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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, 1999.
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
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Commission File No. 1-13998
ADMINISTAFF, INC.
(Exact name of registrant as specified in its charter)
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Delaware 76-0479645
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
19001 Crescent Springs Drive
Kingwood, Texas 77339
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (281) 358-8986
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share New York Stock Exchange
Rights to Purchase Series A Junior Participating Preferred Stock New York Stock Exchange
(Title of class) (Name of Exchange on Which Registered)
Securities Registered Pursuant to Section 12(g) of the Act: NONE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 1, 2000, 13,485,272 shares of the registrant's common stock,
par value $0.01 per share, were outstanding. The aggregate market value of the
common stock held by non-affiliates (based upon the March 1, 2000 closing price
of the common stock as reported by the New York Stock Exchange) was
approximately $437 million.
Part III information is incorporated by reference from the proxy statement
for the annual meeting of stockholders to be held May 2, 2000 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............................................................................ 17
Item 3. Legal Proceedings..................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................................... 17
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters......................................................... 18
Item 6. Selected Financial Data............................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................... 20
Item 7A. Qualitative and Quantitative Disclosures About Market Risk............................ 36
Item 8. Financial Statements and Supplementary Data........................................... 37
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................................ 37
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 38
Item 11. Executive Compensation................................................................ 38
Item 12. Security Ownership of Certain Beneficial Owners and Management ....................... 38
Item 13. Certain Relationships and Related Transactions........................................ 38
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 39
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PART I
This document contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. You can identify such forward-looking statements by the
words "expects", "intends," "plans," "projects," "believes," "estimates," and
similar expressions. 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.
Administaff bases the forward-looking statements on its current expectations,
estimates and projections. Administaff cautions you that these statements are
not guarantees of future performance and involve risks, uncertainties and
assumptions that Administaff cannot predict. In addition, Administaff has based
many of these forward-looking statements on assumptions about future events that
may prove to be inaccurate. Therefore, the actual results of the future events
described in such forward-looking statements 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, factors discussed in Item 1, "Business" and Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations," including the factors discussed under the caption "Factors That May
Affect Future Results and the Market Price of Common Stock," beginning on page
32.
ITEM 1. BUSINESS.
GENERAL
Administaff is a professional employer organization ("PEO") that provides a
comprehensive Personnel Management System which encompasses a broad range of
services, including benefits and payroll administration, health and workers'
compensation insurance programs, personnel records management, employer
liability management, employee recruiting and selection, performance management
and training and development services. The Company was organized as a
corporation in 1986 and has provided PEO services since inception.
The Company's Personnel Management System is designed to improve the
productivity and profitability of small and medium-sized businesses. It relieves
business owners and key executives of many employer-related administrative and
regulatory burdens and enables them to focus on the core competencies of their
businesses. It also promotes employee performance through human resource
management techniques that improve employee satisfaction. The Company provides
the Personnel Management System by entering into a Client Services Agreement
("CSA"), which establishes a three-party relationship whereby the Company and
client act as co-employers of the worksite employees. Under the CSA, Administaff
assumes responsibility for personnel administration and compliance with most
employment-related governmental regulations, while the client company retains
the employees' services in its business and remains the employer for various
other purposes. The Company charges a comprehensive service fee, which is
invoiced along with each periodic payroll of the client. The fee is based upon
the gross payroll of each client and the Company's estimated cost of providing
the services included in the Personnel Management System.
Administaff is a leading provider of PEO services, both in terms of the
number of worksite employees and in terms of revenues. The Company, which serves
client companies with worksite employees located throughout the United States,
is currently executing a long-term national expansion strategy targeting
approximately 90 sales offices located in 40 strategically selected markets. As
part of this expansion strategy, the Company opened three new sales offices and
entered one new market during 1999. As of December 31, 1999, the Company had 25
sales offices located in 15 markets. For the year ended December 31, 1999,
Houston, the Company's original market, accounted for approximately 36% of the
Company's revenues with other Texas markets contributing an additional 25%.
During 1999, revenues grew 15% in the Texas markets and 83% in the non-Texas
markets.
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The Company's national expansion strategy also includes regionalized data
processing for payroll and benefits transactions and localized face-to-face
human resources service capacity. During 1999, the Company opened a new service
center in Atlanta and continued to place human resources and customer service
personnel in its sales markets. As of December 31, 1999, the Company had three
service centers, which when fully staffed, will provide the capacity to serve
approximately 100,000 worksite employees. In addition, the Company has human
resources and customer service personnel located in 13 of its 15 sales markets.
The Company expects to continue its national expansion at a pace consistent with
that of the past few years.
In the fourth quarter of 1999, the Company announced the expansion of its
eBusiness strategy. The strategy includes the continuing development and
expansion of Administaff Assistant, the Company's Internet-based service
delivery platform, with a focus on providing automated, personalized PEO
services to clients and worksite employees. In addition, the Company is
developing a business-to-business eCommerce portal designed to provide the
Company's clients and worksite employees with a wide variety of value-added
products and services. The Company also plans to extend its brand and presence
as the human resources department for small business by developing and
exchanging its human resources content with various community-of-interest sites
targeted to small and medium-sized businesses.
PEO INDUSTRY
The PEO industry began to evolve in the early 1980's largely in response to
the burdens placed on small and medium-sized employers by an increasingly
complex legal and regulatory environment. While various service providers were
available to assist these businesses with specific tasks, PEOs emerged as
providers of a more comprehensive range of services relating to the
employer/employee relationship. PEO arrangements generally transfer broad
aspects of the employer/employee relationship to the PEO. Because PEOs provide
employee-related services to a large number of employees, they can achieve
economies of scale that allow them to perform employment-related functions more
efficiently, provide employee benefits at a level typically available only to
large corporations with substantial resources and devote more attention to human
resources management.
Growth in the PEO industry has been significant. The Company believes that
the key factors driving demand for PEO services include (i) trends relating to
the growth and productivity of the small and medium-sized business community in
the United States, such as outsourcing and a focus on core competencies, (ii)
the need to provide competitive health care and related benefits to attract and
retain employees, (iii) the increasing costs associated with health and workers'
compensation insurance coverage, workplace safety programs, employee-related
complaints and litigation and (iv) 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.
A significant factor in the growth of the PEO industry has been increasing
recognition and acceptance of PEOs and the co-employer relationship by federal
and state governmental authorities. The Company and other industry leaders, in
concert with NAPEO, have worked with the relevant governmental entities for the
establishment of a regulatory framework that protects clients and employees,
discourages unscrupulous and financially unsound companies, and promotes the
legitimacy and further development of the industry. While many states do not
explicitly regulate PEOs, 19 states (including Texas) have enacted legislation
containing licensing, registration, or certification requirements and several
others are considering such regulation. Such laws vary from state to state but
generally provide for monitoring the fiscal responsibility of PEOs. State
regulation assists in screening insufficiently capitalized PEO operations and,
in the Company's view, has the effect of legitimizing the PEO industry by
resolving interpretive issues concerning employee status for specific purposes
under applicable state law. The Company has actively supported such regulatory
efforts and is currently licensed or registered in 18 states. The cost of
compliance with these regulations is not material to the Company's financial
position or results of operations.
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PEO SERVICES
The Company serves small and medium-sized business by providing the
Personnel Management System, which encompasses a broad range of services,
including benefits and payroll administration, health and workers' compensation
insurance programs, personnel records management, employer liability management,
employee recruiting and selection, performance management and training and
development services. The Personnel Management System is designed to attract and
retain high-quality employees, while relieving client owners and key executives
of many employer-related administrative and regulatory burdens. Among the
employment-related laws and regulations that may affect a client company are the
following:
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o Internal Revenue Code (the "Code") o Americans with Disabilities Act (ADA)
o Federal Income Contribution Act (FICA) o Age Discrimination in Employment Act
o Federal Unemployment Tax Act (FUTA) (ADEA)
o Fair Labor Standards Act (FLSA) o The Family and Medical Leave Act (FMLA)
o Employee Retirement Income Security Act o Health Insurance Portability and
(ERISA) Accountability Act (HIPAA)
o Consolidated Omnibus Budget Reconcilia- o Drug-Free Workplace Act
tion Act of 1987 (COBRA) o Occupational Safety and Health Act
o Immigration Reform and Control Act (OSHA)
IRCA) o State unemployment and employment
o Title VII (Civil Rights Act of 1964) security laws
o State workers' compensation laws
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While these regulations are complex, and in some instances overlapping,
Administaff assists its client companies in achieving compliance with these
regulations by providing services in four primary categories: administrative
functions, benefit plans administration, personnel management and employer
liability management. All of the following services are included in the
Personnel Management System and are available to all client companies.
Administrative Functions. Administrative functions encompass a wide variety
of processing and record keeping tasks, mostly related to payroll administration
and government compliance. Specific examples include payroll processing, payroll
tax deposits, quarterly payroll tax reporting, employee file maintenance,
unemployment claims processing and workers' compensation claims reporting.
Benefit Plans Administration. The Company's benefit plans include the
following: a group health plan, a dependent care spending account plan, a
worklife program, an educational assistance plan, an adoption assistance
program, group term life insurance coverage, accidental death and dismemberment
insurance coverage, short-term and long-term disability insurance coverage and a
401(k) plan. The group health plan includes medical, dental, vision and prenatal
care, and a prescription drug program. All eligible employees may participate in
the 401(k) plan, while various components of the welfare and fringe benefit
plans are provided to applicable employees based on eligibility provisions
specific to those plans. The Company is responsible for the costs and premiums
associated with these plans, acts as plan administrator of the plans, negotiates
the terms and costs of the plans, maintains the plans in accordance with
applicable federal and state regulations and serves as liaison for the delivery
of such benefits to worksite employees. The Company believes that this variety
and quality of benefit plans are generally not available to its small and
medium-sized business target market and are usually found only in larger
companies that can spread program costs over a much larger group of employees.
Moreover, the Company believes that the availability of these benefit plans
provide our clients with a competitive advantage that small and medium-sized
businesses are normally unable to attain in the areas of benefits cost, employee
recruiting and employee retention.
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Personnel Management. The Company provides a wide variety of personnel
management services which gives its client companies access to resources
normally found only in the human resources departments of large companies. All
client companies receive the Company's comprehensive personnel guide, which sets
forth a systematic approach to administering personnel policies and practices,
including recruiting, discipline and termination procedures. Other human
resources services provided include drafting and reviewing personnel policies
and employee handbooks, designing job descriptions, performing prospective
employee screening and background investigations, designing performance
appraisal processes and forms, and providing professional development and
issues-oriented training, employee counseling, substance abuse awareness
training, drug testing, outplacement services and compensation guidance.
Employer Liability Management. Under the CSA, the Company assumes many of
the liabilities associated with being an employer. For those potential
employment-related liabilities that Administaff does not assume, the Company can
assist its clients in managing and limiting exposure. This includes first time
and ongoing safety reviews as well as the implementation of safety programs
designed to reduce workers' compensation claims. Administaff can also provide
guidance to clients on avoiding liability for discrimination, sexual harassment
and civil rights violations, and participates in termination decisions to
attempt to secure protection from liability on those grounds. When a claim
arises, the Company often assists in the client's defense regardless of whether
the Company has been named directly. The Company employs in-house and external
counsel specializing in several areas of employment law who have broad
experience in disputes concerning the employer/employee relationship. This
expertise allows Administaff's clients to contest many claims, which they might
otherwise have been inclined to settle. The Company also monitors changing
government regulations and notifies clients of their potential effect on
employer liability.
eBUSINESS SERVICES
In the fourth quarter of 1999, the Company announced the expansion of its
eBusiness strategy. This comprehensive strategy is designed to add new revenues
streams and extend the Company's brand as the human resources department for
small business. The Company also expects its eBusiness services to positively
impact its core PEO services by enhancing the Company's attractiveness to
prospective clients, increasing client retention and reducing operating costs.
Prior to the fourth quarter of 1999, the Company's eBusiness strategy
revolved solely around Administaff Assistant, the Company's Internet-based PEO
service delivery platform. During 1998, the Company released the first version
of Administaff Assistant, which included basic functionality such as (i)
customer-specific payroll information and reports, (ii) an online personnel
guide, (iii) printable online human resources forms, (iv) frequently asked
questions, (v) links to benefits providers and other key vendors and (vi) search
capabilities, including the ability to search for health care providers. In the
fourth quarter of 1999, the Company completed a second major enhancement to
Administaff Assistant, which included improved and expanded reporting of human
resources information and the on-line submission and approval of payroll data.
The Company initially deployed this expanded functionality to a limited number
of clients as beta test participants and expects to make it available to all
clients during 2000.
Under the expanded eBusiness strategy, the Company plans to continue the
development of expanded functionality within Administaff Assistant, with a
continued focus on providing automated, personalized PEO services to the
Company's clients and worksite employees. The Company believes that Administaff
Assistant will become the primary tool used by its PEO clients to complete
routine transactions with the Company, including updating human resource data
and transmitting payroll data. The Company believes this transition will reduce
the costs of performing those routine transactions, while allowing the Company's
corporate employees to focus on its clients' more complex human resources
issues.
The Company's second major eBusiness initiative involves establishing a
business-to-business eCommerce portal, which will bring a wide range of product
and service offerings from best-of-class providers to Administaff clients,
worksite employees and their families. The Company expects this portal to bring
value-added products and
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services to these constituencies and new revenue streams to the Company. In
addition, the Company anticipates that its ability to provide added value for
its clients will improve client retention and enhance the attractiveness of its
core PEO services.
The Company is in the process of building the eCommerce portal, and expects
that the portal will become functional near the end of the first quarter of
2000. Administaff has entered into a number of alliances for products and
services to be offered through the portal, including IBM (Internet tools for
small businesses), Forrester Research (Internet research and rankings of
eCommerce sites), works.com and Accompany.com (online business purchasing) and
Dell (computers and equipment purchasing). In addition, the Company has entered
into a letter of intent to form an alliance with Aon Enterprise Insurance
Services, Inc. under which Aon will offer property and casualty insurance to
Administaff's client companies. In connection with its relationship with the
Company, IBM is participating in the construction of the portal by providing
development and consulting services.
The final initiative in the Company's eBusiness strategy involves
exchanging human resources content with various community-of-interest sites
targeted at the small and medium-sized business community. Through these sites,
the Company plans to provide a wide range of content and services to extend its
brand and attract additional clients to its core PEO service.
In the fourth quarter of 1999, the Company announced a strategic alliance
with Luminant Worldwide Corporation, under which Luminant is providing a broad
range of eBusiness consulting services, including a significant role in the
development of Administaff Assistant and strategic planning for the eCommerce
portal and the Company's overall eBusiness strategy. Administaff estimates that
it will incur consulting costs of approximately $3 million in each of the first
two years of the alliance, and $4 million in the third year. Under the alliance,
Administaff will also provide comprehensive PEO services to Luminant and its
worksite employees. The Company expects to co-employ an average of 1,000
Luminant worksite employees in the first year of the alliance, increasing to an
average of 2,000 worksite employees in the third year of the alliance. In
addition, Administaff and Luminant will work together to refine Administaff's
service model for clients with more than 500 employees.
CLIENT SERVICES AGREEMENT
All clients enter into Administaff's Client Services Agreement. The CSA
generally provides for an on-going relationship, subject to termination by the
Company or the client at any time upon 60 days prior written notice.
The CSA establishes the Company's comprehensive service fee, which is
subject to periodic adjustments to account for changes in the composition of the
client's workforce and statutory changes that affect the Company's costs. The
CSA also establishes the division of responsibilities between Administaff and
the client as co-employers. Pursuant to the CSA, Administaff is responsible for
all personnel administration and is liable for purposes of certain government
regulation. In addition, Administaff assumes liability for payment of salaries
and wages of its worksite employees and responsibility for providing employee
benefits to such persons, regardless of whether the client company makes timely
payment of the associated service fee. The client retains the employees'
services and remains liable for the purposes of certain government regulations,
compliance with which requires control of the worksite or daily supervisory
responsibility or is otherwise beyond Administaff's ability to assume. A third
group of responsibilities and liabilities are shared by Administaff and the
client where such joint responsibility is appropriate. The specific division of
applicable responsibilities under the CSA is as follows:
Administaff
o Payment of wages and related tax reporting and remittance (state and
federal withholding, FICA, FUTA, state unemployment);
o Workers' compensation compliance, procurement, management and reporting;
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o Compliance with COBRA, IRCA, HIPAA and ERISA (for plans sponsored by
Administaff), as well as monitoring changes in other governmental
regulations governing the employer/employee relationship and updating the
client when necessary; and
o Employee benefit procurement.
Client
o Payment and related tax reporting and remittance of non-qualified deferred
compensation and equity-based compensation;
o Assignment to, and ownership of, all intellectual property rights;
o Compliance with Section 414(o) of the Code regarding benefit
discrimination;
o Compliance with OSHA regulations, EPA regulations, FLSA, WARN and state and
local equivalents and compliance with government contracting provisions;
o Compliance with NLRA, including all organizing efforts and expenses related
to a collective bargaining agreement and related benefits; and
o Professional licensing requirements, fidelity bonding and professional
liability insurance.
Joint
o Implementation of policies and practices relating to the employee/employer
relationship;
o Selection of fringe benefits, including employee leave policies; and
o Compliance with all federal, state and local employment laws, including,
but not limited to Title VII of the Civil Rights Act of 1964, ADEA, Title I
of ADA, FMLA, the Consumer Credit Protection Act, and immigration laws and
regulations.
Because Administaff is a co-employer with the client company for some
purposes, it is possible that Administaff could incur liability for violations
of such laws even if it is not responsible for the conduct giving rise to such
liability. The CSA addresses this issue by providing that the client will
indemnify the Company for liability incurred to the extent the liability is
attributable to conduct by the client. Notwithstanding this contractual right to
indemnification, it is possible that Administaff could be unable to collect on a
claim for indemnification and may therefore be ultimately responsible for
satisfying the liability in question. The Company maintains certain general
insurance coverages to manage its exposure to these types of claims, and as a
result, the costs in excess of insurance premiums incurred by the Company with
respect to this exposure have historically been insignificant to the Company's
operating results.
Clients are required to pay Administaff no later than one day prior to the
applicable payroll date by wire transfer or automated clearinghouse transaction,
and receipt of funds is verified prior to release of payroll. Although the
Company is ultimately liable, as the employer for payroll purposes, to pay
employees for work previously performed, it retains the ability to terminate the
CSA as well as the employees upon non-payment by a client. This right, the
periodic nature of payroll and the overall quality of the Company's client base
have resulted in an excellent overall collections history.
CUSTOMERS
Administaff provides a value-added, full-service human resources solution
that it believes is most suitable to a specific segment of the small and
medium-sized business community not served by most PEOs. The Company has set a
long-term goal to serve approximately 10% of the overall small and medium-sized
business community. In comparison to the overall small and medium-sized business
community, the Company believes that its target client segment includes
companies that place a higher-than-average value on its employees, are typically
more successful than average from a growth or profitability perspective, and
typically have a lower-than-average risk profile from a workers' compensation
and benefits perspective. These factors have been demonstrated over the past
several years in several ways. First, the Company's average gross payroll cost
per worksite employee has grown at
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a rate more than double the national average as measured by the U.S. Employment
Cost Index. Second, the Company's average benefits costs per worksite employee
have grown at a rate in line with industry averages as surveyed by the
healthcare consulting industry. Third, the Company's average workers'
compensation insurance premiums as a percentage of payroll cost have declined
significantly during this time period. Finally, Administaff's average gross
payroll per worksite employee and average gross profit per worksite employee
have been more than double the PEO industry average, as surveyed annually by
NAPEO.
Administaff serves client companies and worksite employees located
throughout the United States. The Company's client base is broadly distributed
throughout a wide variety of industries including services, wholesale trade,
manufacturing, construction, finance, insurance, real estate, medical, retail
trade and others. This diverse client base lowers the Company's exposure to
downturns or volatility in any particular industry. However, the Company's
performance could be affected by general economic conditions within the small
and medium-sized business community. For the year ended December 31, 1999,
Houston, the Company's original market, accounted for approximately 36% of the
Company's revenues with other Texas markets contributing an additional 25%.
During 1999, revenues grew 15% in the Texas markets and 83% in the non-Texas
markets.
As part of its client selection strategy, the Company does not offer its
services to businesses falling within certain specified SIC codes, essentially
eliminating certain industries that it believes present a higher risk of
employee injury (such as roofing, logging and oil and gas exploration). All
prospective customers are evaluated individually on the basis of workers'
compensation risk, group medical history, unemployment history and operating
stability.
