Barrett Business Services Inc Q3 FY2021 Earnings Call

Good afternoon, everyone, and thank you for participating in today's conference call to discuss BBSI's financial results for the third quarter ended September 30th, 2021. 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 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. The 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 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 with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ from those expressed or implied by the forward-looking statements. I would like to remind everyone that this call will be available for replay through December 3rd, 2021 starting at 8:00 PM tonight. 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.bbsi.com. Now I'd like to turn the call over to the President and Chief Executive Officer of BBSI, Mr. Gary Kramer. Sir, please go ahead.

Thank you, Doug. Good afternoon, everyone, and thank you for joining the call. We had an excellent quarter, both financially and operationally. The positive momentum we experienced in the first and second quarters continued in the third quarter as the economy continued to recover. Our overall performance exceeded our forecast, leading us once again to raise our full-year outlook. During the quarter our gross billings increased 12% over the prior year's quarter and exceeded our expectations. Our average worksite employees were up 8% over the prior year quarter and up 3.5% sequentially from Q2. Please note that we are almost back to pre-pandemic levels and expect to reach an all-time high at the end of next quarter. Our growth in worksite employees is a combination of our clients hiring or rehiring, as well as net new business, and we are ahead of our forecast for worksite employee stack. Our staffing business increased 2% over the prior year quarter. It could have grown more, but continued to have challenges filling orders with the tightness of the labor market. We discussed last quarter that the government stimulus was set to expire in early September, and it did, and that we expected to see an uptick in applicants and placements about three to four weeks after the stimulus expired—and we did. As I look at our results in October, we are seeing more applicants, placing more applicants, and companies are increasing wages to attract employees. We are still unable to fill all of our orders, but our ratio is improving. Next I would like to provide an update on the de-risking of the company. We discussed last quarter that we entered into a workers' compensation insurance transaction which de-risks our business model and results in better financial predictability. This was our first quarter in the newly insured structure and we are very pleased that the program is operating as intended. These transactions are structured in a manner that greatly limits any potential downside of our insurance program, but we can still share the upside of our disciplined underwriting. In essence, we are passing off the risk to the traditional insurance market, but we can share in the reward as we execute with the precision we are accustomed to. Moving to our branch operational updates. Our branch footprint decreased by one to 53 total branches. We continued to expand on the East Coast and opened new branches in Nashville and Pittsburgh. The East Coast is doing well and clients and referral partners are pulling us into the new geographies. We continue to be mindful of operating efficiencies and consolidated Orem into Sandy, Utah and are now referring to this market as Utah County; and Bend into Medford, now referring to this market as Southern Oregon, as well as Monterey into San Jose, California. These decisions were made with the intention of continuing to grow revenue while servicing our clients, but doing so in a more cost-efficient manner. Our branch stratification is as follows: 22 mature branches with run rates in excess of $100 million, 19 emerging branches running between $30 million and $100 million, and 12 branches we consider developing with run rates up to $30 million. Our business units totaled 100 and incorporate the new openings and consolidations previously mentioned. We also continued our migration into a revised structure of the 16-member business units, which allows us to service more clients with fewer management employees and increases our return on management payroll. Moving to our client and worksite employee stack, our client retention continues to be stronger than pre-pandemic levels. I attribute that to the work we do with our clients and the value our teams bring in this ever-changing and complex economic environment. Regarding our referral channel distribution, leads and prospects in the quarter were greater than the previous quarter and exceeded our internal Q3 forecast. We are still behind pre-pandemic levels, but we are optimistic as we continue to see a gradual recovery as economies open. Our closing ratio continues to be in line with historical levels. Last quarter we discussed longer-term initiatives where we intend to increase the top of the funnel by focusing on lead generation via an omnichannel digital campaign where we target both clients and new referral partners in different markets. We are only four to five months into the various trials, but I am excited about what we are seeing and I'd like to provide some statistics since the last earnings call. We've signed up 82 new referral partners and we set up 40 or 74 new meetings with interested potential clients. We are testing and refining our various sales initiatives by market, measuring the return on investment and will transport the most successful method to our other markets. We continue to package our new technology with our nationwide offering and we continue to see larger opportunities. So, to summarize all these efforts, our client retention is better than historical. We are seeing more opportunities than we forecasted. We continue to see larger opportunities and we are closing at the same levels as historical. These positive trends resulted in the company adding 3,200 new worksite employees from net new customer adds over the past 12 months. To put a finer point on this accomplishment, this is the most net new worksite employees from net new customer additions we've added over the past four years. This is a fabulous result and a testament to our value proposition, as well as the focus of the organization. Next, I'm going to provide some updates on other initiatives. We discussed last quarter a new strategy that we are planning as asset-light markets. We have taken lessons learned in a COVID environment for how to operate remotely, coupled with our digital initiatives, and we will hire and train a professional in a new market and have them sell into that market. We will service this client out of an adjacent branch or at corporate and invest behind them in infrastructure as they build up their client base. It is still early, but we hired four new people in the quarter that are currently going through our training and emerging program. Shifting to IT, our internally built client portal, myBBSI, continues to perform well and is being received favorably by our clients. We are committed to quarterly enhancements that will add new features or improve existing functionality. Our vision is to bring on additional products and services and deliver these through the portal and we have a dedicated team working on this. So, in summary, we are in the people business and people have never been more relevant to the business owner than they are today. We are executing on our strategic initiatives and we are realizing positive results and seeing future positive trends which result in our increased outlook for the remainder of the year. Now I'm going to turn the call over to Anthony for his prepared remarks.

