e10vq

Letter Agreement dated June 20, 2003 between Administaff and United Healthcare Small Business Group. *

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Aakeeg/MF7W98CS6qiIYyibZ0D1w8qrjxmIj2ynTTmGe+MmsS5Jsyly4whYsWTr9 anNF8KkyE4QZtHmXnpER7Q== 0000950129-03-004085.txt : 20030812 0000950129-03-004085.hdr.sgml : 20030812 20030812135137 ACCESSION NUMBER: 0000950129-03-004085 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADMINISTAFF INC \DE\ CENTRAL INDEX KEY: 0001000753 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HELP SUPPLY SERVICES [7363] IRS NUMBER: 760479645 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13998 FILM NUMBER: 03836956 BUSINESS ADDRESS: STREET 1: 19001 CRESCENT SPRINGS DR CITY: KINGWOOD STATE: TX ZIP: 77339 BUSINESS PHONE: 7133588986 MAIL ADDRESS: STREET 1: 19001 CRESCENT SPRINGS DR CITY: KINGWOOD STATE: TX ZIP: 77339 10-Q 1 h08184e10vq.htm ADMINISTAFF, INC. - DATED 6/30/2003 e10vq

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


(Mark One)

x		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the quarterly period ended June 30, 2003.
or
o		Transition Report Pursuant to Section 13 or 15(d) of the Securities 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		76-0479645
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

19001 Crescent Springs Drive Kingwood, Texas		77339
(Address of principal executive offices)		(Zip Code)

(Registrant’s Telephone Number, Including Area Code): (281) 358-8986

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

As of August 8, 2003, 26,627,003 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

TABLE OF CONTENTS


	Financial Statements
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
	ITEM 4. CONTROLS AND PROCEDURES.
	ITEM 1. LEGAL PROCEEDINGS.
	ITEM 4. SUBMISSION OF MATERS TO A VOTE OF SECURITY HOLDERS.
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
Letter Agreement dated June 20, 2003
Certification of CEO pursuant to Section 302
Certification of CFO pursuant to Section 302
Certification of CEO pursuant to Section 906
Certification of CFO pursuant to Section 906

TABLE OF CONTENTS


Part I

Item 1.	Financial Statements	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

Item 4.	Controls and Procedures	36

Part II

Item 1.	Legal Proceedings	37

Item 4.	Submission of Matters to a Vote of Security Holders	37

Item 6.	Exhibits and Reports on Form 8-K	37

ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS


				June 30,			December 31,
				2003			2002

				(Unaudited)
Current assets:
	Cash and cash equivalents			$	56,092		$	71,799
	Marketable securities				18,662			14,714
	Accounts receivable:
		Trade			3,110			5,161
		Unbilled			79,162			74,358
		Other			2,373			2,956
	Prepaid insurance				19,730			10,409
	Other current assets				3,960			12,126
	Deferred income taxes				513			641
	Income tax receivable				331			—
	Operations held for sale				1,250			1,282

			Total current assets		185,183			193,446
Property and equipment:
	Land				2,920			2,920
	Buildings and improvements				54,448			53,899
	Computer hardware and software				47,194			45,554
	Software development costs				17,368			16,707
	Furniture and fixtures				27,691			27,487
	Vehicles and aircraft				6,256			6,606

					155,877			153,173
Accumulated depreciation and amortization					(72,411	)		(62,078	)

			Total property and equipment		83,466			91,095
Other assets:
	Deposits				18,680			26,552
	Other assets				1,175			4,071

			Total other assets		19,855			30,623

			Total assets	$	288,504		$	315,164

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ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands)

LIABILITIES AND STOCKHOLDERS’ EQUITY


			June 30,			December 31,
			2003			2002

			(Unaudited)
Current liabilities:
	Accounts payable		$	1,750		$	3,069
	Payroll taxes and other payroll deductions payable			37,483			57,196
	Accrued worksite employee payroll cost			76,257			69,676
	Accrued health insurance costs			6,348			5,815
	Other accrued liabilities			13,558			13,034
	Income taxes payable			—			348
	Current portion of long-term debt			1,793			1,676
	Operations held for sale			144			112

		Total current liabilities		137,333			150,926
Noncurrent liabilities:
	Long-term debt			41,485			42,493
	Deferred income taxes			3,661			5,396

		Total noncurrent liabilities		45,146			47,889
Commitments and contingencies
Stockholders’ equity:
	Common stock			309			309
	Additional paid-in capital			101,792			102,315
	Treasury stock, at cost			(50,091	)		(43,003	)
	Accumulated other comprehensive income, net of tax			88			153
	Retained earnings			53,927			56,575

		Total stockholders’ equity		106,025			116,349

		Total liabilities and stockholders’ equity	$	288,504		$	315,164

See accompanying notes.

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ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)


		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2003			2002			2003			2002

Revenues (gross billings of $1.2 billion, $1.2 billion, $2.4 billion and $2.3 billion less worksite employee payroll cost of $942 million, $956 million, $1.9 billion and $1.9 billion, respectively)		$	219,226		$	204,966		$	444,746		$	400,924
Direct costs:
	Payroll taxes, benefits and workers’ compensation costs		172,404			168,589			361,943			334,094

Gross profit			46,822			36,377			82,803			66,830
Operating expenses:
	Salaries, wages and payroll taxes		20,603			19,065			40,947			37,563
	General and administrative expenses		13,720			12,899			25,424			24,727
	Commissions		2,656			2,943			5,542			6,084
	Advertising		1,787			1,669			3,997			3,289
	Depreciation and amortization		5,309			5,194			10,714			10,211

			44,075			41,770			86,624			81,874

Operating income (loss)			2,747			(5,393	)		(3,821	)		(15,044	)
Other income (expense):
	Interest income		263			442			578			1,177
	Interest expense		(552	)		—			(1,120	)		—
	Other, net		450			305			458			261

Income (loss) before income tax benefit			2,908			(4,646	)		(3,905	)		(13,606	)
Income tax expense (benefit)			968			(1,835	)		(1,723	)		(5,374	)

Net income (loss) from continuing operations			1,940			(2,811	)		(2,182	)		(8,232	)
Discontinued operations:
	Loss from discontinued operations		(373	)		(582	)		(769	)		(1,049	)
	Income tax expense (benefit)		(146	)		(229	)		(303	)		(413	)

	Net loss from discontinued operations		(227	)		(353	)		(466	)		(636	)
Net income (loss)		$	1,713		$	(3,164	)	$	(2,648	)	$	(8,868	)

Basic and diluted net loss per share of common stock:
	Income (loss) from continuing operations	$	0.07		$	(0.10	)	$	(0.08	)	$	(0.30	)
	Loss from discontinued operations		(0.01	)		(0.01	)		(0.02	)		(0.02	)

	Net income (loss)	$	0.06		$	(0.11	)	$	(0.10	)	$	(0.32	)

See accompanying notes.

-5-

ADMINISTAFF, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2003
(in thousands)
(Unaudited)


													Accumulated
			Common Stock				Additional						Other
			Issued				Paid-In			Treasury			Comprehensive			Retained
			Shares		Amount		Capital			Stock			Income			Earnings			Total

Balance at December 31, 2002				30,839	$	309	$	102,315		$	(43,003	)	$	153		$	56,575		$	116,349
	Purchase of treasury stock			—		—		—			(8,233	)		—			—			(8,233	)
	Exercise of stock options			—		—		(119	)		355			—			—			236
	Sale of treasury stock to Administaff Employee Stock Purchase Plan			—		—		(307	)		599			—			—			292
	Other			—		—		(97	)		191			—			—			94
	Change in unrealized gain on marketable securities, net of tax:
		Unrealized loss (net of tax)		—		—		—			—			(34	)		—			(34	)
		Realized gain (net of tax)		—		—		—			—			(31	)		—			(31	)
	Net loss			—		—		—			—			—			(2,648	)		(2,648	)

	Comprehensive loss																			(2,713	)

Balance at June 30, 2003				30,839	$	309	$	101,792		$	(50,091	)	$	88		$	53,927		$	106,025

See accompanying notes.

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ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)


					Six Months Ended
					June 30,

					2003			2002

Cash flows from operating activities:
	Net loss				$	(2,648	)	$	(8,868	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization				10,821			10,527
		Bad debt expense				207			729
		Deferred income taxes				(1,563	)		(423	)
		Gain on the disposition of assets				(480	)		(255	)
		Changes in operating assets and liabilities:
			Accounts receivable			(2,377	)		(1,140	)
			Prepaid insurance			(9,321	)		(8,970	)
			Other current assets			5,457			(3,729	)
			Other assets			10,672			(6,906	)
			Accounts payable			(1,319	)		(1,636	)
			Payroll taxes and other payroll deductions payable			(19,718	)		(6,788	)
			Accrued worksite employee payroll expense			6,581			14,606
			Accrued health insurance costs			533			2,038
			Other accrued liabilities			560			(3,098	)
			Income taxes payable/receivable			(679	)		(5,809	)

				Total adjustments		(626	)		(10,854	)

				Net cash used in operating activities		(3,274	)		(19,722	)
Cash flows from investing activities:
	Marketable securities:
		Purchases				(11,801	)		(9,638	)
		Proceeds from maturities				2,500			20,113
		Proceeds from dispositions				5,256			22,091
	Cash received (exchanged) for note receivable					2,709			(2,983	)
	Property and equipment:
		Purchases				(2,518	)		(22,588	)
		Investment in software development costs				(661	)		(732	)
		Proceeds from dispositions				127			96
	Proceeds from sale of/investment in other companies					457			(500	)

				Net cash provided by (used in) investing activities		(3,931	)		5,859

-7-

ADMINISTAFF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
(Unaudited)


			Six Months Ended
			June 30,

			2003			2002

Cash flows from financing activities:
	Purchase of treasury stock		$	(8,233	)	$	(17,088	)
	Proceeds from the exercise of common stock purchase warrants			—			13,157
	Principal repayments on long-term debt and capital lease obligations			(891	)		—
	Borrowings under revolving line of credit			—			7,500
	Proceeds from the exercise of stock options			236			743
	Loans to employees			—			694
	Proceeds from sale of common stock to the Administaff Employee Stock Purchase Plan			292			186
	Other			94			32

		Net cash provided by (used in) financing activities		(8,502	)		5,224

Net decrease in cash and cash equivalents				(15,707	)		(8,639	)
Cash and cash equivalents at beginning of period				71,799			53,000

Cash and cash equivalents at end of period			$	56,092		$	44,361

Supplemental disclosures:
	Cash paid for income taxes		$	231		$	484
	Cash paid for interest		$	1,056		$	—

See accompanying notes.

