UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended March 31, 2016
For the Transition Period From to
Commission File Number 0-21886
BARRETT BUSINESS SERVICES, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
(360) 828-0700
(Registrant’s telephone number, including area code)
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 x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer”, and “smaller reporting company” in Rule 12b-2 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 x
As of June 22, 2016, 7,210,251 shares of the registrant’s common stock ($0.01 par value) were outstanding.
INDEX TO FORM 10-Q
PART I - Financial Information
Item 1.
Unaudited Interim Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets – March 31, 2016 and December 31, 2015
Condensed Consolidated Statement of Operations – Three Months Ended March 31, 2016 and 2015
Condensed Consolidated Statement of Comprehensive Loss – Three Months Ended March 31, 2016 and 2015
Condensed Consolidated Statement of Stockholders’ Equity – Three Months Ended March 31, 2016 and 2015
Condensed Consolidated Statement of Cash Flows – Three Months Ended March 31, 2016 and 2015
Notes to Unaudited Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II - Other Information
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
Signatures
Exhibit Index
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EXPLANATORY NOTE
Restatement of Consolidated Financial Statements
In this Quarterly Report on Form 10-Q, Barrett Business Services, Inc. (“BBSI,” “we,” “our,” “us,” or the “Company”), presents for comparison restated condensed consolidated financial statements for the three months ended March 31, 2015 (the “Restated Period”). Investors should review our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, which was filed on May 25, 2016, and should not rely on any other previously filed reports, earnings releases or similar communications relating to the Restated Period. We have not amended any previously filed reports.
For a description of the restatement, see Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements. For more information regarding the restatement and its effects, refer to Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
For a description of material weaknesses in internal control over financial reporting identified by management and management’s plan to remediate the material weaknesses, see Item 4, “Controls and Procedures” in this report and Part II, Item 9A, “Controls and Procedures” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
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PART I – FINANCIAL INFORMATION
Barrett Business Services, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In Thousands, Except Par Value)
Current assets:
Cash and cash equivalents
Trade accounts receivable, net
Income taxes receivable
Prepaid expenses and other
Restricted certificates of deposit
Restricted marketable securities and workers’ compensation deposits
Deferred income taxes
Total current assets
Marketable securities
Property, equipment and software, net
Other assets
Goodwill
Current liabilities:
Current portion of long-term debt
Accounts payable
Accrued payroll, payroll taxes and related benefits
Other accrued liabilities
Workers’ compensation claims liabilities
Safety incentives liability
Total current liabilities
Long-term workers’ compensation claims liabilities
Customer deposits and other long-term liabilities
Total liabilities
Commitments and contingencies (Notes 5 and 7)
Stockholders’ equity:
Common stock, $.01 par value; 20,500 shares authorized, 7,210 and 7,203 shares issued and outstanding
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Condensed Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
Revenues:
Professional employer service fees
Staffing services
Total revenues
Cost of revenues:
Direct payroll costs
Payroll taxes and benefits
Workers’ compensation
Total cost of revenues
Gross margin
Selling, general and administrative expenses
Depreciation and amortization
Loss from operations
Other income (expense):
Investment income
Interest expense
Other, net
Other expense, net
Loss before income taxes
Benefit from income taxes
Net loss
Basic loss per common share
Weighted average number of basic common shares outstanding
Diluted loss per common share
Weighted average number of diluted common shares outstanding
Cash dividends per common share
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Condensed Consolidated Statements of Comprehensive Loss
(In Thousands)
Unrealized gains on marketable securities, net of tax of $23 and $28 in 2016 and 2015, respectively
Comprehensive loss
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Condensed Consolidated Statements of Stockholders’ Equity
Three Months Ended March 31, 2016 and 2015
Balance, December 31, 2014 (As Restated) (1)
Common stock issued on exercise of optionsand vesting of restricted stock units
Share based compensation expense
Excess tax benefits from share-based compensation
Cash dividends on common stock
Unrealized holding gain on marketable securities, net of tax
Balance, March 31, 2015 (As Restated) (1)
Balance, December 31, 2015
Common stock repurchased on vesting of restricted stock units
Unrealized holding gain on marketablesecurities, net of tax
Balance, March 31, 2016
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Condensed Consolidated Statements of Cash Flows
Cash flows from operating activities:
Reconciliations of net loss to net cash (used in) provided by operating activities:
(Gains) losses recognized on marketable securities
Share-based compensation
Excess tax benefit from share-based compensation
Changes in certain operating assets and liabilities:
Trade accounts receivable
Customer deposits, long-term liabilities and other assets, net
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Purchase of property and equipment
Purchase of marketable securities
Proceeds from sales and maturities of marketable securities
Purchase of restricted marketable securities
Proceeds from maturities of restricted marketable securities
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from credit-line borrowings
Payments on credit-line borrowings
Payments on long-term debt
Dividends paid
Proceeds from exercise of stock options vesting of restricted stock units
Net cash (used in) provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
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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 preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the 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 2015 Annual Report on Form 10-K at pages F1 – F62. The results of operations for an interim period are not necessarily indicative of the results of operations for a full year.
