TrueBlue Inc (TBI) 2010 Q4 法說會逐字稿

Good day, everyone, and welcome to TrueBlue's conference call. Today's call is being recorded. Joining us today is TrueBlue's CEO, Steve Cooper, and CFO, Derrek Gafford. They will discuss TrueBlue's 2010 fourth quarter earnings results, which were announced today. At this time, I would like to hand the call over to Ms. Stacy Burke for the reading of the Safe Harbor. Please go ahead, Ms. Burke.

Thank you. Here with me today is TrueBlue CEO and President, Steve Cooper, and CFO, Derrek Gafford. They will be discussing TrueBlue's 2010 fourth quarter earnings results, which were announced after market close today. Please note that our press release and the accompanying financial schedules are now available on our website at www.TrueBlueInc.com.

Before I hand you over to Steve, I ask for your attention as I read the following Safe Harbor. Please note that on this conference call, management will reiterate forward-looking statements contained in today's press release and may make or refer to additional forward-looking statements relating to the Company's financial results and operations in the future. A reconciliation of any non-GAAP measures discussed today can be found in the Investors section of our website. Although we believe the expectations reflected in these statements are reasonable, actual results may be materially different. Additional information concerning factors which could cause results to differ materially is contained in the press release and in the Company's filings with the Securities and Exchange Commissions, including our most recent Forms 10-Q and 10-K.

I now hand this call over to Steve Cooper.

Thank you, Stacy, and thank you for joining us today to discuss our fourth quarter results and our outlook for the first quarter of 2011. Today we reported net income of $4 million or $0.09 per share for the fourth quarter on revenue of $312 million. We're pleased to see strong revenue growth for the fourth straight quarter. For 2010 as a whole, revenue grew 12% on a comparable 52-week basis, and same branch revenue, excluding our largest customer, grew 19% for the year.

I'm extremely proud of our team for delivering outstanding revenue growth throughout 2010. I am constantly impressed with the caliber of our people at every level of our Company, and we are committed to investing in their continued development. Businesses are continuing to increase their use of temporary workers to support their growth, and we will continue to invest in ourselves and customer service programs that emphasize our specialization of going to market to capitalize on further growth.

The fourth quarter was a solid quarter operationally for us. With 14% revenue growth on a 13-week comparable basis, our net income grew 85%. That is a great -- that is great operational leverage. We continue to see expanding profit margins as we produce more revenue over a consistent cost structure. During 2010, our operating income margins expanded to 2.5% from 1.2% a year earlier. We are encouraged with the opportunity to continue to expand our profit margins in 2011. Our expectations for the first quarter of 2011 are for revenue to be in the range of $260 million to $270 million, with net income to be in the range of a $0.05 loss per share to break even.

Our strong revenue growth in the fourth quarter was generated by widespread demand across most industries and geographies. Our growth has been particularly strong in manufacturing, where we have seen close to a 50% increase in revenue over the past three quarters. Our manufacturing business grew from 15% of our business mix a year ago, to about 20% during the fourth quarter. Revenue growth related to our retail trade customers has accelerated throughout 2010. The revenue related to these retail trade accounts grew close to 40% in the fourth quarter alone. Excluding our one large customer, most other industries served, grew in the mid-teens to mid-20% range, compared to a year ago.

We reported last quarter that although our construction business was not contributing to our strong growth rates at that time, it had shown signs of stabilization. Our residential and commercial construction business grew nicely in the 20% range each in the fourth quarter. Our construction growth is primarily coming from remodel work in both commercial facilities and high-end residential, along with some growth from high-end new residential. New commercial construction is continuing to show declines year-over-year for us. Our overall construction business represents about 21% of our business mix, which is down from 23% a year ago. We have confidence in our expanded ability to serve industrial construction projects by placing electricians, welders, pipe-fitters, into building and renovating and remodeling of power facilities and manufacturing facilities. During 2010, we provided hundreds of skilled workers on plant maintenance and shutdown projects, along with new projects in the windmill and solar energy fields. This is a growing segment for us that continues to be exciting.

We remain positive about the opportunities in blue-collar temporary help. Businesses are turning to flexible staffing to fill a larger percentage of their work force. As we have stated in the past, we believe flexible staffing is an important variable for our customers in running their own businesses. We have seen, through various economic cycles, that our customers use flexible staffing as a method to control costs early in a down cycle. We've also seen, throughout time, that once they have stabilized their own cost structures, they turn to flexible staffing quickly, and demand can be strong. Currently we are experiencing the stage of the cycle that demand for temporary workers is strong, and gross margins have stabilized and should begin to show improvement once we work through these latest unemployment tax increases. We believe we are well equipped to serve these markets and customers with our market strategy focused on bringing the right skills to each customer through a specialized approach with specific industry expertise.

