TriNet Group Inc (TNET) 2016 Q1 法說會逐字稿

Good afternoon, and welcome to the TriNet first quarter 2016 conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Alex Bauer, TriNet's Head of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon everyone, and welcome to TriNet's 2016 first quarter conference call.

Joining me today are Burton M. Goldfield, our President and Chief Executive Officer; 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 the call for the Q&A session.

Before I hand the call over to Burton, please note that today's discussion will include our Q2 and 2016 guidance and other forward-looking statements, such as predictions, expectations, estimates, strategy, or other information that may be considered forward-looking. These forward-looking statements are subject to risks, uncertainties, and assumptions that may cause actual results to differ materially from statements being made today.

We do not undertake to update any of these statements in light of new information or future events. We encourage you to review our most recent public filings with the SEC for a more detailed discussion of these risks and uncertainties that may affect our future results, or the market price of our stock.

In addition, our discussion today will include non-GAAP financial measures. For reconciliations of non-GAAP financial measures, please see the Company's earnings release available on our website or through the SEC website.

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

Thank you, Alex. TriNet had a solid start to the year. We delivered strong financial and operating results during the first quarter.

I am encouraged by the strength of our business and our ability to drive profitable growth. By executing our differentiated vertical strategy, we are well positioned to pursue the large market opportunity in front of us.

Looking at our results for the first quarter, we grew net service revenue 15% year-over-year to $163 million. Professional service revenue increased 16% year-over-year to $112 million. We grew net insurance service revenue 12% year-over-year to $51 million.

I am pleased to report that both our health and workers' compensation revenue came in on target for Q1. Our pro forma adjusted net income per share in Q1 came in at the top of our guidance, at $0.27 per share.

We invested significant time and resources during Q1 to complete the first audit of our internal controls, as required by Sarbanes-Oxley. Additional work will be done over the next year to improve our systems and processes. We finished the first quarter with 324,103 work site employees, up 12% year-over-year.

As we stand here today, TriNet is the innovator in our industry. TriNet is the only provider with multiple bundled products at varying price points with different service models. This is important today, because there are more than 55 million workers at small and mid-sized businesses, and they need different solutions. This large addressable market clearly needs innovation to gain meaningful market penetration.

Looking ahead, our primary focus is to make the business even better. We will further expand our presence in key verticals by accelerating the roll-out of new bundled products in 2016. Additionally, we will strengthen our insurance offerings, and drive operational effectiveness for the benefit of our shareholders.

I am more committed than ever to our vertical approach, which deepens relationships in our target industries, and allows us to be more responsive to the needs of clients in those markets.

Our early experience confirms that our clients value an offering that closely matches their specific needs. One of our initial vertical products delivered 16% more revenue per head in the first quarter than our legacy non-vertical products, reflective of the additional functionality vertical clients receive.

Turning to insurance services, our new leadership has taken up my charge to bring a fresh perspective and sharpen our approach to insurance offerings. Our goal is to match our insurance products with the value clients place on these important components in the different verticals and geographies. Our team is working to reflect the varying needs related to plan design, benefits constructs, Company contributions, participation rates, and ACA compliance in our product offerings.

Our industry is occasionally criticized for not providing a user-friendly client experience. We intend to change that at TriNet. Later this year, we will deliver an enhanced platform that will greatly improve both the client and individual work site employee experience from our online interface and our mobile app.

In Q1 we completed the Ambrose migration. Clients are now experiencing the benefits of our improved online and mobile technology offering. The consolidation of the TriNet platform will enable continued improvement in the client experience, as we concentrate our technology investment.

To enhance our sales force productivity, we've expanded our channel partner program, targeted our marketing efforts on key focus verticals, and improved our sales training program. We expect these efforts will result in higher quality leads going to better trained sales people. In turn, this will allow us to grow revenue without the commensurate expansion in quota-carrying sales reps. The TriNet sales force ended Q1 with 507 quota-carrying sales reps.

It remains the case that less than 25% of the commercial quotes issued by TriNet are against a direct competitor. This validates the size of the market and the opportunity for continued growth.