Thanks, Gary, and hello everyone. I am pleased to report that our Q3 performance continued to build on the momentum we reported last quarter, with results that were once again stronger than expected. PEO gross billings increased 12% over the prior year quarter and 5% sequentially from Q2 to $1.66 billion. Staffing revenues increased 2% over the prior year to $29 million. As Gary noted, our increase in PEO gross billings was driven by stronger-than-expected growth from net new clients in the quarter, as well as stronger-than-expected hiring within our customer base. Our average worksite employees increased 8% year-over-year, which is 1% higher than our expectations. We also continue to see higher average billing per worksite employee which is up 3% in Q3 over prior year and continues to trend ahead of expectations. PEO gross billings growth by region versus the prior year third quarter were as follows: Mountain States grew 35%, East Coast grew 16%, the Pacific Northwest grew 14%, Northern California grew 13%, and Southern California grew 6%. While Southern California continues to grow steadily, our customers in the region are expanding more slowly than in other regions, and the effect is generally consistent across industries. For example, our construction industry clients in Northern California have grown 10% on average year-to-date compared to only 3% for those clients in Southern California. Workers' compensation expense continues to trend favorably in the quarter and included an actuarially determined reduction of prior year estimated liability of $800,000 in the third quarter. Our claims performance is also remaining favorable with a relative claim frequency 6% lower than the third quarter of 2019. We announced last quarter our new insurance program that became effective July 1st. This new program greatly reduces the workers' compensation risk that BBSI now retains. As a reminder, we now describe our workers' compensation coverage for clients as being under either our insured program or our self-insured programs. Approximately 82% of our workers' compensation exposure, including all California clients, are covered by our insured program. All claims incurred in these states after July 1 are now covered 100% by the insurance market with zero claim cost retained by BBSI. This is a significant change from our previous structure, which included $3 million of retention per occurrence. Because of this move to our fully insured program, our workers' compensation liabilities no longer increased in the quarter, but instead decreased by nearly $19 million as remaining historical claims were paid. Looking at our margin and pricing, we continue to hold our billing rates effectively flat on renewal when compared to the prior year. The workers' compensation market is firming, but it's still competitive in certain geographies and industries for new business. However, our strong client retention is an indication of the value we are creating for our clients even in this competitive market. Looking at operating expenses, SG&A continues to trend in line with expectations. Although employee expenses are up relative to the prior year, the variance reflects prior year reductions implemented during the COVID-19 pandemic that have since been reversed, increased employee travel and marketing costs, and higher profit-share incentive pay in the current year due to stronger-than-expected results. Through Q3 management headcount levels and non-IT operating costs both remained below 2019 levels. Our investment portfolios earned $1.8 million in the third quarter compared to $1.6 million in the prior year. Our investments continue to be managed conservatively and have an average duration of 4.1 years, average quality of investment at AA, and average book yield of 1.8%. Going forward, investment balances will begin to decline as our collateral funding requirements diminish under our new fully insured workers' compensation program. Turning to the balance sheet, we had $116 million of unrestricted cash and investments at September 30th compared to $110 million at June 30th. We continue to be debt free except for our $4 million mortgage on our corporate headquarters. We remain committed to our capital allocation strategy and returned capital to shareholders in the quarter through $2.3 million in dividends and $4.2 million of stock repurchases at an average price of $75.54. At quarter end, there is approximately $31 million remaining on the Board's approved $50 million share repurchase program. Turning to the outlook for the year, given the stronger-than-expected results in the quarter, we now expect gross billings to increase between 9% and 10%, up from 6% to 8% previously, and we expect average worksite employees to increase between 3% to 5%, up from 2% to 4% previously. We continue to expect gross margin as a percent of gross billings to be between 3% and 3.1% and we expect our effective annual tax rate to be between 22% and 24%. I will now turn the call back to Gary for closing remarks.

