Insperity (NSP) 10-Q 2008 Q2 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2008.

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 (State or other jurisdiction of incorporation or organization)	76-0479645 (I.R.S. Employer Identification No.)
19001 Crescent Springs Drive Kingwood, Texas (Address of principal executive offices)	77339 (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.

          Yesþ       Noo

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filerþ	Accelerated filero	Non-accelerated filero	Smaller reporting companyo
		(Do not check if a smaller reporting company)

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

          Yeso       Noþ

          As of July 28, 2008, 26,038,481 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

TABLE OF CONTENTS

Part I
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3. Quantitative and Qualitative Disclosures About Market Risk	31
Item 4. Controls and Procedures	32
Part II
Item 1. Legal Proceedings	33
Item 1a. Risk Factors	33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 4. Submission of Matters to a Vote of Security Holders	35
Item 6. Exhibits	36
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

PART I

ITEM 1. FINANCIAL STATEMENTS

ADMINISTAFF, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS

	June 30,			December 31,
	2008			2007
	(Unaudited)
Current assets:
Cash and cash equivalents	$	158,637		$	135,793
Restricted cash		34,320			35,318
Marketable securities		3,831			74,880
Accounts receivable, net:
Trade		2,594			3,299
Unbilled		153,955			125,318
Other		3,109			6,217
Prepaid insurance		21,758			22,395
Other current assets		8,455			6,273
Income taxes receivable		—			3,918
Total current assets		386,659			413,411
Property and equipment:
Land		2,920			2,920
Buildings and improvements		62,679			61,620
Computer hardware and software		65,866			65,518
Software development costs		22,405			21,624
Furniture and fixtures		33,134			32,004
Aircraft		22,032			21,909
		209,036			205,595
Accumulated depreciation and amortization		(130,590	)		(127,654	)
Total property and equipment, net		78,446			77,941
Marketable securities		7,850			—
Prepaid health insurance		9,000			9,000
Deposits – healthcare		2,705			2,811
Deposits – workers’ compensation		65,530			51,909
Goodwill and other intangible assets, net		8,948			4,785
Other assets		739			794
Total other assets		94,772			69,299
Total assets	$	559,877		$	560,651

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

LIABILITIES AND STOCKHOLDERS’ EQUITY

	June 30,			December 31,
	2008			2007
	(Unaudited)
Current liabilities:
Accounts payable	$	3,663		$	5,236
Payroll taxes and other payroll deductions payable		76,116			113,929
Accrued worksite employee payroll cost		140,201			110,406
Accrued health insurance costs		15,328			19,297
Accrued workers’ compensation costs		36,731			37,150
Accrued corporate payroll and commissions		16,241			20,123
Other accrued liabilities		8,922			8,395
Current portion of capital lease obligations		652			629
Income tax payable		993			—
Deferred income taxes		2,790			1,066
Total current liabilities		301,637			316,231
Noncurrent liabilities:
Accrued workers’ compensation costs		43,299			39,116
Capital lease obligations		205			537
Deferred income taxes		7,299			6,092
Total noncurrent liabilities		50,803			45,745
Commitments and contingencies
Stockholders’ equity:
Common stock		309			309
Additional paid-in capital		138,977			138,640
Treasury stock, at cost		(133,572	)		(123,600	)
Accumulated other comprehensive income, net of tax		3			5
Retained earnings		201,720			183,321
Total stockholders’ equity		207,437			198,675
Total liabilities and stockholders’ equity	$	559,877		$	560,651

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,
	2008			2007			2008			2007
Revenues (gross billings of $2.456 billion, $2.191 billion, $5.010 billion and $4.465 billion, less worksite employee payroll cost of $2.036 billion, $1.814 billion, $4.133 billion and $3.681 billion, respectively)	$	420,469		$	376,758		$	876,535		$	784,516
Direct costs:
Payroll taxes, benefits and workers’ compensation costs		336,408			298,291			705,867			637,982
Gross profit		84,061			78,467			170,668			146,534
Operating expenses:
Salaries, wages and payroll taxes		37,427			33,076			74,406			65,121
Stock-based compensation		2,908			2,435			5,293			3,743
General and administrative expenses		16,923			14,276			35,662			30,222
Commissions		3,274			2,704			6,368			5,623
Advertising		4,158			3,958			7,936			6,060
Depreciation and amortization		3,799			3,704			7,445			7,424
		68,489			60,153			137,110			118,193
Operating income		15,572			18,314			33,558			28,341
Other income (expense):
Interest income		1,876			2,987			4,383			5,984
Other, net		(7	)		(29	)		(40	)		(52	)
Income before income taxes		17,441			21,272			37,901			34,273
Income tax expense		6,454			7,627			13,758			12,235
Net income	$	10,987		$	13,645		$	24,143		$	22,038
Basic net income per share of common stock	$	0.43		$	0.51		$	0.95		$	0.81
Diluted net income per share of common stock	$	0.43		$	0.50		$	0.94		$	0.79

See accompanying notes.

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ADMINISTAFF, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2008
(in thousands)
(Unaudited)

											Accumulated
	Common Stock				Additional						Other
	Issued				Paid-In			Treasury			Comprehensive			Retained
	Shares		Amount		Capital			Stock			Income (Loss)			Earnings			Total
Balance at December 31, 2007		30,839	$	309	$	138,640		$	(123,600	)	$	5		$	183,321		$	198,675
Purchase of treasury stock		—		—		—			(16,530	)		—			—			(16,530	)
Exercise of stock options		—		—		(846	)		2,195			—			—			1,349
Income tax benefit (expense) from stock-based compensation, net		—		—		(83	)		—			—			—			(83	)
Stock-based compensation expense		—		—		1,248			4,045			—			—			5,293
Other		—		—		18			318			—			—			336
Dividends paid		—		—		—			—			—			(5,744	)		(5,744	)
Change in unrealized gain on marketable securities, net of tax:
Unrealized loss		—		—		—			—			(2	)		—			(2	)
Net income		—		—		—			—			—			24,143			24,143
Comprehensive income																		24,141
Balance at June 30, 2008		30,839	$	309	$	138,977		$	(133,572	)	$	3		$	201,720		$	207,437

See accompanying notes.

