Good afternoon, everyone. Welcome to the TriNet Group, Inc. First Quarter 2014 Earnings Call. [Operator Instructions] Please also note today's event is being recorded. Now I would like to turn the conference call over to Jimmy Franzone, Vice President, Corporate Development, Head of Investor Relations. Sir, please go ahead. .

Thank you, Jamie. Good afternoon, everyone, and welcome to TriNet's Q1 2014 conference call. Joining me today are Burton M. Goldfield, President and CEO; and Bill Porter, our Chief Financial Officer. .

We are very pleased to present the results to you for the first time as a public company. We would like to thank all of our new shareholders who supported our IPO, which was a great success. We very much look forward to updating you on our strategic progress as execute our growth plan in the year ahead..

Burton will begin with recent operating performance and a brief overview of our company. Bill will then review our financial results, as well as review our guidance for the full year. Bill, Burton and I will then open up the call for the Q&A session..

I'd like to remind everyone that during today's conference call, we will make some forward-looking statements that refer to future events and, as such, involve some risks. These risks are discussed in our earnings release and in our registration statement with the SEC..

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

Burton?.

Thank you, Jimmy. There is no question we are off to a very strong start in 2014. The complexities facing small and medium businesses continue unabated. These include the Affordable Care Act, wage and hour issues, diverging federal state and local compliance requirements.

Our differentiated bundled solutions, including TriNet Passport, TriNet Ambrose and TriNet SOI, are resonating in each of the markets they serve. Additionally, our vertical channel strategy continues to strengthen our visibility and impact on the chosen verticals.

We are winning new business by adding clients who were previously trying to stitch together their HR function through insurance brokers, software and limited internal capabilities. Approximately 3/4 of our new clients did not previously use a bundled solution..

Our net service revenues increased 31% year-over-year during the first quarter to $127.8 million. Our adjusted EBITDA increased 23% to $44.3 million. Our first quarter adjusted EBITDA margin was 34.7%, which puts us well on track to achieve our target margin level of 33% to 34% over the medium term.

As of March 31, we served 241,944 work-site employees, or WSEs, across a wide variety of geographies and industries, up 5% sequentially quarter-over-quarter. Year-over-year, Q1 WSE growth was up 22%, organically. We are on track to deliver 25% growth in the sales channel. The goal is 375 frontline, quota-carrying reps by the end of Q2.

At the end of March, we had 336 sales reps. This channel is vertically focused by product line and has deep knowledge of company-specific issues in their assigned industry sectors. I am pleased to report that we used $216.6 million from our IPO proceeds to pay down debt on our balance sheet as of March 31..

Given this is our first quarterly investor conference call and many of you are new to the company, I would like to take a moment to provide you with an overview of our organization, the opportunities we are pursuing, and the strategic plan we are executing to build shareholder value..

local HR expertise. The services are delivered by a team of over 200 HR professionals deployed in our 50-plus regional offices to quickly address our clients' most critical HR challenges. Business owners facing an HR challenge consistently invoke our motto, "Sounds serious. I'll call TriNet." Number two, our fully integrated cloud-based platform.

The scalable platform provides on-demand reporting and mobile apps with real-time access to both company and employee information.

This information can be as simple as the employee's up-to-date medical membership card on an iPhone to complex graphical reporting on turnover rates as they may correlate to bonus payouts; and number three, large company comparable benefit packages.

These include over 105 medical plans in 50 states, as well as worker's compensation, flexible spending accounts and 401(k) offerings. These comprehensive benefits enable companies to attract and retain the very best talent..

Consider that the total HR spending annually among SMBs in the U.S. represents a $90 billion market. Today, only 5% of these companies currently use a bundled solution to manage their HR needs. We believe that this is a tremendous, untapped market opportunity.

Our unique focus, knowledge base and scale provides a level of expertise and service that simply cannot be reproduced by stitching together multiple solutions through varied sources. We are the largest independent company whose sole focus is on providing a complete, bundled HR solution to small businesses.

We are the only company successfully addressing this market with 3 distinct bundled solutions targeted to specific industries, supported by channels with deep vertical expertise. Our Ambrose product, characterized by high-touch service with the top-tier benefits and HR guidance from legal professionals, had strong sales during the first quarter.

We attracted over 50 new hedge funds, as well as multiple private equity firms. This business is being driven by referrals as we deliver an exceptional product.

