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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
or
☐    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-36373
 
TRINETLOGONOTAGLINERGBMDA35.JPG
TRINET GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
95-3359658
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
One Park Place, Suite 600
 
 
Dublin,
CA
 
94568
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (510) 352-5000
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock par value $0.000025 per share
TNET
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o
Smaller reporting company
☐
 
 
 
 
 
 
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  Yes  o    No  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  x
The number of shares of Registrant’s Common Stock outstanding as of October 17, 2019 was 69,839,805.
 


TRINET GROUP, INC.
Form 10-Q - Quarterly Report
For the Quarterly Period Ended September 30, 2019

TABLE OF CONTENTS
 
Form 10-Q
Cross Reference
Page
 
3
Part I, Item 1.
27
 
27
 
28
 
29
 
30
 
31
Part I, Item 2.
5
Part I, Item 3.
26
Part I, Item 4.
26
Part II, Item 1.
45
Part II, Item 1A.
45
Part II, Item 2.
45
Part II, Item 3.
45
Part II, Item 4.
45
Part II, Item 5.
45
Part II, Item 6.
46


GLOSSARY
 


Glossary of Acronyms and Abbreviations
Acronyms and abbreviations are used throughout this report, particularly in Part I, Item 1. Unaudited Condensed Consolidated Financial Statements and Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
AFS
Available-for-sale
ASC
Accounting standards codification
ASU
Accounting standards update
CEO
Chief Executive Officer
CFO
Chief Financial Officer
COPS
Cost of providing services
D&A
Depreciation and Amortization
EBITDA
Earnings before interest expense, taxes, depreciation and amortization of intangible assets
EPS
Earnings Per Share
ERISA
Employee Retirement Income Security Act of 1974
FASB
Financial Accounting Standards Board
G&A
General and administrative
GAAP
Generally Accepted Accounting Principles in the United States
HR
Human Resources
IRS
Internal Revenue Service
ISR
Insurance service revenues
MD&A
Management's Discussion and Analysis of Financial Condition and Results of Operations
NISR
Net Insurance Service Revenues
NSR
Net service revenues
OE
Operating expenses
PFC
Payroll funds collected
PSR
Professional service revenues
ROU
Right-of-use
RSA
Restricted Stock Award
RSU
Restricted Stock Unit
SBC
Stock Based Compensation
S&M
Sales and marketing
SD&P
Systems development and programming
SEC
Securities and Exchange Commission
SMB
Small to midsize business
U.S.
United States
WSE
Worksite employee

 
 
 
3
FORWARD LOOKING STATEMENTS AND OTHER FINANCIAL INFORMATION
 

Cautionary Note Regarding Forward-Looking Statements and Other Financial Information
For purposes of this Quarterly Report on Form 10-Q (Form 10-Q), the terms “TriNet,” “the Company,” “we,” “us” and “our” refer to TriNet Group, Inc., and its consolidated subsidiaries. This Form 10-Q contains statements that are not historical in nature, are predictive in nature, or that depend upon or refer to future events or conditions or otherwise contain forward-looking statements within the meaning of Section 21 of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often identified by the use of words such as, but not limited to, "ability," “anticipate,” “believe,” “can,” “continue,” “could,” “design,” “estimate,” “expect,” “forecast,” “hope,” "impact," “intend,” “may,” “outlook,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “strategy,” “target,” "value," “will,” “would” and similar expressions or variations intended to identify forward-looking statements.
Forward-looking statements are not guarantees of future performance, but are based on management’s expectations as of the date of this Form 10-Q and assumptions that are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from our current expectations and any past results, performance or achievements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements are discussed throughout our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on February 14, 2019 (2018 Form 10-K), including those appearing under the heading “Risk Factors” in Item 1A, and under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our 2018 Form 10-K, as well as in our other periodic filings with the SEC. Examples of forward-looking statements include, among others: risks associated with changes in, uncertainty regarding, or adverse application of the complex laws and regulations that govern our business; our ability to be recognized as an employer of worksite employees under federal and state regulations; our ability to mitigate business risks associated with our co-employment relationship with our worksite employees; our ability to secure private and confidential client and worksite employee data and our information technology infrastructure against cyber-attacks and security breaches; our ability to manage unexpected changes in workers’ compensation and health insurance claims by worksite employees; fluctuation in our results of operation and stock price as a result of numerous factors, many of which are outside of our control, such as the volume and severity of our workers’ compensation and health insurance claims and the amount and timing of our insurance costs, operating expenses and capital expenditure requirements; failures or limitations in the business systems we rely upon; our ability to improve our technology to meet the expectations of our clients; our ability to properly manage our internal controls over financial reporting; our ability to effectively integrate businesses we have acquired and new businesses we may acquire in the future; the effects of volatility in the financial and economic environment on the businesses that make up our client base; our ability to effectively manage and improve our operational processes; market acceptance of our vertical strategy; our ability to manage our sales force effectively; the ability of our products and services to compete effectively in our industry; the concentration of our clients in certain geographies and industries; the outcome of existing and future legal proceedings; changes in our income tax positions or adverse outcomes from on-going and future audits; adverse changes in our insurance coverage or our relationships with key insurance carriers; our ability to manage our client attrition; our ability to comply with the restrictions of our credit facility and meet our debt obligations; the impact of concentrated ownership in our stock; and the effects of increased competition and our ability to compete effectively. These and other factors could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10-Q is based upon the facts and circumstances known as of the date of this Form 10-Q, and any forward-looking statements made by us in this Form 10-Q speak only as of the date of this Form 10-Q. We undertake no obligation to revise or update any of the information provided in this Form 10-Q, except as required by law.
The MD&A of this Form 10-Q includes references to our performance measures presented in conformity with GAAP and other non-GAAP financial measures that we use to manage our business, to make planning decisions, to allocate resources and to use as performance measures in our executive compensation plans. Refer to the Non-GAAP Financial Measures in our Key Financial and Operating Metrics section within our MD&A for definitions and reconciliations from GAAP measures.

 
 
 
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
Overview
TriNet is a leading provider of HR expertise, payroll services, employee benefits and employment risk mitigation services for SMBs. We deliver a comprehensive suite of products and services, which allows our clients to administer and manage various HR-related functions, including compensation and benefits, payroll processing, employee data, health insurance and workers' compensation programs, and other transactional HR needs using our technology platform and HR, benefits and compliance expertise.
We also leverage our scale and industry-specific HR experience to design product and service offerings for SMBs in specific industries. We believe our industry-specific approach, which we call our vertical approach, is a key differentiator for us and creates additional value for our clients by allowing our product and service offerings to address the common HR needs in different client industries.
Operational Highlights
Our consolidated results for the third quarter and nine months ended September 30, 2019 reflect our continued progress in attracting new customers to our industry-oriented (vertical) products, serving our existing customers and improving our brand awareness through marketing.
Our customers are our focus, and we are investing in our processes to ensure a stronger customer experience. We expect this investment will further enhance our value to our customers, support retention and provide further efficiency and scale for our operations. We started this work in 2018 and expect this to continue in the near-term.
During the nine months ended September 30, 2019 we:
•
experienced an improvement in retention as a result of our customer service initiatives,
•
benefited from our clients growing their WSEs,
•
saw an increase in new sales, which delivered additional revenue growth,
•
continued to experience our WSE's increasing their participation, or enrollment, in our insurance services offerings,
•
experienced increased severity of health costs per enrollee (medical cost trend) within a national carrier, and
•
delivered profitable growth.
Our efforts to build a successful and enduring company include building and leveraging a strong national brand presence. Our branding strategy, Incredible Starts Here, is being augmented with our current campaign: People Matter. We place our customers at the center of what we do, including placing our customers at the center of our marketing.


 
 
 
5
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Performance Highlights
Our results for the third quarter and nine months ended September 30, 2019 are as follows (percentages, increases or decreases represent changes when compared to the same periods of 2018):
Q3 2019
 
$969M
 
$68M
 
$221M
 
Total revenues
 
Operating income
 
Net Service Revenue *
 
11
%
increase
 
9
%
increase
 
(4
)%
decrease
 
 
 
 
 
 
 
 
 
 
$55M
 
$0.78
 
$58M
 
Net income
 
Diluted EPS
 
Adjusted Net income *
 
8
%
increase
 
11
%
increase
 
6
 %
increase
 
 
 
 
 
 
 
 
 
*
Non-GAAP measure as defined in the section below.

 
 
 
 
 
331,584
 
330,970
 
$9.4B
 
Total WSEs
 
Average WSEs
 
Payroll and payroll tax payments
 
4
%
increase
 
4
%
increase
 
8
%
increase
 
 
 
 
 
 
 
 
 
During the third quarter of 2019, we continued to achieve year-over-year improvement in our WSE and revenue growth. The growth year-over-year reflects improvement in our new sales performance and the retention of customers that choose to benefit from our service offerings. Increased hiring and enrollments by our customers contributed to the growth. We continue to price to the value of our services and, for our insurance offerings, to our expected risk. Operating income, net income and adjusted net income increased due primarily to a 11% increase in total revenues and a decrease in operating expenses primarily as a result of lower variable incentive compensation reflecting financial performance, offset by higher insurance costs driven by an increase in medical cost trend and health plan participation or enrollment. Net Service Revenue decreased 4% primarily due to medical cost trend within a national carrier.
Average WSEs (defined as average monthly WSEs paid during the period) for the third quarter of 2019 increased 4% compared to the same period in 2018 driven by lower client attrition in our Main Street vertical, improved new sales and increased WSE hiring by our clients.
Our pricing strategy and change in mix of WSEs over the last year contributed to our growth of both PSR and ISR.
YTD 2019
 
$2.8B
 
$205M
 
$703M
 
Total revenues
 
Operating income
 
Net Service Revenue *
 
10
%
increase
 
(2
)%
decrease
 
5
%
increase
 
 
 
 
 
 
 
 
 
 
$164M
 
$2.31
 
$177M
 
Net income
 
Diluted EPS
 
Adjusted Net income *
 
1
%
increase
 
3
 %
increase
 
1
%
increase
 
 
 
 
 
 
 
 
 
*
Non-GAAP measure as defined in the section below.

