEO services. We do not have significant financing components or significant payment terms.

Our revenue is generally recognized ratably over the payroll period as worksite employees perform their service at the client worksite. Customers are invoiced concurrently with each periodic payroll of its worksite employees. Revenues that have been recognized but not invoiced are included in unbilled accounts receivable on our Consolidated Balance Sheets.

- 11 -

Table of Contents


Pursuant to the “practical expedients” provided under ASU No 2014-09, we expense sales commissions when incurred because the terms of our contracts are cancellable by either party with a 30-day notice. These costs are recorded in commissions in our Consolidated Statements of Operations.  

The following table presents our revenues disaggregated by geography:
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Northeast
 
$
239,278

 
$
204,285

 
$
511,642

 
$
440,385

Southeast
 
108,264

 
92,049

 
223,452

 
190,855

Central
 
153,025

 
131,099

 
321,092

 
273,876

Southwest
 
213,920

 
185,094

 
446,785

 
389,201

West
 
194,986

 
170,452

 
407,605

 
357,896

Other revenue(1)
 
12,822

 
12,573

 
26,091

 
26,003

Total revenue
 
$
922,295

 
$
795,552

 
$
1,936,667

 
$
1,678,216

_____________________________

(1) Comprised primarily of revenues generated by our other products and services offerings.

In November 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, clarifying the classification and presentation of changes in restricted cash on the statement of cash flows. The amendments in this ASU require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash. Therefore, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning period and ending period total amounts shown on the statement of cash flows. As a result of our adoption of the new guidance, in the first quarter of 2018, our beginning and ending cash balances on the Consolidated Statements of Cash Flows now include restricted cash and long-term workers compensation deposits and prior period balances were retrospectively adjusted. Restricted cash and long-term workers compensation deposits are cash deposits funded to secure future claim payments under our workers compensation program and are considered restricted under Topic 230.

In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraph Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update) (“ASU 2018-05”), ASU 2018-05 adds the SEC guidance released on December 22, 2017 regarding the U.S. tax reform to the FASB Accounting Standards Codification. At March 31, 2018, we have not made a material adjustment to the provisional tax provision recorded under ASU 2018-05 at December 31, 2017. In addition, we have considered the impact of the statutory changes from the Act in our estimated tax rate for 2018, including reasonable estimates of those provisions effective for the 2018 tax year.

New Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard requires recognition of lease assets and lease liabilities for leases previously classified as operating leases. The guidance is effective for fiscal years beginning after December 15, 2018. We are currently reviewing the guidance and assessing the impact on our consolidated financial statements.


- 12 -

Table of Contents

3.
Cash, Cash Equivalents and Marketable Securities

The following table summarizes our cash and investments in cash equivalents and marketable securities held by investment managers and overnight investments:

 
 
June 30,
2018
 
December 31,
2017
 
 
(in thousands)
Overnight holdings
 
 
 
 
Money market funds (cash equivalents)
 
$
282,337

 
$
338,112

Investment holdings
 
 

 
 

Money market funds (cash equivalents)
 
17,354

 
22,634

Marketable securities
 
7,207

 
1,960

 
 
306,898

 
362,706

Cash held in demand accounts
 
25,053

 
26,700

Outstanding checks
 
(16,033
)
 
(33,186
)
Total cash, cash equivalents and marketable securities
 
$
315,918

 
$
356,220

 
 
 
 
 
Cash and cash equivalents
 
$
308,711

 
$
354,260

Marketable securities
 
7,207

 
1,960

Total cash, cash equivalents and marketable securities
 
$
315,918

 
$
356,220


Our cash and overnight holdings fluctuate based on the timing of clients’ payroll processing cycles. Included in the cash, cash equivalents and marketable securities at June 30, 2018 and December 31, 2017 are $191.9 million and $271.5 million, respectively, of funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as $14.0 million and $23.6 million in client prepayments, respectively.
4.
Fair Value Measurements

We account for our financial assets in accordance with Accounting Standard Codification 820, Fair Value Measurement. This standard defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The fair value measurement disclosures are grouped into three levels based on valuation factors:

