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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, 1998.
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
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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.
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The aggregate market value of the voting stock of Administaff, Inc.
held by non-affiliates (based upon the March 1, 1999 average high and low trade
prices of these shares as reported by the New York Stock Exchange) was
approximately $132 million.
Number of shares outstanding of each of the issuer's classes of common
stock, as of March 1, 1999: 14,319,044 shares.
Part III information is incorporated by reference from the proxy
statement for the annual meeting of stockholders to be held May 4, 1999 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 7A. Qualitative and Quantitative Disclosures About Market Risk...................................... 36
Item 8. Financial Statements and Supplementary Data..................................................... 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................................................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant.............................................. 37
Item 11. Executive Compensation.......................................................................... 37
Item 12. Security Ownership of Certain Beneficial Owners and Management ................................. 37
Item 13. Certain Relationships and Related Transactions.................................................. 37
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 38
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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, health and
workers' compensation insurance programs, personnel records management, employer
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 and 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 four new sales offices and
entered two new markets during 1998. As of December 31, 1998, the Company had 22
sales offices located in 14 markets. Houston, the Company's original location,
accounted for approximately 43% of the Company's revenues for the year ended
December 31, 1998 with other Texas markets contributing an additional 29%.
During 1998, revenues grew 29% in the Texas markets and 72% in the non-Texas
markets. The Company's expansion strategy calls for the opening of a new sales
office approximately quarterly in either a new or existing market, until the
overall plan is completed. In 1999, the Company plans to open an additional
sales office in the San Francisco market and two new sales offices in the New
York City market.
The Company's expansion plan includes the establishment of marketing
partnerships and alliances as an additional means to enhance its growth
prospects. In January 1998, the Company entered into the first significant
agreement of this type with American Express Travel Related Services Company,
Inc. ("American Express").
The Company's Personnel Management System is designed to improve the
productivity and profitability of small and medium-sized businesses. It relieves
business owners and key executives of administrative and regulatory burdens and
enables 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 Client Services Agreement ("CSA") which establishes a
three party relationship whereby the Company and client act as co-employers of
the worksite
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employees. Under the CSA, Administaff assumes responsibility for 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.
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
have 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 that allow them to perform
employment-related functions more efficiently, provide employee benefits at a
level typically available only to large corporations with substantial resources
and devote more attention 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 attract and retain employees, (iii) the increasing costs
associated with health and workers' compensation insurance coverage, workplace
safety programs, employee-related complaints and litigation and (iv) trends
relating to the growth and productivity of the small and medium-sized business
community in the United States, such as outsourcing and a focus on core
competencies.
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. 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 companies, 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 and is currently licensed or registered in 17 states. The cost of
compliance with these regulations is not material to the Company's financial
position or results of 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, health and workers' compensation
insurance programs, personnel records management, employer liability management,
employee recruiting and selection, performance management and training and
development services. The Personnel Management System is designed to attract and
retain high-quality employees, while relieving the administrative and regulatory
burdens on client owners and key executives. Among the employment-related laws
and regulations that may affect a client company are the following:
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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 and Medical Leave Act
tion Act of 1987 (COBRA) o Health Insurance Portability and
o Immigration Reform and Control Act Accountability 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
administration, personnel management and employer liability management. All of
the following services are included in the Personnel Management System and are
available to all client companies.
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 and workers' compensation claims
reporting.
Benefit Plans 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 several different packages
of the other benefit plans are offered by the Company. 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 generally not available to its small and
medium-sized business target market and 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 and medium-sized businesses
normally face in the areas of benefits cost, employee recruiting and employee
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 drafting and reviewing personnel policies and employee
handbooks, 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.
Employer Liability Management. Employer liability management services
consist of several functions. First, pursuant to the Company's CSA 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
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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 includes first time and ongoing safety reviews 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 in-house and external counsel specializing in several areas
of employment law who have 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 potential effect on employer liability.
CLIENT SERVICES AGREEMENT
All clients enter into Administaff's Client Services Agreement. The CSA
generally 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 CSA 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 and statutory changes that affect the Company's costs. The
CSA also establishes the division of responsibilities between Administaff and
the client as co-employers. Pursuant to the CSA, 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 CSA is as follows:
Administaff Client Joint
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Payment of wages and related tax Assignment to, and ownership of, Implementation of policies and
reporting and remittance (state and all intellectual property rights practices relating to the
federal withholding, FICA, FUTA, employer/employee relationship
state unemployment)
Workers' compensation Section 414(o) of the Code Selection of fringe benefits,
compliance, procurement, regarding benefit discrimination including employee leave policies
management, reporting
Compliance with COBRA, Compliance with OSHA Compliance with Title VII of the
Immigration Reform and Control regulations, EPA regulations and Civil Rights Act of 1964, the Age
Act, and Consumer Credit any state or legal equivalent Discrimination in Employment Act,
Protection Act, Title III, as well as government contracting provisions, the Employment Retirement
monitoring changes in other the Fair Labor Standards Act, the Income Security Act, the Polygraph
governmental regulations governing Worker Adjustment and Retaining Protection Act, the Federal Drug
the employer/employee relationship Notification Act, professional Free Workplace Act (and any state
and updating the client when licensing requirements, fidelity or local equivalent), state
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 CSA
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 in
excess of insurance premiums 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 the employer for payroll purposes,
to pay employees for work previously performed, it retains the ability to
terminate the CSA as well as the employees upon non-payment by a client. This
right, the periodic nature of payroll and the Company's client selection process
have resulted in an excellent overall collections history.
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. This diverse client base lowers the Company's exposure to
downturns or volatility in any particular industry. However, the Company's
performance could be affected by general economic conditions within the small
and medium-sized business community.
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 heavily on client retention. Administaff's client
retention record reflects that approximately 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
of the CSA by Administaff resulting from the client's inability to make timely
payments, (ii) client non-renewal due to price factors, (iii) client business
failure or downsizing and (iv) sale, disposition or merger 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.
MARKETING AND SALES
As of December 31, 1998 , the Company had 22 sales offices located in
14 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 sales offices typically consist of six to ten
sales representatives, a district sales manager and an office administrator. The
Company's markets and their respective year of entry are as follows:
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Initial
Market Sales Offices Entry Date
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Houston 3 1986
San Antonio 1 1989
Austin 1 1989
Orlando 1 1989
Dallas 3 1993
Atlanta 2 1994
Phoenix 1 1995
Chicago 2 1995
Washington D.C. 1 1995
Denver 1 1996
Los Angeles 3 1997
Charlotte 1 1997
St. Louis 1 1998
San Francisco 1 1998
During 1998, the Company opened new sales offices in Dallas, Los
Angeles, St. Louis and San Francisco. During 1999, the Company has opened a
second sales office in the San Francisco market and intends to open two offices
in the New York City market in April 1999. Upon the opening of the New York
market, the Company will have offices in markets that include over 60% of the
Company's national target market.
The 40 markets included in the national expansion plan were identified
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 and medium-sized
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 and medium-sized
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. In 1999, the Company expects to capitalize on its
expanding national presence through the use of national radio advertising in
addition to local market coverage.
The Company's organic growth model 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. A prospective client's census
report reflects information gathered by the sales representative about the
prospect's employees, including job classification, state of employment,
workers'
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compensation claims history, health insurance claims history, salary, and
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. Concurrent 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 representative
presents the Company's bid and attempts to enroll the prospect. The Company's
selling process typically takes approximately 90 days.
In 1998 the Company implemented an additional source for the generation
of sales leads and appointments through its Marketing Agreement with American
Express. Under the terms of the Marketing Agreement, American Express is
utilizing its resources to generate appointments with prospects for the
Company's services. In addition, the Company and American Express are working 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
American Express will not enter into an alliance with another PEO 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 implementation of the Marketing Agreement began in the second
quarter of 1998. The Company and American Express have identified several groups
of customers within American Express' business units which the Company believes
have the potential for being a significant source of appointments for the
Company's sales staff. The business units identified include American Express
Small Business Services, American Express Financial Advisors ("AEFA"), American
Express Tax and Business Services, American Express Establishment Services, and
American Express Corporate Services.
In 1998 the Company's efforts with American Express were focused on
American Express Small Business Services and American Express Financial
Advisors. Selected small business corporate cardmembers are being contacted
through a telemarketing campaign designed and directed jointly with American
Express. The process includes identifying potential Administaff clients from the
database of cardmembers, contacting the business owner from a dedicated call
center facility and arranging for a face-to-face appointment with an Administaff
sales representative. Through the end of 1998, the majority of appointments set
through the Marketing Agreement were generated through these telemarketing
efforts. The AEFA channel is being developed through the use of personal
referrals from selected AEFA representatives in the Company's sales markets who
specialize in advising small and medium-sized business owners. The Company and
American Express jointly designed a compensation program for the AEFA
representatives which American Express has implemented to compensate them for
referrals that result in clients being enrolled by the Company.
In late 1998, the Company and American Express launched a co-branded web
site intended to jointly market the Company's services. The web site includes an
overview of the Company and its services and provides an opportunity for a
visitor to the site to arrange for an appointment with a sales representative.
A substantial majority of the costs associated with the telemarketing
call center, the AEFA referral and compensation program, and the co-branded web
site are paid by American Express pursuant to the terms of the Marketing
Agreement.
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, the Company considers
two such contracts to be the most significant elements of the package of
benefits provided to employees.
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The Company's group health insurance plan is provided by Aetna U.S.
Healthcare, Inc. ("Aetna"). The Company offers a range of health plan coverages
under the plan, and Administaff's comprehensive fees to its clients reflect the
coverage options selected. The Company initiated insurance coverage with Aetna
in 1989, and the current one-year policy expires on December 31, 1999. The
Company's coverage options with Aetna primarily include a PPO arrangement and an
HMO plan. All coverages are fully insured and require the Company to fund claims
and premiums up to a specified quarterly maximum amount. Aetna is required to
fund all claims and premiums, if any, in excess of the quarterly maximum amount.