 
 
 
 
 
320,868
 
$30.1B
 
Average WSEs
 
Payroll and payroll tax payments
 
2
%
increase
 
10
%
increase
 
 
 
 
 
 

 
 
 
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Key Financial and Operating Metrics
The following key financial and operating metrics should be read in conjunction with our condensed consolidated financial statements and related notes included in this Form 10-Q.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except per share and WSE data)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Income Statement Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues
$
969

 
$
875

 
11

%
 
$
2,838

 
$
2,586

 
10

%
Operating income
68

 
62

 
9

 
 
205

 
209

 
(2
)
 
Net income
55

 
51

 
8

 
 
164

 
163

 
1

 
Diluted net income per share of common stock
0.78

 
0.71

 
11

 
 
2.31

 
2.25

 
3

 
Non-GAAP measures (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Service Revenues
221

 
228

 
(4
)
 
 
703

 
668

 
5

 
Net Insurance Service Revenues
91

 
109

 
(17
)
 
 
310

 
305

 
1

 
Adjusted EBITDA
93

 
88

 
8

 
 
286

 
277

 
3

 
Adjusted Net Income
58

 
55

 
6

 
 
177

 
176

 
1

 
Operating Metrics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total WSEs payroll and payroll taxes processed
$
9,381

 
$
8,669

 
8

%
 
$
30,113

 
$
27,360

 
10

%
Average WSEs
330,970

 
318,129

 
4

 
 
320,868

 
315,512

 
2

 
Total WSEs at period end
331,584

 
317,496

 
4

 
 
331,584

 
317,496

 
4

 
(1)    Refer to Non-GAAP Financial Measures section below for definitions and reconciliations from GAAP measures.
(in millions)
September 30,
2019
 
December 31,
2018
 
% Change
 
Balance Sheet Data:
 
 
 
 
 
 
Cash and cash equivalents
$
216

 
$
228

 
(5
)
%
Working capital
253

 
221

 
15

 
Total assets
2,245

 
2,435

 
(8
)
 
Long-term debt
397

 
413

 
(4
)
 
Total liabilities
1,768

 
2,060

 
(14
)
 
Total stockholders’ equity
477

 
375

 
27

 

 
Nine Months Ended September 30,
(in millions)
2019
 
2018
 
% Change
Cash Flow Data:
 
 
 
 
 
 
Net cash used in operating activities
$
(211
)
 
$
(476
)
 
(56
)
%
Net cash used in investing activities
(30
)
 
(169
)
 
(82
)
 
Net cash used in financing activities
(109
)
 
(62
)
 
76

 
Non-GAAP measure(1):
 
 
 
 
 
 
Corporate operating cash flows
146

 
184

169

(21
)
 
(1)    Refer to Non-GAAP Financial Measures section below for definitions and reconciliations from GAAP measures.

Non-GAAP Financial Measures
In addition to financial measures presented in accordance with GAAP, we monitor other non-GAAP financial measures that we use to manage our business, to make planning decisions, to allocate resources, and to use as performance measures in our executive compensation plan. These key financial measures provide an additional view of our operational performance over the long-term and provide information that we use in order to maintain and grow our business.
The presentation of these non-GAAP financial measures is used to enhance the understanding of certain aspects of our financial performance. They are not meant to be considered in isolation from, superior to, or as a substitute, for the directly comparable financial measures prepared in accordance with GAAP.

 
 
 
7
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Non-GAAP Measure
Definition
How We Use The Measure
Net Service Revenues
• Sum of professional service revenues and Net Insurance Service Revenues,
or total revenues less insurance costs.
• Provides a comparable basis of revenues on a net basis. Professional service revenues are presented net of client payroll costs whereas insurance service revenues are presented gross of insurance costs for financial reporting purposes.
• Acts as the basis to allocate resources to different functions and evaluates the effectiveness of our business strategies by each business function.
• Provides a measure, among others, used in the determination of incentive compensation for management.
Net Insurance Service Revenues
• Insurance revenues less insurance costs.
• Is a component of Net Service Revenues.
• Provides a comparable basis of revenues on a net basis. Professional service revenues are presented net of client payroll costs whereas insurance service revenues are presented gross of insurance costs for financial reporting purposes. Promotes an understanding of our insurance services business by evaluating insurance service revenues net of our WSE related costs which are substantially pass-through for the benefit of our WSEs. Under GAAP, insurance service revenues and costs are recorded gross as we have latitude in establishing the price, service and supplier specifications.
• We also sometimes refer to Net Insurance Service Margin, which is the ratio of Net Insurance Revenue to Insurance Service Revenue.
Adjusted EBITDA
• Net income, excluding the effects of:
- income tax provision,
- interest expense,
- depreciation,
- amortization of intangible assets, and
- stock based compensation expense.

• Provides period-to-period comparisons on a consistent basis and an understanding as to how our management evaluates the effectiveness of our business strategies by excluding certain non-cash charges such as depreciation and amortization, and stock-based compensation recognized based on the estimated fair values. We believe these charges are either not directly resulting from our core operations or not indicative of our ongoing operations.
• Enhances comparisons to prior periods and, accordingly, facilitates the development of future projections and earnings growth prospects.
• Provides a measure, among others, used in the determination of incentive compensation for management.
• We also sometimes refer to Adjusted EBITDA margin, which is the ratio of Adjusted EBITDA to Net Service Revenue.

Adjusted Net Income
• Net income, excluding the effects of:
- effective income tax rate (1),
- stock based compensation,
- amortization of intangible assets,
- non-cash interest expense (2), and
- the income tax effect (at our effective tax rate (1)) of these pre-tax adjustments.
• Provides information to our stockholders and board of directors to understand how our management evaluates our business, to monitor and evaluate our operating results, and analyze profitability of our ongoing operations and trends on a consistent basis by excluding certain non-cash charges.




 
 
 
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Corporate Operating Cash Flows
• Net cash (used in) provided by operating activities, excluding the effects of:
- Assets associated with WSEs (accounts receivable, unbilled revenue, prepaid expenses and other current assets) and
- Liabilities associated with WSEs (client deposits, accrued wages, payroll tax liabilities and other payroll withholdings, accrued health benefit costs, accrued workers' compensation costs, insurance premiums and other payables, and other current liabilities).
• Provides information that our stockholders and management can use to evaluate our cash flows from operations independent of the current assets and liabilities associated with our WSEs.

• Enhances comparisons to prior periods and, accordingly, used as a liquidity measure to manage liquidity between corporate and WSE related activities, and to help determine and plan our cash flow and capital strategies.




(1)
Non-GAAP effective tax rate is 26% for 2019 and 2018, which excludes the income tax impact from stock based compensation, changes in uncertain tax positions, and nonrecurring benefits or expenses from federal legislative changes.
(2)
Non-cash interest expense represents amortization and write-off of our debt issuance costs.
Reconciliation of GAAP to Non-GAAP Measures

The table below presents a reconciliation of Total revenues to Net Service Revenues:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2019
2018
 
2019
2018
Total revenues
$
969

$
875

 
$
2,838

$
2,586

Less: Insurance costs
748

647

 
2,135

1,918

Net Service Revenues
$
221

$
228

 
$
703

$
668

The table below presents a reconciliation of Insurance service revenues to Net Insurance Service Revenues:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2019
2018
 
2019
2018
Insurance service revenues
$
839

$
756

 
$
2,445

$
2,223

Less: Insurance costs
748

647

 
2,135

1,918

Net Insurance Service Revenues
$
91

$
109

 
$
310

$
305

Net Insurance Service Revenue Margin
11
%
14
%
 
13
%
14
%

 
 
 
9
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

The table below presents a reconciliation of Net income to Adjusted EBITDA:
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
(in millions)
2019
2018
 
2019
2018
Net income
$
55

$
51

 
$
164

$
163

Provision for income taxes
12

9

 
42

36

Stock based compensation
9

12

 
29

31

Interest expense and bank fees
6

5

 
17

17

Depreciation and amortization of intangible assets
11

11

 
34

30

Adjusted EBITDA
$
93

$
88

 
$
286

$
277

Adjusted EBITDA Margin
43
%
38
%
 
41
%
41
%
The table below presents a reconciliation of Net income to Adjusted Net Income:
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
(in millions)
2019
2018
 
2019
2018
Net income
$
55

$
51

 
$
164

$
163

Effective income tax rate adjustment
(5
)
(6
)
 
(12
)
(16
)
Stock based compensation
9

12

 
29

31

Amortization of intangible assets
1

1

 
4

4

Non-cash interest expense
1

—

 
1

4

Income tax impact of pre-tax adjustments
(3
)
(3
)
 
(9
)
(10
)
Adjusted Net Income
$
58

$
55

 
$
177

$
176


The table below presents a reconciliation of net cash used in operating activities to corporate operating cash flows:
 
Nine Months Ended
September 30,
(in millions)
2019
2018
Net cash used in operating activities
$
(211
)
$
(476
)
Change in WSE related other current assets
65

51

Change in WSE related liabilities
292

609

Corporate Operating Cash Flows
$
146

$
184




 
 
 
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Results of Operations
Operating Metrics
Worksite Employees (WSE)
Average WSEs increased 4% in the third quarter of 2019 and 2% in the nine months ended September 30, 2019, compared to the same periods in 2018, due to reduced attrition resulting from our customer service initiatives, continued hiring within our installed base, primarily in our Technology vertical, and stronger new sales performance.
Total WSEs can be used to estimate our beginning WSEs for the next period and, as a result, can be used as an indicator of our potential future success in growing our business and retaining clients.
Anticipated revenues for future periods can diverge from the revenue expectation derived from Average WSEs or Total WSEs due to pricing differences across our HR solutions and services and the degree to which clients and WSEs elect to participate in our solutions during future periods. In addition to focusing on growing our Average WSE and Total WSE counts, we also focus on pricing strategies, product participation and product differentiation to expand our revenue opportunities. We report the impact of client and WSE participation differences as a change in mix.
We are focused on growing our WSE base, including pursuing strategic acquisitions where appropriate, while improving our customer experience and continuing to manage attrition. We continued to invest in our efforts to enhance our customers' and WSEs' experiences, through operational and process improvements, and we have started to realize improved retention in some of our verticals.
WSE1023.JPG

 
 
 
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Total Revenues
Our revenues consist of professional service revenues (PSR) and insurance service revenues (ISR). PSR represents fees charged to clients for processing payroll-related transactions on behalf of our clients, access to our HR expertise, employment and benefit law compliance services, and other HR-related services. ISR consists of insurance-related billings and administrative fees collected from clients and withheld from WSEs for workers' compensation insurance and health benefit insurance plans provided by third-party insurance carriers.
Monthly total revenues per Average WSE is a measure we use to monitor the success of our product and service pricing strategies. This measure increased 6% during the third quarter of 2019 compared to the same period in 2018, and increased 8% in the nine months ended September 30, 2019, compared to the same period in 2018.
We also analyze changes in total revenue with the following measures:
•
Volume - the percentage change in period over period Average WSEs,
•
Rate - the combined percentage change in service fees for each vertical product and change in service fees associated with each insurance service offerings, and
•
Mix - the change in composition of Average WSEs within our verticals combined with the composition of our enrolled WSEs within our insurance service offerings.
TOTREV1023.JPG
The changes in volume during the third quarter and nine months ended September 30, 2019, when compared to the same periods in 2018, were primarily driven by WSE growth, especially in our Professional Services and Technology verticals. The changes in rate and mix during the third quarter and nine months ended September 30, 2019, when compared to the same periods in 2018, were primarily driven by increases in insurance services fees and health plan enrollment in our insurance service offerings.

