Business context and reporting period
TriNet Group, Inc. provides HR, payroll, compliance, employee benefits and insurance services to small and midsize businesses through a co-employment model. This unaudited Form 10-Q covers the three months ended March 31, 2014, compared with the same period in 2013. At quarter-end, TriNet served more than 9,000 clients and approximately 241,944 worksite employees (WSEs), up 30% year over year. The March 2014 IPO and the 2013 Ambrose acquisition materially shaped the period.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Professional service revenues | $82.9 million | $59.2 million | +40% |
| Insurance service revenues | $426.0 million | $291.8 million | +46% |
| Total revenues | $508.9 million | $351.1 million | +45% |
| Net Service Revenues (non-GAAP) | $127.8 million | $97.2 million | +31% |
| Operating income | $25.3 million | $21.6 million | +17% |
| Net income | $1.5 million | $10.5 million | Down 85% |
| Adjusted EBITDA (non-GAAP) | $44.3 million | $36.1 million | +23% |
| Adjusted Net Income (non-GAAP) | $17.6 million | $18.2 million | Down 3% |
| Operating cash flow | $30.3 million | $35.7 million | Down $5.4 million |
Insurance costs rose 50% to $381.2 million, faster than insurance service revenues; Net Insurance Service Revenues increased 18% to $44.9 million. Operating margin was approximately 5% of reported total revenues and 20% of Net Service Revenues, versus approximately 6% and 22%, respectively, in Q1 2013. Basic and diluted EPS were each $0.03, compared with $0.22 and $0.20, respectively.
Cash and cash equivalents were $122.6 million at March 31, 2014, versus $94.4 million at year-end. This is distinct from restricted cash, investments and WSE-related balances. Investing cash outflow was $6.1 million, including $5.1 million of property and equipment purchases. Financing cash flow was $4.0 million net, reflecting IPO proceeds and debt repayments.
Debt under the credit facility declined to $601.9 million from $818.4 million at December 31, 2013, principally after $216.6 million of IPO-funded repayments. The company also reported $386,000 of capital lease obligations. The $75 million revolving facility had $52.2 million unused at quarter-end, including $22.8 million used to backstop prior-facility letters of credit. TriNet reported compliance with its credit-facility covenants. Current assets were $823.0 million and current liabilities $729.2 million; substantial portions relate to matched WSE payroll, benefits and other operating balances.
Material changes and unusual items
- TriNet issued 15 million shares at $16 per share in its IPO and received approximately $218 million in net proceeds. Selling stockholders sold an additional 2.25 million shares; TriNet received no proceeds from those shares. IPO proceeds were used principally to repay the second-lien facility in full and $25 million of first-lien term debt.
- All outstanding Series G and H preferred shares converted into 38.1 million common shares at the IPO closing. The offering and preferred-stock conversion substantially changed the capital structure and share count.
- Net income was weighed down by sharply higher interest expense and bank fees, which included a $3.8 million debt prepayment premium and $5.0 million of accelerated loan-fee amortization. Interest expense and bank fees totaled $21.9 million, versus $5.2 million a year earlier.
- Revenue growth reflected higher WSE count, higher average professional service revenue per WSE, and Ambrose, acquired in 2013. Ambrose contributed $7.0 million of professional service revenue and $66.5 million of insurance service revenue in the quarter, according to management. A $2.3 million refund of prior-year payroll taxes also increased professional service revenue.
- The effective tax rate rose to 56.4% from 36.2%, driven in part by nondeductible stock-based compensation, a $0.5 million discrete state-tax-related charge, expiration of the federal R&D tax credit, and comparison with a prior-year release of uncertain tax positions.
Outlook, risks and contingencies
The filing provides no specific numerical guidance. Management expects operating costs to rise as the company expands its sales force, invests in technology and supports growth; it also expects public-company compliance costs to increase. Management cautions that Q1 results are not necessarily indicative of full-year results. January typically brings both high WSE additions and high client attrition, and health claims have historically been higher in Q2 and Q3. The company says health-care reform’s effects on TriNet and its clients remain uncertain and could increase costs or affect client retention.
Key disclosed risks include variable-rate debt and substantial interest obligations; changes in health and workers compensation claims and reserve estimates; client attrition and competitive pricing; acquisition integration; regulatory uncertainty around the co-employment model; and operational, technology, cybersecurity and data-privacy risks. The filing identifies class-action lawsuits related to the WSE relationship; management considered an unfavorable outcome not probable but could not estimate a possible loss or range. TriNet also reported an IRS dispute over employment tax credits: the notes describe proposed assessments totaling $10.5 million, while the risk discussion describes approximately $10.1 million of Gevity credits plus approximately $2.0 million taken by TriNet. The company believes it is more likely than not to prevail, has recorded no reserve, and expects the matter may ultimately proceed to litigation.
Management reported disclosure controls and procedures effective as of March 31, 2014. A previously identified material weakness in internal control over financial reporting related to acquisition deferred-tax accounting and a prior-year stock-compensation tax adjustment remained under remediation; management expected remediation in 2014 but gave no assurance of success. The filing states that no Sarbanes-Oxley evaluation of internal control over financial reporting had been performed.
Important facts for investors to verify
- How recurring operating performance compares with reported net income after separating debt prepayment and loan-fee charges; review the company’s non-GAAP reconciliations and definitions.
- Whether the Ambrose contribution, WSE growth and service revenue per WSE continue, and whether elevated client attrition or insurance claims affect growth and margins.
- Current debt, variable interest exposure, repayment requirements, revolver availability and covenant headroom; confirm how much corporate cash is available apart from restricted and WSE-related funds.
- The status and potential exposure of the employment tax credit dispute, including the filing’s differing stated assessment/credit amounts, and the class-action proceedings for which loss cannot be estimated.
- Progress in remediating the material weakness and any subsequent assessment of internal control over financial reporting.
- The extent of potential share sales as IPO lock-ups expire and the resulting effect on ownership and dilution.