TriNet Group, Inc. — Q3 2016 Form 10-Q
Business context and period. TriNet provides HR, payroll, benefits and related services to small and midsize businesses through a co-employment model. This unaudited report covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. At quarter-end, TriNet served more than 13,000 clients and co-employed approximately 333,778 worksite employees, up 6% year over year.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $770.5m | $668.0m | $2,249.2m | $1,933.6m |
| Net service revenue* | $161.0m | $133.5m | $473.5m | $397.9m |
| Operating income | $29.0m | $11.7m | $81.2m | $48.7m |
| Net income | $14.6m | $3.1m | $38.4m | $17.6m |
| Diluted EPS | $0.20 | $0.04 | $0.53 | $0.24 |
| Adjusted EBITDA* | $45.4m | $30.8m | $130.2m | $105.6m |
Revenue and margins. Q3 revenue rose 15% and nine-month revenue rose 16%. Professional service revenue increased 11% and 13%, respectively; insurance service revenue increased 16% and 17%. Net service revenue increased 21% in Q3 and 19% for nine months. Operating margin on net service revenue was 18% in Q3 and 17% year to date, versus 9% and 12% in 2015. Insurance costs increased 14% in Q3 and 16% year to date, slower than insurance revenue growth; management attributed the increase primarily to higher medical costs per worksite employee. *Net service revenue and Adjusted EBITDA are non-GAAP measures; TriNet cautions they should be considered alongside GAAP results.
Cash flow and liquidity. Nine-month operating cash flow was $78.1m, down from $104.5m, primarily due to income taxes paid and workers’ compensation collateral paid to carriers. Investing cash outflow was $17.4m, including $27.9m of property and equipment purchases; financing cash outflow was $66.4m, including $43.7m of repurchases and debt repayments. Cash and cash equivalents were $160.6m at September 30, down $5.6m from year-end. Restricted cash and investments are not freely available for general corporate use. TriNet reported positive working capital and stated it complied with applicable state minimum net-worth and working-capital requirements.
Debt. Term loans totaled $472.5m at quarter-end, compared with $499.6m at December 31, 2015; debt carried variable-rate exposure. In July 2016, TriNet refinanced $135m of term loans due in 2017 into new loans maturing in 2019. The company was in compliance with its credit-facility covenants. Management estimated a 100-basis-point increase in interest rates would add $11.9m to interest expense over 2016–2019.
Changes, outlook and risks
- Drivers and costs: Revenue growth reflected higher worksite employee counts and higher average revenue per employee. The sales force declined 15% to 406 representatives as management recalibrated teams to improve productivity. Service-delivery costs rose 34% in Q3, and general and administrative costs rose 27%; management cited growth-related staffing, tax and compliance costs, and insurance-program consulting. Lower amortization of acquired intangibles supported operating income growth.
- Outlook: The filing provides no specific numerical earnings or revenue guidance. Management expected insurance costs and service-delivery costs to rise in absolute dollars as the business and worksite employee base grow, and planned continued technology investment. It noted that health-care reform could raise costs, affect client retention, and constrain or delay fee increases.
- Insurance and reserves: Medical and workers’ compensation claims are variable and can materially affect costs; claim volumes have historically been higher in the second and third quarters. Nine-month workers’ compensation incurred claims included $13.0m of adverse development relating to prior years. The estimate of ultimate claims and timing of payments is uncertain.
- Controls: Management concluded disclosure controls were not effective at September 30 because of material weaknesses in internal control over financial reporting. Management said additional procedures supported fair presentation of the financial statements, but remediation was ongoing and its duration and success were not assured.
- Legal and tax matters: A putative securities class action alleges misstatements or omissions concerning health-insurance and workers’ compensation trends; TriNet disputes the claims. Management did not expect the identified matters to have a material adverse effect, but acknowledged an unfavorable resolution could be material. TriNet also sought a refund of $10.5m in employment-tax-credit assessments and believed recovery was more likely than not; no reserve was recorded.
- Capital allocation: TriNet repurchased $43.7m of shares during the first nine months, primarily to offset share-based compensation dilution; $37.9m remained authorized at September 30. Stock-based compensation expense increased to $20.2m from $13.0m year over year.
Important facts for investors to verify
- Whether growth in net service revenue and operating margin can continue as insurance costs, service-delivery expenses and compliance costs rise.
- The adequacy and development of workers’ compensation and health-plan reserves, including prior-period claims estimates and required collateral.
- Progress in remediating the disclosed material weaknesses and the reliability of internal financial reporting controls.
- The outcome and potential exposure from the securities class action and the employment-tax-credit refund claim.
- Variable-rate debt exposure, covenant headroom, and the balance of unrestricted cash after restricted funds and planned spending.
- The impact of health-care regulation, January client churn and seasonal claims variability on retention, pricing and future results.