Barrett Business Services, Inc. (NASDAQ:BBSI) Q3 2016 Results Earnings Conference Call November 9, 2016 12:00 PM ET
Mike Elich - President and CEO
Gary Kramer - CFO
Jeff Martin - ROTH Capital Partners
Kevin Casey - Casey Capital
Bill Dezellem - Tieton Capital Management
Good day everyone and thank you for participating in today's conference call to discuss BBSI's Financial Results for the Third Quarter Ended September 30, 2016.
Joining us today are BBSI's President and CEO, Mr. Michael Elich; and Company's CFO, Mr. Gary Kramer. Following their remarks, we'll open up the call for questions.
Before we go further, I would like to take a moment and 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 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 December 9, 2016, starting at 3 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. As a reminder, today's conference is being recorded.
Now, I would like to turn the conference over to the Chief Financial Officer of BBSI, Mr. Gary Kramer. Please go ahead sir.
Thank you, Denise. The operations of the company were strong in the third quarter and we believe the results represent a solid foundation on which to build. Net revenues of $225.1 million increased 13% from Q3 2015, gross revenues of $1.2 billion grew 17% over the same period.
Diluted earnings per share were $1.38 compared to a $1.49 in Q3 2015. The Q3 2016 results included non-recurring expenses of $0.16 per share for accounting and legal costs associated with financial restatements, outside investigation and legal proceedings and $0.30 per share for the shareholder litigation settlement.
Also in the quarter, PEO gross revenue increased 17% to $1.2 billion compared to the third quarter last year. Contributing to this growth were 200 net new PEO client additions and same customer sales growth of 9.1%. These results are attributable to growth in the economy and ongoing efforts to develop our referral relationship, as well as the ability of our teams to remain focused on delivering value to our clients.
Staffing revenues in the third quarter increased 3% to $47.9 million compared to Q3 2015. This is the first quarter in the last five where we have experienced a year-over-year increase in staffing sales. We tempered growth in this business due to a continued labor shortage and chose not to pursue client relationships that do not align with our own value. We believe this decision was down and we now believe that these levels would be our new base.
Gross margin in the third quarter was $49.6 million or 22% of total net revenues compared to $42.9 million or $21.6 million in the prior year quarter. Gross margin as a percentage of gross revenue in Q3 2016 was 402 basis points compared to 406 basis points in the year ago quarter.
An increase in payroll and Workers' Compensation expense as a percentage of gross revenues were slightly offset by an improvement in payroll taxes as a percentage of gross revenue. This improvement in payroll taxes was due to a $3.8 million federal unemployment tax credit recognized in the third quarter of 2016. This included $2.9 million for tax years '13, '14 and '15, which is non-recurring.
We continue to see a decline relative -- we continue to see decline in relative frequency of Workers' Compensation plan. Our total working claims at 3Q '16 grew 9% from open claims at 3Q '15, while gross revenue grew 17% for the same period.
In the quarter, we saw trailing 12 months relative frequency of claims as a percentage of payroll decrease 14% compared to the third quarter of 2015 and the decrease of 18% compared to the third quarter of 2014. This is a continued result of the way our branch has managed their client retention and acquisition.
Claims from 2012 and prior continue to show positive trending which leads us to believe that our effort of strengthening have had the intended effect. The significant of the 2012 and older claims is that they are now well seasoned and having them fully strengthened provide us with a solid basis for analyzing the development of claim years '13, '14, and '15. We have two actuarial loss periods under the new normal which is important as our outside actuary has incredible base line to start future projections from.
SG&A in the third quarter was $30.4 million or 13.5% of total net revenues compared to $25.4 million or 12.8% in the prior year quarter. The increase as a percentage of revenue was primarily due to non-recurring expenses of $1.7 million related to accounting and legal costs associated with financial restatement, outside investigation and legal proceedings related to security law issues.
We are increasing our 2016 estimates for accounting and legal costs associated with financial restatements, change in Auditor, outside investigation and legal proceedings related to security law issues from $6.4 million to $8.2 million.
These analysis not include the $3.3 million share holder litigation settlement. Our effective tax rate in Q3 2016 was 31.9% down from 33.5% in Q3 2015 due to lower taxable income as a result of the non-recurring expenses and the shareholder litigation settlement.
During the third quarter, we paid off the remaining $7.5 million on the Wells Fargo notes a quarter earlier than required and we had no borrowing under our line of credit with Wells Fargo as of September 30, 2016. The only remaining debt we have is the $4.7 million mortgage on the Bank of Washington headquarters.
