WageWorks (WAGE) Q4 2016 Results - Earnings Call Transcript

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WageWorks, Inc. (NYSE:WAGE) Q4 2016 Earnings Call February 23, 2017 5:00 PM ET

Executives

Kim Wilford - WageWorks, Inc.

Joseph L. Jackson - WageWorks, Inc.

Colm M. Callan - WageWorks, Inc.

Analysts

Robert Paul Napoli - William Blair & Co. LLC

Steven Wardell - Chardan Capital Markets LLC

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

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

Operator

Good day, ladies and gentlemen, and welcome to the WageWorks Incorporated Q4 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will follow at the time. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Kim Wilford. Ma'am, you may begin.

Kim Wilford - WageWorks, Inc.

Thank you, operator. Good afternoon, and thank you for joining us today to review our fourth quarter and full year 2016 financial results. With me on the call today are Joe Jackson, Chief Executive Officer; and Colm Callan, Chief Financial Officer. After prepared remarks, we will open up the call to the question-and-answer session.

During this call, we may make statements related to our business that will be considered forward-looking statements under federal securities laws, including projections of future operating results for our first quarter of 2017 and our fiscal year ending December 31, 2017, expected benefits from our selling efforts, our acquisition of ADP's Consumer Health Spending Account and COBRA businesses, our channel partnership, carrier relationship, portfolio purchases, and exchange opportunities; developments in the commuter space, the demand for consumer directed benefits; market trends for the industries in which we compete, our expectations and beliefs concerning how these trends will affect our operating results, and our strategic and operational plans, objectives, and goals.

These statements are based on our current expectations and assumptions that are subject to risks and uncertainties. Actual results may differ materially from those set forth in such statements. Important factors such as risks related to regulations affecting our industry, our ability to successfully identify, acquire or integrate additional acquisition targets or channel partners, capitalize on sales opportunities and risks related to employer and employee adoption of tax advantaged benefit plans could cause actual results to differ materially from those in the forward-looking statements.

These factors are addressed in the earnings press release that we issued today under the section captioned, Forward-Looking Statements and elsewhere in our Annual Report on Form 10-K for the period ended December 31, 2016. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These statements reflect our views only as of today, and should not be relied upon as representing our views as of any subsequent date.

We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made herein. You should review our SEC filings carefully and with the understanding that actual future results may be materially different from what we expect.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation to the most directly comparable GAAP financial measures is available in our fourth quarter and full year 2016 earnings press release, which can be found at www.wageworks.com in the Investor Relations section. Also please note that our webcast and today's call will be available on our website in the Investor Relations section.

With that, I'd like to turn the call over to our Chief Executive Officer, Joe Jackson. Joe?

Joseph L. Jackson - WageWorks, Inc.

Thanks, Kim, and I'd like to start by thanking you all for joining us today. 2016 was an outstanding year for WageWorks. We experienced continued strength and growth across all of our service offerings. Our sales team delivered another record performance and we just completed a successful open enrollment season that included onboarding the largest number of participants in our history.

We saw increased demand for all of our products, with continued strength in HSAs and FSAs. There was a significant uptick in employers interested in our full suite of Consumer Directed Benefits and selecting us to administer multiple offerings. We added a number of new carrier relationships and channel partners, including our first rideshare partner. We acquired ADP's CHSA and COBRA businesses and are encouraged by the results we are already seeing from the ongoing partnership we established with them as part of that transaction.

We continue to see positive momentum in all aspects of our business and enter 2017 well positioned to execute on the foundation we built in 2016. As we begin to realize the benefits of our 2016 efforts, 2017 is off to a fast start and we are already working to replicate and improve our growth blueprint to position us for an even better 2018.

I will discuss all of these areas in more detail in a moment. But first let me walk through our results. Total revenue for the fourth quarter was $101.1 million, an increase of 22% over the prior-year period; and the first time we have generated more than $100 million in revenue in a single quarter. This is an important milestone in our company's history, and I want to take a moment to thank our employees for their tremendous efforts and our clients and partners for their continued confidence in our company.

It is worth noting that the ADP acquisition closed about two weeks later than we were expecting. So due to this timing, their revenue contribution for the fourth quarter was lower than anticipated. During the fourth quarter, however, the organic growth rate of our core businesses of Healthcare, Commuter and COBRA was an outstanding 16%, which really provides a true reflection of the underlying strength of our business. Non-GAAP adjusted EBITDA was strong at $28.8 million, an increase of 12% over the prior year.

