TriNet Group Inc (TNET) 2014 Q3 法說會逐字稿

Good afternoon and welcome to the TriNet Group, Incorporated, third-quarter 2014 earnings conference call. (Operator Instructions)

Please also note that today's event is being recorded. I would now like to turn the conference call over to Alex Bauer, Executive Director of Investor Relations. Sir, please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to TriNet's third-quarter conference call. Joining me today are Burton 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 over the call 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 discussion 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 8-K filed today, all available on our website.

With that, I will turn the call over to Burton for his opening remarks.

Thank you, Alex.

I am pleased to report that the market demand we saw in the first half of 2014 for our products continued unabated in Q3. We delivered another strong performance during the third quarter, as a result of the compelling value proposition of our HR solution and execution of our strategic plan. Offering tailored products to our chosen verticals, as opposed to a one-size-fits-all model, is resonating in the marketplace.

Small and medium-sized businesses continue to face an increasingly complex HR environment. From the Affordable Care Act, wage and hour issues, and a variety of federal, state and local compliance requirements, HR continues to be an onerous process, draining efficiencies and management resources.

We saw over 200 state and federal labor laws put into effect in 2014 alone; we don't anticipate 2015 being any less complex. For example, we expect the Affordable Care Act requirements for all companies to be fully enforced.

TriNet is performing well against our industry backdrop, due to the fact that we are delivering differentiated solutions. We bundle HR services, benefits and our cloud-based technology platform, creating solutions that address the full suite of critical HR needs faced by small and medium businesses. Unique to TriNet is a sales force that is organized by industry vertical, enabling the channel to leverage industry expertise, referrals, and a focused offering that provides our prospects with a credible and strategic HR vision for their company.

Similar to last quarter, 75% of all new clients previously used an unbundled solution, assembling their HR function through a mix of insurance brokers, software applications, and limited HR in-house expertise. Our strategy is yielding a strong referral network, growth in targeted verticals, and geographic leverage that provides scale for marketing, as well as our critical insurance programs.

The customer feedback about our vertical focus has been excellent. I recently met with a client, a successful 100-person advertising agency. They told me that TriNet has been great for their business, as they scale from a classic ad agency, i.e. print and radio, to one that now includes a significant social media component.

As you can imagine, this transformation requires a very different type of hire. The client stated to me, I love the TriNet relationship and I would trust TriNet to do more for me and my company. Simple words, but they underscore the power of the vertical model, as it relates to both the realized and unrealized potential for our comprehensive solutions.

Our commitment to operating discipline, customer retention, and prudent risk management shows in our financial results. During the third quarter, our net service revenues increased 22% year over year to $127.8 million. Our adjusted EBITDA increased 50% year over year and 5% sequentially to $41.5 million.

We finished the quarter with 272,846 worksite employees, or WSEs, an increase of 13,861 quarter over quarter, for a sequential growth rate of 5%. Year over year, Q3 WSE growth was up 25%. For sake of clarity, all of this growth is organic and not due to acquisitions.

During the quarter, TriNet exceeded the 10,000 client milestone, demonstrating our ability to scale our business, while continuing to provide our clients with the high-quality service they expect from our three bundled products.

On the last earnings call, I talked about the opportunities around building our sales channel. At the end of Q3, we had 391 quota-carrying reps. Taking into account anticipated attrition, we expect to begin 2015 with a sales force of at least 375, representing growth in our sales force of 25% annually.

Our motto is to continue to build the sales force by 25% in 2015, or to get to 470 quota-carrying reps by June 30, 2015. We believe our future WSE growth will be the result of our recruitment and development of this best-in-class sales force. We continue to attract new reps from the same industries that we are selling into, including technology, life sciences, financial services, and hospitality.

As we approach the new year, the on-boarding and training of our new reps is progressing well. I am seeing early signs of success that the 2014 class is maturing and fully prepared to take on the challenge of January sales. In fact, several of the new hires have closed their first deals. For example, in our life sciences vertical, one rep has closed seven new clients in the New Jersey/Philadelphia industry hub.

Turning to our product performance during the third quarter, we witnessed strong sales across each of our three bundled offerings. During the quarter, our Ambrose product, which is characterized by a high-touch service model with top tier benefits and direct access to complex tax and other specialists, generated strong sales. Ambrose continues to attract clients in its selected verticals, including hedge funds, private equity, and legal firms. Furthermore, Ambrose is expanding geographically, producing strong growth in California.