Revenue recognition
We recognize professional employer (PEO) service and staffing service revenue as services are rendered by our workforce. 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. Our client services 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 services agreements provide for immediate termination upon any default of the client regardless of when notice is given.
We report PEO revenues on a net basis because we are not the primary obligor for the services provided by our clients to their customers pursuant to our client services agreements. We reduce these service fee revenues by the amounts invoiced to our clients for direct payroll expenses such as salaries, wages, health insurance, employee out-of-pocket expenses incurred incidental to employment and safety incentives. Safety incentives represent cash incentives paid to certain client companies for maintaining safe-work practices and minimizing workplace injuries. The safety incentive is based on a percentage of annual payroll and is paid annually to clients who meet predetermined workers’ compensation claims cost objectives.
Cost of revenues
Our cost of revenues for staffing services is comprised of direct payroll costs, employer payroll related taxes, employee benefits, and workers’ compensation. Our cost of revenues for PEO services includes only employer payroll related taxes and workers’ compensation. 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 and excess insurance premiums for catastrophic injuries. We maintain separate workers’ compensation insurance policies for employees working in states where the Company is not self-insured, including California.
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Note 1 - Basis of Presentation of Interim Period Statements (Continued)
We consider non-restricted short-term investments, which 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 consolidated statements of cash flows. A substantial portion of the Company’s cash and cash equivalents is invested in tax-exempt money market funds managed by the Company’s principal bank. 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.
As of March 31, 2016, the Company’s marketable securities consisted of money market funds, municipal bonds, and corporate bonds. We classify our marketable securities as trading or available-for-sale. The Company had no trading marketable securities at March 31, 2016 and December 31, 2015. The Company classifies money market funds, municipal bonds, and corporate bonds 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. Management considers available evidence in evaluating potential impairment of investments, including the duration and extent to which fair value is less than cost and the Company’s ability and intent to hold the investments. In the event a loss is determined to be other-than-temporary, the loss will be recognized in the consolidated statements of operations.
Restricted marketable securities
At March 31, 2016, restricted marketable securities consisted of money market funds, certificates of deposit, U.S. Treasuries, municipal bonds, and corporate bonds with maturities generally from 180 days to two years. At March 31, 2016, the approximate fair value of restricted marketable securities equaled their approximate amortized cost. Restricted marketable securities have been 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. Realized gains and losses on sales of restricted marketable securities are included in other income (expense) as other, net in our consolidated statements of operations.
Allowance for doubtful accounts
The Company had an allowance for doubtful accounts of $261,000 and $268,000 at March 31, 2016 and December 31, 2015, 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.
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Our workers’ compensation claims liabilities do not represent an exact calculation of liability but rather represent 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 internal claims adjusters and our third-party administrators for workers’ compensation claims, coupled with an actuarial estimate of future adverse cost development with respect to reported claims and incurred but not reported claims (together, IBNR). At March 31, 2016 and December 31, 2015, workers’ compensation claims liabilities included estimates for case reserve estimates for reported losses, plus additional amounts for estimated future adverse cost development of IBNR claims, MCC and legal costs, and unallocated loss adjustment expenses, including future administrative fees to be paid to third-party service providers. 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, 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 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.
The Company’s independent actuary provides management with an estimate of the current and long-term portions of our total workers’ compensation claims, which is an important factor in our process for estimating workers’ compensation claims liabilities. The current portion represents the independent actuary’s best estimate of payments the Company will make related to workers’ compensation claims over the ensuing twelve months. The Company will also pay out a portion of claims first incurred in the ensuing twelve months during that twelve-month period. The long-term portion represents the independent actuary’s best estimate of payments the Company will make related to workers’ compensation claims more than twelve months in the future.
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.
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Subsequent to March 31, 2016, the Company reached an agreement to pay its third-party provider of MCC services $9.5 million for all MCC fees on workers’ compensation claims with dates of injury between January 1, 2016 and December 31, 2016. Under this agreement, the Company will make payments for these services totaling $593,250 each quarter starting April 1, 2016 and continuing through January 1, 2020. The agreement limits the maximum amount of claims and services to be provided.
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 and the expected payout as determined by historical incentive payment trends. The Company provided $21.8 million and $21.3 million at March 31, 2016 and December 31, 2015, respectively, as an estimate of the liability for unpaid safety incentives. Safety incentive costs are netted against PEO service revenue in our consolidated statements of operations.
Statements of cash flows
Interest paid during the three months ended March 2016 and 2015 did not materially differ from interest expense. Income taxes received during the three months ended March 2016 and 2015 totaled $1.3 million and $1.2 million, respectively.
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. Basic and diluted shares outstanding are summarized as follows (in thousands):
Weighted average number of basic shares outstanding
Effect of dilutive securities
Weighted average number of diluted shares outstanding
As a result of the net loss for the three months ended March 31, 2016 and 2015, 110,797 and 193,549 potential common shares have been excluded from the calculation of diluted loss per share because their effect would be anti-dilutive.
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Reclassifications
Certain prior year amounts have been reclassified to conform with the 2016 presentation. Such reclassifications had no impact on the Company’s financial condition, operating results, cash, working capital or stockholders’ equity.
