Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
or
o    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
 
trinetlogonotaglinergbmda04.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
 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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, 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. (Check one):
Large accelerated filer
x
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o (do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
 
Emerging growth company
o
 
 

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  o    No  x
The number of shares of Registrant’s Common Stock outstanding as of October 22, 2018 was 70,444,420.

 



TRINET GROUP, INC.
Form 10-Q - Quarterly Report
For the Quarterly Period Ended September 30, 2018

TABLE OF CONTENTS
 
Form 10-Q
Cross Reference
Page
       Part I, Item 1.
 
 
 
 
       Part I, Item 2.
       Part I, Item 3.
       Part I, Item 4.
       Part II, Item 1.
         Part II, Item 1A.
       Part II, Item 2.
       Part II, Item 3.
       Part II, Item 4.
       Part II, Item 5.
       Part II, Item 6.
 
 
 
 
 
 



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, “anticipate,” “believe,” “can,” “continue,” “could,” “design,” “estimate,” “expect,” “forecast,” “hope,” “intend,” “may,” “outlook,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “strategy,” “target,” “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, 2017 filed with the Securities and Exchange Commission (SEC) on February 27, 2018 (2017 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” (MD&A) in Item 7 of our 2017 Form 10-K, as well as in our other periodic filings with the SEC. Those 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 accounting principles generally accepted in the United States of America (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.



 
 
 
3

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 human resources (HR) solutions for small to midsize businesses (SMBs). Under our co-employment model, we assume certain of the responsibilities of being an employer and help our clients mitigate employer-related risks and manage many of the complex and burdensome administrative and compliance responsibilities associated with employment.
Our solutions include payroll processing, tax administration, access to employee benefits and an HR technology platform with online and mobile tools that allow our clients and worksite employees (WSEs) to store, view and manage their core HR-related information and efficiently conduct a variety of HR-related transactions anytime and anywhere.
Significant Developments in 2018

Our consolidated results for the nine months ended September 30, 2018 reflect continued progress in marketing and selling our industry-oriented (vertical) products and in our insurance service offerings, combined with higher WSE enrollment growth within our insurance offerings.
We experienced a decline in Average WSEs (defined as average monthly WSEs paid during the period) for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 primarily due to client attrition, including attrition from migrating certain of our clients from our legacy (SOI) platform onto our common TriNet platform, partially offset by growth in our other verticals.
In summary we:
Launched TriNet Professional Services and completed the migration of existing clients from our SOI platform onto our common TriNet platform,
Continued to invest in our efforts to enhance our clients' experience through operational and process improvements,
Improved sales representative retention and launched a marketing and branding campaign in September 2018 to further augment our sales force efforts,
Invested corporate funds to generate interest income and refinanced term loans during the second quarter of 2018,
Continued to benefit from changes for one of our health insurance carrier contracts, where we converted from a guaranteed-cost to risk-based plan in late 2017,
Continued to invest in improving our internal control environment to support our ongoing compliance with the requirements of the Sarbanes-Oxley Act of 2002 (SOX), and
Received IRS designation as a Certified Professional Employer Organization on July 1, 2018 for a TriNet subsidiary.



 
 
 
4

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Performance Highlights
Q3 2018
During the third quarter of 2018, we:
Served approximately 16,400 clients and co-employed Average WSEs of approximately 318,000, a 2% decrease compared to the same period in 2017 and
Processed approximately $8.7 billion in payroll and payroll tax payments for our clients, an increase of 8% compared to the same period in 2017.

Our financial highlights for the third quarter of 2018, compared to the same period in 2017, include:

Total revenues increased 7% to $875 million and Net Service Revenues increased 11% to $228 million,

Operating income decreased 1% to $62 million,

Our effective income tax rate decreased to 16%,

Net income increased 20% to $51 million, or $0.71 per diluted share and Adjusted Net Income increased 35% to $55 million, and

Adjusted EBITDA increased 9% to $88 million.

YTD 2018
During the nine months ended September 30, 2018, we:
Co-employed Average WSEs of approximately 315,500, a 3% decrease compared to the same period in 2017 and
Processed approximately $27.4 billion in payroll and payroll tax payments for our clients, an increase of 6% compared to the same period in 2017.

Our financial highlights for the nine months ended September 30, 2018, compared to the same period in 2017, include:

Total revenues increased 7% to $2.6 billion and Net Service Revenues increased 10% to $668 million,

Operating income increased 24% to $209 million,

Our effective income tax rate decreased to 18%,

Net income increased 46% to $163 million, or $2.25 per diluted share and Adjusted Net Income increased 62% to $176 million, and

Adjusted EBITDA increased 28% to $277 million.


 
 
 
5

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)
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
Income Statement Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues
$
875

 
$
818

 
7
 %
 
 
$
2,586

 
$
2,427

 
7
 %
 
Operating income
62

 
63

 
(1
)
 
 
209

 
169

 
24

 
Net income
51

 
43

 
20

 
 
163

 
112

 
46

 
Diluted net income per share of common stock
0.71

 
0.60

 
18

 
 
2.25

 
1.57

 
43

 
Non-GAAP measures (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Service Revenues
228

 
205

 
11

 
 
668

 
605

 
10

 
Net Insurance Service Revenues
109

 
93

 
17

 
 
305

 
264

 
15

 
Adjusted EBITDA
88

 
80

 
9

 
 
277

 
216

 
28

 
Adjusted Net Income
55

 
41

 
35

 
 
176

 
109

 
62

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Metrics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total WSEs payroll and payroll taxes processed
$
8,669

 
$
8,061

 
8
 %
 
 
$
27,360

 
$
25,835

 
6
 %
 
Average WSEs
318,129

 
324,043

 
(2
)
 
 
315,512

 
325,347

 
(3
)
 
(1)
Refer to Non-GAAP Financial Measures section below for definitions and reconciliations from GAAP measures.
 
Nine Months Ended September 30,
 
%
(in millions, except operating metrics data)
2018
 
2017
 
Change
Operating Metrics:
 
 
 
 
 
 
Total WSEs at period end
317,496

 
325,138

 
(2
)
%
Cash Flow Data:
 
 
 
 
 
 
Net cash used in operating activities (1)
$
(476
)
 
$
(141
)
 
236

 
Net cash used in investing activities
(169
)
 
(15
)
 
1,045

 
Net cash used in financing activities
(62
)
 
(65
)
 
(4
)
 
(1)
Prior year balance has been retrospectively adjusted for Accounting Standards Update (ASU) 2016-18.
(in millions)
September 30,
2018
 
December 31,
2017
 
% Change
 
Balance Sheet Data:
 
 
 
 
 
 
Cash and cash equivalents
$
237

 
$
336

 
(29
)
%
Working capital
226

 
234

 
(3
)
 
Total assets
2,104

 
2,593

 
(19
)
 
Notes payable
418

 
423

 
(1
)
 
Total liabilities
1,754

 
2,387

 
(27
)
 
Total stockholders’ equity
350

 
206

 
70

 

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 useful 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. It is 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.

 
 
 
6

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 represented 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 represented 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 not directly resulting from our core operations or 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.




(1)
We have adjusted the non-GAAP effective tax rate to 26% for 2018 from 41% for 2017 due primarily to a decrease in the statutory rate from 35% to 21%. These non-GAAP effective tax rates exclude 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.


