BARRETT BUSINESS SERVICES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations General Company Background Barrett Business Services, Inc. (“BBSI,” the “Company,” “our” or “we”), is a leading provider of business management solutions for small and mid-sized companies. The Company has developed a management platform that integrates a knowledge-based approach from the management consulting industry with tools from the human resource outsourcing industry. This platform, through the effective leveraging of human capital, helps our business owner clients run their businesses more effectively. We believe this platform, delivered through a decentralized organizational structure, differentiates BBSI from our competitors. BBSI was incorporated in Maryland in 1965. Business Strategy Our strategy is to align local operations teams with the mission of small and mid-sized business owners, driving value to their business. To do so, BBSI: • partners with business owners to leverage their investment in human capital through a high-touch, results-oriented approach; • brings predictability to each client organization through a three-tiered management platform; and • enables business owners to focus on their core business by reducing organizational complexity and maximizing productivity. Business Organization We operate a decentralized delivery model using operationally focused business teams, typically located within 50 miles of our client companies. These teams are led by experienced business generalists and include senior-level professionals with expertise in human resources, organizational development, risk mitigation and workplace safety, recruiting, employee benefits, and various types of administration, including payroll. These teams are responsible for growth and profitability of their operations, and for providing strategic leadership, guidance and expert consultation to our client companies. The decentralized structure fosters autonomous decision-making in which business teams deliver plans that closely align with the objectives of each business owner client. We support clients with a local presence in 68 markets throughout the United States. Services Overview BBSI’s core purpose is to advocate for business owners, particularly in the small and mid-sized business segment. Our evolution from an entrepreneurially run company to a professionally managed organization has helped to form our view that all businesses experience inflection points at key stages of growth. The insights gained through our own growth, along with the trends we see in working with more than 8,000 companies each day, define our approach to guiding business owners through the challenges associated with being an employer. BBSI’s business teams align with each business owner client through a structured three-tiered progression. In doing so, business teams focus on the objectives of each business owner and deliver planning, guidance and resources in support of those objectives. Tier 1: Tactical Alignment The first stage focuses on the mutual setting of expectations and is essential to a successful client relationship. It begins with a process of assessment and discovery in which the business owner’s business objectives, attitudes, and culture are aligned with BBSI’s processes, controls and culture. This stage includes an implementation process, which addresses the administrative components of employment. Tier 2: Dynamic Relationship The second stage of the relationship emphasizes organizational development as a means of achieving each client’s business objectives. There is a focus on process improvement, development of best practices, supervisor training and leadership development. Tier 3: Strategic Counsel With an emphasis on advocacy on behalf of the business owner, the third stage of the relationship is more strategic and forward-looking with a goal of cultivating an environment in which all efforts are directed by the mission and long-term objectives of the business owner. 19 In addition to serving as a resource and guide, BBSI can provide workers’ compensation coverage as a means of meeting statutory requirements and protecting our clients from employment-related injury claims. Through our third-party administrators, we provide claims management services for our clients. We work to manage and reduce job injury claims, identify fraudulent claims and structure optimal work programs, including modified duty. In 2023, BBSI began offering employee benefit programs to our clients. The employee benefit programs are designed to provide strategic value to our clients through access to best-in-class plans and service. Benefit plans available to clients include medical, dental and vision plans, flexible spending accounts and health savings accounts, life insurance and voluntary accident coverage, and critical illness and disability coverage, among others. Results of Operations The following table sets forth the percentages of total revenues represented by selected items in the Company’s condensed consolidated statements of operations for the three months ended