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COPPERFIELD RESEARCH

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Barrett Business Services (BBSI): Throwing Good Money at Bad

Additional analysis reveals another crippling reserve charge is


required, a high probability of an equity raise, an unprofitable core
business, pricing anomalies, and other major red flags
Updated Fair Value: $0.00 to $8.76 per share
65% to 100% downside

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IMPORTANT Disclaimer Please read this Disclaimer in its entirety before


continuing to read our research opinion. You should do your own research
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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
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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
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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.

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------------------------------------------------------------------------------------------------------------Barrett Business Services (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-TickTicking Time Bomb" (it can now be printed to accommodate many requests). 1 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." 2 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

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------------------------------------------------------------------------------------------------------------with BBSI's reserves/underwriting. In our opinion, BBSI would likely go into run-off should ACE nonrenew 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.

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------------------------------------------------------------------------------------------------------------1) BBSI Appears Unprofitable; Another Large Reserve Charge Is Inevitable (& Management Knows
It); ACE Risk Grows
We believe BBSI's core operations generate no economic profit. While BBSI had previously reported
accounting profits, it is now clear under-accruing reserves overstated past results. For this reason, BBSI's
Q3'14 adjusted earnings presentation "excluding" the reserve charge is analytically dishonest. The reserve
charge reflects $80 million of previously reported overstated profits. In the tables and discussion that
follow, we clearly outline why BBSI's previously reported profits were fiction. Additionally, our analysis
indisputably shows that another reserve charge is not only likely, but that it will be large.
Below, we evaluate what BBSI's actual earnings would have been had the $80 million reserve charge been
appropriately recognized in loss accruals over the last 10 years. We also estimate the allocation of adverse
development. The allocation of the $80 million charge ends in 2012 because management confessed on its
Q3'14 conference call that the 2013/2014 accident years were not covered by the charge. 3 For those not
familiar with the insurance universe, accident year analysis attempts to isolate revenue (premiums) and
losses in a given year, regardless of which subsequent years the losses were reported or paid. The goal is a
better view of the underwriting profitability by adjusting prior period development (reported in future
periods) and reserve charges (also reported in future periods) back to the years in which the loss-generating
business was written.
The first step in our analysis applied the $80 million charge to past accident years. Our concentration of
loss allocation from 2010 - 2012 is based on the exposure growth during those periods.

Table 1. Estimated Allocation By Year of Reserve Charge to "2012 & Prior"


$ MMs
2003
1.0

2004
1.0

2005
2.0

2006
2.5

2007
4.0

2008
6.0

2009
9.0

2010
12.5

2011
17.0

2012 Total
25.0 80.0

Source: Our estimates.


The next step required allocating adverse reserve development, which is only disclosed in BBSI's quarterly
filings with the SEC, to a corresponding prior accident year. As a reminder, our original report spent
considerable time highlighting specific examples of development trends at other workers' compensation
insurers and PEOs. The development trends at other workers' comp insurers/PEOs displayed reasonable
balance estimating loss exposure upfront, thus requiring minimal future period adjustments (positive or
negative). BBSI was the extreme outlier with persistent and significant negative development, a trend
which in hindsight resulted in material overstatement of current period financial results. Table 2 below is
our estimated allocation of BBSI's reported adverse development (far right column), applied to its original
accident year. For example, in 2013, BBSI reported a $23.4 million adverse development, which we
applied to past years as follows: 2012 = $15M, 2011 = $5M, 2010 = $3.4M (note: for 1H'14, we applied
$2M of the $5.1M to 2013 which is not in the table).

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------------------------------------------------------------------------------------------------------------Table 2. Estimated Allocation of Adverse Development to Accicent Years


$ MMs
Period With Prior
Prior Year
Development
2008 2009
2010
2011
2012 Development
1H'14
1.0
2.0
5.1
2013
3.4
5.0
15.0
23.4
2012
0.4
3.0
9.0
12.4
2011
1.0
3.5
5.5
10.0
2010
0.2
0.7
0.9
Allocation
1.2
4.6
11.9
15.0
17.0
Source: Company filings and our estimates.

