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Copperfield Research is the pseudonym of a research team focusing on publicly traded equities. As of the publication date of our articles, we may have long or short equity positions in the companies covered. We do not discuss unpublished reports, or provide any advanced warning of future reports... More
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  • BBSI - Garbage In, Garbage Out

    There is not a lot else that can be said as it relates to Barrett Business Services (NASDAQ:BBSI). You either blindly believe in the moving numbers and management that is self-proclaimed as strong as "tempered steel".... or you don't. While our arithmetic is fallible like everybody else with a spreadsheet, we at a minimum try to understand the garbage going in and coming out. This basic desire to understand how a guided number is built makes us a bit different than the two sell-side buddies of BBSI management.

    In its earnings press release, management guided 2015 EPS to $3.30 per share for 2015. Coincidently, this was precisely inline with the average of the two estimates ($3.31 to be precise based on estimates of $3.46 and $3.15). The basic drivers BBSI management provided lead to an EPS number that is starkly different (lower of course) than their inline headline number. The publicly stated disclosures include: 18% revenue growth, a workers' compensation accrual between 4.8% and 5% of gross revenue, and a mid-to-high 30's % tax rate. The company will have around $1.5 million of incremental interest expense based on their maturity schedule. Direct payroll costs and payroll taxes have been relatively consistent for years (and they are already benefiting from applying prior wages against the taxable wage basis as new customers are onboard). The only significant unknown variable is SG&A expense. On its fourth quarter 2014 conference call this morning, management stated that they plan to invest in additional business units, geographies, and related "structural and organizational build," which would seem to suggest continued SG&A growth. If we conservatively assume SG&A grows at a mere 14% (compared to 18% top-line guidance), then a basic model seems to calculate an earnings estimate of $2.25 per share at a 5% accrual. This is approximately 33% lower than management's guidance.

    (click to enlarge)

    Using the lower end of the accrual range (4.8%), we still calculate an earnings number of $2.94 per share, significantly below the $3.30 of guidance (see model at end of the document). It is worth noting that a number of incremental costs will now be flowing through the workers' compensation accrual. Management seemed to suggest that the incremental surety bond expense and letter of credit expense will now flow through the workers' compensation accrual. If their California surety bond covers the size of their reserves, or roughly $185 to $195 million, then this is a large probable step-up expense. In addition, ACE will collect full fronting fees and BBSI will have to pass through premium taxes to the State of California (PEOs avoided this tax prior to having their licenses revoked). We estimate that BBSI's "other workers' comp expense," which covers commissions, fronting, reinsurance and other expenses, was running near 1.6% of gross revenue in the second half of 2014. If this increases to only 1.7% with additional ACE costs and surety / line of credit expenses, management's 4.8% to 5% workers' compensation accrual guidance implies the claims expense accrual (what actually builds reserves to cover future workers' comp claims) would be running at, or below, the levels of 2009, 2011, 2012 and 2013. As we ultimately found out, those accrual levels resulted in BBSI being significantly under reserved. These years included a claims expense accrual of 2.37% to 3.11%, which increased significantly from the company's third quarter 2014 reserve charge. By comparison, we estimate the 2015 claims expense accrual implied in management's guidance will only be 2.52% to 2.72%. As such, we view the 4.8% to 5% accrual as an aggressive assumption.

    We can address BBSI's strained liquidity at a later date. However, we found it amusing (we'll avoid any stronger language) that management pointed to $25 million of restricted cash freeing up this year from California. This cash will only free up as they pay out $25 million of claims (so no real incremental cash flow from the balance sheet). We have previously pointed out that free cash flow is a highly questionable statistic for an insurance company that is growing their exposure in long-tail claim payments. Regardless, BBSI had roughly $65 million of free cash flow in 2014. Of this $65 million, more than $50 million was needed to fund the ACE trust account alone. Contributions into the ACE trust account could double in 2015, in which case a large negative cash flow hole would exist prior to the $25 million of Wells Fargo debt that is scheduled to mature. The only way BBSI we envision BBSI generating sufficient cash flow to fund its growing liabilities would be to continue to under price its workers' compensation business to attract new customers, with the hope claims expense down the road somehow improves. We continue to think this ends badly and believe shares have significant downside from current levels.

