Barrett Business Services Inc (BBSI) 2013 Q1 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 first quarter ended March 31, 2013. Joining us today are BBSI's President and CEO, Mr. Michael Elich, and the Company's CFO, Mr. Jim Miller. Following their remarks, we'll open the call for your questions.

Before we go further, I would like to take a moment to read the Company' 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 further information about the risks and uncertainties that could cause actual results to differ materially. I would like it to remind everyone that this call will be available for replay through May 24, 2013, 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 would like to turn the call over to the Chief Financial Officer of BBSI, Mr. Jim Miller. Please go ahead.

Thank you, Alicia, and depending on where you are calling in from, good morning or afternoon, everyone. As you saw at the close of the market yesterday, we issued a press release announcing our financial results for the first quarter ended March 31, 2013. The solid momentum we built throughout 2012 continued into the first quarter of 2013, as shown by our fifth consecutive quarter of gross revenue growth greater than 30%. This growth can be attributed to a variety of factors, including continued strength in our referral channels, our high client retention rate, and the maturation of our brand in the marketplace. Given this acceleration, we will continue to prudently invest in our operational infrastructure and professional talent throughout 2013 to ultimately support a much larger organization.

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 upon 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 first quarter results, total gross revenues increased 37% to $591 million over the first quarter of 2012. California, which comprised approximately 88% of our overall first-quarter gross revenues, increased 40%, primarily due to continued growth in our co-employment business. Overall, PEO gross revenues increased 38% to $561 million over the first quarter of last year, primarily due to the addition of new clients, as our co-employment business from new customers more than tripled our lost business from former customers as compared to the 2012 first quarter, continuing a trend that we've experienced for the fifth consecutive quarter. Our PEO revenues from existing customers experienced approximately an 8% increase year over year, due to increases in both headcount and hours worked, similar to the year over year increase experienced in the fourth quarter of 2012. Staffing revenues for the first quarter of 2013 increased 13% to $29.7 million, primarily due to a 7% increase in revenue from existing customers. On a percentage basis, gross margin in the first quarter was 1.4%, as compared to 1.5% for the first quarter of 2012.

The key components of this quarter's gross margin are as follows. Direct payroll cost as a percentage of gross revenues in the first quarter decreased to 84.4%, compared to 84.9% in the same quarter last year, due to increases in the overall customer markup percentage, as a result of price increases experienced primarily beginning during the second quarter of 2012. Workers' compensation expense as a percentage of gross revenues was 4.2%, which represents a 60 basis point increase over the same quarter a year ago, primarily due to an increase in the provision for estimated workers' comp claim costs, as well as to higher broker commissions. The 4.2% rate was a bit higher than originally anticipated, a 4.1% rate, due to additional investment in infrastructure to ensure that we remain in alignment with our growth. Payroll taxes and benefits for the first quarter remained nearly flat at 10% of gross revenues when compared to the year ago quarter, as unemployment tax rates for 2013 remained at a similar level compared to 2012.

SG&A expenses increased 21% to $11.8 million, compared to $9.9 million the first quarter of 2012, primarily due to increases in management payroll, as well as variable expense components within SG&A to support the continued business growth. The benefit from income taxes in the first quarter was $1.3 million, which represented a tax rate of approximately 34.2%. We expect a similar rate to continue for the balance of 2013. For the first quarter of 2013 we reported a net loss of $2.5 million, or $0.36 per diluted share, compared to a net loss of $2.2 million, or $0.22 per diluted share, in the same quarter last year. The first quarter of 2013 reflected a decrease of approximately 3 million common shares when compared to the year ago quarter, due to our repurchase of approximately 2.5 million shares from the Estate of William W. Sherertz, as well as 500,000 shares from Nancy Sherertz, effective March 28, 2012. Consistent with our historical experience, the net loss for the first quarter is due primarily to the seasonally higher burden of employment taxes during the first several months of our year.

