TriNet Group Inc (TNET) 2018 Q1 法說會逐字稿

Good afternoon, and welcome to the TriNet Group, Inc. First Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

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

Thank you, operator. Good afternoon, everyone, and welcome to TriNet's 2018 First Quarter Conference Call.

Joining me today are Burton M. Goldfield, our President and CEO; and Richard Beckert, our Chief Financial Officer.

Our prepared remarks were prerecorded. Burton will begin with an overview of our first quarter operating and financial performance. Rich will then review our financial results in more detail. We will then open up the call for the Q&A session.

Before we begin, please note that today's discussion will include our 2018 second 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, strategies, beliefs or other statements that might be considered forward-looking. These forward-looking statements are based on management's current expectations and assumptions and are inherently subject to uncertainties, risks and changes in circumstance that are difficult to predict and 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, including our 10-K and 10-Q filings, 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-looking guidance 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 our earnings release or our 10-Q filing for our first quarter of 2018, both of which are available on our website or through the SEC website. A reconciliation of our non-GAAP forward-looking guidance 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.

During the first quarter, we delivered strong financial results, completed the SOI migration and continued to position the company for our next phase of growth. We grew total revenues 7% year-over-year to $861 million and we grew our Net Service Revenues by 11% year-over-year to $220 million. Professional service revenues grew 7% year-over-year to $129 million. Professional service revenues benefited from our efforts to target the right customers with the right products and services at the right price. We grew insurance service revenues by 7% year-over-year to $732 million, while Net Insurance Service Revenues grew 16% year-over-year to $91 million. Net Insurance Service Revenues in the quarter benefited from administrative cost savings and improved worker's compensation performance.

Our Q1 GAAP earnings per share grew 83% year-over-year to $0.75 per share and our Q1 adjusted net income per share grew 78% to $0.80 per share.

We finished the quarter with 317,000 worksite employees and by completing the SOI migration, we have fully transitioned our entire installed base. All of our clients, totaling almost 16,000, and their WSEs, now reside on our common platform. Our clients are beginning to benefit from our scale as we invest in our platform, products and services.

We are focused on driving process improvements for the benefit of our clients and we are strengthening our operating management team. Olivier Kohler has joined us as our Senior Vice President in charge of operations. Olivier brings extensive client service and operational experience from his prior senior roles at Bridgewater Associates, Cisco and Hewlett-Packard.

Olivier will manage the largest organization within TriNet. His primary focus is to unify our customer-facing services with our back-office operations. Through this process, we expect to improve the client experience, gain efficiencies and ultimately improve customer satisfaction and retention.

As we exit the first quarter, I am very pleased with our financial and operating strength. We are well-positioned to address our large under-penetrated market. We remain on track to return to sequential volume growth in the second half of this year.

In the second quarter, we expect attrition to remain elevated, as the last remaining migration cohorts respond to our insurance price increases. However, with respect to new sales, I am very pleased with the progress we are making under the leadership of our Chief Revenue Officer.

In the first quarter, we returned to mid-teens year-over-year new sales volume growth. We are benefiting from increased sales force retention, higher average PEPM and maturation of sales force leadership.

To augment the sales force momentum, I was pleased to add Michael Mendenhall as our Senior Vice President and Chief Marketing Officer. Michael most recently served as Chief Marketing Officer for IBM Watson and Flex. Additionally, he spent nearly 2 decades at the Walt Disney Company in senior marketing and communications roles.

We are also pleased with our progress in strengthening our insurance services offerings. We continue to look for opportunities to leverage our scale, to further improve plan structures, expand choice and reduce administrative expenses associated with our insurance programs. We expect these efforts to provide additional value to our clients.

During the first quarter, we grew total medical plan enrollment by 4%. Total medical plan enrollment has now increased each quarter for the past 4 quarters. This is significant, as our overall medical plan enrollment grew even though total WSE count declined in the quarter. This trend is primarily driven by SOI clients that may have had higher WSE counts but lower medical plan enrollment rates being replaced by new clients from our core verticals that may have fewer total WSEs, but with higher enrollment rates.

With that, I will pass the call over to Richard for a review of our financial performance. Richard?

Thank you, Burton.

As we review the financials, I would like to focus on the GAAP and non-GAAP numbers where appropriate.

During the first quarter, GAAP total revenue increased 7% year-over-year to $861 million. Net Service Revenue increased 11% year-over-year to $220 million.

We finished the first quarter with 317,000 worksite employees, down 4% year-over-year. Average WSE count for the first quarter was 315,000, down 4% year-over-year.

