10-K 1 a12312018-documentx10k.htm 10-K Document

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, 2018
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
insperitylogoa02.jpg
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
(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 every Interactive Data file required to be submitted 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 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. o

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

Large accelerated filer ý
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Emerging growth company o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No ý

As of February 4, 2019, 40,937,606 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, 2018 closing price of the common stock as reported by the New York Stock Exchange) was approximately $3.6 billion.

DOCUMENTS INCORPORATED BY REFERENCE

Part III information is incorporated by reference from the proxy statement for the 2019 annual meeting of stockholders, which the registrant intends to file within 120 days of the end of the fiscal year.


TABLE OF CONTENTS


 
 
 
Page
 
 
 
 
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.
 
Item 16.


BUSINESS


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, from time to time, we may 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
We provide an array of human resources (“HR”) and business solutions designed to help improve business performance. Since our formation in 1986, we have evolved from being solely a professional employer organization (“PEO”), an industry we pioneered, to our current position as a comprehensive business performance solutions provider.
Our long-term strategy is to provide the best small and medium-sized businesses in the United States with our specialized human resources service offering and to leverage our buying power and expertise to provide additional valuable services to clients. Our most comprehensive HR services offerings are provided through our Workforce Optimization® and Workforce SynchronizationTM solutions (together, our “PEO HR Outsourcing solutions”), which encompass 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, along with our cloud-based human capital management platform, our Insperity PremierTM solution. Our Workforce Optimization solution is our most comprehensive HR outsourcing solution and is our primary offering. Our Workforce Synchronization solution, which generally is offered only to our middle market client segment, is a lower cost offering with a typically longer commitment that includes the same compliance and administrative services as our Workforce Optimization solution and allows those clients to select, for an additional fee, from the strategic HR products and organizational development services that are included with our Workforce Optimization solution.
In addition to our PEO HR Outsourcing solutions, we offer Workforce Acceleration, a comprehensive human capital management and payroll service solution. We also offer a number of other business performance solutions, including Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Expense Management Services, Retirement Services and Insurance Services, many of which are offered as a cloud-based software solution. These other products and services are offered separately or along with our PEO HR Outsourcing solutions or our Workforce Acceleration solution.
Our PEO HR Outsourcing solutions are designed to improve the productivity and profitability of small and medium-sized businesses. These solutions relieve business owners and key executives of many employer-related administrative and regulatory burdens, which enable them to focus on the core competencies of their businesses. Our PEO HR Outsourcing solutions also promote employee performance through human resources management techniques designed to improve employee satisfaction. We enter into a Client Service Agreement (“CSA”) with each of our PEO HR Outsourcing solutions clients under which we and our client act as co-employers of the employees who work at the client’s worksite (“WSEE”). Under the CSA, we assume responsibility for personnel administration and assist our clients in complying with 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

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billing”), which is invoiced concurrently with the processing of payroll for the WSEEs of the client. The comprehensive service fee consists of the payroll of our WSEEs plus an additional amount reflected as a percentage of the payroll cost of the WSEEs.
We accomplish the objectives of our PEO HR Outsourcing solutions 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 customized human resources solution. We utilize a variety of information technology capabilities to deliver our PEO HR Outsourcing solutions, including Insperity Premier, our cloud-based human capital management platform, which provides an online platform through which we, along with our clients and WSEEs, manage worksite employee information, payroll, benefits and retirement solutions, creating efficiencies for all parties.
As of December 31, 2018, we had 73 offices, including 67 sales offices in 33 markets. In addition, we had four regional service centers along with human resources and client service personnel located in a majority of our 33 sales markets, which serviced an average of 221,809 WSEEs per month in the fourth quarter of 2018. Our service centers coordinate PEO HR Outsourcing solutions for clients on a regional basis and localized face-to-face human resources services.
We were organized as a corporation in 1986. 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 www.insperity.com. Our stock is traded on the New York Stock Exchange under the symbol “NSP.” We file or furnish periodic reports with the Securities and Exchange Commission (“SEC”), 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. Through the investor relations section of our website, we make available electronic copies of the documents that we file or furnish to the SEC, the charters of the standing committees of our Board of Directors and other documents related to our corporate governance, including our Code of Conduct. Access to these electronic filings is available free of charge as soon as reasonably practicable after filing or furnishing them to the SEC. Printed copies of our committee charters and other governance documents and filings can be requested by writing to our corporate secretary at the address above.
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
the significant costs, time and specialized knowledge required to purchase or develop the technology infrastructure to administer benefits, HR and payroll processing on an integrated basis
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

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governmental entities for the establishment of a regulatory framework that protects clients and employees, discourages unscrupulous and financially unsound PEOs, and promotes further development of the industry. Currently, 42 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 employer/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 of these states. The cost of compliance with these regulations is not material to our financial position or results of operations.
In 2014, the Small Business Efficiency Act (“SBEA”) was enacted. The SBEA created a federal regulatory framework for the payment of wages to WSEEs and the reporting and remittance of federal payroll taxes on those wages paid by PEOs certified under the statute (“CPEOs”). We actively supported the enactment of this law. The SBEA clarifies that a CPEO, rather than the client, is treated as the employer for purposes of reporting and remitting payroll taxes. It also clarifies that a CPEO is treated as a successor employer for purposes of the wage base of WSEEs on which federal payroll taxes are applied. In addition, the law clarifies that clients of a CPEO remain eligible for specified tax credits for which they would have been eligible absent the CPEO relationship. Following the establishment of the certification program by the Internal Revenue Service of the United States (“IRS”) and Treasury Department, our PEO subsidiary, Insperity PEO Services, L.P., received its designation as a CPEO from the IRS effective as of January 1, 2017.
Service Offerings
PEO HR Outsourcing Solutions
We serve small and medium-sized businesses by providing our PEO HR Outsourcing solutions, which encompass a broad range of services. Both of our PEO HR Outsourcing solutions offer the following:
benefits and payroll administration
health and workers’ compensation insurance programs
personnel records management
employer liability management
assistance with government compliance
general HR advice
access to Insperity Premier for employees, managers and client owners
401(k) retirement plan sponsored by us
Our Workforce Optimization solution also provides additional services that our Workforce Synchronization clients can purchase for an additional fee, including the following:
employee recruiting and support
employee performance management
training and development services
Our PEO HR Outsourcing solutions are 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:

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Internal Revenue Code (the “Code”)
The Family and Medical Leave Act (FMLA)
Federal Income Contribution Act (FICA)
Genetic Information Nondiscrimination Act of 2008
Federal Unemployment Tax Act (FUTA)
Drug-Free Workplace Act
Fair Labor Standards Act (FLSA)
Occupational Safety and Health Act (OSHA)
Employee Retirement Income Security Act, as amended (ERISA)
Worker Adjustment and Retraining Notification Act (WARN)
Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA)
Uniformed Services Employment and Reemployment Rights Act (USERRA)
Immigration Reform and Control Act (IRCA)
State unemployment and employment security laws
Title VII (Civil Rights Act of 1964)
State workers’ compensation laws
Health Insurance Portability and Accountability Act (HIPAA)
Health Care and Education Reconciliation Act of 2010 (the “Reconciliation Act”)
Age Discrimination in Employment Act (ADEA)
Patient Protection and Affordable Care Act (PPACA)
Americans with Disabilities Act (ADA)
State and local law equivalents of the foregoing
These laws and regulations are complex, and in some instances overlapping. We assist our PEO HR Outsourcing solutions clients in complying with these laws and regulations by providing services in the categories set forth below:
Administrative Functions. Administrative functions encompass a wide variety of processing and recordkeeping tasks, mostly related to payroll administration and regulatory compliance. Specific examples include:
payroll processing
payroll tax deposits
quarterly payroll tax reporting
employee file maintenance
unemployment claims processing
workers’ compensation claims reporting and monitoring
Benefit Plans Administration. We maintain several benefit plans for eligible WSEEs including the following:
a group health plan
a health savings account program
a health care flexible spending account plan
an educational assistance program
an adoption assistance program
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

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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 these benefits to WSEEs and corporate employees. COBRA coverage is extended to eligible terminated WSEEs 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.
Insperity Premier. Insperity Premier is our cloud-based human capital management platform for our PEO HR Outsourcing solutions and is available to our clients with almost no implementation effort or cost. It is designed to provide our service providers with insight into client and worksite employee HR information to better support their needs. Insperity Premier provides role-based access to a wide range of human capital management functions, along with personalized content to the managers, owners and WSEEs of our PEO HR Outsourcing solutions clients, including:
For managers and client owners:
WebPayroll for the submission, approval and reporting of payroll data
tools to manage the onboarding of new employees
employee administration functions such as viewing or changing information about employees
access to client-specific compliance-related information relevant to many HR areas, including the Affordable Care Act
a reporting and analytics tool to create, view, save and export reports and data about employees
ability to manage employee time and attendance information, absences and paid time off
access to talent management tools in the areas of recruiting, performance management and learning management
access to a library of online human resources forms
access to a wide range of best-practices human resources management content
mobile access to review and approve payroll transactions and employee time entry
For WSEEs:
access to view, edit and change a range of employee profile information
online check stubs, pay history reports and W-2s
employee-specific benefits content, including summary plan descriptions, enrollment status and tools to assist with benefits selection
access to 401(k) retirement plan information
e-Learning web-based training
links to benefits providers and other key vendors
performance management tools including self-reviews and review history
ability to submit time and attendance information, absences and paid time off requests

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mobile access to view a wide range of employee-specific information such as pay stub, insurance coverage and ID card, 401(k) balances and other commonly accessed data
Personnel Management. In addition to the services that we deliver through Insperity Premier, we provide a wide variety of personnel management services that give our clients access to HR advisors and additional resources normally found only in the human resources departments of large companies. All PEO HR Outsourcing solutions clients have access to our advice concerning 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 of both the client and us, we may assist our clients in managing and limiting liability. This assistance may include safety-related risk management reviews as well as the implementation by our clients 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 we assist with termination decisions when consulted 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 who specialize in several areas of employment law, have broad experience in disputes concerning the employer/employee relationship and provide support to our internal human resources professionals. As part of our comprehensive service, we also maintain employment practice liability insurance coverage for ourselves and our clients, monitor developments in HR-related laws and regulations, and notify clients of the potential effect of such changes on employer liability.
MarketPlaceSM provided by Insperity®. Through our many alliances with best-of-class providers, Insperity’s MarketPlace is an e-commerce portal that brings a wide range of products and services to our clients, WSEEs and their families. Through MarketPlace, which is provided through Insperity Premier, our clients also have the opportunity to offer their products and services to other clients and WSEEs.
Middle Market Solutions. We believe the middle market sector, which we generally define as those companies with employees ranging from approximately 150 to 5,000 WSEEs, has historically been under-served by the PEO industry. Currently, we have a dedicated sales management, service personnel and consulting staff who concentrate solely on the middle market sector. Our average number of WSEEs per month in our middle market sector increased 19.2% over 2017, representing approximately 24.6% of our total paid WSEEs during 2018.
Other Product and Services Offerings
We offer other product and services offerings on a stand-alone basis and to our PEO HR Outsourcing solutions clients. We also strive to leverage our relationships with our customers to enable cross-selling of our various products and services.
During 2018 and 2017, revenues from our other products and services offerings as a percentage of our total revenues were 1.1% and 1.3%, respectively.

