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

Great. I think we'll get started here. Thanks, everyone, for joining. This is Tien-Tsin Huang. I cover the payments processors and IT services names and I always have a good portion of covering a lot of the great HR outsourcing names over the years. And Burton Goldfield here is kind enough to spend some time with us and do a fireside chat. He's the President and CEO of TriNet, and we'll do some questions that I've gathered from investors. And if it's okay, Burton, we'll take some questions from the audience as well.

Would love it.

Awesome. So thank you so much for being here.

It's great to be here. Nice to see your Tien-Tsin.

Likewise, it's been a while. It's been a while. Certainly -- haven't seen you since the pandemic. So it's good to press palms. We had ADP earlier, and they were quite positive on the PEO space. It did give us an update on the health of the economy. I figured we should always start with that since you've got such a great view on what's happening with employment and SMBs in general.

Yes, I heard that ADP was bullish on the PEO as we are. I think that the secular trend will be strong over the next couple of years for the PEO model. As far as the overall SMB economy, I think it's mixed. We're certainly seeing some of the economic slowdown. One interesting fact is we do quarterly polls of all of our clients, and we added the question is, what were your plans for 2023 as it relates to hiring. Over 30% said they were going to grow their employee base by 10% to 20% next year. So we either have really optimistic CEOs or there is a resilience in the SMB space that we have seen over the last couple of years that may continue into the future. New company formation is down in Q3. But overall, we are still seeing the positive growth of the installed base from an employee standpoint.

Great. We always debate this, and I think you would agree, Burton, that there is some positive selection bias for the PEO that stronger SMBs will gravitate to PEO in general. So can you speak to that and just the demand side of the equation and what you're seeing on the ground? Because of course, everyone wants to understand how demand might be impacted by the recession or what have you, but it does feel like there's some secular benefits as well. Can you talk to that?

So -- as I opened with, I think there's a strong secular benefit for the PEO model for many reasons, but one is this divergence at a federal state and local level that's going on right now, where employment in multiple states is very, very difficult. Access to health care is now varying widely based on the gov's decision. And ultimately, with employees still working remote, in many cases, particularly knowledge workers, it is very hard to stay compliant. The PEO model not only allows you to stay compliant but shares the liability to make sure that you're compliant.

Right. So with all the complexity that's happening and compliance being so important, it does feel like the pendulum is going to swing more into the PEO favor. I know you guys had a press release this morning, Burton, we were just talking about briefly you're reorganizing a little bit maybe to go after that. Can you maybe talk to that?

Absolutely. So we have promoted 2 internal executives, 20-plus year PEO experience. One is Alex Warren, who will now be the Chief Revenue Officer. We haven't had that role in the past where we're uniting all revenue under a single individual. Tom (sic) [ Alex ] has been responsible for most of the revenue over the last many years as he's responsible for both the renewals and the installed base to cross-sell, upsell, the distribution of the recovery credits, et cetera, and the customer experience. And we have also added an individual who was in our organization, Tom Rose, who will now run the services organization.

Good. No, it's good to get the reorg done. So yes, I guess that's the macro update. Burton, before we get into some of the details on the business, I guess sticking with current events here, you're live with the second Dutch tender offer. I think that, to me, speaks to the bullishness on your side of the business and the balance sheet or whatnot. What more can you tell us about the thinking there?

Yes. It's an interesting economic backdrop, as you are aware, and everybody in the audience is aware, I believe that as companies seek to add variable cost models as opposed to fixed cost models, they will be reducing the fixed cost and overhead around their HR organizations and moving to a PEO. And I think that's a great benefit for TriNet and all the other PEOs. So ultimately, we are optimistic about the future and believe that there's the value for our shareholders by buying back shares of the company stock in the Dutch auction that's taking place. Over the past year, we have bought Zenefits. We did one Dutch tender earlier in the year. And with the successful completion of the second Dutch tender, we will have bought back over $600 million of stock based on our cash flow and CapEx-light model.

