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Benefitfocus, Inc. (NASDAQ:BNFT)

Q4 2013 Earnings Conference Call

March 6, 2014 5:00 p.m. ET


Milt Alpern – CFO

Shawn Jenkins – President and CEO


Greg Dunham – Goldman Sachs

Nandan Amladi – Deutsche Bank

Ross McMillan – Jefferies

Terry Tillman – Raymond James

Sean Wieland – Piper Jaffray


Ladies and gentlemen, thank you for standing by, and welcome to the Benefitfocus 2013 Fourth Quarter Earnings Call. [Operator Instructions] Thank you.

I would now like to turn the call over to Milt Alpern, CFO. You may begin.

Milt Alpern

Thank you. Good afternoon everyone and welcome to Benefitfocus' fourth quarter 2013 earnings call.

Today we will be discussing the preliminary operating results announced on our press release issued after the close of market today. I'm Milt Alpern, Chief Financial Officer of Benefitfocus. And with me today in the call is Shawn Jenkins, our President and CEO.

As a reminder, today's discussion will include forward-looking statements such as first quarter and full year 2013 guidance and other predictions, expectations and information that might be considered forward-looking under federal securities laws. These statements reflect our views as of today only and should not be considered as representing our views as of any subsequent date. These statements are subject to a variety of risks and uncertainties, including the review of our lease accounting and completion of our audit, the early stage of our market, management of growth, and a changing regulatory environment, that could cause actual results to differ materially from expectations.

For a further discussion of the material risks and other important factors that could affect our actual results, please refer to our final prospectus for our IPO which is on file with the SEC, and our other SEC filings.

During the course of today's call we will also refer to certain non-GAAP financial measures. You will find important disclosures about those measures in our press release.

Please note that the results discussed today are preliminary in nature and subject to change upon the completion of our fiscal year 2013 audit.

With that, let me turn the call over to Shawn, and then I will come back at the end to provide details regarding our fourth quarter results as well as our guidance for the first quarter and the full year of 2014. Shawn?

Shawn Jenkins

Super. Thanks, Milt. And thanks to all of you for joining us today.

Benefitfocus ended 2013 with a strong fourth quarter performance, including preliminary results that exceeded the high end of our guidance range from both a revenue and profitability perspective. The total revenue is expected to be $30.3 million for the fourth quarter, an increase of 36% year over year, and was highlighted by expected employer revenue growth at 79%.

For the full year we expect to report total revenue $104.8 million, an increase of 28% year over year and an acceleration from 19% growth for the full year 2012. The continued revenue mix shift towards our faster-growing employer business, which exited the year at over 40% of our revenue, is a primary driver to the acceleration in our overall revenue growth profile.

As we look ahead, we believe we are seeing strong momentum across our businesses and we expect that to continue into 2014. We are sitting at the center of a powerful secular trend in the market that we expect should be tailwind for our business for some time. The first and most important is the migration of the benefits management industry to next-generation cloud-based platforms that provide both carriers and employers the flexibility, scalability, user experience necessary in this fast-evolving market.

Providing employer sponsored benefits represent approximately 30% of total employee compensation is one of the most ineffectively, inefficiently managed areas of spend for companies. They increasingly recognize that moving to the cloud can generate significant efficiency in cost savings.

The second tailwind comes from the growing trend of employers moving towards more of a defined contribution offering from the traditional defined benefit model. This is a similar transition to the one that has taken place over the last 30 years in retirement market, which is an area employers have already sought to gain increased cost certainty. In addition to the cost benefits, the combination of defined contribution model and the cloud-based benefits management platform gives employees the flexibility to create the benefits package that best suits their individual needs.

The third tailwind relates to the implementation of Affordable Care Act which has increased the regulatory complexity of benefits management. Our 13 years of deep domain expertise in the industry makes Benefitfocus the ideal partner for employers and insurance carriers that are looking to not only comply with ACA but also to positively impact their business.

The fourth quarter was a milestone for the industry with the launch of the first major open enrollment season under the Affordable Care Act. Employers and individuals now have a host of new regulations to comply with, as well as the addition of millions of previously uncovered lives coming into the insurance marketplace. We had a record number of go-lives going into the fourth quarter, which we believe demonstrates the scalability of our platform and our team's ability to effectively implement our growing list of new customers.

Something that we speak up often about the focus is this concept of one platform, two markets, which refers to our unique ability to serve both the insurance carrier and employer markets from the same underlying platform. This highly differentiated process is clearly working and in many ways the momentum we are experiencing in both the carrier and employer business is mutually reinforcing.

A great example of this tremendous level of activity we are seeing with carriers and brokers is in the private exchange market, which is an opportunity to developing much faster than even our initial expectations. As we discussed last quarter, an old example of this exciting opportunity is Mercer who has already signed a number of employer customers on Mercer Marketplace which is built on the Benefitfocus platform. As we look ahead to 2014, we believe Mercer is looking to build off its early success.

I'm very pleased to share that during the fourth quarter we also signed an exciting new agreement with Aetna who selected Benefitfocus to build its large employer private exchange marketplace. The Aetna marketplace will be made available to large employer groups including Aetna's national accounts. In addition, we have several Blue Cross Blue Shield plans that are deploying group marketplaces in 2014 on the Benefitfocus platform.

These private exchanges for Mercer, Aetna and several Blue Cross Blue Shield plans are validating this emerging distribution channel. Carriers are increasing investments in private exchanges because they believe it has the potential to become one of their most substantial growth opportunities, and we are proud to be the technology platform supporting these initiatives.

