The Daily Magic Formula Stock for 06/20/2008 is Barrett Business Services Inc. According to the Magic Formula Investing Web Site, the ebit yield is 23% and the EBIT ROIC is >100%.
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Barrett Business Services, Inc. (âBarrett,â the âCompany,â âourâ or âweâ), was incorporated in the state of Maryland in 1965. We offer a comprehensive range of human resource management services to assist small and medium-sized businesses manage the increasing costs and complexities of a broad array of employment-related issues. Our principal services, Professional Employer Organization (âPEOâ) and staffing, assist our clients in leveraging their investment in human capital. We believe that the combination of these two principal services enables us to provide our clients with a unique blend of services not offered by our competition. Our platform of outsourced human resource management services is built upon our expertise in payroll processing, employee benefits and administration, workersâ compensation coverage, effective risk management and workplace safety programs and human resource administration.
In a PEO arrangement, we enter into a contract to become a co-employer of the clientâs existing workforce and assume responsibility for some or all of the clientâs human resource management responsibilities. Staffing services include on-demand or short-term staffing assignments, long-term or indefinite-term contract staffing and comprehensive on-site management. Our staffing services also include direct placement services, which involve fee-based search efforts for specific employee candidates at the request of our PEO clients, staffing customers or other companies.
Our ability to offer clients a broad mix of services allows us to effectively become the human resource department and a strategic business partner for our clients. We believe our approach to human resource management services is designed to positively affect our clientsâ business results by:
allowing our clients to focus on core business activities instead of human resource matters;
increasing our clientsâ productivity by improving employee satisfaction and generating greater employee retention;
reducing overall payroll expenses due to lower workersâ compensation costs; and
assisting our clients in complying with complex and evolving human resource related regulatory and tax issues.
We provide services to a diverse array of customers, including, among others, electronics manufacturers, various light-manufacturing industries, forest products and agriculture-based companies, transportation and shipping enterprises, food processing, telecommunications, public utilities, general contractors in numerous construction-related fields and various professional services firms. During 2007, we provided staffing services to approximately 2,300 staffing services customers, which compares to approximately 1,800 during 2006. In addition, at December 31, 2007, we served approximately 1,200 PEO clients and employed approximately 32,200 employees pursuant to PEO contracts, as compared to 1,100 PEO clients and approximately 25,300 employees as of December 31, 2006. We serve our clients, who have employees located in 25 states and the District of Columbia, through a network of 44 branch offices in California, Oregon, Washington, Idaho, Arizona, Utah, Colorado, Maryland, Delaware and North Carolina. We also have several smaller recruiting offices in our general market areas, which are under the direction of a branch office.
The human resource outsourcing industry is large and growing rapidly. Some of the key factors driving growth include the desire of businesses to outsource non-core business functions, to reduce regulatory compliance risk, to rationalize the number of service providers that they use, and to reduce costs by integrating human resource systems and processes.
The outsourcing of business processes continues to represent a growing trend within the United States. By utilizing the expertise of outsourcing service providers, businesses are able to reduce processing costs and administrative burdens while at the same time offering competitive benefits for their employees. The technical capabilities, knowledge and operational expertise that we have built, along with our broad portfolio of services for clients, have enabled us to capitalize on the growing business processing outsourcing trend.
We believe that the small and medium-sized business segment of the human resource outsourcing market is particularly attractive because:
this segment is large and has a low penetration rate by providers of outsourced comprehensive human resource services;
small and medium-sized businesses typically have fewer in-house resources than larger businesses and, as a result, are generally more dependent on their service providers;
quality of service, ease-of-use and responsiveness to clientsâ needs are key considerations of this business segment in selecting a service provider;
small and medium-sized businesses generally do not require customized solutions, enabling service providers to achieve significant economies of scale through an integrated technology and service platform; and
this segment is generally characterized by a relatively high client retention rate and lower client acquisition costs.
Our Strategic Approach
Our long-term goal is to become the leading provider of human resource outsourcing services for small and medium-sized businesses. We seek to differentiate our strategic position by offering a full spectrum of PEO and staffing services, along with, but to a far lesser extent, permanent placement and administrative service organization (ASO) services. We believe that the integrated nature of our service platform assists our clients and customers in successfully aligning and strengthening their organizational structure to meet the demands of their businesses. In pursuit of this goal, we have adopted the operating and growth strategies described below to provide the framework for our future growth, while maintaining the quality and integrity of our current service offerings.
Provide a broad scope of services. We provide our clients with a broad range of human resource management tools and professional services that meet their critical human resource needs. We believe that most human resource service providers offer discrete services, requiring client companies to engage and manage multiple vendors in order to obtain a comprehensive human resource management solution. Companies that purchase services from multiple vendors typically fail to realize the benefits and economies of scale of having a single, integrated source of human resource information. Our comprehensive solutions allow our clients to maximize the value realized from integrating information and establishing a partnership with a single vendor to address all of their human resource needs. We believe that the aggregate cost of purchasing discrete services from multiple vendors is greater than the cost of purchasing our integrated solution, such that we can offer cost savings and managerial efficiencies to our clients.
Promote a decentralized and autonomous management philosophy and structure. We hire senior-level managers to oversee, develop and expand our business at the branch-office level. We believe that highly experienced senior-level branch managers possess the skill set to handle the day-to-day demands of our business and still be proactive in solving client needs and focusing on further business development. We believe that by making significant investments in the best management talent available, within their respective areas of expertise, we can leverage the value of this investment many times over. We have also found that this philosophy facilitates our ability to attract and retain additional experienced senior-level managers to oversee our branch offices.
Motivate employees through a competitive compensation package. We offer a very competitive base salary structure at the branch-office level and provide the opportunity to earn additional profit sharing on a quarterly basis. This profit sharing is earned by each branch-level employee based upon branch office profitability after achieving certain minimum profitability standards. Our risk managers have an opportunity to earn incentive compensation based upon the workersâ compensation claims experience of their specific client base. All profit sharing and incentive compensation measures are tangible and objective, with few subjective components.
