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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[x] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997.
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 [No Fee required]
For the transition period from ______________ to _________________
Commission File No. 1-13998
ADMINISTAFF, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0479645
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
19001 Crescent Springs Drive
Kingwood, Texas 77339
(Address of principal executive offices) (Zip Code)
(Registrant's Telephone Number, Including Area Code): (281) 358-8986
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share New York Stock Exchange
(Title of class) (Name of Exchange on Which Registered)
Securities Registered Pursuant to Section 12(g) of the Act: NONE
Indicate by check mark 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 X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
----
The aggregate market value of the voting stock of Administaff, Inc.
held by non-affiliates (based upon the March 2, 1998 average high and low trade
prices of these shares as reported by the New York Stock Exchange) was
approximately $354 million.
Number of shares outstanding of each of the issuer's classes of common
stock, as of March 2, 1998: 13,906,221 shares.
Part III information is incorporated by reference from the proxy
statement for the annual meeting of stockholders to be held May 5, 1998 which
the registrant intends to file within 120 days of the end of the fiscal year.
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TABLE OF CONTENTS
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . 16
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . 33
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . 33
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . 33
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . 34
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PART I
The statements contained in this Annual Report on Form 10-K ("Annual
Report") which are not historical facts, including, but not limited to,
statements found in Item 1, "Business" and in Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," are
forward-looking statements that involve a number of risks and uncertainties.
In the normal course of business, Administaff, Inc. ("Administaff" or the
"Company"), in an effort to help keep its stockholders and the public informed
about the Company's 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 or other aspects of operating results.
All phases of the Company's operations are subject to a number of
uncertainties, risks and other influences. Therefore, the actual results of
the future events described in such forward-looking statements in this Annual
Report, or elsewhere, could differ materially from those stated in such
forward-looking statements. Among the factors that could cause actual results
to differ materially are the risks and uncertainties discussed in this Annual
Report, including, without limitation, the portions referenced above, and the
uncertainties set forth from time to time in the Company's other public reports
and filings and public statements, many of which are beyond the control of the
Company, and any of which, or a combination of which, could materially affect
the results of the Company's operations and whether forward-looking statements
made by the Company ultimately prove to be accurate.
ITEM 1. BUSINESS.
GENERAL
Administaff is a professional employer organization ("PEO") that
provides a comprehensive Personnel Management System which encompasses a broad
range of services, including benefits and payroll administration, medical and
workers' compensation insurance programs, personnel records management,
liability management, employee recruiting and selection, performance management
and training and development services. The Company was organized in 1986 and
has provided PEO services since inception. In January 1997, the Company
completed an initial public offering of 3,000,000 shares of its common stock.
Administaff is a leading provider of PEO services, both in terms of the
number of worksite employees and in terms of revenues. The Company serves
client companies with worksite employees located throughout the United States.
Houston, the Company's original location, accounted for approximately 47% of
the Company's revenues for the year ended December 31, 1997 with other Texas
markets contributing an additional 30%. As of December 31, 1997, the Company
had 18 sales offices located in 12 markets. The Company is currently executing
a long-term national expansion strategy which has targeted approximately 90
sales offices located in 40 strategically selected markets. As part of this
expansion strategy, the Company opened five new sales offices and entered two
new markets during 1997. The Company plans to enter at least one new market or
open at least one additional sales office in an existing market in each quarter
of 1998 and 1999.
The Company believes that there are additional opportunities to enhance
the growth of the Company's worksite employee base, including the establishment
of marketing partnerships and alliances. In 1997, the Company developed a
strategy for identifying and evaluating potential alliances, and in January
1998, the Company entered into the first significant agreement of this type
with American Express Travel Related Services, Inc.
The Personnel Management System is designed to improve the productivity
and profitability of small and medium sized businesses (generally, businesses
with 100 or fewer employees). It relieves business owners and key executives
of administrative and regulatory burdens, enabling them to focus on the core
competencies of their businesses. It also promotes employee satisfaction
through human resource management techniques that improve employee performance.
The Company provides the Personnel Management System by entering into a
Personnel Management Services Agreement ("PMSA") which establishes a three
party relationship whereby the Company and client act as co-employers of the
worksite employees. Under the PMSA, Administaff assumes responsibility for
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personnel administration and compliance with most employment-related
governmental regulations while the client company retains the employees'
services in its business and remains the employer for various other purposes.
The Company charges a comprehensive service fee which is invoiced along with
each periodic payroll of the client. The fee is based upon the gross payroll
of each client and the Company's estimated cost of providing the services
included in the Personnel Management System. Companies providing comprehensive
services in this manner have become known as professional employer
organizations, or PEOs, as distinguished from "fee for service" companies, such
as payroll processing firms, human resource consultants and safety consulting
firms.
PEO INDUSTRY
The PEO industry began to evolve in the early 1980's largely in response
to the burdens placed on small and medium sized employers by an increasingly
complex legal and regulatory environment. While various service providers were
available to assist these businesses with specific tasks, PEOs emerged as
providers of a more comprehensive range of services relating to the
employer/employee relationship. PEO arrangements generally transfer broad
aspects of the employer/employee relationship to the PEO. Because PEOs provide
employee-related services to a large number of employees, they can achieve
economies of scale as a professional employer and perform the
employment-related functions at a level typically available only to large
corporations with substantial resources to devote to human resources
management.
Growth in the PEO industry has been significant. According to the
National Association of Professional Employer Organizations ("NAPEO"), the
number of employees under PEO arrangements in the United States has grown from
approximately 10,000 in 1984 to approximately 2.0 million in 1995. The Company
believes that the key factors driving demand for PEO services include (i)
complex regulation of labor and employment issues and the related costs of
compliance, including the allocation of time and effort to such functions by
owners and key executives, (ii) the need to provide competitive health care and
related benefits to employees of small businesses, (iii) the increasing costs
associated with workers' compensation and health insurance coverage, workplace
safety programs, employee-related complaints and litigation and (iv) trends
relating to the growth and productivity of the small business community in the
United States.
A significant factor in the growth of the PEO industry has been
increasing recognition and acceptance of PEOs and the co-employer relationship
by federal and state governmental authorities. As the concept of PEO services
became understood by regulatory authorities, the regulatory environment began
to shift from one of hostility and skepticism to one of regulatory cooperation
with the industry. During the mid to late 1980's, legitimate industry
participants were challenged to overcome well publicized failures of
financially unsound and, in some cases, unscrupulous operators. Given this
environment, the Company and other industry leaders, in concert with NAPEO,
have worked with the relevant governmental entities for the establishment of a
regulatory framework that protects clients and employees, discourages
unscrupulous and financially unsound operators, and promotes the legitimacy and
further development of the industry.
While many states do not explicitly regulate PEOs, 18 states (including
Texas) have enacted legislation containing licensing or registration
requirements and several others are considering such regulation. Such laws vary
from state to state but generally provide for monitoring the fiscal
responsibility of PEOs. State regulation assists in screening insufficiently
capitalized PEO operations and, in the Company's view, has the effect of
legitimizing the PEO industry by resolving interpretive issues concerning
employee status for specific purposes under applicable state law. The Company
has actively supported such regulatory efforts. The Company, which is currently
licensed or registered in 17 states, does not view the burdens of compliance
with these regulations as material to its business operations.
PRINCIPAL SERVICES
The Company serves small and medium-sized business by providing the
Personnel Management System which encompasses a broad range of services,
including benefits and payroll administration, medical and workers'
compensation insurance programs, personnel records management, liability
management, employee recruiting and
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selection, performance management and training and development services. Among
the laws and regulations that may affect a small business are the following:
o Internal Revenue Code (the "Code") o Civil Rights Act of 1991
o Federal Income Contribution Act (FICA) o Americans with Disabilities Act (ADA)
o Employee Retirement Income Security Act o Tax Equalization and Fiscal
(ERISA) Responsibility Act (TEFRA)
o Occupational Safety and Health Act o Age Discrimination in Employment Act
(OSHA) (ADEA)
o Federal Unemployment Tax Act (FUTA) o Drug-Free Workplace Act
o Fair Labor Standards Act (FLSA) o Consumer Credit Protection Act
o Consolidated Omnibus Budget Reconcilia- o The Family Medical Leave Act
tion Act of 1987 (COBRA) o Health Insurance Portability and Accountability
o Immigration Reform and Control Act Act
(IRCA) o State unemployment and employment
o Title VII (Civil Rights Act of 1964) security laws
o State workers' compensation laws
While these regulations are complex, and in some instances overlapping,
Administaff assists in achieving client companies' compliance by providing
services in four primary categories: administrative functions, benefit plans
and administration, personnel management and liability management. All of the
following services are included in the Personnel Management System and are
available to all client companies in consideration for the Company's
comprehensive service fee.
Administrative Functions. Administrative functions encompass a wide
variety of processing and record keeping tasks, mostly related to payroll
administration and government compliance. Specific examples include payroll
processing, payroll tax deposits, quarterly payroll tax reporting, employee
file maintenance, unemployment claims processing, workers' compensation claims
reporting, and monitoring and responding to changing regulatory requirements.
Benefit Plans and Administration. The Company's benefit plan offerings
include the following: a group health plan, a dependent care spending account
plan, an employee assistance plan, an educational assistance plan, an adoption
assistance program, group term life insurance coverage, accidental death and
dismemberment insurance coverage, short- term and long-term disability
insurance coverage and a 401(k) retirement plan. The group term health plan
includes medical, dental, vision and prenatal care and a prescription card.
All eligible employees may participate in the 401(k) plan, while there are
several different packages of the other benefit plans offered by the Company.
As part of its service package, the Company administers these benefit plans,
negotiates the terms and costs of such plans, maintains the plans in accordance
with applicable federal and state regulations, serves as liaison for the
delivery of such benefits to worksite employees and monitors and reviews claims
for loss control purposes. The Company believes that this variety and quality
of benefit plans is usually found only in larger companies that can spread
program costs across many employees. Moreover, the Company believes that the
availability and administration of these benefits tend to mitigate the
competitive disadvantage small businesses normally face in the areas of cost
control and employee recruiting and retention.
Personnel Management. The Company provides a wide variety of personnel
management services which gives its client companies access to resources
normally found only in the human resources departments of large companies. All
client companies receive the Company's comprehensive personnel guide, which
sets forth a systematic approach to administering personnel policies and
practices including recruiting, discipline and termination procedures. Other
human resources services available to client company owners, worksite
supervisors and employees include personnel policy and employee handbook
drafting and reviewing, job description design, prospective employee screening
and background investigations, performance appraisal process and forms design,
professional development and issues-oriented training, counseling, substance
abuse awareness training, drug testing, outplacement services and compensation
guidance.
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Liability Management. Liability management services consist of several
functions. First, pursuant to the Company's PMSA and basic to the Administaff
client relationship, the Company assumes many of the liabilities associated
with being an employer. These include liability for compliance with payroll tax
reporting and payment obligations, workers' compensation regulations, the
Consolidated Omnibus Budget Reconciliation Act of 1987 ("COBRA"), the
Immigration Reform and Control Act and the Consumer Credit Protection Act. For
those potential liabilities that Administaff does not assume, the Company
assists its clients in managing and limiting exposure. This management for many
clients includes first time and ongoing safety inspections as well as the
implementation of safety programs designed to reduce workers' compensation
claims. Administaff also provides guidance to clients on avoiding liability for
discrimination, sexual harassment and civil rights violations and participates
in termination decisions to attempt to secure protection from liability on
those grounds. When a claim arises, the Company often assists in the client's
defense regardless of whether the Company has been named directly. The Company
employs attorneys specializing in several areas of employment law and has broad
experience in disputes concerning the employer/employee relationship. This
expertise allows Administaff's clients to contest many claims which they might
otherwise have been inclined to settle. The Company also monitors changing
government regulations and notifies clients of their effect on potential
employer liability.
PERSONNEL MANAGEMENT SERVICES AGREEMENT
All clients enter into Administaff's Personnel Management Services
Agreement. The PMSA provides for an on-going relationship, subject to
termination by the Company or the client at any time upon 60 days prior written
notice.
The PMSA establishes the Company's comprehensive service fee, which is
subject to periodic adjustments to account for changes in the composition of
the client's workforce. The PMSA also establishes the division of
responsibilities between Administaff and the client as co-employers. Pursuant
to the PMSA, Administaff is responsible for all personnel administration and is
liable for purposes of certain government regulation. In addition, Administaff
assumes liability for payment of salaries and wages of its worksite employees
and responsibility for providing employee benefits to such persons, regardless
of whether the client company makes timely payment of the associated service
fee. The client retains the employees' services and remains liable for the
purposes of certain government regulations, compliance with which requires
control of the worksite or daily supervisory responsibility or is otherwise
beyond Administaff's ability to assume. A third group of responsibilities and
liabilities are shared by Administaff and the client where such joint
responsibility is appropriate. The specific division of applicable
responsibilities under the PMSA is as follows:
Administaff Client Joint
----------- ------ -----
Tax reporting and payment (state Assignment to, and ownership of, Implementation of policies and
and federal withholding, FICA, all intellectual property rights practices relating to the
FUTA, state unemployment) employer/employee relationship
Workers' compensation compliance, Section 414(o) of the Code Selection of fringe benefits,
procurement, management, regarding benefit discrimination including employee leave policies
reporting
Compliance with COBRA, Compliance with OSHA regulations, Compliance with Title VII of the
Immigration Reform and Control EPA regulations and any state or Civil Rights Act of 1964, the Age
Act, and Consumer Credit legal equivalent government Discrimination in Employment Act,
Protection Act, Title III, as contracting provisions, the Fair the Employment Retirement Income
well as monitoring changes in Labor Standards Act, the Worker Security Act, the Polygraph
other governmental regulations Adjustment and Retaining Protection Act, the Federal Drug
governing the employer/employee Notification Act, professional Free Workplace Act (and any state
relationship and updating the licensing requirements, fidelity or local equivalent), state
client when necessary bonding requirements employment discrimination law
Employee benefit procurement Professional liability or
malpractice
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Because Administaff is a co-employer with the client company, it is
possible that Administaff could incur liability for violations of such laws
even if it is not responsible for the conduct giving rise to such liability.
The PMSA addresses this issue by providing that the client will indemnify the
Company for liability incurred to the extent the liability is attributable to
conduct by the client. Notwithstanding this contractual right to
indemnification, it is possible that Administaff could be unable to collect on
a claim for indemnification and may therefore be ultimately responsible for
satisfying the liability in question. The Company maintains certain general
insurance coverages to manage its exposure to these types of claims, and as a
result, the costs incurred by the Company with respect to this exposure have
historically been insignificant to the Company's operating results.
Clients are required to pay Administaff no later than one day prior to
the applicable payroll date by wire transfer or automated clearinghouse
transaction, and receipt of funds is verified prior to release of payroll.
Although the Company is ultimately liable as an employer to pay employees for
work previously performed, it retains the ability to terminate the PMSA as well
as the employees upon non-payment by a client. This right, the periodic nature
of payroll and the natural screening effect of the Company's client selection
process have resulted in an excellent overall collections history. However, in
1997 the Company incurred a $1.3 million bad debt charge related to a single
payroll period of a significant former customer. The Company attempted to
collect or obtain a secured position on the amount owed by the customer, but
was unable to do so. In late June 1997, the customer filed for bankruptcy
protection and the Company subsequently learned that the customer's ability to
pay the amounts owed had become severely impaired. The Company is currently
pursuing all avenues of collection available through the bankruptcy
proceedings. Excluding the effects of this charge, the Company's losses from
nonpayment of service fees have historically been insignificant to the
Company's operating results.
CUSTOMERS
Administaff serves client companies and worksite employees located
throughout the United States. The Company's client base is broadly distributed
throughout a wide variety of industries including services, wholesale trade,
manufacturing, construction, finance, insurance, real estate, medical, retail
trade and others.
The Company attempts to maintain diversity within its client base to
lower its exposure to downturns or volatility in any particular industry and to
help insulate the Company from general economic cyclicality. As part of its
client selection strategy, the Company does not offer its services to
businesses falling within certain specified SIC codes, essentially eliminating
certain industries that it believes present a higher risk of employee injury
(such as roofing, logging and oil and gas exploration). All prospective
customers are evaluated individually on the basis of workers' compensation
risk, group medical history, unemployment history and operating stability. On
average, Administaff's clients have been in business approximately 12 years.
The Company focuses significant resources on client retention.
Administaff's client retention record reflects that in excess of 80% of
Administaff's clients remain for more than one year and that the retention rate
improves for clients who remain with Administaff for longer periods. Client
attrition experienced by Administaff is attributable to a variety of factors,
including (i) termination by Administaff resulting from the client's inability
to make timely payments, (ii) client election due to price factors, (iii)
client business failure or downsizing and (iv) sale or disposition of the
client company. The Company believes that only a small percentage of
nonrenewing clients withdraw due to dissatisfaction with service or to retain
the services of a competitor.
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MARKETING AND SALES
As of December 31, 1997, the Company had 18 sales offices located in 12
markets. The Company is currently executing a long-term national expansion
strategy which targets approximately 90 sales offices in 40 strategically
selected markets. The Company's markets and their respective year of entry are
as follows:
Initial
Market Sales Offices Entry Date
------ ------------- ----------
Houston 3 1986
San Antonio 1 1989
Austin 1 1989
Orlando 1 1989
Dallas 2 1993
Atlanta 2 1994
Phoenix 1 1995
Chicago 2 1995
Washington D.C. 1 1995
Denver 1 1996
Los Angeles 2 1997
Charlotte 1 1997
During 1997, the Company opened new sales offices in Houston, Los
Angeles (2), Charlotte and Atlanta. Subsequent to December 31, 1997, the
Company has opened a third sales office in the Los Angeles area as part of its
plan to open at least one new sales office or enter one new market in each
quarter of 1998 and 1999.
The Company identified the 40 markets included in the national expansion
strategy using a systematic market evaluation and selection process. The
Company continues to evaluate a broad range of factors in the selection
process, using a market selection model that weights various criteria that the
Company believes are reliable predictors of successful penetration based on its
experience. Among the factors considered are (i) market size, in terms of small
businesses engaged in selected industries that meet the Company's risk profile,
(ii) market receptivity to PEO services, including the regulatory environment
and relevant history with other PEO providers, (iii) existing relationships
within a given market, such as vendor or client relationships, (iv) expansion
cost issues, such as advertising and overhead costs, (v) direct cost issues
that bear on the Company's effectiveness in controlling and managing the cost
of its services, such as workers' compensation and health insurance costs,
unemployment risks and various legal and other factors, (vi) a comparison of
the services offered by Administaff to alternatives available to small
businesses in the relevant market, such as the cost to the target clients of
procuring services directly or through other PEOs and (vii) long-term strategy
issues, such as the general perception of markets and their long-term revenue
growth potential. Each of the Company's expansion markets, beginning with
Dallas in 1993, was selected in this manner.
