TriNet Group (NYSE:TNET) Q4 2018 Earnings Call

0:00 Good day, everyone, and welcome to the Trinet fourth quarter and full year 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. And to withdraw your question, please press star, then two. And please do note that today's event is being recorded. And I would now like to turn the conference over to your host, Alex Bauer of Investor Relations. Please go ahead with your presentation. Thank you, operator. Good afternoon, everyone, and welcome to Trinet's 2018 fourth quarter conference call. Joining me today are Burton M. Goldfield, our president and CEO, and Richard Beckert, our chief financial officer.

0:47 Our prepared remarks were prerecorded. Burton will begin with an overview of our fourth quarter operating and financial performance. Richard 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 2019 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, 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.

1:48 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 10K and 10Q 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-K filing for our fourth quarter and full year of 2018, respectively, both of which are available on our website or through the SEC website.

2:46 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. Our very strong 2018 financial results highlighted our commitment to provide our clients with extraordinary human resources solutions. By executing our core strategy of targeting the right clients with the right vertical products at the right price, we delivered our value proposition and strong financial performance to our shareholders. In the fourth quarter, we grew GAAP total revenues 8% year-over-year to $917 million, and we grew our net service revenues by 10% year-over-year to $225 million.

3:36 Professional service revenues grew 6% year-over-year to $124 million. Professional service revenues in the quarter continued to benefit from our shift in client mix towards our white-collar verticals and customers within Main Street that value our comprehensive solution. We also grew insurance service revenues by 8% year-over-year to $793 million, while net insurance service revenues grew 16% year over year to $101 million for the quarter.

4:27 Net insurance service revenues in the quarter benefited from improved workers' compensation performance. As a reminder, a year ago, GAAP net income for the fourth quarter received a 56 cent per share benefit due to the Tax Cuts and Jobs Act of 2017. As a result, Our Q4 GAAP earnings per share contracted by 57% year-over-year to 40 cents per share, while our Q4 adjusted net income per share increased 28% to 59 cents per share. For 2018, we grew GAAP total revenues 7% year-over-year to $3.5 billion, and we grew net service revenues 10% year over year to $893 million.

5:22 We increased gap earnings per share by 6% to $2.65 per share and we grew adjusted net income per share by 52% to $3.02 per share. 2018 was not only a year of strong financial results, it was a year where we strategically invested in our business to drive growth over the long term. Specifically, we completed the migration of our installed base to one platform. We launched our new brand and marketing campaign that celebrates our nation's small and mid-sized businesses.

6:13 We remediated our final material weakness. We continued our efforts to further improve our processes and client experience, and we launched Trinet Professional Services, our sixth vertical product. Our deliberate effort to structure our products and services to our core verticals drove our strong 2018 financial performance. As a result, we experienced higher participation rates in our health programs and improved workers' compensation performance, which positively impacted Net Insurance Services revenue.

7:00 We are also pleased to have finished the quarter with approximately 326,000 worksite employees, flat year-over-year and up 2% sequentially. Throughout 2018, we experienced elevated attrition due to our planned platform migration, which is now complete. This anticipated attrition masked the strong hiring within our install base and our improvement in new sales. We are deliberate in the service of our six verticals. Technology, Financial Services, Professional Services, Life Sciences, Nonprofits, and Main Street.

7:52 TriNet is addressing their distinct needs and challenges. We accomplish this by leveraging our unique technology, service models, and price points. Our focus is on pursuing dynamic, small and mid-sized companies The backbone of American businesses and innovation. We pursue these businesses with our comprehensive HR products and solutions that include the following common capabilities. HR expertise, benefit options, payroll services, risk mitigation, and our technology platforms. Trinet's comprehensive HR solution is a differentiator for our SMB clients versus their competition as they seek to secure and retain employees in a historically tight labor market.

8:57 Our vertical strategy positioned us to benefit from higher U.S. labor market participation rates and historically low unemployment rates in 2018. This employment dynamic positively impacted us as we realized strong hiring across our installed base. In addition to the strong hiring within our installed base, we made progress with new sales in 2018. 2018 was our second year compensating our sales team on ACV, or annual contract value.

