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, 2020, 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 we provide by entering into a co-employment relationship with our clients. Our PEO HR Outsourcing solutions 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 significant changes 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 the workplace and workplace safety. In the second quarter of 2021 (“Q2 2021”), the average number of WSEEs paid per month increased 6.7% year-over-year as the Q2 2021 increase in WSEEs paid at existing clients combined with WSEEs paid from new sales exceeded the second quarter of 2020 (“Q2 2020”) levels. We expect the average number of paid WSEEs per month to increase between 9.5% and 10.5% in the third quarter of 2021 as compared to the third quarter of 2020, which, if achieved, would equate to the average number of paid WSEEs per month growing 4.3% to 5.3% sequentially from the second quarter of 2021. We experienced a 12.4% increase in the year-over-year benefits costs per covered employee during the first half of 2021 as compared to the first half of 2020. During the second quarter of 2020, we experienced a 10.7% decrease in benefits costs per covered employee due primarily to lower utilization of medical services by plan participants as a result of the COVID-19 pandemic, including in response to COVID-19 governmental requirements or guidance related to the deferral of non-essential medical procedures and shelter in place and similar orders. During the remainder of 2021 and possibly beyond 2021, we currently expect to experience higher benefits costs as utilization continues to normalize and deferred procedures and treatments are rescheduled. As a result, we expect that our health care claim costs will be higher than our historical claim cost trends during this period of normalization. While we have experienced a reduced frequency in workers’ compensation claims during the COVID-19 pandemic, we have also experienced an increase in the number of COVID-19 workers’ compensation claims. As a result, 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. Accordingly, the impact of the COVID-19 pandemic, if any, on our workers’ compensation program will be reflected in future reporting periods. 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, impacts of changes in or variants of the COVID-19 virus, 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 Insperity | 2021 Second Quarter Form 10-Q 20 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS speed and effectiveness of responses to combat the virus, including the development, availability and acceptance of therapeutics and vaccines. See Part II, Item 1A. “Risk Factors” for additional information. 2021 Highlights Second Quarter 2021 Compared to Second Quarter 2020 • Average number of WSEEs paid per month increased 6.7% • Net income and diluted earnings per share (“diluted EPS”) decreased 51.5% and 51.1% to $25.2 million and $0.65, respectively • Adjusted EPS decreased 40.9% to $0.91 • Adjusted EBITDA decreased 34.5% to $60.2 million First Six Months 2021 Compared to First Six Months 2020 • Average number of WSEEs paid per month increased 2.3% • Net income and diluted EPS decreased 23.6% and 23.0% to $87.1 million and $2.24, respectively • Adjusted EPS decreased 16.0% to $2.72 • Adjusted EBITDA decreased 14.9% to $164.4 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 | 2021 Second Quarter Form 10-Q 21 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 June 30, Six Months Ended June 30, 2021 2020 % Change 2021 2020 % Change Financial data: Revenues $ 1,185,371 $ 993,366 19.3 % $ 2,472,206 $ 2,222,849 11.2 % Gross profit 199,554 220,249 (9.4) % 450,999 454,271 (0.7) % Operating expenses 164,331 147,262 11.6 % 331,952 296,063 12.1 % Operating income 35,223 72,987 (51.7) % 119,047 158,208 (24.8) % Other income (expense) (539) (1,850) (70.9) % (1,595) (2,333) (31.6) % Net income 25,154 51,851 (51.5) % 87,076 113,943 (23.6) % Diluted EPS 0.65 1.33 (51.1) % 2.24 2.91 (23.0) % Non-GAAP financial measures (1) : Adjusted net income $ 35,292 $ 59,646 (40.8) % $ 106,058 $ 126,539 (16.2) % Adjusted EBITDA 60,191 91,958 (34.5) % 164,427 193,212 (14.9) % Adjusted EPS 0.91 1.54 (40.9) % 2.72 3.24 (16.0) % Average WSEEs paid 243,270 227,894 6.7 % 238,220 232,954 2.3 % Statistical data (per WSEE per month) : Revenues (2) $ 1,624 $ 1,453 11.8 % $ 1,730 $ 1,590 8.8 % Gross profit 273 322 (15.2) % 316 325 (2.8) % Operating expenses 225 215 4.7 % 232 212 9.4 % Operating income 48 107 (55.1) % 83 113 (26.5) % Net income 34 76 (55.3) % 61 82 (25.6) % ____________________________________ (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 June 30, Six Months Ended June 30, (per WSEE per month) 2021 2020 2021 2020 Gross billings $ 10,466 $ 9,296 $ 10,976 $ 9,868 Less: WSEE payroll cost 8,842 7,843 9,246 8,278 Revenues $ 1,624 $ 1,453 $ 1,730 $ 1,590 Insperity | 2021 Second Quarter Form 10-Q 22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Key Operating Metrics We monitor certain key metrics to measure our performance, including: • WSEEs • 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 WSEEs paid at existing clients through new hires and layoffs. • During “Q2 2021”, WSEEs paid increased 6.7% compared to Q2 2020”. The number of WSEEs paid from new client sales improved compared to Q2 2020 and the net gain (loss) in our client base improved compared to Q2 2020 as clients continue to recover from the effects of the pandemic. Client retention remained consistent compared to Q2 2020. • During the first six months of 2021 (“YTD 2021”), WSEEs paid increased 2.3% compared to the first six months of 2020 (“YTD 2020”). The number of WSEEs paid from new client sales improved compared to YTD 2020 and the net gain (loss) in our client base improved compared to YTD 2020 as clients continue to recover from the effects of the pandemic. Client retention remained consistent compared to YTD 2020. Average WSEEs Paid and Year-over-Year Growth Percentage Insperity | 2021 Second Quarter Form 10-Q 23 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 | 2021 Second Quarter Form 10-Q 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue and Year-over-Year Growth Percentage (in thousands) Second Quarter 2021 Compared to Second Quarter 2020 Our revenues for Q2 2021 were $1.2 billion, an increase of 19.3%, primarily due to the following: • Revenues per WSEE per month increased 11.8%, or $171, on 5.8% higher average pricing, as well as the non-recurrence of the 2020 FICA deferral credits of $44.8 million and $11.6 million of comprehensive service fee credits. • Average WSEEs paid increased 6.7%. First Six Months 2021 Compared to First Six Months 2020 Our revenues for YTD 2021 were $2.5 billion, an increase of 11.2%, primarily due to the following: • Revenues per WSEE per month increased 8.8%, or $140, on 6.1% higher average pricing, as well as the non-recurrence of the 2020 FICA deferral credits of $44.8 million and $11.6 million of comprehensive service fee credits. • Average WSEEs paid increased 2.3%. Insperity | 2021 Second Quarter Form 10-Q 25 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 throughout the United States. Our PEO HR Outsourcing solutions revenue distribution by region follows: PEO HR Outsourcing Solutions Revenue by Region (in thousands) ________________________________________________________ (1) The Southwest region includes Texas. The percentage of total PEO HR Outsourcing solutions revenue in our significant markets includes the following: Significant Markets We believe the middle market sector, which we generally define as those companies with employees ranging from approximately 150 to 5,000 WSEEs, has historically been under-served by the PEO industry. Currently, we have a dedicated sales management, service personnel and consulting staff who concentrate solely on the middle market sector. Our average number of WSEEs per month in our middle market sector decreased 2.0% during YTD 2021 compared to YTD 2020, representing approximately 23.6% and 24.6% of our total average paid WSEEs during YTD 2021 and YTD 2020, respectively. Insperity | 2021 Second Quarter Form 10-Q 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 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 Insperity | 2021 Second Quarter Form 10-Q 27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Second Quarter 2021 Compared to Second Quarter 2020 Gross profit for Q2 2021 decreased 9.4% to $199.6 million compared to $220.2 million in Q2 2020. Gross profit per WSEE per month for Q2 2021 decreased $49 to $273 compared to $322 in Q2 2020 due primarily to higher direct costs, offset in part by higher average pricing, 