A great story from the quarter that really demonstrates the TriNet value proposition came out of Ambrose. A few years ago, we lost a private equity client over cost. Despite the high switching cost, we recently won back that client and its 29 WSEs because of our high-touch service model and rich benefit options.

During the process of bringing the client back onto TriNet, the client executive commented to us, you get what you pay for. Our offerings are tailored to deliver clear value in a way that positively impacts how our clients run their businesses.

With regard to our SOI product line, which is characterized by complex multi-state HR and payroll needs, we saw major wins represented by several light manufacturing companies, restaurant chains, and hotel and hospitality companies. In addition to our nationwide presence and technology platforms, these new SOI clients were attracted to our ACA-compliant offerings. We are providing an attractive solution by mitigating ACA compliance risk, thus allowing these businesses to focus on growth. Having ACA-compliant offerings is driving SOI momentum, and we expect this trend to continue into 2015.

Technology, life sciences, and professional services all played heavily into Passport Q3 wins. This product is characterized by an intuitive, paperless, self-service platform, and extensive benefit selections. Clients cite Passport's complex platform, defined by technology, service model, and benefits as the key reason why they choose Passport.

For a good example of a Passport win, I highlight a technology company with 56 WSEs that came onboard this quarter. This client came to us through a competitive process, directed by their private equity partner. Based in Atlanta, the client expects to double its WSEs in 2015, creating the need for a flexible and competitive bundled HR solution.

After evaluating multiple solutions, the company chose TriNet Passport, due to our attractive benefits package and highly-transparent pricing per employee, which allows the company to better plan for their anticipated growth. The company also noted our high level of HR expertise and our TriNet Cloud offerings as key differentiators.

The value of our three differentiated products was proven during a recent meeting that I personally attended with a West Coast law firm that also operates a consulting business, as well as an investment arm, which owns a variety of high-end concept restaurants. I was joined in this meeting by three TriNet sales people, representing each of our bundled solutions: Ambrose, SOI and Passport. While this situation was somewhat unique, the ability to bring a highly targeted and capable solution for each of this prospect's client's businesses spoke volumes about what we bring to the table.

This prospect can use Ambrose for the law firm, Passport for the consulting group, and SOI for the many restaurants they currently own. In addition to driving sales of our core bundled solutions, an important part of our growth strategy is to continue to enhance our technology platform to provide clients and prospects with additional relevant products. Our cloud-based products -- TriNet Perform, TriNet Marketplace, and TriNet Expense -- are becoming differentiators in the PEO market.

These cloud-based products will enhance retention, create incremental opportunities, and continue to provide additional value to new and existing clients. In Q3, TriNet Perform demo contributed to a 170 WSE Passport win, tipping the deal in our favor. TriNet Perform was also implemented at an existing 327 WSE client, an example of how we plan to leverage our install base with these great cloud products.

This quarter, we announced our latest product, TriNet Hire, our cloud-based solution for helping clients simplify and manage the entire recruitment function, from the creation and posting of positions through the screening and interview process.

In summary, we continue to see notable momentum in our business, as we expand our unique bundled solutions to the HR marketplace. Our sales force is working hard to generate business across our vertical markets and we are well-positioned to generate continued strong growth.

Let me turn over the conversation to Bill Porter for the financial review.

Bill?

Thanks, Burton. Our third-quarter financial and operating results reflect continued execution of our strategy, and growth across all of the key metrics used to measure the financial and operating health of our business.

Net services revenues grew 22% organically during the third quarter to $127.8 million, as we leveraged our growing sales force to drive further penetration of our multiple product offerings across our national footprint. Total WSE count was 272,846 employees, up 25% from 218,577 worksite employees at the end of the third quarter of 2013.

Professional services revenues, which represent approximately two-thirds of our net service revenues in Q3, increased 15% to $86.9 million, while our net insurance service revenues, which represent the remaining one-third of our net service revenues, increased 41% to $40.9 million during the third quarter.

Total adjusted EBITDA increased to $41.5 million during the third quarter, compared to $27.7 million for the prior-year period. For the first nine months, our adjusted EBITDA margin was 32.9%. We are well on track in pursuing our target margin level of 33% to 34%.

