Barrett Business Services Inc (BBSI) 2013 Q2 法說會逐字稿

Good morning, everyone, and thank you for participating in today's conference to discuss BBSI's financial results for the second quarter ended June 30, 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 will open the call for your questions.

Before we go any 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 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 a replay through August 24, 2013 starting at 3.00 PM Eastern this afternoon. A webcast replay of this 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. Sir, please go ahead.

Thank you, Craig, and depending upon where you are dialing 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 second quarter ended June 30, 2013. Obviously, we are pleased with those results. The second quarter's gross revenues represented the highest quarterly revenue figure in our Company's history, and the sixth consecutive quarter we grew more than 30%. We continue to see robust growth from our strong referral channels driving new business, increased organic growth from existing clients, and heightened brand awareness within our market. Investments in our operational infrastructure played an integral role in the quarter's results and will continue to be an important strategic initiative as we prepare BBSI for future growth. Ultimately, we are confident BBSI's brand will continue to mature in the marketplace.

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 mutual in managing and analyzing 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 second quarter's results, total gross revenues increased 37% to $675 million over the second quarter of 2012. California, which comprised approximately 88% our overall second-quarter gross revenues, increased 38% due to continued growth in our PEO business, and to increased organic growth from existing clients. Overall, PEO gross revenues increased 38% to $639.7 million over the second quarter of last year, primarily due to the addition of new clients as PEO business from new customers nearly tripled our lost PEO business from former customers; as compared to the 2012 quarter, which follows a similar trend we've experienced over the last six quarters. Our PEO revenue from existing customers increased approximately 12% year over year due to increases in both headcount and hours of work. This compares to an 8% increase experienced during the first quarter 2013.

Staffing revenues for the second quarter 2013 increased 16% to $35.3 million, primarily due to an increase in new business as the increase in business from existing customers nearly equaled lost business from former customers. During the second quarter, we saw staffing revenue growth in all of our geographic regions. On a percentage basis, gross margin in the second quarter was 3 5% as compared to 3.3% for the second quarter of 2012. The key components of this quarter's gross margins are as follows -- direct payroll cost as a percentage of gross revenues in the second quarter decreased to 84.3% compared to 84.7% in the same quarter last year due to increases in the overall customer market percentages as a result of price increases experienced primarily during the past 12 months.

Workers' compensation expense as a percentage of gross revenues was 4.3%, which represents a 30 basis point increase over the same quarter a year ago, primarily due to an increase in the provision for estimated workers' comp claims cost as well as the higher broker commissions and higher safety incentives. Looking ahead to the third quarter of 2013, we anticipate the level of gross revenues for workers' compensation expense to continue in the 4.2% to 4.3% range.

Payroll taxes and benefits as a percentage of gross revenues for the second quarter were 7.9% as compared to 8% of gross revenues in the year ago quarter, as the effective payroll tax rates were similar between the second quarters of 2013 and 2012.

SG&A expenses increased 37% to $14.5 million compared to $10.5 million in the second quarter of 2012, primarily due to higher branch incentive pay based upon increased branch performance, increases in management payroll, as well as the variable expense components within SG&A to support the continued growth in business.

The provision for income taxes in the second quarter was $3 million, which represented a tax rate of approximately 33.4%. We expect such a rate to continue through the balance of 2013. For the second quarter of 2013, net income increased 57% to $5.9 million compared to net income of $3.7 million in the same period last year. Diluted earnings per share in the second quarter increased 51% to $0.80 per share compared to $0.53 per diluted share in the year ago quarter.

Now, turning to the balance sheet of June 30, during the second quarter of 2013 we posted $63.9 million in restricted investments to collateralize a letter of credit issued to satisfy an increased surety requirement for our self-insured workers' compensation program in the State of California. Beginning in 2013, the State of California changed its method of calculating surety requirements to be based on an actuarial evaluation for each self-insured employer in the state. While this requirement is part of the recent legislative reform in California, it is unrelated to our compliance with Senate Bill 863.

I should point out that while this change represented a sizable increase to the letter of credit previously posted, we have continually maintained the discipline of keeping cash and investments on our balance sheet to fully fund our workers' comp liabilities, which are also determined by the same actuarial evaluation process. Therefore, the restricted investments provide a more formal external presentation to how we have always viewed these funds internally. This change will have no effect on cash needed to run the business. As a result, on June 30, 2013, our cash, cash equivalents, and marketable securities totaled $18.6 million compared to $72.4 million at September 31, 2012.

