Business context and reporting period
Barrett Business Services, Inc. (BBSI) provides professional employer organization (PEO) and staffing services, primarily to small and mid-sized businesses. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2016; dollar amounts below are in millions unless noted. The company serves clients in 22 states and the District of Columbia, with substantial revenue exposure to California.
Important reporting caveat: The filing presents restated 2015 comparisons. BBSI advises investors not to rely on previously filed reports, releases, or similar communications for those restated periods.
Financial performance and position
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015, restated | Six months ended June 30, 2016 | Six months ended June 30, 2015, restated |
|---|---|---|---|---|
| Total revenue | $203.4 | $182.0 | $394.4 | $348.4 |
| Gross margin | $42.3 (20.8%) | $36.5 (20.0%) | $52.6 (13.3%) | $45.4 (13.0%) |
| Operating income | $13.0 | $14.3 | $0.7 | $5.6 |
| Net income | $8.5 | $8.9 | $0.5 | $3.1 |
| Diluted EPS | $1.16 | $1.21 | $0.07 | $0.42 |
| Operating cash flow | Not presented by quarter | $4.5 | $12.6 |
Second-quarter revenue rose 11.8%; six-month revenue rose 13.2%. PEO service fees increased 18.7% in the quarter and 20.1% year to date, while staffing revenue fell 11.1% and 9.3%, respectively. Net income declined despite revenue growth: SG&A increased 33.0% in the quarter and 31.2% for six months, including $2.6 million and $4.4 million, respectively, of legal and accounting costs related to restatements, investigations, and securities litigation.
Workers’ compensation costs increased to $50.1 million in the quarter from $41.5 million, and to $99.5 million for six months from $81.1 million. Management attributed the higher expense rate in part to smaller favorable prior-period claims adjustments than in 2015. The filing reports total workers’ compensation claims liabilities of $277.1 million at June 30, including $140.1 million of incurred-but-not-reported claims.
At June 30, cash and cash equivalents were $0.4 million, compared with $25.2 million at December 31, 2015. Current assets were $252.4 million and current liabilities $299.0 million; current assets include restricted funds. Operating cash flow was $4.5 million, down from $12.6 million a year earlier, with the $87.4 million increase in receivables a major use of operating cash. Investing activities used $18.8 million and financing activities used $10.5 million in the first half. Total debt was approximately $12.2 million, including a $7.5 million term loan and a $4.7 million mortgage. No revolving-credit borrowings were outstanding.
Restricted investments and workers’ compensation deposits support claims and regulatory requirements. The ACE trust account held $232.9 million at June 30. The balance sheet also reports $48.4 million of current restricted marketable securities and workers’ compensation deposits and $235.6 million of long-term restricted amounts.
Material changes, outlook, and risks
- Restatement and controls: Restated 2015 financial statements reflect identified accounting errors, including unsupported journal entries made by the former CFO. The company reported that workers’ compensation expense had been understated and payroll tax and benefits expense overstated in earlier periods. Management concluded disclosure controls were ineffective at June 30, 2016 and identified multiple material weaknesses involving management oversight, workers’ compensation estimates, journal entries, reconciliations, IT controls, and payroll tax accruals. Remediation was underway; the filing does not say the weaknesses had been resolved.
- Credit agreement: BBSI violated the required 1.0:1.0 ratio of restricted and unrestricted cash and marketable securities to workers’ compensation and safety incentive liabilities at June 30; the bank waived the violation. The term loan requires a $5.0 million payment on September 30, 2016 and a further $2.5 million payment upon the earlier of December 31, 2016 or receipt of federal unemployment tax refunds. The company is subject to financial covenants and limits on capital spending, debt, stock repurchases, and dividends.
- Management outlook: No quantified revenue or earnings guidance is provided. Management expects operating cash generation, liquid assets, and revolver availability to be sufficient for working-capital needs over the next 12 months. BBSI noted that quarterly results historically fluctuate due to seasonality, payroll-tax wage limits, demand, competition, and workers’ compensation claims.
- Claims and unusual agreement: During the quarter, BBSI agreed to pay its third-party medical-cost-containment provider $9.5 million for specified 2016 claims and services, through quarterly payments of $593,250 continuing through January 2020, subject to a maximum service amount. Workers’ compensation reserves depend on actuarial estimates and may differ materially from ultimate claims payments.
- Legal and regulatory matters: Securities class and derivative litigation remained pending; management could not estimate the probability or potential range of loss. The SEC had issued subpoenas concerning workers’ compensation reserve accounting and subsequent disclosures, and the Department of Justice had commenced an investigation. BBSI said it was cooperating. The IRS was examining 2011–2014 federal returns. Nasdaq notified the company on July 7, 2016 that it had regained listing compliance. Subsequent to quarter-end, the IRS notified BBSI of FUTA overpayments of $795,000 for 2013 and $1.8 million for 2014; the 2015 refund request was still pending as of August 9.
- Other subsequent event: On July 1, BBSI sold riverfront property for $1.5 million; the loss was described as immaterial. The company said there were no material changes to the risk factors in its 2015 Form 10-K.
Important facts for investors to verify
- Review the restatement disclosures and confirm the implications of the former CFO’s unsupported entries and the effects on prior-period financial statements.
- Track remediation of material weaknesses, including whether independent oversight, journal-entry review, actuarial data controls, reconciliations, and IT controls become effective.
- Monitor workers’ compensation reserve development, claims payments, and the adequacy and restrictions of assets held for claims and surety requirements.
- Confirm continued compliance with bank covenants, the terms of the waiver, scheduled debt payments, and the timing and use of any FUTA refunds.
- Assess outcomes and potential costs from shareholder litigation, SEC and DOJ investigations, and the IRS examination; the filing provides no clear loss estimate for the legal matters.
- Compare growth in PEO services with continuing weakness in staffing revenue, and assess whether SG&A and investigation-related costs continue to weigh on earnings.
- The cover page marks “No” for having filed all required reports during the preceding 12 months and for required Interactive Data Files. Verify the status and implications of those certifications.