Financial Engines Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.19.13 | About: Financial Engines, (FNGN)

Financial Engines (NASDAQ:FNGN)

Q4 2012 Earnings Call

February 19, 2013 5:00 pm ET

Executives

Raymond Jay Sims - Chief Financial Officer and Executive Vice President

Jeffrey Nacey Maggioncalda - Chief Executive Officer and Director

Analysts

Mayank Tandon - Needham & Company, LLC, Research Division

Moshe Katri - Cowen and Company, LLC, Research Division

Hugh M. Miller - Sidoti & Company, LLC

Brian Karimzad - Goldman Sachs Group Inc., Research Division

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Operator

Good day, and welcome to the Financial Engines Q4 2012 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Ray Sims, Chief Financial Officer. Mr. Sims, please we go ahead, sir.

Raymond Jay Sims

Good afternoon, and thank you all for being on today's call. Before we get started, I need to remind everyone that part of today's discussion will include forward-looking statements, such as statements regarding our operating metrics; anticipated costs and expenses; growth and growth opportunities; strategy and timing; trends impacting our business; impact of new laws and regulations; enrollment rates, implementation and potential impact of enrollment enhancements and strategies; anticipated features, benefits, success and impact of Income+; anticipated adoption of our products and services; anticipated benefits and impact of customer experience enhancements; long-term objectives and financial outlook for 2013.

These statements are based on what we expect as of this conference call, as well as current market and industry conditions, financial and otherwise, and we undertake no obligation to update these statements to reflect events, circumstances or changes that might arise after this call.

These forward-looking statements are not guarantees of future performance or plans and, therefore, investors should not place undue reliance on them. We refer all of you to our SEC filings for more detailed discussions of the risks that could impact our future operating results and financial conditions, which could cause actual results to differ materially from those discussed in the forward-looking statements.

I also want to inform our listeners that we will make some reference to non-GAAP financial measures during today's call. You will find supplemental data in our press release, which reconciles our non-GAAP measures to our GAAP results.

Now I would like to turn the call over to Jeff Maggioncalda, our Chief Executive Officer.

Jeffrey Nacey Maggioncalda

Good afternoon, everyone. Thank you for joining us today. I'm pleased to report that Financial Engines had a good fourth quarter and a strong 2012. Let's take a look at our fourth quarter numbers. Revenue increased 26% to $51.4 million in Q4, compared to $40.9 million a year ago. Non-GAAP adjusted EBITDA increased 25% to $17.5 million in Q4, compared to $14 million a year ago. Non-GAAP adjusted earnings per share increased 14% to $0.16 in Q4, compared to $0.14 a year ago.

And as for our year-end numbers, revenue increased 29% to $185.8 million in 2012, compared to $144.1 million in 2011. Non-GAAP adjusted EBITDA increased 37% to $55.8 million in 2012, compared to $40.8 million in 2011. Non-GAAP adjusted earnings per share increased 32% to $0.50 for the full-year 2012, compared to $0.38 for the full-year 2011.

In addition to our financial performance, we report quarterly on some important operating metrics, including assets under management, assets under contract, total members and enrollment rates. Please refer to our SEC filings for definitions of these operating metrics.

We had a solid quarter across all of these metrics. As of December 31, assets under management reached $63.9 billion, a 35% increase from $47.5 billion a year ago. Assets under contract increased by 23% to $575 billion from $467 billion a year ago. Total members enrolled in Professional Management grew to more than 660,000, and enrollment rates among employer plans, where services had been available 26 months or more, averaged 12.7% at the end of the fourth quarter.

There are number of fundamental forces driving our growth opportunity. As we've discussed previously, demographic trends continue to drive our business. According to Cerulli Associates, total U.S. retirement assets grew to over $16 trillion in 2011, and are expected to grow to nearly $24 trillion by 2017. And the burden of managing that large pool of assets, with all its complexity and uncertainty, fits with the individual. As we've helped millions of participants over the years, we're realizing that there is a sea change in the way that people perceive and experience retirement. As 70 million Baby Boomers transition into retirement, nearly half expect to enter retirement with debt, such as mortgage payments, credit card debt, car payments and even student loans, according to Fidelity Investments.

It is a different retirement than their parents experienced, in which they likely relied on their employer-sponsored pension plan and Social Security. The primary source of retirement income for most Baby Boomers will be their 401(k) plan and Social Security. However, Cerulli Associates note that majority of households are not effectively utilizing Social Security, even though it is considered a primary source of retirement income. The Cerulli Research also found that participants are often forced into retirement due to medical, financial or employment reasons. When asked if they were adequately prepared, if forced into retirement, 58% of the participants responded with no or were unsure.

In addition to demographics, we believe another factor driving our growth is the increasing reliance on defined contribution plans. American companies have steadily shifted their retirement offering for newly hired employees away from the traditional defined benefit plan and towards the employee's self-directed retirement plan. The consulting firm Towers Watson studied Fortune 100 companies from 1985 to 2012, and found that the type of retirement plan offered by the companies has essentially flipped over the last 3 decades. Whereas in 1985, 89 of the Fortune 100 companies offered a traditional DB plan, in 2012, only 11 of the Fortune 100 companies offered defined benefit plans to newly hired employees. And despite a stronger stock market, U.S. companies have not been able to gain ground in funding their pension plans. 2012 pension plan funding levels declined to unhealthy levels for the second consecutive year, from 78% in 2011 to 75% in 2012.

In the 2013 Hot Topics in Retirement Study published by Aon Hewitt, more than 1/3 of employers indicate that they are planning to offer a lump sum distribution in 2013. Financial Engines' current plan sponsor customers represent about $600 billion in defined benefit assets, and we believe that plan sponsors offering lump sum distributions presents an opportunity for Financial Engines to manage additional assets, especially with the availability of Income+.

Financial Engines also continues to benefit from legal and regulatory tailwinds. As the fiscal cliff debate intensified in the final months of 2012, there were questions about whether or not policymakers would modify 401(k) plan rules in a way that could adversely affect Financial Engines, such as limiting or eliminating the tax deductibility of 401(k) contributions.

