Barrett Business Services (BBSI) : A Tick-Tick-Ticking Time Bomb

COPPERFIELD RESEARCH
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Barrett Business Services (BBSI): A Tick-Tick-Ticking Time Bomb

Our BBSI Opinion: An insurance company with blow-up potential due
to thin reserves, questionable accounting, a recently disclosed
reserve study, and other red flags

Fair Value - $29.00 per share, 52% 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
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.

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We believe Barrett Business Services (BBSI) operates with a precarious business model and substantial
reserve deficiencies, which has created immense blow-up risk for public market investors. The
combination of aggressive growth into the pernicious California workers' compensation market and
minimal transparency regarding a recently disclosed reserve study has created an un-investable stock. Our
work suggests BBSI has systematically under reserved, which has resulted in materially overstated
earnings and a high probability of a massive reserve charge. With only three covering sell-side analysts
(none of whom appear to have any insurance domain expertise based on a collective coverage universe
that includes movie theatres, executive staffing, water dispensers, and ecommerce solutions), the
combustible issues at BBSI have largely escaped investor scrutiny. That should change with our report,
which includes a compendium of forensic issues, as well as background on BBSI's model and end markets.

Based on our analysis of 2013 incremental adverse development (applied to 2012 claims expense), we
believe BBSI may have overstated earnings by 57%. Depending on the degree to which BBSI's reserves
may be inadequate, there are scenarios discussed herein which would completely wipe out BBSI's
previously reported profits. In addition to arguing our belief that BBSI has overstated past earnings, we
outline why BBSI appears to be in blatant violation of U.S. GAAP accounting. Our accounting concerns are
amplified by a 2014 lawsuit brought by a long tenured branch manager accusing BBSI C-Suite executives
of "effectively cooking the books to create inflated profit margins to entice interest in BBSI stock in
violation of SEC regulations."
1
Unsurprisingly, we have been unable to find any disclosures in BBSI's public
filings about the existence of the lawsuit and associated incendiary charges. BBSI's auditor is tiny Moss
Adams, who does not even list insurance as an area of expertise on its website.

It is well understood that insurance companies can hide long-term economic liabilities for extended
periods of time. However, a recently announced reserve study should act as the catalyst to publicly
expose the magnitude of BBSI's reserve hole. The dramatic shift in IBNR and case reserves are additional
red flags, with the latter inexplicably increasing from $51 million to nearly $93 million in BBSI's most
recent quarter. Based on our analysis, if BBSI simply matched the reserve coverage of other PEOs and
insurance companies, a charge between $69 million to $280 million would be required. For perspective,
BBSI's shareholder equity at 6/30/14 was just $74 million. A reserve charge representing just a fraction of
our estimate would likely eliminate years of pretax earnings, while creating uncertainty over BBSI's
profitability and ongoing business model.

Adding even more asymmetry to BBSI's stock is the new fronting agreement with ACE. Should the reserve
study (or other issues discussed herein) cause ACE to non-renew its fronting agreement, BBSI's corporate
profile could be impaired with no replacement to renew its California business.

Under a rosy scenario analysis that assumes BBSI is somehow able to delay reserve charges, we still
believe the stock will revalue significantly lower to account for balance sheet risk and incremental
earnings pressure from regulatory changes occurring on January 1, 2015. Generously assuming benign
outcomes for many of the issues identified in this report, we still believe fair value for BBSI's stock is
$29.00 per share, which is 50% below its recent price. The $29.00 per share scenario assumes the
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company is NOT required to take significant reserve charges to address its thin reserve position, has no
negative changes in its ACE fronting agreement, and no restatement of past results for inappropriate
reserving practices occur. On the other hand, if we are correct about the considerable hole in BBSI's
reserve, we believe there are a plethora of long-tail scenarios that could cause the stock price to go much,
much lower. We encourage all shareholders (and sell-side promoters) without insurance expertise to
consult an insurance expert to independently verify our analysis and conclusions.

Our report contains several sections focused on relevant background information on BBSI, workers' comp,
as well as the California PEO dynamics. Other sections are specific to the problems we have identified at
BBSI, including detailed analysis examining BBSI's reserving practices and business/financial models. For
those with time constraints, we would encourage you to jump directly to sections 4, 6, 7, and 8, which
provide the most specific analysis and discussion into the significant risks and "meat" of our BBSI opinion.
If you can only read one section in its entirety, please see section 6 ("Severely Inadequate Reserves May
Require a Significant Charge"). Sections 1-3 provide relevant, yet admittedly boring background. The
following segments are covered in this report:

1) Investors Should View BBSI as an Insurance Company - BBSI is a PEO with a small staffing business. The
PEO represents approximately 95% of gross revenues. BBSI competes in the challenging market of
providing workers' compensation insurance for blue collar employers. Further, most of its exposure
growth has come in California, which now represents roughly 74% of net revenues. Over the past three
years, the new management team more than doubled the company's exposure to this risky market.
2) A Brief Background on the Seedy History of PEOs - The PEO industry has a tumultuous history that is
marred by extensive fraud. In recent months, officials tied to several PEOs were sentenced in one of the
largest insurance fraud cases ever, misappropriating $133 million of their clients' money. According to the
FBI, "Workers compensation insurance accounts for as much as 46 percent of small business owners
general operating expenses. Due to this, small business owners have an incentive to shop workers
compensation insurance on a regular basis. This has made it ripe for entities that purport to provide
workers compensation insurance to enter the marketplace, offer reduced premium rates, and
misappropriate funds without providing insurance."
2

3) California Bans PEOs - Under Senate Bill 863, all California PEO licenses, including BBSI's, will be
revoked on 1/1/15. This provision passed due to concerns related to the financial stability and/or solvency
of the industry following PEO bankruptcies in the State. BBSI's core PEO business will effectively be
banned on 1/1/15, likely resulting in a significant growth and/or earnings hit.
4) BBSI Losing Its License = Possible Collapse of Growth and/or Earnings - In response to getting its
license revoked, BBSI entered a fronting agreement with ACE, a rated and admitted insurance company.
We believe management has misled investors on the financial impact of this fronting agreement. After
initially describing it as "earnings neutral," management recently revised the estimated potential drag to
25 to 30 basis points. A 25 to 30 basis point hit relative to gross revenue would have cut 2013 earnings by
as much as one-third. BBSI's second quarter 10Q suggests the fronting costs may already be 2x
management's updated estimate, with approximately 66% of its clients still not transitioned to the more
expensive policy forms. We expect significant earnings pressure as the remaining two-thirds of clients
transition to the ACE fronting arrangement.
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5) A "Reserve Study" By Any Other Name Would Smell as Rancid - On July 30, 2014 BBSI's management
disclosed that a third party actuary had been hired to conduct a reserve study of its insurance reserves.
Two similar reserve study announcements (GNW and TWGP), both with similar workers' compensation
exposure, resulted in significant stock price declines. It is unclear why BBSI is conducting a reserve study
now, but we believe ACE, BBSI's new fronting partner, may be the driver. While management has
provided minimal transparency or detail into the reserve study, based on our reserve analysis, we believe
it is reasonable to assume ACE may not be comfortable with BBSI's existing reserve. Our suspicion is that
one of ACE's preferred actuaries (Milliman or Willis) is conducting the study. If the third party actuary
results are not addressed appropriately, it is possible ACE will not renew their fronting agreement with
BBSI. A non-renewal could shut-down BBSI in California post SB 863.
6) Severely Inadequate Reserves May Require a Significant Charge - We believe the ongoing reserve
study will reveal a large hole in BBSI's reserve position. Our in-depth review suggests BBSI may be
required to recognize a material charge to substantially increase its loss reserves. We analyzed five
significant red flags at BBSI: 1) persistent prior year reserve development, 2) exposure, revenue, and
claims payment growth well in excess of reserve growth, 3) irreconcilably low short-term reserves, 4)
extremely thin IBNR levels, and 5) reserve levels well below paid claims. Each of these red flags suggests
BBSI has severely inadequate reserves. Further, our analysis suggests BBSI met their earnings guidance in
the second quarter 2014 by dramatically under accruing claim expenses. Based on BBSI's low level of
short-term reserves, and the decline of short-term reserves as a percentage of overall reserves, we
believe BBSI will need to take a charge of at least $30 million. Our analysis concludes a charge of this
magnitude would be required to simply increase short-term reserves to a level that would cover claim
payments over the next twelve months. Additionally, BBSI's SEC filings illuminate a dramatic shift in IBNR
and case reserves, with the latter inexplicably increasing from $51 million to nearly $93 million in the
most recent quarter. Generally, IBNR makes up a substantial portion of long-tail insurance reserves.
However, IBNR constitutes just 24% of BBSI's reserves. BBSI will need to take a charge of approximately
$63 million to move its IBNR inline with a comparable group of workers' compensation insurers. We show
how BBSI's run-rate of paid claims would deplete their reserves significantly faster than the comp group,
despite BBSI's rapid exposure growth (and the backward looking nature of paid claims versus the
supposedly forward looking nature of reserves). According to our analysis, matching the reserve coverage
of other PEOs and insurance companies would require BBSI to recognize a charge between $69 million
and $280 million.
7) BBSI's Reserving Practices & Accounting Appear to Violate GAAP Resulting in Overstated Earnings
Management's public description of its reserving practices appears to violate U.S. GAAP accounting,
specifically FAS 60. Management recently explained its accounting approach, which indeed matches BBSI's
historical financials. Neither their explanation, nor the historical financials appear to conform to U.S.
GAAP. We clearly analyze how reserve accruals related to prior accident years constitute an inexplicably
large percentage of the total reserve accrual. The consistently high accrual for prior years is inconsistent
with other PEOs and insurance companies. As a result of its unorthodox accounting, we believe BBSI has
dramatically overstated past earnings. Applying the incremental adverse development in 2013 to claims
expense the prior year, suggests that 2012 EPS was overstated by 57%. We believe an accounting
restatement may be required, which would result in substantially lower historical earnings. BBSI's auditor
is Moss Adams, who does not appear to audit other insurance companies, or even list insurance as a
practice area.
8) Insurance Subsidiary Inconsistencies & a Lawsuit Accusing BBSI of "Cooking the Books"
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Results within a BBSI statutory insurance subsidiary show deteriorating growth, earnings, and a miniscule
reserve position. These results filed with state insurance regulators are inconsistent with reported
consolidated trends. Ecole Insurance, which is wholly owned by BBSI, discloses contact information and
addresses that do not appear to match any of BBSI's disclosed offices. Further, it appears Ecole shares an
address with a Home Warranty Insurer, while listing a "Statutory Statement Contact" that appears to be a
Beecher Carlson employee based in Hawaii. Further adding to our overall suspicion, a recent lawsuit filed
by a 10-year branch manager accuses BBSI's CEO and the company of "manipulating the bottom line to
avoid paying bonuses to managers," and "effectively 'cooking the books' to create inflated profit margins
to entice interest in BBSI stock in violation of SEC regulations." We have been unable to corroborate these
accusations, however taken with numerous other management misrepresentations that we believe exist,
the litigation raises incremental flags.
9) California Workers' Compensation Destruction (brief background) - The California workers'
compensation market has a treacherous history, with numerous stock market examples of investor losses
in companies tied to this market. In the last downturn, carriers representing nearly 1/3 of the market
failed due to significant reserve issues.
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More recently, investors in TWGP, MIG, EIG, and QBE AU have
experienced steep losses following reserve issues tied to California workers' compensation. We believe
BBSI investors will follow in these footsteps.
10) Deterioration of California Loss Trends Should Pressure BBSI - California workers' compensation
insurers have reported a deterioration in underwriting results. A recent state insurance authority report
found ominous trends in frequency and severity of loss costs. EIG recently took a large reserve charge
related to its California workers' compensation business, warning, "We believe these [deteriorating]
trends are an issue for us and for any workers' compensation insurance company doing business in
California." BBSI has 74% of net revenues in California, with a heavy risk concentration in the exact areas
experiencing increasing adverse claim trends.
11) ObamaCare & California State Fund = Risk of Large Client Departures and Negative Growth - It is
unclear if the employer mandate under the Affordable Care, which goes into effect 1/1/15, will define
large employers (50 or more) at the PEO level or the client level. If at the PEO level, we believe BBSI could
lose a significant number of its clients. We are unable to reconcile BBSI's assertion that a high percentage
of its clients offer healthcare. Our rudimentary analysis leads us to believe management may be taking
liberties with certain qualitative commentary. After nearly eight years of contracting premiums and
ceding market share, the California State Fund appears to be increasing its competitive positioning. After
a major restructuring and new tiered pricing, California's largest workers' compensation insurer grew
premiums by 23% in 2013. With a more competitive State Fund, insurance companies and PEOs focused
on the low end of the market (like BBSI) should find growth much more challenging.
12) Normalized Valuation Suggests Substantial Downside - Sell-side analysts and investors utilizing cash
flow and/or EV/EBITDA multiples to value BBSI are fundamentally erring in their valuation approach.
These irresponsible valuation methodologies, which ignore the long-tail of workers' compensation
coverage and are wholly inconsistent with traditional insurance valuation analysis, have been used to
justify BBSI's lofty valuation. If we apply aggressive growth assumptions, generously assume BBSI can
lower its fronting costs from the implied Q2'14 levels, and apply a 15% premium to the earnings multiple
of a comparable insurance group, BBSI would trade at $29.00 per share, representing 50% downside. Our
$29.00 fair value estimate assumes none of the myriad of long-tail risks discussed in this report
materialize, which could create substantially more downside to our $29.00 estimate.
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1) Investors Should View BBSI as an Insurance Company
BBSI is a professional employer organization ("PEO") with a small staffing business that has 55 offices in
10 states. In 2013, the PEO business represented nearly 95% of gross revenues, while 74% of net revenues
were derived in the State of California.
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BBSI's PEO generally focuses on blue collar businesses, such as
construction, agriculture, and food processing. Due to the high hazard nature of claims in these end
markets, business owners often have trouble procuring workers' compensation insurance coverage in the
standard market. As a result, high hazard businesses often rely on the secondary market for their workers'
comp needs, turning to PEOs or other "options of last resort" like state funds. The California Department
of Industrial Relations found "widespread use of PEOs by small business in the construction industry and
other industries with a high risk of workplace injuries" within California.
5

