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Edited Transcript of BBSI earnings conference call or presentation 27-Feb-19 5:00pm GMT

Q4 2018 Barrett Business Services Inc Earnings Call

VANCOUVER Mar 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Barrett Business Services Inc earnings conference call or presentation Wednesday, February 27, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary Edward Kramer

Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary

* Michael L. Elich

Barrett Business Services, Inc. - CEO, President & Director

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Conference Call Participants

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* Christopher Paul Moore

CJS Securities, Inc. - Senior Research Analyst

* Jeffrey Michael Martin

Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst

* Joshua David Vogel

Sidoti & Company, LLC - Analyst

* William J. Dezellem

Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer

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Presentation

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Operator [1]

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Good day, 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, 2018.

Joining us today are BBSI's President and CEO, Mr. Michael Elich; and the company's CFO, Mr. Gary Kramer. Following their remarks, we'll open the call for your questions.

Before we go further, please take note of the company's safe harbor statements 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 the information presented that does not reflect historical facts, are subject to a number of certain 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.

I would like to remind everyone that this call will be available for replay through March 27, 2019, starting at 3:00 p.m. Eastern time this afternoon. A webcast replay will also be available via the link provided in today's press release as well as the company's website at www.barrettbusiness.com.

And I would like to turn the call over to Chief Financial Officer of BBSI, Mr. Gary Kramer. Sir, please go ahead.

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [2]

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Thank you, Brenda. Depending upon where you're dialing in from, good morning or good afternoon, everyone. The operations of the company continued to be strong in the fourth quarter. Diluted income per share for the quarter increased 60% to a record $2.21 compared to $1.38 in Q4 '17. Net revenue in the fourth quarter of 2018 were $237.8 million compared to $244.7 million in the fourth quarter of 2017 and reflected weaker staffing revenue.

Gross billings of $1.5 billion grew 6% over the same period. PEO gross billings increased 7% to $1.5 billion compared to the fourth quarter last year. Gross billings grew by 4% in California, rose 17% in all other combined geographies. Same customer sales growth was 6.3% compared to 7.2% in Q4 of '17 and was about 100 basis points lower than we forecasted. Southern California comprised 51% of our total gross billings in the quarter and experienced the softest same customer sales growth at a rate of 4.8%. Also, bonuses our clients pay to themselves and their employees were lower than expected with only 2% growth over the prior year quarter, down from 16% growth in 4Q of '17.

We continued to increase our client base with a gross addition of 370 clients or 183 net of runoff in the quarter. This was a record for gross additions for any fourth quarter in our history.

Staffing revenues in the fourth quarter decreased 16% to $37 million. This was a slightly greater decrease than expected and is a direct result of the continued tight labor market. Each quarter we've discussed that this trend is making it difficult for employers to hire and we are experiencing this effect in our staffing business. We have the demand and orders from our client, but it is challenging to fulfill orders without compromising hiring standards. As such, we anticipate that staffing will continue to be a slight headwind to near term revenue growth.

Moving to the gross cost of billings. The fee we charge to our clients remained relatively unchanged. However, payroll as a percentage of gross billings is increasing as other components of gross margin decrease. This is related to an increase in PEO business mix and continued expansion outside of California where many states have lower payroll taxes and workers' compensation ratios. Given the passthrough nature of our pricing, this shift in the composition of our cost of revenue does not affect our branch profit.

Gross payroll taxes and benefits as a percentage of payroll was 5.6% in Q4 versus 7% in Q4 of '17 and contained a favorable adjustment for annual payroll tax expense being less than originally estimated for the year. Workers' compensation expense as a percentage of gross billings was 4.8% this quarter, which is below our expected range of 4.9% to 5.1% for the year. This compares to 5% of gross billings in the fourth quarter of 2017. The quarterly independent actuarial evaluation resulted in a reduction in prior year estimated liability of $1.5 million. Also, as previously discussed, we restructured our arrangement with Chubb to reduce frictional costs and are seeing these benefits increase as more clients transition into the new structure.