Control workersâ compensation costs through effective risk management. We are committed to the proactive mitigation of workersâ compensation risk through stringent underwriting and disciplined management processes. Our chief executive officer defines and maintains our strict underwriting standards. Our underwriting process begins with the selection of only the best candidate companies. Next, our professional risk managers in the field corroborate the underwriting data by assessing the candidateâs operating culture, workplace safety standards and human resource administration philosophies, including compensation rates and benefit levels. If the candidate company satisfies all underwriting standards, then we accept the company and immediately implement a plan to further strengthen their workplace safety standards and practices. If the clientâs safe-work culture or adherence to workplace safety procedures declines to unsatisfactory levels, we will terminate the relationship under the terms of our contract.
Support, strengthen and expand branch office operations. We believe that increasing the penetration of our existing markets is an effective and cost-efficient means of growth as we are able to capitalize on our reputation and growing brand awareness in the territories in which we operate. We believe that there is substantial opportunity to further penetrate these territories. We intend to increase our penetration in our existing markets by continued growth through the effective use of insurance broker networks, referrals from current clients and marketing efforts within the local business community.
Increase client utilization of our services. We believe that we will be able to continue to maintain our average level of professional service fees per client employee and improve client retention as our clients more fully utilize our current service offerings, including cross selling between staffing, PEO and permanent placement. We invest substantial time integrating our services into our client organizations to optimize their effectiveness and measure their results. Our long-term partnership philosophy provides us with the opportunity to expand our PEO and staffing services.
Enhance management information systems . We continue to invest in developing our information technology infrastructure. We believe that our platform gives us a competitive advantage by allowing us to provide a high level of flexibility to satisfy a variety of demands of our small and medium-sized business clients on a cost-effective basis. Furthermore, we believe that our current technology platform is capable of supporting our planned develop-ment of new business units and increased market share for the foreseeable future.
Penetrate new markets. We intend to open additional branch offices in new geographic markets as opportunities arise. Since the beginning of 2003, we have opened four new offices in California to expand our presence in select geographic markets, including Bakersfield, Fresno, Redding and San Diego. We have developed a well-defined approach to geographic expansion which we will use as a guide for entering new markets.
Pursue strategic acquisitions. Since our initial public offering in June 1993, we have completed 26 acquisitions of complementary businesses. In 2006, we acquired certain assets of Pro HR, LLC, a privately held PEO company with three offices, two of which are in Idaho and one in Western Colorado. Effective July 2, 2007, we acquired certain assets of Strategic Staffing, Inc., a privately held staffing services company with 6 offices, 5 of which are in Utah and one in Colorado. Effective December 3, 2007, we acquired certain assets of Phillips Temps, Inc., a privately held staffing services company with one office in Denver, Colorado. In addition, effective February 4, 2008, we acquired certain assets of First Employment Services, Inc., a privately-held staffing services company with two offices in Arizona. In order to increase our client base, expand our presence in existing markets, enter new markets and broaden our service offerings, we may continue to pursue strategic acquisitions, particularly in the staffing area.
Our services are typically provided under a variety of contractual arrangements through which we offer a continuum of proactive human resource management services. While some services are more frequently associated with our PEO arrangements, our expertise in such areas as safety services and personnel-related regulatory compliance may also be used by our staffing services customers. Our human resource management services are built upon the following five areas of expertise:
Payroll Processing. For both our PEO and staffing services employees, we assist our clients in managing employment-related administration by providing payroll processing, employment-related tax filings and administration. These services are administered at each branch office, as well as centralized at our headquarters in Vancouver, Washington.
Employee Benefits and Administration. We assist our PEO clients in retaining the best employees for their businesses by helping them obtain, at their cost, comprehensive health benefits, including medical, dental and vision benefits, life and accident insurance, short-term and long-term disability. We also provide, at no cost to our PEO clients and our staffing employees, a 401(k) retirement savings plan and a Section 125 cafeteria plan.
Human Resource Management. We focus on developing and implementing a client-specific proactive human resource management system for each PEO client company. Through these efforts, clients achieve a more productive workforce through the disciplined application of standards for hiring and firing. Specifically, we assist our clients in attracting the right people by providing best recruiting practices, job description development, skills testing, salary information, drug testing, interview guidelines and assistance, evaluating job applications and references and compliance with a broad range of employment regulations.
Risk Management . We focus on developing and implementing a client-specific proactive risk management program so as to further mitigate risk of injury associated with workplace practices. These efforts enable our clients and us to achieve a reduction in accidents and workersâ compensation claims. We provide such tactical services as safety training and safety manuals for both workers and supervisors, job-site visits and meetings, improvements in workplace procedures and equipment to further reduce the risk of injury, compliance with OSHA requirements, environmental regulations, and workplace regulations of the U.S. Department of Labor and state agencies and leading accident investigations. We have at least one risk manager available at each branch office to perform workplace safety assessments for each prospective client and to implement systems to improve work practices. All risk managers report directly to our Chief Executive Officer. Each risk manager has the authority to cancel our business relationship with any customer or client company.
Workersâ Compensation Coverage. We assist our clients in protecting their businesses from employment-related injury claims by providing workersâ compensation coverage. Through our internal claims managers and our third-party administrators, we provide claims management services for our PEO clients. We work aggressively to manage and reduce job injury claims, including identifying fraudulent claims and taking advantage of our staffing services to return injured workers to active employment earlier. As a result of our efforts to manage workersâ compensation costs, we are often able to reduce our clientsâ overall expenses arising out of job-related injuries and insurance.
PEO Services . In a PEO services arrangement, we enter into a contract to become a co-employer of the clientâs existing workforce and assume responsibility for some or all of the human resource management responsibilities, including payroll and payroll taxes, employee benefits, health insurance, workersâ compensation coverage, workplace safety programs, compliance with federal and state employment laws, labor and workplace regulatory requirements, and related administrative responsibilities. We have the right to hire and fire our PEO employees, although the client remains responsible for day-to-day assignments, supervision and training and, in most cases, recruiting.