The tax bill that was passed on January 1st to avoid the fiscal cliff contained no unfavorable changes to the tax deductibility of contributions in the 401(k) plan. In fact, the bill enhanced 401(k) plan flexibility by broadening the ability of participants to convert their 401(k) balances to Roth 401(k)s, allowing all participants to convert to a Roth 401(k) at any time, as opposed to only after age 59.5, or due to a separation from service.

We believe this is another example of policymakers recognizing the importance of the 401(k) plan, and the need that participants have for more flexibility with their account. But as flexibility increases, so too, does complexity. The decision whether and when to convert a 401(k) or IRA to Roth accounts and to contribute new savings as Roth or non-Roth contributions are good examples of the overwhelming range of choices that individuals must make in respect to their retirement. Increased complexity gives rise to an increased need for help. And we believe these more complex features will prompt more sponsors to seek services like Financial Engines for their employees. With respect to fee disclosure, the Department of Labor's fee disclosure regulations took effect in the second half of 2012. The Plan Sponsor Council of America conducted a survey on the impact of the new regulations on participants, and found that fee disclosure information that participants received seemed to have little or no impact on their behavior. 95% of all plan sponsors reported no change in participant behavior as a result of the fee information, and we have not seen any apparent participant reaction to these fee disclosures among our members in the Professional Management program.

Nevertheless, fee disclosure regulations have increased plan sponsor scrutiny on the fees associated with all plan services, including ours, and we will need to continue to expand the range and value of our services to mitigate the fee pressure that we are seeing as a result.

We also see a continued trend of sponsors providing more help to participants in 401(k) plans. The recent plan sponsor-defined contribution survey found that nearly 3 quarters of plan sponsors agree or somewhat agree, that their organization had an obligation to help participants plan for retirement. The survey also revealed that the automatic features in plan design continue to be endorsed by plan sponsors as a way to improve retirement readiness for their employees. Plan sponsors are taking greater advantage of automatic features to improve participant outcomes by driving participation rates within the plan.

In addition to increasing the level of automation, another 2013 priority for many plan sponsors is to increase their communications about the retirement process to near retirees. Plan sponsors are also recognizing their role in providing retirement income solutions. According to the Defined Contribution Institutional Investment Association, 40% of plan sponsors expect to implement a retirement income solution within the next 5 years.

So our growth opportunities continue to benefit from demographic trends, increased reliance on 401(k) plans, legal and regulatory tailwinds and increased demand for investment advice in the workplace. Now I'd like to discuss our strategy to take advantage of these growth opportunities and the progress that we're making.

Let's start with assets under contract, which is the value of assets in a retirement plan where Professional Management has been made available. Assets under contract rose to $575 billion by the end of Q4, up from $560 billion at the beginning of the quarter and up 23% over the last year. The growth in the fourth quarter was driven primarily by new employers making our services available, the positive performance of financial markets over the last year and the steady contributions that participants and employers made into their 401(k) accounts. As we broaden the scope of the services we offer, we've increased our focus on designing a compelling customer experience that drives engagement, enrollment, and retention. We continue to focus our efforts on converting assets under contract into assets under management by improving enrollment.

In Q4, we added $3.8 billion of AUM from new enrollment, yielding $1.1 billion net of voluntary and involuntary cancellations. This growth in AUM was due to high campaign volume and an increase in ongoing enrollment. We now have 11 large plan sponsors who each have more than $1 billion in plan assets being professionally managed by Financial Engines.

With regard to cancellations, as we've seen in the past, we experienced slightly higher than usual voluntary cancellations in Q4, following the strong net additions we saw in Q3. In addition to enrollment campaigns, we are pleased with the ongoing progress from our integrated enrollment efforts and continue to focus on noncampaign enrollment methods.

Integrated enrollment consists of 3 primary activities: First, securing placement on the provider's website; second, providing engaging content and experiences that participants will click on; and third, enrolling these engaged participants.

In terms of placement, we continue to make progress securing real estate with our record-keeping partners. During Q4 2012, we extended our integrated enrollment capability to 2 of our largest provider partners, including Vanguard. Our total AUC coverage for integrated enrollment has increased from 50% to 81% in coverage over the quarter, and we expect this number to continue to grow during 2013.

Our increasing presence on the provider website is important, as about 30% of all participants consider their plan provider to be a primary source for retirement advice, according to Cerulli Associates. And nearly 60% of participants want personalized information that relates to their current lifestage.

In terms of engagement and enrollment, we continue to make progress in enhancing the flexibility of our provider integrations, so that we can more rapidly test and improve our methods of engaging participants and driving enrollment. We continue to see increased speed with which we can develop and test new content and messaging to participants and continue to see steady progress in the effectiveness of this enrollment method. We believe integration efforts will help increase our enrollment rate by improving the customer experience and engaging more participants throughout the year, rather than just during the communication campaign window.

We continue to make progress, understanding what drives enrollment, designing more effective communication programs and deploying these programs more broadly across our installed base. Enrollment for employers rolled out 26 months or more averaged 12.7% at the end of Q4. An attractive characteristic of our business model is the built-in growth that comes from ongoing contributions from 401(k) participants. Every 2 weeks, a part of most participants' paycheck is deducted and deposited into their 401(k) account, which is usually partially matched by their employer. We estimate that in addition to the $1.1 billion of AUM from net new enrollees, our AUM increased by approximately $1.2 billion more in Q4, due to member and employer matching contributions, an increase of about 33% over last year.

The net inflows from contributions have steadily risen as our member and AUM base has grown and Americans continue to increase their savings rates. For the full year 2012, member and employer matching contributions increased our AUM by approximately $4.3 billion.

The retirement industry is seeing some positive trends in participant savings behavior. According to Fidelity Investments, a recent analysis of participant 401(k) accounts, found that over the past 5 years, the average annual employee contributions grew 7% and the 401(k) match and profit sharing from employer contributions grew 19%.

