Good day and welcome to the TriNet Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Alex Bauer, Investor Relations. Please go ahead..

Thank you, operator. Good afternoon everyone and welcome to TriNet's 2019 second 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 pre-recorded. Burton will begin with an overview of our second 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 third 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 second quarter of 2019, 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. I am pleased with our second quarter results, which puts us on track for delivering our 2019 plan. Capitalizing on our first quarter momentum, the second quarter saw the TriNet sales and services organizations successfully deliver value in the verticals we serve.

In the second quarter, we grew GAAP total revenues 10% year-over-year to $935 million and we grew our net services revenues by 5% year-over-year to $231 million. Professional service revenues grew 11% year-over-year to $127 million.

The strength in professional service revenues in the quarter was the result of our focus on keeping our customers at the center of everything we do. Professional service revenues benefitted from improved retention and strength in our new sales.

During the second quarter, we grew insurance service revenues by 10% year-over-year to $808 million, while net insurance services revenues declined 2% year-over-year to $104 million for the quarter. Net insurance service revenues were in-line with our forecast.

Please recall net insurance service revenues in the second quarter of 2018 saw significant outperformance due to prior period adjustments. In the second quarter, our Q2 GAAP earnings per share declined 20% year-over-year to $0.64 per share, while our Q2 adjusted net income per share declined 19% to $0.70 per share.

Please not that both our GAAP and non-GAAP EPS came in near the top of our guidance range.

Finally, we finished the quarter with approximately 324,000 work site employees, up 2% year-over-year, due to improved customer retention as a result of our customer service teams proactive customer engagement, improved new sales as we built on our first quarter momentum by successfully selling our value proposition, and continued strong hiring from our installed base.

I am encouraged that the improvement in customer retention that we saw at the end of the first quarter has continued throughout the second quarter. We benefitted from our improved customer engagement process, which involves leveraging our customer analytics to anticipate and respond to our customer concerns.

Our ability to monitor thousands of customers for events such as renewal pricings or management changes has become increasingly beneficial. For example, during the quarter, we engaged a 300 plus WSE design company, which was at risk of leaving.

Anticipating sensitivity to their renewal pricing, we proactively engage the customer on their upcoming renewal. We leveraged our insurance services team to propose cost containment strategies for the upcoming year. Our customer implemented the proposed strategies and based on these actions remains a customer today.

Our focus on improving our customer experience is a critical component in our strategy for returning to sustainable WSE growth. The early returns on our efforts are positive and are gaining momentum. During the second quarter new sales, another key component of our strategy for returning to sustainable WSE growth improved.

Our sales force successfully sold our products and services into the verticals we serve. We package HR expertise, benefit options, payroll services, risk mitigation, and our technology platform together so that our customers have more time to focus on their business and are in a stronger position to attract and retain top talent.

Our value proposition was on full display this quarter when we won the business of a New York based architecture firm. The process began when a new CFO joined the firm and quickly sort out a PEO partner. TriNet’s comprehensive products and services prove compelling. First, the new CFO was impressed with our platform and cloud-based products.

The TriNet user interface was critical for winning over the firm’s executives. Second, based in New York with the diverse employee group, the new customer valued TriNet’s benefits offering.

We could accommodate their employees’ various benefit needs including access to rich plans as well as high deductible, HSA eligible plans, an important advantage when competing for talent in a tight labor market. Finally, with several employees on work visas in country, the customer valued our visa service capabilities.

Having TriNet streamline the VISA workflow was very attractive to the customer in making the decision to purchase TriNet. This process is not atypical of the way we engage with prospects in the selling cycle. We continue to be attractive and add value in our core customer segments as this example demonstrates.

Given our reported WSE performance, during the second quarter and the trend of our retention and new sales results, we now expect to grow our volume for the remainder of 2019. The evolution of our products continues with the July 16 release of TriNet Workforce Analytics, our fully integrated HR reporting and analytics tool.

Workforce Analytics provides our SMB customers with rich data enabling in-depth needed for accurate reporting and forecasting. We assist our customers through our services team of industry specific consultants to interpret this data and empower informed business decision.

