2004 Annual Report
Small business is good for America.
Administaff is good for small business.SM
A
d
m
n
i
i
s
t
a
f
f
,
I
n
c
.
2
0
0
4
A
n
n
u
a
l
R
e
p
o
r
t
S
m
a
l
l
b
u
s
i
n
e
s
s
i
s
g
o
o
d
f
o
r
A
m
e
r
i
c
a
.
A
d
m
n
i
i
s
t
a
f
f
i
s
g
o
o
d
f
o
r
s
m
a
l
l
b
u
s
i
n
e
s
s
.S
M
19001 Crescent Springs Drive
Kingwood, Texas 77339-3802
www.administaff.com
Company Profile
Financial Highlights
With 2004 revenues of $969.5 million, Administaff 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. At year-end 2004,
Administaff had more than 4,600 client companies, 81,000 worksite employees and
1,300 corporate employees. The Company also had four client service centers and
38 sales offices in 21 major markets.
Administaff ’s common stock is listed on the New York Stock Exchange and traded under
the symbol “ASF.” 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.
(in thousands, except per share amounts and statistical data)
2004
2003
2002
2001
2000
Year ended December 31,
Income Statement Data:
Revenues(1)
Gross profit
Operating income
Net income (loss) from continuing operations(4)
Net loss from discontinued operations
$ 969,527
$ 890,859
$ 848,416
$ 720,219
$ 598,291
197,694
22,131
19,210
197,105
24,274
14,985
165,790
67
(2,921)
–
(2,121)
(1,160)
165,015
18,539
10,357
–
138,534
22,234
16,900
–
Net income (loss)(4)
19,210
12,864
(4,081)
10,357
16,900
Diluted net income (loss) per share from
continuing operations(2)(4)
$
0.72
$
0.55
$
(0.11)
$
0.36
$
0.58
Balance Sheet Data:
Working capital
Total assets
Total debt
Total stockholders’ equity
Statistical Data:
$ 47,500
$ 56,032
$ 41,238
$ 36,609
$ 51,179
354,638
36,539
126,529
348,071
42,362
122,634
315,164
44,169
116,349
274,003
13,500
122,935
242,817
–
105,510
Average number of worksite employees paid
per month during period
Revenues per worksite employee per month(3)
Gross profit per worksite employee per month
Operating income per worksite employee per month
77,936
75,036
77,334
69,480
62,140
$ 1,037
$
$
211
24
$
$
$
989
219
27
$
$
$
914
179
–
$
$
$
864
198
22
$
$
$
802
186
30
(1) Gross billings of $5.377 billion, $4.829 billion, $4.857 billion, $4.373 billion and $3.708 billion less worksite
employee payroll cost of $4.407 billion, $3.938 billion, $4.009 billion, $3.653 billion and $3.110 billion, respectively.
(2) Adjusted to reflect the two-for-one split of the common stock effected on October 16, 2000.
(3) Gross billings of $5,749, $5,363, $5,234, $5,245 and $4,973 per worksite employee per month less payroll
cost of $4,712, $4,373, $4,320, $4,381 and $4,171 per worksite employee per month, respectively.
(4) Includes $8.25 million ($5.2 million and $0.19 per share after taxes) in other income in 2004 related to a settlement
of a legal matter. See Note 12 to the consolidated financial statements.
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 “are confident,” “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” in the Company’s Annual Report on Form 10-K.
Board of Directors
Michael W. Brown | Independent Director
Mr. Brown joined the Company as a director in
November 1997, and he currently serves on the
Finance, Risk Management and Audit Committee
and on the Nominating and Corporate Governance
Committee. A certified public accountant, he 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 1997.
Prior to joining Microsoft, Mr. Brown spent 18 years with Deloitte & Touche LLP.
Mr. Brown also is a director of 360networks, FatKat, Inc. and ExchangeAdvantage,
and is a member of the Thomas Weisel Partners Advisory Board, the University
of Washington Business School Advisory Board and the Particle Economics
Research Institute.
Jack M. Fields, Jr. | Independent Director
Mr. Fields joined the Company as a director in
January 1997. He currently serves as Chairman
of the Compensation Committee and is a member
of the Nominating and Corporate Governance
Committee. Mr. Fields served in the United States
House of Representatives for 16 years prior to his
retirement. 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 Twenty-First Century Group in
Washington, D.C., and serves on the Board of Directors for AIM Mutual
Funds and the Discovery Channel – Global Education Fund.
Eli Jones | Independent Director
Dr. Jones joined the Company as a director in April
2004, and he currently serves on the Compensation
Committee and on the Nominating and Corporate
Governance Committee. He has been an Associate
Professor of Marketing at the University of Houston
since 2002 and was an Assistant Professor at
the University of Houston from 1997 until 2002.
Dr. Jones currently serves as the Executive Director
of the Program for Excellence in Selling and the Sales Excellence Institute at
the University of Houston. He also serves on the Board of Directors of Dovarri,
a CRM company based in Houston, and on the editorial review boards of the
Journal of Personal Selling and Sales Management and Industrial Marketing
Management. Dr. Jones has conducted research and published articles on
sales and sales management topics in major journals and has co-authored
a sales textbook, Selling ASAP. Before becoming a professor, Dr. Jones
worked in sales and sales management for three Fortune 100 companies –
Quaker Oats, Nabisco and Frito-Lay.
Paul S. Lattanzio | Independent Director
Mr. Lattanzio has been a director of the Company
since 1995, and he currently serves on the Finance,
Risk Management and Audit Committee and on the
Nominating and Corporate Governance Committee.
He joined Bear Stearns, Inc. in 2003 as a Senior
Managing Director and head of Bear Growth Capital
Partners, a private equity group. Mr. Lattanzio previ-
ously served as a Managing Director for TD Capital
Communications Partners (f/k/a Toronto Dominion Capital), a venture capital
investment firm, from 1999 until 2002; and he was a co-founder and Senior
Managing Director of NMS Capital Management, LLC, a private equity fund
affiliated with NationsBanc Montgomery Securities. Mr. Lattanzio also served
in several positions with various affiliates of Bankers Trust New York Corpora-
tion, lastly as a Managing Director of BT Capital Partners, Inc. He also serves
on the Board of Directors of Clintrak Pharmaceutical Services, LLC, Harlem
Furniture and Avid Health, Inc.
Gregory E. Petsch | Independent Director
Mr. Petsch joined the Company as a director in
October 2002. He currently serves as Chairman
of the Nominating and Corporate Governance
Committee and is a member of the Compensation
Committee. He retired in 1999 from Compaq
Computer Corporation, where he had held various
positions since 1983, most recently as Senior Vice
President of Worldwide Manufacturing and Quality
since 1991. Prior to joining Compaq, he worked for 10 years at Texas Instru-
ments. In 1992, Mr. Petsch was voted Manufacturing Executive of the Year
by Upside magazine, and from 1993 to 1995 he was nominated to the
Who’s Who of Global Business Leaders. He is founder and President of
Godsmoneyman Ministries and is a Board member of Culture Shapers.
Richard G. Rawson | Management Director
Mr. Rawson is Administaff’s President. Prior to
his election as President in 2003, he served as
Executive Vice President of Administration, Chief
Financial Officer and Treasurer. He has served
as a director of the Company since April 1989.
Before joining the Company, Mr. Rawson served
as a Senior Financial Officer and Controller for
several companies in the manufacturing and
seismic data processing industries. He has previously served the National
Association of Professional Employer Organizations (NAPEO) as President
(1999–2000), First Vice President, Second Vice President and Treasurer.
In addition, he served as Chairman of the Accounting Practices Committee
of NAPEO for five years.
Paul J. Sarvadi | Management Director
Mr. Sarvadi is Chairman of the Board, Chief
Executive Officer and a co-founder of Administaff.
Prior to his election as Chairman in 2003, he served
as Chief Executive Officer and President. 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 mem-
ber of its Board of Directors for five years. Mr. Sarvadi serves on the Board
of Trustees of the DePelchin Children’s Center in Houston. In 2001, he was
named National Ernst & Young Entrepreneur Of The Year in the Service cate-
gory, and in 2004 he received the Conn Family Distinguished New Venture
Leader Award from Mays Business School at Texas A&M University.
Austin P. Young | Independent Director
Mr. Young became a director of the Company
in January 2003. He currently serves as Chairman
of the Finance, Risk Management and Audit
Committee and is a member of the Nominating
and Corporate Governance Committee. He is a
certified public accountant and served as Senior
Vice President, Chief Financial Officer and Treasurer
of CellStar Corporation from 1999 until his retire-
ment at year-end 2001. From 1996 to 1999, he served as Executive Vice Presi-
dent – Finance and Administration of Metamor Worldwide, Inc. Mr. Young also
has served as Senior Vice President and Chief Financial Officer at American
General Corporation, and he was a partner in the Houston and New York
offices of KPMG Peat Marwick. He currently serves as Director and Chair-
man of the Audit Committee of Tower Group, Inc.; Director and Chairman
of the Audit Committee of Houston Zoo, Inc.; Chairman of the Houston Zoo
Advisory Committee; Director and Treasurer of The Park People, Inc.; and
Director of the Houston Fire Museum.
Letter to Shareholders
Entering 2004, Administaff’s primary goal was to re-establish double-digit
unit growth – an objective we achieved in December with an increase of
10 percent over the same period in 2003. This accomplishment – supported
by continued advances in sales and client retention – has laid a strong foun-
dation for growth and profitability in 2005.
Revenues for the year increased 8.8 percent to $969.5 million, primarily due
to a 4.9 percent increase in revenue per worksite employee per month and a
3.9 percent increase in the average number of worksite employees paid per
month. Gross profit increased slightly to $197.7 million, as the 3.9 percent
increase in the number of worksite employees paid offset a decline in the
average monthly gross profit per worksite employee, from $219 in the 2003
period to $211 in the 2004 period.
In addition to accelerating our growth in 2004, we accomplished several
major milestones:
(cid:1) Improved client retention and satisfaction, including an increase from
71 percent to 75 percent in our retention rate. In addition, our most
recent client survey revealed that overall satisfaction with Administaff
was higher in 2004 than any other year in Company history. Other
key findings of the survey are highlighted throughout this report.
(cid:1) Growth in our middle-market sales effort, which targets clients with
150 to 2,000 employees. In 2004, we added 19 accounts and nearly
3,000 worksite employees from this market, versus three accounts and
500 employees in 2003.
(cid:1) The introduction of two new employee health care options: The Health
Care Flexible Spending Account allows employees to contribute a portion of
their earnings on a pretax basis for the subsequent reimbursement of quali-
fied medical expenses, and the High Deductible Health Plan allows employ-
ees to elect coverage with higher deductibles and lower health insurance
premiums and potentially qualify to establish a health savings account.
Administaff | 01
Paul J. Sarvadi
Chairman and
Chief Executive Officer
Re-establishing
double-digit growth
and continued advances
in sales and client
retention laid a strong
foundation for growth
and profitability
in 2005.
Our accomplishments
in 2004 successfully
capped a three-year
drive to build a
stronger financial
base, demonstrate
the capital efficiency
of our business model
and create a more
positive outlook for
financial performance.
(cid:1) Launching of our new branding initiative with the most comprehensive
and targeted marketing campaign in the Company’s history, which empha-
sizes our new message: “Small business is good for America. Administaff
is good for small business.SM” This strategy included our first-ever national
television advertising campaign – featuring our new spokesperson, golf
legend and small business owner Arnold Palmer – as well as our sponsor-
ship of the inaugural Administaff Small Business Classic,SM a PGA
Champions Tour event.
(cid:1) Our first full year under our new pricing and billing system, which
eliminated the potential for revenue shortfall resulting from changes
in pay rates or benefit elections of worksite employees. In addition, the
system provides our clients with important pricing insights, allowing
them to view labor costs based on their business model. It also gives the
Company a significantly more detailed base of information, helping us
to confirm effective pricing, identify trends and forecast operating results.
Our accomplishments in 2004 successfully capped a three-year drive to
build a stronger financial base, demonstrate the capital efficiency of our
business model and create a more positive outlook for financial performance.
Since 2002, we have increased working capital to $47.5 million, and we
accomplished this in spite of using approximately $80 million to repurchase
shares, reduce our debt and improve our core gross profit enhancement
opportunities. We also have generated more than $117 million in EBITDA,
resulting in a run rate of more than $40 million in the two most recent
years, which is four to five times greater than the level of capital expendi-
tures needed to develop and grow our business. Finally, the significant
improvements we have implemented in our pricing and billing system
enable us to better manage our business and improve performance.
With our positive outlook for continued growth and profitability,
Administaff’s Board of Directors announced the Company’s first quar-
terly dividend in February 2005. Payable at the rate of $.07 per share of
common stock to holders of record on March 7, 2005, the dividend will
be paid on April 1, 2005.
In closing, I would like to extend management’s appreciation for the dedica-
tion of our corporate employees and valuable guidance from our Board of
Directors. And to our clients, sincere gratitude for the continued opportu-
nity to demonstrate that Administaff is good for small business.
Sincerely,
02 | Administaff
Paul J. Sarvadi
Chairman and Chief Executive Officer
March 22, 2005
Small business is good for America.
With small businesses comprising 99 percent of employers in the United
States, there is no question that small business is good for America. In fact,
the goods, services and technology produced by American small businesses
make up the world’s third-largest economy, after the United States and
Japan. Administaff was founded on the belief that small business owners
should be free to focus on what’s important – growing their businesses –
not caught up in red tape and administrative burdens. For almost 20 years,
Administaff has been there, working behind the scenes to make our clients
successful. So we take it as a matter of pride when 92 percent of our
surveyed clients say they would recommend Administaff to other business
owners. Yes, small business is good for America. And Administaff is good
for small business.
Good For America
99%
of all U.S. employers
are small businesses.
Good For Small Business
92%
of surveyed clients would
recommend Administaff to
other business owners.
Administaff is good for small business.
Administaff | 03
Good For America
75%
of the net new jobs in
our economy are created
by small businesses.
© Houston Chronicle
04 | Administaff
Good For Small Business
88%
of clients surveyed are
“completely or mostly
satisfi ed” with Administaff
products and services, the
highest level in Company history.
Administaff supports:
Dynamic Orthotics and Prosthetics
Location: Houston, Texas
Industry type: Orthotic and Prosthetic Services
Number of employees: 46
“Service and quality are not clichés to our company, but
keystones of performance. We rely on Administaff for pay-
roll and benefi ts management, recruiting and selection,
training, and safety reviews to help us meet those stan-
dards and improve the quality of life for many others.”
– Tom DiBello, Certifi ed Orthotist and Owner, Dynamic Orthotics and Prosthetics
Administaff provides comprehensive people
strategies for America’s best small businesses.
America’s small business community is vital to the health
of the nation’s economy. In much the same way, Administaff
is vital to the health of our clients because we provide adminis-
trative relief, big company benefi ts and a systematic way to
help them improve productivity.
For more than 15 years, Dynamic Orthotics and Prosthetics has served patients, physicians and therapists,
applying orthotic and prosthetic skills to needs ranging from the purely cosmetic to adaptation of the
most complex myoelectric devices. Under the leadership of Tom DiBello, Certified Orthotist and owner,
the company’s commitment to personalized care and customized quality solutions for all patients gained
international recognition and respect when Dynamic’s dedicated staff donated hundreds of hours to
reconstruct the limbs and lives of seven Iraqi merchants whose hands were amputated by order of Saddam
Hussein. Each day, Dynamic Orthotics and Prosthetics enables pediatric, adult and geriatric patients from
across the country and around the world to live as independently and productively as possible.
Dynamic Orthotics and Prosthetics creates customized solutions for its clients, including the Iraqi businessmen pictured joining hands with company technicians.
Though most small companies can’t justify the resources
Growth-minded entrepreneurs understand that their people
to hire and maintain their own human resources department,
are their most important business asset. In fact, studies confi rm
a strong people strategy can still be an option. That’s where
it – strong people practices can increase a company’s produc -
Administaff comes in, fi lling the void by providing high-impact,
tivity and profi tability. By becoming part of a company’s growth
team-based HR services and value-added people strategies
strategy, Administaff supplies the tools and resources its clients
to help the best small businesses get even better.
need to set them apart from their competitors, draw the most
talented employees and fuel their growth. (cid:1)
Administaff | 05
Administaff supports:
SpaceDev, Inc.
Location: Poway, California
Industry type: Space Technology and Engineering Services
Number of employees: 40
“Our business really is rocket science. Administaff helps
us maintain critical focus by providing the essential HR
resources and support we need to continue successfully
developing and delivering fast turnaround, high perfor-
mance and responsive space systems at affordable prices.”
– Richard B. Slansky, President and Chief Financial Offi cer, SpaceDev, Inc.
Administrative relief. In business, focus is critical to success.
Yet too often, a business owner is inundated by paperwork, not
focused on core business activities. Increasing sales, improving
customer service and developing new products take a back seat
to daily details. Whether it’s handling payroll, fi ling payroll tax
reports, taking care of workers’ compensation claims, or any
Good For America
55%
of all innovations are produced
by small businesses.
Good For Small Business
90%
of clients surveyed consider
Administaff a good value
for the money.
06 | Administaff
SpaceDev, Inc. (OTCBB: SPDV) was founded in 1997 by successful computer entrepreneur
Jim Benson to lead the way in transforming the vision of commercial space into reality. Using
innovative technologies and business practices spawned by the microcomputer revolution, SpaceDev
provides affordable, reliable space products and services, including hybrid propulsion systems and
small satellites, to government and commercial enterprises. SpaceDev gained international recogni-
tion in 2004 when its proprietary hybrid propulsion technology powered Scaled Composite/Paul
Allen’s SpaceShipOne into space flight history to garner the $10 million Ansari X Prize for safely
creating the first private-sector astronauts.
SpaceDev engineers assemble microsatellites, provide orbital tracking and monitoring services, and test-fi re their hybrid propulsion rocket motors to help
bring 21st century space solutions to clients that include the Air Force Research Laboratory, Boeing, the Jet Propulsion Laboratory, Lockheed Martin, the
Missile Defense Agency, NASA, the National Reconnaissance Offi ce and a number of commercial customers.
number of other administrative headaches, Administaff steps in
that otherwise would be out of reach for small companies,
to provide welcome relief. Then a business owner can put his
including health care plans, dental and vision insurance,
or her focus squarely where it belongs.
prescription drug programs, life and disability insurance, a
Big company benefi ts. A quality benefi ts package gives small
and medium-sized companies the means to attract and keep the
most talented employees. Administaff offers premium benefi ts
401(k) savings plan, an employee assistance program, educa-
tion assistance and adoption assistance. A benefi ts package
with that kind of punch levels the playing fi eld for client
companies to hire the best people for the right jobs. (cid:1)
Administaff | 07
Administaff supports:
Comverge, Inc.
Location: East Hanover, New Jersey
Industry type: Energy Management Hardware and Software
Number of employees: 87
“From payroll to benefi ts administration and online
training to recruiting, Comverge managers and
employees use a wide variety of Administaff services.
As a result, we are better equipped individually and
corporately to serve our clients and expand our business.”
– Bob Chiste, Chairman, President and Chief Executive Offi cer, Comverge, Inc.
Improved productivity. Companies that are systematic
and strategic about the role people play in their business see
bottom-line benefi ts. Employees who are engaged, focused and
energized contribute directly to a company’s productivity and
profi tability. Cultivating a workplace where employees can learn,
develop and be challenged gives a business a competitive edge.
Good For America
75%
of Americans were
hired for their fi rst job
in a small business.
Good For Small Business
94%
of surveyed clients said
they plan to renew their
Administaff relationship.
08 | Administaff
Comverge, Inc. is making a difference across the country by helping electric utilities manage
their resources more efficiently. Using Comverge hardware and software, a utility can reduce
peak power demand on hot summer days, decreasing the need for new power plants, lowering
average electricity rates for consumers and helping to protect the environment. With over
500 utility clients and more than 5.5 million devices currently installed, Comverge’s innovative
marriage of technology and software solutions for energy management is helping to ensure
that America has reliable energy resources for generations to come.
Comverge equipment and software is used to relay vital residential and commercial peak power load information
to utilities and manage valuable power resources more effi ciently.
What’s more, a positive corporate culture reaps dividends
The American small business community is the backbone
such as employee loyalty, a reduction in turnover, continuation
of America, representing the economic future of our country.
of institutional knowledge and improved customer service.
Administaff is pleased to provide the HR support needed
Administaff provides leading-edge HR strategies through
by small and medium-sized businesses to help lead our
which a company can communicate its values and mission.
nation in the 21st century.
Administaff | 09
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(cid:1) Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
(cid:2)(cid:3) Transition Report Pursuant to Section 13 or 15(d) of the Securities
For the fiscal year ended December 31, 2004.
or
Exchange Act of 1934
For the transition period from to
Commission File No. 1-13998
Administaff, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
19001 Crescent Springs Drive
Kingwood, Texas
(Address of principal executive offices)
76-0479645
(I.R.S. Employer
Identification No.)
77339
(Zip Code)
Registrant's Telephone Number, Including Area Code: (281) 358-8986
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
Rights to Purchase Series A Junior Participating Preferred Stock
(Title of class)
New York Stock Exchange
New York Stock Exchange
(Name of Exchange on Which Registered)
Securities Registered Pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes (cid:4) No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:4)
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes (cid:4) No
As of February 14, 2005, 25,494,437 shares of the registrant’s common stock, par value $0.01 per share, were
outstanding. As of the end of the registrant’s most recently completed second quarter, the aggregate market value of the
common stock held by non-affiliates (based upon the June 30, 2004 closing price of the common stock as reported by
the New York Stock Exchange) was approximately $369 million.
Part III information is incorporated by reference from the proxy statement for the annual meeting of
stockholders to be held May 5, 2005, which the registrant intends to file within 120 days of the end of the fiscal year.
TABLE OF CONTENTS
Part I
Item 1.
Item 2.
Item 3.
Item 4.
Business ......................................................................................................................... 2
Properties ....................................................................................................................... 16
Legal Proceedings.......................................................................................................... 17
Submission of Matters to a Vote of Security Holders.................................................... 19
Item S-K 401(b).
Executive Officers of the Registrant .............................................................................. 19
Part II
Item 5.
Market for the Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Securities ............................... 21
Item 6.
Item 7.
Selected Financial Data.................................................................................................. 22
Management’s Discussion and Analysis of Financial Condition
and Results of Operations........................................................................................... 23
Item 7A.
Qualitative and Quantitative Disclosures About Market Risk ....................................... 45
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Financial Statements and Supplementary Data .............................................................. 46
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ............................................................................................ 46
Controls and Procedures ................................................................................................ 46
Other Information .......................................................................................................... 47
Part III
Directors and Executive Officers of the Registrant........................................................ 48
Executive Compensation................................................................................................ 48
Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters ............................................................................... 48
Certain Relationships and Related Transactions ............................................................ 48
Principal Accounting Fees and Services ........................................................................ 48
Item 15.
Exhibits and Financial Statement Schedules.................................................................. 49
Part IV
PART I
Unless otherwise indicated, “Administaff,” “the Company,” “we,” “our” and “us” are used in this annual
report to refer to the businesses of Administaff, Inc. and its consolidated subsidiaries. This annual report contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. You can identify such forward-looking statements by the words “expects”,
“intends,” “plans,” “projects,” “believes,” “estimates,” “likely,” “goal,” “assume” and similar expressions. In the
normal course of business, in an effort to help keep our stockholders and the public informed about our operations
we 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. We base
the forward-looking statements on our current expectations, estimates and projections. We caution you that these
statements are not guarantees of future performance and involve risks, uncertainties and assumptions that we cannot
predict. In addition, we have based many of these forward-looking statements on assumptions about future events
that may prove to be inaccurate. Therefore, the actual results of the future events described in such forward-looking
statements in this annual report, or elsewhere, could differ materially from those stated in such forward-looking
statements. Among the factors that could cause actual results to differ materially are the risks and uncertainties
discussed in this annual report, including, without limitation, factors discussed in Item 1, “Business” and Item 7,
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” including the factors
discussed under the caption “Factors That May Affect Future Results and the Market Price of Common Stock,”
beginning on page 40.
ITEM 1. BUSINESS.
General
Administaff is a professional employer organization (“PEO”) that provides a comprehensive Personnel
Management SystemSM encompassing a broad range of services, including benefits and payroll administration, health
and workers’ compensation insurance programs, personnel records management, employer liability management,
employee recruiting and selection, employee performance management and employee training and development
services to small and medium-sized businesses in strategically selected markets. We were organized as a corporation
in 1986 and have provided PEO services since inception. In 2003, we formed Administaff Retirement Services, LP,
which currently performs recordkeeping services for defined contribution plans.
Our principal executive offices are located at 19001 Crescent Springs Drive, Kingwood, Texas 77339. Our
telephone number at that address is (281) 358-8986 and the Company’s website address is
http://www.administaff.com. Our stock is traded on the New York Stock Exchange under the symbol “ASF.”
Periodic SEC filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 are available through our website free of charge as soon as reasonably practicable
after such material is electronically filed with, or furnished to, the SEC.
Our Personnel Management System is designed to improve the productivity and profitability of small and
medium-sized businesses. It relieves business owners and key executives of many employer-related administrative
and regulatory burdens, which enables them to focus on the core competencies of their businesses. It also promotes
employee performance through human resource management techniques that improve employee satisfaction. We
provide the Personnel Management System by entering into a Client Service Agreement (“CSA”), which establishes
a three-party relationship whereby we and our client act as co-employers of the employees who work at the client’s
location (“worksite employees”). Under the CSA, we assume responsibility for personnel administration and
compliance with most employment-related governmental regulations, while the client company retains the
employees’ services in its business and remains the employer for various other purposes. We charge a
comprehensive service fee (“comprehensive service fee” or “gross billing”), which is invoiced concurrently with the
processing of payroll for the worksite employees of the client. The comprehensive service fee consists of the payroll
of our worksite employees and a markup computed as a percentage of the payroll cost of the worksite employees.
- 2 -
We accomplish the objectives of the Personnel Management System through a High Touch/High Tech
approach to service delivery. In advisory areas, such as recruiting, employee performance management and
employee training, we employ a high touch approach designed to ensure that our clients receive the personal
attention and expertise needed to create a customized human resources solution. For transactional processing, we
employ a high tech approach that provides secure, convenient information exchange among Administaff, our clients
and our worksite employees, creating efficiencies for all parties. The primary component of the high tech portion of
our strategy is the Employee Service Center (“ESC”). The ESC is our web-based interactive PEO service delivery
platform, which is designed to provide automated, personalized PEO services to our clients and worksite employees.
We are the nation’s leading provider of PEO services in terms of revenues. As of December 31, 2004, we
had 38 sales offices in 21 markets, and we paid 81,426 worksite employees in the month of December. Our long-
term strategy is to operate in approximately 90 sales offices located in 40 strategically selected markets. While we
are currently planning no new sales offices in 2005, we intend to resume our national expansion strategy in 2006,
subsequent to the utilization of existing sales office capacity.
Our national expansion strategy also includes regionalized data processing for payroll and benefits
transactions and localized face-to-face human resources service. As of December 31, 2004, we have four service
centers, which when fully staffed will provide the capacity to serve approximately 160,000 worksite employees. In
addition, we have human resources and client service personnel located in a majority of our 21 sales markets.
PEO Industry
The PEO industry began to evolve in the early 1980s largely in response to the burdens placed on small and
medium-sized employers by an increasingly complex legal and regulatory environment. While various service
providers were available to assist these businesses with specific tasks, PEOs emerged as providers of a more
comprehensive range of services relating to the employer/employee relationship. In a PEO arrangement, the PEO
assumes broad aspects of the employer/employee relationship. Because PEOs provide employer-related services to a
large number of employees, they can achieve economies of scale that allow them to perform employment-related
functions more efficiently, provide a greater variety of employee benefits and devote more attention to human
resources management.
We believe the key factors driving demand for PEO services include:
•
•
•
the focus on growth and productivity of the small and medium-sized business community in the United
States, utilizing outsourcing to concentrate on core competencies;
the need to provide competitive health care and related benefits to attract and retain employees;
the increasing costs associated with health and workers’ compensation insurance coverage, workplace
safety programs, employee-related complaints and litigation; and
• complex regulation of labor and employment issues and the related costs of compliance, including the
allocation of time and effort to such functions by owners and key executives.
A significant factor in the development of the PEO industry has been increasing recognition and acceptance
of PEOs and the co-employer relationship by federal and state governmental authorities. Administaff and other
industry leaders, in concert with the National Association of Professional Employer Organizations (“NAPEO”), have
worked with the relevant governmental entities for the establishment of a regulatory framework that protects clients
and employees, discourages unscrupulous and financially unsound companies, and promotes further development of
the industry. Currently, 25 states have legislation containing licensing, registration, or certification requirements and
several others are considering such regulation. Such laws vary from state to state but generally provide for
monitoring the fiscal responsibility of PEOs. State regulation assists in screening insufficiently capitalized PEO
operations and helps to resolve interpretive issues concerning employee status for specific purposes under applicable
state law. We have actively supported such regulatory efforts and are currently licensed, registered or pursuing
registration in all 25 of these states. The cost of compliance with these regulations is not material to our financial
position or results of operations.
- 3 -
PEO Services
We serve small and medium-sized businesses by providing our Personnel Management System, which
encompasses a broad range of services, including:
• benefits and payroll administration;
• health and workers’ compensation insurance programs;
• personnel records management;
• employer liability management;
• employee recruiting and selection;
• employee performance management; and
•
training and development services.
