GVHR Gevity HR (MM)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For the transition period from             to            

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes x          No o

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

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

Yes o          No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

GEVITY HR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

UNAUDITED

(in thousands, except share and per share data)

See notes to condensed consolidated financial statements.

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GEVITY HR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

UNAUDITED

(in thousands, except share and per share data)

See notes to condensed consolidated financial statements.

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GEVITY HR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

UNAUDITED

(in thousands, except share and per share data)

See notes to condensed consolidated financial statements.

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GEVITY HR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

(in thousands)

Supplemental disclosure of non-cash transactions:

Capital expenditures and cash flows from financing activities for the nine months ended September 30, 2008 exclude approximately $199 of capital items purchased by the Company through capital leases.

Capital expenditures for the nine months ended September 30, 2008 and 2007, exclude approximately $705 and $387, respectively, of capital items purchased by the Company in the third quarter of each year and not paid for until the fourth quarter of that year.

See notes to condensed consolidated financial statements.

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GEVITY HR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(in thousands, except share and per share data)

1.              GENERAL

The accompanying unaudited condensed consolidated financial statements of Gevity HR, Inc. and subsidiaries (collectively, the “Company” or “Gevity”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q.  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 (the “Form 10-K”), as filed with the Securities and Exchange Commission (the “SEC”). These financial statements reflect all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented.

The Company’s significant accounting policies are disclosed in Note 1 of the Company’s consolidated financial statements contained in the Form 10-K.  The Company’s critical accounting estimates are disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Form 10-K.  On an ongoing basis, the Company evaluates its policies, estimates and assumptions, including those related to revenue recognition, workers’ compensation receivable/reserves, intangible assets, medical benefit plan liabilities, state unemployment taxes, allowance for doubtful accounts, deferred taxes and share-based payments.  During the first nine months of 2008, there have been no material changes to the Company’s significant accounting policies and critical accounting estimates except as described below.

Recent Accounting Pronouncements

In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) Statement of Financial Accounting Standards (“SFAS”) No. 157-3, Determining the Fair Value of a Financial Asset When the Market For That Asset Is Not Active (FSP SFAS No. 157-3), with an immediate effective date, including prior periods for which financial statements have not been issued.  FSP SFAS No. 157-3 amends SFAS No. 157 (as described below) to clarify the application of fair value in inactive markets and allows for the use of management’s internal assumptions about future cash flows with appropriately risk-adjusted discount rates when relevant observable market data does not exist.  The objective of SFAS No. 157 has not changed and continues to be the determination of the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date.  The adoption of FSP SFAS No. 157-3 in the third quarter did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In June 2008, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 08-3, Accounting by Lessees for Maintenance Deposits under Lease Agreements (“EITF No. 08-3”). EITF No. 08-3 provides that all nonrefundable maintenance deposits paid by a lessee, under an arrangement accounted for as a lease, should be accounted for as a deposit. When the underlying maintenance is performed, the deposit is expensed or capitalized in accordance with the lessee’s maintenance accounting policy. Once it is determined that an amount on deposit is not probable of being used to fund future maintenance expense, it is recognized as additional rent expense at that time. EITF No. 08-3 is effective for the Company on January 1, 2009. The Company is currently evaluating the impact of adopting EITF No. 08-3 on the Company’s financial position, results of operations and cash flows.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF No. 03-6-1”).   This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in SFAS No. 128, Earnings per Share .  FSP EITF No. 03-6-1 redefines participating securities to include unvested share-based payment awards that contain non-forfeitable dividends or dividend equivalents as participating securities to be included in the computation of EPS pursuant to the “two-class method.”  Outstanding unvested restricted stock issued under employee compensation programs containing such dividend participation features would be considered participating securities subject to the “two-class method” in computing EPS rather than the “treasury stock method.”  FSP EITF No. 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and for interim periods within those years.  All prior-period EPS data presented is to be adjusted retrospectively to conform to the provisions of this FSP.  Early application is not permitted. The Company has not yet determined the impact, if any, that FSP EITF 03-6-1 will have on its computation and presentation of EPS.