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Following are the key components of our other products and services, which are offered separately or as a bundle:
Traditional Payroll and Human Capital Management. Our Insperity Workforce Acceleration solution is a comprehensive human capital management and payroll services solution for clients that do not choose our PEO HR Outsourcing solutions. This solution combines a cloud-based human resources software suite that provides integrated payroll, HR administration and employee onboarding, benefits administration, performance management, and time and attendance functionality with HR guidance and tools, as well as reporting and analytics. In addition, through a strategic partner, Workforce Acceleration clients have access to a national, licensed insurance brokerage that specializes in the insurance needs of small businesses.
Time and Attendance. Our Time and Attendance products and services provide small to medium-sized businesses with software, hardware and services to track, allocate, and analyze employee resources and provide inputs into clients’ payroll processing and accounting systems. The service is primarily delivered as a cloud-based solution, including Insperity Premier for our PEO HR Outsourcing solutions clients.
Performance Management. Our Performance Management products and services provide human resources software offerings including Insperity® PerformSmart® a performance management cloud-based offering. Insperity PerformSmart is available to both our Workforce Optimization and Workforce Synchronization clients. For customers utilizing PerformSmart in conjunction with our PEO HR Outsourcing solutions, we provide access through Insperity Premier. Performance Management products are sold through online subscription arrangements and through various reseller arrangements.
Organizational Planning. Organizational Planning offers cloud-based software used by companies to facilitate the creation, management and communication of detailed organizational management charts. For customers utilizing OrgPlus RealTime in conjunction with our PEO HR Outsourcing solutions, we provide access through Insperity Premier.
Recruiting Services. Our Recruiting Services offer 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.
Employment Screening. Our Employment Screening services offer a customized approach to background-check reporting for companies. Services include criminal records checks; verification of employment history or education; driving record, civil record and credit history checks; and confirmation of extraordinary credentials.
Expense Management. Our Expense Management product 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 as a cloud-based solution.
Retirement Services. Our Retirement Services solutions deliver comprehensive 401(k) retirement plan recordkeeping and administrative services to small and medium-sized businesses, primarily in connection with a 401(k) retirement plan we sponsor for our PEO HR Outsourcing solutions 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 solutions offer assistance through our licensed insurance agency to small and medium-sized businesses throughout the United States to secure affordable, customizable business insurance packages and life, health and disability insurance policies. Insurance Services also assists individuals in obtaining insurance coverages.
Client Service Agreement
All PEO HR Outsourcing solutions clients execute a CSA with us. The CSA provides for an ongoing relationship between Insperity and the PEO HR Outsourcing solutions client. For most clients, the CSA generally is an annual contract subject to earlier termination by Insperity or the client upon 30 days’ written notice or upon shorter notice in the event of default. CSAs for our middle market clients are generally two-year contracts, subject to earlier termination by clients upon payment of a termination fee or otherwise by the parties upon an 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 CSA, clients

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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 us with our 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.
The CSA also establishes the division of responsibilities between us and the client as co-employers. Pursuant to the CSA, we are responsible for personnel administration and for compliance with certain employment-related government regulations. In addition, we assume liability for payment of salaries and wages (as well as related payroll taxes) of our WSEEs 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. Instead, as a result of our employment relationship with each of our WSEEs, we are liable for payment of salary and wages to the WSEEs 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 assumed by both Insperity and the client where such concurrent responsibility is appropriate. The specific division of applicable responsibilities under our CSAs generally is 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 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, PPACA, the Code and ERISA compliance for client-sponsored benefit plans

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Concurrent
Implementation of policies and practices relating to the employee/employer relationship
Compliance with all federal, state and local employment laws, including 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. Our incurred costs in excess of annual premiums 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. Our CSA ordinarily 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 WSEEs or to require prepayment, letters of credit, or other collateral upon deterioration in a 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.
PEO HR Outsourcing Solutions Clients
Insperity’s PEO HR Outsourcing solutions provide value-added, full-service human resources solutions we believe are most suitable to a specific segment of the small and medium-sized business community. We target successful businesses with approximately 10 to 5,000 employees that recognize the advantage in the strategic use of high-performance human resources practices. We have set a long-term goal to serve approximately 10% of the overall small and medium-sized business community in terms of WSEEs. We serve clients and WSEEs located throughout the United States.
By region, our revenue distribution for the year ended December 31, 2018, were as follows:
chart-f48f04bf49d657a3419.jpg
Please read Note 1Accounting Policies,” to the Consolidated Financial Statements for additional information related to the change in revenues by region.

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All prospective PEO HR Outsourcing solutions clients are evaluated on the basis of a comprehensive analysis of employer-related risks entailing many factors, including industry and operations, workplace safety and workers’ compensation, unemployment history, operating stability, group medical information, human resources practices and other employer risks. As part of our client selection strategy, we strive to minimize offering our PEO HR Outsourcing solutions to businesses falling within certain specified NAICS (North American Industry Classification System) codes for those industries that we believe present a higher employer risk such as employee injury, high turnover or litigation.
Our PEO HR Outsourcing solutions client base is broadly distributed throughout a wide variety of industries including:
chart-3f58aa37c2e6b038b01.jpg
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 2018 and 2017, our retention rate was approximately 86% and 85%, respectively. For all PEO HR Outsourcing solutions clients, the average annual retention rate over the last five years was approximately 84%. Client attrition is attributable to a variety of factors, including: (1) client non-renewal due to price or service factors; (2) client business failure, sale, merger, or disposition; (3) our termination of the CSA resulting from the client’s non-compliance or inability to make timely payments; and (4) competition from other PEOs or business services firms.

Insperity
11

2018 Form 10-K

BUSINESS


Marketing and Sales
As of December 31, 2018, we had 67 PEO HR Outsourcing solutions sales offices located in 33 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:
Market
Sales Offices
 
Initial Entry Date
 
 
 
 
Houston
7
 
1986
San Antonio
1
 
1989
Austin
1
 
1989
Orlando
1
 
1989
Dallas/Fort Worth
5
 
1993
Atlanta
3
 
1994
Phoenix
1
 
1995
Chicago
4
 
1995
Washington D.C.
2
 
1995
Denver
2
 
1996
Los Angeles
6
 
1997
Charlotte
1
 
1997
St. Louis
1
 
1998
San Francisco
3
 
1998
New York
5
 
1999
Baltimore
2
 
2000
Newark
2
 
2000
San Diego
1
 
2001
Boston
3
 
2001
Minneapolis
2
 
2002
Raleigh
1
 
2006
Kansas City
1
 
2007
Columbus
1
 
2010
Nashville
1
 
2011
Philadelphia
2
 
2012
Seattle
1
 
2015
Indianapolis
1
 
2016
Fort Lauderdale
1
 
2017
Milwaukee
1
 
2017
Oklahoma City
1
 
2018
Pittsburgh
1
 
2018
San Jose
1
 
2018
Stamford
1
 
2018
We identify markets 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 weighs various criteria that, based on our experience, we believe are reliable predictors of successful penetration. Among the factors we consider are:

Insperity
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2018 Form 10-K

BUSINESS


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
long-term strategy issues, such as the general perception of markets and our estimate of the long-term revenue growth potential of the market
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 the Internet, television, radio, newspapers, periodicals and direct mail. 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 routinely 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 an arrangement with Jim Nantz, a sports commentator, to serve as our national spokesperson. Our marketing campaigns use this event and the relationship with 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, third-party channel programs, referrals, marketing alliances, and the Internet. These leads result in initial presentations to prospective PEO HR Outsourcing solutions clients, and ultimately, prospective PEO HR Outsourcing solutions client business profiles. A prospective PEO HR Outsourcing solutions client’s business profile reflects information gathered by the BPA about the prospect’s employees, including base compensation, level of benefits coverage options, job classification, state of employment and workers’ compensation classification. This information is used to generate a bid from our customized bid system, which applies Insperity’s proprietary pricing model to the census data. Concurrent with this process, we evaluate prospective clients through the previously described comprehensive employer risk analysis. Upon completion of a favorable employer risk evaluation, the BPA presents the bid and attempts to complete the sale and enroll the prospect. Our selling process typically takes approximately 90 days for clients with less than 150 employees, and 180 days or longer for middle market clients. The process can be extended during economic downturns.
We have implemented cross-selling channels between our PEO HR Outsourcing solutions business and our other products and services. This cross-selling strategy focuses on using our PEO HR Outsourcing solutions to increase market penetration in each of our other products and services and using our other product and service offerings as a source of leads for our PEO HR Outsourcing solutions. The cross-selling channels attempt to reduce barriers to selling our products and services and allow us to tailor service packages to better meet the specific needs of the business.
Competition
We provide a value-added, full-service human resources solution through our PEO HR Outsourcing solutions, 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 WSEEs (the “staff support ratio”) that is higher than average for the PEO industry.

