10-K 1 document-12312013x10k.htm 10-K Document - 12.31.2013 - 10K

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

FORM 10-K
(Mark One)
ý
 Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 
For the fiscal year ended December 31, 2013.
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

Securities Registered Pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share
 
New York Stock Exchange
Rights to Purchase Series A Junior Participating Preferred Stock
 
New York Stock Exchange
 
 
 
(Title of class)
 
(Name of Exchange on Which Registered)

Securities Registered Pursuant to Section 12(g) of the Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  
Yes ý   No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   
Yes o   No ý

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 website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o (Do not check if a smaller reporting company)
Smaller reporting company  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 February 3, 2014, 25,504,983 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.  As of the last business day of the registrant’s most recently completed second quarter, the aggregate market value of the common stock held by non-affiliates (based upon the June 30, 2013, closing price of the common stock as reported by the New York Stock Exchange) was approximately $688 million.

DOCUMENTS INCORPORATED BY REFERENCE

Part III information is incorporated by reference from the proxy statement for the annual meeting of stockholders to be held May 13, 2014, which the registrant intends to file within 120 days of the end of the fiscal year.



TABLE OF CONTENTS
Part I
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item S-K 401(b).
 
 
 
Part II
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
Part III
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
Part IV
 
 
 
Item 15.



PART I

Unless otherwise indicated, “Insperity,” “we,” “our” and “us” are used in this annual report to refer to Insperity, Inc. and its consolidated subsidiaries.  This annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  You can identify such forward-looking statements by the words “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” “likely,” “possibly,” “probably,” “goal,” “opportunity,” “objective,” “target,” “assume,” “outlook,” “guidance,” “predicts,” “appears,” “indicator” and similar expressions.  In the normal course of business, in an effort to help keep our stockholders and the public informed about our operations we may, from time to time, issue such forward-looking statements, either orally or in writing.  Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, or projections involving anticipated revenues, earnings or other operating results.  We base the forward-looking statements on our current expectations, estimates and projections.  We caution you that these statements are not guarantees of future performance and involve risks, uncertainties and assumptions that we cannot predict.  In addition, we have based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate.  Therefore, the actual results of the future events described in such forward-looking statements in this annual report, or elsewhere, could differ materially from those stated in such forward-looking statements.  Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this annual report, including, without limitation, factors discussed in Item 1, “Business,” Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 1.   BUSINESS.

General

Insperity, Inc., formerly named Administaff, Inc. (“Insperity”) provides an array of human resources (“HR”) and business solutions designed to help improve business performance.  Our name change, which was effective March 3, 2011, reflects our evolution over 27 years from a professional employer organization (“PEO”), an industry we pioneered, to our current position as a comprehensive business performance solutions provider.  We were organized as a corporation in 1986 and have provided PEO services since inception.

Our long-term strategy is to provide the best small and medium-sized businesses in the United States with our unique human resources service offering and to leverage our buying power and expertise to provide additional valuable services to clients.  Our most comprehensive HR business offering is provided through our PEO services, now known as our Workforce Optimization® solution, which encompasses a broad range of human resources functions, including payroll and employment administration, employee benefits, workers’ compensation, government compliance, performance management and training and development services.

In addition to our Workforce Optimization solution, we offer a number of other business performance solutions, including Human Capital Management, Payroll Services, Time and Attendance, Performance Management, Organizational Planning, Recruiting Services,  Employment Screening, Financial Services, Expense Management, Retirement Services and Insurance Services, (collectively “Adjacent Businesses”), many of which are offered via desktop applications and software as a service (“SaaS”) delivery models.  These other products or services are offered separately, as a bundle, or along with Workforce Optimization.

Our Workforce Optimization solution is designed to improve the productivity and profitability of small and medium-sized businesses.   It relieves business owners and key executives of many employer-related administrative and regulatory burdens, which enables them to focus on the core competencies of their businesses.  It also promotes employee performance through human resources management techniques designed to improve employee satisfaction.  We provide our Workforce Optimization solution by entering into a Client Service Agreement (“CSA”), which establishes a three-party relationship whereby we and our client act as co-employers of the employees who work at the client’s location (“worksite employees”). Under the CSA, we assume responsibility for personnel administration and compliance with most employment-related governmental regulations, while the client retains the employees’ services in its business and remains the employer for various other purposes.  We charge a comprehensive service fee (“comprehensive service fee” or “gross billing”), which is invoiced concurrently with the processing of payroll for the worksite employees of the client.  The comprehensive service fee consists of the payroll of our worksite employees and a markup computed as a percentage of the payroll cost of the worksite employees.

We accomplish the objectives of our Workforce Optimization solution through a “high-touch/high-tech” approach to service delivery.   In advisory areas, such as recruiting, employee performance management and employee training, we employ a high-touch approach designed to ensure that our clients receive the personal attention and expertise needed to create a

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customized human resources solution.  For transactional processing, we employ a high-tech approach that provides secure, convenient information exchange among Insperity, our clients and our worksite employees, creating efficiencies for all parties.  The primary component of the high-tech portion of our strategy is the Employee Service CenterSM (“ESC”).  The ESC is our web-based interactive Workforce Optimization solution delivery platform, which is designed to provide automated, personalized Workforce Optimization solutions to our clients and worksite employees.

As of December 31, 2013, we had 57 offices, including 48 Workforce Optimization sales offices in 25 markets.  In addition, we had four regional service centers along with human resources and client service personnel located in a majority of our 25 sales markets, which serviced an average of 130,732 worksite employees per month in the fourth quarter of 2013.  Our service centers coordinate Workforce Optimization solutions for clients on a regional basis and localized face-to-face human resources services.

Our principal executive offices are located at 19001 Crescent Springs Drive, Kingwood, Texas 77339.  Our telephone number at that address is (281) 358-8986 and our website address is insperity.com.  Our stock is traded on the New York Stock Exchange under the symbol “NSP.”  Periodic Securities and Exchange Commission (“SEC”) filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through our website free of charge as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

PEO Industry

The PEO industry began to evolve in the early 1980s largely in response to the burdens placed on small and medium-sized employers by an increasingly complex legal and regulatory environment.  While various service providers were available to assist these businesses with specific tasks, PEOs emerged as providers of a more comprehensive range of services relating to the employer/employee relationship.  In a PEO arrangement, the PEO assumes certain aspects of the employer/employee relationship as defined in the contract between the PEO and its client.  Because PEOs provide employer-related services to a large number of employees, they can achieve economies of scale that allow them to perform employment-related functions more efficiently, provide a greater variety of employee benefits, and devote more attention to human resources management than a client can individually.

We believe the key factors driving demand for PEO services include:

the focus on growth and productivity of the small and medium-sized business community in the United States, utilizing outsourcing to concentrate on core competencies
the need to provide competitive health care and related benefits to attract and retain employees
the increasing costs associated with health and workers’ compensation insurance coverage, workplace safety programs, employee-related complaints and litigation
complex regulation of employment issues and the related costs of compliance, including the allocation of time and effort to such functions by owners and key executives

A significant factor in the development of the PEO industry has been increasing recognition and acceptance of PEOs and the co-employer relationship by federal and state governmental authorities.  Insperity and other industry leaders, in concert with the National Association of Professional Employer Organizations (“NAPEO”), have worked with the relevant governmental entities for the establishment of a regulatory framework that protects clients and employees, discourages unscrupulous and financially unsound companies, and promotes further development of the industry.  Currently, 41 states have enacted legislation either recognizing PEOs or requiring licensing, registration, or certification, and several others are considering such regulation.  Such laws vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs.  State regulation assists in screening insufficiently capitalized PEO operations and helps to resolve interpretive issues concerning employee status for specific purposes under applicable state law.  We have actively supported such regulatory efforts and are currently recognized, licensed, registered, certified or pursuing registration in all 41 of these states. The cost of compliance with these regulations is not material to our financial position or results of operations.

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Service Offerings

Workforce Optimization® Solution
 
We serve small and medium-sized businesses by providing our Workforce Optimization solution, which encompasses a broad range of services, including the following:
 
benefits and payroll administration
health and workers’ compensation insurance programs
personnel records management
employer liability management
employee recruiting and selection
employee performance management
training and development services

Our Workforce Optimization solution is designed to attract and retain high-quality employees, while relieving client owners and key executives of many employer-related administrative and regulatory burdens.  Among the employment-related laws and regulations that may affect a client are the following:

Ÿ
Internal Revenue Code (the “Code”)
Ÿ
The Family and Medical Leave Act (FMLA)*
Ÿ
Federal Income Contribution Act (FICA)
Ÿ
Genetic Information Nondiscrimination Act of 2008
Ÿ
Federal Unemployment Tax Act (FUTA)
Ÿ
Drug-Free Workplace Act*
Ÿ
Fair Labor Standards Act (FLSA)*
Ÿ
Occupational Safety and Health Act (OSHA)*
Ÿ
Employee Retirement Income Security Act, as amended (ERISA)
Ÿ
Worker Adjustment and Retraining Notification Act (WARN)*
Ÿ
Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA)*
Ÿ
Uniformed Services Employment and Reemployment Rights Act (USERRA)
Ÿ
Immigration Reform and Control Act (IRCA)
Ÿ
State unemployment and employment security laws
Ÿ
Title VII (Civil Rights Act of 1964)*
Ÿ
State workers’ compensation laws
Ÿ
Health Insurance Portability and Accountability Act (HIPAA)
Ÿ
Health Care and Education Reconciliation Act of 2010 (the “Reconciliation Act”)
Ÿ
Age Discrimination in Employment Act (ADEA)*
Ÿ
Patient Protection and Affordable Care Act (PPACA)
Ÿ
Americans with Disabilities Act (ADA)*
 
 
 
*    And similar state laws

While these laws and regulations are complex, and in some instances overlapping, we assist our clients in achieving compliance with these laws and regulations by providing services in four primary categories:

administrative functions
benefit plans administration
personnel management
employer liability management

All of the following services are included in our Workforce Optimization solution and are available to all clients:

Administrative Functions.  Administrative functions encompass a wide variety of processing and recordkeeping tasks, mostly related to payroll administration and government compliance.  Specific examples include:
 
payroll processing
payroll tax deposits
quarterly payroll tax reporting
employee file maintenance
unemployment claims processing
workers’ compensation claims reporting


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Benefit Plans Administration.  We maintain several benefit plans including the following:
 
a group health plan
a health savings account program
a health care flexible spending account plan
an educational assistance plan
an adoption assistance plan
group term life insurance
group universal life insurance
accidental death and dismemberment insurance
short-term and long-term disability insurance
a 401(k) retirement plan
cafeteria plans for group health and health savings account contributions

The group health plan includes medical, dental, vision and prescription drug coverage, as well as a work-life program. All benefit plans are provided to eligible employees based on the specific eligibility provisions of each plan.  We are the policyholder responsible for the costs and premiums associated with any group insurance policies that provide benefits under these plans, and we act as plan sponsor and administrator of the plans.  We negotiate the terms and costs of the plans, maintain the plans in accordance with applicable federal and state regulations and serve as liaison for the delivery of such benefits to worksite employees.  COBRA coverage is extended to eligible terminated worksite and corporate employees and other eligible individuals, in accordance with applicable law. We believe that the variety and comprehensive nature of our benefit plan offerings are generally not available to employees in our small and medium-sized business target market and are usually offered only by larger companies that can spread program costs over a much larger group of employees.  As a result, we believe the availability of these benefit plans provides our clients with a competitive advantage that small and medium-sized businesses are typically unable to attain on their own.

Personnel Management.  We provide a wide variety of personnel management services that give our clients access to resources normally found only in the human resources departments of large companies. All clients have access to our comprehensive personnel guide, which sets forth a systematic approach to administering personnel policies and practices, including recruiting, discipline and termination procedures.  Other personnel management services we provide include:

drafting and reviewing personnel policies and employee handbooks
designing job descriptions
performing prospective employee screening and background investigations
designing performance appraisal processes and forms
professional development and issues-oriented training
employee counseling
substance abuse awareness training
outplacement services
compensation guidance

Employer Liability Management.  Under the CSA, we assume many of the employment-related responsibilities associated with the administrative functions, benefit plans administration and personnel management services we provide.  For many of those employment-related responsibilities that are the responsibility of the client or that we share with our clients, we may assist our clients in managing and limiting exposure.  This includes first-time and ongoing safety-related risk management reviews, as well as the implementation of safety programs designed to reduce workplace accidents and consequently, workers’ compensation claims.  We also provide guidance to clients for avoiding discrimination, sexual harassment and civil rights violations, and participate in termination decisions to attempt to minimize liability on those grounds.  While we do not provide legal services to our clients, we employ in-house and external counsel, specializing in several areas of employment law, who have broad experience in disputes concerning the employer/employee relationship and who provide support to our human resources service specialists.  As part of our comprehensive service, we also maintain employment practice liability insurance coverage for ourselves and our clients, monitor changing government laws and regulations, and notify clients of the potential effect of such changes on employer liability.


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Employee Service CenterSM.  The ESC is our web-based interactive Workforce Optimization solution delivery platform, which is designed to provide automated, personalized Workforce Optimization content and services to our clients and worksite employees.  The ESC provides a wide range of functionality, including:

WebPayroll for the submission, approval and reporting of payroll data
client-specific payroll information and reports
employee information, including online check stubs and pay history reports
employee on-boarding including payroll enrollment, policy acknowledgments and employment verification
employee benefits enrollment and changes
employee-specific benefits content, including summary plan descriptions and enrollment status
access to 401(k) plan information through the Retirement Service CenterSM powered by Insperity® 
self-service and customizable access to data and reports through an interactive reporting environment
online human resources forms
best practices human resources management process maps and process overviews
online personnel guide
e-Learning web-based training
online recruiting services
links to benefits providers and other key vendors
frequently asked questions

MarketPlaceSM provided by Insperity®.  Through our many alliances with best-of-class providers, Insperity’s MarketPlace is an eCommerce portal that brings a wide range of products and services to our clients, worksite employees and their families.  Through MarketPlace, our clients also have the opportunity to offer their products and services to other clients and worksite employees.

MidMarket Solutions.  We believe the mid-market sector, which we generally define as those companies with employees ranging from 150 to 2,000 worksite employees, has historically been under-served by the PEO industry.  Currently, we have a dedicated sales management and consulting staff who concentrate solely on the mid-market sector.  In addition, we have service personnel who have been trained and specialize in the mid-market sector.  The mid-market sector, which represented approximately 19% of our total paid worksite employees during 2013, increased 8% over 2012.

Adjacent Business Unit Offerings

Our ABU strategy is designed to expand the type of business performance improvement services we offer to our current and prospective clients and to increase our overall client base by providing services that can be offered separately from our Workforce Optimization solution. We also strive to leverage our ABU customer relationships to cross sell our Workforce Optimization solution as well as other ABU services. During 2013 and 2012, total ABU revenues unrelated to our Workforce Optimization solution as a percentage of our total revenues were 1.4% and 1.2%, respectively. Also during 2013 and 2012, our ABU gross profit unrelated to our Workforce Optimization as a percentage of our total gross profit was 5.6% and 4.3%, respectively.  The following are the key components of our ABU services, which are offered separately or as a bundle:

Human Capital Management.  Insperity HCM is a comprehensive human capital management solution for human resources data and processes.  This SaaS solution is a unified human resources suite that includes payroll processing, tax compliance, employee administration, benefits management and enrollment, reporting and analytics, as well as employee and manager self-service.  The solution is offered as a stand-alone SaaS solution or in conjunction with our Payroll Services offering and/or our Time and Attendance products.  We initially launched this product late in 2012.

