UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File No. 0-22701

Gevity HR, Inc.

(Exact name of registrant as specified in its charter)

(Registrant’s Telephone Number, Including Area Code):

(941) 741-4300

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01 per share

(Title of class)

     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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

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

      The aggregate market value of the registrant’s voting stock held by non-affiliates (based upon the June 30, 2004, $26.19 closing sale price for the registrant’s common stock, $.01 par value per share, on the Nasdaq National Market) was approximately $662.4 million.

      The number of shares of the registrant’s common stock, outstanding as of February 28, 2005 was 27,461,975.

DOCUMENTS INCORPORATED BY REFERENCE

      PART III — Portions of the registrant’s definitive Proxy Statement relating to the 2005 Annual Meeting of shareholders expected to be held May 12, 2005, are incorporated herein by reference in Part III.

TABLE OF CONTENTS

PART I

General

      Gevity HR, Inc. (the “Company”) is a leading provider of a comprehensive, fully integrated employee management solution to small- and medium-sized businesses. The Company’s solution allows it to effectively become the insourced human resource department for its clients. Gevity creates value for its clients by helping them achieve workforce alignment, obtain administrative relief and access business protection services.

      In the delivery of its solution to its clients, the Company provides employee recruitment and development assistance, payroll and benefits administration, access to workers’ compensation insurance, health, welfare and retirement plans and employment-related regulatory guidance. The Company’s solution is delivered through a combination of dedicated HR professionals, a shared processing center and a Web portal.

      Gevity’s employee management solution is designed to positively impact its clients’ business results by:

      The Company serves a growing and diverse client base of small- and medium-sized businesses in a wide variety of industries. The Company’s clients have employees located in all 50 states and the District of Columbia. These clients and their employees are served by a network of offices in Alabama, Arizona, California, Colorado, Florida, Georgia, Maryland, Minnesota, New Jersey, New York, North Carolina, Tennessee and Texas. In addition, the Company has internal employees located on site at certain client facilities. As of December 31, 2004, the Company served approximately 8,500 clients, as measured by individual client Federal Employer Identification Numbers (“FEIN”), with approximately 130,000 active client employees. For the year ended December 31, 2004, the Company’s top 25 clients represented approximately 5% of its client billings, with no single client representing more than 1.1% of its client billings.

      The Company’s operations are conducted through a number of wholly-owned limited partnerships and wholly-owned limited liability companies. The terms “Company” or “Gevity” as used in this report includes Gevity HR, Inc. and such partnerships and limited liability companies.

      The Company was incorporated in Florida in 1997 and consummated its initial public offering in 1997 after acquiring all of the interest in a limited partnership originally organized in 1993 to acquire the assets of the Company’s predecessor professional employer organization business. In May 2002, the Company’s shareholders voted to change the Company’s name from “Staff Leasing, Inc.” to “Gevity HR, Inc.”

      Until 2002, the Company’s business was primarily focused on providing cost effective insurance offerings and payroll processing services for its clients. During the past two years, the Company has shifted its business model to focus on providing its clients with a comprehensive, full service human resource management solution. The Company believes that this important shift in focus allows the Company to better serve its client base and to grow its business.

      In October of 2004, the Company announced that in addition to the services offered by Gevity on a co-employment platform, which facilitates co-insurance under the Company’s plans, clients can now also opt for a custom model. This new option adds the significant flexibility for the client to retain benefits and insurance programs of the client’s choice and experience the full value of the Company’s end-to-end, single point solution. The Company introduced this concept on a pilot basis in its Baltimore, Maryland office that opened in 2004. Broader market introduction is expected in the second quarter of 2005.

Human Resource Outsourcing Industry

      The human resource outsourcing industry is large and growing rapidly. Some of the key factors driving growth of the industry include businesses’ desire to outsource non-core business functions, reduce regulatory compliance risk, rationalize the number of service providers that they use and reduce costs by integrating human resource systems and processes. The Company believes that smaller businesses, i.e. those with between one and 500 employees, represent a large part of this market. According to Dun & Bradstreet, Inc., there are over 10 million businesses of this size in the United States.