Unlike many PEOs, especially those targeting white collar employers, BBSI does not provide self-insured
health insurance through their PEO offering. Instead, BBSI typically sources significant levels of business
through insurance brokers. Like an insurance company, BBSI adjudicates claims, keeps insurance reserves
on its balance sheet, and maintains catastrophic reinsurance coverage (between $5 million and $15
million per occurrence).
6

BBSI was run by its founder Bill Sherertz from 1980 until his unfortunate and unexpected passing in early
2011. At the time of his death, Sherertz owned 25.7% of BBSI, while his ex-wife owned an additional
8.3%.
7
Following a dispute with the Board and company management, Sherertz's widow and ex-wife sold
a majority of her BBSI shares back to the company in March 2012 at $20 per share. As a result, BBSI
reduced its shares outstanding by 28% and set the stage for the stock to increase by nearly 400% over the
proceeding three years. Alignment of interest changed dramatically after Sherertz passing. Today, existing
management and the Board own just 4.5% of BBSI.
8

After taking over the company in 2011, new management began to grow aggressively, with an emphasis
on its California PEO business. Over the last three years, BBSI has grown its PEO employee base by 115%.

Table 1. Growth in PEO Employees
Dec-10 Dec-11 Dec-12 Dec-13
Employees pursuant to PEO contracts 32,800 41,500 56,210 70,250
Year-over-year growth 26.5% 35.4% 25.0%
Source: Company filings
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The rapid growth in PEO employees resulted in a significant increase in net income, which combined with
the lowered share count, led to rapid EPS growth. In addition to EPS growth, BBSI's earnings multiple has
expanded. By understating the significance of workers' comp to its growth and earnings, BBSI has
successfully garnered an earnings multiple dwarfing the 8x - 12x at which workers' compensation insurers
typically trade.

2) A Brief Background on the Seedy History of PEOs
A PEO typically offers small businesses a bundled package of HR services. Most PEOs offer a combination
of payroll, payroll tax administration, health care insurance coverage, and workers' compensation
insurance. Under a PEO co-employment agreement, the PEO becomes the employer of record for tax and
insurance purposes. As such, the PEO assumes, or shares, many employer-related liabilities (most notably,
workers compensation costs).

The economics and history of PEOs were built on the foundation of arbitrage. Following the passage of
ERISA in the 1970's, PEOs grew in popularity by exploiting a tax loophole that allowed them to claim an
exemption from certain tax requirements. State Unemployment Tax (SUTA) arbitrage, aka "SUTA
dumping," also became popular, which was premised on employers with high unemployment insurance
rates "dumping" employees into newly acquired businesses with lower rates. The more scrupulous PEOs
simply pooled a group of smaller employers to attain better insurance rates.

There are many different flavors of the reportedly 700 to 900 PEOs in the U.S.
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Given the commoditized
service offerings provided by payroll providers like ADP (ADP), Paychex (PAYX), and other administrative
service organizations, PEOs tend to differentiate themselves by offering health care or workers'
compensation coverage. PEOs like Insperity (NSP) and TriNet (TNET) predominantly focus on white collar
employers. According to the FBI, workers' compensation can constitute as much as 46% of small business
owners' general operating expenses.
10
As a result, blue collar focused PEOs often compete on the basic
affordability of providing workers' compensation. Whereas the competitive focus of white collar PEOs
tends to be on the breadth and features of health care plans.
11

The cash flow dynamics of PEO's has resulted in a history of rampant fraud. Most PEO fraud involves
managers misappropriating employee paycheck deductions that were meant to fund insurance or pay
government entities. For example, a few months ago, six officials tied to Synergy Personnel PEO (and
several other PEOs) were sentenced in the largest fraud case ever in the Western District of Texas.
12
In
that case, the PEO managers diverted $133 million of payroll deductions (meant for payroll taxes and
workers' compensation insurance coverage) to "vacations, girlfriends, gambling trips to Las Vegas, a
private jet, real estate and other personal expenses."
13
The PEO scheme went as far as setting up a
telephone giving clients the illusion they were calling an agent for Hartford Underwriters Insurance, and
also providing clients with fake Hartford certificates of liability insurance.
14
The fraud devastated mom-
and-pop businesses that remained on the hook for back taxes and workers' compensation liabilities.
15

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In another recent example, Arthur Weiss was sentenced to 185 months in prison last year for
employment tax fraud.
16
Over eight years, Weiss failed to remit employment taxes and workers'
compensation insurance premiums on behalf of his PEO clients. Instead, Weiss used a portion of his fraud
proceeds to purchase expensive jewelry and exotic cars, such as Ferraris, Lamborghinis, and Porsches.
17
In
another 2013 case, six people associated with a temporary staffing agency called Preferred Staffing of
America were charged for masterminding an organized scheme to defraud while operating without an
insurance license.
18
Preferred Staffing claimed they ran a licensed PEO and could provide workers'
compensation insurance coverage to their clients, but instead pocketed the premium payments.
19

A California Department of Industrial Relations investigation found many employers who purchase
workers' compensation coverage as part of a bundle of services from a PEO were "not [actually] covered
by a valid workers' compensation policy."
20
The FBI provided a similar warning in its Workers
Compensation Fraud Warning on the Professional Employer Organization (PEO) industry.
21
Because of the
rampant fraud and inherent business risk in the PEO industry (BBSI's largest market), California has
enacted a Bill that will ban all PEOs.

