Barrett Business Services Inc Q4 FY2021 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, 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 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. 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 filed 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 April 2, 2022 starting at 8:00 PM Eastern 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 would like to turn the call over to the President and Chief Executive Officer of BBSI, Mr. Gary Kramer. Sir, please go ahead.

Thank you, Paul. Good afternoon, everyone, and thank you for joining the call. Our operational and financial results were exceptional in the fourth quarter and capped off a great year. We consistently exceeded our internal estimates for client retention, net client adds and worksite employee growth, all of which resulted in better-than-expected financial results. Before I speak to the financial results, I would like to recap some of the key operational and strategic accomplishments for the year. We successfully completed the conversion of our existing clients over to our new My BBSI platform. We are pleased with the platform, but more importantly, our clients are appreciative of the investment and the feedback continues to be positive. We are not done with our investment and have an IT roadmap of enhancements, new features, as well as new products. We packaged our new technology with our nationwide offering and brought on larger clients on average this year than we have in previous years. We built out a corporate sales department and increased the top of the funnel by focusing on lead generation via an omnichannel digital campaign, which brought on new clients and new referral partners. We executed on our employer-of-choice initiative and invested in our employees with robust enhancements in compensation, benefits, vacation, training and volunteerism. People are our product and we attract, train and ultimately retain the best employees that any PEO has to offer. In November, we were pleased to announce that we were certified as a Great Place to Work for the first time. We successfully rolled out our asset-light markets, which encapsulates everything I just mentioned: attract and hire great people, train them well, apply the lessons we learned in a COVID environment for how to operate remotely and package that with our digital initiatives to help grow their market penetration. We will serve these clients out of an adjacent branch or a corporate location and invest behind them in infrastructure as they build up their client base. We entered into workers' compensation insurance transactions, which de-risk our business model and result in better financial predictability. These transactions are structured in a manner that greatly limits any potential downside of our insurance program, while still allowing us to share in the upside of our disciplined underwriting. I want to again thank everyone in the BBSI family for their exceptional efforts. Plainly stated, I am proud that we foster a culture that embraces innovation and execution. Moving to our financial results. During the quarter our gross billings increased 13% over the prior year quarter and exceeded our expectations. Our average worksite employees were up 7% over the prior year quarter. We have exceeded our pre-pandemic levels and 2021 finished the year with the highest year-end worksite employee count in BBSI’s history. This is due to our clients hiring as well as net new business and we continue to be at the head of our internal forecast for our worksite employee stack. Our staffing business increased 14% over the prior year quarter. We could have grown more, but continued to have challenges filling orders with the tightness of the labor market. 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 fill ratio is improving. So to summarize our financial performance for the year, our gross billings increased by 11% and our earnings per share grew by 14%, which is in line with our long-term growth plans. We returned $9 million in dividends and bought back shares totaling $17 million, which reduced our shares outstanding by 3.2%. These are fabulous results and a great return for shareholders. Moving to the branch operational updates. Our branch footprint decreased by three to 50 total branches. We continue to be mindful of operating efficiencies and consolidated Glendale into Phoenix, Eugene into Willamette Valley and Valencia into Pasadena. 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: 23 mature branches with run rates in excess of $100 million, 17 emerging branches running between $30 million and $100 million, and 10 branches we consider developing with run rates up to $30 million. Our business units total 98 and incorporate the consolidations previously mentioned. We also continued our migration into a revised structure of our 16-member business unit, which allows us to serve more clients with fewer management employees and increases our return on management payroll. To summarize our branch footprint over the past two years: at the end of 2019 we had 64 branches. Over the past two years, we consolidated 19 branches within existing markets and expanded five branches in new markets, finishing 2021 with 50 branches. By the end of 2022, we forecast that our gross billings will be up by approximately 20% over 2019 but our SG&A and payroll will only be up by 6%, and that includes investing in 14 asset-light markets. Speaking to the asset-light model, our first class has graduated and is currently selling in four new markets. We are still in the early innings but through February we have eight new clients added during contracting. We are seeing positive trends in this model and intend to invest in approximately 10 new markets in 2022 and are actively recruiting in markets we're not in now. Moving to our client and WSE stack. Our client retention continues to be stronger than pre-pandemic levels. I like to 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 distribution channels, business is almost back to normal. Our leads and prospects in the quarter were greater than the previous quarter and it was our best quarter post-pandemic. We had a strong fourth quarter and our year-end WSE stack was the highest in our history. More importantly, we capitalized on the one-on-one selling season and this January was our best January for net new business in the past five years, better than pre-pandemic. We continue to invest and refine our longer-term initiatives of increasing 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. Results thus far are positive. We are signing up new referral partners and new clients that would not have come to us via our traditional channels. We will continue this initiative and make further investments in 2022. These positive trends resulted in the company adding over 1,300 net new worksite employees in the quarter, which was ahead of our forecast and further supports our optimistic outlook for 2022. As I think to the future, I've never been more optimistic about BBSI's trajectory. We had great momentum in 2021 and it is carrying into 2022. Our client retention is the best it's ever been, and we're closing on more prospects. Our prospects continue to be larger because of our technology stack, coupled with our nationwide offering. We will continue to invest in technology. And we will continue to invest in growth initiatives. We have minimized the insurance risk to the company. And the only thing that can hinder our progress now is execution risk. And honestly, our fabulous results speak for themselves. Now I'm going to turn the call over to Anthony for his prepared remarks.