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In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles , (“SFAS No. 162”), which becomes effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to US Auditing Standards Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP. This standard is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

In April 2008, the FASB issued FSP SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP SFAS No. 142-3”). FSP SFAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets . The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141 (revised 2007), Business Combinations , and other US GAAP. FSP SFAS No. 142-3 is effective for the Company on January 1, 2009. The Company is currently evaluating the impact of adopting FSP SFAS No. 142-3 on the Company’s financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about a company’s derivative and hedging activities. These enhanced disclosures will discuss (a) how and why a company uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect a company’s financial position, results of operations and cash flows. SFAS No. 161 is effective for the Company on January 1, 2009. This standard will have no impact on the Company’s financial position, results of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 gives entities the irrevocable option to carry many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 was effective for the Company on January 1, 2008. The implementation of this standard did not have a material impact on the Company’s financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for the measurement of assets and liabilities that use fair value and expands disclosures about fair value measurements. SFAS No. 157 will apply whenever another US GAAP standard requires (or permits) assets or liabilities to be measured at fair value but does not expand the use of fair value to any new circumstances. SFAS No. 157 is effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued FSP 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 , which removed leasing transactions accounted for under Statement 13 and related guidance from the scope of SFAS No. 157.  In addition, the FASB issued FSP 157-2, Partial Deferral of the Effective Date of Statement 157 , which deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.

The implementation of SFAS No. 157 for financial assets and financial liabilities, effective January 1, 2008, did not have a material impact on the Company’s financial position, results of operations or cash flow. The Company is currently assessing the impact of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities on its financial position, results of operations and cash flows.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).  SFAS No. 157 classifies the inputs used to measure fair value into the following hierarchy:

The Company utilizes the best available information in measuring fair value.  Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.  The Company

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has determined that its financial assets are currently level 1 in the fair value hierarchy.  Financial assets at September 30, 2008 consist solely of investments held in money market accounts.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141-R”), which will become effective for business combination transactions having an acquisition date on or after January 1, 2009.  This standard requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date to be measured at their respective fair values. SFAS No. 141-R requires acquisition related costs, as well as restructuring costs the acquirer expects to incur for which it is not obligated at the acquisition date, to be recorded against income rather than included in the purchase price determination.  It also requires recognition of contingent arrangements at their acquisition date fair values, with subsequent changes in fair value generally reflected in income. The Company does not anticipate that the adoption of SFAS No. 141-R will have a material impact on its financial position and results of operations.

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF No. 06-11”). EITF No. 06-11 applies to share-based payment arrangements with dividend protection features that entitle an employee to receive dividends or dividend equivalents on nonvested equity-based shares or units, when those dividends or dividend equivalents are charged to retained earnings and result in an income tax deduction for the employer under SFAS No. 123 (revised 2004), Share-Based Payment . Under EITF No. 06-11, a realized income tax benefit from dividends or dividend equivalents charged to retained earnings and paid to an employee for nonvested equity-based shares or units should be recognized as an increase in additional paid-in capital. EITF No. 06-11 is effective for fiscal years beginning after December 15, 2007 with early adoption permitted. The Company adopted EITF No. 06-11 on January 1, 2008, which did not have a material effect on the Company’s results of operations or financial position.

2.              DISCONTINUED OPERATIONS

After completion of a comprehensive strategic review, the Company decided to focus on the growth of its core co-employment offering, Gevity Edge ^TM . As such, on February 25, 2008, the board of directors of the Company approved a plan to discontinue the Company’s non co-employment offering, Gevity Edge Select ^TM . Clients that existed at February 25, 2008, were notified of this decision and given until June 30, 2008 to transition to other service providers.  The Company completed its transition of all remaining Gevity Edge Select clients during the second quarter of 2008, processing the final payrolls dated June 30, 2008.  The Company has determined that the exit from the Gevity Edge Select business meets the criteria of discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets .  Accordingly, the results of operations and related exit costs associated with Gevity Edge Select have been reported as discontinued operations for all periods presented.

Summarized operating results for the discontinued operations of Gevity Edge Select for the three and nine month periods ended September 30, 2008 and September 30, 2007 are as follows:

Pre-tax costs associated with the exit from the Gevity Edge Select business approximate $2,952 for the nine months ended September 30, 2008.  Management does not expect to incur any further significant costs in connection with the exit

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from this business. Costs associated with the exit from the Gevity Edge Select business are included in the loss from discontinued operations and are presented in the following table:

Activity in the liability accounts associated with the exit costs related to the discontinuation of the Gevity Edge Select business for the nine months ended September 30, 2008 is presented in the following table and is included within accounts payable and other accrued liabilities in the condensed consolidated balance sheet:

3.              MARKETABLE SECURITIES - RESTRICTED

At September 30, 2008 and December 31, 2007, the Company’s investment portfolio consisted of restricted money market funds classified as available-for-sale.

