August 7, 2019 - 10-Q: Quarterly report pursuant to Section 13 or 15(d)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended June 30, 2019

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

For the Transition Period From to

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 Incorporation or organization)		(IRS Employer 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	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, Par Value $0.01 Per Share	BBSI	The NASDAQ Stock Market LLC

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 every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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 Exchange Act). Yes ☐ No ☒

As of August 1, 2019, 7,469,780 shares of the registrant’s common stock ($0.01 par value) were outstanding.

BARRETT BUSINESS SERVICES, INC.

INDEX TO FORM 10-Q

Part I - Financial Information (Unaudited)
		Page
Item 1.	Unaudited Interim Condensed Consolidated Financial Statements

	Condensed Consolidated Balance Sheets - June 30, 2019 and December 31, 2018	3

	Condensed Consolidated Statements of Operations - Three and Six Months Ended June 30, 2019 and 2018	4

	Condensed Consolidated Statements of Comprehensive Income (Loss) - Three and Six Months Ended June 30, 2019 and 2018	5

	Condensed Consolidated Statements of Stockholders’ Equity - Six Months Ended June 30, 2019 and 2018	6

	Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2019 and 2018	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.	Controls and Procedures	30

Part II - Other Information

Item 1.	Legal Proceedings	31

Item 1A.	Risk Factors	31

Item 5.	Other Information	31

Item 6.	Exhibits	32

Signature		33

PART I – FINANCIAL INFORMATION

Item 1.

Unaudited Interim Condensed Consolidated Financial Statements

Barrett Business Services, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In Thousands, Except Par Value)

	June 30,		December 31,
	2019		2018
ASSETS
Current assets:
Cash and cash equivalents	$	23,693	$	35,371
Trade accounts receivable, net		163,228		151,597
Prepaid expenses and other		15,720		13,880
Investments		77,271		416
Restricted cash and investments		108,275		120,409
Total current assets		388,187		321,673
Investments		—		1,687
Property, equipment and software, net		27,999		24,812
Operating lease right-of-use assets		25,005		—
Restricted cash and investments		335,966		348,165
Goodwill		47,820		47,820
Other assets		3,329		3,474
Deferred income taxes		5,897		8,458
	$	834,203	$	756,089
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt	$	221	$	221
Accounts payable		4,824		4,336
Accrued payroll, payroll taxes and related benefits		181,966		158,683
Income taxes payable		2,670		4,403
Current operating lease liabilities		6,381		—
Other accrued liabilities		15,908		20,566
Workers' compensation claims liabilities		108,289		109,319
Safety incentives liability		27,316		29,210
Total current liabilities		347,575		326,738
Long-term workers' compensation claims liabilities		322,447		304,078
Long-term debt		3,840		3,951
Long-term operating lease liabilities		19,101		—
Customer deposits and other long-term liabilities		3,773		2,285
Total liabilities		696,736		637,052
Commitments and contingencies (Notes 4, 5 and 7)
Stockholders' equity:
Common stock, $.01 par value; 20,500 shares authorized, 7,414 and 7,395 shares issued and outstanding		74		74
Additional paid-in capital		19,265		15,437
Accumulated other comprehensive income (loss)		1,632		(5,068	)
Retained earnings		116,496		108,594
Total stockholders' equity		137,467		119,037
	$	834,203	$	756,089

The accompanying notes are an integral part of these condensed consolidated financial statements.

Barrett Business Services, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In Thousands, Except Per Share Amounts)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
Revenues:
Professional employer service fees	$	203,157		$	197,277		$	393,684		$	386,239
Staffing services		27,825			34,326			55,513			69,340
Total revenues		230,982			231,603			449,197			455,579
Cost of revenues:
Direct payroll costs		20,992			26,020			41,834			52,423
Payroll taxes and benefits		101,697			98,249			216,494			222,437
Workers' compensation		53,174			58,854			107,403			115,976
Total cost of revenues		175,863			183,123			365,731			390,836
Gross margin		55,119			48,480			83,466			64,743
Selling, general and administrative expenses		39,005			35,614			72,165			65,043
Depreciation and amortization		970			1,274			1,939			2,278
Income (loss) from operations		15,144			11,592			9,362			(2,578	)
Other income (expense):
Investment income, net		3,332			2,201			6,404			4,220
Interest expense		(481	)		(68	)		(958	)		(110	)
Other, net		—			(12	)		12			4
Other income, net		2,851			2,121			5,458			4,114
Income before income taxes		17,995			13,713			14,820			1,536
Provision for (benefit from) income taxes		4,088			2,473			3,213			(581	)
Net income	$	13,907		$	11,240		$	11,607		$	2,117
Basic income per common share	$	1.88		$	1.54		$	1.57		$	0.29
Weighted average number of basic common shares outstanding		7,410			7,310			7,408			7,307
Diluted income per common share	$	1.81		$	1.46		$	1.51		$	0.28
Weighted average number of diluted common shares outstanding		7,692			7,675			7,674			7,658

The accompanying notes are an integral part of these condensed consolidated financial statements.

Barrett Business Services, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(In Thousands)

	Three Months Ended
	June 30,
	2019		2018
Net income	$	13,907	$	11,240
Unrealized gains (losses) on investments, net of tax of $1,164 and ($373) in 2019 and 2018, respectively		3,043		(975	)
Comprehensive income	$	16,950	$	10,265

	Six Months Ended
	June 30,
	2019		2018
Net income	$	11,607	$	2,117
Unrealized gains (losses) on investments, net of tax of $2,561 and ($1,928) in 2019 and 2018, respectively		6,700		(4,939	)
Comprehensive income (loss)	$	18,307	$	(2,822	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

Barrett Business Services, Inc.

