Barrett Business Services, Inc. — Q2 2015 Form 10-Q
Business context and period. The unaudited filing covers the quarter and six months ended June 30, 2015, compared with the same 2014 periods. BBSI provides professional employer organization (PEO) and staffing services, primarily to small and midsized businesses. It reported PEO service fees net of specified client payroll costs; reported revenue therefore is not comparable to gross payroll volume.
Financial performance
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $182.4 million, +20.7% year over year | $349.3 million, +22.0% |
| PEO service fees | $140.0 million, +24.5% | $267.8 million, +25.0% |
| Staffing revenue | $42.3 million, +9.8% | $81.5 million, +13.2% |
| Gross margin | $36.2 million; 19.8% of revenue, flat | $45.1 million; 12.9%, versus 13.7% |
| Operating income | $14.2 million, versus $11.3 million | $5.5 million, versus $5.6 million |
| Net income | $8.7 million, versus $7.3 million | $2.9 million, versus $3.7 million |
| Diluted EPS | $1.19, versus $0.98 | $0.40, versus $0.50 |
Figures are in U.S. dollars; financial statements generally report dollars in thousands. Q2 growth reflected new customers and increased employee headcount and hours at continuing PEO clients. Management said new PEO customer business in the quarter was twice the business lost from former customers. About 78% of Q2 revenue came from California operations.
- Margins and costs: Q2 gross margin percentage held at 19.8%, as higher workers’ compensation costs were offset by lower direct payroll and payroll-tax costs as a share of revenue. For the six months, workers’ compensation expense rose to $81.8 million from $58.4 million and reached 23.5% of revenue, contributing to lower gross margin percentage.
- Operating expenses and interest: Q2 SG&A increased 18.5% to $21.3 million; six-month SG&A rose 18.3% to $38.3 million, driven by management and field compensation and, for the half year, IT spending. Six-month interest expense increased to $1.1 million from $88,000 following the new bank credit agreement.
- Cash flow: Six-month operating cash flow was $12.6 million, versus $8.7 million. Receivables consumed $35.2 million of cash, partly offset by increases in accrued payroll ($24.1 million), workers’ compensation liabilities ($13.6 million), and safety incentives ($3.9 million). Investing used $17.3 million; financing used $2.3 million. Cash and cash equivalents fell $7.1 million to $4.4 million.
- Balance sheet and liquidity: At June 30, current assets were $219.9 million and current liabilities $257.6 million, a working-capital deficit of about $37.7 million. The filing includes substantial restricted collateral: $114.3 million of certificates of deposit and approximately $109.5 million held in trust, among other restricted assets. These should not be treated as freely available cash.
- Debt and distributions: Debt comprised a $37.0 million term loan, $3.2 million revolving-credit borrowing, and a separate building loan of about $4.9 million. The main term loan required $7.0 million and $15.0 million principal payments in September and December 2015, respectively. The company paid $3.1 million in dividends in the first half; quarterly dividends up to $0.22 per share are permitted under the facility subject to conditions. BBSI reported compliance with financial covenants at June 30.
Outlook, risks, and notable items
- No specific revenue or earnings guidance was provided. Management expected operations and revolver availability to fund working-capital needs for the next 12 months, and expected the effective tax rate for the rest of 2015 to remain near Q2’s 36.2%.
- Management anticipated working-capital improvement as California workers’ compensation collateral requirements ease. After quarter-end, California reduced its security requirement from $190.6 million to $147.2 million; related cash-secured letters of credit and certificates of deposit were expected to decline from $114.3 million to $88.3 million during Q3.
- Workers’ compensation estimates are a significant judgment and risk. The estimated total claims liability rose to $229.6 million from $216.0 million at year-end 2014; Q2 included $29.0 million of current-period claims accrual and a $4.4 million favorable adjustment to prior-period estimates. Actual ultimate losses may differ materially from reserves.
- BBSI had transitioned California clients to an ACE fronted insurance program, retaining up to $5 million of risk per claim under an indemnity arrangement. The agreement ran through January 2016, with possible annual renewals. The company also depends on insurers’ financial capacity and state-required collateral arrangements.
- Three shareholder securities class actions were consolidated; defendants moved to dismiss, with a hearing scheduled for early September 2015. A shareholder derivative action was filed in June. The SEC issued a subpoena in May concerning workers’ compensation reserve accounting, and the company said it was cooperating. Management could not estimate the probability or potential loss from the lawsuits; no liability was recorded. Insurance coverage remained subject to insurers’ reservations of rights.
- Healthcare reform compliance is a stated risk: failure to offer required affordable coverage, or inability to recover related costs through pricing, could result in penalties or adversely affect results. Other risks include seasonality, customer retention, claims experience, receivable collection, and access to borrowing and letters of credit.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How workers’ compensation reserves develop, including the large IBNR component and prior-period claims experience.
- Whether the California collateral reduction occurred as expected and how much restricted cash becomes available.
- Near-term debt maturities, covenant headroom, and the effect of restricted assets on practical liquidity.
- Resolution and potential costs of the shareholder litigation and SEC inquiry, including the extent of D&O insurance coverage.
- Whether revenue growth converts to sustained earnings and cash flow as workers’ compensation costs, SG&A, and interest expense evolve.