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WageWorks, Inc. (NYSE:WAGE)

Q3 2013 Earnings Call

November 5, 2013 5:00 PM ET

Executives

Lisa Sheldon – ICR, IR

Joseph L. Jackson – Chief Executive Officer

Richard T. Green – Chief Financial Officer

Analysts

Bob Napoli – William Blair & Co. LLC

David Grossman – Stifel, Nicolaus & Co., Inc.

Michael Huang – Needham & Company

Tobey Sommer – SunTrust Robinson Humphrey

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 WageWorks Incorporated Earnings Conference Call. My name is Denise, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will facilitate a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host for today, Lisa Sheldon, WageWorks' Investor Relations. Please proceed.

Lisa Sheldon

Thank you, operator. Good afternoon and thank you for joining us today to review WageWorks’ third quarter 2013 financial results. With me on the call today are Joe Jackson, Chief Executive Officer and Rich Green, Chief Financial Officer. After prepared remarks, we will open up the call to a question-and-answer session.

During this call, we may make statements related to our business that will be considered forward-looking statements under Federal Securities Laws, including projections of future operating results for our fourth quarter and our fiscal year ending December 31, 2013. Our selling efforts and the anticipated benefits from those efforts, anticipated benefits of the modification to the "Use It or Lose it" rule relating to healthcare flexible spending accounts, expected benefits from our channel partnerships, expected benefits of our portfolio purchases, the demand for Consumer-Directed Benefits, market trends for the industries in which we compete; anticipated benefits of exchange opportunities, our expectations and beliefs concerning how those trends will affect our operating results and our strategic and operational plans, objectives and goals. These statements are based on management’s current expectations and assumptions that are subject to risks and uncertainties.

Actual results may differ materially from those set forth in such statements. Important factors such as risks related to regulations affecting our industry; our ability to successfully identify, acquire or integrate additional portfolio purchases, acquisition targets or channel partnerships and risks related to employer and employee adoption of tax-advantage benefits plans could cause actual results to differ materially from those in the forward-looking statements. These factors are addressed in the earnings press release that we issued today under the section captioned Forward-looking Statements and elsewhere in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2013.

We encourage all investors to read our SEC filings. These statements reflect our views only as of today and should not be relied upon as representing our views of any subsequent date. WageWorks expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made herein.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation to the most directly comparable GAAP financial measure is available on our second quarter 2013 earnings Press Release which can be found at www.wageworks.com in the Investor Relations section. Also please note that our webcast and today’s call will be available on our website in our Investor Relations section.

With that, I would like to turn the call over to WageWorks’ Chief Executive Officer, Joe Jackson. Joe?

Joseph L. Jackson

Thank you, Lisa, and I would like to start by thanking all of you for joining us today. We are very pleased with our strong third quarter performance and this is shaping up to be an outstanding year for WageWorks.

We just completed a record enterprise selling season. I've started the process of transitioning Ceridian’s healthcare clients to the WageWorks' platform and are preparing for the kick-off of Open Enrollment for Towers Watson's OneExchange Active clients. And finally we are also very happy with the long-awaited Department of Treasury's decision last Thursday to positively amend the "Use It or Lose It" rule with regard to healthcare flexible spending accounts. I'll elaborate on each of these areas in a moment, but first let me run through the financial highlights.

Total revenue for the quarter was $53.6 million, an increase of 26% over the prior year period. Our organic growth was strong again at approximately 13% in the quarter and we remain on track for our full year target organic growth rate of 10% to 11%. Our GAAP operating income was $9.9 million, leading to GAAP net income attributable to common shareholders per diluted common share of $0.22. Our non-GAAP operating income was $11.3 million, leading to non-GAAP net income per diluted common share of $0.18. Non-GAAP adjusted EBITDA was strong at $14.2 million, an increase of 33% over the prior year period.

As I mentioned, we just completed an extremely successful enterprise selling season and are very pleased with the record number of quality companies that selected WageWorks to administer their consumer-directed benefit plans in 2014. We added a meaningful number of noteworthy logos to our client base including American Airlines, NextEra Energy, Phillips 66 and Tiffany & Co. to name just a few.

Our strong enterprise selling season was a direct result of the investments we have made to expand our sales force, develop our relationships with channel partners and increase overall awareness in brand recognition. We have also made some modifications to our enterprise sales process and we are seeing great results. As an example, we learned that when potential clients come to visit WageWorks' facilities to see first-hand how we are staffed and how we manage our operations, our win rate was much higher.