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

	Six Months Ended
	June 30,
	2008			2007
Cash flows from operating activities:
Net income	$	24,143		$	22,038
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		7,453			7,423
Stock-based compensation		5,293			3,743
Deferred income taxes		2,931			3,074
Changes in operating assets and liabilities:
Restricted cash		998			1,613
Accounts receivable		(24,824	)		715
Prepaid insurance		(334	)		4,802
Other current assets		(2,182	)		(2,405	)
Other assets		(14,392	)		11,968
Accounts payable		(1,573	)		(495	)
Payroll taxes and other payroll deductions payable		(37,813	)		(27,285	)
Accrued worksite employee payroll expense		29,795			8,078
Accrued health insurance costs		(2,998	)		70
Accrued workers’ compensation costs		3,764			(1,179	)
Accrued corporate payroll, commissions and other accrued liabilities		(2,935	)		(8,274	)
Income taxes payable/receivable		4,911			3,145
Total adjustments		(31,906	)		4,993
Net cash provided by (used in) operating activities		(7,763	)		27,031
Cash flows from investing activities:
Marketable securities:
Purchases		—			(70,943	)
Proceeds from maturities		2,395			950
Proceeds from dispositions		60,795			69,239
Cash exchanged for acquisition		(3,780	)		—
Property and equipment:
Purchases		(7,906	)		(5,509	)
Proceeds from dispositions		84			14
Net cash provided by (used in) investing activities		51,588			(6,249	)

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

	Six Months Ended
	June 30,
	2008			2007
Cash flows from financing activities:
Purchase of treasury stock	$	(16,530	)	$	(47,973	)
Dividends paid		(5,744	)		(6,065	)
Proceeds from the exercise of stock options		1,349			1,972
Principal repayments on capital lease obligations		(309	)		(286	)
Income tax benefit (expense) from stock-based compensation, net		(83	)		1,721
Other		336			366
Net cash used in financing activities		(20,981	)		(50,265	)
Net increase (decrease) in cash and cash equivalents		22,844			(29,483	)
Cash and cash equivalents at beginning of period		135,793			148,416
Cash and cash equivalents at end of period	$	158,637		$	118,933
Supplemental disclosures:
Cash paid for income taxes	$	6,093		$	4,408

See accompanying notes.

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ADMINISTAFF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2008

1. Basis of Presentation

          Administaff, Inc. (“Administaff” or 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, 2008 and 2007, revenues from the Company’s Texas markets represented 31% and 32% of the Company’s total revenues, respectively.

          In April 2008, the Company purchased certain assets and operations of U.S. Datalink, Limited, an employee screening services company, for $4.2 million, including $420,000 to be paid in April 2009. An additional $300,000 is payable in 2009 upon the satisfaction of certain conditions, as specified in the purchase agreement.

          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 accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

          The accompanying consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2007. The Consolidated Balance Sheet at December 31, 2007, has been derived from the audited financial statements at that date, but does not include all of the information or footnotes required by accounting principles generally accepted in the United States for complete financial statements. The Company’s Consolidated Balance Sheet at June 30, 2008, and the Consolidated Statements of Operations, Cash Flows and Stockholders’ Equity for the periods ended June 30, 2008 and 2007, 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.

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2. Accounting Policies

Health Insurance Costs

          The Company provides group health insurance coverage to its worksite employees through a national network of carriers including UnitedHealthcare (“United”), PacifiCare, Kaiser Permanente, Blue Cross and Blue Shield of Georgia, Blue Shield of California, Hawaii Medical Service Association and Tufts, all of which provide fully insured policies or service contracts.

          The policy with United, which was first obtained in January 2002, provides the majority of the Company’s health insurance coverage. As a result of certain contractual terms, the Company has accounted for this plan since its inception using a partially self-funded insurance accounting model. Accordingly, Administaff records the costs of the United Plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”) as benefits expense in the Consolidated Statements of Operations. The estimated incurred claims are based upon: (i) the level of claims processed during the quarter; (ii) recent claim development patterns under the plan, to estimate a completion rate; and (iii) the number of participants in the plan. Each reporting period, changes in the estimated ultimate costs resulting from claims trends, plan design and migration, participant demographics and other factors are incorporated into the benefits costs.

          Additionally, since the plan’s inception in January 2002, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the cash funded to United, a deficit in the plan would be incurred and the Company would accrue a liability for the excess costs on its Consolidated Balance Sheet. On the other hand, if the Plan Costs for the reporting quarter are less than the cash funded to United, a surplus in the plan would be incurred and the Company would record an asset for the excess premiums on its Consolidated Balance Sheet. As of June 30, 2008, Plan Costs were less than the net cash funded to United by $26.3 million. As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $17.3 million balance is included in prepaid insurance, a current asset, on the Company’s Consolidated Balance Sheet.

Workers’ Compensation Costs

          The Company’s workers’ compensation coverage (the “ACE Program”) is currently provided by ACE Group of Companies (“ACE”). Under the arrangement with ACE, Administaff bears the economic burden for the first $1 million layer of claims per occurrence. ACE bears the economic burden for all claims in excess of such first $1 million layer. The ACE Program is a fully insured policy whereby ACE has the responsibility to pay all claims incurred under the policy regardless of whether the Company satisfies its responsibilities.

          Prior to October 1, 2007, workers’ compensation coverage (the “AIG Program”) was provided through selected member insurance companies of American International Group, Inc. (“AIG”). The AIG Program structure was consistent with the ACE Program. AIG remains the carrier for all claim activity incurred between September 1, 2003 and September 30, 2007.

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          Because the Company bears the economic burden of the first $1 million layer of claims per occurrence, such claims, which are the primary component of the Company’s workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing healthcare and indemnity coverage whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which take into account the ongoing development of claims and therefore requires a significant level of judgment. The Company estimates its workers’ compensation costs by applying an aggregate loss development rate to worksite employee payroll levels.

          The Company employs a third party actuary to estimate its loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into the Company’s workers’ compensation claims cost estimates. During the six months ended June 30, Administaff reduced accrued workers’ compensation costs by $5.7 million in 2008 and $11.4 million in 2007 for changes in estimated losses related to prior reporting periods. Workers’ compensation cost estimates are discounted to present value at a rate based upon the U.S. Treasury rates that correspond with the weighted average estimated claim payout period (the average discount rate utilized in 2008 and 2007 was 2.8% and 5.0%, respectively) and are accreted over the estimated claim payment period and included as a component of direct costs in the Company’s Consolidated Statements of Operations.

          The following table provides the activity and balances related to accrued workers’ compensation claims for the six months ended June 30, 2008 and 2007:

	2008			2007
	(in thousands)
Beginning balance, January 1,	$	74,433		$	77,424
Accrued claims		17,563			12,584
Present value discount		(1,698	)		(1,990	)
Paid claims		(12,679	)		(11,735	)
Ending balance, June 30,	$	77,619		$	76,283
Current portion of accrued claims	$	34,320		$	35,792
Long-term portion of accrued claims		43,299			40,491
	$	77,619		$	76,283

          Under both the ACE and AIG Programs, a portion of Administaff’s monthly premiums are set aside to fund the payment of claims, and any excess premiums funded into the program are returned to the Company subsequent to the end of the policy period. As of June 30, 2008, the total funds held by ACE and AIG were $99.8 million, of which $34.3 million is included in restricted cash and $65.5 million is included in deposits in the Company’s Consolidated Balance Sheets.

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3. Investments

          The Company invests its excess cash in money market funds and debt instruments of U.S. municipalities. Administaff’s investments do not include any asset-backed securities with underlying collateral of sub-prime mortgages or home equity loans, nor do they include any collateralized debt obligations or collateralized loan obligations. All highly liquid investments with stated maturities of three months or less from date of purchase are classified as cash equivalents. Liquid investments with stated maturities of greater than three months are classified as marketable securities in current assets, while less liquid investments are classified as marketable securities in non-current assets.

