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

Thanks, everybody, for joining. I'll kick it off. My name is Ryan Fenske. I'm the High Yield Services analyst here at BofA. It's my pleasure to have TriNet with us this morning. Up here on stage with me, we have Kelly Tuminelli, Executive Vice President and CFO of TriNet; and in the audience, we have Alex Bauer as well, Vice President of Investor Relations. So with that, get it going. And Kelly, to kick this off, just for anybody that's not familiar with the business, could you provide some background on what TriNet does and the problems that you're solving for your customers?

Great. Ryan. I'd be happy to. TriNet is a professional employment organization. And so as a PEO, we take the tough out of HR from your back office. So what we're doing is we are handling all of your federal, state, local employment regulations. We're handling payroll. We're providing access to high-quality benefits, including medical, dental, vision, 401(k), life, disability, and a bunch of voluntary plans. We also provide employment practices liability insurance up to a specific limit. And the co-employment concept is as a professional employment organization. So when our co-employed worksite employees get their W-2 at year-end, it is under our tax ID number. So if you think about the value that we provide, so the second part of your question there, moving to remote work definitely increased the value of going to a PEO. Regulations have become very, very complex for a lot of our clients. Our average customer size is between 20 and 30 worksite employees, but we do have customers up to and over 1,000. We use our scale and service of our customers and allow them to have access to competitive benefit plans that they wouldn't have access to as a small or medium-sized business. So it really helps them focus on the front office, while we take care of the back office. And generally, for that size of the company, it's much less expensive than hiring a full-time person to manage that for you.

Awesome. Thanks for that intro. And with that in mind, you guys have a really interesting vantage point into the health of the economy, particularly as it relates to small and medium-sized businesses. Can you just talk about what you're seeing right now and maybe touch on your clients' hiring plans for 2024?

Yes. No, that sounds great. We really are -- we go to market using a vertical strategy. So when I think about our employment base overall and our client base overall, we're approximately 80% white collar. So we have really a unique vantage point into that. We target technology, financial services, life sciences, broadly, professional services, nonprofit, and select Main Street clients. So as we look at our installed base of customers, we've really seen the following. Hiring has been muted, not a surprise to any of you there. There's been really very little net growth in our installed base, which is unusual for us, because typically, our installed base has grown in the high single digits. As we look forward, we are anticipating and running our business assuming sort of a steady state right now and will really be the first to call out any growth that we start to see. When I'm thinking about tech, obviously, tech, the funding has been much tighter with the interest rate environment that we're seeing. And so as I look back at hiring, we really started seeing the slowdown in tech really in the second half of 2022. I do believe, though, this is going to reverse, and we are invested in the greatest new tech companies coming out these days, and we're looking forward to seeing them grow. The really unique thing that we're seeing as we're looking at the economy as well is businesses just aren't going out of business like they have in the past. So as I think about hiring plans for next year, it's really kind of a bright spot that I think some of the prudence that people have done from a hiring perspective and really kind of rationalizing their workforce has helped them remain healthy and strong, and we're not seeing those companies go out of business like we have like during the early part of the pandemic as well as what we saw in the financial crisis.

Okay. Great. And you just mentioned the resilience of your client base, and as well earlier, you touched on the remote work trends and how that benefits you guys. More broadly for the PEO industry, what are some of the other secular tailwinds that you guys are seeing?

Other secular tailwinds. Well, for one, for small and medium-sized businesses, really what they're trying to manage is and why they've come to a PEO is they're trying to manage cost complexity and compliance, because complying with the regulations as they've expanded and diverged across states has become quite costly. When we think about those regulations, there are significant complexities with them in providing health care to your employees. When we think about what happened during the pandemic, and more employees at least for a period of time went to remote work, we had people spread across multiple states that had different rules around health care, and we've been able to really provide certain benefits related to that. With respect to cost, it is expensive to remain compliant. And what we do is we allow these small- and medium-sized businesses to really leverage our scale and use more of a variable cost model. So we charge on a per employee per month basis, although we do have certain client minimums, because we have to manage each client individually. But that really allows them to flex up or down depending on their work base and not have to change their back-office support associated with it.

Okay. Great. And so you guys have been experiencing really strong ACV growth throughout this year, particularly in the third quarter. You've mentioned a number of kind of broader industry tailwinds that are benefiting you and the rest of the industry. What specific to TriNet is driving that growth?