We began offering PEO services to Oregon customers in 1990 and subsequently expanded these services to other states, primarily California. In 2007, approximately 85% of our PEO service fee revenues were generated from customers in California with an additional 6% of revenues generated in Oregon.
We have entered into co-employer arrangements with a wide variety of clients, including companies involved in moving and shipping, professional firms, construction, retail, manufacturing and distribution businesses. PEO clients are typically small to mid-sized businesses with up to several hundred employees. None of our PEO clients individually represented more than 2% of our total revenues in 2007.
Prior to entering into a co-employer arrangement, we perform an analysis of the potential clientâs actual personnel and workersâ compensation costs based on information provided by the prospect. We introduce our workplace safety program and recommend improvements in procedures and equipment following a risk assessment of the prospectâs facilities. The potential client must agree to implement recommended changes as part of the co-employer arrangement. We also offer financial incentives to PEO clients to maintain a safe-work environment.
Our standard PEO services agreement typically provides for an initial term of one year with automatic renewal for one-year periods. Our agreements generally permit cancellation by either party upon 30 daysâ written notice. In addition, we may terminate the agreement at any time for specified reasons, including nonpayment or failure to follow our workplace safety program.
The PEO services agreement also provides for indemnification of us by the client against losses arising out of any default by the client under the agreement, including failure to comply with any employment-related, health and safety, or immigration laws or regulations. We require our PEO clients to maintain comprehensive liability coverage in the amount of $1.0 million for acts of our work-site employees. Although no claims exceeding such policy limits have been paid by us to date, the possibility exists that claims for amounts in excess of sums available to us through indemnification or insurance may be asserted in the future, which could adversely affect our profitability.
Staffing Services . Our staffing services include on-demand or short-term staffing assignments, contract staffing, long-term or indefinite-term on-site management, direct placement and human resource administration. Short-term staffing involves demands for employees caused by such factors as seasonality, fluctuations in customer demand, vacations, illnesses, parental leave and special projects without incurring the ongoing expense and administrative responsibilities associated with recruiting, hiring and retaining additional permanent employees. As more and more companies focus on effectively managing variable costs and reducing fixed overhead, the use of employees on a short-term basis allows firms to utilize the âjust-in-timeâ approach for their personnel needs, thereby converting a portion of their fixed personnel costs to a variable expense.
Contract staffing refers to our responsibilities to provide employees for our clients for a period of more than three months or an indefinite period. This type of arrangement often involves outsourcing an entire department in a large corporation or providing the workforce for a large project.
In an on-site management arrangement, we place an experienced manager on site at a clientâs place of business. The manager is responsible for conducting all recruiting, screening, interviewing, testing, hiring and employee placement functions at the clientâs facility for a long-term or indefinite period.
Direct placement services involve fee-based search efforts for specific employee candidates at the request of our PEO clients, staffing customers or other companies.
Our staffing services customers operate in a broad range of businesses, including agriculture-based companies, electronic manufacturers, transportation and logistics companies, food processors, professional firms and construction. Such customers generally range in size from small local firms to companies with international operations that use our services on a domestic basis. None of our staffing services customers individually represented more than 3% of our total revenues in 2007.
In 2007, the light-industrial sector generated approximately 81% of our staffing services revenues, while clerical office staff accounted for 14% of such revenues and technical personnel represented the balance of 5%. Our light-industrial workers perform such tasks as operation of machinery, manufacturing, loading and shipping, site preparation for special events, construction-site cleanup and janitorial services. Technical personnel include electronic parts assembly workers and designers of electronic parts.
We employ a variety of methods to recruit our work force for staffing services, including among others, referrals by existing employees, online job boards, our Web site for job postings, newspaper advertising, and marketing brochures distributed at colleges and vocational schools. The employee application process may include an interview, skills assessment test, reference verification, drug screening, criminal background checks and pre-employment physicals. The recruiting of qualified employees requires more effort when unemployment rates are low. We use a comprehensive pre-employment screening test to ensure that applicants are appropriately qualified for employment.
Our staffing services employees are not under our direct control while working at a customerâs business. We have not experienced any significant liability due to claims arising out of negligent acts or misconduct by our staffing services employees. Claims could be asserted against us which could have a material adverse effect on our financial condition and results of operations.
Mr. Carley was President and Chief Financial Officer of Jensen Securities, a securities and investment banking firm in Portland, Oregon, for eight years until February 1998, when the company was sold to D.A. Davidson & Co. Thereafter, he was a research analyst covering technology companies and financial institutions at D.A. Davidson & Co. until December 1999. Mr. Carley was a private investor until July 2006, when he co-founded Portal Capital, an investment management company.
Dr. Hicks is also a co-founder and director of Virogenomics, Inc., a biotechnology company located in the Portland metropolitan area, for which he has served as Chief Technology Officer. He also serves as Vice President for Science of GenDx, Inc., a cancer diagnostic company based in New York. Dr. Hicks was a director of AVI BioPharma, Inc., from 1997 until October 2007.
Prior to joining Coldstream, Mr. Johnson was President and CEO of Western Pacific Investment Advisers, Inc., which was acquired by Coldstream in 2005.
Mr. Justesen has managed Justesen Ranches in eastern Oregon since 1970. He also serves as President of Buck Hollow Ranch, Inc., and is a private investor.
Mr. Meeker retired in 2003 as a Managing Director of Victory Capital Management, Inc. (formerly known as Key Asset Management, Inc.), where he was employed for ten years. Mr. Meeker is Chairman of the Board of First Federal Savings and Loan Association of McMinnville and a director of Oregon Mutual Insurance Company. From 1987 to 1993, he was Treasurer of the State of Oregon.
Mr. Sherertz also serves as Chairman of the Board of Directors.
Mr. Johnson and Mr. Justesen are first cousins.
