TriNet Group, Inc. — 2018 Form 10-K
Reporting period: Year ended December 31, 2018. This is an annual filing, not a standalone Q4 report; quarterly figures below are included where relevant. TriNet provides payroll, HR, benefits and employment-risk services to small and midsize businesses through a co-employment model. At year-end it served approximately 16,900 clients and 325,616 worksite employees (WSEs).
Financial performance
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenue | $3.503 billion | $3.275 billion | +7% |
| Net service revenue (non-GAAP) | $893 million | $809 million | +10% |
| Net insurance service revenue (non-GAAP) | $406 million | $351 million | +16% |
| Operating income | $251 million | $217 million | +15% |
| Net income | $192 million | $178 million | +8% |
| Diluted EPS | $2.65 | $2.49 | +6% |
| Adjusted EBITDA (non-GAAP) | $347 million | $285 million | +22% |
GAAP operating margin was approximately 7.2% of revenue and net margin approximately 5.5%. Adjusted EBITDA margin was 39% of net service revenue, versus 35% in 2017. Insurance costs rose 6% to $2.610 billion; operating expenses rose 8% to $642 million. The effective tax rate was 20%, compared with 11% in 2017, which benefited from a substantial one-time tax benefit related to the Tax Cuts and Jobs Act.
Payroll and payroll taxes processed increased 1% to $37.7 billion. Average WSEs declined 2% to 317,104, while year-end WSEs were essentially flat. Management attributed attrition partly to migrating Main Street clients from a legacy platform; growth in other verticals partially offset it.
Cash flow, balance sheet and capital
- Cash and cash equivalents were $228 million, down from $336 million; investments were $189 million. Restricted cash, cash equivalents and investments were $1.129 billion, primarily supporting payroll and insurance obligations.
- Reported operating cash flow was negative $104 million, versus positive $606 million in 2017. The result included a $338 million use of WSE-related operating cash, driven largely by timing of client receipts, payroll and tax payments, and insurance collateral and claims. Corporate operating cash flow, a company-defined non-GAAP measure, was $234 million versus $299 million.
- Capital expenditures were $43 million; investing cash outflow was $200 million, including net securities purchases. The company reported $1.349 billion in unrestricted and restricted cash and cash equivalents at year-end.
- Debt was $414 million outstanding, with $22 million current. In June 2018, TriNet refinanced its term loans and replaced a $75 million revolver with a $250 million revolver; $234 million of revolver capacity was unused at year-end. Debt matures in June 2023. The company reported compliance with its financial covenants.
- Working capital was $221 million, but essentially all WSE-related current assets were matched by WSE-related current liabilities; corporate working capital was $221 million. TriNet repurchased approximately $61 million of stock in 2018 and paid no dividends. In February 2019, the board authorized an additional $300 million for repurchases.
Material changes, outlook and risks
- Revenue growth and improved insurance service margins reflected increased health-plan participation, higher fees and favorable prior-year workers’ compensation development. Favorable workers’ compensation development was $28 million in 2018 versus $6 million in 2017. Medical cost trend was estimated at 7%–8%, up from 3.2% in 2017.
- TriNet continued investing in technology, customer experience and controls; technology development investment was approximately $81 million. It completed the legacy-platform migration, launched its sixth vertical product, TriNet Professional Services, and began a new branding campaign.
- No numerical 2019 financial guidance is provided in the filing. Management expects operating expenses to rise in the foreseeable future as it invests in service, systems, processes and internal controls. Management states existing corporate liquidity should cover working capital and capital expenditure needs for at least 12 months.
- ASC 606 was adopted in 2018. Among other effects, sales commissions previously expensed are generally capitalized and amortized over estimated client life. TriNet reported that 2018 net income would have been $168 million under the prior standard, rather than $192 million, primarily reflecting this accounting change; prior-year comparisons were not restated.
- Key risks include uncertain application of employment, PEO, benefits and insurance regulation; health and workers’ compensation claims volatility; client attrition and competitive pricing; cybersecurity and service interruptions; and reliance on insurance carriers. A 2.5% increase in workers’ compensation loss development factors would increase estimated insurance costs by $20 million; a 250-basis-point increase in medical cost trend would add approximately $13 million to accrued health costs.
- A securities class action dismissed by the district court was on appeal, with a hearing scheduled for March 2019; the company could not estimate potential loss. Separately, a federal court entered a $15 million judgment in TriNet’s favor in an IRS tax-credit dispute in January 2019; the IRS could appeal and recovery remained uncertain.
- The company said the material weakness in internal control reported for 2017 was remediated. Management and its auditor concluded internal control over financial reporting was effective as of December 31, 2018; the auditor issued unqualified opinions on the financial statements and controls.
Important facts for investors to verify
- Whether WSE growth and client retention improve after the Main Street platform migration, and whether other verticals can offset attrition.
- Whether insurance service margins and favorable workers’ compensation development are sustainable as medical costs rise.
- The drivers and timing of the negative reported operating cash flow, distinguishing WSE-related funds from corporate cash generation.
- The effect of ASC 606 commission capitalization on reported earnings and comparability with prior periods.
- Debt covenant headroom and the funding capacity for the expanded share repurchase authorization.
- Developments in the securities appeal, IRS dispute and any material changes in regulatory, cyber or insurance-claims exposure.