At September 30, 2016 we had cash, cash equivalents investments and restricted securities totaling $325.6 million compared to $296.7 million at June 30, 2016.
As part of our fronted workers' compensation insurance program with Chubb, formerly the ACE Group, we established and funded a trust called the Chubb Trust. On the balance sheet the Chubb Trust is included in restricted cash investments, the balance in the Chubb Trust was $235.3 million at September 30, 2016 and $232.9 million at June 30, 2016.
The September 30, Chubb Trust balance does not reflect an additional 13.2 million that was in transit and pace of travel in September 29, so it was not deposited into the trust account until October. On the balance sheet, this in-transit amount is included in other assets. The debt program has insured and is more predictable it has been and as such we will see our net funding levels decrease going forward. This in turn will increase our unrestricted cash position over time.
On October 27, we announced the agreement with Federal lawsuit filed as a class-action on behalf of shareholders in November 2014, the settlement subject to approval by the U.S. District Court for the Western District of the Washington calls for the payment of $12 million with approximately $8.7 million to be paid by BBSI’s insurance carrier and $3.3 million paid by BBSI.
The $3.3 million litigation settlement was recognized in the third quarter of 2016 in other expense. This settlement avoids the cost of distraction associated with prolonged litigation and that allows us to focus on our core business and growing our organization.
On September 20, 2016 we appointed Deloitte and Touche as our new principal independent registered public accounting firm. We’ve also retained another big four public accounting firm to assist with assessing and enhancing our financial control environment.
On October 11, Tom Cusick was appointed to the Board of Directors and as a member of the audit and compliance committee. The Board of Directors is continuing their search for an additional individual to add in the ensuing month. These appointments and actions are all part of our short and long term remediation plan that we are executing to and we’re pleased with our progress so far.
As we introduced last year in order to provide our investors with a more appropriate forward looking view of our business we have initiated a rolling 12-month outlook for gross revenues, which we plan to update on a quarterly basis.
We continue to expect gross revenues for the next rolling 12-month period to increase approximately 18%. Due to the aforementioned $0.30 settlement charge and an increase in nonrecurring legal and accounting expenses BBSI now expects 2016 diluted earnings per share to be $3.
Now I’d like to turn the call over to the President and CEO of BBSI, Mike Elich who will comment further on the recently completed third quarter as well as our outlook for the remainder of the year. Mike?
Good morning and thank you for taking time to be on the call.
Before moving on to a discussion about the quarter, I’d like to highlight a few areas of note. In recent months we spent time in the field getting perspective on business and guiding the organization and looking towards 2017.
Specifically we conducted operational reviews with all area managers in the company assessing the performance of each branch and we conducted our annual all meeting as the means to setting tone for 2017 during which we spent a full day with each employee in the organization over the course of 14 days and five regions.
As Gary mentioned in addition to a new seat on the Board and engaging Deloitte we continue to execute on our remediation plan while laying a solid foundation for the future.
Moving forward in the third quarter of 2016 we saw through growth and maturing of our brand in all markets, the strength of our organizational bench and culture of BBSI as evidenced by progress we saw in our operational reviews and in our all meeting as well as consistency in tone and messaging across the organization and in the market.
In the quarter we added 287 new PEO clients. We lost 87. Three were due to accounts receivable issues and were due to lack of tier progression, 3 were cancelled due to risk performance, 22 businesses sold or closed, and 49 business left due to pricing, competition or companies that have moved away from an outsourcing model. This represents approximately net build in the quarter of 200 net new clients that we also saw same-customer sales increase 9.1% in the quarter.
Related to pipeline and regional growth, we continue to see consistent activity in pipeline and new client growth as a result of focused efforts on our referral channel. As we focused attention on the drivers supporting growth and retention we continue to see broader contribution to client growth from all regions, as a result of these efforts.
Related to structural and organizational build, we have made multiple additions to our accounting team -- accounting and finance team including a new controller and new assistant controller. We continue to build business units as needed to support current and future organizational and market demand.
We currently have 52 business units supported by 55 branches. We currently have five business units in development, which will bring our total of 57 by the end of 2016.
We now have 15 branches that have or will have reached the $100 million mark by the end of 2016, a measure we use to indicate a branch's ability to increase leverage and tipping point of our brand in these markets. We have two branches slated to open in coming months on the East Coast and in Southern California, which will bring our total branch count to 57.
Also we have restructured our IT organization to better align with the structure of our field organization and culture and client lifecycle in support of our next leg of growth.