The Company focuses heavily on client retention. Administaff's client
retention record reflects that approximately 80% of Administaff's clients remain
for more than one year, and that the retention rate improves for clients who
remain with Administaff for longer periods. Client attrition is attributable to
a variety of factors, including (i) client non-renewal due to price factors,
(ii) sale, disposition or merger of the client company, (iii) competition from
other PEOs and business services firms, (iv) termination of the CSA by
Administaff resulting from the client's inability to make timely payments, and
(v) client business failure or downsizing.
MARKETING AND SALES
As of December 31, 1999, the Company had 25 sales offices located in 15
markets. The Company is currently executing a long-term national expansion
strategy, which targets approximately 90 sales offices in 40 strategically
selected markets. The Company's sales offices typically consist of six to ten
sales representatives, a district sales manager and an office administrator. The
Company's markets and their respective year of entry are as follows:
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Initial
Market Sales Offices Entry Date
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Houston 3 1986
San Antonio 1 1989
Austin 1 1989
Orlando 1 1989
Dallas 3 1993
Atlanta 2 1994
Phoenix 1 1995
Chicago 2 1995
Washington D.C. 1 1995
Denver 1 1996
Los Angeles 3 1997
Charlotte 1 1997
St. Louis 1 1998
San Francisco 2 1998
New York 2 1999
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The 40 markets included in the national expansion plan were identified
using a systematic market evaluation and selection process. The Company
continues to evaluate a broad range of factors in the selection process, using a
market selection model that weights various criteria that the Company believes
are reliable predictors of successful penetration based on its experience. Among
the factors considered are (i) market size, in terms of small and medium-sized
businesses engaged in selected industries that meet the Company's risk profile,
(ii) market receptivity to PEO services, including the regulatory environment
and relevant history with other PEO providers, (iii) existing relationships
within a given market, such as vendor or client relationships, (iv) expansion
cost issues, such as advertising and overhead costs, (v) direct cost issues that
bear on the Company's effectiveness in controlling and managing the cost of its
services, such as workers' compensation and health insurance costs, unemployment
risks and various legal and other factors, (vi) a comparison of the services
offered by Administaff to alternatives available to small and medium-sized
businesses in the relevant market, such as the cost to the target clients of
procuring services directly or through other PEOs and (vii) long-term strategy
issues, such as the general perception of markets and their long-term revenue
growth potential. Each of the Company's expansion markets, beginning with Dallas
in 1993, was selected in this manner.
The Company's marketing strategy is based on the application of techniques
that have produced consistent and predictable results in the past. The Company
develops a mix of advertising media and a placement strategy tailored to each
individual market. After selecting a market and developing its marketing mix,
but prior to entering the market, the Company engages in an organized media and
public relations campaign to prepare the market for the Company's entry and to
begin the process of generating sales leads. The Company markets its services
through a broad range of media outlets, including radio, newspapers,
periodicals, direct mail and the Internet. The Company employs a public
relations firm in each of its markets as well as advertising consultants to
coordinate and implement its marketing campaigns. The Company has developed an
inventory of proven, successful radio and newsprint advertisements, which are
utilized in this effort.
The Company's organic growth model generates sales leads from five primary
sources: direct sales efforts, advertising, referrals, the American Express
marketing alliance described below and the Internet. These leads result in
initial presentations to prospective clients, and, ultimately, a predictable
number of client census reports. A prospective client's census report reflects
information gathered by the sales representative about the prospect's employees,
including job classification, state of employment, workers' compensation claims
history, health insurance claims history, salary, and desired level of benefits.
This information is entered into the Company's customized bid system, which
applies Administaff's proprietary pricing model to the census data, leading to
the preparation of a bid. Concurrent with this process, the prospective client's
workers' compensation and health insurance histories are evaluated from a risk
management perspective. This prospective client screening process plays a vital
role in controlling the Company's benefits costs and limiting its exposure to
liability. Upon completion of a favorable risk evaluation, the sales
representative presents the Company's bid and attempts to enroll the prospect.
The Company's selling process typically takes approximately 90 days.
In 1998, the Company entered into a Marketing Agreement with American
Express, under which American Express is utilizing its resources to generate
appointments with prospects for the Company's services in certain markets. In
addition, the Company and American Express are working to jointly develop
product offerings that enhance the current PEO services offered by the Company.
The Marketing Agreement has a seven-year term and provides that American Express
will not enter into an alliance with another PEO for the first three years. The
Company pays a commission to American Express based upon the number of worksite
employees paid after being referred to the Company pursuant to the Marketing
Agreement.
Since the inception of the Marketing Agreement, efforts to generate sales
appointments for Administaff sales representatives have been focused primarily
through telemarketing to American Express' small business client base.
Appointment generation has been substantial and steady since inception, while
conversion rates have improved consistently as the co-branded sales effort has
been enhanced. During 1998, American Express set a substantial number of
appointments for Administaff sales representatives, but the conversion rate on
those prospects was lower than the goal set for this relationship. After
evaluating the types of appointments that were being generated, the process
employed by American Express to set appointments was refined to focus on clients
with
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<PAGE> 11
more than 10 employees. During the first half of 1999, American Express again
set a substantial number of appointments, and the conversion rates on these
appointments increased. However, both Administaff and American Express believed
that the Marketing Agreement was not significantly accretive to Administaff's
growth and that the efficiency of these sales efforts could be further improved.
As a result, the companies developed a new customized, co-branded sales effort
designed to more accurately reflect the business partnership between Administaff
and American Express. In addition, Administaff dedicated approximately 20% of
its sales force specifically to the American Express alliance and provided
specific training to these sales representatives regarding the co-branded sales
presentation. Also, the appointment generation process employed by American
Express was again refined to provide appointments to these specific sales
representatives. During the second half of 1999, the American Express alliance
generated approximately 26% of the Company's new clients sold, even though only
20% of the Company's sales representatives were involved. In addition, the
conversion rate of the American Express appointment channel improved
significantly and was second only to referrals from existing clients. During
2000, the Company expects to expand this customized sales approach to include a
larger percentage of its sales representatives and sales markets.
COMPETITION
Due to the differing geographic regions and market segments in which most
PEOs operate, and the relatively low level of market penetration by the
industry, the Company considers its primary competition to be the traditional
in-house provision of employee-related services. The PEO industry is highly
fragmented, and the Company believes that it is one of the largest PEOs in the
United States in terms of revenues. The Company's largest national competitors
include Staff Leasing, Inc. and PEO divisions of large business services
companies such as Automatic Data Processing, Inc. and Paychex, Inc. In addition,
the Company faces competition from large regional PEOs in certain areas of the
country. As the Company and other large PEOs expand nationally, the Company
expects that competition may intensify among larger PEOs. In addition, the
Company competes to some extent with fee-for-service providers such as payroll
processors and human resource consultants.
Competition in the PEO industry revolves primarily around quality of
services, breadth of services, choice of benefits packages, quality of benefits,
reputation and price. The Company believes that reputation, national presence,
regulatory expertise, financial resources, risk management and information
technology capabilities distinguish leading PEOs from the rest of the industry.
The Company also believes that it competes favorably in these areas. In
addition, the Company believes that its value-added, full-service human
resources solution is most suitable to a specific segment of the small and
medium-sized business market not served by most PEOs.
VENDOR RELATIONSHIPS
Administaff provides benefits to its worksite employees under arrangements
with a variety of vendors. Although the Company believes that any of its benefit
contracts could be replaced if necessary, the Company considers two such
contracts to be the most significant elements of the package of benefits
provided to employees.
The Company's primary group health insurance vendor is Aetna U.S.
Healthcare, Inc. ("Aetna"). The Company provides a range of health plan
coverages under the plan, and Administaff's comprehensive fees to its clients
reflect the coverage options provided. The Company initiated insurance coverage
with Aetna in 1989, and the current one-year policy expires on December 31,
2000. The Company's coverage options with Aetna primarily include a PPO
arrangement and an HMO plan. All Aetna coverages are fully insured and require
the Company to fund claims and premiums up to a specified quarterly maximum
amount. Aetna is required to fund all claims and premiums, if any, in excess of
the quarterly maximum amount. These quarterly maximum amounts are adjustable,
based on claims experience, with six months notice by Aetna. While Aetna bears
ultimate legal responsibility for all claims, the Company seeks to minimize the
costs of providing health care coverages through active assistance in the claims
administration and resolution process, because the Company's long-term health
care costs could be affected by its claims experience.
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<PAGE> 12
The Company's workers' compensation policies have been provided by Reliance
National Indemnity Co. since 1990. Since November 1994, the Company has been
covered under a guaranteed cost plan whereby premiums are paid for complete
coverage of all claims under the policy. The current three-year policy expires
on September 30, 2001.
INFORMATION TECHNOLOGY
The Company has developed state-of-the-art information technology capable
of meeting the demands of payroll and related processing for the Company's
worksite employees, satisfying the Company's administrative and management
information needs, providing productivity enhancement tools to the Company's
corporate staff and providing web-based access to certain tools and data. While
the Company utilizes commercially available software for standard business
functions such as finance and accounting, it has developed a proprietary
professional employer information system for the delivery of its primary
services. This system manages data relating to worksite employee enrollment,
human resource management, benefits administration, payroll processing,
management information, and sales bid calculations that are unique to the PEO
industry and to Administaff. Central to the system is a payroll processing
system that allows the Company to process a high volume of payroll transactions
that meet the customized needs of its client companies.
The Company's proprietary PEO information system is now in its fourth
generation. The software uses Informix, a relational database and program
development language, and PowerBuilder, a state-of-the-art, object oriented
client/server development system. The software is designed to provide high
volume professional employer services utilizing a combination of on-line and
batch processing capabilities that can be readily expanded to handle additional
processing needs. The system is accessed through a graphical user interface
engineered to maximize both the quality of Administaff's services and the
efficiency with which they are delivered.
Beginning in 1998, the Company began to develop the next generation of this
system using a combination of internal staff and contracted programmers. The
scope of this development activity includes unifying and extending the database
structure, improving processing speed, implementing a comprehensive payroll tax
calculation module, integrating functionality with Administaff Assistant,
increasing the reporting capabilities, and simplifying the user interface with
the system. This project is currently expected to be completed during the second
quarter of 2000 for deployment shortly thereafter.
In addition, in 1998, the Company began to develop Administaff Assistant,
an Internet-based service delivery platform, intended to combine functionality
and content used in providing the Company's PEO services. During 1998 and 1999,
the Company periodically deployed incremental enhancements and increased
functionality through this platform such as access to payroll information and
reports, access to various human resources forms, frequently asked questions,
links to benefits providers and other key vendors, search capabilities and
on-line submission of payroll data. The Company expects to continue to develop
additional features and functionality to this platform throughout 2000. The
majority of the resources being used in the development of this platform are
being provided through the Company's relationship with Luminant Worldwide
Corporation.
The Company's primary information processing facility is located at the
Company's corporate headquarters in Kingwood, Texas (a suburb of Houston) with
secondary processing facilities located in Dallas, Texas and Atlanta, Georgia.
The Dallas facility acts as a disaster recovery facility for the Company,
capable of handling all of the Company's operations for a short period of time.
During 1998 and 1999, the Company invested in substantially upgrading its
overall network infrastructure. Workstations throughout the Company's corporate
offices and services centers are connected to the corporate data center by
high-speed network service through a Nortel solution utilizing the latest
Gigabit technology. The Company's sales offices are connected to the data center
through high-speed frame relay connections. The network backbone is a
fiber-based network utilizing traffic leveling and advanced diagnostic
capabilities allowing for optimal network performance. This network technology
is intended to provide for faster, more reliable network connectivity throughout
the Company's nationwide presence and to eventually take advantage of the
convergence
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<PAGE> 13
of voice, data and video telecommunications opportunities. The Company's
principal computing platforms are Compaq/NT and IBM RISC 6000/AIX servers and
Dell workstations. The Company utilizes RISC 6000 servers for its corporate
database and Compaq/NT servers for file and other services.
INDUSTRY REGULATION
The Company's operations are affected by numerous federal and state laws
relating to labor, tax and employment matters. By entering into a co-employer
relationship with employees who are assigned to work at client company locations
(referred to as "worksite employees"), the Company assumes certain obligations
and responsibilities of an employer under these federal and state laws. Because
many of these federal and state laws were enacted prior to the development of
nontraditional employment relationships, such as professional employer
organizations, temporary employment and outsourcing arrangements, many of these
laws do not specifically address the obligations and responsibilities of
nontraditional employers. While many states do not explicitly regulate PEOs, 19
states (including Texas) have passed laws that have licensing, registration or
certification requirements for PEOs, and several others are considering such
regulation.
Certain federal and state statutes and regulations use the terms "employee
leasing" or "staff leasing" to describe the arrangement among a PEO, such as the
Company, and its clients and worksite employees. The terms "employee leasing,"
"staff leasing" and "professional employer arrangements" are generally
synonymous in such contexts and describe the arrangements entered into by the
Company, its clients and worksite employees.
As an employer, the Company is subject to all federal statutes and
regulations governing the employer-employee relationship. Subject to the issues
discussed below, the Company believes that its operations are in compliance in
all material respects with all applicable federal statutes and regulations.
EMPLOYEE BENEFIT PLANS
The Company offers various employee benefit plans to its employees,
including its worksite employees. The Company maintains these employee benefit
plans 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 an employer matching
contribution feature under Code Section 401(m)); a cafeteria plan under Code
Section 125; a group welfare benefits plan which includes medical, dental,
vision, life insurance, disability and worklife programs; a dependent care plan;
an educational assistance plan; and an adoption assistance program. Generally,
employee benefit plans are subject to provisions of both the Internal Revenue
Code and the Employee Retirement Income Security Act of 1974, as amended
("ERISA").
Employer Status. In order to qualify for favorable tax treatment under the
Code, the plans must be established and maintained by an employer for the
exclusive benefit of its employees. Generally, an entity is an "employer" of
individuals for federal employment tax purposes if an employment relationship
exists between the entity and the individuals 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. Generally, the test is applied to
determine whether an individual is an independent contractor or an employee for
federal employment tax purposes and not to determine whether each of two or more
companies is a "co-employer." Substantial weight is typically given to the
question of whether the purported employer has the right to direct and control
the details of an individual's work. Among the 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).
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<PAGE> 14
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 contribution feature
under Code Section 401(m) to the 401(k) Plan. In March 1995, the Company
submitted the amended and restated 401(k) Plan to the IRS for a determination on
its continued tax qualified status. The Company supplemented this filing with
additional information on October 22, 1996, September 15, 1998 and June 25,
1999. 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.
Separate from the IRS' review of the pending determination request, the
Company's 401(k) Plan is currently under audit for the 1993 plan year, although
certain conclusions of the IRS could be applicable to other years as well. In
addition, the IRS has established an Employee Leasing Market Segment Group (the
"Market Segment Group") for the purpose of identifying specific compliance
issues prevalent in certain segments of the PEO industry. Approximately 70 PEOs,
including the Company, have been randomly selected by the IRS for audit pursuant
to this program. One issue that has arisen from these audits is the Industry
Issue (whether a PEO can be a co-employer of worksite employees, including
officers and owners of client companies, for various purposes under the Code,
including participation in the PEO's 401(k) plan). NAPEO and the Company are
cooperating with the IRS in this study of the PEO industry. With respect to the
401(k) Plan audit, the IRS Houston District has sought technical advice (the
"Technical Advice Request") from the IRS National Office. A copy of the
Technical Advice Request and the Company's response has been sent to the IRS
National Office for review. The Technical Advice Request contains the
conclusions of the IRS Houston District with respect to the 1993 plan year that
the 401(k) Plan should be disqualified because it (1) covers worksite employees
who are not employees of the Company and (2) failed a nondiscrimination test
applicable to contributions and the Company has not furnished evidence that the
401(k) Plan satisfies an alternative test (see "401(k) Plan Nondiscrimination
Testing Issues" below). The Company's response to the Technical Advice Request
refutes the conclusions of the IRS Houston District. The Company understands
that the Industry Issue identified by the Market Segment Group study also was
referred to the National Office. If the Market Segment Group study were to reach
a conclusion that is adverse to the PEO industry, there is an administrative
procedure available to appeal that conclusion. In addition to working with the
Market Segment Group study, NAPEO is actively engaged in policy discussions with
both the Treasury Department and with members of Congress in an effort to reduce
the likelihood of unfavorable conclusions and to procure favorable legislation.
The Company does not know whether the National Office will address the
Technical Advice Request independently of the Industry Issue. The Company is not
able to predict either the timing or the nature of any final decision that may
be reached by the IRS with respect to the 401(k) Plan audit or with respect to
the Technical Advice Request or the Market Segment Group study and the ultimate
outcome of such decisions. Further, the Company is unable to predict whether the
Treasury Department will issue a policy statement with respect to its position
on the issues or, if issued, whether such a statement would be favorable to the
Company. The Company intends to vigorously pursue a favorable resolution of the
issues through one or more of the following methods: the audit-Technical Advice
Request, the Market Segment Group study process, regulatory and legislative
efforts, and, if necessary, legal action. If, however, any of these processes
were to conclude that a PEO is not a co-employer of its worksite employees and
such conclusion were to ultimately prevail, worksite employees could not
continue to make salary deferral contributions to the 401(k) Plan or pursuant to
the Company's cafeteria plan or continue to participate in certain other
employee benefit plans of the Company as they currently exist. The Company
believes that, although unfavorable to the Company, a prospective application by
the IRS of such an adverse conclusion (that is, one applicable only to periods
after the conclusion by the IRS is finalized) would not have a material adverse
effect on its financial position or results of operations, as the Company could
continue to make available similar benefit
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<PAGE> 15
programs to its client companies at comparable costs to the Company. However, if
the IRS National Office adopts the conclusions of the IRS Houston District and
any such conclusions were applied retroactively to disqualify the 401(k) Plan
for 1993 and subsequent years, employees' vested account balances under the
401(k) Plan would become taxable, the Company would lose its tax deductions to
the extent its matching contributions were not vested, the 401(k) Plan's trust
would become a taxable trust and the Company would be subject to liability with
respect to its failure to withhold applicable taxes with respect to certain
contributions and trust earnings. Further, the Company would be subject to
liability, including penalties, with respect to its cafeteria plan for the
failure to withhold and pay taxes applicable to salary deferral contributions by
employees, including worksite employees. In such a scenario, the Company also
would face the risk of client dissatisfaction and potential litigation. A
retroactive application by the IRS of an adverse conclusion could have a
material adverse effect on the Company's financial position and results of
operations. While the Company believes that a retroactive disqualification is
unlikely, there can be no assurance as to the ultimate resolution of these
issues by the IRS.
401(k) Plan Nondiscrimination Testing Issues. In August 1996, the 401(k)
Plan's record keeper advised the Company that certain nondiscrimination tests
had been performed incorrectly for certain prior plan years, and it was
determined that the 401(k) Plan had failed these nondiscrimination tests for the
1992, 1993, 1994 and 1995 plan years. With respect to the 1995 plan year, the
Company voluntarily "cured" the operational defect in 1996 by causing the 401(k)
Plan to refund the required excess contributions and earnings thereon to
affected highly compensated participants, and the Company paid an excise tax of
approximately $47,000 in 1996 related to refunded excess contributions. With
respect to the 1992, 1993 and 1994 plan years, the Company entered into a
Closing Agreement on Final Determination Covering Specific Matters ("Closing
Agreement") dated December 22, 1999, with the IRS agreeing and determining that
the IRS will treat the 401(k) Plan and its related trust as not being
disqualified because of the 401(k) Plan's failure of these nondiscrimination
tests during those plan years. As part of the Closing Agreement, the Company
agreed to make a contribution to the 401(k) Plan on behalf of certain
participants in an aggregate amount of approximately $831,000, which is equal to
an amount which, if contributed, would cause the Plan to satisfy the failed
nondiscrimination tests for such years, plus a calculated earnings amount on
such contributions. Further, the Company agreed to pay a penalty of $70,000 to
the United States Treasury. The amount of this settlement was substantially
lower than the amount originally estimated and accrued in 1996, resulting in a
non-recurring gain of $932,000 ($852,000 net of income tax effect) during the
fourth quarter of 1999. This gain includes the impact of an adjusted amount
recoverable from the plan's former record keeper pursuant to a 1996 agreement,
under which the record keeper agreed to reimburse the Company for a portion of
its settlement of the nondiscrimination testing issues.
ERISA Requirements. Employee pension and welfare benefit plans are also
governed by ERISA. ERISA defines "employer" as "any person acting directly as an
employer, or indirectly in the interest of an employer, in relation to an
employee benefit plan." ERISA defines the term "employee" as "any individual
employed by an employer." The United States Supreme Court has held that the
common law test of employment must be applied to determine whether an individual
is an employee or an independent contractor under ERISA. A definitive judicial
interpretation of "employer" in the context of a PEO or employee leasing
arrangement has not been established.
