Barrett Business Services Inc (BBSI) 2012 Q3 法說會逐字稿

Good morning, everyone, and thank you for participating in today's conference call to discuss BBSI's financial results for the third quarter ended September 30, 2012. Joining us today are BBSI's President and CEO, Mr. Mike Elich; and the Company's CFO, Mr. Jim Miller. Following the remarks, we will open the call for your questions.

Before we go further, I would like to take a moment to read the Company's Safe Harbor statement, within the meaning of the Private Securities Litigation Reform Act of 1995, that provides important cautions regarding forward-looking statements. The Company's remarks during today's conference call may include forward-looking statements. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by these forward-looking statements. Please refer to the Company's recent earnings release and to the Company's quarterly and annual reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ.

I would like to remind everyone that this call will be available for replay through November 24, 2012 starting at 3 PM Eastern Time this afternoon. A webcast replay will also be available via the link provided in today's press release, as well as available on the Company's website at www.barrettbusiness.com. Now I'd like to turn the call over to the Chief Financial Officer of BBSI, Mr. Jim Miller. Sir, please go ahead.

Thank you, George, and depending upon where you are dialing in from, good morning or good afternoon, everyone. As you saw after the close of the market yesterday, we issued a press release announcing our financial results for the third quarter ended September 30, 2012. The momentum we realized in the first half of the year grew stronger in the third quarter, as seen by our 37% year-over-year increase in gross revenues. We attribute these results to BBSI's maturing brand and strong referral channels that have helped fuel new client growth, along with our ability to retain existing clients. BBSI's operations-driven, results-oriented approach continually supports the evolution of our clients' businesses, and is responsible for our better than 90% retention rate. These positive results have also been supported by the proactive investments we have made in our operational infrastructure and professional talent, which we continue to evolve BBSI into a more mature company.

Before taking you through our financial results, I would like to mention that yesterday's earnings release summarizes our revenues and cost of revenues on a net revenue basis, as required by Generally Accepted Accounting Principles, or GAAP. Most of our comments today, however, will be based on gross revenues and various relationships to gross revenues, because we believe such information is, one, more informative as to the level of our business activity; two, more useful in managing and analysing our operations; and three, adds more transparency to the trends within our business. Comments related to gross revenues as compared to a net revenue basis of reporting have no effect on gross margin dollars, SG&A expenses or net income.

Now turning to the third-quarter results, total gross revenues increased 37% to $558 million over the third quarter of 2011. California, which comprised approximately 87% of our overall third-quarter gross revenues, increased 44% due to continued growth in our PEO business. Overall PEO gross revenues increased 41% to $522 million over the third quarter of last year, primarily due to the addition of new clients, as PEO business for new customers more than tripled our lost PEO business from former customers as compared to the 2011 third quarter, which follows a similar trend we've experienced throughout 2012. Our PEO revenues from existing customers experienced approximately a 4% increase year-over-year, due to increases in both headcount and hours worked. Staffing revenues for the third quarter of 2012 increased 5% to $36.2 million, primarily due to an increase in revenue from existing customers, as the addition of new business nearly equaled lost business from former customers. On a percentage basis, gross margin in the third quarter was 3.9% as compared to 4% for the third quarter of 2011. The key components of this quarter's gross margin are as follows. Direct payroll cost as a percentage of gross revenues in the third quarter decreased to 84.4% compared to 84.9% in the same quarter last year, due to increases in the overall customer markup percentages as a result of price increases experienced primarily during the last 6 months.

Workers compensation expense as a percentage of gross revenues was 4.1%, which is up 40 basis points from the same quarter a year ago, primarily due to an increase in a provision for estimated workers comp claim cost, as well as to higher broker commissions and higher safety incentives. Looking ahead to the fourth quarter of 2012, we anticipate the 4% level of gross revenues for workers comp expense to continue. Payroll taxes and benefits for the third quarter increased from approximately 7.5% of gross revenues to 7.7%, primary due to higher state unemployment rates in various states the Company does business in. SG&A expenses increased 29% to $12.7 million versus Q3 of 2011, primarily due to a higher branch profit sharing based upon increased branch performance and increases in management payroll, as well as to the variable expense components within SG&A to support the business growth. Our income tax rate for the third quarter was 32.4%, and we expect this rate to remain at a similar level for the fourth quarter of 2012.

