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 our 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 third quarter of 2022 (“Q3 2022”), the average number of WSEEs paid per month increased 17.8% year-over-year as the Q3 2022 increase in WSEEs paid from new sales and client retention exceeded the third quarter of 2021 (“Q3 2021”) levels. The net gain in our client base declined from Q3 2021, a period in which many clients were rehiring employees as the pandemic conditions improved. We expect the average number of paid WSEEs per month to increase between 14.5% and 15.5% in the fourth quarter of 2022 as compared to the fourth quarter of 2021, which, if achieved, would equate to the average number of paid WSEEs per month growing 1.5% to 2.4% sequentially from the third quarter of 2022. We experienced a 1.8% increase in the year-over-year benefits costs per covered employee during Q3 2022 as compared to Q3 2021. During Q3 2021, we experienced a 6.0% increase in the year-over-year benefits costs per covered employee as compared to Q3 2020. During the remainder of 2022 and possibly beyond 2022, benefits costs trends are expected to continue to be affected by the dynamics of the pandemic, including the impact on healthcare utilization and COVID-19 testing, vaccination and treatment costs. This has resulted and may continue to result in a higher or more volatile level of healthcare claims costs than our historical claim cost trends. We have experienced a reduced frequency in workers’ compensation claims since the beginning of the pandemic, driven by the trend toward hybrid and remote work. While certain COVID-19 cases are covered under workers’ compensation, they have not had a material impact on our workers’ compensation costs. 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 Third Quarter Form 10-Q 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2022 Highlights Third Quarter 2022 Compared to Third Quarter 2021 • Average number of WSEEs paid per month increased 17.8% • Net income and diluted earnings per share (“diluted EPS”) increased 38.0% and 40.0% to $37.7 million and $0.98, respectively • Adjusted EPS increased 38.2% to $1.23 • Adjusted EBITDA increased 32.7% to $79.8 million First Nine Months 2022 Compared to First Nine Months 2021 • Average number of WSEEs paid per month increased 18.9% • Net income and diluted EPS increased 23.4% and 24.5% to $141.2 million and $3.66, respectively • Adjusted EPS increased 21.0% to $4.38 • Adjusted EBITDA increased 21.8% to $273.4 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 | 2022 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, 2022 2021 % Change 2022 2021 % Change Financial data: Revenues $ 1,439,160 $ 1,209,628 19.0 % $ 4,449,104 $ 3,681,834 20.8 % Gross profit 244,553 198,479 23.2 % 770,195 649,478 18.6 % Operating expenses 191,922 158,876 20.8 % 570,819 490,828 16.3 % Operating income 52,631 39,603 32.9 % 199,376 158,650 25.7 % Other expense (1,274) (1,712) 25.6 % (4,797) (3,307) (45.1) % Net income 37,669 27,296 38.0 % 141,152 114,372 23.4 % Diluted EPS 0.98 0.70 40.0 % 3.66 2.94 24.5 % Non-GAAP financial measures (1) : Adjusted net income $ 47,420 $ 34,793 36.3 % $ 169,311 $ 140,851 20.2 % Adjusted EBITDA 79,811 60,133 32.7 % 273,410 224,560 21.8 % Adjusted EPS 1.23 0.89 38.2 % 4.38 3.62 21.0 % Average WSEEs paid 303,347 257,560 17.8 % 290,838 244,667 18.9 % Statistical data (per WSEE per month) : Revenues (2) $ 1,581 $ 1,565 1.0 % $ 1,700 $ 1,672 1.7 % Gross profit 269 257 4.7 % 294 295 (0.3) % Operating expenses 211 206 2.4 % 218 223 (2.2) % Operating income 58 51 13.7 % 76 72 5.6 % Net income 41 35 17.1 % 54 52 3.8 % ____________________________________ (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) 2022 2021 2022 2021 Gross billings $ 10,470 $ 10,346 $ 11,122 $ 10,755 Less: WSEE payroll cost 8,889 8,781 9,422 9,083 Revenues $ 1,581 $ 1,565 $ 1,700 $ 1,672 Insperity | 2022 Third 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 Q3 2022, WSEEs paid increased 17.8% compared to Q3 2021. The number of WSEEs paid from new client sales and client retention improved compared to Q3 2021, while the net gain in our client base continued, although at lower levels than Q3 2021, a period when many clients were rehiring employees as the pandemic conditions improved. • During the first nine months of 2022 (“YTD 2022”), WSEEs paid increased 18.9% compared to the first nine months of 2021 (“YTD 2021”). The number of WSEEs paid from new client sales, the net gain in our client base and client retention all improved compared to YTD 2021. Average WSEEs Paid and Year-over-Year Growth Percentage Insperity | 2022 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 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 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 