Michael Elich - Chief Executive Officer Jim Miller - Chief Financial Officer.

Jeff Martin - Roth Capital Partners Matt Blazei - Lake Street Capital Markets Dan Mendoza - Prospect Scott Redmond - Redmond Asset Management Charles Bellows - White Pine Capital.

Good morning everyone and thank you for participating in today’s conference call to discuss BBSI’s financial results for the third quarter ended September 30, 2014. Joining us today are BBSI's President and CEO, Mr. Michael Elich, and the company's CFO, Mr. Jim Miller. Following their remarks we'll open the 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 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 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 November 29, 2014, starting at 3:00 PM Eastern 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..

Thank you, 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 third quarter ended September 30, 2014.

Our third quarter results continued to be balanced by new client additions and strong growth from our existing client base. At 8% same store sales were at the upper end of our high single digit expectations where we added net new 182 clients.

These results reflect our continued focus on delivering a management platform that supports well-run companies over the long term, as well as a maturation of BBSI’s brand in the marketplace.

Before taking you through our financial results 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 with 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 third quarter results, as disclosed in yesterday’s press release of the company’s recording an additional charge to the workers comp claims liabilities of $80 million.

The net funding needed for that charge will be on an after tax basis, which equates to approximately $48 million. I will discuss the charge in greater detail momentarily. In some cases however I will discuss our third quarter results without the impact of the charge, to provide you with a view of the quarter on more of an isolated basis.

Total gross revenues increased 18% to $900.2 million over the third quarter of 2013, primarily due to the continued build in our co-employed client count and same-store sales growth, coupled with an increase in staffing revenues.

Overall PEO gross revenues increase 18% over the third quarter of last year to $851.6 million, due primarily to the continued build in our co-employed client count and same-store sales. Our PEO revenues from existing customers increased approximately 8% year-over-year due to increases in both headcount and hours worked.

This compares to a 13% increase in the third quarter of 2013 and a 9% increase in the second quarter of 2014. Staffing revenues for the third quarter of 2014 grew 16% to $48.5 million, primarily due to an increase in revenues from existing customers and to new staffing business.

On a percentage basis, setting side the additional workers comp charge, gross margin in the third quarter was 4.1% as compared to 4% for the third quarter of 2013.

The key drivers of this quarter's gross margin is as follows; direct payroll cost as a percentage of gross revenues declined slightly from 84.2% in the third quarter of 2013 to 84.1% in the third quarter of 2014, which reflects a small increase in the overall average customer mark-up percentage on a year-over-year basis.

For the third quarter payroll taxes and benefits as a percentage of gross revenues were 7.2% compared to 7.6% in the year ago quarter.

The lower effective payroll tax rate resulted from our ability to optimize the use of prior wages against the taxable wage base as new customers are brought on-board and to a rise in the overall average wage rates, which allow the tax ceilings to be reached sooner in the years compared to 2013.

This continues a trend experienced in the second quarter 2014 and we expect a similar rate of savings to continue during the fourth quarter. During the first quarter of 2014 we announced and began implementing an arrangement with ACE Insurance that provides workers compensation coverage to BBSI clients and their employees in California.

The arrangement typically known as the fronted program provides BBSI with the use of a licensed admitted insurance carrier in California to issue policies on behalf of BBSI, without the intention of transferring any of the workers comp risks for the first 5 million per claim. The risk of loss up to the first 5 million per claim is retained by BBSI.

BBSI implemented this strategy as a means of continuing operations in California. Under California Senate Bill 863, BBSI will no longer have the ability to be a self-insured employer for workers compensation in California as of January 1, 2015. BBSI’s arrangement addresses the requirements of SB863 and allows us to remain in compliance in California.

Today we have transferred coverage of approximately 72% of clients to the new program and we are on track to have most clients converted by mid-December.

Moving on to the workers compensation expense, without the addition charge workers comp expense as a percentage of gross revenues was 4.6%, which represents a 34 basis point increase over the same quarter a year ago, primarily due to the incremental cost associated with the new rates program, and to higher costs associated with administering our workers comp program.

Looking ahead to the fourth quarter of 2014, anticipate the level of gross revenues for workers comp expense to be in the 4.8% to 4.9% range.

This projected percentage increase is due to the increase in the accrual rate for claims expense and a continued transition of California customers into the ACE program and the associated incremental expense of that program.

As expected, once all employees in California are completely implemented into the ACE program, which will be fully reflected in our Q1, 2015 results, the full burden to the workers comp expense will be in the neighborhood of the 25 to 30 basis points we’ve previously disclosed.