Now turning to the balance sheet at September 30, cash, cash equivalents and marketable securities totaled $50.7 million compared to $81.8 million at December 31, 2011. This decrease is primarily due to the repurchase of approximately 3 million shares of the Company's common stock associated with the Estate of William Sherertz and Nancy Sherertz for a total consideration of approximately $59.7 million or $20 per share. As part of the financing of this repurchase, the Company issued and redeemed within 6 months all outstanding shares of the Series A nonconvertible, non-voting, redeemable preferred stock for $34.8 million on September 21, 2012. We funded the redemption using a combination of cash and availability under a new revolving credit facility provided by our principal bank, despite your credit agreement as a revolving reducing secured loan, initially for a maximum amount of $24 million. Advances under the revolving and reducing loan bear interest at our discretion, at either a fixed rate for a term from time to time, or a fluctuating rate. In each case, the rate is calculated based on LIBOR plus 1.75%. Redeeming the preferred stock allowed us to avoid paying a semi-annual dividend on the preferred shares of approximately $870,000 that would have been due September 28, 2012.

We are also negotiating with our principal bank for a term loan in the amount of approximately $5.5 million, to be secured by our corporate office building here in Vancouver, Washington, which is expected to be finalized at November 1, and will increase the total credit facility to approximately $29.5 million. At September 30, however, we had no outstanding borrowings on the credit facility, primarily due to temporary favorable timing differences between cash collections and cash disbursements, which resulted in a high cash balance that we used to pay down the line completely. However, as we move into the fourth quarter, where we will have the majority of our 2012 corporate estimated income tax payments due, as well as inter-company captive insurance premium payments, we expect to carry a balance on the line at December 31, 2012.

We generated approximately $32 million in operating cash flow during the first 9 months of 2012. Free cash flow during the first 9 months was approximately $18 million. Most of our cash generated from operations is in the form of free cash flow, except for the bill in the workers' compensation and safety incentive liabilities, as cash used to fund our insurance subsidiaries is primarily generated from the workers' compensation expense, which we recognize but not immediately pay out to third parties. During a period of growth, as we are experiencing, free cash flow will be tend to be in line or exceed our net income on an annual basis.

Now turning to our outlook for the fourth quarter of 2012, we are expecting gross revenues to range between $585 million and $590 million. This projection represents a likely midpoint increase of 39% over the $423.6 million in gross revenues for the fourth quarter of 2011. The projected increase of 2012 fourth-quarter gross revenues is based upon our recent revenue trends. We expect diluted income per common share to range between $0.75 and $0.78, compared to a net loss for common share of $0.01 in the year-ago quarter. Diluted loss per common share in the fourth quarter of 2011 reflected an increase for the Company's workers' compensation reserve of approximately $8.5 million, as a result of adverse loss development, partially offset by a favorable income tax rate benefit related to the effect of a much lower annual effective income tax rate, attributable to life insurance proceeds. Without the effect of these items, diluted income per common share in the fourth quarter of 2011 was $0.41.

We continue to be very enthusiastic about the momentum in our financial results over the past several quarters. I look forward to addressing you again on our fourth-quarter earnings call. Now I would like to turn the call over to our President and CEO of BBSI, Mike Elich, who will comment further on the recently completed third quarter and our outlook for the fourth quarter of 2012. Mike?

Good morning. It's hard to say anything more than very pleased with the quarter, very pleased with the quarter overall. In the quarter, we saw continued growth in our new client adds. We continue to be very -- I continue to be very impressed with the rate at which we are maturing, and -- as an organization against record levels of growth. Overall, I'm just very fortunate to be part of such a great organization.