Level 1 - quoted prices in active markets using identical assets
Level 2 - significant other observable inputs, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other observable inputs
Level 3 - significant unobservable inputs


- 13 -

Table of Contents

Fair Value of Instruments Measured and Recognized at Fair Value

The following tables summarize the levels of fair value measurements of our financial assets:

 
 
Fair Value Measurements
 
 
(in thousands)
 
 
June 30,
2018
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
299,691

 
$
299,691

 
$

 
$

Municipal bonds
 
7,207

 

 
7,207

 

Total
 
$
306,898

 
$
299,691

 
$
7,207

 
$

 
 
 
Fair Value Measurements
 
 
(in thousands)
 
 
December 31,
2017
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
360,746

 
$
360,746

 
$

 
$

Municipal bonds
 
1,960

 

 
1,960

 

Total
 
$
362,706

 
$
360,746

 
$
1,960

 
$


The municipal bond securities valued as Level 2 investments are primarily pre-refunded municipal bonds that are secured by escrow funds containing U.S. government securities. Our valuation techniques used to measure fair value for these securities during the period consisted primarily of third party pricing services that utilized actual market data such as trades of comparable bond issues, broker/dealer quotations for the same or similar investments in active markets and other observable inputs.

Fair Value of Other Financial Instruments

The carrying amounts of cash, cash equivalents, restricted cash, accounts receivable, deposits and accounts payable approximate their fair values due to the short-term maturities of these instruments.

As of June 30, 2018, the carrying value of our borrowings under our revolving credit facility approximates fair value and was classified as Level 2 in the fair value hierarchy. Please read Note 5, “Long-Term Debt,” for additional information.
5.
Long-Term Debt

We have a revolving credit facility (the “Facility”) with borrowing capacity up to $350 million. The Facility may be increased to $400 million based on the terms and subject to the conditions set forth in the agreement relating to the Facility (the “Credit Agreement”). The Facility is available for working capital and general corporate purposes, including acquisitions, stock repurchases and issuances of letters of credit. Our obligations under the Facility are secured by 65% of the stock of our captive insurance subsidiary and are guaranteed by all of our domestic subsidiaries. At June 30, 2018, our outstanding balance on the Facility was $104.4 million, and we had an outstanding $1.0 million letter of credit issued under the Facility, providing us with an available borrowing capacity of $244.6 million.

The Facility matures on February 6, 2023. Borrowings under the Facility bear interest at an alternate base rate or LIBOR, at our option, plus an applicable margin. Depending on our leverage ratio, the applicable margin varies (i) in the case of LIBOR loans, from 1.50% to 2.25% and (ii) in the case of alternate base rate loans, from 0.00% to 0.50%. The alternate base rate is the highest of (i) the prime rate most recently published in The Wall Street Journal, (ii) the federal funds rate plus 0.50% and (iii) the 30-day LIBOR rate plus 2.00%. We also pay an unused commitment fee on the average daily unused portion of the Facility at a rate of 0.25%. The interest rate at June 30, 2018 was 3.59%. Interest expense and unused commitment fees are recorded in other income (expense).

- 14 -

Table of Contents


The Facility contains both affirmative and negative covenants that we believe are customary for arrangements of this nature. Covenants include, but are not limited to, limitations on our ability to incur additional indebtedness, sell material assets, retire, redeem or otherwise reacquire our capital stock, acquire the capital stock or assets of another business, make investments and pay dividends. In addition, the Credit Agreement requires us to comply with financial covenants limiting our total funded debt, minimum interest coverage ratio and maximum leverage ratio. We were in compliance with all financial covenants under the Credit Agreement at June 30, 2018.
6.
Stockholders' Equity

During the first six months of 2018, we repurchased or withheld an aggregate of 211,876 shares of our common stock, as described below.

Two-for-One Stock Split

On December 18, 2017, we effected a two-for-one stock split in the form 100% stock dividend.

Repurchase Program

Our Board of Directors (the “Board”) has authorized a program to repurchase shares of our outstanding common stock (“Repurchase Program”). The purchases are to be made from time to time in the open market or directly from stockholders at prevailing market prices based on market conditions and other factors. During the six months ended June 30, 2018, 80,000 shares were repurchased under the Repurchase Program. As of June 30, 2018, we were authorized to repurchase an additional 2,597,564 shares under the Repurchase Program.

