TriNet Group Inc (TNET) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the TriNet Group, Incorporated second quarter 2014 earnings conference call.

(Operator Instructions)

Please also note that today's event is being recorded. At this time, I'd like to turn the conference call over to Jimmy Franzone, Vice President, Corporate Development, Head of Investor Relations. Sir, you may begin.

Thank you, Jamie. Good afternoon, everyone, and welcome to TriNet's second quarter conference call. Joining me today are Burton M. Goldfield, President and CEO and Bill Porter, our Chief Financial Officer. Burton will begin with an overview of our operating and financial performance during the quarter. Bill will then review our financial results in more detail, as well as provide an update on our guidance for the full year. Bill, Burton, and I will then open up the call for the Q&A session.

Before I hand the call over to Burton, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties, and assumptions. In addition, some of our discussions may include non-GAAP financial measures. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, please see the Company's public filings, including the Form 8K filed today, all available on our website. With that, I will turn the call over to Burton for his opening remarks.

Thank you, Jimmy. The strong market demand we saw in the first quarter continued into the second quarter. I'm excited that in Q2 we met or exceeded our targets for sales and operational excellence. Our results reflected the robust demand for TriNet's three differentiated bundled solutions, each targeting specific vertical market opportunities with dedicated sales channels.

Growing HR complexities facing small- and medium-size businesses continue unabated. These include the Affordable Care Act, wage and hour issues, and a variety of additional federal, state, and local compliance requirements. And in fact, we are seeing that the ACA's eve- evolving rules and uncertainty implementation timelines continue to raise awareness for the need to seek a solution by TriNet, that deliver the full range of HR requirements.

We are winning new business by adding clients who were previously trying to stitch together their HR function to insurance brokers, software, and limited internal capabilities. What we term an unbundled solution. In fact, similar to last quarter, approximately 75% of our new clients added during Q2 did not previously use a bundled solution.

Our verticalized sales force is building deep relationships within each of our target market segments. They do so by offering a detailed understanding of the HR issues facing that business and their specific industries. Our relationships, and most importantly the building of trust, begin from the very first meeting with these entrepreneurs. These relationships, paired with our bundled products, create a winning formula that takes the pain away from customers in dealing with HR, so they can focus on growing their businesses.

Our knowledge of their industry provides credibility in strategizing around HR. For example, when we sell to a green tech CEO and can intelligently discuss the triple bottom line -- people, profit and planets -- we are helping them to build their dream. For our manufacturing clients, our sales organization understands cost accounting and the critical issues of assigning people job cost to each particular job. This expertise is greatly appreciated by the CFO and the entrepreneur alike.

Our Q2 results demonstrate the potential of our business model to provide a bundled solution to tap a large unpenetrated market. The three pillars of our value proposition are: local HR expertise, our fully integrated cloud based paperless platform, and our ability to offer large company comparable benefit packages.

As we build market share, we are converting our revenue growth into profitable cash flows, given our efficient operating infrastructure and capital-like investment requirements. During the second quarter, our net service revenues increased 32% year-over-year to $124.8 million. And our adjusted EBITDA increased 38% to $39.4 million for an adjusted EBITDA margin of 31.6%.

During the quarter we surpassed a major milestone, a 0.25 million work site employees. Our more than 2,000 internal colleagues couldn't be more excited about completing this milestone. We ended June with 258,985 work-site employees, or WSEs, across a wide variety of geographies and industries, up 7% sequentially quarter-over-quarter. And year-over-year Q2 WSE growth was up 23% organically.

A key to success in this large underpenetrated market is the development of our sales channel. This channel is vertically focused by product line. At the end of June, we had 388 reps on board, exceeding our goal of delivering 375, representing in excess of 25% growth in the sales channel. I committed to you 375 quota carrying field reps in the Q1 earnings call and my team delivered.

This year we have attracted a terrific class of representatives who are eager to get out into the market and begin interacting with Management teams across all of our verticals. This is one of the best groups we have put through our rigorous sales training program to-date. We are very pleased with both the quality and the size of these classes.

Many of our new sales reps come to us with significant sales experience, averaging over 10 years per rep, but generally coming from outside our own industry. This has been a deliberate decision on our part. We are hiring quality talent from the same industries that we're selling into, including technology, healthcare, software, financial services and others. Sales reps are joining TriNet from an illustrious set of companies that include household names in the markets I just referenced.