The Personnel Management System is designed to attract and retain high-quality employees, while relieving
client owners and key executives of many employer-related administrative and regulatory burdens. Among the
employment-related laws and regulations that may affect a client company are the following:
Internal Revenue Code (the “Code”);
•
• Federal Income Contribution Act (FICA);
• Federal Unemployment Tax Act (FUTA);
• Fair Labor Standards Act (FLSA);
• Employee Retirement Income Security Act,
as amended (ERISA);
• Consolidated Omnibus Budget Reconcilia-
•
tion Act of 1987 (COBRA);
Immigration Reform and Control Act;
(IRCA);
• Title VII (Civil Rights Act of 1964);
• Americans with Disabilities Act (ADA);
• Age Discrimination in Employment Act
(ADEA);
• The Family and Medical Leave Act (FMLA);
• Health Insurance Portability and
Accountability Act (HIPAA);
• Drug-Free Workplace Act;
• Occupational Safety and Health Act
(OSHA);
• Worker Adjustment and Retraining
Notification Act (WARN);
• Uniform Services Employment and
Reemployment Rights Act (USERRA);
• State unemployment and employment
security laws; and
• State workers’ compensation laws.
While these regulations are complex, and in some instances overlapping, we assist our client companies in
achieving compliance with these regulations by providing services in four primary categories:
• administrative functions;
• benefit plans administration;
• personnel management; and
• employer liability management.
All of the following services are included in the Personnel Management System and are available to all
client companies.
Administrative Functions. Administrative functions encompass a wide variety of processing and record
keeping tasks, mostly related to payroll administration and government compliance. Specific examples include:
• payroll processing;
• payroll tax deposits;
• quarterly payroll tax reporting;
• employee file maintenance;
• unemployment claims processing; and
• workers’ compensation claims reporting.
- 4 -
Benefit Plans Administration. We maintain several benefit plans including the following types of coverage:
• group health coverage;
• a health care flexible spending account plan;
• an educational assistance program;
• an adoption assistance program;
• group term life insurance;
• universal life insurance coverage;
• accidental death and dismemberment insurance coverage;
• short-term and long-term disability insurance coverage; and
• a 401(k) plan.
The group health plan includes medical, dental, vision, a worklife program and a prescription drug program.
All benefit plans are provided to applicable employees based on eligibility provisions specific to those plans. We are
responsible for the costs and premiums associated with these plans and act as plan sponsor and administrator of the
plans. We negotiate the terms and costs of the plans, maintain the plans in accordance with applicable federal and
state regulations and serve as liaison for the delivery of such benefits to worksite employees. We believe this variety
and quality of benefit plans are generally not available to employees in our small and medium-sized business target
market and are usually offered only by larger companies that can spread program costs over a much larger group of
employees. As a result, we believe the availability of these benefit plans provides our clients with a competitive
advantage that small and medium-sized businesses are typically unable to attain on their own.
Personnel Management. We provide a wide variety of personnel management services that give our client
companies access to resources normally found only in the human resources departments of large companies. All
client companies have access to our comprehensive personnel guide, which sets forth a systematic approach to
administering personnel policies and practices, including recruiting, discipline and termination procedures. Other
human resources services we provide include:
• drafting and reviewing personnel policies and employee handbooks;
• designing job descriptions;
• performing prospective employee screening and background investigations;
• designing performance appraisal processes and forms;
• providing professional development and issues-oriented training;
• employee counseling;
• substance abuse awareness training;
• drug testing;
• outplacement services; and
• compensation guidance.
Employer Liability Management. Under the CSA, we assume many of the employment-related
responsibilities associated with the administrative functions, benefit plans administration and personnel management
services we provide. For those employment-related responsibilities that are the responsibility of the client or we
share with our clients, we can assist our clients in managing and limiting exposure. This includes first time and
ongoing safety-related risk management reviews, as well as the implementation of safety programs designed to
reduce workers’ compensation claims. We also provide guidance to clients for avoiding liability claims for
discrimination, sexual harassment and civil rights violations, and participate in termination decisions to attempt to
minimize liability on those grounds. When a claim arises, we often assist in our client’s defense regardless of
whether Administaff has been named directly. We employ in-house and external counsel, specializing in several
areas of employment law, who have broad experience in disputes concerning the employer/employee relationship
and provide support to our human resources service specialists. As part of our comprehensive service, we also
maintain employment practice liability insurance coverage for our clients, monitor changing government regulations
and notify clients of the potential effect of such changes on employer liability.
- 5 -
Employee Service CenterSM. The Employee Service Center (“ESC”) is our web-based interactive PEO
service delivery platform, which is designed to provide automated, personalized PEO content and services to our
clients and worksite employees. The ESC provides a wide range of functionality, including:
• WebPayrollSM for the submission and approval of payroll data;
• Client-specific payroll information and reports;
• Employee information, including online check stubs and pay history reports;
• Employee specific benefits content, including summary plan descriptions and enrollment status;
• Access to 401K plan information through MyPlansOnline;
• Online human resources forms;
• Best practices human resource management process maps and process overviews;
• An online personnel guide;
•
• Online recruiting services through the Administaff Talent Network;
• Links to benefits providers and other key vendors; and
• Frequently asked questions.
e-Learning web-based training;
The ESC also contains My MarketPlaceSM, an eCommerce portal that brings a wide range of product and
service offerings from best-of-class providers to our clients, worksite employees and their families. My Marketplace
offerings include:
•
•
•
•
•
•
•
•
•
•
•
financial services;
technology solutions;
communications services;
travel services;
leisure and entertainment services;
retail services;
gifts and rewards;
insurance services;
real estate services;
research and consulting services; and
other business and consumer products and services.
My MarketPlace also features the unique Best2Best® client network, where our clients can offer their
products and services to one another.
Client Service Agreement
All clients enter into Administaff’s Client Service Agreement (“CSA”). The CSA generally provides for an
on-going relationship, subject to termination by Administaff or the client upon 30 to 60 days written notice.
The CSA establishes our comprehensive service fee, which is subject to periodic adjustments to account for
changes in the composition of the client’s workforce, employee benefit election changes and statutory changes that
affect our costs. Prior to January 1, 2003, our comprehensive service fees were typically determined at the outset of
the CSA, and remained relatively static throughout the contract year. If significant changes to the underlying pricing
assumptions occurred during a contract year, the CSA specifically allows us to initiate a manual process to review
that specific client’s pricing and adjust it accordingly, based on the rates in effect at the date of the original contract.
We modified our CSA for new and renewing clients beginning January 1, 2003. Under the provisions of the
modified CSA, clients active in January of any year are obligated to pay the estimated payroll tax component of the
comprehensive service fee in a manner which more closely reflects the pattern of incurred payroll tax costs. This
contractual change coincided with the implementation of a new pricing and billing system. The impact of new and
renewing clients active under the modified CSA in January 2003, which represented approximately 20% of our client
base, resulted in the partial offset of our historical earnings pattern in 2003. Substantially all clients were active
- 6 -
under the modified CSA in January 2004. For those clients, we experienced an offset of our historical earnings
pattern. However, new clients enrolling subsequent to January of any year are invoiced at a relatively constant rate
throughout the remaining portion of the year, resulting in improved profitability over the course of the year for those
clients.
The CSA also establishes the division of responsibilities between Administaff and the client as co-
employers. Pursuant to the CSA, we are responsible for personnel administration and are liable for certain
employment-related government regulations. In addition, we assume liability for payment of salaries and wages (as
well as related payroll taxes) of our worksite employees and responsibility for providing specified employee benefits
to such persons. These liabilities are not contingent on the prepayment by the client of the associated comprehensive
service fee and, as a result of our employment relationship with each of our worksite employees, we are liable for
payment of salary and wages to the worksite employees and are responsible for providing specified employee
benefits to such persons, regardless of whether the client company pays the associated comprehensive service fee.
The client retains the employees’ services and remains liable for the purposes of certain government regulations,
compliance with which requires control of the worksite or daily supervisory responsibility or is otherwise beyond our
ability to assume. A third group of responsibilities and liabilities are shared by Administaff and the client where
such joint responsibility is appropriate. The specific division of applicable responsibilities under the CSA is as
follows:
Administaff
• Payment of wages and related tax reporting and remittance (local, state and federal withholding, FICA, FUTA, state
unemployment);
• Workers’ compensation compliance, procurement, management and reporting;
• Compliance with COBRA, HIPAA and ERISA (for each employee benefit plan sponsored by Administaff only), as
well as monitoring changes in other governmental regulations governing the employer/employee relationship and
updating the client when necessary; and
• Employee benefits administration of plans sponsored by Administaff.
Client
• Payment, through Administaff, of commissions, bonuses, paid leaves of absence and severance payments;
• Payment and related tax reporting and remittance of non-qualified deferred compensation and equity-based
compensation;
• Assignment to, and ownership of, all client intellectual property rights;
• Compliance with OSHA regulations, EPA regulations, FLSA, WARN, USERRA and state and local equivalents and
compliance with government contracting provisions;
• Compliance with the National Labor Relations Act (“NLRA”), including all organizing efforts and expenses related
to a collective bargaining agreement and related benefits;
• Professional licensing requirements, fidelity bonding and professional liability insurance;
• Products produced and/or services provided; and
• COBRA, HIPAA and ERISA compliance for client-sponsored benefit plans.
Joint
Implementation of policies and practices relating to the employee/employer relationship; and
•
• Compliance with all federal, state and local employment laws, including, but not limited to Title VII of the Civil
Rights Act of 1964, ADEA, Title I of ADA, FMLA, the Consumer Credit Protection Act, and immigration laws and
regulations.
Because we are a co-employer with the client company for some purposes, it is possible that we could incur
liability for violations of such laws, even if we are not responsible for the conduct giving rise to such liability. The
CSA addresses this issue by providing that the client will indemnify us for liability incurred to the extent the liability
is attributable to conduct by the client. Notwithstanding this contractual right to indemnification, it is possible that
we could be unable to collect on a claim for indemnification and may therefore be ultimately responsible for
satisfying the liability in question. We maintain certain general insurance coverages (including coverages for our
- 7 -
clients) to manage our exposure for these types of claims, and as a result, the costs in excess of insurance premiums
we incur with respect to this exposure have historically been insignificant to our operating results.
Clients are required to remit their comprehensive service fees no later than one day prior to the applicable
payroll date by wire transfer or automated clearinghouse transaction. Although we are ultimately liable, as the
employer for payroll purposes, to pay employees for work previously performed, we retain the ability to terminate
immediately the CSA and associated worksite employees or to require prepayment, letters of credit or other
collateral upon deterioration in a client’s financial condition or upon non-payment by a client. These rights, the
periodic nature of payroll and the overall quality of our client base have resulted in an excellent overall collections
history.
Customers
Administaff provides a value-added, full-service human resources solution we believe is most suitable to a
specific segment of the small and medium-sized business community. We target successful small businesses with 10
to 2,000 employees, who recognize the advantage in the strategic use of high-performance human resource practices.
We have set a long-term goal to serve approximately 10% of the overall small and medium sized business
community. We serve client companies and worksite employees located throughout the United States. For the year
ended December 31, 2004, Houston, our original market, accounted for approximately 20% of our revenues, with
other Texas markets contributing an additional 19%. By region, our revenue growth over 2003 and revenue
distribution for the year ended December 31, 2004 were as follows:
Northeast .......................................................
Southeast .......................................................
Central ...........................................................
Southwest ......................................................
West...............................................................
Other revenue ................................................
Revenue
Growth
15.8%
(4.9)%
4.4%
6.6%
18.2%
29.1%
% of
Total
Revenues
13.8%
9.4%
14.1%
39.1%
22.9%
0.7%
As part of our client selection strategy, we do not offer our services to businesses falling within certain
specified NAICS (North American Industry Classification System) codes, formerly known as Standard Industrial
Classification codes, essentially eliminating certain industries we believe present a higher employer risk such as
employee injury, high turnover or litigation. All prospective clients are evaluated individually on the basis of
workers’ compensation risk, group medical history (where permitted by law), unemployment history, operating
stability and human resource practices. Our client base is broadly distributed throughout a wide variety of industries
including:
• Finance, insurance and real estate – 16%;
• Computer and information services – 14%;
• Management, administration and consulting services – 12%;
• Medical services – 9%;
• Manufacturing – 9%;
• Construction – 9%;
• Wholesale trade – 8%;
• Engineering, accounting and legal services – 7%;
• Retail trade – 4%;
• Transportation – 2%; and
• Other – 10%.
- 8 -
This diverse client base lowers our exposure to downturns or volatility in any particular industry. However,
our performance could be affected by a downturn in one of these industries or by general economic conditions within
the small and medium-sized business community.
We focus heavily on client retention. Administaff’s client retention record over the last five years reflects
that approximately 69% of our clients remain for more than one year, and that the retention rate improves for clients
who remain with us for longer periods, up to approximately 81% for clients in their fifth year with Administaff. The
resulting average retention rate over the last five years was 76%. During 2004, our retention rate increased to 75%
compared to 71% during 2003. Client attrition is attributable to a variety of factors, including: (i) client non-renewal
due to price factors; (ii) our termination of the CSA resulting from the client’s non-compliance or inability to make
timely payments; (iii) client business failure, sale, merger, or disposition; and (iv) competition from other PEOs or
business services firms.
Marketing and Sales
As of December 31, 2004, we had 38 sales offices located in 21 markets. Our long-term goal is to operate
90 sales offices in 40 strategically selected markets. Our sales offices typically consist of six to eight sales
representatives, a district sales manager and an office administrator. To take advantage of economic efficiencies,
multiple sales offices may share a physical location. Administaff’s markets and their respective year of entry are as
follows:
Market
Sales Offices
Initial
Entry Date
Houston
San Antonio
Austin
Orlando
Dallas/Fort Worth
Atlanta
Phoenix
Chicago
Washington D.C.
Denver
Los Angeles
Charlotte
St. Louis
San Francisco
New York
Baltimore
New Jersey
San Diego
Boston
Minneapolis
Cleveland
4
1
1
1
3
3
1
3
2
1
3
1
1
4
2
1
1
1
2
1
1
1986
1989
1989
1989
1993
1994
1995
1995
1995
1996
1997
1997
1998
1998
1999
2000
2000
2001
2001
2002
2002
Our existing and potential future plan was identified using a systematic market evaluation and selection
process. We continue to evaluate a broad range of factors in the selection process, using a market selection model
that weights various criteria we believe are reliable predictors of successful penetration based on our experience.
Among the factors considered are:
• market size, in terms of small and medium-sized businesses engaged in selected industries that meet our
risk profile;
- 9 -
• market receptivity to PEO services, including the regulatory environment and relevant history with
•
•
•
•
•
other PEO providers;
existing relationships within a given market, such as vendor or client relationships;
expansion cost issues, such as advertising and overhead costs;
direct cost issues that bear on our effectiveness in controlling and managing the cost of our services,
such as workers’ compensation and health insurance costs, unemployment risks and various legal and
other factors;
a comparison of the services we offer to alternatives available to small and medium-sized businesses in
the relevant market, such as the cost to the target clients of procuring services directly or through other
PEOs; and
long-term strategy issues, such as the general perception of markets and our estimate of the long-term
revenue growth potential of the market.
Each of our expansion markets, beginning with Dallas in 1993, was selected in this manner.
Our marketing strategy is based on the application of techniques that have produced consistent and
predictable results in the past. We develop a mix of national and local advertising media and a placement strategy
tailored to each individual market. After selecting a market and developing our marketing mix, but prior to entering
the market, we engage in an organized media and public relations campaign to prepare the market for our entry and
to begin the process of generating sales leads. We market our services through a broad range of media outlets,
including television, radio, newspapers, periodicals, direct mail and the Internet. We employ a public relations firm
in most of our markets as well as advertising consultants to coordinate and implement our marketing campaigns. We
have developed an inventory of proven, successful television, radio and newsprint advertisements, which are utilized
in this effort. We continuously seek to develop new marketing approaches and campaigns to capitalize on changes in
the competitive landscape for our PEO service and to more successfully reach our target market.
In March 2004, we entered into a three-year agreement with the Champions Tour to become the title
sponsor of the annual Administaff Small Business Classic professional golf tournament held in Houston, Texas. In
addition, we entered into a three-year arrangement with Arnold Palmer to become our national spokesperson. Our
marketing campaigns use this event and the relationship with Mr. Palmer as a focal point of our brand marketing
efforts.
Our organic growth model generates sales leads from five primary sources: direct sales efforts, advertising,
referrals, marketing alliances and the Internet. These leads result in initial presentations to prospective clients, and
ultimately, a predictable number of client census reports. A prospective client’s census report reflects information
gathered by the sales representative about the prospect’s employees, including job classification, state of
employment, workers’ compensation claims history, group medical information (where permitted by law), salary and
desired level of benefits. This information is entered into our customized bid system, which applies Administaff’s
proprietary pricing model to the census data, leading to the preparation of a bid. Concurrent with this process, we
evaluate the prospective client’s workers’ compensation, health insurance, employer practices and financial stability
from a risk management perspective. Upon completion of a favorable risk evaluation, the sales representative
presents the bid and attempts to enroll the prospect. Our selling process typically takes approximately 90 days.
In 1998, we entered into a strategic marketing agreement with American Express, under which American
Express was utilizing its resources and working jointly with us to generate appointments with prospects for our
services from the American Express customer base in certain markets. In return, we paid a commission to American
Express based upon the number of worksite employees paid after being referred to Administaff pursuant to the
Marketing Agreement and the total number of worksite employees we paid. In 2004, the American Express
marketing agreement was mutually terminated. We currently have several other marketing alliances with companies
that target small businesses, such as Pitney Bowes, MassMutual and Avaya.
- 10 -
Competition
Administaff provides a value-added, full-service human resources solution we believe is most suitable to a
specific segment of the small and medium-sized business community. This full-service approach is exemplified by
our commitment to service and technology personnel and tools, which has produced a ratio of corporate staff to
worksite employees (the “staff support ratio”) that is higher than average for the PEO industry. Based on an analysis
of the 2001 through 2003 annual NAPEO surveys of the PEO industry, we have successfully leveraged our full-
service approach into significantly higher returns for Administaff on a per worksite employee per month basis.
During the three-year period from 2001 through 2003, our staff support ratio averaged 50% higher than the PEO
industry average, while gross profit per worksite employee and operating income per worksite employee exceeded
industry averages by 132% and 85%, respectively.
Competition in the PEO industry revolves primarily around quality of services, scope of services, choice
and quality of benefits packages, reputation and price. We believe reputation, national presence, regulatory
expertise, financial resources, risk management and information technology capabilities distinguish leading PEOs
from the rest of the industry. We also believe we compete favorably in these areas.
Due to the differing geographic regions and market segments in which most PEOs operate, and the
relatively low level of market penetration by the industry, we consider our primary competition to be the traditional
in-house provision of human resource services. The PEO industry is highly fragmented, and we believe Administaff
is one of the largest PEOs in the United States. Our largest national competitors include Gevity HR and PEO
divisions of large business services companies such as Automatic Data Processing, Inc. and Paychex, Inc. In
addition, we compete to some extent with fee-for-service providers such as payroll processors and human resource
consultants and face competition from large regional PEOs in certain areas of the country. As Administaff and other
large PEOs expand nationally, we expect that competition may intensify among larger PEOs.
Vendor Relationships
Administaff provides benefits to its worksite employees under arrangements with a variety of vendors.
Although we believe that any of our benefit contracts could be replaced if necessary, we consider two such contracts
to be the most significant elements of the package of benefits provided to employees and the most difficult to
replace.
We provide health insurance coverage to our worksite employees through a national network of carriers
including UnitedHealthcare (“United”), Cigna Healthcare, PacifiCare, Kaiser Permanente, Blue Cross and Blue
Shield of Georgia, Blue Shield of California and Tufts, all of which provide fully insured policies or service
contracts. The policy with United provides the majority, 76%, of our health insurance coverage and automatically
renews on January 1 of each year, subject to cancellation by either party upon 180 days notice. For a discussion of
our contract with United, please read Item 7. “Management’s Discussion and Analysis of Financial Condition and
Results of Operations - Critical Accounting Policies and Estimates – Benefits Costs” on page 26.
Our workers’ compensation policy (the “2005 Policy”) is currently provided through selected member
insurance companies of American International Group, Inc. (“AIG”). Under our arrangement with AIG, we bear the
economic burden for the first $1 million layer of claims per occurrence. AIG bears the economic burden for all
claims in excess of such first $1 million layer. The 2005 Policy is a fully insured policy whereby AIG has the
responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. For
additional discussion of our policy with AIG, please read Item 7. “Management’s Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting Policies and Estimates – Workers’
Compensation Costs” on page 27.
Information Technology
Administaff utilizes a variety of information technology capabilities to provide its human resource services
to client companies and worksite employees and for its own administrative and management information
requirements.
- 11 -
Administaff Information Management System (“AIMS”), is our proprietary PEO information system and
utilizes both purchased and internally developed software applications. This system manages transactions and
information unique to the PEO industry and to Administaff, including:
human resource management;
benefits and defined contribution plan administration;
payroll processing;
client invoicing and collection;
• worksite employee enrollment;
•
•
•
•
• management information and reporting; and
•
sales bid calculations that are unique to the PEO industry and to Administaff.
Central to the system is a payroll processing system that allows us to process a high volume of payroll
transactions that meet the specific needs of our client companies. Our retirement services operations are conducted
utilizing an industry leading retirement plan administration application in a third-party hosted environment. We
utilize commercially available software for other business functions such as finance and accounting, sales force
activity management, and customer service issue tracking.
The Employee Service Center is our proprietary web-based PEO service delivery platform. With its
integration into AIMS, the ESC is designed to provide automated, personalized PEO content and services to our
clients and worksite employees. For a description of the functionality provided through the ESC, please read “PEO
Services – Employee Service Center” on page 6.
We have entered into a software licensing agreement to acquire a new Customer Relationship Management
application and will be implementing that application during 2005. This application is intended to enhance our
ability to manage the data and interactions with our customers on a day-to-day basis and replaces an application
originally installed in 1999 for which maintenance and support is no longer commercially available.
Administaff’s primary data center is located at our corporate headquarters in Kingwood, Texas (a suburb of
Houston). Substantially all of our business applications, telecommunications equipment and network equipment are
hosted in this data center. We maintain a disaster recovery data center in our Dallas service center. This data center
is fully equipped with the hardware and software necessary to run all of our critical business applications and has
sufficient capacity to handle all of our operations for short periods of time, if required. Periodically, we perform
testing to ensure the disaster recovery capabilities remain effective and available.
We have invested substantially in our network infrastructure to ensure appropriate connectivity exists
between our service centers in Atlanta, Dallas, Houston and Los Angeles, our district sales offices and our corporate
offices, and to provide appropriate Internet connectivity to conduct business through the Employee Service Center.
The network infrastructure is provided through industry standard core network hardware and via high-speed frame-
relay and point-to-point network services provided by multiple vendors.
Industry Regulation
Administaff’s operations are affected by numerous federal and state laws relating to tax and employment
matters. By entering into a co-employer relationship with our worksite employees, we assume certain obligations
and responsibilities of an employer under these federal and state laws. Because many of these federal and state laws
were enacted prior to the development of nontraditional employment relationships, such as PEOs, temporary
employment and outsourcing arrangements, many of these laws do not specifically address the obligations and
responsibilities of nontraditional employers. Currently, 25 states have passed laws that have licensing, registration or
certification requirements for PEOs, and several others are considering such regulation.
Certain federal and state statutes and regulations use the terms “employee leasing” or “staff leasing” to
describe the arrangement among a PEO and its clients and worksite employees. The terms “employee leasing,”
- 12 -
“staff leasing” and “professional employer arrangements” are generally synonymous in such contexts and describe
the arrangements we enter with our clients and worksite employees.
As an employer, we are subject to all federal statutes and regulations governing the employer/employee
relationship. Subject to the issues discussed below, we believe that our operations are in compliance, in all material
respects, with all applicable federal statutes and regulations.
Employee Benefit Plans
We offer various employee benefits plans to eligible employees, including our worksite employees. These
plans include:
•
•
•
•
•
•
•
a 401(k) Plan (a profit-sharing plan with a cash or deferred arrangement (“CODA”) under Code
Section 401(k) and an employer matching contribution feature under Code Section 401(m)) maintained
consistent with the provisions of Revenue Procedure 2002-21 and 2003-86 (each of which is explained
in more detail below);
a cafeteria plan under Code Section 125;
a group health plan which includes medical, dental, vision and worklife programs;
a welfare benefits plan which includes life insurance and disability programs;
a health care flexible spending plan;
an educational assistance program; and
an adoption assistance program.
Generally, employee benefit plans are subject to provisions of both the Code and ERISA.
Employer Status. In order to qualify for favorable tax treatment under the Code, the plans must be
established and maintained by an employer for the exclusive benefit of its employees. Generally, an entity is an
“employer” of individuals for federal employment tax purposes if an employment relationship exists between the
entity and the individuals under the common law test of employment. In addition, the officers of a corporation are
deemed to be employees of that corporation for federal employment tax purposes. The common law test of
employment, as applied by the IRS, involves an examination of approximately 20 factors to ascertain whether an
employment relationship exists between a worker and a purported employer. Generally, the test is applied to
determine whether an individual is an independent contractor or an employee for federal employment tax purposes
and not to determine whether each of two or more companies is a “co-employer.” Substantial weight is typically
given to the question of whether the purported employer has the right to direct and control the details of an
individual’s work. Among the factors that appear to have been considered more important by the IRS are:
•
•
•
the employer’s degree of behavioral control (the extent of instructions, training and the nature of the
work);
the financial control or the economic aspects of the relationship; and
the intended relationship of the parties (whether employee benefits are provided, whether any contracts
exist, whether services are ongoing or for a project, whether there are any penalties for
discharge/termination, and the frequency of the business activity).
ERISA Requirements. Employee pension and welfare benefit plans are also governed by ERISA. ERISA
defines “employer” as “any person acting directly as an employer, or indirectly in the interest of an employer, in
relation to an employee benefit plan.” ERISA defines the term “employee” as “any individual employed by an
employer.” The United States Supreme Court has held that the common law test of employment must be applied to
determine whether an individual is an employee or an independent contractor under ERISA. A definitive judicial
interpretation of “employer” in the context of a PEO or employee leasing arrangement has not been established.
If Administaff were found not to be an employer with respect to worksite employees for ERISA purposes,
its plans would not comply with ERISA. Further, as a result of such finding Administaff and its plans would not
enjoy, with respect to worksite employees, the preemption of state laws provided by ERISA and could be subject to
- 13 -
varying state laws and regulations, as well as to claims based upon state common laws. Even if such a finding were
made, we believe we would not be materially adversely affected because we could continue to make available similar
benefits at comparable costs.
In addition to ERISA and the Code provisions discussed herein, issues related to the relationship between
Administaff and its worksite employees may also arise under other federal laws, including other federal income tax
laws.
401(k) Plan. On April 24, 2002, the Internal Revenue Service (“IRS”) issued Revenue Procedure 2002-21,
and on November 11, 2003, issued Revenue Procedure 2003-86, each of which provided guidance for the operation
of defined contribution plans maintained by PEOs that benefit worksite employees. Each applies to plans in
existence on May 12, 2002 and their operation in plan years beginning after December 31, 2003.
Consistent with the guidance for all periods beginning on or after January 1, 2004, electing client companies
are treated as adopting employers for plan qualification purposes under Code Section 413(c). On December 31,
2003, participant account balances attributable to worksite employees associated with client companies who failed
to: (i) agree to be treated as an adopting employer; or (ii) make another valid election in a timely manner, were
transferred to the newly established Administaff Spinoff 401(k) Plan. Additionally, a small number of client
companies chose to transfer attributable participant account balances to other 401(k) plans separately maintained by
the client companies pursuant to the guidance. The Administaff Spinoff 401(k) Plan was also terminated effective
December 31, 2003, subject to IRS approval. Upon receipt of IRS approval, which was requested on September 15,
2004, all remaining participant account balances in such plan will be distributed to the participants pursuant to the
guidance. Compliance with Revenue Procedures 2002-21 and 2003-86 requires additional administrative
compliance efforts, the cost of which is expected to be primarily born by the plan and therefore is not expected to
have a material adverse impact on the Company’s financial condition or results of operations.
Federal Employment Taxes
As a co-employer, Administaff assumes responsibility and liability for the payment of federal and state
employment taxes with respect to wages and salaries paid to our worksite employees. There are essentially three
types of federal employment tax obligations:
• withholding of income tax requirements governed by Code Section 3401, et seq.;
•
•
obligations under FICA, governed by Code Section 3101, et seq.; and
obligations under FUTA, governed by Code Section 3301, et seq.
Under these Code sections, employers have the obligation to withhold and remit the employer portion and, where
applicable, the employee portion of these taxes.
Code Section 3401, which applies to federal income tax withholding requirements, contains an exception to
the general common law test applied to determine whether an entity is an “employer” for purposes of federal income
tax withholding. Section 3401(d)(1) states that if the person for whom services are rendered does not have control of
the payment of wages, the “employer” for this purpose is the person having control of the payment of wages. The
Treasury regulations issued under Section 3401(d)(1) state that a third party can be deemed to be the employer of
workers under this section for income tax withholding purposes where the person for whom services are rendered
does not have legal control of the payment of wages. While Section 3401(d)(1) has been examined by several
courts, its ultimate scope has not been delineated. Moreover, the IRS has to date relied extensively on the common
law test of employment in determining liability for failure to comply with federal income tax withholding
requirements.
Accordingly, while we believe that we can assume the withholding obligations for worksite employees, in
the event we fail to meet these obligations, the client company may be held ultimately liable for those obligations.
While this interpretive issue has not to our knowledge discouraged clients from enrolling with Administaff, there can
be no assurance that a definitive adverse resolution of this issue would not do so in the future. These interpretive
- 14 -
uncertainties may also impact our ability to report employment taxes on our own account rather than the accounts of
our clients.
State Unemployment Taxes
We record our state unemployment (“SUI”) tax expense based on taxable wages and tax rates assigned by
each state. State unemployment tax rates vary by state and are determined, in part, based on prior years’
compensation experience in each state. In addition, states have the ability under law to increase unemployment tax
rates to cover deficiencies in the unemployment tax fund. Many states have experienced and are experiencing
significant increases in unemployment claims due to depressed economic conditions over the last few years. As a
result, our unemployment tax rates have increased over the last several years and are expected to continue to
increase. Some states have implemented retroactive cost increases. Prior to the receipt of final tax rate notices, we
estimate our expected SUI tax rate in those states for which tax rate notices have not yet been received.