 
 
 
7

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

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)
2018
2017
 
2018
2017
Total revenues
$
875

$
818

 
$
2,586

$
2,427

Less: Insurance costs
647

613

 
1,918

1,822

Net Service Revenues
$
228

$
205

 
$
668

$
605

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)
2018
2017
 
2018
2017
Insurance service revenues
$
756

$
706

 
$
2,223

$
2,086

Less: Insurance costs
647

613

 
1,918

1,822

Net Insurance Service Revenues
$
109

$
93

 
$
305

$
264

Net Insurance Service Revenue Margin
14
%
13
%
 
14
%
13
%
The table below presents a reconciliation of Net income to Adjusted EBITDA:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions)
2018
2017
 
2018
2017
Net income
$
51

$
43

 
$
163

$
112

Provision for income taxes
9

15

 
36

44

Stock-based compensation
12

8

 
31

21

Interest expense and bank fees
5

5

 
17

15

Depreciation
10

8

 
26

20

Amortization of intangible assets
1

1

 
4

4

Adjusted EBITDA
$
88

$
80

 
$
277

$
216

Adjusted EBITDA Margin
38
%
39
%
 
41
%
36
%
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)
2018
2017
 
2018
2017
Net income
$
51

$
43

 
$
163

$
112

Effective income tax rate adjustment
(6
)
(8
)
 
(16
)
(19
)
Stock-based compensation
12

8

 
31

21

Amortization of intangible assets
1

1

 
4

4

Non-cash interest expense

1

 
4

2

Income tax impact of pre-tax adjustments
(3
)
(4
)
 
(10
)
(11
)
Adjusted Net Income
$
55

$
41

 
$
176

$
109


 
 
 
8

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Results of Operations
Operating Metrics
Worksite Employees (WSE)
Average WSE growth is a volume measure we use to monitor the performance of our business. Average WSEs decreased 2% in the third quarter of 2018 and decreased 3% in the nine months ended September 30, 2018, compared to the same respective periods in 2017. The declines in Average WSEs during the third quarter and nine months ended September 30, 2018 compared to the same periods in 2017 were the result of attrition, including attrition from migrating certain of our clients to our common platform, partially offset by WSE growth due to new sales and hiring within our installed base.
Total WSE, defined as WSEs paid at period end, comparisons have served as an indicator of our success in growing our business and retaining clients. Anticipated revenues for future periods can diverge from Total WSEs due to pricing differences across our HR solutions and insurance service offerings and the degree to which clients and WSEs elect to participate in our solutions.

a01wsea22.jpg


 
 
 
9

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Revenues and Income

Our revenues consist of professional service revenues (PSR) and insurance service revenues (ISR). PSR represent 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 consist 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.
In addition to focusing on growing our Average WSE and Total WSE counts, we also focus on pricing strategies and product differentiation to expand our revenue opportunities. Monthly total revenues per Average WSE, as a measure to monitor the success of such strategies, increased 9% in the third quarter of 2018 and increased 10% in the nine months ended September 30, 2018 compared to the same periods in 2017, respectively.


a02revenuesandincomea06.jpg

Q3 2018 - Q3 2017 Commentary
Total revenues were $875 million for the third quarter of 2018, a 7% increase compared to the same period in 2017.
PSR increased 6% compared to the same quarter in 2017 to $119 million due primarily to rate increases.
ISR increased 7% compared to the same quarter in 2017 to $756 million due primarily to an increase in WSEs electing to participate in our insurance services.
Operating income was $62 million in the third quarter of 2018, a decrease of $1 million or 1% compared to the third quarter of 2017, primarily as a result of:
an increase of $22 million in other operating expenses (OOE) which includes $10 million of anticipated costs associated with our marketing campaign and additional investment in operational and process improvements,
partially offset by an increase of $23 million in total revenues less insurance costs due to:
favorable experience from the change in the economic arrangement with one of our carriers from a guaranteed cost contract to a risk-based contract, and
favorable experience with other risk-based contracts, including favorable prior period development of $4 million in workers' compensation insurance costs.

 
 
 
10

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

YTD 2018 - YTD 2017 Commentary
Total revenues were $2.6 billion for the nine months ended September 30, 2018, a 7% increase compared to the same period in 2017.
PSR increased 6% compared to the same period in 2017 to $363 million due to rate increases and changes in vertical mix partially offset by a reduction in Average WSEs.
ISR increased 7% compared to the same period in 2017 to $2.2 billion due primarily to an increase in WSEs electing to participate in our insurance services.
Operating income was $209 million, in the nine months ended September 30, 2018, up $40 million or 24% compared to the nine months ended September 30, 2017, primarily as a result of:
An increase of $63 million in total revenues less insurance costs due to:
favorable experience from the change in the economic arrangement of one of our health insurance contracts as noted above, and
favorable experience with other risk-based contracts, including favorable prior period development of $17 million in workers' compensation insurance costs,
partially offset by an increase of $17 million in OOE, which includes $10 million of anticipated costs associated with our marketing campaign and additional investment in operational and process improvements.

 
 
 
11

MANAGEMENT'S DISCUSSION AND ANALYSIS
 


Net Service Revenues
Net Service Revenues (total revenues less insurance costs) provide a comparable basis of revenues on a net basis, act as the basis to allocate resources to different functions, and help us evaluate the effectiveness of our business strategies by each business function.
a03nsrv4.jpg
Q3 2018 - Q3 2017 Commentary
Net Service Revenues were $228 million for the third quarter of 2018, representing an 11% increase compared to the same period in 2017. This increase is primarily due to an increase in Net Insurance Service Revenues from changes in the composition of our enrolled WSEs within our insurance offerings (ISR mix) partially offset by health plan participation costs (insurance cost mix). Additionally, Monthly Net Service Revenues per Average WSE increased 13% over the same period in 2017.
YTD 2018 - YTD 2017 Commentary
Net Service Revenues were $668 million for the nine months ended September 30, 2018, representing a 10% increase compared to the same period in 2017. This increase is primarily due to an increase in Net Insurance Service Revenues from changes in the composition of our enrolled WSEs within our insurance offerings (ISR mix) partially offset by health plan participation costs (insurance cost mix). Additionally, Monthly Net Service Revenues per Average WSE increased 14% over the same period in 2017.


 
 
 
12

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Professional Service Revenues (PSR)
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 may also be an indicator of our PSR growth.
Our investment in a vertical approach provides us the flexibility to offer our clients in different industries with varied services at different prices. We believe that this vertical approach will improve our ability to retain our customers, and potentially reduce the value of using WSEs as the only leading indicator of future revenue performance. During the nine months ended September 30, 2018, we have seen a client base (mix) change with increased attrition in our Main Street vertical, partially offset by new sales in other verticals, primarily our technology and financial services verticals.

