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Notes to Consolidated Financial
Statements
Note 1. Accounting
Policies
Description of Business
Administaff, Inc. ("the Company") is a professional
employer organization ("PEO") that provides a comprehensive
Personnel Management System which encompasses a broad range
of services, including benefits and payroll administration,
medical and workers' compensation insurance programs, personnel
records management, employer liability management, employee
recruiting and selection, performance management, and training
and development services to small and medium-sized businesses
in strategically selected markets. During 1999, 1998 and 1997,
revenues from the Company's Texas markets represented 61%,
72% and 77% of the Company's total revenues, respectively.
Segment Reporting
Effective January 1, 1998, the Company adopted the Statement
of Financial Accounting Standards ("SFAS") No. 131,
Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 131 superseded SFAS No. 14, Financial
Reporting for Segments of a Business Enterprise. SFAS
No. 131 establishes standards for reporting information about
operating segments, products and services, geographic areas,
and major customers. The adoption of SFAS No. 131 did not
affect the Company's results of operations or financial position.
The Company operates in one reportable segment under SFAS
No. 131 due to its centralized structure.
Principles
of Consolidation The
consolidated financial statements include the accounts of
Administaff, Inc. and its wholly owned subsidiaries. Intercompany
accounts and transactions have been eliminated in consolidation.
Use
of Estimates The preparation
of financial statements in conformity with generally accepted
accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ
from those estimates.
Cash
and Cash Equivalents
Cash and cash equivalents
include bank deposits and short-term investments with original
maturities of three months or less at the date of purchase.
Concentrations
of Credit Risk Financial
instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable.
The Company generally requires clients to pay invoices for
service fees no later than one day prior to the applicable
payroll date, and receipt of funds is verified prior to the
release of payroll. As such, the Company generally does not
require collateral.
Effective April 21,1999, the Company entered into a one-year
Credit Guaranty Bond agreement (the "Guaranty Bond"),
under which an insurance company has agreed to reimburse the
Company for losses incurred related to certain customer non-payments.
The reimbursements are limited to one pay period through and
including the date of the invoice for that period, are applicable
only to clients who have executed an indemnity agreement with
the insurance company, and are subject to a $25,000 deductible
per claim. The Company has targeted clients with large payroll
and clients with perceived credit risk for this program. At
December 31, 1999, approximately 70% of the Company's targeted
clients have executed an indemnity agreement under the Guaranty
Bond. During 1999, activity covered under the Guaranty Bond
was immaterial to the Company's results of operations and
financial position, and the Company does not expect the Guaranty
Bond to be renewed in April 2000. The Company intends to explore
alternative credit insurance programs, but does not anticipate
any material impact on its results of operations or financial
position in the event that the Guaranty Bond is not replaced.
Marketable
Securities The Company
accounts for marketable securities in accordance with SFAS
No.115, Accounting for Certain Investments in Debt and
Equity Securities. The Company determines the appropriate
classification of all marketable securities as held-to-maturity,
available-for-sale or trading at the time of purchase and
re-evaluates such classification as of each balance sheet
date. At December 31, 1999, all of the Company's investments
in marketable securities are classified as available-for-sale,
and as a result, are reported at fair value. Unrealized gains
and losses, net of tax, are reported as a component of accumulated
other comprehensive income (loss) in stockholders' equity.
The amortized cost of debt securities is adjusted for amortization
of premiums and accretion of discounts from the date of purchase
to maturity. Such amortization is included in interest income
as an addition to or deduction from the coupon interest earned
on the investments. The cost of investments sold is based
on the average cost method, and realized gains and losses
are included in other income (expense).
Property
and Equipment Property
and equipment is recorded at cost and is depreciated over
the estimated useful lives of the related assets using the
straight-line method. The estimated useful lives of property
and equipment for purposes of computing depreciation are as
follows:
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Effective January 1, 1998, the Company adopted Statement of
Position ("SOP") 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use.
The requirements of SOP 98-1 are materially consistent with
the Company's previous capitalization policy, and as a result,
the adoption of SOP 98-1 did not have a significant impact on
the Company's financial position or results of operations.
Software development costs relate primarily to the Company's
proprietary professional employer information system and its
Internet-based service delivery platform, Administaff Assistant.