Withheld Shares

During the six months ended June 30, 2018, we withheld 131,876 shares to satisfy tax withholding obligations for the vesting of long-term incentive and restricted stock awards.

Dividends

The Board declared quarterly dividends as follows:
 
 
2018
 
2017
 
 
(amounts per share)
 
 
 
 
 
First quarter
 
$
0.20

 
$
0.125

Second quarter
 
0.20

 
0.150


 During the six months ended June 30, 2018 and 2017, we paid dividends totaling $16.8 million and $11.6 million, respectively.
7.
Net Income Per Share

We utilize the two-class method to compute net income per share. The two-class method allocates a portion of net income to participating securities, which includes unvested awards of share-based payments with non-forfeitable rights to receive dividends. Net income allocated to unvested share-based payments is excluded from net income allocated to common shares. Any undistributed losses resulting from dividends exceeding net income are not allocated to participating securities. Basic net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options.


- 15 -

Table of Contents

The following table summarizes the net income allocated to common shares and the basic and diluted shares used in the net income per share computations:
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Net income
 
$
24,560

 
$
14,018

 
$
74,551

 
$
49,646

Less distributed and undistributed earnings allocated to participating securities
 
(346
)
 
(248
)
 
(1,064
)
 
(909
)
Net income allocated to common shares
 
$
24,214

 
$
13,770

 
$
73,487

 
$
48,737

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
41,377

 
41,258

 
41,301

 
41,194

Incremental shares from assumed LTIP awards and conversions of common stock options
 
156

 
217

 
324

 
210

Adjusted weighted average common shares outstanding
 
41,533

 
41,475

 
41,625

 
41,404

8.
Commitments and Contingencies

Worksite Employee 401(k) Retirement Plan Class Action Litigation

In December 2015, a class action lawsuit was filed against us and the third-party discretionary trustee of the Insperity 401(k) retirement plan that is available to eligible worksite employees (the “Plan”) in the United States District Court for the Northern District of Georgia, Atlanta Division, on behalf of Plan participants. The suit generally alleges that Insperity’s third-party discretionary trustee of the Plan and Insperity breached their fiduciary duties to plan participants by selecting an Insperity subsidiary to serve as the recordkeeper for the Plan, by causing participants in the Plan to pay excessive recordkeeping fees to the Insperity subsidiary, by failing to monitor other fiduciaries, and by making imprudent investment choices. The parties filed a stipulation concerning class certification that defined the class as “all participants and beneficiaries of the Insperity 401(k) Plan from December 22, 2009 through September 30, 2017.” In November 2017, the court approved the class certification stipulation and denied the plaintiffs’ request for a jury trial. Discovery is complete. On June 8, 2018, we filed a motion for summary judgment seeking dismissal of all claims. Briefing on that motion is scheduled to be complete in September 2018. A date for the bench trial has not yet been set. We believe we have meritorious defenses, and we intend to vigorously defend this litigation. As a result of uncertainty regarding the outcome of this matter, no provision has been made in the accompanying consolidated financial statements.
    
Other Litigation

We are a defendant in various other lawsuits and claims arising in the normal course of business. Management believes it has valid defenses in these cases and is defending them vigorously. While the results of litigation cannot be predicted with certainty, management believes the final outcome of such litigation will not have a material adverse effect on our financial position or results of operations.

- 16 -

Table of Contents

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017, as well as our Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q.

New Accounting Pronouncements

Please read Note 2 to the Consolidated Financial Statements, "Accounting Policies – New Accounting Pronouncements," for new accounting pronouncements information.

Results of Operations

Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017.