Thanks, Anthony. In conclusion, we had a great quarter as we executed our short- and long-term strategies. We continue to always think of the client first and to advocate for the success of the business owners. We've been working on the right things and I think we're in a great position for future growth. Now, I'd like to turn the call over to the operator for questions.

Thank you. Ladies and gentlemen, at this time we'll be conducting a question-and-answer session. Our first question comes from the line of Chris Moore with CJS Securities. Please proceed with your question.

Hey, good afternoon guys. Thanks for taking a couple of questions. Maybe I would just start on the mechanics and the impact of the Chubb agreement. My understanding is that you had the two LPTs that basically took care between 2014 and 2018. The current agreement with Chubb starts as of July 1st, 2021, so 2019, 2020 and half of 2021 are the years where you still theoretically would have unfavorable workers' comp claims that could be an issue. Am I looking at that correctly?

Yes, that is correct. So, it was 2.5 years—the only claims we have remaining on the balance sheet. We do have some self-insured claims that are outside of our fully insured program—that's the 18%, which is not part of the fully insured program. But under the fully insured program, those were the only remaining claims.

I know that's a lot of information. I don't want to say it's confusing—it's a lot, and there's a good disclosure in the 10-Q that has the liabilities by year for what we're at risk on.

Got it. Alright, that's helpful. Will there likely be additional LPTs? Is there kind of a normal period of aging—for example, mid next year might be something that's focused on 2019?

Yes. We have it in our plan to look at the next year, but it comes down to price to risk, and if it makes economic sense for both sides of the transaction. So, we both intend to look at it next year and if we can get to an agreeable price, then we'll get a deal. If not, we'll keep it—we're comfortable keeping it if we have to.

Got it. And maybe just one more from me, on the investment income. It sounds like the investable base is going to continue to decline. How rapidly should we expect that to happen?

It will be gradual as we pay claims. Our rule of thumb is that we pay about 25% of our remaining claims in the year and that will drive the rate of decline in terms of the investments. We are seeing rates tick up slightly from their lows, so I'm also optimistic that we'll get some offset there as our investment yield goes up.

Got it. I'll jump back in line. I appreciate it guys.

Our next question comes from the line of Josh Vogel with Sidoti. Please proceed with your question.

Thanks, good afternoon guys. Gary, you talked about initiatives to expand the business, whether opening new branches or the asset-light markets, the trials there, your investments in tech enablement and myBBSI. I'm curious if Q3's SG&A run rate is the new normal—a new normal base for us to think about going forward?

So, Q3 is higher because this is the quarter where we're increasing our guide and there is some variable compensation to the branches as far as profit share—if they hit revenue targets and they're not only hitting them, they are exceeding them. So, there is going to be a variable profit share that realizes in Q3. That will be our highest SG&A rate for the year; it will slow down in Q4.

All right, great. Thank you. Obviously an impressive build in worksite employees. Anything that can be read into the average number being higher than the ending count—was that just because there's some seasonal stuff that hit over the summer months?

Yes. In terms of the pattern of our worksite employee count, it always peaks in the middle of summer and that's driven by two large industries: the agricultural industry and construction, which have more bodies working in the summer.

Right, okay. I was looking at the safety incentive costs and it was down a lot, even from the prior two quarters in which you revised that element of the business. Is this a move to do away with that altogether, and how should we think about that as part of workers' comp going forward?

Good question, Josh. If you go back to this quarter last year, we talked about how we refined our pricing in the market. What we really did was respond to a competitive workers' compensation environment—specifically in California. We lowered our pay-in rates to our clients and ultimately moved that safety incentive upfront and netted it out of what we would charge clients. It made sense because of market competition and it helps clients in cash flow, which we did during COVID. What you see now is we've renewed almost all of our accounts without a safety incentive—some accounts may still have it, but the overwhelming majority do not. What you're left with is a liability that's going to slowly run off or has been running off.

All right, great. And just last one from me right now. Thinking about the vaccine mandates, I know your average client has around 30 or fewer employees today, but you are moving upstream and landing larger national accounts. What dialogue are you having with clients today? You can make the argument that your relationship and value proposition comes into play when holding their hand through a process like this—similar to what you did in the early days of the pandemic with small business loans. Just curious, your thoughts around the mandates, the ongoing dialogue you're having with clients today and whether this is going to be a potential positive or a tailwind for you?

