Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2017.
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from  _______________ to _______________

Commission File No. 1-13998
 Insperity, Inc.

(Exact name of registrant as specified in its charter)
Delaware
 
76-0479645
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
19001 Crescent Springs Drive
 
 
Kingwood, Texas
 
77339
(Address of principal executive offices)
 
(Zip Code)

(Registrant’s Telephone Number, Including Area Code):  (281) 358-8986

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ý  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company.  See definition of “large accelerated filer,” “accelerated filer”, “non-accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
Accelerated filer o
Non-accelerated filer o
(Do not check if a Smaller reporting company)
Smaller reporting company o
Emerging growth company o
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   
Yes o No ý
 
As of October 25, 2017, 20,842,861 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.



 
TABLE OF CONTENTS
 
 
 
 
 
Part I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II
 
 
 
Item 1.
 
 
 
Item 1a.
 
 
 
Item 2.
 
 
 
Item 6.


Table of Contents

PART I

ITEM 1.  FINANCIAL STATEMENTS

INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS

 
 
September 30,
2017
 
December 31, 2016
 
 
(Unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
285,934

 
$
286,034

Restricted cash
 
41,748

 
42,637

Marketable securities
 
1,950

 
1,851

Accounts receivable, net:
 
 

 
 

Trade
 
3,396

 
13,107

Unbilled
 
295,667

 
254,999

Other
 
3,228

 
2,178

Prepaid insurance
 
18,978

 
15,041

Other current assets
 
19,260

 
19,526

Income taxes receivable
 
878

 
4,949

Total current assets
 
671,039

 
640,322

 
 
 
 
 
Property and equipment:
 
 

 
 

Land
 
6,215

 
5,214

Buildings and improvements
 
95,162

 
90,151

Computer hardware and software
 
101,761

 
97,311

Software development costs
 
58,819

 
51,956

Furniture, fixtures and other
 
42,509

 
38,483

 
 
304,466

 
283,115

Accumulated depreciation and amortization
 
(210,726
)
 
(202,854
)
Total property and equipment, net
 
93,740

 
80,261

 
 
 
 
 
Other assets:
 
 

 
 

Prepaid health insurance
 
9,000

 
9,000

Deposits – health insurance
 
5,300

 
4,700

Deposits – workers’ compensation
 
142,821

 
143,938

Goodwill and other intangible assets, net
 
12,783

 
13,088

Deferred income taxes, net
 
8,205

 
14,025

Other assets
 
4,484

 
1,840

Total other assets
 
182,593

 
186,591

Total assets
 
$
947,372

 
$
907,174


- 3 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands)

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
September 30,
2017
 
December 31,
2016
 
 
(Unaudited)
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,070

 
$
4,189

Payroll taxes and other payroll deductions payable
 
185,456

 
247,766

Accrued worksite employee payroll cost
 
256,702

 
215,214

Accrued health insurance costs
 
34,543

 
26,360

Accrued workers’ compensation costs
 
44,011

 
44,231

Accrued corporate payroll and commissions
 
34,703

 
40,761

Other accrued liabilities
 
20,856

 
22,437

Total current liabilities
 
579,341

 
600,958

 
 
 
 
 
Noncurrent liabilities:
 
 
 
 

Accrued workers’ compensation costs
 
161,691

 
141,291

Long-term debt
 
104,400

 
104,400

Total noncurrent liabilities
 
266,091

 
245,691

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Stockholders’ equity:
 
 

 
 

Common stock
 
277

 
277

Additional paid-in capital
 
20,439

 
9,240

Treasury stock, at cost
 
(247,956
)
 
(227,152
)
Retained earnings
 
329,180

 
278,160

Total stockholders’ equity
 
101,940

 
60,525

Total liabilities and stockholders’ equity
 
$
947,372

 
$
907,174

 
See accompanying notes.

- 4 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Revenues (gross billings of $4.898 billion, $4.314 billion, $14.656 billion and $13.040 billion less worksite employee payroll cost of $4.102 billion, $3.611 billion, $12.182 billion and $10.828 billion, respectively)
 
$
795,513

 
$
702,538

 
$
2,473,729

 
$
2,212,278

 
 
 
 
 
 
 
 
 
Direct costs:
 
 

 
 

 
 

 
 

Payroll taxes, benefits and workers’ compensation costs
 
655,547

 
584,742

 
2,043,864

 
1,831,207

 
 
 
 
 
 
 
 
 
Gross profit
 
139,966

 
117,796

 
429,865

 
381,071

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

Salaries, wages and payroll taxes
 
65,223

 
56,897

 
189,138

 
170,910

Stock-based compensation
 
6,584

 
4,191

 
16,390

 
12,527

Commissions
 
5,675

 
5,030

 
15,815

 
13,646

Advertising
 
3,476

 
3,540

 
13,623

 
13,299

General and administrative expenses
 
24,513

 
21,318

 
75,315

 
66,356

Depreciation and amortization
 
4,696

 
4,047

 
13,355

 
12,494

 
 
110,167

 
95,023

 
323,636

 
289,232

Operating income
 
29,799

 
22,773

 
106,229

 
91,839

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 

 
 

 
 

 
 

Interest income
 
1,015

 
335

 
2,158

 
927

Interest expense
 
(894
)
 
(628
)
 
(2,320
)
 
(1,915
)
Income before income tax expense
 
29,920

 
22,480

 
106,067

 
90,851

Income tax expense
 
10,718

 
8,415

 
37,219

 
34,380

Net income
 
$
19,202

 
$
14,065

 
$
68,848

 
$
56,471

 
 
 
 
 
 
 
 
 
Less distributed and undistributed earnings allocated to participating securities
 
(337
)
 
(330
)
 
(1,233
)
 
(1,283
)
 
 
 
 
 
 
 
 
 
Net income allocated to common shares
 
$
18,865

 
$
13,735

 
$
67,615

 
$
55,188

 
 
 
 
 
 
 
 
 
Basic net income per share of common stock
 
$
0.92

 
$
0.66

 
$
3.29

 
$
2.64

 
 
 
 
 
 
 
 
 
Diluted net income per share of common stock
 
$
0.91

 
$
0.66

 
$
3.27

 
$
2.64


See accompanying notes.