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 all marketable securities, allowance for doubtful accounts, deferred income taxes, carrying values for goodwill and property and equipment, accrued workers’ compensation liabilities and safety incentive liabilities. Actual results may differ from such estimates.
Recent accounting pronouncements
In May 2014, FASB issued ASU No. 2014-09 which provides for a single, principles-based model for revenue recognition that will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. In March and April 2016, the FASB issued ASU 2016-08 Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10 Identifying Performance Obligations and Licensing, ASU 2016-11 Revenue Recognition and Derivatives and Hedging: Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting, and ASU 2016-12 Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients, which all provide further clarification to be considered when implementing ASU 2014-09. The Company has not yet selected a transition method or determined the effect of the standard on its ongoing financial reporting.
In August 2015, the FASB issued ASU 2015-14 which defers the effective date of ASU 2014-09 by one year. ASU 2014-09 is discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted as of the date of the original effective date, for interim and annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the provisions of ASU 2015-14 and ASU 2014-09.
Note 2 - Restatement of Previously Issued Condensed Consolidated Financial Statements
On May 25, 2016, the Company filed its Form 10-K for 2015 which included annual financial statements for the year ended December 31, 2015. Included within the 2015 Form 10-K were the restated consolidated financial statements for the years ended December 31, 2014 and 2013 and related quarters, as well as the quarterly periods ended March 31, 2015 and June 30, 2015.
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Note 2 - Restatement of Previously Issued Condensed Consolidated Financial Statements(Continued)
The following schedules reflect the previously reported and restated financial information as of and for the three months ended March 31, 2015.
Impact on Condensed Consolidated Balance Sheet (Unaudited) (In Thousands, Except Par Value)
Line of credit
Long-term debt
Commitments and contingencies
Common stock, $.01 par value; 20,500 shares authorized, 7,141 shares issued and outstanding
Accumulated other comprehensive income
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Impact on Condensed Consolidated Statement of Operations (Unaudited) (In Thousands, Except Per Share Amounts)
15
Impact on Condensed Consolidated Statement of Comprehensive Loss (Unaudited) (In Thousands)
Unrealized gains on marketable securities, net of tax of $28
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Impact on Condensed Consolidated Statement of Cash Flows (Unaudited) (In Thousands)
Reconciliations of net loss to net cash provided by operating activities:
Losses recognized on marketable securities
Share based compensation
Net cash provided by operating activities
Net cash used in investing activities
Proceeds from the exercise of stock options and vesting of restricted stock units
Net cash provided by financing activities
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Note 3 - Fair Value Measurement
The following table summarizes the Company’s marketable securities at March 31, 2016 and December 31, 2015 measured at fair value on a recurring basis (in thousands):
Current:
Cash Equivalents:
Money Market Funds
Available for Sale - Restricted:
Certificate of Deposit
Total Current Investments
Long term:
Available-for-sale:
Corporate Bonds
Municipal Bonds
U.S. Treasuries
Total Long Term Investments
Total Investments
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Note 3 - Fair Value Measurement (Continued)
The following table summarizes the Company’s financial assets measured at fair value on a recurring basis by fair value hierarchy level (in thousands):
Money Market
Available for Sale - Unrestricted:
Total Available for Sale Securities
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Note 4 - Workers’ Compensation Claims
The following table summarizes the aggregate workers’ compensation reserve activity (in thousands):
Balance at January 1,
Claims expense accrual:
Current period
Prior periods
Claim payments related to:
Balance at March 31,
Incurred but not reported (IBNR)
The states of California, Oregon, Maryland, Washington, Delaware and Colorado require us to maintain specified investment balances or other financial instruments totaling $158.2 million at March 31, 2016 to cover potential workers’ compensation claims losses related to the Company’s current and former status as a self-insured employer. In partial satisfaction of these requirements, at March 31, 2016, we have provided surety bonds and standby letters of credit totaling $152.0 million, including a California requirement of $147.2 million.
As part of its fronted workers’ compensation insurance program with ACE Group (“ACE”) in the states of California, Delaware, Virginia, Pennsylvania and the District of Columbia, the Company makes payments into a trust account (“the ACE trust account”) to be used for the payment of future claims. The balance in the ACE trust account was $190.2 million and $166.6 million at March 31, 2016 and December 31, 2015. The ACE trust account balances are included as a component of the current and long-term restricted marketable securities and workers’ compensation deposits in the Company’s consolidated balance sheets.
Note 5 - Revolving Credit Facility and Long-Term Debt
The Company maintains a credit agreement (the “Agreement”) with its principal bank, Wells Fargo Bank, National Association (the “Bank”). The Agreement provided for a $40.0 million term loan maturing December 31, 2016, as well as a $14.0 million revolving credit line, with a $5.0 million sublimit for unsecured standby letters of credit. The outstanding balance on the term loan was $15.0 million at March 31, 2016 and December 31, 2015. The Agreement also included $37.3 million in cash-secured letters of credit at March 31, 2016 to satisfy collateral requirements associated with security deposit requirements for workers’ compensation purposes in California. In conjunction with these letters of credit, the Company posted with the Bank as collateral $38.8 million in restricted money market funds and restricted certificates of deposit.