Payroll Services.  Insperity® Payroll Services offers a robust SaaS payroll solution that is designed to help alleviate administrative burdens associated with payroll processing and government-related compliance and includes a premium level support of our highly skilled service team.  We offer a seamless integration with three new offerings, including Insperity NetSaver, an online 401(k) solution for small businesses; a pay-as-you-go workers’ compensation program; and HR Essentials, a fully integrated HR platform that assists companies with tracking employee data, important milestones and company property.

Time and Attendance.  Our Time and Attendance business unit provides small to medium-sized businesses, including Workforce Optimization clients, with software, hardware and services to track, allocate, and analyze employee resources and provide inputs into customers’ payroll processing and accounting systems.  The service is delivered as a SaaS solution or as an “on-premise” client-server solution.  Custom interfaces exist between our Time and Attendance products and our Workforce Optimization technologies for those customers utilizing both services.

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Performance Management.  Our Performance Management business provides human resources software offerings including a suite of desktop products:  Insperity® Descriptions Now®, Insperity® Policies Now®, Insperity® Performance Now®, and Insperity® Ultimate Employer®; along with Insperity® PerformSmart® a performance management SaaS offering.  Insperity PerformSmart has been integrated into our Workforce Optimization solution and we will continue to sell to both Workforce Optimization and non-Workforce Optimization customers through online subscription arrangements, packaged software ordered online, and through various reseller arrangements.

Organizational Planning.  In January 2011, we entered the organizational planning and analysis solution business with our acquisition of certain assets from HumanConcepts associated with the OrgPlus® desktop product lines for small and medium-sized businesses and a source code license for a SaaS based version.  In December 2012 we launched the SaaS product derived from this source code, OrgPlus® Realtime.  Organizational planning facilitates the creation, management and communication of detailed organizational management charts.

Recruiting Services.  Our Recruiting Services business unit offers direct hire placement on an as-needed basis and provides outsourced support for individual requisitions or large-scale hiring projects.  In addition, we provide consulting services to assist in the creation and maintenance of consistent hiring practices and retention strategies.  We also provide compensation services, behavior-based interview training and talent assessment.  These services are provided to both Workforce Optimization customers and non-Workforce Optimization customers.

Employment Screening.  Our Employment Screening business unit offers a customized approach to background-check reporting for companies, including our Workforce Optimization clients. Services include criminal records checks; verification of employment history or education; driving record, civil record and credit history checks; and confirmation of extraordinary credentials.

Financial Services.  In 2012, we announced the launch of Insperity® Financial Services.  This suite of financial management tools and solutions for small to medium-sized companies provides business owners with financial intelligence. The core products and services include Insperity Reveal®, a Web-based financial dashboard and toolset, and an outsourced, online bookkeeping and controller service offered through an alliance with a third party.

Expense Management.  Our Expense Management business unit delivers employee expense management solutions that automate employee expense reporting, enforce travel and expense policies, and provide management reporting and analysis.  The service is delivered both as a SaaS solution and as a desktop software product.

Retirement Services.  Our Retirement Services business unit delivers comprehensive 401(k) plan recordkeeping and administrative services to small and medium-sized businesses, primarily to our Workforce Optimization clients. Services include employee education and enrollment, participant communications, elective deferral withholding and transmission, matching contribution calculation, loan and distribution processing, regulatory filing preparation and nondiscrimination testing.

Insurance Services.  Our Insurance Services business unit offers assistance to small businesses to secure affordable, customizable business insurance packages and life, health and disability insurance policies. Insurance Services also assists individuals in obtaining insurance solutions.

Client Service Agreement

All Workforce Optimization clients execute a CSA with us.  The CSA generally provides for an ongoing relationship between Insperity and the Workforce Optimization client.  The CSA generally is subject to termination by Insperity or the client upon 30 days written notice or upon shorter notice in the event of default.  The CSA establishes our comprehensive service fee, which is subject to periodic adjustments to account for changes in the composition of the client’s workforce, employee benefit election changes and statutory changes that affect our costs.  Under the provisions of the CSA, clients active in January of any year are obligated to pay the estimated payroll tax component of the comprehensive service fee in a manner that reflects the pattern of incurred payroll tax costs.  This practice aligns clients’ payments to Insperity for payroll taxes with Insperity’s obligations to make payments to tax authorities, which are higher in the earlier part of the year, and decrease as limits on wages subject to payroll tax, are reached.  New clients enrolling subsequent to January of any year are invoiced at a relatively constant rate throughout the remaining portion of the year, resulting in Insperity’s improving profitability over the course of the year for those clients because of the typical pattern of incurred payroll tax costs.

The CSA also establishes the division of responsibilities between Insperity and the client as co-employers.  Pursuant to the CSA, we are responsible for personnel administration and are liable for compliance with certain employment-related

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government regulations.  In addition, we assume liability for payment of salaries and wages (as well as related payroll taxes) of our worksite employees and responsibility for providing specified employee benefits to such persons.  These liabilities are not contingent on the prepayment by the client of the associated comprehensive service fee and, as a result of our employment relationship with each of our worksite employees, we are liable for payment of salary and wages to the worksite employees as reported by the client and are responsible for providing specified employee benefits to such persons, regardless of whether the client pays the associated comprehensive service fee.  The client retains the employees’ services and remains liable for complying with certain government regulations that require control of the worksite or daily supervisory responsibility or is otherwise beyond our ability to assume.  A third group of responsibilities and liabilities are shared by Insperity and the client where such joint responsibility is appropriate.  The specific division of applicable responsibilities under the majority of CSAs are as follows:

Insperity

Payment of wages and salaries as reported by the client and related tax reporting and remittance (local, state and federal withholding, FICA, FUTA, state unemployment)
Workers’ compensation compliance, procurement, management and reporting
Compliance with the Code, COBRA, HIPAA and ERISA (for each employee benefit plan sponsored solely by Insperity), as well as monitoring changes in other governmental laws and regulations governing the employer/employee relationship and updating the client when necessary
Offering benefits under Insperity-sponsored employee benefit plans that comply with PPACA requirements
Employee benefits administration of plans sponsored solely by Insperity

Client

Payment, through Insperity, of commissions, bonuses, vacations, paid time off, sick pay, paid leaves of absence and severance payments
Payment and related tax reporting and remittance of non-qualified deferred compensation and equity-based compensation
Ownership and protection of all client intellectual property rights
Compliance with OSHA regulations, EPA regulations, FLSA, FMLA, WARN, USERRA and state and local equivalents and compliance with government contracting provisions
Compliance with federal, state and local pay or play health care mandates and all such other similar federal, state and local legislation
Compliance with the National Labor Relations Act (“NLRA”), including all organizing efforts and expenses related to a collective bargaining agreement and related benefits
Professional licensing requirements, fidelity bonding and professional liability insurance
Products produced and/or services provided
COBRA, HIPAA and ERISA compliance for client-sponsored benefit plans

Joint

Implementation of policies and practices relating to the employee/employer relationship
Compliance with all federal, state and local employment laws, including, but not limited to Title VII of the Civil Rights Act of 1964, ADEA, Title I of ADA, the Consumer Credit Protection Act, and immigration laws and regulations

We maintain employment practice liability insurance coverages (including coverages for our clients) to manage our exposure for various employee-related claims, and as a result, our incurred costs with respect to this exposure have historically been insignificant to our operating results.

Because we are a co-employer with the client for some purposes, it is possible that we could incur liability for violations of such laws, even if we are not responsible for the conduct giving rise to such liability.  The CSA addresses this issue by providing that the client will indemnify us for liability incurred to the extent the liability is attributable to conduct by the client.  Notwithstanding this contractual right to indemnification, it is possible that we could be unable to collect on a claim for indemnification and may therefore be ultimately responsible for satisfying the liability in question.

In most instances, clients are required to remit their comprehensive service fees no later than one day prior to the applicable payroll date by wire transfer or automated clearinghouse transaction.  Although we are ultimately liable, as the employer for payroll purposes, to pay employees for work previously performed, we retain the ability to terminate immediately the CSA and associated worksite employees or to require prepayment, letters of credit or other collateral upon deterioration in a

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client’s financial condition or upon non-payment by a client.  These rights, the periodic nature of payroll, and the overall quality of our client base have resulted in an excellent overall collections history.

Workforce Optimization Clients

Insperity’s Workforce Optimization solution provides a value-added, full-service human resources solution we believe is most suitable to a specific segment of the small and medium-sized business community.  We target successful businesses with 10 to 2,000 employees that recognize the advantage in the strategic use of high-performance human resources practices.  We refer to clients with approximately 150 to 2,000 employees as mid-market clients.  These clients, which represented approximately 19% of our total client base as of December 31, 2013, are sold and serviced by sales and service personnel who specialize in the mid-market sector.  We have set a long-term goal to serve approximately 10% of the overall small and medium-sized business community.  We serve clients and worksite employees located throughout the United States.  By region, our 2013 revenue change compared to 2012 and revenue distribution for the year ended December 31, 2013, was as follows:

 
 
Revenue Change
 
% of Total Revenues
Northeast
 
3.0
%
 
26.0
%
Southeast
 
7.4
%
 
9.6
%
Central
 
5.4
%
 
14.8
%
Southwest
 
3.0
%
 
27.6
%
West
 
5.8
%
 
22.0
%

As part of our client selection strategy, we generally do not offer our Workforce Optimization solution to businesses falling within certain specified NAICS (North American Industry Classification System) codes, attempting to minimize our exposure to certain industries which we believe present a higher employer risk such as employee injury, high turnover or litigation.  All prospective Workforce Optimization clients are evaluated individually on the basis of workers’ compensation risk, group medical history (where permitted by law), unemployment history, operating stability and human resources practices.

Our client base is broadly distributed throughout a wide variety of industries including:

Industry
 
% of Client Base
Computer and information services
 
25
%
Finance, insurance and real estate
 
14
%
Management, administration and consulting services
 
14
%
Manufacturing
 
9
%
Wholesale trade
 
8
%
Medical services
 
7
%
Retail trade
 
5
%
Not-for-profit and similar organizations
 
5
%
Engineering, accounting and legal services
 
4
%
Construction
 
4
%
Other
 
5
%

This diverse client base lowers our exposure to downturns or volatility in any particular industry.  However, our performance could be affected by a downturn in one of these industries or by general economic conditions within the small and medium-sized business community.

We focus heavily on client retention.  During both 2013 and 2012, our retention rate was approximately 81%. Insperity’s client retention record over the last five years reflects that approximately 79% of our Workforce Optimization clients remain for more than one year.  The average annual retention rate over the last five years was approximately 80%.  Client attrition is attributable to a variety of factors, including: (i) client non-renewal due to price or service factors; (ii) client business

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failure, sale, merger, or disposition; (iii) our termination of the CSA resulting from the client’s non-compliance or inability to make timely payments; and (iv) competition from other PEOs or business services firms.

Marketing and Sales

As of December 31, 2013, we had 48 Workforce Optimization sales offices located in 25 markets.  Our sales offices typically consist of six to eight Business Performance Advisors (“BPAs”), a district sales manager and an office administrator.  To take advantage of economic efficiencies, multiple sales offices may share a physical location.  Insperity’s markets and their respective year of entry are as follows:

 
 
 
 
Initial
Market
 
Sales Offices
 
Entry Date
Houston
 
5
 
1986
San Antonio
 
1
 
1989
Austin
 
1
 
1989
Orlando
 
1
 
1989
Dallas/Fort Worth
 
4
 
1993
Atlanta
 
2
 
1994
Phoenix
 
1
 
1995
Chicago
 
2
 
1995
Washington D.C.
 
2
 
1995
Denver
 
2
 
1996
Los Angeles
 
5
 
1997
Charlotte
 
1
 
1997
St. Louis
 
1
 
1998
San Francisco
 
3
 
1998
New York
 
3
 
1999
Maryland
 
2
 
2000
New Jersey
 
2
 
2000
San Diego
 
1
 
2001
Boston
 
2
 
2001
Minneapolis
 
2
 
2002
Raleigh
 
1
 
2006
Kansas City
 
1
 
2007
Columbus
 
1
 
2010
Nashville
 
1
 
2011
Philadelphia
 
1
 
2012

Our existing and prospective markets are identified using a systematic market evaluation and selection process. We continue to evaluate a broad range of factors in the selection process, using a market selection model that weights various criteria we believe are reliable predictors of successful penetration based on our experience. Among the factors we consider are:

market size, in terms of small and medium-sized businesses engaged in selected industries that meet our risk profile;
market receptivity to PEO services, including the regulatory environment and relevant history with other PEO providers;
existing relationships within a given market, such as vendor or client relationships;
expansion cost issues, such as advertising and overhead costs;
direct cost issues that bear on our effectiveness in controlling and managing the cost of our services, such as; workers’ compensation and health insurance costs, unemployment risks and various legal and other factors;
a comparison of the services we offer to alternatives available to small and medium-sized businesses in the relevant market, such as the cost to the target clients of procuring services directly or through other PEOs; and

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long-term strategy issues, such as the general perception of markets and our estimate of the long-term revenue growth potential of the market.

Each of our expansion markets, beginning with Dallas in 1993, was selected in this manner.

In 2011, we launched our rebranding initiative whereby Administaff became Insperity; a new brand backed by an innovative strategy for meeting the ongoing performance needs of America’s best companies.  The name Insperity is drawn from the linked entrepreneurial goals of inspiration and prosperity, and underscores our ongoing vision of helping businesses succeed.

We develop a mix of national and local advertising media and a placement strategy tailored to each individual market.  After selecting a market and developing our marketing mix, but prior to entering the market, we engage in an organized media and public relations campaign to prepare the market for our entry and to begin the process of generating sales leads.  We market our services through various business promotions and a broad range of media outlets, including television, radio, newspapers, periodicals, direct mail and the Internet.  We employ public relations firms for most of our markets as well as advertising consultants to coordinate and implement our marketing campaigns.  We have developed an inventory of television, radio and newsprint advertisements, which are utilized in this effort.

We continuously seek to develop new marketing approaches and campaigns to capitalize on changes in the competitive landscape for our human resources services and to more successfully reach our target market.  We have an agreement with the Professional Golf Association Champions Tour to be the title sponsor of the annual Insperity Invitational presented by UnitedHealthcare® professional golf tournament held annually in The Woodlands, Texas (a suburb of Houston).  In addition, we have arrangements with Arnold Palmer and Jim Nantz, a sports commentator, to serve as our national spokespersons.  Our marketing campaigns use this event and the relationships with Mr. Palmer and Mr. Nantz as a focal point of our brand marketing efforts.