Now turning to the balance sheet at March 31, cash, cash equivalents and marketable securities totaled $78.3 million, compared to $72.4 million at December 31, 2012. This increase is primarily due to the build in accrued payroll and payroll taxes, while most of the payroll tax expense recognized during 1Q will be paid out at the end of April. At March 31, 2013, we had no outstanding borrowings on our revolving credit facility. We anticipate being back into the credit line during 2Q as a result of our 1Q payroll tax payments, but likely out or nearly out of the line at June 30, 2013. We generated approximately $13 million in operating cash flow in the first quarter of 2013. Most of our cash generated from operations is in the form of free cash flow, except for the build in workers' compensation and safety incentive liabilities, as cash used to fund our insurance subsidiaries is primarily generated from the workers' compensation expense we recognize but do not immediately paid out to third parties. During a period of growth, our free cash flow will tend to be in line or exceed our net income on an annual basis.

Now turning to our outlook for the second quarter of 2013, we are expecting gross revenues to increase to a range between $630 million and $635 million. This projection represents a likely midpoint increase of 29% over the $491.1 million in gross revenues for the second quarter of 2012. The projected increase of 2013 second-quarter gross revenues is based upon recent revenue trends. We expect diluted income per common share to range between $0.68 and $0.72, compared to $0.53 in the year ago quarter. We continue to be very enthusiastic about the momentum in our financial results over the past five quarters. I look forward to addressing you again in our second-quarter earnings call. Now I'd like to turn the call over to the President and CEO of BBSI, Michael Elich, who will further comment on the recently-completed first quarter and our outlook for the second quarter of 2013. Mike?

Thank you, Jim, and thank you all for being on the call. I'd don't want to say this is getting boring, but it seems like we're -- seems like a reoccurring message, and hopefully it will all -- new things will resonate today. But we are very pleased with another successful quarter. We continue to see strength, and our growing pipelines will continue to mature the organization as we build for our future.

In the quarter, we saw an add of 216 new clients. We lost 18 clients -- three were to AR issues; eight clients canceled for non-AR issues, risk and/or tier-related development issues; three businesses sold, which is actually down significantly from what we saw mid-last year; one client left on their own due to price; two clients left to take payroll in-house; and one client left to go to a competitor. On a net basis, we added 198 new clients, which represents the largest new client build of any quarter in our history. We saw hiring flat, for the most part, to slightly up in the first quarter. Results were fairly consistent across all regions. 39% of our clients added headcount, while 31% of our clients reduced headcount. 30% of our clients were unchanged. So roughly one-third/one-third/one-third, if you want to balance that a little bit. 46% of our clients increased hours worked, while 50% reduced hours worked. In comparison to fourth quarter, we saw 46% of our clients increase hours worked, while 55% increased hours worked in the fourth quarter.

We did see some softness in January, following uncertainty in the economy at the end of last year related to the tax increase, the sequester, and the inevitable Obamacare or Affordable Health Care Act, giving business owners a little bit of pause. But we have seen a regain in momentum the last four or five weeks in our run rate. So it's still not a trend, or a reverse in trend, but we are still kind of seeing the strength we had been seeing last year. We continue to see strong momentum across all regions at this point, all but the Northwest saw double-digit growth in the quarter. The Northwest, which is our greatest seasonal region, saw a little less than 10% growth, but overall, everything looks pretty strong. Our pipelines remained strong as our branches continued -- as the brand continues to tip within local markets, while we maintain a 95% retention rate within our client base. Our primary obstacle to growth is how far we are built out in front of our demand, which is where we are consistently putting a great deal of effort, attention and effort, investing back in the infrastructure.