We are increasing our focus on retention of Professional Management members. Our increased retention efforts are currently focused on reducing voluntary cancellations. Because participants must speak with an advisor to cancel, we have considerable data on their reasons for cancellation, and we believe that we can reduce cancellations over the coming years by increasing personalization, flexibility and the breadth of services we offer.

For the fourth quarter of 2012, our average quarterly overall in cancellation rate was 4.3%. Which is generally in-line with our historical cancellation rate. And as we previously explained, we typically see higher participant cancellation rates in the 90 days following the completed campaigns, and as you may recall, we had a high volume of campaigns in Q3 2012, and saw a corresponding increase in voluntary cancellations in Q4.

We continue to improve the customer experience by broadening our capabilities and expanding our understanding of the total household portfolio of our customers. Sponsor and participant response to broader advisory service capabilities continue to be positive, and reinforces our unique ability to provide a holistic advice that is independent and free from conflicts, and we will continue to invest in developing these services.

Our other primary growth initiative is Income+, the retirement income feature that provides retirees with a steady monthly paycheck from their 401(k) to a checking account that can last for life. We continue to make progress deploying Income+ with our provider partners and plan sponsors. As the demographic wave of Baby Boomers enters into retirement, we believe that employers will be motivated to help generate lifetime income. Cerulli Associates estimates that $318 billion of contributions will flow into 401(k) plans in 2013, and $319 billion of distributions will flow out of them, and that contributions and distributions will continue to offset one another, rising to about $400 billion in the year 2017.

When we introduced Income+ in January 2011, we announced that 5 plan provider partners have committed to offer Income+ to their plan sponsor clients within a year or so. We went live with Aon Hewitt in 2010, Mercer in Q4 of 2011, and JPMorgan in Q2 of 2012. In prior quarters, I mentioned that we are seeing broad interest in Income+, and that we expected providers beyond the 5 initially announced to agree to offer it to their sponsors. It gives me great pleasure to say that in Q4, we went live with our Income+ connection with Fidelity Investments. I am also extremely pleased to announce that Vanguard has committed to offer Income+ to it's plan sponsors and efforts are now underway to establish an Income+ connection with Vanguard.

Providers who have committed to offering Income+, including those who's connections are not yet live, represent more than 95% of our AUC. Provider partners with live Income+ connections now represent more than 50% of our AUC. We have previously announced that 2 additional providers would be offering Income+, and we expect that these connections will come online in the future. With more provider connections in place, we can concentrate our efforts on signing contracts with plan sponsors and making Income+ available to more participants. We believe that the demographic wave of Baby Boomers entering retirement, with $5 trillion in defined contribution accounts, will compel employers to offer ways for employees to generate lifetime income from these accounts.

The broad adoption of Income+ by plan providers and sponsors in 2012, puts Financial Engines in an attractive positioned to become the standard for retirement income in 401(k) plans. As of December 31, 2012, plan sponsors who have made Income+ available to their participants represent $33 billion in assets under contract and more than 380,000 participants.

Income+ was established to be a gateway, to help us broaden our services. To date, we've been focused on helping people manage their 401(k) accounts. But sponsors and participants are now seeking more support with all the complexities of approaching retirement. Participants have been asking us for more help with the decisions they need to make at retirement, as well as help managing retirement assets beyond their 401(k). And sponsors have been asking us to broaden the scope of the services we offer to participants, and particularly, to expand our income planning services. We believe we are uniquely positioned to provide substantially more value to participants, by helping them with all the pieces of their retirement puzzle, questions like Social Security claiming, pension lump sum distributions, valuable retirement assets and managing IRA accounts.

Following validation with plan sponsors, we initiated testing with plan participants to look at their broader retirement picture and help them with more than just their 401(k). Over the last year, in our effort to broaden our services, we have built the infrastructure and capability to manage IRA accounts, as well as 401(k) accounts. This extension of our infrastructure is in place today, and it enables us to introduce a wider range of services.

IRA management, which includes the Income+ capability, has been rolled out to a select group of plan sponsors, record kept in the direct advisory channel, and we are now managing IRA assets for participants on multiple custodial platforms. We believe continued investment in this capability will serve us well. The IRA market is one of the largest and fastest-growing opportunities on the financial services landscape. According to Vanguard's support, How America Saves 2012, about half of retired or separated defined contribution assets remain in the plan, but 38% of the assets roll over to an IRA. Cerulli estimates, as of 2012, millions of people hold IRA accounts, totaling nearly $5.6 trillion and growing 8.7% per year. Cerulli forecasts IRA assets to reach $8.5 trillion by year end 2017. A substantial portion of this growth will come from rollovers from 401(k) plans. Cerulli estimates that new IRA rollovers increase by 12.5% in 2011 to $307 billion, and they expect rollovers to reach over $450 billion by 2017. Before today, Financial Engines lost every dollar of AUM that rolled from a 401(k) to IRA in the form of involuntary cancellations. And we believe that ability to manage IRA accounts, with an Income+ feature, will help retain 401(k) rollovers and attract pension lump sum distributions.

Also, we are now able to manage additional accounts for our existing customers, and to retain our customers as they retire and leave the workplace. We are now proceeding with further validation and testing of our broader retirement management offering. And we'll continue to invest over the longer term to expand and deploy this expanded platform.

For the near term, IRA management will be available only to Professional Management members at the Financial Engines direct channels. We believe that extending our offerings to include the management of IRA, as well as 401(k) accounts, will better engage members and help drive enrollment, and broadening our services will also differentiate us from competitors and products like target date funds. We believe expanding our service offering will help mitigate the pricing pressure prevalent in the industry, and we expect our IRA capability will improve sponsor and member satisfaction, revenue per member and voluntary and involuntary cancellation rates over time.