          The following table summarizes the Company’s investments in cash equivalents and marketable securities held by investment managers:

	June 30,		December 31,
	2008		2007
	(in thousands)
Money market funds (cash equivalents)	$	63,916	$	9,824
Marketable securities (current assets)		3,831		74,880
Marketable securities (non-current assets)		7,850		—
Total	$	75,597	$	84,704

          The Company accounts for marketable securities in accordance with SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities. The Company determines the appropriate classification of all marketable securities as held-to-maturity, available-for-sale or trading at the time of purchase, and re-evaluates such classification as of each balance sheet date. At June 30, 2008 and December 31, 2007, all of the Company’s investments in marketable securities were classified as available-for-sale, and as a result, were reported at fair value.

          On January 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements” (SFAS 157), for financial assets and liabilities. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The fair value measurement disclosures are grouped into three levels based on valuation factors:

• Level 1 — quoted prices in active markets using identical assets;

• Level 2 — significant other observable inputs, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other observable inputs, and

• Level 3 — significant unobservable inputs.

The following table summarizes the levels of fair value measurements of the Company’s financial assets:

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	Fair Value Measurements
	(in thousands)
	June 30,
	2008		Level 1		Level 2		Level 3
Current marketable securities	$	3,831	$	—	$	3,831	$	—
Non-current marketable securities		7,850		—		—		7,850
Total	$	11,681	$	—	$	3,831	$	7,850

          All of the Company’s marketable securities investments are in debt instruments of U.S. municipalities, the majority of which are debt instruments with variable interest rates that periodically reset through an auction process, known as auction rate securities (“ARS”). As a result of the recent liquidity issues experienced in the credit and capital markets, in February and March of 2008, auctions for certain ARS held by the Company have failed. However, a failed auction does not represent a default by the issuer. Liquidity will be limited until there is a successful auction or until such time as other markets for these investments develop.

          All of the Company’s investments in ARS have continued to pay interest in accordance with the terms of the underlying security. The Company believes the credit quality of these assets has not been impacted and the current lack of liquidity in the market is temporary; therefore, no decline in market value has been recorded as of June 30, 2008. The Company has valued these investments at cost, which it believes continues to be a reasonable approximation of fair value under current circumstances.

          We have included $3.8 million in ARS as Level 2 assets, due to the significant observable inputs associated with these investments, including successful auctions of these or similar securities, but at volumes below historical levels. In addition, all Level 2 assets are secured by municipal bonds, carry an AA or better credit rating, and are insured by monoline insurance companies.

          We have included $7.9 million in ARS as Level 3 assets, due to the unobservable inputs caused by the lack of liquidity in the recent auctions. These securities represent investments in preferred shares in a municipal bond fund, which are required to maintain at least 200% asset coverage with respect to the preferred shares. Due to the current absence of a liquid market, the Company has reclassified these investments to non-current assets in the Company’s consolidated balance sheet. When liquidity for these types of investments returns in the market, these ARS will be reclassified back to current assets. The issuer of these investments has announced its intent to redeem these securities at par during 2008. As such, the Company expects to fully realize its investment upon redemption.

          The Company has the intent and ability to hold these investments until the ARS market returns to normal liquidity levels, without any significant impact to the Company’s operations. If auctions continue to fail and if the credit quality of these investments were to deteriorate in the future, or adverse developments occur in the bond insurance market, the Company may be required to record an impairment charge on these investments in the future.

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4. Stockholders’ Equity

          The Company’s Board of Directors (the “Board”) has authorized a program to repurchase up to 12,500,000 shares of the Company’s outstanding common stock. The Company has repurchased 10,996,481 shares at a total cost of $216.2 million, including 638,639 shares at a total cost of $16.5 million during the six months ended June 30, 2008, under this authorization.

          During each quarter of 2008, the board of directors declared quarterly dividends of $0.11 per share of common stock. During the six months ended June 30, total dividends of $5.7 million in 2008 and $6.1 million in 2007 have been paid.

5. Net Income Per Share

          The numerator used in the calculations of both basic and diluted net income per share for all periods presented was net income. The denominator for each period presented was determined as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2008		2007		2008		2007
Basic net income per share – weighted average shares outstanding		25,384		26,919		25,413		27,195
Effect of dilutive securities – treasury stock method:
Common stock options		308		545		300		580
Restricted stock awards		93		53		57		70
		401		598		357		650
Diluted net income per share – weighted average shares outstanding plus effect of dilutive securities		25,785		27,517		25,770		27,845
Potentially dilutive securities not included in weighted average share calculation due to anti-dilutive effect		464		878		674		760

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, 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.

State Unemployment Taxes

          During 2008, the State of Colorado Department of Labor and Employment Unemployment Insurance Division (the “Division”) notified the Company of its identification of discrepancies, originating in 2002, regarding the application of the provisions of the Employment Security Act of Colorado.  The Division has indicated that it is reviewing Administaff’s prior corporate reorganizations to determine whether the state unemployment accounts of certain Administaff subsidiaries should be combined into a single account, which could result in higher

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rates for certain prior and prospective periods. The Division has not issued a formal assessment of any additional taxes owed. The Company does not believe that the Division has any valid basis for assessing additional taxes and intends to defend itself vigorously.  As a result of the uncertainty regarding the outcome of this matter, at this time the Company is unable to determine the ultimate additional tax liability, if any, related to this matter. 

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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 our 2007 annual report on Form 10-K, as well as with our consolidated financial statements and notes thereto included in this quarterly report on Form 10-Q.

Critical Accounting Policies and Estimates

          Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to health and workers’ compensation insurance claims experience, state unemployment and payroll taxes, client bad debts, income taxes, property and equipment, goodwill and other intangibles, and contingent liabilities. Management bases these estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

          We believe the following accounting policies are critical and/or require significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

•

Benefits costs– We provide group health insurance coverage to our worksite employees through a national network of carriers including UnitedHealthcare (“United”), PacifiCare, Kaiser Permanente, Blue Cross and Blue Shield of Georgia, Blue Shield of California, Hawaii Medical Service Association and Tufts, all of which provide fully insured policies or service contracts.

The policy with United, which was first obtained in January 2002, provides the majority of our health insurance coverage. As a result of certain contractual terms, we have accounted for this plan since its inception using a partially self-funded insurance accounting model. Accordingly, we record the costs of the United Plan, including an estimate of the incurred claims, taxes and administrative fees (collectively the “Plan Costs”), as benefits expense in the Consolidated Statements of Operations. The estimated incurred claims are based upon: (i) the level of claims processed during the quarter; (ii) recent claim development patterns under the plan, to estimate a completion rate; and (iii) the number of participants in the plan. Each reporting period, changes in the estimated ultimate costs resulting from claims trends, plan design and migration, participant demographics and other factors are incorporated into the reported benefits costs.

