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

Hi, everybody. Thank you for joining us this afternoon. My name is Ryan Fenske. I'm the High Yield Services analyst here at BofA. Pleased to have TriNet Group with us for a fireside chat. From TriNet, I've got Kelly Tuminelli, Executive Vice President and Chief Financial Officer. Kelly, thank you so much for taking the time today. I really appreciate it.

Hey, Ryan, it's great to be here with you.

Great. And so just to start us off, could you give us a quick overview of the markets that you're doing business in, new services you're providing and maybe highlight some of the industry tailwinds that you expect to drive growth going forward?

Sure. I'd be happy to. There are -- we are relatively new issuer. We issued our first bond in February of this year. And so there's probably a few of you that don't know TriNet yet. We are a professional employer organization that provide small- and medium-sized businesses, or SMBs, with full-service HR solutions tailored by industry. We offer access to human capital expertise, benefits, risk mitigation and compliance, payroll, real-time technology to clients. And we've got around 351,000 worksite employees and we are their co-employer as of September 30, 2021. There are other companies in the PEO space, about 4 or 5 public companies, and over 400 regional and private companies also acting as PEOs. In terms of, you asked about the tailwinds we expect to drive growth. Well, 1 thing I would say, Ryan, is new business formation, I'm very bullish on the growth in the SMB market. What we saw in the third quarter was tremendous growth as new companies are being funded at a faster pace than ever. And we're actually seeing that funding translate into hiring. When I look at our operational and financial performance in 2021, it definitely reflected that strong customer base that we have and our commitment to provide them with the best possible HR experience. So our strategy has been to attract vibrant and durable customers across our core verticals and it has consistently led to growth in our installed base. So we do see some tailwinds. It's based on the strong hiring that we're seeing. And even though with the tough labor market, our clients are still able to hire.

Excellent. Throughout recent quarters, you guys have highlighted the large market opportunity for the professional employer organization industry, with more than 90% of employees at small- and medium-sized businesses currently not using a PEO. What do you think are the key issues holding the industry back from more deeply penetrating this market?

It's a great question. I think it's really the knowledge of what a PEO can bring. There have been some new entrants into the market. And from my perspective, I actually see that as very beneficial. The more knowledge that people can understand that small and medium-sized businesses can actually have access to large company benefit through the public employer organization construct is something that just a lot of small businesses don't understand. Now the other thing is, I think when a business is very small, they really don't need a PEO. But with COVID, I think we've benefited from being able to see companies basically having distributed workforces and they never had, had this before, until the complexity has increased and the value of the PEO really is there to help you navigate that complexity.

Great. And then maybe for people that aren't familiar with the industry or the business, could you just kind of quickly highlight why that distributed workforce model that we're seeing more in COVID is really beneficial for your industry and for you?

Yes. It's a great question. Think about if you were all in 1 location, you could provide health insurance benefits, the whole benefit package for your clients based on 1 provider in 1 area under 1 contracting in 1 construct. When you've got employees across the entire United States, there are different carriers that are stronger and have different provider relationships in different areas. And we have all of those carrier relationships that can provide good quality benefits across the U.S. You also have tax filings that you have to do on behalf of all of your employees in each of the states that they locate or even in regional areas. We have employees in all 50 states. And therefore, we've got the expertise and just to add another worksite employee to our tax filings that are currently going on and you don't have to build up that back office expertise. We've got workforce analytics that we can help you understand all the details behind your workforce and your changing workforce. And there's just a lot of things that you previously didn't need as a much smaller business that now that you've got a distributed workforce, a private employer organization can take care of it for you.

Great. And then with that -- the large market opportunity in front of you and your industry, what are some things that TriNet is specifically doing to capitalize on this large wide space that maybe some other players in the industry aren't doing today?

Yes. Great question. I think all of us are trying to capitalize on the industry. But one of the things, I think, that really helped TriNet to stand apart during COVID is, we partnered with our customers and we created a Recovery Credit program. What that Recovery Credit program did is, it took some of the benefits that we received due to underutilization of health care and it gave them back to those customers that helped create that benefit and it helps them really get through when they had a tough time. And so I do think that's 1 thing that differentiated us during the pandemic, as we were able to use some of the benefits that we received and share that with our customers and create goodwill and retention.

Great. And then -- can you talk a little bit about the different industry verticals in which you operate? And then which verticals do you see the most opportunity to grow in over the next couple of years?