Condensed Consolidated Statements of Stockholders’ Equity

Six Months Ended June 30, 2019 and 2018

(Unaudited)

(In Thousands)

									Accumulated
									Other
						Additional			Comprehensive
	Common Stock					Paid-in			(Loss)			Retained
	Shares			Amount		Capital			Income			Earnings			Total
Balance, December 31, 2017		7,301		$	73	$	12,311		$	(1,430	)	$	77,880		$	88,834
Common stock issued on exercise of options and vesting of restricted stock units		7			—		53			—			—			53
Common stock repurchased on vesting of restricted stock units		(1	)		—		(76	)		—			—			(76	)
Share-based compensation expense		—			—		1,542			—			—			1,542
Cash dividends on common stock ($0.25 per share)		—			—		—			—			(1,826	)		(1,826	)
Unrealized loss on investments, net of tax		—			—		—			(3,964	)		—			(3,964	)
Net loss		—			—		—			—			(9,123	)		(9,123	)
Balance, March 31, 2018		7,307		$	73	$	13,830		$	(5,394	)	$	66,931		$	75,440
Common stock issued on exercise of options and vesting of restricted stock units		5			—		48			—			—			48
Common stock repurchased on vesting of restricted stock units		(1	)		—		(92	)		—			—			(92	)
Share-based compensation expense		—			—		1,041			—			—			1,041
Cash dividends on common stock ($0.25 per share)		—			—		—			—			(1,827	)		(1,827	)
Unrealized loss on investments, net of tax		—			—		—			(975	)		—			(975	)
Net income		—			—		—			—			11,240			11,240
Balance, June 30, 2018		7,311		$	73	$	14,827		$	(6,369	)	$	76,344		$	84,875

Balance, December 31, 2018		7,395		$	74	$	15,437		$	(5,068	)	$	108,594		$	119,037
Common stock issued on exercise of options and vesting of restricted stock units and performance awards		17			—		122			—			—			122
Common stock repurchased on vesting of restricted stock units and performance awards		(2	)		—		(178	)		—			—			(178	)
Share-based compensation expense		—			—		1,387			—			—			1,387
Cash dividends on common stock ($0.25 per share)		—			—		—			—			(1,852	)		(1,852	)
Unrealized gain on investments, net of tax		—			—		—			3,657			—			3,657
Net loss		—			—		—			—			(2,300	)		(2,300	)
Balance, March 31, 2019		7,410		$	74	$	16,768		$	(1,411	)	$	104,442		$	119,873
Common stock issued on exercise of options and vesting of restricted stock units		4			—		56			—			—			56
Common stock repurchased on vesting of restricted stock units		—			—		—			—			—			—
Share-based compensation expense		—			—		2,441			—			—			2,441
Cash dividends on common stock ($0.25 per share)		—			—		—			—			(1,853	)		(1,853	)
Unrealized gain on investments, net of tax		—			—		—			3,043			—			3,043
Net income		—			—		—			—			13,907			13,907
Balance, June 30, 2019		7,414		$	74	$	19,265		$	1,632		$	116,496		$	137,467

The accompanying notes are an integral part of these condensed consolidated financial statements.

Barrett Business Services, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In Thousands)

	Six Months Ended
	June 30,
	2019			2018
Cash flows from operating activities:
Net income	$	11,607		$	2,117
Reconciliations of net income to net cash provided by operating activities:
Depreciation and amortization		1,939			2,278
Non-cash lease expense		3,509			—
Losses recognized on investments		26			38
Share-based compensation		3,828			2,583
Changes in certain operating assets and liabilities:
Trade accounts receivable		(11,631	)		(15,896	)
Income taxes receivable		—			(643	)
Prepaid expenses and other		(1,840	)		(4,100	)
Accounts payable		488			(1,215	)
Accrued payroll, payroll taxes and related benefits		24,740			4,533
Other accrued liabilities		(4,658	)		(80	)
Income taxes payable		(1,733	)		—
Workers' compensation claims liabilities		17,470			27,341
Safety incentives liability		(1,894	)		(468	)
Operating lease liabilities		(3,032	)		—
Other assets and liabilities, net		46			(27	)
Net cash provided by operating activities		38,865			16,461
Cash flows from investing activities:
Purchase of property and equipment		(5,127	)		(3,517	)
Purchase of investments		(117	)		(1,401	)
Proceeds from sales and maturities of investments		15,262			1,369
Purchase of restricted investments		(3,245	)		(103,388	)
Proceeds from sales and maturities of restricted investments		34,765			32,749
Net cash provided by (used in) investing activities		41,538			(74,188	)
Cash flows from financing activities:
Proceeds from credit-line borrowings		18,843			8,500
Payments on credit-line borrowings		(18,843	)		(8,500	)
Payments on long-term debt		(111	)		(110	)
Common stock repurchased on vesting of restricted stock units		(178	)		(168	)
Dividends paid		(3,705	)		(3,653	)
Proceeds from exercise of stock options		178			101
Net cash used in financing activities		(3,816	)		(3,830	)
Net increase (decrease) in cash, cash equivalents and restricted cash		76,587			(61,557	)
Cash, cash equivalents and restricted cash, beginning of period		140,702			120,205
Cash, cash equivalents and restricted cash, end of period	$	217,289		$	58,648

The accompanying notes are an integral part of these condensed consolidated financial statements.

Barrett Business Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1 - Basis of Presentation of Interim Period Statements

The accompanying condensed consolidated financial statements are unaudited and have been prepared by Barrett Business Services, Inc. (“BBSI”, the “Company”, “our” or “we”), pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures typically included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods presented. The accompanying condensed financial statements are prepared on a consolidated basis. All intercompany account balances and transactions have been eliminated in consolidation. The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results may differ from such estimates and assumptions. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s 2018 Annual Report on Form 10-K at pages F1 – F27. The results of operations for an interim period are not necessarily indicative of the results of operations for a full year.

Revenue recognition

Professional employer (“PEO”) services are normally used by organizations to satisfy ongoing needs related to the management of human capital and are governed by the terms of a client services agreement which covers all employees at a particular work site. Staffing revenues relate primarily to short-term staffing, contract staffing and on-site management services. The Company’s performance obligations for PEO and staffing services are satisfied, and the related revenue is recognized, as services are rendered by our workforce.

Our PEO client service agreements have a minimum term of one year, are renewable on an annual basis, and typically require 30 days’ written notice to cancel or terminate the contract by either party. In addition, our client service agreements provide for immediate termination upon any default of the client regardless of when notice is given. PEO customers are invoiced following the end of each payroll processing cycle, with payment generally due on the invoice date. Staffing customers are invoiced weekly based on agreed rates per employee and actual hours worked, typically with payment terms of 30 days. The amount of earned but unbilled revenue is classified as a receivable on the condensed consolidated balance sheets.

We report PEO revenues net of direct payroll costs because we are not the primary obligor for these payments to our clients’ employees. Direct payroll costs include salaries, wages, health insurance, and employee out-of-pocket expenses incurred incidental to employment. We also present revenue net of customer incentives, including safety incentives, because those incentives represent consideration payable to customers.