Related to systems, our philosophy is to focus on systems that first allow our teams to engage more effectively with their client, second allowing our teams to collaborate with each other more efficiently because it’s people not systems are our product. We emphasize systems that support operational leverage.
And also sales force and 360 have been successfully adopted by the field we can see the value these tools provide to our team. Both tolls support collaboration and bring visibility to our two key drivers.
Related to workers' comp and underwriting of risk, we continue to make progress in bringing predictability to the company's workers' comp expense. Through our approach to running the company and bringing business owners to run better companies, we're seeing systemic improvements related to stronger cultural alignment with all disciplines during pipeline phases, which continues through the client relationship. Emphasis on continuous improvement and on root cause analysis as we interface with our clients, and focus on frequency as a controllable factor in claims expense.
Moving forward, we will continue to monitor trends to maintain a proactive position related to workers' comp. We expect this to continue to result in greater predictability within the model. Looking at the remainder of 2016, over the past many months we've often talked to our internal teams about the need to run two companies, one that exists that support the efforts of small business and the other that exists to support the interest of shareholders.
Having spent the past two months in the field I continue to be impressed by the maturity of the organization, the progress we’re making and the impact we are having on our client companies. I have confidence that we have continued focus on the right things to build a good company. Our leadership bench in the field is growing strengths at an impressive rate and it is the role our executive team to continue pulling them forward.
On the public front we continue to remove obstacles to include settling of the shareholder litigation, significant advancement with our Board composition and new auditor. Additionally we were able to pay off our Wells Fargo note ahead of schedule.
As I look at the organization today, I can look forward with confidence that our efforts are beginning to have the intended effect. We've put resources into the organization we're building, with the emphasis on bringing predictability to the model. We have operationalized our approach to developing our leadership bench and have roughly 18 months runway.
We have brought a consistent approach to channel development, resulting in predictable pipelines and new client builds. And we have focused on systemic reduction of risk in our client's businesses resulting, in continued decrease in relative frequency and an increase in predictability.
As an organization we seek to help small business navigate plateaus and inflection points within their growth. We have learnt from our clients' experience and our own and we speak to share the lessons we’ve learned. Looking today, we are executing on a plan and we plan - and we have made critical steps towards migrating plateaus in our own business as we grow.
With that, I'll turn it over to questions.
[Operator Instructions] And we'll take our first question from Jeff Martin of ROTH Capital Partners. Please proceed sir.
Thank you, good morning. Mike, could you talk about - or Gary perhaps might have more granularity on the detail, but same-store sales growth 9.1%. How does that break down between headcount, hours worked, wages, and then just general pricing?
I would probably say on the general pricing front it's just pretty flat. I wouldn’t probably attribute it much to inflation there. Probably if you were to look at hours worked to - hours worked and headcount added, it's hard to really get to that granular detail but we would suspect looking at the data that headcount has been a little bit flat in the quarter but hours worked seem to have increased throughout the quarter. Could be an indication that small businesses aren't really taken the risk - weren’t taken the risk during the quarter to higher and against the tighter labor market is well chose to increase hours worked more than headcount.
And then we didn’t really see a lot of moment year-over-year basis as far as increased or wage inflation maybe some so far a bit, I would say probably two-third is probably due to hours worked and headcount added and then maybe a third related to wage inflation throughout the year.
Okay. Bigger, broader question on Affordable Care Act, if that were repealed over the coming years how do you see that affecting the business?
My view of that is our business we have never attached ourselves to healthcare’s value stream. We do continue to build systems that help in the collection and remittance of information and data just to afford the rules of Affordable Care and I think that’s the value we bring to clients today but wouldn’t be missed if it wasn’t needed.
I would say that for many small businesses if they've incorporated the class - the health benefits today that it would probably be pretty disruptive for them to discontinue providing health benefits, so that might already be in their DNA. What it could give for small businesses is the market that we’re changed too much it maybe adverse in pricing because you wouldn’t have the big of an aggregated pool.
But for our model in particular, the effect would be more neutral. I think it would be any disruption that might come to small business, but if anything it would be taking pressure off where they are living.
Right, okay. And then to shift over to worker's comp, in California what are the pricing trends you are seeing on a market basis, not necessarily specific to Barrett, but on a market basis?
We’re not really - we kind of got a good take in the ground. You know it is - the market is softening a little bit and we’re just making a trace not to chase business but we believe that are offset and our value set is bridging any gap or we might see softening market related to workers comp but the trend of races probably more neutral for down.
Okay. In terms of the reserve accruals, any shift in any contribution positively back into gross profit in the quarter from a worker's comp adjustment?