In the quarter, we added 171 new clients. We lost 34. Five of the clients left to AR issues, seven left for non-AR issues, typically risk and/or not evolving effectively in our tier model of measures for a progressing company or client. We had 14 clients leave because the business either sold or closed, which is a little higher than we've seen in the past. Seven left due to pricing or taking payroll inside, and one left to a competitor. So overall, our net build on our client base was 137 clients. The net gain of 137 clients represents a quarter-to-quarter -- or year-over-year add of 57 -- or 54% growth compared to previous years.

In the quarter, we also saw our clients begin to hire. 43% of our clients added headcount, 28% reduced headcount, fairly in line with what we saw in second quarter. 29% remained unchanged. In the quarter, we saw 55% of our clients increase hours worked, while 41% reduced hours worked, so we continue to see a net gain there. In the second quarter, we actually did see a gain of 60% of our clients adding hours, so 55% was off that mark a little bit.

Overall, we continue to run very well. We are seeing returns on the investments made back into the branch infrastructure to support a larger, more complex organization. We've made significant progress in the quarter aligning investments in our corporate infrastructure, this is IT, systems, people, et cetera, to support our future growth. Our pipeline, overall we continue to see growth coming from a broader base of branch operations and industry sectors. We feel that the continued strong momentum in our pipeline is attributed to the continued maturing of our brand and organizational culture. We continue to see a high retention level, which is also supporting the growth in the overall business, and a client in the second and third year yields us a higher return on our investment, and with the 95% plus retention level at this point, we continue to be able to build and continue to manage a net gain on our client build.

Overall by region, both Northern and Southern California still continue to see double-digit growth. Northwest, oddly, was more flat in the quarter, although we did not lose ground there. Mountain states, we are seeing growth in both PEO and staffing, where on the East Coast we saw strong growth in PEO, where staffing was flat. Continued tailwinds, our pipelines remain strong, and our customer base is probably as healthy as I've seen it. We see other -- we see over ourselves heading -- ahead of plan to aligning the organization to support our growth curve. When I took over almost -- close to two years ago, I figured it was going to take us roughly three years to really convert to who we needed to be or get to where we needed to be, and today I feel like we are probably a year ahead of where I thought we would be by this point. Very, very positive.

Headwinds that we are experiencing, and this is an issue that surfaced in mid-September, there is a bill that was passed in California, it was targeted towards workers' comp reform. The bill, for 90% of what's in it, is very positive for us, in that it removes some of the frictional costs that we incur relative to claim management and cost of workers' comp claims. The one part of it that becomes a little bit of a rub for us is in section 12 of the bill, there was a target at bad actors, be it past performance of PEOs that did not do very well in the state, and left the state holding the bill, and because of that there is a clause that prohibits PEOs from being able to be self-insured in California effective 1/1/2015. For us, we are taking several steps forward in addressing that area, as it does affect us, but we feel very confident that we have several mechanisms in place to be able to continue to mature the organization and find alternatives to that section in the bill. Personally, I feel that the steps we are taking are going to continue to make us a stronger company, and on the other side of it, it's going to offer us a stronger competitive advantage.

Moving forward, we will continue looking internally to infrastructure to support growth, while gaining efficiencies in our branch operations and at corporate. All efforts are geared towards strengthening and maturing the organization's product offerings, and creating a broader runway in front of us so we have time to adapt to any changes in market, and overall continue to mature our product. You have to remember, we still only have roughly -- if at all, 1% penetration in existing markets, so we still have a lot of work to get done, and as our product continues to mature, we are continuing to gain momentum and gaining market share as well. With that, I will open it up to questions.

Thank you, sir. We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Jeff Martin with ROTH Capital Partners. Please go ahead.

Thanks. Good morning, Mike and Jim.

Good morning, Jeff.

Mike, can you elaborate on the workers' compensation reform bill, specifically the section 12? What are the possible outcomes, and what are your options in terms of alternatives in preparing for it to be not a material event for your business?