Major wins in our SOI product line, characterized by complex, multistage HR and payroll needs came from large, regional retail chains, as well as light manufacturing and building services business, many with over 300 work-site employees.

Among other factors, these groups were attracted to our SOI product because of the seamless solutions we offer in transitioning their health care to ACA-compliant offerings. Technology incubators, digital media, biotech firms and software startups represent a sampling of the Q1 wins for the Passport product.

This product is characterized by an intuitive, paperless, self-serve platform and extensive selection of benefits. .

In addition to our organic growth, we will also continue to look for selective acquisitions. These acquisitions will strengthen our products, technology and market penetration, as well as increase our revenue and cash flow. We will continue to innovate our products and services through internal development alliances and investment in technology.

I am excited to share that in Q1, we announced the launch of TriNet Travel, a cloud-based online travel booking application that enforces compliance with corporate travel policies. TriNet Travel is seamlessly integrated with TriNet Expense, our award-winning expense management solution.

I expect to see additional product releases, delivering incremental value to our clients over the coming months..

In summary, we had a terrific first quarter, and we are very pleased to report our results to you for the first time as a public company. By aggressively implementing our strategy, bundled HR solutions, vertical focus and sales force growth, we will have an outstanding opportunity to create value for our shareholders.

I would like to acknowledge our operating management team, our sales force and all of the dedicated colleagues for their continued maniacal focus on providing the best customer service in the industry..

Now let me turn the call over to Bill Porter for the financial review.

Bill?.

Thanks, Burton. As Burton noted, we reported strong first quarter financial and operating results as we executed our strategy and continued to drive growth across all of the key metrics used to measure the financial and operating health of our business..

Our net service revenues increased 31% during the first quarter to $127.8 million as we leveraged our growing sales force to drive further penetration of our multiple product offerings across our national footprint. On an organic basis, first quarter net services revenue growth was 19%.

Our total work-site employee count was 241,944 employees, up 30% from 185,894 work-site employees at the end of the first quarter of 2013. On an organic basis, WSE growth was 22%.

Our professional services revenues, which represent approximately 2/3 of our net insurance service revenues, increased 40% to $82.9 million during the first quarter; while our net insurance service revenues, which represents the remaining 1/3 of our total revenue, increased 18% to $44.9 million during the first quarter.

On an organic basis, professional services revenues grew 28%, and net insurance services revenue grew 4%. Included in our first quarter professional services revenue is a onetime $2.3 million refund of prior year payroll taxes and $2.8 million of seasonal items. These items will not carry forward into our Q2 run rate..

Total adjusted EBITDA increased 23% to $44.3 million during the first quarter, compared to the prior year period, representing an adjusted EBITDA margin of 34.7%. We are well on track in pursuing our target margin level of 33% to 34% over the medium term..

Our GAAP effective tax rate was 56.4% for the first quarter, primarily due to a discrete tax of $500,000 or 14% for the revaluation of deferred taxes based on a New York State tax change in March. The remainder of the increase is primarily due to nondeductible stock-based compensation and the expiration of the research and development tax credit.

We expect our long-term effective tax rate will increase to 39.5% from 39%, primarily due to the state tax law change..

Adjusted net income decreased 3% to $17.6 million, $0.24 per share on a pro forma basis, including IPO shares, compared to $18.2 million or $0.27 per share in the prior year, primarily due to increased interest expense..

We also generated $25.3 million in free cash flow during the first quarter, which is defined as operating cash flow less CapEx. Our ability to generate healthy free cash flow is supported by our strong margin profile and asset-light model. Historically, we spent approximately 3% to 4% of our net revenue on capital expenditures.

We also benefit from the positive net working capital. During the quarter, our CapEx spending was $5.1 million. We plan to continue to primarily use our free cash flow to further delever our balance sheet, providing additional earnings leverage going forward..

TriNet launched its IPO on March 27. We raised total net proceeds of $218.9 million through the issuance of 15 million shares. We used $216.6 million of the proceeds to repay debt on the balance sheet on March 31. This enabled us to close the quarter with total debt $602 million, representing a debt to EBITDA ratio of 4.2x trailing 12-month EBITDA.

Total cash was $122.6 million at the end of the first quarter, and working capital was $93.8 million. .

Turning to our financial guidance for 2014.

Based on our Q1 performance, we expect net service revenue in the range of $504 million to $511 million for 2014, which represents organic growth of 15% to 17%, with adjusted EBITDA in the range of $171 million to $174 million for the same period, in line with our target range of 33% to 34% and adjusted net income in the range of $75 million to $77 million or $1.03 to $1.06 per share..