9:42 We continue to benefit from this compensation structure as our salespeople sell the value of our services. This resulted in strong professional service revenue growth. In January, we refreshed our mobile app to address the needs of an increasingly mobile workforce. This provides our clients and their employees with more in-depth real-time information on pay, paycheck history, benefits, time off requests, and company directory. We also added an in-app messaging feature that allows employees to communicate and collaborate instantly on one unified platform.

10:36 The new mobile update will help our clients handle HR, and payroll on the go so they can keep the vital tasks of their businesses moving forward without being tied to a desk. Our process improvement initiative includes further automating and improving operations and procedures. This strengthens our ability to keep our customers at the center of everything we do. We believe a key to our long-term success will be leveraging our scale through automation and improved processes. As we become more efficient, our customers will benefit from an improved experience as our products and services are delivered more consistently.

11:26 Our shareholders will benefit from our lower cost to serve and ultimately higher client retention rates. Finally, I am pleased to announce that our Board of Directors authorized an additional $300 million for our Share Repurchase Program. The expansion of our Share Repurchase Program leverages a core strength of our business, strong and consistent cash generation. Now, let me turn the call over to Richard for a review of our financials. Richard? 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 total revenues increased 8% year-over-year to $917 million.

12:18 Net service revenues increased 10% year-over-year to $225 million. We finished the fourth quarter with approximately 326,000 worksite employees, flat year-over-year and up 2% sequentially. Average WSE count for the fourth quarter was approximately $322,000, flat year-over-year. Professional service revenues for the fourth quarter increased 6% year-over-year to $124 million. Professional service revenues benefited from improved pricing and our shift in client mix towards our white-collar verticals and those Main Street clients who value our comprehensive solutions. Insurance service revenues for the fourth quarter increased 8% year-over-year to $793 million, and net insurance service revenues increased 16% year-over-year to $101 million.

13:10 Net insurance service revenues in the quarter benefited from continued strength in workers' comp and reduced administrative costs. Our fourth quarter gap effective tax rate was 31%. Our tax rate in the quarter was impacted by higher state taxes, and a reduced benefit from tax treatment of employee equity compensation. For the quarter, our non-GAAP tax rate was 26%. As Burton noted, a year ago, GAAP net income for the fourth quarter received a 56 cent per share benefit due to the Tax Cuts and Jobs Act of 2017. GAAP net income decreased 57% year-over-year to $29 million, or 40 cents per share, compared to $66 million or $0.92 per share in the same quarter last year.

13:58 Adjusted net income increased 27% year over year to $42 million or $0.59 per share compared to $33 million or $0.46 per share in the same quarter last year. Adjusted EBITDA for the fourth quarter increased 2% year over year to $70 million compared to $69 million during the prior year period for an adjusted EBITDA margin of 32%. As previewed on our third quarter earnings call, adjusted EBITDA was impacted by increased OPEX as we invested in our marketing and process improvement initiatives. We closed the fourth quarter with total cash of $228 million in working capital of $221 million versus $237 million and $226 million, respectively, in the third quarter of 2018. During the fourth quarter, we generated $50 million of positive corporate cash flow from operating activities and generated $322 million, primarily comprised of WSE-related payroll tax obligations.

15:03 As a result, the total cash inflow from operations was $372 million. We spent approximately $14 million to repurchase approximately 295,000 shares of stock in our fourth quarter. As Burton stated, our Board of Directors authorized $300 million expansion of our share repurchase program. Turning to our 2018 full-year results, we grew GAAP total revenue 7% to $3.5 billion, and we grew net services revenue 10% to $893 million. Total adjusted EBITDA increased 22% to $347 million, with an adjusted EBITDA margin of 39%. are year-over-year improvement of four percentage points.