These quarterly maximum 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's long-term
health care costs could be affected by its claims experience.
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 premiums are paid for complete
coverage of all claims under the policy. The current three-year policy expires
on September 30, 2001.
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 its 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 Irving, Texas (a suburb of Dallas). The
Kingwood facility handles approximately one-half of the Company's daily client
service load as well as administrative and management information processing.
The Irving facility handles approximately one-half 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 platforms are Compaq/NT and IBM RISC
6000/AIX servers and Dell workstations. The Company utilizes RISC 6000 servers
for its corporate database and Compaq/NT servers for file and other services.
Located at the Company's facilities throughout the country, these systems and
employee workstations are interconnected by a high-speed Asynchronis Transfer
Mode network operating on dedicated telecommunications facilities.
In July 1998, the Company deployed the first version of its Internet
service delivery platform, Administaff Assistant. This version included basic
functionality such as access to a personnel guide, a variety of human resources
forms, frequently asked questions, customer-specific payroll information,
searches for health care providers and links to benefits providers and other key
vendors. The Company has also approved a longer-term
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project to develop more extensive service delivery functions through Administaff
Assistant. The Company intends to extend its PEO information system to its
clients and worksite employees through Administaff Assistant, including on-line
submission and approval of payroll data and real-time access to human resource
and payroll information contained within the Company's database. The Company
believes that extending its Internet platform in this manner can provide
operating efficiencies and increase client satisfaction and retention.
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 largest PEOs in the United States in terms of revenues. The Company's
largest national competitors include Staff Leasing, Inc. and The Vincam Group,
Inc. In addition, the Company faces competition from large regional PEOs in
certain areas of the country. Due to the differing geographic regions and market
segments in which most PEOs operate, and the relatively low level of market
peneration by the industry, the Company considers its primary competition to be
the traditional in-house provision of employee-related services. However, as the
Company and other large PEOs expand nationally, the Company expects that
competition may 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 quality of
services, breadth of services, choice of benefits packages, quality of benefits,
reputation and price. The Company believes that reputation, national presence,
regulatory expertise, financial resources, risk management and information
technology capabilities distinguish leading PEOs from the rest of the industry.
The Company believes that it competes favorably in these areas. In addition, the
Company believes that its suite of products is most suitable to a segment of the
small and medium-sized business market not served by most PEOs.
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
organizations, 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"), in 1993,
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
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12
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 the employer-employee relationship. 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.
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 welfare benefits plan which includes medical, dental,
vision, life insurance, disability and employee assistance programs; a dependent
care plan; an educational assistance plan; and an adoption assistance program.
Generally, employee benefit plans are subject to provisions of both the Internal
Revenue 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 Company supplemented this filing with
additional information on October 22, 1996, and September 15, 1998. 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
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13
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. The Company understands that the
Industry Issue identified by the Market Segment Group study also was referred to
the National Office. 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.
The Company does not know whether the National Office will address the
Technical Advice Request independently of the Industry Issue. 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 as they currently exist. 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.
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14
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 the
record keeper reported to the Company that the 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 certain
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 the 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
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 recorded an accrual
during the third 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 the accrual represents 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 accrued. 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
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15
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 could 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.
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
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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, Maine, Montana, New Hampshire, Oregon, South Carolina, Tennessee and
Utah. The Company is registered or certified in Illinois, Kentucky,
Massachusetts, Minnesota, Nevada, New Mexico, 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 665 corporate office and sales employees
as of December 31, 1998. 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 Kingwood, Texas
campus-style facility is owned by the Company and includes two buildings
totaling 142,000 square feet and land totaling 17 acres. This facility includes
the Company's corporate headquarters, an operations center, a records retention
center, a data processing center and a training center. The Irving, Texas
facility is a 40,000 square foot leased facility that includes an operations
center and a data processing center. In addition, the Irving facility serves as
a backup data processing facility and disaster recovery center. The lease on
this facility expires in 2008.
The Company also leases facilities in each of its sales markets. These
offices are typically staffed by six to ten sales representatives, a district
sales manager and an office administrator.
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.
Currently, the Company has plans to open a third operations center in Atlanta
during 1999 and to expand its facilities in Kingwood. In addition, the Company
intends to lease additional facilities in new markets as appropriate.
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 its 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, 1998.
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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 1, 1999, there were 162 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. On March 5, 1999, the
closing sales price for the Company's Common Stock was $13.688.
HIGH LOW
1998
First Quarter........................................ $ 47.625 $ 24.000
Second Quarter....................................... 46.250 36.813
Third Quarter........................................ 51.750 24.438
Fourth Quarter....................................... 34.000 24.438
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,
--------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
INCOME STATEMENT DATA:
Revenues................................... $ 564,459 $ 716,210 $ 899,596 $ 1,213,620 $ 1,683,063
Gross profit............................... 25,196 28,873 37,856 51,269 68,610
Operating income ......................... 5,859 2,221 6,477 9,346 (1) 11,201
Net income ................................ 3,766 1,116 2,603 (2) 7,439 (1) 9,123
Basic net income per share ................ $ 0.39 $ 0.11 $ 0.24 (2) $ 0.56 (1) $ 0.63
Diluted net income per share............... $ 0.38 $ 0.10 $ 0.24 (2) $ 0.53 (1) $ 0.62
BALANCE SHEET DATA:
Working capital............................ $ 8,797 $ 4,737 $ 4,629 $ 46,611 $ 52,475
Total assets............................... 41,081 39,474 48,376 109,455 142,799
Total debt ................................ 5,007 4,679 4,603 -- --
Total stockholders' equity ................ 8,056 10,689 13,292 63,763 86,857
STATISTICAL DATA:
Average number of worksite employees
paid per month during period............ 15,500 19,255 22,234 26,907 34,819
Gross payroll per employee per month(3).... $ 2,268 $ 2,331 $ 2,562 $ 2,855 $ 3,083
- -----------------
(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 9 of Notes to
Consolidated Financial Statements and Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
(3) Excludes bonus payroll of worksite employees 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, health and workers' compensation insurance programs, personnel
records management, employer liability management, employee recruiting and
selection, performance management, and training and development services. As of
December 31, 1998, the Company had 22 sales offices located in 14 markets. The
Company is currently executing a long-term national expansion strategy which
targets 40 strategically selected markets. The objective of this expansion
program is to consistently increase the Company's primary unit of revenue which
is the number of worksite employees paid each month. In addition, the Company's
overall operating results are largely dependent on this unit of revenue and can
be measured in terms of revenues or costs per worksite employee paid per month.
As a result, the Company often uses this unit of measurement in analyzing and
discussing its results of operations, including the discussion in this Item 7.
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 computed 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, over time, broaden the
scope of the Company's sales and marketing efforts into 40 strategically
selected markets, where the Company's objective is to duplicate its systematic
sales and marketing approach. The Company has increased the size of its sales
force from 22 at January 1, 1994 to 147 at December 31, 1998 as a result of this
systematic expansion. The Company expects to continue this expansion strategy
until it has achieved its stated goal of 90 sales offices in 40 markets.
Direct Costs
The Company's primary direct costs are (i) the salaries and wages of
worksite employees ("payroll cost"), (ii) employment-related taxes ("payroll
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 generally have a proportionate impact on the Company's
revenues.
Payroll taxes consist of the employer's portion of Social Security and
Medicare taxes under FICA, federal unemployment taxes and state unemployment
taxes. Payroll taxes are generally paid as a percentage of payroll.
- 19 -
21
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.
Employee benefit costs are comprised primarily of health insurance costs
but also include costs of other employee benefits such as life insurance, vision
care, dental insurance, disability insurance, prescription card, education
assistance, adoption assistance, 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 program under
which premiums are paid for coverage of all accident claims occurring during the
policy period.
The Company's gross profit per worksite employee 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. Gross profit, measured
as a percent of revenue, is also affected by the comprehensive services fees and
direct cost structure; however, due to the large portion of the Company's
revenue being directly related to worksite employee payroll cost, changes in the
level of payroll cost per worksite employee can cause fluctuations in this
statistic which are not necessarily indicative of relative performance from
period to period.
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, commissions, advertising and depreciation and amortization. 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, corporate operating expenses have increased to expand the Company's
infrastructure, technology, and service capacity. The Company expects continued
growth in its operating expenses as it enters new markets and expands its
service capacity.
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 and tax exempt
interest income. 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.
- 20 -
22
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997.
The following table presents certain information related to the
Company's results of operations for the years ended December 31, 1997 and 1998
expressed on a dollar per worksite employee per month basis.