Once the $80 million reserve charge and reported adverse development were allocated to past accident
years, a more accurate economic picture of BBSI's estimated earnings can be seen. This approach provides
the best estimate for previously reported earnings had BBSI conformed to GAAP accounting and accrued
reserves at an accurate level. We believe BBSI would have lost money in every year from 2009 through
2012 had its accounting and reserves been accurate.
Below are BBSI's actual reported results, taken directly from its public filings.
Table 3.
$ MMs

2009 to 2012 BBS I ACTUALS

Total gross revenue


Reported gross workers' comp expense
Reported work comp expense as % gross rev
Reported gross margin
Reported pretax earnings

2009
1,019.9

2010
1,236.8

2011
1,527.5

2012
2,080.9

46.0
4.51%
25.6

41.6
3.36%
44.7

60.6
3.97%
43.5

82.4
3.96%
66.7

(6.5)

9.9

15.2

19.5

In the next iteration of Table 3 (Table 3.1 below), we have added the allocation of the $80 million reserve
charge to previously reported annual results as estimated from Table 1.

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BBSI's "accounting" profits vanish.


Table 3.1 2009 to 2012 Earnings Adjusted For $80 million Reserve Charge
$ MMs
ACTUALS
2009
Total gross revenue
1,019.9
A

Reported gross workers' comp expense


Reported work comp expense as % gross rev
Reported gross margin

Reported pretax earnings

2010
1,236.8

2011
1,527.5

2012
2,080.9

46.0
4.51%
25.6

41.6
3.36%
44.7

60.6
3.97%
43.5

82.4
3.96%
66.7

(6.5)

9.9

15.2

19.5

9.0
55.0
5.40%
11.9
20.9

12.5
54.1
4.37%
16.9
29.4

17.0
77.6
5.08%
26.2
43.2

25.0
107.4
5.16%
38.4
63.4

(15.5)

(2.6)

(1.8)

(5.5)

Allocation of $80 million charge


C Reserve Charge Allocation from Table 1
A+C Adjusted gross work comp expense

Adjusted work comp expense as % gross rev


D Claims expense - current period
C+D Claims expense - current accident year
B-C

"Adjusted" pretax earnings

Taking Table 3 once step further (Table 3.2), we then add the estimated annual prior development
allocation (from Table 2 above) to the adjusted results above that already included the $80 million reserve
charge.
Table 3.2 2009 to 2012 Earnings Adjusted For $80 million Reserve Charge & Adverse Development
$ MMs
ACTUALS
2009
2010
2011
2012
Total gross revenue
1,019.9 1,236.8 1,527.5
2,080.9
Reported gross workers' comp expense
Reported work comp expense as % gross rev
Reported gross margin
Reported pretax earnings

46.0
4.51%
25.6
(6.5)

41.6
3.36%
44.7
9.9

60.6
3.97%
43.5
15.2

82.4
3.96%
66.7
19.5

D
C+D

Allocation of $80 million charge


Reserve Charge Allocation from Table 1
Adjusted gross work comp expense
Adjusted work comp expense as % gross rev
Claims expense - current period
Claims expense - current accident year

9.0
55.0
5.40%
11.9
20.9

12.5
54.1
4.37%
16.9
29.4

17.0
77.6
5.08%
26.2
43.2

25.0
107.4
5.16%
38.4
63.4

B-C

"Adjusted" pretax earnings for reserve charge

(15.5)

(2.6)

(1.8)

(5.5)

(12.7)
4.6
46.9
4.59%

(0.9)
11.9
65.2
5.27%

(10.0)
15.0
82.6
5.41%

(12.4)
17.0
112.1
5.39%

(7.3)

(13.6)

(6.9)

(10.2)

C
A+C

Adjustment for prior development


E
(-) Prior period development from calendar year
F
+ Allocation of development from Table 2
(A+C)-E+F Adjusted gross work comp expense

Adjusted work comp expense as % gross rev


"Adjusted" pretax earnings for reserve charge & adverse dev
Source: Company filings and our estimates.