We present the percentage changes in PSR using the following measures:
Volume - the percentage change in period over period Average WSEs,
Rate - the percentage changes in prices for each vertical, and
Mix - the change in composition of Average WSEs within our verticals.
a04psra01.jpg

a05psrqtdcommentarya01.jpg
a05psrytdcommentary.jpg


 
 
 
13

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Insurance Service Revenues (ISR)
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 present the percentage changes in ISR using the following measures:
Volume - the percentage change in period over period Average WSEs,
Rate - the percentage changes in prices 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.
a06isra01.jpg
a07isrqtdcommentarya01.jpg
a07isrytdcommentary.jpg

 
 
 
14

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 loss reserves related to contractual obligations with our workers' compensation and health benefit carriers.
We present the percentage changes in insurance costs using the following measures:
Volume - the percentage change in period over period Average WSEs,
Rate - the percentage changes 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 offerings.

a08isca02.jpg

a09iscqtdcommentarya01.jpg

 
 
 
15

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

a09iscytdcommentaryv2.jpg












 
 
 
16

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Other Operating Expenses (OOE)
Other operating expenses includes cost of providing services (COPS), sales and marketing (S&M), general and administrative (G&A), and systems development and programming (SD&P) expenses. Other operating expenses excludes depreciation and amortization expenses.
We manage and monitor our other operating expenses and allocate resources across different business functions based on OOE as a percentage of Net Service Revenues which increased to 68% in the third quarter of 2018 from 65% in the same period in 2017 and decreased to 64% in the nine months ended September 30, 2018 from 68% in the same period in 2017.
At September 30, 2018, we had approximately 2,900 corporate employees in 53 offices across the United States. Our corporate employees' compensation related expenses represent the majority of our operating expenses. Compensation costs for our corporate employees include payroll, payroll taxes, stock-based compensation, bonuses, commissions and other payroll and benefits related costs.
The percentage of compensation related expenses to OOE was 65% and 62% in the third quarters of 2018 and 2017, respectively, and increased to 66% in the nine months ended September 30, 2018 from 64% in the same period in 2017. The increases for the third quarter of 2018 and the nine months ended September 30, 2018 when compared to the same periods in 2017 are due to increased headcount intended to enhance our clients' experience through operational and process improvements.
OOE for third quarter and year to date 2018 includes approximately $10 million of anticipated costs associated with our marketing campaign and additional investments in operational and process improvements. We expect our OOE to increase in the foreseeable future due to expected growth, our continued strategy to develop new vertical products, and additional costs associated with our continued efforts to improve our systems, processes, and internal controls. These expenses may fluctuate as a percentage of our total revenues from period-to-period depending on the timing of when expenses are incurred.
ooe1a03.jpg


 
 
 
17

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Q3 2018 - Q3 2017 Commentary
Other operating expenses were $155 million for the third quarter of 2018, an increase of $22 million compared to the same period in 2017. Specific costs varied as follows:
Total compensation costs increased $18 million, or 21%, primarily due to:
an increase of $24 million due primarily to increased headcount in various customer service functions and general administrative functions to support process improvement initiatives,
partially offset by a decrease of $6 million in commission expense with the adoption of ASC Topic 606 in the first quarter of 2018. Refer to Note 1 in Item 1 of this Form 10-Q for additional details surrounding the impact of this adoption.
Marketing costs increased $5 million due to the launch of our new marketing and branding campaign.
YTD 2018 - YTD 2017 Commentary
Other operating expenses were $429 million for the nine months ended September 30, 2018, an increase of $17 million compared to the same period in 2017. Specific costs varied as follows:
Total compensation costs increased $21 million, or 8%, primarily due to an increase of $42 million resulting from additional headcount, offset by a decrease of $21 million in commission expense.
Other Income (Expense)
Other income (expense) in the third quarter of 2018 and the nine months ended September 30, 2018 decreased $3 million compared to the same periods in 2017. Specific income (expense) items for the third quarter of 2018 and nine months ended September 30, 2018 varied as follows:
For the third quarter of 2018, interest and dividend income increased $2 million due to an increase in yields from investing activities we initiated in the second quarter of 2018 in an effort to maximize return on our cash balances.
For the nine months ended September 30, 2018, interest and dividend income increased $6 million due to an increase in yields from investing activities, partially offset by $2 million increase in interest expense associated with the write-off of debt issuance costs related to the refinancing of our previous terms loans, as compared to the same period in 2017.
Provision for Income Taxes
Our effective income tax rate was 16% and 26% for the three months ended September 30, 2018 and 2017, respectively, and 18% and 28% for the nine months ended September 30, 2018 and 2017, respectively. These decreases are primarily due to a reduction in the federal corporate income tax rate from 35% to 21% under the Tax Cuts and Jobs Act (TCJA), additional tax benefits from a decrease in uncertain tax positions, an increase in tax credits and an increase in excludable income for state tax purposes. These benefits are partially offset by a decrease in excess tax benefits related to stock-based compensation and a one-time qualified production activities deduction for certain software offerings recorded in the prior year.

 
 
 
18

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Liquidity and Capital Resources
Liquidity
We report our liquidity separately between WSE-related assets and liabilities and our corporate assets and liabilities. 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. Our liquid assets are as follows:
 
September 30, 2018
December 31, 2017
(in millions)
Corporate
WSE
Total
Corporate
WSE
Total
Current assets
 
 
 
 
 
 
WSE-related assets
$

$
403

$
403

$

$
360

$
360

Cash and cash equivalents
237


237

336


336

Restricted cash, cash equivalents and investments
15

606

621

15

1,265

1,280

All other current assets
76


76

15


15

Current assets
$
328

$
1,009

$
1,337

$
366

$
1,625

$
1,991

 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
WSE-related liabilities
$

$
1,009

$
1,009

$

$
1,618

$
1,618

All other current liabilities
102


102

139


139

Current liabilities
$
102

$
1,009

$
1,111

$
139

$
1,618

$
1,757

 
 
 
 
 
 
 
Working capital
$
226

$

$
226

$
227

$
7

$
234

Working capital for WSE-related assets and liabilities
We present our WSE-related assets and liabilities separately from our corporate assets and liabilities on our condensed consolidated balance sheets to better distinguish those assets and liabilities held by us to satisfy WSE-related obligations. WSE-related assets and liabilities primarily consist of current assets and current liabilities, respectively, resulting from transactions directly or indirectly associated with WSEs, including payroll and related taxes and withholdings, our sponsored insurance programs, and other benefit programs.
We designate funds to ensure that we have adequate current assets to satisfy our current WSE-related obligations. 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 the client's payroll date. We regularly review our short-term WSE-related obligations (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 payroll funds collected (PFC). PFC is included in current assets as restricted cash, cash equivalents and investments in our condensed consolidated financial statements.
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 the balance when facts and circumstances change. We regularly review our collateral balances with our insurance carriers and anticipate funding further collateral based upon our capital requirements. We classify our restricted cash, cash equivalents and investments as current and noncurrent assets to match against the anticipated payment of claims.