Key features of the workforce analytics product includes access to important workforce data such as annualized compensation, average employee tenure, and benefit selections.

Integration with third party vendors such as QuickBooks, NetSuite, Xero and Intacct to sync accounting data for more accurate reporting and the ability to create, save, and quickly access customized favorite or recently viewed reports, as well as many other features.

Additionally, during the second quarter, we launched our brand and marketing campaign people matter. Our campaign places at its center TriNet customers who represent a diverse cross-section of American entrepreneurialism and celebrates their many contributions to the U.S. economy and our commitment to small and medium size businesses.

Following our brand campaign launch, featuring New York customers in April, we expanded the campaign to feature additional customers from the San Francisco Bay area and Los Angeles. As we approach our critical selling season, these customers will play a role in our demand focused omnichannel marketing campaign.

We remain committed to developing a world-class brand aligned with our powerful value proposition and in support of our sales efforts. 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 were appropriate. During the second quarter, GAAP total revenue increased 10% year-over-year to $935 million, and we grew our net service revenues by 5% year-over-year to $231 million.

We finished the second quarter with approximately $324,000 worksite employees showing 25 year-over-year growth. Average WSE count for the second quarter was approximately 319,000, also a 2% year-over-year increase. Professional service revenue for the second quarter increased 11% year-over-year to $127 million.

Professional service revenue benefitted from higher than expected WSE count as a result of both our process improvement initiatives and new sales, as well as a mix towards our white-collar verticals.

Insurance service revenues for the second increased 10% year-over-year to $808 million, and net insurance service revenues decreased 2% year-over-year to $104 million.

Net insurance service revenues in the quarter benefited from strong revenue due to our higher WSE count and lower works comp cost driven by $11 million worth of favorable prior period development, which were offset by increased health cost.

As a reminder, net insurance service revenues in the second quarter of 2018 benefited from $6 million in workers comp favorable prior period development. The reversal of our Q1 fully reserved and the realized favorable workers comp and health experience. Our second quarter GAAP effective tax rate was 17%.

Our tax rate in the quarter benefitted from the tax treatment of employee equity compensation and a discrete benefit from tax changes. For the quarter, our non-GAAP tax rate was 26%. GAAP net income decreased 22% year-over-year to $46 million or $0.64 per share compared to $58 million or $0.80 per share in the same quarter last year.

Adjusted net income decreased 21% year-over-year to $50 million or $0.70 per share, compared to $63 million or $0.87 per share in the same quarter last year. Adjusted EBITDA for the second quarter decreased 16% year-over-year to $85 million, compared to $99 million during prior year period for an adjusted EBITDA margin of 36%.

Adjusted EBITDA was impacted by increased OpEx as we’ve invested in our marketing campaign and process improvement initiatives. We closed the second quarter with total cash of $219 million and working capital of $236 million, versus $251 million and $226 million respectively in the first quarter of 2019.

Through the first half we generated $108 million of positive corporate cash flow from operating activities and used $270 million primarily comprised of WSE related payroll tax obligations. As a result, total cash outflow from operations were $162 million.

We spent approximately $25 million to repurchase approximately 393,000 shares of stock in the second quarter. Turning to our 2019 full-year and third quarter outlook, I will provide GAAP and non-GAAP guidance. For the full-year, we are raising guidance reflecting both our first half performance and our second half expectations.

First for the second half, we expect OpEx growth to moderate even as we continue to invest in both our process improvement initiatives and our 2019 marketing campaign. Second, our revised guidance reflects our expectation that health cost at 1 carrier will remain elevated.

For FY 2019, we are forecasting GAAP revenue in the range of $3.8 billion to $3.85 billion, up from $3.7 billion to $3.8 billion, and now representing year-over-year growth of 8% to 10%.

We expect net service revenues in the range of $938 million to $951 million, an increase from $906 million to $933 million, which now represents year-over-year growth of 5% to 7%. Adjusted EBITDA is now expected to be in the range of $385 million to $400 million, up from $380 million to $390 million.