As a result of the 2001 corporate restructuring, we filed for a transfer of our reserve account with the
Employment Development Department of the State of California (“EDD”). The EDD approved our request for
transfer of the reserve account in May 2002 and also notified us of our new contribution rates based upon the
approved transfer. In December 2003, we received a Notice of Duplicate Accounts and Notification of Assessment
from the EDD. The notice stated that the EDD was collapsing the accounts of our subsidiaries into the account of
the entity with the highest unemployment tax rate. The notice also retroactively imposed the higher unemployment
insurance rate on all of our California employees for 2003, resulting in an assessment of $5.6 million. In January
2004, we filed a petition with an administrative law judge of the California Unemployment Insurance Appeals Board
(“ALJ”) to protest the notice. Pending a resolution of our protest, in the fourth quarter of 2003 we accrued and
recorded at the higher assessed rate for all of 2003.
In June 2004, we agreed to settle our dispute with the EDD for $3.3 million. Based upon receipt of written
acknowledgement of this agreement, we reduced our accrued payroll tax liability and payroll tax expense by $2.3
million during the quarter ended June 30, 2004. The settlement was subject to the final approval by EDD’s legal
department, the California Attorney General’s office and the ALJ. In October 2004, the legal department of the
EDD verbally indicated they considered the previously agreed-upon settlement amount to be insufficient and
suggested a settlement amount of $5.2 million. We continued discussions with the State of California, but in
February 2005, we were notified that the EDD had rejected our settlement offer, and the matter will proceed with the
appeals process with the ALJ. If the outcome of the appeals process is unfavorable and we are assessed additional
interest and penalties, we may recognize an increase in our payroll tax expense in a future period. Conversely, if the
outcome of the appeals process is favorable to us, we may recognize a decrease in our payroll tax expense in a future
period. The ultimate outcome of this matter is not expected to have a material impact on our 2005 unemployment
tax rate in California. For a discussion of the impact of rising unemployment tax rates, please read “Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Factors That May Affect Future Results
and the Market Price of Common Stock – Increases in Unemployment Tax Rates” on page 42.
State Regulation
While many states do not explicitly regulate PEOs, 25 states have regulations containing licensing,
registration or certification requirements for PEOs, and several others are considering such regulation. Such laws
vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs, and in some cases
codify and clarify the co-employment relationship for unemployment, workers’ compensation and other purposes
under state law. We hold licenses in Arkansas, Florida, Montana, New Hampshire, New Mexico, Oklahoma,
Oregon, South Carolina, Tennessee, Texas and Vermont. We are registered or certified in Colorado, Illinois,
Kentucky, Louisiana, Maine, Minnesota, Nevada, New Jersey, New York, North Carolina, Rhode Island, Utah and
Virginia. We are applying for registration pursuant to a recently enacted registration statute in Ohio. Regardless of
whether a state has licensing, registration or certification requirements, we must comply with a number of other state
and local regulations that could impact our operations. Administaff was instrumental in obtaining enactment of PEO
legislation in various states, including Texas, where it faced a number of challenges under state law. We believe that
our prior experience with Texas and other state regulatory authorities will be valuable in surmounting regulatory
obstacles or challenges we may face in the future.
- 15 -
Corporate Office Employees
We had approximately 1,350 corporate office and sales employees as of December 31, 2004. We believe
our relations with our corporate office and sales employees are good. None of our corporate office and sales
employees are covered by a collective bargaining agreement.
Intellectual Property
Administaff currently has registered trademarks and pending applications for registration. Although the
Administaff mark is the most material trademark to our business, our trademarks as a whole are also of considerable
importance to us. Finally, we have certain copyrights and a pending patent application for our WebPayroll software
program.
ITEM 2. PROPERTIES.
We believe our current facilities are adequate for the purposes for which they are intended and they provide
sufficient capacity to accommodate our expansion goals. We will continue to evaluate the need for additional
facilities based on the rate of growth in worksite employees, the geographic distribution of the worksite employee
base and our long-term service delivery requirements.
Corporate Headquarters
Our corporate headquarters is located in Kingwood, Texas, in a 327,000 square foot office campus-style
facility. This 28-acre company-owned office campus includes approximately nine acres of undeveloped land for
future expansion. All development and support operations are located in the Kingwood facility, along with our
record retention center and primary data processing center. Our corporate headquarters secures a $34 million
mortgage on the property. For more information regarding the mortgage, please read “Management’s Discussion
and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” on page 37.
Service Centers
We currently have four service centers located in Atlanta, Dallas, Houston and Los Angeles.
The Atlanta service center, which currently services approximately 23% of our worksite employee base, is
located in a 40,000 square foot leased facility. This facility, which is under lease until 2014, is designed to service
approximately 40,000 worksite employees at full capacity.
The Dallas service center, which currently services approximately 31% of our worksite employee base, is
located in a 40,000 square foot leased facility, which also serves as our backup data processing and disaster recovery
center. This facility, which is under lease until 2008, is designed to service approximately 40,000 worksite
employees at full capacity.
The Houston service center, which currently services approximately 29% of our worksite employee base, is
located in a 40,000 square foot leased facility. This facility, which is under lease until 2014, is designed to service
approximately 40,000 worksite employees at full capacity.
The Los Angeles service center, which currently services approximately 17% of our worksite employee
base, is located in a 45,000 square foot leased facility. This facility, which is under lease until 2012, is designed to
service approximately 40,000 worksite employees at full capacity.
Sales Offices
As of December 31, 2004, we had sales and service personnel in 27 facilities located in 21 sales markets
throughout the United States. All of the facilities are leased facilities, and some of these facilities are shared by
multiple sales offices and/or client service personnel. As of December 31, 2004, we had 38 sales offices in these 21
- 16 -
markets. To take advantage of economic efficiencies, multiple sales offices may share a physical location. Each
sales office is typically staffed by six to eight sales representatives, a district sales manager and an office
administrator. In addition, we have placed certain client service personnel in a majority of our sales markets to
provide high-quality, localized service to our clients in those major markets. We expect to continue placing various
client service personnel in sales markets as a critical mass of clients is attained in each market.
ITEM 3. LEGAL PROCEEDINGS.
Other than as set forth below, we are not a party to any material pending legal proceedings other than
ordinary routine litigation incidental to our business that we believe would not have a material adverse effect on our
financial condition or results of operations.
Aetna Healthcare Litigation
On November 5, 2001, Administaff filed a lawsuit against Aetna Life Insurance Company (“Aetna”). We
alleged, among other things, that during the third quarter of 2001, Aetna breached its contract with us. Aetna filed a
counterclaim alleging, among other things, that we breached our contractual obligations to Aetna. On October 30,
2003, a jury returned a verdict in favor of Administaff, awarding Administaff $15.5 million in compensatory
damages. On November 7, 2003, the court entered a final judgment in favor of Administaff in the amount of $15.5
million, with post judgment interest at a rate of 1.3% per annum. On December 10, 2003, the court granted Aetna’s
motion to reduce the judgment to $10.6 million. Aetna subsequently filed its notice to appeal the judgment and other
rulings of the trial court.
During the first quarter of 2004, Administaff and Aetna executed a settlement agreement. Under the terms
of the agreement, Aetna paid us $8.25 million and both parties released all claims and agreed to dismiss all court
proceedings. The settlement was recorded in other income in our 2004 Consolidated Statements of Operations, and
the matter has now been concluded.
Class Action Litigation
On June 13, 2003, a class action lawsuit was filed against Administaff in the United States District Court for
the Southern District of Texas on behalf of purchasers of our common stock alleging violations of the federal
securities laws. After that date, six similar class actions were filed against Administaff in that court. Those lawsuits
also named as defendants certain of our officers and directors. Those lawsuits generally allege that Administaff and
certain of its officers and directors made false and misleading statements or failed to make adequate disclosures
concerning, among other things: (i) our pricing and billing systems with respect to recalibrating pricing for clients
that experienced a decline in average payroll cost per worksite employee; (ii) the matching of price and cost for
health insurance on new and renewing client contracts; and (iii) our former method of reporting worksite employee
payroll costs as revenue. The complaints sought unspecified damages, among other remedies. On March 31, 2004,
the court entered an order consolidating all of the cases and appointing Carpenters Pension Trust for South
California as “lead plaintiff” and Lerach Coughlin Stoia Geller Rudman & Robbins LLP as “lead counsel.” The lead
plaintiff alleges that its losses are $352,000, although the alleged damages of the purported class have not been
specified.
In May 2004, the lead plaintiff filed its Consolidated Complaint, which amended and consolidated the seven
previously filed cases. In the consolidated complaint, the lead plaintiff has essentially abandoned the allegations of
fraud contained in the initial seven lawsuits. Through the consolidated complaint, the lead plaintiff now generally
asserts, among other things, that Administaff and certain of its officers and directors fraudulently made false and
misleading statements regarding the cost of its health plan during 2001 and 2002. In June 2004, we filed a motion to
dismiss the consolidated complaint. We believe these claims are without merit and intend to vigorously defend this
litigation. As a result of the uncertainty regarding the outcome of this matter, no provision has been made in the
accompanying consolidated financial statements.
- 17 -
Reliance National Indemnity Co. Bankruptcy Liquidation and Related Litigation
In October 2001, Reliance National Indemnity Co. (“Reliance”), a former workers’ compensation insurance
carrier of Administaff, was forced into bankruptcy liquidation. State laws 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, the guaranty associations in some states, including Texas, have asserted that state law
returns the liability for open claims under policies with the liquidated insurance carrier to Administaff. In Texas, we
disputed the right of the guaranty association to be reimbursed for such claims.
On August 1, 2003, we filed a lawsuit against the Texas Property and Casualty Insurance Guaranty
Association (“TPCIGA”) seeking a declaratory judgment that we are not required to reimburse TPCIGA for
workers’ compensation benefits paid or to be paid by TPCIGA under our workers’ compensation policies with
Reliance. On August 15, 2003, TPCIGA filed its answer, denying the claims asserted as well as filing a
counterclaim that TPCIGA is entitled to full reimbursement from Administaff for workers’ compensation benefits
paid or to be paid by TPCIGA under our workers’ compensation policies with Reliance. We estimated that
TPCIGA’s claim for reimbursement was approximately $6.8 million. During the fourth quarter of 2003, we paid
$1.1 million to settle the lawsuit, including TPCIGA’s claim for reimbursement. The cost of the settlement was
reported as a component of workers’ compensation expense in our 2003 Consolidated Statement of Operations.
We initially secured $1.8 million in insurance coverage to cover potential claims returned to Administaff
related to our Reliance policies. We submitted the TPCIGA settlement as a claim under the policy. We collected
and recorded a $1.1 million reimbursement during the year ended December 31, 2004. As of December 31, 2004,
there was no coverage remaining on the policy. At December 31, 2004, the estimated outstanding claims under our
former policies with Reliance totaled approximately $100,000. We have accrued and recorded our estimate of the
outstanding claims as of December 31, 2004. It is possible that such losses could exceed our estimates, resulting in
an increase to workers’ compensation expense, which would reduce net income.
State Unemployment Taxes
We record our SUI tax expense based on taxable wages and tax rates assigned by each state. State
unemployment tax rates vary by state and are determined, in part, based on prior years’ compensation experience in
each state.
In December 2001, as a result of a 2001 corporate reorganization, we filed for a transfer of our reserve
account with the Employment Development Department of the State of California (“EDD”). The EDD approved our
request for transfer of the reserve account in May 2002 and also notified us of our new contribution rates based upon
the approved transfer. In December 2003, we received a Notice of Duplicate Accounts and Notification of
Assessment from the EDD. The notice stated that the EDD was collapsing the accounts of our subsidiaries into the
account of the entity with the highest unemployment tax rate. The notice also retroactively imposed the higher
unemployment insurance rate on all our California employees for 2003, resulting in an assessment of $5.6 million.
In January 2004, we filed a petition with an administrative law judge of the California Unemployment Insurance
Appeals Board (“ALJ”) to protest the notice. Pending a resolution of our protest, in the fourth quarter of 2003 we
accrued and recorded at the higher assessed rate for all of 2003.
In June 2004, we agreed to settle our dispute with the EDD for $3.3 million. Based upon receipt of written
acknowledgement of this agreement, we reduced our accrued payroll tax liability and payroll tax expense by $2.3
million during the quarter ended June 30, 2004. The settlement was subject to the final approval by EDD’s legal
department, the California Attorney General’s office and the ALJ. In October 2004, the legal department of the
EDD verbally indicated they considered the previously agreed-upon settlement amount to be insufficient and
suggested a settlement amount of $5.2 million. We continued discussions with the State of California, but in
February 2005, we were notified that the EDD had rejected our settlement offer, and the matter will proceed with
the appeals process with the ALJ. If the outcome of the appeals process is unfavorable and we are assessed
additional interest and penalties, we may recognize an increase in our payroll tax expense in a future period.
- 18 -
Conversely, if the outcome of the appeals process is favorable, we may recognize a decrease in our payroll tax
expense in a future period. The ultimate outcome of this matter is not expected to have a material impact on our
2005 unemployment tax rate in California.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders, through solicitation of proxies or otherwise,
during the quarter ended December 31, 2004.
ITEM S-K 401 (b). EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth the names, ages (as of February 14, 2005) and positions of the Company’s
executive officers:
Name
Age
Position
Paul J. Sarvadi ....................................... 48 Chairman of the Board and Chief Executive Officer
Richard G. Rawson ................................ 56
A. Steve Arizpe...................................... 47
Jay E. Mincks ........................................ 51
John H. Spurgin, II ................................ 58
Douglas S. Sharp ................................... 43 Vice President, Finance, Chief Financial Officer and Treasurer
President
Executive Vice President, Client Services and Chief Operating
Officer
Executive Vice President, Sales and Marketing
Senior Vice President, Legal, General Counsel and Secretary
Paul J. Sarvadi has served as Chairman of the Board and Chief Executive Officer since August 2003. Mr.
Sarvadi co-founded Administaff in 1986 and served as Vice President and Treasurer of the Company from its
inception in 1986 through April 1987, as Vice President from April 1987 through 1989 and as President and Chief
Executive Officer from 1989 to August 2003. Prior to founding Administaff, Mr. Sarvadi started and operated
several small businesses. Mr. Sarvadi has served as President of NAPEO and was a member of its Board of
Directors for five years. He also served as President of the Texas Chapter of NAPEO for three of the first four years
of its existence. Mr. Sarvadi was selected as the 2001 National Ernst & Young Entrepreneur Of The Year® for
service industries.
Richard G. Rawson has served as President since August 2003. He served as Executive Vice President,
Administration, Chief Financial Officer and Treasurer from February 1997 to August 2003. He joined Administaff
in 1989 as Senior Vice President, Chief Financial Officer, and Treasurer. He previously served as a Senior Financial
Officer and Controller for several companies in the manufacturing and seismic data processing industries. Mr.
Rawson has served as President, First Vice President, Second Vice President and Treasurer of NAPEO as well as
Chairman of the NAPEO Accounting Practices Committee.
A. Steve Arizpe has served as Executive Vice President, Client Services and Chief Operating Officer since
August 2003. He joined Administaff in 1989 and has served in a variety of roles, including Houston Sales Manager,
Regional Sales Manager, Vice President of Sales and Executive Vice President, Client Services. Prior to joining
Administaff, Mr. Arizpe served in sales and sales management roles for two large corporations.
Jay E. Mincks has served as Executive Vice President, Sales and Marketing since January 1999. Mr.
Mincks served as Vice President, Sales and Marketing from February 1997 through January 1999. He joined
Administaff in 1990 and has served in a variety of other roles, including Houston Sales Manager and Regional Sales
Manager for the Western United States. Prior to joining Administaff, Mr. Mincks served in a variety of positions,
including management positions, in the sales and sales training fields with various large companies.
- 19 -
John H. Spurgin, II has served as Senior Vice President, Legal, General Counsel and Secretary since August
2003. He joined Administaff in January 1997 as Vice President, Legal, General Counsel and Secretary. Prior to joining
Administaff, Mr. Spurgin was a partner with the Austin office of McGinnis, Lochridge & Kilgore, L.L.P., where he
served as Administaff’s outside counsel for nine years.
Douglas S. Sharp has served as Vice President, Finance, Chief Financial Officer and Treasurer since August
2003. He joined Administaff in January 2000 as Vice President, Finance and Controller. From July 1994 until he
joined Administaff, Mr. Sharp served as Chief Financial Officer for Rimkus Consulting Group, Inc. Prior to that, he
served as Controller for a small publicly held company; as Controller for a large software company; and as an Audit
Manager for Ernst & Young LLP. Mr. Sharp has served as a member of the Accounting Practices Committee of
NAPEO since January 2002.
- 20 -
PART II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF SECURITIES.
Price Range of Common Stock
Our common stock is traded on the New York Stock Exchange under the symbol “ASF”. As of February
14, 2005, there were 185 holders of record of the common stock. This number does not include stockholders for
whom shares were held in “nominee” or “street name.” The following table sets forth the high and low sales prices
for the common stock as reported on the New York Stock Exchange composite transactional tape.
2004
First Quarter ................................................................
Second Quarter ............................................................
Third Quarter...............................................................
Fourth Quarter .............................................................
2003
First Quarter ................................................................
Second Quarter ............................................................
Third Quarter...............................................................
Fourth Quarter .............................................................
High
$ 18.45
18.18
16.59
15.50
$ 7.50
10.57
13.31
18.10
Low
$ 14.06
14.37
9.38
10.31
$ 4.42
5.10
8.53
8.80
Dividend Policy
We have not paid cash dividends on our common stock since our formation. On February 4, 2005, our
Board of Directors declared a $0.07 quarterly dividend per share of common stock for the holders of record on
March 7, 2005. The dividend will be paid on April 1, 2005. The payment of dividends is made at the discretion of
our Board of Directors and depends upon our operating results, financial condition, capital requirements, general
business conditions and such other factors as our Board of Directors deems relevant.
Issuer Purchases of Equity Securities
The following table provides information about our purchases of Administaff common stock during the
three months ended December 31, 2004:
Period
10/01/2004 –
10/31/2004
11/01/2004 –
11/30/2004
12/01/2004 –
12/31/2004
Total
Total Number
of Shares
Purchased (1)
Average Price Paid
per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced
Program (2)
Maximum Number of
Shares that May Yet Be
Purchased Under the
Program (2)
—
—
—
—
$
$
—
—
—
—
- 21 -
—
—
—
—
1,247,477
1,247,477
1,247,477
1,247,477
(1)
(2)
Our board of directors has approved the repurchase of up to an aggregate amount of 8,000,000 shares of
Administaff common stock, of which 6,752,523 shares had been repurchased as of December 31, 2004.
During the three months ended December 31, 2004, we did not purchase shares of our common stock.
Unless terminated earlier by resolution of the board of directors, the repurchase program will expire when
we have repurchased all shares authorized for repurchase under the repurchase program.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data set forth below should be read in conjunction with the
Consolidated Financial Statements and accompanying Notes and Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” on page 23.
Income Statement Data:
Revenues(1) .............................................
Gross profit ............................................
Operating income ...................................
Net income (loss) from
continuing operations .........................
Net loss from discontinued operations ...
Net income (loss) ...................................
Diluted net income (loss) per share
from continuing operations (2) .............
2004
Year ended December 31,
2002
(in thousands, except per share and statistical data)
2001
2003
2000
$ 969,527
197,694
22,131
$ 890,859
197,105
24,274
$ 848,416
165,790
67
$ 720,219
165,015
18,539
$ 598,291
138,534
22,234
19,210
—
19,210
14,985
(2,121)
12,864
(2,921)
(1,160)
(4,081)
10,357
—
10,357
16,900
—
16,900
$
0.72
$
0.55
$
(0.11)
$
0.36
$
0.58
Balance Sheet Data:
Working capital......................................
Total assets.............................................
Total debt ..............................................
Total stockholders’ equity......................
$ 47,500
354,638
36,539
126,529
$ 56,032
348,071
42,362
122,634
$ 41,238
315,164
44,169
116,349
$ 36,609
274,003
13,500
122,935
$ 51,179
242,817
—
105,510
Statistical Data:
Average number of worksite employees
paid per month during period .............
Revenues per worksite
employee per month (3) .......................
Gross profit per worksite
employee per month ...........................
Operating income per worksite
employee per month ...........................
_________________
77,936
75,036
77,334
69,480
62,140
$
$
$
1,037
211
24
$
$
$
989
219
27
$
$
$
914
179
—
$
$
$
864
198
22
$
$
$
802
186
30
(1)
(2)
(3)
Gross billings of $5.377 billion, $4.829 billion, $4.857 billion, $4.373 billion and $3.708 billion less worksite
employee payroll cost of $4.407 billion, $3.938 billion, $4.009 billion, $3.653 billion and $3.110 billion,
respectively.
Adjusted to reflect the two-for-one split of the common stock effected on October 16, 2000.
Gross billings of $5,749, $5,363, $5,234, $5,245 and $4,973 per worksite employee per month less payroll
cost of $4,712, $4,373, $4,320, $4,381 and $4,171 per worksite employee per month, respectively.
- 22 -
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
You should read the following discussion in conjunction with our Consolidated Financial Statements and
related Notes included elsewhere in this annual report. Historical results are not necessarily indicative of trends in
operating results for any future period.
The statements contained in this annual report that are not historical facts are forward-looking statements
that involve a number of risks and uncertainties. The actual results of the future events described in such forward-
looking statements in this annual report could differ materially from those stated in such forward-looking statements.
Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this
Item 7 under “Factors that May Affect Future Results and the Market Price of Common Stock” on page 40 and the
uncertainties set forth from time to time in our other public reports and filings and public statements.
Overview
We provide a comprehensive Personnel Management System that encompasses a broad range of services,
including benefits and payroll administration, health and workers’ compensation insurance programs, personnel
records management, employer liability management, employee recruiting and selection, employee performance
management, and employee training and development services. Our overall operating results are largely dependent
on the number of worksite employees paid, and can be measured in terms of revenues, payroll costs, gross profit or
operating income per worksite employee per month. As a result, we often use this unit of measurement in analyzing
and discussing our results of operations.
Our net income from continuing operations increased 28.2% to $19.2 million in 2004 over 2003. During
2004 we received and recorded $8.25 million, or $5.2 million after taxes, related to a legal settlement with our
former health insurance carrier, Aetna. We ended 2004 with working capital of $47.5 million, which is a $9 million
decline from the end of 2003, despite share repurchases of $17 million and capital expenditures of $8 million during
2004.
One of our key objectives for 2004 was to develop a pricing strategy and manage our direct costs in such a
manner as to produce gross profit of $209 to $215 per worksite employee per month, while returning to double-digit
unit growth levels by the end of 2004. In addition, we sought to maintain annual operating expenses between $173.5
million and $177.5 million. During 2004, we achieved all of these key objectives.
Our 2004 average gross profit per worksite employee per month of $211 reflected the effective execution
of our pricing strategy, including moderation of increases in the healthcare allocation component of the
comprehensive service fee, while managing our direct costs to slightly better than expected levels. Lower 2004
direct costs, particularly benefits costs and workers’ compensation costs, were primarily a result of the favorable
trends in claims experience. Benefits costs per participant increased 5.7 % over 2003, lower than our initial forecast
of 8-10%. Declines in both the frequency and severity of workers compensation claims also resulted in lower
workers compensation costs.
We ended 2004 with 81,426 paid worksite employees in December, which represents a 10.5% increase over
December 2003. When we established the goal of returning to double-digit unit growth, we specifically targeted
improvements in both client retention and sales. During 2004, we experienced a 14% decline in the number of
worksite employees lost due to client terminations as compared to 2003. In addition, we saw a 24% increase in the
number of new worksite employees over 2003 related to new client sales.
Operating expenses increased by only 1.6% in 2004 to $175.6 million and are expected to increase only
slightly in 2005, as Administaff plans to leverage the existing infrastructure and operating expense levels. Capital
expenditures totaled $8.1 million in 2004 and are expected to remain below $10 million in 2005.
- 23 -
Our long-term strategy continues to be aggregating the best small businesses in the United States on the
common platform of our unique human resource service offering, and leveraging the buying power to provide
additional valuable services to clients.
Revenues
We account for our revenues in accordance with Emerging Issues Task Force (“EITF”) 99-19, Reporting
Revenues Gross as a Principal Versus Net as an Agent. Our revenues are derived from our gross billings, which are
based on:
•
•
the payroll cost of our worksite employees; and
a markup computed as a percentage of the payroll cost.
In determining the pricing of the markup component of the gross billings, we consider our estimates of the
costs directly associated with our worksite employees, including payroll taxes, benefits and workers’ compensation
costs, plus an acceptable gross profit margin. We invoice the gross billings concurrently with each periodic payroll
of our worksite employees. Revenues, which exclude the payroll cost component of gross billings, are recognized
ratably over the payroll period as worksite employees perform their service at the client worksite. We include
revenues that have been recognized but not invoiced in unbilled accounts receivable on our Consolidated Balance
Sheets.
Our revenues are primarily dependent on the number of clients enrolled, the resulting number of worksite
employees paid each period and the number of worksite employees enrolled in our benefit plans. Because our
markup is computed as a percentage of payroll cost, revenues are also affected by the payroll cost of worksite
employees, which can fluctuate based on the composition of the worksite employee base, inflationary effects on
wage levels and differences in the local economies of our markets.
Direct Costs
The primary direct costs associated with our revenue generating activities are:
employment-related taxes (“payroll taxes”);
•
costs of employee benefit plans; and
•
• workers’ compensation claim costs.
Payroll taxes consist of the employer’s portion of Social Security and Medicare taxes under FICA, federal
unemployment taxes and state unemployment taxes. Payroll taxes are generally paid as a percentage of payroll cost.
The federal tax rates are defined by federal regulations. State unemployment tax rates are subject to claim histories
and vary from state to state.
Employee benefits costs are comprised primarily of health insurance costs (including dental and pharmacy
costs), but also include costs of other employee benefits such as life insurance, vision care, disability insurance,
education assistance, adoption assistance, a flexible spending account and a worklife program.
Our gross profit per worksite employee is determined in part by our ability to accurately estimate and
control direct costs and our ability to incorporate changes in these costs into the gross billings charged to clients,
which are subject to contractual arrangements that are typically renewed annually. Gross profit is also affected by
the markup portion of gross billings, which is calculated based on a percentage of worksite employee payroll cost,
and our direct cost structure. We use gross profit per worksite employee per month as our principal measurement of
relative performance at the gross profit level.
- 24 -
Operating Expenses
• Salaries, wages and payroll taxes – Salaries, wages and payroll taxes are primarily a function of the number of
corporate employees and their associated average pay and any additional incentive compensation. Our corporate
employees primarily include client services, sales and marketing, benefits, legal, finance, information technology
and administrative support personnel.
• General and administrative expenses – Our general and administrative expenses primarily include:
•
•
•
•
•
rent expenses related to our service centers and sales offices;
outside professional service fees related to legal, consulting and accounting services;
administrative costs, such as postage, printing and supplies;
employee travel expenses; and
repairs and maintenance costs associated with our facilities and technology infrastructure.
• Commissions – Commission expense primarily consists of amounts paid to sales personnel and to American
Express. Commissions for sales personnel are based on a percentage of revenue generated by such personnel and
commissions paid to American Express were paid in accordance with our former Marketing Agreement. The
Marketing Agreement was mutually terminated in December 2004.
• Advertising – Advertising expense primarily consists of media advertising and other business promotions in our
current and anticipated sales markets, including the Administaff Small Business Classic sponsorship and
endorsement fees paid to Arnold Palmer.
• Depreciation and amortization – Depreciation and amortization expense is primarily a function of our capital
investments in corporate facilities, service centers, sales offices and technology infrastructure.
Income Taxes
Administaff’s provision for income taxes typically differs from the U.S. statutory rate of 35%, due primarily
to state income taxes and non-deductible expenses. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities used for financial reporting purposes and the
amounts used for income tax purposes. Significant items resulting in deferred income taxes include depreciation,
software development costs, prepaid assets and accruals for workers’ compensation expenses. Changes in these
items are reflected in our financial statements through a deferred income tax provision.
Critical Accounting Policies and Estimates
Administaff’s discussion and analysis of our financial condition and results of operations are based upon
our consolidated financial statements, which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements requires our management to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those
related to health and workers’ compensation insurance claims experience, state unemployment taxes, client bad
debts, income taxes, property and equipment, and contingent liabilities. We base these estimates on historical
experience and on various other assumptions that management believes to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these estimates.
- 25 -
We believe the following accounting policies are critical and/or require significant judgments and estimates
used in the preparation of our consolidated financial statements:
• Benefits costs – We provide health insurance coverage to our worksite employees through a national network of
carriers including UnitedHealthcare (“United”), Cigna Healthcare, PacifiCare, Kaiser Permanente, Blue Cross
and Blue Shield of Georgia, Blue Shield of California and Tufts, all of which provide fully insured policies.
The policy with United provides the majority of our health insurance coverage. Pursuant to the terms of our
contract with United, within 195 days after contract termination, a final accounting of the plan will be performed
and we will receive a refund for any accumulated surplus or will be liable for any accumulated deficit in the
plan, up to the amount of our then-outstanding security deposit with United, which is $17.5 million as of
December 31, 2004. As a result of these contractual terms, we account for this plan using a partially self-funded
insurance accounting model.
Each reporting period, we record the costs of the United Plan, including paid claims, an estimate of the change
in incurred but not reported (“IBNR”) claims, taxes and administrative fees (collectively the “Plan Costs”) as
benefits expense, a direct cost, in the Consolidated Statements of Operations. We base the estimated IBNR
claims upon both (i) a recent level of monthly paid claims under the plan; and (ii) an estimated lag factor based
on recent paid claims under the plan, to provide for those claims that have been incurred but not yet paid. We
believe that the use of recent claims activity is representative of incurred and paid trends during the reporting
period. The estimated lag factor used to compute IBNR claims involves a significant level of judgment.
