Barrett Business Services, Inc.

Marks 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 September 5th, 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.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 and good afternoon everyone and thank you for joining the call. We delivered another quarter of top line growth and solid profitability. while revenue came in slightly below our expectations, we added more new business than anticipated. This strong top of the funnel momentum was partially offset by ongoing macro and geopolitical headwinds, which continue to constrain our existing clients' ability to grow their own workforces. Moving to our financial results and worksite employees, during the quarter, our gross billings increased 2.6% over the prior year. While this came in slightly below expectations, Our go-to-market strategies are driving positive momentum at the top of the funnel. Q2 new client acquisitions were up 17% year over year, and we exceeded our internal expectations for both new clients and new worksite employees for client additions. Additionally, we continue to see strong client retention, a direct testament to the high-value work our teams provide every day. The result of all these efforts, or what I refer to as controllable growth, is that we added approximately 4,500 worksite employees year over year from net new clients. That said, our overall growth was tempered by broader client workforce reductions. As a reminder, macroeconomic uncertainty led many of our clients to reduce headcount starting in Q3 of last year. That trend persisted in Q4 and then moderated in Q1. Unfortunately, that trend resumed in Q2. However, while we have seen further workforce reductions, we expect the rate of decline to moderate in the back half of the year as we have easier year-over-year compares. To summarize, despite workforce reductions within our existing client base, strong sales volume and strong retention allowed us to achieve an increase of 1% in total worksite employees for the quarter. Turning to our staffing operations, our staffing business declined by 18% over the prior year quarter. Our new business outpaced our runoff business. However, our existing clients reduced their staffing demand and remained reluctant to place orders amid macroeconomic uncertainty. In response, we continue to leverage our recruiting expertise for our PEO clients, successfully placing 157 applicants during the quarter, a 35% increase over the prior year quarter. Turning to the field operational updates, we're very pleased with our entrance into new markets with our asset light model. These folks continue to gain traction and consistency and added approximately 400 new WSEs in the quarter. We continue to hire locally to support our existing operations while we continue to expand into new markets. We anticipate converting three additional locations to traditional branches later this year. Regarding product updates, we continued to execute on the sale and service of EBSI benefits, our health insurance offering. We had a great start to the year and our momentum continued into the second quarter as we added around 70 clients and over 2,000 participants to our various benefits plans during the quarter. We have achieved operational consistency and continue to invest to improve the sale and service of BBSI benefits. Our value proposition resonates well, and we are having success with small and large clients in white and blue-collar industries in every state we operate and with a diverse distribution channel. Next, I'd like to shift to our 2026 IT product objectives. I've previously mentioned that we've been investing in our tech stack on the product side to service and support our clients better. We have been rounding out the employee lifecycle, which is from when an employee is hired to when the employee retires and everywhere in between. Over the last couple of years, we've launched an applicant tracking system, a BBSI benefits offering, an employee file cabinet, a learning management system, and a performance management module. We have been successfully rolling these products out to our existing clients and utilizing in our new sales efforts. Ultimately, these products will result in increased sales and better client retention, and we are excited to bring these products to market. Regarding the California workers' compensation environment and the effect on our margin, we've been saying for several years that the California workers' compensation market was nearing an inflection point as lost cost trends consistently outpaced premium rates. We now believe that turning point has arrived with insurers pushing rate for the first time in more than a decade. As a result, we've characterized 2026 as a transition year and provided a wider than usual range for gross margin at the start of the year. The encouraging news is that we're getting rate and those rate increases are more than offsetting our cost inflation. The downside is simply timing. Because our clients renew monthly, those pricing improvements roll in gradually rather than all at once. As a result, we continue to expect 2026 to represent the low watermark for gross margin, with margins improving in 2027 as more of our clients renew at higher rates. Next, I would like to shift to our view of the remainder of the year. We've had consecutive quarters of solid momentum. While we expect our clients to continue growing at a rate below historical norms, we expect that rate of impact from low client hiring to moderate in the second half of the year. We believe BBSI is well suited to navigate macroeconomic and geopolitical uncertainties. In challenging times, small businesses are better off in a PEO relationship and can benefit from our scale and our expertise. We remain steadfast and aligning our insurance pricing to our insurance costs. At the same time, we are maintaining strict expense discipline while continuing to invest in the business throughout this transition. We have consistently achieved strong controllable growth by focusing on the needs of our clients and by adding new clients, a focus that we will maintain. We have more products to sell and more folks selling. Our consistent execution differentiated service model and strong relationships position us to continue driving sustainable growth through 2026 and beyond. Now I'm going to turn the call over to Anthony for his prepared remarks.