For the full year 2016, we reported total revenue of $364.7 million. Non-GAAP adjusted EBITDA for the full year 2016 was $108 million, an increase of 12% over the prior year and represents a 30% EBITDA margin. This is also the first time we surpassed $100 million in annual EBITDA. And as I told many of our employees last week, we will get to $200 million much faster than we got to $100 million. Our organic growth rate for our core businesses for the full year was very strong at 15%.

Historically, during this call, we provide updated statistics on several metrics we follow closely. As of January 31, 2017, we now administer Consumer Directed Benefits for just over 100,000 employers, up from 58,000 at the same point in time last year. A little more than 25,000 of these new employers are a result of our channel partnership with Ceridian, where we transition their COBRA and Direct Bill portfolio to our platform during the first half of last year, an additional 10,000 are part of the ADP's CHSA and COBRA businesses we acquired in late November. The remaining represent new employers that joined us through traditional sales activity.

The number of Fortune 100 clients that we service increased from 68% to 71%, and the number of Fortune 500 we service grew from 55% to 67%. This significant growth in new employers directly correlated to an increase in the number of participants we serve. With that number, jumping from 4.5 million in January 2016 to approximately 6.5 million participants as of January 31, 2017.

Combined revenue from all of our sales channels was up almost 60% year-over-year due to the strong execution from our direct sales team, channel partners, carriers, exchange partners, resellers and brokers. This significant increase is also a result of more and more employers looking for a partner that offers the full suite of Consumer Directed Benefits.

This competitive differentiator resulted in us selling over 13,000 distinct lines of business in 2016, up from 3,700 distinct lines we sold in 2015. A distinct line of business is represented by an individual product. So when an employer is selecting us to administer HSA, FSA and COBRA for example, that equals three distinct lines of business. This increased interest in our multi-product offerings also fueled our cross-selling efforts and results there continue to be a strong contributor to our overall growth.

Our carrier and partner relationships also continue to thrive with more than a quarter of our new sales revenue being generated from these various arrangements. We now work with over 90 partners and the substantial majority of them offer all of our products and services. About a year ago, you may recall, we restructured our sales team and focused some of our best sales executives on developing new and enhancing existing carrier relationships. As a result, we more than doubled the number of revenue generating carriers we work with. We started 2016 with 12 and now work with 26 carriers, all of them are reselling one or more of our products and services.

We look to continue growing that number during 2017. These partnerships and carrier relationships meaningfully increase our reach and help drive awareness and adoption of Consumer Directed Benefits. This outstanding sales performance would not be possible without the phenomenal efforts of our IT, operations and the service teams.

During 2016, we implemented almost seven times as many plans than we had the previous year, onboarding approximately 32,000 new employers. Included in that number was the OPM, which was the largest transition of healthcare accounts in our industry's history. As a reminder, the OPM, who we view as one employer, includes over 400 participating agencies and sub-agencies including the United States Post Office. And we successfully completed that transition on September 1, on a very tight timeline.

Our investment in customized content and educational materials for the OPM to raise awareness as a convenient in cost savings associated with participation in the Federal FSA program, resulted in positive increases in participation rates, consistent with what we have seen with other large clients during their first open enrollment experience with us. We're very optimistic about continued participation growth for this plan over the next couple of years.

As you know, January is our busiest month of the year, when our call volumes triple. I'm happy to report that for the tenth consecutive year, we successfully exceeded our service levels for January. Our ability to answer calls timely within seconds is only surpassed by doing so while maintaining a 92% first-call resolution rate.

Our service performance directly correlates to our client retention rate, which remained at the outstanding level we have achieved in recent years. These impressive results are a testament to the quality of our products and customer service teams and are a meaningful differentiator in the marketplace.

Now, let's take a closer look at our core businesses, starting with Healthcare. HSAs were again our fastest growing product, with accounts increasing a little over 50% year-over-year. In addition to increased accounts, we had a significant number of new and existing partners at our HSA product to their portfolio of services they offer. We expect this trend to continue, as market demand continue shifting towards high deductible health plan.

One of our objectives in the HSA space has been to increase our revenues by better monetizing the assets generated by these accounts, particularly in a rising interest rate environment. As you may remember, throughout 2016, we began implementing a relationship with our custodian bank partner to do just that. As we enter 2017, the vast majority of our accounts are now covered by that arrangement. And we expect to have an incrementally positive impact to both revenue and adjusted EBITDA during 2017.