Cost of revenues

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 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, as well as costs associated with operating our two wholly owned insurance companies, Associated Insurance Company for Excess (“AICE”) and Ecole Insurance Company (“Ecole”).

Cash and cash equivalents

We consider non-restricted short-term investments that are highly liquid, readily convertible into cash, and have maturities at acquisition of less than three months, to be cash equivalents for purposes of the condensed consolidated statements of cash flows and condensed consolidated balance sheets. The Company maintains cash balances in bank accounts that normally exceed FDIC insured limits. The Company has not experienced any losses related to its cash concentration.

Investments

The Company classifies investments as available-for-sale. The Company’s investments are reported at fair value with unrealized gains and losses, net of taxes, shown as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Investments are recorded as current on the condensed consolidated balance sheets as the invested funds are available for current operations. Management considers available evidence in evaluating potential impairment of investments, including the duration and extent to which fair value is less than cost. Realized gains and losses on sales of investments are included in investment income in our condensed consolidated statements of operations. In the event a loss is determined to be other-than-temporary, the loss will be recognized in the condensed consolidated statements of operations.

Restricted cash and investments

The Company holds restricted cash and investments primarily for the future payment of workers’ compensation claims. These investments are categorized as available-for-sale. They are reported at fair value with unrealized gains and losses, net of taxes, shown as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Restricted cash and investments are classified as current and noncurrent on the condensed consolidated balance sheets based on the nature of the restriction. Management considers available evidence in evaluating potential impairment of restricted investments, including the duration and extent to which fair value is less than cost. Realized gains and losses on sales of restricted investments are included in investment income in our condensed consolidated statements of operations. In the event a loss is determined to be other-than-temporary, the loss will be recognized in the condensed consolidated statements of operations.

Restricted cash and investments also includes investments held as part of the Company’s deferred compensation plan. These investments are classified as trading securities and are recorded at fair value with unrealized gains and losses reported as a component of other income (expense), net.

Allowance for doubtful accounts

The Company had an allowance for doubtful accounts of $586,000 and $533,000 at June 30, 2019 and December 31, 2018, respectively. We make estimates of the collectability of our accounts receivable for services provided to our customers. Management analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customers’ payment trends when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.

Workers’ compensation claims liabilities

Our workers’ compensation claims liabilities do not represent an exact calculation of liability but rather management’s best estimate, utilizing actuarial expertise and projection techniques, at a given reporting date. The estimated liability for open workers’ compensation claims is based on an evaluation of information provided by our third-party administrators for workers’ compensation claims, coupled with an actuarial estimate of future adverse loss development with respect to reported claims and incurred but not reported claims (together, “IBNR”). Workers’ compensation claims liabilities included case reserve estimates for reported losses, plus additional amounts for estimated IBNR claims, MCC and legal costs, and unallocated loss adjustment expenses. The estimate of incurred costs expected to be paid within one year is included in current liabilities, while the estimate of incurred costs expected to be paid beyond one year is included in long-term liabilities on our condensed consolidated balance sheets. These estimates are reviewed at least quarterly and adjustments to estimated liabilities are reflected in current operating results as they become known.

The process of arriving at an estimate of 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, changes in reserve estimation procedures, inflation, trends in the litigation and settlement of pending claims, and legislative changes.

Our estimates are based on informed judgment, derived from individual experience 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.

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. Nonetheless, 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.

Customer incentives

We accrue for and present expected customer incentives as a reduction of revenue. Safety incentives represent cash incentives paid to certain PEO client companies for maintaining safe-work practices and minimizing workplace injuries. The incentive is based on a percentage of annual payroll and is paid annually to customers who meet predetermined workers’ compensation claims cost objectives. Safety incentive payments are made only after closure of all workers’ compensation claims incurred during the customer’s contract period. The safety incentive liability is estimated and accrued each month based upon contract year-to-date payroll and the then current amount of the customer’s estimated workers’ compensation claims reserves as established by us and our third party administrator. The Company provided $27.3 million and $29.2 million at June 30, 2019 and December 31, 2018, respectively, as an estimate of the liability for unpaid safety incentives. Also, a one-time customer incentive of $9.8 million was declared in December 2018, and is included in other accrued liabilities on the consolidated balance sheets. At June 30, 2019 the remaining balance of this incentive was $7.2 million.

Customer deposits

We require deposits from certain PEO customers to cover a portion of our accounts receivable due from such customers in the event of default of payment.

Comprehensive income (loss)

Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders.

Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under U.S. generally accepted accounting principles (“GAAP”) are included in comprehensive income (loss), but excluded from net income (loss) as these amounts are recorded directly as an adjustment to stockholders’ equity. Our other comprehensive income (loss) comprises unrealized holding gains and losses on our available-for-sale investments.

Statements of cash flows

Interest paid during the six months ended June 30, 2019 did not materially differ from interest expense. Interest paid during the six months ended June 30, 2018 totaled $1.8 million, primarily related to prepaid fees for the Company’s letter of credit. Income taxes paid during the six months ended June 30, 2019 totaled $5.0 million. Income taxes paid during the six months ended June 30, 2018 totaled $0.1 million.

Bank deposits and other cash equivalents that are restricted for use are classified as restricted cash. The table below reconciles the cash, cash equivalents and restricted cash balances from our condensed consolidated balance sheets to the amounts reported on the condensed consolidated statements of cash flows (in thousands):

	June 30,		December 31,		June 30,		December 31,
	2019		2018		2018		2017
Cash and cash equivalents	$	23,693	$	35,371	$	33,786	$	59,835
Restricted cash, included in restricted cash and investments		193,596		105,331		24,862		60,370
Total cash, cash equivalents and restricted cash shown in the statement of cash flows	$	217,289	$	140,702	$	58,648	$	120,205

Basic and diluted earnings per share

Basic earnings per share are computed based on the weighted average number of common shares outstanding for each year using the treasury method. Diluted earnings per share reflect the potential effects of the exercise of outstanding stock options and the issuance of stock associated with outstanding restricted stock units. Basic and diluted shares outstanding are summarized as follows (in thousands):

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Weighted average number of basic shares outstanding		7,410		7,310		7,408		7,307
Effect of dilutive securities		282		365		266		351
Weighted average number of diluted shares outstanding		7,692		7,675		7,674		7,658

Accounting estimates

The preparation of our condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. 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. Estimates are used for fair value measurement of investments, allowance for doubtful accounts, deferred income taxes, carrying values for goodwill and property and equipment, accrued workers’ compensation liabilities and customer incentive liabilities. Actual results may or may not differ from such estimates.