Restricted money market funds relate to collateral held in connection with the Company’s workers’ compensation programs, collateral held in connection with the Company’s general insurance programs and amounts held in escrow related to purchase price contingencies associated with the Company’s acquisition of HRAmerica, Inc. (“HRA”) on February 16, 2007. These securities are recorded at fair value, which is equal to cost. The interest earned on these investments is recognized as interest income in the Company’s condensed consolidated statements of operations.

For the three and nine months ended September 30, 2008 and 2007, there were no realized gains or losses from the sale of marketable securities.  As of September 30, 2008 and December 31, 2007, there were no unrealized gains or losses on marketable securities.

During the third quarter of 2008, the Company reached a settlement with the former HRA owners for (i) the release of $1,400 held in escrow related to purchase price contingencies for the acquisition of HRA, and (ii) the indemnification for certain representations made by the former owners of HRA in connection with the acquisition of HRA.  The settlement resulted in the release to Gevity of the $1,400 held in escrow as well a recovery by Gevity of approximately $100 related to indemnification claims as of September 30, 2008. The indemnification recovery of $100 is included in the loss from discontinued operations for the three and nine months ended September 30, 2008.

4.              ACCOUNTS RECEIVABLE

At September 30, 2008 and December 31, 2007, accounts receivable from clients consisted of the following:

The Company establishes an allowance for doubtful accounts based upon management’s assessment of the collectibility of specific accounts and other potentially uncollectible amounts.  The Company reviews its allowance for doubtful accounts on a quarterly basis.

5.              WORKERS’ COMPENSATION RECEIVABLE/ RESERVES

The Company has maintained 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

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currently insured by member insurance companies of American International Group , Inc. (“AIG”) and includes coverage for the 2003 through 2008 policy years. In states where private insurance is not permitted, client employees are covered by state insurance funds.

Under the 2008 workers’ compensation program with AIG, AIG is responsible for paying the claims; the Company is responsible for paying to AIG the first $1,000 per occurrence of claims and AIG is responsible for amounts in excess of $1,000 per occurrence.  In addition, the AIG policy provides $20,000 of aggregate stop loss coverage once claims in the deductible layer exceed $138,500.

Similar to prior years’ workers’ compensation programs with AIG, the Company, through its wholly-owned Bermuda-based insurance subsidiary, remits premiums to AIG to cover claims to be paid within the Company’s $1,000 per occurrence deductible layer. AIG deposits the premiums into an interest bearing loss fund collateral account for reimbursement of paid claims up to the $1,000 per occurrence amount. Interest on the loss fund collateral account (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.  Under the 2008 program, the Company initially agreed to pay $55,510 of loss fund collateral premium, subject to certain volume adjustments, and is guaranteed to receive a 3.19% per annum fixed return so long as the program and the interest accrued under the program remain with AIG for at least 10 years. If the program is terminated early, the interest rate is adjusted downward based upon a sliding scale. The 2008 program provides for an initial loss fund collateral premium true-up 18 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 in the deductible layer as of the date of the true-up. In the third quarter of 2008 AIG agreed to reduce the 2008 loss fund collateral premium payments by $13,858 to $41,652, based upon favorable loss trends and the sufficiency of the overall loss collateral funds held by AIG related to all policy years. This reduction will eliminate the fourth quarter loss fund collateral premium payments.

The Company reviews its estimated cost of claims in the deductible layer on a quarterly basis.  The determination of the estimated cost of claims is based upon a number of factors, including but not limited to: actuarial calculations, current and historical loss trends, the number of open claims, developments relating to the actual claims incurred and the impact of acquisitions, if any.  The Company uses a certain amount of judgment in this estimation process. During the three months ended September 30, 2008 and 2007, the Company revised its ultimate loss estimates for prior open policy years, which resulted in a net reduction of workers’ compensation expense of approximately $3,306 and $4,063, respectively. During the nine months ended September 30, 2008 and 2007, the Company revised its ultimate loss estimates for prior open policy years, which resulted in a net reduction of workers’ compensation expense of approximately $13,349 and $12,106, respectively. These revisions were based upon continued favorable claims development that occurred during the periods.