      The Company believes that this segment of the human resource outsourcing market is particularly attractive because:

Professional Services Provided by the Company

      The Company provides a broad range of tools and services to its clients. These tools and services are primarily offered to the Company’s clients on a “bundled” or all-inclusive basis. In addition to the Company’s core services, clients may elect to offer to their employees health and welfare and retirement programs. The Company provides these tools and services to its clients through the following core activities:

Workforce Alignment — Engage the right people in the right place at the right time doing the right things

      Find Exceptional Talent

      Formal Human Resource Processes and Professional Management Standards

      Employee Motivation and Retention Practices

Administrative Relief — Manage employee administration

      Processing of Payroll, Taxes and Premiums

      Comprehensive Record Keeping and Technology

Business Protection — Help ensure employment-related regulatory compliance and sound risk management practices

      Up-to-Date Regulatory Compliance

      Cost-Effective Risk Management Practices and Insurance Programs

Gevity Institute

      There is a large body of study describing the positive impact of human resource practices on key financial outcomes such as productivity, revenue growth and profitability. However, most of the data concentrates on large employers. There is little information available regarding this important topic that focuses on small- and medium-sized employers.

      As a result, the Company established the Gevity Institute to identify and quantify the relationship between human resource practices and the performance of smaller businesses. The Institute’s goal is to become a unique and recognized authority on how professional human resource management impacts small- to medium-sized business success, and to help the Company’s clients improve their business results by applying this expertise in their firms.

      The Gevity Institute is currently working in collaboration with Cornell University on a study that examines the financial impact of small employer human resource practices. The study’s first phase concluded that employees and employee management are widely recognized as key elements in the success of small firms. However, 90% of the small business owners surveyed said they did not know which employee management practices could help them achieve the best results for their business.

      Following up on these findings, the second phase of the study focused more specifically on the relationship between employee management practices and a small business’ performance. The study yielded answers regarding the type of people management practices that work best to achieve optimal employee contributions in building a small business’ success.

      Confirming the link between employee performance and a small business’ success, the study showed that workforce alignment, or having the right people in the right place at the right time doing the right things, helped the business succeed and was a clear characteristic of the most successful businesses surveyed. In effect, the investment made by these businesses in achieving an aligned workforce was perhaps as crucial as any other investment they made to grow their businesses.

      The next phase of this study examines the relationship between the use of people management practices and key employee attitudes and behaviors such as discretionary effort and productivity. Finally, the study will attempt to quantify the financial impact of employee management practices on key business measures including revenue and profit growth.

      In an effort to further examine the impact of employee management practices, the Gevity Institute is also working with the International Association of Business Communicators (IABC) to study the business impact of effective employee communication practices in small- to medium-sized businesses.

Clients

      As of December 31, 2004, the Company served approximately 8,500 clients, as measured by individual client FEIN, with approximately 130,000 active client employees. In addition, the Company had clients classified in over 500 Standard Industrial Classification (“SIC”) codes. The following table shows the Company’s client distribution by major SIC code industry grouping for the years indicated, ranked as a percentage of gross billings to clients:

      As part of its current client selection strategy, the Company offers its services to businesses within specified industry codes. All prospective clients are evaluated individually on the basis of total predicted profitability. This analysis takes into account workers’ compensation risk and claims history, unemployment claims history, payroll adequacy, and credit status.

      With respect to potential clients operating in certain industries believed by the Company to present a level of risk exceeding industry norms, more rigorous approval requirements must be met before the Company agrees to provide services to the potential client. This process may include an on-site inspection and review of workers’ compensation and unemployment claims experience for the last three years.

      The Company considers industries to be high risk if there is a likelihood of a high frequency of on-the-job accidents involving client employees or a likelihood that such accidents will be severe. In addition, under the terms of the Company’s workers’ compensation agreement, prospective clients operating in certain industries or with historically high workers’ compensation insurance claims experience must also be approved by the Company’s insurance carrier before the Company enters into a contract to provide services.

      The Company maintains a client review program that includes a detailed profitability and risk analysis of all of its clients. Based on the results of these analyses, the Company may modify its pricing or, if necessary, terminate certain clients that the Company believes would otherwise be detrimental or not contribute to its long-term profitability.

      The Company’s client retention rate for 2004 was approximately 77%. This rate is computed by dividing the number of clients at the end of the period by the sum of the number of clients at the beginning of the period plus the number of clients added during the period. The client retention rate is affected by a number of

factors, including the natural instability of the smaller business market and the number of clients that were terminated by the Company for reasons that include unacceptable risk and low profitability to the Company.

