Document - 09.30.2014 - 10Q

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

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

 
For the quarterly period ended September 30, 2014.
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 
For the transition period from  _______________ to _______________


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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No ý
 
As of October 27, 2014, 25,332,418 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.


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

Table of Contents

PART I

ITEM 1.  FINANCIAL STATEMENTS

INSPERITY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS
 
 
 
September 30,
2014
 
December 31, 2013
 
 
(Unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
179,458

 
$
225,755

Restricted cash
 
57,222

 
51,928

Marketable securities
 
45,953

 
46,340

Accounts receivable, net:
 
 

 
 

Trade
 
3,730

 
7,453

Unbilled
 
237,748

 
199,628

Other
 
3,336

 
2,928

Prepaid insurance
 
30,613

 
10,638

Other current assets
 
12,851

 
12,053

Income taxes receivable
 
2,740

 
409

Deferred income taxes
 
—

 
8,185

Total current assets
 
573,651

 
565,317

 
 
 
 
 
Property and equipment:
 
 

 
 

Land
 
5,214

 
4,115

Buildings and improvements
 
68,471

 
67,939

Computer hardware and software
 
87,631

 
85,241

Software development costs
 
40,628

 
38,522

Furniture and fixtures
 
36,855

 
36,479

Aircraft
 
35,879

 
35,879

 
 
274,678

 
268,175

Accumulated depreciation and amortization
 
(191,913
)
 
(181,760
)
Total property and equipment, net
 
82,765

 
86,415

 
 
 
 
 
Other assets:
 
 

 
 

Prepaid health insurance
 
9,000

 
9,000

Deposits – health insurance
 
3,700

 
3,700

Deposits – workers’ compensation
 
93,686

 
81,878

Goodwill and other intangible assets, net
 
14,808

 
18,434

Other assets
 
1,748

 
1,816

Total other assets
 
122,942

 
114,828

Total assets
 
$
779,358

 
$
766,560


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Table of Contents

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

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
September 30,
2014
 
December 31,
2013
 
 
(Unaudited)
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,255

 
$
2,678

Payroll taxes and other payroll deductions payable
 
105,026

 
165,604

Accrued worksite employee payroll cost
 
211,028

 
173,801

Accrued health insurance costs
 
26,351

 
5,103

Accrued workers’ compensation costs
 
59,393

 
52,930

Accrued corporate payroll and commissions
 
26,474

 
21,611

Other accrued liabilities
 
23,008

 
14,960

Total current liabilities
 
454,535

 
436,687

 
 
 
 
 
Noncurrent liabilities:
 
 
 
 

Accrued workers’ compensation costs
 
73,009

 
68,905

Deferred income taxes
 
3,806

 
7,696

Total noncurrent liabilities
 
76,815

 
76,601

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Stockholders’ equity:
 
 

 
 

Common stock
 
308

 
308

Additional paid-in capital
 
136,972

 
135,653

Treasury stock, at cost
 
(151,091
)
 
(138,688
)
Accumulated other comprehensive income, net of tax
 
24

 
29

Retained earnings
 
261,795

 
255,970

Total stockholders’ equity
 
248,008

 
253,272

Total liabilities and stockholders’ equity
 
$
779,358

 
$
766,560

 
See accompanying notes.

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Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Revenues (gross billings of $3.362 billion, $3.236 billion, $10.231 billion and $9.736 billion, less worksite employee payroll cost of $2.802 billion, $2.696 billion, $8.469 billion and $8.037 billion, respectively)
 
$
560,303

 
$
539,869

 
$
1,761,923

 
$
1,698,979

 
 
 
 
 
 
 
 
 
Direct costs:
 
 

 
 

 
 

 
 

Payroll taxes, benefits and workers’ compensation costs
 
459,486

 
442,460

 
1,459,477

 
1,395,706

 
 
 
 
 
 
 
 
 
Gross profit
 
100,817

 
97,409

 
302,446

 
303,273

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

Salaries, wages and payroll taxes
 
49,384

 
43,797

 
148,245

 
137,697

Stock-based compensation
 
2,701

 
2,749

 
8,346

 
8,351

Commissions
 
3,790

 
3,609

 
10,753

 
10,349

Advertising
 
4,885

 
4,273

 
18,182

 
19,243

General and administrative expenses
 
20,295

 
20,567

 
64,143

 
62,592

Impairment charge
 
—

 
—

 
2,485

 
—

Depreciation and amortization
 
5,302

 
5,302

 
15,827

 
15,692

 
 
86,357

 
80,297

 
267,981

 
253,924

Operating income
 
14,460

 
17,112

 
34,465

 
49,349

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 

 
 

 
 

 
 

Interest, net
 
9

 
26

 
80

 
155

Other, net
 
34

 
(1
)
 
20

 
(2,668
)
Income before income tax expense
 
14,503

 
17,137

 
34,565

 
46,836

Income tax expense
 
6,118

 
7,055

 
14,725

 
20,093

Net income
 
$
8,385

 
$
10,082

 
$
19,840

 
$
26,743

 
 
 
 
 
 
 
 
 
Less distributed and undistributed earnings allocated to participating securities
 
(243
)
 
(289
)
 
(576
)
 
(769
)
 
 
 
 
 
 
 
 
 
Net income allocated to common shares
 
$
8,142

 
$
9,793

 
$
19,264

 
$
25,974

 
 
 
 
 
 
 
 
 
Basic net income per share of common stock
 
$
0.33

 
$
0.39

 
$
0.78

 
$
1.05

 
 
 
 
 
 
 
 
 
Diluted net income per share of common stock
 
$
0.33

 
$
0.39

 
$
0.78

 
$
1.04


See accompanying notes.

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Table of Contents

INSPERITY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
 
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Net income
 
$
8,385

 
$
10,082

 
$
19,840

 
$
26,743

 
 
 
 
 
 
 
 
 
Other comprehensive income:
 
 

 
 
 
 

 
 

Unrealized gain (loss) on available-for-sale securities, net of tax
 
(17
)
 
26

 
(5
)
 
7

 
 
 
 
 
 
 
 
 
Comprehensive income
 
$
8,368

 
$
10,108

 
$
19,835

 
$
26,750

 
See accompanying notes.