Insperity
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2018 Form 10-K

BUSINESS


Based on an analysis of the 2015 through 2017 annual NAPEO surveys of the PEO industry, we have successfully leveraged our full-service approach into significantly higher returns for Insperity on a per WSEE per month basis. During the three-year period from 2015 through 2017, our staff support ratio averaged 53% higher than the PEO industry average. During the same three-year period, our gross profit per WSEE and operating income per WSEE exceeded industry averages by 140% and 183%, 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 believe we compete favorably in these areas; however, other PEOs may offer their PEO services at lower prices than we 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 for our PEO HR Outsourcing solutions 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 the PEO divisions of large business services companies such as Automatic Data Processing, Inc. and Paychex, Inc., and other national PEOs, such as TriNet Group, Inc. In addition, we also face competition from: (1) fee-for-service providers such as payroll processors and human resources consultants; (2) human resources technology solution companies; and (3) large regional PEOs in certain areas of the country. As Insperity and other large PEOs expand nationally, we expect that competition may intensify.
Vendor Relationships
Insperity provides benefits to its WSEEs under arrangements with a variety of vendors. We consider our contracts with UnitedHealthcare (“United”) and the Chubb Group of Insurance Companies (“Chubb”) to be the most significant elements of our employee benefits package, as they would be the most difficult to replace.
We provide group health insurance coverage to our WSEEs through a national network of carriers including United, UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield of Hawaii and Tufts, all of which provide fully insured policies or service contracts. The health insurance contract with United provides approximately 86% of our health insurance coverage and expires on December 31, 2022, 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 “Chubb Program”) has been provided through an arrangement with Chubb (formerly ACE American Insurance Company) since 2007. The Chubb Program is a fully insured program whereby Chubb has the responsibility to pay all claims incurred under the policies regardless of whether we satisfy our responsibilities. For additional discussion of the Chubb 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 PEO HR Outsourcing solutions and business performance improvement services to its clients and WSEEs and for its own administrative and management information requirements.
Insperity’s PEO HR Outsourcing solutions information systems, which include Insperity Premier, are a proprietary mix of applications that includes both internally developed and licensed software applications. These systems manage a wide range of transactions and information specific to our PEO HR Outsourcing solutions, to Insperity and to our clients and WSEEs, including:
WSEE enrollment
human resources management and employee administration

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2018 Form 10-K

BUSINESS


benefits and defined contribution plan administration
time and attendance collection and administration
payroll processing
client invoicing and collection
management information and reporting
sales bid calculations
Central to these systems are transaction processing capabilities that allow us to process a high volume of employee enrollment, employee administration, 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 PEO HR Outsourcing solutions clients and WSEEs through Insperity Premier. We utilize commercially available software for other business functions such as finance and accounting, sales force activity management and customer relationship management.
Our products and services utilize a variety of owned and licensed software applications to deliver business performance improvement services to our clients, including to some of our PEO HR Outsourcing solutions clients.
Insperity has hosting facilities located at two separate leased facilities, located in Bryan, Texas and The Woodlands, Texas. These facilities host the majority of our business applications, telecommunications equipment, information security infrastructure 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 have the capacity 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. We have an active Business Continuity Plan, which includes information technology capabilities and we utilize a variety of measures to ensure our Business Continuity Plan remains effective and available.
Our network infrastructure is designed to ensure appropriate connectivity exists among all of our facilities and employees and provides appropriate Internet connectivity to conduct business with our clients and WSEEs. 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 our data centers and network environment; best practice security policies and procedures; and a variety of measures designed to control access to sensitive and private information.
Industry Regulations
The operations for our PEO HR Outsourcing solutions are affected by numerous federal and state laws relating to tax, insurance and employment matters. By entering into a co-employer relationship with our WSEEs, 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, 42 states have passed laws that recognize PEOs or require licensing, registration or certification requirements for PEOs, and several others are considering such regulation. The SBEA, which was enacted in 2014, established a certification program and created a federal regulatory framework for the payment of wages to WSEEs and for the reporting and remittance of federal payroll taxes on those wages paid by CPEOs. In 2016, our PEO subsidiary, Insperity PEO Services, L.P., received its designation as a CPEO from the IRS effective as of January 1, 2017. Please read Item 1. “Business – PEO Industry” for further information.

Insperity
15

2018 Form 10-K

BUSINESS


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 WSEEs. These plans include:
a group health plan, which includes medical, dental, vision and prescription drug coverage, as well as a work-life program
a 401(k) retirement plan
cafeteria plans under Code Section 125
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. The number and complex nature of federal and state regulations relating to employer-sponsored health plans has continued to increase over time. 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 in their efforts to comply with governmental regulations due to limited resources and a 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 that 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.
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 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

Insperity
16

2018 Form 10-K

BUSINESS


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 WSEEs 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 WSEEs, 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, issues related to the relationship between Insperity and its WSEEs 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 original staggered effective dates from 2010 through 2018, some of which were subsequently extended until as late as 2020. While the Act did not have a material adverse impact on our results of operations in 2018, the future impact of the following provisions or changes to the provisions, including any changes or a repeal that may be proposed by this Congressional session, is unknown at this time.
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. As part of the Tax Cuts and Jobs Act enacted in December 2017, the requirements that individuals maintain health insurance coverage or pay a penalty, which was known as the individual mandate, was effectively eliminated beginning in 2019. At this time, the Exchanges, tax credits, and subsidies have not had a material impact on our operations, but the impact of future changes to these provisions is unknown.
Additionally in 2014, the Act ushered in a number of insurance market reforms for the small group and individual markets. The reforms required guaranteed issue and renewability of coverage, eliminated certain underwriting practices by issuers, consolidated the number of risk pools in each state and restricted the permissible factors and variable ranges of those factors that can be considered in determining health insurance premiums. Transition relief permitted states to delay the effective date of some of these reforms. At this time, we are unable to determine whether the insurance market reforms 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.
The health insurance industry became subject to additional excise taxes in 2014, and reinsurance taxes were 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 were passed on to us by our carriers. At this time, these taxes have not had a material impact on our operations, but the impact of future changes to these provisions is unknown.
Effective January 1, 2015, “pay or play” requirements applied to large employers with at least 50 full-time and full-time equivalent employees in the prior calendar year (“Applicable Large Employers” or “ALEs”). ALEs who fail to offer “minimum essential coverage” satisfying minimum value and affordability requirements may be subject to a penalty if a full-time employee obtains coverage from an Exchange and receives a subsidy or tax credit for such coverage. While clients are responsible for employer pay or play health care mandates under the CSA, the Insperity Group Health Plan qualifies as minimum essential coverage and is designed to satisfy the minimum value and affordability requirements. Clients are not required to use the affordability safe harbor utilized by us.
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 if pay or play penalties may be assessed against a PEO for coverage provided to WSEEs under a PEO sponsored plan.

Insperity
17

2018 Form 10-K

BUSINESS


The effective date of the rules imposing excise taxes on employers and insurers who offer excessive health benefits under so-called “Cadillac plans” has been delayed until 2022. 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 that the excise taxes will have on our ability to match pricing with any increased costs.
401(k) Retirement Plans. Our 401(k) Retirement Plan for WSEEs 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 WSEEs. This guidance provides qualification standards for PEO plans that, 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 WSEEs. There are essentially three types of federal employment tax obligations included in Subtitle C - Employment Taxes of the Code:
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.
The SBEA provides that a CPEO shall be treated as the employer under Subtitle C – Employment Taxes of the Code, and shall be responsible for reporting federal employment taxes rather than the CPEO clients. Insperity PEO Services, L.P. received its designation as a CPEO from the IRS effective as of January 1, 2017.
For any client CSA that is not a CPEO contract, 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. Code 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 Code 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 several courts have examined Code Section 3401(d)(1), 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 WSEEs, 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. 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.

Insperity
18

2018 Form 10-K

BUSINESS


State Regulation
While some states do not explicitly regulate PEOs, 42 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. We believe that we are in compliance with the material requirements in all 42 states that have such laws. 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 3,200 corporate employees as of December 31, 2018. We believe our relations with our corporate employees are good. None of our corporate employees are covered by a collective bargaining agreement.
Intellectual Property
Insperity currently has registered trademarks, copyrights and other intellectual property. We believe that our trademarks as a whole are of considerable importance to our business.

Insperity
19

2018 Form 10-K

RISK FACTORS


Item 1A.  Risk Factors.
The statements in this section describe the known material risks to our business and should be considered carefully.
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 conditions, 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 WSEE 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 WSEEs and assume the obligations to pay the salaries, wages and related benefits costs and payroll taxes of such WSEEs. 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 WSEEs, 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 WSEEs 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 WSEEs exceed the fees a client pays us, our ultimate liability for WSEE 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 WSEEs is a significant part of our business. Our primary health insurance contract expires on December 31, 2022, 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 and costs 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 or delay our ability to incorporate increases in costs into our 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 Act entails sweeping health care reforms with original staggered effective dates from 2010 through 2018, some of which were subsequently extended out as far as 2022. Some provisions in the Act still require the issuance of additional guidance from the U.S. Department of Health and Human Services (“HHS”) and the states.
Beginning in 2014, a number of key provisions of the Act took effect, including the 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 Applicable Large Employers were fully phased-in by 2016. As part

Insperity
20

2018 Form 10-K

RISK FACTORS


of the Tax Cuts and Jobs Act enacted in December 2017, the requirements that individuals maintain health insurance coverage or pay a penalty, which was known as the individual mandate, was effectively eliminated beginning in 2019. In January 2018, the excise tax for offering “Cadillac Plans” was further delayed until 2022. In addition, supporters in various states are advocating for adoption of healthcare-related reforms at the state level. Collectively, these items have the potential to significantly change the insurance marketplace for small and 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 the 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.
Although we do not believe that the Act has had a material adverse effect on our benefit plans, business model, or operations to date, the elimination of the penalty associated with the individual mandate and subsequent changes resulting from action that may be taken at the federal or state level, including repeal or repeal and replacement of the Act as has been advocated by Congressional leaders and the administration of President Trump, may impact our benefit plans, business model and future results of operations. In future periods, 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 the Act, please read Item 1. “Business - Industry Regulations - Patient Protection and Affordable Care Act.” We are currently unable to determine whether potential future changes to the Act or other regulatory action, including at the state level, may adversely affect our business or market conditions.
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 Chubb (formerly ACE American Insurance Company) since 2007. Under our current arrangement with Chubb, we have a financial responsibility to Chubb for the first $1 million layer of claims per occurrence and for claims over $1 million, up to a maximum aggregate amount of $6 million per policy year for claims that exceed the first $1 million. Chubb bears the financial responsibility for all claims in excess of these levels. The Chubb Program is a fully insured program whereby Chubb has the responsibility to pay all claims incurred under the policies regardless of whether we satisfy our responsibilities. For additional discussion of our policy with Chubb, 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 Chubb expires on September 30, 2019. 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. SUI 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, SUI tax rates would likely increase substantially. Some states have the ability under law to increase SUI tax rates retroactively to cover deficiencies in the unemployment fund. In addition, FUTA 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 statutory tax 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 clients’ 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.