Our organic growth model generates sales leads from five primary sources: direct sales efforts, advertising, referrals, marketing alliances and the Internet.  These leads result in initial presentations to prospective Workforce Optimization clients, and ultimately, prospective Workforce Optimization client census reports.  A prospective Workforce Optimization client’s census report reflects information gathered by the BPA about the prospect’s employees, including job classification, state of employment, workers’ compensation claims history, group medical information (where permitted by law), salary and desired level of benefits.  This information is entered into our customized bid system, which applies Insperity’s proprietary pricing model to the census data, leading to the preparation of a bid.  Concurrent with this process, we evaluate the prospective client’s workers’ compensation, health insurance, employer practices and financial stability from a risk management perspective.  Upon completion of a favorable risk evaluation, the BPA presents the bid and attempts to enroll the prospect.  Our selling process typically takes approximately 90 days for clients with less than 150 employees, and up to approximately 180 days for larger clients. The process can be extended during economic downturns.

We have implemented cross-selling channels between our Workforce Optimization business and our ABUs in order to execute on our ABU strategy.  This strategy focuses on using our Workforce Optimization offering to increase market penetration in each of our ABU businesses and using our ABU offering as a source of leads for our Workforce Optimization solution.  The cross-selling channels attempt to reduce barriers to selling our products and services and results in tailored service packages to better meet the specific needs of the business.

Competition

We provide a value-added, full-service human resources solution through our Workforce Optimization solution, which we believe is most suitable to a specific segment of the small and medium-sized business community.  This full-service approach is exemplified by our commitment to provide a high level of service and technology personnel, which has produced a ratio of corporate staff to worksite employees (the “staff support ratio”) that is higher than average for the PEO industry.  Based on an analysis of the 2010 through 2012 annual NAPEO surveys of the PEO industry, we have successfully leveraged our full-service approach into significantly higher returns for Insperity on a per worksite employee per month basis.  During the three-year period from 2010 through 2012, our staff support ratio averaged 55% higher than the PEO industry average.  During the same three-year period, our gross profit per worksite employee and operating income per worksite employee exceeded industry averages by 154% and 249%, respectively.

Competition in the PEO industry revolves primarily around quality of services, scope of services, choice and quality of benefits packages, reputation and price.  We believe reputation, national presence, regulatory expertise, financial resources, risk management and information technology capabilities distinguish leading PEOs from the rest of the industry.  We also

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believe we compete favorably in these areas; however, other PEOs may offer their PEO services at more competitive prices than we may be able to offer.

Due to the differing geographic regions and market segments in which most PEOs operate, and the relatively low level of market penetration by the industry, we consider our primary competition to be the traditional in-house provision of human resources services.  The PEO industry is highly fragmented, and we believe Insperity is one of the largest PEO service providers in the United States.  Our largest national competitors include PEO divisions of large business services companies such as Automatic Data Processing, Inc. and Paychex, Inc., and other national PEOs, such as TriNet.  In addition, we compete to some extent with: i) fee-for-service providers such as payroll processors and human resources consultants; ii) human resources technology solution companies; and iii) large regional PEOs in certain areas of the country.  As Insperity and other large PEO service providers expand nationally, we expect that competition may intensify.

Vendor Relationships

Insperity provides benefits to its worksite employees under arrangements with a variety of vendors. We consider our contracts with UnitedHealthcare (“United”) and member insurance companies of ACE American Insurance Company (“ACE”) to be the most significant elements of our employee benefits package.  These contracts would be the most difficult to replace.

We provide group health insurance coverage to our worksite employees through a national network of carriers including United, UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield of Hawaii, Unity Health Plan and Tufts, all of which provide fully insured policies or service contracts. The health insurance contract with United provides approximately 85% of our health insurance coverage and expires on December 31, 2015, subject to cancellation by either party upon 180 days notice. For a discussion of our contract with United, which is accounted for using a partially self-funded insurance accounting model, please read Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Benefits Costs.”

Our workers’ compensation coverage (the “ACE Program”) has been provided through an arrangement with ACE since 2007.  The ACE Program is a fully insured policy whereby ACE has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. For additional discussion of the ACE Program, which includes terms shifting some of the economic burden to us, please read Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Workers’ Compensation Costs.”

Information Technology

Insperity utilizes a variety of information technology capabilities to provide its human resources services and business performance improvement services to its clients and worksite employees and for its own administrative and management information requirements.

Insperity’s Workforce Optimization information system is a proprietary system that utilizes internally developed and licensed software applications.  This system manages transactions and information unique to the Workforce Optimization solution and to Insperity, including:

worksite employee enrollment
human resources management
benefits and defined contribution plan administration
payroll processing
client invoicing and collection
management information and reporting
sales bid calculations

Our ABUs utilize a variety of owned and licensed software applications to deliver business performance improvement services to our clients, including to some of our Workforce Optimization clients.

Central to the system are transaction processing capabilities that allow us to process a high volume of payroll, invoice, and bid transactions that meet the specific needs of our clients and prospects.  We administer our employee benefits through a proprietary application designed to process employee eligibility and enrollments, manage carrier relationships, and maintain a variety of plan offerings.  Our retirement services operations are conducted utilizing an industry leading retirement plan administration application in a third-party hosted environment.  Aspects of all of these components are delivered to our Workforce Optimization clients and worksite employees through the ESC.  We utilize commercially available software for

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other business functions such as finance and accounting, contract and litigation management, sales force activity management and customer relationship management.

Insperity has hosting facilities located at our corporate headquarters in Kingwood, Texas (a suburb of Houston), and in Bryan, Texas.  The hosting facilities house the majority of our business applications, telecommunications equipment and network equipment.  Each hosting facility houses a mix of primary production applications, disaster recovery, replication and back-up applications, and pre-production environments with the Bryan facility acting as our primary data center for all mission-critical applications.  Both hosting facilities are designed to run all of our critical business applications and have sufficient capacity to handle all of our operations on a stand-alone basis, if required.  Periodically, we perform testing to ensure our disaster recovery capabilities remain effective and available.  We leverage the hosting facilities and related infrastructure that we originally designed for our Workforce Optimization system to support the systems required for our business performance improvement services offered through our ABUs.  We also utilize additional leased hosting facilities for certain of our business units.

Our network infrastructure ensures appropriate connectivity exists among all of our facilities and employees and provides appropriate Internet connectivity to conduct business with our clients and worksite employees.  The network infrastructure is provided through industry standard core network hardware and via high-speed network services provided by multiple vendors.

We have incorporated a variety of measures to maintain the security and privacy of the information managed through our systems and applications.  These measures include industry standard technologies designed to protect, monitor and assess the network environment; best practice security policies and procedures; and standard access controls designed to control access to sensitive and private information.

Industry Regulations

Insperity’s Workforce Optimization operations are affected by numerous federal and state laws relating to tax, insurance and employment matters.  By entering into a co-employer relationship with our worksite employees, we assume certain obligations and responsibilities of an employer under these federal and state laws.  Because many of these federal and state laws were enacted prior to the development of nontraditional employment relationships, such as PEOs, temporary employment and outsourcing arrangements, many of these laws do not specifically address the obligations and responsibilities of nontraditional employers.  Currently, 41 states have passed laws that recognize PEOs or require licensing, registration or certification requirements for PEOs, and several others are considering such regulation.

As an employer, we are subject to federal statutes and regulations governing the employer/employee relationship.  Subject to the issues discussed below, we believe that our operations are in compliance, in all material respects, with all applicable federal statutes and regulations.

Employee Benefit Plans

We offer various employee benefits plans to eligible employees, including our worksite employees.  These plans include:

a 401(k) retirement plan
cafeteria plans under Code Section 125
a group health plan, which includes medical, dental, vision and prescription drug coverage, as well as a work-life program
a health savings account program
a welfare benefits plan, which includes life, disability and accidental death and dismemberment coverage
a health care flexible spending account plan
an educational assistance program
an adoption assistance program
a commuter benefits program

Generally, employee benefit plans are subject to provisions of the Code, ERISA and COBRA.

Employer Status.  In order to qualify for favorable tax treatment under the Code, employee benefit plans must be established and maintained by an employer for the exclusive benefit of its employees.  Generally, an entity is an “employer” of individuals for federal employment tax purposes if an employment relationship exists between the entity and the individuals

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under the common law test of employment.  In addition, the officers of a corporation are deemed to be employees of that corporation for federal employment tax purposes.  The common law test of employment, as applied by the IRS, involves an examination of approximately 20 factors to ascertain whether an employment relationship exists between a worker and a purported employer.  Generally, the test is applied to determine whether an individual is an independent contractor or an employee for federal employment tax purposes and not to determine whether each of two or more companies is a “co-employer.”  Substantial weight is typically given to the question of whether the purported employer has the right to direct and control the details of an individual’s work.  Among the factors that appear to have been considered more important by the IRS are:

the employer’s degree of behavioral control (the extent of instructions, training and the nature of the work)
the financial control or the economic aspects of the relationship
the intended relationship of the parties (whether employee benefits are provided, whether any contracts exist, whether services are ongoing or for a project, whether there are any penalties for discharge/termination, and the frequency of the business activity)

ERISA Requirements.  Employee pension and welfare benefit plans are also governed by ERISA.  ERISA defines “employer” as “any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan.”  ERISA defines the term “employee” as “any individual employed by an employer.”  The United States Supreme Court has held that the common law test of employment must be applied to determine whether an individual is an employee or an independent contractor under ERISA.  A definitive judicial interpretation of “employer” in the context of a PEO or employee leasing arrangement has not been established.

If Insperity were found not to be an employer with respect to worksite employees for ERISA purposes, its plans would not comply with ERISA.  Further, as a result of such finding, Insperity and its plans would not enjoy, with respect to worksite employees, the preemption of state laws provided by ERISA and could be subject to varying state laws and regulations, as well as to claims based upon state common laws.  Even if such a finding were made, we believe we would not be materially adversely affected because we would endeavor to make available similar benefits at comparable costs.

In addition to ERISA and the Code provisions discussed herein, issues related to the relationship between Insperity and its worksite employees may also arise under other federal laws, including other federal income tax laws.

Patient Protection and Affordable Care Act.  The PPACA was signed into law on March 23, 2010.  The PPACA was subsequently amended on March 30, 2010, by the Reconciliation Act.  The PPACA and the Reconciliation Act (collectively the “Act”) entail sweeping health care reforms with staggered effective dates from 2010 through 2018, and many provisions in the Act require the issuance of additional guidance from the U.S. Department of Labor, the Internal Revenue Service (“IRS”), the U.S. Department of Health & Human Services and the states.  Many provisions of the Act do not become operative until future years.  The Act did not have a material adverse impact on our results of operations in 2013.

The number and complex nature of federal and state regulations relating to employer-sponsored health plans has continued to increase over time.  The Act has already generated many new regulations, and is expected to generate many more as various provisions take effect.  We believe that additional regulatory burdens placed on employers can increase the demand for our services because small and medium-sized businesses are especially challenged by such governmental regulations due to limited resources and the lack of expertise.  As a co-employer in the PEO relationship, we assume or share many of the employer-related responsibilities and assist our clients in complying with many employment-related governmental laws and regulations.  Historically, we believe we have successfully marketed the compliance component of our service offering and that our compliance-related services have increased the value proposition of our service offering.  However, given the length and complexity of the Act, the extended time period over which the reforms will be implemented, and the unknown impact of regulatory guidance, much of which has not yet been issued, we are unable to determine the ultimate impact the Act will have in future periods on the costs we will incur to comply with the Act, our ability to match any resulting increased costs with pricing, our ability to attract and retain clients, our business model and our results of operations.

Beginning in 2010, the Act provided for a small business tax credit for eligible companies offering health care coverage to employees.  Based upon information contained in the Congressional Record, which specifically references PEOs, we believe that these tax credits are available to our clients that meet the qualification requirements.  However, the Act and subsequently issued IRS guidance do not expressly address the issue of whether qualifying small business clients of a PEO are entitled to the tax credits.  At this time, we do not believe that this issue has had an adverse effect on our operations or our ability to attract and retain clients.


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Beginning in 2011, the Act imposed a number of new mandates on the coverage required to be provided under health insurance plans, some of which were already standard in our group health plan.  For mandates not already included, we worked with our insurance carriers to incorporate the required changes. While we are unable to determine the impact of the required plan changes at this time, in future periods they may result in increased costs to us and could affect our ability to attract and retain clients.  Additionally, contractual arrangements and competitive market conditions may limit or delay our ability to increase service fees to offset the associated potential increased costs.

Beginning in 2014, the Act provided for the establishment of state insurance exchanges (“Exchanges”) to make health insurance available to individuals and small employers (initially defined as 100 employees or less).  States had the option of building a state-based exchange, entering into a state-federal partnership exchange or accepting the federally-facilitated exchange.  States that accept the federally-facilitated exchange can transition to a state-based exchange at a later date.  The Exchanges provide consumers with educational services and information on available options and offer a variety of health plans.  Small business tax credits and subsidies are available to qualifying businesses and individuals who purchase health insurance through the Exchanges.

Additionally in 2014, the Act ushers in a number of insurance market reforms for the small group and individual markets.  The reforms, intended to result in the community rating of health insurance for these markets, require guaranteed issue and renewability of coverage, eliminate certain underwriting practices by issuers, consolidate the number of risk pools in each state and restrict the permissible factors and variable ranges of those factors that can be considered in determining health insurance premiums.

The health insurance industry will be subject to additional excise taxes beginning in 2014.  In addition, starting in 2014 reinsurance taxes will be imposed on insurers and third party administrators for the purpose of helping to offset the cost for insurance covering high risk individuals.  As the policyholder, all or a portion of these increased costs may be passed on to us by our carriers.  Contractual arrangements and competitive market conditions may limit or delay our ability to match pricing with any potential increased costs.

On July 2, 2013, the federal government delayed implementation of the employer shared responsibility (“pay or play”) provisions of the Act until 2015. Under pay or play, penalties are imposed on large employers (those with at least 50 full-time equivalent employees) who fail to offer “minimum essential coverage” if any employee obtains coverage from an Exchange and receives a subsidy or tax credit for such coverage.  To qualify as minimum essential coverage, employer plans must satisfy affordability and minimum value tests or be subject to financial penalties if any employee obtains coverage from an Exchange and receives a subsidy or tax credit for such coverage.  Information contained in the Congressional Record, which specifically references PEOs, indicates that any pay or play penalties should apply separately to clients of a PEO and not at the PEO level.  However, the Act and subsequently issued IRS guidance do not expressly address the issue of whether the pay or play penalties apply only at the client level or whether the penalties can be applied at the PEO level.  At this time, we are unable to determine whether the Exchanges, tax credits, subsidies, insurance market reforms or the pay or play penalties will have an adverse impact on our business operations, our ability to attract and retain clients, or our ability to increase service fees to offset any increased costs or associate penalties assessed at the PEO level.

In 2018, the Act implements rules imposing excise taxes on employers and insurers who offer excessive health benefits under so-called “Cadillac plans.”  We anticipate taking appropriate steps to avoid, to the extent necessary and possible, benefits under our group health plan from triggering such excise taxes, which our carrier may pass on to us in the form of increased premiums.  At this time, we are unable to determine the effect the excise taxes will have on our ability to match pricing with any increased costs.

401(k) Retirement Plans.  Our 401(k) Retirement Plans are operated pursuant to guidance provided by the IRS under Revenue Procedure 2002-21 and Revenue Procedure 2003-86, each of which provides guidance for the operation of defined contribution plans maintained by PEOs that benefit worksite employees.  This guidance provides qualification standards for PEO plans which, if met, negate the inquiry of common law employer status for purposes of the exclusive benefit rule.  All of Insperity’s 401(k) Retirement Plans have received determination letters from the IRS confirming the qualified status of the Plans.