Yes. Simply, I'd say, focus and diligence and knowing where we can win. So when I think about the changes over the last year, we did definitely see a slowdown in 2022 and saw that it was taking people longer to make decisions just given the economic changes that were happening. There's a few things that we did last year that have paid dividends into this year. One is improving the go-to-market operational aspect. So we've improved our speed to quote by over 50%. We've really provided support to our clients in terms of the amount of data and information they've got to give us to be able to price and quote business to them. We've made changes in leadership. And I think we've done some internal reorganizations and promoted a Chief Revenue Officer, which has provided greater benefits across our sales and service organizations and aligned the go-to-market strategy related to onboarding new clients. And lastly, we really saw that we were capacity constrained. So we made some tough choices. We reduced our G&A expenses in the back office. We integrated our Zenefits acquisition more quickly, so that we could fund growth in our sales force. And we had a big need there. We've grown our productive reps about 19%. We've grown our overall rep base around 19% as well, and it is paying dividends and, spoiler alert, as we're looking at our January pipeline, it's one of the strongest ever. So we're feeling great about the sales execution, pricing discipline and being able to continue the momentum into next year.

That's excellent. Maybe taking a step back, could you frame the competitive landscape for us? Where are you competing against other PEOs, and separately, where is the market a bit more fragmented where maybe there's a little less competition?

Yes, I'd be happy to. When I think about the PEO market, it's very concentrated in 4 geographies: California, New York, Florida, and Texas. So in those areas, you do see a little bit more competition. But the one thing I would reiterate is outside of the broker channel, in 50% of our opportunities, there's no competition. So it's really us because it is a relatively underpenetrated market. It's us explaining the value of moving to a PEO, being able to invest in your employees, provide them access to things that they really wouldn't have access to otherwise, and give you a competitive edge from a hiring perspective. So what I'd say, Ryan, is there's a lot of white space out there. We are targeted when we're approaching it, though, because we want to balance the marketing spend and the spend of going into new areas with measured growth.

Okay. Great. And you mentioned the white space that's out there. And I think you guys have talked about 7% of all small and medium-sized business employees fall under a PEO. So it's certainly a very underpenetrated market. I guess given the value prop and what you guys do for your clients, why do you think -- both for TriNet and the industry broadly, why is the market still so underpenetrated?

Yes. I really think it's an awareness issue. And a few years ago, I don't think you'd really seen PEOs advertising. I think we really led the charge in that in terms of trying to get brand recognition, our name out there. We did see entrants potentially going public as well, which did help, I think, from an awareness perspective, getting PEO out there. So that is the toughest part from my perspective, but I do think over the last 5 to 7 years, we have seen that penetration grow as there's been more awareness. So I think everyone's offering is slightly different. I think our vertical focus and the technology that we provide is different than what other competitors offer. And so I don't see competition as a bad thing.

Okay. Great. You just mentioned technology. So I mean, to kind of capture some of that incremental white space, you guys acquired Zenefits a couple of years ago. Hard to believe it's been about 2 years at this point. But it's still a small portion of your revenue, but growing nicely. So could you maybe just dig into the strategic importance of that Zenefits acquisition and how you guys are thinking about the growth opportunity from here?

Yes. No, happy to do that. When we bought Zenefits, we did the diligence at the end of 2021, and then closed the acquisition in February of 2022. And when we announced that, one of the things that we mentioned was we expected, well, it wouldn't be accretive immediately. We expected it to be roughly breakeven by 2024, and we're on track to do that. So I feel great. Even with the slowing economy, which wasn't contemplated at the time we did the acquisition, we've done things on the cost side to make it breakeven in 2024. One of the strategic values of the Zenefits acquisition was the technology. And so when we bought Zenefits, we saw bespoke software built for small and medium-sized businesses and had done a scan of a number of companies and really felt like it was the best fit for us. So we are making significant progress in terms of thinking about that. And part of the Zenefits rationale as well was being able to capture more of a customer's life cycle. We're still on that journey. We've gone through and provided really more of a -- we're trying to provide a barbell of products and services to fit clients' needs depending on where they are in their life cycle. One of the first products that we introduced was a brokered PEO product using the benefit admin platform from Zenefits. So it's a combined PEO-Zenefits product, where we're providing brokered benefits to small and medium-sized businesses that maybe don't fit our typical PEO model, but want the advantages of a PEO. But the real advantage I see going forward with Zenefits as well, as we think about that barbell, is adding services. So as we looked at the attrition rate of the customers, we looked at the NPS score, we looked at what customers were trying to get out of their relationship with their HRIS provider, we realized that it was lacking human services to really help them with the complexities of HR. And so we are -- it's nascent at this point in time, but we're starting to add administrative services to make HR easier as well.