Our workers' compensation claims frequency continues to trend in line with expectations. In the quarter, we saw trailing 12-month relative frequency of claims as a percentage of payroll decrease 6% compared to the fourth quarter of 2017. All in, we are very pleased with the way our workers' compensation portfolio is performing. We have taken many steps to reduce frequency, minimize severity, reduce frictional costs and wrap the program with best-in-class people, processes and procedures. This strict focus and attention has resulted in a redundancy in the portfolio 2 quarters in a row and is why our expense is coming in below our range.

Taking these cost of sale items into consideration, gross margin was $62.2 million or 4.1% of gross billings compared to $49 million or 3.4% in the prior year quarter. SG&A in the fourth quarter was $43.8 million or 2.9% of gross billings compared to $34.5 million or 2.4% in the prior year quarter. The SG&A dollar growth is attributable to an increase in profit sharing and incentive compensation as a result of record earnings plus $3 million related to legal settlements and accruals. We continue to be mindful and diligent about balancing spend against growth while investing in the business for the future.

The provision for income taxes in the fourth quarter was $2.5 million. Our effective tax rate for the year was 15% and was lower than our previous estimate of 20%. The favorability was due to actions taken in the fourth quarter to gain efficiencies with the passage of the Tax Cuts and Jobs Act as well as other credits being greater than anticipated.

Moving to the balance sheet. We had no borrowings under our credit line as of 12/31/18 and we continue to be debt free except for the $4.2 million mortgage on our corporate headquarters in Vancouver, Washington. As part of our front-end workers' compensation insurance program with Chubb, we established and funded trust accounts called the Chubb Trust. On the balance sheet, the Chubb Trust are included in restricted cash and investments. The balance in the Chubb Trust were $451 million at 12/31/18 and $381 million at 12/31/17.

We discussed the last quarter that we shifted our asset liability matching investment strategy slightly due to rising rates and a flattening yield curve, and made the decision to stay shorter in duration for the near term. We negotiated an investment vehicle with one of our banks where we will target a cash balance of $100 million that will earn a spread of 25 basis points over the 3-month treasury. At 12/31/18, we had $96.4 million in cash that returned an annual crediting rate of 248 basis points. At December 31, the book yield of the portfolio was 239 basis points and the duration decreased from 2.8 years at 9/30/18 to 2.4 years at 12/31/18. The trust has eligible security guidelines with restrictions on asset class and asset diversification. This is a high-quality and highly liquid portfolio. At 12/31/18, the average quality of the portfolio was AA, and no investment was greater than 4% of the portfolio. In the quarter, we earned $2.7 million of investment income from the trust.

In summary for the year, we faced slight headwind to revenue growth for both staffing and PEO due to challenging hiring conditions. However, we continue to focus on the things in our control like widening our client base. In return, we added a record number of new clients for the year. We continue to invest in the business and future growth while being mindful of expenses and looking for savings and efficiencies in everything we do. Our workers' compensation portfolio developed favorably and is a direct result of the various steps and actions we have taken. This resulted in record earnings in 2018 of $4.98, which is a 50% growth versus 2017 and well exceeded our outlook of $4.31. We also returned dividends to shareholders in the amount of $7.3 million.

Turning the page to 2019 and our outlook on the business. Our pipeline remains strong and we continue to build our base of net new clients. Our referral relationships are deep and our distribution channels continue to widen. We expect gross billings growth for the next rolling 12-month period to be approximately 8%. This contemplates continuing deceleration in staffing revenue and same customer sales growth for PEO to be similar to 2018.

For the full year 2019, we expect diluted earnings per share to be approximately $5.40. This assumes an effective tax rate of approximately 18%. We will also be lowering our workers' compensation expense estimate and now expect a range of workers' compensation as a percentage of gross billings to be 4.6% to 4.8%.

Our 2019 earnings outlook represents expected EPS growth of 19% compared to a normalized 2018 after adjusting for certain nonrepeating transactions of the SEC settlement and the change in estimate in prior year's workers' compensation, plus an estimated 300 point spread in our federal tax rate between 2018 and 2019.

Now I'd like to turn the call over to the President and CEO of BBSI, Mike Elich, who will comment further on the recently completed fourth quarter as well as our operational outlook for 2019. Mike?