As with the deployment of Income+, we expected that the larger benefit of IRA management will be realized over the longer-term, as the demographic wave of Baby Boomers retiring continues over the next 2 decades. We continue to expand the number of retirement plan sponsors we serve. At the end of the fourth quarter, we had 513 plan sponsors where Professional Management was available, representing $575 billion in assets, and about 6.5 million participants. At the end of the fourth quarter, we were managing portfolios worth $63.9 billion for more than 660,000 members, and half of those members had less than $44,000 in their accounts. As of December 31, 2012, 141 of the Fortune 500 have hired Financial Engines to help their employees and our advice is available to over 8.3 million participants. When I look at the fundamental trends driving our growth, the breadth and strength of our relationships, and the qualities, scalability and uniqueness of our services, I feel that Financial Engines is increasingly well-positioned to take advantage of a significant market opportunity and to deliver on our promise of providing everyone with the independent, personalized retirement help that they deserve.

And now I'd like to turn it over to our CFO, Ray Sims, to discuss our financial results in more detail. Ray?

Raymond Jay Sims

Thanks, Jeff. As Jeff said, total revenue increased 26% to $51.4 million in the fourth quarter of 2012, from $40.9 million in the prior year period. The increase in revenue was driven primarily by the growth in Professional Management revenue, which increased 37% to $43.2 million for the fourth quarter of 2012. Professional Management revenue growth was driven by higher AUM, which reached $63.9 billion at the end of the fourth quarter compared with $47.5 billion, ending the prior year period. The increase in AUM was the result of increased enrollment from marketing campaigns and other ongoing member acquisitions, as well as contributions and market performance.

Platform and other revenue was down 13% to $8.1 million for the fourth quarter of 2012, compared with $9.4 million for the fourth quarter of 2011. This was due primarily to 2012 year-to-date fee adjustments for a few sponsors, as well as a few sponsor terminations, which resulted mainly from an effort to unify all sponsors onto our full-service platform. We expect platform and other fees to average approximately $9 million per quarter in calendar year 2013.

Cost of revenue, exclusive of amortization of internally-used software, increased 44% to $18.6 million for the quarter, compared to $12.9 million in the prior year period. As a percentage of revenue, cost of revenue increased from 32% in the fourth quarter last year, to 36% this quarter. This was due primarily to an increase in data connectivity fees, resulting from the achievement of certain contractual AUM-based milestones in 2012, and, to a lesser extent, an increase in print costs as a result of a revised agreement with one of our sub-advised plan providers.

As most of you already know, employee-related costs are our largest expense, and include items such as wages, cash incentive compensation, noncash stock-based compensation and benefits. The expense variances that I will be talking about within each of the functional areas, were driven primarily by increases in employee-related wages from growth in headcount and annual cash compensation increases, as well as noncash, stock-based compensation expenses, related primarily to equity grants in mid-November of both 2011 and 2012. Rent expense, which is allocated based on headcount, also increased across each of the functional areas, due to the commencement of our release of the new headquarters facilities in April 2012.

Research and development expense increased to $6.8 million for the quarter, up 22% from $5.5 million in the prior year period, due primarily to increases in employee-related and allocated rent expenses. As a percentage of revenue, R&D decreased from 14% in the prior year period to 13% this quarter, as employee-related expenses grew at a slower rate than revenue.

Sales and marketing expense increased to $10.0 million for the quarter, up 20% from $8.4 million in the prior year's quarter. This increase was driven primarily by increased employee-related expenses and an increase in the amortization of direct response advertising. As a percentage of revenue, sales and marketing expenses decreased from 21% in the prior year period to 20% this quarter, as employee-related expenses grew at a slower rate than revenue.

General and administrative expense increased to $4.3 million for the quarter, up 16% from $3.7 million in the prior year quarter, due primarily to increases in employee-related costs and allocated rent expenses. As a percentage of revenue, general and administrative expense decreased from 9% in the prior year period to 8% this quarter.

Income from operations as a percentage of revenue decreased to 20% for the fourth quarter of 2012 from 21% in the prior year period. Net income increased to $6.5 million in the fourth quarter of 2012 compared with net income of $5.8 million in the fourth quarter of 2011.

As many of you know, we look at non-GAAP adjusted EBITDA as a key measure of our financial performance. Our earnings release has a table that reconciles our GAAP net income to adjusted EBITDA. Adjusted EBITDA in the quarter increased to $17.5 million, up 25% from $14 million in the fourth quarter of last year. Adjusted EBITDA is one of the metrics we use to determine employee cash incentive compensation. We provide further information about the calculation of our non-GAAP, adjusted EPS in today's earnings release. Non-GAAP adjusted EPS was $0.16 in the fourth quarter of 2012 compared with $0.14 in the fourth quarter of 2011.

In terms of cash resources, as of December 31, 2012, we had total cash and cash equivalents of $181 million, compared to $145 million as of December 31, 2011.

On February 14, 2013, Financial Engines' Board of Directors declared a cash dividend of $0.05 per share of the company's common stock. The cash dividend will be paid on April 5, 2013 to stockholders of record, as of the close of business on March 22, 2013. We have initiated a quarterly cash dividend because we believe we can continue to profitably grow the business while generating cash. The dividend is a reflection of our commitment to deliver value to our shareholders.

Now on to our outlook for 2013. Based on financial markets remaining at February 14, 2013 levels, when the S&P 500 index closed at 1,521, we estimate 2013 revenue to be in the range of $224 million to $229 million, and 2013 non-GAAP adjusted EBITDA to be in the range of $69 million to $71 million. We estimate that from February 14, 2013 market levels, a sustained 1% change in the S&P index on February 14, through the end of 2013, would impact our 2013 revenue by approximately 0.57%, and our 2013 non-GAAP adjusted EBITDA by approximately 1.09%, all else being equal. In planning for the growth of our business, we have accelerated hiring into the earlier months of 2013, and it may affect the quarterization of our adjusted EBITDA. While we have historically provided sensitivity based on the S&P 500, for simplicity, we encourage investors to utilize the breakdown of our aggregate portfolios provided in our earnings release to run more accurate sensitivities, as international equity and bond market performance may deviate substantially from the S&P 500's performance. The recommended indices are the S&P 500 for domestic equities, the MSCI EFA index for international equities, and the Barclays Capital U.S. bond index for bonds.