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INSPERITY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2014
(in thousands)
(Unaudited)
 
 
 
Common Stock Issued
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Total
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
 
30,758

 
$
308

 
$
135,653

 
$
(138,688
)
 
$
29

 
$
255,970

 
$
253,272

Purchase of treasury stock, at cost
 
—

 
—

 
—

 
(20,769
)
 
—

 
—

 
(20,769
)
Exercise of stock options
 
—

 
—

 
(177
)
 
454

 
—

 
—

 
277

Income tax benefit from stock-based compensation, net
 
—

 
—

 
66

 
—

 
—

 
—

 
66

Stock-based compensation expense
 
—

 
—

 
1,233

 
7,113

 
—

 
—

 
8,346

Other
 
—

 
—

 
197

 
799

 
—

 
—

 
996

Dividends paid
 
—

 
—

 
—

 
—

 
—

 
(14,015
)
 
(14,015
)
Unrealized loss on marketable securities, net of tax
 
—

 
—

 
—

 
—

 
(5
)
 
—

 
(5
)
Net income
 
—

 
—

 
—

 
—

 
—

 
19,840

 
19,840

Balance at September 30, 2014
 
30,758

 
$
308

 
$
136,972

 
$
(151,091
)
 
$
24

 
$
261,795

 
$
248,008

 
See accompanying notes.

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

 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
Cash flows from operating activities:
 
 
 
 
Net income
 
$
19,840

 
$
26,743

Adjustments to reconcile net income to net cash used in operating activities:
 
 

 
 

Depreciation and amortization
 
15,827

 
15,692

Impairment charge
 
2,485

 
2,679

Amortization of marketable securities
 
1,474

 
1,597

Stock-based compensation
 
8,346

 
8,351

Deferred income taxes
 
4,299

 
3,150

Changes in operating assets and liabilities:
 
 

 
 

Restricted cash
 
(5,294
)
 
(3,168
)
Accounts receivable
 
(34,805
)
 
(28,576
)
Prepaid insurance
 
(19,975
)
 
(1,729
)
Other current assets
 
(798
)
 
(446
)
Other assets
 
(11,761
)
 
(11,406
)
Accounts payable
 
577

 
(349
)
Payroll taxes and other payroll deductions payable
 
(60,578
)
 
(76,246
)
Accrued worksite employee payroll expense
 
37,227

 
34,072

Accrued health insurance costs
 
21,248

 
(7,118
)
Accrued workers’ compensation costs
 
10,567

 
2,828

Accrued corporate payroll, commissions and other accrued liabilities
 
12,911

 
3,850

Income taxes payable/receivable
 
(2,572
)
 
(4,301
)
Total adjustments
 
(20,822
)
 
(61,120
)
Net cash used in operating activities
 
(982
)
 
(34,377
)
 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Marketable securities:
 
 

 
 

Purchases
 
(36,468
)
 
(49,580
)
Proceeds from dispositions
 
10,630

 
8,025

Proceeds from maturities
 
24,759

 
9,474

Property and equipment
 
(11,032
)
 
(9,281
)
Net cash used in investing activities
 
(12,111
)
 
(41,362
)

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

 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
Cash flows from financing activities:
 
 
 
 
Purchase of treasury stock
 
$
(20,769
)
 
$
(17,130
)
Dividends paid
 
(14,015
)
 
(13,039
)
Proceeds from the exercise of stock options
 
277

 
1,163

Income tax benefit from stock-based compensation
 
307

 
1,181

Other
 
996

 
862

Net cash used in financing activities
 
(33,204
)
 
(26,963
)
 
 
 
 
 
Net decrease in cash and cash equivalents
 
(46,297
)
 
(102,702
)
Cash and cash equivalents at beginning of period
 
225,755

 
264,544

Cash and cash equivalents at end of period
 
$
179,458

 
$
161,842

 


See accompanying notes.

- 9 -
Table of Contents

INSPERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(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 Optimization®, 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 Human Capital Management, Payroll Services, Time and Attendance, Performance Management, Organizational Planning, Recruiting Services, Employment Screening, Financial Services, Expense Management, Retirement Services and Insurance Services (collectively “Strategic Business Units”, formerly known as 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, in customizable bundles, or along with Workforce Optimization.

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, 2013. Our Consolidated Balance Sheet at December 31, 2013 has been derived from the audited financial statements at that date, but does not include all of the information or footnotes required by GAAP for complete financial statements.  Our Consolidated Balance Sheet at September 30, 2014 and our Consolidated Statements of Operations and Comprehensive Income for the three and nine month periods ended September 30, 2014 and 2013, our Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2014 and 2013, and our Consolidated Statement of Stockholders’ Equity for the nine month period ended September 30, 2014 , 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.

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”), UnitedHealthcare of California, Kaiser Permanente, Blue Shield of California, HMSA 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, we have accounted for this plan since its inception using a partially self-funded insurance accounting model.  Accordingly, we record the costs of the United plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”) as benefits expense in our Consolidated Statements of Operations.  The estimated incurred 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 Plan Costs.

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Additionally, since the plan’s inception, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter.  If the Plan Costs for a reporting quarter are greater than the premiums paid and owed to United, a deficit in the plan would be incurred and a liability for the excess costs would be accrued in our Consolidated Balance Sheets.  On the other hand, if the Plan Costs for the reporting quarter are less than the premiums paid and owed to United, a surplus in the plan would be incurred and we would record an asset for the excess premiums in our Consolidated Balance Sheets.  The terms of the arrangement require us to maintain an accumulated cash surplus in the plan of $9.0 million, which is reported as long-term prepaid insurance.  In addition, United requires a deposit equal to approximately one day of claims funding activity, which was $3.5 million as of September 30, 2014, and is reported as a long-term asset.  As of September 30, 2014, Plan Costs were less than the net premiums paid and owed to United by $31.8 million.  As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $22.8 million balance is included in prepaid insurance, a current asset, in our Consolidated Balance Sheets.  The premiums owed to United at September 30, 2014 were $22.7 million, which is included in accrued health insurance costs, a current liability in our Consolidated Balance Sheets. Our benefits costs incurred in the first nine months of 2014 included costs of $2.4 million for changes in estimated run-off related to 2013.

