2 0 0 1 A N N U A L R E P O RT Have you heard the news? FINANCIAL HIGHLIGHTS (in thousands, except per share amounts and statistical data) INCOME STATEMENT DATA: Revenues Gross profit Operating income Net income Basic net income per share Diluted net income per share BALANCE SHEET DATA: Working capital Total assets Total debt Total shareholders’ equity STATISTICAL DATA: Average worksite employees paid per month during period Fee payroll cost per worksite employee per month 2001 2000 1999 $ 4,373,244 165,015* 18,539* 10,357* 0.38* 0.36* 36,609 274,003 13,500 122,935 69,480 4,020 $ $ $ $ $ $ $ $ $ 3,708,531 138,534 22,234 16,900 0.62 0.58 51,179 242,817 – 105,510 62,140 3,830 $ $ $ $ $ 2,260,743 89,528 10,559 9,358 0.34 0.34 35,792 147,698 – 80,468 42,479 3,360 % change from 2000 17.9 % 19.1 % (16.6)% (38.7)% (38.7)% (37.9)% (28.5)% 12.8 % N/A 16.5 % 11.8 % 5.0 % * For the year ended December 31, 2001, gross profit, operating income, net income, and basic and diluted earnings per share would have been $171.2 million, $24.7 million, $17.7 million, $0.64 and $0.62, excluding the impact of non-recurring items, including disputed health insurance rate increases by Aetna totaling $12.7 million, a credit received on the Company’s workers’ compensation policy of $6.6 million and the write-off of the Company’s $3.8 million investment in Virtual Growth, Inc. This Annual Report includes forward-looking statements within the meaning of the federal securities laws. You can identify such forward-looking statements by the words “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” “likely,” “goal,” “assume” and similar expressions. For information concerning important factors that could cause actual results to differ materially from those in such statements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 20. COMPANY PROFILE Administaff (NYSE: ASF) is the nation’s leading Professional Employer Organization (PEO), serving as an outsourced human resources department for small and medium-sized businesses throughout the United States. Administaff’s revenues in 2001 totaled $4.4 billion. At year-end 2001, the Company had more than 4,400 client companies, 70,000 worksite employees and 1,200 corporate employees; it also had three client service centers and 36 sales offices in 19 major markets. Administaff’s common stock is listed on the New York Stock Exchange. Headquartered in Houston, Texas, the Company is accredited by the Employer Services Assurance Corporation and is an active member of the National Association of Professional Employer Organizations. Administaff ranks number 448 on the Fortune 500 list. The Company also is included on Fortune’s list of America’s Most Admired Companies, the Forbes Platinum 400 list of the Best Big Companies in America, and the InformationWeek 500 list of leading information technology innovators. CONTENTS 3 Highlights, Mission Statement 4 Letter to Shareholders 7 Personnel Management System 10 Employer of Choice 14 Work-Life Balance 16 Glossary 17 Financial Review 60 Officers, Corporate Information Inside Back Cover Board of Directors 2001 ANNUAL REPORT | 1 The real news behind Administaff’s success is its ability to balance growth and profitability, along with a strong commitment to help client companies become employers of choice. HAVE YO U H EA RD ? ADMINISTAFF ADDED TO FORTUNE 500 LIST HOUSTON - April 3, 2001 - Administaff, Inc. (NYSE: ASF) announced today it has been added to the Fortune 500 list of America’s largest corporations. The Company is now ranked number 448, moving up from a Fortune 1000 ranking of 615 the previous year. Administaff also is listed among the top five companies in the Diversified Outsourcing Services sector. 2 | ADMINISTAFF “Administaff’s 2001 results demonstrate our ability to execute our long-term growth plan while operating profitably through a difficult period.” Paul J. Sarvadi – President and Chief Executive Officer 2001 Highlights 2001 ANNUAL REPORT | 3 O U R M I S S I ON | The mission of Administaff is to be the recognized leader in the development, sale and delivery of quality Professional Employer Organization services to our strategically selected market comprised of small and medium–sized businesses. This mission will be accomplished by a highly motivated team of innovative people dedicated to finding, attracting and satisfying clients in a manner that will produce consistent and superior productivity among clients, employees and the Company. 4 | ADMINISTAFF 90-office, 40-market national expansion program. Because of these efforts, our average number of work- site employees paid per month rose nearly 12 percent over the prior year. We believe that our increased sales capacity is a leading indicator of our future growth, and our highly successful year-end sales efforts clearly demonstrated that potential. Before September 11, we had set an aggressive goal to sell new accounts representing 16,000 worksite employees during our Fall Campaign. We exceeded that goal, achieving 106 percent of our sales target. In December alone, we sold new accounts representing more than 6,000 worksite employees – without giving way on pricing, and despite the strug- gling economy and the temporary disruption caused by our change in health insurance carriers. We also continued to expand and make major refinements to our service offering. A number of serv- ice enhancements launched in 2001 are boosting client satisfaction while simultaneously creating opportuni- ties for operating leverage. In April, we launched WebPayroll,SM an Internet- based system that reduces the need for data entry personnel and significantly lowers the amount of time required for our payroll specialists to perform transactional activities. By the end of the year, 51 per- cent of our clients were already using the system to input the payroll data for more than 55 percent of our worksite employees. FELLOW SHAREHOLDERS: Two thousand and one was a year of continuing achievement despite tough tests for our Company. In a recessionary economy still rife with uncertainty, Admin- istaff emerged from 2001 a stronger enterprise than it was at the beginning of the year. We grew our revenues, expanded our sales and service capacity, held the line on operating expenses and stayed the course of our long-term plan. We are pleased with our results and are poised for greater strength in the year that is unfolding. Our financial performance reflects those facts. Revenues reached $4.4 billion, an 18 percent increase over 2000. Total gross profit was $165 million, a 19 per- cent increase. Average monthly gross profit per work- site employee was $198, a 6 percent increase. Net income was $10.4 million, or $0.36 per diluted share. Excluding non-recurring charges, pro forma diluted earnings per share were $0.62 for the year. In addition, we took steps to enhance shareholder value by repur- chasing 900,000 shares of Administaff common stock at a total cost of $21.6 million. Clearly, these accomplishments took place in a year of challenge. Layoffs generally exceeded new hires among our client companies and financially-related client terminations increased. In the face of those obstacles, I cannot overemphasize the importance of our success in continuing to produce unit growth. While much of the nation’s business community was contracting, we were expanding. We proved that an effective ramp-up of sales capacity, coupled with a powerful marketing message, could produce growth without compromising pricing even in the toughest of times. During the year, we increased our number of trained sales consultants by 30 percent. By year’s end, we had 36 offices in 19 markets, which approaches the halfway point in our HAVE YO U H EA RD ? ADMINISTAFF NAMED ONE OF AMERICA’S MOST ADMIRED COMPANIES HOUSTON - February 19, 2001 - Administaff, Inc. (NYSE: ASF) is listed as one of America’s Most Admired Companies by Fortune magazine for the third consecutive year. The Company ranked among the top four businesses in the Outsourcing Services Category. The rankings were based on eight criteria, including financial soundness, quality of products and services, long–term investment value, quality of management, employee talent, social responsibility, innovativeness and the use of corporate assets. Letter to Shareholders 2001 ANNUAL REPORT | 5 2000 62,140 1999 42,479 2001 69,480 2001 $4,373 2000 $3,709 1999 $2,261 2000 $0.58 1999 $0.34 2001 $0.62 (pro forma) 2001 $0.36 (as reported) Average Number of Worksite Employees Paid Per Month Revenues (in millions) Diluted Net Income Per Share Also in April, we offered our larger clients a new service that is designed to enhance their shareholders’ return. This tool – the Watson Wyatt Human Capital Index – helps companies gauge how well they perform various HR practices,including areas such as recruiting excellence, clear rewards and accountability, and a mutually respectful workplace. By completing a simple but comprehensive survey, client companies can learn how they compare to other companies and what steps they can take to improve their HR performance in areas that can positively impact their market value. In September, we expanded our eService platform with the launch of the Employee Service Center.SM This interactive Web site consolidates and expands what we previously delivered through Administaff Assistant® and bizzportSM into a co-brandable, fully customizable site for each client and employee. Now, every Admin- istaff client has immediate access to the kind of employee service center that many large companies spend hundreds of thousands, if not millions, of dollars developing and operating. We believe this helps further distinguish our clients as employers of choice. Along with the launch of the Employee Service Cen- ter, we introduced online enrollment for new employees at client companies. This capability streamlines new employee orientation and benefits enrollment, and makes the entire process simpler, faster and less costly. At the same time, we expanded our eUniversity online course offerings to include introductory, intermediate and advanced training in a variety of Microsoft appli- cations, including Word, Excel, Outlook, FrontPage, PowerPoint and Projects. One of the biggest challenges and most significant accomplishments of 2001 was the transitioning of our health insurance carriers. In November, we took steps to replace Aetna U.S. Healthcare with a new network of carriers, effective January 1, 2002. This network includes an array of best-of-class providers, including United- Healthcare, which serves as our anchor carrier, along with PacifiCare, Kaiser Permanente and Blue Cross/Blue Shield of Georgia. Importantly, the network makes Administaff and our client companies less dependent on any one carrier. It also improves our health care service and coverage options, and gives us greater flexibility to meet client and worksite employee needs. On balance,2001 was a year of solid achievement for Administaff, producing several important accolades: • In February, Administaff was named one of Amer- ica’s Most Admired Companies by Fortune magazine for the third consecutive year. The Company ranked among the top four businesses in the Outsourcing Services category. HAVE YO U H EA RD ? ADMINISTAFF RECOGNIZED AS AN EMPLOYER OF CHOICE HOUSTON - October 19, 2001 - Administaff, Inc. (NYSE: ASF) has been named by the Houston Business Journal as one of the city’s Best Places to Work, ranking fourth in the large company category. Earlier in the year, Administaff was named to the 2001 Employers of Choice 500 list, a national ranking conducted by Employment Review and BestJobsUSA.com. 6 | ADMINISTAFF In assessing our prospects for 2002 and beyond, I see extraordinary market opportunities, and I am con- fident that the challenges and accomplishments of 2001 will play a key role in our future success. Our proven business model will continue to allow us to grow and add value to the enterprise for the benefit of all stakeholders. I would like to close these remarks with three important acknowledgements. The first is to our employees. In an internal survey, 86 percent of our corporate employees said they viewed their position with the Company as a calling and impor- tant to the Company; an opportunity to do what they do best. This high-level commitment is reflected in the hard work they perform as a dedicated team to get the job done every day. The second is to the members of our manage- ment team. Their strong leadership skills contributed greatly to our continuing progress despite the chal- lenges of 2001. The third is to the members of our Board of Direc- tors. Their expert guidance and unwavering support continue to be tremendous assets as we drive our business forward. Sincerely, Paul J. Sarvadi President and Chief Executive Officer March 8, 2002 • In April, we were listed on the Fortune 500 list of America’s largest companies. Administaff is now ranked number 448, up from 615 on the Fortune 1000. The Company also is listed among the top five companies in the Diversified Outsourcing Services sector and was among the top 20 companies in all three categories used to benchmark the “most bang for the buck.” Those categories included revenues per dollar of assets, revenues per dollar of equity and revenues per employee. • In January 2002, Administaff was named to the Forbes magazine Platinum 400 list of the Best Big Companies in America. As part of this ranking, we were recognized for posting the highest five-year average earnings-per-share growth rate (55.9 percent) in the Business Services category. Together, these important milestones represent a great way to celebrate 15 years in business and five years as a public company. As we move into 2002, we have a high level of confidence in our business model and are cautiously optimistic about the economy. With an expanded sales force and the momentum of our record-setting fall selling season, we expect con- tinued revenue growth through increased unit volume. Our target small business prospects are facing the like- lihood of profit pressure and ballooning costs for health care, unemployment and workers’ compensation insurance. We expect that our proven ability to manage those costs will be more attractive than ever. In addition, we will continue to enhance the quality and scope of our service offering for the benefit of both clients and worksite employees. These efforts will support our goal of helping our client companies strengthen their role as employers of choice. We are proud that Administaff has been recognized both locally and nationally as a great place to work, and we are dedicated to helping our client companies achieve that same distinction. HAVE YO U H EA RD ? ADMINISTAFF NAMED ONE OF BEST BIG COMPANIES BY FORBES HOUSTON - January 7, 2002 - Administaff, Inc. (NYSE: ASF) is included for the third time on the annual Forbes Platinum 400 list of the Best Big Companies in America. In addition, Forbes has recognized Administaff for posting the highest five–year average earnings–per–share growth rate (55.9 percent) in the Business Services category. 2001 ANNUAL REPORT | 7 Personnel Management System Administaff’s eight-point Personnel Management Systemsm includes a comprehensive range of human resources services that enables business owners to be more systematic and strategic about the role that people play in the success of a company. With Administaff managing the “business of employment,” growth-minded business owners and employees are free to focus on the “business of business.” RECRUITING & SELECTION Find and hire the highest- quality employees possible. • Job Descriptions • Resume Review & Interviewing • Salary Planning & Administration • Classified Advertising • Background Checks • Pre-employment Testing • Profiling • Drug Testing • Outplacement PERFORMANCE MANAGEMENT Increase employee productiv- ity by improving individual and group performance. • Performance Measurement & Review • Compensation & Incentive Plans • Employee Relations • Supervisor Training • Dispute Resolution • Job Design TRAINING & DEVELOPMENT Become more productive and profitable with a professional development program for employees. • Needs Analysis to Identify Areas for Performance Improvement • Curriculum Development for Professional & Personal Growth • Customization & Delivery of Training Programs • Certified Provider of Continuing Education Units BENEFITS MANAGEMENT Gain the best benefits value in the marketplace for cost sta- bility and employee retention. • Health Care, Dental & Vision Plans • Employee Assistance & Work-Life Programs • 401(k) Plan • Disability Plan • Basic & Voluntary Life Insurance • Basic & Voluntary Personal Accident Insurance • Adoption Assistance • Credit Union • Educational Assistance • Dependent Care Spending Account GOVERNMENT COMPLIANCE Keep pace with changing government regulations to reduce or eliminate fines and penalties. • Government Reporting & Agency Interface • Unemployment Claims Management • Employment Records Management • Wage Claims & Audits • OSHA, EEOC, DOL, ADA, FMLA, ADEA, Title VII, COBRA, HIPAA & Other Government Regulations EMPLOYMENT ADMINISTRATION Reduce the burden of employee-related paperwork by sharing it with Administaff. • Payroll Processing • Payroll Tax Filing • FICA, FUTA, SUTA • Insurance Procurement • Garnishments • Quarterly Reports • Human Resources Management Reports • Direct Deposit • W-2s & W-4s • Employment Verification EMPLOYER LIABILITY MANAGEMENT Manage employer obligations more effectively with lower risk and reduced liability. • Workers’ Compensation Coverage & Claims Resolution • Employment Practices Liability Insurance • Safety Review & Policy Development • Unemployment Claims Management • Conflict Resolution • Employee Handbooks • Personnel Guide, Forms & Policies • Terminations Support OWNER SUPPORT Achieve a more secure future through forward- focused resources that help create value. • Personnel Consulting • Employee Communications • Employee Service CenterSM Through our alliance with American Express Financial Advisors: • Financial Education & Planning Services • Executive Benefits • Business Continuation Planning • Key Person Insurance Coverage • Tax & Business Services 8 | ADMINISTAFF HAVE YO U H EA RD ? ADMINISTAFF CLIENT ENERVEST WINS BEST PLACE TO WORK AWARD HOUSTON - October 19, 2001 - Administaff, Inc. (NYSE: ASF) announced today that one of its client companies, EnerVest Management Partners, Ltd., has been recognized by the Houston Business Journal as one of the city’s Best Places to Work, ranking first in the small business category. In receiving this award, EnerVest President and Chief Executive Officer John B. Walker credited Administaff with helping his company become an employer of choice. Employer of Choice 2001 ANNUAL REPORT | 9 “Outsourcing our human resources functions to Administaff frees us from having to support a large corporate infrastructure. For a small or medium-sized company, it makes all the sense in the world.” John B. Walker – President and Chief Executive Officer EnerVest Management Partners, Ltd. 10 | ADMINISTAFF Client Case Study ADMINISTAFF SERVICES HELP ENERVEST BECOME AN EMPLOYER OF CHOICE John Walker understands how vital people are to the success of a company. Since founding EnerVest Management Partners, Ltd. in 1992, Walker and his management team have placed a high priority on bringing employees together to accomplish the com- pany’s goals. Indicative of their success, EnerVest was recognized in 2001 by the Houston Business Journal as one of the city’s Best Places to Work, ranking first in the small business category. EnerVest acquires, operates and sells oil and gas properties throughout the country on behalf of large institutional investors. Based in Houston, Texas, the company entered into a co-employment relationship with Administaff in January 2000. As President and Chief Executive Officer of EnerVest, Walker credits Administaff ’s human resources services with helping his company become an employer of choice. For example, Administaff’s ability to provide Fortune 500-level benefits plans means EnerVest is in a better position to compete with major corporations for top talent. “In this industry, we’re dependent upon highly experienced technical people. Administaff gives us access to a comprehensive and affordable benefits pack- age,” Walker said. “As a result, EnerVest has been able to attract highly trained employees from some very large companies.” Selena Stuchly, Manager of Human Resources for EnerVest, agrees: “Employees who are drawn to EnerVest by our creative, small-company environment are pleased to know they have access to a big-company benefits package.” EnerVest and other employers of choice invest in their employees because they understand the long- term advantages of a people-oriented business strat- egy. Cultivating a workplace where employees can learn, develop and be challenged gives companies a competitive edge. “The value-added training and development pro- grams Administaff offers are vitally important to our employees and our company,” Walker said. “When we talk with the people in our field offices across the country, we are able to discuss much more than basic benefits – the education and training services are a real plus for them.” Employees who are engaged, focused and ener- gized contribute directly to a company’s profitability and