Moving forward, and in the quarter, we continued to make progress in maturing management systems to recognized outliers within our clients, so we can focus resources more proactively. We're continuing to mature the branch within branch structure and business unit teams, as they support clients. To date, we have 20 business units operating within branches, with six additional business units in development. We continue to roll out our -- the rollout of our HRP platform, which -- with approximately 36% of our clients now on the system. Our implementation rate is starting to accelerate over the last few weeks. The new payroll and data management system ultimately will offer additional scalability of operating systems, more client flexibility, a more robust platform for data structure, and expanded interface capability to support client data interface access over time. We continue to work on areas that mature the alignment of brand with our branch operations, which supports continued maturity of our referral networks, and we continue to re-focus on continued internal organizational development, which we see as one of the more critical elements to our long-term success.

Overall, we continue to maintain strong pipelines for new business, while remaining -- or while retaining a healthy client base. We continue to see the quality of our client base maturing significantly, both seen in reducing attrition rates as well as -- the clients that we have just seem much more healthy, and able to sustain the headwinds of the economy, and things that get in the way. We remain ahead of plan in aligning the organization to support our growth curve, and we'll continue to make the necessary investments in the infrastructure to stay out in front. We continue to make progress addressing issues related to California Senate Bill 863. We have three options designed to address the issue, related to our inability to be self-insured for workers' comp in California, effective 1/1/2015. I feel we have made good progress in the quarter addressing the situation, and we'll keep you posted as things evolve.

Lastly, we continue to look internally to infrastructure to support growth, while gaining efficiency in branch operations within corporate support functions. All efforts continue to focus towards strengthening and maturing the organization product offering. We feel like we're continuing to make significant progress in all areas. The organization today is not even close to where we even were a year ago, and I'm very, very pleased with the bench that's building, the overall tone of the organization, and the way the infrastructure and the organization itself continues to take ownership in our overall success. With that, I'll open it up for questions.

(Operator Instructions)

Jeff Martin, ROTH Capital Partners.

Mike, could you touch on the staffing business? First double-digit growth rate in several years. Just curious if that's a trend we can expect for the next several quarters? And, also, is there any impact that you see on that business from the Affordable Care Act implementation?

You know, one of the things in -- on the staffing front is we have not chased that business for reasons over the last couple of years, primarily because as we've gone through, even the last 10 years, the margins have been suppressed. It's been -- it's become very much commoditized over time, and in general the business itself has not matured in a direction that I felt was the best interests of the organization. With that said, though, we are beginning to find that the clients that we have, and also that the new market that we are penetrating, continues to see value in our approach, which is we are not going to just hire people to hire people for them. We're trying to find the best people that's appropriate for their business operation. And we're also doing a lot of staffing now relative to supporting our existing PEO clients. So, in general, I think that you will continue to see that piece of business growing, mature, as we have more branches supporting it as well. As well, I think that as we make the turn into an economy where business owners are looking for more options, it lends itself to support that.

Relative to the Affordable Care Act, we do see additional expenses associated with having people on our payroll from a staffing standpoint, of -- which were responsible for, and we are working today around the matrix related to what is the best way to deal with that cost structure, mainly for supporting those benefits. And ultimately for the industry, it will mean a higher transfer cost going back to existing clients, and it will have to be absorbed into higher mark-ups, which will affect how companies are using temporary help. But over time, I think it will normalize itself as being probably neutral across the market, because everybody will be subject to the same issue, and for those that might want to cheat short-term, the not going to get away with it long-term.

Okay. Then, was curious about the workers' compensation infrastructure investment that affected the workers' comp as a percentage of gross payroll by about 10 basis points. If that investment -- curious what specifically that investment is, if it was specific to 2Q, if that's an ongoing investment, because according to my calculation that's $600,000 pretax, which means absent that investment you could have beat by $0.06 or $0.07 in the quarter?