We have both momentum and position, which sets us up well for our upcoming 2015 selling season. We witnessed a very strong performance across each of our bundled product offerings in the second quarter. We saw healthy trends across multiple business segments and multiple geographies, with particular strength in California, New York, Massachusetts and Florida. I would like to touch on our progress in each of our products in the second quarter.

Our Ambrose product, characterized by a high touch service model with top tier benefits and direct access to compliance, tax and other specialists, generated strong sales during the second quarter. We continue to attract clients in select verticals, including hedge funds and legal firms. We saw several high-profile clients sign on to the Ambrose product due to our high-end ACA compliant health benefit plans.

Our Ambrose product is also benefiting from strong word-of-mouth and a growing number of referrals as professionals in areas such as money management and legal share their delight of our service model with their peers. Frankly, being a public company has helped in this sector as well.

Major wins in our SOI product line, characterized by complex multi-state HR and payroll needs, were represented by several large restaurant chains, as well as a hotel chain that was building a new management company and looked to SOI for complete HR support. An example of how verticalization works is that we were able to win the business of a 200 WSE restaurant inside the San Francisco Bay Area's preeminent brand-new sports stadium. Go Niners.

Our sales team leveraged the TriNet name and brand in this region, and showed that our SOI product line is tailor fit to this employee profile. The message of TriNet providing the best product for each specific vertical resonated with this new client.

Among other factors, these groups were attracted to our SOI product because of the nationwide presence and technology platform that enables businesses to scale aggressively. In addition, clients referenced SOI's seamless solutions in transitioning their healthcare to ACA-compliant offerings.

Technology, biotech, nonprofit and consulting companies all played heavily in Passport's Q2 wins. This product is characterized by intuitive, paperless, self-service platform and extensive benefit selections. Clients cite Passport's complete platform, defined by its technology, service model and benefits, as the key reason why they choose Passport.

For a good example of a Passport win, I will highlight a biotech company with 80 WSEs that came on board this quarter. This is a business that came to us from a referral partner who has worked for TriNet for years. This business is currently operating in Canada and the US with employees in over 20 states.

During the next one to two years, this biotech company expects to double in size. They were looking for an HR solution that would manage their employment compliant issues across a multi-state organization and would provide the expertise to help them grow aggressively in the near-term. All in a cost effective and predictable manner.

In addition to these client wins, an important part of our growth strategy is to continue to enhance our technology platform to provide clients and prospects with additional relevant products. I'm excited to share that during the second quarter we launched TriNet Perform, an internally developed, web-based performance management system that is integrated with our other products. We launched the product with early wins and we expect to see additional traction as we recently rolled out our product to the sales force.

In the coming months, other product releases are planned that will deliver incremental value to our clients. In summary, we made good progress on building the channel, developing new products, and selling into this underpenetrated market. Let me turn it over to Bill Porter for the financial review. Bill?

Thanks, Burton. As Burton noted, we reported strong second quarter financial and operating results, as we executed on our strategy and continue to drive growth across all of the key metrics used to measure the financial and operating health of our business. Our net service revenues increased 32% during the second quarter to $124.8 million, as we leveraged our growing sales force to drive further penetration of our multiple product offerings across our national footprint.

On an organic basis, second quarter net services revenue growth was 20%. Our total WSE count was 258,985 employees, up 31% from 197,458 work-site employees at the end of the second quarter 2013. On an organic basis, WSE growth was 23%.

Our professional services revenues, which represent approximately two-thirds of our net service revenues in Q2, increased 35% to $82.3 million. While our net insurance service revenues, which represent the remaining one-third of our net service revenues, increased 28% to $42.5 million during the second quarter. On an organic basis for Q2, professional services revenues grew 24% and net insurance services revenue grew 15% year-over-year.

Total adjusted EBITDA increased 38% to $39.4 million during the second quarter compared to the prior period year, representing an adjusted EBITDA margin of 31.6%. For the first six months our adjusted EBITDA margin was 33.2%. We are well on track in pursuing our target margin level of 33% to 34%. Our GAAP effective tax rate was 44.2% for the second quarter. As I indicated in Q1, we expect our long-term effective rate will be approximately 39.5%.

