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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, 1996.
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: NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share New York Stock Exchange
(Title of class) (Name of Exchange on Which Registered)
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. X
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The aggregate market value of the voting stock of Administaff, Inc.
held by non-affiliates (based upon the March 14, 1997 average high and low
trade prices of these shares as reported by the New York Stock Exchange was
approximately $95 million.
Number of shares outstanding of each of the issuer's classes of common
stock, as of March 14, 1997: 13,797,443 shares.
Part III information is incorporated by reference from the proxy
statement for the annual meeting of stockholders to be held May 28, 1997 which
the registrant intends to file within 120 days of the end of the fiscal year.
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TABLE OF CONTENTS
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . 20
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . 43
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . 43
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . 43
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . . . . 44
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PART I
The statements contained in this Annual Report on Form 10-K ("Annual
Report") which are not historical facts, including, but not limited to,
statements found in Item 1. "Business" and in Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations," are
forward-looking statements that involve a number of risks and uncertainties.
In the normal course of business, Administaff, Inc. ("Administaff" or the
"Company"), in an effort to help keep its stockholders and the public informed
about the Company's operations, may from time to time issue such forward-
looking statements, either orally or in writing. Generally, these statements
relate to business plans or strategies, projected or anticipated benefits or
other consequences of such plans or strategies, or projections involving
anticipated revenues, earnings or other aspects of operating results. All phases
of the Company's operations are subject to a number of uncertainties, risks and
other influences. Therefore, the actual results of the future events described
in such forward-looking statements in this Annual Report, or elsewhere, could
differ materially from those stated in such forward-looking statements. Among
the factors that could cause actual results to differ materially are the risks
and uncertainties discussed in this Annual Report, including, without
limitation, the portions referenced above, and the uncertainties set forth from
time to time in the Company's other public reports and filings and public
statements, many of which are beyond the control of the Company, and any of
which, or a combination of which, could materially affect the results of the
Company's operations and whether forward-looking statements made by the Company
ultimately prove to be accurate.
ITEM 1. BUSINESS.
GENERAL
Administaff is a professional employer organization ("PEO") that
provides a comprehensive Personnel Management System which encompasses a broad
range of services, including benefits and payroll administration, medical and
workers' compensation programs, payroll tax filings, personnel records
management, liability management, and related human resource services to small
to medium sized businesses in several strategically selected markets. The
Company was organized in Texas in 1986 and has been engaged in providing PEO
services since inception. During 1995, the Company completed a reorganization
into a Delaware holding company structure. 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
number of worksite employees and in terms of revenues, with current operations
in 10 markets, including Houston, San Antonio, Austin, Orlando, Dallas,
Atlanta, Phoenix, Chicago, Baltimore/Washington, D.C. and Denver. The Company
serves over 1,500 client companies with approximately 25,000 worksite employees
and believes that it currently ranks, in terms of revenues and worksite
employee base, as one of the three largest PEOs in the United States. Houston
is the Company's original location and accounted for approximately 52% of the
Company's revenues for the year ended December 31, 1996 with other Texas
markets accounting for an additional 29%. In October 1993, the Company opened
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a sales office in Dallas as the first step in implementing a long-term internal
growth and expansion strategy. Subsequent to obtaining expansion capital in
May 1994, the Company opened sales offices in Atlanta, Phoenix, Chicago and
Washington D.C. during a twelve month period beginning in October 1994. The
Company opened a second office in Dallas in January 1996 and opened an office
in Denver in September 1996. The Company opened a third office in Houston in
January 1997 and plans to open an office in Los Angeles in April 1997. The
Company plans to enter at least one new market or open at least one additional
sales office in an existing market in each quarter of 1997 and 1998.
Administaff's goal is to improve the productivity and profitability of
small businesses (generally, businesses with 100 or fewer employees) by
relieving business owners and key executives of administrative and regulatory
burdens, enabling them to focus on the core competencies of their businesses,
and by promoting employee satisfaction through human resource management
techniques that improve employee performance. The Company provides a
comprehensive personnel management system which encompasses a broad range of
services, including benefits and payroll administration, medical and workers'
compensation insurance programs, payroll tax filings, personnel records
management, liability management and other human resource services. The fees
charged by the Company are invoiced along with each periodic payroll of the
client and include the gross payroll of each client plus the Company's
estimated costs of paying employment related taxes, providing human resource
services, performing administrative functions, providing insurance coverages
and benefit plans and performing other services offered by the Company.
Administaff provides these services by entering into a Client Service Agreement
which establishes a three party relationship whereby the Company and client act
as co-employers of the worksite employees. Responsibilities are allocated
between the co-employers pursuant to the Client Service Agreement, with
Administaff assuming responsibility for personnel administration and compliance
with most employment-related governmental regulations. The client company
retains the employees' services in its business and remains the employer for
various other purposes. Companies providing comprehensive services in this
manner have come to be known as professional employer organizations, or PEOs,
as distinguished from "fee for service" companies, such as payroll processing
firms, human resource consultants and safety consulting firms, that provide a
specific service to a client under a traditional two party contract.
PEO INDUSTRY
The PEO industry began to evolve in the early 1980's largely in response
to the burdens placed on small to medium sized employers by an increasingly
complex legal and regulatory environment. While various service providers, such
as payroll processing firms, benefits and safety consultants and temporary
services firms were available to assist these businesses with specific tasks,
PEOs began to emerge as providers of a more comprehensive range of services
relating to the employer/employee relationship. As the industry has evolved
the term "professional employer organization" has come to describe an entity
that enters into a three-party relationship among the PEO, the client business
and the employee.
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Administaff establishes such three-party relationships through the
Client Service Agreement entered between the Company and the client business.
The standard Client Service Agreement provides for an initial one year term
(subject to cancellation on 30 days notice), sets forth the service fee payable
to the Company and establishes the division of responsibilities between
Administaff and the client as co-employers. In consideration for payment of the
service fee (which vary based upon relative employment tax rates, benefits
participation, workers' compensation risk profile, and level of pay of worksite
employees), the Company has the obligation to pay the direct costs associated
with the agreement, which generally consist of (i) the salaries and wages of
the worksite employees, (ii) employment related taxes, (iii) employee benefit
plan premiums, and (iv) workers' compensation insurance premiums and (v)
administrative costs and related expenses, in each case regardless of whether
the client company pays Administaff the associated service fee.
PEO arrangements (including the Client Service Agreement) generally
transfer broad aspects of the employer/employee relationship to the PEO.
Because the business of the PEO is to enter into these relationships and
provide employee related services to a large number of employees, the PEO can
achieve economies of scale as a professional employer and perform the
employment related functions at a level typically available only to large
corporations with substantial resources to devote to human resources
management.
Growth in the PEO industry has been significant. According to the
National Association of Professional Employer Organizations ("NAPEO"), the
number of employees under PEO arrangements in the United States has grown from
approximately 10,000 in 1984 to approximately 2.0 million in 1995. Administaff
believes that the key factors driving demand for PEO services include (i)
complex regulation of labor and employment issues and the related costs of
compliance, including the allocation of time and effort to such functions by
owners and key executives, (ii) the need to provide competitive health care and
related benefits to employees of small businesses, (iii) the increasing costs
associated with workers' compensation and health insurance coverage, workplace
safety programs, employee related complaints and litigation and (iv) trends
relating to the growth and productivity of the small business community in the
United States.
A critical aspect of the growth of the PEO industry has been increasing
recognition and acceptance by federal and state governmental authorities of
PEOs and the employer/employee relationship created by PEOs. As the concept of
PEO services became understood by regulatory authorities, the regulatory
environment began to shift from one of hostility and skepticism to one of
regulatory cooperation with the industry. During the mid to late 1980's,
legitimate industry participants were challenged to overcome well publicized
failures of financially unsound and in some cases unscrupulous operators. Given
this environment, Administaff and other industry leaders, in concert with
NAPEO, have worked with the relevant government entities for the establishment
of a regulatory framework that would protect clients and employees and
discourage unscrupulous and financially unsound operators, and thereby promote
the legitimacy and further development of the industry.
While many states do not explicitly regulate PEOs, 16 states (including
Texas) have enacted
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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
generally by resolving interpretive issues concerning employee status for
specific purposes under applicable state law. The Company has actively
supported such regulatory efforts. The Company, which is currently licensed or
certified in 12 states, does not view the burdens of compliance with these
regulations as material to its business operations.
PRINCIPAL SERVICES
Administaff provides a comprehensive Personnel Management System
encompassing a broad range of services, including personnel management,
benefits and payroll administration, medical and workers' compensation
insurance programs, payroll tax filings, personnel records management,
liability management and other human resource services. Among the laws and
regulations that may affect a small business 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 Medical Leave Act of 1993
tion Act of 1987 (COBRA) o State unemployment and employment
o Immigration Reform and Control Act securities laws
(IRCA) o State workers' compensation laws
o Title VII (Civil Rights Act of 1964)
</TABLE>
While these regulations are complex, and in some instances overlapping,
Administaff assists in achieving client companies' compliance by providing
services in four primary categories: administrative functions, benefit plans
and administration, personnel management and liability management.
Administrative Functions. Administrative functions encompass a wide
variety of processing and record keeping tasks, mostly related to payroll
administration, government compliance and employee benefit plan filing.
Specific examples include payroll processing, payroll tax deposits, quarterly
payroll tax reporting, employee file maintenance, unemployment claims, workers'
compensation reporting, and monitoring and responding to changing regulatory
requirements.
Benefit Plans and Administration. The Company's benefit plan offerings
include the following:
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comprehensive health, dental, vision, prenatal care, prescription card,
counseling, education assistance and adoption assistance. Insurance coverages
also include group term life, accidental death and dismemberment and long-term
disability. Each client company can select from among several different
packages of these plans in accordance with its needs. Administaff also offers a
retirement savings (401(k)) plan to its eligible employees. As part of its
service package, the Company administers these benefit plans and is responsible
for negotiating the benefits and costs of such plans and for maintaining the
plans in accordance with applicable federal and state regulations. The Company
serves as liaison for the delivery of such services to the worksite employee
and monitors and reviews claims for loss control purposes. The Company believes
that this type of intensive benefit management 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
tends to mitigate the competitive disadvantage small businesses normally face
in the areas of cost control and employee recruiting and retention.
Personnel Management. The wide variety of personnel management services
provided by Administaff allow its client companies access to resources normally
found only in the human resources departments of large companies. On-site
supervisors are provided with a detailed personnel guide, which sets forth a
systematic approach to administering personnel policies and practices including
recruiting, discipline and termination procedures. Personnel policies and
employee handbooks are reviewed and revised, if necessary, or customized
handbooks can be created. The Company assists clients with the development of
refined job descriptions as well as a systematic performance appraisal process.
A variety of human resource programs can be implemented where needed, including
orientation, professional development and issues oriented training, counseling,
substance abuse awareness and outplacement services. In addition, clients'
management are provided with detailed information, compiled from the Company's
experience, regarding competitive salaries for a wide range of positions across
the country.
Liability Management. Liability management services consist of several
functions. First, pursuant to the Company's Client Service Agreement and basic
to the Administaff client relationship, the Company assumes many of the
liabilities associated with being an employer. These include liability for
compliance with payroll tax reporting and payment obligations, workers'
compensation regulations, the Consolidated Omnibus Budget Reconciliation Act of
1987 ("COBRA"), the Immigration Reform and Control Act and the Consumer Credit
Protection Act. For those potential liabilities that Administaff does not
assume, the Company assists its clients in managing and limiting exposure. This
management for many clients includes first time and ongoing safety inspections
as well as the implementation of safety programs designed to reduce workers'
compensation claims. Administaff also provides guidance to clients on avoiding
liability for discrimination, sexual harassment and civil rights violations and
participates in termination decisions to attempt to secure protection from
liability on those grounds. When a claim arises, the Company often assists in
the client's defense regardless of whether the Company has been named directly.
The Company employs attorneys specializing in several areas of employment law
and has broad experience in disputes concerning the employer/employee
relationship. This expertise allows Administaff's clients to contest many
claims which they might otherwise have been inclined to settle. The Company
also monitors
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changing government regulations and notifies clients of their effect on
potential employer liability.
Additional Services. All of Administaff's clients receive the foregoing
services as part of the Company's basic package in consideration of a
comprehensive service fee. Administaff also provides supplemental services to
its clients for additional fees, with the actual fee determined on the basis of
the particular supplemental service to be rendered. These services include
prospective employee screening and background investigations, drug testing,
incentive plans, personnel policy development, employee handbook development,
and pre-employment testing, scoring and reporting. The Company also stages a
wide variety of seminars for both employees and management, on subjects such as
communication, leadership, motivation and time and stress management skills.
While these services constitute an immaterial source of additional revenue to
Administaff, they afford the Company an opportunity to solidify its
relationships with existing clients. Moreover, to the extent these services
tend to reduce liability, they serve as an additional element of the Company's
liability and risk management process.
CLIENT SERVICE AGREEMENT
All clients enter into Administaff's Client Service Agreement. The
Client Service Agreement provides for an initial one year term, subject to
termination by the Company or the client at any time upon 30 days' prior
written notice. After the initial term the contract may be renewed, terminated
or continued on a month-to-month basis, although the Company's standard
practice is to attempt to renew its contracts with its clients prior to
expiration of the initial term.
The Company's service fee is set forth in the Client Service Agreement,
and is based on a pricing model that takes into account the gross payroll of
each employee plus the estimated costs of paying employment related taxes,
providing human resource services, performing administrative functions,
providing insurance coverages and benefit plans and other services offered by
the Company. These items are combined to yield a service fee which is stated as
a percentage of gross pay. Fees are invoiced along with each periodic payroll.
The Client Service Agreement also establishes the division of
responsibilities between Administaff and the client as co-employers. Pursuant
to the Client Service Agreement, Administaff is solely 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 supervisorial
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 Client Service Agreement is as follows:
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Administaff Client Joint
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Tax reporting and payment (state Assignment to, and ownership of, Implementation of policies and
and federal withholding, FICA, all intellectual property rights practices relating to the
FUTA, state unemployment) employer/employee relationship
Workers' compensation compliance, Section 414(o) of the Code Selection of fringe benefits,
procurement, management, regarding benefit discrimination including employee leave policies
reporting
Employee benefit procurement Professional liability or Employer liability under workers'
malpractice compensation laws
Compliance with COBRA, Compliance with OSHA regulations, Compliance with Title VII of the
Immigration Reform and Control EPA regulations and any state or Civil Rights Act of 1964, the Age
Act, and Consumer Credit legal equivalent government Discrimination in Employment Act,
Protection Act, Title III, as contracting provisions, the Fair the Employment Retirement Income
well as monitoring changes in Labor Standards Act, the Worker Security Act, the Polygraph
other governmental regulations Adjustment and Retaining Protection Act, the Federal Drug
governing the employer/employee Notification Act, professional Free Workplace Act (and any state
relationship and updating the licensing requirements, fidelity or local equivalent), state
client when necessary bonding requirements employment discrimination laws
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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 Client Service Agreement addresses this issue by providing that the Company
or the client will indemnify the other party for liability incurred to the
extent the liability is attributable to conduct by the indemnifying party.
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's total expense incurred with respect to such exposure was
approximately $175,000, $154,000 and $73,000, for the years ended December 31,
1994, 1995 and 1996 respectively.
Clients are required to pay Administaff no later than one day prior to
the applicable payroll date by wire transfer or automatic clearinghouse
transaction, and receipt of funds is verified prior to release of payroll.
Although the Company is ultimately liable as employer to pay employees for work
previously performed, it retains the ability to terminate the Client Service
Agreement as well as the employees upon non-payment by a client. This right and
the periodic nature of payroll, combined with the natural screening effect of
the Company's client selection process, has resulted in an excellent overall
collections history. Bad debt expense for the three years ended December 31,
1996 was
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approximately $236,000 on approximately $2.2 billion of total revenues.
CUSTOMERS
Administaff's customer base consists of over 1,500 client companies,
representing approximately 25,000 worksite employees as of December 31, 1996.
The Company's client base is broadly distributed throughout a wide variety of
industries including services, construction, manufacturing, wholesale trade,
finance, insurance, real estate, medical, retail trade and others.
The Company attempts to maintain diversity within its client base to
lower its exposure to downturns or volatility in any particular industry and
help insulate the Company to some extent from general economic cyclicality. As
part of its client selection strategy, the Company offers its services to
businesses falling within 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
also 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 14 years.
The Company also attempts to retain a large percentage of its clients
beyond the initial one-year term. Administaff's client retention record
reflects that in excess of 80% of Administaff's clients remain for over one
year and that the attrition rate declines for clients who remain with
Administaff for longer periods. Client attrition experienced by Administaff is
attributable to a variety of factors, including (i) termination by Administaff
resulting from the client's inability to make timely payments, (ii) client's
non-renewal due to price, (iii) client business failure or downsizing and (iv)
sale or disposition of the client company. The Company believes that only a
small percentage of nonrenewing clients withdraw due to dissatisfaction with
service or to retain the services of a competitor.
MARKETING AND SALES
Administaff's marketing strategy is based on the application of
techniques that have produced predictable results for the Company 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, Administaff 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.
Administaff markets its services through a broad range of media outlets,
including radio, newspapers, periodicals and direct mail. The Company employs a
local public relations firm in each of its markets as well as an advertising
firm to coordinate and implement its marketing campaigns, and has developed an
inventory of proven, successful radio and newsprint advertisements which are
utilized in this effort.