The FSA portion of our business also continues to grow with a 55% increase in account growth year-over-year, and more companies taken advantage of the carryover provision. In 2016, approximately $1.4 million of our participants benefited from their employers' adoption of carryover, which is up from around 800,000 participants in 2015, and a trend we expect will continue in 2017 and beyond.

We also saw a jump in HRA accounts during 2016, where more employers are looking to gain flexibility in their planned design through the use of this product. More importantly, for HRAs however, is the Cures Act that passed Congress in December last year. This act allows businesses with fewer than 50 full-time employees to fund HRA accounts, so that the employees can pay for qualified out-of-pocket medical expenses as well as health insurance premiums for coverage on the individual market.

Our Commuter business also remained strong with revenue increasing 12% year-over-year. Growth here was driven by several factors, including the many city ordinances mandating that employers with a certain number of employees offer commuter benefits and the development of partner relationships in this segment of our business.

As previously discussed, our partnership with Uber allows customers to pay for UberPOOL rides with their WageWorks' commuter benefit funds. The program kicked off in New York City at the end of last summer, and is now operating in all metropolitan areas where UberPOOL is offered. While UberPOOL is increasingly popular with existing participants, we have also seen a number of new individuals enrolling in our commuter offering and adding a commuter card to pay for UberPOOL rides.

Given this interest from new and existing participants and the number of ride share operators in the U.S., we have been working with other companies to establish similar programs, and are pleased to announce that in January we signed a new partnership with Lyft, that allows their Lyft Line customers to pay for these rides with their commuter benefit funds. We implemented Lyft Line last month in Miami, Boston, Seattle, and New York. We'll continue to add other markets, as they roll out this benefit to other locations in the country. We continue to talk to other rideshare providers as well as companies that allow our parking participants to leverage their commuter benefit and pay for parking through their apps and/or websites.

Our COBRA business is up 15% year-over-year and continues to be a solid grower for us. When you combine this Ceridian clients that we brought across last year, COBRA customers that came to us as part of the ADP transaction and a healthy amount of new sales activity, you can see why we remain optimistic about the opportunities in this space.

Speaking of ADP, the integration of their CHSA and COBRA businesses is off to a great start. We're already realizing integration and synergy benefits and expect that these will continue to what you've seen us do with prior acquisitions. We are also pleased with the number of leads we are seeing from the ongoing partnership we have with them, with over 450 new business opportunities already coming to us from this relationship alone.

And before I turn the call over to Colm, I wanted to provide you with an update on our long-term operating model. As many of you know, at the conclusion of each year, we review some of our key metrics and create a three-year outlook based upon the industry landscape. As a result of these discussions, over the next three years, even with the growth we're seeing today as well as contemplating further acquisitions, we continue to expect an overall annual revenue growth rate of 15% to 25%, with 9% to 14% coming from organic means, based on the long-term business drivers we have outlined.

Gross margin is expected to remain in the 63% to 67%, operating margin is expected to remain in the range of 13% to 18%. And lastly, based upon our track record, what we see right now in our business and the confidence we have in our ability to drive scale, we are increasing our expected adjusted EBITDA margin from 28% to 34%, to 30% to 36%.

In closing, this was another very strong quarter and year for WageWorks. As we look towards 2017, I've never been more excited about the opportunities we see and our ability to continue adding market share. Market dynamics continue to support greater interest and participation in Consumer Directed Benefits. And our integrated multi-product platform and full suite of offerings positions us very well.

We are excited about the growth we're seeing from our channel partner and carrier relationships, and their ability to help us continue expanding our reach. When you combine all of that with our best-in-class sales team, a robust pipeline of deal opportunities and our unmatched technology and service organizations, we believe that we have a meaningful opportunity to continue driving growth and scale in this business. And it's no wonder that we feel like we're just getting started.

Now, I'll turn the call over to Colm, for a review of the numbers.

Colm M. Callan - WageWorks, Inc.

Thanks, Joe. I'd also like to add my thanks to all of you for joining us on the call this afternoon. Before I begin, please note that every time I reference non-GAAP numbers on this call, those non-GAAP numbers exclude expenses related to the stock-based compensation, amortization of acquired intangibles, contingent consideration expense, severance costs related to integration initiatives, costs associated with the acquisition of ADP's CHSA and COBRA businesses, and the related tax impact of these items. A GAAP to non-GAAP reconciliation can be found in the tables of our press release, which is available on our website.