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [3]

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Hello, and thank you for taking time to be on the call. Before I move on to a discussion about the quarter, I'd like to comment on 2018. We had a strong year. While top line remains softer than historical levels, we feel very good about the record earnings and our ability to share -- to create shareholder value. The fundamentals of the business remained strong and we are seeing continued support of our value proposition in the market. As we closed out 2018, I spent a great deal of time in the field aligning vision, which reinforces confidence in the maturity of the organization. We also continued to spend time with referral partners broadening and strengthening our referral channels. And we continue to spend time with business owners working to understand what they may be seeing in their market. These disciplines provided means to understanding how we may evolve our offering over time to address challenges business owners face.

Additionally, we restructured our agreement with Chubb while continuing to emphasize discipline in our approach to workers' compensation. We also opened new branches in California and Nevada and we successfully navigated slight headwinds of top line growth while at the same time adding 831 net new clients in the year.

In the quarter, we added 370 new PEO clients. We experienced attrition of 187 clients, with 8 due to accounts receivable, 10 for lack of tier progression, 5 were canceled due to risk profile, 17 businesses sold, 35 businesses closed and 112 left due to pricing competition and companies that have moved away from the outsourced model. This represents an approximate build in the quarter of 183 net new clients.

Also in the quarter, once again, we took time to poll our existing clients to better understand what they may be seeing. In speaking with our clients, most are cautiously optimistic. We also heard that there is runway and opportunity for expansion but the shortage of skilled labor continues to be the #1 limitation to growth. There is also general uncertainty related to a variety of macro issues. In general, the business owners we spoke to expressed optimism but are not able to find the talent they need to grow which is why we believe we are seeing softness in same customer sales.

Related to pipeline. We continue to see strong client adds in the quarter and we believe this is a result of our referral partners' understanding and recommending BBSI. We continue to evolve our ability to scale from a model based on individual market contributors to a systemic approach for developing referral channels on a national basis. Today, we are seeing development of new referral channels in all markets which support strong pipeline growth as evidenced by continued new client adds.

Related to organizational structure. We continue to build the field organization to support future growth, scale into new markets and invest in support of our product offering. In the quarter, we opened a branch in Santa Barbara, California. Also, in the quarter, we added 4 business teams closing out 2018 with 110 business teams housed across 61 physical branches.

Related to branch stratification. We have 17 mature branches with run rates in excess of $100 million. This is a measure we use to indicate a branch's ability to increase leverage. We have 19 emerging branches running between $30 million and $100 million. We regularly reinvest back into these teams to support capacity as they grow. Finally, we have 25 branches we consider developing with run rates of up to $30 million. In these branches, we invest to support consistency of pipeline while maintaining integrity of product as they scale.

Although we're experiencing softness in some markets, we see this as temporary to our long-term strategy and we'll continue to invest in infrastructure as appropriate.

Looking forward to 2019. The fundamentals of the business are strong. We remain focused on bringing predictability and value to the business over the long term. Feedback I received from our clients and referral partners throughout the year support relevance in our product and we look at -- as we look at the next 5 years. Having spent a great deal of time in the field, my confidence in our ability to execute comes from the strength of our organization's leadership, the maturity of our teams and the structure that allows us to stay nimble. We continue to invest in infrastructure that supports both product, evolution and our ability to scale into new markets with predictable outcomes.

In conjunction with our long-term growth strategy, our goal is to add 18 new teams and 4 physical locations in 2019. At the end of 2019, we anticipate having more than 128 business teams housed in 65 physical locations. We are at a point where the foundation is strong, we know where we need to focus our energy and we are executing to our plan.

With that, I'll leave it open to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jeff Martin with Roth Capital.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [2]

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Can we look out beyond 2019 in terms of growth? Say, we get past some of these revenue headwinds, and your business has traditionally grown at a much faster rate. What sort of things would need to transpire in the market in respect to maybe California and your strategy overall to get back to, say, a 15% to 20% growth rate?

