Overview

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

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

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

• allowing clients to focus on core business activities instead of human resource matters;

• increasing clients' productivity by improving employee satisfaction and generating greater employee retention;

• reducing overall payroll expenses due to lower workers' compensation and health insurance costs; and

• assisting clients in complying with complex and evolving human resource-related regulatory and tax issues.

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

Item 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations (Continued)


Results of Operations

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



                                                              Percentage of Total Revenues
                                                      Three Months Ended         Six Months Ended
                                                           June 30,                  June 30,
                                                      2009           2008        2009         2008
Revenues:
Staffing services                                       48.9 %        56.3 %      48.0 %       55.2 %
Professional employer service fees                      51.1          43.7        52.0         44.8


Total revenues                                         100.0         100.0       100.0        100.0


Cost of revenues:
Direct payroll costs                                    36.9          41.5        36.2         40.7
Payroll taxes and benefits                              33.9          28.7        38.8         32.7
Workers' compensation                                   33.1          10.3        23.6         10.3


Total cost of revenues                                 103.9          80.5        98.6         83.7


Gross margin                                            (3.9 )        19.5         1.4         16.3

Selling, general and administrative expenses            14.6          12.7        15.1         12.9
Depreciation and amortization                            0.7           0.5         0.7          0.5


(Loss) income from operations                          (19.2 )         6.3       (14.4 )        2.9

Other income                                             0.5           0.8         0.3          0.9


(Loss) income before taxes                             (18.7 )         7.1       (14.1 )        3.8

(Benefit from) provision for income taxes               (6.9 )         2.6        (5.0 )        1.4


Net (loss) income                                      (11.8 )%        4.5 %      (9.1 )%       2.4 %

We report PEO revenues in accordance with the requirements of Emerging Issues Task Force No. 99-19, "Reporting Revenues Gross as a Principal Versus Net as an Agent" ("EITF No. 99-19"), which requires us to report such revenues on a net basis because we are not the primary obligor for the services provided by our PEO clients to their customers pursuant to our PEO contracts. We present for comparison purposes the gross revenues and cost of revenues information set forth in the table below. Although not in accordance with GAAP, management believes this information is more informative as to the level of our business activity and more illustrative of how we manage our operations, including the preparation of our internal operating forecasts, because it presents our PEO services on a basis comparable to our staffing services.

Results of Operations (Continued)

The presentation of revenues on a net basis and the relative contributions of staffing and PEO revenues can create volatility in our gross margin percentage. The general impact of fluctuations in our revenue mix is described below.

• A relative increase in staffing revenues will typically result in a lower gross margin percentage. Staffing revenues are presented at gross with the related direct costs reported in cost of sales. While staffing relationships typically have higher margins than PEO relationships, an increase in staffing revenues and related costs presented at gross dilutes the impact of the net PEO revenue on gross margin percentage.

• A relative increase in PEO revenue will result in a higher gross margin percentage. Improvement in gross margin percentage occurs because incremental PEO revenue dollars are reported as revenue net of all related direct costs.

                                              Unaudited                 Unaudited
                                          Three Months Ended        Six Months Ended
      (in thousands)                           June 30,                 June 30,
                                         2009           2008        2009        2008
      Revenues:
      Staffing services                $  28,002      $  40,604   $  52,044   $  76,423
      Professional employer services     220,150        228,891     423,975     452,652

      Total revenues                     248,152        269,495     476,019     529,075

      Cost of revenues:
      Direct payroll costs               210,720        225,887     404,276     443,740
      Payroll taxes and benefits          19,434         20,721      42,061      45,166
      Workers' compensation               20,221          8,833      28,216      17,553

      Total cost of revenues             250,375        255,441     474,553     506,459

      Gross margin                     $  (2,223 )    $  14,054   $   1,466   $  22,616

Item 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations (Continued)


Results of Operations (Continued)

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



                                                                     Unaudited
                                                            Three Months Ended June 30,
                                       Gross Revenue                                            Net Revenue
(in thousands)                       Reporting Method           Reclassification             Reporting Method
                                     2009        2008         2009            2008           2009        2008
Revenues:
Staffing services                  $  28,002   $  40,604   $       -       $       -       $  28,002   $  40,604
Professional employer services       220,150     228,891     (190,887 )      (197,312 )       29,263      31,579

