BARRETT BUSINESS SERVICES INC - Quarter Report: 2009 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended September 30, 2009

Commission File No. 0-21886

BARRETT BUSINESS SERVICES, INC.

(Exact name of registrant as specified in its charter)

(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  x    No  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined 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

Number of shares of common stock, $.01 par value, outstanding at October 30, 2009 was 10,488,202 shares.

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BARRETT BUSINESS SERVICES, INC.

INDEX

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Part I - Financial Information

BARRETT BUSINESS SERVICES, INC.

Consolidated Balance Sheets

(Unaudited)

(In thousands, except per share amounts)

The accompanying notes are an integral part of these financial statements

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BARRETT BUSINESS SERVICES, INC.

Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share amounts)

The accompanying notes are an integral part of these financial statements

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BARRETT BUSINESS SERVICES, INC.

Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share amounts)

The accompanying notes are an integral part of these financial statements

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BARRETT BUSINESS SERVICES, INC.

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these financial statements

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited)

Note 1 - Basis of Presentation of Interim Period Statements

The accompanying consolidated financial statements are unaudited and have been prepared by Barrett Business Services, Inc. (“Barrett”, “BBSI” or the “Company”), 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 have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the 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 financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from such estimates and assumptions. The consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2008 Annual Report on Form 10-K at pages F1 - F25. The results of operations for an interim period are not necessarily indicative of the results of operations for a full year.

Marketable securities

As of September 30, 2009, the Company’s marketable securities consisted of tax-exempt municipal securities, variable rate demand notes (“VRDN”), closed-end bond funds, equity securities, U.S. treasuries and corporate bonds. The Company classifies municipal securities, VRDN, the closed-end bond funds, U.S. treasuries and certain of its 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 other comprehensive income (loss) in stockholders’ equity. In the event a loss is determined to be other-than-temporary, the loss will be recognized in the statement of operations. The equity securities are classified as trading and are reported at fair value with unrealized gains and losses, net of taxes, shown as a component of net income. Certain of the Company’s corporate bonds are classified as held-to-maturity and are reported at amortized cost.

Allowance for doubtful accounts

The Company had an allowance for doubtful accounts of $480,000 and $409,000 at September 30, 2009 and December 31, 2008, respectively. The Company must make estimates of the collectibility of accounts receivable. Management analyzes historical bad debts, customer concentrations, customer creditworthiness, current economic conditions and changes in customers’ payment trends when evaluating the adequacy of the allowance for doubtful accounts. The Company deems an account balance uncollectible only after it has pursued all available assets of the customer and, where applicable, the assets of the personal guarantor.

Workers’ compensation claims

The Company is a self-insured employer with respect to workers’ compensation coverage for all of its employees (including employees subject to Professional Employer Organization (“PEO”) contracts) working in California, Oregon, Maryland, Delaware and Colorado. In the state of Washington, state law allows only the Company’s staffing services and internal management employees to be covered under the Company’s self-insured workers’

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 1 - Basis of Presentation of Interim Period Statements (Continued)

Workers’ compensation claims (Continued)

compensation program. To manage our financial exposure, in the event of catastrophic injuries or fatalities, we maintain excess workers’ compensation insurance (through our wholly owned captive insurance company, Associated Insurance Company for Excess (“AICE”) with a per occurrence retention of $5.0 million, except in Maryland and Colorado, where our per occurrence retention is $1.0 million. AICE maintains excess workers’ compensation insurance coverage with AIG between $5.0 million and $15.0 million per occurrence, except in Maryland and Colorado, where coverage with AIG is between $1.0 million and $25.0 million per occurrence. AIG’s exposure to subprime mortgage securities and disruptions in the U.S. financial markets has adversely impacted AIG. However, AIG’s commercial insurance subsidiary continues to be a fully accepted insurance carrier for all major brokers. As a result, we do not expect these developments to have a material impact on our insurance coverage with AIG. However, we will continue to evaluate the financial capacity of our insurers to assess the recoverability of the related insurer receivables.

