Barrett Business Services Inc (BBSI) 2013 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, 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'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 remarks during today's conference call may include forward-looking statements. These statements, along with the 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 30, 2013, starting at 3.00 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. Sir, please go ahead

Thank you, Lily and depending on where you are dialing in from good morning or good afternoon, everyone.

As you saw at the close of the market yesterday, we issued a Press Release announcing our financial results for the third quarter ended September 30, 2013. During the third quarter gross revenues grew by more than 30% for the seventh consecutive quarter and were the highest in the Company's history by nearly $90 million.

We continue to mature BBSI's brand in the marketplace complimented by our strong referral channels helping to drive new business, as well as healthy organic growth from our existing client base. Our three-tier partnership platform and operational focus also continues to drive our industry-leading 90% plus retention rate. While we are pleased with the quarter's strong results, it is important to note that we continue to reinvest in our Company to ultimately support a much larger and more mature 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 relationship to gross revenues because we believe such information is, one, more formative as to the level of our business activity, two, more useful 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 third quarter's results, total gross revenues increased 37% to $764.1 million over the third quarter of 2012. California, which comprised approximately 88% of our overall third quarter gross revenues, increased 38% due to continued growth in our PEO business and to increased organic growth from existing customers.

Overall, PEO gross revenues increased 38% to $722.4 million, over the third 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 third quarter of 2012, which follows a similar trend we've experienced over the last seven quarters.

Additionally during the third quarter we experienced double-digit growth in PEO revenues in all of our geographic regions. Our PEO revenues from existing customers increased approximately 13% year-over-year due to increases in both headcount and hours worked. This compares to a 12% increase experienced during the second quarter of 2013 and a 4% year-over-year increase in the third quarter of 2012.

Staffing revenues for the third quarter of 2013 increased 15% to $41.7 million, primarily due to an increase in new business, as staffing business from existing customers was only slightly up. On a percentage basis, gross margin for the third quarter was 4% as compared to 3.9% for the third quarter of 2012.

The key components of the third quarter's gross margin are as follows. Direct payroll cost as a percentage of gross revenues in the third quarter decreased 20 basis points to 84.2%, compared to 84.4% in the same quarter last year, due to increases in the overall client mark up percentages as a result of price increases experienced primarily during the last 18 months.

Workers compensation expense as a percentage of gross revenues was 4.2%, which represents a 10-basis point increase over the same quarter a year ago, primarily due to an increase in provision for estimated workers comp claim cost and to higher referral commissions.

Looking ahead to the fourth quarter of 2013 we anticipate the level of gross revenues for workers comp expense to continue in the 4.2% to 4.3% range. Payroll taxes and benefits as a percentage of gross revenues for the third quarter were 7.6%, compared to 7.7% of gross revenues in the 2012 quarter, as the effective payroll tax rates were slightly lower for the third quarter of 2013.

SG&A expenses increased 32% to $16.8 million compared to $12.7 million in the third quarter of 2012 primarily due to higher branch incentive pay based on increased branch performance, increases in Management payroll and other variable expense components within SG&A to support our continued business growth.

The provisions for income taxes in the third quarter was $4 million, which represented a tax rate of approximately 30.6%. We expect such a rate to continue for the fourth quarter of 2013. The tax rates for the third quarter came in more favorable in comparison with the first two orders of 2013, primarily due to higher employment tax credits earned by the Company than originally projected.

For the third quarter of 2013, net income increased 55% to $9 million compared to net income of $5.8 million in the same period last year. Diluted earnings per share in the third quarter of 2013 increased 49% to $1.21, compared to $0.81 per diluted share in the year ago quarter.

Now, turning to the balance sheet at September 30, 2013, as you may recall during the second quarter of 2013 we posted $63.9 million in restricted certificates of deposit 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. As a result of posting the $63.9 million in restricted certificates of deposit, as of September 30, 2013, our cash, cash equivalents and marketable securities totaled $48 million compared to $72.4 million at December 31, 2012.

We are currently in the process of replacing the $63.9 million letter of credit with surety bonds which once in place will significantly reduce the amount of the restricted certificates of deposit required as collateral. We expect this replacement to be completed during the 2013 fourth quarter. Of the $48 million of cash, cash equivalents and marketable securities at September 30, 2013, approximately $17 million is unencumbered or said another way, not part of our captive insurance subsidiary. At September 30, 2013 we had no outstanding borrowings on our Revolving Credit Facility. Our expectation is that we will remain out of the line for the rest of 2013, as cash will continue to build from operations.