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	Additionally, since the plan’s inception in January 2002, under the terms of the contract, United establishes cash funding rates 90 days in advance of the beginning of a reporting quarter. If the Plan Costs for a reporting quarter are greater than the cash funded to United, a deficit in the plan would be incurred and we would accrue a liability for the excess costs on our Consolidated Balance Sheet. On the other hand, if the Plan Costs for the reporting quarter are less than the cash funded to United, a surplus in the plan would be incurred and we would record an asset for the excess premiums on our Consolidated Balance Sheet. As of June 30, 2008, Plan Costs were less than the net cash funded to United by $26.3 million. As this amount is in excess of the agreed-upon $9.0 million surplus maintenance level, the $17.3 million balance is included in prepaid insurance, a current asset, in our Consolidated Balance Sheet.
•	Workers’ compensation costs– Our workers’ compensation coverage (the “ACE Program”) is currently provided by ACE Group of Companies (“ACE”). Under our arrangement with ACE, we bear the economic burden for the first $1 million layer of claims per occurrence. ACE bears the economic burden for all claims in excess of such first $1 million layer. The ACE Program is a fully insured policy whereby ACE has the responsibility to pay all claims incurred under the policy regardless of whether we satisfy our responsibilities. Prior to October 1, 2007, our coverage (the “AIG Program”) was provided through selected member insurance companies of American International Group, Inc. (“AIG”). The AIG program structure was consistent with the ACE Program. AIG remains the carrier for all claim activity incurred between September 1, 2003 and September 30, 2007.
	Because we bear the economic burden of the first $1 million layer of claims per occurrence, such claims, which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing healthcare and indemnity coverage, whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which take into account the ongoing development of claims and therefore require a significant level of judgment. Our management estimates our workers’ compensation costs by applying an aggregate loss development rate to worksite employee payroll levels.
	We employ a third party actuary to estimate our loss development rate, which is primarily based upon the nature of worksite employees’ job responsibilities, the location of worksite employees, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates. During the six months ended June 30, Administaff reduced workers’ compensation costs by $5.7 million in 2008 and $11.4 million in 2007 for changes in estimated losses related to prior reporting periods. Workers’ compensation cost estimates are discounted to present value at a rate based upon the U.S. Treasury rates that correspond with the weighted average estimated claim payout period (the average discount rate utilized in 2008 and 2007 was 2.8% and 5.0%, respectively) and are accreted over the estimated claim payment period and included as a component of direct costs in our Consolidated Statements of Operations.

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•	State unemployment taxes– We record our state unemployment (“SUI”) tax expense based on taxable wages and tax rates assigned by each state. State unemployment tax rates vary by state and are determined, in part, based on prior years’ compensation experience in each state. Prior to the receipt of final tax rates notices, we estimate our expected SUI tax rate in those states for which tax rate notices have not yet been received.
	During 2008, the State of Colorado Department of Labor and Employment Unemployment Insurance Division (the “Division”) notified Administaff of its identification of discrepancies, originating in 2002, regarding the application of the provisions of the Employment Security Act of Colorado.  The Division has indicated that it is reviewing Administaff’s prior corporate reorganizations to determine whether the state unemployment accounts of certain Administaff subsidiaries should be combined into a single account, which could result in higher rates for certain prior and prospective periods. The Division has not issued a formal assessment of any additional taxes owed. We do not believe the Division has any valid basis for assessing additional taxes and intends to defend itself vigorously.  As a result of the uncertainty regarding the outcome of this matter, at this time we are unable to determine the ultimate additional tax liability, if any, related to this matter.
•	Contingent liabilities– We accrue and disclose contingent liabilities in our Consolidated Financial Statements in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5,Accounting for Contingencies. SFAS No. 5 requires accrual of contingent liabilities that are considered probable to occur and 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. From time to time we disclose in our financial statements issues that we believe are reasonably possible to occur, although we cannot determine the range of possible loss in all cases. As these issues develop, we 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, we would be required to accrue our estimated loss, which would reduce net income in the period such determination was made.
•	Deferred taxes– We have recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, our ability to realize our deferred tax assets could change from our current estimates. If we determine we will be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to reduce the valuation allowance would increase net income in the period that such determination is made. Likewise, should we determine we will not be able to realize all or part of our net deferred tax assets in the future, an adjustment to increase the valuation allowance would reduce net income in the period such determination is made.
•	Allowance for doubtful accounts– We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to pay our comprehensive service fees. We believe that the success of our business is heavily dependent on our ability to collect these comprehensive service fees for several reasons, including:

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• the fact that we are at risk for the payment of our direct costs and worksite employee payroll costs regardless of whether our clients pay their comprehensive service fees;

• the large volume and dollar amount of transactions we process; and

• the periodic and recurring nature of payroll, upon which the comprehensive service fees are based.

	To mitigate this risk, we have established very tight credit policies. We generally require our clients to pay their comprehensive service fees no later than one day prior to the applicable payroll date. In addition, we maintain the right to terminate the Client Service Agreement and associated worksite employees or to require prepayment, letters of credit or other collateral if a client’s financial position deteriorates or if the client does not pay the comprehensive service fee. As a result of these efforts, losses related to customer nonpayment have historically been low as a percentage of revenues. However, if our clients’ financial condition were to deteriorate rapidly, resulting in nonpayment, our accounts receivable balances could grow and we could be required to provide for additional allowances, which would decrease net income in the period that such determination was made.
•	Property and equipment– Our property and equipment relate primarily to our facilities and related improvements, furniture and fixtures, computer hardware and software and capitalized software development costs. These costs are depreciated or amortized over the estimated useful lives of the assets. If the useful lives of these assets were determined to be shorter than their current estimates, our depreciation and amortization expense could be accelerated, which would decrease net income in the periods of such a determination. In addition, we periodically evaluate these costs for impairment in accordance with SFAS No. 144,Accounting for Impairment or Disposal of Long-Lived Assets. If events or circumstances were to indicate that any of our long-lived assets might be impaired, we would analyze the estimated undiscounted future cash flows to be generated from the applicable asset. In addition, we would record an impairment loss, which would reduce net income, to the extent 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.
•	Goodwill and other intangibles– The Company’s goodwill and intangible assets are subject to the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). In accordance with SFAS 142, goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired. Furthermore, SFAS 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. Our purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, five to ten years.

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New Accounting Pronouncements

          In September 2006, FASB Statement 157, “Fair Value Measurements” (“SFAS 157”) was issued. SFAS 157 establishes a framework for measuring fair value by providing a standard definition of fair value as it applies to assets and liabilities. SFAS 157, which does not require any new fair value measurements, clarifies the application of other accounting pronouncements that require or permit fair value measurements. Our effective date was initially January 1, 2008. However, the FASB has released FASB Staff Position No.FAS 157-b, Effective Date of FASB Statement No. 157, which delayed the effective date of Statement 157 for all non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. Accordingly, we adopted SFAS on January 1, 2008 for our financial assets and liabilities only. The adoption of SFAS 157 for our financial assets and liabilities did not have a material impact on our consolidated financial statements and we do not anticipate a material impact when applied to our non-financial assets and liabilities.