TriNet's singular focus on the needs of our clients and prospects allows us to provide more value to these specific verticals. We will strengthen our insurance offerings, and we will drive operational effectiveness to benefit our shareholders. With that, I'd like to hand the call over to Bill for our financial review.

Thanks, Burton. As we review the financials, I will focus on the non-GAAP numbers, and go into the GAAP numbers where appropriate.

During the first quarter, net service revenue increased 14.7% year-over-year to $163.3 million. Total WSE count was $324,103, up 12.2% year-over-year, or flat since the end of the fourth quarter. Professional service revenue for the first quarter increased 15.9% year-over-year to $112.4 million.

Net insurance service revenue for the first quarter increased 12.1% year-over-year to $50.8 million. Total adjusted EBITDA for the first quarter decreased 15.8% year-over-year to $42.2 million, compared to $50.1 million for the prior-year period, due to $7.4 million in additional stocks and audit expenses in 2015.

We had to invest significant additional costs and resources to complete our first audit of our internal controls, as required by Sarbanes-Oxley. We have turned to remediating our material weaknesses, and we will continue to focus on improving our processes and systems until remediation is complete.

Returning to our results, adjusted net income for the first quarter decreased 23% year-over-year to $19.5 million, or $0.27 per share, compared to $25.4 million, or $0.35 per share in the same quarter last year. Adjusted net income and earnings per share in the first quarter were negatively impacted by the higher-than-expected stocks -- 2015 stocks and audit expenses.

Our GAAP effective tax rate was 44.4% for the first quarter and our Q1 pro forma tax rate was 42.5%. Our ability to generate operating cash flow is supported by our strong margin profile and asset-light models. During the first quarter, we generated $40.9 million in operating cash flow and spent $6.8 million on CapEx, representing 4.2% of net service revenue during Q1.

We closed the first quarter with total debt of $494.5 million, representing a debt-to-EBITDA ratio of 3.4 times trailing 12 months EBITDA. Total cash was $195.9 million at the end of the first quarter, and working capital was $130.8 million.

Included in our professional service revenue for Q1 is approximately $7 million in seasonal items. These items will not be included in our Q2 run rate. In the first quarter of 2015, we had $3.3 million in seasonal items.

Turning to our outlook, and excluding these seasonal items, we expect our second-quarter net service revenue in the range of $145 million to $150 million, which represents growth of 19% to 23% year-over-year; adjusted EBITDA in the range of $36 million to $41 million, and adjusted net income in the range of $17 million to $19 million, or $0.23 million to $0.27 per share.

Based on our first-quarter performance and our outlook for the remainder of 2016, we are raising our net service revenue range to $615 million to $630 million, which represents growth of 12% to 15%, maintaining adjusted EBITDA in the range of $170 million to $180 million, reflecting a forecasted adjusted EBITDA margin of 28% to 29%, and maintaining adjusted net income in the range of $82 million to $87 million, or $1.12 to $1.19 per share.

Now I'll turn the call back over to Burton.

Thank you, Bill. In summary, we're off to a solid start in 2016. We are executing on our plan, and focused on rolling out our differentiated products to allow us to further penetrate the large available market.

This concludes our formal remarks, and now I would like to turn the call over to the operator for the Q&A session.

Thank you.

(Operator Instructions)

At this time we will pause momentarily to assemble our roster. Our first question will come from Tien-tsin Huang of JPMorgan.

Thank you.

Everything looks pretty clean here. I just wanted to ask on the WSE growth, it looks like that moderated a little bit. How did that come in versus plan? Any call-outs or change in retention, new sales additions, things like that?

Hi,Tien-tsin, how are you?

Good.

Good. We grew WSEs 12% year over year, and we grew the revenue as you know by 15%. It was slightly moderated early renewals from the brokers in December to remain on the non-ACA compliant plans -- seemed to have an impact on switching in January, so January is a little slower. February and March were back right on track. Change in existing, or same-store sales, was a little muted in Q1, I think reflective of the broader economic environment. Ultimately, my focus is to grow the net revenue in the key verticals year over year. As you heard from some of the early vertical results, not as much to focus on the WSE count.

Yes. You called out the -- go ahead.

I'm sorry, this is Bill. I'll add one thing. Attrition was marginally up in Q1 versus our historical experience. I think some of that can be attributed to just the increased pricing that we announced in the fourth quarter.

Okay. Moderately up, but nothing -- it sounds like nothing unusual. You did mention the 16% revenue per head productivity on the vertical product. I think you also talked about accelerating bundled products. In 2016, how quickly can this come to market, and we actually can see this in the top line?

Tien-tsin, I'm expecting at least two more products out before the end of the year, and part of it is contingent on getting my new platform out, which I talked a little bit about earlier.

Right.

There is a completely new front end to the product, which will allow me to much quicker customize the functionality on the front end. Obviously, common back end. As I talked about, now we had Ambrose on the TriNet platform. We already have the Passport on the TriNet platform, and we have the TriNet by Sciences product on the TriNet platform. We've been able to start refining our capabilities around changing the front end to meet the industry standards that we're going after.

Okay. One more, and then I'll jump off -- go ahead.

Two more -- two incremental products which have not been announced, I'll commit to this year.

Okay, got it. One more, and I'll jump off the phone. The sales rep additions were higher than we expected, up 24%, I think, last quarter. You said you were going to rein that in a little bit. Has that view changed?

No, I think last quarter it was at 481. I'm at 507. It's going to ebb and flow. It just depends opportunistically as we bulk out these verticals, I need a critical mass of reps to go after a vertical. We're looking at the verticals, Tien-tsin, on a national basis and there's a minimum amount of reps I'm going to place in each of the verticals in order to capture and measure the market penetration by national vertical. I will commit to you it will be more than 481 by the end of the year, but I'm not sure exactly how many more.

Understood. Thanks for the update.

Yes, thank you.

Tim McHugh, William Blair.

Hi. I wanted to ask first on -- can you elaborate on that retention comment, that it was up a little bit, in the response to the re-pricing? What anecdotally did you see, and can you be any more precise with the exact metrics? Thanks.

Yes Tim, this is Bill. We generally don't give a specific attrition number, but we've generally guided to be right around the 20% level on an annual basis. We've historically run a little better than 20%. This quarter we were right at the 20% level, so slightly worse than what we've seen historically, but I think we're fine.

Okay, thanks. Then just a few questions on the guidance. One, the reinsurance, is that still incorporated into the guidance, and is there any change in your thought on doing that?

Yes, were still continuing to look at that, Tim. It's not something that we're walking away from, but we're continuing to evaluate it. That's something that Ed and his team are looking at. We're still providing information for the markets, and we're still looking to see does that make sense for us. If we find the right product, we could implement it in any quarter, but at this stage we are still evaluating it.

Okay, thanks. Maybe one more. The insurance or net insurance revenue was nicely better than what I had. You made the comment that the revenue was in line with what thought. Can you talk about claims trends in those businesses? Were those lower than you expected, or consistent? How did they trend?

Sure. On the medical side, I think we saw in the components premiums pretty much came in line with what we were expecting. In terms of the claims, as you know we look at it and the three components: run rate, large, and pharmacy. Each of those were pretty close to what we were expecting. I think all in all, both on the premium and the claims side we were fairly close.

We did see -- and probably just a touch better on the comp side. I think that's just average wages up a bit. I think some of that's probably in line with the vertical approach where we're getting slightly higher revenue per WSE. All in all, I think all our targeting are coming in within our target range, a little bit extra on the average wage probably gave us slightly more maybe than what you were estimating.

Okay, thanks.

George Tong, Piper Jaffray.

Hi, thanks. Good afternoon. Your insurance costs as a percentage of insurance service revenue dropped about 140 basis points sequentially. Can you talk about the drivers of the improvement, and how sustainable these levels of insurance costs are?

Yes, George, I think it's still a little early to try to call too much out of one quarter, but I do think that we are seeing, really, the revenue starting to come into play in the installed base based on the pricing and that we rolled out in the fourth quarter. That will take a full year to fully work its way through the system, so you'll see, I think, really the revenue pretty much catching up.

I think the cost is something that we monitor. As I mentioned, we look at the three different components. Nothing stood out at us, either in large, run rate or pharmacy. I think at this stage they're pretty much tracking to the trends we've been expecting, but I think it's a little too early to call out anything as a major driver of change.

Got it. Can you elaborate a bit on your recent performance in terms of the severity and frequency of medical claims, and what trends you see that may cause either improvement or deterioration in those metrics?

Sure. We again haven't seen anything that's really dramatically different than what our trend estimates are, both on frequency and severity. Going to last year, we did see obviously a large increase in both frequency and severity of large claims, and we have not seen that again, so we're watching it carefully.

Other than that, as you know we've been following carefully pharmacy, but that's been tracking pretty much to what we're expecting. We're tracking that, of course, because there been a number of announced higher-priced drugs that have come into the market, but that seems to be in line with what we're expecting.

Got it. Then last for me, you've indicated this quarter you've increased prices in your insurance business. Can you talk about how your pricing strategy is -- will be playing out this year, and whether the pricing increases from this quarter are sustainable in the quarters ahead?

Sure. Based on our experience last year, we did see that our costs on the claims side went up a couple hundred basis points higher than where we traditionally were seeing, but we adjusted our pricing so that we could get back in line. That is going to take, as I mentioned, about a year to completely roll through our installed base.

That being said, what we were targeting pretty much was realized when we looked at the premium increase that we actually realized based on our experience in Q1 versus what we were targeting. That tells us that it is coming in and holding as we had thought. Now clearly it does have slight impact on attrition, just because there may be some who are getting a higher increase than what they would like, and that's really the way we try to price to risk.

I think all in all, we will have to watch trend, because we always -- of course, we want to be pricing the trend. But right now, I think trend looks like it's reasonable compared to our expectations. I think future pricing should also be in that -- what I consider to be a reasonable range based on trend.

George, just to add to that. This is Burton. I see a real opportunity. We've gone through the toughest period because of the early renewals in December by many companies with non-ACA-compliant plans for the last time. There's no opportunity to do that any more.

Additionally, in certain key states space in the 50 to 99 range, many of those clients must now go to small group, which has very limited banding, and even more limited choice. There's an opportunity for our fully ACA-compliant plans,105 of them in 50 states, and a chance for folks to avail themselves of that opportunity, particularly in the key states like New York and California.

Got it, thank you.

Danyal Hussein, Morgan Stanley.

Hi. You're raising top-line guidance, maintaining bottom line. Is that a function of the higher Sarbanes-Oxley costs? Could you call out the incremental costs in the quarter and the incremental costs throughout the year that weren't factored into your guidance last quarter?

Thanks.

Sure Daniel, this is Bill. The additional cost in the quarter was approximately $7 million. That was higher than what we were forecasting. It is a significant item, and that was not something that at that level that we expected when we looked at and gave our guidance for Q1, and for the year.

We do -- we have recalibrated. We'll be spending a lot of our focus on -- getting those controls improved throughout the year. We've built in those costs into our expense estimates for the remainder of 2016. I think we're well covered there. But we don't give out a specific number for what those incremental costs will be.

Got it. You gave the example of the verticalized product delivering16% more revenue per head. Is that what we can expect going forward for most of these new products, where it falls somewhere between Passport and Ambrose, or are you also going to launch products somewhere between Passport and SOI, where you might have lower revenue per head as well, with the offset being higher growth in work-spend employees?

Great question. Over time, as I've talked about in the past, there will be somewhere between eight and 14 products. We're starting with some of the derivative passport products first. But they'll clearly be products that are at a lower price to address the right price point and service model for other industries. You may see one of those as a third product in this fiscal year.

You're exactly right, in the end it's about getting the fit product for use at the right price point, and some of those products will be higher, some will be lower. But it should be at the advantage of higher retention, as well as an easier sale.

Got it, and then --

I'm sorry. This is Bill.

I'll just add a little color. I think as a trend, I would expect revenue for WSE to generally move up slightly, and volume probably to come down slightly. I think that's just the pattern that I would expect as we continue to verticalize and really target our key markets.

Okay, and then one last quick question. The seasonal items for the quarter, you called out $7 million this quarter and I think three in 2015. Is there a normal number we would expect? Is the 2015 number more of a normalized number we should project going forward?

Yes. I don't know what that would be, but it's probably somewhere in that range -- probably a little bit higher in Q1 of this year than what we were expecting, and a lot of those are tax-related. But it's probably somewhere in that 4% to 7% range, would be the right place I'm assuming it is going forward. It's always hard to predict some of those rates.

Understood, thank you.

Thank you.

Ato Garrett, Deutsche Bank.

Hi, good afternoon. Looking back at last quarter, I know you made some comments specifically about your financial services vertical. I'm wondering if you can give us any more details on specific verticals' performances in the quarter?

Yes, this is Bill. I don't think at this stage we're quite at the ability to call those out, although -- and that would be something if we get down in the future, we should be able to provide more color, still a little early to be able to provide that level of detail.

We did see coming into January just on the back-drop we thought it was a little weaker in both financial services and technology. But I think throughout the quarter, I don't think that's a trend that we saw really taking hold. I think it was a little bit of early caution.

Okay, great. Then following up on some of the -- again, a little more detail on some of the changes that have come in since the hiring of your Chief Risk Officer and re-pricing of insurance. Is that really -- have those been the primary changes to your go-to-market strategy as you address the health care side of the offering, or has it been anything else there?

Having the Chief Risk Officer looking at the fitness of the product to use in a particular vertical, he is reviewing all constructs associated with the insurance product. The question is, how much does ACA impact a particular vertical?

Almost none at all in financial services. They were already giving high-end medical plans, very significant in the hospitality industry. The question is, what are the right set of products, what is the right amount of plans to be offering to any particular client? There can be too many, too few, and how do we get the right concentration?

I think the big difference since we've hired the new team, the two actuaries and the Senior Vice President, is to look at each of these verticals and see where the real opportunity is to enhance the offering to a particular vertical. It's not about a general offering any more. It's about what vertical resonates with each part of the plan. I think that as we -- these products become more and more different from each other, the medical plans associated with these products will become more and more different from each other.

Great, thank you.

Jason Kupferberg, Jefferies.

Hi, Jason.

Thanks, guys. Hi, how you doing?

Good.

Good. Nice quarter results. Stepping back, a big-picture question. I wanted to just test the overall confidence level that you have, as far as the ability to forecast the business, especially the medical and the workers' comp claims. It seems like that has improved, but just wanted to take your temperature on that, and get a sense of how sustainable you feel that improvement is? Obviously you've got Ed and his team in place. That seems to be making a difference. Are you pretty comfortable that we're out of the woods, so to speak?

Yes, Jason, this is Bill. I think we're trying to operationalize a number of the things that we looked at as we looked at our experience in 2015 to improve the information we received, and to improve the ability to forecast using all that information.

With that, it is an area that has some volatility to it, particularly on the claims side; but I think we're focusing on operational improvements throughout that information change to help us better forecast that business. We think we've tried to build that in, in addition to getting better data faster, and just do a better job in terms of how we construct the forecast, and maybe a little bit more in terms of our ability to absorb any bumps that we can't see coming down the line. We try to do all that.

That being said, you never can be completely sure on how that component will come in, just because you can't have higher frequency of a number of items that we'll bounce around. That being said, I think we're comfortable with our forecast. We think we've built in some prudent cushions to be able to cover that kind of volatility. But you never know what can happen down the line.

Okay, that's fair. Maybe a related question. On the full-year guidance, you beat the Q1 revenue guide I think by about $13 million-ish at the mid-point, if I'm not mistaken. I know the full-year guidance is going up $5 million. Are we just expressing some of that apparent conservatism that you think is prudent at this relatively early stage of the year, or has anything fundamentally changed in terms of your outlook for the remainder of the year from a revenue standpoint?

That's a good question. No, I think we got off to a good start in Q1, but it's still early. I do think we want to maintain some level of conservatism, just because we could see, based on last year that you can have some volatility. I think we need to get a little further into the year before we can -- let's just say let things move through.

Okay. No, that's good color. Last question for me. I don't think I heard any comments about the Teleborder acquisition. I know that was announced last (inaudible, audio difficulty) if I'm not mistaken. Anything you can tell us there, just in terms of sizing the business and the strategic fit?

We're excited about the team that came on board and the technology we were able to acquire, but we're not ready to release a product yet and talk about that. There's some fantastic capabilities that they bring to the table that will be incorporated into frankly multiple products. Stand by, and we will continue to look aggressively at other M&A type activities. We're feeling a little better about it. A couple more back to the question that Bill answered for you, I'll feel real comfortable when we nail four in a row. I got one, now I'm waiting for the next quarter, Q2. From an acquisition standpoint, I'm excited about the quarter, and we'll look at how these products get released into the market over the next few quarters.

Okay, makes sense. Thanks.

Thank you.

David Grossman, Stifel.

Thanks. I was hoping to -- I had to hop off for a minute, so if this has been answered we can take this off line. But just going back to the quarter, it looks like you guided at the high end $41 million in EBITDA. You did $42 million. I don't know, Bill, if I understood you correctly, but did you say that the $7 million of audit expenses were over and above what you had modeled in or guided to for the first quarter? If I did get that right, what was the offset that allowed you to come in above the high end of the range on EBITDA?

No, David, you're correct. We weren't expecting that level of cost in Q1. I think it was the combination of doing a little better on the top line, and primarily through slightly higher revenue for WSE, and some ability to maintain a little bit of other expense controls. But effectively, we were able to beat a little bit more on the top line, and to maintain expenses to offset those additional costs, which were much higher than we had expected them to be.

Right, so if a component of that is the pricing dynamic, should we think about, all else being equal, of course, that the net insurance revenue as a percentage of growth should continue to improve over the next two quarters, until your anniversary that increase some time in the fourth quarter?

I think it's a little early to call out a trend on the net insurance revenue, particularly given Q2 and Q3, are generally the quarters where we see higher seasonal claims activity. I think we need to see the year develop, David, before we can really go back to see what's happening on the claims side. That being said, we are -- we think we're getting the hold on the revenue, so we should see some improvement on the revenue per insurance of WSE.

Right. Okay, fair enough on that.

Then just finally, maybe Burton can you talk just a minute about the different -- if there's any difference in trend among the three offerings? In particular, maybe you could update us on what's going on with SOI now that you've had several months behind you in terms of the change in the sales strategy?

I don't honestly David look at it as three offerings any more. I have a technology offering, a life sciences offering, a not-for-profit offering. I'm focused on professional services, the financial services, which is the Ambrose offering, and the SOI. I don't consider SOI a market. I consider property management a market. I consider retail, I consider manufacturing, I consider hospitality.

We will laser focus and slice these verticals up, and find out where we get the retention, where we can get profitable growth in revenue, and where we have an opportunity to tailor the product to be fundamentally different in either the legacy SOI product, or frankly any of the other products that are out there in the market.

In general, if you ask me about SOI, it did very well in Q1, which is a legacy up-tick, because last year was a challenging year, so it snapped back nicely. I think that obviously as look at the total addressable market, I stare at the TAM data every day. I stare at the attrition, the change in existing or same-store sales, as well as new sales. Within those markets, there's trends emerging that give me a lot of excitement about our ability to target on a national basis very specific verticals within that overall -- let's just say SOI market.

SOI from a quote product by the end of the year, I expect that all new clients will be going on to the TriNet platform, and those TriNet products will be called property management or financial services. My feeling is that there's a big opportunity here to really focus on a segment, and either succeed in it or decide that we're going to exit that vertical.

Okay, very good. Thanks very much.

This concludes our question-and-answer session. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.