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Barrett Business Services, Inc. (NASDAQ:BBSI)

Q1 2012 Earnings Call

April 25, 2012 12:00 PM ET

Executives

Jim Miller – CFO

Mike Elich – President and CEO

Analysts

Jeff Martin – ROTH Capital Partners

Josh Vogel – Sidoti & Co

Operator

Good afternoon, everyone, and thank you for participating in today’s conference call to discuss BBSI’s Financial Results for First Quarter ended March 31, 2012. Joining us today are BBSI’s President and CEO, Mr. Mike Elich and the company’s CFO, Mr. Jim Miller. Following their remarks, we’ll open this call for questions.

Before we go further, I would like to take a moment to read the company’s Safe Harbor statement within the meaning of Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements. The company’s remarks during today’s conference call may include forward-looking statements. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by these forward-looking statements.

Please refer to the company’s recent earnings release and to the company’s quarterly and annual reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ.

I would like to remind everyone that this call will be available for replay through May 25, 2012 starting at 3:00 p.m. Eastern Standard 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. Please go ahead, sir.

Jim Miller

Thank you, Marisa. And depending upon where you are dialing in from, good morning or afternoon, everyone. As you saw at the close of the market yesterday, we issued a press release announcing our financial results for the first quarter ended March 31, 2012. I would like to mention that yesterday’s earnings release summarizes our revenues and cost of revenues on a net revenue basis as required by generally accepted accounting principles, or GAAP.

Most of our comments today, however, will be based upon gross revenues and various relationships to gross revenues because we believe such information is, one, more informative as to the level of our business activity; two, more useful in managing and analyzing our operations; 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, SG&A expenses or net income.

Now turning to the first quarter results, total gross revenues increased 31% to $432 million, compared to the first quarter of 2011. California, which comprised approximately 86% of our overall first quarter gross revenues, increased 35% due to continued growth in PEO business. PEO gross revenues increased 34% to $406 million, compared to the first quarter of last year, primarily due to new clients as PEO business from new customers during the first quarter of 2012 more than tripled our lost PEO business from former customers as compared to the 2011 first quarter. Our PEO revenues from existing customers experienced approximately a 10% increase year-over-year.

Staffing revenues for the first quarter of 2012 decreased 7% to $26 million, compared to the first quarter of 2011, primarily due to a small decline in revenues of lost business from former customers, partially offset by new business and a slight increase in revenues from existing customers.

On a percentage basis, gross margin in the first quarter was 1.5%, as compared to the 1.7% for the first quarter of 2011.

Direct payroll cost, as a percentage of gross revenues in the first quarter, decreased to 84.9%, compared to 85.4% in the same quarter last year due to increases in the overall customer markup percentage as a result of price increases during the past year.

Payroll taxes and benefits for the first quarter, as a percentage of gross revenues, was 10% versus 9.6% for the same quarter a year ago. The 40 basis point increase was largely due to higher effective state unemployment tax rates in 2012, primarily in California, and to a lesser extent, in various others states in which we operate, as compared to the 2011 first quarter.

Workers’ Compensation, as a percentage of gross revenues, was 3.6%, which is up 30 basis points from the same quarter a year ago, primarily due to an increase in the provision for estimated Workers’ Comp claim cost and to higher safety incentives, which act as a partial hedge against claim costs.

SG&A expenses increased $935,000, or 11%, to $9.8 million versus Q1 of 2011, primarily due to increased management payroll and to $460,000 of incremental legal and professional fees in connection with a response to requests for a special stockholders’ meeting.

The benefit from income taxes in the first quarter was $1.1 million, which represented a tax rate of approximately 34%. We expect such a rate to continue for the balance of 2012. Consistent with our historical experience, the net loss for the first quarter is due primarily to the seasonally higher burden of employment taxes during the first several months of our fiscal year.

Now turning to the balance sheet at March 31, cash, cash equivalents and marketable securities totaled $67.9 million, compared to $81.8 million at December 31, 2011. This decrease is primarily due to the completion of BBSI repurchasing 2.5 million common shares from the estate of William Sherertz, which represents all of the common shares held by the estate, as well as 500,000 common shares from Nancy Sherertz for a combination of $24.9 million in cash and $34.8 million of nonconvertible, non-voting, mandatorily redeemable preferred stock for an aggregate purchase price of approximately $59.7 million, or $20 per common share.