The Company's marketing strategy is based on the application of
techniques that have produced consistent and predictable results in the past.
The Company develops a mix of advertising media and a placement strategy
tailored to each individual market. After selecting a market and developing its
marketing mix, but prior to entering the market, the Company engages in an
organized media and public relations campaign to prepare the market for the
Company's entry and to begin the process of generating sales leads. The
Company markets its services through a broad range of media outlets, including
radio, newspapers, periodicals, direct mail and the Internet. The Company
employs a public relations firm in each of its markets as well as advertising
consultants to coordinate and implement its marketing campaigns. The Company
has developed an inventory of proven, successful radio and newsprint
advertisements which are utilized in this effort.
The Company generates sales leads from three primary sources: direct
sales efforts, advertising and referrals. These leads result in initial
presentations to prospective clients, and, ultimately, a predictable number of
client census reports. The client's census report reflects information gathered
by the sales associate about the prospect's employees,
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including job classification, state of employment, workers' compensation claims
history, health insurance claims history, salary, and a desired level of
benefits. This information is entered into the Company's customized bid system,
which applies Administaff's pricing model to the census data, leading to the
preparation of a bid. Concurrently with this process, the prospective client's
workers' compensation and health insurance histories are evaluated from a risk
management perspective. Unfavorable aspects of either of these histories could
result in termination of the sales effort and rejection of the prospect. This
prospective client screening process plays a vital role in controlling the
Company's benefits costs and limiting its exposure to liability. Upon
completion of a favorable risk evaluation, the sales associate presents the
prospective client with the Company's bid and attempts to enroll the prospect.
The Company believes that it can improve the effectiveness and
efficiency of its sales efforts through marketing partnerships and alliances.
During 1997, the Company developed a strategy for identifying and evaluating
potential alliances. As a result of these efforts, the Company has evaluated
and will continue to evaluate such relationships.
In January 1998, the Company entered into a Securities Purchase
Agreement with American Express Travel Related Services Company, Inc.
("American Express") whereby the Company agreed to sell 693,126 shares of its
common stock to American Express for a total purchase price of $17.7 million.
The shares of common stock include warrants to purchase an additional 2,065,515
shares of common Stock at prices ranging from $40 to $80 per share.
In conjunction with the Securities Purchase Agreement, the Company
agreed to enter into a Marketing Agreement with American Express to jointly
market the Company's services to American Express' substantial small business
customer base across the country. Under the Marketing Agreement, American
Express will utilize its resources to generate appointments with prospects for
the Company's services. In addition, the Company and American Express will
work to jointly develop product offerings that enhance the current PEO services
offered by the Company. The Marketing Agreement has a seven year term and
provides that Administaff will be the exclusive PEO partner of American Express
for the first three years. The Company will pay a commission to American
Express based upon the number of worksite employees paid after being referred
to the Company pursuant to the Marketing Agreement.
In late 1997, the Company entered into two additional business
alliances. The Company received an endorsement from International Center for
Entrepreneurial Development, Inc. (an affiliate of Kwik Kopy Corporation) to
serve as the preferred vendor for PEO services for all Kwik Kopy and affiliated
company franchises. In addition, the Company signed an Endorsement Agreement
with the Texas Bankers Association to be a preferred vendor of PEO services for
its member institutions. While the Company does not expect these relationships
to have a material impact on its overall growth rate, they will serve as
prototypes for similar relationships which, in the aggregate, could enhance the
Company's overall sales efficiency.
The Company believes that the agreement with American Express and other
alliances and partnerships will enhance its ability to increase its base of
worksite employees and clients in existing and future markets, although there
can be no assurances to that effect. The Company intends to pursue other such
marketing partnerships and alliances to further enhance its ability to grow.
VENDOR RELATIONSHIPS
Administaff provides benefits to its worksite employees under
arrangements with a variety of vendors. Although the Company believes that any
of its benefit contracts could be replaced if necessary with minimal disruption
to its operations, the Company considers two such contracts to be the most
significant elements of the package of benefits provided to employees.
The Company's group health insurance plan is provided by Aetna U.S.
Healthcare, Inc. ("Aetna"). Each client company selects from a range of health
plan coverages available under the plan and Administaff's comprehensive fees to
that client reflect the coverage options selected. The Company initiated
insurance coverage with Aetna in 1989. The current one-year policy expires on
December 31, 1998. The fully-insured policy requires the Company to fund claims
and premiums up to a specified quarterly cap amount. Aetna is required to fund
all claims and premiums, if any, in
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excess of the quarterly cap amount. These cap amounts are in place for
quarterly periods and such cap amounts are adjustable, based on claims
experience, with six months notice by Aetna. While Aetna bears ultimate legal
responsibility for all claims, the Company seeks to minimize health care claims
through its benefits administration management practices because the Company
bears the burden of higher costs as claims experience increases.
The Company's workers' compensation policies have been provided by
Reliance National Indemnity Co. since 1990. Since November 1994, the Company
has been covered under a guaranteed cost plan whereby monthly premiums are paid
for complete coverage of all claims under the policy. The current one-year
policy expires on October 31, 1998.
INFORMATION TECHNOLOGY
The Company has developed state-of-the-art information technology
capable of meeting the demands of payroll and related processing for the
Company's worksite employees, satisfying the Company's administrative and
management information needs, and providing productivity enhancement tools to
the Company's corporate staff. While the Company utilizes commercially
available software for standard business functions such as finance and
accounting, it has developed a proprietary professional employer information
system for the delivery of its primary services. This system manages data
relating to worksite employee enrollment, human resource management, benefits
administration, payroll processing, management information, and sales bid
calculations that are unique to the PEO industry and to Administaff. Central
to the system is a payroll processing system that allows the Company to process
a high volume of payroll transactions that meet the customized needs of client
companies.
The Company's proprietary PEO information system is now in its fourth
generation. The software uses Informix, a relational database and program
development language, and PowerBuilder, a state-of-the-art, object oriented
client/server development system. The software is designed to provide high
volume professional employer services utilizing a combination of on-line and
batch processing capabilities that can be readily expanded to handle additional
processing needs. The system is accessed through a graphical user interface
engineered to maximize both the quality of Administaff's services and the
efficiency with which they are delivered.
The Company's primary information processing facility is located at the
Company's corporate headquarters in Kingwood, Texas (a suburb of Houston). A
second processing facility is located in Las Colinas, Texas (a suburb of
Dallas). The Kingwood facility handles approximately two-thirds of the
Company's daily client service load as well as administrative and management
information processing. The Las Colinas facility handles approximately
one-third of the daily client service load and acts as a disaster recovery
facility for the Company capable of handling all of the Company's operations
for a short period of time.
The Company's principal computing platform is the IBM RISC/6000. The
Company utilizes six IBM RISC/6000s at its Kingwood facility and two at its Las
Colinas facility. These processing facilities are linked by a high speed wide
area network utilizing dedicated telecommunications facilities. The IBM
RISC/6000 computers are also connected by local area networks to PC
workstations running Microsoft Windows95(C) software. The Company's district
sales offices are equipped with Microsoft NT Advanced Server(C) networks and
are linked to the Kingwood and Las Colinas facilities through public
telecommunications facilities.
In late 1997, the Company assessed the feasibility of augmenting its
current service delivery capabilities with certain functions available through
the Internet. As part of a potential longer-term project, the Company approved
the first steps in developing "Administaff Online" and expects initial portions
of the project to be available for use during 1998. Depending on the success
and acceptance of the initial phase of Administaff Online, the Company may
choose to invest significant resources into further developing Internet-based
service delivery functions.
COMPETITION
The PEO industry consists of approximately 2,000 companies, most of
which serve a single market or region. The Company believes that it is one of
the two largest PEOs in the United States in terms of revenues. The Company's
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11
competitors include Staff Leasing, Inc. and The Vincam Group, Inc. Due to the
differing geographic regions and market segments in which these companies
operate, the Company considers its primary competition to be the traditional
in-house provision of employee-related services. However, there can be no
assurance that, as the Company and other large PEOs expand into a more national
presence, competition will not intensify among larger PEOs. In addition, the
Company competes to some extent with fee-for-service providers such as payroll
processors and human resource consultants.
Competition in the PEO industry revolves primarily around breadth and
quality of services, reputation, choice and quality of benefits and price. The
Company believes that reputation, national presence, regulatory expertise,
financial resources, risk management and data processing capabilities
distinguish leading PEOs from the rest of the industry. The Company believes
that it competes favorably in these areas.
In recent years, several large companies in related industries have
entered the PEO market either through acquiring existing PEOs or through
start-up operations. Examples of such market entrants include Paychex, Inc.,
Automatic Data Processing, Inc. and NovaCare, Inc. The Company believes its
long operating history, experience and branding in the PEO industry will allow
it to compete on favorable terms with such companies.
INDUSTRY REGULATION
The Company's operations are affected by numerous federal and state laws
relating to labor, tax and employment matters. By entering into a co-employer
relationship with employees who are assigned to work at client company
locations (referred to as "worksite employees"), the Company assumes certain
obligations and responsibilities of an employer under these federal and state
laws. Because many of these federal and state laws were enacted prior to the
development of nontraditional employment relationships, such as professional
employer, temporary employment and outsourcing arrangements, many of these laws
do not specifically address the obligations and responsibilities of
nontraditional employers. In addition, the definition of "employer" under these
laws is not uniform.
Some governmental agencies that regulate employment and labor laws have
developed rules that specifically address labor and employment issues raised by
the relationship among PEOs, client companies and worksite employees. This is
particularly true in Texas where the Company's management has worked with
numerous regulatory agencies and was instrumental in the ultimate passage of
the Staff Leasing Services Licensing Act (the "Texas Staff Leasing Act"), an
act which formally recognized the PEO industry in Texas and resolved prior
interpretive disputes as to the status of PEOs. Existing regulations are
relatively new and, therefore, their interpretation and application by
administrative agencies and federal and state courts is limited or
non-existent. The development of additional regulations and interpretation of
existing regulations can be expected to evolve over time. While the Company
cannot predict with certainty the nature or direction of the development of
federal, state and local regulations, management will continue to pursue a
proactive strategy of educating administrative authorities as to the advantages
of PEOs and achieving regulation which appropriately accommodates their
legitimate business function.
Certain federal and state statutes and regulations use the terms
"employee leasing" or "staff leasing" to describe the arrangement among a PEO,
such as the Company, and its clients and worksite employees. The terms
"employee leasing," "staff leasing" and "professional employer arrangements"
are generally synonymous in such contexts and describe the arrangements entered
into by the Company, its clients and worksite employees.
As an employer, the Company is subject to all federal statutes and
regulations governing its employer-employee relationships. Subject to the
issues discussed below, the Company believes that its operations are in
compliance in all material respects with all applicable federal statutes and
regulations.
EMPLOYEE BENEFIT PLANS
The Company offers various employee benefit plans to its employees,
including its worksite employees. These employee benefit plans are treated by
the Company as "single-employer" plans rather than multiple employer plans.
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12
These plans include the 401(k) Plan (a profit-sharing plan with a cash or
deferred arrangement ("CODA") under Code Section 401(k) and a matching
contributions feature under Code Section 401(m)), a cafeteria plan under Code
Section 125, a group health plan, a group life insurance plan, a group
disability insurance plan, a dependent care spending account plan, an
educational assistance plan, an adoption assistance program and an employee
assistance plan. Generally, employee benefit plans are subject to provisions of
both the Code and the Employee Retirement Income Security Act of 1974, as
amended ("ERISA").
Employer Status. In order to qualify for favorable tax treatment under
the Code, the plans must be established and maintained by an employer for the
exclusive benefit of its employees. Generally, an entity is an "employer" of
certain workers for federal employment tax purposes if an employment
relationship exists between the entity and the workers under the common law
test of employment. In addition, the officers of a corporation are deemed to be
employees of that corporation for federal employment tax purposes. The common
law test of employment, as applied by the IRS, involves an examination of
approximately 20 factors to ascertain whether an employment relationship exists
between a worker and a purported employer. That test is generally applied to
determine whether an individual is an independent contractor or an employee for
federal employment tax purposes and not to determine whether each of two or
more companies is a "co-employer." Substantial weight is typically given to
the question of whether the purported employer has the right to direct and
control the details of an individual's work. Among the various categories of
factors which appear to be considered more important by the IRS are (1) the
employer's degree of behavioral control (the extent of instructions, training
and the nature of the work), (2) the financial control or the economic aspects
of the relationship, and (3) the intended relationship of the parties (whether
employee benefits are provided, whether any contracts exist, whether services
are ongoing or for a project, whether there are any penalties for
discharge/termination, and the frequency of the business activity).
In 1992, the Company applied for and received a favorable determination
from the IRS regarding the qualified status of the 401(k) Plan. In that
application, the Company disclosed to the IRS that the Company is involved in
the business of leasing employees to recipient companies and that the 401(k)
Plan covered worksite employees who satisfied the plan's eligibility
requirements. However, the statement that the 401(k) Plan covered worksite
employees does not necessarily resolve the issue of who is the employer of
those employees for purposes of the 401(k) Plan.
The Company amended and restated the 401(k) Plan on December 15, 1994.
Among other amendments, the Company added the matching contributions feature
under Code Section 401(m) to the 401(k) Plan. In March 1995, the Company
submitted the amended and restated 401(k) Plan to the IRS for a determination
on its continued tax qualified status. The amended and restated 401(k) Plan is
currently under review by the IRS. An IRS finding that the 401(k) Plan document
merits tax qualified status is a determination as to form only and would not
preclude a subsequent disqualification based on the Plan's operation, including
a finding that certain worksite employees are not employees of the Company for
401(k) Plan purposes.
Separate from the IRS' review of the pending determination request, the
Company's 401(k) Plan for the 1993 plan year is currently under audit. Although
the audit is for the 1993 plan year, certain conclusions of the IRS would be
applicable to other years as well. In addition, the IRS has established an
Employee Leasing Market Segment Group (the "Market Segment Group") for the
purpose of identifying specific compliance issues prevalent in certain segments
of the PEO industry. Approximately 70 PEOs, including the Company, have been
randomly selected by the IRS for audit pursuant to this program. One issue that
has arisen from these audits is the Industry Issue (whether a PEO can be a
co-employer of worksite employees, including officers and owners of client
companies, for various purposes under the Code, including participation in the
PEO's 401(k) plan). NAPEO and the Company are cooperating with the IRS in this
study of the PEO industry. With respect to the 401(k) Plan audit, the IRS
Houston District has sought technical advice (the "Technical Advice Request")
from the IRS National Office. A copy of the Technical Advice Request and the
Company's response has been sent to the IRS National Office for review. The
Technical Advice Request contains the conclusions of the IRS Houston District
with respect to the 1993 plan year that the 401(k) Plan should be disqualified
because it (1) covers worksite employees who are not employees of the Company
and (2) failed a nondiscrimination test applicable to contributions and the
Company has not furnished evidence that the 401(k) Plan satisfies an
alternative test. The Company's response to the Technical Advice Request
refutes the conclusions of the IRS Houston District.
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13
The Company understands that the Industry Issue identified by the Market
Segment Group study also was referred to the National Office. If, after
review, the IRS National Office concludes that its response to the Technical
Advice Request will be adverse to Administaff, Administaff will be granted a
conference with the National Office to discuss the proposed results. If the
Market Segment Group study were to reach a conclusion that is adverse to the
PEO industry, there is an administrative procedure available to appeal that
conclusion. In addition to working with the Market Segment Group study, NAPEO
is actively engaged in policy discussions with both the Treasury Department and
with members of Congress in an effort to reduce the likelihood of unfavorable
conclusions and to procure favorable legislation.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. The Company is not able to
predict either the timing or the nature of any final decision that may be
reached by the IRS with respect to the 401(k) Plan audit or with respect to the
Technical Advice Request or the Market Segment Group study and the ultimate
outcome of such decisions. Further, the Company is unable to predict whether
the Treasury Department will issue a policy statement with respect to its
position on the issues or, if issued, whether such a statement would be
favorable to the Company. The Company intends to vigorously pursue a favorable
resolution of the issues through one or more of the following methods: the
audit-Technical Advice Request, the Market Segment Group study process, the
policy and legislative efforts, and, if necessary, legal action. If, however,
any of these processes were to conclude that a PEO is not a co-employer of its
worksite employees and such conclusion were to ultimately prevail, worksite
employees could not continue to make salary deferral contributions to the
401(k) Plan or pursuant to the Company's cafeteria plan or continue to
participate in certain other employee benefit plans of the Company. The Company
believes that, although unfavorable to the Company, a prospective application
by the IRS of such an adverse conclusion (that is, one applicable only to
periods after the conclusion by the IRS is finalized) would not have a material
adverse effect on its financial position or results of operations, as the
Company could continue to make available similar benefit programs to its client
companies at comparable costs to the Company. However, if the IRS National
Office adopts the conclusions of the IRS Houston District and any such
conclusions were applied retroactively to disqualify the 401(k) Plan for 1993
and subsequent years, employees' vested account balances under the 401(k) Plan
would become taxable, the Company would lose its tax deductions to the extent
its matching contributions were not vested, the 401(k) Plan's trust would
become a taxable trust and the Company would be subject to liability with
respect to its failure to withhold applicable taxes with respect to certain
contributions and trust earnings. Further, the Company would be subject to
liability, including penalties, with respect to its cafeteria plan for the
failure to withhold and pay taxes applicable to salary deferral contributions
by employees, including worksite employees. In such a scenario, the Company
also would face the risk of client dissatisfaction and potential litigation. A
retroactive application by the IRS of an adverse conclusion would have a
material adverse effect on the Company's financial position and results of
operations. While the Company believes that a retroactive disqualification is
unlikely, there can be no assurance as to the ultimate resolution of these
issues by the IRS.