We expect to more than recovery this increate expense with price increases in the market. SG&A expenses increased 26% to $21.2 million, primarily due to higher management payroll, increased IT spend and other variable expense components within SG&A to support continued business growth.

The increased IT expense related to projects designed to enhance access and delivery of information to the field, as well as improved efficiencies over time. The provision for income taxes in the third quarter without the effect of the additional workers comp charge was $5.5 million, which represented a tax rate of approximately 35.4%.

However, the income tax rate of 30.6% for the third quarter of 2013 was more favorable due to higher than projected employment tax credits.

As a result of the effect in the large pre-tax loss from the workers comp charge, which impacts the full year tax rate, we expect a tax rate of approximately 43% for the fourth quarter of 2014, but then a return to a more historical range in the mid to upper 30s for 2015.

Now turning to the balance sheet at September 30, our cash, cash equivalents, marketable securities, as well as restricted securities totaled $167.5 million compared to $143.2 million at December 31, 2013.

At September 30, 2014 approximately $15 million of our cash is unencumbered or said another way, not part of our captive insurance subsidiary or our new ACE funded program.

We expect the unencumbered cash to build during the fourth quarter, but as we get towards the end of fourth quarter we will be using a portion of this cash to put into the captive insurance company towards the end of the year.

During the third quarter we funded approximately $8.1 million of cash into the new ACE trust account to supplement our $23 million on deposit at June 30 for our fronted arrangement with ACE. These funds are included with the component of restricted marketable securities and workers comp deposits within long-term assets on our balance sheet.

The balance in these trusts will continue to build as we transition customers into the ACE program throughout the remainder of 2014. We generated approximately $33.5 million in operating cash flow during the first nine months of 2014.

Much of our cash generated from operations is in the form of free cash flow, except for the build and the workers comp and safety incentive liabilities as cash is used to fund our insurance subsidiaries is primary generated from the workers comp expense we recognize, but do not immediately payout to third parties.

This is also true of the new fronted agreement with ACE that actually flows through our captive insurance company as well. During the third quarter we repurchased approximately 28,000 shares for approximately $1.1 million or an average price of $39.95 per share.

We currently have approximately $1.1 million of authorized shares remaining on the repurchase program. We will continue to strongly consider share repurchases as the use of available unencumbered cash as the market should present appropriate opportunities.

As we mentioned on our last earnings call, in order to provide investors with a more appropriate forward looking view of our business, we have initiate a rolling 12 month outlook, which we plan to update on a quarterly basis. As a result we expect gross revenues for the next 12-month period to increase approximately 18%.

Included in this expectation is a high single digit contribution from same store sales growth, as well as growth consistent with trends from new business. Moving on, I’d like to address some recent criticisms of the company and really our three issues that I think merits from further discussion.

The first topic I’d like to address is adverse development a prior year claims.

Over time we had been seeing adverse development of older claims and we believe that if we could proactively affect those older climes and minimize future developments, it would allow us to bring stability to those years and create a basis for estimating cost on a go forward basis.

And I think, as we’ll talk about it here in a few minutes, the charge we took yesterday will greatly address that issue of adverse development that we have seen in our history. The second issue I’d like to address is the IBNR versus case reserves.

Our total claims liability of comprised of two components, one specific case reserves; and two, a general provisions for future adverse development on known claims and that’s referred to as the IBNR portion of the reserve. Typically there is an expected ratio of IBNR to case reserves.

We have continued to progress through the reserve strengthening process in order to move us closer to the ultimate expected level of liability on all open claims, including those in 2013 and 2014.

In strengthening claims for 2012 and prior, we accelerated in the development of those claims, which had a noticeable impact on our IBNR versus the case reserves ratio.

As we move through the strengthening process, we have transferred IBNR to those specific claims, which increased our case reserves and resulted in a corresponding decrease in the IBNR portion of the overall liability. The charge that we reported yesterday will greatly increase that IBNR component to what we believe to be a very conservative amount.

Finally, I’d like to address the issue of the increase in the paid activity.

In addition, due to the strengthening of all open claims for 2012 and prior years, in mid-2013 we initiated a change in reserve practices, in which we are now reserving claims and more fully early on in the claims life cycle, and simultaneously paying more dollars out sooner on those claims, which has allowed us to close more complex claims sooner in their lifecycle and to minimize the cost of future legal expense where before the change in practice we would tend to fight those more complex claims some times over a period of several years, which would result in increased costs.