-8-

ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2003

1. Basis of Presentation

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. For the six months ended June 30, 2003 and 2002, revenues from the Company’s Texas markets represented 41% and 43% of the Company’s total revenues, respectively.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

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.

The accompanying consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2002. The consolidated balance sheet at December 31, 2002, has been derived from the audited financial statements at that date but does not include all of the information or footnotes required by generally accepted accounting principles for complete financial statements. The Company’s consolidated balance sheet at June 30, 2003, and the consolidated statements of operations, cash flows and stockholders’ equity for the interim periods ended June 30, 2003 and 2002, have been prepared by the Company without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the consolidated financial position, results of operations and cash flows have been made.

The results of operations for the interim periods are not necessarily indicative of the operating results for a full year or of future operations. Historically, the Company’s earnings pattern has included losses in the first quarter, followed by improved results in subsequent quarters throughout the year. This pattern is due to the effects of employment-related taxes that are based on each employee’s cumulative earnings up to specified wage levels, causing employment-related tax costs to be highest in the first quarter and then decline over the course of the year. Since the Company’s revenues related to each employee have been generally earned

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and collected at a relatively constant rate throughout the year, payment of such tax obligations has a substantial impact on the Company’s financial condition and results of operations during the first six months of the year. Other factors that affect direct costs could mitigate or enhance this trend.

Effective January 1, 2003, the Company implemented a new pricing and billing system for new and renewing clients. For clients active on the new system in January of any year, the system includes a feature that accelerates invoicing of the payroll tax component of the comprehensive service fee to more closely reflect the pattern of incurred payroll tax costs. Accordingly, the impact of new and renewing clients invoiced on the new billing system in January 2003, which represented approximately 20% of the Company’s client base, has resulted in the partial offset of the Company’s historical earnings pattern in the first half of 2003. All clients will be invoiced by the new system by January 2004.

Certain prior year amounts have been reclassified to conform to current year presentation. Effective December 31, 2002, the Company changed its method of reporting its revenues under Emerging Issues Task Force (“EITF”) 99-19, Reporting Revenues Gross as a Principal Versus Net as an Agent. Previously, the Company reported its entire gross billings as revenue and reported the payroll cost of its worksite employees as a component of direct costs. The Company’s revenues are now reported net of worksite employee payroll cost (net method). To conform to the net method, the Company reclassified worksite employee payroll costs of $956 million and $1.9 billion for the three months and six months ended June 30, 2002, respectively, from direct costs to an offset of revenues. This reclassification had no effect on gross profit, operating income (loss), or net income (loss).

Stock-Based Compensation

At June 30, 2003, the Company has three stock-based employee compensation plans. 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 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 of net loss and net loss 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.

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		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2003			2002			2003			2002

		(in thousands)						(in thousands)
Net income (loss) as reported		$	1,713		$	(3,164	)	$	(2,648	)	$	(8,868	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(1,831	)		(2,513	)		(3,966	)		(4,811	)

Pro forma net loss		$	(118	)	$	(5,677	)	$	(6,614	)	$	(13,679	)

Net income (loss) per share:
	Basic and diluted – as reported	$	0.06		$	(0.11	)	$	(0.10	)	$	(0.32	)
	Basic and diluted – pro forma	$	0.00		$	(0.20	)	$	(0.24	)	$	(0.49	)

The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model. For options granted during the periods above, the following assumptions were used: volatility ranging from 66% to 93%, expected life of five years, risk free interest rate ranging from 3.0% – 4.5% and a dividend yield of 0%. The weighted average fair value of options granted in the six months ended June 30, 2003 and 2002 was $4.71 and $10.34, respectively.

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.

2. Accounting Policies

Health Insurance Costs

The Company provides health insurance coverage to its worksite employees through a national network of carriers including UnitedHealthcare (“United”), Cigna, PacifiCare, Kaiser Permanente and Blue Cross and Blue Shield of Georgia, all of which provide fully insured policies. 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

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plan, up to the amount of the Company’s security deposit with United. Accordingly, the Company accounts for this plan using a partially self-funded insurance accounting model, under which the Company must estimate its incurred but not reported (“IBNR”) claims at the end of each accounting period to determine the existence of any accumulated deficit or surplus. Any resulting accumulated deficit or surplus is recorded as a current liability or asset, respectively, on its balance sheet. During the three months ended June 30, 2003, the Company has recorded an estimated surplus of $6.1 million, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003.

Workers’ Compensation Costs

The Company’s workers’ compensation insurance policy for the two-year period ending September 30, 2003 is a guaranteed-cost policy under which premiums are paid for full-insurance coverage of all claims incurred during the policy period. This policy also contains a dividend feature for each policy year, under which the Company is 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 are 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 estimates the amount of refund, if any, that has 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. The Company is currently in the process of reviewing final proposals for replacement coverage which is scheduled to be effective September 1, 2003. In addition, the Company recorded a charge of $2.5 million in the second quarter of 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. This charge resulted in the reduction of other assets by $2.5 million.

3. Operations Held for Sale

During the first quarter of 2002, the Company purchased substantially all of the assets of Virtual Growth, Inc. (“VGI”) through bankruptcy proceedings for a total cost of $1.6 million. The Company established a subsidiary, Administaff Financial Management Services, Inc. (“FMS”), to provide outsourced accounting and bookkeeping services using the assets acquired from VGI. In January 2003, the Company committed to a plan to sell FMS and initiated a program to market the division and locate a buyer. As a result, FMS operating results have been included in discontinued operations in the accompanying consolidated statements of operations. As of June 30, 2003, the assets of FMS held for sale was as follows:

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Property and equipment, net	$	1,250
Accrued liabilities		144

Net assets held for sale	$	1,106

4. Stockholders’ Equity

On February 25, 2003, the Company repurchased 1,286,252 shares of common stock from American Express at $6 per share.

The Company’s Board of Directors has authorized the repurchase of up to 6,000,000 shares of the Company’s outstanding common stock. As of June 30, 2003, the Company has repurchased 5,341,523 shares under this authorization at a total cost of approximately $65.6 million, including the 1,286,252 shares repurchased from American Express.

5. Net Income (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:


		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2003		2002		2003		2002

Basic net income (loss) per share – weighted average shares outstanding			26,579		27,905		27,000		27,925
Effect of dilutive securities:
	Common stock options – treasury stock method		235		—		—		—

Diluted net income (loss) per share – weighted average shares outstanding plus effect of dilutive securities			26,814		27,905		27,000		27,925

Potentially dilutive securities not included in weighted average share calculation due to anti-dilutive effect			5,682		7,099		6,455		7,126

6. Commitments and Contingencies

The Company is a defendant in various lawsuits and claims arising in the normal course of business. Management believes it has valid defenses in these cases and is defending them vigorously. While the results of litigation cannot be predicted with certainty, except as set forth below, management believes the final outcome of such litigation will not have a material adverse effect on the Company’s financial position or results of operations.

Aetna Healthcare Litigation

On November 5, 2001, the Company filed a lawsuit against Aetna US Healthcare (“Aetna”). The Company has asserted claims against Aetna for breach of contract, economic duress, negligent misrepresentation, breach of good faith and fair dealing, and violations of the

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Texas Insurance Code. The Company has alleged that during the third quarter of 2001, Aetna placed the Company under economic duress by threatening, without any legal right, to terminate the Company’s health insurance plan if Administaff did not pay immediate and retroactive rate increases, even though Aetna had not provided at least two quarters advance notice as required under the contract. In addition, the Company has alleged that Aetna failed to properly administer the health plan and to produce timely and accurate reports regarding the health plan’s claims data and financial condition. The Company is seeking damages in excess of $42 million.

On January 28, 2002, Aetna filed its answer denying the claims asserted by the Company and, as anticipated by the Company, filed a counterclaim. In the counterclaim, Aetna has alleged that the Company has violated the Employee Retirement Income Security Act, as amended, breached its contractual obligations by failing to pay premiums owed to Aetna, and made material misrepresentations during its negotiations of rates with Aetna for the purpose of delaying rate increases while the Company sought a replacement health insurance carrier. Aetna is alleging damages of approximately $35 million.

Both the Company and Aetna have filed motions for summary judgment, which could result in the court dismissing some or all of the Company’s claims and/or Aetna’s counterclaim. While the Company cannot predict the ultimate outcome or the timing of a resolution of this dispute or the related lawsuit and counterclaim, the Company plans to vigorously pursue its case. In addition, the Company believes that Aetna’s allegations in the counterclaim are without merit and intends to defend itself vigorously. However, an adverse outcome in this dispute could have a material adverse effect on the Company’s results of operations or financial condition.

The Company has a fiduciary liability insurance policy (“the policy”) issued by National Union Fire Insurance Company of Pittsburgh, Pennsylvania (“National Union”). The policy provides for the reimbursement of defense related legal fees and costs (“defense costs”) associated with the Aetna counterclaim. National Union has recognized its duty to defend the Company under a reservation of rights and to date has reimbursed the Company for $200,000 in defense costs. However, National Union and the Company disagree about the scope of National Union’s defense obligations. On January 29, 2003, the Company filed a lawsuit against National Union requesting the court to determine National Union’s obligations to reimburse the Company for defense costs. On June 17, 2003 National Union filed its Original Answer and Counterclaim, generally seeking, among other remedies; (1) a declaration that the Aetna counterclaim is not covered by the policy; (2) a declaration that Administaff is not entitled to a defense under the policy; and (3) reimbursement of the previously advanced defense costs. Through June 30, 2003, the Company has submitted claims for approximately $3.5 million in defense costs to National Union for reimbursement. Although the Company believes that it is entitled to full reimbursement of the amount submitted, all defense costs, net of amounts reimbursed, have been expensed.