      In order to use the Company’s professional services, all clients are required to enter into a professional services agreement, which generally provides for an initial one-year term, subject to termination by the Company or the client at any time upon 30 days prior written notice or less. Following the initial term, the contract may be renewed, terminated or continued on a month-to-month basis. Under the co-employment business service model, which covered substantially all of the Company’s clients in 2004, the Company and the client each become a co-employer of the client’s employees, and the Company operates as a licensed professional employer organization. Clients are also offered the option to use the Company’s services without the Company becoming a co-employer of the client’s employees, in which case tax filings are made under the client’s FEIN and the client provides its own workers’ compensation insurance and health and welfare plans.

      The Company retains the ability to immediately terminate the client (and co-employment relationship, if applicable) upon non-payment by a client. The Company manages its credit risk through the periodic nature of payroll, client credit checks, owner guarantees, the Company’s client selection process and its right to terminate the professional services agreement and the co-employment relationship with the client employees, if applicable.

      Under the professional services agreement applicable to the co-employment model, employment-related liabilities are contractually allocated between the Company and the client. For instance, the Company assumes responsibility for, and manages the risks associated with, each client’s employee payroll obligations, including the liability for payment of salaries and wages (including payroll taxes) to each client employee and, at the client’s option, responsibility for providing group health, welfare, and retirement benefits to such individuals.

      These Company obligations are fixed, whether or not the client makes timely payment of the associated service fee. In this regard, it is important to understand that, unlike payroll processing service providers, the Company issues to each of the client employees Company payroll checks drawn on the Company’s bank accounts. The Company also reports and remits all required employment information and taxes to the Internal Revenue Service (IRS) and issues a federal Form W-2 to each client employee under the appropriate Company FEIN.

      Under the co-employment model, the Company assumes the responsibility for compliance with employment-related governmental regulations that can be effectively managed away from the client’s worksite. The Company provides workers’ compensation insurance coverage to each client employee under the Company’s master insurance policy. The client, on the other hand, contractually retains the general day-to-day responsibility to direct, control, hire, terminate, set the wages and salary of, and manage each of the client’s employees. The client employee services are performed for the exclusive benefit of the client’s business. The client also remains responsible for compliance with those employment-related governmental regulations that are more closely related to the day-to-day management of client employees.

      In some cases, employment-related liabilities are shared between the Company and the client. The following table summarizes the general division of responsibilities for employment-related regulatory compliance under the professional services agreement applicable to the co-employment model:

      Under the co-employment model, the Company charges its clients a professional service fee that is designed to yield a profit and to cover the cost of certain employment-related taxes, workers’ compensation insurance coverage and human resource services provided to the client. The component of the professional service fee related to human resource management varies according to the size of the client, the amount and frequency of the payroll payments and the method of delivery of such payments. If the client elects to obtain the Company’s services directly, without the co-employment model, the Company charges a professional service fee that is designed to cover the cost of its delivery of services and still yield a profit to the Company.

      Under the co-employment model, the component of the service fee related to workers’ compensation and unemployment insurance is based, in part, on the client’s historical claims experience. In addition, the client may choose to offer certain health, welfare and retirement benefits to its client employees. The Company invoices each client for the service fee and costs of selected benefit plans, as well as the wages and other employment-related taxes of each client employee. The gross billings are invoiced at the time that each periodic payroll is delivered to the client.

Service Delivery and Information Technology

      The Company delivers its services through a combination of human resource consultants located in the field offices, at the Company’s headquarters and in certain cases on-site at the client location, as well as through Gevity Central, a self-service portal, which provides real-time, 24x7 access to a broad range of human

resource tools and services through the Internet. In order to provide proactive client relationship management, each of the Company’s clients is assigned a single human resource consultant to serve as the client relationship manager. This allows the client to interface with the Company through a single point person.

      As of December 31, 2004, the Company had approximately 190 human resource consultants with significant experience in the human resource industry. Many of the Company’s human resource consultants hold industry recognized certifications from organizations such as the Society of Human Resource Management.

      As of December 31, 2004, the Company had invested approximately $45 million and is continuing to invest capital resources in the development and enhancement of its information and technology infrastructure. This investment is intended to better serve the Company’s client base, achieve a high level of client satisfaction and allow the Company to improve efficiencies in its operations.

      The Company processes payroll for all of its client employees using Oracle’s Human Resource Management System (“HRMS”) and Payroll processing application. The Oracle system enables the Company to effectively manage its existing operations and maintain appropriate controls. The Oracle HRMS and Payroll systems provide the Company with the capability to promptly and accurately deliver human resource services and generate comprehensive management reports. The Company’s information systems manage all data relating to client employee enrollment, payroll processing, benefits administration, management information and other requirements of the clients’ operations. The current systems have high-volume processing capabilities that allow the Company to produce and deliver payrolls to its clients, each customized to the needs of such clients.