2022 Compared to Third Quarter 2021 Our revenues for Q3 2022 were $1.4 billion, an increase of 19.0%, primarily due to the following: • Average WSEEs paid increased 17.8%. • Revenues per WSEE per month increased 1.0%, or $16. First Nine Months 2022 Compared to First Nine Months 2021 Our revenues for YTD 2022 were $4.4 billion, an increase of 20.8%, primarily due to the following: • Average WSEEs paid increased 18.9%. • Revenues per WSEE per month increased 1.7%, or $28. Insperity | 2022 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 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 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 23.3% during YTD 2022 compared to YTD 2021, representing approximately 24.6% and 23.7% of our total average paid WSEEs during YTD 2022 and YTD 2021, respectively. Insperity | 2022 Third 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 Third Quarter Form 10-Q 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Third Quarter 2022 Compared to Third Quarter 2021 Gross profit for Q3 2022 increased 23.2% to $244.6 million compared to $198.5 million in Q3 2021. Gross profit per WSEE per month for Q3 2022 increased $12 to $269 compared to $257 in Q3 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 $16 due to higher average pricing. The net decrease in direct costs between Q3 2022 and Q3 2021 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $13.0 million as discussed below. The $4 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 $6 per WSEE per month and increased 1.8% on a cost per covered employee basis in Q3 2022 as compared to Q3 2021. • The percentage of WSEEs covered under our health insurance plans was 64.7% in Q3 2022 compared to 66.4% in Q3 2021. • Reported results include changes in estimated claims run-off related to prior periods, which was a reduction in costs of $16.6 million, or $18 per WSEE per month, in Q3 2022 compared to a decrease in costs of $3.7 million, or $5 per WSEE per month, in Q3 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 increased 0.4%, but decreased $4 on a per WSEE per month basis, in Q3 2022 compared to Q3 2021 on a 23.9% increase in non-bonus payroll costs. • As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.25% in Q3 2022 and 0.30% Q3 2021. • We recorded a reduction in workers’ compensation costs of $9.4 million, or 0.12% of non-bonus payroll costs, in Q3 2022 compared to a reduction of $9.3 million, or 0.15% of non-bonus payroll costs, in Q3 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 21.7% on a 19.2% increase in payroll costs, or $18 per WSEE per month. • Payroll taxes as a percentage of payroll costs increased to 6.1% in Q3 2022 compared to 6.0% in Q3 2021. First Nine Months 2022 Compared to First Nine Months 2021 Gross profit for YTD 2022 increased 18.6% to $770.2 million compared to $649.5 million in YTD 2021. Gross profit per WSEE per month for YTD 2022 decreased $1 to $294 compared to $295 in YTD 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 $28 due to higher average pricing. Insperity | 2022 Third Quarter Form 10-Q 27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 $4.4 million as discussed below. The $29 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 remained flat on a per WSEE per month basis and increased 2.6% on a cost per covered employee basis. • The percentage of WSEEs covered under our health insurance plans was 65.5% in YTD 2022 compared to 67.2% in YTD 2021. • Reported results include changes in estimated claims run-off related to prior periods which was an increase in costs of $12.8 million, or $5 per WSEE per month, in YTD 2022 compared to an increase in costs of $4.5 million, or $2 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 4.9%, 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 0.22% compared to 0.29% in YTD 2021. • We recorded a reduction in workers’ compensation costs of $35.3 million, or 0.16% of non-bonus payroll costs, in YTD 2022 compared to a reduction of $31.4 million, or 0.18% 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 25.8% on a 23.3% increase in payroll costs, or $35 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 6.8% in YTD 2022 compared to 6.7% 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. • 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: Insperity | 2022 Third Quarter Form 10-Q 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ◦ 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 ◦ facility costs, including repairs and maintenance ◦ technology costs, including software-as-a-service (“SaaS”) subscription costs and amortization of SaaS implementation 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. Third Quarter 2022 Compared to Third Quarter 2021 The following table presents certain information related