This is tricky because it's still not in effect. What we're coaching our clients on—and that's how we're handling our business now because this will affect our management employees—is: get your plan ready so if it does go into effect, you know how to operate to it. We have our own plan internally and we're working with our clients so they can develop their plans. Anytime, nobody wants to get into a political discussion, because they want to be sure of where vaccines are. This is an example of when you open a business and now you're an employer and you have more challenges—this pulls you away from your core business. We're there to help clients get through this, because we see this and can take it to all of our clients rather than one person trying to figure it out on their own. It really does help the business owner to be with a PEO in times like this.

Great. Well, thanks for taking my questions.

Our next question comes from the line of Jeff Martin with ROTH Capital Partners. Please proceed with your question.

Thank you. Hi Gary and Anthony, hope you're doing well. Gary, I wanted to dive into the referral partner network. You mentioned that the leads are still below pre-pandemic levels. Just curious if you can give us some relative perspective—are they three quarters back, are they almost all the way back? And how would you describe the quality of those leads relative to perhaps pre-pandemic levels?

So, I gave a stat in my prepared remarks: over the last 12 months, organically, business we added versus business we lost—we added 3,200 worksite employees. Over the last 12 months, our organic growth is 3,200, which I think going through a pandemic is a phenomenal number. You take that number and you add in same-customer sales, which gets us up to our total increase. What we're seeing in the pipeline is good quality leads; we're seeing larger leads which we are able to convert to clients. That's really what we're seeing as far as how we were able to build those 3,200 over the last 12 months—we're keeping the business and the business we're adding is larger than it's been historically. Even with fewer submissions, we're adding more worksite employees which is why we changed our metric to focus on worksite employees as opposed to client count so there is no head-count fix on the business. The reality is we're growing the business organically through the pandemic.

Great. And with respect to your omnichannel initiative, could you give us some perspective? We added 82 new referral partners—I'm assuming that's off of a relatively small pilot test, not 82 out of a nationwide broad effort. Some perspective there would be helpful.

Yes. We're doing that in about 20 markets now and these 82 are folks that signed up who want to be partners. It doesn't mean we've done a deal with them, but it means they understand our value proposition, want to learn more about BBSI, and want to sell that value proposition in the market or to their clients. We look at them as future pipeline that the teams in the field are working with to cultivate those relationships and hopefully bring on clients in the future.

Okay. And you also mentioned adding additional products and services on the technology platform. Could you give a sneak peek at what some of those are and how mature you anticipate those being for growth acceleration over time?

Good question. We built our portal with the idea that we own our technology destiny. We have the ability to plug in more products and services—whether we make enhancements to increase productivity or we white-label things and plug them in. There is a lot of potential for products and services that we can bring in. We have people working on executing the product roadmap so we can ultimately have more things to sell to make us either more attractive or the business stickier. But we are not going to reveal specifics until we do the launches on those.

Okay, great. And one housekeeping item: what was the same-customer gross number in the quarter?

Gary said we added 3,200 worksite employees from net new customers. The year-over-year same-customer worksite employee growth was 5,500.

Okay. That's it from me, thanks guys.

Our next question comes from the line of Vincent Colicchio with Barrington Research. Please proceed with your question.

Hi Gary and Anthony, hope you're doing well. I'm curious—are you seeing any pushback from clients on pricing given the wage pressures out there in the market?

I would say no more than normal. It has been a competitive market, driven in part by workers' comp dynamics. As Anthony mentioned in his prepared remarks, we've been able to hold renewals relatively flat. Our markup is relatively flat for 2021 versus 2020. We believe the product we bring to market is worth the price our clients are paying, and because we're able to hold pricing consistently and our run-off is the best we've seen, the indicators point in the right direction.

What portion of your teams have transitioned thus far to the new model with more HR professionals?

That model will be adopted primarily in the larger, mature branches. So it's going to be those mature branches that have or are close to that model. We have 22 mature branches, so those 22 would have adopted some form of that new model.

So, the efficiencies you should start seeing from that are fully in place? Is that what you're saying?

Well, if you think of efficiency, our management payroll is still down compared to 2019. We have more clients and more worksite employees while management payroll remains lower. The reason we're able to do that is because of efficiencies from technology like myBBSI and because of moving to a six-person team model rather than a larger management structure.

And last one from me: how are some of your newer locations performing?

It's still early days. We opened Pittsburgh and Nashville and they are about three months into being new branches. It takes time to judge performance. We have good professionals in those branches—one was from another BBSI branch and the other was a new hire who has been trained and is operating in the new model. We're confident they will do well, but we need to give them time.

Okay. Thanks for answering my questions.

There are no further questions in the queue. I'd like to hand the call back over to Mr. Kramer for closing remarks.

Sure. Thank you everybody for taking the time to be on the call. Thank you to everybody at BBSI for the hard work and a great quarter. I appreciate everybody dialing in and we'll talk to you again next quarter. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.