          In December 2007, the FASB Statement 141R, “Business Combinations” (“SFAS 141R”) was issued. SFAS 141R replaces SFAS 141. SFAS 141R requires the acquirer of a business to recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at fair value. SFAS 141R also requires transactions costs related to the business combination to be expensed as incurred. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Our effective date will be January 1, 2009. We have not yet determined the impact of SFAS 141R, if any, on our consolidated financial statements, because the impact of SFAS 141R is fact-specific and will not be invoked until we acquire a business after the effective date.

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Results of Operations

          Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007.

          The following table presents certain information related to Administaff’s results of operations for the three months ended June 30, 2008 and 2007.

	Three months ended
	June 30,
	2008		2007		% Change
	(in thousands, except per share and statistical data)
Revenues (gross billings of $2.456 billion and $2.191 billion, less worksite employee payroll cost of $2.036 billion and $1.814 billion, respectively)	$	420,469	$	376,758		11.6	%
Gross profit		84,061		78,467		7.1	%
Operating expenses		68,489		60,153		13.9	%
Operating income		15,572		18,314		(15.0	)%
Other income		1,869		2,958		(36.8	)%
Net income		10,987		13,645		(19.5	)%
Diluted net income per share of common stock		0.43		0.50		(14.0	)%
Statistical Data:
Average number of worksite employees paid per month		116,149		108,336		7.2	%
Revenues per worksite employee per month (1)	$	1,207	$	1,159		4.1	%
Gross profit per worksite employee per month		241		241		—
Operating expenses per worksite employee per month		197		185		6.5	%
Operating income per worksite employee per month		45		56		(19.6	)%
Net income per worksite employee per month		32		42		(23.8	)%

⁽¹⁾ Gross billings of $7,049 and $6,741 per worksite employee per month less payroll cost of $5,842 and $5,582 per worksite employee per month, respectively.

          Revenues

          Our revenues for the second quarter of 2008 increased 11.6% over the 2007 period due to a 7.2% increase in the average number of worksite employees paid per month and a 4.1%, or $48, increase in revenues per worksite employee per month.

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          By region, our revenue growth over the second quarter of 2007 and revenue distribution for the quarter ended June 30, 2008 were as follows:

	Three months ended June 30,							Three months ended June 30,
	2008		2007		% Change			2008			2007
	(in thousands)							(% of total revenues)
Northeast	$	88,672	$	74,042		19.8	%		21.1	%		19.7	%
Southeast		44,603		39,735		12.3	%		10.6	%		10.5	%
Central		60,249		52,495		14.8	%		14.4	%		13.9	%
Southwest		140,104		128,800		8.8	%		33.3	%		34.2	%
West		83,006		78,726		5.4	%		19.7	%		20.9	%
Other revenue		3,835		2,960		29.6	%		0.9	%		0.8	%
Total revenue	$	420,469	$	376,758		11.6	%		100.0	%		100.0	%

          Our 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 2008, client retention improved, while new client sales and the net change in existing clients declined slightly compared to the 2007 period.

          Gross Profit

          Gross profit for the second quarter of 2008 increased 7.1% to $84.1 million, compared to the second quarter of 2007. The average gross profit per worksite employee remained flat at $241 per month. Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses.

          While our revenues increased 4.1% per worksite employee per month, our primary direct costs, which include payroll taxes, benefits and workers’ compensation expenses, increased 5.2% to $966 per worksite employee per month in the second quarter of 2008 versus $918 in the second quarter of 2007.

• Benefits costs– The cost of group health insurance and related employee benefits increased $29 per worksite employee per month, or 5.7% on a cost per covered employee basis, compared to the second quarter of 2007. The percentage of worksite employees covered under our health insurance plans was 73.1% in the 2008 period compared to 72.8% in the 2007 period. The 2007 benefits costs were partially offset by a $3.3 million, or $10 per worksite employee per month, administrative fee credit from United related to the three-year health insurance agreement signed in April 2007. Please read “Critical Accounting Policies and Estimates – Benefits Costs” on page 16 for a discussion of our accounting for health insurance costs.

• Workers’ compensation costs– Workers’ compensation costs increased $4 per worksite employee per month compared to the second quarter of 2007. As a percentage of non-bonus payroll cost, workers’ compensation costs increased to 0.57% in the 2008 period from 0.52% in the 2007 period. During the 2008 period, the Company recorded reductions in workers’ compensation costs of $3.7 million, or 0.19% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods compared

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to $6.4 million, or 0.38% of non-bonus payroll costs, in the 2007 period. Please read “Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 17 for a discussion of our accounting for workers’ compensation costs.

•

Payroll tax costs– Payroll taxes increased $16 per worksite employee per month compared to the second quarter of 2007, due primarily to a 6.0% increase in average payroll cost per worksite employee per month. Payroll taxes as a percentage of payroll cost declined from 7.14% in the 2007 period to 7.09% in the 2008 period due primarily to lower state unemployment tax rates in 2008. In the period ended June 30, 2008, the Company received a $1.5 million, or 0.07% of payroll cost, state unemployment tax refund from the State of Texas, as compared to a 2007 refund of $2.9 million, or 0.16% of payroll cost.

          Operating Expenses

          The following table presents certain information related to the Company’s operating expenses for the three months ended June 30, 2008 and 2007.

	Three months ended June 30,							Three months ended June 30,
	2008		2007		% change			2008		2007		% change
	(in thousands)							(per worksite employee per month)
Salaries, wages and payroll taxes	$	37,427	$	33,076		13.2	%	$	108	$	102		5.9	%
Stock-based compensation		2,908		2,435		19.4	%		8		8		—
General and administrative expenses		16,923		14,276		18.5	%		49		44		11.4	%
Commissions		3,274		2,704		21.1	%		9		8		12.5	%
Advertising		4,158		3,958		5.1	%		12		12		—
Depreciation and amortization		3,799		3,704		2.6	%		11		11		—
Total operating expenses	$	68,489	$	60,153		13.9	%	$	197	$	185		6.5	%

          Operating expenses increased 13.9% to $68.5 million compared to the second quarter of 2007. Operating expense per worksite employee increased to $197 per month in the 2008 period from $185 in the 2007 period due largely to: (i) growth initiatives, including the development of the middle-market sales and service departments; (ii) redesign and enhancement of the HRTools software products; and (iii) expenses associated with the acquisition of USDatalink. The components of operating expenses changed as follows:

• Salaries, wages and payroll taxes of corporate and sales staff increased 13.2%, or $6 per worksite employee per month compared to the 2007 period. The increase in total dollars was due to the 12.8% increase in corporate headcount, primarily in the sales and service areas of the business in late 2007 and early 2008.

