TriNet Group Inc (TNET) 2016 Q4 法說會逐字稿

Good afternoon and welcome to the TriNet Group Incorporated fourth-quarter and full-year 2016 conference call.

(Operator Instructions)

Please note: this event is being recorded.

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

Thank you, Operator.

Good afternoon, everyone, and welcome to TriNet's 2016 fourth-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 fourth-quarter and annual 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 2017 first-quarter and full-year guidance and other statements that are not historical in nature, are predictive in nature, or depend upon or refer to future events or conditions, such as our expectations, estimates, predictions, strategy, or other statements that might be considered forward-looking. These forward-looking statements are inherently subject to risks, uncertainties, and assumptions that may cause actual results to differ materially from statements being made today or in the future. Except as may be required by law, we do not undertake to update any of these statements in light of new information, future events, or otherwise. 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 available on our website.

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

Thank you, Alex.

I am pleased with our fourth-quarter and FY16 financial results. We delivered strong growth, reflecting healthy contributions from both our professional service revenues and significantly improved insurance service revenues. These results reflect our commitment to profitable growth and providing industry-specific products optimized for our client needs. In my formal remarks, I will review our fourth-quarter and full-year 2016 financial results, highlight some of our 2016 operational accomplishments, and finally provide our 2017 outlook.

During the fourth quarter, we grew GAAP revenues 12% year over year to $811 million, and we grew our net service revenues by 16% year over year to $173 million. Professional service revenues increased 7% year over year to $114 million, and net insurance service revenues increased 40% year over year to $59 million. Our strong net insurance service revenues performance is the result of our repricing efforts, claims tracking to our forecast, and administrative cost savings in the quarter. I am pleased with the progress of our insurance services team has made during the past year under its new leadership. This team is focused on growing our business in a disciplined manner by delivering tailored insurance products and services at competitive prices using a data-driven approach.

Our Q4 GAAP EPS grew 60% year over year to $0.32 per share, and our Q4 adjusted net income per share exceeded the top end of our guidance by $0.01 at $0.38 per share. We closed the year with a worksite employee count of approximately 338,000, up 4% year over year, while servicing nearly 14,000 clients. For 2016, we grew GAAP revenues 15% year over year to $3.1 billion and we grew our net service revenues by 18% to $647 million. This revenue growth translated to strong profitability and earnings growth. We grew GAAP earnings by 93% year over year to $0.85 per share, and we grew adjusted net income per share by 24% year over year to $1.20 per share.

We remain excited about our market opportunity. In the United States, 57 million people work for companies with 500 or fewer employees, representing an available market of approximately $90 billion. After excluding those employers with a limited operating complexity, we estimate the addressable market for our targeted vertical strategy to be approximately $45 billion. My focus is on continuing to work to drive sustainable, long-term growth for TriNet, to take advantage of this large market opportunity.

HR challenges for small midsized businesses have never been more complex. The new administration is a signaling significant changes to business regulations, including a very public discussion around the future of the Affordable Care Act. Additionally, state regulatory frameworks continue to diverge from each other and from the federal government. TriNet is well-positioned to address these challenges. In 2016 alone, we identified over 3,000 new local, state, and federal regulations impacting employment. Our clients face an increasingly difficult regulatory environment and the burden of compliance for small and midsized businesses is high. For example, SMBs can expect at least one employment practices claim every three years. While 75% to 80% of these claims are meritless, the remediation process is neither painless nor cost-free.

TriNet's market opportunity is, in part, driven by the challenge of regulatory compliance in a changing world. TriNet handles this complexity and risk on behalf of each of our nearly 14,000 US-based clients so they can focus on growing their business. Now more than ever, TriNet's comprehensive bundled solutions offer our clients relief from these challenges across four primary pillars of value. Number one is a robust technology platform that serves as their HR system of record, allowing clients and employees to view HR data and perform HR transactions online and through mobile apps. Number two, HR expertise to help support them on everything from recruiting, onboarding, terminations, compensation design, and much more. Number three, a variety of benefits offerings tailored to fit the client's needs from health and workers compensation insurance to retirement products and COBRA administration. Number four, compliance expertise built into our products and services to help clients stay on the right side of employment regulations in all 50 states.

