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.

                        BARRETT BUSINESS SERVICES, INC.



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


Results of Operations

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



                                                           Percentage of Total Revenues
                                                   Three Months Ended         Nine Months Ended
                                                     September 30,              September 30,
                                                  2009           2008         2009          2008
Revenues:
Staffing services                                   50.7 %         57.4 %       49.0 %       56.0 %
Professional employer service fees                  49.3           42.6         51.0         44.0

Total revenues                                     100.0          100.0        100.0        100.0

Cost of revenues:
Direct payroll costs                                38.4           42.5         37.0         41.4
Payroll taxes and benefits                          31.1           27.4         35.9         30.7
Workers' compensation                               12.0           10.9         19.3         10.5

Total cost of revenues                              81.5           80.8         92.2         82.6

Gross margin                                        18.5           19.2          7.8         17.4
Selling, general and administrative expenses        12.9           12.9         14.2         12.9
Depreciation and amortization                        0.6            0.5          0.7          0.5

Income (loss) from operations                        5.0            5.8         (7.1 )        4.0
Loss on impairment of investments                     -            (4.5 )         -          (1.7 )
Other income                                         1.5            0.6          0.8          0.8

Income (loss) before taxes                           6.5            1.9         (6.3 )        3.1
Provision for (benefit from) income taxes            2.0            1.1         (2.3 )        1.3

Net income (loss)                                    4.5 %          0.8 %       (4.0 )%       1.8 %

We report PEO revenues in accordance with the current accounting guidance for revenue recognition, which requires us to report such revenues on a net basis because we are not the primary obligor for the services provided by our PEO clients to their customers pursuant to our PEO contracts. We present for comparison purposes the gross revenues and cost of revenues information set forth in the table below. Although not in accordance with GAAP, management believes this information is more informative as to the level of our business activity and more illustrative of how we manage our operations, including the preparation of our internal operating forecasts, because it presents our PEO services on a basis comparable to our staffing services.

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

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       Nine Months Ended
      (in thousands)                       September 30,            September 30,
                                          2009        2008        2009        2008
      Revenues:
      Staffing services                $   33,180   $  44,468   $  85,224   $ 120,891
      Professional employer services      239,872     243,927     663,847     696,579

      Total revenues                      273,052     288,395     749,071     817,470

      Cost of revenues:
      Direct payroll costs                231,532     242,396     635,808     686,136
      Payroll taxes and benefits           20,399      21,201      62,460      66,367
      Workers' compensation                 8,980       9,889      37,196      27,442

      Total cost of revenues              260,911     273,486     735,464     779,945

      Gross margin                     $   12,141   $  14,909   $  13,607   $  37,525

                        BARRETT BUSINESS SERVICES, INC.



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 September 30,
                                         Gross Revenue                                           Net Revenue
(in thousands)                         Reporting Method           Reclassification             Reporting Method
                                       2009        2008         2009            2008           2009        2008
Revenues:
Staffing services                    $  33,180   $  44,468   $       -       $       -       $  33,180   $ 44,468
Professional employer services         239,872     243,927     (207,558 )      (210,934 )       32,314     32,993

Total revenues                       $ 273,052   $ 288,395   $ (207,558 )    $ (210,934 )    $  65,494   $ 77,461

Cost of revenues                     $ 260,911   $ 273,486   $ (207,558 )    $ (210,934 )    $  53,353   $ 62,552

                                                                     Unaudited
                                                          Nine Months Ended September 30,
                                       Gross Revenue                                            Net Revenue
(in thousands)                       Reporting Method           Reclassification             Reporting Method
                                     2009        2008         2009            2008           2009        2008
Revenues:
Staffing services                  $  85,224   $ 120,891   $       -       $       -       $  85,224   $ 120,891
Professional employer services       663,847     696,579     (575,240 )      (601,632 )       88,607      94,947

Total revenues                     $ 749,071   $ 817,470   $ (575,240 )    $ (601,632 )    $ 173,831   $ 215,838

Cost of revenues                   $ 735,464   $ 779,945   $ (575,240 )    $ (601,632 )    $ 160,224   $ 178,313

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

Three months ended September 30, 2009 and 2008

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

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

Results of Operations (Continued)

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

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

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

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

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

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

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

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

Results of Operations (Continued)

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

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

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

Nine months ended September 30, 2009 and 2008

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

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

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

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

Results of Operations (Continued)

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

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

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

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

The first nine months of 2008 included the Company's approximately $3.5 million non-cash, other-than-temporary impairment charge on a portion of its investments. The impairment charge assumed no income tax benefit due to the uncertainty of the Company's ability to generate future taxable investment gains to offset these losses.

Other income for the first nine months of 2009 was $1.4 million compared to other income of $1.7 million for the comparable period of 2008. The decline in other income for the first nine 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, partially offset by a gain on the sale of certain corporate bonds.

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

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

Factors Affecting Quarterly Results (Continued)

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 nine months ended September 30, 2009 decreased $3.7 million from December 31, 2008, which compares to an increase of $18.5 million for the comparable period in 2008. The decrease in cash at September 30, 2009 as compared to December 31, 2008, was primarily due to a net loss from operating activities of $7.0 million and purchases of marketable securities of $19.5 million, offset in part by proceeds from sales and maturities of marketable securities of $23.4 million.

Net cash used in operating activities for the nine months ended September 30, 2009 amounted to $1.7 million, compared to cash provided by operating activities of $7.7 million for the comparable 2008 period. For the nine months ended September 30, 2009, cash flow was principally used by a $7.0 million net loss, an increase in trade accounts receivable of $11.8 million and an increase in deferred income taxes and income taxes receivable totaling $5.6 million, offset in part by an increase in workers' compensation claims liabilities of $13.0 million and an increase in accrued payroll, payroll taxes and related benefits of $9.7 million.

Net cash provided by investing activities for the nine month period ended September 30, 2009 was $2.4 million as compared to $18.9 million for the similar 2008 period. For the 2009 period, cash from investing activities was principally provided by the proceeds from the sales and maturities of marketable securities of $23.4 million, offset in part by the purchase of marketable securities totaling $19.5 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 nine-month period ended September 30, 2009, was $4.4 million as compared to $8.1 million for the similar 2008 period. For the 2009 period, the principal use of cash for financing activities was the payment of regular quarterly cash dividends totaling $2.5 million to holders of the Company's common stock and the Company's repurchase of 252,500 shares of its common stock for $2.4 million under the approved repurchase program, offset in part by the tax benefit of stock option exercises of $445,000.

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

Liquidity and Capital Resources (Continued)

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.

. . .