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, 2021, 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 and to the workplace in general. While uncertainties continue regarding the pandemic, including its duration, future variants, and its longer-term impacts, we believe that we are positioned to continue to adjust our business plans and workforce practices as conditions change. In response to the pandemic’s impact on the workplace, we implemented flexible remote working arrangements for our employees. 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 with the impacts of the pandemic include additional benefits support; remote workforce transition; monitoring and educating on regulatory changes, including vaccine mandates; return to the workplace; and workplace safety. In the second quarter of 2022 (“Q2 2022”), the average number of WSEEs paid per month increased 19.4% year-over-year as the Q2 2022 increase in WSEEs paid at existing clients combined with WSEEs paid from new sales and client retention all exceeded the second quarter of 2021 (“Q2 2021”) levels. We expect the average number of paid WSEEs per month to increase between 17% and 18% in the third quarter of 2022 as compared to the third quarter of 2021, which, if achieved, would equate to the average number of paid WSEEs per month growing 3.7% to 4.6% sequentially from the second quarter of 2022. We experienced a 0.6% decrease in the year-over-year benefits costs per covered employee during Q2 2022 as compared to Q2 2021. During Q2 2021, we experienced a 23.9% increase in the year-over-year benefits costs per covered employee as compared to Q2 2020. During 2022 and possibly beyond 2022, benefits costs are expected to continue to be affected by the dynamics of the pandemic, including the impact on healthcare utilization and incremental COVID-19 testing, vaccination and treatment costs. This may result in a higher level of healthcare claims costs than our historical claim cost trends. While we have experienced a reduced frequency in workers’ compensation claims during the COVID-19 pandemic, 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. 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 speed and effectiveness of responses to combat the virus, including the development, availability and acceptance of therapeutics and vaccines. See Item 1A. “Risk Factors” included in Part I of our Annual Report on Form 10-K for the year ended December 31, 2021. Insperity | 2022 Second Quarter Form 10-Q 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2022 Highlights Second Quarter 2022 Compared to Second Quarter 2021 • Average number of WSEEs paid per month increased 19.4% • Net income and diluted earnings per share (“diluted EPS”) increased 33.6% and 33.8% to $33.6 million and $0.87, respectively • Adjusted EPS increased 27.5% to $1.16 • Adjusted EBITDA increased 24.6% to $75.0 million First Six Months 2022 Compared to First Six Months 2021 • Average number of WSEEs paid per month increased 19.5% • Net income and diluted EPS increased 18.8% and 19.6% to $103.5 million and $2.68, respectively • Adjusted EPS increased 15.8% to $3.15 • Adjusted EBITDA increased 17.7% to $193.6 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 | 2022 Second 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 June 30, Six Months Ended June 30, 2022 2021 % Change 2022 2021 % Change Financial data: Revenues $ 1,432,107 $ 1,185,371 20.8 % $ 3,009,944 $ 2,472,206 21.8 % Gross profit 239,868 199,554 20.2 % 525,642 450,999 16.6 % Operating expenses 191,518 164,331 16.5 % 378,897 331,952 14.1 % Operating income 48,350 35,223 37.3 % 146,745 119,047 23.3 % Other expense (1,746) (539) 223.9 % (3,523) (1,595) 120.9 % Net income 33,599 25,154 33.6 % 103,483 87,076 18.8 % Diluted EPS 0.87 0.65 33.8 % 2.68 2.24 19.6 % Non-GAAP financial measures (1) : Adjusted net income $ 44,885 $ 35,292 27.2 % $ 121,891 $ 106,058 14.9 % Adjusted EBITDA 75,026 60,191 24.6 % 193,599 164,427 17.7 % Adjusted EPS 1.16 0.91 27.5 % 3.15 2.72 15.8 % Average WSEEs paid 290,507 243,270 19.4 % 284,583 238,220 19.5 % Statistical data (per WSEE per month) : Revenues (2) $ 1,643 $ 1,624 1.2 % $ 1,763 $ 1,730 1.9 % Gross profit 275 273 0.7 % 308 316 (2.5) % Operating expenses 220 225 (2.2) % 222 232 (4.3) % Operating income 55 48 14.6 % 86 83 3.6 % Net income 39 34 14.7 % 