TriNet Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; filed August 3, 2016. TriNet provides HR, payroll, benefits, workers’ compensation and related services to small and midsize businesses under a co-employment model. At quarter-end, it served more than 13,000 clients and co-employed 325,466 worksite employees (WSEs).
Financial performance
| Metric | Q2 2016 | Q2 2015 | H1 2016 | H1 2015 |
|---|---|---|---|---|
| Total revenues | $745.8 million | $640.0 million | $1,478.8 million | $1,265.6 million |
| Net Service Revenues* | $149.2 million | $122.0 million | $312.4 million | $264.4 million |
| Operating income | $26.4 million | $6.0 million | $52.3 million | $37.0 million |
| Net income (loss) | $12.3 million | ($1.3 million) | $23.9 million | $14.5 million |
| Diluted EPS | $0.17 | ($0.02) | $0.33 | $0.20 |
| Adjusted EBITDA* | $42.6 million | $24.7 million | $84.8 million | $74.8 million |
*Non-GAAP measures. Net Service Revenues equal total revenues less insurance costs; Adjusted EBITDA is defined by the company and excludes specified expenses. Consider these alongside GAAP results.
- Q2 revenue rose 17% year over year; professional service revenue grew 12% and insurance service revenue 17%. H1 revenue also increased 17%.
- Net Service Revenues grew 22% in Q2 and 18% in H1. Net Insurance Service Revenues rose 63% in Q2 and 30% in H1.
- Insurance costs increased 15% in Q2 and 16% in H1, slower than insurance-service revenue growth. Management attributed the increases to WSE growth and higher average insurance costs per WSE, primarily medical costs.
- Operating margin was approximately 3.5% of total revenue in Q2 versus 0.9% a year earlier; net margin was approximately 1.6% versus a loss. Amortization expense fell substantially as certain acquired intangible assets reached the end of their useful lives.
- H1 operating cash flow was $43.0 million, compared with $45.2 million. Investing used $7.0 million and financing used $35.5 million; cash increased $0.5 million to $166.7 million.
Financial position and liquidity
- At June 30, cash and cash equivalents were $166.7 million; total assets were $1.70 billion and stockholders’ equity was $33.5 million.
- Debt and capital lease obligations, net of deferred loan costs, totaled $472.4 million, including $25.0 million current. The company reported $476.8 million of credit-facility principal outstanding and $59.5 million of unused revolving capacity. It was in compliance with its financial covenants at quarter-end.
- Cash less reported credit-facility principal was approximately $310 million; this is a simple calculation, not a company-reported net-debt measure. Much of current assets and liabilities relates to WSE payroll and benefits flows and should not be read as ordinary corporate liquidity.
- H1 capital expenditures were $16.7 million. Financing cash use included $22.8 million of debt repayments and $16.5 million of share repurchases.
Changes, outlook and items to monitor
- WSEs increased 8% year over year to 325,466; the sales force declined 3% to 471 as TriNet pursued sales productivity and efficiency.
- Operating expenses excluding insurance costs rose 6% in Q2 and 14% in H1. H1 G&A increased 49%, including higher staffing and additional audit and professional fees; stock-based compensation rose to $13.9 million from $8.8 million.
- Management expects continued investment in technology and platform upgrades, while aiming to improve sales productivity and operational efficiency. The filing provides no quantified earnings or revenue guidance.
- On July 29, 2016, after quarter-end, TriNet amended its credit facility: $135 million of tranche B loans due July 2017 was refinanced into tranche A-2 loans due July 2019. The company expects about $1 million of fees and stated it will repay $36 million of tranche A and A-2 principal over the following 12 months.
- Insurance claims are variable and historically higher in the second and third quarters. Workers’ compensation reserves depend on estimates, and actual claim settlements or payment timing may differ materially. The company also cited uncertainty about the Affordable Care Act’s effects on costs, clients and retention.
- A putative securities class action alleges misstatements or omissions concerning health-insurance and workers’ compensation claim trends; TriNet moved to dismiss and says it will defend the case. Management did not expect the matter to have a material adverse effect, while noting an unfavorable outcome could be material.
- Disclosure controls were deemed ineffective because of material weaknesses in internal control over financial reporting. Management said additional analyses supported fair presentation of the statements, but remediation timing is uncertain and may require further steps.
- TriNet filed a federal complaint seeking a $10.5 million refund of previously paid employment-tax-credit assessments. It believes recovery is more likely than not and recorded no reserve; the outcome remains uncertain.
Important facts for investors to verify
- Whether the insurance-margin improvement and growth in Net Insurance Service Revenues persist as medical claims and costs per WSE evolve.
- Progress in remediating the disclosed material weaknesses and the timing and results of internal-control testing.
- The amended debt repayment schedule, interest costs, covenant headroom and liquidity after the July refinancing.
- Developments in workers’ compensation reserves, the securities litigation and the tax-refund claim.
- Whether client and WSE growth, sales-force productivity and technology investments translate into sustainable GAAP earnings and cash generation.