Part of it is associated with just a -- with the growth rate that we've had, we continue to have to invest back out in our infrastructure. So when you look at some of the cost structures that we build into that bucket, you have risk management, which on a build basis, or quarter over quarter or year over year basis, we see build there to stay out in front of that infrastructure build. We also have increased costs around our TPA fees, or our third-party administrators, of which we internally administer part of our claims, and then we externally administer. So -- and in an effort to make sure that we're not getting behind the curve, we have invested further out in front of that. And another area would be increases to the variable cost of commission or referral fees that we pay back to individuals, and as we have gone through and increased our overall rate structure, it reflects back into a higher basis for that calculated fee. So all of those are components. They'll -- over time, if our growth rate normalizes, you are going to see that number normalize back a little bit. But for the most part, it's just us also being conservative with how we're running the business and not wanting to short-change today for tomorrow.

Okay. So we might see that elevated for another quarter or two, then come down, if the growth rate normalizes somewhere in the 20% to 25% range, is that what you're saying?

Yes, you -- the thing about infrastructure cost is that we do -- you always have a build-out in front of it, just like you are seeing that in our SG&A costs. But over time, as growth starts to normalize, you are going to also see us start to lever that investment more effectively. So, we talk about what our capacity would be at a zero or normalized growth rate, and that capacity increases significantly. Since we've really never been there, we don't know how much. But, at the same time, when you're growing at even plus-30%, you better make sure you are out in front of yourself 1 year to 18 months, because that is not a very long timeframe when you are running the kind of volume through your organization that we are.

Okay. Then was curious, Mike, in terms of what you might deem mid-market clients, say, north of 100 or 200 employees, if you are seeing any noticeable trends there? I know that one of your competitors faced a pretty sharp downward adjustment to their work-site employee base at the start of the year because they lost a couple of mid-market clients. Curious if you're seeing any of those mid-market clients start to reevaluate their PEO model? Do you see that as a threat to them taking that in-house, or do you think you're past that since you passed the start of the year and the renewal phase?

Actually, we're seeing the opposite. We're seeing where our pipeline is offering up more large clients. We are very, very particular about which large clients we take on, because we know that they can be a little bit more finicky, and sometimes absorb a lot more resources of the organization short-term. But, no, we are seeing actually the opposite, where our pipeline probably has more large clients in it today than it has in years, and we are not seeing any attrition of those larger clients, as well. In fact, the upcoming -- through the first of the year, where you usually see a turnover or if you are going to shake out your client base, we probably have the lowest attrition rate of any quarter we've ever had, with only 18 lost, and 1 going to a competitor. So I'm not seeing that, Jeff.

Okay. Then, any reads on the economy as a whole? Are you seeing strengthening, and the internal metrics suggest modest strength, but just curious if you have any additional insights there?

You know, I go back a little bit to where we were even a couple of years ago when I say it's -- I really didn't see a double-dip, and I would say I still don't see it. We do skew that a little bit, because of you look at our client base, it's made up of pretty well-run companies, and they're pretty solid, and they make money and they pay their bills, and they are probably the more nimble in the economy. But one of the things we saw January is just a lot of indecision, a lot more fear, as people were trying to understand how they were going to be affected by certain changes in -- administratively, and from -- just from the tax, and just different things that were going on. What we've seen probably the last half of the quarter is that well-run companies are continuing to grow and add incrementally, but they're not just -- they're not getting too far out in front of themselves, but we see stability there. I think that you're going through a period right now that will probably last -- maybe even through this year, of companies really evaluating, okay, who do -- how do I have to -- what other surprises can I expect in my business model, and how do I adapt to it? I think, for the most part, we have our clients fairly out -- fairly far out in front of that, right now. But we're working on it every day, and I'm not seeing where clients are retracing, I just don't see them being very aggressive about adding a lot of headcount and expanding. But the good ones are growing at a manageable rate.

All right. Thanks for the insight, Mike.

Josh Vogel, Sidoti & Company.

Just a quick follow-up on the staffing business. Can you just remind us the seasonality there?