      The Company continues its development and deployment of Gevity Central, which allows clients to input their payroll data directly into the Company’s payroll applications via the Internet. Clients can regularly add or delete employees, view reports, and change payroll information. Gevity Central is fully integrated with the Company’s HRMS and Payroll applications, Customer Relationship Management solution and financial reporting package, as well as the Company’s comprehensive line of online tools and services. This full integration results in improved client satisfaction, as well as improved efficiencies and operating margins for the Company. Oracle’s portal software provides the foundation, enabling a robust, client configurable portal, and the Company’s custom-developed software provides additional ease of use and service capabilities.

      At the end of 2004, approximately 77% of the client employee base interacted with the Company via Gevity Central. Use of this technology is expected to increase in 2005 as approximately 93% of clients are registered to use Gevity Central.

      The combination of the Oracle systems for access and functionality and Gevity Central online capabilities provides a unique solution capable of growing and adapting to the evolving needs of the Company’s clients.

      The Company’s information technology staff consisted of 75 colleagues at December 31, 2004. The Company believes the development of its information technology is an integral part of achieving its growth objectives and intends to continue to invest in its technology infrastructure.

Sales and Marketing

      The Company markets its services through a direct sales force which, as of December 31, 2004, consisted of 166 business development managers. In order to exercise more control over the client selection process, the Company uses a direct sales force rather than selling through agents. The Company does not expect to increase its sales force during 2005.

      The Company’s sales force is distributed throughout its 41 branch offices. The Company plans to expand its national coverage and add sales offices in selected major metropolitan areas over the next few years. The Company’s business development managers are compensated through a combination of salary and commission that has, for top producers, generated annual earnings in excess of $200,000.

      As the Company’s focus has shifted to selling human resource tools and services to slightly larger target clients, rather than selling low cost insurance offerings, an associated change has been required in the profile of

the sales force. As a result, the Company has revised the profile of its targeted sales candidates and has also restructured its hiring practices.

      The new sales candidate profile typically includes attributes such as: strong analytical skills; knowledge of technology; experience working with small business owners; good business acumen; proven high performance and strong prospecting sales skills. Generally the candidate will also have prior employment experience in the field of outsourcing, human resource consulting, benefits consulting or human resource information systems.

      As a result of the Company’s aggressive hiring efforts with respect to business development managers during the last two years, many regions of the country have business development managers who have a relatively short tenure with the Company. For example, the average tenure of the sales force in California, the Midwest and the Northeast is less than 16 months. This group makes up approximately 48% of the overall sales force.

      Consequently, the Company continues to expand and improve its training and orientation programs. For many years, the Company provided a formal one-week training program for new business development manager hires, together with on-the-job training. In 2003, the Company implemented a comprehensive and expanded training program for all new sales associates and also designed a new training program for all existing sales associates. Both training courses emphasize the advantages available to clients through the Company’s expansive technology-based service delivery model and also include substantial focus on the Company’s sales process.

      The Company also restructured the compensation system of its sales force in 2003 and anticipates further restructuring its sales compensation programs during 2005. Historically, business development managers had no defined sales territory and earned commissions based entirely on their individual production levels. In certain instances, this led to internal competition as business development managers competed against each other for the same potential clients.

      The new client acquisition model subdivides all markets into individually assigned and identified sales territories and is intended to result in the development of market share by territory. The new compensation structure pays a higher base salary to attract more qualified sales candidates and provides an incentive based on the efforts of all business development managers in a particular geographic region, thus facilitating a collaborative environment between business development managers.

      The Company generates sales leads from various external sources as well as from direct sales efforts and inquiries. Each business development manager visits his or her clients on-site periodically in order to maintain an ongoing relationship and to seek new business referrals. The Company also generates sales leads from independent referral relationship partners and an information database of small businesses. The Company uses a referral incentive program with its relationship partners to encourage increased referral activity.