 
 
 
19

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Working capital for corporate purposes
We use the remaining available cash and cash equivalents and cash from operations 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, 2018 remained flat compared to December 31, 2017.
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 operations, our borrowing capacity under our revolving credit facility and the potential issuance of debt or equity securities through our filed shelf registration statement.
In June 2018 we refinanced approximately $415 million of, and repaid in full, our outstanding A and A-2 term loans (together, our 2014 Term Loans) under our previous credit agreement (our 2014 Credit Agreement). Our 2014 Term Loans were replaced with a $425 million term loan A (our 2018 Term Loan) under our new credit agreement (our 2018 Credit Agreement). We also replaced our previous $75 million revolving credit facility established under our 2014 Credit Agreement with a $250 million revolving credit facility under our 2018 Credit Agreement (our 2018 Revolver), which will be used solely for working capital and other general corporate purposes.
Each of our 2018 Term Loan and our 2018 Revolver mature in June 2023 and bear interest, at our option, either at a LIBOR rate, or the prime lending rate, plus an applicable margin subject to change in the future based on our leverage ratio, as set forth in our 2018 Credit Agreement. As of September 30, 2018, $420 million was outstanding under our 2018 Term Loan and the full amount of our 2018 Revolver, less approximately $16 million representing an undrawn letter of credit, was available.
Cash Flows

In January 2018, we adopted ASU 2016-18 Statement of Cash Flows (Topic 230): Restricted Cash, which significantly impacted our net cash provided by (used in) operating activities as changes in our restricted cash and cash equivalents balances are no longer included within operating cash activities.
The following table presents our cash flow activities for the stated periods:
 
Nine Months Ended
September 30,
(in millions)
2018
2017
 
Corporate
WSE
Total
Corporate
WSE
Total
Net cash provided by (used in):
 
 
 
 
 
 
Operating activities (1)
$
184

$
(660
)
$
(476
)
$
205

$
(346
)
$
(141
)
Investing activities
(169
)

(169
)
(15
)

(15
)
Financing activities
(62
)

(62
)
(65
)

(65
)
Net increase (decrease) in cash and cash equivalents, unrestricted and restricted
$
(47
)
$
(660
)
$
(707
)
$
125

$
(346
)
$
(221
)
Cash and cash equivalents, unrestricted and restricted:
 
 
 
 
 
 
Beginning of period
$
476

$
1,262

$
1,738

$
278

$
955

$
1,233

End of period
$
429

$
602

$
1,031

$
403

$
609

$
1,012

 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents:
 
 
 
 
 
 
Unrestricted
$
(99
)
$

$
(99
)
$
80

$

$
80

Restricted
52

(660
)
(608
)
45

(346
)
(301
)
(1)
Prior year balances were retrospectively adjusted for Accounting Standards Update (ASU) 2016-18.

 
 
 
20

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Operating Activities
Components of net cash used in operating activities are as follows:
 
Nine Months Ended
September 30,
(in millions)
2018
2017
 
Corporate
WSE
Total
Corporate
WSE
Total
Net income
$
163

$

$
163

$
112

$

$
112

Depreciation and amortization
36


36

26


26

Stock-based compensation expense
31


31

21


21

Payment of interest
(13
)

(13
)
(12
)

(12
)
Income tax payments, net
(33
)

(33
)



Collateral paid to insurance carriers, net
(1
)

(1
)
(3
)

(3
)
Changes in other operating assets
10

(51
)
(41
)
33

(5
)
28

Changes in other operating liabilities
(9
)
(609
)
(618
)
28

(341
)
(313
)
Net cash provided by (used in) operating activities (1)
$
184

$
(660
)
$
(476
)
$
205

$
(346
)
$
(141
)
(1)
Prior year balances were retrospectively adjusted for Accounting Standards Update (ASU) 2016-18.

Net cash used in operating activities from WSE-related activities was primarily driven by the timing of client payments, payroll amounts, collateral funding and insurance claim activities. Cash used in operating activities for WSE purposes increased by $314 million during the nine months ended September 30, 2018, compared to the same period in 2017, and was primarily driven by payments of payroll taxes and related liabilities. 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 WSE-related obligations through restricted cash.

Cash provided by corporate operating activities decreased $21 million in the first nine months of 2018 compared to the same period in 2017 and was driven by the timing of corporate income tax payments as well as payments to vendors. The overall decrease was partially offset by a 46% increase in our net income.

We expect our tax payments to continue to increase in 2018 due to our inability to defer taxes as a result of new restrictions in the TCJA.
Investing Activities
Net cash used in investing activities in the nine months ended September 30, 2018 and 2017, respectively, primarily consisted of purchases of investments partially offset by proceeds from the sale and maturity of restricted investments, and cash paid for capital expenditures.
 
Nine Months Ended
September 30,
(in millions)
2018
2017
Investments:
 
 
Purchases of investments
$
223

$

Proceeds from sale of investments
(54
)

Proceeds from maturity of investments
(33
)
(14
)
Cash used in investments
$
136

$
(14
)
 
 
 
Capital expenditures:
 
 
Software and hardware
$
21

$
23

Office furniture, equipment and leasehold improvements
12

6

Cash used in capital expenditures
$
33

$
29


 
 
 
21

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Investments
During the nine months ended September 30, 2018, we invested a portion of available cash in investment-grade securities with effective maturities less than five years that are classified on our balance sheet as investments. As of September 30, 2018, we had approximately $168 million in 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 balance sheet included 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, 2018, we held approximately $802 million of restricted cash, cash equivalents and investments in noncurrent and current accounts, of which approximately $5 million is in U.S. long-term treasuries.
As of September 30, 2018, we held approximately $1.2 billion in cash, cash equivalents and investments. Refer to Note 2 in Item 1 in this Form 10-Q for a summary of these funds.
Capital Expenditures
During the nine months ended September 30, 2018 and 2017, we continued to make investments in software and hardware, enhanced existing products and platforms, and implemented legacy platform migrations. 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, 2018 and 2017 consisted of our debt and equity related activities.
 
Nine Months Ended September 30,
(in millions)
2018
2017
Financing activities
 
 
Repurchase of common stock, net of issuance
$
53

$
36

Repayment of borrowings
15

29

Net proceeds from issuance of notes payable
(6
)

Cash used in financing activities
$
62

$
65

In the nine months ended September 30, 2018 we refinanced our 2014 Term Loans with our 2018 Term loan as discussed above. For additional information refer to Note 7 in item 1 of this Form 10-Q.
Our board of directors authorizes common stock repurchases through an ongoing program initiated in May 2014, primarily 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, 2018, we repurchased 895,699 shares of our common stock for approximately $47 million through our stock repurchase program. As of September 30, 2018, approximately $90 million remained available for repurchase under all authorizations by our board of directors.
Covenants
Our 2018 Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable to us, including, among other things, restrictions on indebtedness, liens, investments, mergers, dispositions, prepayment of indebtedness (other than our 2018 Term Loan and our 2018 Revolver), dividends, distributions and transactions with affiliates. It also contains financial covenants requiring us to maintain certain minimum interest coverage and maximum total leverage ratios, as set forth in our 2018 Credit Agreement. These covenants took effect on June 30, 2018. We were in compliance with these financial covenants under the credit facilities at September 30, 2018. For more details on the covenants under our 2018 Credit Agreement, refer to Note 7 in Item 1 of this Form 10-Q.