We also had a number of other go-lives for individual marketplaces during the fourth quarter where we provide carriers with a white-labeled private exchange solution to support their direct-to-consumer market. This is an extension of the work we have done historically with carrier customers and a prime example of carriers using the Affordable Care Act implementation to fundamentally rethink how they are serving their markets, which is leading to greater price transparency and customer engagement.

From an overall perspective, we are increasingly optimistic about what the private exchange opportunity means for Benefitfocus when we consider that third-party analysts like Accenture are forecasting that the number of lives coverage through private exchanges will increase from 1 million in 2014 to 40 million by 2018. Additionally, our expansion into the private exchange marketplace also serves as a powerful indirect sales channel into the highly underserved employer market.

Beyond the private exchange opportunity, our insurance carrier business had a strong quarter and we are pleased to sign new carrier agreements with Prudential, Blue Cross Blue Shield of Minnesota, and Capital District Physician's Health Plan. In welcoming Prudential in particular, we are seeing a growing list of life insurance and non-medical insurance carriers selecting our technology for their market strategies. This is a very exciting component of the acceleration in our carrier business.

In the employer business we are already seeing strong sales momentum and we bought a record number of customers live during the quarter. Our ability to quickly bring customers' lives is one of the drivers to our 79% employee revenue growth during the quarter, and it reflects the great work done by our dedicated team of implementation specialists. A shout-out to all of them.

Our sales team had a strong performance during the quarter, adding great new customers such as AMETEK, Chik-Fil-A, The San Francisco 49ers, Midwest Health and the University of Alabama Health Services Foundation.

A key aspect of Benefitfocus' differentiation in the market is continuous innovation that we are bringing to the market every quarter. One of the areas that we are making significant investments in is enhancing our big data and analytics capabilities. During the quarter we brought two new analytics functionalities to the market, our Flexible Query Tool and Web Stats.

With the Flexible Query Tool we now offer an ad hoc reporting capability that provides advanced options to create customized reports from multiple data sources. This allows our employers, consultants and insurance carriers to access and analyze the benefits data that's most important to them.

With Web Stats, we now offer the ability to track web usage. We can compile site statistics of all users of our technology, including employees, brokers and benefits administrators. This provides our customers with aggregate information about their employees' buying patterns and preferences, allowing them to analyze how to cater the shopping and enrollment experience to their unique population.

During the quarter we also became certified as a Web-Based Entity by the Centers for Medicare and Medicaid Services. As a WBE, we can help navigate the process for an individual who may be eligible to receive subsidies under the Affordable Care Act, and then enroll in a qualified medical plan on our platform, which is a big advantage for employers who are now able to offer a solution to employees to obtain insurance who are not necessarily eligible for their employer's sponsored plan, such as part-time workers. We refer to this as the whole workforce concept, and we think it's very powerful going forward.

Continually enhancing and expanding our product offerings is core to the DNA of Benefitfocus and we have an exciting year of innovation on tap for 2014. An important area of focus will be further expanding and enhancing our data exchange program, which is a highly differentiated part of our ecosystem and helps to facilitate our expanding network effect. We will be highlighting some of this new functionality at our annual One Place user conference coming up in May.

As we look ahead in 2014, we couldn't be more excited about the opportunity we are seeing across both of our markets. We have established a strong leadership position and plan to increase investments in the three growth initiatives in order to fully capitalize on the multi-billion dollar market opportunity that's in front of us. Let me walk you through each of these.

First, we plan to further increase our sales capacity, particularly for the employer market segment where our revenue growth accelerated from 49% in 2012 to over 70% in 2013. With less than 3% penetration in the employer market and given the speed with which we are seeing employers embrace cloud-based benefits management solutions, we believe it is important that we keep our foot on the gas with respect to investing in our sales and marketing organization.

Our efforts related to our private exchange offering will be the second major area in which we will be ramping investments in a meaningful way during 2014. As discussed earlier, this opportunity is both meaningful in developing faster than we initially expected. As we finalize our 2014 planning process over the last several months, we made the decision to commit approximately $10 million of incremental investments related to our private exchange offerings this year. Based on market forces and our momentum, we are highly confident that we are going to see a significant return on this investment beyond the current year.

The third area of increased investments in 2014 will be ramping our third-party implementation partnership program. As an example, during the fourth quarter of 2013 we advanced our overall efforts in this regard by making core product enhancements to our cloud-based platform. These enhancements make it much easier for third-party partners to take over the implementation of new employer customers. We are already in discussions with a number of potential implementation partners who are focused on signing, training, certifying and ramping multiple partners to launch our ecosystem of third-party implementation providers.

As part of this effort, we have already started to add headcount to manage these future channel partners and develop a certification process to ensure a continued high-quality implementation experience for our customers. There is a meaningful near-term cost to building out a third-party implementation ecosystem because we need to invest in resources to manage these partnerships and there are duplicate costs. As we are recruiting, training and ramping the knowledge base of partners, we still need to do the implementation work alongside of them until they are able to take over such efforts on their own. This is a strategic initiative for Benefitfocus and an essential element to our long-term growth objectives and our ability to scale profitably.

We strongly believe that our increased investments in this set of key initiatives will position Benefitfocus to capitalize on its accelerating momentum as the benefits management industry transitions to cloud-based platforms. As our financial results and customer wins indicate, we have strong momentum in both our employer and carrier businesses and we continue to extend our clear market leadership position. We expect that our increased investments will lead to a greater adjusted EBITDA loss in 2014 versus '13, as Milt will share in a moment. We are confident that this is the right strategic move in the short term in order to continue growth and to maximize shareholder value over the long term.

Let me turn the call back over to Milt.

Milt Alpern

Thanks, Shawn. As discussed, we're very pleased to have delivered a strong fourth quarter with preliminary results that were above our expectations from both a revenue and a profitability perspective. I'll begin by reviewing the details of our financial performance, and then I'll finish with our guidance for Q1 and the full year of 2014.