Competition

      The human resource outsourcing industry is highly fragmented. The Company seeks to compete through its ability to provide a full-service human resource solution to its clients through dedicated HR professionals and its advanced information technology solutions. The Company believes its primary competitors to be single point solution providers who offer segments of the entire service offering that the Company provides to its clients in an all-inclusive offering. These competitors include certain information technology outsourcers and broad-based outsourcing and consultancy firms that are now providing or may seek to provide human resource outsourcing services; companies that provide a discrete group of transactional services, such as payroll or benefits administration and aspire to provide additional services; and other consulting companies that perform individual projects, such as development of human resource strategy and human resource information systems.

      The Company believes that it is one of the largest co-employers of client employees in the United States in terms of active client employees and revenues. Historically, most of the Company’s competitors have focused upon discrete processes, but many of them are now promoting integrated process management offerings that may be viewed as competitive with the Company’s offerings. Many of these businesses that operate under the co-employment business model, especially the larger ones such as Administaff, Inc. and

companies that primarily provide payroll processing services and also have co-employment businesses, including Automatic Data Processing, Inc. and Paychex, Inc., are capitalizing on the co-employment model and transforming their businesses into full-service human resource outsourcing companies while still offering workers’ compensation and group health benefit insurance programs. The Company expects competition to increase, and competitors to develop broad service capabilities that match the Company’s offerings.

Vendor Relationships

      The Company provides its services to its client employees under arrangements with a number of partners. The maintenance of insurance plans, including workers’ compensation plans and health benefit plans that cover client employees, is a significant part of the Company’s business. If the Company were required to obtain replacement contracts, such replacement could cause a significant disruption to the Company’s business and possible dissatisfaction with the Company’s service offering because of the possible lack of continuity between current and new health care providers and the associated plan terms and conditions. This could lead to a decrease in client retention and an adverse effect on the Company’s future results of operations or financial condition.

      Following is a description of the Company’s workers’ compensation insurance program, which covers all clients who are insured under the co-employment model:

      The Company has had a loss sensitive workers’ compensation insurance program since January 1, 2000. The program is insured by CNA Financial Corporation (“CNA”) for the 2000, 2001 and 2002 program years. The program is currently insured by member insurance companies of American International Group, Inc. (“AIG”) and includes coverage for the 2003 and 2004 program years. In states where private insurance is not permitted, client employees are covered by state insurance funds.

      The insured loss sensitive programs provide insurance coverage for claims incurred in each plan year but which may be paid out over future periods dependent upon the nature and extent of the worksite injury. The fully insured loss sensitive programs provide for a sharing of risk between the insurance companies and the Company whereby the Company is responsible for paying, through the respective insurance company, the first $1.0 million per occurrence of claims through 2003 and $2.0 million during the year ended December 31, 2004, and the respective insurance company is responsible for amounts in excess of the Company’s per occurrence amount. For the 2004 program year, the Company purchased additional insurance coverage from Munich American Reassurance Company for the layer of claims between $1.0 million and $2.0 million per occurrence, thereby effectively limiting the Company’s liability to the first $1.0 million per occurrence.

      In addition, for policy years 2000 through 2003, the Company obtained aggregate stop-loss insurance coverage through CNA and AIG, as applicable, further limiting its ultimate liability. The stop loss coverage provided by CNA for the 2000-2002 program years limits the Company’s aggregate exposure for claims below the $1.0 million per occurrence level to 130% of the expected losses as determined by CNA. The stop loss coverage provided by AIG for the 2003 program year limits the Company’s aggregate exposure for claims below the $1.0 million per occurrence level to 175% of the expected losses as determined by AIG. The Company did not purchase aggregate stop loss coverage for the 2004 program year, as the Company believed that the risk of losses exceeding the proposed aggregate stop loss level was remote.

      Effective September 30, 2004, the Company entered into agreements with AIG and CNA whereby the Company purchased insurance from AIG to cover the Company’s workers’ compensation claims liability up to the $1.0 million per occurrence deductible level for policy years 2000, 2001 and 2002. CNA remains the insurer on the underlying claims for these policy years. The insurance purchased from AIG also provides the Company greater protection relative to the aggregate insurance stop-loss coverage by effectively reducing the Company’s maximum exposure for claims that fall below the $1.0 million deductible level from 130% of expected total losses to approximately 117% of expected total losses over the life of the 2000, 2001 and 2002 policies. The insurance purchased from AIG was funded substantially through the release by CNA to the

Company of restricted marketable securities previously pledged to CNA as collateral and the release by CNA to the Company of premium payments and deposits previously paid to CNA.