Workers’ Compensation Costs

Our 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 we satisfy our responsibilities.  We bear the economic burden for the first $1 million layer of claims per occurrence, as well as a maximum aggregate amount of $5 million per policy year for those claims that exceed $1 million, and the insurance carrier bears responsibility for the claims in excess of such amounts.

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

We employ a third party actuary to estimate our loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends.  Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates.  During the nine months ended September 30, 2014 and 2013, we reduced our workers’ compensation costs by $3.0 million and $8.3 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 utilized in the 2014 and 2013 periods were 1.0% and 0.7%, respectively) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.


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

 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
 
(in thousands)
 
 
 
 
 
Beginning balance, January 1,
 
$
120,833

 
$
111,685

Accrued claims
 
39,130

 
30,496

Present value discount
 
(1,418
)
 
(748
)
Paid claims
 
(28,314
)
 
(24,462
)
Ending balance
 
$
130,231

 
$
116,971

 
 
 
 
 
Current portion of accrued claims
 
$
57,222

 
$
50,317

Long-term portion of accrued claims
 
73,009

 
66,654

 
 
$
130,231

 
$
116,971


The current portion of accrued workers’ compensation costs on our Consolidated Balance Sheets at September 30, 2014 includes $2.2 million of workers’ compensation administrative fees.

As of September 30, 2014 and 2013, the undiscounted accrued workers’ compensation costs were $140.0 million and $127.5 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. During the first nine months of 2014 and 2013, we paid the insurance carrier an additional $7.2 million and $5.0 million, respectively, in claim funds for prior policy years, which increased deposits.  As of September 30, 2014, we had restricted cash of $57.2 million and deposits of $93.7 million.

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


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3.
Cash, Cash Equivalents and Marketable Securities

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

 
 
September 30,
2014
 
December 31,
2013
 
 
(in thousands)
Overnight Holdings
 
 
 
 
Money market funds (cash equivalents)
 
$
123,800

 
$
192,040

Investment Holdings
 
 

 
 

Money market funds (cash equivalents)
 
43,427

 
42,913

Marketable securities
 
45,953

 
46,340

 
 
213,180

 
281,293

Cash held in demand accounts
 
20,778

 
23,054

Outstanding checks
 
(8,547
)
 
(32,252
)
Total cash, cash equivalents and marketable securities
 
$
225,411

 
$
272,095

 
 
 
 
 
Cash and cash equivalents
 
$
179,458

 
$
225,755

Marketable securities
 
45,953

 
46,340

Total cash, cash equivalents and marketable securities
 
$
225,411

 
$
272,095


Our cash and overnight holdings fluctuate based on the timing of clients’ payroll processing cycles.  Included in the cash balance as of September 30, 2014 and December 31, 2013, are $90.8 million and $143.0 million, respectively, in funds associated with federal and state income tax withholdings, employment taxes and other payroll deductions, as well as $18.3 million and $24.5 million in client prepayments, respectively.

We account for our 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

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

 
 
Fair Value Measurements
 
 
(in thousands)
 
 
September 30,
2014
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
167,227

 
$
167,227

 
$
—

 
$
—

Municipal bonds
 
45,953

 
—

 
45,953

 
—

Total
 
$
213,180

 
$
167,227

 
$
45,953

 
$
—

 

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Fair Value Measurements
 
 
(in thousands)
 
 
December 31,
2013
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
$
234,953

 
$
234,953

 
$
—

 
$
—

Municipal bonds
 
46,340

 
—

 
46,340

 
—

Total
 
$
281,293

 
$
234,953

 
$
46,340

 
$
—


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

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

 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
 
 
 
(in thousands)
 
 
September 30, 2014
 
 
 
 
 
 
 
 
Municipal bonds
 
$
45,912

 
$
45

 
$
(4
)
 
$
45,953

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

Municipal bonds
 
$
46,290

 
$
51

 
$
(1
)
 
$
46,340


As of September 30, 2014, the contractual maturities of our marketable securities were as follows:

 
 
Amortized
Cost
 
Estimated
Fair Value
 
 
(in thousands)
 
 
 
 
 
Less than one year
 
$
14,503

 
$
14,519

One to five years
 
31,409

 
31,434

Total
 
$
45,912

 
$
45,953


4.
Goodwill and Other Intangible Assets

During the second quarter of 2014, impairment indicators were identified in our Employment Screening business, which is a discrete reporting unit, due to changes in management, the reporting unit’s financial results and the loss of certain customers. As a result, we performed impairment tests for our Employment Screening business’ long-lived assets and goodwill and concluded that the assets were impaired. The impairments resulted primarily from lower projected revenue growth rates and profitability levels. Accordingly, we recognized intangible asset impairments of $0.7 million and, upon completion of step two of the goodwill impairment test, we recognized a goodwill impairment charge of $1.8 million in the second quarter of 2014. The fair values of the long-lived assets and reporting unit were estimated using discounted cash flow models, which we believe appropriately estimates the fair values of the long-lived assets and reporting unit. The material assumptions used in the models included the weighted average cost of capital and long-term growth rates.  We consider these to be Level 3 fair value measures.


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The following table presents the gross carrying amount and accumulated amortization for each class of intangible assets and the gross carrying amount and accumulated impairment for goodwill:

 
 
December 31, 2013
 
Nine Months Ended 
 September 30, 2014
 
September 30, 2014
 
 
Balance
 
Impairment
 
Amortization Expense
 
Balance
 
 
(in thousands)
Gross carrying amount:
 
 
 
 
 
 
 
 
Trademarks
 
$
1,230

 
$
(1,010
)
 
$
—

 
$
220

Customer relationships
 
7,784

 
(1,392
)
 
—

 
6,392

Aggregate goodwill acquired:
 
 
 
 
 
 
 
 
Goodwill
 
21,156

 
—

 
—

 
21,156

Total
 
$
30,170

 
$
(2,402
)
 
$
—

 
$
27,768

 
 
 
 
 
 
 
 
 
Accumulated amortization:
 
 
 
 
 
 
 
 
Trademarks
 
$
(680
)
 
