UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

Commission File Number 0-21886

 

BARRETT BUSINESS SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

 

Maryland

 

52-0812977

(State or other jurisdiction of

 

(IRS Employer

incorporation or organization)

 

Identification No.)

 

 

 

8100 NE Parkway Drive, Suite 200

 

 

Vancouver, Washington

 

98662

(Address of principal executive offices)

 

(Zip Code)

 

(360) 828-0700

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, Par Value $0.01 Per Share

 

The NASDAQ Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  No 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  No 

State the aggregate market value of the common equity held by non-affiliates of the registrant: $402,103,034 at June 30, 2017

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

 

Class

Outstanding at March 1, 2018

Common Stock, Par Value $.01 Per Share

7,304,085 Shares

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the 2018 Annual Meeting of Stockholders are hereby incorporated by reference in Part III of Form 10-K.

 

 


BARRETT BUSINESS SERVICES, INC.

2017 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

 

 

PART I

 

Page

Item 1.

 

Business

 

2

 

 

 

 

 

Item 1A.

 

Risk Factors

 

9

 

 

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

17

 

 

 

 

 

Item 2.

 

Properties

 

17

 

 

 

 

 

Item 3.

 

Legal Proceedings

 

18

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

18

 

 

 

 

 

 

 

PART II

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

18

 

 

 

 

 

Item 6.

 

Selected Financial Data

 

20

 

 

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

 

 

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

30

 

 

 

 

 

Item 8.

 

Financial Statements and Supplementary Data

 

30

 

 

 

 

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

30

 

 

 

 

 

Item 9A.

 

Controls and Procedures

 

30

 

 

 

 

 

Item 9B.

 

Other Information

 

34

 

 

 

 

 

 

 

PART III

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

34

 

 

 

 

 

Item 11.

 

Executive Compensation

 

34

 

 

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

34

 

 

 

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

34

 

 

 

 

 

Item 14.

 

Principal Accountant Fees and Services

 

34

 

 

 

 

 

 

 

PART IV

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

35

 

 

 

 

 

Item 16.

 

Form 10-K Summary

 

35

 

 

 

Financial Statements

 

F -1

 

 

 

 

 

Signatures

 

 

 

 

 

Exhibit Index

 

 

- 1 -


Item 1.

BUSINESS

General

Company Background

Barrett Business Services, Inc. (“BBSI,” the “Company,” “our” or “we”), is a leading provider of business management solutions for small and mid-sized companies. The Company has developed a management platform that integrates a knowledge-based approach from the management consulting industry with tools from the human resource outsourcing industry. This platform, through the effective leveraging of human capital, helps our business owner clients run their businesses more effectively. We believe this platform, delivered through a decentralized organizational structure, differentiates BBSI from our competitors. BBSI was incorporated in Maryland in 1965.

Certain statements below contain forward-looking information that is subject to risks and uncertainties. See “Forward-Looking Information” in Item 7 of Part II of this report and “Risk Factors” in Item 1A of Part I of this report.

Business Strategy

Our strategy is to align local operations teams with the mission of small and mid-sized business owners, driving value to their business. To do so, BBSI:

 

partners with business owners to leverage their investment in human capital through a high-touch, results-oriented approach;

 

brings predictability to each client organization through a three-tiered management platform; and

 

enables business owners to focus on their core business by reducing organizational complexity and maximizing productivity.

Business Organization

We operate a decentralized delivery model using operationally-focused business teams, typically located within 50 miles of our client companies. These teams are led by senior level business generalists and comprise senior level professionals with expertise in human resources, organizational development, risk mitigation and workplace safety, and various types of administration, including payroll. These teams are responsible for growth of their operations, and for providing strategic leadership, guidance and expert consultation to our client companies. The decentralized structure fosters autonomous decision-making in which business teams deliver plans that closely align with the objectives of each business owner client. This structure also provides a means of incubating talent to support increased growth and capacity. We support clients with employees located in 24 states and the District of Columbia through a network of 58 branch locations in California, Oregon, Utah, Washington, Idaho, Arizona, Colorado, Maryland, North Carolina, Delaware, Nevada, Pennsylvania and Virginia. We also have several smaller recruiting locations in our general market areas, which are under the direction of a branch office.

BBSI believes that making significant investments in the best talent available allows us to leverage the value of this investment many times over. We motivate our management employees through a compensation package that includes a competitive base salary and the opportunity for profit sharing. At the branch level, profit sharing is in direct correlation to client performance, reinforcing a culture focused on achievement of client goals.

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Services Overview

BBSI’s core purpose is to advocate for business owners, particularly in the small and mid-sized business segment. Our evolution from an entrepreneurially run company to a professionally managed organization has helped to form our view that all businesses experience inflection points at key stages of growth. The insights gained through our own growth, along with the trends we see in working with more than 5,600 companies each day, define our approach to guiding business owners through the challenges associated with being an employer. BBSI’s business teams align with each business owner client through a structured three-tiered progression. In doing so, business teams focus on the objectives of each business owner and deliver planning, guidance and resources in support of those objectives.

Tier 1: Tactical Alignment

The first stage focuses on the mutual setting of expectations and is essential to a successful client relationship. It begins with a process of assessment and discovery in which the business owner’s business objectives, attitudes, and culture are aligned with BBSI’s processes, controls and culture. This stage includes an implementation process, which addresses the administrative components of employment.

Tier 2: Dynamic Relationship

The second stage of the relationship emphasizes organizational development as a means of achieving each client’s business objectives. There is a focus on process improvement, development of best practices, supervisor training and leadership development.

Tier 3: Strategic Counsel

With an emphasis on advocacy on behalf of the business owner, the third stage of the relationship is more strategic and forward-looking with a goal of cultivating an environment in which all efforts are directed by the mission and long-term objectives of the business owner.

In addition to serving as a resource and guide, BBSI has the ability to provide workers’ compensation coverage as a means of meeting statutory requirements and protecting our clients from employment-related injury claims. Through our third-party administrators, we provide claims management services for our clients. We work aggressively to manage and reduce job injury claims, identify fraudulent claims and structure optimal work programs, including modified duty.

Categories of Services

We report financial results in two categories of services: Professional Employer Services (“PEO”) and Staffing. During 2017, we supported in excess of 5,600 PEO clients and approximately 188,000 employees. This compares to more than 4,900 PEO clients and approximately 171,000 employees during 2016. See Item 7 of this Report for information regarding the percentages of total net revenues provided by our PEO and staffing services for each of the last three fiscal years, and our consolidated financial statements incorporated into Item 8 of Part II of this Report for information regarding revenues, net income and total assets in our single reportable segment.

PEO

We enter into a client services agreement to establish a co-employment relationship with each client company, assuming responsibility for payroll, payroll taxes, workers’ compensation coverage and certain other administrative functions for the client’s existing workforce. The client maintains physical care, custody and control of their workforce, including the authority to hire and terminate employees.

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Staffing and Recruiting

Our staffing services include on-demand or short-term staffing assignments, contract staffing, direct placement, and long-term or indefinite-term on-site management. On-site management employees are BBSI management employees who are based on the client-site and whose jobs are to assist BBSI staffing employees. Our recruiting experts maintain a deep network of professionals from which we source candidates. Through an assessment process, we gain an understanding of the short and long-term needs of our clients, allowing us to identify and source the right talent for each position. We then conduct a rigorous screening process to help ensure a successful hire.

Clients and Client Contracts

Our business is typically characterized by long-term relationships that result in recurring revenue. The terms and conditions applicable to our client relationships are set forth in a client services agreement, which typically provides for an initial term of one year with renewal for additional one-year periods, but generally permits cancellation by either party upon 30 days’ written notice. In addition, we may terminate the agreement at any time for specified breach of contract, including nonpayment or failure to follow our workplace safety recommendations.

The client services agreement also provides for indemnification by the client against losses arising out of any default by the client under the agreement, including failure to comply with any employment-related, health and safety, or immigration laws or regulations. Our client service agreement requires that clients enter into a co-employment arrangement and maintain comprehensive liability coverage in the amount of $1.0 million for acts of their employees. It is nevertheless possible that claims not satisfied through indemnification or insurance may be asserted against us, which could adversely affect our results of operations.

We have client services agreements with a diverse array of customers, including electronics manufacturers, various light-manufacturing industries, agriculture-based companies, transportation and shipping enterprises, food processors, telecommunications companies, public utilities, general contractors in various construction-related fields, and professional services firms. None of our clients individually represented more than 1% of our total revenues in 2017.

Market Opportunity

As a company that aligns with the mission of business owners by providing resources and guidance to small and mid-size businesses, BBSI believes its growth is driven by the desire of business owners to focus on mission-critical functions, reduce complexity associated with the employment function, mitigate costs and maximize their investment in human capital. Our integrated management platform has enabled us to capitalize on these needs within the small to mid-size business sector.

The small and mid‑sized business segment is particularly attractive because:

 

it is large, continues to offer significant growth opportunity and remains underserved by professional services companies;

 

it typically has fewer in-house resources than larger businesses and, as a result, is generally more dependent on external resources;

 

we generally experience a relatively high client retention rate and lower client acquisition costs within this market segment; and

 

we have found that small to mid-sized businesses are responsive to quality of service when selecting a PEO or staffing services provider.

- 4 -


Competition

The business environment in which we operate is characterized by intense competition and fragmentation. BBSI is not aware of reliable statistics regarding the number of its competitors, but certain large, well-known companies typically compete with us in the same markets and also have greater financial and marketing resources than we do, including Automatic Data Processing, Inc., ManpowerGroup, Inc., Kelly Services, Inc., Insperity, Inc., TriNet Group, Inc., Robert Half International Inc. and Paychex, Inc. We face additional competition from regional providers and we may in the future also face competition from new entrants to the field, including other staffing services companies, payroll processing companies and insurance companies. The principal competitive factors in the business environment in which we operate are price and level of service.

We believe that our growth is attributable to our ability to provide small and mid-sized companies with the resources and knowledge base of a large employer delivered through a local operations team. Our level of integration with each client business provides us an additional competitive advantage.