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Reliance National Indemnity Co. Bankruptcy Liquidation

In October 2001, the Company’s former workers’ compensation insurance carrier, Reliance National Indemnity Co. (“Reliance”), was forced into bankruptcy liquidation. At June 30, 2003, the estimated outstanding claims under the Company’s former policies with Reliance totaled approximately $7.5 million. 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 disputes the right of the guaranty association to be reimbursed for such claims. The Company initially secured $1.8 million in insurance coverage from its current workers’ compensation insurance carrier to cover potential claims returned to the Company related to its Reliance policies. As of June 30, 2003, the Company had $1.3 million in insurance coverage remaining. While the Company believes, based on its analysis of applicable state provisions, that its insurance coverage will be adequate to cover any probable losses, it is possible that such losses could exceed the Company’s insurance coverage limit resulting in an increase to workers’ compensation expense which would reduce net income.

State Unemployment Taxes

In January 2002, as a result of a corporate restructuring plan, Administaff filed for a partial transfer of compensation experience used to determine unemployment tax rates with the state of Texas. On October 30, 2002, the Texas Workforce Commission (“TWC”) approved Administaff’s application for a partial transfer of compensation experience.

Pending computation of the Company’s Texas unemployment tax rate, the Company paid its unemployment taxes to the state of Texas at the higher new employer rate as required by state law, resulting in a $6.0 million prepayment balance as of December 31, 2002. In July 2003, in lieu of requesting a refund, the TWC allowed the Company to apply the prepayment balance to the estimated first quarter and second quarter 2003 tax liabilities, resulting in a remaining prepaid balance of $1.7 million at June 30, 2003. The Company also received its initial 2002 and 2003 unemployment tax rate computations from the TWC in July 2003. While the Company is currently reviewing the computations with the TWC, it does not expect the final rates to have any negative impact to the estimates used to record payroll taxes.

Class Action Litigation

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Company and certain of its officers and directors made false and misleading statements or failed to make adequate disclosures concerning, among other things: (1) 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; (2) the matching of price and cost for health insurance on new and renewing client contracts; and (3) the Company’s former method of reporting worksite employee payroll costs as revenue. The Complaints seek unspecified damages, among other remedies. The Company believes these claims are without merit and intends to vigorously defend this litigation, which is in its preliminary stages.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion should be read in conjunction with the 2002 annual report on Form 10-K, as well as with the consolidated financial statements and notes thereto included in this quarterly report on Form 10-Q.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon its 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 the Company 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, the Company evaluates its estimates, including those related to health and workers’ compensation insurance claims experience, client bad debts, investments, income taxes, and contingent liabilities. The Company bases its 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.

The Company believes the following accounting policies are critical and/or require significant judgments and estimates used in the preparation of its consolidated financial statements:

• Revenue and direct cost recognition – The Company accounts for its revenues in accordance with Emerging Issues Task Force (“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 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.

Historically, the Company has included both components of its gross billings in revenues (gross method) due primarily to the assumption of significant contractual rights and obligations associated with being an employer, including the obligation for the payment of the payroll costs of its worksite employees. The Company assumes its employer obligations regardless of whether the Company collects its gross billings. After discussions with the Securities and Exchange Commission staff, effective December 31, 2002, the Company changed its presentation of revenues from the gross method to an approach that presents its revenues net of worksite

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employee payroll costs (net method) primarily because the Company is not generally responsible for the output and quality of work performed by the worksite employees. 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.

To conform to the net method, the Company reclassified worksite employee payroll costs of $956 million and $1.9 billion for the three months and six months ended June 30, 2002, respectively, from direct costs to an offset of revenues. This reclassification had no effect on gross profit, operating income (loss), or net income (loss).

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 premiums.

• Benefits 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 and Blue Cross and Blue Shield of Georgia, all of which provide fully insured policies. 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 of June 30, 2003, the Company’s security deposit totaled $25 million. In January 2004, the security deposit will be adjusted to $17.5 million, at which time the $7.5 million security deposit reduction, plus accrued interest, is to be returned to the Company. As a result of these contractual terms, the Company accounts for this plan using a partially self-funded insurance accounting model, under which the Company must estimate its incurred but not reported (“IBNR”) claims at the end of each accounting period. If the estimated IBNR claims, paid claims, taxes and administrative fees are collectively greater than the premiums paid to United, an accumulated deficit in the plan would be incurred and the Company would accrue a current liability on its balance sheet up to the amount of the security deposit, which would increase benefits expense and decrease net income in the period that such determination was made. On the other hand, if the estimated IBNR claims, paid claims, taxes and administrative fees are collectively less than the premiums paid to United, an accumulated surplus in the plan would be incurred and the Company would record this surplus as a current asset, which would reduce benefits expense

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and increase net income in the period that such a determination was made. As of June 30, 2003, the Company has estimated an IBNR component at approximately $34.3 million.

During the six months ended June 30, 2003, the Company recorded an estimated surplus of approximately $9.9 million, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003. For the six months ended June 30, 2003, the Company’s total United Plan costs were approximately $145.1 million.

• 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. The Company must estimate its expected SUI tax rate in those states for which tax rate notices have not yet been received.

In January 2002, as a result of a corporate restructuring plan, the Company filed for a partial transfer of compensation experience with the state of Texas. On October 30, 2002, the Texas Workforce Commission (“TWC”) approved Administaff’s application for a partial transfer of compensation experience.

Pending computation of the Company’s Texas unemployment tax rate, the Company paid its unemployment taxes to the state of Texas at the higher new employer rate as required by state law, resulting in a $6.0 million prepayment balance as of December 31, 2002. In July 2003, in lieu of requesting a refund, the TWC allowed the Company to apply the prepayment balance to the estimated first quarter and second quarter 2003 tax liabilities, resulting in a remaining prepaid balance of $1.7 million at June 30, 2003. The Company also received its initial 2002 and 2003 unemployment tax rate computations from the TWC in July 2003. While the Company is currently reviewing the computations with the TWC, it does not expect the final rates to have any negative impact to the estimates used to record payroll taxes.

• Workers’ compensation costs – The Company’s workers’ compensation insurance policy for the two-year period ending September 30, 2003 is a guaranteed-cost policy under which premiums are paid for full-insurance coverage of all claims incurred during the policy. This policy also contains a dividend feature for each policy year, under which the Company is 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 the policy year are 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 estimates the amount of refund, if any, that has 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 the Company’s estimates were to indicate that an additional dividend had been earned, the Company would record a receivable for the amount of that dividend and decrease its workers’ compensation insurance expense, which would increase net income in the period

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that such determination was made. On the other hand, if the Company’s estimates were to indicate that the amount of any recorded dividend receivable had been reduced due to greater than anticipated claim developments, the Company would reduce its receivable and increase its workers’ compensation insurance expense, which would reduce net income in the period that such determination was made. 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. The Company is currently in the process of reviewing final proposals for replacement coverage which is scheduled to be effective September 1, 2003. In addition, the Company recorded a charge of $2.5 million in the second quarter of 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.

• Contingent liabilities – The Company accrues and discloses contingent liabilities in its 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. The Company has disclosed in its audited financial statements several issues that it believes are reasonably possible to occur, although it cannot determine the range of possible loss in all cases. As these issues develop, the Company 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 reasonably estimated, the Company would be required to accrue its estimated loss, which would reduce net income in the period that such determination was made.

• Deferred taxes – The Company has recorded a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, the Company’s ability to realize its deferred tax assets could change from its current estimates. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period that such determination is made. Likewise, should the Company determine that it will not be able to realize all or part of its 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 – The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to pay its comprehensive service fees. The Company believes that the success of its business is heavily dependent on its ability to collect these comprehensive service fees for several reasons, including: (i) the fact that the Company is at risk for the payment of its direct costs and worksite employee payroll costs regardless of whether its clients pay their comprehensive

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service fees; (ii) the large volume and dollar amount of transactions processed by the Company; and (iii) the periodic and recurring nature of payroll, upon which the comprehensive service fees are based. To mitigate this risk, the Company has established very tight credit policies. The Company generally requires its clients to pay their comprehensive service fees no later than one day prior to the applicable payroll date. In addition, the Company maintains the right to terminate its Client Service Agreement and associated worksite employees or to require prepayment, letters of credit or other collateral upon deterioration in a client’s financial position or upon nonpayment by a client. As a result of these efforts, the outstanding balance of accounts receivable and subsequent losses related to customer nonpayment has historically been very low as a percentage of revenues. However, if the financial condition of the Company’s customers were to deteriorate rapidly, resulting in nonpayment, the Company’s accounts receivable balances could grow and the Company could be required to provide for additional allowances, which would decrease net income in the period that such determination was made.

• Property and equipment – The Company’s property and equipment relate primarily to its 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 the useful lives of these assets were determined to be shorter than their current estimates, the Company’s depreciation and amortization expense could be accelerated, which would decrease net income in the periods following such a determination. In addition, the Company periodically evaluates 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 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, 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. In January 2003, the Company committed to a plan to sell Administaff Financial Management Services, Inc. (“FMS”) and initiated a program to market the division and locate a buyer. As a result, FMS is being reported as a discontinued operation in accordance with SFAS No. 144. As of June 30, 2003, the net book value of FMS was approximately $1.1 million. Failure to sell FMS at an amount at least equal to the net book value would result in the Company incurring and recording a loss on the disposal of FMS.

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Results of Operations

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002.

The following table presents certain information related to the Company’s results of operations for the three months ended June 30, 2003 and 2002.


	Three months ended June 30,
							%
	2003		2002			Change

	(in thousands, except per share and statistical data)
Revenues (gross billings of $1.2 billion and $1.2 billion less worksite employee payroll cost of $942 million and $956 million, respectively)	$	219,226	$	204,966			7.0	%
Gross profit		46,822		36,377			28.7	%
Operating expenses		44,075		41,770			5.5	%
Operating income (loss)		2,747		(5,393	)		150.9	%
Other income		161		747			(78.4	)%
Net income (loss) from continuing operations		1,940		(2,811	)		169.0	%
Diluted net income (loss) from continuing operations per share of common stock		0.07		(0.10	)		170.0	%
Statistical Data:
Average number of worksite employees paid per month		75,103		76,477			(1.8	)%
Revenues per worksite employee per month(1)	$	973	$	893			9.0	%
Gross profit per worksite employee per month		208		159			30.8	%
Operating expenses per worksite employee per month		196		182			7.7	%
Operating income (loss) per worksite employee per month		12		(24	)		150.0	%
Net income (loss) from continuing operations per worksite employee per month		9		(12	)		175.0	%

(1)

Gross billings of $5,152 and $5,059 per worksite employee per month less payroll cost of $4,179 and $4,166 per worksite employee per month, respectively.