$
695

 
$
(67
)
 
$
(52
)
Customer relationships
 
(4,340
)
 
976

 
(1,074
)
 
(4,438
)
Accumulated impairment:
 
 
 
 
 
 
 
 
Goodwill
 
(6,716
)
 
(1,754
)
 
—

 
(8,470
)
Total
 
$
(11,736
)
 
$
(83
)
 
$
(1,141
)
 
$
(12,960
)
 
 
 
 
 
 
 
 
 
Net carrying amount:
 
 
 
 
 
 
 
 
Trademarks
 
$
550

 
$
(315
)
 
$
(67
)
 
$
168

Customer relationships
 
3,444

 
(416
)
 
(1,074
)
 
1,954

Goodwill
 
14,440

 
(1,754
)
 
—

 
12,686

Total goodwill and other intangible assets
 
$
18,434

 
$
(2,485
)
 
$
(1,141
)
 
$
14,808

5.
Other Assets
    
In 2011, we acquired a minority interest in The Receivables Exchange (“TRE”), an online marketplace for the sale of accounts receivable, for $2.8 million. In the second quarter of 2013, TRE issued similar securities at per share amounts substantially below the per share book value of our investment. Accordingly, we valued the investment based on a similar security market transaction, which is a Level 2 valuation technique. This resulted in a non-cash impairment charge of $2.7 million, which is included in other income (expense) in our Consolidated Statements of Operations, during the second quarter of 2013. Due to federal income tax limitations on capital losses, no tax benefit associated with the impairment was recognized.

6.
Revolving Credit Facility

We have a $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 matures on September 15, 2015.  The Facility contains both affirmative and negative covenants, which we believe are customary for arrangements of this nature.  At September 30, 2014, we were in compliance with all financial covenants under the Credit Agreement and had not drawn on the Facility. As of September 30, 2014, we had an outstanding $0.6 million letter of credit issued under the Facility.


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7.
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 nine months ended September 30, 2014, 580,804 shares were repurchased under the Repurchase Program and 112,458 shares not subject to the Repurchase Program were withheld to satisfy tax withholding obligations for the vesting of restricted stock awards.  As of September 30, 2014, we were authorized to repurchase an additional 768,765 shares under the program.

The Board declared quarterly dividends as follows:
 
 
2014
 
2013
 
 
(amounts per share)
 
 
 
 
 
First quarter
 
$
0.17

 
$
0.17

Second quarter
 
0.19

 
0.17

Third quarter
 
0.19

 
0.17


 During the nine months ended September 30, 2014 and 2013, we paid dividends totaling $14.0 million and $13.0 million, respectively.     

8.
Net Income per Share

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

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

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Net income
 
$
8,385

 
$
10,082

 
$
19,840

 
$
26,743

Less distributed and undistributed earnings allocated to participating securities
 
(243
)
 
(289
)
 
(576
)
 
(769
)
Net income allocated to common shares
 
$
8,142

 
$
9,793

 
$
19,264

 
$
25,974

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
24,650

 
24,849

 
24,747

 
24,855

Incremental shares from assumed conversions of common stock options
 
2

 
18

 
5

 
24

Adjusted weighted average common shares outstanding
 
24,652

 
24,867

 
24,752

 
24,879

 
 
 
 
 
 
 
 
 
Potentially dilutive securities not included in weighted average share calculation due to anti-dilutive effect
 
16

 
—

 
5

 
10



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9.
Commitments and Contingencies

We are 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.

Federal Unemployment Taxes

Employers in certain states are experiencing higher Federal Unemployment Tax Act (“FUTA”) tax rates as a result of certain states not repaying their unemployment loans from the federal government in a timely manner.  The Benefit Cost Ratio Add-On (“BCR”) is an additional tax on the FUTA wage base for employers in states that continue to have outstanding federal unemployment insurance loans beginning with the fifth year in which there is a balance due on the loan.  States had the option to apply for a waiver before July 1st of the year in which the BCR is applicable.  During the second quarter of 2014, Georgia, Missouri and Wisconsin repaid their unemployment loans. There are currently 11 states with outstanding unemployment loans and of those, all but one, Connecticut, have filed for a BCR waiver. Eleven states, including California, are at risk for assessment of the BCR in 2014.  We expect most states will be notified by the federal government in the fourth quarter of 2014 if a waiver has been granted in response to the state’s application.  The potential additional FUTA tax associated with worksite employees in these 11 states was approximately $4.3 million as of September 30, 2014.

Generally, our contractual agreements allow us to incorporate such increases into our service fees upon the effective date of the rate change.  However, our ability to fully adjust service fees in our billing systems and collect such increases over the remaining term of the customers’ contracts could be limited, resulting in a potential tax increase not being fully recovered.  As a result, if these FUTA tax increases are instituted and not collected from our clients, such increases could have a material adverse effect on our financial condition or results of operations.



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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013, as well as our Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 outlines a single comprehensive revenue recognition model for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Under ASU No. 2014-09, an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 is effective for annual reporting periods ending after December 15, 2016, and early adoption is not permitted. Companies may use either a full retrospective or a modified retrospective approach to adopt ASU No. 2014-09. We are currently evaluating the guidance and have not determined the impact this standard may have on our Consolidated Financial Statements.

Results of Operations

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013.

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

 
 
Three Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
 
(in thousands, except per share and statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $3.362 billion and $3.236 billion, less worksite employee payroll cost of $2.802 billion and $2.696 billion, respectively)
 
$
560,303

 
$
539,869

 
3.8
 %
Gross profit
 
100,817

 
97,409

 
3.5
 %
Operating expenses
 
86,357

 
80,297

 
7.5
 %
Operating income
 
14,460

 
17,112

 
(15.5
)%
Other income
 
43

 
25

 
72.0
 %
Net income
 
8,385

 
10,082

 
(16.8
)%
Diluted net income per share of common stock
 
0.33

 
0.39

 
(15.4
)%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
131,545

 
129,248

 
1.8
 %
Revenues per worksite employee per month(1)
 
$
1,420

 
$
1,392

 
2.0
 %
Gross profit per worksite employee per month
 
255

 
251

 
1.6
 %
Operating expenses per worksite employee per month
 
218

 
207

 
5.3
 %
Operating income per worksite employee per month
 
37

 
44

 
(15.9
)%
Net income per worksite employee per month
 
21

 
26

 
(19.2
)%
 ____________________________________
 
(1) 
Gross billings of $8,519 and $8,346 per worksite employee per month, less payroll cost of $7,099 and $6,954 per worksite employee per month, respectively.


