Earnings Call Transcript - BBSI Q2 2020

Operator, Operator

Good day, everyone. Thank you for participating in today's conference call to discuss BBSI's financial results for the second quarter ended June 30, 2020. Joining us today are BBSI's President and CEO, Mr. Gary Kramer; and the company's CFO, Mr. Anthony Harris. Following their remarks, we'll open the call for your questions. Before we go further, please take note of the company's safe harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995. The statement provides important cautions regarding forward-looking statements. The company's remarks during today's conference call will include forward-looking statements. These statements, along with other information presented that does not reflect historical fact, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by 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 September 5, 2020, 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 available on the company's website at www.mybbsi.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.

Gary Kramer, President and CEO

Thank you, David. Good morning, everyone, and thank you for being on the call. I hope everyone is staying safe and healthy during these times. The second quarter presented a challenging environment due to COVID-19 and its economic effects. Our teams across the country performed admirably while working remotely to support our clients in these difficult times. I want to extend my gratitude again to everyone at BBSI for their outstanding response to this crisis. We have continued to provide exceptional and uninterrupted service to our clients and distribution partners. I am very proud of the support that we have delivered, especially as we assisted clients through layoffs and furloughs, while navigating various legislations such as those regarding essential status, FFCRA, and the CARES Act. We developed reports and made introductions to aid clients in applying for grants, loans, and subsidies, and we also supported work-from-home and return-to-work programs. Simply put, our services have never been more relevant. Unfortunate events like COVID-19 are the reason BBSI exists—to advocate for the success of business owners. I will now structure my remaining comments into three sections: first, I will discuss our financial strength; second, I will comment on second-quarter operations; and third, I will update our growth strategy. Following that, Anthony Harris will present his remarks regarding the second quarter, along with a financial and capital review for the rest of the year, after which we will open the line for questions. Regarding our financial strength, our balance sheet is in excellent shape. We previously talked about building a financial cushion for the company, and I am happy to report that this cushion is even more robust following a loss portfolio transfer, which is a significant step in reducing our workers' compensation risk. This transaction provided a one-time boost of $48 million in unrestricted cash and will generate additional cash flow benefits later this year. As of the end of the quarter, our available cash and securities increased by $36 million from the first quarter to $130 million, and we still have a $50 million credit facility available. Anthony will elaborate on our liquidity in his remarks, but it's important to note that we have made considerable progress in enhancing our already strong balance sheet despite the global uncertainties caused by COVID-19. This speaks volumes about the intrinsic value of our company. For second-quarter operations, our gross billings fell by 6% compared to the previous year. In our interim financials from last quarter, we indicated that April would likely represent the lowest point, and we’re pleased to confirm that it was. Our gross billings decreased by 14% in April, while May and June saw a more moderate average decrease of 2.6%. Overall, we are very satisfied with the resilience of our customer base, and gross billings came in higher than our internal forecasts for the quarter. We believe Q2 will be the low point for the year. In the last quarter, we shared insights about BBSI's client base and how we anticipated the pandemic would impact their industries. Our portfolio is primarily focused on blue and gray collar industries, avoiding highly distressed sectors like airlines and cruises, and maintaining low exposure to retail, restaurants, gyms, and salons. This strategy has helped us mitigate risks associated with COVID-19. Of our client base this quarter, 44% experienced a slight increase in gross billings, including sectors like construction and warehousing. 17% were minimally affected with a small decrease, including waste management and landscaping. 