In 2016, we continued to execute against our strategic plan, including: migrating clients off Ambrose and Accord, two of our legacy platforms, onto our common TriNet platform; launching three additional vertical products, TriNet Technology, TriNet Financial Services, and TriNet nonprofit; beta-testing a substantial platform upgrade with active client participation; expanding the usage of our mobile app, now with 77,000 active users; completing the verticalization of our sales force with national sales leaders by vertical; finally, investing nearly $53 million into our technology platform and supporting infrastructure. This is in addition to our focus on enhancing profitability in insurance services and the introduction of client relationship executives to our largest clients.

Each of our initiatives drive a combination of new sales, retention, and operational excellence. I expect 2017 to be another significant year for our products and platform. Through our focus and investment, we are committed to both improving our client experience and creating more operational scale by leveraging a common technology platform. The outcome of our efforts are expected to include: first, the launch of our Main Street product targeting verticals such as retail, manufacturing, and real estate. This product will offer upgraded capabilities in important areas such as flexible time and attendance functionality, improved management of multiple job classifications, and increased payroll flexibility. Second, the migration of our legacy SOI clients onto the common platform. Third, the delivery of a more intuitive user experience for all clients, enabling improved productivity for both online and mobile users. Finally, the release of an API-first architecture allowing our platform to integrate more effectively with third-party products, a critical component of our commitment to working with our clients as they succeed, grow larger, and grow more complex.

By way of priority, we have focused our 2017 road map as a logical progression. First, we will improve the usability and interoperability of our products. With the implementation of these changes, we expect a successful SOI migration to the common platform and improved products. With these enhanced products and the common platform, we will then turn to the launch of our new Main Street product and the introduction of additional new verticals including our hospitality vertical, whose launch date is being adjusted accordingly. While our investment in these initiatives is substantial, the benefits to TriNet from product enhancements and a successful SOI migration are significant. Upon completion of the migration, we expect to have all of our clients on a single platform with products that enhance the user experience, with an opportunity to continue to build operational scale and efficiency.

Verticalization remains a key focus in 2017. In prior quarters, we discussed the early pricing successes of our life sciences product. We were happy to see that these successes continued in Q4. We are expecting similar traction in the other verticals. As our new products are being adopted into the verticals, our clients are recognizing additional value, yielding better pricing. We continue to be patient in order to realize growth and volume at the right price. As part of our commitment to our vertical product strategy, starting February 1, all of the technology prospects have been quoted solely on the new technology product. On April 1, all new financial services prospects will be quoted solely on the new financial services product. Each of these products have been tailored to the needs of clients in these industries. We look forward to updating you on the success of these products as the year progresses.

Retention of our larger clients will also be a continuing focus in 2017. Our client relationship executives, which we introduced last year, are tasked with owning the business relationship with TriNet's largest clients. Through the expansion of this team, TriNet will become more proactive in anticipating their needs and deepening our partnership with our largest clients. 2017 will also see TriNet continue to enhance the insurance benefits that we make available to our clients and their employees. We expect to further tailor these benefits to our target verticals and the unique needs of each market.

Turning to our sales strategy, during 2016, we enhanced our vertical go-to-market approach by structuring our sales force under national vertical VPs. These VPs have the flexibility to invest in their teams subject to the needs of their specific market. We finished 2016 with 452 quota-carrying sales reps. In the beginning of 2017, we rolled out a new sales compensation plan based on annual contract value and revenue attainment. This compares to the prior plan that was focused on worksite employees. We expect our targeted vertical sales organization to create a virtuous cycle. As our sales teams focus within their verticals, they will gain a richer understanding of the common challenges faced by clients within those verticals. This ongoing feedback will allow us to further tailor our offerings to meet their needs, which will make our products even more relevant and therefore attractive to our clients.