You know, if it were today, it would be a bigger issue. With having two years to work through it, or actually 26 months from today, one of the things that -- if you go back in time a couple years ago, workers' comp was a much larger portion of our product offering. Today, as I have continued to mature our organization and push the envelope towards less reliance on the fact that we are self-insured, it really puts us in a position where, one -- first of all, we have been self-insured in the market for close to 20 years, and have always been a good citizen in the process. So we are going to pursue avenues that are going to get people to really listen to the story, and recognize that some adverse selection was created in the bill, that is step one. Step two is that there are alternatives. People ask me sometimes, why are we self-insured? Well, primarily the reason for being self-insured is that we invest a lot of energy and time into reducing costs for our customers in the area of workers' comp, through mitigation of exposure to risk and making them cleaner and tighter, and being self-insured allows us to share in that success.

So the problem with going out to the insurance market is that you, ultimately, might lose some of the competitive advantage that you have for getting the job done, mainly in -- can we share in the gain, or do we get stuck in the adverse selection of insurance? Be it -- we end up being better than the whole, and so we end up paying for those that aren't as good. So as we look to fix that, I think that we are building better relationships than we have before in the area of insurers that might offer us a measure. We have always been not really a cast -- a front, but in a lot of ways always having a retention of using Chartis, or ACE, or AIG at $5 million. We've always had somewhat of a front. So the first step is figuring out, how can we maybe mature what that looks like? The other part is, is that we do own an insurance company, and I think that there is more that we can do in that area as well. That will help us to maybe offset some of the adverse effects to -- or having to go directly to market to get coverage for our clients.

Okay. Are you going to dedicate incremental resources to this? Namely, are you going to have some sort of step up in SG&A? Are you going to quantify that at this point?

Yes, and we will see some of that. You know, I don't know that that will be very material over the next year. We are already actually quite a ways ahead of the ball in this process so, frankly, we are going to see some step up probably in legal and some different areas, but I don't know that it will really be material in the effect to our earnings.

Okay, great. And then shifting gears to the California market. You had some expansion, two new branches and then creating some branches within branches. I was curious if you could give an update on how that's going? Obviously, by the growth numbers it's going well, but if you could give us some detail there, and highlight some of the additional expansion plans, if you've got incremental plans at this point?

You know, I am very excited about what we are seeing in this area. One of the things that we kind of discovered, probably close to a year ago or at least in the first quarter of this year, was that as we expanded the way that we looked at the structure of our internal branches, needed to mature or go in a different direction, and not necessarily a different direction but needed to evolve. And so the business unit concept, or business unit product that we've morphed our branches into, or -- better said, branches inside of branches, is coming along very well. What we are really seeing out of that is that the product quality and integrity within those business units is combining resources more effectively as we interface with our clients. So we are seeing a couple things. We are seeing, one, where we have increased capacity, but I also believe that our product quality and who we are as an organization is better affected through that business unit infrastructure.

So we will continue to mature that in a direction, and we've got a lot of runway there and a lot of opportunity to continue to mature the business unit concept. We are probably building out in front of ourselves a little bit, and we've done that probably in the last two quarters, to get ourselves moving in that direction. So we will continue to see more on that. The two branches that we have opened up, both Monterey and Valencia, they've got off the ground very well. They are contributing to our growth. But more importantly, they are allowing us to maintain consistency within our pipeline because of the low-leveling efforts that is allowing us to focus on those markets, as opposed to stretching branches further than they should be working at. Ultimately, we are always looking for fillers or gaps within the market. We have some things that we are doing in the Mountain states that I think are going to help in the next year or two to expand, and continue to mature those markets for us. Within California, we can actually take our client base and spatter it up against the Google map, and we can literally see where all of our clients are and recognize where we are maybe being pulled. And we will continue to look to see if we need extra capacity to support clients in those other markets.

Aside from that we are still growing up. We are really trying to mature our infrastructure. One of the areas that we've really put a lot of energy this year is looking at just the organizational and talent development internally, and how to keep everybody on the same page. Today we have, again, another two-day boot camp of new hires at corporate, and this is the third one since early July -- or mid-July. In doing that, we are continuing to mature the organization and keep everybody on the same page. I think that's probably going as far to increasing our capacity and increasing the leverage within the organization as adding a new branch ever would.