Please note that I will be discussing preliminary financial results for the fourth quarter and full year 2014. We are still in the process of finalizing the review of the historical accounting related to the lease of our Charleston headquarters which is currently accounted for as an operating lease. I would point out that the results of this review will not have a cash impact and it is expected to be positive to adjusted EBITDA but slightly negative to non-GAAP EPS on a historical basis. We are working to complete this review both quickly and accurately and at this time we expect meeting the filing requirements and timing of our Form 10-K.

Beginning with the fourth quarter, total revenues is expected to be $30.3 million, an increase of 36% compared to the fourth quarter of 2012 and above the high end of our guidance range. Breaking this down, software subscription revenue is expected to be $28.3 million, representing 93% of total revenue and growing 36% year over year. Professional services revenue is expected to be $2 million, representing the remaining 7% of total revenue, and up 45% over the prior-year period.

Looking at revenue by segment, employer revenue for the quarter is expected to be $13.2 million or 79% growth compared to the year-ago period, while our carrier revenue is expected to be $17 million, up 15% from the year-ago period. For both our employer and carrier revenue, our year-over-year growth rates were not only at a high point for 2013 but they are also expected to exceed the growth we delivered in any quarter for 2012 as well. This is a reflection of solid momentum in both major segments of our business.

Our employer business is expected to grow to 44% of total revenue in the fourth quarter compared to 33% in the year-ago period. This mix shift towards the employer business is positively impacting our overall revenue growth profile. We believe the employer market opportunity is highly under-penetrated and that we are well-positioned to continue driving strong growth in this area of our business for many years ahead.

Now let me review the supplemental metrics we report on a quarterly basis. We ended the quarter with 393 large employer customers, an increase of 37% compared to 286 in the fourth quarter of 2012, and up from 379 at the end of last quarter. We had a solid sales performance in the fourth quarter and would remind investors that customer adds are seasonally stronger in the second and third quarter due to the timing of the open enrollment season. As we look ahead with over 18,000 large employers in the United States alone, our addressable market opportunity remains significantly under-penetrated.

We ended the quarter with 40 carrier customers, up from 34 in the fourth quarter of 2012 and up from 37 from the end of last quarter. Adding three carrier customers in a single quarter is a particularly strong sales performance and indicative of the interest we are seeing in that segment of the market.

As discussed in the past, while we remain focused on adding new carrier logos in the domestic market, much of the near-term carrier revenue growth will continue to come from increasing the penetration within our blue-chip customer base, many of whom have only deployed Benefitfocus in certain states or with certain products. We are seeing strong interest in carrier customers in our marketplace solutions as evidenced by the Aetna marketplace that Shawn referenced earlier. Our software revenue retention rate was once again greater than 95% in the fourth quarter, and we believe this is evidence of the significant value that Benefitfocus generates for its customers.

Moving down the P&L, I'll start by discussing gross profit on an adjusted basis, which excludes stock-based compensation, amortization of acquired intangibles and depreciation and amortization of capitalized software. Again these results are preliminary as we continue the work necessary to finalize our 2013 financial audit process. As the review process is still ongoing, I will review our non-GAAP profitability measures for the quarter and the full year excluding the impact of any changes to the treatment of our lease accounting. Once we have finalized our review, we intend to include the changes in our accounting treatment for leases in our non-GAAP results on a historical and go-forward basis. We expect these adjustments will be positive to adjusted EBITDA on a historical and go-forward basis, slightly negative to non-GAAP EPS on a historical basis, and largely neutral to non-GAAP EPS on a go-forward basis.

Adjusted gross profit in the fourth quarter is expected to be $12.5 million, resulting in an adjusted gross margin of 41%. This is down from the 53% adjusted gross margin in the year-ago period due to a number of significant professional services engagements we are undertaking for some of our customers. As a reminder, we recognize expenses for professional services on an upfront basis, but defer the revenue until our customer is live, and then the service revenue is amortized over a 10-year customer relationship period.

We are seeing significant demand in our carrier business and for our marketplace solutions, which tend to be larger in nature and more services intensive than employer customers. Over time these engagements should drive incremental subscription revenue as our customers sign up lives to these new channels. In addition, we expect our professional services margins to scale o the future as we begin to recognize the revenue from our services engagements and the associated expense lines down. So while there is a short-term negative impact to gross margins due to the acceleration in the carrier side of our business in particular, we expect to realize significant long-term benefits. In addition, we expect the creation of a third-party implementation ecosystem will be a major driver of future gross margin expansion.

Adjusted EBITDA is expected to be negative $5.7 million or negative 19% of revenue. This is better than our guidance of an adjusted EBITDA loss of $6 million to $6.5 million and compares to positive $67,000 in the fourth quarter of 2012.

As we mentioned in our last call, the reduction in the adjusted EBITDA margin reflects the focused strategy of increasing investment in sales and products to capitalize on our leadership position in our multi-billion dollar market opportunity, as well as the increased costs associated with becoming a public company. We believe our investment and grow strategy will enable Benefitfocus to create substantial long-term shareholder value. Over time as the growth of our employer business moderates and our business achieves greater scale, we believe that we could increase our adjusted EBITDA margin to the 20% or better level.

Turning to the balance sheet, we ended the quarter with cash, cash equivalents and marketable securities of $78.8 million. This is a decrease from $84.7 million at the end of the third quarter.

Now let me provide a summary level revenue of our results for the full year 2013. Total revenue in the year is expected to be $104.8 million, an increase of 28% on a year-over-year basis and representing an acceleration from the 19% growth we delivered for the full year 2012. Software subscription revenue is expected to be $97.7 million, representing 93% of total revenue and growing 29% year over year. And professional services revenue was $7 million, which represented the remaining 7% of total revenue and was up 21% over the prior-year period.

