Benefitfocus, Inc.
Q3 2014 Earnings Call Transcript

Published: 10 Nov 2014

[Operator:]

Good afternoon. My name is Loanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Benefitfocus Third Quarter 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Milt Alpern, Chief Financial Officer. Please go ahead.

[Milt Alpern:]

Thank you, operator. Good afternoon everyone, and welcome to Benefitfocus' third quarter 2014 earnings call. We will be discussing the operating results announced in our press release issued after the close of market today. I am Milt Alpern, Chief Financial Officer of Benefitfocus. With me on the call today is Shawn Jenkins, our President and Chief Executive Officer. As a reminder, today's discussion will include forward-looking statements such as fourth quarter and full year 2014 guidance and other predictions, expectations and information that might be considered forward-looking under Federal Securities Laws. These statements reflect our views as of today only and should not be considered as representing our views as of any subsequent date. These statements are subject to a variety of risks and uncertainties, including the fluctuation of our financial results, general economic risks, 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 which was on file with the SEC and our other SEC filings. During the course of today’s call, we will also refer to certain non-GAAP financial measures. You can find important disclosures about those measures in our press release. With that, let me turn the call over to Shawn. Then I will come back to you at the end to provide details regarding our third quarter results as well as our updated guidance for the fourth quarter and the full year 2014. Shawn?

[Shawn Jenkins:]

