INSPERITY, INC. 10-Q

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, 2019, as well as our Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q. Executive Summary Overview Insperity, Inc. (“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 Synchronization TM 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 Premier TM platform. COVID-19 Pandemic The effects of the COVID-19 pandemic, including actions taken by businesses and governments, have resulted in a significant reduction in U.S. economic activity. As the duration of the pandemic and such economic impacts remain uncertain, we have planned for a range of scenarios and have modified certain business and workforce practices. To conform to government restrictions and best practices, we have taken steps designed to keep our staff safe while continuing to serve clients, including implementing remote working for all non-essential employees and providing extra safety measures at corporate facilities. To serve our clients, we have instituted a number of service offerings and developed COVID-19 resources to assist clients with obtaining government provided tax credits, tax deferrals, loans and loan forgiveness and to provide guidance to assist clients with addressing the challenges faced by employers as a result of the pandemic. These service offerings and guidance to assist clients during the pandemic included additional benefits support, remote workforce transition, monitoring and educating on regulatory changes, return to workforce and workplace safety. The COVID-19 pandemic did not have a significant impact to our first quarter 2020 financial results due to the increased spread of, and related government and business responses to, the COVID-19 pandemic not occurring until late in the quarter. However, towards the end of the first quarter, clients began layoffs and temporary leaves of absence of worksite employees (“WSEEs”), and this trend continued into the second quarter and resulted in a 1.8% decline in year-over-year average number of paid WSEEs per month in the second quarter. In the third quarter of 2020, the number of WSEEs returning to work as well as new hires exceeded layoffs, resulting in a 1.7% sequential increase and a 3.8% year-over-year decline in the average number of paid WSEEs per month. We expect the average number of paid WSEEs per month to decline between 2.1% and 3.0% in the fourth quarter of 2020 as compared to the fourth quarter of 2019, which equates to the average number of paid worksite employees per month growing 2% to 3% sequentially from the third quarter of 2020. We expect overall reduced employment levels to have a negative impact on our financial results for at least the remainder of 2020 as compared to 2019. We experienced a 10.7% decrease in the year-over-year benefits costs per covered employee during the second quarter of 2020 and a 1.1% increase in the year-over-year benefits costs per covered employee during the third quarter of 2020. The third quarter 2020 increase in benefits costs per covered employee over the preceding second quarter of 2020 was due primarily to an increase in non-essential claims as a result of higher utilization and fewer deferrals or cancellations associated with the COVID-19 pandemic. We currently expect to experience higher costs related to COVID-19 and certain non-essential elective healthcare procedures during the remainder of 2020 and possibly into 2021 that had been deferred in response to COVID-19 governmental requirements or guidance related to shelter in place and similar orders. As a result, we expect that our healthcare claim costs will not be reflective of our historical quarterly claim cost trends. In addition, the COVID-19 pandemic has not had a material impact on our workers’ compensation cost estimate; however, the ultimate impact of COVID-19 on our workers’ compensation program remains uncertain. As the impact of the COVID-19 pandemic emerges, such impact, if any, on our workers’ compensation program will be reflected in future reporting periods. Insperity | 2020 Third Quarter Form 10-Q 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The extent to which our future results are affected by the COVID-19 pandemic will depend on various factors and consequences beyond our control, such as the scope, duration and magnitude of the pandemic, actions by businesses and governments in response to the pandemic, including programs designed to assist small and medium-sized businesses with the economic impact of the pandemic; and the speed and effectiveness of responses to combat the virus, including the development and availability of therapeutics and vaccines. See Part II, Item 1A. “Risk Factors” for additional information. 