Connecture's (CNXR) CEO Jeff Surges on Q2 2016 Results - Earnings Call Transcript

| About: Connecture (CNXR)

Connecture Inc. (NASDAQ:CNXR)

Q2 2016 Earnings Conference Call

August 8, 2016 5:00 PM ET

Executives

Lea DeVillers – General Counsel

Jeff Surges – Chief Executive Officer

Jamie Purko – Chief Financial Officer

Analysts

Jamie Stockton – Wells Fargo

Andy Schnenker – Morgan Stanley

Andrew Cooper – Raymond James

Operator

Good day, ladies and gentlemen. And welcome to the Q2 2016 Connecture’s Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. And instruction will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded.

I would now like to turn the conference over to your host Mr. Lea DeVillers. Connecture's General Counsel. Mam you may begin.

Lea DeVillers

Thank you. Good afternoon, everyone, and welcome to Connecture's 2016 second quarter conference call. Today we'll be discussing the results announced in our press release issued after the close of the market this afternoon. With me on today's call are Jeff Surges, Connecture's Chief Executive Officer; and Jamie Purko, Connecture's Chief Financial Officer.

During the course of this call, we will make making forward-looking statements regarding future events and the future financial performance of the Company. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in the press release and on today's call. These risk factors are described in our press release, and are more fully detailed in the risk factors section of Connecture's annual report on Form 10-K and our other SEC filings.

During the call today, we will present both GAAP and non-GAAP financial measures. These non-GAAP measures are not intended to be considered in isolation from, a substitute for, or superior to, our GAAP results, and we encourage you to consider all measures when analyzing the Company's performance.

A reconciliation of non-GAAP financial measures discussed on this earnings call can be found in the Company's earnings release issued today and posted on the investor section of Connecture's corporate web site at www.connecture.com. In addition, please note that any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date, and we undertake no obligation to update these statements as a result of new information or future events.

With that, I'll turn the call over to Jeff Surges.

Jeff Surges

Thank you, Lea. And good afternoon. And thank you for joining us on today's call to discuss our second quarter 2016 results. During my first six months as CEO I’ve spent a lot of time customers who are all facing challenges and trying hard to figure out how to help people get the help benefits they need in an ever-changing regulatory, political and financial environment.

I've been encouraged by the fact that I know we can help our customers accomplish their goals. I'm happy to announce that we signed new business and welcomed important new customers during the quarter. We also expanded and renewed our relationships with several key customers from our current base. These things were meaningful highlights for the quarter and a great signal for our future. I will provide more detail on these highlights as they are important, but I want to get right into our performance as I know it is top of mind.

Our financial performance expectations that were set several months ago have not materialized at the rate we had originally expected. We have been impacted by the changing market as stated earlier, but we are also trying to do this at a time when we are materially strengthening our core offerings and capabilities. Plainly put there was just more than fixed than initially estimating during a tougher than expected year. The sales team was lacking segment focus and our sales pipeline was not as robust as originally presented. In addition, customer adoption in our new platforms were slower than we anticipated. Delays with implementations were more pronounced and our ability to address the broker market had more challenges than anticipated.

Given the size of our company and the complexity of the decisions we've had to make fixing these areas is an extensive process and that is why we are lowering guidance for 2016. We did not make this decision lightly. However, we believe this reset is important and are confident we are doing the right things. We have addressed some talent issues, took care product gaps in the broker segment with the Connected Health acquisition and have made significant strides towards making our newest platform and product suite truly the most comprehensive in the market. These things bode well for our future but we can't deny that we were overly ambitious regarding what we can accomplish in the first half of the year and we acknowledge that it will take more time than planned. With that said I’m encouraged by what we are building in this pivot year here at Connecture.

This work will create a foundation for sustained growth and a rational approach to the markets we serve. We think this is demonstrated by the following. One, we are adding new significant clients and expanding the scope of relationships with existing customers. Two, we finalized the purchase and integration of Connected Health. And three we continue to advance strength while addressing some go-to-market challenges. These important facts along with the rationalizing of our near-term investments away from the Medicaid space, will help us to solidify our core and fuel the company’s future growth.

On the first point, despite some of the churn we are all experiencing in the healthcare industry we have signed impressive new clients in our position for more to come. We concluded an agreement with the American Association of Retired Persons better known as AARP to become their solution for one-stop health benefit shopping for their 39 million members. Set to launch later this year the new marketplace will leverage Connecture's advance benefits comparison tools and personalized support technology to deliver a robust and holistic shopping experience, designed specifically for people 50 years of age and over.