Superb. Thanks Milt, and thanks to all of you for joining us today. Benefitfocus reported strong third quarter results with both, revenue and profitability that exceed the high-end of our guidance range. The total revenue for the quarter was $34.2 million, a 30% increase year-over-year. Both businesses contributed the strong revenue growth in the quarter, with employer revenue increasing by 52% and Care revenue up 17% year-over-year. We had a strong quarter in both business segments highlighted by the addition of 52 net new employer customers, a 68% increase of new employer customers year-over-year. Both carrier and employer customers are embracing the fundamental changes possible from the transition to the cloud-based benefit administration paradigm, which provides significantly more flexibility and the opportunity to get greater control of the one of their largest and fastest-growing expense items. More than 160 million people in the United States receive their health benefits through their employers, and the way in which they are shopping and rolling for these benefits is undergoing a generational shift. As we have long anticipated, this market is migrating to the cloud in a couple different ways depending on the needs and requirements of the employer. The power of the Benefitfocus model is that however employers ultimately decide the movement to cloud for benefits administration we believe we are in the leading position to bring these lives on to our platform. For the majority of these 160 million lives, they are covered through companies we are having a comprehensive benefits offering is the competitive differentiator in the market for talent. For these employers having control over the types of benefits offerings provided to their employees that are medical, dental, supplemental and voluntary benefits is essential. Employers with this profile are struggling with the outdated and inflexible benefits [administrator exclusions] solutions that limit their ability to upgrade the benefits they can make available to their employees. They had previously seen the value of migrating to the cloud in other areas of their enterprise like CRM, travel expense management and talent management and they are rapidly embracing the lower cost, a greater flexibility of our cloud-based benefit management platform. We service these employers with our direct sales team who are having great success in the early stages of penetrating this massive market as evidenced our growth and new customers in revenue to-date. At the same time, there is a meaningful segment of the market where employers are looking for the convenience of outsourcing the benefits ministration needs to private exchanges. Accenture estimates that up to 40 million lives will be on private exchanges by 2018, which is tremendous growth for market that did not even exist just a few years ago. We have seen private exchanges being a particular interest for certain employers who have many part-time employees and greater compliance burden under the Affordable Care Act. Private exchanges, which offer substantially same set of benefit offerings to all of their participants, can be a compelling solution for these types of employers. We expect the part exchange market to develop between broker run exchanges and insurance care exchanges as both groups looked to best position themselves for the future. We are extremely proud to be the platform for the largest broker-led private exchange market through our partnership with Mercer and their Mercer Marketplace. As Mercer recently reported, the number of lives in the Mercer Marketplace increased five-fold in 2014 to nearly 1 million lives, which is a terrific validation of this market and how the Benefitfocus platform benefits from its growth. At the same time, there is incredible energy in the carrier markets to transform how they are going to communicate and sell their products to employer groups going forward. Private exchanges represent the most significant change in distribution for insurance care since the rise of HMOs more than 20 years ago. This is a strategic imperative for carriers who are making long-term investments and commitments to private exchanges to ensure they are properly positioned to take advantage of the changing benefits market. We are very proud to be powering a number of private exchanges firms including Aetna CareFirst, a growing number Blue Cross, Blue Shield plans across the country among others. During the third quarter, we signed a new private exchange agreement with Blue Shield of California, who has more than 3 million health members. We believe Benefitfocus is in a great position to grow alongside cares in this market, through our long history of generating significant value for these customers. We believe private exchanges represent a multibillion-dollar market opportunity, which has been validated by the tremendous amount of activity in the market in the last 12 to 18 months. We believe one of the reasons the Benefitfocus marketplace offering continues to build significant momentum in the market is our credible integration capabilities and the growing network effect created by over 1,500 Ecosystem data exchange connections. The way we see the strength manifesting itself in the market is an unique ability of our customers to extend our platform with their own internal capabilities, with partnerships that they bring to the table and with the acquisitions they make along the way, because many of our customers who are deploying the private exchange on the Benefitfocus platform are multibillion-dollar enterprises. They operate in many market segments and geographies. The ability of our platform is to help them adapt and know strategy over time is a very powerful enabler. We have many examples of how our customers extend their marketplace through partnerships, through their own internal capabilities. One recent example is Mercer's acquisition of Transition Assist, a retiree exchange provider. We have worked with Mercer to integrate the transition assist functionality services into the Mercer marketplace and in so doing have strengthened their strategic positioning. Similar, we have worked on deep integrations with both eHealth and GetInsured for several of our marketplace deployments. Along these customers were rapidly introduced new consumer products into their employer-sponsored marketplaces. The Aetna Marketplace powered by the Benefitfocus platform has a fantastic set of service for services provided by Pay Flex an acquired company of Aetna's. More recently Aetna announced the acquisition of Bswift to further develop our consumer offering that we see as following this pattern's extensibility and flexibility with the Benefitfocus platform. We see the continued pace of innovation, investment and integrations is further proof that the private exchange market is a massive opportunity and still in a very early stages of development. Our deep integration capabilities combined with the powerful network effect of our growing ecosystem is enabling our customers to be extremely adaptive and flexible as the market rapidly develops. Turning to our third quarter performance, we had strong sales activity during the quarter with 52 new employer customers, including McDonald's, Logan's Roadhouse, ICF Consulting, Keuhne + Nagel, IQor, RHA Management and Bauer Hockey. We now have 540 large employer customers, which is a tremendous milestone for the companies across 500 large employers on the Benefitfocus platform. McDonald's selected Benefitfocus in our communications portal in order to better communicate benefit options to their U.S.