Yes. We do have. It's a great question, because we talk about our vertical strategy quite a bit. We have a differentiated vertical strategy where we do target on those verticals or industries where we think high-quality benefits make the biggest difference to the employment opportunity. And when I think about our verticals, our largest vertical is technology. We're located in the San Francisco Bay area and have had long-standing relationships with technology, and it's a large portion of our book. But we also target financial services, life sciences, nonprofits, a variety of other -- and even about 20% of our book is Main Street. Now when you look at Main Street, we don't typically target hospitality or leisure type industries because those aren't the industries that are really looking for those high-quality benefit offerings given the amount of part-time employees that they have. And so really, by our targeted selection, we're able to provide better benefits to those people that value it and get appropriate margins for the services that we're providing.

Great. And then can you tell us about your customer selection process? And how did you strike a balance between prudent selection of customers in verticals that are a bit more stable versus an overall desire to grow the business?

Yes. It's a great question. And 1 of the things I'll just highlight is when I started with TriNet a little over a year ago, one of the things we kicked off was a more robust view of client lifetime value. And so we have been analyzing what really is the right client that aligns with the value proposition that we are providing to the marketplace. And it's a variety of things. What's the percentage of asset utilization, what's the demographics of the group that we are taking on to our platform, what types of services, and what type of distributed workforce do they need from us. And what we really found is we're trying to target those clients that, frankly, value that and will, therefore, stay with us longer, enhancing client lifetime value over time. I think the verticals that we target, all do value that. And even in our Main Street verticals, we're looking at really skilled labor that need benefits for their family and need comprehensive services. So we plan to continue those efforts in 2022. But we also think that there's so much white space that we can't actually still be selective.

Okay. Great. Now pivoting a little bit to some of the sales trends that you're seeing recently. Now that we're in your peak selling season, can you provide any color on what you're seeing in terms of the pipeline, conversion rates and just the general length of the sales cycle?

Yes, happy to, Ryan. One of the things I would say is, effective in May, we have a new sales leader, his name is Jonathan LeCompte and we're super excited about the things that he is bringing to TriNet. I'm confident in the momentum going forward with his leadership. He's brought in some key leaders that really are helping us continue to refine our processes for speed and ease for our prospects. I think the sales cycle is picking up. We talked about it on our third quarter call, and clients are really becoming a little bit more comfortable focusing on what are they doing to make sure they've got the right back office in addition to focusing on the front office. From a sales perspective, we still haven't really returned to pre-pandemic levels, but I do think we are approaching and targeting the right small- and medium-sized businesses in our core verticals. And we've mentioned on the last 2 quarters that sales are up year-over-year and I would also mention conversion rates are actually up year-over-year as well. So of those deals that are coming to us, we are converting more of those to win. And while the sales cycle is a little bit longer than I would like, given the complexity of the sale on and trying to teach new people about what a PEO is, I have the utmost confidence in Jonathan and his team working with my team to make sure that we can shrink that sales cycle and get to market even quicker.

Great. And then sticking with the sales team, from a new sales perspective, is there a particular client size that you're more focused on targeting? And how has that evolved over time, if it has changed?

It's a great question. If you look at where we were pre-pandemic or actually -- I'll just go back to last year since that's really during my tenure, we were just under -- our average client size was just under 20. Our average client size is really between 21 and 22 right now. And so it has picked up a little. We do have different offerings for clients of different sizes because we do believe they have different needs. And over the last year, we actually have targeted a group of -- some of our best sales people to focus on some of the larger clients as well because we do think they have given the needs, differentials between small and large clients. Those over 100 may have very different needs than those under 100 or under 50. So we have changed our go-to-market a little bit. So we've got a specialized group dealing with those larger clients. And then the way we also differentiate our sales force is both by vertical, because we think people have additional specialties given their background and tech, for example, they understand better, they speak the language. Financial services, same thing. So we do have specialists by vertical, but also by region.

Great. It's been about 10 months since TriNet launched Connect 360. Maybe for anybody in the audience is a bit newer to the business, if you could just quickly highlight what that means for TriNet? And then talk about some of the benefits that you've seen or expect to see as we get into 2022?

Yes. No, I'd be happy to. Connect 360 was an offering that we launched in an attempt to have our clients have instant access to experts and really get all the solutions and HR needs with a single phone call. A good majority of our clients actually adopted this and utilized this offering the way that we intended it, but we also learned a lot. I would call Connect 360 really a beta test where we learned that different verticals and industries at times require different levels of service and support. So we are incorporating those learnings going forward. We've learned a lot through the process. We've refined our knowledge management, so that we have better information at our fingertips at that point of contact. And I think that we've learned a lot more from that initial pilot launch. Regarding retention into 2022, it's probably too early to call at this stage. But we are making sure that our clients are really -- really do understand the different levels of services, so we can align the right support behind them to meet each of their clients' needs.

Great. And then on the cost side, you mentioned on your last earnings call that your insurance cost ratio, particularly from reduced elective procedures in the third quarter as a result of the Delta variant. Have you seen a pickup so far over the last few months in elective procedures? And are you planning for any catch-up as we get into 2022?