The change represents managements efforts of putting up dollars on claims quicker and we have seen an increased rate of closer by 27% in the first nine months of 2013, compared to the same period 2012, and have also seen a 69% increase in closer in 2014 versus the same period of 2012 on these claims.

Since we are reserving claims at a faster rate, this reduces our Loss Development Factor or LDF. This is a factor that is the multiplier it takes for us to fully close out a claim after its first year value has been determined.

This is the key in really getting a handle on being able to estimate the future cost of claims, which we believe we have a much better understanding and application of. So while there has been an increase in the incurred and paid activity, we have done so intentionally with the knowledge that we will ultimately reduce our overall cost of claims.

The combined effort of the strengthening process of 2012 and prior year claims and simultaneously change in reserve practices on all claims has caused disruption in our actuarial date for both the incurred and paid values. This disruption we are seeing impacts 2012 and prior years and impacts also 2013 and 2014 as well.

And we believe that it will take some times for that new strength in data to normalize and impact, the positive impact of the changes in practice to fully be reflected in that data. I’d like to comment on the company’s $80 million workers comp charge we reported yesterday and some of the financial effects of that charge.

We anticipate our loss accrual rate for workers comp claims to increase potentially up to 20 basis points or up to 5% of our total workers comp expense going forward. We believe that the current price adjustments being made as a result of the ACE program will also grow towards mitigating the impact of the accrual rate increase.

In order to fund the charge, we anticipating using a combination of cash on hand and debt financing, existing credit facility with our principle bank provides current borrowing capacity of up to $14 million. We’ve entered into discussions with the bank to increase the borrowing capacity and meet the liquidity needs of the company.

As the charge flows through our captive insurance company, we have some flexibility as to the timing of putting that money into the captives and that is, we do not have a hard stop date such as December 31, 2014.

With that said, we will work on moving the funds into the captive in an orderly manner, so that we remain in compliance with the governing captive insurance regulations. The company’s free cash flow, which is typically near its net income continuous to remain strong.

The free cash has been primarily used for the payment of dividends and stock buyback with minor CapEx activity, and during 2014 some free cash has been used into the initial funding of the ACE program, but I should state that the ACE program is primarily funded from the workers comp expense that we recognize, but do not immediately pay out.

We anticipate that the borrowings connected with funding a portion of the maximum expected charge we reported yesterday can be repaid within a range of three to five years at a maximum. I would like to say a couple of things related to that.

In looking back at our history of our equity and going back to the last seven years from 2008 to 2014, we have spent a combined of $109 million for stock buyback and dividends paid out. So I think that that needs to be said, because I think that’s the valuable piece in viewing our company.

We continue again to remain a very strong cash generating operation and continue to see that for the foreseeable future.

One other last thing I would like to say about the charge we took in yesterday’s release, we received the 930 actuarial report during mid-October, and as we went through the report and we are doing our own analysis and have been looking at information for a while as we went through that strengthening process, coupled with the Willis Claims audit that Mike will talk about here in a few minutes.

Its taken several weeks to analyze the data used and to understand how the data and the change that’s been effected in that data by practices that we’ve undertaken to make process improvements.

It really wasn’t until yesterday morning that we finally concluded that we would use the actuarial record as our best estimate, as it was the best supportable information that we had and we felt that it was important that with the information we now have on hand that it was time to recognize the charge.

Now, I would 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. Mike..

adjusting claims to put dollars into incurred more quickly on all claims; we have increased our claims teams allowing for adequate capacity to manage the best practices and we are paying claims faster; and we are closing claims faster as a result of better visibility into the long term liability.

As a result we are seeing incurred amounts on claims increase by 78% in the first nine months for 2013 claims compared to the same period in 2012, while it increased by 149% in the first nine months for 2014 claims compared to the same period in 2012.

The combined factors of the strengthening process and the change in practice are causing disruption in the data that is making it difficult for the actuary models to provide an estimate of probably liability. While the actuary has provided his best estimate of $207 million, we believe this number to be conservative.

That said, by taking the charge, we are impacting the obstacle of the unknown tail factor allowing us to focus on the long-term strategy of the company. Moving forward, overall we are very pleased with the result of the last three months. We have made significant progress in all areas of the business since the beginning of 2013.

In the quarter we added 233 PEO clients, a new record. We lost 51 clients; five clients were for AR reasons. 10 clients were cancelled for non-AR issues and lack of tier progression. 16 clients business was sold and 20 left due to pricing to competition or companies that have moved away from the outsource model, taking payroll in-house.

