TriNet Group, Inc. (TNET) Earnings Call Transcript & Summary

Great. Thanks, everyone, for joining us. This is again, Tien-Tsin Huang, I cover the IT services and payments and processing sector at JPMorgan. And super excited to have TriNet with us. It's a very popular stock. We get a lot of inbound queries on TriNet in this space. And as a result, so pleased and happy to have with us the CEO and President, Burton Goldfield; and also the new CFO, Kelly Tuminelli. So welcome to you both. Thanks for spending a few minutes with us today.

I am excited to be here.

Great. Thanks [indiscernible]

Sounds great. Great to see you guys. So we'll do like the other sessions, we'll do a fireside chat. I feel with a lot of these questions from the investment community, we'll try and get through a lot of these. [Operator Instructions] So let's get right into it, if that's okay. Let's just kick it off because we have ADP later for full disclosure. You have a great view on what's happening on the ground in the economy, especially with SMEs. So maybe if you can just start off and give us an update on what you're seeing on the ground. How healthy are your clients? What's happening on the employment side and new business formation, et cetera?

So we're pretty humbled by our client base, the small and medium businesses across the U.S. and their tenacity and in fact, their growth. Now we have a view into a very select customer base. 80% of our customers are white collar, and they're in the verticals that we serve but the stunning statistic that we announced on our earnings call was that the net hiring, the net growth of our installed base, was larger in Q3 2020 than it was in Q3 '19. So our customers are working hard to continue to grow and be successful despite what's going on with COVID.

It does seem like there's some natural selection that the clients that engage with a PEO like China, do seem to be healthier and have more growth mindset. So it is interesting to see that.

It was certainly higher in change in existing than we expected, as you know, Tien-Tsin. What I would say is that the sectors -- they all grew but the sectors that grew the most were technology, biotech and financial services. There is a significant amount of activity going on in the investment community, and we saw hiring in the capital-providing firms. It's obvious around biotech and both new company formation as well as growth within the companies that were already on our book of business, but they are growing and technology investments are accelerating in the SaaS space as well as other parts of technology.

Got it. That's helpful to hear. So when I was interviewing other investors to put together the question list, a lot of folks just wanted to understand what drove the big upside, right, in the most recent quarter. It was obviously much higher than what we had modeled, but also higher than your guidance as well. So would you mind maybe sharing with us the top 2 or 3 reasons of why you saw that level of upside in the most recent quarter? I mean that will help to drive the rest of the conversation.

Yes.

Yes. Happy to, Tien-Tsin. And I got to say, I'm happy to be at TriNet. It was a great quarter to start. When we came out with guidance in the second quarter, I think there had been a couple of different phenomenons we expected. One was we expected more business insolvencies. And frankly, the PPP loans definitely help businesses stay in the game and continue to improve. We also expected -- we didn't expect what Burton was just talking about is the improvement in hiring. And so volume was probably about half of our outperformance. The other thing we had anticipated was both higher direct COVID costs and somewhat of a surge back in health care utilization, which we really didn't see. We saw a benefit overall from health care utilization and the net hiring really helped us from a volume perspective. And customer retention, which I'm sure you've probably heard from some of our competitors, retention has been good as people have delayed making some of those back office decisions, and that definitely contributed to the outperformance as well.

So retention has been a big theme, but I think even before you joined, Kelly, right going into the pandemic, retention was sort of skewing better. We were focusing on it a lot more. I think that the firm was putting a lot of efforts to improve that. So what would you attribute some of this -- the retention efforts to things that are in TriNet's control?

So what I would say is that hiring of our COO and the changes in our service model over the last year have yielded the highest NPS scores in the history of TriNet, and I've been here 13 years. So what we are striving to do is give an exceptional customer experience and capture the lifetime value of these customers as they grow with TriNet. So I do think they're part of that, and you've seen that over the years, is the customer experience, is the changes in our service model, and also, we have now gone through a 3-year painful process of getting the book of business that we want, that we believe we can serve over the long-term and who we can deliver the value to incrementally over the next 5 years. So we went through that, and you and others kept saying, why aren't your WSE counts growing at the rate of others? It was because we were treating customers that we didn't believe were the right customers for TriNet. That is all done, and it's starting to show in the retention numbers, which are exceptionally high.

All right. No, that's great. So building on the retention, I know you have the recovery credit program underway where you're giving back some of the upside on the insurance side. I would imagine that some of the benefit there should be in the form of higher retention. Can you walk us through what might happen here or what you're thinking? Or what your goals are with the recovery credit program?

Yes, but before I go through the goals, since there's some people that probably aren't as close to the TriNet story that are watching right now, maybe I'll just give a little bit of background, but yes, the recovery credit, from my perspective, it differentiates TriNet. We're really not seeing other competitors doing that. What it was, was in the second quarter predominantly, we had gotten cost savings well in excess of our forecast. So there were approximately $160 million worth of cost savings that we got that we hadn't anticipated from health utilization. And so we're really taking a large portion of that and committing it to our customers to show them we're as committed to them as they are to us. So we've accrued $104 million to date in the second and third quarter. We plan to accrue about 2% to 3% of GAAP revenue in the fourth quarter and up to 2% of GAAP revenue in early 2021. And what we've seen so far is we've used that as a tool as we've done our fourth quarter cohort. So everyone with contracts renewing in the fourth quarter related to retention of those customers. We haven't given a number yet, and I'm not going to do it today, but the response is very favorable. And so we definitely are seeing a lot of our customers want to stick with the model and with TriNet and are extremely appreciative. We do plan on giving an update with the fourth quarter call because just we're looking at -- we'll have a lot more information. When you think about fourth quarter and first quarter renewals, it's roughly 70% of our book. And so as we're thinking about those renewals, first quarter is a big one, and we want to be able to give investors full information. But so far, so good. It's being very favorably received.