Well, you have two blocks of seasonality. If you take Utah, where we do a little bit more staffing, you tend to have a fall, winter staffing build relative to Christmas and the holidays. Then if you rotate yourself more to the Northwest, you have more of a food processing, agriculture-related ramp that we see starting mid-May that runs through maybe an April timeframe, and it just depends on how big your crops are and what you have coming in. We're not doing any field work, but we are working with the ConAgra's of the world, the Simplot's of the world, and some larger organizations that even their runs are subject to how much raw material they have and raw product they have to process. So that's the second piece.

The third piece would just be general seasonality of expansion/contraction relative to what you see in the second and third quarter, just because you are kind of past the -- you're past the January/February hangover of companies trying to figure out where they're going for the year. Then they find their stride mid-year, and they tend to expand a little bit. Then as they are going into -- it's been the cycle the last few years, kind of toward the end of the year of again, indecision, they tend to contract a little bit. So I guess those are probably the three cycles that I would measure against. I think the biggest one on the staffing side that creates flexibility is that in the ag world, you can be put off three weeks because of weather, and when that happens it will change your run, and it will change how much revenue you're going to drive through that model in a particular period of time.

Kevin Casey, Casey Capital.

I wanted to -- a question about margins. Look back a few years, you had a lot higher margins, [lots of growth and much improvement] in margins. I have two theories on why. I'll let you answer first, and then I'll [ask you what you decided to] those two theories.

I will try to answer your question, Kevin. You are kind of hard to hear, but at the same time, let me know if I missed anything. One of the things that we saw last year was just where we were in the maturing cycle within our business model. And also where we were from a cost standpoint post-recession is we did go back into our client base and increase client prices somewhat across-the-board. We looked at every client individually, and we brought them in line to where we needed to be to ensure that organizationally we were yielding what we needed to make, to be able to continue to deliver and invest back into our own infrastructure, as well as what we were accreting out of doing business with each client. So we've picked up, probably on aggregate, maybe 0.5 basis points throughout the year, and as -- continued to see that mature coming into the first part of this year. I don't see us continuing to go back to that well, in that I think that we're pretty much in line. But I would say, also, that all the clients that came on this last quarter are priced at that higher rate. So you'll continue to see margins at least firming to increasing, based on those principles or factors.

Okay. Because the two theories I have, one is we are not getting huge headcount improvement from your customers. Isn't that a big driver for margins?

Yes, the big -- a big driver for margins would be -- on a revenue basis, headcount would not make a difference in margin. It would make a difference in operating margin, because if you have a client that has 20 employees and the client goes from 20 to 30 employees, you're going to lever those dollars, and you're not going to spend anything more to support that broader client. So if you look back and said, today, that we have 2,300, 2,500 clients, I don't even know what the number is anymore, but if we added 2 employees to every one of those clients, you just added 5,000 employees. We don't have to spend anything, incrementally, to support them. So from an operating margin, yes, we are going to lever that significantly. From a gross margin, or margin percent, the thing that would affect your gross margin percent would be overtime. If you find that the same person's working more hours, then you now have more margin generated per employee, so then your gross margin by -- per dollar or per hour worked would increase.

Okay. Then my other question about that also is workers' comp seems to be under-priced, especially in California. Theoretically, it should be -- you can argue how much higher, but at least it's double-digits, if not in the -- 20% to 30% higher. Is that hurting you guys a little bit on margin, because you and your workers' comp insurance competitors need to catch up there?

Yes, I think that we've done a pretty good job over the last year -- the last few years, bringing that into line. I don't consider -- I don't think that we're under-priced at this point. I think that our accrual rate -- we are taking on more of a conservative approach relative to what we feel we need to accrue for the future liabilities of the losses or claims that we have on our books. But we have matured a lot in the last year at being able to look at what we are charging relative to what we are accruing, and where we are at in that equation, and we're continuing to get better at it all the time. But the place where I see today, that I think is very positive, is that when we sit down and start looking at the whole equation from the 360 different vantage points, we are starting to come up with very similar answers. I would say that, yes, California in general is probably broken and under-priced, and they will always follow the next reform until it doesn't work, to say whether or not prices are correct. But when we look at our current trend of loss -- in loss development in different things, I think that we're starting to hit a pretty good sweet spot in there, and it seems to be a number that's sustainable.

