TriNet Group Inc (TNET) 2018 Q3 法說會逐字稿

Good day, and welcome to the TriNet Group, Inc. Third 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. Please go ahead.

Good afternoon, everyone, and welcome to TriNet's 2018 Third 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 third quarter operating and financial performance. Richard will then review our financial results in more detail. We'll then open up the call for the Q&A session.

Before we begin, please note that today's discussion will include our 2018 fourth 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 risks, uncertainties and changes in circumstances 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 the risks, uncertainties and changes in circumstances 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, adjusted EBITDA margin 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 third 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 also available on our website.

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

Thank you, Alex. We are pleased with our strong financial performance during the third quarter. We generated solid revenue and earnings growth as we continue to target both new and existing customers with the right products and services at the right price, driving our PEPM and bottom line. Given the increased competition for talent across the economy, TriNet's competitive, industry-specific HR offerings are proving to be of increasing importance for our SMB clients as they seek to secure and maintain employees. We believe the strength of our revenue growth reflects how important TriNet and its offerings are to our clients.

In the third quarter, we grew GAAP total revenues 7% year-over-year to $875 million, and we grew our Net Service Revenues by 11% year-over-year to $228 million. In Q3, professional service revenues grew 6% year-over-year to $119 million. Professional service revenues in the quarter benefited from a shift in client mix towards our white-collar verticals. We also grew insurance service revenues by 7% year-over-year to $756 million, while Net Insurance Service Revenues grew 17% year-over-year to $109 million for the quarter. Net Insurance Service Revenues in the quarter again benefited from the change in economic arrangement with one of our carriers, lower than expected health costs and favorable workers' compensation performance.

Our Q3 GAAP earnings per share grew 18% year-over-year to $0.71 per share, and our Q3 adjusted net income per share increased 35% to $0.75 per share. We finished the quarter with over 317,000 worksite employees, down 2% year-over-year. Throughout 2018, we have seen a mix shift to our white-collar verticals. The financial impact of this client mix shift has been to grow total revenues and professional service revenues by growing our PEPM and realizing increased utilization of our entire value proposition. Our vertical market strategy allows TriNet to understand and serve the needs of each industry as it relates to HR expertise, benefits, risk and compliance, payroll and mobile access. We also continue to make long-term strategic investments necessary to drive future growth while growing earnings in the quarter.

For example, in Q3, we launched a comprehensive rebranding of our company, with a multifaceted marketing campaign that spans social, digital, television, radio and out-of-home media, all designed to raise awareness of TriNet, its offerings and the value TriNet can deliver to our targeted audience, small- and medium-size businesses. Our new brand campaign highlights the entrepreneurship, ingenuity and determination behind thousands of SMBs that form the backbone of our country. Our tagline, "Incredible starts here," celebrates our nation's SMBs, from Main Street to Wall Street, affirming their passions, their drive and their dedication to delivering nothing short of incredible. An example of the reach and impact of our reinvigorated marketing campaign is happening right now in New York City, running for the entire month of October. If you have passed through Grand Central Terminal this month, you will have seen TriNet's station invasion, an advertising campaign with approximately 150 TriNet billboards throughout Grand Central, where an average of 200,000 commuters pass through each day.

We are excited for our rebranding program, which is in support of our marketing campaign and coordinated with our sales teams. While still early in the campaign, we are pleased with the results to date. As we look forward, we expect to continue benefiting from our disciplined go-to-market approach and the mix shift to our white-collar verticals while continuing to focus on long-term strategic investments and delivering solid financial performance.

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

Thank you, Burton. As we review the financials, I will focus on the GAAP and non-GAAP numbers where appropriate. During the third quarter, GAAP total revenues increased 7% year-over-year to $875 million. Net Service Revenues increased 11% year-over-year to $228 million. We finished the third quarter with over 317,000 worksite employees, down 2% year-over-year. Average WSE count for the third quarter was over 318,000, down 2% year-over-year.

Professional services revenues for the third quarter increased 6% year-over-year to $119 million. Professional service revenues continued its recent trend by benefiting from improved pricing and a client mix shift towards our white-collar verticals. These benefits were offset by reduced average WSEs.

Insurance service revenues for the third quarter increased 7% year-over-year to $756 million, and Net Insurance Service Revenues increased 17% year-over-year to $109 million. Net Insurance Service Revenues benefited from the change of economic arrangement with one of our carriers, lower-than-expected health care costs and favorable workers' compensation performance. In the 4 quarters since we announced the change to the economic arrangement with one of our carriers, Net Insurance Service Revenues received a total benefit of $32 million, of which $26 million was received in FY '18.

Our GAAP effective tax rate was 16%, primarily due to the 2017 tax reform legislation and the tax treatment of employee equity compensation. For the quarter, our non-GAAP tax rate was 26%. GAAP net income increased 20% year-over-year to $51 million or $0.71 per share compared to $43 million or $0.60 per share in the same quarter last year.