Recent accounting pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, “Leases.” The core principle is that a lessee should recognize the assets and liabilities that arise from leases, including operating leases. Under the new guidance, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. The amendments in this update were adopted using the optional transition method, effective January 1, 2019. The lease commitments appear on our consolidated balance sheets as operating lease right-of-use assets and current and long-term operating lease liabilities. Such amounts are based on the present value of such commitments using our incremental borrowing rate. We have utilized the transition package of practical expedients permitted within the new standard, which allows us to carry forward the historical lease classification. See “Note 5 – Leases” for additional information.

Note 2 - Fair Value Measurement

The following table summarizes the Company’s investments at June 30, 2019 and December 31, 2018 measured at fair value on a recurring basis (in thousands):

	June 30, 2019							December 31, 2018
			Gross							Gross
			Unrealized							Unrealized
			Gains			Recorded				Gains			Recorded
	Cost		(Losses)			Basis		Cost		(Losses)			Basis
Current:
Cash equivalents:
Money market funds	$	224	$	—		$	224	$	30	$	—		$	30
Total cash equivalents		224		—			224		30		—			30
Investments:
Corporate bonds		48,822		(126	)		48,696		20		—			20
U.S. treasuries		19,002		(50	)		18,952		347		—			347
U.S. government agency securities		8,913		248			9,161		50		(1	)		49
Mortgage backed securities		447		(4	)		443		—		—			—
Asset backed securities		19		—			19		—		—			—
Total current investments		77,203		68			77,271		417		(1	)		416
Long term:
Investments:
U.S. treasuries		—		—			—		794		(3	)		791
Mortgage backed securities		—		—			—		484		(13	)		471
Corporate bonds		—		—			—		422		(7	)		415
Asset backed securities		—		—			—		10		—			10
Total long term investments		—		—			—		1,710		(23	)		1,687
Restricted cash and investments ⁽¹⁾:
Corporate bonds		128,012		1,265			129,277		185,116		(3,739	)		181,377
Mortgage backed securities		71,839		192			72,031		89,426		(2,026	)		87,400
U.S. government agency securities		29,801		675			30,476		45,548		(908	)		44,640
U.S. treasuries		18,794		21			18,815		44,304		(283	)		44,021
Money market funds		16,614		—			16,614		419		—			419
Supranational bonds		4,767		34			4,801		4,765		(24	)		4,741
Mutual funds		2,550		—			2,550		1,093		—			1,093
Asset backed securities		126		1			127		75		(1	)		74
Municipal bonds		50		—			50		50		—			50
Total restricted cash and investments		272,553		2,188			274,741		370,796		(6,981	)		363,815
Total investments	$	349,980	$	2,256		$	352,236	$	372,953	$	(7,005	)	$	365,948

(1) Included in restricted cash and investments within the condensed consolidated balance sheet is restricted cash of $169.5 million and $104.5 million as of June 30, 2019 and December 31, 2018, respectively, which is excluded from the table above. Restricted cash and investments are classified as current and noncurrent on the balance sheet based on the nature of the restriction.

The following table summarizes the Company’s investments at June 30, 2019 and December 31, 2018 measured at fair value on a recurring basis by fair value hierarchy level (in thousands):

	June 30, 2019								December 31, 2018
	Total								Total
	Recorded								Recorded
	Basis		Level 1		Level 2		Other ⁽¹⁾		Basis		Level 1		Level 2		Other ⁽¹⁾
Cash equivalents:
Money market funds	$	224	$	—	$	—	$	224	$	30	$	—	$	—	$	30
Investments:
Corporate bonds		48,696		—		48,696		—		435		—		435		—
U.S. treasuries		18,952		—		18,952		—		1,138		—		1,138		—
U.S. government agency securities		9,161		—		9,161		—		49		—		49		—
Mortgage backed securities		443		—		443		—		471		—		471		—
Asset backed securities		19		—		19		—		10		—		10		—
Restricted cash and investments:
Corporate bonds		129,277		—		129,277		—		181,377		—		181,377		—
Mortgage backed securities		72,031		—		72,031		—		87,400		—		87,400		—
U.S. government agency securities		30,476		—		30,476		—		44,640		—		44,640		—
U.S. treasuries		18,815		—		18,815		—		44,021		—		44,021		—
Money market funds		16,614		—		—		16,614		419		—		—		419
Supranational bonds		4,801		—		4,801		—		4,741		—		4,741		—
Mutual funds		2,550		2,550		—		—		1,093		1,093		—		—
Asset backed securities		127		—		127		—		74		—		74		—
Municipal bonds		50		—		50		—		50		—		50		—
Total investments	$	352,236	$	2,550	$	332,848	$	16,838	$	365,948	$	1,093	$	364,406	$	449

(1) Investments in money market funds measured at fair value using the net asset value per share practical expedient are not subject to hierarchy level classification disclosure. The Company invests in money market funds that seek to maintain a stable net asset value. These investments include commingled funds that comprise high-quality short-term securities representing liquid debt and monetary instruments where the redemption value is likely to be the fair value. Redemption is permitted daily without written notice.

The following table summarizes the contractual maturities of the Company’s available for sale securities at June 30, 2019. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

	June 30, 2019
(In thousands)	Less than 1 Year		Between 1 to 5 Years		Between 5 to 10 Years		After 10 Years		Total
Corporate bonds	$	9,162	$	143,773	$	24,886	$	152	$	177,973
U.S. government agency securities		4,002		7,921		27,714		—	$	39,637
U.S. treasuries		21,155		16,612		—		—	$	37,767
Money market funds		16,838		—		—		—	$	16,838
Supranational bonds		—		4,801		—		—	$	4,801
Asset backed securities		—		146		—		—	$	146
Municipal bonds		50		—		—		—	$	50
Total	$	51,207	$	173,253	$	52,600	$	152	$	277,212

The average contractual maturity of mortgage backed securities was 17 years as of June 30, 2019.