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 per WSEE per month increased $171 due to higher average pricing, as well as the non-recurrence of the 2020 FICA deferral elections by clients and the 2020 comprehensive service fee credits. The net increase in direct costs between Q2 2021 and Q2 2020 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $28.8 million as discussed below. The $220 per WSEE per month increase in direct costs is due primarily to the direct cost components changes as follows: Benefits costs • The cost of group health insurance and related employee benefits increased $129 per WSEE per month and increased 23.9% on a cost per covered employee basis due primarily to an increase in claims in Q2 2021 compared to Q2 2020, which had significantly lower claims as a result of lower utilization and deferral of non-essential elective health care procedures in response to COVID-19 pandemic and related governmental requirements or guidance. • The percentage of WSEEs covered under our health insurance plans was 67.3% in Q2 2021 compared to 69.3% in Q2 2020. • Reported results include changes in estimated claims run-off related to prior periods, which was an increase in costs of $15.3 million, or $21 per WSEE per month, in Q2 2021 compared to a reduction in costs of $10.4 million, or $15 per WSEE per month, in Q2 2020. 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 has allowed for claims within our policy periods to be closed out at amounts below our original cost estimates. • Workers’ compensation costs increased 22.6%, or $3 per WSEE per month, in Q2 2021 compared to Q2 2020 on a 15.2% increase in non-bonus payroll costs. • As a percentage of non-bonus payroll cost, workers’ compensation costs in Q2 2021 were 0.30% compared to 0.29% in Q2 2020. • We recorded a reduction in workers’ compensation costs of $10.8 million, or 0.19% of non-bonus payroll costs, in Q2 2021 compared to a reduction of $13.9 million, or 0.28% of non-bonus payroll costs, in Q2 2020, 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 increased 26.7% on a 20.3% increase in payroll costs, or $87 per WSEE per month, due primarily to the non-recurrence of the $44.8 million of the 2020 FICA deferral elections by clients pursuant to the CARES Act, partially offset by an $11.2 million reduction related to final 2021 state unemployment taxes and the Q2 2021 collection of $11.3 million in federal payroll tax refunds related to prior years. • Payroll taxes as a percentage of payroll costs increased to 6.2% in Q2 2021 compared to 5.9% in Q2 2020 due primarily to the non-recurrence of the $44.8 million of the 2020 FICA deferral elections by clients pursuant to the CARES Act. Insperity | 2021 Second Quarter Form 10-Q 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS First Six Months 2021 Compared to First Six Months 2020 Gross profit for YTD 2021 decreased 0.7% to $451.0 million compared to $454.3 million in YTD 2020. Gross profit per WSEE per month for YTD 2021 decreased $9 to $316 compared to $325 in YTD 2020 due primarily to higher direct costs, offset in part by higher average pricing, 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 per WSEE per month increased $140 due to higher average pricing, as well as the non-recurrence of the 2020 FICA deferral elections and the 2020 comprehensive service fee credits. The net increase in direct costs between YTD 2021 and YTD 2020 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $7.9 million as discussed below. The $149 per WSEE per month increase in direct costs is due primarily to the direct cost components changes as follows: Benefits costs • The cost of group health insurance and related employee benefits increased $76 per WSEE per month and increased 12.4% on a cost per covered employee basis due primarily to an increase in claims in YTD 2021 compared to YTD 2020, which had lower claims as a result of lower utilization and the deferral of non-essential health care procedures, primarily in Q2 2020, in connection with the COVID-19 pandemic and related government requirements or guidance. • The percentage of WSEEs covered under our health insurance plans was 67.6% in YTD 2021 compared to 68.1% in YTD 2020. • Reported results include changes in estimated claims run-off related to prior periods which was an increase in costs of $5.7 million, or $4 per WSEE per month, in YTD 2021 compared to a reduction in costs of $3.0 million, or $2 per WSEE per month, in YTD 2020. 