 
 
 
22

MANAGEMENT'S DISCUSSION AND ANALYSIS
 

Contractual Obligations
The following table summarizes our significant contractual obligations associated with our debt refinance at September 30, 2018:
 
Payments Due by Period
(in millions)
Total
Less than 1 year
1-3 years
3-5 years
Debt obligations (1)
$
489

$
38

$
74

$
377

(1)
Includes principal and the projected interest payments of our term loans, refer to Note 7 in Item 1 of this Form 10-Q for details.
Off-Balance Sheet Arrangements
There has been no material change in our off-balance sheet arrangements discussed in Item 7 of our 2017 Form 10-K.
Critical Accounting Policies, Estimates and Judgments
During the first quarter of 2018, we adopted ASC Topic 606. 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 additional material changes to our critical accounting policies as discussed in our 2017 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 1 in Item 1 of this Form 10-Q.

 
 
 
23

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.
In the first quarter of 2018 our board of directors approved a corporate investment policy that defines our investable cash in instruments that meet certain credit quality, liquidity, diversification and other requirements. We believe that our exposure to losses resulting from credit risk is not significant. A sensitivity analysis to determine the impact a change in interest rates would have on the value of the investment portfolio assuming a 100 basis point parallel shift in the yield curve. Based on investment positions as of September 30, 2018, a hypothetical 100 basis point increase or decrease in interest rates across all maturities would result in a $2 million incremental increase or decrease in the fair market value of the portfolio, respectively. Such losses would only be realized if we sold the investments prior to maturity. The risk of rate changes on investment balances was not significant at September 30, 2018.
In June 2018, we refinanced our term loans which would have matured in July 2019 and replaced them with a term loan maturing in 2023. At September 30, 2018, after this refinancing, we had total outstanding indebtedness of $420 million, of which $22 million is due within 12 months. A 100 basis point increase or decrease in market interest rates would cause interest expense on our debt as of September 30, 2018 to increase or decrease by $4 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, 2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of September 30, 2018, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were not effective as a result of a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
Notwithstanding the material weakness in our internal control over financial reporting, 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 accounting principles generally accepted in the United States of America. Additionally, the material weakness did not result in any restatements of our condensed consolidated financial statements or disclosures for any prior period.
Additional Analyses and Procedures and Remediation Plan
We are taking specific steps to remediate the material weakness identified by management and described in greater detail in our 2017 Form 10-K. Although we intend to complete the remediation process with respect to this material weakness as quickly as possible, we cannot at this time estimate how long it will take, and our remediation plan may not prove to be successful.
Because the reliability of the internal control process requires repeatable execution, the successful remediation of this material weakness will require review and evidence of effectiveness prior to concluding that the controls are effective and there is no assurance that additional remediation steps will not be necessary. As such, as we continue to evaluate and work to improve our internal control over financial reporting, our management may decide to take additional measures to address the material weaknesses or modify the remediation steps already underway. As noted above, although we plan to complete the remediation process as quickly as possible, we cannot at this time estimate how long it will take, and our initiatives may not prove to be successful. Accordingly, until this weakness is remediated, we plan to perform additional analyses and other procedures to ensure that our condensed consolidated financial statements are prepared in accordance with GAAP.
Changes in Internal Control Over Financial Reporting
Other than the material weakness remediation efforts underway, 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, 2018, 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.

 
 
 
24

FINANCIAL STATEMENTS
 


CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except share and per share data)
September 30,
2018
 
December 31,
2017
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
 
$
237

 
 
$
336

Investments
 
38

 
 

Restricted cash, cash equivalents and investments
 
621

 
 
1,280

Worksite employee related assets:
 
 
 
 
 
Unbilled revenue (net of advance collections of $39 and $12
at September 30, 2018 and December 31, 2017, respectively)
$
306

 
 
$
297

 
Accounts receivable
5

 
 
20

 
Prepaid insurance premiums and other insurance related
receivables (net of health benefit loss reserves of $45 and $0
at September 30, 2018 and December 31, 2017, respectively
47

 
 
26

 
Other payroll assets
45

 
 
17

 
Worksite employee related assets


403

 


360

Prepaid expenses and other current assets
 
38

 
 
15

Total current assets
 
1,337

 
 
1,991

Investments, noncurrent
 
130

 
 

Restricted cash, cash equivalents and investments, noncurrent
 
181

 
 
162

Workers' compensation collateral receivable
 
40

 
 
39

Property and equipment, net
 
78

 
 
70

Goodwill and other intangible assets, net
 
311

 
 
315

Other assets
 
27

 
 
16

Total assets
 
$
2,104

 
 
$
2,593

Liabilities and stockholders’ equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable and other current liabilities
 
$
43

 
 
$
59

Accrued corporate wages
 
37

 
 
40

Notes payable
 
22

 
 
40

Worksite employee related liabilities:
 
 
 
 
 
Accrued wages
$
326

 
 
$
289

 
Client deposits
35

 
 
52

 
Payroll tax liabilities and other payroll withholdings
419

 
 
1,034

 
Health benefits loss reserves (net of prepayments of $0 and $19
at September 30, 2018 and December 31, 2017, respectively)
144

 
 
151

 
Workers' compensation loss reserves (net of collateral paid of $4 and $6
at September 30, 2018 and December 31, 2017, respectively)
68

 
 
67

 
Insurance premiums and other payables
17

 
 
25

 
Worksite employee related liabilities


1,009

 
 
1,618

Total current liabilities
 
1,111

 
 
1,757

Notes payable, noncurrent
 
396

 
 
383

Workers' compensation loss reserves (net of collateral paid of $14 and $17
at September 30, 2018 and December 31, 2017, respectively)
 
159

 
 
165

Deferred income taxes
 
72

 
 
68

Other liabilities
 
16

 
 
14

Total liabilities
 
1,754

 
 
2,387

Commitments and contingencies (see Note 10)
 


 




Stockholders’ equity:
 
 
 
 
 
Preferred stock
($0.000025 par value per share; 20,000,000 shares authorized; no shares issued and outstanding at September 30, 2018 and December 31, 2017)
 

 
 

Common stock and additional paid-in capital
($0.000025 par value per share; 750,000,000 shares authorized; 70,508,389 and 69,818,392 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively)
 
623

 
 
583

Accumulated deficit
 
(273
)
 
 
(377
)
Total stockholders’ equity
 
350

 
 
206

Total liabilities and stockholders’ equity
 
$
2,104

 
 
$
2,593

See accompanying notes.

 
 
 
25

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)
2018
2017
 
2018
2017
Professional service revenues
$
119

$
112

 
$
363

$
341

Insurance service revenues
756

706

 
2,223

2,086

Total revenues
875

818

 
2,586

2,427

Insurance costs
647

613

 
1,918

1,822

Cost of providing services (exclusive of depreciation and amortization of intangible assets)
58

50

 
166

157

Sales and marketing
52

44

 
132

139

General and administrative
33

28

 
95

82

Systems development and programming
12

11

 
36

34

Depreciation
10

8

 
26

20

Amortization of intangible assets
1

1

 
4

4

Total costs and operating expenses
813

755

 
2,377

2,258

Operating income
62

63

 
209

169

Other income (expense):
 
 
 
 
 
Interest expense, bank fees and other, net
(2
)
(5
)
 
(10
)
(13
)
Income before provision for income taxes
60

58

 
199

156

Income tax expense
9

15

 
36

44

Net income
$
51

$
43

 
$
163

$
112

Comprehensive income
$
51

$
43

 
$
163

$
112

 
 
 
 
 
 
Net income per share:
 
 
 
 
 
Basic
$
0.73

$
0.62

 
$
2.32

$
1.62

Diluted
$
0.71

$
0.60

 
$
2.25

$
1.57

Weighted average shares:
 
 
 
 

 
Basic
70,556,877

69,498,218

 
70,353,597

69,016,054

Diluted
72,599,944

71,499,591

 
72,388,598

71,138,743

 
See accompanying notes.