 
 
 
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Operating Income
Our operating income consists of total revenues less insurance costs and OE. Our insurance costs include insurance premiums for coverage provided by insurance carriers, reimbursement of claims payments made by insurance carriers or third-party administrators, and changes in accrued costs related to contractual obligations with our workers' compensation and health benefit carriers. Our OE consists primarily of our corporate employees' compensation related expenses which includes payroll, payroll taxes, SBC, bonuses, commissions and other payroll-and benefits-related costs.
The tables below provide a view of the changes in components of operating income for the third quarter and nine months ended September 30, 2019, as compared to the same periods in 2018, respectively.
(in millions)
 
$62
Third Quarter 2018 Operating Income
 
+94
Higher total revenues primarily as a result of WSE growth, especially in our Professional Services and Technology verticals, increases in ISR fees and health plan enrollment.
 
-101
Higher insurance costs primarily as a result of an increase in medical cost trend and health plan participation, or enrollment.
 
+13
Lower OE primarily as a result of lower variable incentive compensation reflecting financial performance.
$68
Third Quarter 2019 Operating Income
(in millions)
 
$209
YTD 2018 Operating Income
 
+252
Higher total revenues primarily as a result of increases in insurance services fees and health plan enrollment in our insurance service offerings
 
-217
Higher insurance costs primarily as a result of an increase in medical cost trend and health plan participation, or enrollment.
 
-39
Higher OE primarily as a result of growth in the number of our corporate employees and costs associated with initiatives to improve customer experience and our growth initiatives.
$205
YTD 2019 Operating Income


 
 
 
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Professional Service Revenues
Our clients are billed either based on a fee per WSE per month per transaction or on a percentage of the WSEs’ payroll. For those clients that are billed on a percentage of WSEs' payroll, as our clients' payrolls increase, our fees also increase. As such, payroll and payroll taxes processed, which includes recurring payrolls and non-recurring bonus payrolls, benefits, and associated payroll taxes may also be an indicator of our PSR growth.
Our vertical approach provides us the flexibility to offer our clients in different industries with varied services at different prices, which we believe potentially reduces the value of using Average WSE and Total WSE counts as indicators of future potential revenue performance.
We also analyze changes in PSR with the following measures:
•
Volume - the percentage change in period over period Average WSEs.
•
Rate - the percentage change in fees for each vertical, and
•
Mix - the change in composition of Average WSEs across our verticals,
PSR1023.JPG
The increase in PSR, for the third quarter ended and nine months ended September 30, 2019 compared to the same periods in 2018, reflects the result of our vertical pricing strategy. During the third quarter and nine months ended September 30, 2019, we continued to experience WSE growth especially in our Professional Services and Technology verticals, while our Main Street vertical continued to shrink, but at a reduced rate when compared to the same periods in 2018.


 
 
 
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Insurance Service Revenues
ISR consists of insurance services-related billings and administrative fees collected from clients and withheld from WSE payroll for health benefits and workers' compensation insurance provided by third-party insurance carriers.
We use the following measures to analyze changes in ISR:
•
Volume - the percentage change in period over period Average WSEs,
•
Rate - the percentage change in fees associated with each of our insurance service offerings, and
•
Mix - all other changes including the composition of our enrolled WSEs within our insurance service offerings (health plan enrollment).
ISR1023.JPG

The growth in ISR for the third quarter and nine months ended September 30, 2019, as compared to the same periods in 2018, primarily resulted from increases in Average WSEs, changes in rate due to higher insurance service fees per plan participant and changes in mix due to higher health plan enrollment.

 
 
 
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Insurance Costs

Insurance costs include insurance premiums for coverage provided by insurance carriers, reimbursement of claims payments made by insurance carriers or third-party administrators, and changes in accrued costs related to contractual obligations with our workers' compensation and health benefit carriers.
We use the following measures to analyze changes in insurance costs:
•
Volume - the percentage change in period over period Average WSEs,
•
Rate - the percentage change in cost trend associated with each of our insurance service offerings, and
•
Mix - all other changes including the composition of our enrolled WSEs within our insurance service offerings (health plan enrollment).
ISC1023.JPG

The increase in insurance cost rates during the third quarter and nine months ended September 30, 2019, as compared to the same periods in 2018, was primarily driven by:
•
Increased severity of health costs per enrollee (medical cost trend) within a national carrier, arising from a shift in pharmaceutical utilization from brand name drugs to higher cost specialty drugs, combined with elevated health costs in a portion of this business.
•
Partially offset by lower health administrative costs and lower workers' compensation claim costs.

We continued to experience favorable prior year development on our accrued workers' compensation costs of $6 million for the third quarter and $22 million for the nine months ended September 30, 2019, primarily due to lower than expected claim severity. The increase in volume and mix during the third quarter and nine months ended September 30, 2019 is consistent with the change in volume and mix for ISR, which was a result of higher health plan enrollment.

 
 
 
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Net Service Revenues
NSR provides us with a comparable basis of revenues on a net basis, acts as the basis to allocate resources to different functions and helps us evaluate the effectiveness of our business strategies by each business function.
NSR1023.JPG
NISR margin for the third quarter and nine months ended September 30, 2019 decreased by 3% and 1%, respectively when compared to the same periods in 2018, due to insurance costs increasing faster than insurance service revenues.


 
 
 
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Operating Expenses
OE includes cost of providing services (COPS), sales and marketing (S&M), general and administrative (G&A), systems development and programming (SD&P), and depreciation and amortization expenses (D&A).
We manage our operating expenses and allocate resources across different business functions based on percentage of NSR, which decreased to 69% in the third quarter of 2019 from 73% in the same period in 2018 and increased to 71% in the nine months ended September 30, 2019 from 69% in the same period in 2018. The decrease in operating expenses and compensation costs was primarily the result of lower variable incentive compensation reflecting financial performance.
We had approximately 3,000 corporate employees as of September 30, 2019 in 54 offices across the U.S. Our corporate employees' compensation-related expenses represent a majority of our OE. Compensation costs for our corporate employees include payroll, payroll taxes, SBC, bonuses, commissions and other payroll- and benefits-related costs. Compensation expense for internal employees was and is primarily driven by our continued efforts to improve our customer experience. Compensation-related expense represented 59% and 62% of our OE in the third quarter of 2019 and 2018, respectively, and 62% and 63% in the nine months ended September 30, 2019 and 2018, respectively.
We expect our OE to increase for the foreseeable future from our continued efforts to improve our customer experience, and our systems and processes. These expenses may fluctuate as a percentage of our total revenues from period-to-period depending on the timing of when expenses are incurred.
OE1023.JPG


 
 
 
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

We analyze and present our OE based upon the business functions COPS, S&M, G&A and SD&P and D&A. The charts below provide a view of the expenses of the business functions. Dollars are presented in millions and percentages represent year-over-year change.
EXPGROUPS1023.JPG
COPS remained consistent in the third quarter of 2019 when compared to the same period in 2018. The increase in the nine months ended September 30, 2019, when compared to the same periods in 2018, was due to increased headcount and consulting expense to support initiatives to improve the customer experience, enhancing our product offerings and process improvement initiatives.
S&M decreased in the third quarter of 2019, when compared to the same period in 2018, primarily due to a decrease in compensation related expenses. S&M increased in the nine months ended September 30, 2019, when compared to the same period in 2018, driven by an increase in headcount, advertising expenses for our People Matter campaign and commissions expense related to our growth in new sales.
G&A decreased in the third quarter and increased in the nine months ended September 30, 2019, when compared to the same periods in 2018, primarily driven by a decrease in compensation related expenses and professional fees.
SD&P decreased in the third quarter and nine months ended September 30, 2019, when compared to the same periods in 2018, primarily driven by a decrease in compensation related expenses.
D&A remained consistent in the third quarter. The increase in the nine months ended September 30, 2019, when compared to the same periods in 2018, was a result of our investments in technology to support our customer service initiatives.


 
 
 
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
 


We break out the change in expenses that make up our OE in the chart below:
CHART-28CAC8091935BA8C37F.JPG
CHART-D176B7569B1F50C6563.JPG

Other Income (Expense)
Other income (expense) consists primarily of interest and dividend income from investments and interest expense under our credit facility.
Interest income increased to $5 million in the third quarter of 2019 and $18 million for the nine months ended September 30, 2019 from $3 million and $7 million when compared to the same periods in 2018, respectively, as a result of a change in our investment strategy initiated in the second quarter of 2018 to improve our interest income.
Our investment strategy has improved our interest income, net income, Adjusted Net Income and Adjusted EBITDA, year over year.
Interest expense, bank fees and other, remained consistent for the third quarter and nine months ended September 30, 2019 and 2018.

 
 
 
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Provision for Income Taxes
Our effective income tax rate was 18% and 16% for the third quarter of 2019 and 2018, respectively, and 20% and 18% for the nine months ended September 30, 2019 and 2018, respectively. The increase in rate for the third quarter of 2019 was primarily due to a decrease in tax credits and a benefit from revaluation of deferred taxes recorded in the prior year. The increase in rate for the nine months ended September 30, 2019 was primarily due to decreases in excludable income for state tax purposes and tax benefits recognized from excess tax benefits related to stock based compensation, as well as an increase in uncertain tax positions. These expenses are partially offset by a one-time benefit associated with prior year tax expense.