If the Company were found not to be an employer for ERISA purposes, its
plans would not comply with ERISA. Further, as a result of such finding the
Company and its plans would not enjoy, with respect to worksite employees, the
preemption of state laws provided by ERISA and could be subject to varying state
laws and regulations, as well as to claims based upon state common laws. Even if
such a finding were made, the Company believes it would not be materially
adversely affected because it could continue to make available similar benefits
at comparable costs.
In addition to ERISA and the Code provisions discussed herein, issues
related to the relationship between the Company and its worksite employees may
also arise under other federal laws, including other federal income tax laws.
Possible Multiple Employer Plan Treatment. The U.S. Department of Labor
("DOL") issued an Advisory Opinion in December 1995 to a staff leasing company
advising that particular company that its health plan, which
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<PAGE> 16
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, individually or in the
aggregate, would be material to the Company's financial condition or results of
operations. Further, even if such a conclusion is reached, the Company believes
that it could continue to be able to make available comparable benefit programs
to client companies.
FEDERAL EMPLOYMENT TAXES
As a co-employer, the Company assumes responsibility and liability for the
payment of federal and state employment taxes with respect to wages and salaries
paid to worksite employees. There are essentially three types of federal
employment tax obligations: (i) withholding of income tax requirements governed
by Code Section 3401, et seq.; (ii) obligations under FICA, governed by Code
Section 3101, et seq.; and (iii) obligations under 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.
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
While many states do not explicitly regulate PEOs, 19 states (including
Texas) have passed laws that have licensing, registration or certification
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, and in some cases codify and clarify the co-employment
relationship for unemployment, workers' compensation and other purposes under
state law. Administaff holds licenses in Arkansas, Florida, Montana, New
Hampshire, New Mexico, Oregon, South Carolina, Tennessee, Texas and Utah. The
Company is registered or certified in Colorado, Illinois, Kentucky, Maine,
Massachusetts, Minnesota, Nevada, and Rhode Island. Regardless of whether 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 was instrumental in obtaining enactment of PEO
legislation in
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<PAGE> 17
Texas, where it faced a number of challenges under state law, and 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 had approximately 800 corporate office and sales employees as
of December 31, 1999. 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.
INTELLECTUAL PROPERTY
The Company currently has registered trademarks and pending applications
for registration. Although the Administaff mark is the most material to the
Company's business, the Company's trademarks as a whole are also of considerable
importance to the Company.
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<PAGE> 18
ITEM 2. PROPERTIES.
The Company believes that its current facilities are adequate for the
purposes for which they are intended and that they provide sufficient capacity
to accommodate the Company's short-term expansion plan. The Company will
continue to evaluate the need for additional facilities based on the rate of
growth in worksite employees, the geographic distribution of the worksite
employee base and the Company's long-term service delivery requirements.
CORPORATE HEADQUARTERS
The Company's corporate headquarters are located in Kingwood, Texas, in a
142,000 square foot campus-style facility. This facility, which includes 30
acres of undeveloped land for future expansion, is company-owned. All corporate
operations are housed in the Kingwood facility, along with the Company's record
retention center and primary data processing center.
SERVICE CENTERS
The Company currently has three service centers located in Houston, Texas;
Dallas, Texas and Atlanta, Georgia. The Houston service center, which services
approximately 40% of the Company's worksite employee base, is currently located
at the Company's corporate headquarters. The Houston service center will be
relocated to a 40,000 square foot leased facility in late 2000. This planned
facility, when fully staffed, will provide the capacity to service approximately
20,000 worksite employees.
The Dallas service center, which currently services approximately 50% of
the Company's worksite employee base, is located in a 40,000 square foot leased
facility, which also serves as the Company's backup data processing center and
disaster recovery center. This facility, which is under lease until 2008, is
designed to service approximately 40,000 worksite employees when fully staffed.
During 1999, the Company opened its third service center in Atlanta. The
Atlanta service center, which currently services approximately 10% of the
Company's worksite employee base, is located in a 40,000 square foot leased
facility. This facility, which is under lease until 2009, is designed to service
approximately 40,000 worksite employees when fully staffed.
SALES OFFICES
The Company currently has 25 sales offices located in 15 markets throughout
the United States. All sales offices are located in leased facilities, and some
of these facilities are shared by multiple sales offices and/or client service
personnel. Each sales office is typically staffed by six to 10 sales
representatives, a district sales manager and an office administrator. In
addition, the Company has placed certain client service personnel in 13 of its
15 sales markets to provide high-quality, localized service to its clients in
those major markets. The Company expects to continue placing various client
service personnel in its sales markets as a critical mass of clients is attained
in each market.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material pending legal proceedings other
than ordinary routine litigation incidental to its business. The Company
believes that its pending legal proceedings would not have a material adverse
effect on its financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the quarter ended December
31, 1999.
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<PAGE> 19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
PRICE RANGE OF COMMON STOCK
The common stock commenced trading on the New York Stock Exchange following
the Company's initial public offering on January 29, 1997. The Company's trading
symbol is "ASF". As of March 1, 2000, there were approximately 1,955 holders of
the common stock, including holders of record and persons for whom shares were
held in "nominee" or "street name." The following table sets forth the high and
low sale prices for the common stock as reported on the New York Stock Exchange
composite transactional tape. On March 1, 2000, the closing sales price for the
Company's common stock was $40.25.
<TABLE>
<CAPTION>
HIGH LOW
1999
<S> <C> <C>
First Quarter ....................... $ 34.500 $ 12.125
Second Quarter ...................... 17.875 11.125
Third Quarter ....................... 17.313 14.313
Fourth Quarter ...................... 30.750 14.375
1998
First Quarter ....................... $ 49.000 $ 23.938
Second Quarter ...................... 46.250 35.500
Third Quarter ....................... 52.938 22.188
Fourth Quarter ...................... 34.750 21.625
</TABLE>
DIVIDEND POLICY
The Company has not paid cash dividends on its common stock since its
formation and does not anticipate declaring or paying dividends on its common
stock in the foreseeable future. The Company expects that it will retain all
available earnings generated by the Company's operations for the development and
growth of its business. Any future determination as to the payment of dividends
will be made at the discretion of the Board of Directors of the Company and will
depend upon the Company's operating results, financial condition, capital
requirements, general business conditions and such other factors as the Board of
Directors deems relevant.
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<PAGE> 20
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,
--------------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(in thousands, except per share and statistical data)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues .............................. $ 716,210 $ 899,596 $1,213,620 $1,683,063 $2,260,743
Gross profit .......................... 28,873 37,856 51,269 68,610 89,528
Operating income ...................... 2,221 6,477 9,346(2) 11,201 10,559(1)
Net income ............................ 1,116 2,603(3) 7,439(2) 9,123 9,358(1)
Basic net income per share ............ $ 0.11 $ 0.24(3) $ 0.56(2) $ 0.63 $ 0.68(1)
Diluted net income per share .......... $ 0.10 $ 0.24(3) $ 0.53(2) $ 0.62 $ 0.68(1)
BALANCE SHEET DATA:
Working capital ....................... $ 4,737 $ 4,629 $ 46,611 $ 52,475 $ 35,792
Total assets .......................... 39,474 48,376 109,455 142,799 147,698
Total debt ............................ 4,679 4,603 -- -- --
Total stockholders' equity ............ 10,689 13,292 63,763 86,857 80,468
STATISTICAL DATA:
Average number of worksite employees
paid per month during period ....... 19,255 22,234 26,907 34,819 42,479
Gross payroll per employee per month(4) $ 2,331 $ 2,562 $ 2,855 $ 3,083 $ 3,360
Gross profit per worksite
employee per month .................. $ 125 $ 142 $ 159 $ 164 $ 176
Operating income per worksite
employee per month(5) ................. $ 10 $ 24 $ 33 $ 27 $ 24
</TABLE>
- ----------
(1) For the year ended December 31, 1999, operating income, net income and
basic and diluted earnings per share would have been $12.0 million, $9.4
million, $0.69 and $0.68, excluding the impact of two unrelated,
non-recurring items. See Notes 1 and 9 of the Notes to Consolidated
Financial Statements and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(2) For the year ended December 31, 1997, operating income, net income and
basic and diluted net income per share would have been $10.7 million, $8.3
million, $0.62 and $0.59, excluding the impact of a non-recurring item. See
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
(3) For the year ended December 31, 1996, net income and basic and diluted net
income per share would have been $3.8 million, $0.35 and $0.34, excluding
the impact of a non-recurring item. See Note 9 of Notes to Consolidated
Financial Statements and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(4) Excludes bonus payroll of worksite employees not subject to the Company's
normal service fee.
(5) Results for the years ended December 31, 1999 and 1997 have been adjusted
for non-recurring items as noted above.
-19-
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Company's Consolidated Financial Statements
and Notes thereto included elsewhere in this Annual Report. Historical results
are not necessarily indicative of trends in operating results for any future
period.
The statements contained in this Annual Report which are not historical
facts are forward-looking statements that involve a number of risks and
uncertainties. The actual results of the future events described in such
forward-looking statements in this Annual Report could differ materially from
those stated in such forward-looking statements. Among the factors that could
cause actual results to differ materially are the risks and uncertainties
discussed in this Item 7 and the uncertainties set forth from time to time in
the Company's other public reports and filings and public statements.
OVERVIEW
Administaff provides a comprehensive Personnel Management System which
encompasses a broad range of services, including benefits and payroll
administration, health and workers' compensation insurance programs, personnel
records management, employer liability management, employee recruiting and
selection, performance management, and training and development services. The
Company's overall operating results are largely dependent on the number of
worksite employees paid and can be measured in terms of revenues or costs per
worksite employee paid per month. As a result, the Company often uses this unit
of measurement in analyzing and discussing its results of operations.
In addition to the ongoing sales of the Company's principal PEO services
and the servicing of its client base, the Company currently has several
strategic initiatives in progress, which, while supporting the Company's
long-term plans, have increased the level of operating expenses for the
near-term. The Company believes that these initiatives will provide long-term
benefits to the Company, including the ability to maintain steady and
predictable growth, enhanced client retention, new and incremental revenue
streams and increased internal operational efficiencies. The initiatives
include:
o Sales and Service Expansion. The Company is currently executing a long-term
national expansion strategy targeting approximately 90 sales offices
located in 40 markets. The plan calls for continuous expansion with
approximately one new sales office opening each quarter. To support this
expansion, the Company plans to open additional service centers as
warranted by the growth in the number of clients and worksite employees in
different regions of the country. In addition, the Company is expanding its
service capacity by placing service personnel in its sales markets as the
number of clients and worksite employees grows in each market.
As of December 31, 1999, the Company had 25 sales offices located in
15 markets, three service centers, located in Houston, Texas; Dallas, Texas
and Atlanta, Georgia, and 200 service personnel located in 13 markets,
including approximately 150 located in the three service centers.
o Telecommunications and Network Upgrade. The Company has significantly
upgraded and modified its telecommunications and network infrastructure to
allow for enhanced communications among its sales offices, service centers
and corporate offices.
o eBusiness Strategy. The Company is in the process of implementing a
comprehensive eBusiness strategy, which comprises three primary components.
First, the Company is continuing its development of its Internet-based
service delivery platform, Administaff Assistant, which is designed to
provide clients and worksite employees access to human resources information,
transactional data and other components of the Company's PEO services 24
hours-a-day and seven days per week. Second, the Company is developing a
business-to-business eCommerce portal for its client companies. Third, the
Company plans to develop and share content with various community-of-interest
sites targeting small and medium-sized businesses.
-20-
<PAGE> 22
o Software Development. During 1998, the Company began to develop the next
generation of its proprietary PEO information system and other software
development projects associated with this system. Development activities on
these projects continued in 1999, and are expected to continue in 2000.
In addition to the expenses associated with these strategic initiatives,
the Company continues to be affected by the ongoing IRS audit of the Company's
401(k) plan and IRS Employee Leasing Market Segment Study, although certain
aspects of these issues were settled during 1999. For a discussion of these
matters, see "Employee Benefit Plans" beginning on page 12.
Revenues
The Company's revenues are derived from its comprehensive service fees,
which are based upon each employee's gross pay and a mark-up computed as a
percentage of the gross pay. The comprehensive service fees are invoiced along
with each periodic payroll. The Company's revenues are dependent on the number
of clients enrolled, the resulting number of employees paid each period, the
gross payroll of these employees and the number of employees enrolled in benefit
plans.
Direct Costs
The Company's primary direct costs are (i) the salaries and wages of
worksite employees ("payroll cost"), (ii) employment-related taxes ("payroll
taxes"), (iii) employee benefit plan premiums and (iv) workers' compensation
insurance premiums. Payroll costs of worksite employees are affected by the
composition of the worksite employee base, inflationary effects on wage levels
and differences in the local economies of the Company's markets. Changes in
payroll costs generally have a proportionate impact on the Company's revenues.
Payroll taxes consist of the employer's portion of Social Security and
Medicare taxes under FICA, federal unemployment taxes and state unemployment
taxes. Payroll taxes are generally paid as a percentage of payroll. The federal
tax rates are defined by the appropriate federal regulations. State unemployment
tax rates are subject to claims histories and vary from state to state.
Employee benefit costs are comprised primarily of health insurance costs
but also include costs of other employee benefits such as life insurance, vision
care, dental insurance, disability insurance, prescription card, education
assistance, adoption assistance, a dependent care spending account and a
worklife program.
Workers' compensation costs include premiums, administrative costs and
claims-related expenses under the Company's workers' compensation program. Since
November 1994, the Company has been insured under a guaranteed cost program
under which premiums are paid for full insurance coverage of all accident claims
occurring during the policy period.
The Company's gross profit per worksite employee is determined in part by
its ability to accurately estimate and control direct costs and its ability to
incorporate changes in these costs into the comprehensive service fees charged
to clients, which are subject to contractual arrangements. Gross profit,
measured as a percentage of revenue, is also affected by the comprehensive
services fees and direct cost structure; however, due to the large portion of
the Company's revenue being directly related to worksite employee payroll cost,
changes in the level of payroll cost per worksite employee can cause
fluctuations in this statistic which are not necessarily indicative of relative
performance from period to period. As a result, the Company uses gross profit
per worksite employee per month as its principal measurement of the relative
performance at the gross profit level.
Operating Expenses
As a result of the strategic initiatives referred to above, operating
expenses have increased significantly during the last several years. The types
of operating expenses affected by each of the initiatives are as follows:
-21-
<PAGE> 23
o Sales and Service Expansion.
- general and administrative expenses associated with establishing
and maintaining sales offices and service centers;
- compensation expense for additional sales and service staff;
- travel expense associated with maintaining a national sales and
service presence; and
- depreciation expense associated with capitalized costs of
facilities, furniture and equipment and computer hardware and
software.
o Telecommunications and Infrastructure Upgrade.
- compensation expense of additional technology staff;
- consulting expense associated with design and selection of
technology products;
- ongoing maintenance costs of network hardware and software;
- ongoing data and voice transmission service costs; and
- depreciation expense associated with capitalized costs of network
hardware and software.
o eBusiness Initiatives.
- compensation expense of service, technology and support staff for
Administaff Assistant;
- consulting expense associated with the planning and development
of Administaff Assistant, the eCommerce portal and the overall
eBusiness strategy;
- travel, legal and compensation expenses associated with obtaining
alliance partners to participate in the eCommerce portal;
- depreciation and amortization expenses associated with computer
hardware and software used for, and the development costs of,
Administaff Assistant and the eCommerce portal; and
- ongoing maintenance costs of hardware and software associated
with Administaff Assistant and the eCommerce portal.
o Software Development. Capitalized software costs that did not significantly
affect operating results in 1999, but will begin to affect operating
expenses through amortization expense as the new system is placed into
service in 2000.
In addition, the Company has incurred travel and legal expenses associated with
the IRS 401(k) plan audit and the IRS Employee Leasing Market study.
Income Taxes
The Company's provision for income taxes typically differs from the U.S.
statutory rate of 34% due primarily to state income taxes and tax exempt
interest income. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities used for
financial reporting purposes and the amounts used for income tax purposes.
Significant items resulting in deferred income taxes include depreciation and
amortization, software development costs, accrued state income taxes, client
list acquisition costs, and the allowance for uncollectible accounts receivable.
Changes in these items are reflected in the Company's financial statements
through the Company's deferred income tax provision.
-22-
<PAGE> 24
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998.
The following table presents certain information related to the Company's
results of operations for the years ended December 31, 1998 and 1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1998 1999 % change
-------------- -------------- ---------
(in thousands, except per share and statistical data)
<S> <C> <C> <C>
Revenues .............................................. $ 1,683,063 $ 2,260,743 34.3%
Gross profit .......................................... 68,610 89,528 30.5%
Operating expenses .................................... 57,409 78,969 37.6%
Operating income ...................................... 11,201 10,559 (5.7)%
Other income .......................................... 3,417 3,653 6.9%
Net income ............................................ 9,123 9,358 2.6%
Diluted net income per share of common stock .......... 0.62 0.68 9.7%
STATISTICAL DATA:
Average number of worksite employees paid per month ... 34,819 42,479 22.0%
Fee revenue per worksite employee per month ........... $ 3,756 $ 4,084 8.7%
Fee payroll cost per worksite employee per month ...... 3,083 3,360 9.0%
Gross mark-up per worksite employee per month ......... 673 724 7.6%
Gross profit per worksite employee per month .......... 164 176 7.3%
Operating expenses per worksite employee per month .... 137 155 13.1%
Operating income per worksite employee per month ...... 27 21 (22.2)%
Net income per worksite employee per month ............ 22 18 (18.2)%
</TABLE>
REVENUES
The Company's revenues increased 34.3% over 1998 due to a 22.0% increase in
the average number of worksite employees paid per month accompanied by a 8.7%
increase in the fee revenue per worksite employee per month. The Company's
continued expansion of its sales force through new market and sales office
openings was the primary factor contributing to the increase in the average
number of worksite employees paid. Revenues from markets opened prior to 1993
(the commencement of the Company's national expansion plan) increased 14% over
1998, while revenues from markets opened after 1993 increased 63%. Revenues from
the state of Texas represented 61% of the Company's total revenues and Houston,
the Company's original market, represented 36% of the total.
The 8.7% increase in fee revenue per worksite employee per month directly
related to the 9.0% increase in fee payroll cost per worksite employee per
month, reflecting (i) compensation increases within the Company's existing
worksite employee base; (ii) the addition of clients with worksite employees
that had a higher average base pay than the existing client base; (iii) the
attrition of clients with worksite employees that had a lower average base pay
than the existing client base; and (iv) the penetration of markets with
generally higher wage levels, such as San Francisco, New York and Washington,
D.C.
GROSS PROFIT
Gross profit increased 30.5% over 1998 due primarily to the 22.0% increase
in the average number of worksite employees paid per month accompanied by a 7.3%
increase in gross profit per worksite employee per month. Gross profit per
worksite employee increased from $164 per month in 1998 to $176 per month in
1999, reflecting effective execution of the Company's pricing strategy. The
Company's pricing objectives attempt to
-23-
<PAGE> 25
maintain or improve the gross profit per worksite employee by matching or
exceeding changes in its primary direct costs with changes in the gross markup
per worksite employee.
Gross mark-up per worksite employee per month increased 7.6% from $673 in
1998 to $724 in 1999. Approximately 43% of the $51 increase in gross markup per
employee was the result of increased service fees designed to match the
increased payroll tax expense associated with the higher average payroll cost
per worksite employee. The remaining increase in gross markup per employee was
related to other increases in the Company's comprehensive service fees, which
were designed to match or exceed known trends in the Company's primary direct
costs, including approximately $4 per worksite employee related to a change in
the method used to calculate service fees for clients who experience turnover
within their workforce.
Payroll taxes increased $23 per worksite employee per month, primarily due
to the increased average payroll cost per worksite employee. The overall cost of
payroll taxes as a percentage of payroll cost was 7.2% in 1999 versus 7.3% in
1998.
The cost of health insurance and related employee benefits increased $12
per worksite employee per month over 1998 due to a 3.1% increase in the cost per
covered employee and a slight increase in the percentage of worksite employees
covered under the Company's health insurance plans from 66.4% in 1998 to 67.8%
in 1999.
Workers' compensation costs increased $5 per worksite employee per month,
and increased slightly from 1.20% of payroll cost in 1998 to 1.25% in 1999,
primarily due to higher bonus and other year-end compensation of worksite
employees, some of which is subject to workers' compensation insurance premiums.