This now represents a 41% to 42% adjusted EBITDA margin range for FY 2019 versus a 42% previously. The low end of our adjusted EBITDA guidance reflects potential elevated cost with one of our carriers.

We now expect GAAP earnings per share in the range of $2.99 to $3.16, up from $2.94 to $3.07 and adjusted net income per share in the range of $3.34 to $3.50, up from $3.34 to $3.47.

Before providing our third quarter guidance, please note that during the third quarter of 2018 we had a very strong net insurance margin of 14%, which is unlikely to be repeated during our third quarter of 2019.

As a reminder, the 3Q 2018 margin benefited from the change in economic arrangement with one of our carriers and the realized favorable workers comp and health experience.

For Q3 2019, we expect GAAP revenue in the range of $954 million to $964 million, representing year-over-year growth of 9% to 10%, and net service revenues in the range of $213 million to $228 million, which represents a year-over-year decline of minus 7% to flat growth.

Adjusted EBTIDA is expected to be in a range of $84 million to $97 million for the quarter, representing an adjusted EBITDA margin range of 39% to 42%. We expect GAAP earnings per share in the range of $0.62 to $0.77 per share and adjusted net income per share in the range of $0.71 to $0.85 per share.

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

Burton?.

Thank you, Richard. This has been a particularly satisfying beginning to our fiscal year. The marketing campaign people matter has allowed me the opportunity to get even closer to our customers who are doing incredible things. This energizes me and inspires the team to do even better.

With respect to our growth, as I’ve said in the past, WSE’s are an element of our growth model, but do not represent the only metrics. Having said that, I am pleased that we returned to volume growth and expect to continue to grow WSE’s. We’re reflecting this growth by raising our full-year topline and net service revenue guidance.

Our goal continues to be profitable growth by servicing our core verticals. I’d like to end by again thanking the team for the incredible work you are doing.

Operator?.

[Operator Instructions] Our first question will come from Timothy McHugh with William Blair. Please go ahead..

Thanks.

Just following up on the commentary around retention, can you quantify that at all, I guess and I guess give us some contacts relative to where it was earlier this year, as well as a year ago, just trying to understand how much better it has gotten for you guys?.

Tim, it’s Rich. As we’ve talked about on the call, lot of the investing that we did in the fourth quarter of last year and through the first half of this year is starting to pay dividends, so that’s why you see the elevated OpEx.

What we saw, as we finished up the last migration of the OSI platform, what we really start to see now is us coming in very strong.

A lot of the things you heard Burton talk about being preemptive, I think are really starting to pay dividends, we are not going declare it’s over, but we feel pretty good about what we’ve been able to accomplish in the last six months on retention..

Okay..

Tim, there’s not much that I can add there other than to say that was expected, it’s better than I thought, having SOI behind us, focused on our core verticals and allowing our teams to service these great customers is starting to pay off in terms on track to return to growth in the WSE count..

Let me follow-up.

Is retention operating near a peakish type of level or higher than you’ve seen in the past or is there room for further improvement over the next medium-term here?.

Well, remember we were elevated in Q1 right, so we should be able to improve on that moving on into next year. A lot of the effort that we’re doing we believe will continue to have a pay-off as you move out into next year and beyond.

So, we can see things like our net promoter score increasing and things like that, these are all indicators that we are touching in the right parts of the customer..

Okay, and then just on the healthcare claim side, I guess you highlighted one care which you talked about last quarter as well.

How are you looking at the risk that that’s a trend line that you could start to see more broadly across the business, I guess you just talk about how you’ve looked at that?.

Yes. Look it’s contained to the one carrier. It’s in the low end of guidance for both Q3 and full year if they do perform.

Now, remember the wrap around effect, because we started to see it in Q4 last year, so it will naturally start to get muted, but we think that we know it’s contained to that one carrier, we know the geographic region and we’re continuing to work with them and then of course we will reprice the entire book of business during Q1 of next year..

Great. Thank you..