61 61 — ____________________________________ (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) 2022 2021 2022 2021 Gross billings $ 10,585 $ 10,466 $ 11,469 $ 10,976 Less: WSEE payroll cost 8,942 8,842 9,706 9,246 Revenues $ 1,643 $ 1,624 $ 1,763 $ 1,730 Insperity | 2022 Second Quarter Form 10-Q 21 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 2022, WSEEs paid increased 19.4% compared to Q2 2021. The number of WSEEs paid from new client sales and the net gain (loss) in our client base improved compared to Q2 2021, while client retention remained consistent with Q2 2021. • During the first six months of 2022 (“YTD 2022”), WSEEs paid increased 19.5% compared to the first six months of 2021 (“YTD 2021”). The number of WSEEs paid from new client sales, the net gain (loss) in our client base and client retention all improved compared to YTD 2021. Average WSEEs Paid and Year-over-Year Growth Percentage Insperity | 2022 Second 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 monthly markup component. 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 monthly markup is computed in part 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 | 2022 Second 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) Second Quarter 2022 Compared to Second Quarter 2021 Our revenues for Q2 2022 were $1.4 billion, an increase of 20.8%, primarily due to the following: • Average WSEEs paid increased 19.4%. • Revenues per WSEE per month increased 1.2%, or $19. First Six Months 2022 Compared to First Six Months 2021 Our revenues for YTD 2022 were $3.0 billion, an increase of 21.8%, primarily due to the following: • Average WSEEs paid increased 19.5%. • Revenues per WSEE per month increased 1.9%, or $33. Insperity | 2022 Second 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 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 increased 23.2% during Q2 2022 compared to Q2 2021, representing approximately 24.3% and 23.6% of our total average paid WSEEs during Q2 2022 and Q2 2021, respectively. Insperity | 2022 Second Quarter Form 10-Q 25 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 | 2022 Second Quarter Form 10-Q 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Second Quarter 2022 Compared to Second Quarter 2021 Gross profit for Q2 2022 increased 20.2% to $239.9 million compared to $199.6 million in Q2 2021. Gross profit per WSEE per month for Q2 2022 increased $2 to $275 compared to $273 in Q2 2021 due primarily to higher average pricing, offset in part by higher 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 per WSEE per month increased $19 due to higher average pricing. The net decrease in direct costs between Q2 2022 and Q2 2021 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $24.5 million as discussed below. The $17 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 decreased $26 per WSEE per month and decreased 0.6% on a cost per covered employee basis due primarily to lower utilization and lower COVID-19 related costs in Q2 2022 as compared to Q2 2021. • The percentage of WSEEs covered under our health insurance plans was 65.4% in Q2 2022 compared to 67.3% in Q2 2021. • Reported results include changes in estimated claims run-off related to prior periods, which was a reduction in costs of $7.2 million, or $8 per WSEE per month, in Q2 2022 compared to an increase in costs of $15.3 million, or $21 per WSEE per month, in Q2 2021. 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, workplace 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 decreased 11.7%, or $6 per WSEE per month, in Q2 2022 compared to Q2 2021 on a 25.9% increase in non-bonus payroll costs. • As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.21% in Q2 2022 and 0.30% Q2 2021. • We recorded a reduction in workers’ compensation costs of $12.8 million, or 0.18% of non-bonus payroll costs, in Q2 2022 compared to a reduction of $10.8 million, or 0.19% of non-bonus payroll costs, in Q2 2021, 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 30.5% on a 20.8% increase in payroll costs, or $51 per WSEE per month, due to the non-recurrence of an $11.2 million reduction in Q2 2021 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 6.7% in Q2 2022 compared to 6.2% Q2 2021. First Six Months 2022 Compared to First Six Months 2021 Gross profit for YTD 2022 increased 16.6% to $525.6 million compared to $451.0 million in YTD 2021. Gross profit per WSEE per month for YTD 2022 decreased $8 to $308 compared to $316 in YTD 2021 due primarily to higher direct costs, offset in part by higher average pricing, as discussed below. Insperity | 2022 Second Quarter Form 10-Q 27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 $33 due to higher average pricing. The net increase in direct costs between YTD 2022 and YTD 2021 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $0.7 million as discussed below. The $41 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 $4 per WSEE per month and increased 3.1% on a cost per covered employee basis. • The percentage of WSEEs covered under our health insurance plans was 65.9% in YTD 2022 compared to 67.6% in YTD 2021. • Reported results include changes in estimated claims run-off related to prior periods which was an increase in costs of $10.2 million, or $6 per WSEE per month, in YTD 2022 compared to an increase in costs of $5.7 million, or $4 per WSEE per month, in YTD 2021. 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, workplace 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 8.0%, or $5 per WSEE per month, in YTD 2022 compared to YTD 2021. • As a percentage of non-bonus payroll cost, workers’ compensation costs in YTD 2022 were 0.21% compared to 0.28% in YTD 2021. • We recorded a reduction in workers’ compensation costs of $26.8 million, or 0.19% of non-bonus payroll costs, in YTD 2022 compared to a reduction of $23.0 million, or 0.21% of non-bonus payroll costs, in YTD 2021, 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 27.6% on a 25.4% increase in payroll costs, or $44 per WSEE per month, due to the non-recurrence of 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 7.1% in YTD 2022 compared to 7.0% in YTD 2021. 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. Insperity | 2022 Second Quarter Form 10-Q 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • 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 2022 Compared to Second Quarter 2021 The following table presents certain information related to our operating expenses: Three Months Ended June 30, per WSEE (in thousands, except per WSEE) 2022 2021 % Change 2022 2021 % Change Salaries $ 106,522 $ 94,362 12.9 % $ 123 $ 129 (4.7) % Stock-based compensation 15,631 13,781 13.4 % 18 19 (5.3) % Commissions 10,743 8,251 30.2 % 12 11 9.1 % Advertising 12,427 8,975 38.5 % 14 12 16.7 % General and administrative 36,095 29,211 23.6 % 41 41 — Depreciation and amortization 10,100 9,751 3.6 % 12 13 (7.7) % Total operating expenses $ 191,518 $ 164,331 16.5 % $ 220 $ 225 (2.2) % Operating expenses for Q2 2022 increased 16.5% to $191.5 million compared to $164.3 million in Q2 2021. Operating expenses per WSEE per month for Q2 2022 decreased 2.2% to $220 compared to $225 in Q2 2021. • Salaries of corporate and sales staff for Q2 2022 increased 12.9% to $106.5 million, but decreased $6 on a per WSEE per month basis, compared to Q2 2021 on the 19.4% increase in WSEEs paid per month. This increase was primarily due to a 5.2% increase in corporate headcount in Q2 2022 compared to Q2 2021, as well as higher incentive compensation accruals in Q2 2022 and increases due to staff compensation adjustments in response to current labor market dynamics and our recruiting and retention goals. • Stock-based compensation expense for Q2 2022 increased 13.4% to $15.6 million, but decreased $1 on a per WSEE per month basis, compared to Q2 2021. The increase was primarily due to awards issued under our restricted stock program. • Commissions expense for Q2 2022 increased 30.2% to $10.7 million, or $1 per WSEE per month, compared to Q2 2021. The increase was primarily due to commissions associated with our PEO HR Outsourcing solutions, including a new incentive program for our BPAs and sales managers. • Advertising expense for Q2 2022 increased 38.5% to $12.4 million, or $2 per WSEE per month, compared to Q2 2021. The increase was primarily due to increases in radio, print and digital advertising and sponsorship costs. Insperity | 2022 Second Quarter Form 10-Q 29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • General and administrative expenses for Q2 2022 increased 23.6% to $36.1 million, but remained flat on a per WSEE per month basis, compared to Q2 