Mike Elich - President & CEO
Jim Miller - CFO
Jeff Martin - Roth Capital Partners
Josh Vogel - Sidoti
Kevin Casey - Casey Capital
Barrett Business Services, Inc. (BBSI) Q2 2012 Earnings Call July 25, 2012 12:00 PM ET
Good day ladies and gentlemen and thank you for participating in today’s conference call to discuss BBSI’s financial results for the second quarter ended June 30, 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 the call 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 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 August 25, 2012 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.
Thank you, George 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 second quarter ended June 30, 2012. The 35% increase in gross revenues represents our tenth consecutive quarter of year-over-year double-digit sales growth and is also an all-time quarterly revenue record for us.
We attribute these results in parts to building with within our organization and a robust performance of our three sales channels, customer referrals, referral networks and internal sales staff.
Results are also attributed to the returns we’re realizing from our investment back in the organization which are supporting this continued pipeline growth and rewarding execution in this field. While we continue to mature our product offering, organizational culture and brand offering to our client base, we are seeing continued strength in our pipeline of new client additions while also maintaining very strong client retention.
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 based on gross revenues and various relationships, pure gross revenues because we believe such information is, one, more informative as to the level of our business activities, two, more useful in managing and analyzing our operations and three, add more transparency to the trends within our business. Comments related to gross revenues is compared to net revenue basis of reporting, have no effect on gross margin dollars, SG&A expenses or net income.
Now turning to the second quarter results, as I mentioned, total gross revenues increased 35% to $494 million over the second quarter of 2011. California, which comprised approximately 86% of our overall second quarter gross revenues, increased 39% due to considerable growth in PEO business.
Overall PEO gross revenues increased 38% to $464 million over the second quarter of last year primarily due to new clients as PEO business from new customers more than tripled our lost PEO business from former customers as compared to the 2011 second quarter. Our PEO revenues from existing customers experienced approximately a 7% increase year-over-year due to increases in both headcount and hours worked.
Staffing revenues for the second quarter of 2012 were flat at $30.4 million primarily due to the addition of new business and small increase in revenue from existing customers echoing the amount of lost business from former customers.
On a percentage basis gross margin in the second quarter was 3.3 percentage compared to 3.6% in the second quarter of 2011. The key components of this quarter’s gross margin are as follows: Direct PEO cost as a percentage of gross revenues in the second quarter increased to 84.7% compared to 85.1% in the same quarter last year due to increases in the overall customer market percentages as a result of price increases which we began to see flow through during much of the 2012 second quarter.
Workers compensation expense as a percentage of gross revenues was 4% which is up 60 basis points from the same quarter a year ago primarily due to an increase in the provision for estimated workers comp claim cost and a higher safety incentive. We continue to work closely with our third-party actuary as well as monitor our own internal data to evaluate our workers comp reserves.
Looking ahead to the balance of 2012, we anticipate that 4% level of gross revenues for workers compensation expense to continue. SG&A expenses increased 19% to $10.6 million versus Q2 of 2011 primarily due to increases in management payroll and profit sharing as well as to the variable expense components within the SG&A as the course of this business grow. Our tax rate is currently at 33.5% and we expect this rate to remain at similar levels for the balance of 2012.
Now turning to the balance sheet at June 30th, cash, cash equivalents and marketable securities totaled $68 million compared to $81.8 million at December 31, 2011. This decrease was primarily due to the fruition of BBSI repurchasing 2.5 million common shares from the Estate of William Sherertz, 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 in March of 2012.
The 3 million common shares were retired following the repurchase the mandatorily redeemable preferred stock is reflected on our balance sheet at June 30, 2012 as a liability given its mandatorily redeemable nature. The preferred stock has a provision whereby if we redeem the preferred stock in full before September 28, 2012, no dividend would be payable. As a result, we are nearing completion of putting a bank line of credit in place in order to redeem the preferred stock within this time period.
Out of the $68 million in total cash investments, we consider approximately $20 million as truly free to invest back into our business, distribute to shareholders, spend on growth initiatives or repay our anticipated bank line that will redeem the preferred stock.
We generated approximately $13 million in cash flow during the first six months of 2012; free cash flow during the six months of 2012 was approximately $7 million, most of our cash generated from operations is in the form of free cash flow except for a build in the workers compensation accrual as cash used to fund our insurance subsidiary is primarily generated from the workers compensation expense we recognize, but we got immediately pay out to third parties. Saying it another way, over the course of the year, our free cash flow will generally be in line with our net income.