33% of clients saw a moderate impact resulting in a 12% decline, covering transportation, logistics, and manufacturing. Lastly, 6% of clients were severely affected with a 34% decrease, primarily in restaurants and hospitality. Regarding client acquisition, we added 227 new PEO clients. While these numbers are lower than our expectations and those of previous years, they align with what we consider to be reasonable in the context of COVID-19. We had significant drops in prospect meetings in April and May, but June showed improvement. July appears to be trending better than June but remains about 20% lower than last year. Client acquisition remains our top priority, and I will address this further shortly. We experienced an attrition of 142 clients, which was better than anticipated and improved compared to the previous year. This attrition occurred as businesses reacted to the pandemic; however, our services became increasingly necessary during these times. In terms of attrition reasons, we lost four clients to accounts receivable issues, five for lack of peer progression, seven due to risk profile concerns, 14 businesses sold, seven closed, 22 due to COVID, and 83 due to pricing competition or companies moving away from outsourcing. Overall, we ended the quarter with a net increase of 85 clients. Our staffing business was hit the hardest and quickest, dropping 26% during the quarter. When companies need to make cuts, temporary workforce reductions are typically one of the first actions taken, leading to a swift decline in staffing revenue. The recovery of this sector is lagging behind overall economic recovery since many individuals find unemployment benefits more appealing than working wages. At the end of June, we operated 57 branches: 18 mature branches with run rates exceeding $100 million, 20 emerging branches running between $30 million and $100 million, and 19 developing branches with run rates up to $30 million. Our teams generated a total of $114 million in business units. Overall, we saw a 6% decrease in gross billings, but we remain optimistic about stability in this area. Looking ahead, we forecast a 3% decrease in gross billings for the full year. Next, I will share updates on our actions to navigate through COVID-19 during the quarter. Our SG&A expenses were significantly lower compared to the previous year. We acted quickly at the end of Q1 to cut discretionary spending, consolidate branches, and create satellite branches by removing management layers, resulting in layoffs and furloughs. These measures aimed to lower costs while maintaining revenue and product quality. I am pleased to report that we have successfully brought back more than half of our furloughed employees. I will now discuss various initiatives and strategies we are pursuing in the context of COVID-19. We are focusing on sales and organic growth. In Q3, we plan to open a new branch in Albuquerque and a second in Phoenix. While our products will remain constant, our marketing approach will adapt to the COVID environment, with newly trained area managers concentrated on sales and pipeline development. We will utilize alternative lease options to minimize costs rather than committing to long-term commercial real estate contracts. Support for these branches will come from adjacent markets or headquarters until they reach a critical mass, at which point we will invest in local teams. Furthermore, we are exploring potential acquisitions of smaller PEOs in regions where we lack a presence. The ideal candidate would align with our values, have fewer than 10,000 worksite employees, and employ a similar distribution strategy. We believe our balanced approach of organic reinvestment in new branches and possible acquisitions in unfamiliar areas is the right strategy to become a truly national and geographically diversified PEO with robust long-term gross billing growth. In June, we successfully launched My BBSI for all new clients, and we have received highly positive feedback about the system's ease of use and customization. We are excited about this technology and are executing marketing campaigns to inform our referral partners about it. Over the remainder of the year, we will convert our existing client base to the new system in phases, aiming for full transition by year-end. We have also submitted applications for our PEO licenses in every state and anticipate being fully licensed within the next two months, having added 16 states since our last call, bringing our total to 35 licensed states. Lack of a nationwide license can sometimes restrict our ability to work with new clients, but our system changes will enable us to service clients better, and our expanded insurance offerings will support this growth. We will now be able to acquire new clients that may have previously been too large for us. As we go to market, we present the best of BBSI, offering a range of products and services, including strategic consulting, human resources, technology, insurance, risk management, retirement services, staffing, and recruiting. Clients may choose BBSI for a specific need today, but they will stay for our comprehensive service suite. Our people have always been and remain our greatest asset—more relevant now than ever. The integration of their expertise with our new technology platform allows us to serve larger, more tech-savvy clients and expands our overall market potential. We are truly poised for significant growth and are eager to accelerate our sales efforts as we move past COVID-19. Now, I will turn the call over to Anthony for his remarks.