Yes. No, you've been very proactive with the capital deployment. I get the question a lot, Burton, right, with market valuations on the public side have come in quite a bit. Competitively, are you seeing any changes, especially from some of the private smaller players? I know there's been some consolidation in some of the PEO land, but what are you seeing?

Largely the quotes that we generated are still uncontested, meaning there's a lot of open market out there. As you know, we're verticalized by industry. We're playing in industries that are not necessarily being focused on by other PEOs, industries like the nonprofit sector, et cetera. So from a competitive landscape on the PEO side, I would say there hasn't been radical change. There's opportunity for everyone. And I appreciate the growth of the PEO space. As I said, I believe the secular trend will go in the direction of PEOs, which floats all boats. I do see more competition in the HCM space. There's a lot of great players in the software arena. And I believe the opportunity is to address the entirety of the SMB market with the approach that we've talked about in the past, which is having an HCM solution as well as the PEO solution and being able to switch seamlessly between the 2 based on the needs of the customer at that particular time.

Yes. Okay. Now I do want to talk more about the ASO and the HCM in general, for sure. But let's get into some of the numbers, if you don't mind, just to get out of the way to get everybody on the same page. You had a pretty big quarter, 21% growth in Professional Services on 1% growth in volume or WSE. So can you, Burton, maybe break up or decompose that 21% growth in professional services? Clearly, that's a pretty strong figure there.

Yes. No, and we were really thrilled with the quarter. I measure our success by the growth in professional services revenue, as you just pointed out, thank you. And this was an exceptional quarter. About 9% of that was inorganic growth. The rest of that was rate and volume.

Right. So from a rate standpoint, I think we've talked on that. But just from a volume standpoint, if we look at it from a benchmarking exercise, the quality versus quantity on volume, Burton. I know that's been important. And I know we get caught up sometimes too much on unit growth and looking at what ADP and some of your peers discuss, but tell us about how you benchmark that. And what are you looking for from a go-to-market standpoint?

I believe we have a unique and wonderful customer base. We are verticalized by industries and are selective on who comes to our model. So sometimes the volume doesn't match other folks in the industry. I am managing for top line revenue growth and profitability, not necessarily WSE count too, which is a very convenient volume metric as you point out. So ultimately, I want a set of customers that have a total lifetime value reflected in the professional services revenue where they are receiving the value that they expect and exceeding that value based on the professional service fees that they're paying TriNet. And I'm really pleased with the last year as it relates to the growth in professional services revenue. I believe over time, in fact, part of the evolution of the revenue model is to select more great customers that have a total lifetime value. Part of that is the growth. Part of that is the retention. Part of that is the additional services they offer. And cross-sell and upsell will become more a part, as you and I have talked about, of the model as we move forward with a total single revenue owner.

Yes. So let's talk about cross-sell, upsell. ARPU is a simple measure that we look at across all of our names, and you've been talking about product speed and breadth. I think there's, what, TriNet Enrich, Clarus R+D are some of the things that you talked about. Can you just help us with the product road map in general and how those things fit, what else you would underline?

So if you visualize a barbell at one end, we have this HCM solution, which is benefits modern user interface, API-first, Amazon-cloud base that is at one end, and it's a great product. At the other end, we have the PEO model, which involves the transfer of liability, the full services from an HR standpoint and the ability to have a single employer benefit plan across the entire country. In the middle, we've started to add the products to allow us to both cross-sell, upsell, which is really in the nascent stages. We talked about Enrich, you mentioned Enrich. We also bought Clarus R+D, which allows us to automate the tax credit process, which is particularly applicable to a large percentage of our existing customers as well as bringing in some net new customers. I believe, over time, with a single platform that allows us to transfer seamlessly between the legal models of HCM and PEO, same payroll engine, same input screens, same reporting capabilities but allows us to closely follow the customer journey and keep the customer longer will be an increase in total lifetime value that needs to be managed holistically.

Yes. And so when you bought Zenefits and the thesis of getting in more to HCM or ASO model and the barbell as you just described it and the ability to help capture some of the graduating clients, as you just described, any surprises or variance from the thesis that you originally described to us in buying Zenefits?