The 3 million common shares were retired following the repurchase. The mandatorily redeemable preferred stock is reflected on our balance sheet at March 31, 2012 as a liability given its mandatorily redeemable nature. As a reminder, the preferred stock is not tradable, and the initial preferred dividend rate is 5% per year and is payable, at our option, in cash or additional preferred shares.

The dividend rate has an escalation cost whereby the rate increases by 2% each April, beginning April 1, 2013. However, the preferred stock has a provision whereby if the company redeems the preferred stock in full before September 28, 2012, no dividend would be payable. As a result, we are in the initial stage of exploring other sources of financing in order to redeem the preferred stock within this time period.

We generated $11.5 million in free cash flow during the first quarter of 2012. However, I need to point out that much of the free cash flow build was driven by the favorable effective collections at quarter end. Most all of our cash generated from operations is in the form of free cash flow, as cash used to fund our insurance subsidiaries is primarily generated from workers’ compensation expense the company recognizes but does not immediately payout to third parties. Said another way, over the course of the year, our free cash flow will generally be in line with our net income.

Trade accounts receivable at March 31 were $53.2 million, an increase of $6.7 million over December 31, 2011, primarily due to increases in first quarter revenue and accrued revenue at March 31, 2012, partially offset by the timing of collections at the end of the quarter. Accrued payroll and payroll taxes and related benefits increased $16.5 million over December 31, 2011 to $68.9 million, due to increases in accrued payroll and first quarter payroll taxes, which are at their peak during the first quarter as taxable unemployment wage ceilings reset each January 1.

Stockholders’ equity decreased approximately $61.6 million to $40.1 million, compared to December 31, 2011, primarily due to the 3 million of common shares repurchased in March 2012 and to the net loss for the first quarter.

Now turning to our outlook for the second quarter of 2012, we are expecting gross revenues to range between $453 million and $459 million. This projection represents a likely midpoint increase of 24% over the $366.9 million in gross revenues for the second quarter of 2011. The projected increase of 2012’s second quarter revenues is based upon our recent revenue trends.

The range of anticipated diluted earnings per common share for the second quarter of 2012 excludes an accrual of a dividend on the redeemable preferred stock. As previously mentioned, the company expects to redeem the preferred stock before September 28, 2012, whereby no dividend would be payable.

We expect diluted income per common share to range between $0.43 and $0.46, compared to $0.34 in the same quarter last year. Please keep in mind that the second quarter of 2011 included a favorable income tax rate benefit related to the effect of a much lower annual effective income tax rate attributable to the life insurance proceeds received following the passing of the company’s former President and CEO. Without this favorable tax benefit, diluted income per common share was $0.28.

Now I would like to turn the call over to the CEO of the BBSI, Mike Elich, who will comment further on the recently completed quarter and our outlook for the second quarter of 2012. Mike?

Mike Elich

Good morning. I appreciate you all taking time for the call. Overall, very pleased with the successful quarter. We continue to see things moving in the right direction, moving forward to plan. We are working on infrastructure, design and supporting current and future growth trends, and feel like we’re making great progress in those areas.

In the quarter, we added 211 new PEO clients. That’s a new record for us in a quarter. We lost 29 clients, five due to AR reasons; 10 cancelled for non-AR, typically risk related; four businesses were sold; one left on their own due to pricing; one left, took payroll in-house; and then eight left with – to work with other resources or other competitors.

Overall, that’s a net gain of about 182 PEO clients, an increase year-over-year for us in the quarter of 70 – for our quarter build, of 75%, compared to our build of, I think, 104 in the quarter last year, or in 2011.

Headcount for our clients, we saw 37% of our clients add head count, 30% reduced head count and the rest, which was right at 33%, remained neutral. So, I guess we kind of see a little bit of trend to the upside as far as adding head count, but still relatively flat. Nothing robust in that area.

Hours worked is flat to slightly up after removing January noise from the holiday. What happens in the first two, three weeks in January if you look at data over a full quarter is is it gets pretty choppy as companies are ramping backup and putting themselves back on track. And if you pull that up, the overall trend in the last two months has been increasing, but moderately.

