10-Q 1 form10q.htm INSPERITY, INC 10-Q 6-30-2012 form10q.htm


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

FORM 10-Q
(Mark One)
 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the quarterly period ended June 30, 2012.
or
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from                                   to                                  

Commission File No. 1-13998
 
Insperity, Inc.
(Exact name of registrant as specified in its charter)

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o  No þ
 
As of July 24, 2012, 25,720,605 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.
 


 
 

 

 
Part I
 

 
PART I


INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS
 
   
June 30,
2012
   
December 31,
2011
 
   
(Unaudited)
       
             
Current assets:
           
Cash and cash equivalents
  $ 180,590     $ 211,208  
Restricted cash
    44,580       44,737  
Marketable securities
    57,182       56,987  
Accounts receivable, net:
               
Trade
    2,765       7,893  
Unbilled
    166,030       158,508  
Other
    7,633       4,532  
Prepaid insurance
    18,152       21,300  
Other current assets
    8,133       11,488  
Income taxes receivable
          2,902  
Deferred income taxes
    2,851       3,233  
Total current assets
    487,916       522,788  
                 
Property and equipment:
               
Land
    3,653       3,653  
Buildings and improvements
    69,255       67,496  
Computer hardware and software
    79,460       76,105  
Software development costs
    34,347       32,699  
Furniture and fixtures
    36,489       36,133  
Aircraft
    35,879       35,866  
      259,083       251,952  
Accumulated depreciation and amortization
    (165,592 )     (159,008 )
Total property and equipment, net
    93,491       92,944  
                 
Other assets:
               
Prepaid health insurance
    9,000       9,000  
Deposits – health insurance
    2,840       2,640  
Deposits – workers’ compensation
    56,377       52,320  
Goodwill and other intangible assets, net
    27,565       28,433  
Other assets
    4,868       4,134  
Total other assets
    100,650       96,527  
Total assets
  $ 682,057     $ 712,259  


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

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
   
June 30,
2012
   
December 31,
2011
 
   
(Unaudited)
       
             
Current liabilities:
           
Accounts payable
  $ 2,873     $ 5,085  
Payroll taxes and other payroll deductions payable
    122,590       168,652  
Accrued worksite employee payroll cost
    144,885       130,317  
Accrued health insurance costs
    9,868       9,427  
Accrued workers’ compensation costs
    45,320       46,548  
Accrued corporate payroll and commissions
    13,474       22,383  
Other accrued liabilities
    14,008       13,814  
Income taxes payable
    1,429        
Total current liabilities
    354,447       396,226  
                 
Noncurrent liabilities:
               
Accrued workers’ compensation costs
    63,664       60,054  
Deferred income taxes
    11,414       10,772  
Total noncurrent liabilities
    75,078       70,826  
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Common stock
    309       309  
Additional paid-in capital
    136,762       135,871  
Treasury stock, at cost
    (139,467 )     (134,647 )
Accumulated other comprehensive income, net of tax
    58       24  
Retained earnings
    254,870       243,650  
Total stockholders’ equity
    252,532       245,207  
Total liabilities and stockholders’ equity
  $ 682,057     $ 712,259  
 
See accompanying notes.
 
 
INSPERITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenues (gross billings of $3.039 billion, $2.731 billion, $6.271 billion and $5.619 billion, less worksite employee payroll cost of $2.520 billion, $2.258 billion, $5.156 billion and $4.610 billion, respectively)
  $      519,256     $      472,903     $      1,114,433     $      1,009,284  
Direct costs:
                               
Payroll taxes, benefits and workers’ compensation costs
    431,962       389,062       924,135       834,484  
Gross profit
    87,294       83,841       190,298       174,800  
                                 
Operating expenses:
                               
Salaries, wages and payroll taxes
    40,047       38,467       83,370       78,064  
Stock-based compensation
    2,801       2,556       4,956       4,346  
Commissions
    3,506       3,255       6,941       6,351  
Advertising
    8,566       7,539       13,321       13,045  
General and administrative expenses
    18,494       17,023       40,572       38,916  
Depreciation and amortization
    4,465       3,601       8,677       7,549  
      77,879       72,441       157,837       148,271  
Operating income
    9,415       11,400       32,461       26,529  
Other income (expense):
                               
Interest, net
    156       304       320       584  
Other, net
    20             144       4  
      176       304       464       588  
Income before income tax expense
    9,591       11,704       32,925       27,117  
                                 
Income tax expense
    3,970       4,963       13,420       11,590  
                                 
Net income
  $ 5,621     $ 6,741     $ 19,505     $ 15,527  
                                 
Less net income allocated to participating securities
    (162 )     (199 )     (564 )     (463 )
                                 
Net income allocated to common shares
  $ 5,459     $ 6,542     $ 18,941     $ 15,064  
                                 
Basic net income per share of common stock
  $ 0.22     $ 0.25     $ 0.75     $ 0.59  
                                 
Diluted net income per share of common stock
  $ 0.22     $ 0.25     $ 0.75     $ 0.59  
 
See accompanying notes.
 

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 (Unaudited)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Net income
  $ 5,621     $ 6,741     $ 19,505     $ 15,527  
                                 
Other comprehensive income:
                               
                                 
Unrealized gain (loss) on available-for-sale securities, net of tax
    (1 )     24       34       38  
                                 
Comprehensive income
  $ 5,620     $ 6,765     $ 19,539     $ 15,565  
 
See accompanying notes.
 

INSPERITY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2012
(in thousands)
(Unaudited)
 
   
Common Stock
Issued
   
Additional
Paid-In
   
 
Treasury
   
Accumulated
Other
Comprehensive
   
 
Retained
       
   
Shares
   
Amount
   
Capital
   
Stock
   
Income (Loss)
   
Earnings
   
Total
 
                                           
Balance at December 31, 2011
    30,839     $ 309     $ 135,871     $ (134,647 )   $ 24     $ 243,650     $ 245,207  
Purchase of treasury stock, at cost
                      (11,741 )                 (11,741 )
Exercise of stock options
                (470 )     1,514                   1,044  
Income tax benefit from stock-based compensation, net
                      1,193                                 1,193  
Stock-based compensation expense
     —        —       100       4,856                   4,956  
Other
                68       551                   619  
Dividends paid
                                  (8,285 )     (8,285 )
Unrealized gain on marketable securities, net of tax
                                    34             34  
Net income
                                  19,505       19,505  
Balance at June 30, 2012
    30,839     $ 309     $ 136,762     $ (139,467 )   $ 58     $ 254,870     $ 252,532  
 
See accompanying notes.
 