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Note 5 - Revolving Credit Facility and Long-Term Debt (Continued)
Subsequent to March 31, 2016, the surety insurers increased their letter of credit requirements from $37.3 million to $42.3 million. In conjunction with this increase, the Company increased the amount posted with the Bank as collateral from $38.8 million to $44.0 million. The $44.0 million is included in restricted non-current assets on the consolidated balance sheet at March 31, 2016.
The term loan with the Bank requires payments of $5.0 million on June 30, 2016, September 30, 2016 and December 31, 2016. The term loan bears interest at the one month LIBOR plus 4.0%.
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 2.0% or (b) a fixed rate of LIBOR plus 2.0%. The Agreement also provides for an unused commitment fee of 0.35% per year on the average daily unused amount of the revolving credit facility, and a fee of 1.75% of the face amount of each letter of credit. The Company had no outstanding borrowings on its revolving credit line at March 31, 2016 and December 31, 2015. The revolving line of credit expires on October 1, 2017.
The credit facility is collateralized by the Company’s accounts receivable and other rights to receive payment, general intangibles and equipment.
The Agreement requires the satisfaction of certain financial covenants as follows:
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The Agreement includes certain additional covenants as follows:
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.
The Company is currently in default under the terms of the Agreement based upon the Company’s failure to comply with timeliness of financial information. We have entered into a forbearance agreement with the Bank in connection with the current default. The forbearance agreement establishes a time period during which our lender has voluntarily agreed not to cause the payment obligations under the Agreement to be immediately due and payable, to invoke default interest rates or to exercise any of the Bank’s other rights, powers and remedies. The Bank has agreed to forbear from immediate enforcement of its rights and remedies based upon the defaults through June 30, 2016. BBSI must deliver its Form 10-Q for the quarter ended March 31, 2016 by June 30, 2016 as part of this agreement.
At March 31, 2016, the Company was in violation of the fixed charge coverage ratio of 1.50:1.0. Effective June 28, 2016, the Company and the Bank amended the Credit Agreement. As part of this amendment, the Bank agreed to waive this covenant violation, increased the sublimit for unsecured standby letters of credit from $5.0 million to $6.0 million and modified the minimum Fixed Charge Coverage ratio to not less than 2.25:1.0, measured quarterly on a rolling four-quarter basis, with Fixed Charge Coverage Ratio defined as (i) EBITDA (defined as net profit before taxes plus interest expense, net of capitalized interest expense, depreciation expense and amortization expense) minus distributions, dividends and cash taxes paid, divided by (ii) $9,425,000.
As part of its negotiations with the Bank on the forbearance and waiver discussed above, the Company accelerated to May 24, 2016 the payment of $2.5 million of the $5 million originally due December 31, 2016 on its term loan. The Company also agreed to pay the remaining $2.5 million balance of the December 31, 2016 payment upon the earlier of December 31, 2016 or the receipt of federal unemployment tax refunds. In addition, the Bank amended the Agreement to include delisting of the Company’s common stock by The Nasdaq Stock Market (“Nasdaq”) as an event of default.
The Company maintains a mortgage loan with the Bank with a balance of approximately $4.8 million at both March 31, 2016 and December 31, 2015, 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 2.25%, with the unpaid principal balance due November 1, 2017. This mortgage loan is included in the current portion of long-term debt at March 31, 2016 and December 31, 2015 due to the forbearance agreement with the Bank.
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Note 6 - Income Taxes
Under 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 March 31, 2016.
Note 7 - Litigation
On November 6, 2014, plaintiffs in Michael Arciaga, et al. v. Barrett Business Services, Inc., et al., filed an action in the United States District Court for the Western District of Washington against BBSI, Michael L. Elich, BBSI’s Chief Executive Officer, and James D. Miller, BBSI’s then Chief Financial Officer. The action purported to be a class action brought on behalf of all Company shareholders alleging violations of the federal securities laws. The claims arose from the decline in the market price for BBSI common stock following announcement of a charge for increased workers compensation reserves expense. The lawsuit sought compensatory damages (in an amount to be determined at trial), plus interest, and costs and expenses (including attorney fees and expert fees).
On November 13, 2014, a second purported shareholder class action was filed in the United States District Court for the Western District of Washington, entitled Christopher P. Carnes, et al. v. Barrett Business Services, Inc., et al. The Carnes complaint named the same defendants as the Arciaga case and asserted similar claims for relief.
Similarly, on November 17, 2014, a third purported shareholder class action was filed in the United States District Court for the Western District of Washington, entitled Shiva Stein, et al. v. Barrett Business Services, Inc., et al. The Stein complaint named the same defendants as the Arciaga and Carnes cases and asserted similar claims for relief.
On February 25, 2015, the court ordered consolidation of the three cases, and any new or other cases involving the same subject matter, into a single action for pretrial purposes. The consolidated cases were recaptioned as In re Barrett Business Services Securities Litigation. The court also appointed the Painters & Allied Trades District Council No. 35 Pension and Annuity Funds as the lead plaintiff. Discovery has not been undertaken as it is automatically stayed under the federal Private Securities Litigation Reform Act.