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [3]

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So one of the things that we watched as we've gotten through different periods of time is that as you go through a period of expansion, there typically can be a sellout period, there can be recession, there can be different things that will create softness in the market or maybe a little bit of drawdown in that market. One of the things that we do in our discipline is, one, from an expense standpoint, we move into a mode where we load level against the organization and reinvest dollars where we know we can create the most traction. That's number one. Secondly, we are always focused on the discipline of widening our base. So the controllable we have is how many clients we can add and retain in our book. And as we do that, we simply get wider. So even today, if we see ourselves adding smaller clients and probably facing a headwind of expansion in labor based on the shortage or softness or tight labor market, that becomes our headwind. And so with that headwind, we continue to widen our base. And at some point, when that market potentially settles out, corrects and we get back to more of a growth environment related to our customer, you'll see them start to hire people. And as they can hire people, you've got a wider base and that's where the uptick comes from.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [4]

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Okay. And then kind of segue into my next question here. Your client adds in the second half of the year were up 39% versus second half of '17, whereas first half was down 18% versus the first half of '17. Does that suggest we'll get an acceleration of growth here in the next 2, 3 quarters based on the client add as we continue to see the year-over-year growth in that kind of range?

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [5]

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You should see that. It just depends on what happens in the underlying client themselves. So if you take the base getting close to 6,000 clients and then you're adding, call it, 800 plus in the year, you're making a little bit of a turn on new to old or -- and what you're adding. Yes, we should -- you should, by just nature of the numbers, be able to see a bit of a turn as you have quarter-over-quarter comps in your bill. And then with a little bit of help from same customer momentum, yes, you should -- that's how we're viewing it. It's just hard to predict exactly when that happens.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [6]

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Okay. And then in terms of the California workers' comp market with rates being more competitive, is there any shift in your approach to the market there?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [7]

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Jeff, you're getting to a point in the market where it's rate reductions on rate reductions which is where it gets kind of exponential. And when you get exponential, your rate decreases get lower. So when I think about where the market is going to go for '19, I think, the rate reductions will be much less than we've seen in the historical just because of the whole exponential rate on rate factor. And then for us, we try to be long-term partners with our clients. We've done a lot of things in 2018 that are going to pay dividends in 2019 as far as trying to revamp our cost structure. And then really, the decision comes down to rather not doing a book idea but doing a surgical idea. And if we have accounts where we can be a little more flexible, we can -- we have the gas in the tank to get that flexibility based upon the way we've rightsized some of our costs here.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [8]

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One of the things I feel very good about the work that we've gotten done over the year to 18 months with that drawdown is that we've not put ourselves in a spot where we see any kind of adverse selection. The clients that we want, we're keeping. And we're in a good spot to make sure that we're not losing business for the wrong reason. And as we watched it, we're starting to see a little bit of a normalizing in some of the -- sea change that we saw over the last year to 18 months. And that's when we look out into the next year. It's hard to understand exactly what period you're going to see maybe a shift in reverse. But we at least feel comfortable that where we are at right now, we're in a good spot and we can see a new trend.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [9]

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Okay. And then, Kramer, could you elaborate on the payroll taxes and benefits adjustment in the fourth quarter and how that affected the quarter and the year in general?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [10]

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Yes. So the -- when we do our accruals through the year, we base that upon estimates and those estimates are going to have a couple of different factors, right? So really, what you see is the wage caps, they're not keeping pace with wage inflation, right? So people are getting, call it, 3.5% raises but those wage caps are staying fixed which means that payroll tax ratio is going to go down. We're also seeing some states where the employer taxes were less than we thought they would be. And then really, the other bucket of this is the pseudo tax which is really based upon the client's experience. And the client's experiences have been coming in favorable because the pseudo taxes really peg to an unemployment tax and unemployment's low. So really you're getting these 3 confluences which are making the estimate for the payroll tax to come down. And then when I think about that or if I'm sitting at your desk and thinking about how that's going to react in '19, when I think about that payroll, let me say, it's the annual payroll tax to revenue ratio for '18. Take the full year ratio, that's going to be consistent to what we think '19 is going to be. I actually think the '19 ratio is going to come down a little bit from where we were for '18. But really, that's the trend of this is -- it's not a onetime thing. This is just how taxes are trending and how we're going to have positive accretion to our gross margin from it.