Also during the three months ended September 30, 2008 and 2007, the Company received from AIG its annual premium expense audit related to premiums, taxes and administrative costs of the prior policy years, which resulted in an increase in workers’ compensation expense during the third quarter of 2008 of $44 and a decrease in workers’ compensation expense during the third quarter of 2007 of $955.  As a result of the premium expense audit, the Company expects to receive $4,602 from AIG during the fourth quarter of 2008.

The balance in the loss fund collateral accounts (including accrued interest) in excess of the net present value of the Company’s liability to AIG with respect to claims payable within the deductible layer is recorded as a workers’ compensation receivable. Returns to the Company of amounts held in the loss fund collateral accounts are recorded as reductions to the workers’ compensation receivable, net. During the first three quarters of 2008 and 2007, AIG released approximately $35,127 ($33,127 in the third quarter) and $48,148 ($43,148 in the third quarter), respectively, of cash, from the loss fund collateral accounts in connection with the annual loss fund collateral true-up.

The Company accrues for workers’ compensation costs based upon:

·       premiums paid for the layer of claims in excess of the deductible;

·       estimated total costs of claims that fall within the Company’s policy deductible calculated on a net present value basis;

·       the administrative costs of the programs (including claims administration, state taxes and surcharges); and

·       the return on investment for loss fund premium dollars paid to AIG.

At September 30, 2008 and December 31, 2007, the weighted average discount rate used to calculate the net present value of the claim liability was 3.91% and 4.15%, respectively. Premium payments made to AIG relating to program years 2000 through 2008 are in excess of the net present value of the estimated claim liabilities. This has resulted in a workers’ compensation receivable, net, at September 30, 2008 and December 31, 2007 of $120,896 and $122,271, respectively, of which $23,996 and $16,950 was classified as short-term at September 30, 2008 and December 31, 2007, respectively. The short-term workers’ compensation receivable consists of $4,602 expected to be received in the fourth quarter of 2008 related

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to the 2008 premium expense audit true-up and $19,394 expected to be received in the third quarter of 2009 related to the 2009 annual loss fund collateral true-up.  The Company is currently negotiating with AIG and CNA regarding the potential release during 2009 of a substantial amount of loss fund collateral relating to excess collateral held by AIG for the 2000-2002 policy years.  The Company has not reclassified this amount into short-term receivable at September 30, 2008.

The workers’ compensation receivable from AIG represents a significant concentration of credit risk for the Company. Gevity has various commercial insurance relationships with AIG Commercial Insurance Group (“AIG CI”), a subsidiary of AIG, including our workers’ compensation program.  As of November 7, 2008, AIG CI’s financial strength rating by A.M. Best is an “A”.  The Company does not believe that the current financial condition of AIG will have a material adverse effect on AIG CI or the Company’s workers’ compensation receivable, net, as of September 30, 2008.

6.              INTANGIBLE ASSETS

At September 30, 2008 and December 31, 2007, intangible assets consisted of the following:

Amortization expense for the three months ended September 30, 2008 and 2007 was $2,410 and $2,524, respectively. Amortization expense for the nine months ended September 30, 2008 and 2007 was $7,397 and $7,516, respectively. Estimated amortization expense for the remainder of 2008 and for 2009 is $2,164 and $1,825, respectively.

7.              HEALTH BENEFITS

Blue Cross Blue Shield of Florida, Inc. and its subsidiary Health Options, Inc. (together “BCBSF/HOI”) is the Company’s primary healthcare partner in Florida, delivering medical care benefits to approximately 19,000 Florida-based client employees. The Company’s policy with BCBSF/HOI is a minimum premium policy expiring September 30, 2009. Pursuant to this policy, the Company is obligated to reimburse BCBSF/HOI 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 in the agreement and aggregate loss coverage is provided to the Company at the level of 115% of projected claims.  The Company is required to pre-fund the estimated monthly expenses and claim liability charges of the plan by the first of each calendar month.  The estimated monthly expenses are based upon the Minimum Premium Rate and the Annual Excess liability rate, as set forth in the agreement, times the number of insureds. The monthly estimated claim liability charge is based upon an average of monthly paid claims as determined by BCBSF/HOI based on three month periods specified in the agreement.  Differences between the pre-funded amounts and actual amounts subsequently determined shall be settled in the following month. As part of the Company’s obligation to BCBSF/HOI, the Company posted an irrevocable letter of credit in favor of BSBSF/HOI in an initial amount of $5,000 on October 1, 2008, which shall be increased monthly by approximately $1,000 over a seven month period until it reaches $11,766 on May 1, 2009.