Prospective clients as well as existing clients are consistently impressed by our people, our processes, our technology and, most importantly, our passion for service. Realizing that on-site visits result in a significant competitive advantage for WageWorks, we've worked to include them now as a standard part of our sales process.

As you know, we are currently in the middle of our SMB selling season as well as the client renewal period, and both are progressing extremely well. We are also in the middle of Open Enrollment for the vast majority of our employer clients. In support of all these efforts and with an eye towards our 2014 sales goals, we have been working on a host of WageWorks' branding initiatives as well as new marketing and communications programs.

These have all been designed to help better educate employers and employees on the value of consumer-directed benefit programs and with the goal of ultimately generating higher participation rates specifically in close collaboration with our clients, we developed fresh campaign materials such as videos, virtual benefit fairs, and social campaigns.

We have also introduced our updated WageWorks brand which is reflective of the evolution and growth of our company's experience over the last few years. The updated brand is strengthening our presence and differentiation in the market place, reinforcing our dedication to customers' success and creating excitement around Consumer-Directed Benefits.

Now I'd like to spend a moment to update you on our channel partnership arrangement with Ceridian. Last month, we began the process of transitioning approximately 1,500 direct healthcare clients and approximately 175,000 participants from Ceridian's existing Consumer-Directed Benefit account administration to WageWorks. We're now expecting meaningful percentage of these clients to come on-board for a 1/1/14 start and anticipate further waves of Ceridian clients to transition throughout 2014, the vast majority of these coming in in the first half of the year.

We are still in the early days and we'll know more once we get through Open Enrollment. However, once fully transitioned, we continue to expect the organic annual revenue impact for the Ceridian business to be between $9.5 million and $11.5 million. We have also made solid progress in training the Ceridian sales force on our products and services and believe that they will be ready to hit the ground running for the 2014 sales season.

We continue to be very excited about this agreement and channel partnerships like these are a key component of our long-term growth strategy. In fact, in addition to our strong relationships with Aflac and Ceridian, we have also entered into a few additional channel partnership arrangements with Summit Health, Benefitfocus and Q4 Systems.

Summit Health provides on-site wellness programs and is involved with the Towers Watson OneExchange Active program to provide biometrics screening for all of the OneExchange Active clients. While part of our exchange strategy, our agreement with Summit involves a subcontracting component that allows them to offer our products outside of the Exchange environment and directly to their client base.

Benefitfocus and Q4 Systems will also be reselling some of the consumer-directed benefit services to their own client base. All of these partnerships involve the referral or resale of some or all of our products and services and provide us new growth opportunities going forward.

I'll also take this time to update you on our partnership with Towers Watson. Again, we're the exclusive administrator of HSAs and HRAs for the OneExchange Active, Towers Watson's offering for active full-time employees. OneExchange Active will enroll participants this fall for January 1, 2014 health plan start dates. Once the Open Enrollment period is complete, we will have additional color to provide on our earnings call in February. However, we're very optimistic about the current opportunity and the potential for future expansion as additional employers are added to this exchange.

Prior to the exchanges are broadening our overall market opportunity and provide a significant long-term growth potential for WageWorks, and we're actively pursuing additional partnerships in this space similar to the relationship with Towers Watson.

I also wanted to take this opportunity to applaud the Department of Treasury's decision last Thursday to make what we believe is a very positive change to the "Use It or Lose It" rule for Healthcare Flexible Spending Account. As many of you know, WageWorks has led the charge for our industry to get this change made. Now once adopted by employers, millions of working Americans will be able to carry over up to $500 of their FSA funds into the following plan year.

This rule change also virtually eliminates the perceived risk of losing money when employees consider signing up for a Flexible Spending Account. The timing of this change could not be better as most companies now are in their Open Enrollment period. In terms of impact to our business, it's really still too early to quantify but we are optimistic that this will have a very positive impact over time on employee participation as we know this rule has always been identified as the biggest deterrent for employees considering whether or not to sign up for an FSA.

We will know a lot more when we get through the Open Enrollment season and we'll update you when we report our fourth quarter earnings, but we would expect the impact of this change to be limited for 2014 with a more meaningful impact starting in 2015.

However, with all these exciting opportunities, it is important to note that with the Towers Watson OneExchange Active ticking off, Ceridian's healthcare clients making the transition to WageWorks, our record enterprise selling season and the change to the "Use It or Lose It" rule, we expect the first quarter of 2014 to be even more of a busy time for us than usual.

