NSP

Business Context and Reporting Period

Company: Administaff, Inc. (Note: Metadata listed "INSPERITY, INC." but the filing text identifies the registrant as Administaff, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: Administaff is a Professional Employer Organization (PEO) providing bundled personnel management services, including payroll, benefits administration, and workers' compensation insurance. Texas markets represented 31% of total revenues for the six months ended June 30, 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 11.6% for the quarter and 11.7% for the six-month period compared to 2007. This was driven by a 7.2% increase in average worksite employees and a 4.1% increase in revenue per employee.
• Profitability:
  • Quarterly: Net income decreased 19.5% to $11.0 million, primarily due to a 13.9% increase in operating expenses outpacing revenue growth.
  • Six-Month: Net income increased 9.6% to $24.1 million. Operating income rose 18.4% due to improved gross profit margins (up 16.5%) which offset higher operating expenses.
• Cost Pressures: Direct costs increased due to higher health insurance costs ($29/employee/month increase) and payroll taxes. Operating expenses rose 13.9% quarterly, driven by corporate headcount growth, stock-based compensation, and software development initiatives.
• Cash Flow: Net cash provided by operating activities turned negative at $(7.8) million for the six months ended June 30, 2008, compared to $27.0 million in the prior year. This was largely due to timing differences in payroll funding and increased funding for workers' compensation claims.

Outlook, Risks, and Unusual Items

• Auction Rate Securities (ARS) Liquidity: The company holds $11.7 million in ARS. Due to market liquidity issues, auctions for certain securities failed in early 2008. While the company believes credit quality is intact and no impairment was recorded, $7.9 million has been reclassified to non-current assets due to limited liquidity.
• Colorado Unemployment Tax Dispute: The State of Colorado is reviewing prior corporate reorganizations to determine if unemployment accounts should be combined, potentially resulting in higher tax rates. No formal assessment has been issued, and the company cannot determine the ultimate liability.
• Workers' Compensation Carrier Risk: The company notes a "run-off" status for a former carrier (Kemper). If Kemper enters liquidation, state guaranty associations may attempt to return liability for remaining claims to Administaff, which could materially affect net income.
• Acquisition: In April 2008, the company purchased assets of U.S. Datalink, Limited for $4.2 million to expand employee screening services.
• Capital Allocation: The company repurchased $16.5 million of treasury stock and paid $5.7 million in dividends during the first six months of 2008.

Investor Verification Checklist

• ARS Liquidity Status: Verify the current market status of the $11.7 million in auction rate securities and any potential future impairment charges if liquidity does not return.
• Colorado Tax Liability: Monitor the outcome of the Colorado Department of Labor review regarding unemployment tax account consolidation.
• Operating Cash Flow Volatility: Review the reconciliation of net income to operating cash flow, noting the significant impact of timing in payroll funding and insurance claim deposits.
• Health Insurance Costs: Assess the sustainability of the $29 per employee monthly increase in health insurance costs and its impact on future gross margins.
• Former Carrier Exposure: Evaluate the potential financial impact of the Kemper "run-off" situation and any potential claims returned by state guaranty associations.