Anthony Harris, CFO

Thanks, Gary. Similar to last quarter, I will begin with an overview of our quarter results and current capital position, and I will conclude with more commentary on how COVID-19 is currently impacting our business and our outlook for the year. Net income for the quarter was $11.5 million compared to $13.9 million in Q2 '19. The gross billings declined 6% to $1.37 billion. PEO gross billings declined 6% to $1.35 billion, while staffing revenues declined 26% to $20.5 million. Net revenues of $201 million were down 13% from Q2 '19. Remember that our GAAP revenue presentation differs from PEO and staffing services, so a change in mix will impact our net revenue trend. As Gary noted, April was the low point for our billings on the COVID-19 slowdown, and we are pleased with the speed of the recovery of billings in May and June. Gross billings by region varied in part due to the actions taken by various states in different geographies. In the quarter, gross billings by region were as follows: Mountain states grew 11% over the prior year quarter, East Coast grew by 4%, northwest billings declined by 7%, and California billings declined by 10%. Customer growth trends also came in line with our expectations relative to the current environment. As Gary noted, new customer adds slowed in the quarter, which was partially offset by slower client runoff. There remains a headwind to net customer adds in this environment. Workers' compensation expense as a percent of gross billings was 3.8% this quarter, which is below our expected range of 4.2% to 4.4%. This decline is partly attributable to actuarially determined reductions of prior year estimated liabilities of $1.4 million in the second quarter and additional reductions due to cost-saving measures. Our workers' compensation claims frequency also continues to trend favorably. In the quarter, we saw trailing 12-month relative frequency of claims as a percentage of payroll decrease 18% compared to the second quarter of '19. SG&A in the quarter was $33.3 million compared to $39 million in the prior year quarter, representing a decline of 15%. As we described in our first quarter call, the BBSI management team was quick to plan for and respond to declining business volumes due to COVID-19. We executed on those plans, which included meaningful expense reduction and cash flow management in the second quarter. In addition, a key part of our employee compensation comprises profit share and other incentive-based payments, and our accrued expenses for these programs has decreased based on our reduced profitability in the COVID-19 slowdown. As business volumes have recovered, SG&A levels will continue to increase as we bring employees back from furlough and incur other employee compensation costs. Our investment portfolios earned $1.8 million in the second quarter compared to $3.3 million in the prior year. The decrease in investment income is directly attributable to the decline in interest rates in the period and is consistent with our expectations communicated in the prior quarter. Turning to the balance sheet. We are very pleased to report the progress we have made in our workers' compensation program structure. Part of our long-term goal is continuing to derisk our business model. We entered into a loss portfolio transfer agreement in Q2 to transfer $116 million of workers' compensation claims liabilities off of our balance sheet. This transfer of claims for accident years 2014 through 2017 represented approximately 27% of our outstanding claims liabilities. As a result of this transfer, BBSI has no exposure for any potential adverse development on those claims. However, the terms of the transaction do allow us to continue to participate in favorable development in future years based on certain predefined benchmarks. In summary, there's only upside for the company. By transferring these claims, we were also able to unlock excess collateral that was tied to those claims, which resulted in the immediate transfer of $48 million of restricted cash investments moving back to the company's unrestricted accounts at June 30. In addition, the company's renewal of its fronted program with Chubb as of July 1 also included several positive achievements. We were able to renew at favorable rates with considerably lower collateral funding requirements than prior years. The result is expected collateral savings over the next 12 months of approximately $30 million compared to what we would have funded under the previous terms. This will be reflected as an increase in our unrestricted cash and investments over the coming year. In addition, we lowered the company's loss retention from $5 million per occurrence to $3 million. And lastly, we also agreed to a multiyear term with Chubb for the first time with coverage secured through June 2022. Not only do these arrangements derisk our model, they speak again to the success we have had in managing our workers' compensation program and the consistency of the company's results in this area. After the loss portfolio transfer and collateral returns I just discussed, our ending unrestricted cash and investments balance at June 30 was $130 million compared to $94 million at March 31 and $101 million at the prior June 30. Also remember that we typically build cash in the third and fourth quarters due primarily to the timing of payroll tax payments that occur earlier in the year. Because of these transfers, our restricted cash and investments at June 30 declined to $322 million from $467 million at March 31. These restricted balances will now grow at a slower pace due to our more favorable collateral terms. Our investments continue to be managed conservatively. As market yields have dropped, our unrealized gains on our investments increased significantly to $9.6 million. Our average duration remains conservative at 1.6 years and the average quality of investments remains at AA. As expected, our interest income is down due to a combination of our variable rate investments, comprising approximately 26% of the total portfolio and lower interest rates on all new fixed rate investments acquired since March. Our average book yield has decreased to 1.8% from 2.3% at year-end. We continue to be debt-free at quarter end except for our $4 million mortgage on our corporate headquarters. We discussed in our first quarter call that we had agreed with Wells Fargo to increase our line of credit in the second quarter from $33 million to $50 million, and that agreement was subsequently executed as planned. This has built a vote of confidence from Wells Fargo and a source of additional financial flexibility given the economic uncertainty. Our agreement with Wells Fargo provides management the option to revert to the lower credit line if we wish. I will now move to our discussion of how COVID-19 has continued to impact our business. The effects of the pandemic on our operations are now reflected in a full quarter of results, and they are more favorable than expected. Client payrolls and therefore, gross billings, recovered at an encouraging pace in May, and we have still not seen a meaningful increase in customer defaults or bad debts. Because billings have recovered from their low, we have brought back many of our employees from furlough. We also continue to believe our workers' compensation program is well insulated from the effects of COVID-19. As noted last quarter, less than 2% of our work site employees were in the health care sector or were considered first responders as generally defined. Through underwriting actions, we have now reduced our exposure to these categories to less than 1% of our work site employees. As of July 31, we had 16 reported claims for cases of COVID-19 with only 2 being accepted. Both claims are for immaterial dollar amounts, and both individuals have returned to work. Our claims frequency has also trended favorably. This is consistent with our expectation that the economic downturn related to COVID-19 would not necessarily translate to a significant increase in claims frequency. That is in part due to the nature of this economic contraction as well as the significant amount of financial stimulus that has been made available to individuals through a variety of programs. We continue to monitor legislative and executive actions that could impact our workers' compensation exposure, and there have been some positive developments there recently. A California executive order related to workers' compensation coverage expired on July 5, and related pending legislation in that state is more restrictive in scope than the original order. Even with these positive trends and although the amounts today are much smaller than they were a quarter ago, we have continued to approach our workers' compensation accruals conservatively. Moving to our outlook for the remainder of the year. While there continues to be real uncertainty in the market created by the pandemic, we are reinstating our full-year outlook based on the information that we have today. Our forecast does not contemplate the return to shelter-in-place orders like we saw in April. We expect our gross billings for the year to decline by 3% compared to the full year of 2019. Within this figure, we expect staffing revenues to decline by 19% for the year. We expect gross workers' compensation expense as a percent of gross billings to range between 3.8% and 4%. This range includes our favorable experience recorded year-to-date. We expect our full-year diluted earnings per share to be $3.70, which assumes an effective tax rate of 21%. In closing, we are pleased with the results of the quarter and the pace of the recovery so far. While there remains continued macroeconomic uncertainty, we have been able to derisk our business model, strengthen our balance sheet, and streamline our operations in the second quarter, and we are well positioned for the future. I will now turn the call back to Gary for closing remarks.