 
INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

   
Six Months Ended
June 30,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net income
  $ 19,505     $ 15,527  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    8,652       7,546  
Amortization of marketable securities
    1,279       985  
Stock-based compensation
    4,956       4,346  
Deferred income taxes
    1,001       1,379  
Changes in operating assets and liabilities, net of effects from acquisitions:
               
Restricted cash
    157       (127 )
Accounts receivable
    (5,495 )     7,018  
Prepaid insurance
    3,148       455  
Other current assets
    3,355       (1,217 )
Other assets
    (4,991 )     5,909  
Accounts payable
    (2,212 )     (885 )
Payroll taxes and other payroll deductions payable
    (46,062 )     (46,886 )
Accrued worksite employee payroll expense
    14,568       61,379  
Accrued health insurance costs
    441       (2,994 )
Accrued workers’ compensation costs
    2,382       4,850  
Accrued corporate payroll, commissions and other accrued liabilities
    (7,515 )     (3,537 )
Income taxes payable/receivable
    4,090       562  
Total adjustments
    (22,246 )     38,783  
Net cash provided by (used in) operating activities
    (2,741 )     54,310  
                 
Cash flows from investing activities:
               
Marketable securities purchases
    (14,818 )     (13,903 )
Marketable securities proceeds from dispositions
    13,401       17,387  
Marketable securities proceeds from maturities
          1,365  
Cash exchanged for acquisitions
    (1,200 )     (11,450 )
Property and equipment
    (8,331 )     (8,404 )
Net cash used in investing activities
    (10,948 )     (15,005 )
 
 
INSPERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
(Unaudited)

   
Six Months Ended
June 30,
 
   
2012
   
2011
 
             
Cash flows from financing activities:
           
Purchase of treasury stock
  $ (11,741 )   $ (6,639 )
Dividends paid
    (8,285 )     (7,953 )
Proceeds from the exercise of stock options
    1,044       3,283  
Income tax benefit from stock-based compensation
    1,434       1,880  
Other
    619       486  
Net cash used in financing activities
    (16,929 )     (8,943 )
                 
Net increase (decrease) in cash and cash equivalents
    (30,618 )     30,362  
Cash and cash equivalents at beginning of period
    211,208       234,829  
Cash and cash equivalents at end of period
  $ 180,590     $ 265,191  
 
See accompanying notes.
 

INSPERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2012
(Unaudited)
 
1.
Basis of Presentation

Insperity, Inc., a Delaware corporation (“Insperity,” “we,” “our,” and “us”), provides an array of human resources (“HR”) and business solutions designed to help improve business performance. Our most comprehensive HR business offering is provided through our professional employer organization (“PEO”) services, known as Workforce OptimizationTM , which encompasses a broad range of HR functions, including payroll and employment administration, employee benefits, workers’ compensation, government compliance, performance management, and training and development services.

In addition to Workforce Optimization, we offer Performance Management, Expense Management, Time and Attendance, Organizational Planning, Recruiting Services, Employment Screening, Retirement Services and Business Insurance (collectively “Adjacent Businesses”), many of which are offered via desktop applications and software as a service (“SaaS”) delivery models.  These other products or services are offered separately, as a bundle, or along with Workforce Optimization (“Bundle Plus”).

We provide our Workforce Optimization solution to small and medium-sized businesses in strategically selected markets throughout the United States.  For the six months ended June 30, 2012 and 2011, Workforce Optimization revenues from Insperity’s Texas markets represented 26% and 27%, while Workforce Optimization revenues from Insperity’s California markets represented 17% and 16%, of Insperity’s total Workforce Optimization revenues, respectively.

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

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

The accompanying Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements as of and for the year ended December 31, 2011. Our Consolidated Balance Sheets at December 31, 2011 have been derived from the audited financial statements at that date, but do not include all of the information or footnotes required by GAAP for complete financial statements.  Our Consolidated Balance Sheet at June 30, 2012 and the Consolidated Statements of Operations and Comprehensive Income for the three and six month periods ended June 30, 2012 and 2011, the Consolidated Statements of Cash Flows for the six month periods ended June 30, 2012 and 2011, and Consolidated Statement of Stockholders’ Equity for the six month period ended June 30, 2012, have been prepared by us without audit.  In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows, have been made.
 
 
- 10 -


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

2.
Accounting Policies

Health Insurance Costs

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

The policy with United provides the majority of our health insurance coverage.  As a result of certain contractual terms, Insperity has accounted for this plan since its inception using a partially self-funded insurance accounting model.  Accordingly, Insperity records the costs of the United plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”) as benefits expense in the Consolidated Statements of Operations.  The estimated incurred claims are based upon: (i) the level of claims processed during the quarter; (ii) estimated completion rates based upon recent claim development patterns under the plan; and (iii) the number of participants in the plan, including both active and COBRA enrollees.  Each reporting period, changes in the estimated ultimate costs resulting from claim trends, plan design and migration, participant demographics and other factors are incorporated into the benefits costs.

Additionally, since the plan’s inception, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter.  If the Plan Costs for a reporting quarter are greater than the premiums paid and owed to United, a deficit in the plan would be incurred and a liability for the excess costs would be accrued in our Consolidated Balance Sheets.  On the other hand, if the Plan Costs for the reporting quarter are less than the premiums paid and owed to United, a surplus in the plan would be incurred and we would record an asset for the excess premiums in our Consolidated Balance Sheets.  The terms of the arrangement require Insperity to maintain an accumulated cash surplus in the plan of $9.0 million, which is reported as long-term prepaid insurance.  In addition, United requires a deposit equal to approximately one day of claims funding activity, which was $2.8 million as of June 30, 2012, and is reported as a long-term asset.  As of June 30, 2012, Plan Costs were less than the net premiums paid and owed to United by $17.3 million.  As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $8.3 million balance is included in prepaid insurance, a current asset, in our Consolidated Balance Sheets.  The premiums owed to United at June 30, 2012 were $6.3 million, which is included in accrued health insurance costs, a current liability in our Consolidated Balance Sheets.
 
 
- 11 -


Workers’ Compensation Costs

Insperity’s workers’ compensation coverage has been provided through an arrangement with the ACE Group of Companies (“the ACE Program”) since 2007.  The ACE Program is fully insured in that ACE has the responsibility to pay all claims incurred regardless of whether Insperity satisfies its responsibilities.  Through September 30, 2010, Insperity bore the economic burden for the first $1 million layer of claims per occurrence and the insurance carrier was and remains responsible for the economic burden for all claims in excess of such first $1 million layer.

Effective October 1, 2010, in addition to our bearing the economic burden for the first $1 million layer of claims per occurrence, we also bear the economic burden for those claims exceeding $1 million, up to a maximum aggregate amount of $5 million per policy year.

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

Insperity employs a third party actuary to estimate its loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends.  Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates.  During the six months ended June 30, 2012 and 2011, Insperity reduced accrued workers’ compensation costs by $6.7 million and $4.0 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 rates utilized in 2012 and 2011 were 0.8% and 1.3%, respectively) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.
 