 
 
 
26

FINANCIAL STATEMENTS
 

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
September 30,
(in millions)
2018
2017
Operating activities
 
 
Net income
$
163

$
112

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
36

26

Stock-based compensation
31

21

Changes in operating assets and liabilities:
 
 
Prepaid income taxes
1

42

Prepaid expenses and other current assets
(24
)
(1
)
Workers' compensation collateral receivable and other noncurrent assets
(10
)
(7
)
Accounts payable and other current liabilities
(9
)
7

Accrued corporate wages
(4
)
1

Workers' compensation loss reserves and other noncurrent liabilities

4

Worksite employee related assets
(51
)
(5
)
Worksite employee related liabilities
(609
)
(341
)
Net cash used in operating activities
(476
)
(141
)
Investing activities
 
 
Purchases of marketable securities
(223
)

Proceeds from sale of marketable securities
54


Proceeds from maturity of marketable securities
33

14

Acquisitions of property and equipment
(33
)
(29
)
Net cash used in investing activities
(169
)
(15
)
Financing activities
 
 
Repurchase of common stock
(47
)
(39
)
Proceeds from issuance of common stock on exercised options
6

9

Proceeds from issuance of common stock on employee stock purchase plan
3

2

Awards effectively repurchased for required employee withholding taxes
(15
)
(8
)
Proceeds from issuance of notes payable, net
210


Payments for extinguishment of debt
(204
)

Repayment of notes payable
(15
)
(29
)
Net cash used in financing activities
(62
)
(65
)
Net decrease in cash and cash equivalents, unrestricted and restricted
(707
)
(221
)
Cash and cash equivalents, unrestricted and restricted:
 
 
Beginning of period
1,738

1,233

End of period
$
1,031

$
1,012

 
 
 
Supplemental disclosures of cash flow information
 
 
Interest paid
$
13

$
12

Income taxes paid, net
33


Supplemental schedule of noncash investing and financing activities
 
 
Payable for purchase of property and equipment
$
2

$
2

Supplemental schedule of cash and cash equivalents
 
 
Net increase (decrease) in unrestricted cash and cash equivalents
$
(99
)
$
80

Net decrease in restricted cash and cash equivalents
(608
)
(301
)
See accompanying notes.

 
 
 
27

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 (PEO) founded in 1988, provides comprehensive human resources (HR) solutions for small to midsize businesses (SMBs) under a co-employment model. These HR solutions include bundled services, such as 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 services. Through the co-employment relationship, we are the employer of record for most administrative and regulatory purposes, 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 worksite employees (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 (Financial Statements) and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) 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 (SEC). 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 the nine months ended September 30, 2018 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 of our Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Form 10-K).
Reclassifications
Certain prior year amounts have been reclassified to conform to current period presentation. These reclassifications include short-term restricted cash, cash equivalents and investments previously classified as WSE-related assets and now presented within restricted cash, cash equivalents and investments. Refer to the accounting policy below for a description of amounts currently included in restricted cash, cash equivalents, and investments.

 
 
 
28

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 (loss reserves) related to workers' compensation and workers' compensation collateral receivable,
health insurance loss reserves,
liability for insurance premiums payable,
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.

Revenue Recognition
On January 1, 2018, we adopted Accounting Standards Codification Topic 606 (ASC Topic 606) using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC Topic 606, while the comparative prior period amounts are not restated and continue to be reported in accordance with statements previously accounted for under Accounting Standards Codification Topic 605.
Upon adoption of ASC Topic 606, we recorded a $1 million cumulative effect adjustment to opening retained earnings as of January 1, 2018. Impacts from adoption of the new standard on our revenue recognition include:
Our annual service contracts with our clients that are cancellable with 30 days' notice are initially considered 30-day contracts under the new standard;
Professional service revenues are recognized on an output basis which results in recognition at the time payroll is processed;
Our non-refundable set up fees are no longer deferred but accounted for as part of our transaction price and are allocated among professional service revenues and insurance services revenues; and
The majority of sales commissions related to onboarding new clients that were previously expensed are capitalized as contract assets and amortized over the estimated customer life.
Revenues are recognized when control of the promised services are transferred to our clients, in an amount that reflects the consideration that we expect to receive in exchange for services. We generate all of our revenue from contracts with customers. We disaggregate revenues into professional services revenues and insurance services revenues as reported on the condensed consolidated statements of operations and comprehensive income. Generally, both the client and the Company may terminate the contract without penalty by providing a 30-day notice.

 
 
 
29

FINANCIAL STATEMENTS
 

Performance Obligations
At contract inception, we assess the services promised in our contracts with customers and identify a performance obligation for each distinct promise to transfer to the customer a service or bundle of services. We determined that the following distinct services represent separate performance obligations:
Payroll and payroll tax processing,
Health benefits services, and
Workers’ compensation services.
Payroll and payroll tax processing performance obligations include services to process payroll and payroll tax-related transactions on behalf of our clients. Revenues associated with this performance obligation are reported as professional service revenues and recognized using an output method in which the control of the promised services is considered transferred when a client's payroll is processed by us and its WSEs are paid. Professional service revenues are stated net of the gross payroll and payroll tax amounts funded by our clients. Although we assume the responsibilities to process and remit the payroll and payroll related obligations, we do not assume employment-related responsibilities such as determining the amount of the payroll and related payroll obligations. As a result, we are the agent in this arrangement for revenue recognition purposes.
Health benefits and workers' compensation services include performance obligations to provide TriNet-sponsored health benefits and workers' compensation insurance coverage through insurance policies provided by third-party insurance carriers and settle high deductible amounts on those policies. Revenues associated with these performance obligations are reported as insurance services revenues and are recognized using the output method over the period of time that the client and WSEs are covered under TriNet-sponsored insurance policies.
We control the selection of health benefits and workers' compensation coverage made available, insurance services revenues are reported gross as we are the principal in this arrangement for revenue recognition purposes. See Item 8 Note 1 in our 2017 Form 10-K for further discussion on our accounting policy for insurance costs.
We generally charge new customers a nominal upfront non-refundable fee to recover our costs to set up the client on our TriNet platform for payroll processing and other administrative services, such as benefit enrollments. These fees are accounted for as part of our transaction price and are allocated among the performance obligations based on their relative standalone selling price.
Variable Consideration and Pricing Allocation
Our contracts with customers generally do not include any variable consideration. However, from time to time, we may offer incentive credits to our clients considered to be variable consideration including incentive credits issued related to contract renewals. Incentive credits are recorded as a reduction to revenue as part of the transaction price at contract inception when there is a basis to reasonably estimate the amount of the incentive credit and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur. These incentive credits are allocated among the performance obligations based on their relative standalone selling price.
We allocate the total transaction price to each performance obligation based on the estimated relative standalone selling prices of the promised services underlying each performance obligation. The transaction price for payroll and payroll tax processing performance obligations are determined upon establishment of the contract that contains the final terms of the sale, including the description and price of each service purchased. The estimated service fee is calculated based on observable inputs and include the following key assumptions: target profit margin, pricing strategies including the mix of services purchased and competitive factors, and customer and industry specifics.
The transaction price for health benefits insurance and worker’s compensation insurance performance obligations is determined during the new client on-boarding and enrollment processes based on the types of benefits coverage the clients and WSEs have elected and the applicable risk profile of the client. We estimate our service fees based on actuarial forecasts of our expected insurance premiums and claim costs, and to amounts to cover our costs to administer these programs.
We require our clients to prefund payroll and related taxes and other withholding liabilities before payroll is processed or due for payment. Under the provision of our contracts with customers, we generally will process the payment of a client’s payroll only when the client successfully funds the amount required. As a result, there is no financing arrangement

