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, 2022, 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. 2023 Highlights First Quarter 2023 Compared to First Quarter 2022 • Average number of WSEEs paid per month increased 10.1% • Net income and diluted earnings per share (“diluted EPS”) increased 35.4% and 36.1% to $94.6 million and $2.45, respectively • Adjusted EPS increased 34.2% to $2.67 • Adjusted EBITDA increased 28.5% to $152.4 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 | 2023 First Quarter Form 10-Q 18 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 March 31, 2023 2022 % Change Financial data: Revenues $ 1,769,652 $ 1,577,837 12.2 % Gross profit 332,146 285,774 16.2 % Operating expenses 211,139 187,379 12.7 % Operating income 121,007 98,395 23.0 % Other income (expense), net 2,572 (1,777) — Net income 94,595 69,884 35.4 % Diluted EPS 2.45 1.80 36.1 % Non-GAAP financial measures (1) : Adjusted net income $ 103,099 $ 77,006 33.9 % Adjusted EBITDA 152,413 118,573 28.5 % Adjusted EPS 2.67 1.99 34.2 % Average WSEEs paid 306,691 278,660 10.1 % Statistical data (per WSEE per month) : Revenues (2) $ 1,923 $ 1,887 1.9 % Gross profit 361 342 5.6 % Operating expenses 229 224 2.2 % Operating income 132 118 11.9 % Net income 103 84 22.6 % ____________________________________ (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 March 31, (per WSEE per month) 2023 2022 Gross billings $ 12,446 $ 12,390 Less: WSEE payroll cost 10,523 10,503 Revenues $ 1,923 $ 1,887 Insperity | 2023 First Quarter Form 10-Q 19 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 Q1 2023, WSEEs paid increased 10.1% compared to Q1 2022. The number of WSEEs paid from new client sales remained consistent when compared to Q1 2022, while the net gain in our client base and client retention declined compared to Q1 2022. Average WSEEs Paid and Year-over-Year Growth Percentage Insperity | 2023 First Quarter Form 10-Q 20 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 | 2023 First Quarter Form 10-Q 21 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue and Year-over-Year Growth Percentage (in thousands) First Quarter 2023 Compared to First Quarter 2022 Our revenues for Q1 2023 were $1.8 billion, an increase of 12.2%, primarily due to the following: • Average WSEEs paid increased 10.1%. • Revenues per WSEE per month increased 1.9%, or $36. 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. Insperity | 2023 First Quarter Form 10-Q 22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The percentage of total PEO HR Outsourcing Solutions revenue in our significant markets includes the following: Significant Markets The middle market sector, which we generally define as those companies with approximately 150 to 5,000 WSEEs, includes smaller clients whose number of WSEEs have grown to approximately 150 or more WSEEs. 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 19.7% during Q1 2023 compared to Q1 2022, representing approximately 26.1% and 24.0% of our total average paid WSEEs during Q1 2023 and Q1 2022, respectively. 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. Insperity | 2023 First Quarter Form 10-Q 23 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS First Quarter 2023 Compared to First Quarter 2022 Gross Profit and Year-over-Year Growth Percentage (in thousands) Gross Profit per WSEE per Month and Year-over-Year Growth Percentage Gross profit for Q1 2023 increased 16.2% to $332.1 million compared to $285.8 million in Q1 2022. Gross profit per WSEE per month for Q1 2023 increased $19 to $361 compared to $342 in Q1 2022 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 $36 due to higher average pricing. The net decrease in direct costs between Q1 2023 and Q1 2022 attributable to the changes in cost estimates for benefits and workers’ compensation totaled $2.5 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: Insperity | 2023 First Quarter Form 10-Q 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Benefits costs • The cost of group health insurance and related employee benefits increased $5 per WSEE per month and increased 2.1% on a cost per covered employee basis in Q1 2023 as compared to Q1 2022. • The percentage of WSEEs covered under our health insurance plans was 65.4% in Q1 2023 compared to 66.3% in Q1 2022. • Reported results include changes in estimated claims run-off related to prior periods, which was a reduction in costs of $9.0 million, or $10 per WSEE per month, in Q1 2023 compared to an increase in costs of $0.8 million, or $1 per WSEE per month, in Q1 2022. 