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INSPERITY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

May 2, 2014

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. Results of Operations



Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013.

The following table presents certain information related to our results of operations: Three Months Ended March 31, 2014 2013 % Change (in thousands, except per share and statistical data) Revenues (gross billings of $3.588 billion and $3.332 billion, less worksite employee payroll cost of $2.951 billion and $2.720 billion, respectively) $ 636,999$ 611,836 4.1 % Gross profit 106,176 108,118 (1.8 )% Operating expenses 89,585 86,109 4.0 % Operating income 16,591 22,009 (24.6 )% Other income 21 78 (73.1 )% Net income 9,564 13,173 (27.4 )% Diluted net income per share of common stock 0.37



0.51 (27.5 )%

Statistical Data: Average number of worksite employees paid per month 126,289 123,391 2.3 % Revenues per worksite employee per month(1) $ 1,681$ 1,653 1.7 % Gross profit per worksite employee per month 280 292 (4.1 )% Operating expenses per worksite employee per month 236 233 1.3 % Operating income per worksite employee per month 44 59 (25.4 )% Net income per worksite employee per month 25



36 (30.6 )%

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(1) Gross billings of $9,469 and $9,002 per worksite employee per month, less

payroll cost of $7,788 and $7,349 per worksite employee per month, respectively. Revenues Our revenues for the first quarter of 2014 increased 4.1% over the 2013 period, primarily due to a 2.3% increase in the average number of worksite employees paid per month and a 1.7%, or $28 increase in revenues per worksite employee per month. - 17 -



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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 quarter of 2013 and distribution for the quarters ended March 31, 2014 and 2013 were as follows: Three Months Ended Three Months Ended March 31, March 31, 2014 2013 % Change 2014 2013 (in thousands) (% of total revenue) Northeast $ 165,862$ 162,289 2.2 % 26.4 % 26.9 % Southeast 60,625 55,685 8.9 % 9.7 % 9.2 % Central 90,399 89,749 0.7 % 14.4 % 14.9 % Southwest 169,514 164,061 3.3 % 27.0 % 27.2 % West 141,156 131,689 7.2 % 22.5 % 21.8 % 627,556 603,473 4.0 % 100.0 % 100.0 % Other revenue(1) 9,443 8,363 12.9 % Total revenue $ 636,999$ 611,836 4.1 % _____________________________



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

The percentage of total Workforce Optimization revenues in our significant markets include the following:

Three Months Ended March 31, 2014 2013 Texas 25 % 25 % California 18 % 17 % New York 10 % 10 % Other 47 % 48 % Total 100 % 100 % 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 quarter of 2014, we saw slight improvement in worksite employees paid from new client sales as compared with the first quarter of 2013, while client retention and the net change in existing clients declined modestly compared to the first quarter of 2013.



Gross Profit

Gross profit for the first quarter of 2014 decreased 1.8% compared to the first quarter of 2013 to $106.2 million. The average gross profit per worksite employee decreased 4.1% to $280 per month in the 2014 period from $292 per month in the 2013 period. Included in gross profit in the 2014 period is a $15 per worksite employee per month contribution from our Adjacent Businesses compared to $13 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 quarter of 2014 increased 1.7% per worksite employee per month as compared to the first quarter of 2013. However, our direct costs, which primarily include payroll taxes, benefits and workers' compensation expenses, increased 2.9% to $1,401 per worksite employee per month in the first quarter of 2014 versus $1,361 in the first quarter of 2013. The primary direct cost components changed as follows: - 18 -



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Benefits costs - The cost of group health insurance and related employee

benefits increased $33 per worksite employee per month, or 5.3%, on a cost

per covered employee basis compared to the first quarter of 2013. Our

benefits costs incurred in the first quarter of 2014 included costs of $5.1

million, or $13 per worksite employee per month, for changes in estimated

run-off related to 2013. In addition $2.2 million, or $6 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 72.4% in

both the 2014 and 2013 periods. 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 24.6%, compared to the first quarter of

2013, primarily due to higher incurred claim severity. As a percentage of

non-bonus payroll cost, workers' compensation costs were 0.65% in the 2014

period compared to 0.53% in the 2013 period. During the 2014 period, we

recorded reductions in workers' compensation costs of $0.7 million, or 0.03%

of non-bonus payroll costs, for changes in estimated losses related to prior

reporting periods, compared to $3.6 million, or 0.15% 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 2.2%, but decreased $1 per worksite employee per month, compared to the first quarter of 2013,



primarily due to an 8.5% increase in total payroll costs. Payroll taxes as a

percentage of payroll cost were 8.8% in the 2014 period compared to 9.4% in

the 2013 period, due primarily to lower state unemployment tax rates in 2014. Operating Expenses The following table presents certain information related to our operating expenses: Three Months Ended Three Months Ended March 31, March 31, 2014 2013 % Change 2014 2013 % Change (in thousands)