• Stock-based compensation expense increased 19.4% but remained flat on a per worksite employee per month basis. The stock-based compensation expense represents the vesting of restricted stock awards granted to employees and annual stock awards granted to outside members of the board of directors.

• General and administrative expenses increased 18.5%, or $5 per worksite employee per month compared to the second quarter of 2007, due primarily to: (i) consulting fees

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	associated with the HRTools software development and enhancement initiatives; (ii) software and hardware maintenance; (iii) expenses associated with the opening and relocating of sales offices; and (iv) increased travel expenses.
•	Commissions expense increased 21.1%, or $1 per worksite employee per month compared to the 2007 period, due to the increase in worksite employees and average payroll cost, as well as transition costs associated with a change in the commission program.
•	Advertising costs increased 5.1% but remained flat on a per worksite employee per month basis compared to the second quarter of 2007.
•	Depreciation and amortization expense increased 2.6% but remained flat on a per worksite employee per month basis compared to the 2007 period.

          Other Income (Expense)

          Other income (expense) decreased from $3.0 million in the second quarter of 2007 to $1.9 million in the 2008 period, due primarily to a decline in interest rates.

          Income Tax Expense

          Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses.

          Net Income

          Operating and net income per worksite employee per month was $45 and $32 in the 2008 period, versus $56 and $42 in the 2007 period.

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          Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007.

          The following table presents certain information related to Administaff’s results of operations for the six months ended June 30, 2008 and 2007.

	Six months ended
	June 30,
	2008		2007		% Change
	(in thousands, except per share and statistical data)
Revenues (gross billings of $5.010 billion and $4.465 billion, less worksite employee payroll cost of $4.133 billion and $3.681 billion, respectively)	$	876,535	$	784,516		11.7	%
Gross profit		170,668		146,534		16.5	%
Operating expenses		137,110		118,193		16.0	%
Operating income		33,558		28,341		18.4	%
Other income		4,343		5,932		(26.8	)%
Net income		24,143		22,038		9.6	%
Diluted net income per share of common stock		0.94		0.79		19.0	%
Statistical Data:
Average number of worksite employees paid per month		114,845		106,609		7.7	%
Revenues per worksite employee per month (1)	$	1,272	$	1,226		3.8	%
Gross profit per worksite employee per month		248		229		8.3	%
Operating expenses per worksite employee per month		199		185		7.6	%
Operating income per worksite employee per month		49		44		11.4	%
Net income per worksite employee per month		35		34		2.9	%

⁽¹⁾ Gross billings of $7,270 and $6,981 per worksite employee per month less payroll cost of $5,998 and $5,755 per worksite employee per month, respectively.

          Revenues

          Our revenues for the six months ended June 30, 2008, increased 11.7% over the 2007 period due to a 7.7% increase in the average number of worksite employees paid per month and a 3.8%, or $46, increase in revenues per worksite employee per month.

          By region, our revenue growth over the first six months of 2007 and revenue distribution for the six months ended June 30, 2008 were as follows:

	Six months ended June 30,							Six months ended June 30,
	2008		2007		% Change			2008			2007
	(in thousands)							(% of total revenues)
Northeast	$	185,674	$	155,502		19.4	%		21.2	%		19.8	%
Southeast		92,323		81,743		12.9	%		10.5	%		10.4	%
Central		126,786		110,703		14.5	%		14.4	%		14.1	%
Southwest		288,948		263,422		9.7	%		33.0	%		33.6	%
West		175,908		167,082		5.3	%		20.1	%		21.3	%
Other revenue		6,896		6,064		13.7	%		0.8	%		0.8	%
Total revenue	$	876,535	$	784,516		11.7	%		100.0	%		100.0	%

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          Our 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 six months ended June 30, 2008, new client sales improved, while client retention and the net change in existing clients declined slightly compared to the 2007 period.

          Gross Profit

          Gross profit for the first half of 2008 increased 16.5% to $170.7 million, compared to the first half of 2007. The average gross profit per worksite employee increased 8.3% to $248 per month in the 2008 period from $229 per month in the 2007 period. Our pricing objectives attempt to maintain or improve the gross profit per worksite employee by increasing revenue per worksite employee to match or exceed changes in primary direct costs and operating expenses.

          While our revenues increased 3.8% per worksite employee per month, our primary direct costs, which include payroll taxes, benefits and workers’ compensation expenses, increased 2.7% to $1,024 per worksite employee per month in the first half of 2008 versus $997 in the first half of 2007.

• Benefits costs– The cost of group health insurance and related employee benefits increased $15 per worksite employee per month, or 2.5% on a per covered employee basis, compared to 2007. The percentage of worksite employees covered under our health insurance plans was 73.4% in the 2008 period compared to 73.0% in the 2007 period. Please read “Critical Accounting Policies and Estimates – Benefits Costs” on page 16 for a discussion of our accounting for health insurance costs.

• Workers’ compensation costs– Workers’ compensation costs increased $5 per worksite employee per month compared to the first six months of 2007. As a percentage of non-bonus payroll cost, workers’ compensation costs increased to 0.61% in the 2008 period from 0.56% in the 2007 period. During the 2008 period, we recorded reductions in workers’ compensation costs of $5.7 million, or 0.15% of non-bonus payroll costs, for changes in estimated losses related to prior reporting periods, compared to $11.4 million, or 0.34% of non-bonus payroll costs, in the 2007 period. Please read “Critical Accounting Policies and Estimates – Workers’ Compensation Costs” on page 17 for a discussion of our accounting for workers’ compensation costs.

• Payroll tax costs– Payroll taxes increased $11 per worksite employee per month compared to the first half of 2007, primarily due to a 5.8% increase in average payroll cost per worksite employee per month. Payroll taxes as a percentage of payroll cost declined from 8.05% in the 2007 period to 7.90% in the 2008 period due to lower state unemployment tax rates in 2008.

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          Operating Expenses

          The following table presents certain information related to the Administaff’s operating expenses for the six months ended June 30, 2008 and 2007.

	Six months ended June 30,							Six months ended June 30,
	2008		2007		% change			2008		2007		% change
	(in thousands)							(per worksite employee per month)
Salaries, wages and payroll taxes	$	74,406	$	65,121		14.3	%	$	108	$	102		5.9	%
Stock-based compensation		5,293		3,743		41.4	%		8		6		33.3	%
General and administrative expenses		35,662		30,222		18.0	%		52		47		10.6	%
Commissions		6,368		5,623		13.2	%		9		9		—
Advertising		7,936		6,060		31.0	%		11		9		22.2	%
Depreciation and amortization		7,445		7,424		0.3	%		11		12		(8.3	)%
Total operating expenses	$	137,110	$	118,193		16.0	%	$	199	$	185		7.6	%

          Operating expenses increased 16.0% to $137.1 million compared to the first six months of 2007. Operating expense per worksite employee increased to $199 per month in the 2008 period from $185 in the 2007 period. The components of operating expenses changed as follows:

• Salaries, wages and payroll taxes of corporate and sales staff increased 14.3%, or $6 per worksite employee per month compared to the 2007 period due to: (i) a 10.4% increase in corporate headcount, primarily in the sales and service areas of the business; and (ii) a $1.1 million increase in the incentive compensation expense accrual, which is largely tied to our operating results.