The Company periodically evaluates its capitalized software
development costs for impairment in accordance with SOP 98-1
and SFAS No. 121, Accounting for Impairment of Long-Lived
Assets and Long-Lived Assets to be Disposed Of. During
the fourth quarter of 1999, the Company wrote off $1,438,000
related to two terminated projects after evaluating the costs
incurred to date, expected cost of completion, expected maintenance
costs and the availability of alternative software packages.
PEO
Service Fees and Worksite Employee Payroll Costs
The Company's revenues consist of service fees paid by its
clients under its Client Services Agreements. In consideration
for payment of such service fees, the Company agrees to pay
the following direct costs associated with the worksite employees:
(i) salaries and wages, (ii) employment related taxes, (iii)
employee benefit plan premiums and (iv) workers' compensation
insurance premiums. The Company accounts for PEO service fees
and the related direct payroll costs using the accrual method.
Under the accrual method, PEO service fees relating to worksite
employees with earned but unpaid wages at the end of each
period are recognized as unbilled revenues and the related
direct payroll costs for such wages are accrued as a liability
during the period in which wages are earned by the worksite
employee. Subsequent to the end of each period, such wages
are paid and the related PEO service fees are billed. Unbilled
receivables at December 31, 1999 and 1998 are net of prepayments
received prior to year-end of $3,338,000, and $1,505,000 respectively.
Fair
Value of Financial Instruments
The carrying amounts of cash, cash equivalents, accounts receivable
and accounts payable approximate their fair values due to
the short-term maturities of these instruments.
Stock-Based
Compensation The Company
accounts for stock-based compensation arrangements with employees
under the provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees.
Employee Savings Plan
Effective January 1, 1998, the Company adopted
SFAS No.132, Employers' Disclosures about Pension and Other
Postretirement Benefits. This statement standardizes the
disclosure requirements for pension and other postretirement
benefits. The adoption of SFAS No. 132 did not have an effect
on the Company's financial position or results of operations.
Effective January 1, 1999, the Company amended the employer
matching contribution and vesting features of its 401(k) plan.
The Company matches 50% of an eligible worksite employee's
contributions and 100% of an eligible corporate employee's
contributions, both up to 6% of the employee's eligible compensation.
In addition, for active employees on or after January 1, 1999,
the vesting schedule for employer matching contributions was
changed from five-year graded vesting to immediate vesting.
During 1999, 1998 and 1997, the Company made employer-matching
contributions of $4,646,000, $2,805,000 and $1,674,000, respectively.
Of these contributions, $3,761,000, $2,805,000 and $1,674,000
were recovered from its client companies through services
fees charged to those clients. The remainder represents employer
contributions made on behalf of corporate employees.
Advertising
The Company expenses all
advertising costs as incurred.
Income Taxes
The Company uses the liability method in accounting for income
taxes. Under this method, deferred tax assets and liabilities
are determined based on differences between financial reporting
and income tax carrying amounts of assets and liabilities
and are measured using the enacted tax rates and laws that
will be in effect when the differences are expected to reverse.
Comprehensive Income
Effective January 1, 1998, the Company
adopted SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 establishes new rules for the reporting and display
of comprehensive income and its components; however, the adoption
of SFAS No. 130 had no impact on the Company's net income
or stockholders' equity. SFAS No. 130 requires unrealized
gains and losses on the Company's available-for-sale marketable
securities to be included in other comprehensive income. Prior
to the adoption of SFAS No. 130, these amounts were reported
as a separate component of stockholders' equity. Prior year
financial statements have been reclassified to conform to
the requirements of SFAS No. 130.
Reclassifications
Certain prior year amounts have been reclassified to conform
to the 1999 presentation.
Note 2. Marketable
Securities
As of December 31, 1999, the Company's
investments in marketable securities consist of debt securities
with maturities ranging from 91 days to five years from the
date of purchase. Approximately 36% of the marketable securities
mature within one year of the balance sheet date. The following
is a summary of the Company's available-for-sale marketable
securities as of December 31, 1999:
For the years ended December 31, 1999
and 1998, net realized gains on sales of available-for-sale
marketable securities were $92,000 and $72,000, respectively.
Note 3. Notes Receivable
From Employees
In June 1995, an officer and director of
the Company exercised options to purchase 448,667 shares of
common stock at a price of $ 0.75 per share. The purchase
price was paid in cash by the officer. In connection with
the exercise, the Company entered into a loan agreement with
the officer, whereby the Company paid certain federal income
tax withholding requirements related to the stock option exercise
on behalf of the officer in the amount of $694,000. The loan
agreement called for an additional amount to be advanced to
the officer in the event the ultimate tax liability resulting
from the exercise exceeded the statutory withholding requirements.
