TriNet Group Inc (TNET) 2015 Q1 法說會逐字稿

Good day, and welcome to the TriNet Group first-quarter 2015 earnings conference call.

(Operator instructions)

I would now like to turn the conference over to Alex Bauer, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon everyone, and welcome to TriNet's 2015 first-quarter conference call. Joining me today are Burton M. Goldfield, our President and CEO; and Bill Porter, our Chief Financial Officer. Burton will begin with an overview of our first-quarter operating and financial performance. Bill will then review our financial results in more detail. 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 discussion may include non-GAAP financial measures. For a more detailed 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. TriNet's strategic goal was to become the de facto partner for small- and medium-size businesses in our target verticals. This goal is being aided by the continued complexity that SMBs face today. TriNet is uniquely positioned because we're the only company with a vertical strategy that leverages our bundled solutions to solve industry and client specific needs.

Our financial performance in the first quarter reflects the strength of our product and service offering, and the successful execution of our business strategy. For the first quarter, our net service revenues increased 11% year-over-year to $142.4 million. Total WSE count 288,817 was up 19.4% year-over-year, but essentially flat since the end of the fourth quarter. Professional service revenues increased 17% to $97 million. Adjusted EBITDA increased 13% year-over-year to $50.1 million.

TriNet's mission remains simple, to enable SMBs to focus on execution and growing their businesses, while we focus on their critical HR needs. Our bundled solution is comprised of local HR expertise, Fortune 500 benefits, and a cloud-based technology platform. An example of the value we delivered through our Fortune 500 benefits is our 401(k) multiple employer plan. TriNet offers 401(k) administration as part of our bundled solution with the goal of reducing costs, maintaining compliance, and reducing liability for our clients. Notably, assets under management exceeded $1 billion for the first time in Q1, nearly tripling since 2013.

We're executing our differentiated vertical strategy, and I was pleased to announce the formal launch of our TriNet L Life Sciences product in Q1. You have heard me speak about the verticalized sales force and the particular successes we were seeing in our life sciences vertical. We believe a bundled solution tailored to the life sciences vertical, including customized reporting for compliance, tailored worker's comp and risk management, and human capital consultants who are experts in the HR needs of the life-sciences companies will accelerate their success.

TriNet had good sales success across our product portfolio. Passport, an intuitive, paperless self-service platform with an extensive selection of benefits, saw significant wins across our technology, life sciences, and not-for-profit verticals. Clients cite Passport's complete offering, defined by its technology, service model and benefits, as a key reason why they chose Passport.

Our nonprofit vertical continues to see strong growth. Nonprofits are attracted to Passport because of our extensive benefits packages and our tailored technology offering. The nonprofit WSE demographic is very similar to our other professional services verticals, making our offering particularly attractive. Nonprofit administrators are attracted to Passport because we enable them to offer compelling benefits while also mitigating liability, an important deciding factor for many not-for-profit boards of directors. In Q1 we saw notable wins with several nonprofits, including organizations focused on employment training for disadvantaged workers, fighting hunger globally, and residential real estate rehabilitation. These nonprofits, each with WSEs in excess of 50, cited our benefits and liability management as the key deciding factors.

The Passport professional services vertical is seeing similar successes with the proliferation of technology-enabled business services companies. During the quarter, a 60-WSE tech enabled service company joined TriNet. They cited Passport's intuitive self-service tech platform and ACA-compliant offerings as their reason for choosing TriNet Passport. Tech-enabled services companies combine the HR needs of technology startups with the HR needs of traditional call center and service center operations. As such, Passport's ability to address these disparate HR needs represents an attractive solution.

Our Ambrose product, which is characterized by a high-touch service model with top-tier benefits and direct access to compliance, tax and other specialists also generated strong sales during the first quarter. Within its targeted verticals, including hedge funds, private equity and legal firms TriNet Ambrose is a leading solution. A key win in Q1 was a fund administrator group. This group is part of a larger global organization focused on expanding in the United States. TriNet Ambrose offered a compelling solution, as the CEO wanted his employees to have the same benefits as their hedge fund clients. As the client grows in the US business in a very competitive market, the bundled solution model provided by TriNet Ambrose can be an attractive solution for prospective employees joining this fund administrator group.

TriNet SOI, which is characterized by complex multistate HR and payroll needs, saw wins across its verticals as well. Our vertical focus, ability to mitigate multistate compliance and operating risks, and an ACA-compliant offerings are all driving client wins. In the first quarter, 130-WSE facility services businesses joined TriNet, exemplifying the power of our SOI offering. For the facility service business, TriNet SOI is proving to be transformative. For over 30 years, the business managed payroll in-house, and time and attendance by hand. TriNet automated these processes while also providing ACA compliance, improving worker's comp and delivering better healthcare benefits. By putting their trust in TriNet this business changed their established processes, freeing management to focus on growth.