Aetna Health, Inc. (“Aetna”) is the Company’s largest medical care benefits provider for approximately 17,000 client employees outside the state of Florida. The Company’s 2007/2008 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. Beginning with the 2007 plan year, Aetna agreed to eliminate the callable feature of the PPO plan that previously existed and differences in actual plan experience versus projected plan experience for the year will factor into subsequent year rates.

In 2006, the Company announced the addition of UnitedHealthcare as an additional health plan option. As of September 30, 2008, UnitedHealthcare provides medical care benefits to approximately 3,000 client employees. The UnitedHealthcare plan is a fixed cost contract. Effective May 1, 2008, UnitedHealthcare and the Company amended their agreement to extend coverage availability through September 30, 2009 for those clients covered by UnitedHealthcare as of May 1, 2008.

The Company provides coverage under various regional medical benefit plans to approximately 1,000 client employees in various areas of the country. Included in the list of medical benefit plan providers are Kaiser Foundation Health Plan, Inc. and Harvard Pilgrim Healthcare. These regional medical plans are subject to fixed cost contracts.

The Company’s dental plans, which include both a PPO and HMO offering, are provided by Aetna for all client employees who elect coverage. All dental plans are subject to fixed cost contracts that cap the Company’s annual liability.

In addition to dental coverage, the Company offers various fixed 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 healthcare, dependent care and a qualified transportation fringe benefit program.

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Part-time employees of clients are 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.

Included in accrued insurance premiums and health reserves at September 30, 2008 and December 31, 2007 are $8,804 and $10,356, respectively, of short-term liabilities related to the Company’s health benefit plans. Of these amounts $8,773 and $10,100, respectively, represent an accrual for the estimate of claims incurred but not reported at September 30, 2008 and December 31, 2007.

Health benefit reserves are determined quarterly by the Company and include an estimate of claims incurred but not reported and claims reported but not yet paid. The calculation of these reserves is based upon a number of factors, including but not limited to actuarial calculations, current and historical claims payment patterns, plan enrollment and medical trend rates.

During the three months ended September 30, 2008, the Company reduced its reserve for incurred but not reported claims by approximately $940, which decreased its cost of services and resulted in a health plan surplus for the period. This reduction was based upon favorable claims development.  There were no changes to the health plan reserves that impacted cost of services during the three months ended September 30, 2007.

During the nine months ended September 30, 2008 and 2007, the Company reduced its reserve for incurred but not reported claims by approximately $2,671 and $2,600, respectively, which decreased its cost of services and resulted in a health plan surplus for each period. These reductions were based upon favorable claims development.

8.              REVOLVING CREDIT FACILITY

The Company maintains a credit facility with Bank of America, N.A. and Wachovia, N.A. (the “Lenders”). On May 7, 2007, the Company entered into the First Amendment to the Amended and Restated Credit Agreement dated August 30, 2006, which increased the amount of aggregate revolving commitments of the credit facility from $50,000 to $75,000 and allowed the Company to repurchase up to $125,000 of its capital stock during the term of the agreement. On June 14, 2007, the Company entered into the Second Amendment to the Amended and Restated Credit Agreement, which increased the amount of aggregate revolving commitments from $75,000 to $100,000. On February 25, 2008, the Company entered into the Third Amendment to Amended and Restated Credit Agreement (“Third Amendment”). The Third Amendment provides for the grant of security interests and liens in substantially all the property and assets (with agreed upon carveouts and exceptions) of the Company to the Lenders. The Third Amendment also provides for an automatic decrease of the aggregate revolving commitment of the credit facility from $100,000 to $85,000 on September 30, 2008. The Third Amendment includes additional covenants and amends certain financial covenants and negative covenants with an effective date of December 31, 2007. These include the maintenance of a minimum consolidated net worth, a maximum consolidated adjusted leverage ratio, a minimum consolidated fixed charge coverage ratio of 1.25:1.0, minimum monthly cumulative  EBITDA requirements (for 2008 only), and a ceiling on consolidated capital expenditures.  The revised covenants set forth in the Third Amendment now restrict the Company’s ability to repurchase shares of its capital stock in certain circumstances and make acquisitions and requires the Company to provide certain period reports relating to budget and profits and losses, intellectual property and insurance policies.  Each of these covenants is based on defined terms and contain exceptions in the Credit Agreement, as amended.