The GAAP effective tax rate was 75.5% for the third quarter, primarily due to a discrete tax charge of $1.3 million for the revaluation of deferred taxes, based on an income tax accounting method change and nondeductible transaction costs for our secondary offering completed in September. We expect our non-GAAP effective tax rate to continue to be approximately 39.5%.

Adjusted net income increased 118% to $20.2 million, $0.28 per share, compared to $9.3 million, $0.13 per share, in the prior year, primarily due to increased operating income. We also generated $37 million in free cash flow during the third 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% to 4% of our net revenue on an annual basis on capital expenditures. We also benefit from positive net working capital. During the quarter, our CapEx spending was $8.4 million.

We used $25 million of our cash to retire debt during the third quarter. We closed the quarter with total debt of $550 million, representing a debt-to-EBITDA ratio of 3.3 times trailing 12-months EBITDA. Total cash was $98 million at the end of the third quarter, and working capital was $17.3 million.

For our financial guidance for Q4, we expect net service revenue in the range of $137 million to $139 million, which represents organic growth of 13% to 14%; adjusted EBITDA in the range of $51 million to $53 million for the same period; and adjusted net income in the range of $25 million to $27 million, or $0.35 to $0.37 per share.

Based on our year-to-date performance and our Q4 guidance, we expect net service revenue in the range of $517 million to $519 million for 2014, which represents organic growth of 18% to 19%, with adjusted EBITDA in the range of $176 million to $178 million for the same period, in line with our target range of 33% to 34%, and adjusted net income in the range of $80 million to $82 million, or $1.10 to $1.13 per share.

And now, I will turn it back over to Burton.

Thanks, Bill. In summary, we are executing on our strategic plan and delivering compelling bundled solutions that effectively address the many complexities small and medium businesses face today in delivering HR solutions to their employees. Simply put, we are powering business success with extraordinary HR. In turn, our client base is increasing our referral network, and expanding the financial results of the Company.

We are the only company successfully addressing our large underpenetrated market with three distinct bundled solutions, and a sales force dedicated to targeting specific industry verticals. This differentiation sets us apart from the competition, supports our growth targets, and enables us to deliver on our financial goals.

Consider that through the first nine months of this year, we have now processed over $17.5 billion in payroll and payroll tax benefits reflecting the scalability and robustness of our infrastructure, which now serves over 10,000 unique employers across the USA. Our momentum has continued into the fourth quarter, and our channel growth, that exceeds 25%, positions us well for 2015 and beyond.

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

(Operator Instructions) Danyal Hussain, Morgan Stanley.

So I guess first, just on the sales rep count? I think you expect to end the year at 375 and I know you expected to lose maybe some sales reps over the quarter, but I guess maybe could you comment to what extent that count came in higher than expected this quarter? And then how that, I guess, flowed through towards your sales for the quarter? Thanks.

So, the target has always been to have 25% growth between January 1 and the end of June, so that reps could mature over the course of the second six months for the important Q1 season. We always hire a few extra, but the commitment has been to grow the sales force at 25%, and that continues today, that we will exit the year on December 31 north of the 25% growth. So the bottom line is there is some churn, particularly as you get towards the end of the year; people frankly who weren't making it in January may find work in other businesses.

The goal is 25% growth a year, exit the year with north of 375, exit next year with north of 470 and then I will commit it for one more year after that. But that's the mechanics behind it, but there is always some churn in the sales reps, particularly at the end of the year.

I want to make sure that on December 31 in my next report, the number is north of 375. So I'm giving myself a little room on the 391 for the year-end attrition.

Danyal, this is Bill. The other thing I would just add is there is very little impact on the current quarter of new sales reps. So that is really a leading indicator for 2015.

Understood. Thanks.

And then maybe could you just talk maybe at a high level about as you add some of these new products to your portfolio, like TriNet Hire, is the aim there eventually to increase pricing per worksite employee or is the goal to just improve customer satisfaction and retention over time?

That's a good question, Danyal. And exactly it's both.

So initially, it's for adding capabilities to our platform that gives our clients reasons to stay and better functionality. And then I think over time as we have mentioned, we think we'll be able to do some cross-selling into the installed base. But for now, it's really getting that functionality of the clients. And at some point in the future, we should be able to see some average price increase, but not in the short-term.