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Revenues

Our revenues for the third quarter of 2014 increased 3.8% over the 2013 period, primarily due to a 1.8% increase in the average number of worksite employees paid per month and a 2.0%, or $28, increase in revenues per worksite employee per month.

We provide our Workforce Optimization solution to small and medium-sized businesses in strategically selected markets throughout the United States. By region, our Workforce Optimization revenue change from the third quarter of 2013 and distribution for the quarters ended September 30, 2014 and 2013 were as follows:

 
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
142,376

 
$
136,334

 
4.4
%
 
25.9
%
 
25.7
%
Southeast
 
53,615

 
51,813

 
3.5
%
 
9.8
%
 
9.8
%
Central
 
79,448

 
78,322

 
1.4
%
 
14.5
%
 
14.8
%
Southwest
 
150,404

 
147,518

 
2.0
%
 
27.4
%
 
27.8
%
West
 
123,531

 
116,959

 
5.6
%
 
22.4
%
 
21.9
%
 
 
549,374

 
530,946

 
3.5
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
10,929

 
8,923

 
22.5
%
 
 
 
 
Total revenue
 
$
560,303

 
$
539,869

 
3.8
%
 
 
 
 
_____________________________

(1) Comprised primarily of revenues generated by Strategic Business Units.

The percentage of total Workforce Optimization revenues in our significant markets include the following:
 
 
Three Months Ended September 30,
 
 
2014
 
2013
 
 
 
 
 
Texas
 
25.3
%
 
25.8
%
California
 
17.8
%
 
17.5
%
New York
 
9.6
%
 
9.4
%
Other
 
47.3
%
 
47.3
%
Total
 
100.0
%
 
100.0
%

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 third quarter of 2014, we saw improvement in the net change in existing clients and worksite employees paid from new client sales as compared to the third quarter 2013, while client retention remained consistent with the third quarter of 2013.

Gross Profit

Gross profit for the third quarter of 2014 increased 3.5% over the third quarter of 2013 to $100.8 million.  The average gross profit per worksite employee increased 1.6% to $255 per month in the 2014 period from $251 per month in the 2013 period.  Included in gross profit in 2014 is an $18 per worksite employee per month contribution from our Strategic Businesses compared to $15 per worksite employee per month in the 2013 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.  Our revenues during the third quarter of 2014 increased 2.0% per worksite employee per month over the third quarter of 2013. Our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 2.1% to $1,165 per worksite employee

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per month in the third quarter of 2014 versus $1,141 in the third quarter of 2013.  The primary direct cost components changed as follows:

•
Benefits costs – The cost of group health insurance and related employee benefits increased $3 per worksite employee per month, or 1.3% on a cost per covered employee basis, compared to the third quarter of 2013. Our benefits costs incurred in the third quarter of 2014 reflect favorable claim trends due to a reduction in both large claims and COBRA participation levels, partially offset by $3.1 million, or $8 per worksite employee per month, of additional taxes primarily due to new health care reform requirements. Our estimate of incurred but not paid claims increased during the third quarter of 2014. Partially offsetting this increase were benefit cost reductions for changes in estimated claim run-off related to prior periods of $6.4 million, or $16 per worksite employee per month, in the third quarter of 2014. The percentage of worksite employees covered under our health insurance plans was 71.2% in the 2014 period compared to 71.8% in the 2013 period. Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.

•
Workers’ compensation costs – Workers’ compensation costs increased $10 per worksite employee per month, or 29.4% compared to the third quarter of 2013, primarily due to higher incurred claim levels.  As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.68% in the 2014 period compared to 0.55% in the 2013 period. During the 2014 period, we recorded reductions in workers’ compensation costs of $0.4 million, or 0.02% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $1.9 million, or 0.08% of non-bonus payroll costs in the 2013 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 4.0%, or $10 per worksite employee per month, compared to the third quarter of 2013, primarily due to the 3.9% increase in payroll costs. Payroll taxes as a percentage of payroll cost were 6.3% in both the 2014 and the 2013 periods.

Operating Expenses

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

 
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
49,384

 
$
43,797

 
12.8
 %
 
$
125

 
$
113

 
10.6
 %
Stock-based compensation
 
2,701

 
2,749

 
(1.7
)%
 
7

 
7

 
—

Commissions
 
3,790

 
3,609

 
5.0
 %
 
10

 
9

 
11.1
 %
Advertising
 
4,885

 
4,273

 
14.3
 %
 
12

 
11

 
9.1
 %
General and administrative expenses
 
20,295

 
20,567

 
(1.3
)%
 
51

 
53

 
(3.8
)%
Depreciation and amortization
 
5,302

 
5,302

 
—

 
13

 
14

 
(7.1
)%
Total operating expenses
 
$
86,357

 
$
80,297

 
7.5
 %
 
$
218

 
$
207

 
5.3
 %

Operating expenses increased 7.5% to $86.4 million compared to $80.3 million in the third quarter of 2013.  Operating expenses per worksite employee per month increased to $218 in the 2014 period from $207 in the 2013 period.  The components of operating expenses changed as follows:

•
Salaries, wages and payroll taxes of corporate and sales staff increased 12.8%, or $12 per worksite employee per month, compared to the 2013 period.  This increase was primarily due to higher incentive compensation accruals and a 1.3% rise in headcount.

•
Stock-based compensation decreased 1.7%, but remained flat on a per worksite employee per month basis compared to the 2013 period.  Stock-based compensation expense represents amortization of restricted stock awards granted to employees.


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•
Commissions expense increased 5.0%, or $1 per worksite employee per month, compared to the 2013 period, primarily due to commissions associated with our Strategic Businesses.

•
Advertising costs increased 14.3%, or $1 per worksite employee per month, compared to the 2013 period, primarily due to changes in the timing of television advertising spend.