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------------------------------------------------------------------------------------------------------------Our work shows BBSI's perceived profitable model is a mirage. Applying the reserve charge and prior
development to past years conclusively illustrates that BBSI's business model has been a money loser for
the last half-decade.
Adding credence to our analysis in Table 3 is the resulting consistency in the adjusted workers'
compensation accrual level. From 2010 through 2012, our estimated adjusted gross workers' compensation
cost to gross revenue would have been 5.27%, 5.41%, and 5.39% respectively. These levels are much
closer to management's new guidance that the "loss accrual rate for workers' compensation claims [will]
increase to 5%."4
Looking forward, our analysis is applicable in determining BBSI's required reserve charge for 2013 and
year-to-date 2014. As a reminder the $80 million reserve charge did not cover business written after 2012.
It is clear the 2013 and 2014 accident year reserve levels remain significantly deficient. Using our estimate
for 2010 - 2012 loss accruals, we find strengthened 2010 - 2012 accident years have reserve levels that are
approximately 45% and 26% higher than 2013 and 2014 respectively (Table 4 below). Given increased
claims frequency and severity, increased medical inflation, and minimal pricing or underwriting
adjustments, we see no reasonable explanation why 2013 and 2014 reserves would be a fraction of the
recently strengthened 2012 and prior years. To bring 2013 and 2014 YTD reserves inline with the
approximate 5.3% adjusted accrual of 2010, 2011, and 2012, we believe an additional $70.6 million
reserve charge will be required. [If we used management's guidance of a 5% accrual (the level they have
suggested is the current loss pick on an ongoing basis), then a $55 million charge would be required].
Table 4. Estimated Reserve Charge Required for 2013 and 2014 Accident Years
$ MMs
2010
2011
2012
Total gross revenue
1,236.8 1,527.5 2,080.9
Reported gross work comp expense
Reported work comp expense as % gross rev
Adjusted gross work comp expense
Adj work comp exp as % gross rev
Gross work comp expense required to get to 5.3%
Charge required
Cumulative charge for 2013 and 2014

41.6
3.36%
65.2
5.27%

60.6
3.97%
82.6
5.41%

82.4
3.96%
112.1
5.39%

2013
2,809.6

YTD'14
2,425.9

124.9
4.45%
103.5
3.69%

188.5
4.85%
103.4
4.26%

148.9
45.4

128.6
25.2
70.6

Source: Company filings and our estimates.

While management may not be ready to share this bad news explicitly, we believe the carefully chosen
language in the recent earnings release and conference call acknowledges more trouble ahead. On its Q3'14
earnings call, BBSI management communicated that its actuarial data is now skewed and the "disruption in
the data" is making it "difficult for the actuary models to provide an estimate of probable liability."5
Further, management also stated (our emphasis added):
The combined effort of the strengthening process of 2012 and prior year claims and simultaneous
change in reserve practices on all claims has caused disruption in our actuarial date for both the
incurred and paid values. This disruption we are seeing impacts 2012 and prior years and
impacts also 2013 and 2014 as well. And we believe that it will take some time for that new
strength in data to normalize.6
Management's credibility has undoubtedly been destroyed, but we interpreted their statements to mean had
the same actuarial analysis used to establish accident year reserves 2012 and prior also been applied to
2013 and 2014 reserves, further strengthening in reserves would be needed. We do not understand why