Gross profit, measured as a percentage of revenue, declined from 4.08% in
1998 to 3.96% in 1999. This decline was due primarily to the increase in average
payroll cost per worksite employee. Because payroll cost is the largest single
component of both revenues and direct costs, an increase in the average payroll
cost per worksite employee creates a mathematical downward pressure on the
calculation of gross profit as a percentage of revenue.
OPERATING EXPENSES
The following table presents certain information related to the Company's
operating expenses for the years ended December 31, 1998 and 1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------------- -------------------------------
1998 1999 % change 1998 1999 % change
------- ------- -------- ------- ------- --------
(in thousands) (per worksite employee per month)
<S> <C> <C> <C> <C> <C> <C>
Salaries, wages and payroll taxes $26,522 $36,690 38.3% $ 63 $ 72 14.3%
General and administrative expenses 17,474 23,219 32.9% 42 45 7.1%
Commissions 5,968 6,429 7.7% 14 13 (7.1)%
Advertising 3,740 4,090 9.4% 9 8 (11.1)%
Depreciation and amortization 3,705 7,103 91.7% 9 14 55.6%
Write-off of software
development costs -- 1,438 100.0% -- 3 100.0%
------- ------- ------ ------- ------- -----
Total operating expenses $57,409 $78,969 37.6% $ 137 $ 155 13.1%
======= ======= ====== ======= ======= =====
</TABLE>
Operating expenses increased 37.6% over 1998 as a result of the 22.0%
growth in the average number of worksite employees paid per month by the
Company, combined with the effects of the previously mentioned strategic
initiatives, all of which comprise investments in the Company's sales, service
and technology infrastructure. Operating expenses per worksite employee
increased 13.1% from $137 in 1998 to $155 in 1999.
Operating expenses in 1999 include a non-recurring $1.4 million ($920,000
net of tax) write-off of certain capitalized software development costs. This
write-off was the result of a periodic evaluation of all software development
projects, which included a review of costs incurred to date, estimated costs to
complete, estimated
-24-
<PAGE> 26
maintenance costs, and the availability of alternative software packages. Upon
completion of this evaluation, the Company determined that the projects would be
terminated and that the costs associated with two projects should be written
off. The majority of the costs written off related to efforts to customize an
electronic document management system to meet the Company's physical records
management needs. Excluding the impact of this charge, operating expenses
increased 35.1% over 1998, and increased from $137 per worksite employee in 1998
to $152 in 1999.
Salaries, wages and payroll taxes of corporate and sales staff increased
from $63 per worksite employee per month in 1998 to $72 in 1999. Approximately
$6 of this increase was the result of a 25.9% increase in corporate and sales
staff, combined with an 8.0% increase in the average salary per employee. The
remaining increase was related to higher payroll tax rates and the adoption of
an employer matching contribution feature in the Company's 401(k) retirement
plan. The 25.9% increase in corporate and sales staff was devoted largely to
supporting the Company's strategic initiatives, including a 23% increase in
sales and sales support staff in the district sales offices, a 23% increase in
service personnel, predominantly located in the Company's service centers and
sales markets, a 90% increase in technology staff, and newly formed departments
devoted to the Company's eBusiness initiatives.
General and administrative expenses increased $3 per worksite employee per
month over 1998. The increase resulted from (i) hardware and software
maintenance fees and communications costs associated with the Company's Internet
development, national technology platform and other technology initiatives; (ii)
higher legal and accounting fees associated with corporate activities such as
the ongoing 401(k) plan audit, corporate entity changes and eBusiness alliance
contract negotiations; and (iii) higher rent expense due to recent openings of
sales offices in St. Louis, San Francisco and New York, and the new Dallas and
Atlanta service centers.
Depreciation and amortization expense increased $5 per worksite employee as
a result of the increased capital expenditures placed in service in 1998 and
1999, including (i) the implementation of a national technology infrastructure;
(ii) the implementation of certain new components of Administaff Assistant,
primarily the web payroll and web reporting capabilities, which include both
internal software developments costs and externally purchased software; (iii)
the opening of new sales offices; (iv) the expansion and relocation of the
Dallas service center and opening of the Atlanta service center; and (v) the
expansion of corporate headquarters.
Commissions expense declined slightly on a per worksite employee per month
basis due to lower sales agency commissions. Advertising costs also declined
slightly per worksite employee, as the Company was able to increase its
advertising coverage while incurring lower rates for much of its radio
advertising. In addition, the Company utilized resources available through its
marketing agreement with American Express to generate leads and appointments for
its sales representatives.
OTHER INCOME
Interest income decreased 23.3% from $3.3 million in 1998 to $2.6 million
in 1999, due to a lower level of cash and marketable securities resulting from
the repurchase of shares of the Company's common stock under the repurchase
program approved by the Company's Board of Directors in January 1999. In
addition, the average interest rate related to interest-bearing investments
declined slightly as the Company shifted a higher portion of its marketable
securities into tax-exempt securities.
During the fourth quarter of 1999, the Company entered into a Closing
Agreement on Final Determination Covering Specific Matters with the Internal
Revenue Service, settling nondiscrimination testing issues involving the
Company's 401(k) plan for certain prior plan years. The actual amount of the
settlement was substantially lower than the original estimate and accrual made
in 1996, resulting in a non-recurring gain of $932,000 ($852,000 net of income
tax effect) in the fourth quarter of 1999. This gain includes the impact of an
adjusted amount recoverable from the Company's former third-party record keeper
pursuant to a 1996 agreement, under which the record keeper agreed to reimburse
the Company for a portion of its settlement of the nondiscrimination testing
issues.
The Company's provision for income taxes, which includes the effects of the
non-recurring gain from settlement of the 401(k) testing issues, differs from
the U.S. statutory rate of 34% in 1999 due primarily to certain
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<PAGE> 27
portions of the final settlement and original accrual 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 and tax-exempt
interest income in both years.
NET INCOME
Net income for 1999 was $9.4 million, or $0.68 per diluted share compared
to $9.1 million, or $0.62 per diluted share in 1998. The 1999 results include
the effects of two unrelated, non-recurring items: (i) a $932,000 gain ($852,000
net of income tax effect) associated with the settlement of nondiscrimination
testing issues related to the ongoing audit of the Company's 401(k) plan for
amounts less than the amount originally accrued for such issues in 1996; and
(ii) a $1.4 million ($920,000 net of income tax effect) write-off of software
development costs incurred on projects which are not expected to be completed.
Excluding the effects of these items, the 1999 net income and diluted earnings
per share were also $9.4 million and $0.68.
-26-
<PAGE> 28
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997.
The following table presents certain information related to the Company's
results of operations for the years ended December 31, 1997 and 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1997 1998 % change
---------- ---------- --------
(in thousands, except per share and statistical data)
<S> <C> <C> <C>
Revenues .............................................. $1,213,620 $1,683,063 38.7%
Gross profit .......................................... 51,269 68,610 33.8%
Operating expenses .................................... 41,923 57,409 36.9%
Operating income ...................................... 9,346 11,201 19.8%
Other income .......................................... 2,562 3,417 33.4%
Net income ............................................ 7,439 9,123 22.6%
Diluted net income per share of common stock .......... 0.53 0.62 17.0%
STATISTICAL DATA:
Average number of worksite employees paid per month ... 26,907 34,819 29.4%
Fee revenue per worksite employee per month ........... $ 3,492 $ 3,756 7.6%
Fee payroll cost per worksite employee per month ...... 2,855 3,083 8.0%
Gross mark-up per worksite employee per month ......... 637 673 5.7%
Gross profit per worksite employee per month .......... 159 164 3.1%
Operating expenses per worksite employee per month .... 130 137 5.4%
Operating income per worksite employee per month ...... 29 27 (6.9)%
Net income per worksite employee per month ............ 23 22 (4.3)%
</TABLE>
REVENUES
The Company's revenues increased 38.7% over 1997 due to a 29.4% increase in
the average number of worksite employees paid per month accompanied by a 7.6%
increase in the fee revenue per worksite employee per month. The Company's
continued expansion of its sales force through new market and sales office
openings was the primary factor contributing to the increase in the average
number of worksite employees paid. Revenues from markets opened prior to 1993
(the commencement of the Company's national expansion plan) increased 27% over
1997, while revenues from markets opened after 1993 increased 59%. Revenues from
the state of Texas represented 72% of the Company's total revenues and Houston,
the Company's original market, represented 43% of the total. Revenues for the
Texas markets as a whole and the Houston market both increased 29% over 1997.
The 7.6% increase in fee revenue per worksite employee per month directly
related to the 8.0% increase in fee payroll cost per worksite employee per
month, reflecting the continuing effects of the net addition of clients with
worksite employees that had a higher average base pay than the existing client
base, primarily through the penetration of markets with generally higher wage
levels, such as Los Angeles, Chicago and Washington, D.C. In addition, wage
inflation within the Company's existing worksite employee base contributed to
the increase in payroll cost per worksite employee. During the fourth quarter of
1998, the Company experienced a reduction in the rate of growth in the average
payroll per worksite employee. For the quarter, the average payroll per worksite
employee increased 5.5% over the same period in 1997 compared to a 9.0% increase
for the nine months ended September 30, 1998.
GROSS PROFIT
Gross profit increased 33.8% over 1997 due primarily to the 29.4% increase
in the average number of worksite employees paid per month accompanied by a 3.1%
increase in gross profit per worksite employee per month. The increase in gross
profit per employee was due to an increase in gross markup per worksite employee
of $36 offset by an increase in benefits and payroll taxes per worksite employee
of $31. The Company's pricing
-27-
<PAGE> 29
objectives attempt to improve the gross profit per worksite employee by matching
or exceeding changes in the overall cost of its primary direct costs with
increases in the gross markup per worksite employee.
Gross mark-up per worksite employee per month increased 5.7% from $637 in
1997 to $673 in 1998. Approximately half of the $36 increase in gross markup per
employee was the result of increases in the Company's comprehensive service
fees, which were designed to match or exceed known trends in the Company's
primary direct costs. The remaining increase in gross markup per employee was
related to increased service fees designed to match the increased payroll tax
expense associated with the higher average payroll cost per worksite employee.
The $31 increase in benefits and payroll taxes per worksite employee per
month was due to higher payroll taxes and health insurance premiums per worksite
employee, partially offset by lower workers' compensation costs per worksite
employee per month.
Payroll taxes increased $22 per worksite employee per month versus 1997.
Approximately $16 of the increase was due to the increased payroll cost per
worksite employee. The remaining increase was due to a net increase in the
weighted average state unemployment tax rate paid by the Company, which
increased the overall cost of payroll taxes as a percentage of payroll cost to
7.3% in 1998 from 7.1% in 1997.
The cost of health insurance and related employee benefits increased $16
per worksite employee per month versus 1997 due to a 4.9% increase in the cost
per covered employee and an increase in the percentage of worksite employees
covered under the Company's health insurance plans. Approximately 66.4% of the
Company's worksite employees were covered by these plans during 1998 versus
64.6% in 1997.
Workers' compensation costs decreased by $9 per worksite employee per
month, and declined from 1.6% of payroll cost in 1997 to 1.2% in 1998, due
primarily to a lower rate on the Company's fixed premium policy. In addition,
the Company received $475,000 of proceeds in 1998 from the settlement of a class
action lawsuit related to premiums paid in a prior year.
Gross profit, measured as a percent of revenue, declined from 4.22% in 1997
to 4.08% in 1998. This decline was due primarily to the increase in average
payroll per worksite employee, which had the corresponding effect of increasing
revenue and applying mathematical pressure on the gross profit margin.
OPERATING EXPENSES
The following table presents certain information related to the Company's
operating expenses for the years ended December 31, 1997 and 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------------ ------------------------------
1997 1998 % change 1997 1998 % change
------- ------- -------- ------- ------- --------
(in thousands) (per worksite employee per month)
<S> <C> <C> <C> <C> <C> <C>
Salaries, wages and payroll taxes $18,562 $26,522 42.9% $ 57 $ 63 10.5%
General and administrative expenses 12,727 17,474 37.3% 39 42 7.7%
Commissions 4,724 5,968 26.3% 15 14 (6.7)%
Advertising 3,784 3,740 (1.2)% 12 9 (25.0)%
Depreciation and amortization 2,126 3,705 74.3% 7 9 28.6%
------- ------- ----- ------- ------- ------
Total operating expenses $41,923 $57,409 36.9% $ 130 $ 137 5.4%
======= ======= ===== ======= ======= ======
</TABLE>
Operating expenses increased 36.9% over 1997, which compared to an increase
in revenue and gross profit of 38.7% and 33.8%, respectively. The overall
increase in operating expenses can be attributed to the 29.4% growth in the
average number of worksite employees paid by the Company and the continuing
investment in infrastructure, technology and service capacity. Operating
expenses per worksite employee per month were $137 in 1998 versus $130 for 1997,
an increase of 5.4%.
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Salaries, wages and payroll taxes of corporate and sales staff increased
from $57 per worksite employee per month in 1997 to $63 in 1998. Approximately
half of this increase relates to a 45% increase in sales office staff, which
includes district sales management, office administrators and sales
representatives. The remainder of the increase is due to a 35% increase in
corporate staff and a 3.6% increase in average payroll per corporate employee.
General and administrative expenses increased $3 per worksite employee per
month over 1997; however, the 1997 results included an unusual bad debt charge.
Excluding the effects of this charge, general and administrative expenses
increased $7 per worksite employee per month over 1997. Approximately $5 of this
increase can be attributed to professional and consulting fees incurred in
relation to ongoing technology projects, higher telecommunications costs, and
the cost of maintenance contracts on new computer hardware and software. The
Company incurred approximately $1.5 million in consulting fees related to
technology initiatives, including its Internet service delivery platform and
improving and enhancing its local area and wide area networks. The remainder of
the increase is related to the opening of four district sales offices and the
new Dallas operations center.
During the second quarter of 1997 the Company recorded a $1.3 million
(approximately $800,000 after tax) bad debt charge for the uncollectibility of
an account receivable from a significant former customer. This charge resulted
from the customer's inability to pay the invoices related to a single payroll
period in April 1997. The Company attempted to collect the amounts due or obtain
a secured position on the amount owed by the customer; however, the Company was
unable to collect the amounts or obtain such a position. In late June 1997, the
customer filed for bankruptcy protection and the Company subsequently learned
that the customer's ability to pay the amounts owed had become severely
impaired. The Company has not collected, and does not expect to collect, any of
the amounts owed by the customer.
Depreciation and amortization expense increased $2 per worksite employee
per month as a result of the increased capital expenditures placed in service in
1997 and 1998.
Commissions expense was slightly lower per worksite employee per month
versus 1997 due to lower sales agency commissions. Advertising costs declined $3
per worksite employee per month as the Company incurred lower rates for much of
its radio advertising and utilized resources available through its marketing
agreement with American Express to generate leads and appointments for its sales
representatives.
NET INCOME
Net interest income increased 29.8% from $2.6 million in 1997 to $3.3
million in 1998, due to the investment of the proceeds from the Company's
initial public offering for the entire year in 1998 and the investment of the
proceeds from the sale of common stock to American Express received in March
1998. The Company incurred no interest expense in 1998, while the 1997 period
included the write-off of deferred financing costs relating to long-term debt
that was repaid using a portion of the proceeds from the IPO.
The Company's provision for income taxes differs from the U.S. statutory
rate of 34% primarily due to state income taxes and tax exempt interest income.
The effective income tax rate for 1998 was consistent with 1997.
Operating income and net income per worksite employee per month were $27
and $22 in 1998, versus $29 and $23 in 1997. The Company's net income and
diluted earnings per share for the year ended December 31, 1998 increased to
$9.1 million and $0.62, versus $7.4 million and $0.53 for the year ended
December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company periodically evaluates its liquidity requirements, capital
needs and availability of resources in view of, among other things, expansion
plans, debt service requirements and other operating cash needs. As a result of
this process, the Company has, in the past, sought and may, in the future, seek
to raise additional capital or take other steps to increase or manage its
liquidity and capital resources. The Company currently believes that its
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cash on hand, marketable securities and cash flows from operations will be
adequate to meet its short-term liquidity requirements. The Company will rely on
these same sources, as well as public and private debt and equity financing, to
meet its long-term liquidity and capital needs.
The Company had $56.2 million in cash and cash equivalents and marketable
securities at December 31, 1999, of which approximately $21.5 million was
payable in early January 2000 for withheld federal and state income taxes,
employment taxes and other payroll deductions. The remainder is available to the
Company for general corporate purposes, including, but not limited to, current
working capital requirements, expenditures related to the continued expansion of
the Company's sales, service and technology infrastructure, capital expenditures
and the Company's stock repurchase program. At December 31, 1999 the Company had
working capital of $35.8 million compared to $52.5 million at December 31, 1998.
The decrease in working capital was due primarily to the use of $16.1 million to
repurchase shares of the Company's common stock, as cash flows from operations
of $17.8 million funded a large portion of the Company's capital expenditures of
$19.0 million, including $5.2 million in capitalized software development costs.
CASH FLOWS FROM OPERATING ACTIVITIES
The Company's cash flows from operating activities in 1999 increased $3.9
million to $17.8 million due to a $3.9 million increase in net income adjusted
for non-cash items from $16.6 million in 1998 to $20.5 million in 1999.
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, including software development costs, totaled $19.0
million in 1999 and $20.4 million in 1998. The level of capital expenditures
incurred in the past two years is significantly higher than the periods prior to
1998 and relates directly to several of the strategic initiatives the Company
currently has underway. For the two-year period, capital expenditures can be
summarized as follows (in millions):
<TABLE>
<S> <C>
Computer hardware and software $ 16.7
Software development costs 7.7
Furniture and fixtures 8.1
Land 2.1
Buildings and improvements 3.9
Vehicles 0.9
-------
Total for 1998 - 1999 $ 39.4
=======
</TABLE>
Capital expenditures for computer hardware and software include the costs
of application software directly related to the ongoing development of
Administaff Assistant, the costs of network and telecommunications
infrastructure required to support the national technology platform, the costs
of desktop workstations for new employees in the corporate offices, sales
offices and service centers and the cost of software for various corporate
needs.
Software developments costs include approximately $0.8 million to develop
the initial release of Administaff Assistant, and approximately $2.0 million on
subsequent enhancements to Administaff Assistant, including the web payroll and
web reporting applications, which have recently been deployed. In addition,
software development costs include approximately $3.1 million for a substantial
upgrade of the Company's proprietary PEO information system, which is expected
to be deployed during the summer of 2000. Software developments costs also
include $1.4 million related to two projects, a records center automation system
and a web content management system. In the fourth quarter of 1999, the Company
determined that these two projects would not be completed, and the costs were
written off.
Capital expenditures for furniture and fixtures, land, building
improvements and vehicles are largely related to equipping and furnishing seven
new sales offices, new service centers in Dallas and Atlanta, and expansion to
accommodate growth in the number of employees at the Company's corporate
offices.
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<PAGE> 32
The Company expects a continued high level of capital expenditures with a
budget of approximately $21 million for 2000, which is primarily composed of
continued software development, hardware and software costs related to
Administaff Assistant, initial development related to the Company's eBusiness
strategy, including the eCommerce portal, and continued expansion of corporate,
sales and service centers to accommodate the ongoing growth of the Company.
Net sales of marketable securities during 1999 primarily represent funds
used to repurchase shares of the Company's common stock. Net purchases of
marketable securities during 1998 primarily reflect the investment of the
proceeds from the Company's Securities Purchase Agreement with American Express
in highly liquid marketable securities with maturities ranging from 91 days to
five years from the date of purchase, consisting primarily of corporate and
government bonds.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities for 1999 primarily include the
repurchase of 1.1 million shares of the Company's stock under the stock
repurchase program approved by the Company's Board of Directors in January 1999
and expanded in May 1999.
Cash flows from financing activities for 1998 consist primarily of items
relating to the sale of units consisting of 693,126 shares of common stock
(293,126 shares from Treasury Stock) and common stock purchase warrants for an
additional 2,065,515 shares to American Express for a total cost of $17.7
million. Other significant cash flows from financing activities during 1998
included the exercise of warrants to purchase 140,508 shares of common stock by
a third party warrant holder at a price of $4.52 per share, the repurchase of
140,508 shares of common stock from the third party warrant holder at a price of
$21 per share, and the repurchase of 150,000 shares of common stock from three
stockholders at a price of $21 per share.
YEAR 2000
As the Company's operations rely on several internal computer systems and
third party vendor relationships, the Company prepared for the Year 2000 issue
under the assumption it could cause potentially significant operational issues
if not properly addressed. The Year 2000 issue generally describes the various
problems which might have resulted from the failure of computer and other
mechanical systems to properly process certain dates and date sensitive
information.