On the employer side, revenue for the year is expected to be $40.7 million, which represents 71% growth compared to the year-ago period, up from 49% growth in 2012. On the carrier side, revenue for the year is expected to be $64.1 million, up 11% from the year-ago period.

Adjusted EBITDA for the full year 2013 is expected to be approximately negative $20.9 million or negative 20% of revenue, compared to negative $5.5 million or negative 7% of revenue in 2012.

I'd now like to finish with our guidance for the first quarter and full year 2014. For the full year we expect revenue of between $130 million to $134 million, which equates to year-over-year growth of 24% to 28%. We are targeting an adjusted EBITDA loss of $49 million to $53 million and a net loss per share of $2.41 to $2.57 based on 24.5 million weighted average shares outstanding.

Of note, our adjusted EBTIDA guidance does not assume the benefit related to the expected change in accounting treatment for the lease of our headquarters, and any potential benefit is expected to be relatively minor. We do not currently expect any change to our non-GAAP net loss per share guidance as a result of adjustments to our lease accounting.

As Shawn mentioned, our management team and Board of Directors made the decision to accelerate investment in three key growth initiatives during 2014 based on positive industry drivers and the strong market demand we're seeing. These areas include the expansion of our employer sales capacity, our private exchange offering and related efforts, and the build-out of our third-party implementation partner ecosystem.

Our business accelerated in 2013 and we believe the increased investments we are making in the business will position Benefitfocus for rapid growth as we increasingly realize the returns on our investments in 2015 and beyond. We are focused on capturing market share as quickly as possible while also positioning the company to scale profitably in the future.

Turning to the first quarter, we are targeting revenues of between $29.6 million to $30.1 million, which represents year-over-year growth of 24% to 26%. From a profitability perspective, we expect an adjusted EBITDA loss of $10.5 million to $11 million and a non-GAAP net loss per share of $0.53 to $0.55 based on 24.5 million weighted average shares outstanding.

In summary, we are very pleased with our fourth quarter results, which reflect the positive market momentum we have across both of our business segments. We increasingly see the market recognize the attractive value proposition of our next-generation cloud-based benefits management platform can provide carriers, employers and employees. We believe our best-in-class product platform and deep domain expertise position us well to the primary beneficiary of a multi-billion dollar market opportunity we are targeting.

With that, we are now ready to take questions. Operator, please begin the Q&A.

Question-and-Answer Session


[Operator Instructions]

Your first question comes from the line of Greg Dunham with Goldman Sachs.

Greg Dunham – Goldman Sachs

Hi, yes. Good afternoon. Thanks for taking my question. First off, I want to start on the employer side. That clearly accelerated pretty substantially this quarter and beat our numbers. What were the drivers to that upside? Were there any anomalies in Q4? And perhaps could you give us a little color on how the Mercer arrangement performed relative to expectations.

Shawn Jenkins

Sure. Thanks, Greg. So in the fourth quarter, and just a bit our business, for folks that might be new to the Benefitfocus story, the Benefitfocus platform is used to allow employers -- insurance carriers, employers to put all their benefits in one place, in a web-based, a mobile-based context. And a lot of these employer-based benefits are geared around an annual enrollment cycle. Many of them are geared around the January 1st timeframe. And so what we often see is employers selecting Benefitfocus throughout the year, gearing up for an open enrollment season that begins sometime in September, October, November and then it finishes up in the December timeframe.

So we had a record number of go-lives, Greg. It was a historic quarter for Benefitfocus. We had done some really great selling, and really at the end of 2012 and into 2013. You mentioned the Mercer marketplace and some of our other marketplaces, they are contributing to our employer wins throughout the year. And as we activate those employers, as you know, our implementation fees get held until we go live with the customer, and then we begin to take them over an extended period of time. Those monthly subscription fees kick in when the customer begins to use the platform.

So it's really just a surge in activations, go-lives in our employer business, and we couldn't be more proud of the team that was able to pull that off in a gigantic and kind of a national phenomenon of healthcare reform and a lot of interested on what's happening with the Affordable Care Act and exchanges and whatnot. In the midst of that, you can see just an amazing activations in our employer business.

Greg Dunham – Goldman Sachs

Okay, great. And then I guess the follow-up, any -- you mentioned you're going to kind of double-down on private exchanges. When we think about that, is the investment geared more on the broker side or is it going to be geared more on the carrier side? You highlighted Aetna as a big one on the carrier side. How should we think about the investment from a private exchange business perspective?

Shawn Jenkins

Yeah, great follow-up. So the beauty is we have one platform that serves both of our markets, whether it's insurance carrier sponsor, employer coming direct, or someone like a broker, consultant, like a Mercer building Mercer Marketplace, it's the same underlying technology platform.

What we're investing in is the -- we have great visibility into, you know, the customer pipeline, into our channel partners. And what we're hearing from the marketplace is this private exchange demand from employers across our insurance carrier and broker footprint, is, you know, just continues to be revised upward. And what we see as a management team is the need to kind of get ahead of that, what is going to be, you know, what we would see as another very busy fourth quarter coming up in 2014. And so we're investing in the implementation resources, onboarding Benefitfocus associates to come on forward and be trained in our implementation area. We're investing in some product capability to make the implementations faster, more repeatable, so as we scale up our team there's, you know, continued insurance of quality there.

