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 third quarter ended September 30th, 2022. Joining us today are BBSI's President and CEO, Mr. Gary Cramer, and the company's CFO, Mr. Anthony Harris. Following their remarks, we will 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 cautious 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. 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 December 2, 2022, starting at 8 p.m. ET 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.webcast.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, Ryan. Good afternoon, everyone, and thank you for joining the call. We had an excellent third quarter, both financially and operationally. Our performance and momentum continued across all facets of the business, and resulted in us once again raising our full year outlook. We are executing on our objectives, and our strategies are delivering superior results. Our growth in worksite employees resulted in better than expected financial results. Regarding our client and WSE stack, we continue to execute on various strategies to increase the top of the sales funnel, and I am pleased to say that we once again exceeded our expectations in Q3. This is the result of our three-pronged strategy. to mature and deepen relationships with our existing referral partners, to utilize technology and digital campaigns to target and nurture new referral partners, and to utilize technology and digital campaigns to target potential clients directly. I'd like to put a finer point on our new referral partner initiative. Through the third quarter of 2022, we have strategically targeted about 6,000 new potential referral partners, and we have forged new partnerships with about 18% of them. This is a long-term strategy. Trust is earned slowly over time. As these new referral partners see BBSI and our product in action, we believe they will become more comfortable recommending BBSI to their clients. On a year-to-date basis, we added 41 new accounts from these efforts, up from 15 last quarter, and expect this to continue to accelerate into the future. We will continue this strategy in 2023 along with targeting new referral partners that specialize in the benefit space. The next trend that we previously discussed is that we've been able to sell and support larger clients with our upgraded technology stack and national PEO licenses. This continues to progress favorably, and the average size of the clients that we are adding are larger than the average size of the clients that are running off. Regarding client runoff, our 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 provide. The results of all these efforts, or what I refer to as our controllable growth, is that we added approximately 4,300 worksite employees year over year from net new clients. We bill as a percentage of payroll and we grow as our clients grow by adding worksite employees with wage inflation and as hours worked increases. Our client base is resilient and we exceeded our internal forecast for worksite employee growth in the quarter. Our average worksite employees were up 8% over the prior year quarter, which is the culmination of controllable growth as well as our clients hiring. We exceeded our internal forecast for our worksite employee stack. Moving to our staffing operations, our staffing business increased 1% over the prior year quarter and was less than we anticipated. There is still strong demand for labor, and we are receiving more orders, we are placing more applicants, and companies are increasing wages to attract employees. It is still a thin recruiting market, and we are unable to fill all orders. Anthony will give some regional color for what we're seeing in the markets. I mentioned previously that we made investments in our recruiting operations, and we are seeing positive results. One of our objectives was to provide recruiting services for our PEO clients. This is a valuable service to our PEO clients in a tight labor market, which also rewards BBSI. When we place a candidate, we receive a recruiting fee, and as the candidate joins the client's payroll, we realize PEO revenue. We have built out recruiting hubs in every region that support our branch network. On a year-to-date basis, we have placed 287 candidates with 147 PEO clients, and generated $1.7 million in recruiting fees. We expect this to increase as we introduce to more clients. Moving to the field operational updates, we are very pleased with our progress of entering new markets with our asset light model. Our first class of four is doing well, and we added 25 new accounts with about 250 worksite employees. In 2022, we started small with our first class as we were learning and refining the various aspects of our new market development program. We are at a point now that we are confident that we can scale this program and have hired and are training the