Accordingly, an increase (or decrease) in the estimated lag factor used to compute the IBNR claims would result
in a decrease (or increase) in benefits costs and net income would increase (or decrease) accordingly.
The following table illustrates the sensitivity of changes in the lag factor on our estimate of total benefit
costs of $378 million in 2004:
Change in
Lag Factor
(5)%
(2.5)%
2.5%
5%
Change in
Benefits Costs
(in thousands)
$
(1,421)
(711)
711
1,421
Change in
Net Income
(in thousands)
$
888
444
(444)
(888)
Under the terms of the contract, United establishes plan participant cash funding rates 90 days in advance of the
beginning of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the cash funded to
United, a deficit in the plan would be incurred and we would accrue a current liability for the excess costs on our
Consolidated Balance Sheet. On the other hand, if the Plan Costs for the reporting quarter are less than the cash
funded to United, a surplus in the plan would be incurred and we would record a current asset for the excess
premiums on our Consolidated Balance Sheet. During the year ended December 31, 2004, the cash funded to
United exceeded the Plan Costs by approximately $900,000, resulting in an accumulated cash surplus from the
inception of the plan of approximately $10.9 million, which is recorded as prepaid insurance on our
Consolidated Balance Sheet.
•
State unemployment taxes – We record our state unemployment (“SUI”) tax expense based on taxable wages
and tax rates assigned by each state. State unemployment tax rates vary by state and are determined, in part,
based on prior years’ compensation experience in each state. We must estimate our expected SUI tax rate in
those states for which tax rate notices have not yet been received. In determining these estimates, we take into
account the expected payroll levels and unemployment claim history for such states.
As a result of the 2001 corporate restructuring, we filed for a transfer of our reserve account with the
Employment Development Department of the State of California (“EDD”). The EDD approved our request for
transfer of the reserve account in May 2002 and also notified us of our new contribution rates based upon the
approved transfer. In December 2003, we received a Notice of Duplicate Accounts and Notification of
- 26 -
Assessment from the EDD. The notice stated that the EDD was collapsing the accounts of our subsidiaries into
the account of the entity with the highest unemployment tax rate. The notice also retroactively imposed the
higher unemployment insurance rate on all our California employees for 2003, resulting in an assessment of $5.6
million. In January 2004, we filed a petition with an administrative law judge of the California Unemployment
Insurance Appeals Board (“ALJ”) to protest the notice. Pending a resolution of our protest, in the fourth quarter
of 2003 we accrued and recorded at the higher assessed rate for all of 2003.
In June 2004, we agreed to settle our dispute with the EDD for $3.3 million. Based upon receipt of written
acknowledgement of this agreement, we reduced our accrued payroll tax liability and payroll tax expense by
$2.3 million during the quarter ended June 30, 2004. The settlement was subject to the final approval by EDD’s
legal department, the California Attorney General’s office and the ALJ. In October 2004, the legal department
of the EDD verbally indicated they considered the previously agreed-upon settlement amount to be insufficient
and suggested a settlement amount of $5.2 million. We continued discussion with the State of California, but in
February 2005, we were notified that the EDD had rejected our settlement offer and that the matter will proceed
with the appeals process with the ALJ. If the outcome of the appeals process is unfavorable and we are assessed
additional interest and penalties, we may recognize an increase in our payroll tax expense in a future period.
Conversely, if the outcome of the appeals process is favorable, we may recognize a decrease in our payroll tax
expense in a future period. The ultimate outcome of this matter is not expected to have a material impact on our
2005 unemployment tax rate in California.
• Workers’ compensation costs – Our workers’ compensation insurance policy for the two-year period ending
September 30, 2003 (“2003 Policy”) was a guaranteed-cost policy under which premiums were paid for full-
insurance coverage of all claims incurred during the policy period. This policy also contained a dividend feature
for each policy year, under which we were entitled to a refund of a portion of our premiums if, four years after
the end of the policy year, claims paid by the insurance carrier for the policy year were less than an amount set
forth in the policy. In accordance with EITF Topic D-35, FASB Staff Views on EITF No. 93-6, “Accounting for
Multiple-Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises,” we estimated the amount
of refund, if any, that had been earned under the dividend feature, based on the actual claims incurred to date
and a factor used to develop those claims to an estimate of the ultimate cost of the incurred claims during that
policy year. If our estimates were to indicate that an additional dividend had been earned, we would record a
receivable for the amount of that dividend and decrease our workers’ compensation insurance expense, which
would increase net income in the period that such determination was made. On the other hand, if our estimates
were to indicate that the amount of any recorded dividend receivable had been reduced due to greater than
anticipated claim developments, we would reduce our receivable and increase our workers’ compensation
insurance expense, which would reduce net income in the period that such determination was made. In May
2003, our workers’ compensation carrier’s rating was downgraded by A.M. Best Co. (“Best”) from a “B” or
“fair” rating to a “C++” or “marginal” rating. In June 2003, Best further downgraded the carrier to a “D” or
“poor” rating. Best’s rating represents an opinion on the insurer’s financial strength and ability to meet its
ongoing obligations to its policyholders. As a result of these downgrades, we elected to accelerate the
termination of our contract from September 30, 2003 to September 1, 2003. In addition, we recorded a charge
of $2.5 million in the second quarter of 2003 to write-off the dividend receivable from our workers’
compensation carrier due to the uncertainty of the carrier’s ultimate ability to pay this dividend.
On September 1, 2003, we obtained a workers’ compensation policy (“2004 Policy”), which matured and was
subsequently renewed on September 16, 2004 for the period ending September 30, 2005 (“2005 Policy”). The
policies are with selected member insurance companies of American International Group, Inc. (“AIG”). Under
our arrangement with AIG, we bear the economic burden for the first $1 million layer of claims per occurrence.
AIG bears the economic burden for all claims in excess of such first $1 million layer. The policies are fully
insured whereby AIG has the responsibility to pay all claims incurred under the policies regardless of whether
we satisfy our responsibilities.
Because we bear the economic burden of the first $1 million layer of claims per occurrence, such claims, which
are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers
compensation insurance includes ongoing healthcare and indemnity coverage whereby claims are paid over
numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting
- 27 -
period includes estimates, which take into account the ongoing development of claims and therefore requires a
significant level of judgment. Our management estimates our workers’ compensation costs by applying an
aggregate loss development rate to worksite employee payroll levels. We employ a third party actuary to
estimate the loss development rate, which is primarily based upon the nature of worksite employees’ job
responsibilities, the location of worksite employees, the historical frequency and severity of workers
compensation claims and an estimate of future cost trends. Workers’ compensation cost estimates are
discounted to present value at a rate based upon the U.S. Treasury rates that correspond with the weighted
average estimated claim payout period (the discount rate utilized in 2003 and 2004 averaged 2.0% and 2.8%,
respectively) and are accreted over the estimated claim payment period and included as a component of direct
costs in our Consolidated Statements of Operations.
Our claim trends could be greater than or less than our prior estimates, in which case we would revise our
claims estimates and record an adjustment to workers’ compensation costs in the period such determination is
made. If we were to experience any significant changes in actuarial assumptions, our loss development rates
could increase (or decrease) which would result in an increase (or decrease) in workers’ compensation costs and
a resulting decrease (or increase) in net income reported in our Consolidated Statement of Operations.
The following table illustrates the sensitivity of changes in the loss development rate on our estimate of workers’
compensation costs totaling $54 million in 2004:
Change in Loss
Development Rate
Change in Workers’
Compensation Costs
(in thousands)
(5)%
(2.5)%
2.5%
5%
$
(2,000)
(1,000)
1,000
2,000
Change in
Net Income
(in thousands)
$
1,250
625
(625)
(1,250)
At the beginning of each policy period, the insurance carrier, AIG, establishes monthly funding requirements
comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”). The level of
claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers’
compensation loss rates, as determined by AIG. Monies funded into the program for incurred claims expected
to be paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds
are included in deposits, a long-term asset in our Consolidated Balance Sheets.
Our estimate of incurred claim costs expected to be paid within one year are recorded as accrued workers’
compensation costs and included in short-term liabilities, while our estimate of incurred claim costs expected to
be paid beyond one year are included in long-term liabilities on our Consolidated Balance Sheets.
As of December 31, 2004, we had restricted cash of $18.5 million and deposits of $52.3 million. A $13.3
million security deposit related to the 2004 policy is included in deposits. We have estimated and accrued $41.4
million in incurred workers’ compensation claim costs, which is net of $10.5 million in paid claims, as of
December 31, 2004.
• Contingent liabilities – We accrue and disclose contingent liabilities in our consolidated financial statements in
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, Accounting for Contingencies.
SFAS No. 5 requires accrual of contingent liabilities that are considered probable to occur and that can be
reasonably estimated. For contingent liabilities that are considered reasonably possible to occur, financial
statement disclosure is required, including the range of possible loss if it can be reasonably determined. We have
disclosed in our audited financial statements several issues that we believe are reasonably possible to occur,
although we cannot determine the range of possible loss in all cases. See Note 12 to our consolidated financial
statements. As these issues develop, we will continue to evaluate the probability of future loss and the potential
range of such losses. If such evaluation were to determine that a loss was probable and the loss could be
- 28 -
reasonably estimated, we would be required to accrue our estimated loss, which would reduce net income in the
period that such determination was made.
• Deferred taxes – We have recorded a valuation allowance to reduce our deferred tax assets to the amount that is
more likely than not to be realized. While we have considered future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the valuation allowance, our ability to realize our
deferred tax assets could change from our current estimates. If we determine that we would be able to realize
our deferred tax assets in the future in excess of the net recorded amount, an adjustment to reduce the valuation
allowance would increase net income in the period that such determination is made. Likewise, should we
determine that we will not be able to realize all or part of our net deferred tax assets in the future, an adjustment
to increase the valuation allowance would reduce net income in the period such determination is made.
• Allowance for doubtful accounts – We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to pay their comprehensive service fees. We believe that the
success of our business is heavily dependent on our ability to collect these comprehensive service fees for
several reasons, including:
•
•
•
the fact that we are at risk for the payment of our direct costs and worksite employee payroll costs
regardless of whether our clients pay their comprehensive service fees;
the large volume and dollar amount of transactions we process; and
the periodic and recurring nature of payroll, upon which the comprehensive service fees are based.
To mitigate this risk, we have established very tight credit policies. We generally require our clients to pay their
comprehensive service fees no later than one day prior to the applicable payroll date. In addition, we maintain
the right to terminate the Client Service Agreement and associated worksite employees or to require prepayment,
letters of credit or other collateral if a client’s financial position deteriorates or if the client does not pay the
comprehensive service fee. As a result of these efforts, losses related to customer nonpayment have historically
been low as a percentage of revenues. However, if our clients’ financial condition were to deteriorate rapidly,
resulting in nonpayment, our accounts receivable balances could grow and we could be required to provide for
additional allowances, which would decrease net income in the period that such determination was made.
• Property and equipment – Our property and equipment relate primarily to our facilities and related
improvements, furniture and fixtures, computer hardware and software and capitalized software development
costs. These costs are depreciated or amortized over the estimated useful lives of the assets. If we determine
that the useful lives of these assets will be shorter than we currently estimate, our depreciation and amortization
expense could be accelerated, which would decrease net income in the periods of such a determination. In
addition, we periodically evaluate these costs for impairment in accordance with SFAS No. 144, Accounting for
Impairment or Disposal of Long-Lived Assets. If events or circumstances were to indicate that any of our long-
lived assets might be impaired, we would analyze the estimated undiscounted future cash flows to be generated
from the applicable asset. In addition, we would record an impairment loss, which would reduce net income, to
the extent that the carrying value of the asset exceeded the fair value of the asset. Fair value is generally
determined using an estimate of discounted future net cash flows from operating activities or upon disposal of
the asset. During 2003 we ceased operations of Administaff Financial Management Services, Inc. (“FMS”) and
recorded an after-tax impairment charge of approximately $800,000 related to the write down of assets of FMS.
As a result, FMS is being reported as a discontinued operation in accordance with SFAS No. 144.
- 29 -
New Accounting Pronouncement
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-
Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement
123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro forma disclosure is no longer an alternative.
Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted in periods in
which financial statements have not yet been issued. We expect to adopt Statement 123(R) on July 1, 2005.
Statement 123(R) permits public companies to adopt its requirements using one of two methods:
1. A “modified prospective” method in which compensation cost is recognized beginning with the effective
date: (a) based on the requirements of Statement 123(R) for all share-based payments granted after the
effective date; and (b) based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain unvested on the effective date.
2. A “modified retrospective” method which includes the requirements of the modified prospective method
described above, but also permits entities to restate based on the amounts previously recognized under
Statement 123 for purposes of pro forma disclosures either: (a) all prior periods presented; or (b) prior
interim periods of the year of adoption.
We plan to adopt Statement 123(R) using the modified prospective method.
As permitted by Statement 123, we currently account for share-based payments to employees using Opinion
25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on our results of
operations, although it will have no material impact on our overall financial position. We cannot predict the impact
of our adoption of Statement 123(R) at this time because it will depend on levels and types of share-based payments
granted in the future. However, had we adopted Statement 123(R) in prior periods, the impact of that standard
would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and
earnings per share in Note 1 to our consolidated financial statements. Statement 123(R) also requires the benefits of
tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in
the future (because they depend on, among other things, when employees exercise stock options), the amount of
operating cash flows recognized in prior periods for such excess tax deductions were $352,000, $249,000, and
$203,000 in 2004, 2003 and 2002, respectively.
On February 1, 2005, the compensation committee of our Board of Directors approved the acceleration of
vesting of all unvested stock options that have an exercise price greater than our January 31, 2005 closing market
price of $14.59. This accelerated vesting affected approximately 733,000 common stock options with a weighted
average exercise price of $18.09. The primary purpose of the accelerated vesting is to eliminate future compensation
expense we would otherwise recognize in our statement of operations with respect to these accelerated options
subsequent to the July 1, 2005 effective date of FASB 123(R). The estimated maximum future expense that is
eliminated is approximately $5.9 million, including $1.5 million in 2005.
On February 1, 2005, the compensation committee of our Board of Directors approved a grant of 302,000
restricted common shares to certain of our employees and officers. The restricted common shares have a fair value of
$14.86 per share and vest over three years. Restricted common shares, under fixed accounting, are generally
measured at fair value on the date of grant based on the number of shares granted and the quoted price of the
- 30 -
common stock on the date of the grant. Such value is recognized as compensation expense over the corresponding
vesting period.
Transactions with Related and Other Certain Parties
We do not have any transactions with related parties that we consider material to our results of operations
and/or financial condition.
Results of Operations
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
The following table presents certain information related to the Company’s results of operations for the years
ended December 31, 2004 and 2003.
Year ended December 31,
2003
% change
2004
(in thousands, except per share and statistical data)
Revenues (gross billings of $5.377 billion and
$4.829 billion less worksite employee payroll cost of
$4.407 billion and $3.938 billion, respectively)..............
Gross profit.........................................................................
Operating expenses.............................................................
Operating income................................................................
Other income ......................................................................
Net income from continuing operations..............................
Diluted net income from continuing operations
per share of common stock..............................................
Statistical Data:
Average number of worksite employees paid per month ....
Revenues per worksite employee per month (1)...................
Gross profit per worksite employee per month...................
Operating expenses per worksite employee per month.......
Operating income per worksite employee per month..........
Net income from continuing operations
per worksite employee per month ...................................
_______________
$ 969,527
197,694
175,563
22,131
8,605
19,210
$ 890,859
197,105
172,831
24,274
196
14,985
8.8%
0.3%
1.6%
(8.8)%
—
28.2%
0.72
0.55
30.9%
$
77,936
1,037
211
188
24
21
$
75,036
989
219
192
27
3.9%
4.9%
(3.7)%
(2.1)%
(11.1)%
17
23.5%
(1) Gross billings of $5,749 and $5,363 per worksite employee per month less payroll cost of $4,712 and $4,373 per
worksite employee per month, respectively.
Revenues
Our revenues, which represent gross billings net of worksite employee payroll cost, increased 8.8% over
2003 due to a 4.9% increase in revenues per worksite employee per month and a 3.9% increase in the average
number of worksite employees paid per month.
Our unit growth rate is affected by three primary sources – new client sales, client retention and the net
change in existing clients through worksite employee new hires and layoffs. The 3.9% increase in the average
number of worksite employees paid per month during 2004 was due to an increase in worksite employees from all
three sources of paid worksite employees.
- 31 -
The 4.9% increase in revenues per worksite employee per month was primarily due to pricing increases in
the markup portion of our comprehensive service fee.
The following table presents certain information related to the Company’s revenues by region for the years
ended December 31, 2004 and 2003.
Year ended December 31,
2004
2003 % change
(in thousands)
Year ended December 31,
2004
2003
(% of total revenue)
Northeast......................................
Southeast......................................
Central .........................................
Southwest.....................................
West.............................................
Other revenues .............................
Total revenues.....................
$ 134,124
90,657
137,184
378,901
222,209
6,452
$ 969,527
$ 115,872
95,293
131,416
355,283
187,996
4,999
$ 890,859
15.8%
(4.9)%
4.4%
6.6%
18.2%
29.1%
8.8%
13.8%
9.4%
14.1%
39.1%
22.9%
0.7%
100.0%
13.0%
10.7%
14.8%
39.8%
21.1%
0.6%
100.0%
Gross Profit
Gross profit increased 0.3% to $197.7 million compared to 2003. Gross profit per worksite employee
decreased 3.7% to $211 per month in 2004 versus $219 in 2003. This decrease was primarily the result of
moderating price increases in the health insurance component of the comprehensive service fee, relative to expected
cost increases, over the last half of 2003 and first half of 2004. Our pricing objective is to maintain or improve the
gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in our
primary direct costs and our operating costs.
While our revenues per worksite employee per month increased 4.9%, our direct costs, which primarily
include payroll taxes, benefits and workers’ compensation expenses, increased 7.3% to $826 per worksite employee
per month in 2004 versus $770 in 2003. The primary direct cost components changed as follows:
• Payroll tax costs – Payroll taxes increased $33 per worksite employee per month. Payroll taxes as a percentage
of payroll cost increased to 7.41% in 2004 from 7.23% in 2003. The increase was a result of higher weighted
average state unemployment tax rates in 2004 compared to 2003, offset in part by the $2.3 million, or 0.05% of
payroll cost, reduction of payroll tax expense related to the settlement discussions with the state of California in
the second quarter of 2004. In addition, during 2003, we recorded a $3.9 million, or 0.10% of payroll cost,
reduction in payroll taxes due to the receipt of our final 2002 and 2003 unemployment tax rates from the Texas
Workforce Commission. Furthermore, we accrued $5.6 million, or 0.14% of payroll cost, in additional payroll
taxes in 2003 related to an unemployment tax assessment from the Employment Development Department of the
State of California. Please read “Critical Accounting Policies and Estimates – State Unemployment Taxes” on
page 26 for a detailed discussion of our accounting for payroll taxes.
• Benefits costs – The cost of health insurance and related employee benefits increased $24 per worksite employee
per month over 2003, due to a 5.7% increase in the cost per covered employee and an increase in the percentage
of worksite employees covered under our health insurance plan to 71.1% in 2004 versus 70.7% in 2003. Please
read “—Critical Accounting Policies and Estimates – Benefits Costs” on page 26 for a discussion of our
accounting for health insurance costs.
• Workers’ compensation costs – Workers’ compensation costs decreased $5 per worksite employee per month,
and decreased to 1.35% of non-bonus payroll cost in 2004 from 1.56% in 2003. In 2004, we collected and
recorded a $1.1 million, or 0.03% of non-bonus payroll cost, reimbursement from an insurance carrier related to
a 2003 workers’ compensation settlement with the State of Texas. During 2003, we incurred (i) a $2.5 million,
or 0.07% of non-bonus payroll cost, charge related to our former workers’ compensation dividend receivable
due to collectibility concerns; and (ii) approximately $2.0 million, or 0.06% of non-bonus payroll cost, in
- 32 -
workers’ compensation costs related to contract termination costs associated with our former policy and state
surcharges relating to policies dating back to 1999, which were assessed by various states and passed through to
Administaff through our previous carrier. Please read “—Critical Accounting Policies and Estimates –
Workers’ Compensation Costs” on page 27 for a discussion of our accounting for workers’ compensation costs.
Operating Expenses
The following table presents certain information related to our operating expenses for the years ended
December 31, 2004 and 2003.
Year ended December 31,
2004
2003 % change
(in thousands)
Year ended December 31,
2004
2003 % change
(per worksite employee per month)
Salaries, wages and payroll taxes
General and administrative expenses
Commissions
Advertising
Depreciation and amortization
Total operating expenses
$ 88,298
49,283
10,447
10,021
17,514
$ 175,563
$ 82,802
50,033
10,656
8,581
20,759
$ 172,831
6.6%
(1.5)%
(2.0)%
16.8%
(15.6)%
1.6%
$ 94
53
11
11
19
$ 188
$ 92
55
12
10
23
$ 192
2.2%
(3.6)%
(8.3)%
10.0%
(17.4)%
(2.1)%
Operating expenses increased 1.6% to $175.6 million. Operating expenses per worksite employee per
month decreased 2.1% to $188 in 2004 versus $192 in 2003. The components of operating expenses changed as
follows:
• Salaries, wages and payroll taxes of corporate and sales staff increased 6.6%, or $2 per worksite employee per
month compared to 2003. The increase is primarily due to a 2.7% increase in headcount and a 3.6% increase in
average pay, offset by a $1.3 million decrease in incentive compensation and $1.5 million decrease in
capitalized software development costs in 2004.
• General and administrative expenses decreased 1.5%, or $2 per worksite employee per month compared to
2003. The decrease is primarily due to higher legal fees in the 2003 period associated with the legal dispute
with Aetna and lower consulting costs, offset by higher corporate insurance and repairs and maintenance costs in
2004.
• Commissions expense decreased 2.0% or $1 per worksite employee per month compared to 2003.
• Advertising costs increased 16.8% or $1 per worksite employee as compared to 2003, due primarily to
sponsorship costs associated with the Administaff Small Business Classic professional golf tournament held in
October 2004 in Houston, Texas.
• Depreciation and amortization expense decreased 15.6% and $4 on a per worksite employee basis versus 2003
as the effect of certain fixed assets becoming fully amortized more than offset the incremental depreciation and
amortization expense related to the 2004 capital additions.
Other Income (Expense)
Other income (expense) increased to $8.6 million in 2004 compared to $196,000 in 2003, primarily due to
the $8.25 million settlement of our dispute with Aetna during 2004. Please read Note 12 to the consolidated
financial statements for a discussion of this matter.
- 33 -
Income Tax Expense
During 2004, we incurred federal and state income tax expense of $11.5 million on pre-tax income of $30.7
million. Our provision for income taxes differed from the US statutory rate of 35% primarily due to state income
taxes and non-deductible expenses. Our effective income tax rate was 37.5% in the 2004 period compared to 38.8%
in the 2003 period. During 2004, we recorded a $213,000 cumulative tax adjustment due to a change in estimate
resulting from the favorable impact of our captive insurance subsidiary on state income tax rates. In 2003 we
utilized previously unrecognized capital loss carryforwards on a $457,000 gain from the sale of an investment.
Net Income From Continuing Operations
Net income from continuing operations for 2004 was $19.2 million, or $0.72 per diluted share, compared to
$15.0 million, or $0.55 per diluted share in 2003. On a per worksite employee per month basis, net income from
continuing operations increased 23.5% to $21 in 2004 versus $17 in 2003.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002.
The following table presents certain information related to our results of operations for the years ended
December 31, 2003 and 2002.
Year ended December 31,
2002
% change
2003
(in thousands, except per share and statistical data)
Revenues (gross billings of $4.829 billion and
$4.857 billion less worksite employee payroll cost of
$3.938 billion and $4.009 billion, respectively)..............
Gross profit.........................................................................
Operating expenses.............................................................
Operating income................................................................
Other income (expense) ......................................................
Net income (loss) from continuing operations....................
Diluted net income (loss) from continuing operations
per share of common stock..............................................
Statistical Data:
Average number of worksite employees paid per month ....
Revenues per worksite employee per month (1)...................
Gross profit per worksite employee per month...................
Operating expenses per worksite employee per month.......
Operating income per worksite employee per month..........
Net income (loss) from continuing operations
per worksite employee per month ...................................
_______________
$ 890,859
197,105
172,831
24,274
196
14,985
$ 848,416
165,790
165,723
67
(1,747)
(2,921)
5.0%
18.9%
4.3%
36,129.9%
111.2%
613.0%
0.55
(0.11)
600.0%
$
75,036
989
219
192
27
17
$
77,334
914
179
179
—
(3.0)%
8.2%
22.3%
7.3%
—
(3)
666.7%
(1) Gross billings of $5,363 and $5,234 per worksite employee per month less payroll cost of $4,373 and $4,320 per
worksite employee per month, respectively.
Revenues
Our revenues, which represent gross billings net of worksite employee payroll cost, increased 5.0% over
2002 due to an 8.2% increase in revenues per worksite employee per month partially offset by a 3.0% decrease in the
average number of worksite employees paid per month.
Our unit growth rate is affected by three primary sources – new client sales, client retention and the net
change in existing clients through worksite employee new hires and layoffs. The 3.0% decrease in the average
- 34 -
number of worksite employees paid per month during 2003 was primarily related to a decline in worksite employees
from new client sales and lower levels of client retention.
The 8.2% increase in revenues per worksite employee per month was primarily due to pricing increases in
the markup portion of our gross billings. In 2003, worksite employee payroll cost per month increased as compared
to the decrease experienced in 2002.
The following table presents certain information related to our revenues by region for the years ended
December 31, 2003 and 2002.
Year ended December 31,
2003
2002 % change
(in thousands)
Year ended December 31,
2003
2002
(% of total revenue)
Northeast......................................
Southeast......................................
Central .........................................
Southwest.....................................
West.............................................
Other revenues .............................
Total revenues.....................
$ 115,872
95,293
131,416
355,283
187,996
4,999
$ 890,859
$ 101,097
92,480
123,901
360,622
164,221
6,095
$ 848,416
14.6%
3.0%
6.1%
(1.5)%
14.5%
(18.0)%
5.0%
13.0%
10.7%
14.8%
39.8%
21.1%
0.6%
100.0%
11.9%
10.9%
14.6%
42.5%
19.3%
0.8%
100.0%
Gross Profit
Gross profit increased 18.9% to $197.1 million compared to 2002. Gross profit per worksite employee
increased 22.3% to $219 per month in 2003 versus $179 in 2002. This increase was primarily the result of pricing
increases exceeding increases in direct costs, particularly in the healthcare component of the comprehensive service
fee. Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing
revenue per worksite employee to match or exceed changes in our primary direct costs and our operating costs.
While our revenues per worksite employee per month increased 8.2%, our direct costs, which primarily
include payroll taxes, benefits and workers’ compensation expenses, increased 4.6% to $770 per worksite employee
per month in 2003 versus $736 in 2002. The primary direct cost components changed as follows:
• Payroll tax costs – Payroll taxes increased $3 per worksite employee per month. Payroll taxes as a percentage
of payroll cost decreased to 7.23% in 2003 from 7.25% in 2002. During 2003, we recorded a $3.9 million, or
0.10% of payroll cost, reduction in payroll taxes due to the receipt of our final 2002 and 2003 unemployment
tax rates from the Texas Workforce Commission. We accrued $5.6 million, or 0.14% of payroll cost, in
additional payroll taxes in 2003 related to an unemployment tax assessment from the Employment Development
Department of the State of California. Please read “Critical Accounting Policies and Estimates – State
Unemployment Taxes” on page 26 for a detailed discussion of our accounting for payroll taxes.
• Benefits costs – The cost of health insurance and related employee benefits increased $17 per worksite employee
per month over 2002, due to a 8.1% increase in the cost per covered employee and a decrease in the percentage
of worksite employees covered under our health insurance plan to 70.7% in 2003 versus 73.0% in 2002. Please
read “Critical Accounting Policies and Estimates – Benefits Costs” on page 26 for a discussion of the
Company’s accounting for health insurance costs.
• Workers’ compensation costs – Workers’ compensation costs increased $14 per worksite employee per month,
and increased to 1.56% of non-bonus payroll cost in 2003 from 1.23% in 2002. Due to the deterioration of the
financial condition of our former insurance carrier in 2003, as evidenced by rating downgrades, we recorded a
$2.5 million, or 0.07% of non-bonus payroll cost, charge in 2003 related to the write-off of the workers’
compensation dividend, earned and initially recorded in 2002. Additionally, during 2003 we incurred
approximately $2.0 million, or 0.06% of non-bonus payroll cost, in costs related to the termination of our
- 35 -
contract with our former insurance carrier and state surcharges relating to policies dating back to 1999, which
were assessed by various states and passed through to Administaff through our previous carrier. Please read
“Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 27 for a discussion of our
accounting for workers’ compensation costs.
Operating Expenses
The following table presents certain information related to our operating expenses for the years ended
December 31, 2003 and 2002.
Year ended December 31,
2003
2002 % change
(in thousands)
Year ended December 31,
2003
2002 % change
(per worksite employee per month)
Salaries, wages and payroll taxes
General and administrative expenses
Commissions
Advertising
Depreciation and amortization
Total operating expenses
$ 82,802
50,033
10,656
8,581
20,759
$ 172,831
$ 74,989
50,172
12,127
7,138
21,297
$ 165,723
10.4%
(0.3)%
(12.1)%
20.2%
(2.5)%
4.3%
$ 92
55
12
10
23
$ 192
$ 81
54
13
8
23
$ 179
13.6%
1.9%
(7.7)%
25.0%
—
7.3%
Operating expenses increased 4.3% to $172.8 million. Operating expenses per worksite employee per
month increased 7.3% to $192 in 2003 versus $179 in 2002, as worksite employees declined by 3.0%. The
components of operating expenses changed as follows:
• Salaries, wages and payroll taxes of corporate and sales staff increased 10.4%, or $11 per worksite employee per
month. The increase is primarily due to an accrual related to our 2003 incentive compensation plan and the
increased compensation costs to staff the new retirement services business. The average number of corporate
employees during 2003 remained flat as compared to the 2002 average. The average base pay of corporate
employees during 2003 increased 3.2%.