-based employees. Many of whom are eligible for the first time under the new rules of the Affordable Care Act, This agreement is similar to the Office Depot when we announced last quarter and it was a great example of how we are initially engaging with certain large customers who are in the early stages of their benefits administration transformation strategy and process. While the PEPM pricing was lower initially with only our communications portal, we believe this is a terrific opportunity to deliver media value while these customers continue to evaluate their long-term benefits shopping administrative needs and puts us in a great position to sell our full platform in the future. RHA Management services, which provide leadership and operational support to RHA's various healthcare programs, selected the Benefitfocus HR in Touch Marketplace for their 4,500 employees. RHA has the significant percentage of part-time employees and they selected Benefitfocus because of our ability to manage benefits and employee communications for their entire workforce. Our ability to provide federally subsidized eligible employees with sophisticated decision-support tools was the key differentiating factors some of the key thing that we introduced in our One Place Conference earlier this year. It is exciting to see that strategy of new technology be embraced by the market. One of the main advantages of cloud computing and the software as a service delivery model is that a frequent software leases. These rapid releases bring a fresh set of new capabilities to the customer community on a regular basis. We are very proud of our long track record of delivering four major software leases each year, in this quarter saw another lead forward for the Benefitfocus platform. During the quarter, we introduced new solutions to enhance our compliance and analytics capabilities including new reporting capabilities for benefits administrators that assist employers in gathering required W-2 reporting requirements for the IRS, which we plan to leverage to comply with additional reporting requirements like the employer mandate in 2015. Also certification for ICD 10 conversion for our Benefit Infomatics products, which is the new industry-standard diagnosis coding system that is being introduced next fall. We are very proud to have this capability in production well in advance of the required deadlines, thus providing our customers ample time for the transition. We also introduced a new communications package that includes a suite of features designed to help employers reach employees with meaningful of engaging communication tools. This package provides great new decision-support tools like a guided shopping experience and virtual shopping assistant, just in time for the open enrollment season. The third quarter is also our most active implementation period as open enrollment season begins for most companies in early October. Just this week, we have seen our concurrent user account reach almost double the volume we saw on the same week last year. This was the busiest open enrollment season in our history and reflects the growing number of customers on the Benefitfocus platform. We are doing a tremendous job across the company to successful implement our customers and I would like to give a shout out and my sincere thanks to all of the over 1,200-plus Benefitfocus associates. You guys are doing a fantastic job. During the third quarter, we continue to make progress in our third-party implementation program and we remain on track to have the first class of certified third-party implementers to graduate from the Benefitfocus University by the end of the year. This will put them on track to begin delivering implementation services on their own in 2015 as planned. Selling up our third-party implementation program and improving the efficiency of our implementation teams is a major focus for us and is being led by new Chief Operating Officer Ray August. We have make strong improvements in our implementation efficiency in the recent months, which is enabling us to successfully implement the over 100 new large employer customers we have signed in the last two quarters alone and we see significant opportunity to make further meaningful improvements in the future. Ray has hit the ground running with a lot of excellent ideas and energy and is a great example of the incredible talent retracting the Benefitfocus, who have (Inaudible) insurance successfully scale into a much longer larger organization over time. As we mentioned on the last call, Ray comes to Benefitfocus having successfully led software and service organizations with over 10,000 associates and over $3 billion annual revenues. His experience is already showing great results in our scale, efficiency and quality. These will be major themes for our management team going forward. During the quarter, we also strengthened our leadership with two additions to our Board of Directors. Doug Dennerline is currently the CEO of Alfresco Software and is previously served as the president of SuccessFactors and also the Head of Enterprise Sales in the Americans for Salesforce.com. Lanham Napier joins Benefitfocus board after recently retiring as the CEO of Rackspace, which he led for more than 14 years. We are so pleased to have these two executives with such wealth of experience, building and growing successful cloud-based companies join our board and we will look forward to their future contributions. In summary, we delivered strong third-quarter results from both, the financial operations perspective. We are seeing exciting demand activity across our businesses as customers embrace the tremendous value and flexibility, our cloud-based benefit administration platform can provide. We believe that we have a clear leadership position in the market and remain focused on maximizing our opportunity in this multimillion-dollar market. With that, let me turn it back over to Milt, Milt?