For our financial guidance for Q2, we expect net service revenue in the range of $119 million to $121 million, which represents organic growth of 15% to 17%. We expect professional service fee revenues to increase sequentially based on WSE growth and net insurance service revenue to decrease sequentially due to seasonally higher claims activity.

We expect adjusted EBITDA in the range of $36 million to $38 million for the same period, and adjusted net income in the range of $15 million to $17 million or $0.21 to $0.23 per share..

As Burton noted, we welcome our new shareholders and look forward to reporting our progress to all of you in the year ahead. That concludes our formal remarks, and now, I would like to turn this call back to the operator for the Q&A session. .

[Operator Instructions] And our first question comes from Tien-tsin Huang from JPMorgan. .

I want to ask first on the -- you commented on ACA, Burton, and some other factors that's driving the growth. Can you just give us some sense, maybe a little bit more color, on backlog and pipeline given the -- your sales hiring efforts? Curious how it compares versus quota, for example. .

Yes. So the sales hiring, Tien-tsin, is right on track, and the quarter turned out strong, as I expected. A couple of things are going on.

First of all, the bundled solution is resonating really well to folks who have not used it in the past, and that ties back to what you just said, which is complexity is going up, particularly if people don't want to deal with the reporting requirements.

And essentially, whereas in the past, technology led the day, now the Affordable Care Act the gives us a tremendous amount of add-backs.

And when we talk to prospects about the fact that we will make sure that they're properly reported and properly taken care of based on their size and transition across boundaries, they're very interested in discussing it further. So ultimately, the complexity plays well. The Affordable Care Act gives us the add-backs.

And ultimately, I think a lot of the growth is that we're giving the right product to the right market. So we're not trying to shoehorn in TriNet Passport, for instance, in light manufacturing. We have the SOI product to do that, and vice versa with the Ambrose product. And what's great is that across-the-board, our sales force hiring is on track.

And in general, we're hiring sales folks out of the industries that we service. So today, we have about 344 reps in-house as of this morning. .

All right.

So that's really up from the 336 to get to your -- to the guidance that you set out?.

Right, exactly. And they're just -- they're going to keep on coming. So I'm very bullish about being able to meet our target, the 375 about -- by the end of June. So we will increase that.

And as you realize, as frontline, quota-carrying, non-duplicative sales reps, that's not managers, that's not inside sales, that is our frontline reps, and they are all verticalized around the industries they service. .

Understood. That makes a difference. I had just one clarifying question, and then I'll let others ask. Just the seasonal items, Bill, that you mentioned -- that you gave, I think you mentioned $2.8 million.

What is that exactly? What's the margin on those seasonal items? And then maybe if you can just give us the detail on what drove the refund of the prior year payroll taxes. .

Sure. This is Bill. So the seasonal items I mentioned in Q2 that aren't going to carry forward are the things we normally would see, which is some pseudo-margin, which happens in the first quarter that -- and doesn't run into the second quarter.

And when you look at our total service fees per average WSE for the quarter and take out the onetime payroll tax refund, which we called out for you, we're right in line with what we achieved in Q1 of 2013 at about $341, on average, per work-site employee for the quarter.

So it's right in line with what we would expect and what we've seen, historically. .

Our next question comes from Smitti Srethapramote from Morgan Stanley. .

The 5% quarter-over-quarter work-site employee growth that you guys saw and continues to be fairly strong, can you help us decompose the growth rate between what happened in sales force growth, sales force productivity and attrition rates?.

Yes, Smitti. Generally, the growth really is all about new sales. Our attrition has been very steady and has not really changed in terms of rate. So this was just strong performance by the whole team on the sales force side, across all 3 of our product lines. That's really what drove the increase sequentially. .

Got it. And then maybe just another follow-up question on the Affordable Care Act. In February, the Treasury Department Rule 9655 further delayed some of the components of the employer mandate to 2016.

Can you talk about any impact the pushout may have had on your revenue growth outlook? Also, can you remind us what kind of impact you guys saw when the mandate was originally pushed out in July 2013?.

So Smitti, this is Burton. What we're seeing is a lot of hand raisers that are really interested. So frankly, the longer it's pushed out, the more the confusion, the more delays, the more it helps our business. This was not a step function of any sudden influx in business.