In order to identify the most promising potential markets, the Company
employs a systematic market evaluation and selection process. The Company
evaluates a broad range of factors in the selection process, using a market
selection model that weights various criteria that the Company
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believes are reliable predictors of successful penetration based on its
experience. Among the factors considered are (i) market size, in terms of small
businesses engaged in selected industries that meet the Company's risk profile,
(ii) market receptivity to PEO services, including considerations such as
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,
(v) potential direct cost issues that bear on the Company's effectiveness in
controlling and managing the cost of its services, such as workers'
compensation and health insurance costs, unemployment risks and various legal
and other factors, (vi) a comparison of the services offered by Administaff to
alternatives available to small businesses in the relevant market, such as the
cost to the target clients of procuring services directly or through other PEOs
and (vii) long-term strategy issues, such as general perception of markets and
long-term revenue growth potential. Each of the Company's expansion markets,
beginning with Dallas in October 1993, was selected in this manner.
Administaff generates sales leads from three primary sources: direct
sales efforts, advertising and referrals. These leads result in initial
presentations to prospective clients, and, ultimately, a predictable number of
client census reports. The client's census report reflects information gathered
by the sales associate about the prospect's employees, including job
classification, state of employment, workers' compensation claims history,
health insurance claims history, salary, and a desired level of benefits. This
information is entered into the Company's customized bid system, which applies
the prospect's employee characteristics to Administaff's pricing model, leading
to the preparation of a bid. Concurrently with this process, the prospective
client's workers' compensation and health insurance histories are evaluated
from a risk management perspective. Unfavorable aspects of either of these
histories could result in termination of the sales effort and rejection of the
prospect. This prospective client screening process plays a vital role in
controlling the Company's benefits costs and limiting its exposure to
liability.
Upon completion of a favorable risk evaluation, the sales associate then
presents the prospective client with the Company's bid and attempts to enroll
the prospect. If a prospect accepts Administaff's proposal, the new client is
quickly integrated into the Company's system. The client executes the Client
Service Agreement, and an orientation team initiates the process of
transferring human resource functions to Administaff. The Company then assumes
responsibility for administering the client's personnel and benefits.
VENDOR RELATIONSHIPS
Administaff provides benefits to its worksite employees under
arrangements with a variety of vendors. Although the Company believes that any
of its benefit contracts could be replaced if necessary with minimal disruption
to its operations, the Company considers two such contracts to be the most
significant elements of the package of benefits provided to employees.
The Company's group health insurance plan is provided by Aetna, Inc.
("Aetna"). Each client company selects from a range of health plan coverages
available under the plan and Administaff's fees
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to that client reflect the coverage options selected. The Company initiated
insurance coverage with Aetna in 1989, became fully insured in 1992 and has
maintained full insurance with Aetna since that time. The current policy
expires December 31, 1997. The policy requires the Company to fund claims and
premiums up to a specified quarterly cap amount. Aetna is required to fund all
claims and premiums, if any, in excess of the quarterly cap amount. These cap
amounts are in place for quarterly periods and such cap amounts are adjustable,
based on claims experience, with six months notice by Aetna. While Aetna bears
ultimate legal responsibility for all claims, because the Company bears the
burden of higher costs as claims experience increases, the Company seeks to
minimize health care claims through its benefits administration management
practices.
The Company's workers' compensation policy, a guaranteed cost plan
whereby monthly premiums are paid for complete coverage of all claims under the
policy, was originally put in place with Reliance National Indemnity Co.
("Reliance") in November 1994, and the current policy will continue in effect
until October 31, 1997. Reliance has provided the Company's workers'
compensation policies since 1990.
In addition to its health and workers' compensation insurance policies,
significant benefits contracts include the Company's long and short term
disability policies with Fortis Benefits Insurance Co., which were put in place
in January 1993 and August 1995, respectively, and continue until they are
replaced or canceled.
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
calculation capabilities that are unique to the PEO industry and to
Administaff. At the heart of the system is a high volume payroll processing
system that allows the Company to produce and deliver hundreds of payrolls per
day, each customized to the needs of the client companies.
Administaff's proprietary PEO information system is now in its third
generation, with the fourth generation nearing completion. The software has
been developed using 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.
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<PAGE> 13
Administaff's primary information processing facility is located at the
Company's corporate headquarters in Kingwood, Texas (a suburb of Houston). A
second processing facility is located in Las Colinas, Texas (near Dallas). The
Kingwood facility handles approximately two-thirds of the Company's daily
client service load as well as administrative and management information
processing. The Las Colinas facility handles approximately one-third of the
daily client service load as well as acting as a disaster recovery facility for
the Company capable of handling all of the Company's operations for a short
period of time.
Administaff's principal computing platform is the IBM RISC/6000. The
Company utilizes six IBM RISC/6000s at its Kingwood facility and two at its Las
Colinas facility. These processing facilities are linked by a high speed wide
area network utilizing dedicated telecommunications facilities. The IBM
RISC/6000 computers are also connected by local area networks to more than 300
IBM PC workstations running Microsoft Windows(C) software. The Company's
district sales offices are equipped with Microsoft NT Advanced Server(C)
networks and are linked to the Kingwood and Las Colinas facilities through
public telecommunications facilities.
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
three PEOs with annual revenue exceeding $500 million. The Company considers
its primary competition to be the traditional in-house provision of employee
services. In addition, the Company competes to some extent with fee-for-service
providers such as payroll processors and human resource consultants.
Competition in the PEO industry revolves primarily around breadth and
quality of services, reputation, choice and quality of benefits and price. The
Company believes that reputation, national presence, regulatory expertise,
financial resources, risk management and data processing capability distinguish
leading PEOs from the rest of the industry. The Company believes that it
competes favorably in these areas.
INDUSTRY REGULATION
The Company's operations are affected by numerous federal and state laws
relating to labor, tax and employment matters. By entering into a co-employer
relationship with employees who are assigned to work at client company
locations (referred to as "worksite employees"), the Company assumes certain
obligations and responsibilities of an employer under these federal and state
laws. Because many of these federal and state laws were enacted prior to the
development of nontraditional employment relationships, such as professional
employer, temporary employment and outsourcing arrangements, many of these laws
do not specifically address the obligations and responsibilities of
non-traditional 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
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<PAGE> 14
companies and worksite employees. This is particularly true in Texas where
management has worked with numerous regulatory agencies and was instrumental in
the ultimate passage of the Staff Leasing Services Licensing Act (the "Texas
Staff Leasing Act"), an act which formally recognized the PEO industry in Texas
and resolved prior interpretive disputes as to the status of PEOs. Existing
regulations are relatively new and, therefore, their interpretation and
application by administrative agencies and federal and state courts is limited
or non-existent. The development of additional regulations and interpretation
of existing regulations can be expected to evolve over time. While the Company
cannot predict with certainty the nature or direction of the development of
federal, state and local regulations, management will continue to pursue a
proactive strategy of educating administrative authorities as to the advantages
of PEOs and achieving regulation which appropriately accommodates their
legitimate business function.
Certain federal and state statutes and regulations use the terms
"employee leasing" or "staff leasing" to describe the arrangement among a PEO,
such as the Company, and its clients and worksite employees. The terms
"employee leasing," "staff leasing" and "professional employer arrangements"
are generally synonymous in such contexts and describe the arrangements entered
into by the Company, its clients and worksite employees.
As an employer, the Company is subject to all federal statutes and
regulations governing its employer-employee relationships. Subject to the
issues discussed below, the Company believes that its operations are in
compliance in all material respects with all applicable federal statutes and
regulations.
EMPLOYEE BENEFIT PLANS
The Company offers various employee benefit plans to its employees,
including its worksite employees. These employee benefit plans are treated by
the Company as "single-employer" plans rather than multiple employer plans.
These plans include the 401(k) Plan (a profit-sharing plan with a cash or
deferred arrangement ("CODA") under Code Section 401(k) and a matching
contributions feature under Code Section 401(m)), a cafeteria plan under Code
Section 125, a group health plan, a group life insurance plan, a group
disability insurance plan, an educational assistance plan, an adoption
assistance program and an employee assistance plan. Generally, employee benefit
plans are subject to provisions of both the Code and the Employee Retirement
Income Security Act of 1974, as amended ("ERISA").
Employer Status. In order to qualify for favorable tax treatment under
the Code, the plans must be established and maintained by an employer for the
exclusive benefit of its employees. Generally, an entity is an "employer" of
certain workers for federal employment tax purposes if an employment
relationship exists between the entity and the workers under the common law
test of employment. In addition, the officers of a corporation are deemed to be
employees of that corporation for federal employment tax purposes. The common
law test of employment, as applied by the IRS, involves an examination of
approximately 20 factors to ascertain whether an employment relationship exists
between a worker and a purported employer. That test is generally applied to
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<PAGE> 15
determine whether an individual is an independent contractor or an employee for
federal employment tax purposes and not to determine whether each of two or
more companies is a "co-employer." Substantial weight is typically given to
the question of whether the purported employer has the right to direct and
control the details of an individual's work. Among the various categories of
factors which appear to be considered more important by the IRS are (1) the
employer's degree of behavioral control (the extent of instructions, training
and the nature of the work), (2) the financial control or the economic aspects
of the relationship, and (3) the intended relationship of the parties (whether
employee benefits are provided, whether any contracts exist, whether services
are ongoing or for a project, whether there are any penalties for
discharge/termination, and the frequency of the business activity).
In 1992, the Company applied for and received a favorable determination
from the IRS regarding the qualified status of the 401(k) Plan. In that
application, the Company disclosed to the IRS that the Company is involved in
the business of leasing employees to recipient companies and that the 401(k)
Plan covered worksite employees who satisfied the plan's eligibility
requirements. However, the statement that the 401(k) Plan covered worksite
employees does not necessarily resolve the issue of who is the employer of
those employees for purposes of the 401(k) Plan.
The Company amended and restated the 401(k) Plan on December 15, 1994.
Among other amendments, the Company added the matching contributions feature
under Code Section 401(m) to the 401(k) Plan. In March 1995, the Company
submitted the amended and restated 401(k) Plan to the IRS for a determination
on its continued tax qualified status. The amended and restated 401(k) Plan is
currently under review by the IRS. An IRS finding that the 401(k) Plan document
merits tax qualified status is a determination as to form only and would not
preclude a subsequent disqualification based on the Plan's operation, including
a finding that certain worksite employees are not employees of the Company for
401(k) Plan purposes.
Separate from the IRS' review of the pending determination request, the
Company's 401(k) Plan for the 1993 plan year is currently under audit. Although
the audit is for the 1993 plan year, certain conclusions of the IRS would be
applicable to other years as well. In addition, the IRS has established an
Employee Leasing Market Segment Group 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 Company understands
that the IRS Houston District intends to seek technical advice (the "Technical
Advice Request") from the IRS National Office. A draft copy of the Technical
Advice Request has been provided to the Company for its comments before the IRS
Houston District submits it to the IRS National Office. The draft of 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
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<PAGE> 16
(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 understands that the Industry Issue identified by the Market
Segment Group study also will be referred to the National Office. If the
Company and the IRS Houston District do not agree on the facts and the issues
to be presented in the Technical Advice Request, the Company may submit its own
statement of the facts and issues and explanation of its position. If, after
review, the IRS National Office concludes that its response to the Technical
Advice Request will be adverse to Administaff, Administaff will be granted a
conference with the National Office to discuss the proposed results. If the
Market Segment Group study were to reach a conclusion that is adverse to the
PEO industry, there is an administrative procedure available to appeal that
conclusion. In addition to working with the Market Segment Group study, NAPEO
is actively engaged in policy discussions with both the Treasury Department and
with members of Congress in an effort to reduce the likelihood of unfavorable
conclusions and to procure favorable legislation.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. The Company is not able to
predict either the timing or the nature of any final decision that may be
reached by the IRS with respect to the 401(k) Plan audit or with respect to the
Technical Advice Request or the Market Segment Group study and the ultimate
outcome of such decisions. Further, the Company is unable to predict whether
the Treasury Department will issue a policy statement with respect to its
position on the issues or, if issued, whether such a statement would be
favorable to the Company. The Company intends to vigorously pursue a favorable
resolution of the issues through one or more of the following methods: the
audit-Technical Advice Request, the Market Segment Group study process, the
policy and legislative efforts, and, if necessary, legal action. If, however,
any of these processes were to conclude that a PEO is not a co-employer of its
worksite employees and such conclusion were to ultimately prevail, worksite
employees could not continue to make salary deferral contributions to the
401(k) Plan or pursuant to the Company's cafeteria plan or continue to
participate in certain other employee benefit plans of the Company. The Company
believes that, although unfavorable to the Company, a prospective application
by the IRS of such an adverse conclusion (that is, one applicable only to
periods after the conclusion by the IRS is finalized) would not have a material
adverse effect on its financial position or results of operations, as the
Company could continue to make available similar benefit programs to its client
companies at comparable costs to the Company. However, if the IRS National
Office adopts the conclusions of the IRS Houston District and any such
conclusion 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
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<PAGE> 17
believes that a retroactive disqualification is unlikely, there can be no
assurance as to the ultimate resolution of these issues by the IRS.
401(k) Plan Nondiscrimination Testing Issues. In 1991 the Company
engaged a third party vendor to be the 401(k) Plan's record keeper and to
perform the required annual nondiscrimination tests for the plan. Each year
such record keeper reported to the Company that such nondiscrimination tests
had been satisfied. However, in August 1996, the 401(k) Plan's record keeper
advised the Company that certain of these tests had been performed incorrectly
for prior years and, in fact, that the 401(k) Plan had failed certain tests for
the 1993, 1994 and 1995 plan years. The Company has subsequently determined
that the 401(k) Plan also failed a nondiscrimination test for 1991 and 1992,
closed years for tax purposes. At the time the Company received such notice,
the period in which the Company could voluntarily "cure" this operational
defect had lapsed for all such years, except 1995. With respect to the 1995
year, the Company has caused the 401(k) Plan to refund the required excess
contributions and earnings thereon to affected highly compensated participants,
and, subsequent to December 31, 1996, the Company paid an excise tax of
approximately $47,000 related to refunded excess contributions. Because the
401(k) Plan is under a current IRS audit, the IRS voluntary correction program
for this type of operational defect is not available to the Company for years
prior to 1995. Accordingly, the Company informed the IRS of the prior testing
errors for each of 1991, 1992, 1993 and 1994 and proposed a correction that
consists of corrective contributions by the Company to the 401(k) Plan with
respect to these years (including the closed years) and the payment by the
Company of the minimum penalty ($1,000) that the IRS is authorized to accept to
resolve this issue. The IRS Houston District indicated that resolution of the
nondiscrimination test failures is premature until the National Office resolves
the issues presented in the Technical Advice Request. No assurance can be given
that the IRS will permit the Company to administratively "cure" this
operational defect. The Company has recorded a reserve during the third quarter
of 1996 for amounts it may ultimately be required to pay in connection with
corrective action with respect to the 401(k) Plan. The amount of such reserve
is the Company's estimate of the cost of corrective measures and penalties,
although no assurance can be given that the actual amount that the Company may
ultimately be required to pay will not substantially exceed the amount so
reserved. In addition, the Company has recorded an asset for an amount
recoverable from the 401(k) Plan's record keeper should the Company ultimately
be required to pay the amount accrued for such corrective measures and
penalties. Based on its understanding of the settlement experience of other
companies with respect to similar issues, the Company does not believe that the
ultimate resolution of the nondiscrimination test issue will have a material
adverse effect on the Company's financial condition or results of operations,
although no assurance can be given by the Company because the ultimate
resolution of this issue will be determined in a negotiation process with the
IRS or in litigation.
ERISA Requirements. Employee pension and welfare benefit plans are also
governed by ERISA. ERISA defines "employer" as "any person acting directly as
an employer, or indirectly in the interest of an employer, in relation to an
employee benefit plan." ERISA defines the term "employee" as "any individual
employed by an employer." The United States Supreme Court has held that the
common law test of employment must be applied to determine whether an
individual is an employee or an independent contractor under ERISA. A
definitive judicial interpretation of "employer" in the
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<PAGE> 18
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, however, the Company believes it would not be
materially adversely affected because it could continue to make available
similar benefits at comparable costs.
In addition to ERISA and the Code provisions discussed herein, issues
related to the relationship between the Company and its worksite employees may
also arise under other federal laws, including other federal income tax laws.
Possible Multiple Employer Plan Treatment. The U.S. Department of Labor
("DOL") issued an Advisory Opinion in December 1995 to a staff leasing company
advising that particular company that its health plan, which covered worksite
employees, was a multiple employer plan, rather than a single employer plan.
Because the Company believes it is a co- employer of worksite employees, the
Company views its group health plan, which also covers worksite employees, to
be a single employer plan. However, if this DOL opinion were applied to the
Company, it is possible, although the Company believes it is unlikely, that the
DOL would assert penalties against the Company for having incorrectly filed
annual reports treating its plan as a single employer plan. Such a conclusion,
if applied to the other employee benefit plans that cover worksite employees,
could result in additional liabilities of the Company. The Company does not
believe that any such penalties will, individually or in the aggregate, be
material to the Company's financial condition or results of operation. Further,
even if such a conclusion is reached, however, the Company believes that it
would continue to be able to make available comparable benefit programs to
client companies.
FEDERAL EMPLOYMENT TAXES
As a co-employer, the Company assumes responsibility and liability for
the payment of federal and state employment taxes with respect to wages and
salaries paid to worksite employees. There are essentially three types of
federal employment tax obligations: (i) withholding of income tax requirements
governed by Code Section 3401, et seq.; (ii) obligations under FICA, governed
by Code Section 3101, et seq.; and (iii) obligations under the FUTA, governed
by Code Section 3301, et seq. Under these Code sections, employers have the
obligation to withhold and remit the employer portion and, where applicable,
the employee portion of these taxes.