•
General and administrative expenses decreased 1.3%, or $2 per worksite employee per month, compared to the 2013 period.

Income Tax Expense

Our effective income tax rate was 42.2% in the 2014 period compared to 41.2% in the 2013 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 $37 and $21 in the 2014 period, versus $44 and $26 in the 2013 period.

    

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Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013.

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

 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
 
(in thousands, except per share and statistical data)
 
 
 
 
 
 
 
Revenues (gross billings of $10.231 billion and $9.736 billion, less worksite employee payroll cost of $8.469 billion and $8.037 billion, respectively)
 
$
1,761,923

 
$
1,698,979

 
3.7
 %
Gross profit
 
302,446

 
303,273

 
(0.3
)%
Operating expenses
 
267,981

(1) 
253,924

 
5.5
 %
Operating income
 
34,465

 
49,349

 
(30.2
)%
Other income (expense)
 
100

 
(2,513
)
(2) 
(104.0
)%
Net income
 
19,840

 
26,743

 
(25.8
)%
Diluted net income per share of common stock
 
0.78

 
1.04

 
(25.0
)%
 
 
 
 
 
 
 
Statistical Data:
 
 

 
 

 
 

Average number of worksite employees paid per month
 
128,703

 
126,445

 
1.8
 %
Revenues per worksite employee per month(3)
 
$
1,521

 
$
1,493

 
1.9
 %
Gross profit per worksite employee per month
 
261

 
266

 
(1.9
)%
Operating expenses per worksite employee per month
 
231

 
223

 
3.6
 %
Operating income per worksite employee per month
 
30

 
43

 
(30.2
)%
Net income per worksite employee per month
 
17

 
23

 
(26.1
)%
 ____________________________________
 
(1)
Includes a non-cash impairment charge of $2.5 million, or $0.06 per share in the second quarter of 2014. Please read Note 4 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information.

(2) 
Includes the impact of a $2.7 million, or $0.10 per share, non-cash impairment charge in the second quarter of 2013. Please read Note 5 to the Consolidated Financial Statements, “Other Assets,” for additional information.

(3) 
Gross billings of $8,832 and $8,555 per worksite employee per month, less payroll cost of $7,311 and $7,062 per worksite employee per month, respectively.

Revenues

Our revenues for the nine months ended September 30, 2014 increased 3.7% over the 2013 period, primarily due to a 1.8% increase in the average number of worksite employees paid per month and a 1.9%, or $28, increase in revenues per worksite employee per month.


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We provide our Workforce Optimization solution to small and medium-sized businesses in strategically selected markets throughout the United States. By region, our Workforce Optimization revenue change from the first nine months of 2013 and distribution for the nine months ended September 30, 2014 and 2013 were as follows:
 
 
Nine Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
 
(in thousands)
 
(% of total revenue)
 
 
 
 
 
 
 
 
 
 
 
Northeast
 
$
451,505

 
$
439,351

 
2.8
%
 
26.1
%
 
26.3
%
Southeast
 
169,472

 
158,976

 
6.6
%
 
9.8
%
 
9.5
%
Central
 
249,497

 
247,078

 
1.0
%
 
14.4
%
 
14.8
%
Southwest
 
471,218

 
459,740

 
2.5
%
 
27.2
%
 
27.5
%
West
 
389,642

 
367,829

 
5.9
%
 
22.5
%
 
21.9
%
 
 
1,731,334

 
1,672,974

 
3.5
%
 
100.0
%
 
100.0
%
Other revenue(1)
 
30,589

 
26,005

 
17.6
%
 
 
 
 
Total revenue
 
$
1,761,923

 
$
1,698,979

 
3.7
%
 
 
 
 
______________________________

(1) Comprised primarily of revenues generated by Strategic Business Units.

The percentage of total Workforce Optimization revenues in our significant markets include the following:
 
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
 
 
 
 
Texas
 
25.2
%
 
25.5
%
California
 
17.8
%
 
17.5
%
New York
 
9.8
%
 
9.6
%
Other
 
47.2
%
 
47.4
%
Total
 
100.0
%
 
100.0
%

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 nine months of 2014, we saw improvement in worksite employees paid from new client sales, while the net change in existing clients and client retention remained consistent with the first nine months of 2013.

Gross Profit

Gross profit for the first nine months of 2014 decreased 0.3% compared to the first nine months of 2013 to $302.4 million.  The average gross profit per worksite employee decreased 1.9% to $261 per month in the 2014 period from $266 per month in the 2013 period.  Included in gross profit in 2014 is a $16 per worksite employee per month contribution from our Strategic Businesses compared to $14 per worksite employee per month in the 2013 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.  Our revenues during the first nine months of 2014 increased 1.9% per worksite employee per month as compared to the first nine months of 2013. However, our direct costs, which primarily include payroll taxes, benefits and workers’ compensation expenses, increased 2.7% to $1,260 per worksite employee per month compared to $1,227 in the first nine months of 2013.  The primary direct cost components changed as follows:

•
Benefits costs – The cost of group health insurance and related employee benefits increased $21 per worksite employee per month, or 3.8% on a cost per covered employee basis, compared to the first nine months of 2013.  Our benefits costs incurred in the first nine months of 2014 included costs of $2.4 million, or $2 per worksite employee per month, for changes in estimated run-off related to 2013. Included in 2013 benefits costs is a reduction of $3.4 million, or $3 per

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worksite employee per month, for lower than expected claim costs and premium taxes related to prior periods.  In addition, $8.5 million, or $7 per worksite employee per month, of additional taxes were included in the 2014 period, primarily due to new health care reform requirements. The percentage of worksite employees covered under our health insurance plans was 71.7% in the 2014 period compared to 72.1% in the 2013 period.  Please read Note 2 to the Consolidated Financial Statements, “Accounting Policies – Health Insurance Costs,” for a discussion of our accounting for health insurance costs.

