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Barrett Business Services, Inc. (NASDAQ:BBSI)

Q4 2010 Earnings Call

February 10, 2011 12:00 pm ET

Executives

Jim Miller - CFO

Mike Elich - Interim President and CEO

Tony Meeker - Chairman

Analysts

Josh Vogel - Sidoti & Company

Jason Harris - Gartner

Operator

At this time, I would like to welcome everyone to the Barrett Business Service earnings release. (Operator Instructions) Thank you. Mr. Jim Miller, please go ahead.

Jim Miller

Thank you. Good morning, this is Jim Miller. Joining me today on the call are Mike Elich and Tony Meeker. Today, we will provide you with our comments regarding the company's operating results for the recently completed fourth quarter ended December 31st and our outlook for the first quarter of 2011. At the conclusion of our comments, we'll open the call up for questions.

Our 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 the forward-looking statements.

Please refer to our recent earnings release and to our quarterly and annual reports filed with the Securities & Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ. Page one of yesterday's earnings release reflecting our operating results summarizes the company's revenues and cost of revenues on a net revenue basis as required by Generally Accepted Accounting Principles.

Most of our comments today, however, will be based upon gross revenues and various relationships to gross revenues, as management believes such information is more informative as to the level of our business activity, more useful in managing and analyzing our operations and adds more transparency to the trends within our business. Comments related to gross revenues as compared to a net revenue basis of reporting have no effect on gross margin dollars, SG&A expenses or net income.

Turning now to the fourth quarter results, as reported the company earned $0.31 per diluted share in the 2010 fourth quarter as compared to $0.21 per diluted share for the fourth quarter of 2009. Total gross revenues for the 2010 fourth quarter of $344.2 million increased $73.4 million or 27.1% over the 2009 fourth quarter.

The $344.2 million represents a new quarterly high for gross revenues. California, which comprised approximately 82% of our overall fourth quarter gross revenues, increased 31.2% owing to continued growth in PEO business.

Staffing revenues for the fourth quarter of 2010 increased $1.8 or 5.9% over the fourth quarter of 2009, primarily due to an increase in demand from our staffing services from existing customers, as new staffing business during the quarter approximately offset the loss of business from former customers.

PEO gross revenues increased $71.6 million or 29.9% on a quarter-over-quarter basis, primarily due to the addition of new customers. Our new PEO business during the quarter from customers added since January 1, 2010 more than double the amount of loss PEO business from the fourth quarter of 2009 from former customers.

Our PEO revenues from existing customers also experienced a moderate increase on a quarter-over-quarter basis. The increase in PEO revenues from existing customers represents the third consecutive quarter of existing customer growth.

Gross margin dollars for the 2010 fourth quarter of $13.6 million increased approximately $1.6 million over the 2009 fourth quarter primarily due to the increase in revenues. Gross margin percent on a gross revenue basis was 4% for the 2010 fourth quarter as compared to 4.4% for the 2009 fourth quarter, primarily due to higher direct payroll cost and higher workers compensation cost as a percentage of revenues.

Direct payroll cost increased 36 basis points over the 2009 fourth quarter, primarily due to an increase in our mix of PEO services, which typically have a higher payroll cost component than staffing services. Payroll taxes and benefits for the 2010 fourth quarter as a percentage of gross revenues decreased slightly from approximately 7.3% to 7.2%, primarily as a result from the effect of company changing to client specific state unemployment wage reporting in California for all of our PEO clients, which was effective January 1, 2010.

Workers compensation expense for the fourth quarter of 2010 as a percentage of gross revenues increased from 3.3% to 3.5%, primarily due to an increase in self-insured claim cost particularly in California, as a result of an increase in overall projected severity of the 2010 claims.

Selling, general and administrative or SG&A expenses of $9.6 million increased $953,000 or 11% over the 2009 fourth quarter. This increase was primarily due to increased profit sharing and related taxes resulting from increased branch profitability.

Other income net for the 2010 fourth quarter totaled $758,000 primarily due to gains recognized in the sale of certain corporate bonds as well as investment income earned on the company's cash and marketable securities. The income tax rate for the fourth quarter of 2010 was 28.2%, which included a favorable benefit from the reduction through deferred tax assets allowance, as sales of certain corporate bonds during the quarter generated previously unanticipated gains.