I love the team and I love the direction they're going on helping us to build the next-generation platform. What's exciting to me is, in a very short time, we have built a fully integrated product, which is the integrated open market solution, where we can keep a PEO client and give them benefits through the then admin capabilities of the Zenefits platform. So we have integrated those 2. If the risk profile or the desire is to have an open market plan instead of the TriNet single employer plan, they can get an open market plan through Zenefits, administered through that platform and be a PEO customer ongoing. So that's one part of it. The second is we're seeing clients naturally move from the HCM to the PEO. We expected that. Again still in the nascent stages, but we're taking it very slowly. And we're also seeing clients on the PEO side move to the HCM solution as they grow.

Yes. And the timetable on integration and the work and the cultural meshing of the companies? Any you can share there?

Yes. Absolutely. So 3 different areas. The first is we announced this morning that we will do a tighter integration between the solutions as part of the structure that we announced this morning. So bringing the development teams together, particularly as important as we build a next-generation solution, really bringing the sales engine together as a single organization. What they've been doing is passing leads back and forth. Now we'll have the opportunity to be one sales force. And I'm just thrilled with the fact that we delivered an integrated product for a very important use case. From an overall time standpoint, what I've asked for, Tien-Tsin, is incremental value delivery to our customers every single quarter until the integration is done. So this is not about going off for 2 years in some big bang. It is about every quarter, give me capabilities that we did not have jointly before this and deliver that value to the customers, whether it's new service solutions, whether it's an integration of the open market benefits to the PEO, whether it's additional payroll capabilities on the Zenefits side, the TriNet Zenefits product has been enhanced dramatically from a payroll standpoint since February when we acquired Zenefits. And they are meeting their deadlines to add the capabilities that the Zenefits customers are looking for.

Yes, yes. No, it's good. Like I said, it's the development team, the engineering staff, tech. I think it's good to have that muscle, right?

And I -- look, from my vantage point, technology needs to keep moving forward. I believe companies that don't keep up with the evolution of technology, ultimately, will be constrained on the value they can deliver to their customers. It's not tech for tech's sake. It is that the industry is changing. The desire to use third-party products and integrate them with the solution, the desire to build out how reports and customize them specifically for my small business, all of that is being asked for and is customer-driven. And by owning the technology, as TriNet does, I believe we can continue to provide customer-driven value at the time.

Good. I mean you have a lot going on, obviously, with Zenefits and the reorg and the focus on product. I know throughout this earnings season, we've heard a lot of companies talking about being tighter or more disciplined around their operating expenses potentially going into a recession here. So what's your thinking here, Burton, have your priorities changed around investing versus cost cutting in the last 90 days given everything that you have on your plate?

So the hurdle rate for additional acquisitions, you have to take into account the cost of capital. So I'm being more circumspect about the companies that we acquire. Obviously, we're excited about the Dutch auction that's going on and returning capital to our shareholders through it this year and proud that, that is all with free cash flow, not borrowing money. And I believe that ultimately, the future wise in providing more service, better service better usability, interoperability with our customers. And I do believe that at the core of that needs to be technology that enables it, we're very focused on that next-generation technology.

So if we bring it to the margin question, I know there's a lot of moving pieces in the business, but just philosophically here going into next year and the following year, any consideration from a margin lift or pressure standpoint?

So Kelly, our CFO, has a lot of levers to pull as it relates to the cost of the organization. Managing cost has always been a priority for us as we're cash generative and profitable. And we're currently trying to balance the commitment for the long-term investments. I am not pulling out of making the investments to keep this company grade 5 in 10 years from now, but we'll also make sure that we continue to become more efficient and grow the business. So from a capital priority, it's the same. We'll invest in growth. We will look at M&A activity, although that's probably a little slower now as we digest the existing acquisitions. And then finally, returning capital to shareholders. And I think the team is doing a great job with the Dutch auction.

Yes. No, that's clear. That's clear. So before I open it up, let me make sure I hit a few more just on the health utilization front. I know the performance on health doesn't matter. Health care utilization, what are you seeing trend-wise?