Insperity
21

2018 Form 10-K

RISK FACTORS


Many of our contracts for our PEO HR Outsourcing solutions may be canceled on short notice.  Our inability to renew client contracts or attract new clients could materially and adversely affect our financial conditions or 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 PEO HR Outsourcing Solution clients, which could materially and adversely affect our financial condition or results of operations. In addition, in the event we have a high proportion of terminating clients from our middle market client base (which are generally subject to CSAs with two-year terms), the financial impact of such an event could be significant due to the number of WSEEs involved and the longer time it takes to replace middle market clients. Also, 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 14% in 2018. 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 economic conditions in the markets we operate. Clients electing to purchase our 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.
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 WSEEs, including questions concerning the ultimate liability for violations of employment, payroll, discrimination, and workplace safety 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, payroll, discrimination, and workplace safety laws despite these contractual provisions, even if we do not participate in such violations. Although the CSA generally requires the client to indemnify us for certain liabilities 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, WSEEs may be deemed to be our agents, which may subject us to liability for the actions of such WSEEs.
Competition and other developments in the HR services industry may impact our growth and/or profitability.
The human resources services industry, including the PEO industry, is highly fragmented. Many PEOs have limited operations and fewer than 1,000 WSEEs, 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 as well as cloud-based self-service bundled human resources offerings. 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 Group, Inc. In many cases, these competitors offer a reduced service PEO offering at a lower price than our PEO HR Outsourcing solutions. 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. In addition, competitors may be able to offer or develop new technology-based lower service models that may require us to make substantial investments in order to effectively compete.
We offer a lower priced reduced service level PEO offering referred to as Workforce Synchronization in response to certain middle market client needs and the evolving PEO marketplace. As of December 2018, approximately 14% of our WSEEs were co-employed by Workforce Synchronization clients. In the event we were to experience a significant increase in the number of clients using the Workforce Synchronization offering or increased pricing pressures in the PEO marketplace without corresponding reductions in operating costs, our operating margins may decline, which could have a material adverse impact on our financial condition or results of operations.

Insperity
22

2018 Form 10-K

RISK FACTORS


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 current 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 despite the SBEA having provided clarification under federal employment tax laws for CPEOs. 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 or PEO health insurance plans. Any adverse application of, or adverse legislative/regulatory response to, new or existing federal or state laws to the PEO relationship with our WSEEs and client companies could have a material adverse effect on our results of operations or financial condition.
While some states do not explicitly regulate PEOs, 42 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. In addition, the SBEA provides certain benefits for companies that qualify as a CPEO. 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 or that we will be able to maintain our CPEO designation.
Geographic market concentration makes our results of operations vulnerable to regional economic factors.
Our New York, California and Texas markets accounted for approximately 10%, 16% and 22% (including 10% in Houston), respectively, of our WSEEs for the year ended December 31, 2018. 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, statutory, and regulatory factors specific to New York, California and Texas.
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 WSEEs. 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. The SBEA clarifies that a CPEO is treated as the employer for purposes of federal payroll taxes on wages it pays to WSEEs. 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 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, including from cyber attacks and data breaches, could damage our reputation, materially disrupt our business operations, and increase our costs and cause losses.
Many of the HR services offerings we provide to clients are conducted through a technology infrastructure using both internally developed and purchased commercial software, a wide variety of hardware infrastructure technologies, and a multi-carrier wide area network. The processing of payroll, benefits and other transactions is dependent upon this complex

Insperity
23

2018 Form 10-K

RISK FACTORS


infrastructure, some of which is provided by third-party vendors. Hardware or applications we develop or procure from third-party vendors may contain defects in design or other problems that could unexpectedly compromise the confidentiality, integrity or availability of data or our systems. 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.
In connection with our HR services offerings, we collect, use, transmit and store large amounts of personal and business information about our WSEEs and clients, including payroll information, personal and business financial data, social security numbers, bank account numbers, tax information and other sensitive personal and business information. Attacks on information technology systems continue to grow in frequency and sophistication, and we and our third-party vendors are targeted by unauthorized parties using malicious tactics, code and viruses. Because the techniques used to obtain unauthorized access and disable or sabotage systems change frequently and may be difficult to detect for long periods of time, we and our third-party vendors may be unable to anticipate these techniques or implement adequate preventive measures. As these threats continue to evolve, we may be required to invest significant additional resources to modify and enhance our information security and controls or to investigate and remediate any security vulnerabilities. While our technology infrastructure is designed to safeguard and protect personal and business information, we do not have the ability to monitor the implementation of similar safeguards by our vendors, clients or WSEEs.
Any cyber-attack, unauthorized intrusion, malicious software infiltration, network disruption, corruption of data, or theft of private or other sensitive information, or inadvertent acts by our own employees, could result in the disclosure or misuse of confidential or proprietary information, and could have a material adverse effect on our business operations or that of our clients, result in liability or regulatory sanction, or cause a loss of confidence in our ability to serve clients. The impact of a data security incident could have a material adverse effect on our business, results of operations and financial condition.
We are also subject to various federal and state laws, rules and regulations relating to the collection, use, transmission and security and privacy of personal and business information. Most states and the District of Columbia have enacted notification rules that may require notification to regulators, clients or employees in the event of a privacy breach. In addition, new laws and regulations governing data privacy and the unauthorized disclosure of confidential information pose increasingly complex compliance challenges and potentially elevate our costs. It is possible that these federal and states 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 adverse 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 future enactment of more restrictive laws, rules or regulations could have a material adverse impact on us through increased costs or restrictions on our businesses and noncompliance could result in regulatory penalties and significant liability. Additionally, any failure by us to comply with these laws and regulations, including as a result of a security or privacy breach, could result in significant penalties and liabilities for us.
The failure of our insurance carriers or financial institutions could have a material adverse effect on us.
As part of our PEO HR Outsourcing solutions, we contract with various insurance carriers to provide insurance coverage including 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, cyber liability 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 on our business.
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. 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.

Insperity
24

2018 Form 10-K

RISK FACTORS


New and higher federal, state and local taxes could have a material adverse impact on our financial condition and results of operations.
In times of economic slowdowns, states and municipalities in which we operate may experience reductions in tax revenues and corresponding budget deficits. In response to budget shortfalls, many states and municipalities have in the past and may in the future increase or enact new taxes on businesses operating within their tax jurisdiction, including business activity taxes and income taxes. In addition, federal, state and local taxing agencies may increase 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.
Failure to integrate or realize the expected return on our acquisitions and investments could have a material adverse impact on our financial condition or results of operations.
We have adopted a strategy to market and sell additional products and services within and outside of traditional PEO HR Outsourcing solutions. 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. Based on market conditions or changes in operating plans, the fair value of our other acquired businesses could decline, requiring us to record impairment charges for all or portions of the investments.
Our business could be disrupted as a result of actions of certain stockholders.
If any of our stockholders commence a proxy contest, advocate for change, make public statements critical of our performance or business, or engage in other similar activities, then our business could be adversely affected because we may have difficulty attracting and retaining clients due to perceived uncertainties as to our future direction and negative public statements about our business; responding to proxy contests and other similar actions by stockholders is likely to result in us incurring substantial additional costs and significantly divert the attention of management and our employees; and, if individuals are elected to our Board with a specific agenda, the execution of our strategic plan may be disrupted or a new strategic plan altogether may be implemented, which could have a material adverse impact on our business, financial condition or results of operations. Further, any of these matters or any such actions by stockholders may impact and result in volatility of the price of our common stock.

Insperity
25

2018 Form 10-K

OTHER INFORMATION


Item 1B.  Unresolved Staff Comments.
None.

Insperity
26

2018 Form 10-K

PROPERTIES


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 client growth, the geographic distribution of our client base and our long-term service delivery requirements.
Corporate Facilities
Our corporate headquarters is located in Kingwood, Texas, in a campus-style facility. This 33-acre company-owned office campus includes 430,000 square feet of office space and approximately 9 acres of undeveloped land for future expansion. Development and support operations are located in the Kingwood facility. In February 2019, we executed a contract to construct a 270,000 square foot office facility to be located on our corporate campus. Please read Item 9B. “Other Information” for additional information.
We have hosting facilities, totaling approximately 2,000 square feet, located at two separate leased facilities. The hosting facilities house the majority of our business applications, telecommunications equipment and network equipment. The facilities, located in Bryan, Texas and The Woodlands, Texas, are under lease until 2024 and 2022, respectively.
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 34% of our worksite employee base, is located in a 40,500 square foot facility under lease until 2023.
The Dallas service center, which currently services approximately 23% of our worksite employee base, is located in a 42,500 square foot facility under lease until 2023. In addition to the service center operations, the facility also contains sales operations.
The Houston service center, which currently services approximately 21% of our worksite employee base, is located on our corporate campus.
The Los Angeles service center, which currently services approximately 22% of our worksite employee base, is located in a 39,000 square foot facility under lease until 2029.
Sales and Service Offices
As of December 31, 2018, we had sales and service personnel in 59 facilities located in 33 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, 2018, we had 67 sales offices in these 33 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 client service personnel in sales markets as a critical mass of clients is attained in each market.

Insperity
27

2018 Form 10-K

LEGAL PROCEEDINGS


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 12 to the Consolidated Financial Statements, “Commitments and Contingencies,” which is incorporated herein by reference.