• General and administrative expenses decreased 0.3%, or $1 per worksite employee per month compared to
2002.
• Commissions expense decreased 12.1% or $1 per worksite employee per month compared to 2002 due to the
decline in paid worksite employees in 2003 as compared to 2002.
• Advertising costs increased 20.2% or $2 per worksite employee as compared to 2002 due to increased
marketing efforts focused on lead generation.
• Depreciation and amortization expense decreased 2.5% and remained constant on a per worksite employee basis
versus 2002 as the effect of certain fixed assets becoming fully amortized more than offset the incremental
depreciation and amortization expense related to the 2003 capital additions.
Other Income (Expense)
Other income (expense) improved from net expense of $1.7 million in 2002 to net other income of
$196,000 in 2003, primarily because we recorded a write-off of our investment in eProsper of $3.1 million in 2002.
- 36 -
Income Tax Expense
During 2003, we incurred federal and state income tax expense from continuing operations of $9.5 million
on pre-tax income of $24.5 million. Our effective income tax provision differed from the US statutory rate of 35%
primarily due to state income taxes and non-deductible expenses.
Net Income (Loss) From Continuing Operations
Net income from continuing operations for 2003 was $15.0 million, or $0.55 per diluted share, compared to
a net loss of $2.9 million, or $0.11 per diluted share in 2002. On a per worksite employee per month basis, net
income increased 666.7% to $17 in 2003 versus a net loss of $3 in 2002.
Discontinued Operations
During 2003 we incurred a net loss from our discontinued operations, Administaff Financial Management
Services, of $2.1 million versus $1.2 million in 2002. During 2003, we ceased operations of FMS and incurred
after-tax impairment charges of $800,000 related to the write-off of the assets of FMS.
Non-GAAP Financial Measures
Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to
our worksite employees. Bonus payroll cost varies from period to period, but has no direct impact to our ultimate
workers’ compensation costs under the current program. As a result, our management refers to non-bonus payroll cost
in analyzing, reporting and forecasting our workers’ compensation costs. These non-GAAP financial measures are not
prepared in accordance with generally accepted accounting principles (“GAAP”) and may be different from non-GAAP
financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute
for, or superior to, measures of financial performance prepared in accordance with GAAP. We include these non-
GAAP financial measures because we believe they are useful to investors in allowing for greater transparency related
to the costs incurred under our current workers’ compensation program. Please review the reconciliation of the non-
GAAP financial measures used to their most directly comparable GAAP financial measures as provided in the table
below.
Year ended December 31,
2003
% Change
2004
GAAP to non-GAAP reconciliation:
Payroll cost (GAAP)
Less: bonus payroll cost
Non-Bonus payroll cost
$4,407,063
392,909
$ 4,014,154
$ 3,938,021
330,903
$ 3,607,118
11.9%
18.7%
11.3%
Payroll cost per worksite employee (GAAP)
$
4,712
$
4,373
7.8%
Less: Bonus payroll cost per worksite employee
420
367
14.4%
Non-bonus payroll cost per worksite employee
$
4,292
$
4,006
7.1%
Liquidity and Capital Resources
We periodically evaluate our liquidity requirements, capital needs and availability of resources in view of,
among other things, our expansion plans, debt service requirements and other operating cash needs. To meet short-
and long-term liquidity requirements, including payment of direct and operating expenses and repaying debt, we rely
primarily on cash from operations. However, we have in the past sought, and may in the future seek, to raise
additional capital or take other steps to increase or manage our liquidity and capital resources. We had $109.7
million in cash and cash equivalents and marketable securities at December 31, 2004, of which approximately $57.0
million was payable in early January 2005 for withheld federal and state income taxes, employment taxes and other
- 37 -
payroll deductions. At December 31, 2004, we had working capital of $47.5 million compared to $56.0 million at
December 31, 2003. We currently believe that our cash on hand, marketable securities and cash flows from
operations will be adequate to meet our liquidity requirements for the remainder of 2005. We will rely on these
same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital
needs.
Cash Flows From Operating Activities
Our cash flows from operating activities in 2004 decreased $45.7 million from 2003 to $10.5 million. Our
primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our
clients. The level of cash and cash equivalents, and thus our reported cash flows from operating activities are
significantly impacted by various external and internal factors, which are reflected in part by the changes in our
balance sheet accounts. These include the following:
•
•
•
•
Timing of customer payments / payrolls – We typically collect our comprehensive service fee, along with
the client’s payroll funding, from clients at least one day prior to the payment of worksite employee
payrolls. Therefore, the date of the last day of a reporting period has a substantial impact on our reporting
of operating cash flows. For example, many worksite employees are paid on Fridays; therefore, operating
cash flows decline in the reporting periods, which end on a Friday, such as in 2004, when client
prepayments were $11.2 million and accrued worksite employee payroll was $59.3 million. However, for
those reporting periods which end on a Wednesday, such as in 2003, when customer prepayments were
$31.8 million and accrued worksite employee payroll was $65.5 million, our cash flows are higher due to
the collection of the comprehensive service fee and client’s payroll funding prior to processing the large
number worksite employees’ payrolls two days subsequent to year-end.
Medical plan funding – Our healthcare contract with United establishes participant cash funding rates 90
days in advance of the beginning of a reporting quarter. Therefore, changes in the participation level of the
United Plan have a direct impact on our operating cash flows. In addition, changes to the funding rates,
which are solely determined by United based primarily upon recent claim history and anticipated cost
trends, also have a significant impact on our operating cash flows. Since inception of the United Plan in
January 2002, cash funded to United has exceeded Plan Costs resulting in a $10.9 million surplus, which is
reflected as a current asset on our Consolidated Balance Sheet at December 31, 2004.
Workers’ compensation plan funding – Under our arrangement with AIG, we make monthly payments to
AIG comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).
These pre-determined amounts are stipulated in our agreement with AIG, and are based primarily on
anticipated worksite employee payroll levels and workers compensation loss rates during the policy year.
Changes in payroll levels from that which was anticipated in the arrangement with AIG can result in
changes in the amount of the cash payments to AIG, which will impact our reporting of operating cash
flows. Our claim funds paid to AIG, based upon anticipated worksite employee payroll levels and workers’
compensation loss rates, net of claims paid, were $42.4 million in 2004 and $15.1 million for the four
months under the new plan in 2003, respectively. This compares to our estimate of workers’ compensation
loss costs of $29.4 million and $12.0 million in 2004 and 2003, respectively.
Operating results – Our net income has a significant impact on our operating cash flows. Our net income
increased to $19.2 million in 2004 from $12.9 million in 2003. Please read Results of Operations – Year
Ended December 31, 2004 Compared to Year Ended December 31, 2003 on page 31. During 2004, we
executed a settlement agreement with Aetna Life Insurance Company resulting in our receipt of $8.25
million in settlement proceeds in the first quarter of 2004. Please read Note 12 to the Consolidated
Financial Statements.
- 38 -
Cash Flows From Investing Activities
Capital expenditures totaled $8.1 million in 2004 and consisted primarily of computer hardware and
software. Capital expenditures for computer hardware and software included costs associated with purchasing
software licenses and computer hardware to enhance the performance and stability of our technology infrastructure.
We expect a consistent level of capital expenditures in 2005 and therefore have budgeted approximately
$10 million.
Cash Flows Used In Financing Activities
Cash flows used in financing activities were $21.4 million during 2004. These cash flows were primarily
related to $17.2 million of treasury stock purchases and the repayment of $5.8 million of our term notes and capital
lease obligations.
On December 20, 2002, we entered into a $36 million mortgage agreement that matures in January 2008.
The proceeds were used to repay our outstanding balance under our revolving credit agreement, which expired in
December 2002. The mortgage bears interest at a variable rate equal to the greater of (a) 4.5%; or (b) the 30-day
LIBOR rate (2.3% at December 31, 2004) plus 2.9%. The mortgage is secured by real estate and related fixtures
located at Administaff’s headquarters in Kingwood, Texas. Monthly principal and interest payments are
approximately $230,000, with the remaining balance due upon maturity. The mortgage provides for prepayment
penalties, as a percentage of the outstanding principal balance, ranging from 5% down to 1% during the first four
years of the term. There is no prepayment penalty during the final year of the mortgage.
In October 2002, we entered into a $3.8 million capital lease arrangement to finance the purchase of office
furniture. The assets under capital lease were capitalized using an effective interest rate of 7.5%. The current
monthly lease payments are $58,000 per month over the seven-year lease term.
In October 2002, we obtained a $4.5 million term loan bearing interest at the one-month commercial paper
rate plus 3.1% (4.53% at September 30, 2004). The loan was secured by our aircraft and repaid in November 2004.
Our borrowings in 2002 primarily related to the financing of the construction and furnishing of our
corporate headquarters. We do not anticipate any significant borrowings over the next several years.
Contractual Obligations and Commercial Commitments
The following table summarizes our contractual obligations and commercial commitments as of December
31, 2004 and the effect they are expected to have on our liquidity and capital resources (in thousands):
Contractual obligations:
Mortgage
Capital lease obligations
Non-cancelable operating leases
Purchase obligations (1)
Other long-term liabilities
Accrued workers’
compensation costs (2)
Total contractual cash obligations
Total
Less than
1 Year
1-3 Years
3-5 Years
More than
5 Years
$ 38,530
3,334
50,774
11,745
$ 2,844
695
9,395
5,098
$ 5,315
1,390
17,146
5,637
$ 30,371
1,249
11,420
480
$ —
—
12,813
530
41,423
18,800
$145,806 $ 36,832
9,682
$ 39,170
8,076
$ 51,596
4,865
$ 18,208
(1) The table includes purchase obligations associated with non-cancelable contracts individually greater than $100,000.
(2) The current portion of these liabilities is also included. For more information, please read “Critical Accounting Policies and Estimates –
Workers’ Compensation Costs” on page 27.
- 39 -
Other Matters
On February 4, 2005, the board of directors declared a quarterly dividend of $0.07 per share of common
stock to holders of record on March 7, 2005. The dividend will be paid on April 1, 2005.
On February 1, 2005, the compensation committee of the board of directors approved accelerated vesting of
all unvested stock options that have an exercise price greater than our January 31, 2005 closing market price of
$14.59. This accelerated vesting affected approximately 733,000 common stock options with a weighted average
exercise price of $18.09. The primary purpose of the accelerated vesting is to eliminate future compensation
expense we would otherwise recognize in our income statement with respect to these accelerated options subsequent
to the July 1, 2005 effective date of FASB Statement No. 123(R) (“FASB 123(R)”). The estimated maximum future
expense that is eliminated is approximately $5.9 million, including $1.5 million in 2005.
On February 1, 2005, the compensation committee of the board of directors approved a grant of 302,000
restricted common shares to certain employees and officers pursuant to our 2001 Incentive Plan. The restricted
common shares have a fair value of $14.86 per share and vest over three years. Restricted common shares, under
fixed accounting, are generally measured at fair value on the date of grant based on the number of shares granted and
the quoted price of the common stock. Such value is recognized as compensation expense over the corresponding
vesting period.
Seasonality, Inflation and Quarterly Fluctuations
Historically, our earnings pattern has included losses in the first quarter followed by improved profitability
in subsequent quarters throughout the year. This pattern was due to the effects of employment-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. Because our revenues related to each
employee were generally earned and collected at a relatively constant rate throughout each year, payment of such tax
obligations had a substantial impact on our financial condition and results of operations during the first six months of
each year. Other factors that affect direct costs could have mitigated or enhanced this trend.
We modified our Client Service Agreement (“CSA”) for new and renewing clients beginning January 1,
2003. Under the provisions of the modified CSA, clients active in January of any year are obligated to pay the
estimated payroll tax component of the comprehensive service fee in a manner which more closely reflects the
pattern of incurred payroll tax costs. This contractual change coincided with the implementation of a new pricing
and billing system. The impact of new and renewing clients active under the modified CSA in January 2003, which
represented approximately 20% of our client base, has resulted in the partial offset of our historical earnings pattern
in 2003. Substantially all clients were active under the modified CSA in January 2004. For those clients, we
experienced an offset of our historical earnings pattern. However, based on contractual arrangements, new clients
enrolling subsequent to January of any year are invoiced at a relatively constant rate throughout the remaining
portion of the year, resulting in improved profitability over the course of the year for those clients.
We believe the effects of inflation have not had a significant impact on our results of operations or financial
condition.
Factors That May Affect Future Results and the Market Price of Common Stock
Liability for Worksite Employee Payroll and Benefits Costs
Under the CSA, we become a co-employer of worksite employees and assume the obligations to pay the
salaries, wages and related benefits costs and payroll taxes of such worksite employees. We assume such obligations
as a principal, not as an agent of the client company. Our obligations include responsibility for:
- 40 -
•
•
payment of the salaries and wages for work performed by worksite employees, regardless of
whether the client company timely pays us the associated service fee; and
providing benefits to worksite employees even if our costs to provide such benefits exceed the fees
the client company pays us.
If a client company does not pay us, or if the costs of benefits we provide to worksite employees exceed the fees a
client company pays us, our ultimate liability for worksite employee payroll and benefits costs could have a material
adverse effect on our financial condition or results of operations.
Increases in Health Insurance Premiums and Workers’ Compensation Costs
Maintaining health and workers’ compensation insurance plans that cover worksite employees is a
significant part of our business. Our primary health insurance contract expires on December 31, 2005, and
automatically renews each year, subject to cancellation by either party upon 180 days notice. The current workers’
compensation contract expires on September 30, 2005. In the event we are unable to secure replacement contracts
on competitive terms, significant disruption to our business could occur.
Health insurance premiums and workers’ compensation costs are in part determined by our claims
experience and comprise a significant portion of our direct costs. We employ extensive risk management procedures
in an attempt to control our claims incidence and structure our benefits contracts to provide as much cost stability as
possible. However, if we experience a sudden and unexpected large increase in claim activity, our health insurance
costs or workers’ compensation insurance costs could increase. Contractual arrangements with our clients limit our
ability to incorporate such increases into service fees, which could result in a delay before such increases could be
reflected in service fees. As a result, such increases could have a material adverse effect on our financial condition
or results of operations.
We experienced a 5.7% increase in benefits costs per covered employee during 2004 and expect an 8% to
10% increase in 2005. We experienced a 13.6% decline in workers’ compensation costs as a percentage of non-
bonus payroll. Please read Results of Operations – Gross Profit – Workers’ Compensation Costs on page 32.
However, we expect a 2% to 5% increase in 2005. While our results of operations may be impacted to some degree
in future periods by the healthcare and workers’ compensation cost increases or decreases and our contractual
pricing constraints, we do not expect this situation to have a material adverse effect on our financial position.
We provide health insurance coverage to our worksite employees through a national network of carriers
including UnitedHealthcare (“United”), Cigna Healthcare, PacifiCare, Kaiser Permanente, Blue Cross and Blue
Shield of Georgia, Blue Shield of California and Tufts, all of which provide fully insured policies. The policy with
United provides the majority of our health insurance coverage. Pursuant to the terms of our contract with United,
within 195 days after contract termination, a final accounting of the plan will be performed and we will receive a
refund for any accumulated surplus or will be liable for any accumulated deficit in the plan, up to the amount of our
then-outstanding security deposit with United, which is $17.5 million as of December 31, 2004. As a result of these
contractual terms, we account for this plan using a partially self-funded insurance accounting model.
Each reporting period, we record the costs of the United Plan, including paid claims, an estimate of the
change in incurred but not reported (“IBNR”) claims, taxes and administrative fees (collectively the “Plan Costs”) as
benefits expense, a direct cost, in the Consolidated Statements of Operations. The estimated IBNR claims are based
upon both (i) a recent level of monthly paid claims under the plan; and (ii) an estimated lag factor based on recent
paid claims under the plan, to provide for those claims that have been incurred but not yet paid. We believe that the
use of recent claims activity is representative of incurred and paid trends during the reporting period. Our estimated
lag factor used to compute IBNR claims involves a significant level of judgment. Accordingly, an increase (or
decrease) in the estimated lag factor used to compute the IBNR claims would result in a decrease (or increase) in
benefits costs and net income would increase (or decrease) accordingly.
In 2003, facing continued capital constraints and a series of downgrades from various rating agencies, our
former workers’ compensation insurance carrier for the two-year period ending September 2003, Lumbermens
- 41 -
Mutual Casualty Company, a unit of Kemper Insurance Companies (“Kemper”), made the decision to substantially
cease underwriting operations and voluntarily entered into “run-off.” A “run-off” is the professional management of
an insurance company’s discontinued, distressed or nonrenewed lines of insurance and associated liabilities outside
of a judicial proceeding. In the event the run-off process is not successful and Kemper is forced into bankruptcy or a
similar proceeding, most states have established guaranty funds to pay remaining claims. However, the guarantee
associations in some states, including Texas, have asserted that state law returns the liability for open claims under
such policies to the insured, as we experienced when another former insurance carrier, Reliance National Indemnity
Co., declared bankruptcy in 2001. In that case, the Texas state guaranty association asserted that it was entitled to
full reimbursement from us for workers’ compensation benefits paid by the association. Although we settled that
dispute within the limits of insurance coverage we had secured to cover potential claims returned to us related to the
Reliance policies, if one or more states were to assert that liability for open claims with Kemper should be returned
to us, we may be required to make a payment to the state covering estimated claims attributable to us. Any such
payment would reduce net income, which may have a material adverse effect on net income in the reported period.
On September 1, 2003, we obtained a workers’ compensation policy (“2004 Policy”), which matured and
was subsequently renewed commencing on September 16, 2004 until September 30, 2005 (“2005 Policy”) with
selected member insurance companies of American International Group, Inc. (“AIG”). Under our arrangement with
AIG, we bear the economic burden for the first $1 million layer of claims per occurrence. AIG bears the economic
burden for all claims in excess of such first $1 million layer. The 2004 Policy is a fully insured policy whereby AIG
has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities.
Because we bear the economic burden of the first $1 million layer of claims per occurrence, such claims,
which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers
compensation insurance includes ongoing healthcare and indemnity coverage whereby claims are paid over
numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting
period includes estimates, which take into account the ongoing development of claims and therefore requires a
significant level of judgment. Our management estimates our workers’ compensation costs by applying an aggregate
loss development rate to worksite employee payroll levels. We employ a third party actuary to estimate our loss
development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location
of worksite employees, the historical frequency and severity of workers compensation claims and an estimate of
future cost trends. Workers’ compensation cost estimates are discounted to present value at a rate based upon the
U.S. Treasury rates that correspond with the weighted average estimated claim payout period (the discount rate
utilized in 2003 and 2004 averaged 2.0% and 2.8%, respectively) and are accreted over the estimated claim payment
period and included as a component of direct costs in our Consolidated Statements of Operations.
Our claim trends could be greater than or less than our prior estimates, in which case we would revise our
claims estimates and record an adjustment to workers’ compensation costs in the period we determine that the claims
trends are higher or lower than our estimates. If we were to experience any significant changes in actuarial
assumptions, our loss development rates could increase (or decrease) which would result in an increase (or decrease)
in workers’ compensation costs and a resulting decrease (or increase) in net income reported in our Consolidated
Statement of Operations.
In conjunction with entering into the 2004 Policy, we formed a wholly owned captive insurance subsidiary
(the “Captive”). We recognize the Captive as an insurance company for federal income tax purposes, with respect to
our consolidated federal income tax return. In the event the Internal Revenue Service (“IRS”) were to determine that
the Captive does not qualify as an insurance company, we could be required to make accelerated income tax
payments to the IRS that we otherwise would have deferred until future periods.
Increases in Unemployment Tax Rates
We record our state unemployment tax expense based on taxable wages and tax rates assigned by each state.
State unemployment tax rates vary by state and are determined, in part, based on prior years’ compensation
experience in each state. Should our claim experience increase, our unemployment tax rates could increase. In
addition, states have the ability under law to increase unemployment tax rates to cover deficiencies in the
unemployment tax fund. Many states have experienced and are experiencing significant increases in unemployment
- 42 -
claims due to depressed economic conditions over the last few years. As a result, our unemployment tax rates have
increased over the last several years and are expected to continue to increase. Some states have implemented
retroactive cost increases. Contractual arrangements with our clients limit our ability to incorporate such increases
into service fees, which could result in a delay before such increases could be reflected in service fees. As a result,
such increases could have a material adverse effect on our financial condition or results of operations.
As a result of the 2001 corporate restructuring, we filed for a transfer of our reserve account with the EDD.
The EDD approved our request for transfer of our reserve account in May 2002 and also notified us of our new
contribution rates based upon the approved transfer. In December 2003, we received a Notice of Duplicate
Accounts and Notification of Assessment from the EDD. The notice stated that the EDD was collapsing the
accounts of our subsidiaries into the account of the entity with the highest unemployment tax rate. The notice also
retroactively imposed the higher unemployment insurance rate on all our California employees for 2003, resulting in
an assessment of $5.6 million. In January 2004, we filed a petition with an administrative law judge of the California
Unemployment Insurance Appeals Board (“ALJ”) to protest the notice. Pending a resolution of our protest, in the
fourth quarter of 2003 we accrued and recorded at the higher assessed rate for all of 2003.
In June 2004, we agreed to settle our dispute with the EDD for $3.3 million. Based upon receipt of written
acknowledgement of this agreement, we reduced our accrued payroll tax liability and payroll tax expense by $2.3
million during the quarter ended June 30, 2004. The settlement was subject to the final approval by EDD’s legal
department, the California Attorney General’s office and the ALJ. In October 2004, the legal department of the
EDD verbally indicated they considered the previously agreed-upon settlement amount to be insufficient and
suggested a settlement amount of $5.2 million. We continued discussion with the State of California, but in February
2005, we were notified that the EDD had rejected our settlement offer and the matter will proceed with the appeals
process with the ALJ. If the outcome of the appeals process is unfavorable and we are assessed additional interest
and penalties, we may recognize an increase in our payroll tax expense in a future period. Conversely, if the
outcome of the appeals process is favorable to us, we may recognize a decrease in our payroll tax expense in a future
period. The ultimate outcome of this matter is not expected to have a material impact on the Company’s 2005
unemployment tax rate in California.
Need to Renew or Replace Client Companies
Our standard CSA can be cancelled by us or the client with 30 to 60 days notice. Accordingly, the short-
term nature of the CSA makes us vulnerable to potential cancellations by existing clients, which could materially and
adversely affect our financial condition and results of operations. In addition, our results of operations are dependent
in part upon our ability to retain or replace our client companies upon the termination or cancellation of the CSA.
Our client attrition rate was approximately 25% in 2004. There can be no assurance that the number of contract
cancellations will continue at these levels or increase in the future.
Competition and New Market Entrants
The PEO industry is highly fragmented. Many PEOs have limited operations and fewer than 1,000 worksite
employees, but there are several industry participants that are comparable to our size. We also encounter
competition from “fee for service” companies such as payroll processing firms, insurance companies and human
resource consultants. Several of our competitors are PEO divisions of large business services companies, such as
Automatic Data Processing, Inc. and Paychex, Inc. Such companies have substantially greater resources than
Administaff. Accordingly, the PEO divisions of such companies may be able to provide their PEO services at more
competitive prices than we may be able to offer. Moreover, we expect that as the PEO industry grows and its
regulatory framework becomes better established, well-organized competition with greater resources than us may
enter the PEO market, possibly including large “fee for service” companies currently providing a more limited range
of services.
- 43 -
Liabilities for Client and Employee Actions
A number of legal issues remain unresolved with respect to the co-employment arrangement between a PEO
and its worksite employees, including questions concerning the ultimate liability for violations of employment and
discrimination laws. Our CSA establishes the contractual division of responsibilities between Administaff and our
clients for various personnel management matters, including compliance with and liability under various
governmental regulations. However, because we act as a co-employer, we may be subject to liability for violations
of these or other laws despite these contractual provisions, even if we do not participate in such violations. Although
the CSA provides that the client is to indemnify us for any liability attributable to the client’s conduct, we may not
be able to collect on such a contractual indemnification claim and thus may be responsible for satisfying such
liabilities. In addition, worksite employees may be deemed to be our agents, which may subject us to liability for the
actions of such worksite employees.
We maintain certain general insurance coverages (including coverages for our clients) to manage our
exposure for these types of claims, and as a result, the costs in excess of insurance premiums we incur with respect to
this exposure have historically been insignificant to our operating results.
Federal, State and Local Regulation
As a major employer, our operations are affected by numerous federal, state and local laws and regulations
relating to labor, tax and employment matters. By entering into a co-employer relationship with employees assigned
to work at client company locations, we assume certain obligations and responsibilities of an employer under these
laws. However, many of these laws (such as ERISA and federal and state employment tax laws) do not specifically
address the obligations and responsibilities of non-traditional employers such as PEOs, and the definition of
“employer” under these laws is not uniform. In addition, many of the states in which we operate have not addressed
the PEO relationship for purposes of compliance with applicable state laws governing the employer/employee
relationship. Any adverse application of these other federal or state laws to the PEO relationship with our worksite
employees could have a material adverse effect on our results of operations or financial condition.
While many states do not explicitly regulate PEOs, 25 states have passed laws that have licensing or
registration requirements for PEOs, and several other states are considering such regulation. Such laws vary from
state to state, but generally provide for monitoring the fiscal responsibility of PEOs, and in some cases codify and
clarify the co-employment relationship for unemployment, workers’ compensation and other purposes under state
law. While we generally support licensing regulation because it serves to validate the PEO relationship, we may not
be able to satisfy licensing requirements or other applicable regulations for all states. In addition, there can be no
assurance that we will be able to renew our licenses in all states.
401(k) Recordkeeping Services
On October 1, 2003, we began performing recordkeeping services for the Administaff 401(k) Plan (“Plan”),
and on December 31, 2003, began performing such services for the Administaff Spinoff 401(k) Plan and Administaff
Corporate 401(k) Plan. In addition, we began to offer such services to certain other defined contribution plans,
which are sponsored and maintained by PEO and non-PEO clients (“Other Plans”). Historically, we have contracted
with a third party administrator to provide a majority of the recordkeeping functions associated with the Plan and
have not offered any significant services with respect to Other Plans. Failure to manage this new service effectively
could have a material adverse effect on our financial condition and results of operations.
- 44 -
Geographic Market Concentration
While we have sales offices in 21 markets, our Houston and Texas (including Houston) markets accounted
for approximately 20% and 39%, respectively, of our revenues for the year ended December 31, 2004. Accordingly,
while we have a goal of expanding in our current and future markets outside of Texas, for the foreseeable future, a
significant portion of our revenues may be subject to economic factors specific to Texas (including Houston).
Potential Client Liability for Employment Taxes
Under the CSA, we assume sole responsibility and liability for paying federal employment taxes imposed
under the Code with respect to wages and salaries we pay our worksite employees. There are essentially three types
of federal employment tax obligations:
•
•
•
income tax withholding requirements;
obligations under the Federal Income Contribution Act (“FICA”); and
obligations under the Federal Unemployment Tax Act (“FUTA”).
Under the Code, employers have the obligation to withhold and remit the employer portion and, where applicable,
the employee portion of these taxes. Most states impose similar employment tax obligations on the employer. While
the CSA provides that we have sole legal responsibility for making these tax contributions, the IRS or applicable
state taxing authority could conclude that such liability cannot be completely transferred to us. Accordingly, in the
event that we fail to meet our tax withholding and payment obligations, the client company may be held jointly and
severally for those obligations. While this interpretive issue has not, to our knowledge, discouraged clients from
enrolling with Administaff, a definitive adverse resolution of this issue may discourage clients from enrolling in the
future.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
We are primarily exposed to market risks from fluctuations in interest rates and the effects of those
fluctuations on the market values of our cash equivalent short-term investments, our available-for-sale marketable
securities, and our long-term debt. The cash equivalent short-term investments consist primarily of overnight
investments, which are not significantly exposed to interest rate risk, except to the extent that changes in interest
rates will ultimately affect the amount of interest income earned on these investments. The available-for-sale
marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate.
As a result, the market values of these securities are affected by changes in prevailing interest rates.
We attempt to limit our exposure to interest rate risk primarily through diversification and low investment
turnover. Our marketable securities are currently managed by two professional investment management companies,
each of which is guided by our investment policy. Our investment policy is designed to maximize after-tax interest
income while preserving our principal investment. As a result, our marketable securities consist primarily of short
and intermediate-term debt securities.
As of December 31, 2004, our available-for-sale marketable securities included an investment in a mutual
fund that holds corporate debt securities with maturities up to 18 months. The amortized cost basis, fair market
value and 30-day yield of this investment was $11.4 million, $11.2 million and 2.39%, respectively, at December 31,
2004. The following table presents information about our available-for-sale marketable securities, excluding the
mutual fund investment, as of December 31, 2004 (dollars in thousands):
- 45 -
Principal
Maturities
Average
Interest Rate
2005
2006
2007
2008
2009
Thereafter
Total
Fair Market Value
$
$
$
450
783
1,665
2,000
1,640
9,665
16,203
16,756
1.6%
5.0%
5.1%
5.1%
5.1%
2.8%
3.6%
Our mortgage loan includes variable interest rates, and as a result, our total cost of borrowing under the
agreement is also subject to interest rate risk. As of December 31, 2004 we had borrowed $33.7 million under the
agreement with an interest rate of 5.2%. At December 31, 2004, the fair market value of our variable rate borrowing
approximated the carrying value. The following table summarizes principal maturities of our variable interest rate
mortgage as of December 31, 2004 (dollars in thousands):
2005
2006
2007
2008
2009
Thereafter
Principal
Maturities
$ 1,147
1,158
1,070
30,371
—
—
$ 33,746
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item 8 is contained in a separate section of this annual report. See “Index
to Consolidated Financial Statements” on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
In accordance with Exchange Act Rules 13a-15 and 15a-15, we carried out an evaluation, under the
supervision and with the participation of management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31, 2004.