Revenues

The Company’s revenues for the three months ended June 30, 2003 increased 7.0% over the same period in 2002 due to a 9.0% increase in revenues per worksite employee per month, offset by a 1.8% decrease in the average number of worksite employees paid per month.

The Company’s 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. During the second quarter of 2003, both paid worksite employees from new client sales and client retention declined as compared to the 2002 period. The net change in existing clients increased slightly over the 2002 period.

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The 9.0%, or $80 increase in revenues per worksite employee per month was primarily due to $82 per worksite employee per month in pricing increases on new and renewing clients over the last year, offset by a $2 per worksite employee per month decline in revenue relating to those clients that were invoiced on the new billing system beginning January 1, 2003. This decline is consistent with the related decline in payroll tax costs as wage limits are met.

By region, the Company’s revenue growth over the second quarter of 2002 and revenue distribution for the quarter ended June 30, 2003 were as follows:


	Three months ended June 30,							Three months ended June 30,

	2003		2002		% Change			2003			2002

	(in thousands)							(% of total revenues)
Northeast	$	28,544	$	23,644		20.7	%		13.0	%		11.6	%
Southeast		23,939		22,798		5.0	%		10.9	%		11.1	%
Central		31,582		29,170		8.3	%		14.4	%		14.2	%
Southwest		87,990		88,335		—			40.2	%		43.1	%
West		46,090		39,406		17.0	%		21.0	%		19.2	%
Other revenue		1,081		1,613		(33.0	)%		0.5	%		0.8	%

Total revenue	$	219,226	$	204,966		7.0	%		100.0	%		100.0	%

Gross Profit

Gross profit for the second quarter of 2003 increased 28.7% to $46.8 million compared to the second quarter of 2002. Gross profit per worksite employee increased 30.8% to $208 per month in the 2003 period from $159 per month in the 2002 period. This increase was primarily the result of the $80 increase in revenue per worksite employee per month discussed above, offset by increases of $13 in benefits cost, $17 in workers’ compensation costs (including the write-off of the workers’ compensation dividend of $11) and $1 in payroll taxes and other direct costs per worksite employee per month. The Company’s 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 its primary direct costs and its operating costs.

While the Company’s revenues per worksite employee per month increased 9.0%, the Company’s primary direct costs, which include payroll taxes, benefits and workers’ compensation expenses, increased 4.2% to $765 per worksite employee per month in the second quarter of 2003 versus $734 in the second quarter of 2002.

• Payroll tax costs – Payroll taxes decreased $1 per worksite employee per month compared to the second quarter of 2002. The overall cost of payroll taxes as a percentage of payroll cost decreased to 7.36% in the 2003 period from 7.40% in the 2002 period. The decrease was the result of lower weighted average effective state unemployment rates in the 2003 period as compared to the 2002 period. The Company has estimated and recorded its state unemployment tax expense during the first six months of 2003 using tax rates in Texas that were based on its expectation that its application for a partial transfer of compensation

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experience resulting from its restructuring, would be approved. While the Company has received a determination from the Texas Workforce Commission that its partial transfer application was approved, the Company has continued to estimate its state unemployment tax expense until its final official tax rates for calendar years 2002 and 2003 are determined. See “Critical Accounting Policies and Estimates – State Unemployment Taxes” on page 19 for a discussion of this matter.

• Benefits costs – The cost of health insurance and related employee benefits increased 1.6% or $13 per worksite employee per month over the second quarter of 2002. This increase is due to a 9.1% increase in the cost per covered employee offset by a decrease in the percentage of worksite employees covered under the Company’s health insurance plans to 70.5% in the 2003 period from 74.4% in the 2002 period. The increase in benefits costs during the three months ended June 30, 2003 were mitigated in part by the impact of the cost savings derived from the benefit plan design changes initiated by the Company in January 2003. During the three months ended June 30, 2003, the Company recorded an estimated surplus of approximately $6.1 million related to the Company’s health insurance plan with United, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003. See “Critical Accounting Policies and Estimates – Benefits Costs” on page 18 for a discussion of the Company’s accounting for health insurance costs.

• Workers’ compensation costs – Workers’ compensation costs increased $17 on a per worksite employee per month basis over the second quarter of 2002, and increased to 1.58% of payroll cost in the 2003 period from 1.19% in the 2002 period. The primary cause of the increase was the $2.5 million charge related to the write-off of the Company’s workers’ compensation dividend receivable. The charge was taken due to credit concerns caused by recent downgrades of its workers’ compensation carrier. See “Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 19 and “Other Matters – Workers’ Compensation Costs” on page 34 for a discussion of the Company’s accounting for workers’ compensation costs.

Gross profit, measured as a percentage of revenue, increased to 21.4% in the 2003 period from 17.7% in the 2002 period.

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Operating Expenses

The following table presents certain information related to the Company’s operating expenses for the three months ended June 30, 2003 and 2002.


		Three months ended June 30,							Three months ended June 30,

		2003		2002		% change			2003		2002		% change

		(in thousands)							(per worksite employee per month)
Salaries, wages and payroll taxes		$	20,603	$	19,065		8.1	%	$	91	$	83		9.6	%
General and administrative expenses			13,720		12,899		6.4	%		61		56		8.9	%
Commissions			2,656		2,943		(9.8	)%		12		13		(7.7	)%
Advertising			1,787		1,669		7.1	%		8		7		14.3	%
Depreciation and amortization			5,309		5,194		2.2	%		24		23		4.3	%

	Total operating expenses	$	44,075	$	41,770		5.5	%	$	196	$	182		7.7	%

Operating expenses increased 5.5% over the second quarter of 2002 to $44.1 million. Operating expense per worksite employee increased to $196 per month in the 2003 period from $182 in the 2002 period. The components of operating expenses changed as follows:

• Salaries, wages and payroll taxes of corporate and sales staff increased 8.1%, or $8 per worksite employee per month, compared to the 2002 period, primarily due to an accrual relating to the Company’s 2003 incentive compensation plan, which is payable only upon the achievement of certain predetermined annual goals.

• General and administrative expenses increased 6.4%, or $5 per worksite employee per month, compared to the second quarter of 2002. The increase resulted primarily from increases in legal costs associated with the lawsuit with Aetna, the Company’s former health insurance carrier.

• Commissions expense decreased 9.8%, or $1 per worksite employee per month, compared to the 2002 period, due to the decline in paid worksite employees from new client sales.

• Advertising costs increased 7.1% or $1 per worksite employee per month, compared to the second quarter of 2002 primarily due to the national advertising campaign initiated in 2003.

• Depreciation and amortization expense increased 2.2%, or $1 per worksite employee per month, over the 2002 period as a result of the increased capital assets placed in service in the last quarter of 2002. These capital assets consist primarily of the new corporate headquarters facilities.

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Other Income

Other income decreased from $747,000 in the second quarter of 2002 to $161,000 in the 2003 period, primarily due to interest expense related to the Company’s long-term debt borrowings and reduced interest income as a result of reduced levels of cash and marketable securities. Offsetting the decline in other income was a $457,000 gain related to proceeds from the sale of the Company’s investment in eProsper, Inc., which had been previously written off in 2002.

Income Tax Expense

The Company’s provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. The effective income tax rate for the 2003 period was 33.3% compared to 39.5% in the 2002 period. The decline in the effective tax rate is primarily due to utilization of previously unrecognized capital loss carryforwards on the $457,000 gain from the sale of the Company’s investment in eProsper, Inc.

Net Income (Loss) from Continuing Operations

Operating and net income from continuing operations per worksite employee per month was $12 and $9 in the 2003 period, versus operating and net loss from continuing operations of $24 and $12 in the 2002 period.

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Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002.

The following table presents certain information related to the Company’s results of operations for the six months ended June 30, 2003 and 2002.


	Six months ended
	June 30,
							%
	2003			2002			Change

	(in thousands, except per share and statistical data)
Revenues (gross billings of $2.4 billion and $2.3 billion less worksite employee payroll cost of $1.9 billion and $1.9 billion, respectively)	$	444,746		$	400,924			10.9	%
Gross profit		82,803			66,830			23.9	%
Operating expenses		86,624			81,874			5.8	%
Operating income (loss)		(3,821	)		(15,044	)		74.6	%
Other income (expense)		(84	)		1,438			(105.8	)%
Net income (loss) from continuing operations		(2,182	)		(8,232	)		73.5	%
Diluted net income (loss) from continuing operations per share of common stock		(0.08	)		(0.30	)		73.3	%
Statistical Data:
Average number of worksite employees paid per month		75,764			74,982			1.0	%
Revenues per worksite employee per month(1)	$	978		$	891			9.8	%
Gross profit per worksite employee per month		182			149			22.1	%
Operating expenses per worksite employee per month		191			182			4.9	%
Operating income (loss) per worksite employee per month		(8	)		(33	)		75.8	%
Net income (loss) from continuing operations per worksite employee per month		(5	)		(18	)		72.2	%

(1)

Gross billings of $5,186 and $5,134 per worksite employee per month less payroll cost of $4,207 and $4,243 per worksite employee per month, respectively.

Revenues

The Company’s revenues for the six months ended June 30, 2003 increased 10.9% over the same period in 2002 due to a 1.0% increase in the average number of worksite employees paid per month and a 9.8% increase in revenues per worksite employee per month.

The Company’s 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. While the average number of worksite employees paid per month increased during the first half of 2003, paid worksite employees from all three primary sources declined as compared to the 2002 period.

The 9.8%, or $87 increase in revenues per worksite employee per month was primarily due to $76 per worksite employee per month in pricing increases on new and renewing clients

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over the last year. The remaining $11 per worksite employee per month was due to the accelerated collection of the payroll tax allocation component of the comprehensive service fee for those clients that were invoiced on the new billing system beginning January 1, 2003. This increase is consistent with the higher payroll tax costs typically incurred during the first half of the year.