- 5 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2017
(in thousands)
(Unaudited)
 
 
 
Common Stock Issued
 
Additional Paid-In Capital
 
Treasury Stock
 
Retained Earnings
 
Total
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
27,744

 
$
277

 
$
9,240

 
$
(227,152
)
 
$
278,160

 
$
60,525

Purchase of treasury stock, at cost
 

 

 

 
(27,172
)
 

 
(27,172
)
Stock-based compensation expense
 

 

 
10,553

 
5,837

 

 
16,390

Other
 

 

 
646

 
531

 
3

 
1,180

Dividends paid
 

 

 

 

 
(17,831
)
 
(17,831
)
Net income
 

 

 

 

 
68,848

 
68,848

Balance at September 30, 2017
 
27,744

 
$
277

 
$
20,439

 
$
(247,956
)
 
$
329,180

 
$
101,940

 
See accompanying notes.

- 6 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

 
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
68,848

 
$
56,471

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
13,355

 
12,494

Stock-based compensation
 
16,390

 
12,527

Deferred income taxes
 
5,820

 
7,205

Changes in operating assets and liabilities:
 
 

 
 

Restricted cash
 
889

 
(4,361
)
Accounts receivable
 
(32,007
)
 
(40,744
)
Prepaid insurance
 
(3,937
)
 
(10,179
)
Other current assets
 
266

 
(1,291
)
Other assets
 
(2,078
)
 
118

Accounts payable
 
(1,119
)
 
(1,347
)
Payroll taxes and other payroll deductions payable
 
(62,310
)
 
(43,317
)
Accrued worksite employee payroll expense
 
41,488

 
40,585

Accrued health insurance costs
 
8,183

 
7,064

Accrued workers’ compensation costs
 
20,180

 
16,172

Accrued corporate payroll, commissions and other accrued liabilities
 
(7,639
)
 
(9,543
)
Income taxes payable/receivable
 
4,071

 
(7,055
)
Total adjustments
 
1,552

 
(21,672
)
Net cash provided by operating activities
 
70,400

 
34,799

 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Marketable securities:
 
 

 
 

Purchases
 
(1,337
)
 
(946
)
Proceeds from dispositions
 

 
7,269

Proceeds from maturities
 
1,181

 
1,665

Property and equipment:
 
 
 
 
Purchases
 
(26,518
)
 
(21,302
)
Net cash used in investing activities
 
(26,674
)
 
(13,314
)

- 7 -

Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
(Unaudited)

 
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
Cash flows from financing activities:
 
 
 
 
Purchase of treasury stock
 
$
(27,172
)
 
$
(13,913
)
Repurchase of common stock
 

 
(144,263
)
Dividends paid
 
(17,831
)
 
(15,324
)
Proceeds from the exercise of stock options
 

 
598

Borrowings under long-term debt agreement
 

 
124,400

Principal repayments
 

 
(20,000
)
Other
 
1,177

 
1,029

Net cash used in financing activities
 
(43,826
)
 
(67,473
)
 
 
 
 
 
Net decrease in cash and cash equivalents
 
(100
)
 
(45,988
)
Cash and cash equivalents at beginning of period
 
286,034

 
269,538

Cash and cash equivalents at end of period
 
$
285,934

 
$
223,550

 


See accompanying notes.

- 8 -

Table of Contents

INSPERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


1.
Basis of Presentation

Insperity, Inc., a Delaware corporation (“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 SynchronizationTM solutions (together, our “PEO HR Outsourcing solutions”), which encompass a broad range of HR functions, including payroll and employment administration, employee benefits, workers’ compensation, government compliance, performance management, and training and development services, along with our cloud-based human capital management platform, the Employee Service CenterTM.

In addition to our PEO HR Outsourcing solutions, we offer a number of other business performance solutions, including Human Capital Consulting, Payroll & Human Capital Management, Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Financial and Expense Management Services, Retirement Services and Insurance Services, a number of which are offered via desktop applications and cloud-based delivery models. These other products and services are offered separately, along with our PEO HR Outsourcing solutions or as a bundle, such as our new Workforce AdministrationTM solution that provides a comprehensive human capital management and payroll services solution.

The Consolidated Financial Statements include the accounts of Insperity and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

The accompanying Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements at and for the year ended December 31, 2016. Our Consolidated Balance Sheet at December 31, 2016 has been derived from the audited financial statements at that date, but does not include all of the information or footnotes required by GAAP for complete financial statements.  Our Consolidated Balance Sheet at September 30, 2017 and our Consolidated Statements of Operations for the three and nine month periods ended September 30, 2017 and 2016, our Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2017 and 2016, and our Consolidated Statement of Stockholders’ Equity for the nine month period ended September 30, 2017, have been prepared by us without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows, have been made. Certain prior year amounts have been reclassified to conform to the 2017 presentation.

The results of operations for the interim periods are not necessarily indicative of the operating results for a full year or of future operations.
2.
Accounting Policies

Health Insurance Costs

We provide group health insurance coverage to our worksite employees in our PEO HR Outsourcing solutions through a national network of carriers, including UnitedHealthcare (“United”), UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield, and Tufts, all of which provide fully insured policies or service contracts.

The policy with United provides the majority of our health insurance coverage. As a result of certain contractual terms, we have accounted for this plan since its inception using a partially self-funded insurance accounting model. Accordingly, we record the costs of the United plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”) as benefits expense in our Consolidated Statements of Operations. The estimated incurred

- 9 -

Table of Contents

claims are based upon: (i) the level of claims processed during the quarter; (ii) estimated completion rates based upon recent claim development patterns under the plan; and (iii) the number of participants in the plan, including both active and COBRA enrollees. Each reporting period, changes in the estimated ultimate costs resulting from claim trends, plan design and migration, participant demographics and other factors are incorporated into the benefits costs.