      Of the total premium paid by the Company to AIG, AIG deposited $94.4 million into an interest bearing loss fund account to fund all claims under the program up to AIG’s aggregate limit. Interest on the loss fund (which will be reduced as claims are paid out over the life of the policy) will accrue to the benefit of the Company at a fixed annual rate of 3.0% until all claims are closed. AIG will return to the Company that portion of the loss fund account, if any, not used or retained to pay claims, including interest earned, at intervals of 36, 60, 84 and 120 months from the date of the inception of the agreement. The maximum return amount, which is based upon a pre-determined formula, at 36 and 60 months is limited to $5.5 million for each payment due, with no limit as to the return amount at either 84 and 120 months.

      With respect to the 2003 and 2004 policy years, the Company, through its Bermuda-based insurance subsidiary, remits premiums to AIG to cover AIG’s estimates of claims related to the first $1.0 million ($2.0 million for policy year 2004) per occurrence. AIG deposits the funds into an interest bearing loss fund account to fund all claims up to the $1.0 million per occurrence amount ($2.0 million for policy year 2004). Interest on the loss fund (which will be reduced as claims are paid out over the life of the policy) will accrue to the benefit of the Company at fixed annual rates. Under the 2003 program year, the Company paid $85.0 million of such premium and is guaranteed to receive a 2.42% per annum fixed return on $73.5 million and 1.85% on $11.5 million so long as the program and the interest accrued under the program, remain with AIG for at least 7 years. If the program is terminated prior to end of the 7 year period, the interest rate is adjusted downward based upon a sliding scale. Under the 2004 program year, the Company paid $111.4 million of such premiums and is guaranteed to receive a 2.92% per annum fixed return so long as the program and the related interest accrued under the program remain with AIG for a 10 year period. If the program is terminated prior to the end of the 10 year period, the interest rate is adjusted downward based upon a sliding scale. Both program years provide for an initial premium true-up eighteen months after the policy inception and annually thereafter. The true-up is based upon a pre-determined loss factor times the amount of incurred claims as of the date of the true-up.

      See the further discussion of the Company’s workers’ compensation policies at Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates-Workers’ Compensation Receivable/ Reserves”.

      Following is a description of the Company’s health plans, which are offered to all clients who are served under the co-employment model:

      Blue Cross and Blue Shield of Florida(1) — Blue Cross and Blue Shield of Florida (“BCBSFL”) is the Company’s primary partner in Florida, delivering medical care benefits to approximately 21,000 Florida based client employees. The Company’s policy with BCBSFL is a minimum premium policy expiring September 30, 2005. Pursuant to this policy, the Company is obligated to reimburse BCBSFL for the cost of the claims incurred by participants under the plan, plus the cost of plan administration. The administrative costs per covered client employee associated with this policy are specified by year and aggregate loss coverage is provided to the Company at the level of 115% of projected claims. The Company’s obligation to BCBSFL, related to incurred but not reported claims, is secured by a letter of credit. As of December 31, 2004, the amount of the letter of credit for BCBSFL securing such obligations was $6.0 million. The amount of the letter of credit was initially intended to approximate one month’s claims payments. The policy allows for an adjustment to the letter of credit amount based on premium volume and for increases to the claims payment factor to a maximum of two months of expected claims payments.

      Aetna Health, Inc. — Aetna Health, Inc. (“Aetna”) is the Company’s primary medical care benefits provider for approximately 26,000 client employees throughout the remainder of the country, including client

1BCBSFL is an independent licensee of the Blue Cross and Blue Shield Associations.

employees acquired in the acquisition of the client service agreements of EPIX Holdings Corporation (“EPIX”) on March 26, 2004, and the acquisition of the client service agreements of TeamStaff, Inc. (“TeamStaff”) on November 17, 2003. The Company’s 2004 policy with Aetna provides for an HMO and PPO offering to plan participants. The Aetna HMO medical benefit plans are subject to a guaranteed cost contract that caps the Company’s annual liability. The Aetna PPO medical benefit plan is a retrospective funding arrangement whereby the PPO plan is subject to a 7.5% additional premium if actual claims are greater than projected at the inception of the policy year. The maximum charge per year is 7.5% with a carryover into subsequent years of amounts that exceed 7.5% per year.