Now, I'll provide details on our strong financial performance during the fourth quarter and full year 2016, then I'll discuss our financial guidance for the first quarter and full year 2017. Total revenue for the fourth quarter was $101.1 million, an increase of 22% over the same period last year. As Joe mentioned, the ADP CHSA and COBRA acquisition closed a couple of weeks later than we were expecting. Had this transaction closed when we expected it to, we believe that revenues would have been solidly within the range of guidance we provided.

Excluding the impact of both the ADP CHSA and COBRA acquisition in 2016 and the public exchange relationship that we discontinued the previous year, the organic growth rate of our core businesses was an outstanding 16% during the fourth quarter of 2016, which we believe provides a true reflection of the strength of our business.

Healthcare revenue was $56 million for the quarter, an increase of 29% compared to the fourth quarter of 2015. Commuter revenue was $17.8 million for the fourth quarter, an increase of 12% over the same period last year. COBRA revenue was $23.3 million, an increase of 64% over the fourth quarter of 2015. Other revenue was $4 million, a decrease from $9.7 million compared to the same period last year. This reflects the discontinuation of a public exchange relationship which I mentioned previously.

Let's now turn to costs and margins. We'll review our numbers on a GAAP basis and where applicable, on a non-GAAP basis. Gross profit for the fourth quarter was $61.1 million and represents a gross margin of 60% compared to the 65% gross margin in the fourth quarter of 2015. This decline was expected due to the additional one-time investments associated with the open enrollment for the OPM that we made in the fourth quarter, as well as some incremental Q4 expenses we incurred in onboarding the ADP CHSA and COBRA businesses upon the closing of that transaction. Operating expenses totaled $52.3 million in the fourth quarter compared with $43.4 million in the same period last year.

As a result, our income from operations on a GAAP basis for the fourth quarter was $8.7 million, representing an operating margin of 9% compared with GAAP operating income of $10.8 million or an operating margin of 13% in the same period last year. Our non-GAAP income from operations was $22.1 million for the fourth quarter, representing a non-GAAP operating margin of 22%. For the same period last year, non-GAAP income from operations was $20.8 million, representing a non-GAAP operating margin of 25%.

Our GAAP net income was $5.7 million or $0.15 per share based on 37.7 million diluted shares outstanding in the fourth quarter of 2016. This compares to GAAP net income of $6.2 million or $0.17 per share based on 36.6 million diluted shares outstanding in the fourth quarter of 2015.

On a non-GAAP basis, our net income was $13.6 million for the fourth quarter of 2016 compared to a non-GAAP net income of $12 million for the fourth quarter of 2015. Non-GAAP net income per diluted common share was $0.36 for the fourth quarter of 2016 compared with $0.33 for the fourth quarter of 2015, based on 37.7 million and 36.6 million shares outstanding respectively.

Non-GAAP adjusted EBITDA for the fourth quarter was $28.8 million, which reflects an increase of 12% year-over-year and an adjusted EBITDA margin of 28.5%. This compares to $25.8 million or a 31% margin in the fourth quarter of 2015.

Now, I'll briefly recap our full year results. Total revenue was $364.7 million, a 9% increase over 2015. Organic growth in our core businesses of Healthcare, Commuter, and COBRA was an outstanding 15%. Healthcare revenue increased 15% to $202.9 million. Commuter revenue increased 10% to $70.2 million. And COBRA revenue was $75.2 million, an increase of 47% over 2015. Other revenue was $16.4 million.

Non-GAAP net income was $51.3 million in 2016 as compared to a non-GAAP net income of $45.8 million for 2015. Non-GAAP net income per diluted common share was $1.38 for the full year 2016 and $1.25 for 2015, based on 37.7 million and 36.6 million shares outstanding respectively.

Non-GAAP adjusted EBITDA for the full year 2016 was $108 million compared to $96.5 million in 2015, which corresponds to an increase of 12% and an adjusted EBITDA margin of 29.6%. This represents our eighth consecutive year of generating both positive adjusted EBITDA and increasing margins.