Additionally, since the plan’s inception, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the premiums paid and owed to United, a deficit in the plan would be incurred and a liability for the excess costs would be accrued in our Consolidated Balance Sheets. On the other hand, if the Plan Costs for the reporting quarter are less than the premiums paid and owed to United, a surplus in the plan would be incurred and we would record an asset for the excess premiums in our Consolidated Balance Sheets. The terms of the arrangement require us to maintain an accumulated cash surplus in the plan of $9.0 million, which is reported as long-term prepaid insurance. In addition, United requires a deposit equal to approximately one day of claims funding activity, which was $5.1 million as of September 30, 2017, and is reported as a long-term asset. As of September 30, 2017, Plan Costs were less than the net premiums paid and owed to United by $24.5 million. As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $15.5 million difference is included in prepaid insurance, a current asset, in our Consolidated Balance Sheets. The premiums, including the additional quarterly premiums, owed to United at September 30, 2017 were $30.4 million, which is included in accrued health insurance costs, a current liability in our Consolidated Balance Sheets. Our benefits costs incurred in the first nine months of 2017 included a reduction of $1.1 million for changes in estimated run-off related to prior periods.

Workers’ Compensation Costs

Our workers’ compensation coverage for our worksite employees in our PEO HR Outsourcing solutions has been provided through an arrangement with the Chubb Group of Insurance Companies or its predecessors (the “Chubb Program”) since 2007. The Chubb Program is fully insured in that Chubb has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. Under the Chubb Program, we have financial responsibility to Chubb for the first $1 million layer of claims per occurrence and, for claims over $1 million, up to a maximum aggregate amount of $5 million per policy year for claims that exceed $1 million. Chubb bears the financial responsibility for all claims in excess of these levels.

Because we bear the financial responsibility for claims up to the levels noted above, such claims, which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing health care and indemnity coverage whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which take into account the ongoing development of claims and therefore requires a significant level of judgment.

We utilize a third party actuary to estimate our loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates. During the nine months ended September 30, 2017 and 2016, we reduced accrued workers’ compensation costs by $11.0 million and $9.1 million, respectively, for changes in estimated losses related to prior reporting periods. Workers’ compensation cost estimates are discounted to present value at a rate based upon the U.S. Treasury rates that correspond with the weighted average estimated claim payout period (the average discount rate utilized in the 2017 period was 1.5% and in the 2016 period was 1.0%) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.



- 10 -

Table of Contents

The following table provides the activity and balances related to incurred but not paid workers’ compensation claims:

 
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
 
Beginning balance, January 1,
 
$
183,928

 
$
162,174

Accrued claims
 
52,133

 
46,967

Present value discount
 
(3,048
)
 
(1,785
)
Paid claims
 
(29,574
)
 
(29,537
)
Ending balance
 
$
203,439

 
$
177,819

 
 
 
 
 
Current portion of accrued claims
 
$
41,748

 
$
41,778

Long-term portion of accrued claims
 
161,691

 
136,041

 
 
$
203,439

 
$
177,819


The current portion of accrued workers’ compensation costs on our Consolidated Balance Sheets at September 30, 2017 includes $2.3 million of workers’ compensation administrative fees.

As of September 30, 2017 and 2016, the undiscounted accrued workers’ compensation costs were $215.0 million and $187.7 million, respectively.

At the beginning of each policy period, the workers’ compensation insurance carrier establishes monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”). The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers’ compensation loss rates, as determined by the insurance carrier. Monies funded into the program for incurred claims expected to be paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds are included in deposits - workers’ compensation, a long-term asset in our Consolidated Balance Sheets. During the first nine months of 2017 and 2016, we received $22.7 million and $12.8 million, respectively, for the return of excess claim funds related to the workers’ compensation program, which resulted in a net decrease to deposits - workers’ compensation. As of September 30, 2017, we had restricted cash of $41.7 million and deposits - workers’ compensation of $142.8 million.

Our estimate of incurred claim costs expected to be paid within one year is included in short-term liabilities, while our estimate of incurred claim costs expected to be paid beyond one year is included in long-term liabilities on our Consolidated Balance Sheets.

New Accounting Pronouncements

We believe we have implemented the accounting pronouncements with a material impact on our financial statements and do not believe there are any new or pending pronouncements that will materially impact our financial position or results of operations, other than discussed below.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 outlines a single comprehensive revenue recognition model for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Under ASU No. 2014-09, an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, and early adoption is permitted. Companies may use either a full retrospective or a modified retrospective approach to adopt ASU No. 2014-09. We plan to adopt ASU 2014-09 effective January 1, 2018 using the modified retrospective method. Under this method, the guidance will be applied only to the most current period presented in the financial statements. While our technical analysis is on-going, we expect our revenue recognition policies to remain substantially unchanged as a result of adopting ASU 2014-09. Additionally, we do not anticipate significant changes in business processes or systems.


- 11 -

Table of Contents

In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard requires recognition of lease assets and lease liabilities for leases previously classified as operating leases. The guidance is effective for fiscal years beginning after December 15, 2018. We are currently reviewing the guidance and assessing the impact on our consolidated financial statements.
3.
Cash, Cash Equivalents and Marketable Securities

The following table summarizes our cash and investments in cash equivalents and marketable securities held by investment managers and overnight investments:

 
 
September 30,
2017
 
December 31,
2016
 
 
(in thousands)
Overnight holdings
 
 
 
 
Money market funds (cash equivalents)
 
$
260,000

 
$
255,091

Investment holdings
 
 

 
 

Money market funds (cash equivalents)
 
16,392

 
28,231

Marketable securities
 
1,950

 
1,851

 
 
278,342

 
285,173

Cash held in demand accounts
 
25,648

 
25,758

Outstanding checks
 
(16,106
)
 
