Barrett Business Services Inc Q4 FY2020 Earnings Call

Good afternoon, everyone, and thank you for participating in today's Conference Call to discuss BBSI's Financial Results for the Fourth Quarter and Full Year Ended December 31, 2020. Joining us today are BBSI's President and CEO, Mr. Gary Kramer; and the company's CFO, Mr. Anthony Harris. Following their remarks, we'll open the call for your questions. Before we go further, please take note of the company's Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995. This statement provides important cautions regarding forward-looking statements. The company's remarks during today's conference call will include forward-looking statements. These statements, along with other information presented that does not reflect historical fact, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by these forward-looking statements.

Thank you. Good afternoon, everyone, and thank you for joining the call. 2020 proved to be a challenging year for the world and the economy. I am extremely proud of the work that our business teams performed throughout the year. We quickly embraced working remotely, and our operations did not miss a beat as we assisted our clients with the rapidly changing economic and regulatory landscape. Our client retention rate was the best we've experienced in years, and our client failure rate was better than expected. I'd like to attribute that to the work we do with our clients. This ultimately led to our gross revenue and profit being better than we forecasted. We also executed on various long-term strategic initiatives, including securing a nationwide PEO license, standing up myBBSI, our state-of-the-art technology portal, and derisking the company with an alternative insurance structure. I want to again thank everyone in the BBSI family for their exceptional efforts. Plainly stated, I am proud of the actions everyone at BBSI contributed and of our financial results. Before I step into the fourth quarter operations and the outlook for 2021, I'd like to take some time to discuss metrics that the executive team utilizes to measure and manage the operations. First, we grow by adding additional clients, maintaining good client retention and by our clients themselves growing. Our clients grow by adding more employees, which we refer to as worksite employees, by their employees working more hours and with wage inflation. Worksite employees is a key driver of our clients' businesses and are the closest metric that correlates with gross billings. Going forward, we will be reporting on and providing guidance for worksite employees and average worksite employee growth. We will no longer be providing information regarding client counts as this may not truly reflect gross billings. The purest example of why this is important is to take a retrospective look at 2020. We started the year with 7,200 clients and 115,000 worksite employees. We finished the year with an additional 398 net new clients, but our worksite employees decreased to 109,000 or 5% as a result of the pandemic. The decrease in worksite employees for the year translates better to our gross billings decrease of 1%.

Thanks, Gary. Hello, everyone. I am pleased to report that our Q4 results and our full year 2020 results were both stronger than expected despite the continued economic impacts of the COVID-19 pandemic.

Thanks, Anthony. In conclusion, 2020 was a challenging year and the company managed to exceed expectations. Our product is strong and has never been more relevant to the business owner. We are working on the right things and I am extremely optimistic about the future. We continue to always think of the client first and to advocate for the success of the business owner. Now I'd like to turn the call over to the operator for questions.

And our first question comes from Chris Moore with CJS Securities.

Maybe we could start with the gross billings growth. Just the guidance is 2% to 5%. Can you maybe talk a little bit about the puts and takes between the low and high end?

Yes, Chris, it's Kramer. Generally speaking, forecasting in this environment is challenging, and we want to present something we feel confident about that we believe is achievable. While it's not guaranteed, we think this range is within reach. If we look at the curve, Q1 will be our toughest comparison, Q2 will see the most growth, Q3 will be lower than Q2, and Q4 will be lower than Q3. We're comfortable with the numbers we have projected in the 2% to 5% range. Looking at the broader economic trends, we expect the economy to behave similarly to how it is now, and we anticipate that in the latter half of the year, particularly starting in the third quarter, business activity will pick up for us in terms of new additions.

Got you. So SG&A is going to be a little bit below fiscal '19. I haven't had a chance to put this in. So at the midpoint of gross billings growth at 3.5% and gross margin in the 3% range, roughly, where does that get us EPS?

We gave you all the numbers. You got to do the math.

