Barrett Business Services Inc (BBSI) 2017 Q1 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 first quarter ended March 31, 2017. Joining us today are BBSI's President and CEO, Mr. Michael Elich; and the company's CFO, Mr. Gary Kramer. Following their remarks, we'll open the call for your questions.

Before we go further, please take note of the company's safe harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995. The statement provides important cautions regarding forward-looking statements. The company's remarks during today's conference call will include forward-looking statements. These statements, along with other information presented that does not reflect historical fact, 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 cause actual results to differ.

I would like to remind everyone that this call will be available for replay through June 5, 2017, starting at 3 p.m. Eastern 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. Gary Kramer. Sir, please go ahead.

Thank you, Vicky. Depending upon where you're dialing in from, good morning or good afternoon, everyone. The operations of the company were strong in the first quarter, and we believe our results represent a solid foundation on which to build.

Net revenue of $210 million increased 10% from Q1 '16. Gross revenue of $1.2 billion grew 13% over the same period. Diluted loss per share was $1.55 compared to $1.11 in Q1 '16. The Q1 '17 results included nonrecurring expenses of $400,000 or $0.03 per share for outside investigations and legal proceedings. Please recall that we historically incur loss in the first quarter due to higher effective payroll taxes at the beginning of each year.

Also in the quarter, PEO gross revenue increased 13% to $1.2 billion compared to the first quarter last year. Contributing to this growth were 225 net new PEO client additions, and growth in same-customer sales comprised 3.7% of total PEO revenue growth. As mentioned last quarter, we encountered some less-than-predictable events that resulted in the slowdown in same-customer sales in the fourth quarter of 2016, and as anticipated, extended into the first quarter of 2017. Severe weather in many of our markets had a direct effect on hours worked in certain industries.

Also the labor market has tightened to levels where our employers cannot easily hire to fulfill their needs. So the combination of a decrease in days worked and a slowdown in hiring resulted in the lower same-customer sales growth. Staffing revenues in the first quarter increased 4.1% to $37.8 million. We have experienced 3 quarters of consecutive year-over-year growth and anticipate sequential growth for the foreseeable future. Our strategy to pursue only those client relationships that align with our core values is bearing fruit.

Workers' compensation expense as a percentage of gross revenue declined to 5.17% compared to 5.23% in the year-ago quarter. This decline was due to a minor shift in state allocation plus consecutive periods of favorable reduction in claim frequency, which is being factored into the current year expense. This is partially offset by an increase due to unfavorable change in the estimate of prior year liability of $2.9 million.

We are required to have an expert independent actuarial evaluation annually. However, we have one completed quarterly and we booked to that result. This process provides greater overall confidence, but can result in variability by quarter. This quarter's change in estimate is primarily related to adverse claim development on a certain number of claims that had changes of facts. This is not a reserve strengthening, but rather increases on a certain number of claims that resulted in a small change in estimate of the total liability. To give you better perspective, our workers' compensation liability for year-end 2016 was $313 million and a $2.9 million change is less than a 1% variation.

Our workers' compensation claim frequency continues to improve as we experienced a decline in the relative frequency of claims reported. Our total open claims at Q1 '17 grew 8% from open claims at Q1 '16, while gross revenue grew 13% for the same period. In the quarter, we saw trailing 12-month relative frequency of claims as a percentage of payroll decrease 13% compared to the first quarter of '16, and decreased 19% compared to the first quarter of '15.

Claim severity continues to trend in line with expectation. Although we experienced a change in facts on a certain number of claims that resulted in an increase on prior year estimate, all in, the workers' compensation program is performing as expected. This is a continued result of the way our branches manage their client retention and the controls and processes that we have in place to manage and mitigate risk.

Gross margin was negatively affected by the unfavorable change in estimate of prior year workers' compensation liabilities and was $10.5 million or 5% of total net revenues compared to $10.4 million or 5.4% in the prior year quarter. The fee we charge our clients has remained constant. We continue to see direct payroll costs comprise a larger share of gross cost of revenue. This is because we are experiencing improvement in payroll tax as wage gaps continue to lag with wage inflation, coupled with current year improvement in workers' compensation as we continued to expand outside of California. Given the pass-through nature of our pricing, this shift in the composition of our cost of revenue does not have an effect on profit.

SG&A in the first quarter was $26.6 million or 2.2% of gross revenue compared to $21.9 million or 2.1% in the prior year quarter. The increase as a percentage of revenue was primarily due to a $2.2 million investment in management payroll and related expenses in order to support our growth. We also experienced an increase in $1.4 million in audit fees related to a change in auditor for the year-end 2016 audit.