No. That's helpful to hear. Because I'm trying to think about that as a form of pricing, almost. And as you're going through these renewals, how does that influence your general thinking about pricing and how you benchmark? Because intuitively, I would think retention goes up and you can use this as a weapon as well. But I'm curious, overall, given what's going on, what you just explained there, what does that mean for overall pricing?

Yes. No, great question. When I think about TriNet's pricing, really, we have 2 main parts of pricing. We've got our HR services and we have insurance services. With respect to insurance services, we continue to price for risk. We've added some tools over the last few years to really help better assess the health risks, and we also look at demographics of the groups that we're underwriting. And so as we take that information in, we're going to continue to price to risk and we're going to price renewals to risk as well. So with respect to HR services, we are continuing to price for the value that we're bringing. Burton mentioned the fact that Olivier Kohler has done a lot to improve the service of TriNet overall and I think our clients are recognizing that. And we are -- it's an underpenetrated market. And I think it gives us the opportunity to price appropriately for the value that we're providing. So we are looking at it in 2 different pieces. We're continuing to price the HR services for the value that we're bringing in and pricing the insurance to risk. But we're not using that credit to really subsidize any new business or renewals.

So that's an important point is that we wanted to show that we are a different company and that we are truly partnered with the companies that come with TriNet. The lack of utilization, particularly in May, and the insurance construct that we use based on the strength of our balance sheet, gave us immediate access to that cash and I know you understand that. So ultimately, the decision was made to show partnership more than a word on a page, we would return a significant amount of that to our customers. It is tangential to pricing to risk, and it is tangential to the PEPM service charge. It was more to say, with TriNet, you were part of creating this surplus. We are not going to use it to incentivize new companies to come on board. It wasn't them who generated it. It was you, and we are going to return that to you. I believe in as much as that's the case, it is generating interest in TriNet because nobody else in our industry has done it.

Yes. I mean, logic would say that it should drive a lot of goodwill for your clients. So let's see what that ultimately brings. I guess to wrap this part of the conversation enough, just thinking about we're coming in hopefully into a recovery period. Hopefully, the vaccine will be here sooner rather than later. You've got regulatory sort of always being complex, but it does feel like it's ticking up. So I know Burton, I've asked you this for all the years I have known you, so I have to ask it here a few questions in. Just as this pendulum swinging between outsourcing and do-it-yourself, where do you stand now? And what do you see? The -- is it fair to think that we could be moving more towards an outsourcing bias here overall?

So I believe we're heading towards an outsourcing bias for a couple of reasons. The conversation that is coming up when I talk to CEOs right now is around fixed versus variable cost. To build it in-house, you have a fixed cost. With TriNet, it's a per-employee, per-month fee. You're growing, you're shrinking, you're going to pay in proportion to your staff. So fixed versus variable leans towards the outsourcing model and it leans towards the PEO model because the fact that we are taking on the employment liability. I think the second thing is, which you've heard me say and I'll continue to say, I've been here 13 years, and it has never been simpler in any subsequent quarter to do business as a small business than it did the quarter before. So I am not worried the complexity will leave the system. Obviously, this model is shown really, really well during COVID because of the volume of information and essentially life-threatening issues that are facing these companies. We can get, and we have 3,000 people on a call about PPP loan forgiveness, run by our Head of our CX group; and Samantha Wellington, our Chief Legal Officer. That is a very different model than TriNet of 5 years ago. The advice that we're giving around loan forgiveness, the regulations around sick time related to COVID, the regulations around workers' comp as it relates to requiring people to be at work vis-à-vis COVID, things are changing on a regular basis. And whereas a few years ago, I was hearing that the pure software model would overtake the PEO or the TriNet model. I believe now there's firm proof that people are availing themselves of the expertise in these small businesses, and a lot of the software companies haven't fared quite as well.

Yes. And that's a -- used the goodwill word again, but I would think that helping clients navigate through that difficult period at the beginning of a pandemic, that has to build some goodwill and obviously, word of mouth to maybe propel the PEO model further. And again, that's why I asked the question. So thanks for that, Burton. So maybe just sticking with -- and I hate to always ask -- I hate to ask COVID questions, but with cases rising and we're going into the holidays here, it could be -- get a little tricky and health care utilization is one unknown and then what's going to happen on the back end of it, we'll have to see. But can you help us a little bit with what the P&L impact, what could be or should be? What should we consider with respect to net insurance margin, that kind of thing?

Yes. Sure, Tien-Tsin. I'll be happy to give you perspectives on it. Overall, health care utilization has come up since kind of the dip in the April and May time frame, but it's still below a level we would expect on a normalized basis right now. In the near term, some of the behavioral changes we saw were really fewer elective procedures, increased use of telemedicine, and we are really seeing that continue. We have seen slightly higher direct COVID costs, but what we're seeing from a direct COVID perspective, about half of our costs are related to testing. I don't really see testing abating at this point in time until a vaccine is really widespread across the globe, frankly. And so we would anticipate testing costs would stay up, but the good thing is, is cost of people that have gone into hospitals have really come down slightly just due to better treatments that are out there. So net-net, as we're looking at the fourth quarter, we really see probably utilization still being a little bit depressed, offset by -- somewhat by COVID. And I think the guidance that I had given at the end of the third quarter was a 4% to 8% net insurance margin in the fourth quarter as some of our pooling limits reset in October. And really, we haven't seen anything at this point that would change that. And as we look to 2021, we really want to keep watching the developments with COVID, the vaccine distribution and all of those things before we make a call on whether you expect a surge back or not.