This represents an approximate build in the quarter of 182 new clients. Also in the quarter we saw an 8% build in same-store sales. As we saw clients increase hiring long with the increase in hours worked in the quarter sequentially compared to last quarter, all trends were seen as positive.

44% of clients had a headcount, which is actually up above 5% over what we’ve seen in past several quarters. 28% clients reduced headcount and 28% of clients were unchanged. We saw 63% of customers increase payroll, while 36% reduced payrolls. 64% of clients increased hours worked, while 33% reduced hours work.

Related to pipeline and regional growth, we continue to see strong momentum across all regions. In serving the organization as to forward-looking pipeline strength and general market outlook, we are not seeing change in momentum and things seem to be continuing on track related to new client ads.

Related to structural and organizational build, we continue to expand and build business units as needed to support current and further organizational and market demands. Currently, we have 35 business units supported by 52 branches.

We are forecasting for an additional one-business unit to start by the end of this year, by the end of 2014 and have forecasted to build as many as 12 business units in 2015. We will add one additional location in San Mateo, California by the end of 2014. We also continue to see positive momentum with new markets opened in the past two years.

We have accomplished a great deal in 2014. Over the past four years we have evolved and reengineered a number of key factors supporting the business model. We now have infrastructure to operate as a much larger company and are starting to see operational efficiencies from various initiatives we have implemented over the past 18 to 36 months.

From an organizational perspective we have just finished our annual all meeting, which consist of our senior team and me meeting with each person working for the company for a full day to focus our attention on the organization and to mature our company’s culture.

My observations from the field, over the last eight weeks is that we have never looked better, leading me to believe that we have turned a corner. With that, I will leave you opened to questions..

Thank you. (Operator Instructions) And we’ll take our first question from Jeff Martin with Roth Capital Partners..

Thanks. Good morning Mike and Jim. .

Good morning Jeff..

Good morning..

Mike, could you go into some detail about the loss development factor specifically.

How is that shifting around with this $80 million reserve charge and where ultimately does it settle in do you think?.

So what happens with your LDF as you move your triangles over time and the triangles are the actuaries model of looking at development in dollars from a couple of different angles by year, as those years develop over time.

So you have a factor of incurred, which is how dollars are put up on claims, and then you have a factor of paid, which is how those dollars that are incurred are paid out, that move within those triangles.

Each year as you have a new claim, you have a basis that’s built, that over time says that if you had a claim today or you have a block of claims today, it may take three years, five years, 10 years to get to a full development on those claims.

Well, as you come into to – and if I go back and I look at old practice, we tended to put up dollars and then we kind of late (ph) wait and see what would happen and then we put up dollars and this was prior to even 2011 where we would kind of spread that tail out a little bit more where it would take us longer to get to the ultimate incurred, which means that your LDF, it creeps, it moves from three to four to five to six, meaning that ultimately it will take longer for you to realize those same dollars.

So it gives you less credit for what you did, because it still says that you have a multiplier on how long it will take you to get to your ultimate expected. When you step back and you start to step into the process of accelerating that process, you get no credit that says that its going to take you less time to get those dollars up.

When in fact the opposite does happen, you are still pegged to your current LDF, which today is closer because of the reserve strengthening to a six or a seven, when that’s actually given us some credit for some strengthening that not really, actuary models don’t allow for a credit to strengthening.

So if you took your number at a seven times multiple to-date, you would take that dollar that you set up and you put up and you’d say I’d have to do it seven more times to get to that number. Well, as we have moved dollars in the triangle, it’s moved our LDF out.

The problem with it is, is that it will take a little bit of time to show that even with what we’ve done in 2013 and what we’ve done in 2014, that your ultimate tail factor or how fast your getting dollars up is bringing that LDF down. So today we believe strongly that the LDF factor is trending lower than five.

Some analysis will tell us that maybe it’s going to settle in around three. If it does, then it tells you that the factors that you are looking at for 2013 and 2014 are roughly double of what you might overall anticipate longer term. So the LDF is really a product of how the claims move.

The problem that we were having in 2012 is that each quarter or each year that you would grow a little bit further and because you would have a development in the claim in 2006, it would move all your estimates all the way through the model, creating a combined effect.

Its not until you can back up and you can look into the bucket and say, we are 100% full in that bucket. So all those claims are fully reserved that you now can say, I have a stable base.