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Operator [11]

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And our next question comes from the line of Chris Moore with CJS.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [12]

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Maybe we could just go back to the same customer sales for a minute and just kind of compare '19 versus '18 and talk a little bit more about expectations. Was it most of the growth you're expecting coming from wages or kind of how you're looking at it?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [13]

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Yes. So I mean, when we give our guidance number, we have to take a step back and think of the macro. And for the macro first, we think the macro for '19 is going to be consistent with the macro for '18, right? So that's the basic assumption that we're making in there. And then when we look at same customer sales, the way that our same customer sales are growing now is through wage inflation, right? And that's a function of where we are in the cycle of the economy. So we get wage inflation, we get add and work site employees and then we get hours worked. And really, where we're seeing over half of our same customer sales growth now is coming from wage inflation. So when we take that for 2018, and I'll call it a simple average for the year, is about 6.2% over all geographies. And then if we think about how that's going to trend going forward in '19, we think it's going to trend lower than that. So we think it's going to trend around 6% and that's how we're building up our guide and building up our model. It's -- I think it's arguably potentially a little conservative. We can maybe have some upside there. But it's really going to depend upon the macro effect of the economy for that same customer sales. I mean, that's the true uncontrollable that we don't have in our book.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [14]

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Got it. That's helpful. When we're talking about -- I'm looking at the Chubb Trust, I'm just trying to get a feel for -- I know the program started in July and then you will ultimately roll in all new policies by July of '19. Is that -- when you talked about potential flexibility in pricing, when you're adding new clients or retaining new ones, is that kind of an important component of what's -- what the conversation is there?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [15]

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It depends on the client. And I'll say it this way, it's just kind of another tool in the box that we had to use. I don't want to say it's a strategic concerted effort to try and go and give back any efficiency we've gained. But we know it's there if we need it.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [16]

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Got it. Specific -- the legal fees that you guys incurred in '18 that will not necessarily be recurring. I know you said it was about $3 million in Q4. What was the total number for the year?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [17]

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So we had the SEC which was earlier in the year, which was 2Q. And then in the fourth quarter, we had a -- you'll see it in the K when we release it next week, but we had a couple of legal actions go against this that added up to $3 million in addition to that. And they were specifically, that's just the normal course of business and they were just changes in facts on those claims. And you'll see some disclosures on that in the K.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [18]

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Got it. And just in terms -- you started out -- on the staffing side, so you assume a couple of points -- kind of negative headwind at this point in time where you're sitting?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [19]

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I think for staffing in general, it's going to be down another 5% to 10% for 2019. I mean, we're just -- that's a tough market to be in. Unemployment, where it's at, it's hard to find bodies to fill it. And what we're seeing with a lot of our clients is they're having to modify their behavior based upon that or modify their operations to try to maximize the efficiencies of where the people are which are the scarce resources. So we're seeing some things for clients shifting operations from West Coast to East Coast and things of that nature. And that's a function of really trying to get the work where the people are to do it.

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Operator [20]

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Our next question is from the line of Joshua Vogel with Sidoti.

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Joshua David Vogel, Sidoti & Company, LLC - Analyst [21]

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I guess first question is around pricing. I guess when you look at 2019, what are your initial plans there? Are you going to look to maybe keep it flat? And I guess on that vein, are you seeing any cost pressures or even relief maybe outside of workers' comp that you think you can pass along to clients?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [22]

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Yes. I just kind of want to level set kind of '19. So when you're going to get into Q1, Q1, we know, is going to be our toughest compare because we had -- that was our biggest growth in Q1 of '18. But also in Q1 of '19, we have one less business day. For the year, the year-over-year is a good analysis because in the third quarter, we have an extra business day so it right sizes for the whole year which is, to kind of give you a heads up in your modeling, Q1 going into this, we know that revenue is going to be a little soft -- it's going to be the softest quarter of the year. So I'll say it that way. And then when we think of gross margin. Gross margin, we're going to have accretion in gross margin, right? We've had -- first quarter is going to be probably a better first quarter than we've seen based upon the last couple of years. And a lot of that is going to be due to the margin that we're getting, the margin that we're holding. And then also, you're going to see more of the workers' comp change in structure come through, as those clients roll in for the 1 1 selling cycle. So when we think about margin for the year, we think margin for the year is going to be better than it was for 2018.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [23]

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Yes, Josh. And I would say, too, that if we look at the roadwork we've done over the last couple of years, organizationally, whether it's how we're generating pipeline, how we're bringing clients on, how we're creating alignment within our model, our value proposition today is probably never been stronger. And I -- when we look at just the echo chamber of the market to our teams, to how -- what the value we're bringing back, I think that there's a continued accretion there where the -- our ability to even expand margin and/or be able to sustain where we're at has improved dramatically even in the last couple of years. And so I think that we're on a good trend there.