- 46 -
Design and Evaluation of Internal Control Over Financial Reporting
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we included a report of management’s
assessment of the design and effectiveness of our internal controls as part of this Annual Report on Form 10-K for
the fiscal year ended December 31, 2004. Ernst & Young, LLP, our independent registered public accounting firm,
also attested to, and reported on, management’s assessment of the effectiveness of internal control over financial
reporting. Management’s report and the independent registered public accounting firm’s attestation report are
included in our 2004 Consolidated Financial Statements on pages F-3 and F-4 under the captions entitled
“Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public
Accounting Firm on Internal Control Over Financial Reporting” and are incorporated herein by reference.
There has been no change in our internal controls over financial reporting that occurred during the three
months ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our
internal controls over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
- 47 -
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Some of the information required by this item is incorporated by reference to the information set forth under
the captions “Proposal Number 1: Election of Directors – Nominees – Class I Directors (For Terms Expiring at the
2008 Annual Meeting),” “– Directors Remaining in Office,” and “– Section 16(a) Beneficial Ownership Reporting
Compliance” in our definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A within 120 days after the end of the fiscal year covered by this report (the “Administaff Proxy
Statement”).
Code of Business Conduct and Ethics
Our Board of Directors adopted our Code of Business Conduct and Ethics (the “Code of Ethics”), which
meets the requirements of Rule 303.A of the New York Stock Exchange Listed Company Manual and Item 406 of
Regulation S-K. You can access our Code of Ethics on the Corporate Governance page of our website at
www.administaff.com. Any stockholder who so requests may obtain a printed copy of the Code of Ethics from
Administaff. Changes in and waivers to the Code of Ethics for the Company’s directors, executive officers and
certain senior financial officers will be posted on our Internet website within five business days and maintained for at
least twelve months.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to the information set forth under the
captions “Proposal Number 1: Election of Directors – Director Compensation” and “—Executive Compensation” in
the Administaff Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required by this item is incorporated by reference to the information set forth under the
caption “Security Ownership of Certain Beneficial Owners and Management” and “Proposal Number 2 – Approval
of the 2001 Incentive Plan, as amended and restated – Equity Compensation Plan Information” in the Administaff
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to the information set forth under the
caption “Proposal Number 1: Election of Directors – Certain Relationships and Related Transactions” in the
Administaff Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required by this item is incorporated by reference to the information set forth under the
caption “Proposal Number 3: Ratification and Appointment of Independent Public Accountants – Fees of Ernst &
Young LLP” and “—Finance, Risk Management and Audit Committee Pre-Approval Policy for Audit and Non-
Audit Services” in the Administaff Proxy Statement.
- 48 -
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)
1.
Financial Statements of the Company
PART IV
The Consolidated Financial Statements listed by the Registrant on the accompanying Index to
Consolidated Financial Statements (see page F-1) are filed as part of this Annual Report.
(a)
2.
Financial Statement Schedules
The required information is included in the Consolidated Financial Statements or Notes thereto.
(a)
3.
List of Exhibits
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Registrant’s
Registration Statement on Form S-1 (No. 33-96952)).
3.2 Bylaws, as amended on March 7, 2001 (incorporated by reference to Exhibit 3.2 to the
Registrant’s Form 10-K filed for the year ended December 31, 2000).
3.3 Certificate of Designations of Series A Junior Participating Preferred Stock of
Administaff, Inc. Dated February 4, 1998 (incorporated by reference to Exhibit 2 to the
Registrant’s Form 8-A filed on February 4, 1998).
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the
Registrant’s Registration Statement on Form S-1 (No. 33-96952)).
4.1
4.2 Rights Agreement dated as of February 4, 1998, between Administaff, Inc. and Harris
Trust and Savings Bank, as Rights Agent (incorporated by reference to Exhibit 1 to the
Registrant’s Form 8-A filed on February 4, 1998).
4.3 Amendment No. 1 to Rights Agreement dated as of March 9, 1998 between Administaff,
Inc. and Harris Trust and Savings Bank, as Rights Agent (incorporated by reference to
Exhibit 4.3 to the Registrant’s Form 10-K for the year ended December 31, 1999).
4.4 Amendment No. 2 to Rights Agreement dated as of May 14, 1999 between Administaff,
Inc. and Harris Trust and Savings Bank, as Rights Agent (incorporated by reference to
Exhibit 2 to the Registrant’s Form 8-A/A filed on May 19, 1999).
4.5 Amendment No. 3 to Rights Agreement dated as of July 22, 1999 between Administaff,
Inc. and Harris Trust and Savings Bank, as Rights Agent (incorporated by reference to
Exhibit 1 to the Registrant’s Form 8-A/A filed on August 9, 1999).
4.6 Amendment No. 4 to Rights Agreement dated as of August 2, 1999 between Administaff,
Inc. and Harris Trust and Savings Bank, as Rights Agent (incorporated by reference to
Exhibit 2 to the Registrant’s form 8-A/A filed on August 9, 1999).
Form of Rights Certificate (incorporated by reference to Exhibit 3 to the Registrant’s
Form 8-A filed on February 4, 1998).
4.7
4.8 Amended and Restated Rights Agreement effective as of April 19, 2003 between
Administaff, Inc. and Mellon Investor Services LLC, as Rights Agent (incorporated by
reference to Exhibit 1 to the Registrant’s Form 8-A/A filed on May 16, 2003).
4.9 Amendment No. 1 to Amended and Restated Rights Agreement dated as of August 21,
2003 between Administaff, Inc. and Mellon Investor Services LLC, as Rights Agent
(incorporated by reference to Exhibit 1 to the Registrant’s Form 8A/A filed on August 22,
2003).
4.10 Amendment No. 2 to Amended and Restated Rights Agreement dated as of February 24,
2004 between Administaff, Inc. and Mellon Investor Services LLC, as Rights Agent
(incorporated by reference to Exhibit 4.10 to the Registrant’s Form 10-K for the year
ended December 31, 2003).
- 49 -
10.1† Administaff, Inc. 1997 Incentive Plan (incorporated by reference to Exhibit 99.1 to the
Registrant’s Registration Statement on Form S-8 (No. 333-85151)).
10.2† First Amendment to the Administaff, Inc. 1997 Incentive Plan (incorporated by reference
to Exhibit 99.2 to the Registrant’s Registration Statement on Form S-8 (No. 333-85151)).
10.3† Second Amendment to the Administaff, Inc. 1997 Incentive Plan (incorporated by
reference to Exhibit 99.3 to the Registrant’s Registration Statement on Form S-8 (No.
333-85151)).
10.4† Third Amendment to the Administaff, Inc. 1997 Incentive Plan (incorporated by reference
to Exhibit 99.4 to the Registrant’s Registration Statement on Form S-8 (No. 333-85151)).
10.5† Fourth Amendment to the Administaff, Inc. 1997 Incentive Plan (incorporated by
reference to Exhibit 99.5 to the Registrant’s Registration Statement on Form S-8 (No.
333-85151)).
10.6† Administaff, Inc. 2001 Incentive Plan (incorporated by reference to Exhibit 10.1 to the
Registrant’s Form 10-Q filed for the quarter ended March 31, 2001).
10.7†* Form of Incentive Stock Option Agreement (1997 Plan).
10.8†* Form of Incentive Stock Option Agreement (2001 Plan – 3 year vesting).
10.9†* Form of Incentive Stock Option Agreement (2001 Plan – 5 year vesting).
10.10†* Form of Director Stock Option Agreement (Initial Grant).
10.11†* Form of Director Stock Option Agreement (Annual Grant).
10.12†* Form of Restricted Stock Agreement.
10.13 Administaff, Inc. Nonqualified Stock Option Plan (incorporated by reference to Exhibit
99.6 to the Registrant’s Registration Statement on Form S-8 (No. 333-85151)).
10.14 First Amendment to Administaff, Inc. Nonqualified Stock Option Plan, effective August
7, 2001 (incorporated by reference to Exhibit 10.8 to the Registrant’s Form 10-K for the
year ended December 31, 2002).
10.15 Second Amendment to Administaff, Inc. Nonqualified Stock Option Plan, effective
January 28, 2003 (incorporated by reference to Exhibit 10.9 to the Registrant’s Form 10-
K for the year ended December 31, 2002).
10.16 Administaff, Inc. Amended and Restated Employee Stock Purchase Plan effective April
1, 2002 (incorporated by reference to Exhibit 10.10 to the Registrant’s Form 10-K for the
year ended December 31, 2002).
10.17 First Amendment to Administaff, Inc. Amended and Restated Employee Stock Purchase
Plan, effective July 31, 2002 (incorporated by reference to Exhibit 10.11 to the
Registrant’s Form 10-K for the year ended December 31, 2002).
10.18 Second Amendment to Administaff, Inc. Amended and Restated Employee Stock
Purchase Plan, effective August 15, 2003 (incorporated by reference to Exhibit 10.12 to
the Registrant’s Form 10-K for the year ended December 31, 2003).
10.19† Board of Directors Compensation Arrangements (incorporated by reference to Form 8-K
dated February 7, 2005).
10.20 Promissory Note dated December 20, 2002 executed by Administaff Services, L.P,
payable to General Electric Capital Business Asset Funding Corporation (incorporated by
reference to Exhibit 10.18 to the Registrant’s Form 10-K for the year ended December
31, 2002).
10.21 Guaranty dated December 20, 2002 by Administaff, Inc. in favor of General Electric
Capital Business Asset Funding Corporation (incorporated by reference to Exhibit 10.19
to the Registrant’s Form 10-K for the year ended December 31, 2002).
10.22 Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents, and
Fixture Filing, dated December 20, 2002, executed by Administaff Services, L.P. in favor
of General Electric Capital Business Asset Funding Corporation (incorporated by
reference to Exhibit 10.20 to the Registrant’s Form 10-K for the year ended December
31, 2002).
10.23 Minimum Premium Financial Agreement by and between Administaff of Texas, Inc. and
United Healthcare Insurance Company, Hartford, Connecticut (incorporated by reference
to Exhibit 10.3 to the Registrant’s Form 10-Q for the quarter ended June 30, 2002).
- 50 -
10.24 Minimum Premium Administrative Services Agreement by and between Administaff of
Texas, Inc. and United Healthcare Insurance Company, Hartford, Connecticut
(incorporated by reference to Exhibit 10.4 to the Registrant’s Form 10-Q for the quarter
ended June 30, 2002).
10.25 Amended and Restated Security Deposit Agreement by and between Administaff of
Texas, Inc. and United Healthcare Insurance Company, Hartford, Connecticut
(incorporated by reference to Exhibit 10.5 to the Registrant’s Form 10-Q for the quarter
ended June 30, 2002).
10.26* Amendment to Various Agreements Between United Healthcare Insurance Company and
Administaff of Texas, Inc.
10.27* Houston Service Center Operating Lease Amendment.
21.1* Subsidiaries of Administaff, Inc.
23.1* Consent of Independent Registered Public Accounting Firm.
24.1* Powers of Attorney.
31.1* Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2* Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1* Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2* Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
_____________________
*
†
Filed herewith.
Management contract or compensatory plan or arrangement required to be filed as an
exhibit to this Form 10-K.
- 51 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Administaff,
Inc. has duly caused this report to be signed in its behalf by the undersigned, thereunto duly authorized, on February
22, 2005.
ADMINISTAFF, INC.
By: /s/ Douglas S. Sharp
Douglas S. Sharp
Vice President, Finance
Chief Financial Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the
following persons on behalf of Administaff, Inc. in the capacities indicated on February 22, 2005:
Title
Chairman of the Board, Chief Executive Officer
and Director
(Principal Executive Officer)
President and Director
Vice President, Finance
Chief Financial Officer and Treasurer
(Principal Financial Officer)
Director
Director
Director
Director
Director
Director
Signature
/s/ Paul J. Sarvadi
Paul J. Sarvadi
/s/ Richard G. Rawson
Richard G. Rawson
/s/ Douglas S. Sharp
Douglas S. Sharp
*
Michael W. Brown
*
Jack M. Fields, Jr.
*
Eli Jones
*
Paul S. Lattanzio
*
Gregory E. Petsch
*
Austin P. Young
* By:/s/ John H. Spurgin, II
John H. Spurgin, II, attorney-in-fact
- 52 -
ADMINISTAFF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm ...................................................................................... F-2
Management’s Report on Internal Control ................................................................................................................ F-3
Report of Independent Registered Public Accounting Firm
on Internal Control over Financial Reporting......................................................................................................... F-4
Consolidated Balance Sheets as of December 31, 2004 and 2003 ............................................................................ F-5
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003 and 2002 ...................................................................................................................... F-7
Consolidated Statements of Stockholders’ Equity for the years ended
December 31, 2004, 2003 and 2002 ...................................................................................................................... F-8
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002 ...................................................................................................................... F-9
Notes to Consolidated Financial Statements............................................................................................................ F-11
F-1
THIS PAGE INTENTIONALLY LEFT BLANK
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Administaff, Inc.
We have audited the accompanying consolidated balance sheets of Administaff, Inc. as of December 31,
2004 and 2003, and the related consolidated statements of operations, stockholders’ equity and cash flows for each
of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Administaff, Inc. at December 31, 2004 and 2003, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity
with United States generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of Administaff, Inc.’s internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2005 expressed an
unqualified opinion thereon.
ERNST & YOUNG LLP
Houston, Texas
February 17, 2005
F-2
MANAGEMENT’S REPORT ON INTERNAL CONTROL
The Company has assessed the effectiveness of its internal control over financial reporting as of December
31, 2004 based on criteria established by Internal Control – Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO Framework”). The Company’s management is
responsible for establishing and maintaining adequate internal controls over financial reporting. The Company’s
independent registered public accountants that audited the Company’s financial statements as of December 31, 2004
have issued an attestation report on management’s assessment of the Company’s internal control over financial
reporting, which appears on page F-4.
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Internal control over financial reporting includes those policies and
procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on
the financial statements. Because of the inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies and procedures may deteriorate.
The Company’s assessment of the effectiveness of its internal control over financial reporting included
testing and evaluating the design and operating effectiveness of its internal controls. In management’s opinion, the
Company has maintained effective internal control over financial reporting as of December 31, 2004, based on
criteria established in the COSO Framework.
/s/ Paul J. Sarvadi
Paul J. Sarvadi
Chairman of the Board and
Chief Executive Officer
/s/ Douglas S. Sharp
Douglas S. Sharp
Vice President, Finance
Chief Financial Officer and Treasurer
F-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Administaff, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Control, that Administaff, Inc. maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the COSO criteria). Administaff, Inc.’s management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on
management’s assessment and an opinion on the effectiveness of the company’s internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether effective internal control over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial reporting, evaluating management’s
assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies
or procedures may deteriorate.
In our opinion, management’s assessment that Administaff, Inc. maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Administaff, Inc. maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of Administaff, Inc. as of December 31, 2004 and 2003, and
the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in
the period ended December 31, 2004 of Administaff, Inc. and our report dated February 17, 2005 expressed an
unqualified opinion thereon.
Houston, Texas
February 17, 2005
Ernst & Young LLP
F-4
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
December 31,
2004
2003
Current assets:
Cash and cash equivalents........................................................................................ $ 81,740
18,511
Restricted cash .........................................................................................................
Marketable securities ...............................................................................................
27,950
Accounts receivable:
Trade...................................................................................................................
Unbilled ..............................................................................................................
Other ...................................................................................................................
Prepaid insurance .....................................................................................................
Other current assets ..................................................................................................
Income taxes receivable ...........................................................................................
Deferred income taxes..............................................................................................
Total current assets .............................................................................................
610
65,149
1,451
14,428
3,981
489
—
214,309
Property and equipment:
Land .........................................................................................................................
Buildings and improvements....................................................................................
Computer hardware and software.............................................................................
Software development costs.....................................................................................
Furniture and fixtures ...............................................................................................
Vehicles and aircraft ................................................................................................
Accumulated depreciation........................................................................................
Total property and equipment, net ......................................................................
2,920
57,005
50,765
18,622
28,412
5,725
163,449
(94,392)
69,057
$ 104,728
4,584
23,989
5,752
53,033
2,959
22,554
7,468
—
3,423
228,490
2,920
55,465
49,822
18,699
27,997
6,090
160,993
(82,224)
78,769
Other assets:
Deposits – healthcare ..............................................................................................
Deposits – workers’ compensation...........................................................................
Other assets ..............................................................................................................
Total other assets ................................................................................................
18,329
52,264
679
71,272
Total assets .................................................................................................................. $ 354,638
18,314
21,357
1,141
40,812
$ 348,071
F-5
ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands)
LIABILITIES AND STOCKHOLDERS’ EQUITY
December 31,
2004
2003
Current liabilities:
Accounts payable ..................................................................................................... $
Payroll taxes and other payroll deductions payable .................................................
Accrued worksite employee payroll cost..................................................................
Accrued health insurance costs ................................................................................
Accrued workers’ compensation costs .....................................................................
Accrued corporate payroll and commissions............................................................
Other accrued liabilities ...........................................................................................
Income taxes payable ...............................................................................................
Deferred income taxes..............................................................................................
Current portion of long-term debt ............................................................................
Total current liabilities ..................................................................................
2,380
64,471
59,277
1,991
19,349
11,031
6,430
—
231
1,649
166,809
$
4,319
65,310
65,503
6,559
5,489
10,299
5,599
7,520
—
1,860
172,458
Noncurrent liabilities:
Long-term debt.........................................................................................................
Accrued workers’ compensation costs .....................................................................
Deferred income taxes..............................................................................................
Total noncurrent liabilities ............................................................................
34,890
22,912
3,498
61,300
40,502
7,417
5,060
52,979
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 – 60,000
Shares issued – 30,839 at December 31, 2004 and 2003, respectively...............
Additional paid-in capital.........................................................................................
Treasury stock, at cost – 5,362 and 4,120 shares
309
101,623
(63,925)
at December 31, 2004 and 2003, respectively...............................................
(127)
Accumulated other comprehensive loss, net of tax ..................................................
88,649
Retained earnings .....................................................................................................
126,529
Total stockholders’ equity........................................................................................
Total liabilities and stockholders’ equity ..................................................................... $ 354,638
309
101,681
(48,795)
—
69,439
122,634
$ 348,071
See accompanying notes.
F-6
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Year ended December 31,
2003
2004
2002
Revenues (gross billings of $5.377 billion, $4.829 billion and
$4.857 billion less worksite employee payroll cost of
$4.407 billion, $3.938 billion, and $4.009 billion, respectively)
$ 969,527
$ 890,859
$ 848,416
Direct costs:
Payroll taxes, benefits and workers’ compensation costs .......
771,833
693,754
682,626
Gross profit..................................................................................
197,694
197,105
165,790
Operating expenses:
Salaries, wages and payroll taxes ...........................................
General and administrative expenses......................................
Commissions ..........................................................................
Advertising .............................................................................
Depreciation and amortization ...............................................
Operating income.........................................................................
Other income (expense):
Interest income .......................................................................
Interest expense ......................................................................
Write-off of investments.........................................................
Other, net................................................................................
Income (loss) before income tax expense ....................................
Income tax expense......................................................................
Net income (loss) from continuing operations.............................
Discontinued operations:
Loss from discontinued operations.........................................
Income tax expense (benefit)..................................................
Net loss from discontinued operations ...................................
88,298
49,283
10,447
10,021
17,514
175,563
22,131
82,802
50,033
10,656
8,581
20,759
172,831
24,274
74,989
50,172
12,127
7,138
21,297
165,723
67
2,449
(2,093)
—
8,249
8,605
30,736
11,526
19,210
1,910
(2,176)
—
462
196
24,470
9,485
$ 14,985
1,772
(437)
(3,354)
272
(1,747)
(1,680)
1,241
(2,921)
$
$
—
—
—
(3,264)
(1,143)
(2,121)
(1,917)
(757)
(1,160)
Net income (loss).........................................................................
$
19,210
$ 12,864
$
(4,081)
Basic net income (loss) per share of common stock:
Income (loss) from continuing operations ..............................
Loss from discontinued operations.........................................
Basic net income (loss) per share of common stock ....................
Diluted net income (loss) per share of common stock:
Income (loss) from continuing operations ..............................
Loss from discontinued operations.........................................
Diluted net income (loss) per share of common stock .................
$
$
$
$
0.74
—
0.74
0.72
—
0.72
$
$
$
$
0.56
(0.08)
0.48
0.55
(0.08)
0.47
$
$
$
$
(0.11)
(0.04)
(0.15)
(0.11)
(0.04)
(0.15)
See accompanying notes.
F-7
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
Common Stock
Issued
Shares Amount
Additional
Accumulated
Other
Paid-In Treasury Comprehensive Retained
Income (Loss) Earnings
Capital
Stock
Total
Balance at December 31, 2001
Purchase of treasury stock, at cost
Exercise of common stock
purchase warrant
Sale of common stock to Administaff
Employee Stock Purchase Plan
Sale of treasury stock to Administaff
Employee Stock Purchase Plan
Exercise of stock options
Income tax benefit from
exercise of stock options
Other
Change in unrealized gain on
marketable securities (net of tax):
Unrealized gain
Realized gain
Net loss
Comprehensive loss
Balance at December 31, 2002
Purchase of treasury stock, at cost
Sale of treasury stock to Administaff
Employee Stock Purchase Plan
Exercise of stock options
Income tax benefit from
exercise of stock options
Other
Change in unrealized gain (loss) on
marketable securities (net of tax):
Unrealized loss
Realized gain
Net income
Comprehensive income
Balance at December 31, 2003
Purchase of treasury stock, at cost
Sale of treasury stock to Administaff
Employee Stock Purchase Plan
Exercise of stock options
Income tax benefit from
exercise of stock options
Other
Change in unrealized gain (loss) on
marketable securities (net of tax):
30,776
—
—
4
—
59
—
—
—
—
—
30,839
—
$ 308
—
$ 95,114
—
$(33,467)
(17,088)
$ 324
—
$60,656 $122,935
(17,088)
—
—
—
—
1
—
—
—
—
—
6,952
6,205
109
—
(724)
742
203
(81)
—
—
—
1,185
—
—
162
—
—
—
—
—
—
—
—
—
23
(194)
—
$ 309
—
$102,315 $(43,003)
(8,233)
—
$ 153
—
—
—
—
—
—
—
13,157
109
461
743
203
81
—
—
(4,081)
23
(194)
(4,081)
(4,252)
$56,575 $116,349
(8,233)
—
—
—
—
—
—
—
—
—
(322)
(466)
249
(95)
848
1,343
—
250
—
—
—
—
30,839
—
—
—
—
—
—
—
—
—
$ 309
—
—
—
—
—
—
—
—
—
—
—
—
—
$101,681 $(48,795)
(17,153)
—
80
(511)
363
1,522
352
21
—
138
—
—
—
—
(109)
(44)
—
—
—
—
—
—
—
—
—
—
—
—
526
877
249
155
(109)
—
(44)
—
12,864
12,864
12,711
—
$69,439 $122,634
(17,153)
—
—
—
—
—
443
1,011
352
159
Unrealized loss
Realized gain
Net income
Comprehensive income
Balance at December 31, 2004
—
—
—
—
30,839
—
—
—
—
$ 309
—
—
—
—
—
—
—
—
$101,623 $(63,925)
(114)
(13)
—
—
$ (127)
(114)
—
(13)
—
19,210
19,210
19,083
—
$88,649 $126,529
See accompanying notes.
F-8
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year ended December 31,
2003
2002
2004
Cash flows from operating activities:
Net income (loss) .....................................................................
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization............................................
Write-off of investments .....................................................
Deferred income taxes ........................................................
Bad debt expense ................................................................
Loss (gain) on disposition of assets ....................................
Changes in operating assets and liabilities:
Restricted cash...............................................................
Accounts receivable.......................................................
Prepaid insurance ..........................................................
Other current assets .......................................................
Other assets ...................................................................
Accounts payable...........................................................
Payroll taxes and other payroll deductions payable.......
Accrued worksite employee payroll expense.................
Accrued health insurance costs......................................
Accrued workers’ compensations costs .........................
Accrued corporate payroll
and 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 .................................................
Cash received (exchanged) for note receivable........................
Property and equipment:
Purchases ............................................................................
Proceeds from dispositions .................................................
Proceeds from the sale of / (investments in) other companies..
Net cash used in investing activities ..........................
$ 19,210
$ 12,864
$ (4,081)
17,770
—
2,168
463
59
(13,927)
(5,929)
8,126
3,487
(30,637)
(1,939)
(839)
(6,226)
(4,568)
29,355
1,563
(7,657)
(8,731)
10,479
(21,644)
453
16,912
—
(8,114)
289
—
(12,104)
22,185
—
(3,018)
494
(467)
(4,584)
20,237
(4,645)
1,949
(17,886)
1,250
8,082
(4,173)
744
12,811
2,879
7,421
43,279
56,143
(25,779)
6,645
9,612
2,709
(8,651)
275
457
(14,732)
21,857
3,354
77
1,139
(268)
—
(7,654)
(10,165)
(5,948)
(12,623)
(1,263)
7,420
6,826
4,489
(2,114)
2,067
16
7,210
3,129
(15,499)
23,436
25,130
(2,983)
(38,425)
148
(500)
(8,693)
F-9
ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
Cash flows from financing activities:
Purchase of treasury stock........................................................
Proceeds from the exercise of common
stock purchase warrants ........................................................
Proceeds from sale of common stock to the
employee stock purchase plan ..............................................
Proceeds from the exercise of stock options ............................
Long-term debt and short-term borrowings:
Borrowings under long-term debt agreements ......................
Net borrowings under revolving line of credit......................
Deferred financing costs .......................................................
Principal repayments on long-term debt
and capital lease obligations .............................................
Collection of (loans) to employees...........................................
Other ........................................................................................
Net cash provided by (used in) financing activities.......
Year ended December 31,
2003
2002
2004
$ (17,153)
$
(8,233)
$ (17,088)
—
—
13,157
443
1,011
—
—
—
526
877
—
—
—
(5,823)
—
159
(21,363)
(1,807)
—
155
(8,482)
570
743
40,500
(13,500)
(689)
(105)
694
81
24,363
Net increase (decrease) in cash and cash equivalents ..................
Cash and cash equivalents at beginning of year...........................
Cash and cash equivalents at end of year.....................................
(22,988)
104,728
$ 81,740
32,929
71,799
$ 104,728
18,799
53,000
$ 71,799
Supplemental disclosures:
Cash paid for income taxes ......................................................
Cash paid for interest ...............................................................
$ 19,877
1,964
$
$
$
5,072
2,053
$
$
663
209
Noncash Investing and Financing Activities:
During 2002, the Company entered into a long-term capital lease agreement to finance the purchase of office
furniture with a purchase price of $3.8 million.
See accompanying notes.
F-10
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004
1. Accounting Policies
Description of Business
Administaff, Inc. (“the Company”) is a professional employer organization (“PEO”). As a PEO, the
Company provides a bundled comprehensive service for its clients in the area of personnel management. The
Company provides its comprehensive service through its Personnel Management System, which encompasses a
broad range of human resource functions, including payroll and benefits administration, health and workers’
compensation insurance programs, personnel records management, employer liability management, employee
recruiting and selection, employee performance management, and employee training and development.
The Company provides its comprehensive service by entering into a co-employment relationship with its
clients, under which the Company and its clients each take responsibility for certain portions of the employer-
employee relationship. The Company and its clients designate each party’s responsibilities through its Client
Services Agreement (“CSA”), under which the Company becomes the employer of its worksite employees for most
administrative and regulatory purposes.
As a co-employer of its worksite employees, the Company assumes most of the rights and obligations
associated with being an employer. The Company enters into an employment agreement with each worksite
employee, thereby maintaining a variety of employer rights, including the right to hire or terminate employees, the
right to evaluate employee qualifications or performance, and the right to establish employee compensation levels.
Typically, the Company only exercises these rights in consultation with its clients or when necessary to ensure
regulatory compliance. The responsibilities associated with the Company’s role as employer include the following
obligations with regard to its worksite employees: (i) to compensate its worksite employees through wages and
salaries; (ii) to pay the employer portion of payroll-related taxes; (iii) to withhold and remit (where applicable) the
employee portion of payroll-related taxes; (iv) to provide employee benefit programs; and (v) to provide workers’
compensation insurance coverage.
In addition to its assumption of employer status for its worksite employees, the Company’s comprehensive
service also includes other human resource functions for its clients to support the effective and efficient use of
personnel in their business operations. To provide these functions, the Company maintains a significant staff of
professionals trained in a wide variety of human resource functions, including employee training, employee
recruiting, employee performance management, employee compensation, and employer liability management. These
professionals interact and consult with clients on a daily basis to help identify each client’s service requirements and
to ensure that the Company is providing appropriate and timely personnel management services.
The Company provides its comprehensive service to small and medium-sized businesses in strategically
selected markets throughout the United States. During 2004, 2003 and 2002, revenues from the Company’s Texas
markets represented 39%, 40% and 43% of the Company’s total revenues, respectively.
Revenue and Direct Cost Recognition
The Company accounts for its revenues in accordance with EITF 99-19, Reporting Revenues Gross as a
Principal Versus Net as an Agent. The Company’s revenues are derived from its gross billings, which are based on
(i) the payroll cost of its worksite employees; and (ii) a markup computed as a percentage of the payroll cost. The
gross billings are invoiced concurrently with each periodic payroll of its worksite employees. Revenues are
F-11
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
recognized ratably over the payroll period as worksite employees perform their service at the client worksite.