MANAGEMENT DISCUSSION FROM LATEST 10K
We provide human resource management services, comprised principally of staffing services and PEO services. We generate staffing services revenues primarily from short-term staffing, contract staffing, on-site management and direct placement services. Our PEO service fees are generated from contractual agreements with our PEO clients under which we become a co-employer of our clientâs workforce with responsibility for some or all of the clientâs human resource functions. We recognize revenues from our staffing services for all amounts invoiced, including direct payroll, employer payroll-related taxes, workersâ compensation coverage and a service fee (equivalent to a mark-up percentage). PEO service fee revenues are recognized on a net basis in accordance with Emerging Issues Task Force No. 99-19, â Reporting Revenues Gross as a Principal Versus Net as an Agent â (âEITF No. 99-19â). As such, our PEO service fee revenues represent the gross margin generated from our PEO services after deducting the amounts invoiced to PEO customers for direct payroll expenses such as salaries, wages, health insurance and employee out-of-pocket expenses incurred incidental to employment. These amounts are also excluded from cost of revenues. PEO service fees also include amounts invoiced to our clients for employer payroll-related taxes and workersâ compensation coverage.
Through centralized operations at our headquarters in Vancouver, Washington, we prepare invoices weekly for our staffing services customers and following the end of each payroll processing cycle for PEO clients. We invoice our customers and clients as each payroll is processed. Payment terms for staffing customers are generally 30 days, while PEO clientsâ invoices are generally due on the invoice date.
Our business is concentrated in California and Oregon and we expect to continue to derive a majority of our revenues from these markets in the future. Revenues generated in our California and Oregon offices accounted for 72% of our total revenues in 2007, 74% in 2006 and 74% in 2005. Consequently, any weakness in economic conditions or changes in the regulatory environments in these regions could have a material adverse effect on our financial results.
We offer cash safety incentives to certain PEO clients for maintaining safe-work practices in order to minimize workplace injuries. The cash incentive is based on a percentage of annual payroll and is paid annually to customers who meet predetermined workersâ compensation claims cost objectives. Safety incentive payments are made only after closure of all workersâ compensation claims incurred during the customerâs contract period. The safety incentive expense is also netted against PEO revenues on our statements of operations.
Our cost of revenues is comprised of direct payroll costs for staffing services, employer payroll-related taxes and employee benefits and workersâ 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 employerâs portion of Social Security and Medicare taxes, federal unemployment taxes, state unemployment taxes and staffing services employee reimbursements for materials, supplies and other expenses, which are paid by the customer. Workersâ compensation expense consists primarily of the costs associated with our self-insured workersâ compensation program, such as claims reserves, claims administration fees, legal fees, state administrative agency fees and excess insurance costs for catastrophic injuries. We also maintain separate workersâ compensation insurance policies for employees working in states where we are not self-insured.
The largest portion of workersâ compensation expense is the cost of workplace injury claims. When an injury occurs and is reported to us, our respective independent third-party claims administrator (âTPAâ) or our internal claims management personnel analyze the details of the injury and develop a case reserve, which becomes the estimate of the cost of the claim based on similar injuries and their professional judgment. We then record or accrue an expense and a corresponding liability based upon our estimate of the ultimate claim cost. As cash payments are made by our TPA against specific case reserves, the accrued liability is reduced by the corresponding payment amount. The TPA and our in-house claims administrators also review existing injury claims on an on-going basis and adjust the case reserves as new or additional information for each claim becomes available. Our reserve includes a provision for both future anticipated increases in costs (âadverse loss developmentâ) of the claims reserves for open claims and for claims incurred but not reported related to prior and current periods. We believe our operational policies and internal claims reporting system help to limit the occurrence of unreported incurred claims.
Selling, general and administrative expenses represent both branch office and corporate-level operating expenses. Branch operating expenses consist primarily of branch office staff payroll and personnel related costs, advertising, rent, office supplies, depreciation and branch incentive compensation. Corporate-level operating expenses consist primarily of executive and office staff payroll and personnel related costs, professional and legal fees, travel, depreciation, occupancy costs, information systems costs and executive and corporate staff incentive compensation.
Amortization of intangible assets consists of the amortization of software costs, and covenants not to compete, which are amortized using the straight-line method over their estimated useful lives, which range from two to ten years.
Critical Accounting Policies
We have identified the following policies as critical to our business and the understanding of our results of operations. For a detailed discussion of the application of these and other accounting policies, see Note 1 to the audited consolidated financial statements included in Item 15 of this Report. Note that the preparation of this Annual Report on Form 10-K requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Self-Insured Workersâ Compensation Reserves . We are self-insured for workersâ compensation coverage in a majority of our employee work sites in Oregon, California, Maryland and Delaware and for staffing services only in Washington. The estimated liability for unsettled workersâ compensation claims represents our best estimate, which includes an evaluation of information provided by our internal claims adjusters and our third-party claims administrators, coupled with managementâs assessment of claim development trends and claim conversion factors. These elements serve as the basis for our overall estimate for workersâ compensation claims liabilities, which include more specifically the following components: case reserve estimates for reported losses, plus additional amounts based on projections for incurred but not reported claims, anticipated increases in case reserve estimates and additional claims administration expenses. These estimates are continually reviewed and adjustments to liabilities are reflected in current operating results as estimates for such costs change. We believe that the amounts recorded for our estimated liabilities are reasonable and objective and are based upon facts and development factors and other trends associated with the Companyâs historical universe of claims data. Nevertheless, it is reasonably possible that adjustments to such estimates may be required in future periods if the development of claim costs varies materially from our estimates and such adjustments, if necessary, could be material to results of operations.
Safety Incentives Liability . Our accrued safety incentives represent cash incentives paid to certain PEO client companies for maintaining safe-work practices in order to minimize workplace injuries. The incentive is based on a percentage of annual payroll and is paid annually to customers who meet predetermined workersâ compensation claims cost objectives. Safety incentive payments are made only after closure of all workersâ compensating claims incurred during the customerâs contract period. The liability is estimated and accrued each month based upon the then-current amount of the customerâs estimated workersâ compensation claims reserves as established by our internal claims adjusters and our third party administrators.
Allowance for Doubtful Accounts . We are required to make estimates of the collectibility of accounts receivables. Management analyzes historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in the customersâ payment tendencies 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.