2020 Highlights Third Quarter 2020 Compared to Third Quarter 2019 • Average number of WSEEs paid per month decreased 3.8% • Net income and diluted earnings per share (“diluted EPS”) decreased 22.6% and 19.0%, to $20.0 million and $0.51, respectively • Adjusted EPS increased 21.3% to $0.91 • Adjusted EBITDA increased 12.5% to $57.6 million First Nine Months 2020 Compared to First Nine Months 2019 • Average number of WSEEs paid per month decreased 0.1% • Net income and diluted EPS increased 2.5% and 7.9% to $134.0 million and $3.43, respectively • Adjusted EPS increased 16.2% to $4.15 • Adjusted EBITDA increased 19.8% to $250.8 million Please read “Non-GAAP Financial Measures” for a reconciliation of adjusted EBITDA and adjusted EPS to their most directly comparable financial measures calculated and presented in accordance with accounting principles generally accepted in the United States (“GAAP”). Insperity | 2020 Third Quarter Form 10-Q 20 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Key Financial and Statistical Data (in thousands, except per share, WSEE and statistical data) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 % Change 2020 2019 % Change Financial data: Revenues $ 1,007,820 $ 1,043,388 (3.4) % $ 3,230,669 $ 3,239,714 (0.3) % Gross profit 185,033 170,546 8.5 % 639,304 570,998 12.0 % Operating expenses 156,261 135,813 15.1 % 452,324 412,084 9.8 % Operating income 28,772 34,733 (17.2) % 186,980 158,914 17.7 % Other income (expense) (1,628) 452 — (3,961) 3,179 — Net income 20,009 25,859 (22.6) % 133,952 130,704 2.5 % Diluted EPS 0.51 0.63 (19.0) % 3.43 3.18 7.9 % Non-GAAP financial measures (1) : Adjusted net income $ 35,389 $ 30,648 15.5 % $ 161,928 $ 146,699 10.4 % Adjusted EBITDA 57,558 51,154 12.5 % 250,770 209,277 19.8 % Adjusted EPS 0.91 0.75 21.3 % 4.15 3.57 16.2 % Average WSEEs paid 231,750 240,939 (3.8) % 232,553 232,825 (0.1) % Statistical data (per WSEE per month) : Revenues (2) $ 1,450 $ 1,444 0.4 % $ 1,544 $ 1,546 (0.1) % Gross profit 266 236 12.7 % 305 272 12.1 % Operating expenses 225 188 19.7 % 216 197 9.6 % Operating income 41 48 (14.6) % 89 76 17.1 % Net income 29 36 (19.4) % 64 62 3.2 % ____________________________________ (1) 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. (2) Revenues per WSEE per month are comprised of gross billings per WSEE per month less WSEE payroll costs per WSEE per month as follows: Three Months Ended September 30, Nine Months Ended September 30, (per WSEE per month) 2020 2019 2020 2019 Gross billings $ 9,441 $ 9,070 $ 9,726 $ 9,451 Less: WSEE payroll cost 7,991 7,626 8,182 7,905 Revenues $ 1,450 $ 1,444 $ 1,544 $ 1,546 New Accounting Pronouncements Please read Note 2 to the Consolidated Financial Statements, "Accounting Policies – Recently Adopted Accounting Standards," for new accounting pronouncements information. Results of Operations Key Operating Metrics We monitor certain key metrics to measure our performance, including: • WSEEs Insperity | 2020 Third Quarter Form 10-Q 21 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • Adjusted EBITDA • Adjusted EPS Our growth in the number of WSEEs paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through WSEE new hires and layoffs. • During the third quarter of 2020 (“Q3 2020”), WSEEs paid declined 3.8% compared to the third quarter of 2019 (“Q3 2019”). The net gain (loss) in our client base improved over Q3 2019. In addition, the number of WSEEs paid from new client sales was 92% of Q3 2019 paid from new client sales and client retention averaged 99% in 2020 and 2019. • During the first nine months of 2020 (“YTD 2020”), WSEEs paid declined 0.1% compared to the first nine months of 2019 (“YTD 2019”). The number of WSEEs paid from new client sales was 96% of YTD 2019. While the net gain (loss) in our client base declined compared to YTD 2019, due primarily to layoffs and furloughs of WSEEs by our clients resulting from the effect of the on-going COVID-19 pandemic, we have seen certain clients make significant hiring of worksite employees while other clients have experienced significant layoffs. Average client retention declined slightly compared to YTD 2019. Average WSEEs Paid and Year-over-Year Growth Percentage Insperity | 2020 Third Quarter Form 10-Q 22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Adjusted EBITDA and Year-over-Year Growth Percentage (in thousands) Adjusted EPS and Year-over-Year Growth Percentage (amounts per share) Revenues Our PEO HR Outsourcing solutions revenues are primarily derived from our gross billings, which are based on (1) the payroll cost of our WSEEs and (2) a markup computed as a percentage of the payroll cost. Our revenues are primarily dependent on the number of clients enrolled, the resulting number of WSEEs paid each period and the number of WSEEs enrolled in our benefit plans. Because our total markup is computed as a percentage of payroll cost, certain revenues are also affected by