To handle the increased volume while maintaining our track record of impeccable customer service, we will need to hire even more additional staff in advance of the revenue than we do each year at this time. In addition, we will now be ramping up some of our marketing expenses to educate our clients and most importantly their employees about the exciting change to the "Use It or Lose It" rule. Rich will provide more detail but we will be ramping up expenses in Q4 even more than we normally would to ensure that we provide the best experience possible for employers and participants.

In closing, this was another strong quarter for WageWorks as we continue to execute on our growth initiative and drive scale. We have seen our market expand significantly over the last couple of quarters first with the rollout of private exchanges, and now with the positive change to the "Use It or Lose It" rule. As I have said many times before and I probably start to sound like a broken record, but we believe now more than ever that as a company we are just getting started.

With that, I’ll turn the call over to Rich Green, our CFO. Rich?

Richard T. Green

Thanks, Joe. I’ll start by providing details on our strong financial performance during the third quarter then I’ll discuss our financial guidance for the fourth quarter and full-year 2013.

Total revenue for the third quarter was $53.6 million, an increase of 26% over the same period last year and at the top of our guidance range. Healthcare revenue was $32.6 million for the quarter, an increase of 23% compared to the third quarter of 2012. Commuter revenue was $14.9 million for the third quarter, an increase of 14% over the same period last year.

Other revenue was $6 million, an increase of 103% compared to the same period last year and driven primarily by the Benefit Concepts acquisition.

Now let’s turn to costs and margins. We will review our numbers on a GAAP basis and where applicable on a non-GAAP basis. The non-GAAP numbers for the third quarter exclude stock-based compensation expense, the amortization of acquired intangibles, contingent consideration gain and the tax impact of these items. A GAAP to non-GAAP reconciliation can be found in the tables of our Press Release, which is available on our website.

Gross profit for the third quarter was $34.3 million and represented a gross margin of 64%, compared with a 64% gross margin in the third quarter of 2012. Operating expenses totalled $24.4 million in the third quarter, compared to $22.3 million in the same period last year. In the third quarter of 2012, we had approximately $3.7 million in amortization and change in contingent consideration versus $554,000 in the third quarter of 2013.

Overall, our third quarter operating expenses increased year-over-year due to cost associated with our recent acquisitions and ongoing investments to drive growth and innovation in the business.

As a result, our income from operations on a GAAP basis for the third quarter was $9.9 million, representing an operating margin of 18%, an increase compared with the GAAP operating income of $5 million or an operating margin of 12% in the same period last year.

Our non-GAAP income from operations was $11.3 million for the third quarter, representing a non-GAAP operating margin of 21%. For the same period last year, non-GAAP income from operations was $8.1 million, representing a non-GAAP operating margin of 19%.

Our GAAP net income attributable to common stockholders was $7.8 million or $0.22 per share based upon $35.9 million diluted shares in the third quarter of 2013. This compares to GAAP net income attributable to common stockholders of $2.5 million or $0.08 per share based upon $31.6 million diluted shares in the third quarter of 2012.

On a non-GAAP basis, our net income was $6.6 million for the third quarter of 2013, which assumes a tax rate of 40%, compared to a non-GAAP net income of $4.5 million for the third quarter of 2012, which assumes a tax rate of 41%.

Non-GAAP net income per diluted share was $0.18 for the third quarter of 2013 and $0.14 for the third quarter of 2012, based upon $35.9 million and $31.6 million shares outstanding respectively. Non-GAAP adjusted EBITDA for the third quarter was $14.2 million and exceeded our guidance. This compares to $10.6 million in the third quarter of 2012 and represents a 33% increase over the previous year period and includes $400,000 of one-time expenses related to our follow-on offering in August.

Now moving to the balance sheet, cash and cash equivalents totalled $309.1 million as of September 30, 2013, compared to $305.1 million as of December 31, 2012.

Now let's turn our thoughts to the fourth quarter and full-year 2013. Starting with the fourth quarter, we expect our total revenue to be in the range of $52.7 million to $54.2 million, GAAP net income per diluted share of $0.05 to $0.09 and non-GAAP net income per diluted share of $0.13 to $0.16. Our expectation of non-GAAP net income per diluted share for the fourth quarter excludes stock-based compensation expense, the amortization of acquired intangibles and contingent consideration expense.

GAAP and non-GAAP net income per diluted share assume a tax rate of approximately 32% and 40% respectively, and weighted average shares outstanding of approximately $37 million. Non-GAAP adjusted EBITDA for the fourth quarter of 2013 is expected to be in the range of $11.5 million to $13 million.

For the full-year 2013, we expect total revenue to be in the range of $216.9 million to $218.4 million. GAAP net income attributable to common stockholders per diluted share is expected to be in the range of $0.52 to $0.56. Non-GAAP net income per diluted share is expected to be in the range of $0.71 to $0.75.