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------------------------------------------------------------------------------------------------------------claim trends would magically improve, which appears to be the only way BBSI can avoid taking a second
reserve charge. (Note to sell-side: Before immediately rejecting a second charge because management tells
you so, see our analysis above and the paltry 3.69% and 4.26% estimated work comp accrual for 2013 and
2014 respectively).
Finally, based on our experience, we continue to believe there is a reasonable probability of a long-tail
negative outcome with ACE. It is our understanding that ACE was initially satisfied, and even impressed
by the reported claims experience at BBSI. However, the fact BBSI used Willis, one of ACE's trusted
partners, to conduct its reserve study (as we predicted in our original report), suggests ACE was
uncomfortable with BBSI's reserves and/or underwriting. 7
The ACE fronting agreement was originally announced on January 21, 2014. At the time, BBSI's stock
price was above $100 per share and the company was perceived as a safe credit risk for ACE. 8 However,
since the fronting agreement was announced, BBSI's stock has collapsed, the company increased its
reserves in Q3'14 by 70% QoQ and 117% YoY, while 2013 and 2014 reserves appear woefully inadequate.
Further, we believe state regulators will require BBSI to fund its incremental reserve increases on a dollarfor-dollar basis (more on this below). Given the dramatic change in BBSI's "health," we would not be
surprised if ACE's perspective towards BBSI's credit risk and underwriting practices has changed. As
discussed in our original report, a typical fronting arrangement is structured so the fronting partner only
backstops policies written on its paper. Because BBSI's management has said the transition of policies to
ACE's paper will not be completed until November 2014, we believe ACE has limited exposure to BBSI's
2014 accident year. However, with full exposure beginning with 2015 accident year claims, we believe the
easiest path for ACE to minimize its BBSI exposure would be to non-renew the fronting agreement. Should
this occur, our base case would be that a majority of BBSI's business would be put into run-off. Less
catastrophic would be ACE charging a higher fronting fee (to account for the high credit risk) and
increasing the collateral requirements. These changes would place even more stress on BBSI's weakened
earnings and cash flow.
2) Debt Alone Can Not Bridge BBSI's Funding Gap, Which Appears Much Larger Than Disclosed
Investors do not seem to recognize the precarious capital shortfall BBSI currently faces. According to
public filings, BBSI is required "to maintain specified investment balances or other financial instruments
to cover potential workers' compensation claims losses" in six states, including California which represents
the company's largest exposure.9 Based on the most recent 10Q, we believe BBSI's required investment
balance at June 30, 2014 was $115.1 million, with $104.7 million needed to satisfy the State of California's
requirements alone. 10 For perspective on BBSI's lack of "wiggle room," the $115.1 million of required
collateral represented 94% of the $122.5 million reserve balance at June 30, 2014. To satisfy its regulatory
liability, BBSI provided surety bonds and standby letters of credit totaling $111.5 at June 30, 2014. BBSI's
third-party issued surety bonds were backed by a $20.9 million letter of credit. BBSI deposited the same
$20.9 million, dollar-for-dollar, with Wells Fargo to serve as collateral for the letter of credit (the total
standby letters of credit with Wells Fargo was $27.6 million at June 30, 2014). 11
Considering the substantial nominal value of its surety bonds compared to the cash deposits backing the
bonds and letters of credit, we believe BBSI has negligible incremental surety issuance that can be used to
fund state collateral requirements. Our assumptions were indirectly confirmed on BBSI's Q3'14 earnings
call when management stated the $80 million reserve charge meant they would "actually have to post that
cash" on a dollar-for-dollar basis.12 Further confirmation is provided by the same law, SB 863, that revokes
all PEO self insured licenses in California on January 1, 2015. SB 863 requires a self insurer to maintain a
security deposit with the State "equal to the actuarial determined undiscounted central estimate, including
IBNR, ALAE and ULAE, net of excess insurance," or a broad definition of loss reserves. 13
BBSI's management claims it will fund the $80 million of required cash with a $32 million tax refund, cash
on hand, and newly issued debt. While management has assured investors that discussions with Wells
Fargo have commenced, we are troubled by the basic math behind its strategy. First, the $32 million tax

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------------------------------------------------------------------------------------------------------------refund appears to be nothing more than the application of a 40% tax rate against the $80 million charge.
What management failed to explain was how they would induce the U.S Treasury to issue a refund that
represented 55% more than BBSI has paid in cash taxes since the end of 2008. Despite reporting significant
GAAP profits (which we now know were overstated), BBSI has only paid $20.7 million of cash taxes in
the last five-and-a-half years. Management's tax refund strategy appears somewhat disingenuous
considering past cash taxes paid and the uncertainty on timing of any refund.
Table 5. Cash Taxes Paid
$ MMs
Cash Taxes Paid

2009 2010 2011 2012 Q1'13 Q2'13 Q3'13 Q4'13 2013 Q1'14 Q2'14 Total
0.6 1.8 4.7 3.3
5.9
0.0
0.2
2.9
9.0
1.2
0.1 20.7

Source: Company filings.