Growth Strategy

We believe our clients are our best advocates and powerful drivers of referral-based growth. In each market, operations teams provide expertise, consultation and support to our clients, driving growth and supporting retention. We anticipate that by adding business teams to existing branches, we can achieve incremental growth in those markets, driven by our reputation and by client referrals. While in most markets business development efforts are led by area managers, in some markets our sales efforts are further supported by business development managers.

Our business growth has three primary sources: referrals from existing clients, direct business-to-business sales efforts by our area managers and an extensive referral network. Partners in our referral network include insurance brokers, financial advisors, attorneys, CPA’s, and other business professionals who can facilitate an introduction to prospective clients. These referral partners facilitate introductions to business owners on our behalf, typically in exchange for a fee equal to a small percentage of payroll.

We see two key drivers to our growth:

 

Increase market share in existing markets. We seek to support, strengthen and expand branch office operations through the ongoing development of business teams. We believe that strengthening and expanding the operations of each location is an efficient and effective means of increasing market share in the geographic areas in which we do business, and that our business teams serve a dual purpose: 1) Delivering high-quality service to our clients, thereby supporting client business growth and retention, and driving client referrals, and 2) Incubating talent at the branch level to support expansion into new markets.

 

Penetrate new markets. We intend to open additional branch offices in new geographic markets as opportunities arise. We have developed a strategic approach to geographic expansion, which will serve as a guide for determining if and when to enter new markets. We believe our decentralized organizational model built on teams of senior-level professionals allows us to incubate talent to support our expansion efforts.

- 5 -


Workers’ Compensation

Through our client services agreement, BBSI has the ability to provide workers’ compensation coverage to its clients. We provide this coverage through a variety of methods, all of which are subject to rigorous underwriting to assess financial stability, risk factors and cultural alignment related to safety and the client’s desire to improve their operations. In providing this coverage, we are responsible for complying with applicable statutory requirements for workers' compensation coverage.

Risk mitigation is also an important contributor to our principal goal of helping business owners operate their business more efficiently. It is in the mutual interests of the client and BBSI to commit to workplace safety and risk mitigation. We maintain clear guidelines for our area managers and risk management consultants, directly tying their continued employment to their diligence in understanding and addressing the risks of accident or injury associated with the industries in which client companies operate and in monitoring clients’ compliance with workplace safety requirements.

Elements of Workers' Compensation System

State law (and for certain types of employees, federal law) generally mandates that an employer reimburse its employees for the costs of medical care and other specified benefits for injuries or illnesses, including catastrophic injuries and fatalities, incurred in the course and scope of employment. Most states require employers to maintain workers' compensation insurance or otherwise demonstrate financial responsibility to meet workers' compensation obligations to employees. The benefits payable for various categories of claims are determined by state regulation and vary with the severity and nature of the injury or illness and other specified factors. In return for this guaranteed protection, workers' compensation is an exclusive remedy and employees are generally precluded from seeking other damages from their employer for workplace injuries. In many states, employers who meet certain financial and other requirements are permitted to self-insure.

Insurance Coverage for Workers' Compensation

The Company is a self-insured employer with respect to workers' compensation coverage for all of its employees (including employees co-employed through our client service agreements) working in Colorado, Maryland and Oregon. In the state of Washington, state law allows only the Company's staffing services and internal management employees to be covered under the Company's self-insured workers' compensation program.

Regulations governing self-insured employers in each jurisdiction typically require the employer to maintain surety bonds, surety deposits of government securities, letters of credit or other financial instruments to cover workers' claims in the event the employer is unable to pay for such claims.

BBSI was self-insured as to worker’s compensation claims in California from 1995 until December 31, 2014. Effective January 1, 2015, the Company stopped maintaining a certificate to self-insure in the state of California, and it now maintains policies with Chubb Limited (“Chubb”)  for all California-based clients, along with clients in Delaware, Virginia, Pennsylvania, North Carolina, New Jersey, West Virginia, Idaho, and the District of Columbia. The arrangement with Chubb, known as a fronted program, provides BBSI a licensed, admitted insurance carrier to issue policies on behalf of BBSI.

Our wholly owned, fully licensed captive insurance company incorporated in Arizona, Associated Insurance Company for Excess (“AICE”), provides reinsurance coverage up to $5.0 million per occurrence, except in Maryland and Colorado, where our retention per occurrence is $1.0 million and $2.0 million, respectively. The Company maintains excess workers’ compensation insurance coverage with Chubb between $5.0 million and statutory limits per occurrence, except in Maryland, where coverage with Chubb is between $1.0 million and statutory limits per occurrence, and in Colorado, where the coverage with Chubb is between $2.0 million and statutory limits per occurrence.

Overall, this approach results in a per occurrence retention on a consolidated basis of $5.0 million for most claims. In light of the per occurrence retention, we may experience significant workers' compensation costs from catastrophic claims, should they occur.

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AICE provides us with access to an alternative mechanism for insurance coverage, as well as certain income tax benefits arising from the ability to accelerate the tax deduction of certain accruals for workers' compensation claims.

The Company also operates a wholly owned insurance company, Ecole Insurance Company (“Ecole”). Ecole is a fully licensed insurance company holding a certificate of authority from the Arizona Department of Insurance. Ecole provides workers’ compensation coverage to the Company’s employees working in Arizona, Utah and Nevada. The Company maintains additional reinsurance coverage for Ecole with Chubb between $5.0 million and statutory limits per occurrence.

Claims Management

As a result of our status as a self-insured employer in four states and our retention arrangements, our workers' compensation expense is tied directly to the incidence and severity of covered workplace injuries. We seek to contain our workers' compensation costs through an aggressive approach to claims management. We use managed-care systems to reduce medical costs and keep time-loss costs to a minimum by assigning injured workers, whenever possible, to short-term assignments which accommodate the workers' physical limitations. We believe that these assignments minimize both time actually lost from work and covered time-loss costs. We engage third-party claims administrators ("TPAs") to provide the primary claims management expertise. Typical claims management procedures include performing thorough and prompt on-site investigations of claims filed by employees, working with physicians to encourage efficient medical management of cases, denying questionable claims and attempting to negotiate early settlements to eliminate future adverse development of claims costs. We also maintain a corporate-wide pre-employment drug screening program and a post-injury drug test program. We believe our claims management program has resulted in a reduction in the frequency of fraudulent claims and in accidents in which the use of illicit drugs appears to have been a contributing factor.

Employees and Employee Benefits

At December 31, 2017, we had 124,212 total employees, including 8,753 staffing services employees, 114,775 employees under our client service agreements, 679 managerial, sales and administrative employees (together, “management employees”), and 5 executive officers. The number of employees at any given time may vary significantly due to business conditions at customer or client companies. We believe our employee relations are good.

We offer various qualified employee benefit plans to our employees, including those employees for whom we are the administrative employer in a co-employment arrangement who so elect. Employees covered under a PEO arrangement may participate in our 401(k) plan at the sole discretion of the PEO client. Our qualified staffing and management employee benefit plans include our 401(k) plan, in which employees may enroll upon reaching 21 years of age and completing 1,000 hours of service in a 12 consecutive month period. We make matching contributions to the 401(k) plan under a safe harbor provision, which are immediately 100% vested. We match 100% of contributions by management and staffing employees up to 3% of each participating employee's annual compensation and 50% of the employee's contributions up to an additional 2% of annual compensation. We may also make discretionary contributions to the 401(k) plan, which vest over six years and are subject to certain legal limits, at the sole discretion of our Board of Directors.

We also offer a cafeteria plan under Section 125 of the Internal Revenue Code and group health, life insurance and disability insurance plans to qualified staffing and management employees. Generally, qualified employee benefit plans are subject to provisions of both the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 ("ERISA"). In order to qualify for favorable tax treatment under the Internal Revenue Code, qualified plans must be established and maintained by an employer for the exclusive benefit of its employees.

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The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the “Acts”) subject us to potential penalties unless we offer to our employees minimum essential healthcare coverage that is affordable. Because each PEO client is considered to be the sole employer in the application of any rule or law included within the scope of the Acts, we do not offer health care coverage to the employees of our PEO clients. However, in order to comply with the employer mandate provision of the Acts, we offer health care coverage to all eligible staffing employees and management employees eligible for coverage under the Acts.

Regulatory and Legislative Issues

We are subject to the laws and regulations of the jurisdictions within which we operate, including those governing self-insured employers under the workers' compensation systems in Oregon, Maryland, and Colorado, as well as in Washington for staffing and management employees. We are also subject to laws and regulations governing our two wholly owned insurance companies in Arizona. While the specific laws and regulations vary among these jurisdictions, they typically require some form of licensing and often have statutory requirements for workplace safety and notice of change in obligation of workers’ compensation coverage in the event of contract termination. Although compliance with these requirements imposes some additional financial risk, particularly with respect to those clients who breach their payment obligation to us, such compliance has not had a material adverse effect on our business to date.

Our operations are affected by numerous federal and state laws relating to labor, tax and employment matters. Through our client services agreement, we assume certain obligations and responsibilities as the administrative employer under federal and state laws. Since many of these federal and state laws were enacted prior to the development of nontraditional employment relationships, such as professional employer, temporary employment, and outsourcing arrangements, many of these laws do not specifically address the obligations and responsibilities of nontraditional employers. In addition, the definition of "employer" under these laws is not uniform.

As an employer, we are subject to all federal statutes and regulations governing our employer-employee relationships. Subject to the discussion of risk factors below, we believe that our operations are in compliance in all material respects with applicable federal statutes and regulations.

Additional Information

Our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, periodic reports on Form 8-K and amendments to these reports, are accessible free of charge at our website at http://www.barrettbusiness.com as soon as reasonably practicable after they are electronically filed with the SEC. By making this reference to our website, we do not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report.

Materials that the Company files with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers with publicly traded securities, including the Company.

 

- 8 -


Item 1A.

RISK FACTORS

In addition to other information contained in this report, the following risk factors should be considered carefully in evaluating our business.

Risks Relating to Our Business and Industry

Our consolidated retention for workers' compensation claims is $5.0 million per occurrence under our insurance arrangement with Chubb in the majority of states in which we operate.

