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Executives

Jim Miller - President and CEO

Mike Elich - CFO

Analysts

Jeff Martin - ROTH Capital Partners

Josh Vogel - Sidoti and Company

Kevin K C - KC Capital

Michael Hughes - SGF Capital

Barrett Business Services (BBSI) Q1 2013 Earnings Call April 24, 2013 12:00 PM ET

Operator

Good morning everyone and thank you for participating in today’s conference call to discuss BSSI’s Financial Results for the First Quarter Ended March 31st, 2013.

Joining us today are BSSI’s President and CEO, Mr. Michael Elich, and the company’s CFO, Mr. Jim Miller. Following their remarks, we will open the call up for your questions.

Before we go further, I would like to take a moment to read the company’s Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements.

The company’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 further information about the risks and uncertainties that could cause actual results to differ materially.

I would like to remind everyone that this call will be available for replay through May 24, 2013 starting at 3:00 p.m. Eastern time this afternoon. A webcast replay will also be available via the link provided in today’s press release as well as available on the company’s website at www.barrettbusiness.com.

Now, I would like to turn the call over to the Chief Financial Officer of BBSI, Mr. Jim Miller. Sir, please go ahead.

Jim Miller

Thank you, Alisha.

And depending upon where you are calling in from, good morning or afternoon, everyone. As you saw after the close of the market yesterday, we issued a press release announcing our financial results for the firth quarter ended March 31st, 2013.

The solid momentum we built throughout 2012 continued into the first quarter of 2013 as shown by our consecutive quarter of gross revenue growth greater than 30%. This growth can be attributed to a variety of factors including continued strength in our referral channel, a high client retention rate, and the maturation of our brand in the marketplace.

Given this acceleration, we will continue to prudently invest in our operational infrastructure and professional talent throughout 2013 to ultimately the quarter much large origination.

Before taking you to our financial results I would like to mention that yesterday’s earnings released summarizes our revenues and cost of revenues and our net revenues basis as required by generally accepted accounting principles for GAAP. Most of our comments today however will be based upon gross revenues and various relationships to gross revenue because we believe such information is one informative as to the level of our business activity too more useful in managing and analyzing our operation and three, adds more transparency to the trends within our business, comments related to gross revenues as compared to a net revenue basis of reporting have no effect on gross margin dollars, ex G&A expenses or net income. Now turning to the first quarter result, total gross revenues increased 37% to 591 million over the first quarter of 2012. California which comprised approximately 88% of our overall first quarter gross revenues increased 40% primarily due to continued growth in our co-employment business.

Overall PEO gross revenues increased 38% to 561 million over the first quarter of last year primarily due to the addition of new clients as our co-employment business from new customers more than tripled our lost business from former customers as compared to the 2012 first quarter, continuing trend that we've experienced for the fifth consecutive quarter. Our PEO revenues from existing customers, experienced approximately an 8% increase year over year due to increases in both headcount and hours' worth similar to the year over year increase experienced in the fourth quarter of 2012.

Staffing revenues for the first quarter of 2013 increased 13% to 29.7 million primarily due to a 7% increase in revenue from existing customers. On a percentage basis gross margin in the first quarter was 1.4% as compared to 1.5% in the first quarter of 2012, the key components of this quarter's gross margin are as followed, direct payroll cost as a percentage of gross revenues in the first quarter decreased to 84.4% compared to 84.9% in the same quarter last year due to increases in the overall customer markup percentage as a result of price increases experienced primarily beginning during the second quarter of 2012. Workers' compensation expense as a percentage of gross revenues was 4.2% which represents the 60 basis point increase over the same quarter a year ago primarily due to an increase in the provision for estimated workers' comp claim costs as well as to higher broker commission. The 4.2% rate was a bit higher than the originally anticipated 4.1% rate due to additional investment in the infrastructure which ensured that we remained in alignment with our growth.