the payroll cost of WSEEs, which may fluctuate based on the composition of the WSEE base, inflationary effects on wage levels and differences in the local economies of our markets. Insperity | 2020 Third Quarter Form 10-Q 23 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue and Year-over-Year Growth Percentage (in thousands) Third Quarter 2020 Compared to Third Quarter 2019 Our revenues for Q3 2020 were $1.0 billion, a decrease of 3.4%, primarily due to the following: • Average WSEEs paid decreased 3.8%. • Revenues per WSEE per month increased 0.4%, or $6, primarily due to higher average pricing partially offset by $40.2 million in FICA deferral elections by clients and credits pursuant to the CARES Act and the Families First Coronavirus Response Act, which also reduced our direct costs and therefore has no net effect on our gross profit. First Nine Months 2020 Compared to First Nine Months 2019 Our revenues for YTD 2020 were $3.2 billion, a decrease of 0.3%, primarily due to the following: • Average WSEEs paid decreased 0.1%. • Revenues per WSEE per month decreased 0.1%, or $2, primarily due to higher average pricing, which was partially offset by $85.0 million in FICA deferral elections by clients and credits pursuant to the CARES Act and the Families First Coronavirus Response Act, which also reduced our direct costs and therefore has no net effect on our gross profit. In addition, during the second quarter of 2020, we accrued $11.6 million of client comprehensive service fee credits applied generally on a WSEE basis across our active client base to assist clients in addressing the unprecedented economic impact of the COVID-19 pandemic. Insperity | 2020 Third Quarter Form 10-Q 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. Our PEO HR Outsourcing solutions revenue distribution by region follows: PEO HR Outsourcing Solutions Revenue by Region (in thousands) The percentage of total PEO HR Outsourcing solutions revenue in our significant markets includes the following: Significant Markets Gross Profit In determining the pricing of the markup component of our gross billings, we take into consideration our estimates of the costs directly associated with our WSEEs, including payroll taxes, benefits and workers’ compensation costs, plus an acceptable gross profit margin. As a result, our operating results are significantly impacted by our ability to accurately estimate, control and manage our direct costs relative to the revenues derived from the markup component of our gross billings. Our gross profit per WSEE is primarily determined by our ability to accurately estimate and control direct costs and our ability to incorporate changes in these costs into the gross billings charged to PEO HR Outsourcing solutions Insperity | 2020 Third Quarter Form 10-Q 25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS clients, which are subject to pricing arrangements that are typically renewed annually. We use gross profit per WSEE per month as our principal measurement of relative performance at the gross profit level. Gross Profit and Year-over-Year Growth Percentage (in thousands) Gross Profit per WSEE per Month and Year-over-Year Growth Percentage Third Quarter 2020 Compared to Third Quarter 2019 Gross profit for Q3 2020 increased 8.5% to $185.0 million compared to $170.5 million in Q3 2019. Gross profit per WSEE per month for Q3 2020 increased $30 to $266 compared to $236 in Q3 2019 due primarily to the relative changes in higher pricing and lower direct costs as discussed below. Our pricing objectives attempt to achieve a level of revenue per WSEE that matches or exceeds changes in primary direct costs and operating expenses. Our revenues and direct costs per WSEE per month increased $6 and decreased $24, respectively, due to higher average pricing, which was partially offset by client FICA deferral elections pursuant to the CARES Act in Q3 2020 and changes in the primary direct cost components, respectively. The net decrease in costs between Q3 2020 and Q3 2019 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $18.6 million as discussed below. The primary direct cost components changed as follows: Benefits costs Insperity | 2020 Third Quarter Form 10-Q 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • The cost of group health insurance and related employee benefits increased $27 per WSEE per month and increased 1.1% on a cost per covered employee basis. • The percentage of WSEEs covered under our health insurance plans was 67.9% in Q3 2020 compared to 66.0% in Q3 2019. • Reported results include changes in estimated claims run-off related to prior periods, which was a decrease in costs of $7.7 million, or $11 per WSEE per month, in Q3 2020 compared to an increase in costs of $7.0 million, or $10 per WSEE per month, in Q3 2019. 