Gary Kramer, President and CEO

Thanks, Anthony. In conclusion, our product, fundamentals, and financials are solid, and I am confident that we will weather this pandemic and emerge stronger. Our client base is situated in industries that are not heavily affected by COVID, and I am optimistic that we can return to growth as normalcy resumes. We continue to always think of the client first and advocate for the success of the business owner. Now I'll turn the call over to the operator. David?

Operator, Operator

Our first question is from Chris Moore with CJS Securities.

Christopher Moore, Analyst

Impressive quarter. Can you maybe start just with workers' comp? Obviously, workers' comp as a percentage of gross billings has come down meaningfully. Two questions on the 3.8% to 4% range. One is that range is just for fiscal '20, correct? It includes $2.2 million of favorable adjustments in the first half. So that just applies for '20?

Anthony Harris, CFO

Yes, that's correct. So we don't include actuarial adjustments in our forecast. But for this year, for the full-year guide, we were already accounting for the first half of the year, the $2 million that we recorded. That's correct.

Christopher Moore, Analyst

Got it. And what's kind of the theoretical limit here on the workers' comp as a percentage? I mean, could it be meaningfully below 4% or is that kind of a fair place to be?

Anthony Harris, CFO

So we are seeing a long-term trend in reductions of workers' compensation costs that I think we've approached that trend cautiously in terms of our reserving. I think you've seen that come through our favorable actuarial adjustments, right? So the manifestation of that is the prior accident year contacts that we've been taking each quarter. So there were reforms, especially in California several years ago that have favorably impacted the cost structure. There's still some unknowns with how COVID will play out, but I'll say in this last quarter, the data on that has been very favorable as well. So even though we continue to be cautious, the trends are very favorable on cost reductions.

Gary Kramer, President and CEO

Yes, Chris. And if you just look at the quarter for us, the claims reported in Q2 compared to prior year was down 20%, which is a good sign, right? I'll say we're fortunate that we're not in health care, which is where the COVID claims really are, on the workers' comp side. So we dodged that bullet. We haven't seen COVID claims. We don't think COVID claims are going to be an issue for us. So we were conservative going through our first half of the year accrual just because there's unknown out there. But if things continue to trend the way they are, and we're getting some tightness on the legislative side, I could see our accrual rate coming down just because of the experiences in there.