We maintain our consolidated retention at $5.0 million per occurrence, except in Colorado and Maryland where our retention is at $2.0 million and $1.0 million per occurrence, respectively, due to regulatory requirements. The Company maintains its excess workers’ compensation insurance coverage with Chubb through our AICE subsidiary. Additionally, Ecole’s retention is at $5.0 million per occurrence for coverage in Arizona, Nevada and Utah. Thus, the Company has financial risk for most workers' compensation claims under $5.0 million on a per occurrence basis. This level of per occurrence retention may result in higher workers’ compensation costs to us with a corresponding negative effect on our operating results and financial condition.

Adverse developments in the market for excess workers' compensation insurance could lead to increases in our costs.

To manage our financial exposure in the event of catastrophic injuries or fatalities, we maintain excess workers' compensation insurance. Changes in the market for excess workers' compensation insurance may lead to limited availability of such coverage, additional increases in our insurance costs or further increases in the amount for which we retain financial risk, any of which may have a material adverse effect on our results of operations and financial condition.

Our ability to continue our business operations under our present service model is dependent on maintaining workers' compensation insurance coverage.

Our arrangement with Chubb to provide workers’ compensation coverage to BBSI’s PEO clients in California, Delaware, Virginia, Pennsylvania, North Carolina, New Jersey, West Virginia, Idaho and the District of Columbia extends through February 1, 2019, with the possibility of additional annual renewals. If Chubb is unwilling or unable to renew our arrangement in the future, we would need to seek alternative coverage. If replacement coverage were unavailable or available only on significantly less favorable terms, our business and results of operations would be materially adversely affected.

Failure to manage the severity and frequency of workplace injuries will increase our workers’ compensation expenses.

Significant increases in the relative frequency or severity of workplace injuries due to failures to accurately assess potential risks or assure implementation of effective safety measures by our clients may result in increased workers’ compensation claims expenses, with a corresponding negative effect on our results of operations and financial condition.

- 9 -


Our investment portfolio is subject to market and credit risks, which could adversely impact our financial condition or results of operations.

We seek to hold a diversified portfolio of high-quality investments that is managed by a professional investment advisory firm in accordance with our investment policy and routinely reviewed by management and approved by the risk management committee. However, our investments are subject to general economic conditions and market risks as well as risks inherent to particular securities, including credit and liquidity risks. Our portfolio consists primarily of debt securities and is subject to the risk that certain investments may default or become impaired due to deterioration in the financial condition of one or more issuers of the securities. Although our investment strategy is designed to preserve our capital, we cannot be certain that our investment objectives will be achieved, and we could incur substantial realized and unrealized investment losses in future periods.

We may be unable to draw on our revolving credit facility in the future.

As discussed in more detail in “Note 6. Revolving Credit Facility and Long-Term Debt” to the consolidated financial statements incorporated into Item 8 of Part II of this report, our Credit Agreement with our principal bank, Wells Fargo Bank, National Association (the “Bank”), which expires July 1, 2018, provides for a revolving credit facility with a borrowing capacity of up to $25.0 million at December 31, 2017, to be used to finance working capital. There was no outstanding balance at that date. The Credit Agreement includes a standby letter of credit agreement providing for a sublimit of approximately $6.0 million in unsecured letters of credit, as well as a mortgage loan with a balance of approximately $4.4 million secured by our company office building in Vancouver, Washington.

If our business does not perform as expected, including if we generate less revenue than anticipated from our operations or encounter significant unexpected costs, we may fail to comply with the financial covenants under our credit facilities. If we do not comply with our financial covenants and we do not obtain a waiver or amendment from the Bank, the Bank may elect to cause all amounts owed to become immediately due and payable or may decline to renew our credit facility. In that event, we would seek to establish a replacement credit facility with one or more other lenders, including lenders with which we have an existing relationship, potentially on less desirable terms. There can be no guarantee that replacement financing would be available at commercially reasonable terms, if at all.

Our business is subject to risks associated with geographic market concentration.

Our California operations accounted for approximately 79% of our total revenues in 2017. As a result of the current importance of our California operations and anticipated continued growth from these operations, our profitability over the next several years is expected to be largely dependent on economic and regulatory conditions in California. If California experiences an economic downturn, or if the regulatory environment changes in a way that adversely affects our ability to do business or limits our competitive advantages, our profitability and growth prospects may be materially adversely affected.

In order to continue to grow revenues at or near current rates, we are dependent on retaining current clients and attracting new clients.

The Company has experienced significant growth in recent years. Revenues increased 9.5% in 2017 and 13.5% in 2016. There can be no assurance that we will continue to grow revenues at or near current rates of growth. Maintaining rates of growth at these levels becomes increasingly difficult as the size of the Company increases. Efforts to achieve business growth intensifies pressure on retaining current clients and attracting increasing numbers of new clients.

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Economic conditions, particularly in California, may impact our ability to attract new clients and cause our existing clients to reduce staffing levels or cease operations.

Weak economic conditions typically have a negative impact on small-and mid-sized businesses, which make up the majority of our clients. In turn, these businesses could cut costs, including trimming employees from their payrolls, or closing locations or ceasing operations altogether. If weak economic conditions were to develop, these forces may result in decreased revenues due both to the downsizing of our current clients and increased difficulties in attracting new clients in a poor economic environment. In addition, weak economic conditions may also result in additional bad debt expense to the extent that existing clients cease operations.

Our business is subject to risks associated with healthcare reforms.

The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the “Acts”) subject us to potential penalties unless we offer our employees minimum essential healthcare coverage that is affordable. In order to comply with the employer mandate provision of the Acts, we offer health care coverage to all temporary and permanent employees eligible for coverage under the Acts other than employees of our PEO clients, which are responsible for providing required health care coverage to their employees. Designating employees as eligible is complex, and is subject to challenge by employees and the Internal Revenue Service. While we believe we have properly identified eligible employees, a later determination that we failed to offer the required health coverage to eligible employees could result in penalties that may materially harm our business. We cannot be certain that compliant insurance coverage will remain available to us on reasonable terms, and we could face additional risks arising from future changes to or repeal of the Acts or changed interpretations of our obligations under the Acts. There can be no assurance that we will be able to recover all related costs through increased pricing to our customers or that such costs will be recovered in the period in which costs are incurred, and the net financial impact on our results of operations could be significant.

If we are unable to maintain our brand image and corporate reputation, our business may suffer.

Our success depends in part on our ability to maintain our reputation for providing excellent service to our customers. Service quality issues, actual or perceived, even when false or unfounded, could tarnish the image of our brand and may cause customers to use other companies. Also, adverse publicity surrounding labor relations, data breaches, SEC investigations, securities class actions and the like, could negatively affect our overall reputation. Damage to our reputation could reduce demand for our services and thus have an adverse effect on our business, financial condition and results of operations.

Our staffing business is vulnerable to economic fluctuations.

Demand for our staffing services is sensitive to changes in the level of economic activity in the regions in which we do business. As economic activity slows down, companies often reduce their use of temporary employees before undertaking layoffs of permanent staff, resulting in decreased demand for staffing services. During strong economic periods, on the other hand, we often experience shortages of qualified employees to meet customer needs, as occurred during 2017.

Because we assume the obligation to make wage, tax and regulatory payments in respect of some employees, we are exposed to client credit risks.

We generally assume credit risk associated with our clients’ employee payroll obligations, including liability for payment of salaries and wages (including payroll taxes), as well as retirement benefits. These obligations are fixed whether or not the client makes payments to us as required by our services agreement. We attempt to mitigate this risk by invoicing our clients at the end of their specific payroll processing cycle. We also carefully monitor the timeliness of our clients' payments and impose strict credit standards on our customers. If we fail to successfully manage our credit risk, our results of operations and financial condition could be materially and adversely affected.

- 11 -


Increases in unemployment claims could raise our state and federal unemployment tax rates which we may not be able to pass on to our customers.

During weak economic conditions in our markets, the level of unemployment claims tends to rise as a result of employee layoffs at our clients and lack of work in our temporary staffing pool. The rise in unemployment claims often results in higher state and federal unemployment tax rates, which in most instances cannot be concurrently passed on to our customers either due to existing client services agreements or competitive pricing pressures. Increases in our state and federal unemployment tax rates could have a material adverse effect on our results of operations, particularly in the early part of the calendar year when payroll tax rates are at or near their maximum.

If we are determined not to be an “employer” under certain laws and regulations, our clients may stop using our services, and we may be subject to additional liabilities.

We are the administrative employer in our co-employment relationships under the various laws and regulations of the Internal Revenue Service and the U.S. Department of Labor. If we are determined not to be the administrative employer under such laws and regulations and are therefore unable to assume our clients’ obligations for employment and other taxes, our clients may be held jointly and severally liable for payment of such taxes. Some clients or prospective clients may view such potential liability as an unacceptable risk, discouraging current clients from continuing a relationship with us or prospective clients from entering into a new relationship with us. Any determination that we are not the administrative employer for purposes of ERISA could also adversely affect our cafeteria benefits plan operated under Section 125 of the Internal Revenue Code and result in liabilities to us under the plan.

We may be exposed to employment‑related claims and costs and periodic litigation that could adversely affect our business and results of operations.

We either co-employ employees in connection with our PEO client services agreements or place our employees in our customers' workplace in connection with our staffing business. As such, we are subject to a number of risks inherent to our status as the administrative employer, including without limitation:

 

claims of misconduct or negligence on the part of our employees, discrimination or harassment claims against our employees, or claims by our employees of discrimination or harassment by our clients;

 

immigration-related claims;

 

claims relating to violations of wage, hour and other workplace regulations;

 

claims relating to employee benefits, entitlements to employee benefits, or errors in the  calculation or administration of such benefits; and

 

possible claims relating to misuse of customer confidential information, misappropriation of assets or other similar claims.

If we experience significant incidents involving any of the above-described risk areas, we could face substantial out-of-pocket losses, fines or negative publicity. In addition, such claims may give rise to litigation, which may be time consuming, distracting and costly, and could have a material adverse effect on our business. With respect to claims involving our co-employer relationships, although our client services agreement provides that the client will indemnify us for any liability attributable to the conduct of the client or its employees, we may not be able to enforce such contractual indemnification, or the client may not have sufficient assets to satisfy its obligations to us. An increase in employment-related claims against us may have a material adverse effect on our results of operations.