Payroll taxes and benefits for the first quarter remain nearly flat at 10% of gross revenues when compared to the year ago quarter as unemployment tax rates for 2013 remained at a similar level compared to 2012. SG&A expenses increased 21% to 11.8 million compared to 9.8 million in the first quarter of 2012, primarily due to increases in management payroll as well as the variable expense components within SG&A that support the continued business growth.

The benefit from income taxes in the first quarter was 1.3 million which represented a tax rate of approximately 34.2%. We expect the similar rate to continue for the balance of 2013.

For the first quarter of 2013, we reported a net loss of $2.5 million or $0.36 per diluted share compared to a net loss of $2.2 million or $0.22 per diluted share in the same quarter last year. The first quarter of 2013 reflected a decrease of approximately 3 million common shares when compared to a year ago quarter due to our repurchase of approximately 2.5 million shares from the Estate of William W. Sherertz as well as 500,000 shares from Nancy Sherertz affective of March 28, 2012. Consistent with our historical experience, the net loss for first quarter is due primarily to the seasonally higher burden of employment taxes during the first several months of our year.

Now, turning to the balance sheet of March 31, cash, cash equivalents and marketable securities totaled $78.3 million compared to $72.4 million at December 31st, 2012. This increase is primarily due to the build in accrued payroll and payroll taxes where most of the payroll tax expense recognized during 1Q were repaid out at the end of April.

At March 31st, 2013 we have no outstanding borrowings on our revolving credit facility. We anticipate being back into the credit line during 2Q as a result of our 1Q payroll tax payments but likely out or nearly out of the line at June 30th, 2013. We generated approximately $13 million in operating cash flow in the first quarter of 2013. Most of our cash generated from operations, is in the form of free cash flow except for the build in the workers’ compensation and safety incentive liabilities as cash used to fund our insurance subsidiaries is primarily generated from the workers’ compensation expense we recognized but do not immediately payout to third parties.

During a period of growth, our free cash flow will tend to be inline or exceed our net income on an annual basis.

Now, turning to our outlook for the second quarter of 2013, we are expecting gross revenues to increase to a range between $630 million and $635 million. This projection represents a likely midpoint increase of 29% or with a $491.1 million in gross revenues for the second quarter of 2012. The projected increase of 2013's second quarter gross revenues is based upon recent revenue trends.

We expect diluted income per common share to range between $0.68 and $0.72 compared to $0.53 in the year ago quarter. We continue to be very enthusiastic about the momentum in our financial results over the past five quarters. I look forward to addressing you again in our second quarter earnings call. Now I would like to turn the call over to the President and CEO of BBSI Mike Elich for further comment on the recently completed first quarter and our outlook for the second quarter of 2013. Mike?

Mike Elich

Thank you Jim. And thank you for all for being on the call. Do not want to say this is getting boring but it seems like we are, it seems like a recurring message and hopefully it will all, new things will resonate today, but we are very pleased with another successful quarter. We continue to see strength in our growing pipeline and we will continue to mature the organization as build to our future. In the quarter, we saw an add of 216 new clients, we lost 18 clients three were to AR issues, eight clients were cancelled for non-AR issues risk and or Tier related development issues. Three businesses sold which is actually down significantly from what we saw mid last year. One client left on their own due to price, two clients left to take payroll in-house and one client left to go to a competitor. On a net basis, we added 198 new clients, which represents the largest new client build of any quarter in our history. We saw hiring flat for the most part to slightly up in the first quarter; results were fairly consistent across all regions.

39% of our clients added headcount while 31% of our clients reduced headcount. 30% of our clients were unchanged so roughly a 30, 30 and a 30 if you want to balance that a little bit. 46% of our clients increased hours worked, while 50% reduced hours worked. In comparison to fourth quarter, we saw 46% of our clients increase hours worked while 55% increased hours worked in the first quarter. We did see some softness in January following uncertainty in the economy at the end of last year related to tax increase at the cluster and inevitable Obamacare our affordable health care act giving business owners a little bit of pause but we have seen a redeem in momentum the last four to five weeks in our run rate. So it's still not a trend or a reverse in trend that we are still kind of seeing the strengths that we have been seeing last year.