next class of 11 folks. This class is primarily located in the central states plus a few East Coast markets and will begin selling in Q1 of next year. At the end of Q3, we operated in 13 states and 68 markets, which is consistent with the prior year quarter and does not include our asset-light markets. Some markets will be more profitable than others due to their maturity, but with our evolution, every market is expected to be profitable. Regarding product updates, we successfully launched our new health benefits offering in the quarter and began selling for the 1-1-23 enrollment season. As a refresher, we entered into a strategic multi-year partnership with one of the world's leading health insurance companies. This is a fully insured program where we take no underwriting risk. We have been de-risking the workers' compensation program over the past couple of years, and it was a key objective of ours not to take underwriting risk. We have invested in IT to allow this offering to be delivered seamlessly through our MyBBSI portal, and clients will find value from the ease of administration, billing, and compliance. BBSI clients will now have access to discounted products and plan designs that are not currently available to them in the traditional small group market. We will be offering health insurance plus ancillary benefits, including but not limited to dental, vision, life, disability, and critical illness. In the quarter, we rolled this out to a limited number of existing clients in select markets for the 1-1-23 enrollment season. Our intent is to perfect our craft and then shift our focus to California and to new prospects. This will not move the needle for revenue or profit in 2023 as we targeted a very small cohort of clients, but we anticipate this will provide material contribution as we look to the future of BVSI. We view this as an opportunity to diversify our client's profile while expanding our total addressable market. We have the people, product, operations, and technology in place and are executing to our sales plan. I am pleased with where we are with this new offering and of our sell-through thus far. In addition to our benefits offering, we have also been investing in electronic training and development. You've heard me say over the past two years that we've invested in technology that was designed to train and develop our new market development managers. We are taking this technology and are now making it available to our clients through MyBBSI. We are excited to be launching BBSI-U in the fourth quarter. This is a learning management portal that our clients can purchase and contains various catalogs consisting of HR and compliance, risk and safety, leadership, and professional skills. This does not replace our experts in the field, but will be a valuable tool that complements our offering. Next, I'd like to shift and speak about the macro economy. The growth in worksite employees for our installed base during the third quarter was strong, and our October numbers were equally strong. Wage inflation is still prevalent, but at a slower growth rate than 2021. As the payroll in HR company for over 8,000 clients over various states and industries, there is nothing in our data that would reflect the slowdown in the economy at this time. However, we would be remiss if we didn't acknowledge that times are growing more challenging for business owners given tight labor markets, record inflation, supply chain challenges, and a rising interest rate environment. We know that labor is in high demand, that the unemployment rate is still at all-time lows, that the labor force participation is lower than pre-pandemic levels, that job openings rose last month, that immigration is low. These are all unusual facts that do not fit any previous historical inflationary recession scenario. Also, layoffs should be delayed due to business owners' recent memories of how challenging it was to attract new employees post-pandemic. Based upon all these factors, plus our higher-than-expected Q4 starting point for our installed base of clients and WSE stacks, and our optimism of our revamped and disciplined sales and service teams executing on controllable growth. We believe BBSI is poised for growth in 2023, even if a recessionary environment arises. As I think to the future, we have consecutive quarters of great momentum, and I don't see it slowing. Our client retention is the best it's ever been, and we're seeing more business opportunities. Our prospects continue to be larger because of our tech stack, coupled with our nationwide offering. We are executing to our plan, and things are going well. Our optimism increases exponentially as we think of the opportunities that our new benefits offering brings to our existing clients, new clients, and new referral partners. With that, I'm going to turn it over to Anthony for his prepared remarks.