The Market Segment Group discussed above is examining, among other
issues, whether PEOs, such as the Company, are employers of worksite employees
under the Code provisions applicable to federal employment taxes and,
consequently, responsible for payment of employment taxes on wages and salaries
paid to such worksite employees. However, the IRS Houston District has
concluded that the Company is not the employer of worksite employees for this
purpose and has requested National Office guidance on this issue in the
Technical Advice Request described above.
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<PAGE> 19
Code Section 3401, which applies to federal income tax withholding
requirements, contains an exception to the general common law test applied to
determine whether an entity is an "employer" for purposes of federal income tax
withholding. Section 3401(d)(1) states that if the person for whom services are
rendered does not have control of the payment of wages, the "employer" for this
purpose is the person having control of the payment of wages. The Treasury
regulations issued under Section 3401(d)(1) state that a third party can be
deemed to be the employer of workers under this section for income tax
withholding purposes where the person for whom services are rendered does not
have legal control of the payment of wages. While Section 3401(d)(1) has been
examined by several courts, its ultimate scope has not been delineated.
Moreover, the IRS has to date relied extensively on the common law test of
employment in determining liability for failure to comply with federal income
tax withholding requirements.
Accordingly, while the Company believes that it can assume the
withholding obligations for worksite employees, in the event the Company fails
to meet these obligations the client company may be held jointly and severally
liable therefor. While this interpretive issue has not to the Company's
knowledge discouraged clients from enrolling with the Company, there can be no
assurance that a definitive adverse resolution of this issue would not do so in
the future. These interpretive uncertainties may also impact the Company's
ability to report employment taxes on its own account rather than for the
accounts of its clients.
STATE REGULATION
TEXAS
As an employer, the Company is subject to all Texas statutes and
regulations governing the employer-employee relationship. Subject to the
discussion below, the Company believes that its operations are in compliance in
all material respects with all applicable Texas statutes and regulations.
Prior to 1993, the PEO industry was not regulated as an industry in
Texas. Various state agencies attempted to apply their statutory schemes to
PEOs on a case-by-case basis and the Company faced various challenges from both
the Texas Employment Commission and the State Board of Insurance of Texas. Each
of these challenges was resolved with the passage of Texas' PEO licensing act
described below.
The Company was instrumental in obtaining enactment of the Texas Staff
Leasing Act, which now regulates and establishes a legal framework for PEOs in
Texas. The Texas Staff Leasing Act, which became effective on September 1,
1993, established a mandatory licensing scheme for PEOs and expressly
recognizes a licensee as the employer of the assigned employee for purposes of
the Texas Unemployment Compensation Act. The Texas Staff Leasing Act also
provides, to the extent governed by Texas law, that a licensee may sponsor and
maintain employee benefit plans for the benefit of assigned employees. In
addition, the Texas Staff Leasing Act not only provides that a licensee may
elect to obtain workers' compensation insurance coverage for its assigned
employees but also provides that, for workers' compensation insurance purposes,
a licensee and its client
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<PAGE> 20
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.
On January 28, 1997, George W. Bush, Governor of the State of Texas,
announced that he would seek to substantially cut property taxes to make state
rather than local governments the primary source of funding for Texas public
schools. As part of this proposal, the Governor has proposed a number of
funding alternatives, including a business activity tax as a substitute for the
current state franchise tax. As described by the Governor, the tax would
consist of a 1.25% tax on Texas Business Activity (as proposed, Texas Business
Activity is defined as federal taxable income plus business payroll and
associated benefits costs plus depreciation less new capital investment). It
is unclear how any such tax ultimately would be calculated or how it would be
interpreted in relation to the Company and its operations. Enacting
legislation has been introduced, however there can be no assurance as to
whether or not it will be enacted and what effect, if any, it would have on the
Company.
OTHER STATE REGULATION
While many states do not explicitly regulate PEOs, 16 states have passed
laws that have licensing or registration requirements for PEOs and several
others are considering such regulation. Such laws vary from state to state but
generally provide for monitoring the fiscal responsibility of PEOs. In addition
to holding a license in Texas, Administaff holds licenses in Arkansas, Florida,
New Hampshire, Oregon, South Carolina, Tennessee and Utah. The Company has
also been registered or certified in Massachusetts, Minnesota, New Mexico and
Nevada, and has applied for a license in Montana. 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 360 corporate office and sales employees
as of December 31, 1996. 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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<PAGE> 21
ITEM 2. PROPERTIES
Administaff maintains two primary facilities. The corporate
headquarters are located in Kingwood, Texas (20 miles north of Houston), on
approximately 17 acres owned by the Company. This location includes a 66,000
square foot campus style facility and a 76,000 square foot facility that
serves as the Company's operations and records retention facility. Together
these facilities house the Company's executive offices, corporate staff,
service delivery personnel, data-processing center, training facilities and all
other corporate functions.
The Company's other primary facility is located in Las Colinas, near
Dallas, Texas. This 15,300 square foot leased facility, which became
operational in October 1994, currently handles approximately one-third of the
Company's data processing and service delivery needs and serves as a backup
data processing facility and disaster recovery center.
The Company also leases nine other facilities in Houston, Orlando,
Atlanta, Phoenix, Chicago, Washington, D.C./Baltimore and Denver that serve as
sales offices. These offices are typically staffed by six to eight sales
associates, a district sales manager and an administrative assistant.
The Company believes that its facilities are adequate for the purposes
for which they are intended and that its headquarters have sufficient
additional capacity to accommodate the Company's foreseeable expansion plan.
The Company intends to lease additional facilities in new markets as
applicable.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings
other than ordinary routine litigation incidental to its business that the
Company believes 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, 1996.
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<PAGE> 22
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.
Accordingly, information on price ranges for the Common Stock has not been
included in this Annual Report. The Company's trading symbol is "ASF".
As of March 14, 1997 there were approximately 200 holders of record of
the Common Stock. This number does not include stockholders for whom shares
were held in "nominee" or "street name."
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. In addition, the Company's
$10 million revolving credit agreement prohibits the payment of dividends or
other distributions on the Common Stock, except that, so long as no default
exists thereunder, after giving effect to such dividend or distribution, will
exist thereunder, the Company may pay dividends on its Common Stock.
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<PAGE> 23
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."
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues . . . . . . . . . . . . . . . . . . . . $ 409,046 $ 496,058 $ 564,459 $ 716,210 $ 899,596
Gross profit . . . . . . . . . . . . . . . . . . 13,551 19,782 25,196 28,873 37,856
Operating income (loss) . . . . . . . . . . . . (53) 3,127 5,859 2,221 6,477
Net income . . . . . . . . . . . . . . . . . . 33 1,949 3,766 1,116 2,603 (1)
Net income per share . . . . . . . . . . . . . $ 0.00 $ 0.22 $ 0.37 $ 0.10 $ 0.24 (1)
BALANCE SHEET DATA
Working capital . . . . . . . . . . . . . . . . $ (2,431) $ (2,340) $ 8,797 $ 4,737 $ 4,629
Total assets . . . . . . . . . . . . . . . . . . 19,929 19,401 41,081 39,474 48,376
Total debt . . . . . . . . . . . . . . . . . . 1,502 1,196 5,007 4,679 4,603
Total stockholders' equity (deficit) . . . . . . (1,371) 569 8,056 10,689 13,292
STATISTICAL DATA:
Worksite employees at period end(2) . . . . . . 13,409 15,165 15,780 20,502 23,794
Client companies at period end . . . . . . . . . 598 687 809 1,130 1,516
Gross payroll per employee per month(3) . . . . $ 1,919 $ 2,117 $ 2,268 $ 2,331 $ 2,562
- -----------------
</TABLE>
(1) For the year ended December 31, 1996, net income and net income per share
would have been $3.8 million 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."
(2) Reflects the number of employees paid during the last month of the period
shown.
(3) Excludes bonus payroll of worksite employees, which is not subject to the
Company's normal service fee.
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<PAGE> 24
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
encompassing a broad range of services, including benefits and payroll
administration, medical and workers' compensation insurance programs, payroll
tax filings, personnel records management, liability management and related
human resource service. The Company has current operations in 10 markets,
including Houston, San Antonio, Austin, Orlando, Dallas, Atlanta, Phoenix,
Chicago, Baltimore/Washington, D.C. and Denver. In October 1993 the Company
opened a sales office in Dallas as the first step in implementing a long-term
internal growth and expansion strategy. Subsequently, sales offices were opened
in Atlanta, Phoenix, Chicago and Baltimore/Washington, D.C. The Company opened
a second office in Dallas in January 1996, and a new office in Denver in
September 1996. The costs associated with this expansion into new markets
(which for the purposes hereof refers to Dallas and subsequently opened
markets) have been significant and have affected the results of operations for
1994, 1995 and 1996.
Revenues
The Company's revenues are derived from the comprehensive service fee
percentage applied to each employee's gross pay which is invoiced along with
each periodic payroll. The most significant direct costs of the Company are
the salaries and wages of worksite employees which generally are disbursed
promptly after the applicable client service fee is received.
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 program is designed to broaden the scope of the Company's sales and
marketing efforts into new, strategically selected markets, where the Company's
objective is to duplicate the sales and marketing success experienced in the
Houston market to date. The Company has expanded its sales force from 22 at
January 1, 1994 to 74 at December 31, 1996.
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<PAGE> 25
The Company expects to open at least one new market or one additional sales
office in existing markets in each quarter during 1997 and 1998.
Direct Costs
The Company's primary direct costs are (i) the salaries and wages of
worksite employees (payroll cost), (ii) employment related taxes, (iii)
employee benefit plan premiums and (iv) workers' compensation insurance
premiums. Salaries and wages of worksite employees are affected by the
inflationary effects on wage levels and by differences in the local economies
of the Company's markets. Changes in payroll costs have a proportionate impact
on the Company's revenues.
Employment related taxes consist of the employer's portion of payroll
taxes required under FICA, which includes Social Security and Medicare, and
federal and state unemployment taxes. The federal tax rates are defined by the
appropriate federal regulations. State unemployment rates are subject to claims
histories and vary from state to state.
Employee benefit costs are comprised primarily of medical insurance
costs but also include costs of other employee benefits such as prescription
card, vision care, disability insurance and an employee assistance plan.
Workers' compensation costs include premiums, administrative costs and
claims related expenses under the Company's workers' compensation program.
Currently, the Company is insured under a guaranteed cost plan whereby monthly
premiums are paid for coverage of all accident claims occurring during the
policy period. Prior to November 1994, the Company had been insured under two
other types of workers' compensation policies: a retrospective rating plan,
whereby monthly premiums were paid to the insurance carrier based on estimated
actual losses plus an administrative fee, and a high deductible paid loss plan,
whereby monthly premiums were paid based on a $500,000 deductible per
occurrence. Costs related to these prior plans include estimates of ultimate
claims amounts that are recorded as accrued workers' compensation claims.
Changes in these estimates are reflected as a component of direct costs in the
period of the change.
The Company's gross profit margin is determined in part by its ability
to accurately estimate and control direct costs and its ability to incorporate
such costs into the service fees charged to clients. The Company attempts to
reflect changes in the primary direct costs through adjustments in service fees
charged to clients, subject to contractual arrangements.
Operating Expenses
The Company's primary operating expenses are salaries, wages and payroll
taxes of both corporate employees and sales associates, general and
administrative expenses and sales and marketing expenses. As a result of the
Company's market expansion program, 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
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<PAGE> 26
expenses of newly hired sales associates and expansion of the Company's
advertising efforts. In addition, the anticipated growth as a result of the
sales expansion is also reflected in increased corporate operating expenses to
provide expansion of the Company's service capacity. The Company expects that
the investment in new markets will continue at a level comparable to or greater
than 1995 and 1996 through at least 1998.
Income Taxes
The Company's provision for income taxes typically differs from the U.S.
statutory rate of 34% due primarily to state income taxes. Deferred income
taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities used for financial reporting purposes and the
amounts used for income tax purposes. Significant items resulting in deferred
income taxes include accrued workers' compensation claims, depreciation and
amortization, state income taxes, client list acquisition costs, allowance for
uncollectible accounts receivable, accrual of PEO service fees and costs and
other accrued liabilities. Changes in these items are reflected in the
Company's financial statements though the Company's deferred income tax
provision.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995.
The following table presents certain information related to the
Company's results of operations for the years ended December 31, 1995 and 1996.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------------------------
1995 1996 CHANGE
--------- -------- ------
(OPERATING RESULTS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING RESULTS:
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 716,210 $ 899,596 25.6%
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 28,873 37,856 31.1%
Gross profit margin . . . . . . . . . . . . . . . . . . . 4.0% 4.2%
Operating income . . . . . . . . . . . . . . . . . . . . . 2,221 6,477 191.6%
STATISTICAL DATA:
Monthly revenue per worksite employee . . . . . . . . . . 2,904 3,166 9.0%
Monthly payroll cost per worksite employee . . . . . . . . 2,331 2,562 9.9%
Monthly gross markup per worksite employee . . . . . . . . 573 604 5.4%
Average number of worksite employee paid
per month during period . . . . . . . . . . . . . . . . . 19,255 22,234 15.5%
</TABLE>
- 25 -
<PAGE> 27
REVENUES
The Company's revenues increased 25.6% over 1995 due to an increase in
worksite employees paid accompanied by an increase in the revenue per employee.
The Company's continued expansion of its sales force through new market and
sales office openings is the primary factor contributing to the increased
number of worksite employees. The Company's new markets contributed
approximately $221 million of the Company's total revenues for 1996 versus
approximately $110 million in 1995. In addition, the 1995 period includes
approximately 1,400 new employees enrolled through a referral agreement with an
unaffiliated PEO in Chicago. The Company added to its sales force in the Dallas
market in January 1996 and the Denver market in September 1996 and expects
continued growth in the number of worksite employees in 1997 due to the effect
of sales in existing markets and expansion into new markets.
The increase in revenue per employee of 9.0% directly relates to the
increase in payroll cost per employee of 9.9%. This increase reflects the
continuing effects of the net addition, through the Company's sales efforts, of
clients with worksite employees with higher average base pay to the existing
client base.
GROSS PROFIT MARGIN
The Company's gross profit margin increased from 4.0% in 1995 to 4.2%
in 1996. The primary factors contributing to the increased gross profit margin
were a decrease in unemployment taxes as a percent of payroll cost and a slight
decrease in the cost of providing employee benefits as a percent of revenue.
These factors were partially offset by a decrease in the gross markup per
person as a percent of revenue.
Employment related taxes as a percent of payroll cost declined from
7.9% in 1995 to 7.3% in 1996. This reduction was primarily due to reduced
unemployment tax expense in the State of Texas. The Company's unemployment tax
rate in the State of Texas was substantially lower in 1996 than 1995 due to the
effects of a reorganization of the Company's operating subsidiaries completed
on January 1, 1996.
The cost of providing employee benefits was slightly lower in 1996
versus 1995 primarily due to decreased workers' compensation costs. Workers'
compensation costs decreased from 2.5% of payroll cost in 1995 to 2.1% of
payroll cost in 1996. This reduction was due to the overall rate on the
Company's fixed premium policy in effect during 1996 being lower than the
previous policy. The Company's recently renewed workers' compensation policy is
at a slightly lower rate, and such policy is in effect through October 31,
1997. These rate reductions reflect a reduced risk sensitivity of the current
composition of the Company's client base. Medical plan premiums were comparable
as a percent of revenues in 1996 versus 1995.
The continued addition of higher wage, less risk sensitive worksite
employees resulted in a decrease in markup per employee as a percent of revenue
from 19.7% in 1995 to 19.1% in 1996.
- 26 -
<PAGE> 28
The Company generally charges lower overall rates as a percentage of gross
payroll on higher wage, less risk sensitive employees.
OPERATING EXPENSES
Operating expenses decreased as a percent of revenue from 3.7% in 1995
to 3.5% in 1996. Total operating expenses increased 17.7% while revenues and
gross profit increased 25.6% and 31.1%, respectively. The overall increase in
operating expenses can be attributed principally to increased compensation
related costs (salaries, wages and payroll taxes and commissions) which
increased in proportion to revenues and increased depreciation and amortization
expense. General and administrative expenses were slightly higher than in 1995
and advertising expenses were approximately equal to 1995. The factors noted
above include the effects of continued significant operating expenses in new
markets. Operating expenses incurred directly in new markets (which include
salaries, payroll taxes, recruiting and training costs of newly hired sales
associates, advertising and public relations costs and general office expenses)
totaled $6.1 million in 1996 versus $4.3 million in 1995. Excluding the impact
of expenses incurred directly in the new markets, operating expenses increased
only $2.9 million, or 11.0% as compared to 1995.
Total compensation costs, which include salaries, wages, payroll taxes
and commissions, increased 24.6% compared to 1995. Salaries and wages increased
at a higher rate while commissions were relatively unchanged due to a
restructuring of the Company's sales compensation plan to a more salary based
system. Overall, corporate staff, including sales personnel, increased 11.7%
versus 1995. This increase is primarily due to increased sales personnel and
continued increases in corporate service capacity.
Depreciation and amortization expense increased 64.8% over the 1995
period. The Company placed into service a new corporate facility in February
1996 which has resulted in higher depreciation and amortization expense
compared to 1995. Capital expenditures related to the opening of new sales
offices as part of the Company's market expansion process and increases in
corporate service capacity also contributed to the increase.
General and administrative expenses as a percent of revenue declined
slightly versus 1995 from 1.1% to 0.9%. This trend is due to the Company's
focused efforts to contain costs in its selling, service and administrative
functions.