We continue to see strong momentum across all regions, at this point all the Northwest saw double-digit growth in the quarter. The Northwest our double-digit growth in the quarter, the Northwest which is that our greatest seasonal region saw little less than 10% growth but overall everything was pretty strong. Our pipeline remains strong as our brand continues to tip within local market what we maintained a 95% retention rate within our client base.

Our primary obstacle to growth is how far we have build in front of our demand which is where we are consistently putting a great deal of effort, attention and effort investing back in the infrastructure.

Moving forward and in the quarter we continue to make progress and maturing management systems to recognize outliers within our client that we can focus resources more proactively, we continuing to mature the branch, within branch structure and business unit team as raised up for client.

Today, we have 20 business units operating within branches with 6 additional business unit and development. We continue to rollout our HRP platform which with approximately 36% of our client now on the system, our implementation rate is starting to accelerate over the last few weeks. The new payroll and data management system ultimately will operate additional scalability of operating systems, more client flexibility and more robust platform for data structure and expanded interface capability to port client data interface access overtime.

We continue to work on areas that mature the alignment of brand with our branch operations which supports continuing maturity of our referral networks and we continue to focus on continued internal organizational development which we see is one of more critical elements to our long terms success.

Overall, we continue to maintain strong pipelines for new business while remaining – while retaining our healthy client base. We continue to see the quality of our client base maturing significantly both seen and reducing traction rate as well as the client that we have just seem much more healthy and able to sustain the headwinds of the economy and things that get in the way.

We remain ahead of plan and align the organization to support a growth curve and we’ll continue to make the necessary investment in the infrastructure to stay out in front. We continue to make progress addressing issues related to California Senate Bill 863. We have three options designed to address the issue related to our inability to self-ensure for Workers’ Comp in California effective 1/1/2015. I feel, we have made progress in the quarter addressing the situation and we will keep you posted as things evolve. And lastly we continue to look internally to infrastructure to support growth while gaining efficiency and branch operations with incorporate support functions. All efforts continue to focus towards strengthening and maturing the organization product offering. We feel like we are continuing to make significant progress in all areas the organization today is not even close to where we were even a year ago and I am very pleased with the bench that is building the overall tone of the organization and the way the infrastructure and the organization itself continues to take ownership and overall success.

With that I will open it up for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen we will now begin the question and answer session. (Operator Instructions). And our first question comes from the line of Jeff Martin with ROTH Capital Partners please go ahead.

Jeff Martin - ROTH Capital Partners

Mike could you touch on the staffing business first start what is your growth rate in several years; just curious if that is the trend we can expect for the next several quarters? And, also is there any impact that you see on that business from the affordable care act implementation?

Mike Elich

One of those things on the staffing front is we have not chased that business for a reason over the last couple of years primarily because as we have gone through even in the last 10 years the margins have been suppressed. It's become very much commoditized overtime and in general the business itself has not matured in a direction that I felt was the best interest of the organization. With that said though, we are beginning to find that the clients that we have and also the new markets that we are penetrating continues to see value in our approach which is we are not going to just hire people, to hire people for them we are trying to find the best people that is appropriate for their business operations and we are also doing a lot of staffing now relative to supporting our existing PO client. So, in general I think that you will continue to see that piece of business grow and mature, as we have more branches supporting it as well. As well, I think that as we make the turn into an economy where business owners are looking for more options, it lends itself to support that relative to the Affordable Care Act, we do see additional expense associated with having people on our payroll from a staffing standpoint of which were responsible for and we are working today around the matrix related to what is the best way to deal with that cost structure mainly for supporting those benefits. And ultimately for the industry it will mean a higher transfer cost going back to existing clients and it will have to be absorbed in the higher markups which will affect how companies are using temporary help but in over time I think it will normalize itself as being through a neutral across the market, because everybody will be subject to the same issue and for those that might want to achieve short term, they are not going to get away with the long term.