Our next question will come from Tien Tsin Huang with JP Morgan. Please go ahead..

Hi, thanks. It is good to see the WSE count go positive here.

So, I know it’s hard to give specifics, but could be maybe rank the factors that drove the -- drove you back to positive and the outlook for volume and I heard new sales for contributor retention from the tools you put in was a contributor, it sounds like same store growth at your installed base was positive as well, so can you may be just help us rank the factors that contribute to the positive outcome?.

Sure. As you’ve heard me say in the past, the WSE growth is an element of our growth, but not the only metric. And the fact is, all three of the areas that you just talked about; I’m really pleased with interop. I’m pleased with new sales. I’m pleased with the productivity of new sales.

The demand in the market remains strong and the competitive landscape hasn’t changed much. So that’s the new sales side. Attrition or on the other side of the coin retention was strong for me.

A lot of it is the work that we did at the end of last year, the beginning of the year and being completely away from the attrition factors associated with the migration in the SOI book of business. So, it’s better than I thought, but I fully expected to get back to this growth stance. And then finally, new hiring was great within our installed base.

The customers are hiring people, the market is limited in number of great people out there, and I’m finding that the TriNet customers are out there getting more than their fair share of great employees to put on their companies..

Got it. Good.

So, just as a quick second question, maybe just – the trend on commercial service revenue for WSE is still trending up, the net insurance margin on the other hand I think is coming – was still a little bit better than we expected, but a little bit back to normal versus last year, so have you changed, should we change or thinking on trend line on both of those items here as we cross into the second half of the year.

Again, professional service revenue per work site employee and then the net insurance margin outlook for the second half versus first half?.

No, I think we’ve captured it. As you can tell on the low end of guidance that would be if that trends from that one carrier continues. And at the top end, you know we are still online with what we had said, you know the 12% to 13%, you know that’s not – it’s all within that guidance range.

From a professional services revenue, I think Burton highlighted in his opening remarks and we are going after the right verticals with the right product at the right price. We’re able to get that. We’re seeing the tax rate of our – the people who are taking our insurance increase, so that says that price correctly, and we are very selective.

We’re making sure that the price to risk inside insurance is correct and the customers that we are going after need a value of what we have inside the total company..

Great. Thanks, as always..

Our next question will come from David Grossman with Stifel. Please go ahead..

Thanks, good afternoon. So, the last couple of questions I think were trying to get some better perspective on the different elements of growth, and it sounds like you’re reticent to get too specific about each of those elements, but what can you tell us about where we are in this cycle that gets you back to more of an equilibrium level of growth.

I mean, I think it’s a fair question given that we’re coming of a period where a lot of those metrics were going down or sideways.

So, now that they are pointing in the right direction, you know what color can you give us that can better give us a sense of how we should think about, where the model – what kind of growth we can generate in equilibrium once those metrics are in place for a couple of quarters and they continue to improve?.

Yes David, this is Burton. Look it’s a huge addressable market and we are very excited about the future. I believe we’re on track to return to mid-to-high single digit growth and I believe that the retention will continue to get better and the new sales productivity as the reps mature will get better.

So, ultimately there is a strong opportunity for us to build market share with net new logos and companies that grow to continue to increase on the volume metric, which you are focused on, which is a WSE count.

But equal for me is the PEPM growth and selecting the right customers that sees the full value proposition of TriNet at that right price that stay with us for a long period of time..

So, can you give us….

Let me just add to that. Remember we have talked about the flywheel effect for the company. So, we’ve been saying that new sales have been growing in the industry and that it was just going to take a while for the flywheel effect to tick in and you are just starting to see that as we continue to retain the right customers.

As Burton had said, your WSE count is a piece of it, but we’re pretty happy with the 11% growth rate that you see and 10% overall in GAAP..

So, just to the point Burton made about revenue for client, so what can you tell us about what the change has been now that you are focusing on a different client in terms of what kind of revenue, because we just see the blended average of course, but just curious as you think about the new business you’re bringing in.

What is the difference that we’re talking about, a 5% difference, 10% difference, can you could give us any granularity at all?.