Okay. And then that kind of segues into at what point do you look to expand outside of California, and what would be the first couple steps to that strategy?

Well, I think the Mountain states, and really gaining the momentum that we see potential for, and really pushing that over the top is part of it. I think that in pockets we are already seeing the kind of growth in several markets in the north -- in the Mountain states. Idaho Falls, believe it or not, is growing at the level and rate of many of our California branches. So how do you unlock what is going on there, and then unlock that in actually some bigger markets within the Mountain states? That is a big part of that. The other part is also looking at what we have accomplished on the East Coast. We continue to see 40% plus growth rate on the East Coast, and so looking at what has gone on and what has worked there, how do we expand on that, and then how can we do tuck-in markets?

I still believe that there is a lot of ways for us to expand, but one of the keys to our developing new markets is going to be, first off, developing talent within our business units, which becomes a carry-on of our culture and who we are, into new markets. So for instance, if we have somebody that worked in a branch in Southern California, and they really wanted to move to say Texas or New Mexico, or some other market besides where they were at, and they had been in our ranks and had able to develop the skill sets, and really understand our product, we can now go to either a greenfield or a small acquisition of some sort, because we can transfer culture more effectively into those markets.

The other part is if you look at -- I kind of use a little bit of how Costco expanded. Its brand led its expansion, and as you reach tipping points in your brand, more people are talking about it in local markets, but that has spilled over into new markets. So how can we get our message out in front of us enough that -- and learn how to get it tight enough that as we go to new markets, we have a ready-made customer base as we move there. I think that we are probably -- we are working towards that right now, but I'd say over the next couple years we can see that opportunity coming together.

Okay, great. I've got more questions. I will circle back in the queue.

Thank you.

(Operator Instructions)

Our next question comes from the line of Josh Vogel with Sidoti & Company. Please go ahead.

Thank you. Good morning, Mike and Jim.

Good morning, Josh.

Just building off the earlier questions about the branches, I was just curious how much -- I think I ask this pretty much every quarter, but how much capacity do you have left at existing branches? And should we expect to see any significant hiring or investing in new build-outs in the next quarter or two?

You know, we've done a lot this year. I think that, one, the way we are building our branches now, they are really -- we don't see a limit yet to the capacity of an individual branch. So there is significant leverage ahead of us and across-the-board. We take -- our Ontario branch, for instance, has five business units. So that's five branches within branches, and as we recognize capacity, we will add two additional business units. The one thing that becomes a little bit of a draw on our capacity is just the overall function of paperwork, and how we process payroll, and how big the pipe is coming in.

One of the things that we've been working on the last couple years is the implementation of a new payroll system, which right now we are actually stress testing before implementation is scheduled to start in February. That is going to actually add a lot of capacity to each one of our business units and/or branches as they sit. So I don't think we probably know the full potential of each business unit and how much leverage we can get out of it until that comes together, but that will help. The other area, too, that we are looking at is, how do we refine best practice around just simple things like paper flow within our organization from our customer, to contracts, to all the different places where we touch paper that impinges on our capacity. And as we refine that over the next couple years -- I don't see a capacity issue being in the market, I see it being more internally as how well can we get the job done faster and focus in the right areas.

Okay, great. With regard to the payroll system, do you have a target set for, basically, like a full rollout?

We are going to start -- and we are fortunate that the way we can do the rollout is one client at a time, and then once we get that going and we are comfortable with that, then we can go blocks of clients at a time. So we don't have kind of a dead man's switch, where you got to get it done today or over the weekend, it could really hurt you. So we can go as fast or as slow as we need, but our target is right now to accomplish that conversion in the year 2013, because we do not want to be operating off of two systems by the end of next year. But we are going to take it as slow or as fast as we can. We're not going to get out in front of ourselves. We are not going to -- we are trying to maintain transparency even to our clients, to the standpoint that they are going to see a cleaner system that has many more capabilities, but at the same time we are not going to do it at the expense of making sure that we are maintaining the integrity in our product.

