Barrett Business Services, Inc. — Q3 2017 Form 10-Q
Period: Quarter and nine months ended September 30, 2017. Unaudited consolidated results. BBSI provides business management and professional employer organization (PEO) and staffing services to small and midsized businesses. PEO service fees are reported net of specified direct payroll and safety incentive costs; staffing revenue is reported gross.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $240.1m | $225.1m | $675.7m | $619.5m |
| Gross margin | $54.9m; 22.8% | $49.6m; 22.1% | $109.6m; 16.2% | $102.2m; 16.5% |
| Operating income | $19.9m | $18.3m | $18.0m | $19.0m |
| Net income | $14.8m | $10.2m | $14.7m | $10.8m |
| Diluted EPS | $1.96 | $1.38 | $1.95 | $1.46 |
| Operating cash flow | Not presented separately for quarter | Not presented separately for quarter | $60.5m | $57.3m |
At September 30, 2017, cash and cash equivalents were $35.6m, versus $50.8m at year-end 2016. Current assets were $290.0m and current liabilities $317.9m; substantial restricted cash and investments—$372.0m combined current and noncurrent—are held primarily for workers’ compensation obligations and are not equivalent to unrestricted liquidity. Total assets were $659.2m and stockholders’ equity $80.7m.
Total debt was approximately $4.4m, principally the mortgage; there were no revolving-credit borrowings. The company had a $25.0m revolving facility, expiring July 1, 2018, with $5.9m of a $6.0m letter-of-credit sublimit used. BBSI reported compliance with its covenants. Management expected operating funds, liquid assets and credit availability to cover working capital needs for the next 12 months.
Changes versus comparable periods
- Q3 revenue increased 6.7%; PEO fees rose 11.4% to $197.4m, while staffing revenue fell 10.9% to $42.7m. Management attributed PEO growth to new and existing customers, increased headcount and hours, and strong referrals. Adjusted for one fewer business day, continuing-customer PEO revenue grew 8.4%.
- For the first nine months, revenue rose 9.1%; PEO fees grew 12.0%, while staffing revenue declined 2.8%. Continuing-customer PEO revenue increased 5.8%.
- Q3 gross margin percentage improved, reflecting lower direct payroll and workers’ compensation costs as a percentage of revenue, partly offset by higher payroll taxes and benefits. Nine-month gross margin percentage declined, mainly because workers’ compensation costs and payroll taxes increased as a share of revenue.
- Nine-month operating income decreased despite higher revenue and gross profit. Workers’ compensation reserve estimates included a $5.0m unfavorable prior-period adjustment in 2017, compared with a $1.5m favorable adjustment in 2016.
- Net income benefited from other income of $2.9m for the nine months, versus other expense of $3.3m in 2016. The change reflected higher investment income and the absence of the prior-year $3.3m litigation loss.
Management commentary, risks and unusual items
- Workers’ compensation claims liabilities were $344.7m, including $177.2m of incurred-but-not-reported reserves. Reserve estimates rely on actuarial judgments and actual claim costs may differ materially. The Chubb trust account held $358.4m for future claims.
- Operating cash flow was supported by higher claims liabilities and accrued payroll, partly offset by a $29.9m increase in receivables. Investing cash use was $68.6m, largely reflecting purchases of restricted cash and investments, net of maturities and sales.
- The company disclosed ongoing SEC inquiries/investigations concerning reported financial-statement errors and workers’ compensation reserve accounting, and a Department of Justice investigation. BBSI is cooperating. A shareholder derivative action remains pending; management could not estimate the likelihood or range of loss.
- Disclosure controls and procedures were deemed ineffective at September 30, 2017 because of a previously identified material weakness in IT user-access and program/data-change controls. Remediation was underway but required further repeatable execution to establish effectiveness.
- No specific financial guidance was provided. Management noted seasonality, customer demand and service mix, wage-tax limits, claims experience, medical-cost inflation and regulatory changes as factors that can affect results. The filing says quarterly results have historically fluctuated, including first-quarter losses.
- A 50-basis-point increase in market interest rates was estimated to affect investment-portfolio fair value by $5.9m; the effect on outstanding borrowings was expected to be immaterial.
Investor verification priorities
- Track workers’ compensation reserve development, including the $5.0m nine-month unfavorable prior-period adjustment, and compare subsequent claims payments with recorded reserves.
- Monitor whether PEO growth continues and whether staffing weakness, payroll-tax costs and customer mix affect margins.
- Review the progress and independent validation of remediation of the IT-control material weakness.
- Follow outcomes of the SEC and DOJ matters and shareholder litigation; the filing provides no clear estimate of potential loss.
- Distinguish unrestricted cash from restricted claims assets, and confirm ongoing covenant compliance and renewal or replacement of the revolving facility before its July 2018 expiration.