Our outlook for 2013 is consistent with the longer-term objectives we shared with you earlier, which assume fairly normal market conditions. Revenue growth of 20% to 30% per year, operating margins of 15% to 20%, long-term EPS growth of 25% to 40% per year, assets under management growth of 25% to 30% per year, and enrollment rates and plans rolled out for 26 months or more of 12% to 15%.

With that, operator, we'd like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question we have comes from Mayank Tandon of Needham.

Mayank Tandon - Needham & Company, LLC, Research Division

I had a quick question on the AUC. I think the growth rate was a little bit lighter than we've seen the last several quarters, again nitpicking a little bit, but if you could maybe just provide some color on terms of was it timing, or was there anything else that may have impacted the quarter in terms of the growth in AUC?

Jeffrey Nacey Maggioncalda

Yes hey, Mayank, this is Jeff. With respect to AUC, obviously, when you're aren't looking at large plan sponsors it can be a bit lumpy. Over the last 3 years we've said, assume $50 billion, $75 billion of AUC per year that we add, we basically came up with that number in 2012, and I think looking forward, we basically expect it will be about similar.

Raymond Jay Sims

And just to repeat, the outlook is consistent with our internal assumptions as to the timing and amount of the -- and the market was down a little bit between Q3 and Q4.

Mayank Tandon - Needham & Company, LLC, Research Division

Okay, and then, just given strength in the markets of late, have you seen any change in momentum in your business without having any impact in terms of lowering the cancellation rates coming out of the 4Q numbers? I think in the past, you've said that the volatility of the market can have an impact one way or the other, so I wanted to get a sense of, it's actually having a positive impact in the first quarter.

Jeffrey Nacey Maggioncalda

Yes, I'd say that, generally speaking, our cancellation rates had normalized at about 15%, voluntary plus involuntary. I think that we see minor fluctuations. In the year-to-date so far, I wouldn't say anything outside of the norm. Of course, it is better when you see the markets going up, people are more likely to save, they're more likely to stay with the service and they feel better about it. So it's definitely good, but nothing materially different from what we'd expect.

Raymond Jay Sims

As long as we can avoid discussions of fiscal cliffs and sequesters, and limit the news items to meteors over Russia, I think that should decline modestly over time.

Mayank Tandon - Needham & Company, LLC, Research Division

Sure. Absolutely right. Also, in terms of the cancellation rate in 4Q, and I'm sorry, I forget, why does the cancellation rate pick up after a high volume campaigns, again Jeff, could you remind us of that?

Jeffrey Nacey Maggioncalda

Sure. We typically see, is that, if you look at the cancellation rate, the cancellation rate is highest within the first 90 days of somebody signing up. And so when we have a strong quarter, a lot of what that's reflecting is a lot of new people signing up for the service, getting introduced to it and ultimately deciding is this something I want to stick with or not. We think there's a pretty decent opportunity for better retention efforts as we discussed in the script, but generally speaking, we see a higher rate of a shakeout in the early -- first 90 days. We had a pretty strong Q3, and some of the following voluntary cancellations in Q4 reflect the fact that there is a lot of new people being brought under the service in Q3.

Mayank Tandon - Needham & Company, LLC, Research Division

And one last question for my side, you mentioned the timing, I think you may have mentioned the timing on entering new markets, if so, could you remind us what that timeframe is? And also, I wanted to get a sense from you in terms of what the investment would have to be made to be able to make it available to your customers?

Jeffrey Nacey Maggioncalda

Yes, so with respect to new markets, I should mention that we remain very dedicated to the workplace. Clearly we have a big franchise there, we have a lot of comparative advantages, with respect to our relationships, connections, customer base and independence. What we talked about in this call is the fact that over the last year or 2, we have been building the capability to manage, not only 401(k) accounts, but also IRA accounts. And as you've seen, particularly in 2012 and going into the 2013 outlook, we have got a lot of questions about why aren't you guys expanding your profit margins a bit. We said, well we think that there are ways that we could really expand the services and take advantage of new opportunities. The first one that we talked about today is the ability to manage not just a 401(k) but an IRA. The way we're thinking about this, initially, is helping manage people's IRA, who current members in the 401(k). So it's not so much a big expense on sales and marketing to go after a new, sort of a distribution channel, but it has been a big expense in terms of technologies development, where we have expanded the capabilities to manage multiple accounts at once, including IRA accounts. I think I was asked last quarter, do I think that this capability will be live in 2013? I said yes, fair to say, it will be live sometime in 2013. Well, what we announced is that in fact, it was live actually in 2012 and in limited -- I mean we're going to be able to rolling this out over the longer term. But the infrastructure is now in place, and so now, over the longer term, we'll be ramping that up.

Mayank Tandon - Needham & Company, LLC, Research Division

Okay, and just one final question. Any of these record key relationships coming up for renewal, and also, do you have any new ones in the pipeline that you may look to sign this year?

Jeffrey Nacey Maggioncalda

Yes, I don't think that we have any material contracts coming up for renewal. Obviously, with all of our record keeping partners, we've been through renewal periods, and a number of them are in sort of 1 year automatic renewal. So I'd say that, no, I don't see anything on the horizon in 2013, contractually, that would need to be renewed during the course of the calendar year.

Operator

And next, we have Moshe Katri of Cowen.

Moshe Katri - Cowen and Company, LLC, Research Division

When we're trying to build the quarterly model for this year, how should we think about the revenue progression throughout the year? And then, how should we think about adjusted EBIT margins?

Raymond Jay Sims

So Moshe, hi, this is Ray. We typically have revenue building through the quarters, and I would expect that we'll see a repeat of that historic pattern. I did mention, during the prepared remarks that we had the opportunity to make some hires early in the year, and so while our guidance for the full year is unaffected, we expect that there'll be a little bit less than the historic, adjusted EBITDA and all the related measures of income in the first quarter and we'll come out of the year a little stronger, meeting those totals headed into 2014.