Revenues that have been recognized but not invoiced are included in unbilled accounts receivable on the Company’s
Consolidated Balance Sheets.
In determining the pricing of the markup component of the gross billings, the Company takes into
consideration its estimates of the costs directly associated with its worksite employees, including payroll taxes,
benefits and workers’ compensation costs, plus an acceptable gross profit margin. As a result, the Company’s
operating results are significantly impacted by the Company’s ability to accurately estimate, control and manage its
direct costs relative to the revenues derived from the markup component of the Company’s gross billings.
Consistent with its revenue recognition policy, the Company’s direct costs do not include the payroll cost of
its worksite employees. The Company’s direct costs associated with its revenue generating activities are comprised
of all other costs related to its worksite employees, such as the employer portion of payroll-related taxes, employee
benefit plan premiums and workers’ compensation insurance costs.
Segment Reporting
The Company operates in one reportable segment under the Statement of Financial Accounting Standards
(“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information.
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 accounting principles generally accepted in the
United States 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.
Concentrations of Credit Risk
Financial instruments that could potentially subject the Company to concentration of credit risk include
accounts receivable.
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.
Marketable Securities
The Company accounts for marketable securities in accordance with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. The Company determines the appropriate classification of all marketable
securities as held-to-maturity, available-for-sale or trading at the time of purchase, and re-evaluates such
classification as of each balance sheet date. At December 31, 2004 and 2003, 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 comprehensive income (loss) in stockholders’
equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts
F-12
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
from the date of purchase to maturity. Such amortization is included in interest income as an addition to or
deduction from the coupon interest earned on the investments. The Company follows its investment managers’
methods of determining the cost basis in computing realized gains and losses on the sale of its available-for-sale
securities, which includes both the specific identification and average cost methods. Realized gains and losses are
included in other income (expense).
Property and Equipment
Property and equipment are recorded at cost and are 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...................................................................................... 5-30 years
Computer hardware and software .............................................................................. 2-5 years
Software development costs....................................................................................... 3-5 years
Furniture and fixtures................................................................................................. 5-7 years
Aircraft....................................................................................................................... 10 years
5 years
Vehicles .....................................................................................................................
Software development costs relate primarily to the Company’s proprietary professional employer
information system and its Internet-based service delivery platform, the Employee Service Center, and are accounted
for in accordance with Statement of Position (“SOP”) 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use.
The Company periodically evaluates its long-lived assets for impairment in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that an impairment loss be
recognized for assets to be disposed of or held-for-use when the carrying amount of an asset is deemed to not be
recoverable. If events or circumstances were to indicate that any of the Company’s long-lived assets might be
impaired, the Company would analyze the estimated undiscounted future cash flows to be generated from the
applicable asset. In addition, the Company would record an impairment loss to the extent that the carrying value of
the asset exceeded the fair value of the asset. Fair value is generally determined using an estimate of discounted
future net cash flows from operating activities or upon disposal of the asset.
Health Insurance Costs
The Company provides health insurance coverage to its worksite employees through a national network of
carriers including UnitedHealthcare (“United”), Cigna Healthcare, PacifiCare, Kaiser Permanente, Blue Cross and
Blue Shield of Georgia, Blue Shield of California and Tufts, all of which provide fully insured policies or service
contracts. The policy with United provides the majority of the Company’s health insurance coverage. Pursuant to
the terms of the Company’s annual contract with United, within 195 days after contract termination, a final
accounting of the plan will be performed and the Company will receive a refund for any accumulated surplus or will
be liable for any accumulated deficit in the plan, up to the amount of the Company’s then-outstanding security
deposit with United. As a result of these contractual terms, the Company accounts for this plan using a partially self-
funded insurance accounting model.
Each reporting period, the Company records the costs of the United Plan, including paid claims, an estimate
of the change in incurred but not reported (“IBNR”) claims, taxes and administrative fees (collectively the “Plan
Costs”) as benefits expense in the Consolidated Statements of Operations. The estimated IBNR claims are based
upon both (i) a recent average level of paid claims under the plan; and (ii) an estimated lag factor, to provide for
those claims which have been incurred but not yet paid.
Under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning
of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the cash funded to United, a deficit in
F-13
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the plan would be incurred and the Company would accrue a current liability for the excess costs on its Consolidated
Balance Sheet. On the other hand, if the Plan Costs for the reporting quarter are less than the cash funded to United,
a surplus in the plan would be incurred and the Company would record a current asset for the excess premiums on its
Consolidated Balance Sheet. During the year ended December 31, 2004, the cash funded to United exceeded the
Plan Costs by approximately $900,000, resulting in an accumulated cash surplus from the inception of the plan of
approximately $10.9 million, which is recorded as prepaid insurance on the Company’s Consolidated Balance Sheet.
As of December 31, 2003, the Company’s security deposit with United totaled $25 million. In January
2004, the security deposit was reduced to $17.5 million, at which time the $7.5 million security deposit reduction
plus accrued interest was returned to the Company. Accordingly, as of December 31, 2003, the Company has
recorded, on its Consolidated Balance Sheet, a long-term deposit of $17.5 million and prepaid insurance of $7.5
million relating to the portion returned to the Company in January 2004. As of December 31, 2004, the security
deposit remained at $17.5 million.
Workers’ Compensation Costs
The Company’s workers’ compensation insurance policy for the two-year period ending September 30,
2003 was a guaranteed-cost policy (“2003 Policy”) under which premiums were paid for full-insurance coverage of
all claims incurred during the policy period. This policy also contained a dividend feature for each policy year,
under which the Company was entitled to a refund of a portion of its premiums if, four years after the end of the
policy year, claims paid by the insurance carrier for any policy year were less than an amount set forth in the policy.
In accordance with EITF Topic D-35, FASB Staff Views on EITF No. 93-6, “Accounting for Multiple-Year
Retrospectively Rated Contracts by Ceding and Assuming Enterprises,” the Company estimated the amount of
refund, if any, that had been earned under the dividend feature, based on the actual claims incurred to date and a
factor used to develop those claims to an estimate of the ultimate cost of the incurred claims during that policy year.
In May 2003, the Company’s workers’ compensation carrier’s rating was downgraded by A.M. Best Co. (“Best”)
from a “B” or “fair” rating to a “C++” or “marginal” rating. In June 2003, Best further downgraded the carrier to a
“D” or “poor” rating. Best’s rating represents an opinion on the insurer’s financial strength and ability to meet its
ongoing obligations to its policyholders. As a result of these downgrades, the Company elected to accelerate the
termination of its contract from September 30, 2003 to September 1, 2003. In addition, the Company recorded a
charge of $2.5 million in 2003 to write-off its dividend receivable from its workers’ compensation carrier due to the
uncertainty of the carrier’s ultimate ability to pay this dividend.
On September 1, 2003, the Company obtained a workers’ compensation policy (“2004 Policy”), which
matured and was subsequently renewed on September 16, 2004 for the period ending September 30, 2005 (“2005
Policy”). The policies are with selected member insurance companies of American International Group, Inc.
(“AIG”). Under its arrangement with AIG, the Company bears the economic burden for the first $1 million layer of
claims per occurrence. AIG bears the economic burden for all claims in excess of such first $1 million layer. The
policies are fully insured whereby AIG has the responsibility to pay all claims incurred under the policies regardless
of whether the Company satisfies its responsibilities.
Because the Company bears the economic burden of the first $1 million layer of claims per occurrence,
such claims, which are the primary component of the Company’s workers’ compensation costs, are recorded in the
period incurred. Workers compensation insurance includes ongoing healthcare and indemnity coverage whereby
claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs
in each reporting period includes estimates, which take into account the ongoing development of claims and
therefore requires a significant level of judgment. The Company estimates its workers’ compensation costs by
applying an aggregate loss development rate to worksite employee payroll levels. The Company employs a third
party actuary to estimate its loss development rate, which is primarily based upon the nature of worksite employees’
job responsibilities, the location of worksite employees, the historical frequency and severity of workers
compensation claims and an estimate of future cost trends. Workers’ compensation cost estimates are discounted to
present value at a rate based upon the US Treasury rates that correspond with the weighted average estimated claim
payout period (the discount rate utilized in 2003 and 2004 averaged 2.0% and 2.8%, respectively) and are accreted
F-14
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
over the estimated claim payment period and included as a component of direct costs in the Company’s Consolidated
Statements of Operations.
The following table provides the activity and balances related to incurred but not reported workers’
compensation claims for the years ended December 31, 2004 and 2003 (in thousands):
Beginning balance
Accrued claims
Present value discount
Paid claims
Ending balance
Current portion of accrued claims
Long-term portion of accrued claims
Year ended
2004
$
$
$
$
12,000
43,087
(3,871)
(9,793)
41,423
18,511
22,912
41,423
Year ended
2003
$
—
13,529
(844)
(685)
$ 12,000
$
4,583
7,417
$ 12,000
At the beginning of each policy period, the insurance carrier, AIG, establishes monthly funding
requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”).
The level of claim funds is primarily based upon anticipated worksite employee payroll levels and expected workers
compensation loss rates, as determined by AIG. Monies funded into the program for incurred claims expected to be
paid within one year are recorded as restricted cash, a short-term asset, while the remainder of claim funds are
included in deposits, a long-term asset in the Company’s Consolidated Balance Sheets.
The Company’s estimate of incurred claim costs expected to be paid within one year are recorded as
accrued workers’ compensation costs and included in short-term liabilities, while its estimate of incurred claim costs
expected to be paid beyond one year are included in long-term liabilities on the Company’s Consolidated Balance
Sheets.
As of December 31, 2004, the Company had restricted cash of $18.5 million and deposits of $52.3 million.
Included in deposits is a $13.3 million security deposit related to the 2004 policy. The Company has estimated and
accrued $41.4 million in incurred workers’ compensation claim costs, which is net of $10.5 million in paid claims,
as of December 31, 2004.
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents, accounts receivable and accounts payable approximate
their fair values due to the short-term maturities of these instruments. The carrying amount of the Company’s
marketable securities and long-term debt approximate fair value due to the stated interest rates approximating market
rates.
Stock-Based Compensation
At December 31, 2004, the Company has three stock-based employee compensation plans, which are
described more fully in Note 9. The Company accounts for these plans under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based compensation cost is reflected in net income (loss), as all options granted under
those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income (loss) and earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
F-15
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net income (loss), as reported .................................................................
Deduct: Total stock-based employee compensation expense
determined under fair value based methods for all awards,
net of related tax effects....................................................................
Pro forma net income (loss).....................................................................
Year ended December 31,
2002
2003
2004
(in thousands)
$ 19,210
$ 12,864 $ (4,081)
(2,530)
$ 16,680
(5,800)
(9,253)
$ 7,064 $(13,334)
Net income (loss) per share:
Basic – as reported ...........................................................................
Basic – pro forma .............................................................................
Diluted – as reported ........................................................................
Diluted – pro forma ..........................................................................
0.74
$
0.64
$
$
0.72
$ 0.62
$
$
$
0.48 $ (0.15)
0.26 $ (0.48)
0.47 $ (0.15)
0.26 $ (0.48)
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,
2002
2004
2003
3.4%
0.0%
0.90
5.0
3.0%
0.0%
0.92
5.0
3.8%
0.0%
0.86
5.0
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded
options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require
the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s
employee stock options have characteristics significantly different from those of traded options, and because changes
in the subjective input assumptions can materially affect the fair value estimate, in the Company’s opinion, the
existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Employee Savings Plan
The Company matches 50% of an eligible worksite employee’s eligible contributions and 100% of eligible
corporate employees’ contributions, both up to 6% of the employee’s eligible compensation with immediate vesting.
During 2004, 2003 and 2002, the Company made employer-matching contributions of $13,521,000, $10,854,000
and $11,434,000, respectively. Of these contributions, $10,658,000, $8,494,000 and $9,244,000 were made on
behalf of worksite employees. The remainder represents employer contributions made on behalf of corporate
employees.
Advertising
The Company expenses all advertising costs as incurred.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under this method, deferred tax
assets and liabilities are determined based on differences between financial reporting and income tax carrying
F-16
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
amounts of assets and liabilities and are measured using the enacted tax rates and laws in effect when the differences
are expected to reverse.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 2004 presentation.
New Accounting Pronouncement
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-
Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement
123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro forma disclosure is no longer an alternative.
Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted in periods in
which financial statements have not yet been issued. The Company expects to adopt Statement 123(R) on July 1,
2005.
Statement 123(R) permits public companies to adopt its requirements using one of two methods:
1. A “modified prospective” method in which compensation cost is recognized beginning with the effective
date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the
effective date; and (b) based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain unvested on the effective date.
2. A “modified retrospective” method which includes the requirements of the modified prospective method
described above, but also permits entities to restate based on the amounts previously recognized under
Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented; or (b) prior
interim periods of the year of adoption.
The Company plans to adopt Statement 123(R) using the modified prospective method.
As permitted by Statement 123, the Company currently accounts for share-based payments to employees
using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee
stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on
the Company’s results of operations, although it will have no material impact on the Company’s overall financial
position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on
levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior
periods, the impact of that standard would have approximated the impact of Statement 123 as described in the
disclosure of pro forma net income and earnings per share in Note 1 to the Company’s consolidated financial
statements. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost
to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.
This requirement will reduce net operating cash flows and increase net financing cash flows in periods after
adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on,
among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior
periods for such excess tax deductions were $352,000, $249,000, and $203,000 in 2004, 2003 and 2002,
respectively.
F-17
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Accounts Receivable
The Company’s accounts receivable is primarily composed of trade receivables and unbilled receivables.
The Company’s trade receivables, which represent outstanding gross billings to clients, are reported net of allowance
for doubtful accounts of $604,000 and $647,000 as of December 31, 2004 and 2003, respectively. The Company
establishes an allowance for doubtful accounts based on management’s assessment of the collectibility of specific
accounts and by making a general provision for other potentially uncollectible amounts.
The Company makes an accrual at the end of each accounting period for its obligations associated with the
earned but unpaid wages of its worksite employees and for the accrued gross billings associated with such wages.
These accruals are included in accrued worksite employee payroll cost and unbilled accounts receivable; however,
these amounts are presented net in the Consolidated Statements of Operations. The Company generally requires that
clients pay invoices for service fees no later than one day prior to the applicable payroll date. As such, the Company
generally does not require collateral. Customer prepayments directly attributable to unbilled accounts receivable
have been netted against such receivables as the gross billings have been earned and the payroll cost has been
incurred, thus the Company has the legal right of offset for these amounts. As of December 31, 2004 and 2003,
unbilled accounts receivable consisted of the following:
2004
2003
(in thousands)
Accrued worksite employee payroll cost..............
Unbilled revenues.................................................
Customer prepayments .........................................
Unbilled accounts receivable................................
$ 59,277
17,025
(11,153)
$ 65,149
$ 65,503
19,324
(31,794)
$ 53,033
3. Marketable Securities
The following is a summary of the Company’s available-for-sale marketable securities as of December 31,
2004 and 2003:
December 31, 2004:
Gross
Gross
Amortized Unrealized Unrealized Estimated
Fair Value
Cost
Losses
Gains
(in thousands)
Fixed income mutual funds...............................
$ 11,360
$ —
$ (166)
$ 11,194
U.S. corporate debt securities ...........................
State and local government securities ...............
753
16,040
$ 28,153
—
18
$ 18
—
(55)
$ (221)
753
16,003
$ 27,950
December 31, 2003:
Fixed income mutual funds...............................
U.S. Treasury securities and obligations
of U.S. government agencies.......................
U.S. corporate debt securities ...........................
Foreign corporate debt securities......................
$ 11,132
$ —
$
(54)
$ 11,078
8,266
4,253
338
$ 23,989
62
5
1
$ 68
(12)
(1)
(1)
(68)
$
8,316
4,257
338
$ 23,989
F-18
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended December 31, 2004, 2003 and 2002, the Company’s realized gains and losses
recognized on sales of available-for-sales marketable securities are as follows:
Net
Realized
Realized
Gains
Realized
Losses
(in thousands)
Gains
(Losses)
2004....................................................
2003....................................................
2002....................................................
$ 64
78
354
$ (43)
(7)
(33)
$ 21
71
321
As of December 31, 2004, the contractual maturities of the Company’s marketable securities were as
follows:
Amortized
Cost
Estimated
Fair Value
(in thousands)
Less than one year ...........................
One to five years..............................
Five to ten years ..............................
Greater than ten years......................
Total ................................................
$ 11,809
6,211
881
9,252
$ 28,153
$ 11,644
6,207
878
9,221
$ 27,950
4. Deposits
In December 2001, the Company made a cash security deposit of $15.0 million with its primary health
insurance carrier, United. During 2002, the Company made two additional deposits of $5.0 million each with
United. In January 2004, $7.5 million of the security deposit plus accrued interest was returned to the Company and
was included as a component of prepaid insurance in the Company’s Consolidated Balance Sheet at December 31,
2003. At December 31, 2004, $17.5 million is included as a component of deposits – healthcare. In the event of a
default or termination of the Company’s contract with United or the reduction of the Company’s current ratio below
0.60, United may draw against the security deposit to collect any unpaid health insurance premiums or any
accumulated deficit in the Plan.
As of December 31, 2004, the Company also had $52.3 million of workers’ compensation long-term
deposits, including $13.3 million of collateral and $39.0 million of claim deposits with the Company’s workers’
compensation carrier, AIG. See Note 1.
5. Investments
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 wrote-off its investments in VGI as of that date totaling $3.8
million.
Subsequent to December 2001, the Company purchased substantially all of the assets of VGI through
bankruptcy proceedings for a total cost of $1.6 million. The Company established a subsidiary, FMS, to provide
outsourcing accounting and bookkeeping services using the assets acquired from VGI. During 2003, the Company
ceased operations of FMS and incurred after tax asset impairment charges of $800,000 to write off the assets of
F-19
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FMS. FMS operating results are included in discontinued operations in the accompanying Consolidated Statements
of Operations. Revenues were immaterial to the Consolidated Statements of Operations.
During 2000, the Company purchased 500,000 shares of convertible preferred stock of eProsper, Inc.
(“eProsper”) for $2.5 million. In 2002, the Company made an additional $500,000 investment in convertible
preferred stock of eProsper. The Company has accounted for this investment using the cost method. Under the cost
method, the Company periodically evaluates the realizability of this investment based on its review of the investee’s
financial condition, financial results, financial projections and availability of additional financing sources. In
December 2002, the Company determined that the fair value of its investment in eProsper had declined below its
carrying value, for reasons that were other than temporary, resulting in the Company writing-off its entire investment
totaling approximately $3.1 million. During 2003, the Company collected $457,000 from the sale of its investment
in eProsper, which is included as a component of other income in the accompanying Consolidated Statements of
Operations.
6. Debt Obligations
The Company’s debt obligations consist of the following:
December 31,
2004
2003
(in thousands)
Mortgage loan .............................................................
Term loan ....................................................................
Capital lease obligations .............................................
Total debt.................................................................
Less current maturities ................................................
Long-term debt, net of current maturities ................
$ 33,746
—
2,793
$ 36,539
1,649
$ 34,890
$ 34,880
4,221
3,261
$ 42,362
1,860
$ 40,502
Maturities of long-term debt at December 31, 2004 are summarized as follows (in thousands):
2005 ............................................................................
2006 ............................................................................
2007 ............................................................................
2008 ............................................................................
2009 ............................................................................
Thereafter....................................................................
$ 1,649
1,700
1,653
30,999
538
—
$ 36,539
Mortgage Loan
On December 20, 2002, the Company entered into a $36 million mortgage agreement (“Mortgage”) that
matures in January 2008. The proceeds were used to repay the Company’s outstanding balance under its revolving
credit agreement. The Mortgage bears interest at a variable rate equal to the greater of (a) 4.5%; or (b) the 30-day
LIBOR rate (2.3% at December 31, 2004) plus 2.9%. The Mortgage is secured by the Company’s real estate and
related fixtures located at Administaff’s headquarters in Kingwood, Texas, which has a net book value of $40.3
million at December 31, 2004. Monthly principal and interest payments are approximately $230,000, with the
remaining balance due upon maturity. The Mortgage provides for prepayment penalties as a percentage of the
outstanding principal balance, ranging from 5% down to 1% during the first four years of the term. There is no
prepayment penalty during the final year of the Mortgage.
F-20
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Term Loan
In October 2002, the Company entered into a $4.5 million term loan agreement that matures in October
2012 and bears interest at the one-month commercial paper rate plus 3.1% (4.53% at September 30, 2004). The
loan was secured by the Company’s aircraft and was repaid in November 2004.
Capital Lease Obligations
In October 2002, the Company entered into a capital lease arrangement to finance the purchase of office
furniture. The assets under capital lease were capitalized using an effective interest rate of 7.5%. The current
monthly lease payments are $58,000 per month over the seven-year lease term. As of December 31, 2004 and 2003,
the capitalized cost and accumulated depreciation under the capital lease arrangement were $3.8 million and $1.2
million, and $3.8 million and $656,000, respectively. Depreciation of the capitalized lease costs is included in
depreciation and amortization in the Consolidated Statements of Operations.
Revolving Line of Credit
On June 25, 2002, the Company entered into a six-month, $30 million revolving credit agreement, replacing
its former $21 million line of credit (collectively, “the Credit Agreements”), which expired in December 2002. The
proceeds of the Credit Agreements were used to finance the construction of the Company’s new corporate
headquarters facility. In December 2002, the Company repaid the outstanding balance of the revolving line of credit
with the proceeds from the Mortgage. During 2002, the Company capitalized interest expense of $371,000 incurred
under the Credit Agreements.
F-21
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Income Taxes
Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets
and liabilities used for financial reporting purposes and the amounts used for income tax purposes. Significant
components of the net deferred tax assets and net deferred tax liabilities as reflected on the balance sheet are as
follows:
December 31,
2004
2003
(in thousands)
Deferred tax liabilities:
Prepaid assets .......................................................................................
Depreciation.........................................................................................
Software development costs.................................................................
Total deferred tax liabilities............................................................
$ (6,023)
(2,876)
(667)
(9,566)
$
(250)
(3,647)
(1,552)
(5,449)
Deferred tax assets:
Workers’ compensation accruals..........................................................
Long-term capital loss carry-forward ...................................................
State unemployment tax accruals .........................................................
Accrued rent.........................................................................................
State income taxes net operating loss carryforward .............................
Uncollectible accounts receivable ........................................................
Unrealized loss on marketable securities .............................................
Other ....................................................................................................
Total deferred tax assets .................................................................
Valuation allowance.............................................................................
Total net deferred tax assets............................................................
3,057
2,109
1,791
554
274
231
76
128
8,220
(2,383)
5,837
2,767
2,248
—
531
—
254
—
288
6,088
(2,276)
3,812
Net deferred tax liabilities .......................................................................
$ (3,729)
$
(1,637)
Net current deferred tax assets (liabilities) ..............................................
Net noncurrent deferred tax liabilities .....................................................
$
(231)
(3,498)
$ (3,729)
$
$
3,423
(5,060)
(1,637)
The components of income tax expense from continuing operations are as follows:
Current income tax expense:
Federal .................................................................................................
State .....................................................................................................
Total current income tax expense ...................................................
Deferred income tax expense (benefit):
Federal .................................................................................................
State .....................................................................................................
Total deferred income tax (benefit) expense...................................
Total income tax expense from continuing operations.........................
Year ended December 31,
2002
2003
2004
(in thousands)
$ 9,066
292
9,358
1,680
488
2,168
$11,526
$11,115
1,388
12,503
$ 554
610
1,164
(2,632)
(386)
(3,018)
$ 9,485
59
18
77
$ 1,241
In 2004, 2003 and 2002, income tax benefits of $352,000, $249,000 and $203,000, respectively, resulting from
deductions relating to nonqualified stock option exercises and disqualifying dispositions of certain employee incentive
stock options were recorded as increases in stockholders’ equity.
F-22
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The reconciliation of income tax expense computed at U.S. federal statutory tax rates to the reported income
tax expense from continuing operations is as follows:
Year ended December 31,
2003
2004
(in thousands)
2002
Expected income tax expense at 35% ..................................................
State income taxes, net of federal benefit.............................................
Nondeductible expenses.......................................................................
Tax-exempt interest income .................................................................
Valuation allowance against long-term capital loss carry-forward.......
Other, net..............................................................................................
Reported total income tax expense from continuing operations...........
$10,758
429
486
(142)
(32)
27
$11,526
$ 8,565
688
375
—
(160)
17
$ 9,485
$ (588)
518
262
(20)
1,069
—
$ 1,241
The income tax rate for the year ended December 31, 2004 was 37.5%. During the period the Company
recorded a $213,000 cumulative tax adjustment due to a change in estimate resulting from the favorable impact of the
Company’s captive insurance subsidiary on state income tax rates.
As a result of the write-off of the investments in eProsper and VGI, the Company has capital loss carryforwards
totaling $5.8 million that will expire during 2006 and 2007, but can only be used to offset future capital gains. The
Company has recorded a valuation allowance of $2.1 million and $2.3 million in 2004 and 2003, respectively, against
these related deferred tax assets as it is uncertain that the Company will be able to utilize the capital loss carryforwards
prior to their expiration. In addition, the Company has incurred net operating losses at the subsidiary level for state
income tax purposes totaling $4.2 million ($274,000 tax effected) that expire from 2008 to 2023. The Company has
recorded a valuation allowance of $274,000 at December 31, 2004, as it is uncertain if it will be able to utilize the net
operating loss carryforward in these entities.
8. Stockholders’ Equity
In 1998, the Company entered into a Securities Purchase Agreement with American Express Travel Related
Services Company, Inc. (“American Express”) whereby the Company issued warrants to purchase 4,131,030 shares of
common stock to 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. In March 2002, American Express exercised
526,271 common stock purchase warrants at $25.00. As of December 31, 2004, American Express had 931,030
warrants remaining at an exercise price of $40 which are scheduled to expire in March 2005.
The Company’s Board of Directors (the “Board”) has authorized a program to repurchase up to 8,000,000
shares of the Company’s outstanding common stock. The purchases are to be made from time to time in the open
market or directly from stockholders at prevailing market prices based on market conditions or other factors. During
2004, 2003 and 2002, the Company repurchased 1,411,000, 1,373,252 and 726,271 shares at a cost of $17.2 million,
$8.2 million and $17.1 million, respectively. As of December 31, 2004, the Company had repurchased 6,752,523 shares
under this program at a total cost of approximately $82.8 million, including 2,612,523 shares repurchased from
American Express. As a result, the Company has the authorization to repurchase an additional 1,247,477 shares.
At December 31, 2004, 20 million shares of preferred stock were authorized and were designated as Series A
Junior Participating Preferred Stock that is reserved for issuance on exercise of preferred stock purchase rights under
Administaff’s Share Purchase Rights Plan (the “Rights Plan”). Each issued share of the Company’s common stock has
F-23
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
one-half of a preferred stock purchase right attached to it. No preferred shares have been issued and the rights are not
currently exercisable. The Rights Plan expires on February 9, 2008.
9. Employee Incentive Plans
The Administaff, Inc. 1997 Incentive Plan, as amended, and the 2001 Incentive Plan (collectively, the
“Incentive Plans”) provide for options and other stock-based awards that may be granted to eligible employees and non-
employee directors 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, 2004, 177,510 and 360,830 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 Incentive Plan have been stock options, primarily intended to qualify as
“incentive stock options” within the meaning of Section 422 of the Internal Revenue Code (the “Code”). The Incentive
Plans also permit stock awards, phantom stock awards, stock appreciation rights, performance units, other stock-based
awards and cash awards, all of which may or may not be subject to the achievement of one or more performance
objectives. The purposes of the Incentive Plans generally are to retain and attract persons of training, experience and
ability to serve as employees of the Company and its subsidiaries and to serve as non-employee directors of the
Company, to encourage the sense of proprietorship of such persons and to stimulate the active interest of such persons in
the development and financial success of the Company and its subsidiaries. The Incentive Plans are administered by the
Compensation Committee of the Board of Directors (the “Committee”). The Committee has the power to determine
which eligible employees will receive awards, the timing and manner of the grant of such awards, the exercise price of
stock options (which may not be less than market value on the date of grant), the number of shares and all of the terms
of the awards. The Board has granted limited authority to the Chief Executive Officer of the Company regarding the
granting of stock options to employees who are not officers. The Company may at any time amend or terminate the
Incentive Plans. However, no amendment that would impair the rights of any participant, with respect to outstanding
grants, can be made without the participant’s prior consent. Stockholder approval of amendments to the Incentive Plans
is necessary only when required by applicable law or stock exchange rules.
The Administaff Nonqualified Stock Option Plan (the “Nonqualified Plan”) provides for options to purchase
shares of the Company’s common stock that may be granted to employees who are not officers. An aggregate of
3,600,000 shares of common stock of the Company are authorized to be issued under the Nonqualified Plan. At
December 31, 2004, 511,916 shares of common stock were available for future grants under the Nonqualified Plan. The
purpose of the Nonqualified Plan is similar to that of the Incentive Plans. The Nonqualified Plan is administered by the
Chief Executive Officer of the Company (the “CEO”). The CEO has the power to determine which eligible employees
will receive stock option rights, the timing and manner of the grant of such rights, the exercise price (which may not be
less than market value on the grant date), the number of shares and all of the terms of the options. The Committee may
at any time terminate or amend the Nonqualified Plan, provided that no such amendment may adversely affect the rights
of optionees with regard to outstanding options.