The benefit from income taxes in the first quarter was $5.8 million. The annual tax rate increase was primarily due to higher forecasted pretax income, which dilutes the effect of state and federal tax credits.

We had no borrowing under our line of credit with Wells Fargo as of March 31, 2017. We continue to be debt-free, except for the $4.6 million mortgage on our corporate headquarters in Vancouver, Washington. This mortgage is now classified as a current liability as it is due in Q1 '18.

At March 31, 2017, we had cash, cash equivalents, investments and restricted securities totaling $343.4 million compared to $358.3 million at December 31, 2016. The unrestricted cash position in the first quarter decreased by $32.2 million to $18.4 million. This decrease is primarily related to 2016 annual payroll tax filings due in the first quarter of 2017.

As part of our fronted workers' compensation insurance program with Chubb, we established and funded a trust account called the Chubb trust. On the balance sheet, the Chubb trust is included in restricted cash and investments. The balance in the Chubb trust was $299.6 million at Q1 '17 and $277.1 million at Q4 '16. The March 31 Chubb trust balance does not reflect an additional $11.3 million that was in transit and paid to Chubb on March 24, but was not deposited into the trust account until April 5. On the balance sheet, this in-transit amount is included in other assets.

We constantly look for efficiencies in our operation and in how we structure our finance and insurance. The Chubb trust has historically been invested in a money market investment, which earned a low yield. The Chubb program has matured, which provides greater flexibility on program structure. We negotiated program changes and will now be investing the assets in the Chubb trust into a conservative, fixed income portfolio. A portion of the trust was invested in late March and will continue to be deployed until completely invested. This change will result in a greater return on the assets with low risk to the company.

In summary, our pipeline remains strong and we continue to build our base of net new clients. While we saw the continued and expected slowdown in same-customer sales, we anticipate the continued growth in the economy will translate to sustained health of our clients. We believe that economic growth, coupled with our ongoing efforts to deepen our referral relationships and the ability of our teams to remain focused on delivering value to our clients, will result in another strong year for the company.

As introduced in 2015, in order to provide our investors with a more appropriate forward-looking view of our business, we initiated a rolling 12-month outlook for gross revenue, which we will update on a quarterly basis. We expect gross revenue for the next rolling 12-month period to increase approximately 16%.

For the full year 2017, we continue to confirm diluted earnings per share expectations of approximately $3.65. This includes nonrecurring legal and accounting expenses of $1.6 million or $0.13 per diluted share as well as the return to a more normalized effective tax rate of 33.5% compared to 26.5% in 2016.

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 first quarter as well as our operational outlook for the remainder of the year. Mike?

Hello, and thank you for being on the call. As Gary mentioned, despite headwinds, we had a good start to 2017. As I look at the business, we built a strong foundation and the fundamentals of the model are sound. The organization is well aligned, our pipelines are consistent, and we're seeing our value proposition mature in all markets.

Looking at the quarter, we added 334 new PEO clients. We experienced attrition in 109 clients. 10 were due to accounts receivable, 4 were due to lack of tier progression, 12 were canceled due to risk profile, 25 sold or were closed and 58 left due to pricing to competition or companies that left to move away from the outsource model. This represents an approximate net build in the quarter of 225 net new clients.

Looking forward, our focus remains on drivers that support scale in the model, while bringing consistency and ongoing relevance to our offering. Related to pipeline, we continued to evolve our ability to scale from a model based on individual market contribution to a systemic approach for developing channels and pipeline. As a result, we are seeing development of new referral channels in all markets, which support strong pipeline growth. This approach also supports consistency of message and product, which allows us to move more easily into new markets and support growth against the law of large numbers.

We continue to see a consistent increase in contribution of new business from all markets, most notably from developing and emerging markets that have historically underperformed. Related to organizational structure, we've operationalized our approach to developing leadership and have roughly 18 months of runway with our existing bench. We continue to build the field organization to support future growth, scale into new markets and invest in support of our product offering. Currently, we have 95 business units -- business teams, housed in 57 physical locations. By the end of 2017, we expect to have 101 business teams housed in 62 physical location.

If you look at the stratification of our branches across the organization, we now have 17 mature branches in excess of $100 million in gross margin -- gross revenue. This is a measure we use to indicate a branch's ability to increase leverage. We have 13 emerging branches that are running between $30 million and $100 million in gross revenue. We regularly invest -- reinvest back into these teams to support capacity as they grow.

Finally, we have 27 branches we consider developing with run rates of up to $30 million in gross revenue. And these branches we invest in infrastructure, which supports consistency of pipeline, while maintaining integrity of product as they scale.