Our niche approach in the industry, having specialized recruiters and customer service teams, that we have shown that we have the unique understanding of our customers. We have continued to invest during the downturn in sales and service training, which has increased the quality of our teams and improved our tenure and our employee base that serves our customer needs. We are committed to furthering our employees' development. We have historically served small customers. During the latest recession, small customers were hit the hardest, and we saw our small-customer sector decline the farthest. We retooled how we serve larger customers, with a sales and service strategy focused on the different needs larger customers have. That has turned out to be a great strategy, as we are now stronger in serving larger customers and we are also now seeing smaller customers begin to grow and use flexible staffing once again.

We will now be stronger at serving all sizes of customers, with our new sales and service programs in place to serve the larger customers, along with our well-established ability to serve smaller businesses in over 700 markets where we have recruiters located. With strong revenue growth rates, stabilizing gross margins, and operating costs being controlled tightly, we believe the operating leverage in our business model will continue to be strong.

At this time, I will turn the call over to Derrek Gafford, our CFO, for further analysis of our operating trends and performance.

Before we get started on some of the details of our results, I want to discuss where our strategic growth efforts are focused. We believe we can achieve a 7% EBITDA margin this cycle. Our methods of growth to hit this target are in three areas. First, our top priority is growing revenue through our current geographic footprint. Our business produced strong incremental operating margins as we leverage more revenue and the associated gross profit across our largely fixed cost structure. With a healthy economic environment, our business can produce strong incremental operating margins in 2011, of 15% to 18%. Second, acquisitions are still on our radar, with a focus on companies that operate in our current lines of blue-collar staffing. Third, we also see opportunity for geographic expansion at all of our brands, with emphasis at CLP, Centerline, Spartan, and PlaneTechs, much of which can be done through specialized recruit -- centralized recruiting and dispatch models, or shared office space. All three of these growth strategies are clearly focused on maximizing our profit margins.

Now I'll provide some additional background on our operating trends, starting with revenue. For clarification purposes, any reference to revenue growth or decline is based on a comparison of the same period a year ago, unless stated otherwise. Total revenue for the quarter was $312 million, which was more than $10 million above our midpoint expectation. Nearly half the additional revenue was from higher than expected revenue from our largest customer, and the other half due to higher than expected revenue in December.

Total revenue growth for Q4 was 19%. 2010 was a 53-week year for us, resulting in a 14-week fourth quarter, versus our standard 13-week quarter. Excluding the additional revenue from the 14th week, Q4 revenue growth was about 14%. Net income was not impacted by the 14th week, due to the additional operating expenses associated with that week. Due to the impact of our largest customer on our revenue trends, I'll give a little background here. Revenue from this customer was $25 million this quarter, which is roughly consistent with the amount of revenue we experienced in Q2 and Q3 of 2010. However, we have not yet anniversaried our near peak quarterly revenue of $39 million in Q4, 2009. Excluding this customer's revenue from Q4 in both years, and excluding the benefit of the 14th week of revenue, revenue for the quarter grew at 22%.

Now let's discuss future revenue expectations. For the first quarter of 2011, which is our seasonally slowest revenue quarter of the year, we expect total revenue in the range of $260 million to $270 million. Included in our Q1 estimate is revenue from our largest customer of about $20 million, in comparison with revenue in Q1, 2010, up $37 million. Excluding this revenue from both periods, our expected revenue growth rate for Q1, 2011 would be about 20%.

Now let's discuss gross margin. Our gross margin for the quarter was 26.3%, which was lower than our expectation of about 26.5%, due to a lower than expected HIRE act, spelled H-I-R-E, benefit, net of other non-recurring payroll tax-related items. Q4 gross margin compared to Q4 last year was down 150 basis points, largely due to workers compensation expense. Workers comp was 4% of revenue in Q4 this year versus 2.8% of revenue in Q4 of last year. Work comp has been running at about 4% of revenue the last three quarters, which we believe is a reasonable run rate as we enter 2011.