I'm happy to report that we are on track to grow our front-line quota-carrying sales reps to 470 by June 30 of this year. We finished the first quarter at 408 reps. We remain confident in our value proposition to prospective and current clients. And we remain committed to seizing the SMB market opportunity.

And with that, I would like to turn the call over to Bill for the financial review. Bill?

Thanks, Burton. Our first-quarter net service revenues grew 11% to $142.4 million. If we exclude the $2.3 million payroll tax refund we received in the first quarter of 2014, net service revenues would have shown an increase of 13%.

Total WSE count was 288,817 up 19.4% year-over-year but flat since the end of the fourth quarter. Our WSE count was flat as a result of higher than anticipated attrition, primarily due to a number of our larger clients being acquired during the quarter, as well as a lower contribution from our SOI verticals. Professional services revenue increased 17% to $97 million. Again, if we exclude the $2.3 million payroll tax refund we received in the first quarter of 2014, professional services revenues would have shown an increase of 20%.

Net insurance service revenues increased 1% to $45.4 million during the first quarter. Net insurance service revenues were affected by higher than expected workers compensation costs in our blue- and gray-collar book for older years. The actuarial report we received in April resulted in $4 million in additional Q1 claimed costs above our forecast. We've also increased our forecast of future claims cost for the remainder of 2015 by an additional $6 million, bringing the total claims increase to $10 million for the year above our forecast. Medical premiums, run rate medical claims, pharmacy claims and large medical claims came in as expected during the quarter.

Total adjusted EBITDA for the first quarter increased 13% to $50.1 million compared to $44.3 million for the prior-year period. Our Q1 adjusted EBITDA margin was 35.2%. Adjusted net income for the first quarter increased 44% to $25.4 million, or $0.35 per share, compared to $17.6 million, or $0.24 per share in the prior year. Our GAAP effective tax rate was 40% for the first quarter. We expect our long-term effective tax rate to increase by 1% from 39.5% to 40.5%, reflecting a recently enacted increase in New York City's tax rate.

During the first quarter we generated $9 million in free cash flow, which is defined as operating cash flow less CapEx. Free cash flow was $16 million below the prior-year quarter, due to an increase in workers compensation collateral. Historically, we have spent approximately 3% to 4% of our net services revenue on an annual basis on capital expenditures. During Q1, our CapEx spending totaled $4.6 million. We used $25 million of our cash to retire debt during the first quarter. We closed the quarter with total debt of $515 million, representing a debt-to-EBITDA ratio of 3 times trailing 12-months EBITDA.

We spent an additional $25 million in the quarter to repurchase stock. Total cash was $104.4 million at the end of the first quarter and working capital was $15.2 million. Included in our professional services revenues for Q1 is $3.3 million in seasonal items. Those items will not be included in our Q2 run rate. In the first quarter of 2014 we had $2.8 million in seasonal items.

Turning to our outlook. Excluding these seasonal items, we expect Q2 net service revenues in the range of $135 million to $140 million, which represents growth of 10%. Adjusted EBITDA in the range of $37 million to $42 million. And adjusted net income in the range of $18 million to $21 million, or $0.24 to $0.28 per share. Based on the impact of the higher worker's comp costs, we are reducing our annual outlook by $10 million. And we now expect net services revenues in the range of $580 million to $590 million for 2015, which represent organic growth of 14% to 16%. We expect adjusted EBITDA in the range of $188 million to $198 million for the same period, in line with our target EBITDA margin range of 33% to 34%. And adjusted net income in the range of $94 million to $100 million, or $1.27 to $1.35 per share.

And now I will turn it back over to Burton.

Thanks, Bill.

We're executing our strategic plan as we focus on effectively addressing the many complexities SMBs face today. We're successfully addressing the large unpenetrated market with three distinct bundled solutions targeted to specific industries and supported by a highly professional and knowledgeable sales force with deep vertical expertise. We're focused on delivering our financial model of 15% top-line organic growth in 2015, with 33% to 34% EBITDA margins, while growing our sales force by 25% year-over-year, positioning TriNet for growth in 2016 and beyond.

This concludes our formal remarks. And now I'd like to turn it back to the operator for the Q&A session.

(Operator instructions)

Smitti Srethapramote, Morgan Stanley.

Hi, Burt and Bill and Alex. This is Daniel calling in for Smitti.