3) California Bans PEOs
In September 2012, California Senate Bill 863 was signed into law. The Bill's objective is to reform the
workers' compensation market. We believe SB 863 will have a profound negative impact on BBSI. SB 863
revokes the certificate of consent to self-insure for all PEOs, leasing employers, and "any employer the
director determines to be in the business of providing employees to other employers" no later than
January 1, 2015.
22
The Bill effectively bans PEO's from providing self-insured workers' compensation in
California, which happens to be BBSI's core business model. According to Sedgwick, California's largest
third party administrator, changes to the PEO industry were made to remedy "recent PEO defaults as well
as employer bankruptcies due to significantly underfunded liability."
23
LexisNexis Legal Newsroom cited a
similar goal:

The prohibition of certain employers, specifically the PEO's emanate from concerns
related to the financial stability and/or solvency of many of the self-insurers. There have
been two PEOs that have defaulted since 2011. There have also been several public self-
insurers that have encountered severe financial problems, including bankruptcy, in recent
years."
24

We believe SB 863 was long overdue given the spate of increasing risk in the PEO market. In November
2010, the Department of Industrial Relations declared Contractors Access Program of California in default
after determining its workers' compensation program lacked sufficient funding.
25
In 2012, California
insurance regulators seized deposits of Administrative Concepts Corp, after the PEO failed to pay required
workers compensation benefit payments to its injured workers as required by the California Labor
Code.
26
The California Department of Industrial Relations recently issued a "Statement of Emergency"
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after it assumed the claims of 54 insolvent private self insured employers.
27
Sedgwick expects the ban of
PEOs in California will "bring greater stability to the states work comp program."
28
While SB 863 should
be a clear positive for the State of California, it may be the regulatory event that pushed BBSI's previously
uninspected issues into the public's eye.

4) BBSI Losing Its License = Possible Collapse of Growth and/or Earnings
We are convinced investors (and especially the sell-side analysts) do not fully understand the impact from
BBSI losing its license in California. In an effort to work around the regulatory changes, BBSI has entered a
fronting agreement with ACE Limited (ACE).
29
Under the agreement, BBSI will pay a fronting fee to issue
workers' compensation policies under ACE's name. Beginning on January 1, 2015, new policies, as well as
annual renewals, will be written on ACE's paper. BBSI's management has suggested this transition will be
relatively seamless and inexpensive. We believe the impact will be substantial, and management's recent
revision to its estimated fronting cost supports our view.

In a fronting agreement, the fronting insurer (ACE) takes on the credit and liability risk of their customer's
book of business (BBSI). As a result, fronting arrangements are usually very expensive. For example,
Meadowbrook Insurance Group (MIG) lost its A-rating from A.M. Best in August 2013, because of
persistent adverse reserve development in its California workers' compensation book of business.
30

Meadowbrook was forced to enter a fronting agreement with State National Insurance to continue
writing ratings sensitive business (while also serving as an example of the challenges in the California
workers' comp market).
31
Based on industry discussions, we believe MIG is currently paying State
National a 5% fronting fee for its workers' compensation business. One of the most meaningful metrics
for measuring underwriting profitability is the combined ratio, which is a measure of underwriting
profitably comprised of the sum of the claims loss ratio and the expense ratio. For most insurance
companies in long-tail lines of business, combined ratios generally run in the 90% to 110% range (or a -
10% to +10% underwriting margin). As such, adding a 5% fronting cost can have a material effect on
profitability and earnings.

BBSI's management has consistently downplayed the impact of SB 863 on its business. On its Q2'13
earnings conference call (7/24/13), BBSI's CEO Mike Elich unequivocally outlined the impact from the
revocation of its license, stating, "[It] should be roughly cost neutral to the existing self-insurance system
we currently operate in California."
32
We believe this stance was a gross misstatement of the potential
impact. We believe BBSI's arrangement with ACE is similar to the MIG/State National agreement. On the
fourth quarter conference call, just six months after providing his "roughly cost neutral" assessment, Elich
changed the estimated impact:

Once all employees are transitioned, we expect the full incremental or frictional cost of
the program to be approximately 25 to 30 basis points above the recent workers'
compensation rate of approximately 4.3% of gross revenue. During the transition in
2014, the frictional costs will be ramping towards that full 25 to 30 basis point level,
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with a small effect in 1Q, and then growing in the remaining quarters as more clients
are transitioned. But we won't see the full effect until the first quarter of 2015
33

With $2.8 billion of gross revenue in 2013, a 25 to 30 basis point "cost" would imply a $7.0 million - $8.4
million payment to ACE as fronting fees. With only $24.9 million of pretax earnings in 2013, the new
impact outlined by Elich would have cut annual earnings by 28% - 34%. Not exactly what most consider
"roughly cost neutral."

BBSI has very convoluted financial presentations, which makes identifying the steep impact from the ACE
fronting costs challenging. In earnings releases, BBSI discloses gross and net workers' compensation
expense. However, the company does not provide their claims accrual expense in these releases, thus
sell-side analysts would not only need to read the quarterly SEC filings, but they would need to
contextualize the claims accrual expense. This may explain why the sell-side has been so deficient in
accurately quantifying the significance of the 2015 fronting impact on estimates. Based on commentary in
BBSI's 10K, it is our understanding that reinsurance costs (including fronting fees), commissions, and other
costs account for the difference between "net work comp expense" and "claims accrual" (see Table 2
below). In Q2'14, "other claims expense" nearly doubled year-over-year to $11.9 million, representing
1.49% of gross revenue, or a 61 basis point increase compared to Q2'13 (1.49% vs. 0.89% = 0.61% when
rounded to two decimals in Table 2). It is our belief that the significant step-up in "other claims expense"
was principally driven by the new ACE fronting agreement. Supporting our analysis, management said on
its Q2'14 earnings call they had converted "about a third of our new and existing clients into the fronted
arrangement" through the third week in July. They also said the other two-thirds were expected to be
converted over the remainder of 2014.
34
If less than "a third" of clients drove a 61 basis point increase in
costs, it seems rather straightforward that the remaining "two-thirds" should result in a more dramatic
rise in costs in 2H'14 and 2015 as these remaining clients transition to ACE's paper.

As we discuss at length in later sections, we believe BBSI management may have attempted to offset this
dramatic rise in fronting costs by under accruing loss reserves in Q2'14. Assuming our suspicions on under
accruing loss reserves are correct, management's actions would not only be unsustainable, but it would
further exacerbate their already inadequate reserve position (as more workers' comp expense went to
ACE rather than building reserves). Given only one-third of the employee transition has occurred, the
Table 2. Other Expense / Fronting Cost Increase
$ MMs
Q1'12 Q2'12 Q3'12 Q4'12 2012 Q1'13 Q2'13 Q3'13 Q4'13 2013 Q1'14 Q2'14
Net workers' compensation expense 13.2 17.0 19.4 21.5 71.1 21.8 25.0 28.2 33.6 108.6 27.6 30.8
Claims accrual 8.2 11.3 13.7 17.6 50.7 16.1 19.0 22.4 29.8 87.3 20.2 18.9
Other: reinsurance, commissions, other 5.1 5.7 5.7 3.9 20.3 5.7 6.0 5.8 3.8 21.3 7.4 11.9
% gross revenue
Net workers' compensation expense 3.06% 3.44% 3.48% 3.59% 3.42% 3.69% 3.70% 3.69% 4.31% 3.87% 3.79% 3.85%
Claims accrual 1.89% 2.28% 2.46% 2.94% 2.44% 2.73% 2.81% 2.93% 3.82% 3.11% 2.77% 2.36%
Other: reinsurance, commissions, other 1.17% 1.15% 1.02% 0.65% 0.98% 0.96% 0.89% 0.76% 0.49% 0.76% 1.02% 1.49%
Incremental "other cost" year-over-year 0.06% 0.61%
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12
dramatic rise in fronting/reinsurance/other claim costs suggest management's "25 to 30 basis point"
estimate appears highly misleading.

An optimist (or sell-side analyst) may argue that BBSI could attempt to offset the increased fronting
agreement costs by increasing prices. We believe a price increase would impair BBSI's ability to compete
considering most workers' compensation insurance companies use price as their competitive lever. As
discussed later in another background segment, the California workers' compensation market has become
more price-competitive with the reemergence of the State Fund. If BBSI attempts to raise price to offset
significant future earnings compression, we believe the offsetting lever will be declining customer counts
and negative growth. This conundrum of lower earnings and declining growth contrasts with the common
BBSI investment thesis premised on accelerating growth and earnings.

5) A "Reserve Study" By Any Other Name Would Smell as Rancid
We believe BBSI is currently in the midst of a reserve study, which insurance analysts understand is often
confession time. We are troubled by the effort BBSI management appears to have expended to avoid
using traditional industry parlance for the reserve study. On its Q2'14 earnings conference call (7/30/14),
BBSI's management disclosed they "engaged an outside consulting firm, who will soon be reviewing a
sample of these strengthened claims to evaluate the sufficiency of the new estimated claim values, as
well as assist management in gaining an enhanced understanding of trends within our claim
population."
35
In the insurance world, this is known as a "reserve study" and is typically performed by a
third party actuary when concerns emerge about existing reserves. If BBSI's analysts or shareholders were
familiar with insurance, they would know reserve study announcements often serve as ominous
harbingers for future charges. In our experience, nearly every insurance company melt-down has been
triggered by the dreaded "reserve study." For example, less than two months ago, Genworth Financial
(GNW) announced a reserve study for their long-term care insurance business.
36
Similar to workers'
compensation, long-term care insurance has a long-tail liability, which requires significant assumptions to
set reserves. On July 29th, 2014, GNW management disclosed, "As a result of recent experience, and in
connection with its regular review of claims reserve assumptions for its long term care insurance
products, the company is conducting a comprehensive review of the adequacy of its claim reserves [and]
we'll have inside and outside actuaries."
37
This statement is not much different from the casual disclosure
BBSI provided in its conference call. The difference appears to be the genre of sell-side analysts and
financial investors. Despite long-term care representing a small percentage of its overall business,
Genworth's stock dropped 22% in the week following the disclosure, erasing $1.8 billion of market cap.

