BBSI

Business Context and Reporting Period

Company: Barrett Business Services, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2007
Business Overview: Barrett provides human resource management services, primarily Professional Employer Organization (PEO) services and staffing services, to small and medium-sized businesses. The company operates through a network of branch offices across the western and eastern United States.

Key Financial Metrics

Note: Management also presents non-GAAP gross revenues of $257.5 million for Q1 2007, reflecting the gross payroll of PEO clients, compared to $235.3 million in Q1 2006.

Material Changes vs. Prior Period

• Revenue Growth: Total GAAP revenues increased 4.0% ($2.3 million) year-over-year. Staffing services revenue grew 5.1% due to new customer acquisition, while PEO service fee revenue grew 3.0% despite a softening effect from general economic conditions on existing clients.
• Profitability: Net income increased 27.4% ($371,000) to $1.7 million. This improvement was driven primarily by a 10.8% reduction in workers' compensation expenses.
• Cost Structure: Workers' compensation expense decreased from $6.6 million to $5.8 million. This reduction is attributed to lower insurance premiums in non-self-insured states and cost savings from the new captive insurance company, AICE. Conversely, direct payroll costs and payroll taxes/benefits increased as a percentage of revenue due to a shift in the service mix toward PEO services.
• Acquisitions: The company paid the final $500,000 contingent consideration for the 2006 acquisition of Pro HR, LLC in February 2007.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Captive Insurance: Effective January 1, 2007, the company formed Associated Insurance Company for Excess (AICE) to manage workers' compensation risks. Management expects potential annual pre-tax savings of up to $3.0 million from AICE.
• Seasonality: The company expects quarterly fluctuations due to seasonality, particularly in agriculture, food processing, and construction sectors. Historically, the third quarter yields higher revenues and net income.
• Liquidity: Management expects current liquid assets, operating cash flows, and the existing $4.0 million credit facility to be sufficient to fund working capital needs. The credit agreement expires July 1, 2007, and management expects to renew it on terms no less favorable than the current agreement.

Risks and Contingencies

• Internal Controls: The company disclosed a material weakness in internal control over financial reporting related to IT general controls (program development, access, and change management) as of December 31, 2006. While remedial actions were initiated in Q1 2007, the controls were deemed ineffective as of March 31, 2007.
• Workers' Compensation Volatility: Operating results are subject to volatility based on the frequency and severity of workplace injury claims and adverse loss development of prior period claims.
• Tax Risk: If the IRS determines that the new captive insurance company (AICE) does not qualify as an insurance company, the company could face accelerated income tax payments.

Investor Verification Checklist

• Internal Control Remediation: Verify the progress and effectiveness of the remedial actions taken to address the material weakness in IT general controls.
• Captive Insurance Performance: Monitor the actual cost savings realized from the AICE captive insurance company against the projected $3.0 million annual savings.
• Workers' Compensation Reserves: Review the adequacy of the $11.4 million estimated liability for unsettled workers' compensation claims and potential for adverse loss development.
• PEO Client Retention: Assess the impact of softening economic conditions on the retention and payroll levels of existing PEO clients.
• Credit Facility Renewal: Confirm the terms of the renewal of the $4.0 million credit facility expiring in July 2007.