 
 
 
21
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Liquidity and Capital Resources
Liquidity
We believe that we have sufficient liquidity and capital resources to satisfy future requirements and meet our obligations to our clients, creditors and debt holders.
Included in our balance sheets are assets and liabilities resulting from transactions directly or indirectly associated with WSEs, including payroll and related taxes and withholdings, our sponsored workers' compensation and health insurance programs, and other benefit programs. Although we are not subject to regulatory restrictions that require us to do so, we distinguish and manage our corporate assets and liabilities separately from those current assets and liabilities held by us to satisfy our employer obligations associated with our WSEs as follows:
 
September 30, 2019
 
December 31, 2018
(in millions)
Corporate
WSE
Total
 
Corporate
WSE
Total
Current assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
216

$
—

$
216

 
$
228

$
—

$
228

Investments
67

—

67

 
54

—

54

Restricted cash, cash equivalents and investments
15

570

585

 
15

927

942

Other current assets
56

451

507

 
36

386

422

Total current assets
$
354

$
1,021

$
1,375

 
$
333

$
1,313

$
1,646

 
 
 
 
 
 
 
 
Total current liabilities
$
101

$
1,021

$
1,122

 
$
112

$
1,313

$
1,425

 
 
 
 
 
 
 
 
Working Capital
$
253

$
—

$
253

 
$
221

$
—

$
221

Working capital for WSE-related assets and liabilities
We designate funds to ensure that we have adequate current assets to satisfy our current obligations associated with WSEs. We manage our WSE payroll and benefits obligations through collections of payments from our clients which generally occurs two to three days in advance of client payroll dates. We regularly review our short-term obligations associated with our WSEs (such as payroll and related taxes, insurance premium and claim payments) and designate funds required to fulfill these short-term obligations, which we refer to as PFC. PFC is included in current assets as restricted cash, cash equivalents and investments.
We manage our sponsored benefit and workers' compensation insurance obligations by maintaining collateral funds in restricted cash, cash equivalents and investments. These collateral amounts are generally determined at the beginning of each plan year and we may be required by our insurance carriers to adjust our collateral balances when facts and circumstances change. We regularly review our collateral balances with our insurance carriers and anticipate funding further collateral in the future based upon our capital requirements. We classify our restricted cash, cash equivalents and investments as current and noncurrent assets to match against the anticipated timing of claims payments.
Working capital for corporate purposes
We use our available cash and cash equivalents to satisfy our operational and regulatory requirements and to fund capital expenditures. We believe that our existing corporate cash and cash equivalents and positive working capital will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Corporate working capital as of September 30, 2019 increased compared to December 31, 2018.
Capital Resources
Sources of Funds
We believe that we can meet our present and reasonably foreseeable operating cash needs and future commitments through existing liquid assets, continuing cash flows from corporate operating activities, our borrowing capacity under our revolving credit facility and the potential issuance of debt or equity securities.

 
 
 
22
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

We also have available a $250 million revolving credit facility. The total unused portion of the revolving credit facility was $235 million as of September 30, 2019.
Cash Flows
The following table presents our cash flow activities for the stated periods:
 
Nine Months Ended September 30,
(in millions)
2019
 
2018
 
Corporate
WSE
Total
 
Corporate
WSE
Total
Net cash (used in) provided by :
 
 
 
 
 
 
 
Operating activities
$
146

$
(357
)
$
(211
)
 
$
184

$
(660
)
$
(476
)
Investing activities
(32
)
2

(30
)
 
(169
)
—

(169
)
Financing activities
(109
)
—

(109
)
 
(62
)
—

(62
)
Net increase (decrease) in cash and cash equivalents, unrestricted and restricted
$
5

$
(355
)
$
(350
)
 
$
(47
)
$
(660
)
$
(707
)
Cash and cash equivalents, unrestricted and restricted:
 
 
 
 
 
 
 
Beginning of period
425

924

1,349

 
476

1,262

1,738

End of period
$
430

$
569

$
999

 
$
429

$
602

$
1,031

 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents:
 
 
 
 
 
 
 
Unrestricted
$
(12
)
$
—

$
(12
)
 
$
(99
)
$
—

$
(99
)
Restricted
17

(355
)
(338
)
 
52

(660
)
(608
)
Operating Activities
Components of net cash (used in) provided by operating activities are as follows:
 
Nine Months Ended September 30,
(in millions)
2019
 
2018
 
Corporate
WSE
Total
 
Corporate
WSE
Total
Net income
$
164

$
—

$
164

 
$
163

$
—

$
163

Depreciation and amortization
41

—

41

 
36

—

36

Noncash lease expense
14

—

14

 
—

—

—

Stock based compensation expense
29

—

29

 
31

—

31

Interest paid
(15
)
—

(15
)
 
(13
)
—

(13
)
Income tax payments, net
(48
)
—

(48
)
 
(33
)
—

(33
)
Collateral refunded from insurance carriers, net
—

—

—

 
(1
)
—

(1
)
Changes in other operating assets
(42
)
(65
)
(107
)
 
10

(51
)
(41
)
Changes in other operating liabilities
3

(292
)
(289
)
 
(9
)
(609
)
(618
)
Net cash (used in) provided by operating activities
$
146

$
(357
)
$
(211
)
 
$
184

$
(660
)
$
(476
)

Year-over-year fluctuation in net cash used in operating activities for WSE purposes was primarily driven by timing of client payments, payments of payroll and payroll taxes, and collateral funding and insurance claim activities. We expect the changes in restricted cash and cash equivalents to correspond to WSE cash provided by (or used in) operations as we manage our obligations associated with WSEs through restricted cash.

Our corporate operating cash flows decreased when comparing the nine months ended September 30, 2019 to the same period in 2018 due to timing of payments to our vendors.

 
 
 
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Investing Activities
Net cash (used in) provided by investing activities in the nine months ended September 30, 2019 decreased, when compared to the same period of 2018, primarily due to decrease in purchases of investments.
 
Nine Months Ended September 30,
(in millions)
2019
2018
Investments:
 
 
Purchases of investments
(109
)
(223
)
Proceeds from sale and maturity of investments
113

87

Cash (used in) provided by investments
$
4

$
(136
)
 
 
 
Capital expenditures:
 
 
Software and hardware
$
(27
)
$
(21
)
Office furniture, equipment and leasehold improvements
(7
)
(12
)
Cash used in capital expenditures
$
(34
)
$
(33
)
Cash used in investing activities
$
(30
)
$
(169
)
Investments
We invest a portion of available cash in investment-grade securities with effective maturities less than five years that are classified on our condensed consolidated balance sheets as investments. As of September 30, 2019, we had approximately $195 million in corporate investments.
We also invest funds held as collateral to satisfy our long-term obligation towards workers' compensation liabilities in U.S. long-term treasuries. These investments are classified on our condensed consolidated balance sheets as restricted cash, cash equivalents and investments. We review the amount and the anticipated holding period of these investments regularly in conjunction with our estimated long-term workers' compensation liabilities and anticipated claims payment trend.
As of September 30, 2019, we held approximately $1.2 billion in cash, cash equivalents and investments of which $0.8 billion was restricted. Refer to Note 2 in this Form 10-Q for a summary of these funds.
Capital Expenditures
During the nine months ended September 30, 2019 and 2018, we continued to make investments in software and hardware, and to enhance our existing products and technology platform. We also incurred expenses related to the build out of our corporate headquarters and our technology and client service centers. We expect capital investments in our software and hardware to continue in the future.
Financing Activities
Net cash used in financing activities in the nine months ended September 30, 2019 and 2018 consisted of our debt and equity-related activities.
 
Nine Months Ended September 30,
(in millions)
2019
2018
Financing activities
 
 
Repurchase of common stock, net of issuance
$
(92
)
$
(53
)
Repayment of borrowings, net of proceeds from issuance of notes payable
(17
)
(9
)
Cash used in financing activities
$
(109
)
$
(62
)


 
 
 
24
MANAGEMENT'S DISCUSSION AND ANALYSIS
 

In February 2019, our board of directors authorized a $300 million incremental increase to our ongoing stock repurchase program initiated in May 2014, primarily to return value to our stockholders and to offset dilution from the issuance of stock under our equity-based incentive plan and employee stock purchase plan. During the nine months ended September 30, 2019, we repurchased 1,482,655 shares of our common stock for approximately $84 million through our stock repurchase program. As of September 30, 2019, approximately $292 million remained available for repurchase under all authorizations by our board of directors. We plan to use current cash and cash generated from ongoing operating activities to fund this share repurchase program.
Covenants
We were in compliance with the financial covenants under our credit facilities at September 30, 2019. For information on the covenants under our 2018 credit facility, refer to Note 7 in Part II, Item 8. Financial Statements and Supplementary Data, of our Form 10-K.
Off-Balance Sheet Arrangements
There have been no additional material changes in our off-balance sheet arrangements discussed in Part II, Item 7. Management's Discussion and Analysis of our 2018 Form 10-K.
Critical Accounting Policies, Estimates and Judgments
During the first quarter of 2019, we adopted ASC Topic 842. Refer to Note 1 in Item 1 of this Form 10-Q for disclosure of the changes related to this adoption. There have been no material changes to our critical accounting policies as discussed in our 2018 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 1 in Item 1 of this Form 10-Q.

 
 
 
25
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
AND CONTROLS AND PROCEDURES
 

Quantitative and Qualitative Disclosures About Market Risk
Our exposure to changes in interest rates relates primarily to our investment portfolio and outstanding floating rate debt. Changes in U.S. interest rates affect the interest earned on the Company’s cash, cash equivalents and investments and the fair value of the investments, as well as interest costs associated with our debt.
On June 2019, we entered into an interest rate collar derivative transaction with no upfront premium. We use this derivative to hedge against interest rate risk on a portion of our outstanding floating rate debt. We have designated this derivative as a cash flow hedge. Our primary objective in purchasing and holding this derivative is to reduce our volatility of net earnings and cash flows associated with changes in the benchmark interest rate in our interest rate payments. We do not enter into any derivatives for trading or other speculative purposes.
We performed a sensitivity analysis to determine the impact a change in interest rates would have on the cash flows of the collar assuming a 100 basis point parallel shift in the current LIBOR rate. Based on the terms and remaining settlements as of September 30, 2019, a hypothetical 100 basis point decrease in one-month LIBOR across all maturities would not result in any cash payments or cash receipts by the Company, respectively, while a hypothetical 100 basis point increase in one-month LIBOR across all maturities would result in cash receipts of $4 million.
Our cash equivalents consist primarily of money market mutual funds, which are not significantly exposed to interest rate risk. Our AFS marketable securities are subject to interest rate risk because these securities generally include a fixed interest rate. As a result, the market values of these securities are affected by changes in prevailing interest rates. We attempt to limit our exposure to interest rate risk and credit risk, as our investment policy defines minimum credit quality, liquidity, diversification and other requirements for eligible investments. Our AFS marketable securities consist of highly liquid, investment-grade securities. The risk of rate changes on investment balances was not significant at September 30, 2019.
At September 30, 2019, we had total outstanding long-term debt of $397 million. A 100 basis point increase or decrease in market interest rates would cause interest expense on our debt as of September 30, 2019 to increase by $10 million or decrease by $14 million on an annualized basis, respectively.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We have, with the participation of our Chief Executive Officer (CEO) and our Chief Financial Officer (CFO), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2019, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act.
Based on the evaluation of our disclosure controls and procedures as of September 30, 2019, our CEO and CFO have concluded that the Company’s disclosure controls and procedures were effective as of such date in ensuring that (i) information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the CEO and CFO, to allow timely decisions regarding required disclosure and (ii) such information is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
We have concluded that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended September 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 
 