Okay. And did you guys give headcount growth per customer or per client?

We did not. We don't typically measure it that way, because that number can get skewed so many different ways, and it's probably still averaging that 25 to 30 employees, which has been the average. It may be skewing up a little bit because we are bringing on some larger clients, but the overall base, I think, is stable at best. I wouldn't say it's been growing.

Okay. Then one final margin question. When you think long-term about your business, and the tremendous service you offer your customers, wouldn't you expect a lot higher margin, at least better pricing?

Well, I guess it depends on how much I have to invest back into that client. I think if you take that on a normalized basis, and take growth out and everything else, it would be how much am I making per client, if I wasn't supporting a lot of different missions? The challenge for us, and for our clients specifically, is that as we work with them over time, they get -- they become better clients. So as they become better clients, we get more leverage out of the time that we spend with them. As that continues, I could probably go back and raise prices for them, but I don't really have an incentive to do that, because now I'm just creating adverse selection in my book. So for the most part, yes, I might always be able to always get a little bit more. But at some point, I like the idea of having stable margin for my clients so they have a sustainable cost, and the increase I get from them is that they refer me 10 more clients, because it works. Over time, as we start to normalize our growth and get out far enough ahead of ourselves organizationally, we're doing fine I think per client. If we can bring 50%, 60% of our margin to our bottom line on a branch basis, and continue to do that, I don't know why I would stress it to the point of jeopardizing what's working. I think that's what our competitors have always done, and I think that's why we don't see a lot of competitors competing with us.

All right. Got it. Thanks.

(Operator Instructions)

Mike Hughes, SGF Capital.

A couple questions for you. First, on the workmans' comp expense line of $25 million, I think you can basically break that down into three component parts, the current period claims expense accrual, then the prior period claims expense accrual role, and then kind of other, which would be administrative. Do you happen to have those numbers handy, or we have to wait for the 10-Q?

Probably would need to wait. Yes, probably would need to wait, just because the current and prior is probably blended a little bit more than -- you are kind of working through some other areas. There is kind of an SG&A block that would be easier to separate out. I don't know, Jim, do you --

Yes, I would just say that if you are looking at total workers' comp expense, you know, the loss component, be it the combination of current and prior, you know, that's less than 50% of the overall cost, so -- the other cost being those infrastructure costs, actually carry a higher cost component than the losses. That's running a risk mitigation model, so there's a lot of components in there in addition to the losses.

And so also just to add to that, one cost, we do buy Access Insurance, so it's a variable cost against that. That tends to be a -- not really a significant portion, but it's variable in the equation that tracks -- that could almost be put back into -- it could be put in either bucket, so --depending on how you want to look at it.

Okay. Do you happen have the IBNR?

That would be mentioned in the 10-Q.

Okay. Then the SG&A in the fourth quarter was $13.4 million, and a step down to $11.8 million this quarter. Can you just kind of bridge that for us?

Yes, that's primarily due to branch and corporate bonuses. Throughout the year, as branch and corporate cumulative profits increase, there's an increase in the percentage of that bonus structure. So you're going to have higher bonuses, and therefore higher SG&A expenses as a percentage in the third and fourth quarters. First quarter is always going to be the lowest, just because there is very little net profitability.

Okay. Did you hold back on any discretionary SG&A spend in, let's say, the month of January, just because you saw some softness? Was there any of that in there?

No, I -- no. We continue to build for tomorrow. We typically don't manage our P&L that way. We look -- we know what our -- we know where our run is. If we ever find that the run or build in clients is softening, or we don't -- we will adapt to that. But even quarter-to-quarter, we wouldn't do that.

Okay. And then, it sounds like the payroll cost as a percentage of gross revenue at 84.4% in the first quarter, that's a good run rate for the balance of the year, would you agree with that?