 
 
 
30

FINANCIAL STATEMENTS
 

for the contracts, however, certain contracts to provide payroll and payroll tax processing services permit the client to pay certain payroll tax components ratably over a 12-month period rather than as payroll tax is determined on wages paid, which may be considered a significant financing arrangement under ASC Topic 606. However, as the period between our performing the service under the contract and when the client pays for the service is less than one year, we have elected as a practical expedient, not to adjust the transaction price.
Contract Costs
We recognize as deferred commission expense the incremental cost to obtain a contract with a client for certain components under our commission plans for sales representatives and channel partners that are directly related to new customers onboarded as we expect to recover these costs through future service fees. Such assets will be amortized over the estimated average client tenure. These commissions are earned on the basis of the revenue generated from payroll and payroll tax processing performance obligations. When the commission on a renewal contract is not commensurate with the commission on the initial contract, such commission will be capitalized and amortized over the estimated average client tenure. If the commission for both initial contract and renewal contracts are commensurate, such commissions are expensed in the contract period. When the amortization period is less than one year, we apply practical expedient to expense sales commissions in sales and marketing expenses in the period incurred. The below table summarizes the amounts capitalized and amortized during the three and nine months ended September 30, 2018:
 
Three Months Ended September 30, 2018
Nine Months Ended September 30, 2018
(in millions)
Capitalized
Amortized
Capitalized
Amortized
Deferred commission costs
$
8

$
2

$
24

$
3

Certain commission plans will pay a commission on estimated professional service revenues over the first 12 months of the contract with customers. The portion of commission paid in excess of the actual commission earned in that period is recorded as prepaid commission. When the prepaid commission is considered earned, it is classified as a deferred commission expense and subject to amortization.
We do not have material contract assets and contract liabilities as of September 30, 2018. We require our clients to prefund payroll and related liabilities before payroll is processed or due for payment. If a client fails to fund payroll or misses the funding cut-off, at our sole discretion, we may pay the payroll and the resulting unfunded payroll is recognized as accounts receivable on the accompanying consolidated balance sheets. When client payment is received in advance of our performance under the contract, such amount is recorded as client deposits.

Restricted Cash, Cash Equivalents and Investments
Restricted cash, cash equivalents and investments presented on our condensed consolidated balance sheets include:
corporate cash and cash equivalents in trust accounts functioning as security deposits for our insurance carriers,
payroll funds collected represents cash collected in advance from clients which we designate as restricted for the purpose of funding WSE payroll and payroll taxes and other payroll related liabilities, and
amounts held in trust for current and future premium and claim obligations with our insurance carriers, which amounts are held in trust according to the terms of the relevant insurance policies and by the local insurance regulations of the jurisdictions in which the policies are in force.
Investments
Our investments are classified as available-for-sale and are carried at estimated fair value.
Unrealized gains and losses are reported as a component of accumulated other comprehensive income (loss), net of deferred income taxes. The amortized cost of debt investments is adjusted for amortization of premiums and accretion of discounts from the date of purchase to maturity or sale. Such amortization is included in interest income as an addition to or deduction from the coupon interest earned on the investments. We use the specific identification method to determine the realized gains and losses on the sale of available-for-sale securities. Realized gains and losses are included in other income in the accompanying consolidated statements of income and comprehensive income.

 
 
 
31

FINANCIAL STATEMENTS
 

We assess our investments for an other-than-temporary impairment loss due to a decline in fair value or other market conditions. We review several factors to determine whether a loss is other than temporary, such as the length and extent of the fair value decline, the financial condition and near-term prospects of the issuer and whether we have the intent to sell or will more likely than not be required to sell before the securities' anticipated recovery, which may be at maturity. If management determines that a security is impaired under these circumstances, the impairment recognized in earnings is measured as the entire difference between the amortized cost and the then-current fair value.
We have investments within our unrestricted and our restricted accounts. Unrestricted investments are recorded on the balance sheet as current or noncurrent based upon the remaining time to maturity, and investments subject to WSE restrictions are classified as current or noncurrent based on the expected payout of the related liability.
Concentrations of Credit Risk
Financial instruments subject to concentrations of credit risk include cash, cash equivalents and investments (unrestricted and restricted), accounts receivable, and amounts due from insurance carriers. We maintain these financial assets principally in domestic financial institutions. We perform periodic evaluations of the relative credit standing of these institutions. Our exposure to credit risk in the event of default by the financial institutions holding these funds is limited to amounts currently held by the institution in excess of insured amounts.
Recent Accounting Pronouncements
Recently adopted accounting guidance
Revenue Recognition - In May 2014, the FASB issued ASU 2014-09-Revenue from Contracts with Customers, which will replace most existing revenue recognition guidance under GAAP. The core principle of the guidance is that an entity should recognize revenue for the transfer of promised goods or services to customers that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard provides a five-step analysis of transactions to determine when and how revenue is recognized.
We have adopted the new standard effective January 1, 2018 using the modified retrospective method. For further discussion of our adoption of ASC Topic 606, including our operating results under the new standard, see Revenue Recognition section above.
The impact from the adoption of ASC Topic 606 to our condensed consolidated income statements and balance sheets is as follows:
 
Three Months Ended September 30, 2018
Nine Months Ended September 30, 2018
(in millions, except per share data)
As Reported
Balance Using Previous Standard
Increase (Decrease)
As Reported
Balance Using Previous Standard
Increase (Decrease)
Income statement
 
 
 
 
 
 
Revenue
 
 
 
 
 
 
Professional service revenues
$
119

$
120

$
(1
)
$
363

$
362

$
1

Total revenues
875

876

(1
)
2,586

2,585

1

Expense
 
 
 
 
 
 
Sales and marketing expense
 
 
 
 
 
 
Commissions expense
6

13

(7
)
17

38

(21
)
Total expense
813

819

(6
)
2,377

2,398

(21
)
Income before provision for income taxes
60

55

5

199

177

22

Income tax expense
9

8

1

36

31

5

Net income
51

47

4

163

146

17

Basic earnings per share
0.73

0.68

0.05

2.32

2.09

0.23

Diluted earnings per share
$
0.71

$
0.66

$
0.05

$
2.25

$
2.03

$
0.22


 
 
 
32

FINANCIAL STATEMENTS
 

 
September 30, 2018
(in millions)
As reported
Balance Using Previous Standard
Increase (Decrease)
Balance sheet
 
 
 
Assets
 
 
 