The deep consumer insights and technologies from Connecture will guide AARP's members and non-members alike through the comparison and purchasing process across a wide selection of health insurance and financial products. We could not be more product AARP selecting Connecture as their partner. This is another example of a trusted household brand name client and allows us another route to a new revenue model with considerable upside.

In addition, we are pleased to announce that we are welcoming Connected Care, OrchestraRx, the League of California Cities and Indiana University Health Plans, to our roster of fantastic customers. These new and important relationships indicate that Connecture is seen as a solid, proven choice for a preferred long-term solutions partner. Winning the trust of customers like IU Health for their Medicare needs is another signal that we have great offerings for provider-sponsored health plans, i.e. Payviders. Both for those already established in their market and those new entrants looking to migrate from the ACL world.

Lastly, do impart to our strong performance on Medicare.gov, we were recently awarded the opportunity to participate in the Spark federal contracting program. This multi-billion dollar program will be the primary vehicle for this federal Centers for Medicare and Medicaid Services or CMS to acquire IT services and system software development over the next 10 years. For those of you not familiar with doing business with the government, this is not easy to accomplish and we are excited to be one of the approved providers. Each of these new clients is a great parameter of continued momentum in our business, but it is also important for us to talk about major contract renewals and milestones with our existing customers.

OptumRx is currently using Connecture to help empower their members to drive down drug cost by identifying dose-specific therapeutic alternatives that may have better coverage options for their existing benefits. Through the catamaran acquisition, we expect to have expanded reach to even more OptumRx consumers. In addition to the OptumRx renewal we've also secured renewals with nationwide insurance in several blue cross blue shield plans, including BCBS of Massachusetts and BCBS of Michigan. Prime Therapeutics, another customer renewal, is a leading pharmacy benefits management firm which utilizes our drug comparison and drug compared solutions to better serve their member base of over 20 million people.

In addition to these examples of client renewals, we also launched the first phase of our new marketplace platform with USAA. With over a 11 million members and one of the highest customer satisfaction, net promoter scores in the country, USAA is a company committed to solving to help and financial security of the military community and their families. We are proud to do our part in helping USAA better service its constituents. In many ways for those of you that have been following us, USAA is representative of the patients we need to continue to have. This client and others are examples of long cycle relationships, now coming to fruition after being initially announced a year-ago.

In summary, helping these and over our 120 other customers achieve their objectives and deliver real, tangible benefits to their millions of consumer members is vitally important to each of our employees and that's what helps get us up in the morning to take advantage of this healthcare challenge.

On the second point, another demonstrable way we are making progress is through inorganic moves to expedite product roadmaps. In June we announced the acquisition of Connected Health. We added to our existing capabilities for speed to market and also new ways to engage the consumer within and beyond the enrollment period. Their depth and expertise combined with Connecture’s five years of primary consumer research truly sets us apart the competition. The integrated offering is helping us address the gaps in the market.

We believe that our capabilities in Medicare, individual and small group when coupled with Connected Health large group Smart Choices™ Marketplace should be looked at as an engine for growth. Our customers are telling us that having one integrated platform for all this segments is very important. We're now able to effectively deliver this to the market with greater product depth and capabilities. The acquisition of Connected Health is not the last strategic opportunity we see coming as inorganic expansion is and will remain an essential component of our growth strategy. Our base of customers provides us a broad and diverse platform to deliver expanded offerings beyond our core member acquisition and retention solutions.

While it may be premature to provide much detail at this time, we nonetheless see opportunities to accelerate our partnership initiatives in consumer engagement, analytics, benefits administration, turnkey services and wellness.

On the third point we have added proven talent to our leadership and sales teams and we will continue to add more to address key growth initiatives in the future. We are moving away from a centralized sales approach and instead we’ll address the market through vertical customers segments. This move accompanied by putting new sales teams under experienced leaders, along with better training, pipeline management and visibility, will position us for more predictable and proven results. With this focus on upstream activities, we are also working on infrastructure improvements including sales operations and solution design.

Like many in our space, we overestimated the uptake of the broker and private exchange market to say the least. So we will look to leverage this market pause upon us and continue to build our offerings, integrate our assets and assist our clients in achieving and exceeding their results. The initial six months were devoted to strengthening the balance sheets and our talent. We will now begin a process to evaluate our internal R&D and expenditures to ensure that we are leveraging our investments and scaling across the organization. One example of these initiatives is our approach to out source development. Previously we had not fully rationalized our vendors that came to the organization through acquisitions. Going forward, we will look to consolidate this portfolio and focus our attention and spend on a smaller group of partners. Along the way we will also be working to the right size our product and R&D spends.