By region, the Company’s revenue growth over the first half of 2002 and revenue distribution for the six months ended June 30, 2003 were as follows:


	Six months ended June 30,							Six months ended June 30,

	2003		2002		% Change			2003			2002

	(in thousands)							(% of total revenues)
Northeast	$	58,210	$	45,883		26.9	%		13.1	%		11.4	%
Southeast		48,263		44,508		8.4	%		10.9	%		11.1	%
Central		64,659		58,123		11.2	%		14.5	%		14.5	%
Southwest		180,062		172,614		4.3	%		40.5	%		43.1	%
West		91,534		76,491		19.7	%		20.6	%		19.1	%
Other revenue		2,018		3,305		(38.9	)%		0.4	%		0.8	%

Total revenue	$	444,746	$	400,924		10.9	%		100.0	%		100.0	%

Gross Profit

Gross profit for the first half of 2003 increased 23.9% to $82.8 million compared to the first half of 2002. Gross profit per worksite employee increased 22.1% to $182 per month in the 2003 period from $149 per month in the 2002 period. This increase was primarily the result of the $87 increase in revenue per worksite employee per month discussed above, offset by increases of $33 in benefits cost, $15 in workers’ compensation costs (including the write-off of the workers’ compensation dividend of $6) and $6 in payroll taxes and other direct costs per worksite employee per month. The Company’s 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 its primary direct costs and its operating costs.

While the Company’s revenues per worksite employee per month increased 9.8%, the Company’s primary direct costs, which include payroll taxes, benefits and workers’ compensation expenses, increased 7.3% to $796 per worksite employee per month in the first half of 2003 versus $742 in the first half of 2002.

• Payroll tax costs – Payroll taxes increased $6 per worksite employee per month over the first half of 2002. The overall cost of payroll taxes as a percentage of payroll cost increased to 8.14% in the 2003 period from 7.93% in the 2002 period. The increase was the result of higher weighted average effective state unemployment rates in the 2003 period as compared to the 2002 period. The Company has estimated and recorded its state unemployment tax expense during the first six months of 2003 using tax rates in Texas that were based on its expectation that its application for a partial transfer of compensation experience resulting

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from its restructuring, would be approved. While the Company has received a determination from the Texas Workforce Commission that its partial transfer application was approved, the Company has continued to estimate its state unemployment tax expense until its final official tax rates for calendar years 2002 and 2003 are determined. See “Critical Accounting Policies and Estimates – State Unemployment Taxes” on page 19 for a discussion of this matter.

• Benefits costs – The cost of health insurance and related employee benefits increased 10.5% or $33 per worksite employee per month over the first half of 2002. This increase is due to a 13.6% increase in the cost per covered employee offset by a decrease in the percentage of worksite employees covered under the Company’s health insurance plans to 71.2% in the 2003 period from 73.9% in the 2002 period. The increase in benefits costs during the six months ended June 30, 2003 were mitigated in part by the impact of the cost savings derived from the benefit plan design changes initiated by the Company in January 2003. During the six months ended June 30, 2003, the Company recorded an estimated surplus of approximately $9.9 million related to the Company’s health insurance plan with United, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003. See “Critical Accounting Policies and Estimates – Benefits Costs” on page 18 for a discussion of the Company’s accounting for health insurance costs.

• Workers’ compensation costs – Workers’ compensation costs increased $15 on a per worksite employee per month basis over the first half of 2002, and increased to 1.47% of payroll cost in the 2003 period from 1.10% in the 2002 period. The primary cause of the increase was the $2.5 million charge in the second quarter of 2003 related to the workers’ compensation dividend as a result of the workers’ compensation carrier’s rating downgrades compared to the $1.5 million estimated dividend recorded by the Company during the six months ended June 30, 2002. Additionally, during the first half of 2003 the Company incurred approximately $1.0 million in workers’ compensation costs related to state surcharges relating to policies dating back to 1999, which were assessed by various states and passed through to the Company through its current carrier. See “Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 19 and “Other Matters – Workers’ Compensations Costs” on page 34 for a discussion of the Company’s accounting for workers’ compensation costs.

Gross profit, measured as a percentage of revenue, increased to 18.6% in the 2003 period from 16.7% in the 2002 period.

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Operating Expenses

The following table presents certain information related to the Company’s operating expenses for the six months ended June 30, 2003 and 2002.


		Six months ended June 30,							Six months ended June 30,

		2003		2002		% change			2003		2002		% change

		(in thousands)							(per worksite employee per month)
Salaries, wages and payroll taxes		$	40,947	$	37,563		9.0	%	$	90	$	83		8.4	%
General and administrative expenses			25,424		24,727		2.8	%		56		55		1.8	%
Commissions			5,542		6,084		(8.9	)%		12		14		(14.3	)%
Advertising			3,997		3,289		21.5	%		9		7		28.6	%
Depreciation and amortization			10,714		10,211		4.9	%		24		23		4.3	%

	Total operating expenses	$	86,624	$	81,874		5.8	%	$	191	$	182		4.9	%

Operating expenses increased 5.8% over the first six months of 2002 to $86.6 million. Operating expense per worksite employee increased to $191 per month in the 2003 period from $182 in the 2002 period. The components of operating expenses changed as follows:

• Salaries, wages and payroll taxes of corporate and sales staff increased 9.0%, or $7 per worksite employee per month, compared to the 2002 period, primarily due to an accrual relating to the Company’s 2003 incentive compensation plan, which is payable only upon the achievement of certain predetermined annual goals.

• General and administrative expenses increased 2.8%, or $1 per worksite employee per month, compared to the first half of 2002. The increase resulted primarily from increases in legal costs associated with the lawsuit with Aetna, the Company’s former health insurance carrier, and was offset by decreases in other expenses including data communications and telephone expenses.

• Commissions expense decreased 8.9%, or $2 per worksite employee per month, compared to the 2002 period, due to the decline in paid worksite employees from new client sales.

• Advertising costs increased 21.5% or $2 per worksite employee per month, compared to the first half of 2002 primarily due to the national advertising campaign initiated in 2003.

• Depreciation and amortization expense increased 4.9%, or $1 per worksite employee per month, over the 2002 period as a result of the increased capital assets placed in service in the last quarter of 2002. These capital assets consist primarily of the new corporate headquarters facilities.

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Other Income (Expense)

Other income (expense) decreased from income of $1.4 million in the first half of 2002 to a net expense of $84,000 in the 2003 period. This decline is primarily due to interest expense related to the Company’s long-term debt borrowings and reduced interest income as a result of reduced levels of cash and marketable securities. Offsetting the decline in other income was a $457,000 gain related to proceeds from the sale of the Company’s investment in eProsper, Inc., which had been previously written off in 2002.

Income Tax Benefit

The Company’s provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. During periods of reported losses, the Company records an income tax benefit. The effective income tax benefit rate increased from 39.5% in the 2002 period to 44.1% in the 2003 period due to the additional benefit from the utilization of previously unrecognized capital loss carryforwards on the $457,000 gain from the sale of the Company’s investment in eProsper, Inc. in 2003.

Net Income (Loss) from Continuing Operations

Operating loss and net loss from continuing operations per worksite employee per month was $8 and $5 in the 2003 period, versus $33 and $18 in the 2002 period.

Liquidity and Capital Resources

The Company periodically evaluates its liquidity requirements, capital needs and availability of resources in view of, among other things, expansion plans, debt service requirements and other operating cash needs. As a result of this process, the Company has in the past sought, and may in the future seek, to raise additional capital or take other steps to increase or manage its liquidity and capital resources. The Company currently believes that its cash on hand, marketable securities and cash flows from operations and will be adequate to meet its liquidity requirements for the remainder of 2003. The Company will rely on these same sources, as well as public and private debt or equity financing, to meet its longer-term liquidity and capital needs.

The Company has experienced significant increases in health insurance costs and may continue to experience significant increases in future periods. The Company’s pricing objectives attempt to maintain or improve gross profit per worksite employee per month by matching or exceeding changes in its primary direct costs with increases in its revenue per worksite employee. The Company has implemented pricing increases designed to match the anticipated health insurance cost increases. However, due to annual contract commitments, pricing for current customers can only be increased upon contract renewal. Changes in health insurance claim trends that underlie the Company’s direct costs could enhance or hinder the Company’s ability to

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meet its pricing objectives during 2003. Failure to achieve its pricing objectives could have a material adverse effect on the Company’s financial position.

As of June 30, 2003, the Company has made cash security deposits totaling $25 million with its primary health insurance carrier, United. In January 2004, the security deposit will be adjusted to $17.5 million, at which time the $7.5 million reduction, plus accrued interest, is to be returned to the Company. 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 a result of the existing workers’ compensation carrier’s recent credit rating downgrades, the Company has elected to accelerate the termination of its contract from September 30, 2003 to September 1, 2003. The Company is currently in the process of reviewing final proposals for replacement coverage which is scheduled to be effective September 1, 2003, and will likely involve terms different from the existing policy including increased costs and significant collateral requirements.

The Company had $74.8 million in cash and cash equivalents and marketable securities at June 30, 2003, of which approximately $31.4 million was payable in July 2003 for withheld federal and state income taxes, employment taxes and other payroll deductions. At June 30, 2003, the Company had working capital of $47.9 million compared to $42.5 million at December 31, 2002.

Cash Flows From Operating Activities

The $16.4 million increase in net cash flows from operating activities was primarily the result of changes in the Company’s operating asset and liability accounts and the decrease in the Company’s net loss for the first half of 2003 as compared to 2002.

Cash Flows From Investing Activities

The Company invested $4.0 million in marketable securities, net of maturities and dispositions, and approximately $3.2 million in capital expenditures, primarily related to computer hardware and software, during the 2003 period. In addition, the Company collected a $2.7 million note receivable and $584,000 from the sale of assets during the first half of 2003.

Cash Flows From Financing Activities

Cash flows used in financing activities primarily related to the repurchase of $8.2 million in treasury stock.

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Other Matters

Investments in Other Companies

In January 2002, the Company purchased substantially all of the assets of VGI through bankruptcy proceedings for a total cost of approximately $1.6 million. The Company established a new subsidiary, known as FMS, to provide outsourced accounting and bookkeeping services using the assets acquired from VGI. In January 2003, the Company committed to a plan to sell FMS and initiated a program to market the division and locate a buyer during 2003. As a result, FMS is being reported as a discontinued operation in 2003. As of June 30, 2003, the net book value of FMS was approximately $1.1 million. The Company expects the sales proceeds to exceed the net book value of FMS at June 30, 2003.