Note 3 – Workers’ Compensation Claims

The following table summarizes the aggregate workers’ compensation reserve activity (in thousands):

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
Beginning balance
Workers' compensation claims liabilities	$	422,872		$	378,874		$	413,397		$	363,517
Add: claims expense accrual
Current period		41,145			39,967			81,530			79,019
Prior periods		(2,952	)		—			(4,652	)		(6	)
		38,193			39,967			76,878			79,013
Less: claim payments related to
Current period		4,145			5,148			5,604			6,281
Prior periods		26,088			22,856			53,804			45,391
		30,233			28,004			59,408			51,672

Add: Change in claims incurred in excess of retention limits		(96	)		(23	)		(131	)		(44	)

Ending balance
Workers' compensation claims liabilities	$	430,736		$	390,814		$	430,736		$	390,814
Incurred but not reported (IBNR)	$	273,114		$	231,702		$	273,114		$	231,702

Ratio of IBNR to workers' compensation claims liabilities		63	%		59	%		63	%		59	%

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.

The Company obtains policies from Chubb Limited (“Chubb”) for all clients in California, Delaware, Virginia, Pennsylvania, North Carolina, New Jersey, West Virginia, Idaho, Nevada 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. The risk of loss up to the first $5.0 million per occurrence is retained by BBSI through various agreements. Chubb assumes credit risk should BBSI be unable to satisfy its indemnification obligations.

The Company’s wholly owned, fully licensed captive insurance company incorporated in Arizona, 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.

The Company also operates a wholly owned, fully licensed insurance company, Ecole, which provides workers’ compensation coverage to the Company’s employees working in Arizona and Utah. The Company maintains additional reinsurance coverage for Ecole with Chubb, for losses above $5.0 million per occurrence.

The Company restructured its fronted program with Chubb effective July 1, 2018. The new agreement maintains retention levels of $5.0 million per occurrence but now requires that collateral be advanced at the inception of the policy term. To partially satisfy these additional collateral requirements, the Company provided a surety bond of $30.0 million and a letter of credit of $63.7 million from its principal bank, Wells Fargo Bank, National Association (the “Bank”).

As part of its fronted workers’ compensation insurance program with Chubb, the Company makes monthly payments into trust accounts (the “Chubb trust accounts”) to be used for the payment of future claims. The balance in the Chubb trust accounts was $407.7 million and $451.0 million at June 30, 2019 and December 31, 2018, respectively. The Chubb trust accounts’ balances are included as a component of the current and long-term restricted cash and investments on the Company’s condensed consolidated balance sheets.

The states of California, Maryland, Oregon, Washington, Colorado and Delaware required us to maintain specified investment balances or other financial instruments totaling $73.2 million and $85.2 million at June 30, 2019 and December 31, 2018, respectively, to cover potential workers’ compensation claims losses related to the Company’s current and former status as a self-insured employer. At June 30, 2019, the Company provided surety bonds and standby letters of credit totaling $73.2 million, including a California requirement of $55.6 million.

The Company provided a total of $430.7 million and $413.4 million at June 30, 2019 and December 31, 2018, respectively, as an estimated future liability for unsettled workers' compensation claims liabilities. Of this amount, $3.2 million at June 30, 2019 and December 31, 2018, represent case reserves incurred in excess of the Company’s retention. The accrual for costs incurred in excess of retention limits is offset by a receivable from excess insurance carriers of $3.2 million at June 30, 2019 and December 31, 2018, included in other assets on the condensed consolidated balance sheets.

Note 4 - Revolving Credit Facility and Long-Term Debt

On August 6, 2019, the Company entered into an amended credit agreement (the “Agreement”) with the Bank, which supersedes the previous agreement. The Agreement increased the revolving credit line from $28.0 million to $33.0 million and increased the sublimit for standby letters of credit from $7.5 million to $8.0 million. At June 30, 2019, $5.9 million of the sublimit for standby letters of credit was used. The Agreement expires on July 1, 2022. There were no changes to the previous credit agreement in place during the second quarter of 2019.

Advances under the revolving credit line bear interest, as selected by the Company, of (a) the daily floating rate of one month LIBOR plus 1.75% or (b) the 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 line, as well as a fee of 1.75% of the face amount of each letter of credit reserved under the line of credit. The Company had no outstanding borrowings on its revolving credit line at June 30, 2019 and December 31, 2018. The credit facility is collateralized by the Company’s accounts receivable and other rights to receive payment.

The Agreement also provides for a $63.7 million standby letter of credit (the “Chubb Letter of Credit”). The Chubb Letter of Credit has an expiration date of July 1, 2020, subject to automatic renewal in specified circumstances.

In connection with the Chubb Letter of Credit, the Bank has been granted a security interest of first priority in certain blocked securities accounts (collectively, the “Collateral Accounts”). The Company has agreed to deposit in the Collateral Accounts 50% of the Company’s consolidated net income (after tax and less cash dividends) for each quarter plus, to the extent necessary, an additional amount by May 15 each year so that the deposits in the Collateral Accounts for the prior year total at least $16 million.

The initial fee paid under the Chubb Letter of Credit in June 2018 was equal to 2.5% of the face amount thereof. Upon annual renewal, the fees payable to the Bank quarterly in advance include (a) a fee at the annual rate of 2.5%, calculated based on the difference between the face amount of the Chubb Letter of Credit and 95% of the aggregate value of the Collateral Accounts as of the end of the previous quarter, (b) a fee at the annual rate of 1.0% calculated based on the balance of the face amount, and (c) other fees upon the payment or negotiation of each drawing under the Chubb Letter of Credit.

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

•

EBITDA [net income 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 $30 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 and specified cross-defaults under the Company’s workers’ compensation insurance arrangements. 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 June 30, 2019, the Company was in compliance with all covenants.

The Company maintains a mortgage loan with the Bank with a balance of approximately $4.1 million and $4.2 million at June 30, 2019 and December 31, 2018, 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.

Note 5 – Leases

Effective January 1, 2019, the Company adopted Accounting Standards Codification Topic 842 “Leases” using the optional transition method. Under this method of adoption, the prior period comparative information in the consolidated financial statements has not been revised and continues to be reported under the previously applicable lease accounting guidance. Additionally, we elected the package of practical expedients permitted under the transition guidance, which included the carry-forward of historical lease classification.

The Company primarily leases office buildings under operating leases which are included in Operating lease right-of-use (“ROU”) assets, Current operating lease liabilities, and Long-term operating lease liabilities on the condensed consolidated balance sheets. The Company’s leases have remaining terms of 1 to 7 years and often include one or more options to renew. The Company evaluates renewal options at lease inception and on an ongoing basis, and includes renewal options that it is reasonably certain to exercise in its expected lease terms when classifying leases and measuring liabilities. Leases with initial terms of 12 months or less are considered short-term lease costs and are not recorded as ROU assets on the condensed consolidated balance sheets. The Company has elected the practical expedient not to separate non-lease components from lease components for all classes of assets. Our lease agreements contain $3.7 million of residual value guarantees, and generally do not contain material variable lease payments or restrictive covenants.