shareholder return. Employers of choice also enjoy dividends such as employee loyalty, reduced turnover, continuation of company knowledge and improved customer service. That’s why being an employer of choice is now recognized as a smart business strategy. What does such a strategy involve? In addition to providing a quality work environment supported by leading-edge human resources practices, employers of choice take time to communicate with employees about their business goals and core values. HAVE YO U H EA RD ? ADMINISTAFF INTRODUCES NEW ONLINE PAYROLL APPLICATION HOUSTON - April 23, 2001 - Administaff, Inc. (NYSE: ASF) today announced the rollout of WebPayroll,SM a unique payroll processing system that allows client companies to input, submit and approve payroll information via the Web 24/7. This secure application increases confidentiality and enhances control of the payroll process. In addition, it benefits both Administaff and its client companies through improved efficiencies and opportunities for long–term operating leverage. Employer of Choice 2001 ANNUAL REPORT | 11 “Open communication between the management team and employees is a key component of EnerVest’s corporate culture,” Walker said. “We try to help our employees understand the EnerVest vision and how what they’re doing fits in with the needs of our institution.” Walker found that becoming a co-employer with Administaff provided him with significant relief from day-to-day administrative distractions, giving him more time to maintain open communication and focus on the company’s core business. “By outsourcing to Administaff, I now have the ability to make true economic decisions and execute them properly, with “From a human resources standpoint, we believe we’re doing things prop- erly as a result of our relationship with Administaff. That’s a nice assur- ance for me and the whole company.” John B. Walker – President and Chief Executive Officer EnerVest Management Partners, Ltd. the appropriate resources and professional human landscape,” she explained. “Administaff’s specialists resources support,” he said. track changes and keep us continually updated.” Stuchly also has more time to devote to bottom-line Walker also recognizes that Administaff’s employer activities. She sees the Administaff Client Services liability management strategy is especially valuable. team as “a complete right hand” for handling EnerVest’s As part of the co-employment relationship, EnerVest human resources needs. transferred many of its employer-related liabilities to “As we have grown and developed, so has our need Administaff, is now able to share others and can better to have established human resources policies and manage those that remain the company’s responsibility. procedures in place,” said Stuchly. “We now have an “We wanted to make sure we didn’t lose what we employee handbook with guidelines and formal pro- had built because we overlooked something,” Walker cedures to follow. That’s an important safety net for said. “From a human resources standpoint, we believe our employees as well as the company.” we’re doing things properly as a result of our rela- Other Administaff services also have proven ben- tionship with Administaff. That’s a nice assurance for eficial to EnerVest, Stuchly said. With 120 employees me and the whole company.” in seven states, EnerVest has obligations under a vari- Companies that set out to become employers of ety of federal and state regulations. “That made us see choice subscribe to the axiom, “A company is known by how significant it was to understand the regulatory the people it keeps.” They invest in their people and work to develop their employees in order to differen- tiate themselves from their competitors. It is an effort that requires commitment, dedication and creative strategies, and Administaff is fully committed to help- ing its client companies become employers of choice. HAVE YO U H EA RD ? ADMINISTAFF EXPANDS ITS ONLINE COURSE OFFERINGS HOUSTON - September 21, 2001 - Administaff, Inc. (NYSE: ASF) has expanded its eUniversity course offerings to include online training in various Microsoft applications: Word, Excel, Access, Outlook, FrontPage, PowerPoint and Projects. Among the dozens of other eUniversity courses are training opportunities in customer service, health and safety practices, problem solving, goal setting, management, leadership and workplace diversity. 12 | ADMINISTAFF HAVE YO U H EA RD ? ADMINISTAFF LAUNCHES WEB–BASED EMPLOYEE SERVICE CENTER HOUSTON - September 21, 2001 - Administaff, Inc. (NYSE: ASF) has expanded and enhanced its eBusiness operations with the launch of its Web–based Employee Service Center.SM This co–brandable site is organized into four major categories - My Page, My Work, My MarketPlaceSM and Directory - that provide 24/7 access to a wide range of services, products and resources for both work and home. Work-Life Balance 2001 ANNUAL REPORT | 13 “I use the Employee Service Center to process payroll, access forms and run reports. It’s very user-friendly, and it provides a wealth of information and resources for all of our employees.” Selena M. Stuchly – Manager of Human Resources EnerVest Management Partners, Ltd. 14 | ADMINISTAFF The Employee Service Center is designed to reflect the work and personal lives of those who use it by: • Allowing client owners to transact business online and streamline administrative tasks through the use of tools including WebPayroll,SM WebReporting,SM online enrollment and personnel forms. • Providing employees with access to time-saving, job-specific information such as pay history, informa- tion about health benefits and the 401(k) savings plan, Administaff service contacts, health care providers and the LifeWorks employee assistance program. • Functioning as a one-stop online shopping center, featuring alliance offers negotiated for Administaff client companies and employees, and affiliate Web sites gathered for convenience. The site is organized into four areas: My Page, My Work, My MarketPlaceSM and Directory. Employees can customize these pages to fit the way they work and live, using tools – or “gadgets” – to maximize the site’s performance and provide key information at a glance. Cindy Iverson, EnerVest’s Treasury Cash Manager, uses the Employee Service Center for several functions. “I’ve customized my gadgets so My Page is organized the way I like,” Iverson said. “And I especially like the online training and development center – I can enroll in and take classes at my own pace and convenience.” Client Case Study EMPLOYEE SERVICE CENTER SUPPORTS WORK-LIFE BALANCE AT ENERVEST Melissa Coronado has added a new Web site – Employee Service CenterSM – to her list of bookmarked favorites. A Land Office Administrator at EnerVest’s Houston headquarters, Coronado uses resources on the portal to streamline various activities. “There’s an abundance of information to explore in the Employee Service Center. I’ve used it for both work-related and personal tasks. With just a click, I was able to change my address in my personnel records,” Coronado said. “I also found a physician in my provider network and browsed online for a computer. And the best part is that it’s so user-friendly.” EnerVest encourages its employees to balance their work and personal lives, and Administaff provides them with tools and resources to help them achieve that goal. The result? EnerVest enjoys a competitive advantage in attracting and keeping the most talented people. As an employer of choice, EnerVest understands the link between innovative working practices and improved employee performance, company profitability and investor return. Launched in September 2001, the Employee Service Center supports Administaff’s strategy of integrating high tech with high touch for optimum service delivery. The Center is an easy-to-use Web portal that functions as an interactive online management tool, providing users with instant access to valuable work and personal information. The password-protected site is available only to Administaff employees and client owners through Administaff’s Web site, www.administaff.com. HAVE YO U H EA RD ? ADMINISTAFF EXPANDS AND ENHANCES ITS eCOMMERCE PORTAL HOUSTON - September 21, 2001 - Administaff, Inc. (NYSE: ASF) today announced the introduction of My MarketPlace,SM an expanded and enhanced version of the Company’s eCommerce portal. Accessible through the Employee Service Center,SM the site offers a wide range of personal and work–related products and services from some of the nation’s leading companies, including American Express, AT&T, Continental Airlines, Dell, IBM and Spiegel. Work-Life Balance 2001 ANNUAL REPORT | 15 Administaff provides its client companies and worksite employees with the high-powered human resources tools they need to help manage the demands of the office and their personal lives. My MarketPlace features a wide variety of offers for work and home. Employees and client owners can find products and services from Administaff’s nationally recognized alliance companies, often with preferred pricing, VIP status or other special benefits available only through Administaff. Also available is a list of consumer offers with links to some of the nation’s best-known retailers to create a convenient, one-stop shopping point for business and personal needs. In addition, client owners and employees can do business with Administaff’s nationwide community of premier small businesses through the Best2Best® Like Coronado and Iverson, EnerVest Operations Client Network. Manager Harvey Barney can now locate information The Directory is an at-a-glance index, giving online that once required a phone call. “It’s a great employees quick access to all of the information source of information on my health benefits. I have available through the Employee Service Center. The the information I need at any time,” he said. directory organizes online resources into “centers” for On My Page, a client owner can add the company’s easy reference, including “how to” information, bene- brand or logo to the site to enhance corporate identity. fits, education and training, enrollment, finance, Employees can personalize and organize information forms, help, human resources, My Profile and news. on their pages by choosing tools that can be added, Work-life balance doesn’t have to be an out-of- moved or deleted based on their needs and interests. reach ideal for employees at small and medium-sized Examples include stock quotes, news, entertainment, businesses. Administaff provides its client companies local weather, frequently used Administaff forms and worksite employees with the high-powered and a list of Administaff service contacts. In addition, human resources tools they need to help manage the employees can choose from six color schemes to match demands of the office and their personal lives. As their personal preferences. a result, businesses ultimately can reap the rewards My Work provides access to job-related informa- of a competitive advantage gained through increased tion and resources specific to an employee’s position, productivity and staff retention. helping to streamline the workday. Employees can access their pay history; locate a doctor, pharmacy or hospital; and view their personal profile and other job- specific details. They also can find information about financial planning, manage their 401(k) plan account, and explore training and development opportunities through eUniversity. HAVE YO U H EA RD ? ADMINISTAFF INTRODUCES ONLINE ENROLLMENT FOR NEW EMPLOYEES HOUSTON - September 21, 2001 - Administaff, Inc. (NYSE: ASF) today announced the introduction of online enrollment for new employees at its client companies. Accessible through the Employee Service Center,SM this new feature is designed to streamline the orientation process. It enables new employees to be enrolled quickly and efficiently so they can begin receiving their paychecks, benefits and services. 16 | ADMINISTAFF GLOSSARY Administaff University – Training and professional development program designed to help employees succeed in the workplace. Includes instructor-led classes and Web-based courses (eUniversity). Best2Best® Client Network – An online networking forum located in the My MarketPlaceSM section of the Employee Service Center.SM Provides Administaff’s clients with an opportunity to market their products and services to other clients, employees and their families. Co-Employment – A relationship established between Administaff, a client company and that client’s existing employees, including the business owner. Under this arrangement, Administaff assumes or shares many of the responsibilities of being an employer. In addition, Administaff provides the client company and worksite employees with a wide range of value-added benefits and services not typically avail- able at a small business. eBusiness Strategy – Administaff’s Web-based initiatives. Represented primarily by the Employee Service Center, which includes both eService capabilities and eCommerce opportunities. Employee Service CenterSM – A customizable and password-protected eBusiness platform that provides client companies, employees and their families access to a wide range of services, products and resources for both work and home. Consists of four major categories (My Page, My Work, My MarketPlace and Directory) that include various gadgets (information modules) that can be organized according to personal preference. Clients can co-brand the Employee Service Center with their company’s logo. Employer Services Assurance Corporation (ESAC) – Formerly the Institute for the Accreditation of Professional Employer Organizations (IAPEO). Established in 1995, ESAC has become the nationally recognized accreditation entity for providing financial assurance and establishing responsibility standards and certification for the PEO industry and its client companies. Members must complete ongoing monitoring and quarterly evaluations to maintain accreditation. Administaff has earned this accreditation annually since 1995. For more information, visit www.esacorp.org. High Touch/High Tech – Describes Administaff’s two-tiered approach to service delivery. Combines “high touch” personal attention with a convenient “high tech” approach to important information and transactions available on the Employee Service Center. My MarketPlaceSM – An eCommerce portal on the Employee Service Center that conveniently offers Administaff ’s clients, employees and their families a wide array of business and consumer products and services from nationally recognized companies. Also includes client company marketing opportunities on the Best2Best Client Network. National Association of Professional Employer Organizations (NAPEO) – A national trade association for PEOs, NAPEO serves as the “voice of the industry” in legislation, regulation and educational services. Administaff is an active member of NAPEO. For more infor- mation, visit www.napeo.org. Personnel Management SystemSM – Administaff’s comprehensive suite of human resources services, designed to help small and medium-sized businesses enhance their productivity and profitability by implementing a more systematic people strategy. This eight-point approach includes performance management, training and develop- ment, benefits management, employer liability management, owner support, government compliance, employment administration, and recruiting and selection. Portal – a Web site that includes information and links to various sources. Professional Employer Organization (PEO) – An organization that serves as an off-site human resources department for small and medium-sized businesses. A PEO delivers its value-added services by entering into a co-employment relationship with a client company’s existing employees, including the business owner. Worksite Employee – An employee who works at an Administaff client company location. A worksite employee is co-employed by both Administaff and the client company. Traditional Employment Relationship Company Co–Employment Relationship Administaff delivers its Personnel Management System by entering into a co-employment relationship with a client company and that client’s existing employees, including the business owner. This trans- action replaces the traditional two-party employment relationship with a three-party arrangement. The co- employment relationship enables Administaff to deliver comprehensive benefits and services that help position the client company as an employer of choice. Employee Client Company Client Service Agreement Administaff Employment Relationship Employment Relationship Worksite Employee FINANCIAL REVIEW Selected Financial Data Market for the Company’s Common Equity and Related Stockholder Matters Management’s Discussion and Analysis of Financial Condition and Results of Operations Report of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 2001 ANNUAL REPORT | 17 18 19 20 43 44 46 47 48 49 18 | ADMINISTAFF 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” (in thousands, except per share and statistical data) INCOME STATEMENT DATA: Revenues Gross profit Operating income Net income Basic net income per share(4) Diluted net income per share(4) BALANCE SHEET DATA: Working capital Total assets Total debt Total stockholders’ equity STATISTICAL DATA: Average number of worksite employees paid per month during period Gross payroll per worksite employee per month(5) Gross profit per worksite employee per month Operating income per worksite employee per month 2001 2000 1999 1998 1997 Year ended December 31, $ $ $ $ $ $ $ 4,373,244 165,015(1) 18,539(1) 10,357(1) 0.38(1) 0.36(1) 36,609 274,003 13,500 122,935 69,480 4,020 198(1) 22(1) $ $ $ $ $ $ $ 3,708,531 138,534 22,234 16,900 0.62 0.58 51,179 242,817 – 105,510 62,140 3,830 186 30 $ $ $ $ $ $ $ 2,260,743 89,528 10,559(2) 9,358(2) 0.34(2) 0.34(2) 35,792 147,698 – 80,468 42,479 3,360 176 21(2) $ $ $ $ $ $ $ 1,683,063 68,610 11,201 9,123 0.32 0.31 52,475 142,799 – 86,857 34,819 3,083 164 27 $ $ $ $ $ $ $ 1,213,620 51,269 9,346(3) 7,439(3) 0.28(3) 0.27(3) 46,611 109,455 – 63,763 26,907 2,855 159 29(3) (1) For the year ended December 31, 2001, gross profit, operating income, net income, basic net income per share, diluted net income per share, gross profit per worksite employee per month and operating income per worksite employee per month would have been $171.2 million, $24.7 million, $17.7 million, $0.64, $0.62, $205 and $30 excluding the impact of non-recurring items. The non-recurring items included a $6.6 million credit ($4.0 million net of tax) related to the Company’s workers’ compensation policy, disputed health insurance rate increases by Aetna totaling approximately $12.7 million ($7.7 million net of tax), and the write-off of the Company’s $3.8 million ($3.7 million net of tax) investment in Virtual Growth, Inc. See “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.” (2) For the year ended December 31, 1999, operating income, net income, basic net income per share, diluted net income per share and operating income per worksite employee per month would have been $12.0 million, $9.4 million, $0.34, $0.34 and $24, excluding the impact of non-recurring items. The non-recurring items included a $1.4 million ($920,000 net of tax) write-off of certain capitalized software development costs and a $932,000 ($852,000 net of tax) gain related to a settlement of issues involving the Company’s 40l(k) plan. (3) For the year ended December 31, 1997, operating income, net income, basic net income per share, diluted net income per share and operating income per worksite employee per month would have been $10.7 million, $8.3 million, $0.31, $0.30 and $33, excluding the impact of a non-recurring bad debt charge. (4) Adjusted to reflect the two-for-one split of the common stock effected on October 16, 2000. (5) Excludes bonus payroll of worksite employees not subject to the Company’s normal service fee. 2001 ANNUAL REPORT | 19 MARKET FOR THE COMPANY’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Price Range of Common Stock >> The Company’s common stock is traded on the New York Stock Dividend Policy >> The Company has not paid cash dividends on its common stock since its formation and Exchange under the symbol “ASF”. As of February 22, does not anticipate declaring or paying dividends on its 2002, there were 156 holders of record of the common common stock in the foreseeable future. The Company stock. This number does not include stockholders for expects that it will retain all available earnings gener- whom shares were held in “nominee” or “street name.” ated by the Company’s operations for the development The following table sets forth the high and low sales and growth of its business. Any future determination as prices for the common stock as reported on the New to the payment of dividends will be made at the discre- York Stock Exchange composite transactional tape. tion of the Board of Directors of the Company and will These amounts have been adjusted to reflect the two- depend upon the Company’s operating results, financial for-one split of the common stock effected on October 16, condition, capital requirements, general business condi- 2000 in the form of a stock dividend. tions and such other factors as the Board of Directors deems relevant. 