Total revenues                     $ 248,152   $ 269,495   $ (190,887 )    $ (197,312 )    $  57,265   $  72,183


Cost of revenues                   $ 250,375   $ 255,441   $ (190,887 )    $ (197,312 )    $  59,488   $  58,129


                                                                     Unaudited
                                                             Six Months Ended June 30,
                                       Gross Revenue                                            Net Revenue
(in thousands)                       Reporting Method           Reclassification             Reporting Method
                                     2009        2008         2009            2008           2009        2008
Revenues:
Staffing services                  $  52,044   $  76,423   $       -       $       -       $  52,044   $  76,423
Professional employer services       423,975     452,652     (367,682 )      (390,698 )       56,293      61,954

Total revenues                     $ 476,019   $ 529,075   $ (367,682 )    $ (390,698 )    $ 108,337   $ 138,377


Cost of revenues                   $ 474,553   $ 506,459   $ (367,682 )    $ (390,698 )    $ 106,871   $ 115,761

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

Three months ended June 30, 2009 and 2008

Net loss for the second quarter of 2009 amounted to $6.7 million, a decline of $10.0 million from net income of $3.3 million for the second quarter of 2008. The decline for the second quarter of 2009 was primarily due to lower revenues and lower gross margin dollars primarily resulting from an $11.8 million increase in worker' compensation expense due to the Company's change in estimate of its workers' compensation claims liabilities as of June 30, 2009. Diluted loss per share for the second quarter of 2009 was $.65 compared to a diluted earnings per share of $.29 for the comparable 2008 period.

Results of Operations (Continued)

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

Revenues for the second quarter of 2009 totaled $57.3 million, a decrease of approximately $14.9 million or 20.7%, which reflects a decrease in both the Company's staffing service revenue and PEO service fee revenue. Staffing services revenue decreased approximately $12.6 million or 31.0% due to a continued decline in demand for our staffing services from existing customers in the majority of our markets. Management expects demand for the Company's staffing services will continue to reflect overall economic conditions in its market areas. PEO service fee revenue decreased approximately $2.3 million or 7.3% from the comparable 2008 quarter. While our PEO business from new customers during the second quarter of 2008 exceeded our loss of PEO business from former customers, the overall decline in PEO business resulted from decreased hours worked at existing PEO customer worksites.

Gross margin for the second quarter of 2009 represented a loss of approximately $2.2 million, or a decrease of $16.3 million from the second quarter of 2008, primarily due to the $11.8 million additional workers' compensation expense adjustment, a 20.7% decline in revenues and higher payroll taxes and benefits as a percentage of revenues. The increase in payroll taxes and benefits, as a percentage of revenues, from 28.7% for the second quarter of 2008 to 33.9% for the second quarter of 2009, was principally due to higher statutory state unemployment tax rates in various states in which the Company operates as compared to the second quarter of 2008 as well as to an increase in business mix of PEO services where payroll taxes and benefits are presented at gross cost whereas the related direct payroll costs are netted against PEO services revenue.

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

Workers' compensation expense, as a percent of revenues, increased from 10.3% in the second quarter of 2008 to 33.1% in the second quarter of 2009. Workers' compensation expense for the second quarter of 2009 totaled $18.9 million, compared to $7.5 million for the second quarter of 2008. The increase in the expense as a percentage of revenues was primarily due to the $11.8 million additional workers' compensation expense adjustment.

The decrease in direct payroll costs, as a percentage of revenues, from 41.5% for the second quarter of 2008 to 36.9% for the second quarter of 2009 was largely due to the significant decline in staffing services business.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Results of Operations (Continued)

Selling, general and administrative ("SG&A") expenses for the second quarter of 2009 amounted to approximately $8.3 million, a decline of $829,000 or 9.0% from the second quarter of 2008. The decrease from the second quarter of 2008 was primarily attributable to lower branch management payroll, profit sharing and commissions due to the decline in business activity and profitability.

Other income for the second quarter of 2009 was $293,000 compared to other income of $587,000 for the second quarter of 2008. The decline in other income for the second quarter of 2009 was primarily attributable to decreased investment income earned on the Company's cash and investments resulting from a significant decline in investment yields compared to the 2008 second quarter.