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Joshua David Vogel, Sidoti & Company, LLC - Analyst [24]

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Okay, great. And just looking a little bit more at margins. Clearly, you're seeing great leverage on the workers' comp front. But where else can we look to or expect to see additional operating leverage? Over time, do you think workers' comp can come in at 4.5% or lower? Is there room on the SG&A line?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [25]

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Yes, we gave -- we lowered our expectations for the workers' comp range from 4.6% to 4.8%. We'll see how the year goes and give a revise on that. Ultimately, when we give our earnings guide, we try to err on the side of conservatism. So keep that in mind when you're looking at it. And then really for SG&A, we try to keep our SG&A in line with our revenue growth so that we can show leverage in the model. So our SG&A in 2018 was higher than our revenue growth and what we're going to see in 2019 is more the normalizing in that SG&A, where it's going to grow with parity to the gross revenue number.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [26]

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And I'd also add, Josh, that as you look at the stratification of branches, as we get more of those branches -- a larger percentage of the branches to that mature and super mature level, they tend to operate more efficiently and then that's where you, in time, will see more leverage coming from our individual operating units, which will also begin to leverage our operating infrastructure more effectively.

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Joshua David Vogel, Sidoti & Company, LLC - Analyst [27]

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Okay, great. And just one last one. When we look at workers' comp, I know it kind of, at this point, is running around net neutral to earnings. Is this something that you think you can try to squeeze some profits out of over time? Or you'd rather just pass that along to the clients?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [28]

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How do you get to the net neutral?

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Joshua David Vogel, Sidoti & Company, LLC - Analyst [29]

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That was just based on commentary you had told in the past.

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [30]

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Okay, yes. I mean, historically, we try to price it until a breakeven to a slight profit. We don't really -- we don't ever -- I mean, our philosophy is we don't ever want to be the highest, we don't ever want to be the lowest. We want to be consistent, right? And that's what we are seeing. And then what you're seeing now is the industry and the work we've done is paying some dividends here. And we've seen a change in estimate 2 quarters in a row in the third quarter, in the fourth quarter, for our prior years coming in more favorably than we thought. And we don't include any of that in our 2019 guide. If that happens, that would be greedy. But we don't bank on that. We bank on the core operations of the business.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [31]

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And I'll say also Josh, that as we've matured the program, we also can look at that a little different than we maybe used to have to look at it. And I think it's the efficiencies that we're finding that does allow it to be a little bit more accretive.

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Joshua David Vogel, Sidoti & Company, LLC - Analyst [32]

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Okay. And Mike, you just had some commentary around the branches. I may have missed it, I'm sorry. But of the 4 physical locations you plan to add in 2019, are those going to be all outside of California?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [33]

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No.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [34]

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No.

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [35]

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It will be a mix of inside California and outside.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [36]

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Yes, I think our target markets right now, there's one in California right now that's already in the works. We got one in Colorado, one in Philadelphia and...

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [37]

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One in Nashville later.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [38]

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Nashville, yes. So Tennessee. So we're diverse -- so 1/3 California -- or 1/4 California and 3/4 outside.

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Operator [39]

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(Operator Instructions) Our next question is from the line of Bill Dezellem of Tieton.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [40]

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A group of questions. First of all, relative to the $3 million charge that you referenced, if we understand correctly, that's going to be roughly $0.34 of additional earnings that you would have had in the fourth quarter had you not had those expenses. Is that correct?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [41]

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Your math, not mine.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [42]

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30% to 35%.