Christopher Moore, Analyst

Got it. That's helpful. Let’s shift focus. Regarding post-COVID revenue growth, you mentioned at a recent conference a target of 15% revenue growth, which is allocated between same-store sales, new clients, and mergers and acquisitions. I believe the M&A contribution was around 5%. Can you clarify the breakdown between same-store sales and new clients? Would they be approximately equal, or how are you approaching this?

Gary Kramer, President and CEO

Yes. We haven't given any guidance yet for '21. And honestly, the reason we can't do that is because it's even hard to give revenue guidance for Q3 or Q4 with the unknowable factors that are happening in the economy right now. But when we think of the business over a long-term cycle, organically, between our investing in business units, investing in additional branches with the capacity we have at the company, there's really no reason that we shouldn't be organically 10-plus percent gross billings grower. And then if we were to layer an M&A on top of that, it would just be accretive, which would get you up in that mid-teens plus range.

Operator, Operator

Our next question is from Josh Vogel with Sidoti.

Josh Vogel, Analyst

A couple of questions about the outlook for the balance of the year. And you talked about payroll trends had improved significantly in May and June versus April. I think you said down 2.6% on average. And I'm curious how much of that you think was just some pent-up and maybe not sustainable? And then to build off that, understanding that net client builds are expected to be slower than you've achieved historically, I'm just curious, what are the assumptions behind the implied 4% to 5% annual gross revenue declines that you built into your second half guidance?

Anthony Harris, CFO

Sure. Yes. So first of all, on the revenue kind of shape of the recovery, we definitely saw what I would call a mini V-shaped recovery. So it was a deep cut in April as everybody went to shelter-in-place and companies immediately furloughed and laid off employees, and that bounced back rapidly in May. And that payroll, we saw that level off pretty quickly. So June payroll sequentially were up over May but not much. And July payroll sequentially are trending fairly flat as well. So it definitely was a V-shaped recovery. And so we're seeing that as a fairly stable base at this point.

Gary Kramer, President and CEO

Yes. When forecasting Q3 and Q4, we are assuming that it will behave similarly to June and July. This forms the basis of our expectations for the economy for the rest of the year. One uncertain factor is the effect of the PPP, which has influenced some of our assumptions. Regarding our client additions and retention for Q3 and Q4, we expect to add fewer clients than initially planned in Q3, with an uptick in Q4. However, we anticipate improved retention rates. Specifically for Q3, we believe it will mirror Q2, and we have aligned our assumptions accordingly for additions and retention.

Josh Vogel, Analyst

That's helpful. And just thinking about the comment on the sales conversion rate, you had 227 new client adds. How many prospect meetings did you have?

Gary Kramer, President and CEO

We run at about a 34% closing ratio. So our closing ratio was consistent. We just didn't get as many pitches. So we had a good batting average. We just didn't get as many pitches. So if you do the math...

Anthony Harris, CFO

Really all the same there.

Josh Vogel, Analyst

So Anthony, you mentioned that the SG&A spending will increase as the year goes on. I want to focus on the incremental $5.6 million you mentioned coming out of 2019 for the new portal rollout. How much of that should we expect to see reflected in the third and fourth quarters, respectively?

Anthony Harris, CFO

Yes. And that's, I think, what also makes the SG&A decline extra impressive, right, is the 15% decline, that's year-over-year. But of course, you correctly note that at year-end, we had guided for an SG&A increase this year. Right? So our decrease from plan really demonstrates kind of the effort that was put into that. The $5.6 million, I mean, I think at this point, that's kind of baked in. That's obviously baked into our model. That does ramp up a little bit in Q3 and Q4. There's not much there in terms of incremental second half shape versus the first half. But what I will say is the big trend difference is going to be our employee costs. Right? It's for the two things I mentioned. Not only are we going to bring more employees back and therefore have headcount adds in the second half of the year as our business volumes stabilize and increase. We're also going to have an increase in our profit share and incentive compensation accruals, which, if you followed us, you know that's an important part of our compensation strategy for our teams. And so as our branch profitability improves, as our company profitability improves from what we saw in the first half of the year, we're going to see those accruals increase as well.

