UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities

Exchange Act of 1934

For the quarterly period ended June 30, 2012.

or

o Transition Report Pursuant to Section 13 or 15(d) of the Securities

Exchange Act of 1934

For the transition period from  to 

Commission File No. 1-13998

Insperity, Inc.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨

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

As of July 24, 2012, 25,720,605 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

TABLE OF CONTENTS

Part I

Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31
Item 4.	Controls and Procedures	31
Part II
Item 1.	Legal Proceedings	32
Item 1a.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 6.	Exhibits	35

PART I

ITEM 1.  FINANCIAL STATEMENTS

INSPERITY, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

ASSETS

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

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INSPERITY, INC.

CONSOLIDATED BALANCE SHEETS (Continued)

(in thousands)

LIABILITIES AND STOCKHOLDERS’ EQUITY

	June 30, 2012			December 31, 2011
	(Unaudited)
Current liabilities:
Accounts payable	$	2,873		$	5,085
Payroll taxes and other payroll deductions payable		122,590			168,652
Accrued worksite employee payroll cost		144,885			130,317
Accrued health insurance costs		9,868			9,427
Accrued workers’ compensation costs		45,320			46,548
Accrued corporate payroll and commissions		13,474			22,383
Other accrued liabilities		14,008			13,814
Income taxes payable		1,429			—
Total current liabilities		354,447			396,226
Noncurrent liabilities:
Accrued workers’ compensation costs		63,664			60,054
Deferred income taxes		11,414			10,772
Total noncurrent liabilities		75,078			70,826
Commitments and contingencies
Stockholders’ equity:
Common stock		309			309
Additional paid-in capital		136,762			135,871
Treasury stock, at cost		(139,467	)		(134,647	)
Accumulated other comprehensive income, net of tax		58			24
Retained earnings		254,870			243,650
Total stockholders’ equity		252,532			245,207
Total liabilities and stockholders’ equity	$	682,057		$	712,259

See accompanying notes.

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INSPERITY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Revenues (gross billings of $3.039 billion, $2.731 billion, $6.271 billion and $5.619 billion, less worksite employee payroll cost of $2.520 billion, $2.258 billion, $5.156 billion and $4.610 billion, respectively)	$	519,256		$	472,903		$	1,114,433		$	1,009,284
Direct costs:
Payroll taxes, benefits and workers’ compensation costs		431,962			389,062			924,135			834,484
Gross profit		87,294			83,841			190,298			174,800
Operating expenses:
Salaries, wages and payroll taxes		40,047			38,467			83,370			78,064
Stock-based compensation		2,801			2,556			4,956			4,346
Commissions		3,506			3,255			6,941			6,351
Advertising		8,566			7,539			13,321			13,045
General and administrative expenses		18,494			17,023			40,572			38,916
Depreciation and amortization		4,465			3,601			8,677			7,549
		77,879			72,441			157,837			148,271
Operating income		9,415			11,400			32,461			26,529
Other income (expense):
Interest, net		156			304			320			584
Other, net		20			—			144			4
		176			304			464			588
Income before income tax expense		9,591			11,704			32,925			27,117
Income tax expense		3,970			4,963			13,420			11,590
Net income	$	5,621		$	6,741		$	19,505		$	15,527
Less net income allocated to participating securities		(162	)		(199	)		(564	)		(463	)
Net income allocated to common shares	$	5,459		$	6,542		$	18,941		$	15,064
Basic net income per share of common stock	$	0.22		$	0.25		$	0.75		$	0.59
Diluted net income per share of common stock	$	0.22		$	0.25		$	0.75		$	0.59

See accompanying notes.

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INSPERITY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 (Unaudited)

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

See accompanying notes.

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INSPERITY, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2012

(in thousands)

(Unaudited)

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

See accompanying notes.

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INSPERITY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

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

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INSPERITY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(in thousands)

(Unaudited)

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

See accompanying notes.

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INSPERITY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Unaudited)

1. Basis of Presentation

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

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

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

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

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

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

- 10 -

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

2. Accounting Policies

Health Insurance Costs

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

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

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

- 11 -

Workers’ Compensation Costs

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

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

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

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

- 12 -

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

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

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

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

At the beginning of each policy period, the insurance carrier establishes monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).  The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers’ compensation loss rates, as determined by the insurance carrier.  Monies funded into the program for incurred claims expected to be paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds are included in deposits, a long-term asset in our Consolidated Balance Sheets.  In the first half of 2012 and 2011, we received $2.5 million and $9.6 million, respectively, for the return of excess claim funds related to the ACE Program, which reduced deposits.  As of June 30, 2012, we had restricted cash of $44.6 million and deposits of $56.4 million.

