Barrett Business Services Inc (BBSI) 2016 Q3 法說會逐字稿

Good day everyone and thank you for participating in today's conference call to discuss BBSI's financial results for the third quarter ended September 30, 2016. Joining us today are BBSI's President and CEO, Mr. Michael Elich and Company CFO, Mr. Gary Kramer.

Following their remarks we will open up the call for questions. Before we go further, I would like to take a moment and read the Company's Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements.

The Company's remarks during today's conference call may include forward-looking statements. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by these forward-looking statements. Please refer to the Company's recent earnings release and to the Company's quarterly and annual reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ.

I would like to remind everyone that this call will be available for replay through December 9, 2016, 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. As a reminder, today's conference is being recorded. Now I would like to turn the conference over to the Chief Financial Officer of BBSI, Mr. Gary Kramer. Please go ahead, sir.

Thank you, Denise. The operations of the Company were strong in the third quarter, and we believe the results represent a solid foundation on which to build. Net revenues of $225.1 million increased 13% from Q3 2015. Gross revenues of $1.2 billion grew 17% over the same period.

Diluted earnings per share were $1.38 compared to $1.49 in Q3 2015. The Q3 2016 results included nonrecurring expenses of $0.16 per share for accounting and legal costs associated with financial restatement, outside investigation, and legal proceedings and $0.30 per share for the shareholder litigation settlement.

Also in the quarter EEO gross revenue increased 17% to $1.2 billion compared to the third quarter last year. Contributing to this growth were 200 net new PEO client additions and same-customer sales growth of 9.1%. These results were attributable to growth in the economy and ongoing efforts to develop our referral relationships as well as the ability of our teams to remain focused on delivering value to our clients.

Staffing revenue in the third quarter increased 3% to $47.9 million, compared to Q3 2015. This is the first quarter in the last five where we've experienced a year-over-year increase in staffing sales. We've tempered growth in this business due to a continued labor shortage and chose not to pursue client relationships that do not align with our own values. We believe this decision was sound, and we now believe that these levels will be our new base.

Gross margin in the third quarter was $49.6 million, or 22% of total net revenue, compared to $42.9 million, or 21.6% in the prior-year quarter. Gross margin as a percentage of gross revenue in Q3 2016 was 402 basis points, compared to 406 basis points in the year-ago quarter.

An increase in payroll and workers compensation expense as a percentage of gross revenues were slightly offset by an improvement in payroll taxes as a percentage of gross revenue. This improvement in payroll taxes was due to a $3.8 million federal unemployment tax credit recognized in the third quarter of 2016. This included $2.9 million for tax years 2013, 2014, and 2015 which is nonrecurring.

We continued to see a decline relative -- we continue to see a decline in relative frequency of worker's compensation claims. Our total open claims at Q3 2016 grew 9% from open claims at Q3 2015, while gross revenue grew 17% for the same period.

In the quarter we saw trailing 12-month relative frequency of claims as a percentage of payroll decrease 14% compared to the third quarter of 2015, and a decrease of 18% compared to the third quarter of 2014. This is a continued result of the way our branches manage their client retention and acquisition.

Claims from 2012 and prior continue to show positive trending which leads us to believe that our efforts at strengthening have had the intended effect. The significance of the 2012 and older claims is that they are now well seasoned and having been fully strengthened provide us with a solid basis for analyzing a development of claim years 2013, 2014, and 2015. We have two actuarial loss periods under the new normal, which is important as our outside actuary has a credible baseline to start future projections from.

SG&A in the third quarter was $30.4 million, or 13.5% of total net revenues, compared to $25.4 million, or 12.8% in the prior-year quarter. The increase as a percentage of revenue was primarily due to nonrecurring expenses of $1.7 million related to accounting and legal costs associated with financial restatement, outside investigations, and legal proceedings related to security law issues.

We are increasing our 2016 estimate for accounting and legal costs associated with financial restatement, change in auditor, outside investigation, and legal proceedings related to security law issues from $6.4 million to $8.2 million. This amount does not include the $3.3 million shareholder litigation settlement. Our effective tax rate from Q3 2016 was 31.9%, down from 33.5% in Q3 2015 due to lower taxable income as a result of the nonrecurring expenses and the shareholder litigation settlement.

During the third quarter we paid off the remaining $7.5 million on the Wells Fargo note a quarter earlier than required. And we had no borrowing under our line of credit with Wells Fargo as of September 30, 2016. The only remaining debt we have is the $4.7 million mortgage on the Vancouver, Washington headquarters.