And then we touched just a little bit on this idea of third-party implementation certification. And this crosses over just a bit in the private exchange. We want to be able to equip the private exchange partners to do some of the implementation work themselves, some of the configuration, some of the onboarding, some of the testing work. So we're really, you know, plowing pretty heavy into that. And just the overall, you know, the product, the elegant user experience that Benefitfocus is known for, offering multiple voluntary benefits and the array of wellness programs that now employers want to provide. So it's just a deep set of investments across the implementation, onboarding and the product.

Greg Dunham – Goldman Sachs

Okay. One last one from me and then I'll turn it over. One other bucket you highlighted is the investment in sales and marketing, and you're pointing to the employer side. When we think about kind of the level of investment that you're targeting on the sales headcount side, I mean should we think about it as, you know, roughly equivalent to kind of what the overall growth in that business is being, or, you know, or maybe the growth of the overall business? How should we think about the level of growth that you guys intend?

Milt Alpern

I think, you know, Greg, this is Milt, we are certainly bolstering up the employer sales organization. I think when we look at the increased level of investment that we're targeting for '14, kind of expect probably in the, I would say, 45% to 50% of the total increased investment to go towards the sales and marketing initiative as we grow that sales organization. Beat on the street, build out the management organization across the country, and also make further investments just from the marketing side of our business to promote the product, increase visibility and move the product forward certainly.

Greg Dunham – Goldman Sachs

Great. Thanks.

Shawn Jenkins

-- talk a lot about the employer, just to follow on, the carrier business is obviously surging, and you see three new logos in the quarter. And so we want to make sure that we're not, you know, leaving anything there. So we're investing in our carrier sales infrastructure and we have a smaller team that's having very successful period here, and we want to make sure that we have the right talent there and the right folks to support those initiatives.

Greg Dunham – Goldman Sachs

Makes sense. Thanks.


Your next question comes from the line of Nandan Amladi with Deutsche Bank.

Nandan Amladi – Deutsche Bank

Hi, good afternoon. Thanks for taking my question. The first one is on the exchanges. Obviously that is new since your IPO, I think the level of interest we have seen, and the business [ph] you've had. What is the revenue model going to look like for the exchanges? And when might you start disclosing that distinctly from the carrier and the employer segment?

Shawn Jenkins

Yes. I'll let Milt take the second half but I'll just jump in. So the private exchanges that we deploy are built on our -- on the Benefitfocus platform. They're private labeled for the exchange partner. They put their special sauce in there, they're unique products, unique consulting and so forth. But at the end of the day, they result in a very similar economics that you see both in insurance carrier and employer business.

So we have an implementation fee to set up the private exchange. We have a per employer type of an implementation fee that matches with our resource allocation. And then there's a subscription basis that's on a monthly basis based on the volume. So a number of employees on the platform will get a subscription. And the economics, you know, the way we take the revenue on implementation and when we begin to see the subscription are really identical to our other businesses. I'll let you talk about, you know --

Milt Alpern

The accounting to the revenue. I mean the -- our revenue from the marketplace, Shawn mentioned, very similar to the employer business. And the wins that we get in the marketplace side or the private exchange side of our business will be categorized as employer revenue and those employers will be counted as employer customers in our accounts.

Nandan Amladi – Deutsche Bank

Okay. And a quick follow-up if I might. As you build out your partnership program and certification, what is your vision for it say in the next two to three years? And more immediately, what is the size of this program relative to your own consultants, will it grow through the implementations today?

Shawn Jenkins

Yes, great. So with the volume of new customers in both businesses, yes, we see the need to increase our own internal resource, but obviously what the market likes to see is the ecosystem develop. So we have a lot of interest from folks that have third-party implementation or SI-type shops, folks who want to build their practice around the Benefitfocus platform. We've worked primarily on the productization of our implementation, and now the training and certification. So we're in the process now of interviewing these folks, discussing the format of the partnership. We would like to sign them and announce them. Obviously this year we think it'll take better part of the year to begin to train the first batch. We'll keep the first list of them manageable so that we don't kind of flood ourselves with too much to do on that piece of it.

We -- our hope is that by the end of the year we have several of these implementation partners, the companies themselves, you know, under agreement with consultants coming out the other side of certification, and folks that can begin to actually affect the implementation pipeline by the fourth quarter of this year. And really then it would be more of a 2015 phenomenon with how big that gets. And we would see it getting as big as the growing customer base.

Nandan Amladi – Deutsche Bank

Thank you.

Shawn Jenkins

Thanks, Nandan.


Your next question comes from the line of Ross McMillan with Jefferies.

Ross McMillan – Jefferies

Thanks a lot. Shawn, I'm curious what you're seeing competitively. And I'm especially curious by what you see from traditional HR outsourcers such as Towers post the Liaison acquisition. And I'm also curious as to whether you think your addressable market is changing in any way and whether there's an opportunity to move below the 1,000 employer -- sorry, the 1,000 employee category over time?

Shawn Jenkins

Yes, thanks. Thanks, Ross. So with respect to what we see with some acquisitions like Towers buying Liaison, I think that demonstrates that big companies see this as a massive opportunity and they're looking to make investments in the technology and providing to their existing customers, if they happen to be [indiscernible] in the market with these customers today, they want to provide something that they obviously don't want to what it go somewhere else. So we're feeling that energy in the marketplace, as you can see, with the wins that we're announcing and the successes that were happening.

We continue hearing from both our existing customers and prospective customers that they're increasing their sense of how big this opportunity is. They're seeing folks like Accenture saying 40 million people by 2018 on these exchanges. And so they're looking for more technology.

They're also beginning to really understand how they add value, so whether it's someone like [indiscernible] wonderful products in the marketplace and the great array of capabilities and services, how they can really take the marketplace and change the conversation with the individual employee and [indiscernible] product to them. So I think it's an exciting time, a lot of energy going into the marketplace, and it's a very -- it's halfway through the first inning I would say. So, long opportunity going forward.