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

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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:

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

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

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

· Level 1 - quoted prices in active markets using identical assets

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

· Level 3 - significant unobservable inputs

- 14 -

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

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

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

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

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

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

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

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

4. Revolving Credit Facility

On September 15, 2011, we entered into a four-year, $100 million revolving credit facility (the “Facility”), which may be increased to $150 million based on the terms and subject to the conditions set forth in the agreement relating to the Facility (the “Credit Agreement”). The Facility is available for working capital and general corporate purposes, including acquisitions. Insperity’s obligations under the Facility are secured by 65% of the stock of our captive insurance subsidiary and are guaranteed by all of our domestic subsidiaries.  In January 2012, we issued an irrevocable standby letter of credit for $285,000 under the Facility to a state workers’ compensation agency.  At June 30, 2012, we had not drawn on the Facility.

The Facility matures on September 15, 2015.  Borrowings under the Facility bear interest at an alternate base rate or LIBOR, at our option, plus an applicable margin.  Depending on our leverage ratio, the applicable margin varies (i) in the case of LIBOR loans, from 2.00% to 2.75%; and (ii) in the case of alternate base rate loans, from 0.00% to 0.75%.  The alternate base rate is the highest of (i) the prime rate most recently published in The Wall Street Journal; (ii) the federal funds rate plus 0.50%; and (iii) the 30-day LIBOR rate plus 2.00%.  We also pay an unused commitment fee on the average daily unused portion of the Facility at a rate of 0.25%. Interest expense and unused commitment fees are recorded in other income (expense).

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

5. Stockholders’ Equity

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

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

6. Net Income per Share

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

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

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

7. Commitments and Contingencies

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

Pennsylvania Sales Taxes

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

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

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Kemper Insurance Companies

In 2003, facing continued capital constraints and a series of downgrades from various rating agencies, our former workers’ compensation insurance carrier for the two-year period ended September 2003, Lumbermens Mutual Casualty Company, formerly known as Kemper, (“Lumbermens Mutual”) made the decision to substantially cease underwriting operations and voluntarily entered into “run-off.”   In July 2012, Lumbermens Mutual announced that an agreed order of rehabilitation had been entered against it in Cook County, Illinois.  Under the order, the Director of the Illinois Department of Insurance was vested with control over Lumbermens Mutual property and decision-making.  The Director has publicly announced that while claims will continue to be paid during the rehabilitation process, he intends to use the rehabilitation period to work with state guaranty associations to prepare for the orderly transition of claim handling responsibilities to such funds once an Order of Liquidation is entered.  After this transition process has been completed, the Director has stated that he intends to file a verified complaint for liquidation.

Guaranty associations are non-profit organizations created by statute for the purpose of protecting policyholders from severe financial losses and preventing delays in claim payment due to the insolvency of an insurer. They do this by assuming responsibility for the payment of claims that would otherwise have been paid by the insurer had it not become insolvent. Each state has one or more guaranty association(s), with each association handling certain types of insurance. Insurance companies are required to be members of the state guaranty association as a condition of being licensed to do business in the state.

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

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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, 2011, as well as our Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q.

New Accounting Pronouncements

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

Results of Operations

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

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

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

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

Revenues

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

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

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

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

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

Gross Profit

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

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

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

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

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

Operating Expenses

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

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

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

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

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

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

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

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

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

Income Tax Expense

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

Operating and Net Income

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

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

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

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

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

Revenues

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

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

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

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

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

Gross Profit

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

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

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

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

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

Operating Expenses

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

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

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

· Salaries, wages and payroll taxes of corporate and sales staff increased 6.8%, but decreased $2 per worksite employee per month compared to the 2011 period.  This increase was primarily due to a 7.9% rise in headcount, due in part to our adjacent business strategy, offset by lower incentive compensation expenses.

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· Stock-based compensation increased 14.0%, but remained flat on a per worksite employee per month basis compared to the 2011 period, due primarily to an increase in the weighted average market value on the date of grant associated with restricted awards. The stock-based compensation expense represents amortization of restricted stock awards granted to employees.

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

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

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

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

Income Tax Expense

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

Operating and Net Income

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

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Non-GAAP Financial Measures

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

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

Liquidity and Capital Resources

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

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

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Cash Flows from Operating Activities

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

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

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

· Medical plan funding – Our health care contract with United establishes participant cash funding rates 90 days in advance of the beginning of a reporting quarter.  Therefore, changes in the participation level of the United plan have a direct impact on our operating cash flows.  In addition, changes to the funding rates, which are solely determined by United based primarily upon recent claim history and anticipated cost trends, also have a significant impact on our operating cash flows.  At June 30, 2012, premiums owed and cash funded to United have exceeded Plan Costs, resulting in a $17.3 million surplus, $8.3 million of which is reflected as a current asset, and $9.0 million of which is reflected as a long-term asset on our Consolidated Balance Sheets.  The premiums owed to United at June 30, 2012, were $6.3 million, which is included in accrued health insurance costs, a current liability, on our Consolidated Balance Sheets.