March 31, 2024 and 2023 ($ in thousands): Percentage of Total Net Revenues Three Months Ended March 31, 2024 2023 Revenues: Professional employer services $ 246,189 92.6 % $ 232,307 91.2 % Staffing services 19,593 7.4 22,360 8.8 Total revenues 265,782 100.0 254,667 100.0 Cost of revenues: Direct payroll costs 14,717 5.5 16,871 6.6 Payroll taxes and benefits 161,895 60.9 144,582 56.8 Workers’ compensation 49,603 18.7 51,670 20.3 Total cost of revenues 226,215 85.1 213,123 83.7 Gross margin 39,567 14.9 41,544 16.3 Selling, general and administrative expenses 42,414 16.0 41,226 16.2 Depreciation and amortization 1,852 0.7 1,677 0.7 Loss from operations (4,699 ) (1.8 ) (1,359 ) (0.6 ) Other income, net 3,296 1.2 2,313 0.9 (Loss) income before income taxes (1,403 ) (0.6 ) 954 0.3 (Benefit from) provision for income taxes (1,267 ) (0.5 ) 135 0.1 Net (loss) income $ (136 ) (0.1 ) % $ 819 0.2 % We report PEO revenues net of direct payroll costs because we are not the primary obligor for wage payments to our clients’ employees. However, management believes that gross billings and wages are useful in understanding the volume of our business activity and serve as an important performance metric in managing our operations, including the preparation of internal operating forecasts and establishing executive compensation performance goals. We therefore present for purposes of analysis gross billings and wage information for the three months ended March 31, 2024 and 2023. (Unaudited) Three Months Ended March 31, (in thousands) 2024 2023 Gross billings $ 1,907,549 $ 1,789,218 PEO and staffing wages $ 1,656,443 $ 1,551,352 In monitoring and evaluating the performance of our operations, management also reviews the following ratios, which represent selected amounts as a percentage of gross billings. Management believes these ratios are useful in understanding the efficiency and profitability of our service offerings. 20 (Unaudited) Percentage of Gross Billings Three Months Ended March 31, 2024 2023 PEO and staffing wages 86.8% 86.7% Payroll taxes and benefits 8.5% 8.1% Workers' compensation 2.6% 2.9% Gross margin 2.1% 2.3% The presentation of revenue on a net basis and the relative contributions of PEO and staffing services revenue can create volatility in our gross margin as a percentage of revenue. Generally, a relative increase in PEO services revenue will result in a higher gross margin as a percentage of revenue. Improvement in gross margin percentage occurs because incremental client services revenue dollars are reported as revenue net of all related direct payroll costs. We refer to employees of our PEO clients as worksite employees (“WSEs”). Management reviews average and ending WSE growth to monitor and evaluate the performance of our operations. Average WSEs are calculated by dividing the number of unique individuals paid in each month by the number of months in the period. Ending WSEs represents the number of unique individuals paid in the last month of the period. (Unaudited) Three Months Ended March 31, 2024 % Change 2023 % Change Average WSEs 123,050 3.1% 119,313 2.7% Ending WSEs 124,785 2.8% 121,363 2.9% 21 Three Months Ended March 31, 2024 and 2023 Net loss for the first quarter of 2024 amounted to $0.1 million compared to net income of $0.8 million for the first quarter of 2023. Diluted net loss per share for the first quarter of 2024 was $0.02 compared to diluted net income per share of $0.12 for the first quarter of 2023. Revenue for the first quarter of 2024 totaled $265.8 million, an increase of $11.1 million or 4.4% over the first quarter of 2023, which reflects an increase in the Company’s PEO services revenue of $13.9 million or 6.0% and a decrease in staffing services revenue of $2.8 million or 12.4%. The increase in PEO services revenue was primarily attributable to an increase in average number of WSEs as well as an increase in average billing per WSE. Gross margin for the first quarter of 2024 totaled $39.6 million or 14.9% of revenue compared to $41.5 million or 16.3% of revenue for the first quarter of 2023. The separate components of gross margin are discussed below. Direct payroll costs for the first quarter of 2024 totaled $14.7 million or 5.5% of revenue compared to $16.9 million or 6.6% of revenue for the first quarter of 2023. The decrease in direct payroll costs as a percentage of revenues was primarily due to a decrease in staffing services within the mix of our customer base compared to the first quarter of 2023. Payroll taxes and benefits for the first quarter of 2024 totaled $161.9 million or 60.9% of revenue compared to $144.6 million or 56.8% of revenue for the first quarter of 2023. The increase in payroll taxes and benefits expense as a percentage of revenue was primarily due to higher average payroll tax rates in the first quarter of 2024 and PEO client benefit costs of $6.6 million in the first quarter of 2024 compared to $1.4 million in the first quarter of 2023. Workers’ compensation expense for the first quarter of 2024 totaled $49.6 million or 18.7% of revenue compared to $51.7 