Q1, 2011 gross margin is our lowest of the year, due to seasonal business mix changes, and the taxable payroll base resetting for many of our temporary employees. For 2011, unemployment taxes did increase, which represent about 60 basis points of negative impact to gross margin, which disproportionately hits Q1. Also, while we expect work comp to be consistent with our run rate over the last three quarters of about 4% of revenue, work comp in Q1 of last year was 3.3% of revenue or 70 basis points lower than our current run rate. We expect Q1 gross margin to be about 25% to 25.5%, which is close to Q1, 2010 of 25.5%. This would be an exceptional accomplishment for us, due to the unemployment tax and work comp headwinds I just mentioned.

We believe we are entering the phase of the staffing cycle where we should achieve positive momentum in our gross margin while growing revenue. Our teams have been preparing for this year's bill rate process since August, and are extremely focused on succeeding in this area. When estimating 2011 gross margin, I would encourage everyone to remember the 2011 unemployment increase of 60 basis points, as well as the non-recurring benefits to gross margin in 2010 of 40 basis points, related to net higher act credit and a lower work comp rate as a percentage of revenue. We plan to make great strides in overcoming these headwinds to keep our 2011 gross margin comparable to 2010.

Now let's discuss sales, general, and administrative expense. SG&A as a percentage of revenue was 23%, which equalled our expectation. The positive impact of leveraging higher than expected revenue across our fixed-cost structure was somewhat offset by higher than expected expenses in a couple areas. When we increased our branch head count during Q4 to prepare for expected demand increases during 2011, versus our prior practice of decreasing head count in Q4, we also experienced higher than expected expense during the 14th week, as well as some additional income tax-related professional fees.

Looking forward to Q1, 2011, we expect SG&A, as a percentage of revenue, to be about 24% to 25%. Our 31% income tax rate for Q4 was lower than our 38% expectation, due to additional worker-related tax credits. The benefit of a lower than expected tax rate was offset by additional tax-related professional fees and SG&A.

Let me touch on a few balance sheet and cash flow items. We ended the year with over $160 million in cash, and days sales outstanding in accounts receivable was 34 days in Q4, versus 36 days in Q4 last year. Free cash flow, defined as cash flow from operations less CapEx, improved to $35 million in 2010 versus $20 million in 2009.

I'll finish off here with some remaining expectations for Q1, 2011. We expect depreciation and amortization to be slightly over $4 million. We expect about $2 million of CapEx. We expect our effective income tax rate to be about 38% to 40%.

That concludes our prepared remarks. We can now open the call for questions.

(Operator Instructions) Our first question comes from T.C. Robillard with Signal Hill Capital. Please go ahead.

Thank you. Good afternoon, guys.

I'd just -- Derrek, I wanted to ask a little bit about your outlook in the first quarter for gross margin, for essentially flattish and just a little bit of a headwind which is, as you said, is a great accomplishment considering all of the headwinds you have there. You guys consistently deliver on your expectations. So can you just help me see what is offsetting that, especially because the recovery, as you said, tends not to be as strong pursuit increases in the first quarter. I'm just trying -- is there a mix shift, is there something else that I'm missing that is allowing you guys to make up a decent chunk of that initial headwind?

No, this is black and white, brass knuckle increase in bill rates. I mean, our team has done an outstanding job going through customer by customer, market by market, preparing for four or five months and they came out, and we had a cold January, they came out with a lot of courage and did an extremely exceptional job. So this is true bill rate increase that's making the progress.

And so have you -- have you seen those stick in January, or is that something that you're expecting for February and March?

No, we saw it stuck in January -- I mean, we go month by month here, but January is a very good starting point for us to kind of confirm on where we are. So there are multiple risks in gross margin, but we are off to a very good start. So we are expecting 100% pass-through of these unemployment rate increases.

And has there been any -- any material loss on the customer side, or is it actually -- I mean, sounds like it's been a more pleasing situation for you guys than one would have expected.

Well, it has not been easy. These are very difficult conversations that our folks have with our customers, but our folks understand the importance of gross margin, and they understand the point at which we are in the cycle and the importance of these increases at this point in time.

January was a tough -- was a very tough month to understand, because we had bill rate increases going on, as well as some severe weather. And both of which -- I mean, let's just be real here -- there is no perfect way to measure this, but the feedback from our team has been good as far as customer acceptance on the bill rate increase, and I think it's due to an excellent job by our teams in communicating not just the increase but the why behind it.

Okay. That's helpful. Thank you.

And can you -- going to your comment about a peak EBITDA margin through the cycle is about 7%, that seems to be a bit lower than where you guys were, which was, you know, 8%, 8.5% range, the peak of last cycle. Is the main difference there just the difference in construction as a percentage of your business, or can you just help me kind of reconcile the differences there, cycle to cycle?