Another recent example of the steep losses that can result from a reserve study is Tower Group (TWGP).
On August 7, 2013, TWGP announced it was postponing earnings "to review matters relating to the
estimate of its loss reserves [and] working to resolve these matters with the assistance of outside
processionals."
38
On October 7, 2013, following the review by independent actuarial consultants, TWGP
announced a massive $365 million reserve increase "primarily for accident years 2009 through 2011 in
commercial insurance lines of business, including workers' compensation."
39
TWGP's stock was around
$22.00 prior to announcing its reserve study. In the two months after disclosing its reserve study, TWGP's
stock fell to $4.00, or an 82% decline.
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13

Despite the material risk of investor losses following a reserve study, BBSI management has still not
clearly articulated the drivers necessitating the review of its reserves. Nonetheless, as we clearly argue in
the next section, we believe BBSI's reserves are severely inadequate. As such, it is our belief that the
impetus behind BBSI's reserve study is its new fronting partner, ACE. Simply put, in the hypothetical event
BBSI went bankrupt, ACE would be required to cover BBSI's insurance claims. This was the outcome of
PEO Certified Services' bankruptcy, which left its excess workers' comp insurer CNA with a $60 million loss
covering PEO Certified Services' work comp claims.
40
Given the potential risk to ACE, we would not be
surprised if Milliman or Willis were conducting the reserve study. These third party actuarial firms have
worked with ACE in the past. Should it be disclosed Milliman or Willis is conducting the reserve study,
we believe it could signal ACE may not be comfortable with BBSI's reserve position. If the actuary
determines BBSI's reserves are deficient, and these concerns go unaddressed by management, it is
possible that ACE will not renew their fronting agreement with BBSI in early 2015. Should this occur, we
believe BBSI would be forced to find another fronting partner (which would be difficult in that
circumstance), attempt to raise dilutive equity to fund an admitted insurance carrier in the state (which
would also be difficult), or be forced to non-renew their California business. We believe any of these
scenarios would be catastrophic for BBSI investors.

6) Severely Inadequate Reserves May Require a Significant Charge
The current reserve study should illuminate any hole in BBSI's reserves shortly. Below, we discuss a few
approaches to assessing BBSI's reserve adequacy (BBSI does not publish loss triangles like other long-tail
insurers). Our conclusion is that BBSI's current reserves are woefully inadequate. BBSI's workers'
compensation costs are the most volatile and important component of its earnings (although as we
explain below, we believe their accounting may violate U.S. GAAP). Below is the breakdown of the
workers' compensation expense components:

Our in-depth review of BBSI's reserve position revealed several glaring red flags that lead us to believe
BBSI will have to substantially increase its loss reserves. The first red flag is the high level of "prior period"
claims adjustments. We discuss this in more detail in the next section (we believe their reserving process
does not conform to GAAP, or looks like any other insurance company for that matter). We analyze why
consistent adverse development suggests inadequate reserves.

Table 3. Components of Workers Compensation Costs
$ MMs
2008 2009 2010 2011 2012 Q1'13 Q2'13 Q3'13 Q4'13 2013 Q1'14 Q2'14
Claims expense accrual - current period 13.9 11.9 16.9 26.2 38.4 12.7 14.8 17.4 19.0 63.8 16.4 17.5
Claims expense accrual - adverse development 3.1 12.7 0.9 10.0 12.4 3.5 4.2 5.0 10.8 23.4 3.8 1.3
Total claims expense 17.0 24.7 17.7 36.1 50.7 16.1 19.0 22.4 29.8 87.3 20.2 18.9
Commission expense, reinsurance costs, other 14.2 15.1 18.6 17.7 20.3 5.7 6.0 5.8 3.8 21.3 7.4 11.9
Net workers' compensation expense 31.2 39.8 36.3 53.8 71.1 21.8 25.0 28.2 33.6 108.6 27.6 30.8
Safety incentive accrual 5.9 6.3 5.3 6.8 11.3 3.2 4.0 4.2 4.8 16.3 4.3 4.6
Gross workers' compensation expense 37.0 46.0 41.6 60.6 82.4 25.0 29.0 32.5 38.4 124.9 31.9 35.3
Source: Company filing
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14
The second red flag is BBSI's revenue, exposure, and paid claims have significantly outgrown its reserve
position. For example, in Q2'14, we estimate BBSI grew its employees under PEO contracts by 16% year-
over-year (on top of roughly 30% growth in the prior year) and approximately 3% quarter-over-quarter. In
Q2'14, workers comp paid claims increased by a dramatic 41% year-over-year and 32% quarter-over-
quarter. Despite the significant year-over-year and quarter-over-quarter exposure growth trends, BBSI
incredulously accrued LESS reserve expense in Q2'14 than in Q2'13 AND Q1'14. As a result, Q2'14 ending
reserves increased by only $2.4 million quarter-over-quarter, which represented the smallest quarterly
increase in years. We cannot fathom a reasonable fundamental explanation for the significant discrepancy
between growth in exposure and reserves. Instead, we believe the ACE fronting agreement costs are
running much higher than management expected. As such, after two challenging quarters relative to
investor expectations, we believe management may have decided to under-accrue for reserves in order to
avoid a third straight disappointing quarter.

A third red flag is the incredibly low level of short-term reserves, in absolute dollars and as a percentage
of total reserves. At June 30, 2014, short term reserves were $39 million, or 31.9% of total reserves. The
percentage of short-term reserves has declined every year since 2008, when they represented 48% of
reserves. Short-term reserves are earmarked for expected claims payments within the next year.
However, BBSI's $39 million of short-term reserves are inexplicably 29% less than the $53.2 million of
claims payments made over the past year. The decline in short-term reserves suggests management
believes claim payments will fall substantially over the next year, which is unfathomable considering the
Q2'14 run-rate was $65.9 million. To increase short-term reserves to a level that would cover the run-rate
of claims payments over the next year, we estimate BBSI would need to take a charge of at least $30
million. While this accounting issue is not addressed further in the next section devoted to accounting
irregularities, we do believe it represents another potential accounting issue for BBSI.

A fourth red flag is the extremely low level of Incurred But Not Reported (IBNR) reserves and the dramatic
growth of "case reserves" allocated to known claims (Table 5 below). IBNR reflects claim estimates for
covered losses that have yet to be reported. Given the long-tail nature of workers' compensation
liabilities, IBNR would typically be expected to account for a significant portion of reserves. For example,
Table 4. Dramatic Reserve Under-Accrual
$ MMs
Jun-13 Mar-14 Jun-14
Est. PEO employee growth - yoy 31% 19% 16%
Est. PEO employee growth - qoq 3%
Paid claims 11.7 12.5 16.5
% change year-over-year 41%
% change quarter-over-quarter 32%
Reserve expense accrual 19.0 20.2 18.9
% change year-over-year -1%
% change quarter-over-quarter -6%
Source: Company filings and our estimates
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15
according to their SEC filings, IBNR made up 50.4%, 42.4%, and 61.8% of the December 31, 2013 reserves
at workers' compensation insurers EIG, AFSI, and MIG, respectively. Over the past two years, BBSI's IBNR
has declined from 74% of reserves to just 24% at June 30, 2014 (highlighted in red in the Table below). It
appears the collapse in IBNR resulted from an arbitrary shift of reserves, with claim reserves rising
dramatically in the past few quarters. Case reserves increased to $92.6 million from $51.0 million in this
past quarter alone. Over many years analyzing insurance companies, we have NEVER seen anything like
this before. The dramatic shift to case reserves appears to have left IBNR at unsustainably low levels,
while providing us with another indication of the perilous state of BBSI's reserve position. If BBSI
increased its IBNR to 50% of total reserves, which would be more inline with other workers' compensation
insurers, a charge of nearly $63 million would be required.

The fifth highly concerning red flag is BBSI's small reserve versus paid claims. As stated numerous times,
workers' compensation is a very long-tail line of business, often taking years, or even decades, for a
workers' compensation insurer to pay out a claim. Without loss triangles, analyzing paid claim trends is
one of the more insightful methods to assess reserve adequacy. This approach is useful because actual
claims payments are independent of management assumptions (although we have found nearly every
insurance company insists that they pay and settle claims faster than their competitors). When reviewing
paid claims data for 2013 and Q2'14, BBSI appears dramatically under-reserved when compared to other
companies with workers' compensation exposure. BBSI's 2013 and Q2'14 run-rate claims payments would
deplete BBSI's entire reserve position in only 1.9 to 2.5 years. As can be seen in Table 6 below (which
compares BBSI to PEOs TNET & NSP as well as work comp insurer EIG), BBSI's run-rate claims payments
coverage is dramatically below its peer group. Amazingly, the opposite should be true. Given BBSI's
dramatic growth, we would have expected a HIGHER coverage of reserves (as future claim payments
increase with a lag given the big growth in exposure the previous few years). This was not the case, again
supporting our belief that a massive charge is coming.

Table 5. Insurance Reserves
$ MMs
2008 2009 2010 2011 Q1'12 Q2'12 Q3'12 Q4'12 2012 Q1'13 Q2'13 Q3'13 Q4'13 2013 Q1'14 Q2'14
Beginning reserves 22.0 24.6 36.0 39.3 51.2 52.8 55.8 61.6 51.2 70.6 77.2 84.5 96.0 70.6 112.4 120.1
Claims expense accrual - current period 13.9 11.9 16.9 26.2 8.2 8.2 9.9 12.2 38.4 12.7 14.8 17.4 19.0 63.8 16.4 17.5
Claims expense accrual - prior periods 3.1 12.7 0.9 10.0 0.0 3.1 3.8 5.4 12.4 3.5 4.2 5.0 10.8 23.4 3.8 1.3
Total expense accrual 17.0 24.7 17.7 36.1 8.2 11.3 13.7 17.6 50.7 16.1 19.0 22.4 29.8 87.3 20.2 18.9
Claims paid - current period 2.8 3.0 3.8 5.6 0.3 1.3 2.2 3.0 6.7 0.4 2.4 3.1 4.6 10.6 0.4 2.7
Claims paid - prior periods 11.6 10.3 10.6 18.7 6.3 7.0 5.7 5.7 24.6 9.1 9.2 7.8 8.7 34.8 12.1 13.7
Total claims paid 14.4 13.3 14.4 24.2 6.6 8.3 7.9 8.6 31.4 9.5 11.7 11.0 13.3 45.4 12.5 16.5
Paid to incurred 85% 54% 81% 67% 80% 74% 57% 49% 62% 59% 61% 49% 45% 52% 62% 87%
End balance 24.6 36.0 39.3 51.2 52.8 55.8 61.6 70.6 70.6 77.2 84.5 96.0 112.4 112.4 120.1 122.5
IBNR 15.8 25.4 27.2 37.3 38.3 41.0 44.3 48.0 48.0 51.8 56.4 59.4 69.6 69.6 69.2 29.9
% Reserves 64% 71% 69% 73% 73% 74% 72% 68% 68% 67% 67% 62% 62% 62% 58% 24%
Implied case reserve 8.7 10.5 12.1 13.9 14.5 14.8 17.3 22.6 22.6 25.4 28.1 36.6 42.8 42.8 51.0 92.6
% Reserves 36% 29% 31% 27% 27% 26% 28% 32% 32% 33% 33% 38% 38% 38% 42% 76%
Change in reserve period-over-period 24.6 11.4 3.3 11.9 1.6 3.0 5.9 8.9 19.4 6.6 7.3 11.4 16.5 41.9 7.7 2.4
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16

In Table 7 below, we analyze BBSI's dramatic under-reserving by applying the lowest run-rate reserve
coverage for TNET, NSP, and EIG to BBSI's paid claims. This analysis provides an estimate for the reserve
charge that would be required for BBSI to match the comp group's paid claims coverage. If we apply the
lowest assumed coverage (NSP's 3.5 years), it suggests BBSI would need to incur a $108.2 million charge
to reach a similar level of reserves. Using EIG's coverage, BBSI would require a mind boggling $279.6
million charge. Conducting the same analysis using the last twelve months claims paid generates a slightly
lower range of charges, consisting of a $69 million to $223 million shortfall relative to peer levels.
Demonstrating once again the severity of BBSI's reserve issues, the lowest end of the charge range ($69
million) would wipe out BBSI's pretax earnings for the past three-and-a-half years ($65 million). We admit
paid claim analysis has some deficiencies. Nonetheless, we believe our varied approaches clearly illustrate
why BBSI's reserves appear to be grossly deficient regardless of the method of analysis.