Six months ended June 30, 2009 and 2008

Net loss for the six months ended June 30, 2009 amounted to $9.9 million, a decline of $13.2 million from net income of $3.3 million for the comparable period of 2008. The decline for the six months ended June 30, 2009 was primarily due to lower revenues and lower gross margin dollars principally due to an $11.8 million increase in workers' compensation expense resulting from the Company's change in estimate of its workers' compensation reserves during the second quarter of 2009. Diluted loss per share for the first six months of 2009 was $.95 compared to diluted earnings per share of $.30 for the comparable 2008 period.

Revenues for the six months ended June 30, 2009 totaled $108.3 million, a decrease of approximately $30.0 million or 21.7%, which reflects a decrease in both the Company's staffing service revenue and PEO service fee revenue. Staffing services revenue decreased approximately $24.4 million or 31.9% due to a significant decline in demand for our staffing services from existing customers in the majority of our markets. PEO service fee revenue decreased approximately $5.6 million or 9.1% from the comparable 2008 period primarily due to a decline in business as a result of decreased hours worked at existing PEO customer worksites, partially offset by the net effect of the addition of new customers.

Gross margin for the six months ended June 30, 2009 totaled approximately $1.5 million, which represented a decrease of $21.2 million from the comparable period of 2008, primarily due to the $11.8 million additional workers' compensation expense adjustment, a 21.7% decline in revenues and higher payroll taxes and benefits as a percentage of revenues. The gross margin percent decreased from 16.3% of revenues for the first six months of 2008 to 1.4% for the first six months of 2009. The increase in payroll taxes and benefits, as a percentage of revenues, from 32.7 % for the first six months of 2008 to 38.8% for the first six months of 2009, was principally due to higher statutory state unemployment tax rates in various states in which the Company operates in 2009 as compared to 2008.

Workers' compensation expense, as a percent of revenues, increased from 10.3% in the first six months of 2008 to 23.6% in the first six months of 2009. Workers' compensation expense for the first six months of 2009 totaled $25.6 million, compared to $14.3 million for the first six months of 2008. The increase in the expense as a percentage of revenues was primarily due to the $11.8 million additional workers' compensation expense adjustment. The decrease in direct payroll costs, as a percentage of revenues, from 40.7% for the first six months of 2008 to 36.2% for the first six months of 2009 was largely due to the significant decline in staffing services business.

Results of Operations (Continued)

Six months ended June 30, 2009 and 2008 (Continued)

SG&A expenses for the first six months of 2009 amounted to approximately $16.4 million, a decline of $1.5 million or 8.2% from the first six months of 2008. The decrease from the first six months of 2008 was primarily attributable to lower branch management payroll, lower profit sharing and an overall reduction in variable operating expenses due to the decline in business activity.

Other income for the first six months of 2009 was $408,000 compared to other income of $1.2 million for the comparable period of 2008. The decline in other income for the first six months of 2009 was primarily attributable to decreased investment income earned on the Company's cash and investments resulting from a significant decline in investment yields.

Factors Affecting Quarterly Results

The Company has historically experienced significant fluctuations in its quarterly operating results and expects such fluctuations to continue in the future. The Company's operating results may fluctuate due to a number of factors such as seasonality, wage limits on statutory payroll taxes, claims experience for workers' compensation, demand and competition for the Company's services and the effect of acquisitions. The Company's revenue levels may fluctuate from quarter to quarter primarily due to the impact of seasonality on its staffing services business and on certain of its PEO clients in the agriculture, food processing and construction-related industries. As a result, the Company may have greater revenues and net income in the third quarter of its fiscal year. Revenue levels in the fourth quarter may be affected by many customers' practice of operating on holiday-shortened schedules. Payroll taxes and benefits fluctuate with the level of direct payroll costs, but tend to represent a smaller percentage of revenues and direct payroll later in the Company's fiscal year as federal and state statutory wage limits for unemployment and social security taxes are exceeded on a per employee basis. Workers' compensation expense varies with both the frequency and severity of workplace injury claims reported during a quarter and the estimated future costs of such claims. Adverse loss development of prior period claims during a subsequent quarter may also contribute to the volatility in the Company's estimated workers' compensation expense.