As I reflect on 2016, we executed on a number of challenging projects aimed at better positioning our Company for long-term growth. In 2017, we will build on these accomplishments, strengthening our position to sell the right products to the right clients at the right price. I am confident, as we execute on these initiatives, TriNet will be positioned to deliver on our revenue and profit targets for 2017.

With that, I will turn the call over to Bill for his review of our financial performance. Bill?

Thank you, Burton.

As we review the financials, I will focus on the GAAP and non-GAAP numbers where appropriate. During the fourth quarter, GAAP revenues increased 11.8% year over year to $811.1 million. Net service revenues increased 16.2% year over year to $173.1 million. Total WSE count was 337,885, up 4.2% year over year and up 1.2% since the end of the third quarter.

Professional service revenues for the fourth quarter increased 6.8% year over year to $114.3 million. Net insurance service revenues for the fourth quarter increased 40.1% year over year to $58.8 million. The increase in net insurance service revenues was the result of our repricing efforts, claims activity trending to our trend forecast, and administrative cost savings. Total adjusted EBITDA for the fourth quarter increased 23.4% year over year to $56.4 million compared to $45.7 million during the prior-year period.

GAAP net income increased 62.9% year over year to $23 million or $0.32 per share compared to $14.1 million or $0.20 per share in the same quarter last year. Adjusted net income increased 21.4% year over year to $26.9 million or $0.38 per share compared to $22.2 million or $0.31 per share in the same quarter last year. Our GAAP effective tax rate was 40.3% for the fourth quarter and our pro forma tax rate was 42.5%. During the fourth quarter, we generated $66.4 million in operating cash flow and spent $11.7 million on CapEx, representing 6.8% of net service revenues. We spent $27.9 million to repurchase 1.2 million shares of stock during the fourth quarter.

Turning to the full-year results for 2016, we grew GAAP revenues 15.1% to $3.1 billion and we grew net service revenues 18.2% or $646.6 million. Total adjusted EBITDA for 2016 increased 23.3% to $186.6 million, with an adjusted EBITDA margin of 28.9%, an improvement of 1.2 percentage points versus 2015. 2016 GAAP net income increased 93.7% to $61.4 million or $0.85 per share and adjusted net income increased 22.6% to $86.7 million or $1.20 per share. For the full year 2016 we generated $144.5 million in operating cash flow and spent $39.7 million in CapEx, or approximately 6% of net service revenues. The increase in CapEx in 2016 was largely the result of our investment in technology. To close the year with total debt of $458.9 million, representing a debt to EBITDA ratio of 2.5 times trailing 12-months EBITDA. We finished the year with total cash of $184 million and working capital of $156.8 million.

Turning to our 2017 full-year outlook, I will provide both GAAP and non-GAAP guidance. We forecast GAAP revenues in the range of $3.3 billion to $3.4 billion, which represents year-over-year growth of 7.8% to 11.1%. We expect net service revenues in the range of $705 million to $720 million, which represents year-over-year growth of 9% to 11.4%. We expect to see WSE volume growth [live] overall revenue growth in 2017 as we continue to align products and price as well as complete our platform migration. As we saw in Q4, we expect a higher contribution from insurance revenue throughout 2017, aligning to our historical experience in 2014. For the year, we expect adjusted EBITDA in the range of $198 million to $208 million, representing an adjusted EBITDA margin of 28% to 29%. We expect GAAP net income in the range of $69 million to $75 million or $0.97 to $1.06 per share, and we expect adjusted net income of $94 million to $100 million or $1.32 to $1.41 per share. Our 2017 guidance assume a GAAP tax rate of approximately 44% and a pro forma tax rate of approximately 42.5%.

Based on our 2017 full-year guidance, we expect our first-quarter GAAP revenues in the range of $780 million to $800 million, which represents year-over-year growth of 6.4% to 9.2%, and net service revenues in the range of $175 million to 180 million, which represents year-over-year growth of 7.2% to 10.2%. We expect first-quarter adjusted EBITDA in the range of $45 million to $50 million, representing an adjusted EBITDA margin of 26% to 28%. Our first-quarter GAAP net income is expected to be in the range of $15 million to $18 million or $0.21 to $0.25 per share. We expect first-quarter adjusted net income in the range of $21 million to $24 million or $0.30 to $0.34 per share.