In preparing for the Year 2000 issue, the Company followed a methodology
widely used in various industries to prepare for this event. Those steps
included:
o sanctioning of the preparation efforts by management and the Board of
Directors;
o assessing the potential risks associated with both its proprietary PEO
system and its reliance on several critical third party vendors;
o testing the hardware and software application components of this system in
various scenarios;
o obtaining written information from critical third party vendors on their
state of readiness;
o communicating the status of the Company's preparations to its customers,
employees and shareholders; and
o developing contingency plans including staffing the conversion time period
and alternatives for customers during the period surrounding January 1,
2000.
Through March 1, 2000, the Company has not experienced any adverse effects
from the Year 2000 conversion and does not currently expect that it will
experience any adverse effects. In addition, the Company has not experienced any
adverse effects with any of its third party vendors or customers. While the
Company does not expect that it will experience any adverse effects related to
this issue, it will continue to monitor for Year 2000 specific issues on an
informal basis using existing staff.
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<PAGE> 33
The Company did not incur any significant costs related to preparations for
the Year 2000 issue other than the time of internal personnel required to
adequately prepare for the event, and does not expect to incur any material
costs in the future.
OTHER MATTERS
The Company had net deferred tax liabilities of $4.5 million at December
31, 1999, versus $2.9 million at December 31, 1998. This increase is due
primarily to differences between the book and tax basis of software development
costs, prepaid commissions and depreciation.
SEASONALITY, INFLATION AND QUARTERLY FLUCTUATIONS
Historically, the Company's earnings pattern includes losses in the first
quarter followed by improved profitability in subsequent quarters throughout the
year. This pattern is due to the effects of employment-related taxes which are
based on the individual employees' cumulative earnings up to specified wage
levels, causing employment-related taxes to be highest in the first quarter and
then decline over the course of the year. Since the Company's revenues related
to an individual employee are generally earned and collected at a relatively
constant rate throughout each year, payment of such tax obligations has a
substantial impact on the Company's financial condition and results of
operations during the first six months of each year. Other factors that affect
direct costs could mitigate or enhance this trend.
The Company believes the effects of inflation have not had a significant
impact on its results of operations or financial condition.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND THE MARKET PRICE OF COMMON STOCK
Audit of the Company's 401(k) Plan; IRS Employee Leasing Market Segment
Group
The Company's 401(k) plan is currently under audit by the IRS for the year
ended December 31, 1993. Although the audit is for the 1993 plan year, certain
conclusions of the IRS could be applicable to other years as well. In addition,
the IRS has established an Employee Leasing Market Segment Group for the purpose
of identifying specific compliance issues prevalent in certain segments of the
PEO industry. Approximately 70 PEOs, including the Company, have been randomly
selected by the IRS for audit pursuant to this program. One issue that has
arisen from these audits is whether a PEO can be a co-employer of worksite
employees, including officers and owners of client companies, for various
purposes under the Internal Revenue Code of 1986, as amended (the "Code"),
including participation in the PEO's 401(k) plan. For a discussion of the issues
being considered by the Market Segment Group, see Item 1, "Business - Industry
Regulation". With respect to the 401(k) plan audit, the IRS Houston District has
sought technical advice (the "Technical Advice Request") from the IRS National
Office about 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. A copy of the
Technical Advice Request and the Company's response have been sent to the IRS
National Office for review. The Technical Advice Request contains the
conclusions of the IRS Houston District with respect to the 1993 plan year that
the 401(k) plan should be disqualified because it covers worksite employees who
are not employees of the Company. The Company's response refutes the conclusions
of the IRS Houston District. The Company also understands that, with respect to
the Market Segment Group study, the issue of whether a PEO and a client company
may be treated as co-employers of worksite employees for certain federal tax
purposes (the "Industry Issue") has been referred to the IRS National Office.
The Company does not know whether the National Office will address the
Technical Advice Request independently of the Industry Issue. The Company is not
able to predict either the timing or the nature of any final decision that may
be reached with respect to the 401(k) plan audit or with respect to the
Technical Advice Request or the Market Segment Group study and the ultimate
outcome of such decisions. Should the IRS conclude that the Company is not a
"co-employer" of worksite employees for purposes of the Code, worksite employees
could not
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<PAGE> 34
continue to make salary deferral contributions to the 401(k) plan or pursuant to
the Company's cafeteria plan or continue to participate in certain other
employee benefit plans of the Company. The Company believes that, although
unfavorable to the Company, a prospective application of such a conclusion (that
is, one applicable only to periods after the conclusion by the IRS is finalized)
would not have a material adverse effect on its financial position or results of
operations, as the Company could continue to make available comparable benefit
programs to its client companies at comparable costs to the Company. However, if
the IRS National Office adopts the conclusions of the IRS Houston District set
forth in the Technical Advice Request and any such conclusions were applied
retroactively to disqualify the 401(k) plan for 1993 and subsequent years,
employees' vested account balances under the 401(k) plan would become taxable,
the Company would lose its tax deductions to the extent its matching
contributions were not vested, the 401(k) plan's trust would become a taxable
trust and the Company would be subject to liability with respect to its failure
to withhold applicable taxes with respect to certain contributions and trust
earnings. Further, the Company would be subject to liability, including
penalties, with respect to its cafeteria plan for the failure to withhold and
pay taxes applicable to salary deferral contributions by employees, including
worksite employees. In such a scenario, the Company also would face the risk of
client dissatisfaction and potential litigation. A retroactive application by
the IRS of an adverse conclusion resulting in disqualification of the 401(k)
plan would have a material adverse effect on the Company's financial position
and results of operations.
EXPENSES ASSOCIATED WITH EXPANSION
The Company's past operating results have been affected by the Company's
long-term national sales and service expansion. In many cases, the costs of this
expansion have been incurred in advance of the anticipated growth in worksite
employees (the primary driver of the Company's revenues). The Company expects to
continue to incur substantial additional operating expenses in the foreseeable
future as a result of continuing national expansion. See page 22 for a
discussion of the types of expenses incurred in this expansion.
ESTIMATED COSTS AND EFFECTIVENESS OF CAPITAL PROJECTS AND INVESTMENTS IN
INFRASTRUCTURE
The Company currently has several strategic initiatives in progress, which
have significantly increased the level of capital expenditures and related
depreciation expense incurred over the past several years. The Company has
incurred approximately $39.4 million in capital expenditures in the past two
years, and expects to incur approximately $21 million during 2000. These capital
expenditures have been, and will continue to be, primarily associated with the
expansion and upgrade of the Company's technology and telecommunications
infrastructure, Internet service delivery capabilities, and corporate
headquarters, sales and service facilities. There can be no assurances that the
Company's cost to complete these projects will be as estimated or that the
ultimate effectiveness of such projects will provide the necessary operating
efficiencies required to offset the resulting increases in depreciation and
amortization expense which accompany these expenditures. In addition, the
Company may require additional capital resources to fund these and future
capital expenditure requirements.
ESTIMATED COSTS AND EFFECTIVENESS OF EBUSINESS STRATEGY
The Company is implementing a comprehensive eBusiness strategy, which
includes (i) the continued development of Administaff Assistant, the Company's
Internet-based service delivery platform, with a focus on providing automated,
personalized PEO services to the Company's clients and worksite employees; (ii)
the development of a business-to-business eCommerce portal designed to deliver a
wide variety of value-added products and services to the Company's clients,
worksite employees and their families; and (iii) the development and exchanging
of human resource content with various community-of-interest sites targeted at
small and medium-sized businesses to extend the Company's brand and attract
additional customers to its core PEO service.
While the Company believes that this comprehensive strategy will ultimately
lead to increased profitability through new revenue streams, operating expense
savings and higher client retention, there can be no assurances that losses or
diminished profitability will not be incurred in future periods as a result of
these initiatives.
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<PAGE> 35
Among the factors which could affect the success of the Company's eBusiness
strategy are (i) the Internet connectivity and computer literacy of the
Company's clients; (ii) the willingness of clients to accept an electronic
service delivery platform; (iii) the Company's ability to identify, negotiate
and integrate agreements with strategic partners; (iv) the timely rollout of the
Company's eCommerce portal; (v) the attraction of clients and worksite employees
to the eCommerce portal; (vi) the effective generation of revenues from the
eBusiness initiatives, particularly eCommerce portal; (vii) unanticipated
development costs related to the eBusiness initiatives; and (viii) the Company's
ability to control or reduce operating expenses as a result of the eBusiness
initiatives, particularly the development of Administaff Assistant.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES AND WORKERS'
COMPENSATION RATES
Health insurance premiums, state unemployment taxes and workers'
compensation rates are in part determined by the Company's claims experience and
comprise a significant portion of the Company's direct costs. The Company
employs extensive risk management procedures in an attempt to control its claims
incidence and structures its benefits contracts to provide as much cost
stability as possible. However, should the Company experience a large increase
in claim activity, its unemployment taxes, health insurance premiums or workers'
compensation insurance rates could increase. The Company's ability to
incorporate such increases into service fees to clients is constrained by
contractual arrangements with clients, which could result in a delay before such
increases could be reflected in service fees. As a result, such increases could
have a material adverse effect on the Company's financial condition or results
of operations.
FAILURE TO MANAGE GROWTH
The Company has experienced significant growth and expects such growth to
continue for the foreseeable future. As described under the above caption
"Expenses Associated with Expansion," the costs associated with the Company's
sales and service expansion have been significant. Accordingly, the Company's
expansion plan may place a significant strain on the Company's management,
financial, operating and technical resources. Failure to manage this growth
effectively could have a material adverse effect on the Company's financial
condition or results of operations.
LIABILITY FOR WORKSITE EMPLOYEE PAYROLL AND BENEFITS COSTS
Under the CSA, the Company becomes a co-employer of worksite employees and
assumes the obligations to pay the salaries, wages and related benefit costs and
payroll taxes of such worksite employees. The Company assumes such obligations
as a principal, not merely as an agent of the client company. The Company's
obligations include responsibility for (i) payment of the salaries and wages for
work performed by worksite employees, regardless of whether the client company
makes timely payment to the Company of the associated service fee, and (ii)
providing benefits to worksite employees even if the costs incurred by
Administaff to provide such benefits exceed the fees paid by the client company.
If a client company does not pay the Company or if the costs of benefits
provided to worksite employees exceeds the fees paid by a client company, the
Company's ultimate liability for worksite employee payroll and benefits costs
could have a material adverse effect on its financial condition or results of
operations.
FEDERAL, STATE AND LOCAL REGULATION
As a major employer, the Company's operations are affected by numerous
federal, state and local laws relating to labor, tax and employment matters. By
entering into a co-employer relationship with employees assigned to work at
client company locations, the Company assumes certain obligations and
responsibilities of an employer under these laws. However, many of these laws
(such as the Employee Retirement Income Security Act ("ERISA") and federal and
state employment tax laws) do not specifically address the obligations and
responsibilities of non-traditional employers such as PEOs, and the definition
of "employer" under these laws is not uniform. In addition, many of the states
in which the Company operates have not addressed the PEO relationship for
purposes of compliance with applicable state laws governing the
employer/employee relationship. If these other
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<PAGE> 36
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.
While many states do not explicitly regulate PEOs, 19 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, and in some cases codify and clarify the co-employment
relationship for unemployment, workers' compensation and other purposes under
state law. While the Company generally supports licensing regulation because it
serves to validate the PEO relationship, there can be no assurance that the
Company will be able to satisfy licensing requirements or other applicable
regulations for all states. In addition, there can be no assurance that the
Company will be able to renew its licenses in all states.
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.
NEED TO RENEW OR REPLACE CLIENT COMPANIES
The Company's standard CSA is subject to cancellation on 60 days' notice by
either the Company or the client. Accordingly, the short-term nature of the CSA
makes the Company vulnerable to potential cancellations by existing clients,
which could materially and adversely affect the Company's financial condition
and results of operations. In addition, the Company's results of operations are
dependent in part upon the Company's ability to retain or replace its client
companies upon the termination or cancellation of the Client Service Agreement.
Historically, approximately 20% of the Company's clients have remained clients
for less than one year and there can be no assurance that the number of contract
cancellations will not increase in the future.
MARKETING AGREEMENT WITH AMERICAN EXPRESS
The Company has entered into a Marketing Agreement with American Express to
jointly market the Company's services to American Express' substantial small and
medium-sized business customer base across the country. Under the terms of the
Marketing Agreement, American Express is utilizing its resources to generate
appointments with prospects for the Company's services. In addition, the Company
and American Express are working to jointly develop product offerings that
enhance the current PEO services offered by the Company. The Company believes
that the agreement will enhance its ability to increase its base of worksite
employees and clients; however, there can be no assurances to that effect. Among
the factors that could cause the effectiveness of the Marketing Agreement to be
less than anticipated are the ability of American Express to set qualified
appointments, the Company's ability to make timely presentations to all of the
appointments set by American Express, and the Company's ability to convert those
appointments into sales.
LIABILITIES FOR CLIENT AND EMPLOYEE ACTIONS
A number of legal issues remain unresolved with respect to the
co-employment arrangement between a PEO and its worksite employees, including
questions concerning the ultimate liability for violations of employment and
discrimination laws. The Administaff CSA establishes the contractual division of
responsibilities between the Company and its clients for various personnel
management matters, including compliance with and liability under various
governmental regulations. However, because the Company acts as a co-employer,
the Company may be subject to liability for violations of these or other laws
despite these contractual provisions, even if it does not participate in such
violations. Although the CSA provides that the client is to indemnify the
Company for any liability attributable to the conduct of the client, the Company
may not be able to collect on such a contractual
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<PAGE> 37
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.
GEOGRAPHIC MARKET CONCENTRATION
While the Company has sales offices in 15 markets, 11 of these represent
expansion markets pursuant to the Company's national expansion plan. The
Company's Houston and Texas (including Houston) markets accounted for
approximately 36% and 61%, respectively, of the Company's revenue for the year
ended December 31, 1999. 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 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. Many of these PEOs have limited
operations and fewer than 1,000 worksite employees, but there are several
industry participants which are comparable in size to the Company. The Company
also encounters competition from "fee for service" companies such as payroll
processing firms, insurance companies and human resource consultants. In
addition, several of the Company's PEO competitors have recently been acquired
by large business services companies, such as Automatic Data Processing, Inc.
Such companies have substantially greater resources and provide a broader range
of services than the Company. Accordingly, the PEO divisions of such companies
may be able to provide more services at more competitive prices than may be
offered by the Company. Moreover, the Company expects that as the PEO industry
grows and its regulatory framework becomes better established, well-organized
competition with greater resources than the Company may enter the PEO market,
possibly including large "fee for service" companies currently providing a more
limited range of services.
POTENTIAL CLIENT LIABILITY FOR EMPLOYMENT TAXES
Pursuant to the CSA, the Company assumes sole responsibility and liability
for the payment of federal employment taxes imposed under the Code with respect
to wages and salaries paid to its worksite employees. There are essentially
three types of federal employment tax obligations: (i) income tax withholding
requirements; (ii) obligations under the Federal Income Contribution Act
("FICA"); and (iii) obligations under the Federal Unemployment Tax Act ("FUTA").
Under the Code, employers have the obligation to withhold and remit the employer
portion and, where applicable, the employee portion of these taxes. Most states
impose similar employment tax obligations on the employer. While the CSA
provides that the Company has sole legal responsibility for making these tax
contributions, the IRS or applicable state taxing authority could conclude that
such liability cannot be completely transferred to the Company. Accordingly, in
the event the Company fails to meet its tax withholding and payment obligations,
the client company may be held jointly and severally liable therefor. While this
interpretive issue has not, to the Company's knowledge, discouraged clients from
enrolling with the Company, there can be no assurance that a definitive adverse
resolution of this issue would not do so in the future.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is primarily exposed to market risks from fluctuations in
interest rates and the effects of those fluctuations on the market values of its
cash equivalent short-term investments and its available-for-sale marketable
securities. The cash equivalent short-term investments consist primarily of
overnight investments, which are not significantly exposed to interest rate,
risk, except to the extent that changes in interest rates will ultimately affect
the amount of interest income earned on these investments. The
available-for-sale marketable securities are subject to interest rate risk
because these securities generally include a fixed interest rate. As a result,
the market values of these securities are affected by changes in prevailing
interest rates.
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The Company attempts to limit its exposure to interest rate risk primarily
through diversification and low investment turnover. The Company's marketable
securities are currently managed by three professional investment management
companies, each of whom is guided by the Company's investment policy. The
Company's investment policy is designed to maximize after-tax interest income
while preserving its principal investment. As a result, the Company's marketable
securities consist primarily of short and intermediate-term debt securities.
As of December 31, 1999, the Company's available-for-sale marketable
securities include an investment in a mutual fund, which holds corporate debt
securities with maturities ranging up to 18 months. The amortized cost basis,
fair market value and 30-day yield of this investment was $1,763,000, $1,749,000
and 5.95% at December 31, 1999. The following table presents information about
the Company's remaining available-for-sale marketable securities as of December
31, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
Principal Average
Maturities Interest Rate
------------- -------------
<S> <C> <C>
2000 $ 10,510 5.9%
2001 10,562 6.5%
2002 4,855 5.1%
2003 645 6.0%
2004 600 4.8%
------------ -------
Total $ 27,172 6.0%
============ =======
Fair Market Value $ 28,968
============
</TABLE>
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.
-37-
<PAGE> 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated by reference to the
information set forth under the captions "Proposal Number 1: Election of
Directors - Nominees - Class II Directors (For Terms Expiring at the 2003 Annual
Meeting)," "-Directors Remaining in Office," "-Executive Officers of the
Company" and "-Section 16(a) Beneficial Ownership Reporting Compliance" in 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 is incorporated by reference to the
information set forth under the captions "Proposal Number 1: Election of
Directors - Director Compensation" and "-Executive Compensation" in the
Administaff Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to the
information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Administaff Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to the
information set forth under the caption "Proposal Number 1: Election of
Directors - Certain Relationships and Related Transactions" in the Administaff
Proxy Statement. See also Note 3 to the Consolidated Financial Statements.
-38-
<PAGE> 40
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)).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (No. 33-96952)).
3.3 Certificate of Designations of Series A Junior Participating
Preferred Stock of Administaff, Inc. Dated February 4, 1998
(incorporated by reference to Exhibit 2 to the Registrant's Form
8-A filed on February 4, 1998).
4.1 Specimen Common Stock Certificate (incorporated by reference to
Exhibit 4.1 to the Registrant's Registration Statement on Form
S-1 (No. 33-96952)).
4.2 Rights Agreement dated as of February 4, 1998, between
Administaff, Inc. and Harris Trust and Savings Bank, as Rights
Agent (incorporated by reference to Exhibit 1 to the Registrant's
Form 8-A filed on February 4, 1998).
4.3 Amendment No. 1 to Rights Agreement dated as of March 9, 1998
between Administaff, Inc. and Harris Trust and Savings Bank, as
Rights Agent.
4.4 Amendment No. 2 to Rights Agreement dated as of May 14, 1999
between Administaff, Inc. and Harris Trust and Savings Bank, as
Rights Agent (incorporated by reference to Exhibit 2 to the
Registrant's Form 8-A/A filed on May 19, 1999).
4.5 Amendment No. 3 to Rights Agreement dated as of July 22, 1999
between Administaff, Inc. and Harris Trust and Savings Bank, as
Rights Agent (incorporated by reference to Exhibit 1 to the
Registrant's Form 8-A/A filed on August 9, 1999).
4.6 Amendment No. 4 to Rights Agreement dated as of August 2, 1999
between Administaff, Inc. and Harris Trust and Savings Bank, as
Rights Agent (incorporated by reference to Exhibit 2 to the
Registrant's form 8-A/A filed on August 9, 1999).
4.7 Form of Rights Certificate (incorporated by reference to Exhibit
3 to the Registrant's Form 8-A filed on February 4, 1998).
4.8 Securities Purchase Agreement between Administaff, Inc. and
American Express Travel Related Services Company, Inc., dated
January 27, 1998 and the Letter Agreement between Administaff,
Inc. and American Express Travel Related Services Company, Inc.,
dated March 10, 1998 amending the Securities Purchase Agreement
(incorporated by reference to Exhibit 4.2 to the Registrant's
Form 10-Q for the quarter ended March 31, 1998).
4.9 Registration Rights Agreement between Administaff, Inc. and
American Express Travel Related Services Company, Inc., dated
March 10, 1998 (incorporated by reference to Exhibit 4.3 to the
Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.10 Warrant Agreement between Administaff, Inc. and American Express
Travel Related Services Company, Inc., dated March 10, 1998
(incorporated by reference to Exhibit 4.4 to the Registrant's
Form 10-Q for the quarter ended March 31, 1998).
4.11 Warrant Certificate No. 1, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder of
400,000 warrants to purchase 400,000 shares of
-39-
<PAGE> 41
the common stock of Administaff, Inc. (incorporated by reference
to Exhibit 4.5 to the Registrant's Form 10-Q for the quarter
ended March 31, 1998).