Yes, I mean cycle to cycle, the peak that you were just mentioning was when we were largely a Labor Ready-based Company, and we have made acquisitions into other lines, and those lines -- those acquisitions have been on delivering an ROI above our cost of capital, not necessarily a hurdle rate on an acquisition on it being having a higher net incremental or total operating margin in the Labor Ready business. So the 7% is based on kind of our current mix of our different specialized approaches, really, to the market.

I guess just my last one and I'll get back in the queue, I was under the impression that some of the acquisitions that you did should have held better margins, you know, for some of the centralized recruiting functions, and am I misremembering some of the margins of the acquisitions? I thought some of the stuff that you were doing on acquisitions over the last few years were actually better margin business?

Yes, T.C., there is -- that is true on some of them, there is a mixed bag. There's a couple of things going on, and you hit on it in your first part of your question there about this, is construction margins drive better EBITDA margins for us. And that shift in that business mix has pulled us down a bit where we were getting 32% margins on a lot of that work, that's averaged down a couple points. So that's a big driver of it, is that mix.

The brands that we've bought, though, they have a mixed bag with them, as far as the operating margins. They're -- we're very strategic in nature of most of those brands, and we're trying to take them nationwide. So for right now, they're not as profitable as our average business mix because we're reinvesting so much in the expansion as we -- as we're adding people, we're adding a lot into those other brands that sells people, strategic people, that are driving that business.

So Derrek, you're kind of speaking out a few years when we get back to our peak margins, but it is going to be a business mix deal, and primarily construction was close to 40% of our business, and I've disclosed here today that it was 21% of our business, so I think that's the biggest driver.

Okay. That makes sense. I appreciate the -- appreciate the insights. Thank you.

Our next question comes from John Healy with Northcoast Research. Please go ahead.

Hi, good evening.

Question for you, Derrek, about some of the investments into the emerging brands. I was wondering if you could give some color about what sort of investment in either into technology or offices or head count that you need to do to roll out some of these brands into new geographies, and maybe what you think the revenue potential could be for the Company, maybe over the next couple of years as you, you know, focus your efforts in terms of making some of the brands more nationwide?

You know, John, the -- it's kind of mixed on what we're doing there. You know, like with our Centerline brand, that's our truck driving brand, we're moving into offices that already exist, so we're not adding a lot of infrastructure cost. But for the size of the organization that it was, adding new sales people in every market is the investment we're talking about. So when we move to Chicago or moving to Dallas or we're moving on to some East Coast properties, you know, there is -- there is that cost that you're adding those sales people and recruiters ahead of -- ahead of the business. So that is what that investment looks like.

In our Spartan brand, it is going to be more of a geographic expansion, and it could come through acquisitions, and Derrek talked about that in his prepared remarks. That's a big growth area for us. We haven't pushed that hard the last couple of years due to valuation. Hard to get a handle around what the potential is, around some of these other businesses, but I think 2010 is going to prove out to be a time where we can now get our hands around valuation and better understand the potential of some of these companies that we might be able to acquire. So we're positive -- a little more positive outlook on our ability to grow Spartan through bolt on acquisitions through geographic expansion.

Most of the investment, though, that Derrek has spoken to is people. It is really not IT systems. We have common systems that can run the business, and as we expand, there is not a higher degree of investment in systems. We've invested quite a bit in the last three years, and we're feeling comfortable that we've got the right systems, and if anything we can consolidate now that we've made some good investments in some of our systems. So this is really a people investment, John.

Okay. Makes a lot of sense.

And, Derrek, I was hoping you could give a little bit of color on the capacity in the system. It makes entirely a lot of sense right now; it seems like you added some people in the fourth quarter. I was wondering where you feel like where you are from a head count investment and what you think about office count expansion, maybe as we think about 2011?

Yes, I think we filled in some capacity needs in Q4 and incorporated into our guidance in Q1 as adding in a little more capacity. We have been running these branches extremely thin. I mean, we threw on $130 million of revenue in 2010 and actually brought SG&A down. That is just not a sustainable trend. And with the strong growth that we're seeing in Q4 and that we're expecting to continue, we want to make sure that we're ready for that.

So, you know, we've talked about a variety of metrics, but I think we'll -- we will be prepared in Q1 to have the right staffing levels to handle that revenue. There could be some additional investments in the future, but we've given you guys a rate of, you know, it takes about 7% of revenue to support that revenue. I think that's still a good metric, and we've probably got a couple million dollars of run rate investment and people on top of that incorporated into our guidance for Q1 and going forward.