 
26
FINANCIAL STATEMENTS
 


CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
 
 
September 30,
 
December 31,
(in millions, except share and per share data)
 
2019
 
2018
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
216

 
$
228

Investments
 
67

 
54

Restricted cash, cash equivalents and investments
 
585

 
942

Accounts receivable, net
 
9

 
11

Unbilled revenue, net
 
366

 
304

Prepaid expenses, net
 
63

 
48

Other current assets
 
69

 
59

Total current assets
 
1,375

 
1,646

Restricted cash, cash equivalents and investments, noncurrent
 
198

 
187

Investments, noncurrent
 
128

 
135

Property & equipment, net
 
86

 
79

Operating lease right-of-use asset
 
57

 
—

Goodwill
 
289

 
289

Other intangible assets, net
 
17

 
21

Other assets
 
95

 
78

Total assets
 
$
2,245

 
$
2,435

Liabilities and stockholders' equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable and other current liabilities
 
$
33

 
$
45

Long-term debt
 
22

 
22

Client deposits
 
28

 
56

Accrued wages
 
405

 
352

Accrued health insurance costs, net
 
156

 
135

Accrued workers' compensation costs, net
 
63

 
67

Payroll tax liabilities and other payroll withholdings
 
389

 
729

Operating lease liabilities
 
17

 
—

Insurance premiums and other payables
 
9

 
19

Total current liabilities
 
1,122

 
1,425

Long-term debt, noncurrent
 
375

 
391

Accrued workers' compensation costs, noncurrent, net
 
146

 
158

Deferred taxes
 
64

 
68

Operating lease liabilities, noncurrent
 
52

 
—

Other non-current liabilities
 
9

 
18

Total liabilities
 
1,768

 
2,060

Commitments and contingencies (see Note 6)
 

 

Stockholders' equity:
 
 
 
 
Preferred stock
 
—

 
—

($0.000025 par value per share; 20,000,000 shares authorized; no shares issued or outstanding at September 30, 2019 and December 31, 2018)
 
 
 
 
Common stock and additional paid-in capital
 
676

 
641

($0.000025 par value per share; 750,000,000 shares authorized; 69,834,253 and 70,596,559 shares issued and outstanding at September 30, 2019 and December 31, 2018)
 
 
 
 
Accumulated deficit
 
(200
)
 
(266
)
Accumulated other comprehensive income
 
1

 
—

Total stockholders' equity
 
477

 
375

Total liabilities & stockholders' equity
 
$
2,245

 
$
2,435

See accompanying notes.

 
 
 
27
FINANCIAL STATEMENTS
 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except share and per share data)
2019
2018
 
2019
2018
Professional service revenues
$
130

$
119

 
$
393

$
363

Insurance service revenues
839

756

 
2,445

2,223

Total revenues
969

875

 
2,838

2,586

Insurance costs
748

647

 
2,135

1,918

Cost of providing services
59

58

 
186

166

Sales and marketing
47

52

 
145

132

General and administrative
27

33

 
99

95

Systems development and programming
9

12

 
34

36

Depreciation and amortization of intangible assets
11

11

 
34

30

Total costs and operating expenses
901

813

 
2,633

2,377

Operating income
68

62

 
205

209

Other income (expense):
 
 
 
 
 
Interest expense, bank fees and other
(6
)
(5
)
 
(17
)
(17
)
Interest income
5

3

 
18

7

Income before provision for income taxes
67

60

 
206

199

Income tax expense
12

9

 
42

36

Net income
$
55

$
51

 
$
164

$
163

Other comprehensive income, net of tax
—

—

 
1

—

Comprehensive income
$
55

$
51

 
$
165

$
163

 
 
 
 
 
 
Net income per share:
 
 
 
 
 
Basic
$
0.80

$
0.73

 
$
2.35

$
2.32

Diluted
$
0.78

$
0.71

 
$
2.31

$
2.25

Weighted average shares:
 
 
 
 
 
Basic
69,612,362

70,556,877

 
69,740,956

70,353,597

Diluted
70,972,874

72,599,944

 
71,069,852

72,388,598

 See accompanying notes.

 
 
 
28
FINANCIAL STATEMENTS
 

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)

2019
2018
2019
2018
Total Stockholders' Equity, beginning balance
$
439

$
309

 
$
375

$
206

Common Stock and Additional Paid-In Capital
 
 
 
 
 
Beginning balance
667

611

 
641

583

Issuance of common stock from exercise of stock options
—

—

 
2

6

Issuance of common stock for employee stock purchase plan
—

—

 
4

3

Stock based compensation expense
9

12

 
29

31

Ending balance
676

623

 
676

623

 
 
 
 
 
 
Accumulated Deficit
 
 
 
 
 
Beginning balance
(229
)
(302
)
 
(266
)
(377
)
Net income
55

51

 
164

163

Cumulative effect of accounting change
—

—

 
—

3

Repurchase of common stock
(22
)
(17
)
 
(84
)
(47
)
Awards effectively repurchased for required employee withholding taxes
(4
)
(5
)
 
(14
)
(15
)
Ending balance
(200
)
(273
)
 
(200
)
(273
)
 
 
 
 
 
 
Accumulated Other Comprehensive Loss
 
 
 
 
 
Beginning balance
1

—

 
—

—

Other comprehensive income
—

—

 
1

—

Ending balance
1

—

 
1

—

Total Stockholders' Equity, ending balance
$
477

$
350

 
$
477

$
350

See accompanying notes.


 
 
 
29
FINANCIAL STATEMENTS
 

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended September 30,
(in millions)
2019
2018
Operating activities
 
 
Net income
164

163

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
41

36

Noncash lease expense
14

—

Stock based compensation
29

31

Changes in operating assets and liabilities:
 
 
Accounts receivable, net
5

12

Unbilled revenue, net
(61
)
(3
)
Prepaid expenses, net
(17
)
(26
)
Other assets
(34
)
(54
)
Accounts payable and other current liabilities
(16
)
(18
)
Client deposits
(28
)
(17
)
Accrued wages
53

34

Accrued health insurance costs, net
21

(7
)
Accrued workers' compensation costs, net
(16
)
(5
)
Payroll taxes payable and other payroll withholdings
(340
)
(616
)
Operating lease liabilities
(13
)
—

Other liabilities
(13
)
(6
)
Net cash used in operating activities
(211
)
(476
)
Investing activities
 
 
Purchases of marketable securities
(109
)
(223
)
Proceeds from sale and maturity of marketable securities
113

87

Acquisitions of property and equipment
(34
)
(33
)
Net cash used in investing activities
(30
)
(169
)
Financing activities
 
 
Repurchase of common stock
(84
)
(47
)
Proceeds from issuance of common stock from employee stock purchase plan
4

3

Proceeds from issuance of common stock from exercised options
2

6

Awards effectively repurchased for required employee withholding taxes
(14
)
(15
)
Proceeds from issuance of notes payable, net
—

210

Payments for extinguishment of debt
—

(204
)
Repayment of debt
(17
)
(15
)
Net cash used in financing activities
(109
)
(62
)
Net decrease in unrestricted and restricted cash and cash equivalents
(350
)
(707
)
Cash and cash equivalents, unrestricted and restricted:
 
 
Beginning of period
1,349

1,738

End of period
999

1,031

 
 
 
Supplemental disclosures of cash flow information
 
 
Interest paid
15

13

Income taxes paid, net
48

33

Supplemental schedule of noncash investing and financing activities
 
 
Payable for purchase of property and equipment
4

2

See accompanying notes.

 
 
 
30
FINANCIAL STATEMENTS
 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business
TriNet Group, Inc. (TriNet, or the Company, we, our and us), a professional employer organization, provides comprehensive human resources solutions for small to midsize businesses under a co-employment model. These HR solutions include multi-state payroll processing and tax administration, employee benefits programs, including health insurance and retirement plans, workers' compensation insurance and claims management, employment and benefit law compliance, and other HR-related services. Through the co-employment relationship, we are the employer of record for certain employment-related administrative and regulatory purposes for the worksite employees, including:
•
compensation through wages and salaries,
•
employer payroll-related tax payments,
•
employee payroll-related tax withholdings and payments,
•
employee benefit programs, including health and life insurance, and others, and
•
workers' compensation coverage.

Our clients are responsible for the day-to-day job responsibilities of the WSEs.

We operate in one reportable segment. All of our service revenues are generated from external clients. Less than 1% of our revenue is generated outside of the U.S.
Basis of Presentation
These unaudited condensed consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Rules and Regulations of the Securities and Exchange Commission. Certain information and note disclosures included in our annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the condensed consolidated financial statements reflect all adjustments, that are normal and recurring in nature, necessary for fair financial statement presentation. The results of operations for the three and nine months ended September 30, 2019 are not necessarily indicative of the operating results anticipated for the full year. These Financial Statements should be read in conjunction with the audited Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of our Annual Report on Form 10-K for the year ended December 31, 2018 (2018 Form 10-K).