So the trends through Q3 were below our expectations. That's why we are doing a credit program back to our customers. It's now our fourth. And I believe that the partnership is enhanced by returning the excess premiums versus claims to our customers. I'm not sure I know what the new normal is. Certainly, from a preventative care standpoint, it's back to what it was pre-pandemic. I actually applaud that because it reduces the catastrophic cases down the road. Whether the utilization will go back up to pre-pandemic levels, I don't know. We continue to be conservative in our accruals and estimates from an insurance standpoint. And -- but it will be interesting to see what the next year holds. I'm not overly worried about it. Our ability to analyze on both a customer by customer basis and overall trends in our customer base, the WSEs in our customer base, is better than it's ever been. So my visibility, we're doing a daily analysis as the claims come in to make sure we catch any trends. But the bottom line and the headline is that through Q3, utilization remain below our forecast.

Yes. And look, from the actuarial side and with Kelly and some of the changes and working closer with the carriers, it does seem like the visibility has gotten better there.

Yes, that doesn't mean we can't get it wrong, but I'm a lot more comfortable than I was a few years ago, and I think they're just doing a good job. And we can -- what it means to our customers is they get choice. We have over 550 medical plans in the U.S. They get choice around everything from what they want in their plans and the localization around having the plan, Tufts in Boston and Kaiser in California and Colorado, et cetera, as well as the Blues as well as UnitedHealthcare. And our customer base really values that choice as opposed to saying, you will go with one insurance company, period, full stop.

Yes. Do you have the customized and give choice, I think that's helped you from a selling perspective. So yes, and it's moved down on the list. In terms of questions when someone's asking you, so I guess that does show it.

We're making progress.

Yes. And my daughter's getting braces next month, just so you move that into your model. One more. Just with -- you mentioned the credit program, how would you grade the success of these credit programs in general? You've done a few now like you just said and I know the thinking was that it should drive goodwill, greater goodwill with your clients, and that kind of thing. Have you observed that?

We have. But first and foremost, I believe that doing it is fulfilling our commitment as a trusted adviser to our customers. What I can tell you concretely is that over half of our customers are now on longer-term contracts, whereas before they had 30-day contracts. So 50% of the installed base has moved to long-term contracts as opposed to our model in the past. And from my vantage point, it's all part of what a true partnership is. I take on my ability for my customers when I have the opportunity to return capital to them, I will do so. And I do think things will normalize over the couple -- next couple of years. But ultimately, I want to make sure that we get as close to the pin as it relates to premiums versus claims in every single quarter. We all know that's impossible. And this was an effective way to balance the scorecard as it relates to premiums and claims.

Right. Right. So better retention.

Better retention, right, and then also the retention is impacted by having additional products and services. So the more utilization of products and services is stickier it is and we just want to add more value. So Clarus R+D, to be able to do the investment tax credits is awesome for us because there's another chance to hand another check back to a customer who's paying us. And in many cases, these are credits that they were either unable or unwilling to spend the time to invest in. So for them, it's a net upside.

There is no downside.

Yes. It's their own money.

That's important to point out. Any questions from folks. Yes, please. I can't remember if we're webcasting this, but if you wouldn't mind taking the mic, that would be helpful for us.

Burton, when you look at the delta between the professional services revenue growth and WSE growth, can you help us break that down between sort of like-for-like pricing versus the upsell, cross-sell or maybe some mix shift? Or what are the biggest drivers of that? And then if you could just talk to the sustainability of that going forward, double-digit pricing effectively growth going forward?

So breaking it down, again, year-over-year, the professional service revenue grew 21%. Of that, 9% was inorganic, was the acquisition of Zenefits and the professional service revenue associated with it. The rest was both rate and volume. Rate, we've been consistently in the mid-single digits every year for as many as I can remember. And then obviously, there's the volume. The volume component is a combination of the new sales coming in the door, the change in existing of the -- since we're charging on a per employee basis, change in existing PEPM and then finally, the retention. So as the base continues, obviously, you get the full total lifetime value out of the customer.