Cash and cash equivalents
$
237

$
245

$
(8
)
Restricted cash, cash equivalents and investments
621

613

8

Unbilled revenue (net of advance collections)
306

314

(8
)
Prepaid expenses and other current assets
38

29

9

Other assets
27

16

11

Liabilities
 
 


Accounts payable and other current liabilities
43

46

(3
)
Deferred income taxes
72

70

2

Other liabilities
16

20

(4
)
Equity
 
 


Retained earnings
$
(273
)
$
(290
)
$
17

Statement of Cash Flows - In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 addresses diversity in practice from entities classifying and presenting transfers between cash and restricted cash as operating, investing or financing activities or as a combination of those activities in the statement of cash flows. The ASU requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the Statement of Cash Flows. As a result, transfers between such categories are no longer be presented in the Statement of Cash Flows. We adopted ASU 2016-18 on January 1, 2018 using the retrospective method.
Recently issued accounting pronouncements
Lease arrangements - In February 2016, the FASB issued ASU 2016-02-Leases (ASC 842) and subsequent amendments to the initial guidance under ASU 2017-13, ASU 2018-10 and ASU 2018-11 (collectively, Topic 842) to supersede existing guidance on accounting for leases in ASC 840, Leases (ASC 840). Topic 842 requires us to recognize on our balance sheet a lease liability representing the present value of future lease payments and a right-of-use asset representing the lessee's right to use, or control the use of a specified asset for the lease term for any operating lease with a term greater than one year. This standard is effective for annual and interim reporting periods beginning after December 15, 2018.
We will adopt the new standard effective January 1, 2019 using the alternative transition method, under which we will recognize 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.
Additionally, we plan to elect the practical expedient approach and we will not reassess whether any contracts that existed prior to adoption have or contain leases. We will continue to classify initial indirect costs of existing leases as part of our existing leases.
Based on our evaluation to-date, we are not a lessor and have no capitalized leases. Our leases primarily consist of leases for office space. Our process is still in progress but we anticipate that we will have changes to the way we recognize, present and disclose our operating leases in our consolidated financial statements.
We are still in the process of quantifying the impact at this time, but anticipate this standard will have a material impact on our condensed consolidated balance sheet with material increases in long-term and current assets and long-term and current lease liabilities associated with our property leases representing our nationwide office locations. We do not anticipate a material impact on our condensed consolidated statements of operations, as the majority of our leases will remain operating leases for which the right-of-use assets amortization will be similar to previously required straight-line expense treatment for operating leases. The adoption of Topic 842 will not have an impact on the financial covenants set forth in our credit agreement.


 
 
 
33

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 and other WSE-related liabilities.
Our total cash, cash equivalents and investments are summarized below:
 
September 30, 2018
December 31, 2017
(in millions)
Cash and cash equivalents
Available-for-sale marketable securities
Certificate
of
deposits
Total
Cash and cash equivalents
Available-for-sale marketable securities
Certificate
of
deposits
Total
Cash and cash equivalents
$
237

$

$

$
237

$
336

$

$

$
336

Investments

38


38





Restricted cash, cash equivalents and investments
 
 
 
 
 
 
 
 
Insurance carriers security deposits
15



15

15



15

Payroll funds collected
441



441

1,095



1,095

Collateral for health benefits claims
75



75

69



69

Collateral for workers' compensation claims
87

1


88

98

1


99

Collateral to secure standby letter of credit


2

2



2

2

Total restricted cash, cash equivalents and investments
618

1

2

621

1,277

1

2

1,280

Investments, noncurrent

130


130





Restricted cash, cash equivalents and investments, noncurrent
 
 
 
 
 
 
 
 
Collateral for workers' compensation claims
176

5


181

125

37


162

Total
$
1,031

$
174

$
2

$
1,207

$
1,738

$
38

$
2

$
1,778


 
 
 
34

FINANCIAL STATEMENTS
 

NOTE 3. INVESTMENTS
All of our investment securities that have a contractual maturity date greater than three months are classified as available-for-sale (AFS). The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of our investments as of September 30, 2018 and December 31, 2017 are presented below:
 
September 30, 2018
(in millions)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Asset-backed securities
$
35

$

$

$
35

Corporate bonds
86



86

U.S. government agencies and government-
sponsored agencies
8



8

U.S. treasuries
34



34

Exchange traded fund
1



1

Other debt securities
10



10

Total
$
174

$

$

$
174

 
December 31, 2017
(in millions)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
U.S. treasuries
$
37

$

$

$
37

Exchange traded fund
1



1

Total
$
38

$

$

$
38

Investments in a continuous unrealized loss position for less than 12 months and 12 months or more as of September 30, 2018 and December 31, 2017 are presented below.
 
September 30, 2018
 
Less than 12 months
12 months or more
Total
(in millions)
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Asset-backed securities
$
26

$

$

$

$
26

$

Corporate bonds
72




72


U.S. government agencies and government-sponsored agencies
7




7


U.S. treasuries
31




31


Exchange Traded Fund
1




1


Other debt securities
8




8


Total
$
145

$

$

$

$
145

$

 
December 31, 2017
 
Less than 12 months
12 months or more
Total
(in millions)
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
U.S. treasuries
$
5

$

$
24

$

$
29

$

Total
$
5

$

$
24

$

$
29

$


 
 
 
35

FINANCIAL STATEMENTS
 

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.
The fair value of debt investments by contractual maturity (actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties) are shown below.
 
September 30, 2018
(in millions)
One year or less
Over One Year Through Five Years
Over Five Years Through Ten Years
Over Ten Years
Fair Value
Asset-backed securities
$
3

$
29

$
3

$

$
35

Corporate bonds
32

54



86

U.S. government agencies and government-sponsored agencies
1

2


5

8

U.S. treasuries
7

27



34

Other debt securities

1


9

10

Total
$
43

$
113

$
3

$
14

$
173

 
December 31, 2017
(in millions)
One year or less
Over One Year Through Five Years
Over Five Years Through Ten Years
Over Ten Years
Fair Value
U.S. treasuries
$

$
37

$

$

$
37

Total
$

$
37

$

$

$
37

We had immaterial gross realized gains and losses from sales of investments for the three and nine months periods ended September 30, 2018 and 2017.
Our asset-backed securities include auto loan/lease, credit card, and equipment leases with investment-grade ratings.
Our corporate bonds include investment-grade debt securities from a wide variety of issuers, industries, and sectors.
Our U.S. government agencies and government-sponsored agencies securities primarily include commercial mortgage-backed securities and mortgage backed securities consisting of Federal Home Loan Mortgage Corporation and Federal National Mortgage Association securities with investment-grade ratings.
Our other debt securities primarily include mortgage-backed securities with investment-grade ratings issued by institutions without federal backing.

 
 
 
36

FINANCIAL STATEMENTS
 

NOTE 4. WORKERS' COMPENSATION LOSS RESERVES
The following table summarizes the workers’ compensation loss reserve activity for the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
(in millions)
2018
2017
2018
2017
Total loss reserves, beginning of period
$
244

$
255

$
255

$
255

Incurred
 
 
 
 
Current year
20

22

59

70

Prior years
(4
)
(4
)
(17
)
(3
)
Total incurred
16

18

42

67