We generated approximately $47.2 million in operating cash flow during the first nine months of 2013. Much of our cash generated from operations is in the form of free cash flow except for the building worker's 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 pay 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 fourth quarter of 2013, we are expecting gross revenues to grow at least 30% to a range between $780 million and $790 million, compared to $596.7 million in the fourth quarter of 2012. The projected increase of 2013 fourth quarter gross revenues was based upon our recent revenue trends.

We expect diluted income per common share to increase at least 43% to a range between a buck 15 and a buck 20, compared to $0.80 in the fourth quarter of 2012. We continue to be very enthusiastic about the momentum in our financial results, over the first nine months of the year and I look forward to addressing you again on our fourth quarter earnings call.

Now, I would like to turn the call over to the 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 2013. Mike?

Good morning.

And, I wanted to just say I appreciate your continued taking time and joining us on the call. And also, your continued efforts to understand what we are about and what we're trying to accomplish. Very pleased with another successful quarter. We continue to see build in our -- in both increases in existing clients and build and also our clients adding customers. Overall, very pleased with how we are running as a Company and how we continue to build and mature for the future.

In the quarter we added 167 new clients. We lost 47 clients, three due to Accounts Receivable, 14 were canceled for non-Accounts Receivable risk or tier development related issues. 15 businesses sold, seven left on their own due to pricing, two took payroll in-house, three left to work with a competitor and three for other reasons.

We see this new net of a 120 new clients in the quarter as a strong -- is very strong and key to continue build on our base of clients as we continue to maintain a 95% plus retention rate, while at the same time expanding margin. We continue to see strength within our existing clients base with increases in hiring and hours worked. 43% of our clients added headcount in the quarter, 30% reduced headcount and 20% -- 27% were unchanged.

We did see 50% of our clients increase hours worked while 48% of our clients reduced hours worked within same store sales. In comparison to second quarter, we saw 50% of our clients increase hours worked versus 57% in the second quarter.

We did see some chop in our September data as there may have been a slight pullback due to uncertainty related to budget issues and debt ceiling issues with the federal government. But, we think -- but things seem to have leveled off in the last couple of weeks and we -- everything seems to be back on track.

Overall, we continue to see strong momentum across all regions. And in the fourth quarter, we -- excuse me, in the quarter, all regions saw growth rates anywhere from 22% up in the Northwest, to 41% in Southern California. We continue to see strong diversification in the type of business we are bringing on, which remains primarily blue and gray color mix. We continue to see larger clients prospects coming into the pipeline, but at this point, we still have no client that is larger than 1% of our total business and are not seeing a shift in client mix.

Our primary obstacle to growth has been maintaining of capacity while we build out in front of demand. We continue to make significant progress in the areas, in this area this year, but will continue to invest in infrastructure to support the integrity of our product.

With that said our pipelines remain very strong as our brand continues to mature in check within local markets while we maintain a large, a strong, 95% plus retention rate with our existing clients while expanding, while experiencing no measurable headwinds from a competitive landscape.

We continue to make progress in maturing management systems to recognize outliers within our clients so we can focus resources more proactively. As we also continue to mature our branch within branch structure or business unit structures as they support clients. We, to date, we have 30 business units or branch within branches. In the quarter, we added five new business unit teams and -- and have five new business teams currently in development. Forecasted in the next 12 months, we have an additional 20 business unit teams on the books at least at this moment.

We completed our conversion of our HRP data platform payroll system in the quarter. This is a big step. This, as this process started in early February, but has been in the works for the past two years. The new data system provides for additional scalability and operational systems, more client flexibility, a more robust platform for data structure and expanded interface capabilities to support client data access over time. We have begun our move into Phase II of the process, which will begin to offer areas of increased efficiency and expand the use of our systems capabilities.

In the quarter we also continue to build on areas that mature our overall brand by bringing alignment of our organizational culture with the development of our product as we grow and add headcount. We continue to be -- this continues to be a key focus, as we continue to invest resources back into the organizational alignment and development while growing at 30% plus.

Overall we continue to maintain a strong pipeline with new business, while retaining a healthy client base. We continue to see the quality of our client base maturing while actively vetting those clients that do not make sense for the Company or may compromise the integrity of our business offering. We continue -- we remain ahead of plan in aligning the organization to support our growth curve and we'll continue to make necessary investment into infrastructure to stay out in front of our growth curve.