Turning now to the balance sheet at December 31st, cash and marketable securities totaled $55.4 million compared to $50.4 million at December 31, 2009. The increase was primarily due to cash generated from operations of $7.4 million and increase in payroll related accruals was $7.3 million. These were offset by $6.1 million used to capitalize our wholly owned fully licensed insurance company in Arizona, in early 2010. As well as to $3.4 million in share repurchases of the company's common stock and payment of quarterly cash dividends totaling another $3.4 million in 2010.

Trade accounts receivable at December 31, 2010 of $37.6 million increased about $4.5 million over the same 2009 period, primarily due to an increase in business. The day sales outstanding and accounts receivable or DSO of 10 days declined from December 2009 of approximately 11 days, due primarily to the weighted growth in PEO business, which has much shorter payment terms as compared to staffing business.

Stockholders equity increased approximately $500,000 over December 31, 2009, primarily due to net income of $7.4 million during 2010, which was offset by the company's repurchase of approximately 267,000 shares of its common stock and to cash dividends, which in total of the two was $6.8 million.

Looking now at our outlook for the 2011 first quarter, as reported yesterday, we are expecting gross revenues to range from $320 million to $325 million for the first quarter of 2011. This projection represents a likely midpoint increase of 22.8% over the $262.6 million in first quarter 2010 gross revenues.

The projected increase of 2011 first quarter gross revenue is based upon our recent revenue trends. As we reported yesterday, the company expects to receive proceeds of $10 million for its key man life insurance coverage, the company carried on Bill Sherertz, our President and CEO, who passed away January 20th.

As a result of the life insurance proceeds, we anticipated diluted earnings per share for the 2011 first quarter to range from $0.50 to $0.54 per share as compared to a diluted loss per share $0.16 for the 2010 first quarter. Without the positive effect of the life insurance proceeds, we estimate a diluted loss per share for the first quarter of 2011 to range from $0.19 to $0.22.

As we've mentioned, in previous years during the period of PEO growth as we are currently experiencing, first quarter estimates tend to project larger losses due to low or negative customer margins resulting from the effect of high payroll taxes at the start of a new year.

However, the PEO growth becomes additive for the remaining of the year, once these payroll tax ceilings are reached, which usually begins towards the end of the first quarter and into the beginning of the second quarter.

I also want to point out that while we estimate there to be little, if any, income tax directly associated with the life insurance proceeds, the inclusion of proceeds in pre-tax income provides a favorable impact to our estimated effective tax rate for 2011, which we currently estimate to be in a range of about 18% to 20% as compared to a more normalized rate in the low 30% range. This effective tax rate of between 18% and 20% is expected to be used for each of the four quarters in 2011.

At this time, Mike Elich will comment further on the recently completed fourth quarter, and our outlook for the first quarter of 2011.

Mike Elich

I just wanted to start off by saying that I'm very proud and humbled by the way everyone in the company has stepped up to support the transition since Bill Sherertz's passing on Thursday, January 20. He left a great legacy, left us with the tools to carry the torch forward. He would basically say, to get over it, time to move forward, so we shall.

In the quarter, we added 105 new clients, we lost 60 due to AR reasons, 19 were cancelled for non-AR reasons, 21 sold, 5 left on their own due to pricing, 9 took payroll in-house and 4 left to work with a competitor.

2011 is starting off to be a good year. Pipelines are full and the tone in the field is more optimistic than I've seen in the last four years. Through the first four weeks of 2011, revenues were up by 23% year-over-year. California continues to see strength. Southern California continues to have strong momentum. Northern California has emerged as the strongest growth region for 2010 and year-to-date 2011. The Northwest continues to recover from the recession, although slower than we are seeing in California.

Mountain states were later to feel the pains of the recession, but are now beginning to see recovery in sight. Most recently we're beginning to see companies making decisions to move forward, while generally indicating we should see these markets strengthening in 2011.

East Coast continues to add clients, but we have seen some headwinds in the last six weeks due to weather on the East Coast. 2010 was a good year that has left us with wins at our back for 2011. The recession has offered us the opportunity to continue maturing our business infrastructure while making key investments in talent.

I would give us high marks in our ability to retain top talent and strengthen our presence in all markets during the recession.

With that said, we do continue to see headwinds in the coming quarters due to the recession's effect on state unemployment tax rates and the lingering effect of the recession on workers' comp. The overall tone in the market is that business owners are starting to look forward, making forward-looking decisions with better optimism, which gives us greater hope and confidence that this will be strong year.

With that, I'd like to offer Tony to go ahead with his comments.