Adjusted net income increased 35% year-over-year to $55 million or $0.75 per share, compared to $41 million or $0.56 per share in the same quarter last year.

Adjusted EBITDA for the third quarter increased 9% year-over-year to $88 million, compared to $80 million during the prior year period, for an adjusted EBITDA margin of 38%. Adjusted EBITDA benefited in the quarter from the performance of Net Insurance Service Revenues, which was partially offset by increased OpEx. As discussed on our second quarter earnings call, our investment in both our marketing campaign and process improvements contributed an incremental $10 million in OpEx during the third quarter. This binge continued in the fourth quarter.

We closed the third quarter with total cash of $237 million and working capital of $226 million versus $202 million and $188 million, respectively, in the second quarter of 2018. We ended the third quarter with $169 million of corporate cash invested in our investment strategy. Historically, the cash used to purchase these investments would have been included in our total cash and working capital calculations.

During the third quarter, we generated $76 million of positive corporate cash flow from operating activities and paid out $9 million, primarily comprised of WSE-related payroll tax obligations. As a result, total cash inflow from operations were $67 million. We spent approximately $17 million to repurchase approximately 301,000 shares of stock in the third quarter, leaving approximately $90 million authorized for share repurchase as of quarter end.

Turning to our fourth quarter outlook. I will provide both GAAP and non-GAAP guidance. For the fourth quarter, we expect GAAP revenue in the range of $903 million to $917 million, representing year-over-year growth of 7% to 8% and Net Service Revenues in the range of $203 million to $217 million, flat to up 7% year-over-year. Adjusted EBITDA is expected to be in the range of $58 million to $72 million for the quarter, representing an adjusted EBITDA margin range of 28% to 33%. We expect Q4 GAAP earnings per share in the range of $0.28 to $0.46 per share, and Q4 adjusted net income per share in the range of $0.42 to $0.56 per share. As a reminder, during Q4 2017, GAAP earnings per share received a $0.56 per share benefit due to the revaluation of our deferred tax liabilities under the Tax Cuts and Jobs Act of 2017.

Turning to full year 2018 guidance. We now forecast GAAP revenues to be approximately $3.5 billion, which represents year-over-year growth of 7% and is at the bottom end of our previous guidance range. We raised our full year Net Service Revenue guidance range to $872 million to $886 million, which represents year-over-year growth of 8% to 10%. We raised our 2018 adjusted EBITDA guidance range to $335 million to $349 million, representing an adjusted EBITDA margin range of 38% to 39%, a 1- to 2-point increase when compared to our previous guidance. We now expect full year GAAP earnings per share in the range of $2.54 to $2.72, a $0.26 increase when compared to our previous guidance. Regarding adjusted net income per share, we are raising our guidance range to $2.85 to $2.99, a $0.27 increase when compared to our previous guidance. For FY '18, we are modeling a pro forma tax rate of 26%.

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

Thank you, Richard. U.S. economic growth remains strong and small business optimism remains at an all-time high. Our clients are growing and competing for talent in the tightest labor market in over 40 years. Against a strong economic backdrop, our products are resonating in the marketplace. We continue to focus on our disciplined go-to-market approach to support profitable growth as we target the right customers at the right price with the right products and services.

As we look forward to 2019 and become more adept in addressing the specific needs of our targeted verticals, we will continue to tailor our solutions to offer more value to our clients.

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

(Operator Instructions) Our first question comes from Tien-tsin Huang with JPMorgan.

Just want to say upfront that I've been seeing a lot of the ads in Grand Central myself, so they're pretty well placed, I got to say. My question...

Thanks, Tien-tsin.

No problem, got to pay attention to this stuff. I guess my question is on the insurance revenues side. You mentioned the 3 factors that drove the upside, the repricing, workers' comp mix and the health cost being better. Can you maybe quantify those 3 for us in some way or at least maybe prioritize them for us?

I think I would rather prioritize them. The first piece I would say is, if you look at the cost, that when we say at any point in time in a quarter, we could have a plus or minus 2% around the cost. In Q3, we saw that coming at the lower end. And so therefore, that flowed to the bottom line, it flowed to the full year. So that's the single-biggest. If you look at the prior period adjustment for workers' comp, you'll see in the Q, that was around $4 million. And then the remainder is the rest.

Great. Good to know. That's helpful. Then on the, I guess, worksite employee maybe a little bit lighter than what we had and perhaps what you had expected. I heard the mix shift to white-collar, but any surprises in terms of new sales or retention or just the competitive front on worksite employees?