As we continue to make significant progress addressing the issues related to California's Senate Bill 863, we are to a point of narrowing our original three options to two options and expect to have a solution in the next couple of months related to the issue, and also will begin to implement our new solution at the start of 2014.

Of the options we have mentioned previously, ranging from licensing our wholly-owned subsidiary insurance Company in California, to working with existing licensed carriers, we feel these options when combined will position us to remain relatively cost neutral to the current model other than some allocated capital on our balance sheet for collateral.

The key steps to this point are to finalize decisions pertaining to our best option for the Company overall and long-term, long-term financially and for long-term stability while implementing the platform without market disruption. Given that the new law, the changes our status of self-health insurance does not take effect until 1/1/15. We are well out in front of the challenge, the change, excuse me.

Lastly, as always we continue to look internally to infrastructure to support growth, while again gaining efficiency in branch operations and within corporate support functions. All efforts continue to focus towards strengthening and maturing the organizational product offering.

With that we'll open it to questions.

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

(Operator Instructions)

Jeff Martin, Roth Capital Partners. Please go ahead.

Good morning, Mike. Good morning, Jim.

Good morning, Jeff

Good morning.

Nice to see another good quarter. I'm not one who likes to congratulate on an earnings call, but congratulations

Thank you

Mike, could you touch on the client pipeline if you're seeing any changes favorably or unfavorably? In terms of leads, in terms of future opportunity? If you think that -- it looks like the net client adds were down a little bit year over year, which breaks the year-over-year positive trend going back quite a ways.

Just was curious if you think that is tied to budget uncertainty, government shutdown, people kind of taking their foot off the accelerator a little bit on a temporary basis? That would be helpful.

Our pipelines and in fact it's always hard to tell how the psychology of the market's changing relative to different things -- the government shutdown, sequester, debt ceiling and everything. But we did see a little bit of a pullback in September or if nothing else, just maybe the foot come off the accelerator a tiny bit. But we did see a regain of momentum in October.

It could've just been the way the weeks fall actually. Or it could be just how the weather was in August that we just didn't get quite as much done. But for the most part we're not seen a change in our pipeline, if anything our overall pipeline and our client add is becoming more broad-based.

If you go back probably two years ago we were probably getting 80% of our new client adds, or 90% of our new client adds from 10% of our branch operations. Today, it's probably 80% of our clients adds are coming from 50% of our branch operations.

So, I would probably say that, given that the market and the product continues to get tighter and cleaner. And we continue to do things that mature how we're bringing clients in, which means that the sales cycle need even be a little longer now because we're slowing the process to the point that it reduces the frictional cost of operations once we add them.

All those things could be a little bit of a transitional point for us. But for the most part we're not seen any change in the overall pipeline. In fact, if anything, it's the strongest it's ever been.

And then, you mentioned about the growth in the Business units, pretty significant increases. That was 5 add in the quarter, 5 in development and then an additional 20 so, a combined 30 or is that a combined 20 over the next 12 months?

I would say probably -- again you have work in process and then you have projections so, they kind of blend over. But, I would say probably another 25 in the next 12 months.

The one thing that you have to be careful of is, where we have business units structured, say in San Diego, say Orange County, a lot of Southern California branches. We already have established business units. So, part of where the new business units are coming from is going to be the restructure of an existing business or existing branches as they move from branches that have pods to full-fledged business units.

So we'll added maybe one person or two people in a branch say like we'll just take Sacramento, where we'll add one person to a team that's already there that will now formalize it into a business unit. So you have some of that going on and then you also have, in the queue, for our more mature business unit, our branches are actually building full teams which is a four-person team.

So you have a combination of the two and that's why seems like there is a lot of add. But realistically, there is probably out of the 25 maybe 15 of those are going to be a transition of how that overall branch runs at a local market from being a single branch, two bit branches within branches. And then you have of the other 10 that may be remaining is going to be building additional capacity within our larger branches.

Okay. And then, could you touch on the growth rate of the business? I mean obviously you can't grow 37% a quarter year-over-year forever. How would you like people to think about the growth rate?

It obviously should normalize at some point. But it seems like we've got at least a couple more quarters where you're going to see 30% growth. Just wanted to give you an opportunity to kind of frame in people's minds what kind of growth outlook to expect.

When we look at it internally, one of the things that we've had to do is back up a little bit. One of the ways that we've always looked at growth and tried to forecast growth was to look at our current run rate by day and then look at that extrapolated as it builds throughout each month into a quarter, which gives us our guide.