[Milt Alpern:]

Thanks Shawn. We are very pleased with our third quarter performance, which exceeded our guidance on both, the top and bottom-line. I'll begin by reviewing the details of our financial performance and then I'll finish with our updated guidance for the full year 2014 as well as the fourth quarter. Total revenue for the third quarter was $34.2 million, an increase of 30% compared to the third quarter of 2013 and above the high end of our guidance range of $33.5 million to $34 million. Breaking revenue down further, software subscription revenue was $30.7 million, representing 90% of total revenue and up 25% year-over-year. While professional services revenue was $3.5 million, representing the remaining 10% of total revenue and up 96% year-over-year. Our professional services revenue reflects the increasing number of successful go lives across both of our business segments, which enables additional professional services revenue to begin getting recognized ratably from a deferred revenue balance. Professional services revenue in the quarter also includes the impact on the acceleration of revenue recognition from changes to our customer relationship period for two carrier customers who are being acquired. Looking at revenue by segment employer revenue for the quarter was $14.9 million, up 52% compared to the year ago period while carrier revenue was $19.3 million, up 17% from a year ago period. We believe the employer market is highly underpenetrated and represents a substantial growth opportunity for Benefitfocus. In the third quarter, our employer business represented 44% of total revenue compared to 37% in the year ago period and we expect to see our revenue mix continue to shift in that direction and become a majority of our revenue in the near future. Let me now review the supplemental metrics we report on a quarterly basis. We ended the quarter with 540 large employer customers, an increase of 52 compared to 488 at the end of last quarter and up from 379 in the third quarter of 2013. As a reminder, the second and third quarters are typically our largest selling quarters as customers look ahead to the upcoming open enrollment season. We ended the quarter with 44 carrier customers, up one from the end of Q2. We continue to see strong sales activity within our installed base and are making good progress with the implementation at the six new carrier customers we won in the region quarters, including United HealthCare. Our software revenue retention rate was once again greater than 95% in the third quarter, which we believe continues to reflect the significant value, our platform generates for our customers. Moving down the P&L, I will start by discussing gross profit on an adjusted basis, which excludes stock-based compensation, depreciation and amortization of acquired intangibles, amortization of capitalize software and development cost. Adjusted gross profit in the third quarters was $13.3 million or an adjusted gross margin of 39%, down from 46% adjusted gross margin in the year ago period. The decline on adjusted gross margin reflects the significant demand we continue to see from our solutions and the growing number of implementations we are undertaking. This negatively impacts our services margins in the short-term, because we recognize expenses for professional services as incurred, but the further revenue until the customer is live in the Benefitfocus platform and then amortize it over a 10-year customer relationship period. In addition, we have also made meaningful investment in our customer service organization to scale that group to successfully serve as a growing number of employer customers throughout this open enrollment season. As a result of these investments, we do expect to generate notable, sequential improvement in both, our adjusted software margin and adjusted total gross margin in the fourth quarter. Last quarter, we began providing additional disclosure around our adjusted gross margin in order to get investors better insight into the profitability of the business by aligning our professional services revenue and expenses in the period they are incurred. This view the gross margin assumes we recognize professional services revenue as delivered during the third quarter instead of the customer relationship period, which would increased our adjusted gross margin in the quarter by 900 basis points. As Shawn mentioned earlier, we all are on track with our systems integrated program, which will enable us to shift the employer implementation services work to our partners next year and help us achieve progress towards our long-term gross margin target. Turning to operating expenses, on a non-GAAP basis excluding stock-based compensation and amortization of acquired intangibles, sales and marketing expenses were $11.8 million an increase of 61% compared to the third quarter of 2013. R&D expenses were $11 million, an increase of 71% to the year ago period and G&A expenses were $4.2 million, up 69% compared to the year ago period. The increase in operating expenses reflects the incremental investment we are making across an organization to position us for future growth and profitability. Adjusted EBITDA was negative $13.5 million or negative 40% of revenue. This is better than our guidance of adjusted EBITDA loss a $14.8 million to $15.3 million and compares to a negative $4 million in the third quarter of 2013. As we have mentioned in the past, our adjusted EBITDA margin reflects the increasing investments we are making in our sales organization and products in order to capitalize on a leadership position in this multibillion-dollar market. We believe these investments will position the company for continued significant long-term growth and will drive increased shareholder value. As our business achieves greater scale, we continue to believe that we can achieve our adjusted EBITDA target of 20%. Non-GAAP net loss per share was $0.62 based on 25.5 million weighted average shares outstanding, better than our guidance with a loss $0.70 to $0.72 per share compared to a per share loss of $0.28 on 21.6 million pro forma weighted average shares outstanding in the year ago period. Looking quickly at our GAAP results, gross profit was $10.8 million our operating loss was $17.8 million and our net loss per share was $0.74. Turning to the balance sheet, we ended the quarter with cash, cash equivalents and marketable securities of $60.9 million. This was down from $71.7 million at the end of the second quarter. During the quarter, under the terms of our existing line of credit, the borrowing availability increased from two times to three times our monthly recurring revenue. At September 30, 2014, our borrowing availability under the credit line is approximately $17.4 million, which will expand as our monthly recurring revenue stream grows. In total, we currently have over $78 million of liquidity available for the company, which we believe can support our operations into the foreseeable future. I would now like to finish with our guidance for the fourth quarter and full year 2014. For the full year, we are increasing our revenue forecast to $135.3 million to $135.8 million, which equates to year-over-year growth of 29% to 30%. We are targeting an adjusted EBITDA loss of $48.2 million to $48.7 million and a net loss per share of $2.31 to $2.32 based on $25.2 million weighted average outstanding shares. Turning to the fourth quarter, we are targeting revenues of $38.1 million to $38.6 million, which represents year-over-year growth of 26% to 28%. From a profitability perspective, we expect an adjusted EBITDA loss of $12.3 million to $12.8 million and a non-GAAP net loss per share of $0.60 to $0.62 based on 25.6 million weighted average shares outstanding. In summary, we are very pleased to have delivered a solid third quarter performance from both, the financial and operating perspective. We remain focused on leveraging our investments to drive growth and further increase the scale of our business and we believe this puts Benefitfocus in a very strong position to capitalize in this multibillion-dollar market opportunity. With that, we are now ready to take your question. Operator, let's please begin the Q&A.

[Operator:]

Thank you. (Operator Instructions) Your first question comes from the line of Greg Dunham with Goldman Sachs.

[Greg Dunham:]

Hi. Yes. Thanks for taking my question. I would like to start off on the employer side. I mean, that was obviously a very strong number following what was a very strong 2Q. Part of that, I think, was previewed with the Mercer results, but could you give us a sense of how the non-Mercer employer growth has been tracking this year?

[Milt Alpern:]

Sure. Yes. Thanks Greg. We are extremely pleased with the quarter and results of our employer sales team crossing the 500 large employer milestone getting the 540 is just incredible. We are super proud of that. Just a frame of reference, we define large employers as a 1,000 or more employees and we are really happy to see the way our direct sales force is performing as well as our private exchange marketplaces. Keep in mind that in the private exchange marketplaces that were operating, one account employers would have a 1,000 more employees. The way that our customers report, there might be slightly different the timing of when the account and what not obviously at their discretion. I would just reiterate how fantastic the quarter was for us and two quarters in a row like that. As you know from watching the company, we do tend to sell most of our activity in the employer business in the second third quarter as employers gear up to get their new platform, their shiny new elegantly designed Benefitfocus platform for open enrollment season, so that drives a lot of decision-making in Q2 and Q3, so they rely on the Benefitfocus platform for the October, November and December timeframe, which is leading to all the implementation work right now, but we are really happy to see the way both of those things are firing.