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 Our continued discipline around our client selection, safety and claims management contributed to the decrease in our cost per WSEE and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original cost estimates. • Workers’ compensation costs decreased 30.8%, or $9 per WSEE per month, in Q3 2020 compared to Q3 2019. • As a percentage of non-bonus payroll cost, workers’ compensation costs in Q3 2020 were 0.30% compared to 0.43% in Q3 2019. • We recorded a reduction in workers’ compensation costs of $11.4 million, or 0.22% of non-bonus payroll costs, in Q3 2020 compared to a reduction of $7.5 million, or 0.15% of non-bonus payroll costs, in Q3 2019, primarily as a result of closing out claims at lower than expected costs. 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 decreased 12.7% on an 0.8% increase in payroll costs, or $44 per WSEE per month, primarily due to $40.2 million of FICA deferral elections by clients pursuant to the CARES Act. In addition, Internal Revenue Service tax reporting changes in 2020 eliminated PEO reporting of payroll taxes for self-employed owners. • Payroll taxes as a percentage of payroll costs decreased to 5.4% in Q3 2020 compared to 6.2% in Q3 2019. First Nine Months 2020 Compared to First Nine Months 2019 Gross profit for YTD 2020 increased 12.0% to $639.3 million compared to $571.0 million in YTD 2019. Gross profit per WSEE per month for YTD 2020 increased $33 to $305 compared to $272 in YTD 2019 due primarily to the relative changes in higher pricing and lower direct costs as discussed below. Our pricing objectives attempt to achieve a level of revenue per WSEE that matches or exceeds changes in primary direct costs and operating expenses. Our revenues and direct costs per WSEE per month decreased $2 and $35, respectively, due to higher average pricing, which was offset by client FICA deferral elections pursuant to the CARES Act in YTD 2020 and changes in the primary direct cost components, respectively. The net decrease in costs between YTD 2020 and YTD 2019 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $11.2 million as discussed below. The primary direct cost components changed as follows: Benefits costs • The cost of group health insurance and related employee benefits increased $3 per WSEE per month and decreased 1.5% on a cost per covered employee basis due primarily to a decrease in claims as a result of lower utilization and the deferral of nonessential healthcare procedures, primarily in the second quarter of 2020, in response to COVID-19 government requirements or guidance. Insperity | 2020 Third Quarter Form 10-Q 27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • The percentage of WSEEs covered under our health insurance plans was 68.0% in YTD 2020 compared to 66.6% in YTD 2019. • Reported results include changes in estimated claims run-off related to prior periods which was a decrease in costs of $1.9 million, or $1 per WSEE per month, in YTD 2020 compared to an increase in costs of $2.9 million, or $2 per WSEE per month, in YTD 2019. 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 Our continued discipline around our client selection, safety and claims management contributed to the decrease in our cost per WSEE and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original cost estimates. • Workers’ compensation costs decreased 15.4%, or $4 on a per WSEE per month basis, in YTD 2020 compared to YTD 2019. • As a percentage of non-bonus payroll cost, workers’ compensation costs in YTD 2020 were 0.33% compared to 0.40% in YTD 2019. • We recorded a reduction in workers’ compensation costs of $32.4 million, or 0.21% of non-bonus payroll costs, in YTD 2020 compared to a reduction of $26.0 million, or 0.18% of non-bonus payroll costs, in YTD 2019, primarily as a result of closing out claims at lower than expected costs. 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 decreased 6.3% on a 3.4% increase in payroll costs, or $35 per WSEE per month, primarily due to $85.0 million of FICA deferral elections by clients pursuant to the CARES Act. In addition, Internal Revenue Service tax reporting changes in 2020 eliminated PEO reporting of payroll taxes for self-employed owners. • Payroll taxes as a percentage of payroll costs decreased to 6.4% in YTD 2020 compared to 7.1% in YTD 2019. Operating Expenses • Salaries, wages and payroll taxes — Salaries, wages and payroll taxes (“Salaries”) are primarily a function of the number of corporate employees, their associated average pay and any additional incentive compensation. • Stock-based compensation — Our stock-based compensation relates to the recognition of non-cash compensation expense over the requisite service period of time-vested and performance-based awards. • Commissions — Commissions expense consists