In April 1996, the Company loaned the officer an additional
$300,000 relating to this transaction. The loans are repayable
on June 22, 2002, and April 11, 2001, respectively, accrue
interest at 6.83%, and are secured by 48,982 shares of the
Company's common stock.
Note 4. Income Taxes
Deferred taxes reflect the net tax effects
of temporary differences between the carrying amounts of assets
and liabilities used for financial reporting purposes and
the amounts used for income tax purposes. Significant components
of the net deferred tax assets and net deferred tax liabilities
as reflected on the balance sheet are as follows:
The components of income tax expense are
as follows:
In 1999 and 1998, tax benefits of $95,000
and $575,000, respectively, resulting from deductions relating
to disqualifying dispositions of certain employee incentive
stock options were recorded as increases in stockholders'
equity.
The reconciliation of income tax expense computed at U. S.
federal statutory tax rates to the reported income tax expense
is as follows:
Note 5. Stockholders'
Equity
In January 1999, the Company's Board of
Directors (the "Board") authorized a program to
repurchase up to one million shares of the Company's outstanding
common stock. In May 1999, the Board authorized the repurchase
of up to one million additional shares under the repurchase
program. The purchases are to be made from time to time in
the open market or directly from stockholders at prevailing
market prices based on market conditions or other factors.
As of December 31, 1999, the Company had repurchased 1,121,000
shares at a total cost of approximately $16.1 million, including
144,600 shares purchased from affiliates of Mr. Lang Gerhard,
a greater than 10% shareholder, in a private transaction for
approximately $2.3 million.
In January, 1998, the Company entered into a Securities Purchase
Agreement with American Express Travel Related Services Company,
Inc. ("American Express") whereby the Company sold
units consisting of 693,126 shares of its common stock (293,126
shares from Treasury Stock) and warrants to purchase an additional
2,065,515 shares of common stock to American Express for a
total purchase price of $17.7 million. The warrants have exercise
prices ranging from $40 to $80 per share and terms ranging
from three to seven years.
In March 1998, the Company repurchased 150,000 shares of
common stock from three stockholders, two of whom were officers
of the Company and one who was a director of the Company at
the time of the purchase, for a total cost of $3.1 million.
The Company completed an initial public offering in January
1997. The net proceeds to the Company from the sale of the
3,000,000 shares of common stock offered by the Company (after
deducting underwriting discounts and commissions of $3.6 million)
were $47.4 million. In addition, during the registration process,
the Company incurred $2.1 million in legal, accounting, printing
and other costs, which were offset against the proceeds of
the offering as a component of additional paid-in capital.
The Company utilized approximately $7.1 million of the proceeds
as follows: (i) $4.6 million to repay certain subordinated
notes and other secured notes comprising all of the Company's
outstanding indebtedness at the time the offering was completed,
(ii) approximately $2.0 million to exercise its option to
repurchase 348,945 shares of common stock from one of its
stockholders, and (iii) approximately $0.5 million to exercise
its option to repurchase 173,609 warrants to purchase shares
of common stock from the subordinated note holder.
In 1994, the Company issued warrants to purchase 153,230
shares of common stock with escalating exercise prices to
a third party. In connection with the Company's initial public
offering, 12,722 of such warrants were exercised at a price
of $3.77 per sharing during 1997. During 1998, the remaining
140,508 warrants were exercised at a price of $4.52 per share
and the Company repurchased these shares from the warrant
holder at a price of $21 per share.
Note 6. Employee Incentive
Plan
The Administaff, Inc. 1997 Incentive Plan,
as amended, (the "Incentive Plan"), provides for
options and other stock-based awards which may be granted
to eligible employees and non-employee directors of the Company
or its subsidiaries. An aggregate of 1,482,957 shares of common
stock of the Company are authorized to be issued under the
Incentive Plan. At December 31, 1999, 470,077 shares of common
stock were available for future grants under the Incentive
Plan. All awards previously granted to employees under the
Incentive Plan have been stock options, primarily intended
to qualify as "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code (the "Code").