Employment Taxes

As a co-employer, Insperity assumes responsibility and liability for the payment of federal and state employment taxes with respect to wages and salaries paid to our worksite employees.  There are essentially three types of federal employment tax obligations:


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withholding of income tax requirements governed by Code Section 3401, et seq.
obligations under FICA, governed by Code Section 3101, et seq.
obligations under FUTA, governed by Code Section 3301, et seq.

Under these Code sections, employers have the obligation to withhold and remit the employer portion and, where applicable, the employee portion of these taxes.

Code Section 3401, which applies to federal income tax withholding requirements, contains an exception to the general common law test applied to determine whether an entity is an “employer” for purposes of federal income tax withholding.  Section 3401(d)(1) states that if the person for whom services are rendered does not have control of the payment of wages, the “employer” for this purpose is the person having control of the payment of wages.  The Treasury regulations issued under Section 3401(d)(1) state that a third party can be deemed to be the employer of workers under this section for income tax withholding purposes where the person for whom services are rendered does not have legal control of the payment of wages.  While Section 3401(d)(1) has been examined by several courts, its ultimate scope has not been delineated. Moreover, the IRS has to date relied extensively on the common law test of employment in determining liability for failure to comply with federal income tax withholding requirements.

Accordingly, while we believe that we can assume the withholding obligations for worksite employees, in the event we fail to meet these obligations, the client may be held ultimately liable for those obligations.  While this interpretive issue has not to our knowledge discouraged clients from enrolling with Insperity, there can be no assurance that a definitive adverse resolution of this issue would not do so in the future.  These interpretive uncertainties may also impact our ability to report employment taxes on our own account rather than the accounts of our clients.

Unemployment Taxes

We record our state unemployment (“SUI”) tax expense based on taxable wages and tax rates assigned by each state.  State unemployment tax rates vary by state and are determined, in part, based on Insperity’s prior years’ compensation experience in each state.  Certain rates are determined, in part, by each client’s own compensation experience.  In addition, states have the ability under law to increase unemployment tax rates, including retroactively, to cover deficiencies in the unemployment tax funds.  State unemployment tax rates increased substantially from 2010 to 2012 due to U.S. economic conditions, but declined in 2013 and are anticipated to decline in 2014.  Rate notices are typically provided by the states during, or prior to, the first quarter of each year; however, some notices are received later.  Until we receive the final tax rate notices, we estimate our expected SUI rate in those particular states.

Employers in certain states are experiencing higher FUTA tax rates as a result of certain states not repaying their unemployment loans from the federal government in a timely manner.  We are obligated to pay the federal government at a higher rate in these situations.  As such, we estimate the additional tax owed in states that have had a history of not repaying their federal loans in a timely manner.

State Regulation

While many states do not explicitly regulate PEOs, 41 states have adopted provisions for licensing, registration, certification or recognition of PEOs, and several others are considering such regulation.  Such laws vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs, and in some cases codify and clarify the co-employment relationship for unemployment, workers’ compensation and other purposes under state law.  Insperity is in compliance with the requirements in all 41 states.  Regardless of whether a state has licensing, registration or certification requirements for PEOs, we must comply with a number of other state and local regulations that could impact our operations.

Corporate Office Employees

We had approximately 2,300 corporate employees as of December 31, 2013.  We believe our relations with our corporate employees are good.  None of our corporate employees is covered by a collective bargaining agreement.

Intellectual Property

Insperity currently has registered trademarks, copyrights and other intellectual property.  In connection with our rebranding, we registered our new trademarks in 2013. We believe that our trademarks as a whole are of considerable importance to our business.


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ITEM 1A.  RISK FACTORS.

Factors That May Affect Future Results and the Market Price of Common Stock

Adverse Economic Conditions Could Negatively Affect our Industry, Business and Results of Operations

The small and medium-sized business market is sensitive to changes in economic activity levels as well as the credit markets. As a result, the demand for the outsourced HR services we provide clients could be adversely impacted by weak economic conditions or difficulty obtaining credit. Current and prospective clients may respond to such conditions by reducing employment levels, compensation levels, employee benefit levels and outsourced HR services. In addition, during periods of weak economic levels, current clients may have difficulty meeting their financial obligations to us and may select alternative HR services at more competitive rates than we offer. Such developments could adversely impact our financial condition, results of operations and future growth rates.

We Assume Liability for Worksite Employee Payroll, Payroll Taxes and Benefits Costs and are Responsible for their Payment Regardless of the Amount Billed to or Paid by our Clients

Under the CSA, we become a co-employer of worksite employees and assume the obligations to pay the salaries, wages and related benefits costs and payroll taxes of such worksite employees.  We assume such obligations as a principal, not as an agent of the client.  Our obligations include responsibility for:

payment of the salaries and wages for work performed by worksite employees, regardless of whether the client timely pays us the associated service fee
withholding and payment of federal and state payroll taxes with respect to wages and salaries reported by Insperity
providing benefits to worksite employees even if our costs to provide such benefits exceed the fees the client pays us

If a client does not pay us, or if the costs of benefits we provide to worksite employees exceed the fees a client pays us, our ultimate liability for worksite employee payroll and benefits costs could have a material adverse effect on our financial condition or results of operations.
 
Increases in Health Insurance Costs or Inability to Secure Replacement Contracts on Competitive Terms Could have a Material Adverse Effect on our Financial Condition or Results of Operations

Maintaining health insurance plans that cover worksite employees is a significant part of our business.  Our primary health insurance contract expires on December 31, 2015, subject to cancellation by either party upon 180 days notice.  In the event we are unable to secure replacement contracts on competitive terms, significant disruption to our business could occur.

Health insurance costs are in part determined by our claims experience and comprise a significant portion of our direct costs.  If we experience an increase in the number or severity of claims, our health insurance costs could increase.  Claim activity levels are impacted by a number of factors, including, but not limited to, macro-economic changes, proposed and enacted regulatory changes and medical outbreaks. Contractual arrangements with our clients limit our ability to incorporate such increases into service fees, which could result in a delay before such increases could be reflected in service fees.  As a result, such increases could have a material adverse effect on our financial condition or results of operations.  For additional information related to our health insurance costs, please read Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Benefits Costs.”

Health Care Reform Could Affect Our Health Insurance Plan and Could Lead to a Significant Disruption in our Business

The PPACA was signed into law on March 23, 2010.  The PPACA was subsequently amended on March 30, 2010 by the Reconciliation Act.  The PPACA and Reconciliation Act (collectively the “Act”) entail sweeping health care reforms with staggered effective dates from 2010 through 2018, and many provisions in the Act require the issuance of additional guidance from the U.S. Department of Labor, the IRS, the U.S. Department of Health & Human Services (“HHS”), and the states.

Beginning in 2014, a number of key provisions of the Act take effect including, the establishment of state insurance exchanges (“Exchanges”), insurance market reforms and the imposition of excise taxes on the health insurance industry and reinsurance taxes on insurers and third party administrators.  Additionally, the pay or play penalties on large employers take effect in 2015. Collectively, these items have the potential to significantly change the insurance marketplace for small and

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medium sized businesses and how employers provide insurance to employees.  In addition, as a co-employer in the PEO relationship, we assume or share many of the employer-related responsibilities and assist our clients in complying with many employment-related governmental regulations.  Generally, the Act and subsequently issued guidance by IRS and HHS have not addressed or in some instances are unclear as to their application in the PEO relationship or whether such provisions should be applied at the PEO or client level.

We are currently unable to determine the impact of the Act on our benefit plans, business model and future results of operations.  In future periods, the changes may result in increased costs to us and could affect our ability to attract and retain clients.  Additionally, contractual arrangements and competitive market conditions may limit or delay our ability to increase service fees to offset any associated potential increased costs.  For additional information related to PPACA, please read Item 1. “Business – Industry Regulations – Patient Protection and Affordable Care Act.”

Increases in Workers’ Compensation Costs or Inability to Secure Replacement Coverage on Competitive Terms Could Lead to a Significant Disruption to our Business

Our workers’ compensation coverage has been provided through an arrangement with ACE since 2007.  Under our current arrangement with ACE, we bear the economic burden for the first $1 million layer of claims per occurrence and the economic burden for claims over $1 million, up to a maximum aggregate amount of $5 million per policy year for claims that exceed the first $1 million.  ACE bears the burden for all claims in excess of these levels. The ACE Program is a fully insured policy whereby ACE has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. For additional discussion of our policy with ACE, please read Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Workers’ Compensation Costs.”

Workers’ compensation costs are a significant portion of our direct costs.  If we were to experience an unexpected large increase in the number or severity of claims, our workers’ compensation costs could increase, which could have a material adverse effect on our results of operations or financial condition.

The current workers’ compensation coverage with ACE expires on September 30, 2014.  In the event we are unable to secure replacement coverage on competitive terms, significant disruption to our business could occur.

Our Ability to Adjust and Collect Service Fees for Increases in Unemployment Tax Rates May be Limited

We record our SUI tax expense based on taxable wages and tax rates assigned by each state.  State unemployment tax rates vary by state and are determined, in part, based on prior years’ compensation experience in each state.  Prior to the receipt of final tax rate notices, we estimate our expected SUI tax rate in those states for which tax rate notices have not yet been received for purposes of pricing.  In a period of adverse economic conditions state unemployment funds may experience a significant increase in the number of unemployment claims.  Accordingly, state unemployment tax rates would likely increase substantially.  Some states have the ability under law to increase unemployment tax rates retroactively to cover deficiencies in the unemployment fund.  In addition, federal unemployment tax rates may be retroactively increased in certain states in the event the state fails to timely repay federal unemployment loans.  Generally, our contractual agreements allow us to incorporate such increases into our service fees upon the effective date of the rate change.  However, our ability to fully adjust service fees in our billing systems and collect such increases over the remaining term of the customers’ contracts could be limited, resulting in a potential tax increase not being fully recovered.  As a result, such increases could have a material adverse effect on our financial condition or results of operations.  For additional information related to state unemployment taxes, please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies.”

Our Contracts May be Canceled on Short Notice.  Our Inability to Renew Client Contracts or Attract New Clients Could Materially and Adversely Affect our Financial Conditions and Results of Operations

Our standard CSA can generally be canceled by us or the client with 30 days notice.  Accordingly, the short-term nature of the CSA makes us vulnerable to potential cancellations by existing clients, which could materially and adversely affect our financial condition and results of operations. In the event we have a high proportion of terminating clients from our mid-market customer base (which are generally under a two-year CSA), the financial impact of such an event could be significant.  In addition, our results of operations are dependent in part upon our ability to retain or replace our clients upon the termination or cancellation of the CSA.  Our client attrition rate was approximately 19% in 2013.  There can be no assurance that the number of contract cancellations will continue at these levels and such cancellations may increase in the future due to various factors, including but not limited to, economic conditions in the markets we operate. Clients electing to purchase our

- 18 -


services or electing an alternative solution often do so at the beginning of the calendar year. As a result, we typically experience our largest concentration of new client additions and attrition in the first quarter of each year.

Established Competitors and New Market Entrants May Have a Competitive Advantage over Us

The human resources services industry, including the PEO industry, is highly fragmented.  Many PEOs have limited operations and fewer than 1,000 worksite employees, but there are several industry participants that are comparable to our size or larger.  We also encounter competition from “fee for service” companies such as payroll processing firms, insurance companies, human resources consultants and human resources technology solutions.  Our competitors include the PEO divisions of large business services companies, such as Automatic Data Processing, Inc. and Paychex, Inc., and other national PEOs such as TriNet.  Other PEOs may offer their PEO services at more competitive prices than we may be able to offer.  Moreover, we expect that as the PEO industry grows and its regulatory framework becomes better established, well-organized competition with greater resources than we have may enter the PEO market, possibly including large “fee for service” companies currently providing a more limited range of services.

We May be Subject to Liabilities for Client and Employee Actions

A number of legal issues remain unresolved with respect to the co-employment arrangement between a PEO and its worksite employees, including questions concerning the ultimate liability for violations of employment and discrimination laws.  Our CSA establishes the contractual division of responsibilities between Insperity and our clients for various personnel management matters, including compliance with and liability under various governmental regulations.

Because we act as a co-employer, we may be subject to liability for violations of various employment and discrimination laws despite these contractual provisions, even if we do not participate in such violations.  Although the CSA provides that the client is to indemnify us for any liability attributable to the client’s conduct, we may not be able to collect on such a contractual indemnification claim and thus may be responsible for satisfying such liabilities to the extent that such liabilities are not covered or insured against under our insurance policies. In addition, worksite employees may be deemed to be our agents, which may subject us to liability for the actions of such worksite employees.

Changes in Federal, State and Local Regulation or our Inability to Obtain Licenses under New Regulatory Frameworks Could Have a Material Adverse Effect on our Results of Operations or Financial Condition

As a major employer, our operations are affected by numerous federal, state and local laws and regulations relating to labor, tax, benefit, insurance and employment matters.  By entering into a co-employer relationship with employees assigned to work at client locations, we assume certain obligations and responsibilities of an employer under these laws.  However, many of these laws (such as the Act, ERISA and federal and state employment tax laws) do not specifically address the obligations and responsibilities of non-traditional employers such as PEOs, and the definition of “employer” under these laws is not uniform.  In addition, many of the states in which we operate have not addressed the PEO relationship for purposes of compliance with applicable state laws governing the employer/employee relationship.  Any adverse application of new or existing federal or state laws to the PEO relationship with our worksite employees and client companies could have a material adverse effect on our results of operations or financial condition.

While many states do not explicitly regulate PEOs, 41 states have passed laws that have recognition, licensing, certification or registration requirements for PEOs and several other states are considering such regulation.  Such laws vary from state to state, but generally provide for monitoring the fiscal responsibility of PEOs, and in some cases codify and clarify the co-employment relationship for unemployment, workers’ compensation and other purposes under state law.  While we generally support licensing regulation because it serves to validate the PEO relationship, we may not be able to satisfy licensing requirements or other applicable regulations for all states.  In addition, there can be no assurance that we will be able to renew our licenses in all states.

Geographic Market Concentration Makes our Results of Operations Vulnerable to Economic Factors

Our New York, California, and Texas (including 13% in Houston) markets accounted for approximately 9%, 18% and 26%, respectively, of our worksite employees for the year ended December 31, 2013.  Accordingly, while we have a goal of expanding in our current markets and into new markets, for the foreseeable future, a significant portion of our revenues may be subject to economic factors specific to New York, Texas and California.
 

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A Determination that a Client is Liable for Employment Taxes not Paid by a PEO May Discourage Clients from Contracting With Us in the Future

Under the CSA, we assume sole responsibility and liability for paying federal employment taxes imposed under the Code with respect to wages and salaries we pay our worksite employees.  There are essentially three types of federal employment tax obligations:

income tax withholding requirements
FICA
FUTA

Under the Code, employers have the obligation to withhold and remit the employer portion and, where applicable, the employee portion of these taxes.  Most states impose similar employment tax obligations on the employer.  While the CSA provides that we have sole legal responsibility for making these tax contributions, the IRS or applicable state taxing authority could conclude that such liability cannot be completely transferred to us.  Accordingly, in the event that we fail to meet our tax withholding and payment obligations, the client may be held jointly and severally liable for those obligations.  While this interpretive issue has not, to our knowledge, discouraged clients from enrolling with Insperity, a definitive adverse resolution of this issue may discourage clients from enrolling in the future.