 
- 12 -

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

   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
(in thousands)
 
             
Beginning balance, January 1,
  $ 104,791     $ 96,934  
Accrued claims
    19,164       19,523  
Present value discount
    (532 )     (898 )
Paid claims
    (15,179 )     (14,493 )
Ending balance
  $ 108,244     $ 101,066  
                 
Current portion of accrued claims
  $ 44,580     $ 41,331  
Long-term portion of accrued claims
    63,664       59,735  
    $ 108,244     $ 101,066  

The current portion of accrued workers’ compensation costs on the Consolidated Balance Sheets at June 30, 2012 includes $0.7 million of workers’ compensation administrative fees.

As of June 30, 2012 and 2011, the undiscounted accrued workers’ compensation costs were $120.9 million and $115.2 million, respectively.

At the beginning of each policy period, the insurance carrier establishes monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).  The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers’ compensation loss rates, as determined by the 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 the first half of 2012 and 2011, we received $2.5 million and $9.6 million, respectively, for the return of excess claim funds related to the ACE Program, which reduced deposits.  As of June 30, 2012, we had restricted cash of $44.6 million and deposits of $56.4 million.

Insperity’s estimate of incurred claim costs expected to be paid within one year are recorded as accrued workers’ compensation costs and included in short-term liabilities, while its estimate of incurred claim costs expected to be paid beyond one year are included in long-term liabilities on our Consolidated Balance Sheets.
 
 
- 13 -


3.
Cash, Cash Equivalents and Marketable Securities

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

   
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(in thousands)
 
Overnight Holdings
           
Money market funds (cash equivalents)
  $ 26,579     $ 71,350  
Investment Holdings
               
Money market funds (cash equivalents)
    59,348       59,587  
Marketable securities
    57,182       56,987  
      143,109       187,924  
Cash held in demand accounts
    110,920       113,968  
Outstanding checks
    (16,257 )     (33,697 )
Total cash, cash equivalents and marketable securities
  $ 237,772     $ 268,195  
                 
Cash and cash equivalents
  $ 180,590     $ 211,208  
Marketable securities
    57,182       56,987  
    $ 237,772     $ 268,195  

Our cash and overnight holdings fluctuate based on the timing of the client’s payroll processing cycle.  Included in the cash balance as of June 30, 2012 and December 31, 2011, are $111.9 million and $150.8 million, respectively, in funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as $10.5 million and $10.4 million in client prepayments, respectively.

Insperity accounts for its financial assets in accordance with Accounting Standard Codification (“ASC”) 820, Fair Value Measurement.  This standard defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  The fair value measurement disclosures are grouped into three levels based on valuation factors:

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

 
- 14 -


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

   
Fair Value Measurements
 
   
(in thousands)
 
   
June 30,
                   
   
2012
   
Level 1
   
Level 2
   
Level 3
 
                         
Money market funds
  $ 85,927     $ 85,927     $     $  
Municipal bonds
    57,182             57,182        
Total
  $ 143,109     $ 85,927     $ 57,182     $  
                                 
   
Fair Value Measurements
 
   
(in thousands)
 
   
December 31,
                         
    2011    
Level 1
   
Level 2
   
Level 3
 
                                 
Money market funds
  $ 130,937     $ 130,937     $     $  
Municipal bonds
    56,987             56,987        
Total
  $ 187,924     $ 130,937     $ 56,987     $  

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

The following is a summary of our available-for-sale marketable securities:

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
         
(in thousands)
       
June 30, 2012:
                       
Municipal bonds
  $ 57,083     $ 114     $ (15 )   $ 57,182  
                                 
December 31, 2011:
                               
Municipal bonds
  $ 56,945     $ 90     $ (48 )   $ 56,987  

During the periods ended June 30, 2012 and 2011, we had no realized gains or losses recognized on sales of marketable securities.
 
 
- 15 -

 
As of June 30, 2012, the contractual maturities of our marketable securities were as follows:

   
Amortized
Cost
   
Estimated
Fair Value
 
   
(in thousands)
 
             
Less than one year
  $ 30,597     $ 30,620  
One to five years
    26,486       26,562  
Total
  $ 57,083     $ 57,182  

4.
Revolving Credit Facility
 
On September 15, 2011, we entered into a four-year, $100 million revolving credit facility (the “Facility”), which may be increased to $150 million based on the terms and subject to the conditions set forth in the agreement relating to the Facility (the “Credit Agreement”). The Facility is available for working capital and general corporate purposes, including acquisitions. Insperity’s obligations under the Facility are secured by 65% of the stock of our captive insurance subsidiary and are guaranteed by all of our domestic subsidiaries.  In January 2012, we issued an irrevocable standby letter of credit for $285,000 under the Facility to a state workers’ compensation agency.  At June 30, 2012, we had not drawn on the Facility.
 
The Facility matures on September 15, 2015.  Borrowings under the Facility bear interest at an alternate base rate or LIBOR, at our option, plus an applicable margin.  Depending on our leverage ratio, the applicable margin varies (i) in the case of LIBOR loans, from 2.00% to 2.75%; and (ii) in the case of alternate base rate loans, from 0.00% to 0.75%.  The alternate base rate is the highest of (i) the prime rate most recently published in The Wall Street Journal; (ii) the federal funds rate plus 0.50%; and (iii) the 30-day LIBOR rate plus 2.00%.  We also pay an unused commitment fee on the average daily unused portion of the Facility at a rate of 0.25%. Interest expense and unused commitment fees are recorded in other income (expense).

The Facility contains both affirmative and negative covenants, which we believe are customary for arrangements of this nature.  Covenants include, but are not limited to, limitations on our ability to incur additional indebtedness, sell material assets, retire, redeem or otherwise reacquire our capital stock, acquire the capital stock or assets of another business, make investments and pay dividends.  In addition, the Credit Agreement requires us to comply with financial covenants limiting our total funded debt, minimum interest coverage ratio and maximum leverage ratio. We were in compliance with all financial covenants under the Credit Agreement at June 30, 2012.

5.
Stockholders’ Equity

Our Board of Directors (the “Board”) has authorized a program to repurchase shares of our outstanding common stock (“Repurchase Program”).  The purchases are to be made from time to time in the open market or directly from stockholders at prevailing market prices based on market conditions and other factors.  During the six months ended June 30, 2012, 325,970 shares were repurchased under the Repurchase Program and 107,041 shares not subject to the Repurchase Program were withheld to satisfy tax withholding obligations for the vesting of restricted stock awards.  As of June 30, 2012, we were authorized to repurchase an additional 910,902 shares under the program.
 
 
- 16 -


The Board declared a quarterly dividend of $0.17 per share of common stock in the second quarter of 2012 and quarterly dividends of $0.15 per share of common stock in the first quarter of 2012 and the first two quarters of 2011, resulting in a total of $8.3 million and $8.0 million, respectively, in dividend payments made by Insperity during the first half of each year.

