Overview

Barrett Business Services, Inc. ("Barrett", the "Company," "our" 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 businesses.

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.

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 months ended March 31, 2012 and 2011.



                                                   Percentage of Total Revenues
                                                        Three Months Ended
                                                             March 31,
                                                    2012                   2011
 Revenues:
 Staffing services                                      31.8 %                 41.2 %
 Professional employer service fees                     68.2                   58.8

 Total revenues                                        100.0                  100.0

 Cost of revenues:
 Direct payroll costs                                   23.9                   31.2
 Payroll taxes and benefits                             52.2                   46.2
 Workers' compensation                                  16.0                   14.5

 Total cost of revenues                                 92.1                   91.9

 Gross margin                                            7.9                    8.1
 Selling, general and administrative expenses           11.8                   12.8
 Depreciation and amortization                           0.4                    0.5

 Loss from operations                                   (4.3 )                 (5.2 )
 Other income                                            0.3                   15.2

 (Loss) income before income taxes                      (4.0 )                 10.0
 (Benefit from) provision for income taxes              (1.3 )                  1.9

 Net (loss) income                                      (2.7 )%                 8.1 %

We report PEO 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. 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.

Results of Operations (Continued)

• 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.

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.

                                                       Unaudited
                                                  Three Months Ended
               (in thousands)                          March 31,
                                                  2012          2011
               Revenues:
               Staffing services                $  26,210     $  28,332
               Professional employer services     405,851       302,734

               Total revenues                     432,061       331,066

               Cost of revenues:
               Direct payroll costs               366,934       282,642
               Payroll taxes and benefits          42,992        31,763
               Workers' compensation               15,578        11,063

               Total cost of revenues             425,504       325,468

               Gross margin                     $   6,557     $   5,598

Results of Operations (Continued)



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



                                                         Unaudited Three Months Ended March 31,
                                         Gross Revenue                                               Net Revenue
(in thousands)                         Reporting Method              Reclassification             Reporting Method
                                      2012          2011           2012            2011           2012         2011
Revenues:
Staffing services                   $  26,210     $  28,332     $        0      $        0      $ 26,210     $ 28,332
Professional employer services        405,851       302,734     ($ 349,639 )      (262,297 )      56,212       40,437

Total revenues                      $ 432,061     $ 331,066     ($ 349,639 )    $ (262,297 )    $ 82,422     $ 68,769

Cost of revenues                    $ 425,504     $ 325,468     ($ 349,639 )    $ (262,297 )    $ 75,865     $ 63,171

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

Three months ended March 31, 2012 and 2011

Net loss for the first quarter of 2012 amounted to $2.2 million, as compared to net income of $5.5 million for the first quarter of 2011. The first quarter of 2011 included $10.0 million of key man life insurance proceeds received following the passing of the Company's former president and CEO and the related benefit of a lower annual effective income tax rate. Diluted loss per share for the first quarter of 2012 was $.22 compared to diluted income per share of $.54 for the comparable 2011 period.

Revenues for the first quarter of 2012 totaled $82.4 million, an increase of approximately $13.7 million or 19.9%, which reflects an increase in the Company's PEO service fee revenue of $15.8 million or 39.0% and a small decline in staffing services revenue of $2.1 million or 7.5%. Our growth in PEO revenues continues to be primarily attributable to new customers as PEO business from new customers during the first quarter of 2012 more than tripled our lost PEO business from former customers. PEO revenues from continuing customers reflected a 9.8% increase compared to the first quarter of 2011 primarily resulting from an increase in employee headcount and a slight increase in hours worked. Staffing revenues decreased because lost business from former customers exceeded the business from new and continuing customers.

Gross margin for the first quarter of 2012 totaled approximately $6.6 million or an increase of $959,000 over the first quarter of 2011, primarily due to the 19.9% increase in revenues and a decline in direct payroll costs, partially offset by higher payroll taxes and benefits and workers' compensation expense, as a percentage of revenues.