YEAR ENDED
DECEMBER 31,
------------------------ %
1997 1998 CHANGE CHANGE
---------- ---------- ---------- ----------
($ PER WORKSITE EMPLOYEE PER MONTH)
Revenues:
Fee revenue .............................. $ 3,492 $ 3,756 $ 264 7.6%
Bonus revenue ............................ 261 265 4 1.5%
Other revenue ............................ 5 7 2 40.0%
---------- ---------- ---------- ----------
3,758 4,028 270 7.2%
Direct costs:
Fee payroll of worksite employees ........ 2,855 3,083 228 8.0%
Bonus payroll of worksite employees ...... 261 265 4 1.5%
Benefits and payroll taxes ............... 476 507 31 6.5%
Other direct costs ....................... 7 9 2 28.6%
---------- ---------- ---------- ----------
3,599 3,864 265 7.4%
---------- ---------- ---------- ----------
Gross profit ................................ 159 164 5 3.1%
Operating expenses:
Salaries, wages and payroll taxes ........ 57 63 6 10.5%
General and administrative expenses ...... 39 42 3 7.7%
Commissions .............................. 15 14 (1) (6.7)%
Advertising .............................. 12 9 (3) (25.0)%
Depreciation and amortization ............ 7 9 2 28.6%
---------- ---------- ---------- ----------
130 137 7 5.4%
---------- ---------- ---------- ----------
Operating income ............................ 29 27 (2) (6.9)%
Other income ................................ 8 8 -- --
---------- ---------- ---------- ----------
Income before taxes ......................... 37 35 (2) (5.4)%
Income tax expense .......................... 14 13 (1) (7.1)%
---------- ---------- ---------- ----------
Net income .................................. $ 23 $ 22 $ (1) (4.3)%
========== ========== ========== ==========
Monthly gross markup per worksite employee .. $ 637 $ 673 $ 36 5.7%
========== ========== ========== ==========
Average number of worksite employees
paid per month during period ............. 26,907 34,819 7,912 29.4%
========== ========== ========== ==========
REVENUES
The Company's revenues increased 38.7% over 1997 due to a 29.4%
increase in worksite employees paid accompanied by a 7.6% increase in the fee
revenue per worksite employee. The Company's continued expansion of its sales
force through new market and sales office openings was the primary factor
contributing to the increase in the number of worksite employees paid. Revenues
from markets opened prior to 1993 (the commencement of the
- 21 -
23
Company's national expansion plan) increased 27% over 1997, while revenues from
markets opened after 1993 increased 59%. Revenues from the state of Texas
represented 72% of the Company's total revenues and Houston, the Company's
original market, represented 43% of the total. Revenues for the Texas markets as
a whole and the Houston market both increased 29% over 1997. The Company expects
continued growth in the number of worksite employees in 1999 due to the effect
of sales in existing markets and expansion into new markets.
The increase in fee revenue per worksite employee of $264, or 7.6%,
directly relates to the increase in payroll cost per worksite employee of $228,
or 8.0%. This increase reflects the continuing effects of the net addition of
clients with worksite employees that have a higher average base pay than the
existing client base, primarily 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. During
the fourth quarter of 1998, the Company experienced a reduction in the rate of
growth in the average payroll per worksite employee. For the quarter, the
average payroll per worksite employee increased 5.5% over the same period in
1997 compared to a 9.0% increase for the nine months ended September 30, 1998.
GROSS PROFIT
Gross profit increased 33.8% versus 1997 due primarily to the 29.4%
increase in the number of worksite employees paid accompanied by a 3.1% increase
in gross profit per worksite employee. The increase in gross profit per employee
was due to an increase in gross markup per worksite employee of $36 offset by an
increase in benefits and payroll taxes per worksite employee of $31. The
Company's pricing objectives attempt to improve the gross profit per worksite
employee by matching or exceeding changes in the overall cost of its primary
direct costs with increases in the gross markup per worksite employee. There can
be no assurances that the Company will be able to achieve these results in the
future.
Approximately half of the $36 increase in gross markup per employee
was the result of increases in the Company's comprehensive service fees, which
were designed to match or exceed known trends in the Company's primary direct
costs. The remaining increase in gross markup per employee was related to
increased service fees designed to match the increased payroll tax expense
associated with the higher average payroll cost per worksite employee.
The $31 increase in benefits and payroll taxes per worksite employee
was due to higher payroll taxes and health insurance premiums per worksite
employee, partially offset by lower workers' compensation costs per worksite
employee.
Payroll taxes increased $22 per worksite employee versus 1997.
Approximately $16 of the increase was due to the increased average payroll per
worksite employee. The remaining increase was due to a net increase in the
weighted average state unemployment tax rate paid by the Company, which
increased the overall cost of payroll taxes as a percentage of payroll cost to
7.3% in 1998 from 7.1% in 1997.
The cost of health insurance and related employee benefits increased
$16 per worksite employee versus 1997 due to a 4.9% increase in the cost per
covered employee and an increase in the percentage of worksite employees covered
under the Company's health insurance plans. Approximately 66.4% of the Company's
worksite employees were covered by these plans during 1998 versus 64.6% in 1997.
Workers' compensation costs decreased by $9 per worksite employee, and
declined from 1.6% of payroll cost in 1997 to 1.2% in 1998, due primarily to a
lower rate on the Company's fixed premium policy. In addition, the Company
received $475,000 of proceeds in 1998 from the settlement of a class action
lawsuit related to premiums paid in a prior year.
- 22 -
24
Gross profit, measured as a percent of revenue, declined from 4.22% in
1997 to 4.08% in 1998. This decline was due primarily to the increase in average
payroll per worksite employee, which had the corresponding effect of increasing
revenue and applying mathematical pressure on the gross profit margin.
OPERATING EXPENSES
Operating expenses increased 36.9% over 1997 which compared to an
increase in revenue and gross profit of 38.7% and 33.8%, respectively. The
overall increase in operating expenses can be attributed to the 29.4% growth in
worksite employees paid by the Company and the continuing investment in
infrastructure, technology and service capacity. Operating expenses per worksite
employee were $137 versus $130 for 1997.
Salaries, wages and payroll taxes of corporate and sales staff
increased from $57 per worksite employee in 1997 to $63 per worksite employee.
Approximately half of this increase relates to a 45% increase in sales office
staff, which includes district sales management, office administrators and sales
representatives. The remainder of the increase is due to a 35% increase in
corporate staff and a 3.6% increase in average payroll per corporate employee.
General and administrative expenses increased $3 per worksite employee
over 1997; however, the 1997 results included an unusual bad debt charge.
Excluding the effects of this charge, general and administrative expenses
increased $7 per worksite employee over 1997. Approximately $5 of this increase
can be attributed to professional and consulting fees incurred in relation to
ongoing technology projects, higher telecommunications costs, and the cost of
maintenance contracts on new computer hardware and software. The Company
incurred approximately $1.5 million in consulting fees related to technology
initiatives, including its Internet service delivery platform and improving and
enhancing its local area and wide area networks. The remainder of the increase
is related to the opening of four district sales offices and the new Dallas
operations center.
During the second quarter of 1997 the Company recorded a $1.3 million
(approximately $800,000 after tax) bad debt charge for the 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 has not collected, and does not expect to collect, any of
the amounts owed by the customer.
Depreciation and amortization expense increased $2 per worksite
employee as a result of the increased capital expenditures placed in service in
1997 and 1998.
Commissions expense was slightly lower per worksite employee versus
1997 due to lower sales agency commissions. Advertising costs declined $3 per
worksite employee as the Company incurred lower rates for much of its radio
advertising and utilized resources available through its marketing agreement
with American Express to generate leads and appointments for its sales
representatives.
NET INCOME
Net interest income increased 29.8% from 1997 to 1998 due to the
investment of the proceeds from the Company's initial public offering for the
entire year in 1998 and the investment of the proceeds from the sale of common
stock to American Express received in March 1998. The Company incurred no
interest expense in 1998, while the 1997 period included the write-off of
deferred financing costs relating to long-term debt that was repaid using a
portion of the proceeds from the IPO.
The Company's provision for income taxes differs from the U.S.
statutory rate of 34% primarily due to state income taxes and tax exempt
interest income. The effective income tax rate for 1998 was consistent with
1997.
- 23 -
25
Operating income and net income per worksite employee were $27 and $22
in 1998, versus $29 and $23 in 1997. The Company's net income and diluted
earnings per share for the year ended December 31, 1998 increased to $9.1
million and $0.62, versus $7.4 million and $0.53 for the year ended December 31,
1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996.
The following table presents certain information related to the
Company's results of operations for the years ended December 31, 1996 and 1997
expressed on a dollar per worksite employee per month basis.
YEAR ENDED
DECEMBER 31,
------------------------- %
1996 1997 CHANGE CHANGE
---------- ---------- ---------- ----------
($ PER WORKSITE EMPLOYEE PER MONTH)
Revenues:
Fee revenue .............................. $ 3,166 $ 3,492 $ 326 10.3%
Bonus revenue ............................ 200 261 61 30.5%
Other revenue ............................ 6 5 (1) (16.7)%
---------- ---------- ---------- ----------
3,372 3,758 386 11.4%
Direct costs:
Fee payroll of worksite employees ........ 2,562 2,855 293 11.4%
Bonus payroll of worksite employees ...... 200 261 61 30.5%
Benefits and payroll taxes ............... 462 476 14 3.0%
Other direct costs ....................... 6 7 1 16.7%
---------- ---------- ---------- ----------
3,230 3,599 369 11.4%
---------- ---------- ---------- ----------
Gross profit ................................ 142 159 17 12.0%
Operating expenses:
Salaries, wages and payroll taxes ........ 55 57 2 3.6%
General and administrative expenses ...... 30 39 9 30.0%
Commissions .............................. 15 15 -- --
Advertising .............................. 12 12 -- --
Depreciation and amortization ............ 6 7 1 16.7%
---------- ---------- ---------- ----------
118 130 12 10.2%
---------- ---------- ---------- ----------
Operating income ............................ 24 29 5 20.8%
Other income ................................ (6) 8 14 NM
---------- ---------- ---------- ----------
Income before taxes ......................... 18 37 19 105.6%
Income tax expense .......................... 8 14 6 75.0%
---------- ---------- ---------- ----------
Net income .................................. $ 10 $ 23 $ 13 130.0%
========== ========== ========== ==========
Monthly gross markup per worksite employee .. $ 604 $ 637 $ 33 5.5%
========== ========== ========== ==========
Average number of worksite employees
paid per month during period ............. 22,234 26,907 4,673 21.0%
========== ========== ========== ==========
- ---------------------
NM - Not meaningful
- 24 -
26
REVENUES
The Company's revenues increased 34.9% over 1996 due to a 21.0%
increase in worksite employees paid accompanied by a 10.3% increase in the
fee revenue per worksite employee. The Company's expansion of its sales force
through new market and sales office openings over the past four years was the
primary factor contributing to the increased number of worksite employees paid.