As I remarked at the start of the year, 2016 continues to be a transitional year for Connecture. We have chosen to make major changes that will form the foundation for higher and more sustainable growth in the future rather than taking potentially easier incremental steps. We believe this path is the right one based on validation from new and existing clients, as well as from investors who remain supportive.

Likewise, focusing on the high-value, high-growth markets is the right call. As we migrate away from historically beneficial, but no longer core markets such as the state exchanges. There is momentum for us as we capitalize on a differentiated position in the market. We've established a greater depth of talent and experience on the leadership team, as well as across the company in all levels of the organization.

We've added and retained a great customer roster with tremendous assets that deliver 100 million annual transactions for 20 million plus consumers. We have a broad product suite covering individual, group, ancillary and an unequaled expertise in Medicare. We have the foundation now to manage the growth trajectory we are capable of. We remain optimistic about where we are headed and look forward to the days when we can talk about the rewards of our reset company.

Let me now turn it over to Jamie, who will go through the greater detail of our financial results.

Jamie Purko

Thanks Jeff. Turning to the second quarter results, revenue in the quarter was $18.7 million, down 20% from the second quarter of 2015. However excluding the Enterprise State and the impact of accelerated revenue recognized in the second quarter of 2015 on two terminated health plan contracts, our second quarter revenue was approximately 12% higher than the same period last year. From a segment perspective, Enterprise Commercial segment revenue was $11.4 million for the second quarter, which represented approximately 61% of our total revenue for the quarter, and which decreased 18%, compared to the same quarter a year-ago.

As previously noted, revenues for the second quarter of 2015 for this segment included $3.6 million of accelerated revenue recorded due to the termination of two health plan customer contracts. Excluding the impact of this accelerated revenue, revenues increased 11%, compared to the same quarter a year-ago. We attribute this increase primarily to the impact of customers added in a 2015, as well as key goal lives that occurred over the past couple of quarters.

Also of note, we are seeing a number of our commercial health plan customers move from maintaining their current platforms to upgrading to our latest platforms. While we believe that this will have a positive impact on our revenue growth and long-term gross margins in this segment in the future, this will have a slightly detrimental impact on 2016 revenues.

Enterprise State segment revenue of $0.9 million, represented 5% of total revenue, lower than the same quarter last year due to the previously mentioned impacts of having one state exchange client as of June 30, 2016, compared to having two in the period ended June 30, 2015.

Medicare revenue of $4.5 million in the quarter represented 24% of revenues, increasing 6% on a year-over-year basis. Revenue growth for this segment was largely driven by the impact of new customers that we added during the past year, as well cross-selling to existing customers.

Private Exchange segment revenue of $2 million represented 11% of total revenues for the second quarter, increasing 46%, compared to the same quarter last year. The revenue increase in this segment was also driven primarily by the addition of new customers during the past twelve months, most notably USAA, where we recognized revenue for the first time in the second quarter of 2016 upon successful completion of the first phase of that project.

Adjusted gross margin was $6.2 million for the second quarter or 33% of revenue, compared to $10.6 million or 45% of revenue in the same period last year. Of note, second quarter of 2016 results included $0.6 million of one-time severance and integration costs incurred in connection with the Connected Health acquisition. Excluding these costs, adjusted gross margins were $6.8 million for the second quarter or 36% of revenue. The year-over-year decline in adjusted gross margins was primarily driven by the impact of having lower enterprise/state segment revenues on quarter-over-quarter basis.

In addition, during the second quarter of 2016, we continue to incur higher levels of outside contractor cost supporting certain of our enterprise commercial customers. Those incremental costs had a dampening effect on adjusted gross margin levels. We've taken actions to rationalize these cost sense and as a result expect outside contractor cost to decline in the second half of the year. This when combined with increasing revenue levels in the second half of the year, should bode well for improving gross margin levels.

Moving down the income statement to our operating expenses. First, research and development expense of $5.9 million in the second quarter of 2016, represented 31% of total revenue, compared to $6.1 million or 26% of total revenue in the same period the previous year and in-line with expectations.

Sales and marketing expense was $3.1 million or 17% of revenue in the second quarter of 2016, compared to $2.3 million or 10% of revenue in the same period the previous year. This increase is mainly attributed to investments made since the beginning of 2016 in sales and marketing in the form of additional headcount and support of new product initiatives, such as the provider-sponsored health plans, as well as a planned deeper focus on marketing that was initiated at the beginning of 2016

General and administrative expense of $3.3 million in the first quarter accounted for 18% of total revenue, compared to $3.9 million or 17% of total revenue in the same period the previous year. The decrease in general and administrative expense was largely attributed to lower incentive compensation and lower stock compensation expense.