The Company has provided a total of $27.8 million and $15.1 million at September 30, 2009 and December 31, 2008, respectively, as an estimated future liability for unsettled workers’ compensation claims liabilities. Included in the foregoing liabilities are insured claims that will be paid by the Company’s former excess workers’ compensation insurer and for which the Company has reported a receivable from the insurer for the insured claims liability. Insured claims totaled $2.6 million and $2.7 million at September 30, 2009 and December 31, 2008, respectively. The estimated liability for unsettled workers’ compensation claims represents management’s best estimate based upon an actuarial valuation provided by a third party actuary. Included in the claims liabilities are case reserve estimates for reported losses, plus additional amounts based on projections for incurred but not reported claims and anticipated increases in case reserve estimates. These estimates are continually reviewed and adjustments to liabilities are reflected in current operating results as they become known.

During the second quarter of 2009, the Company engaged a new actuary to review its workers’ compensation liabilities. While the Company historically obtained an actuarial study, management determined the study was not the best estimate of the workers’ compensation liability. Based upon discussions with the new actuary and a thorough review of the Company’s reserving process and consideration of recent developments, management determined the actuarial estimate as of June 30, 2009 was the best estimate of the ultimate cost to settle open claims. Our primary considerations included the significant erosion in the economy, the increasing complexity and uncertainty surrounding healthcare costs, unexpected development in open claims and growth in our business. The change in estimate resulted in the Company increasing its workers’ compensation claims liabilities by approximately $11.8 million at June 30, 2009.

Safety incentives liability

Safety incentives represent cash incentives paid to certain PEO client companies for maintaining safe-work practices in order to minimize workplace injuries, thereby meeting certain established loss objectives. The Company has provided $4.6 million at September 30, 2009 and December 31, 2008, respectively, as an estimate of the liability for unpaid safety incentives.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 1 - Basis of Presentation of Interim Period Statements (Continued)

Safety incentives liability (Continued)

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 liability is estimated and accrued each month based upon the incentive earned less the then-current amount of the customer’s estimated workers’ compensation claims reserves as established by the Company’s internal and third-party claims administrators, adjusted for expected future development of claims reserves.

Comprehensive income (loss)

Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by or distributions to a company’s stockholders. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under GAAP are included in comprehensive income (loss), but are excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity. The Company’s other comprehensive income (loss) is comprised of unrealized holding gains and losses on its publicly traded marketable securities designated as “available-for-sale”, net of realized gains or losses included in net income.

Subsequent events

We have evaluated events and transactions occurring after the balance sheet date through November 9, 2009, which is the date that the financial statements are issued, and noted no events that are subject to recognition or disclosure.

Note 2 - Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance on fair value measurements. The new guidance defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years for financial assets and liabilities. The effective date of the provisions of the new guidance for non-financial assets and liabilities, except for items recognized at fair value on a recurring basis, was deferred by the FASB and are effective for fiscal years beginning after November 15, 2008. The adoption of the new guidance for both financial and non-financial assets and liabilities has not had a material effect on our consolidated financial statements.

In December 2007, the FASB issued new accounting guidance for business combinations. The new guidance requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 2 - Recent Accounting Pronouncements (Continued)

and liabilities assumed; and requires the acquirer to disclose to investors and other users all the information they need to evaluate and understand the nature and financial effect of the business combination. The new guidance is effective for fiscal years beginning after December 15, 2008. The adoption of the new guidance has not had a material effect on our consolidated financial statements.

In May 2009, the FASB issued new accounting guidance on subsequent events. The new guidance requires disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. We adopted the guidance effective for the second quarter of 2009. See Note 1 for the disclosure.