Fair enough. To make sure I understand that the WSE growth versus the gross billings, the delta is just the payroll growth at the WSEs?

Yes, that's correct.

Can you discuss the 6-team approach a bit more? There are three human resource people within each team, correct?

Yes. We have improved efficiencies with our new technology portal, which positively impacts both risk management and payroll. On the risk side, we've gained insights from remote work that have allowed us to complete our tasks more effectively. One of the significant strengths of BBSI is our HR and HR consulting. We have enhanced that business unit by providing additional HR support, enabling us to serve nearly double the number of clients. This strategy increases our return on management dollars from a 5x return to an 8x return. Therefore, we can service more clients with the best of BBSI while reducing management payroll.

And our next question is from Jeff Martin with ROTH Capital Partners.

Gary, I want to get your sense in terms of growth initiatives, not necessarily this year but over a 5-year period. Are you kind of on hold with some of those or paring them back while we kind of trudge along and gradually recover here this year? And then also wanted to get a sense of your view on lead generation, if you see a shift over from the intermediate to longer term in terms of generating additional client referrals, given that's one of the primary inhibitors to growth currently. And will you take a direct sales approach at some point to go after larger accounts?

Yes, I appreciate the question. You mentioned I have two questions, but there are actually several points to address. Let’s discuss our growth plans. In the last quarter, we consolidated three branches, a strategy we’ve implemented in earlier quarters to effectively service those areas while continuing to expand our business. Many of these branches are located within 40 minutes of each other, allowing us to manage them under one team and promote growth while being more cost-effective. Nonetheless, we are making investments. The SG&A figures include plans to open additional branches, with an anticipated addition of three to five branches in 2021. These new branches will follow the model established in 2020, which includes a local salesperson supported by either an adjacent market or our corporate office. As these branches increase their business, we will begin hiring locally to support that growth. We remain committed to investing in new branches and business units. Regarding lead generation, we’re implementing various initiatives and understand that it’s more challenging during COVID to attract new business. Rather than waiting for opportunities to come to us, we are proactive in seeking them out. We have strategies integrated into our operational plan for 2021, but I’m not prepared to disclose details until we confirm their success and the organization adopts them. We are being careful in our approach to this aspect as well.

Okay. And then was curious if you have a sense of, relative to the first round of PPP loans, if you're seeing a significant number of clients get a second round or if they're applying for a second round.

So similar to last time, it's difficult for us to get good data on that, right? It's mostly anecdotal. But the answer is, yes, our clients are participating in that and taking advantage of that as well as the other relief that was included, the expansion of the employee retention tax credits as well as the extension of the FCRA. So those are all a boon for small business, including our clients. And so we're grateful for those, and they are having an impact.

Okay. And then I know you gave guidance for gross profit as a percentage of gross billings. But within that gross profit guidance, what kind of assumption is embedded in that for workers' compensation? Is that going to stay in the 3.7% to 3.9% range that you expected for the third quarter for next year? Or is there additional benefit forthcoming?

So we introduced that workers' comp guide range at a time when our program was experiencing some uncertainty; we wanted to be able to give that transparency. And as the program has become more predictable and a pretty steady trend of favorable results, really, the more important metric, we think, is the gross margin percent, which obviously is influenced by that workers' comp number. But we've seen the positive trends in workers' comp. We expect those to continue. We're not giving a specific guide range for workers' comp this year. But there is no evidence that the positive trend line we've seen would change.

Okay. And then for the final question, can you share the overall pricing on a blended basis across the book? What was your experience in 2020, and what are your expectations for 2021? It would be helpful to have some directional insights.