401(k) Plan Nondiscrimination Testing Issues. In 1991, the Company
engaged a third party vendor to be the 401(k) Plan's record keeper and to
perform the required annual nondiscrimination tests for the plan. Each year
such record keeper reported to the Company that such nondiscrimination tests
had been satisfied. However, in August 1996, the 401(k) Plan's record keeper
advised the Company that certain of these tests had been performed incorrectly
for prior years and, in fact, that the 401(k) Plan had failed certain tests for
the 1993, 1994 and 1995 plan years. The Company has subsequently determined
that the 401(k) Plan also failed a nondiscrimination test for 1991 and 1992,
closed years for tax purposes. At the time the Company received such notice,
the period in which the Company could voluntarily "cure" this operational
defect had lapsed for all such years except 1995. With respect to the 1995
year, the Company has caused the 401(k) Plan to refund the required excess
contributions and earnings thereon to affected highly compensated participants,
and the Company paid an excise tax of approximately $47,000 related to refunded
excess contributions. Because the 401(k) Plan is under a current IRS audit,
the IRS voluntary correction program for this type of operational defect is not
available to the Company for years prior to 1995. Accordingly, the Company
informed the IRS of the prior testing errors for each of 1991, 1992, 1993 and
1994 and proposed a correction that consists of corrective contributions by the
Company to the 401(k) Plan with respect to these years (including the closed
years) and the payment by the Company of the minimum penalty ($1,000) that the
IRS is authorized to accept to resolve this issue. The IRS Houston District
indicated that resolution of the nondiscrimination test failures is premature
until the National Office resolves the issues presented in the Technical Advice
Request. No assurance can be given that the IRS will permit the Company to
administratively "cure" this operational defect. The Company has recorded a
reserve during the third
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14
quarter of 1996 for amounts it may ultimately be required to pay in connection
with corrective action with respect to the 401(k) Plan. The amount of such
reserve is the Company's estimate of the cost of corrective measures and
penalties, although no assurance can be given that the actual amount that the
Company may ultimately be required to pay will not substantially exceed the
amount so reserved. In addition, the Company has recorded an asset for an
amount recoverable from the 401(k) Plan's record keeper should the Company
ultimately be required to pay the amount accrued for such corrective measures
and penalties. Based on its understanding of the settlement experience of other
companies with respect to similar issues, the Company does not believe that the
ultimate resolution of the nondiscrimination test issue will have a material
adverse effect on the Company's financial condition or results of operations,
although no assurance can be given by the Company because the ultimate
resolution of this issue will be determined in a negotiation process with the
IRS or in litigation.
ERISA Requirements. Employee pension and welfare benefit plans are also
governed by ERISA. ERISA defines "employer" as "any person acting directly as
an employer, or indirectly in the interest of an employer, in relation to an
employee benefit plan." ERISA defines the term "employee" as "any individual
employed by an employer." The United States Supreme Court has held that the
common law test of employment must be applied to determine whether an
individual is an employee or an independent contractor under ERISA. A
definitive judicial interpretation of "employer" in the context of a PEO or
employee leasing arrangement has not been established.
If the Company were found not to be an employer for ERISA purposes, its
plans would not comply with ERISA. Further, as a result of such finding the
Company and its plans would not enjoy, with respect to worksite employees, the
preemption of state laws provided by ERISA and could be subject to varying
state laws and regulations, as well as to claims based upon state common laws.
Even if such a finding were made, the Company believes it would not be
materially adversely affected because it could continue to make available
similar benefits at comparable costs.
In addition to ERISA and the Code provisions discussed herein, issues
related to the relationship between the Company and its worksite employees may
also arise under other federal laws, including other federal income tax laws.
Possible Multiple Employer Plan Treatment. The U.S. Department of Labor
("DOL") issued an Advisory Opinion in December 1995 to a staff leasing company
advising that particular company that its health plan, which covered worksite
employees, was a multiple employer plan, rather than a single employer plan.
Because the Company believes it is a co- employer of worksite employees, the
Company views its group health plan, which also covers worksite employees, to
be a single employer plan. However, if this DOL opinion were applied to the
Company, it is possible, although the Company believes it is unlikely, that the
DOL would assert penalties against the Company for having incorrectly filed
annual reports treating its plan as a single employer plan. Such a conclusion,
if applied to the other employee benefit plans that cover worksite employees,
could result in additional liabilities of the Company. The Company does not
believe that any such penalties will, individually or in the aggregate, be
material to the Company's financial condition or results of operations. Further,
even if such a conclusion is reached, the Company believes that it would
continue to be able to make available comparable benefit programs to client
companies.
FEDERAL EMPLOYMENT TAXES
As a co-employer, the Company assumes responsibility and liability for
the payment of federal and state employment taxes with respect to wages and
salaries paid to worksite employees. There are essentially three types of
federal employment tax obligations: (i) withholding of income tax requirements
governed by Code Section 3401, et seq.; (ii) obligations under FICA, governed
by Code Section 3101, et seq.; and (iii) obligations under the FUTA, governed
by Code Section 3301, et seq. Under these Code sections, employers have the
obligation to withhold and remit the employer portion and, where applicable,
the employee portion of these taxes.
The Market Segment Group discussed above is examining, among other
issues, whether PEOs, such as the Company, are employers of worksite employees
under the Code provisions applicable to federal employment taxes and,
consequently, responsible for payment of employment taxes on wages and salaries
paid to such worksite employees. However, the IRS Houston District has
concluded that the Company is not the employer of worksite employees for this
purpose and has requested National Office guidance on this issue in the
Technical Advice Request described above.
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Code Section 3401, which applies to federal income tax withholding
requirements, contains an exception to the general common law test applied to
determine whether an entity is an "employer" for purposes of federal income tax
withholding. Section 3401(d)(1) states that if the person for whom services are
rendered does not have control of the payment of wages, the "employer" for this
purpose is the person having control of the payment of wages. The Treasury
regulations issued under Section 3401(d)(1) state that a third party can be
deemed to be the employer of workers under this section for income tax
withholding purposes where the person for whom services are rendered does not
have legal control of the payment of wages. While Section 3401(d)(1) has been
examined by several courts, its ultimate scope has not been delineated.
Moreover, the IRS has to date relied extensively on the common law test of
employment in determining liability for failure to comply with federal income
tax withholding requirements.
Accordingly, while the Company believes that it can assume the
withholding obligations for worksite employees, in the event the Company fails
to meet these obligations the client company may be held jointly and severally
liable therefor. While this interpretive issue has not to the Company's
knowledge discouraged clients from enrolling with the Company, there can be no
assurance that a definitive adverse resolution of this issue would not do so in
the future. These interpretive uncertainties may also impact the Company's
ability to report employment taxes on its own account rather than for the
accounts of its clients.
STATE REGULATION
TEXAS
As an employer, the Company is subject to all Texas statutes and
regulations governing the employer-employee relationship. Subject to the
discussion below, the Company believes that its operations are in compliance in
all material respects with all applicable Texas statutes and regulations.
Prior to 1993, the PEO industry was not regulated as an industry in
Texas. Various state agencies attempted to apply their statutory schemes to
PEOs on a case-by-case basis and the Company faced various challenges from both
the Texas Employment Commission and the State Board of Insurance of Texas. Each
of these challenges was resolved with the passage of Texas' PEO licensing act
described below.
The Company was instrumental in obtaining enactment of the Texas Staff
Leasing Act, which now regulates and establishes a legal framework for PEOs in
Texas. The Texas Staff Leasing Act, which became effective on September 1,
1993, established a mandatory licensing scheme for PEOs and expressly
recognizes a licensee as the employer of the assigned employee for purposes of
the Texas Unemployment Compensation Act. The Texas Staff Leasing Act also
provides, to the extent governed by Texas law, that a licensee may sponsor and
maintain employee benefit plans for the benefit of assigned employees. In
addition, the Texas Staff Leasing Act not only provides that a licensee may
elect to obtain workers' compensation insurance coverage for its assigned
employees but also provides that, for workers' compensation insurance purposes,
a licensee and its client company are treated as co-employers. After February
28, 1994, it became a class A misdemeanor to engage in PEO activities in Texas
without a license issued pursuant to the Texas Staff Licensing Act. In order to
obtain a license, applicants must undergo a background check, demonstrate a
history of good standing with tax authorities and meet certain capitalization
requirements that increase with the number of worksite employees employed. The
Texas Staff Leasing Act specifies that the Texas Department of Licensing and
Regulation ("TDLR") is responsible for enforcement of the Texas Staff Leasing
Act and TDLR has adopted regulations under the Texas Staff Leasing Act. The
Company believes that it is in compliance with such regulations in all material
respects.
OTHER STATE REGULATION
While many states do not explicitly regulate PEOs, 18 states have passed
laws that have licensing or registration requirements for PEOs and several
others are considering such regulation. Such laws vary from state to state but
generally provide for monitoring the fiscal responsibility of PEOs. In addition
to holding a license in Texas, Administaff holds licenses in Arkansas, Florida,
New Hampshire, Oregon, South Carolina, Tennessee, Utah and Maine. The Company
has applied for a license in Montana and currently holds a provisional license.
The Company is registered
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or certified in Illinois, Massachusetts, Minnesota, New Mexico, Nevada,
Kentucky and Rhode Island. Whether or not a state has licensing, registration
or certification requirements, the Company faces a number of other state and
local regulations that could impact its operations. The Company believes that
its prior experience with Texas regulatory authorities will be valuable in
surmounting regulatory obstacles or challenges it may face in the future.
CORPORATE OFFICE EMPLOYEES
The Company has approximately 480 corporate office and sales employees
as of December 31, 1997. The Company believes that its relations with its
corporate office and sales employees are good. None of the Company's corporate
office and sales employees are covered by a collective bargaining agreement.
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ITEM 2. PROPERTIES.
Administaff maintains two primary facilities. The corporate
headquarters are located in Kingwood, Texas (20 miles north of downtown
Houston), on approximately 17 acres owned by the Company. This location
includes a 66,000 square foot campus style facility and a 76,000 square foot
facility that serves as the Company's operations and records retention
facility. Together these facilities house the Company's executive offices,
corporate staff, service delivery personnel, data-processing center, training
facilities and all other corporate functions.
The Company's other primary facility is located in Las Colinas, near
Dallas, Texas. This 15,300 square foot leased facility, which became
operational in October 1994, currently handles approximately one-third of the
Company's data processing and service delivery needs and serves as a backup
data processing facility and disaster recovery center. The lease on this
facility expires in early 1999. The Company is currently evaluating potential
replacements for this facility in the Dallas area which will provide the
capacity for growth in data processing and service delivery at this location.
The Company also leases facilities in each of its sales markets. These
offices are typically staffed by six to eight sales associates, a district
sales manager and an administrative assistant.
The Company believes that its facilities are adequate for the purposes
for which they are intended and that its headquarters have sufficient
additional capacity to accommodate the Company's foreseeable expansion plan.
The Company will continue to evaluate the need for additional facilities based
on the rate of growth in worksite employees, the geographic distribution of the
worksite employee base and the Company's long-term service delivery
requirements. The Company intends to lease additional facilities in new
markets as applicable.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material pending legal proceedings
other than ordinary routine litigation incidental to its business. The Company
believes that pending legal proceedings would not have a material adverse
effect on its financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of the
Company, through solicitation of proxies or otherwise, during the quarter ended
December 31, 1997.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
PRICE RANGE OF COMMON STOCK
The Common Stock commenced trading on the New York Stock Exchange
following the Company's initial public offering on January 29, 1997. The
Company's trading symbol is "ASF". As of March 2, 1998, there were 203
holders of record of the Common Stock. This number does not include
stockholders for whom shares were held in "nominee" or "street name." The
following table sets forth the high and low closing sale prices for the Common
Stock on the New York Stock Exchange as reported by The Wall Street Journal for
1997.
HIGH LOW
1997
First Quarter . . . . . . . . . . . . . . . . . $ 25.500 $ 16.625
Second Quarter . . . . . . . . . . . . . . . . . 24.375 14.875
Third Quarter . . . . . . . . . . . . . . . . . 25.625 20.500
Fourth Quarter . . . . . . . . . . . . . . . . . 25.875 19.250
DIVIDEND POLICY
The Company has not paid cash dividends on its Common Stock since its
formation and does not anticipate declaring or paying dividends on its Common
Stock in the foreseeable future. The Company expects that it will retain all
available earnings generated by the Company's operations for the development
and growth of its business. Any future determination as to the payment of
dividends will be made at the discretion of the Board of Directors of the
Company and will depend upon the Company's operating results, financial
condition, capital requirements, general business conditions and such other
factors as the Board of Directors deems relevant.
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ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data set forth below should be
read in conjunction with the Consolidated Financial Statements and accompanying
Notes, and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
INCOME STATEMENT DATA:
Revenues . . . . . . . . . . . . . . . . . . . . $ 496,058 $ 564,459 $ 716,210 $ 899,596 $ 1,213,620
Gross profit . . . . . . . . . . . . . . . . . . 19,782 25,196 28,873 37,856 51,269
Operating income . . . . . . . . . . . . . . . 3,127 5,859 2,221 6,477 9,346(1)
Net income . . . . . . . . . . . . . . . . . . 1,949 3,766 1,116 2,603 (2) 7,439(1)
Basic net income per share . . . . . . . . . . $ 0.22 $ 0.39 $ 0.11 $ 0.24 (2) $ 0.56(1)
Diluted net income per share . . . . . . . . . . $ 0.22 $ 0.38 $ 0.10 $ 0.24 (2) $ 0.53(1)
BALANCE SHEET DATA
Working capital . . . . . . . . . . . . . . . . $ (2,340) $ 8,797 $ 4,737 $ 4,629 $ 46,611
Total assets . . . . . . . . . . . . . . . . . . 19,401 41,081 39,474 48,376 109,455
Total debt . . . . . . . . . . . . . . . . . . 1,196 5,007 4,679 4,603 --
Total stockholders' equity . . . . . . . . . . 569 8,056 10,689 13,292 63,763
STATISTICAL DATA:
Worksite employees at period end(3) . . . . . . 15,165 15,780 20,502 23,794 29,725
Client companies at period end . . . . . . . . . 687 809 1,130 1,516 1,893
Gross payroll per employee per month(4) . . . . $ 2,117 $ 2,268 $ 2,331 $ 2,562 $ 2,855
- -----------------
(1) For the year ended December 31, 1997, operating income, net
income and basic and diluted net income per share would
have been $10.7 million, $8.3 million, $0.62 and $0.59,
respectively, excluding the effects of a bad debt charge
incurred during the second quarter of 1997. See Item 7,
"Management's Discussion and Analysis of Financial
Condition and Results of Operations."
(2) For the year ended December 31, 1996, net income and basic
and diluted net income per share would have been $3.8
million, $0.35 and $0.34, respectively, excluding the
impact of a non-recurring charge relating to certain issues
involving the failure of the Company's 401(k) Plan to
comply with certain nondiscrimination tests required by the
Code, which impact has been adjusted for income taxes and
is net of amounts recoverable from the 401(k) Plan record
keeper. See Note 11 of Notes to Consolidated Financial
Statements and Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
(3) Reflects the number of employees paid during the last month
of the period shown.
(4) Excludes bonus payroll of worksite employees, which is not
subject to the Company's normal service fee.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Company's Consolidated Financial Statements
and Notes thereto included elsewhere in this Annual Report. Historical results
are not necessarily indicative of trends in operating results for any future
period.
The statements contained in this Annual Report which are not
historical facts are forward-looking statements that involve a number of risks
and uncertainties. The actual results of the future events described in such
forward- looking statements in this Annual Report could differ materially from
those stated in such forward-looking statements. Among the factors that could
cause actual results to differ materially are the risks and uncertainties
discussed in this Item 7 and the uncertainties set forth from time to time in
the Company's other public reports and filings and public statements.
OVERVIEW
Administaff provides a comprehensive Personnel Management System which
encompasses a broad range of services, including benefits and payroll
administration, medical and workers' compensation insurance programs, personnel
records management, liability management, employee recruiting and selection,
performance management, and training and development services. As of December
31, 1997, the Company had 18 sales offices located in 12 markets. The Company
is currently executing a long-term national expansion strategy which targets 40
strategically selected markets. The costs associated with this expansion into
new markets (which for the purposes hereof refers to markets entered since the
commencement of the expansion strategy in September 1993) have been significant
and have affected the results of operations for 1995, 1996 and 1997.
Revenues
The Company's revenues are derived from its comprehensive service fees
which are based upon each employee's gross pay and a mark-up determined as a
percentage of the gross pay. The comprehensive service fees are invoiced along
with each periodic payroll. The Company's revenues are dependent on the number
of clients enrolled, the resulting number of employees paid each period, the
gross payroll of such employees and the number of employees enrolled in benefit
plans.
The Company's expansion strategy is designed to broaden the scope of the
Company's sales and marketing efforts into new, strategically selected markets,
where the Company's objective is to duplicate the sales and marketing success
experienced in the Houston market to date. The Company has expanded its sales
force from 22 at January 1, 1994 to 111 at December 31, 1997. The Company
expects to open at least one new market or one additional sales office in an
existing market in each quarter during 1998 and 1999.
Direct Costs
The Company's primary direct costs are (i) the salaries and wages of
worksite employees ("payroll cost"), (ii) employment related taxes, (iii)
employee benefit plan premiums and (iv) workers' compensation insurance
premiums. Payroll costs of worksite employees are affected by the composition
of the worksite employee base, by inflationary effects on wage levels and by
differences in the local economies of the Company's markets. Changes in payroll
costs have a proportionate impact on the Company's revenues.
Employment related taxes consist of the employer's portion of payroll
taxes required under FICA, which includes Social Security and Medicare, and
federal and state unemployment taxes. The federal tax rates are defined by the
appropriate federal regulations. State unemployment tax rates are subject to
claims histories and vary from state to state.
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21
Employee benefit costs are comprised primarily of health insurance costs
but also include costs of other employee benefits such as prescription card,
vision care, disability insurance, a dependent care spending account and an
employee assistance plan.
Workers' compensation costs include premiums, administrative costs and
claims related expenses under the Company's workers' compensation program.
Since November 1994 the Company has been insured under a guaranteed cost plan
under which monthly premiums are paid for coverage of all accident claims
occurring during the policy period.
The Company's gross profit margin is determined in part by its ability
to accurately estimate and control direct costs and its ability to incorporate
such costs into the comprehensive service fees charged to clients, which are
subject to contractual arrangements. In addition, the gross profit margin is
affected by changes in the level of payroll cost per worksite employee because
the Company's revenues and direct costs both include the payroll cost.
Operating Expenses
The Company's primary operating expenses are salaries, wages and payroll
taxes of both corporate office and sales employees, general and administrative
expenses and sales and marketing expenses. As a result of the Company's
overall growth and market expansion strategy, operating expenses have increased
significantly during the last several years. The increases include expenses
associated with establishing and maintaining each new sales office facility,
the increased compensation related expenses of newly hired sales associates and
expansion of the Company's advertising efforts. In addition, the anticipated
growth as a result of the sales expansion is also reflected in increased
corporate operating expenses to provide expansion of the Company's service
capacity. The Company expects that the investment in new markets will continue
at a level comparable to or greater than 1997 through at least 1999.
