TriNet Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. TriNet provides HR, payroll, benefits, insurance and compliance services to small and midsize businesses through a co-employment model. It operates as one reportable segment; less than 1% of revenue came from outside the U.S.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $800.5 million (+7%) | $745.8 million | $1,608.2 million (+9%) | $1,478.8 million |
| Net Service Revenues (non-GAAP) | $201.0 million (+35%) | $149.2 million | $400.0 million (+28%) | $312.4 million |
| Operating income | $56.8 million (+116%) | $26.4 million | $106.3 million (+103%) | $52.3 million |
| Net income | $40.0 million; diluted EPS $0.56 | $12.3 million; diluted EPS $0.17 | $68.7 million; diluted EPS $0.97 | $23.9 million; diluted EPS $0.33 |
| Adjusted EBITDA (non-GAAP) | $72.4 million (+70%) | $42.6 million | $135.7 million (+60%) | $84.8 million |
Q2 operating margin was approximately 7.1%, compared with 3.5% a year earlier; first-half operating margin was approximately 6.6%, versus 3.5%. Revenue growth primarily reflected higher health-plan participation and insurance service fees. Insurance costs were flat year over year in Q2 and rose 4% in the first half, with lower claims and premium costs per participant partly offsetting increased covered lives. Professional service revenue declined 1% in Q2 but increased 3% for the first half.
- Operating scale: Average worksite employees (WSEs) were 324,194 in Q2, roughly flat year over year, and 325,999 for the first half (+2%). Payroll and payroll taxes processed were $8.0 billion in Q2 (+2%) and $17.8 billion for the first half (+3%).
- Cash flow: First-half operating cash flow was $104.1 million, compared with $43.7 million in 2016. The increase reflected higher earnings, lower cash taxes and reduced collateral payments to insurers. Investing cash outflow was $9.3 million and financing cash outflow was $45.1 million.
- Liquidity and debt: Corporate cash was $233.9 million at June 30, up from $184.0 million at year-end; working capital was $168.7 million. Notes and capital leases payable were $440.8 million, down from $459.1 million. The $75 million revolving facility had $59.5 million unused; the company reported compliance with its financial covenants.
Changes, outlook and notable matters
- Results improved substantially year over year, led by higher net insurance service revenue and moderated insurance-cost growth. First-half WSE growth remained modest as client migration to a common platform contributed to attrition; TriNet also moderated new-customer growth ahead of a new product launch.
- TriNet Main Street, targeting industries including hospitality, retail and manufacturing, launched in July 2017, after quarter-end. Management described continued investment in technology, platform integrations and vertical products.
- Management expects operating expenses to increase in the foreseeable future due to growth, product development, integrations and internal-control remediation. No quantified earnings or revenue guidance is provided in the filing.
- The effective tax rate fell to 23.5% in Q2 and 29.3% for the first half, from 42.9% and 43.6%, respectively. The decline included benefits from adopting share-based compensation accounting guidance, state tax changes and other tax items; the resulting earnings improvement should be considered in evaluating underlying performance.
- Controls: Management concluded disclosure controls were ineffective at June 30 because of material weaknesses in internal control over financial reporting. Remediation was underway, but management could not estimate when it would be completed or assure it would succeed. The filing says the weaknesses had not caused a restatement of prior-period financial statements.
- Risks and contingencies: Workers’ compensation reserves depend on estimates of claims; favorable prior-year claims development was reported, partly offset by increased severity for some non-office claims. A putative securities class action alleges misstatements or omissions concerning health insurance and workers’ compensation trends; the company could not estimate a possible loss. Management stated it did not then expect the matters discussed to have a material adverse effect, while noting outcomes remain uncertain.
- In July 2017, the company agreed to lease additional office space beginning in February 2018, with approximately $32.4 million of commitments over ten years. First-half share repurchases totaled $29.5 million, with approximately $30.5 million remaining authorized.
Important facts for investors to verify
- Whether insurance revenue growth and favorable claims-cost trends persist, and how claims experience affects reserves and required collateral.
- Progress and effectiveness of the internal-control remediation plan, given the disclosed material weaknesses.
- The earnings impact of unusually favorable tax items and the company’s underlying profitability excluding non-GAAP adjustments.
- Developments in the securities class action and any change in estimated exposure or other legal contingencies.
- TriNet Main Street’s client adoption and the costs and returns from platform, product and office investments.