TriNet Group, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. TriNet provides payroll, benefits, HR and employment-risk services to small and midsize businesses through a co-employment model. Results are unaudited; the company operates as one reportable segment.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $975 million (+1%) | $969 million | $2.971 billion (+5%) | $2.838 billion |
| Net income | $33 million (-40%) | $55 million | $250 million (+52%) | $164 million |
| Diluted EPS | $0.48 (-38%) | $0.78 | $3.66 (+58%) | $2.31 |
| Operating income | $45 million | $68 million | $338 million | $205 million |
| Net Service Revenue (non-GAAP) | $216 million (-2%) | $221 million | $834 million (+19%) | $703 million |
| Net Insurance Service Revenue (non-GAAP) | $90 million (-1%) | $91 million | $431 million (+39%) | $310 million |
| Adjusted EBITDA (non-GAAP) | $69 million (-26%) | $93 million | $413 million (+44%) | $286 million |
| Adjusted EBITDA margin | 32% | 43% | 49% | 41% |
Q3 operating income was about 4.6% of revenue, versus about 7.0% a year earlier; nine-month operating income was about 11.4% of revenue, versus about 7.2%. Reported net insurance margin was 11% for Q3, unchanged year over year, and 17% year to date, compared with 13%.
Average worksite employees (WSEs) fell 4% in Q3 year over year to 317,737; nine-month average WSEs rose 1%. Total WSEs were 320,604, down 3% year over year but up 2% from June 30.
Cash flow, liquidity and debt
- For the first nine months, GAAP operating cash flow was negative $40 million, compared with negative $211 million in 2019. Corporate operating cash flow, a non-GAAP measure excluding WSE-related working-capital activity, was $308 million versus $146 million. WSE-related operating cash flow was negative $348 million.
- Investing cash outflow was $151 million, mainly reflecting net investment purchases of $112 million and $27 million of capital expenditures. Financing cash flow was positive $77 million, including a $234 million revolver draw and $135 million of share repurchases.
- At September 30, cash and cash equivalents were $563 million; unrestricted investments were $202 million. Total cash, cash equivalents and investments were $1.802 billion, including substantial restricted and WSE-related funds that are not freely available for corporate use. Corporate working capital was $342 million.
- Total debt was $609 million, including $234 million drawn on the revolving facility and $375 million of long-term debt. The revolver had $16 million of letters of credit outstanding and was payable by June 2023. TriNet reported compliance with its credit covenants.
Material changes and management commentary
- The Recovery Credit program reduced reported revenue by $48 million in Q3 and $104 million for the nine-month period. Eligible clients receive discounts on future services; the total credit depends partly on future net insurance performance and is capped. The company planned to continue recognizing the revenue reduction as clients earn credits.
- Q3 revenue growth reflected rate increases and higher health-plan enrollment, partly offset by fewer average WSEs and the Recovery Credit. Q3 net income and adjusted earnings declined amid the credit, higher insurance costs as medical utilization returned toward typical levels, and higher operating expenses. Management attributed much of the expense comparison to a nonrecurring reduction in variable incentive compensation in Q3 2019.
- Lower medical-service utilization, particularly in Q2, reduced medical cost trend and supported higher year-to-date insurance margins. Utilization moved toward more typical levels in Q3; management cautioned that pandemic-related claims and medical costs remain unusually difficult to predict.
- Management expects the rate of growth in total revenue, professional service revenue and insurance service revenue to decrease in future periods, and operating expenses as a percentage of revenue to increase. It also expects ongoing investment in customer and WSE experience. No numerical earnings or revenue guidance is provided in the supplied filing text.
- TriNet acquired Little Bird HR in July, expanding its presence in the education-institution market. The acquisition was immaterial to reported results; $5 million of goodwill was recognized, which is not tax deductible.
Risks, contingencies and unusual items
- COVID-19 has affected clients through business closures, reduced hiring, furloughs and attrition. TriNet reported lower new-sales growth and higher WSE attrition during the first nine months. The company highlighted risks to client retention and payment, revenue growth, margins, service delivery and cybersecurity from remote work.
- Insurance-cost uncertainty is elevated: deferred care could shift claims patterns, health claims may be more volatile, and evolving workers’ compensation standards could increase covered claims. TriNet also bears a share of retention costs under employment-practices liability coverage.
- The Recovery Credit may not achieve its intended retention and loyalty benefits; competitors could offer more attractive incentives. The program’s future cost and effect depend on client renewals and net insurance performance.
- A class action filed September 29, 2020 alleges fiduciary-duty violations concerning investment and recordkeeping fees in two TriNet 401(k) plans. The matter is at an early stage and a possible loss could not be estimated; TriNet said it believes the claims are without merit.
- TriNet is pursuing a tax-refund dispute with the U.S. involving $11 million of employment tax credits plus interest. A district court entered judgment in TriNet’s favor for $15 million plus interest; the government appealed, and recovery remains uncertain.
Key facts for investors to verify
- How the Recovery Credit’s estimated total, timing and client-retention effects evolve, and how much further revenue reduction is recognized.
- Whether WSE counts, new sales and client attrition stabilize, and whether management’s expected slower revenue growth materializes.
- Health claims, medical utilization and workers’ compensation developments, including effects on net insurance revenue and margins.
- Corporate liquidity apart from restricted/WSE funds, debt reduction plans, interest-rate exposure and continued share repurchases.
- Developments in the retirement-plan class action and tax-refund appeal, including any change in estimated exposure or recovery.