Of the $18.6 million at June 30, approximately $7.1 million is unencumbered -- or said another way, not part of our captive insurance subsidiary. At June 30, 2013, we had no outstanding borrowings on our revolving credit facility. Our expectation is that we will remain out of the line for most, if not all of the second half of 2013 as cash will continue to build from operations.

We generated approximately $17.4 million in operating cash flow during the first six months of 2013. Most of our cash generated from operations is in the form of free cash flow, except for the build in the workers' compensation 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 pay out to third parties. During a period of growth, our free cash flow will continue to be in line or exceed our net income on an annual basis.

Now, turning to our outlook for the third quarter of 2013, we are expecting gross revenues to grow at least 31% to a range between $730 million and $735 million compared to $588 million in the third quarter of 2012. The projected increase in 2013 third-quarter gross revenues is based upon our recent revenue trends. We expect diluted income per common share to increase at least 30% to a range between $1.05 and $1.10 compared to $0.81 in the third quarter of 2012. We continue to be very enthusiastic about the momentum in our financial results over the first half of the year. I look forward to addressing you again on our third-quarter earnings call.

Now, I would like to turn the call over to the President and CEO of BBSI. Mike Elich will comment further on the recently completed second quarter and our outlook for the third quarter of 2013. Mike?

Good morning, and I appreciate your taking time for the call.

Very pleased with another successful quarter. We saw a fall-through of the build in revenue run seen in late March continue into and throughout the quarter. As a result, the run rate exceeded expectations we originally modeled internally for May and June which, although it was difficult to model to plan -- to plan a growth in excess of 30%, we continue to run well and feel that we are making investments to keep us in front of the curve.

In the quarter, we added 201 new clients; we lost 38 new clients. Of the 38, we lost two to AR issues; 14 were canceled for non-AR risk or tier-related issues. 12 businesses actually sold, which is a little bit higher than what we have seen in the last couple quarters. Three left on their own due to price, three to payroll in-house, and four left to work with and competitor.

We see the net new build of 163 clients in the quarter, very strong and key to the continued growth of our base, while maintaining a 95% plus retention rate in our existing client while we have actually increased margins over the last four quarters. We did see strength within our existing client base with the increase of hiring and hours worked over first quarter. 48% of our clients have added hours worked, 25% of our clients reduced hours worked and -- or excuse me, headcount -- 48% added headcount, 25% reduced headcount and 27% were unchanged. Of our client base, 57% of our clients increased hours worked, while 40% of our clients reduced hours worked. In comparison to first quarter, we saw 57% of our clients increase hours worked, while 46% of our clients increased hours worked in the first quarter.

Related to our pipeline, we continue to see strong momentum across all regions. In the quarter, all regions saw strong growth, as Jim had mentioned -- anywhere from 23% to 39%. We continue to see strong diversification in the type of business we're bringing on, which remains primarily blue- to gray-collar mix. If anything, we are seeing a larger client prospect coming into our pipeline, but at this point, we still have no client that is larger than 1% of our total book.

Our primary objective obstacle to growth has been the amount of capacity we have built out in front of our demand. We seem to have made significant progress in the last six months in this area, but will continue to invest in infrastructure to support the integrity of our products. With that said, our pipelines remained strong and as our brand continues to tip within local markets while we maintain a strong 95% retention rate within our client base, we continue to see strong growth and see that in the foreseeable future.

Moving forward, we continued in the quarter also to make progress in maturing management systems to recognize outliers within our clients so we are able to focus resources more effectively on our clients on a proactive basis. We've continued to mature our branch within branch structure or business unit teams, as they support clients. Our model is, is that we will build branches within branches when we reach a certain tipping point within a branch where it makes more sense to build capacity within the branch that add geography. To date, we have 25 business unit teams operating within branches. We have four additional business units in development currently, and we have forecasted for the next 12 months an additional 30 business units, but that will be based on demand and the need for additional capacity.

We have converted over 90% of our clients to HRP, our new payroll and data platform. Process has started in early February, but it has been in the works for the past two years. The new system will ultimately offer additional scalability of operational systems, more flexibility, more client flexibility, more robust platform for data structure, and expand interface capabilities to support client data access over time. The process has gone extremely well, given the monumental task, and we will take our hat off to our teams that have an able to get that done with very little or no disruption in our existing client base.

We continue to work on areas that mature the alignment of brand and branch operations, which supports continued maturity in our referral networks. And we will continue to focus on continuing internal organizational development.