- 12 -


We are dependent upon technology services and if we experience damage, service interruptions or failures in our computer and telecommunications systems, our client relationships and our ability to attract new clients may be adversely affected.

We rely extensively on our computer systems to manage our branch network, perform employment-related services and accounting and reporting functions, and summarize and analyze our financial results. Our systems are subject to damage or interruption from telecommunications failures, power-related outages, computer viruses and malicious attacks, security breaches and catastrophic events. If our systems are damaged or fail to function properly, we may incur substantial costs to repair or replace them, experience loss of critical data and interruptions or delays in our ability to manage our operations, and encounter a loss of client confidence. In addition, our clients’ businesses may be adversely affected by any system or equipment failure or breach we experience. As a result, our relationships with our clients may be impaired, we may lose clients, our ability to attract new clients may be adversely affected, and we could be exposed to contractual liability. We may continue to invest in upgrades or replacements to our existing systems or additional security measures, each of which can involve substantial costs and risks relating to installation and implementation.

We depend on third-party software in order to provide our services and support our operations.

Significant portions of our services and operations rely on software that is licensed from third-party vendors. The fees associated with these license agreements could increase in future periods, resulting in increased operating expenses. If there are significant changes to the terms and conditions of our license agreements, or if we are unable to renew these license agreements, we may be required to make changes to our vendors or information technology systems. These changes may impact the services we provide to our clients or the processes we have in place to support our operations, which could have an adverse effect on our business.

If our efforts to protect the security of personal information about our employees and clients are unsuccessful, we could be subject to costly government enforcement actions and private litigation and our reputation could suffer.

The nature of our business involves the receipt, storage, and transmission of personal and proprietary information about thousands of employees and clients. If we experience a significant data security breach or fail to detect and appropriately respond to a significant data security breach, we could be exposed to government enforcement actions and private litigation. In addition, our employees and clients could lose confidence in our ability to protect their personal and proprietary information, which could cause them to terminate their relationships with us. Any loss of confidence arising from a significant data security breach could hurt our reputation, further damaging our business.

We operate in a complex regulatory environment, and failure to comply with applicable laws and regulations could adversely affect our business.

Corporate human resource operations are subject to a broad range of complex and evolving laws and regulations, including those applicable to payroll practices, benefits administration, employment practices, workers’ compensation coverage, and privacy. Because our clients have employees in many states throughout the United States, we must perform our services in compliance with the legal and regulatory requirements of multiple jurisdictions. Some of these laws and regulations may be difficult to ascertain or interpret and may change from time to time. Violation of such laws and regulations could subject us to fines and penalties, damage our reputation, constitute a breach of our client agreements, impair our ability to obtain and renew required licenses, and decrease our profitability or competitiveness. If any of these effects were to occur, our operating results and financial condition could be adversely affected.

- 13 -


Changes in government regulations may result in restrictions or prohibitions applicable to the provision of employment services or the imposition of additional licensing, regulatory or tax requirements.

Our business is heavily regulated in most jurisdictions in which we operate. We cannot provide assurance that the states in which we conduct or seek to conduct business will not:

 

impose additional regulations that prohibit or restrict employment-related businesses like ours;

 

require additional licensing or add restrictions on existing licenses to provide employment-related services; or

 

increase taxes or make changes in the way in which taxes are calculated for providers of employment-related services.

Any changes in applicable laws and regulations may make it more difficult or expensive for us to do business, inhibit expansion of our business, or result in additional expenses that limit our profitability or decrease our ability to attract and retain clients.

The tax status of our insurance subsidiaries could be challenged resulting in an acceleration of income tax payments.

In conjunction with our workers’ compensation program, we operate two wholly owned insurance subsidiaries, AICE and Ecole. We treat the two subsidiaries as insurance companies for federal income tax purposes with respect to our consolidated federal income tax return. If the Internal Revenue Service (“IRS”) were to determine that the subsidiaries do not qualify as insurance companies, in which insurance reserves are currently deductible, we could be required to make accelerated income tax payments to the IRS that we otherwise would have deferred until future periods.

We may find it difficult to expand our business into additional states due to varying state regulatory requirements.

Future growth in our operations depends, in part, on our ability to offer our services to prospective clients in new states, which may subject us to different regulatory requirements and standards. In order to operate effectively in a new state, we must obtain all necessary regulatory approvals, adapt our procedures to that state's regulatory requirements and modify our service offerings to adapt to local market conditions. As we expand into additional states, we may not be able to duplicate in other markets the financial performance experienced in our current markets.

We face competition from a number of other companies.

We face competition from various companies that may provide all or some of the services we offer. Our competitors include companies that are engaged in staffing services such as Robert Half International Inc., Kelly Services, Inc., and ManpowerGroup Inc.; companies that are focused on co-employment, such as Insperity, Inc., and TriNet Group, Inc.; and companies that primarily provide payroll processing services, such as Automatic Data Processing, Inc. and Paychex, Inc. We also face competition from information technology outsourcing firms and broad-based outsourcing and consulting firms that perform individual projects.

- 14 -


Several of our existing or potential competitors have substantially greater financial, technical and marketing resources than we do, which may enable them to:

 

develop and expand their infrastructure and service offerings more quickly and achieve greater cost efficiencies;

 

invest in new technologies;

 

expand operations into new markets more rapidly;

 

devote greater resources to marketing;

 

compete for acquisitions more effectively and complete acquisitions more easily; and

 

aggressively price products and services and increase benefits in ways that we may not be able to match financially.

In order to compete effectively in our markets, we must target our potential clients carefully, continue to improve our efficiencies and the scope and quality of our services, and rely on our service quality, innovation, education and program clarity. If our competitive advantages are not compelling or sustainable, then we are unlikely to increase or sustain profits and our stock price could decline.

We are dependent upon certain key personnel and recruitment and retention of key employees may be difficult and expensive.

We believe that the successful operation of our business is dependent upon our retention of the services of key personnel, including our Chief Executive Officer, other executive officers and area managers. We may not be able to retain all of our executives, senior managers and key personnel in light of competition for their services. If we lose the services of one of our executive officers or a significant number of our senior managers, our results of operations likely would be adversely affected.

We do not have an expansive in-house sales staff and therefore rely extensively on referral partners.

We maintain a minimal internal professional sales force, and we rely heavily on referral partners to provide referrals to new business. In connection with these arrangements, we pay a fee to referral partners for new clients. These referral firms and individuals do not have an exclusive relationship with us. If we are unable to maintain these relationships or if they increase their fees or lose confidence in our services, we could face declines in our business and additional costs and uncertainties as we attempt to hire and train an internal sales force.

We depend on attracting and retaining qualified employees; during periods of economic growth, our costs to do so increase and attracting and retaining people becomes more difficult.

Our teams of client-facing professionals are the foundation of our value proposition. Our ability to attract and retain qualified personnel could be impaired by economic conditions resulting in lower unemployment and increases in compensation. During periods of economic growth, we face increased competition for retaining and recruiting qualified personnel, which in turn leads to greater advertising and recruiting costs and increased salary expenses. If we cannot attract and retain qualified employees, the quality of our services may deteriorate and our reputation and results of operations could be adversely affected.

Our service agreements may be terminated on short notice, leaving us vulnerable to loss of a significant amount of customers in a short period of time, if business or regulatory conditions change or events occur that negatively affect our reputation.

Our client services agreements are generally terminable on 30 days’ notice by either us or our client. As a result, our clients may terminate their agreement with us at any time, making us particularly vulnerable to changing business or regulatory conditions or changes affecting our reputation or the reputation of our industry.

- 15 -


Our industry has at times received negative publicity that, if it were to become more prevalent, could cause our business to decline.

In the staffing and co-employment industries in which we compete, companies periodically have been tarnished by negative publicity or scandals from poor business judgment or even outright fraud. If we or our industry face negative publicity, customers' confidence in the use of temporary personnel or co-employed workers may deteriorate, and they may be unwilling to enter into or continue our staffing or co-employment relationships. If a negative perception were to prevail, it would be more difficult for us to attract and retain customers.

Changes in federal and state unemployment tax laws and regulations could adversely affect our business.

In past years, there has been significant negative publicity relating to the use of staffing or PEO companies to shield employers from poor unemployment history and high unemployment taxes. New legislation enacted at the state or federal level to try to counter this perceived problem could have a material adverse effect on our business by limiting our ability to market our services or making our services less attractive to our customers and potential customers.

Risks Related to Ownership of our Common Stock

Our stock price may be volatile or may decline, resulting in substantial losses for our stockholders.

The market price of our Common Stock has been, and may continue to be, volatile for the foreseeable future. Important factors that may cause our trading price to decline include the factors listed below and other factors that may have a material adverse effect on our business or financial results, including those described above in this “Risk Factors” section:

 

actual or anticipated fluctuations in our results of operations, including a significant slowdown in our revenue growth or material increase in our workers’ compensation expense;

 

our failure to maintain effective internal control over financial reporting or otherwise discover additional material errors in our financial reporting;

 

imposition of significant fines or penalties or other adverse action by the SEC or other regulatory authorities against the Company;

 

adverse developments in the legal proceedings described in “Item 3. Legal Proceedings”;

 

our failure to meet financial projections or achieve financial results anticipated by analysts; or

 

changes in our board of directors or management.

Maryland law and our Charter and bylaws contain provisions that could make the takeover of the Company more difficult.

Certain provisions of Maryland law and our Charter and bylaws could have the effect of delaying or preventing a third party from acquiring the Company, even if a change in control would be beneficial to our stockholders. These provisions of our Charter and bylaws:

 

permit the Board of Directors to issue up to 500,000 shares of preferred stock with such rights and preferences, including voting rights, as the Board may establish, without further approval by the Company's stockholders, which could also adversely affect the voting power of holders of our Common Stock; and

 

vest the power to adopt, alter or repeal the Company's bylaws solely in the Board of Directors; the stockholders do not have that power.