2001 First Quarter Second Quarter Third Quarter Fourth Quarter 2000 First Quarter Second Quarter Third Quarter Fourth Quarter High Low $ $ 32.90 28.20 33.90 36.48 21.38 33.22 44.56 43.00 $ $ 17.42 15.40 22.30 19.80 10.38 17.06 24.81 22.30 20 | ADMINISTAFF MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in con- OVERVIEW junction 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. This document contains forward-looking state- ments within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Secu- rities Exchange Act of 1934. You can identify such forward-looking statements by the words “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” “likely,” “goal,” “assume” and similar expressions. In the normal course of business, Administaff, Inc. Administaff provides a comprehensive Personnel Management SystemSM that encompasses a broad range of services, including benefits and payroll admin- istration, health and workers’ compensation insurance programs, personnel records management, employer liability management, employee recruiting and selec- tion, performance management, and training and development services. The Company’s overall operating results are largely dependent on the number of work- site employees paid and can be measured in terms of revenues or costs per worksite employee per month. As a result, the Company often uses this unit of measurement in analyzing and discussing its results (“Administaff” or the “Company”), in an effort to help of operations. 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 per- formance and involve risks, uncertainties and assump- tions 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 Revenues >> The Company’s revenues are derived from its comprehensive service fees, which are based upon each employee’s gross pay and a markup com- puted as a percentage of the gross pay. The comprehen- sive service fees are invoiced concurrently with each periodic payroll of its worksite employees. The Com- pany’s revenues are primarily dependent on the num- ber of clients enrolled, the resulting number of worksite employees paid each period, the gross payroll costs of these worksite employees and the number of worksite employees enrolled in the Company’s benefit plans. Direct Costs >> The Company’s primary direct costs are (i) the salaries and wages of worksite employ- ees (“payroll cost”); (ii) employment-related taxes (“payroll taxes”); (iii) costs of employee benefit plans; 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 pay- roll costs generally have a proportionate impact on the uncertainties discussed in this Annual Report, includ- Company’s revenues. ing, without limitation, factors discussed under the cap- tion “Factors That May Affect Future Results and the Market Price of Common Stock,” beginning on page 36. 2001 ANNUAL REPORT | 21 Payroll taxes consist of the employer’s portion of The Company’s gross profit per worksite employee Social Security and Medicare taxes under FICA, fed- is determined in part by its ability to accurately estimate eral unemployment taxes and state unemployment and control direct costs and its ability to incorporate taxes. Payroll taxes are generally paid as a percentage changes in these costs into the comprehensive service of payroll cost. The federal tax rates are defined by fed- fees charged to clients, which are subject to contractual eral regulations. State unemployment tax rates are arrangements that are typically renewed annually. subject to claims histories and vary from state to state. Gross profit, measured as a percentage of revenue, is Employee benefits costs are comprised primarily of also affected by the comprehensive service fees and health insurance costs (including dental and pharmacy direct cost structure. However, worksite employee pay- costs), but also include costs of other employee benefits roll cost is the largest component of both revenues and such as life insurance, vision care, disability insurance, direct costs and, as a result, changes in the level of education assistance, adoption assistance, a dependent payroll cost per worksite employee can cause fluctua- care spending account and a worklife program. tions in this statistic that are not necessarily indica- The Company experienced a 13.4% increase in tive of relative performance from period to period. As a benefits costs per covered employee during 2001 and result, the Company uses gross profit per worksite expects a similar increase in 2002. While the Com- employee per month as its principal measurement of pany’s results of operations will be impacted to some relative performance at the gross profit level. degree in 2002 by the expected increase and its Operating Expenses >> contractual pricing constraints, the Company does not expect this situation to have a material adverse effect >> SALARIES, WAGES AND PAYROLL TAXES – Salaries, wages and payroll taxes are primarily a function of the on its financial position. number of corporate employees and their associated The Company is currently in a dispute with Aetna average pay. The Company’s corporate employees U.S. Healthcare (“Aetna”), its former health insurance primarily include sales and marketing, client serv- carrier, relating to health insurance cost increases dur- ices, technical and administrative support and busi- ing 2001 and Aetna’s administration of its health plan ness and technology development personnel. over the last several years. For a discussion of the Com- pany’s dispute with Aetna, see “Other Matters – Health >> GENERAL AND ADMINISTRATIVE EXPENSES – The Company’s general and administrative expenses primarily Insurance Costs” on page 35. An unfavorable outcome in include (i) rent expenses related to the Company’s this dispute could have a material adverse effect on the service centers and sales offices; (ii) outside profes- Company’s financial position or results of operations. sional service fees related to legal, consulting and Workers’ compensation costs include premiums accounting services; (iii) administrative costs, such and administrative costs under the Company’s workers’ as postage and supplies; (iv) employee travel compensation program. The Company is insured under expenses; and (v) repairs and maintenance costs a guaranteed cost program under which premiums are associated with the Company’s facility and technol- paid for full insurance coverage of all accident claims ogy infrastructure. occurring during the policy period. See “Other Matters – Reliance National Indemnity Co. Bankruptcy Liqui- >> DEPRECIATION AND AMORTIZATION – Depreciation and amortization expense is primarily a function of the dation” on page 35. Company’s capital investments in corporate facili- ties, service centers, sales offices and technology infrastructure. 22 | ADMINISTAFF >> COMMISSIONS – Commission expense primarily con- sists of amounts paid to sales personnel and to CRITICAL ACCOUNTING POLICIES AND ESTIMATES American Express. Commissions for sales personnel The Company’s discussion and analysis of its finan- are based on a percentage of payroll revenue gener- cial condition and results of operations are based upon ated by such personnel, while commissions are paid its consolidated financial statements, which have been to American Express in accordance with its Market- prepared in accordance with accounting principles gen- ing Agreement with the Company. >> ADVERTISING – Advertising expense primarily consists of media advertising and other business promotions erally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported in the Company’s current and anticipated sales mar- amounts of assets, liabilities, revenues and expenses, kets. This expense is impacted to some degree by the and related disclosure of contingent assets and liabili- number of new markets included in each year’s ties. On an ongoing basis, the Company evaluates its expansion plan. estimates, including those related to customer bad The Company’s long-term national expansion debts, investments, income taxes, and contingencies and strategy has impacted operating expenses significantly litigation. The Company bases its estimates on histori- in the past few years, primarily through (i) the addition cal experience and on various other assumptions that of sales, service, technology and administrative support are believed to be reasonable under the circumstances, personnel; (ii) capital expenditures associated with new the results of which form the basis for making judg- facilities, technology infrastructure and eBusiness ini- ments about the carrying values of assets and liabilities tiatives; (iii) the restructuring of the sales representa- that are not readily apparent from other sources. Actual tive compensation plan; and (iv) incremental general results may differ from these estimates. and administrative costs to support the expansion. The The Company believes the following critical Company expects that its national expansion strategy accounting policies reflect the more significant judg- will continue to impact its operating expenses for the ments and estimates used in the preparation of its foreseeable future. Income Taxes >> The Company’s provision for income taxes typically differs from the U.S. statutory consolidated financial statements: >> REVENUE RECOGNITION – The Company’s revenues are derived from its comprehensive service fees, which rate of 35% due primarily to state income taxes. are based upon each worksite employee’s gross pay Deferred income taxes reflect the net tax effects of tem- and a markup computed as a percentage of the gross porary differences between the carrying amounts of pay. The Company includes the component of its assets and liabilities used for financial reporting pur- comprehensive service fees related to the gross pay poses and the amounts used for income tax purposes. of its worksite employees as revenue based on its Significant items resulting in deferred income taxes analysis of EITF 99-19, Reporting Revenue Gross as include depreciation and amortization, software devel- a Principal versus Net as an Agent. In accordance opment costs, accrued state income taxes, client list with the EITF consensus, the Company is deemed to acquisition costs and the allowance for uncollectible be a principal in its personnel management services accounts receivable. Changes in these items are because it assumes a significant number of risks as reflected in the Company’s financial statements a co-employer of its worksite employees. Among the through the Company’s deferred income tax provision. more significant of those risks is the Company’s assumption of risk for the payment of its direct costs, including the gross pay of its worksite employees, 2001 ANNUAL REPORT | 23 regardless of whether the Company’s clients pay their comprehensive service fees on a timely basis or >> MARKETABLE SECURITIES – The Company’s investments in marketable securities consist of exchange-traded at all. If the Company were deemed to be an agent debt securities which are managed by professional in its personnel management services, the Company investment management companies. These invest- could be required to record its revenues net of the ment managers are guided by the Company’s invest- gross payroll cost component of its comprehensive ment policy, which is designed to maximize after-tax service fees. In such an event, there would be no interest income while preserving its principal effect on the Company’s net income. >> ALLOWANCE FOR DOUBTFUL ACCOUNTS – The Company maintains an allowance for doubtful accounts for investment. As of December 31, 2001, all of the Com- pany’s investments in marketable securities are classified as available-for-sale, and as a result, are estimated losses resulting from the inability of its reported at fair value as determined by the profes- customers to pay its comprehensive service fees. sional investment management companies. See The Company believes that the success of its busi- “Qualitative and Quantitative Disclosures About ness is heavily dependent on its ability to collect Market Risk” on page 41 for additional information these comprehensive service fees for several rea- regarding these investments. sons, including (i) the large volume and dollar amount of transactions processed by the Company; >> PROPERTY AND EQUIPMENT – The Company’s property and equipment relate primarily to its facilities and (ii) the periodic and recurring nature of payroll, upon related improvements, furniture and fixtures, com- which the comprehensive service fees are based; and puter hardware and software and capitalized soft- (iii) the fact that the Company is at risk for the pay- ware development costs. These costs are depreciated ment of its direct costs regardless of whether its or amortized over the estimated useful lives of the clients pay their comprehensive service fees. To mit- assets. If the useful lives of these assets were deter- igate this risk, the Company has established very mined to be shorter than their current estimates, the tight credit policies. The Company generally Company’s depreciation and amortization expense requires its clients to pay their comprehensive serv- could be accelerated, which would decrease net ice fees no later than one day prior to the applicable income in the periods following such a determina- payroll date. In addition, the Company maintains tion. In addition, the Company periodically evaluates the right to terminate its Client Service Agree- these costs for impairment in accordance with State- ment (“CSA”) and associated worksite employees or ment of Financial Accounting Standards (“SFAS”) to require prepayment, letters of credit or other col- No. 121, Accounting for Impairment of Long-Lived lateral upon deterioration in a client’s financial posi- Assets and Long-Lived Assets to be Disposed Of. If tion or upon nonpayment by a client. As a result of events or circumstances were to indicate that any of these efforts, the outstanding balance of accounts the Company’s long-lived assets might be impaired, receivable and subsequent losses related to cus- the Company would be required to analyze the esti- tomer nonpayment have historically been very low mated undiscounted future cash flows from the as a percentage of revenues. However, if the financial applicable asset. In addition, the Company would be condition of the Company’s customers were to deteri- required to record an impairment loss, which would orate rapidly, resulting in nonpayment, the Com- reduce net income, to the extent that the carrying pany’s accounts receivable balances could grow and value of the asset exceeded the estimated undis- the Company could be required to provide for addi- counted future cash flows. tional allowances, which would decrease net income in the period that such determination was made. 24 | ADMINISTAFF >> INVESTMENT VALUATION – The Company has an equity investment in a privately-held development stage considered reasonably possible to occur, financial statement disclosure is required, including the company whose operations fit within the Com- range of possible loss if it can be reasonably deter- pany’s strategic focus. This investment is recorded mined. The Company has disclosed in its audited using the cost method. Under the cost method, the financial statements several issues that it believes Company periodically evaluates the realizability of are reasonably possible to occur, although it cannot this investment based on its review of the investee’s determine the range of possible loss in all cases. As financial condition, financial results, financial pro- these issues develop, the Company will continue to jections and availability of additional financing evaluate the probability of future loss and the poten- sources. If, based on its review, the Company was tial range of such losses. If such evaluation were to to determine that the investment’s estimated fair determine that a loss was probable and the loss market value had declined below its carrying could be reasonably estimated, the Company would value for a reason that was other than temporary, be required to accrue its estimated loss, which would the Company would be required to write down the reduce net income in the period that such determi- value of the investment to its estimated fair market nation was made. See “Other Matters – Health value, which would reduce net income in the period Insurance Costs” on page 35, “Other Matters – of such determination. >> DEFERRED TAXES – The Company has recorded a valu- ation allowance to reduce its deferred tax assets to Reliance National Indemnity Co. Bankruptcy Liqui- dation” on page 35 and “Factors that May Affect Future Results and Market Price of Common Stock the amount that is more likely than not to be real- – Audit of the Company’s 401(k) Plan; IRS Employee ized. While the Company has considered future Leasing Market Segment Group” on page 36. taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for >> BENEFITS COSTS – Effective January 1, 2002, the Company replaced its former health insurance the valuation allowance, the Company’s ability to carrier, Aetna, with a network of carriers including realize its deferred tax assets could change from its UnitedHealthcare (“United”), PacifiCare, Kaiser current estimates. If the Company is able to realize Permanente and Blue Cross and Blue Shield of Geor- its deferred tax assets in the future in excess of its gia, all of which are fully-insured policies. The policy net recorded amount, an adjustment to reduce the with United provides the majority of the Company’s valuation allowance would increase net income in health insurance coverage. Although the terms of the the period that such determination is made. Like- Company’s annual contract with United are not wise, should the Company determine that it will finalized, it is likely that the contract will provide not be able to realize all or part of its net deferred United with deficit protection upon contract termi- tax assets in the future, an adjustment to increase nation, up to the amount of the Company’s security the valuation allowance would reduce net income deposit with United. While the Company expects in the period such determination is made. that United will establish rates at levels sufficient to >> CONTINGENT LIABILITIES – The Company accrues or discloses contingent liabilities in accordance with cover plan costs, if the premiums paid by the Com- pany at such rates were not sufficient to cover plan SFAS 5, Accounting for Contingencies. SFAS 5 costs, a deficit could be incurred. In that event, the requires accrual of contingent liabilities that are Company would be required to accrue additional considered probable to occur and that can be rea- health insurance expense based on an estimate of its sonably estimated. For contingent liabilities that are contractual obligations under the security deposit 2001 ANNUAL REPORT | 25 agreement in the period that such determination In February 2001 and March 2002, American was made. The annual contracts with carriers other Express exercised common stock purchase warrants for than United do not require deficit protection, and as 800,000 shares and 526,271 shares of the Company’s a result, are not subject to such estimates. common stock at exercise prices of $20 and $25 per TRANSACTIONS WITH RELATED AND OTHER CERTAIN PARTIES The Company does not have any transactions with related parties that are considered material to the Com- pany’s results of operations and/or financial condition. share, respectively. The Company repurchased these shares from American Express in private transactions at $24.46 and $27.02 per share, respectively. These repurchase prices were calculated based on the Com- pany’s closing stock prices on the New York Stock Exchange over designated time periods prior to the warrant exercises. RESULTS OF OPERATIONS Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 >> The following table presents certain information related to the Company’s results of operations for the years ended December 31, 2001 and 2000. (in thousands, except per share and statistical data) Revenues Gross profit Operating expenses Operating income Other income Net income Diluted net income per share of common stock STATISTICAL DATA: Average number of worksite employees paid per month Fee revenue per worksite employee per month Fee payroll cost per worksite employee per month Gross markup per worksite employee per month Gross profit per worksite employee per month Operating expenses per worksite employee per month Operating income per worksite employee per month Net income per worksite employee per month $ $ 2001 4,373,244 165,015 146,476 18,539 848 10,357 0.36 69,480 4,876 4,020 856 198 176 22 12 Year ended December 31, $ $ 2000 3,708,531 138,534 116,300 22,234 4,380 16,900 0.58 62,140 4,623 3,830 793 186 156 30 23 % change 17.9 % 19.1 % 25.9 % (16.6)% (80.6)% (38.7)% (37.0)% 11.8 % 5.5 % 5.0 % 7.9 % 6.5 % 12.8 % (26.7)% (47.8)% Revenues >> The Company’s revenues increased 17.9% over 2000 due to an 11.8% increase in the aver- The Company’s continued expansion of its sales force through new market and sales office openings age number of worksite employees paid per month was the primary factor contributing to the increase in accompanied by a 5.5% increase in the fee revenue per the average number of worksite employees paid. In worksite employee per month. 