It was a realization that the complexities around health care for a person that was passionate about building business are getting harder and harder. So the pushout of the mandate, from my perspective, is a good thing.

It just keeps the fun around how companies need to report, at what size they need to report and what each of the plans need to look like in order to be compliant, a topic of conversation for yet another year. So look, we're seeing a tremendous amount of activity, and it's part of, virtually, every prospect conversation.

It's -- 100% of the prospects ask about it, but it is not, "I'm facing this next month. So quick, get me on the platform." It is about, "How am I going to manage my business, control my cost and be compliant for years to come?" So we love the opportunity, go and discuss it.

We love the opportunity to give them a solution that is highly tailored to the vertical that they are in and, ultimately, to compete and win that business. .

Our next question comes from Paul Ginocchio from Deutsche Bank. .

Just on the service fees, I think as calculated, you just said it's roughly flat. Last year, I think, because of the mix effects, it was down -- excluding the FICA tax return in the third quarter of '13, down around 3%.

Are we to assume those sort of mix impacts are over and we should assume it's relatively flat going forward? And then maybe, could you make some comments on the relative growth rates on the 3 products?.

Sure, Paul. I think the mix is pretty stable now that we've got all 3 products in and most of the operational integration complete. So I would expect it to be fairly stable. And all of the product lines are doing equally well. Nothing really has changed since we've talked to everyone, yes, a couple of months ago.

So the results of Q1 just confirm what we have seen through the fourth quarter, which is the product story is resonating with our clients based on the differentiated products, and they're each doing well in their respective markets. .

And should -- because service fee per average work-site employee was relatively stable versus down around 3% last quarter, is there anything we should read into that sequential improvement? Or that's just sort of the -- cycling the mix effects?.

I think it's a stable mix effect, Paul. I wouldn't try to read too much into it. There's always going to be a little bit of movement when you look at the mix over any particular quarter, but I think -- in general, as we look at the business moving forward on the professional service fee side, we think it's going to look pretty steady.

We'll have small increases, as we discussed, regarding price, but that's not a major driver. It's really just, I think, stable price for the products and volume that are going to drive the increases. .

Our next question comes from Tim McHugh from William Blair. .

I guess first, I want to just ask pricing environment and how you've seen that awfully good WSE growth, but is there any -- or what -- I guess, just in general, what's the competition like in terms of winning your clients?.

Yes, so -- Tim, this is Burton. A couple of things. First of all, on the competitive side, as I reported, 3 out of 4 new clients that came on board in Q1 were coming from a multi-vendor product suite, not from a bundled competitor. We did not feel a lot of price pressure in Q1.

The good news there is by having each of the 3 products stick to their verticals, if there was price pressure from one product, they may be using the wrong product. So with 3 different price points and 3 different products, we were able to hold the pricing line across all 3 of our product lines. .

Okay, great. And Bill, just one numbers question.

The -- I guess, the table kind of credit you had to the revenue line, does that all fall through the bottom line as we think about the EBITDA and EPS impact this quarter? Or are there any offsetting costs recognized?.

Tim, no. There really isn't any offsetting cost. This is pretty much a onetime thing that comes in from a prior Gevity filing. So there really isn't any cost associated with this one. .

Okay. And then last question, just the acquisition environment, you have -- you're certainly still looking, I guess, given the profile of your IPO and the success of it and your success with acquisitions.

Have you seen others try and be any more aggressive with acquisitions in the market? I guess, what your perception of the acquisition multiples that you have to pay. .

Tim, it's Jimmy here. So as you know, we continue to be active in keeping the pipeline live with some opportunities that we'll be looking at. We haven't really seen a change in the overall acquisition environment.

Certainly, it's an attractive business, an attractive business model, but nothing has really come up that would change either valuation characteristics or the way we would think about assessing an acquisition or then integrating it in.

I think we've been able to prove our ability to integrate businesses in and allow them to continue to succeed, and that is the game plan for going forward. .

Our next question comes from Jason Kupferberg from Jefferies. .

I just wanted to ask a follow-up on the competitive landscape. I know you mentioned that 3/4 with the new clients are coming from kind of unbundled, stitched-together solutions versus a bundled solution. But if you think about the larger players in the PEO space, many of which tend to also have other businesses that are much bigger than PEO itself.

I mean, are you seeing some of those big competitors focus more on PEO, specifically, than they might have been a couple of years ago? I mean, just as core payroll seems to be a bit more mature and maybe a bit slower.