Tony Meeker

The Board of Directors is very pleased with the way the transition has occurred over the last several weeks since Bill's passing. We are very pleased with this quarterly result. Clearly, having increases in the last three quarters tells us that the model of our business is working well.

We look forward to the next quarter, although there are some challenges as Mike has just outlined. But we feel very comfortable with the staff that we have and with the direction of the company. The Board's planning to observe how things go over the next quarter. We are very excited about our opportunities as we see them.

Mike, let us turn it to questions now.

Operator

(Operator Instructions) Your first question comes from the line of Josh Vogel.

Josh Vogel - Sidoti & Company

I have couple of questions here. I guess, first I'll start with the PEO business. Obviously, it's growing very robustly right now. And Jim you talked about some trends with your existing clients. And I was curious, the gains there, or the year-over-year growth, they're added to the payroll. Is this more of a function of increased hours worked and overtime or more employees are adding to their payrolls?

Jim Miller

I would say both; where hours worked has strengthened over the last year, and also wages have stabilized, but I think the greatest growth is coming also from adding new business clients. A year ago, clients that we were bringing on were much smaller. We are seeing today, where the clients that are bringing on are larger in size.

Josh Vogel - Sidoti & Company

Is there any way to break down, between the 30% year-over-year growth in PEO how much came from existing and how much from new business?

Jim Miller

Yes, of the $71 million in PEO growth, about $10 million of that was from existing customer increases and the rest was the net of new customers less business loss from previous customers.

Josh Vogel - Sidoti & Company

And we saw a couple years ago, the big surge in PEO and it led to I guess a workers' comp accrual that was a little too late. And given that this business is growing so robustly, do you feel you have adequate accrual set aside or you have marked for future potential claims?

Jim Miller

Yes, I think we do. We work very closely with an independent actuarial firm, who values our reserves and updates their model each quarter. So we are working very closely with them, feeding them data and keeping in contact with them as far as the trends they are seeing in the numbers to make sure that we continue to keep our reserves on an appropriate level.

So we don't see anything out there that's looming that will come back to fight us.

Mike Elich

I would also Josh add that in that model, we look a little bit more towards that payroll growth. And there is a component that adds to reserves for that reason.

Josh Vogel - Sidoti & Company

And Mike, you just discussed some challenges regarding SUTA and workers' comp. And I was wondering if you could just give a little more detail there? And I don't know how much you want to comment about full year 2011, but maybe just what impact do you think that could have on full year margins.

Mike Elich

I think most of the challenge is probably already built in. One of the things that we continue to see is, no matter what our history is related to our state unemployment tax rate, the states across the border incrementally increasing, we see some states that have doubled over the last two years. Their unemployment rate, that has very little to do with history at an individual company.

So that continues to be a little bit of a headwind, more….

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… individual company. So that continues to be a little bit of a headwind, more so because of the unknown as well, but you don't know where states are going to end up, being able to fund those deficits.

We continue though to pass that cost forward to our clients, although there is a timing lag associated with that. We assess each individual client as we do that, and usually it's addressed at the clients' contract renewal time.

Related to workers' comp, this recession went on a long time. And if you really consider the fact that we started to see the effects of the recession as late as fall of '06 in Southern California, typically if you had a short recession, people will go back to work. Because the unemployment rates are staying high, employees are still finding a way to use workers' comp as an offset to not being employed.

Josh Vogel - Sidoti & Company

Just one more now and I'll jump back in the queue. As the PEO business continues to grow and you are adding new clients, are you seeing any sort of shift in the seasonality of your business?

Mike Elich

I would say, if anything, it's probably leveling a little bit. As we grow by region as well, we're capping into different industries which have a little less seasonality associated with it. Plus, we're diluting some of the seasonality that we might find in different markets such as the agriculture market in Washington and Eastern Oregon.

Operator

Your next question comes from the line of Jeff Martin.

Unidentified Analyst

This is actually Amit calling in for Jeff. Just a few questions here. First off, how does the sales environment look in terms of new client additions?

Mike Elich

It looks very strong. One of the things that we have run into in the last year, especially in our mountain states regions where the recovery is a little bit slower, is that companies were not making decisions to move forward. We're just in the last quarter and more specifically in the visits that I have had with all managers in the last three weeks, there is a great deal of optimism looking forward that companies are starting to look at their business differently and they are starting to make decisions moving forward. So our sales pipelines are very strong right now. And we see that we are in a great position to add new clients.

Unidentified Analyst

Has there been any change in lead sources for new clients?