Moving to the balance sheet, cash and cash equivalents totaled $678.3 million as of December 31, 2016 compared to $500.9 million as of December 31, 2015. In 2016, we generated approximately $265 million in cash from operating activities compared to generating $114.3 million in cash from operating activities in 2015. Once again, this increase was driven by the growth in and profitability of our business, including the addition of the OPM.

Now, let me turn to our guidance. As a reminder, the outlook we are providing today does not include the impact of any acquisitions that we may complete during the year. We entered 2017 with good visibility into our full year revenue adjusted EBITDA, including the timing of when we expect to realize those results.

Starting with the first quarter, we expect total revenue to be in the range of $121.3 million to $123.8 million. Non-GAAP net income per diluted share is expected to be in the range of $0.42 to $0.44, which assumes a tax rate of approximately 40% and approximately 37.7 million weighted average shares outstanding.

Non-GAAP adjusted EBITDA for the first quarter of 2017 is expected to be in the range of $32.7 million to $34.3 million. For the full year 2017, we expect total revenue to be in the range of $476 million to $484 million. Non-GAAP net income per diluted share is expected to be in the range of $1.75 to $1.80, which assumes a tax rate of approximately 40% and approximately 38 million weighted average shares outstanding. Non-GAAP adjusted EBITDA for the full year of 2017 is expected to be in the range of $139 million to $143 million.

Our guidance reflects strong revenue growth and EBITDA performance. Our Q1 revenue guidance incorporates typical seasonal strength we experienced related to grace period and run-out fees, as well as the increased interchange revenues we see earlier in the year. Our Q1 adjusted EBITDA guidance assumes typical seasonal expenses associated with Q1 open enrollment and the meaningful number of new participants we have onboarded, as well as the impact of the ongoing integration of ADP's CHSA and COBRA businesses.

In summary, we are pleased with our strong fourth quarter and full year 2016 performance, and believe we are well positioned for continued success in 2017 and beyond.

Operator, I think we are ready to begin the Q&A session. Thank you.

Question-and-Answer Session

Operator

Thank you. And our first question comes from Bob Napoli from William Blair. Your line is open.

Robert Paul Napoli - William Blair & Co. LLC

Good afternoon. Nice job on the quarter. The delay in the ADP, what revenue did you guys get from ADP in the quarter?

Joseph L. Jackson - WageWorks, Inc.

Well, we gave you a range Bob, in the last quarter and you just assume it's probably towards the low end of that number.

Robert Paul Napoli - William Blair & Co. LLC

Okay. Okay. Just kind of a big picture question, Joe. You seem to be still doing quite well on the FSA business with – all the discussion around out of Washington, D.C. as a growth of the HSA, but the FSA continues to do well. What is going on with – and what do you see over the next five years as far as growth of product? And are these becoming very different markets or different customer basis? What is going on between the two products?

Joseph L. Jackson - WageWorks, Inc.

Yeah. Thanks, Bob. I think the – going forward and I've talked about this before, I think we can see people utilizing both FSA and HSA much in the same way people use 401(k)s to say for retirement. I think people will have a 401(k) for retirement and eventually have a healthcare account, whether it's a savings or a spending account. And both of those really becoming the new normal as employers and employees kind of look for ways to keep up with rising costs of healthcare.

We see a couple of different dynamics there. We see a very large population out there. Average salary roughly about $55,000, that really take advantage of an FSA product because the dollars are available on day one at the beginning of the year to spend throughout the year. And folks like that aren't necessarily interested in providing savings, or having this as a savings tool, it's more of a spending tool.

HSAs; well, first of all, you have to have a high-deductable health plan to have one. And obviously, there's people that are savers as well that want to, like myself, utilizing HSA account as a savings vehicle to use like a 401(k) for healthcare. So I have kind of a healthcare nest egg when I retire. So, we think that there is a strong market for both products, we see that in the employers that we work with, because I mentioned FSA volume was up quite a bit. You have changes in Washington going on right now, or – for example, the Senator Hatch put a bill out there recently that had several different advantages and positive changes to the HSA accounts, as well as several different changes that we would consider to be positive for FSA accounts.

And so, I think going forward, I don't know if it's two distinct markets, but I think each product appeals to individuals in a different way. But I think they both have in essence the same result as – this is really one of the only ways that working Americans can use either one of these vehicles to offset the rising cost of healthcare expenses. And when you look at the pre-tax benefits not only to employees, but to employers, I believe that's why I think our industry is really at an inflection point and we should – and we'll continue to see growth here going forward.