We have noted the weakness in the workers' comp market for the past couple of years and have adjusted our strategies accordingly to manage our portfolio and maintain profitability. In the second quarter, we mentioned the reduction in the safety incentive to enhance the efficiency of that program, as we are unable to charge what we could previously. However, it appears we are nearing the bottom of this cycle, and I believe it is beginning to turn. Looking ahead to 2021, I expect the market to be stable or improve. Given the low interest rates and the current market conditions, it seems unlikely we won't see rate increases in workers' comp. While we're not aggressively pursuing this yet, we are observing our competitors raising their rates, and we will certainly take action to align with the market when it shifts.

And our next question is from Josh Vogel with Sidoti & Company.

You were talking about profitability management, and you had priced out 124 clients in the quarter. Are you done with that? Or should we expect to see more of that at least in the early part of this year?

Good question, Josh. Generally, we see addition through subtraction in this context. We might lose some revenue, but we compensate with profit. This strategy began in the second quarter of 2020 and involves our underwriters collaborating with our branches to evaluate certain accounts and adjust pricing based on risk. Throughout the year, we implemented these changes, with a noticeable increase this quarter due to the market cycle for year-end business. I expect that in the first quarter, we will continue to see some of these adjustments, although they will likely ease after we move past the second quarter. It's in our nature to prioritize both client relationships and profitability, and we aim to foster mutual success. However, I do not anticipate a shift as significant as what we experienced in the fourth quarter.

Great. I know the pandemic makes this next question a little bit murky, but it's been about 9 months since the rollout of the portal and the big build-out you said was completed in February. But have you seen any quantifiable success here when we think about new business or opportunities in the pipeline that were driven to you because of the portal?

Yes, that's a great question, Josh. This is why when we discuss WSEs externally, we're also talking about them internally. Our sales teams have metrics, and their goals are focused on WSEs rather than client size. Currently, we are observing more significant opportunities. In Q3, we encountered an increase in large opportunities, and in Q4, we successfully closed more of them. That's why I mentioned that we saw a 25% increase in Q4 compared to Q3 for accounts exceeding $1 million in payroll, which is closely linked to our ability to deliver the IT solutions that larger clients demand.

I appreciate that. So your definition of a large client is north of $1 million in annual payroll. So what percent of your client base exiting the year falls under that definition?

I don't have that information. However, when we examined our profitability management, we approached it from two angles. We assessed where we were losing money from an insurance viewpoint and where we weren't profitable from a margin to worksite employee perspective. In Q4, we increased pricing on smaller accounts, which are more sensitive to price changes. Despite losing a number of small accounts, our worksite employees still grew during the quarter.

You've accumulated a significant amount of cash and have been investing in the portal and business teams. You mentioned potential acquisitions in underserved markets that align with your client and cultural values. I'm interested to know your plan for capital deployment this year. Additionally, what is the ideal amount of cash you prefer to maintain on your balance sheet?

We prioritize maintaining our financial strength, but we haven't disclosed the specific safety net number we are comfortable with as it is somewhat subjective. We have our own internal figure, but it's not public. When considering excess cash, our first focus is on investing in the business, which could involve mergers and acquisitions that align strategically. We're also dedicated to enhancing our IT systems, including improvements to the myBBSI portal. Additionally, investments will be made in sales and marketing initiatives. We remain committed to stock buybacks and dividends, and as the year progresses, we can provide updates, but this is our current plan and philosophy.

Yes, Josh. And then on the acquisition side, we've been active in the market for the last couple of quarters, probably for the last 3 quarters. And my view on acquisitions is I'd rather not do an acquisition than do the wrong acquisition. So we will be meticulous and thoughtful about companies that we bring in under the BBSI umbrella. We are looking, but I come from the school of you got to kiss a lot of frogs when you do acquisitions, and we're not going to rush into it.

That's certainly a good strategy. When we consider your PEO platform today, it's evident that there is a digitization revolution happening, especially in large enterprises, which is gradually affecting the SMB sector. As companies strive to move to the cloud and improve their back office and administrative functions, how well is your PEO platform equipped to manage this, particularly beyond just the portal? You touched on this earlier, Anthony, but what new features or capabilities are you planning to introduce to the platform? Will these be developed internally and organically?