Hi, Jeff. For the quarter, from the second quarter last year we had a - I’ll call it a prior period credit of $2.7 million. In this quarter we had a $1 million credit. $1 million in the quarter for change in estimate for prior period.
Okay. And then as we look at worker's compensation expense as a percentage of gross revenue it's about 5.1% in the quarter, is that a level we should model going forward, or is that going to come down a little bit over time?
Around 5 is the good number. It's going to ebb and flow a little bit but 5 is a good number. This quarter compared to last quarter it was - we had a reduction in what I’ll say for prior period decreases which is affecting it. And we also had a minor uptick for the way that we’re handling the MCC versus prior.
So we had a little bit of not as much of the change in ultimate a little bit of an uptick but around 5 is where, up or down a little bit is where we sit.
Okay. Great. Thanks for taking my question.
And we’ll take our next question from Kevin Casey of Casey Capital. Please proceed, sir.
Hi, couple questions. One next year if you add up your non-recurring plus your guidance, you get up 406. I was curious if some of those costs are actually recurring like their controller, assistant controller to be custom more of the finance or is that the base to use going forward?
We don’t know -- we don’t have control on some of the outside investigations as far as the SEC. That’s going to take what it takes and the costs are going to be what they are or just complying. The one increase that we know about that we'll have is the change in auditor in the first quarter. As far as the fourth quarter expenses that start with the K review, which will trickle into the first quarter.
We know that that will be up a little bit on a year-over-year, but the expenses will not be up significantly. We’re going to – we try to keep that a region or a range that's in line lower than our gross rev growth.
Hi, Kevin I would also say that we're - from an SG&A, we’ve had a lot of build over the last several years and we’re continuing to build up front of rule, we made enough normalization there that might offset a few of those costs. So I think that for us wouldn't be a bad basis t that basis forward.
And then can you talk about ballpark percent of net income, the cash flow is? And you kind of mention that’s been ticked off, I was wondering, this is starting next year, we have to wait another year to talk about that?
Yes, so we’re going to see a growth in our unrestricted which is going to be attributable to A, higher net income, and then B, call it the stabilization of the funding with the Chubb program. So we’ll get an uptick for unrestricted for all of those plus also we don’t have the debt payment going forward. So cash flows are looking promising.
And then do you have the frequency trailing 12 month, as opposed to just for the quarter. So we can get more of a feel for the trend on Worker’s Comp?
I'll have to get that back to you. I have it for the quarter and for the quarter-over-quarter for not just for the year.
Yes, I think trailing 12 month and I’m not going up, what I have in front of me. But I take that trailing 12 is down – were down 7%, or 5% or 7%.
Yes, I think it’s down 14% over 15% and 17.5% over 14% on a year-over-year basis.
Okay. I think that’s everything, thanks congratulations on paying all your debt down.
[Operator Instructions] And we’ll take our next question from Bill Dezellem of Tieton Capital Management. Please proceed, sir.
Thank you. I wanted to follow up on that kind of that baseline point does roughly $4 a year if your revenue guidance is roughly 18% growth, if we add 18% to the $4 that takes this up around the $4.70 plus mark. Are we thinking about that correctly or is there some big piece of the puzzle that we’re missing?
No, I mean in a linear model that – without any other surprises that we – as we’ve add deal with the past year. We would expect that would be a fair way to look at it.
Mike, I think you’ve had a lifetime of surprises, so what’s the…
I would concur.
Next I think for your help there, next is relative to the staffing business. I think in the open remarks, if you had referenced that that business seems to stabilize, but it actually up about $10 million if I remember right sequentially which is better than the stabilization. Would you talk about kind of what you’re actually seeing there in a better more detail please and how we should be thinking about that business?
So if you look at the year-over-year base, probably use that as your better comp, so it was up 3%. So the problem sequentially is that you have a lot of seasonality in the third quarter and when that process a little bit, that might to store a little bit of where that trend might be.
So I would probably use if you were comparing year-over-year basis you want to look forward, 3% growth over where we’ve been seem to be reasonable if you were to take that out next quarter or even a next year and it my might increase from there some. I think that’s a better way to look at it rather than sequentially.
That is helpful. Thank you very much.
At this time, we conclude our question-and-answer session. I would now like to turn the conference back over Mr. Michael Elich. Please proceed.
Thank you for taking time to be on the call. We will continue to be available and keep you informed as we keep moving the company forward. Look forward to the journey. Thank you.
Thank you for your participation. We look forward to talking to you again in our fourth quarter earnings call. Thank you.