On April 29, 2015, the plaintiffs in the class action filed a consolidated amended complaint, naming BBSI, Elich and Miller as defendants. On June 12, 2015, defendants filed a motion to dismiss the consolidated amended complaint.
On November 23, 2015, before the court had ruled on the motion to dismiss, plaintiffs filed a first amended consolidated complaint, naming the same defendants. The first amended consolidated complaint included new allegations relating to disclosures in BBSI’s Current Report on Form 8-K filed on November 9, 2015.
On February 16, 2016, BBSI filed a motion to dismiss the first amended consolidated complaint. That same day, Messrs. Elich and Miller, through separate counsel, also filed motions to dismiss the first amended consolidated complaint, adopting BBSI’s motion in its entirety.
On March 21, 2016, before the court had ruled on the motion to dismiss the first amended consolidated complaint, plaintiffs filed a second amended consolidated complaint, naming the same defendants. The second amended consolidated complaint dropped certain allegations from the first amended complaint and added new allegations relating to disclosures in BBSI’s Current Report on Form 8-K filed on March 9, 2016. Among other disclosures, BBSI reported that (1) previously issued financial statements could not be relied on, (2) Mr. Miller had reported making unsupported journal entries, (3) Mr. Miller’s employment had been terminated, and (4) BBSI was in the process of engaging a Big Four accounting firm to conduct an independent forensic accounting investigation.
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Note 7 – Litigation (Continued)
BBSI responded to the second amended consolidated complaint by filing a motion to dismiss on May 23, 2016. Messrs. Elich and Miller joined in that motion. Under the current briefing schedule ordered by the court, plaintiffs’ opposition to the motion to dismiss is due June 27, 2016, and any reply is due July 25, 2016.
BBSI received a subpoena from the San Francisco office of the Division of Enforcement of the Securities and Exchange Commission (the “SEC”) in May 2015 in connection with the SEC’s investigation of the Company’s accounting practices with regard to its workers’ compensation reserves. In April 2016, the SEC issued a second subpoena to BBSI for documents relating to the disclosures made by the Company following Mr. Miller’s termination. The Company was also advised by the United States Department of Justice in mid-June 2016 that it has commenced an investigation. BBSI is cooperating fully with the investigations.
On June 17, 2015, Daniel Salinas (“Salinas”) filed a shareholder derivative lawsuit against BBSI and certain of its officers and directors in the Circuit Court for Baltimore City, Maryland. The complaint alleges breaches of fiduciary duty, unjust enrichment and other violations of law and seeks recovery of various damages, including the costs and expenses incurred in connection with the Company’s reserve strengthening process, reserve study and consultants, the cost of stock repurchases by BBSI in October 2014, compensation paid to the Company’s officers, and costs of negotiating the Company’s credit facility with its principal lender, as well as the proceeds of sales of stock by certain of BBSI’s officers and directors during 2013 and 2014. On September 28, 2015, the Company and the individual defendants filed motions to dismiss the derivative suit and a motion to stay pending resolution of In re Barrett Business Services Securities Litigation. On December 4, 2015, Salinas filed an opposition to each motion. On January 27, 2016, the defendants filed a reply to the opposition brief. On February 11, 2016, Judge Michel Pierson heard oral argument on the motions. A decision has not been issued.
Management is unable to estimate the probability, or the potential range, of loss arising from the legal actions described above.
BBSI is subject to other legal proceedings and claims, which arise in the ordinary course of our business. In the opinion of management, the amount of ultimate liability with respect to other currently pending or threatened actions is not expected to materially affect the Company’s consolidated financial position or results of operations.
Note 8 – Subsequent Events
Subsequent to March 31, 2016, the surety insurers increased their letter of credit requirement from $37.3 million to $42.3 million. The collateral associated with the letters of credit increased from $38.8 million to $44.0 million.
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Note 8 – Subsequent Events (Continued)
The Company accelerated to May 24, 2016 the payment of $2.5 million of the $5 million payment originally due December 31, 2016 on its term loan.
The Company received a letter on May 10, 2016 from Nasdaq stating that, because the Company had failed to file by May 9, 2016 its Form 10-Q for the period ended September 30, 2015 and its Form 10-K for the period ended December 31, 2015 with the SEC, the Company was non-compliant with the filing requirements of Nasdaq Listing Rule 5250(c)(1). As a result, the Company’s common stock was subject to suspension and delisting unless the Company submitted a timely request for a hearing by the Nasdaq Hearings Panel (the “Panel”).
On May 12, 2016, BBSI received another letter from Nasdaq stating that the Company’s failure to file its Form 10-Q for the period ended March 31, 2016 with the SEC served as an additional basis for delisting the Company’s securities.
On May 17, 2016 the Company submitted its request for a hearing before the Panel.
Nasdaq granted a stay of suspension and delisting pending the issuance of a written decision by the Panel. The hearing before the Panel was held on June 16, 2016.