The second piece of that question is, as far as the addressable market, to me it feels like the addressable market is just being confirmed over and over again. And if anything, being told sooner into our view over the next few years, obviously it's a huge market, it's a $1.6 trillion spend in the U.S. on employer-sponsored benefits. So it's going to take a while. It's going to take a while for this massive spend to kind of modernize. But everything we see makes us believe more and more in the addressable market. And if anything, more people are coming into the ecosystem that we believe will help us scale up and get to that market faster. And our intention is to stay in the lead and keep our foot on the gas, as we mentioned before.

Ross McMillan – Jefferies

Thanks. And maybe one for Milt, or I guess it's really two. Milt, do you have the gross margin on software subscriptions for Q4? And when we think about your guidance for 2014, is there anything you can provide just now to help us with gross margin range for the year? Thanks.

Milt Alpern

If we go on to the software margins or the software subscription side, we don't have them yet because we're obviously, as we mentioned, we're still kind of finalizing the -- we're finalizing the results from our 2013 audit. So once we do that, we'll be able to address what those margins will be.

Guidance for gross margin rate for the year, I think we're talking about kind of in the, again, still looking at what the impact of the adjustment from this lease accounting will have, not only historically but going forward, and there again, Ross, we'll publish that once we get the accounting for it done and the audit finalized.

Shawn Jenkins

Hey, if I might, Ross, is I think -- you touched one of the things too that I just want to make sure I address here. Going below 1,000, you know, our direct sales force in employer is doing a great job in the 1,000 plus market. But these channels, these marketplaces do afford us the ability to tap into the channel and their sales force and their distribution to go below 1,000. So we do think that is part of the accelerating opportunity that we see. So, great leverage there in that aspect of the speeding up of the private exchange.

Ross McMillan – Jefferies

Thank you.

Shawn Jenkins



Your next question comes from the line of Richard Davis with Canaccord.

Unidentified Participant

Hey guys. It's DJ [ph] on the line for Richard.

So, Shawn, as I think about the platform on the employer side, it's something that employees engage with for only a limited item during the year. So is there stuff, for lack of a better term, that you could add to drive more regular employee engagement? And then, you know, how would you think about monetizing that with the customer?

Shawn Jenkins

Sure. Yes, great question. It is something we think about a lot. As we engineer and design the Benefitfocus platform, we use words like elegant and beautiful and sophisticated and flexible, because we really believe we've built a consumer orientation for benefits and that's driving a lot of the uptick.

We launched something two quarters ago called Benefitfocus HR Touch Mobile, which is a native app on both iOS and Android. And the idea here is to put all your benefits in your pocket, is really the idea. And so an employee who uses HR Touch can have the mobile app. It comes with the subscription that the employer pays, and things that they can find on there, like their insurance ID information. They can see who's covered, they can check different balance information depending on what benefits they have configured. And we see a great set of usage patterns happening with HR Touch Mobile, so it's a very fluent, active type of app. I used it recently when one of my kids needed to see the doctor. I pulled what our information was on there and saw the medical ID and was able to provide it to the docs' office. It's a really fun capability.

And the other piece that we see a lot of energy happening around, like an ongoing utilization, employers are using the Benefitfocus platform more and more for wellness initiatives. So they're trying to provide, you know, healthy behavior, education, incentives, in some cases even penalties, for employees to guide their behavior post open enrollment. And our platform, the Benefitfocus platform really encourages those employees to come back, it's very sticky. We then use various sort of niche or point wellness programs that do some fantastic work, and content, some of our content, some content created by like a partnership with Mayo Clinic that we have. And this allows the employee to really interact on an ongoing basis.

In many cases they get rewards for interacting with their wellness vendors. Those rewards come back through the Benefitfocus platform, sort of proves that they've been active on the wellness program. And then we can actually take that data back into the employer's payroll system, give them credits and store up information for them.

So it's a really fascinating sort of technologies. And it's one of the things that I think is really going to [indiscernible] the benefit to the largest provider in our space, because over time if you think about collecting, we now have over 20 million consumers on the Benefitfocus platform, that's a giant audience, and more and more insurance companies, content vendors, all sorts of gamification [ph] of health and whatnot, they want to tap into this audience but they need someone to organize the audience [indiscernible] secure information. And we provide a great cloud, if you will, of those folks. So a lot of exciting things happening particularly on that topic.

Unidentified Participant

Yes. That's good color. Thanks.

And then, Milt, as I kind of look at the Q1 guidance, can you just remind me of the variables that could drive either the carrier or employer revenues down on a sequential basis?

Milt Alpern

I think we did talk about there is seasonality in the sales process. During -- get the larger majority, about two-thirds of our selling, is done in the middle two quarters of the year. So that has an impact certainly on the seasonality of revenue.

As we look at certainly increasing the number of some of these professional services engagements that we're getting from our carrier customers and their larger employer customers, the time it takes to bring them live is, remember, we recognize all of the extensive implementations over the implementation period and further recognition of revenue, until the customer is live, and then it's recognized over a 10-year customer relationship period.

So while we continue to be in a period where we are getting a lot of large implementation projects from the carriers that we're bringing onboard, as we mentioned, we added three carrier logos alone in the fourth quarter of last year, that has an impact in when revenue comes onboard and how that will impact the seasonality of revenue recognition.

Unidentified Participant

Okay. But I think that would make -- there's no change in retention, there's nothing that would drive revenues down sequentially. [Indiscernible] revenue coming onboard.

Milt Alpern

In the fourth quarter, I mean there are certain types of revenue in Q4 of '13 that are seasonal in nature that really relate to the open enrollment season. Some of that is, you know, there's a relatively large number of video, relatively speaking, a large number of video deals that we do in the fourth quarter, some fulfillment activities that we do as well, add revenues in Q4, as a result of the open enrollment season that don't necessarily repeat themselves in Q1.

