Barrett Business Services, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; the filing was signed May 25, 2016. The 2014 and 2013 comparative financial statements, and specified earlier periods, are restated. Previously filed financial statements for periods from January 1, 2011 through June 30, 2015 should not be relied upon.
Business context
BBSI provides professional employer organization (PEO) services and staffing to small and mid-sized businesses. It reported one operating segment. California accounted for 78% of 2015 net revenue. The company served about 4,195 PEO clients in 2015, up from 3,665 in 2014; annual client retention exceeded 90%.
Financial performance
Amounts below are in millions, except per-share data and percentages; 2014 figures are restated.
| Metric | 2015 | 2014 | Change / context |
|---|---|---|---|
| Net revenue | $740.8 | $636.4 | Up 16.4% |
| PEO service fees | $572.3 | $470.5 | Up 21.6% |
| Staffing revenue | $168.6 | $165.8 | Up 1.6% |
| Gross margin | $129.5; 17.5% | $33.4; 5.2% | Improved mainly as workers’ compensation expense declined |
| Operating income (loss) | $36.4; 4.9% margin | $(43.2); (6.8)% margin | Returned to operating profit |
| Net income (loss) | $25.5 | $(25.5) | Diluted EPS: $3.47 vs. $(3.57) |
| Workers’ compensation expense | $171.1 | $213.5 | 2014 included a substantial reserve increase |
| Operating cash flow | $100.6 | $69.6 | Cash generation increased |
| Cash and cash equivalents at year-end | $25.2 | $11.5 | Much of the company’s investment balance was restricted |
| Working capital | $(10.4) | $(42.5) | Deficit narrowed |
| Total workers’ compensation claims liabilities | $255.7 | $225.3 | Includes current and long-term reserves |
For fourth-quarter 2015, restated net revenue was $193.8 million, net income was $11.4 million, and diluted EPS was $1.55. The filing notes seasonal and quarterly volatility, including a historical tendency toward first-quarter losses.
Cash, debt and liquidity
- Operating cash flow was $100.6 million; investing cash outflow was $55.6 million and financing cash outflow was $31.4 million. Financing outflows included $25.2 million of long-term debt payments and $6.3 million of dividends.
- Year-end debt was approximately $19.8 million, classified as current: a $15.0 million term-loan balance and approximately $4.8 million mortgage. The revolving facility had capacity of up to $14.0 million and no year-end borrowing balance.
- Access to credit was materially constrained by covenant and reporting defaults. The bank agreed to forbear from enforcement for specified periods and agreed to waive certain covenant violations upon filing of the 10-K. The agreement also made NASDAQ delisting an event of default. BBSI accelerated a $2.5 million term-loan payment in May 2016 and agreed to pay another $2.5 million upon the earlier of December 31, 2016 or receipt of federal unemployment tax refunds.
- Workers’ compensation security requirements tied up substantial assets: required investment balances or other financial instruments totaled $156.8 million at year-end, and the ACE claims trust held $166.6 million. The filing says management expected operating funds, liquid assets and revolving-credit availability to cover working capital needs for the next 12 months, but this expectation is subject to the stated financing and collateral risks.
Material changes, restatement and unusual items
- The 2015 results improved sharply from 2014, principally as workers’ compensation expense fell from its 2014 elevated level. The company recorded a large workers’ compensation charge in 2014; following restatement, the filing says the charge was recorded in the second quarter rather than the third quarter.
- The restatement followed an investigation confirming unsupported former-CFO journal entries, along with errors in workers’ compensation estimates and payroll-tax calculations. Workers’ compensation errors included omitted medical cost containment (MCC) information in data sent to actuaries and an omitted reserve for unallocated loss adjustment expenses. The restatement affected 2011–2015 periods and quarterly results; BBSI said it would not amend the prior filings.
- Management identified six material weaknesses in internal control, including control environment and management override, workers’ compensation estimates and data, manual journal entries, account reconciliations, IT access and change controls, and payroll-tax accrual review. Management and the auditor concluded controls were not effective as of December 31, 2015. Moss Adams issued an adverse opinion on internal control, while its opinion on the 2015 financial statements was unqualified.
- Subsequent to year-end, BBSI agreed to pay its MCC provider $10.0 million to eliminate specified future fees on claims incurred through 2015, in quarterly installments of $1.25 million from April 2016 through January 2018, subject to contractual limitations.
Outlook, risks and contingencies
- No specific 2016 revenue or earnings guidance is provided. Management cited continued growth opportunities through existing markets and new branches, while noting growth depends on client retention, referrals and hiring qualified personnel.
- Key operating risks include workers’ compensation reserve uncertainty and claims severity, dependence on California, reliance on the ACE fronted insurance arrangement, client credit exposure, regulation and healthcare costs. California generated 78% of 2015 net revenue; the ACE arrangement was stated to run through February 2017, with possible annual renewals.
- NASDAQ had notified BBSI of a delisting determination following late filings; the company requested a hearing and stay. The March 31, 2016 Form 10-Q was also late as of the filing, creating further listing and credit-agreement issues.
- The company faced a consolidated shareholder securities class action, a shareholder derivative action and SEC investigations/subpoenas. Management could not estimate the probability or range of loss and recorded no reserve for those matters. The company said it was cooperating with the SEC.
- Dividends were $0.88 per share for 2015, but the credit agreement permitted quarterly dividends only up to $0.22 per share when the company was not in default and payment would not cause a default; share repurchases were prohibited under the agreement.
Most important facts for investors to verify
- Progress and independent validation of remediation of the six material weaknesses, and whether subsequent filings remain timely and reliable.
- Workers’ compensation claims development, actuarial assumptions, reserve adequacy and the effect of the MCC settlement on cash flow and expenses.
- Current bank covenant status, extensions or waivers, debt repayment capacity, availability of the revolver and any consequences of NASDAQ listing status.
- How much cash and investments are unrestricted and available for operations, given collateral, trust and statutory workers’ compensation requirements.
- Developments in the SEC investigations and shareholder litigation, including any potential financial or operational consequences.