At September 30, 2016, we had cash, cash equivalents, investments, and restricted securities totaling $325.6 million compared to $296.7 million at June 30, 2016. As part of our fronted workers compensation insurance program with Chubb, formerly the ACE Group, we established and funded a trust called the Chubb Trust. On the balance sheet the Chubb Trust is included in restricted cash investment. The balance in the Chubb Trust was $235.2 million at September 30, 2016, and $232.9 million at June 30, 2016. The September 30 Chubb Trust balance does not reflect an additional $13.2 million that was in transit and paid to Chubb on September 29, but was not deposited into the trust account until October.

On the balance sheet this in-transit amount is included in other assets. The Chubb fronting program has matured and is more predictable and consistent, and as such we will see our net funding levels decrease going forward. This in turn will increase our unrestricted cash position over time.

On October 27 we announced the agreement to settle a lawsuit filed as a class action on behalf of shareholders in November 2014. The settlement, subject to approval by the US District Court for the Western District of Washington, calls for the payment of $12 million, with approximately $8.7 million to be paid by BBSI's insurance carrier and $3.3 million paid by BBSI. The $3.3 million litigation settlement was recognized in the third quarter of 2016 in other expense. This settlement avoids the cost and distraction associated with prolonged litigation and it allows us to focus on our core business and growing our organization.

On September 20, 2016, we appointed Deloitte and Touche as our new principal independent registered public accounting firm. We have also retained another big four public accounting firm to assist with assessing and enhancing our financial control environment.

On October 11 Tom Cusick was appointed to the Board of Directors and as a member of the Audit and Compliance Committee. The Board of Directors is continuing research for an additional individual to add in the ensuing months. These appointments and actions are all part of our short and long-term remediation plan that we are executing to and we are pleased with our progress so far.

As we introduced last year, in order to provide our investors with a more appropriate forward-looking view of our business we have initiated a rolling 12-month outlook for gross revenue which we plan to update on a quarterly basis. We continue to expect gross revenues for the next rolling 12-month period to increase approximately 18%. Due to the aforementioned $0.30 per share settlement charge and an increase in nonrecurring legal and accounting expenses, BBSI now expects 2016 diluted earnings share to be $3. Now I'd 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 as well as our outlook for the remainder of the year. Mike?

Good morning and thank you for taking time to be on the call. Before moving on to a discussion about the quarter, I would like to highlight a few areas of note. In recent months we spent time in the field getting perspective on the business and guiding the organization and looking for -- looking towards 2017.

Specifically we conducted operational reviews of all area managers in the Company, assessing the performance of each branch, and we conducted our annual all-meetings as a means to setting the tone for 2017, during which we spent a full day with each employee in the organization over the course of 14 days and five regions. As Gary mentioned, in addition to a new seat on the Board and engaging Deloitte, we continued to execute on our remediation plan while laying a solid foundation for the future.

Moving forward, in the third quarter of 2016 we saw progress through growth and maturing of our brand in all markets, the strength of our organizational bench and culture of BBSI as evidenced by progress we saw in our operational reviews and in our all-meetings, as well as consistency in tone and messaging across the organization and in the market. In the quarter we added 287 new PEO clients, we lost 87. Three were due to accounts receivable issues, 10 were due to lack of tier progression, three were canceled due to risk performance, 22 businesses sold or closed, and 49 businesses left due to pricing, competition, or companies that have moved away from an outsourcing model.

This represents approximately net build in the quarter of 200 net new clients that we also saw same-customer sales increase 9.1% in the quarter. Related to pipeline and regional growth, we continue to see consistent activity in pipeline and new client growth as a result of focused efforts on our referral channel.

As we focused attention on the drivers supporting growth and retention, we continue to see broader contribution to client growth from all regions as a result of these efforts. Related to structure and organizational build, we have made multiple additions to our accounting team -- accounting and finance team, including a new Controller and new Assistant Controller.

We continue to build business units as needed to support current and future organizational and market demand. We currently have 52 business units supporting about -- supported by 55 branches. We currently have five business units in development which will bring our total to 57 by the end of 2016. We now have 15 branches that have or will have reached the $100 million mark by the end of 2016, a measure we use to indicate a branch's ability to increase leverage and tipping point of our brand in these markets.

We have two branches slated to open in coming months on the east coast and in southern California, which will bring our total branch count to 57. Also we have restructured our IT organization to better align with the structure of our field organization, and culture and client lifecycle to support -- in support of our next leg of growth.