Got it. Thanks.

Maybe just a quick one on insurance costs. I know Q3 is seasonally high, but maybe to what extent it came in higher or lower than your expectations? Thanks.

Sure. We did see slightly higher claims activity than we were expecting in Q3. And, as we have described, it is our seasonally higher activity for claims. And what we saw, which we're paying close attention to, is just higher pharmacy costs. And some of this is from some of the new drug regimens that have been put out in the marketplace, particularly in the second quarter. So we're watching that. It is built into our forecast going forward. And ultimately, if it increases our trend, it will get covered by our premium increases.

Thank you.

Paul Ginocchio, Deutsche Bank.

Thanks. I don't know if this is for Bill or Burton.

But it does look like the guidance for revenue growth shows a pretty steep deceleration to the fourth quarter; around 13%, 14% from the 22% you just reported. Just wondering, what is driving that deceleration? What are some of the -- is it either revenue per worksite employee, or worksite employee growth, or something else? Thanks.

Sure, Paul. So I think the first thing I would highlight is that excluding a one-time charge, Q4 organic growth rate is really in line with what we have seen historically. Let me give you some more detail.

In the fourth quarter of 2013, we received a $2 million payroll tax refund. And as many of you know, we did receive a few of those, one in Q3, one in Q4, and actually one in Q1 of this year. So excluding that $2 million, our growth rate in Q4 of 2014 will be between 14.5% and 16% organically, which is in line with our 15% targeted growth rate.

For comparison, in Q4 of 2013, the year-over-year pro forma growth rate was 14%, so in line with what we have historically seen in our fourth quarter.

The other bit of color, Paul, is generally in Q4, clients who are prospects actually, have an option whether they want to start in Q4 or start in Q1. So we're generally a little bit more on the cautious side of projecting when they will start, assuming they have the flexibility to either move from Q4 or into Q1.

Right. If I go back and adjust for the $5 million in FICA tax in the third quarter of 2013 and then add $4.2 million for the adjustment to Worker's Comp from a year ago -- I think was the right number -- I still get 23% growth. Maybe we should just take this off line and talk through it.

Sure. And what I was referring to is the year-over-year growth for Q4. Surely there is always going to be, I think, some sequential seasonality going from Q3, down to Q4. And again, that is why I was mentioning clients sometimes will just not start in the fourth quarter, so that's why there is a difference between Q3 and Q4. And then just historically, this is about what our organic growth rate has been in the fourth quarter.

Okay. So it doesn't sound like there is any big change to revenue per worksite employee, maybe just a little conservatism around the 4Q start?

Sure. Again -- and when you look at pricing -- and pricing in the third quarter, again, you have to strip out that $5 million payroll tax refund you highlighted. Our pricing is pretty much within 0.5% of what it was a year ago, so pricing is very stable. And we expect the same when you strip out the Q4, $2 million that was in last year's Q4, that we probably will see also very stable pricing in Q4 of 2014.

Great. Thanks. And Burton, if I could ask you one, just -- there was a plan to do a little bit of acquisitions annually. I just wonder what you thought of the acquisition environment, and then the availability of smaller deals.

Great question, Paul. I'm going to turn that to Jimmy Franzone, who is in the room with me, and keenly focused on that every day. So, Jimmy?

So the focus is still on contributing to growth overall on an annual basis, and we have noted that it is in the area of, call it, 5% a year. It would be lumpy. We have actually been quite active looking at deals over the last month.

And frankly, there have been some expensive deals that we have seen out there. I think we're being picky and choosy both on the software side, as well as the HR bundled side. There are deals that are out there, and opportunities.

We are going to continue to be pursuing them. And we're going to be diligent about what we're paying for them, though. And so I think it is still going to be a key focus of what we're doing going forward.

Thank you.

Tim McHugh, William Blair & Company.

Just -- there is a competitor obviously, that I'm sure you have seen, that we also -- that had a pretty significant Worker's Comp charge and issue this quarter. Just wondering can you comment on -- I guess -- I'm sure a lot of people have been speculating on the risk of that to you, and I guess, to what extent is there risk, of any sort of similar issues? Or what type of checks do you have that make it unlikely that you would see some sort of similar issue here?