What we found is though is, is that we are getting more choppiness in that. Ad it makes it very difficult to look out a year, two years, three years and try to gauge where will that existing growth or additional growth come from. So, one of the things that we've actually done in the quarter, and this is still we're still learning and experimenting a little but with this methodology, but, is to break it into two buckets.

If you take your first bucket and you look at our existing base of clients and assume that you're not going to have any kind of run off of that base, that it'll be relatively stable and you say that you can get maybe a 10% same-store sales from that base. So if you look at where we're kind of running up to in the year, of about $2.8 billion, 10% in the future year would be another -- we'll just roughly make we'll round it up a little bit to $300 million. And if you put that up against the $2.8 billion a gives you at least a portion of the growth that you'll expect next year from same store sales.

Then, what you do is the second base is you look at your client build. And if you assume that your clients are coming in at a certain size, then you look at how many clients you're adding and then you'd layer that up against your existing base. And you say, all right, that's going to take me up by X.

What we've found by doing that is if we look at 10% same-store sales and we look at a build say in the next year of even 500 to 600 new clients net, which we're out in front of that number. And each client came in at another basically $1 million in run. Now it depends on timing of how much revenue you actually recognize in that year, but that's a one way to extrapolate forward is the growth rate that we're seeing sustainable. And one of those things as we did the math and we keep running it out, the real driver is how wide our base is right now and the impact of same store sales.

In the quarter I think we saw 13% same-store sales growth. So even at 10% your somewhat modest. And so if you take 10% plus a pretty nominal or modest build of existing clients net building of existing clients the 30% is actually fairly manageable going out. And as we've looked at capacity utilization in our business units and our teams and how we're maturing the organization and efficiencies of systems and then the minimal real market penetration we have, I don't know when it will start to normalize.

I know that we're trying -- we're running the Company today to that 30% to 35% range. And we'll continue to do that until we run up against something that says that we can't do it. But, right now, I'm probably as optimistic as I've ever been about our ability to continue to run the Company as we have been.

Okay. Let me jump out of queue and I'll come back. I've got a couple more questions.

(Operator Instructions)

Josh Vogel, Sidoti & Company. Please go ahead.

Thank you. Good morning, Mike and Jim

Good morning, Josh

Good morning.

I had a question about margins. I know staffing business is higher margins and is starting to pick up, but based on the business mix today and the weighting of the PEO work, can you talk about what are the primary levers to remain focused on that will move margins higher?

And also, maybe you could talk to where do you see peak margins getting to this cycle? I know you're at 2% plus operating margin off the gross revenue and the staffing business was like 15% to 20% of revenue. So where do you see peak margins getting to this cycle?

You know we're running up again such a large base it's going to be hard to move it a whole lot further. Where you will see a flow-through is going to be on your net operating margin, which is going to be a product of capacity up against operating overheads over time.

We started increasing pricing back in early 2012. We basically made a full turn and we'll finish a full turn of that. And we continue to price at a higher basis right now than we have been over the last couple of years. So we will continue to see some incremental increase of overall gross margin. But operating margin is where you'll see more flow-through as we continue to, one, mature our business units and ultimately refine some of the technology that allows us to be more effective and more efficient internally.

Right now, growing at 30% we're probably operating at maybe a 50% to 60% utilization of capacity within the organization. As we either normalize or find more efficient ways to do what we do, we'll then start to increase the amount of capacity we can use with the existing operations. But those are going to be the drivers.

It's hard to say right now if you were to model a maybe an expansion of from an operating basis maybe 10 bps a year even, it starts to lever the business pretty well.

But, it's hard -- we're still maturing as an organization. We've grown up a lot in the last three years. We have a key individual in organization that says we've been around a long time, but at the same time we're kind of a new company over the last three to five years. And as we're growing into our model, one of the things that I worry about is that we'll stress it too hard to get to our long-term targets too quick

Okay that's helpful, thank you.

Looking geographically, do you see any markets out there that have a similar profile or fit to California, where you see potential big opportunities? And, would it be easier for you to build out or make an acquisition? And if it is the latter can you maybe talk about the acquisition pipeline?

We continue to see acquisitions probably two, three a month. And I still -- we're such a culturally based organization, to acquire somebody and bring them into the fold would be in a lot of ways a complete rework.

So, I'm not going to say that we wouldn't look at a small tuck-in at some point in a small market where we knew that we could commit resources to get that operation to where it needed to be to be able to work within our infrastructure. But I still think that the best mode of growth for us is going to be organic build as our clients and referral networks continue to expand and drag us to new markets.

