Business context and reporting period
Barrett Business Services, Inc. provides professional employer organization (PEO) and staffing services to small and midsize businesses. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012; amounts are in millions unless otherwise noted.
Financial performance and liquidity
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $95.5, up 25.6% from $76.0 | $177.9, up 22.9% from $144.8 |
| Gross margin | $16.3; 17.1% of revenue versus 17.5% | $22.9; 12.9% versus 13.0% |
| Operating income | $5.4 versus $4.1 | $1.9 versus $0.5 |
| Net income | $3.7 versus $3.4 | $1.5 versus $9.0 |
| Diluted EPS | $0.53 versus $0.34 | $0.18 versus $0.88 |
| Cash from operating activities | Not provided for the quarter | $13.1 versus $12.5 |
Quarterly PEO service-fee revenue rose 43.1% to $65.1 million, while staffing revenue slipped 0.4% to $30.4 million. For the six-month period, PEO fees increased 41.2% to $121.3 million and staffing revenue declined 3.8% to $56.6 million. The company reports PEO revenue net of certain client payroll costs, so revenue mix affects reported margins.
At June 30, cash and cash equivalents were $36.4 million, marketable securities totaled $31.7 million, and current assets were $126.3 million against current liabilities of $98.1 million. Cash declined $13.2 million from year-end, mainly reflecting the share repurchase. The company reported no material long-term capital commitments and said it had no material borrowing outstanding, but had $6.7 million of standby letters of credit at June 30. A July 11 increase of $17.2 million related to California workers’ compensation surety requirements.
Workers’ compensation claims liabilities totaled an estimated $55.8 million at June 30, including $41.0 million of incurred-but-not-reported claims. The company recorded $3.1 million of additional expense in the second quarter for increased estimated costs to close prior-year claims. Safety-incentive liabilities were $7.5 million.
Material changes and unusual items
- Second-quarter net income increased despite a higher effective tax rate; the 2011 six-month comparison included $10.0 million of non-taxable key-person life-insurance proceeds. This one-time item largely explains why six-month 2012 net income fell to $1.5 million from $9.0 million.
- Workers’ compensation expense increased to $17.0 million in the quarter from $10.8 million, reflecting current- and prior-year claim costs and higher insurance broker commissions. Management also cited higher payroll taxes and benefits as PEO activity grew.
- On March 28, the company repurchased approximately 2.986 million common shares from the Sherertz family at $20 per share for $59.7 million total consideration: $24.9 million in cash and $34.8 million of redeemable preferred stock, plus $0.514 million of related professional and legal fees. The transaction materially reduced common shares outstanding. The preferred stock is recorded as a liability and carries cumulative dividends initially at 5% annually, with scheduled increases beginning April 1, 2013; it is mandatorily redeemable in five years.
Outlook, risks and contingencies
Management expects the effective tax rate for the remainder of 2012 to remain near the second-quarter rate of 33.5%, and expects liquid assets and operating cash generation to cover working-capital needs for the next 12 months. It anticipates using a bank line of credit to redeem the preferred stock in full before September 28, 2012, but cautions that financing may not be available on acceptable terms or at all. The filing states the company was in compliance with its credit-agreement covenants at June 30, including a $10 million minimum liquid-assets covenant.
Management notes that results may fluctuate with seasonality, customer demand and retention, payroll-tax wage limits, and workers’ compensation claims frequency, severity, and prior-period development. It generally expects higher revenue and net income in the third quarter; holiday-shortened customer schedules can affect the fourth quarter. Other cited risks include receivable collectibility, insurance-carrier recoverability, workers’ compensation regulation and reserve estimates, and the availability of capital or letters of credit for state-mandated surety requirements. No numerical full-year revenue or earnings guidance is provided.
Important facts for investors to verify
- Whether the planned preferred-stock redemption was completed, its financing terms, and any dividends or refinancing costs.
- Subsequent workers’ compensation reserve development, especially the assumptions behind the $41.0 million IBNR estimate and prior-year claim costs.
- Whether PEO customer growth and retention can continue while staffing revenue remains weak and workers’ compensation and payroll-related costs rise.
- The effect of the California surety requirement and increased standby letters of credit on available liquidity and covenant headroom.
- The sustainability of operating cash flow, which benefited from increases in accrued payroll and workers’ compensation liabilities while receivables also rose.