As discussed in previous quarters, our average WSE count in the first quarter was impacted by an increased attrition largely attributable to our SOI migration. We expect this specific attrition trend to conclude during the second quarter of 2018, as clients complete their SOI migration.

Professional service revenue for the first quarter increased 7% year-over-year to $129 million. When compared to the same quarter last year, professional service revenue benefited from improved pricing and a mix shift away from blue and gray verticals. These benefits were offset by reduced average WSEs.

Insurance service revenue for the first quarter increased 7% year-over-year to $732 million and Net Insurance Service Revenues increased 16% year-over-year to $91 million. Net Insurance Service Revenues benefited from continued positive worker's comp performance, where we saw favorable development across our whole book, continued reduction of administrative costs and continued increased medical plan enrollment rates due to change in mix and growth in our core verticals. We offset a portion of these benefits by prudently increasing our health reserves in anticipation of flu seasonal headwinds.

GAAP net income increased 88% year-over-year to $54 million or $0.75 per share compared to $29 million or $0.41 a share in the same quarter last year.

Our GAAP effective tax rate was 20%, primarily due to the 2017 tax reform legislation and the tax treatment of employee equity compensation. We ended the quarter with a non-GAAP pro forma rate of 26%.

Adjusted net income increased 84% year-over-year to $58 million or $0.80 per share compared to $32 million or $0.45 per share in the same quarter last year.

Adjusted EBITDA for the first quarter increased 45% year-over-year to $91 million compared to $63 million during the prior year period, for an adjusted EBITDA margin of 41%. Adjusted EBITDA benefited from a $9 million reduction in commissions expense as a result of ASC 606.

Furthermore, we managed operating expense in Q1 lower than originally expected. We would expect to see our investment in OpEx increase in the second half of this year.

We closed the first quarter with total cash of $330 million and working capital of $247 million versus $336 million and $234 million, respectively, in the fourth quarter of 2017.

In the quarter, we adopted ASU 2016-18 on Statement of Cash Flows: Restricted Cash. The adoption of the accounting standard impacted the statement of cash flows by moving restricted cash from WSE-related assets to restricted cash, cash equivalent and investments.

You will notice this change in how we present our WSE-related assets. Previously, the change in WSE-related assets included restricted cash. We now show the change in WSE restricted cash as part of operating cash flow.

Due to this change, our operating cash flow statement shows that we paid out $536 million in Q1 versus $161 million in Q1 of '17. A table clarifying these changes can be found in the liquidity section of our current Form 10-Q filed with the SEC or in an exhibit in our first quarter earnings release issued today.

During the first quarter, we generated $45 million of positive corporate cash flow from operating activities and paid out $581 million, primarily comprised of WSE-related payroll tax obligations. As a result, total cash outflows from operations were $536 million.

In the first quarter, our cash flow from operating activities was predominantly impacted by: Timing of compensation-related expenses, which were in response to tax reform; and the payment of the 2017 fee credit. We spent $8 million to repurchase approximately 160,000 shares of stock in the first quarter, leaving $129 million authorized for the share repurchase as of quarter-end. We finished the first quarter with total debt of $415 million.

Turning to our 2018 full year and second quarter outlook, I will provide both GAAP and non-GAAP guidance.

For the full year, we are leaving our GAAP and non-GAAP guidance unchanged. We are forecasting GAAP revenue in the range of $3.5 billion to $3.6 billion, which represents year-over-year growth of 7% to 10%. We expect Net Service Revenues in the range of $841 million to $868 million, which represents year-over-year growth of 4% to 7%. Adjusted EBITDA is expected to be in the range of $306 million to $316 million, representing a 36% adjusted EBITDA margin for FY '18. We expect GAAP earnings per share in the range of $2.33 to $2.46 and adjusted net income per share in the range of $2.50 to $2.63. For FY '18, we are modeling a pro forma tax rate of 26%.

Moving on to our second quarter guidance. We expect GAAP revenues in the range of $850 million to $863 million, representing year-over-year growth of 6% to 8%; and Net Service Revenues in the range of $201 million to $216 million dollars or flat to 7% year-over-year growth. Adjusted EBITDA is expected to be in the range of $71 million to $86 million, representing an adjusted EBITDA margin range of 35% to 40%. We expect GAAP earnings per share in the range of $0.53 to $0.70 per share and adjusted net income per share in the range of $0.60 to $0.77.

With that, I will return the call to Burton for his closing remarks. Burton?

Thank you, Richard.

I was pleased with our first quarter financial and operating performance. We made significant progress as we positioned ourselves for the next phase of growth. We intend to accelerate our market position by leveraging the vertical strategy at a broader scale. We returned to mid-teens new sales growth in the first quarter and we remain on track to return to sequential volume growth in the second half of 2018.

