Barrett Business Services, Inc.

Good afternoon, everyone, and thank you for participating in today's conference call to discuss BBSI's financial results for the second quarter ended June 30th, 2021. Joining us today are BBSI's president and CEO, Mr. Gary Kramer, and the company's CFO, Mr. Anthony Harris. Following the 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 fact, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by those forward-looking statements. Please refer to the company's recent earnings releases 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'd like to remind everyone that this call will be available for replay through September 4, 2021, starting at 8 p.m. Eastern Time 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, www.bbsi.com. Now I would like to turn the call over to President and Chief Executive Officer of BBSI, Mr. Gary Kramer. Sir, please go ahead.

Thank you, Kevin. Good afternoon, everyone, and thank you for joining the call. We had an exceptional second quarter, both financially and operationally. The positive momentum we experienced in the first quarter accelerated in the second quarter as the economy reopened. Our overall performance exceeded our plan, leading us again to raise our full-year outlook. During the quarter, our gross billings increased 17% over the prior year's quarter and exceeded our expectations. Our average worksite employees were up 10% over the prior year quarter and up 6% sequentially from Q1. Our growth in worksite employees is a combination of our clients' hiring as well as net new business, and we are on plan for our worksite employee stack. Our staffing business rebounded, increasing 20% over the prior year quarter. We could have grown more, but it is challenging to fill orders with a tight labor market. At the end of Q2, we had 1,300 open job recs nationally, with approximately 700 open in California. The tightness of the labor market is the number one complaint we hear from our PEO clients today. On the positive note, we have seen an uptick in applicants and placements about three to four weeks after the government stimulus is reduced or expired. Our gross margin as percentage of gross billings exceeded the prior year quarter and benefited from continued favorable development on workers' compensation, as well as affirming of workers' compensation pricing. Before moving to the operational updates, I'd like to spend some time on a strategic milestone for the organization. We announced on July 6th that we entered into two material workers' compensation insurance transactions, which de-risked our business model and result in better financial predictability. These transactions were a culmination of many years of hard work and were only possible due to our disciplined underwriting coupled with the quality of our insurance operations. Anthony will go into more detail in his prepared remarks regarding the terms and structures of the transactions, but I'd like to make a couple of points on their significance. These transactions are structured in a manner that greatly limit any potential downside of our insurance program, but we can still share in 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. We believe our value will be maximized due to the perceived insurance risk under the old model and that these transactions materially reduce or eliminate that insurance risk. Moving to the branch operational updates and other initiatives, we continue to be mindful of operating efficiencies and consolidated Vacaville into Concord, California and Twin Falls into Idaho Falls. This decision was made with the intention of continuing to grow revenue while servicing our clients but doing so in a more cost-efficient manner. The consolidation decreases our branch footprint from 56 to 54 total branches. And the stratification of our 54 branches as of Q2 is as follows. 21 mature branches with run rates in excess of 100 million, 21 emerging branches running between 100 and 30 million, 12 branches we consider developing with run rates up to 30 million, Our business units totaled 101 and decreased from the prior year quarter as we migrate into our revised structure of the 16-member business unit, which allows us to service more clients with less management employees and increases our return on management payroll. In addition, we continue pursuing our strategy of opening new branches, and we will open three new branches in Q3 of 21, Pittsburgh, Pennsylvania, Nashville, Tennessee, and Raleigh, North Carolina. Next, I'm going to provide some updates on operational initiatives. We successfully completed the conversion of our existing clients over to our new MyBVSI platform. I would like to thank our various IT teams and the folks in the field that supported the migration and the client education. I'm very pleased with the platform, but more importantly, our clients are appreciative of the investment and the feedback continues to be positive. We continue to package our new technology with our nationwide offering, and we continue to see larger opportunities. In the quarter, we onboarded three clients in excess of $15 million annual payroll with operations in multiple states. These clients joined us for our core offering, but without the technology investment we have made, it is unlikely that we would have onboarded them. Regarding our client count, In previous earnings calls, we stated that our referral partners and business owners went into the bunker during the pandemic, and this