Thanks, Gary, and hello, everyone. I am pleased to report that we again had strong results for the quarter. PEO gross billings increased 13% over the prior year quarter, to $1.9 billion, while staffing revenues increased 1% over 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, continued stronger-than-expected hiring within our client base, and higher average billing per worksite employee. Overall, worksite employees increased 8.2% over Q3 21, and average billing per WSE increased 4.2%. The increase in average billing per WSE was driven primarily by rising wages in our existing employee base, offset partially by continued hiring of more lower wage roles relative to the prior year. CEO gross billings growth by region versus the prior year third quarter were as follows. Mountain states grew 21%, East Coast grew 20%, Southern California grew 14%, Northern California grew by 10%, and the Pacific Northwest grew 7%. Staffing revenues increased 1% over prior year, which is a slower growth rate than we have seen recently. We monitor our staffing revenues closely for broader trends, but the slowing growth this quarter was primarily driven by client and region-specific circumstances. In the Northwest, we have agricultural clients where work has shifted from Q3 to Q4 in response to a late harvest season, And in the Mountain States, we experienced a slowdown in certain light manufacturing clients due to supply chain challenges. Both of these examples are transitory. The one market where we have seen demand contraction is in Northern California, where we support more technology clients. However, we are not seeing broader negative trends. We continue to see stability in our workers' compensation market, and our overall pricing has remained consistent and in line with our plan. The gross margin rate continues to trend ahead of prior year through Q3 with cost savings and payroll taxes and, more significantly, from lower workers' compensation expense in the current year. Our workers' compensation program continues to perform well with favorable claims frequency trends and favorable development on historical claims reserves. This quarter included an actuarially determined reduction of prior year estimated liabilities of $1.4 million. compared to $0.8 million the year-ago quarter. As a reminder, we renewed our fully insured workers' compensation program effective July 1 of this year. The prior year program has performed favorably, and our renewed program includes several enhancements, including even more cost certainty. For the 12-month policy effective July 1, 2022, if claims develop favorably in future periods, BBSI receives the benefit of those lower claims costs through return premium from carriers. If claims develop unfavorably, there is no additional premium that can be owed. That is, BBSI continues to participate in all of the upside of favorable workers' compensation cost trends, but has no exposure to downside risk. Turning to operating expenses, SG&A in the quarter is on plan. Our new health benefits program has launched successfully, on schedule and with costs in line with our forecast. Our top line growth and profitability are ahead of expectations, and we accordingly have increased employee compensation expense for profit sharing and incentives, but those increases have been offset by other savings in the quarter. As a reminder, we expect our earnings growth rate of approximately 1.5 times our top line growth rate. Even with the incremental expense in preparation for our health benefits offering, We continue to expect earnings leverage to be ahead of target for the year. Moving to our invested assets, our investment portfolios earned $1.6 million in the third quarter compared to $1.8 million in the prior year. With the rapid increase in interest rates, our fixed income portfolios remain in an unrealized loss position. However, we intend to hold those securities, and our portfolio continues to be managed conservatively with an average duration of four years, average quality of investment at AA, an average book yield of 2.1%. Looking at the balance sheet, we had $132 million of unrestricted cash investments at September 30 compared to $111 million at June 30. The increase is primarily due to the results of operations and the timing of payroll tax payments. As a reminder, BBSI is now completely debt-free. We continue to see intrinsic value in our share price relative to our profitability and growth potential, and we've continued to repurchase shares under the board's $75 million share repurchase program. In the third quarter, BBSI repurchased 130,000 shares at an average price of $81.74 per share. Year-to-date, we have now purchased more than 7% of the company's shares outstanding and still have $36 million remaining on the program. The company also paid $2.1 million in dividends in the quarter and reaffirmed its dividend for the following quarter. We have paid $6.6 million in dividends year-to-date. Given the strong results for the quarter and positive trends, we are increasing our full-year outlook. We now expect gross billings for the year to increase between 12% and 13%, up from 11% to 13% previously. We expect average WSEs to increase 8% to 9%, up from 7% to 8% previously. And we expect gross margin as a percent of gross billings to be between 3.1% and 3.2%, up from 3.05% to 3.15% previously. And we expect our effective annual tax rate to be between 26% and 28%, which is consistent with our previous guide. As we finish this year and look ahead to the next, we believe BBSI is poised for continued growth, even in an uncertain economic environment. We will continue to invest in growth and products, including our new health benefit offering and new market expansion. And even with those investments, we'll continue to benefit from leverage in our operating model. In short, we are optimistic about the future and are looking forward to the year ahead. Now I will turn the call back to the operator to open the line for questions.