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· Operating results – Our net income has a significant impact on our operating cash flows.  Our net income increased 25.6% to $19.5 million in the six months ended June 30, 2012, compared to $15.5 million in the six months ended June 30, 2011.  Please read “Results of Operations – Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011.”

Cash Flows from Investing Activities

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

Cash Flows from Financing Activities

Net cash flows used in financing activities were $16.9 million for the six months ended June 30, 2012, including $11.7 million in stock repurchases and $8.3 million in dividends paid.

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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.   In addition, borrowings under our Facility bear interest at a variable market rate.  As of June 30, 2012, we had not drawn on the Facility.  Please read Note 4 to the Consolidated Financial Statements, “Revolving Credit Facility,” for additional information.  Our cash equivalent short-term investments consist primarily of overnight investments and money market funds, which are not significantly exposed to interest rate risk, except to the extent that changes in interest rates will ultimately affect the amount of interest income earned on these investments.  The available-for-sale marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate.  As a result, the market values of these securities are affected by changes in prevailing interest rates.

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

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 June 30, 2012.

There has been no change in our internal controls over financial reporting that occurred during the three months ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

ITEM 1. LEGAL PROCEEDINGS.

Please read Note 7 to our Consolidated Financial Statements, 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) continued effects of the economic recession and general economic conditions; (ii) regulatory and tax developments and possible adverse application of various federal, state and local regulations; (iii) the ability to secure competitive replacement contracts for health insurance and workers’ compensation contracts at expiration of current contracts; (iv) increases in health insurance costs and workers’ compensation rates and underlying claims trends, health care reform, financial solvency of workers’ compensation carriers and other insurers, state unemployment tax rates, liabilities for employee and client actions or payroll-related claims; (v) failure to manage growth of our operations and the effectiveness of our sales and marketing efforts; (vi) changes in the competitive environment in the PEO industry, including the entrance of new competitors and our ability to renew or replace client companies; (vii) our liability for worksite employee payroll, payroll taxes and benefits costs; (viii) our liability for disclosure of sensitive or private information; (ix) our ability to integrate or realize expected return on our adjacent business strategy, including acquisitions; and (x) an adverse final judgment or settlement of claims against Insperity.  These factors are discussed in further detail in our 2011 Annual Report on Form 10-K under “Factors That May Affect Future Results and the Market Price of Common Stock” on page 19, and elsewhere in this report.  Any of these factors, or a combination of such factors, could materially affect the results of our operations and whether forward-looking statements we make ultimately prove to be accurate.

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There have been no material changes in the risk factors disclosed pursuant to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011, except for the item noted below.

In 2003, facing continued capital constraints and a series of downgrades from various rating agencies, our former workers’ compensation insurance carrier for the two-year period ended September 2003, Lumbermens Mutual Casualty Company, formerly known as Kemper, (“Lumbermens Mutual”) made the decision to substantially cease underwriting operations and voluntarily entered into “run-off.”   In July 2012, Lumbermens Mutual announced that an agreed order of rehabilitation had been entered against it in Cook County, Illinois.  Under the order, the Director of the Illinois Department of Insurance was vested with control over Lumbermens Mutual property and decision-making.  The Director has publicly announced that while claims will continue to be paid during the rehabilitation process, he intends to use the rehabilitation period to work with state guaranty associations to prepare for the orderly transition of claim handling responsibilities to such funds once an Order of Liquidation is entered.  After this transition process has been completed, the Director has stated that he intends to file a verified complaint for liquidation.

Guaranty associations are non-profit organizations created by statute for the purpose of protecting policyholders from severe financial losses and preventing delays in claim payment due to the insolvency of an insurer. They do this by assuming responsibility for the payment of claims that would otherwise have been paid by the insurer had it not become insolvent. Each state has one or more guaranty association(s), with each association handling certain types of insurance. Insurance companies are required to be members of the state guaranty association as a condition of being licensed to do business in the state.

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

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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 June 30, 2012, of equity securities that are registered by Insperity pursuant to Section 12 of the Exchange Act:

Period	Total Number of Shares Purchased(1)(2)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Program(1)		Maximum Number of Shares that may yet be Purchased under the Program(1)
04/01/2012 – 04/30/2012		26,229	$	27.50		13,289,092		1,210,908
05/01/2012 – 05/31/2012		275,672		25.88		13,564,499		935,501
06/01/2012 – 06/30/2012		25,187		24.75		13,589,098		910,902
Total		327,088	$	25.92		13,589,098		910,902

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

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

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ITEM 6. EXHIBITS

(a) List of exhibits.

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.DEF	**	XBRL Extension Definition Document.

* Filed with this report.

** Furnished with this report.

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

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Insperity, Inc.
Date:  July 31, 2012	By: /s/ Douglas S. Sharp
	Douglas S. Sharp
	Senior Vice President of Finance,
	Chief Financial Officer and Treasurer
	(Principal Financial and Duly Authorized Officer)

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