Benefitfocus, Inc.
Q2 2016 Earnings Call Transcript

Published: 4 Aug 2016

[Operator:]

Greetings and welcome to the Benefitfocus Second Quarter of 2016 earnings call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Michael Bauer, Director of Investor Relations. Thank you, you may begin.

[Michael Bauer:]

Thank you, operator. Good afternoon and welcome to Benefitfocus's second quarter 2016 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, and Ray August, our President and Chief Operating Officer. Shawn and Ray will offer some prepared remarks and then we'll open the call for a Q&A session. As a reminder, today's discussion will include forward-looking statements such as third-quarter and full-year 2016 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 at 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 and 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 are actual results, please refer to our annual report on form 10-K and our 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:]

Super. Thanks, Mike. Good afternoon, everyone and thank you all for joining us today. Benefitfocus deliver strong second-quarter results with both revenue and profitability outperforming our targets. The outperformance in adjusted EBITDA was dramatic with our quarterly loss nearing to just 2% of revenue from 25% of revenue in the year-ago period. We are especially proud of this performance, as revenue during the quarter increased a robust 36% compared to the same period a year ago. Our performance in the second quarter shows clear evidence that we are well on our way to achieving Adjusted EBITDA profitability in the fourth quarter of this year, a major milestone for our business. During the quarter, employer revenue increased an impressive 75% year over year. With 18,000 large employers in the United States, we are establishing a leadership position in a strategic and highly underpenetrated market opportunity. Once again for the quarter we delivered revenue retention rates in excess of 95%. The secular shift of large employers moving core operational activities to the cloud, including benefits management, is one of the most powerful IT trends in the last few decades that continues to drive demand for our platform. Many of you will recall that entering 2016, we made changes to the structure of our employer sales organization to best align our resources with the growing adoption of cloud solutions in the benefits market, to optimize the ROI on our overall sales investments and to ensure that we are fully leveraging our leadership position to capture the massive market opportunity in front of us. This meant that we moved from a single employer sales team to an employer sales organization with three teams. First, our tradition large employer team, which is now focused on employers with between 1000 and 10,000 employees; a new back-to-base team to target are large and rapidly growing customer base; and a new national accounts team which is focused on employers with over 10,000 employees. As we made this transition within our sales work structure, we moved roughly 25% of our resources from our large employer sales team, which focused on driving volume with new logos, over to our new national accounts team. At the same time, during the first half of 2016, we essentially kept our overall sales headcount even as we focused first and foremost on ensuring our new sales structure was effective. And was also consistent with our overall focus on driving operational efficiency throughout our entire organization as we continue to scale the business. The results to date have been fantastic. First in national accounts, during the quarter we closed six new national accounts. This success drove a material increase in our average deal size in and lives on the platform. Let me highlight a few of the wins for you. First, a leading global technology company selected Benefitfocus Marketplace, Core Analytics and our core communications package for its approximate 12,000 US employees. This industry leader selected Benefitfocus for our industry-leading data integration and advanced capabilities to personalize benefit recommendations and communications to its 12,000 unique employees. Second, a family-owned grocery and pharmacy retailer, with approximately 15,000 employees across multiple states, selected Benefitfocus Marketplace for the platform's ease of use and to simplify their benefits administration process. Third, a global energy company with approximately 19,000 employees and operations in the United States, Middle East and Latin America selected Benefitfocus Marketplace, Benefitfocus Service center, Core Analytics and AC management reporting to simplify the complexity of managing benefits in compliance for its US employees. In addition to these new clients, shortly after the quarter closed, our national accounts team signed a massive employer with 120,000 employees. This is a multi-year, multi-product contract that is slated to go live in the first quarter of 2017. As we add new national accounts, we're also getting the benefit from the natural expansion in average revenue per count as existing customers add additional solutions. One national account, a retailer with over 35,000 employees who initially deployed Benefitfocus in 2015, significantly expanded their relationship during the quarter with the addition of Benefitstore, Core and advanced analytics and other solutions. In short, the momentum of our national accounts program is very strong. We couldn't be more pleased and we will be adding more investments in this area of our business. With respect to our large employer team, they delivered a solid performance in the quarter. From an account perspective, this team still drives the majority of new customer logos. During the second quarter, we added 62 customers in total finishing the quarter with 803 large-employer customers. The number of customer adds was down compared to a high volume quarter a year ago; however, I mentioned a moment ago that we migrated roughly 25% of our large employer sales organization over to our new national accounts team. I would also keep in mind that there is a wide variation in customer size. For example, the 120,000 employee national accounts added by our national account team in early July is essentially equivalent to approximately three dozen large accounts added by our large employer team. As we look ahead, we feel very good about the momentum of our large employer sales team. We expect to benefit from increasing tenure of this sales team, in addition to the fact that we plan to hire aggressively in the second half of this year, increasing the capacity of our large employer sales team well above where it was prior to carving out resources to create the new national accounts team. Our increased investments in large employer sales will continue to provide a large and expanding opportunity for our new back-to-base sales organization. During the second quarter, we saw over 50% growth in the number of add-on transactions into our installed base. Additionally, our new employer solutions continue to experience strong demand from new customers as over two-thirds of new employer customers selected more than one product during the quarter. From an overall perspective, I'm very excited about the structure and performance of the employer sales teams. During the first half of 2016, we have generated strong growth in sales by better allocating our resources to meet the market demand for our platform and growing suite of solutions. With the effectiveness of our three employer sales teams proven out and market demand remaining strong, we're now going to step on the gas with additional investments in the second half of 2016. Importantly, these investments were already taken into consideration with respect to our move to positive-adjusted EBITDA by the close of this year and we expect to remain in positive territory as we