The problem with actuarial models is they look back and they can’t tell whether your 40% of adequate or your 50%, whether your 80%, whether your 90% and then likewise they are only going to give you credit for roughly that’s best, 85% to 90% credit and that’s if they even believe that your 100% full.

So the LDF factor will continue to trend down, which given more time we would have been able to let that play out and then that would have probably had an impact on even the 207 number.

But given with where we are at and what we’ve looked at, we felt that it was the more conservative approach to be able to just say, lets get out in front of this tail and make sure that we are in a good position to over time continue to run.

And know also that we are running and we’ve got good picks or good estimates for our accrual rate, both in ’13, ’14 and the angling in to ’15..

So help us understand the timeline for getting more of a clear picture of how those ultimate claim costs are going to play out.

I mean is it a matter of quarters or is it a matter of a couple of years?.

You’ll get different opinions from different people. The actuary will tell you its going to take you five years, but we feel that with the results that we’ve seen already in the quarter and then even what we’ve seen in October moving forward, that we’ll have a better feel and a much better idea, even by the end of this year of what that trend is.

We’ve already seen where that trend is starting to move down and how I think things from different angles. But I would say that by the end of this year you’ll see some movement I would say in the first six months or to the next three quarters.

Taking us to mid-June or end of second quarter, we’ll start seeing that movement and then now will allow for a more accurate basis I think within the actuarial models..

Okay, assuming that claims, payments and the cost of claims and the frequency doesn’t change much from here, what kind of scenario are we looking at a year or two down the road in terms of this $80 million increase in reserves? I mean is it a situation where that will need to be un-winded and what kind of scenario is required for that to play out?.

Well, I would say two things. One is, is that once you’ve gone through this processing you get on the other side of the tail and you feel that you’re in a very conservative position.

I’m going to be very reluctant to take dollars back to earnings and hopefully we will be able to put ourselves at a higher confidence level and ultimately allow ourselves to maintain a level of adequacy based on the charge that we had and normalize and smooth out the whole business model.

The challenge though, and this is where we were even as much as the last two days, is looking at further out.

If you take data today that you know is skewed, then at some point your going to find that you could be on the other side of that curve, where in a quarter just as we’ve had charges that went up by $10 million, they could go down that much as well, but I think you have a better… Again, we did this because it was in the best interest of the company.

We did this because it gave us a better visibility and one of the things you can’t do and this is one of the thing that we probably could have done going back to ’13 and ’14 or even to the claim strengthening processes, we could have managed the process a little bit to get to a number that didn’t disrupt the data.

The problem I had with that is that until you step in to the ring and get your past taken care of and know where your at, its hard to move forward and so that was really the process that we used.

It was to just go in and just say, lets look at 100% and higher probable expected amount and that will let us as we are even seeing in the closed claims to maybe overshooting and at least in some pockets as much as 120% of what was the actual closed out amount, leaving us to a point where we can say, we feel very comfortable that we are at least to an adequate level and that we are not under reserved.

The run off coming back, I think that we’ll be watching that very closely quarter-to-quarter to not allow for choppiness coming the other direction over time..

Okay. And then diving into the P&L a little bit, SG&A was up pretty dramatically as a percent of gross revenue. Just curious if there were any unusual items in that, I mean maybe quantifying the cost of working with Willis. I mean that might explain some of that. Just curious what kind of SG&A level to expect in the model going forward..

Jeff, this is Jim. Probably the biggest component that we saw move up, and we saw this in the second quarter too, and probably just incremental cost.

We had about $1 million in just IT expense and that again is for the various IT projects we’ve been working on during 2014 and I think we are probably near the peak on those costs and we should see those costs, at least level off and probably start to come down a little bit once we get into 2015, but that’s probably the single biggest driver of the increase in SG&A.

.

I would add to Jeff that in the last couple of years we have been building a lot of infrastructure. We really had to get out in front of our growth rate and retooling a lot and we basically had reengineered the whole company over the last three years.

And in doing that we had to reinvest back a significant amount of dollars to get us to a point where the basis at where we are running today is actually a good solid base and we don’t see stress in how we are running the company today.

One of the things that you compare that over last year or even a couple of years and you see that acceleration in SG&A growth, we’ve had to reinvest quite a bit, but even in the last, and sequentially even in the last couple of quarters, and I’ll refer more to like just our management payroll infrastructure, its really started to normalize where we are not seeing the big jumps quarter-to-quarter that we were seeing going back six months ago or even a year 18 months ago..

Okay. And then just wanted to touch on funding the captive, I think you said about $46 million would actually needed to be funded. Is that taking anticipated tax credits or tax savings…..