6.
Net Income per Share

We utilize the two-class method to compute net income per share.  The two-class method allocates a portion of net income to participating securities, which include unvested awards of share-based payments with non-forfeitable rights to receive dividends.  Net income allocated to unvested share-based payments is excluded from net income allocated to common shares.  Basic net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period.  Diluted net income per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options.
 
 
- 17 -

 
The following table summarizes the net income allocated to common shares and the basic and diluted shares used in the net income per share computations:

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
 
                         
Net income
  $ 5,621     $ 6,741     $ 19,505     $ 15,527  
Less income allocated to participating securities
    (162 )     (199 )     (564 )     (463 )
Net income allocated to common shares
  $ 5,459     $ 6,542     $ 18,941     $ 15,064  
                                 
Weighted average common shares outstanding
    25,095       25,726       25,091       25,608  
Incremental shares from assumed conversions of common stock options
    60       101       66       110  
Adjusted weighted average common shares outstanding
    25,155       25,827       25,157       25,718  
                                 
Potentially dilutive securities not included in weighted average share calculation due to anti-dilutive effect
    42       8       29       4  

7.
Commitments and Contingencies

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

Pennsylvania Sales Taxes

Pennsylvania imposes a sales tax on “help supply services.”  The Pennsylvania Department of Revenue (“Department”) has maintained that PEO services constitute help supply services and are subject to the tax.  On February 21, 2012, the Pennsylvania Supreme Court (“Supreme Court”) affirmed the Appeals Court decision in the matter titled All Staffing vs. Commonwealth of Pennsylvania, which ruled that PEO services are not subject to the Pennsylvania sales tax.

We have filed two refund claims totaling $2.9 million with the Department for the sales taxes paid in error for the period April 1, 2007 through December 31, 2009.  In the second quarter of 2012, we received a letter from the Pennsylvania Board of Finance and Revenue in response to one of the two refund requests affirming that our PEO services are not subject to sales tax, and therefore, we are entitled to the sales tax refund.  We are still awaiting written confirmation on the second refund request; however, given that the facts and circumstances are virtually identical except for the amount of the refund claim, and considering this information in connection with the Supreme Court ruling, we have recognized a $2.9 million receivable and a corresponding reduction to payroll tax expense, a component of direct costs, in the second quarter of 2012.
 
 
- 18 -


Kemper Insurance Companies

In 2003, facing continued capital constraints and a series of downgrades from various rating agencies, our former workers’ compensation insurance carrier for the two-year period ended September 2003, Lumbermens Mutual Casualty Company, formerly known as Kemper, (“Lumbermens Mutual”) made the decision to substantially cease underwriting operations and voluntarily entered into “run-off.”   In July 2012, Lumbermens Mutual announced that an agreed order of rehabilitation had been entered against it in Cook County, Illinois.  Under the order, the Director of the Illinois Department of Insurance was vested with control over Lumbermens Mutual property and decision-making.  The Director has publicly announced that while claims will continue to be paid during the rehabilitation process, he intends to use the rehabilitation period to work with state guaranty associations to prepare for the orderly transition of claim handling responsibilities to such funds once an Order of Liquidation is entered.  After this transition process has been completed, the Director has stated that he intends to file a verified complaint for liquidation.
 
Guaranty associations are non-profit organizations created by statute for the purpose of protecting policyholders from severe financial losses and preventing delays in claim payment due to the insolvency of an insurer. They do this by assuming responsibility for the payment of claims that would otherwise have been paid by the insurer had it not become insolvent. Each state has one or more guaranty association(s), with each association handling certain types of insurance. Insurance companies are required to be members of the state guaranty association as a condition of being licensed to do business in the state.

The guaranty associations in some states, including Texas, may assert that state law allows them to return the liability for open claims under such policies to an insured with a net worth exceeding certain specified levels. We encountered this assertion when another former insurance carrier, Reliance Insurance Company (“Reliance”), was placed into liquidation in 2001.  In that case, the Texas state guaranty association asserted that it was entitled to full reimbursement from us for workers’ compensation benefits paid by the association.  Although we settled that dispute at a level substantially below full reimbursement and within the limits of insurance coverage we had secured to cover potential claims returned to us related to the Reliance policies, we have no similar insurance coverage for the Lumbermens Mutual claims.  If an Order of Liquidation is entered and if one or more states were to assert that liability for open claims with Lumbermens Mutual should be returned to us, we may be required to make a payment to the state covering estimated claims attributable to us.  While we are not certain one or more states will ultimately assert that we have claim responsibility, we intend to vigorously assert any and all available defenses to any such claim.  We estimate the outstanding claims to range from $2.9 million to $5.0 million as of June 30, 2012.  If such a payment were made, it would reduce net income, which may have a material adverse effect on net income in the reported period.
 
 
- 19 -



You should read the following discussion in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011, as well as our Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q.

New Accounting Pronouncements

We believe we have implemented the accounting pronouncements with a material impact on our financial statements.

Results of Operations

Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011.

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

   
Three Months Ended June 30,
 
   
2012
   
2011
   
% Change
 
   
(in thousands, except per share and statistical data)
 
Revenues (gross billings of $3.039 billion and $2.731 billion, less worksite employee payroll cost of $2.520 billion and $2.258 billion, respectively)
  $ 519,256     $ 472,903       9.8 %
Gross profit
    87,294       83,841       4.1 %
Operating expenses
    77,879       72,441       7.5 %
Operating income
    9,415       11,400       (17.4 )%
Other income (expense)
    176       304       (42.1 )%
Net income
    5,621       6,741       (16.6 )%
Diluted net income per share of common stock
    0.22       0.25       (12.0 )%
                         
Statistical Data:
                       
Average number of worksite employees paid per month
    124,219       114,656       8.3 %
Revenues per worksite employee per month(1)
  $ 1,393     $ 1,375       1.3 %
Gross profit per worksite employee per month
    234       244       (4.1 )%
Operating expenses per worksite employee per month
    209       211       (0.9 )%
Operating income per worksite employee per month
    25       33       (24.2 )%
Net income per worksite employee per month
    15       20       (25.0 )%
 

 
(1)
Gross billings of $8,156 and $7,938 per worksite employee per month, less payroll cost of $6,763 and $6,563 per worksite employee per month, respectively.

Revenues

Our revenues for the second quarter of 2012 increased 9.8% over the 2011 period, primarily due to an 8.3% increase in the average number of worksite employees paid per month and a 1.3%, or $18 increase in revenues per worksite employee per month.
 
 
- 20 -


By region, our Workforce Optimization revenue change from the second quarter of 2011 and distribution for the quarters ended June 30, 2012 and 2011 were as follows:

   
Three Months Ended June 30,
   
Three Months Ended June 30,
 
   
2012
   
2011
   
% Change
   
2012
   
2011
 
   
(in thousands)
   
(% of total revenues)
 
                               
Northeast
  $ 134,571     $ 122,199       10.1 %     26.3 %     26.2 %
Southeast
    47,534       46,474       2.3 %     9.3 %     9.9 %
Central
    74,295       67,997       9.3 %     14.5 %     14.6 %
Southwest
    142,968       135,093       5.8 %     28.0 %     29.0 %
West
    111,672       94,465       18.2 %     21.9 %      20.3 % 
      511,040       466,228       9.6 %     100.0 %     100.0 %
Other revenue
    8,216       6,675       23.1 %                
Total revenue
  $ 519,256     $ 472,903       9.8 %                

Other revenue is comprised primarily of revenues generated by our Adjacent Businesses.