Income Taxes
The Company's provision for income taxes typically differs from the U.S.
statutory rate of 34% due primarily to state income taxes. Deferred income
taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities used for financial reporting purposes and the
amounts used for income tax purposes. Significant items resulting in deferred
income taxes include depreciation and amortization, state income taxes, client
list acquisition costs, allowance for uncollectible accounts receivable,
software development costs and other accrued liabilities. Changes in these
items are reflected in the Company's financial statements through the Company's
deferred income tax provision.
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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996.
The following table presents certain information related to the
Company's results of operations for the years ended December 31, 1996 and 1997.
YEAR ENDED
DECEMBER 31,
-------------------------
1996 1997 CHANGE
--------- -------- ------
(OPERATING RESULTS IN THOUSANDS)
OPERATING RESULTS:
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 899,596 $ 1,213,620 34.9%
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 37,856 51,269 35.4%
Gross profit margin . . . . . . . . . . . . . . . . . . . 4.2% 4.2%
Operating income . . . . . . . . . . . . . . . . . . . . . 6,477 9,346 44.3%
STATISTICAL DATA:
Monthly revenue per worksite employee . . . . . . . . . . 3,166 3,492 10.3%
Monthly payroll cost per worksite employee . . . . . . . . 2,562 2,855 11.4%
Monthly gross markup per worksite employee . . . . . . . . 604 637 5.5%
Average number of worksite employees paid
per month during period . . . . . . . . . . . . . . . . 22,234 26,907 21.0%
REVENUES
The Company's revenues increased 34.9% over 1996 due to an increase in
worksite employees paid accompanied by an increase in the revenue per worksite
employee. The Company's expansion of its sales force through new market and
sales office openings over the past four years is the primary factor
contributing to the increased number of worksite employees. The Company's
expansion markets (defined as markets opened after September 1993 - the
commencement of the Company's national expansion plan) contributed
approximately $438 million, or 36.1%, of the Company's total revenues in 1997
versus approximately $221 million, or 24.6%, in 1996. The Company expects
continued growth in the number of worksite employees in 1998 due to the effect
of sales in existing markets and expansion into new markets.
The increase in revenue per worksite employee of 10.3% directly
relates to the increase in payroll cost per worksite employee of 11.4%. This
increase reflects the continuing effects of the net addition, through the
Company's sales efforts, of clients with worksite employees that have a higher
average base pay than the existing client base and through the penetration of
markets with generally higher wage levels, such as Los Angeles, Chicago and
Washington, D.C. In addition, wage inflation within the Company's existing
worksite employee base has contributed to the increase in payroll cost per
worksite employee.
GROSS PROFIT MARGIN
The Company's gross profit margin was unchanged at 4.2% in 1996 and
1997. The continued addition of higher wage, less risk sensitive worksite
employees resulted in a decrease in the gross markup per worksite employee as a
percentage of revenue from 19.1% in 1996 to 18.2% in 1997. This decrease was
matched by a decrease in the cost of providing employee benefits as a
percentage of revenue and a slight decrease in employment related taxes as a
percentage of payroll cost. Gross profit per worksite employee increased from
$142 per employee per month in 1996 to $159 per employee per month in 1997.
The Company attempts to match changes in the overall gross mark-up percentage
charged for its services with changes in its direct cost structure while
improving the overall gross profit per worksite employee. However, there can
be no assurances that the Company will be able to achieve these results in the
future.
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The cost of providing employee benefits was slightly lower in 1997
versus 1996 primarily due to decreased health insurance premiums and workers'
compensation costs. Health insurance premiums decreased as a percentage of
revenues from 6.2% in 1996 to 5.6% in 1997. Workers' compensation costs
decreased from 2.1% of payroll cost in 1996 to 1.6% of payroll cost in 1997.
Both of these decreases reflect the reduced risk sensitivity of the current
composition of the Company's client base as compared to the 1996 period.
Employment related taxes as a percentage of payroll cost declined from
7.3% in 1996 to 7.1% in 1997. This reduction reflects a net decrease in the
weighted average state unemployment tax rates paid by the Company.
OPERATING EXPENSES
Operating expenses remained constant as a percentage of revenue at
3.5% in 1996 and 1997. Total operating expenses increased 33.6% while revenues
and gross profit increased 34.9% and 35.4%, respectively. The most significant
increases in operating expenses were in general and administrative expenses and
compensation related costs which reflect the overall growth of the Company.
General and administrative expenses increased 57.3% from 1996 to 1997
and increased from 0.9% of revenue in 1996 to 1.0% of revenue in 1997. These
increases primarily relate to (i) increased bad debt expense, (ii) higher
travel expenses associated with the Company's national expansion, (iii) higher
legal, accounting and professional fees associated with being a public company
and (iv) increased expenses associated with the growth in the number of
worksite and corporate employees.
During the second quarter of 1997 the Company recorded a $1.3 million
(approximately $800,000 after tax) bad debt charge for the potential
uncollectibility of an account receivable from a significant former customer.
This charge resulted from the customer's inability to pay the invoices related
to a single payroll period in April 1997. The Company attempted to collect the
amounts due or obtain a secured position on the amount owed by the customer;
however, the Company was unable to collect the amounts or obtain such a
position. In late June 1997, the customer filed for bankruptcy protection and
the Company subsequently learned that the customer's ability to pay the amounts
owed had become severely impaired. The Company is currently pursuing all
avenues of collection available through the bankruptcy proceedings. However,
the Company has not collected, and does not expect to collect, any of the
amounts owed by the customer.
Compensation costs, which include salaries, wages, payroll taxes and
commissions, increased 25.5% compared to 1996, but decreased as a percentage of
revenue from 2.1% in 1996 to 1.9% in 1997. The overall increase in
compensation related costs is primarily related to an 18.2% increase in the
average number of corporate staff, including sales personnel.
Depreciation and amortization expense increased 44.3% over the 1996
period, but remained constant at 0.2% of revenue in both periods. The overall
increase is attributable to capital expenditures related to the opening of new
sales offices as part of the Company's national expansion strategy and
investments in technology and infrastructure related to increasing corporate
service capacity.
The increase in operating expenses includes the effects of continued
significant operating expenses in new markets. Operating expenses incurred
directly in expansion markets (which include salaries, payroll taxes,
recruiting and training costs of newly hired sales associates, advertising and
public relations costs and general office expenses) totaled $7.9 million in
1997 versus $6.1 million in 1996.
NET INCOME
Interest income increased $2.3 million from 1996 to 1997 due to the
investment of the proceeds from the Company's initial public offering received
in early February 1997. Interest expense decreased $567,000 as reductions
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in interest expense due to the repayment of the Company's outstanding
indebtedness were partially offset by the write off of deferred financing costs
relating to the repaid indebtedness.
Other expense in 1996 includes a non-recurring charge relating to
certain issues involving the failure of the Company's 401(k) Plan to comply
with certain nondiscrimination tests required by the Code, net of amounts
recoverable from the 401(k) Plan record keeper. See Note 11 of Notes to
Consolidated Financial Statements.
The Company's provision for income taxes differs from the U.S.
statutory rate of 34% due primarily to state income taxes. For the 1996
period, the provision for income taxes differs from the statutory rate also
because certain portions of the non-recurring charge are non-deductible for
income tax purposes.
The Company's net income for the year ended December 31, 1997
increased to $7.4 million, or $0.53 per share (diluted), versus $2.6 million,
or $0.24 per share (diluted), for the year ended December 31, 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995.
The following table presents certain information related to the
Company's results of operations for the years ended December 31, 1995 and 1996.
YEAR ENDED
DECEMBER 31,
-------------------------
1995 1996 CHANGE
--------- -------- ------
(OPERATING RESULTS IN THOUSANDS)
OPERATING RESULTS:
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 716,210 $ 899,596 25.6%
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 28,873 37,856 31.1%
Gross profit margin . . . . . . . . . . . . . . . . . . . 4.0% 4.2%
Operating income . . . . . . . . . . . . . . . . . . . . . 2,221 6,477 191.6%
STATISTICAL DATA:
Monthly revenue per worksite employee . . . . . . . . . . 2,904 3,166 9.0%
Monthly payroll cost per worksite employee . . . . . . . . 2,331 2,562 9.9%
Monthly gross markup per worksite employee . . . . . . . . 573 604 5.4%
Average number of worksite employees paid
per month during period . . . . . . . . . . . . . . . . 19,255 22,234 15.5%
REVENUES
The Company's revenues increased 25.6% over 1995 due to an increase in
worksite employees paid accompanied by an increase in the revenue per worksite
employee. The Company's expansion of its sales force through new market and
sales office openings is the primary factor contributing to the increased
number of worksite employees. The Company's expansion markets contributed
approximately $221 million, or 24.6%, of the Company's total revenues for 1996
versus approximately $110 million, or 15.4%, in 1995. In addition, the 1995
period includes approximately 1,400 new employees enrolled through a referral
agreement with an unaffiliated PEO in Chicago. The Company added to its sales
force in the Dallas market in January 1996 and the Denver market in September
1996.
The increase in revenue per worksite employee of 9.0% directly relates
to the increase in payroll cost per worksite employee of 9.9%. This increase
reflects the continuing effects of the net addition, through the Company's
sales efforts, of clients with worksite employees with higher average base pay
to the existing client base.
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GROSS PROFIT MARGIN
The Company's gross profit margin increased from 4.0% in 1995 to 4.2%
in 1996. The primary factors contributing to the increased gross profit margin
were a decrease in unemployment taxes as a percentage of payroll cost and a
slight decrease in the cost of providing employee benefits as a percentage of
revenue. These factors were partially offset by a decrease in the gross markup
per person as a percentage of revenue.
Employment related taxes as a percentage of payroll cost declined from
7.9% in 1995 to 7.3% in 1996. This reduction was primarily due to reduced
unemployment tax expense in the State of Texas. The Company's unemployment tax
rate in the State of Texas was substantially lower in 1996 than 1995 due to the
effects of a reorganization of the Company's operating subsidiaries completed
on January 1, 1996.
The cost of providing employee benefits was slightly lower in 1996
versus 1995 primarily due to decreased workers' compensation costs. Workers'
compensation costs decreased from 2.5% of payroll cost in 1995 to 2.1% of
payroll cost in 1996. This reduction was due to the overall rate on the
Company's fixed premium policy in effect during 1996 being lower than the
previous policy. These rate reductions reflect a reduced risk sensitivity in
the Company's client base. Medical plan premiums were comparable as a
percentage of revenues in 1996 versus 1995.
The continued addition of higher wage, less risk sensitive worksite
employees resulted in a decrease in markup per employee as a percentage of
revenue from 19.7% in 1995 to 19.1% in 1996. The Company generally charges
lower overall rates as a percentage of gross payroll on higher wage, less risk
sensitive employees.
OPERATING EXPENSES
Operating expenses decreased as a percentage of revenue from 3.7% in
1995 to 3.5% in 1996. Total operating expenses increased 17.7% while revenues
and gross profit increased 25.6% and 31.1%, respectively. The overall increase
in operating expenses can be attributed principally to increased compensation
related costs (salaries, wages and payroll taxes and commissions) which
increased in proportion to revenues and increased depreciation and amortization
expense. General and administrative expenses were slightly higher than in 1995
and advertising expenses were approximately equal to 1995. The factors noted
above include the effects of continued significant operating expenses in new
markets. Operating expenses incurred directly in expansion markets (which
include salaries, payroll taxes, recruiting and training costs of newly hired
sales associates, advertising and public relations costs and general office
expenses) totaled $6.1 million in 1996 versus $4.3 million in 1995. Excluding
the impact of expenses incurred directly in the new markets, operating expenses
increased only $2.9 million, or 11.0% as compared to 1995.
Total compensation costs, which include salaries, wages, payroll taxes
and commissions, increased 24.6% compared to 1995. Salaries and wages increased
at a higher rate while commissions were relatively unchanged due to a
restructuring of the Company's sales compensation plan to a more salary based
system. Overall, corporate staff, including sales personnel, increased 11.7%
versus 1995. This increase is primarily due to increased sales personnel and
continued increases in corporate service capacity.
Depreciation and amortization expense increased 64.8% over the 1995
period. The Company placed into service a new corporate facility in February
1996 which has resulted in higher depreciation and amortization expense
compared to 1995. Capital expenditures related to the opening of new sales
offices as part of the Company's market expansion process and increases in
corporate service capacity also contributed to the increase.
General and administrative expenses as a percentage of revenue
declined slightly versus 1995 from 1.1% to 0.9%. This trend is due to the
Company's focused efforts to contain costs in its selling, service and
administrative functions.
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NET INCOME
Interest expense increased $232,000 due to financing charges related
to the payment plan for the Company's annual workers' compensation insurance
policy and short-term borrowings on the Company's revolving line of credit.
Interest income was essentially unchanged from 1995.
Other expense in 1996 includes a non-recurring charge relating to
certain issues involving the failure of the Company's 401(k) Plan to comply
with certain nondiscrimination tests required by the Code, net of amounts
recoverable from the 401(k) Plan record keeper. See Note 11 of Notes to
Consolidated Financial Statements.
The Company's provision for income taxes, which includes the effects
of the non-recurring charge for 401(k) Plan issues, differs from the U.S.
statutory rate of 34% due primarily to certain portions of the non-recurring
charge being non-deductible for income tax purposes. In addition, the Company's
provision for income taxes differs from the U.S. statutory rate due to state
income taxes.
The increase in net income for the year ended December 31, 1996 versus
December 31, 1995 of $1.5 million, or 133.2%, is due to the same factors which
resulted in increased operating income, partially offset by the effects of the
non-recurring charge in the third quarter for certain 401(k) Plan issues, net
of amounts recoverable from the 401(k) Plan recordkeeper. Excluding the
non-recurring third quarter charge and the related income tax effects of such
charge, net income would have been $3.8 million (or $0.34 per share - diluted)
in 1996 as compared to $1.1 million (or $0.10 per share - diluted) in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company periodically evaluates its liquidity requirements, capital
needs and availability of resources in view of, among other things, expansion
plans, debt service requirements and other operating cash needs. As a result of
this process, the Company has, in the past, sought and may, in the future, seek
to raise additional capital or take other steps to increase or manage its
liquidity and capital resources. The Company currently believes that its cash
on hand, marketable securities and cash flows from operations will be adequate
to meet its liquidity requirements through at least 1999. The Company will rely
on these same sources, as well as public and private debt and equity financing,
to meet its long-term liquidity needs.
The Company has $66.6 million in cash and cash equivalents and
marketable securities at December 31, 1997, of which approximately $19.2
million is payable in early January 1998 for withheld federal and state income
taxes, FICA and other payroll deductions. The remainder is available to the
Company for general corporate purposes, including, but not limited to, current
working capital requirements, expenditures related to the continued expansion
of the Company's sales force through the opening of new sales offices and
capital expenditures. The Company repaid all of its long-term debt utilizing
the proceeds from its initial public offering in January 1997 and accordingly,
has no long-term debt repayment requirements during 1998. At December 31, 1997
the Company had working capital of $46.6 million which is significantly
increased from $4.6 million at December 31, 1996 due to the proceeds from the
Company's initial public offering.
CASH FLOWS FROM OPERATING ACTIVITIES
The Company's cash flows from operating activities in 1997 increased
substantially from 1996. The increase of $8.7 million resulted from the higher
level of net income during the year and the timing of the accrual, collection
and payment of the Company's service fees, payroll costs and payroll taxes at
the end of the respective periods. Net income, adjusted for non-cash expense
items, provided cash of $11.2 million in 1997 versus $5.5 million in 1996. In
addition, the Company had higher levels of accounts receivable, accrued
worksite employee payroll expense and payroll taxes and other payroll
deductions payable as of December 31, 1997 due to the higher volume of payroll
surrounding the last day of the month.
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CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures during the year ended December 31, 1997 totaled
$7.1 million and related primarily to furniture, equipment, computer equipment
and building improvements at its corporate facilities as part of the Company's
continued investment in technology and infrastructure to accommodate its rapid
growth rate. In addition, capital expenditures during 1997 include furniture
and computer equipment related to the opening of five new sales offices.
Capital expenditures during the year ended December 31, 1996 totaled $4.0
million and included approximately $2.1 million to complete, furnish and equip
a Company-owned facility to accommodate continued growth in corporate
employees. This facility was opened in February 1996. In addition, capital
expenditures in 1996 included expenditures for corporate and disaster recovery
computer equipment, furniture and equipment for new and existing sales offices
and new corporate telephone systems. Capital expenditures of $4.6 million in
1995 included approximately $2.4 million for construction on the company-owned
facility completed in February 1996, expenditures to equip and furnish new and
existing sales offices and for corporate and disaster recovery computer
equipment.
Net purchases of marketable securities during 1997 reflect the
investment of a portion of the proceeds from the Company's initial public
offering in short-term, highly liquid marketable securities with maturities
ranging from 91 days to two years from the date of purchase. The marketable
securities consist primarily of debt securities issued by corporate and
governmental entities.
CASH FLOWS FROM FINANCING ACTIVITIES
The Company completed an initial public offering of 3,000,000 shares
of common stock in January 1997. The net proceeds to the Company from the
offering (after deducting underwriting discounts and commissions of $3.6
million) were $47.4 million. The Company utilized approximately $7.1 million of
the proceeds as follows: (i) $4.6 million to repay certain subordinated notes
and other secured notes comprising all of the Company's outstanding
indebtedness at the time, (ii) approximately $2.0 million to exercise its
option to repurchase 348,945 shares of common stock from one of its
stockholders, which is now held in treasury by the Company, and (iii)
approximately $0.5 million to exercise its option to repurchase 173,609
warrants to purchase shares of common stock from the subordinated noteholder.
With the remaining proceeds, the Company intends to continue to support
expansion of the Company's operations, including the opening of sales offices
in new geographic markets as well as in established markets and, as favorable
opportunities arise, expansion of the Company's client base in new or existing
markets through marketing or other business alliances or acquisitions of
existing PEO offices. For the year ended December 31, 1997, the Company
incurred $7.1 million in capital expenditures primarily related to the opening
of sales offices and the necessary corporate infrastructure and technology to
support this expansion. Pending the application of such funds, the Company has
invested the net proceeds of the offering in diversified, highly-liquid,
investment grade, interest-bearing instruments.
Cash flows from financing activities in 1997, 1996 and 1995 include
loans to employees related to the federal income tax impact of the exercise of
stock options. In 1996, the Company borrowed, on two occasions, a total of
$2.5 million under its $10 million revolving credit agreement. Both borrowings
were repaid during the third quarter of 1996. During 1995, 1996 and 1997, the
Company incurred $0.7 million, $1.1 million and $0.3 million, respectively, in
costs related to its initial public offering which was completed in January
1997.