As you'll recall from last year, we had a number of material weaknesses in our internal controls that we described in our 2015 10-K. While we made significant progress in improving our internal controls environment throughout 2016, we have concluded that we continue to have material weaknesses relating to our internal control over financial reporting. However, after extensive review and the performance of additional analysis and other procedures, no material adjustments, restatements, or other revisions to our previously issued financial statements were required. We are taking specific steps to remediate the material weaknesses that we identified by implementing and enhancing our control procedures. This is a high priority for the Company. We would refer you to item 9A in our 2016 Annual Report on Form 10-K to be filed with the SEC today for more details.

Now I will turn the call back over to Burton.

Thank you, Bill.

I am proud of the team and the progress we have made in 2016. I believe that our strong financial performance was the result of our commitment to profitable growth and providing industry-specific solutions. I am pleased to welcome Atairos as a long-term investor and strategic partner. Michael Angelakis, Chairman and Chief Executive Officer of Atairos is an asset to our Board. I look forward to benefiting from his insights and experience as a successful operator and entrepreneur. It is gratifying to have a TriNet client feel so strongly about the TriNet value proposition that they have decided to make a significant financial commitment.

We have several important initiatives in 2017. As we execute these initiatives, TriNet will be better positioned to serve all of our clients. Our business model is strong, with volume, price, and insurance already setting levers that allow us to continue driving profitable growth as we take steps to further align our business with the market opportunity. This gives me confidence for 2017 and beyond.

In closing, I want to thank our over 2,500 TriNet colleagues all around the country who worked very hard every day in service of our amazing clients.

With that, I will turn the call back to the Operator for questions. Operator?

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Tien-tsin Huang, JPMorgan.

Hi. Good afternoon. Thanks for the update. I will ask about -- obviously, a lot of change going on with the move to the common tech platform and the verticalization including the sales.

I'm curious, how should we measure certain items? I am assuming there should be some impact on attrition and retention, higher revenue per WSE. Looks like no margin expansion per se this year, but perhaps as you convert the platform there will get some lift there. Maybe could you address some of those topics, just some of the KPIs and how they might get impacted short-term/long-term for the changes? Thank you.

Thanks, Tien-tsin. I'll start; there's a couple of questions in there and then I will turn it over to Bill. I think you've outlined some of the highlights for 2017. Getting to the one common platform is key from my standpoint. Getting the additional functionality for the Main Street clients, obviously, at that point all additional functionality attributes to all of our customers on that single platform.

Obviously, there's an impact to the medical pricing over the course of the year. They've had some headwind associated with it, but I believe that the PEPM, or the revenue per client, is going up. And I believe the uptake of the new products, with the additional functionality, creates opportunity for additional revenue.

How about on the --?

Go ahead.

Sorry, I was just going to say, how about any thoughts on the retention and attrition, not only on the client side but also on the sales force retention and attrition?

Yes, Tien-tsin, this is Bill. On the retention side, as we generally look at our business, we are averaging around 20%. Last year in 2016, we were a little worse than that. I think as we look forward to 2017, we expect to do slightly better than our historical experience in the majority of the verticals. And as we called out with SOI migration, there is going to be some, probably, some additional attrition there. That's where there is a little bit more of a risk, so we will manage that carefully throughout 2017. But I think it should benefit us when we get to 2018 with a better client experience and, I think, improved attrition across all of the verticals.

Got it. Thank you.

Thank you.

Tim McHugh, William Blair.

Hi, it is Stephen Sheldon in for Tim. Thanks for taking our questions. First, I wanted to ask what you are kind of embedding in your guidance for sales and marketing expense in 2017? It's come down quite a bit in the second half of the year, so I'm wondering how you would expect that to trend as you look through the year?