Overall, regionally, we still see strong momentum and strong growth momentum in both Northern Cal and Southern Cal. Both the Northwest and as well as the East Coast continue to show consistent and – consistent growth and strong momentum. And we’re finally starting to see a turn or what seems to be a turn in the Mountain states. Even though we’re not seeing it so much in the data yet, it does seem as though the tone in those regions is changing, and we should be hopefully reflecting that in future quarters.

In the quarter, and then moving forward, we opened up two branches in the quarter one in Monterey, California and then another one in the San Fernando Valley. Those branches already are adding customers, and we see those moving in a direction that should help us load level in different markets. Some of the activity is we’re getting pulled to different markets within regions in California. Also it will – we were able to bring and move some mature talent and management into those branches. So, we feel that we’re going to get off the ground pretty quick there.

Continuing effort – also in the quarter, we continued efforts to mature our management systems, both internally and also at the customer level. Our overall focus is to continue to bring more real time data to both people in the field and to our customers, so we can respond to outliers in our overall human capital mix on a regular basis, just so we can manage better and be more proactive about what we’re doing.

We continue to mature our organizational structure at the corporate level while looking at tension points for – leading to a larger organization. We made a great deal of progress in the quarter in maturing the alignment of our management director level within the organization, and it has us now better focused on working on the right things for building a stronger bench for years to come.

We also continued to focus on continuous organizational development, recognizing today’s certain tension points to grow us in areas we need to work on in maturing leverage in the future, while ensuring integrity of our product. At the end of day, our product is our people. And so, we know the more we can invest back and ensure that we have the right people in place and maturing our bench as we go, the more we’re building out – or building in capacity overall. So, building out noise for the future.

We continue to work on methods to build volatility out of how we estimate for Workers’ Comp. We’re – we have enough history to model forward, and we continue to improve on understanding of what we need to be accruing for potential liabilities, while ensuring that we are charging our clients enough for the exposure. Still, we’re making significant progress, and we’ll continue to take a conservative approach in this area.

Tailwinds to our overall business, and we continue to see high retention level, 90% plus, in our client base. We also continue to retain our top talent, and continue to be able to recruit and mature top talent within the organization. Our pipelines remain very strong, what we’re finding is as we continue to mature our product in markets and we reach certain tipping points that our referral networks continue to grow, which leads us to more clients to pick from, which also improves our risk characteristic of clients coming in because we have more to pick from.

We continue to hire and retain very strong talent at all levels and disciplines, and we’re figuring out certain areas where just looking at alignment within our branch operations will in time be able to lever capacity of our branches more effectively as we grow.

Headwinds, our ability to invest in the infrastructure to support growth and innovation while managing short-term expectations will continue to be a headwind probably through this year and maybe a little bit into next year a bit. But we feel like with the investments we’re making will – that’ll start to true itself up here in the next probably four quarters. We continue to also be very conservative in our estimates to Workers’ Comp liability and getting out in front of that to make sure that we’re not creating volatility down the road for unmet expectations.

Also moving forward, we continue to reinvest back into the organizational infrastructure to support growth. And then, we’ll continue to mature our pipeline sources. We’re looking at just messaging in general trying to understand more specifically what’s working very well and how to capitalize on that. And then also, understanding what could be improved on. And by collecting information and acting on it, we’re really working towards aligning the organization towards being a much larger organization and company.

Overall, very pleased with how the company is running. Very pleased with the direction things are going. And looking forward to our progress in the next quarters to coming years.

With that, we would open to questions.

Question-and-Answer Session

Operator

Thank you, sir. (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

Thanks, good morning, guys.

Mike Elich

Good morning, Jeff.

Jim Miller

Good morning.

Jeff Martin – ROTH Capital Partners

Mike, I was hoping you could elaborate on the pace of client ads, if you – if there’s anything specific you can attribute that to. It sounds like your channels of referrals is really what’s driving. Is there anything beyond that that you can point to?

Mike Elich

You know, I – it’s the – you’re always looking for cause and effect. And I would say that as much as anything, it’s really the maturing of our talent and maturing of our bench strength and our branches. We’re just building a better product today than we ever have, and I think that it’s resonating with our clients and also our referral partners that bring us those opportunities.

And you live through enough cycles in business and people believe – start to believe that you really are the real deal. And as we’re starting to have lived through those cycles a couple of times, and we’re retaining our talent and we have the same people with the relationships and different things that it is, I believe, sponsoring an accelerated growth and that people have more confidence bringing us that referral.