    (click to enlarge)

    Tags: BBSI
    Feb 04 3:16 PM | Link | 3 Comments
  • Barrett Business Services (BBSI): Throwing Good Money At Bad

    Today we share a follow-up to our original BBSi report. We believe the analysis herein is even more impactful than our original report. Below are the highlights of our second report, which concludes BBSI may have as much as a $135 million funding gap (as well as revealing another crippling reserve charge is likely). Our analysis, based on a plethora of new disclosures and data points suggests an updated fair value for BBSI is between $0.00 and $8.76 per share, representing 65% to 100% downside.

    Our full report can be found here:

    Barrett Business Services (NASDAQ:BBSI) has suffered a precipitous stock price decline over the last two months as the confession process has begun. Despite a stock price down nearly 75% from its highs, we believe the risk speculating in BBSI's common stock has never been higher. Simply put, a $100 stock that goes to $25 generates a smaller percentage loss than a $25 stock that goes to $0. Uninformed investors/traders appear to have fallen victim to the dangerous temptation of assuming the worst is behind BBSI, declaring the bottom is in, the bounce is at hand, or as the irresponsible sell-side has proclaimed - the decks have been cleared. This follow-up report, based on new information and disclosures since our first report, unequivocally concludes the worst has yet to come for BBSI.

    On 9/16/14, we shared a lengthy BBSI report titled, "Barrett Business Services (BBSI): A Tick-Tick-Ticking Time Bomb" (it can now be printed to accommodate many requests).[i] Following BBSI's third quarter financial release and disclosure of an $80 million reserve charge (10/28/14), we briefly shared updated thoughts in "BBSI: Tick-Tick Boom."[ii] In short, substantial downside still exists and making money owning BBSI's stock appears to be effectively capped.

    It is our opinion that the $80 million reserve charge is just the beginning. Based on management's recent disclosures, our analysis suggests BBSI will be required to take another reserve charge of at least $55 million. We believe the company is not only aware of this probability, but management's bizarre actions are an attempt to prop up the stock price long enough to minimize the dilution of an eventual distressed equity raise. (To this point, we are admittedly surprised BBSI's management has not yet "hit the road" to meet with institutional investors).

    Our first report accurately analyzed BBSI's systematic reserve deficiencies. In this report, we provide an equally concise, and perhaps irrefutable argument supporting our belief that another reserve charge is on the horizon. We can not stress enough that the recent $80 million charge does not "clear the decks" as some interested parties have argued. In fact, per BBSI's own admission, the $80 million charge only targets reserve deficiencies for accident years 2012 and prior, leaving the severe workers' comp under-accrual from 2013 and 2014 unaddressed. This begs the question - Did BBSI ignore Willis' recommendation of a larger reserve charge that would have covered the 2013/2014 under-accruals, but also would have effectively wiped out the common equity in the process?

    The same sell-side analysts that were politely excused from prior culpability (due to their lack of insurance expertise) have failed to think independently, suggesting the bad medicine has been taken. Our analysis herein unequivocally concludes BBSI is still massively under-reserved. By extension, a common equity raise appears to be a question of "when" not "if" which explains management's token buyback, dividend increase, and immaterial insider buying. In this report, we cover a number of topics, including:

    1) BBSI Appears Unprofitable; Another Large Reserve Charge Is Inevitable (& Management Knows It); ACE Risk Grows

    BBSI's reserve charge only addresses reserve deficiencies through calendar year 2012. As such, 2013/2014 reserves require significant strengthening. Based on an accident year model allocating the $80 million reserve charge and prior period development, we estimate BBSI's core business lost money every year between 2009 and 2012.Our analysis found the strengthened 2010 - 2012 reserves are approximately 45% and 26% higher than 2013 and 2014 reserve levels respectively. To bring 2013/2014 reserve levels to parity with 2010 - 2012 reserves, we estimate another $70 million charge is required. If BBSI management took the 2013/2014 reserves to a level consistent with updated accrual guidance, a $55 million charge would be required. We believe management's carefully worded press release and prepared remarks on its Q3'14 call means the actuarial rigor used to establish accident year reserves for "2012 and prior" was abandoned for determining 2013/2014 reserves. While management may try to buy time, hoping the actuarial data magically improves, we believe ACE may reconsider the fronting agreement in the interim. BBSI has changed materially since the fronting agreement was announced. Further, ACE's trusted partner Willis was used for the reserve study (as we predicted), suggesting ACE may not be comfortable with BBSI's reserves/underwriting. In our opinion, BBSI would likely go into run-off should ACE non-renew its fronting agreement.