Insperity
28

2018 Form 10-K

EXECUTIVE OFFICERS


Item S-K 401 (b).  Executive Officers of the Registrant.
The following table sets forth the names, ages (as of February 4, 2019) and positions of Insperity’s executive officers:
Name
 
Age
 
Position
 
 
 
 
 
Paul J. Sarvadi
 
62
 
Chairman of the Board and Chief Executive Officer
A. Steve Arizpe
 
61
 
Executive Vice President of Client Services and Chief Operating Officer
Jay E. Mincks
 
65
 
Executive Vice President of Sales and Marketing
Douglas S. Sharp
 
57
 
Senior Vice President of Finance, Chief Financial Officer and Treasurer
Daniel D. Herink
 
52
 
Senior Vice President of Legal, General Counsel and Secretary
James D. Allison
 
50
 
Senior Vice President of Gross Profit Operations
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.
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 promoted and elected to Vice President of Legal, General Counsel and Secretary 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.
James D. Allison has served as Senior Vice President of Gross Profit Operations since May 2018. Mr. Allison joined Insperity in 1997 and has held positions of increased responsibility, including Manager of Financial Reporting, Director of Accounting, Managing Director of Planning and Analysis, Managing Director of Finance, and Senior Vice President of Pricing and Cost Analysis. Mr. Allison has served on the Accounting Practices Committee of NAPEO and, prior to joining Insperity, he worked in the audit practice of Ernst & Young LLP. Mr. Allison earned his Bachelor of Business Administration and Master in Professional Accounting degrees from the University of Texas and is a certified public accountant.

Insperity
29

2018 Form 10-K

STOCK ACTIVITIES


PART II
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Common Stock
Our common stock is traded on the New York Stock Exchange under the symbol “NSP.” As of February 4, 2019, there were 411 holders of record of our common stock. This number does not include stockholders for whom shares were held in “nominee” or “street name.”
Dividend Policy
The payment of dividends is made at the discretion of our Board and depends upon our operating results, financial condition, capital requirements, general business conditions and such other factors as our Board 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, 2018:
Period
Total Number of Shares Purchased(1)(2)
 
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)
10/01/2018 – 10/31/2018
186,000

 
$
107.06

 
186,000

 
2,411,564

11/01/2018 – 11/30/2018
394,000

 
100.63

 
394,000

 
2,017,564

12/01/2018 – 12/31/2018
406,458

 
92.33

 
406,409

 
1,611,155

Total
986,458

 
$
98.42

 
986,409

 
 
__________________________________
(1) 
Our Board has approved a program to repurchase shares of our outstanding common stock. During the three months ended December 31, 2018, 986,409 shares were repurchased under the program. As of December 31, 2018, we were authorized to repurchase an additional 1,611,155 shares under the program. Unless terminated earlier by resolution of the Board, the repurchase program will expire when we have repurchased all the shares authorized for repurchase under the repurchase program.

(2) 
During the three months ended December 31, 2018, 49 shares of restricted stock were withheld to satisfy tax-withholding obligations arising in conjunction with the vesting of restricted stock. The required withholding is calculated using the closing sales price reported by the New York Stock Exchange on the date prior to the applicable vesting date. These shares are not subject to the repurchase program described above.

Insperity
30

2018 Form 10-K

STOCK ACTIVITIES


Performance Graph
The following graph compares our cumulative total stockholder return since December 31, 2013, with the S&P Smallcap 600 Index, the S&P Midcap 400 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, 2013.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Insperity, Inc., the S&P Smallcap 600 Index, the S&P Midcap 400 Index,
and S&P 1500 Composite Human Resource and Employment Services Index
chart-05fd99e4d91bc039ddb.jpg
*$100 invested on 12/31/13 in Insperity stock or in the specified index, including reinvestment of dividends.
Fiscal year ending December 31.

Copyright© 2019 Standard & Poor's, a division of S&P Global. All rights reserved.
 
12/13

12/14

12/15

12/16

12/17

12/18

 
 
 
 
 
 
 
Insperity, Inc.
100.00

102.09

147.64

220.80

367.89

604.10

S&P Smallcap 600
100.00

105.76

103.67

131.20

148.56

135.96

S&P Midcap 400
100.00

109.77

107.38

129.65

150.71

134.01

S&P 1500 Composite Human Resource and Employment Services
100.00

104.57

108.13

119.90

153.45

129.80

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.

Insperity
31

2018 Form 10-K

SELECTED FINANCIAL DATA


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.”
(in thousands, except per share and statistical data)
Year Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
 
 
 
Income Statement Data:
 
Revenues(1)
$
3,828,549

 
$
3,300,223

 
$
2,941,347

 
$
2,603,614

 
$
2,357,788

 
Gross profit
681,909

 
572,731

 
491,610

 
437,867

 
403,805

 
Operating income
179,036

 
129,941

 
106,306

 
65,699

(2) 
47,474

(3) 
Net income
135,413


84,402

 
65,991

 
39,390

 
28,004

 
Diluted EPS
3.22

 
2.01

(4) 
1.54

(4) 
0.79

(4) 
0.53

(4)(5) 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP Financial Measures(6):
 
 
 
 
 
 
 
 
 
Adjusted net income
$
157,536

 
$
103,005

 
$
76,718

 
$
54,519

 
$
36,734

 
Adjusted EPS
3.75

 
2.45

(4) 
1.79

(4) 
1.10

(4) 
0.72

(4) 
Adjusted EBITDA
239,601

 
177,681

 
141,183

 
110,014

 
84,124

 
 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Working capital
$
94,204

 
$
54,206

 
$
39,364

 
$
54,337

 
$
66,742

 
Total assets
1,191,816

 
1,063,695

 
907,174

 
784,912

 
792,595

 
Total debt
144,400

 
104,400

 
104,400

 

 

 
Total stockholders’ equity
77,676

 
66,321

 
60,525

 
172,455

 
204,096

 
Cash dividends per share
0.80

 
1.58

(4)(7) 
0.49

(4) 
0.43

(4) 
1.37

(4)(7) 
 
 
 
 
 
 
 
 
Average WSEEs paid
209,123

 
182,696

 
165,850

 
145,830

 
130,718

 
 
 
 
 
 
 
 
 
 
 
 
Statistical Data (per WSEE per month):
 
 
 
 
 
 
 
Revenues(8)
$
1,526

 
$
1,505

 
$
1,478

 
$
1,488

 
$
1,503

 
Gross profit
272

 
261

 
247

 
250

 
257

 
Operating income
71

 
59

 
53

 
38

 
30

 
Adjusted EBITDA(6)
95

 
81

 
71

 
63

 
54

 
____________________________________
(1) 
Revenues are comprised of gross billings less worksite employee (“WSEE”) payroll costs as follows:
 
Year Ended December 31,
(in thousands)
2018
 
2017
 
2016
 
2015
 
2014
 
 
 
 
 
 
 
 
 
 
Gross billings
$
23,830,731

 
$
20,173,812

 
$
17,932,857

 
$
15,806,178

 
$
14,186,921

Less: WSEE payroll cost
20,002,182

 
16,873,589

 
14,991,510

 
13,202,564

 
11,829,133

Revenues
$
3,828,549

 
$
3,300,223

 
$
2,941,347

 
$
2,603,614

 
$
2,357,788

(2) 
Includes non-cash impairment and other charges in the first and second quarters of 2015 of $9.8 million and $1.3 million, respectively, partially offset by a reduction of $0.6 million in the fourth quarter of 2015.
(3) 
Includes a non-cash impairment charge in the second quarter of 2014 of $2.5 million. Also includes a non-cash charge in 2014 of $1.2 million.
(4) 
Adjusted to reflect the two-for-one split of our common stock effected on December 18, 2017 as a stock dividend.
(5) 
Includes the impact of dividends exceeding earnings under the two-class method, resulting in a $0.03 earnings per share decrease in 2014.

Insperity
32

2018 Form 10-K

SELECTED FINANCIAL DATA


(6) 
These are non-GAAP measures used by management to analyze Insperity’s performance. Please read Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP.
(7) 
Includes a $1.00 per share special dividend paid in both the fourth quarters of 2017 and 2014.
(8) 
Revenues per WSEE per month are comprised of gross billings per WSEE per month less WSEE payroll costs per WSEE per month as follows:
 
Year Ended December 31,
(per WSEE per month)
2018
 
2017
 
2016
 
2015
 
2014
Gross billings
$
9,496

 
$
9,202

 
$
9,011

 
$
9,032

 
$
9,044

Less: WSEE payroll cost
7,970

 
7,697

 
7,533

 
7,544

 
7,541

Revenues
$
1,526

 
$
1,505

 
$
1,478

 
$
1,488

 
$
1,503



Insperity
33

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.
Executive Summary
Overview
Our long-term strategy is to provide the best small and medium-sized businesses in the United States with our specialized human resources service offering and to leverage our buying power and expertise to provide additional valuable services to clients. Our most comprehensive HR services offerings are provided through our Workforce Optimization® and Workforce SynchronizationTM solutions (together, our PEO HR Outsourcing solutions), which encompass 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, gross profit or adjusted EBITDA per WSEE per month. We often use the average number of WSEEs paid during a period as our unit of measurement in analyzing and discussing our results of operations.
In addition to our PEO HR Outsourcing solutions, we offer a comprehensive traditional payroll and human capital management solution, known as Workforce Acceleration. We also offer a number of other business performance solutions, including Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Expense Management, Retirement Services, and Insurance Services, many of which are primarily offered via cloud-based delivery models. These other products or services are offered separately or with our other solutions.
2018 Highlights
Our results for 2018 reflect the impact of continued worksite employee (“WSEE”) growth and effective management of gross profit and operating costs contributing to our significant earnings growth. We ended 2018 averaging 221,809 paid WSEEs, which represents a 17.0% increase over fourth quarter 2017. We expect the average number of paid WSEEs per month to be between 224,000 and 226,000 in the first quarter 2019.
2018 Compared to 2017
Average number of WSEEs paid per month increased 14.5% to 209,123, driving a 19.1% gross profit increase
Net income and diluted earnings per share (“Diluted EPS”) increased 60.4% and 60.2% to $135.4 million and $3.22, respectively
Adjusted EBITDA increased 34.8% to $239.6 million
Adjusted net income increased 52.9% to $157.5 million
Adjusted EPS increased 53.1% to $3.75
Approximately 24.6% and 23.6% of our average paid WSEEs were in our middle market sector for the years ended December 31, 2018 and 2017, respectively, which is generally defined as companies with 150 to 5,000 WSEEs.
Our average gross profit per worksite employee per month was $272 in 2018 and $261 in 2017.