Finally, we are committed to improving our client experience by unifying the customer-facing operations with our back office. We expect this effort to enhance customer satisfaction, retention and gain operating efficiencies.

Now with that, I would like to return the call to the operator. Operator?

(Operator Instructions) The first question today will come from David Grossman with Stifel Financial.

I guess, first, maybe Burton, you gave us some nuggets in terms of why the professional services growth rate accelerated in the quarter. But despite the decline of WSEs, perhaps you can go in a little more detail as to whether this was predominantly pricing? Was it predominantly mix or retention? Or what other factors may have really driven this number? And how we should expect that to trend as the year progresses?

So David, there was a couple of different factors that are really important. The first is that we returned to mid-teens new sales growth, which I was very pleased with. The market is accepting the products. The PEPMs were higher, which was really important from my standpoint, and they were pretty much higher across the board. And the mix was good, which was also important.

So I think that the vertical products, which command somewhat of a premium price, have taken hold. And obviously, there's still more work to be done to grow the Main Street product, which has a slightly lower PEPM. And I also think that the tax reform is a benefit to small businesses. And we're going to continue to focus on the strategy, which is retention of the sales force, increase in productivity and selling the value, which increases the PEPMs.

And just on that, the sales force and the attrition and the better performance in the quarter. I don't know if we have these comparable numbers on a year-over-year basis or not, but how much of that do you think was actually driven by product and all the things that we've been talking about versus maybe easier comparisons in the prior year? And are you still expecting positive sales growth for the year, which is, I think, something we talked about last quarter?

Yes, look, I think the first driver is retention of the sales force. So retention of sales force is up significantly year-over-year. So I would put that #1, to be honest. They have to get productive. Once they're productive, it's incremental net new PEPM for the company, I expect that to continue. I'm happy with both the strategy and the leadership of our new sales executives, who have now been in the saddle about 6 months. And then, second is the traction that the vertical products are getting in the market. And finally, the comparison I would say is that since Main Street is a little lighter, what you're seeing is higher PEPMs on average, because the mix of Main Street is less.

If I could just add to that, David. All the verticals performed well. And as we have said, most of last year, all the verticals, with the exception of Main Street, were growing with or faster than the market. And we saw that happen again in Q1.

Okay, got that. And then, I guess, looking at the underlying kind of dynamic that you guys talked about. We have one more cohort of clients to renew, I guess, in the June quarter. So maybe you could talk a little bit about just how the growth in the underlying core is, ex that migration? So in other words, if we break out WSE growth, is the non-SOI portion still growing, I guess, at market rates, which we would consider around 10%, with the balance of the decline coming from SOI? Or is there a different underlying dynamic in the mix?

No. So clearly, the decline was driven only by the SOI migration. The other segments, as I said earlier, are actually growing with or higher than the market. So we were quite pleased with how the quarter performed.

In 2Q, it is really just the tail end of the SOI population we'll have left, due to the repricings and mix. And we really now see ourselves continuing in that high single-digit, low double-digit as a company. You know, it will really start sequentially, as Burton had said in his comments, in the back half of the year. But you're starting to see the headlights to that in current new sales.

Our next question comes from Tien-tsin Huang with JPMorgan.

Just a follow-up to David's question, when if -- when you return to growth in WSE or volumes in the second half of the year as you mentioned, can we still expect a similar result in revenue per WSE? Just curious how that might compound your -- what you're seeing in terms of revenue per WSE on the PS revenue side -- sorry, professional services revenue per WSE?

We'll still see, as the year progresses, that the -- the Main Street is still catching up as a percentage of the total population. So it will be a little bit heavier than how you normally would have seen it historically. But as Main Street continues to ramp, with that clearly comes in at a slightly less PEPM.

That being said, overall for the year, we have been very happy with what we saw with our PEPM growth rates. So we continue to sell the value of our product set and that's really in a pretty disciplined way, in what we would say is good solid revenue.

Yes, makes sense.

And Tien-tsin, just to add to that, the other thing I'm particularly excited about is the attach rate of medical benefits. So I -- it's tangential to your issue of PEPM, but that's significant for me, to have the declining WSE and an increase of 5% in my medical attach rates. So it's -- I think that that's going to have a positive effect in the back half as well, even on the SOI book of business.

And remember, what we've seen is the people that have left us tended not to take medical. So as a percentage of the book of business that remain, they are a higher percent at [peak] medical. So as Burton said, the 4% that we saw grow in the base business, compounded with the SOI book of business that stays that takes medical, bodes well for that side of the business.