Adjusted EBITDA was negative $5.5 million in the second quarter of 2016, compared to negative $0.4 million in the second quarter of 2015. As previously mentioned the second quarter of 2016 adjusted EBITDA results include approximately $1.1 million of one-time costs associated with the acquisition and integrated of ConnectedHealth as well as $0.2 million of net operating loss related to ConnectedHealth that were incurred post acquisition.

The lower adjusted EBITDA compared to the same period a year ago was due primarily to the previously mentioned impact of lower second quarter of 2016 revenues against the relatively fixed cost structure. Lastly second quarter 2016 diluted earnings per share was negative $0.47 compared to negative $0.20 in the second quarter of 2015 based on $22.2 million weighted average shares outstanding.

Of note, the impact of previously mentioned one-time costs incurred during the quarter on EPS was $0.05 per share. In addition the impact of one-time non-operating cost associated with the financing transactions completed during the quarter totaled $0.09 per share and the impact of preferred stock dividends accrued during the quarter on EPS was $0.03 for share. Otherwise decrease in EPS was largely a function of lower earnings as previously noted.

Now, turning to the balance sheet, as of June 30, 2016, we had $19 million in cash and net debt of $16.3 million, compared to $0.2 million in cash and $49.4 million of net debt in March 31, 2016. The sequential increase in cash was anticipated and was driven by the preferred stock investment and the expansion of our credit facility with Wells Fargo both of which were completed during the second quarter of 2016. Specifically, we received net proceeds of approximately $18 million from the preferred stock issuance after paying down the THL debt and $14 million from the expansion of our credit facility and used approximately $4.9 million of cash on the ConnectedHealth acquisition and integration during the quarter.

Thus the net impact of these three events and cash during the quarter was approximately $27 million. Cash used in operations for the three months ended June 30, 2016 was $10 million, compared to cash used in operations of $7 million for the same period last year. As previously noted cash used in operations in the second quarter included $0.4 million related to the acquisition and integration of ConnectedHealth in the quarter. Otherwise the decrease in cash used in operations is primarily attributed to the decrease in adjusted EBITDA previously noted and higher working capital requirements due to the timing of an invoicing as compared to the second quarter of 2015.

Total deferred revenue increased to $47.4 million at June 30, 2016, compared to $46.9 million at March 31, 2016. The sequential increase in deferred revenue was attributed to an increase in invoicing activity during the second quarter, we began delivery efforts surrounding the annual open enrollment period offset by the continued runoff of state exchange revenues in the second quarter.

Now, we'll turn to a brief discussion of the other financial metrics that we report on each quarter. First in terms of contracted backlog, we ended the second quarter of 2016 with approximately $95.7 million and contracted backlog up 2% from the $94 million balance we reported at March 31, 2016, and up 12% from the $85.5 million balance we reported at June 30, 2015.

The sequential increase in March 31, 2016 was primarily attributed to relatively strong sales activity during the second quarter, on a comparative basis at the selling season that leads up to the annual open enrollment cycle continued. A particular note was affected our Medicare segment again experienced stronger sales activity than anticipated. As a result this segment now represents nearly 40% of our total contracted backlog. In terms of the composition of our backlog approximately 95% of the contracted backlog balance at the end of the quarter was software revenue compared to 94% at March 31, 2016 and 91% at the end of the second quarter of 2015.

And from a software revenue retention standpoint for the second quarter of 2016, we had a software revenue retention rate excluding enterprise state customers in excess of 97% for the trailing 12-month period. Lastly it's important to note that our contracted backlog does not include variable fee revenue opportunities. We currently have approximately 20 customers from which we expect to generate variable fee revenues in 2016 and beyond the most notable of which is USAA.

In addition new opportunities like the AARP deal previously mentioned are variable in nature. We believe these contracted opportunities represent a significant incremental revenue opportunity that is not reflected in our current contracted backlog as reported. The final portion of my prepared remarks address our 2016 guidance and the typical quarterly seasonality of our business. For our full year 2016 guidance, we expect total revenue in the range of $85 million to $88 million, adjusted EBITDA in the range of zero to $2 million.

This compares to previous guidance of total revenues in the range of $100 million to $110 million, and adjusted EBITDA in the range of $10 million to $15 million. Of note, the revised guidance includes the impact of approximately $1.8 million of one-time severance, integration and acquisition costs associated with the ConnectedHealth acquisition that have either been incurred to date or expected to be incurred by the end of 2016.