Yes, Stephen, this is Bill. I do expect that we would see some increase. We are going to continue to invest in our sales force. It is going to be more specific based on how the verticals are coming to market, the vertical products, so it is not going to be across-the-board. I do expect by the end of the year that we should see an increase probably somewhere in mid- to low-double digits in terms of sales force growth. Again, I think we will be surgical in when those increases happen, and it could vary quarter to quarter depending on how the new VP leaders are realigning their sales force.

Okay. That is helpful. Secondarily, I wanted to know what your specific assumptions are for -- if you're looking between growth and net insurance revenue versus professional services? How would -- what are you guys embedding for that?

Sure. That is a good question. Historically, if we look back prior to having the additional claims experience, we were running our professional services revenue in those 67% to 65% of total net services revenue. As we look at 2017, I think we're going to go back to that historical average of around two-thirds of our net revenue coming from professional services. We're getting our net insurance contribution kind of back to the historical level that we saw prior to the claims experience we saw in 2015.

Okay. Great. Thank you.

Thank you.

Kevin McVeigh, Deutsche Bank.

Great. Thank you. Thanks for the color. Any thoughts on how WSE growth should trend as we work our way through 2017?

Hey, Kevin. What I'd say on WSE growth is, long term, we expect to grow both volume, so WSE growth and revenue with this data-driven approach that has really being used by our actuarial team. I would expect double-digit growth in both areas. I think in 2017, obviously, we're not going to have that same level of WSE growth based on our outlook, so it will be less than that. I am not going to give a specific target, but it is not going to be quite double digits in 2017.

Great. Then, any thoughts on -- with all the kind of moving parts around ACA, are you getting any feedback from clients in terms of trying to position for that or is it still too early? Do you have any thoughts on how we're think about the ACA act in 2017?

Yes, Kevin, this is Burton. It's good to hear from you. A couple of points on that, obviously, complexity and change are good for our business. We have taken this vertical-driven approach and we help our clients through all the changes that occur.

We do not have products that are focused on specific laws like ACA. We [didn't] have a big uplift from ACA because of the large quantity, frankly, of white-collar workers who already had great benefits. But I see change as being good for business as people want to focus on growing their business and allowing us to deal with that complexity. Nothing precipitous either positive or negative, but a great opportunity for us to be into this client base with the ones that are affected and help them through any changes that might occur.

Thank you so much.

Thank you.

George Tong, Piper Jaffray.

Thanks for taking my questions. Can you provide an update on what you are seeing with medical claims frequency and severity trends, some more details there, and what those trends may imply for gross margins on a near- and intermediate-term basis?

Sure, George, this is Bill. In general, we have seen very consistent MLRs in 87% to 88% range. As you recall, that is very consistent between what we saw early in year and it has been consistent in Q4 as well. Where we saw a lot of the improvements is in the fixed costs or the administrative portion of the program, and I expect that to continue into 2017, so we think we are probably right where we need to be with trend.

Medical trend as far as we can see on a national basis is probably running around 7%. It is somewhat unique to each region, but in general -- and our trend is running very close to that in terms of total medical, and it does vary slightly by the components. Pharmacy is probably running high-single digits. We are seeing run rate medical running in the lower single digits. Large claims have been subsiding but in total are all part of that medical trend that I just referred to.

I think it is fairly steady. Our pricing is adjusted to that trend line, and we are continuing to watch it very carefully. I do expect over time that we will continue to see very competitive pricing as we really -- our team is monitoring that claims activity and our pricing accordingly.

Got it. Very helpful. I wanted to touch a bit on average professional services revenue per WSE. In the quarter, the average revenue per WSE on the professional side was in the 2% range. As you begin to embark on your verticalization initiative and force folks on to these upgraded platforms and provide more value add, how do you envision the average revenue per WSE evolving on the professional side of the business?