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 increase in fee revenue per worksite employee of $326, or 10.3%,
directly relates to the increase in fee payroll cost per worksite employee of
$292, or 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
Gross profit increased 35.4% versus 1996 due primarily to the 21.0%
increase in the number of worksite employees paid accompanied by a 12.0%
increase in gross profit per worksite employee. The increase in gross profit per
employee is due primarily to an increase in gross markup per worksite employee
of $33 offset by an increase in benefits and payroll taxes per worksite employee
of only $14.
The increase in gross markup per employee is the result of overall
increases in the Company's comprehensive service fees, which were designed to
match or exceed known trends in the Company's primary direct costs, combined
with the effects of increases in the average payroll per worksite employee.
The $14 increase in benefits and payroll taxes per worksite employee
is due to higher payroll taxes per worksite employee, partially offset by lower
costs of health insurance and workers' compensation premiums per worksite
employee. Payroll taxes increased $21 per worksite employee versus 1996 due to
the increased average payroll of worksite employees. Payroll taxes declined as a
percentage of payroll from 7.3% in 1996 to 7.1% in 1997. The cost of health
insurance and related employee benefits costs were 3.8% lower per covered
employee compared to 1996. Workers' compensation costs declined by $8 per
worksite employee, and from 2.1% of payroll in 1996 to 1.6% of payroll in 1997.
Gross profit, measured as a percent of revenue, was unchanged at 4.2%
as the effect of increases in average payroll cost per worksite employee were
offset by lower costs of benefits and workers' compensation costs per worksite
employee.
OPERATING EXPENSES
Operating expenses increased from $118 per worksite employee in 1996
to $130 per worksite employee in 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%, or $9 per
worksite employee, from 1996 to 1997. This increase primarily relates 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.
- 25 -
27
During the second quarter of 1997 the Company recorded a $1.3 million
(approximately $800,000 after tax) bad debt charge for the 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 has not collected, and does not expect to collect, any of
the amounts owed by the customer.
Salaries, wages, payroll taxes and commissions, increased 25.5%, or $2
per worksite employee, compared to 1996. The overall increase in these 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%, or $1 per
worksite employee, over the 1996 period. 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.
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 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 9 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.
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 short-term liquidity requirements. The Company will rely on these same
sources, as well as public and private debt and equity financing, to meet its
long-term liquidity and capital needs.
The Company has $73.2 million in cash and cash equivalents and
marketable securities at December 31, 1998, of which approximately $26.6 million
is payable in early January 1999 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. At
- 26 -
28
December 31, 1998 the Company had working capital of $52.5 million compared to
$46.6 million at December 31, 1997. The increase in working capital is due to
the receipt of the net proceeds from the Securities Purchase Agreement with
American Express in March 1998, offset by the use of cash and marketable
securities for capital expenditures during the year. As of December 31, 1998,
the Company had no long-term debt.
CASH FLOWS FROM OPERATING ACTIVITIES
The Company's cash flows from operating activities in 1998 were $13.9
million versus $20.5 million in 1997. The decrease of $6.6 million resulted from
a $3.3 million payment to two former sales agencies, as part of an agreement to
terminate the agency agreements, and a lower increase in the level of accrued
worksite employee payroll expense than occurred in 1997. Accrued worksite
employee payroll expense and related unbilled accounts receivable vary
significantly based on the day of the week on which a period ends. Net income,
adjusted for non-cash expense items, provided cash of $16.6 million in 1998
versus $11.2 million in 1997, an increase of 48%.
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures in 1998 totaled $17.9 million and consisted
primarily of computer equipment, furniture and fixtures, and telecommunications
equipment at the Company's headquarters, its new Dallas operations center, and
its new sales offices in Los Angeles, Dallas, St. Louis and San Francisco. The
capital expenditures included significant hardware and software related to the
Company's project to develop its Internet-based service platform, Administaff
Assistant. In addition, the Company purchased land adjacent to its Kingwood,
Texas headquarters to provide the capacity for future facilities expansion.
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, and furniture and computer
equipment related to the opening of five new sales offices.
Net purchases of marketable securities during 1998 primarily reflect
the investment of the proceeds from the Company's Securities Purchase Agreement
with American Express in highly liquid marketable securities with maturities
ranging from 91 days to five years from the date of purchase, consisting
primarily of corporate and government bonds. Net purchases of marketable
securities in the 1997 period reflect a similar investment of a portion of the
proceeds from the Company's IPO.
Investments in intangible assets during 1998 primarily represent
capitalized software development costs related to Administaff Assistant and
enhancements to the Company's proprietary professional employer information
system.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities for 1998 consist primarily of
items relating to the sale of units consisting of 693,126 shares of common stock
(293,126 shares from Treasury Stock) and common stock purchase warrants for an
additional 2,065,515 shares to American Express for a total cost of $17.7
million. Other significant cash flows from financing activities during 1998
included the exercise of warrants to purchase 140,508 shares of common stock by
a third party warrant holder at a price of $4.52 per share, the repurchase of
140,508 shares of common stock from the third party warrant holder at a price of
$21 per share, and the repurchase of 150,000 shares of common stock from three
shareholders at a price of $21 per share.
Cash flows from financing activities during 1997 consist primarily of
items resulting from the completion of the Company's IPO, which was completed 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, and
- 27 -
29
(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.
MARKETING AND SECURITIES PURCHASE AGREEMENTs
In January 1998, the Company entered into a Securities Purchase
Agreement with American Express whereby the Company sold units consisting of
693,126 shares of its common stock (293,126 shares from Treasury Stock) and
warrants to purchase an additional 2,065,515 shares of common stock to American
Express for a total purchase price of $17.7 million. The warrants include
exercise prices ranging from $40 to $80 per share and terms ranging from three
to seven years. The proceeds from this transaction, received in March 1998, are
available for general corporate purposes.
In conjunction with the Securities Purchase Agreement, the Company
entered 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 terms of the Marketing Agreement, American Express
is utilizing its resources to generate appointments with prospects for the
Company's services. In addition, the Company and American Express are working 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
American Express will not enter into an alliance with another PEO 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.
YEAR 2000
As the Company's operations rely on several internal computer systems
and third party vendor relationships, the Company believes that the Year 2000
issue presents potentially significant operational issues if not properly
addressed. The Year 2000 issue generally describes the various problems that may
result from the failure of computer and other mechanical systems to properly
process certain dates and date sensitive information.
State of Readiness. The Company has concluded the assessment phase of
its Year 2000 preparations and has identified two primary risk areas. First, the
Company's operations rely heavily on its proprietary PEO information system,
which includes several applications such as payroll processing, benefits
enrollment, bid calculation, client invoicing and direct deposit payroll
transmission. Second, the Company relies on several third party vendors to
assist in delivering its PEO services to its clients and worksite employees. The
Company believes that it does not have material risks associated with Year 2000
issues for non-information technology systems due to the nature of its
operations.
In conjunction with the redesign and upgrade of the Company's PEO
information system in 1996 and 1997, the Company addressed Year 2000 programming
issues in a manner which it believes makes the system Year 2000 compliant. The
Company intends to perform testing on the system to ensure that it is able to
process all dates appropriately. In October 1998, the Company completed the
first phase of tests designed to assess the ability of its internal operating
environment to operate appropriately under Year 2000 dates. No significant
issues were detected during this testing phase. The Company plans to test the
system for data processing accuracy through the use of test data on a wide
variety of the Company's normal operating transactions under various date
conditions. The Company believes that these tests can be completed in sufficient
time to ensure that required modifications, if any, can be made on a timely
basis.
The Company has also assessed its third party vendor relationships and
has identified approximately 40 vendors that it considers critical to the
operations of the Company. These critical vendors primarily include third party
hardware and software vendors, financial institutions and benefit providers. The
Company has requested written information from each of these vendors regarding
their Year 2000 plans and state of readiness. The Company has received responses
to most of the requests and is in the process of evaluating the responses. Upon
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30
completion of the evaluation, and upon completion of the testing of its PEO
information system, the Company intends to test significant data interfaces with
third party vendors to verify their compliant status.
Costs to Address Year 2000 Issues. The Company has not incurred and
does not expect to incur significant costs related to Year 2000 issues other
than the time of internal personnel to complete the Company's Year 2000 plans.
Risks Associated with Year 2000 Issues. The Company believes that the
risks associated with Year 2000 issues would primarily affect the areas of
payroll processing, electronic funds transfers and the dissemination of benefits
information electronically. Among the problems which might occur without
appropriate planning and testing are: the inability to transmit direct deposit
payroll through banking systems to deposit funds into worksite employees' bank
accounts; the inability to collect funds electronically in payment of the
Company's service fees; the failure to properly calculate payroll information;
the untimely transmission of benefits enrollment or claims data to and from
benefit providers; and the inability to deliver payroll checks to employees due
to failure in transportation or courier systems. As a result, the Company's
plans, including the testing of its systems, vendor assessment and contingency
planning, will be focused in these areas.
Contingency Planning. The Company has previously developed a disaster
recovery plan to be used in the event of unexpected business interruptions. The
Company is currently developing specific contingency plans, to complement its
disaster recovery plan, for those processes that are considered critical in
preventing an interruption of business operations as a result of Year 2000
issues.
The Company's Year 2000 plans, as discussed above, represent an ongoing
process which will continue throughout 1999. Although the Company believes it is
taking the appropriate courses of action to ensure that material interruptions
in business operations do not occur as a result of the Year 2000 conversion,
there can be no assurances that the actions discussed herein will have the
anticipated results or that the Company's financial condition or results of
operations will not be adversely affected as a result of Year 2000 issues. Among
the factors which might affect the success of the Company's Year 2000 plans are:
(i) the Company's ability to properly identify deficient systems; (ii) the
ability of third parties to adequately address Year 2000 issues or to notify the
Company of potential deficiencies; (iii) the Company's ability to adequately
address any such internal or external deficiencies; (iv) the Company's ability
to complete its Year 2000 plans in a timely manner; and (v) unforseen expenses
related to the Company's Year 2000 plans.