2021. The increase was primarily due to increased travel and event costs. • Depreciation and amortization expense for Q2 2022 increased 3.6% to $10.1 million, but decreased $1 on a per WSEE per month basis, compared to Q2 2021. The increase was primarily due to capital expenditures related to software development costs. First Six Months 2022 Compared to First Six Months 2021 Six Months Ended June 30, per WSEE (in thousands, except per WSEE) 2022 2021 % Change 2022 2021 % Change Salaries $ 213,961 $ 197,437 8.4 % $ 126 $ 138 (8.7) % Stock-based compensation 25,477 25,603 (0.5) % 15 18 (16.7) % Commissions 21,053 15,970 31.8 % 12 11 9.1 % Advertising 21,022 14,297 47.0 % 12 10 20.0 % General and administrative 77,100 60,847 26.7 % 45 43 4.7 % Depreciation and amortization 20,284 17,798 14.0 % 12 12 — Total operating expenses $ 378,897 $ 331,952 14.1 % $ 222 $ 232 (4.3) % Operating expenses for YTD 2022 increased 14.1% to $378.9 million compared to $332.0 million in YTD 2021. Operating expenses per WSEE per month for YTD 2022 decreased 4.3% to $222 compared to $232 in YTD 2021. • Salaries of corporate and sales staff for YTD 2022 increased 8.4% to $214.0 million, but decreased $12 on a per WSEE per month basis, compared to YTD 2021 on a 19.5% increase in WSEEs paid per month. This increase was primarily due to a 3.5% increase in corporate headcount, as well as increases due to staff compensation adjustments in response to current labor market dynamics and our recruiting and retention goals. • Commissions expense for YTD 2022 increased 31.8% to $21.1 million, or $1 per WSEE per month, compared to YTD 2021. The increase was primarily due to commissions associated with our PEO HR Outsourcing solutions, including a new incentive program for our BPAs and sales managers, as well as an increase in the amount of sales channel referral fees paid during YTD 2022. • Advertising expense for YTD 2022 increased 47.0% to $21.0 million, or $2 per WSEE per month, compared to YTD 2021. The increase was primarily due to increases in radio, print and digital advertising and sponsorship costs, partially offset by a reduction in television advertising. • General and administrative expenses for YTD 2022 increased 26.7% to $77.1 million, or $2 per WSEE per month, compared to YTD 2021. The increase was primarily due to increased travel and event costs, as well as technology SaaS licensing costs related to the implementation of a CRM solution. • Depreciation and amortization expense for YTD 2022 increased 14.0% to $20.3 million, but remained flat on a per WSEE per month basis, compared to YTD 2021. 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 and sales office expansions. Other Income (Expense) Other Income (expense) for Q2 2022 was net expense of $1.7 million compared to net expense of $0.5 million in Q2 2021, and for YTD 2022 was net expense of $3.5 million compared to net expense of $1.6 million in YTD 2021. Insperity | 2022 Second Quarter Form 10-Q 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income Tax Expense Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Effective income tax rate 27.9% 27.5% 27.7% 25.9% For the six months ended June 30, 2022, 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 2022 and 2021, we recognized an income tax benefit of $0.2 million and $2.2 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, • depreciation and amortization expense, and • amortization of SaaS implementation costs 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 | 2022 Second 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 June 30, Six Months Ended June 30, 2022 2021 2022 2021 Per WSEE Per WSEE Per WSEE Per WSEE Payroll cost $ 7,792,536 $ 8,942 $ 6,452,480 $ 8,842 $ 16,572,604 $ 9,706 $ 13,216,067 $ 9,246 Less: Bonus payroll cost 668,503 767 796,154 1,092 2,652,356 1,553 2,216,629 1,551 Non-bonus payroll cost $ 7,124,033 $ 8,175 $ 5,656,326 $ 7,750 $ 13,920,248 $ 8,153 $ 10,999,438 $ 7,695 % Change period over period 25.9 % 5.5 % 15.2 % 7.9 % 26.6 % 6.0 % 9.3 % 6.8 % 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, 2022 December 31, 2021 Cash, cash equivalents and marketable securities $ 541,650 $ 607,603 Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions 258,180 424,800 Client prepayments 116,646 20,054 Adjusted cash, cash equivalents and marketable securities $ 