Yes. It's a great question. And I did speak on a conference earlier this month and mentioned, we really only have 1 more month worth of data at this point. So we've got the month of October. And we saw a little bit of a catch-up, but not quite to the level that we had anticipated during the month of October. I think it's really too early to call what the Omicron variant may do to health utilization. You hear reports like the Governor of New York stopping elective procedures and if you read the fine print, you see that there's lots of procedures are really stopped only for those hospitals that have less than 10% capacity in their hospital beds. But we are watching it very closely. We're monitoring utilization very closely. But during the month of October, it was slightly better than we had anticipated.

Great. Since the onset of pandemic, we've seen quite a bit of government support for small- and medium-sized businesses. How are you managing the risks associated with stimulus programs rolling off?

It's a good question. I think everyone has the same risk associated with stimulus programs rolling off because when you saw the amount of utilization for like the PPP loans, the utilization was pretty high and it was actually higher in PEOs. And the reason it was higher in PEOs wasn't because our clients needed it more than people that were not utilizing PEO offerings, but that we were able to help them navigate the process, and get all the background to be able to apply for PPP loans as well as get fully reimbursed for them. What do I think that program did? I think what that program did is, it provided the uplift that they needed at that point in time. But given the strength that we're seeing in the market right now, I really don't think that same level of stimulus is needed for the majority of the clients out there. So I really don't think it's going to be a tough fall from that perspective.

Okay. That makes sense. Your average client size is around 21. So the majority of your clients aren't going to be affected by the White House asking mandate is the 1 that goes into effect. But how exposed are you to medium-sized clients with over 100 worksite employees? Is it a meaningful percentage of the business?

Yes, it's a good question. Between 3% and 4% of our clients are over 100. And we've been watching the -- it's our job to watch those regulations very, very carefully. What we have done, though, is we are prepared that if those requirements do go into a fact, that we have a solution that can help our clients not only track attestation from their track testing results, track vaccination status, and we are ready to be able to roll that out shortly to our client base, which I think can be extremely helpful for those large clients who have to comply with that. And we can also make it available to our smaller clients who want to do it even if they are not subject to the restrictions. So it's about 3% of our clients, but it is over 25% of our WSE base.

Okay. Great. And while we're on the topic of WSEs and your clients, I thought maybe you could just take a step back and if you could kind of talk about your co-employment model a little bit and why that's important to the business, I think that could be something useful for the audience?

Sure, sure. What a co-employment model is, is an employer takes responsibility for hiring and selection of their employees and makes sure they have the right talent there for the people that they need to do the job. What a co-employer does is, we are able to group a whole bunch of clients, and we've got -- we call our -- the employees that are co-employed by TriNet, worksite employees. And we are able to provide them full HR support including benefits as a part of our single employer plan. So we provide a single employer benefit plan that they all participate in, just like I participate in under TriNet. In addition to that, we cover employment practices liability. And so we buy employment practices liability insurance, and we cover anything related to employment practices, whether it's sexual harassment, we provide training associated with all of the compliance requirements that you may have, whether it is state-regulated harassment training, whether it's compliance with policies, et cetera. And we also make sure that all of our clients have workers' compensation insurance and then we provide for all state and local taxes required as a part of that employment relationship. Each of the worksite employees in our TriNet offerings will get a W-2 issued directly from TriNet. So we're -- when an employee gets hired, we are bringing them on to our platform. We are doing open enrollment. We are checking I-9 forms to ensure compliance and everything that you would do as an employer and including all of the back-end workforce tracking. Was that helpful? Did that answer it?

Yes, definitely. Shifting gears a bit. Can we just talk about your -- how you think about your capital allocation strategy and maybe any priorities you want to highlight as we think about next year?

Sure. I love talking about capital allocation. We -- when I think about capital allocation, first and foremost, I'm going to invest in growing our business. So organic growth is our #1 priority. Second of all, we will look at M&A. We haven't done anything recently on the M&A front. And frankly, valuations are high, and we want to make sure that M&A is accretive to our shareholder base. But when I think about M&A, I'm really thinking about it in 2 different ways. One, I'm thinking about it for within the PEO space, are there geographies or verticals or things that would complement our current offerings and really fit within the TriNet umbrella and help us expand in areas where we may not be as strong. And then secondly, technology. In the technology side, is there something that I think will be beneficial to our client base or help us get more clients in. And we're looking at that. Separately, we will always look at are there other offerings that we think would be helpful for our clients and evaluate that. But nothing has been a perfect shiny object that we absolutely have on TriNet yet, but I'm continuing to spend quite a bit of time looking at M&A as an opportunity to continue to expand and grow the business. And then lastly, actually, I didn't finish, though. We still will utilize share repurchase just given we've been a very cash-generative business and right now have about 0 net debt and only about 1 turn of leverage on a gross basis. And so we will still continue to utilize share repurchase.