    2) Debt Alone Can Not Bridge BBSI's Funding Gap, Which Appears Much Larger Than Disclosed

    BBSI is required to collateralize its $80 million reserve charge on a dollar-for-dollar basis to stay in compliance with State requirements. Under new law, California regulators have the discretion to require a security deposit greater than 100% of reserves in cases resembling BBSI. Management has proclaimed $32 million of the required funding can be met through a tax refund. But based on our analysis, the anticipated refund (40% of the $80 million charge) represents 55% more than the $20.7 million of cash taxes BBSI has paid since 2009. Insurance companies are typically limited to debt-to-capitalization ratios of 20% to 25%. Should Wells Fargo view BBSI in the same vein as other insurers, BBSI's debt capacity may only be $8.5 to $11.5 million. If BBSI somehow raised $65 million of debt (on just $34.4 million of equity), its leverage ratio would be 65%, higher than any solvent insurance company we could find. BBSI's 2014 cash flow has failed to cover the required funding of the ACE trust account. Year-to-date, BBSI has contributed $31.1 million to the ACE trust account representing more than 100% of its already overstated cash flow. We believe an additional $20 million to $50 million is needed to fully collateralize the original ACE funding agreement. The ACE funding burden will be concurrent with the State level funding requirements on legacy reserve levels, at the same time BBSI will also be struggling to fund current and future reserves dollar-for-dollar. According to BBSI management, the company has $15 million of unencumbered cash, $14 million on an undrawn credit facility, and our estimate of a $21 million tax refund from cash taxes paid. We estimate BBSI has $185 million of near-term capital needs with only $50 million of identified sources. The result is a $135 million capital hole. Considering the expected hole, we find management's actions in the wake of the reserve charge irrational and irresponsible. As recently as September 2014, BBSI wasted precious capital to buy back stock at prices nearly 100% higher than the current price. Instead of prudently rightsizing exposure through re-underwriting and re-pricing its business, BBSI management announced it would grow same store sales in 2015. Finally, BBSI increased its quarterly dividend by 22% (which it will not be able to cover based on our 2015 estimates), despite requiring $80 million of near-term capital.

    3) Irrationally Aggressive Pricing and Outlandish Marketing Claims

    We believe BBSI has materially underpriced its workers' compensation insurance to grow in a highly commoditized industry. BBSI's own marketing materials claim to offer "lower workers' compensation premiums [due to] aggressive claims management." Amazingly, we have obtained BBSI marketing slides stating their California loss ratio is just 10% - 14%. This compares to standard market carrier loss ratios between 50% and 75%. BBSI's own marketing materials suggest it would be 600% - 700% more profitable than the industry average cited by the California Department of Insurance. Further, we question what BBSI means when referring to "aggressive claims management." Public lawsuits shed insight into the challenges individuals have had obtaining settlements, while also leading us to question why BBSI accepted a workers' compensation client one year after being charged with defrauding the California State Compensation Insurance Fund.

    4) Stock Still Significantly Overvalued on Estimated 2015 EPS

    At a 12x earnings multiple on our generous set of 2015 earnings estimates, BBSI's fair value would be $8.76 per share. Our estimates generously exclude increased costs associated with changes to the ACE fronting agreement (which mathematically appears impossible). With the combination of another reserve charge looming for 2013/2014 business, uncertainty about its funding/capital ratios/leverage, and the pending ACE fronting agreement renewal, we see numerous scenarios, and a growing probability that BBSI's equity will be worth zero.

    IMPORTANT Disclaimer - Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.