Jeff Martin - ROTH Capital Partners

Okay and then I was curious about the workers compensation infrastructure investment, then it affected the worker’s comp as their percentage of gross payroll by about 10 basis points. If that investment, just curious about specifically that investment, and if that was specific to Q2, is that an ongoing investment because according to my calculation, $600,000 free tax which means out of that that investment you could beat it by 6% to 7% a quarter?

Mike Elich

Part of it is associated with just a, with the growth rate that we have had we continued to have the invest back up in infrastructure, so when you look at some of the cost structures that we build into that bucket you have risk management which on a build basis or quarter-over-quarter or year-over-basis we see build there to see upfront of that infrastructure build. We also have increase cost around our TPACs or our third party administrators of which we internally administer part of our claims than we externally administer, and so in an effort to make sure that we are not getting claim to occur, we have invested further upfront of that.

And another area would be increase to the variable cost of commission or referral fees that we pay back to individuals and as we have gone through an increased our overall rate structure, it reflects that into a higher basis for that calculated fee. So, all those are components. Over time if our growth rate normalizes, you are going to see that number normalize back a little bit but for the most part it’s just us also been conservative with how we are running the business but not wanting to short change today for tomorrow.

Jeff Martin - ROTH Capital Partners

Okay, so we might see that elevated for another quarter or two then come down if gross rate normalizes somewhere in the 20% to 25% range, is that what you're saying?

Mike Elich

Yes, you would think about infrastructure cost is that you always have the build out in front of it just like you’re seeing that in our SG&A cost but overtime as growth starts to normalize you’re going also see a start to lever that investment more effectively. So we talked about what our capacity would be at a zero or normalized growth rate and the capacity increases significantly. Since we’ve really never been there we don’t know how much but at the same time when you’re growing at even plus 30%. You better make sure that you’re out in front of yourself a year to 18 months because that is not a very long timeframe when you’re running the kind of volume through your organization that we are.

Jeff Martin - ROTH Capital Partners

Okay and then just curious, in terms of you know what you might be midmarket client, say north of 100 or 200 employees, if you’re seeing any nose dip trend there. I know one of your competitors traced a pretty sharp downward adjustment to their worksite employee basically to start of the year as they lost couple of big client, curious if you’re seeing any of those midmarket clients start to reevaluate their PEO model. Do you see that as a threat that taking that in-house or do you think you’ve passed that since you’ve passed the start of year in the renewal phase?

Mike Elich

Actually we’re seeing the office that we’re seeing where our pipeline is offering up more large client and we're very-very particular about which large clients we take on because we know that they can be a little more finicky and sometimes absorb a lot more resources of the organization short term but now we’re seeing actually the office that where our pipeline probably has more large clients than today than it has in years and we’re not seeing any attrition of those larger clients as well. In fact get coming through the first of the year where you usually see a turnover for which you’re going to shakeout your client base. We probably have the lowest attrition rate of any quarter we ever had with only 18 lost and one going to a competitor, so I’m not seeing that.

Jeff Martin - ROTH Capital Partners

Okay and then any reads on the economy as a whole are you seeing strengthening in the internal metrics that just modest strengthening but just curious if you have any additional insights there?

Mike Elich

You know I go back a little bit to where we were even a couple of years ago and I say, I didn’t see a double dip and I would say I still don’t see it. We do skew that a little bit because if you look at our client base, it's made up of pretty well run companies and they're pretty solid and they make money and they pay their bills and they're part of the more nimble in the economy but one of the things we saw in January is just a lot of indecision, a lot more fear as people were trying to understand how they were going to be affected by certain changes in administratively and from just from the tax, and just different things that were going on and what we've seen probably the last half of the quarter is that well run companies are continuing to grow and add incrementally but they're not getting too far out in front of themselves but we see stability there, and I think that you're going through a period right now that will probably last maybe even through this year of companies really evaluating, okay, how do I have to, what are the surprises can I expect in my business model and how do I adapt to it and I think for the most part we have our clients fairly far out in front of that right now but we're working on it every day and I'm not seeing where our clients are retreating. I just don’t see them being very aggressive about adding a lot of headcount and expanding that. The good ones are growing at a manageable rate.