primarily of amounts paid to sales managers and other sales personnel, including business performance advisors (“BPAs”), as well as, channel referral fees. Commissions are based on new accounts sold and a percentage of revenue generated by such personnel. • Advertising — Advertising expense primarily consists of media advertising and other business promotions in our current and anticipated sales markets. • General and administrative expenses — Our general and administrative expenses primarily include: ◦ rent expenses related to our service centers and sales offices ◦ outside professional service fees related to legal, consulting and accounting services ◦ administrative costs, such as postage, printing and supplies ◦ employee travel and training expenses Insperity | 2020 Third Quarter Form 10-Q 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ◦ technology and facility repairs and maintenance costs • Depreciation and amortization — Depreciation and amortization expense is primarily a function of our capital investments in corporate facilities, service centers, sales offices and technology infrastructure. Third Quarter 2020 Compared to Third Quarter 2019 The following table presents certain information related to our operating expenses: Three Months Ended September 30, $ WSEE (in thousands, except per WSEE) 2020 2019 % Change 2020 2019 % Change Salaries $ 89,429 $ 79,264 12.8 % $ 129 $ 110 17.3 % Stock-based compensation 20,864 6,517 220.1 % 30 9 233.3 % Commissions 7,722 8,034 (3.9) % 11 11 — Advertising 4,781 4,895 (2.3) % 7 7 — General and administrative 25,646 29,773 (13.9) % 37 41 (9.8) % Depreciation and amortization 7,819 7,330 6.7 % 11 10 10.0 % Total operating expenses $ 156,261 $ 135,813 15.1 % $ 225 $ 188 19.7 % Operating expenses for Q3 2020 increased 15.1% to $156.3 million compared to $135.8 million in Q3 2019. Operating expenses per WSEE per month for Q3 2020 increased 19.7% to $225 compared to $188 in Q3 2019. • Salaries of corporate and sales staff for Q3 2020 increased 12.8% to $89.4 million, or $19 per WSEE per month, compared to Q3 2019. This increase was primarily due to a 2.3% increase in corporate headcount, including a 6.8% increase in total BPAs in Q3 2020 compared to Q3 2019 and higher incentive compensation accruals in Q3 2020 related to better than expected YTD 2020 operating results compared to lower than expected YTD 2019 operating results in Q3 2019. • Stock based compensation expense for Q3 2020 increased 220.1% to $20.9 million, or $21 per WSEE per month, compared to Q3 2019. The increase was primarily due to an increase in the number of stock awards anticipated to be earned related to performance-based awards granted under our short-term and long-term incentive plans based on our higher than expected year-to-date operating results in Q3 2020 compared to lower than expected year-to-date results in Q3 2019. In addition, Q3 2020 contains the acceleration of expense for employees who meet the retirement eligibility requirements for continued vesting. Please read Note 7 to the Consolidated Financial Statements, “Incentive Plans,” for additional information. • Commissions expense for Q3 2020 decreased 3.9% to $7.7 million, but remained flat on a per WSEE per month basis, compared to Q3 2019. The decrease was primarily due to reductions in commissions associated with PEO HR Outsourcing solutions and our other business performance solutions offerings, partially offset by an increase in the amount of sales channel referral fees paid during Q3 2020. • Advertising expense for Q3 2020 decreased 2.3% to $4.8 million, but remained flat on a per WSEE per month basis, compared to Q3 2019. The decrease was primarily due to decreases in trade shows and events due to COVID-19, partially offset by an increase in internet advertising. • General and administrative expenses for Q3 2020 decreased 13.9% to $25.6 million, or $4 per WSEE per month, compared to Q3 2019. The decrease was primarily due to reductions in travel and training costs in response to the COVID-19 pandemic, partially offset by increases in technology licensing costs, corporate insurance and rent. • Depreciation and amortization expense for Q3 2020 increased 6.7% to $7.8 million, or $1 per WSEE per month, compared to Q3 2019. The increase was primarily due to increased capital expenditures related to software development costs and sales office expansions. Insperity | 2020 Third Quarter Form 10-Q 29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS First Nine Months 2020 Compared to First Nine Months 2019 Nine Months Ended September 30, $ WSEE (in thousands, except per WSEE) 2020 2019 % Change 2020 2019 % Change Salaries $ 266,640 $ 237,340 12.3 % $ 127 $ 113 12.4 % Stock-based compensation 38,110 20,813 83.1 % 18 10 80.0 % Commissions 23,657 22,727 4.1 % 11 11 — Advertising 15,334 