      Other Medical Benefit Plans — The Company provides coverage under various regional medical benefit plans to approximately 1,500 client employees in various areas of the country, including Kaiser Foundation Health Plan, Inc. in California, HealthPartners (Minnesota) in Minnesota, Harvard Pilgrim Healthcare in Massachusetts and Capital Health Plan in the Tallahassee, Florida region. Such regional medical plans are subject to fixed costs that cap the Company’s annual liability. Client employees acquired in the EPIX acquisition and the TeamStaff acquisition were provided medical care benefits under the medical benefit plans in which they participated on the date of the respective acquisition through September 30, 2004. These plans were fixed cost contracts that capped the Company’s annual liability. On October 1, 2004, these employees were provided coverage through the Company’s ongoing plans.

      Other Health Benefit Plans — The Company’s dental plans, which include both a PPO and HMO offering, are primarily provided by Aetna for all client employees who elect coverage. Delta Dental and American Dental provided dental coverage for certain client employees acquired in the EPIX and TeamStaff acquisitions through September 30, 2004. All dental plans are subject to guaranteed cost contracts that cap the Company’s annual liability.

      In addition to dental coverage, the Company offers various other guaranteed cost insurance programs to client employees, such as vision care, life, accidental death and dismemberment, short-term disability and long-term disability. The Company also offers a flexible spending account for health care, dependent care and transportation costs.

      Beginning October 1, 2004, part-time client employees became eligible to enroll in limited benefit programs from Star HRG. These plans include fixed cost sickness and accident and dental insurance programs, and a vision discount plan.

      The Company offers to clients served under the co-employment model a 401(k) retirement plan, designed to be a multiple employer plan under Section 413(c) of the Internal Revenue Code of 1986, as amended (the Code). This plan design enables owners of client companies and highly compensated client employees, as well as highly compensated internal employees of the Company, to participate. These persons were previously excluded from the single employer 401(k) retirement plan offered by the Company prior to April 1, 1997, in order to avoid issues of discrimination in favor of highly compensated employees. Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act (ERISA).

      In connection with the EPIX and TeamStaff acquisitions, the Company assumed certain employee benefit plans, including two multiple-employer 401(k) plans.

Internal Company Employees

      As of December 31, 2004, the Company employed 993 internal employees of whom 513 were located at the Company’s headquarters in Bradenton, Florida. The remaining employees were located in the Company’s branch offices. None of the Company’s internal employees are covered by a collective bargaining agreement.

Industry Regulation

      Numerous federal and state laws and regulations relating to employment matters, benefit plans and employment taxes affect the operations of the Company or specifically address issues associated with co-employment. Many of these federal and state laws were enacted before the development of non-traditional employment relationships, such as professional employer organizations, temporary employment and other employment-related outsourcing arrangements and, therefore, do not specifically address the obligations and responsibilities of a professional employer organization.

      Other federal and state laws and regulations are relatively new, and administrative agencies and federal and state courts have not yet interpreted or applied these regulations to the Company’s business or its industry. The development of additional regulations and interpretation of those regulations can be expected to evolve over time. In addition, from time to time, states have considered, and may in the future consider, imposing certain taxes on gross revenues or service fees of the Company and its competitors.

      Twenty-five states, including eight states where the Company has offices (Colorado, Florida, Minnesota, New Jersey, New York, North Carolina, Texas and Tennessee), have passed laws that have licensing, registration or other regulatory requirements for professional employer organizations, and several other states are currently considering similar regulation. Such laws vary from state to state, but generally codify the requirements that a professional employer organization must reserve the right to hire, terminate and discipline client employees and secure workers’ compensation insurance coverage. In certain instances, the Company delegates or assigns such rights to the client. The laws also generally provide for monitoring the fiscal responsibility of professional employer organizations and, in many cases, the licensure of the controlling officers of the professional employer organization.

      In addition, some states through legislative or other regulatory action have proposed to modify the manner in which the Company is allowed to provide services to the its clients which could increase the administrative cost associated with providing such services. To the extent modifications are adopted in these states, other states may follow. For example, California is considering modifying the interpretation of the law that governs workers’ compensation insurance coverage to require insurance carriers to issue policies directly to the Company’s clients rather than through the Company under a single master policy. Adoption of this interpretation would increase the Company’s administrative expense in providing workers’ compensation coverage to its clients.

      The Company believes that its operations are currently in compliance in all material respects with applicable federal and state statutes and regulations.