Goodwill . We assess the recoverability of goodwill annually and whenever events or changes in circumstances indicate that the carrying value might be impaired. Factors that are considered include significant underperformance relative to expected historical or projected future operating results, significant negative industry trends and significant change in the manner of use of the acquired assets. Managementâs current assessment of the carrying value of goodwill indicates there was no impairment as of December 31, 2007. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets, as of the date of our annual assessment on December 31.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements and their potential effect on the Companyâs results of operations and financial condition, refer to Note 1 in the Notes to the Financial Statements beginning at page F-6 of this Annual Report on Form 10-K.
Results of Operations
The following table sets forth the percentages of total revenues represented by selected items in the Companyâs Statements of Operations for the years ended December 31, 2007, 2006 and 2005, included in Item 15 of this report. References to the Notes to Financial Statements appearing below are to the notes to the Companyâs financial statements included in Item 15 of this report.
We report PEO revenues in accordance with the requirements of EITF No. 99-19 which requires us to report such revenues on a net basis because we are not the primary obligor for the services provided by our PEO clients to their customers pursuant to our PEO contracts. We present for comparison purposes the gross revenues and cost of revenues information for the years ended December 31, 2007 and 2006 set forth in the table below. Although not in accordance with generally accepted accounting principles in the United States (âGAAPâ), 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 PEO services on a basis comparable to our staffing services.
Years Ended December 31, 2007 and 2006
Net income for 2007 amounted to $16.8 million, an improvement of 2.9% or $470,000 over net income of $16.3 million for 2006. The improvement for 2007 was primarily due to higher gross margin dollars as a result of significant growth in our staffing business, partially offset by higher selling, general and administrative expenses. Diluted earnings per share for 2007 was $1.44 compared to $1.40 for 2006.
Revenues for 2007 totaled $289 million, an increase of approximately $30.0 million or 11.6%, which reflects growth in both the Companyâs staffing service revenue and in PEO service fee revenue. Staffing service revenue increased approximately $23.7 million or 19.2% over 2006 primarily due to the acquisitions of Strategic Staffing on July 2, 2007 and Phillips Temps on December 3, 2007. The increase was offset in part by a decline in business with existing or former customers in excess of market share gains attributable to new customers. On a comparable branch office basis, i.e. without the benefit from the incremental revenue generated from Strategic Staffing and Phillips Temps during the year ended December 31, 2007, staffing revenues for the year declined 0.7% or approximately $898,000. During 2007, the Company served approximately 2,300 staffing service customers, which compares to approximately 1,800 customers during 2006. Management expects demand for the Companyâs staffing services will continue to reflect overall uncertain economic conditions in its market areas. PEO service fee revenue increased approximately $6.3 million or 4.6% over the 2006 comparable period primarily due to the net effect from the addition of new client companies. During 2007, the Company served approximately 1,500 PEO clients, which compares to approximately 1,300 PEO clients during 2006. Net growth in the Companyâs PEO business has slowed due to general economic conditions.
Gross margin for 2007 totaled approximately $58.9 million, which represented an increase of $3.4 million or 6.0% over 2006, primarily due to the 11.6% increase in revenues. The gross margin percent declined from 21.4% of revenues for 2006 to 20.4% for 2007. The decline in the gross margin percentage was mainly due to higher direct payroll costs, expressed as a percent of revenues. The increase in direct payroll costs, as a percentage of revenues, from 35.8% for 2006 to 39.2% for 2007 reflects the moderate shift in the overall mix of services from PEO services to staffing services in the Companyâs customer base primarily attributable to the acquisitions of Strategic Staffing and Phillips Temps and the effect of each customerâs unique mark-up percent. Workersâ compensation expense, as a percent of revenues, declined from 10.5% in 2006 to 10.0% in 2007. Workersâ compensation expense for 2007 totaled $29.0 million, which compares to $27.2 million for 2006. The decrease, as a percentage of revenues, was due, in part, to cost savings from lower excess insurance premiums as a result of an increase in the self-insured retention from $1.0 million to $5.0 million in four of the five states in which the Company is self-insured for workersâ compensation purposes and to slightly lower insurance premiums in states where the Company is not self-insured, offset in part by higher estimated costs for claims. Based upon our evaluation of open workersâ compensation claims at December 31, 2007, we recorded an additional workersâ compensation expense of $2.2 million (pre-tax) in the fourth quarter of 2007 to reflect our estimated costs to close workersâ compensation claims. The decline in payroll taxes and benefits, as a percentage of revenues, from 32.3% for 2006 to 30.4% for 2007, was largely due to the effect of growth in staffing services, offset in part by lower effective state unemployment tax rates in various states in which the Company operates as compared to 2006. We expect gross margin as a percentage of total revenues to continue to be influenced by fluctuations in the mix between staffing and PEO services, as well as the adequacy of our estimates for workersâ compensation claims liabilities.
Selling, general and administrative (âSG&Aâ) expenses consist of compensation and other expenses relating to the operation of our headquarters and our branch offices and the marketing of our services. SG&A for 2007 amounted to approximately $34.7 million, an increase of $3.1 million or 9.8% over 2006. The increase over 2006 was primarily attributable to increases in branch management personnel and related expenses as a result of the incremental SG&A expenses associated with the Strategic Staffing and Phillips Temps acquisitions, which represented $2.5 million or 81.4% of the increase. SG&A expenses, as a percentage of revenues, decreased from 12.2% in 2006 to 12.0% in 2007.
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R, âShare-Based Paymentâ (âSFAS 123Râ), which requires the grant-date fair value of all share-based payment awards, including employee stock options, to be recorded as employee compensation expense over the requisite service period. We applied the modified prospective transition method when we adopted SFAS 123R and, therefore, did not restate any prior periods. Effective with the close of business on December 30, 2005, the Company accelerated the vesting of all outstanding stock options to eliminate future compensation expense associated with those options under SFAS 123R. As a result of the accelerated vesting, during 2007 and 2006, we recorded no incremental compensation expense as a result of adopting SFAS 123R. If we had accounted for our share-based payment awards under SFAS 123R during 2005, our compensation expense would have been approximately $1.7 million higher. The Company has not determined if it will grant future awards under its 2003 Stock Incentive Plan. For additional information about the adoption of SFAS 123R, refer to Note 1 of the Notes to Consolidated Financial Statements included in Item 15 of this report.
Other income for 2007 was $3.1 million compared to other income of $2.8 million for 2006. The increase in other income for 2007 was primarily attributable to increased investment income earned on the Companyâs higher cash balances.
Depreciation and amortization totaled $1.4 million for 2007, which compares to $1.3 million for 2006. The increase in the depreciation and amortization expense level compared to 2006 was primarily due to the acquisitions of Strategic Staffing and Phillips Temps.
Our effective income tax rate for 2007 was 35.2%, as compared to 35.9% for 2006. The lower 2007 effective rate was primarily attributable to increases in Federal tax credits and Federal tax-exempt interest income.
At December 31, 2007, we had deferred income tax assets of $3.1 million, which consist of temporary differences between taxable income for financial accounting and tax purposes, which will reduce taxable income in future years. Pursuant to GAAP, we are required to assess the realization of the deferred income tax assets as significant changes in circumstances may require adjustments during future periods. Although realization is not assured, management has concluded that it is more likely than not that the remaining deferred income tax assets will be realized, principally based upon projected taxable income for the next two years. The amount of the deferred income tax assets actually realized could vary, if there are differences in the timing or amount of future reversals of existing deferred income tax assets or changes in the actual amounts of future taxable income as compared to operating forecasts. If our operating forecast is determined to no longer be reliable due to uncertain market conditions, our long-term forecast may require reassessment. As a result, in the future, a valuation allowance may be required to be established for all or a portion of the deferred income tax assets. Such a valuation allowance could have a significant effect on our future results of operations and financial position.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
The following table sets forth the percentages of total revenues represented by selected items in the Companyâs Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007.
We report PEO revenues in accordance with the requirements of Emerging Issues Task Force No. 99-19, âReporting Revenues Gross as a Principal Versus Net as an Agentâ (âEITF No. 99-19â), which requires us to report such revenues on a net basis because we are not the primary obligor for the services provided by our PEO clients to their customers pursuant to our PEO contracts. We present for comparison purposes the gross revenues and cost of revenues information set forth 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 PEO services on a basis comparable to our staffing services.
Three months ended March 31, 2008 and 2007
Net income for the first quarter of 2008 amounted to $91,000, a decline of 94.7% or $1.6 million from net income of $1.7 million for the first quarter of 2007. The decline for the first quarter of 2008 was primarily due to lower gross margin dollars as a result of higher direct payroll costs and higher workersâ compensation expense and to higher selling, general and administrative expenses. Diluted earnings per share for the first quarter of 2008 were $.01 compared to $.15 for the comparable 2007 period.
Revenues for the first quarter of 2008 totaled $66.2 million, an increase of approximately $5.6 million or 9.3%, which reflects an increase in the Companyâs staffing services revenue, and a slight decrease in PEO service fee revenue. Staffing services revenue increased approximately $7.8 million or 27.9% over the comparable 2007 quarter primarily due to the three acquisitions made since July 2007. On a comparable branch office basis, i.e. without the effect of the three acquisitions, staffing services revenues for the first quarter declined 11.5% or approximately $3.2 million from the comparable quarter in 2007. The decline in staffing services revenue was attributable to general economic conditions affecting our customersâ business. Management expects demand for the Companyâs staffing services will continue to reflect overall economic conditions in its market areas. PEO service fee revenue decreased approximately $2.2 million or 6.7% from the 2007 first quarter primarily due to a decline in business with existing PEO customers, offset in part by the net effect from the addition of new customers. General economic conditions continue to adversely affect the growth of our existing PEO customer base.
Gross margin for the first quarter of 2008 totaled approximately $8.6 million, which represented a decrease of $1.1 million or 11.6% from the first quarter of 2007, primarily due to higher direct payroll costs and higher workersâ compensation costs in terms of total dollars and as a percentage of revenues. The gross margin percent decreased from 16.0% of revenues for the first quarter of 2007 to 12.9% for the first quarter of 2008. The increase in direct payroll costs, as a percentage of revenues, from 34.9% for the first quarter of 2007 to 39.9% for the first quarter of 2008 reflects the shift in the overall mix of services from PEO services to staffing services in the Companyâs customer base primarily resulting from the three acquisitions made since July 2007 and the effect of each customerâs unique mark-up percent. Workersâ compensation expense, as a percent of revenues, increased from 9.6% in the first quarter of 2007 to 10.3% in the first quarter of 2008. Workersâ compensation expense for the first quarter of 2008 totaled $6.8 million, compared to $5.8 million for the first quarter of 2007. This increase was primarily due to higher estimates for claim costs in states where the Company is self-insured. The decrease in payroll taxes and benefits, as a percentage of revenues, from 39.5% for the first quarter of 2007 to 36.9% for the first quarter of 2008, was largely due to the effect of growth in staffing services, offset in part by higher effective state unemployment tax rates in various states in which the Company operates as compared to the first quarter of 2007.
Selling, general and administrative (âSG&Aâ) expenses for the first quarter of 2008 amounted to approximately $8.7 million, an increase of $1.3 million or 17.3% over the first quarter of 2007. The increase over the first quarter of 2007 was primarily attributable to the incremental SG&A expense associated with the three acquisitions made since July 2007, which represented $1.4 million, partially offset by a $150,000 or 2.0% decrease in comparable branch operating expenses resulting from the similar level of business in the first quarter of 2008 compared to the same quarter of 2007. SG&A expenses, as a percentage of revenues, increased from 12.2% in the first quarter of 2007 to 13.1% in the first quarter of 2008.
Other income for the first quarter of 2008 was $626,000 compared to $785,000 for the first quarter of 2007. The decline in other income for the first quarter of 2008 was primarily attributable to decreased investment income earned on the Companyâs cash balances.