- 16 -


In addition, the Company is subject to the Maryland control share act (the “Control Share Act”). Under the Control Share Act, a person (an “Acquiring Person”) who acquires voting stock in a transaction (a “Control Share Acquisition”) which results in its holding voting power within specified ranges cannot vote the shares it acquires in the Control Share Acquisition unless voting rights are accorded to such control shares by the holders of two-thirds of the outstanding voting shares, excluding the Acquiring Person and the Company's officers and directors who are also employees of the Company.

The Company is also subject to the provisions of Maryland law limiting the ability of certain Maryland corporations to engage in specified business combinations (the “Business Combination Act”). Subject to certain exceptions, the Business Combination Act prohibits a Maryland corporation from engaging in a business combination with a stockholder who, with its affiliates, owns 10% or more of the corporation's voting stock. These provisions will not apply to business combinations that are approved by the Board of Directors before the stockholder became an interested stockholder.

Item 1B

UNRESOLVED STAFF COMMENTS

None.

Item 2.

PROPERTIES

We operate through 58 branch offices. The following table shows the number of locations in each state in which we have offices. We also lease office space in other locations in our market areas which we use to recruit and place employees.

 

 

 

 

Number of

Branch

Offices

 

Locations

California

 

22

Oregon

 

11

Utah

 

5

Washington

 

5

Idaho

 

3

Arizona

 

2

Colorado

 

2

Maryland

 

2

North Carolina

 

2

Delaware

 

1

Nevada

 

1

Pennsylvania

 

1

Virginia

 

1

 

We lease office space for our branch offices. At December 31, 2017, our leases had expiration dates ranging from less than one year to seven years. Our corporate headquarters occupies approximately 75 percent of the 65,300 square foot building we own in Vancouver, Washington.

- 17 -


Item 3.

LEGAL PROCEEDINGS

BBSI is not subject to material legal proceedings and claims other than those which arise in the ordinary course of our business, except for those matters discussed in “Note 12. Litigation” to the consolidated financial statements incorporated into Item 8 of Part II of this report.

Item 4.

MINE SAFETY DISCLOSURES

Not Applicable

PART II

Item 5.

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock (the "Common Stock") trades on the Global Select Market segment of The Nasdaq Stock Market under the symbol "BBSI."  At March 1, 2018, there were 25 stockholders of record and approximately 1,525 beneficial owners of the Common Stock.

The following table presents the high and low sales prices of the Common Stock and cash dividends paid for each quarterly period during the last two fiscal years, as reported by The Nasdaq Stock Market. Any future determination as to the payment of dividends will be made at the discretion of the Board and will depend upon the Company's operating results, financial condition, capital requirements, general business conditions and such other factors as the Board deems relevant.

 

 

 

 

 

 

 

 

 

 

 

Cash

Dividends

 

 

 

High

 

 

Low

 

 

Declared

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

42.80

 

 

$

22.55

 

 

$

0.22

 

Second Quarter

 

 

43.08

 

 

 

27.28

 

 

 

0.22

 

Third Quarter

 

 

49.75

 

 

 

41.06

 

 

 

0.22

 

Fourth Quarter

 

 

66.93

 

 

 

43.00

 

 

 

0.22

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

66.64

 

 

$

50.56

 

 

$

0.25

 

Second Quarter

 

 

60.35

 

 

 

52.95

 

 

 

0.25

 

Third Quarter

 

 

59.50

 

 

 

44.52

 

 

 

0.25

 

Fourth Quarter

 

 

69.32

 

 

 

54.41

 

 

 

0.25

 

 

The Company maintains a Board-approved stock repurchase program which originally authorized up to 3.0 million shares of the Company’s Common Stock to be repurchased from time to time in open market purchases. The repurchase program allowed for the repurchase of approximately 1.1 million shares as of December 31, 2017. No repurchases were made during the quarter ended December 31, 2017.

  

- 18 -


The following graph shows the cumulative total return at the dates indicated for the period from December 31, 2012 until December 31, 2017, for our Common Stock, The Nasdaq Composite Index, and the S&P 1500 Human Resource & Employment Services Index, a published industry index that is considered reflective of the Company’s peers.

 

The stock performance graph has been prepared assuming that $100 was invested on December 31, 2012 in our Common Stock and the indexes shown, and that dividends are reinvested. The stock price performance reflected in the graph may not be indicative of future price performance.

 

 

 

 

 

12/12

 

12/13

 

12/14

 

12/15

 

12/16

 

12/17

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Barrett Business Services, Inc.

 

 

100.00

 

 

245.76

 

 

74.03

 

 

120.37

 

 

181.28

 

 

185.55

 

NASDAQ Composite

 

 

100.00

 

 

141.63

 

 

162.09

 

 

173.33

 

 

187.19

 

 

242.29

 

S&P 1500 Human Resource & Employment Services index

 

 

100.00

 

 

167.71

 

 

175.38

 

 

181.34

 

 

201.09

 

 

257.35

 

 

- 19 -


Item 6.

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with the Company's consolidated financial statements and the accompanying notes incorporated into Item 8 of Part II, “Financial Statements and Supplementary Data,” and the information contained in Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Historical results are not necessarily indicative of future results.

 

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional employer service fees

 

$

758,046

 

 

$

673,924

 

 

$

572,286

 

 

$

470,522

 

 

$

393,085

 

Staffing services

 

$

162,386

 

 

 

166,662

 

 

 

168,555

 

 

 

165,833

 

 

 

143,881

 

Total revenues

 

 

920,432

 

 

 

840,586

 

 

 

740,841

 

 

 

636,355

 

 

 

536,966

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct payroll costs

 

 

122,533

 

 

 

126,753

 

 

 

127,964

 

 

 

126,399

 

 

 

108,875

 

Payroll taxes and benefits

 

 

404,687

 

 

 

357,867

 

 

 

312,284

 

 

 

263,100

 

 

 

222,163

 

Workers' compensation

 

 

234,681

 

 

 

210,430

 

 

 

171,137

 

 

 

213,451

 

 

 

123,427

 

Total cost of revenues

 

 

761,901

 

 

 

695,050

 

 

 

611,385

 

 

 

602,950

 

 

 

454,465

 

Gross margin

 

 

158,531

 

 

 

145,536

 

 

 

129,456

 

 

 

33,405

 

 

 

82,501

 

Selling, general and administrative expenses

 

 

123,138

 

 

 

113,342

 

 

 

90,177

 

 

 

74,065

 

 

 

59,439

 

Depreciation and amortization

 

 

5,452

 

 

 

3,253

 

 

 

2,851

 

 

 

2,506

 

 

 

2,037

 

Income (loss) from operations

 

 

29,941

 

 

 

28,941

 

 

 

36,428

 

 

 

(43,166

)

 

 

21,025

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

 

4,668

 

 

 

956

 

 

 

771

 

 

 

543

 

 

 

539

 

Interest expense

 

 

(313

)

 

 

(807

)

 

 

(1,965

)

 

 

(173

)

 

 

(238

)

Loss on litigation

 

 

 

 

(3,544

)

 

 

 

 

 

 

Other, net

 

 

82

 

 

 

40

 

 

 

(88

)

 

 

152

 

 

 

(9

)

Other income (expense), net

 

 

4,437

 

 

 

(3,355

)

 

 

(1,282

)

 

 

522

 

 

 

292

 

Income (loss) before income taxes

 

 

34,378

 

 

 

25,586

 

 

 

35,146

 

 

 

(42,644

)

 

 

21,317

 

Provision for (benefit from) income taxes

 

 

9,208

 

 

 

6,787

 

 

 

9,652

 

 

 

(17,098

)

 

 

5,644

 

Net income (loss)

 

$

25,170

 

 

$

18,799

 

 

$

25,494

 

 

$

(25,546

)

 

$

15,673

 

Basic income (loss) per common share

 

$

3.46

 

 

$

2.60

 

 

$

3.55

 

 

$

(3.57

)

 

$

2.21

 

Weighted average number of basic  common

   shares outstanding

 

 

7,275

 

 

 

7,226

 

 

 

7,173

 

 

 

7,160

 

 

 

7,105

 

Diluted income (loss) per common share

 

$

3.33

 

 

$

2.55

 

 

$

3.47

 

 

$

(3.57

)

 

$

2.12

 

Weighted average number of diluted common

   shares  outstanding

 

 

7,551

 

 

 

7,378

 

 

 

7,353

 

 

 

7,160

 

 

 

7,397

 

Cash dividends per common share

 

$

1.00

 

 

$

0.88

 

 

$

0.88

 

 

$

0.76

 

 

$

0.57

 

Selected balance sheet data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

59,835

 

 

$

50,768

 

 

$

25,218

 

 

$

11,544

 

 

$

93,557

 

Investments

 

 

1,873

 

 

 

6,317

 

 

 

6,082

 

 

 

50,887

 

 

 

25,696

 

Current assets

 

 

308,235

 

 

 

235,383

 

 

 

206,068

 

 

 

163,664

 

 

 

202,315

 

Current liabilities

 

 

322,255

 

 

 

275,164

 

 

 

237,393

 

 

 

225,302

 

 

 

153,988

 

Working capital (deficit) surplus

 

 

(14,020

)

 

 

(39,781

)

 

 

(31,325

)

 

 

(61,638

)

 

 

48,327

 

Total assets

 

 

682,485

 

 

 

581,888

 

 

 

483,521

 

 

 

443,844

 

 

 

305,929

 

Long-term workers' compensation liabilities

 

 

265,844

 

 

 

231,198

 

 

 

190,094

 

 

 

164,214

 

 

 

79,849

 

Long-term debt, net of current portion

 

 

4,171

 

 

 

4,392

 

 

 

 

 

19,833

 

 

 

5,053

 

Stockholders' equity

 

 

88,834

 

 

 

69,693

 

 

 

54,551

 

 

 

32,820

 

 

 

65,177

 

 

The net loss in 2014 is primarily due to expense associated with an increase in the Company’s reserve for workers’ compensation claims liabilities of approximately $104.2 million.

- 20 -


Item 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Company is a leading provider of business management solutions for small and mid-sized companies. The Company has developed a management platform that integrates a knowledge-based approach from the management consulting industry with tools from the human resource outsourcing industry. This platform, through the effective leveraging of human capital, helps our business owner clients run their businesses more effectively. We believe this platform, delivered through a decentralized organizational structure, differentiates BBSI from our competitors.