OTHER MATTERS
The Company had net deferred tax liabilities of $2.9 million at
December 31, 1998 versus $0.1 million at December 31, 1997. This increase is due
primarily to differences between the book and tax basis of software development
costs, prepaid commissions and depreciation.
In July 1998, the Company announced plans to accelerate the development
of Administaff Assistant, the Company's Internet-based service platform, along
with other technology and telecommunications infrastructure projects. This
decision was made based on several factors, including the Company's growth rate,
the Marketing Agreement with American Express, and the initial client response
to the Administaff Assistant project.
The Company currently expects to incur approximately $20 million of
capital expenditures during 1999, including continued software development,
hardware and software costs related to the Administaff Assistant project, the
continued implementation of a national technology platform, the opening of new
sales offices and the opening of a new operations facility. The Company believes
it has sufficient capital resources to accommodate these investments; however,
the Company may explore financing alternatives for any or all of these projects.
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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 9 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, 1998 and 1997. Based on its
understanding of the settlement experience of other companies in similar
situations, 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, results of operations or liquidity.
In November 1998, the Company entered into agreements to terminate
agency relationships with the Company's Austin and San Antonio sales agencies.
Pursuant to the agreements, the Company paid the agencies $3.3 million, with an
additional cash payment of $0.2 million due in November 1999, in exchange for
the termination of the agency agreements. These payments also represent full and
final payment of all commissions due to the former agencies. The Company is
amortizing the payment on a declining basis over the expected life of the client
base for which commissions would have been due in the future. The termination
agreements had no effect on the Company's clients or worksite employees under
contract in these two markets and the Company expects to continue to serve those
clients, subject to normal attrition patterns. Based on historical attrition
rates, the Company expects that the total cost of the termination agreements
will be less than the commissions which would have been due under the agency
agreements during the amortization period. The Company is continuing to operate
in the Austin and San Antonio markets through Company-operated sales offices
which opened immediately following the terminations.
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.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND THE MARKET PRICE OF COMMON STOCK
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 could 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 IRS Houston
District has sought technical advice (the "Technical Advice Request") from the
IRS National Office about (i) whether participation in the 401(k) Plan by
worksite employees, including officers of client companies,
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violates the exclusive benefit rule under the Code because they are not
employees of the Company and (ii) 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 for the 1993 plan
year. 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 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.
The Company does not know whether the National Office will address the
Technical Advice Request independently of the Industry Issue. 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 the record keeper reported to the Company
that the 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
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 the 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 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
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33
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
disqualification of the 401(k) Plan. The Company recorded an accrual during the
third quarter of 1996 with respect to these 401(k) Plan issues representing its
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 accrued. 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 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 9 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 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 for all states. In addition, there can be no
assurance that the Company will be able to renew its licenses in all states.
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 and structures its benefits contracts to provide as much cost
stability as possible. However, should the Company experience a large increase
in claim activity, its unemployment taxes, health insurance premiums or workers'
compensation insurance rates could increase. The Company's ability to
incorporate such increases into service fees
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34
to clients is constrained by contractual arrangements with clients, which could
result in a delay before such increases could 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 CSA 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
violations. Although the CSA 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 AND BENEFITS COSTS
Under the CSA, 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. 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 14 markets, 10 of these
represent expansion markets pursuant to the Company's national expansion plan.
The Company's Houston and Texas (including Houston) markets accounted for
approximately 43% and 72%, respectively, of the Company's revenue for the year
ended December 31, 1998. 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.
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35
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 CSA, 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
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
CSA 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
national expansion activities. These activities include the expansion of sales
activities through the opening of new sales offices and the expansion of service
capacity to accommodate the growth in the number of worksite employees paid. The
primary operating costs associated with the opening of new sales offices include
establishing and maintaining sales office facilities, compensating the sales
staff and increased advertising costs. The primary costs associated with the
expanding service capacity include the costs of hiring, training and
compensating service delivery personnel, establishing and maintaining client
services facilities and providing the tools necessary to deliver high quality
human resource services. In addition, the costs of both sales and service
expansion may often be incurred in advance of the anticipated growth resulting
from the overall sales strategy.
The Company expects continued growth in its operating expenses as it
enters new markets and expands its service capacity. While the Company believes
that its national 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. As described under the above caption
"Expenses Associated with Expansion," the costs associated with the Company's
sales and service expansion have been significant. Accordingly, the Company's
expansion plan may place a significant strain on the Company's management,
financial, operating and technical resources. Failure to
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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 CSA is subject to cancellation on 60 days'
notice by either the Company or the client. Accordingly, the short-term nature
of the CSA 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, approximately 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.
YEAR 2000
The Company's Year 2000 plans represent an ongoing process which will
continue throughout 1999. Although the Company believes it is taking the
appropriate courses of action to ensure that material interruptions in business
operations do not occur as a result of the Year 2000 conversion, there can be no
assurances that the Company's Year 2000 plans will have the anticipated results
or that the Company's financial condition or results of operations will not be
adversely affected as a result of Year 2000 issues. Among the factors which
might affect the success of the Company's Year 2000 plans are: (i) the Company's
ability to properly identify deficient systems; (ii) the ability of third
parties to adequately address Year 2000 issues or to notify the Company of
potential deficiencies; (iii) the Company's ability to adequately address any
such internal or external deficiencies; (iv) the Company's ability to complete
its Year 2000 plans in a timely manner; and (v) unforseen expenses related to
the Company's Year 2000 plans.
MARKETING AGREEMENT WITH AMERICAN EXPRESS
The Company has entered into a Marketing Agreement with American
Express to jointly market the Company's services to American Express'
substantial small and medium-sized business customer base across the country.
Under the terms of the Marketing Agreement, American Express is utilizing its
resources to generate appointments with prospects for the Company's services. In
addition, the Company and American Express are working to jointly develop
product offerings that enhance the current PEO services offered by the Company.
The Company believes that the agreement will enhance its ability to increase its
base of worksite employees and clients; however, there can be no assurances to
that effect. Among the factors that could cause the effectiveness of the
Marketing Agreement to be less than anticipated are the ability of American
Express to set qualified appointments, the Company's ability to make timely
presentations to all of the appointments set by American Express, and the
Company's ability to convert those appointments into sales.
ESTIMATED COSTS AND EFFECTIVENESS OF CAPITAL PROJECTS AND INVESTMENTS
IN INFRASTRUCTURE
The level of capital expenditures incurred by the Company has
increased substantially over the past three years, from $4.0 million in 1996 to
$19.4 million in 1998 (including additions to intangible assets, primarily
software development costs). The Company anticipates it will incur approximately
$20 million in capital expenditures in 1999 associated with ongoing capital
projects, primarily in the areas of Internet service delivery, a national
technology and telecommunications platform and expansion of facilities to house
corporate, sales and service personnel. There can be no assurances that the
Company's cost to complete these projects will be as estimated or that the
ultimate effectiveness of such projects will provide the necessary operating
efficiencies required to offset the resulting increases in depreciation and
amortization expense which accompany these expenditures. In addition, the
Company may require additional capital resources to fund these and future
capital expenditure requirements.
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ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is primarily exposed to market risks from fluctuations in
interest rates and the effects of those fluctuations on the market values of its
cash equivalent short-term investments and its available-for-sale marketable
securities. The cash equivalent short-term investments consist primarily of
overnight investments which are not significantly exposed to interest rate risk,
except to the extent that changes in interest rates will ultimately affect the
amount of interest income earned on these investments. The available-for-sale
marketable securities are subject to interest rate risk because these securities
generally include a fixed interest rate. As a result, the market values of these
securities are affected by changes in prevailing interest rates.
The Company attempts to limit its exposure to interest rate risk
primarily through diversification and low investment turnover. The Company's
marketable securities are currently managed by three professional investment
management companies, each of whom is guided by the Company's investment policy.
The Company's investment policy is designed to maximize after-tax interest
income while preserving its principal investment. As a result, the Company's
marketable securities consist primarily of short and intermediate-term debt
securities.
As of December 31, 1998, the Company's available-for-sale marketable
securities include an investment in a mutual fund which holds corporate debt
securities with maturities ranging up to 18 months. The amortized cost basis,
fair market value and interest rate of this investment is $6,964,000, $6,998,000
and 5.1% at December 31, 1998. The following table presents information about
the Company's remaining available-for-sale marketable securities as of December
31, 1998 (dollars in thousands):
Principal Average
Maturities Interest Rate
---------- -------------
1999 $ 5,585 5.9%
2000 23,100 5.4%
2001 6,090 6.4%
2002 5,739 5.3%
2003 625 5.8%
---------- ----------
Total $ 41,139 5.6%
========== ==========
Fair Market Value $ 42,672
==========
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.
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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 8 to the Consolidated
Financial Statements.
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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
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).
3.3 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).
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 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).
4.3 Form of Rights Certificate (incorporated by reference
to the Registrant's Form 8-A filed on February 4,
1998).
4.4 Securities Purchase Agreement between Administaff,
Inc. and American Express Travel Related Services
Company, Inc., dated January 27, 1998 and the Letter
Agreement between Administaff, Inc. and American
Express Travel Related Services Company, Inc., dated
March 10, 1998 amending the Securities Purchase
Agreement (incorporated by reference to the
Registrant's Form 10-Q filed on May 11, 1998).
4.5 Registration Rights Agreement between Administaff,
Inc. and American Express Travel Related Services
Company, Inc., dated March 10, 1998 (incorporated by
reference to the Registrant's Form 10-Q filed on May
11, 1998).
4.6 Warrant Agreement between Administaff, Inc. and
American Express Travel Related Services Company,
Inc., dated March 10, 1998 (incorporated by reference
to the Registrant's Form 10-Q filed on May 11, 1998).
4.7 Warrant Certificate No. 1, evidencing that American
Express Travel Related Services Company, Inc. is the
registered holder of 400,000 warrants to purchase
400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's
Form 10-Q filed on May 11, 1998).