Table 6. Years of Reserves: Reserves to Paid Claims
$ MMs
Dec-13 Jun-14
BBSI
Last twelve months ("LTM") claims paid 45.4 53.2
Recent run-rate ("RR") claims paid 53.2 65.9
Gross reserves 112.4 122.5
Years: gross reserves to LTM paid claims 2.5 2.3
Years: gross reserves to RR paid claims 2.1 1.9
TNET
LTM claims paid 18.9 18.0
Recent run-rate claims paid 20.4 16.1
Net reserve 58.6 75.7
Years: net reserves to LTM paid claims 3.1 4.2
Years: net reserves to RR paid claims 2.9 4.7
NSP
EIG
Gross reserves 2,330.5 2,354.8
Net reserve 1,587.4 1,655.6
Years: net reserves to LTM paid claims 4.7 4.6
Years: net reserves to RR paid claims 4.4 4.3
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17

7) BBSI's Reserving Practices & Accounting Appear to Violate GAAP Resulting in Overstated Earnings
We have identified inconsistencies with BBSI's accounting and reserving practices compared to accounting
guidelines and peer group reporting. As such, BBSI's financials do not appear to conform with Generally
Accepted Accounting Principles. FAS 60 outlines accounting principles for setting reserves on long-tail
insurance liabilities:

The liability for unpaid claims shall be based on the estimated ultimate cost of settling
the claims (including the effects of inflation and other societal and economic factors),
using past experience adjusted for current trends, and any other factors that would
modify past experience
41

In addition, FAS 60 states that the liability amount required must encompass the estimated ultimate cost
to investigate and settle claims "relating to insured events that have occurred on or before a particular
date." The particular date is ordinarily defined as the balance sheet date. FAS 60 also stipulates:

The estimated liability includes the amount of money that will be required for future
payments on both (a) claims that have been reported to the insurer and (b) claims
relating to insured events that have occurred but have not been reported to the insurer
as of the date the liability is estimated
42

Based on BBSI's own public explanation of its reserving practice, we believe the company is in direct
violation of FAS 60 and U.S. GAAP. On it February 5, 2014 earnings conference call, BBSI's CEO Mike Elich
provided insight into one of the reasons they took an initial reserve charge:

Let's just say that claim in our history was a $10,000 claim. In the past what we would
do is we would put up on the first day or early in the claim maybe $2,500 in and on
that claim. If the person and the claim matured we would put dollars up again and
maybe again and again. And what our history said is that we would turn four times
Table 7. BBSI's Potential Reserve Deficiency
$ MMs
NSP TNET EIG NSP TNET EIG
Run-rate Basis LTM Basis
Reserves to run-rate payments 3.5 5.7 6.1 3.6 5.1 6.5
2Q'14 run-rate / LTM claims paid 65.9 53.2
Reserves needed 230.7 375.7 402.1 191.5 271.3 345.7
Current reserves 122.5 122.5
Deficiency / Potential Charge (108.2) (253.2) (279.6) (69.0) (148.8) (223.2)
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18
before we recognize the $10,000 for the total liability as it was paid out the claim was
paid. The challenge is that when you start to change your reserving practices to get
more dollars up on the claim earlier, say, we put $5000 now under the claim earlier;
the total liability hasn't changed from $10,000, but now we are half way there
earlier.
43

As quoted above, FAS 60 clearly guides companies to incur the entire expected liability on day one. Per
Elich's example, BBSI would need to incur a $10,000 liability on day one, as opposed to his public
explanation of putting "dollars up again and maybe again and again" or recognizing "half" of the liability.
We believe the accounting approach Elich described unequivocally overstates BBSI's current period
income. The table below compares BBSI's adverse development to three other insurance companies with
a large focus on workers' compensation. Adverse development on prior year reserves (represented by
positive percentages and figures in Table 8 and 9) signifies that the initial estimate of claim losses for a
given accident year were too low, which requires an increase in estimated costs in subsequent years.
Positive reserve development is seen by a negative number for "claims expense - prior period
development" and indicates that initial reserve estimates were conservative (too high). Conversely, a
negative adverse prior period development means previous reserve accruals were too low, and can be
seen in Table 9 with positive numbers for "claims expense - prior period development." If initial reserve
estimates are balanced, then it is reasonable to expect companies over time to experience prior period
developments that were both positive (original claim estimates were too high/conservative) and negative
(original claim estimates were too low/aggressive) over the course of time. BBSI is the only company in
our workers' comp peer set that has not had a positive reserve development since the beginning of 2009.
Further, the percentage of adverse reserve development to total loan loss provision (represented by a
positive percentage in Table 8) is dramatically higher than the other three companies, suggesting the
consistent degree of aggressive estimates at BBSI may not be the result of chance. The clear consistency
in BBSI's adverse reserve development, spanning nearly six years, is further proof BBSI's reserve
accounting mirrors management's own description, which we believe is a blatant violation of FAS 60.

BBSI's aggressive reserve approach appears unique among PEOs. Insperity Group (NSP) had positive prior
year reserve development in its workers' compensation book for 5.5 consecutive years. TriNet (TNET),
another publically traded PEO, had positive development for the past 2.5 years. These figures are in stark
contrast to the 5.5 years of persistently negative development at BBSI.

Table 8. Prior Period Development
% of Claim Provision
Company Ticker 2009 2010 2011 2012 2013 1Q'14 2Q'14
Barrett Business BBSI 51.7% 5.0% 27.6% 24.3% 26.9% 18.9% 6.9%
Employers Holdings EIG -22.1% -6.6% 0.4% 0.5% 1.4% 1.4% 1.2%
Amtrust Financial AFSI -1.5% 1.7% 1.8% 1.4% 2.0% n/a n/a
Meadowbrook Insurance MIG -8.8% -7.8% 1.5% 12.6% 12.5% -0.7% 0.0%
Note: positive percentage represents negative development, negative represents positive development
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19

We believe a consequence of the habitual negative developments at BBSI has been the material
overstatement of current period financial results. For example, by adjusting a prior year's results by the
following year's adverse development, we get a more accurate picture of the economic earnings from the
prior year. BBSI's 2013 adverse development was $11 million higher than 2012. If we adjusted 2012
results to account for this adverse development (better reflecting GAAP), 2012 earnings would have been
57% lower than BBSI reported.

We believe limited scrutiny from BBSI's long-time auditor, Moss Adams, has provided cover for BBSI to
violate GAAP accounting and understate reserves for years. We do not think Moss Adams is acting in a
nefarious manner, we simply believe they are ill-equipped to identify or interpret the accounting
irregularities at BBSI. Moss Adams is a small Seattle-based firm that has audited BBSI since 2005.
According to CapitalIQ, Moss Adams has completed the audit for 64 public companies since the beginning
of 2013. However, not one of those completed audits appears to have been an insurance company. A.M.
Best published their "Bests Review" in January 2014, which included a list of the 25 largest audit firms
ranked by property/casualty loss reserves. The top 25 firms (Table 11) cover 2,032 insurance companies,
representing 99.1% of industry reserves.
44
Supporting our belief that Moss Adams is not considered a
Table 9. PEO Prior Year Development
$ MMs
Barrett Business - BBSI 2009 2010 2011 2012 2013 1H'14
Claims expense - current period 11.9 16.9 26.2 38.4 63.8 33.9
Claims expense - prior period development 12.7 0.9 10.0 12.4 22.4 5.1
Total claims expense 24.7 17.7 36.1 50.7 86.3 39.0
Insperity - NSP
Claims expense - current period 56.3 53.9 58.2 64.4 63.9 33.0
Claims expense - prior period development (8.8) (8.1) (11.4) (13.1) (9.3) (1.4)
Total claims expense 47.5 45.8 46.8 51.3 54.6 31.6
TriNet - TNET
Claims expense - current period 24.4 23.2 26.4 25.8
Claims expense - prior period development 2.1 (3.3) (3.3) (0.7)
Total claims expense 26.5 19.9 23.1 25.1
Note: positive figures represents negative development, negative represents positive development
Table 10. Earnings Adjusted For Prior Development
$ 000s
'13 Adv
2012 Reserve Dev 2012
Actual Less '12 Adjusted
Pretax earnings 19,459 11,093 8,366
Tax rate 32.5% 32.5%
Net Income 13,131 5,645
Ave diluted shares outstanding 7,863 7,863
Diluted EPS $1.67 $0.72
% change vs. Reported -57%
Source: Company filing and our estimate
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20
domain expert in the insurance industry, A.M. Best's list does not include Moss Adams. Providing further
proof of Moss Adams' relative inexperience in the insurance industry, they do not even list insurance as a
practice area on their website.
45