Health Insurance Costs

The Company provides health insurance coverage to its worksite employees through a national network of providers including United, Cigna Healthcare, PacifiCare, Kaiser Permanente and Blue Cross and Blue Shield, all of which are fully insured policies. The policy with United provides the majority of the Company’s health insurance coverage. As of June 30, 2003, the Company has made cash security deposits totaling $25 million with United. In January 2004, the security deposit will be adjusted to $17.5 million, at which time the $7.5 million reduction, plus accrued interest, is to be returned to the Company.

Pursuant to the terms of the Company’s annual contract with United, within 195 days following the termination of the contract, a final accounting of the plan will be performed. The final accounting will assess the premiums paid to United and the total administrative fees, taxes and claims incurred during the policy term. The incurred claims will include those paid plus an estimate of claims incurred but not processed within 180 days after the contract termination date. In the event that the incurred claims, administrative fees and taxes are collectively less than the premiums paid, the Company will receive a refund equal to the amount of such accumulated surplus. In the event that the incurred claims, administrative fees and taxes are collectively greater than the premiums paid, the Company will be liable for such accumulated deficit up to the amount of its security deposit.

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.

Because the Company has a contractual right to collect an accumulated surplus and is liable for an accumulated deficit up to the amount of its security deposit with United, the Company accounts for the United plan using a partially self-funded insurance accounting model. Under this approach, the Company must estimate its incurred but not reported (“IBNR”) claims at the end of each accounting period. If the estimated IBNR claims, paid claims, taxes and administrative fees, collectively, exceed the premiums paid to United, an accumulated deficit in

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the plan would be incurred and the Company would be required to accrue the estimated accumulated deficit on its balance sheet, which would increase benefits expense and decrease net income in the period that such determination is made. On the other hand, if the estimated IBNR claims, paid claims, taxes and administrative fees, collectively, are less than the premiums paid to United, an accumulated surplus in the plan would exist and the Company would record this surplus as a current asset, which would reduce benefits expense and increase net income in the period that such determination is made. As of June 30, 2003, the Company has recorded an estimated accumulated surplus from the inception of the plan of approximately $7.7 million.

Workers’ Compensation Costs

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. A small number of the Company’s clients require an “A” rating in order to comply with various contractual commitments. In certain instances the Company has obtained supplemental insurance coverage in order to assist its clients to comply with their contractual obligations, and the Company may be required to obtain additional coverage for other clients as well. In addition, the Company’s ability to attract and retain clients could be adversely impacted by the downgrade. As a result of the downgrades in the Company’s workers’ compensation carrier’s rating, the Company wrote-off its $2.5 million dividend receivable in the second quarter of 2003 and has elected to accelerate the termination of its contract from September 30, 2003 to September 1, 2003. The Company is currently in the process of reviewing final proposals for replacement coverage which is scheduled to be effective September 1, 2003 and will likely involve terms different from the existing policy including increased costs and significant collateral requirements.

Securities Class Action Suits

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: (1) 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; (2) the matching of price and cost for health insurance on new and renewing client contracts; and (3) the Company’s former method of reporting worksite employee payroll costs as revenue. The Complaints seek unspecified damages, among other remedies. The Company believes these claims are without merit and intends to vigorously defend this litigation, which is in its preliminary stages.

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Seasonality, Inflation and Quarterly Fluctuations

Historically, the Company’s earnings pattern includes losses in the first quarter, followed by improved profitability in subsequent quarters throughout the year. This pattern is due to the effects of employment-related taxes, which are based on each employee’s cumulative earnings up to specified wage levels, causing employment-related tax costs to be highest in the first quarter and then decline over the course of the year. Since the Company’s revenues related to an individual employee have been generally earned and collected at a relatively constant rate throughout the year, payment of such tax obligations has a substantial impact on the Company’s financial condition and results of operations during the first six months of each year. Other factors that affect direct costs could mitigate or enhance this trend.

Effective January 1, 2003, the Company implemented a new pricing and billing system for new and renewing clients. For clients active on the new system in January of any year, the new system includes a feature that accelerates invoicing of the payroll tax component of the comprehensive service fee to more closely reflect the pattern of incurred payroll tax costs. Accordingly, the impact of new and renewing clients invoiced on the new billing system in January 2003, which represented approximately 20% of the Company’s client base, has resulted in the partial offset of the Company’s historical earnings pattern in the first half of 2003. All clients will be invoiced by the new system by January 2004.

The Company believes the effects of inflation have not had a significant impact on its results of operations or financial condition.

Factors That May Affect Future Results and the Market Price of Common Stock

The statements contained herein that are not historical facts are forward-looking statements within the meaning of the federal securities laws (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,” “possibly,” “probably,” “goal,” and “assume,” and similar expressions. Forward-looking statements involve a number of risks and uncertainties. In the normal course of business, Administaff, Inc., in an effort to help keep its stockholders and the public informed about the Company’s operations, may from time to time issue such forward-looking statements, either orally or in writing. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, or projections involving anticipated revenues, earnings, unit growth, profit per worksite employee, pricing, operating expenses or other aspects of operating results. Administaff bases the forward-looking statements on its current expectations, estimates and projections. These statements are not guarantees of future performance and involve risks and uncertainties that Administaff cannot predict. In addition, Administaff has based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Therefore, the actual results of the future events described in such forward-looking statements could differ materially from those

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stated in such forward-looking statements. Among the factors that could cause actual results to differ materially are: (i) changes in general economic conditions; (ii) regulatory and tax developments, including, but not limited to the Company’s ability to comply with Revenue Procedure 2002-21, and possible adverse application of various federal, state and local regulations; (iii) changes in the Company’s direct costs and operating expenses including, but not limited to, increases in health insurance premiums, increases in underlying health insurance claims trends, workers’ compensation rates and state unemployment tax rates, liabilities for employee and client actions or payroll-related claims, changes in the costs of expanding into new markets, and failure to manage growth of the Company’s operations; (iv) the estimated costs and effectiveness of capital projects and investments in technology and infrastructure, including the Company’s ability to maintain adequate financing for such projects; (v) the Company’s ability to effectively implement its 401(k) recordkeeping services; (vi) the effectiveness of the Company’s sales and marketing efforts, including the Company’s marketing arrangements with American Express and other companies; (vii) the failure to sell Administaff Financial Management Services, Inc.; (viii) changes in the competitive environment in the PEO industry, including the entrance of new competitors and the Company’s ability to renew or replace client companies; (ix) the Company’s liability for worksite employee payroll and benefits costs; and (x) an adverse final judgment or settlement of claims against the Company, including the Aetna lawsuit. These factors are discussed in detail in the Company’s 2002 annual report on Form 10-K and elsewhere in this report. Any of these factors, or a combination of such factors, could materially affect the results of the Company’s operations and whether forward-looking statements made by the Company ultimately prove to be accurate.

ITEM 4. CONTROLS AND PROCEDURES.

In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2003, in all material respects, to provide reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There has been no change in the Company’s internal controls over financial reporting that occurred during the three months ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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PART II

ITEM 1. LEGAL PROCEEDINGS.

See Note 6 to financial statements, which is incorporated herein by reference.

ITEM 4. SUBMISSION OF MATERS TO A VOTE OF SECURITY HOLDERS.

An Annual Meeting of Stockholders of the Company was held on May 8, 2003. At the Meeting, holders of 24,282,573 shares of common stock were present in person or by proxy, which constituted a quorum thereof. The vote of stockholders in respect of the two proposals voted on at the Meeting, both of which were approved, is set for the below:

1. Election of Class II Directors to serve until the Annual Meeting of Stockholders in 2006.


	For		Withheld

Paul J. Sarvadi		21,011,980		3,270,593
Austin P. Young		21,201,000		3,081,573

Directors continuing in office were Michael W. Brown, Jack M. Fields, Jr., Paul S. Lattanzio, Gregory E. Petsch and Richard G. Rawson.

2. Ratification of Ernst & Young, LLP as the Company’s independent auditors for the year ending December 31, 2003.


For		Against		Abstain

	20,843,845		3,325,743		112,985

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) List of exhibits.

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(b) Reports on Form 8-K.

Current Report on Form 8-K dated May 1 2003, furnishing Items 9 and 12 for a press release announcing 2003 first quarter results.

* Portions of the exhibit have been omitted pursuant to a request for confidential treatment.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Administaff, Inc.

Date: August 12, 2003	By:	/s/ Richard G. Rawson

		Richard G. Rawson Executive Vice President of Administration and Chief Financial Officer (Principal Financial Officer)

Date: August 12, 2003	By:	/s/ Douglas S. Sharp

		Douglas S. Sharp Vice President, Finance (Principal Accounting Officer)

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EXHIBIT
NUMBER		DESCRIPTION

10.1		Letter Agreement dated June 20, 2003 between Administaff and United Healthcare Small Business Group. *

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.

* Portions of the exhibit have been omitted pursuant to a request for confidential treatment.

EX-10.1 3 h08184exv10w1.htm LETTER AGREEMENT DATED JUNE 20, 2003 exv10w1

EXHIBIT 10.1

CONFIDENTIAL TREATMENT REQUESTED

Howard G. Buff
Vice President, Benefits and
Corporate Human Resources
Phone: 281-348-2985

June 20, 2003

Mr. Simeon Schindelman, President
UnitedHealthcare Small Business Group
5901 Lincoln Drive
MN012-NL23
Edina, MN 55436

Dear Simeon:

We believe that the contents of this letter sets forth our agreement as to modifications to the terms of our existing contracts and other agreements. The contracts being modified are the Minimum Premium Financial Agreement, Minimum Premium Administrative Services Agreement, and the Security Deposit Agreement. Please execute this letter on the appropriate signature line below indicating the agreement of UnitedHealthcare to the modifications and return a signed copy to me. After the letter has been signed by you, we will work together to incorporate the modifications into the existing contracts.

Profit/Risk Charge and Pharmacy Rebates
We have agreed that effective October 1, 2003, UnitedHealthcare will reduce the profit/risk charge to ***%. Further, UnitedHealthcare will retain all pharmacy rebates subject to the disclosure provisions in the existing agreements.

Security Deposit
We have agreed that UnitedHealthcare will reduce the balance of the Security Deposit to a flat amount of $17.5 million, effective December 31, 2003. The refund of $7.5 million in excess of $17.5 million, plus accrued interest, shall be returned to Administaff by January 31, 2004.