resulted in lower sales leads. We continue to see a gradual recovery and saw more opportunities in Q2 than in Q1, but we are still behind pre-pandemic levels. Our client retention continues to be stronger than pre-pandemic levels and is partially offsetting the slowness at the top of the sales funnel. we previously mentioned that we are not going to sit idly by and wait for business to come to us during the pandemic and we have been investing in sales and marketing initiatives accordingly in the second quarter we executed on the next step of the plan which is to increase the top of the funnel by focusing on lead generation via an omni-channel digital campaign where we target both clients and new referral partners in 10 different markets It is still early days as we are only one to two months into this initiative depending upon the market, but I am excited about what we are seeing and would like to provide some statistics. We had about 7,500 unique emails opened. We had over 3,000 views of our information and the prospects were spending more time viewing pages than anticipated. We set up 65 meetings with interested prospects. We onboarded three clients thus far. This is expected given the duration of our sales cycle, which is typically 45 days. We have signed up 50 new referral partners. We are testing and refining our various sales initiative by market, measuring the return on investment, and will transport the most successful method to other markets. In summary, I'm encouraged by our excellent client retention. We are in the people business, and people have never been more relevant to the business owner than they are today. Packaging our knowledge and expertise along with our new technology platform and the ability to transact nationally strategically positions us better in the market and with our referral channels. We have exceeded our plan for the first half of the year, and I am optimistic about the back half and beyond. We are executing to 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 Q2 results continue to build on the momentum we reported last quarter with results that were once again stronger than expected. PEO growth billings increased 17 percent over the prior year quarter and 9 percent sequentially from Q1 to $1.58 billion. Staffing revenues increased 20 percent over the prior year to $24.7 million. PEO gross buildings growth by region versus the prior year's second quarter were as follows. Mountain states grew 36%, Northern California grew 24%, the Pacific Northwest grew 20%, East Coast grew 17%, and Southern California grew 8%. We've discussed for several quarters that we're seeing differences in performance by region, and particularly in Southern California, where we've seen a significant lag in our customers expanding their workforce. For example, when comparing between Northern California and Southern California, there is a 6% difference in the growth rate of WSCs in the year from existing clients. And Southern California remains the only region with negative year-to-date WSC growth through Q2 when compared to the prior year. Our average client wage has historically been lower in Southern California than Northern California, and we expect that Southern California is being impacted more than other regions by the effects of stimulus and other government programs and restrictions in place. Looking at our overall increase in PO gross billings for the company, the prior year's second quarter was the period most impacted by COVID, and as a result, our year-over-year billings growth was driven largely by higher average WSEs paid versus 2020, with the average number of WSEs in the quarter increasing 10% year-over-year. This is in line with our expectations overall, despite Southern California growing slower than expected. We also continue to see higher average billing per WSE, which is up 6% in Q2 over the prior year and continues to trend ahead of our expectations for the year. Workers' compensation expense continues to trend favorably and included an actuarially determined reduction of prior year estimated liabilities of $5.5 million in the second quarter. Included in this adjustment was a gain of approximately $1 million from the lost portfolio transfer that was effective in Q2. Our overall workers' compensation claims performance remains favorable. In the quarter, we saw trailing 12-month relative frequency of claims as a percentage of payroll increase modestly compared to the second quarter of 20, but frequency remains 11% lower than the second quarter of 2019. Consistent with 2020, we continue to expect that COVID-19 claims will not materially increase our overall workers' compensation expense. We are very pleased to report on the significant strides we've made in Q2 in de-risking our business model related to our workers' compensation program. First, we entered into a loss portfolio transfer, or LPT, to transfer approximately $53 million of claims liabilities from our balance sheet at June 30th. These claims were primarily from the 2018 calendar year. As a reminder, with the LPT entered into in 2020 and the LPT entered into this year, we have now effectively removed claim exposure for most claims incurred prior to 2019. The workers' compensation liabilities on our balance sheet therefore relate primarily to 2019, 2020, and the first half of 2021. What is even more transformative is our new insurance program that became effective July 1st. This new program greatly reduces the risk that BBSI will retain on