2001, the Company’s unit growth rate was lower than 26 | ADMINISTAFF in 2000 due to softness in the U.S. economic conditions. with the average number of paid worksite employees. In the first half of 2001, all three of the Company’s However, improvements in these two sources of paid sources of paid worksite employees – new client sales, worksite employees were offset by further net layoffs client retention, and net change in existing clients within the existing client base. through new hires and terminations – were negatively The 5.5% increase in fee revenue per worksite impacted. The net change in existing clients was employee per month directly related to the 5.0% impacted as terminations in the existing client base increase in fee payroll cost per worksite employee per exceeded new hires throughout the year, compared to month, reflecting (i) compensation increases within strong gains in this area during 2000. Client retention the Company’s existing worksite employee base; and declined primarily as a result of an increase in the (ii) further penetration of markets with generally number of clients experiencing financial difficulties higher wage levels, such as San Francisco, New York and/or seeking lower cost alternatives. New client sales and Washington, D.C. In 2001, the growth in fee were impacted by uncertainty in the direction of the payroll cost per worksite employee per month was economy, which impacted the Company’s ability to close lower than the growth rates experienced in 2000, as sales. During the latter half of the year, new client sales weakness in U.S. economic conditions resulted in and client terminations gradually returned to histori- lower compensation increases and a reduction in the cal levels, with new client sales increasing proportion- payroll cost for new and replacement worksite ately with the increase in trained sales representatives employees within the Company’s existing client base. and client terminations decreasing to a level consistent The following table presents certain information related to the Company’s revenues by region for the years ended December 31, 2001 and 2000. Northeast Southeast Central Southwest West Other revenues Total revenues 2001 499,235 431,104 597,138 1,961,978 876,948 6,841 4,373,244 $ $ Year ended December 31, (in thousands) (% of total revenue) 2000 358,564 393,470 451,361 1,844,519 653,658 6,959 3,708,531 $ $ % change 39.2 % 9.6 % 32.3 % 6.4 % 34.2 % (1.7)% 17.9 % 2001 11.4 % 9.9 % 13.6 % 44.9 % 20.1 % 0.1 % 100.0 % 2000 9.7 % 10.6 % 12.2 % 49.7 % 17.6 % 0.2 % 100.0 % Gross Profit >> Gross profit increased 19.1% over 2000 due primarily to the 11.8% increase in the average $186 in 2000. Gross profit in 2001 was affected by two non-recurring items: (i) a $6.6 million one-time credit number of worksite employees paid per month accom- related to the workers’ compensation policy period panied by a 6.5% increase in gross profit per worksite ended September 30, 2001; and (ii) disputed health employee per month. Gross profit per worksite insurance rate increases by Aetna totaling approxi- employee increased to $198 per month in 2001 versus mately $12.7 million in the third and fourth quarters 2001 ANNUAL REPORT | 27 of 2001. Excluding these non-recurring items, gross employee. The overall cost of payroll taxes as a per- profit per worksite employee per month would have centage of payroll cost was 7.20% in 2001 versus been $205 in 2001. The Company’s pricing objectives 7.34% in 2000. This decrease was primarily the attempt to maintain or improve the gross profit per result of an increase in bonus payroll cost per work- worksite employee by increasing gross markup per site employee and the Company’s lower growth worksite employee to match or exceed changes in (i) its rate, which caused a smaller portion of the total primary direct costs; and (ii) its operating costs associ- compensation of worksite employees to be subject to ated with enhancements in the Company’s comprehen- state unemployment taxes in 2001 compared to the sive service offering. 2000 period. The disputed health insurance premiums had a negative effect on gross profit in the third and fourth >> BENEFITS COSTS – The cost of health insurance and related employee benefits increased $44 per work- quarters of 2001 primarily because the Company was site employee per month over 2000, due to a 13.7% required to pay such increases immediately, but was increase in the cost per covered employee and an unable to immediately pass those similar increases increase in the percentage of worksite employees through to most of its clients due to contractual limi- covered under the Company’s health insurance plan tations. The Company’s CSA generally allows the to 72.0% in 2001 versus 69.7% in 2000. The increase Company to change its pricing upon renewal, which in cost per covered employee includes the impact of typically occurs annually. See “Other Matters – Health the disputed health insurance rate increases of Insurance Costs” on page 35 and “Factors That May approximately $12.7 million by Aetna. See “Other Affect Future Results and the Market Price of Com- Matters – Health Insurance Costs” on page 35 for a mon Stock – Increases in Health Insurance Premiums, discussion of the health insurance rate increase dis- Unemployment Taxes and Workers’ Compensation pute. Excluding the disputed increases, the cost of Rates” on page 38. health insurance and related employee benefits per Gross markup per worksite employee per month covered employee would have increased 7.8% com- increased 7.9% to $856 in 2001 versus $793 in 2000. pared to 2000. Approximately 24.1% of the $63 increase in gross markup per employee was the result of increased serv- >> WORKERS’ COMPENSATION COSTS – Workers’ compensa- tion costs decreased $4 per worksite employee per ice fees designed to match the increased payroll tax month, and decreased to 1.07% of fee payroll cost in expense associated with the higher average payroll cost 2001 from 1.22% in 2000. During negotiations of its per worksite employee. The remaining increase in gross workers’ compensation insurance policy for the markup per employee was the result of other increases period beginning October 1, 2001, the Company in the Company’s comprehensive service fees, which negotiated a one-time $6.6 million credit related to were designed to meet the Company’s pricing objectives. the policy period ended September 30, 2001 based The Company’s primary direct costs, which include on the Company’s claims history during that policy payroll taxes, benefits and workers’ compensation period. Excluding the non-recurring credit, workers’ expenses, increased 8.2% to $655 per worksite employee compensation cost would have been 1.26% of fee per month in 2001 versus $605 in 2000. The primary payroll cost. components changed as follows: >> PAYROLL TAX COSTS – Payroll taxes increased $10 per worksite employee per month, primarily due to the increased average payroll cost per worksite Gross profit, measured as a percentage of rev- enue, increased slightly to 3.77% in 2001 from 3.74% in 2000. 28 | ADMINISTAFF Operating Expenses >> The following table presents certain information related to the Company’s operating expenses for the years ended December 31, 2001 and 2000. Salaries, wages and payroll taxes General and administrative expenses Commissions Advertising Depreciation and amortization Total operating expenses Year ended December 31, (in thousands) (per worksite employee per month) 2001 67,761 44,569 11,173 6,092 16,881 146,476 $ $ 2000 54,477 35,426 9,278 5,117 12,002 116,300 $ $ % change 24.4 % 25.8 % 20.4 % 19.1 % 40.7 % 25.9 % 2001 2000 $ $ 81 54 14 7 20 176 $ $ 73 48 12 7 16 156 % change 11.0 % 12.5 % 16.7 % – 25.0 % 12.8 % Operating expenses increased 25.9% to $146.5 mil- puted health insurance rate increases; and (iv) lion. Operating expenses per worksite employee per legal issues pertaining to the purchase of assets month increased 12.8% to $176 in 2001 versus $156 in 2000. The components of operating expenses changed as follows: >> Salaries, wages and payroll taxes of corporate and sales staff increased 24.4%, or $8 per worksite from Virtual Growth, Inc. (“VGI”) out of bankruptcy. >> Depreciation and amortization expense increased 40.7%, or $4 per worksite employee per month, as a result of the capital projects placed into service in late 2000 and 2001. Late in 2000, the Company employee per month, primarily due to a 23.5% implemented its fifth generation proprietary PEO increase in corporate personnel, a 9.7% increase in information system (AIMS) and relocated and the average base pay per corporate employee and a expanded its Houston service center. See “Cash Flows decrease in incentive compensation as a percentage From Investing Activities” on page 33 for a detailed of base pay from 11.2% in 2000 to 0.1% in 2001. The increase in corporate personnel was primarily due to a 30% increase in sales personnel, a 33% increase discussion of capital expenditures made in 2001. >> Commissions expense increased 20.4%, or $2 per worksite employee per month, over 2000 due to a in service personnel and a 12% increase in other restructuring of the sales representative compensa- corporate personnel. tion plan effective January 1, 2001. >> General and administrative expenses increased 25.8%, or $6 per worksite employee per month, over 2000. This increase primarily resulted from expenses such as rent, repairs and maintenance, data commu- >> Advertising costs increased 19.1% and remained con- stant on a per worksite employee basis versus 2000. Other Income >> Other income decreased 80.6% to $848,000 in 2001, primarily due to the non-recurring nication, telecommunications, equipment leases and write-off of the Company’s $3.8 million investment in utilities expenses associated with the Company’s VGI. See “Other Matters – Investments in Other Com- expansion initiatives, including new service centers panies” on page 35. in Houston and Los Angeles and five new sales The Company’s provision for income taxes dif- offices. In addition, legal expenses increased due to (i) fered from the U.S. statutory rate of 35% primarily PEO litigation matters; (ii) trademark, intellectual due to the valuation allowance for deferred assets, property and other corporate litigation; (iii) the dis- state income taxes and non-deductible expenses. 2001 ANNUAL REPORT | 29 The effective income tax rate for the 2001 period increased to 46.6% versus an effective rate of 36.5% Net Income >> Net income for 2001 was $10.4 mil- lion, or $0.36 per diluted share compared to $16.9 mil- during the 2000 period. This increase was primarily lion, or $0.58 per diluted share in 2000. On a per work- a result of (i) a deferred tax asset valuation allowance site employee per month basis, net income decreased related to the capital loss carryforward that resulted 47.8% to $12 in 2001 versus $23 in 2000. Excluding from the VGI investment write-off, the realizability of non-recurring items, net income would have been which is uncertain; (ii) a 1% increase in the federal $17.7 million, or $0.62 per diluted share, and would income tax rate to 35%; and (iii) a reduction in tax- have decreased 8.7% on a per worksite employee basis exempt interest income. to $21 per month. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 >> The following table presents cer- tain information related to the Company’s results of operations for the years ended December 31, 2000 and 1999. (in thousands, except per share and statistical data) Revenues Gross profit Operating expenses Operating income Other income Net income Diluted net income per share of common stock STATISTICAL DATA: Average number of worksite employees paid per month Fee revenue per worksite employee per month Fee payroll cost per worksite employee per month Gross markup per worksite employee per month Gross profit per worksite employee per month Operating expenses per worksite employee per month Operating income per worksite employee per month Net income per worksite employee per month Year ended December 31, $ $ 2000 3,708,531 138,534 116,300 22,234 4,380 16,900 0.58 62,140 4,623 3,830 793 186 156 30 23 $ $ 1999 2,260,743 89,528 78,969 10,559 3,653 9,358 0.34 42,479 4,084 3,360 724 176 155 21 18 % change 64.0 % 54.7 % 47.3 % 110.6 % 19.9 % 80.6 % 70.6 % 46.3 % 13.2 % 14.0 % 9.5 % 5.7 % 0.6 % 42.9 % 27.8 % Revenues >> The Company’s revenues increased 64.0% over 1999 due to a 46.3% increase in the average employees paid. The general strength of the U.S. econ- omy during the second half of 1999 and the first number of worksite employees paid per month accom- three quarters of 2000 was also a contributing factor. panied by a 13.2% increase in the fee revenue per work- Revenues from markets opened prior to 1993 (the com- site employee per month. The Company’s continued mencement of the Company’s national expansion plan) expansion of its sales force through new market and increased 30% over 1999, while revenues from markets sales office openings was the primary factor contribut- opened after 1993 increased 98%. Revenues from the ing to the increase in the average number of worksite state of Texas represented 50% of the Company’s total 30 | ADMINISTAFF revenues, and Houston, the Company’s original mar- addition of clients with worksite employees that had a ket, represented 27% of the total. higher average base pay than the existing client base; The 13.2% increase in fee revenue per worksite (iii) the attrition of clients with worksite employees employee per month directly related to the 14.0% that had a lower average base pay than the existing increase in fee payroll cost per worksite employee per client base; and (iv) further penetration of markets month, reflecting (i) compensation increases within the with generally higher wage levels, such as San Fran- Company’s existing worksite employee base; (ii) the cisco, New York and Washington, D.C. The following table presents certain information related to the Company’s revenues by region for the years ended December 31, 2000 and 1999. Northeast Southeast Central Southwest West Other revenues Total revenues 2000 358,564 393,470 451,361 1,844,519 653,658 6,959 3,708,531 $ $ Year ended December 31, (in thousands) (% of total revenue) 1999 108,567 219,324 232,736 1,388,503 307,197 4,416 2,260,743 $ $ % change 230.3 % 79.4 % 93.9 % 32.8 % 112.8 % 57.6 % 64.0 % 2000 9.7 % 10.6 % 12.2 % 49.7 % 17.6 % 0.2 % 100.0 % 1999 4.8 % 9.7 % 10.3 % 61.4 % 13.6 % 0.2 % 100.0 % Gross Profit >> Gross profit increased 54.7% over 1999 due primarily to the 46.3% increase in the aver- fees designed to match the increased payroll tax expense associated with the higher average payroll age number of worksite employees paid per month cost per worksite employee. The remaining increase in accompanied by a 5.7% increase in gross profit per gross markup per employee was related to other worksite employee per month. Gross profit per work- increases in the Company’s comprehensive service site employee increased to $186 per month in 2000 fees, including approximately $3 per worksite versus $176 in 1999, reflecting effective execution of employee related to a mid-1999 change in the method the Company’s pricing strategy. The Company’s pric- used to calculate service fees for clients who experi- ing objectives attempt to maintain or improve the ence turnover within their workforce. gross profit per worksite employee by increasing gross Payroll taxes increased $40 per worksite employee markup per worksite employee to match or exceed per month, primarily due to the increased average pay- changes in (i) its primary direct costs; and (ii) its oper- roll cost per worksite employee. The overall cost of pay- ating costs associated with enhancements in the Com- roll taxes as a percentage of payroll cost was 7.34% in pany’s comprehensive service offering. 2000 versus 7.19% in 1999. This increase was primarily Gross markup per worksite employee per month the result of the Company’s accelerating unit growth increased 9.5% to $793 in 2000 versus $724 in 1999. during the first three quarters of 2000, which caused a Approximately 55% of the $69 increase in gross mark- larger proportion of the Company’s payroll to be subject up per employee was the result of increased service to payroll taxes later in the year. 2001 ANNUAL REPORT | 31 The cost of health insurance and related employee Gross profit, measured as a percentage of revenue, benefits increased $14 per worksite employee per month declined to 3.74% in 2000 from 3.96% in 1999. This over 1999 due to a 3.0% increase in the cost per covered decline was due primarily to the increase in average employee and a slight increase in the percentage of payroll cost per worksite employee. Because payroll worksite employees covered under the Company’s health cost is the largest single component of both revenues insurance plan to 69.7% in 2000 versus 67.8% in 1999. and direct costs, an increase in the average payroll cost Workers’ compensation costs increased $5 per per worksite employee creates a mathematical down- worksite employee per month, but decreased slightly to ward pressure on the calculation of gross profit as a 1.22% of fee payroll cost in 2000 from 1.25% in 1999. percentage of revenue. Operating Expenses >> The following table presents certain information related to the Company’s operating expenses for the years ended December 31, 2000 and 1999. Year ended December 31, (in thousands) (per worksite employee per month) Salaries, wages and payroll taxes General and administrative expenses Commissions Advertising Depreciation and amortization Write-off of software development costs Total operating expenses 2000 54,477 35,426 9,278 5,117 12,002 – 116,300 $ $ 1999 36,690 23,219 6,429 4,090 7,103 1,438 78,969 $ $ % change 48.5 % 52.6 % 44.3 % 25.1 % 69.0 % (100.0)% 47.3 % 2000 1999 $ $ 73 48 12 7 16 – 156 $ $ 72 45 13 8 14 3 155 % change 1.4 % 6.7 % (7.7)% (12.5)% 14.3 % (100.0)% 0.6 % Operating expenses increased 47.3% over 1999 as maintenance costs and the availability of alternative a result of the 46.3% growth in the average number of software packages. Upon completion of this evaluation, worksite employees paid per month by the Company, the Company determined that the projects would be combined with the effects of the previously mentioned terminated and that the costs associated with two proj- strategic initiatives, all of which comprise invest- ects should be written off. The majority of the costs ments in the Company’s sales, service and technology written off related to efforts to customize an electronic infrastructure. Operating expenses per worksite document management system to meet the Company’s employee per month increased 0.6% to $156 in 2000 physical records management needs. Excluding the versus $155 in 1999. impact of this charge, operating expenses in 2000 Operating expenses in 1999 included a non- increased 50.0% over 1999, and increased to $156 per recurring $1.4 million ($920,000 net of tax) write-off of worksite employee per month in 2000 from $152 in 1999. certain capitalized software development costs. This Salaries, wages and payroll taxes of corporate and write-off was the result of a periodic evaluation of all sales staff increased to $73 per worksite employee per software development projects, which included a review month in 2000 versus $72 in 1999. The ratio of worksite of costs incurred, estimated costs to complete, estimated employees to corporate employees improved to 65 in 32 | ADMINISTAFF 2000 from 58 in 1999. This improvement was partially interest-bearing investments. This increase was par- offset by an average increase in gross pay per corporate tially offset by the effect of a prior year non-recurring employee of 6.3% over 1999. In addition, incentive com- gain from the Company’s settlement of a 401(k) plan pensation as a percentage of corporate employee gross issue with the Internal Revenue Service. pay increased to 11.2% in 2000 versus 3.5% in 1999 due The Company’s provision for income taxes dif- to the Company’s strong financial performance. fered from the U.S. statutory rate of 34% in 2000 due General and administrative expenses increased primarily to state income taxes and tax-exempt inter- $3 per worksite employee per month over 1999. The est income. increase resulted from increased travel expenses associ- ated with the Company’s expanding national presence, Net Income >> Net income for 2000 was $16.9 mil- lion, or $0.58 per diluted share compared to $9.4 million, increased outside labor and recruiting costs associated or $0.34 per diluted share in 1999. These results reflect with the Company’s accelerated growth rate and the two-for-one stock split effected on October 16, 2000. increased consulting expenses associated with the On a per worksite employee per month basis, net income development and rollout of new technology projects. increased 27.8% to $23 in 2000 versus $18 in 1999. Depreciation and amortization expense increased $2 per worksite employee per month as a result of the LIQUIDITY AND CAPITAL RESOURCES increased capital expenditures placed in service in 1999 and 2000, including (i) the implementation of the fifth generation of the Company’s proprietary PEO informa- tion system; (ii) the implementation of certain new com- ponents of Administaff Assistant, primarily the web payroll and web reporting capabilities, which included both internal software development costs and