Perfect.

And then just two quick housekeeping questions. I wanted to make sure I heard you right. Derrek, you mentioned you thought that for 2011 gross margins would be similar to 2010 on a full-year basis, and I wasn't sure if you mentioned anything about revenue trends in the month of January. Thanks.

Well, we're not giving guidance on 2011. What I mentioned to everyone that is that we have some headwinds in gross margin. We got 60 basis points of negative impact, assuming that we didn't take any action at all due to unemployment taxes. And we've got 40 basis points of what we consider, you know, one-time or non-recurring benefits related to the higher act credits and a quarter or two of pretty low work comp rates in our gross margins for 2010. You sum those together that is 100 basis points of headwind that you've got to overcome to keep your margins flat.

So that's what I kind of pointed out in my prepared remarks. I just want to make sure everybody is aware of. Now, we've gotten off to a great start, and that's what we are shooting for, and who knows what's going to happen in the back half of the year. Maybe we can be a little more successful.

As far as January goes, I would say December was an unusually strong December. Keep in mind that both Christmas and New Year's fell on Saturdays. That does make a difference in December. January was a little softer than we expected, and -- but due to our standard seasonal ramp we would expect coming out of the holidays, but there was also some pretty severe weather, and we were pushing through some very severe -- I wouldn't call severe -- I would call it some pretty necessary bill rate increases, as well. So little softer, but nothing that we don't think is going to spring back in February and March.

Our next question comes from Sara Gubins with Bank of America. Please go ahead.

Yes, thank you. Could you talk a bit about the acquisition pipeline and if you would expect to be active in acquisitions this year, or if it was kind of a longer term comment?

Yes, thanks, Sarah.

As I just mentioned, the pipeline is looking better from our eyes, because we're able to get our hands around valuation a little bit better. We struggled a year ago with trying to understand the potential of some of the companies that were available, as their earnings were somewhat depressed and it was hard to understand where they might end up. With some good traction of 2011, and I believe a good outlook for the next few years in staffing and especially in some of these areas we're wanting to buy in, manufacturing and logistics, that it looks good for us. That we're -- we are going to be able to come to some grips with what valuation means, and be able to come to some better terms. So that improves the pipeline from our eyes.

From a seller's eyes, I'm not sure yet where that is. There were quite a few companies for sale last year. Whether they remain for sale as profits improve and what their expectations are, we don't know, but we're active in talking and using brokers and searching ourselves.

We have a high degree of interest in expanding our current skill sets into new geographies, so we're not really looking to get into other skill sets such as IT or F&A or healthcare. We're pretty committed to stay right where we are in the blue-collar sector, and manufacturing logistics, and truck driving, and kind of the sweet spots of areas we're looking for. I think you'll hear more from us as the year goes on because we are active internally, and let's see what the external world can bring to us as we move forward.

Okay. Thanks.

I just wanted to go back to the discussion around the 7% EBITDA margins this cycle versus the last cycle. When you considered margins for some of the businesses that you've acquired over the last several years, you mentioned that you were making investments in those areas and that is one of the reasons we might see lower margins. Does that suggest that you would expect margins for those businesses to continue to expand kind of past this cycle? Meaning were you thinking of those as your peak margins when you included that in the 7%, or should those businesses continue to expand?

Those businesses will continue to expand. I mean, in the long run the EBITDA margin on all of these businesses, if they're the same size and scale, are roughly the same. We've just got businesses of different size, and scaling makes an impact here.

When I've given the 7% EBITDA target for us for this cycle, I mentioned that and talked through this, this is something that we believe is a very attainable EBITDA target. It is not a pie-in-the-sky one. It is not to suggest that it can't be beaten, either. This is one that we think is a very reasonable target that we can hit, based on what we're seeing in the market and how we see our brands going to market as we look forward.

Sarah, I think that the upside to the EBITDA margins from our perspective comes from construction expanding. So the numbers that Derrek has given today include our current business mix, not with a strong recovery in construction. We haven't seen that, yet, even though we showed some good signs here at the end of the year and the teams are scrambling as we move into 2011 and now it looks like it will hold. That business mix is still quite low, from what our long-term expectations can be.

If we move that construction percentage business mix up, then we do believe that that EBITDA -- ultimate EBITDA margin can move up. But it is really billed off of our current thoughts of business mix, which, like I said, don't include a booming construction market yet.