Our Workforce Optimization growth rate is affected by three primary sources – worksite employees paid from new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs.  During the second quarter of 2012, the net change in existing clients improved as compared to the second quarter of 2011, while worksite employees paid from new client sales declined and client retention remained consistent with the second quarter of 2011.

Gross Profit

Gross profit for the second quarter of 2012 increased 4.1% over the second quarter of 2011 to $87.3 million.  The average gross profit per worksite employee decreased 4.1% to $234 per month in the 2012 period from $244 per month in the 2011 period.  Included in gross profit in 2012 is a $12 per worksite employee per month contribution from our Adjacent Businesses compared to $11 per worksite employee per month in the 2011 period.

Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses.  While our revenues increased 1.3% per worksite employee per month, our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 2.5% to $1,159 per worksite employee per month in the second quarter of 2012 versus $1,131 in the second quarter of 2011.

 
·
Benefits costs – The cost of group health insurance and related employee benefits increased $26 per worksite employee per month, or 6.5% on a cost per covered employee basis compared to the second quarter of 2011.  The 2012 amount includes an additional $2.4 million, or $6 per worksite employee per month, in claim costs for higher than expected runoff of health insurance claims incurred in prior quarters.  The percentage of worksite employees covered under our health insurance plans was 72.2% in the 2012 period compared to 73.8% in the 2011 period.  Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.
 
 
- 21 -

 
 
·
Workers’ compensation costs – Workers’ compensation costs increased 0.3%, but decreased $3 per worksite employee per month compared to the second quarter of 2011.  As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.53% in the 2012 period compared to 0.59% in the 2011 period.  During the 2012 period, we recorded reductions in workers’ compensation costs of $3.4 million, or 0.15% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $2.2 million, or 0.11% of non-bonus payroll costs, in the 2011 period.  Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Workers’ Compensation Costs,” for a discussion of our accounting for workers’ compensation costs.

 
·
Payroll tax costs – Payroll taxes increased 9.1%, or $3 per worksite employee per month compared to the second quarter of 2011, primarily due to the 11.6% increase in payroll costs, offset by a $2.9 million (or $8 per worksite employee per month) credit related to the Pennsylvania sales tax matter.  Please read Note 7 to the Consolidated Financial Statements, “Commitments and Contingencies” for further information.  Payroll taxes as a percentage of payroll cost were 7.0% in the 2012 period compared to 7.2% in the 2011 period.

Operating Expenses

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

   
Three Months Ended June 30,
   
Three Months Ended June 30,
 
   
2012
   
2011
   
% Change
    2012     2011    
% Change
 
   
(in thousands)
   
(per worksite employee per month)
 
                                     
Salaries, wages and payroll taxes
  $ 40,047     $ 38,467       4.1 %   $ 107     $ 112       (4.5 )%
Stock–based compensation
    2,801       2,556       9.6 %     8       7       14.3 %
Commissions
    3,506       3,255       7.7 %     9       9        
Advertising
    8,566       7,539       13.6 %     23       22       4.5 %
General and administrative expenses
    18,494       17,023       8.6 %     50       50        
Depreciation and amortization
    4,465       3,601       24.0 %     12       11       9.1 %
Total operating expenses
  $ 77,879     $ 72,441       7.5 %   $ 209     $ 211       (0.9 )%

Operating expenses increased 7.5% to $77.9 million compared to $72.4 million in the second quarter of 2011.  Operating expenses in the second quarter of 2011 included $3.1 million in costs associated with the launch of our new brand.  Operating expenses per worksite employee per month decreased to $209 in the 2012 period from $211 in the 2011 period.  The components of operating expenses changed as follows:

·
Salaries, wages and payroll taxes of corporate and sales staff increased 4.1%, but decreased $5 per worksite employee per month compared to the 2011 period.  This increase was primarily due to a 6.5% rise in headcount, due in part to our adjacent business strategy, offset by lower incentive compensation expenses.
 
 
- 22 -

 
·
Stock-based compensation increased 9.6%, or $1 per worksite employee per month compared to the 2011 period, due primarily to an increase in the weighted average market value on the date of grant associated with restricted awards.  The stock-based compensation expense represents amortization of restricted stock awards granted to employees.

·
Commissions expense increased 7.7% in the 2012 period, due primarily to increased commissions paid by our Adjacent Businesses.  Commissions expense remained flat on a per worksite employee per month basis compared to the 2011 period.

·
Advertising costs increased 13.6%, or $1 per worksite employee per month compared to the 2011 period, primarily due to the timing of business promotion expenses related to our Insperity ChampionshipTM professional golf tournament,  which moved into the second quarter, partially offset by the non-recurrence of expenses related to our 2011 rebranding initiative.  Advertising costs in the 2011 period included $2.4 million associated with the launch of our new brand.

·
General and administrative expenses remained flat on a per worksite employee per month basis, but increased 8.6% compared to the 2011 period, primarily due to increased professional services, travel and training, and repairs and maintenance, partially offset by reductions in bad debt expense, rent expense and the non-recurrence of expenses related to our 2011 rebranding initiative.  General and administrative expenses in the 2011 period included $0.7 million associated with the launch of our new brand.

·
Depreciation and amortization expense increased 24.0%, or $1 per worksite employee per month compared to the 2011 period, primarily due to investments in our technology infrastructure made in the second half of 2011.

Income Tax Expense

Our effective income tax rate was 41.4% in the 2012 period compared to 42.4% in the 2011 period.  Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses.

Operating and Net Income

Operating and net income per worksite employee per month was $25 and $15 in the 2012 period, versus $33 and $20 in the 2011 period.
 
 
- 23 -

 
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011.

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

   
Six Months Ended June 30,
 
   
2012
   
2011
   
% Change
 
   
(in thousands, except per share and statistical data)
 
Revenues (gross billings of $6.271 billion and $5.619 billion, less worksite employee payroll cost of $5.156 billion and $4.610 billion, respectively)
  $ 1,114,433     $ 1,009,284       10.4 %
Gross profit
    190,298       174,800       8.9 %
Operating expenses
    157,837       148,271       6.5 %
Operating income
    32,461       26,529       22.4 %
Other income (expense)
    464       588       (21.1 )%
Net income
    19,505       15,527       25.6 %
Diluted net income per share of common stock
    0.75       0.59       27.1 %
                         
Statistical Data:
                       
Average number of worksite employees paid per month
    123,079       113,533       8.4 %
Revenues per worksite employee per month(1)
  $ 1,509     $ 1,482       1.8 %
Gross profit per worksite employee per month
    258       257       0.4 %
Operating expenses per worksite employee per month
    214       218       (1.8 )%
Operating income per worksite employee per month
    44       39       12.8 %
Net income per worksite employee per month
    26       23       13.0 %
 


(1)
Gross billings of $8,491 and $8,249 per worksite employee per month, less payroll cost of $6,982 and $6,767 per worksite employee per month, respectively.