4.8 Warrant Certificate No. 2, evidencing that American
Express Travel Related Services Company, Inc. is the
registered holder of 400,000 warrants to purchase
400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's
Form 10-Q filed on May 11, 1998).
4.9 Warrant Certificate No. 3, evidencing that American
Express Travel Related Services Company, Inc. is the
registered holder of 400,000 warrants to purchase
400,000 shares of
- 38 -
40
the common stock of Administaff, Inc. (incorporated
by reference to the Registrant's Form 10-Q filed on
May 11, 1998).
4.10 Warrant Certificate No. 4, evidencing that American
Express Travel Related Services Company, Inc. is the
registered holder of 400,000 warrants to purchase
400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's
Form 10-Q filed on May 11, 1998).
4.11 Warrant Certificate No. 5, evidencing that American
Express Travel Related Services Company, Inc. is the
registered holder of 465,515 warrants to purchase
465,515 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's
Form 10-Q filed on May 11, 1998).
10.1 Second Amended and Restated Promissory Note in the
amount of $693,694.75 among Administaff, Inc.,
Richard G. Rawson, Dawn Rawson, and RDKB Rawson LP,
dated as of July 13, 1998, amending and restating a
Promissory Note dated June 22, 1995.
10.2 Second Amended and Restated Promissory Note in the
amount of $300,000 among Administaff, Inc., Richard
G. Rawson, Dawn Rawson, and RDKB Rawson LP, dated as
of July 13, 1998, amending and restating a Promissory
Note dated April 11, 1996.
10.3 Second Amended and Restated Security Agreement-Pledge
among Administaff, Inc., Richard G. Rawson, Dawn
Rawson, and RDKB Rawson LP, dated as of July 13,
1998, pursuant to which the collateral securing the
promissory notes included in Exhibits 10.1 and 10.2
is pledged.
10.4 Second Amended and Restated Promissory Note in the
amount of $141,360 among Administaff, Inc., Jerald L.
Broussard and Mary Catherine Broussard, dated as of
June 23, 1998, amending and restating a Promissory
Note dated September 4, 1995.
10.5 Second Amended and Restated Security Agreement-Pledge
among Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of June 24, 1998,
pursuant to which the colateral securing the
promissory note incuded in Exhibit 10.4 is pledged.
10.6 Amended Promissory Note in the amount of $46,176
among Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of June 23, 1998,
amending a Promissory Note dated June 27, 1997.
10.7 Amended and Restated Security Agreement-Pledge among
Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of June 24, 1998,
pursuant to which the collateral securing the
promissory note included in Exhibit 10.6 is pledged.
10.8 Administaff, Inc. 1997 Incentive Plan (incorporated
by reference to Exhibit 99.1 to the Registrant's Form
S-8 filed on August 20, 1997).
10.9 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).
10.10 Second Amendment to the Administaff, Inc. 1997
Incentive Plan (incorporated by reference to the
Registrant's 1997 Annual Report on Form 10-K, filed
on March 13, 1998).
10.11 Marketing Agreement between American Express Travel
Related Services Company, Inc., Administaff, Inc.,
Administaff Companies, Inc. and Administaff of Texas,
Inc. dated March 10, 1998 (incorporated by reference
to the Registrant's Form 10-Q filed on May 11, 1998).
10.12 First Amendment to the Marketing Agreement between
American Express Travel Related Services Company,
Inc., Administaff, Inc., Administaff Companies, Inc.
and Administaff of Texas, Inc., dated November 17,
1998.
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
Form 8-K dated January 20, 1998, filed February 5, 1998
relating to (i) the Securities Purchase Agreement with
American Express Travel Related Services Company, Inc. and
(ii) the adoption of a Preferred Share Rights Plan by the
Company's Board of Directors.
- 39 -
41
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 11, 1999:
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/ 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
/s/ ANNE M. BUSQUET Director
- ---------------------------
Anne M. Busquet
- 40 -
42
INDEX TO EXHIBITS
Index
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).
3.3 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).
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 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).
4.3 Form of Rights Certificate (incorporated by reference to the
Registrant's Form 8-A filed on February 4, 1998).
4.4 Securities Purchase Agreement between Administaff, Inc. and American
Express Travel Related Services Company, Inc., dated January 27, 1998
and the Letter Agreement between Administaff, Inc. and American Express
Travel Related Services Company, Inc., dated March 10, 1998 amending
the Securities Purchase Agreement (incorporated by reference to the
Registrant's Form 10-Q filed on May 11, 1998).
4.5 Registration Rights Agreement between Administaff, Inc. and American
Express Travel Related Services Company, Inc., dated March 10, 1998
(incorporated by reference to the Registrant's Form 10-Q filed on May
11, 1998).
4.6 Warrant Agreement between Administaff, Inc. and American Express Travel
Related Services Company, Inc., dated March 10, 1998 (incorporated by
reference to the Registrant's Form 10-Q filed on May 11, 1998).
4.7 Warrant Certificate No. 1, evidencing that American Express Travel
Related Services Company, Inc. is the registered holder of 400,000
warrants to purchase 400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's Form 10-Q filed on
May 11, 1998).
4.8 Warrant Certificate No. 2, evidencing that American Express Travel
Related Services Company, Inc. is the registered holder of 400,000
warrants to purchase 400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's Form 10-Q filed on
May 11, 1998).
4.9 Warrant Certificate No. 3, evidencing that American Express Travel
Related Services Company, Inc. is the registered holder of 400,000
warrants to purchase 400,000 shares of
43
the common stock of Administaff, Inc. (incorporated by reference to the
Registrant's Form 10-Q filed on May 11, 1998).
4.10 Warrant Certificate No. 4, evidencing that American Express Travel
Related Services Company, Inc. is the registered holder of 400,000
warrants to purchase 400,000 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's Form 10-Q filed on
May 11, 1998).
4.11 Warrant Certificate No. 5, evidencing that American Express Travel
Related Services Company, Inc. is the registered holder of 465,515
warrants to purchase 465,515 shares of the common stock of Administaff,
Inc. (incorporated by reference to the Registrant's Form 10-Q filed on
May 11, 1998).
10.1 Second Amended and Restated Promissory Note in the amount of
$693,694.75 among Administaff, Inc., Richard G. Rawson, Dawn Rawson,
and RDKB Rawson LP, dated as of July 13, 1998, amending and restating a
Promissory Note dated June 22, 1995.
10.2 Second Amended and Restated Promissory Note in the amount of $300,000
among Administaff, Inc., Richard G. Rawson, Dawn Rawson, and RDKB
Rawson LP, dated as of July 13, 1998, amending and restating a
Promissory Note dated April 11, 1996.
10.3 Second Amended and Restated Security Agreement-Pledge among
Administaff, Inc., Richard G. Rawson, Dawn Rawson, and RDKB Rawson LP,
dated as of July 13, 1998, pursuant to which the collateral securing
the promissory notes included in Exhibits 10.1 and 10.2 is pledged.
10.4 Second Amended and Restated Promissory Note in the amount of $141,360
among Administaff, Inc., Jerald L. Broussard and Mary Catherine
Broussard, dated as of June 23, 1998, amending and restating a
Promissory Note dated September 4, 1995.
10.5 Second Amended and Restated Security Agreement-Pledge among
Administaff, Inc., Jerald L. Broussard and Mary Catherine Broussard,
dated as of June 24, 1998, pursuant to which the colateral securing the
promissory note incuded in Exhibit 10.4 is pledged.
10.6 Amended Promissory Note in the amount of $46,176 among Administaff,
Inc., Jerald L. Broussard and Mary Catherine Broussard, dated as of
June 23, 1998, amending a Promissory Note dated June 27, 1997.
10.7 Amended and Restated Security Agreement-Pledge among Administaff, Inc.,
Jerald L. Broussard and Mary Catherine Broussard, dated as of June 24,
1998, pursuant to which the collateral securing the promissory note
included in Exhibit 10.6 is pledged.
10.8 Administaff, Inc. 1997 Incentive Plan (incorporated by reference to
Exhibit 99.1 to the Registrant's Form S-8 filed on August 20, 1997).
10.9 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).
10.10 Second Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to the Registrant's 1997 Annual Report on
Form 10-K, filed on March 13, 1998).
10.11 Marketing Agreement between American Express Travel Related Services
Company, Inc., Administaff, Inc., Administaff Companies, Inc. and
Administaff of Texas, Inc. dated March 10, 1998 (incorporated by
reference to the Registrant's Form 10-Q filed on May 11, 1998).
10.12 First Amendment to the Marketing Agreement between American Express
Travel Related Services Company, Inc., Administaff, Inc., Administaff
Companies, Inc. and Administaff of Texas, Inc., dated November 17,
1998.
