Barrett Business Services, Inc. — FY2016 Form 10-K
Reporting period: Year ended December 31, 2016; the filing also reports unaudited fourth-quarter results. Unless stated otherwise, dollar amounts are in millions.
Business context
BBSI provides professional employer organization (PEO) services and staffing to small and mid-sized businesses. PEO fees are reported net of certain payroll costs because BBSI is not the primary obligor for those amounts. The company served approximately 4,972 PEO clients in 2016 and operated 57 branch offices. California accounted for 78% of revenue.
Key financial metrics
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $840.6 | $740.8 | +13.5% |
| PEO service fees | $673.9 | $572.3 | +17.8% |
| Staffing revenue | $166.7 | $168.6 | -1.1% |
| Gross margin | $145.5 | $129.5 | +12.4% |
| Gross margin percentage | 17.3% | 17.5% | -0.2 percentage points |
| Operating income | $28.9 | $36.4 | -20.6% |
| Net income | $18.8 | $25.5 | -26.3% |
| Diluted EPS | $2.55 | $3.47 | -26.5% |
| Operating cash flow | $80.3 | $100.6 | Lower by $20.3 |
Workers’ compensation expense rose to $210.4 million from $171.1 million, or 25.0% of revenue versus 23.1%. SG&A increased to $113.3 million from $90.2 million, including $8.5 million of non-recurring legal and accounting costs related to restatements, investigations and securities litigation. FY2016 included a $3.5 million litigation loss. The effective tax rate was 26.5%, compared with 27.5%.
At December 31, 2016, cash and cash equivalents were $50.8 million; current assets were $260.6 million and current liabilities were $275.2 million, a $14.5 million working-capital deficit. Restricted cash and investments totaled approximately $301.3 million. Workers’ compensation claims liabilities were $312.5 million, including $158.2 million of IBNR. The $40 million term loan was fully repaid; $4.6 million of mortgage debt remained. The $25 million revolving facility was undrawn, with $5.3 million of its letter-of-credit sublimit in use. FY2016 dividends were $0.88 per share.
Fourth quarter: Revenue was $221.1 million versus $193.8 million in Q4 2015; gross margin was $43.3 million versus $41.2 million. Net income was $8.0 million versus $11.4 million, and diluted EPS was $1.08 versus $1.55.
Material changes and management commentary
- Revenue growth was driven by PEO: revenue from continuing PEO customers increased 6.8%, while new-customer business nearly doubled business lost from former customers. Staffing revenue declined slightly.
- Higher workers’ compensation costs and payroll taxes and benefits reduced gross margin percentage. Management attributed the workers’ compensation comparison in part to a $13.7 million reserve decrease recorded in 2015 for prior-year claims.
- Operating cash flow declined despite higher revenue and was supported by workers’ compensation liabilities and accrued payroll balances; increased receivables were a partial cash use.
- Management stated that operating cash generation, liquid assets and the revolving facility should be sufficient for working capital needs over the next 12 months. No quantified revenue or earnings guidance was provided.
- Management reported historical quarterly volatility, including first-quarter losses, related to seasonality, payroll-tax wage limits, staffing demand and workers’ compensation claims experience.
Risks, contingencies and unusual items
- Controls and reporting: Management concluded disclosure controls were ineffective at year-end, and Deloitte issued an adverse opinion on internal control over financial reporting. Material weaknesses remained in IT access/change controls and review of workers’ compensation data supplied to the actuary. The financial statement audit opinion was unqualified.
- Legal and regulatory matters: A securities class-action settlement of $12.0 million was approved in February 2017; insurers paid approximately $8.7 million and BBSI approximately $3.3 million. SEC and Department of Justice investigations were ongoing, and a shareholder derivative suit remained pending. Management could not estimate potential losses from the remaining matters and recorded no additional reserve for them.
- Workers’ compensation: Reserve estimates are actuarial and subject to adverse development; actual costs may materially exceed recorded reserves. BBSI generally retains the first $5 million per claim, with lower retentions in Maryland and Colorado. Its Chubb fronted program was scheduled to continue through February 1, 2018, subject to renewal.
- Geographic and operating concentration: California generated 78% of revenue, exposing results to changes in its economy, regulation and insurance environment. Client agreements are generally terminable on 30 days’ notice.
- Credit agreement: BBSI breached the 2016 capital-expenditure limit; Wells Fargo waived the violation. The facility includes financial covenants, and the mortgage balance is due February 2018.
- Other exposures: Risks include client payment defaults on payroll obligations, healthcare-law compliance, employee claims, data and technology failures, and changes in workers’ compensation coverage costs or availability.
Important facts for investors to verify
- Whether the IT-control and workers’ compensation reserve-control weaknesses have been remediated and independently tested.
- Subsequent workers’ compensation reserve development, including the assumptions behind the $312.5 million liability and $158.2 million IBNR estimate.
- Developments in the SEC and DOJ investigations and the remaining derivative litigation, including any uninsured costs or penalties.
- Renewal terms and availability of Chubb coverage, and whether California concentration or regulatory changes affect growth and margins.
- Liquidity and covenant compliance, including the use of restricted assets, the revolving facility’s July 2018 expiration and the 2018 mortgage maturity.
- Whether PEO growth can continue while staffing revenue, operating income and net income remain under pressure.