Certain of the Company’s subsidiaries named in the credit agreement have guaranteed the obligations under the credit agreement. The credit facility has a five-year term that expires August 30, 2011. Loan advances bear an interest rate equal to an Applicable Rate (which ranges from 1.50% to 2.25% for Eurodollar Rate Loans, and from 0.25% to 1.00% for Prime Rate Loans, depending upon the Company’s consolidated leverage ratio) plus one of the following indexes: (i) Eurodollar Rate; or (ii) Prime Rate (each as defined in the credit agreement). Up to $20,000 of the loan commitment can be drawn through letters of credit. With respect to outstanding letters of credit, a fee determined by reference to the Applicable Rate plus a fronting fee ranging from 1.50% to 2.25% per annum will be charged on the aggregate stated amount of each outstanding letter of credit. A fee ranging from 0.30% to 0.45% (based upon the Company’s consolidated leverage ratio) is charged on any unused portion of the loan commitment. At September 30, 2008 the Company had outstanding advances of $32,500 at a weighted average interest rate of 5.71%. At December 31, 2007, the Company had outstanding advances of $17,367 at an interest rate of 6.11%.

The Company was in compliance with all of the covenants under the credit agreement at September 30, 2008. The ability to draw funds under the credit agreement is dependent upon meeting the aforementioned financial covenants.  Additionally, the level of compliance with the financial covenants determines the maximum amount available to be drawn. At September 30, 2008, the maximum facility available to the Company was approximately $66,400.

Pursuant to the terms of the credit agreement, the obligations of the Company may be accelerated upon the occurrence and continuation of an Event of Default. Such events include the following: (i) the failure to make principal, interest or fee payments when due (beyond applicable grace periods); (ii) the failure to observe and perform certain covenants

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contained in the credit agreement; (iii) any representation or warranty made by the Company in the credit agreement or related documents proves to be incorrect or misleading in any material respect when made or deemed made; and (iv) other customary events of default. If current operating trends continue, the Company may not be able to meet one of its four covenants (the monthly cumulative EBITDA covenant as defined in the credit agreement) during the fourth quarter of 2008 and may need to seek a waiver of this covenant from the Lenders.  The monthly cumulative EBITDA covenant is only in effect through December 31, 2008 and is not required after December 31, 2008.  If the Company requires a waiver in the fourth quarter of 2008 and the waiver is not obtained, this may have a material impact on the Company’s cash flow and ability to conduct its operations.

The Company recorded $789 and $1,131 of interest expense for the three months ended September 30, 2008 and 2007, respectively, related to the amortization of loan costs, unused loan commitment fees and interest on advances. Interest expense for the nine months ended September 30, 2008 and 2007 was approximately $2,034 and $2,094, respectively.

9.              COMMITMENTS AND CONTINGENCIES

Litigation

The Company is a party to certain pending claims that have arisen in the ordinary course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows if adversely resolved. However, the defense and settlement of these claims may impact the future availability of, and retention amounts and cost to the Company for, applicable insurance coverage.

Regulatory Matters

The Company’s employer and health care operations are subject to numerous federal, state and local laws related to employment, taxes and benefit plan matters. Generally, these rules affect all companies in the United States. However, the rules that govern professional employer organizations (“PEO”) constitute an evolving area due to uncertainties resulting from the non-traditional employment relationship among the PEO, the client and the client employees. Many federal and state laws relating to tax and employment matters were enacted before the widespread existence of PEO’s and do not specifically address the obligations and responsibilities of these PEO relationships. If the Internal Revenue Service concludes that PEO’s are not “employers” of certain client employees for purposes of the Internal Revenue Code of 1986, as amended, the tax qualified status of the Company’s defined contribution retirement plans as in effect prior to April 1, 1997 could be revoked, its cafeteria plan may lose its favorable tax status and the Company may no longer be able to assume the client’s federal employment tax withholding obligations and certain defined employee benefit plans maintained by the Company may be denied the ability to deliver benefits on a tax-favored basis as intended.