Have you seen any difference in their approach to the market out in the field?.

So good question. No change in approach or pricing or relative aggressiveness. As you know, we're targeting 50 million workers to go to work every day in the United States in companies under 500 employees, and the penetration is so low.

We are hoping that all of the players get their share of the market and the bundled solution becomes a preeminent solution based on the market environment.

But certainly, it's a good business, and it wouldn't surprise me if there's additional focus from other companies, but I do not see that as a direct competitive difference between this quarter and the last quarter and, frankly, 1 year ago, Q1. .

Okay, good to know. Just another strategic question. I think you guys have indicated in the past that your average client life is roughly 5 years or so. Obviously, some SMBs go out of business. Others graduate to different offerings.

Are there -- I mean, how important is it to you guys, strategically, to try and extend that number to something north of 5 years? Or are there strategies that you're working on to try and affect that kind of change? Or is that less of a concern in the scheme of things?.

One is changes to our technology product. Some of the extensive reporting capabilities that we've added to the platform over the last couple of years were a direct result of client feedback. As they grew, they wanted more extensive, real-time, ad hoc reporting.

We're looking at additional benefits offering, service models, and ultimately, we want to continue to remain relevant to our existing clients as they grow with us.

So it's not that I'm focused on selling to bigger clients because the market is big enough to stay focused on the 5 to 500, but certainly, the idea of retaining clients and keeping them happy and longer is something we always look at.

So we do have a group that focuses on our larger clients as they grow and make sure that their needs are taken care of. Our Client Advisory Board is weighted heavily with some of our larger clients. So we make sure their input is taken directly to my management team as we evolve the product strategy.

And ultimately, we want to provide a solution that can grow with our client base. .

okay. That's helpful. Last one for me.

Bill, just on free cash flow for the year, any ranges we should be thinking about?.

Jason, I don't think I want to put a range out there. It will generally be a good cash flow generation business, but I don't think I want to range it at this point. There is going to be some movement that will happen quarter-to-quarter as we see opportunities, but I don't think you should see anything that will be significantly down.

I think it's just going to be -- I don't want to put a range on it at this point. .

Our next question comes from David Grossman from Stifel Financial. .

Burton, maybe you could talk a little bit more about the attach rates on the installed base? As you look to try to increase the revenue per client, is there any reason to think that the attach rates for products outside the core bundle may increase over the next year or so?.

So we don't spend a lot of focus on incremental attach rates, and the models that we have given do not show significant attach rates from the incremental products.

Certainly, these products add value and stickiness to the overall product, but our focus right now is really on market capture, maintaining the profitability and growth rates and growing with that client base. But ultimately, I won't build significant incremental attach rates to the existing client base.

I believe that it is an opportunity for the future, but we have one mantra right now, which is to gain profitable market share with our 3 bundled products while the opportunity exists in the market to deliver a tailored solution to these verticals. So our focus is not running around, selling point products.

Our focus is really to make sure that our installed base clients get the services they need and, where applicable, add the incremental products, like TriNet Expense and TriNet Travel, and you'll see a few more coming out. But that's not the primary focus. So I wouldn't model large attach rates. I'm really looking to capture market share right now. .

Okay, fair enough. And then as you were talking about sales, it sounds like your hires are pretty much on track.

So is the implication then that we're still on track for sales and marketing expenses going up roughly 100 basis points a year as a percentage of revenue? Is the model pretty much kind of on track in that context?.

David, this is Bill. Yes, that's the case. That is a long-term model that we have, and we don't see any reason why we would change that at this point. We see the success of the channel as vertically focused, and for us, it's just continuing to get those good candidates, get them in, train them and then get them in the field, so they can season.

As we all know, it takes some time for them to do that. .

Right. And then just for you, one last one, Bill, on the tax rates so just to make sure I'm clear.

So should we be seeing 39.5% going forward? Or was that 39.5% for the year?.

No. For the year, it'd actually be 42% on a GAAP basis, David. But, yes, going forward, and I think economically, it's going to be 39.5%. So we think that change in state apportionment in New York -- as you know, that's a strong market for us. So we're doing quite well there.

Unfortunately, with the change, it's going to mean we have to pay a little bit more New York State tax, but I guess that's the price of success. .

And ladies and gentlemen, we've reached the end of the allotted time for today's question-and-answer session. That will conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your telephone lines..