Time does not appear to be on BBSI's side. On its Q3'14 earnings conference call, management was
extremely vague on the required timeframe to regain compliance with state regulatory capital requirements.
As we documented at length in our original report, the State of California's expensive history with self
insured workers' compensation PEOs has resulted in a risk averse approach when dealing with noncompliant insurers. As such, we believe time is working against BBSI, and its near-term fate likely rests
with Wells Fargo and State Regulators. In fact, new California law allows the California Office of SelfInsurance Plans to require an additional security deposit ABOVE 100% of loss reserves for "good cause." 14
"Good cause" is defined by, but not limited to, several circumstances that appear to apply to BBSI,
including:
Understated future liability of claims on the Self-Insurer's Annual Report; the lack of, or an
inadequate or unacceptable, actuarial study or summary; a pattern of understated liabilities in
claim files audited in an audit; failure to report all claims; poor administration of claims or
payment of benefits due injured workers found in the audit results impairment of financial
15
condition of the self insurer as determined by the Chief.
Contrary to the confidence management projected on its earnings call, we believe BBSI's ability to raise
debt depends squarely on how Wells Fargo approaches the workers' compensation insurance liability.
Should Wells Fargo share our view that BBSI's liability is comparable to that of an insurance company,
debt capacity will likely fall well short of what management has implied. Rarely do insurance companies
carry debt that exceeds 25% of the capital base. Should Wells Fargo view BBSI as an insurance company,
which was an integral argument in our original report, its debt capacity would probably be limited to $11.5
million (in the context of its paltry $34.4 million of shareholders' equity and negative tangible equity). It is
also worth noting that should BBSI raise $65 to $80 million of debt, its capitalization ratio would be 65% 70%, higher than any solvent insurance company we could find.
But what investors have failed to realize, and BBSI management has definitely not volunteered, is the
gaping 2013/2014 reserve hole BBSI will also need to be filled. As discussed in the previous section, we
believe BBSI will require an addition $55 to $70 million charge/capital raise to increase reserves on its
2013 and 2014 books of business. If BBSI is somehow able to fund its current $80 million capital hole, we
believe the additional $55 to $70 million charge would need to be funded with equity.
The funding challenges do not end with the recently announced $80 million capital hole and the yet-to-beannounced charge to fill the 2013/2014 reserve deficiency. BBSI's cash flow nightmare will be further
stressed by its requirement to fund the ACE fronting program trust account at the same time it must meet
State level funding requirements on legacy reserve levels AND concurrently fund current and future
reserves dollar-for-dollar. On its Q3'14 earnings call, BBSI's management disclosed $8.1 million of cash
was contributed in Q3'14 to the ACE trust account. The $8.1 million in Q3'14 was in addition to the $23
million contributed during the first half of 2014. 16 Combined, we estimate ACE trust contributions
represented more than 100% of BBSI's free cash flow year-to-date (through Q3'14). To our knowledge,

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------------------------------------------------------------------------------------------------------------BBSI's management has yet to disclose the precise amount that must be contributed to the ACE account.
Based on our work, we believe the mandatory contribution is between $50 and $80 million.
Taken together, BBSI is likely facing a funding gap well in excess of the already staggering $80 million
needed to fund its reserve charge. Similar to the $80 million that is earmarked for 2012 and prior years, any
2013/2014 reserve charge will need to be funded on a dollar-for-dollar basis. We estimate BBSI would
need $65 million (at the midpoint) to fully collateralize the ACE trust account, which would require an
additional $35 million of cash contributions to the roughly $30 million that has already been funded yearto-date. Over the short-to-intermediate term, we believe BBSI may have a $185 million funding
requirement, which dwarfs its existing sources of capital. Management has said it has roughly $15 million
of unencumbered cash at the holding company, $14 million undrawn on its credit facility, and we estimate
approximately $21 million of cash taxes paid that could be refunded. With $185 million of potential capital
needs and only $50 million of identified sources, we estimate that BBSI is currently facing a $135 million
capital hole.
Table 6. Estimated Sources & Uses of Capital
$ MMs
Uses
Funding 3Q'14 reserve charge
Estimated funds to collateralize ACE trust account
Funding for estimated reserve charge required
Estimated funding gap

80
35
70
185

Sources
Unencumbered cash
Undrawn facility
Cash tax refund

15
14
21
50
135

Source: Company filings and our estimates.

Finally, as it relates to the capital structure, we think it is fair to ask the question - Why is management so
focused on propping up its stock when they should be filling capital holes? In the wake of the reserve
charge, we find it incredibly irresponsible that BBSI was buying back token amounts of stock as late as
September 2014. After its surprising reserve charge announcement that confirmed BBSI has been writing
far less profitable business than originally assumed, management had the audacity to provide a 12-month
revenue outlook premised on high single-digit same store sales growth.17 Why weren't immediate steps
taken to stabilize and right size the business? And why hasn't the Board of Directors, which has also
collectively been buying token amounts of stock to provide price support, insist the company shrink
exposure through re-underwriting and re-pricing its book of business? Considering an $80 million funding
uncertainty, the required funding of the ACE trust account, the inevitability of additional reserve increases,
and a likely violation of state funding requirements, one would reasonably expect BBSI's management and
Board of Directors to preserve all possible sources of liquidity. Instead, management increased the
quarterly dividend by 22% to $0.22 per share last week! 18 As discussed in more detail later, we estimate
2015 earnings will not even cover the increased annualized dividend. BBSI management's spontaneous and
irrational behavior unequivocally signals to us that they are more concerned with investor perception than
making the right decisions to save the company.
3) Irrationally Aggressive Pricing and Outlandish Marketing Claims
In our first BBSI report, we provided germane background on the pervasive capital destruction caused by
the California workers' compensation market, otherwise known as the "graveyard of dead insurance
companies." We also shared a few examples of companies that either mispriced business or failed to
understand the long-tail nature and magnitude of their ultimate liabilities. As documented in our first report,
hundreds of companies have ended up in run-off or liquidation because of California workers'
compensation exposure.
Abundant competition, combined with a highly regulated industry, has significantly compressed loss ratio
variances in the California Workers' Compensation market. Some companies tell fanciful stories about