Well the granularity that I’ll give you is that I’m focused on ACV, the annual contract value, and it continues to improve on a per rev basis in the second quarter. Additional granularity is, I’m very pleased with the first half results from my sales team.

And then when you couple that with the increased retention and the change in existing, I find that we’re headed in the right direction, which is the reason I say, we’re on track to return to mid-to-high single digit growth in that WSE metric..

Got it. Okay. Fair enough.

And then, just maybe a longer term question about margin since, you know our longer term margin target for net insurance margin is more in that 11% to 12% range, if we head back to that level from where we are now, do you still feel you’ve got enough leverage embedded in the business that you can still show overall margin expansion even as the net insurance margins come back down to that target level, which is probably a little over 100 basis points from where we are right now?.

Right. So, as you know, part of that is due to the prior period development, predominantly workers comp and that should have been over time. At the same time, it also says, the job we are doing in selecting the right customers in pricing to risk, we think is paying off.

As far as the – a lot of the effort that we are doing right now for getting our internal operations to work much better, so we're on the process improvements and the work we’re doing right now on marketing to have the entire quarter longer in marketing are all things that we think will stimulate both the topline and the bottom line.

To the degree, we choose to increase or decrease in the future will be whether or not the right mix for revenue growth versus profit, but we plan on – the selection of clients is always going to be profitable smart client selection. Yes..

Right.

So, I guess, just to rephrase it directly is that even if we return to that more natural spot for insurance margin, does that necessarily increase your ability to expand margin overall going forward?.

Again, it will be a choice that we have. We have levers inside the company that we can – we know we can be more efficient and effective with these, with our dollars internally to support our customers sell to our customers.

So, there’s a lot we can still do, but again, I want to quantify that with, we will decide whether or not the right choices are to drive incremental revenue or go after incremental profit, but we’re confident that we can do either, which makes the best sense for our investors..

Got it. And then just one last one.

Is the range or the wide range in the third quarter EPS just reflect the variability around this one carrier and the clients is that why the range is so large?.

Correct. Remember last year, you have to remember about the prior year-over-year compare, but when you're talking about the actual width of it, is that we see that one carrier in the low end of that range of seeing that they will not return to the norm with the other carriers that they will stay elevated..

Right. And I'm sorry. Just one last one.

As you may have seen some of the [MCOs] that reported within the last week and their [MLR's] went up, are you seeing any of that or is this kind of what we’re talking about kind of unrelated to what may be happening in those carriers?.

I can't say that we’ve seen anything in particular..

Great. Okay. Thank you..

Thank you, David..

And now our next question will come from Kevin McVeigh with Credit Suisse. Please go ahead..

Hi, guys. This is Palmer on for Kevin. Just looking at the WSE volumes are again, nice to see those tick up in the quarter.

You know, was the WSE growth attributable to any one geographic region or any particular industry vertical?.

Not particularly, and it’s a good question, but it was felt across our core markets and across the verticals. So, there is no standout that I can tell you about one vertical dramatically or overemphasizing the change in existing or CIE..

Got it. Thanks that's helpful.

And then can you guys talk about your sales force hiring expectations, are you going to higher in your sales force and the expected growth in WSEs or are you focused on the existing salesforce that you have and just increasing productivity?.

So, both, increasing productivity, which is critically important for our sales force. We have our sales kickoff in two weeks called [Triumph] and my expectation is, will be up in quarter caring reps at [Triumph] in the mid-single digits..

Got it. Okay. It’s helpful.

And then last one from me, you guys have fair amount of cash on the balance sheet, you know late leverage pass the SOI migration, how should we think about capital allocation from here? How are you guys thinking about M&A from here relative to flexing into the buyback?.

Hi, Palmer. So, I would say three things. We will always first invest in the company. We’re always looking for M&A that makes sense to us that could either be bringing on another carrier and geographic region or adding to the vertical in an existing or new. And then clearly, we will always want to offset dilution..

Got it. Thanks a lot, guys. Appreciate it..

Thank you..

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