million or 20.3% of revenue for the first quarter of 2023. The decrease in workers’ compensation expense as a percentage of revenue was primarily due to favorable prior year liability and premium adjustments of $3.0 million in the first quarter of 2024, compared to favorable prior year liability and premium adjustments of $1.1 million in the first quarter of 2023. Selling, general and administrative (“SG&A”) expenses for the first quarter of 2024 totaled $42.4 million or 16.0% of revenue compared to $41.2 million or 16.2% of revenue for the first quarter of 2023. The decrease as a percentage of revenue was primarily the result of decreased employee-related costs as a percentage of revenue. Other income, net for the first quarter of 2024 totaled $3.3 million compared to other income, net of $2.3 million for the first quarter of 2023. The increase was primarily attributable to an increase in investment income in the first quarter of 2024. Our effective income tax rate for the first quarter of 2024 was 90.3% compared to 14.2% for the first quarter of 2023. Our income tax rate typically differs from the federal statutory tax rate of 21% primarily due to state taxes as well as federal and state tax credits. Fluctuations in Quarterly Operating Results We have historically experienced significant fluctuations in our quarterly operating results, including losses or minimal income in the first quarter of each year, and expect such fluctuations to continue in the future. Our operating results may fluctuate due to a number of factors such as seasonality, wage limits on statutory payroll taxes, claims experience for workers’ compensation, demand for our services, and competition. Payroll taxes, as a component of cost of revenues, generally decline throughout a calendar year as the applicable statutory wage bases for federal and state unemployment taxes and Social Security taxes are exceeded on a per employee basis. Our revenue levels may be higher in the third quarter due to the effect of increased business activity of our customers’ businesses in the agriculture, food processing and forest products-related industries. In addition, revenues in the fourth quarter may be reduced by many customers’ practice of operating on holiday-shortened schedules. Workers’ compensation expense varies with both the frequency and severity of workplace injury claims reported during a quarter and the estimated future costs of such claims. In addition, positive or adverse loss 22 development of prior period claims during a subsequent quarter may also contribute to the volatility in the Company’s estimated workers’ compensation expense. Liquidity and Capital Resources The Company’s cash balance of $87.8 million, which includes cash, cash equivalents, and restricted cash, increased $13.0 million for the three months ended March 31, 2024, compared to a decrease of $39.3 million for the comparable period of 2023. The increase in cash at March 31, 2024 as compared to December 31, 2023 was primarily due to increased premium payable, increased accrued payroll, payroll taxes and related benefits, and proceeds from sales and maturities of restricted and unrestricted cash and investments, partially offset by increased trade accounts receivable, decreased workers’ compensation claims liabilities, repurchases of common stock, and purchases of investments and restricted investments. Net cash provided by operating activities for the three months ended March 31, 2024 amounted to $9.0 million, compared to cash used of $26.5 million for the comparable period of 2023. For the three months ended March 31, 2024, net cash provided by operating activities was primarily due to increased premium payable of $26.2 million and increased accrued payroll, payroll taxes and related benefits of $22.0 million, partially offset by increased trade accounts receivable of $29.0 million and decreased workers’ compensation claims liabilities of $9.8 million. Net cash provided by investing activities for the three months ended March 31, 2024 totaled $14.1 million, compared to cash used of $2.0 million for the comparable period of 2023. For the three months ended March 31, 2024, net cash provided by investing activities consisted of proceeds from sales and maturities of investments and restricted investments of $21.5 million, partially offset by purchases of restricted investments of $4.6 million and purchases of property, equipment and software of $2.8 million. Net cash used in financing activities for the three months ended March 31, 2024 was $10.1 million, compared to cash used of $10.8 million for the comparable period of 2023. For the three months ended March 31, 2024, net cash used in financing activities primarily consisted of repurchases of common stock of $7.1 million and dividend payments of $2.0 million. The Company is required to maintain minimum collateral levels for certain policies issued under the insured program, which is held in a trust account (the “trust account”). The balance in the trust account was $234.2 million and $210.9 million at March 31, 2024 and December 31, 