(23,046
)
Total cash, cash equivalents and marketable securities
 
$
287,884

 
$
287,885

 
 
 
 
 
Cash and cash equivalents
 
$
285,934

 
$
286,034

Marketable securities
 
1,950

 
1,851

Total cash, cash equivalents and marketable securities
 
$
287,884

 
$
287,885


Our cash and overnight holdings fluctuate based on the timing of clients’ payroll processing cycles. Included in the cash, cash equivalents and marketable securities at September 30, 2017 and December 31, 2016, are $168.3 million and $221.7 million, respectively, of funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as $14.2 million and $21.3 million in client prepayments, respectively.
4.
Fair Value Measurements

We account for our financial assets in accordance with Accounting Standard Codification 820, Fair Value Measurement. This standard defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The fair value measurement disclosures are grouped into three levels based on valuation factors:

Level 1 - quoted prices in active markets using identical assets
Level 2 - significant other observable inputs, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other observable inputs
Level 3 - significant unobservable inputs


- 12 -

Table of Contents

Fair Value of Instruments Measured and Recognized at Fair Value

The following table summarizes the levels of fair value measurements of our financial assets:

 
 
Fair Value Measurements
 
 
(in thousands)
 
 
September 30,
2017
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
276,392

 
$
276,392

 
$

 
$

Municipal bonds
 
1,950

 

 
1,950

 

Total
 
$
278,342

 
$
276,392

 
$
1,950

 
$

 
 
 
Fair Value Measurements
 
 
(in thousands)
 
 
December 31,
2016
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
283,322

 
$
283,322

 
$

 
$

Municipal bonds
 
1,851

 

 
1,851

 

Total
 
$
285,173

 
$
283,322

 
$
1,851

 
$


The municipal bond securities valued as Level 2 investments are primarily pre-refunded municipal bonds that are secured by escrow funds containing U.S. government securities. Our valuation techniques used to measure fair value for these securities during the period consisted primarily of third party pricing services that utilized actual market data such as trades of comparable bond issues, broker/dealer quotations for the same or similar investments in active markets and other observable inputs.

Fair Value of Other Financial Instruments

The carrying amounts of cash, cash equivalents, restricted cash, accounts receivable, deposits and accounts payable approximate their fair values due to the short-term maturities of these instruments.

As of September 30, 2017, the carrying value of our borrowings under our revolving credit facility approximates fair value and was classified as Level 2 in the fair value hierarchy. Please read Note 5, “Long-Term Debt,” for additional information.
5.
Long-Term Debt

We have a revolving credit facility (the “Facility”) with borrowing capacity up to $200 million. The Facility may be increased to $250 million based on the terms and subject to the conditions set forth in the agreement relating to the Facility (the “Credit Agreement”). The Facility is available for working capital and general corporate purposes, including acquisitions, stock repurchases and issuances of letters of credit. Our obligations under the Facility are secured by 65% of the stock of our captive insurance subsidiary and are guaranteed by all of our domestic subsidiaries. At September 30, 2017, our outstanding balance on the Facility was $104.4 million, in addition we have an outstanding $1.0 million letter of credit issued under the Facility, providing us with an available borrowing capacity of $94.6 million.

The Facility matures on February 6, 2020. Borrowings under the Facility bear interest at an alternate base rate or LIBOR, at our option, plus an applicable margin. Depending on our leverage ratio, the applicable margin varies (i) in the case of LIBOR loans, from 2.00% to 2.75% and (ii) in the case of alternate base rate loans, from 0.00% to 0.75%. The alternate base rate is the highest of (i) the prime rate most recently published in The Wall Street Journal, (ii) the federal funds rate plus 0.50% and (iii) the 30-day LIBOR rate plus 2.00%. We also pay an unused commitment fee on the average daily unused

- 13 -

Table of Contents

portion of the Facility at a rate of 0.25%. The interest rate at September 30, 2017 was 2.99%. Interest expense and unused commitment fees are recorded in other income (expense).

The Facility contains both affirmative and negative covenants that we believe are customary for arrangements of this nature. Covenants include, but are not limited to, limitations on our ability to incur additional indebtedness, sell material assets, retire, redeem or otherwise reacquire our capital stock, acquire the capital stock or assets of another business, make investments and pay dividends. In addition, the Credit Agreement requires us to comply with financial covenants limiting our total funded debt, minimum interest coverage ratio and maximum leverage ratio. We were in compliance with all financial covenants under the Credit Agreement at September 30, 2017.
6.
Stockholders' Equity

During the first nine months of 2017, we repurchased or withheld an aggregate of 348,957 shares of our common stock, as described below.

Repurchase Program

Our Board of Directors (the “Board”) has authorized a program to repurchase shares of our outstanding common stock (“Repurchase Program”). The purchases are to be made from time to time in the open market or directly from stockholders at prevailing market prices based on market conditions and other factors. During the nine months ended September 30, 2017, 262,487 shares were repurchased under the Repurchase Program. As of September 30, 2017, we were authorized to repurchase an additional 873,782 shares under the Repurchase Program.

Withheld Shares

During the nine months ended, September 30, 2017, we withheld 86,470 shares to satisfy tax withholding obligations for the vesting of restricted stock awards.

Dividends

The Board declared quarterly dividends as follows:
 
 
2017
 
2016
 
 
(amounts per share)
 
 
 
 
 
First quarter
 
$
0.25

 
$
0.22

Second quarter
 
0.30

 
0.25

Third quarter
 
0.30

 
0.25


 During the nine months ended September 30, 2017 and 2016, we paid dividends totaling $17.8 million and $15.3 million, respectively.
7.
Net Income per Share

We utilize the two-class method to compute net income per share. The two-class method allocates a portion of net income to participating securities, which include unvested awards of share-based payments with non-forfeitable rights to receive dividends. Net income allocated to unvested share-based payments is excluded from net income allocated to common shares. Any undistributed losses resulting from dividends exceeding net income are not allocated to participating securities. Basic net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options.