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 8.5%, or $3 on a per WSEE per month basis, in YTD 2021 compared to YTD 2020. • As a percentage of non-bonus payroll cost, workers’ compensation costs in YTD 2021 were 0.28% compared to 0.34% in YTD 2020. • We recorded a reduction in workers’ compensation costs of $23.0 million, or 0.21% of non-bonus payroll costs, in YTD 2021 compared to a reduction of $22.2 million, or 0.22% of non-bonus payroll costs, in YTD 2020, 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 increased 15.5% on a 14.2% increase in payroll costs, or $74 per WSEE per month, due primarily to the non-recurrence of the $44.8 million of the 2020 FICA deferral elections by clients pursuant to the CARES Act, offset by the YTD 2021 collection of $16.8 million in federal payroll tax refunds related to prior years. • Payroll taxes as a percentage of payroll costs increased to 7.0% in YTD 2021 compared to 6.9% in YTD 2020. Insperity | 2021 Second Quarter Form 10-Q 29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 ◦ technology and facility costs, including repairs, maintenance and software-as-a-service (“SaaS”) licensing costs • Depreciation and amortization — Depreciation and amortization expense is primarily a function of our capital investments in corporate facilities, service centers, sales offices, software development and technology infrastructure. Second Quarter 2021 Compared to Second Quarter 2020 The following table presents certain information related to our operating expenses: Three Months Ended June 30, per WSEE (in thousands, except per WSEE) 2021 2020 % Change 2021 2020 % Change Salaries $ 94,362 $ 90,710 4.0 % $ 129 $ 133 (3.0) % Stock-based compensation 13,781 10,694 28.9 % 19 16 18.8 % Commissions 8,251 7,475 10.4 % 11 11 — Advertising 8,975 5,720 56.9 % 12 8 50.0 % General and administrative 29,211 24,755 18.0 % 41 35 17.1 % Depreciation and amortization 9,751 7,908 23.3 % 13 12 8.3 % Total operating expenses $ 164,331 $ 147,262 11.6 % $ 225 $ 215 4.7 % Operating expenses for Q2 2021 increased 11.6% to $164.3 million compared to $147.3 million in Q2 2020. Operating expenses per WSEE per month for Q2 2021 increased 4.7% to $225 compared to $215 in Q2 2020. • Salaries of corporate and sales staff for Q2 2021 increased 4.0% to $94.4 million, but decreased $4 on a per WSEE per month basis, compared to Q2 2020. The increase was primarily due to higher incentive compensation accruals in Q2 2021 related to better than expected operating results. • Stock based compensation expense for Q2 2021 increased 28.9% to $13.8 million, or $3 per WSEE per month, compared to Q2 2020. The increase was primarily due to awards issued under our incentive plan and the increase in the number of stock awards anticipated to be earned related to our long-term incentive plans based on our higher than expected operating results in 2021. Insperity | 2021 Second Quarter Form 10-Q 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • Commissions expense for Q2 2021 increased 10.4% to $8.3 million, but remained flat on a per WSEE per month basis, compared to Q2 2020. The increase was primarily due to higher sales management commissions and an increase in the amount of sales channel referral fees paid during 2021. • Advertising expense for Q2 2021 increased 56.9% to $9.0 million, or $4 per WSEE per month, compared to Q2 2020. The increase was primarily due to the resumption of the Insperity Invitational in 2021, which was canceled in 2020 due to the COVID-19 pandemic, and increases in television, radio and digital advertising and sponsorships. • General and administrative expenses for Q2 2021 increased 18.0% to $29.2 million, or $6 per WSEE per month, compared to Q2 2020. The increase was primarily due to technology SaaS licensing costs and professional services related to implementation of a CRM solution, as well as increased travel costs as the COVID-19 pandemic travel restrictions have eased. • Depreciation and amortization expense for Q2 2021 increased 23.3% to $9.8 million, or $1 per WSEE per month, compared to Q2 2020. The increase was primarily due to the completion of a new facility on our corporate campus and increased capital expenditures related to software development costs. First Six Months 2021 