Robert Paul Napoli - William Blair & Co. LLC

Thank you. And just on the competitive front amongst those products, are you seeing less competitors? The FSA business seems to be really consolidating maybe more so than the HSA business. And is that becoming the FSA kind of – an oligopoly of sorts over the next five years? And do you see any consolidation in the HSA business?

Joseph L. Jackson - WageWorks, Inc.

Yeah. Well, I would say, on the FSA side, we probably have overall a significant number of greater competitors there because of some of the smaller administrators throughout the country that really focus on FSA and not so much on HSA. So, the competitive landscape on FSAs I think continues to be quite strong, but we continue and will continue to see consolidation.

On the HSA front, I think the number of competitors there overall is probably smaller, but I think that will consolidate over time. As I mentioned in my comments, one of the things that we've seen that's really started to change and become more prevalent is, employers looking for a partner that can support all other Consumer Directed Benefit activities, whether that's HSA, FSA, HRAs, which I mentioned as well that I think we're seeing some growth, and it will continue especially in the small employer market going forward.

To be able to provide all of those products on a combined integrated platform along with Commuter and COBRA, I think is a real competitive differentiator for us. And if you look at the landscape of competition, there really is very few administrators out there that do offer that complete full range of Consumer Directed Benefits. And I think that's why we're excited, especially with the partners we're working with and the carriers we're working with, that as this growth comes about we should be in a position to give more than our fair share of that.

Robert Paul Napoli - William Blair & Co. LLC

So, that one stop shop is resonating with the carriers as well as directly?

Joseph L. Jackson - WageWorks, Inc.

I think with everyone we work with.

Robert Paul Napoli - William Blair & Co. LLC

Great. Thank you. Appreciate it.

Joseph L. Jackson - WageWorks, Inc.

No problem. Thanks, Bob.

Operator

Thank you. Our next question comes from Steven Wardell from Chardan Capital. Your line is open.

Steven Wardell - Chardan Capital Markets LLC

Hi. Thanks, guys. Just wondering can you tell us what you're hearing from customers in the marketplace? We're a couple of months into the year. Are you hearing about stronger interest in one product, one healthcare product over another or are you hearing about stronger employer promotion of products to employees members?

Joseph L. Jackson - WageWorks, Inc.

Yeah. Thanks, Steve. I think I'd even take it back a few more months. Where we really start to see employer interest in these products really takes place during open enrollment season. So if I kind of go back and look at some of the statistics that we kind of followed during open enrollment season about how many people access our materials, our collateral, our micro sites, the requests that we get for customized collateral and information from employers, that was all up pretty significantly during open enrollment season. So that would tell me that employers seem to be getting it a lot more than maybe they used to and are doing more to promote the value of these products to their employees.

Now, as we get into the first couple of months of 2017, when people sign up for a high-deductable health plan during open enrollment season, sometimes there can be a little bit of a lag from the time that they sign up for it to the time that they actually complete the materials and enroll in their HSA account. So, we'll continue to see nice growth in HSAs I think over the first quarter like we have in the last few years. But I think when you compare and look at, obviously HSA has been our fastest growing product, high-deductable health plans becoming more popular. I think we see that consistent theme in kind of early in 2017, and I think that will continue throughout the year.

Steven Wardell - Chardan Capital Markets LLC

Great. Thank you.

Operator

Thank you. And our next question comes from Tobey Sommer from SunTrust. Your line is open.

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Thank you. I was wondering if you could comment on what you're seeing in terms of pricing, and then maybe also what the principal drivers are of margin expansion? Thank you.

Joseph L. Jackson - WageWorks, Inc.

Great. Well, thanks, Tobey. I think pricing still maintains a pretty strong consistency that we've talked about over the last few years. I don't really think that I could point to a product or one of the services we have and see any meaningful differentiation than what we've seen over the past few years. And I would still standby, it seems pretty stable and consistent to me.

The second question...

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Margin.

Joseph L. Jackson - WageWorks, Inc.

Margin expansion, sorry. On the margin expansion side, Tobey, that's pretty consistent with what Edgar and his team continue to look to do each year, continuing to focus on improving service, answering calls in a more high-quality way. Our IT teams developing more self-service functionality that allows people to get information either through their mobile application or through their online devices, that takeaway from phone calls coming in, continually looking at ways to become more efficient and productive.