Yes, Tim, this is Bill. First, we do not expect any sizable increases in our reserves. We do have a very consistent fully-insured high deductible plan, which hasn't changed, and we carefully review that, and adjust the reserves every quarter.

So we play close attention to it, we have multiple sets of eyes look at it, and we make adjustments as we see them, which is ongoing. So net, I don't expect any significant increases to that in terms of reserves.

Okay. And then you talked about the cloud products. How much of the sales force growth is directed at that sort of product? Is that going to be an increasing focus in terms of your sales force additions?

And then maybe just -- any sense of how big that is in terms of the revenue today for you guys? My sense is it's pretty small, but I'm just trying to get a feel for the growth trend in that business.

So, a great question, Tim. The answer is zero.

My direct sales force is focused on growing net new clients for the TriNet bundled products. The cloud products are being sold through the web. The cloud products are being sold as part of new sales for our bundled product sale. But I am not going to get de-focused on our goal of acquiring net new logos in the SMB marketplace, where there is an addressable market of over 27 million WSEs, when I am sitting at less than 1 million.

Okay. Great. Thank you.

David Grossman, Stifel Financial.

Thank you. I'm wondering, Burton, if you could look at the sales force productivity, adjusting for the new hires, and just give us a sense of how that has trended throughout the year? And how it is comping perhaps, against where you were a year ago?

David, this is Bill. I'll take the first shot at that, and Burton can provide (multiple speakers). It has been very steady historically, and we do pay attention to our total productivity. What we are committed to is to be able to maintain our productivity, and we are actually seeing that, as we grow the sales force. Over time, we will look for ways to enhance that. But at this stage, we are very pleased to grow the sales force, and to maintain historical productivity.

So, just to add to that, David, I will just echo what Bill said. My goal is to maintain sales force productivity. A red flag would be to see a drop in sales force productivity.

I think that the amount of new reps obviously adds some drag on that, but that is being made up by the referral networks associated with the verticalization of the channel. It's also being made up by the amount of net new leads that are coming in the door, and frankly, the environment out there with the complexities around HR.

So, a couple of the things that I am looking at each and every day. One is whether we are competing head-to-head more against under-bundled solutions. The answer is a resounding no, even though over the last couple years, we have over doubled our sales force.

The second thing is the cost to acquire a new WSE. That has not gone up over the last three years.

And then finally, the ability to bring on these new reps and make them productive in their first year, and I will tell you more about that in January, but the bottom line is, I am pretty excited about where they are.

And I don't know -- sorry if I missed it -- if you talked about pricing, but how should we really think about pricing both on a -- think of it like an apples-to-apples basis, as well as, I think the question came up earlier in terms of increasing revenue per client, so that you are actually -- again the yield is going up per client, either because you're selling them more stuff, or because pricing is going up?

David, this is Bill. And what we are expecting is a stable pricing environment with maybe 1% increase a year, which is really inflationary. So that is how we are looking at it in the near term.

And as Burton mentioned, potentially in the future, we may be able to get some additional sell-in to those clients with our products, particularly the cloud products. But that is not something that is built in to anything at this stage.

Got it. And then maybe if I could just ask you two quick financial questions; I think you mentioned CapEx.

It looks like it spiked up this quarter if I got the numbers right, and if it did, maybe you could explain perhaps what happened during the quarter? What drove that? And I'm assuming the margin performance during the quarter was pretty much a seasonal thing?

Yes, for CapEx we actually had an opportunity to purchase some licenses that will take us out for a couple of years at a very attractive price. So that is what you are seeing in the additional higher CapEx, as a percentage of revenue in Q3. I still expect to be right around 4% of net revenue for the year for CapEx. So as these opportunities present themselves, if we see something that will allow us to get a lower fee as we grow the business, we will absolutely take advantage of it.

And in terms of the EBITDA margin, if that is your question, we do -- that is seasonally what we would normally expect in the quarter, EBITDA margins in the 32% range, 32.9% I think is -- for the nine months, is well within our track to get to that 33% to 34% range for the year, which we expect to get to. And as you know, Q4 is generally one of the higher-margin quarters for us, and that's because of the seasonal pick-up in insurance.

Sure. Okay. Very good. Thank you.

And at this time, I am showing no additional questions. I would like to turn the conference call back over for any closing remarks.

That does conclude today's conference call. You may now disconnect your telephone lines.