Unidentified Participant

Got it, got it. Yes, fine. Okay. Sounds good. Thanks guys.

Shawn Jenkins

Thank you.


The next question comes from the line of Terry Tillman with Raymond James.

Terry Tillman – Raymond James

Hey, good afternoon guys. Thanks for taking my questions.

Shawn, you talked at length about the optimism in really all parts of the business and even the acceleration of the carrier business, which is nice to see. But on the employer side, I know you talked about a strong amount of go-lives. But what about the new signings in the quarter? I think it was 14 or so. Anything you can say about how that was versus maybe your expectation? And what about the type of business, I mean were the sizes of those employer deals any different than you had been seeing in the prior quarters?

And then lastly, what's the pipeline actually like around that employer business given all that capacity that's come online so far?

Shawn Jenkins

Sure. Great question, and obviously something that we manage closely and I personally pay an enormous amount of attention to, is the sales team, the pipeline, the partnerships now, the channels.

This past fourth quarter was, we think, is a great quarter overall in a lot of different areas, you know, adding new employers. Our average sales price, if you will, our average size of employer has actually been going up significantly maybe even over the last several years, and we continue to see that trend.

I think as we went public in September, the awareness of our -- the Benefitfocus name in larger circles, if you will, we're starting to see the effect of that. And we did have some nice large wins in the fourth quarter. So we're very happy with the performance.

I guess there's probably another [indiscernible] phenomenon, being this is what we live and breathe every day, is this idea of the first major open enrollment season under the Affordable Care Act, most of the new things. A lot of employers were extremely busy just taking care of business in the fourth quarter, getting things in place. And if they weren't on our platform yet, they obviously had to get through their enrollments and so forth. So it's not really uncommon for our employer business to not be as heavy in the fourth quarter.

Interestingly enough, the carrier business tends to be pretty good in the fourth quarter because we're often selling to the business folks and the strategy folks who are thinking about next year, and they kind of get ahead of the curve a bit. So they come on in the fourth quarter, maybe first quarter, for a longer ramp time. Our employers can come on in the first second or sometimes even a little bit in the third quarter this year and still make open enrollment. So we're real proud of the performance and feel like it sets us up for a great year.

You also would have heard a bit in the script and maybe our Q&A now about this idea of these channels, these private exchanges, they are really showing great pipeline, and we're gearing up for those, and the investments that our partners are making in those is -- continues to increase our optimism in that. And that'll be employer flow-through in the next couple of years.

Terry Tillman – Raymond James

Okay. And then -- and just because you are so close to the sales side, first quarter, I mean granted, and Milt, you said this repeatedly, 2Q and 3Q tends to be the real heavy part of the new bookings. But in the first quarter, is there also the same level of timing, if you will, that you can see in the fourth quarter as employers are just busy? Or does it start to free up a little bit? I don't know if it's kind of getting in the weeds then to see the sort of difference between 4Q and 1Q, but I'm just curious if you could talk about, if there's any at least moderate difference then in activity between 4Q and 1Q historically in employer.

Milt Alpern

I think that really not so much, Terry. I mean I think it's kind of like a bell curve. As I said, you got the middle two quarters doing about two-thirds of your selling and probably evenly dispersed between Q4 and Q1. We did have, as Shawn said, some good customer wins, employer wins in Q4. There were two chunky-sized deals in there, upwards of, you know, several that were over $0.75 million in value, some approaching $1 million. So I think -- and also the average deal size is increasing on the employer side of the business as well.

Terry Tillman – Raymond James

Okay. And Milt, since you're talking there, I mean is there anything to think about here in terms of carrier versus employer growth? I mean if we build our models up more from that angle as opposed to the software subscription and those services, if we think about it more by segment to segment, is there anything at all you could give us directionally or comparability of the growth rates of those two businesses? Because it sounds like nothing's really changed in employer, a lot of momentum, maybe this private exchange thing could even add some more oomph. But the carrier side sounds like that's a little bit more fluid now too in a positive way. So I'm just trying to -- anything you could say at all about relative growth rates in '14 for those two segments?

Milt Alpern

Yes, I think clearly as you see, I mean 79% growth in the employer revenue base in the fourth quarter, and even on the carrier side I think the number was 15%, so even that kind of exceeded our expectation. You're right on the marketplace activity. I mean that's going to add momentum to the employer side of our business and provide some added push in that segment. And as we've talked about before, we're kind of seeing, and I've said before, that probably by the end of '14 or early '15, you're going to see the employer revenues begin to outpace carrier revenues as a percentage of our total revenue.

Now I think that phenomena still going to happen, you know, carrier revenues or carrier sales performance has been a little bit better than expected, so may take, you know, maybe just a little bit longer, but I'm still feeling pretty good about the end of '14 or Q1 of '15 being that kind of cutover point where employer revenues will begin to represent more than 50% of total.

Terry Tillman – Raymond James

Okay. Okay. And I think somebody else gave a good college try on trying to pin you down on gross margins, maybe I could try it too. It sounds like pro services is going to be strong because of some of the work you're doing with the carriers, marketplaces, et cetera, and maybe to a certain extent some of the larger, chunkier employer deals. I mean just directionally, can we at least think about what happens to gross margin for the full year basis in '14? I mean it could be down from '13, or is that not going to happen, it's just it's not going to expand as much as maybe I would have originally anticipated?

Milt Alpern

I think, you know, everything that you just said is right. I mean we continue to see lots of professional services engagement, larger professional services engagement that are going to put downward pressure on margins if you do those implementations. The notion of building out the marketplaces and really gearing up to do implementations on behalf of those marketplace partners, yet [indiscernible] that Shawn had mentioned.