NET INCOME
Interest expense increased $232,000 due to financing charges related
to the payment plan for the Company's annual workers' compensation insurance
policy and short-term borrowings on the Company's revolving line of credit.
Interest income was essentially unchanged from 1995.
Other net, 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
- 27 -
<PAGE> 29
Code, which charge is 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, which includes the effects
of the non-recurring charge for 401(k) Plan issues, differs from the U.S.
statutory rate of 34% due primarily to certain portions of the non-recurring
charge being non-deductible for income tax purposes. In addition, the Company's
provision for income taxes differs from the U.S. statutory rate due to state
income taxes.
The increase in net income for the year ended December 31, 1996 versus
December 31, 1995 of $1.5 million, or 133.2%, is due to the same factors which
resulted in increased operating income, partially offset by the effects of the
non-recurring charge in the third quarter for certain 401(k) Plan issues, net
of amounts recoverable from the 401(k) Plan recordkeeper. Excluding the
non-recurring third quarter charge and the related income tax effects of such
charge, net income would have been $3.8 million (or $0.34 per share) in 1996 as
compared to $1.1 million (or $0.10 per share) in 1995.
- 28 -
<PAGE> 30
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
The following table represents certain information related to the
Company's results of operations for the years ended December 31, 1994 and 1995.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------------------------
1994 1995 CHANGE
--------- -------- ------
(OPERATING RESULTS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING RESULTS:
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 564,459 $ 716,210 26.9%
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 25,196 28,873 14.6%
Gross profit margin . . . . . . . . . . . . . . . . . . . 4.5% 4.0%
Operating income . . . . . . . . . . . . . . . . . . . . . 5,859 2,221 (62.1)%
STATISTICAL DATA:
Monthly revenue per worksite employee . . . . . . . . . . $ 2,860 $ 2,904 1.5%
Monthly payroll cost per worksite employee . . . . . . . . 2,268 2,331 2.8%
Monthly gross markup per worksite employee . . . . . . . . 592 573 (3.2)%
Average number of worksite employees paid
per month during period . . . . . . . . . . . . . . . . 15,500 19,255 24.2%
</TABLE>
REVENUES
The Company's revenues increased 26.9% over 1994 due primarily to an
increased number of worksite employees paid during the period. The Company
continued to expand its sales force in late 1994 and throughout 1995 by opening
sales offices in Atlanta (October 1994), Phoenix (January 1995), Chicago (April
1995) and Washington, D.C. (October 1995). These sales offices, along with the
continued maturation of the Dallas sales office (opened in the fourth quarter
of 1993) were the primary factors contributing to the increased number of
worksite employees. The Company's new markets contributed approximately $110
million of the Company's 1995 total revenues. In addition, in January 1995, the
Company enrolled, through a referral agreement with an unaffiliated
professional employer organization in Chicago, approximately 1,400 worksite
employees which also contributed to the increase over 1994. Revenue per
employee increased only slightly versus 1994.
GROSS PROFIT MARGIN
Gross profit margin decreased from 4.5% in 1994 to 4.0% in 1995. The
factors that caused this decline were a decline in the gross markup per
worksite employee partially offset by a reduction, as a percent of revenue, in
the costs of providing employee benefits.
The monthly revenue per worksite employee increased slightly during
1995 compared to
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<PAGE> 31
1994. The monthly payroll cost per worksite employee increased at a greater
rate than the increased revenue per worksite employee in the same period
resulting in a 3.2% reduction in the gross markup per worksite employee. This
reduction reflects the effects of a shift in the relative mix of worksite
employees paid by the Company to higher wage, less risk sensitive employees on
which the Company charges lower overall rates as a percentage of gross payroll.
The reduction in employee benefits costs relative to revenues was
primarily due to a reduction in workers' compensation costs partially offset by
increased medical plan premiums. Workers' compensation costs declined primarily
due to the Company's conversion to a guaranteed cost policy in the fourth
quarter of 1994 from the previous high deductible paid loss policy. The high
deductible paid loss policy resulted in increases to accrued workers'
compensation claims which were significantly higher during 1994 than during
1995. In addition, during the third quarter of 1995, the Company settled the
remaining outstanding claims under certain retrospective rating policies in
effect in prior years resulting in a $1 million reduction in overall workers'
compensation costs during 1995. Medical plan premiums increased compared to
1994 as favorable medical claims experience during 1993 and early 1994 resulted
in reduced health insurance premiums during much of 1994.
Employment related taxes relative to payroll costs increased slightly
due to state unemployment tax rate increases.
OPERATING EXPENSES
The Company's operating income decreased from $5.9 million in 1994 to
$2.2 million in 1995. In addition to the decline in gross profit margin
discussed above, operating expenses increased from 3.4% of revenue in 1994 to
3.7% of revenue in 1995. The increase in operating expenses relative to
revenues can be attributed primarily to increased salaries, wages and payroll
taxes and the selling, advertising and other general and administrative
expenses incurred in connection with the Company's market expansion plan.
Operating expenses incurred directly in new markets totaled approximately $4.3
million in 1995 versus $987,000 in 1994.
Costs associated with the expansion of sales and service capacity
primarily relate to the addition of corporate employees and other general and
administrative expenses. Excluding expenses directly incurred in new markets,
salaries, wages and payroll taxes increased $2.1 million during 1995 over those
incurred in 1994. The Company's average staff increased from 221 for 1994 to
320 for 1995. These increases reflected both an increase in the size of the
Company's sales force, from 22 at January 1, 1994 to 84 at December 31, 1995,
and an increase in the corporate infrastructure to manage the overall growth of
the Company.
Advertising expenses in the Company's expansion markets were $1.8
million in 1995 versus $516,000 during 1994. The Company's total advertising
expenses increased by $1.5 million, or 82%, over 1994.
The higher level of revenues during 1995 also contributed to an
increase of approximately
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<PAGE> 32
$711,000 for sales commissions. Such increase did not represent a significant
change from costs incurred during 1994 when considered as a percent of payroll
costs of worksite employees.
Depreciation and amortization expense increased $327,000 in 1995 as
compared to 1994 due to capital expenditures incurred in connection with the
establishment of a disaster recovery computer and operations center and the
opening of new sales offices as part of the Company's market expansion plan.
NET INCOME
Interest expense increased $289,000 over 1994 due to a full year of
interest on the $4.0 million subordinated debt borrowings compared to only
seven months in 1994. Interest income increased $219,000 over 1994 due to
higher level of funds available for investment during the period.
The Company's provision for income taxes differs from the U.S.
statutory rate of 34% primarily due to state income taxes.
Net income for 1995 was $1.1 million versus $3.8 million in 1994. The
decline in net income is attributable primarily to a decline in the overall
gross profit margin combined with increases in operating expenses associated
with the Company's market expansion plan as discussed above.
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 the
proceeds from its initial public offering, its cash on hand, cash flows from
operations and available borrowing capacity under its Credit Agreement will be
adequate to meet its liquidity requirements through at least 1998. The Company
will rely on these same sources, as well as public and private debt and equity
financing, to meet its long-term liquidity needs.
The Company has $13.4 million in cash and cash equivalents at December
31, 1996, of which approximately $8.3 million is payable in early January 1997
for withheld federal and state income taxes and FICA. 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, capital expenditures and repayments of existing indebtedness.
The Company has repaid all of its long-term debt utilizing the proceeds from
its initial public offering subsequent to December 31, 1996 and accordingly,
has no long-term debt repayment requirements during 1997. At December 31, 1996
the Company had positive working capital of $4.6 million which is relatively
unchanged from $4.7 million at December 31, 1995.
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<PAGE> 33
CASH FLOWS FROM OPERATING ACTIVITIES
The Company's cash flows from operating activities in 1996 increased
substantially from 1995. This increase resulted from federal and state income
tax payments relating to 1994 totaling $1.9 million paid in 1995 versus net
federal income tax refunds received of $1.2 million during 1996. Additionally,
higher payments in 1995 for previously accrued workers' compensation claims;
the timing of accounts receivable collection at the end of the respective
periods; and increases in prepaid expenses in 1995 versus decreases in prepaid
expenses in 1996 contributed to the increase in cash flow from operations.
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures during the year ended December 31, 1996 totaled
$4.0 million and include approximately $2.1 million to complete, furnish and
equip a Company-owned facility to accommodate continued growth in corporate
employees. This facility was opened in February 1996. In addition, capital
expenditures in 1996 include expenditures for corporate and disaster recovery
computer equipment, furniture and equipment for new and existing sales offices
and new corporate telephone systems. Capital expenditures of $4.6 million in
1995 included approximately $2.4 million for construction on the company-owned
facility completed in February 1996, expenditures to equip and furnish new and
existing sales offices and for corporate and disaster recovery computer
equipment. Capital expenditures of $1.8 million in 1994 related primarily to
new sales office facilities, improvements to the corporate headquarters in
Kingwood and the disaster recovery center in Las Colinas.
Net dispositions of marketable securities of $4.0 million in 1995
resulted primarily from marketable securities reaching maturity and being
converted to cash equivalents. Net purchases of marketable securities in 1994
of $4.5 million relate to investments in government securities, some of which
were required as security for certain letter of credit agreements in place
during that period.
In January 1995, the Company acquired a client base in its Chicago
market through a referral agreement calling for a referral fee which totaled
$420,000 payable to the referring organization based on the number of worksite
employees enrolled by Administaff. The remainder of the increase in intangible
assets in both years relates to costs incurred for the rewrite of the Company's
computerized payroll software system.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities in 1996 and 1995 include loans to
employees related to the federal income tax impact of the exercise of stock
options. In 1995, cash flows from financing activities include the proceeds
received from the exercise of such options. In 1996, the Company borrowed, on
two occasions, a total of $2.5 million under its $10 million revolving credit
agreement. Both borrowings were repaid during the third quarter of 1996.
During 1995 and 1996, the Company incurred $0.7 million and $1.1 million,
respectively, in costs related to its initial public offering which
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<PAGE> 34
was completed in January 1997. Financing activities in 1994 were primarily the
net proceeds from the issuance of subordinated notes of $4.0 million and the
sale of common stock of $3.6 million.
CREDIT AGREEMENT
In October 1995 the Company's wholly-owned subsidiary, Administaff of
Texas, Inc. ("Administaff of Texas"), entered into a $10 million revolving
credit agreement (the "Credit Agreement") with a bank. Such Credit Agreement
includes an agreement to issue standby letters of credit (in an amount not to
exceed a sublimit of $5,000,000). The Company is a guarantor under the Credit
Agreement. The Credit Agreement includes, among other covenants, a limitation
on the declaration and payment of dividends, a change of control provision and
other covenants customary in lending transactions of this type. At December 31,
1996 no borrowings were outstanding under the Credit Agreement. Borrowings
under the Credit Agreement bear interest at rates based on the bank's Corporate
Base Rate or LIBOR plus an applicable margin at the time of the borrowing.
INITIAL PUBLIC OFFERING AND EXPANSION PLAN
The Company filed a registration statement with the Securities and
Exchange Commission in September 1995 to register the sale of up to 3,000,000
shares of its common stock in the Company's initial public offering. Such
offering 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. Of these proceeds, the Company currently expects
to allocate approximately $12.0 million to support expansion of the Company's
operations, including the opening of sales offices in new geographic markets as
well as in established markets and, as favorable opportunities arise, expansion
of the Company's client base in new or existing markets through acquisitions of
existing PEO offices. In addition, the Company utilized approximately $7.2
million of such proceeds as follows: (i) $4.0 million to repay certain
subordinated notes, (ii) approximately $2.5 million to exercise its option to
repurchase 348,945 shares of Common Stock from one of its stockholders and its
option to repurchase 173,609 warrants to purchase shares of Common Stock from
the subordinated noteholder, and (iii) approximately $0.7 million to retire the
balances of certain secured loans. The balance of the proceeds will be used
for working capital purposes, which may include acquisitions of existing PEO
operations should favorable acquisition opportunities arise. Pending the
application of such funds, the Company has invested the net proceeds of the
offering in diversified, highly-liquid, investment grade, interest-bearing
instruments.
OTHER MATTERS
The Company's net deferred income tax assets and liabilities have
fluctuated significantly from December 31, 1994 to December 31, 1996. At
December 31, 1994, the Company had net deferred tax assets of $2.2 million,
relating primarily to accrued workers' compensation claims for which tax
deductions were not available until the claims were paid. During 1995, a
significant portion of these claims were paid resulting in substantial
deductions for income tax purposes. Therefore, as of December 31, 1995, the
Company had no net deferred tax assets or liabilities. The Company had net
- 33 -
<PAGE> 35
deferred tax liabilities of $0.9 million at December 31, 1996 due primarily to
the phase in of a change in accounting method for income tax purposes. In
January and May 1996, the IRS approved the Company's request for a change in
the method of accounting for PEO service fees and worksite employee payroll
costs to the accrual method. These changes were adopted for financial reporting
purposes effective January 1, 1994. For PEO service fees the change, for tax
purposes, was approved effective January 1, 1995 with a three year phase in
period for the cumulative effect of the change. For worksite employee payroll
costs, the change, for tax purposes, was approved effective January 1, 1995
with a one year phase in period for the cumulative effect of the change. As a
result, the Company amended its 1995 consolidated federal income tax return to
account for these changes. The Company received $3.5 million in federal income
tax refunds in May and July 1996 related to the original and amended tax
returns. Deferred income taxes at December 31, 1996 reflected the effect of the
three year phase in for the cumulative effect of the change in accounting for
PEO service fees as a component of net deferred income tax liabilities. See
Note 4 of Notes to Consolidated Financial Statements.
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, 1996. 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.
SEASONALITY, INFLATION AND QUARTERLY FLUCTUATIONS
The timing of the assessment of employment related taxes has a
seasonal effect on the Company's cash flows, with the Company generally having
lower cash flow from operations during the first six months of each year. As
individual worksite employees meet applicable wage limits for such taxes, the
Company's employment tax obligation declines which increases cash flows from
operations during the balance of the year.
The Company's operating results have historically fluctuated from
quarter to quarter. In addition, due to the timing of the assessment of
employment related taxes, the Company's gross profit margin typically improves
from quarter to quarter within each year with the first quarter generally being
the least favorable. Employment related taxes are based on the cumulative
earnings of individual employees up to a specified wage level. 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 or results of operations during the first six months of
each year.
- 34 -
<PAGE> 36
The Company believes the effects of inflation have not had a
significant impact on its results of operations or financial condition.
CERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
AUDIT OF THE COMPANY'S 401(k) PLAN; IRS EMPLOYEE LEASING MARKET
SEGMENT GROUP
The Company's 401(k) Plan is currently under audit by the Internal
Revenue Service ("IRS") for the year ended December 31, 1993. Although the
audit is for the 1993 plan year, certain conclusions of the IRS would be
applicable to other years as well. In addition, the IRS has established an
Employee Leasing Market Segment Group for the purpose of identifying specific
compliance issues prevalent in certain segments of the PEO industry.
Approximately 70 PEOs, including the Company, have been randomly selected by
the IRS for audit pursuant to this program. One issue that has arisen from
these audits is whether a PEO can be a co-employer of worksite employees,
including officers and owners of client companies, for various purposes under
the Internal Revenue Code of 1986, as amended (the "Code"), including
participation in the PEO's 401(k) plan. For a discussion of the issues being
considered by the Market Segment Group, see Item 1. "Business - Industry
Regulation". With respect to the 401(k) Plan audit, the Company understands
that the IRS Houston District intends to seek technical advice (the "Technical
Advice Request") from the IRS National Office about (1) whether participation
in the 401(k) Plan by worksite employees, including officers of client
companies, violates the exclusive benefit rule under the Code because they are
not employees of the Company and (2) whether the 401(k) Plan's failure to
satisfy a nondiscrimination test relating to contributions should result in
disqualification of the 401(k) Plan because the Company has failed to provide
evidence that it satisfies an alternative discrimination test. A draft copy of
the Technical Advice Request has been sent to the Company for its comments
before the IRS Houston District submits it to the IRS National Office. The
draft of 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 also understands that, with respect
to the Market Segment 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") is being referred to the IRS National Office.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. The Company is not able to
predict either the timing or the nature of any final decision that may be
reached with respect to the 401(k) Plan audit or with respect to the Technical
Advice Request or the Market Segment Group study and the ultimate outcome of
such decisions. Should the IRS conclude that the Company is not a "co-employer"
of worksite employees for purposes of the Code, worksite employees could not
continue to make salary deferral contributions to the 401(k) Plan or pursuant
to the Company's cafeteria plan or continue to participate in certain other
employee benefit plans of the Company. The Company believes that,
- 35 -
<PAGE> 37
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 conclusion were applied retroactively to disqualify the
401(k) Plan for 1993 and subsequent years, employees' vested account balances
under the 401(k) Plan would become taxable, the Company would lose its tax
deductions to the extent its matching contributions were not vested, the 401(k)
Plan's trust would become a taxable trust and the Company would be subject to
liability with respect to its failure to withhold applicable taxes with respect
to certain contributions and trust earnings. Further, the Company would be
subject to liability, including penalties, with respect to its cafeteria plan
for the failure to withhold and pay taxes applicable to salary deferral
contributions by employees, including worksite employees. In such a scenario,
the Company also would face the risk of client dissatisfaction and potential
litigation. A retroactive application by the IRS of an adverse conclusion
resulting in disqualification of the 401(k) Plan would have a material adverse
effect on the Company's financial position and results of operations.