Okay. Great. You mentioned valuations are high. But even if there's not something that you guys are ready to move forward with today, can you just -- is there anything attractive in the pipeline? How do you feel about the pipeline? And are -- you mentioned that the way that you think about it in terms of verticals, geographies, expanding certain technology offerings. Is there a specific area of the business that you view as a logical next step for M&A or a priority to address?

Yes. It's a good question. I don't want to give away the secret sauce, of course. But I would say probably some of the more interesting things really are on the tech side or adjacent offerings than in the PEO space right now. But that doesn't mean that that's necessarily where we're going to land. It's great to be the CFO of a company that has a lot of dry powder at this point in time. We did our first bond wins last year and being only really 1x leverage on gross basis, we've got dry powder to be able to make a move if we find the right thing that's right for TriNet.

Great. Yes, this is right into my next question. You guys have a lot of capacity on the balance sheet today. So how are you thinking about tuck-ins or something larger or more transformative? Are you open to the latter?

Yes. I think it's our responsibility on behalf of our shareholders to really look at all of those options all of the time. I think we're open to it, but I also think there's so much white space out there that we've got a lot of great organic opportunities. And definitely we'll always evaluate what are our organic growth opportunities versus what we think we could do differently transformationally as a part of something larger. But right now, we're really focused on continuing to grow and move the ball forward organically.

Great. And then if we could pivot a little bit to your credit ratings. They've been on a nice upward trajectory as of late. You're upgraded at Moody's. The positive outlook at S&P. How are you thinking about your long-term rating target? Do you have any investment-grade aspirations down the road?

Coming from financial services, myself, I always have investment-grade aspirations. But do I think we need it to run TriNet and get a great cost of capital? I really don't think we need it at this point in time. I think we will always take a relatively conservative position overall. But like we said in the last question, we've got a lot of dry powder. In terms of what do I think really would help move the ratings in more of an upward trajectory, I think our continued growth path, honestly. We've proven the fact that we're disciplined. We've proven the fact that we're going to make the right decisions to grow margins in the right way and to grow our size in the right way. And I think continuing down that path will naturally give us ratings uplift.

Okay. Great. And then just 1 more question on the leverage side of things. Can you remind us that there's a target that you kind of keep in mind? Obviously, you're very lowly levered right now. A target or a range that you're comfortable in trying to get a sense of if there's any kind of upper bound that you would want to consider, should 1 of the larger M&A opportunities be something that you want to move forward with?

Yes. Ryan, it's a good question. We do not have a public stated leverage target. Our debt covenants for something larger and transformational would let us go up to 4.5 turns. So I think at 4.5x, we would not plan on keeping it there. Our plan would be to get it down to a more reasonable level, call it, 2.5 in a short enough period of time that is comfortable to digest something much larger. But we do not have a stated leverage target out there right now.

Okay. Great. And then on your debt structure earlier this year, you transitioned to an unsecured capital structure, look at your loan, you have the 29s now. Do you see a place for secured debt in your capital structure going forward? Or you plan to predominantly use unsecured debt now that you've entered that market?

Yes. Well, we do have secured debt in our capital structure, meaning that we've got a credit line. And so we do have a secured credit line for $500 million as part of our secured debt. If we were going to move forward with some larger type of transaction, I think we would evaluate all possible financing options at that point in time based on the market and market conditions. So I don't want to say never, but I think we've got very good terms with our unsecured offering, and I think the market still is very attractive to us.

Perfect. And just 1 last one, Kelly. You've been at TriNet for a little over a year now. What surprised you the most in your first year there? And what are you most excited for as we get into 2022?

Yes. That's a great question. I mean I -- 1 I love TriNet. I think the company, having been public for about 7 years, is still very entrepreneurial. I think there's still a lot of opportunity for us to continue to grow and have -- just be creative in the marketplace. It's not such a big company that we don't have an opportunity to be agile. And that's really what excites me a lot about being at TriNet. When I look forward, and what I see has happened over the last year since I've been here, I do think that people have learnt to work less functionally and more cross-functionally, and I think that has worked very well. And I think it's only improved the speed that we can do things and go to market. And I think the thing looking forward is, together, the whole organization is looking at further developing our view on client lifetime value further refining our market focus and further making sure we can grab our fair share of that white space out there.

Great. That's awesome. Kelly, thank you so much for the time today. I really appreciate you joining us at the conference. Thank you.

Great. Thanks for having me, Ryan.