Our expectation of non-GAAP net income per diluted share for the full-year excludes stock-based compensation expense, the amortization of acquired intangibles and contingent consideration expense. GAAP and non-GAAP net income per diluted share assumes the tax rate of approximately 32% and 40% respectively, and weighted average shares outstanding are expected to be approximately $35 million.

Non-GAAP adjusted EBITDA for the full-year of 2013 is now expected to be in the range of $54.5 million to $56 million. And as Joe mentioned, as we do every year as we prepare for the beginning of a new plan year, we will be ramping up our expenses in the fourth quarter relating to the call center, the claims personnel and card production expenses.

This year we'll also have the addition of the Ceridian, the Towers Watson OneExchange Active kicking off and the new partnerships that Joe discussed. And due to the exciting change in the "Use It or Lose It" provision, we are now also broadening our marketing efforts to drive awareness and participation. The net of all of this is that we will be ramping our Q4 expenses more than usual to support our growth. And even with these expenses, we are maintaining our profitability guidance for 2013.

So in summary, we are very pleased with our strong third quarter performance and believe that we are well positioned for continued success in 2013 and beyond.

So with that operator, I think we are ready to begin our question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Bob Napoli with William Blair. Please proceed.

Bob Napoli – William Blair & Co. LLC

Good afternoon, Joe and Rich. Thank you. Question on Towers Watson, I'm not sure what you can say at this point because I'm sure you'd be able to tell us a lot more on the fourth quarter call, but can you maybe tell us how you're engaged with Towers Watson, how you're organized, how that partnership is organized and do you know how many – I mean they've announced a number of accounts in the Active exchange that they're going to have and I was wondering if you're working with those accounts ahead of the year-end.

Joseph L. Jackson

Yes, we're working very closely with them. And Bob, they're not – they've announced I believe eligible employees, not necessarily accounts. And so we work with them and we're highly involved with the process of onboarding those clients now. We've had existing kind of communication file transfer protocols et cetera that have been set up. Edgar in the call center is setting up kind of a dedicated part of our call center to be able to handle exchange clients going forward because we think some of the questions could be potentially a little bit different and we want to make sure that we've got the right skill set in place.

With regard to the numbers, Bob, we're kind of in the background doing the administration for the HRAs and HSAs. I kind of leave it to them to talk about the employers that they're bringing on, the number of eligibles that are out there. But what I can say is, the teams that are working with them today would reiterate similar things that I've talked about before that consumer-directed benefits and the strategy of those are embedded in those policies and we would expect a pretty significant percentage of those eligibles to be signing up for insurance. And when they do, those should probably generate either an HSA or an HRA or both.

Bob Napoli – William Blair & Co. LLC

Great. "Use It or Lose It," congratulations. I know it's been a long road and that's not exactly what you wanted. But how effective do you think the $500 can be because I mean I think the average amount lost is $100 or something like that? And if you had any preliminary discussions with companies understanding you've only been out there a couple of days.

Joseph L. Jackson

Yes sure. Well we've been working on this now for a couple of years. We had a strategy, a plan that we've executed very well that was in place, hopefully being proactive and assuming the change would happen. We've been executing on that plan since last Thursday. The $500 amount I think is significant because, like you said, the average forfeited dollars by a participant each year when they do lose money is around $120 to $130. So we think the $500 covers a significant majority of those.

And by educating folks going forward, I think people will be able to do a good job once they kind of understand it and being able to manage the balances as they go throughout the year. With regard to talking to employers, we hosted a webinar yesterday that we made available to our clients and I think we had almost 3,000 people attend. And we've put a process in place again that we had planned to make it very easy and seamless for an employer to adopt this change even for the 2013 plan year.

So we've posted a separate page to www.wageworks.com/useitorloseit which gives all of our employers all the information that they would need. It has a number of questions and answers that we're getting from employers on there. And I would say we had the webinar yesterday, and as of today we are getting – all they have to do is sign an amendment and send it in. And we're getting amendments sent in all day today.

So the great news about what Treasury did was, first of all, made it available as an option for an employer to take advantage of this year so that employees that were out there that have a balance could actually roll it over into 2014, or they can basically take advantage of it in 2014. And we thought it was important, and again that's why I talked about why I think it's important for the factors in Open Enrollment now.

So if an employer says, "Look, I'm not going to do it for 2013. I'm going to take advantage of it for 2014," it's still important that they get that amendment signed because as employees enrol this year or new people look to enrol this year, it's important for them to know that in 2014 they'll be able to roll over $500. So we think the timing was very good.

