Business context and reporting period
TriNet Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2016. TriNet provides bundled HR, payroll, benefits, insurance and compliance services to small and midsize businesses through a co-employment model. At quarter-end, it served more than 13,000 clients and co-employed 324,103 worksite employees (WSEs). Comparisons below are with Q1 2015 unless otherwise noted. Dollar amounts are in millions unless stated.
Reported revenue includes insurance billings and is substantially larger than the company’s net service revenue measure, which deducts insurance costs.
Financial and operating performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Professional service revenue | $112.4 | $97.0 | +16% |
| Insurance service revenue | $620.5 | $528.6 | +17% |
| Total revenue | $732.9 | $625.6 | +17% |
| Insurance costs | $569.7 | $483.2 | +18% |
| Net Insurance Service Revenue | $50.8 | $45.4 | +12% |
| Net Service Revenue | $163.3 | $142.4 | +15% |
| Operating income | $25.9 | $31.0 | -17% |
| Net income | $11.6 | $15.8 | -27% |
| Diluted EPS | $0.16 | $0.22 | -27% |
| Adjusted EBITDA (non-GAAP) | $42.2 | $50.1 | -16% |
| Adjusted Net Income (non-GAAP) | $19.5 | $25.4 | -23% |
- Reported operating margin fell to approximately 3.5% from 5.0%; net margin declined to approximately 1.6% from 2.5%. Operating income as a share of Net Service Revenue fell to approximately 15.9% from 21.8%.
- WSEs increased 12% to 324,103, and sales representatives increased 24% to 507. Management attributed revenue growth to higher WSEs and increased average revenue per WSE.
- Insurance costs grew faster than insurance revenue. Management cited higher medical costs per WSE, partly offset by lower workers’ compensation costs per WSE.
- Cost of providing services rose 26%, sales and marketing 29%, and general and administrative expense 79%. G&A included higher professional fees associated with the first Sarbanes-Oxley Section 404 internal-controls audit. Stock-based compensation increased to $7.4 million from $3.9 million. Amortization declined 56% as certain acquired intangible assets reached the end of their useful lives.
- The effective tax rate rose to 44.4% from 39.9%, primarily reflecting higher state taxes and prior-year discrete tax benefits.
Cash flow, liquidity and debt
- Operating cash flow was $40.9 million, versus $13.3 million a year earlier; management attributed the increase primarily to lower workers’ compensation collateral funding. Investing cash outflow was $5.6 million, including $6.8 million of property and equipment purchases. Financing cash outflow was $5.7 million, including $5.1 million of debt repayments.
- Cash and cash equivalents were $195.9 million at March 31, up from $166.2 million at December 31, 2015. The balance sheet also includes restricted cash and investments; these are not equivalent to unrestricted corporate cash.
- Notes payable were $494.5 million, net of debt issuance costs, compared with $499.6 million at year-end. The company had $59.5 million of unused capacity under its $75 million revolving facility. The tranche B term loan matures in July 2017; tranche A loans and the revolver mature in July 2019.
- TriNet was in compliance with its credit-facility financial covenants at March 31, 2016. It reported a minimum interest coverage requirement of 3.50-to-1 and a maximum leverage ratio then set at 4.25-to-1. A $12.7 million excess-cash-flow prepayment was paid in April 2016.
- Current assets and liabilities include substantial WSE-related payroll and benefits balances that fluctuate with payroll timing. Management said client prefunding generally matches these obligations and reported positive working capital during the period.
Outlook, risks and unusual items
- The filing provides no numerical earnings or revenue guidance. Management expected insurance costs and service-delivery costs to rise in absolute dollars as WSEs grow, while continuing technology investment. It also described plans to improve sales productivity and expand products and platform capabilities.
- Insurance claims and reserves are inherently variable; management noted historically higher health-claim volumes in the second and third quarters and January seasonality in WSE additions and client attrition. Higher health-plan renewal costs may also contribute to client attrition.
- Management said the full effects of the Affordable Care Act remained uncertain and could increase costs, affect client retention, or delay outsourcing decisions.
- Disclosure controls and procedures were deemed ineffective due to material weaknesses in internal control over financial reporting. Management was pursuing remediation but could not estimate when it would be complete; additional procedures were used to support the reported financial statements.
- A putative securities class action alleges misstatements or omissions concerning health-insurance and workers’ compensation claim trends. The complaint was amended to expand the class period and add defendants; TriNet planned to move to dismiss. Management did not then expect a material financial effect but cautioned that outcomes are uncertain. A separate $10.5 million employment-tax-credit assessment had been paid; the company said it intended to pursue resolution through litigation and recorded no reserve because it believed it was more likely than not to prevail.
- The board added $50 million to the share repurchase authorization in February 2016; approximately $81.6 million remained available at quarter-end. No shares were repurchased during the quarter.
Most important facts for investors to verify
- Progress and independent evidence of remediation of the disclosed material weaknesses in internal controls.
- Workers’ compensation and health-plan claim experience, reserve estimates, collateral requirements and the effect of medical-cost trends on insurance margins.
- Whether WSE and revenue growth can translate into improved operating margins given rising sales, service and administrative costs.
- Debt repayment capacity, leverage and covenant headroom, including the effect of the April 2016 prepayment and the 2017 tranche B maturity.
- Developments in the securities class action and the employment-tax-credit dispute, including any change in estimated exposure.