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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:
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 comprised of 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 22 states and the District of Columbia through a network of 55 branch locations in California, Oregon, Washington, Arizona, Colorado, Idaho, Nevada, Utah, Delaware, Maryland, North Carolina 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 4,000 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.
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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 internal claims managers and 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.
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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 months ended March 31, 2016 and 2015.
We report professional employer service revenues on a net basis because we are not the primary obligor for the services provided by our co-employed clients to their customers pursuant to our client service agreements. We present for comparison purposes the gross revenues and cost of revenues information for the three months ended March 31, 2016 and 2015 in the table below. Although not in accordance with GAAP, management believes this information is more informative as to the level of our business activity and more illustrative of how we manage our operations, including the preparation of our internal operating forecasts, because it presents our professional employer services on a basis comparable to our staffing services.
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.
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Non-GAAP (in thousands)
Professional employer services
A reconciliation of non-GAAP gross revenues to net revenues is as follows for the three months ended March 31, 2016 and 2015 (in thousands):
The amount of the reclassification is comprised of direct payroll costs and safety incentives attributable to our professional employer services client companies.
Three months ended March 31, 2016 and 2015
Net loss for the first quarter of 2016 amounted to $8.0 million compared to a net loss of $5.8 million for the first quarter of 2015. Diluted loss per share for the first quarter of 2016 was $(1.11) compared to a diluted loss per share of $(0.82) for 2015.
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Revenues for the first quarter of 2016 totaled $191.0 million, an increase of approximately $24.6 million or 14.8% over the first quarter of 2015, which primarily reflects a 21.6% increase in the Company’s professional employer service fee revenue to $27.4 million, partially offset by a 7.3% decrease in staffing services revenue of $2.9 million.
Approximately 79% and 78%, respectively, of our total net revenues during 2016 and 2015 was attributable to our California operations.
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 quarter of 2016 nearly doubled business lost from former customers. Professional employer service revenue from continuing customers reflected a 6.2% increase compared to the first quarter of 2015, primarily resulting from increases in employee headcount and hours worked. The decrease in staffing services revenue was due primarily to a decrease in net staffing business as lost business from former customers exceeded the addition of new business, coupled with a decrease in revenue from continuing customers.
Gross margin for the first quarter of 2016 totaled approximately $10.4 million or 5.4% of revenue compared to $8.9 million or 5.4% of revenue for the first quarter of 2015.
Direct payroll costs as a percentage of revenues decreased to 14.4% for the first quarter of 2016 from 17.9% for the first quarter of 2015, primarily due to the increase in professional employer services compared to the first quarter of 2015.
Payroll taxes and benefits as a percentage of revenues for the first quarter of 2016 was 54.3% compared to 52.9% for 2015. The percentage rate increase was primarily due to the effect of growth in professional employer services, where payroll taxes and benefits are presented at gross cost, whereas the related direct payroll costs are netted against professional employer services revenue. The effect of the growth in professional employer services on payroll taxes and benefits was partially offset by a decline in the overall state unemployment tax rates in states where the Company does business.
Workers’ compensation expense, in terms of dollars and as a percentage of revenues, increased from $39.6 million or 23.8% in the first quarter of 2015 to $49.4 million or 25.9% in the first quarter of 2016. The percentage rate increase was due to the change in prior periods’ claims expense from $(2,897,000) in the first quarter of 2015 to $848,000 in the first quarter of 2016.
Selling, general and administrative (“SG&A”) expenses for the first quarter of 2016 totaled approximately $21.9 million, an increase of $4.9 million or 29.1% over the first quarter of 2015. This was primarily due to $1.8 million in legal and accounting costs associated with financial restatements, outside investigations and legal proceedings related to securities law issues. We also incurred higher management payroll and other branch level expenses to support our business growth.
Other expense, net for the first quarter of 2016 totaled approximately $8,000 as compared to other expense, net of $447,000 for the first quarter of 2015. The change was primarily attributable to a decrease in interest expense from $520,000 in the first quarter of 2015 to $260,000 in the first quarter of 2016, as well as an increase in investment income from $87,000 in the first quarter of 2015 to $248,000 in the first quarter of 2016.
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Our effective income tax rate for the first quarter of 2016 was (34.8)%, compared to (36.4)% for the first quarter of 2015. Our income tax rate typically differs from the federal statutory tax rate of 35% primarily due to 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 position of $43.5 million at March 31, 2016 increased $18.2 million from December 31, 2015, and $3.7 million from March 31, 2015. The increase in cash at March 31, 2016, as compared to December 31, 2015, was primarily due to an increase in accrued payroll, payroll taxes and related benefits of $66.8 million, proceeds from sales and maturities of securities of $55.8 million, and an increase in workers’ compensation claims liabilities of $9.5 million, partially offset by a net loss of $8.0 million, an increase in trade accounts receivable of $73.3 million, and purchases of securities of $27.0 million.
Net cash used in operating activities for the three months ended March 31, 2016 amounted to $7.8 million, compared to cash provided by operating activities of $5.5 million for the comparable period of 2015. For the three months ended March 31, 2016, cash flow was primarily used for the net loss of $8.0 million and an increase in trade accounts receivable of $73.3 million, partially offset by an increase in accrued payroll, payroll taxes and related benefits of $66.8 million and workers’ compensation claims liabilities of $9.5 million.