[Greg Dunham:]

Okay. Great. Then maybe another question on the employer side. When you look at the profile of the employer, employers that you are adding, is there any reason to think that the revenue per employee customer should change going forward. Should that you continue to go up, should it be flat or how should we think about that on a go forward basis.

[Milt Alpern:]

Yes. I think we are extremely happy with the pricing and the revenue per subscriber that we have in the market something we have been thoughtful about for number of years now. We really feel like we fit quite well and it is obviously being well received by evidence of the wins. One notable jumbo employer that we announced is McDonald's and similar to the Office Depot, when we had in the prior quarter. In that case, we are doing I would say just a targeted number of these communication portal, our HR INTOUCH communication portal only deals with certain large employers because they take many years to transform their benefits and we found, I guess, similar to what we found in our carrier business over the years Greg is a way to get into those large organizations, get a quick win for them, give them some really quick value. In those cases, the pricing is little bit less, because it is just a communication portal, but we think it leads to much greater opportunity but that's kind of a limited program that we have there and we are happy with the early results of it, but the of the rest of the business is, I would call it, very stable or in line with what we think from the pricing standpoint.

[Greg Dunham:]

Okay. Last question. In the script you mentioned several times that you power Aetna's exchange. In the last week, we saw the announcement that Aetna intends to acquire Bswift. Can you talk about how and where you fit in to Aetna's strategy and how they may fit in? How does that evolve over time?

[Milt Alpern:]

Yes. Good question. As the private exchange new phenomenon merges it really is creating an enormous amount of energy and momentum for our business and understandable amount of learning by a lot of people who are coming up has been on healthcare and how the Affordable Care Act is being implemented in these private exchanges and what investments people are making. In context Aetna is a great long-term customer of ours. They have been our customer for over eight years now. We have deep, deep set of products and integrations throughout the Aetna organization in their small and large employer market, they use the Benefitfocus eEnrollment platform, eBilling, eSales and a number of additional technologies that we are really proud of that relationship. We think it is durable relationship in all of our communication with them this week has been very positive. As the company size of Aetna or other large customers, there are in bunch of different markets. They are in consumer markets, they are in different geographies, they are in small business, large business and to us it really seems like a strategy that we have seen with other partners when they made an acquisition that would end up bolting on or integrating with the Benefitfocus platform. I think specifically with this particular one, these guys were also in the employer business I guess and they had been doing some new consumer things in large employer, so one way to think about it is from an employer standpoint it will be - obviously, they will have comments from Aetna's standpoint what the intention is there, but everything that that have seen come out publicly has been around consumer individual type of play and we actually have several of those partnerships today that mentioned in script like with eHealth and GetInsured, they sell individual products in multiple states that can manifest themselves inside the group marketplace. I think time will tell to see how that plays out, but I guess just from a macro standpoint eight-plus years of deep integration with Aetna and the bulk of the work that we have done with them is different than this announcement would be - I think, really it has a potential I would say to enhance the overall marketplace dynamic as opposed to take away.

[Greg Dunham:]

Okay. Thank. I will then pass on. Thanks guys.

[Milt Alpern:]

Thanks.

[Operator:]

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

[Nandan Amladi:]

Thanks for taking my question. Shawn, the first question is on the changes in congress. If there are changes to the Affordable Care Act for example, how much time would it take you to sort of make changes in the business roles in the platform to reflect that to the end users?

[Shawn Jenkins:]

Sure. Yes. Great question, so the beautiful thing of our model as you know Nandan is our ability to quickly adapted configurations, all of our customers Benefitfocus are on the same version of our source code and we make a release like we do every quarter everybody gets a fresh set of new capabilities including compliance and that is the growing concern for employers is how they comply with the Affordable Care Act and brokers and carriers and it has propelled a lot of momentum and just energy getting people to think about a new and better way. What we see now is, the Affordable Care Act is being implemented. I mean, there is a millions of people covered down by the individual coverages, employers are implementing their programs. We don't think there is anything that would the near-term would kind of unwind the things that employers are going to have to comply with in 2015-2016. I think longer-term it continues to emphasize the point that you need a flexible platform, you need a platform that has an engineering team that is focused on not only what the market requires and the dynamics about consumerism and mobile technologies, but also they can stay current with regulatory change with what's likely to happen in our view is that they go in and make some tweaks to it and it probably becomes more complicated not less complicated, so certain provisions stay intact they have a different set of rules that might be implied different to different businesses, which is more and more complexity. I was with our engineers this week and they were making updates to some of the technology that were actually regulations regimented under Clinton in the 90s and that those regulations are still being used and some are morphing a little bit, so that that theme of being able to rapidly adapt in the expectation that it gets more complicated not less is more and more of a reason for both, employers and carriers to adapt to cloud-based technology and with the scale of the engineering team that we have at Benefitfocus, we think we are the best option.