Insperity
34

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Operating expenses increased 13.6% in 2018 to $502.9 million. On a per worksite employee per month basis, operating expenses decreased from $202 in 2017 to $201 in 2018.
Adjusted operating expenses increased 12.0% in 2018 to $493.6 million. On a per worksite employee per month basis, adjusted operating expenses decreased from $201 in 2017 to $197 in 2018.
Net income in 2018 was $135.4 million, a 60.4% increase compared to 2017.
Our adjusted EBITDA per worksite employee per month increased 17.3% from $81 in 2017 to $95 in 2018.
We ended 2018 with working capital of $94.2 million.
During 2018, we paid $33.4 million in dividends and repurchased 1.2 million shares of our common stock at a cost of $113.3 million.
Please read “Non-GAAP Financial Measures” for a reconciliation of adjusted EBITDA, adjusted net income, adjusted EPS and adjusted operating expenses to their most directly comparable financial measures calculated and presented in accordance with GAAP.
Revenues
We account for our revenues in accordance with Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). Our PEO HR Outsourcing solutions 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 WSEEs. 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 WSEEs 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.
Our revenues are primarily dependent on the number of clients enrolled, the resulting number of WSEEs paid each period and the number of WSEEs enrolled in our benefit plans. Because our total markup is computed as a percentage of payroll cost, certain revenues are also affected by the payroll cost of WSEEs, which may fluctuate based on the composition of the 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 revenue-generating activities for our PEO HR Outsourcing solutions 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 unemployment 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 program 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.

Insperity
35

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 PEO HR Outsourcing solutions clients, which are subject to pricing 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 (“Salaries”) are primarily a function of the number of corporate employees, 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 other products and services.
Stock-based compensation – Our stock-based compensation relates to the recognition of non-cash compensation expense over the vesting period of restricted stock and long-term incentive plan awards.
Commissions – Commissions expense consists primarily of amounts paid to sales managers and BPAs as well as channel referral fees. Commissions are based on new accounts sold and a percentage of revenue generated by such personnel.
Advertising – Advertising expense primarily consists of media advertising and other business promotions in our current and anticipated sales markets, including the Insperity Invitational presented by UnitedHealthcare® sponsorship.
General and administrative expenses – Our general and administrative expenses primarily include:
rent expenses related to our service centers and sales offices
outside professional service fees related to legal, consulting, and accounting services
administrative costs, such as postage, printing, and supplies
employee travel and training expenses
technology expenses
facility repairs and maintenance costs
Depreciation and amortization – Depreciation and amortization expense is primarily a function of our capital investments in corporate facilities, service centers, sales offices, software development, technology infrastructure and that associated with our acquisitions.
Impairment charges and other – Impairment charges and other consist of non-cash expense associated with the decline in fair value of long-lived and intangible assets, including goodwill. Please read Note 1Accounting Policies,” to the Consolidated Financial Statements for additional information.
Other Income (Expense)
Other income (expense) includes interest charges incurred in connection with borrowings under our credit facility and interest income earned on our cash, cash equivalents and marketable securities. Please read “—Liquidity and Capital Resources” for additional information.
Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Reform Act”) was signed into law. The 2017 Tax Reform Act significantly changes U.S. corporate income tax laws by, among other things, reducing the U.S. corporate income tax rate from 35% to 21% beginning in 2018. As a result, we remeasured our deferred tax assets at the new lower corporate income tax rate and recorded a non-cash tax charge of $2.5 million in 2017. Our provision for income taxes typically differs from the U.S. statutory rate of 21%, due primarily to state income taxes, non-deductible expenses and

Insperity
36

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

various tax credits. 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, software development costs, accrued incentive compensation and depreciation. Changes in these items are reflected in our financial statements through a deferred income tax provision. Please read Note 7 to the Consolidated Financial statements, “Income Taxes,” for additional information.
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 we believe 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 WSEEs through a national network of carriers including United, UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA BlueCross BlueShield of Hawaii 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: (1) the level of claims processed during the quarter; (2) estimated completion rates based upon recent claim development patterns under the plan; and (3) 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, 2018, Plan Costs were more than the premiums paid and owed to United by $6.3 million. As this amount is less than the agreed-upon $9.0 million surplus maintenance level, the $15.3 million difference is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets. In addition, the premiums owed to United at December 31, 2018, were $15.2 million, which is also included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets.
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.

Insperity
37

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table illustrates the sensitivity of changes in the completion rate and annual trend on our estimate of total benefit costs of $1.7 billion in 2018:
Change in
Completion Rate and Annual Trend
 
Change in
Benefits Costs
(in thousands)
 
Change in
Net Income
(in thousands)
 
 
 
 
 
(2.5)%
 
$
(21,170
)
 
$
15,729

(1.0)%
 
(8,468
)
 
6,292

1.0%
 
8,468

 
(6,292
)
2.5%
 
21,170

 
(15,729
)

Workers’ compensation costs – Since 2007, our workers’ compensation coverage has been provided through our arrangement with Chubb. The Chubb Program is fully insured in that Chubb has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. Under the Chubb Program, we have financial responsibility to Chubb for the first $1 million layer of claims per occurrence and, for claims over $1 million, up to a maximum aggregate amount of $6 million per policy year for claims that exceed $1 million.
Because we bear the financial responsibility for claims up to the levels noted above, such claims, which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing health care and indemnity coverage whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which take into account the ongoing development of claims and therefore requires a significant level of judgment.
We utilize a third-party actuary to estimate our loss development rate, which is primarily based upon the nature of WSEEs’ job responsibilities, the location of WSEEs, 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, 2018 and 2017, we reduced accrued workers’ compensation costs by $18.8 million and $16.3 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 was 2.6% in 2018 and 1.6% in 2017) 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.
The following table illustrates the sensitivity of changes in the loss development rate on our estimate of workers’ compensation costs totaling $86.0 million in 2018:
Change in Loss Development Rate
 
Change in Workers’ Compensation Costs
(in thousands)
 
Change in
Net Income
(in thousands)
 
 
 
 
 
(5.0)%
 
$
(4,044
)
 
$
3,005

(2.5)%
 
(2,022
)
 
1,502

2.5%
 
2,022

 
(1,502
)
5.0%
 
4,044

 
(3,005
)

At the beginning of each policy period, the workers’ compensation insurance carrier establishes monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”). The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected

Insperity
38

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

workers’ compensation loss rates, as determined by the insurance carrier. Monies funded into the program for incurred claims expected to be paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds are included in deposits, a long-term asset in our Consolidated Balance Sheets. In 2018, we received $19.4 million for the return of excess claim funds related to the workers’ compensation program, which decreased deposits. As of December 31, 2018, we had restricted cash of $42.2 million and deposits of $166.5 million. We have estimated and accrued $229.6 million in incurred workers’ compensation claim costs as of December 31, 2018. Our estimate of incurred claim costs expected to be paid within one year are recorded as accrued workers’ compensation costs and is included in short-term liabilities, while our estimate of incurred claim costs expected to be paid beyond one year is included in long-term liabilities on our Consolidated Balance Sheets.
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. In 2018, we finalized certain tax positions when we filed our 2017 federal tax return, and concluded no further adjustments were required to our net deferred tax asset balance of $8.8 million as of December 31, 2018 related to the remeasurement of our deferred tax assets under the 2017 Tax Reform Act.
Allowance for doubtful accounts – We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients 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 PEO HR Outsourcing solutions clients to pay their comprehensive service fees no later than one day prior to the applicable payroll date. In addition, we generally maintain the right to terminate the CSA and associated WSEEs 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 result of these efforts, losses related to client 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

Insperity
39

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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. Please read Note 1 to the Consolidated Financial Statements, “Accounting Policies,” for additional information.
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 1 to the Consolidated Financial Statements, “Accounting Policies,” 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.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard requires recognition of lease assets and lease liabilities for leases previously classified as operating leases. The guidance is effective for fiscal years beginning after December 15, 2018. We expect the lease commitments discussed in Note 11, to the Consolidated Financial Statements,Leases” to appear on our Consolidated Balance Sheets in the form of a lease asset and a lease liability. Such amounts are based on the present value of such commitments using our incremental borrowing rate. We plan to utilize the transition package of practical expedients permitted within the new standard, which among other things, allows us to carryforward the historical lease classification. We do not plan to elect the practical expedient to use hindsight in determining the lease term and in assessing impairment of right-of-use assets.

Insperity
40

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations
The following table summarized our key financial and statistical information related to our results of operations:
(in thousands, except per share and statistical data)
Year Ended December 31,
 
% Change
2018
 
2017
 
2016
 
2018 v 2017
2017 v 2016
 
 
 
Financial data:
 
 
 
 
 
 
 
 
Revenues(1)
$
3,828,549

 
$
3,300,223

 
$
2,941,347

 
16.0
 %
12.2
%
Gross profit
681,909

 
572,731

 
491,610

 
19.1
 %
16.5
%
Operating expenses
502,873

 
442,790

 
385,304

 
13.6
 %
14.9
%
Operating income
179,036

 
129,941

 
106,306

 
37.8
 %
22.2
%
Other income (expense)
3,324

 
200

 
(1,129
)
 


Net income
135,413

 
84,402

 
65,991

 
60.4
 %
27.9
%
Diluted EPS
3.22

 
2.01

(2) 
1.54

(2) 
60.2
 %
30.5
%
 
 
 
 
 
 
 
 
 
Non-GAAP financial measures(3):
 
 
 
 
 
 
 
 
Adjusted net income
$
157,536

 
$
103,005

 
$
76,718

 
52.9
 %
34.3
%
Adjusted EBITDA
239,601

 
177,681

 
141,183

 
34.8
 %
25.9
%
Adjusted EPS
3.75

 
2.45

(2) 
1.79

(2) 
53.1
 %
36.9
%
 
 
 
 
 
 
 
 
 
Average WSEEs paid
209,123

 
182,696

 
165,850

 
14.5
 %
10.2
%
 
 
 
 
 
 
 
 
 
Statistical data (per WSEE per month):
 
 
 
 
 
 
 
