TriNet Group, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; filed August 6, 2014. TriNet provides outsourced HR services to small and midsize businesses using a co-employment model. At quarter-end, it served over 9,000 clients and approximately 258,985 worksite employees (WSEs).
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data. Revenue includes insurance billings and related costs; TriNet also reports non-GAAP Net Service Revenues, which subtract insurance costs.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $525.0 | $363.4 | $1,033.9 | $714.5 |
| Net Service Revenues (non-GAAP) | $124.8 | $94.2 | $252.6 | $191.4 |
| Operating income | $20.0 | $13.9 | $45.3 | $35.5 |
| Net income | $6.2 | $4.3 | $7.8 | $14.9 |
| Adjusted EBITDA (non-GAAP) | $39.4 | $28.5 | $83.7 | $64.7 |
| Diluted EPS | $0.09 | $0.08 | $0.12 | $0.28 |
- Q2 revenue rose 44% year over year; six-month revenue rose 45%. Net Service Revenues increased 32% in both periods. WSEs grew 31% year over year, and sales representatives increased from 298 to 388.
- Q2 operating margin was approximately 3.8%, versus 3.8% a year earlier; six-month operating margin was 4.4%, versus 5.0%. Insurance costs grew 49% in both comparison periods, faster than insurance service revenue growth of 46%.
- Six-month net income declined despite higher revenue and operating income. Interest expense and bank fees were $30.7 million versus $12.2 million, including $5.0 million of accelerated loan-fee amortization and a $3.8 million debt prepayment premium. The six-month effective tax rate rose to 47.1% from 36.8%.
- Six-month operating cash flow was $53.7 million, compared with $60.6 million. Investing cash outflow was $25.5 million, including $16.8 million of debt-security purchases and $8.7 million of capital expenditures. Financing cash outflow was $22.2 million, reflecting IPO proceeds offset by $243.0 million of debt repayments.
- At June 30, cash and cash equivalents were $100.3 million; restricted cash and investments were additional but not freely available. Total debt and capital leases were approximately $575.7 million, including $575.4 million under the credit facility. The revolving facility had $59.5 million unused. Current assets exceeded current liabilities by $70.3 million, though balances include substantial WSE-related items.
- Total assets were $1.33 billion and total liabilities were $1.37 billion; stockholders’ deficit was $36.7 million. In March, the IPO raised approximately $218.6 million net for the company, and preferred shares converted into common stock.
Material changes and management commentary
- Growth reflected higher WSE counts and the 2013 Ambrose acquisition. Ambrose contributed $8.5 million of Q2 professional-service revenue and $63.9 million of Q2 insurance-service revenue; approximately 13,000 of the year-over-year WSE increase was attributable to Ambrose.
- Management attributed higher service-delivery costs partly to acquired-business integration, and higher sales and marketing costs to expansion of the direct sales force. It expects sales and marketing, general and administrative, service-delivery, and technology costs to increase in absolute dollars, with technology spending expected to rise modestly.
- On July 9, 2014, after quarter-end, TriNet amended and restated its first-lien credit agreement. It provided for $375 million of tranche A loans, $200 million of tranche B loans, and a $75 million revolver; maturities are 2019 for tranche A and the revolver, and 2017 for tranche B. New covenants include minimum interest coverage of 3.50:1 and a maximum total leverage ratio initially set at 5.00:1.
- Management gave no specific revenue or earnings guidance in this filing. It cautioned that results may vary with WSE growth and attrition, claims experience, client payment timing, acquisition integration, and seasonality. January is historically a period of higher additions and attrition; health claims have historically been higher in the second and third quarters.
Risks, contingencies, and unusual items
- Workers’ compensation liabilities were $91.2 million, up from $68.8 million at year-end. Claims reserves depend on estimates and actual settlements and payment timing may differ materially. Health and workers’ compensation claims can also pressure insurance costs and margins.
- TriNet faces class-action lawsuits related to its co-employment relationships. Management said an unfavorable outcome was not probable but could not estimate a possible loss or range. The IRS has proposed disallowing $10.5 million of employment tax credits relating to acquired Gevity entities; the company intends to pursue administrative remedies and believes it is more likely than not to prevail, so it recorded no reserve.
- A previously identified material weakness in internal control over financial reporting concerned income-tax accounting, including an Ambrose acquisition deferred-tax error and a prior-year stock-option tax adjustment. Remediation was ongoing; management expected remediation during 2014 but gave no assurance. Management separately concluded disclosure controls were effective at a reasonable-assurance level.
- Management said the effects of the Affordable Care Act remained uncertain and could increase costs, affect client retention, or constrain fee increases. Other disclosed risks include substantial variable-rate debt, regulatory uncertainty over co-employment, client attrition, acquisition integration, and data-security or systems disruptions.
Important facts for investors to verify
- Whether WSE and Net Service Revenue growth persists after accounting for Ambrose contributions, client attrition, and the cost of expanding sales capacity.
- Whether claims experience and workers’ compensation reserves support the reported insurance costs and liabilities, and how subsequent claim development affects margins.
- The final economics and covenant headroom of the July 2014 refinancing, including interest expense, required amortization, and leverage and interest-coverage compliance.
- Progress in remediating the income-tax internal-control material weakness and any resulting changes, restatements, or additional control findings.
- Developments in the $10.5 million tax-credit dispute, class-action litigation, and the financial impact of health-care reform and regulatory changes.
- How much of reported cash is corporate liquidity versus restricted or WSE-related funds, and whether operating cash flow remains adequate for debt service and investment needs.