Yes, I think that's a good number. We continue to see, as the -- getting back to Kevin's question a little bit, is we have bumped mark-ups throughout our business model. You see that -- you're going to see that number normalize, and it seems like it's starting to get there. We may be a little better than that for the balance of the year, but then, too, like in this -- where you really see it spike and get choppy in that this quarter, we have Memorial Day weekend. So when you have that, it gets a little jumpy. Then in the second and the third quarter, you have both the Fourth of July and then you also have Labor Day weekend. Like the Fourth of July this week is on a Thursday, so it will affect you more, because Friday will typically be a holiday, so now you're going to get a two-day holiday in there. So those are the things.

I think that [40] is a pretty good number, but if you see sit jumping around a little bit, those are some of the things we are always working with and working around. That's why you see a jump in the fourth quarter as well, because you get around Thanksgiving, and then you have really your three weeks of holiday in there that makes that number move. But no, I think the 84.4% is a good basis to work around. Then we'll continue -- as it's moved a bunch in the last year for us, we're trying to figure out where that normalizes, too, as well.

Last question for you. I think in the past, you've been somewhat hesitant to do an acquisition, given all the opportunity you have in front of you on an organic basis. Any changes there?

You know, we're -- we've got a great organic model that continues to mature and grow. I have two acquisition prospects on my desk today. We're always seeing them come across the desk. The challenge with it today is that with what we have going on, and where we're going, the distraction and/or potential risk of trying to stair-step somewhere we don't need to, today, doesn't make a lot of sense. So we'll continue to watch for that perfect fit, but I don't see it in the near future in our -- on our time horizon. We have enough to do internally, right now.

Thank you very much.

Josh Vogel, Sidoti & Company.

Sorry about that earlier, we were having phone problems over here. I just wanted to build off some of the line of questioning on the SG&A. Given the reinvestment in the business and the rollout of the payroll and data management systems, should we expect G&A throughout the year to trend higher as a percentage of revenue in 2013 versus 2012?

You know, I think that the biggest things that are going to contribute to the build in SG&A would be -- you know, the payroll rollout will ultimately make us more efficient, so you will see that investment will at some point normalize. There is some CapEx expenses that will start being realized as that SG&A -- or the system comes online and goes into operation. But we are pretty much running the business with those built-in. I think the biggest incremental cost that you will see to SG&A, you know, I mentioned that we had in the last year established and framed roughly 20 business units, and we have 6 more in the queue, and we probably have another 6 to 10 that we'll probably build in the next year to 18 months. So with that kind of build, that's probably incrementally where you're going to see the real charge to SG&A and build in SG&A coming from. But the best part about that is there's a direct return on investment over time within that spend. So as much as it's fixed cost to SG&A, it becomes a variable cost to operations.

Okay. Great. You guys have the western US well covered, but can you just talk about any opportunities you see in other states? I was also curious how much more of an opportunity for growth you have seen in California? Then, beyond that, if you did enter a new market or a new state, would you -- do think of build-out from the ground up is the way to go, or do you think you'd make maybe an acquisition to get an immediate footing there?

That's a good question. So let me back you up on the size of the market in general. In general, if you take client -- companies that average from 20 to 500 employees, just in California alone, there are roughly 70,000 companies that we could -- that really fit into our sweet spot. Today, we do business with under 2,000 of those. So, on a percentage basis, we are less than 2% market penetration. I was down in Irvine last week, and I saw an article come, and it was just talking about business just in Irvine, in particular, and when we stripped back, there were 2,200 -- 2,400 companies that we -- that would fit our sweet spot in Irvine, and we are doing business with probably less than 80, in that little city proper. So from a market penetration, we haven't even scratched the surface.