Operator

Our next question comes from the line of Josh Vogel with Sidoti and Company, please go ahead.

Josh Vogel - Sidoti and Company

Just a quick follow up on the staffing business, can you remind us the seasonality there?

Mike Elich

Well you have two blocks of seasonality, if you take Utah, where we do a little bit more staffing, you tend to have a fall winter staffing build relative to Christmas and the holidays, then if you rotate yourself more to the northwest, you have more of a food processing, agriculture related ramp that we see. Starting mid-May that runs through maybe an April time frame and it just depends on how big your crops are and what you have coming in. We're not doing any fieldwork but we are working with the ConAgra's of the world, the (inaudible) of the world and some larger organizations that even their runs are subject to how much raw material they have and raw product they have to process, so that's the second piece. The third piece would be just general seasonality of expansion contraction relative to what you see in the second and third quarter, it’s just because you've passed the January-February hangover of companies trying to figure out where they're going for the year, then they find their stride mid-year and they tend to expand a little bit and then as they are going into what’s been the cycle last few years, kind of towards the end of the year or again a decision, they tend to contract a little bit. And so I guess those apply to three cycles that I would measure again. I think the biggest one on the staffing side that creates flexibility is that, in the AG world you could put up three weeks because of weather. And when that happens it will change your run and it will change how much revenue you are going to drive through that model in a particular period of time.

Operator

Our next question comes from the line of Kevin K C with KC Capital, please go ahead.

Kevin K C - KC Capital

One question about margin, look back a few years, get a lot higher volume (inaudible), answer first in the last few weeks started to (inaudible).

Mike Elich

I will try answer your question Kevin, you are kind of hard to hear but at the same time let me know if I miss anything. One of the things that we saw last year was just where we were in the deterring cycle within our business model. And also where we were from a cost standpoint post-recession, is we did go back into our client base and increased current prices somewhat across the board. We looked at every client individually and we brought them in line to where we needed to be to ensure that organizationally we were yielding what we needed to make to be able to continue to deliver and invest back into our own infrastructure as well as what we were exceeding out of doing business with each client. And so we have picked up probably on aggregate, maybe half a basis point throughout the year and has continued to see that mature coming into the first part of this year. I don’t see it continuing to go back to that well and that I think that we are pretty much in line but I would say also that all the clients that came on this last quarter are priced at that higher rate. So you will continue to see margins, you know at least affirming to, over to, increasing based on those principles or factors.

Kevin K C - KC Capital

Two theories I have; one is we are not getting huge headcount improvements from your customers, isn’t that a big driver for margins?

Mike Elich

Yes, the big driver for margins would be, on a revenue basis, headcount would not make a difference in margin. It would make a difference in operating margin because if you have a client that has 20 employees and the client goes from 20 to 30 employees, you are going to lever those dollars and you are not going to spend anything more to support that broader client. So if you look back and said today that we have 2,300, 2,500 clients, I don’t even know what the number is anymore but if we added two employees to every one of those clients you just added 5,000 employees. We don’t have to spend anything incrementally to support them. So from an operating margin, yes, we are going to lever that significantly. From a gross margin percent, the thing that would affect your gross margin percent would be overtime. If you find that the same person is working more hours, then you now have more margins generated per employee, so then your gross margin by per dollar or per hour worked would increase.

Kevin KC - KC Capital

Okay and then my other question about that also is workers’ comp seems to be underpriced. In specially in California, theoretically it should be, you can argue how much higher but at least it's double-digit if not in 20% to 30% higher. Is that hurting you guys a little bit on margin because you and your worker comp insurance competitors need to catch up there?