We report revenues in our financial results in two categories of services: professional employer services (“PEO”) and staffing.

With our PEO clients, we enter into a co-employment arrangement in which we become the administrative employer while the client maintains physical care, custody and control of their workforce. Our PEO services are billed as a percentage of client payroll, with the gross amount invoiced including direct payroll costs, employer payroll-related taxes, workers’ compensation coverage (if provided) and a service fee. PEO customers are invoiced following the end of each payroll processing cycle, with payment generally due on the invoice date. Revenues for PEO services exclude direct payroll billings because we are not the primary obligor for those payments.

We generate staffing services revenues primarily from short-term staffing, contract staffing, on-site management and direct placement services. For staffing services other than direct placement, invoiced amounts include direct payroll, employer payroll-related taxes, workers’ compensation coverage and a service fee. Staffing customers are invoiced weekly and typically have payment terms of 30 days. Direct placement services are billed at agreed fees at the time of a successful placement.

Our business is concentrated in California, and we expect to continue to derive a majority of our revenues from this market in the future. Revenues generated in our California offices accounted for 79% of our total net revenues in 2017, 78% in 2016 and 78% in 2015. Consequently, any weakness in economic conditions or changes in the regulatory or insurance environment in California could have a material adverse effect on our financial results.

Our cost of revenues for PEO services includes employer payroll-related taxes and workers' compensation costs. Our cost of revenues for staffing services includes direct payroll costs, employer payroll-related taxes, employee benefits, and workers’ compensation costs. Direct payroll costs represent the gross payroll earned by staffing services employees based on salary or hourly wages. Payroll taxes and employee benefits consist of the employer's portion of Social Security and Medicare taxes, federal and state unemployment taxes and staffing services employee reimbursements for materials, supplies and other expenses, which are paid by our customer. Workers' compensation costs consist primarily of the costs associated with our workers' compensation program, including claims reserves, claims administration fees, legal fees, medical cost containment (“MCC”) expense, state administrative agency fees, third-party broker commissions, risk manager payroll, premiums for excess insurance and the fronted insurance program, and costs associated with operating our two wholly owned insurance companies, AICE and Ecole.

Selling, general and administrative expenses represent both branch office and corporate-level operating expenses. Branch operating expenses consist primarily of branch office staff payroll and personnel related costs, advertising, rent, office supplies, professional and legal fees and branch incentive compensation. Corporate-level operating expenses consist primarily of executive and office staff payroll and personnel related costs, professional and legal fees, travel, occupancy costs, information systems costs, and executive and corporate staff incentive compensation.

- 21 -


Depreciation and amortization represent depreciation of property and equipment, leasehold improvements and capitalized software costs. Property, equipment and software are depreciated using the straight-line method over their estimated useful lives, which range from 3 to 39 years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life.  

Critical Accounting Policies and Estimates

We have identified the following accounting estimate as critical to our business and the understanding of our results of operations. For a detailed discussion of the application of this and other accounting policies, see “Note 1. Summary of Operations and Significant Accounting Policies” to the consolidated financial statements incorporated into Item 8 of Part II of this report. The preparation of this Annual Report on Form 10-K requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

Workers' Compensation Reserves

We recognize our liability for the ultimate payment of incurred claims and claims adjustment expenses by establishing a reserve which represents our estimates of future amounts necessary to pay claims and related expenses with respect to workplace injuries that have occurred. When a claim involving a probable loss is reported, our independent third-party administrator for workers’ compensation claims (“TPA”) establishes a case reserve for the estimated amount of ultimate loss. The estimate reflects a judgment based on established case reserving practices and the experience and knowledge of the TPA regarding the nature and expected amount of the claim, as well as the estimated expenses of settling the claim, including legal and other fees and expenses of claims administration. The adequacy of such case reserves in part depends on the professional judgment of the TPA to properly and comprehensively evaluate the economic consequences of each claim.

Our reserves include an additional component for potential future increases in the cost to finally resolve open injury claims and claims incurred in prior periods but not reported (together, "IBNR") based on actuarial estimates provided by the Company’s independent actuary. IBNR reserves, unlike specific case reserves, do not apply to a specific claim but rather apply to the entire population of claims arising from a specific time period. IBNR primarily covers costs relating to:

 

Future claim payments in excess of case reserves on recorded open claims;

 

Additional claim payments on closed claims; and

 

Claims that have occurred but have not yet been reported to us.

The process of estimating unpaid claims and claims adjustment expense involves a high degree of judgment and is affected by both internal and external events, including changes in claims handling practices, modifications in reserve estimation procedures, changes in individuals involved in the reserve estimation process, inflation, trends in the litigation and settlement of pending claims, and legislative changes.

Our estimates are based on informed judgment, derived from individual experiences and expertise applied to multiple sets of data and analyses. We consider significant facts and circumstances known both at the time that loss reserves are initially established and as new facts and circumstances become known. Due to the inherent uncertainty underlying loss reserve estimates, the expenses incurred through final resolution of our liability for our workers’ compensation claims will likely vary from the related loss reserves at the reporting date. Therefore, as specific claims are paid out in the future, actual paid losses may be materially different from our current loss reserves.

- 22 -


A basic premise in most actuarial analyses is that historical data and past patterns demonstrated in the incurred and paid historical data form a reasonable basis upon which to project future outcomes, absent a material change. Significant structural changes to the available data can materially impact the reserve estimation process. To the extent a material change affecting the ultimate claim liability becomes known, such change is quantified to the extent possible through an analysis of internal company data and, if available and when appropriate, external data. Actuaries exercise a considerable degree of judgment in the evaluation of these factors and the need for such actuarial judgment is more pronounced when faced with material uncertainties.

We believe that the amounts recorded for our estimated liabilities for workers’ compensation claims, which are based on informed judgement, analysis of data, actuarial estimates, and analysis of other trends associated with the Company’s historical universe of claims data, are reasonable. Nevertheless, adjustments to such estimates will be required in future periods if the development of claim costs varies materially from our estimates and such future adjustments may be material to our results of operations.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements and their potential effect on the Company's results of operations and financial condition, see “Note 1. Summary of Operations and Significant Accounting Policies” to the consolidated financial statements incorporated into Item 8 of Part II of this report.

Forward-Looking Information

Statements in this Item or in Items 1, 1A, 3 and 9A of this report include forward-looking statements which are not historical in nature and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, discussion of economic conditions in our market areas and their effect on revenue levels, the effect of changes in our mix of services on gross margin, the adequacy of our workers' compensation reserves, the effect of changes in estimates of our future claims liabilities on our workers’ compensation reserves, including the effect of changes in our reserving practices and claims management process on our actuarial estimates, the effects of recent federal tax legislation, our ability to generate sufficient taxable income in the future to utilize our deferred tax assets, the effect of our formation and operation of two wholly owned licensed insurance subsidiaries, the risks of operation and cost of our fronted insurance program with Chubb, the financial viability of our excess insurance carriers, the effectiveness of our management information systems, our relationship with our primary bank lender and the availability of financing and working capital to meet our funding requirements, litigation costs and the effect of the potential resolution of any enforcement action that may be brought by the SEC Division of Enforcement, the effect of changes in the interest rate environment on the value of our investment securities and long-term debt, the adequacy of our allowance for doubtful accounts, and the potential for and effect of acquisitions.

- 23 -


All of our forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors with respect to the Company include our ability to retain current clients and attract new clients, difficulties associated with integrating clients into our operations, economic trends in our service areas, the potential for material deviations from expected future workers’ compensation claims experience, the workers’ compensation regulatory environment in our primary markets, security breaches or failures in the Company’s information technology systems, collectability of accounts receivable, the carrying values of deferred income tax assets and goodwill (which may be affected by our future operating results), the impact of the Patient Protection and Affordable Care Act and escalating medical costs on our business, the effect of conditions in the global capital markets on our investment portfolio, and the availability of capital, borrowing capacity on our revolving credit facility, or letters of credit necessary to meet state-mandated surety deposit requirements for maintaining our status as a qualified self-insured employer for workers' compensation coverage or our fronted insurance program. Additional risk factors affecting our business are discussed in Item 1A of Part I of this report. We disclaim any obligation to update any such factors or to publicly announce any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

Results of Operations

The following table sets forth the percentages of total revenues represented by selected items in the Company's consolidated statements of operations for the years ended December 31, 2017, 2016 and 2015, included in Item 15 of this report. References to the Notes to Consolidated Financial Statements appearing below are to the notes to the Company's consolidated financial statements incorporated into Item 8 of Part II of this report.

 

 

 

 

Percentage of Total Net Revenues

 

 

 

 

Years Ended December 31,

 

 

 

 

2017

 

 

 

2016

 

 

 

2015

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional employer service fees

 

$

758,046

 

 

 

82.4

 

%

 

$

673,924

 

 

 

80.2

 

%

 

$

572,286

 

 

 

77.2

 

%

Staffing services

 

 

162,386

 

 

 

17.6

 

 

 

 

166,662

 

 

 

19.8

 

 

 

$

168,555

 

 

 

22.8

 

 

Total revenues

 

 

920,432

 

 

 

100.0

 

 

 

 

840,586

 

 

 

100.0

 

 

 

 

740,841

 

 

 

100.0

 

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct payroll costs

 

 

122,533

 

 

 

13.3

 

 

 

 

126,753

 

 

 

15.1

 

 

 

 

127,964

 

 

 

17.3

 

 

Payroll taxes and benefits

 

 

404,687

 

 

 

44.0

 

 

 

 

357,867

 

 

 

42.6

 

 

 

 

312,284

 

 

 

42.1

 

 

Workers’ compensation

 

 

234,681

 

 

 

25.5

 

 

 

 

210,430

 

 

 

25.0

 

 

 

 

171,137

 

 

 

23.1

 

 

Total cost of revenues

 

 

761,901

 

 

 

82.8

 

 

 

 

695,050

 

 

 

82.7

 

 

 

 

611,385

 

 

 

82.5

 

 

Gross margin

 

 

158,531

 

 

 

17.2

 

 

 

 