Overall, we continue to maintain a strong pipeline for new clients, new business, while retaining a healthy client base. We continue to see a quality of our client base mature as well. We remain ahead of plans in aligning the organization to support our growth curve and will continue to make necessary investments into the infrastructure to stay out in front. We continue to make significant progress addressing the issue related to California's Senate Bill 863. Of the three options we have mentioned previously, ranging from licensing our wholly-owned subsidiary insurance company in California, to working with existing carriers, we feel we are on track to having a solution in the next couple of quarters.

he key issue at this point is determining our best option for the Company over the long-term, both financially and for stability. What we do feel we know at this point is that any one of the solutions should be roughly cost-neutral to the existing self-insurance system we currently operate in California. The one demand we will recognize is the need to post collateral based on the amount of premiums that may be written in any one of the options we may pursue. Given the new law does not come into effect until 1/1/2015, we are comfortable we will have a solution soon.

And last, we continue to look internally to infrastructure and support growth while gaining efficiencies in branch operations within appropriate support functions. All efforts continue to focus towards strengthening and maturing our organizational product offering, as well as making Company in Oregon operationally more scalable to support existing growth.

With that, I will turn it over to questions.

Thank you very much.

(Operator Instructions)

Jeff Martin with ROTH Capital Partners.

Thanks, good morning, Mike and Jim.

Good morning.

Mike, did I hear you correctly? You said that you are forecasting 30 additional business units. Could you elaborate on that and over what timeframe?

What we are doing currently is, we've built somewhat of an a log rhythm that will -- gives us a pretty good estimate of what is coming from our pipeline versus what it takes to hire and build a mature -- and mature an existing build business unit and how long it takes to get to capacity. Of the 25 business units we currently have, we have roughly -- I would say we are roughly at about a 60% capacity level within those. Relative to how fast we're growing, we know that the four coming is going to take us to 29%.

But if our pipeline continues to add 163 clients a quarter net, we can see where just to stay out in front of a 30% growth curve. The branches actually from ground up are forecasted roughly -- or requested for 30 additional business units to be built. Which in effect, if you build them over the next 12 months, would not be fully matured until roughly, we will even call it 36 to 44 months from now.

And what that is, is for each one of those business units, we're going -- it looks to hire four people, one in the capacity of business partner, which is the driver of the overall team. We look at risk management and strength. We look at HR brand strength and we look at payroll capacity. It is still a work in progress, but right now, that is at least how we're forecasting the need to invest back into the organization relative to the growth curve that we are managing.

Is it safe to say that you look to basically double the business in the next three to four years, based on that?

Capacity-wise, correct, yes. Meanwhile, we do have excess capacity still built into the organization today.

Right, right, okay. And then could you touch on your various geographies? You recently were pulled into some expanded geographies from where you're currently are. Are you continuing to see that as a trend? And maybe you could elaborate on that.

We have not had to add any physical locations in the -- since we added physical geography into Monterey and to Valencia last year. The business unit and/or the physical footprint that we have in California seems to be adequate that now we can build this is unit teams to support most of the geography there.

As far as the Northwest, we had a very strong footprint there. Mountain states, it is strong. I think that as we expand in the Colorado region, possibly in Utah and maybe Arizona, we will see a need to expand footprint there. But currently, we are able to expand our reach primarily through the development of the business units.

Okay. And then segueing into potential pioneering of new geographies. Is that in the works? Are you planning longer-term for that and if so, what would be the underlying strategy there?

Longer-term, currently, you take the market momentum you're getting and you have got to make sure you are capitalizing on that. That has where our focus has been over the last year to 18 months. As we look out, we do see pressure coming from our existing client base and referral networks to pull us to other states and to open existing or new geography. But we are being very careful at how far or how we step out before we know that we have got a pretty good anchor where we are already at.

All of the regions that we're working in are doing well. We see a strong growth rate, even on the East Coast. With that, I could see that as an area where we would also maybe expand geography. It is kind of a wraparound the existing regions that we already have to support some of the outlying markets that we are supporting now, but we are getting pulled to.

But for the most part, we know how to do it, it is more just looking for the drivers that are going to get us there or make us have to go there. But I think more importantly today, it is focusing on and making sure that we are supporting the very low penetration rate that we already have in the existing markets. If you figure where we have maybe 2%, 3% tops penetration rate in existing markets, to get to 5% is a pretty big jump. We have got to take care of that first.

Great. Congratulations on a strong performance.

Thank you.

Our next question does come the line of Josh Vogel with Sidoti.

Good morning, Mike and Jim.