[Nandan Amladi:]

Thanks. A quick follow-up if I might. On the trajectory of the system integration partnership and the rollouts of certified engineers to do your deployments, what is the scale of that heading into next year? If you could give us a rough idea of what percentage or what share of projects you will have them initially engage with during next year and the year after?

[Milt Alpern:]

Well, it has been incredible year to introduce that program as we start out with five system integrators. All five are actively involved that have people going through the certification program. We expect multiple teams to come out the other side of the certification by the end of the year. Everything that we had talked about back in May, when we introduced the concept, including the people that are participating are really moving along quite well. The reception has been phenomenal and were beginning to see as they shadow some of the projects that we have, so all that is on track to where we thought. We think they will be in the market in 2015, doing implementations. We don't have a percentage yet. It is probably something we will talk to on the next call Nandan around how we will measure success next year as far as percentage. Clearly, we have been doing implementations at Benefitfocus for 14 years now. We have a big meaningful team that does that. They are fantastic. Many of our experts have been on their training and certification and partnership development, so we think it will be a good blend of solid Benefitfocus implementation people that can really serve our customers and the volume of renewals that we have with just an amazing amount of new working on the platform that these new SIs will be able to pick up and hit the ground running, so I very, happy with the results.

[Nandan Amladi:]

Thank you.

[Milt Alpern:]

Sure. Thank you.

[Operator:]

Your next question comes from the line of Ross McMillan with RBC Capital Markets.

[Ross McMillan:]

Thanks a lot. First question that I have would just be along the lines of your large employers signings and carrier signings have actually been I would say a bit better than we had expected, but we are seeing deceleration in that software services line. I guess, my question is, you addressed the point on pricing, so it is not so much a pricing issue. What are your thoughts around that line in terms of growth rate? Maybe could you provide any color as to why that did decelerate here in Q3 and maybe what your thoughts are around that line's trajectory for growth? Thanks.

[Milt Alpern:]

Hi Ross, this is Milt. Good question. You know one of the issues around that the community celebration gross margin has to do with the timing of the carrier implementations. I mean, these are things that are not as sort of predictable. I guess I would say as employers we were adding many more employers over the course of the year. I also think that other factors that have gone into the deceleration in the margin that you are seeing in the quarter were obviously still entering into a sizable professional service engagements on both, the carrier side as well as the employer side. On the software margins side, here again we are making investments in the service delivery side, where we are staffing up to take care of the open enrollment season that we are in right now and which is the latest open enrollment season that we have been in. We will begin to leverage these investments in Q4. Shawn touched up the systems integration program where we are continuing to make investments and also in the third quarter as we made a shift from utilizing external resources to help with our open enrollment needs to opening our own call center and bring our own people in-house to a service the open enrollment requirements. There has been a bit of an overlap with some expenses in the quarter as we transitioned from those third-party resources to our own in-house resources.

[Ross McMillan:]

Just leaving aside gross margins, just so I am clear on this software services growth rate, the point you are making is that there can be some timing issues around larger carrier customers. Is that the right takeaway on the growth rate for that line?

[Milt Alpern:]

Yes. I think this is kind of one of the questions there we are talking about, so it is sort of a year-over-year compared to 3Q last year to this quarter we had some big early activation last year in the care business and this year we have activations, but they might come a little bit later in the quarter or be in the fourth quarter, so that particular software revenue growth rate was really phenomenon of the timing and size of activations of some of the care business, not really the employer piece of it.

[Ross McMillan:]

Understood. Then just on the professional services line, obviously that spiked up here and you said there was two factors. One was just the level of implementation work, but then there was also, I think, a shortening of the revenue recognition period, because some smaller carriers were being acquired. Does that imply that there were some one-time in that number and that that will decline sequentially? I just was not clear on the impact from that second part? Thanks.

[Shawn Jenkins:]

Yes. I mean, it is a one-time take as we call it as a result of a couple of smaller carriers of ours that were acquired and as a result of the acquisition of that were noticed that this is happening. We then accelerate the recognition of any revenue that is in deferred revenue to the shortened relationship period based on what we expect them to - when they expect drop off the platform, so there was this one-time take if you will relative to these two small carriers in the third quarter services revenue. Probably you will see some of it still remaining in the fourth quarter, so some additional impact in the fourth quarter as a result as well, but then certainly it will normalize again back in 2015.

[Ross McMillan:]

Milt, just to be clear, can you quantify how big that was, the one-time element in pro services in the quarter? Is it possible to do that?

[Milt Alpern:]

It was in the neighborhood of the hundreds of thousands of dollars. Okay. I think it was considered in our guidance, so it was not something that kind of came as a surprise. We did build it into the guidance that we projected for the quarter, so again it wasn't something unexpected and sometimes those things happen.

[Ross McMillan:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Sean Wieland of Piper Jaffray.