Premium Stabilization Reserve
We have agreed that, at Administaff’s request, UnitedHealthcare will negotiate terms of an agreement under which a premium stabilization reserve or equivalent thereof to be held by UnitedHealthcare would operate to reduce or eliminate the balance of the Security Deposit subsequent to such an agreement. Any premium reserve fund established would, when combined with the remaining security deposit, provide UnitedHealthcare the same required or needed overall level of risk protection.

*** indicates material has been omitted pursuant to a Confidential Treatment Request filed with the Securities and Exchange Commission. A complete copy of this agreement has been filed separately with the Securities and Exchange Commission.

Mr. Simeon Schindelman
Page 2

Rate Setting Methodology
We have agreed in principle to change the Rate Setting Methodology. Towers Perrin and Jay Jaeger will work together to develop fully a methodology for setting prospective rates which is consistent with the methodology set forth below which was included in Kim Bacon’s letter of May 15, 2003. In addition, the rate setting process will include a reporting mechanism that will provide the information necessary for Towers Perrin and Administaff to understand the factors used in the rate calculations.

The methodology for setting funding rates beginning with the first quarter of 2004 (that is based on the Actuarial Standard of Practice No.31—Documentation of Health Benefit Plan Ratemaking) will be as follows; subject to any refinements approved by Jay Jaeger and Towers Perrin:

1) Use a rolling ***-months of paid claims to estimate future PEPM claims. For example, Q2 2004 premiums would use *** through *** paid claims experience, since Q2 premiums would be provided by UnitedHealthcare in December 2003.

2) Use a ***-month lag for headcount to come up with the PEPM rate before trends, adjustments, etc. For example, if the claims used are from *** through *** (to estimate Q2 2004 rates), the enrollment count used should be *** through ***.

3) Apply the following health cost risk factors to reflect changes between the base period and the future predicted period. In the example we have been using, the base period is *** through *** and the future predicted period is Q2 2004. The health cost risk factors are:

Age
Gender distribution
Family size distribution
Geographic distribution
Enrollment distribution by plan type (HMO, PPO, etc.)
Plan design changes

The change in costs due to these health risk factors should be actuarially justifiable, i.e., using credible database and tools agreed upon by Administaff and UnitedHealthcare. Further, the tabular data used to make adjustments should be documented and discussed, and should change no more frequently than annually.

4) UnitedHealthcare undoubtedly uses some form of *** in their own small group underwriting accounting. A *** should be developed for Administaff and Administaff should have the option of paying this *** to minimize *** fluctuation in experience.

5) UnitedHealthcare will use trend separately for ***. In addition, trend period will reflect mid-point of base period (with *** months lag) to mid-point of projected period. This should eliminate the need to calculate change in IBNR in the calculations.

6) Administration costs should be reflected in the rate calculations as a separate item with individual items for ***.

7) Components of claims costs should be segregated for ***, etc.

UnitedHealthcare will notify Administaff *** days in advance of any change in the methodology before the next coming rate cycle. In addition, UnitedHealthcare will include the details of rate calculations in a renewal package every quarter and will review them with Administaff.

Mr. Simeon Schindelman
Page 3

Additionally, effective the first quarter of 2004, the following deficit/surplus recovery process shall be utilized. If UnitedHealthcare notifies Administaff that an unrecovered deficit or unrefunded surplus exists as of the end of a calendar quarter in connection with its applicable quarterly review, UnitedHealthcare may adjust the rates for the *** successive calendar quarters beginning no earlier than *** days subsequent to such notice.

Further, if a an unrecovered deficit at the end of a quarter exceeds ***% of aggregate quarterly premiums for such quarter, UnitedHealthcare will have the ability to recover such amount more quickly than *** quarters.

Exclusivity
We have agreed to a modification to the exclusivity provisions of the contracts as described below. In that regard, through the course of detailed market discussions, Administaff and UnitedHealthcare will determine the circumstances under which a modified carrier offering will be a viable alternative to our current approach in any or all of the following six markets for 2004.

1. ***

2. ***

3. ***

4. ***

5. ***

6. ***

Detailed discussions for these markets will include the following:

• Pricing, product and other competitive information.

• Specific expected advantages to be gained through another carrier offering.

• Discussion and determination of how another carrier option would be introduced and offered to customers. This would include price, contribution, product and benefit plan design differences, employee level choice versus customer level choice, etc.

• Discussion of whether some combination of different or additional offerings through UnitedHealthcare would best serve Administaff.

• Based upon these discussions, the existing product options available through UnitedHealthcare, and the size and product distribution of the existing membership in each market, UnitedHealthcare would then decide to:

1. Continue to be offered as an HMO and/or PPO option at the *** level (a customer could have more than ***).

2. Continue to be offered as an HMO and/or PPO option at the *** level only with all *** selecting plans offered only through ***.

3. Elect to no longer be offered as an option in that market.

• Decisions and changes in offering status may also have pricing implication.

The provisions regarding exclusivity change notice and cure periods contained within the existing contracts will not apply to these six markets for all periods after UnitedHealthcare and Administaff have reached agreement on the details of Administaff’s introduction of carrier alternatives in these markets.

Mr. Simeon Schindelman
Page 4

Sincerely,

/s/ Howard Buff

Howard Buff

ACCEPTED and AGREED to:


By:		/s/ Simeon Schindelman Simeon Schindelman President UnitedHealthcare Small Business Group

cc:		Ron White, UnitedHealth Group Jay Jaeger, UnitedHealthcare Steve Walli, UnitedHealthcare Mike Barbour, Towers Perrin Kim Bacon, Administaff Simeon Schindelman, UnitedHealthcare

EX-31.1 4 h08184exv31w1.htm CERTIFICATION OF CEO PURSUANT TO SECTION 302 exv31w1

Exhibit 31.1

CERTIFICATION

I, Paul J. Sarvadi, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Administaff, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: August 12, 2003
		/s/ Paul J. Sarvadi

		Paul J. Sarvadi President and Chief Executive Officer

EX-31.2 5 h08184exv31w2.htm CERTIFICATION OF CFO PURSUANT TO SECTION 302 exv31w2

Exhibit 31.2

CERTIFICATION

I, Richard G. Rawson, certify that:


Date: August 12, 2003
		/s/ Richard G. Rawson

		Richard G. Rawson Executive Vice President of Administration, Chief Financial Officer and Treasurer

EX-32.1 6 h08184exv32w1.htm CERTIFICATION OF CEO PURSUANT TO SECTION 906 exv32w1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Administaff, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2003 (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, I, Paul J. Sarvadi, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Paul J. Sarvadi

Paul J. Sarvadi
President and Chief Executive Officer
August 12, 2003

A signed original of this written statement required by Section 906 has been provided to Administaff, Inc. and will be retained by Administaff, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 7 h08184exv32w2.htm CERTIFICATION OF CFO PURSUANT TO SECTION 906 exv32w2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Administaff, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2003 (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, I, Richard G. Rawson, Executive Vice President of Administration and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Richard G. Rawson

Richard G. Rawson
Executive Vice President of Administration and Chief Financial Officer
August 12, 2003

•		Revenue and direct cost recognition – The Company accounts for its revenues in accordance with Emerging Issues Task Force (“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 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.

		Historically, the Company has included both components of its gross billings in revenues (gross method) due primarily to the assumption of significant contractual rights and obligations associated with being an employer, including the obligation for the payment of the payroll costs of its worksite employees. The Company assumes its employer obligations regardless of whether the Company collects its gross billings. After discussions with the Securities and Exchange Commission staff, effective December 31, 2002, the Company changed its presentation of revenues from the gross method to an approach that presents its revenues net of worksite

		employee payroll costs (net method) primarily because the Company is not generally responsible for the output and quality of work performed by the worksite employees. 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.

		To conform to the net method, the Company reclassified worksite employee payroll costs of $956 million and $1.9 billion for the three months and six months ended June 30, 2002, respectively, from direct costs to an offset of revenues. This reclassification had no effect on gross profit, operating income (loss), or net income (loss).

		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 premiums.

•		Benefits 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 and Blue Cross and Blue Shield of Georgia, all of which provide fully insured policies. 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 of June 30, 2003, the Company’s security deposit totaled $25 million. In January 2004, the security deposit will be adjusted to $17.5 million, at which time the $7.5 million security deposit reduction, plus accrued interest, is to be returned to the Company. As a result of these contractual terms, the Company accounts for this plan using a partially self-funded insurance accounting model, under which the Company must estimate its incurred but not reported (“IBNR”) claims at the end of each accounting period. If the estimated IBNR claims, paid claims, taxes and administrative fees are collectively greater than the premiums paid to United, an accumulated deficit in the plan would be incurred and the Company would accrue a current liability on its balance sheet up to the amount of the security deposit, which would increase benefits expense and decrease net income in the period that such determination was made. On the other hand, if the estimated IBNR claims, paid claims, taxes and administrative fees are collectively less than the premiums paid to United, an accumulated surplus in the plan would be incurred and the Company would record this surplus as a current asset, which would reduce benefits expense

		and increase net income in the period that such a determination was made. As of June 30, 2003, the Company has estimated an IBNR component at approximately $34.3 million.

		During the six months ended June 30, 2003, the Company recorded an estimated surplus of approximately $9.9 million, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003. For the six months ended June 30, 2003, the Company’s total United Plan costs were approximately $145.1 million.

•		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. The Company must estimate its expected SUI tax rate in those states for which tax rate notices have not yet been received.

		In January 2002, as a result of a corporate restructuring plan, the Company filed for a partial transfer of compensation experience with the state of Texas. On October 30, 2002, the Texas Workforce Commission (“TWC”) approved Administaff’s application for a partial transfer of compensation experience.

		Pending computation of the Company’s Texas unemployment tax rate, the Company paid its unemployment taxes to the state of Texas at the higher new employer rate as required by state law, resulting in a $6.0 million prepayment balance as of December 31, 2002. In July 2003, in lieu of requesting a refund, the TWC allowed the Company to apply the prepayment balance to the estimated first quarter and second quarter 2003 tax liabilities, resulting in a remaining prepaid balance of $1.7 million at June 30, 2003. The Company also received its initial 2002 and 2003 unemployment tax rate computations from the TWC in July 2003. While the Company is currently reviewing the computations with the TWC, it does not expect the final rates to have any negative impact to the estimates used to record payroll taxes.