8) Insurance Subsidiary Inconsistencies & a Lawsuit Accusing BBSI of "Cooking the Books"
In 2010, BBSI formed a wholly owned insurance company called Ecole Insurance Company to provide
workers' compensation coverage in the state of Arizona. We reviewed Ecole's statutory financial
statements, which are required to be filed with state insurance regulators. The statutory filings
(highlighted in Table 12) contained several troubling metrics that are completely inconsistent with the
"growth" at BBSI. For example, earned premiums declined by over 20% in 2013, which suggests BBSI is
shrinking its Arizona business. The loss ratio and combined ratio also skyrocketed in 2013, while Ecole
reported a $204,000 pretax loss in its most recent quarterly filing. The reserve position on the balance
sheet ended at only $556,900 at March 31, 2014, which is less than half of the annualized loss and loss
adjustment expense in the quarter. It is generally understood in the insurance industry that the loss
reserve should be multiples of the quarterly provision. Hence, the low level at BBSI's Ecole suggests the
regulated insurance entity, along with the GAAP balance sheet, may also be significantly under reserved.
Currently, public documents show BBSI's has $8.5 million of its cash and investments residing in this
regulated entity.
Table 11. Property/Casualty Audit Firms Ranked By Loss Reserves
$ MMs
Client P/C Loss
Audit Firm Count Reserves %
1 PricewaterhouseCoopers, LLP 507 204,589 33.84%
2 KPMG, LLP 388 128,641 21.28%
3 Ernst & Young, LLP 436 116,975 19.35%
4 Deloitte & Touche, LLP 238 112,534 18.61%
5 EisnerAmper, LLP 17 10,068 1.67%
6 Johnson Lambert & Co, LLP 80 6,197 1.02%
7 BDO, LLP 78 3,750 0.62%
8 WeiserMazars, LLP 23 2,707 0.45%
9 Crowe Horwath, LLP 11 1,859 0.31%
10 ParenteBeard, LLC 22 1,485 0.25%
11 Strohm Ballweg, LLP 33 1,442 0.24%
12 Dixon Hughes Goodman, LLP 11 1,394 0.23%
13 Eide Bailly, LLP 9 1,190 0.20%
14 McGladery, LLP 30 955 0.16%
15 Saslow Lufkin & Buggy, LLP 19 752 0.12%
16 Blackman Kallick, LLP 8 704 0.12%
17 Plante & Moran, PLLC 15 681 0.11%
18 Larson & Rosenberger, LLP 19 631 0.10%
19 BKD, LLP 16 535 0.09%
20 Dean Dorton Allen Ford, PLLC 3 510 0.08%
21 Brown Schultz Sheridan & Fritz 24 387 0.06%
22 Buffamante Whipple Buttafaro, PC 29 305 0.05%
23 Postlethwaite & Netterville 9 302 0.05%
24 Mayer Hoffman McCann, PC 1 302 0.05%
25 Ham, Langston & Brezina, LLP 6 247 0.04%
Total 2,032 599,143 99.10%
Source: A.M. Best
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________________________________________________________________________
21

We found the addresses and contact information for the insurance Ecole listed on its statutory financial
statements similarly confusing (picture below). Ecole's filings list "8390 E. Crescent Parkway, Suite 200,
Greenwood Village, CO" as its main office and mailing address. This address does not match any of BBSI's
disclosed locations.
46
Instead, the listed address is the same as Beecher Carlson, who is an insurance
broker. Ecole also appears to share an office suite with a Home Warranty Insurer.
47
Further, Ecole's
regulatory filing lists "2999 N. 44th St, #550, Phoenix, AZ" as the statutory home office and "primary
location of books and records." Once again, this address does not tie back to BBSI, but instead it appears
to be the address of an Arizona law firm called Low & Cohen.
48
Finally, Ecole lists its "Statutory Statement
Contact" as Matt Takamine, who appears to be a Beecher Carlson employee that is based in Hawaii.
49
It
remains unclear what the relationship may be between BBSI, Beecher Carlson, and Low & Cohen.
However, we have found BBSI policy documentation that lists Beecher Carlson as the "producer" of record
for a BBSI policy.
50
It would be highly concerning if a broker, with no "skin" in the game, was
administering, underwriting, and producing the financial statements for BBSI's insurance company. Any
experienced insurance investor will know that the only thing worse than rapid growth in the California
workers' compensation market, is a company that hands over underwriting authority to insurance brokers
with no risk of underwriting loss.

Table 12. Ecole Insurance
$ 000s
2012 2013 1Q'14
Income Statement
Premiums earnings 924.6 735.5 195.4
Loss and loss adjusted expenses 68.6 657.2 329.3
Loss ratio 7.4% 89.4% 168.6%
Other underwriting expenses 270.2 341.0 99.8
Expense ratio 29.2% 46.4% 51.1%
Underwriting income 585.9 (262.7) (233.8)
Combined ratio 36.6% 135.7% 219.7%
Net investment income 160.5 138.5 29.6
Miscellaneous income 102.5 40.3 0.0
Pretax earnings 848.8 (83.9) (204.2)
Balance Sheet
Cash 1,523 2,807 2,433
Bonds 5,888 5,771 6,086
Total cash & Investments 7,421 8,589 8,519
Losses 94.1 315.8 528.8
Loss Adjustment Expenses 3.6 16.8 28.1
Total statutory reserves 97.7 332.5 556.9
Surplus 7,157.0 7,148.0 6,999.5
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22

While we look forward to hearing BBSI's explanation behind the inconsistencies at Ecole, we admit a
heightened skepticism towards management based on a recently filed lawsuit. Admittedly, employee
lawsuits can be fraught with misstatements driven by impure motives. However, given the myriad of
troubling issues we have found at BBSI, it may be imprudent to cavalierly dismiss the accusations. Todd
Krug, a BBSI branch manager for ten years, filed a lawsuit in Washington Superior Court in February 2014
(case number 14-2-00405-6), accusing BBSI and its CEO of criminal activity. According to the lawsuit, Krug
alleges that BBSI "was manipulating the bottom line to avoid paying bonuses to managers" and "had been
violating Wage and Hour laws." Further, he claims that BBSI was "effectively 'cooking the books' to create
inflated profit margins to entice interest in BBSI stock in violation of SEC regulations." If true, this would
obviously have extensive ramification for BBSI management and shareholders. According to Krug, he met
with BBSI executives in 2013 and "inquired of them regarding his suspicions of fraud, and other illegal
activity." Following the meeting, Krug claims he was threatened "for questioning any action,
determination or statement of BBSI CEO, Mike Elich" then suspended for insubordination, and later
terminated by Director of Operations Gerald Blotz. While it is difficult to judge the veracity of these
allegations, given numerous other misrepresentations by management highlighted in this report, we
believe it would be unwise to arbitrarily dismiss the allegations.

9) California Workers' Compensation Destruction (brief background)
No geography has been more important to BBSI's unabated growth than California. While BBSI may be an
exception, history has not been kind to companies that have taken a "growth-at-all-cost" tactic in the
State of California. John Hempton, a blogger and portfolio manager, recently provided thoughtful insight
into the pitfalls of the California Workers' Comp market. Hempton's blog was predominantly focused on
the company AmTrust (AFSI). While AFSI's issues are alarming, we believe they are no more severe than
the different set of issues we have identified at BBSI. Further, the investment margin of safety in BBSI
appears far less than AFSI, considering AFSI trades at 8x earnings, or approximately 1/3 of the multiple of
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23
BBSI (we are not suggesting AFSI is a long or short, it is imply worth noting AFSI appears to have some of
its issues in the multiple, whereas BBSI does not):

California Workers Comp has left a graveyard of dead insurance companies including
some from Australia. It's an ugly place to do difficult business. The first reason is a
technical one: California Workers Comp policies are - by law - unlimited. When you buy
auto or liability insurance there is almost always a maximum claim. The insurance
company can bound its risk - and if - per chance you crash your car into a Rolls Royce
showroom (causing $20 million in damage) your insurance company will cover you for
damages up until the cap. But in California you might wind up with $40 million
damages on a single policy [sic]. [Imagine the medical and care bills for a quadriplegic
who lives another 45 years...] The second reason why California is difficult is persistent
"social inflation". The things an (unlimited) insurer is meant to cover have increased
over the decades with Californian social mores. Think about "diseases" like
fibromyalgia or carpels tunnel syndrome. Combined with increasing life expectancy for
some injured (eg paraplegics, carpels tunnel "victims") this has been expensive. The
third reason that California is difficult is that the (state) insurance regulator is very
competent at grabbing and securing your assets for the benefit of policyholders and
not for the benefit of shareholders.
51

While hard to prove, we believe the California workers' comp market has bankrupted more insurance
companies than any single hurricane or earthquake. The California Conservation & Liquation Office lists
over 300 insurance companies that have been placed under conservation or liquidation by the State of
California.
52

53
According to a RAND study, during the last California workers' compensation downturn, "31
insurers that wrote workers compensation coverage in the state, including some of the largest market
participants, failed."
54
These insolvent insurers accounted for between 23% - 31% of the market and 26 of
the 31 failed between 2000 and 2002 alone.
55
The California Workers' comp market has sent many other
insurance companies into run-off or left generating large losses. The aforementioned Meadowbrook
Insurance (MIG) is one such example.

Following two years of adverse reserve development in their California workers' compensation business,
rating agency A.M. Best downgraded their financial strength rating.
56
To continue writing business, MIG
was forced to enter an expensive fronting agreement. Uncertainty over their California workers'
compensation reserves, combined with the earning hit from the fronting agreement, cut the stock by
more than 50% to prices approaching decade lows.

Tower Group International (TWGP) investors have lost roughly 90% of their investment since August 2013,
after a reserve analysis uncovered a massive whole in commercial insurance reserves, largely driven by
workers' compensation losses.
57
At the time of the disclosures, Tower Group was the 15th largest
workers' compensation insurer in California.
58
The size of the workers' compensation losses forced TWGP
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24
into a death spiral, ultimately leading to the sale of the business to an entity associated AFSI at a highly
distressed price.
59

On December 9, 2013, Australian insurer QBE (QBE AU) pre-announced a $650 million increase in their
prior accident year claims reserves in North America, with the largest piece relating to "long tail classes of
business such as workers compensation, general liability and construction defects risks."
60
The disclosure
drove QBE's shares down by more than 30%.

