TriNet Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. TriNet provides HR, payroll, benefits, and related services to small and midsize businesses through a co-employment model.
Financial and operating performance
| Metric | Q3 2018 | Change vs. Q3 2017 | Nine months 2018 | Change vs. prior year |
|---|---|---|---|---|
| Total revenue | $875 million | +7% | $2.586 billion | +7% |
| Net Service Revenues | $228 million | +11% | $668 million | +10% |
| Operating income | $62 million | −1% | $209 million | +24% |
| Net income | $51 million | +20% | $163 million | +46% |
| Diluted EPS | $0.71 | +$0.11 | $2.25 | +$0.68 |
| Adjusted EBITDA | $88 million | +9% | $277 million | +28% |
Net Insurance Service Revenues increased 17% to $109 million in Q3 and 15% to $305 million year to date; the corresponding margin was 14%, versus 13% in both prior-year periods. Adjusted EBITDA margin was 38% in Q3 versus 39%, and 41% year to date versus 36%. Effective tax rates fell to 16% for Q3 and 18% year to date, from 26% and 28%, respectively.
Average worksite employees (WSEs) declined 2% in Q3 to 318,129 and 3% year to date to 315,512. Payroll and payroll taxes processed rose 8% in Q3 to $8.7 billion and 6% year to date to $27.4 billion. Revenue growth reflected rate increases and greater insurance participation; management also cited favorable insurance-contract experience.
Cash, liquidity, and debt
- At September 30, cash and cash equivalents were $237 million; working capital was $226 million. Total cash, cash equivalents, and investments were approximately $1.2 billion, much of it restricted or held for WSE and insurance obligations.
- Nine-month net cash used in operating activities was $476 million, compared with $141 million used in the prior year. This comprised $184 million provided by corporate operating activities and $660 million used in WSE-related activities, primarily reflecting timing of payroll-tax and other obligations. The company noted that adoption of restricted-cash accounting changed cash-flow presentation.
- Investing activities used $169 million and financing activities used $62 million. Investing included $136 million net purchases of investments and $33 million of capital expenditures.
- Debt was $420 million under a term loan maturing in 2023; $22 million was current. The $250 million revolving facility had $234 million available, net of an undrawn letter of credit. TriNet reported compliance with its debt covenants.
Material developments, outlook, and risks
- Q3 operating income was nearly flat despite revenue growth: other operating expenses rose $22 million to $155 million, including $10 million of anticipated marketing and operational-improvement costs. Management expects operating expenses to increase in the foreseeable future as it invests in growth, vertical products, systems, processes, and controls.
- TriNet refinanced its prior term loans in June 2018, replacing them with a $425 million term loan and a $250 million revolver. The new term loan had $420 million outstanding at quarter end.
- Management reported that disclosure controls and procedures were not effective because of a material weakness in internal control over financial reporting. Remediation was underway, but completion timing was uncertain. The company said the weakness had not caused a restatement and that the filed statements fairly presented results.
- No specific numeric earnings or revenue guidance is provided in the supplied filing text. The company stated it expected higher tax payments in 2018 and continued investment and expense growth.
- TriNet won summary judgment in a dispute with the IRS over employment-tax credits; it was working toward a judgment and anticipated that any recovery would likely be less than the total amount in dispute. The IRS could appeal. A securities class-action dismissal was on appeal; management said it could not reasonably estimate any possible loss.
- Adoption of ASC 606 changed revenue and commission accounting; prior-year comparisons were not restated. The company reported that the adoption increased nine-month 2018 net income by $17 million versus the previous standard. The company also anticipated a material balance-sheet impact from adopting the new lease standard in 2019.
Investor verification points
- Track WSE retention and growth, especially attrition associated with platform migration and the Main Street client base.
- Assess whether favorable insurance-contract experience and prior-period workers’ compensation reserve development persist.
- Separate corporate liquidity from restricted WSE and insurance funds when evaluating cash flow and available cash.
- Monitor remediation and independent effectiveness testing of the material weakness in internal controls.
- Follow the IRS litigation and appeal process, the securities class-action appeal, and the quantified balance-sheet effect of lease-standard adoption.