Thanks, Gary. Hello, everyone. I am pleased to report we finished 2021 with strong results and, as Gary noted, strong momentum. Both the quarter and the year exceeded our expectations. Starting with the full year first: our gross billings increased 11% to $6.6 billion and diluted EPS increased 14% to $5.00 per share compared to $4.39 in the prior year. The increase in earnings leverage was achieved even with the return to more sustainable SG&A levels in 2021 from the uniquely low levels seen in 2020. Focusing on our Q4 numbers, net income for the quarter was $10.6 million compared to $7.2 million in Q4 2020. Q4 PEO gross billings increased 13% over the prior year quarter to $1.8 billion. Staffing revenues increased 14% to $33 million. Our increase in PEO gross billings was driven by stronger-than-expected growth from net new clients in the quarter, continued strong hiring within our customer base and higher average billing per WSE. Our Q4 average WSEs increased 7% year-over-year, while our average billing per WSE increased 5%, driven primarily by higher wages. PEO gross billings growth by region versus the prior year fourth quarter were as follows: Mountain States grew 38%, East Coast grew 19%, the Pacific Northwest grew 15%, Northern California grew 13% and Southern California grew 6%. As discussed in prior quarters, the primary driver of the slower growth in Southern California is lower same-customer sales growth, as our clients are adding fewer new employees than in other regions. However, we continue to see positive trends in the region, including faster sequential growth in Q4 than in Q3 and we expect this momentum to continue into 2022. Workers' compensation expense continued to trend favorably in the quarter and included an actual, early determination reduction of prior-year estimated liabilities of $1.7 million in the quarter. Our claims performance also remains favorable and our relative frequency rate once again trended down in the quarter and remains well below historical rates. As a reminder, we entered into a new fully insured workers' compensation program effective July 1 for the majority of our clients. We now describe our workers' compensation coverage for clients as being under either this 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 100% covered by the insurance market, with zero claims cost retained by BBSI. The strategy of de-risking our operations through this insured program is operating as planned with favorable results, and we expect these favorable results to continue into 2022. Because of the move to our fully insured program, our workers' compensation liabilities decreased by approximately $18 million in the fourth quarter, as remaining historical claims continue to be paid. Looking at margin and pricing, we are seeing billing rates for new hires at levels consistent with the prior year. Looking at the market more broadly, market pricing for workers' compensation coverage has now largely flattened after decreasing for several years. Rates remain at low levels relative to historical rates, but these lower rates have been offset by lower workers' compensation expense in the year, and our margin rates have remained stable. We continue to see strong client retention in the fourth quarter and beyond, which demonstrates the value we're creating for our clients and supports our ability to maintain margins even in competitive pricing environments. Moving to operating expenses, SG&A for the quarter came in line with expectations at approximately the same levels as Q4 2020. As discussed in prior quarters, much of 2021 saw faster year-over-year growth in SG&A due to the abnormal comparables in Q2 and Q3 of 2020. As we look ahead to 2022, we expect to return to a more normalized SG&A growth rate, in line with our target of approximately half of our top-line billings