17,474 (12.2) % 7 8 (12.5) % General and administrative 85,254 92,801 (8.1) % 42 45 (6.7) % Depreciation and amortization 23,329 20,929 11.5 % 11 10 10.0 % Total operating expenses $ 452,324 $ 412,084 9.8 % $ 216 $ 197 9.6 % Operating expenses for YTD 2020 increased 9.8% to $452.3 million compared to $412.1 million in YTD 2019. Operating expenses per WSEE per month for YTD 2020 increased 9.6% to $216 compared to $197 in YTD 2019. • Salaries of corporate and sales staff for YTD 2020 increased 12.3% to $266.6 million, or $14 per WSEE per month, compared to YTD 2019. This increase was primarily due to a 5.0% increase in corporate headcount, including an 10.7% increase in total BPAs in YTD 2020 compared to YTD 2019 and higher incentive compensation accruals in YTD 2020 related to better than expected YTD 2020 operating results compared to lower than expected YTD 2019 operating results in Q3 2019. • Stock based compensation expense for YTD 2020 increased 83.1% to $38.1 million or $8 per WSEE per month, compared to YTD 2019. The increase was primarily due to an increase in the number of stock awards anticipated to be earned related to performance-based awards granted under our short-term and long-term incentive plans based on our higher than expected YTD 2020 operating results compared to lower than expected YTD 2019 operating results. In addition, YTD 2020 contains the acceleration of expense for employees who meet the retirement eligibility requirements for continued vesting. Please read Note 7 to the Consolidated Financial Statements, “Incentive Plans,” for additional information. • Commissions expense for YTD 2020 increased 4.1% to $23.7 million, but remained flat on a per WSEE per month basis, compared to YTD 2019. The increase was 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 2020. Additionally, as a result of the extension of our fall campaign into Q1 2020, the bonuses paid to sales managers increased in YTD 2020 compared to YTD 2019. • Advertising expense for YTD 2020 decreased 12.2% to $15.3 million, or $1 per WSEE per month, compared to YTD 2019. The decrease was primarily due to the cancellation of the 2020 Insperity Invitational and decreases in trade shows and events due to COVID-19, partially offset by an increase in internet advertising. • General and administrative expenses for YTD 2020 decreased 8.1% to $85.3 million, or $3 per WSEE per month, compared to YTD 2019. The decrease was primarily due to decreased travel and training expenses in response to the COVID-19 pandemic, partially offset by increases in technology licensing costs, corporate insurance and rent. • Depreciation and amortization expense for YTD 2020 increased 11.5% to $23.3 million, or $1 per WSEE per month, compared to YTD 2019. The increase was primarily due to increased capital expenditures related to software development costs and sales office expansions. Other Income (Expense) Other Income (expense) for Q3 2020 was an expense of $1.6 million compared to income of $0.5 million in Q3 2019, and an expense of $4.0 million in YTD 2020 compared to income of $3.2 million in YTD 2019. The net decrease was primarily due to decreased interest income on our marketable securities investments and workers’ compensation deposit and increased interest expense related to the higher outstanding balance on our credit facility. Please read Note 5 to the Consolidated Financial Statements, “Long-Term Debt,” for additional information. Insperity | 2020 Third Quarter Form 10-Q 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income Tax Expense Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Effective income tax rate 26.3% 26.5% 26.8% 19.4% For the nine months ended September 30, 2020, our provision for income taxes differed from the U.S. statutory rate primarily due to state income taxes, non-deductible expenses and vesting of restricted and long-term incentive stock awards. During the first nine months of 2020 and 2019, we recognized an income tax benefit of $2.0 million and $14.5 million, respectively, related to the vesting of long-term incentive and restricted stock awards. 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-GAAP Measure Definition Benefit of Non-GAAP Measure Non-bonus payroll cost Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our WSEEs. Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program. 