Josh Vogel, Analyst

Okay. And a quick question on the workers' comp benefit in the quarter. Was that from this 2014 to 2017 time period?

Anthony Harris, CFO

No. So the $1.4 million actuarial adjustment, is that what you're referring to?

Josh Vogel, Analyst

Yes.

Anthony Harris, CFO

No. So that would be for the claims that are remaining with us at June 30.

Gary Kramer, President and CEO

The adjustments will apply to the years 2018 and earlier, as 2019 is still too new to take action on.

Josh Vogel, Analyst

Okay. And just lastly, the comments around inorganic growth. Can you just talk about the pipeline? Is this something you're looking to be active on in the second half of the year? Or do you just want the dust to completely settle with COVID?

Gary Kramer, President and CEO

I want to clarify that we're not in a rush to spend money. We manage our capital responsibly and will consistently invest in our business, including IT, various business units, and branches. We remain committed to supporting the dividend as mentioned in our press release. After prioritizing these areas, we will evaluate where we can provide better returns for investors, whether through mergers and acquisitions or buybacks. The PEO industry is currently fragmented, with about 920 PEOs in the U.S. Most of these are small, and only about 30 have more than 20,000 worksite employees. We are interested in regional players, such as those in Texas with 4 to 5 branches. Our goal isn't just to acquire a client base but to buy companies with teams and products in those areas, allowing us to provide our services to their clients. We aim to establish a solid foundation and grow organically in those states afterward. We are actively exploring opportunities, but we do not feel the need to act hastily, especially considering the current state of the economy.

Operator, Operator

Our next question is from Jeff Martin with ROTH Capital Partners.

Jeff Martin, Analyst

Kramer and Anthony, I hope you're doing well. I wanted to ask if you have the same-store sales number for the quarter and how it breaks down, as that information would be helpful.

Anthony Harris, CFO

Yes. So same-customer sales for the quarter was down 4.5%. And so as expected, clients reduced headcount, it's kind of a weird quarter for same customer sales. And in that sense, obviously, it's highly impacted by COVID, but that reduction was split pretty evenly between headcount, of course, and hours reductions. We have seen wage inflation over the year. We have been mentioning that, and there's some wage inflation that continued to come through there just because that's a year-over-year number. So there's some inflation baked into that as well.

Jeff Martin, Analyst

Okay. And then what was the unencumbered cash number at the end of the quarter?

Anthony Harris, CFO

$130 million.

Jeff Martin, Analyst

Okay. And then, Kramer, you mentioned expanded service offerings for insurance. Curious what specifically that entails? And then secondly, could you touch on your longer-term strategy in terms of derisking workers' compensation from the model?

Gary Kramer, President and CEO

Sure. Considering our expansion as a PEO in additional states, we implemented system changes necessary for handling payroll, processing, and billing, and that aspect is complete. Additionally, through our collaboration with our front-end carrier, we can now provide our workers' compensation insurance product in those states, which is also complete. We are now equipped to operate in 36 states, and we are addressing the remaining states. Progress is slightly slower than anticipated due to COVID impacting state governments, but we have a plan to include the additional 14 states within the next 2 to 3 months. That answers the first question. What was the second question?

Jeff Martin, Analyst

Derisking the workers' comp, longer-term strategy?

Gary Kramer, President and CEO

When we consider our insurance product, we have made significant progress in how we manage and price for risk, as well as handle claims effectively with strong processes and controls. This improvement is reflected in the predictability of our losses and the positive trends seen in previous accident years. The successful completion of a loss portfolio transfer at our carried price is a strong indicator for investors and the market, as an independent third party was confident enough in that price to proceed, knowing they operate to earn profits. Following this, when we renewed our program, we reduced our retention from $5 million to $3 million, aligning our funding with our loss expectations. This indicates a shared understanding of the market outlook with our carriers. Looking ahead, we aim to selectively take on future risks and establish relationships that can reduce our overall exposure, allowing us to share some risk rather than taking it all. Our solid performance enables us to consider such financial strategies which weren't feasible for us just four years ago.

Jeff Martin, Analyst

Okay. That's very helpful. Could you elaborate a bit more on the geographic growth and contraction differences between, say, Mountain states and California? Are there specific things going on that are either BBSI specific or state specific that are causing that separation in terms of how those different areas are performing?