Moshe Katri - Cowen and Company, LLC, Research Division

And how about margins for the year, looking at this, versus 2012?

Raymond Jay Sims

So what we had said, I think over the last few quarters is that we wanted to demonstrate we can show a pretty high and consistent, and consistently growing adjusted EBITDA margins, while putting a lot of money into developing enhanced capabilities to grow revenue. I would expect you would see, at today's market levels, modest improvements in our annual adjusted EBITDA margins. So they were about 30% this year, and I would expect, at these levels, you'd see modest improvement from there.

Moshe Katri - Cowen and Company, LLC, Research Division

All right, and then, free cash flow expectations for the year?

Jeffrey Nacey Maggioncalda

Well, after that monumental dividend, we declared of a $0.05 a share. We declared that on Valentine's Day, by the way, so I hope people appreciate that. We're generating close to $10 million a quarter in cash. The dividend in total, at our current share count is around $10 million on an annualized basis, and I would expect again, cash to grow at about that rate.

Moshe Katri - Cowen and Company, LLC, Research Division

All right, and then, last question. I don't think you mentioned total enrollment rates for the quarter.

Jeffrey Nacey Maggioncalda

It's was about 11.1% in total, and 12.7%, looking at the cohort of 26 months and more.

Operator

Next, we have Hugh Miller of Sidoti.

Hugh M. Miller - Sidoti & Company, LLC

Had a question, a couple of kind of housekeeping questions. One on, you guys comment I think, on the cost of revenue on an annual basis, but the -- in the quarter, coming into just a touch lighter than what we've seen in the past couple of quarters, and was just wondering, was there anything in particular that was kind of maybe a year end true-up or something else, and how we should be thinking about that for next year?

Raymond Jay Sims

We had said our cost of revenue long term would fluctuate between about $65 million where it was pinned for a few years and $60 million as that ratchets began to come in, and as we absorbed a little more print cost in cost of goods sold in exchange for more revenue from a sub-advised partner. You will see fluctuations around those levels. It historically has been a little higher in Q4, because of the strong Q2 and Q3 enrollment rates, but I would expect we'd be at the lower and of that 60% to 65%, and most of our growth in margins will come from the ability to grow expenses below the gross margin line more slowly than revenues.

Hugh M. Miller - Sidoti & Company, LLC

And then the other thing too, was that the fee rate capture seemed to be on par with the third quarter, which I believe you guys have commented that, was just kind of a -- that which was higher than what you'd normally seen, and that some of that was just a mix of some clients that, had maybe hit some of those fee rate points, but just wondering, how we should we be thinking about that, as it happened again in this particular quarter, I mean, is this the fee capture we should be thinking about, or was this also just kind of an unusual scenario in the fourth quarter?

Jeffrey Nacey Maggioncalda

I think it's -- I think you should look at this as pretty much -- look at the four quarters, average them and extend it going forward, basis points will fluctuate a little bit, based on mix, but again, at the provider level, we've hit all the relevant ratchets and we've had some minor changes in a couple of our provider agreements, which will improve it going forward, but I'd look for very modest changes in that number.

Hugh M. Miller - Sidoti & Company, LLC

And you guys give us some color on the kind of the rollout, the IRA product. And obviously, there's a potential long term implication from it. But we're just wondering, as you think about -- do you have a sense now of how many people it is available to and the planned roll out, and you guys have always talked about, kind of that 25% to 30% per year of AUM growth. I mean, does that kind of adjust at all in 2013, just given that you will have, maybe a benefit on the cancellation, is just, given your ability to kind of maintain some of those accounts?

Jeffrey Nacey Maggioncalda

Yes, the -- I'd really look at IRA as a longer term proposition. When you look at our 2013 outlook, there is actually some incremental AUM and revenues associated with those projections. And to some degree, some incremental expense. But we've really been slugging away at building this thing out in previous quarters where you guys have already seen a lot of the cost accrue on the R&D side. So I'd say that we'll see gradual and steady improvement in contributions, I think, from IRA over the longer term. It's already built in the outlook, so I don't think there's a whole lot more that you should be factoring in for 2013.

Hugh M. Miller - Sidoti & Company, LLC

Sure, okay. And then, I mean, as we think about -- in 2014, do you think that, that really changes that type of assumption, or is it just kind of that benefit will help to mitigate just the growth off of a larger base?

Jeffrey Nacey Maggioncalda

Yes, obviously, there's a lot of details to get, from experience, going out there and determining to how many participants can we make this available and how rapidly. Also to what degree will participants take us up on the offer to manage multiple accounts, or when they roll over, have us continue to provide our services to them. My sense is that it would be a good idea to say, "Hey, this is just an enhancement to the service", think about those long term rates being the same, but when you go after and open up a $5 trillion market opportunity, clearly, there's some upside that we're paying for. I just don't think there's a lot of evidence yet, then we'll know how big and how soon we might be able to realize that.

Hugh M. Miller - Sidoti & Company, LLC

Okay. And the last question I have is with regards to, you guys have talked about trying to improve, like the enrollment rates as people are kind of clicking on to some of your advertisements when they go on the website. Can you just talk about some of the trends that you're seeing there, between people actively clicking on some of your advertisements and the conversion rates for sign up, and how that is, in the fourth quarter, relative to prior quarters, and what you're kind of gleaning from that, for your abilities to improve that conversion rate?