Yes. Good question, Josh. We're currently in a strong position with the development of myBBSI because we can integrate various products through our portal to benefit our clients. Our focus is on generating revenue, improving margins, and increasing customer loyalty. We didn't have this capability until recently, as we just completed a major update to myBBSI about a week and a half ago. Now, we're exploring additional features to enhance our offerings. We have ongoing projects, but we're not ready to share details at this time.

And our next question is from Vincent Colicchio of Barrington Research.

Yes. Gary, just curious in the workers' comp market. Is it simply pricing discipline that's brought to market to a better place? Or has there been any consolidation or any other industry changes?

No, it's a function of workers' comp has been a profitable line. When there's profit, people flock to it. When they flock to it, prices go down. And we've seen year-over-year price decreases that we think are going to subside in '21.

Okay. You gave a good read on quarterly revenue outlook. I missed if you said it on Q1. How does that look sequentially?

In the first quarter, we anticipated it would be our most challenging comparison since we grew 6% in the first quarter of 2019 and the first quarter of 2020. However, what we have observed so far is that we finished the year strongly, particularly with our WSE stack showing growth. We also experienced a robust selling season at the start of the year. Although we expect the first quarter to be our slowest growth quarter this year, we are confident in our solid foundation or stack, which we believe will enable us to achieve positive growth moving forward.

Okay. I'm curious to know what feedback you are hearing about the new portal and how it compares to your more automated competitors.

We have made significant progress compared to our previous capabilities. We transitioned from a payroll engine to a comprehensive platform, resulting in a much more user-friendly and adaptable system. Our clients have shared positive feedback regarding its ease of use, freedom, and flexibility. We regularly evaluate our technology against competitors and have confidence in our position. I believe we can stand alongside any competitor in terms of technology.

And our next question is from Bill Dezellem with Tieton Capital Management.

A couple of questions. I'm not sure if you covered this, but I'm trying to back into what's happening with wages. So you had a 6% decline in employees. With billings up 1%, does that imply that compensation on average was up 7%?

Not the 7% but you're picking at the point, which is what we saw when our clients faced tough times was that they let go their low-wage employees, which was driving up our average wage per WSE.

Okay. That's very helpful. And it actually leads into the next question I was trying to think through. So employee count is down 6%. How much of that is, to your point, cost savings where they were let go, again, to improve profitability versus COVID restrictions leading to them being furloughed or otherwise laid off? And I'm trying to really differentiate between those 2 buckets as cost savings measures versus COVID restrictions.

I would be guessing if I provided you with those specifics. When we process payrolls, we include only those who are on the list. I can tell you that the COVID restrictions peaked in Q2 and then began to recover. By Q3 and Q4, we returned to normal conditions. Fortunately, we are not in the sectors that were significantly impacted, which has been a positive aspect of our client base. Our clients have shown great resilience, and our product remains robust. If you had asked me in March if we would end the year down 1%, I would have been surprised by that figure. Overall, we are quite satisfied with our year-end results.

Great. And then finally, relative to Southern California, is there anything that you feel like you have in terms of levers that you can improve the revenue situation down there since it's the only region where you are seeing a decline?

The decline in revenue in Southern California is primarily due to our clients reducing their size and the impacts of COVID in the area. We believe that depending on how the economy recovers, Southern California will experience the most significant rebound compared to other regions. The Mountain States have remained relatively stable throughout this period and are not expected to see the same upward trend as Southern California. Therefore, when the economy returns to normal, we anticipate a positive boost for us in Southern California.

At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Kramer for closing remarks.

Once again, I just wanted to thank everybody, and I want to thank all the BBSI employees for all their hard work and challenging year, get through 2020. We are very optimistic about the future. We know that we're working on the right things. We know that we have the right product, and we know that our product has the relevance. So we are excited about the future here. So with that, we're going to let it go, and thank you everybody for joining.