Yes, so that net of $48 million, we will realize about 32,000 in tax.

Less cash paid in 2014, we’ll have a carry back to ’13 and ’12 and then that will take care of most of that $32 million and maybe some carry forward into that we’ll use as a credit against 2015 to access when we get into ’15, but yes, that’s kind of the tax piece of that that reduces really the net funding down to a $48 million level..

Okay.

And is that something that could be funded with a surety bond or do you have to put up all cash?.

No, we actually have to post that cash. So in looking at operations, we do have like I said on my prepared statements about $15 million in unencumbered cash and we can certainly use a good portion of that, as well as the variable credit line that we have with our bank and as we mentioned, we are in discussions with the bank to increase that as well.

And you know just cash flow from operations over the next few years should quite comfortably be adequate to fund that level..

Jeff, I’ll also comment. I want to also comment on just the fact that we’ve been asked over a long period of time, what are we going to do with the cash.

Your balance sheet, why do you look at your balance sheet the way you do and the reality of it is that it was hard to say where this whole process would land, but when I was even back as far as three years ago when we were buying shares back and doing some different things, we were always very careful not to extend our balance sheet or lever ourselves to the point that we couldn’t be able to address a situation like this and that’s one of the reasons why we have no debt coming into the quarter..

Okay, and then I’m asking this question, because I’ve been asked it a lot and I think people would like to hear your response on, if you went back over the course of the last five years and worked in this accrual adjustment, what do you think the earnings of the business historically would look like?.

I think you have to look at it from two perspectives.

One of the things that gets missed a little bit is in 2012 we realized that we had to bring our picks up or bring our accrual rate up and if you go back even ’11 over ’12, and then even maybe ’11 over ’15 – excuse me, ’13 and ’14, we’ve increased our accrual rate through increase in pricing and different things, by roughly 100 to maybe 120 basis points, while continuing to earn and grow.

So I guess you could go back as far as even 2011 and maybe back or even 2012 and back and say if you were to have accrued another 100 to 120 basis points, where would have you been.

The one thing that we are comfortable with is that we’ve been going through that change over the last couple of years and that’s why we don’t see our accrual rate or our pick going into out of ’14 and into ’15, being that much disrupted by this ultimate new number. So Jim, do you want to….

Yes, so its again we are having – I guess we would call it better information as a result of the reserve strengthening process we went through and really know now where ’12 and prior really landed with the passage of time.

If you went back into some of those earlier years, they could have been understated by say $5 million to $6 million in some cases and as we’ve seen in our financial results over the last couple of years, there’s been some adverse development of those prior years and that’s what really led us to wanting to get in and view the reserve strengthening program that we did.

.

Okay, great. Let me close the line for others to ask questions. Thanks guys..

We’ll go next to Matt Blazei with Lake Street Capital Markets. Your line is open. Please go ahead..

Hello guys. Jeff covered a lot of ground there, so I have more than a couple of more questions just to clarify. You said that the $80 million charge was very, very conservative and yet I think you also said that even if the trends proved to be better than that conservative number, that you don’t see any part of that $80 million coming back.

Is that correct?.

Well, what I said was that line, it will take a little bit for that. We are using evidence of what we are seeing to-date where on the strengthening process to give us confidence that that number is conservative. As we move into future quarters, we’ll know more, one.

Two, given that the data was skewed, that’s what also makes us believe that the report itself puts us to a conservative level. I’m not saying that it won’t come back.

What I don’t want to do is have one quarter where we are doing something to go get out in front of this situation and putting ourselves in a position where this becomes really a non-issue. We go back in our own history and we look at just AR, where back in 1998 we used to deal with AR issues every quarter and today it doesn’t even come up.

Its been locked down and we are very solid that way. And my view and my hope is that in the next year or so that this becomes, that workers comp is a footnote and it doesn’t consume the topic of conversation. If the report, the future actuarial review had that number coming down, we’ll be forced to have to take dollars back to earnings.

It’s just that we’ll follow the model and follow the process. The one thing that we did in this quarter is we’ve set a new basis for ourselves..

And the other queue I have is that given that you’ve taken a very conservative posture on the reserves, why do you then also need to increase your accruals by 30 more basis points going forward?.

Well, I think we have mentioned that the accrual rate couldn’t needed to be bumped by 20 basis points in future quarters. But the other piece of that is still we are transitioning into the new ACE fronted program and that could be where you’re getting the 30 basis points increase. .