Jim Miller

Yes, I think that we have done a pretty good job over the last year bringing that into line. I don’t think that we are underpriced at this point. I think that our accrual rate is, we are taking on more of a conservative approach relative to what we feel we need to accrue for the future liabilities of the losses or the claims that we have on our book but we have matured a lot in the last year, in being able to look at what we are charging relative to what we are accruing and where we are at in that equation and we are continuing to get better at it all the time. But the place where I see us today that I think is very positive is that when we sit down and start looking at the whole equation from the 360 different vantage points, we are starting to come up with very similar answers.

And I would say that, yes, California in general was probably broken and underpriced and that will always fall below the next reform until it doesn't work to stay, whether or not prices are correct but when we look at our current trend of lost development of different things, I think that we are starting to hit a pretty good sweet spot in there and it seems to be a number that is sustainable.

Kevin KC - KC Capital

Okay and did you guys give a headcount growth per customer, per client?

Jim Miller

We did not. We don't typically measure it that way because if that number can get skewed so many different ways and yes it’s probably still averaging that 25 to 30 employees which has been the average. It may be skewing up a little bit because we are bringing on some larger clients but the overall base I think is stable at best. I wouldn’t say it’s been growing.

Kevin K C - KC Capital

Okay then one final margin question. When you think long term about your business and tremendous service you offer your customers when do you expect a lot higher margin on these better pricing?

Mike Elich

Well, I guess it depends on how much I ask to invest back into that client. I think that if you take that on the normalized base and take growth out and everything else it would be how much am I making per client, if I wasn’t supporting a lot of different missions. The challenge for us and for our client specifically is that as we work with them over time they become better clients. So, as they become better client, we get more leverage out of the time that we spend with them, if that continues, I could probably go back and raise prices for them but I don’t really have an incentive to do that because now I’m just creating adverse selection in my book.

So, for the most part, yes, I might be able to always get a little bit more but at some point I like the idea of having stable margin for my client so they have a sustainable cost and the increase I get from them and so they refer me 10 more clients because it works and overtime as we start to normalize our growth and get out far and ahead of ourselves organizationally, we’re doing fine I think per client. If we can bring 50% - 60% of our margin to a bottom line on a branch basis and continue to do that, I don’t know why would stress it to the point of jeopardizing what’s working.

I think that’s what our competitors have always done and I think that’s why we don’t see a lot of competitors competing with us.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Michael Hughes with SGF Capital. Please go ahead.

Michael Hughes - SGF Capital

Yes, couple of questions for you. First on the Workmen Comp the expense line of $25 million, I think you can basically break that down into three component parts the current period claims dispense accrual and the prior period claims dispense accrual and then kind of other which would administrative. Do you happen to have those numbers handy or we have to wait for the 10-Q?

Mike Elich

Probably would lead the way. Probably wait just because the current and prior probably lended a little over more than, you’re kind of working through another area, there is kind of a SG&A block that would be easier to separate out.

Jim Miller

Yes, I would just say that if you are looking at total workers cost expense; the loss component, be it the combination of current and prior; that's less than 50% of the overall cost. So, the other costs being those infrastructure costs actually carry a higher cost component than the losses and that's running a risk mitigation model. So, there is a lot of component in there, in addition to the losses.

Mike Elich

And Phil so just to add to that one cost we do buy excess insurance but there are variable cost against that and that tends to be a not really a significant portion but it is a variable in the equation that tracks that could almost be put back. It could be put in either bucket so depending on how you want to look at it.

Michael Hughes - SGF Capital

Okay. Do you happen to have the IBNR?

Jim Miller

That will be mentioned in the 10-Q.

Michael Hughes - SGF Capital

Okay and then the SG&A in the fourth quarter was 13.4 million and then it stepped down to 11.8 million in this quarter. Can you just kind of bridge that for us?

Jim Miller

That's primarily due to branch and corporate bonuses throughout the year as branch and corporate cumulative profits increase. There is an increase in the percentage of that bonus structure, so you are going to have higher bonuses and therefore higher SG&A expenses as a percentage, in the third and fourth quarters. First quarter is always going to be the lowest just because there is very little net profitability.