In terms of EPS, we expect EPS to be in the range of negative $0.65 to negative $0.74, based on a weighted average share count of 22.5 million shares. Of note, the impact of one the previously noted one-time severance, integration and acquisition cost associated with the ConnectedHealth acquisition that have either been incurred to date or expected to be incurred by the end of 2016 is $0.05 per share. To the impact of one-time non-operating charges incurred in the second quarter of 2016 is $0.08 per share and three of the impact of accrued preferred stock dividends for the full year 2016 as expected to be $0.12 per share.

Overall, this revision is largely a function of our year-to-date performance as well as the following four factors. First, while we are encouraged by certain aspects of sales activity thus for in our current selling season has become clear that our results today, particularly with respect to the addition of new customers will not generate the booking volumes expected or required to support our previous revenue guidance. This is attributed to the change underway in our sales organization and the overall market headwinds Jeff talked about earlier.

Second, as Jeff noted we are seeing slower levels of customer adoption of our private exchange solutions and originally anticipated due in part to the market itself, but to our own product challenges in the segment. As a result we have reduced our revenue expectations for the year in this segment. Third, as I previously noted a number of our commercial health plan customers made a decision earlier in the year to move from maintaining their current platforms to upgrading to our newest platform. But we believe this move is positive and important from a future revenue growth and gross margin perspective, these upgrades are taking a bit longer than expected to complete and as a result are providing and revenue headwind in 2016.

And lastly as Jeff previously noted we have decided to pull back on our focus and investment and pursuing the state Medicaid opportunity. This decision while we believe is a prudent one for the reasons note and we’ll have a near-term impact in the form of lower revenues for our enterprise state segment. As a reminder historically we've seen the majority of our revenues and earnings occur in the second half of the year around the annual open enrollment period that occurs in the fourth quarter. In particular the fourth quarter is usually our strongest from a revenue and earnings perspective.

It's also important to note that a growing portion of our fourth quarter revenue is variable and tied to the success of our clients during the annual open enrollment period. In addition as many of you are aware, we expect to continue – we continue to expect revenues in 2016 from the Enterprise/State segment to be significantly lower than 2015, due to the fact that we have only one customer in this segment heading into 2016. While the majority of this revenue headwind has already been felt in the first half of 2016, we expect the third quarter of 2016 to be the last quarter where this headwind will be felt in a material fashion.

This will be important to note as you consider our past and future quarterly results. That concludes my review of our financial results.

I’d now like to turn the call back over to Jeff for his closing remarks.

Jeff Surges

Thank you, Jamie. While we are disappointed about the pace of this transition, we know that we have not missed the market. This opportunity to reset coupled with our revised approach will be the standard by which we will measure ourselves going forward and I know that we have the right leaders that are now in place to make that happen.

With that operator, I'd like to open the call up to questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Jamie Stockton of Wells Fargo. Your line is open.

Jamie Stockton

Hi. Hey, good evening and thanks for taking my questions. I guess maybe the first one just on the state business, Jamie I heard you say that the third quarter would be the last quarter of difficult kind of year-over-year comps for that business. But the one client that you've got there has kind of been out there staying they might look at another platform. So while I'm curious about is whether we should they can anything for state going forward.

Jamie Purko

So Jamie, thanks. Good question. Our current contract with state of Minnesota goes through 2017. So when I talk about comps, the third quarter is the last quarter and which will basically be comparing two customers to one. So going forward at least toward the next five quarters, we would anticipate that state of Minnesota or MNsure will continue at a current level of revenue that said today. I mean I don't have reason at this point. I would say the – to assume that they won't continue as a customer beyond 2017.

Jamie Stockton

Okay. Thank you. And then maybe on the private exchange of business, I guess maybe be helpful for us Jamie if you would kind of walk us through what your expectations are with the new revenue numbers across each of segments or at least ballpark them. So we can get a sense for how much the private exchange business has been de-risked [ph] specifically.

Jamie Purko

Sure. So as you think about the guidance of $85 million to $88 million, I would say that our enterprise commercial business will be in the neighborhood of $50 million, the state business in the neighborhood of $3.5 million for full year revenues. The Medicare business in the range of $19 million to $20 million and then the private exchange business would represent the balance of that.

Jamie Stockton

Okay.

Jamie Purko

So call it $15-ish million. I mean and maybe the – to clarify the commercial business will be in the low $50 million range, not right at $50 million.

Jamie Stockton

Okay.