fully absorb these investments. Moving on to our carrier business, as a leadership team, we've always believed that as our employer business grows, we would see a strengthening in the care business and find opportunities to cross-sell other solutions back into our carrier installed base. At the start of 2016, we began to transition our carrier business away from the lower margin service revenue to high-margin recurring product revenue, as well as introduce new sales leadership that realigned our account executives to accelerate back-to-base sales. The results have been very encouraging thus far as during the second quarter we completed five sizable renewals and increased our penetration within our installed base. Let me share one recent example. Earlier this year, we identified an opportunity with a large insurance carrier to improve the quality of data they received from their employer customers. This conversation led to the addition of our e-exchange solution as we completed the renewal for our marketplace solution. With the addition of e-exchange we will significantly reduce the carrier's operational costs while helping them increase group retention rates. The impact on our carrier business is substantial. We've secured an important client renewal and expanded our product footprint at this carrier, which will drive nearly an average of $5 million in additional guaranteed annual recurring revenue over multiple years. We also believe we have the opportunity to continue to expand our footprint with this client and grow the relationship. If you will recall, earlier this year that we announced a new solution, a certified carrier program, for our carrier customers. The solution accomplishes two goals for our carrier clients. First, we reduced operational complexity by simplifying how they exchange data with the Benefitfocus platform. Second, we helped them simplify how they design products for our platform to accelerate the sale of voluntary products. I am pleased to report that the pipeline for our certified carrier program is ramping nicely. We also believe this new program will reduce operational costs and increase data quality. Growing sales conversations indicate the market is very receptive and we believe we are on track to secure our first certified carrier partners during the second half of the year. Within our carrier business, we've also invested in a new market adoption team that is aligned with our carrier sellers. This team of talented associates works closely with our installed base carriers and helps them implement strategies to grow their membership on our marketplaces. Given the sheer size of these carriers, the potential for adding additional recurring revenue through market adoption is significant. Finally, in September, we will convene our first carrier Executive forum here in Charleston. Over a two-day period we will host the key buyers from leading health and life and ancillary carriers at our offices on Daniel Island and nearby Kiowa. We have a great line of Benefitfocus Associates prepared to share the latest on our product roadmap and industry thought leaders joining us to share their perspective on this evolving market. Moving on to some product updates. From a product perspective, innovation remains core to the Benefitfocus culture. I'm pleased to share that our product and engineering teams have already delivered over 50% of the new solutions and with our upcoming autumn release slated for September, we'll have delivered 90% of our One Place 2016 announcements. During our recent summer release and our upcoming autumn release, we have a number of exciting new capabilities that set up our employer and carrier clients for a successful open enrollment. First is Benefitstore for part-time employees. Many of our largest customers, especially those in retail, manufacturing and hospitality, have large part-time employee populations that are not eligible for full medical benefits. With Benefitstore for part-time employees, we can now offer these employees a part-time benefit package that includes life and disability insurance, id theft protection, legal assistance and access to telemedicine services. This new package is an incremental revenue opportunity for the Benefitstore beginning this open enrollment. With our summer release, we reiterated our continued focus on community-driven solutions with the introduction of the idea community on our customer service platform One Place 365. The idea community is an exciting advancement for Benefitfocus and reinforces our leadership position in the market, as it's the first crowd sourced product innovation platform in our industry. Clients can submit new product feature ideas and the community votes on which features make it into the product roadmap. The reception has been phenomenal and I'm pleased to report we're introducing two new features from the idea community in our autumn release. One thing slated for auto release I'm particularly excited about is our industry-leading mobile capabilities will include full support for mobile enrollment. One thing slated for our autumn release that I'm particularly excited about is that our industry-leading mobile capabilities will include full support for mobile enrollment. Across our client base, their workforce is increasingly mobile and, today, over 50% of consumers use their smartphones to access health-related information. With our autumn release, we will become the first enterprise benefits management platform to support full mobile enrollment. This is a significant advancement in our capability set and a key differentiator against outdated legacy systems. From a partnership perspective, our relationship with SAP continues to grow and strengthen. Across the first half of 2016, our product team has been working closely with SAP to continue to optimize the product offering available to their sales team. We've made significant progress here and believe we can enter their heavy selling season in the fourth quarter of this year well-positioned. In fact, you may have seen earlier this week that we will be a Gold sponsor at SAP SuccessConnect in late August, an event that drove significant pipeline for us last year. In summary, we had a terrific second quarter. Our innovation has never been better, channel relationships are maturing and I am pleased with the results of the new sales structure put in place entering 2016. Our confidence in the future of Benefitfocus and market demand, evidenced by a significant increase in distribution investments we plan to make in the second half of the year all while keeping an eye on ensuring that we deliver against our commitment of reaching positive adjusted EBITDA in the fourth quarter. We believe our strategy will enable Benefitfocus to create a very large and profitable company as we continue to extend our leadership position in the multibillion-dollar opportunity for cloud-based benefits administration. Before turning the call over, I wanted to mention that last week we announced Dennis Story resigned as CFO for family reasons. As we previously mentioned, Dennis needed to return to Atlanta to care for a loved one. We have started the interview process for this key Executive role and we're excited by the number of very talented candidates already interested in our opportunity. I'm fortunate to be surrounded by a talented and strong management team that is focused on delivering against our strategic objectives. In the interim, our Finance organization will continue to report to our President and COO, Ray August. I also want to extend a special thank you to all of our associates. This great quarter would not have been possible without the hard work and dedication of our Benefitfocus team. I'd like to give you all a shout out to our entire team. You all are doing amazing things in creating an incredible company. Thank you so much. With that, let me turn the call over to Ray. Ray, take it away.