The following table presents certain information related to our results of operations:

 
 
Three Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
 
(in thousands, except per share and
statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $5.550 billion and $4.742 billion, less worksite employee payroll cost of $4.628 billion and $3.947 billion, respectively)
 
$
922,295

 
$
795,552

 
15.9
 %
Gross profit
 
154,544

 
130,553

 
18.4
 %
Operating expenses
 
120,963

 
107,615

 
12.4
 %
Operating income
 
33,581

 
22,938

 
46.4
 %
Other income (expense)
 
699

 
(125
)
 
 %
Net income
 
24,560

 
14,018

 
75.2
 %
Diluted net income per share of common stock(1)
 
0.58

 
0.33

 
75.8
 %
Adjusted net income(2)
 
28,681

 
17,277

 
66.0
 %
Adjusted diluted net income per share of common stock(2)
 
0.68

 
0.41

 
65.9
 %
Adjusted EBITDA(2)
 
46,620

 
33,324

 
39.9
 %
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
203,950

 
180,276

 
13.1
 %
Revenues per worksite employee per month(3)
 
$
1,507

 
$
1,471

 
2.4
 %
Gross profit per worksite employee per month
 
253

 
241

 
5.0
 %
Operating expenses per worksite employee per month
 
198

 
199

 
(0.5
)%
Operating income per worksite employee per month
 
55

 
42

 
31.0
 %
Net income per worksite employee per month
 
40

 
26

 
53.8
 %
 ____________________________________

(1) 
Amounts in 2017 adjusted to reflect the two-for-one split of our common stock effected on December 18, 2017 in the form of a stock dividend.

(2) 
Please read “Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures calculated and presented in accordance with GAAP.

(3) 
Gross billings of $9,071 and $8,767 per worksite employee per month, less payroll cost of $7,564 and $7,296 per worksite employee per month, respectively.

- 17 -

Table of Contents


Revenues

Our revenues for the second quarter of 2018 increased 15.9% over the 2017 period, primarily due to a 13.1% increase in the average number of worksite employees paid per month, and a 2.4%, or $36, increase in revenues per worksite employee per month.

Our growth in the number of worksite employees paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs. During the second quarter of 2018, the number of worksite employees paid from new client sales and the net change in existing clients improved as compared to the second quarter of 2017, while client retention remained consistent with the second quarter of 2017.

We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. Our revenue by region for our PEO HR Outsourcing solutions for the quarters ended June 30, 2018 and 2017 was as follows:

 
 
Three Months Ended 
 June 30,
 
Three Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
239,278

 
$
204,285

 
17.1
%
 
26.3
%
 
26.1
%
Southeast
 
108,264

 
92,049

 
17.6
%
 
11.9
%
 
11.8
%
Central
 
153,025

 
131,099

 
16.7
%
 
16.8
%
 
16.7
%
Southwest
 
213,920

 
185,094

 
15.6
%
 
23.5
%
 
23.6
%
West
 
194,986

 
170,452

 
14.4
%
 
21.5
%
 
21.8
%
 
 
909,473

 
782,979

 
16.2
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
12,822

 
12,573

 
2.0
%
 
 
 
 
Total revenue
 
$
922,295

 
$
795,552

 
15.9
%
 
 
 
 
_____________________________

(1) Comprised primarily of revenues generated by our other products and services offerings.

The percentage of total PEO HR Outsourcing solutions revenues in our significant markets include the following:
 
 
Three Months Ended June 30,
 
 
2018
 
2017
 
 
 
 
 
Texas
 
21.5
%
 
21.8
%
California
 
16.6
%
 
17.0
%
New York
 
9.8
%
 
9.5
%
Other
 
52.1
%
 
51.7
%
Total
 
100.0
%
 
100.0
%

Gross Profit

Gross profit for the second quarter of 2018 increased $24.0 million, or 18.4% over the second quarter of 2017 to $154.5 million. The net increase in the change in cost estimates for benefits and workers compensation between the 2018 period and the 2017 period totaled $4.3 million as discussed below. The average gross profit per worksite employee increased 5.0% to $253 per month in the 2018 period from $241 per month in the 2017 period.