Okay. Thank you.

Our next question comes from Mark Marcon, with Robert W. Baird. Please go ahead.

Good afternoon. I was wondering if you could just give a little more color on the construction comments that you just gave. Specifically, on the whole is construction up, because it sounded like it was a little mixed, depending upon what sub-sector we were looking at?

Right. Yes.

You know, it's quite surprising, Mark. As we've watched this through the last three years of what type of construction that we have been participating in and what might hold in the future, it does look different today than it did in 2006, no doubt. In 2006 everything was booming, driven by residential construction, large plots of land being developed, and everybody gets two or three homes, and that's not what's driving it today.

What is really driving it today is coming out of remodel work. The bulk of our construction work is focused on either remodeling strip malls or some form of commercial construction around remodels. There's also some high-end remodels being done in residential, and then we've started to see a little bit of high-end residential development taking place. That one is kind of the laggard, but the remodel work is the big driver in all categories.

So we're growing. Those are some pretty big percentages I threw out today, but it is from a pretty small depressed window that it's growing from. It didn't take much of a spike. We saw a little spike back in the spring of 2010, and that spike was somewhat driven off of the housing tax credits that we had seen, and building permits took off, and we got our share of that.

That's really not what's driving it this time around. Building permits haven't shown that they're taking off. This is really one-off work, and it is not broad-based. I think it really shows the strength of our ability to send specialized sales and recruiters into businesses and show the specialized contractors that are doing this type of work, that we can provide the spot labor for them and skilled labor it is, for the most part, that we can provide.

So hope that provides a little color, the difference between now and then and what we're seeing.

It does. That was helpful. And to be clear, so overall construction in Q4 was actually up year-over-year.

Yes.

Yes, on a year-over-year basis, construction was up. And --

By how much?

If you take -- if you take -- if we take Q4 and take -- try to take the extra week out, it was up not quite 20%, but strong teens in growth percentage. And so that's construction all in, everything.

Great.

You gave some color with regards to your expectations of your large client for Q1. Would you expect that to hold for the remainder of the year? What are you hearing from them?

Yes, for right now we're servicing them well, and these rates that Derrek gave the numbers around, that, you know, $20 million a quarter each, we can -- we feel strongly that we can hold that. And the demand is still there, and there is a little more jump ball environment there, but that's why our margins came down on this account a year ago and at the same time the revenue volumes came down. But we're holding strong on both fronts, and we do believe we're the leading provider for that customer.

It's just into a different environment. It's no longer a catch-up, hurry-up, environment for them. It's more consistent and contained, and that's why we're feeling confident we can stay on the job at these levels for quite some time.

Great.

And then with regards to your comments on January, are you seeing differences in terms of the areas that were -- that were significantly impacted by weather, versus those that weren't? And, you know, in the areas where you weren't being impacted by weather, how big were the differences?

Well, you know, I can't give a lot of specifics on January because we just don't give specific comments on January, Mark, but I can tell you we -- we've sliced and diced all of that numerous ways by numerous geographies. And those weather patterns that hit the northeast and down the coast and then have hit the Midwest, it ripples through the whole country to some degree. Because not only does the area that gets hit by harsh weather experience some impact, but there are, with this the way this economy works, there are parts and dependencies in other parts of the country where the weather is just fine, that are impacted as well.

So to try to come in here and give you some context on what the specific impact was on an area, I'm just not prepared to do that, and it's not quite that precise of a measurement.

I understand. I mean, things like warehouses, you're not going to have people delivering a truck that can't get there, as an example.

Mark, you know, since we run different brands and they employ different -- they recruit different ways. For instance, our Labor Ready brand does most of its recruiting day in and day out through our branch office network, and they actually sell into shorter term projects and it's a lot more hands-on labor. That group, that brand, has suffered more than the others during the month, and you would expect that with weather-driven.

Some of the other brands that don't recruit day and in day out, where they have a longer-term employee on the job, they weren't affected that much during the month of January. That also gives us a little gut check, that long-term trends, economy-wise we don't feel have changed since December, and the falloff has really been in these brands that work outside more.

Right. And then how many people did you end up adding in Q4, and what were some of the other additional expenses that came on, on the SG&A side?

Well, if we're talking about items that would impact earnings -- our earnings for the quarter, because we had some trade-off between the tax rate and SG&A, so I'll leave that piece out. You know, compared to our expectation, we're talking about, when we were looking at the fourth quarter, we're talking about a little over 50 people with a very small, but higher, salary group of some strategic ads that were made during the quarter.