Jeff Surges

So it still growing Jamie, but just at a slower phase than what we anticipated when we put together our initial guidance for the year.

Jamie Stockton

How much of that growth I mean obviously there is a lot of transactional business that flows into that line, as you referenced earlier you've got 20-ish customers that don't necessarily have all of their revenue reflected in your backlog. As far as the volume that you guys are assuming the private exchange business that materializes in the second half to drive that year-over-year ramp. How comfortable are you with that at this point? Just because it seems like that this has been a perpetual area where I think that kind of underwhelmed expectations.

Jamie Purko

Yes. So I would say the low end of the range we provided assumes flat revenue year-over-year, based on the same number of customers as we had last year, obviously we have USAA in the fray now. So that is something we expect will drive growth, also we reference the AARP opportunity, which is something that we expect will drive growth. So the bottom end of the range I would say – safe to say is conservative.

Jamie Stockton

Okay. And then…

Jeff Surges

Jamie, this is Jeff. I would just add the ConnectedHealth acquisition there really brought forward some functionality that we kind of had a deficit on and I think your comment on underwhelm is appropriate and spot on. So I’ve been encouraged by kind of the rebound or the enthusiasm of our clients have stayed with us there as we've introduced this. And some of the white space that connected has educated us on. Will it happen in AEP and OEP season? We’re modeling that it won’t and looking ahead to 2017, but that doesn't mean we can't be surprised to the good.

Jamie Stockton

And Jeff you kind of jumped on top of my next question which is…

Jeff Surges

Sorry.

Jamie Stockton

Hey, that’s okay. When we think about the ConnectedHealth platform, I mean you guys have alluded to the fact that there's some product migration that is causing some of the issues with revenue this year. It sounds like you've got customers that have been using maybe the traditional enterprise commercial solutions that might be looking to migrate or something like that. Can you just talk us through what the product migration that is occurring looks like now asked question.

Jeff Surges

Yes, great, great and thanks. So when I talk about the delays I don’t really talk about as much of the private exchange business as I talk about our enterprise and our enterprise commercial. As you know the longevity of our clients there is pretty positive 97% retention rate. A lot of these big, big clients are on older systems right and they are on 6X or 5X in a few years ago, is I’ve learned from now meeting them it is a fair amount of customization can be involved in some of the earlier days.

So while we’re proud of our 7X platform and its performing the brute force to migrate somebody in the window of say Q1 and Q2 before they had to lockdown for the fall, is a precious window of time that if we and the we is our customers and us are not at a certain juncture at a certain time, they're going to pause and wait till next year. And so while we may have goals and aspirations to get that migrated up and over it is a collective kind of pause with our customer and as you expect some of these larger clients have some of the larger revenue upgrade tied do it.

And if all the right reasons longevity [indiscernible] out of pause we accept that and then it impacts some of our projections. So I think when I first arrived and started do really look at, at this impressive client base, I didn’t really sense it until the last quarter after we fixed the balance sheet, after we raised the capital, just the amount of effort both parties take in moving over and the confidence that they have to have and I think in many cases our pause here reflects kind of the, the environment we’re talking about.

Jamie Stockton

Ok Thank you.

Jeff Surges

Yes thank you.

Operator

Thank you. Our next question comes from Andy Schnenker of Morgan Stanley. Your line is open.

Andy Schnenker

Hi thanks may be just to follow up on the revenue guide here few points. First off I mean year-to-date obviously down year-over-year some of that to be expected given the client losses both on the enterprise date and commercial but to be honest second quarter actually kind of came in I think ahead of us and the Street probably. So may be just trying to understand better when and how you realized and the second half was going to come in materially kind of below previous guidance or having it to the whole year down by 18%, at most all of that versus last quarter really comes in the second half of the year. So very significant guide down for the second half of the year. So just trying to better understand how that came about and once again what led to that the incorrect assumption to reconfirm last quarter. Just so we can understand may be a little bit better about the confidence in those number is going forward that such that we can then use that as the base to grow of a financial?

Jamie Purko

Andy great question and I think I would once you cleave of what we’ve talked about the Medicaid market as an opportunistic market that we just don't see materializing and you take that number and then you look at what we’ve admitted over the course, this private exchange slowness and you cleave of that number then you start to look at the core sales funnel and while we spend Q1 or at least my time in Q1 was spent raising capital in getting us the pipe and getting us this kind of longer runway.

The near term deals which were flowed from Q4 of last year overflowed from Q1 that had some renewals and some variable upgrade upon looking now that I could concentrate day-to-day for the whole second quarter part looking out at what was called Pipeline and forecast. And as you'll recall we made some replacements of our sales leadership and the way we go to market was a pretty abrupt awakening that these deals in the pipeline were not at a point where we could call them with predictability. And not only calling them but that they could happen at a pace where there would be revenue associated with it.