[Sean Wieland:]

Thanks very much. Among the new employer customers that you are adding are any of them considering providing access to the marketplace to part-time employees or retirees or these focused mainly on full-time employees?

[Milt Alpern:]

Great question. Thanks Sean. One that we talked RHA Management, there are a lot of time and a big factor their decision was along that idea of the benefits for the whole workforce and everyone was eligible, so as employers begin to roll out that new capability we are excited to see the interest in it and the early adoption of it. I think it will be more of a 2015 going into 2016 phenomenon as employers really begin to deal with the employer mandate and any adjustments that might come to that obviously as a result, but we see a lot of interest in that area and several of them are selecting us I would say for that reason.

[Sean Wieland:]

Okay. Great. Then any chance we can get a sneak peak on 2015 either in terms of sustainability? Come on, you can't blame me for asking - in terms of sustainability of revenue or maybe more importantly the burn rate?

[Shawn Jenkins:]

Well, you know me. I am an optimistic guy. I haven't just put 52 new large employers on and so forth we are quite excited. I think the other exciting thing is to see Blue Shield of California selected us for their new private exchange and continued momentum there, great momentum on our existing private exchange Mercer now, I would say in the lead with the largest broker private exchange, so a lot of good things happening from that front and we are pleased with the sales team we have added and the management that we are growing. A lot of talent that is being drawn in the company for all the success that we are having, so we are really pleased with the trajectory and even things like the system integrator program, which we were just talking about. The fact that we were able to introduce that and stick to our schedule and we are predicting that people get certified in the first year, that stuff all bodes well for - our thesis is playing out mostly the way we thought. As far as the burn rate, I will let Milt to tackle that one.

[Milt Alpern:]

Yes. I mean, I guess, what I would say Sean is kind of stay tuned to earnings call for year end and we will give you the [load] down on 2015 guidance. Unfortunately I am not going to give you sneak peek now, but I would certainly reiterate everything that Shawn says. As you can see that we had just another great quarter in Q3 relative to revenue growth and employer adds and everything is still going in right direction, so we are still very bullish.

[Shawn Jenkins:]

Maybe I would add one more other thing that we did put in the script Shawn as we do think that there will be an improvement in the margin in the fourth quarter. We have a huge implementation this quarter, but we are confident and put into the notes that you can expect to see an improvement in the adjusted gross margin software margin in the next period and that is a good sign for all of us and shows that we are managing the business well.

[Sean Wieland:]

That's great. Thank you very much.

[Shawn Jenkins:]

Thanks.

[Operator:]

Your next question comes from the line of Adam Klauber with William Blair.

[Adam Klauber:]

Thanks. Good afternoon, a couple questions. Could you just give us an idea of how the revenue works with the part-time employers? I know when eHealth or GetInsured, they are paid on a commission basis if the part-time workers decide to get a subsidy policy. I guess, just an idea of how your revenue dynamics work in that situation?

[Shawn Jenkins:]

Yes. Great question. Currently it is subscription basis in most of our circumstances, so we have a subscription for the part-time employees and actually in particular in the private exchange market, where some of our customers who have deployed the Benefitfocus platform and they are using eHealth or GetInsured, they have a partnership with them. They are selling individual products through those platforms and we have integrated them. We have woven them into our extensibility capabilities so that the part-time person could see a product from there. In that case, the funding model that those two have worked out were outside the loop on that we get paid per employee per month. We do think there is opportunity for Benefitfocus going forward through our voluntary benefit offerings and also in particular in this case as we look at expanding our voluntary benefit program into more individual products even health products going forward. There is nothing in our near-term model that has a commission based on health products. As we expand and see new opportunity, particularly in the private exchange, we have more and more partners talking to us about that model, so we are evaluating that. We love the subscription-base and availability and predictability of it, but we think there is probably some upside to us in the future in that area.

[Adam Klauber:]

Great, that is helpful. I think you mentioned you won the contract to provide the private exchange to the California Blue.

[Milt Alpern:]

Yes.

[Adam Klauber:]

Is that they are individual, small, mid-group or large? Which exchange would that be?

[Milt Alpern:]

It is across the group segments, so they have multiple group segments and there will be rolling it out in stages, but it is across their group business and they also have a meaningful presence really in all market segments but there will be beginning with the group capabilities being enrolled out in 2015.

[Shawn Jenkins:]

Great customer, it is actually an existing customer on using our Benefitfocus enrollment and billing capability and is a move forward. That is a real theme that we see with a lot of our carriers, the deep integration we have, we can easily move them into the private exchange marketplace capability, lots of flexibility and they can bring new products to market, so super proud of that one.