Okay. Great. And pricing for that offering has been strong as of late. I think you highlighted that on your last call. Is that a function of rolling out the additional services that you're mentioning just now? Or was the offering kind of underpriced to begin with?

Well, it's a great question. When I joined TriNet, we really felt there was an opportunity to improve pricing discipline and better understanding pricing transparency and value that we're providing to all of our customers overall. And Zenefits was just a piece of that. Outside in the third quarter, we did have a commutation of a broker agreement. So I'm going to put that to the side for a minute. But even outside of that, we have increased the value that we're getting from Zenefits on a per user basis by about 20%. So I would say more of that. It's not just a base price increase, but really, it's an upsell opportunity that we've been able to capture through Zenefits by them buying more of our higher-valued products.

Okay. Great. Maybe a quick follow-up on that. Is there kind of a way to frame like how much of that upsell opportunity you guys have captured to date?

Well, it's really a 20% price increase overall. So when I look at our third quarter results, excluding the broker commutation, we've got about a 20% pricing improvement. Now our user count has declined slightly, but we're seeing, with the addition of services, more people much more interested in our HRIS software. So I think that's our real next opportunity.

Okay. Great. Maybe shifting gears to financial policy. Can you just walk us through how you're thinking about capital allocation and what your relative priorities are?

Yes. In July, we made our financial policy public. So before that, we'd really been operating under our financial policy, having discussions with our Board of Directors, talking about what the appropriate leverage for TriNet was, but did decide, as we were going to reshape our balance sheet over the summer, that it was going to be important to investors like all of you for us to make that very, very clear in terms of what we were targeting. First and foremost, though, I want to make sure we're clear. We're always going to invest in core organic growth, first and foremost. So that's our first capital priority. Second, we'll look at M&A. We'll look at M&A opportunistically with a lens of what can be accretive to our shareholders overall and what's really going to add value to our customers that they're willing to pay for. Next, we will look to deploy, through share purchase, and we also announced that we would be initiating a dividend in -- or we were contemplating initiating a dividend in 2024. No final decisions have been made on that, but that is something we're looking at and getting a lot of investor feedback on. All in all, our plan is to deploy approximately 75-plus percent of free cash flow to our shareholders if it's not used for M&A, and maintain a leverage ratio between 1.5x and 2x EBITDA.

Okay. Great. On the M&A front, how is the pipeline looking today? Are there any specific opportunities that you guys are out there looking to address?

I appreciate that. We're always scanning the marketplace, but what we're really looking for is accretive transactions. Right now, I would say we would probably look for things more on the smaller side that are complementary to the product offering. So think about our Clarus R+D acquisition last year. That was really a value we could provide to our customers that weren't even knowledgeable that they had access to research and development tax credits. And so it's a value-added offering. Those types of things we're scanning the environment for. But as we're looking at the marketplace, I do think there's still an opportunity for rationalization of prices.

Got it. That's something that we're hearing a lot of from, I think, broadly from my coverage and other analysts as well. You guys have done an excellent job maintaining a conservative leverage profile. You mentioned your recently announced leverage target. Why is that the right level that you guys settled on as being comfortable for the business?

It's a great question. The way I think about that leverage target is it really helps us be efficient with our balance sheet, but provides us opportunity and flexibility for growth. So hard to say exactly, but it really is the sweet spot that we felt was a conservative profile, but still was prudent in terms of managing our balance sheet efficiently.

Do you view it as having some flexibility? Should a good opportunity on the M&A front pop up and you might want to raise some incremental debt to fund that, is there flexibility to go above temporarily? And if so, is there kind of a threshold that you think about for how high you're willing to go?

Well, absent a transaction, I think we would plan on operating within the guidelines we've laid out. If there was an appropriate transformational opportunity, we would absolutely consider it, but have it in mind. It would be speculative to really talk about what that level is, because it really depends on the opportunity as well as the path to get back within our targeted leverage profile. Our plan would be, if that did happen, albeit speculatively, our plan would be to quickly get back into our target leverage profile.

Okay. Great. And then how do you think about your credit ratings? Is there any interest in being investment grade sometime?