exter- nally purchased software; (iii) the opening of new sales offices; (iv) the expansion and relocation of the Houston service center and the 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 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 Com- pany currently believes that its cash on hand, mar- ketable 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 agency commissions. Advertising costs declined long-term liquidity and capital needs. slightly per worksite employee per month, as four of the Company’s six new offices opened in 2000 were located in existing sales markets, which provided advertising efficiencies. Other Income >> Other income increased 19.9% to $4.4 million in 2000. Interest income increased 72.9% to $4.4 million in 2000 from $2.6 million in 1999, due to a higher level of cash and marketable securities result- ing from the Company’s strong financial performance and an increase in the average interest rate related to The Company had $101.0 million in cash and cash equivalents and marketable securities at December 31, 2001, of which approximately $43.7 million was payable in early January 2002 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, 2001 ANNUAL REPORT | 33 capital expenditures and the Company’s stock repur- Capital expenditures for construction in progress chase program. At December 31, 2001, the Company related to the ongoing construction of additional facil- had working capital of $36.6 million compared to $51.2 ities at the Company’s corporate headquarters, which million at December 31, 2000. The decrease in working began in 2001 and is expected to be completed in the capital was primarily due to a long-term cash security third quarter of 2002. The total cost of the new facili- deposit of $15 million with the Company’s new health ties is expected to be $37.4 million, which includes insurance carrier, UnitedHealthcare, in December 2001. Cash Flows From Operating Activities >> The Company’s cash flows from operating activities in 2001 approximately $4.7 million of furniture and fixtures and $1.0 million of computer cabling and equipment. Capital expenditures for computer hardware and decreased $64.1 million to $10.5 million primarily due software included costs associated with (i) enhancing to a $14.2 million decrease in payroll taxes and other the Company’s development and staging environ- payroll deductions payable in 2001, compared to a ments; (ii) enhancing the performance and stability of $36.4 million increase in 2000, resulting in a net the Company’s production environment through load decrease of $50.6 million in cash flows from operating balancing; (iii) the expansion of the Company’s data activities. The timing and amount of such payments and voice networks; (iv) the addition of new capabili- can vary significantly based on various factors, includ- ties, such as data warehousing and video conferencing; ing the day of the week on which a period ends and the (v) the cost of software for various corporate needs, existence of holidays on or immediately following a including a new financial accounting system and period end. expanded web reporting capabilities; and (vi) replace- The remaining decrease was primarily the result ment computer equipment for corporate employees. of a long-term cash security deposit of $15 million with Capitalized software development costs primarily the Company’s new health insurance carrier in December 2001. During 2002, the Company will make three additional cash security deposits of $5.0 million each with its health insurance carrier, no later than the first day of April, July and October. related to (i) functionality enhancements to the Employee Service Center;SM (ii) the ongoing development of additional functionality for AIMS, the Company’s proprietary PEO information system; and (iii) the enhancement of My MarketPlaceSM. Cash Flows From Investing Activities >> Capital expenditures totaled $36.7 million in 2001. The level Capital expenditures for furniture and fixtures and building improvements were largely related to equip- of capital expenditures incurred in the past three years ping and furnishing a new service center in Los Angeles has been significantly higher than the periods prior and five new sales offices, along with expansion of the to 1999 and has related directly to the Company’s Company’s corporate data center and the expansion of strategic initiatives and national expansion. Capital sales offices to accommodate additional service person- expenditures in 2001 were as follows: nel in the Company’s sales markets. (in millions) Construction in progress Computer hardware and software Buildings and improvements Software development costs Furniture and fixtures Vehicles Total $ $ 14.1 11.0 4.1 3.5 3.0 1.0 36.7 The Company expects a comparable level of capital expenditures in 2002 with a budget of approximately $22.3 million, excluding the cost of the new facilities at its corporate headquarters. This amount is primarily composed of continued software development, computer hardware and software costs and continued expansion of sales offices and service centers to accommodate the ongoing growth of the Company. 34 | ADMINISTAFF Net purchases of marketable securities during As of December 31, 2001, all borrowings under the line 2001 primarily represented the investment of excess of credit have been used to finance the Company’s funds in longer-term, higher-yielding securities. construction in progress. The Company has not yet Cash Flows From Financing Activities >> The $15.4 million increase in cash provided by financing determined whether it will seek long-term financing upon completion of its new facility. However, the activities was primarily due to the $13.5 million bor- Company believes it could obtain such financing at com- rowed as of December 31, 2001 under the revolving mercially reasonable rates. credit agreement. In 2001, the Company entered into a During 2001, the Company received $22.8 million $21 million revolving credit agreement that expires on in proceeds from the exercise of 1,073,729 common November 30, 2002. At the option of the Company, stock purchase warrants by American Express. The amounts borrowed under the agreement accrue interest Company also received $3.6 million in proceeds from at the bank’s prime rate or LIBOR plus 0.45% as deter- the exercise of 341,335 stock options by the Company’s mined at the time of the borrowing (weighted average employees. The Company used $21.6 million to repur- interest rate of 2.55% at December 31, 2001). The chase 900,000 shares of common stock under its share revolving line of credit is 100% secured by cash and repurchase program. marketable securities held in custody by the bank. Contractual Obligations and Commercial Commitments >> The following table summarizes the Company’s contractual obligations and commercial commitments as of December 31, 2001 and the effect they are expected to have on its liquidity and capital resources: (in thousands) Contractual obligations: Revolving line of credit Non-cancelable operating leases Security deposit funding Facilities construction completion costs Total contractual cash obligations Other commercial commitments: Revolving line of credit – remaining Total Less than 1 Year 1–3 Years After 3 Years $ $ $ 13,500 57,955 15,000 8,728 95,183 7,500 $ $ $ 13,500 8,567 15,000 8,728 45,795 7,500 $ $ $ – 16,106 – – 16,106 – $ $ $ – 33,282 – – 33,282 – OTHER MATTERS Deferred Income Taxes >> The Company had net deferred tax liabilities of $4.8 million at December 31, 2001, versus $6.4 million at December 31, 2000. This decrease is due primarily to differences between the book and tax basis of depreciation, uncollectible accounts receivable, prepaid commissions and software development costs. As a result of the write-off of the investment in VGI, the Company has a capital loss carryforward of $3.5 million that will expire in 2006, but can only be used to offset future capital gains. The Company has recorded a valuation allowance against the related deferred tax asset as it is uncertain that it will be able to utilize the capital loss carryforward in future years. 2001 ANNUAL REPORT | 35 Health Insurance Costs >> On November 5, 2001, the Company filed a lawsuit against Aetna, its former While the Company cannot predict the ultimate outcome or the timing of a resolution of this dispute or health insurance carrier. The Company has asserted the related lawsuit and counterclaim, the Company claims against Aetna for breach of contract, economic plans to vigorously pursue its case. In addition, the duress, negligent misrepresentation, breach of good Company believes that Aetna’s allegations in the coun- faith and fair dealing, and violations of the Texas terclaim are without merit and intends to defend itself Insurance Code. The Company has alleged that during vigorously. However, an adverse outcome in this dispute the third quarter of 2001, Aetna placed the Company could have a material adverse effect on the Company’s under economic duress by threatening, without any results of operations or financial condition. legal right, to terminate the Company’s health insur- ance plan if Administaff did not pay immediate and Investments in Other Companies >> During 2000, the Company purchased convertible preferred stock of retroactive rate increases, even though Aetna had not Virtual Growth, Inc. (“VGI”) for a total cost of approxi- provided at least two quarters advance notice as mately $3.2 million. During 2001, the Company pur- required under the contract. In addition, the Company chased an additional $319,000 of convertible preferred has alleged that Aetna failed to properly administer stock and made loans to VGI totaling $224,000. In the health plan and to produce timely and accurate December 2001, VGI filed for bankruptcy protection. As reports regarding the health plan’s claims data and a result of the filing, the Company incurred a one-time financial condition. While the Company is still in the write-off for all investments as of that date totaling process of quantifying its damages, it intends to seek $3.8 million ($3.7 million net of tax). damages in excess of $42 million, including approxi- In January 2002, the Company purchased substan- mately $12.7 million related to increased health insur- tially all of the assets of VGI through bankruptcy pro- ance costs in the third and fourth quarters of 2001. ceedings for a total cost of approximately $1.3 million. On January 28, 2002, Aetna filed its answer deny- The Company has established a new subsidiary, known ing the claims asserted by the Company and, as antici- as Administaff Financial Management Services, Inc., to pated by the Company, filed a counterclaim. In the provide outsourced accounting and bookkeeping serv- counterclaim, Aetna has alleged that the Company has ices using the assets acquired from VGI. The Company violated ERISA, breached its contractual obligations expects these newly established operations to be dilu- by failing to pay premiums owed to Aetna, and made tive to its net income per share by approximately $0.02 material misrepresentations during its negotiations of to $0.03 per share in 2002. rates with Aetna for the purpose of delaying rate increases while the Company sought a replacement health insurance carrier. On February 20, 2002, the Reliance National Indemnity Co. Bankruptcy Liquidation >> In October 2001, the Company’s former workers’ compensation insurance carrier, Reliance Company received Aetna’s initial disclosures related to National Indemnity Co., was forced into bankruptcy the lawsuit and counterclaim, in which Aetna stated its liquidation. At December 31, 2001, the estimated out- preliminary calculation of damages at approximately standing claims under the Company’s Reliance poli- $30 million. cies totaled approximately $8.8 million. State laws 36 | ADMINISTAFF regarding the handling of the open claims of liquidated insurance carriers vary. Most states have established funds through guaranty associations to pay such remaining claims. However, several states have provi- sions that could be construed to return the liability for open claims to the companies that had policies with the liquidated insurance carrier, typically based on net worth. In anticipation of this situation, the Company secured insurance coverage totaling $1.8 million from its current workers’ compensation carrier to cover potential claims returned to the Company related to its Reliance policies. While the Company believes, based on its analysis of applicable state provisions, that its insurance coverage will be adequate to cover any potential losses, it is possible that such losses could exceed the Company’s insurance coverage limit. Seasonality, Inflation and Quarterly Fluctua- tions >> Historically, the Company’s earnings pattern has included losses in the first quarter followed by improved profitability in subsequent quarters through- out the year. This pattern is due to the effects of employ- ment-related taxes which are based on each employee’s 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 each employee are generally earned and collected at a relatively con- stant 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 Com- pany, have been randomly selected by the IRS for audit pursuant to this program. One issue that has arisen from these audits is whether a PEO can be a co-employer of worksite employees, including officers and owners of client companies, for various purposes under the Internal Revenue Code of 1986, as amended (the “Code”), including participation in the PEO’s 401(k) plan. With respect to the 401(k) plan audit, the IRS Houston District has sought technical advice (the “Tech- nical Advice Request”) from the IRS National Office about whether participation in the 401(k) plan by work- site 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 con- clusions of the IRS Houston District with respect to the 1993 plan year that the 401(k) plan should be disquali- fied because it covers worksite employees who are not employees of the Company. The Company’s response refutes the conclusions of the IRS Houston District. 2001 ANNUAL REPORT | 37 With respect to the Market Segment Group study, the respect to its cafeteria plan for the failure to withhold issue of whether a PEO and a client company may be and pay taxes applicable to salary deferral contribu- treated as co-employers of worksite employees for cer- tions by employees, including worksite employees. In tain federal tax purposes (the “Industry Issue”) has also such a scenario, the Company also would face the risk been referred to the IRS National Office. of client dissatisfaction and potential litigation. A The Company does not know whether the National retroactive application by the IRS of an adverse conclu- Office will address the Technical Advice Request inde- sion resulting in disqualification of the 401(k) plan pendently of the Industry Issue. The Company is not would have a material adverse effect on the Company’s able to predict either the timing or the nature of any financial position and results of operations. final decision that may be reached with respect to the 401(k) plan audit or with respect to the Technical Expenses Associated with Expansion >> The Com- pany’s past operating results have been affected by the Advice Request or the Market Segment Group study Company’s long-term national sales and service expan- and the ultimate outcome of such decisions. Should the sion. In many cases, the costs of this expansion have IRS conclude that the Company is not a “co-employer” been incurred in advance of the anticipated growth in of worksite employees for purposes of the Code, work- worksite employees (the primary driver of the Com- site employees could not continue to make salary defer- pany’s revenues). The Company expects to continue to ral contributions to the 401(k) plan or pursuant to the incur substantial additional operating expenses in the Company’s cafeteria plan or continue to participate in foreseeable future as a result of continuing national certain other employee benefit plans of the Company. expansion. See page 22 for a discussion of the types of The Company believes that, although unfavorable to expenses incurred in this expansion. the Company, a prospective application of such a con- clusion (that is, one applicable only to periods after the conclusion by the IRS is finalized) would not have a Estimated Costs and Effectiveness of Capital Pro- jects and Investments in Infrastructure >> The Com- pany currently has several strategic initiatives in material adverse effect on its financial position or progress, which have significantly increased the level results of operations, as the Company could continue to of capital expenditures and related depreciation make available comparable benefit programs to its expense incurred over the past several years. These client companies at comparable costs to the Company. capital expenditures have been, and will continue to However, if the IRS National Office adopts the conclu- be, primarily associated with the expansion and sions of the IRS Houston District set forth in the Tech- upgrade of the Company’s technology and telecommu- nical Advice Request and any such conclusions were nications infrastructure, Internet service delivery applied retroactively to disqualify the 401(k) plan for capabilities, and corporate headquarters, sales and 1993 and subsequent years, employees’ vested account service facilities. There can be no assurances that the balances under the 401(k) plan would become taxable, Company’s cost to complete these projects will be as the Company would lose its tax deductions to the extent estimated or that the ultimate effectiveness of such its matching contributions were not vested, the 401(k) projects will provide the necessary operating efficiencies plan’s trust would become a taxable trust and the Com- required to offset the resulting increases in depreciation pany would be subject to liability with respect to its fail- and amortization expense which accompany these ure to withhold applicable taxes with respect to certain expenditures. In addition, the Company may require contributions and trust earnings. Further, the Company additional capital resources to fund these and future would be subject to liability, including penalties, with capital expenditure requirements. 