Related to systems. As a field-driven organization, we focus on building systems to bring visibility and predictability to our teams, which allows for greater efficiency. These tools also support consistency, which allows us to scale our product with integrity across all markets. As an example, in the quarter, we launched a new platform in support of staffing and recruiting, which will allow us to more effectively meet the needs of our clients in a tight labor market. This also allows us to sunset a legacy staffing payroll system.

Looking forward, in recent months, I have had the opportunity to spend time in the field, gaining perspective on the maturity of our leadership, the quality of our teams, and the consistency of product. This is seen by the impact we're having on our client companies. Through methods designed to maintain a nimble entrepreneurial culture, the organization is aligned, and I believe we have operationalized a variety of methods to stretch our internal teams. We continue to see our value proposition mature. Today, our product has runway and substantial relevance to the small business owner in all markets that we serve.

With that, I'll turn it over to questions.

(Operator Instructions) And we'll go first to Jeff Martin with Roth Capital Partners.

Mike, could you talk about the client attrition in the quarter? If I recall correctly a year ago or going back over time, the rate of client attrition in the first quarter is a bit lower than it was this quarter. Can you compare and contrast, perhaps, the business today versus the last couple of years in terms of the first quarter net adds? Is there anything -- do you see that different today versus the last couple of years?

The one thing, Jeff, that happened in this quarter, and it kind of was a transition between fourth quarter and this quarter, is that we had typically measured whether a client was here and when a client was added, against when we did payroll for that client. In the last 2 quarters, we've actually moved that and actually, throughout last year, we moved it to a measure where we don't count that client as being active until -- we count that client being active once we have a contract with them. So when we have a client that had a contract that normally would have came in to January, it probably was counted back in December. So that would be on the add front. The other thing that we've done, historically, we've moved from a model where we typically would count customer numbers because you can get duplications of -- a customer can have multiple numbers. Today, we've matured a process where we're counting FEIN, which is the federal tax -- federal employer identification -- employee tax number, which is a cleaner number as to whose -- how many clients we have. And that -- so those are actually better measures that are giving us more consistency through how we measure things throughout the organization. Relative to the attrition rate, we've seen a little more competition. And we're just not going to chase business for price, but on a relative basis to our size, the shift over the last couple of years is in line with our growth. We still are seeing a retention level of north of 90%, probably even closer to about 92%. So that's that. And then, the other thing on our adds, you're just going to -- you're going to go through periods where -- well, if we hadn't made that shift, we probably would have had a softer fourth quarter, but we would have been strong in the third quarter. So there's roughly a balancing out of maybe 50 clients that are added quarter-to-quarter if you look at it. And we did see some headwinds probably, just call it -- look at hindsight, maybe a little bit of distraction in third and fourth quarter, which got us off our pipelines a little bit. We're back to -- we're back, we're focused well now, and I think we're -- I'm not too concerned that we won't make that up in the year.

Okay. And with labor being so tight among your client base, how does this new system and new platform help clients meet their need for additional labor?

One of the things that we're working on and this is still in build stage, but we have all the staffing resources already in place to support our staffing business. We're working more and more with our clients from a recruiting base. One of the things that we have, we're supporting 100,000 people on a week-to-week basis and -- our employees on a week-to-week basis. We do see as that -- as that labor pool moves, that we'll have the ability to capture that labor force, and more effectively deploy that in local markets to support a hiring model for our PEO clients.

Okay. And then, could you characterize the current pricing environment? Because you do renew a lot of business in the first couple of months of the year. Maybe how that pricing environment was during that renewal process.

It's always competitive if you're getting as much as you can, but we haven't seen where even though we would say that we ran off 53 clients due to competition, it's been tighter. But I wouldn't say that we're running into -- we're not losing deals on new adds to that and rarely are we really -- I don't think we're losing as -- we're not losing business that we really would choose to keep relative to price on -- from a retention. The other thing we have is that we renew -- as we've moved and evolved our model even to be much less workers' comp dependent, we add -- we're adding business very consistently, even week to week now. So we don't really have a spike in renewals as some of our competitors do.

(Operator Instructions) And we'll go next to Bill Dezellem with Tieton Capital Management.

It's Tieton Capital, and I have a group of questions. First of all, would you please quantify how much weather impacted the quarter in terms of same-location revenues and EPS, please?

So it's -- I'll kind of start and maybe Gary can kind of follow up. It's hard to quantify in dollars by location, but we saw the greatest impact in the Northwest and Northern -- and then in Northern California, but it -- also in Southern California. So if you'd look at, historically, what we would expect same-store sales to be closer to 7%, 8% in the quarter. Coming in at right about 4%, you're looking at a base of probably close to $50 million, but was not seen because of weakness in same-store sales. Gary?