There's always an interest in being investment grade for sure. But I think really our path to being investment grade, it's not necessarily reducing our leverage target, but it's really making sure that we're growing and growing profitably and getting scale. So that's our current target, is profitable growth to gain scale, which, over time, could give us an uplift from a ratings perspective.

Okay. Great. Makes perfect sense. And then one more from me before we kind of open it up to questions from everybody in here. But I know you can't talk about guidance for next year yet, but what are you most excited about as we look out to 2024?

Yes. Good question. We have put some markers down. And so I'm happy to reiterate some of those. Probably first and foremost, I mentioned it a little bit earlier, when we've been talking, pipeline is strong. And so it's one of the strongest sales pipelines we've had in a while. And I feel like for January, in the first quarter, we're in great shape from a new sales and new clients perspective. When I think about retaining clients this year, we're near a historic high from a retention perspective, or low from an attrition perspective. And when I think about retaining clients, I'm not going to go into 2024 thinking it will be quite at that historic low from an attrition perspective. So I'd expect that to go up a couple of points as we move into 2024. I will say my job is to ensure we remain disciplined from an expense management perspective. And so we will manage prudently to be able to invest in growth, but make sure our back office is sized appropriately. And we'll plan, from an insurance cost ratio perspective, to be a little more in line with our targeted levels, which are really more in the 12-ish percent range from a net insurance margin, or 88% cost ratio is sort of the general range, up or down a little bit, that we target from that.

Okay. Great. Thanks so much, Kelly. And now we can open up to questions from the audience. Feel free to shout them out if you have one.

Anyone? Quiet group at 7:30 in the morning.

[indiscernible].

Yes. So the question on the floor, just to repeat, so everyone can hear, is what savings does TriNet provide to a small and medium-sized business versus if they just tried to sort of cobble the things together themselves going out in the open market? One, I would say, we individually underwrite every single client. So you will pay for your risk. So we're able to do that where the small business market may not distinguish in the same way that we have an opportunity to as a PEO. Variable cost. That's another way. You don't have to have fixed cost infrastructure to manage all the compliance and complexity associated with your back office. Largely given our 80-plus percent white-collar base, those clients are looking for high-quality benefits that just really aren't available in the marketplace where it's much more administratively challenging to cobble them all together. And so those are really the main benefits. Now we've -- externally, we have shown some data that says, hey, we can save you over 10% generally. Now -- but it does vary by client based on their risk profile. We do full workers' comp, underwriting, site assessments, and make sure that we're pricing it appropriately based on the risk that we're seeing. Other questions?

[indiscernible].

Yes. And the question, just to repeat in the mic, is how we think about the competitive position outside of the PEO co-employment model? One, it's really an assessment on what fits an individual client. So with the PEO co-employment model, there is full risk transfer. So you are transferring all the risk associated with your medical performance. So it's not a self-insured plan. It's really managed by us. You're transferring your risk associated with workers' comp, because we have the long tail risk on that, and we're providing you a rate based on that. Employment practices liability insurance, we have a risk-sharing model on that, where an employer will cover the first $75,000 per claim, and we cover anything between $75,000 and, depending on the state, anywhere between $250,000 and $500,000. And then we have insurance coverage to cover any claims over and above that. That would be fully covered by you. So risk transfer is a big difference in those. Now in terms of the price points, you also have to rationalize the price points across just a completely outsourced unbundled service versus the risk that we take on, because we take on tax filing risk associated with you as well in compliance risk. So it really is an individual customer-by-customer assessment on what makes the most sense for each customer given where they're at in the life cycle overall. We do think that our HRIS solution, as we're thinking about the barbell of those opportunities, with an administrative services offering associated with it can be something akin to that just without risk transfer, and it can be very attractive, but it's still a little nascent for us at this point.

Anybody else?

[indiscernible].

Yes. The question is around underpenetration of the market. And could that be because you're displacing people and they don't want to be displaced? Again, that really does depend on the client. If you've got a client that has a strong HR leader that -- an HR leader can be the decision-maker, and whether you go to a PEO or not, and it depends on how they want to craft that employment experience, because there are certain things that we offer that we have to, by policy, offer to all of our employees. So it really does depend, but the HR leader is generally one of the decision-makers as part of that if a company has one.

Okay. Great. Well, thank you, everybody, for joining us. Thank you, Kelly, so much for the time this morning. Really appreciate it. Great to have you down here, and I hope everybody has a great rest of their day.

Great. Thanks, everyone.