TriNet Group, Inc. — FY 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; comparative figures are for FY 2014 unless noted. The filing was signed March 31, 2016. The requested “2015 Q4” is not a standalone quarterly filing; selected fourth-quarter results are included below.
Business context
TriNet provides bundled HR, payroll, employee benefits, workers’ compensation and related services to small and midsize businesses under a co-employment model. At year-end it served more than 12,700 clients and 324,399 worksite employees (WSEs), and processed over $31 billion in payroll and payroll taxes during 2015. More than 99% of revenue was attributable to U.S. WSEs.
Key financial metrics
| Metric | FY 2015 | FY 2014 | Change |
|---|---|---|---|
| Total revenue | $2,659.3 million | $2,193.5 million | +21% |
| Professional service revenue | $401.3 million | $342.1 million | +17% |
| Insurance service revenue | $2,258.0 million | $1,851.5 million | +22% |
| Insurance costs | $2,112.4 million | $1,686.3 million | +25% |
| Net Insurance Service Revenues (non-GAAP) | $145.6 million | $165.1 million | -12% |
| Net Service Revenues (non-GAAP) | $546.9 million | $507.2 million | +8% |
| Operating income | $78.3 million | $86.8 million | -10% |
| Net income | $31.7 million | $15.5 million | +104% |
| Diluted EPS | $0.44 | $0.22 | +100% |
| Adjusted EBITDA (non-GAAP) | $151.3 million | $165.3 million | -8% |
| Cash from operating activities | $130.6 million | $151.9 million | -14% |
GAAP operating margin was approximately 2.9% of revenue, versus 4.0% in 2014; net margin was approximately 1.2%, versus 0.7%. These revenue figures include substantial insurance billings and costs; TriNet also presents Net Service Revenues as a non-GAAP measure. Non-GAAP measures should be considered alongside GAAP results.
Liquidity and debt: Year-end cash and cash equivalents were $166.2 million; working capital was $112.4 million, including $108.5 million of corporate working capital. Debt under the credit facility was $499.6 million, largely variable-rate and secured; $35.3 million was due within 12 months, and $59.5 million of the revolver was unused. Restricted cash and investments include amounts supporting insurance obligations and are not equivalent to unrestricted corporate cash. Management said existing cash and expected operating cash flow should meet needs for at least 12 months.
Fourth quarter, unaudited: Revenue was $725.7 million, operating income $29.6 million and net income $14.1 million. Q2 2015 had a net loss of $1.3 million, amid elevated medical claims.
Material changes versus the prior year
- Revenue growth was driven by higher WSE counts and higher average insurance revenue per WSE; WSEs rose 13% to 324,399. Sales representatives increased 25% to 481.
- Insurance costs rose 25%, faster than insurance revenue, as medical claim frequency and severity were unexpectedly high and workers’ compensation cost per WSE also increased. Management cited a significant increase in large medical claims in Q2.
- Net Insurance Service Revenues fell 12%, reducing the growth in Net Service Revenues to 8% despite 21% GAAP revenue growth.
- Operating income declined as operating expenses grew 11%; sales and marketing increased 19% and general and administrative expense increased 29%, including higher sales-force and compliance costs.
- Net income increased partly because interest and bank fees fell to $19.4 million from $54.2 million, following debt repayment/refinancing and prior-year debt-cost write-offs and a prepayment premium.
- Operating cash flow declined to $130.6 million. The company repaid $45.3 million of debt and repurchased $48.4 million of stock during 2015.
Outlook, risks and unusual items
- Outlook: No quantitative earnings or revenue guidance is provided. Management expected insurance costs to rise in absolute dollars with WSE growth and claim-cost inflation; it planned continued technology investment and expected sales and marketing spending to grow more slowly than in recent years.
- Internal controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2015 due to seven categories of material weaknesses, including IT general controls, management review, payroll, insurance liabilities, payroll-tax validation and procurement authorization. The auditor issued an adverse opinion on internal control, but an unqualified opinion on the financial statements. Management reported that additional procedures found no material adjustments or restatements were required and described remediation efforts; remediation was not yet complete.
- Late filing and covenant: The company disclosed that the late 10-K caused a temporary breach of a credit-facility timely-filing covenant; it said the breach was cured within the contractual cure period after filing. The delay also temporarily restricted use of Form S-3.
- Legal and tax contingencies: A putative securities class action alleges misrepresentations or omissions concerning health and workers’ compensation claims trends; the company intended to seek dismissal and said it would defend the case. Management did not expect the matters described to have a material adverse effect, but noted outcomes could be material. TriNet also paid $10.5 million in disputed employment-tax-credit assessments related to acquired Gevity and said litigation was likely; it recorded no reserve because it believed it would prevail.
- Other exposures: The co-employment model creates payroll, employment-law and benefit obligations, with client indemnities that may not be collectible. Insurance claim estimates and reserves are judgmental and can change materially. The company also cited regulatory uncertainty, ACA implementation, client attrition, competition, cybersecurity and systems risks, variable-rate debt, and a 2015 effective tax rate of 47.2%.
Important facts for investors to verify
- Whether the claims-cost increase and decline in Net Insurance Service Revenues persist, and how reserves compare with subsequent claims experience.
- Progress and independent evidence of effective remediation of the seven internal-control material weaknesses.
- Unrestricted corporate liquidity after restricted insurance collateral, scheduled debt payments and the $12.7 million anticipated excess-cash-flow prepayment.
- Developments in the securities class action and the Gevity employment-tax-credit dispute, including potential financial exposure.
- How growth in WSEs, client retention and sales-force productivity translate into Net Service Revenues, operating income and cash generation.