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------------------------------------------------------------------------------------------------------------knowing their customers better, maintaining decentralized branch office models, using tighter underwriting
standards, or possessing better risk models. The undeniable reality is that the only material differentiation
between blue collar workers' compensation providers in California has been price. Based on years of
anecdotal evidence from insurance brokers and market participants, we are convinced BBSI's reserve
inadequacy results squarely from under pricing workers' compensation coverage to drive growth. The
following exchange between two insurance brokers on an Insurance Journal forum is symptomatic of
BBSI's "out of this world" and "extremely low" pricing. 19

In another insurance forum focused on the high costs of workers' compensation (running $15 - $21 per
$100 of payroll), an employee of API Limousine recommends BBSI because their work comp pricing is
40% to 57% lower than other quoted rates.20 21 22

What is astonishing is that BBSI's pricing is matched by its marketing chutzpah. In a presentation to the
North American Transportation Association, BBSI openly promoted their willingness to offer "lower
workers' compensation premium." (Slide pasted below) 23 Based on our belief price is the primary
competitive tool for differentiation, BBSI's marketing pitch was unsurprising. However, we were
flabbergasted by BBSI's ensuing claim that their "average California loss ratio [is] between 10% and 14%"
which they compare to the loss ratio of standard market carriers "between 50% and 75%." 24 BBSI's
marketing claim falls somewhere between deceptive and outrageous. For anybody familiar with the
California Workers' Compensation market - specifically the defined disability payment regulations, it is
unfathomable BBSI could have an average California loss ratio of 10% - 14%. For perspective, the
California Department of Insurance has said the 2013 incurred loss ratio for workers' compensation in
California was 70.2%. Said another way, BBSI has publicly marketed that it is 600% - 700% more
profitable than the cut-throat median California market. 25 We have trouble discerning whether BBSI is

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COPPERFIELD RESEARCH

------------------------------------------------------------------------------------------------------------using false adverting, is taking extreme liberties with its marketing material, or is simply delusional with its
assumed loss rates (which would help explain years of writing business that was unprofitable).

In addition to the baffling loss ratio claims, BBSI also markets that its astonishingly low loss experience is
due to "aggressive claims management." A lawsuit over Rafael Rivas's settlement may provide a window
into BBSI's definition of aggressive claims management (Los Angeles County W.C.A.B. Case No.
ADJ2596770). Rivas worked for one of BBSI's PEO clients and suffered a work-related lower back injury.
26
He settled his workers' compensation claim with BBSI for $20,000. After moving its claims handling inhouse, BBSI sent the settlement check to an out-of-date address, only to have the check fraudulently
27
endorsed and stolen. Despite its shoddy claims handling, BBSI refused to pay the claimant "arguing that
by mailing the settlement check to Mr. Rivas at an address specified in a compromise and release
agreement, it had fulfilled its obligation." After "aggressively" fighting the claim through multiple appeals,
it is our understanding BBSI finally paid the claim to Rivas.
It isn't just BBSI's irrational pricing that we believe is responsible for a book of mispriced exposure, it may
also be the types of businesses BBSI has underwritten. For example, look no further than United States
Pool Corp. and Michael Gregory Silverberg, the owner of United State Pools Corp, who was charged in
2013 with "Defrauding California State Compensation Insurance Fund, the State Board of Equalization and
two insurance companies and committing white-collar crimes [including] falsifying statements to reduce
28
his workers compensation insurance rates, and failing to collect taxes." Despite the well documented
charges, BBSI signed U.S. Pools Corp. as a workers' compensation insurance and staffing services client in
March 2014. Unsurprisingly, on August 28, 2014, just months after taking on the client, BBSI sued U.S.
Pools Corp and Michael Gregory Silverberg for failure to pay service fees (Barrett vs. United States Pools
Corp Case No. PSC 1404644). Clearly, all workers' compensation insurers make mistakes. However, when
growth is required to mask reserve deficiencies, the magnitude and scope of mistakes will ultimately
compound the inevitable losses.