2023, respectively. The trust account balance is included as a component of the current and long-term restricted cash and investments in the Company’s condensed consolidated balance sheets. See “Note 4 – Revolving Credit Facility and Long-Term Debt” to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this report for additional information regarding the Company’s credit agreement with Wells Fargo Bank, N.A. 23 Forward-Looking Information Statements in this report include forward-looking statements which are not historical in nature and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, discussion of economic conditions in our market areas and their effect on revenue levels, the lingering effects of the COVID-19 pandemic on our business operations, the competitiveness of our service offerings, the availability of certain fully insured medical and other health and welfare benefits to qualifying worksite employees, our ability to attract and retain clients and to achieve revenue growth, the effect of changes in our mix of services on gross margin, labor market conditions, the adequacy of our workers’ compensation reserves, the effect of changes in estimates of our future claims liabilities on our workers’ compensation reserves, including the effect of changes in our reserving practices and claims management process on our actuarial estimates, expected levels of required surety deposits and letters of credit, our ability to generate sufficient taxable income in the future to utilize our deferred tax assets, the effect of our formation and operation of two wholly owned licensed insurance subsidiaries, the risks of operation and cost of our insured program, the financial viability of our excess insurance carriers, the effectiveness of our management information systems, our relationship with our primary bank lender and the availability of financing and working capital to meet our funding requirements, litigation costs, the effect of changes in the interest rate environment on the value of our investment securities, the adequacy of our allowance for doubtful accounts, and the potential for and effect of acquisitions. All our forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors with respect to the Company include: our ability to retain current clients and attract new clients; difficulties associated with integrating clients into our operations; economic trends in our service areas; the potential for material deviations from expected future workers’ compensation claims experience; changes in the workers’ compensation regulatory environment in our primary markets; security breaches or failures in the Company’s information technology systems; collectability of accounts receivable; changes in executive management; changes in effective payroll tax rates and federal and state income tax rates; the carrying values of deferred income tax assets and goodwill (which may be affected by our future operating results); the effects of inflation on our operating expenses and those of our clients; the impact of and potential changes to the Patient Protection and Affordable Care Act, escalating medical costs, and other health care legislative initiatives on our business; the effect of conditions in the global capital markets on our investment portfolio; and the availability of capital, borrowing capacity on our revolving credit facility, or letters of credit necessary to meet state-mandated surety deposit requirements for maintaining our status as a qualified self-insured employer for workers’ compensation coverage or our insured program. Additional risk factors affecting our business are discussed in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2023, which was filed with the SEC on March 1, 2024. We disclaim any obligation to publicly announce any revisions to any of the forward-looking statements contained herein to reflect future events or developments. 24 Item 3. Quantitative and Qualitati ve Disclosures About Market Risk The Company’s exposure to market risk for changes in interest rates primarily relates to its investment portfolio and outstanding borrowings on its line of credit. The Company's investments and restricted investments, which are classified as available-for-sale, consist primarily of fixed-rate debt securities, the fair value of which fluctuates with prevailing interest rates. Our cash equivalents consist primarily of money market funds, which are not meaningfully impacted by interest rate risk. We attempt to limit our investment portfolio's exposure to market risk through low investment turnover and diversification. Based on the Company’s overall interest exposure at March 31, 2024, a 50 basis point increase in market interest rates would have a $4.8 million downward effect on the fair value of the Company’s investment portfolio. Outstanding borrowings on the Company's line of credit bear interest at a variable market rate, which makes the cost of borrowing on the line of credit susceptible to changing interest rates. At March 31, 2024, the Company had no outstanding borrowings on its line of credit.