Gary Kramer, President and CEO

Sure. It's a good question, Jeff. The Mountain states had a very strong finish to 2019 concerning client additions and retention, growing significantly in that region. In the second quarter, they gained business towards the end of the year, resulting in revenue that was not there before. They also had a solid client base. In contrast, the Mountain states were not as severely impacted by COVID restrictions as California was. California experienced a 10% decline overall, with both Northern and Southern California also down by 10%. However, the Mountain states showed more economic resilience regarding COVID incidents and shelter-in-place restrictions.

Jeff Martin, Analyst

Got it. Makes sense. Okay. Is there anything specific you would attribute the higher client retention in the quarter, I would imagine, I mean, you've already said that you expect that to kind of remain at a better level than it's been historically. But just curious, is it the value of the assistance you're providing? Is it companies focusing on getting through this and not making any changes right now? Curious to know what your perspective is on that?

Gary Kramer, President and CEO

The product we've been delivering has been outstanding. Our HR team has been exceptional in supporting our clients during a challenging time for business owners. I can't imagine managing this without BBSI or a similar partner to share the burden with. The value we provide is more important now than ever. However, we can't take full credit for this situation. For business owners facing significant risks, especially related to COVID, there is little incentive to take on even more risk by leaving BBSI. This creates a dual effect; while it helps with retention, it also means we're not seeing new clients come on board due to the current uncertainties. Business owners are hesitant to introduce changes such as switching payroll providers or dealing with other complex matters like PPP forgiveness during this turbulent time. There are factors positively and negatively impacting our situation simultaneously.

Jeff Martin, Analyst

Right, right. Okay. And then final question is, would there be any shift in strategy if this slowdown were to extend well into the middle of next year? And if so, what might those changes in the strategy be?

Gary Kramer, President and CEO

Yes, we have learned some lessons from COVID. One key takeaway is that we can work effectively from remote locations, possibly even more efficiently than before. This understanding influences our plans to open new branches in Albuquerque and Phoenix. Initially, we will not assign support staff to these new locations; instead, support will come from other branches or our corporate office until the branches reach sufficient operational volume. We are evaluating how to structure our branches to enhance efficiency and client service in a virtual environment. Our first branch will open this month, followed by the second in September, following this model of centralized support until they achieve critical mass.

Operator, Operator

Our next question is from Vincent Colicchio with Barrington Research.

Vincent Colicchio, Analyst

Well, most of mine have been answered already. Just one or two. Just curious, how did pricing change in the quarter? And what is your outlook for the second half?

Anthony Harris, CFO

Pricing remains relatively consistent, making it challenging to raise rates, especially when business owners are focused on their own operations. Now is not the right time to be aggressive with pricing, despite our belief in the value of our service. We continue to encounter more pricing pressure in California workers' comp. Each quarter, I attempt to identify the bottom and often miss the mark. I anticipated that due to uncertainties from COVID and lower investment income, rates in California would begin to rise, but that hasn’t happened yet. There is still competition in the market, although some competitors are not managing their capital wisely, which complicates the landscape for us. Nevertheless, our teams are skilled and understand how to effectively communicate the value of BBSI beyond just workers' comp.

Vincent Colicchio, Analyst

Okay. And then does your forecast for the balance of the year assume California improves from the current level of economic activity?

Gary Kramer, President and CEO

If California operates how it did in June and July for us.

Vincent Colicchio, Analyst

Okay. So you're not assuming any improvement there per se?

Gary Kramer, President and CEO

We're not. Yes, I mean it's both ways, right? We're not saying it's going to get better, and we're not saying that there's going to be a second shelter-in-place order.

Operator, Operator

Our next question is from Bill Dezellem with Tieton Capital Management.

William Dezellem, Analyst

I have a few questions. Firstly, in response to a previous inquiry, you mentioned that you hope to achieve 10% organic growth in gross billings. What would that amount to? If we assume no acquisitions and just focus on growing 10% organically, what are your expectations for net income growth?

Anthony Harris, CFO

Net income growth is targeted at 15%. This includes some investment income. Currently, we are facing a headwind with investment income. We have adjusted our investment income forecast down by $4 million due to the Federal Reserve raising rates by 100 basis points. When we initially discussed the 15% growth, it was based on rates prior to this adjustment. I believe our growth should align with revenue growth, but it won't reach 15%. Given the current rates, I anticipate it will be closer to 13%.