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
44
ADMINISTAFF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors..................................................................................F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998....................................................F-3
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998.............................................................................F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1996, 1997 and 1998.............................................................................F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998.............................................................................F-7
Notes to Consolidated Financial Statements......................................................................F-9
F-1
45
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, 1997 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. 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, 1997 and 1998, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Houston, Texas
February 12, 1999
F-2
46
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
Current assets:
Cash and cash equivalents .................................... $ 40,561 $ 23,521
Marketable securities ........................................ 26,012 49,670
Accounts receivable:
Trade ..................................................... 4,324 4,663
Unbilled .................................................. 15,371 19,719
Related parties ........................................... 163 67
Other ..................................................... 1,208 1,601
Prepaid expenses ............................................. 1,585 2,469
Income taxes receivable ...................................... -- 1,426
Deferred income taxes ........................................ 199 --
---------- ----------
Total current assets ...................................... 89,423 103,136
Property and equipment:
Land ......................................................... 817 2,913
Buildings and improvements ................................... 7,557 9,915
Computer equipment ........................................... 6,219 15,078
Furniture and fixtures ....................................... 6,342 10,378
Vehicles ..................................................... 950 1,308
---------- ----------
21,885 39,592
Accumulated depreciation ..................................... (5,214) (8,552)
---------- ----------
Total property and equipment .............................. 16,671 31,040
Other assets:
Notes receivable from employees .............................. 1,181 1,181
Intangible assets, net of accumulated amortization of $447
and $758 at December 31, 1997 and 1998, respectively ....... 822 3,010
Other assets ................................................. 1,358 4,432
---------- ----------
Total other assets ........................................ 3,361 8,623
---------- ----------
Total assets .............................................. $ 109,455 $ 142,799
========== ==========
F-3
47
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
Current liabilities:
Accounts payable ........................................ $ 1,421 $ 2,555
Payroll taxes and other payroll deductions payable ...... 19,190 26,607
Accrued worksite employee payroll expense ............... 18,153 19,161
Other accrued liabilities ............................... 3,319 2,190
Deferred income taxes ................................... -- 148
Income taxes payable .................................... 729 --
---------- ----------
Total current liabilities ......................... 42,812 50,661
Noncurrent liabilities:
Other accrued liabilities ............................... 2,558 2,558
Deferred income taxes ................................... 322 2,723
---------- ----------
Total noncurrent liabilities ...................... 2,880 5,281
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 - 14,221 and 14,860
at December 31, 1997 and 1998, respectively ....... 142 149
Additional paid-in capital .............................. 50,670 64,293
Treasury stock, at cost - 349 and 343 shares
at December 31, 1997 and 1998, respectively ....... (1,998) (1,968)
Accumulated other comprehensive income .................. 31 342
Retained earnings ....................................... 14,918 24,041
---------- ----------
Total stockholders' equity ........................ 63,763 86,857
---------- ----------
Total liabilities and stockholders' equity ........ $ 109,455 $ 142,799
========== ==========
See accompanying notes.
F-4
48
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
----------- ----------- -----------
Revenues ......................................... $ 899,596 $ 1,213,620 $ 1,683,063
Direct costs:
Salaries and wages of worksite employees ..... 737,177 1,006,092 1,399,126
Benefits and payroll taxes ................... 124,563 156,259 215,327
----------- ----------- -----------
Gross profit ..................................... 37,856 51,269 68,610
Operating expenses:
Salaries, wages and payroll taxes ............ 14,515 18,562 26,522
General and administrative expenses .......... 8,091 12,727 17,474
Commissions .................................. 4,039 4,724 5,968
Advertising .................................. 3,261 3,784 3,740
Depreciation and amortization ................ 1,473 2,126 3,705
----------- ----------- -----------
31,379 41,923 57,409
----------- ----------- -----------
Operating income ................................. 6,477 9,346 11,201
Other income (expense):
Interest income .............................. 682 2,952 3,341
Interest expense ............................. (945) (378) --
Other, net ................................... (1,400) (12) 76
----------- ----------- -----------
(1,663) 2,562 3,417
----------- ----------- -----------
Income before income tax expense ................. 4,814 11,908 14,618
Income tax expense ............................... 2,211 4,469 5,495
----------- ----------- -----------
Net income ....................................... $ 2,603 $ 7,439 $ 9,123
=========== =========== ===========
Basic net income per share of common stock ....... $ 0.24 $ 0.56 $ 0.63
=========== =========== ===========
Diluted net income per share of common stock ..... $ 0.24 $ 0.53 $ 0.62
=========== =========== ===========
See accompanying notes.
F-5
49
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK ACCUMULATED
ISSUED ADDITIONAL OTHER
-------------------- PAID-IN TREASURY COMPREHENSIVE RETAINED
SHARES AMOUNT CAPITAL STOCK INCOME EARNINGS TOTAL
-------- -------- -------- -------- -------- -------- --------
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
--------
Comprehensive income................... 7,470
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997.............. 14,221 142 50,670 (1,998) 31 14,918 63,763
Purchase of treasury stock, at cost.... -- -- -- (6,101) -- -- (6,101)
Sale of units consisting of
common stock and common
stock purchase warrants, net
of issuance costs of $146........... 400 4 11,468 6,116 -- -- 17,588
Exercise of common stock purchase
warrants............................ 141 2 633 -- -- -- 635
Exercise of stock options.............. 98 1 866 -- -- -- 867
Income tax benefit from
exercise of stock options........... -- -- 575 -- -- -- 575
Other.................................. -- -- 81 15 -- -- 96
Unrealized gain on
marketable securities............... -- -- -- -- 311 -- 311
Net income............................. -- -- -- -- -- 9,123 9,123
--------
Comprehensive income................... 9,434
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1998.............. 14,860 $ 149 $ 64,293 $ (1,968) $ 342 $ 24,041 $ 86,857
======== ======== ======== ======== ======== ======== ========
See accompanying notes.
F-6
50
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
---------- ---------- ----------
Cash flows from operating activities:
Net income ................................................. $ 2,603 $ 7,439 $ 9,123
Adjustments to reconcile net income to net cash
provided by operating activities :
Depreciation and amortization ........................... 1,697 2,661 4,239
Deferred income taxes ................................... 917 (794) 2,748
Bad debt expense ........................................ 280 1,855 575
Loss (gain) on disposal of assets ....................... (9) 7 (75)
Changes is operating assets and liabilities:
Accounts receivable .................................. (2,525) (5,906) (5,559)
Prepaid expenses ..................................... 1,362 (712) (884)
Other assets ......................................... (243) 154 (3,074)
Accounts payable ..................................... (893) 827 1,134
Payroll taxes and other payroll deductions payable ... 270 9,091 7,417
Accrued worksite employee payroll expense ............ 3,291 4,768 1,008
Other accrued liabilities ............................ 2,582 657 (1,129)
Income taxes payable/receivable ...................... 2,470 463 (1,580)
---------- ---------- ----------
Total adjustments ................................. 9,199 13,071 4,820
---------- ---------- ----------
Net cash provided by operating activities ......... 11,802 20,510 13,943
Cash flows from investing activities:
Marketable securities:
Purchases ............................................... -- (51,784) (49,019)
Proceeds from dispositions .............................. 728 25,647 25,282
Property and equipment:
Purchases ............................................... (3,976) (7,147) (17,918)
Proceeds from dispositions .............................. 20 54 86
Investment in intangible assets ............................ (245) (226) (2,499)
---------- ---------- ----------
Net cash used in investing activities ............. (3,473) (33,456) (44,068)
F-7
51
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
---------- ---------- ----------
Cash flows from financing activities:
Long-term debt and short-term borrowings:
Proceeds .................................................. $ 2,500 $ -- $ --
Repayments ................................................ (2,579) (4,603) --
Proceeds from the sale of units consisting of
common stock and common stock purchase warrants ........... -- -- 17,588
Proceeds from the issuance of common stock ................... -- 47,408 --
Purchase of treasury stock ................................... -- (1,999) (6,101)
Repurchase of common stock purchase warrants ................. -- (542) --
Prepaid expenses - initial public offering costs ............. (1,050) (282) --
Proceeds from the exercise of common
stock purchase warrants ................................... -- 48 635
Proceeds from the exercise of stock options .................. -- 156 867
Loans to employees ........................................... (300) (46) --
Other ........................................................ -- 7 96
---------- ---------- ----------
Net cash provided by (used in) financing activities .... (1,429) 40,147 13,085
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents ............ 6,900 27,201 (17,040)
Cash and cash equivalents at beginning of year .................. 6,460 13,360 40,561
---------- ---------- ----------
Cash and cash equivalents at end of year ........................ $ 13,360 $ 40,561 $ 23,521
========== ========== ==========
Supplemental disclosures:
Cash paid for interest ....................................... $ 1,005 $ 62 $ --
Cash paid (refunds received) for income taxes ................ $ (1,176) $ 4,800 $ 4,326
See accompanying notes.
F-8
52
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
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, employer 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.
Segment Reporting
Effective January 1, 1998, the Company adopted the Statement of Financial
Accounting Standards ("SFAS") No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 superseded SFAS No. 14,
Financial Reporting for Segments of a Business Enterprise. SFAS No. 131
establishes standards for reporting information about operating segments,
products and services, geographic areas, and major customers. The adoption of
SFAS No. 131 did not affect the Company's results of operations or financial
position. The Company operates in one reportable segment under SFAS No. 131 due
to its centralized structure.
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 SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities. The
Company determines the appropriate classification of all marketable
F-9
53
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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, 1998, 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 component of
accumulated other comprehensive income in 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).
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....................................... 3-5 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 $60,000 of interest
costs for the year ended December 31, 1996.
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: 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, 1997 and 1998 are net of prepayments received prior to year-end
of $4,850,000 and $1,505,000, respectively.
Intangible Assets
Effective January 1, 1998, the Company adopted Statement of Position ("SOP")
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. The requirements of SOP 98-1 are materially consistent with the
Company's previous capitalization policy, and as a result, the adoption of SOP
98-1 did not have a significant impact on the Company's financial position or
results of operations.
Intangible assets primarily include capitalized software development costs
related to the Company's proprietary professional employer information system
and its new Internet-based service delivery platform, Administaff Assistant.
These software development costs are amortized on a straight-line basis over
periods ranging from three to five years from the date they are placed in
service.
F-10
54
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents, 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.
Employee Savings Plan
Effective January 1, 1998, the Company adopted SFAS No. 132, Employers'
Disclosures about Pension and Other Postretirement Benefits. This statement
standardizes the disclosure requirements for pension and other postretirement
benefits. The adoption of SFAS No. 132 did not have an effect on the Company's
financial position or results of operations.
The Company maintains a 401(k) profit sharing plan, under which the Company
has made employer matching contributions on behalf of certain of its worksite
employees. During 1996, 1997 and 1998, the Company made employer matching
contributions of $993,000, $1,674,000 and $2,805,000, respectively. All of these
contributions were recovered from its client companies through services fees
charged to those clients.