growth. Our largest increase in SG&A will come from employee-related expenses in 2022, including higher average wages and increased headcount, primarily to support growth initiatives. We continue to closely manage our operating expenses and our management employee headcount in 2021 still ended below that of 2019. Our investment portfolios earned $1.7 million in the fourth quarter, compared to $1.6 million in the prior year quarter. Our investments continue to be managed conservatively, have an average duration of 4.1 years, an average quality of investment at AA, and an average book yield of 1.8%. Turning to the balance sheet and our capital plan, we had $166 million of unrestricted cash and investments at December 31st, compared to $116 million at September 30th. As we continue to evaluate our most efficient capital arrangements, we renegotiated our credit agreement with Wells Fargo to increase our line of credit to $50 million from $33 million previously, and extend the maturity of the agreement to June of 2024. With favorable fee changes, the increased capacity will come with little incremental cost. We also restructured our covenants to provide more flexibility, including in share repurchases. To further optimize our capital commitments, we have purchased certain assets that were formerly leased. This will show as an increase in Q1 CapEx, and it will result in lower overall operating expense for the company going forward. Subsequent to year-end, we paid off the remaining balance on our corporate headquarters mortgage, and as a result, we are now completely debt free. We continually assess the level of capital needed to maintain effective business operations with appropriate risk mitigation. This minimum level of required capital has decreased as we have de-risked our model and now retain less workers' compensation claims exposure. We are committed to deploying our excess available cash and investments in ways that benefit the long-term health of the company and our shareholders. I will recap our general philosophy on capital allocation. Our first priority is to invest in the business. Our best path to continued earnings growth is operating leverage through scale, and we continue to seek out new opportunities to invest in order to scale consistently and effectively. This investment typically comes in the form of strategic hiring and focused growth initiatives. It will also continue to include investment in IT software and infrastructure in the year as we focus on enhancing our product and our client experience. Second, we are open to investing in inorganic growth through acquisitions and this remains true, but we are committed to ensuring that any potential acquisition is right for our company and our shareholders for the long term. Third, as BBSI continues to steadily generate positive free cash flow, we remain committed to returning capital to shareholders. In 2021, we returned $26 million to shareholders through a combination of dividends and stock repurchases. This equates to an income payout ratio for the year of approximately 70%. To solidify our commitment to drive shareholder value, our Board of Directors has approved a new $75 million, two-year stock repurchase program, which will replace the $50 million, three-year repurchase program that was previously in effect. In addition, BBSI remains committed to its dividend and the Board also reconfirmed our quarterly dividend of $0.30 per share to be paid April 1st. Turning now to the outlook for 2022, we expect gross billings to increase between 7% and 9% for the year. We expect average WSEs to increase between 3% and 4%. We expect gross margin as a percentage of gross billings to be between 3.0% and 3.1%. And we expect our effective annual tax rate to be between 24% and 25%. I will now turn the call back to Gary for closing remarks.