Net cash provided by investing activities totaled $27.4 million for the three months ended March 31, 2016, compared to net cash used of $6.2 million for the comparable period of 2015. For the three months ended March 31, 2016, cash provided by investing activities consisted primarily of proceeds from sales and maturities of restricted marketable securities of $55.6 million, partially offset by purchases of restricted marketable securities of $26.8 million.
Net cash used in financing activities for the three months ended March 31, 2016 was $1.3 million compared to net cash provided by financing activities of $4.4 million for the comparable period of 2015. For the three months ended March 31, 2016, cash was primarily used for dividend payments of $1.6 million. Borrowings on the Company’s credit line equaled repayments in 2016.
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Due to a decrease in our California workers’ compensation claims liability during the first quarter of 2016, the surety insurers decreased their letter of credit requirement to $37.3 million at March 31, 2016 from $88.3 million at December 31, 2015. The collateral associated with the letters of credit decreased to $38.8 million at March 31, 2016 from $92.4 million at December 31, 2015.
Subsequent to March 31, 2016 the surety insurers increased their letter of credit requirement from $37.3 million to $42.3 million. The collateral associated with the letters of credits increased from $38.8 million to $44.0 million.
Management expects total amounts of the letters of credit and related collateral 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 the ACE fronted workers’ compensation insurance program, the Company makes monthly payments into the ACE trust account, to be used for the payment of future claims. The balance in the ACE trust account was $190.2 million and $166.6 million at March 31, 2016 and December 31, 2015, respectively. The ACE trust account balance is made up of money market funds, included as a component of the current and long-term restricted marketable securities and workers’ compensation deposits in the Company’s consolidated balance sheets.
As disclosed in Note 5 to the condensed consolidated financial statements in this report, the Company maintains a credit agreement (the “Agreement”) with its principal bank, Wells Fargo Bank, National Association (the “Bank”). The Agreement provided for a $40.0 million term loan maturing December 31, 2016, as well as a $14.0 million revolving credit line, with a $5.0 million sublimit for unsecured standby letters of credit. The outstanding balance on the term loan was $15.0 million at March 31, 2016 and December 31, 2015. The Agreement also included $37.3 million in cash-secured letters of credit at March 31, 2016 to satisfy collateral requirements associated with security deposit requirements for workers’ compensation purposes in California. In conjunction with these letters of credit, the Company posted with the Bank as collateral $38.8 million in restricted money market funds and restricted certificates of deposit.
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As part of its negotiations with the Bank on the forbearance and waiver discussed above, the Company accelerated to May 24, 2016 the payment of $2.5 million of the $5 million originally due December 31, 2016 on its term loan. The Company also agreed to pay the remaining $2.5 million balance on the December 31, 2016 payment upon the earlier of December 31, 2016 or the receipt of federal unemployment tax refunds. In addition, the Bank amended the Agreement to include delisting of the Company’s common stock by Nasdaq as an event of default.
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The Company is self-insured for certain business insurance risks such as general liability, errors and omissions and umbrella coverage. Management may explore in the future whether to pursue other vehicles to provide coverage including coverages provided by the Company’s captive insurance companies.
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 expenses for workers’ compensation claims.
Forward-Looking Information
Statements in this report include which are not historical in nature, including 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 need to continue to retain customers following price increases, the adequacy of our workers’ compensation reserves, the effect of changes in estimates of our future claims liabilities on our workers’ compensation reserves, the effect of changes in our reserving practices and claims management process on our actuarial estimates and workers’ compensation reserves, 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 fully licensed insurance subsidiaries, the effects of becoming self-insured for certain business risks, the risks of operation and cost of our fronted insurance program with ACE, our ability to pass on increased costs relating to the mandate to provide health insurance coverage to our clients, the effects of material weaknesses in our internal control environment, the cost of providing healthcare coverage to staffing employees, the financial viability of our excess insurance carriers, the effectiveness of our management information systems, payment of future dividends, our relationship with our primary bank lender and the availability of financing and working capital to meet our funding requirements, compliance with the continued listing requirements of The Nasdaq Stock Market (“Nasdaq”), current and future shareholder litigation, the ongoing investigations by the Securities and Exchange Commission (the “SEC”) and the United States Department of Justice (the “DOJ”), 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, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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 effect of changes in the workers’ compensation regulatory environment in one or more of our primary markets, collectability of accounts receivable, the carrying values of deferred income tax assets and goodwill, which may be affected by our future operating results, the cost of defending against or settling shareholder litigation, the expenses associated with cooperating in the SEC and DOJ investigations and the potential imposition of fines, penalties and other remedies, the costs of remediating material weaknesses in our internal control environment, including the recruitment of a new Chief Financial Officer and additional members of the Board of Directors with experience in the oversight of financial reporting by public companies, the effect on our stock price if our Common Stock is delisted by Nasdaq, 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. 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.