And then just the overall increase in investments that we're making, some of which is going to impact the cost to revenue line. I mean as we build out a third party implementation ecosystem and bring some of these partners onboard, we need to train them, we need to onboard them. And I think Shawn mentioned, there might be some duplicative costs as they kind of shadow us through some implementations until they come fully up to speed and independently able to do them on their, that will also put some downward pressure on margins.

We think, you know, these are all investments that clearly will pay off in '15 and beyond. The notion of building a third-party implementation group or ecosystem is something we've talked about for a while. We've got a great start to it, we've got lots of people interested in doing it for us. I mean I think that's going to add some real opportunity for us to expand our margins once we get them trained and the ecosystem a little bit more developed.

Terry Tillman – Raymond James

Okay. Thanks for answering my questions.

Shawn Jenkins

Thank you.


Your final question comes from the line of Sean Wieland with Piper.

Sean Wieland – Piper Jaffray

Hi. Thanks. So my question is, when you are looking or evaluating a specific area of an investment in your business, what are some of the factors that you consider in terms of payback or time or incremental growth that you need to see in order to justify that level of investment? And I'm in a noisy place, so I'll take my off from here. Thanks.

Shawn Jenkins

Thanks, Sean. So I mean the primary thing that we're looking at when we laid out the three that we talked about, sales and marketing I think is, are we seeing the production of the sales executives that we have, is our model holding up, and can we see good return on that, so when we bring on someone, it takes a while to spin them up and train them and get them equipped and get them in the field and then be productivity. So we're growing in confidence over the last couple of years of our ability to find very talented sales people. We're attracting some of the best sales people in the industry right now. And we do have a good track record of bringing them onboard and getting them productive. And that productivity turning into near-term employer -- primarily employer recurring revenue, so this subscription base. So we see that model. It's very similar to other SaaS model, and we follow the same type of calculation and modeling on that.

The next two work are, you know, obviously the thought through from afinancial basis, but it's just what we're hearing in the market from our channel partners around the private exchange, it's a big phenomenon. It is kind of a here-and-now type thing. And we need to make sure that we maintain and even extend our leadership position in there.

And we also have very good visibility into the pipeline of the folks that are putting these marketplaces in place and our blue plant [ph] partners and so forth. So as we see their pipeline and we see the customers that will be coming through there, it gives us very good confidence that we can get a return on that investment, similar to what you saw last year. So you saw us make some pretty big investments in the first half of '13 and then you see the revenue jump in the fourth quarter of '13. So we know how to do this. This is our business. And we've got a good track record. It's just a bit of a bigger step-up this year.

The third piece, on the third-party implementation, I've looked at different companies and when they attempted to do this and when they did it. Some did it very early on, some had third parties when they were very small, some waited till they were several hundred million in revenue. We've really studied it a good bit, and we think that given the accelerating nature of, particularly in our employer side, it makes a lot of sense. And also the way we account for implementation fees, and again the folks that are new to the story on the phone, we take an implementation invoice. We get paid upfront of our implementations. We do the work and we take all the expense in the current period. We don't take any of the revenue until the customer goes live. And then we recognize it over a 10-year customer life, because our customer stay with us for 10 and more years.

And so this idea of the downward pressure on our margins comes from an increasing implementation cost, even though the cash is matched, we're very happy about that, because we're happy with the cash aspects of implementation. But we think now is the time to train a handful of implementation folks so we can begin to offload some of that expense. Not all, but I mean we still like doing implementations that will support many of our customers. We think that makes a lot of sense now, so then we can begin to get the benefits. If we don't do it this year, you guys will be asking us about next year and we can just keep it canned, but we're going to go ahead and do it.

And we think it'll actually accelerate our growth rates just because more people out in the field, that customers see an ecosystem, they see the strength of the brand, they see these companies that have trained associates or trained experts. Maybe it's the last question, but if you want to add a little bit more to how we make --

Milt Alpern

Yeah. I would say, Sean, certainly it's, again growth on the top line, growing our revenues, getting accelerating growth in the top line, it's kind of the primary factor that we consider when we're making investments, but also certainly there's a 1-A decision point too, and that's generating revenue that's going to really kind of create an increasing opportunity for profitability as we move through this period of investment and kind of pick up some momentum on the profitability line as well.

Sean Wieland – Piper Jaffray

Can you just quantify the impact of the, basically, the accounting adjustment of that deferral, like if you could match revenue with cash flow with the work done, what would that be?

Milt Alpern

Well, I think we -- if you're talking about on the deferral on the services revenue, I mean we did that a while ago we kind of did an analysis and said that that would probably add about 10 points to margin, if we were to basically mask the revenues along with the -- over the period of time that we're doing the implementation.

What it would also do though, basically what I said earlier while I was doing my prepared comments, is that the composition of our revenue today is about 93% professional services -- I'm sorry, 93% recurring revenue and 7% professional services. If you were to recognize revenue in accordance with the implementation period, or over that implementation period, the mix of revenue would probably change to about 80/20. You get about 20% of your revenue being recognized in services and 80% from recurring software services.

Sean Wieland – Piper Jaffray

Right. Thanks.

Shawn Jenkins

Thanks, Sean.


Thank you. I'll now turn the call over to Shawn Jenkins for any closing remarks.

Shawn Jenkins

Excellent. Thanks again everyone. We're super proud of the results of the company and the great job that all the Benefitfocus associates who turned just an amazing quarter. And we appreciate everyone dialing in, and look forward to working with you in 2014 for huge success.


Again thank you for your participation. This concludes today's call. You may now disconnect.

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