      In order to qualify for favorable tax treatment under the Code, 401(k) plans must be established and maintained by an employer for the exclusive benefit of its employees. Generally, an entity is an “employer” of certain workers for federal employment tax purposes if an employment relationship exists between the entity and the workers under the common law test of employment. In addition, the officers of a corporation are deemed to be employees of that corporation for federal employment tax purposes. The common law test of employment, as applied by the IRS, involves an examination of many factors to ascertain whether an employment relationship exists between a worker and a purported employer. Such a test is generally applied to determine whether an individual is an independent contractor or an employee for federal employment tax purposes and not to determine whether each of two or more companies is a “co-employer.” Substantial weight is typically given to the question of whether the purported employer directs and controls the details of an individual’s work. The courts have provided that the common law employer test applied to determine the existence of an employer-employee relationship for federal employment tax purposes can be different than the common law test applied to determine employer status for other federal tax purposes. In addition, control and supervision have been held to be less important factors when determining employer status for ERISA purposes.

      On May 13, 2002, the IRS released guidance applicable solely to the tax-qualified status of defined contribution retirement plans maintained by professional employer organizations. In that guidance, the IRS declared that it would not assert a violation of the exclusive benefit rule under Section 401(a) of the Code if a professional employer organization that maintains a single employer 401(k) retirement plan for client employees takes certain remedial action by the last day of the first plan year beginning on or after January 1, 2003.

      The Company maintains a frozen single employer 401(k) retirement plan benefiting certain client employees and took remedial action to qualify for the relief provided under the IRS guidance within the applicable deadline. As part of the remedial action, the plan was terminated. The Company has submitted an application to request IRS approval to proceed with the plan termination and distribution of assets (approximately $0.9 million as of December 31, 2004).

      In conjunction with the EPIX acquisition, the Company assumed sponsorship of a frozen single employer plan. Prior to the acquisition, EPIX took remedial action to qualify for the relief provided under the IRS guidance. The plan was terminated prior to the applicable deadline and an application was submitted to the IRS to request approval to proceed with the plan termination and distribution of assets (approximately $11 million at December 31, 2004).

      The status of the active multiple employer 401(k) retirement plans maintained by the Company are unaffected by the IRS guidance.

      Employee pension and welfare benefit plans are also governed by ERISA. ERISA defines an “employer” as “any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan.” ERISA defines the term “employee” as “any individual employed by an employer.” The courts have held that the common law test of employment must be applied to determine whether an individual is an employee or an independent contractor under ERISA. However, in applying that test, control and supervision are less important for ERISA purposes when determining whether an employer has assumed responsibility for an individual’s benefits status. A definitive judicial interpretation of “employer” in the context of a professional employer organization or employee leasing arrangement has not been established.

      If the Company were found not to be an employer for ERISA purposes, its former 401(k) retirement plan would not comply with ERISA. Further, the Company would be subject to liabilities, including penalties, with respect to its cafeteria benefits plan for failure to withhold and pay taxes applicable to salary deferral contributions by its clients’ employees. In addition, as a result of such a finding, the Company and its plans would not enjoy, with respect to client employees, the preemption of state laws provided by ERISA and could be subject to varying state laws and regulation, as well as to claims based upon state common laws.

      As a co-employer, the Company assumes responsibility and liability for the payment of federal and state employment taxes with respect to wages and salaries paid to client employees. There are essentially three types of federal employment tax obligations: (i) withholding of income tax governed by Code Section 3401, et seq.; (ii) obligations under FICA, governed by Code Section 3101, et seq.; and (iii) obligations under FUTA, governed by Code Section 3101, et seq. Under these Code sections, employers have the obligation to withhold and remit the employer portion and, where applicable, the employee portion of these taxes.

      Among other employment tax issues related to whether professional employer organizations are employers of client employees are issues under the Code provisions applicable to federal employment taxes. The issue arises as to whether the Company is responsible for payment of employment taxes on wages and salaries paid to such client employees. Code Section 3401(d)(1), which applies to federal income tax withholding requirements, contains an exception to the general common law test applied to determine whether an entity is an “employer” for purposes of federal income tax withholding. The courts have extended this common law employer exception to apply for both FICA and FUTA tax purposes. Code Section 3401(d)(1)

states that if the person for whom services are rendered does not have control of the payment of wages, the “employer” for this purpose is the person having control of the payment of wages. The Treasury Regulations issued under Code Section 3401(d)(1) state that a third party can be deemed to be the employer of workers under this Section for income tax withholding purposes where the person for whom services are rendered does not have legal control of the payment of wages. Although several courts have examined Code Section 3401(d)(1) with regard to professional employer organizations, its ultimate scope has not been delineated. Moreover, the IRS has,