Jeffrey Nacey Maggioncalda

Yes, I'd say that to date, if you think about it in terms of, kind of campaign-based enrollment, as compared to online enrollment, the new AUM that we're bringing on is still primarily coming from campaigns. The fairly traditional, once per year annual campaign that's printed out and sent to folks, an increasing percentage of that new AUM is actually coming from online channels. There are 3 basic levers that we're trying to optimize, one is coverage, with the integration in the provider's websites. We made more progress in the last 3 to 6 months than we have in the last year or so, in terms of actually enabling workplace, the integrated enrollment. The second piece is the click rate's getting people to click. I'd say that we're experimenting with a number of different things. We are learning how to increase the click rate, based on the type of message and the segments a person, and even when you show the message, but I'd still say we're very much in the experimentation phase. It is certainly the case though, that we're seeing more and more participants go online to check their balances. Cerulli actually did a report that we referenced. We didn't reference this statistic, but showed that over 50% of participants older than age 50 check their 401(k) balance online once per month or more. And this is typically increasing as people get more familiar with online banking and things like that. So we're seeing good traffic to the provider's websites, we're getting placement there, we are experimenting with the original click, and on the enrollment rate side, similar sort of thing. And a lot of what we're trying to do is actually implement technology where we have more control over the messaging and we can more quickly and dynamically alter the messaging to increase the rate of learning that we have. So I'd say steady progress, but nothing where I want to give any specific numbers yet.

Raymond Jay Sims

And this is Ray. I -- just to clarify for people who may be new to these calls. As a shorthand, you refer to it as advertising, but actually this is placement on the provider's website that we do not pay for. So there is a concept of clicking through and enrolling, which is reasonably good, but these don't cost us anything at the margin other than the cost of maintaining the inputs to the -- to their website.

Hugh M. Miller - Sidoti & Company, LLC

Sure. And one other question I have, which is with regards to your decision to go solely the organic route, at this point with IRA, and kind of roll that out within the company. Any particular reason why that, as opposed to maybe some type of partnership, and looking at it from a broader perspective, is that still something that you guys are actively considering? Just your thoughts there.

Jeffrey Nacey Maggioncalda

Yes, I think that there will be many opportunities that we should be exploring and will be exploring in terms of business models. I don't know if it was obvious from the script, but we actually, the way we've designed the first introduction of our IRA capabilities is that our services on IRA will work very similarly to our services on 401(k). And what I mean by that is it's very open architecture. Today, we work with 9 different record keepers and at over 500 different companies. They each have different lineups of funds available, and our engines and our advice and our Income+ capability works on different universes of investment options, sending on different record keeping systems. With respect to IRA, at least you sort of -- version 1, we think it's really attractive to our customers, both sponsors, as well as participants, and frankly to our providers too, to maintain that kind of open architecture design, where we have actually created connections with multiple custodial platforms. So there is no Financial Engines IRA. You can have your IRA account at a number of different places, and we'll able to manage it where it is. You don't need to move your money in order for us to be able to manage it. And of course, we do need a connection. So if there's a provider where you had your IRA and we don't have a connection, you wouldn't need to move the money in order for us to manage it. But our intent is to make the IRA piece open architecture as well.

Hugh M. Miller - Sidoti & Company, LLC

Sure. That's great color there. I mean, what I kind of meant was, with a partner that was beyond your 401(k) partners, that there are obviously large participants out there that do a lot of management within the IRA market, which is looking at kind of, those partners beyond the current ones that you're working with, and looking at those.

Jeffrey Nacey Maggioncalda

Yes, I think that, clearly, as it relates to a phenomena of having modest-balanced individuals with investment accounts, our medium balance today is $44,000, there a lot of IRA accounts with modest balances, not clear to a lot of institutions, how to profitably serve those accounts. Our type of a low cost technology offering and kind of turnkey program could be suitable. But we'll certainly be exploring a number of different ways that we might be able to help -- the majority of people who have more modest balances beyond our current relationships.

Operator

Next, we have Brian Karimzad of Goldman Sachs.

Brian Karimzad - Goldman Sachs Group Inc., Research Division

I guess, first question, just when you look at the growth in Professional Management participants, it's actually decelerated quite a bit, as we've gone through the year, maybe you can offer some color on that, were there any comp issues, although when I look at the growth rates from a year ago, there wasn't anything that really stood out there. And then I have a housekeeping question for Ray.

Jeffrey Nacey Maggioncalda

Yes, so this is Jeff, Brian. No, I don't think there's anything specific that would cause the slowdown in growth. I mean, clearly, as we increase our campaign volumes and we get more effective at driving our enrollment rates, we'll pick up more members. Our average balance has been going up, mostly because of the markets. And to some degree, you could imagine that there could be some target date fund substitution going on, perhaps some people with very low balance could be in target date funds, but nothing noticeable, nothing material, and we don't see anything structurally that would explain it.

Raymond Jay Sims

No, some of that is just math. It's just enrollment rates grow at the fastest in the earlier annual campaigns and slowed down, and as we've had more and more of our base age into that 26 month-plus cohort, the new members and the new assets coming in from initial rollouts are a smaller percentage of the total.

Brian Karimzad - Goldman Sachs Group Inc., Research Division

And then, I guess, the housekeeping one, Ray, is, tied back into what you did for the guidance based on February 14th, that looks like you had a weighted average increase in the market level of about 6%. If I straight line the S&P from November 1st, it was about 7%. I think I may have answered my question, but can you help me explain the delta?

Raymond Jay Sims

Yes. So we guide flat. I think what you're seeing is, as I mentioned in the prepared remarks, if you disaggregate from the S&P, because correlations have been moving all over the place, we had a little bit of a funny effect with some of the international funds, that during that period, and I suspect that accounts for the difference that you're noting.

Brian Karimzad - Goldman Sachs Group Inc., Research Division

Okay. So there is no change in the underlying operating guidance then?

Raymond Jay Sims

That's correct. Again, to avoid confusion for people who may be new. In the third quarter, when we give it our first look at the upcoming year, we do also give it assuming typical markets, we only do that in Q3 because we're looking at results that are 5 quarters out. So the outlooks that we give, currently when we report Q4, is at flat markets, and the delta, I think is explained by the changes in those 3 indices we use.

Operator

Next, we have Mike Grondahl of Piper Jaffray.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Could you just talk a little bit about how you're going to rollout the IRA strategy? Is it marketing? I mean, I understand it's to existing 401(k) clients, but how do you expect to go after them and get them?