CREDIT AGREEMENT
In October 1995 the Company's wholly-owned subsidiary, Administaff of
Texas, Inc., entered into a $10 million revolving credit agreement (the "Credit
Agreement") with a bank. In October 1997, the Credit Agreement expired. The
Company elected not to exercise the Credit Agreement's extension provision
because utilization of this credit facility was not expected within the one-year
extension term. The Company believes it could obtain a similar financing
agreement with terms competitive with the Credit Agreement if the need for such
an agreement were to arise.
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MARKETING AND SECURITIES PURCHASE AGREEMENTS
In January 1998, the Company entered into a Securities Purchase
Agreement with American Express Travel Related Services Company, Inc.
("American Express") whereby the Company agreed to sell 693,126 shares of its
common stock to American Express for a total purchase price of $17.7 million.
The shares of common stock include warrants to purchase an additional 2,065,515
shares of common stock at prices ranging from $40 to $80 per share. The
proceeds from this transaction, received in March 1998, will be available for
general corporate purposes.
In conjunction with the Securities Purchase Agreement, the Company
agreed to enter into a Marketing Agreement with American Express to jointly
market the Company's services to American Express' substantial small business
customer base across the country. Under the Marketing Agreement, American
Express will utilize its resources to generate appointments with prospects for
the Company's services. In addition, the Company and American Express will
work to jointly develop product offerings that enhance the current PEO services
offered by the Company. The Marketing Agreement has a seven year term and
provides that Administaff will be the exclusive PEO partner of American Express
for the first three years. The Company will pay a commission to American
Express based upon the number of worksite employees paid after being referred
to the Company pursuant to the Marketing Agreement.
The Company believes that the agreement with American Express will
enhance its ability to increase its base of worksite employees and clients in
existing and yet to be opened markets, although there can be no assurances to
that effect. The Company intends to pursue other such marketing partnerships
and alliances to further enhance its ability to grow.
In January 1998, the Company purchased 140,508 shares of common stock
from Rauscher Pierce Refsnes, Inc. (now known as Dain Rauscher) for a total
cost of approximately $2.9 million. The shares were issued to Dain Rauscher as
a result of the exercise of common stock purchase warrants originally issued in
1994. The net payment to Dain Rauscher after deducting warrant exercise costs
was approximately $2.3 million.
In January 1998, the Company agreed to repurchase 150,000 shares of
common stock from three stockholders, two of whom are former officers of the
Company and one who is a current director of the Company, for a total cost of
$3.1 million. The cost of this common stock repurchase was paid in March 1998.
OTHER MATTERS
The Company had net deferred tax liabilities of $0.1 million at
December 31, 1997 versus $0.9 million at December 31, 1996. This decrease is
due primarily to the completion of the phase in of a change in accounting
method for income tax purposes. In January and May 1996, the IRS approved the
Company's request for a change in the method of accounting for PEO service fees
and worksite employee payroll costs to the accrual method. These changes were
adopted for financial reporting purposes effective January 1, 1994. For PEO
service fees the change, for tax purposes, was approved effective January 1,
1995 with a three year phase in period for the cumulative effect of the change.
For worksite employee payroll costs, the change, for tax purposes, was approved
effective January 1, 1995 with a one year phase in period for the cumulative
effect of the change. As a result, the Company amended its 1995 consolidated
federal income tax return to account for these changes. The Company received
$3.5 million in federal income tax refunds in May and July 1996 related to the
original and amended tax returns.
During the third quarter of 1996, the Company recorded an accrual for
its estimate of the cost of corrective measures and penalties relating to the
401(k) Plan's failure to comply with certain nondiscrimination tests required
by the Code. See Note 11 of Notes to Consolidated Financial Statements. In
addition, during the third quarter of 1996, the Company recorded an asset for
an amount recoverable from the 401(k) Plan's record keeper should the Company
ultimately be required to pay the amount accrued for such corrective measures
and penalties. The income tax effects of these items are reflected in the
Company's net deferred tax liabilities as of December 31, 1997 and 1996. Based
on its understanding of the settlement experience of other companies in similar
situations, the Company does not believe
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the ultimate resolution of this 401(k) Plan matter will have a material adverse
effect on the Company's financial condition, results of operations or
liquidity.
In conjunction with the redesign and upgrade of the Company's
proprietary PEO information system in 1996 and 1997, the Company addressed the
Year 2000 issue. In addition, the Company has had discussions with its vendors
of commercially available software, such as its finance and accounting software,
with regard to this issue. As a result of these procedures, the Company has not
incurred and does not expect to incur significant costs related to Year 2000
compliance. The Company is currently assembling a task force to address Year
2000 issues related to vendors with which the Company communicates
electronically. The most significant of these vendors include the Company's
banks and benefits providers. While the Company is not currently aware of any
significant Year 2000 issues related to its business with these vendors, there
can be no assurances that the Company will not be adversely affected by the
failure of its primary vendors to remediate their own Year 2000 issues.
SEASONALITY, INFLATION AND QUARTERLY FLUCTUATIONS
Historically, the Company's earnings pattern includes losses in the
first quarter, followed by improved profitability in subsequent quarters
throughout the year. This pattern is due to the effects of employment-related
taxes which are based on the individual employees' cumulative earnings up to
specified wage levels, causing employment- related taxes to be highest in the
first quarter and then decline over the course of the year. Since the
Company's revenues related to an individual employee are generally earned and
collected at a relatively constant rate throughout each year, payment of such
unemployment tax obligations has a substantial impact on the Company's
financial condition and results of operations during the first six months of
each year. Other factors that affect direct costs could mitigate or enhance
this trend.
The Company believes the effects of inflation have not had a
significant impact on its results of operations or financial condition.
CERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
AUDIT OF THE COMPANY'S 401(k) PLAN; IRS EMPLOYEE LEASING MARKET
SEGMENT GROUP
The Company's 401(k) Plan is currently under audit by the IRS for the
year ended December 31, 1993. Although the audit is for the 1993 plan year,
certain conclusions of the IRS would be applicable to other years as well. In
addition, the IRS has established an Employee Leasing Market Segment Group for
the purpose of identifying specific compliance issues prevalent in certain
segments of the PEO industry. Approximately 70 PEOs, including the Company,
have been randomly selected by the IRS for audit pursuant to this program. One
issue that has arisen from these audits is whether a PEO can be a co-employer
of worksite employees, including officers and owners of client companies, for
various purposes under the Internal Revenue Code of 1986, as amended (the
"Code"), including participation in the PEO's 401(k) plan. For a discussion of
the issues being considered by the Market Segment Group, see Item 1, "Business
- - Industry Regulation". With respect to the 401(k) Plan audit, the Company
understands that the IRS Houston District has sought technical advice (the
"Technical Advice Request") from the IRS National Office about (1) whether
participation in the 401(k) Plan by worksite employees, including officers of
client companies, violates the exclusive benefit rule under the Code because
they are not employees of the Company and (2) whether the 401(k) Plan's failure
to satisfy a nondiscrimination test relating to contributions should result in
disqualification of the 401(k) Plan because the Company has failed to provide
evidence that it satisfies an alternative discrimination test. A copy of the
Technical Advice Request and the Company's response has been sent to the IRS
National Office for review. The Technical Advice Request contains the
conclusions of the IRS Houston District with respect to the 1993 plan year that
the 401(k) Plan should be disqualified because it (1) covers worksite employees
who are not employees of the Company and (2) failed a nondiscrimination test
applicable to contributions and the Company has not furnished evidence that the
401(k) Plan satisfies an alternative test. The Company's response refutes the
conclusions of the IRS Houston District. The Company also understands that,
with respect to the Market Segment study, the issue of whether a PEO and a
client
- 28 -
30
company may be treated as co-employers of worksite employees for certain
federal tax purposes (the "Industry Issue") has been referred to the IRS
National Office.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. The Company is not able to
predict either the timing or the nature of any final decision that may be
reached with respect to the 401(k) Plan audit or with respect to the Technical
Advice Request or the Market Segment Group study and the ultimate outcome of
such decisions. Should the IRS conclude that the Company is not a "co-employer"
of worksite employees for purposes of the Code, worksite employees could not
continue to make salary deferral contributions to the 401(k) Plan or pursuant
to the Company's cafeteria plan or continue to participate in certain other
employee benefit plans of the Company. The Company believes that, although
unfavorable to the Company, a prospective application of such a conclusion
(that is, one applicable only to periods after the conclusion by the IRS is
finalized) would not have a material adverse effect on its financial position
or results of operations, as the Company could continue to make available
comparable benefit programs to its client companies at comparable costs to the
Company. However, if the IRS National Office adopts the conclusions of the IRS
Houston District set forth in the Technical Advice Request and any such
conclusions were applied retroactively to disqualify the 401(k) Plan for 1993
and subsequent years, employees' vested account balances under the 401(k) Plan
would become taxable, the Company would lose its tax deductions to the extent
its matching contributions were not vested, the 401(k) Plan's trust would
become a taxable trust and the Company would be subject to liability with
respect to its failure to withhold applicable taxes with respect to certain
contributions and trust earnings. Further, the Company would be subject to
liability, including penalties, with respect to its cafeteria plan for the
failure to withhold and pay taxes applicable to salary deferral contributions
by employees, including worksite employees. In such a scenario, the Company
also would face the risk of client dissatisfaction and potential litigation. A
retroactive application by the IRS of an adverse conclusion resulting in
disqualification of the 401(k) Plan would have a material adverse effect on the
Company's financial position and results of operations.
COSTS OF 401(k) PLAN COMPLIANCE
In 1991, the Company engaged a third party vendor to be the 401(k)
Plan's record keeper and to perform certain required annual nondiscrimination
tests for the 401(k) Plan. Each year such record keeper reported to the Company
that such nondiscrimination tests had been satisfied. However, in August 1996
the 401(k) Plan's record keeper advised the Company that certain of these tests
had been performed incorrectly for prior years and, in fact, that the 401(k)
Plan had failed certain tests for the 1993, 1994 and 1995 plan years. The
Company has subsequently determined that the 401(k) Plan also failed a
nondiscrimination test for 1991 and 1992, closed years for tax purposes. At the
time the Company received such notice, the period in which the Company could
voluntarily "cure" this operational defect had lapsed for all such years,
except 1995. With respect to the 1995 year, the Company has caused the 401(k)
Plan to refund the required excess contributions and earnings thereon to
affected highly compensated participants, and the Company paid an excise tax of
approximately $47,000 related to such contributions. Because the 401(k) Plan is
under a current IRS audit, the IRS voluntary correction program for this type
of operational defect is not available to the Company for years prior to 1995.
Accordingly, the Company informed the IRS of the prior testing errors for each
of 1991, 1992, 1993 and 1994 and proposed a correction that consists of
corrective contributions by the Company to the 401(k) Plan with respect to
these years (including the closed years) and the payment by the Company of the
minimum penalty ($1,000) that the IRS is authorized to accept to resolve this
issue. The IRS Houston District has indicated that resolution of the
nondiscrimination test failures is premature until the National Office resolves
the issues presented in the Technical Advice Request. No assurance can be given
that the IRS will permit the Company to administratively "cure" this
operational defect instead of proposing a disqualification of the 401(k) Plan.
The Company recorded a reserve during the third quarter of 1996 with respect to
these 401(k) Plan issues. The amount of such reserve is the Company's estimate
of the cost of corrective measures and penalties, although no assurance can be
given that the actual amount that the Company may ultimately be required to pay
will not substantially exceed the amount so reserved. In addition, the Company
has recorded an asset for an amount recoverable from the 401(k) Plan's record
keeper should the Company ultimately be required to pay the amount accrued for
such corrective measures and penalties. Based on its understanding of the
settlement experience of other companies, the Company does not believe that the
ultimate resolution of the nondiscrimination test issue will have a material
adverse effect on the Company's financial condition
- 29 -
31
or results of operations, although no assurance can be given by the Company
that such will be the case because the ultimate resolution of this issue will
be determined in a negotiation process with the IRS or in litigation. See Note
11 of Notes to the Consolidated Financial Statements.
FEDERAL, STATE AND LOCAL REGULATION
As a major employer, the Company's operations are affected by numerous
federal, state and local laws relating to labor, tax (in addition to the
provisions of the Code discussed above) and employment matters. By entering
into a co- employer relationship with employees assigned to work at client
company locations, the Company assumes certain obligations and responsibilities
of an employer under these laws. However, many of these laws (such as the
Employee Retirement Income Security Act ("ERISA") and federal and state
employment tax laws) do not specifically address the obligations and
responsibilities of non-traditional employers such as PEOs, and the definition
of "employer" under these laws is not uniform. In addition, many of the states
in which the Company operates have not addressed the PEO relationship for
purposes of compliance with applicable state laws governing the
employer/employee relationship. If these other federal or state laws are
ultimately applied to the Company's PEO relationship with its worksite
employees in a manner adverse to the Company, such an application could have a
material adverse effect on the Company's results of operations or financial
condition.
Prior to 1993, the State Board of Insurance of Texas and the Texas
Employment Commission challenged the ability of a PEO to provide workers'
compensation insurance and health benefits and to pay unemployment taxes as an
employer of worksite employees. These challenges were ultimately addressed
through the passage of specific professional employer licensing legislation in
Texas. There can be no assurance that additional challenges will not be faced
in Texas or that similar challenges will not be encountered in other
jurisdictions in which the Company may choose to do business.
While many states do not explicitly regulate PEOs, 18 states
(including Texas) have passed laws that have licensing or registration
requirements for PEOs and several other states are considering such regulation.
Such laws vary from state to state but generally provide for monitoring the
fiscal responsibility of PEOs. While the Company generally supports licensing
regulation because it serves to validate the PEO relationship, there can be no
assurance that the Company will be able to satisfy licensing requirements or
other applicable regulations of any particular state in which it is not
currently operating but later commences operations. In addition, there can be
no assurance that the Company will be able to renew its licenses in the states
in which it currently operates upon expiration of such licenses.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES AND
WORKERS' COMPENSATION RATES
Health insurance premiums, state unemployment taxes and workers'
compensation rates are in part determined by the Company's claims experience
and comprise a significant portion of the Company's direct costs. The Company
employs extensive risk management procedures in an attempt to control its
claims incidence. However, should the Company experience a large increase in
claim activity, its unemployment taxes, health insurance premiums or workers'
compensation insurance rates may increase. The Company's ability to incorporate
such increases into service fees to clients is constrained by contractual
arrangements with clients, which may result in a delay before such increases
can be reflected in service fees. As a result, such increases could have a
material adverse effect on the Company's financial condition or results of
operations.
LIABILITIES FOR CLIENT AND EMPLOYEE ACTIONS
A number of legal issues remain unresolved with respect to the
co-employment arrangement between a PEO and its worksite employees, including
questions concerning the ultimate liability for violations of employment and
discrimination laws. The Administaff PMSA establishes the contractual division
of responsibilities between the Company and its clients for various personnel
management matters, including compliance with and liability under various
governmental regulations. However, because the Company acts as a co-employer,
the Company may be subject to liability for violations of these or other laws
despite these contractual provisions, even if it does not participate in such
- 30 -
32
violations. Although the PMSA provides that the client is to indemnify the
Company for any liability attributable to the conduct of the client, the
Company may not be able to collect on such a contractual indemnification claim
and thus may be responsible for satisfying such liabilities. In addition,
worksite employees may be deemed to be agents of the Company, subjecting the
Company to liability for the actions of such worksite employees.
LIABILITY FOR WORKSITE EMPLOYEE PAYROLL
Under the PMSA, the Company becomes a co-employer of worksite
employees and assumes the obligations to pay the salaries, wages and related
benefit costs and payroll taxes of such worksite employees. As such a
co-employer, the Company assumes such obligations as a principal, not merely as
an agent of the client company. The Company's obligations include
responsibility for (i) payment of the salaries and wages for work performed by
worksite employees, regardless of whether the client company makes timely
payment to the Company of the associated service fee, and (ii) providing
benefits to worksite employees even if the costs incurred by Administaff to
provide such benefits exceed the fees paid by the client company. There can be
no assurance that the Company's ultimate liability for worksite employee
payroll and benefits costs will not have a material adverse effect on its
financial condition or results of operations.
LOSS OF BENEFIT PLANS
The maintenance of health and workers' compensation insurance plans
that cover worksite employees is a significant part of the Company's business.
The current health and workers' compensation contracts are provided by vendors
with whom the Company has an established relationship, and on terms that the
Company believes to be favorable. While the Company believes that replacement
contracts could be secured on competitive terms without causing significant
disruption to the Company's business, there can be no assurance in this regard.
GEOGRAPHIC MARKET CONCENTRATION
While the Company has sales offices in 12 markets, eight of these
represent recent expansions. The Company's Houston and Texas (including
Houston) markets accounted for approximately 47% and 77%, respectively, of the
Company's revenue base for the year ended December 31, 1997. Accordingly,
while a primary aspect of the Company's strategy is expansion in its current
and future markets outside of Texas, for the foreseeable future a significant
portion of the Company's revenues may be subject to economic factors specific
to Texas (including Houston). While the Company believes that its market
expansion plans will eventually lessen or eliminate this risk in addition to
generating significant revenue growth, there can be no assurance that the
Company will be able to duplicate in other markets the revenue growth and
operating results experienced in its Texas (including Houston) markets.
COMPETITION AND NEW MARKET ENTRANTS
The PEO industry is highly fragmented, with approximately 2,000
companies performing PEO services to some extent. Many of these companies have
limited operations and fewer than 1,000 worksite employees, but there are
several industry participants which are comparable in size to the Company.
These companies include Staff Leasing, Inc, headquartered in Bradenton,
Florida, Employee Solutions, Inc., headquartered in Phoenix, Arizona and The
Vincam Group, Inc., headquartered in Coral Gables, Florida. The Company also
encounters competition from "fee for service" companies such as payroll
processing firms, insurance companies and human resource consultants. Moreover,
the Company expects that as the PEO industry grows and its regulatory framework
becomes better established, well-organized competition with greater resources
than the Company may enter the PEO market, possibly including large "fee for
service" companies currently providing a more limited range of services.