Revenues

Our revenues for the six months ended June 30, 2012, increased 10.4% over the 2011 period, primarily due to an 8.4% increase in the average number of worksite employees paid per month and a 1.8%, or $27 increase in revenues per worksite employee per month.
 
 
- 24 -


By region, our Workforce Optimization revenue change from the first six months of 2011 and distribution for the six months ended June 30, 2012 and 2011 were as follows:

   
Six Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
% Change
   
2012
   
2011
 
   
(in thousands)
   
(% of total revenues)
 
                               
Northeast
  $ 293,536     $ 262,944       11.6 %     26.7 %     26.4 %
Southeast
    100,882       97,849       3.1 %     9.2 %     9.8 %
Central
    161,589       146,596       10.2 %     14.7 %     14.7 %
Southwest
    306,774       288,843       6.2 %     27.9 %     29.0 %
West
    236,278       199,557       18.4 %     21.5 %      20.1 % 
      1,099,059       995,789       10.4 %     100.0 %     100.0 %
Other revenue
    15,374       13,495       13.9 %                
Total revenue
  $ 1,114,433     $ 1,009,284       10.4 %                

Other revenue is comprised primarily of revenues generated by our Adjacent Businesses.

Our Workforce Optimization growth rate is affected by three primary sources – worksite employees paid from new client sales, client retention and the net change in existing clients through worksite employee new hires and layoffs.  During the first half of 2012, the net change in existing clients improved as compared to the first half of 2011, while worksite employees paid from new client sales declined and client retention remained consistent with the first half of 2011.

Gross Profit

Gross profit for the first half of 2012 increased 8.9% over the 2011 period to $190.3 million.  The average gross profit per worksite employee increased 0.4% to $258 per month in the 2012 period from $257 per month in the 2011 period.  Included in gross profit is an $11 per worksite employee per month contribution from our Adjacent Businesses in both periods.

Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses. While our revenues increased 1.8% per worksite employee per month, our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 2.1% to $1,251 per worksite employee per month in the first half of 2012 versus $1,225 in the first half of 2011.

 
·
Benefits costs – The cost of group health insurance and related employee benefits increased $17 per worksite employee per month, or 5.1% on a cost per covered employee basis compared to the 2011 period.  The 2012 amount includes an additional $2.4 million, or $3 per worksite employee per month, in claim costs for higher than expected runoff of health insurance claims incurred in prior quarters.  The percentage of worksite employees covered under our health insurance plans was 72.5% in the 2012 period compared to 74.1% in the 2011 period.  Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.
 
 
- 25 -

 
 
·
Workers’ compensation costs – Workers’ compensation costs increased 1.0%, but decreased $2 per worksite employee per month compared to the first six months of 2011.  As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.55% in the 2012 period compared to 0.60% in the 2011 period.  During the 2012 period, we recorded reductions in workers’ compensation costs of $6.7 million, or 0.15% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $4.0 million, or 0.10% of non-bonus payroll costs, in the 2011 period.  Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Workers’ Compensation Costs,” for a discussion of our accounting for workers’ compensation costs.

 
·
Payroll tax costs – Payroll taxes increased 10.5%, or $11 per worksite employee per month compared to the first half of 2011, primarily due to the 11.9% increase in payroll costs, offset by a $2.9 million (or $4 per worksite employee per month) credit related to the Pennsylvania sales tax matter.  Please read Note 7 to the Consolidated Financial Statements, “Commitments and Contingencies” for further information.  Payroll taxes as a percentage of payroll cost were 8.3% in the 2012 period compared to 8.4% in the 2011 period.

Operating Expenses

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

   
Six Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
% Change
    2012     2011    
% Change
 
   
(in thousands)
   
(per worksite employee per month)
 
                                     
Salaries, wages and payroll taxes
  $ 83,370     $ 78,064       6.8 %   $ 113     $ 115       (1.7 )%
Stock–based compensation
    4,956       4,346       14.0 %     7       7        
Commissions
    6,941       6,351       9.3 %     9       9        
Advertising
    13,321       13,045       2.1 %     18       19       (5.3 )%
General and administrative expenses
    40,572       38,916       4.3 %     55       57       (3.5 )%
Depreciation and amortization
    8,677       7,549       14.9 %     12       11       9.1 %
Total operating expenses
  $ 157,837     $ 148,271       6.5 %   $ 214     $ 218       (1.8 )%

Operating expenses increased 6.5% to $157.8 million compared to $148.3 million in the first half of 2011.  Operating expenses in the 2011 period included $7.9 million in costs associated with the launch of our new brand.  Operating expenses per worksite employee per month decreased to $214 in the 2012 period from $218 in the 2011 period.  The components of operating expenses changed as follows:

·
Salaries, wages and payroll taxes of corporate and sales staff increased 6.8%, but decreased $2 per worksite employee per month compared to the 2011 period.  This increase was primarily due to a 7.9% rise in headcount, due in part to our adjacent business strategy, offset by lower incentive compensation expenses.
 
 
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·
Stock-based compensation increased 14.0%, but remained flat on a per worksite employee per month basis compared to the 2011 period, due primarily to an increase in the weighted average market value on the date of grant associated with restricted awards. The stock-based compensation expense represents amortization of restricted stock awards granted to employees.

·
Commissions expense increased 9.3% in the 2012 period, due primarily to an 8.4% increase in the average number of worksite employees paid per month.  Commissions expense remained flat on a per worksite employee per month basis compared to the 2011 period.

·
Advertising costs increased 2.1%, but decreased $1 per worksite employee per month compared to the 2011 period, primarily due to the timing of business promotion expenses related to our Insperity ChampionshipTM professional golf tournament, which moved into the first half of the year, partially offset by the non-recurrence of expenses related to our 2011 rebranding initiative.   Advertising costs in the 2011 period included $4.4 million associated with the launch of our new brand.

·
General and administrative expenses increased 4.3%, but decreased $2 per worksite employee per month compared to the first half of 2011, primarily due to increased professional services and repairs and maintenance, partially offset by reductions in bad debt expense, rent expense, and the non-recurrence of expsenses related to our 2011 rebranding initiative.  General and administrative expenses in the 2011 period included $3.5 million associated with the launch of our new brand.

·
Depreciation and amortization expense increased 14.9%, or $1 per worksite employee per month compared to the 2011 period, primarily due to investments in our technology infrastructure made in the second half of 2011.