Just wanted to dig a little deeper into the claims costs. It sounds like this is not any sort of spillover from the higher medical costs that you saw in Q4. So could you just, I guess, confirm that?

And then talk about what drove the higher worker's comp costs, to the extent that you can provide more detail? And then is this something that you can adjust pricing for going forward? And how soon do you think you could do that? Thanks.

Thanks Daniel.

Yes, to your first question, medical came in pretty much as we had expected. So there was no spillover into Q1 as I mentioned on the last call. And we did change our forecast methodology so we have separated out our claims between run rate claims, pharmacy and large medical claims.

And each of those claims items on the medical side came in pretty much as we had expected. So early on, but the forecast accuracy was good for the first quarter. And medical premiums came in within our estimated range as well.

So to your question on workers comp, we have seen growth in our blue and gray book, particularly in higher cost states. So one of the things that we instituted for Q1 was just a more detailed analysis as part of our actuarial review that we received in April.

The result of that was that we had an increase in our blue and gray book of approximately $4 million. That was higher than our Q1 forecast.

Looking at that going forward, we would expect that that will spillover into Q2 and Q3 and Q4. And so we have increased our claims forecast for worker's comp for the next three quarters by approximately $6 million to cover the higher cost of those claims. But we do expect that that should cover the issue in the blue and gray book as we have identified it in Q1.

Okay. And is that something that you can adjust pricing for going forward?

I think it's something that we will continue to look at. Of course, we think if our costs are going up, we should increase our pricing to cover it. That is our normal policy for risk. So we will look at that.

We just want to make sure we're tuning it exactly where it needs to be tuned by state and by class code based on the experience we're getting. So we're still analyzing that. But in theory -- in fact, (technical difficulty) we will go down that road.

Okay.

And then historically you had given a typical variance, I think, of $2 million to $3 million and you revised that last quarter. Is there a later, more recent update that you could give us in terms of what you would expect typical volatility to see quarter to quarter on claims costs? Or does this worker comp not really have any impact on that volatility?

I think more volatility comes out of the medical side because of the large claims. And again, I think that the estimate that we have made for the rest of the year should cover the increased costs that we're seeing for some of these blue-gray costs for worker's comp.

Got it.

Than maybe just a question on the SOI growth. I think you mentioned that there was a contribution. Is that just lower growth or a lower organic growth? Maybe you could provide some more color there? Thanks.

Daniel, this is Burton. I'll take that. Thanks very much for the questions.

Yes, the new sales on the SOI side was not as strong as I would have liked. The good news about having the multiple verticals and the multiple products is that the productivity on the Passport side was actually up. So that's why for the rest of the year we're not changing the professional services fee outlook, and the forecast supports the 2015 outlook.

Some of it has to do with the continuing refinement of the channel that is selling the SOI verticals. So we're continuing to verticalize that further and redefine territories. And frankly, we had a similar experience in Passport a couple of years ago, as we continue to slice the territories down to the verticals where we believe we can you the long-term retention and the clients be wildly successful.

So that is sort of what we lost on one side, we kind of made up on the other side. It is not, I want to make it clear, it is not an issue of the size of the market or the competitive landscape. I absolutely love the verticals that the SOI team is selling into.

Another point I'll give you on that, Daniel, is that where we have come through the other side of that, there are a few regions that are completely done. The productivity is excellent. The new client acquisition is excellent. And the retention is good as well.

So, it is a work in progress. I think we're going to see strong on the Passport side. And I think that SOI will come back in the near future.

Great. Thank you.

Paul Ginocchio, Deutsche Bank.

Hey, Burton, just with the medical claims and now the worker's comp kind of forecast issues, or popping up. If you think about the growth rate recently, do you think that you can continue to sustain this sales force growth? Or do you think you want to reevaluate the growth in lieu of the recent volatility?

A great question, Paul, and I certainly would have liked less volatility. But from my standpoint, the large addressable market, the acceptance of the product, and the direction we're going I want to hold the growth where we are right now.

This is now our fifth quarter as a public company. I'm learning each and every day. I just get more excited about the opportunity right now to capture market share.

But I think that we need to continue to get better at the forecasting. I will say -- Bill didn't say it directly. We made progress with our carriers. I have been personally involved with that.

So on the medical side, it was as we forecast. The workers comp, with the April report, there was some changes. But we are growing a big book. We're certainly growing pretty quickly.

But right now, Paul, I'm holding to the 15% growth. I'm holding to the 33%, 34% EBITDA margins. And I will continue to verticalize with new products, just like the announcement on the TriNet Life Sciences product, because I believe it's a real differentiator.

Our clients are asking us to get deeper with them in these verticals. And I just think the opportunity is now.