15:48 The increase in margin was largely attributable to our insurance cost savings from reduced administrative costs and favorable claims experience. GAAP net income in 2018 increased 8% to $192 million, or $2.65 per share, and adjusted net income increased 53% to $218 million, or $3.02 per share. Our 2018 GAAP effective tax rate was 20%. For the full year of 2018, we generated $234 million in corporate cash flows, and we spent $43 million in capex, or approximately 5% of our net services revenues. We spent $61 million to repurchase approximately 1.2 million shares of stock.

16:36 Turning to our first quarter in 2019 outlook, I will provide both GAAP and non-GAAP guidance. We expect continued elevated attrition through the first half as the impact from our platform migration lingers longer than initially anticipated. Our 2019 GAAP net income forecast assumes a 22% tax rate, while our non-GAAP adjusted net income assumes 26% tax rate. Finally, both our GAAP earnings per share and our adjusted net income per share forecast assumes 72 million diluted shares unchanged from our 2018 assumption. FY19, we are forecasting gap revenues in the range of $3.7 to $3.8 billion, which represents year-over-year growth of 5% to 8%.

17:21 We expect net services revenue in the range of $906 to $933 million, which represents year-over-year growth of 2% to 5%. Adjusted EBITDA is expected to be in the range of $380 to $390 million, representing a 42% adjusted EBITDA margin for fiscal year 19. We expect GAAP earnings per share in the range of $2.94 to $3.07, and adjusted net income per share in the range of $3.34 to $3.47. For Q1 2019, we expect GAAP revenues in the range of $917 to $927 million, representing year-over-year growth of 7% to 8%, and net services revenue in the range of $225 and many more.

18:39 With that, I'll return the call to Burton for his closing remarks. Thank you, Richard. I would like to thank the entire TriNet team for a successful 2018. We have developed a unique go-to-market strategy and a customer experience that adds value to the verticals we serve. The per-employee, per-month growth we realized in 2018 demonstrated both the value we provide our clients and the quality of our earnings, trends we expect to continue in 2019. For 2019, we are forecasting our adjusted EBITDA margin to expand by approximately 3% and our adjusted net income per share to grow between 11% and 15%.

19:33 We have delivered a financial model which is levered to WSC growth, and we look forward to updating you on our progress throughout 2019. With that, I'd like to turn the call over to the operator. Operator? Thank you, and we will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. And at this time, we will pause momentarily to assemble our roster. And today's first questioner will be Kevin McVey with Credit Suisse. Please go ahead.

20:19 Great. Thank you. Hey, nice job. Hey, Burton, I think you said in your prepared remarks that in the professional services segment, you're seeing a benefit from kind of white-collar customers Valuing the Services. Can you give us a sense of where you are in that process and how much further we can expect that in terms of maybe quarters, just thinking about that over the course of 2019 into 2020? Yeah, thanks, Kevin, and I appreciate the comment. Clearly, there's two things at play here. One is a mixed shift towards the white-collar business. But I would also say that there's been growth in new sales in the Main Street business with clients that value the entire value proposition. So we're seeing PEPM growth from our Main Street customers as well as the core verticals that you were talking about. I think over time, my expectation is all the verticals that we're servicing will grow over time but that mix shift that you're seeing right now will stabilize during the back half of the year.

21:33 And Kevin, we've been pretty consistent on saying over time we believe we should get to the high single digit, low double digit growth rate as you go outside of this fiscal year. Got it. And then, any sense, it sounds like what the attrition levels were like in 18 versus 17 and what we can expect for 19? Can you repeat the question? Sorry, Kevin. Yeah, sure, sure, sure. Sorry about that. Just any sense of how attrition's been trending over the course of 18 and what kind of rate we can expect in 19? Sure. So we had elevated attrition due to the migration, and we knew that that was going to happen, and we talked about that on our last call. We also talked about in the fall of 2018 that we would see... Although the migration is over, there's going to be a lingering effect of having the SOI migration ending at the fiscal year, and then the April timeframe will be the last of anyone who wanted to stay on because of health.