Thanks, Anthony. 2021 was a great year and we think 2022 is going to be even better. We continue to always think of the client first and to advocate for the success of the business owner. 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. We'll now be conducting a question-and-answer session. Our first question comes from Chris Moore with CJS Securities. Please proceed with your question.

Hey, good afternoon, guys. Thanks for taking a couple questions. Yes, so given the changes with the Chubb trust and rising rates, when you’re looking at investment income for 2022, how does that compare with 2021?

Yes, that's a great question, Chris. We've said previously with our fully insured model, as our capital requirements go down, we expect our restricted investments to go down; that will be the case. On the other hand, we are seeing rising short-term interest rates this year. So those effects are effectively offsetting in our forecast for 2022 in terms of investment income.

Got it. All right. Maybe can you talk a little bit about the shape of your earnings quarter-to-quarter in fiscal 2022 versus 2021?

Absolutely. Our income is always seasonal, and that's driven by the timing of when payroll taxes are incurred, which are front-loaded primarily into Q1. So Q1 will always be our lowest profit quarter. Correspondingly, Q3 is typically our highest profit quarter, and Q2 and Q4 usually have similar but lower profits. That will be true again this year. One thing to note is that if you look at our top-line growth for the year, we're expecting sequential growth in each quarter. But when you look at year-over-year compares with 2021, there will be some variance by quarter. Q1 will be our strongest top-line growth quarter on a year-over-year basis. And Q4 will be lower in part because 2022 has one less business day, which equates to about a half percentage point of billings growth that will be lost in Q4. So on a year-over-year basis, Q1 will be strongest, Q4 will be weakest, and Q2 and Q3 will be more consistent on the top line.

That is extremely helpful. I'll jump back in line. I appreciate it, guys.

Thank you. Our next question comes from Jeff Martin with ROTH Capital Partners. Please proceed with your question.

Thanks. Good afternoon, guys. I was just curious if you could dive into the worksite employee growth a little more during the quarter. Primary drivers: net hiring versus wages — how do those two break out and are there any other factors?

I'll start it off and Anthony can clean it up. The item I'm most proud of in the quarter is that clients we added and the worksite employees they had, minus clients that ran off and the worksite employees they had, resulted in us having 1,300 more worksite employees in the quarter. That is our controllable organic growth, which we're very pleased with. We've had strong track records of that over the last couple quarters and a very strong track record going into January as well, which I mentioned in my prepared remarks. So if you take our controllable organic growth and then add same-customer sales, what's the same-customer sales, Anthony?

For the annual figures: average WSE growth for the year was 4.3%, and within that number that includes WSEs from client hiring but also net new client adds. As Gary said, the portion of net new client adds is the highest it's been in years, which is fantastic news. Average billing per WSE increased 6.4% for the year. Early in the year some of that was attributable to employee mix shift toward higher wages, but especially later in the year that was driven by genuine wage inflation. We saw that particularly in Q4, and that's part of the momentum we talked about going into 2022.

Okay. And then the prospects for average size of new clients is interesting. You would think that would become a fairly significant growth tailwind in the not-too-distant future. I was just curious if you could give us some relative perspective on the size of new clients you're bringing on now versus maybe in 2018 or 2019?

Yes. To put it in perspective: our unit counts are more consistent now. In the past we were adding smaller clients and running off larger clients, and you had to add two or three to make up for the one you lost. Now we're adding clients that are larger than what we're running off. If you look at our average worksite employees per client, it's about 26; we're adding clients north of 26 WSEs on average now. We still have some smaller ones, but the majority seem to be larger than that. One of the things we've done is focus on small clients that can grow, but if a smaller client doesn't have plans to grow or doesn't make adequate margin, we make the business decision to focus on larger business now.

You've been in the CEO role for almost two years now. I was just curious from your perspective, how you see a typical market cycle affecting the business and what are some of the things you do strategically and/or operationally as part of the different phases of the cycle?

Good question. It's been a long two years and it's hard to visualize what normal is with a pandemic, wage inflation and geopolitical conflict. But in general, the way we think about the business is roughly this: over a cycle we believe we're capable of putting up annually about 10% topline growth. If SG&A grows at about half the rate of topline in a normal market, that equates to roughly 15% increase in net income. We feel like we've got the machine in place to consistently over a cycle deliver about 10% on the top and 15% on the bottom.

That's nice. It should be great to see that happen. You mentioned that in a normal environment. Do you expect that you'll be able to experience that leverage this year or does wage inflation and employee retention become a factor where that may not be the case, at least this year or parts of this year?

We've modeled in wage inflation and investments in the company, including adding new headcount and investing in approximately 10 new markets. Even layering all of that in, we feel pretty confident that we'll be able to achieve that leverage. If you keep it simple, putting up 10% growth at roughly a 3% margin is about $20 million of gross margin, and we are mindful in how we invest SG&A so that we show leverage down to the bottom for net income growth.

Okay, great. Thanks for taking my questions.

Thank you. Our next question comes from Vincent Colicchio with Barrington Research. Please proceed with your question.