Factors Affecting Quarterly Results
The Company has historically experienced significant fluctuations in its quarterly operating results and expects such fluctuations to continue in the future. The Companyâs operating results may fluctuate due to a number of factors such as seasonality, wage limits on statutory payroll taxes, claims experience for workersâ compensation, demand and competition for the Companyâs services and the effect of acquisitions. The Companyâs revenue levels may fluctuate from quarter to quarter primarily due to the impact of seasonality on its staffing services business and on certain of its PEO clients in the agriculture, food processing and construction-related industries. As a result, the Company may have greater revenues and net income in the third quarter of its fiscal year. Revenue levels in the fourth quarter may be affected by many customersâ practice of operating on holiday-shortened schedules. Payroll taxes and benefits fluctuate with the level of direct payroll costs, but tend to represent a smaller percentage of revenues and direct payroll later in the Companyâs fiscal year as federal and state statutory wage limits for unemployment and social security taxes are exceeded on a per employee basis. Workersâ 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. Adverse loss development of prior period claims during a subsequent quarter may also contribute to the volatility in the Companyâs estimated workersâ compensation expense.
Liquidity and Capital Resources
The Companyâs cash position for the three months ended March 31, 2008 decreased $7.9 million from December 31, 2007, which compares to a decrease of $167,000 for the comparable period in 2007. The decrease in cash at March 31, 2008 as compared to December 31, 2007, was primarily due to cash used for the First Employment Services acquisition of $3.8 million, the Companyâs repurchase of its common stock of $1.5 million and cash used in operating activities of $1.1 million.
Net cash used in operating activities for the three months ended March 31, 2008 amounted to $1.1 million, as compared to cash provided by operating activities of $2.1 million for the comparable 2007 period. For the three months ended March 31, 2008, cash flow was principally used by an increase of $4.5 million in trade accounts receivable and an increase of $1.5 million in prepaid expenses and other, offset in part by an increase in accrued payroll and related benefits of $5.2 million.
Net cash used in investing activities totaled $4.4 million for the three months ended March 31, 2008, compared to $1.5 million for the similar 2007 period. For the 2008 period, the principal uses of cash for investing activities were for the acquisition of First Employment Services of $3.8 million, and the purchase of restricted marketable securities of $1.3 million, offset in part by proceeds totaling $901,000 from maturities of restricted marketable securities. The transactions related to restricted marketable securities were scheduled maturities and the related replacement of such securities held for workersâ compensation surety deposit purposes. The Company presently has no material long-term capital commitments.
Net cash used in financing activities for the three-month period ended March 31, 2008 was $2.4 million as compared to net cash used in financing activities of $744,000 for the similar 2007 period. For the 2008 period, the principal use of cash for financing activities was the Companyâs repurchase of its common stock of $1.5 million and the payment of a regular quarterly cash dividend totaling $883,000 to holders of the Companyâs Common Stock.
As disclosed in Note 3 to the consolidated financial statements included in this report, the Company acquired certain assets of Strategic Staffing, Inc., a privately held staffing services company with five offices in Utah and one office in Colorado Springs, Colorado, effective July 2, 2007. The Company paid $12.0 million in cash on the effective date for the assets of Strategic Staffing and the selling shareholdersâ non-compete agreements and agreed to pay additional consideration based upon the level of financial performance achieved by the Strategic Staffing offices during the ensuing 12-month period. The Company also acquired certain assets of Phillips Temps, Inc., a privately held staffing services company with an office in downtown Denver, Colorado. The Company paid $1.3 million in cash for the assets of Phillips Temps and the selling shareholdersâ noncompete agreements and paid an additional $300,000 on March 3, 2008. There was no contingent consideration.
Also, as disclosed in Note 3 to the consolidated financial statements in this report, the Company acquired certain assets of First Employment Services, Inc., a privately held staffing services company with offices in Tempe and Phoenix, Arizona, effective February 4, 2008. As consideration for the acquisition, the Company paid $3.8 million in cash and agreed to pay additional consideration of $1.2 million contingent upon the first 12 months of financial performance. For 2007, First Employmentâs revenues were approximately $7.5 million. Management anticipates that this acquisition may increase earnings by approximately 3 to 4 cents per diluted share for the 12-month period following the effective date.
Thank you, good morning. This is Mike Mulholland with Bill Sherertz. Today we will provide you with our comments regarding the company's operating results for the first quarter ended March 31, and our outlook for the second quarter of 2008. At the conclusion of our comments we will respond to your questions.
Our remarks during today's conference call may include forward-looking statements. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may different materially from those implied by the forward-looking statements. Please refer to our recent earnings release and to our quarterly and annual reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ.
Most of our comments today will be based upon gross revenues and various relationships to gross revenues because management believes such information is, one, more informative as to the level of our business activity, two, more useful in managing our operations, and thirdly, we believe it adds more transparency to the trends within our business. Comments related to gross revenues as compared to a net revenue basis of reporting have no effect on gross margin dollars, SG&A expenses, or net income.
Turning now to the first quarter results, as reported, the company earned $0.01per diluted share in the first quarter as compared to $0.15 for the same quarter a year ago. On a summary level, the decline in earnings was principally attributable to three factors: One, a modest increase in gross revenues of just eight-tenths of 1%. Two, a 46 basis point decline in the gross margin percent. And, three, higher branch level SG&A expenses due to three acquisitions since 2Q of '07.
Total gross revenues for the first quarter of $259.6 million increased less than 1% over 1Q â07. Excluding the benefit from the three acquisitions, organic growth for the company on a quarter-over-quarter basis was a decline of 3.5%, which reflects overall economic conditions in our markets. California, which comprises approximately 75% of our overall gross revenues, was flat for 1Q '08, down just three-tenths of 1% owing principally to a decline in staffing as PEO revenues in the state increased 1% over a year ago.