Hello, Josh.

My first question kind of multi-tier. I was curious, when you look at California and the growth you are putting up, it still seems like the market is still pretty underpenetrated. And I was curious from a competitive standpoint, are you seeing a lot of competitors coming into this market given the apparent opportunity there? And then building off of that, can you talk about the pricing environment and if any competitors are coming in, are the undercutting you?

As we have seen for years, you will have both smaller operators and then larger operators change up from time to time and take a run at us. To date, we've really never seen anybody really have an effect on us.

If you go back last quarter, we lost one client to a competitor. This quarter we lost four. But on a base of an excess of 2,500, close to 3,000 clients, that is not a real drawdown.

I would say that from a pricing standpoint, we have been able to go through an increase prices pretty much across-the-board over the last 12 months. And have seen very, very little attrition relative to that, so I do not see pricing as being an issue, and I really don't see anyone coming in being able to buy the market. We run a pretty strong operating model that once clients get in, they do see the value of what we bring, and it is hard for competitors to really strip that away.

When we are looking at new market, greenfield, just from our pipeline, we probably see the most competitive pressure there. But even that is not a real -- you don't see one big competitor stepping up. You see probably more of a cross-section of a lot of different types of businesses that are trying to compete or maybe model after what we do.

Okay. With regard to the 30 additional business units you're talking about, how long does it take to build out a business unit? And would this be kind of smoothed out over the next 12 months, or should we expect to see 15 or 20 built out in any one quarter?

No, it will be smooth. And in fact, the process to build them is recruiting, so, you have got the add of payroll ultimately, that is where it is seen. Then you have the team that is developing and then you have kind of a build within the client base around that team. So, that is where the 12 months to 18 months really comes in.

It takes you six months just to hire in that group. I don't really estimate that you are going to see it look a lot different than you've probably seen it look over the last year to two years as far as incremental increases to overheads, just to support -- just a broader base of business.

Okay. And now looking a little longer-term, given pricing is improving and the apparent leverage of the business units, business within a business. Where do you see peak margins during this cycle?

I think it is still really hard to nail that down. I think that we saw this quarter where just with some incremental hiring by existing clients that you had more flow through because it doesn't cost us more to support that. I think that as you build to a certain level you are going to find that you are going to have a certain synergy that is going to offer for economies of scale.

But I don't know that we know what the maximum margin flow-through is going to be. I think in the past we have talked to maybe increasing maybe 0.5 basis point. But, it could be more than that. I wouldn't be able to say today based on what our experience has been.

Okay, and just one last one. With regard to health care reform, could you just discuss your dialogue with clients? And did the delay in the employer mandate, did that help or hurt you, or is that just a non-event?

Where it helped us was I think coming into the first of the year there was a lot of disruption. I think that clients and business owners were very confused as to how they were going to be affected. They were working to get out ahead of that curve a little bit, to have a plan, but I don't think they were making the progress that they needed to. So, having another year reprieve, in the sense, seems to have taken pressure off that conversation.

For us, we're just trying to support our clients to come up with the best option. We are not taking risk in that side of the world. We see ourselves as being able to support it from a backroom TPA facilitated standpoint.

But beyond that, it doesn't -- we are pretty much neutral in that other than it does disrupt business when you take current business models and you change up how they have to look at certain aspects of the economics of their business. But most of our clients already offer health insurance.

The real, I think with a little bit of time for more of the answers to get vetted out in the process, it will help. I think it has been a very confusing process overall. I think that when you even sit down and talk to experts, they are still confused. And I think there is a lot of unintended -- not a clear idea of what the unintended consequences are of the overall bill when it finally does become active.

That's helpful. Thanks a lot for taking my questions.

Thank you.

(Operator Instructions)

Kevin Casey with Casey Capital.

The $63.9 million for the insurance business, is that roughly the amount that is going to be needed if you did a self-insured subsidiary? And then, do you get that money back in case you go down one of the other avenues related to FD 863?

Yes, that amount would be much more than we would need to capitalize our insurance subsidiary in California.

Second of all, the $63.9 million we've put up to back that letter of credit, that was one option we had. Another option we have, and we are going to take a harder look here over the next few months, and that is simply posting a surety bond for that. If we went that route, we probably still have a letter of credit, but it might be $10 million to $15 million rather than the full $63.9 million.

We do have some options there and some flexibility down the road. That would also help us with just the balance sheet aspects of it. But yes, the $63.9 million would be far in excess of what we would need to capitalize potential California insured status.