(per worksite employee per month)

Salaries, wages and payroll taxes $ 51,032$ 48,211 5.9 % $ 134$ 130 3.1 % Stock-based compensation 2,400 2,310 3.9 % 6 6 - Commissions 3,246 3,207 1.2 % 9 9 - Advertising 4,941 5,250 (5.9 )% 13 14 (7.1 )% General and administrative expenses 22,732 21,986 3.4 % 60 60 - Depreciation and amortization 5,234 5,145 1.7 % 14 14 - Total operating expenses $ 89,585$ 86,109 4.0 % $ 236$ 233 1.3 % Operating expenses increased 4.0% to $89.6 million compared to $86.1 million in the first quarter of 2013. Operating expenses per worksite employee per month increased to $236 in the 2014 period from $233 in the 2013 period. The components of operating expenses changed as follows:



Salaries, wages and payroll taxes of corporate and sales staff increased

5.9%, or $4 per worksite employee per month, compared to the 2013 period. This increase was primarily due to a 4.6% rise in headcount in our technology organization, Adjacent Businesses and Business Performance Advisors.



Stock-based compensation increased 3.9%, 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 1.2%, but remained flat on a per worksite

employee per month basis, compared to the 2013 period. - 19 -



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Advertising costs decreased 5.9%, or $1 per worksite employee per month,

compared to the 2013 period, primarily due to lower media advertising spend

in the 2014 period.



General and administrative expenses increased 3.4%, but remained flat on a

per worksite employee per month basis, compared to the 2013 period.

Depreciation and amortization expense increased 1.7%, but remained flat on a

per worksite employee per month basis, compared to the 2013 period.

Income Tax Expense

Our effective income tax rate was 42.4% in the 2014 period compared to 40.4% 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 $44 and $25 in the 2014 period, versus $59 and $36 in the 2013 period.

Non-GAAP Financial Measure

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 March 31, 2014 2013 % Change (in thousands, except per worksite employee per month data) GAAP to non-GAAP reconciliation: Payroll cost (GAAP) $ 2,950,568$ 2,720,512 8.5 % Less: Bonus payroll cost 521,341 342,565 52.2 % Non-bonus payroll cost $ 2,429,227$ 2,377,947 2.2 % Payroll cost per worksite employee per month (GAAP) $ 7,788$ 7,349 6.0 % Less: Bonus payroll cost per worksite employee per month 1,376 925 48.8 % Non-bonus payroll cost per worksite employee per month $ 6,412$ 6,424 (0.2 )%



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 $260.4 million in cash, cash equivalents and marketable securities at March 31, 2014, of which approximately $148.5 million was payable in early April 2014 for withheld federal and state income taxes, employment taxes and other payroll deductions, and approximately $14.9 million were customer prepayments that were payable in April 2014. At - 20 -



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March 31, 2014, we had working capital of $123.1 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 March 31, 2014. Please read Note 4 to the Consolidated Financial Statements, "Revolving Credit Facility," for additional information.



Cash Flows from Operating Activities

Net cash provided by operating activities in 2014 was $8.9 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 March 31, 2014, the last

business day of the reporting period was a Monday, client prepayments were

$14.9 million and accrued worksite employee payroll was $187.3 million. In

the period ended December 31, 2013, the last business day of the reporting

period was a Tuesday, client prepayments were $24.5 million and accrued

worksite employee payroll was $173.8 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 $12.6 million in the first three

months of 2014 and $11.1 million in the first three months of

2013. However, our estimate of workers' compensation loss costs was $12.0

million in the 2014 period and $9.0 million in the 2013 period, respectively.



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 March 31, 2014,

premiums owed and cash funded to United have exceeded Plan Costs, resulting

in a $34.1 million surplus, $25.1 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

March 31, 2014, were $22.3 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 $19.0 million at March 31, 2014 as compared

to no additional quarterly premium at March 31, 2013. Operating results - Our net income has a significant impact on our



operating cash flows. Our net income decreased 27.4% to $9.6 million in the

three months ended March 31, 2014, compared to $13.2 million in the three

months ended March 31, 2013. Please read "Results of Operations - Three

Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013."

Cash Flows from Investing Activities

Net cash flows used in investing activities were $3.5 million for the three months ended March 31, 2014, primarily due to property and equipment purchases of $2.4 million.

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Cash Flows from Financing Activities

Net cash flows used in financing activities were $17.7 million for the three months ended March 31, 2014, including $13.9 million in stock repurchases and $4.4 million in dividends paid.


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