 
Revenues(4)
$
1,526

 
$
1,505

 
$
1,478

 
1.4
 %
1.8
%
Gross profit
272

 
261

 
247

 
4.2
 %
5.7
%
Operating expenses
201

 
202

 
194

 
(0.5
)%
4.1
%
Operating income
71

 
59

 
53

 
20.3
 %
11.3
%
Net income
54

 
38

 
33

 
42.1
 %
15.2
%
Adjusted EBITDA(3)
95

 
81

 
71

 
17.3
 %
14.1
%
___________________________________
(1)Revenues are comprised of gross billings less worksite employee (“WSEE”) payroll costs as follows:
 
Year ended December 31,
(in thousands)
2018
2017
2016
 
 
 
 
Gross billings
$
23,830,731

$
20,173,812

$
17,932,857

Less: WSEE payroll cost
20,002,182

16,873,589

14,991,510

Revenues
$
3,828,549

$
3,300,223

$
2,941,347

(2) 
Adjusted to reflect the two-for-one split of our common stock effected on December 18, 2017 in the form of a stock dividend.
(3) 
Please read “—Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures calculated and presented in accordance with GAAP.
(4)Revenues per WSEE per month are comprised of gross billings per WSEE per month less WSEE payroll costs per WSEE per month as follows:
 
Year Ended December 31,
(per WSEE per month)
2018
2017
2016
Gross billings
$
9,496

$
9,202

$
9,011

Less: WSEE payroll cost
7,970

7,697

7,533

Revenues
$
1,526

$
1,505

$
1,478


Insperity
41

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Key Operating Metrics
We monitor certain key metrics to measure our performance, including:
WSEEs
Adjusted EBITDA
Adjusted EPS
Our growth in the number of WSEEs paid is affected by three primary sources: new client sales, client retention and the net change in existing clients through WSEE new hires and layoffs.
During 2018, the number of WSEEs paid from new client sales increased 27.0% over 2017 on a 16.2% increase in the average number of Business Performance Advisors (“BPAs”). In addition, the net change in existing clients and client retention improved compared to 2017.
During 2017, the number of WSEEs paid from new client sales increased 10.1% over 2016 on an 11.7% increase in the average number of BPAs. In addition, the net change in existing clients and client retention declined compared to 2016.
nspgraph1a04.jpg
Revenues
2018 Compared to 2017
Our revenues for 2018 were $3.8 billion, an increase of 16.0%, primarily due to the following:
Average WSEEs paid increased 14.5%
Revenues per WSEE per month increased 1.4%, or $21
2017 Compared to 2016

Insperity
42

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our revenues for 2017 were $3.3 billion, an increase of 12.2%, primarily due to the following:
Average WSEEs paid increased 10.2%
Revenues per WSEE per month increased 1.8%, or $27
We provide our PEO HR Outsourcing solutions to small and medium-sized businesses in strategically selected markets throughout the United States. PEO HR Outsourcing solutions revenue distribution by region follows:
PEO HR Outsourcing Solutions Revenue by Region
(in thousands)
chart-d2c927c5ca946f4d590.jpg chart-dcb872efe49910c4ca2.jpg chart-ffd02b9f44d96744953.jpg
The percentage of total PEO HR Outsourcing solutions revenues in our significant markets include the following:
Significant Markets
chart-0fc7d6ee48302514d78.jpgchart-f741cc9a362a12596c3.jpgchart-f03b32ec2557a230632.jpg
Gross Profit
In determining the pricing of the markup component of our gross billings, we take into consideration our estimates of the costs directly associated with our WSEEs, including payroll taxes, benefits and workers’ compensation costs, plus an acceptable gross profit margin. As a result, our gross profit per WSEE and our operating results are significantly impacted by our ability to accurately estimate, control and manage our direct costs relative to the revenues derived from the markup component of our gross billings.

Insperity
43

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our gross billings charged to our PEO Outsourcing solutions clients are subject to pricing arrangements that are typically renewed annually. We use gross profit per WSEE per month as our principal measurement of relative performance at the gross profit level.
nspgraph2.jpg
2018 Compared to 2017
Our pricing objectives attempt to achieve a level of revenue per WSEE that matches or exceeds changes in primary direct costs and operating expenses. The net decrease in costs between 2018 and 2017 due to changes in cost estimates for benefits and workers compensation totaled $5.0 million as discussed below. The primary direct cost components changed as follows:
Benefits costs
The cost of group health insurance and related employee benefits increased $6 per WSEE per month, or 2.2%, on a per covered employee basis.
Changes in estimated claims run-off related to prior periods was a reduction of $1.3 million, or $1 per WSEE per month, in 2018 compared to an increase of $1.2 million, or $1 per worksite employee per month, in 2017.
The percentage of WSEEs covered under our health insurance plan was 68.0% in 2018 and 68.8% in 2017.
Please read “—Critical Accounting Policies and Estimates—Benefits Costs” for a discussion of our accounting for health insurance costs.
Workers’ compensation costs
Our continued discipline around our client selection, safety and claims management contributed to the reduction in our cost per WSEE and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original costs estimates.
Workers’ compensation costs increased 6.2%, but decreased $3 on a per WSEE per month basis, in 2018 compared to 2017.

Insperity
44

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As a result of closing out claims incurred in prior periods at lower than expected costs, we recorded a reduction in workers’ compensation costs of $18.8 million, or 0.11% of non-bonus payroll costs, in 2018 compared to a reduction of $16.3 million, or 0.11% of non-bonus payroll costs, in 2017. The 2018 period costs include the impact of a 2.6% discount rate used to accrue workers’ compensation loss claims, compared to a 1.6% discount rate used in the 2017 period.
As a percentage of non-bonus payroll cost, workers’ compensation costs in 2018 were 0.49% compared to 0.54% in 2017.
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 15.8%, or $6 per WSEE per month, due primarily to an 18.5% increase in payroll costs offset by lower unemployment tax rates in 2018.
Payroll taxes as a percentage of payroll cost were 6.7% in 2018 compared to 6.9% in 2017.
2017 Compared to 2016
The net decrease in costs between 2017 and 2016 due to changes in cost estimates for benefits and workers compensation totaled $9.3 million as discussed below. The primary direct cost components changed as follows:
Benefits costs
The cost of group health insurance and related employee benefits increased $4 per WSEE per month, or 1.2%, on a per covered employee basis.
Changes in estimated claims run-off related to prior periods was an increase of $1.2 million, or $1 per WSEE per month, in 2017 compared to $5.1 million, or $3 per worksite employee per month, in 2016.
The percentage of WSEEs covered under our health insurance plan was 68.8% in 2017 and 69.2% in 2016.
Please read “—Critical Accounting Policies and Estimates—Benefits Costs” for a discussion of our accounting for health insurance costs.
Workers’ compensation costs
Our continued discipline around our client selection, safety and claims management contributed to the reduction in our cost per WSEE and, as a result, has allowed for claims within our policy periods to be closed out at amounts below our original costs estimates.
Workers’ compensation costs increased 2.2%, but decreased $3 on a per WSEE per month basis, in 2017 compared to 2016.
As a result of closing out claims incurred in prior periods at lower than expected costs, we recorded a reduction in workers’ compensation costs of $16.3 million, or 0.11% of non-bonus payroll costs, in 2017 compared to $10.9 million, or 0.08% of non-bonus payroll costs, in 2016. The 2017 period costs include the impact of a 1.6% discount rate used to accrue workers’ compensation loss claims, compared to a 1.1% discount rate used in the 2016 period.
As a percentage of non-bonus payroll cost, workers’ compensation costs in 2017 were 0.54% compared to 0.59% in 2016.
Please read “—Critical Accounting Policies and Estimates—Workers’ Compensation Costs” for a discussion of our accounting for workers’ compensation costs.
Payroll tax costs

Insperity
45

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Payroll taxes increased 12.6% primarily due to a 12.6% increase in payroll costs, or $12 on a per WSEE per month basis.
Payroll taxes as a percentage of payroll cost were 6.9% in 2017 compared to 6.8% in 2016.
Operating Expenses
2018 Compared to 2017
The following table presents certain information related to our operating expenses:
 
Year Ended December 31,
 
$
 
WSEE
(in thousands, except per WSEE)
2018
2017
% Change
 
2018
2017
% Change
 
 
 
 
 
 
 
 
Salaries
$
301,027

$
259,531

16.0
 %
 
$
120

$
118

1.7
 %
Stock-based compensation
20,425

24,345

(16.1
)%
 
8

11

(27.3
)%
Commissions
28,957

22,773

27.2
 %
 
12

10

20.0
 %
Advertising
18,554

16,686

11.2
 %
 
7

8

(12.5
)%
General and administrative
111,068

101,273

9.7
 %
 
45

46

(2.2
)%
Depreciation and amortization
22,842

18,182

25.6
 %
 
9

9


Total operating expenses
$
502,873

$
442,790

13.6
 %
 
$
201

$
202

(0.5
)%
Operating expenses for 2018 increased 13.6% to $502.9 million compared to $442.8 million in 2017. Operating expenses per WSEE per month for 2018 decreased 0.5% to $201 compared to $202 in 2017.
Salaries of corporate and sales staff increased 16.0% to $301.0 million, or $2 per WSEE per month, compared to 2017. The increase was primarily due to a $9.3 million charge related to a one-time tax reform bonus paid to corporate employees, a 10.7% increase in headcount, including a 16.2% increase in BPAs in 2018, and additional incentive compensation expense as a result of stronger operating results.
Stock-based compensation decreased 16.1% to $20.4 million, or $3 per WSEE per month, compared to 2017. This decrease was primarily due to the acceleration of restricted stock awards and associated expense into the fourth quarter of 2017 that were originally scheduled to vest in the first quarter of 2018. Please read Note 1Accounting Policies” and Note 9Incentive Plans,” to the Consolidated Financial Statements for additional information.
Commissions expense increased 27.2% to $29.0 million, or $2 per WSEE per month, compared to 2017. Commissions are primarily due to commissions associated with the growth in our PEO HR Outsourcing solutions including an increase in the amount of sales channel referral fees paid in 2018.
Advertising expense increased 11.2% to $18.6 million, but decreased $1 on a per WSEE per month basis, compared to 2017. The increase was due to additional spending on sponsorships, promotional items and billboard advertising.
General and administrative expenses increased 9.7% to $111.1 million, but decreased $1 on a per WSEE per month basis, compared to 2017. The increase was due to increased travel and training expenses associated with the increase in BPAs, professional services, technology costs, rent and office expenses, partially offset by the non-recurrence of charitable contributions made in 2017 related to Hurricane Harvey relief efforts.
Depreciation and amortization expense increased 25.6% to $22.8 million, but remained flat on a per WSEE per month basis, compared to 2017. The increase was primarily due to increased capital expenditures related to software development costs.