The purpose of the Incentive Plan is to promote the interests
of the Company by encouraging employees of the Company and
its subsidiaries and the non-employee directors of the Company
to acquire or increase their equity interests in the Company
and to provide a means whereby such persons may develop a
sense of proprietorship and personal involvement in the development
and financial success of the Company, and to encourage them
to remain with and devote their best efforts to the business
of the Company, thereby advancing the interests of the Company
and its stockholders. The Incentive Plan is administered by
the Compensation Committee of the Board of Directors (the
"Committee"). The Committee has the power to determine
which eligible employees will receive awards, the timing and
manner of the grant of such awards, the exercise price of
stock options, the number of shares, and all of the terms
of the awards. The Committee has granted limited authority
to the President of the Company regarding the granting of
stock options. The Board of Directors may at any time terminate
or amend the Incentive Plan, provided that no such amendment
may adversely affect the rights of optionees with regard to
outstanding options. Stockholder approval of an amendment
to the Incentive Plan is necessary only when required by applicable
law or stock exchange rules.
Effective July 27, 1999, the Company adopted
the Administaff Non-Qualified Stock Option Plan (the "Non-Qualified
Plan"). The Non-Qualified Plan provides that options
to purchase up to 600,000 shares of the Company's common stock
may be granted in any calendar year to employees who are not
officers. The purpose of the Non-Qualified Plan is similar
to that of the Incentive Plan. The Non-Qualified Plan is administered
by the Chief Executive Officer of the Company (the "CEO").
The CEO has the power to determine which eligible employees
will receive stock option rights, the timing and manner of
the grant of such rights, the exercise price (which may not
be less than market value on the grant date), the number of
shares, and all of the terms of the options. The Committee
may at any time terminate or amend the Non-Qualified Plan,
provided that no such amendment may adversely affect the rights
of optionees with regard to outstanding options.
The following summarizes stock option
activity and related information:
The following summarizes information related
to stock options outstanding
at December 31,1999:
The Company has elected to follow Accounting
Principles Board Opinion No.25, Accounting for Stock Issued
to Employees(APB 25) and related interpretations in accounting
for its stock-based compensation arrangements because, as
discussed below, the alternative fair value accounting provided
for under SFAS No. 123, Accounting for Stock-Based Compensation,
requires use of option valuation models that were not developed
for use in valuing employee stock options. Under APB 25, no
compensation expense is recognized because the exercise price
of the Company's employee stock options equals the market
price of the underlying stock on the date of grant.
Pro forma information regarding net income and earnings per
share is required by SFAS No.123, which also requires that
the information be determined as if the Company had accounted
for its employee stock options granted subsequent to December
31, 1994 under the fair value method prescribed by SFAS No.
123. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model with
the following assumptions:
The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded
options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require
the input of highly subjective assumptions including the expected
stock price volatility. Because the Company's employee stock
options have characteristics significantly different from
those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate,
in the Company's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to expense
over the options' vesting period. The Company's pro forma
information, as if the Company had accounted for its employee
stock options granted subsequent to December 31, 1994 under
the fair value method prescribed by SFAS No. 123, follows:
7. Earnings Per Share
The numerator used in the calculations of both basic and diluted
earnings per share for all periods presented was net income.
The denominator for each period presented was determined as
follows:
Note 8. Operating Leases
The Company leases various office facilities,
furniture and equipment under operating leases. Most of the
leases contain purchase and/or renewal options at fair market
and fair rental value, respectively. Rental expense relating
to all operating leases was $2,915,000, $1,827,000 and $1,130,000
in 1999, 1998 and 1997, respectively. At December 31, 1999,
future minimum rental payments under noncancelable operating
leases are as follows (in thousands):
Note 9. Commitments
and Contingencies
The Company is a defendant in various lawsuits
and claims arising in the normal course of business. Management
believes it has valid defenses in these cases and is defending
them vigorously. While the results of litigation cannot be
predicted with certainty, management believes the final outcome
of such litigation will not have a material adverse effect
on the Company's financial position or results of operations.
The Company's 401(k) plan is currently under audit by the
Internal Revenue Service (the "IRS") for the year
ended December 31, 1993. Although the audit is for the 1993
plan year, certain conclusions of the IRS could be applicable
to other years as well. In addition, the IRS has established
an Employee Leasing Market Segment Group (the "Market
Segment Group") for the purpose of identifying specific
compliance issues prevalent in certain segments of the PEO
industry. Approximately 70 PEOs, including the Company, have
been randomly selected by the IRS for audit pursuant to this
program. Two primary issues have arisen from these audits.