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COPPERFIELD RESEARCH

-------------------------------------------------------------------------------------------------------------

4) Stock Still Significantly Overvalued on Estimated 2015 EPS (Excluding Additional Reserve
Charge & Distressed Equity Raise)
We believe in a best case scenario BBSI's earnings are permanently impaired. To be fair, one could argue
there never were "real" economic earnings considering the systematic under-accruing of reserves.
Nonetheless, we believe a best case outcome implies BBSI's stock has another 60% downside.
We have used a very generous set of assumptions in Table 7 below to illustrate the collapse in earnings
compared to the overstated, previously reported results. First, we properly adjusted 2010 through 2012
reserves based on the accident year allocation analysis we presented earlier. This provides a more accurate
depiction of BBSI's run-rate earnings profile from 2010 - 2012. As discussed earlier, and reflected in Table
7, the actual loss accrual has run north of management's new 5% guidance. We have used 5.30% (in blue),
which is almost precisely what accurate loss accruals would appear to have been from 2010 - 2012.
[NOTE: It is worth highlighting that we generously assume the ACE fronting agreement not only stays in
tact in 2015, but the expense is consistent with 2014 levels implied in management's guidance. As discussed
at length in our first report, the sheer mix of California business in 2015 on ACE's paper (100%) when
compared to the transition year of 2014, implies the overall ACE expense must be higher in 2015.
Additionally, self insured PEOs do not pay premium tax to the state of California. Beginning in 2015,
100% of BBSI's California business will be (for now) through an admitted carrier, which means roughly
3% - 5% of all premiums will be passed through to the State. We have also generously assumed BBSI's
estimated 3% to 5% fronting commission to ACE does not increase. As a result of the myriad of cost
pressures (none of which we have included), BBSI must increase price by 7% to 10% just to maintain 2014
profitability levels. None of these adverse financial drivers are contemplated in our model below, which
would result in materially lower 2015 EPS, and perhaps negative earnings per share]
The only change in the financial model on a go-forward basis would be the interest expense associated with
a panicked debt raise. We again generously assumed just a 5% interest rate on the debt. By applying a
workers' comp accrual of 5.30% (consistent with 2010 through 2012 levels) and outlandish 18% revenue
growth (wildly aggressive given the costs of the fronting program and dramatic price increases needed to
maintain profitability), we arrive at a $0.73 EPS estimate for 2015. [For perspective, if we use a 5% accrual
rate instead of 5.3%, and hold all other generous assumptions constant, we arrive at a $1.70 per share
estimate for 2015. Under this absolutely pristine scenario, BBSI's stock would still be trading at an
expensive 15x P/E multiple.
Using a reasonable 12x earnings multiple on our generous 2015 estimates, which would still represent a
premium to the workers' compensation group from our original report, BBSI's fair value target becomes
$8.76 per share. However, the confluence of overhangs (another massive reserve charge, uncertainty on
debt funding, looming ACE fronting agreement renewal, a growing likelihood of a distressed equity raise)
has greatly increased the possibility of BBSI being a zero - rendering the shares univestable in our opinion.

(FINAL ASSUMPTIONS FOR MODEL ON NEXT PAGE)

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COPPERFIELD RESEARCH

------------------------------------------------------------------------------------------------------------Table 7. Adjusted Earnings History and 2015 Earnings Estimate


$ MMs
2009
2010
2011
2012
2013
2014E 2015E
Total gross revenue
1,019.9 1,236.8 1,527.5 2,080.9 2,809.6 3,343.3 3,935.3
% change
-6%
21%
24%
36%
35%
19%
18%
Reported gross workers' compensation expense
Reported work comp expense as % gross rev
Reported gross margin
Reported pretax earnings
Reported net income
Reported GAAP EPS
Average diluted shares

46.0
4.51%
25.6
(6.5)
(3.9)
($0.38)
10.5

41.6
3.36%
44.7
9.9
7.4
$0.71
10.4

60.6
3.97%
43.5
15.2
14.3
$1.41
10.2

82.4
3.96%
66.7
19.5
13.1
$1.67
7.9

124.9
4.45%
86.5
24.9
17.9
$2.42
7.4

233.0
6.97%
30.2
(45.6)