    Tags: BBSI
    Nov 11 1:02 PM | Link | 16 Comments
  • BBSI: Tick-Tick Boom

    After the close on 10/28/2014, BBSI reported a net loss of $5.27 per share, driven by an $80 million pretax increase in workers' comp reserves. In our previous report "Barrett Business Services (NASDAQ:BBSI): A Tick-Tick-Ticking Time Bomb" we highlighted the systematic overstatement of earnings due to persistent under accruing of workers' comp reserves. We also highlighted the consistent trend of prior period adjustments, which in our opinion, blatantly violated U.S. GAAP accounting rules. The result of the accounting irregularities was a further overstatement of earnings. BBSI's $80 million pretax charge effectively wipes out the past five years of pretax earnings. Further, the charge represents a 70% increase in workers' compensation reserves compared to Q2'14. Said another way, our thesis that BBSI has been writing economically unprofitable business (despite reporting accounting profits) over the past few years, now appears incontrovertible.

    As we highlighted in our original report, most of BBSI's sell-side analysts had minimal insurance experience. As such, it our understanding the sell-side has been relying on management's commentary to shape responses to our original report. We believe the sell-side has been suggesting to institutional clients that a charge between $5 and $10 million was a possibility. Considering the $80 million bombshell BBSI just dropped, it is understandable that the previously promotional analysts may feel slightly misled. Further, in no way, does this charge reset past mistakes.

    Demonstrating management's condescending treatment of the investment community, they provided an "adjusted EPS" figure that excludes the all-important reserve charge. Make no mistake, the reserve charge reflects a true-up for years of pre-tax earnings that were overstated. To "adjust" out the most important and volatile cost of BBSI's business is akin to a utility excluding its cost of generating electricity.

    Even more disturbing, management provided a 12-month revenue outlook that included high single-digit same store sales growth, despite apparently having minimal basis to conclude the business they are underwriting is even profitable. It is clear to us that this management team has limited visibility into its insurance exposure. Management's suggestion that they will continue to grow exposure despite having no ability to ensure that exposure is even profitable, unequivocally tells us BBSI management is more concerned with investor perception than right-sizing its future liabilities.

    On top of the catastrophic reserve charge is BBSI's disclosure that "several quarters" of "normalized" claims data will be necessary to "provide a clearer indication of potential liability." Despite a previously unimaginable $80 million charge, BBSI management appears to be confessing that future reserve increases may still be needed. The culmination of all of this "sudden" bad news appears to be BBSI's disclosure that it has entered into discussions with its bank to "meet the liquidity needs of the company." Based on our analysis, much of which was shared in our original report, we would not be surprised if BBSI had insufficient cash to collateralize its business with ACE. By extension, we believe the $80 million charge (with more seemingly to come) could result in ACE re-evaluating its fronting arrangement with BBSI. Despite the concerning statement regarding liquidity, BBSI still had the audacity to buy a token amount of stock, for reasons we can only guess are perception-based.

    After the $80 million reserve charge, BBSI's shareholders' equity has been reduced to a paltry $4.80 per share, while tangible equity declined to a NEGATIVE $13.4 million. While we look forward to hearing their strategy to address any liquidity challenges, it is our opinion that BBSI may ultimately require a distressed equity raise.

    It seems clear to us that management was very much aware of the implications of its reserve deficiencies. Between its "pro-forma" report, token buyback, completely irresponsible growth projections, and "off-line" discussions with sell-side analysts, our guess is that many investors will see through the ruse. Unfortunately, investors were not given the opportunity to sell after-hours. Past earnings reports had been released by BBSI approximately 10 minutes after the market had closed (4:10 PM ET). Perhaps a mere coincidence, but with a high probability of pissed-off analysts and distraught shareholders, we believe management again displayed poor judgment by waiting until 8:17 PM ET to release its report - after most investors had gone home and after-hours trading had stopped.

    In our original report, we generously reached a $29 fair value estimate for BBSI, which assumed BBSI DID NOT take a massive reserve charge. With an $80 million charge, an opaque suggestion of liquidity issues, and shredded credibility, it would not surprise us to see an SEC accounting inquiry and/or justifiable class action lawsuits. Considering all of our past concerns, combined with the possibility of legal woes, we think the probability of BBSI being a zero is now well north of zero.

    Tags: BBSI
    Oct 29 9:19 AM | Link | 9 Comments
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