- 14 -

Table of Contents

The following table summarizes the net income allocated to common shares and the basic and diluted shares used in the net income per share computations:
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Net income
 
$
19,202

 
$
14,065

 
$
68,848

 
$
56,471

Less distributed and undistributed earnings allocated to participating securities
 
(337
)
 
(330
)
 
(1,233
)
 
(1,283
)
Net income allocated to common shares
 
$
18,865

 
$
13,735

 
$
67,615

 
$
55,188

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
20,473

 
20,843

 
20,555

 
20,895

Incremental shares from assumed LTIP awards and conversions of common stock options
 
148

 
13

 
119

 
11

Adjusted weighted average common shares outstanding
 
20,621

 
20,856

 
20,674

 
20,906

8.
Commitments and Contingencies

Worksite Employee 401(k) Retirement Plan Class Action Litigation

In December 2015, a class action lawsuit was filed against us and the third party discretionary trustee of the Insperity 401(k) retirement plan available to eligible worksite employees (the “Plan”) in the United States District Court for the Northern District of Georgia, Atlanta Division, on behalf of Plan participants. This suit generally alleges that Insperity’s third-party discretionary trustee of the Plan and Insperity breached their fiduciary duties to plan participants by selecting an Insperity subsidiary to serve as the recordkeeper for the Plan, by causing participants in the Plan to pay excessive recordkeeping fees to the Insperity subsidiary, by failing to monitor other fiduciaries and by making imprudent investment choices. We believe we have meritorious defenses, and we intend to vigorously defend this litigation. As a result of uncertainty regarding the outcome of this matter, no provision has been made in the accompanying consolidated financial statements.

We are a defendant in various other lawsuits and claims arising in the normal course of business. Management believes it has valid defenses in these cases and is defending them vigorously. While the results of litigation cannot be predicted with certainty, management believes the final outcome of such litigation will not have a material adverse effect on our financial position or results of operations.

- 15 -

Table of Contents

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, 2016, as well as our Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q.

New Accounting Pronouncements

Please read Note 2 to the Consolidated Financial Statements, "Accounting Policies – New Accounting Pronouncements," for new accounting pronouncements information.

Results of Operations

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016.

The following table presents certain information related to our results of operations:

 
 
Three Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
 
(in thousands, except per share and
statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $4.898 billion and $4.314 billion, less worksite employee payroll cost of $4.102 billion and $3.611 billion, respectively)
 
$
795,513

 
$
702,538

 
13.2
%
Gross profit
 
139,966

 
117,796

 
18.8
%
Operating expenses
 
110,167

 
95,023

 
15.9
%
Operating income
 
29,799

 
22,773

 
30.9
%
Other income (expense)
 
121

 
(293
)
 
141.3
%
Net income
 
19,202

 
14,065

 
36.5
%
Diluted net income per share of common stock
 
0.91

 
0.66

 
37.9
%
Adjusted net income(1)
 
24,081

 
16,687

 
44.3
%
Adjusted diluted net income per share of common stock(1)
 
1.14

 
0.78

 
46.2
%
Adjusted EBITDA(1)
 
43,112

 
31,346

 
37.5
%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
186,641

 
168,909

 
10.5
%
Revenues per worksite employee per month(2)
 
$
1,421

 
$
1,386

 
2.5
%
Gross profit per worksite employee per month
 
250

 
232

 
7.8
%
Operating expenses per worksite employee per month
 
197

 
187

 
5.3
%
Operating income per worksite employee per month
 
53

 
45

 
17.8
%
Net income per worksite employee per month
 
34

 
28

 
21.4
%
 ____________________________________

(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) 
Gross billings of $8,748 and $8,513 per worksite employee per month, less payroll cost of $7,327 and $7,127 per worksite employee per month, respectively.


- 16 -

Table of Contents

Revenues

Our revenues for the third quarter of 2017 increased 13.2% over the 2016 period, primarily due to a 10.5% increase in the average number of worksite employees paid per month, and a 2.5%, or $35, increase in revenues per worksite employee per month.

We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. Our revenue by region for our PEO HR Outsourcing solutions for the quarters ended September 30, 2017 and 2016 was as follows:

 
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
204,318

 
$
178,159

 
14.7
 %
 
26.1
%
 
25.8
%
Southeast
 
92,646

 
78,854

 
17.5
 %
 
11.8
%
 
11.4
%
Central
 
131,978

 
111,458

 
18.4
 %
 
16.9
%
 
16.2
%
Southwest
 
184,572

 
163,314

 
13.0
 %
 
23.6
%
 
23.7
%
West
 
169,321

 
157,772

 
7.3
 %
 
21.6
%
 
22.9
%
 
 
782,835

 
689,557

 
13.5
 %
 
100.0
%
 
100.0
%
Other revenue(1)
 
12,678

 
12,981

 
(2.3
)%
 
 
 
 
Total revenue
 
$
795,513

 
$
702,538

 
13.2
 %
 
 
 
 
_____________________________

(1) Comprised primarily of revenues generated by our other products and services offerings.

The percentage of total PEO HR Outsourcing solutions revenues in our significant markets include the following:
 
 
Three Months Ended September 30,
 
 
2017
 
2016
 
 
 
 
 
Texas
 
21.7
%
 
22.1
%
California
 
16.9
%
 
18.0
%
New York
 
9.7
%
 
9.1
%
Other
 
51.7
%
 
50.8
%
Total
 
100.0
%
 
100.0
%

Our growth in the number of worksite employees paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs. During the third quarter of 2017, the number of worksite employees paid from new client sales improved as compared to the third quarter of 2016, client retention remained consistent with the third quarter of 2016, while the net change in existing clients declined as compared to the third quarter of 2016.

Gross Profit

Gross profit for the third quarter of 2017 increased 18.8% over the third quarter of 2016 to $140.0 million. The average gross profit per worksite employee increased 7.8% to $250 per month in the 2017 period from $232 per month in the 2016 period.