Our pricing objectives attempt to achieve a level of revenue per worksite employee that matches or exceeds changes in primary direct costs and operating expenses. Our revenues per worksite employee per month during the second quarter of 2018 increased 2.4% as a result of pricing increases compared to the second quarter of 2017. Our direct costs, which primarily

- 18 -

Table of Contents

include payroll taxes, benefits and workers’ compensation expenses, increased 2.0% to $1,254 per worksite employee per month in the second quarter of 2018 compared to $1,230 in the second quarter of 2017. The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits increased $17 per worksite employee per month, or 2.8% on a cost per covered employee basis, compared to the second quarter of 2017. Included in the second quarter of 2018 benefits costs is a charge of $6.8 million, or $11 per worksite employee per month, for changes in estimated claims run-off related to prior periods. Included in the second quarter of 2017 benefits costs is a reduction of $1.2 million, or $2 per worksite employee per month, for changes in estimated claims run-off related to prior periods. The percentage of worksite employees covered under our health insurance plans was 68.6% in the 2018 period compared to 68.8% in the 2017 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.

Workers’ compensation costs – Workers’ compensation costs decreased 3.0%, or $6 on a per worksite employee per month basis, compared to the second quarter of 2017. In the second quarter of 2018, as a result of closing out claims at lower than expected costs, we recorded reductions in workers’ compensation costs of $6.2 million, or 0.14% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods as compared to a $2.5 million reduction to workers’ compensation costs in 2017. Our continued discipline around our client selection, safety and claims management contributed to the reduction in our cost per worksite employee and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original cost estimates. As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.48% in the 2018 period compared to 0.58% in the 2017 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Workers’ Compensation Costs,” for a discussion of our accounting for workers’ compensation costs.

Payroll tax costs – Payroll taxes increased 16.2% due primarily to a 17.3% increase in payroll costs, or $14 per worksite employee per month, compared to the second quarter of 2017. Payroll taxes as a percentage of payroll costs were 6.9% in 2018 and 7.0% in 2017.

Operating Expenses

The following table presents certain information related to our operating expenses:

 
 
Three Months Ended 
 June 30,
 
Three Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
68,748

 
$
61,458

 
11.9
%
 
$
112

 
$
114

 
(1.8
)%
Stock-based compensation
 
5,752

 
5,303

 
8.5
%
 
10

 
10

 

Commissions
 
6,979

 
5,664

 
23.2
%
 
11

 
10

 
10.0
 %
Advertising
 
6,585

 
6,175

 
6.6
%
 
11

 
11

 

General and administrative expenses
 
27,419

 
24,610

 
11.4
%
 
45

 
46

 
(2.2
)%
Depreciation and amortization
 
5,480

 
4,405

 
24.4
%
 
9

 
8

 
12.5
 %
Total operating expenses
 
$
120,963

 
$
107,615

 
12.4
%
 
$
198

 
$
199

 
(0.5
)%

Operating expenses increased 12.4% to $121.0 million compared to $107.6 million in the second quarter of 2017. Operating expenses per worksite employee per month decreased to $198 in the 2018 period from $199 in the 2017 period. The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased $7.3 million or 11.9%, but decreased $2 on a per worksite employee per month basis, compared to the 2017 period. This increase was primarily due to an 11.2% increase in corporate headcount, which includes a 19.4% increase in the number of Business Performance Advisors.

Stock-based compensation increased $0.4 million or 8.5%, but remained flat on a per worksite employee per month basis, compared to the 2017 period.


- 19 -

Table of Contents

Commissions expense increased $1.3 million or 23.2%, or $1 per worksite employee per month, compared to the 2017 period, primarily due to commissions associated with growth in our PEO HR Outsourcing solutions worksite employees, including an increase in the amount of sales channel referral fees paid during 2018.

General and administrative expenses increased $2.8 million or 11.4%, but decreased $1 on a per worksite employee per month basis, compared to the 2017 period. The increase was primarily due to increased travel and training expenses associated with the increase in Business Performance Advisors and professional services.

Income Tax Expense

Our effective income tax rate was 28.4% in the 2018 period compared to 38.6% in the 2017 period. As a result of U.S. tax reform enacted in 2017, the U.S. statutory rate decreased from 35% to 21%. Our provision for income taxes differed from the U.S. statutory rate of 21% primarily due to state income taxes and non-deductible expenses.

Operating and Net Income

Operating and net income per worksite employee per month was $55 and $40 in the 2018 period, respectively, versus $42 and $26 in the 2017 period, respectively.


- 20 -

Table of Contents

Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017.