California Unemployment Tax Assessment

In May of 2007, the Company received a Notice of Assessment from the State of California Employment Development Department (“EDD”) relative to the Company’s practice of reporting payroll for its subsidiaries under multiple employer account numbers.  The notice stated that the EDD was collapsing the accounts of the Company’s subsidiaries into one account number for payroll reporting purposes and retroactively reassessed unemployment taxes due at a higher overall rate for the 2004-2006 tax years resulting in an assessment of $4,684.  On May 30, 2007, the Company filed a petition with the Office of the Chief Administrative Law Judge for the California Unemployment Insurance Appeals Board asking that the EDD’s assessment be set aside. The petition contends in part that the EDD has exceeded the scope of its authority in issuing the assessment by failing to comply with its own mandatory procedural requirements and that the statute of limitations for issuing the assessments has expired as the Company’s activities within the state were compliant with California statutes and regulations.

The Company and the State of California entered into negotiations in May 2008 in an attempt to resolve the dispute.  As a result, Gevity proposed a settlement offer in June 2008 that included a cash payment offer of $1,200, conceding to the State’s higher overall unemployment tax rate for tax years 2007 – 2008, along with revisions to its unemployment tax reporting methods for post 2008 tax years in consideration for the State’s withdrawal of the existing Assessment for 2004 -2006 (the “ Settlement Offer”).  The Settlement Offer is currently under review by the State.  The Company’s financial statements for the three and nine months ended September 30, 2008 reflect a charge of $82 and $1,132, respectively,  within cost of services, reflecting estimated amounts due in connection with additional unemployment tax costs for the term January 1, 2007 – September 30, 2008 should the State of California accept the Settlement Offer.  In the event that the Company is not able to reach a settlement with the State of California, the Company believes it has valid defenses regarding the assessments and will vigorously challenge the assessments.

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10.           EQUITY

Share Repurchase Program

Under the current share repurchase program (announced by the Company in August 2006 and increased in April 2007), a total of $111,527 of the Company’s common stock is authorized to be repurchased. Share repurchases under the program may be made through open market purchases, block trades or in private transactions at such times and in such amounts as the Company deems appropriate, based on a variety of factors including price, regulatory requirements, overall market conditions and other corporate opportunities. As of December 31, 2007, total shares repurchased under this program were 2,886,884 at a total cost of $60,131.  No shares were repurchased under this program during the nine month period ended September 30, 2008. The Company has suspended its share repurchase program for the time being in order to invest available cash in its business.

11.           INCOME TAXES

The Company records income tax expense (benefit) using the asset and liability method of accounting for deferred income taxes.  Under such method, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement carrying values and the income tax bases of the Company’s assets and liabilities. The Company’s effective tax rate provides for both federal and state income taxes. For the three months ended September 30, 2008 and 2007, the Company’s effective rate for income from continuing operations was (46.9%) and 32.1%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2008 and 2007 was 114.1% and 34.2%, respectively. The Company’s effective tax rates differed from the statutory federal tax rates because of the impact of state taxes, federal tax credits and discrete tax adjustments made during the third quarter of 2008.  The majority of the discrete adjustments made during the third quarter of 2008 related to $456 of interest expense recorded for estimated net additional taxes due determined in connection with the ongoing Internal Revenue Service examination of the Company’s 2004 tax return.   The additional taxes due of $2,246 (net, excluding interest) resulted in an adjustment in the Company’s balance sheet between current taxes payable and the Company’s current deferred tax liability during the third quarter of 2008.

12.           (LOSS) EARNINGS PER SHARE (“EPS”)

For the three months ended September 30, 2008, 324,428 common stock equivalents were excluded from the diluted earnings per share computation as their effect was anti-dilutive. Additionally, 744,265 options to purchase common stock, weighted for the portion of the period they were outstanding, were excluded from the diluted earnings per share computation substantially because the exercise prices of the options were greater than the average price of the common stock.

