Barrett Business Services, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; filed November 9, 2016. Financial statements are unaudited. BBSI provides professional employer organization (PEO) and staffing services, primarily to small and mid-sized businesses.
Financial performance
- Q3 revenue: $225.1 million, up 13.3% year over year. PEO service fees rose 16.5% to $177.2 million; staffing revenue rose 2.7% to $47.9 million.
- Q3 earnings: Gross margin was $49.6 million (22.0% of revenue), versus $42.9 million (21.6%) a year earlier. Operating income increased to $18.3 million from $16.7 million. Net income fell to $10.2 million from $11.0 million; diluted EPS was $1.38 versus $1.49.
- Q3 cost and unusual items: Workers’ compensation expense rose to $55.6 million from $45.3 million. SG&A increased to $30.4 million from $25.4 million, including higher legal and accounting costs. Other expense included a $3.3 million litigation charge. A $3.8 million federal unemployment tax credit benefited payroll taxes and benefits.
- Nine-month results: Revenue was $619.5 million, up 13.2%; gross margin was $102.2 million (16.5%), versus $88.3 million (16.1%). Operating income declined to $19.0 million from $22.3 million; net income fell to $10.8 million from $14.0 million; diluted EPS was $1.46 versus $1.91. PEO fees rose 18.8% to $497.7 million, while staffing revenue declined 4.9% to $121.8 million.
- Cash flow: Nine-month operating cash flow was $57.3 million, compared with $51.3 million. Investing used $35.7 million and financing used $20.0 million. Cash and cash equivalents increased $1.6 million from year-end to $26.8 million.
Balance sheet and liquidity
- At September 30, cash was $26.8 million, while restricted cash and investments totaled approximately $297.0 million. Much of the restricted balance supports workers’ compensation obligations, insurance programs, and collateral requirements and is not freely available for general use.
- Total workers’ compensation claims liabilities were $291.9 million, up from $255.7 million at December 31, 2015; the reported IBNR component was $145.7 million.
- The $15.0 million term loan outstanding at year-end was repaid. No revolving-credit borrowings were outstanding. Long-term debt was $4.4 million, primarily a mortgage due November 2017; the $14 million revolving facility expires October 1, 2017.
- The company reported a waiver of a 2016 capital-expenditure covenant violation. The credit agreement restricts dividends, additional debt, and stock repurchases; quarterly dividends are permitted up to $0.22 per share subject to compliance conditions.
Changes, outlook, risks, and contingencies
- Management attributed PEO growth to new and continuing customers, headcount, and hours worked. Continuing-customer PEO revenue rose 9.1% in Q3 and 8.1% for the nine-month period. California generated approximately 78% of net revenue in both periods.
- Workers’ compensation costs increased, reflecting higher current-period claims expense and smaller favorable adjustments to prior-period claims than in 2015. Reserve estimates involve significant judgment, and actual claims costs may differ materially.
- A shareholder securities-litigation settlement provides for $12.0 million, of which approximately $3.3 million is BBSI’s responsibility and was accrued; insurers are expected to fund approximately $8.7 million. Final court approval was pending, and the filing warns that failure or termination of the settlement could have a material adverse effect.
- The SEC and Department of Justice were investigating matters related to workers’ compensation reserves and company disclosures; BBSI said it was cooperating. A separate shareholder derivative lawsuit remained unresolved, and management could not estimate the probability or range of loss for the legal actions.
- Disclosure controls were deemed ineffective as of September 30 because of material weaknesses in internal control over financial reporting. The filing describes unsupported entries by the former CFO and weaknesses involving reserve estimates, journal entries, reconciliations, IT controls, and payroll taxes. Remediation was underway but the weaknesses were not reported as remediated.
- Management stated that operating cash generation, liquid assets, and available revolving credit were expected to fund working-capital needs for the next 12 months. The filing provides no specific earnings or revenue guidance. Management cited seasonality, customer demand, competition, and workers’ compensation claims experience as sources of operating volatility.
Most important facts for investors to verify
- Progress and effectiveness of remediation of the material weaknesses, and whether future filings report effective controls.
- Workers’ compensation reserve development, claims experience, and adequacy of restricted collateral and insurance funding.
- Final approval and payment of the securities-litigation settlement, plus developments in the SEC, DOJ, and derivative proceedings.
- Cash available for general purposes after accounting for restricted balances, and compliance with credit-facility covenants and the facility’s 2017 expiration.
- Whether PEO growth and margins can offset rising workers’ compensation costs, higher SG&A, and weakness in staffing revenue.