Now turning to our outlook for the third quarter of 2012, we’re expecting gross revenues to range between $525 million and $530 million. This projection refers into likely (inaudible) increase of approximately 30% over the $460 million gross revenues for the third quarter of 2011. The projected increase of 2012 third quarter gross revenues is based upon recent revenue trends.
The range of anticipated diluted earnings per common share for the third quarter of 2012 excludes an accrual of a dividend on the redeemable preferred stock as previously mentioned we expect to redeem preferred stock in it’s entirety before September 28, 2012, whereby no dividend will be payable.
We expect diluted earnings per common share to range between $0.70 and $0.73 compared to $0.54 in the June quarter last year. Please keep in mind that the third 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 benefit, diluted income per common share was $0.42. It should also be noted that 2011 third quarter included the $3 million of stage and founder shares in the calculation of diluted income per share.
The projected percentage increase in the range of net income is less than our gross revenue expectations due primarily to a projected decrease in non-operating income as a result of lower forecasted interest income as compared with third quarter of 2011. We continue to be very enthusiastic about the momentum in our financial results over the past pass several quarters and I look forward to addressing you at the end on our third quarter earnings call.
Now I would like to turn the call over to our President and CEO of BBSI, Mike Elich, who will further comment on the recently completed second quarter and our outlook for the third quarter of 2012. Mike?
Good morning. Overall, very, very pleased with a great quarter, very difficult not to be and probably hanging in the field if I wasn’t. We continue to see strengths in our new client adds and are very pleased with our client retention, client quality maybe as good as I’ve seen it, since I have been at the company.
In the quarter, we added 182 new clients. We lost 27 clients; one to AR issues, 11 were cancelled for non-AR issues, typically a risk for a client quality. Nine businesses were sold; one business left to go on its own pricing and five left to go to competitors. That’s a net of 155 clients that we added in the quarter, an increase of 31% over second quarter 2011, quarter-over-quarter net build of 118.
We also see strengths in our clients beginning to start the higher we saw 41% of our client’s added headcount where 28% of our clients reduced headcount, 51% of our clients remained unchanged in the mix of our PEO business. This is a change from previous quarters we had and we believe were pretty much even, about 60% of our clients increased hours while 35% of our clients reduced hours, so typically we see that as a precursor to hiring or at least seasonal loose that allow companies to add capacity while not adding headcount, but at the same time certain stress internal capacity.
The company overall continues to earn very well, we continue to make progress and aligning our internal organizational structure for growth in our client base. We made significant progress in the quarter aligning investments and corporate infrastructure to support future growth. Our pipelines continue to remain very strong as the brand continues to mature while companies are looking for a better leverage their internal resources.
Overall by region, we still continue to see very strong growth coming from both Southern California and Northern California, both the Mountain states and Northwest continue to make positive, have positive momentum and we are seeing a very strong progress there and on the east coast we are doing extremely well as well.
As far as tailwinds go, continued retention of our top talent while we retain 95 plus of our client based organization and we continue to mature, our pipelines remain very strong, we continue to hire and retain very strong talent in all disciplines. Headwinds that we can see is we will continue to invest in infrastructure to support growth and innovation while managing short-term expectations, and we will continue to take interpreter approach in estimating an estimate in workers comp accrual.
On a go forward basis before continuing to mature the two branches that we opened in the first quarter, we have made a great deal of progress this first six months of 2012 and broadening our foundation to support a larger company. We continue to mature management systems to better support operations and product quality. We will continue to reinvest back into the organizational infrastructure to support our growth curve and we continue to focus on our internal continuous organizational development process. Overall very pleased with the direction things are going and looking forward to measuring our progress in the next couple of quarters. With that I will open it up for questions
Thank you sir 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
I was hoping you could drill down a little more insight on workers' comp accrual, you did mention you feel like you are conservative may be you could give some additional details around duration of claims and closing them down. The recent trends on being able to close them out and the overall cost for them and then characterizing some passion, the degree of conservatism that you are factoring in?
Challenge in that area is that you are paying your accrual based on performance of six years ago and five-six years ago. So it's less about what you are seeing directly in the cost of claims and where they are closing and more around what the trend has been as a reflection of what you see going back many years.
So we are in a position and of course to do is not necessarily look at what's going on today with the existing year but to how to use data in the past that says that in the current year at some future date we will have an estimated liability, and so in that process we are just continuing to accrual dollars against under our current run of payroll given that we have had a pretty good jump in top line growth.
It forces you to look at things in a little more conservative manner. While you might even be adjusting your underlying charge to your client and in doing so we kind of feel that at this point we've increased that accrual rate to the extent that we are taking more conservative approach to how we are estimating those costs.