As I mentioned, on the ADP acquisition, we're already starting to realize some synergies and benefits there. We're continuing to realize even more synergies and benefits from the, Canexus acquisition we did in August of 2014. And so, it's just that kind of consistent servicing, technology and innovation; things like that that drive scale. And Edgar and his team, I don't think there is anybody in our industry that are better at it.

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Perfect. And then, I wanted to ask you, you mentioned about how ADP is kind of contributing some – a good quantity of new leads.

Joseph L. Jackson - WageWorks, Inc.

Yes.

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Is that new leads for prospective sale this year and headed into next year's open enrollment? Could you give us a little bit color on how those will materialize, and how maybe it's surprised you, if at all? Thanks.

Joseph L. Jackson - WageWorks, Inc.

I don't know that I'm surprised, but I'm very pleased by it. I don't know that I'm surprised, because I knew that there was a significant interest from their part, from ADP's part on continuing to support and grow this business line, I feel good about the reaction that we're seeing from the sales force and the leads that have been delivered.

I would say, as a good rule of thumb, the sales leads that we would get today, probably translates into the ones we win of business starting for the most part 1/1/2018. But with that said, there is always going to be a percentage of those leads that come in, sometimes on Commuter, sometimes on COBRA, sometimes with employers that have first benefit months being either April or July or September, that some of those leads can turn into revenue generating opportunities that happen in year.

So, even with the guidance that we've given today and I think that there are some opportunities going forward is, what happens with us each year, mid-year starts, other new products starting throughout the year that can contribute to revenue growth in year. But it's always a good rule of thumb to assume that, especially in our business and especially on the enterprise side, usually these sales leads would be deemed to be opportunities for revenue beginning 1/1/2018.

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Okay. Thanks. And then last question from me. With the prospects for little bit of deregulation perhaps in financial services for the big banks. Just do you think that that alters the kind of mindset that we've seen in recent years, where some financial services institutions have decided to sell their healthcare account portfolios and businesses? Thank you.

Joseph L. Jackson - WageWorks, Inc.

So, are you referring more towards the HSA sales that took place?

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Correct. Yes, exactly. Thanks.

Joseph L. Jackson - WageWorks, Inc.

Yeah, yeah. I don't know – I think there's still some questions about what kind of deregulations would happen. But I think when many of those things have been looked at, I don't know that – I think I don't know that the regulatory aspect was the driver of them getting out of the business. I think it was primarily more towards kind of how these deposits are handled and reviewed (42:23) within the financial institutions. And so, again, I can't go back and really speak to why those folks sold, but I don't know that I would say that it was directly correlated to regulatory aspects of how those funds are handled.

Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Thank you very much.

Joseph L. Jackson - WageWorks, Inc.

Sure.

Operator

Thank you. And our next question comes from David Grossman from Stifel. Your line is open.

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

Thank you. Sorry, I jumped on a little late. So if this has been answered, you can just wait me on and we can take this offline. But I think when we talked about the custodian relationship, when I first started, as I recall, it was another $5 million to $6 million of revenue in 2017. Is it still in that range, because it sounds like maybe you have pretty good uptick and you've got most of the accounts under that agreement now, I'm just curious how that affects the outlook for 2017 if at all?

Joseph L. Jackson - WageWorks, Inc.

Yeah. Okay. So, good question. I think at this point, David, I would directionally stay pretty close to where we talked about it before for a couple of reasons. One, a lot of times when new accounts are generated, it takes time for balances to grow. So, I don't know – so all the – lot of the growth that we've got in new accounts, those balances have to tick up over time to realize some of that benefit. That'll be number one.

Number two. Some of the growth in HSA accounts came from our ADP acquisition. And those accounts are not yet in the scenario that our other HSA accounts are with our existing custodians. So, we're working to try and get a remedy for those accounts where we can participate much like we are in our traditional legacy accounts. And I would consider that to be more of an opportunity in the year, but nothing completed yet.

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

Okay. And is there any algorithm with regard to rising rates, how we should think about the impact on those revenues?

Colm M. Callan - WageWorks, Inc.

The rate of return is based on the Fed Funds rate. So, we haven't put a specific framework as to what each incremental increase in the Fed Funds rate corresponds to. But even if the rates move two or three times this year, it's probably not going to have a huge meaningful impact on revenues obviously, certainly not going to be material overall. It would get us more to the higher end of what we're looking to, but hopefully that turns into a nice deposit as well, if those rate rises materialize.