So it's a fair question. And so far my team hasn't cried uncle. So I moving ahead.

And just a follow-up on that. I know the worker's comp report came out in April. And the SOI growth was a little softer in the first quarter than you expected.

Does the worker's comp report change your view on the growth rate of SOI going forward? Are you going to do anything to limit its growth?

I'm expecting that we're going to do a better job of forecasting. As Bill said, the change had everything to do with the older years claims, frankly, and not related to the new business. So it's a great question.

But I believe, particularly where we have been through the knothole we're getting great clients. We're helping them their with their safety issues. We're getting them worker's comp. I think what it really means is a tighter look at the older years and making sure that we're ticked and tied as they come through the system.

Yes, Paul. This is Bill. I guess I would just add to that. We're really continuing to refine our process by taking it another level down.

We're seeing where we are growing in some higher cost areas. And we needed to refine our actuarial reporting so that we are focusing on those higher cost areas.

And to the earlier question, there is an opportunity for us to continue to align pricing with those costs. So we will do that.

But this does not limit our growth. This just is pointing out for us what we need to do a little better job on as we scale.

Great. So if SOI starts to slow down and you price a little bit for maybe those higher worker's comp areas, should we finally start to see some growth in service fees per work site employee area and net insurance fee?

You have to separate the two. I think professional service fees are going to be continuing to have historically stable pricing. And we're looking at some ways that we can continue to do a little better job of getting that up year over year. So we're watching that.

And then for the insurance side, given this large discussion we had last quarter, we're trying to make sure that we're holding the line on any potential upside until we get to the fourth quarter. So that if we see anything that is positive, we're going to try to hold the forecast and not let it come through.

If we see anything that is showing us higher costs like we did see on the comp side, we're going to -- and obviously raise the claims forecast so that we cover on the more conservative side.

Great, thank you.

Tim McHugh, William Blair.

Hi. It's is Stephen Sheldon in for Tim. Thanks for taking my questions.

On the flat sequentially work site employee count, you talked about an impact from higher expected attrition due to some acquisitions in the client base. Can you frame how big of an impact that had?

Want to start?

Yes, Stephen. It is pretty significant in that it is probably about half the normal growth rate the we would have normally have seen in terms of the acquisition activity.

Okay. That's helpful.

And then adjusted EBITDA margin in the quarter came in above the high end of your guidance and above the longer-term target, you said about 33% to 34%. Just curious what drove the higher margins relative to your expectations? Is it related to a shift in hiring from 1Q to 2Q, or just any color there?

Sure, Stephen.

Generally those EBITDA ranges are annual ranges. So I'd just highlight that in Q1 we normally see a little bit of a higher EBITDA margin. So that by itself is not driving a dramatic change. But we did manage the expenses fairly well. We planned for some additional service growth that did not come through in terms of headcount in Q1.

So we were a little bit under our headcount growth. So I think that helped allow a little bit more flexibility on the spend side to offset some of the increases we saw on the comp side.

Okay.

And then lastly, there's been some improvement from a competitor at the upper end of the market. Just curious, have you seen any notable impact from their improved performance for the last few quarters, especially for the Ambrose product?

No, we really have not seen. I mean, our model and our history has generally been three out of four of our prospects are greenfield. That has not changed. And in particular we really have not seen any competitive change, at least within the industry from others, other than what we have normally done in that 25%.

And to put a fine point on it, there's really, from a new client acquisition in Q1, we are not seeing a change in the competitive landscape, which frankly goes more to the thesis around the 55 million people in these small, medium businesses that go to work every day in companies between 1 and 500.

If you look at our year-over-year growth rate of 19.4%, we added over 50,000 work site employees during the past year. And there has been no change as far as the competitive landscape goes, as I monitor the quotes that are being done, who else is quoting on the deal.

So, I think there is some great companies out there addressing this market. I also believe that the size of the market creates tremendous opportunity for everybody who's able to add value to these small and medium businesses.

Great. Thank you.

Tien-tsin Huang, JPMorgan

Great, thanks.

Just I caught the commentary on that M&A amongst your client base. But how was just general macro trends, same-store growth and the employee count? Anything unusual you saw in the first quarter?

No, we didn't. We continue to see, I think, good growth, Tien-tsin, in our install base.

A lot of our clients are those that are trying to grow their businesses. And so I think we generally [seeing] pretty consistent growth there.

Yes, Tien-tsin, I would add that as far as change in existing, it is similar to prior quarters. On the M&A side, it was a small bunch of accounts. Obviously, they are larger accounts. They're less revenue per employee on those larger accounts.