The first issue involves the Company's rights under the Internal
Revenue Code (the "Code") as a co-employer of its
worksite employees, including officers and owners of clients
companies. In conjunction with the 1993 401(k) plan year audit,
the IRS Houston District has sought technical advice (the
"Technical Advice Request") from the IRS National
Office about whether worksite employee participation in the
401(k) plan violates the exclusive benefit rule under the
Code because they are not employees of the Company. The Technical
Advice Request contains the conclusions of the IRS Houston
District that the 401(k) plan should be disqualified because
it covers worksite employees who are not employees of the
Company. The Company's response to the Technical Advice Request
refutes the conclusions of the IRS Houston District. With
respect to the Market Segment Group study, the Company understands
that the issue of whether a PEO and a client company may be
treated as co-employers for certain federal tax purposes (the
"Industry Issue") has been referred to the IRS National
Office.
The Company does not know whether the IRS National Office
will address the Technical Advice Request independently of
the Industry Issue. Should the IRS conclude that the Company
is not a "co-employer" of worksite employees for
purposes of the Code, worksite employees could not continue
to make salary deferral contributions to the 401(k) plan or
pursuant to the Company's cafeteria plan or continue to participate
in certain other employee benefit plans of the Company. The
Company believes that, although unfavorable to the Company,
a prospective application of such a conclusion (that is, one
applicable only to periods after the conclusion by the IRS
is finalized) would not have a material adverse effect on
its financial position or results of operations, as the Company
could continue to make available comparable benefit programs
to its client companies at comparable costs to the Company.
However, if the IRS National Office adopts the conclusions
of the IRS Houston District set forth in the Technical Advice
Request and any such conclusions were applied retroactively
to disqualify the 401(k) plan for 1993 and subsequent years,
employees' vested account balances under the 401(k) plan would
become taxable, the Company would lose its tax deductions
to the extent its matching contributions were not vested,
the 401(k) plan's trust would become a taxable trust and the
Company would be subject to liability with respect to its
failure to withhold applicable taxes with respect to certain
contributions and trust earnings. Further, the Company would
be subject to liability, including penalties, with respect
to its cafeteria plan for the failure to withhold and pay
taxes applicable to salary deferral contributions by employees,
including worksite employees. In such a scenario, the Company
also would face the risk of client dissatisfaction and potential
litigation. While the Company is not able to predict either
the timing or the nature of any final decision that may be
reached with respect to the 401(k) plan audit or with respect
to the Technical Advice Request or the Market Segment Group
study and the ultimate outcome of such decisions, the Company
believes that a retroactive application of an unfavorable
determination is unlikely. The Company also believes that
a prospective application of an unfavorable determination
would not have a material adverse effect on the Company's
consolidated financial position or results of operations.
The second issue involved nondiscrimination test results
for certain prior plan years. The Technical Advice Request
issued during the 1993 401(k) plan year audit concluded that
the plan should be disqualified because the plan failed to
satisfy a nondiscrimination test related to contributions
and failed to provide evidence that it satisfied an alternative
nondiscrimination test. Separately, the Company notified the
IRS of operational issues related to nondiscrimination test
results for the 1991 through 1995 plan years. With respect
to the 1995 plan year, the Company caused the 401(k) plan
to refund the required excess contributions and earnings thereon
to the affected participants, and the Company paid the excise
tax associated with this correction during 1996. All remaining
nondiscrimination testing issues were settled during 1999,
when the Company and the IRS entered into a Closing Agreement
on Final Determination Covering Specific Matters (the "Closing
Agreement"). Under the terms of the Closing Agreement,
the Company agreed to make a contribution to the 401(k) plan
on behalf of certain participants in an aggregate amount of
approximately $831,000. The settlement amount, which was remitted
to the 401(k) plan in January 2000, represented the amount
necessary to bring the plan into compliance with the nondiscrimination
tests for all years covered, plus calculated earnings on such
contributions. The Company also agreed to pay a penalty of
$70,000. Further, the IRS agreed and determined that the 401(k)
plan will not be treated as disqualified for the 1992, 1993
and 1994 plan years.
The amount of the settlement was significantly lower than
the amount originally estimated and accrued by the Company
in 1996. As a result, the Company recorded a gain of $952,000
during 1999 as a component of other income. This gain includes
the impact of the Company's adjusted amount recoverable from
its third-party record keeper pursuant to a 1996 agreement,
under which the record keeper agreed to reimburse the Company
for a portion of its settlement of the nondiscrimination testing
issues.
Note 10. Quarterly
Financial Data (Unaudited)
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