4.12 Warrant Certificate No. 2, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder of
400,000 warrants to purchase 400,000 shares of the common stock
of Administaff, Inc. (incorporated by reference to Exhibit 4.6 to
the Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.13 Warrant Certificate No. 3, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder of
400,000 warrants to purchase 400,000 shares of the common stock
of Administaff, Inc. (incorporated by reference to Exhibit 4.7 to
the Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.14 Warrant Certificate No. 4, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder of
400,000 warrants to purchase 400,000 shares of the common stock
of Administaff, Inc. (incorporated by reference to Exhibit 4.8 to
the Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.15 Warrant Certificate No. 5, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder of
465,515 warrants to purchase 465,515 shares of the common stock
of Administaff, Inc. (incorporated by reference to Exhibit 4.9 to
the Registrant's Form 10-Q filed for the quarter ended March 31,
1998).
10.1 Third Amended and Restated Promissory Note in the amount of
$693,694.75 among Administaff, Inc., Richard G. Rawson, Dawn
Rawson, and RDKB Rawson LP, dated as of March 6, 2000, amending
and restating a Promissory Note dated June 22, 1995.
10.2 Second Amended and Restated Promissory Note in the amount of
$300,000 among Administaff, Inc., Richard G. Rawson, Dawn Rawson,
and RDKB Rawson LP, dated as of July 13, 1998, amending and
restating a Promissory Note dated April 11, 1996 (incorporated by
reference to Exhibit 10.2 to the Registrant's Form 10-K for the
year ended December 31, 1998).
10.3 Second Amended and Restated Security Agreement-Pledge among
Administaff, Inc., Richard G. Rawson, Dawn Rawson, and RDKB
Rawson LP, dated as of July 13, 1998, pursuant to which the
collateral securing the promissory notes included in Exhibits
10.1 and 10.2 is pledged (incorporated by reference to Exhibit
10.3 to the Registrant's form 10-K for the year ended December
31, 1998).
10.4* Administaff, Inc. 1997 Incentive Plan (incorporated by reference
to Exhibit 99.1 to the Registrant's Registration Statement on
Form S-8 (No. 333-85151)).
10.5* First Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.2 to the Registrant's
Registration Statement on Form S-8 (No. 333-85151)).
10.6* Second Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.3 to the Registrant's
Registration Statement on Form S-8 (No. 333-85151)).
10.7* Third Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.4 to the Registrant's
Registration Statement of Form S-8 (No. 333-85151)).
10.8* Fourth Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.5 to the Registrant's
Registration Statement of Form S-8 (No. 333-85151)).
10.9 Administaff, Inc. Nonqualified Stock Option Plan (incorporated by
reference to Exhibit 99.6 to the Registrant's Registration
Statement on Form S-8 (No. 333-85151)).
10.10 Administaff, Inc. 1997 Employee Stock Purchase Plan
(incorporated by reference to Exhibit 99.1 to the Registrant's
form S-8 (No. 333-36363)).
10.11 Marketing Agreement between American Express Travel Related
Services Company, Inc., Administaff, Inc., Administaff Companies,
Inc. and Administaff of Texas, Inc. dated March 10, 1998
(incorporated by reference to Exhibit 10.1 to the Registrant's
Form 10-Q for the quarter ended March 31, 1998).
-40-
<PAGE> 42
10.12 First Amendment to the Marketing Agreement between American
Express Travel Related Services Company, Inc., Administaff,
Inc., Administaff Companies, Inc. and Administaff of Texas,
Inc., dated November 17, 1998 (incorporated by reference to
Exhibit 10.12 to the Registrant's Form 10-K for the year ended
December 31, 1998)).
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
---------------------
* Management contract or compensatory plan or arrangement required
to be filed as an exhibit to this Form 10-K.
(b) Reports on Form 8-K
None.
-41-
<PAGE> 43
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, on March 10, 2000.
ADMINISTAFF, INC.
By: /s/ RICHARD G. RAWSON
-------------------------------------
Richard G. Rawson
Executive Vice President, Chief Financial
Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated on
March 10, 2000:
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/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, Enterprise Project Management
- ---------------------------- (Principal Accounting Officer)
Samuel G. Larson
/s/ LINDA FAYNE LEVINSON Director
- ----------------------------
Linda Fayne Levinson
/s/ PAUL S. LATTANZIO Director
- ----------------------------
Paul S. Lattanzio
/s/ JACK M. FIELDS, JR. Director
- ----------------------------
Jack M. Fields, Jr.
/s/ MICHAEL W. BROWN Director
- ----------------------------
Michael W. Brown
/s/ STEVE ALESIO Director
- ----------------------------
Steve Alesio
</TABLE>
-42-
<PAGE> 44
ADMINISTAFF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors..................................................................................F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999....................................................F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999.............................................................................F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999.............................................................................F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999.............................................................................F-7
Notes to Consolidated Financial Statements......................................................................F-9
</TABLE>
F-1
<PAGE> 45
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Administaff, Inc.
We have audited the accompanying consolidated balance sheets of
Administaff, Inc. as of December 31, 1998 and 1999, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. 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, 1998 and 1999, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.
ERNST & YOUNG LLP
Houston, Texas
February 8, 2000
F-2
<PAGE> 46
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
---------- ----------
Current assets:
<S> <C> <C>
Cash and cash equivalents ............................... $ 23,521 $ 25,451
Marketable securities ................................... 49,670 30,717
Accounts receivable:
Trade ................................................ 4,663 1,578
Unbilled ............................................. 19,719 31,286
Other ................................................ 1,668 1,342
Prepaid expenses ........................................ 2,469 8,332
Income taxes receivable ................................. 1,426 --
---------- ----------
Total current assets ................................. 103,136 98,706
Property and equipment:
Land .................................................... 2,913 2,920
Buildings and improvements .............................. 9,915 11,222
Computer hardware and software .......................... 15,078 22,232
Software development costs .............................. 3,347 7,075
Furniture and fixtures .................................. 10,378 13,886
Vehicles ................................................ 1,308 1,386
---------- ----------
42,939 58,721
Accumulated depreciation ................................ (8,973) (14,347)
---------- ----------
Total property and equipment ......................... 33,966 44,374
Other assets:
Notes receivable from employees ......................... 1,181 994
Other assets ............................................ 4,516 3,624
---------- ----------
Total other assets ................................... 5,697 4,618
---------- ----------
Total assets ......................................... $ 142,799 $ 147,698
========== ==========
</TABLE>
F-3
<PAGE> 47
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1999
---------- ----------
Current liabilities:
<S> <C> <C>
Accounts payable ........................................ $ 2,555 $ 2,787
Payroll taxes and other payroll deductions payable ...... 26,607 21,518
Accrued worksite employee payroll expense ............... 19,161 31,367
Other accrued liabilities ............................... 2,190 5,737
Deferred income taxes ................................... 148 141
Income taxes payable .................................... -- 1,364
---------- ----------
Total current liabilities ......................... 50,661 62,914
Noncurrent liabilities:
Other accrued liabilities ............................... 2,558 --
Deferred income taxes ................................... 2,723 4,316
---------- ----------
Total noncurrent liabilities ...................... 5,281 4,316
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 - 14,860 and 14,909
at December 31, 1998 and 1999, respectively ....... 149 149
Additional paid-in capital .............................. 64,293 65,210
Treasury stock, at cost - 343 and 1,451 shares
at December 31, 1998 and 1999, respectively ....... (1,968) (18,072)
Accumulated other comprehensive income (loss) ........... 342 (218)
Retained earnings ....................................... 24,041 33,399
---------- ----------
Total stockholders' equity ........................ 86,857 80,468
---------- ----------
Total liabilities and stockholders' equity ........ $ 142,799 $ 147,698
========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE> 48
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Revenues ......................................... $ 1,213,620 $ 1,683,063 $ 2,260,743
Direct costs:
Salaries and wages of worksite employees ..... 1,006,092 1,399,126 1,887,231
Benefits and payroll taxes ................... 156,259 215,327 283,984
------------ ------------ ------------
Gross profit ..................................... 51,269 68,610 89,528
Operating expenses:
Salaries, wages and payroll taxes ............ 18,562 26,522 36,690
General and administrative expenses .......... 12,727 17,474 23,219
Commissions .................................. 4,724 5,968 6,429
Advertising .................................. 3,784 3,740 4,090
Depreciation and amortization ................ 2,126 3,705 7,103
Write-off of software development costs ...... -- -- 1,438
------------ ------------ ------------
41,923 57,409 78,969
------------ ------------ ------------
Operating income ................................. 9,346 11,201 10,559
Other income (expense):
Interest income .............................. 2,952 3,341 2,562
Interest expense ............................. (378) -- --
Other, net ................................... (12) 76 1,091
------------ ------------ ------------
2,562 3,417 3,653
------------ ------------ ------------
Income before income tax expense ................. 11,908 14,618 14,212
Income tax expense ............................... 4,469 5,495 4,854
------------ ------------ ------------
Net income ....................................... $ 7,439 $ 9,123 $ 9,358
============ ============ ============
Basic net income per share of common stock ....... $ 0.56 $ 0.63 $ 0.68
============ ============ ============
Diluted net income per share of common stock ..... $ 0.53 $ 0.62 $ 0.68
============ ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE> 49
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
ISSUED PAID-IN TREASURY COMPREHENSIVE RETAINED
SHARES AMOUNT CAPITAL STOCK INCOME (LOSS) EARNINGS TOTAL
-------- -------- ---------- -------- ------------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 10,726 $ 107 $ 5,706 $ -- $ -- $ 7,479 $ 13,292
Issuance of common stock through
initial public offering, net of
offering costs of $ 5,669 3,000 30 45,301 -- -- -- 45,331
Purchase of treasury stock, at cost -- -- -- (1,999) -- -- (1,999)
Repurchase of common stock
purchase warrants -- -- (542) -- -- -- (542)
Exercise of common stock
purchase warrants 474 5 43 -- -- -- 48
Exercise of stock options 21 -- 156 -- -- -- 156
Other -- -- 6 1 -- -- 7
Change in unrealized gain
on marketable securities -- -- -- -- 31 -- 31
Net income -- -- -- -- -- 7,439 7,439
--------
Comprehensive income 7,470
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997 14,221 142 50,670 (1,998) 31 14,918 63,763
Purchase of treasury stock, at cost -- -- -- (6,101) -- -- (6,101)
Sale of units consisting of
common stock and common
stock purchase warrants, net
of issuance costs of $ 146 400 4 11,468 6,116 -- -- 17,588
Exercise of common stock
purchase warrants 141 2 633 -- -- -- 635
Exercise of stock options 98 1 866 -- -- -- 867
Income tax benefit from
exercise of stock options -- -- 575 -- -- -- 575
Other -- -- 81 15 -- -- 96
Change in unrealized gain
on marketable securities -- -- -- -- 311 -- 311
Net income -- -- -- -- -- 9,123 9,123
--------
Comprehensive income 9,434
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1998 14,860 149 64,293 (1,968) 342 24,041 86,857
Purchase of treasury stock, at cost -- -- -- (16,132) -- -- (16,132)
Sale of common stock put warrant -- -- 119 -- -- -- 119
Exercise of stock options 49 -- 644 -- -- -- 644
Income tax benefit from
exercise of stock options -- -- 95 -- -- -- 95
Other -- -- 59 28 -- -- 87
Change in unrealized gain (loss)
on marketable securities -- -- -- -- (560) -- (560)
Net income -- -- -- -- -- 9,358 9,358
--------
Comprehensive income 8,798
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1999 14,909 $ 149 $ 65,210 $(18,072) $ (218) $ 33,399 $ 80,468
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes.
F-6
<PAGE> 50
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .................................................... $ 7,439 $ 9,123 $ 9,358
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization .............................. 2,661 4,239 7,604
Write-off of software development costs .................... -- -- 1,438
Deferred income taxes ...................................... (794) 2,748 1,586
Bad debt expense ........................................... 1,855 575 699
Loss (gain) on disposition of assets ....................... 7 (75) (182)
Changes is operating assets and liabilities:
Accounts receivable ..................................... (5,906) (5,559) (8,855)
Prepaid expenses ........................................ (712) (884) (5,863)
Other assets ............................................ 154 (3,074) 808
Accounts payable ........................................ 827 1,134 232
Payroll taxes and other payroll deductions payable ...... 9,091 7,417 (5,089)
Accrued worksite employee payroll expense ............... 4,768 1,008 12,206
Other accrued liabilities ............................... 657 (1,129) 989
Income taxes payable/receivable ......................... 463 (1,580) 2,885
-------- -------- --------
Total adjustments .................................... 13,071 4,820 8,458
-------- -------- --------
Net cash provided by operating activities ............ 20,510 13,943 17,816
Cash flows from investing activities:
Marketable securities:
Purchases .................................................. (51,784) (49,019) (13,459)
Proceeds from dispositions ................................. 25,647 25,282 31,517
Property and equipment:
Purchases .................................................. (7,147) (17,918) (13,848)
Proceeds from dispositions ................................. 54 86 165
Investment in software development costs ...................... (226) (2,499) (5,166)
-------- -------- --------
Net cash used in investing activities ................ (33,456) (44,068) (791)
</TABLE>
F-7
<PAGE> 51
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Cash flows from financing activities:
Repayments of long-term debt and short-term borrowings ...... $ (4,603) $ -- $ --
Proceeds from the sale of units consisting of
common stock and common stock purchase warrants .......... -- 17,588 --
Proceeds from the issuance of common stock .................. 47,408 -- --
Purchase of treasury stock .................................. (1,999) (6,101) (16,132)
Repurchase of common stock purchase warrants ................ (542) -- --
Prepaid expenses - initial public offering costs ............ (282) -- --
Proceeds from the sale of common stock put warrant .......... -- -- 119
Proceeds from the exercise of common
stock purchase warrants .................................. 48 635 --
Proceeds from the exercise of stock options ................. 156 867 644
Loans to employees .......................................... (46) -- 187
Other ....................................................... 7 96 87
-------- -------- --------
Net cash provided by (used in) financing activities ... 40,147 13,085 (15,095)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ........... 27,201 (17,040) 1,930
Cash and cash equivalents at beginning of year ................. 13,360 40,561 23,521
-------- -------- --------
Cash and cash equivalents at end of year ....................... $ 40,561 $ 23,521 $ 25,451
======== ======== ========
Supplemental disclosures:
Cash paid for interest ...................................... $ 62 $ -- $ --
Cash paid for income taxes .................................. $ 4,800 $ 4,326 $ 383
</TABLE>
See accompanying notes.
F-8
<PAGE> 52
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ACCOUNTING POLICIES
Description of Business
Administaff, Inc. ("the Company") is a professional employer
organization ("PEO") that provides a comprehensive Personnel Management System
which encompasses a broad range of services, including benefits and payroll
administration, medical and workers' compensation insurance programs, personnel
records management, employer liability management, employee recruiting and
selection, performance management, and training and development services to
small and medium-sized businesses in strategically selected markets. During
1997, 1998 and 1999, revenues from the Company's Texas markets represented 77%,
72% and 61% of the Company's total revenues, respectively.
Segment Reporting
Effective January 1, 1998, the Company adopted the Statement of
Financial Accounting Standards ("SFAS") No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 superseded SFAS No. 14,
Financial Reporting for Segments of a Business Enterprise. SFAS No. 131
establishes standards for reporting information about operating segments,
products and services, geographic areas, and major customers. The adoption of
SFAS No. 131 did not affect the Company's results of operations or financial
position. The Company operates in one reportable segment under SFAS No. 131 due
to its centralized structure.
Principles of Consolidation
The consolidated financial statements include the accounts of
Administaff, Inc. and its wholly owned subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include bank deposits and short-term
investments with original maturities of three months or less at the date of
purchase.
Concentrations of Credit Risk
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable. The Company generally
requires clients to pay invoices for service fees 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.
F-9
<PAGE> 53
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Effective April 21, 1999, the Company entered into a one-year Credit
Guaranty Bond agreement (the "Guaranty Bond"), under which an insurance company
has agreed to reimburse the Company for losses incurred related to certain
customer non-payments. The reimbursements are limited to one pay period through
and including the date of the invoice for that period, are applicable only to
clients who have executed an indemnity agreement with the insurance company, and
are subject to a $25,000 deductible per claim. The Company has targeted clients
with large payroll and clients with perceived credit risk for this program. At
December 31, 1999, approximately 70% of the Company's targeted clients have
executed an indemnity agreement under the Guaranty Bond. During 1999, activity
covered under the Guaranty Bond was immaterial to the Company's results of
operations and financial position, and the Company does not expect the Guaranty
Bond to be renewed in April 2000. The Company intends to explore alternative
credit insurance programs, but does not anticipate any material impact on its
results of operations or financial position in the event that the Guaranty Bond
is not replaced.
Marketable Securities
The Company accounts for marketable securities in accordance with SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities. The
Company determines the appropriate classification of all marketable securities
as held-to-maturity, available-for-sale or trading at the time of purchase and
re-evaluates such classification as of each balance sheet date. At December 31,
1999, all of the Company's investments in marketable securities are classified
as available-for-sale, and as a result, are reported at fair value. Unrealized
gains and losses, net of tax, are reported as a component of accumulated other
comprehensive income (loss) in stockholders' equity. The amortized cost of debt
securities is adjusted for amortization of premiums and accretion of discounts
from the date of purchase to maturity. Such amortization is included in interest
income as an addition to or deduction from the coupon interest earned on the
investments. The cost of investments sold is based on the average cost method,
and realized gains and losses are included in other income (expense).
Property and Equipment
Property and equipment is recorded at cost and is depreciated over the
estimated useful lives of the related assets using the straight-line method. The
estimated useful lives of property and equipment for purposes of computing
depreciation are as follows:
<TABLE>
<S> <C>
Buildings and improvements....................................................... 5-30 years
Computer hardware and software................................................... 3-5 years
Software development costs....................................................... 3-5 years
Furniture and fixtures........................................................... 3-10 years
Vehicles......................................................................... 5 years
</TABLE>
Effective January 1, 1998, the Company adopted Statement of Position
("SOP") 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. The requirements of SOP 98-1 are materially
consistent with the Company's previous capitalization policy, and as a result,
the adoption of SOP 98-1 did not have a significant impact on the Company's
financial position or results of operations.
Software development costs relate primarily to the Company's
proprietary professional employer information system and its Internet-based
service delivery platform, Administaff Assistant. The Company periodically
evaluates its capitalized software development costs for impairment in
accordance with SOP 98-1 and SFAS No. 121, Accounting for Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of. During the fourth
quarter of 1999, the Company wrote off $1,438,000 related to two terminated
projects after evaluating the costs incurred to date, expected cost of
completion, expected maintenance costs and the availability of alternative
software packages.
F-10
<PAGE> 54
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PEO Service Fees and Worksite Employee Payroll Costs
The Company's revenues consist of service fees paid by its clients
under its Client Services Agreements. In consideration for payment of such
service fees, the Company agrees to pay the following direct costs associated
with the worksite employees: (i) salaries and wages, (ii) employment related
taxes, (iii) employee benefit plan premiums and (iv) workers' compensation
insurance premiums. The Company accounts for PEO service fees and the related
direct payroll costs using the accrual method. Under the accrual method, PEO
service fees relating to worksite employees with earned but unpaid wages at the
end of each period are recognized as unbilled revenues and the related direct
payroll costs for such wages are accrued as a liability during the period in
which wages are earned by the worksite employee. Subsequent to the end of each
period, such wages are paid and the related PEO service fees are billed.
Unbilled receivables at December 31, 1998 and 1999 are net of prepayments
received prior to year-end of $1,505,000, and $3,338,000 respectively.
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents, accounts receivable and
accounts payable approximate their fair values due to the short-term maturities
of these instruments.
Stock-Based Compensation
The Company accounts for stock-based compensation arrangements with
employees under the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.
Employee Savings Plan
Effective January 1, 1998, the Company adopted SFAS No. 132, Employers'
Disclosures about Pension and Other Postretirement Benefits. This statement
standardizes the disclosure requirements for pension and other postretirement
benefits. The adoption of SFAS No. 132 did not have an effect on the Company's
financial position or results of operations.
Effective January 1, 1999, the Company amended the employer matching
contribution and vesting features of its 401(k) plan. The Company matches 50% of
an eligible worksite employee's contributions and 100% of an eligible corporate
employee's contributions, both up to 6% of the employee's eligible compensation.