Okay, yes. No, it seems like a natural hedge, as you're going through this migration of SOI, you see some of this uplift and then -- so it sounds like it's more back to normal. Okay, I get it.

I think the -- my follow-up question, just on sales and marketing, I caught the $9 million. Just curious how to tie the strong sales -- the -- the new sales performance you said sounded quite good. I would have expected a bigger sales and marketing sort of number, adjusting for the 606 piece, the $9 million. Am I missing something else that's in the sales and marketing piece maybe this quarter?

No, it's $9 million for 606. We benefited $1 million for the good on the revenue side and that's the total associated with 606.

So the other pieces, though, is we're just being prudent as we manage the business. I think that what you're seeing is, as Burton said, Barrett coming in has been very disciplined with how he is executing the sales team. So we're very happy with that.

Your next question comes from Timothy McHugh with William Blair.

Just following up on that, I guess, I get -- I'm trying to understand the -- I guess the underlying question is as you get past some of the SOI migration challenges, do we need to see the sales force growth accelerate a lot and for sales and marketing expense to come up as growth improves? Just -- I'm sure part of the underlying question is what's normal there as we go forward the next few years?

No, so we'll continue to grow our sales force, as we said. We grew the direct sales piece this quarter. There's a mix going on underneath there, though, so there's some pieces that were not direct that we don't necessarily have to grow at the same rate.

We will, in the back half, you will see more dollars spent on the marketing side of the engine, especially with Michael coming onboard, and we've kind of highlighted that when you see Q2 forecast and the back half forecast. So going into the busy part of our season, Q4 especially, you will see a definite uptick in marketing.

Okay. And I guess, the $9 million, the 606, is that a fairly constant number for the rest of the year? So if we think of full year, a boost of $36 million?

That's about right.

And is that right then that you get -- you lose half of that in '19 and then the rest, it normalizes fully in '20?

It takes 3 years to become normal. So 1/3, 1/3, 1/3, it will normalize that out.

Okay. And then, second, just the sequential, the comment about the second quarter. I felt, Burton, in your remarks, you talked about health care pricing, but then you've also talked about the bigger kind of SOI migration. I know there's some linkage, but I guess, what's the driver of the attrition still in Q2 more so? Is it both? Is it more one than the other, as we think about it?

So what you have is there's a subset of people that left on the last day. They will be up for a full quarter, so it will pull down our average WSE count in the quarter. As we start to backfill that, that will all be back end of the quarter, so it doesn't move the needle a lot on average WSE count, which drives the revenue element of that. Going forward, that's why we talk about the back half of the year and sequentially back half of the year.

(Operator Instructions) Our next question comes from Vasu Govil with Morgan Stanley.

Quickly, first, I wanted to follow up on that ASC 606 impact. I think you said it would be $36 million for the year. I think, last quarter, you kind of mentioned $25 million, if I'm not mistaken? Was there any change in the estimate -- estimated impact from...?

That one is -- we didn't give the precise number, but there's also revenue in there. So when I gave the total, you have revenue impact and cost impact.

Understood. So there's no real change from what you were expecting before?

No. Correct.

Got it. And then on -- I know you guys called out the mid-teens new sales volume growth number. I don't know if you've given that number in the past. I was just looking for some comparability versus how that had been performing the last few quarters?

We have not given that out historically. We are trying to give some people some headlights to how the year is progressing. As we've said publicly before, we should be growing with the market, which we think is high single-digit, low double-digits.

Got it. And then, on just the sales force improvement and retention, I'm wondering if you can share any metrics around sales force productivity improvement, to give us a sense of like the magnitude of improvement you are seeing versus the need to hire new sales?

Yes, so what Burton had alluded to is we've seen our -- the number of people leave the firm year-over-year has reduced by half. And so that -- the second piece of that is the people that stayed now are much more productive. So our least productive employees are the people for the first 18 months. So a large portion, several -- almost 10% of that business now is now getting into their productive phase. So we are feeling pretty good about that as the year progresses.

Got it. And just a very last one. On worksite employee growth, I know you've guided to sequential improvement in the back half, but now we're almost done with April. So I'm guessing you have good visibility into what the attrition levels would be in the second quarter? I mean, how are you thinking about year-on-year growth in WSE exiting 2018?

We don't give forecast WSE growth for the year, but you can imagine it would be suppressed through the first half and then we'll see it accelerate in the back half. And we're not going to give guidance out for that.

And this concludes our question-and-answer session, as well as today's conference. We thank you for attending today's presentation and you may disconnect your lines at this time.