Results of Operations (Continued)

Three months ended March 31, 2012 and 2011 (Continued)

The decrease in direct payroll costs, as a percentage of revenues, from 31.2% for the first quarter of 2011 to 23.9% for the first quarter of 2012 was primarily due to the increase in our mix of PEO services in the Company's customer base over the first quarter of 2011 and the effect of each customer's unique mark-up percent.

Payroll taxes and benefits, as a percentage of revenues, for the first quarter of 2012 was 52.2% compared to 46.2% for the first quarter of 2011. The percentage rate increase was largely due to the effect of significant growth in PEO services, where payroll taxes and benefits are presented at gross cost whereas the related direct payroll costs are netted against PEO services revenue, and to higher effective state unemployment tax rates in various states in which the Company operates as compared to the first quarter of 2011. Management expects the trend in payroll taxes and benefits, as a percentage of revenues, to continue to increase as a result of continued growth in PEO services on a quarter over quarter basis.

Workers' compensation expense, in terms of dollars and as a percentage of revenues, increased from $10.0 million or 14.5% in the first quarter of 2011 to $13.2 million or 16.0% in the first quarter of 2012. The percentage rate increase was primarily due to an increase in the provision for current year claim costs and higher insurance broker commissions as a result of increased worker's compensation insurance rates.

Selling, general and administrative ("SG&A") expenses for the first quarter of 2012 totaled approximately $9.8 million, an increase of $935,000 or 10.6% over the first quarter of 2011. The increase was primarily attributable to increases in management payroll and $460,000 of incremental legal and professional fees in connection with the response to requests for a special stockholders' meeting.

Other income for the first quarter of 2012 was $215,000 compared to other income of $10.5 million for the first quarter of 2011. Other income for the 2012 first quarter was primarily attributable to investment income earned on the Company's cash and marketable securities. The first quarter of 2011 included the $10.0 million of key man life insurance proceeds and a gain of approximately $102,000 on the sale of certain marketable securities.

The income tax rate for the 2012 first quarter was 33.7%. We expect the effective income tax rate for the balance of 2012 to remain at a similar rate to the 2012 first quarter income tax rate. The income tax rate for the 2011 first quarter was 19.5% which included a favorable benefit from the effect of a much lower annual effective tax rate attributable to the non-taxable $10.0 million life insurance proceeds.

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 three months ended March 31, 2012 decreased $11.4 million from December 31, 2011, which compares to a decrease of $3.1 million for the comparable period in 2011. The decrease in cash at March 31, 2012 as compared to December 31, 2011, was primarily due to the net loss of $2.2 million, $25.4 million used to repurchase common stock and a $6.7 million increase in accounts receivable, offset in part by increases in accrued payroll and taxes of $16.5 million, $2.6 million net sales of marketable securities and a $1.8 million increase in workers' compensation claims liabilities.

Net cash provided by operating activities for the three months ended March 31, 2012 amounted to $11.5 million compared to $11.1 million for the comparable 2011 period. For the three months ended March 31, 2012, cash flow was principally provided by increases in accrued payroll, payroll taxes and benefits of $16.5 million and a $1.8 million increase in workers' compensation claims liabilities, partially offset by the net loss of $2.2 million and an increase in accounts receivable of $6.7 million.

Net cash provided by investing activities for the three months ended March 31, 2012 was $1.9 million as compared to $13.3 million of net cash used in investing activities for the similar 2011 period. For the 2012 period, cash from investing activities was provided by the proceeds from the sales and maturities of marketable securities of $16.0 million and $2.7 million from the proceeds of restricted marketable securities, partially offset by the purchase of marketable securities totaling $13.4 million and the purchase of restricted marketable securities of $2.7 million. The transactions related to restricted marketable securities were scheduled maturities and the replacement of such securities held for workers' compensation surety deposit purposes. The Company presently has no material long-term capital commitments.

