Barrett Business Services, Inc. — Q3 2021 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2021, compared with the same periods in 2020. BBSI provides professional employer organization (PEO), staffing, payroll, human-resources and workers’ compensation services, primarily to small and midsized businesses. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $247.0 | $227.5 | $698.6 | $647.6 |
| Gross margin | $60.2; 24.3% | $59.2; 26.1% | $148.6; 21.3% | $131.9; 20.4% |
| Operating income | $17.7 | $22.3 | $30.7 | $27.5 |
| Net income | $14.9 | $18.5 | $27.5 | $26.6 |
| Diluted EPS | $1.96 | $2.40 | $3.59 | $3.46 |
| Operating cash flow | Not separately presented | Not separately presented | $(60.3) | $(78.9) |
- Q3 revenue increased 8.5% year over year; PEO service fees rose 9.5%, while staffing revenue increased 1.9%. For the first nine months, revenue grew 7.9%, with PEO fees up 8.2% and staffing up 5.1%.
- Average worksite employees increased 8.0% in Q3 and 3.6% for the nine-month period. Management attributed PEO growth to higher average billing per worksite employee and increased worksite-employee counts.
- Q3 gross margin dollars rose modestly, but margin as a percentage of revenue fell to 24.3%. Higher payroll taxes and benefits, partly associated with newly hired worksite employees, weighed on the rate. For the nine months, gross margin rate improved to 21.3%.
- SG&A increased to $41.2 million in Q3 and $113.9 million year to date. Management cited restored employee-related spending after prior-year pandemic reductions, increased variable compensation, and, year to date, IT costs related to the myBBSI portal.
- Workers’ compensation costs were $49.8 million in Q3 and $141.7 million year to date. Year-to-date costs benefited from favorable prior-claims development, including a $7.5 million favorable adjustment, versus $5.2 million in the comparable 2020 period.
Liquidity, cash flow and debt
- At September 30, 2021, cash and cash equivalents were $12.9 million; total cash, cash equivalents and restricted cash reported in the cash-flow statement were $22.2 million. Current investments were $102.7 million, and current plus long-term restricted cash and investments totaled $319.5 million. Much of the restricted balance supports workers’ compensation obligations and collateral requirements.
- Working capital was affected by trade receivables rising to $240.3 million from $118.5 million at December 31, 2020, and accrued payroll and related benefits increasing to $249.7 million from $150.0 million.
- Nine-month operating cash use was $60.3 million, mainly reflecting higher receivables and lower workers’ compensation and safety-incentive liabilities, partly offset by higher accrued payroll. Investing cash use was $133.3 million, primarily from purchases of investments and restricted investments. Financing cash use was $18.0 million, including $10.8 million of share repurchases and $6.8 million of dividends.
- The company had no revolving-credit borrowings and approximately $3.6 million of mortgage debt at quarter-end. Its $33.0 million revolving facility had $6.2 million of the $8.0 million letter-of-credit sublimit in use. BBSI reported compliance with all credit covenants.
Material changes, outlook and risks
- In June 2021, BBSI entered a loss portfolio transfer for older insured-program claims, reducing workers’ compensation liabilities by $53.1 million; the remaining payment was made in July. A new insured-program arrangement effective July 1, 2021 shifts risk of loss for claims incurred after June 30, 2021 to third-party insurers, subject to possible premium adjustments. Favorable experience may yield participation up to $20.0 million per 12-month policy period; adverse experience may result in additional premiums up to $7.5 million.
- Management said COVID-19-related business disruption and labor shortages could continue to constrain client growth and revenue. The filing gives no quantified earnings or revenue guidance. Management also noted historically seasonal quarterly results and sensitivity to customer activity, payroll-tax wage limits and workers’ compensation claims.
- Workers’ compensation reserves require significant actuarial estimates and may differ materially from ultimate claim costs. The $297.0 million claims liability at September 30 includes $162.4 million of incurred-but-not-reported claims.
- A California wage-and-hour case, Kaanaana, was remanded after a state Supreme Court decision that certain work constituted public work subject to prevailing-wage rules. Potential liability from that determination was not considered estimable and was not accrued; the company says it believes it may recover increased costs from the customer. BBSI recorded $4.0 million of estimated liabilities for this and other legal matters.
- The IRS has proposed disallowing certain wage-based tax credits, with estimated additional tax of approximately $2.3 million for tax years 2012–2015. BBSI disputes the position and recorded no reserve. The IRS also planned audits of 2017–2019 returns.
- Interest-rate risk is material to the investment portfolio: management estimated a 50-basis-point rate increase would reduce portfolio fair value by $7.0 million. The filing also notes expected LIBOR transition concerns for the mortgage loan’s reference rate.
- Disclosure controls and procedures were reported effective as of September 30, 2021; no material change in internal control over financial reporting was reported during the quarter.
Important facts for investors to verify
- Whether revenue and worksite-employee growth persist, and whether elevated payroll taxes and SG&A continue to pressure quarterly margins.
- The drivers and sustainability of favorable workers’ compensation claims development, the adequacy of reserves, and the financial terms and performance of the new insurance arrangement.
- Receivables collectability and operating cash conversion, given the substantial increase in receivables and negative operating cash flow.
- Potential exposure and timing in the Kaanaana litigation and the outcome of the IRS tax-credit dispute and audits.
- Availability of unrestricted liquidity after accounting for restricted collateral, and compliance with credit covenants and state workers’ compensation collateral requirements.