POTENTIAL CLIENT LIABILITY FOR EMPLOYMENT TAXES
Pursuant to the Company's Client Service Agreement with its clients,
the Company assumes sole responsibility and liability for the payment of
federal employment taxes imposed under the Code with respect to wages and
salaries paid to its worksite employees. There are essentially three types of
federal employment tax obligations: (i) income tax
- 31 -
33
withholding requirements; (ii) obligations under the Federal Income
Contribution Act ("FICA"); and (iii) obligations under the Federal Unemployment
Tax Act ("FUTA"). Under the Code, employers have the obligation to withhold and
remit the employer portion and, where applicable, the employee portion of these
taxes. Most states impose similar employment tax obligations on the employer.
While the PMSA provides that the Company has sole legal responsibility for
making these tax contributions, the IRS or applicable state taxing authority
could conclude that such liability cannot be completely transferred to the
Company. Accordingly, in the event the Company fails to meet its tax
withholding and payment obligations, the client company may be held jointly and
severally liable therefor. While this interpretive issue has not, to the
Company's knowledge, discouraged clients from enrolling with the Company, there
can be no assurance that a definitive adverse resolution of this issue would
not do so in the future.
EXPENSES ASSOCIATED WITH EXPANSION
Past and future operating results are impacted by the Company's market
expansion activities, including establishing and maintaining sales office
facilities, compensating newly hired sales associates and expanding advertising
efforts. The Company's operating results for 1995, 1996 and 1997 have included
$4.3 million, $6.1 million and $7.9 million, respectively, of operating
expenses incurred directly in new markets. The Company expects that investments
in new markets will continue at levels comparable to or greater than 1997
through at least 1999, and that expenses in a new market will not be covered by
the gross profit from that market's revenues for approximately two years. While
the Company believes that its expansion program will ultimately lead to
increased profitability, there can be no assurance that losses or diminished
profitability will not be incurred in future periods as a result of the
Company's planned expansion or that such losses or diminished profitability
will not have a material adverse effect on the Company's results of operations
or financial condition.
FAILURE TO MANAGE GROWTH
The Company has experienced significant growth and expects such growth
to continue for the foreseeable future. The Company plans to enter at least
one new market or open at least one additional sales office in an existing
market in each quarter of 1998 and 1999. As described under the above caption
"Expenses Associated with Expansion," expenses incurred in connection with the
initial expansion into new markets are significant. In addition, because each
market entry is affected by circumstances unique to its particular locale,
there are uncertainties associated with each new market entry. Accordingly, the
Company's expansion plan may place a significant strain on the Company's
management, financial, operating and technical resources. Failure to manage
this growth effectively could have a material adverse effect on the Company's
financial condition or results of operations.
NEED TO RENEW OR REPLACE CLIENT COMPANIES
The Company's standard PMSA is subject to cancellation on 60 days'
notice by either the Company or the client. Accordingly, the short-term nature
of the PMSA makes the Company vulnerable to potential cancellations by existing
clients which could materially and adversely affect the Company's financial
condition and results of operations. In addition, the Company's results of
operations are dependent in part upon the Company's ability to retain or
replace its client companies upon the termination or cancellation of the Client
Service Agreement. Historically, between 15% and 20% of the Company's clients
have remained clients for less than one year and there can be no assurance that
the number of contract cancellations will not increase in the future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item 8 is contained in a separate
section of this Annual Report. See "Index to Consolidated Financial
Statements" on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
- 32 -
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item 10 is incorporated by reference
to the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after the end of
the fiscal year covered by this report (the "Administaff Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item 11 is incorporated by reference
to the Administaff Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item 12 is incorporated by reference
to the Administaff Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item 13 is incorporated by reference
to the Administaff Proxy Statement. See also Note 10 to the Consolidated
Financial Statements.
- 33 -
35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements of the Company
The Consolidated Financial Statements listed by the Registrant on the
accompanying Index to Consolidated Financial Statements (see page F-1)
are filed as part of this Annual Report.
(a) 2. Financial Statement Schedules
The required information is included in the Consolidated Financial
Statements or Notes thereto.
(a) 3. List of Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on
form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on form S-1 (No. 33-96952) declared effective on January
28, 1997).
4.2 Registration Rights Agreement, as amended, dated May 13, 1994, by and among Administaff, Inc.,
Pyramid Ventures, Inc. and the Board of Trustees of the Texas Growth Fund as Trustee for the
Texas Growth Fund-1991 Trust (incorporated by reference to Exhibit 4.2 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.3 Investor Agreement, as amended, date May 13, 1994 by and among Administaff, Inc., Pyramid
Ventures, Inc. and the Board of Trustees of the Texas Growth Fund as Trustee for the Texas
Growth Fund-1991 Trust (incorporated by reference to Exhibit 4.3 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.4 Common Stock Warrant, as amended, issued to the Texas Growth Fund-1991 Trust on May 13, 1994
(incorporated by reference to Exhibit 4.4 to the Registrant's Registration Statement on form S-
1 (No. 33-96952) declared effective on January 28, 1997).
4.5 Warrant Agreement, as amended, dated May 13, 1994, between Rauscher Pierce Refsnes, Inc. and
Administaff, Inc. (incorporated by reference to Exhibit 4.5 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.6 Voting Agreement, as amended, dated May 13, 1994, by and among Administaff, Inc., Pyramid
Ventures, Inc., the Board of Trustees of the Texas Growth Fund as Trustee for the Texas Growth
Fund-1991 Trust and certain stockholders of Administaff, Inc. (incorporated by reference to
Exhibit 4.6 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
4.7 Subordinated Note of Administaff, Inc. in favor of The Board of Trustees of the Texas Growth
Fund, as Trustee (incorporated by reference to Exhibit 4.7 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.8 Rights Agreement dated as of February 4, 1998, between Administaff, Inc. and Harris Trust and
Savings Bank, as Rights Agent (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
4.9 Certificate of Designations of Series A Junior Participating Preferred Stock of Administaff,
Inc. dated February 4, 1998 (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
- 34 -
36
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
4.10 Form of Rights Certificate (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
10.1 Amended and Restated Promissory Note among Administaff, Inc., Richard G. Rawson, Dawn Rawson,
and RDKB Rawson LP, dated as of December 16, 1996, amending and restating a Promissory Note
dated June 22, 1995 (incorporated by reference to Exhibit 10.1 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.2 Amended and Restated Promissory Note among Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of December 30, 1996, amending and restating a Promissory Note
dated September 4, 1995 (incorporated by reference to Exhibit 10.2 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.3 Credit agreement between Administaff, Inc. and First National Bank of Chicago, dated as of
October 16, 1995 (incorporated by reference to Exhibit 10.3 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.4 Amendment No. 1 and Waiver to Credit Agreement, dated as of March 12, 1996 (incorporated by
reference to Exhibit 10.4 to the Registrant's Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
10.5 Amended and Restated Promissory Note, dated as of December 16, 1996, among Administaff, Inc.,
Richard G. Rawson, Dawn Rawson, and RDKB Rawson LP, dated as of December 16, 1996, pursuant to
which the collateral securing the promissory notes included as Exhibit 10.1 is pledged
(incorporated by reference to Exhibit 10.5 to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28, 1997).
10.6 Amended and Restated Security Agreement-Pledge among Administaff, Inc., Jerald L. Broussard and
Mary Catherine Broussard, dated as of December 30, 1996, pursuant to which the collateral
securing the promissory note included as Exhibit 10.2 is pledged (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.7 Form of Second Amended and Restated Promissory Note (incorporated by reference to Exhibit 10.9
to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared effective on
January 28, 1997).
10.8 Form of Second Amended and Restated Security Agreement - Pledge (incorporated by reference to
Exhibit 10.10 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.9 Administaff, Inc. 1997 Incentive Plan (incorporated by reference to Exhibit 99.1 to the
Registrant's Form S-8 filed on August 20, 1997).
10.10 Administaff, Inc. 1997 Employee Stock Purchase Plan (incorporated by reference to Exhibit 99.1
to the Registrant's Form S-8 filed on September 25, 1997).
10.11 Second Amendment to the Administaff, Inc. 1997 Incentive Plan.
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
None
- 35 -
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Administaff, Inc. has duly caused this report to be
signed in its behalf by the undersigned, thereunto duly authorized.
ADMINISTAFF, INC.
By: /s/ RICHARD G. RAWSON
-----------------------
Richard G. Rawson
Executive Vice President,
Chief Financial Officer and
Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities
indicated on March 10, 1998:
SIGNATURE TITLE
--------- -----
/s/ PAUL J. SARVADI President, Chief Executive Officer and
- ------------------------ Director
Paul J. Sarvadi (Principal Executive Officer)
/s/ RICHARD G. RAWSON Executive Vice President, Chief Financial
- ------------------------ Officer, Treasurer and Director
Richard G. Rawson (Principal Financial Officer)
/s/ SAMUEL G. LARSON Vice President, Finance and Controller
- ------------------------ (Principal Accounting Officer)
Samuel G. Larson
/s/ GERALD M. McINTOSH Director
- ------------------------
Gerald M. McIntosh
/s/ SCOTT C. HENSEL Director
- ------------------------
Scott C. Hensel
/s/ LINDA FAYNE LEVINSON Director
- ------------------------
Linda Fayne Levinson
/s/ PAUL S. LATTANZIO Director
- ------------------------
Paul S. Lattanzio
/s/ JACK M. FIELDS, JR. Director
- ------------------------
Jack M. Fields, Jr.
/s/ MICHAEL W. BROWN Director
- ------------------------
Michael W. Brown
Director
- ------------------------
Anne M. Busquet
- 36 -
38
ADMINISTAFF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997 . . . . . . . F-3
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . F-7
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . F-9
F-1
39
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Administaff, Inc.
We have audited the accompanying consolidated balance sheets of
Administaff, Inc. as of December 31, 1996 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Administaff, Inc. at December 31, 1996 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Houston, Texas
February 13, 1998
F-2
40
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
December 31,
---------------------------
1996 1997
----------- ------------
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . $ 13,360 $ 40,561
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . . . . -- 26,012
Accounts receivable:
Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,490 4,324
Unbilled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,742 15,371
Related parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439 163
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344 1,208
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,668 1,585
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . -- 199
-------- ---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . 33,043 89,423
Property and equipment:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 817 817
Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . . 6,564 7,557
Computer equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,093 6,219
Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . 3,767 6,342
Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761 950
-------- ---------
15,002 21,885
Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . (3,359) (5,214)
-------- ---------
Total property and equipment . . . . . . . . . . . . . . . . . . . . 11,643 16,671
Other assets:
Notes receivable from employees . . . . . . . . . . . . . . . . . . . . . 1,135 1,181
Deferred financing costs, net of accumulated
amortization of $327 at December 31, 1996 . . . . . . . . . . . . . . 282 --
Intangible assets, net of accumulated amortization of $293
and $447 at December 31, 1996 and 1997, respectively . . . . . . . . . . 749 822
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,524 1,358
-------- ---------
Total other assets . . . . . . . . . . . . . . . . . . . . . . . . . 3,690 3,361
-------- ---------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 48,376 $ 109,455
======== =========
F-3
41
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31,
------------------------
1996 1997
----------- -----------
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 594 $ 1,421
Payroll taxes and other payroll deductions payable . . . . . . . . . . . . 10,099 19,190
Accrued worksite employee payroll expense . . . . . . . . . . . . . . . . 13,385 18,153
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 2,662 3,319
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . 266 729
Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . 491 --
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 917 --
--------- ---------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . 28,414 42,812
Noncurrent liabilities:
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 2,558 2,558
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,112 --
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . -- 322
--------- ---------
Total noncurrent liabilities . . . . . . . . . . . . . . . . . . . . 6,670 2,880
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $0.01 per share:
Shares authorized - 20,000
Shares issued and outstanding - none . . . . . . . . . . . . . . . . . -- --
Common stock, $0.01 par value:
Shares authorized - 60,000
Shares issued and outstanding - 10,726 and 14,221
at December 31, 1996 and 1997, respectively . . . . . . . . . . . . 107 142
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . 5,706 50,670
Treasury stock, at cost - 348,609 shares at December 31, 1997 . . . . . . -- (1,998)
Unrealized gain on marketable securities . . . . . . . . . . . . . . . . . -- 31
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,479 14,918
--------- ---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . 13,292 63,763
--------- ---------
Total liabilities and stockholders' equity . . . . . . . . . . . . . $ 48,376 $ 109,455
========= =========
See accompanying notes.
F-4
42
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Year Ended December 31,
----------------------------------
1995 1996 1997
--------- --------- ----------
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 716,210 $ 899,596 $1,213,620
Direct costs:
Salaries and wages of worksite employees . . . . . . 582,893 737,177 1,006,092
Benefits and payroll taxes . . . . . . . . . . . . . . 104,444 124,563 156,259
-------- --------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 28,873 37,856 51,269
Operating expenses:
Salaries, wages and payroll taxes . . . . . . . . . . . 10,951 14,515 18,562
General and administrative expenses . . . . . . . . . . 7,597 8,091 12,727
Commissions . . . . . . . . . . . . . . . . . . . . . . 3,942 4,039 4,724
Advertising . . . . . . . . . . . . . . . . . . . . . . 3,268 3,261 3,784
Depreciation and amortization . . . . . . . . . . . . . 894 1,473 2,126
-------- --------- ---------
26,652 31,379 41,923
-------- --------- ---------
Operating income . . . . . . . . . . . . . . . . . . . . . 2,221 6,477 9,346
Other income (expense):
Interest income . . . . . . . . . . . . . . . . . . . . 668 682 2,952
Interest expense . . . . . . . . . . . . . . . . . . . (713) (945) (378)
Other, net . . . . . . . . . . . . . . . . . . . . . . 9 (1,400) (12)
-------- --------- ---------
(36) (1,663) 2,562
-------- --------- ---------
Income before income tax expense . . . . . . . . . . . . . 2,185 4,814 11,908
Income tax expense . . . . . . . . . . . . . . . . . . . . 1,069 2,211 4,469
-------- --------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 1,116 $ 2,603 $ 7,439
======== ========= =========
Basic net income per share of common stock . . . . . . . . $ 0.11 $ 0.24 $ 0.56
======== ========= =========
Diluted net income per share of common stock . . . . . . . $ 0.10 $ 0.24 $ 0.53
======== ========= =========
See accompanying notes.
F-5
43
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Unrealized
Issued Additional Gain on
--------------------- Paid-In Treasury Marketable Retained
Shares Amount Capital Stock Securities Earnings Total
------ -------- --------- -------- ---------- -------- --------
Balance at December 31, 1994 10,238 $ 102 $ 4,194 $ -- $ -- $ 3,760 $ 8,056
Exercise of stock options 488 5 392 -- -- -- 397
Income tax benefit from
exercise of stock options -- -- 1,120 -- -- -- 1,120
Net income -- -- -- -- -- 1,116 1,116
------ -------- --------- -------- ---------- -------- --------
Balance at December 31, 1995 10,726 107 5,706 -- -- 4,876 10,689
Net income -- -- -- -- -- 2,603 2,603
------ -------- --------- -------- ---------- -------- --------
Balance at December 31, 1996 10,726 107 5,706 -- -- 7,479 13,292
Issuance of common stock through
initial public offering, net of
offering costs of $5,669 3,000 30 45,301 -- -- -- 45,331
Purchase of treasury stock, at cost -- -- -- (1,999) -- -- (1,999)
Repurchase of common stock
purchase warrants -- -- (542) -- -- -- (542)
Exercise of common stock
purchase warrants 474 5 43 -- -- -- 48
Exercise of stock options 21 -- 156 -- -- -- 156
Other -- -- 6 1 -- -- 7
Unrealized gain on
marketable securities -- -- -- -- 31 -- 31
Net income -- -- -- -- -- 7,439 7,439
------ -------- --------- -------- ---------- -------- --------
Balance at December 31, 1997 14,221 $ 142 $ 50,670 $ (1,998) $ 31 $ 14,918 $ 63,763
====== ======== ========= ======== ========== ======== ========
See accompanying notes.
F-6
44
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------------------
1995 1996 1997
-------- --------- -----------
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 1,116 $ 2,603 7,439
Adjustments to reconcile net income to net cash
provided by (used in) operating activities :
Depreciation and amortization . . . . . . . . . . . . 1,104 1,697 2,661
Deferred income taxes . . . . . . . . . . . . . . . . 2,191 917 (794)
Bad debt expense . . . . . . . . . . . . . . . . . . 129 280 1,855
Loss (gain) on disposal of assets . . . . . . . . . . 2 (9) 7
Changes is operating assets and liabilities:
Cash and cash equivalents - restricted . . . . . . . 697 -- --
Accounts receivable . . . . . . . . . . . . . . . . (3,395) (2,525) (5,906)
Workers' compensation deposits . . . . . . . . . . . 2,776 1,038 --
Prepaid expenses . . . . . . . . . . . . . . . . . . (1,717) 1,362 (712)
Other assets . . . . . . . . . . . . . . . . . . . . (109) (1,281) 154
Accounts payable . . . . . . . . . . . . . . . . . . 738 (893) 827
Payroll taxes and other payroll
deductions payable . . . . . . . . . . . . . . . . (373) 270 9,091
Accrued workers' compensation claims . . . . . . . . (4,780) (985) --
Other accrued liabilities . . . . . . . . . . . . . 2,384 6,858 5,425
Income taxes payable (refundable) . . . . . . . . . (3,023) 2,470 463
-------- ------- ---------
Total adjustments. . . . . . . . . . . . . . . . . (3,376) 9,199 13,071
-------- ------- ---------
Net cash provided by (used in)
operating activities . . . . . . . . . . . . . . (2,260) 11,802 20,510
Cash flows from investing activities:
Marketable securities:
Purchases . . . . . . . . . . . . . . . . . . . . . . (2,521) -- (51,784)
Proceeds from dispositions . . . . . . . . . . . . . 6,530 728 25,647
Property and equipment:
Purchases . . . . . . . . . . . . . . . . . . . . . . (4,619) (3,976) (7,147)
Proceeds from dispositions . . . . . . . . . . . . . 15 20 54
Additions to intangible assets . . . . . . . . . . . . . (610) (245) (226)
-------- ------- ---------
Net cash used in investing activities . . . . . . (1,205) (3,473) (33,456)
F-7
45
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
Year Ended December 31,
------------------------------------
1995 1996 1997
--------- ----------- ----------
Cash flows from financing activities:
Long-term debt and short-term borrowings:
Proceeds . . . . . . . . . . . . . . . . . . . . . . $ -- $ 2,500 $ --
Repayments . . . . . . . . . . . . . . . . . . . . . (328) (2,576) (4,603)
Deferred financing costs . . . . . . . . . . . . . . (99) (3) --
Proceeds from the issuance of common stock . . . . . . . -- -- 47,408
Purchase of treasury stock . . . . . . . . . . . . . . . -- -- (1,999)
Repurchase of common stock purchase warrants . . . . . . -- -- (542)
Prepaid expenses - initial public offering costs . . . . (745) (1,050) (282)
Proceeds from the exercise of common
stock purchase warrants . . . . . . . . . . . . . . . -- -- 48
Proceeds from the exercise of stock options . . . . . . 397 -- 156
Loans to employees. . . . . . . . . . . . . . . . . . . . (835) (300) (46)
Other . . . . . . . . . . . . . . . . . . . . . . . . . -- -- 7
-------- --------- ---------
Net cash provided by (used in) financing activities. (1,610) (1,429) 40,147
-------- --------- ---------
Net increase (decrease) in cash and cash equivalents . . . (5,075) 6,900 27,201
Cash and cash equivalents at beginning of year . . . . . . 11,535 6,460 13,360
-------- --------- ---------
Cash and cash equivalents at end of year . . . . . . . . . $ 6,460 $ 13,360 $ 40,561
======== ========= =========
Supplemental disclosures:
Cash paid for interest . . . . . . . . . . . . . . . . . $ 787 $ 1,005 $ 62
Cash paid (refunds received) for income taxes . . . . . $ 1,900 $ (1,176) $ 4,800
See accompanying notes.