[Adam Klauber:]

Okay. Staying with the carrier and the exchange topic, I would guess that within the carrier business your exchange and I am not going to ask you what it is, but your exchange revenue is probably a smaller component today. If we see the carriers grow their exchange business, does that mean that in the next couple years that could be a good growth area for you?

[Shawn Jenkins:]

Yes. Matter of fact I think the one we were just talking about is a good example, so we have an existing customer with the deep relationship using our eEnrollment, eBilling, eSales capabilities as we add private exchange. That is an additional incremental opportunity for Benefitfocus to provide more technology, more services to them and it is upside for us in the existing carrier base. Obviously it is helping us win new carriers as well, but with the existing base we think it is a real strong part of the story.

[Adam Klauber:]

Would you give us an idea? Within your existing base of 40-plus carriers, I mean, how many are you providing exchange related services to?

[Shawn Jenkins:]

We haven't put a number out on the number of exchanges. I do see, lots of companies talking about exchanges and some people have different words for them and stuff. It probably is something we will talk to in future calls, but we haven't published the number exchanges. Actually in some of our care, we would look at them as actually having multiple exchanges in side of care, so small employer exchange mid-market large market retiree, so in some cases we actually have more than one exchange whether we would consider that to be one exchange for one care four within one and how we would report that, we haven't broken that out yet. We do feel very good about the natural uptick of our carriers buying the Benefitfocus exchange and implementing it, because they can leverage the existing rating integrations, the date exchange integrations, the billing integrations, the years of work we have done together, they get the benefit [lift] of that.

[Adam Klauber:]

Great. Then, one on the employer business, would you say your growth in lives that you are dealing with eligibility enrollment is similar to the growth we are seeing in the overall growth in the amount of customers or is it greater or less?

[Shawn Jenkins:]

I think it is similar. The average deal size, I guess, would be another way to ask that is it has been consistent if anything trending up a little bit, but we are having a lot of success in the 1,000 to 5,000, 5,000 to 10,000 and obviously you see some jumbo names start to show up, so there has not been a big skew one way or the other certainly hasn't come down.

[Adam Klauber:]

Okay. Thanks a lot.

[Shawn Jenkins:]

Yes. Thank you.

[Operator:]

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

[Unidentified Analyst:]

Thanks, Shawn, It is (Inaudible) on line for Richard. Maybe just one on kind of implementation capacity, I mean, obviously we have had 120-plus large employers over the last two quarters. The channel is not up and running yet. I guess, what are you seeing in terms of wait times for implementation kind of relative to where you were at this time last year?

[Shawn Jenkins:]

Yes. Two years ago, we made significant investments in implementation, staff, management process and a lot of technology, so the way we leverage the Benefitfocus configuration technology, last we in 2013 we made additional investments in that area and we are really see a lot of the benefit of that. Now our staff has grown as you can see and the expenses commensurate with the number of implementations, but the average days to implement is similar maybe a little bit less than it was in years past.

[Unidentified Analyst:]

Okay. Got it. Thanks.

[Shawn Jenkins:]

Sure. Thank you.

[Operator:]

Your next question comes from the line of Brian Peterson with Raymond James.

[Brian Peterson:]

Yes. Just a question on some of the sales investments you have made over the last year or so. Could you talk about how productivity metrics have trended may be relative to your expectations and any improvement that we could see on productivity heading into 2015?

[Shawn Jenkins:]

Sure. Great question. Yes. At the beginning of the year we outlined three major investment themes for the company, having gone public a year ago we came into this year wanting to make sure to capitalize on the massive market opportunity and sales was one of those three. The other two were system integrator program and then significant product investment in private exchange, which all three of those are working well. I think what we learned in the last three or four years on sales, sales hiring, productivity, time to productive, quotas, quarter achievements has been consistent. I would say we are happy with our model and we continue to tune it like any good software as a service company would, but no real surprises there. We have added some really strong talent this year and you can see that obviously flowing through in the expense, but I would say we are on track with the hiring and also with the with the production of the team.

[Brian Peterson:]

Okay. Great. Thank you.

[Shawn Jenkins:]

Yes. Thank you.

[Operator:]

Thank you. I would now like to turn the call back over to Shawn and Milt.

[Shawn Jenkins:]

Great. Well, thanks everybody for joining. It is a super quarter. Again, I want to shout out to all the Benefitfocus associates. You guys are obviously very busy right now taking us through our largest open enrollment season ever and privileged to serve alongside you and be your associate, so I am super proud of you guys and all of our super customers as well. We think it is a real honor to serve you and we are having blast helping you transform your benefits and all of our stakeholders. Thanks for tuning in and developing the Benefitfocus story with us, so we appreciate it. Thanks, Milt, for joining me on the call. Thanks, operator. Everybody have a great night.

[Milt Alpern:]

Thanks, everyone.

[Operator:]

Thank you. This does concludes today's conference call. You may now disconnect.