to our operating expenses: Three Months Ended September 30, per WSEE (in thousands, except per WSEE) 2022 2021 % Change 2022 2021 % Change Salaries $ 109,525 $ 89,232 22.7 % $ 120 $ 115 4.3 % Stock-based compensation 13,341 10,362 28.7 % 15 13 15.4 % Commissions 11,068 8,724 26.9 % 12 11 9.1 % Advertising 9,790 9,507 3.0 % 11 12 (8.3) % General and administrative 38,115 31,134 22.4 % 42 42 — Depreciation and amortization 10,083 9,917 1.7 % 11 13 (15.4) % Total operating expenses $ 191,922 $ 158,876 20.8 % $ 211 $ 206 2.4 % Operating expenses for Q3 2022 increased 20.8% to $191.9 million compared to $158.9 million in Q3 2021. Operating expenses per WSEE per month for Q3 2022 increased 2.4% to $211 compared to $206 in Q3 2021. • Salaries of corporate and sales staff for Q3 2022 increased 22.7% to $109.5 million, or $5 per WSEE per month, compared to Q3 2021 on the 17.8% increase in WSEEs paid per month. This increase was primarily due to a 10.6% increase in corporate headcount in Q3 2022 compared to Q3 2021, as well as higher incentive compensation accruals in Q3 2022. • Stock-based compensation expense for Q3 2022 increased 28.7% to $13.3 million, or $2 per WSEE per month, compared to Q3 2021. The increase was primarily due to awards issued under our restricted stock program. • Commissions expense for Q3 2022 increased 26.9% to $11.1 million, or $1 per WSEE per month, compared to Q3 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. • General and administrative expenses for Q3 2022 increased 22.4% to $38.1 million, but remained flat on a per WSEE per month basis, compared to Q3 2021. The increase was primarily due to increased travel and event costs, SaaS subscription costs and amortization of SaaS implementation costs. Insperity | 2022 Third Quarter Form 10-Q 29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS First Nine Months 2022 Compared to First Nine Months 2021 The following table presents certain information related to our operating expenses: Nine Months Ended September 30, per WSEE (in thousands, except per WSEE) 2022 2021 % Change 2022 2021 % Change Salaries $ 323,486 $ 286,669 12.8 % $ 123 $ 130 (5.4) % Stock-based compensation 38,818 35,965 7.9 % 15 16 (6.3) % Commissions 32,121 24,694 30.1 % 12 11 9.1 % Advertising 30,812 23,804 29.4 % 12 11 9.1 % General and administrative 115,215 91,981 25.3 % 44 42 4.8 % Depreciation and amortization 30,367 27,715 9.6 % 12 13 (7.7) % Total operating expenses $ 570,819 $ 490,828 16.3 % $ 218 $ 223 (2.2) % Operating expenses for YTD 2022 increased 16.3% to $570.8 million compared to $490.8 million in YTD 2021. Operating expenses per WSEE per month for YTD 2022 decreased 2.2% to $218 compared to $223 in YTD 2021. • Salaries of corporate and sales staff for YTD 2022 increased 12.8% to $323.5 million, but decreased $7 on a per WSEE per month basis, compared to YTD 2021 on a 18.9% increase in WSEEs paid per month. This increase was primarily due to a 5.9% increase in corporate headcount, as well as higher incentive compensation accruals in YTD 2022. • Stock-based compensation expense for YTD 2022 increased 7.9% to $38.8 million, but decreased $1 on a per WSEE per month basis, compared to YTD 2021. The increase was primarily due to awards issued under our restricted stock program. • Commissions expense for YTD 2022 increased 30.1% to $32.1 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 29.4% to $30.8 million, or $1 per WSEE per month, compared to YTD 2021. The increase was primarily due to increases in radio, print and digital advertising and sponsorship costs. • General and administrative expenses for YTD 2022 increased 25.3% to $115.2 million, or $2 per WSEE per month, compared to YTD 2021. The increase was primarily due to increased travel and event costs. • Depreciation and amortization expense for YTD 2022 increased 9.6% to $30.4 million, but decreased $1 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. Other Income (Expense) Other Income (expense) for Q3 2022 was net expense of $1.3 million compared to net expense of $1.7 million in Q3 2021, and for YTD 2022 was net expense of $4.8 million compared to net expense of $3.3 million in YTD 2021. Income Tax Expense Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Effective income tax rate 26.7% 28.0% 27.5% 26.4% For the nine months ended September 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 Insperity | 2022 Third Quarter Form 10-Q 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS awards. During the first nine 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. 