Business context and reporting period
Barrett Business Services, Inc. provides staffing and professional employer organization (PEO) human-resource services, primarily to small and medium-sized businesses. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011. Amounts below are in millions except per-share data. PEO fees are reported net of certain client payroll costs, so reported revenue and margin percentages reflect the company’s service mix.
Financial results and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $85.4 | $73.9 | $230.2 | $199.6 |
| Gross margin | $16.2 | $14.0 | $35.0 | $31.1 |
| Income from operations | $5.9 | $4.5 | $6.5 | $4.3 |
| Net income | $5.4 | $3.7 | $14.4 | $4.2 |
| Diluted EPS | $0.54 | $0.36 | $1.41 | $0.41 |
Q3 gross, operating, and net margins were 18.9%, 6.9%, and 6.3%, respectively; nine-month margins were 15.2%, 2.8%, and 6.3%. Nine-month net income includes a $10.0 million life-insurance benefit and is not representative of operating earnings alone. The filing reports no separate debt balance.
- At September 30, cash and cash equivalents were $42.2 million; marketable securities totaled $35.7 million, of which $9.7 million was long-term. Current assets were $129.1 million and current liabilities were $77.6 million.
- Nine-month operating cash flow was $24.8 million, versus $5.5 million in 2010; investing cash outflow was $6.9 million and financing cash outflow was $6.6 million. Operating cash flow benefited from higher accrued payroll and workers’ compensation liabilities and was partly offset by a $13.3 million increase in receivables.
- Cash increased $11.3 million from year-end 2010 to $42.2 million. The company paid $2.7 million in dividends and repurchased $3.8 million of stock during the nine months.
- Workers’ compensation claims liabilities were approximately $43.3 million, including $2.6 million of insured claims. A $6.7 million standby letter of credit was outstanding for workers’ compensation surety requirements.
Material changes versus prior comparable periods
- Q3 revenue rose 15.6% year over year, led by PEO service-fee growth of 27.2%; staffing revenue increased 1.9%. Nine-month revenue increased 15.3%, with PEO fees up 28.3% and staffing revenue up 0.5%.
- Management attributed PEO growth primarily to new customers; revenue from new PEO customers substantially exceeded lost business from former customers. Staffing demand remained pressured by weak economic activity and employment levels in the company’s markets.
- Workers’ compensation expense rose to $12.6 million in Q3 from $9.5 million and to $33.3 million for the nine months from $25.9 million. Management cited higher prior-year claim provisions and insurance broker commissions. Payroll taxes and benefits also increased as a percentage of revenue, partly reflecting PEO mix and higher state unemployment tax rates.
- Comparative 2010 figures were restated for an error in accounting for captive-insurer legal costs on claims administration, with a conforming accounting-policy change. The nine-month 2010 restatement reduced net income by $0.1 million overall; reported operating cash flow was unchanged.
Outlook, risks, and unusual items
- Management expected an approximately 20% effective income tax rate for the balance of 2011. Q3’s 13.7% rate benefited from a $451,000 California tax refund and the effect of the non-taxable $10.0 million life-insurance proceeds received following the CEO’s death in January 2011.
- Management said current liquid assets and anticipated operating cash flows should fund working-capital needs for the next 12 months. It reported compliance with its credit-agreement covenants at quarter-end, including a $10.0 million minimum liquid-assets requirement. No specific revenue or earnings guidance was provided.
- Results are subject to seasonality, customer demand, competition, wage-tax limits, workers’ compensation claim frequency and severity, and changes in estimates for prior-period claims. The company identified risks including customer retention and acquisition, receivable collection, insurer and letter-of-credit availability, and the adequacy of workers’ compensation reserves.
- Management reported effective disclosure controls. However, it had previously identified a material weakness in internal control over financial reporting related to accounting for captive-insurer claims-administration legal fees; remediation was underway, with testing expected to be completed before year-end 2011.
- The company said a 100-basis-point interest-rate increase would not materially affect its investment portfolio or results, given the predominantly short maturities. It reported no material long-term capital commitments.
Important facts for investors to verify
- How much of nine-month earnings growth is sustainable operating improvement versus the one-time $10.0 million insurance proceeds and favorable tax items.
- Whether workers’ compensation reserve estimates, including incurred-but-not-reported claims and prior-period development, remain adequate as liabilities increase.
- Whether PEO customer growth can continue and offset weak staffing demand, while managing rising payroll-tax, benefits, and insurance costs.
- Whether the material weakness remediation is completed and tested as expected, and whether any further restatements or control issues emerge.
- The liquidity and investment assets available after considering restricted securities, surety requirements, dividends, and repurchases.