Michael Hughes - SGF Capital

Did you hold back on any discretionary SG&A spend in let’s say the month of January just because you saw some softness. was there any of that in there?

Mike Elich

No. We continue to build for tomorrow and we typically do not manage our P&L that way. We know where our run is. If we ever find that the run or building clients the softening. We will adapt to that but even quarter-to-quarter we wouldn’t do that.

Michael Hughes - SGF Capital

Okay and then it sounds like the payroll cost as a percentage of growth revenue at 84.4% in the first quarter, that's a good run rate for the balance of the year would you agree with that?

Mike Elich

Yes I think that's a good number we continue to see, getting back to Kevin’s question a little bit, as we have mark ups throughout our business model, you are going to see that number normalized and it seems like it’s starting to get there, yes we may be a little better than that for the balance of the year but then to like in this, where you really see it spike and get choppy is that, in this quarter we have more of a weekend and so when you have that it gets a little jumpy and then in third quarter you have both the 4th July and then you also have Labor Day weekend. And like the 4th July this weeks on a Thursday so it will affect you more because Friday will typically be a holiday and then you are going get a two day holiday in there.

So those are the things, I think the 40 is a pretty is a good number but if you see, it’s jumping around a little bit, those are some of the things that we are always working with and working around and that’s why you see a jump in the fourth quarter as well because you get around thanksgiving. I mean you have really a two weeks holiday in there that makes that number move. So but yes I know I think the 84 fours is a good basis to work around and then we will continue, as its moved a bunch in the last year for us, we are trying to figure out where that normalizes to as well.

Kevin K C – KC Capital

And then the last question for you I think in the past you have been somewhat hesitant to do an acquisition given all the opportunity you have in front of you on an organic basis, any changes there?

Mike Elich

We had a great organic model that continues to mature and grow. I have two acquisitions prospects on my desk today. We are always being, and come cross the desk. The challenge with that today is that what we have going on and where we are going, the distraction and our potential risk of trying to step somewhere we don’t need to today, doesn’t make a lot of sense. So yes we will continue to watch for that perfect bid but I don’t see it in the near future on our time horizon, but pretty good enough to do internally right now.

Operator

Thank you. Our next question comes from the line of Josh Vogel with Sidoti & Company. Please go ahead.

Josh Vogel - Sidoti & Company

I just wanted to build off some of the line of question on the SG&A. given the reinvestment in the business and the rollout of the payroll and data management system, should we expect G&A throughout the year to trend higher as a percentage of revenue in 2013 versus 2012.

Mike Elich

I think that the biggest things that are going to contribute to the build in SG&A would be the payroll rollout will ultimately make us more efficient. So you will see that investment will at some point normalize. There is some CapEx expenses that will start to realize is that SG&A, the system comes online and goes into operation, but we’re pretty much run the business with those built in. I think the biggest incremental cost that you’ll see to SG&A and I mentioned that we had in the last year established and framed roughly 20 business units and we have six more in the queue and we probably have another six to 10 that we'll probably build the next year to 18 months. So with that kind of built, that’s probably incrementally where you’re going to see the real charge to SG&A and building SG&A coming from but the best part of our status is there is a direct return on investment overtime within that spent. So as much as they say fixed SG&A becomes a variable cost operation.

Josh Vogel - Sidoti & Company

Okay great and you guys have the western U.S. well covered. Can you talk about any opportunities you see in other state? I was just curious, how much more of an opportunity for growth do you see in California and then beyond that if you did enter a new market or a new state, do you think a built out from the ground up is a way to go or you think you maybe an acquisition to get an immediate footing there?

Mike Elich

So let me back you up on the size of the market in general. In general if you take client companies that average from 20 to 500 employees, just in California alone there are roughly 70,000 companies that really fit into our sweet spot. Today, we do business with under 2,000 of those. So on a percentage basis we’re less than 2% market penetration.

I was down in Irvine last week and I saw an article come out and I was just talking about business just in Irvine in particular and when we stripped back there were 2,400 companies that would fit out sweet spot in Irvine, and we’re doing business with probably less than 80 and that little city proper. So from a market penetration we haven't even scratched the surface.

