TriNet Group, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; comparisons are with the same 2014 periods unless noted. Amounts are in U.S. dollars. TriNet provides HR, payroll, benefits and related services to small and midsize businesses through a co-employment model. At quarter-end it served over 12,000 clients and approximately 314,930 worksite employees (WSEs).
Financial performance and liquidity
- Q3 revenue: $668.0 million, up 20%. Professional service revenue was $99.5 million (+15%); insurance service revenue was $568.5 million (+21%). Insurance costs rose 25% to $534.5 million, faster than insurance revenue.
- Underlying service revenue: Net Service Revenues, a company-defined non-GAAP measure equal to professional service revenue plus insurance revenue less insurance costs, increased 5% to $133.5 million. Net Insurance Service Revenues fell 17% to $34.1 million. These measures should be considered alongside GAAP results.
- Q3 earnings: Operating income was $11.7 million, down from $21.2 million; operating margin on total revenue was approximately 1.7%, versus 3.8%. Net income was $3.1 million ($0.04 diluted EPS), compared with $0.7 million ($0.01 diluted EPS). Adjusted EBITDA, a non-GAAP measure, declined to $30.8 million from $41.5 million.
- Nine-month results: Revenue was $1.934 billion (+22%), while Net Service Revenues grew 5% to $397.9 million and Net Insurance Service Revenues declined 19% to $103.6 million. Operating income fell to $48.7 million from $66.6 million. Net income increased to $17.6 million from $8.5 million, helped by substantially lower interest expense; Adjusted EBITDA decreased to $105.6 million from $125.2 million.
- Cash flow: Nine-month operating cash flow was $104.5 million, compared with $98.4 million. Investing activities used $33.2 million, including $14.7 million for property and equipment and $4.8 million for acquisitions. Financing activities used $59.1 million, including debt repayments and share repurchases. Cash and cash equivalents ended at $146.3 million.
- Balance sheet and debt: At September 30, cash was $146.3 million and total debt was $504.6 million, down from $544.9 million at December 31, 2014. The company reported $59.5 million of unused revolving-credit capacity and was in compliance with its credit covenants. Current assets exceeded current liabilities by about $54.4 million, but worksite-related balances comprise most of both and are tied to payroll and benefits. Restricted cash and investments are not equivalent to freely available corporate cash. Stockholders’ deficit was $14.1 million.
Material changes and management commentary
- WSEs increased 15% year over year, and sales representatives increased 23% to 479. Management attributed revenue growth primarily to more WSEs; average insurance revenue per WSE also rose 4%–5%.
- Average insurance cost per WSE rose 8% in both the quarter and nine-month period, primarily from higher medical costs and, to a lesser extent, workers’ compensation costs. Consequently, insurance costs outpaced insurance revenue and reduced insurance-service contribution.
- Sales and marketing investment rose 20% in Q3 and 19% for nine months, largely reflecting sales-force expansion. General and administrative costs also increased, including public-company and Sarbanes-Oxley compliance spending. Amortization of acquired intangibles declined as certain assets reached the end of their useful lives.
- Management gave no quantified financial guidance in this filing. It expected insurance costs, service-delivery costs and sales and marketing expenses to rise in absolute dollars as the business grows; it also noted quarterly claims variability and seasonal client additions and attrition. The nine-month results are not necessarily indicative of full-year results.
- Workers’ compensation liabilities totaled $159.3 million, up from $112.2 million at year-end. Estimates depend on claim frequency, severity, development and payment timing; final settlements may differ materially.
Risks, contingencies and other notable items
- A putative securities class action filed in August 2015 alleges misstatements or omissions concerning health-insurance and workers’ compensation trends. The company said it intends to defend the case and did not expect the matters described to have a material adverse effect, while acknowledging an unfavorable outcome could be material.
- The company paid $10.5 million in proposed IRS assessments concerning employment tax credits claimed by acquired Gevity. It disputes the position, believes it is more likely than not to prevail, and has not recorded a reserve; it expects the issue may ultimately be litigated. The filing also discusses approximately $1.9 million of additional credits in its risk factors.
- The credit facility carries variable rates and includes leverage and interest-coverage covenants. The company identified interest-rate exposure and reported $504.6 million of outstanding debt. Required debt payments, workers’ compensation obligations, leases and other commitments total approximately $855.5 million, including estimated claim liabilities that are uncertain.
- Other significant risks include unpredictable insurance claims, client attrition, regulatory uncertainty around co-employment and health-care reform, acquisition integration, competition, cybersecurity and service-system disruptions, and the company’s ability to manage growth. Management reported effective disclosure controls as of September 30, 2015.
Key facts for investors to verify
- Whether insurance costs per WSE and claims reserves stabilize, and whether insurance-service contribution recovers.
- Whether WSE growth converts into improved Net Service Revenue growth and operating profitability after sales-force and compliance spending.
- Debt repayment capacity, variable-rate exposure, covenant headroom and the portion of reported cash that is restricted or needed for WSE obligations.
- Developments in the securities action and IRS employment-tax-credit dispute, including any change in management’s assessment or recorded reserves.
- Client retention and seasonality, especially around year-end health-plan renewals and January transitions.