Information related to the Company's total lease costs were as follows (in thousands):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
Operating lease cost	$	1,646	$	3,602
Variable lease cost		143		250
Short-term lease cost		185		244
Total lease cost	$	1,974	$	4,096

Information related to the Company's ROU assets and related lease liabilities were as follows (in thousands):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
Cash paid for operating lease liabilities	$	1,914	$	3,644
Right-of-use assets obtained in exchange for new operating lease obligations ⁽¹⁾		1,819		28,514

(1) Six-months ended balance includes $25.8 million for operating leases existing on January 1, 2019 and $2.7 million for operating leases that commenced in the first six months of 2019.

			As of June 30, 2019
Weighted-average remaining lease term			4.2 years
Weighted-average discount rate			4.4		%

The table below reconciles the undiscounted future minimum lease payments (displayed by year and in the aggregate) under noncancellable operating leases with terms of more than one year to the total operating lease liabilities recognized on the condensed consolidated balance sheets as of June 30, 2019 (in thousands):

July 1, 2019 through December 31, 2019	$	3,767
2020		7,076
2021		6,450
2022		4,976
2023		3,672
Thereafter		2,087
Total undiscounted future minimum lease payments		28,028
Less: Difference between undiscounted lease payments and discounted operating lease liabilities		2,546
Total operating lease liabilities	$	25,482
Current operating lease liabilities	$	6,381
Long-term operating lease liabilities		19,101
Total operating lease liabilities	$	25,482

As previously disclosed in our 2018 Annual Report on Form 10-K, under the previous lease accounting standard, future minimum lease payments for operating leases having initial or remaining noncancellable lease terms in excess of one year would have been as follows (in thousands):

Year Ending
December 31,
2019	$	7,135
2020		6,198
2021		5,673
2022		4,125
2023		2,642
Thereafter		1,474
	$	27,247

Note 6 – Income Taxes

The Company’s realization of a portion of net deferred tax assets is based in part on our estimates of the timing of reversals of certain temporary differences and on the generation of taxable income before such reversals.

Under Accounting Standards Codification (“ASC”) 740, “Income Taxes,” management evaluates the realizability of the deferred tax assets on a quarterly basis under a “more-likely than not” standard. As part of this evaluation, management reviews all evidence both positive and negative to determine if a valuation allowance is needed. One component of this analysis is to determine whether the Company was in a cumulative loss position for the most recent 12 quarters. The Company was in a cumulative income position for the 12 quarters ended June 30, 2019.

The Company is subject to income taxes in U.S. federal and multiple state and local tax jurisdictions. The Internal Revenue Service is examining the Company’s federal tax returns for the years ended December 31, 2011, 2012, 2013 and 2014. In the major jurisdictions where it operates, the Company is generally no longer subject to income tax examinations by tax authorities for years before 2011.

A portion of the consolidated income the Company generates is not subject to state income tax. Depending on the percentage of this income as compared to total consolidated income, the Company's state effective rate could fluctuate from expectations.

Note 7 – Litigation

On November 21, 2012, David Kaanaana (“Kaanaana”), a former staffing employee, filed a California wage and hour violations lawsuit against BBSI. On May 19, 2016, the court entered a ruling in favor of BBSI, which was subsequently appealed by the plaintiffs. On November 30, 2018, the California Court of Appeal for the Second Appellate District returned its decision in Kaanaana v. Barrett Business Services, Inc., overruling the trial court's decision to dismiss plaintiffs' claims and holding that prevailing wage requirements applicable to “public works” apply to certain types of districts. On January 9, 2019, BBSI filed a petition of review to the California Supreme Court. An amicus letter in support of the petition was filed by the Sanitation Districts of Los Angeles County, joined in by numerous other "special districts" in California. On February 27, 2019, the California Supreme Court granted the petition to review the appellate court’s decision.

BBSI is subject to other legal proceedings and claims that arise in the ordinary course of our business. Given the uncertainties surrounding litigation, management is unable to estimate a potential range of loss arising from these actions.

Note 8 – Subsequent Events

We have evaluated events and transactions occurring after the balance sheet date through our filing date and noted no events that are subject to recognition or disclosure.

Item 2.

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

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.

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 23 states and the District of Columbia through a network of 63 branch locations in California, Oregon, Utah, Washington, Colorado, Idaho, Arizona, Maryland, Nevada, North Carolina, Delaware, 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.

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 6,400 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.

Results of Operations

The following table sets forth the percentages of total revenues represented by selected items in the Company’s condensed consolidated statements of operations for the three and six months ended June 30, 2019 and 2018 ($ in thousands):

	Percentage of Total Net Revenues
	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Revenues:
Professional employer service fees	$	203,157	88.0	%	$	197,277	85.2	%	$	393,684	87.6	%	$	386,239		84.8		%
Staffing services		27,825	12.0			34,326	14.8			55,513	12.4			69,340		15.2
Total revenues		230,982	100.0			231,603	100.0			449,197	100.0			455,579		100.0
Cost of revenues:
Direct payroll costs		20,992	9.1			26,020	11.2			41,834	9.3			52,423		11.5
Payroll taxes and benefits		101,697	44.0			98,249	42.4			216,494	48.2			222,437		48.8
Workers’ compensation		53,174	23.0			58,854	25.4			107,403	23.9			115,976		25.5
Total cost of revenues		175,863	76.1			183,123	79.0			365,731	81.4			390,836		85.8
Gross margin		55,119	23.9			48,480	21.0			83,466	18.6			64,743		14.2
Selling, general and administrative expenses		39,005	16.9			35,614	15.4			72,165	16.1			65,043		14.3
Depreciation and amortization		970	0.4			1,274	0.6			1,939	0.4			2,278		0.5
Income (loss) from operations		15,144	6.6			11,592	5.0			9,362	2.0			(2,578	)	(0.6	)
Other income, net		2,851	1.2			2,121	1.0			5,458	1.2			4,114		0.9
Income before income taxes		17,995	7.8			13,713	6.0			14,820	3.3			1,536		0.3
Provision for (benefit from) income taxes		4,088	1.8			2,473	1.1			3,213	0.7			(581	)	(0.1	)
Net income	$	13,907	6.0	%	$	11,240	4.9	%	$	11,607	2.5	%	$	2,117		0.4		%

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 three and six months ended June 30, 2019 and 2018.