Related to systems, our philosophy is to focus on systems that first allow our teams to engage more effectively with their client, second, allowing our teams to collaborate with each other more efficiently. Because people, not systems, are a product, we emphasize systems that support operational leverage. Also Salesforce and 360 have been successfully adopted by the field. We can see the value these tools provide to our team. Both tools support collaboration and bring visibility to key drivers.

Related to worker's comp and underwriting of risk, we continue to make progress in bringing predictability to the Company's workers comp expense. Per our approach to running the Company and bringing business owners to better -- to run better companies, we're seeing systemic improvement related to cultural -- stronger cultural alignment with all disciplines during pipeline phases, which continues through the client relationship. Emphasis on continuous improvement and on root cause analysis as we interface with our client and focus on frequency as a controllable factor in claims expense.

Moving forward, we will continue to monitor trends to maintain a proactive position related to worker's comp. We expect this to continue to result in greater predictability within the model.

Looking at the remainder of 2016, over the past many months we've often talked to our internal teams about the need to run two companies; one that exists to support the efforts of small business and the other that exists to support the interest of shareholders.

Having spent the past two months in the field, I continue to be impressed by the maturity of the organization, the progress we are making, and the impact we are having on our clients' companies. I have confidence that we have continued to focus on the right things to build a good Company. Our leadership bench in the field is growing strength at an impressive rate, and it is the role of our executive team to continue pulling them forward.

On the public front, we continue to remove obstacles to include selling of the shareholder litigation, significant advancements with our Board composition and new auditor. Additionally, we were able to pay off Wells Fargo, our Wells Fargo note ahead of schedule.

As I look at the organization today, I can look forward with confidence that our efforts are beginning to have the intended effect. We have put resources into the organization we are building with the emphasis on bringing predictability to the model. We have operationalized our approach to developing our leadership bench and have roughly 18 months runway.

We have brought a consistent approach to channel development resulting in predictable pipelines and new client build, and we have focused on systemic reduction of risk in our client business resulting in continued decrease in relative frequency and an increase in predictability. As an organization we seek to help small businesses navigate plateaus and inflection points within their growth.

We have learned from our client experience and our own, and we speak to share the lessons we have learned. Looking today, we are executing on a plan and we plan -- and we have made critical steps towards mitigating -- migrating plateaus and our own plateau in our own business as we grow. With that, I will turn it over to questions.

(Operator Instructions)

Jeff Martin, ROTH Capital Partners.

Thank you, good morning. Mike, could you talk about, or Gary perhaps might have more granularity on the detail, but same-store sales growth 9.1%. How does that break down between headcount, hours worked, wages, and then just general pricing?

I would probably say on the general pricing front it's pretty flat. I wouldn't probably attribute it much to inflation there. Probably if you were to look at hours worked and headcount added, it's hard to really get to that granular detail, but we would suspect looking at the data that headcount has been a little bit flat in the quarter, but hours worked seem to have increased throughout the quarter.

Could be an indication that small businesses weren't taking the risk during the quarter to hire, and against a tighter labor market as well chose to increase hours worked more than add headcount. And then we didn't really see a lot of movement on a year-over-year basis as far as increased, or wage inflation. Maybe some so far, but I would say probably two-thirds was probably due to the hours worked and headcount added and then maybe a third group related to wage inflation throughout the year.

Okay. Bigger, broader question on Affordable Care Act, if that were repealed over the coming years how do you see that affecting the business?

My view of that is for our business we have never attached ourselves to healthcare as a value stream. We do continue to build systems that help in the collection and remittance of information and data to support the rules of affordable care, and I think that's a value we bring to clients today but wouldn't be missed if it was not needed.

I would say that for many small businesses if they have incorporated the cost of health benefits today that it would probably be pretty disruptive for them to discontinue providing health benefits. So that might already be in their DNA.

What it could do for small businesses if the market were to change too much, it may be adverse in pricing because you wouldn't have as big of an aggregated pool. But for our model in particular the effect would be more neutral. I think it would be any disruption that might come to small business, but if anything it would be taking pressure off where they are living.

Right, okay. And then to shift over to worker's comp, in California what are the pricing trends you are seeing on a market basis, not necessarily specific to Barrett, but on a market basis?

What we're not really -- we've got a good stake in the ground. The market is softening a little bit, and we are just making a choice not to chase business, but we believe that our offset and our value set is bridging any gap where we might see a softening market related to worker's comp. But the trend of rates is probably more neutral to down.