F-24
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following summarizes stock option activity and related information:
2004
Weighted
Average
Exercise
Price
Year ended December 31,
2003
Weighted
Average
Exercise
Price
Shares
2002
Weighted
Average
Exercise
Price
Shares
(in thousands, except per share amounts)
$ 18.56
13.69
7.96
19.38
$ 17.98
$ 20.66
$
9.79
4,986
594
(114)
(427)
5,039
3,242
$ 19.77
7.70
7.73
20.53
$ 18.56
$ 21.55
$
5.54
4,276
1,117
(59)
(348)
4,986
2,454
$ 21.99
12.25
12.59
23.15
$ 19.77
$ 20.44
$
8.48
Shares
5,039
861
(127)
(351)
5,422
3,567
Outstanding – beginning of year
Granted
Exercised
Cancelled
Outstanding – end of year
Exercisable – end of year
Weighted average fair value of
options granted during year
The following summarizes information related to stock options outstanding at December 31, 2004:
Range of Exercise Prices
Shares
Options Outstanding
Weighted Average Weighted
Average
Exercise
Price
(share amounts in thousands)
Remaining
Contractual
Life (Years)
Remaining
Contractual
Shares Life (Years)
Options Exercisable
Weighted Average Weighted
$ 4.02
to $10.00
$10.00 to $15.00
to $20.00
$15.00
to $30.00
$20.00
$30.00
to $43.69
Total
1,336
1,165
1,696
601
624
5,422
6.4
7.9
6.1
6.4
5.7
6.6
$
7.15
12.96
18.34
24.15
43.58
$ 17.98
778
333
1,423
412
621
3,567
5.0
5.4
5.6
6.2
5.7
5.5
Average
Exercise
Price
$
7.44
13.36
18.57
24.20
43.61
$ 20.66
10. Earnings (Loss) Per Share
The numerator used in the calculations of both basic and diluted net income (loss) per share for all periods
presented was net income (loss). The denominator for each period presented was determined as follows:
Year ended December 31,
2004
2002
2003
(in thousands)
Denominator:
Basic - weighted average shares outstanding .......................................
Effect of dilutive securities:
26,096
26,821
27,890
Common stock options - treasury stock method .............................
763
432
—
Diluted - weighted average shares outstanding
plus effect of dilutive securities .....................................................
26,859
27,253
27,890
F-25
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Options and warrants to purchase 4,148,000, 5,866,000 and 7,327,000 shares of common stock were not
included in the diluted net income (loss) per share calculation for 2004, 2003 and 2002, respectively, because their
inclusion would have been anti-dilutive.
11. Leases
The Company leases various office facilities, furniture, equipment and vehicles under capital and operating
lease arrangements, some of which contain rent escalation clauses. Most of the leases contain purchase and/or
renewal options at fair market and fair rental value, respectively. Rental expense relating to all operating leases was
$9,700,000, $8,179,000 and $10,222,000 in 2004, 2003 and 2002, respectively. At December 31, 2004, future
minimum rental payments under noncancelable operating and capital leases are as follows (in thousands):
2005...........................................................................
2006...........................................................................
2007...........................................................................
2008...........................................................................
2009...........................................................................
Thereafter ..................................................................
Total minimum lease payments .................................
Less amount representing interest .............................
Total present value of minimum payments................
Less current portion...................................................
Long-term capital lease obligations...........................
Operating
Leases
$ 9,395
8,984
8,162
6,323
5,097
12,813
$ 50,774
Capital
Leases
$ 695
695
695
695
554
—
$ 3,334
541
2,793
502
$ 2,291
12. Commitments and Contingencies
The Company enters into non-cancelable fixed purchase and service obligations in the ordinary course of
business. These arrangements primarily consist of software service contracts and advertising commitments. At
December 31, 2004, future non-cancelable purchase and service obligations greater than $100,000 were as follows (in
thousands):
2005...........................................................................
2006...........................................................................
2007...........................................................................
2008...........................................................................
2009...........................................................................
Thereafter ..................................................................
Total obligations.............................................
$ 5,098
4,334
1,303
290
190
530
$ 11,745
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.
F-26
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Aetna Healthcare Litigation
On November 5, 2001, the Company filed a lawsuit against Aetna Life Insurance Company (“Aetna”). The
Company alleged, among other things, that during the third quarter of 2001, Aetna breached its contract with the
Company. Aetna filed a counterclaim alleging, among other things, that the Company breached its contractual
obligations to Aetna. On October 30, 2003, a jury returned a verdict in favor of the Company, awarding the Company
$15.5 million in compensatory damages. On November 7, 2003, the court entered a final judgment in favor of
Administaff in the amount of $15.5 million, with post judgment interest at a rate of 1.3% per annum. On December 10,
2003, the court granted Aetna’s motion to reduce the judgment to $10.6 million. Aetna subsequently filed its notice to
appeal the judgment and other rulings of the trial court.
During the first quarter of 2004, the Company and Aetna executed a settlement agreement. Under the terms of the
agreement, Aetna paid $8.25 million to the Company and both parties released all claims and agreed to dismiss all court
proceedings. The settlement is recorded in other income in the Company’s 2004 Consolidated Statements of Operations.
This matter has now been concluded.
Class Action Litigation
On June 13, 2003, a class action lawsuit was filed against the Company in the United States District Court for
the Southern District of Texas on behalf of purchasers of the Company’s common stock alleging violations of the
federal securities laws. After that date, six similar class actions were filed against the Company in that court. Those
lawsuits also named as defendants certain of the Company’s officers and directors. Those lawsuits generally allege that
the Company and certain of its officers and directors made false and misleading statements or failed to make adequate
disclosures concerning, among other things: (i) the Company’s pricing and billing systems with respect to recalibrating
pricing for clients that experienced a decline in average payroll cost per worksite employee; (ii) the matching of price
and cost for health insurance on new and renewing client contracts; and (iii) the Company’s former method of reporting
worksite employee payroll costs as revenue. The complaints sought unspecified damages, among other remedies. On
March 31, 2004, the court entered an order consolidating all of the cases and appointing Carpenters Pension Trust for
South California as “lead plaintiff” and Lerach Coughlin Stoia Geller Rudman & Robbins LLP as “lead counsel.” The
lead plaintiff alleges that its losses are $352,000, although the alleged damages of the purported class have not been
specified.
In May 2004, the lead plaintiff filed its Consolidated Complaint, which amended and consolidated the seven
previously filed cases. In the Consolidated Complaint, the lead plaintiff has essentially abandoned the allegations of
fraud contained in the initial seven lawsuits. Through the Consolidated Complaint, the lead plaintiff now generally
asserts, among other things, that the Company and certain of its officers and directors fraudulently made false and
misleading statements regarding the cost of its health plan during 2001 and 2002. In June 2004, the Company filed a
motion to dismiss the Consolidated Complaint. The Company believes these claims are without merit and intends to
vigorously defend this litigation. As a result of the uncertainty regarding the outcome of this matter, no provision has
been made in the accompanying consolidated financial statements.
Reliance National Indemnity Co. Bankruptcy Liquidation and Related Litigation
In October 2001, Reliance National Indemnity Co. (“Reliance”), a former workers’ compensation insurance
carrier of the Company, was forced into bankruptcy liquidation. State laws 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, the guaranty associations in some states, including Texas, have asserted that state law
returns the liability for open claims under policies with the liquidated insurance carrier to the Company. In Texas, the
Company disputed the right of the guaranty association to be reimbursed for such claims.
F-27
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On August 1, 2003, the Company filed a lawsuit against the Texas Property and Casualty Insurance Guaranty
Association (“TPCIGA”) seeking a declaratory judgment that the Company is not required to reimburse TPCIGA for
workers’ compensation benefits paid or to be paid by TPCIGA under the Company’s workers’ compensation policies
with Reliance. On August 15, 2003, TPCIGA filed its answer, denying the claims asserted by the Company as well as
filing a counterclaim that TPCIGA is entitled to full reimbursement from the Company for workers’ compensation
benefits paid or to be paid by TPCIGA under the Company’s workers’ compensation policies with Reliance.
Administaff estimated that TPCIGA’s claim for reimbursement was approximately $6.8 million. During the fourth
quarter of 2003, the Company paid $1.1 million to settle the lawsuit, including TPCIGA’s claim for reimbursement.
The cost of the settlement has been reported as a component of workers’ compensation expense in the Company’s 2003
Consolidated Statement of Operations.
The Company initially secured $1.8 million in insurance coverage to cover potential claims returned to the
Company related to its Reliance policies. Administaff submitted the TPCIGA settlement as a claim under the policy.
The Company collected and recorded at $1.1 million reimbursement during the year ended December 31, 2004. As of
December 31, 2004, there was no coverage remaining on the policy. At December 31, 2004, the estimated outstanding
claims under the Company’s former policies with Reliance totaled approximately $100,000. The Company has accrued
and recorded its estimate of the outstanding claims as of December 31, 2004. It is possible that such losses could
exceed the Company’s estimates, resulting in an increase to workers’ compensation expense, which would reduce net
income.
State Unemployment Taxes
The Company records its state unemployment (“SUI”) tax expense based on taxable wages and tax rates
assigned by each state. State unemployment tax rates vary by state and are determined, in part, based on prior years’
compensation experience in each state. Prior to the receipt of final tax rate notices, the Company estimates its
expected SUI tax rate in those states for which tax rate notices have not yet been received.
In December 2001, as a result of the 2001 corporate reorganization, the Company filed for a transfer of its
reserve account with the Employment Development Department of the State of California (“EDD”). The EDD
approved the Company’s request for transfer of its reserve account in May 2002 and also notified the Company of its
new contribution rates based upon the approved transfer. In December 2003, the Company received a Notice of
Duplicate Accounts and Notification of Assessment (“Notice”) from the Employment Development Department of
the State of California (“EDD”). The Notice stated that the EDD was collapsing the accounts of the Company’s
subsidiaries into the account of the entity with the highest unemployment tax rate. The Notice also retroactively
imposed the higher unemployment insurance rate on all the Company’s California employees for 2003, resulting in
an assessment of $5.6 million. In January 2004, the Company filed a petition with an administrative law judge of the
California Unemployment Insurance Appeals Board (“ALJ”) to protest the Notice. Pending a resolution of its
protest, in the fourth quarter of 2003 the Company accrued and recorded at the higher assessed rate for all of 2003.
In June 2004, the Company agreed to settle its dispute with the EDD for $3.3 million (“Settlement”). Based
upon receipt of written acknowledgement of this agreement, the Company reduced its accrued payroll tax liability
and payroll tax expense by $2.3 million during the quarter ended June 30, 2004. The Settlement was subject to the
final approval by EDD’s legal department, the California Attorney General’s office and the ALJ. In October 2004,
the legal department of the EDD verbally indicated they considered the previously agreed-upon settlement amount
to be insufficient and suggested a settlement amount of $5.2 million. The Company and the State of California
continued discussions, but in February 2005, the Company was notified that the EDD had rejected the Company’s
settlement offer and that the matter will proceed with the appeals process with the ALJ. If the outcome of the
appeals process is unfavorable and the company is assessed additional interest and penalties, the Company may
recognize an increase in its payroll tax expense in a future period. Conversely, if the outcome of the appeals
F-28
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
process is favorable to the Company, the Company may recognize a decrease in its payroll tax expense in a future
period.
13. Quarterly Financial Data (Unaudited)
Quarter ended
March 31
June 30
Sept. 30
Dec. 31
(in thousands, except per share amounts)
Year ended December 31, 2004:
Revenues.................................................
Gross profit.............................................
Operating income ...................................
Net income..............................................
Basic net income per share .....................
Diluted net income per share ..................
$ 252,047
50,034
7,166
9,238 (1)
0.35
0.33
$ 232,892
48,545
4,499
2,811
0.11
0.10
$ 235,865
47,672
5,091
3,612
0.14
0.14
$ 248,723
51,443
5,375
3,549
0.14
0.14
Year ended December 31, 2003:
Revenues.................................................
Gross profit.............................................
Operating income (loss)..........................
Net income (loss)....................................
Basic net income (loss) per share ...........
Diluted net income (loss) per share ........
$ 225,520
35,981
(6,568)
(4,361)
(0.16)
(0.16)
$ 219,226
46,822
2,747
1,713
0.06
0.06
$ 217,849
56,578
13,778
7,476
0.28
0.28
$ 228,264
57,724
14,317
8,036
0.30
0.29
Year ended December 31, 2002:
Revenues.................................................
Gross profit.............................................
Operating income (loss)..........................
Net income (loss)....................................
Basic net income (loss) per share ...........
Diluted net income (loss) per share ........
$ 195,958
30,453
(9,651)
(5,704)
(0.20)
(0.20)
$ 204,966
36,377
(5,393)
(3,164)
(0.11)
(0.11)
$ 218,069
46,746
6,489
3,779
0.14
0.14
$ 229,423
52,214
8,622
1,008
0.04
0.04
(1) Includes $8.25 million ($5.2 million after taxes) related to the legal settlement with Aetna. See Note 12.
14. Subsequent Events
On February 4, 2005, the board of directors declared a quarterly dividend of $0.07 per share of common
stock to holders of record on March 7, 2005. The dividend will be paid on April 1, 2005.
On February 1, 2005, the compensation committee of the board of directors approved accelerated vesting of
all unvested stock options that have an exercise price greater than the Company’s January 31, 2005 closing market
price of $14.59. This accelerated vesting will affect approximately 733,000 common stock options with a weighted
average exercise price of $18.09. The primary purpose of the accelerated vesting is to eliminate future compensation
expense the Company would otherwise recognize in its income statement with respect to these accelerated options
subsequent to the July 1, 2005 effective date of FASB Statement No. 123(R). The estimated maximum future
expense that is eliminated is approximately $5.9 million, including $1.5 million in 2005.
F-29
ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On February 1, 2005, the compensation committee approved a grant of 302,000 restricted common shares
to certain employees and officers of the Company pursuant to the Company’s 2001 Incentive Plan. The restricted
common shares have a fair value of $14.86 per share and vest over three years. Restricted common shares, under
fixed accounting, are generally measured at fair value on the date of grant based on the number of shares granted and
the quoted price of the common stock. Such value is recognized as compensation expense over the corresponding
vesting period.
F-30
GAAP to Non-GAAP Reconciliation
2004
Year ended December 31,
2002
2003
Total
Net income (loss) from continuing operations (GAAP)
$ 19,210
$ 14,985
$ (2,921)
$ 31,274
Interest expense
Income tax expense
Depreciation and amortization
EBITDA
2,093
11,526
17,514
2,176
9,485
20,759
437
1,241
21,297
4,706
22,252
59,570
$ 50,343
$ 47,405
$ 20,054
$ 117,802
EBITDA represents net income from continuing operations, which is computed in accordance with generally accepted
accounting principles (“GAAP”), plus interest expense, income tax expense, depreciation and amortization expense.
Administaff management believes EBITDA is often a useful measure of the Company’s operating performance,
as it allows for additional analysis of the Company’s operating results separate from the impact of taxes, capital
and financing transactions on earnings.
EBITDA is not a financial measure prepared in accordance with GAAP and may be different from similar measures
used by other companies. EBITDA should not be considered as a substitute for, or superior to, measures of financial
performance prepared in accordance with GAAP. Administaff includes EBITDA in this report because the Company
believes it is useful to investors in allowing for greater transparency related to the Company’s operating performance
during the periods presented. Investors are encouraged to review the reconciliation of the non-GAAP financial mea-
sures used in this report to the most directly comparable GAAP financial measures as provided in the tables above.
Officers
Paul J. Sarvadi
Chairman and Chief Executive Officer
Richard G. Rawson
President
A. Steve Arizpe
Executive Vice President, Client Services
and Chief Operating Officer
Jay E. Mincks
Executive Vice President, Sales and Marketing
John H. Spurgin, II
Senior Vice President, Legal,
General Counsel and Secretary
Douglas S. Sharp
Vice President, Finance,
Chief Financial Officer and Treasurer
Corporate Information
Corporate Headquarters
19001 Crescent Springs Drive
Kingwood, Texas 77339-3802
281-358-8986
Sales Department
800-465-3800
Web Site
www.administaff.com
Independent Auditors
Ernst & Young LLP
5 Houston Center
1401 McKinney, Suite 1200
Houston, Texas 77010
Legal Counsel
Baker Botts L.L.P.
One Shell Plaza
910 Louisiana
Houston, Texas 77002-4995
Board of Directors
Members of the Board of Directors can be contacted at
directors@administaff.com.
Certifications
The Company has filed the required certifications under Section 302
of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to our
Annual Report on Form 10-K for the year ended December 31, 2004.
After the 2005 Annual Meeting of Stockholders, the Company intends
to file with the New York Stock Exchange the CEO certification regard-
ing its compliance with the NYSE’s corporate governance listing stan-
dards as required by Rule 303A .12. Last year, the Company filed this
CEO certification with the NYSE on May 24, 2004.
Gregory R. Clouse
Vice President, Service Operations
Roger L. Gaskamp
Vice President, Client Selection and Pricing
Jeff W. Hutcheon
Vice President, Marketing, Research and Development
Samuel G. Larson
Vice President, Enterprise and Technology Solutions
Randall H. McCollum
Vice President, Strategic Alliances
John F. Orth
Vice President, Sales Development
Stock Transfer Agent
Mellon Investor Services LLC
Overpeck Center
85 Challenger Road
Ridgefield Park, New Jersey 07660-2108
866-229-4421
TDD for Hearing Impaired: 800-231-5469
Foreign Shareholders: 201-329-8660
TDD Foreign Shareholders: 201-329-8354
Web Site: www.melloninvestor.com/isd
Common Stock
Administaff, Inc.’s common stock is traded on the New York
Stock Exchange under the symbol “ASF”.
Annual Meeting
Administaff, Inc.’s Annual Meeting of Shareholders will be held at
4 p.m. CDT on Thursday, May 5, 2005, at the Company’s corporate
headquarters, Centre I in the Auditorium, located at 22900 Highway
59N (Eastex Freeway), Kingwood, Texas 77339.
Investor Relations
Shareholders are encouraged to contact the Company with questions
or requests for information. 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
281-348-3987
A Personnel Management SystemSM
for America’s best small businesses.
Administaff’s eight-point Personnel Management SystemSM provides a comprehensive
human resources solution 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 entrepreneurs and employees
are free to focus on the “business of business.”
RECRUITING & SELECTION
Find and hire the highest-quality
employees possible.
(cid:127) Job Descriptions
(cid:127) Resume Review & Interviewing
(cid:127) Salary Planning & Administration
(cid:127) Classified Advertising Coordination
(cid:127) Background Checks
(cid:127) Pre-Employment Testing
(cid:127) Drug Testing
(cid:127) Outplacement
PERFORMANCE MANAGEMENT
Increase employee productivity
by improving individual and
group performance.
(cid:127) Performance Measurement
& Review
(cid:127) Compensation &
Incentive Plans
(cid:127) Employee Relations
(cid:127) Supervisor Training
(cid:127) Conflict Resolution
(cid:127) Job Design
GOVERNMENT COMPLIANCE
Keep pace with changing regulations
to reduce or eliminate fines
and penalties.
OWNER SUPPORT
Achieve a more secure future
through forward-focused
resources that help create value.
(cid:127) Government Reporting
& Agency Interface
(cid:127) Unemployment Claims Management
(cid:127) Wage Claims & Audits
(cid:127) OSHA, EEOC, DOL, ADA,
FMLA, FLSA, Title VII & More
BENEFITS MANAGEMENT
Gain one of the best benefits
values in the marketplace for
employee retention.
(cid:127) Health Care, Dental & Vision Plans
(cid:127) Employee Assistance Program
(cid:127) Retirement Services
(cid:127) Basic & Voluntary Disability Coverage
(cid:127) Basic & Voluntary Life Insurance
(cid:127) Basic & Voluntary Personal
(cid:127) Personnel Consulting
(cid:127) Employee Communications
(cid:127) Employee Service CenterSM
(cid:127) My MarketPlaceSM
(cid:127) Best2Best® Client Network
TRAINING & DEVELOPMENT
Become more productive and
profitable with a professional
development program
for employees.
(cid:127) Needs Analysis
(cid:127) Curriculum Development
(cid:127) Training Programs
(cid:127) Certified Provider of
Continuing Education Units
(cid:127) Online Courses
Accident Insurance
(cid:127) Adoption Assistance
(cid:127) Credit Union
(cid:127) Educational Assistance
(cid:127) Health Care Flexible
Spending Account Plan
EMPLOYER LIABILITY
MANAGEMENT
Manage employer obligations
more effectively with lower
risk and reduced liability.
(cid:127) Workers’ Compensation
Coverage & Claims Resolution
(cid:127) Employment Practices
Liability Insurance
(cid:127) Safety Review & Policy Development
(cid:127) Unemployment Claims Management
(cid:127) Conflict Resolution
(cid:127) Employee Handbooks
(cid:127) Personnel Guide, Forms & Policies
(cid:127) Terminations Support
EMPLOYMENT ADMINISTRATION
Reduce the burden of employee-
related paperwork by sharing it
with Administaff.
(cid:127) Payroll Processing
(cid:127) Payroll Tax Filing
(cid:127) FICA, FUTA, SUTA
(cid:127) Garnishments
(cid:127) Quarterly Reports
(cid:127) HR Management Reports
(cid:127) Direct Deposit
(cid:127) W-2s & W-4s
(cid:127) Employment Verification
Administaff is good for small business.
10 | Administaff
Company Profile
Financial Highlights
With 2004 revenues of $969.5 million, Administaff 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. At year-end 2004,
Administaff had more than 4,600 client companies, 81,000 worksite employees and
1,300 corporate employees. The Company also had four client service centers and
38 sales offices in 21 major markets.
Administaff ’s common stock is listed on the New York Stock Exchange and traded under
the symbol “ASF.” 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.
(in thousands, except per share amounts and statistical data)
2004
2003
2002
2001
2000
Year ended December 31,
Income Statement Data:
Revenues(1)
Gross profit
Operating income
Net income (loss) from continuing operations(4)
Net loss from discontinued operations
$ 969,527
$ 890,859
$ 848,416
$ 720,219
$ 598,291
197,694
22,131
19,210
197,105
24,274
14,985
165,790
67
(2,921)
–
(2,121)
(1,160)
165,015
18,539
10,357
–
138,534
22,234
16,900
–
Net income (loss)(4)
19,210
12,864
(4,081)
10,357
16,900
Diluted net income (loss) per share from
continuing operations(2)(4)
$
0.72
$
0.55
$
(0.11)
$
0.36
$
0.58
Balance Sheet Data:
Working capital
Total assets
Total debt
Total stockholders’ equity
Statistical Data:
$ 47,500
$ 56,032
$ 41,238
$ 36,609
$ 51,179
354,638
36,539
126,529
348,071
42,362
122,634
315,164
44,169
116,349
274,003
13,500
122,935
242,817
–
105,510
Average number of worksite employees paid
per month during period
Revenues per worksite employee per month(3)
Gross profit per worksite employee per month
Operating income per worksite employee per month
77,936
75,036
77,334
69,480
62,140
$ 1,037
$
$
211
24
$
$
$
989
219
27
$
$
$
914
179
–
$
$
$
864
198
22
$
$
$
802
186
30
(1) Gross billings of $5.377 billion, $4.829 billion, $4.857 billion, $4.373 billion and $3.708 billion less worksite
employee payroll cost of $4.407 billion, $3.938 billion, $4.009 billion, $3.653 billion and $3.110 billion, respectively.
(2) Adjusted to reflect the two-for-one split of the common stock effected on October 16, 2000.
(3) Gross billings of $5,749, $5,363, $5,234, $5,245 and $4,973 per worksite employee per month less payroll
cost of $4,712, $4,373, $4,320, $4,381 and $4,171 per worksite employee per month, respectively.
(4) Includes $8.25 million ($5.2 million and $0.19 per share after taxes) in other income in 2004 related to a settlement
of a legal matter. See Note 12 to the consolidated financial statements.
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 “are confident,” “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” in the Company’s Annual Report on Form 10-K.
Board of Directors
Michael W. Brown | Independent Director
Mr. Brown joined the Company as a director in
November 1997, and he currently serves on the
Finance, Risk Management and Audit Committee
and on the Nominating and Corporate Governance
Committee. A certified public accountant, he 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 1997.
Prior to joining Microsoft, Mr. Brown spent 18 years with Deloitte & Touche LLP.
Mr. Brown also is a director of 360networks, FatKat, Inc. and ExchangeAdvantage,
and is a member of the Thomas Weisel Partners Advisory Board, the University
of Washington Business School Advisory Board and the Particle Economics
Research Institute.
Jack M. Fields, Jr. | Independent Director
Mr. Fields joined the Company as a director in
January 1997. He currently serves as Chairman
of the Compensation Committee and is a member
of the Nominating and Corporate Governance
Committee. Mr. Fields served in the United States
House of Representatives for 16 years prior to his
retirement. 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 Twenty-First Century Group in
Washington, D.C., and serves on the Board of Directors for AIM Mutual
Funds and the Discovery Channel – Global Education Fund.
Eli Jones | Independent Director
Dr. Jones joined the Company as a director in April
2004, and he currently serves on the Compensation
Committee and on the Nominating and Corporate
Governance Committee. He has been an Associate
Professor of Marketing at the University of Houston
since 2002 and was an Assistant Professor at
the University of Houston from 1997 until 2002.
Dr. Jones currently serves as the Executive Director
of the Program for Excellence in Selling and the Sales Excellence Institute at
the University of Houston. He also serves on the Board of Directors of Dovarri,
a CRM company based in Houston, and on the editorial review boards of the
Journal of Personal Selling and Sales Management and Industrial Marketing
Management. Dr. Jones has conducted research and published articles on
sales and sales management topics in major journals and has co-authored
a sales textbook, Selling ASAP. Before becoming a professor, Dr. Jones
worked in sales and sales management for three Fortune 100 companies –
Quaker Oats, Nabisco and Frito-Lay.
Paul S. Lattanzio | Independent Director
Mr. Lattanzio has been a director of the Company
since 1995, and he currently serves on the Finance,
Risk Management and Audit Committee and on the
Nominating and Corporate Governance Committee.
He joined Bear Stearns, Inc. in 2003 as a Senior
Managing Director and head of Bear Growth Capital
Partners, a private equity group. Mr. Lattanzio previ-
ously served as a Managing Director for TD Capital
Communications Partners (f/k/a Toronto Dominion Capital), a venture capital
investment firm, from 1999 until 2002; and he was a co-founder and Senior
Managing Director of NMS Capital Management, LLC, a private equity fund
affiliated with NationsBanc Montgomery Securities. Mr. Lattanzio also served
in several positions with various affiliates of Bankers Trust New York Corpora-
tion, lastly as a Managing Director of BT Capital Partners, Inc. He also serves
on the Board of Directors of Clintrak Pharmaceutical Services, LLC, Harlem
Furniture and Avid Health, Inc.
Gregory E. Petsch | Independent Director
Mr. Petsch joined the Company as a director in
October 2002. He currently serves as Chairman
of the Nominating and Corporate Governance
Committee and is a member of the Compensation
Committee. He retired in 1999 from Compaq
Computer Corporation, where he had held various
positions since 1983, most recently as Senior Vice
President of Worldwide Manufacturing and Quality
since 1991. Prior to joining Compaq, he worked for 10 years at Texas Instru-
ments. In 1992, Mr. Petsch was voted Manufacturing Executive of the Year
by Upside magazine, and from 1993 to 1995 he was nominated to the
Who’s Who of Global Business Leaders. He is founder and President of
Godsmoneyman Ministries and is a Board member of Culture Shapers.
Richard G. Rawson | Management Director
Mr. Rawson is Administaff’s President. Prior to
his election as President in 2003, he served as
Executive Vice President of Administration, Chief
Financial Officer and Treasurer. He has served
as a director of the Company since April 1989.
Before joining the Company, Mr. Rawson served
as a Senior Financial Officer and Controller for
several companies in the manufacturing and
seismic data processing industries. He has previously served the National
Association of Professional Employer Organizations (NAPEO) as President
(1999–2000), First Vice President, Second Vice President and Treasurer.
In addition, he served as Chairman of the Accounting Practices Committee
of NAPEO for five years.
Paul J. Sarvadi | Management Director
Mr. Sarvadi is Chairman of the Board, Chief
Executive Officer and a co-founder of Administaff.
Prior to his election as Chairman in 2003, he served
as Chief Executive Officer and President. 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 mem-
ber of its Board of Directors for five years. Mr. Sarvadi serves on the Board
of Trustees of the DePelchin Children’s Center in Houston. In 2001, he was
named National Ernst & Young Entrepreneur Of The Year in the Service cate-
gory, and in 2004 he received the Conn Family Distinguished New Venture
Leader Award from Mays Business School at Texas A&M University.
Austin P. Young | Independent Director
Mr. Young became a director of the Company
in January 2003. He currently serves as Chairman
of the Finance, Risk Management and Audit
Committee and is a member of the Nominating
and Corporate Governance Committee. He is a
certified public accountant and served as Senior
Vice President, Chief Financial Officer and Treasurer
of CellStar Corporation from 1999 until his retire-
ment at year-end 2001. From 1996 to 1999, he served as Executive Vice Presi-
dent – Finance and Administration of Metamor Worldwide, Inc. Mr. Young also
has served as Senior Vice President and Chief Financial Officer at American
General Corporation, and he was a partner in the Houston and New York
offices of KPMG Peat Marwick. He currently serves as Director and Chair-
man of the Audit Committee of Tower Group, Inc.; Director and Chairman
of the Audit Committee of Houston Zoo, Inc.; Chairman of the Houston Zoo
Advisory Committee; Director and Treasurer of The Park People, Inc.; and
Director of the Houston Fire Museum.
2004 Annual Report
Small business is good for America.
Administaff is good for small business.SM
A
d
m
n
i
i
s
t
a
f
f
,
I
n
c
.
2
0
0
4
A
n
n
u
a
l
R
e
p
o
r
t
S
m
a
l
l
b
u
s
i
n
e
s
s
i
s
g
o
o
d
f
o
r
A
m
e
r
i
c
a
.
A
d
m
n
i
i
s
t
a
f
f
i
s
g
o
o
d
f
o
r
s
m
a
l
l
b
u
s
i
n
e
s
s
.S
M
19001 Crescent Springs Drive
Kingwood, Texas 77339-3802
www.administaff.com