BARRETT BUSINESS SERVICES INC quarterly report, Q2 FY2019

Business context and reporting period

Barrett Business Services, Inc. (BBSI) provides professional employer organization (PEO), staffing, and related business-management services, primarily to small and mid-sized businesses. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; comparisons are to the corresponding 2018 periods. Amounts below are in millions unless noted.

Financial performance and position

• Q2 PEO service fees rose 3.0% to $203.2 million, while staffing revenue fell 19.0% to $27.8 million. Six-month PEO fees rose 1.9%; staffing revenue declined 20.0%.
• For the six months, operating cash flow was $38.9 million versus $16.5 million in 2018. Investing activities provided $41.5 million, primarily from investment sales and maturities; financing used $3.8 million, including $3.7 million of dividends.
• At June 30, cash and cash equivalents were $23.7 million. Cash, cash equivalents, and restricted cash totaled $217.3 million; much of the company’s cash and investments is restricted, primarily for workers’ compensation claims. Current assets were $388.2 million and current liabilities $347.6 million.
• Debt included approximately $4.1 million on the office mortgage; there were no revolving-credit borrowings. The revolving facility was increased after quarter-end from $28 million to $33 million. Workers’ compensation liabilities totaled $430.7 million, including $322.4 million long-term.

Material changes versus the prior comparable period

• Q2 revenue was nearly flat, as PEO growth was offset by lower staffing revenue. Management attributed staffing weakness to tight labor-market conditions.
• Gross margin improved in both periods, reflecting lower workers’ compensation costs and changes in service mix. Q2 workers’ compensation expense included a favorable $3.0 million adjustment for prior-period claims; the six-month period included a favorable $4.7 million adjustment.
• SG&A increased to $39.0 million in Q2 and $72.2 million for six months, primarily due to employee-related costs.
• Six-month results improved substantially from 2018, when BBSI reported an operating loss. Investment income also increased, to $3.3 million in Q2 and $6.4 million for six months.
• Adoption of the new lease standard on January 1, 2019 resulted in recognition of $25.0 million of operating lease right-of-use assets and $25.5 million of lease liabilities at June 30.

Outlook, risks, contingencies, and unusual items

• The filing provides no numerical earnings or revenue guidance. Management expects operating cash generation, liquid assets, and available revolving credit to fund working-capital needs for the next 12 months.
• Management noted historical quarterly volatility, including first-quarter losses, tied to seasonality, payroll-tax wage limits, customer demand, labor-market conditions, and workers’ compensation claims experience.
• Workers’ compensation reserves rely on actuarial estimates; actual claims costs may differ materially. Incurred-but-not-reported claims were $273.1 million, or 63% of total claims liabilities, compared with 59% a year earlier.
• The California Supreme Court agreed to review a wage-and-hour case concerning prevailing-wage requirements for certain public works. Management could not estimate a potential loss range. The IRS was examining federal returns for 2011–2014.
• The August 6, 2019 credit amendment extended the facility to July 1, 2022, increased the revolver to $33 million, and removed certain financial and negative covenants, among other changes. The filing states BBSI complied with its covenants at June 30 under the prior agreement.
• Interest-rate sensitivity analysis estimated that a 50-basis-point rate increase would reduce investment-portfolio fair value by $4.6 million. Management cited reserve estimation, client retention, labor-market conditions, investment values, and availability of credit and insurance collateral as risks.

Important facts for investors to verify

• Whether improved workers’ compensation costs and the favorable prior-period reserve adjustments are sustainable, and whether claims reserves remain adequate.
• How restricted cash and investments, trust-account balances, and collateral requirements affect funds actually available for operations.
• Whether PEO growth can offset continued staffing weakness and higher employee-related SG&A costs.
• The status and potential financial exposure of the California litigation and IRS examination.
• The final terms and practical effects of the post-quarter credit amendment, including removed covenants and ongoing letter-of-credit requirements.