Jeff Martin - Roth Capital Partners
And then you mentioned you raised pricing a bit in the quarter, what specific categories did you allocate that to when you are communicating with clients or do you communicate to that degree?
Well, it's continuing to be a leveling of our client base and that many of our clients have been with us for many years and as you've gone through the recession and you've watched everything from your unemployment rate change to maybe what the market is offering in the world workers’ comp to just even our product maturity and where they are at as an organization, much of the price changing in the field has been leveling matching client quality what we have to invest back in turn to accommodate what we need to charge them to be able to do so. So what we've seen in that is and what reflects itself is in a reduced managed or reduced payroll percent as we go and increase our market for customers. There maybe a couple of customers that went down in the quarter but overall on an aggregate, we've seen an increase in our overall market to customers.
Jeff Martin - Roth Capital Partners
Okay, and then again a couple of questions about the mix of client base from a sector perspective maybe you could compare and contrast it today versus say five years ago, because five years ago there was a lot more construction related clients in the base and also if you could get your thoughts on that?
You know I would say that the client base remains predominantly blue collar or gray collar but as far as sector goes we see very little concentration in any one sector. I think the largest concentration we might see in any one grouping is probably 5% maybe even less than that.
So in last five years we've diversified against much of the construction base that we had built in 2003 to 2006, 2007 and in turn have now found that even our pipelines are much more diverse in nature as they are coming in and the clients that we've been doing business with were for many different reasons but much more on the value add.
It also depends on where we are receiving our pipeline and as we continue to mature and expand our customer referral bracket, we see an even more diversified client base coming in. So overall though I would say that our mix of clients across the board is much, much more diversified than it ever was where if you had 20% in the construction six, seven years ago that's been cut its less than five today.
Jeff Martin - Roth Capital Partners
Okay, and then last question would be [10 years] growth strategy, looking out three to five years from a brands perspective within California, lets say and then, is there a strategy to expand geographically into certain regions, other regions that are non-California?
I think the biggest way to peg our growth strategy is to look at how we’re incubating talent.
One of the things that we’ve done in this last 12 months and have been able to look structurally at are growing branches, is to understand how to in a sense replicate branches inside of branches and one of the things that we’ve done is created a system where in our larger branches, something over a $100 million, we begin to create business units within those branches, which in a sense replicate almost a branch operating unit that could stand on it’s own.
Within that, one of the things that we anticipate and hope for is that we’re going to continue to incubate talent within those groupings that has opportunity to present themselves, whether it’s in California or whether it’s in markets that we don’t exist and in today that we will be able to roll that talent and incubate branches, that get a much stronger head start.
But the biggest challenge we run into and open that geographic areas finding, having a footprint that allows us to open market and so, we’re working on how we capture our referral markets and how we can expand those to new markets.
The second part is culturally aligning a branch that you would open in say Texas is a challenge if you don’t have people that are carrying the same message from your existing operation to those new markets because now you are working against currents in the new market while you are trying to mature culture within those new markets and how we operate. So, by building these business units, it’s given us I think it has unlocked a pretty large key for us in our previous lock for us in that region, now take those teams as they mature or those individuals from those teams and we can have more flexibility in relocating our talent to incubate new markets.
And so, from a geographic standpoint as we continue to see the mountain states come online and we accomplish a lot of the infrastructure build that we are working on right now, it will free up excess capacity for us to again move further east at some point.
Thank you. (Operator Instructions) The next question comes from Josh Vogel with Sidoti. Please proceed.
Josh Vogel - Sidoti
With regard to your branches, I was just wondering if you could talk to the capacity that is at the existing branches and how much is left to accommodate the remarkable growth that you are achieving right now and also if you have any plans to open branches in the second half of the year?
Again with the structural alignment that we have brought and our ability now to build branches inside of branches. It unlocked the tremendous amount of capacity for us and given that we have very, very small penetration in most every market that we are in, we could continue to grow significantly in existing markets just by maturing our brand in those markets and also maturing our talent in those markets. But I think the real key for us in unlocking the capacity is then the ability to build business units within existing branches which in a sense replicate the branch.
So rather than having to open – open a new physical location, we are pretty much accomplishing much of the same thing by building new business units inside of a branch while having to – not having to replicate existing leadership and also having to add geographic expense and additional SG&A to do so.
Josh Vogel - Sidoti
And may be building off that, what about additions of sales associate plans for the back half of year within those branches?