Failure of our Information Technology Systems Could Disrupt the HR Services we Provide to Clients

Many of the HR services offerings we provide to clients is conducted through a network infrastructure using both internally developed and purchased commercial software. The processing of payroll, benefits and other transactions is dependent upon Internet connectivity using high-speed network services provided by third party vendors. Any delays or failures caused by network outages, software or hardware failures, or other data processing disruptions, could result in our inability to timely process transactions. If such failures cause us to not meet client service expectations, we may lose existing clients and may have difficulty attracting new clients. Such developments could have a material impact on our financial condition, results of operations and future growth rates.
Potential Disclosure of Sensitive or Private Information Could Damage our Reputation and Impact our Operating Results

Unauthorized access or unintentional disclosure of personal or confidential information could damage our reputation and operating results.  While we strive to comply with all applicable data protection laws and regulations, and maintain stringent privacy and security policies and procedures, any failure or perceived failure to adequately protect sensitive information may result in negative publicity and / or proceedings or actions against us by government entities or others, which could potentially have an adverse effect on our business.
 
Most states and the District of Columbia have enacted notification rules concerning privacy and data protection.  It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices.  If so, in addition to the possibility of fines, this could result in an order requiring that we change our data practices, which could have a material effect on our business.  Complying with these various laws could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business.

The Failure of our Insurance Carriers or Financial Institutions Could Have a Material Adverse Effect on Us

We contract with various insurance carriers to provide certain insurance coverages as a part of our Workforce Optimization solution, which includes health insurance, workers’ compensation insurance and employment practices liability insurance. In addition, we obtain insurance coverage for various commercial risks in our business such as property insurance, errors and omissions insurance, general liability insurance, fiduciary liability insurance, automobile liability insurance, and directors’ and officers’ liability insurance.  The failure of any insurance carrier providing such coverage could leave us exposed to uninsured risk and could have a material adverse effect upon our business.

Please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” for additional information concerning the potential failure of one of our former workers’ compensation carriers.

In conjunction with providing services to clients, we rely on financial institutions to electronically transfer funds for the collection of our comprehensive service fee as well as the payment of wages and associated payroll tax withholdings.

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Failure by these financial institutions, for any reason, to deliver their services in a timely manner could result in material interruptions to our operations, impact client relations, and result in significant penalties or liabilities to us.

New and Higher Federal, State and Local Taxes Could have a Material and Adverse Impact on our Financial Condition and Results of Operations

Many states and municipalities in which we operate have experienced economic slowdowns, as has the nation as a whole.  This decline in economic activity has resulted in reductions of tax revenues and corresponding budget deficits.  In response to the budget shortfalls, many states and municipalities have increased or enacted new taxes on businesses operating within their tax jurisdiction, including but not limited to, business activity taxes and income taxes.  In addition, many federal, state and local taxing agencies have increased their audit activity in an effort to identify additional tax revenues.  New tax assessments on our operations could result in increased costs. Our ability to adjust our service fees and incorporate additional tax assessments into our billing system could be limited.  As a result, such higher taxes could have a material adverse impact on our financial condition or results of operations. Please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” for additional information regarding tax assessments by the State of Texas and the State of Massachusetts.

Failure to Integrate or Realize the Expected Return on our Acquisitions and Investments Could Have a Material and Adverse Impact on our Financial Condition and Results of Operations

We have adopted a strategy to market and sell additional products and services within and outside of the core Workforce Optimization solution. As part of this strategy, periodically we make strategic long-term decisions to invest in and/or acquire new companies, business units or assets. Acquiring new businesses involves a number of risks such as over-valuation of the acquired companies, entering markets or businesses in which we have no prior experience, integrating the technology, operations, and personnel, diversion of management’s attention from other business concerns and litigation resulting from the activities of the acquired company. The occurrence of one or more of these events could result in the loss of existing or prospective clients or employees, not achieving anticipated revenues or profitability, or impairment of acquired assets. Such developments could have a material impact to our financial condition, results of operations and future growth rates.

In connection with our annual goodwill impairment assessment, we recorded impairment charges of $3.3 million in our Expense Management reporting unit in 2013 and $4.2 million in our Performance Management reporting unit in 2012.  In addition, we recorded a $2.7 million impairment charge related to our minority investment in The Receivables Exchange in 2013. Based on market conditions or changes in operating plans, the fair value of our other acquired businesses could decline, requiring us to record additional impairment charges for all or portions of the investments.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information regarding the impairment charges.

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ITEM 1B.  UNRESOLVED STAFF COMMENTS.

None.
 
ITEM 2.  PROPERTIES.

We believe our current real estate and facilities are adequate for the purposes for which they are intended and provide for further expansion to accommodate our long-term growth and expansion goals.  We believe that short-term leased facilities are readily available if needed to accommodate near-term needs if they arise.  We will continue to evaluate the need for additional facilities based on the extent of our product and service offerings, the rate of customer growth, the geographic distribution of our customer base and our long-term service delivery requirements.

Corporate Facilities

Our corporate headquarters is located in Kingwood, Texas, in a 327,000 square foot office campus-style facility.  This 30-acre company-owned office campus includes approximately nine acres of undeveloped land for future expansion. Development and support operations are located in the Kingwood facility, along with our record retention center and a technology hosting facility.

Service Centers

We currently have four regional service centers located in Atlanta, Dallas, Houston and Los Angeles.

The Atlanta service center, which currently services approximately 33% of our worksite employee base, is located in a 40,000 square foot facility under lease until 2014. We are in the process of moving to a 40,500 square foot facility in Atlanta that is under lease until 2022.

The Dallas service center, which currently services approximately 19% of our worksite employee base, is located in a 48,600 square foot facility under lease until 2016.  In addition to the service center, the facility also contains sales operations.

The Houston service center, which currently services approximately 24% of our worksite employee base, is located in a 60,600 square foot facility under lease until 2016.  In addition to the service center operations, the facility also contains corporate support operations.

The Los Angeles service center, which currently services approximately 24% of our worksite employee base, is located in a 38,000 square foot facility under lease until 2019.

Sales Offices

As of December 31, 2013, we had Workforce Optimization sales and service personnel in 39 facilities located in 25 sales markets throughout the United States.  All of the facilities are leased and some are shared by multiple sales offices and/or client service personnel.  As of December 31, 2013, we had 48 Workforce Optimization sales offices in these 25 markets.  To take advantage of economic efficiencies, multiple sales offices may share a physical location.  Each sales office is typically staffed by six to eight BPAs, a district sales manager and an office administrator.  In addition, we have placed certain client service personnel in a majority of our sales markets to provide high-quality, localized service to our clients in those major markets.  We expect to continue placing various client service personnel in sales markets as a critical mass of clients is attained in each market.

ITEM 3.  LEGAL PROCEEDINGS.

We are not a party to any material pending legal proceedings other than ordinary routine litigation incidental to our business that we believe would not have a material adverse effect on our financial condition or results of operations, except as discussed in Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” which is incorporated herein by reference.


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ITEM S-K 401 (b).  EXECUTIVE OFFICERS OF THE REGISTRANT.

The following table sets forth the names, ages (as of February 3, 2014) and positions of Insperity’s executive officers:

Name
 
Age
 
Position
Paul J. Sarvadi
 
57
 
Chairman of the Board and Chief Executive Officer
Richard G. Rawson
 
65
 
President
A. Steve Arizpe
 
56
 
Executive Vice President of Client Services and Chief Operating Officer
Jay E. Mincks
 
60
 
Executive Vice President of Sales and Marketing
Douglas S. Sharp
 
52
 
Senior Vice President of Finance, Chief Financial Officer and Treasurer
Daniel D. Herink
 
47
 
Senior Vice President of Legal, General Counsel and Secretary

Paul J. Sarvadi has served as Chairman of the Board and Chief Executive Officer since August 2003.  Mr. Sarvadi co-founded Insperity in 1986 and served as Vice President and Treasurer of Insperity from its inception in 1986 through April 1987, as Vice President from April 1987 through 1989 and as President and Chief Executive Officer from 1989 to August 2003.  Prior to founding Insperity, Mr. Sarvadi started and operated several small businesses.  Mr. Sarvadi has served as President of NAPEO and was a member of its Board of Directors for five years.  Mr. Sarvadi was selected as the 2001 National Ernst & Young Entrepreneur Of The Year® for service industries.  In 2004, he received the Conn Family Distinguished New Venture Leader Award from Mays Business School at Texas A&M University.  In 2007, he was inducted into the Texas Business Hall of Fame.

Richard G. Rawson is President of Insperity and most of its subsidiaries, a Class III director, and has been a director of Insperity since 1989.  He has been President since August 2003.  Before being elected President, he served as Executive Vice President of Administration, Chief Financial Officer and Treasurer of the Company from February 1997 until August 2003.  Prior to that, he served as Senior Vice President, Chief Financial Officer and Treasurer of Insperity since 1989.  Prior to joining Insperity in 1989, Mr. Rawson served as a Senior Financial Officer and Controller for several companies in the manufacturing and seismic data processing industries.  Mr. Rawson has served NAPEO as Chairman of the Accounting Practices Committee and several other offices and became President in 1999-2000.  Mr. Rawson has a Bachelor of Business Administration in finance from the University of Houston and currently serves as a board member for the C.T. Bauer College of Business.

A. Steve Arizpe has served as Executive Vice President of Client Services and Chief Operating Officer since August 2003.  He joined Insperity in 1989 and has served in a variety of roles, including Houston Sales Manager, Regional Sales Manager and Vice President of Sales.  Prior to joining Insperity, Mr. Arizpe served in sales and sales management roles for NCR Corporation and Clarke-American. He has also served as a director of the Texas Chapter of NAPEO.  Mr. Arizpe graduated from Texas A&M University in 1979, earning his degree in Business Management.

Jay E. Mincks has served as Executive Vice President of Sales and Marketing since January 1999.  Mr. Mincks served as Vice President of Sales and Marketing from February 1997 through January 1999.  He joined Insperity in 1990 and has served in a variety of other roles, including Houston Sales Manager and Regional Sales Manager for the Western United States.  Prior to joining Insperity, Mr. Mincks served in a variety of positions, including management positions, in the sales and sales training fields with various large companies.  He holds a business degree from the University of Houston.

Douglas S. Sharp has served as Senior Vice President of Finance, Chief Financial Officer and Treasurer since May 2008.  He served as Vice President of Finance, Chief Financial Officer and Treasurer from August 2003 until May 2008.  Mr. Sharp joined Insperity in January 2000 as Vice President of Finance and Controller.  From July 1994 until he joined Insperity, he served as Chief Financial Officer for Rimkus Consulting Group, Inc.  Prior to that, he served as Controller for a small publicly held company; as Controller for a software company; and as an Audit Manager for Ernst & Young LLP.  Mr. Sharp has served as a member of the Accounting Practices Committee of NAPEO.  Mr. Sharp is also a certified public accountant.
 
Daniel D. Herink has served as Senior Vice President of Legal, General Counsel and Secretary since May 2008.  Mr. Herink joined Insperity in 2000 as Assistant General Counsel and was promoted to Associate General Counsel in 2002.  He was elected to his current position in May 2007.  Mr. Herink previously served as an attorney at Rodriguez, Colvin & Chaney, L.L.P. and McGinnis, Lochridge & Kilgore, L.L.P.  He earned his Bachelor of Science degree in business administration from the University of Nebraska and a Doctorate of Jurisprudence from The University of Texas School of Law, where he was a member of the Texas Law Review and The Order of the Coif.  Mr. Herink is also a certified public accountant.

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PART II

ITEM 5.  MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Price Range of Common Stock

Our common stock is traded on the New York Stock Exchange under the symbol “NSP.”  As of February 3, 2014, there were 333 holders of record of our common stock.  This number does not include stockholders for whom shares were held in “nominee” or “street name.”  The following table sets forth the high and low sales prices for the common stock as reported on the New York Stock Exchange transactional tape. 
2013
 
High
 
Low
 
Dividends
per Share
 
First Quarter
 
$
34.20

 
$
27.04

 
$
0.17

 
Second Quarter
 
31.80

 
26.44

 
0.17

 
Third Quarter
 
37.80

 
30.36

 
0.17

 
Fourth Quarter
 
39.69

 
32.67

 
0.17

 
 
 
 
 
 
 
 
 
2012
 
 

 
 

 
 

 
First Quarter
 
$
31.79

 
$
25.62

 
$
0.15

 
Second Quarter
 
31.14

 
24.10

 
0.17

 
Third Quarter
 
28.48

 
23.94

 
0.17

 
Fourth Quarter
 
33.24

 
24.95

 
1.17

(1) 
____________________________________

(1) 
Includes a $1.00 per share special dividend.

Dividend Policy

During 2013 and 2012, we paid dividends of $17.4 million and $42.7 million, respectively, including a special cash dividend of $25.7 million paid in the fourth quarter of 2012.  The payment of dividends is made at the discretion of our Board of Directors and depends upon our operating results, financial condition, capital requirements, general business conditions and such other factors as our Board of Directors deems relevant.

Issuer Purchases of Equity Securities

The following table provides information about our purchases of Insperity common stock during the three months ended December 31, 2013:
Period
 
Total Number of Shares Purchased(1)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Program(1)
 
Maximum Number of Shares that may yet be Purchased under the Program(1)
10/01/2013 – 10/31/2013
 

 
$

 

 
1,352,569

11/01/2013 – 11/30/2013
 

 

 

 
1,352,569

12/01/2013 – 12/31/2013
 
3,000

 
32.83

 
3,000

 
1,349,569

Total
 
3,000

 
$
32.83

 
3,000

 
1,349,569

__________________________________

(1) 
Our Board of Directors has authorized a program to repurchase shares of our outstanding common stock.  During the three months ended December 31, 2013, 3,000 shares were repurchased under the program and no shares were withheld to satisfy tax withholding obligations for the vesting of restricted stock awards.  As of December 31, 2013, we are authorized to repurchase an additional 1,349,569 shares under the program.  Unless terminated early by resolution of the Board of Directors, the repurchase program will expire when we have repurchased all shares authorized for repurchase under the repurchase program.


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Performance Graph

The following graph compares our cumulative total stockholder return since December 31, 2008, with the S&P Smallcap 600 Index and the S&P 1500 Composite Human Resources and Employment Services Index.  The graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2008. 

 
 
12/08

 
12/09

 
12/10

 
12/11

 
12/12

 
12/13

 
 
 
 
 
 
 
 
 
 
 
 
 
Insperity, Inc.
 
100.00

 
111.38

 
141.58

 
125.34

 
170.42

 
193.23

S&P Smallcap 600
 
100.00

 
125.57

 
158.60

 
160.22

 
186.37

 
263.37

S&P 1500 Composite Human Resources and Employment Services
 
100.00

 
132.13

 
156.59

 
130.21

 
146.25

 
262.24

 
This graph shall not be deemed “filed” for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Exchange Act, regardless of any general incorporation language in such filing.

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ITEM 6.  SELECTED FINANCIAL DATA.