Mike Elich

I think that there is not necessarily a change, but definitely a maturing process. We use a number of different networks to bring leads to us, one of which is just referrals from our own client base is that our client base continues to grow. We have more tenure with those clients. They bring us more business.

Unidentified Analyst

I noticed that your workers' comp expense rose by $1 million sequentially. How should we read into this?

Mike Elich

It's always a hard game, because you're trying to level so much choppiness of different quarters. We did see an uptick in fourth quarter. I guess we are looking at it quarter-to-quarter and we will address it accordingly, will continue in that direction. I guess it really comes back more to some of the back-years as those start to fall off. And as we are cleaner on the front end, it will start to normalize itself. But we are also building in factors for the growth in revenue.

Unidentified Analyst

Could you also explain how payroll taxes are impacting the business and what your expectations are for improvements in 2011?

Mike Elich

Well, the payroll tax, as most of you probably already know if you've followed us for very long, is built into our equation where we front-load or pay literally 90% of our payroll taxes in the first quarter. So the bigger we get, the bigger the liability gets that's paid in the first quarter.

Also, as we grow PEO, and it does outrun or outpace the staffing growth, we find that that hole gets bigger as well. So as that's paid off, we really have free sales given the balance of the year other than the clients that we have to now prepay as we bring on new business. But as we are getting bigger, the effect of new business that we're bringing on becomes muted somewhat.

Unidentified Analyst

Last question on the stock buybacks. Did you guys buy any shares this quarter?

Jim Miller

Yes, we bought so far just about 4,000 shares, so very little. And we currently have about a little over 1.5 million shares remaining on our buyback plan.

Operator

Your next question comes from the line of Jason Harris.

Jason Harris - Gartner

The cash balance has built quite a bit. Someone just asked about the buyback. What are the Board's thoughts on cash usage going forward? Would there be thoughts of increasing the dividend or stepping up the buyback? Or do you feel more comfortable just keeping the cash on the balance sheet?

Mike Elich

I think given the events of the past two weeks, we're stepping back a little bit. We're looking internally as to where we might need to invest to strengthen our overall base for our future going forward. I think we'll continue to look at acquisition opportunities. We were in the process of exploring two different opportunities prior to January 20. That's not off the calendar. It's definitely in our sights, and we'll continue to look for prudent opportunities to deploy our cash effectively.

Jason Harris - Gartner

Obviously, Bill owned a large stake in the company. Is there any sort of update on what would happen to his shares, or is his family planning on holding on to the company?

Mike Elich

I think the family is still sorting things out. If they were in a position or had a desire to liquidate some shares, we are in a great cash position to support that. But right now, I think it's too early to tell. I think as a whole, we're all working together and communicating. But they as well as we are in a great position not to have to do anything.

Operator

Your next question comes from the line of (Bill Moskowitz).

Unidentified Analyst

How much stock does the current management own, what percent of the company?

Jim Miller

Current management probably about 1%.

Unidentified Analyst

And Bill's ownership or his estate's ownership is what percent?

Jim Miller

About 25%.

Unidentified Analyst

One of the things that attracted us to the company, just wanted to state this, was strong insider ownership certainly represented by Bill. So on behalf of our firm, we'd love to see more insider ownership and not just through options, but direct purchases of shares would be awfully nice to see. Any comment on that?

Mike Elich

I speak for myself. Although I don't own 25%, I do own 43,000 shares. And relative to my overall net worth, that's a pretty significant amount. So my interests are definitely in line with the company's success.

Operator

At this time, there are no further questions

Tony Meeker

This is Tony Meeker speaking. I'd like to respond a little bit to the question asked about the arrangement with the Bill's estate. The Board of Directors is very cognizant of his stock ownership and the estate's ownership. And their concern is going forward on the tax burden that might be faced by them.

And I can tell you that the Board of Directors, there's an open line of conversation with Bill's family. We are quite obvious about the impact that a huge sale might make on the stock. But we believe we're in a very strong position to assist in anyway that might develop out of that.

The board is keeping that line of communication open. We have the ability to add more to our stock buyback program at anytime we feel like we need to. So we're very pleased about our position both in cash and ability to acquire stock.

Jim Miller

All-in-all I guess I would add that we're very excited about where we are at. Bill left us in a great place. And we're very fortunate to have a great company to move forward, to expand new opportunities and to look forward to where we are at and where we are going. So with that we'll leave you till next quarter. And look forward to seeing you on the street. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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