Income Tax Expense

Our effective income tax rate was 40.8% in the 2012 period compared to 42.7% in the 2011 period.  Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses.

Operating and Net Income

Operating and net income per worksite employee per month was $44 and $26 in the 2012 period, versus $39 and $23 in the 2011 period.
 
 
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Non-GAAP Financial Measures

Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our worksite employees.  Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program.  As a result, our management refers to non-bonus payroll cost in analyzing, reporting and forecasting our workers’ compensation costs.  Non-GAAP financial measures are not prepared in accordance with GAAP and may be different from non-GAAP financial measures used by other companies.  Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP.  We include these non-GAAP financial measures because we believe they are useful to investors in allowing for greater transparency related to the costs incurred under our current workers’ compensation program.  Investors are encouraged to review the reconciliation of the non-GAAP financial measures used to their most directly comparable GAAP financial measures as provided in the table below.

   
Three Months Ended
         
Six Months Ended
       
   
June 30,
   
%
   
June 30,
   
%
 
   
2012
   
2011
   
Change
   
2012
   
2011
   
Change
 
   
(in thousands, except per worksite employee data)
 
                                     
Payroll cost (GAAP)
  $ 2,520,058     $ 2,257,602       11.6 %   $ 5,156,187     $ 4,609,865       11.9 %
Less: Bonus payroll cost
    204,042       164,612       24.0 %     571,865       469,461       21.8 %
Non-bonus payroll cost
  $ 2,316,016     $ 2,092,990       10.7 %   $ 4,584,322     $ 4,140,404       10.7 %
                                                 
Payroll cost per worksite employee per month (GAAP)
  $ 6,763     $ 6,563       3.0 %   $ 6,982     $ 6,767       3.2 %
Less: Bonus payroll cost per worksite employee per month
    548       478       14.6 %     774       689       12.3 %
Non-bonus payroll cost per worksite employee per month
  $ 6,215     $ 6,085       2.1 %   $ 6,208     $ 6,078       2.1 %

Liquidity and Capital Resources

We periodically evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, our expansion plans, acquisition plans and other operating cash needs.  To meet short- and long-term liquidity requirements, including payment of direct and operating expenses and repaying debt, we rely primarily on cash from operations.  However, we have in the past sought, and may in the future seek, to raise additional capital or take other steps to increase or manage our liquidity and capital resources.  We had $237.8 million in cash, cash equivalents and marketable securities at June 30, 2012, of which approximately $111.9 million was payable in early July 2012 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $10.5 million of client prepayments that were payable in July 2012.  At June 30, 2012, we had working capital of $133.5 million compared to $126.6 million at December 31, 2011.  We currently believe that our cash on hand and cash flows from operations will be adequate to meet our liquidity requirements for the remainder of 2012.  We will rely on these same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital needs.

In September 2011, we completed the financing for a new four-year, $100 million revolving credit facility (“Facility”), with a syndicate of financial institutions.  The Facility is available for working capital and general corporate purposes, including acquisitions, and was undrawn at June 30, 2012.  Please read Note 4 to our Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.
 
 
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Cash Flows from Operating Activities

Net cash used in operating activities in 2012 was $2.7 million.  Our primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our clients.  Our cash and cash equivalents, and thus our reported cash flows from operating activities are significantly impacted by various external and internal factors, which are reflected in part by the changes in our balance sheet accounts.  These include the following:

 
·
Timing of client payments / payrolls – We typically collect our comprehensive service fee, along with the client’s payroll funding, from clients at least one day prior to the payment of worksite employee payrolls and associated payroll taxes.  Therefore, the last business day of a reporting period has a substantial impact on our reporting of operating cash flows.  For example, many worksite employees are paid on Fridays; therefore, operating cash flows decrease in the reporting periods that end on a Friday.  In the period ended June 30, 2012, the last business day of the reporting period was a Friday and client prepayments were $10.5 million and accrued worksite employee payroll was $111.9 million.  In the period ended June 30, 2011, the last business day of the reporting period was a Thursday and client prepayments were $81.1 million and accrued worksite employee payroll was $171.1 million.

 
·
Workers’ compensation plan funding – Under our workers’ compensation insurance arrangements, we make monthly payments to the carriers comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).  These pre-determined amounts are stipulated in our agreements with the carriers, and are based primarily on anticipated worksite employee payroll levels and workers’ compensation loss rates during the policy year.  Changes in payroll levels from those that were anticipated in the arrangements can result in changes in the amount of cash payments, which will impact our reporting of operating cash flows.  Our claim funds paid, based upon anticipated worksite employee payroll levels and workers’ compensation loss rates, were $21.5 million in the first six months of 2012 and $18.2 million in the first six months of 2011.  However, our estimate of workers’ compensation loss costs was $18.6 million in both 2012 and 2011.  During 2012 and 2011, we received $2.5 million and $9.6 million, respectively, for the return of excess claim funds related to the workers’ compensation program, which resulted in an increase to working capital.

 
·
Medical plan funding – Our health care contract with United establishes participant cash funding rates 90 days in advance of the beginning of a reporting quarter.  Therefore, changes in the participation level of the United plan have a direct impact on our operating cash flows.  In addition, changes to the funding rates, which are solely determined by United based primarily upon recent claim history and anticipated cost trends, also have a significant impact on our operating cash flows.  At June 30, 2012, premiums owed and cash funded to United have exceeded Plan Costs, resulting in a $17.3 million surplus, $8.3 million of which is reflected as a current asset, and $9.0 million of which is reflected as a long-term asset on our Consolidated Balance Sheets.  The premiums owed to United at June 30, 2012, were $6.3 million, which is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets.
 
 
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·
Operating results – Our net income has a significant impact on our operating cash flows.  Our net income increased 25.6% to $19.5 million in the six months ended June 30, 2012, compared to $15.5 million in the six months ended June 30, 2011.  Please read “Results of Operations – Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011.”

Cash Flows from Investing Activities

Net cash flows used in investing activities were $10.9 million for the six months ended June 30, 2012, primarily due to $8.3 million in capital expenditures primarily related to our technology infrastructure.

Cash Flows from Financing Activities

Net cash flows used in financing activities were $16.9 million for the six months ended June 30, 2012, including $11.7 million in stock repurchases and $8.3 million in dividends paid.
 
 
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We are primarily exposed to market risks from fluctuations in interest rates and the effects of those fluctuations on the market values of our cash equivalent short-term investments.   In addition, borrowings under our Facility bear interest at a variable market rate.  As of June 30, 2012, we had not drawn on the Facility.  Please read Note 4 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.  Our cash equivalent short-term investments consist primarily of overnight investments and money market funds, which are not significantly exposed to interest rate risk, except to the extent that changes in interest rates will ultimately affect the amount of interest income earned on these investments.  The available-for-sale marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate.  As a result, the market values of these securities are affected by changes in prevailing interest rates.

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


In accordance with the Securities Exchange Act of 1934 Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2012.
 