Jeffrey Nacey Maggioncalda

Yes, I think that it's very much consistent with our current awareness and marketing programs. I mean, we've typically partner up with the plan sponsors, who let their employees know that they, after a certain amount of due diligence, they selected Financial Engines to provide them with independent help, but that's what they really want. When the individual gets their annual campaign in the mail, or when they see their -- the integrated stoplights in the integrated enrollment process, we have traditionally focused mostly on, we can help you with your 401(k). I would say that you should expect similar awareness in marketing mechanisms, but with a slightly broader message, that is more about retirement than just 401(k). We're not really looking at this time, at substantially new advertising programs and costs associated with that. It's more of an expansion of the value proposition through existing awareness and marketing programs.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

I mean, can you be explicit in that integrated campaign and basically say, hey, we have your 401(k), we want your IRA? I mean, can you go after it aggressively like that?

Jeffrey Nacey Maggioncalda

Well I think that we have been hearing -- I've been saying for a number of quarters, as we started giving investment advice on outside accounts, our advises starting hearing a lot of people say, hey, this is just one piece of a bigger puzzle, can you help me with these other things? Both participants and sponsors have been interested in helping their participants with more than just the 401(k), and so we do think it's a fairly natural extension of the service to say, look, today we're helping you with this, if you have outside accounts, we can help you with broader than just your 401(k), and increasingly, because we decided to give investment advice on those outside accounts starting in the summer, at no additional fee, we're starting to learn who's got the outside accounts, what do those outside accounts look like, what are the typical balances, are they misinvested, and might we be able to help them. So individuals are fairly willing to say, look, I want you to look at my total picture, and when they show us, we can say, we could provide you more help than we're currently providing you, if we would -- if you'd like us to.

Operator

Next, we have Bob Napoli of William Blair.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Question on the Income+. It sounds like to you signed a number of new partners. And I think last year, at various points in time, you put out some -- an 8-K showing the penetration rate being much higher on the Income+ mailings. I was wondering if that has continued. And if there's been any notable change in the penetration rate, driven by Income+, now that you've signed so many additional partners. Do you think we'll see an uplift in '13 and '14, material uplift, with penetration rate, driven by Income+?

Jeffrey Nacey Maggioncalda

Yes. Hey, Bob, this is Jeff. So I'd say that we have really been trying to drive our deployment of Income+ on a few dimensions, clearly getting plan providers to agree to offer this as part of their program and to do the connections. I think we have recently made quite a bit of progress of there. Once you get the connection in place, you got to get the rollout with the plan sponsor. There is a backlog. The last time we announced it, which was, I think last October, we said over 50 sponsors and the $79 billion of AUC and 900,000 participants. Those numbers have been growing nicely. But there still is a backlog to actually get the things rolled out. Once you do the rollout to your question, do people actually sign up in higher numbers, and then the question after that will be one on retention, I'd say that we are still in the early enough stages that it would be too soon to say that there's going to be a material impact in 2013. It is -- our current expectation, in terms of the impact on enrollment rates from Income+ is built into the 2013 outlook. And when you think about 2014, we do expect that over the longer term, a positive effect on both enrollment and retention should be produced because of the Income+ payout capability, as well as now, the ability to make our managed account program portable, if you choose to leave work and roll it over.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Okay. Just a question on the IRA product. Are you pricing at the same, is it -- are the basis points exactly the same? And how do you work with that product with the recordkeepers? Are the recordkeepers involved in the IRA product?

Jeffrey Nacey Maggioncalda

Yes. So with respect to pricing, what -- if you go out there and look at typical pricing in the industry, the difference between asset management fees associated with folks in 401(k) plans, and the asset management fees for folks in an IRA program, which is retailing outside of the 401(k), we find that typically, the expense ratios and the funds are higher, you also find, typically, that the management fee, if it's a managed account, are also higher. We do not expect these prices to be -- I shouldn't say, we do not expect. The prices are not the same, between 401(k) and IRA. They are more reflective of higher prices associated wave a broader set of offerings that is more traditionally seen in the retail market. And with respect to how we work with our provider partners, as I mentioned on one of the earlier questions, our intent is to make this open architecture, and to make available a wide range of potential IRA custodial platforms, we would certainly hope that those would include a number of our provider partners as well.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Okay, but if you go out to somebody who has a 401(k) with you, an employee, and you talk to them about willing their IRA into the plan, are you sharing the fees with a provider on the IRA portion, even though that's not really part of their record-keeping plan?

Jeffrey Nacey Maggioncalda

Yes. So currently, the answer is, we manage the 401(k) with a set of economics in terms of both revenues and cost, and the data connectivity between us and the provider. Those are different than both the price and the cost structure on the IRA side. I think it will depend obviously, custodian by custodian, exactly what the economics are. But we don't expect to see the same economics on either the revenue side or the cost side, with respect to the IRA as we have on the 401(k), and we anticipate if the early data points are any indication they could be a bit more favorable to us.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Okay, and then last question. On the early hiring that you've done in 2013, is it -- what does it -- focuses on? Is it focused on sales efforts into the IRA market, or technology advancements, or what you were -- were you making the investments?

Jeffrey Nacey Maggioncalda

Yes, I'd say that the bulk of the incremental investments, we already have a pretty sizable R&D team, they've been building out infrastructure for the IRA management capability. I'd say that the bulk of emphasis right now is on broadening the customer experience. So we've been talking a lot about these near retirees facing retirement income, coming from multiple sources, whether that's your 401(k), whether that's Social Security, which is a lot of it, a pension lump sum, an IRA account. In many cases, they have questions about things like Medicare. There's a broadening of the services that need to be designed and developed beyond just 401(k) and IRA. And most of the emphasis has really gone towards the broadening of that customer experience, particularly for the near retirees.

Operator

Well it appears that we have no further questions at this time. We'll now conclude today's conference. We would like to thank management for their time and to all of you for joining today. At this time, you may disconnect your lines. Thank you, and take care, everyone.

Jeffrey Nacey Maggioncalda

Great, thank you.

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