Related to West Coast and future penetration, I see what is continuing to happen is our brand continues to tip as our product offering matures, and we have more people that are recognizing the value that we're bringing to market. So that grouping themselves is creating momentum that continues to support our pipeline. The -- beyond that, if you take it now to new markets, I consider our biggest driver to new markets is going to be meeting a company or source for companies, and they're saying, I need you to be in New Mexico, I need you to be in Texas, I need you to be somewhere, and at that point we would make that investment. The thing that we didn't have a year ago that we have today is because of the branch-within-branch philosophy, we have the incubator, in a sense, that is allowing us to mature talent, so we can now transfer culture. The problem that we had before is, to be able to go and follow customer to a new market, we didn't have the capacity to be able to say this person could go to this market and leave their branch or leave their customer base, without wrecking that customer base. Today, we have a model that allows for sustainability of our current business and current customer base, while we would expand to those markets. Now, that hasn't happened yet, and it's continuing to move in that direction, but I see that's going to be the driver to pull us to new markets.

Beyond the West Coast, we've continued to see strong growth on the East Coast, and when we look at our presence in Maryland, Baltimore, Eastern Shore, Dover, and then surrounding areas, we are continuing -- we're starting to get significant market penetration there, with -- well, significant growth, with very little market penetration. So we see tremendous potential there, and will continue to look to build around -- have a spoke method about where we have success to date. So I think all of those things will come in time, and we are looking at all those things. I think the biggest thing I look at internally is, we went from being an organization that was really run top-down to now an organization that is very flat. It's got a much wider bench than it's ever had, and we're continuing to mature and stabilize culture within that, which will allow us, ultimately, to transfer the culture to new markets without eroding the base of product offering that we have.

Okay. That's really helpful. Thank you. Just lastly, of the 70,000 companies that are in your sweet spot in California, do you have an idea of -- do they outsource this work? Are they doing it in-house? Are your competitors -- you know, have a bigger share there? Can you just give me a sense of what's going on there?

All of the above. California, from a [call fund] basis, has a very low penetration rate compared to, say, Florida. In Florida, 70% of companies out there at one point use the PEL. In California, I don't see it, it may be less than 5%. Now, if you take the ADP and straight payroll model, 90% of companies outsource payroll. It's just kind of a given that why would you try to manage a software platform or -- especially after a certain size. So the idea of outsourcing is in line with how people think. It's more a matter of, to what extent and to how far are they taking the model, that I would look.

I would say that of the 70,000 companies, the biggest challenge we have when we see things come through a pipeline, is companies that -- maybe their balance sheet isn't that strong. So when we look at their financials, they're not ready for us. When we look at companies that come through, even just culturally, they're not ready for us. So we help work with them and coach them and say, you know, we're not ready for each other right now. When we look -- let's talk in another year, let's talk in six months. And we have a lot of those -- a lot of opportunities where those same organizations are coming back to us, so we're having a recurring pipeline coming back to us. As we see that, that's also one of the things that's accelerating our pipeline and our growth rate.

But I would say that from a -- the ability to penetrate California, it's always been a challenge out there, because you can't do it from afar, one; and two, if you don't come at it from an operations standpoint, and you just come at it from a sales standpoint, you'll fail on the back end, because the issues in California are real issues. Companies that outsource or go somewhere and use somebody, they need real help. When we interface with our customer, we bring resources to them, and we bring a real solution to them, which is something that I don't see our competitors doing very effectively.

Okay. Great. Thanks for taking my questions.

Thank you. At this time, this concludes our question-and-answer session. I'd like to turn the conference back to Mr. Elich for closing remarks.

Again, thank you for staying in touch, and thank you for taking time out of your day to listen in this morning. Again, very excited about where we are going. I would never dream to believe that we're perfect, but we are continuing to work on building a better model every day, and we feel like we have a pretty good bead on where we are going and what we need to work on. We're going to learn lessons along the way, but as an organization, I'm very, very comfortable with who we are today, and our ability to adapt to any challenges that might be out there. I'm pretty excited about where we're going. Thank you.

Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect.