TriNet Group Inc (TNET) 2016 Q3 法說會逐字稿

Good day and welcome to TriNet's third-quarter 2016 earnings conference call. All participants will be in listen-only mode.

(Operator instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator instructions)

Please note this event is being recorded. 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 2016 third-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 third-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 today's discussion will include our Q4 guidance, and other forward-looking statements, such as predictions, expectations, estimates, strategy or other information that might 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, including our forward outlook for non-GAAP net service revenues, adjusted EBITDA and adjusted net income. For reconciliations of our non-GAAP financial measures to our GAAP financial results, please see the Company's earnings release available on our website or through the SEC website. A reconciliation of our non-GAAP forward outlook to the most directly comparable GAAP measures is not included because material items that affect these measures such as the timing and amount of insurance service revenue and insurance costs in the case of net service revenues, and the income tax impact and number of shares granted in market price needed to quantify stock-based compensation expense, in the case of adjusted EBITDA and adjusted net income, are not ascertainable at this time without unreasonable effort and/or cannot be reasonably predicted. With that I will turn the call over to Burton for his opening remarks.

Thank you, Alex. I am very pleased with our execution in Q3. My team delivered strong financial performance, successfully completed the repricing of medical insurance for our entire install base, launched TriNet Technology, our third vertical product, and completed the consolidation of one of our two remaining legacy platforms through the migration of our Accord clients to the TriNet platform.

Let me first turn to our financial performance. During the third quarter we grew net service revenues 21% year over year to $161 million. Professional services revenues increased 11% year over year to $110 million. Net insurance revenues increased 48% year over year to $51 million.

As I noted earlier, during the third quarter we completed the repricing of medical insurance for our installed base. Medical insurance pricing for our installed base now fully reflects our experience in 2015, putting us in a strong position to move forward with continued, profitable growth. I am pleased with the progress that the insurance team, including the new actuarial team, has made to improve our pricing processes and discipline. It required a number of process improvements and difficult choices throughout the year.

The Q3 results are the most recent indication of the improvement in the insurance business. I am feeling good about the overall quality of the insurance products. They provide us a strong base to profitably grow the overall business. As we lap our medical insurance repricing in 2017, I look forward to sustainable, long-term growth.

Our Q3 adjusted net income per share exceeded the top end of our guidance by $0.02, at $0.29 per share. We finished the quarter with 333,778 work-site employees, up 6% year over year and up 3% since the end of the second quarter.

As we told you on our Q2 earnings call, we took the next step in the verticalization of our direct channel by appointing national, vertical Vice Presidents in Q3. These individuals are accountable for the entire sales performance of their assigned national industry vertical and report directly to the Senior Vice President of Sales. Our national vertical Vice Presidents' responsibilities include aligning their teams to best meet the growth opportunity while executing on our vertical market vision.

As part of this initiative, these leaders have consciously slowed down hiring while they assessed, recalibrated and realigned their sales teams. As a result we ended the third quarter with 406 quota-carrying sales reps. Going forward we expect to grow the sales force strategically within the assigned verticals. The expected ramp in hiring allows us to target approximately 420 to 450 sales reps by year-end.

I believe the national vertical structure, the current base of seasoned sales reps and our new vertical products will pay additional dividends in 2017 and beyond. These vertical products are the key differentiators for TriNet and critical to our long term growth strategy.

In Q3, we launched our third vertical product TriNet Technology, which follows TriNet Life Sciences and TriNet Nonprofit. TriNet Technology's unique within our industry as it delivers features and capabilities that are commonly required by technology companies. Let me walk you through a handful of these capabilities to illustrate how we are being responsive to the specific needs of the technology industry and differentiating ourselves in the market.

First, many technology SMBs recruit and hire international employees. And managing the subsequent visa process is burdensome and error-prone. With over 20,000 WSEs working under H-1B visas, currently on the TriNet platform, we are acutely aware of the challenges our clients face managing this process. TriNet Technology includes immigration services through a proprietary, cloud-based workflow that streamlines the visa paperwork process while also providing our clients access to cost-effective legal advice.

Second, as our clients recruit talent, they must address the difficulties of sourcing, scheduling, and tracking dozens of jobs candidates. Our in-house developed applicant tracking system enables them to efficiently manage this process. Third, technology companies should use equity awards to attract and retain talent. Technology SMBs struggle to manage employee grants and cap tables, TriNet Technology includes access to online equity administration to solve these challenges. And finally, TriNet's market leading benefits enable technology clients to offer Fortune 500-like coverage which is so critical when competing for top technology talent.

Since the launch in mid-August, I will bring you two closed deals that validate the thesis around technology customer needs. Each of these clients, one in New York and one in southern California, face visa challenges for 25% of their workforce. TriNet Technology is addressing these problems with our immigration solution that is built into the TriNet product.

By identifying these requirements, that go above and beyond the standard needs of HR and payroll for technology companies, we have differentiated our products from the rest of the industry. These two clients are now better able to compete for in-demand tech workers around the world to grow their business. It is clear that by understanding customer needs and providing industry-specific products, we deliver a better solution.

Continuing to execute on our vertical strategy, we launched TriNet Financial Services, our fourth vertical product earlier today. TriNet has significant experience serving the financial services sector. This product is a next step in advancing our industry leadership position.

Turning to our platform consolidation strategy, we began 2016 operating four platforms: Ambrose, Passport, SOI and Accord. We completed the migration of Ambrose in Q1. And during the third quarter, we completed the Accord migration. We are now operating just two platforms with our SOI platform scheduled to be migrated in 2017.

Our technology platform is a critical enabler of our advanced products. It allows us to offer a multitude of industry-specific solutions in a very scalable manner while delivering frequent enhancements that benefit all clients. We believe that by listening to our clients and offering tailored products that solve their critical needs, we can continue to grow in our targeted verticals. With that, I would like to turn 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 third quarter, net service revenues increased 20.6% year over year, to $161 million, exceeding the high end of our guidance range by $6 million. Total WSE count was 333,778, up 6% year over year, and up 2.6% since the end of the second quarter. Professional service revenues for the third quarter increased 11.1% year over year, to $110.5 million. The increase was mainly attributed to our increase in WSEs and an increase of 5% in average revenue per WSE.

Net insurance service revenues for the third quarter increased 48.4% year over year, to $50.5 million. The increase in net insurance service revenues was a result of our repricing efforts and claims activity tracking to our trend forecast. Total adjusted EBITDA for the third quarter increased 47.3% year over year, to $45.4 million compared to $30.8 million in the same quarter last year. Adjusted net income for the third quarter increased 56% year over year, to $20.8 million or $0.29 per share compared to $13.3 million or $0.19 per share in the same quarter last year.

Our GAAP effective tax rate was 38.4% for the third quarter, and our Q3 pro forma tax rate was 42.5%. Our lower tax rate during the quarter was primarily due to discrete benefits for disqualifying dispositions of previously nondeductible stock-based compensation and prior year state income tax adjustments.

During the third quarter we generated $35 million in operating cash flow and spent $11.2 million on CapEx, representing 7% of net service revenues during Q3. We spent $27.3 million to repurchase approximately 1.3 million shares of stock during the third quarter. We finished the third quarter with total cash of $160.6 million and working capital of $105.7 million. We ended the third quarter with total debt of $472.5 million, representing a debt-to-EBITDA ratio of 2.7 times trailing 12-months EBITDA.

Turning to our outlook, we expect our fourth quarter net service revenues in the range of $165 million to $170 million, which represents growth of 12% year over year. Adjusted EBITDA in the range of $50 million to $55 million. And adjusted net income in the range of $24 million to $27 million, or $0.33 to $0.37 per share.

Based on our performance through the first three quarters of the year, and our fourth quarter outlook, we are raising our net service revenue range to $638 million to $643 million, raising our adjusted EBITDA range to $180 million to $185 million, reflecting a forecasted the adjusted EBITDA margin of 28% to 29%, and tightening our adjusted net income range to $84 million to $87 million, or $1.16 to $1.20 per share. And now I will turn the call back over to Burton.

Thank you, Bill. I am very pleased with our third-quarter results. We delivered strong financial performance. We successfully completed the repricing of medical insurance for our entire install base. We launched TriNet Technology, our third vertical product, and today announced the launch of TriNet Financial Services, our fourth vertical product. We completed the consolidation of one of our two remaining legacy platforms and are scheduled to migrate the final existing legacy platform in 2017.

I am optimistic about our market positioning and long-term growth given the size of our market and our ability to effectively deliver on the needs of our clients. I look forward to sharing our progress with you. This concludes our formal remarks, and now I would like to turn the call over to the operator for questions.

We will now begin the question and answer session.

(Operator Instructions)

First question, Ato Garrett, Deutsche Bank.

Thank you for taking my questions. And congrats on the solid results today.

Thank you.

I really appreciate the explanation you gave around your new target for your total sales reps for the year. But then when we started to look at the WSE growth for the third quarter relative the other quarters this year, it seemed like it slowed down a little bit. Can you talk about whether that was consistent with your strategy on your sales team or if something else happened there, probably more measured intentional target growth rate for your WSEs in the quarter.

Yes, so great question and thanks for that. As we've stated in the past, we're focused on the profitable revenue growth and not as much on WSE count. We had 19% year-over-year, revenue growth to date, coupled with increased markets.

And to directly answer your WSE count question, frankly the increase medical pricing creating a headwind during the last 12 months, so with the normalization of pricing, and our emphasis on the vertical product, I expect a long-term targeted growth rate in the mid-teens on the revenue side. So I am pretty optimistic. This was an incredibly busy year up to this point. And I think we are in a good position moving forward.

Okay, great, thanks. And then also the net Insurance revenues, that does really look good this quarter. Can you just talk about, a little bit more -- I know with the effect that you did complete the repricing, I think that's clearly a benefit to that. Can you talk a little bit more on the claims experience whether that -- I know you said that's back on trend, but is there any way to kind of couch that in terms of your previous quarters' experiences?

Sure, Ato, this is Bill. The net Insurance is really a combination, as you said, of our pricing efforts continuing to gain traction and the normalization of our claims experience. So when we look at claims, we did see and continue to see our large claim activity continuing to come down. And we have seen pharmacy pretty much in line and we have seen our run-rate in medical claims picking up slightly within our trend.

So effectively claims are on trend, pricing is as we expect with the pricing increase. So a little extra color, we are working an MOR that is sitting kind of in the 87 range, which is close to where we were targeting it. And we are continuing to make progress as we have indicated on reducing our admin costs, which allows us to continue to provide the right pricing and still provide the right returns.

Great, thanks. And last one for me, just any particular areas you want to call out for strength, being that you had such a solid result, just any end markets or claim groups that were really contributing to that whether on the industry basis or geographic basis? Thanks.

Nothing in particular that I would call out. I think we see strength particularly around our new products. And I would continue to expect as we roll out those new vertical products we are continuing to add value, and I see some additional strength coming from those contributions.

And I would add to that, Ato, that tech was pretty strong this quarter, and I'm pretty excited about getting the tech product more into the market. So I would not be surprised at coming back to you and saying that was particularly strong as we move forward, because additionally -- the early interest is really strong. It was a good quarter without that product in tech and I think it may continue.

Great, thanks again and congrats on the quarter.

Next question, Jason Kupferberg, Jefferies.

Thank you, guys. Thank you for taking the question. So where the medical claims also the insurance cost -- by the way, this is Amit Singh on for Jason Kupferberg. Where the insurance costs stay right now, they are around 92% of total insurance revenue, as you see the medical, large medical claims normalizing, is that a good level to think of for the insurance cost going forward?

I think as we continue to move forward, we will see an additional quarter now, so we are moving into our final quarter of the repricing. So we did roll those prices out, but we will see some continued benefit coming into the first quarter based on our Q4 results. So I think it is a good trend, but I do expect over time we will probably see some slight pickup in the insurance side, based on trend continuing on claims and slight improvement in the pricing element.

Okay. Great. And then on one of the earlier questions about WSE growth slightly, and the growth rate year-over-year slightly coming down. So as you look at your overall revenue growth -- I know you are not providing 2017 guidance right now, but could you be -- earlier you just -- to speak about the 15%-ish organic revenue growth, mid, long-term, but that WSE growth coming to sort of mid-high, single-digit. Could you still drive revenue growth of 15%-ish organic beyond 2016?

Yes, so I think the focus here is on revenue growth, with the long-term model in the mid-teens, really is just based on our ability to execute on this large market opportunity we have. And it's going to be a combination of the right product with the right value, and volume will clearly be an element for that in terms of WSE, but it is not going to be the end element. It is one driver of many that I think we can result in just getting mid-teens growth over the long-term.

All right, thank you very much.

Next question, Tim McHugh, William Blair.

Hi, it's Stephen Sheldon in for Tim. Thanks for taking our questions. First can you provide some more details on the sales headcount at the end of the third quarter? Did you essentially shut off hiring and the decline was almost entirely due to voluntary and involuntary turnover? Can you just provide some detail on the change there?

Yes, I think that is a great assessment. As we put in the leaders of each vertical, they step back and reassess the market. I think it is important to understand that we do deep dives into each of these verticals on a national basis, and I have them with capturing a percentage of the TAM, the total addressable market, on a national basis. I frankly don't care if it comes out of California, New York or Des Moines, Iowa.

So as they assess the national opportunity for each of these verticals, they have changed some locations, shut off the hiring, analyzed their teams, but the items that go into this include the total addressable market in each of the specific cities they are looking at. It includes the business complexity and what problems they solve in each region. It includes our current benefits offering and whether that resonates and where that stands in that specific market.

And frankly what problems they are solving in each of those verticals and how they can most easily create a friction-less service to build their business. So they have come in with their own vision, and they are in the process of executing on that. But it is absolutely fair to say for the most part they shut off hiring, did their assessment, took their new roles and their hiring at this point.

If we look at the current sales rep base, would it be fair to say that the current base -- that basically the people that either left, whether it is voluntary or involuntary, were the less productive sales reps, so that you have a more productive base at this point?

Absolutely.

And then one other, I guess stepping back, I think one of your competitors talked about some hesitancy in hiring within their client base during the quarter. Did you see anything similar within your client base? And then I guess how is that not only within the third quarter but how has that kind of trended if you looked into October?

We haven't seen any dramatic changes in the hiring for our install base. I think during the year, clearly it has not been as robust as we have seen in 2015, but it has been fairly steady. It is slightly different in the verticals, each of the verticals, hire slightly different based on their own needs, but generally, technology has continued to hire and across the install base we are seeing growth that I would still see as single-digit, but there is still growth, and it's been fairly consistent.

(Operator Instructions)

Next question, George Tong, Piper Jaffray.

Hi, thanks. Good afternoon. Can you talk about how much effective pricing in medical increased by relative to claims costs on a year to date basis?

It's a good question, George, as I just look at the quarter -- and I just don't have the total. For the quarter we saw a 2% spread, right? So we saw our revenue growing 2 percentage points higher than costs; and as we had talked I think last year, as we went into pricing, we were targeting to get about 200 basis point improvement. So I would say we're starting to realize that now that we are three quarters of the way in based on our pricing. So that is what we have seen. And then when we follow K, you'll be able to see the total nine-month comparisons.

And the two-point spread, can you break that down into claims costs versus actual effective pricing?

Yes, trend is pretty much coming in as we had expected to be so it is really the effect of the additional pricing.

Any way to quantify that, I guess, is it sort of 700 BIPs pricing versus 500 BIPs claims cost?

Well, the spread -- maybe I'm not completely understanding, but the spread really is we have increased our pricing a couple hundred basis points higher than our medical trend, and so that is what we are realizing. And that is what it took to effectively get us to the point where we are today. So if trend is at 7, then pricing is at 9; and that is what we are seeing this 200 basis points being realized.

Okay, yes, the 7 to 9 spread is what I was going for. And then based on your 2016 experience so far, how do you expect to adjust pricing in 2017?

Well our pricing is pretty much going to be aligned with our trend now for medical, since we have already made the adjustment; and that is coming in effectively high single digits, which is one of the things that is being received well by our install base.

Got it, and then lastly, can you discuss how you think about sales rep growth beyond 2016, and how that compares versus your long-term, mid-teens revenue in WSE growth targets?

George, I think we will provide a little bit more beyond 2016 when we get into our outlook for 2017 on the Q4 call. But as I mentioned earlier, I think our target growth model of mid-teens will have a combination of product that has more value with price, with the ability to continue to add, as Burton said, selective sales teams into the verticals where they are most needed based on the opportunity and that TAM and the availability of the new products.

So we will be surgical about it, but we do think there is a big opportunity. So you will see us grow, but we are going to do it in a very thoughtful manner.

And George, just add to that, this is Burton, if you step back for a moment I believe this is a huge market opportunity, and by delivering this vertical product, and technology strategy, we can make this more of a strategic purchase by these SMB owners. And I think it will drive market adoption longer-term growth, and that is what differentiates us from the over all competitors.

So I am looking for increased productivity for my reps as these solutions take hold. I am looking for increased margins on these products as the value delivered through things like H-1B visas, as the value delivered through things, including performance management, including the workflow associated with the hiring of new candidates, to increase the price point, to hopefully increase the margin. So it is about a strategic purchase that is a longer term issue than somebody going to a company to get benefits or payroll.

Got it, very helpful, thank you.

Yes, thank you.

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