And I think a great example is USAA where it was announced a year ago significant booking, significant logo but it was a year for us to take the marketplace to its first phase of life. We’ll now receive that benefit but there was a long protracted both development for all the right reasons in go live that had to be planned. So when I was able to actually get under the hood spend the time day-to-day look at the sales operations and process that we've now implemented and course corrected. So if there wasn't enough strength in what was coming out of the system to say we could support the back half.

Add that to the already compressed timeline we’re now that I've learned a lot of our clients basically lock down in the September time frame for open enrollment our ability to then move any bookings formidably in to revenue for the period starts to haunt us. So while I’m increasingly convinced that 27 and beyond looks good feels good and our process improvement is starting we can't deny that what was in place wasn't working and needed to be audibled quickly.

Jeff Surges

And Andy may be just to a add a little bit of additional color to that from a financial perspective we talked a bit about the selling season which isn’t over yet and we continue to add new logos, even subsequent to the end of Q2, it occurred to us that the guidance that we had put out really required us to probably add something in the neighborhood of 10 to 15 new customers, by this point in the year or by the end of Q2, and we've effectively added four. So I think there is just a lower contribution in the 2016 revenues from new customers at that point in time.

And then secondly, I’d just add, I mentioned the impact of some of our customers transitioning, some of our commercial customers transitioning from maintaining their current platforms to upgrading to our newer platforms.

It started to evolve that’s those upgrades, while positive for the company overall. From a future revenue and earnings perspective, are taking a little bit longer to complete. So there will be a revenue headwind if you will in the second half of the year related to that I that. So those are kind of two big items I would say.

Jeff Surges

Yes. And just finally, the way I think about it is, you look at it, our backlog is up right year-over-year. These variable fee opportunities which will be modeling and talking more about in the future not only USA, AARP can be big and significant, but they're in the form of variable. And then a retention rate of 97% plus is really, really high. It gives us a great foundation, but our segment leader change, our sales process change, and the overall evolution of this business needs a little bit of gestation period to materially give us the guidance and the visibility that I don't think it was in place at the rate I would have expected in the first half, so hence the change.

Andy Schnenker

Okay. Maybe just following up on that, and then thinking about next year and going forward is that, starting point really midpoint $86.5 million and then there’s private exchange growth as we think of slower growth this year as the starting point ongoing for – kind of I feel like a guidance, but just I’m trying to understand is reduce the slowdown private exchange as they permanent slowdown in the potential growth opportunity there for the foreseeable future and so you can re-accelerate that, ensure advantage that the pipelines simply versatile. And to products commercial, the pipeline is just a little bit slower or longer we there, so does that mean that it takes a little bit longer or is there – when you reset and then we get back on to the normalized growth CapEx when we think about that the future opportunity?

Jeff Surges

Yes. So as I said when I guide here, I think 2016 is a transitional year for the business and I think that there was enough to digest in taking the company public in kind of furthering the integration of prior acquisitions and then getting the evolution of our platforms more integrated and healthy then you add in the private exchange market enthusiasm plus a pullback that’s everywhere.

I continue to believe 2016 is just more about transitional and I think we’ve returned in 2017 with these more modest expectations that we can now build off of. And I think our enthusiasm not only in our clients when we talk about our platforms and what we're doing in the future pivoting from enrollment to engagement retention. And then we’ve talked briefly about Indiana University Health Plan, but there is an enormous growing pipeline that we're seeing in the providers sponsored health plans where you know we have already 10 of the top 25 providers sponsored health plan clients serving as the backdrop. We really see this resuming in 2017 executing well on our internal processes, our review of our R&D rationalization and then resetting, but then returning it 2017 to where I know it can be.

Andy Schnenker

Okay. And then just lastly on the expanse side of things, type of the R&D rationalization, I mean how should we be thinking about the expanse line going forward right one again there is a obviously a fixed cost nature to it as you highlighted in your prepared remarks weighing on the lower revenues there, but when you’re just thinking about, first thing are you putting a pause on the numbers until you return to growth or is it a true wholesale reassessment of your kind of expense load here because one of the I think appeal of the Connecture story was the positive EBITDA trajectory on top of this strong sales growth. I’m just trying to understand if that EBITDA trajectory is once again on pause in 2016 rebuilds, or if it’s simply which we think about in a different trajectory there. Thank you.