Okay, great. Jim, you were talking about some favorable timing with regards to some working cap items. I was wondering if that's expected to reverse course -- or it is expected to reverse course in Q4, but should we expect to see a modest free cash outflow?

Yes, on the -- there will be some -- definitely some cash outflow during the fourth quarter, coming from income tax payments that are due for corporate income tax, and certainly some funding of our captive insurance company, too. But on the whole, cash flow -- free cash flow should continue to build, with that said. And at the end of the quarter here at September 30, we had a situation where we had probably being a very high collection date, yet the associated payroll and payroll taxes with that collection in a lot of ways does not get -- does not hit our account until the following Monday or Tuesday. So that is what gave us the very favorable cash position at the end of September.

Okay. And I believe you said the available capacity right now on the credit facility is $24 million?

Right, soon to be $29.5 million.

Okay.

So I guess a person could look at that and say, gee, why do you need that kind of capacity? When we were putting the credit facility together working with our bank here several months ago, we wanted to remain conservative, and given the environment with low interest rates the way they are, it seemed like the prudent thing to do is ask for more than you need. Certainly, the old saying goes that when you need it, it's hard to get. When you don't need it, it's much easier to get. So that's the route we took.

Of course. Could you give us a sense maybe of how much debt you expect to be carrying at year-end?

I think I am in line, a rough ballpark estimate might be $10 million to $15 million.

Okay. That's all I have right now. Thanks a lot.

Sure.

Thank you. And our next question is a follow-up from Jeff Martin with ROTH. Go ahead, please.

Thanks. I wanted to touch on pricing. The majority, it sounds like, of the recent price changes were over the last six months. Is there still some to go there? I mean, has it worked into the renewal process? Are you proactively repricing existing clients mid-contract? Some light there would be helpful.

No, it's tied primarily, and that's something that we've done that's been very different than what we've done in the past, is we've tied it to the renewal process, so as contracts continue to come due, we are going and revisiting it. It's not an increase across-the-board by any means, it's going and looking at individual clients and figuring out where we really need to be with them to maintain retention. I think the biggest thing from my perspective is that as you get out and say, okay, we have to increase prices, or we have to look at it differently, it's more to bring things in line. Because what you don't want to do is go and create a position of adverse selection, were all of a sudden your best customers are leaving you, and the worst ones are hanging around because of price.

So we are being very careful about that, but because of the fact that we have -- a lot of our customers have been written around the 1/1 contract date, a lot of our customers -- maybe one-third of our customers probably will come -- will be up for review here in the next two months, and so that will create the next little wave. But it is on an ongoing basis, been -- we are probably about two-thirds of the way to maybe 75% through it, and today we have really not seen any adverse selection -- or adverse process because of that change.

Okay. And is that -- I mean, do you anticipate that to be the case going forward, or is this kind of a one-time rationalization, given that you really didn't increase prices for the better part of four or five years?

I think that's part of it. I think that as -- we are always trying to -- we don't look necessarily to market to figure out what we need to price to, we look at what do we need to price from a capacity utilization. And we look at the lever point, and what we have to invest back into our clients. We are trying to return ourselves an amount that fits within our model, and that's where the target remains, as opposed to just trying to figure out what we can get. It is more of an operational look at the business, as opposed to a market look at the business. So we will continue to evaluate the situation. As customers get cleaner and cleaner and cleaner, we can -- we've got some flexibility there both ways, just because it's not affecting our overall infrastructure as much.

Okay. And then am I correct in understanding that that shows up as -- when people model this out, it shows up in the direct payroll cost percentage of gross revenue coming down?

That's where I look at it from. It's the net spread between top line and then the payroll percent, and that's -- if you go back to the reason why we look at the gross from a management standpoint, those numbers all stay in line. If you get -- if you are looking at the net, I don't even know how you would try to figure out what it is.

Right, right, okay. So probably a little bit of room for that number to come down a little further? I'm just looking back over the last three quarters, when it started coming down, and Q2 to Q3 was the more prominent of the decreases for direct payroll as a percentage of gross revenue.