Yes. Bill, that's a good question, and we get asked that, but it's a hard one for us to try to quantify because we can tell you kind of by geography or by region where we're seeing the softness in the hours worked. But to actually pinpoint specific industries or specific locations within those geographies, it's difficult because we have a large client base of 5,000 clients, and really, it comes down to their feeding us their payroll, and what we can tell from the payroll they feed us is that the hours worked are down or that their employee base is not growing as much as it historically has.

That's helpful. I appreciate both those comments. And recognizing what you have just said, this next question may be even more difficult or less relevant. But what are you seeing, maybe, in qualitative terms in terms of wage growth, headcount changes from your customers and hours worked, excluding the weather impact? So I'm trying to just get a feeling of general trends that you are seeing on a more normalized, non-weather-influenced basis.

So it kind of gets back to that same piece. What we've seen in hours worked on an aggregated basis, it's hard to separate the 2. The evidence we have, that companies are having some difficulty hiring is more of a survey base, where you hear companies that say, "I would probably grow my business by 20%, but I can't find the labor to scale." One of the things that we have seen relative to the probably more related to the weather effect is if we were running close to a 39-hour a week per FTE in, historically, during this period, we were probably down closer to about 36 hours in the quarter. So that's -- so you have hours that are hit. Wage inflation, as we look back over the last couple of years, has crept. If we went back even 3 years or so, we were probably -- 3 or 4 years ago, we were at roughly $22, $23 an hour base. Today, we're closer to $25. Typically, when you're moving in to a market where you have, call it, 0 unemployment, if you really look seriously and say how much of your labor force below 4% is employable, you're going to have to see a little bit of inflation to break that logjam. And we haven't seen that yet, not at least in the most recent quarters.

And is that something that, given what you've seen in past cycles, that you would anticipate would happen that ultimately someone's going to break price and start to push wages up a bit?

I think it -- if you're going to have an economy that's going to continue to expand, businesses are going to find opportunity where it is. And you're either going to find it through -- you're going to first find it in that if they've got more business than they can handle, you're going to see pricing inflation in the overall economy first. And then, it'll follow because there's opportunity at a new price point so they can pass on the cost of that additional labor. So there's -- the pieces have to work together a little bit and there's more of a cycle. I do sense, and we've had a lot of conversations with owners and principals in our book over the last 3 or 4 months, and there's a lot of optimism and willingness to grow. I still feel that there is a little bit of a risk-off scenario where the business owner may have gotten back to where they were even to a level of where they were in 2007, 2008. They're feeling good, they're making money and they're saying, "What's it worth to me to take the risk to really grow?" And that's probably the bigger headwind right now is why grow? If I can't find good people, I don't want to grow. And that's when we encourage them not to get out over their tips if they can't find good people. And then with those 2 factors, it'll be what will break that logjam and get things moving.

And I do have one additional question, and I'm just going to have to apologize in advance for my ignorance. The $2.9 million adverse claim change that you had referenced, did that impact the P&L? Or did that flow through the balance sheet? Walk me through the accounting, if you would, please.

Yes, Bill. So that is -- so every quarter, we do an outside actuarial evaluation, where we look at the historical claims and the historical loss experience. And then, we also look at the more greener years and the current trends, which we would then use for our, call it, our loss ratio our loss expectation for the current year. In that scenario for the $2.9 million, what we had was a handful of claims that had a change in fact. So the claims are constantly being worked by the claim adjuster. And when you have claims, you can have a claim and a change in fact, and that fact could be the way a medical evaluation came in or somebody else needs a supplemental surgery or things of that nature that weren't originally in there. So what have happened was we had a handful of claims that had changes of fact. When they had a change in fact, we had increased the reserve on those claims. And what happens there is those claims then go into the actuarial evaluation. And then based upon that actuarial evaluation, we moved the estimated liability for the years '16 and prior by $2.9 million. And that change of $2.9 million is -- that's an expense to the P&L and then a liability that goes up on the balance sheet. But the importance there is that's a change that does not affect revenue, so that's just a P&L change with an offset to the liability, where it doesn't have a revenue offset.

So to make sure that I am clear, if I've done the tax effecting correctly, you had a $0.27 negative impact that flowed through the P&L that had you not have these change in facts that you would not have had. And as a result, you would have reported a loss of closer to $1.28 than the $1.55?

Your logic's sound. I don't have the tax effected numbers in front of me, but your logic's sound.

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

Again, I'd like to thank you for being on the call. We feel that 2017 is off to a good start. We got a little bit of makeup to do in the year, but feel confident that our teams are all growing on the same direction and very -- feel very good about where the company is today. I'm looking forward to catching up with you in a couple of months. Thank you.

That does conclude today's conference. We thank you for your participation.