Adjusted net income increased 44% to $17.3 million, or $0.24 per share compared to $12.1 million or $0.18 per share in the prior year, primarily due to increased operating income. We also generated $19.7 million in free cash flow during the second quarter, which is defined as operating cash flow less CapEx. Our ability to generate healthy free cash flow is supported by our strong margin profile and asset light model.

Historically, we spend approximately 3% of 4% of our net revenue on capital expenditures. We also benefit from positive net working capital. During the quarter our CapEx spending was $3.6 million. We used $26 million of our cash to retire debt during the second quarter. We closed the quarter with total debt of $576 million, representing a debt to EBITDA ratio of 3.7 times trailing 12 months EBITDA. Total cash was $100.3 million at the end of the second quarter and working capital was $70.3 million.

In early July we refinanced our debt with a new credit facility of $650 million, which gives us a notable reduction in interest rates going forward. The loan includes a $375 million term loan A maturing in 2019, a $200 million term loan B maturing in 2017, and a $75 million revolver maturing in 2019.

We estimate we can save up to $5 million in interest over the second half of 2014. Pricing on the new term loan A, term loan B, and the revolver were set at LIBOR plus 275 basis points with no LIBOR floor, subject, in the case of the term loan A and the revolver to a leveraged base pricing grid.

Turning to our financial guidance for 2014. Based on our performance for the first half of the year, we expect net service revenue in the range of $512 million to $516 million for 2014, which represents organic growth of 17% to 18%, with adjusted EBITDA in the range of $174 million to $176 million, for the same period, in line with our target range of 33% to 34%. And adjusted net income in the range of $79 million to $81 million, or $1.09 to $1.11 per share.

For our financial guidance for Q3, we expect net service revenue in the range of $124 million to $126 million, which represents organic growth of 18% to 20% and adjusted EBITDA in the range of $39 million to $41 million for the same period. And adjusted net income in the range of $18 million to $20 million or $0.25 to $0.27 per share. And now I will turn it back over to Burton.

Thanks, Bill. In summary, we generated strong growth during the second quarter and first half of the year. We are executing our strategic plan as we focus on effectively addressing the many complexities small- and medium-sized businesses face today in delivering HR services to their employees. Our unique focus, knowledge base and scale, provides a level that expertise and service that simply cannot be replicated by stitching together multiple solutions through various sources.

We are the only company successfully addressing this large underpenetrated market with three distinct bundled solutions targeted to specific industries. We believe this differentiation is what is driving our strong results. Our momentum has continued into the second half of the year, and we are confident we can generate robust growth in 2014. In addition, our success in ramping up the sales force positions us well for 2015.

That concludes our formal remarks and now I would like to turn it back to the operator for the Q&A session.

(Operator Instructions)

Tien-tsin Huang, JPMorgan.

Great results here. I want to ask, Burton, I guess you were pretty bullish, I thought, on the quality of the people you are getting and mentioning it was one of your best classes et cetera. How can we test that or measure that, when all is said and done? Is it simply just higher productivity? I know net revenue growth we'll watch, but is there a way that we can watch productivity to test that thesis?

Good question, Tien-tsin. And thanks, it really was a great quarter.

And as I said on the earlier calls, that my focus was ramping up that sales organization. You, along with a lot of people, understand the complexity around ramping up a sales force 25% a year. So we have reached out into key verticals and well-known companies to pull reps. We have ramped up our training program, and actually adjusted it significantly because many of these people have never sold our bundled solution before.

I wouldn't get out ahead of yourself on the productivity. But the fact is, I expect to at least maintain the productivity. As I ramp up 25% per year over the next couple of years, the sales force to go after the market penetration play.

There are a lot of variabilities that go along with that productivity, as you point out. I think the fact is, we are getting some senior people. I won't know a lot until they are on board six months, but I am pretty optimistic about their ability to go out there and tear off chunks of these verticals.

I just got back from what we call Triumph, which is our sales kickoff. We had almost 600 people there in Arizona; that was all last week. So we have now undertaken the lion's share of the training of these new reps. And having the 388 on board was key. Now we've got to get them in the trenches, making phone calls, first calls. I'm measuring it by activity at this point, Tien-tsin. How many meetings can they schedule? And then how many quotes can they generate?

There is no magic here. But the fact is, that it is a fairly robust plan and a lot of moving parts to ramp up the sales force at this rate. As you know, we have 388 reps. But there's the whole management infrastructure; the marketing infrastructure; the lead regeneration; the training programs; and all types of other factors that go along with getting 388 front-line, quota-carrying, non-duplicative reps up to speed.