Insperity
46

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

2017 Compared to 2016
The following table presents certain information related to our operating expenses:
 
Year Ended December 31,
 
$
 
WSEE
(in thousands, except per WSEE)
2017
2016
% Change
 
2017
2016
% Change
 
 
 
 
 
 
 
 
Salaries
$
259,531

$
229,589

13.0
%
 
$
118

$
115

2.6
%
Stock-based compensation
24,345

16,643

46.3
%
 
11

8

37.5
%
Commissions
22,773

19,288

18.1
%
 
10

10


Advertising
16,686

16,447

1.5
%
 
8

8


General and administrative
101,273

86,693

16.8
%
 
46

44

4.5
%
Depreciation and amortization
18,182

16,644

9.2
%
 
9

9


Total operating expenses
$
442,790

$
385,304

14.9
%
 
$
202

$
194

4.1
%
Operating expenses for 2017 increased 14.9% to $442.8 million compared to $385.3 million in 2016. Operating expenses per WSEE per month for 2017 increased 4.1% to $202 compared to $194 in 2016.
Salaries of corporate and sales staff for 2017 increased 13.0% to $259.5 million, or $3 per WSEE per month, compared to 2016. The increase was primarily due to an 8.3% rise in headcount, including an 11.7% increase in BPAs in 2017 and additional incentive compensation as a result of stronger operating results.
Stock-based compensation for 2017 increased 46.3% to $24.3 million, or $3 per WSEE per month, compared to 2016. This increase was primarily due to awards issued under our Long-Term Incentive Program established in 2015 and the acceleration of restricted stock awards that were scheduled to vest in the first quarter of 2018 in order to maximize our tax deduction on certain restricted stock vestings, which would have been limited under the 2017 Tax Reform Act. Stock-based compensation expense represents amortization of restricted stock and long-term incentive awards granted to employees and the annual stock grant made to non-employee directors. Please read Note 1Accounting Policies” and Note 9Incentive Plans,” to the Consolidated Financial Statements for additional information.
Commissions expense for 2017 increased 18.1% to $22.8 million, but remained flat on a per WSEE per month basis, compared to 2016. Commissions are primarily associated with compensation to our sales force for sales of our PEO HR Outsourcing solutions.
General and administrative expenses for 2017 increased 16.8% to $101.3 million, or $2 per WSEE per month , compared to 2016. Included in 2017 is a $2.0 million donation to Hurricane Harvey relief efforts. The remaining increase was due to increased travel, meals and training on a higher level of corporate employee, event expenses associated with a new client referral program, technology maintenance costs and office costs.
Depreciation and amortization expense for 2017 increased 9.2% to $18.2 million, but remained flat on a per WSEE per month basis, compared to 2016. The increase was primarily due to $1.1 million of depreciation and amortization expense related to the new facility opened on our corporate campus in early 2017.
Other Income (Expense)
Other income (expense), net was income of $3.3 million in 2018, income of $0.2 million in 2017 and expense of $1.1 million in 2016. The 2018 increase in income was primarily due to interest income earned on our investments. Please read Note 2 to the Consolidated Financial Statements, “Cash, Cash Equivalents and Marketable Securities,” for additional information.
Income Tax Expense
Our effective income tax rate was 25.7% in 2018, 35.1% in 2017 and 37.3% in 2016.

Insperity
47

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

During 2018 we incurred federal and state income tax expense of $46.9 million on pre-tax income of $182.4 million. Our provision for income taxes differed from the U.S. statutory rate of 21% primarily due to state income taxes and non-deductible expenses, offset by a $2.7 million tax benefit associated wtih equity compensation.
During 2017 we incurred federal and state income tax expense of $45.7 million on pre-tax income of $130.1 million. Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses, including a non-cash tax charge of $2.5 million related to the enactment of the 2017 Tax Reform Act offset by $6.2 million of tax benefits associated with equity compensation.
During 2016 we incurred federal and state income tax expense of $39.2 million on pre-tax income of $105.2 million. Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. In addition, during 2016, as a result of our adoption of Accounting Standard Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share Based Payment Accounting, we recognized income tax benefits of $1.5 million related to the vesting of restricted stock awards and exercise of non-qualified stock options.
Please read Note 1Accounting Policies” and Note 7Income Taxes,” to the Consolidated Financial Statements for additional information.
Non-GAAP Financial Measures
Non-GAAP financial measures are not prepared in accordance with GAAP and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. Investors are encouraged to review the reconciliation of the non-GAAP financial measures used to their most directly comparable GAAP financial measures as provided in the tables below.

Insperity
48

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Non-GAAP Measure
Definition
Benefit of Non-GAAP Measure
Non-bonus payroll cost
Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our WSEEs.

Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program.
Our management refers to non-bonus payroll cost in analyzing, reporting and forecasting our workers’ compensation costs.

We include these non-GAAP financial measures because we believe they are useful to investors in allowing for greater transparency related to the costs incurred under our current workers’ compensation program.
Adjusted cash, cash equivalents and marketable securities
Excludes funds associated with:
•  federal and state income tax withholdings,
•  employment taxes,
•  other payroll deductions, and
•  client prepayments.
We believe that the exclusion of the identified items helps us reflect the fundamentals of our underlying business model and analyze results against our expectations, against prior periods, and to plan for future periods by focusing on our underlying operations. We believe that the adjusted results provide relevant and useful information for investors because they allow investors to view performance in a manner similar to the method used by management and improves their ability to understand and assess our operating performance. Adjusted EBITDA is used by our lenders to assess our leverage and ability to make interest payments.
 
 
Adjusted operating expense
Represents operating expenses excluding the impact of the following:
•  costs associated with a one-time tax reform bonus paid to corporate employees and
•  charitable donations to Hurricane Harvey relief efforts.
 
 
EBITDA
Represents net income computed in accordance with GAAP, plus:
•  interest expense,
•  income tax expense, and
•  depreciation and amortization expense.
 
 
Adjusted EBITDA
Represents EBITDA plus:
•  non-cash stock based compensation,
•  costs associated with a one-time tax reform bonus paid to corporate employees, and
•  charitable donations to Hurricane Harvey relief efforts.
 
 
Adjusted net income
Represents net income computed in accordance with GAAP, excluding:
•  non-cash stock based compensation,
•  costs associated with a one-time tax reform bonus paid to corporate employees, and
•  charitable donations to Hurricane Harvey relief efforts.
 
 
Adjusted EPS
Represents diluted net income per share computed in accordance with GAAP, excluding:
•  non-cash stock based compensation,
•  costs associated with a one-time tax reform bonus paid to corporate employees, and
•  charitable donations to Hurricane Harvey relief efforts.
Following is a reconciliation of payroll cost (GAAP) to non-bonus payroll costs (non-GAAP):
 
Year Ended December 31,
(in thousands, except per WSEE per month)
2018
 
2017
 
2016
$
WSEE
 
$
WSEE
 
$
WSEE
 
 
 
 
 
 
 
 
 
Payroll cost
$
20,002,182

$
7,971

 
$
16,873,589

$
7,697

 
$
14,991,510

$
7,533

Less: Bonus payroll cost
2,498,875

996

 
1,959,053

894

 
1,648,936

829

Non-bonus payroll cost
$
17,503,307

$
6,975

 
$
14,914,536

$
6,803

 
$
13,342,574

$
6,704

% Change year over year
17.4
%
2.5
%
 
11.8
%
1.5
%
 
15.1
%
1.2
%

Insperity
49

2018 Form 10-K

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Following is a reconciliation of EBITDA (GAAP) and adjusted EBITDA (non-GAAP):
(in thousands, except per WSEE per month)
Year Ended December 31,
2018
 
2017
 
2016
 
2015
 
2014
$
WSEE
 
$
WSEE
 
$
WSEE
 
$
WSEE
 
$
WSEE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
$
135,413

$
54

 
$
84,402

$
38

 
$
65,991

$
33

 
$
39,390

$
23

 
$
28,004

$
18

Income tax expense
46,947

19

 
45,739

21

 
39,186

19

 
26,229

14

 
19,623

13

Interest expense
4,668

2

 
3,213

1

 
2,396

1

 
459


 
370


Depreciation and amortization
22,842

9

 
18,182

9

 
16,644

9

 
18,565

11

 
21,387

14

EBITDA
209,870

84

 
151,536

69

 
124,217

62

 
84,643

48

 
69,384

45

Impairment charges and other


 


 


 
10,480

6

 
3,687

2

Stock-based compensation
20,425

8

 
24,345

11

 
16,643

8

 
13,345

8

 
11,053

7

One-time tax reform bonus
9,306

3

 


 


 


 


Charitable donations to Hurricane Harvey relief efforts


 
2,000

1

 


 


 


Other


 
(200
)

 


 


 


Stockholder advisory expenses


 


 
323

1

 
1,546

1

 


Adjusted EBITDA
$
239,601

$
95

 
$
177,681

$
81

 
$
141,183

$
71

 
$
110,014

$
63

 
$
84,124

$
54

% Change year over year
34.8
%
17.3
%
 
25.9
%
14.1
%
 
28.3
%
12.7
%
 
30.8
%
16.7
%
 
(8.9
)%
(10.0
)%
Following is a reconciliation of cash, cash equivalents and marketable securities (GAAP) to adjusted cash, cash equivalents and marketable securities (non-GAAP) to adjusted cash, cash equivalents and marketable securities (non-GAAP):
 
December 31,
(in thousands)
2018
 
2017
 
 
Cash, cash equivalents and marketable securities
$
387,554


$
356,220

Less:
 
 
 
Amounts payable for withheld federal and state income taxes, employment taxes and other payroll deductions
224,487


271,547

Client prepayments
34,177


23,603

Adjusted cash, cash equivalents and marketable securities