Majestic Capital (formally known as CRM Holdings) filed for bankruptcy in April 2011, citing its decision to
"aggressively grow our California business [which] resulted in our expansion into riskier industries/classes
of business and lowering of certain of our underwriting and pricing standards."
61

SeaBright Holdings, another workers' compensation insurance company with a focus on the California
construction and agriculture markets, sold to Enstar Group (ESGP) in February 2013 at a distressed
valuation, as adverse development repeatedly hurt SeaBright's results.
62
Enstar Group acquired SeaBright
with the intention to operate it as a run-off operation.

As Mark Twain famously said, "History doesn't repeat itself, but it does rhyme." The above examples
highlight that the California workers' compensation market has been punitive towards companies that
have aggressively grown exposure in the state. And while BBSI could potentially be an exception, we could
not find another insurance company that has grown as rapidly in California over the last three years.

10) Deterioration of California Loss Trends Should Pressure BBSI
As discussed earlier, Senate Bill 863 may already be having a deleterious impact on BBSI's business model
and profitability. The fronting agreement expenses, even if severely misrepresented, have been discussed
by management. However, far more impactful are the recent data points that suggest claims frequency
and severity are on the rise in California.

On December 23, 2013, the Workers' Compensation Insurance Rating Bureau (WCIRB) of California
reported in its Analysis of Changes in Indemnity Claim Frequency - 2013 Report troubling "recent" AND
"atypical" frequency increases in California workers' compensation claims, even as the rest of the United
States was experiencing declining trends.
63
The WCIRB noted several potential drivers for the increase,
including: the recovery in higher hazard industries such as construction and manufacturing that carry
much higher claim frequency, growth in new workers entering the system who are more likely to be
injured on the job than more experienced workers, and the impacts of SB 863, which significantly
increased permanent disability benefits in 2013 and 2014.
64
BBSI's focus on high hazard industries and
exposure to new workers bodes very poorly given deterioration in frequency and severity trends. BBSI
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25
management has argued that claim frequency growth is a simple offshoot of exposure growth.
65

However, the recent WCIRB report appears to contradict their "all is well" messaging.
66

The WCIRB report also suggests that "the impact of higher SB 863 permanent disability benefits has
resulted in frequency increases that were broad based by geography and insurer type."
67
According to the
follow-up report issued on August 8, 2014, the estimated changes in indemnity claim frequency has
continued to rise in 2014.
68
The report cites trends in Southern California as a concerning area,
highlighting that "frequency of permanent partial disability claimsincluding those involving cumulative
injuries or multiple injured body partshas increased sharply in the Los Angeles area."
69
A separate
report published by the California Workers' Compensation Institute in February 2014 found that applicant
or defense attorney involvement was "far more prevalent in Southern California, especially in and around
Los Angeles."
70
Increasing involvement by attorneys is noteworthy because the CWCI found the average
benefit and expense payments for lost-time claims in California when an attorney was involved was
$62,652, or nearly 8x the incidents without attorney involvement.
71
With 8 of their 19 California offices
located in the greater Los Angeles area, it would seem BBSI is also in the geographic crosshairs of this
negative secular trend.

The trends identified in the WRICB and CWCI research will not show up immediately. However, even we
were surprised that the negative implications have already been verified by Employers Holdings (EIG). EIG
is a monoline workers' compensation insurance company with a large focus on California. In late February
2014, EIG released fourth quarter results that included a $26.5 million increase in its California workers'
compensation reserves.
72
On its conference call, management provided context that should serve as a
highly relevant warning to BBSI and all California workers' comp insures [emphasis ours]:

"In the first three quarters of 2013, we continued to see modest increases in frequency
and severity in California. In the fourth quarter, our actuarial analysis of ultimate losses
indicated upticks in frequency and severity of indemnity claims for accident year 2013.
The fourth quarter revealed a significant increase in attorney involvement in
indemnity claims in the Los Angeles area. Normally, we would wait more than one
quarter for a loss trend to develop more fully before taking any action. In this case, the
spikes were significant enough that we chose to increase our loss provision rate for the
accident year 2013. The rate of increase in open litigated indemnity claims in the fourth
quarter was significantly higher than expected. We also observed a change in reporting
patterns in 2013 as applicant attorneys were more often involved at the outset of the
claim that they have been historically. Our California business is also influenced by
ongoing loss trends we have observed which are similar to what the Workers'
Compensation Insurance Rating Bureau has reported [with] increases in the number and
size of indemnity claims in California largely the result of late reported claims,
cumulative trauma, shift in business mix as more hazardous industries such as
construction recover from the economic recession, perhaps increased benefits associated
with SB 863, geographical and socioeconomic differences with higher claims rates in the
Los Angeles area and other claim demographics including less experienced workers in
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26
the work force. We believe these trends are an issue for us and for any workers'
compensation insurance company doing business in California"
73

We believe EIG's confession is a harbinger of what BBSI shareholders can expect given its own Southern
California and high hazard industry exposure. We believe BBSI's thin reserves can not cover an increase in
either frequency or severity of claims.

11) ObamaCare & California State Fund = Risk of Large Client Departures and Negative Growth
In addition to the massive reserve issues we believe exist at BBSI, the combination of the Affordable Care
Act and a more competitive California State Fund may also derail BBSI's model. Under the Affordable Care
Act, the "employer mandate" (aka employer shared responsibility or "pay or play") goes into effect on
1/1/15 for employers with over 100 employees, and on 1/1/16 for employers with between 50 and 99
employees.
74
Under pay or play, penalties will be imposed on large employers, defined as those with at
least 50 full-time equivalent employees, who fail to provide healthcare insurance coverage to their
employees. We believe the pay or play provision could be devastating for PEOs, specifically those with
limited healthcare offerings and a concentration of clients with fewer than 50 employees. Based on our
interpretation of the employee mandate, companies with fewer than 50 employees are not required to
offer employees healthcare, thus avoiding any potential monetary penalties. Industry discussions have led
us to conclude that many small businesses will try to avoid eclipsing the 50 employee threshold and the
associated cost increases. As such, if the mandate definition applies at the PEO level, then businesses that
use a PEO could be subject to the mandate, even if they employ fewer than 50 employees. While there is
still a degree of uncertainty if the ACA will define number of employees at the PEO or client level, TriNet's
recently filed S1 (8/22/14) highlighted the risks (emphasis ours):

The guidance issued to date by the IRS and the U.S. Department of Health and Human
Services have not addressed, or in some instances are unclear, as to their application in the
co-employer context or whether such provisions should be applied at the client level. As a
result, we are not yet able to predict all of the impacts to our business, and to our clients,
resulting from the Act. As a result of this uncertainty, we are not yet able to determine the
impacts to our business, and to our clients, resulting from the Act. In future periods, the
changes may result in increased costs to us and our clients and could affect our ability to
attract and retain clients.
75

Insperity alluded to a similar risk in its 10K, which was filed in February, 2014 (emphasis ours):

The Act and subsequently issued IRS guidance do not expressly address the issue of
whether the pay or play penalties apply only at the client level or whether the penalties
can be applied at the PEO level. At this time, we are unable to determine whether the
Exchanges, tax credits, subsidies, insurance market reforms or the pay or play penalties
will have an adverse impact on our business operations, our ability to attract and retain
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27
clients, or our ability to increase service fees to offset any increased costs or associate
penalties assessed at the PEO level.
76

Unlike Insperity and TriNet, we believe BBSI has been less than truthful when discussing its own exposure
and risk from the employee mandate. On a 2/13/13 conference call, CEO Michael Elich suggested that
BBSI's clients had an average of 30 employees, while 70% of its clients had fewer than 50 employees.
77

The facts disclosed at year-end seemed to differ, suggesting an even smaller per employee client base. At
12/31/13, BBSI disclosed it had 2,850 PEO clients with 70,250 "employees pursuant to PEO contracts,"
implying an average of 24.6 per client.
78
Adding to our suspicion towards BBSI's characterization of its
small employee exposure was Elich's claim that "most of our clients already offer health insurance" in
response to an analyst's question on the employer mandate.
79

According to the California HealthCare Foundation, 61% of California employers offered healthcare
coverage to their employees in 2013.
80
However, coverage rates were highly dependent on wages. The
California Healthcare Foundation found that only 22% of lower-wage firms, defined as companies with at
least 35% of their workforce earnings $23,000 or less per year, offered health benefits in 2013. This
compares to 71% of higher-wage firms that offered healthcare coverage.
81
The percentage of BBSI's
clients offering healthcare matters as we discuss below.

As a sanity check for the high/low wage firms above, Insperity disclosed 72% of its worksite employees are
covered by in-house healthcare coverage, which is above the national average, and virtually inline with
the 71% cited for higher-wage firms.
82
It makes sense that Insperity's healthcare offering percentage
would be above the national average when considering their average compensation per worksite
employee was well above average. We estimate Insperity's average compensation per worksite employee
was $88,000 (gross payroll costs divided by average worksite employees). Therefore, it does not seem to
be a coincidence that the California HealthCare Foundation's 71% rate for higher-wage firms matches up
so closely with Insperity's 72% coverage rate.

On the other hand, BBSI's average worksite employee compensation appears much lower. Using the same
formula, we estimate that BBSI's average total compensation per worksite employee is between $37,000
and $38,000 ($2.37 billion gross payroll in 2013 divided by estimated average worksite employees of
63,200), which makes sense considering its blue collar focus. Considering the nearly identical coverage
rate for Insperity (72%) and the estimated 71% for higher-wage firms, we are completely perplexed why
BBSI's coverage rates (Elich claimed "most" have coverage) would be so different than the State average
(22%) for low-wage firms.

So why would Elich potentially mislead investors about the percentage of worksite employees that have
insurance, and why does it even matter? While still unclear, as evidenced by the TNET and NSP disclosures
above, should the ACA define healthcare coverage mandates by the number of employees at the PEO
level, we believe BBSI clients with fewer than 50 employees and no healthcare coverage would be subject
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28
to a $2,000 penalty per employee.
83
Should this interpretation hold, we believe BBSI could lose a
significant number of its clients with fewer than 50 employees. Considering management had previously
estimated 70% of its client fit this genre, the employee mandate could be catastrophic.