We will monitor that as we go on into 2015.

As my follow up, I just ask on the client retention or attrition front, any noticeable trends there? Looks like the guidance is quite good. Just wanted to make sure there wasn't anything, pluses or minuses, on the attrition front.

Tien-tsin, this is Bill.

No, there's nothing notable to speak of. Things are going well. We are spending a lot of effort to maintain the service levels. And as a result, we are having attrition that is trending better than our expectations, below the 20% target that we have.

Smitti Srethapramote, Morgan Stanley.

It sounds like you saw nice growth across the three products lines. But we were just wondering if there was anything to call out regarding any meaningful difference in growth rates in Ambrose versus Passport versus SOI in Q2?

I will start.

Bill, you might want to jump in.

Absolutely not Smitti. I'm thrilled with all three products. We are ramping up the reps across the three products. and they are all doing well.

Smitti, this is Bill.

As you know, and as we have mentioned, we're pretty ambivalent on how all of those products grow because we get similar margin profiles out of each. So we really try to make sure we are investing where the market seems to be hot. And we just like the growth that we are seeing across all three products at this stage.

Maybe for my follow up, just wondering if you can talk about the pricing environment overall and whether you're seeing any irrational pricing at all in the marketplace?

Smitti, I will take this.

The short answer is no. The competitive environment, the pricing pressure has not increased at all. It becomes very much a value sale and a trust sale, as we've talked about in the past. So we are not seeing pricing compression on any of our three product lines.

And Smitti, as you will note that on a quarterly basis, our service fee per average work site employee is up about 1%, when you look at it on a pro forma basis. So it's a very stable pricing environment, and we think that should continue.

Paul Ginocchio, Deutsche Bank.

Really quickly on change in existing, it seems like the NFIB Optimism Index has picked up. I think small business is higher, eight or nine months straight, which hasn't happened since 2006.

Have you seen an acceleration of hiring within your existing client base? And has that the part of the reason you've accelerated? And then I have a quick follow up.

I would say that the environment has been fairly steady. I think there's probably slight improvement in the CIE. But it's a little different across our product lines, Paul, as you know. We see better growth and change in existing in our faster growing verticals, such as technology. We see slower growth in more the mainstream products. And I'd say little bit more, also, slow growth in the high-end financial services. But it's pretty consistent, maybe just a slight bit of uptake, but nothing meaningful.

Just the mix impact -- I think you said 20% organic and 23% work site employee growth. Can you talk about the difference between that 20% and 23%?

Sure, in general there be a little bit of movement because it's not completely correlated depending on the time of the quarter when you bring your work site employees on. So you will see a swing of a couple percentage points generally, but it's in the right direction. I think were very pleased with both the WSE growth and, as I mentioned, the pricing is pretty stable.

We're not picking up any -- as you said, no differential in pricing or differential in growth rates between the brands?

No, not at all.

David Grossman, Stifel Financial.

This is actually Irvin Liu calling in for David.

If you look at the Affordable Care Act compliance as it relates to being a business driver, what type of revenue impact, if any, do the ACA-compliance deadline extensions have on your near-term outlook?

As I said in my opening comments, it is about the uncertainty. It is about the complexity. And the fact that it's extended, frankly, is great news for us, because there was a lot of awareness raised at the beginning and March timeframe. Now the pressure is a little bit off, and it will come back on again as the changes occur and the deadlines come near. So the extension and evolution of both the requirements, meaning the size and the complexity and what the laws are going to be, as well as the timeline, in my mind is all good news.

But I want to make clear, this is not all about the Affordable Care Act. It is about the complexity of running a business in a multi-state environment. It's about the very complex laws in California, as they vary from New York to Boston and other places. And it's the changing environment about what's considered overtime and what is considered regular time, which does change by city.

The Affordable Care Act is great. And I'm sure that's going to continue to evolve, but that's not the main driver for the business. It's about hand raisers with the Affordable Care Act. But in general it's about the real business problems, where people want to offload the complexity of HR and essentially outsource that function to a Company that's large, has the scale to service them in 50 states, and give incredible service to their employees.

That was helpful, thanks.

As a follow up, I was wondering if it is possible for you to give us an idea of how much of the contribution from 20% organic revenue growth was from new sales versus same store sales within the current installed client base?

Irvin, this is Bill.