Interesting enough, we're starting to see an uptick in the Mountain states. The Mountain states overall were up 32% in the quarter. We've seen a significant growth on the East Coast. The East Coast was up 36% almost 37% year over year in the quarter. And those markets show us that we can grow and penetrate and be everything we are in California in other markets.

Interesting enough as well, one of our fastest growing markets is in Idaho Falls. And I predict that it will probably be the first branch, I shouldn't tell him that because he'll just kind of beat his chest a little bit, he's a good guy, but he's going -- that branch itself will probably be the first operation outside of California that will hit $100 million. And there's no economic benefit to doing business with us in Idaho Falls other than we have to deliver a great product.

Okay.

And switching over, you had some comments about the client pipeline and you were talking about larger client or larger potential clients entering the pipeline. I was wondering if you could just talk about the dialogue you're having with these larger clients? Are they doing this work in-house, or are they doing it with an ADP or Paychecks? Your dialogue with them, why would they come to you? Do you maybe have to concede pricing? Could you just talk to that?

As clients get bigger you'll always find economies of scale, and it's all going to depend on where they're trying to take their organization. As we continue to mature our product and our model, it's less and less about what we do and more and more about the results we can offer.

If you think of a small business owner that started with an idea and they grew and whether they were good or they're lucky they reached a certain point in their business for the reached an inflection point of either efficiencies or disruption in their business as a result of being an employer. They've got to solve those problems.

And, as much as you would like to say at 20 to 30 employees if you reached that inflection point and you cleaned up everything and the business started running cleaner because you figured certain things out, once you grow and take the next turn of the wheel you're probably going to have to reinvent yourself again at 50 to 70 employees. And then if you make it through that you're going to get to 200 employees and you're going to have to reinvent yourself there. And that's a continuous cycle.

So we enter the equation at any point along that continuum. And it really comes down to what that business owner and what that organization considers important within with what they're trying to accomplish and what they're experiencing. And where we find that we can build value through an open dialogue. What we do find is with bigger clients that we may be talking to them for a longer period of time. They are typically going to be using some kind of payroll company, be it an ADP, be it Paychecks be it -- but that's all they're getting. They're just getting payroll.

And what they're doing from an HR standpoint is maybe being outrun because what really needs to happen is it needs the overall organizational structure has to be built more around not an HR platform but more of a management platform that helps supervisors and Management more effectively allocate resources as they're running the organization.

So, the evolution of our model and the evolution of business are both come together and that we're dialoguing with our clients today about how we look to their future. And how we begin to come in and solve problems for them that allow them to either scale their organization, bring stability to their organization, or if nothing else, just give the owner a day off.

Okay, that's really helpful, thank you. And just lastly I missed what you said, how many total branches did you end the quarter with?

We have 51 branches and then we have 31 operating business units, which are the branches within branch. We have five in development at the moment and we're -- let me go back to my notes -- and we're -- we're looking at probably adding another 20 next year. 20 to 25. It's just more cycle time because it's all work in progress

Right, okay that's all I have right now. Thanks a lot for taking my question's.

Thank you.

Jeff Martin, Roth Capital Partners. Please go ahead.

Thanks. Mike, could you touch on the workers comp environment right now? Have you seen any changes in severity rates, incident rates? That's part one of the question and then I've got another part to it?

Actually, knock on wood, and this is something that you try never to expand too much on because you might jinx yourself, but we have a seen on a relative basis of probably a 7% to 8% decrease in frequency year over year. Relative to the growth and everything we have.

And from a severity rate, we've not really seen any kind of uptick over time as we've gotten better, if anything, we're getting further and further out in front about. The work that we're doing within our clients has a higher percentage of our clients having no claims. And we're really focusing hard on anybody that's having more than two claims in a year. We know that if we knocked that out and we continue to work with those customers and or vet them out, that have more then one or two or three claims a year, then we'll continue to make progress in the area where we have the most pain.

Related to some of the SB 863 legislation, we are seeing where and we are at least were told and projected to see where in balance we'll probably be a little better off based on the nature of the type of claims we have over time. Which just leaves to us to have more stability in our model, as much as anything.

So I would say in the last year we have made as much or more progress in the area of workers comp that we maybe had in the previous 25 years that we've been doing what we've been doing.

And then do you -- I mean, do you think that SB 863 put some of your competitors at a competitive disadvantage because perhaps they're not as well capitalized? And do you see it perhaps being a net opportunity?