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, 2022 2021 2022 2021 Per WSEE Per WSEE Per WSEE Per WSEE Payroll cost $ 8,089,535 $ 8,889 $ 6,784,378 $ 8,781 $ 24,662,139 $ 9,422 $ 20,000,445 $ 9,083 Less: Bonus payroll cost 583,703 641 726,187 940 3,236,059 1,236 2,942,817 1,337 Non-bonus payroll cost $ 7,505,832 $ 8,248 $ 6,058,191 $ 7,841 $ 21,426,080 $ 8,186 $ 17,057,628 $ 7,746 % Change period over period 23.9 % 5.2 % 18.2 % 6.4 % 25.6 % 5.7 % 12.3 % 6.7 % Insperity | 2022 Third Quarter Form 10-Q 31 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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, 2022 December 31, 2021 Cash, cash equivalents and marketable securities $ 596,636 $ 607,603 Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions 321,930 424,800 Client prepayments 35,794 20,054 Adjusted cash, cash equivalents and marketable securities $ 238,912 $ 162,749 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) 2022 2021 2022 2021 Per WSEE Per WSEE Per WSEE Per WSEE Net income $ 37,669 $ 41 $ 27,296 $ 35 $ 141,152 $ 54 $ 114,372 $ 52 Income tax expense 13,688 15 10,595 14 53,427 20 40,971 19 Interest expense 4,082 4 1,963 3 8,698 3 5,537 3 Amortization of SaaS implementation costs 948 1 — — 948 — — — Depreciation and amortization 10,083 12 9,917 12 30,367 13 27,715 12 EBITDA 66,470 73 49,771 64 234,592 90 188,595 86 Stock-based compensation 13,341 15 10,362 14 38,818 14 35,965 16 Adjusted EBITDA $ 79,811 $ 88 $ 60,133 $ 78 $ 273,410 $ 104 $ 224,560 $ 102 % Change period over period 32.7 % 12.8 % 4.5 % (6.0) % 21.8 % 2.0 % (10.5) % (15.0) % 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) 2022 2021 2022 2021 Net income $ 37,669 $ 27,296 $ 141,152 $ 114,372 Non-GAAP adjustments: Stock-based compensation 13,341 10,362 38,818 35,965 Total non-GAAP adjustments 13,341 10,362 38,818 35,965 Tax effect (3,590) (2,865) (10,659) (9,486) Total non-GAAP adjustments, net 9,751 7,497 28,159 26,479 Adjusted net income $ 47,420 $ 34,793 $ 169,311 $ 140,851 % Change period over period 36.3 % (1.7) % 20.2 % (13.0) % Insperity | 2022 Third Quarter Form 10-Q 32 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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) 2022 2021 2022 2021 Diluted EPS $ 0.98 $ 0.70 $ 3.66 $ 2.94 Non-GAAP adjustments: Stock-based compensation 0.35 0.27 1.01 0.92 Total non-GAAP adjustments 0.35 0.27 1.01 0.92 Tax effect (0.10) (0.08) (0.29) (0.24) Total non-GAAP adjustments, net 0.25 0.19 0.72 0.68 Adjusted EPS $ 1.23 $ 0.89 $ 4.38 $ 3.62 % Change period over period 38.2 % (2.2) % 21.0 % (12.8) % 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 with a borrowing capacity of $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 $596.6 million in cash, cash equivalents and marketable securities at September 30, 2022, of which approximately $321.9 million was payable in early October 2022 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $35.8 million represented client prepayments that were payable in October 2022. At September 30, 2022, we had working capital of $167.8 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 uncertainty related to the ongoing impacts of the COVID-19 pandemic. As of September 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. Cash Flows from Operating Activities Net cash provided by operating activities in the first nine months of 2022 was $122.0 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 September 30, 2022, the last business day of the reporting period was a Friday, client prepayments were $35.8 million and employment taxes and other deductions were $321.9 million. In the period ended September 30, 2021, the Insperity | 2022 Third Quarter Form 10-Q 33 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS last business day of the reporting period was a Thursday, client prepayments were $74.6 million and employment taxes and other deductions were $198.4 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 September 30, 2022, premiums owed and cash funded to United have exceeded the costs of the United plan, resulting in a $25.2 million surplus, $16.2 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, 2022, were $57.6 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 20.2% to $169.3 million in the first nine months ended September 30, 2022, compared to $140.9 million in the first nine months ended September 30, 2021. Please read “Results of Operations – First Nine Months 2022 Compared to First Nine Months 2021.” Cash Flows from Investing Activities Net cash flows used in investing activities were $19.9 million for the nine months ended September 30, 2022, primarily due to property and equipment purchases of $16.4 million. Cash Flows from Financing Activities Net cash flows used in financing activities were $123.4 million for the nine months ended September 30, 2022. We paid $56.9 million in dividends and repurchased or withheld $63.4 million in stock. Insperity | 2022 Third Quarter Form 10-Q 34 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND CONTROLS AND PROCEDURES