The selected consolidated financial data set forth below should be read in conjunction with the Consolidated Financial Statements and accompanying Notes and Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 
 
Year ended December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
 
(in thousands, except per share and statistical data)
Income Statement Data:
 
 
Revenues(1)
 
$
2,256,112

 
$
2,158,824

 
$
1,976,219

 
$
1,719,752

 
$
1,653,096

Gross profit
 
393,251

 
382,221

 
351,775

 
298,536

 
287,967

Operating income
 
56,223

(2) 
67,494

(3) 
57,314

 
37,060

 
27,033

Net income
 
32,032

(4) 
40,402

 
30,470

(5) 
22,440

 
16,574

Diluted net income per share
 
$
1.25

 
$
1.56

 
$
1.16

 
$
0.86

 
$
0.65

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Working capital
 
$
128,630

 
$
115,706

 
$
126,562

 
$
144,479

 
$
127,627

Total assets
 
766,560

 
750,200

 
712,259

 
659,845

 
576,470

Total stockholders’ equity
 
253,272

 
240,905

 
245,207

 
240,395

 
223,160

Cash dividends per share
 
$
0.68

 
$
1.66

(6) 
$
0.60

 
$
0.52

 
$
0.52

 
 
 
 
 
 
 
 
 
 
 
Statistical Data:
 
 
 
 
 
 
 
 
 
 
Average number of worksite employees paid per month during period
 
127,517

 
125,650

 
116,839

 
107,014

 
108,736

Revenues per worksite employee per month(7)
 
$
1,474

 
$
1,432

 
$
1,410

 
$
1,339

 
$
1,267

Gross profit per worksite employee per month
 
$
257

 
$
253

 
$
251

 
$
232

 
$
221

Operating income per worksite employee per month
 
$
37

 
$
45

 
$
41

 
$
29

 
$
21

____________________________________

(1) 
Gross billings of $13.462 billion, $12.992 billion, $11.700 billion, $10.169 billion and $9.856 billion, less worksite employee payroll cost of $11.206 billion, $10.833 billion, $9.724 billion, $8.449 billion and $8.203 billion, respectively.
(2) 
Includes a non-cash impairment charge in the fourth quarter of 2013 of $3.3 million. Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.
(3) 
Includes a non-cash impairment charge in the fourth quarter of 2012 of $4.2 million. Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.
(4) 
Includes the impact of a $2.7 million non-cash impairment charge in the second quarter of 2013, please read Note 6 to the Consolidated Financial Statements, “Other Assets,” for additional information. We also recorded a $2.0 million tax benefit in the fourth quarter of 2013 related to tax years 2009 through 2012, please read Note 9 to the Consolidated Financial Statements, “Income Taxes,” for additional information.
(5) 
Includes the impact of a $4.4 million pre-tax loss related to the exchange of an aircraft, and a $3.1 million pre-tax loss related to a settlement with the State of California.  Please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” for additional information on the settlement with the State of California.
(6) 
Includes a 1.00 per share special dividend paid in the fourth quarter of 2012.
(7) 
Gross billings of $8,797, $8,617, $8,345, $7,919 and $7,553 per worksite employee per month, less payroll cost of $7,323, $7,185, $6,935, $6,580 and $6,286 per worksite employee per month, respectively.

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this annual report.  Historical results are not necessarily indicative of trends in operating results for any future period.

The statements contained in this annual report that are not historical facts are forward-looking statements that involve a number of risks and uncertainties.  The actual results of the future events described in such forward-looking statements in this annual report could differ materially from those stated in such forward-looking statements. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in Item 1A. Risk Factors and the uncertainties set forth from time to time in our other public reports and filings and public statements.

Overview

Our long-term strategy is to provide the best small and medium-sized businesses in the United States with our unique human resources service offering, and to leverage our buying power and expertise to provide additional valuable services to clients.  Our most comprehensive HR business offering is provided through our PEO services, now known as our Workforce Optimization solution, which encompasses a broad range of human resources functions, including payroll and employment administration, employee benefits, workers’ compensation, government compliance, performance management and training and development services.  Our overall operating results can be measured in terms of revenues, payroll costs, gross profit or operating income per worksite employee per month.  We often use the average number of worksite employees paid during a period as our unit of measurement in analyzing and discussing our results of operations.

In addition to Workforce Optimization, we offer Human Capital Management, Payroll Services, Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Financial Services, Expense Management, Retirement Services and Insurance Services, many of which are offered via desktop applications and SaaS delivery models.  These other products or services are offered separately, as a bundle, or along with Workforce Optimization.

We ended 2013 averaging 130,732 paid worksite employees in the fourth quarter, which represents a 1.1% increase over the fourth quarter of 2012.  Approximately 19% of our paid worksite employees were in our mid-market sector for the year ended December 31, 2013, which is defined as companies with 150 to 2,000 worksite employees.  We expect the average number of paid worksite employees per month to be in the range of 127,000 to 128,000 in the first quarter of 2014.

Our 2013 average gross profit per worksite employee per month was $257, a $4 increase over 2012. Included in gross profit in 2013 is a $14 per worksite employee per month contribution from our Adjacent Businesses compared to $11 per worksite employee per month in the 2012 period.

Operating expenses increased 7.1% in 2013 to $337.0 million. On a per worksite employee per month basis, operating expenses increased from $208 in 2012 to $220 in 2013.  

Other expense increased $3.3 million, primarily due to a $2.7 million non-cash impairment charge related to our investment in The Receivables Exchange.

Our net income in 2013 was $32.0 million, an $8.4 million decrease compared to 2012.  

We ended 2013 with working capital of $128.6 million.  During 2013, we paid $17.4 million in dividends and repurchased shares at a cost of $17.2 million.

Revenues

We account for our revenues in accordance with Accounting Standards Codification (“ASC”) 605-45, Revenue Recognition. Our Workforce Optimization gross billings to clients include the payroll cost of each worksite employee at the client location and a markup computed as a percentage of each worksite employee’s payroll cost.  We invoice the gross billings concurrently with each periodic payroll of our worksite employees.  Revenues, which exclude the payroll cost component of gross billings, and therefore, consist solely of the markup, are recognized ratably over the payroll period as worksite employees perform their service at the client worksite.  This markup includes pricing components associated with our estimates of payroll taxes, benefits and workers’ compensation costs, plus a separate component related to our HR services.  We include revenues that have been recognized but not invoiced in unbilled accounts receivable on our Consolidated Balance Sheets.

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Our revenues are primarily dependent on the number of clients enrolled, the resulting number of worksite employees paid each period and the number of worksite employees enrolled in our benefit plans.  Because our total markup is computed as a percentage of payroll cost, certain revenues are also affected by the payroll cost of worksite employees, which may fluctuate based on the composition of the worksite employee base, inflationary effects on wage levels and differences in the local economies of our markets.

Direct Costs

The primary direct costs associated with our Workforce Optimization revenue-generating activities are:

employment-related taxes (“payroll taxes”)
costs of employee benefit plans
workers’ compensation costs

Payroll taxes consist of the employer’s portion of Social Security and Medicare taxes under FICA, federal unemployment taxes and state unemployment taxes.  Payroll taxes are generally paid as a percentage of payroll cost. The federal tax rates are defined by federal regulations.  State unemployment tax rates are subject to claim histories and vary from state to state.

Employee benefits costs are comprised primarily of health insurance premiums and claims costs (including dental and pharmacy costs), but also include costs of other employee benefits such as life insurance, vision care, disability insurance, education assistance, adoption assistance, a flexible spending account and a work-life program.

Workers’ compensation costs include administrative and risk charges paid to the insurance carrier, and claims costs, which are driven primarily by the frequency and severity of claims.

Gross Profit

Our gross profit per worksite employee 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 Workforce Optimization clients, which are subject to contractual arrangements that are typically renewed annually.  We use gross profit per worksite employee per month as our principal measurement of relative performance at the gross profit level.

Operating Expenses

Salaries, wages and payroll taxes – Salaries, wages and payroll taxes are primarily a function of the number of corporate employees and their associated average pay and any additional incentive compensation.  Our corporate employees include client services, sales and marketing, benefits, legal, finance, information technology, administrative support personnel and those associated with our ABUs.

Stock-based compensation – Our stock-based compensation relates to the recognition of non-cash compensation expense over the vesting period of restricted stock awards.

Commissions – Commission expense consists primarily of amounts paid to sales managers and BPAs.  Commissions are based on the number of 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, including the Insperity Invitational presented by UnitedHealthcare® sponsorship.  In 2011, certain costs were incurred as a result of our rebranding initiative and are also included in advertising.

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, and acquisition transaction expenses
administrative costs, such as postage, printing and supplies
employee travel expenses
technology and facility repairs and maintenance costs

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rebranding initiative costs in 2011

Depreciation and amortization – Depreciation and amortization expense is primarily a function of our capital investments in corporate facilities, service centers, sales offices, technology infrastructure and that associated with our acquisitions.

Impairment charge – Non-cash expense associated with the decline in fair value of intangible assets, including goodwill.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.

Income Taxes
 
Our provision for income taxes typically differs from the U.S. statutory rate of 35%, due primarily to state income taxes and non-deductible expenses.  Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities used for financial reporting purposes and the amounts used for income tax purposes.  Significant items resulting in deferred income taxes include prepaid assets, accruals for workers’ compensation expenses, stock-based compensation and depreciation.  Changes in these items are reflected in our financial statements through a deferred income tax provision.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, we evaluate these estimates, including those related to health and workers’ compensation insurance claims experience, client bad debts, income taxes, property and equipment, goodwill and other intangibles, and contingent liabilities.  We base these estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following accounting policies are critical and/or require significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

Benefits costs – We provide group health insurance coverage to our worksite employees through a national network of carriers including UnitedHealthcare (“United”), UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield of Hawaii, Unity Health Plan and Tufts, all of which provide fully insured policies or service contracts.

The health insurance contract 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 the Consolidated Statements of Operations.  The estimated incurred 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 we would accrue a liability for the excess costs on 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 on our Consolidated Balance Sheets.  The terms of the arrangement with United require us to maintain an accumulated cash surplus in the plan of $9.0 million, which is reported as long-term prepaid insurance.  As of December 31, 2013, Plan Costs were less than the premiums paid and owed to United by $13.5 million. As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $4.5 million balance is included in prepaid insurance, a current asset, on our Consolidated Balance Sheets.  The premiums owed to United at December 31, 2013, were $2.1 million, which is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets.

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We believe that recent claims activity is representative of incurred and paid trends during the reporting period.  The estimated completion rate and annual trend used to compute incurred but not reported claims involves a significant level of judgment.  Accordingly, an increase (or decrease) in the completion rate or annual trend used to estimate the incurred claims would result in an increase (or decrease) in benefits costs and net income would decrease (or increase) accordingly.

The following table illustrates the sensitivity of changes in the completion rate and annual trend on our estimate of total benefit costs of $997.6 million in 2013:

Change in
Completion Rate and Annual Trend
 
Change in Benefits Costs
(in thousands)
 
Change in Net Income
(in thousands)
(2.5)%
 
$
(12,377
)
 
$
5,075

(1.0)%
 
(4,951
)
 
2,030

1.0%
 
4,951

 
(2,030
)
2.5%
 
12,377

 
(5,075
)

Workers’ compensation costs – Since October 1, 2007, our workers’ compensation coverage has been provided through our arrangement with the ACE Group of Companies (“ACE”).  Under our arrangement with ACE (the “ACE Program”), we bear the economic burden for the first $1 million layer of claims per occurrence, and effective October 1, 2010, we also bear the economic burden for a maximum aggregate amount of $5 million per policy year for claim amounts that exceed the first $1 million.  ACE bears the economic burden for all claims in excess of these levels.  The ACE Program is a fully insured policy whereby ACE has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities.  Our coverage from September 1, 2003 through September 30, 2007 was provided through selected member insurance companies of American International Group, Inc.

Because we bear the economic burden 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 employ 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 years ended December 31, 2013 and 2012, Insperity reduced accrued workers’ compensation costs by $9.3 million and $13.1 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 2013 and 2012 was 0.8% and 0.6%, respectively) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.

Our claim trends could be greater than or less than our prior estimates, in which case we would revise our claims estimates and record an adjustment to workers’ compensation costs in the period such determination is made.  If we were to experience any significant changes in actuarial assumptions, our loss development rates could increase (or decrease), which would result in an increase (or decrease) in workers’ compensation costs and a resulting decrease (or increase) in net income reported in our Consolidated Statements of Operations.


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The following table illustrates the sensitivity of changes in the loss development rate on our estimate of workers’ compensation costs totaling $54.9 million in 2013:

Change in Loss Development Rate
 
Change in Workers’ Compensation Costs
(in thousands)
 
Change in
Net Income
(in thousands)
(5.0)%
 
$
(2,434
)
 
$
1,436

(2.5)%
 
(1,217
)
 
718

2.5%
 
1,217

 
(718
)
5.0%
 
2,434

 
(1,436
)

At the beginning of each policy period, the 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 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, a long-term asset in our Consolidated Balance Sheets.  In 2013, we paid the insurance carrier an additional $5.0 million in claim funds for policy years prior to 2013, which increased deposits.  As of December 31, 2013, we had restricted cash of $51.9 million and deposits of $81.9 million.  We have estimated and accrued $120.8 million in incurred workers’ compensation claim costs as of December 31, 2013.  Our estimate of incurred claim costs expected to be paid within one year are recorded as accrued workers’ compensation costs and included in short-term liabilities, while our estimate of incurred claim costs expected to be paid beyond one year are included in long-term liabilities on our Consolidated Balance Sheets.

Contingent liabilities – We accrue and disclose contingent liabilities in our Consolidated Financial Statements in accordance with ASC 450-10, Contingencies.  GAAP requires accrual of contingent liabilities that are considered probable to occur and that can be reasonably estimated.  For contingent liabilities that are considered reasonably possible to occur, financial statement disclosure is required, including the range of possible loss if it can be reasonably determined. From time to time we disclose in our financial statements issues that we believe are reasonably possible to occur, although we cannot determine the range of possible loss in all cases.  As issues develop, we evaluate the probability of future loss and the potential range of such losses.  If such evaluation were to determine that a loss was probable and the loss could be reasonably estimated, we would be required to accrue our estimated loss, which would reduce net income in the period that such determination was made.

Deferred taxes – We have recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.  While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, our ability to realize our deferred tax assets could change from our current estimates.  If we determine that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period that such determination is made.  Likewise, should we determine that we will not be able to realize all or part of our net deferred tax assets in the future, an adjustment to increase the valuation allowance would reduce net income in the period such determination is made.

Allowance for doubtful accounts – We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to pay their comprehensive service fees.  We believe that the success of our business is heavily dependent on our ability to collect these comprehensive service fees for several reasons, including:

the fact that we are at risk for the payment of our direct costs and worksite employee payroll costs regardless of whether our clients pay their comprehensive service fees
the large volume and dollar amount of transactions we process
the periodic and recurring nature of payroll, upon which the comprehensive service fees are based

To mitigate this risk, we have established very tight credit policies.  We generally require our Workforce Optimization clients to pay their comprehensive service fees no later than one day prior to the applicable payroll date.  In addition, we maintain the right to terminate the CSA and associated worksite employees or to require prepayment, letters of credit or other collateral if a client’s financial position deteriorates or if the client does not pay the comprehensive service fee.  As a

- 31 -


result of these efforts, losses related to customer nonpayment have historically been low as a percentage of revenues. However, if our clients’ financial conditions were to deteriorate rapidly, resulting in nonpayment, our accounts receivable balances could grow and we could be required to provide for additional allowances, which would decrease net income in the period that such determination was made.