145,536

 

 

 

17.3

 

 

 

 

129,456

 

 

 

17.5

 

 

Selling, general and administrative expenses

 

 

123,138

 

 

 

13.4

 

 

 

 

113,342

 

 

 

13.5

 

 

 

 

90,177

 

 

 

12.2

 

 

Depreciation and amortization

 

 

5,452

 

 

 

0.6

 

 

 

 

3,253

 

 

 

0.4

 

 

 

 

2,851

 

 

 

0.4

 

 

Income from operations

 

 

29,941

 

 

 

3.2

 

 

 

 

28,941

 

 

 

3.4

 

 

 

 

36,428

 

 

 

4.9

 

 

Other income (expense), net

 

 

4,437

 

 

 

0.5

 

 

 

 

(3,355

)

 

 

(0.4

)

 

 

 

(1,282

)

 

 

(0.2

)

 

Income before income taxes

 

 

34,378

 

 

 

3.7

 

 

 

 

25,586

 

 

 

3.0

 

 

 

 

35,146

 

 

 

4.7

 

 

Provision for income taxes

 

 

9,208

 

 

 

1.0

 

 

 

 

6,787

 

 

 

0.8

 

 

 

 

9,652

 

 

 

1.3

 

 

Net income

 

$

25,170

 

 

 

2.7

 

%

 

$

18,799

 

 

 

2.2

 

%

 

$

25,494

 

 

 

3.4

 

%

 

- 24 -


We report PEO revenues net of direct payroll costs because we are not the primary obligor for wage payments to our clients’ employees. However, management believes that gross billing amounts and wages are useful in understanding the volume of our business activity and serve as an important performance metric in managing our operations, including the preparation of internal operating forecasts and establishing executive compensation performance goals. We therefore present for purposes of analysis gross billing and wage information for the years ended December 31, 2017, 2016 and 2015. 

 

 

 

Year Ended

 

 

 

December 31,

 

(in thousands)

 

2017

 

 

2016

 

 

2015

 

Gross billings

 

$

5,300,684

 

 

$

4,692,887

 

 

$

4,016,150

 

PEO and staffing wages

 

 

4,469,845

 

 

 

3,951,021

 

 

 

3,375,976

 

 

Because safety incentives represent consideration payable to PEO customers, safety incentive costs are netted against PEO revenue in our consolidated statements of operations. Management considers safety incentives to be an integral part of our workers’ compensation program because they encourage client companies to maintain safe-work practices and minimize workplace injuries. We therefore present below for purposes of analysis non-GAAP gross workers’ compensation expense, which represents workers’ compensation costs including safety incentive costs. We believe this non-GAAP measure is useful in evaluating the total costs of our workers’ compensation program.

 

 

 

Year Ended

 

 

 

December 31,

 

(in thousands)

 

2017

 

 

2016

 

 

2015

 

Workers' compensation

 

$

234,681

 

 

$

210,430

 

 

$

171,137

 

Safety incentive costs

 

 

32,940

 

 

 

28,033

 

 

 

27,297

 

Non-GAAP gross workers' compensation

 

$

267,621

 

 

$

238,463

 

 

$

198,434

 

In monitoring and evaluating the performance of our operations, management also reviews the following ratios, which represent selected amounts as a percentage of gross billings. Management believes these ratios are useful in understanding the efficiency and profitability of our service offerings.

 

 

Percentage of Gross Billings

 

 

 

Year Ended

 

 

 

December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

PEO and staffing wages

 

 

84.3

%

 

 

84.2

%

 

 

84.1

%

Payroll taxes and benefits

 

 

7.6

%

 

 

7.6

%

 

 

7.8

%

Non-GAAP gross workers' compensation

 

 

5.0

%

 

 

5.1

%

 

 

4.9

%

The presentation of revenues on a net basis and the relative contributions of staffing and professional employer services revenues can create volatility in our gross margin percentage. The general impact of fluctuations in our revenue mix is described below.

 

A relative increase in professional employer services revenue will result in a higher gross margin percentage. Improvement in gross margin percentage occurs because incremental client services revenue dollars are reported as revenue net of all related direct payroll and safety incentive costs.

 

A relative increase in staffing revenues will typically result in a lower gross margin percentage.
Staffing revenues are presented at gross with the related direct costs reported in cost of revenues. While staffing relationships typically have higher margins than professional employer service relationships, an increase in staffing revenues and related costs increases the impact of the net professional employer services revenue on gross margin percentage.

- 25 -


Years Ended December 31, 2017 and 2016

Net income for 2017 was $25.2 million compared to net income of $18.8 million for 2016. Diluted income per share for 2017 was $3.33 compared to diluted income per share of $2.55 for 2016.

Revenues for 2017 totaled $920.4 million, an increase of $79.8 million or 9.5% over 2016, which reflects an increase in the Company’s professional employer service fee revenue of $84.1 million or 12.5% and a decrease in staffing services revenue of $4.3 million or 2.6%. There was one less business day in 2017 compared to 2016.

Our growth in professional employer service revenues was attributable to both new and existing customers. Due to continued strength in our referral channels, business from new customers during 2017 exceeded business lost from former customers. Professional employer service revenue from continuing customers grew 7.2% on a year-over-year basis, primarily resulting from increases in employee headcount and hours worked. The decrease in staffing services revenue was due primarily to a decrease in revenue from continuing customers compared to the prior year.

Gross margin for 2017 totaled $158.5 million or 17.2% of revenue compared to $145.5 million or 17.3% of revenue for 2016. The decrease in gross margin as a percentage of revenues is primarily due to increases in payroll taxes and workers’ compensation expense as a percentage of revenues, partially offset by a decrease in direct payroll costs.

Direct payroll costs for 2017 totaled $122.5 million or 13.3% of revenue compared to $126.8 million or 15.1% of revenue for 2016. The decrease in direct payroll costs percentage was primarily due to the increase in professional employer services and the decrease of staffing services within the mix of our customer base compared to 2016.

Payroll taxes and benefits for 2017 totaled $404.7 million or 44.0% of revenue compared to $357.9 million or 42.6% of revenue for 2016. The increase in payroll taxes and benefits as a percentage of revenues is due to a $3.8 million federal unemployment tax refund recognized in the third quarter of 2016, the increase in professional employer services where payroll taxes and benefits are presented at gross cost, and a decrease in staffing revenue during the period.

Workers’ compensation expense for 2017 totaled $234.7 million or 25.5% of revenue compared to $210.4 million or 25.0% of revenue for 2016. The increase in workers’ compensation expense as a percentage of revenue was primarily due to an unfavorable adjustment of $5.2 million in 2017 compared to a favorable adjustment of $300,000 in 2016 due to changes in actuarial estimates of our workers’ compensation reserves related to claims incurred in prior periods.

Selling, general and administrative (“SG&A”) expenses for 2017 totaled $123.1 million or 13.4% of revenue compared to $113.3 million or 13.5% of revenue for 2016. The decrease as a percentage of revenues was primarily attributable to a $5.0 million decrease in total legal and accounting fees, partially offset by an increase in employee related expenses.   

Other income for 2017 totaled $4.4 million compared to other expense of $3.4 million for 2016. The change was attributable to a decrease in litigation costs of $3.3 million as well as an increase in investment income of $3.7 million in 2017.

Our effective income tax rate for 2017 was 26.8% compared to 26.5% for 2016. Our income tax rate typically differs from the federal statutory tax rate of 35% primarily due to federal and state tax credits. Our effective tax rate in 2017 also includes a provisional adjustment of 3.2% related to a change in the federal tax rate enacted on December 22, 2017. See “Note 9. Income Taxes” to the consolidated financial statements incorporated into Item 8 of Part II of this report for additional information regarding income taxes.

- 26 -


Years Ended December 31, 2016 and 2015

Net income for 2016 was $18.8 million compared to net income of $25.5 million for 2015. Diluted income per share for 2016 was $2.55 compared to diluted income per share of $3.47 for 2015.

Revenues for 2016 totaled $840.6 million, an increase of $99.7 million or 13.5% over 2015, which reflects an increase in the Company’s professional employer service fee revenue of $101.6 million or 17.8% and a decrease in staffing services revenue of $1.9 million or 1.1%.

Our growth in professional employer service revenues was attributable to both new and existing customers. Due to continued strength in our referral channels, business from new customers during 2016 nearly doubled business lost from former customers. Professional employer service revenue from continuing customers grew 6.8% on a year-over-year basis, primarily resulting from increases in employee headcount and hours worked. The decrease in staffing services revenue was due primarily to a decrease in revenue from continuing customers, partially offset by an increase in net staffing revenue from new customers over lost customers.

Gross margin for 2016 totaled $145.5 million or 17.3% of revenue compared to $129.5 million or 17.5% of revenue for 2015. The decrease in gross margin percentage was primarily due to increases in workers’ compensation expense and payroll taxes and benefits, partially offset by a decrease in direct payroll costs.

Direct payroll costs for 2016 totaled $126.8 million or 15.1% of revenue compared to $128.0 million or 17.3% of revenue for 2015. The decrease in direct payroll costs as a percentage of revenues was primarily due to the increase in professional employer services and the decrease of staffing services within the mix of our customer base compared to 2015.

Payroll taxes and benefits for 2016 totaled $357.9 million or 42.6% of revenue compared to $312.3 million or 42.1% of revenue for 2015. The increase in payroll taxes and benefits as a percentage of revenues was primarily due to the effect of growth in professional employer services, where payroll taxes and benefits are presented at gross cost.

Workers’ compensation expense for 2016 totaled $210.4 million or 25.0% of revenue compared to $171.1 million or 23.1% of revenue for 2015. The increase in workers’ compensation expense as a percentage of revenues was primarily due to a decrease in our workers’ compensation reserves in 2015 of $13.7 million related to actuarial adjustments in that year.

SG&A expenses for 2016 totaled $113.3 million, or 13.5% of revenue, compared to $90.2 million or 12.2% of revenue for 2015. The increase as a percentage of revenues was primarily attributable to an increase in employee related expenses and an $11.0 million increase in total legal and accounting expenses, of which $8.5 million pertained to non-recurring legal and accounting costs associated with financial restatements, outside investigations, and legal proceedings related to securities law issues.

