TriNet Group, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; unaudited. TriNet provides HR outsourcing services to small and midsize businesses through a co-employment model. At quarter-end it served more than 10,000 clients and approximately 272,846 worksite employees (WSEs). Unless noted, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $556.0 | $448.1 | $1,589.9 | $1,162.6 |
| Operating income | $21.2 | $7.3 | $66.6 | $42.8 |
| Net income (loss) | $0.7 | ($7.7) | $8.5 | $7.1 |
| Net cash from operations | — | $99.0 | $62.1 |
- Q3 revenue rose 24%; nine-month revenue rose 37%. Growth reflected increased WSEs and the Ambrose acquisition. WSEs increased 25% year over year; sales representatives rose from 301 to 391.
- Insurance service revenue was 84% of total revenue. Insurance costs were $428.2 million in Q3 and $1,209.5 million for nine months. Net Insurance Service Revenue, a company-defined non-GAAP measure, increased 41% in Q3 to $40.9 million and 28% for nine months to $128.3 million. Net Service Revenue increased 22% in Q3 to $127.8 million and 28% for nine months to $380.3 million.
- Operating margin on GAAP revenue was approximately 3.8% in Q3 versus 1.6% in Q3 2013; nine-month margin was approximately 4.2% versus 3.7%. On Net Service Revenue, operating margin was 16.6% in Q3 versus 7.0%, and 17.5% for nine months versus 14.5%.
- Q3 net income improved from a loss in the prior-year quarter. Nine-month net income rose 19%, while diluted EPS was $0.13 versus $0.13; share counts increased substantially following the IPO and conversion of preferred stock.
- Cash and cash equivalents were $98.0 million at September 30, 2014, compared with $94.4 million at December 31, 2013. Operating cash flow was $99.0 million; investing used $33.9 million and financing used $61.5 million in the first nine months.
- Total debt was $550.0 million, down from $818.4 million at year-end 2013. The $75 million revolving facility had $59.5 million unused; TriNet reported compliance with debt covenants. Current liabilities were $840.2 million and current assets $857.5 million, including substantial WSE-related balances that are largely tied to payroll and benefits processing.
Material changes and unusual items
- The March 2014 IPO generated approximately $218.6 million in net proceeds for TriNet. Proceeds were used substantially to repay debt; preferred shares converted into common shares. In July, the company amended and refinanced its first-lien credit facility. Nine-month interest expense increased 53% to $49.2 million, including refinancing charges, a $3.8 million prepayment premium and debt-fee write-offs.
- Q3 insurance costs grew 25%, slightly slower than insurance service revenue growth of 26%. For nine months, insurance costs rose 40%, including Ambrose-related costs and a 2% increase in average insurance costs per WSE excluding Ambrose.
- The effective tax rate was 75.5% in Q3 and 51.9% for nine months, reflecting nondeductible stock compensation, discrete deferred-tax adjustments, secondary-offering costs, and the expiration of the federal R&D tax credit.
- Workers’ compensation liabilities totaled $101.3 million, including estimated unpaid claims; actual claim settlements and timing may differ materially from estimates.
Outlook, risks and contingencies
- No specific revenue, earnings or cash-flow guidance was provided. Management expected operating costs to rise with growth, including sales and marketing, service delivery, technology investment, and public-company compliance costs; it also expected to continue pursuing acquisitions.
- Management cited seasonality: January typically brings the highest WSE additions and client attrition, while health claims have historically been higher in Q2 and Q3. Health-care reform’s effects on TriNet and its clients remained uncertain.
- Key risks include client attrition, claims volatility and reserve estimation, acquisition integration, regulatory uncertainty around co-employment and employer status, competition, cybersecurity and service-system disruption, and variable-rate debt. A 100-basis-point rate change was estimated to affect interest expense over 2014–2019 materially; the filing gives estimated totals of $111.0 million with a 100-basis-point increase and $69.8 million with a decrease.
- TriNet disclosed a previously identified material weakness in income-tax accounting, related to deferred-tax treatment of Ambrose and an earlier stock-option tax adjustment. Remediation was underway; management expected remediation in 2014 but gave no assurance it would succeed. Disclosure controls were deemed effective, but no Sarbanes-Oxley internal-control audit evaluation had been performed.
- Various class-action lawsuits relating to the co-employment relationship were pending. Management could not estimate a loss range and did not consider an unfavorable outcome probable at that stage. Separately, the IRS had proposed disallowing $10.5 million of employment tax credits; TriNet expected litigation and believed it would prevail, recording no reserve.
Investor verification checklist
- Reconcile revenue growth with WSE growth, Ambrose’s contribution, and the distinction between GAAP revenue and management’s non-GAAP Net Service Revenue measures.
- Review insurance claims development, reserve adequacy, and the reported rise in workers’ compensation liabilities.
- Confirm debt amortization, interest-rate exposure, covenant headroom, and the effect of refinancing and debt-related charges on earnings and cash flow.
- Track the income-tax control remediation, tax-rate drivers, and outcomes of the IRS tax-credit dispute and class-action litigation.
- Assess client retention and pricing at insurance renewals, health-care reform effects, and the productivity and returns from the expanded sales force and acquisitions.