William Dezellem, Analyst

That's helpful. And actually, I do want to follow up and take that one step further. If rates stay flat, does that 13% still hold? And I'm sorry, I'm not able to think about this quickly enough. Or after you've annualized the lower rates, then would you be able to move up to that 15% income growth, assuming a 10% billings growth?

Gary Kramer, President and CEO

Yes. When rates change, we saw that our balance sheet's other comprehensive income increased by $9 million this quarter. As rates decreased, our investments appreciated, leading to $9 million in unrealized gains, which affected the balance sheet rather than the profit and loss statement. The profit and loss impact came from our cash investments that were previously advantageous but are no longer so due to low rates. We had been receiving interest at 3 months plus 25 basis points, but now the 3-month rate is flat or negative. Consequently, our investment income is down this quarter due to that variable factor. Looking ahead, we anticipate our investment income will remain lower than last year's, though as we grow and add more assets, even with these low rates, the investment income should increase in 2020 compared to 2019. Therefore, when considering our expected return on capital or net income growth related to the 13% figure, that number incorporates the low investment levels we are facing. Unfortunately, savers are being adversely affected by these conditions.

William Dezellem, Analyst

I'll shift to the inorganic side. Given the increased credit line and your significant cash reserves, should we see this as an indication that you are considering acquisitions with borrowed funds, and that you are preparing your banking facilities for these acquisitions? Or is it solely related to the uncertainty that COVID may bring?

Gary Kramer, President and CEO

Yes. Those are completely separate issues. The increase in the credit line was solely a precautionary measure in the current COVID environment. When we consider acquisitions and refer to our financial notes, we have capital beyond our financial obligations, which we plan to use primarily for any potential acquisitions. I don't want to create any concern about us considering debt offerings or stock offerings that might dilute our shares. We've worked hard to build our capital, and the focus now is on how to effectively utilize that capital.

William Dezellem, Analyst

That's helpful. Speaking of capital, your restricted cash and investments saw a significant decrease in Q2 compared to Q1, which of course shifted to unrestricted funds. I was somewhat surprised by this, considering the $116 million transfer of liabilities didn't occur until July 1. What contributed to the improvement in Q2, especially regarding the decline in restricted cash?

Anthony Harris, CFO

So the loss portfolio transfer actually was in June, Bill. So the $116 million transferred out in June, the $48 million release of excess collateral happened in June. So you really have both of those reducing restricted cash in the quarter. That would be offset, of course, by continued regular funding into the trusts for ongoing business operations.

William Dezellem, Analyst

All right. I need to review that press release more thoroughly again. Lastly, did all of the new clients acquired in Q2 transition to the new mybbsi platform?

Gary Kramer, President and CEO

Yes. We currently have about 500 clients on our new platform, and the response from the field and our clients has been overwhelmingly positive. We plan to transition approximately 400 clients each week from the old system to the new system until the end of November. We are not worried about the IT or conversion aspects; the main focus is educating our clients and addressing their questions, which is why we are taking a gradual approach rather than a big bang. The system is performing exceptionally well, our new business is operating on it, and we are actively selling it in the market while starting to convert our clients from the old systems to the new system.

William Dezellem, Analyst

And you'd mentioned that your win rate with prospects basically held steady. Would you expect your win rate to increase with time here now that you are selling on a more robust platform?

Gary Kramer, President and CEO

The goal is to improve our performance and achieve greater outcomes. We're focused on increasing our pipeline and enhancing the quality of what we bring into it. Our teams are dedicated to sales and marketing initiatives aimed at this improvement. However, it's too early to specify results. While I can share our aspirations, I can't confirm they are reflected in the current numbers yet.

William Dezellem, Analyst

Understood. And congratulations on a solid quarter in a crazy environment.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session and are out of time for today's call. I'll now turn the call back to Gary Kramer for closing remarks.

Gary Kramer, President and CEO

Thank you. Thank you, everybody, for taking the time to be on the call. Thank you for all the BBSI employees for all the hard work they did in the quarter. This was a challenging quarter for the business owner and a challenging quarter for all of our employees that were helping service our clients. So for them, I thank them from the bottom of my heart. With no BBSI employees, there is no BBSI. And I just want to thank everybody for all their hard work.

Operator, Operator

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.