Our pricing objectives attempt to achieve a level of revenue per worksite employee that matches or exceeds changes in primary direct costs and operating expenses. Our revenues per worksite employee per month during the third quarter of 2017 increased 2.5% compared to the third quarter of 2016. Our direct costs, which primarily include payroll taxes, benefits and

- 17 -

Table of Contents

workers’ compensation expenses, increased 1.5% to $1,171 per worksite employee per month in the third quarter of 2017 compared to $1,154 in the third quarter of 2016. The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits decreased $8 per worksite employee per month, or 0.5% on a cost per covered employee basis, compared to the third quarter of 2016. Included in the third quarter of 2017 benefits costs is a reduction of $5.0 million, or $9 per worksite employee per month, for changes in estimated claims run-off related to prior periods. Included in the third quarter of 2016 benefits costs is a charge of $2.8 million, or $6 per worksite employee per month, for changes in estimated claim run-off related to prior periods. The percentage of worksite employees covered under our health insurance plans was 68.1% in the 2017 period compared to 68.5% in the 2016 period. 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 – Workers’ compensation costs increased $6 per worksite employee per month basis, compared to the third quarter of 2016. In the third quarter of 2017, as a result of closing out claims at lower than expected costs, we recorded reductions in workers’ compensation costs of $2.9 million, or 0.08% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods as compared to a $7.1 million reduction to workers’ compensation costs in 2016. Also in the third quarter of 2017, we received a premium tax refund from a former carrier of $1.2 million. As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.53% in the 2017 period compared to 0.46% in the 2016 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Workers’ Compensation Costs,” for a discussion of our accounting for workers’ compensation costs.

Payroll tax costs – Payroll taxes increased 15.3% due primarily to a 13.6% increase in payroll costs, or $19 per worksite employee per month, compared to the third quarter of 2016. Payroll taxes as a percentage of payroll costs were 6.3% in 2017 and 6.2% in 2016.

Operating Expenses

The following table presents certain information related to our operating expenses:

 
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
65,223

 
$
56,897

 
14.6
 %
 
$
116

 
$
112

 
3.6
 %
Stock-based compensation
 
6,584

 
4,191

 
57.1
 %
 
12

 
8

 
50.0
 %
Commissions
 
5,675

 
5,030

 
12.8
 %
 
10

 
10

 

Advertising
 
3,476

 
3,540

 
(1.8
)%
 
6

 
7

 
(14.3
)%
General and administrative expenses
 
24,513

 
21,318

 
15.0
 %
 
44

 
42

 
4.8
 %
Depreciation and amortization
 
4,696

 
4,047

 
16.0
 %
 
9

 
8

 
12.5
 %
Total operating expenses
 
$
110,167

 
$
95,023

 
15.9
 %
 
$
197

 
$
187

 
5.3
 %

Operating expenses increased 15.9% to $110.2 million compared to $95.0 million in the third quarter of 2016. Operating expenses per worksite employee per month increased to $197 in the 2017 period from $187 in the 2016 period. Adjusted operating expenses increased 14.7% to $108.9 million in the 2017 period from $95.0 million in the 2016 period. Please read “—Non-GAAP Financial Measures” for additional information. The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased $8.3 million or 14.6%, or $4 per worksite employee per month, compared to the 2016 period. This increase was primarily due to a 7.9% increase in corporate headcount, which includes an 11.7% increase in the number of Business Performance Advisors. In addition incentive compensation expense increased as a result of an accrual due to better than anticipated operating results.


- 18 -

Table of Contents

Stock-based compensation increased $2.4 million or 57.1%, or $4 per worksite employee per month, compared to the 2016 period. This increase was primarily due to performance-based awards issued under our Long-Term Incentive Program.

Commissions expense increased $0.6 million or 12.8%, but remained flat on a per worksite employee per month basis, compared to the 2016 period, primarily due to commissions associated with growth in our PEO HR Outsourcing solutions worksite employees.

General and administrative expenses increased $3.2 million or 15.0%, or $2 per worksite employee per month, compared to the 2016 period. The increase was primarily due to $1.2 million in charitable donations made in the quarter for Hurricane Harvey relief efforts. Excluding these donations, general and administrative expenses per worksite employee per month was $42 in both periods. The remaining increase was due to increased travel and training expenses and third-party software expenses attributable to growth in corporate staff as a result of worksite employee growth.

Income Tax Expense

Our effective income tax rate was 35.8% in the 2017 period compared to 37.4% in the 2016 period. Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. Our effective income tax rate for the third quarter of 2017 was also impacted by favorable adjustments related to research and development credits.

Operating and Net Income

Operating and net income per worksite employee per month was $53 and $34 in the 2017 period, respectively, versus $45 and $28 in the 2016 period, respectively.


- 19 -

Table of Contents

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016.

The following table presents certain information related to our results of operations:

 
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
 
(in thousands, except per share and statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $14.656 billion and $13.040 billion, less worksite employee payroll cost of $12.182 billion and $10.828 billion, respectively)
 
$
2,473,729

 
$
2,212,278

 
11.8
%
Gross profit
 
429,865

 
381,071

 
12.8
%
Operating expenses
 
323,636

 
289,232

 
11.9
%
Operating income
 
106,229

 
91,839

 
15.7
%
Other expense
 
(162
)
 
(988
)
 
83.6
%
Net income
 
68,848

 
56,471

 
21.9
%
Diluted net income per share of common stock
 
3.27

 
2.64

 
23.9
%
Adjusted net income(1)
 
79,994

 
64,463

 
24.1
%
Adjusted diluted net income per share of common stock(1)
 
3.80

 
3.01

 
26.2
%
Adjusted EBITDA(1)
 
139,150

 
118,110

 
17.8
%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
180,424

 
163,607

 
10.3
%
Revenues per worksite employee per month(2)
 
$
1,523

 
$
1,502

 
1.4
%
Gross profit per worksite employee per month
 
265

 
259

 
2.3
%
Operating expenses per worksite employee per month
 
199

 
197

 
1.0
%
Operating income per worksite employee per month
 
65

 
62

 
4.8
%
Net income per worksite employee per month
 
42

 
38

 
10.5
%
 ____________________________________

(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) 
Gross billings of $9,025 and $8,856 per worksite employee per month, less payroll cost of $7,502 and $7,354 per worksite employee per month, respectively.