• Stock-based compensation expense increased $1.6 million, or $2 per worksite employee per month. Stock based compensation expense primarily represents the vesting of restricted stock awards granted to employees.

• General and administrative expenses increased 18.0%, or $5 per worksite employee per month compared to the first half of 2007, due (i) consulting fees associated with the HRTools software development and enhancement initiatives; (ii) increased travel expenses; and (iii) expenses associated with the opening and relocating of sales offices.

• Commissions expense increased 13.2%, but remained flat on a per worksite employee per month basis compared to the 2007 period.

• Advertising costs increased 31.0%, or $2 per worksite employee per month, due to an increase in radio and television advertising expenditures relative to 2007.

• Depreciation and amortization expense increased 0.3%, but decreased $1 on a per worksite employee per month basis compared to the 2007 period.

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          Other Income (Expense)

          Other income (expense) decreased from $5.9 million in the first half of 2007 to $4.3 million in the 2008 period, due primarily to a decline in interest rates.

          Income Tax Expense

          Our provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses.

          Net Income

          Operating and net income per worksite employee per month was $49 and $35 in the 2008 period, versus $44 and $34 in the 2007 period.

Non-GAAP Financial Measures

          Non-bonus payroll cost is a non-GAAP financial measure that excludes the impact of bonus payrolls paid to our worksite employees. Bonus payroll cost varies from period to period, but has no direct impact to our ultimate workers’ compensation costs under the current program. As a result, our management refers to non-bonus payroll cost in analyzing, reporting and forecasting our workers’ compensation costs. Non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles (“GAAP”) and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. We include these non-GAAP financial measures because we believe they are useful to investors in allowing for greater transparency related to the costs incurred under our current workers’ compensation program. Investors are encouraged to review the reconciliation of the non-GAAP financial measures used to their most directly comparable GAAP financial measures as provided in the table below.

	Three months ended							Six months ended
	June 30,				%			June 30,				%
	2008		2007		Change			2008		2007		Change
	(in thousands, except per worksite employee data)
Payroll cost (GAAP)	$	2,035,626	$	1,814,103		12.2	%	$	4,133,215	$	3,680,862		12.3	%
Less: Bonus payroll cost		111,393		120,779		(7.8	)%		345,918		356,774		(3.0	)%
Non-bonus payroll cost	$	1,924,233	$	1,693,324		13.6	%	$	3,787,297	$	3,324,088		13.9	%
Payroll cost per worksite employee (GAAP)	$	5,842	$	5,582		4.7	%	$	5,998	$	5,755		4.2	%
Less: Bonus payroll cost per worksite employee		320		372		(14.0	)%		502		558		(10.0	)%
Non-bonus payroll cost per worksite employee	$	5,522	$	5,210		6.0	%	$	5,496	$	5,197		5.8	%

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Liquidity and Capital Resources

          We periodically evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, expansion plans, dividends, debt service requirements and other operating cash needs. To meet short and long-term liquidity requirements, including payment of direct costs, operating expenses and repaying debt, we rely primarily on cash from operations. However, we have in the past sought, and may in the future seek, to raise additional capital or take other steps to increase or manage our liquidity and capital resources. We had $162.5 million in cash and cash equivalents and marketable securities at June 30, 2008, including approximately $65.8 million for withheld federal and state income taxes, employment taxes and other payroll deductions, and $16.9 million in customer prepayments that were payable in July 2008. At June 30, 2008, we had working capital of $85.0 million compared to $97.2 million at December 31, 2007. We currently believe that our cash on hand, marketable securities and cash flows from operations will be adequate to meet our liquidity requirements for the remainder of 2008. We will rely on these same sources, as well as public and private debt or equity financing, to meet our longer-term liquidity and capital needs.

          We do not believe the lack of liquidity in the current auction rate securities market will have a material impact on our liquidity requirements. See Note 3, “Investments,” in the consolidated financial statements on page 12, and Item 3. “Quantitative and Qualitative Disclosure about Market Risk” on page 31 for additional details related to the Company’s auction rate securities.

          Cash Flows From Operating Activities

          Our cash flows from operating activities in 2008 decreased $34.8 million from 2007. Our primary source of cash from operations is the comprehensive service fee and payroll funding we collect from our clients. The level of cash and cash equivalents, and thus our reported cash flows from operating activities are significantly impacted by various external and internal factors, which are reflected in part by the changes in our balance sheet accounts. These include the following:

• Workers’ compensation plan funding– Under our workers’ compensation coverage policy, we make monthly payments to the carriers comprised of premium costs and funds to be set aside for payment of future claims (“claim funds”). These pre-determined amounts are stipulated in our agreement with the carrier, and are based primarily on anticipated worksite employee payroll levels and workers compensation loss rates during the policy year. Changes in payroll levels from that which was anticipated in the arrangement can result in changes in the amount of the cash payments to the carriers, which will impact our reporting of operating cash flows. Our claim funds paid, based upon anticipated worksite employee payroll levels and workers’ compensation loss rates, were $21.4 million, less claims paid of $12.7 million in 2008, and $21.3 million, less claims paid of $11.7 million for the 2007 period. This compares to our estimate of workers’ compensation loss costs of $15.9 million and $10.6 million in 2008 and 2007, respectively. In the period ended June 30, 2007, Administaff received $24.3 million from AIG for the return of excess claim funds related to the 2004 – 2006 AIG programs. We

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	are currently in discussions with AIG related to the return of excess funds from the AIG program in 2008.
•	Medical plan funding –Our healthcare contract with United establishes participant cash funding rates 90 days in advance of the beginning of a reporting quarter. Therefore, changes in the participation level of the United Plan have a direct impact on our operating cash flows. In addition, changes to the funding rates, which are solely determined by United based primarily upon recent claim history and anticipated cost trends, also have a significant impact on our operating cash flows. Since inception of the United Plan in January 2002, cash funded to United has exceeded Plan Costs, resulting in a $26.3 million surplus, $17.3 million of which is reflected as a current asset, and $9.0 million of which is reflected as a long-term asset on our Consolidated Balance Sheet at June 30, 2008.
•	Timing of customer payments / payrolls –We typically collect our comprehensive service fee, along with the client’s payroll funding, from clients at least one day prior to the payment of worksite employee payrolls. Therefore, the date of the last day of a reporting period has a substantial impact on our reporting of operating cash flows. For example, many worksite employees are paid on Fridays; therefore, operating cash flows decrease in the reporting periods that end on a Friday. In the period ended June 30, 2008, which ended on a Monday, client prepayments were $16.9 million and accrued worksite employee payroll was $140.2 million. In the period ended June 30, 2007, which was a Friday, client prepayments were $8.2 million and accrued worksite employee payroll was $102.9 million.
•	Operating results– Our net income has a significant impact on our operating cash flows. Our net income increased 9.6% to $24.1 million in 2008 compared to 2007. Please readResults of Operations – Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007on page 25.