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The Company’s exposure to market risk for changes in interest rates primarily relates to its investment portfolio of liquid assets and its outstanding borrowings on its line of credit and long-term debt. As of March 31, 2016, the Company’s investment portfolio consisted principally of approximately $258.4 million in money market funds, $11.8 million in certificates of deposit, $6.3 million in corporate bonds, $6.5 million in municipal bonds, and $6.1 million in U.S. Treasuries. The Company’s outstanding long-term debt totaled approximately $19.8 million at March 31, 2016. Based on the Company’s overall interest exposure at March 31, 2016, a 100 basis point increase in market interest rates would not have a material effect on the fair value of the Company’s investment portfolio of liquid assets, its outstanding borrowings or its results of operations because of the predominantly short maturities of the securities within the investment portfolio and the relative size of the outstanding borrowings.
Evaluation of Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining for our Company adequate internal control over financial reporting as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.
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 not effective as of March 31, 2016 because of the material weaknesses in our internal control over financial reporting (“ICFR”) described below and our inability to timely file required reports with the SEC.
Previously Identified Material Weakness
As reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, management identified the following material weaknesses in internal control over financial reporting:
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Plan for Remediation of Material Weaknesses
The Company’s Board of Directors, Audit Committee, and management are actively engaged in the planning for and implementation of remediation efforts to address the material weaknesses identified above. Management has taken the following actions to address the material weaknesses:
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The following actions are also currently being undertaken by management to address the material weaknesses:
Lastly, over the course of the ensuing months, management intends to undertake the following actions in consultation with an outside third-party expert to address material weaknesses in the Company’s control environment:
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Management believes the measures described above will remediate the material weaknesses that have been identified. As it continues to evaluate and improve ICFR, management may determine to take additional measures to address control deficiencies or to modify, or in appropriate circumstances not to implement, certain of the remediation measures described above.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended March 31, 2016 that has materially affected, or is reasonably likely to materially affect, our 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 our 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
On November 6, 2014, plaintiffs in Michael Arciaga, et al. v. Barrett Business Services, Inc., et al., filed an action in the United States District Court for the Western District of Washington against BBSI, Michael L. Elich, BBSI’s Chief Executive Officer, and James D. Miller, BBSI’s then Chief Financial Officer. The action purported to be a class action brought on behalf of all Company shareholders alleging violations of the federal securities laws. The claims arose from the decline in the market price for BBSI Common Stock following announcement of a charge for increased workers compensation reserves expense. The lawsuit sought compensatory damages (in an amount to be determined at trial), plus interest, and costs and expenses (including attorney fees and expert fees).
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Similarly, on November 17, 2014, a third purported shareholder class action was filed in the United States District Court for the Western District of Washington, entitled Shiva Stein, et al. v. Barrett Business Services, Inc., et al. The Stein complaint named the same defendants as the Arciaga and Carnescases and asserted similar claims for relief.
On March 21, 2016, before the court had ruled on the motion to dismiss the first amended consolidated complaint, plaintiffs filed a second amended consolidated complaint, naming the same defendants. The second amended consolidated complaint dropped certain allegations from the first amended complaint and added new allegations relating to disclosures in BBSI’s Current Report on Form 8-K filed on March 9, 2016. Among other disclosures, BBSI reported that (1) previously issued financial statements could not be relied on, (2) Mr. Miller had reported making unsupported journal entries, (3) Mr. Miller’s employment had been terminated, and (4) BBSI was in the process of engaging a Big Four accounting firm to conduct an independent forensic accounting investigation. In a Current Report on Form 8-K filed on April 19, 2016, BBSI reported the results of the investigation, as well as the discovery of certain errors in BBSI’s previously filed financial statements. See Part I, Item 4 “Controls and Procedures” of this report for additional information.
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BBSI is subject to other legal proceedings and claims which arise in the ordinary course of our business. In the opinion of management, the amount of ultimate liability with respect to other currently pending or threatened actions is not expected to materially affect the Company’s consolidated financial position or results of operations.
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, 2015, which was filed with the SEC on May 25, 2016.
On February 2, 2016, a former branch manager of the Company exercised employee stock options granted under one of the Company’s stockholder-approved stock incentive plans. He purchased a total of 5,000 shares of our Common Stock and paid the exercise price of the options totaling $71,919 in cash.
On February 2, 2016, a total of 1,228 shares of Common Stock were issued to a total of eight employees of the Company in settlement of vested restricted stock units granted under one of the Company’s stockholder-approved stock incentive plans. On February 16, 2016, a total of 961 shares of Common Stock were issued to six of the eight employees in settlement of additional vested restricted stock units granted under one of the Company’s stockholder-approved stock incentive plans. The shares were issued to the employees as compensation for their services to the Company.
All of the foregoing shares of Common Stock were issued in reliance on the exemption from registration afforded by Section 4(a)(2) of the Securities Act of 1933.
The Company maintains a Board-approved stock repurchase program, which in October 2008 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 allows for the repurchase of approximately 1.1 million shares as of March 31, 2016. The Company’s credit agreement with its primary bank currently prohibits the repurchase of our Common Stock.
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Exhibits are listed in the Exhibit Index that follows the signature page of this report.
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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.
/s/ Thomas J. Carley
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EXHIBIT INDEX**
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