Revenues

Our revenues for the nine months ended September 30, 2017 increased 11.8% over the 2016 period, primarily due to a 10.3% increase in the average number of worksite employees paid per month and 1.4%, or $21, increase in revenues per worksite employee per month.

We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. Our revenue by region for our PEO HR Outsourcing solutions for the nine months ended September 30, 2017 and 2016 was as follows:

- 20 -

Table of Contents

 
 
Nine Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
644,703

 
$
566,317

 
13.8
%
 
26.5
%
 
26.0
%
Southeast
 
283,501

 
236,393

 
19.9
%
 
11.6
%
 
10.9
%
Central
 
405,854

 
349,966

 
16.0
%
 
16.7
%
 
16.1
%
Southwest
 
573,773

 
519,147

 
10.5
%
 
23.6
%
 
23.9
%
West
 
527,217

 
502,417

 
4.9
%
 
21.6
%
 
23.1
%
 
 
2,435,048

 
2,174,240

 
12.0
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
38,681

 
38,038

 
1.7
%
 
 
 
 
Total revenue
 
$
2,473,729

 
$
2,212,278

 
11.8
%
 
 
 
 
______________________________

(1) Comprised primarily of revenues generated by our other products and services offerings.

The percentage of total PEO HR Outsourcing solutions revenues in our significant markets include the following:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
 
 
 
 
Texas
 
21.8
%
 
22.3
%
California
 
17.0
%
 
18.4
%
New York
 
9.9
%
 
9.5
%
Other
 
51.3
%
 
49.8
%
Total
 
100.0
%
 
100.0
%

Our growth in the number of worksite employees paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs. During the first nine months of 2017, the number of worksite employees paid from new client sales improved as compared to the first nine months of 2016, client retention remained consistent with the first nine months of 2016, while the net change in existing clients declined as compared to the first nine months of 2016.

Gross Profit

Gross profit for the first nine months of 2017 increased 12.8% over the first nine months of 2016 to $429.9 million. The average gross profit per worksite employee increased 2.3% to $265 per month in the 2017 period from $259 per month in the 2016 period.

Our pricing objectives attempt to achieve a level of revenue per worksite employee that matches or exceeds changes in primary direct costs and operating expenses. Our revenues per worksite employee per month during the first nine months of 2017 increased 1.4% compared to the first nine months of 2016. Our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 1.2% to $1,258 per worksite employee per month in the first nine months of 2017 compared to $1,243 in the first nine months of 2016. The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits increased $6 per worksite employee per month, or 1.6% on a cost per covered employee basis, compared to the first nine months of 2016. Included in 2017 benefits costs is a reduction of $1.1 million, or $1 per worksite employee per month for changes in estimated claim run-off related to prior periods. Benefits costs incurred in the first nine months of 2016 reflect reductions in estimated claims run-off related to prior periods of $4.6 million, or $3 per worksite employee per month. The percentage of worksite employees covered under our health insurance plans was 68.8% in the 2017 period compared to 69.2% in the 2016 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.

- 21 -

Table of Contents


Workers’ compensation costs – Workers’ compensation costs increased 6.0%, but decreased $2 on a per worksite employee per month basis, compared to the first nine months of 2016. In the first nine months of 2017, we recorded reductions in workers’ compensation costs of $11.0 million, or 0.10% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods. In the first nine months of 2016, we recorded reductions in workers’ compensation costs of $9.1 million, or 0.09% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods. As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.56% in the 2017 period compared to 0.59% in the 2016 period. 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 12.3% due primarily to a 12.5% increase in payroll costs, or $10 per worksite employee per month, compared to the first nine months of 2016. Payroll taxes as a percentage of payroll costs were 7.3% in both 2017 and 2016.  

Operating Expenses

The following table presents certain information related to our operating expenses:

 
 
Nine Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
189,138

 
$
170,910

 
10.7
%
 
$
116

 
$
116

 

Stock-based compensation
 
16,390

 
12,527

 
30.8
%
 
10

 
9

 
11.1
 %
Commissions
 
15,815

 
13,646

 
15.9
%
 
10

 
9

 
11.1
 %
Advertising
 
13,623

 
13,299

 
2.4
%
 
8

 
9

 
(11.1
)%
General and administrative expenses
 
75,315

 
66,356

 
13.5
%
 
46

 
45

 
2.2
 %
Depreciation and amortization
 
13,355

 
12,494

 
6.9
%
 
9

 
9

 

Total operating expenses
 
$
323,636

 
$
289,232

 
11.9
%
 
$
199

 
$
197

 
1.0
 %

Operating expenses increased 11.9% to $323.6 million in the first nine months of 2017 compared to $289.2 million in the first nine months of 2016. Operating expenses per worksite employee per month increased to $199 in the 2017 period from $197 in the 2016 period. Adjusted operating expenses increased 11.6% to $322.4 million in the 2017 period from $288.9 million in the 2016 period. Please read “—Non-GAAP Financial Measures” for additional information. The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased $18.2 million or 10.7%, but remained flat on a per worksite employee per month basis, compared to the 2016 period. This increase was primarily due to a 7.8% increase in corporate headcount, which includes a 10.9% increase in the number of Business Performance Advisors and in addition incentive compensation expense increased as a result of an accrual due to better than expected operating results.

Stock-based compensation increased $3.9 million or 30.8%, or $1 per worksite employee per month, compared to the 2016 period. This increase was primarily due to performance-based awards issued under our Long-Term Incentive Program.