 
 
 
31
FINANCIAL STATEMENTS
 

Reclassifications
Certain prior year amounts have been reclassified to conform to current period presentation. Effects on the cash flow statement due to reclassifications are summarized below:
 
Nine Months Ended September 30, 2018
(in millions)
As previously reported
Reclassified amounts
As revised
Operating activities
 
 
 
Accounts receivable, net
$
—

$
12

$
12

Unbilled revenue, net
—

(3
)
(3
)
Prepaid income taxes, net
1

(1
)
—

Prepaid expenses and other current assets
(24
)
24

—

Prepaid expenses, net
—

(26
)
(26
)
Workers' compensation collateral receivable
(10
)
10

—

Accounts payable and other current liabilities
(9
)
(9
)
(18
)
Client deposits
—

(17
)
(17
)
Accrued wages
—

34

34

Accrued corporate wages
(4
)
4

—

Accrued health insurance costs, net
—

(7
)
(7
)
Accrued workers' compensation costs, net
—

(5
)
(5
)
Payroll taxes payable and other payroll withholdings
—

(616
)
(616
)
Worksite employee related assets
(51
)
51

—

Worksite employee related liabilities
(609
)
609

—

Other assets
—

(54
)
(54
)
Other liabilities
—

(6
)
(6
)

Effects on the consolidated statements of income and comprehensive income due to reclassifications are summarized below:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2018
(in millions)
As previously reported
Reclassified amounts
As revised
 
As previously reported
Reclassified amounts
As revised
Depreciation
$
10

$
(10
)
$
—

 
$
26

$
(26
)
$
—

Amortization of intangible assets
1

(1
)
—

 
4

(4
)
—

Depreciation and amortization of intangible assets
—

11

11

 
—

30

30

Interest expense, bank fees and other, net
(2
)
2

—

 
(10
)
10

—

Interest expense, bank fees and other
—

(5
)
(5
)
 
—

(17
)
(17
)
Interest income
—

3

3

 
—

7

7



 
 
 
32
FINANCIAL STATEMENTS
 

Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect certain reported amounts and related disclosures. Significant estimates include:
•
liability for unpaid losses and loss adjustment expenses (accrued workers' compensation costs) related to workers' compensation and workers' compensation collateral receivable,
•
accrued health insurance costs,
•
liability for insurance premiums payable,
•
valuation of the investment portfolio,
•
impairments of goodwill and other intangible assets,
•
income tax assets and liabilities, and
•
liability for legal contingencies.
These estimates are based on historical experience and on various other assumptions that we believe to be reasonable from the facts available to us. Some of the assumptions are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our consolidated financial statements could be materially affected.
Accrued Health Insurance Costs
We sponsor and administer a number of fully insured, risk-based employee benefit plans, including group health, dental, and vision as an employer plan sponsor under section 3(5) of the ERISA. In the nine months ended September 30, 2019, the majority of our group health insurance costs related to risk-based plans. Our remaining group health insurance costs were for guaranteed-cost policies.
Accrued health insurance costs are established to provide for the estimated unpaid costs of reimbursing the carriers for paying claims within the deductible layer in accordance with risk-based health insurance policies. These accrued costs include estimates for reported losses, plus estimates for claims incurred but not paid. We assess accrued health insurance costs regularly based upon independent actuarial studies that include other relevant factors such as current and historical claims payment patterns, plan enrollment and medical trend rates.
In certain carrier contracts we are required to prepay the expected claims activity for subsequent periods. These prepaid balances by agreement permit net settlement of obligations and offset the accrued health insurance costs. As of September 30, 2019 and December 31, 2018, prepayments included in accrued health insurance costs were $39 million and $33 million, respectively. When the prepaid is in excess of our recorded liability, the net asset position is included in prepaid expenses. As of September 30, 2019 and December 31, 2018, accrued health insurance costs included in prepaid expenses were $53 million and $50 million, respectively.
Derivative Instruments
In June 2019, we entered into an interest rate collar derivative transaction with no upfront premium to mitigate the risk of changes in interest rates on our floating rate debt. This derivative, for which we have elected and qualify for cash flow hedge accounting, is recorded on the balance sheet at its fair value. Changes in the derivative’s fair value are recorded each period in other comprehensive income until the underlying monthly interest payment and the corresponding portion of the derivative are settled, at which point changes in fair value are recorded in net income. We evaluate this derivative each quarter to determine that it remains effective by comparing the remaining expected cash flows of the derivative against the related expected interest payments of our floating rate debt. We do not enter into any derivatives for trading or other speculative purposes.
Leases
We adopted ASU 2016-02 - Leases (ASC 842) effective January 1, 2019 using the optional transition method, under which we recognized the cumulative effects of initially applying the standard as an adjustment to the opening balance of retained earnings on January 1, 2019 with unchanged comparative periods. As part of this adoption, we elected the following practical expedients:
•
not to reassess 1) whether any contracts that existed prior to adoption have or contain leases, 2) the classification of our existing leases or 3) initial direct costs for existing leases,

 
 
 
33
FINANCIAL STATEMENTS
 

•
to use the practical expedient of using hindsight to determine the lease terms and evaluate any impairments in right-of-use assets upon transition, and
•
not separately record non-lease and lease components for all leases in which we act as a lessee.
We determine if a new contractual arrangement is a lease at contract inception. If a contract contains a lease, we evaluate whether it should be classified as an operating or a finance lease. If applicable as a lease, we record our lease liabilities and ROU assets based on the future minimum lease payments over the lease term and only include options to renew a lease in the future minimum lease payments if it is reasonably certain that we will exercise that option. For certain leases with original terms of twelve months or less we recognize the lease expense as incurred and we do not recognize lease liabilities and ROU assets.
We measure our lease liabilities based on the future minimum lease payments discounted over the lease term. We determine our discount rate at lease inception using our incremental borrowing rate, which is based on our outstanding term debts that are collateralized by certain corporate assets. As of September 30, 2019, the weighted-average rate used in discounting the lease liability was 4%.
We measure our ROU assets based on the associated lease liabilities adjusted for any lease incentives such as tenant improvement allowances and classify operating ROU assets in other assets in our condensed consolidated balance sheet. For operating leases, we recognize expense for lease payments on a straight-line basis over the lease term.
Recent Accounting Pronouncements
Recently adopted accounting guidance
Leases - In February of 2016, the FASB issued ASC 842, which replaced existing lease guidance under GAAP. Under this guidance, we recognize on our condensed balance sheet lease liabilities representing the present value of future lease payments and an associated right-of-use asset representing our right to use or control the use of specified assets for the lease term for any operating lease with a term greater than one year.
The impact of our adoption of ASC 842 did not have a material impact on our income statement or cash flow statement. The impact on our condensed balance sheets is as follows:
 
 
September 30, 2019
(in millions)
 
As reported
 
Balance Using Previous Standard
 
Increase (Decrease)
Balance sheet
 
 
 
 
 
 
Assets
 
 
 
 
 
 
Operating lease right-of-use assets
 
$
57

 
$
—

 
$
57

Liabilities
 
 
 
 
 
 
Operating lease liabilities
 
17

 
—

 
17

Operating lease liabilities, noncurrent
 
52

 
10

 
42

Equity
 
 
 
 
 
 
Accumulated deficit
 
(200
)
 
(200
)
 
—


Recently issued accounting pronouncements
Credit Losses - In June 2016, the FASB issued ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326) which requires financial assets to be presented at the net amount expected to be collected. We will be required to use forward-looking information when evaluating an allowance for our accounts receivable, unbilled revenue and other financial assets measured at amortized cost. Topic 326 also modifies the impairment guidance for available-for-sale debt securities to require an allowance for credit losses. We will adopt Topic 326 effective January 1, 2020 using a modified retrospective approach through a cumulative-effect adjustment to retained earnings. We do not expect the adoption of Topic 326 to have a material impact on our financial statements.

 
 
 
34
FINANCIAL STATEMENTS
 

NOTE 2. CASH, CASH EQUIVALENTS AND INVESTMENTS
Under the terms of the agreements with certain of our workers' compensation and health benefit insurance carriers, we are required to maintain collateral in trust accounts for the benefit of specified insurance carriers and to reimburse the carriers’ claim payments within our deductible layer. We invest a portion of the collateral amounts in marketable securities. We report the current and noncurrent portions of these trust accounts as restricted cash, cash equivalents and investments on the consolidated balance sheets.
We require our clients to prefund their payroll and related taxes and other withholding liabilities before payroll is processed or due for payment. This prefund is included in restricted cash, cash equivalents and investments as payroll funds collected, which is designated to pay pending payrolls, payroll tax liabilities and other payroll withholdings.
We also invest available corporate funds, primarily in fixed income securities which meet the requirements of our corporate investment policy and are classified as available for sale (AFS).
Our total cash, cash equivalents and investments are summarized below:
 
September 30, 2019
 
December 31, 2018
(in millions)
Cash and cash equivalents
Available-for-sale marketable securities
Total
 
Cash and cash equivalents
Available-for-sale marketable securities
Certificate
of
deposits
Total
Cash and cash equivalents
$
216

$
—

$
216

 
$
228

$
—

$
—

$
228

Investments
—

67

67

 
—

54

—

54

Restricted cash, cash equivalents and investments
 
 


 
 
 
 


Insurance carriers' security deposits
15

—

15

 
15

—

—

15

Payroll funds collected
428

—

428

 
783

—

—

783

Collateral for health benefits claims
80

—

80

 
75

—

—

75

Collateral for workers' compensation claims
62

—

62

 
66

1

—

67

Collateral to secure standby letter of credit
—

—

—

 
—

—

2

2

Total restricted cash, cash equivalents and investments
585

—

585

 
939

1

2

942

Investments, noncurrent
—

128

128

 
—

135

—

135

Restricted cash, cash equivalents and investments, noncurrent
 
 


 
 
 
 


Collateral for workers' compensation claims
198

—

198

 
182

5

—

187

Total
$
999

$
195

$
1,194

 
$
1,349

$
195

$
2

$
1,546


NOTE 3. INVESTMENTS

All of our investment securities that have a contractual maturity date greater than three months are classified as AFS. The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of our investments as of September 30, 2019 and December 31, 2018 are presented below.
 
September 30, 2019
 
December 31, 2018
(in millions)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
 
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Asset-backed securities
$
30

$
—

$
—

$
30

 
$
33

$
—

$
—

$
33

Corporate bonds
97

1

—

98

 
99

—

—

99

U.S. government agencies and government-
sponsored agencies
5

—

—

5

 
7

—

—

7

U.S. treasuries
54

—

—

54

 
46

—

—

46

Exchange traded fund
1

—

—

1

 
1

—

—

1

Other debt securities
7

—

—

7

 
9

—

—

9

Total
$
194

$
1

$
—

$
195

 
$
195

$
—

$
—

$
195



 
 
 
35
FINANCIAL STATEMENTS
 

Gross unrealized losses as of September 30, 2019 and December 31, 2018 were not material.