F-8
46
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
1. Accounting Policies
Description of Business
Administaff, Inc. ("the Company") is a professional employer organization
("PEO") that provides a comprehensive Personnel Management System which
encompasses a broad range of services, including benefits and payroll
administration, medical and workers' compensation insurance programs, personnel
records management, liability management, employee recruiting and selection,
performance management, and training and development services to small and
medium-sized businesses in several strategically selected markets. The Company
operates primarily in the state of Texas.
Principles of Consolidation
The consolidated financial statements include the accounts of Administaff,
Inc. and its wholly owned subsidiaries. Intercompany accounts and transactions
have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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.
Cash and Cash Equivalents
Cash and cash equivalents include bank deposits and short-term investments
with original maturities of three months or less at the date of purchase.
Concentrations of Credit Risk
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable. The Company
generally requires clients to pay no later than one day prior to the applicable
payroll date, and receipt of funds is verified prior to the release of payroll.
As such, the Company generally does not require collateral.
Marketable Securities
The Company accounts for marketable securities in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. The Company determines the
appropriate classification of all marketable securities as held-to-maturity,
available-for-sale or trading at the time of purchase and re-evaluates such
classification as of each balance sheet date. At December 31, 1997, all of the
Company's investments in marketable securities are classified as
available-for-sale, and as a result, are reported at fair value. Unrealized
gains and losses, net of tax, are reported as a separate component of
stockholders' equity. The amortized cost of debt securities is adjusted for
amortization of premiums and accretion of discounts from the date of purchase
to maturity. Such amortization is included in interest income as an addition
to or deduction from the coupon interest earned on the investments. The cost
of investments sold is based on the average cost method, and realized gains and
losses are included in other income (expense).
F-9
47
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property and Equipment
Property and equipment is recorded at cost and is depreciated over the
estimated useful lives of the related assets using the straight-line method.
The estimated useful lives of property and equipment for purposes of computing
depreciation are as follows:
Buildings and improvements . . . . . . . . . . . . . . . . 7-30 years
Computer equipment . . . . . . . . . . . . . . . . . . . . 5-10 years
Furniture and fixtures . . . . . . . . . . . . . . . . . . 3-10 years
Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . 5 years
In connection with the construction of an additional corporate facility which
was completed in February 1996, the Company capitalized $74,000 and $60,000 of
interest costs for the years ended December 31, 1995 and 1996, respectively.
PEO Service Fees and Worksite Employee Payroll Costs
The Company's revenues consist of service fees paid by its clients under
its Personnel Management Services Agreements. In consideration for payment of
such service fees, the Company agrees to pay the following direct costs
associated with the worksite employees: (i) salaries and wages, (ii) employment
related taxes, (iii) employee benefit plan premiums and (iv) workers'
compensation insurance premiums. The Company accounts for PEO service fees and
the related direct payroll costs using the accrual method. Under the accrual
method, PEO service fees relating to worksite employees with earned but unpaid
wages at the end of each period are recognized as unbilled revenues and the
related direct payroll costs for such wages are accrued as a liability during
the period in which wages are earned by the worksite employee. Subsequent to
the end of each period, such wages are paid and the related PEO service fees
are billed. Unbilled receivables at December 31, 1996 and 1997 are net of
prepayments received prior to year-end of $2,371,000 and $4,850,000,
respectively.
Intangible Assets
Intangible assets include software development costs and referral fee costs
paid for the enrollment of certain clients previously with an unrelated PEO.
Software development costs at December 31, 1996 and 1997 include costs to
redesign and upgrade the Company's computerized payroll and management
information system, which was completed and placed in service in July 1997.
These costs are being amortized using the straight-line method over a period of
five years. The referral fee costs are being amortized over a period of five
years, which is the expected average retention period for the related clients.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable and accounts payable
approximate their fair values due to the short-term maturities of these
instruments.
Stock-Based Compensation
The Company accounts for stock-based compensation arrangements with
employees under the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.
F-10
48
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Advertising
The Company expenses all advertising costs as incurred.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and income tax carrying amounts of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Per Share Information
SFAS No. 128, Earnings Per Share, was issued in February 1997. SFAS No.
128 replaced the calculations of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is similar to the
previously reported fully diluted earnings per share. In connection with the
Company's adoption of SFAS No. 128 in the fourth quarter of 1997, earnings per
share calculations for all periods are presented, and where appropriate,
restated to conform with the requirements of SFAS No. 128.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
2. Marketable Securities
As of December 31, 1997, the Company's investments in marketable securities
consist of debt securities with maturities ranging from 91 days to two years
from the date of purchase. Approximately 40% of the marketable securities are
due within one year of the balance sheet date. The following is a summary of
the Company's available-for-sale marketable securities as of December 31, 1997:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ ------------ ------------ ----------
(in thousands)
Obligations of state and local
government agencies . . . . . . . . . . $ 20,125 $ 32 $ -- $ 20,157
U.S. corporate debt securities . . . . . . 3,088 2 -- 3,090
U.S. Treasury securities and obligations
of U.S. government agencies . . . . . . 2,769 -- (4) 2,765
-------- ------- ------- ---------
$ 25,982 $ 34 $ (4) $ 26,012
======== ======= ======= =========
For the year ended December 31, 1997, gross realized gains and losses on sales
of available-for-sale marketable securities were $21,000 and $7,000,
respectively. At December 31, 1997, the Company's marketable securities
include unamortized premiums of $440,000. During the year ended December 31,
1997, premium amortization of $200,000 and discount accretion of $31,000 were
included in interest income.
F-11
49
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Long-term Debt
Following is a summary of long-term debt:
December 31,
------------------------------
1996 1997
---- ----
(in thousands)
Subordinated notes to a related party,
interest at 13%, repaid in February 1997 . . . . . . . . . . . . $ 4,000 $ --
$610,000 note payable to bank,
interest at prime plus 1%, repaid in February 1997 . . . . . . . 452 --
Mortgage note payable to developers,
interest at 8.5%, repaid in February 1997 . . . . . . . . . . . 38 --
Mortgage note payable to bank,
interest at 8.375%, repaid in February 1997 . . . . . . . . . . 113 --
------- -------
Total long-term debt . . . . . . . . . . . . . . . . . . . . . . . 4,603 --
Less current maturities . . . . . . . . . . . . . . . . . . . . . . (491) --
------- -------
Noncurrent portion . . . . . . . . . . . . . . . . . . . . . . . . $ 4,112 $ --
======= =======
In October 1995, the Company's wholly-owned subsidiary, Administaff of
Texas, Inc., entered into a $10 million revolving credit agreement with a bank.
In October 1997, the credit agreement expired and the Company elected not to
exercise the credit agreement's extension provision because utilization of this
credit facility was not expected within the one-year extension term.
4. Income Taxes
Deferred taxes reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities used for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the net deferred tax assets and net deferred tax liabilities as reflected on
the balance sheet are as follows:
December 31,
------------------------------
1996 1997
---- ----
(in thousands)
Deferred tax liabilities:
Accrual of PEO service fees and costs . . . . . . . . . . . . $ (1,190) $ --
Software development costs . . . . . . . . . . . . . . . . . . -- (208)
Depreciation and amortization . . . . . . . . . . . . . . . . (390) (473)
-------- ---------
Total deferred tax liabilities . . . . . . . . . . . . . . (1,580) (681)
Deferred tax assets:
Uncollectible accounts receivable . . . . . . . . . . . . . . 142 105
Other accrued liabilities . . . . . . . . . . . . . . . . . . 263 246
State income taxes . . . . . . . . . . . . . . . . . . . . . . 165 94
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 113
-------- ---------
Total deferred tax assets . . . . . . . . . . . . . . . . . 663 558
-------- ---------
Net deferred tax liabilities . . . . . . . . . . . . . . . . . . $ (917) $ (123)
======== =========
Net current deferred liabilities . . . . . . . . . . . . . . . . $ (917) $ --
Net noncurrent deferred tax liabilities . . . . . . . . . . . . . -- (322)
Net current deferred tax assets . . . . . . . . . . . . . . . . -- 199
-------- ---------
$ (917) $ (123)
======== =========
F-12
50
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The components of income tax expense are as follows:
Year Ended December 31,
------------------------
1995 1996 1997
---- ---- ----
(in thousands)
Current income tax expense (benefit):
Federal . . . . . . . . . . . . . . . . . . . . . . . . . $ (948) $ 928 $ 4,628
State . . . . . . . . . . . . . . . . . . . . . . . . . . (174) 366 635
------- ------- -------
Total current income tax expense (benefit) . . . . . . (1,122) 1,294 5,263
Deferred income tax expense (benefit):
Federal . . . . . . . . . . . . . . . . . . . . . . . . . 1,902 900 (825)
State . . . . . . . . . . . . . . . . . . . . . . . . . . 289 17 31
------- ------- -------
Total deferred income tax expense (benefit) . . . . . . 2,191 917 (794)
------- ------- -------
Total income tax expense . . . . . . . . . . . . . . . . . . $ 1,069 $ 2,211 $ 4,469
======== ======== ========
In 1995, a tax benefit of $1.1 million resulting from deductions relating
to the exercise of certain non-qualified employee stock options was recorded as
an increase in stockholders' equity.
The reconciliation of income tax expense computed at U. S. federal
statutory tax rates to the reported income tax expense is as follows:
Year Ended December 31,
--------------------------
1995 1996 1997
---- ---- ----
(in thousands)
Expected income tax expense at 34% . . . . . . . . . . . . $ 743 $ 1,637 $ 4,048
State income taxes, net of federal benefit . . . . . . . . 218 253 446
Nondeductible expenses . . . . . . . . . . . . . . . . . . 1 272 74
Tax-exempt interest income . . . . . . . . . . . . . . . . -- -- (126)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . 107 49 27
------- ------- -------
Reported total income tax expense . . . . . . . . . . . . $ 1,069 $ 2,211 $ 4,469
======= ======= =======
5. Stockholders' Equity
The Company completed an initial public offering in January 1997. The net
proceeds to the Company from the sale of the 3,000,000 shares of common stock
offered by the Company (after deducting underwriting discounts and commissions
of $3.6 million) were $47.4 million. In addition, during the registration
process, the Company incurred $2.1 million in legal, accounting, printing and
other costs, which were offset against the proceeds of the offering as a
component of additional paid-in capital. The Company utilized approximately
$7.1 million of the proceeds as follows: (i) $4.6 million to repay certain
subordinated notes and other secured notes comprising all of the Company's
outstanding indebtedness at the time the offering was completed, (ii)
approximately $2.0 million to exercise its option to repurchase 348,945 shares
of common stock from one of its stockholders, which is now held in treasury by
the Company, and (iii) approximately $0.5 million to exercise its option to
repurchase 173,609 warrants to purchase shares of common stock from the
subordinated note holder. With the remaining proceeds, the Company intends to
support expansion of its operations, including the opening of sales offices in
new geographic markets as well as in established markets and, as favorable
opportunities arise, expansion of the Company's client base in new or existing
markets through marketing or other business alliances or acquisitions of
existing PEO offices. For the year ended December 31, 1997, the Company
incurred $7.1 million in capital expenditures primarily related to the opening
of sales offices and the necessary corporate infrastructure and technology to
support this expansion. Pending the application of such funds, the Company has
invested the net proceeds of the offering in diversified, highly-liquid,
investment grade, interest-bearing instruments.
F-13
51
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In May 1994, the Company entered into a Stock Purchase Agreement with a
private investor whereby the investor purchased 1,532,303 shares of common
stock from the Company at a price of $2.61 per share. The Company realized net
proceeds of $3,571,000. This transaction provided the Company with an option
to repurchase up to 348,945 of the shares. The Company exercised this
repurchase option using a portion of the proceeds from its initial public
offering.
In connection with the issuance of $4,000,000 in subordinated notes in
1994, the Company issued warrants to purchase 694,436 shares of common stock at
a price of $2.61 per share to the note holder. This transaction provided the
Company with an option to repurchase 173,609 of the warrants or related shares.
The Company exercised this repurchase option using a portion of the proceeds
from its initial public offering. During 1997, all remaining warrants were
exercised by the note holder.
In 1994, the Company issued warrants to purchase 153,230 shares of common
stock with escalating exercise prices to a third party. In connection with
the Company's initial public offering, 12,722 of such warrants were exercised
at a price of $3.77 per share during 1997. Subsequent to December 31, 1997,
the remaining 140,508 warrants were exercised at a price of $4.52 per share and
the Company repurchased these shares from the warrant holder at a price of $21
per share.
In January 1998, the Company agreed to repurchase 150,000 shares of common
stock from three stockholders, two of whom are former officers of the Company
and one who is a current director of the Company, for a total cost of $3.1
million. The cost of this common stock repurchase was paid in March 1998.
During 1995, options to purchase 448,667 shares of common stock at a price
of $0.75 per share and 40,000 shares of common stock at a price of $1.50 per
share were exercised by an officer/director and employee of the Company,
respectively.
6. Employee Incentive Plan
The Administaff, Inc. 1997 Incentive Plan, as amended, (the "Incentive
Plan"), provides for options which may be granted to eligible employees of the
Company or its subsidiaries for the purchase of an aggregate of 882,957 shares
of Common stock of the Company. Stock options granted to employees under the
Incentive Plan are intended to qualify as "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code (the "Code"). The purpose
of the Incentive Plan is to further the growth and development of the Company
and its subsidiaries by providing, through ownership of stock of the Company,
an incentive to employees of the Company and its subsidiaries, to increase such
persons' interests in the Company's welfare, and to encourage them to continue
their services to the Company and its subsidiaries.
The Incentive Plan is administered by the Board of Directors (the "Board").
The Board has the power to determine which eligible employees will receive
stock option rights, the timing and manner of the grant of such rights, the
exercise price, the number of shares, and all of the terms of the options. The
Board has granted limited authority to the President of the Company regarding
the granting of stock options. The Board may at any time terminate or amend
the Incentive Plan, provided that no such amendment may adversely affect the
rights of optionees with regard to outstanding options. Further, no material
amendment to the Incentive Plan, such as an increase in the total number of
shares covered by the Incentive Plan, a change in the class of persons eligible
to receive options, a reduction in the exercise price of options, and extension
of the latest date upon which options may be exercised, shall be effective
without stockholder approval. The Incentive Plan also provides for other types
of incentive awards to be granted by the Board, including, but not limited to,
stock awards, phantom stock and other stock-based awards. Through December 31,
1997, no awards other than stock options have been granted under the Incentive
Plan.
F-14
52
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 1997, options to purchase 176,193 shares were exercisable.
The weighted average remaining contractual life of all outstanding options at
December 31, 1997 was approximately 8.6 years. The weighted average fair value
of options granted during 1995, 1996 and 1997 was $4.64, $5.77 and $7.99
respectively. At December 31, 1997, options to purchase 206,571 shares of
common stock were available for future grants under the Incentive Plan.
Changes in outstanding options granted pursuant to the Incentive Plan are
summarized in the table below.