Yes. You used to talk at times about that there sometimes would be employers who would sort of mature out of the model. They've hit 500 or 1,000 employees and kind of thing perceptually hey, started with a PEO and now met a phase where I don't. And I think it would put some pressure in terms of replacement of all those. Can you just talk about how you adjusted around that or responded to that and where you are today?

Yes. So how we responded is January 1, we start selling an integrated product with Zenefits, which has a benefits administration tool and allows a PEO customer to bring their own medical plan. So instead of saying, "I don't want to be part of your single employer plan. I'm now 600 people. I want to bring one from the open market." We have that capability. We did not have that capability in-house a year ago. So the acquisition of Zenefits allowed us to do it. And we have customers onboarding January 1, utilizing Zenefits back-end and admin plan bringing an open market plan and utilizing the full services of the PEO. So we have plan administration and the PEO. I'll be able to tell you, over time, does that reduce the larger customers of leaving. That is our expectation, but we're just doing that. Before, we had something called TriNet 11, where we mailed them a check, they would have to administer their plans completely totally separately outside of the PEO.

Just picking up on what was discussed about the naming of the new Chief Revenue Officer and the Chief Customer Service Officer. Didn't it respond to any observation about things you see going on in the business or things you've seen going competitively?

All of the above. First of all, it eliminates one direct report of mine. And so I can spend time with Tim and the others and others. Because the revenue components were all rolling up to me separately, so this is a chance to take all revenue and put it under an industry expert. Number 2 is I want to do more selling into the installed base, and we did not have a model that allows you to do that easily. You had new sales, which did not sell into the installed base. Now I have an organization that is responsible for the renewals. Obviously, that's a huge piece of it, over $4 billion. I have new sales. I have Zenefits, and I have cross-sell, upsell across the entire book of business under a single leader. So we can look at total lifetime value of a customer. We can analyze the customers, who we're bringing in the front door, make estimates about their long-term value and make decisions and have a much more seamless experience as opposed to handing it off, keeping all of that client execs and the sales under one leader. So it's a response to a belief that our customers are going to become more complex as they move from PEO to HCM and back again. The fact that we have Clarus R+D, we have the upsell products like Enrich and the fact that new sales which is now quite efficient. Our productivity is up, but needs to grow dramatically to address the market that we see out there, particularly over the last couple of years. So it simplifies my reporting lines and it gives us the chance to trade off how a $1 is spent to attract $1 of revenue.

Good. Any last question. We have time for maybe one more.

What have we got?

Andrew?

Andrew.

I wanted to ask about the sales force consolidation you mentioned before between Zenefits and TriNet. Obviously, TriNet is much more vertical-focused and Zenefits is a little bit more of a horizontal platform. So how does that marriage work between the 2?

They're very different customers to begin with, in most cases, Andrew. So we are going to continue verticalization by industry. It's working in the PEO industry. I do not contemplate ever changing that. As this was announced 3 hours ago, the integration of the sales force, there's a great leader on the Zenefits side running that sales organization. So we will look at opportunities because right now, we're passing leads back and forth. We have a bunch of customers, as I've highlighted in the last earnings call, that have gone from the HCM to the PEO. We have a bunch of customers going the other way. And it simplifies the lead passing the top of the funnel allocation of leads, and we will then look at how the sales forces work together.

Good. I think we're out of time. But just -- I do get this question a lot in calls like this, if you don't mind. We've covered the name for quite some time dating back to even longevity days. But going into likely slow down recession, what have you, how is TriNet different now versus past cycles? And how durable do you think -- already do you think TriNet will be as the world slows a little bit?

So obviously, I love this business. I love TriNet. We've had 14 quarters of beating expectations and, in many cases, raising guidance. We have significant free cash flow as a company. And it's a low -- capital-light business. We have a great team, now adding 2 members with over 50 years' experience in PEO. We have the talent around the table. I believe the SMB market is resilient, and I believe our customers are even more resilient. We have over 3,000 U.S.-based colleagues dedicated to this model. And I've been doing this for almost 15 years, and I believe the value proposition gets even more unique as we roll out new technology and new services.

Great. I always appreciate the passion, sir. Great to have you, Burton.

Yes, it's great. Bye-bye.