Unrealized losses on fixed income securities are principally caused by changes in interest rates and the financial condition of the issuer. In analyzing an issuer's financial condition, we consider whether the securities are issued by the federal government or its agencies, whether downgrades by credit rating agencies have occurred, and industry analysts' reports. As we have the ability to hold these investments until maturity, or for the foreseeable future, no decline was deemed to be other-than-temporary. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

The fair value of debt investments by contractual maturity are shown below:
(in millions)
 
September 30, 2019
 
One year or less
 
$
67

 
Over one year through five years
 
112

 
Over five years through ten years
 
6

 
Over ten years
 
9

 
Total fair value
 
$
194

 

The gross proceeds from sales and maturities of AFS securities for the three and nine months ended September 30, 2019 and September 30, 2018 are presented below. We had immaterial realized gains and losses from sales of investments for the three and nine months ended September 30, 2019 and September 30, 2018.
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
(in millions)
2019
2018
 
2019
2018
Gross proceeds from sales
$
24

$
15

 
$
52

$
54

Gross proceeds from maturities
25

9

 
61

33



 
 
 
36
FINANCIAL STATEMENTS
 

NOTE 4. LEASES
Our leasing activities predominantly consist of leasing office space that we occupy, which we have classified as operating leases. Our leases are comprised of fixed payments with remaining lease terms of 1 to 9 years, some of which include options to extend for up to 15 years. As of September 30, 2019, we have not included any options to extend or cancel in the calculation of our lease liability or ROU asset. We do not have any significant residual value guarantees or restrictive covenants in our leases.
During the third quarter of 2019, we recognized operating lease expense of $5 million and we recognized $14 million during the nine months ended September 30, 2019.
During the third quarter of 2019, we paid $4 million to reduce operating lease liabilities and $13 million during the nine months ended September 30, 2019. During the third quarter of 2019, we recognized $4 million in new operating lease liabilities in exchange for ROU assets and we recognized $21 million during the nine months ended September 30, 2019.
As of September 30, 2019, the weighted average remaining lease term on our operating leases was 6.2 years. Future minimum lease payments as of September 30, 2019 and December 31, 2018 were as follows:
(in millions)
September 30, 2019 (2)
December 31, 2018 (3)
2019(1)
$
5

$
18

2020
19

17

2021
11

11

2022
10

9

2023
9

8

2024
6

5

2025 and thereafter
19

20

Total future minimum lease payments
$
79

$
88

Less: imputed interest
(10
)
N/A(4)

Total operating lease liabilities
69

N/A(4)

Current portion
17

N/A(4)

Non-current portion
52

N/A(4)

(1)    The remaining payments as of September 30, 2019 exclude those made during the nine months ended September 30, 2019.
(2)
Presented in accordance with ASC 842.
(3)    Presented in accordance with ASC 840.
(4)    N/A - Not Applicable under ASC 840.

 
 
 
37
FINANCIAL STATEMENTS
 

NOTE 5. ACCRUED WORKERS' COMPENSATION COSTS
The following table summarizes the accrued workers’ compensation cost activity for the three and nine months ended September 30, 2019 and 2018:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions)
2019
2018
 
2019
2018
Total accrued costs, beginning of period
$
224

$
244

 
$
238

$
255

Incurred
 
 
 
 
 
Current year
19

20

 
54

59

Prior years
(6
)
(4
)
 
(22
)
(17
)
Total incurred
13

16

 
32

42

Paid
 
 
 
 
 
Current year
(5
)
(6
)
 
(8
)
(8
)
Prior years
(11
)
(9
)
 
(41
)
(44
)
Total paid
(16
)
(15
)
 
(49
)
(52
)
Total accrued costs, end of period
$
221

$
245

 
$
221

$
245

The following summarizes workers' compensation liabilities on the condensed consolidated balance sheets:
(in millions)
September 30, 2019
December 31, 2018
Total accrued costs, end of period
$
221

$
238

Collateral paid to carriers and offset against accrued costs
(12
)
(13
)
Total accrued costs, net of carrier collateral offset
$
209

$
225

Payable in less than 1 year
(net of collateral paid to carriers of $3 and $3 at September 30, 2019 and December 31, 2018, respectively)
$
63

$
67

Payable in more than 1 year
(net of collateral paid to carriers of $9 and $10 at September 30, 2019 and December 31, 2018, respectively)
146

158

Total accrued costs, net of carrier collateral offset
$
209

$
225


Incurred claims related to prior years represent changes in estimates for ultimate losses on workers' compensation claims. For the three and nine months ended September 30, 2019, the change was primarily due to a decrease in estimate of ultimate losses related to older plan years and the recognition of current year development of ultimate losses.
As of September 30, 2019 and December 31, 2018, we had $56 million and $57 million, respectively, of collateral held by insurance carriers of which $12 million and $13 million, respectively, was offset against accrued workers' compensation costs as the agreements permit and are net settled against collateral held.

 
 
 
38
FINANCIAL STATEMENTS
 

NOTE 6. COMMITMENTS AND CONTINGENCIES
Contingencies
We are and, from time to time, have been and may in the future become involved in various litigation matters, legal proceedings, and claims arising in the ordinary course of our business, including disputes with our clients or various class action, collective action, representative action, and other proceedings arising from the nature of our co-employment relationship with our clients and WSEs in which we are named as a defendant. In addition, due to the nature of our co-employment relationship with our clients and WSEs, we could be subject to liability for federal and state law violations, even if we do not participate in such violations. While our agreements with our clients contain indemnification provisions related to the conduct of our clients, we may not be able to avail ourselves of such provisions in every instance. We have accrued our current best estimates of probable losses with respect to these matters, which are individually and in aggregate immaterial to our consolidated financial statements.
While the outcome of the matters described above cannot be predicted with certainty, management currently does not believe that any such claims or proceedings will have a materially adverse effect on our consolidated financial position, results of operations, or cash flows. However, the unfavorable resolution of any particular matter or our reassessment of our exposure for any of the above matters based on additional information obtained in the future could have a material impact on our consolidated financial position, results of operations, or cash flows.
NOTE 7. STOCKHOLDERS’ EQUITY
Common Stock
The following table presents a rollforward of our common stock for the three and nine months ended September 30, 2019 and 2018:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
2018
2019
2018
Shares issued and outstanding, beginning balance
69,991,145

70,573,887


70,596,559

69,818,392

Issuance of common stock from vested restricted stock units
198,478

255,268


699,188

1,255,409

Issuance of common stock from exercise of stock options
23,441

70,398


163,214

540,292

Issuance of common stock for employee stock purchase plan
—

—


112,623

84,525

Repurchase of common stock
(307,046
)
(300,900
)

(1,482,655
)
(895,699
)
Awards effectively repurchased for required employee withholding taxes
(71,765
)
(90,264
)

(254,676
)
(294,530
)
Shares issued and outstanding, ending balance
69,834,253

70,508,389


69,834,253

70,508,389


Equity-Based Incentive Plans
Our 2019 Equity Incentive Plan (the 2019 Plan), approved in May 2019, replaced our 2009 Equity Incentive Plan and provides for the grants of options (both non-qualified and incentive stock options), stock appreciation rights, restricted stock, RSUs, performance awards (each as defined in the 2019 Plan) and other cash and stock based awards. Shares available for grant as of September 30, 2019 were 2,920,251.
Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs)
Time-based RSUs and RSAs generally vest over 4 years. Performance-based RSUs and RSAs are subject to vesting requirements based on certain financial performance metrics as defined in the grant notice. Actual number of shares earned may range from 0% to 200% of the target award. Awards granted in 2019 and 2018 are based on a single-year performance period subject to subsequent multi-year vesting with 50% of the shares earned vesting in 1 year after the performance period and the remaining shares in the year after.

 
 
 
39
FINANCIAL STATEMENTS
 

The following table summarizes RSU and RSA activity under our equity-based plans for the nine months ended September 30, 2019:
 
RSUs
 
RSAs
 
Number of Units
Weighted-Average
Grant Date
Fair Value
 
Number of Units
Weighted-Average
Grant Date
Fair Value
Nonvested at December 31, 2018
1,737,554

$
32.83

 
346,792

$
49.13

Granted
678,936

60.79

 
—

—

Vested
(710,291
)
31.12

 
(38,042
)
50.37

Forfeited
(147,622
)
37.55

 
(11,103
)
49.35

Nonvested at September 30, 2019
1,558,577

$
44.63

 
297,647

$
49.11


Stock Based Compensation
Stock based compensation expense is measured based on the fair value of the stock award on the grant date and recognized over the requisite service period for each separately vesting portion of the stock award. Stock based compensation expense and other disclosures for stock based awards made to our employees pursuant to the equity plans was as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2019
2018
 
2019
2018
Cost of providing services
$
2

$
3

 
$
6

$
7

Sales and marketing
1

2

 
2

6

General and administrative
5

6

 
19

15

Systems development and programming costs
1

1

 
2

3

Total stock based compensation expense
$
9

$
12

 
$
29

$
31


Stock Repurchases
In February 2019, our board of directors authorized a $300 million incremental increase to our ongoing stock repurchase program initiated in May 2014. During the nine months ended September 30, 2019, we repurchased 1,482,655 shares of common stock for approximately $84 million. As of September 30, 2019, approximately $292 million remained available for further repurchases of our common stock under all authorizations from our board of directors under this program.
NOTE 8. INCOME TAXES
Our effective income tax rate was 18% and 16% for the third quarter of 2019 and 2018, respectively, and 20% and 18% for the nine months ended September 30, 2019 and 2018, respectively. The increase in rate for the third quarter of 2019 was primarily due to a decrease in tax credits and a benefit from revaluation of deferred taxes recorded in the prior year. The increase in rate for the year to date for 2019 when compared to the same period in 2018 consists primarily of decreases in excludable income for state tax purposes and tax benefits recognized from excess tax benefits related to stock based compensation in addition to an increase in uncertain tax positions. These expenses are partially offset by a one-time benefit associated with prior year tax expense.
During the nine months ended September 30, 2019, there was an increase of $1 million in our unrecognized tax benefits. The total amount of gross interest and penalties accrued was immaterial. It is reasonably possible the amount of the unrecognized benefit could increase or decrease within the next twelve months, which would have an impact on net income.
We are subject to tax in U.S. federal and various state and local jurisdictions, as well as Canada. We are open to federal and significant state income tax examinations for tax years 2015 and subsequent years.