Other expense, net for 2016 totaled $3.4 million compared to $1.3 million for 2015. The change was primarily attributable to a $3.3 million litigation settlement recognized in the third quarter of 2016, partially offset by a decrease in interest expense and an increase in investment income.

Our effective income tax rate for 2016 was 26.5% compared to 27.5% for 2015. Our income tax rate typically differs from the federal statutory tax rate of 35% primarily due to federal and state tax credits.

- 27 -


Fluctuations in Quarterly Operating Results

We have historically experienced significant fluctuations in our quarterly operating results, including losses in the first quarter of each year, and expect such fluctuations to continue in the future. Our operating results may fluctuate due to a number of factors such as seasonality, wage limits on statutory payroll taxes, claims experience for workers’ compensation, demand for our services, and competition. Payroll taxes, as a component of cost of revenues, generally decline throughout a calendar year as the applicable statutory wage bases for federal and state unemployment taxes and Social Security taxes are exceeded on a per employee basis. Our revenue levels may be higher in the third quarter due to the effect of increased business activity of our customers’ businesses in the agriculture, food processing and forest products-related industries. In addition, revenues in the fourth quarter may be reduced by many customers’ practice of operating on holiday-shortened schedules. Workers’ compensation expense varies with both the frequency and severity of workplace injury claims reported during a quarter and the estimated future costs of such claims. In addition, adverse loss development of prior period claims during a subsequent quarter may also contribute to the volatility in the Company’s estimated workers’ compensation expense.

Liquidity and Capital Resources

The Company's cash balance of $59.8 million at December 31, 2017 increased $9.1 million compared to December 31, 2016. The increase in cash was primarily due to increased cash provided by operating activities and decreased cash used by financing activities, partially offset by an increase in purchases of restricted and unrestricted cash and investments.

Net cash provided by operating activities in 2017 amounted to $112.9 million, compared to $80.3 million for 2016. In 2017, cash flow from operating activities was primarily provided by net income of $25.2 million, increased workers’ compensation claims liabilities of $57.1 million, and increased accrued payroll, payroll taxes and related benefits of $28.5 million, partially offset by increased trade accounts receivable of $10.2 million.

Net cash used in investing activities totaled $94.8 million in 2017, compared to $33.1 million in 2016. In 2017, cash used in investing activities consisted primarily of purchases of restricted and unrestricted cash and investments of $1,084.6 million, partially offset by proceeds from sales and maturities of restricted and unrestricted cash and investments of $993.5 million.

Net cash used in financing activities in 2017 was $9.0 million compared to $21.7 million for 2016. In 2017, cash was primarily used for dividend payments of $7.3 million.

The states of California, Maryland, Oregon, Washington, Colorado and Delaware required us to maintain specified financial instruments totaling $96.8 million and $135.0 million at December 31, 2017 and 2016, respectively, to cover potential workers’ compensation claims losses related to the Company’s current and former status as a self-insured employer. At December 31, 2017, the Company provided surety bonds and standby letters of credit totaling $96.8 million, including a California requirement of $84.8 million. Management expects the surety bonds and letters of credit to decrease over time as a result of a declining self-insured liability in California. The Company’s self-insured status in California ended on December 31, 2014.

As part of its fronted workers’ compensation insurance program with Chubb, the Company makes monthly payments into a trust account (the “Chubb trust account”) to be used for the payment of future claims. The balance in the Chubb trust account was $380.6 million and $277.1 million at December 31, 2017 and December 31, 2016, respectively. The Chubb trust account balances are included as a component of the current and long-term restricted cash and investments in the Company’s consolidated balance sheets.

The Company maintains a credit agreement (the “Agreement”) with its principal bank, Wells Fargo Bank, National Association (the “Bank”). The Agreement provides for a $25.0 million revolving credit line, with a $6.0 million sublimit for unsecured standby letters of credit.

- 28 -


Advances under the revolving credit facility bear interest as selected by the Company of either (a) a daily floating rate of one month LIBOR plus 1.75% or (b) a fixed rate of LIBOR plus 1.75%. The Agreement also provides for an unused commitment fee of 0.375% per year on the average daily unused amount of the revolving credit facility, as well as a fee of 1.75% of the face amount of each letter of credit reserved under the line of credit and 0.95% on standalone, fully secured letters of credit. The Company had no outstanding borrowings on its revolving credit line at December 31, 2017 and 2016. The revolving line of credit expires on July 1, 2018.

The credit facility is collateralized by the Company’s accounts receivable and other rights to receive payment, general intangibles, inventory and equipment.

The Agreement requires the satisfaction of certain financial covenants as follows:

 

EBITDA [net profit before taxes plus interest expense (net of capitalized interest expense), depreciation expense, and amortization expense] on a rolling four-quarter basis of not less than $25 million at the end of each fiscal quarter; and

 

ratio of restricted and unrestricted cash and investments to workers’ compensation and safety incentive liabilities of at least 1.0:1.0, measured quarterly.

 

The Agreement includes certain additional restrictions as follows:

 

incurring additional indebtedness is prohibited without the prior approval of the Bank, other than purchase financing (including capital leases) for the acquisition of assets, provided that the aggregate of all purchase financing does not exceed $1,000,000 at any time; and

 

the Company may not terminate or cancel any of the AICE policies without the Bank’s prior written consent.

The Agreement also contains customary events of default. If an event of default under the Agreement occurs and is continuing, the Bank may declare any outstanding obligations under the  Agreement to be immediately due and payable. At December 31, 2017, the Company was in compliance with all covenants.

The Company maintains a mortgage loan with the Bank with a balance of approximately $4.4 million and $4.6 million at December 31, 2017 and 2016, respectively, secured by the Company’s corporate office building in Vancouver, Washington. This loan requires payment of monthly installments of $18,375, bearing interest at the one month LIBOR plus 2.0%, with the unpaid principal balance due July 1, 2022.

Management expects that the funds anticipated to be generated from operations, current liquid assets, and availability under the Company’s revolving credit facility will be sufficient in the aggregate to fund the Company’s working capital needs for the next twelve months.

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Contractual Obligations

The Company's contractual obligations as of December 31, 2017 are summarized below:

 

 

 

As of December 31, 2017

 

 

 

Payments Due by Period

 

(in thousands)

 

 

 

 

 

Less than

 

 

1 - 3

 

 

4 - 5

 

 

After

 

 

 

Total

 

 

1 year

 

 

years

 

 

years

 

 

5 years

 

Operating leases

 

$

23,671

 

 

$

6,231

 

 

$

9,998

 

 

$

6,241

 

 

$

1,201

 

Long-term debt

 

 

4,392

 

 

 

221

 

 

 

441

 

 

 

3,730

 

 

 

 

Total contractual obligations

 

$

28,063

 

 

$

6,452

 

 

$

10,439

 

 

$

9,971

 

 

$

1,201

 

Inflation

Inflation generally has not been a significant factor in the Company's operations during the periods discussed above. The Company has taken into account the impact of escalating medical and other costs in establishing reserves for future workers' compensation claims payments.

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's exposure to market risk for changes in interest rates primarily relates to its investment portfolio and its outstanding borrowings on its line of credit and long-term debt. As of December 31, 2017, the Company’s investments consisted principally of approximately $184.7 million in corporate bonds, $86.2 million in mortgage backed securities, $46.2 million in U.S. treasuries, $38.0 million in U.S. government agency securities, $19.0 million in commercial paper, $16.1 million in money market funds, and $0.5 million in municipal bonds. The Company’s outstanding debt totaled approximately $4.4 million at December 31, 2017. Based on the Company's overall interest exposure at December 31, 2017, a 50 basis point increase in market interest rates would have a $6.2 million effect on the fair value of the Company's investment portfolio. A 50 basis point increase would have an immaterial effect on the Company’s outstanding borrowings because of the relative size of the outstanding borrowings.

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements and notes thereto required by this item begin on page F-1 of this report, as listed in Item 15.

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

Item 9A.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures” that are designed with the objective of providing reasonable assurance that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply their judgment in evaluating the cost-benefit relationship of possible controls and procedures.

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Based on their evaluation, the Company’s CEO and CFO have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective as of December 31, 2017.

Annual Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting (“ICFR”) as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our ICFR is a process designed by, or under the supervision of, our CEO and our CFO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management, with the participation of our CEO and CFO, conducted an evaluation of the effectiveness of our ICFR based on the framework established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon that evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2017.

The effectiveness of the Company’s internal control over financial reporting has also been audited by Deloitte & Touche LLP, the Company’s independent registered public accounting firm, as stated in their report included below.

Changes in Internal Control over Financial Reporting

Management previously identified a material weakness in internal controls related to its information and technology systems (“IT systems”). Specifically, the Company did not maintain effective controls over user access to IT systems and changes to programs and data. The following steps have been implemented by the Company in 2017 to remediate the material weakness:

 

Established a more rigorous review process over the evaluation of user access to IT systems, including preventative reviews during employment changes and periodic detective reviews.

 

Improved the structure and governance surrounding controls over IT systems.

 

Implemented enhanced review procedures and analysis over the segregation of duties in IT systems.

 

Improved the procedures and documentation associated with program change management, including implementing improved tools over system change logging.

 

Revised policies on the documentation of IT control performance and the retention of that documentation.

 

Replaced certain IT systems that had inherent control limitations, including the successful replacement of the staffing services revenue system.

 

As of December 31, 2017, management completed its assessment of the design and operating effectiveness of the internal controls over financial reporting, and based on this assessment, management concluded that the material weakness was remediated as of December 31, 2017.

Other than the activities described above, there have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Inherent Limitations

Control systems, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems' objectives are being met. Further, the design of any control systems must reflect the fact that there are resource constraints, and the benefits of all controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple errors or mistakes. Control systems can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Chief Executive Officer and Chief Financial Officer Certifications

The certifications of our CEO and CFO required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this report.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Barrett Business Services, Inc.

Vancouver, Washington

Opinion on Internal Control over Financial Reporting

We have audited the internal control over financial reporting of Barrett Business Services, Inc.  (the “Company”) and subsidiaries as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Frame