166,824 $ 162,749 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) 2022 2021 2022 2021 Per WSEE Per WSEE Per WSEE Per WSEE Net income $ 33,599 $ 39 $ 25,154 $ 34 $ 103,483 $ 61 $ 87,076 $ 61 Income tax expense 13,005 15 9,530 13 39,739 23 30,376 21 Interest expense 2,691 3 1,975 3 4,616 3 3,574 3 Depreciation and amortization 10,100 11 9,751 14 20,284 11 17,798 12 EBITDA 59,395 68 46,410 64 168,122 98 138,824 97 Stock-based compensation 15,631 18 13,781 18 25,477 15 25,603 18 Adjusted EBITDA $ 75,026 $ 86 $ 60,191 $ 82 $ 193,599 $ 113 $ 164,427 $ 115 % Change period over period 24.6 % 4.9 % (34.5) % (39.3) % 17.7 % (1.7) % (14.9) % (16.7) % Insperity | 2022 Second 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 June 30, Six Months Ended June 30, (in thousands) 2022 2021 2022 2021 Net income $ 33,599 $ 25,154 $ 103,483 $ 87,076 Non-GAAP adjustments: Stock-based compensation 15,631 13,781 25,477 25,603 Total non-GAAP adjustments 15,631 13,781 25,477 25,603 Tax effect (4,345) (3,643) (7,069) (6,621) Total non-GAAP adjustments, net 11,286 10,138 18,408 18,982 Adjusted net income $ 44,885 $ 35,292 $ 121,891 $ 106,058 % Change period over period 27.2 % (40.8) % 14.9 % (16.2) % 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) 2022 2021 2022 2021 Diluted EPS $ 0.87 $ 0.65 $ 2.68 $ 2.24 Non-GAAP adjustments: Stock-based compensation 0.41 0.35 0.66 0.66 Total non-GAAP adjustments 0.41 0.35 0.66 0.66 Tax effect (0.12) (0.09) (0.19) (0.18) Total non-GAAP adjustments, net 0.29 0.26 0.47 0.48 Adjusted EPS $ 1.16 $ 0.91 $ 3.15 $ 2.72 % Change period over period 27.5 % (40.9) % 15.8 % (16.0) % 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 revolving credit facility (“Facility”) with a syndicate of financial institutions, which we amended in June 2022 to, among other things, increase our borrowing capacity from $500 million to $650 million. 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 $541.7 million in cash, cash equivalents and marketable securities at June 30, 2022, of which approximately $258.2 million was payable in early July 2022 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $116.6 million represented client prepayments that were payable in July 2022. At June 30, 2022, we had working capital of $164.0 million compared to $116.3 million at December 31, 2021. 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 2022. 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 related to the ongoing impacts of the COVID-19 pandemic. As of June 30, 2022, 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 | 2022 Second Quarter Form 10-Q 33 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 2022 was $22.8 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, 2022, the last business day of the reporting period was a Thursday, client prepayments were $116.6 million and employment taxes and other deductions were $258.2 million. 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. • Workers’ compensation plan funding - During YTD 2022, we received $30.2 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 June 30, 2022, premiums owed and cash funded to United have exceeded the costs of the United plan, resulting in a $41.8 million surplus, $32.8 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 June 30, 2022, were $55.9 million, which is included in accrued health insurance costs, a current liability, on our Condensed Consolidated Balance Sheets. • Operating results – Our adjusted net income has a significant impact on our operating cash flows. Our adjusted net income increased 14.9% to $121.9 million in the first six months ended June 30, 2022, compared to $106.1 million in the first six months ended June 30, 2021. Please read “Results of Operations – First Six Months 2022 Compared to First Six Months 2021.” Cash Flows from Investing Activities Net cash flows used in investing activities were $8.6 million for the six months ended June 30, 2022, primarily due to property and equipment purchases of $9.0 million. Cash Flows from Financing Activities Net cash flows used in financing activities were $91.6 million for the six months ended June 30, 2022. We paid $37.1 million in dividends and repurchased or withheld $56.8 million in stock. Insperity | 2022 Second Quarter Form 10-Q 34 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND CONTROLS AND PROCEDURES