TriNet Group, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. TriNet provides bundled HR, payroll, benefits, and compliance services to small and midsize businesses through a co-employment model.
Financial and operating performance
| Metric | Q2 2018 | First half 2018 | Change vs. prior year |
|---|---|---|---|
| Total revenue | $850 million | $1.711 billion | +6% in both periods |
| Net Service Revenue | $220 million | $440 million | +10% in both periods |
| Operating income | $76 million | $147 million | +34%; +38% |
| Net income | $58 million | $112 million | +45%; +63% |
| Diluted EPS | $0.80 | $1.55 | +43%; +60% |
| Adjusted EBITDA | $99 million | $190 million | +36%; +40% |
| Average worksite employees (WSEs) | 313,845 | 314,203 | -3%; -4% |
Q2 operating margin was approximately 8.9% of total revenue. Net Insurance Service Revenue was $105 million in Q2 and $196 million for the first half; its margin was 14% and 13%, respectively. Adjusted EBITDA margin, calculated by TriNet against Net Service Revenue, was 45% in Q2 and 43% for the first half. Payroll and payroll taxes processed rose 5% in both periods, to $8.371 billion and $18.690 billion, respectively. Period-end WSEs were down 3% to 318,921.
Growth reflected higher insurance-plan participation, favorable insurance enrollment mix, professional-service rate increases, and—in the first half—a shift toward higher-priced vertical products. The WSE decline reflected attrition, including client migration to the common platform, partly offset by new sales and hiring at existing clients. Insurance costs were 86% of insurance service revenue in Q2, unchanged year over year, and 87% for the first half versus 88%.
Cash flow, liquidity, and debt
First-half operating cash flow was a use of $543 million, including $651 million of WSE-related outflow, primarily due to timing of payroll-tax and other WSE liabilities, client payments, collateral, and claims. Corporate operating cash flow provided $108 million. The filing adopted restricted-cash cash-flow guidance in 2018, changing presentation; therefore, operating cash flow should be read alongside the restricted-cash movements.
Investing cash outflow was $166 million, including $203 million of investment purchases and $26 million of capital expenditures, partly offset by security-sale and maturity proceeds. Financing cash outflow was $36 million. Corporate cash and cash equivalents were $202 million at June 30, down from $336 million at year-end; corporate working capital was $188 million. TriNet reported approximately $1.1 billion of cash, cash equivalents, and investments overall, but substantial amounts are restricted or designated for WSE and insurance obligations.
In June, TriNet refinanced its prior term loans with a $425 million term loan maturing in 2023 and replaced its $75 million revolver with a $250 million facility. The revolver had $234 million unused at quarter-end, after letters of credit. Total debt was $425 million outstanding; $21 million was due within 12 months. The company was in compliance with credit covenants. Management said corporate cash and positive working capital should cover working-capital and capital-expenditure needs for at least 12 months.
Developments, outlook, and risks
- TriNet completed migration of legacy-platform clients to its common platform and launched TriNet Professional Services, its sixth vertical product.
- The effective tax rate declined to 19% in Q2 and the first half, from 24% and 29%, respectively, a change attributed to stock-compensation tax benefits, state tax factors, and the federal tax-rate reduction.
- ASC Topic 606 adoption included a $1 million opening retained-earnings adjustment and capitalization of certain sales commissions. For the first half, the company reported $13 million more net income than it would have under the previous standard; this affects comparability with 2017.
- Management expects operating expenses to increase in the foreseeable future as it supports growth, new vertical products, platform integrations, and systems and internal-control improvements. The filing provides no specific earnings or revenue guidance.
- Disclosure controls were not effective at June 30 because of a material weakness in internal control over financial reporting. Remediation was underway, but timing and success were uncertain. Management stated the weakness had not caused a restatement and that the presented financial statements were fairly stated in all material respects.
- A purported shareholder securities class action was on appeal; TriNet said it could not reasonably estimate potential loss, if any. Management did not then expect the litigation or other disclosed claims to materially affect results, but noted adverse outcomes could have a material impact.
- Other items to monitor include workers’ compensation and health-benefit loss-reserve estimates, floating-rate debt exposure, and a new lease standard expected to materially increase reported assets and lease liabilities upon adoption in 2019.
Most important facts for investors to verify
- Whether WSE attrition associated with platform migration has ended and whether client and WSE growth improves.
- Whether insurance revenue growth and favorable insurance-cost trends persist, including reserve development and plan participation/mix.
- How much of reported cash and investments is available for corporate use versus restricted for payroll, benefits, and insurance obligations.
- Debt costs and covenant headroom under the new floating-rate credit facilities, particularly if interest rates rise.
- Progress and independent validation of remediation of the material weakness in internal controls.
- The effects of ASC 606 and the 2019 lease-standard adoption on period-to-period comparisons and reported balance-sheet measures.