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [43]

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Yes, it doesn't sound unreasonable though.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [44]

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Okay. And then relative to the frictional cost reduction, what was the benefit that, that experienced in the fourth quarter specifically?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [45]

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We -- it's hard to try to parse that out specifically for those programs which is why we're trying to do this on an annual guide. I mean, the way this is going to trend is you're going to see first quarter be less, second quarter is going to trend down. And then in the third quarter of '19 is where we get to call it our new normal for where those synergies are all baked in, as these run off.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [46]

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And so given that we are now halfway through the year but the renewables are not linear, what proportion of the benefit do you feel like you have now accrued?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [47]

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It will be -- if you look through kind of the way our clients onboard, we have a pretty consistent build, quarter-over-quarter for when our clients add. I mean, that's really the strength of we're not a comp company and we don't hold ourselves accountable to the comp selling cycle. So looking by the time we get to the end of Q1, I would say roughly about 80% of our clients will be on the new structure.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [48]

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And as of the fourth quarter, what was that number?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [49]

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I'm shooting from the hip here, Bill. So I can do a little work and try to get you a number off-line.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [50]

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On a linear basis, it would be half. But I think it's still a little less than that.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [51]

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Fair enough. And you've referenced your improving referral partner process. Would you talk about the changes that you have made to improve that funnel? And what additional changes you still think that you can or should make to improve it even further?

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [52]

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Well, one of the things that we have to move from was an organization based on individual contributors, be it individual branches to recognizing that our markets function in more micro regions and regions where we've got shared relationships. And so a couple of years ago, when we really started taking a more active effort towards educating those individuals on a more aggregated basis about who we are, what we're about, what we're trying to accomplish is where we've started to see there was traction around when we start with, call it, any one of our referral partners, when we start at the tip of the spear maybe, the leader in that organization or the owner and then helping them to understand what we're really about, we eliminate them as a roadblock in that process. That's the first step. The second step is that once we really get them to be able to understand and see what we are and what our product is about, well outside workers' comp, but more on the how we impact small business, once they start to see that, then they begin to be ambassadors in their own organization to support our build. And then the next phase that we go through, and this is probably where we're putting our most energy in today is we have these producer track meetings that we work with. The boots on the ground for those individual organizations to help them understand more effectively how they bring us to market. And when they do it effectively, the benefit that they derive. I think the next turn of that is, is where we want to continue to mature that flow in that process in the field. And then looking more at how we strategically align, both within those micro regions and then how those regions with some bigger players that we work with have bigger footprint and really enter into, call it, a multiyear strategic plan with those individuals to even front run our brand into new markets.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [53]

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Great. And then finally, SG&A was, gosh, over 18% of revenues versus 14% or so in the year-ago quarter. I mean it was a $9 million absolute difference. Can you talk about what led to that? And I presume $3 million of it is the charge, or are the charges that you referenced. What's the remainder?

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Gary Edward Kramer, Barrett Business Services, Inc. - VP of Finance, Treasurer, CFO, Principal Accounting Officer & Secretary [54]

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Yes, I mean, it's really the $3 million that we mentioned is a big piece. The second is we invested in the company. At the end of the day, our investments are in our people. Our people are our product. And we have our management payrolls going up. And then the other piece is as the company earns more money and we have record earnings in the year, we have -- our branches and folks are incentivized based upon profit. And as we earn more, we pay out more. And that's something I actually like to do there. So I'm not afraid of paying out profit share for making the money.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [55]

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Okay. Well, we'll hope for massive profit sharing next year.

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Operator [56]

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This time, this concludes our question-and-answer session. I'd like to turn the call back over to Mr. Elich for closing comments.

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Michael L. Elich, Barrett Business Services, Inc. - CEO, President & Director [57]

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Thank you. In closing, I would really just like to reach out to thank all of you for being on the call. I know you've been there to support us over the long period of time. And as we close out 2018, I just want to let you know I'm really excited about where we're going 2019 and well beyond that. And I'd also like to just thank our -- the referral partners we work with for their trust and our clients that we work with for their confidence in us and our ability to continue to stay in the ring for them. But just as much, I wanted to thank everybody, every person, every member of the BBSI team who continue to mature as we stay in the ring in pursuit of what's possible. It's cool work that we get to do and it has very, very good purpose when we look at the impact that we have on small business. And we're just getting started, and I think you got a pretty fired up organization ready to go get it. So I want to thank everybody for all that you do to make it all work. So thank you.

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Operator [58]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.