So that's why you are not seeing a change, although the WSE count is a little bit off. You understand there is not a direct correlation between WSE count and service revenue. So some of the larger accounts, a large ceramic company, there's a whole bunch that were quite large that were acquired or bought in the last quarter.

Got it. Just switching gears on the sales front, booking front in the selling season. Can you just generally talk about sales productivity, and the quarter came in across the sales force?

I caught the consistent competition side, but just curious how the productivity came in versus plan?

As I said in the opening comments, productivity on the Passport side was up. Productivity on the SOI product was down. And I believe Ambrose was about similar.

Okay. So Ambrose was similar.

And then lastly. Just for Q2 on the claims side. So what is the going assumption here, just to be clear, on a sequential basis or year on year, however you want to frame it here, Bill? Anything to call out?

No. I think the thing, Tien-tsin, that I would say is that as we increased our forecast, I think you're probably can see that going to come in Q2, Q3 for the most part in terms of the higher cost, a little bit in Q4 as well.

I think that gets spread out over the next three quarters as sales continue. That's really the only difference.

And then we will see sequentially a pick-up in insurance, net insurance revenues in the fourth quarter, obviously, because the easier compare to last year where we had the, obviously, the large claims impact us. And we would see the normal seasonal pick-up from just higher workers comp revenue from bonuses.

So you're going to see a little bit of a ramp in the fourth quarter. And again, we're going to be holding our forecast, even if we see favorability on the benefit side until we're absolutely sure there's no late claims coming in for medical until the fourth quarter and everything is done.

Okay. Thanks for the update.

David Grossman, Stifel Financial.

Thank you.

I'm on the road, so, if this was mentioned, I missed it. We could take this offline. But I thought you said that your guidance for the second quarter is up about 10% year over year in revenue. And I'm wondering if you could help reconcile the difference, if in fact I heard that right? The difference between the 10% and what you ordinarily are targeting in that 15%-plus range, including whatever impact that workers comp accrual may have on the second quarter.

Sure, David.

So for the net professional services revenue, I think the way you should look at that is that is going to continue to track at the target range. We're not adjusting that at all based on our experience in Q1 with the higher workers cost comp claims. So you'll continue to see that at our target range.

What you are seeing us do is adjust the net insurance revenues for the recent experience. And that is what is primarily causing the reduction in the growth rate compared to what we had talked about when we gave our outlook in Q4. So that's really the driver of the difference.

And as I mentioned, you'll see continued conservatism on the insurance side based on our experience last year to make sure that we actually have that delivered before we show any upside, which probably means Q4.

But the amount of the adjustment in the second quarter theoretically would be below what you saw on the first quarter. So I'm just wondering, is there anything else there that is pressing the insurance revenues in the second quarter beyond that worker's comp accrual?

No. We did -- and I did mention that we have historically seen, and we're building in the seasonal reduction on professional services, which is something that probably has not been updated in people's models. We had it last year. We expect it again this year. So that is built in.

But other than that, that is the only impact to Q2. So the seasonal drop on professional services fees. And then the change or the increase in the workers comp costs.

And then just one more thing on the workers comp. You talked about older claims. Does that imply that the issue that arose was in businesses that you would acquire that perhaps the accrual and the methods for the accrual were different than perhaps what you are using today?

Is that reading too much into it?

No. I think your intuition is correct. It is the blue and gray collar book, which we have not had for obviously as many years as we have had the Passport book.

So the more experience we have, the more we see the reports, the better we understand what is happening. And the need for us to actually do a slightly different, more detailed analysis state by state for that book just tells us that we needed to do a little bit more analysis than we had previously seen. So it is something I think we have got the right analysis now, which we've tried to incorporate into our forecast for 2015.

I see. And then one last thing, it's just on the cash flow. Was there -- I know you mentioned something in there about the cash flow that may have impacted the quarter because it looks like you were down, if I saw it right, year over year.

So what was it that was unusual that impacted the quarter, and does it all impact your outlook for the year?

Sure. What we did mention is that we had an increase and we are forecasting that we will have a higher workers comp collateral. And so we have built that into our Q1 numbers. So it was an increase of $23 million we're expecting for workers comp collateral for this blue-gray book.

Part of that is there is a legacy collateral formula, which is a little higher than our normal rate. So there's a little bit of a leverage to that. So that is the difference between Q1 of 2014 and Q1 of 2015.

Building that in, we were still expect to have a good cash flow from ops for the year. It's going to be down a bit from my previous expectations, but it still will be a good strong outlook for 2015 compared to 2014.

Got it. Okay. That's it for me. Thank you.

Thank you, David.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.