Commissions expense increased $2.2 million or 15.9%, or $1 per worksite employee per month, compared to the 2016 period, primarily due to commissions associated with growth in our PEO HR Outsourcing solutions.

General and administrative expenses increased $9.0 million or 13.5%, or $1 per worksite employee per month, compared to the 2016 period. Included in the nine months ended September 2017 is a $1.2 million donation to Hurricane Harvey relief efforts. The remaining increase was due to increased travel and training expenses and third-party software expenses attributable to growth in corporate staff as a result of worksite employee growth.


- 22 -

Table of Contents

Depreciation and amortization expense increased $0.9 million or 6.9%, but remained flat on a per worksite employee per month basis, compared to the 2016 period.

Income Tax Expense

Our effective income tax rate was 35.1% in the 2017 period compared to 37.8% in the 2016 period. Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. In addition, as a result of our 2016 adoption of Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share Based Payment Accounting, during first quarter of 2017 and 2016, we recognized an income tax benefit of $3.3 million and $1.0 million, respectively, related to the vesting of restricted stock awards.

Operating and Net Income

Operating and net income per worksite employee per month was $65 and $42 in the 2017 period, respectively, versus $62 and $38 in the 2016 period, respectively.

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-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our worksite employees. Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program. As a result, 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.

Following is a GAAP to non-GAAP reconciliation of non-bonus payroll costs:

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
 
 
(in thousands, except per worksite employee per month data)
GAAP to non-GAAP reconciliation:
 
 
 
 
 
 
 
 
 
 
 
 
Payroll cost (GAAP)
 
$
4,102,820

 
$
3,611,159

 
13.6
%
 
$
12,181,816

 
$
10,828,301

 
12.5
%
Less: Bonus payroll cost
 
312,230

 
255,112

 
22.4
%
 
1,233,827

 
1,050,649

 
17.4
%
Non-bonus payroll cost
 
$
3,790,590

 
$
3,356,047

 
12.9
%
 
$
10,947,989

 
$
9,777,652

 
12.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Payroll cost per worksite employee per month (GAAP)
 
$
7,327

 
$
7,127

 
2.8
%
 
$
7,502

 
$
7,354

 
2.0
%
Less: Bonus payroll cost per worksite employee per month
 
557

 
504

 
10.5
%
 
760

 
714

 
6.4
%
Non-bonus payroll cost per worksite employee per month
 
$
6,770

 
$
6,623

 
2.2
%
 
$
6,742

 
$
6,640

 
1.5
%

Adjusted cash, cash equivalents and marketable securities excludes funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as client prepayments. We believe adjusted cash, cash equivalents and marketable securities is a useful measure of our available funds.


- 23 -

Table of Contents

Following is a GAAP to non-GAAP reconciliation of cash, cash equivalents and marketable securities:
 
 
September 30,
2017
 
December 31,
2016
 
 
(in thousands)
 
 
 
 
 
Cash, cash equivalents and marketable securities (GAAP)
 
$
287,884

 
$
287,885

Less: Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions
 
168,334

 
221,710

Customer prepayments
 
14,167

 
21,256

Adjusted cash, cash equivalents and marketable securities
 
$
105,383

 
$
44,919


Adjusted operating expenses represent operating expenses excluding the impact of charitable contributions related to Hurricane Harvey recovery efforts and stockholder advisory expenses. Our management believes adjusted operating expenses is a useful measure of our operating costs, as it allows for additional analysis of our operating expenses separate from the impact of these items.    

Following is a GAAP to non-GAAP reconciliation of operating expenses and adjusted operating expenses:

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
 
 
(in thousands, except per worksite employee per month data)
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses (GAAP)
 
$
110,167

 
$
95,023

 
15.9
%
 
$
323,636

 
$
289,232

 
11.9
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
Charitable donations to Hurricane Harvey relief efforts
 
1,218

 

 

 
1,218

 

 

Stockholder advisory expenses
 

 

 

 

 
323

 

Adjusted operating expenses (non-GAAP)
 
$
108,949

 
$
95,023

 
14.7
%
 
$
322,418

 
$
288,909

 
11.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses per worksite employee per month (GAAP)
 
$
197

 
$
187

 
5.3
%
 
$
199

 
$
197

 
1.0
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
Charitable donations to Hurricane Harvey relief efforts per worksite employee per month
 
2

 

 

 
1

 

 

Stockholder advisory expenses per worksite employee per month
 

 

 

 

 

 

Adjusted operating expenses per worksite employee per month (non-GAAP)
 
$
195

 
$
187

 
4.3
%
 
$
198

 
$
197

 
0.5
%

EBITDA represents net income computed in accordance with GAAP, plus interest expense, income tax expense and depreciation and amortization expense. Adjusted EBITDA represents EBITDA plus non-cash impairment and other charges, non-cash stock-based compensation, costs associated with charitable contributions related to Hurricane Harvey recovery efforts and stockholder advisory expenses. Our management believes EBITDA and adjusted EBITDA are often useful measures of our operating performance, as they allow for additional analysis of our operating results separate from the impact of these items.    


- 24 -

Table of Contents

Following is a GAAP to non-GAAP reconciliation of EBITDA and adjusted EBITDA:

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
 
 
(in thousands, except per worksite employee per month data)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (GAAP)
 
$
19,202

 
$
14,065

 
36.5
%
 
$
68,848

 
$
56,471

 
21.9
%
Income tax expense
 
10,718

 
8,415

 
27.4
%
 
37,219

 
34,380

 
8.3
%
Interest expense
 
894

 
628

 
42.4
%
 
2,320


1,915

 
21.1
%
Depreciation and amortization
 
4,696

 
4,047

 
16.0
%
 
13,355

 
12,494

 
6.9
%
EBITDA
 
35,510

 
27,155

 
30.8
%
 
121,742

 
105,260

 
15.7
%
Stock-based compensation
 
6,584

 
4,191

 
57.1
%
 
16,390

 
12,527

 
30.8
%
Charitable donations to Hurricane Harvey relief efforts
 
1,218