We were also very pleased with the change Treasury made that said if you do roll over $500 and you elect the full $2,500 for the following year, you can have both, which means your balance would be at $3,000 for the following plan year. Like I said, it's still unclear to us, Bob, because it just happened Thursday what impact we will see for this year. But again, we had a plan in place. We've got collateral sample and plea communications that our clients can use to educate people immediately.

So we're hopeful to see increased enrolments this year. We're hopeful for more people to re-enrol in the program because they can carry the money over. But I don't want to set expectations that we're expecting a landslide this year. I think it will be, as I mentioned earlier, somewhat of an impact for '14 we're hopeful for, but I think it's going to be more material in '15.

Bob Napoli – William Blair & Co. LLC

That makes sense. One last question, you have the Towers' exchange and I guess I was wondering if you could maybe give a little update on kind of generally discussions you have around the exchange market. What other types of exchanges are you talking to and is there any reason why you could not do the Retiree exchange that Towers has?

Joseph L. Jackson

Well, that would be a decision Towers would have to make. But we'd strongly encourage them to have a look at it obviously. We have – Jim Lynch runs our sales area. We've taken one of our best salespeople, Melanie Hallenbeck, and we've basically put her in charge of – she's in charge of the Towers relationship. She's also trying to help us go out and find other exchanges in the marketplace that we can work with.

We've developed a nice pipeline of people out there. We're very excited about the opportunities here and hopefully when we get to the February conference call, we'll be able to announce hopefully some other exchanges both in the enterprise market as well as a whole number that we're looking at kind of in the SMB exchange marketplace.

Bob Napoli – William Blair & Co. LLC

Great. Thank you very much.

Joseph L. Jackson

Sure, Bob, thanks.

Operator

Our next question comes from David Grossman with Stifel. Please proceed.

David Grossman – Stifel, Nicolaus & Co., Inc.

Thank you. You know, Joe, I know it's hard for you at times to talk about new customer activity and you gave us a couple of examples of what's coming in the quarter. Can you give us any sense, on a year-to-date basis, just year-over-year what the new business activity looks like and any color you can give us on how that shapes up between the healthcare business and the commuter business?

Joseph L. Jackson

Right. I would say if you look at the totality of all the – like I said, we were very pleased and thankful that several employers that I mentioned kind of allowed us to name them on the call. Believe me, there are many more that we would like to be able to talk about. I think when you look at the totality of what we did this year, it really started with I think kind of our brand awareness and the company awareness. We were involved in at least 20%, at least, or more RFPs than we did all of last year.

Our dollar volume of total potential that we could sign up was up 20%, 25% year-over-year and again driven by channel partnerships, driven by the great job our sales folks do, et cetera has really driven a lot of that. So as we continue to grow, we need to continue – as I tell our folks all the time – we need to continue to sell more and more each year to continue with that double digit organic growth rate.

And I think from what we've seen not only through the new sales that come on board this January, but we'll probably have more next year especially with the Ceridian rollout and other clients that we've signed that have March start dates, June start dates, et cetera. We'll probably see more business being added after January 1 next year than probably at any time since I've been at WageWorks.

I think that's great news for us. We get a good view of the sales pipeline early in the year. We're able to kind of plan to see what that would be for this year. And I think when it's all said and done – don't forget, David, we have to still go through Open Enrollment and those new clients coming on board who are getting a lot of our collateral, who are getting informed on the "Use It or Lose It" piece still have to go through Open Enrollment.

We still have to get those files in. So that's why I'm always a little bit hesitant to give exact numbers. But from what we saw this year, we're a pretty good way in advance of where we were a year ago.

David Grossman – Stifel, Nicolaus & Co., Inc.

Thanks for that. That's actually very helpful. So if I we just transition for a minute to the exchanges and I know that it has been asked and probably will be asked again, but can you help us understand what the revenue opportunity is for a participant with an exchange employee versus a participant that may be an ordinary healthcare participant in the business today?

Joseph L. Jackson

Sure and it's an easy answer. It's basically the same. So if you look at the pricing that we have on the exchanges versus what we have working direct with employers as we have historically done, the price point of our HSAs and the price point of the HRAs are not that different, or there's no meaningful or material difference between that and what we charge folks today.

Now in our normal book of business, you're going to have – SMB clients probably have a little bit higher revenue per participant than you do for the enterprise level clients. And I think the exchanges look to be rolling out in the same way. In fact, David, as we go through budgeting, we don't really make a differentiation between the accounts that will come from exchanges and accounts that come from our traditional means.