Jeff Martin – ROTH Capital Partners

Okay. And then, coupled with that is that the two branch openings, what point in the quarter were those opened or were they subsequent to quarter end, and how quickly should we think of those contributing to revenue?

Mike Elich

They were probably more subsequent to quarter end. In the quarter, we put the infrastructure in place. I think – I want to – what we did is we looked the two markets where we had overlap where we were getting – like take, for instance, San Jose. We were getting drawn down in to the Monterey Peninsula. And we were building a pretty large block down there. Well, in doing that, it was taking capacity south as opposed to driving it more into the Bay area, which is where you have a much larger concentration opportunity.

And so, what we did is we peeled off clients from several different branches and incubated a branch of around 20 clients. So that’s a net/net for us overall as an organization. But with that additional capacity, we continue to see the branches that moved on customers now using that excess capacity to add clients. And in Monterey, in particular, I think on an April 1 basis, we’ve already added a couple clients and are in the process of adding a few more.

So, that will grow, and I think it’ll move faster than branches that we’ve opened in the past, mainly in the Central Valley. And we have the same scenario going on in the San Fernando Valley where we captured probably – in total we’ll capture probably close to 20, 25 clients to incubate the branch. But we already have a pipeline moving where we’re adding business that might not have otherwise gone to another branch.

Jeff Martin – ROTH Capital Partners

Okay. Okay. And then, I was hoping you could elaborate on the 10% increase in the existing PEO customer base in terms of gross revenue. Was that more price-driven, or did you actually have quite a nice benefit from net hiring within some of that?

Mike Elich

Well, you know, when we look at – it’s a little bit of everything, I think. We were trying to nail down where it might come on a – just looking at where 10% might have come from. I think some of it came from the net price increases that we’ve taken over the year. Some of it came from the seven – roughly 37% of our clients added versus 30% reduced. The thing we can’t – we don’t have the visibility to get down into is how big the customers were that added versus how small the customers were – how big or small the customers were that reduced.

So, there’s – within that, there’s some net/net change. Some of it came from there. And then, hours worked are somewhat flat, but we see a little bit of bump up there. But it doesn’t seem to have come from any one area. It’s just more of a culmination of, I think, four or five variables that are working together to create that increase.

Jeff Martin – ROTH Capital Partners

Okay. If some of that was pricing, then we should see some carry forward throughout the balance of the year. Is that the right way to think about it?

Mike Elich

Correct. Correct, yeah.

Jeff Martin – ROTH Capital Partners

Okay. And then, could you give us a little more insight into the staffing business and what your expectation is for it there? It’s been running around flat the past 12 months. It sounds like there were some customer losses that may trickle through the balance of the year.

Mike Elich

You know, I was looking at that, and the thing is is we’re working up against such large numbers. So, to take 7% as a reduction in staffing, it was $2.1 million in overall revenue for the quarter, which would be a little over $8 million for the year. That could be a big customer. I don’t know getting down into the detail where exactly that came from or what branch or what customer that came from. But one of the things that we do know is that January was a little bit of a choppy month. When we look at coming out, it seemed like there was more volatility, and typically that’ll affect staffing more than PEO.

So, you might – there might be a little bit of noise from that. But what’s really gone on too is in California, we’ve had pretty strong pipelines on the PEO front. And not that we’re looking any other way as it comes to staffing, but we’re kind of utilizing capacity to capture opportunity to where it’s most effective. The Mountain states said that January and mid-February was pretty soft (inaudible). Then getting into February and March seemed to be getting better. And we have in most recent weeks seen a little bit of an uptick when we look at the overall in just staffing build where we hadn’t seen that probably earlier in the quarter.

So, will probably need a little bit more time to play out. The first quarter is always a tough quarter to measure staffing results because you always get a lot of chop for about the first six weeks of the year.

Jeff Martin – ROTH Capital Partners

Okay. So, from an outsider’s perspective looking in, is the reasonable assumption to model that down 3% to 5% this year?

Mike Elich

I think to be safe, you can do that. But based on the trend that we’ve seen, just in hours worked in the last, oh, probably four weeks, five weeks, we’ve seen it up – or moving up. It is – but the basis is down from – on a relative basis from a year ago. So, that’s probably fair to say, 3% to 5% down, which will probably only equate to maybe about $1 million off the mark; $1 million, $1.5 million in the quarter.