Okay. In terms of the reserve accruals, any shift in any contribution positively back into gross profit in the quarter from a worker's comp adjustment?

Jeff, for the quarter in the same quarter last year we had a prior-period credit of $2.7 million. In this quarter we had $1 million credit. So $1 million in the quarter for change in estimate for prior period.

Okay. And then as we look at worker's compensation expense as a percentage of gross revenue it's about 5.1% in the quarter, is that a level we should model going forward, or is that going to come down a little bit over time?

Around 5% is the good number. It's going to ebb and flow a little bit, but 5% is a good number. This quarter compared to last quarter was you had a reduction in what I will say for prior period decreases, which is affecting it. And we also had a minor uptick for the way that we're handling the MCC versus prior. You had a little bit of not as much of a change in ultimate and a little bit of an uptick, but around 5% is where up or down a little bit is where we see it.

Thank you for taking my question.

Kevin Casey, Casey Capital.

A couple of questions. One, next year if you add up your nonrecurring plus your guidance you get about $4.06. I was curious if some of those costs are actually recurring, like the Controller, your Assistant Controller. I think you beefed up some more of the finance. Or is that the base to use going forward?

We don't know -- we don't have control on some of the outside investigations as far as the SEC. That's going to take what it takes and the costs are going to be what they are. We are just complying. The one increase that we know about that we will have is the change in auditor in the first quarter.

As far as the fourth-quarter expenses that start for the K review which will trickle into the first quarter, we know that will be up a little bit on a year over year, but the expenses will not be up significantly. We try to keep that at a region or a range that is in line lower than our gross rev growth.

I would also say that we're, even from an SG&A, we have had a lot of build over the last several years and we are continuing to build staff in front of growth that we may see enough normalization there that might offset a few of those costs. So I think $4 is probably -- wouldn't be a bad basis to work from.

And then could you talk about ballpark percent of net income that cash flow is? You mentioned that it's going to tick up; I was wondering does it start next year or do we have to wait another year? Can you talk about that?

Were going to see a growth in our unrestricted, which is going to be attributable to, A, higher net income and then, B, call it the stabilization of the funding with the Chubb program. So we will get an uptick for unrestricted for all of those plus also we don't have the debt payments going forward. So cash flows are looking promising.

And then do you have the frequency trailing 12 months as opposed to just for the quarter so we can get more of a feel for the trend on worker's comp?

I will have to get that back to you. I have it for the quarter and for the quarter over quarter, but not just for the year.

I think trailing 12, and I'm not going off what I have in front of me, but I think trailing 12 is down 5% or 7%

It is down 14% over 2015 and 17.5% over 2014 on a year-over-year basis.

Okay. I think that is everything. Thanks, congratulations on paying all of your debt down.

Thank you.

(Operator Instructions)

Bill Dezellem, Tieton Capital Management.

Thank you. I wanted to follow up on that baseline point of roughly $4 this year. And if your revenue guidance is roughly 18% growth, if we add 18% to the $4 that takes us up around the $4.70-plus mark. Are we thinking about that correctly, or is there some big piece of the puzzle that we're missing?

No, in a linear model without any other surprises as we have had to deal with this past year we would expect that would be a fair way to look at it.

Mike, I think you have had a lifetime of surprises, so what's a few more? (laughter)

I would concur.

Next thought, thanks for your help there. Next thought is relative to the staffing business, I think in the opening remarks you did reference that business, it seems to have stabilized.

But it actually was up about $10 million, if I remember right sequentially which is much better than a stabilization. Would you talk about what you are actually seeing there in a little bit more detail, please, and how we should be thinking about that business?

So if you look at the year-over-year base, probably use that as your better comp. So it was up 3% in the quarter. The problem sequentially is that you have a lot of seasonality in the third quarter, and when that pops a little bit that might distort a little bit of where that trend might be.

So I would probably use, if you were comparing on a year-over-year basis and you wanted to look forward, 3% growth over where we have been seemed to be reasonable. If you were to take that out next quarter and even into next year it might increase from there some. I think that's a better way to look at it rather than sequentially.

That is helpful, thank you very much.

At this time, this concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Michael Elich.

Thank you for taking time to be on the call. We will continue to be available and keep you informed as we keep moving the Company forward. Looking forward to the journey. Thank you.

Thank you for your participation. We look forward to talking to you again on our fourth-quarter earnings call. Thank you.