Yes, Gary. Nice quarter. I think I heard you say that you're investing in 10 new markets in 2022. That sounds pretty aggressive versus the past. Can you maybe take us through your thinking on that? Is it just more optimism — any thoughts would be helpful.

Yeah. This ties into my prepared remarks about our asset-light model. We were able to attract good talent, invested in training, got people up to speed so they can go sell in their markets. When they sell in their market we assist them with our digital campaigns. Essentially, one salesperson in one market can get traction and we support that business either out of corporate or an adjacent market. We call that asset light because we're hiring people and putting them in markets and supporting them centrally until they reach critical mass. We experimented with this in 2021, we got results we feel comfortable with, and we are doubling down in 2022. Once they are successful and get critical mass, we will invest in local infrastructure behind them to help service the business.

And can you talk a little bit about acquisitions? Has your focus changed at all or do you still look in the same markets and how does pricing look?

Not much of an update there. We look at everything that comes across, we're active, but we're thoughtful. We are mindful of shareholder equity and must ensure any potential acquisition is right for our company and our shareholders long term. We're active and will continue to be active, but we will be mindful. As I said in prior quarters, you have to kiss a lot of frogs. We're still kissing frogs.

What did the mix look like in the quarter in terms of WSE additions from referrals and your new model?

We are a heavy referral channel business and that's where the majority of our business comes from and will continue to come from. We love our referral channels. Part of our digital campaign is to try to attract new referral partners. If I look at Q4 versus Q4 2020 for referral partners that were new to BBSI, we had three times the velocity of new referral partners feeding us business in 2021 versus 2020. Part of that is a function of 2020 being heavily impacted by the pandemic, but part of it is we have the discipline to seek out referral partners and we're using technology to assist us.

How does the pipeline of leads and prospects look now versus last quarter?

If I look at our prospects going into Q4, we were about 50% higher than the prior year, which, if you keep your close ratio the same, results in more closes in Q4 and contributed to our strong WSE growth. That momentum carried into January and January was our strongest January for net client adds over the past five years. Those clients we added in Q4 and early January give us a real good tailwind for revenue growth in 2022.

Sounds good. Nice job. Thanks.

Thank you. Our next question comes from Kevin Mackey, Independent Analyst. Please proceed with your question.

Yeah. So I believe it was the last conference call that you mentioned your new technology…

This is the end of our question-and-answer session. I'm sorry. One moment. Our next question comes from Matt Dane with Titan Capital Management. Please proceed with your question.

Great. Thank you. I wanted to delve a little bit more into your initiative to attract larger clients. What additional color can you share around that? What specifically are you doing to help drive those larger clients and attract them to work with BBSI?

The technology we have is able to bring on larger clients. The clients appreciate our technology much more than what we had in the past. Larger clients have exposure in various states; previously we weren't licensed in every state, so now we can go anywhere they go as far as state mix. We are investing in technology in 2022 to better support larger clients because they have different needs and sophistication than smaller clients. We'll utilize and invest in technology to make it easier to flow data with our larger clients.

That's helpful. And on the actual sales and marketing side: in regards to targeting larger clients specifically, is it more about interactions with your referral sources and telling them these are the ideal clients, or are there other sales and marketing approaches that allow you to better target the clients you want?

There are two aspects. One is we're using technology on the sales and marketing side. We utilize technology to reach clients that wouldn't have typically come to us before, especially in new markets where we're building out. We've learned a lot in 2021, have refined our approach, and believe we have a better approach for 2022 than we had in 2021. It isn't perfect, but it is improved and will continue to evolve. On the referral partner side, it's about being comfortable with your expertise and knowing who you are. We work with referral partners by aligning with their specialty — if a partner specializes in transportation, we co-brand and co-market on transportation because we have a large portfolio in that industry. It depends on how the distribution channel comes to you and what their specialty is, and that's how we align with them.

Great. That's helpful. Thank you, guys.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Gary Kramer for any closing comments.

I just want to wrap up and thank everybody at BBSI for their hard work. 2021 was a great year, we feel good momentum and good trajectory, and are optimistic about where 2022 is going to go. So thank you, everybody.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.