The following table presents certain information related to our results of operations:

 
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
 
(in thousands, except per share and statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $11.473 billion and $9.758 billion, less worksite employee payroll cost of $9.537 billion and $8.080 billion, respectively)
 
$
1,936,667

 
$
1,678,216

 
15.4
%
Gross profit
 
354,264

 
289,899

 
22.2
%
Operating expenses
 
255,980

 
213,469

 
19.9
%
Operating income
 
98,284

 
76,430

 
28.6
%
Other income (expense)
 
1,085

 
(283
)
 
%
Net income
 
74,551

 
49,646

 
50.2
%
Diluted net income per share of common stock(1)
 
1.77

 
1.18

 
50.0
%
Adjusted net income(2)
 
88,227

 
55,913

 
57.8
%
Adjusted diluted net income per share of common stock(2)
 
2.09

 
1.33

 
57.1
%
Adjusted EBITDA(2)
 
130,433

 
96,038

 
35.8
%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
199,816

 
177,315

 
12.7
%
Revenues per worksite employee per month(3)
 
$
1,615

 
$
1,577

 
2.4
%
Gross profit per worksite employee per month
 
295

 
272

 
8.5
%
Operating expenses per worksite employee per month
 
214

 
201

 
6.5
%
Operating income per worksite employee per month
 
82

 
72

 
13.9
%
Net income per worksite employee per month
 
62

 
47

 
31.9
%
 ____________________________________

(1) 
Amounts in 2017 adjusted to reflect the two-for-one split of our common stock effected on December 18, 2017 in the form of a stock dividend.

(2) 
Please read “—Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures calculated and presented in accordance with GAAP.

(3) 
Gross billings of $9,570 and $9,171 per worksite employee per month, less payroll cost of $7,955 and $7,594 per worksite employee per month, respectively.

Revenues

Our revenues for the six months ended June 30, 2018 increased 15.4% over the 2017 period, primarily due to a 12.7% increase in the average number of worksite employees paid per month and a 2.4%, or $38, increase in revenues per worksite employee per month.

Our growth in the number of worksite employees paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs. During the first six months of 2018, the number of worksite employees paid from new client sales and the net change in existing clients improved as compared to the first six months of 2017, while client retention remained consistent with the first six months of 2017.


- 21 -

Table of Contents

We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. Our revenue by region for our PEO HR Outsourcing solutions for the six months ended June 30, 2018 and 2017 was as follows:
 
 
Six Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
511,642

 
$
440,385

 
16.2
%
 
26.8
%
 
26.7
%
Southeast
 
223,452

 
190,855

 
17.1
%
 
11.7
%
 
11.6
%
Central
 
321,092

 
273,876

 
17.2
%
 
16.8
%
 
16.6
%
Southwest
 
446,785

 
389,201

 
14.8
%
 
23.4
%
 
23.6
%
West
 
407,605

 
357,896

 
13.9
%
 
21.3
%
 
21.5
%
 
 
1,910,576

 
1,652,213

 
15.6
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
26,091

 
26,003

 
0.3
%
 
 
 
 
Total revenue
 
$
1,936,667

 
$
1,678,216

 
15.4
%
 
 
 
 
______________________________

(1) Comprised primarily of revenues generated by our other products and services offerings.

The percentage of total PEO HR Outsourcing solutions revenues in our significant markets include the following:
 
 
Six Months Ended June 30,
 
 
2018
 
2017
 
 
 
 
 
Texas
 
21.5
%
 
21.8
%
California
 
16.6
%
 
17.0
%
New York
 
10.2
%
 
9.9
%
Other
 
51.7
%
 
51.3
%
Total
 
100.0
%
 
100.0
%

Gross Profit

Gross profit for the first six months of 2018 increased $64.4 million, or 22.2% over the first six months of 2017 to $354.3 million. The net decrease in the change in cost estimates for benefits and workers compensation between the 2018 period and the 2017 period totaled $5.3 million as discussed below. The average gross profit per worksite employee increased 8.5% to $295 per month in the 2018 period from $272 per month in the 2017 period.