So that is one pot. It is probably about $1 million. And we were probably a little overambitious, too, in our own expectations on what the incremental SG&A was in the 14th week of the quarter. It's probably been, you know, seven or eight years since we have taken a crack at that one. It doesn't come along very often. There is probably about a million dollars more there, really, than what we were initially thinking.

Mark, when you're looking at third quarter to fourth quarter, though, it's really important you keep in mind that 14th week that we had in the quarter, when you're comparing those two run rates of the SG&A and Q3 versus Q4.

Of course. We knew it was going to be 14 weeks.

Yes.

Okay. So it is primarily those two items were the biggest deltas?

If you're talking about deltas that impacted earnings in comparison with our -- the expectation that we gave, when we started the quarter, those two items that I just mentioned were the biggest deltas.

Great. But it sounds like you're still feeling pretty good after scrubbing the numbers about the incremental margins for the balance of this year, particularly as we get into the second half.

Yes, yes, I mean we came out with some -- pretty specific set of incremental margins, and we're feeling pretty good about those. We'll be managing the business really to hit those incremental margins.

Great. Thank you.

Our next question comes from Jeff Silber with BMO Capital Markets. Please go ahead.

Thanks so much.

Just mostly some numbers-related questions. I was wondering if you can give us the bill and pay rate increases during the quarter, and if you could just generally talk about what the pricing environment is now.

Yes, well, I'll stay a little bit away from bill and pay rates. We've kind of gotten away from having that discussion like we used to, Jeff, as we got into businesses that some lines of business where we have per diem in our bill rates. And so as we start doing comparisons between bill and pay rates, with per diem being included in the bill rate, it is just not an apples to apples comparison. So I'll probably stick away from that a little bit.

I think from a pricing environment perspective, I think the best thing that I can say to give some guidance is how we have come out this strong here in Q1. Pricing is not easy, but our team has been working very hard on it, and with this unemployment increase, as well as the work comp headwind in Q1, us coming close to holding gross margin the same in Q1, I think speaks to a lot about our confidence in pricing.

Okay. Turning to gross margins, was there a workers comp reversal in the quarter, and roughly how much was that in terms of basis points?

There was. It was about 120 basis points. So 120 basis points, what we are referring to, just to give the background, is that work comp reserves from prior periods did come down, and that amount represents about 1.2% of our revenue for the quarter, so --

I'm sorry, do you have what that was in the fourth quarter of '09 handy?

I do. And it was about 2%.

All right. So relatively less of an impact. And is this something -- I know we ask this every year, or every quarter -- are you still expecting those kind of things to continue going forward?

Well, what we've talked about here is there's a lot of moving parts to workers compensation. We feel like we understand -- it is one of the unique parts about our business. We feel like we understand it, and we understand it very well.

So without taking and dragging everyone through the weeds of what we have said, I think consistently backing up for the last couple of years, is that we thought work comp would settle into a run rate of about 4% of revenue, with everything all in. And that is about where we are running, and that's what we're expecting as we enter 2011 and what's in our guidance for Q1.

Okay.

You typically give out the number of offices; I didn't see it in the press release. Can you just tell us what the number of offices were at the end of the year? Did you close any during the quarter?

There were some 721 offices, so there was a net of five -- most of those were either consolidations or a very small operation, you know, where we had maybe some office-sharing going on. The -- not a significant amount of traditional office closures. But it was a decrease in the number of five from Q3.

Q3. Okay. Great.

In terms of your first quarter EPS guidance, what share count should we be using?

Oh, I think you should follow the traditional pattern of jumping up the diluted average shares by -- on a quarterly basis of some around to 100,000 to 150,000. That is pretty safe and very consistent with our pattern in the past.

Great.

One final one, and I'm going to go back to the goal of the 7% EBITDA margins. Just so I make sure that we're all hitting from the right base, can you tell us what EBITDA number we should be using for 2010 as a base? Is it including stock based comp? Excluding? I'm just curious how you guys calculate it.

Well, I think the best thing for everyone, as Stacey mentioned here in her calculation, and we are including stock-based comp, by the way. But as Stacey mentioned in her prepared remarks, if you go to our website and the Investor Relations section, we -- in the appendix of our investor presentation is a reconciliation of EBITDA to that income there, and you can see exactly what we are using to calculate that.

But we are not making an adjustment, as some do for stock-based comp. We're leaving that in the expense of EBITDA.