You know, I hate to leave the little secret out, but the reality of most of our competitors are built around a sales driven culture. The reality if you're going to be in a risk mitigation business, you better have an operational bench, you better have the temperament to be able to do -- to make hard decisions. Which is what it takes to do -- to run an operations based organization and deliver the product and have the infrastructure that we have.

I think the competitive disadvantage to our competitors is that we're a long ways out in front of them. And we have a lot of visibility and they may be trying to catch up with what we're doing. But you can't sell your way to prosperity. And we have a lot of years of doing what we do and continuing to be -- getting -- becoming deeper and deeper entrenched with the market and our customers and maturing our base.

And capital, you could probably come up with somebody that would throw up enough dollars to be able to make it work. But there's a secret sauce kind of underlying everything that would be very difficult to replicate. I don't know that I could replicate it again.

Good thing is you don't have to try.

One other thing on workers comp. I know a couple years ago, might be going back three years, you were having some challenges that were more state legislative driven headwinds in terms of closing out claims costs. Has that abated? Is it unchanged? And if so, what do you think has driven it?

You know I think that there were -- there were issues related to the state and legislation that I think that the SB 863 law change begins to address. Because it does start to interrupt the cycle of the plaintiff's attorneys have in being able to keep and prolong claims and keep and get claims at least in a little bit tighter box. We'll see how they deed it up over time.

I would also say, though, is that we've learned over time is that we needed to be better. And as we work on areas of how we approach claims from day one to how systemically we are aligned from the client -- from the supervisor to the client to the branch to our CPAs and back into the system. All make a difference. So, I don't know that there's any one area that makes it better but I think you move all 10 areas and everything gets a little bit better.

But, I do think the SB 863 impact will at least temporarily -- that's the one thing about California and most areas, that you'll make some progress and then it's just a matter of how much they let the plaintiff's attorneys come in and punch holes in the product. Because the thing is, is that it's not to the betterment of the worker. It's -- the challenge is, is that the worker is not better off when the plaintiff's attorneys come in and beat up the system.

But they're doing it for their own good they're not doing it for the good of the worker or the workforce. And that becomes a major issue.

The challenge over time and this is a bigger challenge to insurance in general across the country, is that as you look at where California has gone in the past and you look at other states, other states aren't moving towards making themselves better relative to what California is doing. They're actually making themselves more like California. And that's where you continue to see laws go more the direction of California.

So, I don't think this is -- this is going to be an issue that's going to be long-lived I think until -- well I don't know how it ever really gets resolved. I think you just have to make sure that you don't make yourself part of the biggest issue.

The short answer would be it really hasn't changed much in terms of ability to close them out in shorter duration, but you're optimistic that it will improve?

Correct

Okay. And then, could you maybe this is a question for Jim. On the surety bond I assume there'll be some interest expense tied to that. Could you give some -- a range or some guidance in terms of what the interest expense will be to that annualized? Once it's in place.

Actually there's -- the difference between going with the surety bonds and the existing letter of credit is very minor. I think it's maybe on an annual basis maybe 20 basis points. And so it's very insignificant. But, we'll free up those dollars to be used perhaps in association with where we take our 863 solution. So, it gives us much more flexibility.

Okay. So basically 20 basis points on about $67 million?

Yes.

Okay and then, Mike, just wanted -- I didn't catch the percentage of clients that increased hours. Was it 30%?

50%.

50%. Okay.

50% increased hours. The trend had been up in the 55% to 60% range. We see some seasonality usually hit in October I think it maybe get a little bit earlier. Whether it's weather, whether it was just companies pulling back. Maybe projects that were getting pulled off or not moving forward because of shutdown.

It's -- it's hard to really put a finger on it. Originally if you look too you went back to the original Obamacare impact to businesses was scheduled to take effect October 1. And then there was a reprieve. I think a lot of companies still were on track to execute the plan that they had in place but, it's hard -- 50%.

Got it, okay. Great. Thanks, guys.

Thank you.

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 the closing remarks. Please go ahead.

Again, I appreciate everybody that continues to follow the story to take time to understand what it is we're trying to do. I always say this isn't a model that you can be taught. It's one that you have to learn by sticking with it and understanding it over time. And as you do, there's a lot of good things going on.

So, appreciate everybody being on the call. Look forward to speaking with you again in February. Thank you.

Ladies and gentlemen, this concludes the BBSI's third-quarter 2013 earnings conference call. Thank you for your participation.