BARRETT BUSINESS SERVICES INC quarterly report, Q2 FY2017

Business context and reporting period

Barrett Business Services, Inc. (BBSI) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. BBSI provides management, HR outsourcing, payroll and workers’ compensation services to small and mid-sized businesses, alongside staffing services. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.

Financial performance and position

• Revenue mix and growth: Q2 PEO service fees increased 13.2% to $187.7 million; staffing revenue grew 0.8% to $37.9 million. For the first half, PEO fees increased 12.3% and staffing revenue 2.3%. PEO revenue is reported net of specified payroll and safety incentive amounts; BBSI also presents non-GAAP gross revenue, which includes those amounts.
• Cash flow: First-half operating cash flow was $14.2 million, versus $4.5 million in 2016. Investing activities used $43.3 million, primarily reflecting purchases of restricted cash and investments; financing activities used $3.7 million, mainly dividends.
• Liquidity and debt: Cash and cash equivalents were $17.9 million at June 30, down from $50.8 million at year-end 2016. Restricted cash and investments totaled $347.3 million, primarily supporting workers’ compensation claims. Total debt was approximately $4.5 million, consisting mainly of the mortgage; there were no revolving-credit borrowings. The $25 million revolver expires July 1, 2018, and BBSI was in covenant compliance.
• Workers’ compensation: Claims liabilities were $330.1 million at June 30, up from $312.5 million at year-end 2016. BBSI recorded adverse prior-period reserve development of $2.4 million in Q2 and $5.3 million in the first half, increasing workers’ compensation expense.
• Dividends: Cash dividends were $0.25 per share in Q2 and $0.50 per share for the first half.

Material changes versus the prior comparable period

• Q2 revenue rose 10.9% and net income rose to $11.1 million from $8.5 million. First-half revenue increased 10.4%, but the company reported a small net loss versus prior-year net income.
• Gross margin percentage declined in both comparisons, to 19.6% in Q2 from 20.8%, and to 12.5% for the first half from 13.3%. Management attributed the pressure principally to higher workers’ compensation costs and payroll taxes and benefits as a share of revenue.
• First-half operating results also included a $1.4 million increase in net other income, largely from higher investment income; first-half operating loss was $1.9 million.
• Restricted cash and investments increased, while unrestricted cash declined. Management attributed the cash decline mainly to purchases of restricted investments.

Outlook, risks, contingencies and unusual items

• Management expects operating cash generation, current liquid assets and revolver availability to be sufficient for working-capital needs over the next 12 months. No quantified revenue or earnings guidance is provided.
• Management cited continuing customer growth, with new-customer business exceeding lost-customer business in Q2; continuing-customer PEO revenue increased 7.6% in Q2. The filing warns that results fluctuate with seasonality, customer demand, payroll tax wage limits and workers’ compensation claims experience.
• Workers’ compensation reserves depend on actuarial estimates and are subject to uncertainty, including future claim severity, medical costs, litigation and adverse development. BBSI retains risk up to $5 million per occurrence under its Chubb fronted program.
• SEC inquiries/investigations relating to financial statement errors and workers’ compensation reserves, and a Department of Justice investigation, remained ongoing; BBSI said it was cooperating. A shareholder derivative suit was pending. Management could not estimate the probability or potential loss for the described legal matters.
• Disclosure controls were deemed ineffective at June 30 due to an unremediated material weakness in IT access and change-management controls. Management reported progress on remediation, including replacement of the staffing revenue system. A separate workers’ compensation expense control weakness was reported remediated.
• The IRS was examining federal tax returns for 2011–2014. Management reported no material changes to the risk factors in its 2016 Form 10-K.

Important facts for investors to verify

• Subsequent workers’ compensation reserve development, actuarial assumptions and the adequacy and availability of restricted assets supporting claims.
• Progress and independent evidence of remediation of the IT-controls material weakness and effectiveness of disclosure controls.
• Status and potential financial consequences of the SEC and DOJ matters and shareholder litigation, which were not estimable in the filing.
• Cash and investment restrictions, the $90.8 million of surety bonds and standby letters of credit, and continuing compliance with credit-facility covenants.
• Whether revenue growth can continue while workers’ compensation and payroll-related costs pressure gross margin.