Our pricing objectives attempt to achieve a level of revenue per worksite employee that matches or exceeds changes in primary direct costs and operating expenses. Our revenues per worksite employee per month during the first six months of 2018 increased 2.4% as a result of pricing increases compared to the first six months of 2017. Our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 1.1% to $1,320 per worksite employee per month in the first six months of 2018 compared to $1,305 in the first six months of 2017. The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits increased $5 per worksite employee per month, or 0.7% on a cost per covered employee basis, compared to the first six months of 2017. Included in 2018 benefits costs is a reduction of $1.9 million, or $2 per worksite employee per month for changes in estimated claims run-off related to prior periods. Benefits costs incurred in the first six months of 2017 reflect an increase in estimated claims run-off related to prior periods of $0.5 million. The percentage of worksite employees covered under our health insurance plans was 69.1% in both the 2018 and 2017 periods. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.


- 22 -

Table of Contents

Workers’ compensation costs – Workers’ compensation costs decreased 0.6%, or $5 per worksite employee per month, compared to the first six months of 2017. In the first six months of 2018, we recorded reductions in workers’ compensation costs of $10.9 million, or 0.13% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods. In the first six months of 2017, we recorded reductions in workers’ compensation costs of $8.0 million, or 0.11% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods. Our continued discipline around our client selection, safety and claims management contributed to the reduction in our cost per worksite employee and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original cost estimates. As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.49% in the 2018 period compared to 0.57% in the 2017 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Workers’ Compensation Costs,” for a discussion of our accounting for workers’ compensation costs.

Payroll tax costs – Payroll taxes increased 15.5% due primarily to an 18.0% increase in payroll costs, or $15 per worksite employee per month, compared to the first six months of 2017. Payroll taxes as a percentage of payroll costs were 7.6% in 2018 and 7.8% in 2017.  

Operating Expenses

The following table presents certain information related to our operating expenses:

 
 
Six Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
155,934

 
$
123,915

 
25.8
 %
 
$
130

 
$
116

 
12.1
 %
Stock-based compensation
 
8,887

 
9,806

 
(9.4
)%
 
7

 
9

 
(22.2
)%
Commissions
 
13,045

 
10,140

 
28.6
 %
 
11

 
10

 
10.0
 %
Advertising
 
10,150

 
10,147

 

 
9

 
10

 
(10.0
)%
General and administrative expenses
 
57,271

 
50,802

 
12.7
 %
 
48

 
48

 

Depreciation and amortization
 
10,693

 
8,659

 
23.5
 %
 
9

 
8

 
12.5
 %
Total operating expenses
 
$
255,980

 
$
213,469

 
19.9
 %
 
$
214

 
$
201

 
6.5
 %

Operating expenses increased 19.9% to $256.0 million in the first six months of 2018 compared to $213.5 million in the first six months of 2017. Operating expenses per worksite employee per month increased to $214 in the 2018 period from $201 in the 2017 period. Adjusted operating expenses increased 15.6% to $246.7 million in the 2018 period from $213.5 million in the 2017 period. Please read “—Non-GAAP Financial Measures” for additional information. The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased $32.0 million or 25.8%, or $14 per worksite employee per month, compared to the 2017 period. This increase was primarily due to a $9.3 million charge related to a one-time tax reform bonus paid to corporate employees, a 10.6% increase in corporate headcount, which includes a 17.4% increase in the number of Business Performance Advisors, and additional incentive compensation expense as a result of strong operating results.

Stock-based compensation decreased $0.9 million or 9.4%, or $2 per worksite employee per month, compared to the 2017 period. This decrease was primarily due to the acceleration of restricted stock awards and associated expense in the fourth quarter of 2017 that were originally scheduled to vest in the first quarter of 2018.

Commissions expense increased $2.9 million or 28.6%, or $1 per worksite employee per month, compared to the 2017 period, primarily due to commissions associated with growth in our PEO HR Outsourcing solutions, including an increase in the amount of sales channel referral fees paid during 2018.

General and administrative expenses increased $6.5 million or 12.7%, but remained flat on a per worksite employee per month basis, compared to the 2017 period. The increase was primarily due to increased travel and training expenses associated with the increase in Business Performance Advisors.


- 23 -

Table of Contents

Depreciation and amortization expense increased $2.0 million or 23.5%, or $1 on a per worksite employee per month basis, compared to the 2017 period.