David Grossman – Stifel, Nicolaus & Co., Inc.

Do you think at all about a number of services and mix as it relates to the exchanges versus what's in your base today, so HSA versus FSA or a number of combined services that they may or I guess products that they may engage with?

Joseph L. Jackson

Yes. Well, on clients that we work with directly today, I think we've talked about before there's probably in total four or five different products that we can sell to them. On the exchange side, the thing that we're focused on right now with the Towers on OneExchange Active program is, just now, HRAs and HSAs. Over time, that may change and I think each exchange that we work with will be different.

I know one exchange that we are working with kind of in the SMB space right now is using us for commuter and obviously we're continuing to talk to them about healthcare et cetera. But just in – the one that we've kind of identified with Towers, it's primarily HRA and HSA today.

David Grossman – Stifel, Nicolaus & Co., Inc.

Okay, got it. And then just one other thing on the exchanges, have you thought at all about how much business if any that you would be cannibalizing within the base that may go to an exchange? And I know that's probably a hard question to answer this early on, but is that something that we need to look at or do you think that it's just such a wide open opportunity in the market share at this point or small enough that that's probably not something we need to think that much about?

Joseph L. Jackson

I think it's probably something you don't need to think that much about. But I think if I gave a little bit of clarity to it, if I look at an average client of ours today that has probably a 25% to 30% penetration rate and that client moves into one of the exchanges we work with, and through that exchange we get accounts from 80% to 90% of the eligibles so you would be kind of net-net 60%, 65% gain, that's kind of how we look at it.

So even if you may not get a 90% pop, if somebody had 90% of the eligibles take advantage of it, if you had 25% penetration already but it would still be a significant number that we would bring in.

David Grossman – Stifel, Nicolaus & Co., Inc.

Right. And then just one last one and this is perhaps for Rich. Rich, can you help us understand the magnitude of the incremental expenses that you're expecting to incur in the fourth quarter and any color you can give us on kind of how that flows into the first quarter of next year as well?

Richard T. Green

Well again I think you've seen the seasonality of the business, so kind of as we alluded on, kind of the script obviously, we always ramp up our expenses and you've seen how we performed through the quarters. So we try to take into consideration how we've been overperforming and then built that into that range, you would still basically come out on where we're at.

Now as far as breaking it apart between some of the specific activities, I don't think we can really disclose that. But I think you can kind of get a feel for our guidance being maintained compared to how we've been performing in other quarters, and get a pretty good sense on what the range would look like.

Joseph L. Jackson

And, David, I think the other point that I would add would be for us the key thing is being able to maintain the quality of service. It's really important in January that people kind of get off to a good start with you and especially on the exchange side. It's really in business, it's coming on. And again, part of what Rich kind of described was we're still kind of fluid in the number of Ceridian clients that will come on board for 1/1.

We're getting contracts in the mail every day. And we'll take those contracts for at least in the couple of weeks. So at that point in time, we'll know who's going to come in January. Those numbers are important to Edgar and his team as they kind of plan and set their metrics in staffing level in order to be able to achieve the metrics that we need.

Now you have the exchange piece coming on as well that we're going to handle a little bit differently. So there's some uniqueness to there and there's probably some overage that we'd look to do there to ensure that we provide a good service out of the gate. And probably the intangible that kind of hit us last Thursday, which was a good hit by the way, was the change to the "Use It or Lose It" provisions.

So now [Brenda] and her team in a few – go to our website as I mentioned before and look at the "Use It or Lose It" page and some of the sample collateral, some of the materials that we're now going to start working with on our clients to provide them so that they can educate their participants on the "Use It or Lose It" piece, all of that's going to add up to a fairly sizable expense number in the fourth quarter that we wouldn't have planned or foreseen or budgeted to at the beginning of the year. So that's all good news.

And I think even the better news is EBITDA this quarter on our guidance by a couple of hundred thousand which included about $400,000 follow-on offering expense in August. So that normal follow-through that you guys would normally do, we haven't included. So we've maintained our range in kind of that $54.5 million to $56 million and believe that we'll be within that range.

But again, we would probably have – had we not had these opportunities we probably would have done better. But I think anyone who invests in this company is going to want us to do everything we can to spend the marketing dollars and prepare to onboard this business for the first part of the year. And we're doing all of that and maintaining our original guidance.

David Grossman – Stifel, Nicolaus & Co., Inc.

Great. Thank you.

Operator

(Operator Instructions) Your next question comes from Michael Huang with Needham & Company. Please proceed.