•		Workers’ compensation costs – The Company’s workers’ compensation insurance policy for the two-year period ending September 30, 2003 is a guaranteed-cost policy under which premiums are paid for full-insurance coverage of all claims incurred during the policy. This policy also contains a dividend feature for each policy year, under which the Company is 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 the policy year are 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 estimates the amount of refund, if any, that has 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 the Company’s estimates were to indicate that an additional dividend had been earned, the Company would record a receivable for the amount of that dividend and decrease its workers’ compensation insurance expense, which would increase net income in the period

		that such determination was made. On the other hand, if the Company’s estimates were to indicate that the amount of any recorded dividend receivable had been reduced due to greater than anticipated claim developments, the Company would reduce its receivable and increase its workers’ compensation insurance expense, which would reduce net income in the period that such determination was made. 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. The Company is currently in the process of reviewing final proposals for replacement coverage which is scheduled to be effective September 1, 2003. In addition, the Company recorded a charge of $2.5 million in the second quarter of 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.

•		Contingent liabilities – The Company accrues and discloses contingent liabilities in its 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. The Company has disclosed in its audited financial statements several issues that it believes are reasonably possible to occur, although it cannot determine the range of possible loss in all cases. As these issues develop, the Company 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 reasonably estimated, the Company would be required to accrue its estimated loss, which would reduce net income in the period that such determination was made.

•		Deferred taxes – The Company has recorded a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, the Company’s ability to realize its deferred tax assets could change from its current estimates. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period that such determination is made. Likewise, should the Company determine that it will not be able to realize all or part of its 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 – The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to pay its comprehensive service fees. The Company believes that the success of its business is heavily dependent on its ability to collect these comprehensive service fees for several reasons, including: (i) the fact that the Company is at risk for the payment of its direct costs and worksite employee payroll costs regardless of whether its clients pay their comprehensive

		service fees; (ii) the large volume and dollar amount of transactions processed by the Company; and (iii) the periodic and recurring nature of payroll, upon which the comprehensive service fees are based. To mitigate this risk, the Company has established very tight credit policies. The Company generally requires its clients to pay their comprehensive service fees no later than one day prior to the applicable payroll date. In addition, the Company maintains the right to terminate its Client Service Agreement and associated worksite employees or to require prepayment, letters of credit or other collateral upon deterioration in a client’s financial position or upon nonpayment by a client. As a result of these efforts, the outstanding balance of accounts receivable and subsequent losses related to customer nonpayment has historically been very low as a percentage of revenues. However, if the financial condition of the Company’s customers were to deteriorate rapidly, resulting in nonpayment, the Company’s accounts receivable balances could grow and the Company could be required to provide for additional allowances, which would decrease net income in the period that such determination was made.

•		Property and equipment – The Company’s property and equipment relate primarily to its 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 the useful lives of these assets were determined to be shorter than their current estimates, the Company’s depreciation and amortization expense could be accelerated, which would decrease net income in the periods following such a determination. In addition, the Company periodically evaluates 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 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, 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. In January 2003, the Company committed to a plan to sell Administaff Financial Management Services, Inc. (“FMS”) and initiated a program to market the division and locate a buyer. As a result, FMS is being reported as a discontinued operation in accordance with SFAS No. 144. As of June 30, 2003, the net book value of FMS was approximately $1.1 million. Failure to sell FMS at an amount at least equal to the net book value would result in the Company incurring and recording a loss on the disposal of FMS.

		experience resulting from its restructuring, would be approved. While the Company has received a determination from the Texas Workforce Commission that its partial transfer application was approved, the Company has continued to estimate its state unemployment tax expense until its final official tax rates for calendar years 2002 and 2003 are determined. See “Critical Accounting Policies and Estimates – State Unemployment Taxes” on page 19 for a discussion of this matter.

•		Benefits costs – The cost of health insurance and related employee benefits increased 1.6% or $13 per worksite employee per month over the second quarter of 2002. This increase is due to a 9.1% increase in the cost per covered employee offset by a decrease in the percentage of worksite employees covered under the Company’s health insurance plans to 70.5% in the 2003 period from 74.4% in the 2002 period. The increase in benefits costs during the three months ended June 30, 2003 were mitigated in part by the impact of the cost savings derived from the benefit plan design changes initiated by the Company in January 2003. During the three months ended June 30, 2003, the Company recorded an estimated surplus of approximately $6.1 million related to the Company’s health insurance plan with United, resulting in an accumulated surplus from the inception of the plan of approximately $7.7 million as of June 30, 2003. See “Critical Accounting Policies and Estimates – Benefits Costs” on page 18 for a discussion of the Company’s accounting for health insurance costs.

•		Workers’ compensation costs – Workers’ compensation costs increased $17 on a per worksite employee per month basis over the second quarter of 2002, and increased to 1.58% of payroll cost in the 2003 period from 1.19% in the 2002 period. The primary cause of the increase was the $2.5 million charge related to the write-off of the Company’s workers’ compensation dividend receivable. The charge was taken due to credit concerns caused by recent downgrades of its workers’ compensation carrier. See “Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 19 and “Other Matters – Workers’ Compensation Costs” on page 34 for a discussion of the Company’s accounting for workers’ compensation costs.

•		Salaries, wages and payroll taxes of corporate and sales staff increased 8.1%, or $8 per worksite employee per month, compared to the 2002 period, primarily due to an accrual relating to the Company’s 2003 incentive compensation plan, which is payable only upon the achievement of certain predetermined annual goals.

•		General and administrative expenses increased 6.4%, or $5 per worksite employee per month, compared to the second quarter of 2002. The increase resulted primarily from increases in legal costs associated with the lawsuit with Aetna, the Company’s former health insurance carrier.

•		Commissions expense decreased 9.8%, or $1 per worksite employee per month, compared to the 2002 period, due to the decline in paid worksite employees from new client sales.

•		Advertising costs increased 7.1% or $1 per worksite employee per month, compared to the second quarter of 2002 primarily due to the national advertising campaign initiated in 2003.

•		Depreciation and amortization expense increased 2.2%, or $1 per worksite employee per month, over the 2002 period as a result of the increased capital assets placed in service in the last quarter of 2002. These capital assets consist primarily of the new corporate headquarters facilities.

•		Salaries, wages and payroll taxes of corporate and sales staff increased 9.0%, or $7 per worksite employee per month, compared to the 2002 period, primarily due to an accrual relating to the Company’s 2003 incentive compensation plan, which is payable only upon the achievement of certain predetermined annual goals.

•		General and administrative expenses increased 2.8%, or $1 per worksite employee per month, compared to the first half of 2002. The increase resulted primarily from increases in legal costs associated with the lawsuit with Aetna, the Company’s former health insurance carrier, and was offset by decreases in other expenses including data communications and telephone expenses.

•		Commissions expense decreased 8.9%, or $2 per worksite employee per month, compared to the 2002 period, due to the decline in paid worksite employees from new client sales.

•		Advertising costs increased 21.5% or $2 per worksite employee per month, compared to the first half of 2002 primarily due to the national advertising campaign initiated in 2003.

•		Depreciation and amortization expense increased 4.9%, or $1 per worksite employee per month, over the 2002 period as a result of the increased capital assets placed in service in the last quarter of 2002. These capital assets consist primarily of the new corporate headquarters facilities.

			Directors continuing in office were Michael W. Brown, Jack M. Fields, Jr., Paul S. Lattanzio, Gregory E. Petsch and Richard G. Rawson.

	2.		Ratification of Ernst & Young, LLP as the Company’s independent auditors for the year ending December 31, 2003.

			The methodology for setting funding rates beginning with the first quarter of 2004 (that is based on the Actuarial Standard of Practice No.31—Documentation of Health Benefit Plan Ratemaking) will be as follows; subject to any refinements approved by Jay Jaeger and Towers Perrin:

	1)		Use a rolling *-months of paid claims to estimate future PEPM claims. For example, Q2 2004 premiums would use * through *** paid claims experience, since Q2 premiums would be provided by UnitedHealthcare in December 2003.

	2)		Use a *-month lag for headcount to come up with the PEPM rate before trends, adjustments, etc. For example, if the claims used are from * through * (to estimate Q2 2004 rates), the enrollment count used should be * through ***.

	3)		Apply the following health cost risk factors to reflect changes between the base period and the future predicted period. In the example we have been using, the base period is * through * and the future predicted period is Q2 2004. The health cost risk factors are:

			The change in costs due to these health risk factors should be actuarially justifiable, i.e., using credible database and tools agreed upon by Administaff and UnitedHealthcare. Further, the tabular data used to make adjustments should be documented and discussed, and should change no more frequently than annually.

	4)		UnitedHealthcare undoubtedly uses some form of * in their own small group underwriting accounting. A * should be developed for Administaff and Administaff should have the option of paying this * to minimize * fluctuation in experience.

	5)		UnitedHealthcare will use trend separately for *. In addition, trend period will reflect mid-point of base period (with * months lag) to mid-point of projected period. This should eliminate the need to calculate change in IBNR in the calculations.

	6)		Administration costs should be reflected in the rate calculations as a separate item with individual items for ***.

	7)		Components of claims costs should be segregated for ***, etc.

			UnitedHealthcare will notify Administaff *** days in advance of any change in the methodology before the next coming rate cycle. In addition, UnitedHealthcare will include the details of rate calculations in a renewal package every quarter and will review them with Administaff.

	1.	***

	2.	***

	3.	***

	4.	***

	5.	***

	6.	***

Detailed discussions for these markets will include the following:

	•	Pricing, product and other competitive information.

	•	Specific expected advantages to be gained through another carrier offering.

	•	Discussion and determination of how another carrier option would be introduced and offered to customers. This would include price, contribution, product and benefit plan design differences, employee level choice versus customer level choice, etc.

	•	Discussion of whether some combination of different or additional offerings through UnitedHealthcare would best serve Administaff.

	•	Based upon these discussions, the existing product options available through UnitedHealthcare, and the size and product distribution of the existing membership in each market, UnitedHealthcare would then decide to:

		1.	Continue to be offered as an HMO and/or PPO option at the * level (a customer could have more than *).

		2.	Continue to be offered as an HMO and/or PPO option at the * level only with all * selecting plans offered only through ***.

		3.	Elect to no longer be offered as an option in that market.

	•	Decisions and changes in offering status may also have pricing implication.

1.		I have reviewed this quarterly report on Form 10-Q of Administaff, Inc.;

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(c)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.