22:37 So that should be the end of that migration, and we should then be able to transition back to a more normal run rate, if you will, going forward on attrition. Got it. I'm going to add to that because it's a great question. We believe we hit the inflection point in April, which is the decision point for our legacy SOI install-based medical renewal, which as Rich said is the final hurdle on the migration. And don't see after that any other key point and then we see the growth from there. Got it. And is there any way to think about the sensitivity of, you know, from a revenue perspective, what 100 basis points of attrition can mean to revenue, if you were to frame that out?

23:29 It really depends. Every WSC is not the same. So if you think through, a lot of the attrition that you've seen is that the high-end SOI were on a WSC, they're lower PEPM. They tended to not have health. They also tended to not necessarily see the total value that we provide. So as you see us refocus our efforts, that's part of why you see the PEPM come up. And so it's a little bit hard to answer that question in any one way, but I think what you're seeing is as nutrition is abating, you're seeing our PEPM pick up because our new sales are coming in at a higher PEPM than what's leaving. Got it. Thank you. Thank you.

24:14 And the next questioner today will be David Grossman with Stifel Financial. Please go ahead. Thanks. Good afternoon. Good afternoon, David. It looks like the business is evolving pretty much kind of as you had articulated. And with that in mind, can you help us deconstruct a little bit some of the stabilization that you're seeing in the WSC count, helping us kind of understand what is kind of happening in the blue-gray business versus the white-collar business? and since there's so much that it's changed in this business over the last 18 to 24 months, could you maybe give us an update on just how the WC mix has changed from the last time you talked about it?

25:02 I think it used to be a third of the business was blue-gray and just wondering how that's morphed over the last several quarters. So as Burton had said, we are starting to see the uptick in the new year. You'll start to see Main Street come back on as a larger percent than it was in 2018. That being said, it'll take a while for that to really see any meaningful mix change. As we end in 2018, we definitely have a higher percentage of white collar than previous years. And also, and more importantly, inside Main Street, we have people that tend to take and our people that see the entire value so it's not just a price play. And so therefore, we're seeing a higher PEPM in both Main Street and the overall book of business.

25:51 So as we go into, you know, as this year kind of progresses then and you start layering in more growth in the blue-gray business, I assume that there'll be some dilution, though, to PEPM as that business ramps up. Is that the right way to look at it, even though they have a tendency to take more than the old SOI book had taken in the past? That'll probably happen more going into 2020. Got it. Okay. And then in the context of the margins, including the insurance margins, can you walk us through just the puts and takes? Because I know workers' comp has been a tailwind this year. And I'm just curious just how much of a tailwind that's been.

26:36 And I know, Burton, you talked about Starbucks. You finally got the last kind of material weakness remedied. So you've got several moving pieces that could affect margins as well as op-ex spending. So perhaps this would be a good time to just refresh us on what the major books intakes are as we go through 2019. Sure, Dave. So if you think about the workers' comp book of business, as we reprice that to the risk, it has allowed us on an ongoing basis to have a much stronger book of business for workers' comp. If you think about it from the attrition of people that have been attriting, it was people whose risk in us was not where we wanted, so some of them self-selected out, and that was their decision. When you move forward on the rest of the book of business and the way that we're looking at it, it Two things to really think about. We really expanded quite a bit in number of clients that we have.

27:32 So that also helps for you to demonstrate that you're seeing that mix happen in just the volume of new customers. When you go through into the actual margins, so now you're moving away from the insurance margin into the overall margin of the company, as we had said on our last call, Thank you for joining us today. The last piece of that, though, is as you're working your way down through the different elements, we overall have a much better command of the company.

28:28 And I think the overall business model, as you can see, is a margin that we're comfortable with, and we're comfortable with that going forward. And as we start to reach the growth rate acceleration, that just helps with the bottom line margin expansion. Right. And did you say 300 basis points of the over-year EBITDA margin expansion in 2019? Did I get that right? Okay. And the last question really is for you, Burton. I think Rich has touched on this, but can you explain to us, you know, we started with one sales strategy and model and we evolved that, you know, kind of after the first year or two. And just wondering now with all these transitions largely behind you, can you just update us on what you're thinking about in terms of go-to-market, Salesforce ads and productivity? I know you don't want to give specific numbers on Guiding to a number of people. Anything you can do to help us understand what those investments that you're making are and when you expect them to start manifesting themselves in bookings and revenue.

