Barrett Business Services, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The company provides professional employer organization (PEO), staffing, and business-management services, primarily to small and mid-sized businesses. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $231.6 | $225.6 | $455.6 | $435.6 |
| Gross margin | $48.5 (21.0%) | $44.2 (19.6%) | $64.7 (14.2%) | $54.7 (12.5%) |
| Operating income (loss) | $11.6 | $15.2 | $(2.6) | $(1.9) |
| Net income (loss) | $11.2 | $11.1 | $2.1 | $(0.1) |
| Diluted EPS | $1.46 | $1.47 | $0.28 | $(0.01) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $16.5 | $14.2 |
- Q2 revenue rose 2.7%; PEO service fees increased 5.1% to $197.3 million, while staffing revenue declined 9.3% to $34.3 million.
- First-half revenue rose 4.6%; PEO fees increased 7.3% to $386.2 million, while staffing revenue fell 8.3% to $69.3 million.
- Q2 SG&A increased to $35.6 million from $28.1 million, reducing operating income despite higher gross margin. First-half SG&A rose to $65.0 million from $54.7 million, contributing to a wider operating loss.
- Other income was $2.1 million in Q2 and $4.1 million for the first half, principally reflecting higher investment income. Q2 effective tax rate was 18.0%; the first-half rate was negative 37.8%, with management attributing rate volatility to near break-even pretax results.
Financial position, liquidity and debt
- At June 30, cash and cash equivalents were $33.8 million; cash, cash equivalents and restricted cash totaled $58.6 million, down $61.6 million from year-end. Restricted cash and investments totaled $423.0 million on the balance sheet and are principally held for workers’ compensation obligations, so they are not generally available for ordinary liquidity needs.
- Six-month cash flow: $16.5 million provided by operations, $74.2 million used in investing, and $3.8 million used in financing. Investing outflows primarily reflected purchases of restricted investments.
- Total debt was approximately $4.3 million, principally the office mortgage; there were no revolving-credit borrowings at quarter-end. The revolving facility was $25 million at June 30 and increased to $28 million effective July 1, 2018.
- Total workers’ compensation claims liabilities were $390.8 million at June 30, 2018, versus $363.5 million at December 31, 2017. The estimated incurred-but-not-reported portion was $231.7 million, or 59% of reserves.
- Stockholders’ equity was $84.9 million, compared with $88.8 million at year-end. Six-month other comprehensive loss of $4.9 million reflected unrealized investment losses.
Material changes, outlook and risks
- Management attributed PEO growth to new and continuing customers, employee headcount and hours worked; gross billings to continuing PEO customers rose 5.7% in Q2 and 6.0% in the first half. Tight labor-market conditions were cited as the primary reason for lower staffing revenue.
- Workers’ compensation expense as a share of revenue declined year over year, partly because unfavorable prior-period claims development in 2017 did not recur: $2.4 million in Q2 and $5.3 million in the first half.
- SG&A growth reflected higher employee-related expenses and litigation costs related to an expected SEC settlement. In July 2018, the company reached an agreement in principle with SEC enforcement staff for a $1.5 million civil penalty, accrued at June 30 and payable after final regulatory approval, expected in Q3 2018. A Department of Justice investigation continues; the company says it is cooperating. A shareholder derivative suit remains pending, and management cannot estimate its potential loss.
- Effective July 1, 2018, the Chubb workers’ compensation fronted program was restructured. The company retained a $5 million per-occurrence retention and provided a $30 million surety bond and a $63.7 million letter of credit. The credit agreement requires deposits to collateral accounts and includes financial covenants and restrictions, including a quarterly dividend limit of $0.25 per share. The company reported covenant compliance at June 30.
- Management expects operating cash generation, liquid assets and revolving-credit availability to cover working-capital needs for the next 12 months. No quantitative revenue or earnings guidance was provided. The filing notes historical quarterly volatility and seasonality, including workers’ compensation claims variability and seasonal customer activity.
- Key risks include uncertainty in workers’ compensation reserve estimates and claims development, access to collateral and letters of credit, labor-market conditions, customer retention and receivable collection, investment-market exposure, and the continuing investigations and litigation. The filing reported no material changes to the risk factors in the 2017 Form 10-K.
- The company adopted the new revenue-recognition standard in January 2018 with no material financial-statement impact. It expects the lease standard, effective in 2019, to materially affect balance-sheet assets and liabilities.
Important facts for investors to verify
- Whether PEO growth continues to offset lower staffing revenue and whether tight labor conditions persist.
- How workers’ compensation claims experience, actuarial assumptions and reserve development affect future earnings and required collateral.
- Final approval and payment of the $1.5 million SEC settlement, and developments in the DOJ investigation and shareholder litigation.
- The financial and liquidity effects of the Chubb collateral arrangement, letter-of-credit fees, and restricted investment balances.
- Progress toward operating profitability: first-half operating loss widened even as net income improved, supported in part by investment income and tax effects.