COSTS OF 401(k) PLAN COMPLIANCE
In 1991 the Company engaged a third party vendor to be the 401(k)
Plan's record keeper and to perform certain required annual nondiscrimination
tests for the 401(k) Plan. Each year such record keeper reported to the Company
that such nondiscrimination tests had been satisfied. However, in August 1996
the 401(k) Plan's record keeper advised the Company that certain of these tests
had been performed incorrectly for prior years and, in fact, that the 401(k)
Plan had failed certain tests for the 1993, 1994 and 1995 plan years. The
Company has subsequently determined that the 401(k) Plan also failed a
nondiscrimination test for 1991 and 1992, closed years for tax purposes. At the
time the Company received such notice, the period in which the Company could
voluntarily "cure" this operational defect had lapsed for all such years,
except 1995. With respect to the 1995 year, the Company has caused the 401(k)
Plan to refund the required excess contributions and earnings thereon to
affected highly compensated participants, and the Company has paid, subsequent
to December 31, 1996, an excise tax of approximately $47,000 related to such
contributions. Because the 401(k) Plan is under a current IRS audit, the IRS
voluntary correction program for this type of operational defect is not
available to the Company for years prior to 1995. Accordingly, the Company
informed the IRS of the prior testing errors for each of 1991, 1992, 1993 and
1994 and proposed a correction that consists of corrective contributions by the
Company to the 401(k) Plan with respect to these years (including the closed
years) and the payment by the Company of the minimum penalty ($1,000) that the
IRS is authorized to accept to resolve this issue. The IRS Houston District has
indicated that resolution of the nondiscrimination test failures is premature
until the National Office resolves the issues presented in the Technical Advice
Request. No assurance can be given that the IRS will permit the Company to
administratively "cure" this operational defect instead of proposing a
disqualification of the 401(k) Plan. The Company recorded a reserve during the
third quarter of 1996 with respect to these 401(k) Plan issues. The amount of
such reserve is the Company's estimate of the cost of
- 36 -
<PAGE> 38
corrective measures and penalties, although no assurance can be given that the
actual amount that the Company may ultimately be required to pay will not
substantially exceed the amount so reserved. In addition, the Company has
recorded an asset for an amount recoverable from the 401(k) Plan's record
keeper should the Company ultimately be required to pay the amount accrued for
such corrective measures and penalties. Based on its understanding of the
settlement experience of other companies, the Company does not believe that the
ultimate resolution of the nondiscrimination test issue will have a material
adverse effect on the Company's financial condition 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.
STATE AND LOCAL REGULATION
The Company employs worksite employees in over 40 states and is,
therefore, subject to regulation by various local and state agencies pertaining
to a wide variety of labor related laws. As is the case with the provisions of
the Code discussed above, many of these regulations were developed prior to the
emergence of the PEO industry and do not specifically address non-traditional
employers. 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, 16 states
(including Texas) have passed laws that have licensing or registration
requirements for PEOs and several other states are considering such regulation.
Such laws vary from state to state but generally provide for monitoring the
fiscal responsibility of PEOs. While the Company generally supports licensing
regulation because it serves to validate the PEO relationship, there can be no
assurance that the Company will be able to satisfy licensing requirements or
other applicable regulations of any particular state in which it is not
currently operating but later commences operations. In addition, there can be
no assurance that the Company will be able to renew its licenses in the states
in which it currently operates upon expiration of such licenses.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES AND
WORKERS' COMPENSATION RATES
Health insurance premiums, state unemployment taxes and workers'
compensation rates are in part determined by the Company's claims experience
and comprise a significant portion of the Company's direct costs. The Company
employs extensive risk management procedures in an attempt to control its
claims incidence. However, should the Company experience a large increase in
claim activity, its unemployment taxes, health insurance premiums or workers'
compensation insurance rates
- 37 -
<PAGE> 39
may increase. The Company's ability to incorporate such increases into service
fees to clients is constrained by contractual arrangements with clients, which
may result in a delay before such increases can be reflected in service fees.
As a result, such increases could have a material adverse effect on the
Company's financial condition or results of operations.
LIABILITIES FOR CLIENT AND EMPLOYEE ACTIONS
A number of legal issues remain unresolved with respect to the
co-employment arrangement between a PEO and its worksite employees, including
questions concerning the ultimate liability for violations of employment and
discrimination laws. The Administaff Client Service Agreement 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 Client Service Agreement
provides that the client is to indemnify the Company for any liability
attributable to the conduct of the client, the Company may not be able to
collect on such a contractual indemnification claim and thus may be responsible
for satisfying such liabilities. In addition, worksite employees may be deemed
to be agents of the Company, subjecting the Company to liability for the
actions of such worksite employees.
LIABILITY FOR WORKSITE EMPLOYEE PAYROLL
Under the Administaff Client Service Agreement, the Company becomes a
co-employer of worksite employees and assumes the obligations to pay the
salaries, wages and related benefit costs and payroll taxes of such worksite
employees. As such a co-employer, the Company assumes such obligations as a
principal, not merely as an agent of the client company. The Company's
obligations include responsibility for (i) payment of the salaries and wages
for work performed by worksite employees, regardless of whether the client
company makes timely payment to the Company of the associated service fee, and
(ii) providing benefits to worksite employees even if the costs incurred by
Administaff to provide such benefits exceed the fees paid by the client
company. During the three years ended December 31, 1996, the Company has
recorded a total of $236,000 in bad debt expense on approximately $2.2 billion
of total revenues. 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.
- 38 -
<PAGE> 40
POSSIBLE ADVERSE APPLICATION OF OTHER FEDERAL AND STATE LAWS
As a major employer, the Company's operations are affected by numerous
federal and state laws relating to labor, tax (in addition to the provisions of
the Code discussed above) and employment matters. By entering into a
co-employer relationship with employees assigned to work at client company
locations, the Company assumes certain obligations and responsibilities of an
employer under these laws. However, many of these laws (such as the Employee
Retirement Income Security Act ("ERISA") and federal and state employment tax
laws) do not specifically address the obligations and responsibilities of
non-traditional employers such as PEOs, and the definition of "employer" under
these laws is not uniform. In addition, many of the states in which the Company
operates have not addressed the PEO relationship for purposes of compliance
with applicable state laws governing the employer/employee relationship. If
these other federal or state laws are ultimately applied to the Company's PEO
relationship with its worksite employees in a manner adverse to the Company,
such an application could have a material adverse effect on the Company's
results of operations or financial condition.
GEOGRAPHIC MARKET CONCENTRATION
While the Company has operations in 10 markets, six of these represent
recent expansions. The Company's Houston and Texas (including Houston) markets
accounted for approximately 52% and 81%, respectively, of the Company's revenue
base for the year ended December 31, 1996. Accordingly, while a primary aspect
of the Company's strategy is expansion in its current and future markets
outside of Texas, for the foreseeable future a significant portion of the
Company's revenues may be subject to economic factors specific to Texas
(including Houston). While the Company believes that its market expansion plans
will eventually lessen or eliminate this risk in addition to generating
significant revenue growth, there can be no assurance that the Company will be
able to duplicate in other markets the revenue growth and operating results
experienced in its Texas (including Houston) markets.
COMPETITION AND NEW MARKET ENTRANTS
The PEO industry is highly fragmented, with approximately 2,000
companies performing PEO services to some extent. Many of these companies have
limited operations and fewer than 1,000 worksite employees, but there are
several industry participants which are comparable in size to the Company.
These companies include Staff Leasing, Inc, headquartered in Bradenton,
Florida, Employee Solutions, Inc., headquartered in Phoenix, Arizona and The
Vincam Group, Inc., headquartered in Coral Gables, Florida. The Company also
encounters competition from "fee for service" companies such as payroll
processing firms, insurance companies and human resource consultants. Moreover,
the Company expects that as the PEO industry grows and its regulatory framework
becomes better established, well organized competition with greater resources
than the Company may enter the PEO market, possibly including large "fee for
service" companies currently providing a more limited range of services.
- 39 -
<PAGE> 41
QUARTERLY FLUCTUATIONS IN EARNINGS AND IMPACT OF EMPLOYMENT RELATED
TAXES
The Company's operating results have historically fluctuated from
quarter to quarter. In addition, due to the timing of the assessment of
employment related taxes, the Company's gross profit margin typically improves
from quarter to quarter within each year with the first quarter generally the
least favorable. Employment related taxes are based on the cumulative earnings
of individual employees up to specified wage levels. Since the Company's
revenues related to worksite employees are 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.
POTENTIAL CLIENT LIABILITY FOR EMPLOYMENT TAXES
Pursuant to the Company's Client Service Agreement with its clients,
the Company assumes sole responsibility and liability for the payment of
federal employment taxes imposed under the Code with respect to wages and
salaries paid to its worksite employees. There are essentially three types of
federal employment tax obligations: (i) income tax 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 Client Service
Agreement 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.
DEPENDENCE ON KEY PERSONNEL
The Company's success is dependent upon the continued contributions of
its key management personnel, some of whom were founders of the Company. Many
of the Company's key personnel would be difficult to replace. The Company's
executives are not subject to noncompetition agreements.
EXPENSES ASSOCIATED WITH EXPANSION
Past and future operating results are impacted by the Company's market
expansion activities, including establishing and maintaining sales office
facilities, compensating newly hired sales associates and expanding advertising
efforts. The Company's operating results for 1994, 1995 and 1996 have included
$1.0 million, $4.3 million and $6.1 million, respectively, of operating
expenses incurred directly in new markets. The Company expects that investments
in new markets will continue at levels
- 40 -
<PAGE> 42
comparable to or greater than 1996 through at least 1998, and that expenses in
a new market will not be covered by the gross profit from that market's
revenues for approximately two years. While the Company believes that its
expansion program will ultimately lead to increased profitability, there can be
no assurance that losses or diminished profitability will not be incurred in
future periods as a result of the Company's planned expansion or that such
losses or diminished profitability will not have a material adverse effect on
the Company's results of operations or financial condition.
FAILURE TO MANAGE GROWTH
The Company has experienced significant growth and expects such growth
to continue for the foreseeable future. The Company plans to enter at least
one new market or open at least one additional sales office in an existing
market in each quarter of 1997 and 1998. As described under the above caption
"-- Expenses Associated with Expansion," expenses incurred in connection with
the initial expansion into new markets are significant. In addition, because
each market entry is affected by circumstances unique to its particular locale,
there are uncertainties associated with each new market entry. Accordingly, the
Company's expansion plan may place a significant strain on the Company's
management, financial, operating and technical resources. Failure to manage
this growth effectively could have a material adverse effect on the Company's
financial condition or results of operations.
NEED TO RENEW OR REPLACE CLIENT COMPANIES
The Company's standard Client Service Agreement has an initial
one-year term and is subject to cancellation on 30 days' notice by either the
Company or the client. Accordingly, the short-term nature of the Client Service
Agreement makes the Company vulnerable to potential cancellations by existing
clients which could materially and adversely affect the Company's financial
condition and results of operations. In addition, the Company's results of
operations are dependent in part upon the Company's ability to retain or
replace its client companies upon the termination or cancellation of the Client
Service Agreement. Historically, between 15% and 20% of the Company's clients
have remained clients for less than one year and there can be no assurance that
the number of contract cancellations will not increase in the future.
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS AND
DELAWARE LAW
The Company's Certificate of Incorporation and Bylaws include
provisions that may have the effect of discouraging proposals by third parties
to acquire a controlling interest in the Company, which could deprive
stockholders of the opportunity to consider an offer that would be beneficial
to them. These provisions include (i) a classified Board of Directors, (ii) the
ability of the Board of Directors to establish a rights plan, establish a
sinking fund for the purchase or redemption of shares, fix the number of
directors and fill vacancies on the Board of Directors, and (iii) restrictions
on the ability of stockholders to call special meetings, act by written consent
or amend the foregoing provisions. In addition, under certain conditions
Section 203 of the General Corporation Law of the State of Delaware (the
"DGCL") would impose a three-year moratorium on certain business
- 41 -
<PAGE> 43
combinations between the Company and an "interested stockholder" (in general, a
stockholder owning 15 percent or more of a corporation's outstanding voting
stock). The existence of such provisions may have a depressive effect on the
market price of the Common Stock in certain situations.
CONTROL BY DIRECTORS AND OFFICERS
The Company's executive officers and directors beneficially own an
aggregate of approximately 8.8 million shares of Common Stock of the Company,
constituting approximately 65% of the outstanding shares of Common Stock as of
March 14, 1997. Accordingly, such persons will be in a position to control
actions that require the consent of a majority of the Company's outstanding
voting stock, including the election of directors. A person beneficially owning
more than one-third of the Company's outstanding voting stock will be able to
prevent certain actions that require the affirmative vote of at least
four-fifths of the Company's outstanding voting stock.
BROAD DISCRETION OVER USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
Approximately $19.2 million of the net proceeds from the Company's
initial public offering has been allocated to implement the Company's expansion
plan, to repay certain indebtedness and to repurchase Common Stock and Common
Stock warrants held by one of the Company's existing stockholders. The balance
of the net proceeds will be used for working capital purposes, which may
include acquisitions of existing PEO operations should favorable opportunities
arise. Accordingly, the Company will have broad discretion to allocate a
significant portion of the net proceeds without any action or approval of the
Company's stockholders. Therefore, investors in the Common Stock will not have
the opportunity to evaluate the economic, financial and other relevant
information that will be considered by the Company in determining the
application of such net proceeds.
DIVIDEND POLICY
The Company intends to retain all of its earnings to finance the
expansion of its business and for general corporate purposes and does not
anticipate paying any cash dividends on its Common Stock for the foreseeable
future. In addition, the Company's credit facility includes certain
restrictions on the ability of the Company to pay dividends.
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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<PAGE> 44
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.
- 43 -
<PAGE> 45
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).
4.1 Specimen Common Stock Certificate (incorporated by
reference to Exhibit 4.1 to the Registrant's
Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
4.2 Registration Rights Agreement, as amended, dated May
13, 1994, by and among Administaff, Inc., Pyramid
Ventures, Inc. And the Board of Trustees of the Texas
Growth Fund as Trustee for the Texas Growth Fund-1991
Trust (incorporated by reference to Exhibit 4.2 to
the Registrant's Registration Statement on form S-1
(No. 33-96952) declared effective on January 28,
1997).
4.3 Investor Agreement, as amended, date May 13, 1994 by
and among Administaff, Inc., Pyramid Ventures, Inc.
and the Board of Trustees of the Texas Growth Fund as
Trustee for the Texas Growth Fund-1991 Trust
(incorporated by reference to Exhibit 4.3 to the
Registrant's Registration Statement on form S-1 (No.
33-96952) declared effective on January 28, 1997).
4.4 Common Stock Warrant, as amended, issued to the Texas
Growth Fund-1991 Trust on May 13, 1994 (incorporated
by reference to Exhibit 4.4 to the Registrant's
Registration Statement on form S- 1 (No. 33-96952)
declared
- 44 -
<PAGE> 46
effective on January 28, 1997).
4.5 Warrant Agreement, as amended, dated May 13, 1994,
between Rauscher Pierce Refsnes, Inc. and
Administaff, Inc. (incorporated by reference to
Exhibit 4.5 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
4.6 Voting Agreement, as amended, dated May 13, 1994, by
and among Administaff, Inc., Pyramid Ventures, Inc.,
the Board of Trustees of the Texas Growth Fund as
Trustee for the Texas Growth Fund-1991 Trust and
certain stockholders of Administaff, Inc.
(incorporated by reference to Exhibit 4.6 to the
Registrant's Registration Statement on form S-1 (No.
33-96952) declared effective on January 28, 1997).
4.7 Subordinated Note of Administaff, Inc. in favor of
The Board of Trustees of the Texas Growth Fund, as
Trustee (incorporated by reference to Exhibit 4.7 to
the Registrant's Registration Statement on form S-1
(No. 33-96952) declared effective on January 28,
1997).
10.1 Amended and Restated Promissory Note among
Administaff, Inc., Richard G. Rawson, Dawn Rawson,
and RDKB Rawson LP, dated as of December 16, 1996,
amending and restating a Promissory Note dated June
22, 1995 (incorporated by reference to Exhibit 10.1
to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28,
1997).
10.2 Amended and Restated Promissory Note among
Administaff, Inc., Jerald L. Broussard and Mary
Catherine Broussard, dated as of December 30, 1996,
amending and restating a Promissory Note dated
September 4, 1995 (incorporated by reference to
Exhibit 10.2 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.3 Credit agreement between Administaff, Inc. and First
National Bank of Chicago, dated as of October 16,
1995 (incorporated by reference to Exhibit 10.3 to
the Registrant's Registration Statement on form S-1
(No. 33-96952) declared effective on January 28,
1997).
10.4 Amendment No. 1 and Waiver to Credit Agreement, dated
as of March 12, 1996 (incorporated by reference to
Exhibit 10.4 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.5 Amended and Restated Promissory Note, dated as of
December 16, 1996, among Administaff, Inc., Richard
G. Rawson, Dawn Rawson, and RDKB Rawson LP, dated as
of December 16, 1996, pursuant to which the
collateral securing the promissory notes included as
Exhibit 10.1 and is pledged (incorporated by
reference to Exhibit 10.5 to the Registrant's
Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
10.6 Amended and Restated Security Agreement-Pledge among
Administaff, Inc.,
- 45 -
<PAGE> 47
Jerald L. Broussard and Mary Catherine Broussard,
dated as of December 30, 1996, pursuant to which the
collateral securing the promissory note included as
Exhibit 10.2 is pledged (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.7 1995 Administaff Stock Option Plan (as amended and
restated) (incorporated by reference to Exhibit 10.8
to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28,
1997).