	(Unaudited)				(Unaudited)
	Three Months Ended				Six Months Ended
	June 30,				June 30,
(in thousands)	2019		2018		2019		2018
Gross billings	$	1,463,962	$	1,379,483	$	2,824,206	$	2,699,327
PEO and staffing wages	$	1,246,576	$	1,165,860	$	2,402,947	$	2,280,567

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.

	(Unaudited)				(Unaudited)
	Three Months Ended				Six Months Ended
	June 30,				June 30,
(in thousands)	2019		2018		2019		2018
Workers' compensation	$	53,174	$	58,854	$	107,403	$	115,976
Safety incentive costs		7,833		8,039		14,536		15,604
Non-GAAP gross workers' compensation	$	61,007	$	66,893	$	121,939	$	131,580

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.

	(Unaudited)		(Unaudited)
	Percentage of Gross Billings		Percentage of Gross Billings
	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2019	2018	2019	2018
PEO and staffing wages	85.2%	84.5%	85.1%	84.5%
Payroll taxes and benefits	6.9%	7.1%	7.7%	8.2%
Non-GAAP gross workers' compensation	4.2%	4.8%	4.3%	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. 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.

Three Months Ended June 30, 2019 and 2018

Net income for the second quarter of 2019 amounted to $13.9 million compared to net income of $11.2 million for the second quarter of 2018. Diluted income per share for the second quarter of 2019 was $1.81 compared to diluted income per share of $1.46 for the second quarter of 2018.

Revenues for the second quarter of 2019 totaled $231.0 million, a decrease of $0.6 million or 0.3% over the second quarter of 2018, which reflects an increase in the Company’s professional employer service fee revenue of $5.9 million or 3.0% and a decrease in staffing services revenue of $6.5 million or 19.0%.

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 the second quarter of 2019 exceeded business lost from former customers. Gross billings for PEO services to continuing customers increased 4.0% compared to the second quarter of 2018. This growth was primarily the result of increases in employee headcount and wage inflation. PEO revenue is presented net of safety incentives of $7.8 million and $8.0 million in the second quarter of 2019 and 2018, respectively. The decrease in staffing services revenue was due primarily to tight labor market conditions during the 2019 period.

Gross margin for the second quarter of 2019 totaled $55.1 million or 23.9% of revenue compared to $48.5 million or 21.0% of revenue for the second quarter of 2018. The increase in gross margin as a percentage of revenues is primarily due to decreases in payroll taxes and workers’ compensation expense as a percentage of revenues.

Direct payroll costs for the second quarter of 2019 totaled $21.0 million or 9.1% of revenue compared to $26.0 million or 11.2% of revenue for the second quarter of 2018. 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 the second quarter of 2018.

Payroll taxes and benefits for the second quarter of 2019 totaled $101.7 million or 44.0% of revenue compared to $98.2 million or 42.4% of revenue for the second quarter of 2018. The increase in payroll taxes and benefits as a percentage of revenues is primarily due to the relative increase in PEO services within the mix of our customer base compared to the second quarter of 2018.

Workers’ compensation expense for the second quarter of 2019 totaled $53.2 million or 23.0% of revenue compared to $58.9 million or 25.4% of revenue for the second quarter of 2018. The decrease in workers’ compensation expense as a percentage of revenue was primarily due to lower frictional costs and a favorable adjustment of $3.0 million related to prior period claims during the quarter.

Selling, general and administrative (“SG&A”) expenses for the second quarter of 2019 totaled $39.0 million or 16.9% of revenue compared to $35.6 million or 15.4% of revenue for the second quarter of 2018. The increase was primarily attributable to an increase in employee-related expenses.

Other income, net for the second quarter of 2019 was $2.9 million as compared to other income, net of $2.1 million for the second quarter of 2018. The change was primarily attributable to an increase in investment income in the second quarter of 2019.

Our effective income tax rate for the second quarter of 2019 was 22.7%, compared to 18.0% for the second quarter of 2018. Our income tax rate typically differs from the federal statutory tax rate of 21% primarily due to state taxes and federal and state tax credits.

Six Months Ended June 30, 2019 and 2018

Net income for the first six months of 2019 amounted to $11.6 million compared to net income of $2.1 million for the first six months of 2018. Diluted income per share for the first six months of 2019 was $1.51 compared to diluted income per share of $0.28 for the first six months of 2018.

Revenues for the first six months of 2019 totaled $449.2 million, a decrease of $6.4 million or 1.4% over the first six months of 2018, which reflects an increase in the Company’s professional employer service fee revenue of $7.4 million or 1.9% and a decrease in staffing services revenue of $13.8 million or 20.0%.

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 the first six months of 2019 exceeded business lost from former customers. Gross billings for PEO services to continuing customers increased 3.4% compared to the first six months of 2018. This growth was primarily the result of increases in employee headcount and wage inflation. PEO revenue is presented net of safety incentives of $14.5 million and $15.6 million in the first six months of 2019 and 2018, respectively. The decrease in staffing services revenue was due primarily to tight labor market conditions during the 2019 period.

Gross margin for the first six months of 2019 totaled $83.5 million or 18.6% of revenue compared to $64.7 million or 14.2% of revenue for the first six months of 2018. The increase in gross margin as a percentage of revenues is primarily due to decreases in payroll taxes and workers’ compensation expense as a percentage of revenues.

Direct payroll costs for the first six months of 2019 totaled $41.8 million or 9.3% of revenue compared to $52.4 million or 11.5% of revenue for the first six months of 2018. The decrease in direct payroll 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 the first six months of 2018.

Payroll taxes and benefits for the first six months of 2019 totaled $216.5 million or 48.2% of revenue compared to $222.4 million or 48.8% of revenue for the first six months of 2018. The decrease in payroll taxes and benefits as a percentage of revenues is primarily due to lower effective payroll tax rates, partially offset by the relative increase in PEO services within the mix of our customer base compared to the first six months of 2018.

Workers’ compensation expense for the first six months of 2019 totaled $107.4 million or 23.9% of revenue compared to $116.0 million or 25.5% of revenue for the first six months of 2018. The decrease in workers’ compensation expense as a percentage of revenue was primarily due to lower frictional costs and a favorable adjustment of $4.7 million related to prior period claims during the first six months of 2019.