All right. Great. I'll go to your website . I appreciate all the

Our next question comes from Paul Ginocchio with Deutsche Bank. Please go ahead.

Thank you.

First question about the incremental margin. You talked about 15% and 18%. I know you had some extra head count in the fourth quarter, that extra million you just talked about. I would have thought with that extra investment earlier in the year that you would have better incremental margins, as you had to do less investment. I also remember a year ago this time you talked about a 20% to 21% incremental EBIT margin, and that 7% incremental investment in the SG&A line per incremental dollar revenue hasn't changed. So have you lowered your incremental margin target because of a lower gross margin outlook? Am I doing the math correctly?

And then just a second question on your large contract, it sounds like it was up Q-on-Q for the first time in over a year, but then you're guiding it down again. Just why the sort of change in trend? Thanks.

So on incremental margins, roughly what we're talking about is a 26% margin less 7% variable costs to support that revenue. That takes you down to 19%. We've talked about a couple million dollars of investment in people here. That gets you into this 15% to 18% incremental margin that we're talking about.

If you take a look at that, compared with our gross margin, we're talking about [50%] to 70% pass-through of gross margin down to the bottom line, which I think compared to most of our peers is still at the top, if not at the top, as far as gross margin pass-through.

There is no change in your, really, your gross margin assumption, it is just that little bit of incremental investment you made that you need to grow the business of large accounts.

Yes, it's -- as we've ran these branches exceptionally thin, we've had people managing more than one branch. Although there are a variety of other items that we need to be making to help sustain the business. I mean, this is -- we're into the spring and summer season of the cycle. So it's time to do a little bit of investing, and that's what we've got in there.

When it comes to the revenue of our largest customer, I hope I get this right, we did finish the quarter at $25 million. $20 million has been our expectation for the last couple of quarters, and it has come out a little bit larger than that for a couple of unique items. But it is lower than -- lower we finished, but it is not inconsistent with the expectation we have been talking about on prior calls. So I hope that answered your question, Paul.

Okay. Again, it hadn't been up Q-on-Q, and I'm just wondering why you started a new trend. I guess you just don't think it's going to continue?

Give that to me one more time, Paul.

If you look back, that revenue from your large contract has been down every quarter for the last year. Except for this fourth quarter it went up. I'm just wondering why you don't expect that trend to continue, based on what that client is doing.

Why we don't -- why we don't expect the $25 million run rate?

Right.

Just because on conversations with the customer, we think $20 million is more reasonable. We did a couple of unique things for that customer this quarter that helped to get us to $25 million.

Great. Thank you.

(Operator Instructions) Our next question comes from Kevin Mcveigh with Macquarie. Please go ahead.

Great. Thanks. Derrek, I wonder if you can tell us what the margin impact was from the run-off in the Boeing contract in the fourth quarter.

Well, I've given you guys the revenue numbers we -- of what we did. I think we did $20 million and $25 million this quarter versus, say, $39 million, $37 million -- what did I say on the script?

$37 million. That incremental margin on Boeing is very close to our traditional margin, so I would -- I would strip out somewhere between 15% and 20% hit on incremental margins. It is mostly in the margin; there is not much SG&A that burns off with that profit. That is probably the best way to approach understanding the hit.

Got it.

And then as you think about, obviously the business mix is shifting a little bit here. When you think about your client mix in terms of small to medium versus large client base, how does that settle out in the next cycle as opposed to where it finished this cycle?

Well, we have seen very nice growth in our smaller customers, and we're just measuring on spend. Some of those would be larger customers, as we move to the back half of the year, and I'd have to go take a look and see where we finished last cycle. Since it was more construction related, there were more smaller customers in there.

But keep in mind, we measure -- we measure small customers here at a spend of less than $50,000. Some of our larger players in the staffing industry measure a small customer, or as they refer to them as retail, as less than a million dollars of spend a year. That gives you some perspective.

In our Labor Ready brand, we're probably running close to 40% in that retail environment that we're calling the small customer. But it's the area that we are right now seeing some of the largest growth in, is customer spending in the smaller buckets, which are mostly, not all, but mostly geared towards small and mid-sized customers.

Great. Thank you.

This concludes our question-and-answer session for today's call. I would now like to turn the call over to Mr. Steve Cooper for closing remarks.

Thank you. We sure appreciate your questions here today and look forward to talking to you as the first quarter comes to a close. Thanks.

Thank you for your participation in today's conference. This concludes today's presentation. You may now disconnect, and have a great day.