And then on your staffing business, how focused are you guys on that? Are you getting a lot of requests from your customers. Are you planning to ramp it like previous cycles or just kind of keep it there to keep your current customers happy?

I think, if I understand your question correctly, we're -- what we are doing is we ramp into any alternative or new option. One, we are giving ourselves a lot of runway. We plan to ramp into any alternative option throughout 2014.

So, just the operational capital or cash will fund the new model as it builds out. And then from a calendar standpoint, as clients come to a renewal date with us, we will make that transition. Being that we have been able to see somewhat of a cost neutral perspective for the client and what we are charging in a new system versus what we have been doing, the economics don't really change. And to the client, it should become very neutral. They shouldn't even really notice.

Okay. I think you might have mis -- I was talking about your staffing segment.

Oh. Maybe repeat the question for me, Kevin.

Your staffing segment was 16%, which I think is a very high number in recent history. And historically, during previous up cycles, you guys have really ramped that.

It seems like under your Management team, there's less focus on that. And I was just curious if you could just talk about that, it is really used for your current customer base or other customers are using that? And what is driving that growth?

Great, no, thank you, I apologize for missing that question. No, we are -- we have always been pro-recruiting and pro-staffing within our model. The real driver is, is especially in the last several years is staffing, we have not seen staffing to be that strong. Based on the fact that we are very particular about how we do staffing, if we wanted to go out on the market today and just build it, we could build it.

The problem with it is, and this comes from our own DNA of being very, I guess risk sensitive, relative to workers comp and the type of people we are hiring. Is that we have been very particular not to go down a path of getting into low wage, minimum wage, high-risk staffing business. But as we do see that our client base on the PEO side is starting to hire, we're using staffing to augment that as part of our model.

And then the other side of it is, is that we continue to build relationships with existing clients and continue to source well-run companies that want to use staffing for the right reasons. I think you'll continue to see it grow through the next cycle, and as we're maturing that model, we are continuing to support the growth of that model. It is just one of those things that it gets dilutive a little bit when you compare it to the growth rate of the PEO side, but we are still very focused in that area.

Okay, and then just to clarify something you said. You said the incremental costs on the 30 new team is similar to the past. I assume you mean as percent of revenues. Is that correct?

No, probably if you just look at just overheads and how overheads have ramped relative to growth rate in top-line revenues, you will see that continue. There will be a point at which you are going to see that the incremental add of a new team, which might cost $0.5 million would now be diluted by more growth from the overall business. And that is where you'll see more margins start to flow through.

But -- and so you see it in two sides. You are going to build a team today that we already have the business to get them up to speed. But it will take about 1.5 years before, probably six months to a year ago for that team itself was breaking even, and then beyond that it will leverage itself quite a bit. The costs you're going to see is it's going to feed from existing earnings to build those teams, but you are really building a wider base to support a wider base of business over time.

Okay, and then just to clarify on Josh's question about the competitive environment. The competitive environment for a greenfield client, is that still them doing in-house, them choosing one of the payroll guys? Or is that the main competition, or is there a new guy trying to replicate your model?

We have not seen anybody that has shown up in the market that has had any success in replicating our market. I think you see still continued flow, the traditional me too guys, be it ADP paychecks out there.

We tend to -- we do tend to scalp a lot of business from them, mainly because they own such a big market. And as we go in, we are providing a very different product offering, and so clients are moving towards us. That is one area. We are not losing business in the other direction, for the most part, to them.

Where you do see is there's some local regionals, the TriNet, who just bought SOI, who bought the Gevity. We are bumping up against them a little bit, but we see no real -- they are not affecting our ability to grow.

So, nobody has really shown up and saying we are going to replicate BBSI's model. I think it's a very hard model to build. If I had to started over and do it again I don't know if I could build it twice. I think it's a very hard model to build, I don't know that if I had to start it over and do it again, I don't know if I could build it twice. I don't know if I'd want to try. But for the most part, we are not seeing competitive pressures to that degree, no.

Okay, great. Thank you.

At this time this will conclude the question-and-answer session. I would like to turn the call back over to Mr. Elich for any closing comments.

Again, thanks for continuing to show up and visit and meet us on the call. It has been a great last 12 months. It has been a great last couple of years for me.

It is very rewarding to see a company come together, mature, come into its own. And as I continued to say, our best days are still ahead of us.

Looking forward to talking to you in October. Thank you.

Thank you very much. Ladies and gentlemen, that will conclude the conference for today. We do thank you for your participation. You may now disconnect your lines at this time.