Sure, George, that is a good observation. As we have seen the new products come in to the market -- and our best experience right now is with TriNet Life Sciences -- we are continuing to see an approximate 9% improvement in average selling price when we look at clients of the same size who have the new TriNet product versus the legacy product for in life sciences. So we are expecting, hopefully, something similar to that in the new -- or in the rest of the products, both financial services and technology.

It is really too early to tell; we do not have enough data at this stage. As Burton indicated, we are just starting to see 100% of our quotes happening in technology at the end of Q1, and we won't be quoting all of our new business on financial services until the beginning of Q2. It will take us some time to see that come through into the results. But we are getting good feedback on the products, and I do expect to see a good uplift as those products get into the market over time. We will keep you updated with our experience every quarter.

Very helpful. Thank you.

Thank you very much

David Grossman, Stifel.

Thank you. Good afternoon. I wonder if we can go back to the WSE question. If we look at the timing of when the insurance book started to reprice and when you largely completed that effort, it would seem that you would experience more favorable comparisons on the WSE side and the pricing side towards the second half of 2017. Am I understanding that right? Or should we expect that headwind to persist throughout the balance of the year?

Yes, David, that's a good question. I think we still see a bit of a headwind. That was an impact to our volume over the course of 2015, and we are still -- or excuse me 2015 and 2016. I think we are still seeing some of that as we get into 2017.

We are going to continue to refine our pricing. As I mentioned, it is a very data-driven approach that is being used to really analyze what our experience is, so I do expect that we will continue to refine our pricing and over time we should see volume pick up. It is going to be a gradual thing. I do not think it is something that we're going to see immediately.

Okay. Did you say, Bill, that the MLR was between 86% and 88%, or did I hear that incorrectly?

87% to 88%.

87% to 88%. Got it. Okay. Burton, going back to I think a question that was asked earlier about the dynamic around the verticalization of your business. In addition to higher revenue per client, are there any other observations you can share with us that you have seen thus far? I know it is early and you really only have one vertical up and running, but -- or fully running, I should say. Is there anything else you can share with us that you have seen thus far as a result of the shift?

Yes, David, great question. Thanks for asking it. There's three aspects to it that are very important to me, David. First is that we are delivering a higher value product that commands a higher price. That's the point that I expect to continue, the early returns are good but I need a heck of a lot more time to be able to make that blanket statement.

The second is the feedback from the clients and the service team, which is now getting verticalized, to make sure that product is dead on for those clients. Right service model, right pricing, right technology, right programmatic interfaces with third-party software, so early indications are we are getting phenomenal feedback. There is a list of additional functionality that is being asked for in the version two of those products because we are still in version one. I am really happy with the feedback and the communications that is coming from the field team that's servicing them through the client to our development and products organization. That's the second thing.

Finally from a sales force standpoint, I like the direction things are heading. I love the fact that I have VPs that have their handcuffs off to build their organizations where they want to, of the size they want to, in the markets that they believe they can penetrate. This is not about the geography. It is about getting a percentage of a total vertical. There's some great experiences with some of the reps. Some of them need more time and are taking a little longer with this new approach. And it's around building the network around that industry-specific vertical.

Those are three things that are important to me, which is great product that we can command a reasonable price for, great feedback so that product gets better and our dev organization builds amazing feature functionality that cannot be touched. Finally, the overall sales force heading in the right direction with the singularity of leadership to manage those teams and mine the referral networks.

Do you have any metrics yet on sales force productivity or is it just too early to benchmark that?

If I had them I would give them to you. I just do not have enough yet.

Okay. Just one last one, Bill, can you give us a sense of what the pro forma adjustments look like for 2017, what we should assume for stock-based comp and the other pro forma adjustments?

Sure, and actually, David, that is part of the reconciliation that is posted to our website. We can go through those in detail after, but they are posted so you will be able to see them specifically for all the reconciliations, both historical and for the guidance.

Okay. Great. Thank you.

Thanks, David.

This concludes our question-and-answer session for today. Thank you, everyone, for your questions. The conference has now concluded for today. Thank you all for attending today's presentation. You may now disconnect your lines.