Compared to First Six Months 2020 Six Months Ended June 30, per WSEE (in thousands, except per WSEE) 2021 2020 % Change 2021 2020 % Change Salaries $ 197,437 $ 177,211 11.4 % $ 138 $ 127 8.7 % Stock-based compensation 25,603 17,246 48.5 % 18 12 50.0 % Commissions 15,970 15,935 0.2 % 11 11 — Advertising 14,297 10,553 35.5 % 10 8 25.0 % General and administrative 60,847 59,608 2.1 % 43 43 — Depreciation and amortization 17,798 15,510 14.8 % 12 11 9.1 % Total operating expenses $ 331,952 $ 296,063 12.1 % $ 232 $ 212 9.4 % Operating expenses for YTD 2021 increased 12.1% to $332.0 million compared to $296.1 million in YTD 2020. Operating expenses per WSEE per month for YTD 2021 increased 9.4% to $232 compared to $212 in YTD 2020. • Salaries of corporate and sales staff for YTD 2021 increased 11.4% to $197.4 million, or $11 per WSEE per month, compared to YTD 2020. This increase was primarily due to higher incentive compensation accruals in YTD 2021 related to better than expected YTD 2021 operating results, as well as a 1.4% increase in corporate headcount, including a 3.3% increase in total BPAs in YTD 2021 compared to YTD 2020. • Stock based compensation expense for YTD 2021 increased 48.5% to $25.6 million or $6 per WSEE per month, compared to YTD 2020. 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 long-term incentive plans based on our higher than expected YTD 2021 operating results. • Advertising expense for YTD 2021 increased 35.5% to $14.3 million, or $2 per WSEE per month, compared to YTD 2020. The increase was primarily due to the resumption of the Insperity Invitational in 2021, which was canceled in 2020 due to the COVID-19 pandemic, as well as increases in television and digital advertising and sponsorships. • General and administrative expenses for YTD 2021 increased 2.1% to $60.8 million, but remained flat on a per WSEE per month basis, compared to YTD 2020. The increase was primarily due to technology SaaS licensing costs and professional services related to implementation of a CRM solution, partially offset by decreases in travel costs. • Depreciation and amortization expense for YTD 2021 increased 14.8% to $17.8 million, or $1 per WSEE per month, compared to YTD 2020. The increase was primarily due to the completion of a new facility on our Insperity | 2021 Second Quarter Form 10-Q 31 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS corporate campus and increased capital expenditures related to software development costs and sales office expansions. Other Income (Expense) Other Income (expense) for Q2 2021 was net expense of $0.5 million compared to net expense of $1.9 million in Q2 2020, and for YTD 2021 was net expense of $1.6 million compared to net expense of $2.3 million in YTD 2020. Income Tax Expense Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Effective income tax rate 27.5% 27.1% 25.9% 26.9% For the six months ended June 30, 2021, 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 six months of 2021 and 2020, we recognized an income tax benefit of $2.2 million and $2.0 million, respectively, related to the vesting of short-term, 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 | 2021 Second Quarter Form 10-Q 32 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 June 30, Six Months Ended June 30, 2021 2020 2021 2020 Per WSEE Per WSEE Per WSEE Per WSEE Payroll cost $ 6,452,480 $ 8,842 $ 5,362,317 $ 7,843 $ 13,216,067 $ 9,246 $ 11,569,588 $ 8,278 Less: Bonus payroll cost 796,154 1,092 453,121 662 2,216,629 1,551 1,504,089 1,076 Non-bonus payroll cost $ 5,656,326 $ 7,750 $ 4,909,196 $ 7,181 $ 10,999,438 $ 7,695 $ 10,065,499 $ 7,202 % Change period over period 15.2 % 7.9 % 0.6 % 2.4 % 9.3 % 6.8 % 4.7 % 2.9 % Following is a reconciliation of cash, cash equivalents and marketable securities (GAAP) to adjusted cash, cash equivalents and marketable securities (non-GAAP): (in thousands) June 30, 2021 December 31, 2020 Cash, cash equivalents and marketable securities $ 489,984 $ 589,375 Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions 226,727 341,988 Client prepayments 50,420 35,328 Adjusted cash, cash equivalents and marketable securities $ 212,837 $ 212,059 Following is a reconciliation of net income (GAAP) to EBITDA (non-GAAP) and adjusted EBITDA (non-GAAP): Three Months Ended June 30, Six Months Ended June 30, (in thousands, except per WSEE per month) 