[Ray August:]

Thank you very much, Shawn. I will begin by reviewing the details of our financial performance and then I will finish with our updated guidance for the full year of 2016 and our outlook for the third quarter. Total revenue for the second quarter was $57.9 million, an increase of 36% compared to the second quarter of 2015. This was above the high end of our guidance range. Driving the impressive revenue growth in the quarter was a combination of new customer wins and add-on product sales for both new customers and to our installed base. As we highlighted in the prior quarter, in Q2 we benefited from a few million dollars of revenue that was recognized upon successfully delivering forms 1094 and 1095 to the IRS on behalf of all of our ACA-reporting clients. Breaking revenue down further, software subscription revenue was $51 million representing 88% of total revenue and growing 34% year over year. While professional services revenue was $6.9 million representing 12% of total revenue and up 50% year over year. The increase in professional services revenue reflects stand-alone value for implementation services and incremental ACA management and reporting deliveries during the quarter. Looking at revenue by segment, employer revenue for the quarter was $36.3 million, up 75% compared to the year-ago period. If the ACA management and reporting revenue was ratably recognized, total employer revenue would have grown in the high 50% range year over year. Carrier revenue of $21.6 million was in line with our expectations and was down 1% from the year-ago period. As Shawn previous lease dated, we are very excited about the growth initiatives within our carrier segment. We continue to invest in our carrier growth and anticipate the positive impact from our new carrier initiatives materialized in 2017. Let me now review the supplemental metrics we report on a quarterly basis. We ended the second quarter with 803 large employer customers. Compared to 741 at the end of the first quarter. And up from 662 in the end of the second quarter of 2015. We also ended the quarter with 53 carrier customers, up from 52 carriers in the year-ago period and down from 54 carriers in the prior quarter. The sequential decline was expected and reflects a carrier that began to shift its workflow away from our platform in the middle of 2015. Our software services retention rate, once again, exceeded 95% in the second quarter for both carrier and employer segments which we believe is evidence of the significant value our platform generates for our customers. Moving down to P&L, our non-GAAP gross profit was $28.9 million or a 50% non-GAAP gross margin; 48% in the prior quarter and 46% in the year-ago period. The over 400 basis year-over-year improvement reflects a combination of revenue growth, improved efficiencies and the benefits from scale. Non-GAAP software gross margin of 65% was flat from the prior quarter and the year-ago period, while our employer software gross margins were up strongly sequentially and year over year. This expansion was offset by the decline in carrier software gross margins which reflects a loss of a carrier customer in the quarter. We remain very confident in our ability to expand both non-GAAP software gross margins and total gross margins throughout 2016. Adjusted EBITDA was negative $1.4 million in the second quarter or a negative 2% of revenue. This was significantly better than our guidance of an Adjusted EBITDA loss of $6 million to $5.5 million and is an eight-times improvement versus a negative $10.7 million in the second quarter of 2015. Our Adjusted EBITDA, was positively impacted by the revenue outperformance in the quarter which largely falls to the bottom-line, as well as improved efficiencies across the Company. To this point, we are seeing positive results by driving leverage and efficiencies across our entire business. For example, we are benefiting from our shift to more outcome-based marketing and expect to see G&A expenses moderate as we begin to benefit from our new ERP system. Operationally, one of the most important priorities is ensuring a successful open enrollment for our customers. In June, we held our first ever open enrollment success week where 800 of our customer-facing associates gathered in Charleston to attend workshops specifically focused on delivering a pleasant and efficient open enrollment experience for all of our customers. Another way we are preparing our customers for open enrollment is to streamline their implementation by prescheduling their open enrollment dates. As of today, 88% of our employers have confirmed their open enrollment dates using our new open enrollment reservation system. Having this data allows for more rigorous modeling of peak demands which further positions our customers for a quality-driven open enrollment experience. Our investment in these and other open enrollment programs are paying off as we prepare our customers and our entire company for a successful OE season. As Shawn previously highlighted, given the success of our three employer sales teams, we plan to increase our investment in sales and marketing in a meaningful way throughout the rest of the year. That said, we remain on track to achieve Adjusted EBITDA profitability in the fourth quarter of this year and remain confident in our ability to generate EBITDA profitability in 2017 and beyond. Non-GAAP net loss per share was $0.22 based on 29.5 million weighted-average shares outstanding, better than our guidance of a loss of $0.39 to $0.37 per share, and the year-ago period per share loss of $0.53 based on 28.6 million weighted-average shares outstanding. Looking at our GAAP results, gross profit was $28.1 million. Our operating loss was $9.1 million, and our net loss per share was $0.37. Cash used in operations was $418,000 for the quarter, an approximate $10 million improvement from the year-ago period. This reflects our strong top-line growth; improved margin profile; and the reversal of the majority of the one-time items we highlighted in Q1. Moving to the balance sheet. We ended Q2 with cash, cash equivalents and marketable securities of $68 million and believe we have sufficient liquidity to reach cash-flow positive. I will now turn to our outlook for the third quarter and full-year of 2016. Starting with our full-year guidance, we expect revenue of $233 million to $236 million, which equates to year-over-year growth of 26% to 27%. We are targeting an adjusted EBITDA loss of $7.5 million to $5.5 million and continue to expect to achieve Adjusted EBITDA profitability in the fourth quarter. We anticipate a non-GAAP net loss of $29 million to $27 million, and a non-GAAP net loss per share of $0.98 to $0.91 based on 29.5 million weighted-average shares outstanding. Also in 2016, we're targeting free cash flow in the range of negative $37 million to negative $32 million; and again, we believe our improving profitability, our cash balances and our available credit facility will provide us sufficient liquidity until we become cash-flow positive. For the third quarter of 2016, we are targeting revenue of $57 million to $58 million, which represents year-over-year growth of 25% to 28%. From a profitability perspective, we expect an adjusted EBITDA loss of $4 million to $3.5 million, a non-GAAP net loss of $10 million to $9.5 million and a non-GAAP net loss per share of $0.34 to $0.32 based on 29.6 million weighted-average shares outstanding. In summary, we are extremely pleased to have delivered strong second-quarter results that exceeded our expectations on both the top- and bottom-line. We continued to benefit from excellent demand for our platform and increased scale of our business. As we continue to strengthen our leadership position within this multibillion dollar market, we are increasingly confident in our ability to continue delivering strong growth and long-term shareholder value. With that, we are now ready to take your questions. Operator, please begin the Q&A.

[Operator:]

[Operator Instructions] Our first question today comes from Stephen Lynch, Wells Fargo.

[Stephen Lynch:]

Hey guys, thanks for taking the questions. I want to talk about the sales force, given the shift of sales people from the large to national earlier this year, and sales headcount being flat, can you provide some more details around your hiring plans for the back-half of the year and how we should think about that impacting your preparation for the 2017 selling season?

[Shawn Jenkins:]

Sure. Thanks for the question. As we kind of outlined, Stephen, we saw our pipeline building in these national accounts. Last year, we announced several really big wins. That national account, that 10,000-plus market, has really developed pretty substantially over the last 18 months or so. So as we put our plan together for 2016, we designed a three-team structure for our employer sales. It had been one team, selling into all size accounts and exceeding the market from a 1000-plus market. We created a national account team on 10,000 plus; a large account team of 1000 to 10,000 employees; and then a back-to-base team. So the national account back-to-base new groups all together. We wanted to keep the headcount kind of similar, we would say, even from last year. As we got into the year, we wanted to make sure we had good quality. We knew as we saw this pipe of national accounts that a few national accounts would actually equal a whole bunch, dozens and dozens of the smaller and large accounts, if you will, and we're off to a great start. We are extremely pleased with the demand in all three segments. National accounts surging as you can see; we did six really big ones in the quarter. We announced one more 120,000 lives account that we signed in early July. The large account team did awesome. They did 50-plus accounts on their own, even though we had taken about 25% of that team and moved it up into national accounts and the management support associated with that. And then back-to-base is doing fantastic. We saw more than 50% growth in the transactions on the year-ago period. Overall, very strong results. Our actual net-subscriber growth is up over the same period a year ago and to date, even though the logos are a little bit lighter, which is this phenomenon. Now that we have seen that and just moving to the demand and being out in the market with our marketing team, we have strong demand in all three buckets; the national accounts team has a huge and growing pipeline; our large account team with 1000 to 10,000 have experienced great demand as well; and the back-to-base team, obviously, now that we have 800 accounts. We will be hiring for all three teams. As a matter of fact, we have already begun. We will be increasing the size of each of those teams. It was part of our whole year plan to do that. We built into the model, even as we approach EBITDA, adjusted EBITDA profitability, which will be in the fourth quarter, we always knew that we would be back-half loaded on the sales team and the marketing increase in expense. We feel really good about that. Obviously, we hope that that leads to a great 2017 selling season for us. And really it's indicative of the demand that we are seeing across all three of those opportunities.

[Stephen Lynch:]

Thanks, Shawn. That's great. One other question, if you don't mind, on average revenue per employer. Clearly, that number is getting stronger and I'm assuming it's a combination of larger employers, on average, which we can see from you talking about numbers like the six national accounts that were signed in the quarter. I'm thinking about the per employee, per month PEPM number. Are there any numbers you can provide to help us triangulate how that's trending? Maybe average product penetration across the base or a number of lives that have access to more than one product, something like that that can help us get a gauge on how PEPM is doing?

[Shawn Jenkins:]

The good news is that PEPM is increasing while the average size of employers is increasing; both of them are increasing rather swiftly, which is making for a great story and also leads to higher gross margin, as you can imagine. We already have kind of record-high retention rates of 95% plus. I guess some data points, our back-to-base team had over 50% increase in their selling and that's all additional products being attached to our existing customer base. We saw new customers added, over two-thirds of them added more than one product, so we're seeing multi-product sales in the new sales as well. We mentioned on the call, on the notes prior, that we had an existing customer that had 35,000 employees added four products during the quarter. So we are seeing actually really big material adds. And then maybe one other data point that helps and we said this the last couple of calls, we came into really last year with one product in the market, our base Benefitfocus Marketplace, awesome platform. And we've essentially doubled the PEPM opportunity with the series of additional products that we've added, the Benefitstore, Core Advanced Analytics, ACA management reporting, so that opportunity has doubled, or maybe even a little bit more than doubled now, and we're beginning to really get that opportunity realized in both the back-to-base and the new.

[Ray August:]

Stephen, one of the things that really excites me is now that we have a customer base that's over 800 employers in size and we can go back and market into that employer base, that gives us great visibility in terms of incremental revenue, but also speed to revenue. As you know, getting revenue from a customer you already have is much faster and much more accelerated than going out and getting new customers, so it gives us great visibility and it gives us that speed that we are looking for.

[Stephen Lynch:]

That's great.

[Shawn Jenkins:]

Thank you.

[Operator:]

The next question is Nandan Amladi, Deutsche Bank.

[Nandan Amladi:]

Hi and thanks for taking my question. Shawn, you talked about all of the growth and the back-to-base team and so on. How penetrated are you at the moment in your base relative to the entire portfolio that you have say compared to a year or two years ago when your product set was more limited?

[Shawn Jenkins:]

Great question and thanks. The activity that we are seeing with the receptivity to the new products and the activity with the back-to-base team is really, I would characterize it as, fantastic. You can look at the new customers that are attaching, most of them are now attaching more than one product; many of them are attaching multiple products, so we know we've got the right product set. We just really began to formally sell back into the base this year, if you can imagine that, just two quarters in. That team is really doing super. Given the fact that we really started that as a formal effort, there is enormous upside in our mind, and we've a little bit more than doubled the PEPM opportunity and we've just begun to get back into that 800-plus customer base. So we think the runway there is a multi-year runway. We're known for a big One place event in March too and we have an affinity for developing great new products, so I think we have a good long runway ahead of us of selling back into the base and that base is getting bigger. So a lot of upside we see there.

[Ray August:]

Yes and one of the things our customers are telling us is that our new offerings are very, very attractive to them. Our prior two biggest are our Benefitstore offering where we're seeing very rapid adoption of that solution and also our analytics solution, which is giving our customers better access to information to make better decisions. So having those offerings that are extremely compelling is really driving a lot of great activity for us.

[Nandan Amladi:]

Thank you and an accounting question, are there any major changes still to happen? I know you are working on DSOE for the carrier side. The customer relationship period going from 10 years to seven years presumably is all done now. Do we have any residual changes in the accounting that might change how the income statement looks?

[Ray August:]

No. As you accurately said, the biggest change we had last year was the change in our customer relationship period. And also we achieved stand-alone value for our employer customers. Going forward, one of the things we're looking to is achieving stand-alone value for our carrier customers. We see that happening in the next year or so.

[Nandan Amladi:]

Okay. Thank you.

[Ray August:]

Thanks.

[Operator:]

Your next question comes from Brian Peterson of Raymond James.

[Brian Peterson:]

Congratulations on the strong selling quarter. Just a few questions on your national account success. I'm curious who you are typically displacing in those deals? I know you mentioned some of the go-to-market changes, but is there anything technologically different, maybe the mobile functionality or service levels that has really been a differentiator there? I'm curious also on the implementations, is that consistent with maybe some of the smaller employers where, boom, you're getting 120,000 lives in one quarter?

[Shawn Jenkins:]

Thanks for the question. The conversation around national accounts, very large accounts, really begins with our IPOs. We went public three years ago now and we are proud that this is our 12th quarter, 12 times we've beat our guidance and raised it; so we're real proud of that management team. One of the things we hear on the IPO, is man, this looks like great software, it looks like a great platform, but does it apply to large accounts? Does it apply to national accounts, 10,000, 20,000? At the time we said, it absolutely does, but it's going to take us a couple of years to see the market. People have to know who Benefitfocus is; we're the first to go public; we're the first over $100 million in revenue. We have got brand-to-build. And we steadily see the market in all segments,1000 plus, for the last couple of years. The shift really began to feel in the middle of last year. We began to really win some fantastic large customers. And as we interacted with these 10,000, 20,000, 50,000, now 100,000-person cases, what we were hearing from them is, hey, we are on multi-year outsourcing arrangements. We are on a big ERP implementation that we did years ago and we are really hungry for change. We are doing all of this cloud in other areas of our business. We're moving our expenses in the cloud. Our sales force is in the cloud. And benefits is getting older faster, like the legacy systems have really been stuck and they are not seeing the innovation. So we recognized that, obviously; our pipe became very strong and we did what we think is a very thoughtful move and we took existing seasoned experts at Benefitfocus here on our staff and moved them into a national accounts team. And we had some management that we needed to put in there. We knew that we'd have a near-term effect of a fewer less logos, but we felt like we could keep the subscriber growth up and steady and strong, and I'm proud that that's happening. But as we go forward, I've got to tell you, the desire for an enterprise-class platform, as you mentioned, that has great mobile technology, full mobile enrollment, analytics visibility, and really I think what we bolted on the Benefitstore and we added our Benefit Service Center, something clicked last year. We, in the eyes of the enterprise, the national account, we became really what we see as that platform of the future, that platform standard, and we have enough additional product, that really rounds out, that competes extremely favorably and way above the technology from their legacy installation. We are excited about that, but I've got to tell you, that 1000 to 10,000 market is equally exciting, very strong demand. We have a great team in there and we will be adding, as we said, to all three of our employer teams.

[Brian Peterson:]

Got it. And maybe just a follow-up. I wanted to hit on the third-quarter guidance. Is the sequential decline implied in the third quarter, is that mostly related to the roll-off of the ACA revenue where, otherwise, we should still expect sequential growth in employer and carrier revenue? Thanks.

[Ray August:]

Yes, that is absolutely correct. As stated earlier, the ACA revenue came just this year in Q2 when we delivered our solutions to our customers. Going forward, that revenue will be recognized ratably over the entire year and we'll return to our traditional growth levels.

[Brian Peterson:]

Got it. Thank you.

[Shawn Jenkins:]

Thank you.

[Operator:]

The next question is from John DiFucci of Jefferies.

[John DiFucci:]

Shawn, Ray, you have a lot of good things happening here. You talked about them. You had some nice large employer adds, some real large ones, but as you know and you pointed out, the number is lower than the second quarter in each of the last two years. Again, I start to look at this and I understand, okay, you've got some really big ones coming onboard. We understand there's a lag before they actually go live and you start to get revenue there. But your implied fourth-quarter guidance, doesn't really indicate that there's much of an incremental positive from signing these big deals at a lower number of total deals than it would have been if you just kept going after the accounts you were going after. So try to help me get through that because I know I'm going to get that question a lot tomorrow.

[Shawn Jenkins:]

Yes, totally. And as a founder, I've been here 16 years, and we run Benefitfocus for the long view and we think we've got a very compelling long-term market ahead of us. We know that we have that and, combined with our culture and so forth. So we obviously do make these adjustments, thinking about 2017, 2018, 2019, and what's best for that while we are making progress on EBITDA margin and margin improvement. A couple of things that will help you connect with the fourth quarter. First, is our ACA management and reporting. We rolled out a new product last year. We sold it to a lot of our customers. It's a fantastic product; it got delivered and customers submitted on time to the IRS. That revenue is kind of all piled in the second quarter. Really, it should be smooth throughout the year, but the nature of the one-time IRS event. So if you were to kind of smooth that out, you would see, maybe a little bit better fourth quarter look than perhaps what the model might look like. Next year it will be smoothed out that way. That's a little bit of it. The timing of some of these large deals, so we mentioned one or a couple of them will actually go live in the first quarter of next year. So historically, if we had call it 10 or 20 of these more 1000, 2000, 3000 live cases they go live in October, they us it for open enrollment. These are bigger deals. The jumbo that we mentioned is actually multi-year, multi-product. So we think it's worth 30 to 40 and maybe even more of the other ones, but you won't see revenue from that in the fourth quarter. It doesn't alarm us in the long-term view, but for that quarter. And then I would point to one other thing and this has been talked about, I think, in the insurance industry a little bit. The private exchange market and some of the channel activity was a little bit lighter than I think some of the channel partners had thought. And so I think that has kind of a near-term effect on maybe the way our fourth quarter might have otherwise looked. To us, there's nothing about that that changes our view of this private exchange space, the channel partner. These are big long-term shifts in our industry and we still think that the next couple of years in that private exchange market is going to be extremely strong. But that's a little bit of the other part that you saw in the second quarter.

[Ray August:]

Yes, and John, one of the things that's very compelling about that to us is that, obviously, most of our big activity in terms of implementations and open enrollments are happening in October, November, December. By having the jumbo carriers, the large employers that are implementing in the first quarter, it actually allows us to smooth out our resources and use people that are not as busy in that period of time. So it has a very smoothing effect for us.

[John DiFucci:]

That's actually all helpful and it makes sense but if you could maybe, so should we, just given this shift in your go-to-market and we realize you are hiring some more people to go after your traditional accounts too. But should we assume, like next quarter, the number of employer customer adds would probably be decent, but perhaps lower than it has been the last year or two in the third quarter?

[Ray August:]

Yes. Obviously, we don't guide to logos or give you a good revenue number. That said, we did have a few late June signings that we sort of slid to July; one was a very large one. We had a couple of other ones in there. We think our third quarter is going to be really good. It will be, probably overall larger accounts than what we have seen, again, just because of the nature of it. But I think it will be similar, probably similar, to last year. It will not be as dramatic as the second quarter logo count compare will be.

[John DiFucci:]

Great, Shawn and great. Thanks, very much.

[Shawn Jenkins:]

Thank you.

[Operator:]

[Operator Instructions] The next question comes from Ross MacMillan of RBC Capital Markets.

[Ross MacMillan:]

Thanks a lot. I had a quick question on the carrier customer you talked about, that relationship. I think you said a $5 million uptick in annual revenue with that client. Is that example something that could be taken into other carriers? Are we at the start of a potential wave of going back in and being able to upsell your existing carrier customers and extract higher annual revenue per customer from a larger percentage of the base?

[Shawn Jenkins:]

Thanks, Ross. You are exactly right. We are really proud of that particular agreement. It was with an existing carrier who was using our marketplace, our enrollment. We are seeing a pattern now where carriers are getting all sorts of data exchange feeds from hundreds and hundreds employers' payroll systems and whatnot. And so we've really invested in our e-exchange capability which is a data-aggregation capability for carriers. We're going to stand that up in front of this carrier, simplify that, significant ROI savings for them. We were able to bundle that with the renewal, expand our overall marketplace in the exchange and it will be close to $5 million in net add recurring revenue, a good margin. We talked about on the last couple of calls this idea of product sizing our services too. So we've been shifting our carrier business away from services and more exclusively, almost, to recurring software revenue. This is along those lines. Specifically, to your point, we do have a pipeline of existing carriers that have a similar type of profile. Maybe not exactly the same number on the guarantees. But we are very energized about what we are seeing in the base and the products that we will be rolling out. We rolled out a lot of new employer product in the last couple of years. We've got a nice slate of updates and product for carriers coming and our carrier Executive forum that we have in September has got great attendance. And we mentioned this certified carrier program, which actually allows us to bring even more revenue stream to the carrier business. So it will take into 2017 to begin to really see that, as we've talked about for the last couple of calls. But, we're super encouraged about what we are feeling and seeing in our carrier business.

[Ross MacMillan:]

Great. And then a quick one for Ray; last quarter, there was a little bit of a one-time hedge on cash flow. Did that all get normalized this quarter? Or do you have any color on where we stand on that working capital hedged and back on track? Thank you.

[Ray August:]

Yes, we actually reversed the majority of those transactions in Q1, as I stated in my earlier remarks. Our cash-flow performance was actually $10 million better than it was a year ago. One of the things we're seeing from a cash-flow perspective is, as Shawn talked about, we're shifting our carrier business from more Professional Services to a higher margin, higher recurring software services business. What that is doing, actually, is it's dropping our deferred revenue balances, which are having a negative impact on our working capital. But with that said, our cash balances are in line with our guidance.

[Ross MacMillan:]

Thanks so much.

[Shawn Jenkins:]

Yes, thanks.

[Operator:]

The next question is Adam Klauber of William Blair.

[Adam Klauber:]

Good morning. Thanks. Just one or two questions. Sounds good you're ramping up that national sales team, you're having some success there. Given the duration, if we see more success, is it more likely in 2017 or do you have a couple of those in the pipeline that could hit this year?

[Shawn Jenkins:]

Yes, well, we did a pretty meaningful -- we took 25% or so of the sales team and management and put into that new national accounts team. Obviously, they're, I think, off to a great start in the first half. There are more in the pipe for this year. One of them closed in July that we've already mentioned, the 120,000. You will see that in the next quarter's print there. But those deals take time. We've got to seed that market more. We felt now was the time to really have people totally focused on it where before they were seeding, they were there contacting everybody in their territory. So now we've got focus. We've also shifted some marketing attention to it, so we are having specific marketing events, hosting specific regional events, our One Place local now has 40-plus events and some of those are targeted national accounts in certain areas. So we're optimistic that we will see some more this year. And the good news about that is they are big. They are multi-year. They're multiproduct. What we are working is how they go live, instead of fourth quarter, maybe first quarter, second quarter of next year, as long as we get the visibility of those contracts and the know ability of them is the best thing for the management team. But all the more reason why we're really doubling down on that large employer, that 1000 to 10,000. We are still seeing tremendous demand there. I would expect most companies would want to sign 50-plus logos in that segment as well. But we've got a good seasoned team there, a really good management structure, tremendous marketing events across the country, and that ramp is really going to be more for a 2017 selling season, which we are feeling strong about.

[Adam Klauber:]

Okay. Thank you very much.

[Shawn Jenkins:]

Thank you.

[Operator:]

[Operator Instructions] Jesse Hulsing with Goldman Sachs.

[Jesse Hulsing:]

Thanks for taking my question. I was hoping you can provide a little bit more detail about your carrier revenue and the shape of it as we go into the second half and into the first half of 2017. Are you expecting more deceleration versus what we saw in Q2? And then is there a quarter where you think you could start to get back to positive for that part of the business?

[Shawn Jenkins:]

Yes. I think we've been, hopefully, pretty consistent on this year was going to be flattish or even-ish or long-term what we said about the carrier business. We said this at the IPO and consistently for the last couple of years is, we think that's a10 plus% grower business for us, maybe low-teens. We get above with a lot of, some of the Professional Services and so forth. We have been retooling that and getting away from the Professional Services and on to the almost entirely subscription revenue. That's going to have a little bit of an optic effect in this particular year. I think, specifically, that we don't guide, we don't break out our guidance by, but it will kind of look similar to what you saw this quarter. It won't be a lot different than that. And then we think it will pick back up in 2017 for sure.

[Jesse Hulsing:]

Got you. And then, I wanted to ask about the SAP relationship. I'm curious, is there a way you can quantify how many deals or how many of the large employer deals they're influencing or bringing you in on? Also, on the national accounts, are they involved in those types of transactions at all? And do you expect them to be as we move into the second half and to next year?

[Shawn Jenkins:]

Yes, good question. I think the relationship with SAP and their selecting Benefitfocus to be a platform partner of theirs and our go-to-market strategy is getting stronger and better all the time. We will be at their SuccessConnect here in a couple weeks and have some great joint product activity going on there. They've definitely contributed to pulling us upmarket. Some of the national account activity. Just the awareness of Benefitfocus, some of that comes from SAP customers. They have got some of the world's largest customers. They're involved in much of our national account pipeline. Our direct sales force is obviously out there working with accounts, but, clearly, they are helping in that. I would say they're part of the thinking as we shifted resources to that area full-time earlier this year is because of the success we are seeing with SAP in their larger accounts. Going forward, though, they've got customers across the spectrum. And one of the things that we have been fine tuning with our marketing department is product messaging for the SAP sales force in each of their markets. They're much bigger than Benefitfocus, so they've got a lot of market segments in the way they communicate. They've really got some nice ways to talk to their customers across-the-board. And maybe one last thing, and we said this a couple of times before, interestingly enough, we don't actually see the selling with SAP to be as seasonal as our direct force. So our direct people are out talking to folks earlier in the year for a Q2 or Q3 purchase for a go-live. Oftentimes, SAP is bundling us with other things they're doing. So one of the benefits we think we'll get is some more selling in our Q4 and our Q1 through the SAP channel because they're talking to global customers and doing multiple bundled deals that we'll put together. I think that will be good for our Company as well.

[Ray August:]

One of the things we're seeing with SAP is that relationship continues to expand and grow. I was actually talking to an SAP salesperson today and they were very, very specific that they're really seeing how to now use Benefitfocus to differentiate their sales versus the competition. So we're really excited about the prospects of that relationship both today and to the future for both companies.

[Jesse Hulsing:]

Awesome. One really quick follow-up on the deferred revenue headwind. I think, previously, you'd said about $11 million for the full-year. Are we still on track for that? For that amount for the year? Or do you expect any changes?

[Ray August:]

You know, as I said earlier, we are on target for our cash guidance and we expect the deferred revenue to stay about the same.

[Jesse Hulsing:]

Perfect. Thank you.

[Shawn Jenkins:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Frank Sparacino of First Analysis.

[Frank Sparacino:]

I'll keep it short on time. Just one question. As we think about the cross-sell into the base with analytics and Benefitstore, for example, is that conversion in terms of sale to revenue typically an intra-quarter event? Or I want to get a better sense of the timeline on that conversion there?

[Ray August:]

Yes, you know, that happened throughout the year. That's one of the things we really like about the business and one of the reasons we're continuing to expand our back-to-base team. Our customers see those solutions providing benefit throughout the year. And that gives us revenue growth throughout the year; so the lead time to sell those is much shorter. The time-to-value for our customers is much faster and the speed to revenue for Benefitfocus is faster.

[Frank Sparacino:]

Thank you.

[Shawn Jenkins:]

Thank you.

[Operator:]

There are no further questions at this time. I would like to turn the call back over to Shawn Jenkins for closing remarks.

[Shawn Jenkins:]

Super. Thanks everybody and, again, a shoutout to all of Benefitfocus's Associates. Really proud of the exceptional quarter and the incredible improvement in our margins and our adjusted EBITDA. I just couldn't be more proud of how everyone is executing. Thanks, to everyone, for joining us tonight on the call.

[Operator:]

This concludes tonight's conference. Thank you for your participation. You may disconnect your lines.