a prospective basis. For clarity, we will now describe our workers' compensation coverage for clients as being under either our insured program or our self-insured programs. Approximately 82 percent of our workers' compensation exposure, including all California clients, are covered under our insured program. All claims incurred in these states after July 1 are now covered 100 percent by the insurance market with zero claim costs retained by BBSI. This is a significant change from our structure prior to July 1, which included $3 million of retention per occurrence. Our ability to move to this fully insured model is a testament to the effectiveness and favorable performance of our overall workers' compensation program. There is no incremental expense in moving from our high retention model to the new fully insured model. The premium that we now pay for this coverage is equal to the actuarially determined accrual rate that we have been recording for our retained losses. Although workers' comp expense will not change, there will be some impacts to our balance we will now no longer accrue workers' compensation liabilities for insured clients after July 1. Because of this, our workers' compensation liabilities will no longer grow, but will instead begin to decrease over time as the remaining historical claims are paid. Although BBSI has no claim exposure after July 1 on insured clients, our insurance agreements provide for a premium adjustment in future periods, depending on the overall performance of our portfolio of clients. If claims develop more favorably than expected, the premium required will go down with potential refunds of up to $20 million for the 12-month policy year. If claims develop adversely, we may be charged additional premium, but this additional premium is capped at $7.5 million. This structure allows BBSI to benefit from favorable claims trends like we have been but also provides the company and our shareholders with the security of a cap on workers' compensation expense if claims develop negatively. Our self-insured programs remain unchanged, which include our self-insured workers' compensation coverage in Oregon, Maryland, and Colorado, and BBSI employees in Washington, and coverage through our wholly owned insurance company, Ecole, in Arizona and Utah. These states comprise approximately 18% of our workers' compensation exposure, and we have retention limits of $1 million to $3 million per occurrence, depending on the state. We believe the regulatory structure and risk profile of these states warrants the greater level of retained risk in these locations, and we are able to recognize cost efficiencies through self-insurance. However, we will continue to evaluate that optimal tradeoff of risk and economics as we move forward. Turning to the pricing of our services and the fees we are able to charge, We have discussed for several quarters the increased pricing pressure related from the current workers' compensation market, particularly in California. While the workers' comp market remains soft overall, we are seeing rates firming. We are monitoring our billing rates closely on renewal, and for Q2, our billed margin is on average either up or flat over the prior year as expected. Looking at operating expenses, SG&A continues to trend on plan. Headcount levels remain below 2019, while current year increases in SG&A have resulted from increased IT expense and increased selling activities and initiatives. Our investment portfolios earned $2 million in the second quarter compared to 1.9 in the prior year. Our investments continue to be managed conservatively and have an average duration of 4.3 years, average quality of investment at AA, an average book yield of 1.8%. Going forward, our investment balances will begin to decline as our collateral funding requirements diminish under our new fully insured workers' comp program. Turning to the balance sheet, we had $110 million of unrestricted cash investments at June 30th compared to $143 million at March 31st. The decrease in unrestricted cash is primarily due to the cyclical timing of payroll tax payments in April, as well as an agreement reached in the quarter to replace an existing letter of credit with other collateral, which resulted in the transfer of $25 million of unrestricted cash into restricted trust accounts. Separately, due to the timing of payments related to the lost portfolio transfer in the quarter, approximately $13 million was transferred from restricted trust accounts back into unrestricted cash in July after quarter end. 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 returning capital to shareholders in the form – and in the quarter, we return capital to shareholders in the form of $2.3 million in dividends and $3 million of repurchased stock in the quarter. At quarter end, there's approximately $35 million remaining on the board's approved $50 million share repurchase plan. Turning to the outlook for the year, given the stronger than expected results in the quarter, we now expect gross billings to increase between 6% and 8%, up from 5% to 7% previously. We expect average WSEs to increase between 2% and 4%, unchanged from the prior quarter. We expect gross margin as a percent of gross billings to be between 3.0% and 3.1%, up from 2.9% to 3.1%. And we expect our effective annual tax rate to be between 22 and 24%, increasing from 21 to 23% due primarily to our higher income levels. I will now turn the call back to Gary for closing remarks.