38 | ADMINISTAFF Estimated Costs and Effectiveness of eBusiness Strategy >> While the Company believes that its eBusiness strategy will ultimately lead to increased The Company experienced a 13.4% increase in ben- efits costs per covered employee during 2001 and expects a similar increase in 2002. While the Company’s profitability through new revenue streams, operating results of operations will be impacted to some degree in expense savings and higher client retention, it is pos- 2002 by the expected increase and its contractual con- sible that diminished profitability could occur in straints, the Company does not expect this situation to future periods as a result of these initiatives. have a material adverse effect on its financial position. Among the factors which could affect the success The Company is currently in a dispute with Aetna, of the Company’s eBusiness strategy are (i) the Internet its former health insurance carrier, relating to health connectivity and computer literacy of the Company’s insurance costs increases during 2001 and Aetna’s clients; (ii) the willingness of clients to accept the administration of its health plan over the last several Company’s Internet-based service delivery platform, years. For a discussion of the Company’s dispute with the Employee Service Center; (iii) the Company’s Aetna, see “Other Matters – Health Insurance Costs” on ability to identify, negotiate and integrate offerings on page 35. An unfavorable outcome in this dispute could My MarketPlace; (iv) the attraction of clients and have a material adverse effect on the Company’s finan- worksite employees to My MarketPlace; (v) the effective cial position or results of operations. generation of revenues from the eBusiness initiatives, In October 2001, the Company’s former workers’ particularly My MarketPlace; (vi) unanticipated devel- compensation insurance carrier, Reliance National opment costs related to the eBusiness initiatives; and Indemnity Co., was forced into bankruptcy liquidation. (vii) the Company’s ability to control or reduce operating At December 31, 2001, the estimated outstanding expenses as a result of the eBusiness initiatives, par- claims under the Company’s Reliance policies totaled ticularly the Employee Service Center. Increases in Health Insurance Premiums, Unem- ployment Taxes and Workers’ Compensation Rates >> Health insurance premiums, state unemployment approximately $8.8 million. State laws regarding the handling of the open claims of liquidated insurance car- riers vary. Most states have established funds to pay such remaining claims. However, several states have taxes and workers’ compensation rates are in part provisions that could be construed to return the liability determined by the Company’s claims experience and for open claims to the companies that had policies with comprise a significant portion of the Company’s direct the liquidated insurance carrier, typically based on net costs. The Company employs extensive risk manage- worth. In anticipation of this situation, the Company ment procedures in an attempt to control its claims secured insurance coverage totaling $1.8 million from incidence and structures its benefits contracts to pro- its current workers’ compensation carrier to cover vide as much cost stability as possible. However, should potential claims returned to the Company related to its the Company experience a large increase in claim Reliance policies. While the Company believes, based on activity, its unemployment taxes, health insurance its analysis of applicable state provisions, that its insur- premiums or workers’ compensation insurance rates ance coverage will be adequate to cover any potential could increase. The Company’s ability to incorporate losses, it is possible that such losses could exceed the such increases into service fees to clients is constrained Company’s insurance coverage limit. by contractual arrangements with clients, which could result in a delay before such increases could be Failure to Manage Growth >> The Company has experienced significant growth and expects such growth reflected in service fees. As a result, such increases to continue for the foreseeable future. As described could have a material adverse effect on the Company’s under the above caption “Expenses Associated with financial condition or results of operations. Expansion,” the costs associated with the Company’s 2001 ANNUAL REPORT | 39 sales and service expansion have been significant. company. If a client company does not pay the Company Accordingly, the Company’s expansion plan may place or if the costs of benefits provided to worksite employees a significant strain on the Company’s management, exceed the fees paid by a client company, the Company’s financial, operating and technical resources. Failure to ultimate liability for worksite employee payroll and manage this growth effectively could have a material benefits costs could have a material adverse effect on its adverse effect on the Company’s financial condition or financial condition or results of operations. results of operations. Potential Impairment of Investments in Other Companies >> The Company has made an investment totaling $2.5 million in eProsper, Inc., which is in the 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- early stages of development. This company is likely to employer relationship with employees assigned to work require additional capital in the future. If this company at client company locations, the Company assumes cer- is unable to raise sufficient additional capital to con- tain obligations and responsibilities of an employer tinue as a going concern, or if it raises capital at lower under these laws. However, many of these laws (such as valuation levels than those at the time Administaff the Employee Retirement Income Security Act made its investment, Administaff’s investments in this (“ERISA”) and federal and state employment tax laws) company could become impaired. In that event, Admin- do not specifically address the obligations and istaff would be required to write off all or a portion of responsibilities of non-traditional employers such as this investment. Although Administaff does not believe PEOs, and the definition of “employer” under these that such an impairment would materially affect its laws is not uniform. In addition, many of the states in consolidated financial position, an impairment would which the Company operates have not addressed the likely reduce Administaff’s net income materially in the PEO relationship for purposes of compliance with period in which the impairment occurred. During 2001, applicable state laws governing the employer/employee the Company wrote off a $3.8 million investment in relationship. If these other federal or state laws are another development-stage company. See “Other Mat- ultimately applied to the Company’s PEO relationship ters – Investments in Other Companies” on page 35. with its worksite employees in a manner adverse to the Liability for Worksite Employee Payroll and Benefits Costs >> Under the Client Service Agreement (“CSA”), the Company becomes a co-employer of work- Company, such an application could have a material adverse effect on the Company’s results of operations or financial condition. site employees and assumes the obligations to pay the While many states do not explicitly regulate PEOs, salaries, wages and related benefits costs and payroll 21 states (including Texas) have passed laws that have taxes of such worksite employees. The Company licensing or registration requirements for PEOs, and assumes such obligations as a principal, not merely as several other states are considering such regulation. an agent of the client company. The Company’s obliga- Such laws vary from state to state, but generally pro- tions include responsibility for (i) payment of the vide for monitoring the fiscal responsibility of PEOs, salaries and wages for work performed by worksite and in some cases codify and clarify the co-employment employees, regardless of whether the client company relationship for unemployment, workers’ compensa- makes timely payment to the Company of the associ- tion and other purposes under state law. While the ated service fee; and (ii) providing benefits to worksite Company generally supports licensing regulation employees even if the costs incurred by Administaff to because it serves to validate the PEO relationship, provide such benefits exceed the fees paid by the client there can be no assurance that the Company will be 40 | ADMINISTAFF able to satisfy licensing requirements or other applica- American Express customer base. The Company ble regulations for all states. In addition, there can be believes that the agreement will enhance its ability to no assurance that the Company will be able to renew increase its base of worksite employees and clients; its licenses in all states. however, there can be no assurances to that effect. Loss of Benefits Plans >> The maintenance of health and workers’ compensation insurance plans that Among the factors that could cause the effectiveness of the Marketing Agreement to be less than antici- cover worksite employees is a significant part of the pated are the ability of American Express to provide Company’s business. While the Company believes that qualified prospects, the Company’s ability to make replacement contracts could be secured on competitive timely presentations to all of the American Express terms without causing significant disruption to the prospects and the Company’s ability to convert those Company’s business, there can be no assurance in this prospects into clients. regard. The Company replaced its health insurance car- rier effective January 1, 2002. See “Other Matters – Liabilities for Client and Employee Actions >> A number of legal issues remain unresolved with respect Health Insurance Costs.” The current health and work- to the co-employment arrangement between a PEO and ers’ compensation contracts expire on December 31, its worksite employees, including questions concerning 2002 and September 30, 2003, respectively. the ultimate liability for violations of employment and Need to Renew or Replace Client Companies >> The Company’s standard CSA is subject to cancellation discrimination laws. The Administaff CSA establishes the contractual division of responsibilities between the on 60 to 180 days notice by either the Company or the Company and its clients for various personnel manage- client. Accordingly, the short-term nature of the CSA ment matters, including compliance with and liability makes the Company vulnerable to potential cancella- under various governmental regulations. However, tions by existing clients, which could materially and because the Company acts as a co-employer, the Com- adversely affect the Company’s financial condition and pany may be subject to liability for violations of these or results of operations. In addition, the Company’s results other laws despite these contractual provisions, even if of operations are dependent in part upon the Company’s it does not participate in such violations. Although the ability to retain or replace its client companies upon the CSA provides that the client is to indemnify the Com- termination or cancellation of the CSA. Historically, the pany for any liability attributable to the conduct of the Company’s average client attrition rate has been client, the Company may not be able to collect on such a approximately 20%. However, the number of contract contractual indemnification claim and thus may be cancellations could increase in the future. During 2001, responsible for satisfying such liabilities. In addition, the Company’s client attrition ratio increased to approx- worksite employees may be deemed to be agents of the imately 25% due to softness in U.S. economic conditions. Marketing Agreement with American Express >> The Company has entered into a Marketing Agreement with American Express to jointly market the Company’s Company, subjecting the Company to liability for the actions of such worksite employees. Geographic Market Concentration >> While the Company has sales offices in 19 markets, the Com- services to American Express’ substantial small and pany’s Houston and Texas (including Houston) markets medium-sized business customer base across the coun- accounted for approximately 25.1% and 44.9%, respec- try. Under the terms of the Marketing Agreement, tively, of the Company’s revenue for the year ended American Express is utilizing its resources and working December 31, 2001. Accordingly, while a primary aspect jointly with the Company to generate appointments of the Company’s strategy is expansion in its current with prospects for the Company’s services from the and future markets outside of Texas, for the foreseeable 2001 ANNUAL REPORT | 41 future, a significant portion of the Company’s revenues the Federal Unemployment Tax Act (“FUTA”). Under may be subject to economic factors specific to Texas the Code, employers have the obligation to withhold and (including Houston). While the Company believes that remit the employer portion and, where applicable, the its market expansion plans will eventually lessen this employee portion of these taxes. Most states impose risk in addition to generating significant revenue similar employment tax obligations on the employer. growth, there can be no assurance that the Company While the CSA provides that the Company has sole will be able to duplicate in other markets the revenue legal responsibility for making these tax contributions, growth and operating results experienced in its Texas the IRS or applicable state taxing authority could con- (including Houston) markets. clude that such liability cannot be completely trans- Competition and New Market Entrants >> The PEO industry is highly fragmented. Many of these ferred to the Company. Accordingly, in the event the Company fails to meet its tax withholding and payment PEOs have limited operations and fewer than 1,000 obligations, the client company may be held jointly and worksite employees, but there are several industry severally liable therefor. While this interpretive issue participants that are comparable in size to the Com- has not, to the Company’s knowledge, discouraged pany. The Company also encounters competition from clients from enrolling with the Company, there can be “fee for service” companies such as payroll processing no assurance that a definitive adverse resolution of this firms, insurance companies and human resource con- issue would not do so in the future. sultants. Several of the Company’s competitors are PEO divisions of large business services companies, such as Automatic Data Processing, Inc. and Paychex, 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 their PEO 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 competi- tion 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 fed- eral 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 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 inter- est income earned on these investments. The available- for-sale marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate. As a result, the market values of these securities are affected by changes in prevailing interest rates. The Company attempts to limit its exposure to interest rate risk primarily through diversification and low investment turnover. The Company’s marketable securities are currently managed by three professional investment management companies, each of which is guided by the Company’s investment policy. 42 | ADMINISTAFF The Company’s investment policy is designed to maxi- mize after-tax interest income while preserving its principal investment. As a result, the Company’s mar- ketable securities consist primarily of short and intermediate-term debt securities. As of December 31, 2001, 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 amor- tized cost basis, fair market value and 30-day yield of this investment was $10.1 million, $10.2 million and 4.01% at December 31, 2001. The following table presents information about the Company’s remaining available- for-sale marketable securities as of December 31, 2001: (dollars in thousands) 2002 2003 2004 2005 2006 Total Fair Market Value Average Interest Rate 5.0 % 5.4 % 5.5 % – 4.6 % 5.2 % Principal Maturities 14,215 $ 18,695 1,632 – 2,355 $ 36,897 $ 37,767 The Company’s revolving credit agreement includes variable interest rates, and as a result, the Company’s total cost of borrowing under the revolving credit agreement is also subject to interest rate risk. The Company had borrowed $13.5 million under the revolving credit agreement as of December 31, 2001, with an average interest rate of 2.55%. The revolving credit agreement expires in November 2002. 2001 ANNUAL REPORT | 43 REPORT OF INDEPENDENT AUDITORS BOARD OF DIRECTORS AND STOCKHOLDERS ADMINISTAFF, INC. We have audited the accompanying consolidated the accounting principles used and significant estimates balance sheets of Administaff, Inc. as of December 31, made by management, as well as evaluating the overall 2001 and 2000, and the related consolidated statements financial statement presentation. We believe that our of operations, stockholders’ equity and cash flows for audits provide a reasonable basis for our opinion. each of the three years in the period ended December In our opinion, the consolidated financial state- 31, 2001. These financial statements are the responsi- ments referred to above present fairly, in all mate- bility of the Company’s management. Our responsibility rial respects, the consolidated financial position of is to express an opinion on these financial statements Administaff, Inc. at December 31, 2001 and 2000, and based on our audits. the consolidated results of its operations and its cash We conducted our audits in accordance with audit- flows for each of the three years in the period ended ing standards generally accepted in the United States. December 31, 2001, in conformity with accounting Those standards require that we plan and perform the principles generally accepted in the United States. audit to obtain reasonable assurance about whether the financial statements are free of material misstate- ERNST & YOUNG LLP ment. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Houston, Texas financial statements. An audit also includes assessing February 8, 2002 44 | ADMINISTAFF 44 | ADMINISTAFF CONSOLIDATED BALANCE SHEETS (in thousands) ASSETS Current assets: Cash and cash equivalents Marketable securities Accounts receivable: Trade Unbilled Other Prepaid expenses Notes receivable from employees Deferred income tax benefit Total current assets Property and equipment: Land Buildings and improvements Computer hardware and software Software development costs Furniture and fixtures Vehicles Construction in progress Accumulated depreciation Total property and equipment Other assets: Deposits Notes receivable from employees Other assets Total other assets Total assets December 31, 2001 2000 $ 53,000 47,961 $ 69,733 38,953 4,314 70,206 1,440 3,739 694 767 182,121 2,920 18,274 39,723 15,072 20,666 2,372 14,272 113,299 (41,405) 71,894 15,627 – 4,361 19,988 7,311 57,084 820 6,785 — 694 181,380 2,920 14,047 28,679 11,556 18,756 1,863 195 78,016 (25,649) 52,367 421 994 7,655 9,070 $ 274,003 $ 242,817 (in thousands) LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable Payroll taxes and other payroll deductions payable Accrued worksite employee payroll expense Revolving line of credit Other accrued liabilities Income taxes payable Total current liabilities Noncurrent liabilities: Deferred income taxes Total noncurrent liabilities Commitments and contingencies Stockholders’ equity: Preferred stock, par value $0.01 per share: Shares authorized – 20,000 Shares issued and outstanding – none Common stock, par value $0.01 per share: Shares authorized – 120,000 Shares issued – 30,776 and 30,435 at December 31, 2001 and 2000, respectively Additional paid-in capital Treasury stock, at cost – 2,839 and 3,015 shares at December 31, 2001 and 2000, respectively Accumulated other comprehensive income (net of tax) Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying notes. 2001 ANNUAL REPORT | 45 2001 ANNUAL REPORT | 45 December 31, 2001 2000 $ 4,332 43,694 68,964 13,500 14,487 535 145,512 5,556 5,556 $ 1,496 57,919 57,354 – 10,819 2,613 130,201 7,106 7,106 – – 308 95,114 (33,467) 324 60,656 122,935 304 75,378 (20,643) 172 50,299 105,510 $ 274,003 $ 242,817 46 | ADMINISTAFF 46 | ADMINISTAFF CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) Revenues Direct costs: Salaries and wages of worksite employees Benefits and payroll taxes Gross profit Operating expenses: Salaries, wages and payroll taxes General and administrative expenses Commissions Advertising Depreciation and amortization Write-off of software development costs Operating income Other income (expense): Interest income Write-off of investment in other companies Other, net Income before income tax expense Income tax expense Net income Basic net income per share of common stock Diluted net income per share of common stock See accompanying notes. Year ended December 31, 2001 4,373,244 $ 2000 3,708,531 $ 1999 2,260,743 $ 3,653,025 555,204 165,015 3,110,240 459,757 138,534 1,887,231 283,984 89,528 67,761 44,569 11,173 6,092 16,881 – 146,476 18,539 4,128 (3,786) 506 848 19,387 9,030 10,357 0.38 0.36 $ $ $ 54,477 35,426 9,278 5,117 12,002 – 116,300 22,234 4,430 – (50) 4,380 26,614 9,714 16,900 0.62 0.58 $ $ $ 36,690 23,219 6,429 4,090 7,103 1,438 78,969 10,559 2,562 – 1,091 3,653 14,212 4,854 9,358 0.34 0.34 $ $ $ CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY 2001 ANNUAL REPORT | 47 2001 ANNUAL REPORT | 47 (in thousands) Balance at December 31, 1998 Purchase of treasury stock, at cost Sale of common stock put warrant Exercise of stock options Income tax benefit from exercise of stock options Other Change in unrealized gain (loss) on marketable securities Net income Comprehensive income Common Stock Issued Shares 29,719 – – 98 Amount $ 297 – – 1 Additional Paid-In Capital $ 64,145 – 119 643 Accumulated Other Comprehensive Income (Loss) $ 342 – – – $ Treasury Stock (1,968) (16,132) – – Retained Earnings $ 24,041 – – – – – – – – – – – 95 59 – – – 28 – – – – – – (560) – – 9,358 Total $ 86,857 (16,132) 119 644 95 87 (560) 9,358 8,798 Balance at December 31, 1999 29,817 298 65,061 (18,072) (218) 33,399 80,468 Purchase of treasury stock, at cost Sale of common stock put warrant Exercise of stock options Income tax benefit from exercise of stock options Other Change in unrealized gain on marketable securities Net income Comprehensive income – – 618 – – – – – – 6 – – – – – 125 5,689 4,437 66 – – (2,581) – – – 10 – – – – – – – – – – – – 390 – – 16,900 (2,581) 125 5,695 4,437 76 390 16,900 17,290 Balance at December 31, 2000 30,435 304 75,378 (20,643) 172 50,299 105,510 Purchase of treasury stock, at cost Exercise of common stock purchase warrant Exercise of stock options Income tax benefit from exercise of stock options Other Change in unrealized gain on marketable securities (net of tax) Net income Comprehensive income – – 341 – – – – – – 4 – – – – – (21,566) 14,136 3,620 1,957 23 – – 8,707 – – 35 – – – – – – – – – – – – 152 – – 10,357 (21,566) 22,843 3,624 1,957 58 152 10,357 10,509 Balance at December 31, 2001 30,776 $ 308 $ 95,114 $ (33,467) $ 324 $ 60,656 $ 122,935 See accompanying notes. 