Michael Huang – Needham & Company

Thanks very much, just a few questions for you guys. First of all, in terms of enterprise wins, could you tell us about who you cater with and who you're placing here and maybe from a product standpoint, if there's one product that was strong or relative to last year, and were there any customers that you're able to get into healthcare and commuter?

Joseph L. Jackson

Yes. I think most of the ones I mentioned are both healthware and commuter. I think as far as takeaways go, I don't think there was one consistent company in the clients that I mentioned or even in the whole book of business that we brought on. I probably would have mentioned – if there was one, I probably wouldn't have mentioned it either because I don't know that it's fair to those companies.

But we have a lot of strong competitors out there. I think once we get the opportunity to tell our story, as I mentioned in the script, I think we're almost undefeated when somebody comes and visits our facilities, especially our operational facility in Tempe. That group down there does an outstanding job of really putting WageWorks' best foot forward as far as understanding the passion and the commitment they have to service participants well and it shines through 100% with every client that we bring through there.

But more to your question, those have all been I believe healthcare and commuter sales. What I was able to provide was just a small list. There's a number of other large organizations we're very pleased to have on board.

Michael Huang – Needham & Company

Great. Can you remind us, so in terms of kind of in the [indiscernible] partners, what percentage of the business in this was driven by partners? And how does that compare with last year? And given some of the new partnerships that you were able to talk about today, how is that trend over time?

Joseph L. Jackson

I think if you look at new sales this year, probably the vast majority was driven by our sales force. There'll be a significant – a decent portion of that through some of the channel partnership relationships like Aflac and some of the others that we've brought on board. Remember we always have a dedicated group of folks who do nothing more than cross-sell new products to existing clients.

And I think ever since we've started doing that in 2010, they sell more and more each year. That group does an outstanding job. But I think you know – so when you look at it overall – and then probably another part of that is when we acquire companies, those sales forces or those organizations start selling. I think they've done a pretty good job as well.

And the great news about that is when we acquire a company and they have a sales force, we encourage those organizations and they embrace it to begin selling our technology platform from day one. In many of those areas, that's one of the reasons when we acquire a company, their growth rate historically has gone up because they've been able to sell kind of the technology platforms that we provide and sell more in those particular years.

Michael Huang – Needham & Company

Great. Okay. And last question for you, I'm not sure if you have an exact sense this year, but I was wondering if you knew kind of how many required tabs have, you know that great career turn on, and how should we think about whether or not these organizations will ultimately eliminate the grace period in order to turn on that $500 carry over?

Joseph L. Jackson

Yes. We've done kind of a sample run-through. We think the vast majority of our SMB clients do utilize the grace period. Probably about, I don't know, 60%, 70% of our enterprise clients use it as well. And you're right, the guidance from Treasury basically says that employers can offer one or the other. I would tell you from the comments we received back from our clients on the webinar that we did yesterday, the number of clients that I've spoken to, the number of calls that have come in to our client services organization, grace period was basically another 2.5 months before you lost money.

So it wasn't like you could, at the beginning of the year, elect dollars until comfortable that you couldn't lose them because you could. So I think from everything that we've heard, over time, I won't say it goes extinct but I think more and more employers over the next few years will abandon the grace period and adopt this rollover.

You can now go to employees that have never had an FSA because of the "Use It or Lose It" provision or the fear of losing money and they can get started with $500 if they want knowing that they can't lose any of that money. And usually what happens over time – because I think the first year I've started with an FSA, I had $500 in, I spent it by March. The next year I put in $1,000, I would spend by June.

So over time, you gain a lot more control and knowledge over the cost of your healthcare. And I think what people will be able to do is get started into an FSA program if they haven't already; or if they're in it today, elect more going forward because they know they're going to get down under $500. And I think that will be really the catalyst going forward that's going to drive significant growth in FSAs going forward.

I've said from the first time I started talking to you guys and you would ask me about the question, our objective all along has been to kind of move that FSA participation rate from roughly the one-in-five that it was a couple of years ago to two-in-five. We've made very good progress over the last few years in driving towards that goal. I think what this change means going forward is that we will get from one-in-five to two-in-five much faster and probably start to bring into play three-in-five over time.

Michael Huang – Needham & Company

Great. Thanks so much, guys.

Joseph L. Jackson

Sure.

Operator

Our next question comes from Tobey Sommer with SunTrust Robinson Humphrey. Please proceed.

Tobey Sommer – SunTrust Robinson Humphrey

Hi. Good afternoon. When you're looking at an Open Enrollment whether it's on an exchange or a traditional sale, do you root for an FSA or an HSA account opening for that kind of incremental piece of business?