There has been no change in our internal controls over financial reporting that occurred during the three months ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
 
 
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PART II


Please read Note 7 to our Consolidated Financial Statements, which is incorporated herein by reference.

ITEM 1A.

Forward-Looking Statements

The statements contained herein that are not historical facts are forward-looking statements within the meaning of the federal securities laws (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.  Forward-looking statements involve a number of risks and uncertainties.  In the normal course of business, Insperity, Inc., in an effort to help keep our stockholders and the public informed about our operations, may from time to time issue such forward-looking statements, either orally or in writing.  Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, or projections involving anticipated revenues, earnings, unit growth, profit per worksite employee, pricing, operating expenses or other aspects of operating results.  We base the forward-looking statements on our expectations, estimates and projections at the time such statements are made.  These statements are not guarantees of future performance and involve risks and uncertainties 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 could differ materially from those stated in such forward-looking statements.  Among the factors that could cause actual results to differ materially are: (i) continued effects of the economic recession and general economic conditions; (ii) regulatory and tax developments and possible adverse application of various federal, state and local regulations; (iii) the ability to secure competitive replacement contracts for health insurance and workers’ compensation contracts at expiration of current contracts; (iv) increases in health insurance costs and workers’ compensation rates and underlying claims trends, health care reform, financial solvency of workers’ compensation carriers and other insurers, state unemployment tax rates, liabilities for employee and client actions or payroll-related claims; (v) failure to manage growth of our operations and the effectiveness of our sales and marketing efforts; (vi) changes in the competitive environment in the PEO industry, including the entrance of new competitors and our ability to renew or replace client companies; (vii) our liability for worksite employee payroll, payroll taxes and benefits costs; (viii) our liability for disclosure of sensitive or private information; (ix) our ability to integrate or realize expected return on our adjacent business strategy, including acquisitions; and (x) an adverse final judgment or settlement of claims against Insperity.  These factors are discussed in further detail in our 2011 Annual Report on Form 10-K under “Factors That May Affect Future Results and the Market Price of Common Stock” on page 19, and elsewhere in this report.  Any of these factors, or a combination of such factors, could materially affect the results of our operations and whether forward-looking statements we make ultimately prove to be accurate.
 
 
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There have been no material changes in the risk factors disclosed pursuant to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011, except for the item noted below.

In 2003, facing continued capital constraints and a series of downgrades from various rating agencies, our former workers’ compensation insurance carrier for the two-year period ended September 2003, Lumbermens Mutual Casualty Company, formerly known as Kemper, (“Lumbermens Mutual”) made the decision to substantially cease underwriting operations and voluntarily entered into “run-off.”   In July 2012, Lumbermens Mutual announced that an agreed order of rehabilitation had been entered against it in Cook County, Illinois.  Under the order, the Director of the Illinois Department of Insurance was vested with control over Lumbermens Mutual property and decision-making.  The Director has publicly announced that while claims will continue to be paid during the rehabilitation process, he intends to use the rehabilitation period to work with state guaranty associations to prepare for the orderly transition of claim handling responsibilities to such funds once an Order of Liquidation is entered.  After this transition process has been completed, the Director has stated that he intends to file a verified complaint for liquidation.
 
Guaranty associations are non-profit organizations created by statute for the purpose of protecting policyholders from severe financial losses and preventing delays in claim payment due to the insolvency of an insurer. They do this by assuming responsibility for the payment of claims that would otherwise have been paid by the insurer had it not become insolvent. Each state has one or more guaranty association(s), with each association handling certain types of insurance. Insurance companies are required to be members of the state guaranty association as a condition of being licensed to do business in the state.

The guaranty associations in some states, including Texas, may assert that state law allows them to return the liability for open claims under such policies to an insured with a net worth exceeding certain specified levels.  We encountered this assertion when another former insurance carrier, Reliance Insurance Company (“Reliance”), was placed into liquidation in 2001.  In that case, the Texas state guaranty association asserted that it was entitled to full reimbursement from us for workers’ compensation benefits paid by the association.  Although we settled that dispute at a level substantially below full reimbursement and within the limits of insurance coverage we had secured to cover potential claims returned to us related to the Reliance policies, we have no similar insurance coverage for the Lumbermens Mutual claims.  If an Order of Liquidation is entered and if one or more states were to assert that liability for open claims with Lumbermens Mutual should be returned to us, we may be required to make a payment to the state covering estimated claims attributable to us.  While we are not certain one or more states will ultimately assert that we have claim responsibility, we intend to vigorously assert any and all available defenses to any such claim.  We estimate the outstanding claims to range from $2.9 million to $5.0 million as of June 30, 2012.  If such a payment were made, it would reduce net income, which may have a material adverse effect on net income in the reported period.
 
 
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The following table provides information about purchases by Insperity during the three months ended June 30, 2012, of equity securities that are registered by Insperity pursuant to Section 12 of the Exchange Act:

 
 
 
 
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)
 
04/01/2012 04/30/2012
    26,229     $ 27.50       13,289,092       1,210,908  
05/01/2012 05/31/2012
    275,672        25.88       13,564,499       935,501  
06/01/2012 – 06/30/2012
    25,187        24.75       13,589,098       910,902  
Total
    327,088     $ 25.92       13,589,098       910,902  
 


(1)
The Board has approved a repurchase program of Insperity common stock. During the three months ended June 30, 2012, 325,970 shares were repurchased under the program and 1,118 shares were withheld to satisfy tax withholding obligations for the vesting of restricted stock awards.  As of June 30, 2012, we were authorized to repurchase an additional 910,902 shares under the program. Unless terminated earlier by resolution of the Board, the repurchase program will expire when we have repurchased all shares authorized for repurchase under the repurchase program.

(2)
These shares include shares of restricted stock that 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.

 
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ITEM 6.

 
(a)
List of exhibits.

*
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
**
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
**
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
**
XBRL Instance Document.(1)
101.SCH
**
XBRL Taxonomy Extension Schema Document.
101.DEF
**
XBRL Extension Definition Document.
 

 
*
Filed with this report.

 
**
Furnished with this report.

 
(1)
Attached as exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Operations for the three and six month periods ended June 30, 2012 and 2011; (ii) the Consolidated Statements of Comprehensive Income for the three and six month periods ended June 30, 2012 and 2011; (iii) the Consolidated Balance Sheets at June 30, 2012 and December 31, 2011; (iv) the Consolidated Statement of Stockholders’ Equity for the six month period ended June 30, 2012; (v) the Consolidated Statements of Cash Flows for the six month periods ended June 30, 2012 and 2011; and (vi) Notes to the Consolidated Financial Statements.

 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Insperity, Inc.
   
Date:  July 31, 2012
By: /s/ Douglas S. Sharp
 
Douglas S. Sharp
 
Senior Vice President of Finance,
 
Chief Financial Officer and Treasurer
 
(Principal Financial and Duly Authorized Officer)
 
 
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