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. Adjusted cash, cash equivalents and marketable securities Excludes funds associated with: • federal and state income tax withholdings, • employment taxes, • other payroll deductions, and • client prepayments. We believe that the exclusion of the identified items helps us reflect the fundamentals of our underlying business model and analyze results against our expectations, against prior periods, and to plan for future periods by focusing on our underlying operations. We believe that the adjusted results provide relevant and useful information for investors because they allow investors to view performance in a manner similar to the method used by management and improves their ability to understand and assess our operating performance. Adjusted EBITDA is used by our lenders to assess our leverage and ability to make interest payments. EBITDA Represents net income computed in accordance with GAAP, plus: • interest expense, • income tax expense, and • depreciation and amortization expense. Adjusted EBITDA Represents EBITDA plus: • non-cash stock-based compensation. Adjusted Net Income Represents net income computed in accordance with GAAP, excluding: • non-cash stock-based compensation. Adjusted EPS Represents diluted net income per share computed in accordance with GAAP, excluding: • non-cash stock-based compensation. Insperity | 2020 Third Quarter Form 10-Q 31 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Following is a reconciliation of payroll cost (GAAP) to non-bonus payroll costs (non-GAAP): (in thousands, except per WSEE per month) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 $ WSEE $ WSEE $ WSEE $ WSEE Payroll cost $ 5,555,907 $ 7,991 $ 5,512,477 $ 7,626 $ 17,125,495 $ 8,182 $ 16,564,835 $ 7,905 Less: Bonus payroll cost 431,861 621 408,931 566 1,935,950 925 1,851,338 884 Non-bonus payroll cost $ 5,124,046 $ 7,370 $ 5,103,546 $ 7,060 $ 15,189,545 $ 7,257 $ 14,713,497 $ 7,021 % Change period over period 0.4 % 4.4 % 14.7 % 2.3 % 3.2 % 3.4 % 15.1 % 1.3 % Following is a reconciliation of cash, cash equivalents and marketable securities (GAAP) to adjusted cash, cash equivalents and marketable securities (non-GAAP): (in thousands) September 30, 2020 December 31, 2019 Cash, cash equivalents and marketable securities $ 406,350 $ 402,070 Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions 147,149 234,553 Client prepayments 46,526 59,612 Adjusted cash, cash equivalents and marketable securities $ 212,675 $ 107,905 Following is a reconciliation of net income (GAAP) to EBITDA (non-GAAP) and adjusted EBITDA (non-GAAP): Three Months Ended September 30, Nine Months Ended September 30, (in thousands, except per WSEE per month) 2020 2019 2020 2019 $ WSEE $ WSEE $ WSEE $ WSEE Net income $ 20,009 $ 29 $ 25,859 $ 36 $ 133,952 $ 64 $ 130,704 $ 62 Income tax expense 7,135 10 9,326 13 49,067 23 31,389 15 Interest expense 1,731 2 2,122 3 6,312 3 5,442 3 Depreciation and amortization 7,819 12 7,330 10 23,329 12 20,929 10 EBITDA 36,694 53 44,637 62 212,660 102 188,464 90 Stock-based compensation 20,864 30 6,517 9 38,110 18 20,813 10 Adjusted EBITDA $ 57,558 $ 83 $ 51,154 $ 71 $ 250,770 $ 120 $ 209,277 $ 100 % Change period over period 12.5 % 16.9 % (16.9) % (25.3) % 19.8 % 20.0 % 9.0 % (3.8) % Insperity | 2020 Third Quarter Form 10-Q 32 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Following is a reconciliation of net income (GAAP) to adjusted net income (non-GAAP): Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2020 2019 2020 2019 Net income $ 20,009 $ 25,859 $ 133,952 $ 130,704 Non-GAAP adjustments: Stock-based compensation 20,864 6,517 38,110 20,813 Total non-GAAP adjustments 20,864 6,517 38,110 20,813 Tax effect (5,484) (1,728) (10,134) (4,818) Adjusted net income $ 35,389 $ 30,648 $ 161,928 $ 146,699 % Change period over period 15.5 % (24.3) % 10.4 % 14.0 % Following is a reconciliation of diluted EPS (GAAP) to adjusted EPS (non-GAAP): Three Months Ended September 30, Nine Months Ended September 30, (amounts per share) 2020 2019 2020 2019 Diluted EPS $ 0.51 $ 0.63 $ 3.43 $ 3.18 Non-GAAP adjustments: Stock-based compensation 0.54 0.16 0.98 0.51 Total non-GAAP adjustments 0.54 0.16 0.98 0.51 Tax effect (0.14) (0.04) (0.26) (0.12) Adjusted EPS $ 0.91 $ 0.75 $ 4.15 $ 3.57 % Change period over period 21.3 % (21.9) % 16.2 % 16.7 % Liquidity and Capital Resources We periodically evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, our expansion plans, stock repurchase, potential acquisitions, debt service requirements and other operating cash needs. To meet short-term liquidity requirements, which are primarily the payment of direct costs and operating expenses, we rely primarily on cash from operations. Longer-term projects, large stock repurchases or significant acquisitions may be financed with debt or equity. We have a $500 million revolving credit facility (“Facility”) with a syndicate of financial institutions. The Facility is available for working capital and general corporate purposes, including acquisitions and stock repurchases. We have in the past sought, and may in the future seek, to raise additional capital or take other steps to increase or manage our liquidity and capital resources. We had $406.4 million in cash, cash equivalents and