You know, it's the hardest thing for me, personally, to watch, and -- or either get excited about it, or know where it's going to end up. I know where we have trended to or felt we would trend to, those levels have been met, and it's just like guiding. When we look at the guide in our quarter, we are not trying to understate where we are at. It's just -- we run, when we look at the quarter, we kind of look at where we are at in the first four, or probably the last four weeks, and that becomes our trend going into the quarter. And so as we look at those, we look at where that trend moves week-to-week, and then we peg to that, and then that becomes our new basis at the beginning of the next quarter. So it's really hard to say. I think it will come down a little bit more, but I don't know how much. But I know that if we can operate our business effectively at the levels we are at today, it will probably get better and more favorable for us.

Okay. Very helpful. Then a couple more questions. For Jim, on the line of credit, do you see that coming down on a stair step basis after Q4, or do you think it will remain $10 million to $15 million for the balance of next year as well?

No, I would say if we are at $10 million to $15 million at the end of the year, we might be at a similar amount at the end of 1Q of 2013 but, beyond that with strong second, third, fourth quarters of next year, we envision being out of the line for the majority of that time.

Okay. Great. Then Mike, one more, if I might go back to the workers' comp reform in California, have you spoken with clients at all about various scenarios, and gotten feedback from them? And then secondly, on top of that, what percentage of clients right now carry a workers' comp coverage through you?

In California, 100% of our clients -- well, I'd say 99%, 98% of our clients are within -- using our self-insurance product. No, we haven't directly -- I know our branches have addressed questions as they have come from both clients and referral partners. I think at some point they just -- one, people understand the value of what they are getting from us, and it's our job to continue to make sure that we are delivering that and making it less and less about comp on a year-to-year basis. We've been on the trend for quite a while. But as importantly, we have lived through -- we always have stuff that we have to be reengineering and fixing, and so I think that people understand that and they are giving us room to do it.

With 26 months, people laugh at me, do you have -- what is that 2% off chance that you can't fix it or you can't come up with a solution, and I go well, that is my 2 AM thoughts. So that's the thing, I wake up every morning and there is people asking what keeps me up at night, that's that 2% factor. Because I wake up every morning and think about it, I write a few things down, and every day we get a little bit closer to the answer. So I think within 26 months, we will have the results. I think we'll have the results much sooner than that, but we've got a little bit of runway.

Do you see that resolution coming through a reform to the bill, or do you see that resolution coming through a workaround to the new law?

It's hard to say. We are -- it's still really a discovery mode. The bill is still so new that I don't think anybody knows what the final bill will really look like by the time it gets beat up, it was very unpopular. It was a bill that passed -- I think that 11 o'clock the night of -- that the bill was -- before the end of the session. You know, it was actually pushed through by the governor, because he wanted it done for whatever reason, and so I think it will go through a lot of iterations before it is finally done. But at this point, we are looking at roughly four or five different ways of approaching it, or four or five options as we move forward, and to me I look at it as a little bit of one of those times where it is an opportunity to refine or build whatever risk or exposure might have been in the business model out of it. And so I consider this as being one of those things, again, that makes you better if you approach it right.

Right, thanks for all that feedback. It's very helpful, Mike.

You bet.

Thank you. And our next question comes from the line of Mike Hughes with SGF Capital. Please go ahead.

Good morning. Staying with the workmans' comp issue, you mentioned having your own insurance company. Do you actually have your own insurance company in California right now?

Not yet. What we do is we have a company that we've owned for the last -- it will be three years in January. Interesting enough, that -- you need three years of seasoning to be able to make application to get that insurer admitted. So if that were admitted in the state, it gives us a lot of flexibility to do -- to be who we are. We are also -- we've made application in a couple other states, Nevada, Utah, Colorado, and that's moving along very well, and so that's all part of the process.

Okay. So worst case scenario, why wouldn't you just run this through your own insurance company in California? How would the economics change if you had to do that?

It's just one of five of the options that we are looking at.

Okay.