In June 2009, the FASB issued FASB Accounting Standards Codification (“ASC”) 105, Generally Accepted Accounting Principles, which establishes the FASB ASC as the sole source of authoritative generally accepted accounting principles. Pursuant to the provisions of FASB ASC 105, the Company has updated references to GAAP in its financial statements issued for the period ended September 30, 2009. The adoption of FASB ASC 105 did not impact the Company’s financial position or results of operations.

Note 3 - Acquisitions

Effective February 4, 2008, the Company acquired certain assets of First Employment Services, Inc., a privately held staffing company with offices in Tempe and Phoenix, Arizona. The Company paid $3.8 million in cash upon closing and agreed to pay additional consideration of $1.2 million in cash contingent upon the first 12 months of financial performance. Management completed the evaluation of the financial performance criteria for the 12-month period during the first quarter of 2009 and determined no additional consideration was due. The transaction resulted in the recognition of $3.8 million of goodwill, $15,000 of other assets and $15,000 of fixed assets. The Company’s consolidated income statements for the nine months ended September 30, 2008 include First Employment’s results of operations since February 4, 2008.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 4 - Basic and Diluted Earnings Per Share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential effects of the exercise of outstanding stock options. Basic and diluted shares outstanding are summarized as follows:

As a result of the net loss reported for the nine months ended September 30, 2009, 155,521 potential common shares have been excluded from the calculation of diluted loss per share because their effect would be anti-dilutive.

Note 5 - Stock Incentive Plans and Stock-Based Compensation

The Company’s 2009 Stock Incentive Plan (the “2009 Plan”), which provides for stock-based awards to Company employees, non-employee directors and outside consultants or advisors, was approved by shareholders on May 13, 2009. No options have been issued under the 2009 Plan. The number of shares of common stock reserved for issuance under the 2009 Plan is 1,000,000, of which the aggregate number of shares for which incentive stock options may be granted under the Plan is 900,000. No new grants of stock options may be made under the Company’s 2003 Stock Incentive Plan (the “2003 Plan”). At September 30, 2009, there were option awards covering 316,319 shares outstanding under the 2003 Plan and its predecessor, the 1993 Stock Incentive Plan. Outstanding options under both plans generally expire ten years after the date of grant. Options are generally exercisable in four equal annual installments beginning one year after the date of grant.

In accordance with the current accounting guidance for share-based payments, the Company recognizes compensation expense for options awarded under its stock incentive plans. Current accounting guidance requires the grant-date fair value of all share-based payment awards, including employee stock options, to be recognized as employee compensation expense over the requisite service period.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 5 - Stock Incentive Plans and Stock-Based Compensation (Continued)

The following table summarizes options activity in 2009:

The following table presents information on stock options outstanding for the periods shown:

The aggregate intrinsic value of stock options represents the difference between the Company’s closing stock price at the end of the period and the relevant exercise price multiplied by the number of options outstanding at the end of the period at each such price.

Stock-based compensation expense for the three months ended September 30, 2009 and 2008 was $25,000 and $0, respectively, and for the nine months ended September 30, 2009 and 2008, was $75,000 and $0, respectively.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 5 - Stock Incentive Plans and Stock-Based Compensation (Continued)

The fair value of the stock-based awards, as determined under the Black-Scholes model, granted in the three months ended March 31, 2009 of $349,000 or $4.39 per share, was estimated with the following weighted-average assumptions:

There were no stock-based awards granted during the quarter ended September 30, 2009.

The following table summarizes stock-based compensation expense related to stock option awards for the nine months ended September 30, 2009 and 2008 (in thousands):

As of September 30, 2009, unamortized compensation expense related to stock options was $317,000.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 6 - Workers’ Compensation

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

During the second quarter of 2009, the Company engaged a new actuary to review its workers’ compensation liabilities. While the Company historically obtained an actuarial study, management determined the study was not the best estimate of the workers’ compensation liability. Based upon discussions with the new actuary and a thorough review of the Company’s reserving process and consideration of recent developments, management determined the actuarial estimate as of June 30, 2009 was the best estimate of the ultimate cost to settle open claims. Our primary considerations included the significant erosion in the economy, the increasing complexity and uncertainty surrounding healthcare costs, unexpected development in open claims and growth in our business. The change in estimate resulted in the Company increasing its workers’ compensation claims liabilities by approximately $11.8 million at June 30, 2009.

