Barrett Business Services, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; compared with the corresponding 2017 periods. Amounts below are in millions of dollars, except per-share data.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $247.3 | $240.1 | $702.9 | $675.7 |
| Gross margin | $59.7 (24.1%) | $54.9 (22.8%) | $124.4 (17.6%) | $109.6 (16.2%) |
| Income from operations | $22.1 | $19.9 | $19.5 | $18.0 |
| Net income | $19.1 | $14.8 | $21.2 | $14.7 |
| Diluted earnings per share | $2.50 | $1.96 | $2.77 | $1.95 |
| Operating cash flow | Not reported separately | Not reported separately | $46.9 | $60.5 |
Q3 revenue rose 3.0%; nine-month revenue rose 4.0%. Professional employer organization (PEO) service fees increased 4.5% in Q3 and 6.3% year to date, while staffing revenue fell 4.2% and 6.8%, respectively. Management attributed PEO growth to new and continuing clients, headcount and hours worked; tight labor markets weighed on staffing.
Q3 operating income increased about 10.7% and net income about 29.1% year over year. For the first nine months, net income rose despite higher SG&A, partly reflecting increased investment income and a lower effective tax rate. Effective tax rates were 20.0% in Q3 and 16.5% year to date, versus 31.1% and 29.8% in 2017.
Liquidity, debt and capital
- Cash and cash equivalents were $35.0 at September 30, down from $59.8 at December 31, 2017. Cash, cash equivalents and restricted cash totaled $105.1, down $15.1 over the nine months.
- Operating cash flow was $46.9, versus $60.5 in the prior-year period. The filing cites higher workers’ compensation liabilities and accrued payroll as sources of operating cash, partly offset by a $25.9 increase in receivables.
- Investing activities used $53.7, mainly reflecting purchases of restricted investments; financing activities used $8.3, including $5.5 of dividends and $3.0 of stock repurchases on restricted stock vesting.
- Long-term debt was approximately $4.2, principally a mortgage; there were no revolving-credit borrowings. The revolving line was $28.0, expiring July 2020. The company reported compliance with its covenants.
- Restricted cash and investments primarily support workers’ compensation obligations. The company reported $398.8 of workers’ compensation claims liabilities, including $295.3 long term; the IBNR component was $246.2, or 62% of claims liabilities, compared with 51% in 2017.
Material changes, outlook and risks
- Workers’ compensation expense as a percentage of revenue declined year over year. Management attributed this largely to a $2.3 favorable adjustment to prior-period claims in 2018; the comparable nine-month 2017 period included a $5.0 unfavorable adjustment. Reserve estimates are judgmental and actual claim costs may differ materially.
- SG&A increased to $36.7 in Q3 and $101.7 for the first nine months, with higher employee-related costs and, year to date, SEC settlement-related litigation expense. A $1.5 SEC civil penalty was accrued and paid in September 2018.
- Effective July 1, 2018, the Chubb workers’ compensation fronted program was restructured. It retains $5.0 per-occurrence retention but requires collateral at policy inception, including a $63.7 letter of credit. The company must also make specified deposits to collateral accounts, restricting some cash generation.
- Management expects operating cash generation, liquid assets and credit availability to fund working-capital needs for the next 12 months. No specific earnings or revenue guidance was provided. Management warns results can fluctuate due to seasonality, payroll-tax wage limits, labor-market conditions and workers’ compensation claims experience.
- The company reached a resolution with SEC enforcement staff and paid the $1.5 penalty. The U.S. Attorney’s Office announced criminal charges against the company’s former CFO; the filing says the action is solely against the former CFO and the company is cooperating. A shareholder derivative suit remains unresolved, and management could not estimate its probability or potential loss. The IRS was examining the company’s 2011–2014 federal returns.
- Management reported disclosure controls were effective as of September 30, 2018, with no material change in internal control over financial reporting during the quarter. The filing reported no material changes to the risk factors in the 2017 Form 10-K.
Important facts for investors to verify
- Developments in workers’ compensation reserves, especially IBNR, claims severity and prior-period loss adjustments.
- Collateral, letter-of-credit and cash-deposit requirements under the Chubb arrangement, and their effect on liquidity and credit capacity.
- Whether PEO growth continues to offset staffing weakness and rising payroll taxes, benefits and SG&A.
- Outcome or updates concerning the former CFO investigation, derivative litigation and IRS examination.
- Investment portfolio valuation exposure: management estimated a 50-basis-point rate increase could affect fair value by $6.2.