29:35 I love talking about this subject. What I can tell you, David, is that we invested in sales headcount, which grew double digits in 2018. Second, as we've talked about in the past, I'm very focused on keeping the new salespeople and developing them into highly productive sellers. One indication is that we grew our client base in 2018 14% year-over-year in clients to 16,900 approximately clients on the book of business. So we're selling broadly within the verticals that we're starting to penetrate.

30:22 I think we're in the early stages of seeing we have incrementally increased productivity between 17 and 18, but I believe there's much more to do there as we start to understand the verticals and focus on those verticals in each of the geographies. I am optimistic about the growth of the sales force and those new sellers becoming productive. Ultimately, the go-to-market strategy is very unique by focusing on these verticals, and I believe it will pay dividend now that we have better insight into our business and our service models.

31:07 And so how did retention in the Salesforce trend in 2018 on a year-over-year basis? Great question. The new sellers are staying, which was the concern that I echoed a year ago. But I want to see them pass the one-year mark and get highly productive in their second year. But early indications are good with the new sellers that we're hiring. All right, got it. Thanks very much. Thank you. And as a reminder to everyone, it is star then one if you would like to ask a question today. And our next questioner today will be Tim McHugh with William Blair. Please go ahead. Hi, good afternoon. This is actually Trevor Romeo on for Tim.

31:52 Thanks for taking my call. Just wanted to ask, we've seen strong results lately from just about all the PEO companies we follow. Just wondering your thoughts on the broad PEO market growth and the competitive landscape. Are you seeing any signs of increased competition? Do you think there's still a lot of room for strong PEO demand to kind of lift all boats in the market? Thanks for the question. My belief is there's strong demand for PEO. It's being more widely accepted. The PEO companies are investing in marketing like we are. The construct is a phenomenal construct to service small and medium businesses. And my belief is you're seeing an expansion of the market opportunity, not an incremental competitive threat, but a good opportunity for all the PEOs that can deliver the value to those small and medium businesses.

32:54 So Trevor, remember, we still only see, even last quarter, about 25% of the time another PEO when we're out competing. So it's very much still a wide open market. So to answer your question, as Burton said, with a very tight economy, it's a very powerful tool for small and medium businesses to be able to provide the kind of HR and insurance, and it allows them to compete against others. And I think they're seeing that, and we're getting the benefit from that. Okay, great. And maybe just to follow up on that, I think one of the things you've talked about in the past is a lot of people just kind of don't know that the PEO business exists. I know you're investing heavily in marketing. You just said that other PEOs are investing in marketing.

33:39 Have you seen any indications lately that sort of awareness of the industry is increasing? I absolutely believe that. I was on the phone earlier today with a prospect with 200 employees in three states, and he stated, and they're growing quickly, He stated that he had never in the past considered the PEO construct, doing it in-house, and now he's convinced that he's going to go with one of the two PEOs that are being competed for right now. Okay, great. And maybe just one more. We've seen some consolidation in the PEO sector over the last couple of years, let's say, and your balance sheet's pretty strong at the moment.

34:24 Could you maybe just talk about how aggressively you might Look for acquisitions and would you think about accelerating buybacks if you don't end up doing any deals in the near future? Well, as you know, we just received that we're allowed to expand to $300 million from a share buyback and that's definitely to offset dilution and we'll go in opportunistically. We also believe that where we are versus our peers is undervalued, so we think this is a good time for us to be in the market for share buyback. That being said, our number one thing is to reinvest in the company. and then it would be M&A Activity. M&A Activity is kind of frothy right now, so whether or not we find a particular target that we think fits our needs and wants, then we will address that. We constantly have our deal radar out there, so it's not as if we're not in the market. We haven't found something yet that fits into our portfolio.

35:17 Okay, great. Thank you very much for the color. And this will conclude our question and answer session as well as today's conference call. Just want to thank you all for attending today's presentation and you may now disconnect your lines.