10.8 Form of Second Amended and Restated Promissory Note
(incorporated by reference to Exhibit 10.9 to the
Registrant's Registration Statement on form S-1 (No.
33-96952) declared effective on January 28, 1997).
10.9 Form of Second Amended and Restated Security
Agreement - Pledge (incorporated by reference to
Exhibit 10.10 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
11.1 Statement re: Computation of Per Share Earnings.
21.1 Subsidiaries of Administaff, Inc.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
None.
- 46 -
<PAGE> 48
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 24, 1997:
<TABLE>
<S> <C>
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
- -------------------- (Principal Accounting Officer)
Samuel G. Larson
/s/ GERALD M. McINTOSH Senior Vice President and Director
- ----------------------
Gerald M. McIntosh
/s/ JAMES W. HAMMOND Senior Vice President and Director
- --------------------
James W. Hammond
/s/ SCOTT C. HENSEL Senior Vice President and Director
- -------------------
Scott C. Hensel
/s/ LINDA FAYNE LEVINSON Director
- ------------------------
Linda Fayne Levinson
/s/ PAUL S. LATTANZIO Director
- ---------------------
Paul L. Lattanzio
/s/ JACK M. FIELDS, JR. Director
- -----------------------
Jack M. Fields, Jr.
/s/ STEPHEN M. SOILEAU Director
- ----------------------
Stephen M. Soileau
</TABLE>
- 47 -
<PAGE> 49
ADMINISTAFF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . F-3
Consolidated Statements of Operations for the years ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-7
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-9
</TABLE>
F-1
<PAGE> 50
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, 1995 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1996. 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, 1995 and 1996, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.
ERNST & YOUNG, LLP
Houston, Texas
February 21, 1997
F-2
<PAGE> 51
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1995 1996
---------- ----------
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,460 $ 13,360
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 728 --
Accounts receivable:
Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,908 3,490
Unbilled receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,763 12,742
Related parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 439
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 344
Workers' compensation deposits . . . . . . . . . . . . . . . . . . . . . . . . 1,038 --
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,980 2,668
Refundable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,204 --
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 --
--------- ---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 28,238 33,043
Property and equipment:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 817 817
Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . . . . 2,915 6,564
Computer equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,163 3,093
Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,093 3,767
Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 705 761
Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,444 --
--------- ---------
11,137 15,002
Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,008) (3,359)
--------- ---------
Total property and equipment . . . . . . . . . . . . . . . . . . . . . . 9,129 11,643
Other assets:
Notes receivable from employees . . . . . . . . . . . . . . . . . . . . . . . 835 1,135
Deferred financing costs, net of accumulated amortization of
$176 and $327 at December 31, 1995 and 1996 . . . . . . . . . . . . . . . . 430 282
Intangible assets, net of accumulated amortization of
$319 and $293 at December 31, 1995 and 1996 . . . . . . . . . . . . . . . . 599 749
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243 1,524
--------- ---------
Total other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,107 3,690
--------- ---------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 39,474 $ 48,376
========= =========
</TABLE>
F-3
<PAGE> 52
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
-------- ---------
<S> <C> <C>
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,487 $ 594
Payroll taxes and other payroll deductions payable . . . . . . . . . . . . 9,829 10,099
Accrued worksite employee payroll expense . . . . . . . . . . . . . . . . 10,094 13,385
Accrued workers' compensation claims . . . . . . . . . . . . . . . . . . . 404 40
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 1,613 2,622
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 266
Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . 74 491
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . -- 917
-------- ---------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . 23,501 28,414
Noncurrent liabilities:
Accrued workers' compensation claims . . . . . . . . . . . . . . . . . . . 621 --
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . -- 2,558
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,605 4,112
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 58 --
-------- ---------
Total noncurrent liabilities . . . . . . . . . . . . . . . . . . . . 5,284 6,670
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $0.01 per share:
Shares authorized - 20,000
Shares issued and outstanding - none . . . . . . . . . . . . . . . . . -- --
Common stock, $0.01 par value:
Shares authorized - 60,000
Shares issued and outstanding - 10,726 at
December 31, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . 107 107
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . 5,706 5,706
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,876 7,479
-------- ---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . 10,689 13,292
-------- ---------
Total liabilities and stockholders' equity . . . . . . . . . . . . . $ 39,474 $ 48,376
======== =========
</TABLE>
See accompanying notes.
F-4
<PAGE> 53
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1994 1995 1996
---------- --------- ---------
<S> <C> <C> <C>
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 564,459 $ 716,210 $ 899,596
Direct costs:
Salaries and wages of worksite employees . . . . . . . . 453,750 582,893 737,177
Benefits and payroll taxes . . . . . . . . . . . . . . . 85,513 104,444 124,563
--------- --------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 25,196 28,873 37,856
Operating expenses:
Salaries, wages and payroll taxes . . . . . . . . . . . 8,094 10,951 14,515
General and administrative expenses . . . . . . . . . . 5,648 7,597 8,091
Commissions . . . . . . . . . . . . . . . . . . . . . . 3,231 3,942 4,039
Advertising . . . . . . . . . . . . . . . . . . . . . . 1,797 3,268 3,261
Depreciation and amortization . . . . . . . . . . . . . 567 894 1,473
--------- --------- ---------
19,337 26,652 31,379
--------- --------- ---------
Operating income . . . . . . . . . . . . . . . . . . . . . 5,859 2,221 6,477
Other income (expense):
Interest income . . . . . . . . . . . . . . . . . . . . 449 668 682
Interest expense . . . . . . . . . . . . . . . . . . . (424) (713) (945)
Other, net . . . . . . . . . . . . . . . . . . . . . . . 33 9 (1,400)
--------- --------- ---------
58 (36) (1,663)
--------- --------- ---------
Income before income tax expense . . . . . . . . . . . . . 5,917 2,185 4,814
Income tax expense . . . . . . . . . . . . . . . . . . . . 2,151 1,069 2,211
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 3,766 $ 1,116 $ 2,603
========= ======== =========
Net income per share of common stock . . . . . . . . . . . $ 0.37 $ 0.10 $ 0.24
========= ======== =========
Weighted average common shares outstanding . . . . . . . . 10,395 10,865 11,105
========= ======== =========
</TABLE>
See accompanying notes.
F-5
<PAGE> 54
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
OUTSTANDING ADDITIONAL RETAINED
----------------------- PAID-IN EARNINGS
SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
------ ------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1993 . . . . . 8,706 $ 87 $ 488 $ (6) $ 569
Sale of common stock, net of
issuance costs of $429 . . . . . . 1,532 15 3,556 -- 3,571
Issuance of common stock purchase
warrants in connection with
subordinated debt . . . . . . . . -- -- 150 -- 150
Net income . . . . . . . . . . . . . -- -- -- 3,766 3,766
------- -------- -------- -------- --------
Balance at December 31, 1994 . . . . . 10,238 102 4,194 3,760 8,056
Exercise of stock options . . . . . 488 5 392 -- 397
Income tax benefit from
exercise of stock options . . . . -- -- 1,120 -- 1,120
Net income . . . . . . . . . . . . . -- -- -- 1,116 1,116
------- -------- ------- -------- --------
Balance at December 31, 1995 . . . . . 10,726 107 5,706 4,876 10,689
Net income . . . . . . . . . . . . . -- -- -- 2,603 2,603
------- -------- -------- -------- --------
Balance at December 31, 1996 . . . . . 10,726 $ 107 $ 5,706 $ 7,479 $ 13,292
======= ======== ======== ======== ========
</TABLE>
See accompanying notes.
F-6
<PAGE> 55
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 3,766 $ 1,116 $ 2,603
Adjustments to reconcile net income to net cash
provided by (used in) operating activities :
Depreciation and amortization . . . . . . . . . . . . 567 1,104 1,697
Deferred income taxes . . . . . . . . . . . . . . . . (1,344) 2,191 917
Loss (gain) on disposal of assets . . . . . . . . . . 9 2 (9)
Changes is operating assets and liabilities:
Cash and cash equivalents - restricted . . . . . . 1 697 --
Accounts receivable and unbilled revenues . . . . (5,054) (3,266) (2,245)
Workers' compensation deposits . . . . . . . . . . (1,986) 2,776 1,038
Prepaid expenses . . . . . . . . . . . . . . . . . (143) (1,717) 1,362
Other assets . . . . . . . . . . . . . . . . . . . (40) (109) (1,281)
Accounts payable . . . . . . . . . . . . . . . . . (650) 738 (893)
Payroll taxes and other
payroll deductions payable . . . . . . . . . . . 7,589 (373) 270
Accrued workers' compensation claims . . . . . . . 3,007 (4,780) (985)
Other accrued liabilities . . . . . . . . . . . . (1,107) 2,384 6,858
Income taxes payable (refundable) . . . . . . . . 1,543 (3,023) 2,470
-------- ------- --------
Total adjustments . . . . . . . . . . . . . . . 2,392 (3,376) 9,199
-------- -------- --------
Net cash provided by
(used in) operating activities . . . . . . . 6,158 (2,260) 11,802
-------- ------- -------
Cash flows from investing activities:
Marketable securities:
Purchases . . . . . . . . . . . . . . . . . . . . . . (7,333) (2,521) --
Dispositions . . . . . . . . . . . . . . . . . . . . 2,845 6,530 728
Purchases of property and equipment . . . . . . . . . . (1,768) (4,619) (3,976)
Increases in intangible assets . . . . . . . . . . . . . (63) (610) (245)
Proceeds from the sale of assets . . . . . . . . . . . . 10 15 20
-------- -------- ---------
Net cash used in investing activities . . . . . . (6,309) (1,205) (3,473)
-------- -------- ---------
</TABLE>
F-7
<PAGE> 56
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Cash flows from financing activities:
Long-term debt and short-term borrowings:
Proceeds . . . . . . . . . . . . . . . . . . . . . . $ 4,000 $ -- $ 2,500
Repayments . . . . . . . . . . . . . . . . . . . . . (189) (328) (2,576)
Deferred financing costs . . . . . . . . . . . . . . (357) (99) (3)
Loans to employees . . . . . . . . . . . . . . . . . . . -- (835) (300)
Sale of common stock . . . . . . . . . . . . . . . . . . 3,571 -- --
Prepaid expenses - initial public offering costs . . . . -- (745) (1,050)
Proceeds from the exercise of stock options . . . . . . -- 397 --
------- -------- -------
Net cash provided by
(used in) financing activities . . . . . . . . 7,025 (1,610) (1,429)
------- -------- -------
Net increase (decrease) in cash and cash equivalents . . . 6,874 (5,075) 6,900
Cash and cash equivalents at beginning of year . . . . . . 4,661 11,535 6,460
------- -------- -------
Cash and cash equivalents at end of year . . . . . . . . . $11,535 $ 6,460 $13,360
======= ======== =======
Supplemental disclosures:
Cash paid for interest . . . . . . . . . . . . . . . . . $ 424 $ 787 $ 1,005
Cash paid (refunds received) for income taxes . . . . . $ 1,953 $ 1,900 $(1,176)
Noncash financing activity - issuance of common
stock purchase warrants in connection with
subordinated debt borrowings . . . . . . . . . . . . $ 150 $ -- $ --
</TABLE>
See accompanying notes.
F-8
<PAGE> 57
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. ACCOUNTING POLICIES
Description of Business
(PEO) that provides a comprehensive Personnel Management System which
encompasses a broad range of services, including benefits and payroll
administration, medical and workers' compensation programs, payroll tax filings,
personnel records management, liability management, and other human resource
services to small to medium sized businesses in several strategically selected
markets. The Company operates primarily in the State of Texas.
Principles of Consolidation
The consolidated financial statements include the accounts of
Administaff, Inc., and its wholly owned subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
During 1995, the Company completed a reorganization by which it formed
Administaff of Delaware, Inc., (the Holding Company) as a wholly-owned
subsidiary of the Company. At the same time, the Holding Company formed a
wholly- owned subsidiary, Administaff of Texas, Inc. into which the Company
merged. The stockholders of the Company exchanged shares of Common Stock of the
Company for shares of Common Stock of the Holding Company at a ratio of 3 for 2.
All outstanding warrants and stock options of the Company were exchanged for
warrants and stock options of the Holding Company at the same exchange ratio.
The Holding Company then changed its name to Administaff, Inc. The
reorganization had no effect on net income. Share amounts in the consolidated
financial statements and accompanying notes have been restated to reflect the
reorganization into the Holding Company (herein referred to as the Company) and
the 3-for-2 exchange.
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.
Impairment of Long-Lived Assets
In March 1995, Statement of Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, was issued. This
F-9
<PAGE> 58
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Statement requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. SFAS No. 121 also addresses the accounting for long-lived
assets that are expected to be disposed of. The Company adopted SFAS No. 121
effective January 1, 1996. There was no effect on the consolidated financial
statements from such adoption.
Cash and Cash Equivalents
Cash and cash equivalents include bank deposits and short-term
investments with original maturities of three months or less when purchased.
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, based
on the classification of such securities. The Company determines the
appropriate classification of all marketable securities as held-to-maturity,
available-for-sale or trading at the time of purchase and re-evaluates such
classification as of each balance sheet date.
Property and Equipment
Property and equipment is recorded at cost. Maintenance and repairs are
charged to expense as incurred; renewals and betterments are capitalized. The
cost of property and equipment sold or otherwise retired and the accumulated
depreciation applicable thereto are eliminated from the accounts, and the
resulting profit or loss is reflected in operations.
F-10
<PAGE> 59
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The cost of property and equipment 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:
<TABLE>
<S> <C>
Buildings and improvements . . . . . . . . . . . . . . . 7-30 years
Computer equipment . . . . . . . . . . . . . . . . . . . 5-10 years
Furniture and fixtures . . . . . . . . . . . . . . . . . 3-10 years
Vehicles . . . . . . . . . . . . . . . . . . . . . . . . 5 years
</TABLE>
Construction in progress at December 31, 1995 included costs incurred in
connection with the construction of an additional corporate facility which was
completed in February 1996. Interest capitalized in connection with this project
was $74,000 and $60,000 for the years ended December 31, 1995 and 1996,
respectively.
PEO Service Fees and Worksite Employee Payroll Costs
The Company's revenues consist of service fees paid by its clients under
its Client Service Agreements. In consideration for payment of such service
fees, the Company agrees to pay the following direct costs associated with the
worksite employees: (i) salaries and wages, (ii) employment related taxes, (iii)
employee benefit plan premiums and (iv) workers' compensation insurance
premiums. The Company accounts for PEO service fees and the related direct
payroll costs using the accrual method. Under the accrual method, PEO service
fees relating to worksite employees with earned but unpaid wages at the end of
each period are recognized as unbilled revenues and the related direct payroll
costs for such wages are accrued as a liability during the period in which wages
are earned by the worksite employee. Subsequent to the end of each period, such
wages are paid and the related PEO service fees are billed. Unbilled
receivables at December 31, 1995 and 1996 are net of prepayments received prior
to year-end of $661,000 and $2,371,000, respectively.
Intangible Assets
Intangible assets include software development costs and referral fee
costs paid for the enrollment of certain clients previously with an unrelated
PEO. Software development costs at December 31, 1995 primarily include costs
related to designing and installing the Company's computerized payroll system.
Such costs are fully amortized as of December 31, 1996. Software development
costs at December 31, 1996 include costs to redesign and install a new
computerized payroll and management information system. The Company expects the
redesign and installation to be completed during the second half of 1997 at
which time such costs will commence being amortized using the straight- line
method over a period of five years.
F-11
<PAGE> 60
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The referral fee costs are being amortized over a period of five years,
which is the expected average retention period for the related clients.
Accrued Workers' Compensation Claims
The Company has, from time to time, been insured under various types of
workers' compensation policies. These have included a retrospective rating plan,
whereby monthly premiums were paid to the insurance carrier based on estimated
actual losses plus an administrative fee; a high deductible paid loss plan,
whereby monthly premiums were paid based on a $500,000 deductible per
occurrence; and a guaranteed cost plan whereby monthly premiums are paid for
complete coverage of all claims under the policy.
Accrued workers' compensation claims relate to policies in place prior
to November 1, 1994 and are based on an estimate of reported and unreported
losses, net of amounts covered under the applicable insurance policy, for
injuries occurring on or before the balance sheet date. The loss estimates are
based on several factors including the Company's current experience, relative
health care costs, regional influences and other factors. While estimated losses
may not be paid for several years, an accrual for outstanding claims on the
retrospective rating plan and high deductible paid loss plan is maintained using
the estimated net present value of such claims calculated at an interest rate of
6.25%, with changes in the accrual reflected as a component of direct costs in
the period of the change. These estimates are continually reviewed and any
adjustments are reflected in operations as they become known.
In September 1995, the Company settled the remaining outstanding claims
under certain retrospective rating workers' compensation policies in effect in
prior years resulting in a reduction in workers' compensation costs of $1
million in 1995. This amount is included as a reduction in Direct costs:
Benefits and payroll taxes on the Consolidated Statements of Operations. In
exchange for transferring the responsibility for all remaining claims under such
policies, the Company paid the insurer $232,000. Prior to the settlement, the
Company had accrued workers' compensation claims of approximately $1.2 million
related to the settled policies.
Beginning November 1, 1994, the Company has been insured under a
guaranteed cost workers' compensation policy which is currently in effect
through October 31, 1997.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, and accounts payable
approximate their fair values due to the short-term maturities of these
instruments.
The carrying amounts of borrowings pursuant to the Company's revolving
credit facility approximate fair value because the rate on such agreement is
variable, based on current market rates.