In addition, for active employees on or after January 1, 1999, the vesting
schedule for employer matching contributions was changed from five-year graded
vesting to immediate vesting. During 1997, 1998 and 1999, the Company made
employer-matching contributions of $1,674,000, $2,805,000 and $4,646,000,
respectively. Of these contributions, $1,674,000, $2,805,000 and $3,761,000 were
recovered from its client companies through services fees charged to those
clients. The remainder represents employer contributions made on behalf of
corporate employees.
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.
F-11
<PAGE> 55
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
SFAS No. 130 had no impact on the Company's net income or stockholders' equity.
SFAS No. 130 requires unrealized gains and losses on the Company's
available-for-sale marketable securities to be included in other comprehensive
income. Prior to the adoption of SFAS No. 130, these amounts were reported as a
separate component of stockholders' equity. Prior year financial statements have
been reclassified to conform to the requirements of SFAS No. 130.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
1999 presentation.
2. MARKETABLE SECURITIES
As of December 31, 1999, the Company's investments in marketable securities
consist of debt securities with maturities ranging from 91 days to five years
from the date of purchase. Approximately 36% of the marketable securities mature
within one year of the balance sheet date. The following is a summary of the
Company's available-for-sale marketable securities as of December 31, 1999:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Obligations of state and local
government agencies .......................... $ 21,953 $ -- $ (125) $ 21,828
U.S. corporate debt securities ................... 4,487 -- (41) 4,446
U.S. Treasury securities and obligations
of U.S. government agencies .................. 2,732 -- (38) 2,694
Fixed income mutual funds ........................ 1,763 -- (14) 1,749
-------- -------- -------- --------
$ 30,935 $ -- $ (218) $ 30,717
======== ======== ======== ========
</TABLE>
For the years ended December 31, 1998 and 1999, net realized gains on sales of
available-for-sale marketable securities were $72,000 and $92,000, respectively.
3. NOTES RECEIVABLE FROM EMPLOYEES
In June 1995, an officer and director of the Company exercised options
to purchase 448,667 shares of common stock at a price of $ 0.75 per share. The
purchase price was paid in cash by the officer. In connection with the exercise,
the Company entered into a loan agreement with the officer, whereby the Company
paid certain federal income tax withholding requirements related to the stock
option exercise on behalf of the officer in the amount of $694,000. The loan
agreement called for an additional amount to be advanced to the officer in the
event the ultimate tax liability resulting from the exercise exceeded the
statutory withholding requirements. In April 1996, the Company loaned the
officer an additional $300,000 relating to this transaction. The loans are
repayable on June 22, 2002, and April 11, 2001, respectively, accrue interest at
6.83%, and are secured by 48,982 shares of the Company's common stock.
F-12
<PAGE> 56
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,
----------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Software development costs ........................ $ (1,128) $ (2,427)
Depreciation and amortization ..................... (978) (1,193)
Prepaid commissions ............................... (1,265) (1,072)
State income taxes ................................ (100) --
-------- --------
Total deferred tax liabilities ................. (3,471) (4,692)
Deferred tax assets:
Uncollectible accounts receivable ................. 215 57
Other accrued liabilities ......................... 246 --
State income taxes ................................ -- 14
Other ............................................. 139 164
-------- --------
Total deferred tax assets ...................... 600 235
-------- --------
Net deferred tax liabilities ......................... $ (2,871) $ (4,457)
======== ========
Net current deferred tax liabilities ................. $ (148) $ (141)
Net noncurrent deferred tax liabilities .............. (2,723) (4,316)
-------- --------
$ (2,871) $ (4,457)
======== ========
</TABLE>
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current income tax expense:
Federal ........................................... $ 4,628 $ 1,964 $ 2,776
State ............................................. 635 783 492
-------- -------- --------
Total current income tax expense ............... 5,263 2,747 3,268
Deferred income tax expense (benefit):
Federal ........................................... (825) 2,379 1,339
State ............................................. 31 369 247
-------- -------- --------
Total deferred income tax expense (benefit) .... (794) 2,748 1,586
-------- -------- --------
Total income tax expense .......................... $ 4,469 $ 5,495 $ 4,854
======== ======== ========
</TABLE>
In 1998 and 1999, tax benefits of $575,000 and $95,000, respectively,
resulting from deductions relating to disqualifying dispositions of certain
employee incentive stock options were recorded as increases in stockholders'
equity.
F-13
<PAGE> 57
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The reconciliation of income tax expense computed at U. S. federal
statutory tax rates to the reported income tax expense is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Expected income tax expense at 34% ................... $ 4,048 $ 4,970 $ 4,832
State income taxes, net of federal benefit ........... 446 887 488
Nondeductible expenses ............................... 74 91 126
Tax-exempt interest income ........................... (126) (453) (348)
Other, net ........................................... 27 -- (244)
-------- -------- --------
Reported total income tax expense .................... $ 4,469 $ 5,495 $ 4,854
======== ======== ========
</TABLE>
5. STOCKHOLDERS' EQUITY
In January 1999, the Company's Board of Directors (the "Board")
authorized a program to repurchase up to one million shares of the Company's
outstanding common stock. In May 1999, the Board authorized the repurchase of up
to one million additional shares under the repurchase program. The purchases are
to be made from time to time in the open market or directly from stockholders at
prevailing market prices based on market conditions or other factors. As of
December 31, 1999, the Company had repurchased 1,121,000 shares at a total cost
of approximately $16.1 million, including 144,600 shares purchased from
affiliates of Mr. Lang Gerhard, a greater than 10% shareholder, in a private
transaction for approximately $2.3 million.
In January, 1998, the Company entered into a Securities Purchase
Agreement with American Express Travel Related Services Company, Inc. ("American
Express") whereby the Company sold units consisting of 693,126 shares of its
common stock (293,126 shares from Treasury Stock) and warrants to purchase an
additional 2,065,515 shares of common stock to American Express for a total
purchase price of $17.7 million. The warrants have exercise prices ranging from
$40 to $80 per share and terms ranging from three to seven years.
In March 1998, the Company repurchased 150,000 shares of common stock
from three stockholders, two of whom were officers of the Company and one who
was a director of the Company at the time of the purchase, for a total cost of
$3.1 million.
The Company completed an initial public offering in January 1997. The
net proceeds to the Company from the sale of the 3,000,000 shares of common
stock offered by the Company (after deducting underwriting discounts and
commissions of $3.6 million) were $47.4 million. In addition, during the
registration process, the Company incurred $2.1 million in legal, accounting,
printing and other costs, which were offset against the proceeds of the offering
as a component of additional paid-in capital. The Company utilized approximately
$7.1 million of the proceeds as follows: (i) $4.6 million to repay certain
subordinated notes and other secured notes comprising all of the Company's
outstanding indebtedness at the time the offering was completed, (ii)
approximately $2.0 million to exercise its option to repurchase 348,945 shares
of common stock from one of its stockholders, and (iii) approximately $0.5
million to exercise its option to repurchase 173,609 warrants to purchase shares
of common stock from the subordinated note holder.
In 1994, the Company issued warrants to purchase 153,230 shares of
common stock with escalating exercise prices to a third party. In connection
with the Company's initial public offering, 12,722 of such warrants were
exercised at a price of $3.77 per sharing during 1997. During 1998, the
remaining 140,508 warrants were exercised at a price of $4.52 per share and the
Company repurchased these shares from the warrant holder at a price of $21 per
share.
F-14
<PAGE> 58
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. EMPLOYEE INCENTIVE PLAN
The Administaff, Inc. 1997 Incentive Plan, as amended, (the "Incentive
Plan"), provides for options and other stock-based awards which may be granted
to eligible employees and non-employee directors of the Company or its
subsidiaries. An aggregate of 1,482,957 shares of common stock of the Company
are authorized to be issued under the Incentive Plan. At December 31, 1999,
470,077 shares of common stock were available for future grants under the
Incentive Plan. All awards previously granted to employees under the Incentive
Plan have been stock options, primarily intended to qualify as "incentive stock
options" within the meaning of Section 422 of the Internal Revenue Code (the
"Code"). The purpose of the Incentive Plan is to promote the interests of the
Company by encouraging employees of the Company and its subsidiaries and the
non-employee directors of the Company to acquire or increase their equity
interests in the Company and to provide a means whereby such persons may develop
a sense of proprietorship and personal involvement in the development and
financial success of the Company, and to encourage them to remain with and
devote their best efforts to the business of the Company, thereby advancing the
interests of the Company and its stockholders. The Incentive Plan is
administered by the Compensation Committee of the Board of Directors (the
"Committee"). The Committee has the power to determine which eligible employees
will receive awards, the timing and manner of the grant of such awards, the
exercise price of stock options, the number of shares, and all of the terms of
the awards. The Committee has granted limited authority to the President of the
Company regarding the granting of stock options. The Board of Directors may at
any time terminate or amend the Incentive Plan, provided that no such amendment
may adversely affect the rights of optionees with regard to outstanding options.
Stockholder approval of an amendment to the Incentive Plan is necessary only
when required by applicable law or stock exchange rules.
Effective July 27, 1999, the Company adopted the Administaff
Non-Qualified Stock Option Plan (the "Non-Qualified Plan"). The Non-Qualified
Plan provides that options to purchase up to 600,000 shares of the Company's
common stock may be granted in any calendar year to employees who are not
officers. The purpose of the Non-Qualified Plan is similar to that of the
Incentive Plan. The Non-Qualified Plan is administered by the Chief Executive
Officer of the Company (the "CEO"). The CEO 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 (which may not be less than market
value on the grant date), the number of shares, and all of the terms of the
options. The Committee may at any time terminate or amend the Non-Qualified
Plan, provided that no such amendment may adversely affect the rights of
optionees with regard to outstanding options.
The following summarizes stock option activity and related information:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1997 1998 1999
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ------ --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Outstanding - beginning of year 346 $11.36 655 $16.33 720 $21.94
Granted 368 20.22 198 33.58 520 15.76
Exercised (21) 7.38 (98) 8.82 (49) 13.25
Canceled (38) 15.43 (35) 19.68 (69) 20.08
------ ------ ------ ------ ------ ------
Outstanding - end of year 655 $16.33 720 $21.94 1,122 $19.57
====== ====== ====== ====== ====== ======
Exercisable - end of year 176 $10.13 198 $17.12 285 $19.69
====== ====== ====== ====== ====== ======
Weighted average fair value
options granted during year $ 7.99 $17.62 $ 9.34
====== ====== ======
</TABLE>
F-15
<PAGE> 59
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following summarizes information related to stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -------------------------------------
WEIGHTED WEIGHTED
REMAINING AVERAGE REMAINING AVERAGE
LIFE EXERCISE LIFE EXERCISE
RANGE OF EXERCISE PRICES SHARES (YEARS) PRICE SHARES (YEARS) PRICE
- ------------------------ ------ --------- -------- ------ --------- --------
(SHARE AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
$ 6.00 to $15.00 159 6.1 $13.04 136 6.1 $12.92
$15.00 to $20.00 627 8.8 16.29 52 7.3 18.37
$20.00 to $30.00 151 7.7 22.96 60 7.7 22.94
$30.00 to $46.25 182 8.7 33.54 37 8.6 35.24
------ ------ ------ ------ ------ ------
Total 1,122 8.3 $19.57 285 7.1 $19.69
====== ====== ====== ====== ====== ======
</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 share is
required by SFAS No. 123, which also requires that the information be determined
as if the Company had accounted for its employee stock options granted
subsequent to December 31, 1994 under the fair value method prescribed by SFAS
No. 123. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate................................................ 5.6% 5.2% 5.5%
Expected dividend yield................................................ 0.0% 0.0% 0.0%
Expected volatility.................................................... 0.34 0.54 0.65
Weighted average expected life (in years).............................. 5.0 5.0 5.0
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
the Company's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information, as if the Company had accounted for its employee stock
options granted subsequent to December 31, 1994 under the fair value method
prescribed by SFAS No. 123, follows:
F-16
<PAGE> 60
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Pro forma net income (in thousands).................................... $ 6,995 $ 8,070 $ 7,370
Pro forma diluted earnings per share................................... $ 0.50 $ 0.55 $ 0.55
</TABLE>
7. EARNINGS PER SHARE
The numerator used in the calculations of both basic and diluted
earnings per share for all periods presented was net income. The denominator for
each period presented was determined as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1998 1999
------ ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Denominator:
Basic earnings per share - weighted average shares outstanding .... 13,298 14,380 13,731
Effect of dilutive securities:
Common stock purchase warrants - treasury stock method ......... 449 7 --
Common stock options - treasury stock method ................... 175 296 64
------ ------ ------
624 303 64
------ ------ ------
Diluted earnings per share - weighted average shares
outstanding plus effect of dilutive securities ................. 13,922 14,683 13,795
====== ====== ======
</TABLE>
8. OPERATING LEASES
The Company leases various office facilities, furniture and equipment
under operating leases. Most of the leases contain purchase and/or renewal
options at fair market and fair rental value, respectively. Rental expense
relating to all operating leases was $1,130,000, $1,827,000 and $2,915,000 in
1997, 1998 and 1999, respectively. At December 31, 1999, future minimum rental
payments under noncancelable operating leases are as follows (in thousands):
<TABLE>
<S> <C>
2000............................................... $ 3,486
2001............................................... 3,256
2002............................................... 2,969
2003............................................... 2,472
2004 and thereafter................................ 9,287
---------
$ 21,470
=========
</TABLE>
9. COMMITMENTS AND CONTINGENCIES
The Company is a defendant in various lawsuits and claims arising in
the normal course of business. Management believes it has valid defenses in
these cases and is defending them vigorously. While the results of litigation
cannot be predicted with certainty, management believes the final outcome of
such litigation will not have a material adverse effect on the Company's
financial position or results of operations.
The Company's 401(k) plan is currently under audit by the Internal
Revenue Service (the "IRS") for the year ended December 31, 1993. Although the
audit is for the 1993 plan year, certain conclusions of the IRS could be
applicable to other years as well. In addition, the IRS has established an
Employee Leasing Market Segment Group (the "Market Segment Group") for the
purpose of identifying specific compliance issues prevalent in certain
F-17
<PAGE> 61
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
segments of the PEO industry. Approximately 70 PEOs, including the Company, have
been randomly selected by the IRS for audit pursuant to this program. Two
primary issues have arisen from these audits.
The first issue involves the Company's rights under the Internal
Revenue Code (the "Code") as a co-employer of its worksite employees, including
officers and owners of clients companies. In conjunction with the 1993 401(k)
plan year audit, the IRS Houston District has sought technical advice (the
"Technical Advice Request") from the IRS National Office about whether worksite
employee participation in the 401(k) plan violates the exclusive benefit rule
under the Code because they are not employees of the Company. The Technical
Advice Request contains the conclusions of the IRS Houston District that the
401(k) plan should be disqualified because it covers worksite employees who are
not employees of the Company. The Company's response to the Technical Advice
Request refutes the conclusions of the IRS Houston District. With respect to the
Market Segment Group study, the Company understands that the issue of whether a
PEO and a client company may be treated as co-employers for certain federal tax
purposes (the "Industry Issue") has been referred to the IRS National Office.
The Company does not know whether the IRS National Office will address
the Technical Advice Request independently of the Industry Issue. Should the IRS
conclude that the Company is not a "co-employer" of worksite employees for
purposes of the Code, worksite employees could not continue to make salary
deferral contributions to the 401(k) plan or pursuant to the Company's cafeteria
plan or continue to participate in certain other employee benefit plans of the
Company. The Company believes that, although unfavorable to the Company, a
prospective application of such a conclusion (that is, one applicable only to
periods after the conclusion by the IRS is finalized) would not have a material
adverse effect on its financial position or results of operations, as the
Company could continue to make available comparable benefit programs to its
client companies at comparable costs to the Company. However, if the IRS
National Office adopts the conclusions of the IRS Houston District set forth in
the Technical Advice Request and any such conclusions were applied retroactively
to disqualify the 401(k) plan for 1993 and subsequent years, employees' vested
account balances under the 401(k) plan would become taxable, the Company would
lose its tax deductions to the extent its matching contributions were not
vested, the 401(k) plan's trust would become a taxable trust and the Company
would be subject to liability with respect to its failure to 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 would not have a material adverse effect on the
Company's consolidated financial position or results of operations.
The second issue involved nondiscrimination test results for certain
prior plan years. The Technical Advice Request issued during the 1993 401(k)
plan year audit concluded that the plan should be disqualified because the plan
failed to satisfy a nondiscrimination test related to contributions and failed
to provide evidence that it satisfied an alternative nondiscrimination test.
Separately, the Company notified the IRS of operational issues related to
nondiscrimination test results for the 1991 through 1995 plan years. With
respect to the 1995 plan year, the Company caused the 401(k) plan to refund the
required excess contributions and earnings thereon to the affected participants,
and the Company paid the excise tax associated with this correction during 1996.
All remaining nondiscrimination testing issues were settled during 1999, when
the Company and the IRS entered into a Closing Agreement on Final Determination
Covering Specific Matters (the "Closing Agreement"). Under the terms of the
Closing Agreement, the Company agreed to make a contribution to the 401(k) plan
on behalf of certain participants in an aggregate amount of approximately
$831,000. The settlement amount, which was remitted to the 401(k) plan in
January 2000, represented the amount necessary to bring the plan into compliance
with the nondiscrimination tests for all years covered, plus calculated earnings
on such contributions. The Company also agreed to pay a
F-18
<PAGE> 62
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
penalty of $70,000. Further, the IRS agreed and determined that the 401(k) plan
will not be treated as disqualified for the 1992, 1993 and 1994 plan years.
The amount of the settlement was significantly lower than the amount
originally estimated and accrued by the Company in 1996. As a result, the
Company recorded a gain of $952,000 during 1999 as a component of other income.
This gain includes the impact of the Company's adjusted amount recoverable from
its third-party record keeper pursuant to a 1996 agreement, under which the
record keeper agreed to reimburse the Company for a portion of its settlement of
the nondiscrimination testing issues.
10. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year ended December 31, 1997:
<S> <C> <C> <C> <C>
Revenues .................................... $ 262,200 $ 274,792 $ 302,618 $ 374,010
Gross profit ................................ 8,790 11,646 14,028 16,805
Operating income (loss) ..................... (278) 750 3,921 4,953
Net income (loss) ........................... (7) 934 2,923 3,589
Basic net income (loss) per share ........... 0.00 0.07 0.22 0.26
Diluted net income (loss) per share ......... 0.00 0.07 0.21 0.25
Year ended December 31, 1998:
Revenues .................................... $ 362,396 $ 393,643 $ 431,511 $ 495,513
Gross profit ................................ 11,173 16,326 20,037 21,074
Operating income (loss) ..................... (2,048) 2,613 5,252 5,384
Net income (loss) ........................... (742) 2,163 3,786 3,916
Basic net income (loss) per share ........... (0.05) 0.15 0.26 0.27
Diluted net income (loss) per share ......... (0.05) 0.15 0.26 0.27
Year ended December 31, 1999:
Revenues .................................... $ 475,853 $ 505,683 $ 562,812 $ 716,395
Gross profit ................................ 13,555 19,919 26,191 29,863
Operating income (loss) ..................... (4,062) 1,801 6,389 6,431
Net income (loss) ........................... (2,058) 1,515 4,387 5,514
Basic net income (loss) per share ........... (0.14) 0.11 0.32 0.41
Diluted net income (loss) per share ......... (0.14) 0.11 0.32 0.41
</TABLE>
F-19
<PAGE> 63
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
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)).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (No.
33-96952)).
3.3 Certificate of Designations of Series A Junior Participating
Preferred Stock of Administaff, Inc. Dated February 4, 1998
(incorporated by reference to Exhibit 2 to the Registrant's
Form 8-A filed on February 4, 1998).
4.1 Specimen Common Stock Certificate (incorporated by reference
to Exhibit 4.1 to the Registrant's Registration Statement on
Form S-1 (No. 33-96952)).
4.2 Rights Agreement dated as of February 4, 1998, between
Administaff, Inc. and Harris Trust and Savings Bank, as Rights
Agent (incorporated by reference to Exhibit 1 to the
Registrant's Form 8-A filed on February 4, 1998).
4.3 Amendment No. 1 to Rights Agreement dated as of March 9, 1998
between Administaff, Inc. and Harris Trust and Savings Bank,
as Rights Agent.
4.4 Amendment No. 2 to Rights Agreement dated as of May 14, 1999
between Administaff, Inc. and Harris Trust and Savings Bank,
as Rights Agent (incorporated by reference to Exhibit 2 to the
Registrant's Form 8-A/A filed on May 19, 1999).
4.5 Amendment No. 3 to Rights Agreement dated as of July 22, 1999
between Administaff, Inc. and Harris Trust and Savings Bank,
as Rights Agent (incorporated by reference to Exhibit 1 to the
Registrant's Form 8-A/A filed on August 9, 1999).