Exercise Total
Price Proceeds Upon
Shares Per Share Exercise
-------- --------------- -------------
Outstanding at December 31, 1994 . . . . . . . . . . . . -- $ -- $ --
Granted . . . . . . . . . . . . . . . . . . . . . . . 340,905 6.00 - 13.50 3,876,000
------- --------------- -------------
Outstanding at December 31, 1995 . . . . . . . . . . . . 340,905 6.00 - 13.50 3,876,000
Granted . . . . . . . . . . . . . . . . . . . . . . . 22,234 13.50 300,000
Canceled . . . . . . . . . . . . . . . . . . . . . . . (17,083) 13.50 (231,000)
------- --------------- -------------
Outstanding at December 31, 1996 . . . . . . . . . . . . 346,056 6.00 - 13.50 3,945,000
Granted . . . . . . . . . . . . . . . . . . . . . . . 367,875 13.50 - 23.25 7,490,000
Exercised . . . . . . . . . . . . . . . . . . . . . . (21,153) 6.00 - 13.50 (156,000)
Canceled . . . . . . . . . . . . . . . . . . . . . . . (37,545) 13.50 - 18.37 (579,000)
------- --------------- -------------
Outstanding at December 31, 1997 . . . . . . . . . . . . 655,233 $ 6.00 - $23.25 $ 10,700,000
======= =============== =============
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its stock-based compensation arrangements
because, as discussed below, the alternative fair value accounting provided for
under SFAS No. 123, Accounting for Stock-Based Compensation, requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, no compensation expense is recognized because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, which also requires that the information be
determined as if the Company had accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method prescribed
by SFAS No. 123. The fair value for these options was estimated at the date of
grant using a Black-Scholes option pricing model with the following
assumptions:
Year Ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . 6.0% 6.0% 5.6%
Expected dividend yield . . . . . . . . . . . . . . . . . . . . . 0.0% 0.0% 0.0%
Expected volatility . . . . . . . . . . . . . . . . . . . . . . . 0.45 0.45 0.34
Weighted average expected life (in years) . . . . . . . . . . . . 3.4 3.3 5.0
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective
F-15
53
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
input assumptions can materially affect the fair value estimate, in the
Company's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information, as if the Company had accounted for its
employee stock options granted subsequent to December 31, 1994 under the fair
value method prescribed by SFAS No. 123, follows:
Year Ended December 31,
----------------------------
1995 1996 1997
------- ------- -------
Pro forma net income (in thousands) . . . . . . . . . . . . . . . $ 891 $ 2,297 $ 6,995
Pro forma diluted earnings per share . . . . . . . . . . . . . . $ 0.08 $ 0.21 $ 0.50
7. Earnings Per Share
The numerators and denominators used in the calculation of basic and
diluted earnings per share were determined as follows:
Year Ended December 31,
-------------------------
1995 1996 1997
---- ---- ----
(in thousands)
Numerator:
Basic earnings per share - net income . . . . . . . . . . $ 1,116 $ 2,603 $ 7,439
Interest saved on assumed conversion of debt . . . . . . . -- 143 --
------- ------- -------
Diluted earnings per share -
net income available to common stockholders . . . . . . $ 1,116 $ 2,746 $ 7,439
======= ======= =======
Denominator:
Basic earnings per share - weighted average
shares outstanding. . . . . . . . . . . . . . . . . . . . 10,497 10,726 13,298
Effect of dilutive securities:
Common stock purchase warrants - if-converted method . . -- 694 --
Common stock purchase warrants - treasury stock method 109 118 449
Common stock options - treasury stock method . . . . . 159 57 175
------- ------- -------
268 869 624
------- ------- -------
Diluted earnings per share - weighted average shares
outstanding plus effect of dilutive securities . . . . 10,765 11,595 13,922
======= ======= =======
8. Operating Leases
The Company leases various furniture, office facilities, and equipment
under operating leases. Most of the leases contain purchase and/or renewal
options at fair market and fair rental value, respectively. Rental expense
relating to all operating leases was $1,126,000, $1,144,000 and $1,130,000 in
1995, 1996 and 1997, respectively. At December 31, 1997, future minimum rental
payments under noncancelable operating leases are as follows (in thousands):
1998 . . . . . . . . . . . . . . . . . . . . . . $ 1,019
1999 . . . . . . . . . . . . . . . . . . . . . . 723
2000 . . . . . . . . . . . . . . . . . . . . . . 575
2001 . . . . . . . . . . . . . . . . . . . . . . 411
2002 and thereafter . . . . . . . . . . . . . . 174
-------
$ 2,902
=======
F-16
54
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Employee Savings Plan
The Company has adopted a 401(k) profit sharing plan (the Plan) for the
benefit of all eligible employees as defined in the plan agreement. The Plan is
a defined-contribution plan to which eligible employees may make contributions,
on a pre-tax basis, of from 1% to 20% of their compensation during each year
while they are a plan participant. Under the Plan, employee salary deferral
contributions are limited to amounts established by tax laws. Participants are
at all times fully vested in their salary deferral contributions to the Plan
and the earnings thereon. All amounts contributed pursuant to the Plan are held
in a trust and invested, pursuant to the participant's election, in one or more
investment funds offered by a third-party custodian.
Employees are eligible to participate in the Plan on the entry date
coincident with or next following age 21 and upon completion of at least 1,000
hours of service. Client company owners and highly compensated employees
assigned to clients which have less than 85% of their workforce employed by the
Company are not eligible to participate. Entry dates are the first day of each
calendar month. Service with a client company is credited for eligibility and
vesting purposes under the plan.
Effective June 1, 1994 the Plan was amended to add the option of offering
matching contributions to certain worksite employees under Section 401(m) of
the Code. The Company does not make matching contributions to the Plan for its
corporate employees. Under this option, if approved by the Company, worksite
employees at the approved worksites may elect to participate in the matching
program, pursuant to which the client companies contribute 50% of an employee's
contributions up to 6% of the employee's compensation each pay period.
Participants vest in these matching contributions on a graduated basis over
five years with 20% vesting after one year of service and 100% vesting after
five years of service. For employees participating in the matching program, the
maximum salary deferral contribution is 17% rather than 20%. In addition,
participants shall be fully vested in these matching contributions upon normal
retirement (i.e., attainment of age 65) or death. Total matching contributions
related to worksite employees for the years ended December 31, 1995, 1996 and
1997 were $420,000, $993,000 and $1,674,000, respectively, all of which were
reimbursed to the Company by the client companies.
10. Related Party Transactions
Accounts receivable from related parties includes $439,000 and $163,000
from employees of the Company at December 31, 1996 and 1997, respectively.
In April 1996, the Company entered into a settlement agreement relating to
litigation in which the Company and Technology and Business Consultants, Inc.
("TBC") were co-defendants. TBC is a company whose stockholders were three
directors/officers of the Company. In accordance with the settlement
agreement, $285,000 was paid to the plaintiff. The Company paid the entire
amount of the settlement; however, TBC agreed to reimburse the Company for the
entire amount of the settlement not recovered through the Company's general
liability insurance. In August 1996, the Company received $113,000 pursuant to
such coverage. The remaining $172,000 was reimbursed by TBC prior to December
31, 1996.
In October 1996, the Company purchased various computer equipment from TBC
at a total cost of $209,000.
In June 1995, an officer and director of the Company exercised options to
purchase 448,667 shares of common stock at a price of $0.75 per share. The
purchase price was paid in cash by the officer. In connection with the
exercise, the Company entered into a loan agreement with the officer, whereby
the Company paid certain federal income tax withholding requirements related to
the stock option exercise on behalf of the officer in the amount of $694,000.
The loan agreement called for an additional amount to be advanced to the
officer in the event the ultimate tax liability
F-17
55
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
resulting from the exercise exceeded the statutory withholding requirements.
In April 1996, the Company loaned the officer an additional $300,000 relating
to this transaction. The loans are repayable in five years, accrue interest at
6.83%, and are secured by 388,415 shares of the Company's common stock.
In September 1995, an employee, who is now an officer of the Company,
exercised options to purchase 40,000 shares of common stock at a price of $1.50
per share. The purchase price was paid in cash by the employee. In connection
with the exercise, the Company entered into a loan agreement with the employee,
whereby the Company paid certain federal income tax withholding requirements
related to the stock option exercise on behalf of the employee in the amount of
$141,000. In June 1997, the Company loaned the employee an additional $46,000
relating to this transaction. The loans are repayable in five years, accrue
interest at 6.83% for the 1995 loan and 6.60% for the 1997 loan, and are
secured by 40,000 shares of the Company's common stock.
11. Commitments and Contingencies
The Company 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 the Company's financial
position or results of operations.
The Company's 401(k) plan is currently under audit by the Internal Revenue
Service (the "IRS") for the year ended December 31, 1993. Although the audit
is for the 1993 plan year, certain conclusions of the IRS would be applicable
to other years as well. In addition, the IRS has established an Employee
Leasing Market Segment Group (the "Market Segment Group") for the purpose of
identifying specific compliance issues prevalent in certain segments of the PEO
industry. Approximately 70 PEOs, including the Company, have been randomly
selected by the IRS for audit pursuant to this program. One issue that has
arisen from these audits is whether a PEO can be a co-employer of worksite
employees, including officers and owners of client companies, for various
purposes under the Code, including participation in the PEO's 401(k) plan.
With respect to the 401(k) Plan audit, the IRS Houston District has sought
technical advice (the "Technical Advice Request") from the IRS National Office
about (1) whether participation in the 401(k) Plan by worksite employees,
including officers of client companies, violates the exclusive benefit rule
under the Code because they are not employees of the Company, and (2) whether
the 401(k) Plan's failure to satisfy a nondiscrimination test relating to
contributions should result in disqualification of the 401(k) Plan because the
Company has failed to provide evidence that it satisfies an alternative
discrimination test. A copy of the Technical Advice Request and the Company's
response have been sent to the IRS National Office for review. The Technical
Advice Request contains the conclusions of the IRS Houston District with
respect to the 1993 plan year that the 401(k) Plan should be disqualified
because it (1) covers worksite employees who are not employees of the Company,
and (2) failed a nondiscrimination test applicable to contributions and the
Company has not furnished evidence that the 401(k) Plan satisfies an
alternative test. The Company's response to the Technical Advice Request
refutes the conclusions of the IRS Houston District. The Company also
understands that, with respect to the Market Segment Group study, the issue of
whether a PEO and a client company may be treated as co-employers of worksite
employees for certain federal tax purposes (the "Industry Issue") has been
referred to the IRS National Office.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. Should the IRS conclude that
the Company is not a "co-employer" of worksite employees for purposes of the
Code, worksite employees could not continue to make salary deferral
contributions to the 401(k) Plan or pursuant to the Company's cafeteria plan or
continue to participate in certain other employee benefit plans of the Company.
The Company believes that, although unfavorable to the Company, a prospective
application of such a conclusion (that is, one applicable only to periods after
the conclusion by the IRS is finalized) would not have a material adverse
effect on its financial position or results of operations, as the Company could
continue to make available comparable benefit
F-18
56
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
programs to its client companies at comparable costs to the Company. However,
if the IRS National Office adopts the conclusions of the IRS Houston District
set forth in the Technical Advice Request and any such conclusions were applied
retroactively to disqualify the 401(k) Plan for 1993 and subsequent years,
employees' vested account balances under the 401(k) Plan would become taxable,
the Company would lose its tax deductions to the extent its matching
contributions were not vested, the 401(k) Plan's trust would become a taxable
trust and the Company would be subject to liability with respect to its failure
to withhold applicable taxes with respect to certain contributions and trust
earnings. Further, the Company would be subject to liability, including
penalties, with respect to its cafeteria plan for the failure to withhold and
pay taxes applicable to salary deferral contributions by employees, including
worksite employees. In such a scenario, the Company also would face the risk
of client dissatisfaction and potential litigation. While the Company is not
able to predict either the timing or the nature of any final decision that may
be reached with respect to the 401(k) Plan audit or with respect to the
Technical Advice Request or the Market Segment Group study and the ultimate
outcome of such decisions, the Company believes that a retroactive application
of an unfavorable determination is unlikely. The Company also believes that a
prospective application of an unfavorable determination will not have a
material adverse effect on the Company's consolidated financial position or
results of operations.
In addition to the 401(k) Plan audit and Market Segment Group Study, the
Company notified the IRS of certain operational issues concerning
nondiscrimination test results for certain prior plan years. In 1991, the
Company engaged a third party vendor to be the 401(k) Plan's record keeper and
to perform certain required annual nondiscrimination tests for the 401(k) Plan.
Each year such record keeper reported to the Company that such
nondiscrimination tests had been satisfied. However, in August 1996 the 401(k)
Plan's record keeper advised the Company that certain of these tests had been
performed incorrectly for prior years and, in fact, that the 401(k) Plan had
failed certain tests for the 1993, 1994 and 1995 plan years. The Company has
subsequently determined that the 401(k) Plan also failed a nondiscrimination
test for 1991 and 1992, closed years for tax purposes. At the time the Company
received such notice, the period in which the Company could voluntarily "cure"
this operational defect had lapsed for all such years except 1995.
With respect to the 1995 plan year, the Company has caused the 401(k) Plan
to refund the required excess contributions and earnings thereon to the
affected employees. In connection with this correction, the Company paid
approximately $47,000 for an excise tax applicable to this plan year. With
respect to all other plan years, the Company has proposed a corrective action
to the IRS under which the Company would make additional contributions to
certain plan participants which bring the plan into compliance with the
discriminations tests.
The Company has recorded an accrual for its estimate of the cost of
corrective measures and penalties for all of the affected plan years, which
accrual is reflected in Other accrued liabilities - noncurrent on the
Consolidated Balance Sheets. The Company calculated its estimates based on its
understanding of the resolution of similar issues with the IRS. Separate
calculations were made to determine the Company's estimate of both the cost of
corrective measures and penalties for each plan year. In addition, the Company
has recorded an asset for an amount recoverable from the 401(k) Plan's record
keeper should the Company ultimately be required to pay the amount accrued for
such corrective measures and penalties, which amount is reflected in Other
assets on the Consolidated Balance Sheets. The amount of the accrual is the
Company's estimate of the cost of corrective measures and practices, although
no assurance can be given that the actual amount that the Company may be
ultimately required to pay will not substantially exceed the amount accrued.
The net of these amounts is reflected on the Company's Consolidated Statement
of Operations in 1996 as a component of other income (expense), net, and their
tax effect is included in the provision for income taxes. Based on its
understanding of the settlement experience of other companies with the IRS, the
Company does not believe the ultimate resolution of this 401(k) Plan matter
will have a material adverse effect on the Company's financial condition or
results of operations.
F-19
57
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Marketing and Securities Purchase Agreements
In January, 1998, the Company entered into a Securities Purchase Agreement
with American Express Travel Related Services Company, Inc. ("American
Express") whereby the Company agreed to sell 693,126 shares of its common stock
to American Express for a total purchase price of $17.7 million. The shares of
common stock include warrants to purchase an additional 2,065,515 shares of
common stock at prices ranging from $40 to $80 per share and terms ranging from
three to seven years.
In conjunction with the Securities Purchase Agreement, the Company agreed
to enter into a Marketing Agreement with American Express to jointly market the
Company's services to American Express' substantial small business customer
base across the country. Under the Marketing Agreement, American Express will
utilize its resources to generate leads and appointments with prospects for the
Company's services. In addition, the Company and American Express will work to
jointly develop product offerings that enhance the current PEO services offered
by the Company. The Marketing Agreement has a seven year term and provides
that the Company will be the exclusive PEO partner of American Express for the
first three years. The Company will pay a commission to American Express based
upon the number of worksite employees paid after being referred to the Company
pursuant to the Marketing Agreement.
13. Quarterly Financial Data (Unaudited)
Quarter ended
----------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
(in thousands, except per share amounts)
Year ended December 31, 1996:
Revenues . . . . . . . . . . . . . . $ 194,336 $ 209,726 $ 231,190 $ 264,344
Gross profit . . . . . . . . . . . . 6,189 8,651 11,285 11,731
Operating income (loss) . . . . . . (1,302) 1,049 3,476 3,254
Net income (loss) . . . . . . . . . (909) 552 971 1,989
Basic net income (loss) per share . ($ 0.08) $ 0.05 $ 0.09 $ 0.19
Diluted net income (loss) per share ($ 0.08) $ 0.05 $ 0.09 $ 0.17
Year ended December 31, 1997:
Revenues . . . . . . . . . . . . . . $ 262,200 $ 274,792 $ 302,618 $ 374,010
Gross profit . . . . . . . . . . . . 8,790 11,646 14,028 16,805
Operating income (loss) . . . . . . (278) 750 3,921 4,953
Net income (loss) . . . . . . . . . (7) 934 2,923 3,589
Basic net income (loss) per share . $ 0.00 $ 0.07 $ 0.22 $ 0.26
Diluted net income (loss) per share $ 0.00 $ 0.07 $ 0.21 $ 0.25
F-20
58
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on
form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on form S-1 (No. 33-96952) declared effective on January
28, 1997).
4.2 Registration Rights Agreement, as amended, dated May 13, 1994, by and among Administaff, Inc.,
Pyramid Ventures, Inc. and the Board of Trustees of the Texas Growth Fund as Trustee for the
Texas Growth Fund-1991 Trust (incorporated by reference to Exhibit 4.2 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.3 Investor Agreement, as amended, date May 13, 1994 by and among Administaff, Inc., Pyramid
Ventures, Inc. and the Board of Trustees of the Texas Growth Fund as Trustee for the Texas
Growth Fund-1991 Trust (incorporated by reference to Exhibit 4.3 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.4 Common Stock Warrant, as amended, issued to the Texas Growth Fund-1991 Trust on May 13, 1994
(incorporated by reference to Exhibit 4.4 to the Registrant's Registration Statement on form S-
1 (No. 33-96952) declared effective on January 28, 1997).
4.5 Warrant Agreement, as amended, dated May 13, 1994, between Rauscher Pierce Refsnes, Inc. and
Administaff, Inc. (incorporated by reference to Exhibit 4.5 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.6 Voting Agreement, as amended, dated May 13, 1994, by and among Administaff, Inc., Pyramid
Ventures, Inc., the Board of Trustees of the Texas Growth Fund as Trustee for the Texas Growth
Fund-1991 Trust and certain stockholders of Administaff, Inc. (incorporated by reference to
Exhibit 4.6 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
4.7 Subordinated Note of Administaff, Inc. in favor of The Board of Trustees of the Texas Growth
Fund, as Trustee (incorporated by reference to Exhibit 4.7 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
4.8 Rights Agreement dated as of February 4, 1998, between Administaff, Inc. and Harris Trust and
Savings Bank, as Rights Agent (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
4.9 Certificate of Designations of Series A Junior Participating Preferred Stock of Administaff,
Inc. dated February 4, 1998 (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
59
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
4.10 Form of Rights Certificate (incorporated by reference to the Registrant's Form 8-A filed on
February 4, 1998).
10.1 Amended and Restated Promissory Note among Administaff, Inc., Richard G. Rawson, Dawn Rawson,
and RDKB Rawson LP, dated as of December 16, 1996, amending and restating a Promissory Note
dated June 22, 1995 (incorporated by reference to Exhibit 10.1 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.2 Amended and Restated Promissory Note among Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of December 30, 1996, amending and restating a Promissory Note
dated September 4, 1995 (incorporated by reference to Exhibit 10.2 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.3 Credit agreement between Administaff, Inc. and First National Bank of Chicago, dated as of
October 16, 1995 (incorporated by reference to Exhibit 10.3 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on January 28, 1997).
10.4 Amendment No. 1 and Waiver to Credit Agreement, dated as of March 12, 1996 (incorporated by
reference to Exhibit 10.4 to the Registrant's Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
10.5 Amended and Restated Promissory Note, dated as of December 16, 1996, among Administaff, Inc.,
Richard G. Rawson, Dawn Rawson, and RDKB Rawson LP, dated as of December 16, 1996, pursuant to
which the collateral securing the promissory notes included as Exhibit 10.1 is pledged
(incorporated by reference to Exhibit 10.5 to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28, 1997).
10.6 Amended and Restated Security Agreement-Pledge among Administaff, Inc., Jerald L. Broussard and
Mary Catherine Broussard, dated as of December 30, 1996, pursuant to which the collateral
securing the promissory note included as Exhibit 10.2 is pledged (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.7 Form of Second Amended and Restated Promissory Note (incorporated by reference to Exhibit 10.9
to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared effective on
January 28, 1997).
10.8 Form of Second Amended and Restated Security Agreement - Pledge (incorporated by reference to
Exhibit 10.10 to the Registrant's Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.9 Administaff, Inc. 1997 Incentive Plan (incorporated by reference to Exhibit 99.1 to the
Registrant's Form S-8 filed on August 20, 1997).
10.10 Administaff, Inc. 1997 Employee Stock Purchase Plan (incorporated by reference to Exhibit 99.1
to the Registrant's Form S-8 filed on September 25, 1997).
10.11 Second Amendment to the Administaff, Inc. 1997 Incentive Plan.
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.