Thanks, Gary, and hello, everyone. Diving into our performance for the quarter, gross billings increased 2.6% to $2.29 billion in Q2 2026 versus $2.23 billion in Q2 2025. PEO gross billings increased 2.8% in the quarter to $2.28 billion, while staffing revenues declined 18% to $14 million in the quarter. Our PEO worksite employees grew by 1% in the quarter, which, as Gary noted, was driven by strong, controllable growth, partially offset by year-over-year client workforce reductions. Average billing per WSE per day increased 2.2% in the quarter, which was driven by continued rising wages partially offset by lower overtime and hours worked per WSE. Looking at year-over-year PEO gross buildings growth by region for Q2, Southern and Northern California were flat, Mountain grew by 2%, East Coast grew by 16%, the Pacific Northwest grew by 3%, and our asset light markets grew by 73%. A few comments on regional performance. Southern and Northern California, our two largest markets, beat expectations for new client ads, but experienced flat growth in the quarter primarily due to year-over-year client workforce reductions. The net result was that Northern California improved slightly from last quarter, while Southern California saw slower growth. The East Coast continued to stand out, delivering its 21st consecutive quarter of double-digit growth, supported by strong controllable growth. The Pacific Northwest region had its second consecutive quarter of growth, as solid net client ads more than offset softer client hiring activity. Turning to margin and profitability. During the second quarter, we renewed our fully insured workers' compensation policies, which were effective as of July 1, 2026. As we have emphasized in recent quarters, the California workers' compensation market has shifted towards rate increases due to industry-wide higher average claim costs driven largely by increased litigation and cumulative trauma claims. As a reminder, the California Insurance Commissioner approved an average 8.7% premium rate increase in 2025 and recently announced a 6.6% additional increase effective September 2026. Against that backdrop, we once again renewed on favorable terms, including only a modest rate increase, no downside risk for future adverse claim development, and continued participation in favorable claim development through return premium. Looking at our historical workers' compensation policies, they continued to perform well, resulting in favorable adjustments for prior year claims. In Q2-26, we recognized favorable prior year liability and premium adjustments of $2 million compared to favorable adjustments of $8.8 million in the second quarter of 2025. Smaller favorable adjustments in the current year primarily reflect the industry-wide increase in claims costs and the fact that those higher cost expectations are incorporated into our actuarial estimates. Turning to pricing for our workers' compensation products, We have continued to execute on our pricing strategy in this more favorable environment, and we were able to once again increase our pricing each month in the second quarter. We have now established an eight-month trend of increased pricing, first in a decade. As a reminder, the previous period of declining workers' compensation pricing resulted in margin compression in recent years, as cost trends stabilized or increased, but market prices continued to fall. While workers' compensation claims costs are expected to continue increasing in the near term, we expect the pricing actions we've implemented to more than offset those cost increases over time. Because pricing impacts are recognized as clients renew throughout the year, there is a natural lag before those higher prices are fully reflected in our results. We therefore expect gross margins to remain under pressure for the remainder of 2026, before improving in 2027 and beyond. Moving to our operating costs and overall profitability, we continue to exercise disciplined cost control, and in Q2, SG&A decreased approximately 2%, driven primarily by employee-related expenses. We continue to expect full-year SG&A growth to be lower than gross billings growth and in line with prior-year SG&A growth. Moving to investment income, Our investment portfolios earned $1.9 million in the second quarter, down approximately $400,000 from the prior year due to lower average interest rates and lower average investment balances as we continue to use excess cash to fuel our stock buyback program. Our investment portfolio continues to be managed conservatively, with an average quality of investment at AA. The combined impact of these activities resulted in net income per diluted share in the second quarter of 52 cents compared to 70 cents per diluted share in the year-ago quarter. Turning to our balance sheet, we remain in a strong position with $68 million of unrestricted cash and investments at June 30 and no debt. We continued our approach to capital allocation, making investments back into the company through product enhancement and geographic expansion and distributing excess capital to our shareholders through our dividend and stock buyback plan. Under our $100 million August 2025 repurchase program, BBSI repurchased $15 million of shares in the second quarter at an average price of $30.92 per share, with $40 million remaining available under the program at quarter end. The company also paid $1.9 million in dividends in the quarter and reaffirmed its dividend for the following quarter. This brings total capital return to shareholders in the last six months to over $39 million. Now turning to our outlook for the full year. We are narrowing our outlook to reflect our year-to-date results and to adopt a prudent stance given the current macroeconomic and geopolitical uncertainties, which have created clear headwinds for our clients' ability to grow their workforces. We now expect gross billings to increase between 3% and 4% for the year compared to our prior 3% to 5% outlook. And we additionally expect average WSE growth to increase between 2% and 3% compared to our prior 2% to 4% range. We expect gross margin as a percentage of gross billings to be between 2.7% and 2.75% compared to our prior range of 2.7% to 2.85%. This primarily reflects the transitioning rate and cost environment of the California workers' comp market. Finally, we continue to expect our effective annual tax rate, normalized for the one-time tax charge in Q1, to be between 26% and 27%. I will now turn the call back to the operator for questions.