TriNet Group, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are with Q1 2014 unless otherwise noted. TriNet provides outsourced HR, payroll, compliance and employee benefits services to small and medium-sized businesses through a co-employment model. At quarter-end, it served over 11,000 clients and approximately 288,817 worksite employees (WSEs), up 19% year over year.
Financial and operating performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $625.6 million | $508.9 million | +23% |
| Professional service revenue | $97.0 million | $82.9 million | +17% |
| Insurance service revenue | $528.6 million | $426.0 million | +24% |
| Insurance costs | $483.2 million | $381.2 million | +27% |
| Net Insurance Service Revenues | $45.4 million | $44.9 million | +1% |
| Net Service Revenues (non-GAAP) | $142.4 million | $127.8 million | +11% |
| Operating income | $31.0 million | $25.3 million | +23% |
| Net income | $15.8 million | $1.5 million | Improved |
| Diluted EPS | $0.22 | $0.03 | Improved |
| Adjusted EBITDA (non-GAAP) | $50.1 million | $44.3 million | +13% |
Insurance service revenue was 84% of total revenue, but insurance costs grew faster than insurance revenue, leaving net insurance service revenue nearly flat. Management attributed higher insurance costs to WSE growth and a 6% increase in average insurance cost per WSE, primarily from medical costs. WSEs rose 19%; sales representatives increased 21% to 408.
GAAP operating margin was approximately 5% in both periods. Operating income as a share of Net Service Revenues rose to approximately 22% from 20%. Net income benefited substantially from lower interest expense: $5.2 million versus $21.9 million, reflecting lower debt and prior-year IPO-related debt repayment and charges. The effective tax rate fell to 39.9% from 56.4%, principally due to discrete tax items. The diluted share count was much higher in 2015 following the 2014 IPO, so per-share comparisons also reflect a materially different share base.
Cash flow, debt and liquidity
- Operating cash flow was $14.1 million, down from $30.3 million. Management cited increased workers’ compensation collateral as a principal driver.
- Investing cash outflow was $4.6 million, mainly property and equipment purchases; financing cash outflow was $39.3 million, including $30.1 million of debt repayments and $25.0 million of share repurchases.
- Cash and cash equivalents were $104.4 million at March 31, 2015, down from $134.3 million at year-end. Restricted cash and investments are not equivalent to unrestricted corporate cash.
- Debt under the credit facility was $514.7 million, down from $544.9 million at year-end. The $75 million revolver had $59.5 million unused. Debt is secured and bears variable interest; $20.3 million was current. The company reported compliance with its credit covenants; the filing does not provide its actual leverage ratio.
- Reported current assets were $1.067 billion and current liabilities $1.051 billion, but these totals include substantial WSE-related payroll and benefit assets and liabilities that largely move together. The company also reported positive working capital.
Changes, outlook and risks
- Net Service Revenues grew more slowly than GAAP revenue because insurance costs rose faster than insurance billings. Sales and marketing expense increased 18%, and systems development costs increased 23%, as TriNet expanded its sales force and technology investment.
- Management expects costs to rise with business growth, including service delivery, sales and marketing, public-company compliance and technology investment. No specific revenue, earnings or margin guidance is provided.
- TriNet describes seasonality: client additions and attrition tend to be highest in January, while health claims have historically been higher in the second and third quarters. Large claims and claim-reserve estimates can cause substantial quarterly variability.
- Health-care reform may increase costs or affect client retention; its effects on the co-employment model remained uncertain. The company also faces risks from client attrition, competition, acquisition integration, regulation, data security and systems reliability.
- Workers’ compensation liabilities were $144.3 million, including estimates for reported and incurred-but-not-reported claims; actual settlement amounts and timing may differ materially.
- The company paid $10.5 million related to disputed employment tax credits from the Gevity acquisition and plans to pursue administrative remedies; it believes it is more likely than not to prevail and recorded no reserve. Management also identifies approximately $2 million of additional credits taken after the acquisition in its risk discussion.
- TriNet is named in class action lawsuits related to its WSE relationships. Management could not estimate a possible loss or range, though it did not believe pending matters were then reasonably likely to materially affect the company.
- Management said a previously identified material weakness in income-tax controls had been remediated and disclosure controls were effective. However, management and its independent auditor had not performed a Sarbanes-Oxley evaluation of internal control over financial reporting for the period.
Most important facts for investors to verify
- Whether medical and workers’ compensation costs per WSE stabilize, and how claims experience affects reserves and net insurance service revenue.
- Whether WSE and client growth converts into stronger Net Service Revenue growth and operating leverage, given rising sales and technology costs.
- Debt repayment capacity, variable-rate exposure, covenant headroom and unrestricted liquidity; reported debt was $514.7 million and the revolver had $59.5 million unused.
- Developments in the disputed employment tax credits and class action litigation, including any change in estimated exposure or required reserves.
- Whether client attrition, health-care reform, seasonality and the historical tax-control weakness create material changes to future results or reporting reliability.