We generally give an estimate on an annual basis. We're not going to get that level of detail quarterly. Generally, I'd say most of the increase you're going to see is really coming from new sales growth, based on what we look at our annual model. And I would expect that in Q2 it was the same.

Tim McHugh, William Blair & Company.

First, it sounded like you had some success with kind of larger sales this quarter. And I know that's always been a little bit of a mix. But was there a shift toward that at all? And are you seeing more success with, as you said, chains of restaurants or multi-state employers than even before?

Tim, good question.

We are having success with larger employers. On average, I don't think it's changed, because we have so many deals as we grow bigger. But it is true that some of the larger employers are becoming more interested in the solution. Some of that is being driven by the multi-state complexity. And some of it is being driven by the verticalization, where now we are focused on restaurants as a vertical.

For instance, I visited a large restaurant chain in New York City. And they had no idea that we were also currently servicing one of the largest chains out of LA. So they wanted to get together with those folks. We are starting to build the management infrastructure on top of that vertical. So I believe that that will help us to penetrate more of those large accounts.

It is all about focus, and I believe there is a huge opportunity in those larger multi-state restaurant chains. But that's an example of where all of those are going to be over 200 to 300 employees.

At the same time, there is a robust demand in the startup world. We got into six different incubators in the last couple of months to do with biotech, to give you an example. And we are able, by sponsoring those incubators, to get virtually every one of these companies as they're being formed, as opposed to wait for their formation and then identification.

So each of the verticals is in a different stage of maturity. But that gives you two ends of the spectrum, where those small biotech firms are three, four, five employees.

Tim, this is Bill.

I don't think you're going to see any meaningful move in the average number of work site employees per client. And so I think you've got some examples of good high-profile wins. But think across the board, it is resonating, I think, both from small and into larger clients. But you're not going to see it shift in the metrics in any significant way.

Just on a numbers question. The implied guidance -- I know you're not guiding specifically to Q4 -- but implies more or less, if my rough math is correct right now, more like a low double-digit or low teens growth rate in Q4. Can you remind us something about the comp for Q4 -- at least from the top line growth? Or if there's something else that you would expect? That seems pretty conservative given the WSE growth.

Understand -- and I don't think anything is wrong with your math. As we look towards the end of year, there are a lot of moving pieces that we are working with and would just like to be able to get through. We've got a lot were building, both on the WSE service level as well is on the sales level. So I think we just want to make sure that we're not getting ahead of our skis.

One last one, if I could slip in. You had a new program announced about partners, a new partner program, I guess, this quarter. And I've heard other [PDLs] talk about seeing a closer relationship with partner distribution channels. Is that becoming increasingly important? And I guess maybe just talk about what you're doing there.

Good question, Tim.

So I am trying to turn all of the dials around sales productivity. As I add so many new reps, the question is, how do you get them productive quicker? How do allow them to make quota and ultimately go to club? We have historically not done a lot with partners. We have started a partner program. There is an historic program that came through SOI around brokers. And we are trying to exploit that program.

Ultimately, I would expect over the next year for that to bear some fruit. But it's all about how can I bring in these new reps and get them productive very quickly. The ability to go in hand-in-hand with a partner, with already-established credibility is a very important, and ultimately could play a significant role in how we build the channel. My focus right now is entirely on 2015.

Jason Kupferberg, Jefferies LLC.

This is Ahmit Singh for Jason.

Just quickly on the sales force growth, now that you have already grown more than 25% -- the target that you have for the year -- so how should we look at that growth going forward for the year? Should we expect no more additions for the rest of the year?

As we have guided, we will grow the sales force at 25% each and every year for the next three years. We need to bring these folks in and train them up so they can be productive early in January. So my expectation is that we will not exceed the 25% growth, plus or minus a few percent for 2014, as we've guided. And I would expect the same thing next year.

You give good guidance on the top line and the EPS. But how should we think about your free cash flow going forward? Is it safe to assume that free cash flow should start trending towards adjusted EBITDA levels?

Sure, Amit, this is Bill.

Yes, free cash flow should continue to migrate toward EBITDA levels over time. And again, you just have to build in the consideration of where we are with our debt repayments because that, obviously, is not Incorporated into EBITDA.

Ladies and gentlemen, we have reached the end of the allotted time for today's question and answer session. We will now end the conference call. We do thank you for attending. You may now disconnect your telephone lines.