2021 2020 2021 2020 Per WSEE Per WSEE Per WSEE Per WSEE Net income $ 25,154 $ 34 $ 51,851 $ 76 $ 87,076 $ 61 $ 113,943 $ 82 Income tax expense 9,530 13 19,286 28 30,376 21 41,932 30 Interest expense 1,975 3 2,219 3 3,574 3 4,581 3 Depreciation and amortization 9,751 14 7,908 12 17,798 12 15,510 11 EBITDA 46,410 64 81,264 119 138,824 97 175,966 126 Stock-based compensation 13,781 18 10,694 16 25,603 18 17,246 12 Adjusted EBITDA $ 60,191 $ 82 $ 91,958 $ 135 $ 164,427 $ 115 $ 193,212 $ 138 % Change period over period (34.5) % (39.3) % 62.2 % 66.7 % (14.9) % (16.7) % 22.2 % 20.0 % Insperity | 2021 Second Quarter Form 10-Q 33 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 June 30, Six Months Ended June 30, (in thousands) 2021 2020 2021 2020 Net income $ 25,154 $ 51,851 $ 87,076 $ 113,943 Non-GAAP adjustments: Stock-based compensation 13,781 10,694 25,603 17,246 Tax effect (3,643) (2,899) (6,621) (4,650) Total non-GAAP adjustments, net 10,138 7,795 18,982 12,596 Adjusted net income $ 35,292 $ 59,646 $ 106,058 $ 126,539 % Change period over period (40.8) % 73.1 % (16.2) % 9.0 % Following is a reconciliation of diluted EPS (GAAP) to adjusted EPS (non-GAAP): Three Months Ended June 30, Six Months Ended June 30, (amounts per share) 2021 2020 2021 2020 Diluted EPS $ 0.65 $ 1.33 $ 2.24 $ 2.91 Non-GAAP adjustments: Stock-based compensation 0.35 0.27 0.66 0.44 Tax effect (0.09) (0.06) (0.18) (0.11) Total non-GAAP adjustments, net 0.26 0.21 0.48 0.33 Adjusted EPS $ 0.91 $ 1.54 $ 2.72 $ 3.24 % Change period over period (40.9) % 85.5 % (16.0) % 15.3 % 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 repurchases, 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 public or private 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 $490.0 million in cash, cash equivalents and marketable securities at June 30, 2021, of which approximately $226.7 million was payable in early July 2021 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $50.4 million represented client prepayments that were payable in July 2021. At June 30, 2021, we had working capital of $198.6 million compared to $172.3 million at December 31, 2020. 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 2021. 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 continually monitor in light of our strategic goals and the significant uncertainty created by the COVID-19 pandemic. As of June 30, 2021, 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. Insperity | 2021 Second Quarter Form 10-Q 34 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cash Flows from Operating Activities Net cash provided by operating activities in the first six months of 2021 was $7.0 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 no later than the same day as 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 June 30, 2021, the last business day of the reporting period was a Wednesday, client prepayments were $50.4 million and employment taxes and other deductions were $226.7 million. In the period ended June 30, 2020, the last business day of the reporting period was a Tuesday, client prepayments were $31.5 million and employment taxes and other deductions were $190.9 million. • 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 June 30, 2021, premiums owed and cash funded to United have exceeded the costs of the United plan, resulting in a $0.6 million surplus, $8.4 million of which is reflected as a current liability, 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 June 30, 2021, were $14.5 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 decreased 16.2% to $106.1 million in the first six months ended June 30, 2021, compared to $126.5 million in the first six months ended June 30, 2020. Please read “Results of Operations – First Six Months 2021 Compared to First Six Months 2020.” Cash Flows from Investing Activities Net cash flows used in investing activities were $21.2 million for the six months ended June 30, 2021, primarily due to property and equipment purchases of $20.7 million. Cash Flows from Financing Activities Net cash flows used in financing activities were $67.3 million for the six months ended June 30, 2021. We paid $32.8 million in dividends and repurchased or withheld $38.5 million in stock. Insperity | 2021 Second Quarter Form 10-Q 35 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND CONTROLS AND PROCEDURES