Property and equipment – Our property and equipment relate primarily to our facilities and related improvements, furniture and fixtures, computer hardware and software and capitalized software development costs.  These costs are depreciated or amortized over the estimated useful lives of the assets.  If we determine that the useful lives of these assets will be shorter than we currently estimate, our depreciation and amortization expense could be accelerated, which would decrease net income in the periods of such a determination.  In addition, we periodically evaluate these costs for impairment.  If events or circumstances were to indicate that any of our long-lived assets might be impaired, we would assess recoverability based on the estimated undiscounted future cash flows to be generated from the applicable asset.  In addition, we may record an impairment loss, which would reduce net income, to the extent that the carrying value of the asset exceeded the fair value of the asset.  Fair value is generally determined using an estimate of discounted future net cash flows from operating activities or upon disposal of the asset.

Goodwill and other intangibles – Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and is written down when impaired. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite.  Our purchased intangible assets are carried at cost less accumulated amortization.  Amortization is computed over the estimated useful lives of the respective assets, which ranges from three to 10 years.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.

New Accounting Pronouncements

We believe that 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.



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Results of Operations

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012.

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

 
 
Year ended December 31,
 
 
2013
 
2012
 
% Change
 
 
(in thousands, except per share and statistical data)
Revenues (gross billings of $13.462 billion and $12.992 billion, less worksite employee payroll cost of $11.206 billion and $10.833 billion, respectively)
 
$
2,256,112

 
$
2,158,824

 
4.5
 %
Gross profit
 
393,251

 
382,221

 
2.9
 %
Operating expenses
 
337,028

(1) 
314,727

(2) 
7.1
 %
Operating income
 
56,223

 
67,494

 
(16.7
)%
Other income (expense)
 
(2,491
)
(3) 
796

 
(412.9
)%
Net income
 
32,032

(4) 
40,402

 
(20.7
)%
Diluted net income per share of common stock
 
1.25

 
1.56

 
(19.9
)%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
127,517

 
125,650

 
1.5
 %
Revenues per worksite employee per month(5)
 
$
1,474

 
$
1,432

 
2.9
 %
Gross profit per worksite employee per month
 
257

 
253

 
1.6
 %
Operating expenses per worksite employee per month
 
220

 
208

 
5.8
 %
Operating income per worksite employee per month
 
37

 
45

 
(17.8
)%
Net income per worksite employee per month
 
21

 
27

 
(22.2
)%
____________________________________

(1)
Includes a non-cash impairment charge in the fourth quarter of 2013 of $3.3 million. Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.
(2) 
Includes a non-cash impairment charge in the fourth quarter of 2012 of $4.2 million.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.
(3) 
Includes the impact of a $2.7 million non-cash impairment charge in the second quarter of 2013. Please read Note 6 to the Consolidated Financial Statements, “Other Assets,” for additional information.
(4) 
Includes a $2.0 million tax benefit in the fourth quarter of 2013 related to tax years 2009 through 2012. Please read Note 9 to the Consolidated Financial Statements, “Income Taxes,” for additional information.
(5) 
Gross billings of $8,797 and $8,617 per worksite employee per month, less payroll cost of $7,323 and $7,185 per worksite employee per month, respectively.

Revenues

Our revenues in 2013, which represent gross billings net of worksite employee payroll cost, increased 4.5% compared to 2012, due to a 2.9%, or $42 increase in revenues per worksite employee per month and a 1.5% increase in the average number of worksite employees paid per month.  The 2.9% increase in revenues per worksite employee per month was due primarily to increases in the benefits and payroll tax pricing to offset increases in these direct costs.


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By region, our Workforce Optimization revenue change from 2012 and distribution for the years ended December 31, 2013 and 2012 were as follows:

 
 
Year ended December 31,
 
Year ended December 31,
 
 
2013
 
2012
 
% Change
 
2013
 
2012
 
 
(in thousands)
 
(% of total revenue)
Northeast
 
$
577,280

 
$
560,455

 
3.0
%
 
26.0
%
 
26.3
%
Southeast
 
212,664

 
198,049

 
7.4
%
 
9.6
%
 
9.3
%
Central
 
329,110

 
312,373

 
5.4
%
 
14.8
%
 
14.7
%
Southwest
 
613,175

 
595,379

 
3.0
%
 
27.6
%
 
28.0
%
West
 
488,047

 
461,427

 
5.8
%
 
22.0
%
 
21.7
%
 
 
2,220,276

 
2,127,683

 
4.4
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
35,836

 
31,141

 
15.1
%
 
 

 
 

Total revenue
 
$
2,256,112

 
$
2,158,824

 
4.5
%
 
 

 
 

____________________________________

(1)     Comprised primarily of revenues generated by Adjacent Businesses.

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 2013, new client sales and the net change in existing clients remained flat, while client retention declined slightly compared to 2012.  As a result, our year-over-year growth in worksite employees paid per month during 2013 was 1.5% compared to 7.5% during 2012.

Gross Profit

Gross profit was $393.3 million in 2013, a 2.9% increase over 2012.  The average gross profit per worksite employee increased 1.6% to $257 per month in 2013 versus $253 in 2012.  Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses. Included in gross profit in 2013 is a $14 per worksite employee per month contribution from our Adjacent Businesses compared to $11 per worksite employee per month in the 2012 period.

While our revenues per worksite employee per month increased 2.9% to $1,474 in 2013 versus 2012, our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 3.2% to $1,217 per worksite employee per month.  The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits increased $29 per worksite employee per month, or 4.7%, on a per covered employee basis compared to 2012.  The percentage of worksite employees covered under our health insurance plan was 72.1% in both 2013 and 2012.  Please read “—Critical Accounting Policies and Estimates – Benefits Costs” for a discussion of our accounting for health insurance costs.

Workers’ compensation costs – Workers’ compensation costs increased 6.3%, or $2 per worksite employee per month compared to 2012.  As a percentage of non-bonus payroll cost, workers’ compensation costs increased to 0.55% in 2013 from 0.54% in 2012.  During 2013, we recorded reductions in workers’ compensation costs of $9.3 million, or 0.09% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $13.1 million, or 0.14% of non-bonus payroll costs in 2012.  The 2013 period costs include the impact of a 0.8% discount rate used to accrue workers’ compensation loss claims, compared to a 0.6% discount rate used in the 2012 period.  Please read “—Critical Accounting Policies and Estimates – Workers’ Compensation Costs” for a discussion of our accounting for workers’ compensation costs.

Payroll tax costs – Payroll taxes increased 3.2%, or $9 per worksite employee per month compared to 2012, due primarily to a 3.4% increase in total payroll cost in 2013 and a $2.9 million, or $2 per worksite employee per month credit recognized in 2012 related to a Pennsylvania tax matter.  Payroll taxes as a percentage of payroll cost decreased to 7.04% in 2013 compared to 7.05% in 2012.


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Operating Expenses

The following table presents certain information related to our operating expenses:
 
 
 
Year ended December 31,
 
Year ended December 31,
 
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
Salaries, wages and payroll taxes
 
$
181,444

 
$
168,807

 
7.5
 %
 
$
119

 
$
112

 
6.3
 %
Stock–based compensation
 
11,103

 
9,814

 
13.1
 %
 
7

 
7

 

Commissions
 
14,581

 
14,515

 
0.5
 %
 
9

 
10

 
(10.0
)%
Advertising
 
23,795

 
21,586

 
10.2
 %
 
16

 
14

 
14.3
 %
General and administrative expenses
 
81,699

 
77,564

 
5.3
 %
 
53

 
50

 
6.0
 %
Impairment charge
 
3,342

 
4,191

 
(20.3
)%
 
2

 
3

 
(33.3
)%
Depreciation and amortization
 
21,064

 
18,250

 
15.4
 %
 
14

 
12

 
16.7
 %
Total operating expenses
 
$
337,028

 
$
314,727

 
7.1
 %
 
$
220

 
$
208

 
5.8
 %
____________________________________

Operating expenses were $337.0 million in 2013, a 7.1% increase over 2012.   We recorded impairment charges of $3.3 million in our Expense Management reporting unit in 2013 and $4.2 million in our Performance Management reporting unit in 2012.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information. Operating expenses per worksite employee per month increased to $220 in 2013 from $208 in 2012.  The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased 7.5%, or $7 per worksite employee per month compared to 2012, primarily due to a 6.4% rise in headcount, which includes additions in Business Performance Advisors, service and technology personnel.

Stock-based compensation increased 13.1%, but remained flat on a per worksite employee per month basis compared to 2012, due primarily to an increase in the weighted average market value on the date of grant associated with restricted stock awards.  The stock-based compensation expense represents amortization of restricted stock awards granted to employees and the annual stock grant made to non-employee directors.  Please read Note 1 to the Consolidated Financial Statements, “Accounting Policies,” for additional information.

Commissions expense increased 0.5%, but decreased $1 on a per worksite employee per month basis compared to 2012.

Advertising costs increased 10.2%, or $2 per worksite employee per month compared to 2012, primarily due to increased spending on health care reform-related advertising and business promotions.

General and administrative expenses increased 5.3%, or $3 per worksite employee per month, primarily due to increased travel, training, utilities, and repairs and maintenance, partially offset by reductions in professional services.

Depreciation and amortization expense increased 15.4%, or $2 per worksite employee per month compared to 2012, primarily due to investments in our technology infrastructure and amortization associated with our Adjacent Business investments.

Other Income (Expense)

Other expense was $2.5 million in 2013 compared to other income of $0.8 million in 2012. Included in 2013 is a $2.7 million non-cash impairment charge related to our minority investment in The Receivables Exchange. Please read Note 6 to the Consolidated Financial Statements, “Other Assets,” for additional information.


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Income Tax Expense

During 2013 we incurred federal and state income tax expense of $21.7 million on pre-tax income of $53.7 million.  Our provision for income taxes differed from the US statutory rate of 35% primarily due to state income taxes and non-deductible expenses, partially offset by tax benefits of $2.5 million related to tax years 2009 through 2013. Our effective income tax rate was 40.4% in 2013 compared to 40.8% in 2012.

Net Income

Net income for 2013 was $32.0 million, or $1.25 per diluted share, compared to $40.4 million, or $1.56 per diluted share in 2012.  On a per worksite employee per month basis, net income was $21 in 2013 compared to $27 in 2012.

Results of Operations

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011.

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

 
 
Year ended December 31,
 
 
2012
 
2011
 
% Change
 
 
(in thousands, except per share and statistical data)
Revenues (gross billings of $12.992 billion and $11.700 billion, less worksite employee payroll cost of $10.833 billion and $9.724 billion, respectively)
 
$
2,158,824

 
$
1,976,219

 
9.2
 %
Gross profit
 
382,221

 
351,775

 
8.7
 %
Operating expenses
 
314,727

(1) 
294,461

 
6.9
 %
Operating income
 
67,494

 
57,314

 
17.8
 %
Other income (expense)
 
796

 
(6,539
)
(2) 
(112.2
)%
Net income
 
40,402

 
30,470

 
32.6
 %
Diluted net income per share of common stock
 
1.56

 
1.16

 
34.5
 %
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
125,650

 
116,839

 
7.5
 %
Revenues per worksite employee per month(3)
 
$
1,432

 
$
1,410

 
1.6
 %
Gross profit per worksite employee per month
 
253

 
251

 
0.8
 %
Operating expenses per worksite employee per month
 
208

 
210

 
(1.0
)%
Operating income per worksite employee per month
 
45

 
41

 
9.8
 %
Net income per worksite employee per month
 
27

 
22

 
22.7
 %
____________________________________

(1)
Includes a non-cash impairment charge in the fourth quarter of 2012 of $4.2 million. Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.
(2) 
Includes the impact of a $4.4 million loss related to the exchange of an aircraft, and a $3.1 million loss related to a settlement with the State of California.  Please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” for additional information on the settlement with the State of California.
(3) 
Gross billings of $8,617 and $8,345 per worksite employee per month, less payroll cost of $7,185 and $6,935 per worksite employee per month, respectively.


- 36 -


Revenues

Our revenues in 2012, which represent gross billings net of worksite employee payroll cost, increased 9.2% compared to 2011, due to a 1.6%, or $22 increase in revenues per worksite employee per month and a 7.5% increase in the average number of worksite employees paid per month.  The 1.6% increase in revenues per worksite employee per month was due primarily to increases in the benefits and payroll tax pricing to offset increases in these direct costs.

By region, our Workforce Optimization revenue change from 2011 and distribution for the years ended December 31, 2012 and 2011 were as follows:

 
 
Year ended December 31,
 
Year ended December 31,
 
 
2012
 
2011
 
% Change
 
2012
 
2011
 
 
(in thousands)
 
(% of total revenue)
Northeast
 
$
560,455

 
$
513,075

 
9.2
%
 
26.3
%
 
26.3
%
Southeast
 
198,049

 
192,116

 
3.1
%
 
9.3
%
 
9.9
%
Central
 
312,373

 
282,503

 
10.6
%
 
14.7
%
 
14.5
%
Southwest
 
595,379

 
561,908

 
6.0
%
 
28.0
%
 
28.9
%
West
 
461,427

 
397,363

 
16.1
%
 
21.7
%
 
20.4
%
 
 
2,127,683

 
1,946,965

 
9.3
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
31,141

 
29,254

 
6.5
%
 
 

 
 

Total revenue
 
$
2,158,824

 
$
1,976,219

 
9.2
%
 
 

 
 

____________________________________

(1)    Comprised primarily of revenues generated by Adjacent Businesses.

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 2012, new client sales and client retention declined, while the net change in existing clients remained flat compared to 2011.  As a result, our year-over-year growth in worksite employees paid per month during 2012 was 7.5% compared to 9.2% during 2011.

Gross Profit

Gross profit increased 8.7% to $382.2 million compared to 2011.  The average gross profit per worksite employee increased 0.8% to $253 per month in 2012 versus $251 in 2011.  Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses. Included in gross profit in both 2012 and 2011 is an $11 per worksite employee per month contribution from our Adjacent Businesses.

While our revenues per worksite employee per month increased 1.6% to $1,432 in 2012 versus 2011, our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 1.7% to $1,179 per worksite employee per month.  The primary direct cost components changed as follows:

Benefits costs – The cost of group health insurance and related employee benefits increased $8 per worksite employee per month, or 3.5%, on a per covered employee basis compared to 2011.  The percentage of worksite employees covered under our health insurance plan was 72.1% in 2012 versus 73.7% in 2011.  Please read “—Critical Accounting Policies and Estimates – Benefits Costs” for a discussion of our accounting for health insurance costs.

