TriNet Group, Inc. — FY 2017 Form 10-K
Reporting period: Year ended December 31, 2017; filed February 27, 2018. Fourth-quarter figures are also summarized below. TriNet provides HR, payroll, benefits, insurance and compliance services to small and midsize businesses through a co-employment model. It served approximately 14,800 clients and 325,370 worksite employees (WSEs), and processed $37.1 billion of payroll and payroll taxes in 2017.
Financial performance and liquidity
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $3.275 billion | $3.060 billion | +7% |
| Professional service revenue | $458 million | $447 million | +3% |
| Insurance service revenue | $2.817 billion | $2.613 billion | +8% |
| Insurance costs | $2.466 billion | $2.414 billion | +2% |
| Net Service Revenues (non-GAAP) | $809 million | $646 million | +25% |
| Operating income | $217 million | $124 million | +75% |
| Net income | $178 million | $61 million | +190% |
| Diluted EPS | $2.49 | $0.85 | — |
| Adjusted EBITDA (non-GAAP) | $285 million | $185 million | +53% |
| Operating cash flow | $253 million | $149 million | +70% |
Insurance costs were 88% of insurance service revenue, down from 92% in 2016. Approximate GAAP operating margin was 6.6% of total revenue and net margin was 5.4%. Adjusted EBITDA margin was 35% of Net Service Revenues, versus 29% in 2016; this is a non-GAAP measure with a different denominator.
Reported total revenue includes substantial insurance billings and costs; Net Service Revenues, defined as total revenue less insurance costs, is a more useful supplemental view of service economics. Average WSEs declined 1% to 324,679, while total WSEs fell 4%; average monthly revenue per WSE rose 8%.
At year-end, corporate cash and equivalents were $336 million, corporate working capital was $227 million, and total working capital was $234 million. These figures should be distinguished from WSE-related balances, including payroll funds collected. Gross term debt was $425 million, with $40 million current and maturities in July 2019; $60 million remained available under the $75 million revolving facility. The company was in compliance with its debt covenants. Cash used in investing was $24 million and cash used in financing was $77 million. Capital expenditures were $38 million, and share repurchases were $44 million.
Fourth quarter
Q4 2017 revenue was $848 million, operating income $48 million, net income $66 million and diluted EPS $0.92. Q4 2016 figures were $811 million, $43 million, $23 million and $0.32, respectively. Q4 2017 net income included a $40 million tax benefit related to enactment of the Tax Cuts and Jobs Act (TCJA).
Material changes versus prior year
- Profitability improved substantially as insurance costs grew more slowly than insurance revenue; management cited lower-than-forecast medical costs, lower administrative costs and favorable insurance experience.
- Net Insurance Service Revenues increased 76% to $351 million. Insurance service revenue per average WSE rose 9%, while insurance costs per average WSE rose 3%.
- Other operating expenses increased 15% to $559 million, including $41 million higher compensation costs and increased consulting and professional fees, including costs for internal-control remediation.
- The effective tax rate fell to 11% from 41%, principally reflecting a $40 million deferred-tax revaluation benefit from the TCJA and other tax benefits. The tax benefit materially contributed to the increase in net income.
- Technology investment was approximately $74 million, compared with $53 million in 2016. The company launched TriNet Main Street and continued migrating legacy-platform clients to its common platform.
- Debt declined from $462 million to $425 million; corporate cash increased from $184 million to $336 million. Net cash provided by operating activities increased from $149 million to $253 million.
Outlook, risks and unusual items
- Outlook: The filing provides no formal revenue or earnings guidance. Management expected medical cost trends to revert toward long-term averages in 2018, anticipated reintroduction of a health-insurance-premium tax, and expected risk-based plans to rise to about 85% of group health insurance costs from roughly 70% in 2017. It also expected operating expenses to increase with growth, product development, platform integration and process-improvement work.
- Internal controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at year-end. The auditor issued an adverse opinion on internal control because of a material weakness in controls over professional-service and workers’ compensation insurance revenue, particularly review and documentation of renewal-rate changes. The auditor issued an unqualified opinion on the financial statements; no restatement was required. Remediation was ongoing, with no assurance as to timing or success.
- Insurance estimates: Claims experience and reserve assumptions can materially affect results. A 5% change in workers’ compensation loss development factors would change estimated insurance costs by approximately $37 million. A 250-basis-point increase in medical cost trend would increase health-benefit reserves by about $11 million.
- Liquidity and cash interpretation: Much of the balance sheet relates to WSE payroll, benefits and insurance collateral, rather than freely available corporate funds. The filing reported approximately $1.4 billion of restricted cash, restricted cash equivalents and payroll funds collected at year-end.
- Legal and tax contingencies: A securities class action was dismissed in December 2017, but the plaintiff appealed in January 2018; the company could not estimate potential loss. The company was also litigating an IRS dispute involving $11 million of employment tax credits plus interest and penalties, and said recovery was likely below the total amount. Ordinary-course claims and tax positions remain subject to uncertainty.
- Other risks: Key exposures include changing employment, benefits and tax laws; uncertainty about PEO co-employer status; cyber incidents; health and workers’ compensation claims; client attrition and SMB economic conditions; competition; and execution of the vertical strategy. Atairos owned approximately 28% of shares as of February 20, 2018; directors, officers and affiliates collectively held approximately 38%.
Most important facts for investors to verify
- Whether revenue controls and the material weakness were effectively remediated after year-end, and whether revenue-rate reviews are adequately supported.
- How much of 2017 earnings growth was recurring operating improvement versus the $40 million TCJA-related tax benefit and favorable insurance claims experience.
- Whether medical and workers’ compensation costs normalize as management expected, particularly as the share of risk-based health plans increases.
- Corporate liquidity and debt maturities, covenant capacity, and the distinction between corporate cash and WSE-related or restricted funds.
- Developments in the securities appeal, IRS tax-credit litigation, and other legal or tax contingencies.
- Whether WSE retention, client growth and platform migrations improve after the 2017 decline in total WSEs.