Income Tax Expense

Our effective income tax rate was 25.0% in the 2018 period compared to 34.8% in the 2017 period. As a result of U.S. tax reform enacted in 2017, the U.S. statutory rate decreased from 35% to 21%. Our provision for income taxes differed from the U.S. statutory rate primarily due to state income taxes and non-deductible expenses and vesting of long-term incentive and restricted stock awards. During the first six months of 2018 and 2017, we recognized an income tax benefit of $3.7 million and $3.3 million, respectively, related to the vesting of long-term incentive and restricted stock awards.

Operating and Net Income

Operating and net income per worksite employee per month was $82 and $62 in the 2018 period, respectively, compared to $72 and $47 in the 2017 period, respectively.

Non-GAAP Financial Measures

Non-GAAP financial measures are not prepared in accordance with GAAP and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. Investors are encouraged to review the reconciliation of the non-GAAP financial measures used to their most directly comparable GAAP financial measures as provided in the tables below.

Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our worksite employees. Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program. As a result, our management refers to non-bonus payroll cost in analyzing, reporting and forecasting our workers’ compensation costs. We include these non-GAAP financial measures because we believe they are useful to investors in allowing for greater transparency related to the costs incurred under our current workers’ compensation program.

Following is a GAAP to non-GAAP reconciliation of non-bonus payroll costs:

 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
 
(in thousands, except per worksite employee per month data)
GAAP to non-GAAP reconciliation:
 
 
 
 
 
 
 
 
Payroll cost (GAAP)
 
$
4,628,047

 
$
3,946,005

 
17.3
%
 
$
9,537,032

 
$
8,078,997

 
18.0
%
Less: Bonus payroll cost
 
372,225

 
306,340

 
21.5
%
 
1,203,086

 
921,598

 
30.5
%
Non-bonus payroll cost
 
$
4,255,822

 
$
3,639,665

 
16.9
%
 
$
8,333,946

 
$
7,157,399

 
16.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Payroll cost per worksite employee per month (GAAP)
 
$
7,564

 
$
7,296

 
3.7
%
 
$
7,955

 
$
7,594

 
4.8
%
Less: Bonus payroll cost per worksite employee per month
 
608

 
566

 
7.4
%
 
1,003

 
866

 
15.8
%
Non-bonus payroll cost per worksite employee per month
 
$
6,956

 
$
6,730

 
3.4
%
 
$
6,952

 
$
6,728

 
3.3
%

Adjusted cash, cash equivalents and marketable securities excludes funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as client prepayments. We believe adjusted cash, cash equivalents and marketable securities is a useful measure of our available funds.


- 24 -

Table of Contents

Following is a GAAP to non-GAAP reconciliation of cash, cash equivalents and marketable securities:
 
 
June 30,
2018
 
December 31,
2017
 
 
(in thousands)
 
 
 
 
 
Cash, cash equivalents and marketable securities (GAAP)
 
$
315,918

 
$
356,220

Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions
 
191,893

 
271,547

Client prepayments
 
13,952

 
23,603

Adjusted cash, cash equivalents and marketable securities
 
$
110,073

 
$
61,070


Adjusted operating expenses represent operating expenses excluding the impact of costs associated with a one-time tax reform bonus paid to corporate employees. Our management believes adjusted operating expenses is a useful measure of our operating costs, as it allows for additional analysis of our operating expenses separate from the impact of these items.    

Following is a GAAP to non-GAAP reconciliation of operating expenses and adjusted operating expenses:

 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
 
(in thousands, except per worksite employee per month data)
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses (GAAP)
 
$
120,963

 
$
107,615

 
12.4
 %
 
$
255,980

 
$
213,469

 
19.9
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
One-time tax reform bonus
 

 

 

 
9,306

 

 

Adjusted operating expenses (non-GAAP)
 
$
120,963

 
$
107,615

 
12.4
 %
 
$
246,674

 
$
213,469

 
15.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses per worksite employee per month (GAAP)
 
$
198

 
$
199

 
(0.5
)%
 
$
214

 
$
201

 
6.5
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
One-time tax reform bonus