Liquidity and Capital Resources (Continued)

Net cash used in financing activities for the three months ended March 31, 2012 was $24.7 million as compared to $956,000 for the similar 2011 period. For the 2012 period, the primary uses of cash for financing activities were the repurchases of the Company's common stock totaling $25.4 million which included $514,000 of professional and legal fees and the payment of regular quarterly cash dividends totaling $1.1 million to holders of the Company's common stock, partially offset by $1.6 million proceeds from the exercise of stock options.

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 businesses, 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.

The Company is a party to a Standby Letter of Credit Agreement dated as of June 30, 2009 (the "Credit Agreement") with its principal bank. The Credit Agreement provides for standby letters of credit as to which there was $6.7 million outstanding at March 31, 2012 in connection with various surety deposit requirements for workers' compensation purposes.

Pursuant to the Credit Agreement, the Company is required to maintain compliance with the following covenants: (1) to maintain net income after taxes not less than $1.00 (one dollar) on an annual basis, 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. The Company was in compliance with all financial covenants at March 31, 2012.

As disclosed in Note 3 to the Consolidated Financial Statements in this report, effective March 28, 2012, the Company repurchased 2,485,929 shares of the Company's common stock held by the Estate of William W. Sherertz and 500,000 common shares held by Nancy Sherertz. Mr. Sherertz, a founder and former president and CEO of the Company, died January 20, 2011. Nancy Sherertz is also a founder of the Company. The common shares were repurchased at a price of $20 per share, representing total consideration of $59.7 million. The Company used a combination of $24.9 million in cash and issued 34,800 shares of Series A Nonconvertible, Non-Voting Redeemable Preferred Stock with a liquidation preference of $1,000 per share. Additionally, the Company incurred professional and legal fees totaling $514,000 related to the transaction. The preferred stock is entitled to receive cumulative preferential dividends at the rate of 5% per annum based upon the $1,000 liquidation preference with such rate increasing by 2% on each April 1 beginning April 1, 2013, until all of the outstanding preferred stock has been redeemed. The Company may pay the dividends in cash or in additional shares of preferred stock at its option. The Company may redeem all or a portion of the preferred stock at its option at any time at a price of $1,000 per share. The preferred stock is subject to mandatory redemption five years from the original issue date. Due to the mandatory redemption provision the preferred stock is classified as a liability on the Company's Consolidated Balance Sheet. Although no assurances can be given, the Company currently plans to redeem the preferred stock in full before September 28, 2012, in which event no dividend would be payable. The Company is currently exploring potential sources of financing to fund the redemption.

Liquidity and Capital Resources (Continued)

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

Statements in this report which are not historical in nature, including discussion of economic conditions in the Company's market areas and effect on revenue levels, the potential for and effect of past and future acquisitions, the effect of changes in the Company's mix of services on gross margin, the adequacy of the Company's workers' compensation reserves and the effect of changes in estimate of its claims liabilities, the adequacy of the Company's allowance for doubtful accounts, the effect of the Company's formation and operation of two wholly owned, fully licensed captive insurance subsidiaries and becoming self-insured for certain business risks, the financial viability of the Company's excess insurance carriers, the effectiveness of the Company's management information systems, payment of future dividends, redemption of the Company's preferred stock, and the availability of financing and working capital to meet the Company's funding requirements, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors with respect to the Company include the ability to retain current clients and attract new clients, the availability of financing or other sources of capital, difficulties associated with integrating acquired businesses and clients into the Company's operations, economic trends in the Company's service areas, material deviations from expected future workers' compensation claims experience, the effect of changes in the workers' compensation regulatory environment in one or more of the Company's primary markets, collectibility of accounts receivable, the carrying values of deferred income tax assets and goodwill, which may be affected by the Company's future operating results and the availability of capital or letters of credit necessary to meet state-mandated surety deposit requirements for maintaining the Company's status as a qualified self-insured employer for workers' compensation coverage, among others. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.