Staffing revenues for 1Q '08 increased 27.9% over 1Q '07. On an organic basis or comparable branch office basis, staffing revenues declined 11.5% in the quarter. PEO gross revenues declined 2.5% on a quarter-over-quarter basis. Acquisitions did not affect the comparability of this rate. Regionally, the Portland and mid-Atlantic regions demonstrated very strong double-digit growth rates for PEO business. In view of the economic climate, we attribute this growth to fundamental market share gains.
Our gross margin percent on a gross revenues basis for 1Q '08 declined 46 basis points from a year ago. Direct payroll costs decreased by approximately 20 basis points due to increased staffing business, which has a higher mark-up percent, thus, lower payroll percent. Payroll taxes and benefits for 1Q '08, expressed as a percent of total direct payroll, increased over the same quarter last year primarily due to a 50 basis point increase in our California unemployment tax, or SUTA rate. This increase contributed approximately $600,000 of incremental SUTA tax as compared to 1Q of '07, or a decrement of approximately $0.034 per share.
As you may know, for accounting purposes, we do not utilize a constant annualized estimate throughout the year for our payroll tax burden. We recognize the actual effective payroll tax rate as incurred each quarter, which is one of the contributing factors as to why our earnings typically stair step up through a calendar year. This method will create the heaviest payroll tax burden in the first calendar quarter of each year.
Workers' compensation expense for 1Q '08 increased over 1Q '07, both in terms of actual dollars and as a percent of gross revenues. This increase was primarily attributable to higher estimates for claim costs. 1Q '08 SG&A expenses of $8.7 million rose $1.3 million, or 17% over 1Q '07. It is important to note that 100% of this increase was due to the non-comparable branch offices from the three acquisitions we completed between July of last year and February of this year. On a comparable office basis, SG&A expenses for 1Q '08 declined by 2% as compared to 1Q '07.
Turning now to the balance sheet, at March 31, cash and marketable securities of $56.8 million at quarter end declined from December 31 due to an initial payment of $3.8 million in connection with the acquisition of First Employment Services in February, the final deferred payment to Phillips Temps, a December 2007 acquisition, and the payment of our 2008 excess workers' compensation premium in the month of January. The balance of the change in our cash position from year end is simply attributable to fluctuations in working capital requirements. Trade accounts receivable at quarter end of $41.2 million were up over the 12/31 balance due to an increase in days sales outstanding in accounts receivable, or DSO, from 12 to 14 days coupled with the small increase in the amount of accrued receivables at quarter end. In view of the economic environment, we are monitoring collections and credit terms very closely. The increase in goodwill on our balance sheet simply reflects the acquisition of First Employment Services in February.
Turning now to our outlook for the second quarter of 2008, as recently reported, we are expecting gross revenues to range from $262 million to $267 million for the current quarter. This projection represents a very modest sequential increase over 1Q '08 and a likely small decline of approximately 1% to 2% from 2Q of '07.
As we noted in our last conference call, and Bill will reiterate again in a few minutes, we have very little visibility in the directional trends of our revenue stream. There are numerous cross currents in our customer base, which are mitigating, to some extent, market share gain. Based upon the foregoing estimates for revenues, we anticipate diluted earnings per share for the second quarter of 2008 to range from $0.24 to $0.28 as compared to $0.42 per share earned in 2Q of '07. The current economic climate warrants a very cautious outlook as we continue into 2008.
At this time, Bill Sherertz will comment further on the recently completed first quarter and our outlook for the second quarter. Bill?
Thanks, Mike. In the quarter, we signed 87 new PEO customers, which is very strong again. And during that quarter we lost 41. I want to read an excerpt. I'll give you the breakdown of the 41 that we lost. We canceled for AR issues seven. We canceled another two for risk issues. Thirteen were sold, closed or no more employees, and 24 â actually it's less than that, left on their own.
And I'll read you a little excerpt from an e-mail that we got from one of our customer that I think kind of sets the stage for why customers would leave to take it back in-house and I quote, "Hi, Beverly. I know you are aware that we have been shopping or workmen's comp with our broker. We've decided to move our payroll back in-house. I want to emphasize I made the decision for reasons of flexibility, i.e., float time with our workmen's comp schedule and not on BBSI's performance. We've been very satisfied with the work that BBSI has done for us. At this time, I am forecasting a busy schedule in the near future from our general contractors and will be invaluable to future growth. I feel our ability to defer many bills is possible to offset the lag time of our receivables from our general contractors will be invaluable for future growth. I know discussing this with you before making the decision would have been a better course of view, but knowing that BBSI would not be able to allow us same float time as a typical carrier made any other reasons for staying irrelevant. We appreciate all the work your company has done for us and regret to make this change. But at this time, we feel this is a decision we had to make." So, I mean, that's kind of the underlying theme of when companies decide to leave. They have to pay us all of their taxes and workmen's comp virtually on the end of the week on Friday, we trade checks. And so those who want to use IRS money and state withholding money and workmen's comp premiums and medical premiums and â to help finance their business, we are not going to participate with them in that.
March was not a particularly very good month. I think you've seen that in other companies. It has not deteriorated. That is the good news into April from March. It has remained relatively steady. It has not picked up. Our forecast is based on a continuing run rate of what we've seen in the first three weeks of April. So I guess I would tell you that if the economy continues to weaken and gets worse, then we'll be below our estimates. If the economy gets a little stronger or at least stays stable, we'll probably be a little bit above our estimates. But our visibility is not very good in terms of which way the overall economy goes. I remain relatively hopeful that the economic stimulus, the low interest rates, loosening up of the credit markets, will all have an impact on our company at some point.
We continue to sign at a very fast clip [ph] a new business. And so that is a very positive sign for our company. But if you were to examine our customer base, not only do we have a higher churn of our customer base, but the customers who are staying are much smaller than they were, some of them 50% and 60%. So, the headwinds that we face have to do with the macros of the economy. The bad news is that when the economy gets weak the unemployment rates go up and the workmen's comp gets a little more challenging. And so those are the things we are facing. However, I'm really very, very comfortable with the company in terms of the branches, our staff level, our execution level. And there is really not much changes we can make except to nibble at the edges, having to do expenses and run a very tight ship and we will do that.