•
Workers’ compensation costs – Workers’ compensation costs increased $7 per worksite employee per month, or 22.6%, compared to the first nine months of 2013.  As a percentage of non-bonus payroll cost, workers’ compensation costs were 0.65% in the 2014 period compared to 0.54% in the 2013 period.  During the 2014 period, we recorded reductions in workers’ compensation costs of $3.0 million, or 0.04% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $8.3 million, or 0.11% of non-bonus payroll costs, in the 2013 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 2.7%, or $5 per worksite employee per month, compared to the first nine months of 2013, primarily due to the 5.4% increase in payroll costs offset by lower state unemployment tax rates. Payroll taxes as a percentage of payroll cost were 7.4% in the 2014 period and 7.6% in the 2013 period.  

Operating Expenses

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

 
 
Nine Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
 
 
(in thousands)
 
(per worksite employee per month)
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and payroll taxes
 
$
148,245

 
$
137,697

 
7.7
 %
 
$
128

 
$
121

 
5.8
 %
Stock-based compensation
 
8,346

 
8,351

 
(0.1
)%
 
7

 
7

 
—

Commissions
 
10,753

 
10,349

 
3.9
 %
 
9

 
9

 
—

Advertising
 
18,182

 
19,243

 
(5.5
)%
 
16

 
17

 
(5.9
)%
General and administrative expenses
 
64,143

 
62,592

 
2.5
 %
 
55

 
55

 
—

Impairment charge
 
2,485

 
—

 
100.0
 %
 
2

 
—

 
100.0
 %
Depreciation and amortization
 
15,827

 
15,692

 
0.9
 %
 
14

 
14

 
—

Total operating expenses
 
$
267,981

 
$
253,924

 
5.5
 %
 
$
231

 
$
223

 
3.6
 %

Operating expenses increased 5.5% to $268.0 million compared to $253.9 million in the first nine months of 2013.  We recorded impairment charges of $2.5 million in our Employment Screening reporting unit in the first nine months of 2014. Please read Note 4 to the Consolidated Financial Statements, “Goodwill and Other Intangible Assets,” for additional information. Operating expenses per worksite employee per month increased to $231 in the 2014 period from $223 in the 2013 period.  The components of operating expenses changed as follows:

•
Salaries, wages and payroll taxes of corporate and sales staff increased 7.7%, or $7 per worksite employee per month, compared to the 2013 period.  This increase was primarily due to higher incentive compensation accruals and a 3.1% rise in headcount.

•
Stock-based compensation decreased 0.1%, but remained flat on a per worksite employee per month basis compared to the 2013 period.  Stock-based compensation expense represents amortization of restricted stock awards granted to employees.

•
Commissions expense increased 3.9%, but remained flat on a per worksite employee per month basis compared to the 2013 period, primarily due to commissions associated with our Strategic Businesses.

•
Advertising costs decreased 5.5%, or $1 per worksite employee per month compared to the 2013 period, primarily due to reduced spending on radio and television advertising.

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•
General and administrative expenses increased 2.5%, but remained flat on a per worksite employee per month basis compared to the 2013 period.

•
Depreciation and amortization expense increased 0.9%, but remained flat on a per worksite employee per month basis compared to the 2013 period.

Other Income (Expense)

Other expense decreased $2.6 million in the first nine months of 2014 compared to the first nine months of 2013, primarily due to the non-cash impairment charge related to our minority investment in The Receivables Exchange in 2013. Please read Note 5 to the Consolidated Financial Statements, “Other Assets,” for additional information.
Income Tax Expense

Our effective income tax rate was 42.6% in the 2014 period compared to 42.9% in the 2013 period.  Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes, non-deductible expenses, and the effects of the impairment charges recorded during the period. The effect of the non-cash impairment charges on the income tax rates was 0.3% in the 2014 period and 2.3% in the 2013 period.

Operating and Net Income

Operating and net income per worksite employee per month was $30 and $17 in the 2014 period, versus $43 and $23 in the 2013 period.

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 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
 
 
(in thousands, except per worksite employee per month data)
GAAP to non-GAAP reconciliation:
 
 
 
 
 
 
 
 
 
 
 
 
Payroll cost (GAAP)
 
$
2,801,722

 
$
2,696,330

 
3.9
%
 
$
8,468,804

 
$
8,036,532

 
5.4
%
Less: Bonus payroll cost
 
204,405

 
192,868

 
6.0
%
 
947,751

 
706,795

 
34.1
%
Non-bonus payroll cost
 
$
2,597,317

 
$
2,503,462

 
3.7
%
 
$
7,521,053

 
$
7,329,737

 
2.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Payroll cost per worksite employee per month (GAAP)
 
$
7,099

 
$
6,954

 
2.1
%
 
$
7,311

 
$
7,062

 
3.5
%
Less: Bonus payroll cost per worksite employee per month
 
518

 
498

 
4.0
%
 
818

 
621

 
31.7
%
Non-bonus payroll cost per worksite employee per month
 
$
6,581

 
$
6,456

 
1.9
%
 
$
6,493

 
$
6,441

 
0.8
%


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Liquidity and Capital Resources

We periodically evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, our expansion plans, potential acquisitions and other operating cash needs.  To meet short-term liquidity requirements, which are primarily the payment of direct and operating expenses, we rely primarily on cash from operations.  Longer-term projects or significant acquisitions may be financed with debt or equity.  We have in the past sought, and may in the future seek, to raise additional capital or take other steps to increase or manage our liquidity and capital resources.  We had $225.4 million in cash, cash equivalents and marketable securities at September 30, 2014, of which approximately $90.8 million was payable in early October 2014 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $18.3 million were customer prepayments that were payable in October 2014.  At September 30, 2014, we had working capital of $119.1 million compared to $128.6 million at December 31, 2013.  We currently believe that our cash on hand, marketable securities, cash flows from operations and availability under our credit facility will be adequate to meet our liquidity requirements for the remainder of 2014.  We will rely on these same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital needs.

We have a $100 million revolving credit facility (“Facility”) with a syndicate of financial institutions.  The Facility is available for working capital and general corporate purposes, including acquisitions, and was undrawn at September 30, 2014.  Please read Note 6 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.