I choose to not have all the eggs in one crate. We are looking at that, but we are also -- we've operated as a good citizen in California, and we've done a lot of real good things for a lot of small businesses. I could probably get a little ornery about the situation where legislators will go and make decisions without really understanding the facts, and the way the bill went through, there were even some businesses in line that were protecting themselves that got behind the bill. But hindsight, I think that they felt -- in the conversations that we've had, that they were maybe misinformed about all the facts before it went through.

So I think it is one of those things that we are not just going to give up on. We are going to work through it. But we have many -- we do have several options. You know, part of it is, is that I'm using this as an organization to mature who we are, and so I'm not going to just say it is fixed and we can move on. I'm trying to use it as a way to make sure we are maturing in the most effective way.

Okay. Could you actually work this to your advantage? Meaning if you use your own insurance company in the State of California, could you move to like a reinsurance model, and then the extras coverage insurance, that that cost would be reduced, and this actually could be a net positive at the end of the day?

Yes, and ultimately, I think when we get this piece resolved, we are going to be a very, very powerful company. I think that with where we are going, however it works out, it will give us a platform that is consistent across-the-board, and we can ultimately replicate it anywhere we go. And there is some fundamental things, you know, you grow up from who you are to -- from who you have been to who you are is one way, and then you look at who you have to be moving forward. That is sort of -- we are really looking at how we fix the situation more systemically than we are just as a one off going, well, this will just fix the problem. But no, I see great benefit if we do it right.

Okay. And a couple other detail questions, just the SG&A was up about $2.2 million sequentially. Could you kind of bucket that $2.2 million increase between incentive comp and other categories?

You know, it's -- bonuses sequentially year-over-year it's going to be up, because our branches being more profitable, you are going to see more dollars being accrued back into profit-sharing. Also, we continue to build infrastructure, and we are building out in front of ourselves. We've hired probably one of our more aggressive rates this year than we have in several years, and are continuing to build our bench. I'd like to say our payroll per week is up roughly on a year-over-year -- or if I went back two years, is up about $100,000 a week, and our margin generated in that same period is about -- up about 1.3. We are leveraging, even though SG&A has increased, we are levering that, and we continue to gain more leverage against that.

But we're going to continue -- our job -- the way I see it is to run a company that is built to last, and it's going to be built into the future around a strong culture and a strong infrastructure that can support and stick up -- and basically be able to bend in the wind but not break, and that's all part of the process.

Okay, and then my last question for you. Just looking back to last year, I see the new customer adds in the third quarter of last year were, I think, 113, and they had been 151 the prior quarter, whereas this year you added 182 last quarter and 171 this quarter. So I don't know if last year was an anomaly, but it looks like the third quarter is typically more of a seasonally weak quarter for new customer adds, but you overcame that this year. So I guess you are out-performing the economy in general; are things as strong today as they were coming into the quarter?

I think the better way to measure it is looking at new hires and different things, but I think our brand continues to mature. I think it's maturing across the broader base of branches. I think that if I looked at growth a year ago, it was concentrated a little bit more. Today, it is a much broader spread. Typically, August tends to be -- the reason third quarter gets a little soft is because August is -- everybody has gone on vacation. This year, it seemed like we have a lot more activity going on in August. But I would say probably the growth rate of the 54% year-over-year build is more in line with the broader base of branch growth operations, of adding new clients.

Okay. Thank you very much.

You bet.

Thank you. At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Elich for closing remarks.

I truly appreciate you being on the call. I appreciate the patience that you've maybe had to have throughout the years in trusting the leadership and the direction we've tried to take things. I do feel very fortunate to be part of a great organization, and I really believe that our best days are in front of us. I am very excited about things that we are getting done. I am seeing things that I didn't know were possible related to the maturing of our Director level and our Senior Management, and just our overall leadership bench in the organization. It's not that we won't stumble, we will; I don't know when, and I don't look for that, but we are trying to build those areas out. But I think as an organization, you are going to continue to see the product get stronger. You are going to continue to see us evolve, and I like to think that we are building something that has not been done before. Thank you.

Ladies and gentlemen, this concludes the BBSI conference call. Thank you for your participation. You may now disconnect.