          Cash Flows Used in Investing Activities

          Cash flows provided by investing activities were $51.6 million. We liquidated approximately $63.2 million in auction rate securities and reinvested the funds into cash equivalents. In addition, we invested approximately $7.9 million in capital expenditures and $3.8 million in the acquisition of USDatalink, an employment screening services company, during the first six months of 2008.

          Cash Flows Used in Financing Activities

          Cash flows used in financing activities were $21.0 million. During the first six months of 2008, we repurchased $16.5 million in treasury stock and paid $5.7 million in dividends.

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Other Matters

          As previously disclosed, after capital constraints and downgrades from various rating agencies, our former workers’ compensation insurance carrier, Lumbermens Mutual Casualty Company, a unit of Kemper Insurance Companies (“Kemper”) has entered into a “run-off.” If the run-off process is not successful and Kemper is placed into a formal liquidation or a similar proceeding, most states have established guaranty associations to pay the remaining claims. However, the guaranty associations of certain states, including Texas, may attempt to return the liability for such remaining claims to Administaff, which may have a material adverse effect on net income in the reported period.   For more information regarding Kemper, as well as the effect on us of the bankruptcy of another former workers compensation insurance carrier, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Factors That May Affect Future Results and the Market Price of Common Stock- Increases in Workers’ Compensation Costs” on page 40 of our Form 10-K for the year ended December 31, 2007, filed with the SEC.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          The Company has investments in debt instruments of U.S. municipalities, the majority of which are auction rate securities (“ARS”), which are classified as available for sale securities at fair value.

          As a result of the recent liquidity issues experienced in the credit and capital markets, in early 2008, auctions for certain ARS held by the Company have failed. However, a failed auction does not represent a default by the issuer. Liquidity will be limited until there is a successful auction or until such time as other markets for these investments develop. All of the Company’s investments in ARS have continued to pay interest in accordance with the terms of the underlying security. The Company believes the credit quality of these assets has not been impacted and the current lack of liquidity in the market is temporary; therefore, no decline in market value has been recorded as of June 30, 2008. The Company has valued these investments at cost, which it believes continues to be a reasonable approximation of fair value under current circumstances.

          Auction rate securities held at December 31, 2007, were $74.9 million, all classified as current assets. Due to the instability in the markets, the Company sold a majority of these investments, and ended the second quarter 2008 with investments of $11.7 million, of which $3.8 million are classified as current assets and $7.9 million are classified as non-current assets in the unaudited Consolidated Balance Sheet as of June 30, 2008. See Note 3 “Investments,” in the consolidated financial statements on page 12, for additional details related to the Company’s auction rate securities. In addition, see Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 on page 43.

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ITEM 4. CONTROLS AND PROCEDURES.

          In accordance with the Securities Exchange Act of 1934 Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2008.

          There has been no change in our internal controls over financial reporting that occurred during the three months ended June 30, 2008, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

ITEM 1. LEGAL PROCEEDINGS.

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

ITEM 1a. RISK FACTORS

          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,” “objective,” “target,” “assume,” “outlook,” “guidance,” “predicts,” “appears,” “indicator” 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 our stockholders and the public informed about our 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. We base the forward-looking statements on our current expectations, estimates and projections. These statements are not guarantees of future performance and involve risks and uncertainties that we cannot predict. In addition, we have based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Therefore, the actual results of the future events described in such forward-looking statements could differ materially from those 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 and possible adverse application of various federal, state and local regulations; (iii) increases in health insurance costs and workers’ compensation rates and underlying claims trends, financial solvency of workers’ compensation carriers and other insurers, 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 our operations; (iv) the effectiveness of our sales and marketing efforts; (v) changes in the competitive environment in the PEO industry, including the entrance of new competitors and our ability to renew or replace client companies; (vi) our liability for worksite employee payroll and benefits costs; and (vii) an adverse final judgment or settlement of claims against Administaff. These factors are discussed in detail in our 2007 annual report on Form 10-K under “Factors That May Affect Future Results and the Market Price of Common Stock” on page 40, and elsewhere in this report. Any of these factors, or a combination of such factors, could materially affect the results of our operations and whether forward-looking statements we make ultimately prove to be accurate.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

          The following table provides information about purchases by Administaff during the three months ended June 30, 2008, of equity securities that are registered by Administaff pursuant to Section 12 of the Exchange Act:

					Total Number of		Maximum
					Shares Purchased as		Number of Shares
	Total Number				Part of Publicly		that May Yet be
	of Shares		Average Price		Announced		Purchased Under
Period	Purchased(1)		Paid per Share		Program(2)		the Program (2)
04/01/2008 – 04/30/2008		—	$	—		10,941,993		1,558,007
05/01/2008 – 05/31/2008		54,488		27.36		10,996,481		1,503,519
06/01/2008 – 06/30/2008		—		—		10,996,481		1,503,519
Total		54,488	$	27.36		10,996,481		1,503,519

(1)	Our board of directors has approved the repurchase of up to an aggregate amount of 12,500,000 shares of Administaff common stock, of which 10,996,481 had been repurchased as of June 30, 2008. During the three months ended June 30, 2008, we repurchased 54,488 shares of our common stock.
(2)	Unless terminated earlier by resolution of the board of directors, the repurchase program will expire when we have repurchased all shares authorized for repurchase under the repurchase program.

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

          An Annual Meeting of Stockholders of the Company was held on May 6, 2008. At the Meeting, holders of 23,780,669 shares of common stock were present in person or by proxy, which constituted a quorum thereof. The vote of stockholders in respect of the three proposals voted on at the Meeting, all of which were approved, is set forth below:

1. Election of Class I Directors to serve until the Annual Meeting of Stockholders in 2011.

	For		Withheld
Michael W. Brown		12,218,571		11,139,843
Eli Jones		11,624,710		11,733,704
Gregory E. Petsch		11,825,800		11,532,614

	Directors continuing in office were Jack M. Fields, Jr., Paul S. Lattanzio, Richard G. Rawson, Paul J. Sarvadi and Austin P. Young.
2.	Approval of the Administaff, Inc. 2008 Employee Stock Purchase Plan.

For	Against	Abstain
20,073,555	1,545,004	398,024

3 Ratification of Ernst & Young, LLP as the Company’s independent auditors for the year ending December 31, 2008

For	Against	Abstain
22,811,614	960,328	8,727

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ITEM 6. EXHIBITS

          (a) List of exhibits.

31.1	*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	*	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	*	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	*	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.

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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 1, 2008	By:	/s/ Douglas S. Sharp
		Douglas S. Sharp
		Senior Vice President of Finance, Chief Financial Officer and Treasurer (Principal Financial and Duly Authorized Officer)

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EXHIBIT INDEX

          (a) List of exhibits.

31.1	*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	*	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	*	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	*	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.