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

Okay. And then on the OPM and I guess to a lesser extent (45:27). My understanding was that OPM was primarily an FSA account, and I know you just went through open enrollment without any real opportunity to educate their market to that base, but any kind of insights you can give? What's the opportunity may look like as we go into 2018 or the 2017 open enrollment (45:54) for high deductible plans?

Joseph L. Jackson - WageWorks, Inc.

Okay. You broke up a little there, David. Let me just try and – I think I've heard most of it. First of all, we've been really pleased with what we saw during the open enrollment period this year with OPM. I don't know if you heard the early part of the call when we talked about it. But as we talked about on the last call, we did make some investments and put some time and effort into specializing some collateral for that group to basically introduce them to WageWorks and again reiterate the value and educate them on why people should have an FSA. And you're right, the OPM business that we have right now is purely an FSA account.

So, we got through open enrollment, we were pleased with that. The growth we saw there, when I talk to the people who work with OPM over the last several years, was a good – pretty significantly higher than what they had seen in previous years. But for us, it looked to be pretty similar to what we see in the first year we work with kind of a large enterprise employer. Now, we'll piggyback off with some of that success in the year now to continue to educate, continue to put forward the value of those folks enrolling in a Flexible Spending Account program.

And two other things. One, there is still a whole number of agencies or federal agencies out there that are not part of the FSA Feds program. So we'll work with our colleagues there to try and recruit, if you will, other agencies to join the FSA Feds program. And like with all of our clients, when we usually get through open enrollment, we usually go through a quarterly business review, et cetera. And if you can imagine this client like any other client, part of that meeting will be focused on cross-selling and determining what other services we have like HSAs for Commuter, could be applicable to that group.

So, you should assume that we'll continue to be talking to them. You don't really know how those things are going to end up, but we'll be just trying to put our best foot forward, and talk about the value that we could bring with some of the product offerings that we have.

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

Okay. Great. Thanks for that. And then just lastly maybe, Colm, can you help us with the non-GAAP adjustments just for 2017 in terms of stock comp and amortization?

Colm M. Callan - WageWorks, Inc.

Sure. Sure, David. So for interest expense, again, that also depends on what happens with the interest rates, but we have roughly $7.5 million of expected interest expenses this year. Depreciation and amortization, that's probably roughly about say – depreciation is about $12 million and amortization is about $37 million. So between those two, is about $50 million. Stock-based comp is about $36 million and that should help bridge from GAAP to non-GAAP with those numbers done.

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

Right. And sorry, I have one other. Did you give the number of accounts between HSAs and FSAs at the end of the year?

Joseph L. Jackson - WageWorks, Inc.

Yeah. No. We talked about our accounts growth overall growing from $4.5 million to about $6.5 million, we didn't break it out. And then David, the other thing I would mention that I think is important to bring up with regard to OPM is, we completed that large transition of accounts as I mentioned the largest in history in a very tight timeframe. We always go out and try and judge how we've done by satisfaction scores by the participants, and right now we have very high satisfaction scores with OPM, basically as high if not higher than any book of businesses we have.

So, usually when we see that in year two and three, when we get through open enrollment processes, not only do our education and awareness programs help, but word of mouth starts to get around as well. So, we're pretty optimistic about continuing to grow that book over the next couple of years.

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

Great. All right, guys. Thanks very much.

Joseph L. Jackson - WageWorks, Inc.

Thank you.

Operator

Thank you. And I'm showing no further questions from our phone line, so I would now like to turn the conference back over Joe Jackson, for any closing remarks.

Joseph L. Jackson - WageWorks, Inc.

Thank you, operator. And I'd just like to take a quick minute to thank you all again for joining us, for your support of our company. For the employees that I know are listening, for our employees that are listening through the web, I want to again say thank you. A lot of the things that you heard us talk about today as significant increases in our business, and none of it really happens without the outstanding service we provide, the technology and innovation we bring to our clients, our industry leadership and the consumer engagement that allows employees out there to use these products much more with WageWorks and any other administrator in the market. So, that's all driven down by our employees, our partners, our clients. And again, I'd just like to thank all of them for everything that they do every day to help us.

With that, we'll end the call and look forward to talking to you all at the end of the next quarter. Thank you all very much.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a wonderful day.

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