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 $5 per WSEE per month in Q1 2023 compared to Q1 2022 on a 13.0% increase in non-bonus payroll costs. • As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.25% in Q1 2023 and 0.20% in Q1 2022. • We recorded a reduction in workers’ compensation costs of $7.6 million, or 0.10% of non-bonus payroll costs in Q1 2023, as a result of closing out claims at lower than expected costs. In Q1 2022, we recorded a reduction of $14.9 million, or 0.22% of non-bonus payroll 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 11.2% on a 10.3% increase in payroll costs, or $8 per WSEE per month. • Payroll taxes as a percentage of payroll costs increased to 7.6% in Q1 2023 compared to 7.5% in Q1 2022. 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 Insperity | 2023 First Quarter Form 10-Q 25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ◦ 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. First Quarter 2023 Compared to First Quarter 2022 The following table presents certain information related to our operating expenses: Three Months Ended March 31, per WSEE (in thousands, except per WSEE) 2023 2022 % Change 2023 2022 % Change Salaries $ 124,541 $ 107,439 15.9 % $ 135 $ 129 4.7 % Stock-based compensation 11,110 9,846 12.8 % 12 12 — Commissions 11,017 10,310 6.9 % 12 12 — Advertising 5,940 8,595 (30.9 %) 6 10 (40.0 %) General and administrative 48,034 41,005 17.1 % 53 49 8.2 % Depreciation and amortization 10,497 10,184 3.1 % 11 12 (8.3 %) Total operating expenses $ 211,139 $ 187,379 12.7 % $ 229 $ 224 2.2 % • Operating expenses for Q1 2023 increased 12.7% to $211.1 million compared to $187.4 million in Q1 2022. Operating expenses per WSEE per month for Q1 2023 increased 2.2% to $229 compared to $224 in Q1 2022. • Salaries of corporate and sales staff for Q1 2023 increased 15.9% to $124.5 million, or $6 per WSEE per month, compared to Q1 2022, primarily due to an increase in the number of service and support personnel as well as in the number of Business Performance Advisors. • Stock-based compensation expense for Q1 2023 increased 12.8% to $11.1 million, but remained flat on a per WSEE per month basis, compared to Q1 2022. The increase was primarily due to awards issued under our restricted stock program. • Commissions expense for Q1 2023 increased 6.9% to $11.0 million, but remained flat on a per WSEE per month basis, compared to Q1 2022. • Advertising expense for Q1 2023 decreased 30.9% to $5.9 million, or $4 per WSEE per month, compared to Q1 2022. This decrease was primarily due to a change in the timing associated with advertising. • General and administrative expenses for Q1 2023 increased 17.1% to $48.0 million, or $4 per WSEE per month, compared to Q1 2022. The increase was primarily due to increased travel and event costs, software licensing costs, and amortization of SaaS implementation costs. Other Income (Expense) Interest income increased $8.6 million in Q1 2023 compared to Q1 2022 due to increases in interest rates earned on investments in marketable securities and workers’ compensation deposits. Interest expense increased $4.3 million in Q1 2023 compared to Q1 2022 due to increases in interest rates charged on borrowings under our credit facility. Insperity | 2023 First Quarter Form 10-Q 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income Tax Expense Three months ended March 31, 2023 2022 Effective income tax rate 23.5% 27.7% For the three months ended March 31, 2023, 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 three months of 2023 and 2022, we recognized an income tax benefit of $4.9 million and $0.5 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 | 2023 First Quarter Form 10-Q 27 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 March 31, 2023 2022 Per WSEE Per WSEE Payroll cost $ 9,681,610 $ 10,523 $ 8,780,068 $ 10,503 Less: Bonus payroll cost 2,002,043 2,176 1,983,853 2,373 Non-bonus payroll cost $ 7,679,567 $ 8,347 $ 6,796,215 $ 8,130 % Change period over period 13.0 % 2.7 % 27.2 % 6.4 % Following is a reconciliation of cash, cash equivalents and marketable securities (GAAP) to adjusted cash, cash equivalents and marketable securities (non-GAAP): (in thousands) March 31, 2023 December 31, 2022 Cash, cash equivalents and marketable securities $ 732,123 $ 765,896 Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions 457,778 504,817 Client prepayments 42,907 36,800 Adjusted cash, cash equivalents and marketable securities $ 231,438 $ 224,279 Following is a reconciliation of net income (GAAP) to EBITDA (non-GAAP) and adjusted EBITDA (non-GAAP): Three Months Ended March 31, (in thousands, except per WSEE per month) 2023 2022 Per WSEE Per WSEE Net income $ 94,595 $ 103 $ 69,884 $ 84 Income tax expense 28,984 32 26,734 32 Interest expense 6,205 7 1,925 2 Amortization of SaaS implementation costs 1,022 1 — — Depreciation and amortization 10,497 11 10,184 12 EBITDA 141,303 154 108,727 130 Stock-based compensation 11,110 12 9,846 12 Adjusted EBITDA $ 152,413 $ 166 $ 118,573 $ 142 % Change period over period 28.5 % 16.9 % 13.8 % (4.7 %) Insperity | 2023 First Quarter Form 10-Q 28 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 March 31, (in thousands) 2023 2022 Net income $ 94,595 $ 69,884 Non-GAAP adjustments: Stock-based compensation 11,110 9,846 Tax effect (2,606) (2,724) Total non-GAAP adjustments, net 8,504 7,122 Adjusted net income $ 103,099 $ 77,006 % Change period over period 33.9 % 8.8 % Following is a reconciliation of diluted EPS (GAAP) to adjusted EPS (non-GAAP): Three Months Ended March 31, (amounts per share) 2023 2022 Diluted EPS $ 2.45 $ 1.80 Non-GAAP adjustments: Stock-based compensation 0.29 0.25 Tax effect (0.07) (0.06) Total non-GAAP adjustments, net 0.22 0.19 Adjusted EPS $ 2.67 $ 1.99 % Change period over period 34.2 % 9.3 % 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 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 $732.1 million in cash, cash equivalents and marketable securities at March 31, 2023, of which approximately $457.8 million was payable in early April 2023 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $42.9 million represented client prepayments that were payable in April 2023. At March 31, 2023, we had working capital of $215.1 million compared to $158.5 million at December 31, 2022. 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 2023. 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. As of March 31, 2023, 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 | 2023 First Quarter Form 10-Q 29 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 three months of 2023 was $39.4 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 March 31, 2023, the last business day of the reporting period was a Friday, client prepayments were $42.9 million and employment taxes and other deductions were $457.8 million. In the period ended March 31, 2022, the last business day of the reporting period was a Thursday, client prepayments were $117.8 million and employment taxes and other deductions were $338.3 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 March 31, 2023, premiums owed and cash funded to United have exceeded the costs of the United plan, resulting in a $41.5 million surplus, $32.5 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 March 31, 2023 were $71.1 million, which is included in accrued health insurance costs, a current liability in 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 33.9% to $103.1 million in the three months ended March 31, 2023, compared to $77.0 million in the three months ended March 31, 2022. Please read “ Results of Operations – First Quarter 2023 Compared to First Q uarter 2022 .” Cash Flows from Investing Activities Net cash flows used in investing activities were $8.9 million for the three months ended March 31, 2023, primarily due to property and equipment purchases of $6.8 million. Cash Flows from Financing Activities Net cash flows used in financing activities were $46.8 million for the three months ended March 31, 2023. We paid $19.9 million in dividends and repurchased or withheld $34.6 million in stock. Insperity | 2023 First Quarter Form 10-Q 30 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND CONTROLS AND PROCEDURES