Related to west coast and future penetration, I see what’s continuing to happen as our brand continues to tip as our product offering matures and we have more people that are recognizing the value that we’re bringing to market. So that grouping themselves is creating momentum that continues to support out pipeline. Beyond that if you take it now to new markets, I consider our biggest driver to new markets is going to be meeting a company or a source for companies, and they’re saying, I needed to be in New Mexico, I need you to be in Texas, I need to be somewhere and at that point we would make that investment.

The thing that we didn’t have a year ago that we have today is because of the branch within branch philosophy we have the incubator in a sense that is allowing us to mature talent so we can now transfer culture. The problem that we had before is, is to be able to go and follow a customer to a new market, we didn't have the capacity to be able to say, this person could go to this market and leave their branch or leave their customer base without wrecking that customer base. Today we have a model that allows for sustainability of our current business and the current customer base while we would expand to those markets. Now that hasn’t happened yet and it's continued to move in that direction but I see that's going to be the driver to pull us through new markets.

Beyond the West Coast we continue to see strong growth on the East Coast and when we look at our presence in Maryland, Baltimore, Eastern shore Dover and then surrounding areas, we're starting to get significant market penetration there with, well significant growth with very little market penetration. So we see tremendous potential there and we'll continue to look to build around at a hub and spoke method around where we have success today. So, I think all of those things will come in time and we're looking at all those things. I think the biggest thing I look at internally is, we went from being an organization that was really run top down, to now an organization that is very flat, it’s got a much wider bench than it's ever had and we're continuing to mature and stabilize culture within that which will allow us ultimately to transfer the culture to new markets without eroding the base of product offering that we have.

Josh Vogel - Sidoti & Company

That's really helpful, thank you, just lastly of the 70,000 companies that are in your sweet spot in California. Do you have an idea of, do they outsource this work, are they doing it in house, are your competitors have a bigger share there, can you just give me a sense of what’s going on there?

Mike Elich

All of the above, California from a (inaudible) basis has a very low penetration rate, compared to say Florida. And Florida 70% of companies out there at one point used the PEO. In California I don't see it, it may be less than five. Now if you take the (inaudible) payroll model, 90% of companies outsource payroll. It's just kind of a given that why would you try to manage a software platform especially after certified. So the idea of outsourcing is in line with how people think. It's more a matter of to what extent and to how far they’re taking the model that I would look. I would say that of the 70,000 companies, the biggest challenge we have when we see things come through a pipeline is, companies that, maybe their balance sheet isn’t that strong, so when we look at their financials they are not ready for us. When we look at companies that come through even just culturally, they are not ready for us. So we help work with them and coach them and say, we are not ready for each other right now when we look, let’s talk in another year. Let’s talk in six months.

And we have a lot of opportunities for those statements. Organizations are coming back to us. So we are having a reoccurring pipeline coming back to us and as we see that, that’s also one of the things that’s accelerating our pipeline and our growth rate but I would say that from the ability to penetrate California has always been a challenge out there because you can't do it from afar, one; and two if you don’t come out from an operation standpoint and you just come out from a sales standpoint you’ll fail on the backend because the issues in California are real issues. And companies that outsource or go somewhere and use somebody, they need real help. And when we enter space with our customers, we bring resources to them and we bring out a real solution to them which is something that our competitors doing very effectively.

Operator

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

Mike Elich

Again, thank you for staying in touch, and thank you for taking time out of your day to listening this morning. Again, we are very excited about where we are going. I would never dreamed to believe that we are perfect but we are continuing to work on building a better model every day and we are sure that we have a pretty good deal on where we are going and what we need to work on. We are going to learn lessons along the way but as an organization I am very-very comfortable with who we are today and our ability to adapt any challenges that might be out there and pretty excited about where we are going. Thank you.

Operator

Ladies and gentlemen, that concludes our conference for today. Thank you for your participation, you may now disconnect.

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