Yes. So Tien-tsin, let me give you a little bit of color from my perspective. I was pleased with the worksite employee volume mix. And obviously, as you could see, it allowed us to drive professional service revenue up 6%. We're certainly continuing to sell all clients across all verticals that value the offering. One of the interesting things is that health enrollment is up 6% year-over-year with 4% just in the third quarter. I'm particularly pleased about the continued double-digit growth in both technology and life sciences verticals. And another point I'll make is that we grew our client base, meaning the clients, by 12% year-over-year to over 16,000. So I'm excited about the target market. Although there's volatility in the equity markets, my belief is the underlying fundamentals in the U.S. economy are still very strong, and I think it's a tailwind for small businesses in America.

Our next question comes from David Grossman with Stifel Financial.

I'm wondering if you could just go back -- just back to the underlying components of growth in the quarter. And maybe -- I know you don't like to disclose how the Main Street product is going versus the white-collar. You alluded to mix. But can you give us any color on what that dynamic is, both sequentially and year-over-year? And whether you still think based on that mix shift whether we should expect to see sequential unit growth in the fourth quarter?

So let me first talk about Main Street. You can take it from there, Rich. So Main Street has returned to year-over-year growth, David, and also the PEPM on Main Street is up year-over-year. I believe that we're getting more refined about that Main Street vertical and pursuing prospects who appreciate the entire value proposition that TriNet delivers, including transaction excellence, HR, compliance, benefits. And we continue to focus on price to risk. So the disciplined approach that we put in place with the other verticals over the last couple years we're now applying to every prospect and customer, including our Main Street verticals. So I believe that Main Street will continue to grow and be a strong vertical for TriNet.

Yes, if I could just add to that. I think what you see also is a continued mix difference between this year and prior years, where we have more in white-collar and less in blue-collar. And so then you're just continuing to see that PEPM improve. You also see because of that they tend to be a little smaller in size. And so therefore, you can drive PEPM that way as well. So both of those things, David, are leading us to -- and then we haven't backed away from a very disciplined way that we go to market. And we're pricing our health and workers' comp to the right risk premium and profiles. So therefore, we think all those things over time we'll take on and we'll continue to see growth as we exit the year and clearing for the back half of next year.

Our next question comes from Tim McHugh with William Blair.

Just to follow up on that. I guess if Main Street is growing year-over-year, what part is declining?

So the Main Street comment that Burton talked about are new sales. So you still have a piece of the old installed base that was leaving us as they come due and they circle around. Our new sales on Main Street are picking up, but there was downward pressure in the first half, first 3 quarters of the year which drove the average down year-over-year.

Okay. And then just on that new sales. That was part of the prepared remarks, I think, the last couple of quarters. If you gave it this quarter, I didn't catch the color. How would you contrast the momentum in new sales overall versus kind of what you'd been talking about the last 2 quarters?

It continues to expand year-over-year. We continue to see the same mix as before. So our annual contract value continues to grow. We're pretty comfortable, as we said, over time that we believe we should be able to grow the installed base high single digits. Clearly, we're not there yet, but we think we will be on track as we move into the back half of next year.

Okay. And then I didn't catch it, I think the earlier question tried to ask, like would you expect to be showing sequential or year-over-year growth or any sense of when we would get back to -- sorry, sequential growth, and any sense of when we would get back to year-over-year growth in WSEs or what would be your expectation at this point?

Yes. Earlier in the year, we were getting a lot of sequential growth because we wanted people to understand the impact that the migration was having. So we've tended to deemphasize that and gone back to the traditional year-over-year growth. We think we'll be up slightly. But really, that will have a lot more to do with how we end the year and how we move into the first part of next year. So we think we're setting ourselves up with new sales moving forward, as Burton talked about. We're starting to hit all the right elements. We're happy with the mix that we currently have between blue and white-collar. We're happy with how we're pricing the risk.

Okay. And then I guess...

So let me add to that for just one second. ACV, new sales growth was double digit in the quarter. And I will point you to the fact that professional services revenue is up 6% even with a 2% WSE volume decline.

Okay. And then on insurance, the net insurance margin, I guess, this year, besides the kind of structural shift in that one arrangement. You have the lower health care cost, which I don't think is kind of a permanent item you would extrapolate and then the prior period adjustments. Just trying to get a sense of any updated thoughts on the medium term net insurance margin that you think is reasonable and those last 2 pieces we should carry forward?

Right. So I think the way to think about it, in Q3, we were up a little over 14%, which is above what the guidance we had given, which was the 11% to 13% as we started the year. Clearly, we think we'll end the year much higher to the 13% range -- inside the 13% range, we should be. There was about 1 point of prior period adjustment which should not repeat itself.

Okay. And I guess how much is the better-than-expected health care costs contributing to that then if we weren't going to carry that forward?

No, the point is, I think I just gave you kind of the goalpost, right? So that's about as much as we're willing to give at this point in time about next year and beyond.