Note 7 - Fair Value Measurement

The Company has determined that its marketable securities should be presented at their fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company has determined that its closed-end bond funds, U.S. treasuries and equity securities components of its marketable securities fall into the Level 1 category, which values assets at the quoted prices in active markets for the same identical assets. The Company has also determined its municipal bonds, VRDN and corporate bonds components fall into the Level 2 category, which values assets using inputs other than quoted prices that are observable for the asset either directly or indirectly. There were no assets or liabilities where Level 3 valuation techniques were used and there were no assets and liabilities measured at fair value on a non-recurring basis.

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BARRETT BUSINESS SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

Note 7 - Fair Value Measurement (Continued)

Marketable securities consist of the following investments (in thousands):

During the third quarter ended September 30, 2009, the Company realized a $572,000 gain on the sale of certain corporate bonds.

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BARRETT BUSINESS SERVICES, INC.

Overview

Barrett Business Services, Inc. (“Barrett”, the “Company” or “we”), a Maryland corporation, offers a comprehensive range of human resource management services to help small and medium-sized businesses manage the increasing costs and complexities of a broad array of employment-related issues. The Company’s principal services, professional employer organization (“PEO”) services and staffing services, assist its clients in leveraging their investment in human capital. The Company believes that the combination of these two principal services enables it to provide clients with a unique blend of services not offered by the Company’s competition. Barrett’s platform of outsourced human resource management services is built upon expertise in payroll processing, employee benefits and administration, workers’ compensation coverage, effective risk management and workplace safety programs, and human resource administration.

To provide PEO services to a client, the Company enters into a contract to become a co-employer of the client’s existing workforce and Barrett assumes responsibility for some or all of the client’s human resource management responsibilities. PEO services are normally used by organizations to satisfy ongoing human resource management needs and typically involve contracts with a minimum term of one year, renewable annually, which cover all employees at a particular work site. Staffing services include on-demand or short-term staffing assignments, long-term or indefinite-term contract staffing and comprehensive on-site management. The Company’s staffing services also include direct placement services, which involve fee-based search efforts for specific employee candidates at the request of PEO clients, staffing customers or other companies.

The Company’s ability to offer clients a broad mix of services allows Barrett to effectively become the human resource department and a strategic business partner for its clients. The Company believes its approach to human resource management services is designed to positively affect its clients’ business results by:

The Company serves a growing and diverse client base of small and medium-sized businesses in a wide variety of industries through a network of branch offices in California, Oregon, Washington, Idaho, Arizona, Utah, Colorado, Maryland, Delaware and North Carolina. Barrett also has several smaller recruiting offices in its general market areas, which are under the direction of a branch office.

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BARRETT BUSINESS SERVICES, INC.

Results of Operations

The following table sets forth percentages of total revenues represented by selected items in the Company’s Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008.

We report PEO revenues in accordance with the current accounting guidance for revenue recognition, 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.

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BARRETT BUSINESS SERVICES, INC.

Results of Operations (Continued)

The presentation of revenues on a net basis and the relative contributions of staffing and PEO 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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BARRETT BUSINESS SERVICES, INC.

Results of Operations (Continued)

A reconciliation of non-GAAP gross PEO revenues to net PEO revenues is as follows:

The amount of the reclassification is comprised of direct payroll costs and safety incentives attributable to our PEO client companies.