 
 
 
40
FINANCIAL STATEMENTS
 

We previously paid Notices of Proposed Assessments disallowing employment tax credits totaling $11 million, plus interest of $4 million in connection with the IRS examination of Gevity HR, Inc. and its subsidiaries, which was acquired by TriNet in June 2009. TriNet filed suit in June 2016 to recover the disallowed credits, and the issue is being resolved through the litigation process. TriNet and the U.S. filed cross motions for summary judgment in this matter in federal district court on February 27, 2018. On September 17, 2018, the district court granted our motion for summary judgment and denied the U.S.' motion. On January 18, 2019, the district court entered judgment in favor of TriNet in the amount of $15 million, plus interest. The U.S. filed a notice of appeal of the district court's decision on March 18, 2019. The U.S. filed its opening brief in the court of appeals on June 10, 2019 and we filed our answering brief on July 24, 2019 to which the government filed its reply brief on September 6, 2019. We will continue to vigorously defend our position through the litigation process.
NOTE 9. EARNINGS PER SHARE (EPS)
The following table presents the computation of our basic and diluted EPS attributable to our common stock:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions, except per share data)
2019
2018
 
2019
2018
Net income
$
55

$
51

 
$
164

$
163

Weighted average shares of common stock outstanding
70

71

 
70

70

Basic EPS
$
0.80

$
0.73

 
$
2.35

$
2.32

Net income
$
55

$
51

 
$
164

$
163

Weighted average shares of common stock outstanding
70

71

 
70

70

Dilutive effect of stock options and restricted stock units
1

2

 
1

2

Weighted average shares of common stock outstanding
71

73

 
71

72

Diluted EPS
$
0.78

$
0.71

 
$
2.31

$
2.25

 
 
 
 
 
 
Common stock equivalents excluded from income per diluted share because of their anti-dilutive effect
—

—

 
1

1



 
 
 
41
FINANCIAL STATEMENTS
 

NOTE 10. FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS
Fair Value of Financial Instruments
We use an independent pricing source to determine the fair value of our AFS. The independent pricing source utilizes various pricing models for each asset class; including the market approach. The inputs and assumptions for the pricing models are market observable inputs including trades of comparable securities, dealer quotes, credit spreads, yield curves and other market-related data.
We have not adjusted the prices obtained from the independent pricing service and we believe the prices received from the independent pricing service are representative of the prices that would be received to sell the assets at the measurement date (exit price).
The carrying value of the Company's cash equivalents and restricted cash equivalents approximate their fair values due to their short-term maturities. The Company's investments are valued using quoted market prices and multiple dealer quotes.
We did not have any Level 3 financial instruments recognized in our balance sheet as of September 30, 2019 and December 31, 2018. There were no transfers between levels as of September 30, 2019 and December 31, 2018.
Fair Value Measurements on a Recurring Basis
The following table summarizes our financial instruments by significant categories and fair value measurement on a recurring basis as of September 30, 2019 and December 31, 2018.
(in millions)
Level 1
Level 2
Total
September 30, 2019
 
 
 
Cash equivalents:
 
 
 
Money market mutual funds
$
51

$
—

51

U.S. treasuries
—

4

4

Total cash equivalents
51

4

55

Investments:
 
 
 
Asset-backed securities
—

30

30

Corporate bonds
—

98

98

U.S. government agencies and government-sponsored agencies
—

5

5

U.S. treasuries
—

54

54

Other debt securities
—

7

7

Total investments
—

194

194

Restricted cash equivalents:
 
 
 
Money market mutual funds
43

—

43

Commercial paper
18

—

18

Total restricted cash equivalents
61

—

61

Restricted investments:
 
 
 
U.S. treasuries
—

—

—

Exchange traded fund
1

—

1

Certificate of deposit
—

—

—

Total restricted investments
1

—

1

Total unrestricted and restricted cash equivalents and investments
$
113

$
198

$
311



 
 
 
42
FINANCIAL STATEMENTS
 

(in millions)
Level 1
Level 2
Total
December 31, 2018
 
 
 
Cash equivalents
 
 
 
Money market mutual funds
$
4

$
—

$
4

U.S. treasuries
—

1

1

Total cash equivalents
4

1

5

Investments
 
 
 
Asset-backed securities
—

33

33

Corporate bonds
—

99

99

U.S. government agencies and government-sponsored agencies
—

7

7

U.S. treasuries
—

41

41

Other debt securities
—

9

9

Total investments
—

189

189

Restricted cash equivalents:
 
 
 
Money market mutual funds
48

—

48

Commercial paper
20

—

20

Total restricted cash equivalents
68

—

68

Restricted investments:
 
 
 
U.S. treasuries
—

5

5

Exchange traded fund
1

—

1

Certificate of deposit
—

2

2

Total restricted investments
1

7

8

Total unrestricted and restricted cash equivalents and investments
$
73

$
197

$
270


Fair Value of Financial Instruments Disclosure
Long-Term Debt
Our long-term debt is a floating rate debt and the fair value of our floating rate debt approximates its carrying value (exclusive of issuance costs) at September 30, 2019. The fair value of our floating rate debt is estimated based on a discounted cash flow, which incorporates credit spreads and market interest rates to estimate the fair value and is considered Level 3 in the hierarchy for fair value measurement.
Derivative Instruments
In June 2019, we entered into an interest rate collar derivative transaction with no upfront premium to mitigate the risk of changes in interest rates on the interest payments on a portion of our floating rate debt. If short-term interest rates increase, we will incur higher interest expense on any future outstanding balances of floating rate debt. We use this derivative as part of our interest rate risk management strategy and designated it as a cash flow hedge. If interest rates rise above the cap strike rate on the contract, we will receive variable-rate amounts and if interest rates fall below the floor strike rate on the contract, we will pay variable-rate amounts.
The following table summarizes the fair value of our derivative instruments at September 30, 2019:
 
September 30, 2019
 
 
 
 
Fair Market Value
(in millions)
Hedge type
Final settlement date
Notional amount
Other current assets
Accounts payable and other current liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
Collar - LIBOR
Cash flow
May 2022
$
213

$
—

$
—

 
 
 
 
 
 


 
 
 
43
FINANCIAL STATEMENTS
 

The pre-tax effect of derivative instruments for the three and nine months ended September 30, 2019 is insignificant and we estimate that an insignificant amount of net derivative gains or losses included in other comprehensive income will be reclassified into earnings within the following 12 months. There were no cash flows associated with the derivative for the three months and nine months ended September 30, 2019.
As of September 30, 2019, we do not hold, nor have we posted, any collateral related to the above derivative instrument.
The interest rate collar derivative is classified as Level 2 in the fair value hierarchy as its value is determined using observable inputs such as forward LIBOR curves.


 
 
 
44
OTHER INFORMATION
 



Legal Proceedings
For the information required in this section, refer to Note 6 in the condensed consolidated financial statements and related notes included in this Form 10-Q.
Risk Factors
There have been no material changes in our risk factors disclosed in Part 1, Item 1A, of our 2018 Form 10-K.
Unregistered Sales of Equity Securities and Use of Proceeds
(a) Sales of Unregistered Securities
Not applicable.
(b) Use of Proceeds from Sales of Unregistered Securities
Not applicable.
(c) Issuer Purchases of Equity Securities
The following table provides information about our purchases of TriNet common stock during the quarter ended September 30, 2019:
Period
Total Number of
Shares
Purchased (1)
 
Weighted Average Price
Paid Per Share
 
Total Number of
Shares
Purchased as Part of Publicly
Announced Plans (2)
 
Approximate Dollar Value ($ millions)
of Shares that May Yet be Purchased
Under the Plans (2)
July 1- July 31, 2019
101,322

 
$
70.75

 
100,600

 
$
306

August 1 - August 30, 2019
179,109

 
$
68.74

 
108,400

 
$
298

September 1 - September 30, 2019
98,380

 
$
64.84

 
98,046

 
$
292

Total
378,811

 


 
307,046

 

(1) Includes shares surrendered by employees to us to satisfy tax withholding obligations that arose upon vesting of RSUs granted pursuant to approved plans.
(2) We repurchased a total of approximately $22 million of our outstanding common stock during the period ended September 30, 2019.

As of September 30, 2019, we had approximately $292 million remaining for repurchases under our stock repurchase program. Stock repurchases under the program are primarily intended to offset the dilutive effect of share-based employee incentive compensation. The purchases were funded from existing cash and cash equivalents balances.

Our stock repurchases are subject to certain restrictions under the terms of our 2018 credit facility. For more information about our 2018 credit facility and our stock repurchases, refer to Notes 7 and 9 in Part II, Item 8. Financial Statements and Supplementary Data of our 2018 Form 10-K.
Defaults Upon Senior Securities
Not applicable.
Mine Safety Disclosures
Not applicable.
Other Information
Not applicable.

 
 
 
45
OTHER INFORMATION
 


Exhibits
Incorporated herein by reference is a list of the exhibits contained in the Exhibit Index below.
EXHIBIT INDEX
 
 
 
 
Incorporated by Reference
 
 
Exhibit No.
 
Exhibit
 
Form
 
File No.
 
Exhibit
 
Filing Date
 
Filed Herewith
31.1
 
 
 
 
 
 
 
 
 
 
X
31.2
 
 
 
 
 
 
 
 
 
 
X
 
32.1*
 
 
 
 
 
 
 
 
 
 
X
 
101.INS
 
 
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
 
 
 
 
 
 
 
 
 
 
 
101.SCH
 
 
XBRL Taxonomy Extension Schema Linkbase Document
 
 
 
 
 
 
 
 
 
 
 
101.CAL
 
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
 
 
 
 
 
 
 
 
101.DEF
 
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
 
 
 
 
 
 
 
 
101.LAB
 
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
 
 
 
 
 
 
 
 
101.PRE
 
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
 
 
 
 
 
 
104
 
Cover Page Interactive Data File (embedded with the Inline XBRL document)
 
 
 
 
 
 
 
 
 
 
 
 
 
*
Document has been furnished, is deemed not filed and is not to be incorporated by reference into any of TriNet Group, Inc.’s filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, irrespective of any general incorporation language contained in any such filing.

 
 
 
46
SIGNATURES
 

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
TRINET GROUP, INC.
 
 
Date: October 24, 2019
 
By:
/s/ Burton M. Goldfield
 
 
 
Burton M. Goldfield
 
 
 
Chief Executive Officer
 
 
 
 
Date: October 24, 2019
 
By:
/s/ Richard Beckert
 
 
 
Richard Beckert
 
 
 
Chief Financial Officer
 
 
 
 
Date: October 24, 2019
 
By:
/s/ Michael P. Murphy
 
 
 
Michael P. Murphy
 
 
 
Chief Accounting Officer


 
 
 
47
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