Our next question comes from Kevin McVeigh with Crédit Suisse.

Just to follow up on that. So it sounded like there was a $32 million benefit from kind of the change in economic arrangement. If I heard it right, was there $26 million in 2018? Does that mean there's another $6 million that will benefit '19 or was that back in '17?

That was in Q4 '17, the $26 million is for this year. So it came in right what we had said back in '17 at the $32 million. That economic arrangement allows our -- that's more about fee statement, so that allows us moving forward. But from a year-over-year, we will not have a year-over-year improvement, but it's built into the base.

Got it. And as you look out into 2019, is there anything out there that's similar to this that could kind of keep the kind of ratio similar to where they are? I mean, historically, the professional, the insurance has been kind of 2/3, 1/3. Today, you're almost at the kind of 50-50, not quite that, but does that relationship start to normalize again? Or just given the outsized outperformance, we're just trying to get a sense of where that settles.

Right. So as I had said earlier, there was about 1 point of prior period adjustment that we don't anticipate going forward. So that's probably the only thing that we would say. We're going to continue to pull on all the other financial levers we have in the company, so whether they come in costs or OpEx or other elements that allow us to continue to grow our margin over time.

Got it. And then just can you help us, where was attrition in the quarter kind of currently? And where do we expect that to kind of end the year?

Yes, we don't give out an attrition number.

But I would say, it's better year-over-year. So it's moving in the right direction from my standpoint, Kevin. And we're making tremendous investments, as we talked about, for next year. I believe that they should pay off. They're not only in the marketing area, but process improvement, which is directly related to client retention. And we will absolutely continue to remain disciplined around the pricing to risk and the proper customers for each of the verticals that we target. And finally, as I said earlier, there's volatility in the equity markets, but we see our target market as being strong.

Our next question is a follow-up from David Grossman with Stifel Financial.

Sorry, I had my button on mute here. I wanted just to follow up the kind of unit versus pricing question. Is the model shifting at all? And as we look at least over the next 12 months, I know you said you hope to return to kind of high single, low double digit unit growth. But how long does it take to get back to that model just so we can calibrate our expectations around how this dynamic between unit growth and pricing should play out at least over, let's say, the next 15 months?

Great. So the way to think about it, as Burton alluded to, you saw our revenue continue to grow even though our WSE on average was still down. That has a lot to do with the current mix of customers that we have and the way we're pricing them. We know that there's price elasticity in the marketplace. We know that our go to market on a vertical allows us to deliver the right product at the right price. That's been well received. We know the way we have our health and workers' comp priced with the growth of the book, even though the overall WSEs are shrinking so that we have a lot of things that we think are positive momentum for the company that are allowing us to price to risk over time. When you look at the current book of business, it clearly has a higher propensity of white-collar than Main Street only because as we started to ramp through the year, you're seeing more white-collar as a disproportionate amount, and that's why you heard Burton talk about a couple of verticals that actually are performing -- or outperforming this year. So that will continue through the first half of next year, and then you'll continue to see the overall book of business continue to grow back.

So is the white-collar business growing in that high single digit range right now or is it...

Yes. We're doing very well in that book of business.

And I specifically called out tech and life sciences. I think one of the challenges is, we have got 6 very discrete products so price times volume doesn't quite work as well with our model, where we're targeting the right customers at the right price. There is a significant difference in pricing between Main Street and some of the other verticals. So it's very important to understand that the 6% growth in professional services revenue is not a price times volume equation. It is a mix shift. It is a target of the verticals that we're pursuing. And it is a recognition of the fact that PEPM is going up across the board, including in our Main Street vertical.

Got it. And just back to the expenses as it relates to the change in the relationship in the fourth quarter last year with one of your carriers. Is there any benefit that we continue to get in the fourth quarter? I just can't remember if...

Yes. It's a wraparound effect. It's just not a year-over-year increase. It's the same benefit that we received last year going forward.

Got it. Got it. Okay. So you got a full quarter last year, right?

Correct.

Okay. And then just one last question, just on the competitive landscape. Burton, there's kind of been a mixed bag among your 2 larger competitors out there in terms of one doing a little worse and one doing a lot better post an acquisition. Any thoughts on kind of how that plays out? I know you're just getting back into a growth mode in one of your segments. But any thoughts on the competitive landscape, how it's shifted here in the last 6 to 9 months and how it's impacting TriNet?

So look, I think there's plenty of market for everybody. It's a great market. And as you say, this has been a very interesting year for TriNet with the consolidation to one platform, one single payroll engine, a refocus on the core verticals that have made us successful. The branding campaign, I'm seeing significant top-of-the-funnel activity now. And ultimately, I'm pretty excited about the U.S. economy. So I don't see a very significant difference in the competitive landscape, but I believe there's an opportunity for quite a few companies to be very successful based on the market we're in.

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