Three months ended September 30, 2009 and 2008

Net income for the third quarter of 2009 amounted to $2.9 million, an increase of $2.3 million over net income of $650,000 for the third quarter of 2008. The increase for the third quarter of 2009 was primarily due to a $1.6 million decrease in selling, general and administrative expenses from 2008 and the 2008 third quarter mark-to-market impairment charge of approximately $3.5 million taken on the Company’s investment in four closed-end bond funds, partially offset by a 15.5% decline in revenues and a $2.8 million decline in gross margin dollars. Included in the 2009 third quarter earnings was a pre-tax gain of $572,000 or approximately $.04 per diluted share from the sale of certain corporate bonds. Diluted income per share for the third quarter of 2009 was $.28 compared to diluted earnings per share of $.06 for the comparable 2008 period.

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BARRETT BUSINESS SERVICES, INC.

Results of Operations (Continued)

Three months ended September 30, 2009 and 2008 (Continued)

Revenues for the third quarter of 2009 totaled $65.5 million, a decrease of approximately $12.0 million or 15.5%, which reflects a decrease in the Company’s staffing services revenue and a small decline in PEO service fee revenue. Staffing services revenue decreased approximately $11.3 million or 25.4% due to a continued decline in demand for our staffing services from existing customers in the majority of our markets. Management expects demand for the Company’s staffing services will continue to reflect overall economic conditions in its market areas. PEO service fee revenue decreased approximately $679,000 or 2.1% from the comparable 2008 quarter. Our PEO business from new customers during the third quarter of 2009 nearly equaled the sum of our lost PEO business compared to the third quarter of 2008 from former customers and the decline in hours worked at existing PEO customer worksites.

Gross margin for the third quarter of 2009 totaled approximately $12.1 million, or a decrease of $2.8 million from the third quarter of 2008, primarily due to a 15.5% decline in revenues and higher payroll taxes and benefits and higher workers’ compensation expense as a percentage of revenues. The increase in payroll taxes and benefits, as a percentage of revenues, from 27.4% for the third quarter of 2008 to 31.1% for the third quarter of 2009, was principally due to higher statutory state unemployment tax rates in various states in which the Company operates as compared to the second quarter of 2008, as well as to an increase in business mix of PEO services where payroll taxes and benefits are presented at gross cost whereas the related direct payroll costs are netted against PEO services revenue.

Workers’ compensation expense, as a percent of revenues, increased from 10.9% in the third quarter of 2008 to 12.0% in the third quarter of 2009. Workers’ compensation expense for the third quarter of 2009 totaled $7.9 million, compared to $8.4 million for the third quarter of 2008. The decrease in dollars was primarily due to a decline in the number of injury claims incurred during the 2009 quarter.

The decrease in direct payroll costs, as a percentage of revenues, from 42.5% for the third quarter of 2008 to 38.4% for the third quarter of 2009 was largely due to the significant decline in our staffing services business.

Selling, general and administrative (“SG&A”) expenses for the third quarter of 2009 amounted to approximately $8.4 million, a decline of $1.6 million or 15.9% from the third quarter of 2008. The decrease from the third quarter of 2008 was primarily attributable to lower profit sharing and commissions due to the decline in business activity and profitability, and to lower branch management payroll.

During the third quarter of 2008, the Company recorded a non-cash, other-than-temporary impairment charge of approximately $3.5 million relating to its investment in four closed-end bond funds. The impairment charge assumed no income tax benefit given the uncertainty of the Company’s ability to generate future taxable investment gains required to utilize these investment losses.

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BARRETT BUSINESS SERVICES, INC.

Results of Operations (Continued)

Three months ended September 30, 2009 and 2008 (Continued)

Other income for the third quarter of 2009 was $965,000 compared to other income of $465,000 for the third quarter of 2008. The increase in other income for the third quarter of 2009 was primarily attributable to a gain of $572,000 on the sale of certain corporate bonds.

The income tax rate for the 2009 third quarter was 31.0% compared to the 2008 third quarter rate of 56.6%. The higher income tax rate for the 2008 third quarter resulted from the Company’s establishment of a valuation allowance on the $3.5 million impairment charge on its investments, offset in part by state tax benefits attributable to AICE, our wholly-owned captive insurance company, recognized upon the completion and filing of the Company’s 2007 state income tax returns during the 2008 third quarter.