You know we continue to see our stronger sales teams being one, our branch managers. Our sales associates are in a sense pipeline managers managing our referral networks than managing message and then feeding of those opportunities, go back to the branch and back to the business unit. As far as talent goes, we are always looking for talents and fortunately we are in a great position that we can hire people. We are hiring talent when we find it and fortunately with the lot of the work we are doing, we've done a couple of things.
One, we are pretty good at understanding what type of person is successful in our organization. So our success rate is pretty strong and then secondly, because our brand is maturing very well in most market, we found ourselves in a place where people want to work.
Josh Vogel - Sidoti
Now looking at California, you are seeing a lot of growth there. It seems like there is a lot of opportunities. It also seems like the market is still a little bit under penetrated. I am just curious from a competitive standpoint, are you seeing more competitors or the competitive environment intensify at all in California?
We had a record building clients or well at least 31% year-over-year and we lost five clients to competition. We are not seeing that and year-over-year I keep thinking that somebody is going to show up and try that and be able to penetrate that, but we generate a lot of customer loyalty in the way we approach and invest back into our clients. And so -- no today we have not seen where we are up against a tremendous amount of competition from the market.
Josh Vogel - Sidoti
Okay, and of the business that you do lose to competitors, are these local players or are they more of the national players?
You know a little of both. There aren't that many local players anymore, most of them have been consolidated through the recession. What you will find is that some of the maybe larger regionals will expand into our space from time to time, but interesting enough they will show up for six months to a year and then they are gone.
They never seem to have the staying power to do well and so we are not seeing anybody really grab a toehold into one of our markets and be able to take that and we are not seeing where the small mom and pop is starting up from scratch and trying to venture into this business where you've seen that in the past basically the 90s and the early 2000 years.
And our next question comes from the line of Kevin Casey with Casey Capital.
Kevin Casey - Casey Capital
[Technical Difficulty] Number of branches, but it seems to be irrelevant going forward. Can you give us number of business units?
Yeah we have 15 branches right now. If I were to scale that out, we probably have in excess of a 100 business units, that's probably -- and that will grow, it might be closer to 100 in a quarter. That was actually -- that's actually a very good question and something we haven’t looked at closely, but we will start to look at that because I think that does represent much more of our scalability, where for instance in Ontario we have five business units within the one branch.
And most of our 100 million plus branches have an excess of 3 and growing to four business units, where emerging branches will in a sense have, our one business unit and as they reach the point where they have two pods or two teams, then we will hire back in to them and they will become business units. But no, that’s something that we will start to count and start to measure a little closer and that was -- actually I had that thought last night myself.
Kevin Casey - Casey Capital
And then you mentioned a little bit about the talent, how easy or hard is it to hire talent and so it’s probably easier because as the recession we had, given over the last ten years. And then how fast can you do it?
You know, my opinion on hiring talent, if you’re really looking for a real strong talent, it doesn’t matter what the economy is and in fact in a down economy it’s almost harder because people don’t want to move. It’s kind of the last-in first-out principle, but for the most part, what we’re seeing is that we've built a reputation and people want to be part of our organization and then because we’ve been able to have the same power through the recession.
And really are kind of, even though we had some noise in the last couple of years that has pretty strong staying power, people want to work for us and I think that finding talent is one thing, the retention of talent is the other. And we have extremely high retention and I can still go back and say over the last few years, other than maybe for a couple, one or two personal reasons, we have not had anybody leave that we really wanted to keep.
And for the most part, our base that we’ve been building over the last five years has been rock solid and of the new people that we’re bringing in, we continue to find stronger and stronger talent everyday. So finding and retaining people is important.
One of the things that we’re working on and in fact we have one going on right now, but as people are hired into our company right now, within three to six months of their new hires, they are coming up and going through a one-on-one boot camp of who we are.
And one of the things that was a concern as we've evolved is that if we were to leave that just for the field, we will continue to make a copy of a copy. We’re now having people come up, we’re having an influence on the direction and vision of where people and how people are looking at the business long term. And so that’s all part of our organizational development plan and maturing the talent that we’re bringing in and then because of that it’s helping us retain the right people and helping us get the avenue to sustain or expand that.
Thank you. And at this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Elich for closing remarks.
Just want to say thank you for staying in touch and having an interest and understanding what we’re doing. We’re very excited about where we are going. It’s much of what we’ve been talking about over the last couple of years. It’s kind of nice to get a win without a lot of noise in the overall quarter and to be able to start to see some of the things coming together. And I think that for those of you that have been watching us for a while, it’s just going to get better from here. Thank you.
Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect.