Benefitfocus, Inc.
Q1 2017 Earnings Call Transcript

Published: 28 Apr 2017

[Operator:]

Greetings and welcome to the Benefitfocus first quarter 2017 earnings call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Michael Bauer. Please go ahead.

[Michael Bauer:]

Thank you. Good afternoon and welcome to Benefitfocus' first quarter 2017 earnings call. We will be discussing the operating results announced in our press release issued after the close of market today. Joining me today are Shawn Jenkins, our Chief Executive Officer, Ray August, our President and Jeff Laborde, our Chief Financial Officer. Shawn, Ray and Jeff will offer some prepared remarks and then we will open the call up for Q&A session. As a reminder, today's discussion will include forward-looking statements such as second quarter and full-year 2017 guidance and other predictions, expectations and information that might be considered forward-looking under federal security laws. These statements reflect our views as of today only and should not be considered as representing our views as of any subsequent date. These statements are subject to a variety of risks and uncertainties, including the fluctuation of our financial results, recruitment and retention of key personnel, general economic risk, the early stage of our market, management of growth and a changing regulatory environment that could cause actual results to differ materially from expectations. For a further discussion of the material risks and other important factors that could affect our actual results, please refer to our annual report on Form 10-K and other SEC filings. During the course of today's call, we will also refer to certain non-GAAP financial measures. You can find important disclosures about those measures in our press release. With that, let me turn the call over to Shawn.

[Shawn Jenkins:]

Thanks Mike. Good afternoon everyone and thank you all for joining us today. Benefitfocus delivered strong first quarter result with both revenue and profitability outperforming our targets. Consolidated non-GAAP gross margin increased approximately 425 basis points and adjusted EBITDA margin improved by over 1,200 basis points, both compared to the first quarter of 2016. We are proud of our execution during the quarter and remain on track to become free cash flow positive by the fourth quarter of this year. For the quarter, total revenue increased 17% year-over-year to $64.2 million and the strength of our customer relationships is reflected in our revenue retention rate that once again exceeded 95%. Also during the quarter, our employer segment revenue increased 26% over the prior year as our installed base of large employer customers increased to 853. The growth in our employer business reflects continued momentum within enterprise accounts, the positive impact from our expanded enterprise and strategic account teams, strong traction from our expanded portfolio of products with both new and existing customers and steady advancement of our partner ecosystem. I am pleased with our performance in the first quarter as the operational leverage in our model is becoming readily apparent. With the 2017 selling season kicking off, it remains to early to provide specific details on new order activity levels in Q2, yet we are confident that Benefitfocus is well positioned to benefit from a number of important market dynamics that we believe are poised to intensify over the coming quarters and years. A key trend is the secular shift of core operational activities to the cloud. One of the many benefits of the move to the cloud is flexibility and within benefits administration, this has enabled HR departments to better engage employees and offer a more personalized benefits experience. These improvements are allowing employees to utilize a broad and growing number of services to best serve their family's needs, including consumer directed healthcare, high deductible health plan, health savings account and a wide variety of voluntary benefits. Our flexible and scalable platform is an important way employers can facilitate this shift as our easy-to-use tools inform users of their options while simultaneously generating accelerated speed-to value and significant long-term ROI to our customers. Another market dynamic is the complexity of the benefits market, including regulatory factors and the accelerating evolution of consumer directed offerings. Together, the shift of personalized benefits, regulatory change and employer's desire to bend the healthcare cost curve add additional strain on outdated legacy systems and highlight the tremendous value of the Benefitfocus platform. Specifically, our cloud-based software platform, which is written as a single code base and releases new functionality four times a year best positions our customers to more rapidly and cost effectively adapt to these periods of significant market and regulatory change. Let me briefly share some thoughts with you on the status of the regulatory environment. As many of you are aware, Congress continues to push back and forth on the ACA repeal and replace reconciliation bill. While the successful completion of a repeal and replace will have numerous derivative impacts in implementations on other legislation such as broader tax reform and cost sharing subsidies, the process remains fluid as the parties work to finalize this chapter of healthcare reform. Importantly, Benefitfocus remains very well positioned, regardless of the legislative outcome from Washington. From a company specific perspective, we are establishing ourselves as the market standard and our expanded sales force is positively impacting the flywheel which not only drive topline revenue growth but increased operational leverage. From an industry perspective, the previously mentioned trends of the move to the cloud and consumer personalization are not only the most significant drivers of demand in this industry, but also helped elevate and exemplify our unique value to end-users. However in the near-term, the uncertainty lingering around the timing of regulatory change leads us to reiterate the market outlook we provided two months ago during our Q4 call. We continue to approach this year's selling season with cautious optimism as the regulatory uncertainty could impact the timing of customer's inevitable move to the cloud for benefits administration. During the quarter, we made significant progress on three strategic priorities that we highlighted at the start of 2017. The first priority is to grow the business. During the first quarter, our new sales executives continued to ramp as planned. Within our employer segment, our multitiered sales model demonstrated impressive progress and is enabling our sales executives to address our diverse employer market and execute on our land and expand strategy. You may recall, our employer segment includes our enterprise accounts which focused on employers with over 10,000 employees, strategic accounts which sell to employers with between 1,000 and 10,000 employees and our back to base team which sells to our growing installed base of employer customers. Let me provide some additional color on our team's performance in the quarter. Our enterprise team's momentum continues to grow. Highlighting both our momentum and opportunity, we closed an impressive win in Q1 with a large multinational aerospace and defense corporation that selected Benefitfocus Marketplace, the BenefitsStore, our benefit service center and core analytics. With over 25,000 employees, this highly acquisitive enterprise needed a flexible cloud-based platform to retire their heavily customized legacy on-prem application. This industry leader's selection of Benefitfocus reflects our ability to streamline administration, improve efficiencies, integrate with SAP's Employee Central and improve communication to a diverse workforce. During Q1, our strategic account team also logged impressive wins including a luxury clothing and lifestyle corporation who selected Benefitfocus Marketplace, our BenefitStore and ACA Management & Reporting. This strategic account, with over 6,800 employees selected Benefitfocus to drive participation in their new high deductible and HSA offerings to deliver a consolidated and coherent voluntary benefits experience, to enhance user experience for both their full-time and part-time employees and to improve data quality and data integrations. As our strategic sales team ramps in line with our expectations, we are optimistic the velocity of this segment will accelerate as these new sales team members build tenure. As I mentioned earlier, the traction of our expanded portfolio of products continues to be strong and fueled impressive attach rates from new customer bookings and growth in back to base transactions during the first quarter. In our carrier segment, we experienced good renewal and upsell activity in the quarter. With 53 of the top 100 carriers on our platform, we are focused on cross-selling solutions into our underpenetrated installed base and with the assistance of our market adoption team help our existing carriers expand the size of their membership on our platform. During Q1, we demonstrated progress in each of these initiatives and experienced specific strength in developing new expansion opportunities through the use of proprietary tools that show existing customers further cost savings by leveraging our broad suite of products. The second of our 2017 priorities is to continue to improve profitability and achieve positive free cash flow by the fourth quarter of this year. As previously stated, during Q1 we posted impressive margin expansion once again, as our team did a phenomenal job of operational execution in capturing the benefits of our growing scale. Our results reflect our ability to leverage the significant investments we have already made in our products, technology and distribution that together position Benefitfocus to drive long-term value to our shareholders from both topline growth and profit expansion. As we continue to demonstrate operational scale, we remain confident in our ability in 2017 to deliver 300 to 400 basis points of consolidated gross margin improvement and greater acceleration of adjusted EBITDA while simultaneously allocating ample resources to support our long-term topline growth and ongoing investments in sales, marketing and product development. The third priority is to drive continuous solution innovation and efficiencies across our world-class platform and products. Our engineering team is focused on driving innovation within the massive $1.6 trillion benefits industry. This results in a systematic increase in products that not only enables Benefitfocus to capture more wallet and mine share, but also drives a steady increase in our addressable market. Last month, at our annual One Place user conference, we unveiled a number of new enhancements to our best-in-class platform and announced a suite of new products which both enrich the comprehensiveness of our offering and further expand our employer PE/PM opportunity to now nearly $10. This is a meaningful and impressive increased from the approximate $3.50 total employer PE/PM opportunity we had at our IPO just a few years ago. Some of the specific announcements included new advanced reporting functionality for both our carrier and employer customers, which improves visibility as well as confirm the quality and data accuracy of files, consolidated billing to manage invoice reconciliation on our platform, which serves as our customer's enrollment system of record and to simplify complexity and cultivate data for strategic insights. We also announced the release of Benefitfocus business intelligence, which is a portfolio of software and software enabled services that will help our customers drive optimal outcomes. Speaking of optimal outcomes, this week and next week we are hosting our Open Enrollment Success even which brings together our technology solutions and customer success organizations to prepare for this year's upcoming open enrollment. Not only are these groups collaborating on how to ensure this open enrollment is our best enrollment yet, but it's also on additional ways we can further extend our competitive advantage. Finally, I would like to provide an update on our CFO search. Since launching our search for Jeff's replacement after Q4 earnings call, we have met with a number of very talented individuals and I am confident that our focus on this search will yield positive results. Starting next month, our President Ray August will serve as our interim CFO and lead our experienced and talented finance organization during this period of transition. As many of you know, Ray has a strong operational and accounting background and is a member of the American Institute of Certified Public Accountants. Before I turn the call over, I want to thank all of the Benefitfocus associates. This great start of the year would not have been possible without all of your hard work and dedication. Thank you all for all you do to make Benefitfocus such a great company. With that, I will hand it over to Jeff. Jeff, take it away.

[Jeff Laborde:]

Thank you Shawn. We are pleased with our results this quarter which exceeded our revenue and profitability targets. I will begin by reviewing the details of our financial performance for Q1 and then I will pass the call over to Ray to provide our guidance for Q2 and fiscal 2017. Total revenue for the first quarter was $64.2 million, an increase of 17% compared to the first quarter of 2016. This result exceeded our guidance and reflects contribution from the sales of products to both new and existing customers and high revenue retention as well as the completion of certain professional services projects ahead of schedule. Employer revenue for the quarter was $40.6 million, up 26% compared to the year ago period and as discussed last quarter reflects the favorable impact of the shift of revenue from our ACA reporting product into Q1 this year from Q2 of last year. Carrier revenue of $23.5 million was up 4% compared to the same period last year. The sequential decline in carrier revenue reflects the accelerated revenue recognition from a professional services contract that benefited Q4, as we discussed in prior quarter. Total software subscription revenue was $56.7 million, representing 88% of total revenue and grew 16% year-over-year. Employer software subscription revenue was $38.8 million and grew 25% year-over-year. Total professional services revenue was $7.5 million representing 12% of total revenue and an increase of 28% over Q1 2016. As previously mentioned, professional services revenue benefited from the completion of certain projects ahead of schedule, resulting in modestly higher revenue recognized from professional services in the quarter versus our original expectations. Non-GAAP gross profit totaled $33.3 million or 52% non-GAAP gross margin which compares favorably to the 48% non-GAAP gross margin in Q1 of 2016 and the 49% non-GAAP gross margin in the prior quarter. The nearly 425 basis point improvement over last year and over 250 basis points sequential improvement reflects the many operational benefits of our increasing revenue scale, ongoing progress in our infrastructure optimization efforts and continued cost management. Non-GAAP software gross margin of 62% was down from 65% in the year ago period and largely reflects an increase in third-party service expenses for subsegment of RHA product customers. Sequentially non-GAAP software gross margin improved by over 525 basis points. The sequential decline in professional services gross margin resulted from the quarter-over-quarter decline in services revenue which reflects the impact of typical seasonality and as mentioned last quarter the accelerated revenue recognition of a large services contract in Q4 last year. In addition to our strong revenue gross margin performances, I am also pleased with the company's year-over-year and sequential improvements in adjusted EBITDA result. Q1 adjusted EBITDA of $3.6 million was $0.6 million ahead of our guidance and at 6% of revenue reflects continued improvement from 5% of revenue in the prior quarter and a negative 7% of revenue in Q1 2016. Aside from sales and marketing, operating expenses declined as a percentage of revenue which demonstrates our increasing operational scale. We are pleased with our ability to invest for growth will simultaneously driving adjusted EBITDA expansion. Non-GAAP net loss per share was negative $0.11 based on 30.7 million weighted average shares outstanding and was at the high-end of our guidance for loss of negative $0.11 to a negative $0.15 per share and the year ago period loss of negative $0.29 per share. GAAP results for the quarter included gross profit $32.6 million representing a margin of 51% and an operating loss of negative $4.6 million translating into a net loss per share of negative $0.25. Moving to the balance sheet. We ended Q1 with cash, cash equivalents and marketable securities of $57.7 million. Total deferred revenue declined $6.9 million sequentially to $68.9 million. The decline in deferred revenue reflects the recognition of revenue from our ACA products in the quarter, seasonality and our de-emphasis of certain lower margin carrier professional services engagements. On the statement of cash flows. Cash used in operations totaled $7.4 million for the quarter and compares favorably to the $19.8 million used in operations during the same year ago period. The first quarter remains our seasonally heaviest cash outflow quarter, as Shawn previously highlighted. With the benefit of our topline growth and our improving margin profile, Benefitfocus remains on track to become free cash flow positive by the fourth quarter of this year. With that, I would like to pass the call over to Ray.

[Ray August:]

Thank you Jeff. I would also like to congratulate the team for the strong performance in the quarter. As I highlighted last month at our One Place analyst briefing, operationally we are focused on automating manual processes, ensuring data accuracy and visibility, leveraging data standards and investing in training tools to enhance the skills of our associates. Our commitment to these areas not only delivers ongoing product and service enhancements for our customers that deepens our competitive differentiation and drives topline growth but also generates efficiencies within our organization and improves our profitability. With the investments in our platform and products continuing to drive efficiencies and as our scale improves, we remain confident in our ability to achieve 300 to 400 basis points of total gross margin improvement in 2017. Our consistent profitability and cash flow improvement over the last year enabled us again to opportunistically negotiate more favorable terms on our revolving loan facility. Recall that in late October 2016, we amended and extended our agreement to expand the size of our aggregate loan amount from $60 million to $95 million. The details of the new amendment will be filed in conjunction with our 10-Q tomorrow. Now turning to our outlook. For the second quarter of this year, we are targeting revenue of $61.5 million to $62.5 million while our first half revenue expectations remain unchanged as mentioned on our prior quarter's earnings call. Q2 revenue will be impacted in the year-over-year comparison by the shift of ACA product revenue out of Q2 into Q1. Additionally, as Jeff mentioned earlier, Q1 professional services revenue benefited from the completion of several professional service projects ahead of schedule, which resulted in the shift of revenue out of Q2 and into Q1. From a profitability perspective, we expect adjusted EBITDA of $1.5 million to $2.5 million, a non-GAAP net loss of negative $5 million to negative $4 million and a non-GAAP net loss per share of negative $0.16 to a negative $0.13 based on 31 million weighted average shares outstanding. For the full year, we are reiterating our existing 2017 outlook. This includes total revenue in the range of $263.5 million to $268.5 million. We expect adjusted EBITDA of $13 million to $17 million, a non-GAAP net loss of minus $11.5 million to minus $7.5 million and a non-GAAP net loss per share of minus $0.37 to minus $0.24 based on 30.9 million weighted-average shares outstanding. Additionally, we continue to expect free cash flow which we define as cash provided by or used in operations less capital expenditures, to be positive by the fourth quarter of 2017. In summary Q1 was a great start to the year. While we are approaching this year's selling season with cautious optimism to reflect the impacts of ongoing revenue regulatory uncertainty, we remain tremendously excited about the massive long-term opportunity in front of us. With that, we are now ready to take your questions. Operator, please begin the question-and-answer session at this time.

[Operator:]

[Operator Instructions]. Our first question comes from Nandan Amladi of Deutsche Bank. Please proceed with your question.

[Nandan Amladi:]

Hi. Good afternoon. Thanks for taking my question. So you mentioned a couple of times that in the script that you are viewing of this year's enrollment fees for new customer with cautious optimism because of regulatory changes. How much of a driver is regulatory change versus just automating what has thus far been a fairly manual benefits process?

[Shawn Jenkins:]

Sure. Great question. Thanks Nandan. First of all, we are obviously really proud of our sales team and the first quarter's great execution really top to bottom is a refresher for everybody on the call. Our Benefitfocus has now our largest sales team in the company's history and the activity levels are really terrific. As we engage with a large employers, the primary motivation of them moving from their legacy on-premise or of outsourcing arrangements moving to the cloud to gain the efficiencies of cloud-based infrastructure, the Software-as-a-Service delivery model we deliver. At the Benefitfocus platform, in one code base, four software releases each year has been the main macro theme here very much of a tailwind. And as you mentioned, there are still a lot of paper in the benefits industry and islands of information and with the Benefitfocus platform, we improve that dramatically and that's what's really propelled our growth and will continue to into the future. As we look at this particular selling season which we are entering right now where employers make their decisions about their benefits for the upcoming open enrollment season which start in October, November of this year for a January 1, 2018 effective date, the employer looks at the totality of their benefits spend. They look at the programs they are offering and we are very optimistic that the tailwinds in the macro themes are in the favor moving to the cloud, moving to the Benefitfocus platform. But when you have this much back and forth in Washington, it does get the attention obviously of employers as they make their plans for the year. So we are, as we mentioned, cautiously optimistic for the selling season. I think the nice thing is, regardless of how the adjustments to the Affordable Care Act end up coming, whether there is repeal and replace or whether there are incremental changes, all of that really proves to why an employer needs the modern cloud infrastructure to communicate these benefits to employees to be able to keep up with the regulatory environment to be able to adapt to the economic changes that are happening with the way employers are funding benefits. So if anything, it's sort of a period that we have seen before in prior Washington back and forth on healthcare. But we are really proud of the large sales team that we have in the field and the high activity levels that we are having and because we are just now starting that selling season, that's why we are using the idea of cautious optimism at this point.

[Nandan Amladi:]

Fair enough. And a quick follow-up on the sales organization. You have made some changes last year that moving people to the national accounts team and so on. You just mentioned that you now have the largest team in your history. What is the growth trajectory you expect to see for the remainder of the year on the sales capacity?

[Shawn Jenkins:]

Yes. A good follow-up. So just for reference, we now have three employer sales teams at Benefitfocus, what we refer to as enterprise which sells to employers who have 10,000 or more employees. That team is fully staffed. Our strategic accounts team, which sells to 1,000 to 10,000 employees and they are at levels that we wanted them to be at the beginning of the year and they are ramping as planned. A lot of great new folks in there. I am really proud of our management team and the recruiting team and really the talent that we have been able to bring on to our sales team is incredibly impressive. And then we have a back to base team which sells into our installed customer base which has obviously gotten quite large now with 853 large employers. So those three teams are at the size we want them to be at this point in the year. They are ramping as planned. We will do a little bit of incremental adding throughout the year, just opportunistically as we go. But we have got the size of the team in place that we wanted to.

[Nandan Amladi:]

Thank you.

[Shawn Jenkins:]

Thank you.

[Operator:]

Our next question comes from Brian Peterson of Raymond James. Please proceed with your question.

[Brian Peterson:]

Yes. Thanks guys and congrats on the upside this quarter. So you referenced some new carrier products last year and you mentioned on the call this quarter, Shawn. Where are some of those new wins going to start to hit the P&L as we think about 2017 and into 2018?

[Shawn Jenkins:]

Yes. Great question. Well, one of the major new products that we rolled out in the second half of 2016 was our certified carrier partner program and we did announce our first certified carrier win in the fourth quarter. That implementation will take better part of this year. So that will begin to contribute in the second half of 2017. We also did some significant updates to our data exchange, the exchange of product for carriers and we see some really good traction, both in late 2016 and in our pipeline for 2017, 2018 where this phenomenon where employers are getting more and more payroll files and disparate information from brokers and they need help collecting that and organizing that and getting it into their membership systems. We had several of those wins on the last couple of quarters and those are beginning to actually contribute now and they will through the balance of the year. So a lot of exciting things happening in the carrier business and really liking what we are seeing both in the pipeline but also in the customer relationships.

[Brian Peterson:]

Got it. And then maybe just sticking on the same theme but in the employer side. A lot of the newer products there, which ones have really been driving the accretive nature to PE/PM? And anything that you can say on overall deal sizes in that segment? Thanks.

[Shawn Jenkins:]

Yes. Well, deal sizes continue to grow and really meaningfully of the last two years. Our size of employer has grown and the attach rate of our products continues to expand. So directionally both of those are in our favor. As we mentioned on the prepared remarks, we now have approximately $10 PE/PM as a TAM in our employer business. That's up from $3.50 just a few years ago at our IPO. And we are really pleased to see really the broad adoption of products, whether it's the BenefitStore, which provides a wide variety of voluntary benefits to our employers, our core and advanced analytics is extremely popular and at our One Place conference just last month, we introduced a new Benefitfocus business intelligence and we have gotten great feedback from our customer base and prospective customers so far. And one that I am particularly excited about is this notion of consolidated billing. It's a new product that we introduced at One Place. And if you think about what we have historically done at Benefitfocus is communicating benefits for an employer, enrolling employees, signing them up, getting all their information and getting that data to the right place. Now what we are beginning to do is handle the other side of that coin, if you will, where we will consolidate the bills for the employer, show them a reconciled view of all the bills they have and then provide a mechanism for them to pay their insurance carriers. It really is a terrific administrative service for the employer. But we think it fits very nicely with our BenefitsStore, for example, as employers offer more and more of wider array of benefits, they need more help with all the reconciliation of those bills and we have built a terrific technology that takes manual processes and the handling of paper bills and really eliminate that. So we are getting great feedback from our customers as early, we just launched that new product. But I think the last point I would make, Brian, goes back to the size of the employer. One of the reasons we see our Benefitfocus winning in the larger and larger space, the enterprise space is, we really have now a tremendously well-rounded product offering in the field and these large employers expect that level of service and they are excited to be moving paper-based processes or traditional outsourcing models now to the cloud on the Benefitfocus platform. So each time we add those, expand our TAM, I think we also become that much more attractive to the next large employer.

[Brian Peterson:]

Understood. Thanks Shawn.

[Shawn Jenkins:]

Thank you.

[Operator:]

Our next question comes from John DiFucci of Jefferies. Please proceed with your question.

[Howard Mai:]

Hi. This is Howard Ma, on for John. Thanks for taking my question. Shawn, so my question is on the health of the public data exchanges and how we could potentially impact both the carrier business and the employer business? But I think something like 25 of 30 carriers withdraw from their public data exchanges. So one of my initial interpretations of this is that it could actually be positive for the private exchange market and for Benefitfocus as carriers might refocus more attention and resources on the private exchanges and it could also lead to more employers setting up private exchanges. But I am curious on your perspective?

[Shawn Jenkins:]

Yes. Great question. Very insightful too, by the way, Howard. Just by the way of background, at Benefitfocus we are engaged in providing both insurance carriers, large health plans, life insurance companies and employers the world's best we believe cloud platform to manage all the benefits, communicate those benefits. We have not provided the technology to the public exchanges, whether at the federal or state level, something we looked at years ago and just felt like it would have a lot of back-and-forth and we ended up being right about that. And so we see this shift back to the private sector, if you will, as bullish for Benefitfocus. As you point out, I would agree with your statement or your directional thesis. What we proven here is that employers are very important. The funding by employers, the programs that they offer both health insurance but all of the other voluntary benefits that go with it. And clearly, whether it's the state or federal government, we now have a scenario where the private exchange, whether people continue to use that term private exchange a lot or whether it just becomes more referred to as a marketplace for benefits, I think those are going to become more and more popular, more and more necessary. They really are becoming the safety net, if you will. And if there are some changes to the way the public exchanges and the public subsidies as those are affected will stand out and it would be in some way that's going to put, we believe more people into the private sector. And it goes along with this is employment, right. So more people are employed, employers are fighting for talent. A lot of people that would of been on the public exchanges might have been underemployed or unemployed. And so as people come back into the workforce, they are going to be looking for a marketplace from their employer or perhaps their carrier or their broker and we think all of those things are good for the Benefitfocus story in the next couple of years.

[Howard Mai:]

Shawn, thanks. I eternally appreciate those insights. And if I could sneak in another.

[Shawn Jenkins:]

Sure.

[Howard Mai:]

You have carefully reallocated some of your salespeople to focus on the larger employers with 10,000 or more employees. In your discussions with some of these new, you call them the enterprise sales force, I am just curious if you have seen any unexpected insights? As we know, many of these large employers, I imagine almost all of them use on-prem suite and those suite really vary in terms the robustness and benefits administration. So could you comment, I guess, on number one, the competitive dynamics? Are you finding that you might need to give some volume discounts to compete with, not even compete but just to get in the door and to complement an existing suite? And just any other, I guess, sales cycle or anything that you said you are differences versus the 1,000 for 10,000 range?

[Shawn Jenkins:]

Sure. Well, in the 10,000-plus range which we now refer to as enterprise, we did really create a dedicated team over a year ago, mainly because we saw this phenomenon where larger and larger employers were coming to Benefitfocus. And Benefitfocus become a public company back in 2013. It took a couple of years for larger enterprises to really learn who the company was. Our brand recognition is growing every day. And so we began to get in more and more conversations with larger and larger employers. Also as we built out our product suite with consolidated billing, the BenefitStore service center analytics, we really now have the broad cloud platform that these large employers are looking for. And they are seeing the move to the cloud in other areas of their business of being very successful, right. They are seeing the savings. They are seeing their employees engage with other areas of their business whether it's finance or expense management or CRM or whatnot. And benefits needs to move there too for all the reasons that we are discussing today. From a competitive standpoint, we certainly don't see any pricing pressures. There is not really new entrance, particularly as you go upmarket. Large employers, they want to work with a large company. They want to see big research and development. They want to see a large customer community that's growing, it's vibrant. And if anything, historically they have been paying for a lot of manual processes, a lot of paper to be handled, a lot of phones to be answered. And so we are able to offer self-service mobile capability, a much better experience, I mean by far than the traditional ways either on-prem or outsourcing model. And we can do that with leverage and you can see that leverage showing up in our model. So we are very optimistic about really the strategic accounts, but also the enterprise space and we think each new large employer that we add makes the ecosystem that much more attractive and the investment in R&D gets the leverage that much more. So really excited about that trend.

[Howard Mai:]

Okay. That's great to hear. Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from Ross MacMillan of RBC Capital Markets. Please proceed with your question.

[Robert Simmons:]

Hi. This is Robert Simmons, on for Ross. I was wondering if you could update us on the deferred revenue runoff dynamics for this year and next?

[Jeff Laborde:]

Sure. Robert, it's Jeff. We have the broader long-term trend at work or at play going back over two years now where particularly on our the carrier side of our business and the nature of our accounting and revenue recognition dynamics for the professional services work that we do in that business, that area of the business. We were heavily engaged at the time in a lot of work, customization work in particular, very large projects or multiyear that gave rise to a significant amount of that deferred revenue. That has since then continued to, particularly as we have stopped signing up for really a lot of those new projects and focused instead on productizing that kind of work, that kind of work has declined in volume pretty significantly. And so what you have seen is that balance continue to decline pretty consistently with some offsets from time-to-time as you would expect on new professional services projects that are ordinary course, but also on our software revenue. We do not have in terms as a point of comparison with other SaaS software businesses historically that as a leading metric for us our new order activity primarily because in the past, we often did a lot of monthly invoicing contracts as opposed to annually contracts. That is something we are changing to come more in line with the industry norm. And so in particular as that service deferred, services revenue starts to bottom out and you see that bleed off and we do get more of our newer contracts that we sign on to an annual upfront payment, we would expect not in the next couple of quarters in the coming years to see that become a more relevant metric that also will start to grow again with the business.

[Robert Simmons:]

Great. Can you quantify how big a run-off you are expecting this year and for next year? And maybe do you have an idea of the timing of when it might turn around?

[Jeff Laborde:]

No. I don't think we have in the past provided guidance specifically on deferred. I don't expect the trend that I alluded to, to reverse within the next few quarters. It's probably something within the next couple of years that would revert.

[Robert Simmons:]

Got it. And do you expect the seasonality going forward be similar to what embedded guidance for this year? Or is there any changes you expect in terms of timing of revenue that's recognized?

[Jeff Laborde:]

We historically have had a fair amount of seasonality in the business driven by our selling season. For many enterprise software businesses, Q4 is the strongest of new order activity period of the year. For us, it's driven more in the second half of Q2 and on into Q3 as companies are leading into their end of the year open enrollment cycles. That seasonality continues to stay intact from a new order standpoint. One of the things that has diluted that a little bit are some of these larger enterprise accounts that do take more time to implement. And as a result over time, we do expect that that might start to flatten revenue out a little bit at least in terms of Q1, Q2 and Q3, but I think we do expect Q4 to continue to be one of our heaviest quarters in terms of new software revenue as those customers come live, out of our selling season and into actual live deployment and the professional services that comes along with implementing those.

[Robert Simmons:]

Okay. Great. Thanks.

[Shawn Jenkins:]

Thank you.

[Operator:]

Our next question comes from Jesse Hulsing of Goldman Sachs. Please proceed with your question.

[Jesse Hulsing:]

Thanks for taking my question. Shawn, I wanted to dive a little bit into your mix of new orders. When you look at strategic versus enterprises in the adds this quarter, any shift towards the bigger accounts? And when you look at the pipeline in the selling season, should we expect you to sign a higher mix of larger accounts? Or do you expect things to be similar to last year? Just curious about that.

[Shawn Jenkins:]

Yes. Well, I think what we saw last year, certainly in 2016 as we really begin to sign these enterprise accounts, 10,000 employees and more, as we define it, at greater volumes because the market was ready for that, our brand was really getting recognized, our broad portfolio of products and we had really allocated of our seasoned sales people to that segment. Of course in 2016 second half we brought on a fair number of, what we call, freshman, first year folks into the strategic account area. Their activity is great and they are in the field for their first selling season. So I think it will look perhaps similar to last year, where we continue to see very good activity on the enterprise side. However, we do have a bigger team in that strategic account. So as we get into selling season, clearly we will have a better handle on that. But against a couple year trajectory of our deal size getting larger, our average employer getting larger overall and multiproduct sales, both of those things are still intact this year. So we would think that most likely our average size is going to bigger this year than last year.

[Jesse Hulsing:]

Yes. It's helpful. And within that strategic segment, how is the competitive landscape trending? Are you seeing more competitiveness as some of the suite vendors add functionality and I guess do a better job of addressing this market with cloud solutions?

[Shawn Jenkins:]

Yes. For me, when an employer is wanting to add more benefits they want to have multiple health insurance plans, they will need high deductible plans, health savings, account enrollment, they need to communicate things like gap insurance, voluntary programs where an employee pays out of their paycheck or maybe with a credit card and there is no ERP vendor or payroll system or even the traditional outsourcer that is really addressing that broad selection of benefits. Even employers that have 1,500 employees or 2,000 employees, they are expecting the rollout 12, 15, 18 different benefit types to an employee and the legacy systems, regardless of whether they are on-prem or delivered over the Internet, they don't have the breadth of ecosystem of those carriers, the engineering team focused on that. So if anything, I think that we are picking up pace and we have great channel partners too that now are distributing the Benefitfocus platform with their sales teams. So we are not seeing new entrance, particularly in the 1,000 plus space that's a big employer with big expectations and they certainly will be, regardless of what happens with the Affordable Care Act back and forth, they are going to want to offer more consumer oriented benefits which requires a lot more communication, a lot more variety and linkages between these different benefit types. And that's just, it's a big market and I think we are starting to prove that.

[Jesse Hulsing:]

Yes. And the back to base team, how is that initiative going? And I guess as the mix, when you look at new software bookings, are you seeing the mix trending up from a contribution point of view from that base selling motion?

[Shawn Jenkins:]

Yes. So our back to base team, we talked directly about the numbers last year when we brought it to market for the first time and we had five people in the back to base team. It's now larger than that coming into this year. They had a great year in 2016. They are off to a really good start in 2017. So you will start to see those numbers show up later this year in the second half of the year. We would think in the next couple years the base, the customer base is largest. It is now will be a more meaningful contributor to the subscription revenue and particularly as we roll out additional products which we have a really good habit of doing each year. So we got more to sell with base is larger and the back to base team is getting larger. So we are particularly excited about that. And that just points to high retention rates, better margin, we attach more products, better cash flow for us and happier customers that are getting more value out of the Benefitfocus platform.

[Jesse Hulsing:]

Got it. Thanks Shawn. I appreciate it.

[Shawn Jenkins:]

Yes. Thank you.

[Operator:]

Our next question comes from Frank Sparacino of First Analysis. Please proceed with your question.

[Frank Sparacino:]

Hi guys. Shawn, maybe for you, just going back to some of the earlier comments on the enterprise side, I was curious if you can give us an update on sort of the go live that have been completed and implementations scheduled, maybe for the rest of 2017? You had one very large employer, north of 100,000 employees signed last year. I think it was supposed to go live in the first half of this year, but maybe just some thoughts around what that looks like?

[Shawn Jenkins:]

Yes. I would call it on plan. So last year, we really began to see these larger and larger accounts and the dynamic of these enterprise accounts, particularly when they starting getting over 25,000, 50,000, they go live in a cadence that's more aligned with their IT infrastructure and whatnot. And the ones that we signed last year, we feel are moving at the pace we thought they would and on schedule, if not maybe even a little ahead of schedule. Some of them are big and some of them won't go live until this summer. But the implementation team is doing terrific. And matter of fact, we even mentioned in the prepared remarks that we had a couple of projects go live early in the first quarter and really proud of the work that our implementation and project teams are doing. So we are in good shape there.

[Frank Sparacino:]

And maybe just one follow-up on the ACA compliance side of things. I think last year, that was roughly a $5 million boost in the second quarter. Is the contribution similar this year? And I don't know if you have seen any sort of the trail off as it relates to ACA compliance, just given the uncertainty and it has to do that people don't believe the employer mandate is going to get enforced at all. So any thoughts there?

[Ray August:]

Yes. Hi. This is Ray. Last year, we saw the $4.4 million in Q2 in ACA revenue and as w said in the prepared remarks, we have now recognized that in Q1 and it is a similar amount and we are taking that amount ratably through the rest of the year as well. So we are continuing to see demand around ACA and we expect it to continue.

[Shawn Jenkins:]

Yes. And I would add too. Just a little more color on what employers are thinking. We haven't seen any trail off of people saying I don't think I need to do this. They are pretty clear. Even with the degree from of pundits in Washington, regardless of what happens on a repeal or replace situation, it's pretty clear that you have got the current back pattern at least for several years even if they do make some changes, probably 2019, 2020 at the earliest before they would start pulling at some of those things. The employers believe that for the next several years, they are going to need to do the IRS reporting at a minimum and it's showing up in what Ray said.

[Ray August:]

Yes. We are actually already working on the 2017 ACA customer.

[Jeff Laborde:]

And to add in from a modeling perspective, is because it is a bit of a quirk with the shift from last year, the timing from year-to-year on a more normalized basis. So sequentially the subscription software excluding the lumpsum ACA amounts would have been up modestly in Q1 and embedded in the Q2 guidance are you will have your software revenue growth accelerates from Q1, we believe on a normalized basis, not ACA basis, if that helps.

[Frank Sparacino:]

It does. Thank you guys.

[Shawn Jenkins:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from Steve Wardell of Chardan. Please proceed with your question.

[Steve Wardell:]

Hi guys. Thanks for taking my question. You had mentioned previously that you are seeing a little bit of an HR contracting pause. Can you tell us more about this? I know you are going into the selling season now. Do you think that's continuing? How do you think it will play out in terms of what's happening in Congress? Can you give us some more color on that?

[Shawn Jenkins:]

Sure. On the last call our prior call, we mentioned that in the fourth quarter we saw with the election and all that and uncertainties that was going at HR department in general, I think many other companies talked about this and benefits saw a little bit of pause. Clearly we got off to good start in the first quarter here at Benefitfocus. And we talked about in the prepared remarks and a few other comments here that we are just starting the selling season here. Our employers tend to look at their benefits package of now April, May, June, July, make their decisions and then get prepared for open enrollment which they tend to do in November timeframe. So it's too early to really tell if that pause will continue. We have really put together a great sales team though, our largest sales team. Our activity levels are very strong and we will just need to get into the selling season a bit further to see how employers interpret the ACA changes that might be coming their way regardless the macro themes, the tailwinds that we see moving to the cloud are very much intact. And so we are just using the term cautious optimism.

[Steve Wardell:]

Great. Thanks. And when you look at existing customers of Benefitfocus, what are the products for the 2017, 2018 year that they maybe looking to add? What sense do you get from talking to customers about the popular products that they may want to add to their suite of products?

[Shawn Jenkins:]

Sure. It's good distinction actually, because in our existing customer activity, we don't really see any pause. We see a lot of enthusiasm for the new products that we rolled out at One Place as well as the things like our BenefitStore that we have had for the last couple of years. So a lot of enthusiasm around introducing voluntary benefits through the BenefitStore, our analytics and our new business intelligence capability, the Benefitfocus business intelligence suite. We are hearing a lot of good things about our new consolidated billing offering where we will take all the bills on behalf of the employer and consolidate them, reconcile them to their payroll and help them pay their carriers efficiently. So this idea of a wide array of benefits, a more flexible benefits offering to the employees and then the administrative capability to get the data, the insight and then make all that efficient and accurate really is the theme. So the customer community is extremely vibrant and active and our sales there looks really strong.

[Steve Wardell:]

Great. Thank you.

[Shawn Jenkins:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks.

[Shawn Jenkins:]

Great. Well, this is Shawn. Thanks everyone for joining the call tonight and one more shout out to the Benefitfocus team. You guys are tremendous to work with and all of our great customers, we appreciate everything. So have a good night everyone.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.