The reconciliation of net income attributable to common shareholders and shares outstanding for the purposes of calculating basic and diluted earnings per share for the three months ended September 30, 2007 is as follows:

For the three months ended September 30, 2007, 1,133,077 options to purchase common stock, weighted for the portion of the period they were outstanding, were excluded from the diluted earnings per share computation because the exercise prices of the options were greater than the average price of the common stock.

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For the nine months ended September 30, 2008, 367,579 common stock equivalents were excluded from the diluted earnings per share computation as their effect was anti-dilutive.  Additionally, 721,449 options to purchase common stock, weighted for the portion of the period they were outstanding, were excluded from the diluted earnings per share computation because the exercise prices of the options were greater than the average price of the common stock.

The reconciliation of net income attributable to common shareholders and shares outstanding for the purposes of calculating basic and diluted earnings per share for the nine months ended September 30, 2007 is as follows:

For the nine months ended September 30, 2007, 993,245 options to purchase common stock, weighted for the portion of the period they were outstanding, were excluded from the diluted earnings per share computation because the exercise prices of the options were greater than the average price of the common stock.

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

The following discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties (some of which are beyond the Company’s control), other factors and other assumptions that may cause actual results or performance to be materially different from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, elsewhere in this Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 (the “Form 10-K”), as filed with the Securities and Exchange Commission. See “Cautionary Note Regarding Forward-Looking Statements” below in this Item 2. The following discussion should be read in conjunction with the Company’s condensed consolidated financial statements and related notes contained in this report. Historical results are not necessarily indicative of trends in operating results for any future period.

OVERVIEW

Gevity HR, Inc. (“Gevity” or the “Company”) specializes in providing small- and medium-sized businesses nationwide with a wide-range of competitively priced payroll, insurance and human resource (“HR”) outsourcing services.

Gevity is a professional employer organization (“PEO”) that provides certain HR-related services and functions for clients under a co-employment arrangement. Under the co-employment arrangement, Gevity assumes certain HR/employment-related responsibilities, as provided for by a professional services agreement (“PSA”) and as may be required under certain state laws. The co-employment relationship allows the PEO to become an employer of record and administrator for matters such as employment tax and insurance-related paperwork as well as relieving the client of these time-consuming administrative burdens. Because a PEO can aggregate a number of small clients into a larger pool, the PEO is able to create economies of scale—enabling smaller businesses to get competitively priced benefits.

The core services typically provided by a PEO are payroll processing, access to health and welfare benefits and workers’ compensation coverage. In addition to these core offerings, the Company’s Gevity Edge™ offering provides value-adding HR services such as employee retention programs, new hire support, employment practices liability insurance coverage and performance management programs, all designed to help clients effectively grow their businesses. Gevity is one of few PEOs with dedicated field-based HR consultants. The Company’s HR consultants work directly with clients to provide HR expertise and HR strategies that can help drive their business forward, while lowering potential exposure to HR-related claims.

Previously, Gevity also provided service to its clients through a non co-employment relationship. The non co-employment relationship between Gevity and its clients was also governed by a PSA. Under the non co-employment PSA, the employment related liabilities remained with the client and the client was responsible for its own workers’ compensation insurance and health and welfare plans. The Company assumed responsibility for payroll administration (including payroll processing, payroll tax filing and W-2 preparation) and provided access to all of its HR services. This non co-employment offering was known as Gevity Edge Select™.  After completion of a comprehensive strategic review, the Company decided to focus on the growth of its core co-employment offering, Gevity Edge. As such, on February 25, 2008, the board of directors of the Company approved a plan to discontinue the Company’s non co-employment offering, Gevity Edge Select. Clients that existed at February 25, 2008, were notified of this decision and given until June 30, 2008 to transition to other service providers.  The Company completed its transition of all remaining Gevity Edge Select clients during the second quarter of 2008, processing of the final payrolls dated June 30, 2008.  The Company has determined that the exit from the Gevity Edge Select business meets the criteria of discontinued operations in accordance with Statement of Financial Accounting Standards  No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets .  Accordingly, the results of operations and related exit costs associated with Gevity Edge Select have been reported as discontinued operations for all periods presented   The impact of this decision on the results of operations of the Company is included in the “Results of Operations” discussion that follows under “Discontinued Operations.”

RESULTS OF OPERATIONS

Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007

Revenue

The following table presents certain information related to the Company’s revenues from continuing operations for the three months ended September 30, 2008 and 2007:

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