Jeff Surges

Yes, I’ll let Jamie to give a little bit more detail, but if you think about it our cost structure is pretty stable quarter-to-quarter. So what we carry into Q1, while its lighter is the same effective cost structure in Q4 when we have strength. So I think this offset of EBITDA is more in line with revenue – with the revenue ambitions that we thought coming in. I don't see it as materially weakening more so than I see it returning. I think as we’ve finished the rationalization we're always going to look for cost opportunities to reinvest elsewhere. I think ConnectedHealth was a great example of that. I think taking our Medicare platform across all of our segments is a good example of that. And then I think as I talked about taking our offshore contractors which we have three of historically and witling that down to get more price leverage and to get more efficiency across our platforms are examples of that.

I would not characterize it as a wholesale issue or case, think it's just prudently finishing a review that admittedly got started a little later because of the capital raise we had to conduct and it took away from my first three four months, but now that we're under the hood. We’re optimistic about 2017. We're just going to need the full-year here and we’ll continue to report specifically to you and others what we're doing not only to build our backlog and enthusiasm, but how we’re course correcting in the near-term.

Jamie Purko

May be to add Andy to that. I would just reiterate that EBITDA is very important to us and while continuing to be and that will be part of our decision making. But for perspective, you may recall last year in the fourth quarter, we’ve talked a bit about a cost reduction initiative undertaken by the company. We did execute on that. We have a similar initiative in the second quarter here, but those are the largely gone – the results of those two initiatives have largely gone to fund specific investments in ConnectedHealth as Jeff mentioned as well as a purposed investment in sales and marketing. And as we looked to continue to rationalize costs, a lot of the primary focus there will be rightsizing our cost structure if you will to protect EBITDA and to protect cash generation just given that they are very important to us.

Andy Schnenker

Pretty, good. Thank you.

Operator

Thank you our next question comes from Andrew Cooper of Raymond James. Your line is open.

Andrew Cooper

Hi, guys. Just a quick one for me on ConnectedHealth. You said something earlier about that kind of plugging more of a gap. I just want to hear any comment you have on when you saw that gap and when you decided to really had something you needed to plug and whether you were out searching for that specific solution or ConnectedHealth came across and sort of showed you what you might be missing anything of that on there would be great.

Jeff Surges

Yes, great question. So the first area of concentration when I freed up Andrew was to look at our Broker segment. It was an area I was familiar with in my previous roles and I had a lot of energy for that. And the expenditure that we were making historically on-ramp was pretty big. So I had to answer the question right away that’s a lot of money we’re investing in this new segment. Is it really is there – and upon interviewing and meeting all of our clients I met every one of them saw that one they're still learning the impact of ACA regulatory compliance. They're still figuring out the evolution of the Broker and what the private exchange looks like as they consolidate. To be either rolled up to the MAs or towers or is it going to be a strong middle market player or if you're going to run the risk of being exterminated over time as a mom-and-pop we really look at what we delivered which was great coding an enrollment in shopping for what I call the individual and small group and retirees.

But we really were lacking of what I call large group in the benefits administration right and that will open admin area. I think furthering that, and if you follow what we are talking about our strategy of not just enrollment but engagement. You'll quickly see that inside of the technology platform of connected health was not only benefit admin tool, a large group coding and enrollment that complements our Medicare individual small group. But they have consumer engagement that partners with the broker, and partners with the employees to keep them active and engage throughout the year versus a one-time enrollment that to me put us over the top and looking it connected.

Everybody wants to be able to quote and everybody wants to be able to do their ACA reporting but engaging that audience as you focus more on retention and engaging that audiences you focused more on ancillary or smart shopping and filling that analytics bucket. Differentiated connected from a lot of things that we saw because not only does it help us in that space but it's reusable for us across all of our platforms right.

Hospitals morphing into help plans, they're going to engage an audience health plans that are trying to keep people on their, on their plan it's going to be about engagement in retention. So we saw a platform that could become a solution and become a stack of modules that can help all of our customers. And so the technology just made itself more, more available and solve more and problems for us and ultimately reduce the expenditure we're making from building your own mentality.

Andrew Cooper

That's really helpful. Thank you. That’s all from me.

Jeff Surges

Yes, We're excited about what we have there not only the people and the customers that we're learning about that a very early right it was incredibly small business, but we're excited about some of the niches that they found that we did not cover when we went into this as a cording enrollment and shopping platform. So we'll continue and invest in this segment and we'll continue to share results and we think this – finishing this year is kind of a transition year will give us great transparency with everybody going forward in this market

Operator

Thank you. I am showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.

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