Nine months ended September 30, 2009 and 2008

Net loss for the nine months ended September 30, 2009 amounted to $7.0 million, a decline of $11.0 million from net income of $4.0 million for the comparable period of 2008. The decline for the nine months ended September 30, 2009 was primarily due to lower revenues and lower gross margin dollars principally due to an $11.8 million increase in workers’ compensation expense resulting from the Company’s change in estimate of its workers’ compensation reserves during the second quarter of 2009. Diluted loss per share for the first nine months of 2009 was $.67 compared to diluted earnings per share of $.36 for the comparable 2008 period.

Revenues for the nine months ended September 30, 2009 totaled $173.8 million, a decrease of approximately $42.0 million or 19.5%, which reflects a decrease in both the Company’s staffing services revenue and PEO service fee revenue. Staffing services revenue decreased approximately $35.7 million or 29.5% due to a significant decline in demand for our staffing services from existing customers in the majority of our markets. PEO service fee revenue decreased approximately $6.3 million or 6.7% from the comparable 2008 period primarily due to a decline in business as a result of decreased hours worked at existing PEO customer worksites, partially offset by the net effect of the addition of new customers.

Gross margin for the nine months ended September 30, 2009 totaled approximately $13.6 million, which represented a decrease of $23.9 million from the comparable period of 2008, primarily due to the $11.8 million additional workers’ compensation expense adjustment, a 19.5% decline in revenues and higher payroll taxes and benefits as a percentage of revenues. The gross margin percent decreased from 17.4% of revenues for the first nine months of 2008 to 7.8% for the first nine months of 2009. The increase in payroll taxes and benefits, as a percentage of revenues, from 30.7% for the first nine months of 2008 to 35.9% for the first nine months of 2009, was principally due to higher statutory state unemployment tax rates in various states in which the Company operates in 2009 as compared to 2008 and to an increase in business mix of PEO services where payroll taxes and benefits are presented at gross cost whereas the related direct payroll costs are netted against PEO services revenue.

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BARRETT BUSINESS SERVICES, INC.

Results of Operations (Continued)

Nine months ended September 30, 2009 and 2008 (Continued)

During the second quarter of 2009, the Company engaged a new actuary to review its workers’ compensation liabilities. While the Company historically obtained an actuarial study, management has determined the study was not the best estimate of the workers’ compensation liability. Based upon discussions with the new actuary and a thorough review of the Company’s reserving process and consideration of recent developments, management determined the actuarial estimate as of June 30, 2009 was the best estimate of the ultimate cost to settle open claims. Our primary considerations included the significant erosion in the economy, the increasing complexity and uncertainty surrounding healthcare costs, unexpected development in open claims and growth in our business. The change in estimate resulted in the Company increasing its workers’ compensation claims liabilities by approximately $11.8 million at June 30, 2009.

Workers’ compensation expense, as a percent of revenues, increased from 10.5% in the first nine months of 2008 to 19.3% in the first nine months of 2009. Workers’ compensation expense for the first nine months of 2009 totaled $33.5 million, compared to $22.7 million for the first nine months of 2008. The increase in the expense as a percentage of revenues was primarily due to the $11.8 million additional workers’ compensation expense adjustment. The decrease in direct payroll costs, as a percentage of revenues, from 41.4% for the first nine months of 2008 to 37.0% for the first nine months of 2009 was largely due to the significant decline in staffing services business.

SG&A expenses for the first nine months of 2009 amounted to approximately $24.8 million, a decline of $3.0 million or 11.0% from the first nine months of 2008. The decrease from the first nine months of 2008 was primarily attributable to lower profit sharing and an overall reduction in variable operating expenses due to the decline in business activity and profitability, and lower branch management payroll.