48 | ADMINISTAFF CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Write-off of investment in other companies Write-off of software development costs Deferred income taxes Bad debt expense Loss (gain) on disposition of assets Changes in operating assets and liabilities: Accounts receivable Prepaid expenses Deposits and other assets Accounts payable Payroll taxes and other payroll deductions payable Accrued worksite employee payroll expense Other accrued liabilities Income taxes payable/receivable Total adjustments Net cash provided by operating activities Cash flows from investing activities: Marketable securities: Purchases Proceeds from maturities Proceeds from dispositions Property and equipment: Purchases Construction in progress Investment in software development costs Proceeds from dispositions Investments in other companies Net cash used in investing activities Cash flows from financing activities: Purchase of treasury stock Proceeds from the sale of common stock put warrants Proceeds from the exercise of common stock purchase warrants Borrowings under revolving line of credit Proceeds from the exercise of stock options Loans to employees Other Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures: Cash paid for income taxes See accompanying notes. Year ended December 31, 2001 2000 1999 $ 10,357 $ 16,900 $ 9,358 17,075 3,786 – (1,834) 1,783 (82) (12,528) 3,046 (14,833) 2,836 (14,225) 11,610 3,668 (121) 181 10,538 (56,604) 39,005 8,817 (19,156) (14,076) (3,516) 431 (931) (46,030) (21,566) – 22,843 13,500 3,624 300 58 18,759 (16,733) 69,733 53,000 11,259 $ $ 11,969 – – 1,955 1,475 81 (32,484) 1,547 1,282 (1,291) 36,401 25,987 5,082 5,686 57,690 74,590 (27,310) 15,954 3,512 (15,445) – (4,769) 224 (5,789) (33,623) (2,581) 125 – – 5,695 – 76 3,315 44,282 25,451 69,733 2,073 $ $ 7,604 – 1,438 1,586 699 (182) (8,855) (5,863) 808 232 (5,089) 12,206 989 2,885 8,458 17,816 (13,459) 4,120 27,397 (13,848) – (5,166) 165 – (791) (16,132) 119 – – 644 187 87 (15,095) 1,930 23,521 25,451 383 $ $ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2001 ANNUAL REPORT | 49 NOTE 1. ACCOUNTING POLICIES Description of Business >> Administaff, Inc. (“the Company”) is a professional employer organization (“PEO”) that provides a comprehensive Personnel Man- agement System encompassing a broad range of serv- ices, including benefits and payroll administration, health and workers’ compensation insurance programs, personnel records management, employer liability management, employee recruiting and selection, per- formance management, and training and development services to small and medium-sized businesses in strategically selected markets. During 2001, 2000 and 1999, revenues from the Company’s Texas markets represented 45%, 50% and 61% of the Company’s total revenues, respectively. Segment Reporting >> The Company operates in one reportable segment under the Statement of Finan- cial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Informa- tion 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 instru- ments 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 appli- cable payroll date. As such, the Company generally does not require collateral. Marketable Securities >> The Company accounts for marketable securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company determines the appro- priate 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, 2001 and 2000, all of the Company’s investments in marketable securities were classified as available-for-sale, and as a result, were reported at fair value. Unrealized gains and losses are reported as a component of accumulated other com- prehensive income (loss) in stockholders’ equity. The amortized cost of debt securities is adjusted for amorti- zation 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 deduc- tion from the coupon interest earned on the invest- ments. 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 equip- ment is recorded at cost and is depreciated over the estimated useful lives of the related assets using the straight-line method. The estimated useful lives of property and equipment for purposes of computing depreciation are as follows: Buildings and improvements Computer hardware and software Software development costs Furniture and fixtures Vehicles 5–30 years 2–5 years 3–5 years 5–7 years 5 years At December 31, 2001, construction in progress related to the construction of a new facility at the Com- pany’s Kingwood, Texas headquarters. Construction of the new facility is expected to be completed in the third quarter of 2002. The Company is contractually committed to $8.7 million in additional costs related to the completion of the facility at December 31, 2001. 50 | ADMINISTAFF Software development costs relate primarily to During 1999, the Securities and Exchange Com- the Company’s proprietary professional employer infor- mission issued Staff Accounting Bulletin (“SAB”) mation system and its Internet-based service delivery No. 101, Revenue Recognition. Additionally, the Emerg- platform, the Employee Service Center, and are ing Issues Task Force (“EITF”) reached a consensus accounted for in accordance with Statement of Position during 2000 on EITF 99-19, Reporting Revenue Gross (“SOP”) 98-1, Accounting for the Costs of Computer Soft- as a Principal versus Net as an Agent. The Company ware Developed or Obtained for Internal Use. The Com- evaluated its revenue recognition policies, and the pany periodically evaluates its capitalized software effect of adopting SAB 101 and EITF 99-19 resulted in development costs for impairment in accordance with no revisions to the Company’s previous recognition SFAS No. 121, Accounting for Impairment of Long- policies. The Company is deemed to be a principal in Lived Assets and Long-Lived Assets to be Disposed Of. its personal management services because it is at During the fourth quarter of 1999, the Company wrote risk for the payment of direct costs, whether or not the off $1,438,000 related to two terminated projects after Company’s clients pay the Company on a timely basis evaluating the costs incurred to date, expected cost of or at all, and because the Company assumes a sig- completion, expected maintenance costs and the avail- nificant amount of other risks and liabilities as a ability of alternative software packages. co-employer of its worksite employees. As a result, the PEO Service Fees and Worksite Employee Payroll Costs >> The Company’s revenues consist of service fees paid by its clients under its Client Service Agree- Company records the full amount of its comprehensive service fees, including the portion that represents gross pay of worksite employees, as revenue in accordance ments, which are based upon each worksite employee’s with the EITF consensus. gross pay and a markup computed as a percentage of the gross pay. The Company includes the component of Fair Value of Financial Instruments >> The carry- ing amounts of cash, cash equivalents, accounts receiv- its comprehensive service fees related to the gross pay able and accounts payable approximate their fair values of its worksite employees as revenue. In consideration for payment of such service fees, the Company agrees to pay the following direct costs associated with the work- due to the short-term maturities of these instruments. Stock-Based Compensation >> The Company accounts for stock-based compensation arrangements site employees: (i) salaries and wages; (ii) employment- with employees under the provisions of Accounting related taxes; (iii) employee benefit plan premiums; and Principles Board Opinion No. 25, Accounting for Stock (iv) workers’ compensation insurance premiums. The Issued to Employees. Company accounts for PEO service fees and the related direct payroll costs using the accrual method. Under the Employee Savings Plan >> Effective January 1, 1999, the Company amended the employer matching accrual method, PEO service fees relating to worksite contribution and vesting features of its 401(k) plan. employees with earned but unpaid wages at the end of The Company matches 50% of an eligible worksite each period are recognized as unbilled revenues and the employee’s contributions and 100% of an eligible cor- related direct payroll costs for such wages are accrued as porate employee’s contributions, both up to 6% of the a liability during the period in which wages are earned employee’s eligible compensation. In addition, for by the worksite employee. Subsequent to the end of each active employees on or after January 1, 1999, the period, such wages are paid and the related PEO serv- vesting schedule for employer matching contribu- ice fees are billed. Unbilled receivables at December 31, tions was changed from five-year graded vesting to 2001 and 2000 are net of prepayments received prior to immediate vesting. During 2001, 2000 and 1999, the year-end of $6,125,000 and $5,716,000, respectively. Company made employer-matching contributions of 2001 ANNUAL REPORT | 51 $8,847,000, $7,433,000 and $4,646,000, respectively. method, deferred tax assets and liabilities are deter- Of these contributions, $6,831,000, $6,019,000 and mined based on differences between financial reporting $3,761,000 were made on behalf of worksite employees. and income tax carrying amounts of assets and liabili- The remainder represents employer contributions ties and are measured using the enacted tax rates and made on behalf of corporate employees. laws that will be in effect when the differences are Advertising >> The Company expenses all adver- expected to reverse. tising costs as incurred. Income Taxes >> The Company uses the liability method in accounting for income taxes. Under this Reclassifications >> Certain prior year amounts have been reclassified to conform to the 2001 presentation. NOTE 2. MARKETABLE SECURITIES As of December 31, 2001, the Company’s investments in marketable securities consisted of debt securities with maturities ranging from 91 days to five years from the date of purchase. Approximately 29.9% of the marketable securities mature within one year of the balance sheet date. However, all of the Company’s marketable securities are avail- able to fund the Company’s current operations, except for balances securing the Company’s revolving credit agreement. The following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2001 and 2000: (in thousands) DECEMBER 31, 2001 U.S. corporate debt securities U.S. Treasury securities and obligations of U.S. government agencies Fixed income mutual funds Obligations of state and local government agencies Foreign corporate debt securities Commercial paper DECEMBER 31, 2000 Fixed income mutual funds Obligations of state and local government agencies Commercial paper U.S. corporate debt securities U.S. Treasury securities and obligations of U.S. government agencies Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ $ $ $ 16,350 13,367 10,068 4,909 1,634 1,098 47,426 13,025 11,873 8,277 3,761 1,845 38,781 $ $ $ $ 267 111 126 47 28 1 580 101 11 – 29 35 176 $ $ $ $ (1) (44) — — — — (45) – – (4) – – (4) $ $ $ $ 16,616 13,434 10,194 4,956 1,662 1,099 47,961 13,126 11,884 8,273 3,790 1,880 38,953 For the years ended December 31, 2001, 2000 and 1999, net realized gains (losses) on sales of available-for-sale marketable securities were $56,000, $(31,000) and $92,000, respectively. 52 | ADMINISTAFF NOTE 3. DEPOSITS In December 2001, the Company made a cash security deposit of $15.0 million with its new health insurance carrier, UnitedHealthcare. During 2002, the Company will make three additional deposits of $5.0 million each no later than the first day of April, July and October. NOTE 4.NOTES RECEIVABLE FROM EMPLOYEES In June 1995, an officer and director of the Com- pany exercised options to purchase 897,334 shares of common stock at a price of $0.375 per share. The pur- chase 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 offi- cer 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 transac- tion. In 2001, the $300,000 note was repaid. The remain- ing loan is repayable on June 22, 2002, accrues interest at 6.83%, and is secured by 97,964 shares of the Com- pany’s common stock. NOTE 5. OTHER ASSETS During 2000, the Company purchased convertible preferred stock of Virtual Growth, Inc. (“VGI”) for a total cost of approximately $3.2 million. During 2001, the Company purchased an additional $319,000 of convertible preferred stock and made loans to VGI totaling $224,000. In December 2001, VGI filed for bankruptcy protection. As a result of the filing, the Company incurred a one-time write-off for all invest- ments in VGI as of that date totaling $3.8 million ($3.7 million net of tax). Subsequent to December 2001, the Company pur- chased substantially all of the assets of VGI through bankruptcy proceedings for a total cost of $1.3 million. In 2000, the Company purchased 500,000 shares of convertible preferred stock of eProsper, Inc. (“eProsper”) for $2.5 million. The eProsper preferred stock is convertible into an equal number of shares of eProsper common stock, subject to antidilution provisions. The Company has accounted for this investment using the cost method. NOTE 6. REVOLVING LINE OF CREDIT On May 25, 2001, the Company entered into a $21 million revolving credit agreement that expires on November 30, 2002. At the option of the Company, amounts borrowed under the agreement accrue at the bank’s prime rate or LIBOR plus 0.45% as determined at the time of borrowing (weighted average rate of 2.55% at December 31, 2001). The revolving line of credit is 100% secured by cash and marketable securities held in custody by the bank. As of December 31, 2001, the Company has borrowed $13.5 million under the line of credit, the proceeds of which have been used to finance the Company’s construction in progress. Interest expense under the line of credit, which totaled $84,000 in 2001, was capitalized to construction in progress. NOTE 7. INCOME TAXES Deferred taxes reflect the net tax effects of tempo- rary differences between the carrying amounts of assets and liabilities used for financial reporting pur- poses 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 bal- ance sheet are as follows: 2001 ANNUAL REPORT | 53 December 31, 2001 2000 The reconciliation of income tax expense computed at U.S. federal statutory tax rates to the reported (in thousands) Deferred tax liabilities: Software development costs Depreciation and amortization Prepaid commissions Unrealized gains on marketable securities Total deferred tax liabilities Deferred tax assets: Long-term capital loss Uncollectible accounts receivable State income taxes Other Valuation allowance Total deferred tax assets Net deferred tax liabilities Net current deferred tax assets Net noncurrent deferred tax liabilities $ (3,488) (1,824) (606) $ (3,623) (3,026) (824) (211) (6,129) – (7,473) 1,366 842 325 173 (1,366) 1,340 $ (4,789) 767 $ (5,556) $ (4,789) – 584 326 151 – 1,061 $ (6,412) 694 $ (7,106) $ (6,412) The components of income tax expense are Year ended December 31, 2001 2000 1999 $ 9,422 1,442 $ 6,584 1,175 $ 2,776 492 10,864 7,759 3,268 as follows: (in thousands) Current income tax expense: Federal State Total current income tax expense Deferred income tax expense (benefit): Federal State Total deferred income tax expense (1,834) 1,955 1,586 Total income tax expense $ 9,030 $ 9,714 $ 4,854 In 2001, 2000 and 1999, income tax benefits of $1,957,000, $4,437,000 and $95,000, respectively, resulting from deductions relating to nonqualified stock option exercises and disqualifying dispositions of cer- tain employee incentive stock options were recorded as increases in stockholders’ equity. income tax expense is as follows: (in thousands) Expected income tax expense at 35% (34% for 2000 and 1999) State income taxes, net of federal benefit Nondeductible expenses Tax-exempt interest income Valuation allowance against long-term capital loss Other, net Reported total income tax expense Year ended December 31, 2001 2000 1999 $ 6,786 $ 9,049 $ 4,832 924 255 985 180 488 126 (122) (234) (348) 1,208 (21) — (266) — (244) $ 9,030 $ 9,714 $ 4,854 As a result of the write-off of the investment in VGI, the Company has a capital loss carryforward of $3.5 million that will expire in 2006, but can only be used to offset future capital gains. The Company has recorded a valuation allowance against the related deferred tax asset as it is uncertain that it will be able to utilize the capital loss carryforward in future years. NOTE 8. STOCKHOLDERS’ EQUITY In 1998, the Company entered into a Securities Purchase Agreement with American Express Travel Related Services Company, Inc. (“American Express”) with exercise prices ranging from $20 to $40 per share and terms ranging from three to seven years. In February and November 2001, American Express exercised 800,000 and 273,729 common stock purchase warrants at $20.00 and $25.00 per share, respectively. The Company’s Board of Directors (the “Board”) has authorized a program to repurchase up to 5,000,000 shares of the Company’s outstanding common stock. The purchases are to be made from time to time in the (1,438) (396) 1,627 328 1,339 247 whereby the Company issued warrants to purchase 4,131,030 shares of common stock to American Express 54 | ADMINISTAFF open market or directly from stockholders at prevailing Incentive Plan have been stock options, primarily market prices based on market conditions or other fac- intended to qualify as “incentive stock options” within tors. During 2001, 2000 and 1999, the Company repur- the meaning of Section 422 of the Internal Revenue chased 900,000, 100,000 and 2,242,000 shares at a cost Code (the “Code”). The Incentive Plans also permit of $21.6 million, $2.6 million and $16.1 million, respec- stock awards, phantom stock awards, stock apprecia- tively. As of December 31, 2001, the Company had tion rights, performance units, other stock-based repurchased 3,242,000 shares under this program at a awards and cash awards, all of which may or may not total cost of approximately $40.3 million. The 1999 be subject to the achievement of one or more perform- repurchases included 289,200 shares purchased from ance objectives. The purposes of the Incentive Plans affiliates of Mr. Lang Gerhard, a greater than 10% generally are to retain and attract persons of training, shareholder at the repurchase date, in a private trans- experience and ability to serve as employees of the action for approximately $2.3 million. Company and its subsidiaries and to serve as non- At December 31, 2001, 20 million shares of pre- employee directors of the Company, to encourage the ferred stock were authorized and were designated as sense of proprietorship of such persons and to stimu- Series A Junior Participating Preferred Stock that is late the active interest of such persons in the develop- reserved for issuance on exercise of preferred stock ment and financial success of the Company and its purchase rights under Administaff’s Share Purchase subsidiaries. The Incentive Plans are administered by Rights Plan (the “Rights Plan”). Each issued share of the Compensation Committee of the Board of Directors the Company’s common stock has one-half of a (the “Committee”). The Committee has the power to preferred stock purchase right attached to it. No pre- determine which eligible employees will receive ferred shares have been issued and the rights are awards, the timing and manner of the grant of such not currently exercisable. The Rights Plan expires on awards, the exercise price of stock options (which may February 9, 2008. not be less than market value on the date of grant), the On October 16, 2000, the Company effected a two- number of shares and all of the terms of the awards. for-one stock split in the form of a 100% stock dividend. The Board has granted limited authority to the Presi- All share and per share amounts presented in these dent of the Company regarding the granting of stock financial statements have been retroactively restated to options to employees who are not officers. The Com- reflect this change in the Company’s capital structure. pany may at any time amend or terminate the Incen- NOTE 9. EMPLOYEE INCENTIVE PLANS The Administaff, Inc. 1997 Incentive Plan, as amended, and the 2001 Incentive Plan provide for options and other stock-based awards that may be tive Plans. However, no amendment that would impair the rights of any participant, with respect to outstand- ing grants, can be made without the participant’s prior consent. Stockholder approval of amendments to the Incentive Plans is necessary only when required by granted to eligible employees and non-employee direc- applicable law or stock exchange rules. tors of the Company or its subsidiaries. An aggregate of 4,465,914 shares of common stock of the Company are authorized to be issued under the Incentive Plans. At December 31, 2001, 166,708 and 1,290,000 shares of common stock were available for future grants under the 1997 and 2001 Incentive Plans, respectively. All awards previously granted to employees under the The Administaff Nonqualified Stock Option Plan (the “Nonqualified Plan”) provides for options to pur- chase shares of the Company’s common stock that may be granted to employees who are not officers. An aggre- gate of 3,600,000 shares of common stock of the Com- pany are authorized to be issued under the Nonquali- fied Plan. At December 31, 2001, 1,039,194 shares of 2001 ANNUAL REPORT | 55 common stock were available for future grants under and manner of the grant of such rights, the exercise the Nonqualified Plan. The purpose of the Nonquali- price (which may not be less than market value on the fied Plan is similar to that of the Incentive Plans. grant date), the number of shares and all of the terms The Nonqualified Plan is administered by the Chief of the options. The Committee may at any time termi- Executive Officer of the Company (the “CEO”). The nate or amend the Nonqualified Plan, provided that no CEO has the power to determine which eligible such amendment may adversely affect the rights of employees will receive stock option rights, the timing optionees with regard to outstanding options. The following summarizes stock option activity and related information: (in thousands, except per share amounts) Outstanding – beginning of year Granted Exercised Canceled Outstanding – end of year Exercisable – end of year Weighted average fair value of options granted during year Year ended December 31, 2001 2000 1999 Shares 3,433 1,419 (341) (235) 4,276 1,441 Weighted Average Exercise Price 21.58 $ 20.25 10.61 23.37 21.99 18.62 $ $ Shares 2,244 1,894 (618) (87) 3,433 746 Weighted Average Exercise Price 9.79 $ 31.15 9.23 12.74 21.58 10.38 $ $ Shares 1,440 1,040 (98) (138) 2,244 570 Weighted Average Exercise Price 10.97 $ 7.88 6.63 10.04 9.79 9.85 $ $ $ 12.25 $ 19.17 $ 4.67 The following summarizes information related to stock options outstanding at December 31, 2001: Range of Exercise Prices $ 6.75 to $ 15.00 $ 15.00 to $ 20.00 $ 20.00 to $ 30.00 $ 30.00 to $ 43.69 Total Options Outstanding Options Exercisable Shares (in thousands) 957 1,822 697 800 4,276 Remaining Life (Years) 6.5 8.5 9.4 8.7 8.3 Weighted Average Exercise Price 8.63 $ 18.65 24.30 43.56 21.99 $ Shares (in thousands) 705 388 84 264 1,441 Remaining Life (Years) 6.3 7.7 8.2 8.7 7.2 Weighted Average Exercise Price 8.65 $ 18.58 24.18 43.61 18.62 $ The Company has elected to follow Accounting requires use of option valuation models that were not Principles Board Opinion No. 25, Accounting for Stock developed for use in valuing employee stock options. Issued to Employees (APB 25) and related interpreta- Under APB 25, no compensation expense has been rec- tions in accounting for its stock-based compensation ognized because the exercise price of the Company’s arrangements because, as discussed below, the alterna- employee stock options has equaled the market price of tive fair value accounting provided for under SFAS the underlying stock on the date of grant. No. 123, Accounting for Stock-Based Compensation, 56 | ADMINISTAFF Pro forma information regarding net income and net income 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: Risk-free interest rate Expected dividend yield Expected volatility Weighted average expected life (in years) Year ended December 31, 2001 4.6 % 0.0% 0.69 2000 6.2 % 0.0% 0.68 1999 5.5 % 0.0% 0.65 5.0 5.0 5.0 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions NOTE 10. EARNINGS PER SHARE The numerator used in the calculations of both basic and diluted net income per share for all periods presented was net income. The denominator for each period presented was determined as follows: (in thousands) Denominator: Basic net income per share– weighted average shares outstanding Effect of dilutive securities: Common stock purchase warrants – treasury stock method Common stock options– treasury stock method Diluted net income per share – weighted average shares outstanding plus effect of dilutive securities Year ended December 31, 2001 2000 1999 27,531 27,188 27,462 51 379 1,239 1,290 1,368 1,747 – 128 128 28,821 28,935 27,590 Options and warrants to purchase 3,333,000, 2,591,000 and 4,808,000 shares of common stock were not included in the diluted net income per share calculation for 2001, 2000 and 1999, respectively, because the exercise price was greater than the aver- can materially affect the fair value estimate, in the age market price. Company’s opinion, the existing models do not neces- sarily provide a reliable single measure of the fair value NOTE 11. OPERATING LEASES of its employee stock options. The Company leases various office facilities, furni- For purposes of pro forma disclosures, the esti- ture and equipment under operating leases. Most of the mated fair value of the options is amortized to expense leases contain purchase and/or renewal options at fair over the options’ vesting period. The Company’s pro market and fair rental value, respectively. Rental forma information, as if the Company had accounted expense relating to all operating leases was $7,295,000, for its employee stock options granted subsequent to $4,446,000 and $2,915,000 in 2001, 2000 and 1999, December 31, 1994 under the fair value method pre- respectively. At December 31, 2001, future minimum scribed by SFAS No. 123, follows: rental payments under noncancelable operating leases (in thousands, except per share) Pro forma net income (loss) Pro forma diluted net Year ended December 31, 2001 2000 1999 $ (5,528) $ 11,360 $ 7,370 income (loss) per share $ (0.19) $ 0.39 $ 0.28 are as follows: (in thousands) 2002 2003 2004 2005 2006 and thereafter Total $ $ 8,567 8,354 7,752 7,391 25,891 57,955 2001 ANNUAL REPORT | 57 NOTE 12. 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, except as set forth below, 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. On November 5, 2001, the Company filed a lawsuit against Aetna US Healthcare (“Aetna”). The Company has asserted claims against Aetna for breach of con- tract, economic duress, negligent misrepresentation, breach of good faith and fair dealing, and violations of the Texas Insurance Code. The Company has alleged that during the third quarter of 2001, Aetna placed the Company under economic duress by threatening, with- out any legal right, to terminate the Company’s health insurance plan if Administaff did not pay immediate and retroactive rate increases, even though Aetna had not provided at least two quarters advance notice as required under the contract. In addition, the Company has alleged that Aetna failed to properly administer the health plan and to produce timely and accurate reports regarding the health plan’s claims data and financial condition. While the Company is still in the process of quantifying its damages, it intends to seek damages in excess of $42 million, including approxi- mately $12.7 million related to increased health insur- ance costs in the third and fourth quarters of 2001. On January 28, 2002, Aetna filed its answer deny- ing the claims asserted by the Company and, as antic- ipated by the Company, filed a counterclaim. In the counterclaim, Aetna has alleged that the Company has violated ERISA, breached its contractual obligations by failing to pay premiums owed to Aetna, and made material misrepresentations during its negotiations of rates with Aetna for the purpose of delaying rate increases while the Company sought a replacement health insurance carrier. On February 20, 2002, the Company received Aetna’s initial disclosures related to the lawsuit and counterclaim, in which Aetna stated its preliminary calculation of damages at approxi- mately $30 million. While the Company cannot predict the ultimate outcome or the timing of a resolution of this dispute or the related lawsuit and counterclaim, the Company plans to vigorously pursue its case. In addition, the Company believes that Aetna’s allegations in the coun- terclaim are without merit and intends to defend itself vigorously. However, an adverse outcome in this dispute could have a material adverse effect on the Company’s results of operations or financial condition. In October 2001, the Company’s former workers’ compensation insurance carrier, Reliance National Indemnity Co., was forced into bankruptcy liquida- tion. At December 31, 2001, the estimated outstanding claims under the Company’s Reliance policies totaled approximately $8.8 million. State laws regarding the handling of the open claims of liquidated insurance car- riers vary. Most states have established funds through guaranty associations to pay such remaining claims. However, several states have provisions that could be construed to return the liability for open claims to the companies that had policies with the liquidated insur- ance carrier, typically based on net worth. In anticipa- tion of this situation, the Company secured insurance coverage totaling $1.8 million from its current workers’ compensation carrier to cover potential claims returned to the Company related to its Reliance policies. While the Company believes, based on its analysis of applica- ble state provisions, that its insurance coverage will be adequate to cover any potential losses, it is possible that such losses could exceed the Company’s insurance coverage limit. 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 58 | ADMINISTAFF purpose of identifying specific compliance issues its client companies at comparable costs to the Com- prevalent in certain segments of the PEO industry. pany. However, if the IRS National Office adopts the Approximately 70 PEOs, including the Company, have conclusions of the IRS Houston District set forth in the been randomly selected by the IRS for audit pursuant Technical Advice Request and any such conclusions to this program. Two primary issues have arisen from were applied retroactively to disqualify the 401(k) plan these audits. for 1993 and subsequent years, employees’ vested The first issue involves the Company’s rights under account balances under the 401(k) plan would become the Code as a co-employer of its worksite employees, taxable, the Company would lose its tax deductions to including officers and owners of client companies. In the extent its matching contributions were not vested, conjunction with the 1993 401(k) plan year audit, the the 401(k) plan’s trust would become a taxable trust and IRS Houston District has sought technical advice (the the Company would be subject to liability with respect “Technical Advice Request”) from the IRS National to its failure to withhold applicable taxes with respect to Office about whether worksite employee participation certain contributions and trust earnings. Further, the in the 401(k) plan violates the exclusive benefit rule Company would be subject to liability, including under the Code because they are not employees of the penalties, with respect to its cafeteria plan for the fail- Company. The Technical Advice Request contains the ure to withhold and pay taxes applicable to salary defer- conclusions of the IRS Houston District that the 401(k) ral contributions by employees, including worksite plan should be disqualified because it covers worksite employees. In such a scenario, the Company also would employees who are not employees of the Company. The face the risk of client dissatisfaction and potential liti- Company’s response to the Technical Advice Request gation. While the Company is not able to predict either refutes the conclusions of the IRS Houston District. the timing or the nature of any final decision that may With respect to the Market Segment Group study, the be reached with respect to the 401(k) plan audit or with Company understands that the issue of whether a PEO respect to the Technical Advice Request or the Market and a client company may be treated as co-employers Segment Group study and the ultimate outcome of such for certain federal tax purposes (the “Industry Issue”) decisions, the Company believes that a retroactive has been referred to the IRS National Office. application of an unfavorable determination is unlikely. The Company does not know whether the The Company also believes that a prospective applica- IRS National Office will address the Technical tion of an unfavorable determination would not have a Advice Request independently of the Industry Issue. material adverse effect on the Company’s consolidated Should the IRS conclude that the Company is not a financial position or results of operations. “co-employer” of worksite employees for purposes of The second issue involved nondiscrimination test the Code, worksite employees could not continue to results for certain prior plan years. The Technical make salary deferral contributions to the 401(k) plan or Advice Request issued during the 1993 401(k) plan year pursuant to the Company’s cafeteria plan or continue to audit concluded that the plan should be disqualified participate in certain other employee benefit plans of because the plan failed to satisfy a nondiscrimina- the Company. The Company believes that, although tion test related to contributions and failed to provide unfavorable to the Company, a prospective application evidence that it satisfied an alternative nondiscrimina- of such a conclusion (that is, one applicable only to peri- tion test. Separately, the Company notified the IRS of ods after the conclusion by the IRS is finalized) would operational issues related to nondiscrimination test not have a material adverse effect on its financial posi- results for the 1991 through 1995 plan years. With tion or results of operations, as the Company could con- respect to the 1995 plan year, the Company caused the tinue to make available comparable benefit programs to 401(k) plan to refund the required excess contributions 2001 ANNUAL REPORT | 59 and earnings thereon to the affected participants, and The Company also agreed to pay a penalty of $70,000. the Company paid the excise tax associated with this Further, the IRS agreed and determined that the correction during 1996. All remaining nondiscrimina- 401(k) plan will not be treated as disqualified for the tion testing issues were settled during 1999, when the 1992, 1993 and 1994 plan years as a result of opera- Company and the IRS entered into a Closing Agree- tional issues related to nondiscrimination testing ment on Final Determination Covering Specific Mat- results for those years. ters (the “Closing Agreement”). Under the terms of the The amount of the settlement was significantly Closing Agreement, the Company agreed to make a lower than the amount originally estimated and contribution to the 401(k) plan on behalf of certain accrued by the Company in 1996. As a result, the participants in an aggregate amount of approximately Company recorded a gain of $952,000 during 1999 as $831,000. The settlement amount, which was remitted a component of other income. This gain includes the to the 401(k) plan in January 2000, represented the impact of the Company’s adjusted amount recoverable amount necessary to bring the plan into compliance from its third-party record keeper pursuant to a 1996 with the nondiscrimination tests for all years covered, agreement, under which the record keeper agreed to plus calculated earnings on such contributions. reimburse the Company for a portion of its settlement of the nondiscrimination testing issues. NOTE 13. QUARTERLY FINANCIAL DATA (UNAUDITED) (in thousands, except per share amounts) YEAR ENDED DECEMBER 31, 2001: Revenues Gross profit Operating income (loss) Net income (loss) Basic net income (loss) per share Diluted net income (loss) per share YEAR ENDED DECEMBER 31, 2000: Revenues Gross profit Operating income (loss) Net income (loss) Basic net income (loss) per share Diluted net income (loss) per share YEAR ENDED DECEMBER 31, 1999: Revenues Gross profit Operating income (loss) Net income (loss) Basic net income (loss) per share Diluted net income (loss) per share March 31 June 30 September 30 December 31 Quarter ended $ $ $ 1,043,419 27,829 (8,503) (4,337) (0.16) (0.16) 755,545 20,705 (4,699) (2,471) (0.09) (0.09) 475,853 13,555 (4,062) (2,058) (0.07) (0.07) $ $ $ 1,044,776 41,539 4,779 3,774 0.14 0.13 864,450 31,342 3,480 2,800 0.10 0.10 505,683 19,919 1,801 1,515 0.06 0.06 $ 1,085,944 49,321 13,291 8,659 0.32 0.30 $ $ 962,039 40,067 10,573 7,415 0.27 0.25 562,812 26,191 6,389 4,387 0.16 0.16 $ $ $ 1,199,105 46,326 8,972 2,261 0.08 0.08 1,126,497 46,420 12,880 9,156 0.33 0.31 716,395 29,863 6,431 5,514 0.21 0.20 60 | ADMINISTAFF OFFICERS CORPORATE INFORMATION Paul J. Sarvadi President and Chief Executive Officer Richard G. Rawson Executive Vice President, Administration, Chief Financial Officer and Treasurer A. Steve Arizpe Executive Vice President, Client Services Jay E. Mincks Executive Vice President, Sales and Marketing Howard G. Buff Vice President, Benefits and Corporate Human Resources David C. Dickson Vice President, Technology Solutions and Chief Technology Officer Gwen Fey Vice President, Client Services Coordination Roger L. Gaskamp Vice President, Sales Development Jeff W. Hutcheon Vice President, Web Services Corporate Headquarters 19001 Crescent Springs Drive Kingwood, Texas 77339-3802 Telephone: 281-358-8986 Sales Department Telephone: 1-800-465-3800 Stock Transfer Agent Computershare Trust Co., Inc. P.O. Box 1596 Denver, Colorado 80201 Telephone: 303-262-0600 Fax: 303-262-0603 Common Stock Administaff, Inc.’s common stock is traded on the New York Stock Exchange under the symbol ASF. Independent Auditors Ernst & Young LLP 1221 McKinney, Suite 2400 Houston, Texas 77010 Legal Counsel Baker Botts L.L.P. One Shell Plaza 910 Louisiana Houston, Texas 77002-4995 Annual Meeting Administaff, Inc.’s Annual Meeting of Shareholders will be held at 10 a.m. on Tuesday, May 7, 2002, at the Company’s corporate headquarters, Centre II, located at 29801 Loop 494, Kingwood, Texas 77339. Samuel G. Larson Vice President, Enterprise Project Management Randall H. McCollum Vice President, Strategic Alliances Gregory J. Morton Vice President, Marketing John F. Orth Vice President, Sales Douglas S. Sharp Vice President, Finance and Controller John H. Spurgin, II Vice President, Legal, General Counsel and Secretary Investor Relations Shareholders are encouraged to contact the Company with questions or requests for infor- mation. Copies of the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission are available without charge upon written request. Inquiries should be directed to: Investor Relations Administrator Administaff, Inc. 19001 Crescent Springs Drive Kingwood, Texas 77339-3802 Telephone: 281-348-3987 Web Site www.administaff.com e n i V y r r e T : r e h p a r g o t o h P n o t s u o H f o e n w o B : g n i t n i r P s a x e T , n o t s u o H , . c n I , p u o r G n g i s e D e g a v a S : n g i s e D BOARD OF DIRECTORS Steven Alesio Mr. Alesio was named Senior Vice President of The Dun & Brad- street Corporation in January 2001. He has responsibility for Global Marketing, Asia Pacific and Latin America, e-Business and Strategy Implementation, and is a member of that company’s Global Leadership Team. Before joining Dun & Bradstreet, Mr. Alesio was with the American Express Company for 19 years until his resignation in November 2000. He also serves on the Board of Directors for Overture Services, Inc. Mr. Alesio was elected a director of the Company in July 1999. Michael W. Brown Mr. Brown is the past Chairman of the NASDAQ Stock Market Board of Directors and a past governor of the National Association of Securities Dealers. Mr. Brown joined Microsoft Corporation in 1989 as its Treasurer and became its Chief Financial Officer in 1993. He served in that capacity until his retirement in July 1997. Mr. Brown is also a director of Fat Kat, Inc., a member of the Thomas Weisel Part- ners Advisory Board and the XML Fund Advisory Board,and a Fellow at BIOS, L.P. He joined the Company as a director in November 1997. Jack M. Fields, Jr. Mr. Fields joined the Company as a director in January 1997 following his retirement from the United States House of Rep- resentatives, where he served for 16 years. During 1995 and 1996, he served as Chairman of the House Telecommunications and Finance Subcommittee, which has jurisdiction and oversight of the Federal Communications Commission and the Securities and Exchange Commission. Mr. Fields is Chief Executive Officer of 21st Century Group in Washington, D.C., and serves on the Board of Directors for AIM Mutual Funds. Paul S. Lattanzio Mr. Lattanzio is a Managing Director for TD Capital Communica- tions Partners, a venture capital investment firm. He previously served with affiliates of NationsBanc Montgomery Securities and Bankers Trust New York Corporation. Mr. Lattanzio also serves on the Board of Directors of General Communication, Inc. and the Advisory Board of MVP America L.P. He has been a director of the Company since 1995. Members of Administaff’s Board of Directors include: (front row, left to right) Richard G. Rawson and Paul J. Sarvadi; and (back row, left to right) Michael W. Brown, Jack M. Fields, Jr., Steven Alesio, Linda Fayne Levinson and Paul S. Lattanzio. Linda Fayne Levinson Ms. Levinson has served as a partner of GRP Partners, Inc. since 1997. She previously served as President of Fayne Levinson & Asso- ciates and has been an executive with several major corporations. Ms. Levinson currently serves as a director for Jacobs Engineering Group, Inc., NCR Corporation, Overture Services, Inc. and Last- minute.com, plc. She joined Administaff’s Board in April 1996. Richard G. Rawson Mr. Rawson is Administaff’s Executive Vice President of Admin- istration, Chief Financial Officer and Treasurer. He has served as a director of the Company since April 1989. Mr. Rawson has pre- viously served the National Association of Professional Employer Organizations (NAPEO) as President (1999–2000), First Vice President, Second Vice President and Treasurer. In addition, Mr. Rawson served as Chairman of the Accounting Practices Committee of NAPEO for five years. He also is a mem- ber of the Financial Executives Institute. Paul J. Sarvadi Mr. Sarvadi is President, Chief Executive Officer and a co-founder of Administaff. He has served on Administaff’s Board since the Company’s inception in March 1986. Mr. Sarvadi has served as President of the National Association of Professional Employer Organizations (NAPEO) and was a member of its Board of Directors for five years. Mr. Sarvadi serves on the Board of Directors of the DePelchin Children’s Center in Houston. In 2001, he was named as the National Ernst & Young Entrepreneur Of The Year in the Service category. Administaff | 19001 Crescent Springs Drive | Kingwood, Texas 77339-3802 | www.administaff.com