Jeff Martin – ROTH Capital Partners

Got you. Okay. And then, in terms of the preferred stock repurchase, is there a chance you’ll fund some of that with existing cash, or are you looking to take all that out with a bank facility?

Mike Elich

I think we’ll kind of just see how the year is going. I think that from a cash standpoint if we’ve got a more effective route to go with that, we’ll go there. But if we’re finding that we’re – the operation is running well, and we’re able to make the investments we need and it’s not going to put a pinch on cash, we’ll – we’re going to create enough flexibility in whatever credit facility that we establish that we’re not going to have to stress the organization to make it work.

Jeff Martin – ROTH Capital Partners

Okay. And then, you’ve got an existing facility with pretty favorable terms, would you expect similar terms on either a larger facility or a new facility?

Jim Miller

Yeah, this is Jim. Yeah, Jeff, just in kind of some initial discussions that we’ve had, I think that we will get pretty favorable terms in what we’re able to negotiate given our strong position.

Jeff Martin – ROTH Capital Partners

Okay, great. And good luck, guys.

Mike Elich

Thank you very much.

Operator

(Operator Instructions) And your next question comes from the line of Josh Vogel with Sidoti & Co. Please go ahead.

Josh Vogel – Sidoti & Co

Thank you, good morning, Mike and Jim.

Mike Elich

Good morning, Josh.

Jim Miller

Good morning.

Josh Vogel – Sidoti & Co

I’m just trying to get a – I want to get a better handle on the guidance here. I guess if you go apples-to-apples and you back out the tax benefit – tax rate benefit from last year and use a stable share count, looking for EPS to be up in and around 10% on 24% gross revenue growth. And I was just curious, does that really have to do with the infrastructure and human capital investments you’re looking to make?

Mike Elich

I think that’s part of it, and then also part of it is our taking a more conservative approach in how we’re accruing for Worker’s Comp.

Josh Vogel – Sidoti & Co

Okay. And in your guidance, you’re not including any legal or professional costs tied to the estate purchase, kind of like how you backed it out in Q1?

Mike Elich

No, I think we’re pretty clean there. I think on a go-forward basis, we should be running without the noise that we’ve had in the past.

Josh Vogel – Sidoti & Co

Okay. And Jim, you were talking about free cash flow before trending in line with net income for the remainder of the year. But given the timing of receivables collection in Q1, should you expect – should we expect to see an outflow in Q2?

Jim Miller

Yeah, I think we probably will see an outflow. When you look at receivables at the end of the quarter, they are up only about $6.7 million, which is I think about 14% versus our revenue growth of 31%. So, we had a favorable effect right at the end of the quarter of collections. And for example, as we move towards the end of April, we’ll have our first quarter 2012 payroll taxes coming due. So that will eat up a pretty good amount of cash and actually put us probably at our tightest pinch-point of cash for the entire year. Once that date passes, then we’re building cash back at a pretty good rate.

Josh Vogel – Sidoti & Co

Okay, great. And I guess just one more. You know, we’ve seen some of your competitors are offering services that seems to complement pretty well what you’re doing now like time and attendance or performance management. I was just wondering if that’s a potential strategy for you down the line.

Mike Elich

We do all that stuff now, and we don’t see them necessarily as services. We see them as tools. If the tool that we’re offering the client allows them to operate more effectively, we’ll bring it to them, and we we’ll teach them how to use it. And ultimately, they’ll see value, and it’ll continue to drive a good product. What we’ve tried not to do in building our model is to get hung up on the bells and whistles and at the expense of actually getting results for our clients.

Josh Vogel – Sidoti & Co

Okay, great. Thanks a lot, guys.

Mike Elich

Thank you.

Operator

Thank you. And at this time, I’m not showing any further questions. I would like to turn the call back over to Mr. Elich, for any closing remarks.

Mike Elich

Again, thank you for taking time this morning. We look forward moving for – on a go-forward basis to keeping things on track. Very pleased with how things are going. I know we’re kind of in a bit of a build stage right now. And so, as we continue to reinvest back in the organization, we’re really trying to position ourselves to be in a position of a year, year-and-a-half to be much larger. And then, ultimately, running much better with a better product offering.

And so, appreciate your taking time to understand what we’re doing, and look forward to speaking with you next quarter.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference call for today. Thank you for your participation. You may now disconnect.

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