Workers’ compensation costs – Workers’ compensation costs increased 9.8%, or $1 per worksite employee per month compared to 2011.  As a percentage of non-bonus payroll cost, workers’ compensation costs remained flat at 0.54% compared to 2011.  During 2012, we recorded reductions in workers’ compensation costs of $13.1 million, or 0.14% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $11.4 million, or 0.13% of non-bonus payroll costs in 2011.  The 2012 period costs include the impact of a 0.6% discount rate used to accrue workers’ compensation loss claims, compared to a 1.1% discount rate used in the 2011 period.  Please read “—Critical Accounting Policies and Estimates – Workers’ Compensation Costs” for a discussion of our accounting for workers’ compensation costs.


- 37 -


Payroll tax costs – Payroll taxes increased 9.9%, or $11 per worksite employee per month compared to 2011, due primarily to an 11.4% increase in total payroll cost in 2012 as compared to 2011. Payroll taxes as a percentage of payroll cost decreased to 7.05% in 2012 compared to 7.15% in 2011.

Operating Expenses

The following table presents certain information related to our operating expenses:
 
 
 
 Year ended December 31,
 
Year ended December 31,
 
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
Salaries, wages and payroll taxes
 
$
168,807

 
$
155,233

 
8.7
 %
 
$
112

 
$
111

 
0.9
 %
Stock–based compensation
 
9,814

 
8,601

 
14.1
 %
 
7

 
6

 
16.7
 %
Commissions
 
14,515

 
13,451

 
7.9
 %
 
10

 
10

 

Advertising
 
21,586

 
26,613

 
(18.9
)%
 
14

 
19

 
(26.3
)%
General and administrative expenses
 
77,564

 
75,345

 
2.9
 %
 
50

 
53

 
(5.7
)%
Impairment charge
 
4,191

 

 

 
3

 

 

Depreciation and amortization
 
18,250

 
15,218

 
19.9
 %
 
12

 
11

 
9.1
 %
Total operating expenses
 
$
314,727

 
$
294,461

 
6.9
 %
 
$
208

 
$
210

 
(1.0
)%

Operating expenses increased 6.9% to $314.7 million compared to 2011.  The 2012 operating expenses included a $4.2 million impairment charge incurred in connection with our annual goodwill impairment assessment of our Performance Management reporting unit.  Please read Note 5 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information. Operating expenses per worksite employee per month decreased to $208 in 2012 from $210 in 2011.  The components of operating expenses changed as follows:

Salaries, wages and payroll taxes of corporate and sales staff increased 8.7%, or $1 per worksite employee per month compared to 2011, primarily due to a 6.1% rise in headcount.

Stock-based compensation increased 14.1%, or $1 per worksite employee per month compared to 2011, due primarily to an increase in the weighted average market value on the date of grant associated with restricted stock awards.  The stock-based compensation expense represents amortization of restricted stock awards granted to employees and the annual stock grant made to non-employee directors.  Please read Note 1 to the Consolidated Financial Statements, “Accounting Policies,” for additional information.

Commissions expense increased 7.9%, but remained flat on a per worksite employee per month basis compared to 2011.

Advertising costs decreased 18.9%, or $5 per worksite employee per month compared to 2011, primarily due to the non-recurrence of expenses related to our 2011 rebranding initiative.

General and administrative expenses increased 2.9%, but decreased $3 per worksite employee per month, primarily due to increased professional fees and office expenses, partially offset by the non-recurrence of expenses related to our 2011 rebranding initiative.

Depreciation and amortization expense increased 19.9%, or $1 per worksite employee per month compared to 2011, primarily due to investments in our technology infrastructure and amortization associated with our acquisitions.

Other Income (Expense)

Other income was $0.8 million in 2012 compared to other expense of $6.5 million in 2011, primarily due to a $4.4 million loss in 2011 related to the exchange of an aircraft and a $3.1 million loss in 2011 related to a settlement with the State of California.  Please read Note 14 to the Consolidated Financial Statements, “Commitments and Contingencies,” for additional information on the settlement with the State of California.


- 38 -


Income Tax Expense

During 2012 we incurred federal and state income tax expense of $27.9 million on pre-tax income of $68.3 million.  Our provision for income taxes differed from the US statutory rate of 35% primarily due to state income taxes and non-deductible expenses, offset slightly by tax-exempt interest income.  Our effective income tax rate was 40.8% in 2012 compared to 40.0% in 2011.

Net Income

Net income for 2012 was $40.4 million, or $1.56 per diluted share, compared to $30.5 million, or $1.16 per diluted share in 2011.  On a per worksite employee per month basis, net income was $27 in 2012 compared to $22 in 2011.

Non-GAAP Financial Measures

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.  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.  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.  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 table below.
 
 
 
Year ended December 31,
 
 
2013
 
2012
 
% Change
 
 
(in thousands, except per
worksite employee)
GAAP to non-GAAP reconciliation:
 
 
 
 
 
 
Payroll cost (GAAP)
 
$
11,205,652

 
$
10,832,966

 
3.4
 %
Less: bonus payroll cost
 
1,274,575

 
1,326,442

 
(3.9
)%
Non-bonus payroll cost
 
$
9,931,077

 
$
9,506,524

 
4.5
 %
 
 
 
 
 
 
 
Payroll cost per worksite employee (GAAP)
 
$
7,323

 
$
7,185

 
1.9
 %
Less: Bonus payroll cost per worksite employee
 
833

 
880

 
(5.3
)%
Non-bonus payroll cost per worksite employee
 
$
6,490

 
$
6,305

 
2.9
 %

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, potential acquisitions, debt service requirements and other operating cash needs.  To meet short-term liquidity requirements, which are primarily the payment of direct and operating expenses, we rely primarily on cash from operations.  Longer-term projects or significant acquisitions may be financed with debt or equity.  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 $272.1 million in cash, cash equivalents and marketable securities at December 31, 2013, of which approximately $143.0 million was payable in early January 2014 for withheld federal and state income taxes, employment taxes and other payroll deductions, and $24.5 million were customer prepayments that were payable in January 2014.  At December 31, 2013, we had working capital of $128.6 million compared to $115.7 million at December 31, 2012.  We currently believe that our cash on hand, marketable securities, cash flows from operations and availability under our credit facility will be adequate to meet our liquidity requirements for 2014.  We will rely on these same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital needs.

We have a $100 million revolving credit facility (“credit facility”), with a syndicate of financial institutions.  The credit facility, which expires in September of 2015, is available for working capital and general corporate purposes, including

- 39 -


acquisitions, and was undrawn at December 31, 2013.  Please read Note 8 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.

Cash Flows From Operating Activities
 
Our cash flows from operating activities in 2013 were $34.7 million.  Our primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our Workforce Optimization clients.  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 levels – We typically collect our comprehensive service fee, along with the client’s payroll funding, from clients at least one day prior to the payment of worksite employee 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 worksite employees are paid on Fridays and at month-end; therefore, operating cash flows decrease in the reporting periods that end on a Friday.  In the year ended December 31, 2013, which the last business day of the reporting period ended on a Tuesday, client prepayments were $24.5 million and accrued worksite employee payroll was $173.8 million.  In the year ended December 31, 2012, which ended on a Monday, client prepayments were $13.5 million and accrued worksite employee payroll was $150.1 million.

Workers’ compensation plan funding – Under our workers’ compensation insurance arrangements, we make monthly payments to the carriers comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).  These pre-determined amounts are stipulated in our agreements with the carriers, and are based primarily on anticipated worksite employee payroll levels and workers’ compensation loss rates during the policy year.  Changes in payroll levels from those that were anticipated in the arrangements can result in changes in the amount of the cash payments, which will impact our reporting of operating cash flows.  Our claim funds paid, based upon anticipated worksite employee payroll levels and workers’ compensation loss rates, were $50.0 million in 2013 and $46.7 million in 2012.  However, our estimates of workers’ compensation loss costs were $41.7 million and $36.9 million in 2013 and 2012, respectively. During 2013, we paid the insurance carrier an additional $5.0 million in claim funds for policy years prior to 2013, which resulted in a decrease to working capital. During 2012, we received $2.5 million for the return of excess claim funds related to the workers’ compensation program, which resulted in an increase to 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.  Since inception of the United plan, premiums paid and owed to United have exceeded Plan Costs, resulting in an $13.5 million surplus, $4.5 million of which is reflected as a current asset, and $9.0 million of which is reflected as a long-term asset on our Consolidated Balance Sheets at December 31, 2013.  The premiums owed to United at December 31, 2013, were $2.1 million, which is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets.

Operating results – Our net income has a significant impact on our operating cash flows.  Our net income decreased 20.7% to $32.0 million in 2013 from $40.4 million in 2012.  Please read “Results of Operations – Year Ended December 31, 2013 Compared to Year Ended December 31, 2012.


Cash Flows Used in Investing Activities
 
Our cash flows used in investing activities were $43.0 million during 2013.  We invested $11.6 million in capital expenditures, primarily related to our technology infrastructure.  We also invested $31.5 million, net, in marketable securities.


Cash Flows Used in Financing Activities

Our cash flows used in financing activities were $30.4 million during 2013, primarily due to $17.2 million in share repurchases and $17.4 million in dividends paid.


- 40 -


Contractual Obligations and Commercial Commitments

The following table summarizes our contractual obligations and commercial commitments as of
December 31, 2013, and the effect they are expected to have on our liquidity and capital resources (in thousands):

 
 
 
 
Less than
 
 
 
 
 
More than
Contractual obligations
 
Total
 
1 Year
 
1-3 Years
 
3-5 Years
 
5 Years
Non-cancelable operating leases
 
$
51,987

 
$
12,763

 
$
21,761

 
$
11,598

 
$
5,865

Purchase obligations(1)
 
26,751

 
6,448

 
12,431

 
3,528

 
4,344

Other long-term liabilities:
 
 

 
 

 
 

 
 

 
 

Accrued workers’ compensation claim costs(2)
 
$
120,833

 
$
50,645

 
$
33,324

 
$
24,351

 
$
12,513

Total contractual cash obligations
 
$
199,571

 
$
69,856

 
$
67,516

 
$
39,477

 
$
22,722

____________________________________

(1) 
The table includes purchase obligations associated with non-cancelable contracts individually greater than $100,000 and one year.
(2) 
Accrued workers’ compensation claim costs include the short and long-term amounts.  For more information, please read, “Critical Accounting Policies and Estimates – Workers’ Compensation Costs.”

Seasonality, Inflation and Quarterly Fluctuations

We believe the effects of inflation have not had a significant impact on our results of operations or financial condition.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are primarily exposed to market risks from fluctuations in interest rates and the effects of those fluctuations on the market values of our cash equivalent short-term investments and our available-for-sale marketable securities.  In addition, borrowings under our Facility bear interest at a variable market rate.  As of December 31, 2013, we had not drawn on the Facility.  Please read Note 8 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.  The cash equivalent short-term investments consist primarily of overnight investments, which are not significantly exposed to interest rate risk, except to the extent that changes in interest rates will ultimately affect the amount of interest income earned on these investments.  The available-for-sale marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate.  As a result, the market values of these securities are affected by changes in prevailing interest rates.

We attempt to limit our exposure to interest rate risk primarily through diversification and low investment turnover.  Our investment policy is designed to maximize after-tax interest income while preserving our principal investment.  As a result, our marketable securities consist of tax-exempt short and intermediate-term debt securities, which are primarily pre-refunded municipal bonds that are secured by escrow funds containing U.S. Government Securities.

The following table presents information about our available-for-sale marketable securities as of December 31, 2013 (dollars in thousands):

 
 
Principal
Maturities
 
Coupon
Interest Rate
 
Effective
Yield
2014
 
$
28,445

 
5.12
%
 
0.66
%
2015
 
10,894

 
5.18
%
 
0.29
%
2016
 
4,995

 
5.84
%
 
0.53
%
Total
 
$
44,334

 
5.22
%
 
0.56
%
Fair Market Value
 
$
46,340

 
 

 
 



- 41 -


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this Item 8 is contained in a separate section of this Annual Report.  See “Index to Consolidated Financial Statements.”

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A.  CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

In accordance with Exchange Act Rules 13a-15 and 15a-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2013.

Design and Evaluation of Internal Control over Financial Reporting

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we included a report of management’s assessment of the design and effectiveness of our internal controls as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 2013.  Ernst & Young, LLP, our independent registered public accounting firm, also audited our internal control over financial reporting.  Management’s report and the independent registered public accounting firm’s audit report are included in our 2013 Consolidated Financial Statements under the captions entitled “Management’s Report on Internal Control” and “Report of Independent Registered Public Accounting Firm,” and are incorporated herein by reference.

There has been no change in our internal controls over financial reporting that occurred during the three months ended December 31, 2013, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

ITEM 9B.  OTHER INFORMATION.

None.

- 42 -


PART III

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

Some of the information required by this item is incorporated by reference to the information set forth under the captions “Proposal Number 1: Election of Directors – Nominees – Class I Directors (For Terms Expiring at the 2017 Annual Meeting),” “– Directors Remaining in Office,” and “– Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report (the “Insperity Proxy Statement”).

Code of Business Conduct and Ethics

Our Board of Directors adopted our Code of Business Conduct and Ethics (the “Code of Ethics”), which meets the requirements of Rule 303A.10 of the New York Stock Exchange Listed Company Manual and Item 406 of Regulation S-K.  You can access our Code of Ethics on the Corporate Governance page of our website at insperity.com.  Changes in and waivers to the Code of Ethics for our directors, executive officers and certain senior financial officers will be posted on our Internet website within five business days and maintained for at least 12 months.

ITEM 11.  EXECUTIVE COMPENSATION.

The information required by this item is incorporated by reference to the information set forth under the captions “Proposal Number 1: Election of Directors – Director Compensation” and “—Executive Compensation” in the Insperity Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The information required by this item is incorporated by reference to the information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Insperity Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.

The information required by this item is incorporated by reference to the information set forth under the caption “Proposal Number 1: Election of Directors – Certain Relationships and Related Transactions” in the Insperity Proxy Statement.

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information required by this item is incorporated by reference to the information set forth under the caption “Proposal Number 3:  Ratification and Appointment of Independent Public Accountants – Fees of Ernst & Young LLP” and “—Finance, Risk Management and Audit Committee Pre-Approval Policy for Audit and Non-Audit Services” in the Insperity Proxy Statement.

- 43 -


PART IV

ITEM 15.  EXHIBITS FINANCIAL STATEMENT SCHEDULES.

(a)    1.    Financial Statements of the Company

The Consolidated Financial Statements listed by the Registrant on the accompanying Index to Consolidated Financial Statements are filed as part of this Annual Report.

(a)    2.    Financial Statement Schedules

The required information is included in the Consolidated Financial Statements or Notes thereto.

(a)    3.    List of Exhibits

 
3.1
Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1 (No. 33-96952)).
 
3.2
Certificate of Ownership and Merger dated March 3, 2011 (incorporated by reference to Exhibit 3.1 to the Registrant’s Form 10-Q for the quarter ended March 31, 2011).
 
3.3
Amended and Restated Bylaws of Insperity, Inc. dated March 3, 2011 (incorporated by reference to Exhibit 3.2 to the Registrant’s Form 10-Q for the quarter ended March 31, 2011).
 
3.4
Certificate of Designation of Series A Junior Participating Preferred Stock setting forth the terms of the Preferred Stock (included as Exhibit A to the Rights Agreement).
 
4.1
Specimen Common Stock Certificate  (incorporated by reference to Exhibit 4.1 to the Registrant’s Registration Statement on Form S-1 (No. 33-96952)).
 
4.2