I’d assume that that was involved in the increase in this year. That was the assumption that that ACE transition was part of the 20 or 30 basis point accrual for this year..

Correct, yes. And so the adjustment to the accrual rate for claims, obviously we’ll be watching that growth in 4Q, but that comment was I guess maybe more for 2015 as we analyze that accrual rate for the year..

Yes, well I guess I’m confused that is – I mean taken what you said as a very conservative reserve charge here.

If that was the case, why would the accrual need to pick up rates even more?.

Well, because the charge itself sets the benchmark for where you’ve been in the past and where you are at even in ’13 and ’14. So to-date your sure of that, but then you – and until your given more credit, you start to accrue going into 2015 at a level that’s going to support the new basis that’s being created by the charge.

So its good, its smart business to make sure that you are not disrupting your overall accrual rate. 20 basis points in the grander scheme of it all is – we’ll capture that. We’re capturing that actually just through price increases right now.

But that’s just it could be we’re not – I mean once I’m on the right side of this curve, I don’t want to get on the wrong side of the curve again..

And against that I would say that also we believe that the improvements that we made on our processes will potentially bring that accrual rate down over time, but again until that data settles out, we just we’ll get started now and we need to plan on maintaining that conservatism..

All right, thank you..

Thank you..

Lets take our next questions from Dan Mendoza with Prospect..

Hi. I have a couple of questions guys. One of them, I still don’t really understand the 20 basis point accrual rate that gets discussed. You also mentioned in that same sense in the press release that its 5% of total workers comp on a go forward basis.

So if its 4.6% now, should we be using 4.8% or 5% for next year?.

I think as you model that out its probably going to be in that range, 4.8% to possibly as high as 5%. I think that would be the upper end. (Cross Talk).

Okay.

I mean, the difference?.

Well, but that would represent the full inclusion of the ACE fronted costs as well..

Okay, that’s helpful. One last question on kind of, you talked about the deposit with the ACE increasing as you bring more of your customers or clients onto the program.

Do you envision there being an increase, kind of an overall increase associated with the reserve charge as we kind of move into next year’s agreement?.

No, the accrual rate again is what your feeding that collateral agreement, that’s why you want to get your picks right, because those dollars are funding that collateral agreement, which then those dollars are used to ultimately payoff claims. So again, we haven’t felt like our pick is that far out of line.

So we don’t see where that’s going to change and we haven’t had indication from ACE that that will significantly… This actually helps the relationship and that it gets us trued up to a point where we at least are working off a basis of being more out in front of the process, at least we believe it will be.

We’ll be having conversations around that, but we are not seeing from an earnings basis that will have that much of a change, it might, so….

Right. I understand that it provides them with sort of the opportunity or comments, they look – your reserves are volatile or unknown and we need a little bit more collateral to get comfortable.

But I guess kind of the related question around that just in terms of timing, you mentioned there was not a kind of a hard date to get your captive funded, but I assume you’d want to be – get that funded in front of renewing your ACE agreement at the beginning of next year..

Well, the funding into an ACE agreement is really a separate matter and that’s done monthly and….

No, no, not in terms of the deposit, but just in terms of getting the captive fully capitalized before your renegotiate the 2015 fronting agreement..

Right. Yes, I think that timing will – it will be an event (ph) of that..

Yes, we’ll be putting attention to that, we already are. So its not going to be a delay. We are just going to make sure we have take enough time with the process to be on the right side of the curve as well..

Okay. And how far back do these reserve true-ups go. I’m just trying to, kind of getting back to the question from Roth about sort of pro forming out.

You talked about free cash flow and net income being equal, which is great, but we are going to have to pro forma at this reserve, but wondering over kind of what period of time we should be doing that?.

We went all the way back. We don’t have that many claims prior to – most of the things are closed out prior to roughly 2003, 2004, other than maybe one or two claims that are just sitting out there and that’s just processed. But for the most part, we went back to every claim that’s ever been opened. .

Okay. So we are going back along ways..

A long time. Yes, end of the 90’s..

You guys have been good returning capital to shareholders, but ultimately if you look at that kind of $109 million, you could argue that $80 million of that that you used to return to shareholders should have been, in hindsight should have gone into reserves. .

Yes, yes and that’s why its been very important for me over the last couple of years to get this right. So on a go forward basis we can have confidence that all the pieces in the model, if the model had to grow up, are working as they should be and that the future itself doesn’t pin us back into another corner..

Okay. Well obviously a lot of questions about this, but I’ll let some other people hop on and ask them as well. Thanks..