Even if ACA does not create massive disruptions and/or client attrition, we believe the resurrection of the
California Compensation Insurance Fund will create incremental growth challenges for BBSI. The State
Fund was created as a "fund of last resort" and is California's largest work comp insurer. Since its creation
in 1914, the State Fund has insured an average of 23% of the entire market.
84
The State Fund's market
share peaked at 53% in 2003 in the wake of multiple workers' comp insurer failures in the state.
85
From
2006 through 2012, the State Fund's annual premium declined by double digits every year, resulting in a
41% loss of market share. After years of market share declines, the State Fund restructured in 2011,
including a 25% reduction of its employee base. Benefitting from the leaner structure, as well as the
introduction of a tiered pricing model, the State Fund grew premiums by 23% in 2013.
86

87

88
For the past
decade, PEOs have grown as the State's biggest workers' comp entity was dysfunctional and ceding
market share. However, with a more focused and competitive State Fund in high hazard industries, BBSI's
organic growth will become much more challenging.

12) Normalized Valuation Suggests Substantial Downside
We believe investors and sell-side analysts are using valuation metrics for BBSI that are nonsensical
considering insurance is the major driver of BBSI's results. Many sell-side analysts, and we presume
investors, have used EV/EBITDA and cash flow multiples to justify BBSI's lofty valuation. While we
recognize the BBSI analyst contingency may not have insurance experience, there is a reason insurance
companies are never valued on these metrics. First, it is easy for an insurance company to generate
operating cash flow by growing exposure. Insurance companies collect premiums upfront (represented in
cash flow from operations) with the hope that premiums and investment returns will be greater than
claims paid in the future (the tail on workers' compensation insurance claims can be decades long). Simply
put, there is a timing mismatch that distorts cash flow for a growing insurance company. Using EV/EBITDA
also paints a highly misleading picture. BBSI reported $80 million of cash and marketable securities on its
balance sheet. However, a substantial portion of that cash is trapped in insurance subsidiaries,
encumbered due to collateral requirements under the ACE agreements, or earmarked to pay claims.
Illustrating the flaw in blindly crediting BBSI for its cash, BBSI recently disclosed that only $10 million of
the cash on its balance sheet was unencumbered (and this is before ACE is fully collateralized).
89
Further,
investors are ill-equipped to adjust the "Enterprise Value" to properly account for the large liability of
future claims payments.
Table 13. California State Compensation Insurance Fund
$ MMs
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Written premium 8,216 6,141 3,567 2,388 1,725 1,287 1,140 1,011 904 1,113
Premium growth -25% -42% -33% -28% -25% -11% -11% -11% 23%
California market share 51.0% 42.1% 32.0% 26.5% 22.6% 18.6% 16.0% 12.9% 10.0% 10.8%
Source: California Department of Insurance and statefundca.com
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29

Using a more traditional earnings-based approach makes far more sense, and helps explain the large delta
between BBSI's P/E and its real peers (even with the unsatisfactory reserve policies). If we ignore all of the
growth risks and assume BBSI achieves 15% annual growth for 2014 and 2015 (ignoring major reserve
issues), assume workers' compensation margins increase by 0.30% vs. 2013 (this considers the fronting
arrangement but generously assumes they lower the costs significantly from implied Q2'14 levels), and
BBSI can offset one-third of the cost increase through scale, we estimate 2015 EPS of $2.25 per share.
Despite all of the generous assumptions, we still get a 2015 earnings estimate well below the $3.80
consensus.

At a P/E of 13x, which is generously a 15% premium to the average multiple of monoline insurance
companies MIG, AFSI, AMSF, and EIG, BBSI's stock would trade at $29.00 per share. This generous set of
assumptions still results in a price target with 50% downside from its current price. It is worth noting
some workers' compensation insurance companies have elevated P/E ratios due to very low price-to-book
multiples. BBSI only has $26 million of tangible net worth (tangible book value matters for long-tail
insurers because claims can not be paid with goodwill), so BBSI does not have the same P/B support level.

Assuming we are correct on the considerable hole in BBSI's reserve, then there are multiple scenarios that
can send BBSI's stock much lower. Some of these scenarios were discussed earlier, including large
Table 14. Earnings Assumptions
$ MMs
2013 2014E 2015E
Total gross revenue 2,810 3,231 3,716
Revenue growth assumption 15% 15%
Total net revenue 533 613 705
Revenue growth assumption 15% 15%
Gross workers' compensation costs 125 176
Percent of gross revenue 4.45% 4.75%
Change 0.30%
Gross profit 87 106
Percent of gross revenue 3.08% 2.85%
Change -0.23%
SG&A 60 79
Percent of net revenue 11.3% 11.1%
Change -0.13%
D&A 2 3
Investment income 0.5 0.7
Pretax 25 25
Tax 7 8
% tax rate 28.2% 32.5%
Net income 18 17
EPS $2.42 $2.25
Diluted Shares 7.4 7.4
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30
potential reserve charges [including short-term reserves ($30 million), IBNR ($63 million) and paid claims
coverage ($69 million to $280 million)]. Adjusting past results for these charges suggests that BBSI is
significantly less profitable than historically reported numbers. In our generous $29.00 scenario, we did
not even assume more appropriate higher future reserve accruals. Additionally, BBSI is now beholden to
their fronting partner. If ACE non-renews their fronting agreement and BBSI cannot find a replacement, its
inability to renew their California business could threaten the viability of the business. We believe BBSI
has significant earnings and headline risk, rendering the shares fundamentally univestable.

Table 15. Workers' Compensation Insurer Valuation
Recent Market EPS Book Value P/E P/BV
Name Ticker Price Cap 2013 2014 2015 GAAP Tang 2014 2015 GAAP Tang
Amerisafe AMSF $37.09 $695 $2.37 $2.66 $3.35 $22.41 $22.41 13.9x 11.1x 1.7x 1.7x
Amtrust Financial AFSI $43.88 $3,318 $3.39 $4.89 $5.25 $17.85 $8.95 9.0x 8.4x 2.5x 4.9x
Employers Holdings EIG $21.70 $683 $0.81 $0.87 $1.23 $18.17 $16.70 25.0x 17.6x 1.2x 1.3x
Meadowbrook Insurance MIG $6.38 $320 ($0.32) $0.48 $0.64 $8.91 $7.68 13.3x 10.0x 0.7x 0.8x
Tower Group TWGP $2.11 $121 ($10.0) ($3.00) ($0.50) $1.67 $0.27 -0.7x -4.2x 1.3x 7.8x
Barrett Business BBSI $59.91 $430 $2.84 $3.10 $3.80 $10.29 $3.61 19.3x 15.8x 5.8x 16.6x
Source: Bloomberg
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31

1
Todd Krug vs. Barrett Business Services Inc. (14-2-00405-6)
2
www.fbi.gov/stats-services/publications/financial-crimes-report-2010-2011
3
www.rand.org/pubs/monographs/MG949.html
4
www.sec.gov/Archives/edgar/data/902791/000119312514100025/d629759d10k.htm
5
www.dir.ca.gov/peo.html
6
www.sec.gov/Archives/edgar/data/902791/000119312513109536/d443983d10k.htm
7
www.sec.gov/Archives/edgar/data/902791/000119312511100688/ddef14a.htm
8
http://www.sec.gov/Archives/edgar/data/902791/000119312514152638/d629767ddef14a.htm
9
http://www.napeo.org/peoindustry/industryfacts.cfm
10
11
12
www.expressnews.com/news/local/article/Players-in-largest-fraud-case-ever-sentenced-5257022.php
13
www.mysanantonio.com/news/local_news/article/Local-employment-firms-accused-in-66-million-tax-974935.php
14
www.mysanantonio.com/news/local_news/article/Local-employment-firms-accused-in-66-million-tax-974935.php
15
www.expressnews.com/news/local/article/Players-in-largest-fraud-case-ever-sentenced-5257022.php
16
www.fbi.gov/charlotte/press-releases/2013/operator-of-payroll-companies-sentenced-in-north-carolina-for-federal-fraud-and-
money-laundering-crimes
17
www.fbi.gov/charlotte/press-releases/2013/operator-of-payroll-companies-sentenced-in-north-carolina-for-federal-fraud-and-
money-laundering-crimes
18
www.myfloridacfo.com/sitePages/newsroom/pressRelease.aspx?id=4194
19
www.myfloridacfo.com/sitePages/newsroom/pressRelease.aspx?id=4194
20
https://www.dir.ca.gov/peo.html
21
22
http://www.leginfo.ca.gov/pub/11-12/bill/sen/sb_0851-0900/sb_863_bill_20120919_chaptered.html
23
https://www.sedgwick.com/resources/Documents/Studies/SB%20863%20Client%20Forum%20Summary.pdf
24
http://www.lexisnexis.com/legalnewsroom/workers-compensation/b/reform-legislation/archive/2012/08/28/california-workers-
compensation-reform-sb-863-analysis-self-insurance-provisions.aspx
25
http://peopros.com/?tag=california-peo
26
http://www.wcexec.com/Says-Self-Insured-Employee-Leasing-Firm-Is-In-Default.aspx
27
www.dir.ca.gov/osip/SIP_StatementofEmergency.doc
28
https://www.sedgwick.com/resources/Documents/Studies/SB%20863%20Client%20Forum%20Summary.pdf
29
http://finance.yahoo.com/news/bbsi-enters-workers-compensation-insurance-210500648.html
30
http://www3.ambest.com/ambv/bestnews/presscontent.aspx?altsrc=0&refnum=20108
31
http://www.insurancejournal.com/news/national/2013/08/05/300687.htm
32
http://seekingalpha.com/article/1569532-barrett-business-services-inc-bbsi-ceo-discusses-q2-2013-results-earnings-call-
transcript?part=single
33
http://seekingalpha.com/article/1997121-barrett-business-services-ceo-discusses-q4-2013-results-earnings-call-transcript
34
http://seekingalpha.com/article/2359655-barrett-business-services-bbsi-ceo-mike-elich-on-q2-2014-results-earnings-call-
35
http://seekingalpha.com/article/2359655-barrett-business-services-bbsi-ceo-mike-elich-on-q2-2014-results-earnings-call-transcript
36
http://investor.genworth.com/investors/news-releases/archive/archive/2014/Genworth-Financial-Announces-Second-Quarter-2014-
Results/default.aspx
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Barrett Business Services (BBSI) : A Tick-Tick-Ticking Time Bomb

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