F-12
<PAGE> 61
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The fair value of the other long-term debt was estimated by discounting future
cash flows, including interest payments, using rates currently available for
debt of similar terms and maturities, based on the Company's credit standing and
other market factors. At December 31, 1996, the carrying amount of the
Company's other long-term debt approximates fair value.
Stock-Based Compensation
The Company accounts for stock-based compensation arrangements under the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and intends to continue to do so. See Note 10.
Advertising
The Company expenses all advertising costs as incurred.
Income Taxes
The Company uses the liability method in accounting for income taxes.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and income tax carrying amounts of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Per Share Information
Per share amounts have been computed based on the weighted average
number of common shares and common stock equivalents outstanding during the
respective periods. Common stock equivalent shares consist of the incremental
shares issuable upon the exercise of stock options and warrants (using the
treasury stock or if- converted method where applicable). Shares for which stock
options were granted within a twelve month period prior to the Company's initial
public offering are treated as outstanding for all periods presented. Therefore,
shares for which options were granted subsequent to September 1994 have been
considered as having been outstanding for purposes of the calculation for all
periods presented. Common stock equivalent shares from stock options and
warrants granted prior to the twelve months preceding the initial public
offering are excluded from computations if their effect is antidilutive.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1996
presentation.
F-13
<PAGE> 62
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
2. MARKETABLE SECURITIES
At December 31, 1995, the Company's marketable securities consisted of
debt securities issued by local municipalities. The balance at December 31,
1995 consisted of securities with contractual maturities ranging from 10 years
to 15 years from the date of purchase and were classified as available-for-
sale. There were no unrealized holding gains or losses at December 31, 1995.
Marketable securities held at December 31, 1995 were converted to cash
equivalents during 1996, therefore, the Company had no marketable securities at
December 31, 1996.
3. LONG-TERM DEBT
Following is a summary of long-term debt:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Subordinated notes to a related party . . $ 4,000 $4,000
$610,000 note payable to bank . . . . . . 492 452
Mortgage note payable to developers . . . 73 38
Mortgage note payable to bank . . . . . . 114 113
------- -------
Total long-term debt . . . . . . . . . . . 4,679 4,603
Less current maturities . . . . . . . . . (74) (491)
------- -------
Noncurrent portion . . . . . . . . . . . . $ 4,605 $ 4,112
======= =======
</TABLE>
In May 1994, the Company issued $4,000,000 in subordinated notes to a
private investor pursuant to a Securities Purchase Agreement. The subordinated
notes mature in May 1999 and contain certain optional prepayment clauses.
Interest accrues at the annual rate of 13% and is payable quarterly. The
subordinated notes are subordinate to the $610,000 note payable to bank. The
Securities Purchase Agreement provides the Company with the right of first
refusal to repurchase the subordinated notes in the event of a proposed transfer
of the subordinated notes by the investor. In connection with the subordinated
notes, the Company issued the investor warrants to purchase 694,436 shares of
common stock. In connection with this transaction, a representative of the
investor became a member of the Board of Directors of the Company. Interest
expense includes $520,000 in 1995 and 1996 related to the subordinated notes.
See Note 5.
The $610,000 note is payable to the bank in monthly installments of
$7,000, including interest, with a final balloon payment of all remaining
principal due on December 31, 1997. Interest accrues at the bank's prime rate
plus 1% (9.25% at December 31, 1996). The note is secured by land, buildings and
improvements.
The mortgage note payable to developers is payable in annual
installments of $41,327, including interest at 8.5%, through December 31, 1997.
The note is secured by land with a cost of $218,000.
F-14
<PAGE> 63
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The mortgage note payable to bank is payable in monthly installments of
$884, including interest at 8.375%, with a final balloon payment of all
remaining principal due on July 1, 2008. The note is secured by land with a cost
of $160,000.
The subordinated notes, the $610,000 note, the mortgage note payable to
developers, and the mortgage note payable to bank were repaid subsequent to
December 31, 1996 using the proceeds from an initial public offering. In
connection with the repayment of the subordinated notes, the Company will fully
amortize the remaining deferred financing costs relating to such notes in the
period of repayment. As of December 31, 1996, these costs totaled $237,000, net
of accumulated amortization. See Note 11.
The subordinated notes and the $610,000 note payable require the Company
to maintain certain specified financial ratios and contain other restrictions
customary in lending transactions of this type. The Company has obtained a
waiver of the quick ratio covenant of the subordinated note agreement (a
requirement covering two consecutive quarters) for the two quarters ended
December 31, 1996. This waiver cures any noncompliance with the covenant as of
December 31, 1996.
In October 1995, the Company's wholly-owned subsidiary, Administaff of
Texas, Inc. (AT), entered into a revolving credit agreement with The First
National Bank of Chicago, as agent, pursuant to which the lenders that are
parties thereto have agreed to advance funds to AT on a revolving basis in an
amount not to exceed $10 million for general corporate purposes. Such agreement
includes an agreement to issue standby letters of credit in an amount not to
exceed a sublimit of $5 million. Borrowings under the agreement will bear
interest at rates based on the bank's Corporate Base Rate or LIBOR plus an
applicable margin at the time of borrowing. The Company is a guarantor under the
agreement. The agreement requires the Company to maintain certain specified
financial ratios and contains other restrictions customary in lending
transactions of this type. This agreement also prohibits the declaration and
payment of dividends if a default exists or, after giving effect to such
dividend, would exist under such agreement. As of December 31, 1996 there is no
amount outstanding under the agreement and AT has $10 million available for
borrowings under the agreement.
Maturities of long-term debt at December 31, 1996 are summarized as
follows (in thousands):
<TABLE>
<S> <C>
1997 . . . . . . . . . . . . . . . . $ 491
1998 . . . . . . . . . . . . . . . . 1
1999 . . . . . . . . . . . . . . . . 4,001
2000 . . . . . . . . . . . . . . . . 2
2001 . . . . . . . . . . . . . . . . 2
Thereafter . . . . . . . . . . . . . 106
---------
$ 4,603
=========
</TABLE>
F-15
<PAGE> 64
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. INCOME TAXES
Deferred taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities used for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the net deferred tax assets and net deferred tax liabilities as
reflected on the balance sheet are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Accrual of PEO service fees and costs . . . . . . . . . . . . $ -- $ (1,190)
Client list acquisition costs . . . . . . . . . . . . . . . . (133) --
State income taxes . . . . . . . . . . . . . . . . . . . . . . (117) --
Depreciation and amortization . . . . . . . . . . . . . . . . (203) (390)
--------- --------
Total deferred tax liabilities . . . . . . . . . . . . . . (453) (1,580)
Deferred tax assets: . . . . . . . . . . . . . . . . . . . . . .
Accrued workers' compensation claims . . . . . . . . . . . . . 404 16
Uncollectible accounts receivable . . . . . . . . . . . . . . -- 142
Client list acquisition costs . . . . . . . . . . . . . . . . -- 45
Other accrued liabilities . . . . . . . . . . . . . . . . . . 16 263
State income taxes . . . . . . . . . . . . . . . . . . . . . . -- 165
Property and equipment . . . . . . . . . . . . . . . . . . . . 33 32
---------- ---------
Total deferred tax assets . . . . . . . . . . . . . . . . . 453 663
---------- --------
Net deferred tax assets (liabilities) . . . . . . . . . . . . . . $ -- $ (917)
========== ========
Net current deferred liabilities . . . . . . . . . . . . . . . . $ -- $ (917)
Net noncurrent deferred tax liabilities . . . . . . . . . . . . . (58) --
Net current deferred tax assets . . . . . . . . . . . . . . . . 58 --
---------- ---------
$ -- $ (917)
========== ========
</TABLE>
At December 31, 1995 and 1996, the Company had no valuation allowance
related to the deferred tax assets as these deferred tax assets relate to tax
deductions available to the Company as incurred in the future for which
sufficient income taxes have been paid in prior years to ensure recoverability.
F-16
<PAGE> 65
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1995 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current income tax expense (benefit):
Federal . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,013 $ (948) $ 928
State . . . . . . . . . . . . . . . . . . . . . . . . . . 482 (174) 366
-------- -------- -------
Total current income tax expense (benefit) . . . . . . 3,495 (1,122) 1,294
-------- -------- -------
Deferred income tax expense (benefit):
Federal . . . . . . . . . . . . . . . . . . . . . . . . . (1,160) 1,902 900
State . . . . . . . . . . . . . . . . . . . . . . . . . . (184) 289 17
-------- -------- -------
Total deferred income tax expense (benefit) . . . . . . (1,344) 2,191 917
-------- ------- -------
Total income tax expense . . . . . . . . . . . . . . . $ 2,151 $ 1,069 $ 2,211
======== ======= =======
</TABLE>
In 1995, a tax benefit of $1.1 million resulting from deductions
relating to the exercise of certain non- qualified employee stock option was
recorded as an increase in stockholders' equity.
The reconciliation of income tax expense computed at U. S. federal
statutory tax rates to the reported income tax expense is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1995 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Expected income tax expense at 34% . . . . . . . . . . . . $ 2,012 $ 743 $ 1,637
State income taxes, net of federal benefit . . . . . . . . 135 218 253
Nondeductible expenses . . . . . . . . . . . . . . . . . . 4 1 272
Other, net . . . . . . . . . . . . . . . . . . . . . . . . -- 107 49
------- ------ -------
Reported total income tax expense . . . . . . . . . . . . $ 2,151 $1,069 $ 2,211
======= ====== =======
</TABLE>
5. STOCKHOLDERS' EQUITY
In May 1994, the Company entered into a Stock Purchase Agreement with a
private investor whereby the investor purchased 1,532,303 shares of common stock
from the Company at a price of $2.61 per share. The Company realized net
proceeds of $3,571,000. The Stock Purchase Agreement contains various
restrictive covenants and provides the investor with certain antidilution
privileges. An Investor Agreement provides the Company with the right of first
refusal to repurchase the shares in the event of a proposed transfer of the
shares by the investor. In addition, the Investor Agreement provides the Company
with an option to repurchase up to 348,945 of the shares through June 1999 at
prices beginning at $5.73 per share through June 1997 and escalating annually
thereafter. See Note 11.
F-17
<PAGE> 66
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In connection with the issuance of $4,000,000 in subordinated notes, the
Company issued warrants to purchase 694,436 shares of common stock at a price of
$2.61 per share to the noteholder. The Investor Agreement provides the Company
with an option to repurchase 173,609 of the warrants or related shares through
June 1999 at a price of $5.73 per warrant or related share less $2.61 per
warrant if not yet exercised, through June 1997 and escalating annually
thereafter. The holder of the subordinated notes may elect to exercise a portion
or all of the warrants at the exercise price as a reduction of the outstanding
balance of the subordinated notes. The warrants are exercisable through May 13,
2001 and contain certain antidilution provisions. In connection with the
Company's initial public offering, 68,112 of such warrants were exercised
subsequent to December 31, 1996. See Note 11.
The Investor Agreement also provides the holders of the shares of common
stock sold pursuant to the Stock Purchase Agreement and the common stock
purchase warrants issued in connection with the subordinated notes with the
right, subject to certain conditions, to require the Company to repurchase all
or any portion of the shares and warrants at a price to be calculated in
accordance with the Investor Agreement. This right becomes partially exercisable
in November 1998 and fully exercisable in November 2002 and terminates upon a
qualified public offering as defined in the Stock Purchase Agreement.
Subsequent to December 31, 1996, the Company exercised its option,
pursuant to the Investor Agreement, to repurchase 348,945 shares of common stock
and 173,609 warrants to purchase common stock from the private investor and the
noteholder. The total aggregate cost of the repurchase was approximately $2.5
million which was paid using proceeds from the Company's initial public
offering. See Note 11.
In connection with the Stock Purchase Agreement and the subordinated
notes, the Company issued warrants to purchase 153,230 shares of common stock to
a third party as partial payment of fees related to the transactions. The
warrants are exercisable through June 1999 at prices commencing at $2.61 per
share with annual escalations to $5.42 per share for the final year. The
warrants contain certain antidilution provisions. In connection with the
Company's initial public offering, 12,722 of such warrants were exercised
subsequent to December 31, 1996.
During 1995, options to purchase 448,667 shares of common stock at a
price of $.75 per share and 40,000 shares of common stock at a price of $1.50
per share were exercised by an officer/director and employee of the Company,
respectively.
6. OPERATING LEASES
The Company leases various furniture, equipment, and office facilities
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 $905,000, $1,126,000 and $1,144,000 in
1994, 1995 and 1996, respectively. At December 31, 1996, future minimum rental
F-18
<PAGE> 67
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
payments under noncancelable operating leases are as follows (in thousands):
<TABLE>
<S> <C>
1997 . . . . . . . . . . . . . . . . $ 945
1998 . . . . . . . . . . . . . . . . 663
1999 . . . . . . . . . . . . . . . . 405
2000 . . . . . . . . . . . . . . . . 199
2001 . . . . . . . . . . . . . . . . 33
-------
$ 2,245
=======
</TABLE>
7. EMPLOYEE SAVINGS PLAN
The Company has adopted a 401(k) profit sharing plan (the Plan) for the
benefit of all eligible employees as defined in the plan agreement. The Plan is
a defined-contribution plan to which eligible employees may make contributions,
on a before-tax basis, of from 1% to 20% of their compensation during each year
while they are a plan participant. Under the Plan, employee salary deferral
contributions are limited to amounts established by tax laws. Participants are
at all times fully vested in their salary deferral contributions to the Plan and
the earnings thereon. All amounts contributed pursuant to the Plan are held in a
trust and invested, pursuant to the participant's election, in one or more
investment funds offered by a third party record keeper.
Employees are eligible to participate in the plan on the entry date
coincident with or next following age 21 and upon completion of at least 1,000
hours of service in a consecutive 12-month period. Highly compensated employees
assigned to clients which have less than 100% of their workforce employed by the
Company are not eligible to participate. Entry dates are the first day of each
calendar month. Service with a client company is credited for eligibility and
vesting purposes under the plan.
Effective June 1, 1994 the plan was amended to add the option of
offering matching contributions to certain worksite employees under Section
401(m) of the Internal Revenue Code (the "Code"). The Company does not make
matching contributions to the plan for its corporate employees. Under this
option, client companies may elect to participate in the matching program,
pursuant to which the client companies contribute 50% of an employee's
contributions up to 6% of the employee's compensation each pay period.
Participants vest in these matching contributions on a graduated basis over five
years with 20% vesting after one year of service and 100% vesting after five
years of service. For employees participating in the matching program, the
maximum salary deferral contribution is 17% rather than 20%. In addition,
participants shall be fully vested in these matching contributions upon normal
retirement (i.e., attainment of age 65) or death. Total matching contributions
related to worksite employees for the years ended December 31, 1994, 1995 and
1996 were $41,000, $420,000 and $993,000, respectively, all of which were
reimbursed to the Company by the client companies.
F-19
<PAGE> 68
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
8. RELATED PARTY TRANSACTIONS
Accounts receivable from related parties at December 31, 1995 includes
$93,000 from a company in which three of the directors of the Company own a
minority interest. Such amount was repaid during 1996. Accounts receivable from
related parties also includes $627,000 and $439,000 from employees of the
Company at December 31, 1995 and 1996, respectively.
In April 1996, the Company entered into a settlement agreement relating
to litigation in which the Company and Technology and Business Consultants, Inc.
("TBC") were co-defendants. TBC is a company whose stockholders are three
directors/officers of the Company. In accordance with the settlement agreement,
$285,000 was paid to the plaintiff. The Company paid the entire amount of the
settlement; however, TBC agreed to reimburse the Company for the entire amount
of the settlement not recovered through the Company's general liability
insurance. In August 1996, the Company received $113,000 pursuant to such
coverage. The remaining $172,000 was reimbursed by TBC prior to December 31,
1996.
In October 1996, the Company purchased various computer equipment from
TBC at a total cost of $209,000.
In June 1995, an officer 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 in
five years, accrue interest at 6.83%, and are secured by 414,252 shares of the
Company's common stock.
In September 1995, an employee of the Company exercised options to
purchase 40,000 shares of common stock at a price of $1.50 per share. The
purchase price was paid in cash by the employee. In connection with the
exercise, the Company entered into a loan agreement with the employee, whereby
the Company paid certain federal income tax withholding requirements related to
the stock option exercise on behalf of the employee in the amount of $141,000.
The loan is repayable in five years, accrues interest at 6.83%, and is secured
by 40,000 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
F-20
<PAGE> 69
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
or results of operations.
The Company's 401(k) plan is currently under audit by the Internal
Revenue Service (the "IRS") for the year ended December 31, 1993. Although the
audit is for the 1993 plan year, certain conclusions of the IRS would be
applicable to other years as well. In addition, the IRS has established an
Employee Leasing Market Segment Group 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. With respect to the 401(k) Plan audit, the Company
understands that the IRS Houston District intends to seek technical advice (the
"Technical Advice Request") from the IRS National Office about (1) whether
participation in the 401(k) Plan by worksite employees, including officers of
client companies, violates the exclusive benefit rule under the Code because
they are not employees of the Company, and (2) whether the 401(k) Plan's failure
to satisfy a nondiscrimination test relating to contributions should result in
disqualification of the 401(k) Plan because the Company has failed to provide
evidence that it satisfies an alternative discrimination test. A draft copy of
the Technical Advice Request has been sent to the Company for its comments
before the IRS Houston District submits it to the IRS National Office. The
draft of 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 also understands that, with respect
to the Market Segment 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") is being referred to the IRS National Office.
Whether the National Office will address the Technical Advice Request
independently of the Industry Issue is unclear. Should the IRS conclude that
the Company is not a "co-employer" of worksite employees for purposes of the
Code, worksite employees could not continue to make salary deferral
contributions to the 401(k) Plan or pursuant to the Company's cafeteria plan or
continue to participate in certain other employee benefit plans of the Company.