Joseph L. Jackson

No. Well we'd encourage maybe more than one, maybe an HSA with a limited-purpose FSA. HRAs are becoming more and more popular as well. We're excited about the change to the "Use It or Lose It" provision for flexible spending accounts. We've been fighting for it for a long time, very pleased with what Treasury did. But we are equally supportive and work with our clients as they roll out high deductible health plans which encourage HSA participation.

We have separate collateral, separate education information that we provide to employers and employees for those accounts. HRAs might even be one of our more faster growing products right now. And then obviously commuter, we're heavily involved in that and the leader in the market. So Tobey, to answer your question, if a client wants to do an HSA and an FSA or an HRA or all three, we're equally supportive and have material to cover it all. So we like them all.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you. Did I understand from your previous comment that the shift to exchanges is a driver of high penetration of the health accounts?

Joseph L. Jackson

Well what we've – and I talked about this a little bit on the third quarter call or second quarter call, I'm sorry – what we've seen when we looked at some of the exchanges that are out there, both that we participate in and folks that we're talking to, we see the plans, the insurance plans that are being offered in these exchanges many times have a Consumer-Directed Benefit component embedded in them.

So whether it's an HSA or an HRA, and most of these plans as well have Wellness Incentives embedded in them as well. So what we've seen in a lot of circumstances is when you sign up for one of these plans, a Consumer-Directed Benefit product will come along with it versus having to elect it once you have the plan in place. And so when you see employers that kind of go from the defined benefit model of selecting kind of one insurance company with a number of plans to the defined contribution model, there's usually wellness incentives in there and at least one of our accounts is embedded in them.

So when you think about an employer today as an example with an FSA where we get somewhere between 25% and 30% penetration in that employer, in an employer that we sign up or work with through an exchange, that percentage rate, because those products are embedded in the plan, we think could be somewhere between 80% and 90%. Does that make sense?

Tobey Sommer – SunTrust Robinson Humphrey

My last question is a follow-up on something you mentioned relative to new business and that your off-calendar enrolments are probably going to be stronger next year than they have been in previous years. Is that a function of just new sales for companies who had enrolments that weren't based on the calendar year? Or are you finding that employers are shifting their enrolment period?

Joseph L. Jackson

I don't think we're seeing a shift in it. I think it just happens to be one of those years where we've had more success in signing up employers in those off-plan years. We have a nice wave of employers that are starting in March. We have a number coming up in June or July. As I mentioned earlier with the Ceridian transition, we'll see a good percentage of those come in January 1 and we'll see probably a significant majority of all of those employers come over before halfway through the year.

But I know now that there's a couple of Ceridian or a few Ceridian transitions that will take place in the latter half and even at the end of next year as well.

Tobey Sommer – SunTrust Robinson Humphrey

Okay, thank you. If I could kick one more in, could you give a comment or some color about what the pipeline looks for portfolio purchases at this time versus a couple of quarters ago?

Joseph L. Jackson

Sure. I mean it's still robust. We're still talking to a number of folks. One of the things that we've kind of kicked around here over the last couple of days is, and we're starting to reach out to some people now that we've been talking to to see what if any impact the "Use It or Lose It" provision would have because obviously I think many of those portfolio purchases were probably looking and see account growth coming in the future, so that potentially could cause some hesitation.

However, I think the way that we've structured these transactions with earn-outs over a two or even a three-year period at given points in time, we can allow people to not only get good value for their business today, but in the earn-out structure, let them take advantage of that increased account growth going forward over the next couple of years. So that'll be a message that we're going to be getting out to the pipeline of folks that we're talking to.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you very much.

Joseph L. Jackson

Sure.

Operator

At this time, we have no further time for questions. I would like to turn the call back over to Joe Jackson for closing remarks. Please proceed.

Joseph L. Jackson

All right. Well thank you operator and I'll make this brief. But again, as we usually do, I just wanted to thank you all for joining us. Many thanks to all the WageWorks employees out there who have worked tirelessly over the past year to put us in the position we are now that I think we will reap benefits from in the future. And again, our business in our industry with regard to Consumer-Directed Benefits with the advent of private exchanges, now finally the change to "Use It or Lose It" and just the amount of awareness that's being generated for Consumer-Directed Benefits, I think behooves WageWorks probably more than others going forward. And it is our intent to take advantage of this opportunity. So thank you all for joining us and talk to you in February. Thank you, operator.

Operator

This concludes today's conference. You may now disconnect. Have a great day.

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