Liquidity and Capital Resources

The Company's cash position for the six months ended June 30, 2009 decreased $15.1 million from December 31, 2008, which compares to an increase of $6.9 million for the comparable period in 2008. The decrease in cash at June 30, 2009 as compared to December 31, 2008, was primarily due to purchases of marketable securities of $14.0 million, and a net loss from operating activities of $9.9 million, offset in part by proceeds from sales and maturities of marketable securities of $8.2 million.

Liquidity and Capital Resources (Continued)

Net cash used in operating activities for the six months ended June 30, 2009 amounted to $4.3 million, compared to cash provided by operating activities of $736,000 for the comparable 2008 period. For the six months ended June 30, 2009, cash flow was principally used by a $9.9 million net loss, an increase in trade accounts receivable of $7.1 million, and an increase in deferred income taxes and income taxes receivable totaling $5.5 million, offset in part by an increase in workers' compensation claims liabilities of $12.7 million and an increase in accrued payroll, payroll taxes and related benefits of $6.6 million.

Net cash used in investing activities totaled $7.0 million for the six months ended June 30, 2009 compared to cash provided by investing activities of $11.6 million for the similar 2008 period. For the 2009 period, cash from investing activities was principally used in the purchase of marketable securities totaling $14.0 million, offset in part by the proceeds from the sales and maturities of marketable securities of $8.2 million. The transactions related to restricted marketable securities were scheduled maturities and the related replacement of such securities held for workers' compensation surety deposit purposes. The Company presently has no material long-term capital commitments.

Net cash used in financing activities for the six-month period ended June 30, 2009, was $3.8 million as compared to $5.5 million for the similar 2008 period. For the 2009 period, the principal use of cash for financing activities was the Company's repurchase of 235,800 shares of its common stock for $2.2 million under the approved repurchase program and the payment of regular quarterly cash dividends totaling $1.7 million to holders of the Company's Common Stock.

As disclosed in Note 3 to the consolidated financial statements in this report, the Company acquired certain assets of First Employment Services, Inc., a privately held staffing services company with offices in Tempe and Phoenix, Arizona, effective February 4, 2008. As consideration for the acquisition, the Company paid $3.8 million in cash and agreed to pay additional consideration of $1.2 million contingent upon the first 12 months of financial performance. Management completed the evaluation of the financial performance criteria for the 12-month period during the first quarter of 2009 and determined no additional consideration was due.

The Company's business strategy continues to focus on growth through the expansion of operations at existing offices, together with the selective acquisition of additional personnel-related business, both in its existing markets and other strategic geographic markets. The Company periodically evaluates proposals for various acquisition opportunities, but there can be no assurance that any additional transactions will be consummated.

Effective May 27, 2009, the Company chose to eliminate its line of credit with its principal bank and subsequently amended its credit agreement with the bank. The Standby Letter of Credit Agreement dated as of June 30, 2009 (the "Credit Agreement") provides for standby letters of credit as to which there were $6.7 million outstanding at June 30, 2009 in connection with various surety deposit requirements for workers' compensation purposes.

Liquidity and Capital Resources (Continued)

Pursuant to the Credit Agreement, the Company is required to maintain compliance with the following covenants: (1) to incur a net loss after taxes of no more than $8.0 million for the year ending December 31, 2009 and maintain net income after taxes not less than $1.00 (one dollar) on an annual basis thereafter, determined as of each fiscal year end; (2) to maintain liquid assets (defined as unencumbered cash, cash equivalents, and publicly traded and quoted marketable securities) having an aggregate fair market value at all times not less than $10.0 million, determined as of the end of each fiscal quarter; and (3) to not borrow or permit to exist indebtedness (other than from or to the bank), or mortgage, pledge, grant, or permit to exist a security interest in, or a lien upon, all or any portion of the Company's assets now owned or hereafter acquired, except for purchase money indebtedness (and related security interests) which does not at any time exceed $500,000.

Management expects that current liquid assets and the funds anticipated to be generated from operations will be sufficient in the aggregate to fund the Company's working capital needs for the next twelve months.

Inflation

Inflation generally has not been a significant factor in the Company's operations during the periods discussed above. The Company has taken into account the impact of escalating medical and other costs in establishing reserves for future expenses for self-insured workers' compensation claims.

Forward-Looking Information

. . .