SG&A expenses for the first six months of 2019 totaled $72.2 million or 16.1% of revenue compared to $65.0 million or 14.3% of revenue for the first six months of 2018. The increase was primarily attributable to an increase in employee-related expenses.

Other income, net for the first six months of 2019 was $5.5 million as compared to other income, net of $4.1 million for the first six months of 2018. The change was primarily attributable to an increase in investment income in the first six months of 2019.

Our effective income tax rate for the first six months of 2019 was 21.7% compared to -37.8% for the first six months of 2018. Our income tax rate typically differs from the federal statutory tax rate of 21% primarily due to state taxes and federal and state tax credits.

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 $217.3 million, which includes cash, cash equivalents, and restricted cash, increased $76.6 million for the six months ended June 30, 2019, compared to a decrease of $61.6 million for the comparable period of 2018. The increase in cash at June 30, 2019 as compared to December 31, 2018 was primarily due to increased accrued payroll, payroll taxes and related benefits, increased workers’ compensation claims liabilities, and proceeds from the sales and maturities of investments and restricted investments.

Net cash provided by operating activities for the six months ended June 30, 2019 was $38.9 million, compared to net cash provided of $16.5 million for the comparable period of 2018. For the six months ended June 30, 2019, cash flow from operating activities was primarily due to net income of $11.6 million, increased accrued payroll, payroll taxes and related benefits of $24.7 million and increased workers’ compensation claims liabilities of $17.5 million, partially offset by increased trade accounts receivable of $11.6 million and decreased other accrued liabilities of $4.7 million.

Net cash provided by investing activities for the six months ended June 30, 2019 was $41.5 million, compared to net cash used of $74.2 million for the comparable period of 2018. For the six months ended June 30, 2019, cash provided by investing activities consisted primarily of proceeds from sales and maturities of investments and restricted investments of $50.0 million, partially offset by purchases of property and equipment of $5.1 million and purchases of restricted investments of $3.2 million.

Net cash used in financing activities for the six months ended June 30, 2019 was $3.8 million, compared to net cash used of $3.8 million for the comparable period of 2018. For the six months ended June 30, 2019, cash was primarily used for dividend payments of $3.7 million.

The states of California, Maryland, Oregon, Washington, Colorado and Delaware required us to maintain specified financial instruments totaling $73.2 million at June 30, 2019 to cover potential workers’ compensation claims losses related to the Company’s current and former status as a self-insured employer. At June 30, 2019, the Company provided surety bonds and standby letters of credit totaling $73.2 million, including a California requirement of $55.6 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.

As part of its fronted workers’ compensation insurance program with Chubb, the Company makes monthly payments into trust accounts (the “Chubb trust accounts”) to be used for the payment of future claims. The balance in the Chubb trust accounts was $407.7 million and $451.0 million at June 30, 2019 and December 31, 2018, respectively. Included within the Chubb trust account at June 30, 2019, is $168.5 million of restricted cash. The restricted cash accrues interest at the 3-month Treasury bill yield rate plus 0.25%. The Chubb trust accounts balances are included as a component of the current and long-term restricted cash and investments on the Company’s condensed consolidated balance sheets.

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

•

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:

•

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

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.

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.

Forward-Looking Information

Statements in 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 effect of tight labor market conditions, 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, 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.

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, changes in effective payroll tax rates and federal and state income tax rates, 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, escalating medical costs, and other health care legislative initiatives 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 our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on March 5, 2019. We disclaim any obligation to publicly announce any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

Item 3.

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 June 30, 2019, the Company’s investments consisted principally of $178 million in corporate bonds, $72 million in mortgage backed securities, $40 million in U.S. government agency securities, $38 million in U.S. treasuries, $17 million in money market funds, $5 million in supranational bonds, and $3 million in mutual funds. The Company’s outstanding debt totaled approximately $4.1 million at June 30, 2019. Based on the Company’s overall interest exposure at June 30, 2019, a 50 basis point increase in market interest rates would have a $4.6 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 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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 Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our condensed consolidated financial statements for external purposes in accordance with GAAP.

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 CEO and 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.

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 June 30, 2019.

Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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.

PART II-OTHER INFORMATION

Item 1.

Legal Proceedings

See the information disclosed in “Note 7 - Litigation," to the condensed consolidated financial statements included in Part I of this report, which is incorporated herein by reference.

Item 1A.

Risk Factors

There have been no material changes in the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on March 5, 2019.

Item 5.

Other Information

On August 6, 2019, the Company and the Bank entered into a Second Amended and Restated Credit Agreement that provides for an increase in the revolving credit line from $28.0 million to $33.0 million, the removal of certain financial covenants and negative covenants, and an extended term from July 1, 2020, to July 1, 2022, among other changes. For additional information regarding the Company’s borrowing relationship with the Bank, see Note 4 to our unaudited interim condensed consolidated financial statements in Part I, Item 1 of this report. The amended loan documents are filed with this report as Exhibits 4.1 and 4.2.

Item 6.

Exhibits

4.1		Second Amended and Restated Credit Agreement between the Registrant and Wells Fargo Bank, National Association, dated as of August 6, 2019.
4.2		Third Amended and Restated Revolving Line of Credit Note dated August 6, 2019 of the Registrant.
10.1		Form of Non-Employee Director Restricted Stock Units Award Agreement for awards granted in 2019 and thereafter under the Registrant's 2015 Stock Incentive Plan.
10.2		Transition and Separation Agreement between the Registrant and Gregory R. Vaughn dated as of June 3, 2019.
10.3		Summary of Compensatory Arrangements for Non-Employee Directors of the Registrant effective July 1, 2019.
10.4		Indemnification Agreement between the Registrant and Michael L. Elich dated as of July 15, 2019.
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
32		Certification pursuant to 18 U.S.C. Section 1350.
101		INS XBRL Instance Document
101		SCH XBRL Taxonomy Extension Schema Document
101		CAL XBRL Taxonomy Extension Calculation Linkbase Document
101		DEF XBRL Taxonomy Extension Definition Linkbase Document
101		LAB XBRL Taxonomy Extension Label Linkbase Document
101		PRE XBRL Taxonomy Extension Presentation Linkbase Document

**	Except as otherwise indicated, the SEC File Number for all exhibits is 000-21866.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	BARRETT BUSINESS SERVICES, INC.
	Registrant

Date: August 7, 2019	By:	/s/ Gary E. Kramer
		Gary E. Kramer
		Vice President-Finance, Treasurer and Secretary

Form: 10-Q

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