196.8
5.00%
112.2
24.2

7.3

7.5

Adjusted gross work comp expense - Table 3


Adj work comp expense as % gross rev

46.9
4.59%

65.2
5.27%

82.6
5.41%

112.1
5.39%

148.9
5.30%

177.2
5.30%

208.6
5.30%

24.8
33.5
3.3%
1.6

21.2
35.4
2.9%
1.4

21.4
38.2
2.5%
1.3

37.1
46.5
2.2%
1.5

62.5
60.1
2.1%
2.0

86.0
74.0
2.2%
2.5

1.6
(8.7)
37.0%
(5.5)
($0.52)

2.0
(13.6)
37.0%
(8.6)
($0.83)

11.2
(6.9)
37.0%
(4.3)
($0.43)

0.7
(10.2)
37.0%
(6.4)
($0.82)

0.5
0.9
37.0%
0.6
$0.07

0.7
10.2
37.0%
6.4
$0.88

100.4
85.9
2.2%
2.8
(3.8)
0.7
8.7
37.0%
5.5
$0.73

"Adjusted" gross margin


SG&A
% gross revenue
D&A
Incremental interest expense
other income (expense)
"Adjusted" pretax earnings
Tax rate
Adjusted net income
Adjusted EPS
Source: Company filings and our estimates.

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-------------------------------------------------------------------------------------------------------------

1 http://www.scribd.com/doc/239934271/Barrett-Business-Services-BBSI-A-Tick-Tick-Ticking-Time-Bomb
2 http://seekingalpha.com/instablog/890075-copperfield-research/3409505-bbsi-tick-tick-boom
3 http://seekingalpha.com/article/2613585-barrett-business-services-bbsi-ceo-michael-elich-on-q3-2014-results-earnings-call-transcript?part=single
4 http://www.marketwired.com/press-release/bbsi-reports-third-quarter-2014-financial-results-nasdaq-bbsi-1962020.htm
5 http://seekingalpha.com/article/2613585-barrett-business-services-bbsi-ceo-michael-elich-on-q3-2014-results-earnings-call-transcript?part=single
6 http://seekingalpha.com/article/2613585-barrett-business-services-bbsi-ceo-michael-elich-on-q3-2014-results-earnings-call-transcript?part=single
7 http://www.marketwatch.com/story/bbsi-reports-third-quarter-2014-financial-results-2014-10-28
8 http://finance.yahoo.com/news/bbsi-enters-workers-compensation-insurance-210500648.html0
9 http://www.sec.gov/Archives/edgar/data/902791/000119312514303164/d735780d10q.htm
10 http://www.sec.gov/Archives/edgar/data/902791/000119312514303164/0001193125-14-303164-index.htm
11 http://www.sec.gov/Archives/edgar/data/902791/000119312514303164/0001193125-14-303164-index.htm
12 http://seekingalpha.com/article/2613585-barrett-business-services-bbsi-ceo-michael-elich-on-q3-2014-results-earnings-call-transcript?part=single
13 http://www.dir.ca.gov/osip/Newsline/2013/ActuarialReportingRequirementsInformationSheet.pdf
14 http://www.dir.ca.gov/osip/SIPRegulations/OSIPApprovedEmergencyRegs-12-31-2012.pdf
15 http://www.dir.ca.gov/osip/SIPRegulations/OSIPApprovedEmergencyRegs-12-31-2012.pdf
16 http://seekingalpha.com/article/2613585-barrett-business-services-bbsi-ceo-michael-elich-on-q3-2014-results-earnings-call-transcript?part=single
17 http://www.marketwired.com/press-release/bbsi-reports-third-quarter-2014-financial-results-nasdaq-bbsi-1962020.htm
18 http://www.columbian.com/news/2014/oct/31/barrett-raise-dividend
19 http://www.insurancejournal.com/forums/viewtopic.php?f=1&t=1279&p=5066&hilit=BBSI#p5066
20 http://www.apilimo.com/About-Us-2.html
21 http://www.limousinesonline.com/showthread.php?21111-Workers-Comp-21-per-100
22 http://www.limousinesonline.com/showthread.php?21111-Workers-Comp-21-per-100
23 http://ntassoc.com/uploads/FileLinks/105955191a7242e984bd99046dbb6d7a/ntassocCompPowerPoint.pps
24 http://www.insurance.ca.gov/01-consumers/120-company/04-mrktshare/2013/index.cfm
25 http://www.insurance.ca.gov/01-consumers/120-company/04-mrktshare/2013/index.cfm
26 caselaw.lp.findlaw.com/data2/californiastatecases/B233168.PDF
27 caselaw.lp.findlaw.com/data2/californiastatecases/B233168.PDF
28 http://www.insurancejournal.com/news/west/2013/02/05/280116.htm

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