Effective January 1, 1999, the Company amended the employer matching
contribution and vesting features of the plan. The Company will match 50% of an
eligible worksite employee's contributions and 100% of an eligible corporate
employee's contributions, both up to 6% of the employee's eligible compensation.
In addition, for active employees on or after January 1, 1999, the vesting
schedule for employer matching contributions was changed from five-year graded
vesting to immediate vesting.
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.
Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
SFAS No. 130 had no impact on the Company's net income or stockholders' equity.
SFAS No. 130 requires unrealized gains and losses on the Company's
available-for-sale marketable securities to be included in other comprehensive
income. Prior to the adoption of SFAS No. 130, these amounts were reported as a
separate component of stockholders' equity. Prior year financial statements have
been reclassified to conform with the requirements of SFAS No. 130.
F-11
55
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
2. MARKETABLE SECURITIES
As of December 31, 1998, the Company's investments in marketable securities
consist of debt securities with maturities ranging from 91 days to five years
from the date of purchase. Approximately 11% of the marketable securities mature
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, 1998:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
(IN THOUSANDS)
Obligations of state and local
government agencies ..................... $ 37,586 $ 275 $ -- $ 37,861
U.S. corporate debt securities .............. 2,304 5 -- 2,309
U.S. Treasury securities and obligations
of U.S. government agencies ............. 2,474 28 -- 2,502
Fixed income mutual funds ................... 6,964 34 -- 6,998
---------- ---------- ---------- ----------
$ 49,328 $ 342 -- $ 49,670
========== ========== ========== ==========
For the years ended December 31, 1997 and 1998, net realized gains and losses on
sales of available-for-sale marketable securities were $14,000 and $72,000,
respectively.
F-12
56
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. 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,
-------------------------
1997 1998
---------- ----------
(IN THOUSANDS)
Deferred tax liabilities:
Software development costs ............. $ (208) $ (1,128)
Depreciation and amortization .......... (473) (978)
Prepaid commissions .................... -- (1,265)
State income taxes ..................... -- (100)
---------- ----------
Total deferred tax liabilities ...... (681) (3,471)
Deferred tax assets:
Uncollectible accounts receivable ...... 105 215
Other accrued liabilities .............. 246 246
State income taxes ..................... 94 --
Other .................................. 113 139
---------- ----------
Total deferred tax assets ........... 558 600
---------- ----------
Net deferred tax liabilities .............. $ (123) $ (2,871)
========== ==========
Net current deferred tax liabilities ...... $ -- $ (148)
Net noncurrent deferred tax liabilities ... (322) (2,723)
Net current deferred tax assets ........... 199 --
---------- ----------
$ (123) $ (2,871)
========== ==========
The components of income tax expense are as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997 1998
---------- ---------- ----------
(IN THOUSANDS)
Current income tax expense:
Federal .......................................... $ 928 $ 4,628 $ 1,964
State ............................................ 366 635 783
---------- ---------- ----------
Total current income tax expense .............. 1,294 5,263 2,747
Deferred income tax expense (benefit):
Federal .......................................... 900 (825) 2,379
State ............................................ 17 31 369
---------- ---------- ----------
Total deferred income tax expense (benefit) ... 917 (794) 2,748
---------- ---------- ----------
Total income tax expense ......................... $ 2,211 $ 4,469 $ 5,495
========== ========== ==========
In 1998, a tax benefit of $575,000 resulting from deductions relating to
disqualifying dispositions of certain employee incentive stock options was
recorded as an increase in stockholders' equity.
F-13
57
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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,
---------------------------------------
1996 1997 1998
---------- ---------- ----------
(IN THOUSANDS)
Expected income tax expense at 34% ............ $ 1,637 $ 4,048 $ 4,970
State income taxes, net of federal benefit .... 253 446 887
Nondeductible expenses ........................ 272 74 91
Tax-exempt interest income .................... -- (126) (453)
Other, net .................................... 49 27 --
---------- ---------- ----------
Reported total income tax expense ............. $ 2,211 $ 4,469 $ 5,495
========== ========== ==========
4. STOCKHOLDERS' EQUITY
In January, 1998, the Company entered into a Securities Purchase Agreement
with American Express Travel Related Services Company, Inc. ("American Express")
whereby the Company sold units consisting of 693,126 shares of its common stock
(293,126 shares from Treasury Stock) and warrants to purchase an additional
2,065,515 shares of common stock to American Express for a total purchase price
of $17.7 million. The warrants include exercise prices ranging from $40 to $80
per share and terms ranging from three to seven years.
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, 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.
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. During 1998, 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.
5. 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
F-14
58
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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,
1998, no awards other than stock options have been granted under the Incentive
Plan.
At December 31, 1996, 1997 and 1998, options to purchase 142,197, 176,193
and 198,493 shares, respectively, were exercisable. The weighted average
remaining contractual life of all outstanding options at December 31, 1998, was
approximately 8.3 years. The weighted average fair value of options granted
during 1996, 1997 and 1998 was $5.77, $7.99 and $17.62, respectively. At
December 31, 1998, options to purchase 43,019 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, 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
Granted.................................................... 198,200 32.56 - 46.25 6,656,000
Exercised.................................................. (98,311) 6.00 - 23.00 (867,000)
Canceled................................................... (34,648) 13.50 - 41.50 (682,000)
--------- --------------- ------------
Outstanding at December 31, 1998.............................. 720,474 $ 6.00 - $46.25 $ 15,807,000
========= ================ ============
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
F-15
59
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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,
--------------------------
1996 1997 1998
---- ---- ----
Risk-free interest rate................................................ 6.0% 5.6% 5.2%
Expected dividend yield................................................ 0.0% 0.0% 0.0%
Expected volatility.................................................... 0.45 0.34 0.54
Weighted average expected life (in years).............................. 3.3 5.0 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 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,
-----------------------------
1996 1997 1998
------- ------- -------
Pro forma net income (in thousands).................................... $ 2,297 $ 6,995 $ 8,070
Pro forma diluted earnings per share................................... $ 0.21 $ 0.50 $ 0.55
6. EARNINGS PER SHARE
The numerators and denominators used in the calculation of basic and
diluted earnings per share were determined as follows:
F-16
60
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1997 1998
---------- ---------- ----------
(IN THOUSANDS)
Numerator:
Basic earnings per share - net income ............................. $ 2,603 $ 7,439 $ 9,123
Interest saved on assumed conversion of debt ...................... 143 -- --
---------- ---------- ----------
Diluted earnings per share -
net income available to common stockholders .................... $ 2,746 $ 7,439 $ 9,123
========== ========== ==========
Denominator:
Basic earnings per share - weighted average shares outstanding .... 10,726 13,298 14,380
Effect of dilutive securities:
Common stock purchase warrants - if-converted method ........... 694 -- --
Common stock purchase warrants - treasury stock method ......... 118 449 7
Common stock options - treasury stock method ................... 57 175 296
---------- ---------- ----------
869 624 303
---------- ---------- ----------
Diluted earnings per share - weighted average shares
outstanding plus effect of dilutive securities ................. 11,595 13,922 14,683
========== ========== ==========
7. OPERATING LEASES
The Company leases various office facilities, furniture 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 $1,144,000, $1,130,000 and $1,827,000 in
1996, 1997 and 1998, respectively. At December 31, 1998, future minimum rental
payments under noncancelable operating leases are as follows (in thousands):
1999............................................... $ 1,927
2000............................................... 1,781
2001............................................... 1,558
2002............................................... 1,300
2003 and thereafter................................ 4,167
---------
$ 10,733
=========
8. RELATED PARTY TRANSACTIONS
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 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 on June 22, 2000, and April 11, 2001, respectively, accrue interest at
6.83%, and are secured by 48,982 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
F-17
61
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 on September 4, 2000, and June 27,
2002, respectively, accrue interest at 6.83% for the 1995 loan and 6.60% for the
1997 loan, and are secured by 6,500 shares of the Company's common stock.
9. 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 could 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: (i) 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 (ii) 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 for the 1993 plan
year. 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 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.
The Company does not know whether the IRS National Office will address the
Technical Advice Request independently of the Industry Issue. 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
F-18
62
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 the record keeper reported to the Company that the 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 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 the
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 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. This
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. This 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.
10. AGENCY TERMINATION AGREEMENTS
In November 1998 the Company entered into agreements to terminate the
agency relationships with two entities operating the Company's Austin and San
Antonio sales offices as agents. Pursuant to the agreements, the Company paid
the agencies $3.3 million, with an additional cash payment of $0.2 million due
in November 1999, in exchange for termination of the agency agreements and
representing full and final payment of all commissions due to the agencies. The
Company is amortizing the payment as a component of commissions expense on a
declining
F-19
63
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
basis over the expected life of the client base for which commissions would have
been due in the future. The Company is continuing to operate in the Austin and
San Antonio markets through Company-operated sales offices which opened
immediately following the terminations.
11. QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTER ENDED
-------------------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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
Year ended December 31, 1998:
Revenues............................... $ 362,396 $ 393,643 $ 431,511 $495,513
Gross profit........................... 11,173 16,326 20,037 21,074
Operating income (loss)................ (2,048) 2,613 5,252 5,384
Net income (loss)...................... (742) 2,163 3,786 3,916
Basic net income (loss) per share...... (0.05) 0.15 0.26 0.27
Diluted net income (loss) per share.... (0.05) 0.15 0.26 0.27
12. SUBSEQUENT EVENTS (UNAUDITED)
In January 1999, the Company's Board of Directors authorized a program to
repurchase up to one million shares of the Company's outstanding common stock.
The purchases are to be made from time to time in the open market or directly
from stockholders at prevailing market prices based on market conditions or
other factors. As of March 5, 1999, the Company had repurchased 309,500 shares
on the open market at a total cost of approximately $4.8 million. In addition,
as part of the repurchase program, the Company has sold a put warrant which, if
exercised, obligates the Company to purchase 125,000 shares for a net cost of
approximately $1.6 million.
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