Cash Flows from Operating Activities

Net cash used in operating activities in 2014 was $1.0 million.  Our primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our clients.  Our cash and cash equivalents, and thus our reported cash flows from operating activities are significantly impacted by various external and internal factors, which are reflected in part by the changes in our balance sheet accounts.  These include the following:

•
Timing of client payments / payroll levels – We typically collect our comprehensive service fee, along with the client’s payroll funding, from clients at least one day prior to the payment of worksite employee payrolls and associated payroll taxes.  Therefore, the last business day of a reporting period has a substantial impact on our reporting of operating cash flows.  For example, many worksite employees are paid on Fridays; therefore, operating cash flows decrease in the reporting periods that end on a Friday or a Monday.  In the period ended September 30, 2014, the last business day of the reporting period was a Tuesday, client prepayments were $18.3 million and accrued worksite employee payroll was $211.0 million.  In the period ended September 30, 2013, the last business day of the reporting period was a Monday, client prepayments were $9.0 million and accrued worksite employee payroll was $184.1 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 $40.9 million in the first nine months of 2014 and $33.5 million in the first nine months of 2013.  However, our estimate of workers’ compensation loss costs was $37.7 million in the 2014 period and $29.7 million in the 2013 period, respectively. During the first nine months of 2014 and 2013, we paid the insurance carrier an additional $7.2 million and $5.0 million, respectively, in claim funds for prior policy years.

•
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 September 30, 2014, premiums owed and cash funded to United have exceeded Plan Costs, resulting in a $31.8 million surplus, $22.8 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 September 30, 2014, were $22.7 million, which is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets. Higher funding rates, as determined by United, resulted in a higher additional quarterly premium of $20.1 million at September 30, 2014 as compared to no additional quarterly premium at September 30, 2013.


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•
Operating results – Our net income has a significant impact on our operating cash flows.  Our net income decreased 25.8% to $19.8 million in the nine months ended September 30, 2014, compared to $26.7 million in the nine months ended September 30, 2013, due to higher operating expenses. Please read “Results of Operations – Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013.”

Cash Flows from Investing Activities

Net cash flows used in investing activities were $12.1 million for the nine months ended September 30, 2014, primarily due to property and equipment purchases of $11.0 million.

Cash Flows from Financing Activities

Net cash flows used in financing activities were $33.2 million for the nine months ended September 30, 2014, including $20.8 million in stock repurchases and $14.0 million in dividends paid.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are primarily exposed to market risks from fluctuations in interest rates and the effects of those fluctuations on the market values of our cash equivalent short-term investments and our available-for-sale marketable securities.   In addition, borrowings under our Facility bear interest at a variable market rate.  As of September 30, 2014, we had not drawn on the Facility.  Please read Note 6 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.  The cash equivalent short-term investments consist primarily of overnight investments, which are not significantly exposed to interest rate risk, except to the extent that changes in interest rates will ultimately affect the amount of interest income earned on these investments.  The available-for-sale marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate.  As a result, the market values of these securities are affected by changes in prevailing interest rates.

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

ITEM 4.  CONTROLS AND PROCEDURES.

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 September 30, 2014.
 
There has been no change in our internal controls over financial reporting that occurred during the three months ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.


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PART II

ITEM 1.  LEGAL PROCEEDINGS.

Please read Note 9 to the Consolidated Financial Statements, “Commitments and Contingencies,” which is incorporated herein by reference.

ITEM 1A.  RISK FACTORS.

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) adverse 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, other insurers or financial institutions, state and federal 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 acquisitions; (x) failure of our information technology systems; and (xi) an adverse final judgment or settlement of claims against Insperity.  These factors are discussed in further detail in our 2013 Annual Report on Form 10-K under “Factors That May Affect Future Results and the Market Price of Common Stock” on page 17, 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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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

The following table provides information about purchases by Insperity during the three months ended September 30, 2014, 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 Announced Program(1)
 
Maximum Number of Shares Available for Purchase under Announced Program(1)
 
 
 
 
 
 
 
 
 
07/01/2014 – 07/31/2014
 
36,916

 
$
31.98

 
36,786

 
928,885

08/01/2014 – 08/31/2014
 
160,120


30.28

 
160,120

 
768,765

09/01/2014 – 09/30/2014
 
—

 
—

 
—

 
768,765

Total
 
197,036

 
$
30.60

 
196,906

 
768,765

 ____________________________________

(1) 
Our Board has approved a program to repurchase shares of our outstanding common stock.  During the three months ended September 30, 2014, 196,906 shares were repurchased under the program and 130 shares were withheld to satisfy tax withholding obligations for the vesting of restricted stock awards.  As of September 30, 2014, we were authorized to repurchase an additional 768,765 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.  EXHIBITS.

 
(a)
List of Exhibits
 

10.1(+)
*
Letter Agreement, dated September 2, 2014, by and between Insperity Holdings, Inc. and UnitedHealthcare Insurance Company.
10.2(+)
*
Amendment to Minimum Premium Financial Agreement, as amended effective January 1, 2011, by and between Insperity Holdings, Inc. (fka Administaff of Texas, Inc.) and UnitedHealthcare Insurance Company, effective as of January 1, 2013.
10.3(+)
*
Amendment to Minimum Premium Administrative Services Agreement, as amended effective January 1, 2011, by and between Insperity Holdings, Inc. (fka Administaff of Texas, Inc.) and UnitedHealthcare Insurance Company, effective as of January 1, 2013.
31.1
*
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
*
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
**
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
**
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.CAL
*
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
*
XBRL Extension Definition Linkbase Document.
101.LAB
*
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
*
XBRL Taxonomy Extension Presentation Linkbase Document.
 
____________________________________
 
 
 
 
 
 
(+)
Confidential treatment has been requested for this exhibit and confidential portions have been filed with the Securities and Exchange Commission.
 
 
 
 
 
*
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 nine month periods ended September 30, 2014 and 2013; (ii) the Consolidated Statements of Comprehensive Income for the three and nine month periods ended September 30, 2014 and 2013; (iii) the Consolidated Balance Sheets at September 30, 2014 and December 31, 2013; (iv) the Consolidated Statement of Stockholders’ Equity for the nine month period ended September 30, 2014; (v) the Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2014 and 2013; 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: November 3, 2014
By:
/s/ Douglas S. Sharp
 
 
Douglas S. Sharp
 
 
Senior Vice President of Finance,
 
 
Chief Financial Officer and Treasurer
 
 
(Principal Financial Officer)

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