4.6 Amendment No. 4 to Rights Agreement dated as of August 2, 1999
between Administaff, Inc. and Harris Trust and Savings Bank,
as Rights Agent (incorporated by reference to Exhibit 2 to the
Registrant's form 8-A/A filed on August 9, 1999).
4.7 Form of Rights Certificate (incorporated by reference to
Exhibit 3 to the Registrant's Form 8-A filed on February 4,
1998).
4.8 Securities Purchase Agreement between Administaff, Inc. and
American Express Travel Related Services Company, Inc., dated
January 27, 1998 and the Letter Agreement between Administaff,
Inc. and American Express Travel Related Services Company,
Inc., dated March 10, 1998 amending the Securities Purchase
Agreement (incorporated by reference to Exhibit 4.2 to the
Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.9 Registration Rights Agreement between Administaff, Inc. and
American Express Travel Related Services Company, Inc., dated
March 10, 1998 (incorporated by reference to Exhibit 4.3 to
the Registrant's Form 10-Q for the quarter ended March 31,
1998).
4.10 Warrant Agreement between Administaff, Inc. and American
Express Travel Related Services Company, Inc., dated March 10,
1998 (incorporated by reference to Exhibit 4.4 to the
Registrant's Form 10-Q for the quarter ended March 31, 1998).
4.11 Warrant Certificate No. 1, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder
of 400,000 warrants to purchase 400,000 shares of the common
stock of Administaff, Inc. (incorporated by reference to
Exhibit 4.5 to the Registrant's Form 10-Q for the quarter
ended March 31, 1998).
</TABLE>
<PAGE> 64
<TABLE>
<S> <C>
4.12 Warrant Certificate No. 2, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder
of 400,000 warrants to purchase 400,000 shares of the common
stock of Administaff, Inc. (incorporated by reference to
Exhibit 4.6 to the Registrant's Form 10-Q for the quarter
ended March 31, 1998).
4.13 Warrant Certificate No. 3, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder
of 400,000 warrants to purchase 400,000 shares of the common
stock of Administaff, Inc. (incorporated by reference to
Exhibit 4.7 to the Registrant's Form 10-Q for the quarter
ended March 31, 1998).
4.14 Warrant Certificate No. 4, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder
of 400,000 warrants to purchase 400,000 shares of the common
stock of Administaff, Inc. (incorporated by reference to
Exhibit 4.8 to the Registrant's Form 10-Q for the quarter
ended March 31, 1998).
4.15 Warrant Certificate No. 5, evidencing that American Express
Travel Related Services Company, Inc. is the registered holder
of 465,515 warrants to purchase 465,515 shares of the common
stock of Administaff, Inc. (incorporated by reference to
Exhibit 4.9 to the Registrant's Form 10-Q filed for the
quarter ended March 31, 1998).
10.1 Third Amended and Restated Promissory Note in the amount of
$693,694.75 among Administaff, Inc., Richard G. Rawson, Dawn
Rawson, and RDKB Rawson LP, dated as of March 6, 2000,
amending and restating a Promissory Note dated June 22, 1995.
10.2 Second Amended and Restated Promissory Note in the amount of
$300,000 among Administaff, Inc., Richard G. Rawson, Dawn
Rawson, and RDKB Rawson LP, dated as of July 13, 1998,
amending and restating a Promissory Note dated April 11, 1996
(incorporated by reference to Exhibit 10.2 to the Registrant's
Form 10-K for the year ended December 31, 1998).
10.3 Second Amended and Restated Security Agreement-Pledge among
Administaff, Inc., Richard G. Rawson, Dawn Rawson, and RDKB
Rawson LP, dated as of July 13, 1998, pursuant to which the
collateral securing the promissory notes included in Exhibits
10.1 and 10.2 is pledged (incorporated by reference to Exhibit
10.3 to the Registrant's form 10-K for the year ended December
31, 1998).
10.4* Administaff, Inc. 1997 Incentive Plan (incorporated by
reference to Exhibit 99.1 to the Registrant's Registration
Statement on Form S-8 (No. 333-85151)).
10.5* First Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.2 to the Registrant's
Registration Statement on Form S-8 (No. 333-85151)).
10.6* Second Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.3 to the Registrant's
Registration Statement on Form S-8 (No. 333-85151)).
10.7* Third Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.4 to the Registrant's
Registration Statement of Form S-8 (No. 333-85151)).
10.8* Fourth Amendment to the Administaff, Inc. 1997 Incentive Plan
(incorporated by reference to Exhibit 99.5 to the Registrant's
Registration Statement of Form S-8 (No. 333-85151)).
10.9 Administaff, Inc. Nonqualified Stock Option Plan (incorporated
by reference to Exhibit 99.6 to the Registrant's Registration
Statement on Form S-8 (No. 333-85151)).
10.10 Administaff, Inc. 1997 Employee Stock Purchase Plan
(incorporated by reference to Exhibit 99.1 to the Registrant's
form S-8 (No. 333-36363)).
10.11 Marketing Agreement between American Express Travel Related
Services Company, Inc., Administaff, Inc., Administaff
Companies, Inc. and Administaff of Texas, Inc. dated March 10,
1998 (incorporated by reference to Exhibit 10.1 to the
Registrant's Form 10-Q for the quarter ended March 31, 1998).
10.12 First Amendment to the Marketing Agreement between American
Express Travel Related Services Company, Inc., Administaff,
Inc., Administaff Companies, Inc. and Administaff of Texas,
Inc., dated November 17, 1998 (incorporated by reference to
Exhibit 10.12 to the Registrant's Form 10-K for the year ended
December 31, 1998)).
21.1 Subsidiaries of Administaff, Inc.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
</TABLE>
---------------------
* Management contract or compensatory plan or arrangement required to
be filed as an exhibit to this Form 10-K.
<PAGE> 1
EXHIBIT 4.3
AMENDMENT NO. 1 TO THE RIGHTS AGREEMENT BETWEEN
ADMINISTAFF, INC.
AND
HARRIS TRUST AND SAVINGS BANK, AS RIGHTS AGENT
THIS AMENDMENT NO. 1 ("Amendment No. 1") to the Rights
Agreement, dated as of February 4, 1998 (the "Rights Agreement"), is by and
between Administaff, Inc., a Delaware corporation (the "Company"), and Harris
Trust and Savings Bank, as Rights Agent (the "Rights Agent"). This Amendment
No. 1 is dated as of March 9, 1998. Capitalized terms used herein but not
defined shall have the meanings assigned to such terms in the Rights Agreement.
R E C I T A L S:
WHEREAS, the Company and the Rights Agent have heretofore
executed the Rights Agreement; and
WHEREAS, the Company desires to amend the Rights Agreement to
revise clause (iii) of the definition of "Exempt Person" included in Section
1(p) thereof; and
WHEREAS, in accordance with Section 27 of the Rights
Agreement the Rights Agreement may be amended without the approval of any
holders of Rights;
NOW, THEREFORE, in consideration of the premises and the
mutual agreements herein set forth and in accordance with Section 27 of the
Rights Agreement, the parties hereby agree as follows:
1. Clause (iii) of the definition of "Exempt Person" included
in Section 1(p) of the Rights Agreement is hereby amended, effective
as of the date set forth above, by revising such clause (iii) to read
in its entirety as follows:
"(iii) American Express Travel Related Services
Company ("AXTRSC"), its Affiliates and Associates
(provided that, for purposes of this sub-clause
(iii) only, the terms Affiliate and Associate as
used with respect to AXTRSC shall not include
nonemployee directors of AXTRSC or its affiliates
that are in the investment advisory, discretionary
money management, asset management, brokerage,
insurance, annuity, lending or similar business to
the extent such non-employee directors are acting
for their own account or for the account of, or
investing the funds of, their respective customers
or clients or funds advised or distributed by
<PAGE> 2
them) (collectively, the "AMEX Stockholders"),
provided that the AMEX Stockholders shall cease to
be an Exempt Person if the shares of which the AMEX
Stockholders are the Beneficial Owner exceed 19.9%
of the Common Stock determined on a Fully Diluted
Basis at the time of calculation (the "AMEX
Threshold"); provided, however, that (A) if during
the term of this Agreement the AMEX Stockholders
sell, transfer or otherwise dispose of any shares of
Common Stock of which the AMEX Stockholders are a
Beneficial Owner and after giving effect to (and
solely as a result of) such sale(s), transfer(s) or
disposition(s) the AMEX Stockholders Beneficially
Own less than 15.8% of the Common Stock on a Fully
Diluted Basis, the AMEX Threshold shall be reduced
to that percentage of the Common Stock of which the
AMEX Stockholders are a Beneficial Owner, determined
on a Fully Diluted Basis immediately after giving
effect to such sale, transfer or other disposition
(assuming for purposes of such calculation that
after giving effect to the closing of the
transactions contemplated by the Securities Purchase
Agreement, dated as of January 27, 1998, as amended
("AMEX Investment Agreement"), among the Company,
its subsidiaries and AXTRSC the AMEX Stockholders
were the Beneficial Owner of 19.9% of the Common
Stock determined on a Fully Diluted Basis), and (B)
if the AMEX Threshold is reduced during the term of
this Agreement to 15% or less, then the AMEX
Threshold shall be 15%. As used in clause (iii) of
this definition, the term "Fully Diluted Basis"
means the sum, without duplication, of (i) all
shares of Common Stock then outstanding (as such
term is used in the definition of Beneficial
Ownership in Section 1(d) hereof), (ii) shares of
Common Stock issuable upon the exercise of all
outstanding warrants, options and other rights to
acquire Common Stock, directly or indirectly, and
(iii) Common Stock issuable upon conversion of all
securities convertible, directly or indirectly, into
Common Stock."
2. Except to the extent amended by this Amendment No. 1,
the Rights Agreement shall continue in full force and
effect.
<PAGE> 3
IN WITNESS WHEREOF, the parties hereto have caused this First
Amendment to be duly executed and attested, all as of the day and year first
above written.
ADMINISTAFF, INC.
By: /s/ Paul J. Sarvadi
----------------------------------
Name: Paul J. Sarvadi
Title: President and
Chief Executive Officer
HARRIS TRUST AND SAVINGS BANK,
as Rights Agent
By: /s/ Lorraine Rodewald
----------------------------------
Name: Lorraine Rodewald
Title: Assistant Vice President
<PAGE> 1
EXHIBIT 10.1
THIRD AMENDED AND RESTATED PROMISSORY NOTE (THIS "NOTE")
(SECURED BY SECURITY AGREEMENT)
<TABLE>
<S> <C>
Effective Date: ..................................... June 22, 1995
Makers: ............................................. Richard G. Rawson and wife, Dawn Rawson
2902 Valley Manor Drive
Kingwood, Harris County, Texas 77339; and
RDKB Rawson, L.P., a Texas Family Limited Partnership
2902 Valley Manor Drive
Kingwood, Harris County, Texas 77339
(collectively, the "Makers," and individually, a "Maker")
Payee: .............................................. Administaff, Inc., a Delaware corporation
(sometimes hereinafter referred to as the "Payee")
Place for Payment: .................................. 19001 Crescent Springs Drive
(including county) Kingwood, Montgomery County, Texas or any other place that
Payee may designate in writing
Principal Amount:.................................... Six Hundred Ninety-Three Thousand Six Hundred Ninety-Four
and 75/100 Dollars ($693,694.75)
Annual Interest Rate on
Unpaid Principal from Date: ...................... Six and 83/100 Percent (6.83%)
Annual Interest Rate on
Matured Unpaid Amounts: .......................... Six and 83/100 Percent (6.83%)
</TABLE>
Terms of Payment (principal and interest):
The principal of this Note shall be due and payable in full on June
22, 2002.
Interest shall be due and payable annually as interest accrues,
beginning on June 22, 1996, and continuing regularly and annually
thereafter on the 22nd day of June of each year thereafter until June
22, 2002, when, as stated above, the entire principal balance of this
Page 1 of 5
<PAGE> 2
Note, and all accrued unpaid interest thereon shall be due and payable
in full. Interest installments shall be calculated on the unpaid
principal balance from time to time outstanding hereunder, from the
date following the last interest payment date through the date of
payment.
Security for Payment:
A security interest created and granted in the following Second
Amended and Restated Security Agreement (the "Security Agreement"):
<TABLE>
<S> <C>
Date: ...................................... July 13, 1998
Debtors: ................................... Richard G. Rawson and wife, Dawn Rawson
2902 Valley Manor Drive
Kingwood, Harris County, Texas 77339; and
RDKB Rawson, L.P., a Texas Family Limited Partnership
2902 Valley Manor Drive
Kingwood, Harris County, Texas 77339
Secured Party: ............................. Administaff, Inc.
19001 Crescent Springs Drive
Kingwood, Montgomery County, Texas 77339
(sometimes hereinafter referred to as the "Secured Party")
Collateral Location: ....................... Secretary of Administaff, Inc.
(including County) 19001 Crescent Springs Drive
Kingwood, Montgomery County, Texas 77339
Collateral Description: .................... Stock Certificate Nos. ASF 1855 (48,982 shares), and such
other stock certificates representing shares of common stock
issued by Administaff, Inc., a Delaware corporation, as may
from time to time be held by Secured Party as security for
the indebtedness evidenced hereby and any and all stock
certificate(s) issued in replacement, substitution, or
redemption thereof or as a result of any share split or
reverse share split, together with all proceeds thereof, all
as more fully described in the Security Agreement.
</TABLE>
Page 2 of 5
<PAGE> 3
Each Maker jointly and severally promises to pay to the order of Payee
the principal balance of this Note and accrued interest thereon, at the place
for payment, according to the terms of payment and at the rates stated above.
Makers shall have the right to prepay all or any portion of the outstanding
principal balance of this Note.
If Makers default in the payment of this Note or under any term of the
Security Agreement, or in the performance of any obligation under any other
agreement, instrument or other document executed as security for, or otherwise
in connection with, this Note, whether now existing or hereafter executed
(collectively, the "Other Documents"), and such default continues after the
holder of this Note gives Makers notice of such default and the time within
which it must be cured, as may be required by law or by written agreement, then
the holder of this Note may, at its option, declare the unpaid principal
balance hereof and accrued, unpaid interest thereon immediately due and payable
in full without notice of any kind. Makers and each surety, endorser, and
guarantor waive all demands for payment, presentations for payment, notices of
intention to accelerate maturity, notices of acceleration of maturity,
protests, and notices of protests and all other notices of whatever kind, to
the extent permitted by law.
If any one or more of this Note, the Security Agreement or any of the
Other Documents are given to an attorney for collection or enforcement, or if
suit is brought for collection or enforcement, or if this Note is collected
through probate, bankruptcy, or other judicial proceeding, then Makers shall
pay the holder of this Note all costs of collection and enforcement, including
reasonable attorney's fees and court costs, of not less than 10% of the amount
due under this Note, in addition to other amounts due.
It is the intention of Makers and Payee to comply strictly with all
applicable usury laws. Interest on the debt evidenced by this Note, however
denominated, shall not exceed the maximum amount of nonusurious interest that
may be contracted for, taken, reserved, charged, collected or received under
applicable law; any interest collected or received in excess of such maximum
nonusurious amount shall be deemed a mistake and credited against the unpaid
principal balance hereof then outstanding or, if the principal hereof has been
repaid, refunded to Makers, and the effective interest rate and amount
applicable to this Note shall automatically be reduced to the maximum
nonusurious contract rate and amount of interest allowed for this Note under
applicable law. The foregoing provision shall override all demands and charges,
the effect of all prepayments, and all contrary provisions, if any, in this
Note, the Security Agreement and the Other Documents.
Each Maker is jointly and severally liable for all obligations set
forth by this Note.
It is the express understanding of the Makers and Payee that any
judgment for the repayment of the indebtedness evidenced hereby or interest
thereon will be enforced first against the collateral furnished
Page 3 of 5
<PAGE> 4
pursuant to the Security Agreement (the "Collateral") and, second, only to the
extent that the indebtedness evidenced hereby or any interest thereon is not
satisfied by the Collateral, against Richard G. Rawson and Dawn Rawson, or
either of them personally or any property of Richard G. Rawson and Dawn Rawson
or either of them to the full extent of such deficiency, but not against RDKB
Rawson, L.P. or, except for the Collateral, any of its property, in any action
to collect any amount payable hereunder or to enforce performance of any of the
other provisions of the Security Agreement or any of the Other Documents;
provided, however:
(a) Nothing herein contained shall be construed as limiting
or impairing enforcement against the Collateral or otherwise
prohibiting Payee from exercising any and all remedies which this
Note, the Security Agreement or the Other Documents permit, so long as
the exercise of any remedy shall only extend to execution against or
recovery out of any property of Richard G. Rawson and Dawn Rawson, or
either of them in addition to the Collateral in any action to
foreclose or to collect any amounts payable hereunder at such time as
the Collateral is fully exhausted and then only to the extent any
deficiency was not satisfied by the Collateral;
(b) Makers shall be fully and personally liable, jointly and
severally, for any and all costs, expenses and other sums payable to
third parties (including, without limitation, attorney's fees and
court costs) paid or incurred by Payee to enforce this Note, to
protect or enforce Payee's security interest in the Collateral or
otherwise to enforce the Security Agreement, or to enforce the Other
Documents, together with interest thereon at the rate of ten percent
per annum.
This Note is executed for the sole purpose of extending the maturity
date of that certain Second Amended and Restated Promissory Note (Secured by
Security Agreement), dated as of June 22, 1995, in the original principal
amount of $693,694.75 executed by Richard G. Rawson, wife, Dawn Rawson and RDKB
Rawson L.P., payable to the order of Payee (the "Second Amended Note"), for a
period of two years with a new maturity date of June 22, 2002, on which date
the entire principal balance of this Note and all accrued, unpaid interest
thereon shall be due and payable in full. Makers hereby acknowledge and agree
that the principal amount of $693,694.75, together with accrued, unpaid
interest thereon is fully due and owing under the Second Amended Note, and that
such amounts (both principal and accrued, unpaid interest thereon) are fully
valid and subsisting as of the date of execution hereof and are not subject to
set-off, deduction, defense, or counterclaim of any kind whatsoever.
When the context requires, singular nouns and pronouns include the
plural and vice versa.
Page 4 of 5
<PAGE> 5
EXECUTED the 6th day of March, 2000 to be effective as of June 22,
1995.
/s/ Richard G. Rawson /s/ Dawn Rawson
- -------------------------------- ---------------------------
Richard G. Rawson Dawn Rawson
RDKB RAWSON L.P., a Texas Family Limited Partnership
By: /s/ Richard G. Rawson
----------------------------------------
Richard G. Rawson, General Partner
Page 5 of 5
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF ADMINISTAFF, INC.
- - Administaff of Texas, Inc., a Delaware corporation and wholly owned
subsidiary of Administaff, Inc.
- - Administaff Companies, Inc., a Delaware corporation and wholly owned
subsidiary of Administaff of Texas, Inc.
- - Administaff Partnerships Holding, Inc., a Delaware corporation and
wholly owned subsidiary of Administaff of Texas, Inc.
- - Administaff Enterprises, Inc., a Delaware corporation and wholly owned
subsidiary of Administaff of Texas, Inc.
- - Administaff Services L.P., a Delaware limited partnership, with
Administaff of Texas, Inc. being a 1% general partner and Administaff
Partnerships Holding, Inc. being a 99% limited partner.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8) pertaining to the Administaff, Inc. Nonqualified Stock Option Plan,
Administaff, Inc. 1997 Employee Stock Purchase Plan and the Administaff, Inc.
1997 Incentive Plan of our report dated February 8, 2000, with respect to the
consolidated financial statements of Administaff, Inc. included in the Annual
Report (Form 10-K) for the year ended December 31, 1999.
ERNST & YOUNG LLP
Houston, Texas
March 10, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 25,451
<SECURITIES> 30,717
<RECEIVABLES> 34,800
<ALLOWANCES> (594)
<INVENTORY> 0
<CURRENT-ASSETS> 98,706
<PP&E> 58,721
<DEPRECIATION> (14,347)
<TOTAL-ASSETS> 147,698
<CURRENT-LIABILITIES> 62,914
<BONDS> 0
0
0
<COMMON> 149
<OTHER-SE> 80,319
<TOTAL-LIABILITY-AND-EQUITY> 80,468
<SALES> 2,260,743
<TOTAL-REVENUES> 2,260,743
<CGS> 2,171,215
<TOTAL-COSTS> 2,171,215
<OTHER-EXPENSES> 75,316
<LOSS-PROVISION> 699
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 14,212
<INCOME-TAX> 4,854
<INCOME-CONTINUING> 9,358
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,358
<EPS-BASIC> 0.68
<EPS-DILUTED> 0.68
</TABLE>