marketable securities at September 30, 2020, of which approximately $147.1 million was payable in early October 2020 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $46.5 million represented client prepayments that were payable in October 2020. In March 2020, we borrowed $100.0 million under the Facility, which increased working capital. At September 30, 2020, we had working capital of $207.8 million compared to $105.7 million at December 31, 2019. We currently believe that our cash on hand, marketable securities, cash flows from operations and availability under the Facility will be adequate to meet our liquidity requirements for the remainder of 2020. We intend to rely on these same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital needs, which we are carefully monitoring in light of the significant uncertainty created by the COVID-19 pandemic. Insperity | 2020 Third Quarter Form 10-Q 33 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As of September 30, 2020, we had an outstanding letter of credit and borrowings totaling $370.4 million under the Facility. Please read Note 5 to the Consolidated Financial Statements, “Long-Term Debt,” for additional information. Cash Flows from Operating Activities Net cash provided by operating activities in the first nine months of 2020 was $106.6 million. Our primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our clients. Our cash and cash equivalents, and thus our reported cash flows from operating activities, are significantly impacted by various external and internal factors, which are reflected in part by the changes in our balance sheet accounts. These include the following: • Timing of client payments / payroll taxes – We typically collect our comprehensive service fee, along with the client’s payroll funding, from clients at least one day prior to the payment of WSEE payrolls and associated payroll taxes. Therefore, the last business day of a reporting period has a substantial impact on our reporting of operating cash flows. For example, many WSEEs are paid on Fridays; therefore, operating cash flows decrease in the reporting periods that end on a Friday or a Monday. In the period ended September 30, 2020, the last business day of the reporting period was a Wednesday, client prepayments were $46.5 million and employment taxes and other deductions were $147.1 million. In the period ended September 30, 2019, the last business day of the reporting period was a Monday, client prepayments were $19.7 million and employment taxes and other deductions were $153.8 million. • Workers’ compensation plan funding – During YTD 2020, we received $24.8 million for the return of excess claim funds related to the workers’ compensation program, which resulted in an increase in working capital. • Medical plan funding – Our health care contract with United establishes participant cash funding rates 90 days in advance of the beginning of a reporting quarter. Therefore, changes in the participation level of the United plan have a direct impact on our operating cash flows. In addition, changes to the funding rates, which are solely determined by United based primarily upon recent claim history and anticipated cost trends, also have a significant impact on our operating cash flows. As of September 30, 2020, premiums owed and cash funded to United have exceeded the costs of the United plan, resulting in a $32.8 million surplus, $23.8 million of which is reflected as a current asset, and $9.0 million of which is reflected as a long-term asset on our Condensed Consolidated Balance Sheets. The premiums, including an additional quarterly premium, owed to United at September 30, 2020, were $38.3 million, which is included in accrued health insurance costs, a current liability, on our Condensed Consolidated Balance Sheets. • Operating results – Our net income has a significant impact on our operating cash flows. Our adjusted net income increased 10.4% to $161.9 million in the first nine months ended September 30, 2020, compared to $146.7 million in the first nine months ended September 30, 2019. Please read “Results of Operations – First Nine Months 2020 Compared to First Nine Months 2019.” Cash Flows from Investing Activities Net cash flows used in investing activities were $68.4 million for the nine months ended September 30, 2020, primarily due to property and equipment purchases of $68.8 million. Cash Flows from Financing Activities Net cash flows used in financing activities were $31.4 million for the nine months ended September 30, 2020. We borrowed $100.0 million under the Facility for general corporate purposes, repurchased or withheld $91.2 million in stock and paid $46.5 million in dividends. Insperity | 2020 Third Quarter Form 10-Q 34 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND CONTROLS AND PROCEDURES