The Company believes that, although unfavorable to the Company, a prospective
application of such a conclusion (that is, one applicable only to periods after
the conclusion by the IRS is finalized) would not have a material adverse effect
on its financial position or results of operations, as the Company could
continue to make available comparable benefit 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 conclusion 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
F-21
<PAGE> 70
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Company would be subject to liability with respect to its failure to withhold
applicable taxes with respect to certain contributions and trust earnings.
Further, the Company would be subject to liability, including penalties, with
respect to its cafeteria plan for the failure to withhold and pay taxes
applicable to salary deferral contributions by employees, including worksite
employees. In such a scenario, the Company also would face the risk of client
dissatisfaction and potential litigation. While the Company is not able to
predict either the timing or the nature of any final decision that may be
reached with respect to the 401(k) Plan audit or with respect to the Technical
Advice Request or the Market Segment Group study and the ultimate outcome of
such decisions, the Company believes that a retroactive application of an
unfavorable determination is unlikely. The Company also believes that a
prospective application of an unfavorable determination will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
In addition to the 401(k) Plan audit and Market Segment Study, the
Company notified the IRS of certain operational issues concerning
nondiscrimination test results for certain prior plan years. In 1991 the
Company engaged a third party vendor to be the 401(k) Plan's record keeper and
to perform certain required annual nondiscrimination tests for the 401(k) Plan.
Each year such record keeper reported to the Company that such nondiscrimination
tests had been satisfied. However, in August 1996 the 401(k) Plan's record
keeper advised the Company that certain of these tests had been performed
incorrectly for prior years and, in fact, that the 401(k) Plan had failed
certain tests for the 1993, 1994 and 1995 plan years. The Company has
subsequently determined that the 401(k) Plan also failed a nondiscrimination
test for 1991 and 1992, closed years for tax purposes. At the time the Company
received such notice, the period in which the Company could voluntarily "cure"
this operational defect had lapsed for all such years, except 1995.
With respect to the 1995 plan year, the Company has caused the 401(k)
Plan to refund the required excess contributions and earnings thereon to the
affected employees. In connection with this correction, the Company paid,
subsequent to December 31, 1996, approximately $47,000 for an excise tax
applicable to this plan year. With respect to all other plan years, the Company
has proposed a corrective action to the IRS under which the Company would make
additional contributions to certain plan participants which bring the plan into
compliance with the discriminations tests.
The Company has recorded an accrual for its estimate of the cost of
corrective measures and penalties for all of the affected plan years, which
accrual is reflected in Other accrued liabilities - noncurrent on the
Consolidated Balance Sheet. The Company calculated its estimates based on its
understanding of the resolution of similar issues with the IRS. Separate
calculations were made to determine the Company's estimate of both the cost of
corrective measures and penalties for each plan year. In addition, the Company
has recorded an asset for an amount recoverable from the 401(k) Plan's record
keeper should the Company ultimately be required to pay the amount accrued for
such corrective measures and penalties, which amount is reflected in Other
assets on the Consolidated Balance Sheet. 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
F-22
<PAGE> 71
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 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. EMPLOYEE STOCK OPTION PLAN
In April 1995, the Company established the 1995 Administaff Employee
Stock Option Plan (the "Stock Option Plan"), pursuant to which options may be
granted to eligible employees of the Company or its subsidiaries for the
purchase of an aggregate of 357,957 shares of Common Stock of the Company. Stock
options granted to employees under the Stock Option Plan are intended to qualify
as "incentive stock options" within the meaning of Section 422 of the Code. The
purpose of the Stock Option Plan is to further the growth and development of the
Company and its subsidiaries by providing, through ownership of stock of the
Company, an incentive to employees of the Company and its subsidiaries, to
increase such persons' interests in the Company's welfare, and to encourage them
to continue their services to the Company and its subsidiaries.
The Stock Option 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, and the number of shares to be covered by and all of the
terms of the options. The Board may at any time terminate or amend the Stock
Option Plan; provided that no such amendment may adversely affect the rights of
optionees with regard to outstanding options. Further, no material amendment to
the Stock Option Plan, such as an increase in the total number of shares covered
by the Stock Option 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.
Beginning in April 1995, the Company has granted, from time to time,
options to purchase common stock to certain employees of the Company pursuant to
the Stock Option Plan. At December 31, 1996, options to purchase 142,197 shares
were exercisable and options to purchase 53,353 shares become exercisable in
1997. The weighted average remaining contractual life of all outstanding
options at December 31, 1996 was approximately 8.8 years. The weighted average
fair value of options granted during 1995 and 1996 was $4.64 and $5.77,
respectively. At December 31, 1996, options to purchase 4,401 shares of common
stock were available for future grants under the Stock Option Plan. Changes in
outstanding options granted pursuant to the Stock Option Plan are summarized in
the table below.
F-23
<PAGE> 72
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
EXERCISE TOTAL
PRICE PROCEEDS UPON
SHARES PER SHARE EXERCISE
------ --------- --------
<S> <C> <C> <C>
Outstanding at December 31, 1994 . . . . . . . . . . . . -- -- --
Granted . . . . . . . . . . . . . . . . . . . . . . . 340,905 $6.00 - $13.50 $3,876,000
-------- -------------- ----------
Outstanding at December 31, 1995 . . . . . . . . . . . . 340,905 6.00 - 13.50 3,876,000
Granted . . . . . . . . . . . . . . . . . . . . . . . 22,234 13.50 300,000
Canceled . . . . . . . . . . . . . . . . . . . . . . . (17,083) 13.50 (231,000)
--------- --------------- -----------
Outstanding at December 31, 1996 . . . . . . . . . . . . 346,056 $ 6.00 - $13.50 $ 3,945,000
========= =============== ===========
</TABLE>
The Company has elected to follow Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its stock-based compensation arrangements
because, as discussed below, the alternative fair value accounting provided for
under SFAS No. 123, Accounting for Stock- Based Compensation, requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, no compensation expense is recognized because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant.
Pro forma information regarding net income and earnings per shares is
required by SFAS No. 123, which also requires that the information be determined
as if the Company has 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 weighted- average
assumptions: risk-free interest rates of 6.0% in both years; no dividend yield;
a volatility factor of the expected market price of the Company's common stock
of 0.45; and a weighted-average expected life of the options of 4.9 years.
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
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
F-24
<PAGE> 73
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
---- ----
<S> <C> <C>
Pro forma net income (in thousands) . . . . . . . . . . . $ 891 $ 2,297
Pro forma earnings per share . . . . . . . . . . . . . . $ 0.08 $ 0.21
</TABLE>
11. INITIAL PUBLIC OFFERING
The Company filed a registration statement with the Securities and
Exchange Commission ("SEC") in September 1995 to register the sale of up to
3,000,000 shares of its common stock. Such offering was completed in January
1997. The net proceeds to the Company from the sale of the 3,000,000 shares
offered by the Company (after deducting underwriting discounts and commissions
of $3.6 million) were $47.4 million. Of these proceeds, the Company currently
expects to allocate approximately $12.0 million to support expansion of the
Company's operations, including the opening of sales offices in new geographic
markets as well as in established markets and, as favorable opportunities arise,
expansion of the Company's client base in new or existing markets through
acquisitions of existing PEO offices. In addition, the Company utilized
approximately $7.2 million of such proceeds as follows: (i) $4.0 million to
repay the subordinated notes, (ii) approximately $2.5 million to exercise its
option to repurchase 348,945 shares of Common Stock from a private investor and
its option to repurchase 173,609 warrants to purchase shares of Common Stock
from the noteholder, and (iii) approximately $0.7 million to retire the current
balances of certain secured loans. The Company incurred approximately $1.8
million in legal, accounting, printing and other costs in connection with the
offering. Such costs are included in prepaid expenses at December 31, 1996.
Such costs will be reflected as a reduction to stockholders' equity in the first
quarter of 1997. The balance of the proceeds will be used for working capital
purposes, which may include acquisitions of existing PEO operations should
favorable acquisition opportunities arise. Pending the application of such
funds, the Company intends to invest the net proceeds of the offering in
diversified, highly-liquid, investment grade, interest-bearing instruments.
Supplemental net income per share is $0.27 for the year ended December
31, 1996 and is determined by adding back the interest expense, net of income
taxes associated with the debt which was retired by the proceeds of the offering
to net income. The number of shares outstanding used in calculating
supplemental net income per share was the weighted average common shares
outstanding after giving effect to the estimated number of shares that would be
required to be sold in the offering to repay the debt and to repurchase the
common stock and warrants.
F-25
<PAGE> 74
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
12. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
QUARTER ENDED,
----------------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Year ended December 31, 1995:
Revenues . . . . . . . . . . . . . . $ 158,223 $ 167,064 $ 180,332 $ 210,591
Gross profit . . . . . . . . . . . . 4,761 6,704 8,811 8,597
Operating income (loss) . . . . . . (1,675) 67 2,672 1,157
Net income (loss) . . . . . . . . . (1,149) 47 1,718 500
Net income (loss) per share . . . . ($ 0.11) ($ 0.00) $ 0.16 $ 0.05
Year ended December 31, 1996:
Revenues . . . . . . . . . . . . . . $ 194,336 $ 209,726 $ 231,190 $ 264,344
Gross profit . . . . . . . . . . . . 6,189 8,651 11,285 11,731
Operating income (loss) . . . . . . (1,302) 1,049 3,476 3,254
Net income (loss) . . . . . . . . . (909) 552 971 1,989
Net income (loss) per share . . . . ($ 0.08) $ 0.05 $ 0.09 $ 0.17
</TABLE>
F-26
<PAGE> 75
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Certificate of Incorporation (incorporated by reference to
Exhibit 3.1 to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28, 1997).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference
to Exhibit 4.1 to the Registrant's Registration Statement on
form S-1 (No. 33-96952) declared effective on January 28,
1997).
4.2 Registration Rights Agreement, as amended, dated May 13, 1994,
by and among Administaff, Inc., Pyramid Ventures, Inc. And the
Board of Trustees of the Texas Growth Fund as Trustee for the
Texas Growth Fund-1991 Trust (incorporated by reference to
Exhibit 4.2 to the Registrant's Registration Statement on form
S-1 (No. 33-96952) declared effective on January 28, 1997).
4.3 Investor Agreement, as amended, date May 13, 1994 by and among
Administaff, Inc., Pyramid Ventures, Inc. and the Board of
Trustees of the Texas Growth Fund as Trustee for the Texas
Growth Fund-1991 Trust (incorporated by reference to Exhibit
4.3 to the Registrant's Registration Statement on form S-1
(No. 33-96952) declared effective on January 28, 1997).
4.4 Common Stock Warrant, as amended, issued to the Texas Growth
Fund-1991 Trust on May 13, 1994 (incorporated by reference to
Exhibit 4.4 to the Registrant's Registration Statement on form
S- 1 (No. 33-96952) declared
<PAGE> 76
EXHIBIT
NUMBER DESCRIPTION
------- -----------
effective on January 28, 1997).
4.5 Warrant Agreement, as amended, dated May 13, 1994, between
Rauscher Pierce Refsnes, Inc. and Administaff, Inc.
(incorporated by reference to Exhibit 4.5 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
4.6 Voting Agreement, as amended, dated May 13, 1994, by and
among Administaff, Inc., Pyramid Ventures, Inc., the Board of
Trustees of the Texas Growth Fund as Trustee for the Texas
Growth Fund-1991 Trust and certain stockholders of
Administaff, Inc. (incorporated by reference to Exhibit 4.6 to
the Registrant's Registration Statement on form S-1 (No.
33-96952) declared effective on January 28, 1997).
4.7 Subordinated Note of Administaff, Inc. in favor of The Board
of Trustees of the Texas Growth Fund, as Trustee
(incorporated by reference to Exhibit 4.7 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.1 Amended and Restated Promissory Note among Administaff,
Inc., Richard G. Rawson, Dawn Rawson, and RDKB Rawson LP,
dated as of December 16, 1996, amending and restating a
Promissory Note dated June 22, 1995 (incorporated by
reference to Exhibit 10.1 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on
January 28, 1997).
10.2 Amended and Restated Promissory Note among Administaff,
Inc., Jerald L. Broussard and Mary Catherine Broussard, dated
as of December 30, 1996, amending and restating a Promissory
Note dated September 4, 1995 (incorporated by reference to
Exhibit 10.2 to the Registrant's Registration Statement on
form S-1 (No. 33-96952) declared effective on January 28,
1997).
10.3 Credit agreement between Administaff, Inc. and First
National Bank of Chicago, dated as of October 16, 1995
(incorporated by reference to Exhibit 10.3 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.4 Amendment No. 1 and Waiver to Credit Agreement, dated as of
March 12, 1996 (incorporated by reference to Exhibit 10.4 to
the Registrant's Registration Statement on form S-1 (No.
33-96952) declared effective on January 28, 1997).
10.5 Amended and Restated Promissory Note, dated as of December
16, 1996, among Administaff, Inc., Richard G. Rawson, Dawn
Rawson, and RDKB Rawson LP, dated as of December 16, 1996,
pursuant to which the collateral securing the promissory notes
included as Exhibit 10.1 and is pledged (incorporated by
reference to Exhibit 10.5 to the Registrant's Registration
Statement on form S-1 (No. 33-96952) declared effective on
January 28, 1997).
10.6 Amended and Restated Security Agreement - Pledge Among
Administaff, Inc.,
<PAGE> 77
EXHIBIT
NUMBER DESCRIPTION
------- -----------
Jerald L. Broussard and Mary Catherine Broussard, dated as of
December 30, 1996, pursuant to which the collateral securing
the promissory note included as Exhibit 10.2 is pledged
(incorporated by reference to Exhibit 10.7 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.7 1995 Administaff Stock Option Plan (as amended and restated)
(incorporated by reference to Exhibit 10.8 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.8 Form of Second Amended and Restated Promissory Note
(incorporated by reference to Exhibit 10.9 to the Registrant's
Registration Statement on form S-1 (No. 33-96952) declared
effective on January 28, 1997).
10.9 Form of Second Amended and Restated Security Agreement -
Pledge (incorporated by reference to Exhibit 10.10 to the
Registrant's Registration Statement on form S-1 (No. 33-96952)
declared effective on January 28, 1997).
11.1 Statement re: Computation of Per Share Earnings.
21.1 Subsidiaries of Administaff, Inc.
27.1 Financial Data Schedule.
<PAGE> 1
EXHIBIT 11.1
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS OF ADMINISTAFF, INC.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1994 1995 1996
---------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C>
PRIMARY
Average shares outstanding 9,680 10,498 10,726
Net effect of dilutive stock options --
based on the treasury stock method
using average market price 130 170 56
Net effect of dilutive stock warrants --
based on the treasury stock method 32 109 93
using average market price
Net effect of dilutive stock warrants --
based on the if-converted method 441 * 174
Adjustment to give effect to shares optioned
to employees within 12 months of the initial
filing of an initial public offering as outstanding
as of the beginning of each period presented
based on the treasury stock method using
the initial public offering price 112 88 56
---------------------------------------
Total 10,395 10,865 11,105
=======================================
Net income $ 3,766 $ 1,116 $ 2,603
Add interest from subordinated debt, net of taxes 92 * 36
---------------------------------------
Net income available for common stockholders $ 3,858 $ 1,116 $ 2,639
=======================================
Per share amount $ 0.37 $ 0.10 $ 0.24
=======================================
FULLY DILUTED
Average shares outstanding 9,680 10,498 10,726
Net effect of dilutive stock options --
based on the treasury stock method
using ending market price 259 213 56
Net effect of dilutive stock warrants --
based on the treasury stock method
using ending market price 55 124 93
Net effect of dilutive stock warrants --
based on the if-converted method 441 * 174
Adjustment to give effect to shares optioned
to employees within 12 months of the initial
filing of an initial public offering as
outstanding as of the beginning of each period
presented based on the treasury method using
the initial public offering price 112 72 56
---------------------------------------
Total 10,544 10,908 11,105
=======================================
Net income $ 3,766 $ 1,116 $ 2,603
Add interest from subordinated debt, net of taxes 92 * 36
---------------------------------------
Net income available for common stockholders $ 3,858 $ 1,116 $ 2,639
=======================================
Per share amount $ 0.37 $ 0.10 $ 0.24
=======================================
</TABLE>
* Conversion of the stock warrants is not assumed in the computation because
its effect is antidilutive
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF ADMINISTAFF, INC.
- Administaff of Texas, Inc., a Texas corporation and wholly owned
subsidiary of Administaff, Inc.
- Administaff Companies, Inc., a Delaware corporation and wholly owned
subsidiary of Administaff of Texas, Inc.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 13,360
<SECURITIES> 0
<RECEIVABLES> 17,015
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 33,043
<PP&E> 15,002
<DEPRECIATION> (3,359)
<TOTAL-ASSETS> 48,376
<CURRENT-LIABILITIES> 28,414
<BONDS> 4,603
0
0
<COMMON> 107
<OTHER-SE> 13,185
<TOTAL-LIABILITY-AND-EQUITY> 48,376
<SALES> 899,596
<TOTAL-REVENUES> 899,596
<CGS> 861,740
<TOTAL-COSTS> 861,740
<OTHER-EXPENSES> 33,042
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 945
<INCOME-PRETAX> 4,814
<INCOME-TAX> 2,211
<INCOME-CONTINUING> 4,814
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,603
<EPS-PRIMARY> 0.24
<EPS-DILUTED> 0.24
</TABLE>