Thanks..

We’ll take our next question from Scott Redmond with Redmond Asset Management..

Hey, good morning or afternoon.

Could you all be charging more and should you be exiting the PEO services in certain businesses?.

We are very, very ridged about how we underwrite and there are sectors of business that we don’t do business with, today that we did business back with in 2006, 2007.

We look at today, we have no business that’s, no client that’s more than I think 0.5% of our total book and we have, concentration wise I think our largest industry might be 1%, 2% tops. In fact our largest fee code or code that designates where employees are working is 8810, which is office clerical and that’s over 22%, 23%.

So we continue to look at our book and look at where we are taking risks that we shouldn’t be or where we shouldn’t be doing business and keep moving the model to get to a better place there.

As far as being able to increase pricing and do different things, one of the things that – one of the advantages we have in the market is that, if you were to go back 2008, 2009 and maybe even as early as 2010, we were seeing much more as a workers comp company.

I think in the market today if you were to go back, more and more of our clients – in fact I would almost guess to say as much as 50% to 60% of our clients would say that workers comp is a portion of the value proposition, but the real value proposition is through the consultative offering that we have.

And our job over the next several years and actually over the next year things continue to, as we continue to mature, what we are doing is to dilute that value proposition away from being workers comp specific and make sure that we are doing business with well run companies for the sake of the true value proposition, which is more the consultative interface that we have with our clients.

.

Yes, and I’d just say that many areas that we do business in California, those businesses are much better than California as a whole. And its really not, its not about bad business or pricing. .

Okay and then one other things we’ve noted is that the – you have your cost associated with claims, but then there is also a loss cost multiplier relating to serving those claims and getting those closed, and that from what we have seen is going up 30% in the last, since 2010.

Is that a meaningful portion of your increase?.

That’s increased some of the workers comp expense and a lot of that is just in growing our claim management teams as we have continued to grow and to make sure that they are right sized and that we remain in front of the curve with that structure. .

One of the things related to those costs is just as we’ve scaled infrastructure to support a bigger company, we’ve gotten out in front of that and that creates an acceleration to those cost structures.

But over time as we are gaining more efficiency with technology and just reaching a point of critical mass, we’ll find whether those costs and expenses will start to lever themselves a little more effectively as well. .

Thank you very much. .

Thank you. .

And we will take our last question from Charles Bellows with White Pine Capital..

Yes, I guess just to make it simple for me is are you going to able, or how much can you raise your rates on workers comp and get that going? And then where do you sit competitively, especially in California for that?.

We were looking at – that’s a good question. Since 2011 just looking at where we were then relative to where we are now and mark-up percentage in whether it’s a comp or whether is the full value of the offering, we’ve increased our market percentage on an aggregate of approximately about 100 to 125 basis points.

We’ve been going through a process of making adjustments where its appropriate with our clients in the most recent quarters and that’s to accommodate the ACE transition and because of the value proposition that we are offering, we’ve not seen headwind.

In fact I don’t know that we’ve – there’s a few clients that you are going to loose and that’s okay.

That means you are at least getting closer to the market and you are stressing it a little bit that that number is not accelerating, the number of clients that we loosing, and we are capturing that and then in fact we are not seeing headwinds as it relates to increasing pricing recently.

Right now our target is to pick up another 20 to 30 basis points over the next year. .

Okay thanks. That helps..

Thank you. .

Thank you. That concludes our question-and-answer session. I would like to turn the call back over to Mr. Elich for closing remarks. .

Again, thank you for being on the call. I know we’ve been on quite a while and I appreciate everybody’s interest and continue to understand and learn more about what we are doing.

I wish with hindsight that we never have to have any disruption as we’ve had to grow up as an organization and unfortunately that’s a lot of times not the case when you are doing something that’s not been done before, and with each turn of the wheel though the model gets better and we are committed to making it better.

I do feel that we’ve turned a corner. This in particular when I look back over the last four years as we’ve been realigning the entire organization in all aspects and retooling the business model, we had a lot of areas that we had to address and with this latest move today, I do feel that we’ve cleared the desk and that we are in pretty good shape.

We are not going to be perfect moving forward. We are going to make mistakes, but we have a real strong infrastructure, great people, great teams that are committed to where we are going and I have a lot of confidence from where I sit today, that we are going to continue on and the model looks really good. So I appreciate your time.

I look forward to seeing you in the street and I’ll talk to you next quarter. Thank you..

Thank you everyone. That does conclude today’s conference. We thank you for your participation..